Subscribe to the Bombay Chartered Accountant Journal Subscribe Now!

Year: 2020

Cash credits (Bogus purchases) – Section 68 of ITA, 1961 – Assessee had declared certain purchases to be made during year and A.O. added entire quantum of purchases to income of assessee on plea that purchases were bogus purchases – Tribunal held that only reasonable profit at rate of 5% on purchases should be added back to income of assessee – Tribunal was justified in its view; A.Y.: 2010-11

21. Principal CIT vs. Rishabhdev Technocable Ltd. [2020] 115 taxmann.com 333 (Bom.) Date of order: 10th February, 2020 A.Y.: 2010-11

 

Cash credits (Bogus purchases) – Section 68 of ITA, 1961 – Assessee had
declared certain purchases to be made during year and A.O. added entire quantum
of purchases to income of assessee on plea that purchases were bogus purchases
– Tribunal held that only reasonable profit at rate of 5% on purchases should
be added back to income of assessee – Tribunal was justified in its view; A.Y.:
2010-11

 

The assessee is a company engaged in the business of manufacturing and
dealership of all kinds of industrial power controlling instrument cables and
related items. For the A.Y. 2010-11, the assessee filed return of income
declaring income of Rs. 1,35,31,757. The A.O. noticed that the Sales Tax
Department, Government of Maharashtra, had provided a list of persons who had
indulged in the unscrupulous act of providing bogus hawala entries and
purchase bills. The names of beneficiaries were also provided. The A.O. also
noticed that the assessee was one of the beneficiaries of such bogus hawala
bills. He referred to the purchases allegedly made by the assessee through four
hawala entries for the assessment year under consideration. He
disallowed the entire expenditure shown as incurred by the assessee on
purchases and made the addition.

 

The CIT(A) enhanced the quantum of such purchases from Rs. 24,18,06,385
to Rs. 65,65,30,470. The CIT(A) held that there can be no sales without
purchases. When the sales were accepted, then the corresponding purchases could
not be disallowed. Therefore, the CIT(A) held that only the profit element
embedded in the purchases would be subject to tax and not the entire purchase
amount. The CIT(A) added 2% of the purchase amount of Rs. 65,65,30,470 as
profit which worked out to Rs. 1,31,30,609 to the income of the assessee and
the balance addition was deleted. On appeal by the Revenue, the Tribunal
increased the profit element from 2% to 5% and increased the addition
accordingly.

 

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

 

‘i)     In Bholanath Polyfab
(P.) Ltd. (Supra), the Gujarat High Court was also confronted with a
similar issue. In that case the Tribunal was of the opinion that the purchases
might have been made from bogus parties but the purchases themselves were not
bogus. Considering the facts of the situation, the Tribunal was of the opinion
that not the entire amount of purchases but the profit margin embedded in such
amount would be subjected to tax. The Gujarat High Court upheld the finding of
the Tribunal. It was held that whether the purchases were bogus or whether the
parties from whom such purchases were allegedly made were bogus, was
essentially a question of fact. When the Tribunal had concluded that the
assessee did make the purchase, as a natural corollary not the entire amount
covered by such purchase but the profit element embedded therein would be
subject to tax.

 

ii)     We are in respectful
agreement with the view expressed by the Gujarat High Court.

 

iii)    Thus, we do not find any
merit in this appeal. No substantial question of law arises from the order
passed by the Tribunal. Consequently, the appeal is dismissed.’

Business expenditure – Allowability of (prior period expenses) – Section 37 of ITA, 1961 – Assessee had prior period income and prior period expenses – Assessee set off the two and offered only net amount of expenses for disallowance – A.O. disallowed the claim – Tribunal allowed the claim – No substantial question of law arose from Tribunal’s order; A.Y.: 2004-05

20. Principal CIT vs. Mazagon Dock Ltd. [2020] 116 taxmann.com 325 (Bom.) Date of order: 20th August, 2019 A.Y.: 2004-05

 

Business expenditure – Allowability of (prior period expenses) – Section
37 of ITA, 1961 – Assessee had prior period income and prior period expenses –
Assessee set off the two and offered only net amount of expenses for
disallowance – A.O. disallowed the claim – Tribunal allowed the claim – No
substantial question of law arose from Tribunal’s order; A.Y.: 2004-05

 

The assessee had prior period income and prior period expenses. The
assessee had set off the two and offered only the net amount of expenses for
disallowance. The A.O. did not accept the method of setting off of prior period
income with prior period expenses as claimed by the assessee and disallowed the
expenditure.

 

The Tribunal held that the assessee was justified in computing the
disallowance after setting off prior period income against the prior period
expenses. In fact, the Tribunal noted the fact that for the A.Y. 2007-08, the
Revenue had accepted the net income offered after set-off of prior period
income with prior period expenses. This is in that year where expenses of prior
period were less than prior period income. The Tribunal allowed the assessee’s
claim.

 

On appeal by the Revenue, the following question of law was raised:

 

‘Whether on the facts and in the circumstances of the case and in law,
the Tribunal is correct in allowing the setting off of the prior period income
against the prior period expenditure without ascertaining the nexus between
income and expenditure?’

 

The Bombay High Court upheld the decision of the Tribunal and held as
under:

 

‘i)    We find that the view taken
by the Tribunal on the facts cannot be found fault with. This particularly as
the Revenue for a subsequent period accepted this practice of set-off, which
resulted in income and subjected it to tax. The basis / principles for allowing
the set-off of prior period income with prior period expenses has to be consistent
for years. Therefore, the view taken by the Tribunal cannot be faulted.

 

ii)    In view of the above, the
question as framed does not give rise to any substantial question of law. Thus,
not entertained.’

 

Business expenditure – Section 37 of ITA, 1961 – General principles – Difference between ascertained and contingent liability – Public sector undertaking – Provision for revision of pay by government committee – Liability not contingent – Provision deductible u/s 37 Income – Accrual of income – Principle of real income – Public sector undertaking – Amounts due as fees – Amounts included in accounts in accordance with directions of Comptroller and Auditor-General – Amounts had not accrued – Not assessable; A.Y.: 2007-08

19. Housing and Urban Development Corporation Ltd. vs.
Additional CIT [2020] 421 ITR 599 (Del. [2020] 115 taxmann.com 166 (Del.) Date of order: 6th February, 2020 A.Y.: 2007-08

 

Business expenditure – Section 37 of ITA, 1961 – General principles –
Difference between ascertained and contingent liability – Public sector
undertaking – Provision for revision of pay by government committee – Liability
not contingent – Provision deductible u/s 37

 

Income – Accrual of income – Principle of real income – Public sector
undertaking – Amounts due as fees – Amounts included in accounts in accordance
with directions of Comptroller and Auditor-General – Amounts had not accrued –
Not assessable; A.Y.: 2007-08

 

The assessee was a public sector undertaking. For the A.Y. 2007-08, it
claimed deduction of Rs. 1.60 crores on account of the provision for revision
of pay in its books of accounts. The deduction was made in the light of the Pay
Revision Committee appointed by the Government of India. The A.O. disallowed
the claim, holding that the expenditure was purely a provision against an
unascertained liability and could not be claimed as expenditure for the A.Y.
2007-08. The disallowance was upheld by the Tribunal.

 

The assessee was following the accrual or mercantile system of
accounting and was accounting the ‘fees’ as its revenue from the date of
signing of the loan agreement. The amount was finally realised from the loan
amount, when it was actually disbursed to the borrower. There were instances
when the loan agreement was signed and the borrower would not take the
disbursement and, accordingly, fees would not be realised. The Comptroller and
Auditor-General (CAG) objected to this on the ground that the accounting
treatment was not in accordance with the Accounting Standards issued by the
Institute of Chartered Accountants of India which provide guidance for
determination of income on accrual basis. The assessee assured the CAG that the
accounting policy was reviewed for the F.Y. 2006-07 and, accordingly, the Board
had approved the change in accounting policy in its meeting held on 27th
September, 2007. The revised accounting policy recognised the fees as on the
date of their realisation, instead of the date of signing of the loan
agreement. For the A.Y. 2007-08, the A.O. made an addition of Rs. 1.28 crores
on the ground that the change had resulted in understatement of profits and
also because the change was introduced after the closing of the financial year.
The addition was upheld by the Tribunal.

 

The Delhi High Court allowed the assessee’s appeal and held as under:

 

‘(i)   The position was that the
liability to pay revised wages had already arisen with certainty. The committee
was constituted for the purpose of wage revision. That the wages would be
revised was a foregone conclusion. Merely because the making of the report and
implementation thereof took time, it could not be said that there was no basis
for making the provision. The expenditure of Rs. 1.60 crores on account of
anticipated pay revision in the A.Y. 2007-08 was deductible.

 

(ii)   No income accrued at the
point of execution of agreement. The change in the accounting policy was a
result of the audit objection raised by the CAG. The assessee had claimed
deduction in profits in the computation of the total income and added it as
income in the subsequent assessment year, which had been accepted by the A.O.
The change was, thus, revenue-neutral. The addition of Rs. 1,28,00,000 was not
justified.’

Section 92A(2)(c) of the Act – Loan given by each enterprise should be considered independently and an enterprise can be deemed to be an AE only if loan given by it exceeds 51% of book value of total assets – Business advances cannot be construed as loan to determine AE

10. Soveresign Safeship Management Pvt. Ltd. vs.
ITO ITA No. 2070/Mum/2016 A.Y.: 2011-12 Date of order: 5th March, 2020

 

Section 92A(2)(c) of the Act – Loan given
by each enterprise should be considered independently and an enterprise can be
deemed to be an AE only if loan given by it exceeds 51% of book value of total
assets – Business advances cannot be construed as loan to determine AE

 

FACTS

The assessee was
engaged in providing ship management and consultancy services. In Form 3CEB it
had considered two group companies as AEs (Associated Enterprises) and reported
international transactions by way of advances received in the course of
business from these entities. The assessee was providing ship management and
consultancy services to one of the entities from which it had received business
advances.

 

Before the TPO, the
assessee contended that though the said entities were not AEs, it had
inadvertently disclosed them in Form 3CEB as AEs. The TPO deemed the two group
entities as AEs u/s 92A(2)(m) on the basis that there was a relationship of
mutual interest between the taxpayer and the two group entities.

 

The DRP observed
that business advances received were separately reported and included within
‘sundry creditors’. The assessee had not rendered any service to the entities
for which it had received advances. Hence, advances received by the assessee
from the said entities were to be treated as loans taken from the AEs. The DRP
further observed that since the aggregate loans taken from the two entities
exceeded 51% of the book value of the total assets of the assessee, u/s
92A(2)(c) of the Act they were AEs of the assessee.

 

Being aggrieved,
the assessee appealed before the Tribunal.

 

HELD

(A) In terms of section 92A(2)(c),
an enterprise will be deemed to be an AE if ‘loan advanced by one enterprise
to the other enterprise constitutes not less than fifty-one per cent of the
book value of the total assets of the other enterprise’. As the language of
the section is unambiguous, only lending enterprises which had advanced loan
exceeding 51% of the book value of the total assets could be deemed as AEs.

 

(B) Advances received by the assessee from one of
the entities were towards ship management and consultancy services rendered by
it to the said entity. Business advances cannot be construed as loans.
Accordingly, such advances should be excluded while determining AE
relationship.

 

(C)       The tax authority could not rely merely on
self-disclosure of AEs by the assessee in Form 3CEB when the facts in the
financial statements of the assessee were clear and the language of the statute
was unambiguous.

 

 

 

 

Article 12 of India-Korea DTAA, section 9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of candidates as per job description, were not in the nature of FTS u/s 9(1)(vii) of the Act

9. TS-141-TAT-2020 (Ind) D&H Secheron Electrodes Pvt. Ltd. vs.
ITO ITA No. 104/Ind/2018 A.Y.: 2016-17 Date of order: 6th March, 2020

 

Article 12 of India-Korea DTAA, section
9(1)(vii) of the Act – Fees paid to foreign company for providing shortlist of
candidates as per job description, were not in the nature of FTS u/s 9(1)(vii)
of the Act

 

FACTS

The assessee was
engaged in the business of manufacture of welding electrodes and was looking
for engineers for development of certain products. Hence, it entered into an
agreement with a Korean company (‘Kor Co’) for providing a list of engineers
matching the job description provided by it. On the basis of the list provided,
the assessee interviewed the candidates and recruited them if found suitable.
For its service, the assessee made payments to Kor Co without withholding tax.

 

According to the A.O., since the said services were technical in nature,
the assessee was liable to withhold tax. Therefore, the A.O. treated the
assessee as ‘assessee in default’ and initiated proceedings u/s 201 and u/s
201(1A) of the Act. The CIT(A) upheld the view of the
A.O.

 

Being aggrieved,
the assessee filed an appeal before the Tribunal.

 

HELD

(1) In the contract between the
assessee and Kor Co, the assessee had not sought any technical expertise from
the latter.

(2) The process involved in the services provided
by Kor Co was as follows:

(a) Assessee provided detailed job description to
Kor Co;

(b) After matching the job description with the
profile of candidates available in its database, Kor Co shortlisted candidates
for the assessee and had merely provided the list of such candidates to the
assessee;

(c) Kor Co had guaranteed that if the appointed
candidate were to voluntarily leave the job within the first 90 days of
employment, Kor Co would provide suitable replacement at no cost to the
assessee.

(3) The assessee had evaluated the
shortlisted candidates on its own by interviewing them and taking tests. The
decision whether the relevant candidates were suitable as per its requirements
was solely that of the assessee and Kor Co had not provided any inputs for the
same.

(4) Having regard to the nature of
the services provided by Kor Co, the payments made by the assessee to Kor Co
were not in the nature of ‘fees for technical services’ as defined in
Explanation 2 to section 9(1)(vii). Accordingly, the assessee was not required
to withhold tax from such payments.

 

Note: Apparently, though the assessee had also
referred to Article 12 of the India-Korea DTAA, the Tribunal concluded only in
the context of section 9(1)(vii) of the Act.

Section 9(1)(vi) and section 194J of the Act – Payments made to telecom operators for providing toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and, consequently, tax was required to be withheld

8. [2020] 116
taxmann.com 250 (Bang.)(Trib.) Vidal Health
Insurance TPA (P) Ltd. vs. JCIT ITA Nos. 736 &
1213 to 1215 (Bang.) of 2018 A.Ys.: 2011-12 to
2014-15 Date of order: 26th
February, 2020

 

Section 9(1)(vi)
and section 194J of the Act – Payments made to telecom operators for providing
toll-free number service were in nature of ‘royalty’ u/s 9(1)(vi) and,
consequently, tax was required to be withheld

 

FACTS

The assessee was
licensed by IRDA for providing TPA services to insurance companies. It engaged
telecom operators (‘telcos’) for allotting toll-free numbers and providing
toll-free telephone services to policy-holders of insurance companies such that
the charges for calls made by policy-holders to the toll-free number were borne
by the assessee and not the policy-holders. The assessee did not deduct tax
from the payments made to the telcos.

 

According to the
A.O., the payments were in the nature of royalty u/s 9(1)(vi) of the Act, read
with Explanation 6 thereto. Accordingly, he disallowed the payments u/s
40(a)(ia) of the Act.

 

The CIT(A) held
that since the payments were made by the assessee for voice / data services,
they were in the nature of royalty.

 

Being aggrieved,
the assessee appealed before the Tribunal. The assessee’s principal argument
was that section 194J deals with deduction of tax from payment of ‘royalty’. As
per Explanation (ba) in section 194J, the meaning of ‘royalty’ should be
construed as per Explanation 2 to section 9(1)(vi) of the Act. Explanation 6 to
section 9(1)(vi) of the Act defines ‘process’. Since section 194J has nowhere
referred to Explanation 6 to section 9(1)(vi) of the Act, it could not be
considered.

 

HELD

Royalty
characterisation

(i)   A toll-free number involves providing
dedicated private circuit lines to the assessee.

 

(ii) The consideration paid by the assessee was
towards provision of bandwidth / telecommunication services and further, for
‘the use of’ or ‘right to use equipment’. The assessee was provided assured
bandwidth through which it was guaranteed transmission of data and voice. Such
transmission involved ‘process’, thus satisfying the definition of ‘royalty’ in
Explanation 2 to section 9(1)(vi) of the Act.

 

Royalty definition
u/s 194J

(a) Explanation 6 to section 9(1)(vi) defines the
expression ‘process’, which is included in the definition of ‘royalty’ in
Explanation 2.

 

(b) Since Explanation 2 does not define ‘process’,
the definition of ‘process’ in Explanation 6 must be read into Explanation 2 to
analyse whether a particular service comprised ‘process’ and consequently
consideration paid for the same was ‘royalty’.

 

Section 54 – Deduction in full is available to the assessee even when the new house property is purchased in the joint names of the assessee and others

6. 
Subbalakshmi Kurada vs. ACIT (Bangalore) N.V. Vasudevan (V.P.) and B.R. Baskaran
(A.M.) ITA No. 2493/Bang/2019 A.Y.: 2016-17 Date of order: 8th May, 2020 Counsel for Assessee / Revenue: V.
Srinivasan / Rajendra Chandekar

 

Section 54 –
Deduction in full is available to the assessee even when the new house property
is purchased in the joint names of the assessee and others

 

FACTS

The assessee had
sold a residential house property for a sum of Rs. 12.75 crores on 6th
November, 2015. She purchased another residential house property on 17th
February, 2016 for Rs. 11.02 crores.

 

The new house
property was purchased in the joint name of the assessee and her son. The
assessee claimed deduction of Rs. 8.47 crores u/s 54. Since the new residential
house property was purchased in the name of the assessee and her son, the A.O.
restricted the deduction u/s 54 to 50%, i.e., he allowed deduction to the extent
of Rs. 4.23 crores only. The CIT(A) also confirmed the same.

 

Before the
Tribunal, the Revenue supported the order passed by the CIT(A).

 

HELD

The Tribunal
observed that the entire consideration towards the purchase of the new
residential house had flown from the bank account of the assessee. It also
noted that the Karnataka High Court in the case of DIT (Intl.) vs. Mrs.
Jennifer Bhide (15 taxmann.com 82) had held that deduction u/s 54
should not be denied merely because the name of the assessee’s husband was
mentioned in the purchase document, when the entire purchase consideration had
flown from the assessee. Therefore, following the ratio laid down in the
said decision and the decision of the co-ordinate Bench in the case of Shri
Bhatkal Ramarao Prakash vs. ITO (ITA No. 2692/Bang/2018 dated 4th
January, 2019), the Tribunal held that the assessee was entitled to
full deduction of Rs. 8.47 crores u/s 54.

 

Sections 10(37) and 56(2)(viii) – Interest received u/s 28 of the Land Acquisition Act, 1894 treated as enhanced consideration not liable to tax

5.  Surender vs. Income-tax Officer (New Delhi) Sushma Chowla
(V.P.) and Dr. B.R.R. Kumar (A.M.) ITA No.
7589/Del/2018 A.Y.:
2013-14 Date of
order: 27th April, 2020 Counsel
for Assessee / Revenue: Sudhir Yadav / N.K. Choudhary

 

Sections 10(37) and 56(2)(viii) – Interest
received u/s 28 of the Land Acquisition Act, 1894 treated as enhanced
consideration not liable to tax

 

FACTS

The agricultural
land of the assessee was acquired by Haryana State Industrial and
Infrastructure Development Corporation Ltd. (‘HSIIDC’) u/s 4 of the Land
Acquisition Act, 1894 (‘the Acquisition Act’). The HSIIDC had not paid the
compensation at the prevailing market rate, therefore the assessee filed an
appeal before the High Court for increase in compensation. The Court enhanced
the compensation which included Rs. 1.84 crores in interest u/s 28 of the
Acquisition Act. The assessee claimed that the amount so received was enhanced
consideration, hence exempt u/s 10(37). However, according to the A.O. as well
as the CIT(A), the amount so received could not partake the character of
compensation for acquisition of agricultural land. Hence, both held that the
sum so received was interest taxable u/s 56(2)(viii).

The question before
the Tribunal was whether the amount received can be treated as enhanced
consideration u/s 28 of the Acquisition Act and hence exempt u/s 10(37) as
claimed by the assessee, or u/s 34 of the Acquisition Act and hence taxable u/s
56(2)(viii) as held by the CIT(A).

 

HELD

The Tribunal
referred to the decision of the Supreme Court in Commissioner of
Income-tax, Faridabad vs. Ghanshyam (HUF) (Civil Appeal No. 4401 of 2009
decided on 16th July, 2009). As per that decision, section
28 of the Acquisition Act empowers the Court in its discretion to award
interest on the excess amount of compensation over and above what is awarded by
the Collector. It depends upon the claim by the assessee, unlike interest u/s
34 which depends upon and is to be paid for undue delay in making the award /
payment. The Apex Court in the said decision further observed that interest
awarded could either be in the nature of an accretion in the value of the lands
acquired, or interest for undue delay in payment. According to the Court,
interest u/s 28 of the Acquisition Act is an accretion to the value of the land
and thus it forms part of the enhanced compensation or consideration. On the
other hand, interest awarded u/s 34 of the Acquisition Act is interest paid for
a delay in payment of compensation.

 

Therefore, relying
on the decision of the Apex Court referred to above, the Tribunal held that
since the compensation payable to the assessee was increased u/s 28 of the
Acquisition Act as per the order of the High Court, the amount received by the
assessee was exempt u/s 10(37).

 

Section 194C r/w/s 40(a)(ia) – Even an oral contract is good enough to invoke section 194C – Payment of hire charges made by assessee to cab owners for hiring cabs for the purpose of providing transportation services to its customers would attract section 194C – Since payment is made by the assessee, the presumption would be that there was a contract for hiring of vehicles

12.
[2020] 116 taxmann.com 230 (Bang.) Singonahalli
Chikkarevanna Gangadharaiah vs. ACIT ITA No.
785/Bang/2018 A.Y.: 2014-15 Date of
order: 24th February, 2018

 

Section 194C r/w/s 40(a)(ia) – Even an oral
contract is good enough to invoke section 194C – Payment of hire charges made
by assessee to cab owners for hiring cabs for the purpose of providing
transportation services to its customers would attract section 194C – Since
payment is made by the assessee, the presumption would be that there was a
contract for hiring of vehicles

 

FACTS

The A.O. noticed
from the Profit & Loss account of the assessee that the assessee has debited
a sum of Rs. 6,18,73,785 for vehicle hire charges paid and Rs. 2,48,39,356 for
petrol and diesel expenses paid. The assessee was asked to produce details of
TDS on expenses. However, the assessee failed to do so.

 

Subsequently, the
assessee submitted the PAN cards from cab drivers and owners to whom hire
charges were paid and said that the cab drivers and owners were all regular
income tax payers and hence, as per section 194C, no TDS was made where PAN was
provided.

 

According to the
A.O., section 194C will only apply to a contractor engaged in the  business of plying, hiring or leasing goods
carriages – and not to a contractor engaged in the business of plying passenger
vehicles. Accordingly, the A.O. held that the assessee is liable to deduct
TDS and disallowed a sum of Rs. 6,18,73,785 for vehicle hire charges u/s
40(a)(ia) of the Act.

 

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

 

HELD

Upon going through
the provisions of section 194C, the Tribunal held that there is no doubt that
the assessee in this case has made the payments of hire charges to cab owners.
As regards the contention of the assessee that the payments have not been made
in pursuance of any contract, the Tribunal held that a contract need not be in
writing; even an oral contract is good enough to invoke the provisions of
section 194C. The cab owners have received the payments from the assessee
towards the hiring charges, therefore, the presumption normally would be that
there was a contract for hiring of vehicles. Hence, if the assessee has made
the payment for hiring the vehicles, the provisions of section 194C are clearly
applicable.

 

The contract has to
be looked into party-wise, not on the basis of the individual. The Tribunal
held that all the payments made to a cab owner throughout the year are to be
aggregated to ascertain the applicability of the TDS provision as all the
payments pertain to a contract. A contract need not be in writing. It may infer
from the conduct of the parties. It may even be oral. The Tribunal also noted
that u/s 194C, sub-section (5) proviso thereto, if the aggregate amount
paid or credited to a person  exceeds Rs.
75,000, then the assessee shall be liable to deduct income tax at source.

 

The Tribunal then
discussed the amendment brought in by the Finance (No. 2) Act, 2014 with effect
from 1st April, 2015 by virtue of which only 30% of any sum payable
to a resident is to be disallowed. It noted that in the present case the
authorities below have added the entire sum of Rs. 6,18,73,785 by disallowing
the whole amount. Though the substitution in section 40 has been made effective
from 1st April, 2015, in its view the benefit of the amendment
should be given to the assessee either by directing the A.O. to confirm from
the cab owners as to whether the said parties have deposited the tax or not,
and further restrict the addition to 30% of the disallowance. The Tribunal held
that it will be tied (sic) and meet the ends of justice if the
disallowance is only restricted to 30% of the amount liable for TDS u/s 194C.
Accordingly, this issue is partly allowed.

 

Following the decision of the Calcutta High Court in IT Appeal No.
302 of 2011, GA 3200/2011, CIT vs. Virgin Creations decided on 23rd
November, 2011, the Tribunal restored the issue to the file of the A.O.
with the direction that the assessee shall provide all the details to the A.O.
with regard to the recipients of the income and the taxes paid by them. The
A.O. shall carry out necessary verification in respect of the payments made to
the cab drivers and taxes paid on the same by the cab drivers and filing of
returns by the recipients. In case the A.O. finds that the recipient has duly
paid the taxes on the income, the addition made by the A.O. shall stand
deleted.

 

The appeal filed by
the assessee was partly allowed.

Section 54F – Even after amendment w.e.f. A.Y. 2015-16, investment of long-term capital gain in two bungalows located adjacent to each other and used as one residential unit qualifies for exemption u/s 54F – Benefit of exemption could not have been denied on reasoning that there were two different registries of buildings / properties as both properties purchased by assessee were a single property located in same geographical area

7. [2020] 114 taxmann.com 508 (Ahd.)(Trib.)

Mohammadanif Sultanali Pradhan vs. DCIT

ITA No. 1797/Ahd/2018

A.Y.: 2015-16

Date of order: 6th January, 2020

 

Section 54F – Even after amendment w.e.f. A.Y. 2015-16,
investment of long-term capital gain in two bungalows located adjacent to each
other and used as one residential unit qualifies for exemption u/s 54F –
Benefit of exemption could not have been denied on reasoning that there were
two different registries of buildings / properties as both properties purchased
by assessee were a single property located in same geographical area

 

FACTS

During the previous year relevant to the A.Y. 2015-16, the
assessee in his return of income declared income under the head capital gain at
Rs. 23,84,101 after claiming exemption u/s 54F for Rs. 1,08,00,000. In support
of the exemption claimed, the assessee contended that he has made investment in
two bungalows which are adjacent to each other, bearing Nos. 18 and 19 located
at survey No. 606/2, TPS No. 92, Sarkhej – Makarba – Okaf – Fatewadi of Mouje
Sarkhej, taluka Vejalpur, district Ahmedabad.

 

The A.O. was of the view that the assessee can claim
exemption u/s 54F with respect to the investment in one bungalow only.
Accordingly, he computed the exemption with respect to one bungalow only
amounting to Rs. 43,77,118 and thus disallowed the excess claim u/s 54F of Rs.
64,22,882.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) and
submitted that both the bungalows are in the same society, adjacent to each
other. As such both the bungalows are one unit for residential purposes.
Therefore, he claimed that he is entitled to deduction / exemption for both the
bungalows u/s 54F.

 

The CIT(A) rejected the claim of the assessee on the ground
that there is an amendment under the provisions of section 54F of the Act where
the expression previously used, ‘a residential house’, has been substituted
with ‘one residential house’. Such amendment is effective with effect from A.Y.
2015-16, i.e., the year under consideration.

 

Aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that:

(i) the
issue relates to whether the assessee is eligible for exemption u/s 54F of the
Act against the long-term capital gain for the investment made in the two
properties which are adjacent to each other and used as one residential unit.
It noted that indeed, the provision of the law requires that the exemption will
be available to the assessee u/s 54F for the investment in one residential
unit;

 

(ii) under
the provisions of section 54F, there is no definition / clarification provided
about the area of the residential property. It means that one assessee can buy
a huge bungalow / property of, say, one thousand square metres and can claim
the deduction subject to conditions. Similarly, another assessee acquired two
different residential properties adjacent to each other but both the properties
put together were only two hundred square metres – but he will be extended the
benefit of the exemption with respect to one unit only because there are two
different properties based on registry documents;

 

(iii) there can be a situation that the family of the assessee is quite
large, comprising of several members, and therefore he needs two properties
adjacent to each other to accommodate them. So from the point of view of the
assessee it is a single property but he got two different properties registered
as per the requirement of the builder;

 

(iv) the
assessee cannot be deprived of the benefit conferred under the statute merely
on the reasoning that there were two different registries of the buildings /
properties;

 

(v) it
is also not a case of the Revenue / assessee that both the properties purchased
by the assessee were located in different geographical areas. In such a
situation the law amended u/s 54F appears to be applicable where the assessee
buys two properties in two different areas;

 

(vi) the
principles laid down by the courts cannot be just brushed aside on the aspect
of defining one residential unit. It noted the observations of the Hon’ble High
Court of Karnataka in the case of CIT vs. D. Ananda Basappa [(2009) 309
ITR 329].

 

The Tribunal held that the assessee
is entitled to claim exemption u/s 54F in respect of investment made in two
adjacent bungalows used as one residential unit. The Tribunal deleted the
addition made by the A.O. and confirmed by the CIT(A).

 

This ground of appeal filed by the assessee was
allowed.

GOVERNANCE & INTERNAL CONTROLS: THE TOUCHSTONE OF SUSTAINABLE BUSINESS – PART I

‘Barings Bank
collapsed by rogue trader’, screamed media headlines in February, 1995,
shocking the world. Is this even possible? How can one person bring down a
two-century-old reputed bank and a banker to the Queen of England? But it did
happen. And not isolated, though – closer home, the country opened 2009 reading
the confession of the Satyam Chairman, Mr. Ramalinga Raju, saying ‘It was like
riding a tiger, not knowing how to get off without being eaten’. Mr Raju
admitted to inflating profits with fictitious positions in the balance sheet,
including inflated (non-existent) cash and bank balances, overstated debtors,
understated liabilities and accrued interest which was non-existent1.
He confessed to manipulating the books for several years which attained
unmanageable proportions to the tune of Rs. 14,162 crores through these devious
methods. Ironically, Satyam had just received the Golden Peacock Global Award
for Excellence in Corporate Governance in September, 2008! But this was revoked
soon after Mr. Raju’s confession.

 

Quite a few major
debacles have followed since – Enron, Tyco, Lehman Brothers, Kingfisher,
Café  Coffee Day, PMC Bank… Regrettably,
we are witnessing this not just in business ventures, but scams, or at least
alleged ones, are also surfacing in diverse spheres such as government spends,
sports arena and so on. That we live in a VUCA world dogged with volatility,
uncertainty, complexity and ambiguity only compounds the
issue.

 

Why do these occur?
Many factors could propel such events or behaviour including arrogance, power (nasha)
and greed. But what I would like to share here is my learning on two
fundamental drivers to a sustainable business – Governance and Internal
Controls. Broadly speaking, the former is all about ethos, culture, mind-set
and a way of life embedded in individuals, leaders and enterprises. Internal
Controls encompass the practices, processes and procedures which serve to
auto-generate and instil self-correcting operating mechanisms, thereby
functioning as a secure preventive measure. While effective internal controls
are integral to running operations, good governance is the edifice on which
great organisations are built. Leaders, therefore, while ensuring adequate
controls need to exhibit personal integrity and uphold high governance
standards to establish a sustainable business.

In recent times, a
lot has been written on these subjects and regulatory frameworks and awareness
levels have improved considerably. Yet, we witness cases of deceit cropping up
in numbers and magnitude which are discomforting. And at the core seems to be
intent and character. Given the ingenuity of the human race, if there is
a chosen intent to defraud, person/s acting unilaterally and / or in collusion will
find a way to do it. This ends up in a curative process and the learning from
each episode then gets calibrated in the system for improvements.
Investigations post the Barings Bank debacle revealed that a trader, Mr.
Nicholas Leeson’s greed and inadequate operational risk controls at Barings
made the bank collapse under a $1.4 billion debt. In Satyam’s case, Mr. Raju
wanted to divert funds to real estate which eventually fell through. It was, inter
alia, found that the cash and bank verification procedures were lacking. It
is customary now for auditors to seek balance certification from banks. The
Companies Act, 20132 has made corporate fraud a criminal offence and
lays out the responsibilities on fraud reporting. The Act also provides for a
rigorous framework for related party transactions. A Serious Fraud
Investigation Office (SFIO) which was set up under the Act has a statutory
status and now has the power to arrest as well. The SFIO has been actively
investigating cases relating to corporate fraud. The Securities and Exchange
Board of India published detailed disclosure requirements in 2015, applicable
to all listed companies3. This sets out stringent guidelines relating
to reporting / disclosure of material events and actual and suspected fraud.
The Institute of Chartered Accountants of India4 came out with a
Guidance Note on Reporting on Fraud.

HOW
IT PLAYS OUT: ENRON, A CLASSIC CASE

Enron was a company
headquartered in Houston, Texas which was dealing in commodities, energy and
services and ranked as America’s fifth largest company. In 2001, the company
filed for bankruptcy leading to shareholders losing $74 billion, thousands of
employees and investors losing their retirement accounts and many employees
losing their jobs. The CEO, Mr. Jeffrey Skilling, and the former CEO, Mr,
Kenneth Lay, kept huge debts off balance sheets. An internal whistle-blower, Ms
Sherron Watkins, helped to bring them to book as high stock prices stoked
external suspicions. How unfortunate! This company was named by Fortune
Magazine as ‘America’s Most Innovative Company’ six years in a row prior to
the scandal and lost its sheen overnight. A Committee entrusted to examine the
role of the auditors, Arthur Andersen, assessed that the firm did not fulfil
its professional responsibilities in connection with its audits of Enron’s
financial statements. Moreover, in 2002, Andersen was convicted of obstruction
of justice for shredding documents related to its audit of Enron. The Supreme
Court in 2005, however, reversed Andersen’s conviction but serious damage had
been done which practically wrecked the firm. Consequent to this scandal, new
regulations were designed to strengthen the accuracy of financial reporting for
publicly-traded companies, the most important being the Sarbanes-Oxley Act
(2002) which imposed criminal penalties for destruction, falsification or
fabricating financial records.

 

Having good
governance as the DNA complemented by sound internal controls are, hence, the
hallmarks of world-class enterprises. Let us examine each of them. This is
covered in two parts – Part I: Governance, and Part II: Internal Controls.

 

GOVERNANCE

Governance or
Corporate Governance comprises the suite of principles and processes by which
an enterprise is controlled, directed or governed in a manner balancing the
interests of the stakeholders, creating long-term sustainable value.
Stakeholders include customers, investors, workforce, suppliers, funders, the
government and the society at large. It is based on policies such as commitment
to conducting business with all integrity and fairness, being transparent by making
all the necessary disclosures and decisions, complying with the laws of the
land and discharging responsibility towards all the stakeholders.

 

Corporate Governance provides the structure for a company to achieve its
aspirations and hence encompasses every aspect of management, from operations
and internal controls to performance measurement and corporate disclosure. Most
companies strive to establish a high standard of Corporate Governance. For many
investors, it is not enough for a company to be just profitable; it also needs
to demonstrate good corporate citizenship through ethical behaviour, respect
for the environment and sound Corporate Governance practices. It is about
balancing individual and social purpose, as well as economic and sustainability
goals.

 

Clearly, there is a
level of confidence that is attached to a company practising good Corporate
Governance. Foreign investors accord weightage to this aspect, too. It is not
surprising, therefore, that the markets have demonstrated a positive approach
towards companies reputed for upholding good governance standards.

 

INSTILL
GOVERNANCE

Some people
consider that governance is an innate quality – you either have it or you
don’t! While this is true in some ways, great corporations also have a systematic
way of nurturing and reinforcing good Corporate Governance. Here, I draw upon
my experience associated over decades with the Unilever and Tata Groups to
highlight some codified best-in-class practices – Unilever Code of Business
Principles (CoBP5) and Tata Code of Conduct (TCoC6).

 

Both CoBP and TCoC
bring out clearly the way these world-class enterprises conduct their
businesses as well as expect their business collaborators to respect and behave
in dealings with their companies. It is expressly communicated that violations
to the Code are unacceptable. They go a step further to clarify that no grudge
will be held against any employee who may even give up a business benefit for
the sake of upholding the Code and not compromising it.

 

Instilling this culture
is a continuous process and also requires review and updation to reflect the
changing environment. Some of the building blocks to make this a living
document are:

 

(i)            
The Code Document: Publishing a written Code is an important step which helps as a good
reference point for all the enterprise stakeholders to guide their behaviour.
CoBP which was launched in 1995 now has 14 clauses in the Code supported by 24
policies. TCoC was first formalised in 1998 and the amended version of 2015
comprises detailed guidelines for all stakeholders. These Codes address varied
aspects from ethics to compliance to diversity to environment.

 

(ii)  Putting
to Work: A practice manual is quite useful wherein
live situations are enumerated explaining how one applies the Code in
day-to-day working, including Musts / Must nots and Q&A. Case
studies are shared. A fascinating format used is through performing skits.
These skits are done innovatively in town hall meetings or annual family day
functions through short engaging stories which convey the essence of the Code.
An impactful variation is the use of contests with several groups competing for
prizes with creative skits bringing out the ethos through interesting
sequences.

 

(iii)  Monitoring and Review: These entities have robust mechanisms to ensure that the Code is
communicated, explained and implemented. Apart from imparting training, some
simple steps such as a written annual confirmation from every employee, an
appropriate clause in contracts with business associates, feedback surveys, a
strong whistle-blowing mechanism, etc. facilitate to monitor the Code in
action.

 

(iv) Completing the Loop: An important
component is to Walk the Talk. A policy should spell out the
consequences for breach of the Code and the process followed to investigate any
allegation of Code violation. Once established, it is vital to implement the
outcome in an objective manner. Finally, sharing of such instances including
action taken is critical not only to demonstrate seriousness but also to raise
awareness levels within the organisation. However, communication is handled
sensitively given the personal ramifications of each case.

 

VALUE SYSTEMS AND BOARD ENGAGEMENT

Governance also
comprises not only voicing core beliefs but also making them integral to the
ways of doing business. The aspect of beliefs and value systems is tested right
upfront at the time of recruitment, assessing business collaborations, or in
acquiring businesses. In acquisitions, finding the right pedigree and therefore
cultural fit becomes the first filter even before business
considerations are put to play. I can quote Safety and Sustainability as great
examples of mettles of governance. These beliefs are embedded into the core of
the strategy rather than appearing on the periphery. Some simple but effective
actions of institutionalising behaviour are listed in the box below.

 

  •     Employment terms spelling
    out that Safety is a condition of employment.  This drives home that Safety is paramount.
  •     Wearing seat belts even
    while seated in the rear of a vehicle.   
  •     Holding on to the handrail
    and refraining from using a mobile phone, while climbing up or down the stairs
    is made into a conscious habit. 
  •     Building Sustainability as
    a mind-set and weaving it into all strategies and decisions made. Here a
    shining example is to consciously go for green buildings as a policy even if
    construction costs work out to be a tad higher.
  •     Keeping these as focus
    Internal Audit themes
  •     Compelling every employee
    particularly in locations such as factories to come  up with suggestions
    pertaining to Safety
  •     Recognising identification
    of near-misses reporting
  •     Encouraging innovation
    towards green manufacturing processes and products
  •     Prohibiting highway travel
    at night and restricting number of persons travelling on the same flight

 

Beyond operations,
I had the privilege of experiencing governance at a Board level. Many years
ago, we had introduced a practice of Board evaluation in a rather structured
manner. All Board members including independent directors were asked to share
their perceptions on a simple two-page questionnaire annually, with due ratings
followed by comments. As the Managing Director, I, too, filled in one and here
I put forth the management viewpoint on the functioning of the Board. I had the
privilege along with the Company Secretary to tabulate the forms both for the
rating as well as other comments. The summary showed the average rating score
against each question as well as comments on what went well and where we could
do better as a Board. We followed a ritual of a Board dinner post every Annual
General Meeting. But prior to the dinner, we had a chat session for about an
hour debating on progress from the previous year and the outcome of the
evaluation to decide on what to focus on going forward.  Actions such as expediting the Board meeting
agenda papers and minutes, field familiarisation for directors, exposure of key
personnel with the Board, etc. came out of such interactions. I found this
entire process delightful and this created a good bonhomie, too, amongst the
Directors. Of course, some of these actions and the Board evaluation processes
have become mandatory in recent years.

 

ESTABLISHING GOOD GOVERNANCE IS NON- NEGOTIABLE

The topic of
governance is wide and encompasses many other aspects – for instance, insider
trading, competitive intelligence, peer dynamics, compensation structures,
workforce conduct, etc. Every element has not been dealt with in this article.
There are legislative pronouncements, too, covering these. One can study the
Codes referred to above to comprehend the various ramifications of this
critical subject. Other companies, such as Johnson & Johnson, Google, Ford
Motor Company, IKEA, Starbucks, Toyota, etc., have their Codes available
publicly on their websites.

 

In sum,
establishing good governance is non-negotiable for any entity striving to
create sustained value while balancing and meeting the interests of multiple
stakeholders. A one-size-fits-all approach, however, may not work with
the modalities and structure varied to suit every enterprise given its ethos
and culture.

 

Do the right thing is what we see as the belief of great institutions. Even if it
means, in many situations, not just sticking to regulations but going beyond
the rule book and what is mandated! And… that is the test of good governance.

This is the second article in the series by V. Shankar
(The first in this series appeared in our issue of January, 2020)

 

_______________________________________

1.  7 January 2009: Satyam Chairman, Mr.
Ramalinga Raju’s letter to his Board of Directors

2.  The Companies Act, 2013: Sections 143,
211, 447

3.  Securities and Exchange Board of India (Listing
Obligations and Disclosure Requirements) Regulations, 2015

4.    The Institute of Chartered Accountants of
India: ICAI Guidance Note on Reporting on Fraud Under Section 143(12), 2016

5. Unilever.com: About | Who we are | Our Values & Principles |
Code of Business

Principles and related Code policies

6. Tata.com: About Us| Values & Purpose | Tata Code
of Conduct)

INSOLVENCY CODE VS. PMLA – CONFLICT OR OVERLAP?

The Insolvency
and Bankruptcy Code, 2016 (the Code) came into force on 28th May,
2016. It was enacted as a special statute to deal with important aspects of insolvency
and bankruptcy. Being a complete Code, it is to prevail over other laws so that
no person can take advantage of pendency of a proceeding under any other law to
stall insolvency and bankruptcy proceedings1. A specific provision
in the Code that confers overriding powers is section 238 which reads as under:

 

‘The provisions of
this Code 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’ (emphasis supplied).

 

A review of section
238 of the Code, particularly the non-obstante expression therein, shows
that provisions of the Code have overriding effect over the provisions of other
statutes which are inconsistent with the Code.

 

The Prevention
of Money-Laundering Act, 2002 (‘PMLA’) came into force on 1st
July, 2005. PMLA was enacted as a special statute to prevent money-laundering
and for matters connected therewith and incidental thereto. A specific
provision of the PMLA that confers overriding powers is section 71 which reads
as under:

 

‘The provisions of
this Act shall have effect notwith-standing anything inconsistent therewith
contained in any other law for the time being in force’ (emphasis
supplied).

 

Thus, a review of section
71 of the PMLA, particularly the non-obstante expression therein, shows
that the provisions of the PMLA have overriding effect over provisions of other
statutes which are inconsistent with the provisions of the PMLA.

 

TWO SPECIAL ENACTMENTS
– OVERLAP OR CONFLICT?

From a review of
the preamble to the Code and the PMLA which specify their respective
objectives, it is evident that both the Code and the PMLA are special Acts. The
moot issue for consideration is: when there are two Special Acts, how to resolve
overlap or conflict between the two?

This issue has been
addressed by Courts and other forums in the following manner: When there is
an overlap or conflict between any two Acts, both of which are special Acts,
then the Act which came later must prevail2.

 

Reiterating the
view that it is the subsequent legislation which will have the overriding
effect, the Supreme Court3 observed that it is possible that both
the enactments have the non-obstante clause. In that case, the proper
approach would be that one must be guided by the object and the dominant
purpose for which the special enactment was made.

 

Where the dominant
purpose of a law is covered by certain contingencies, even then the intention
can be ascertained by looking to the objects and reasons notwithstanding that
the law might have come at a later point of time.

 

OVERRIDING EFFECT OF
THE CODE

The overriding
effect of the Code has been examined in various decisions in the context of
specific legislations and proceedings thereunder. Thus, in respect of
proceedings under PMLA vis-a-vis the Code, the following important propositions
have been laid down:

 

(i)   PMLA is a statute which came into effect much
prior to the coming into force of the Code and, therefore, the Code has
overriding effect over the PMLA4.

(ii)   Where the properties of a corporate debtor
under liquidation were attached under PMLA, the question whether attached
properties were proceeds of crime or whether lenders were bona fide
lenders must be decided by the authorities under

 

PMLA. Besides, the
liquidator appointed under the Code has to approach the authorities under PMLA
for withdrawal of the attachment5.

(iii) Since the PMLA relates to a different field of
penal action regarding proceeds of crime, it can be simultaneously invoked with
the Code. Because of the absence of inconsistency, the PMLA has no overriding
effect over the Code and vice versa6.

(iv) Where prior to admission of the Corporate
Insolvency Resolution Process certain properties of a corporate debtor were
attached under the PMLA, the same could not be released as section 14 of the
Code does not have overriding effect on the PMLA7.

RECENT CASES

Keeping in mind the
afore-mentioned legal position, a few recent cases are examined.

 

PMT Machines case

In this case8,
in 2011-12, the debt-laden Sterling Biotech’s subsidiary, PMT Machines (‘the
company’) defaulted on its debt repayments following which the consortium of
banks, led by UCO Bank, initiated recovery proceedings in 2013 before the Debt
Recovery Tribunal.

In 2017, the
Enforcement Directorate conducted search and seizure under the provisions of
the Foreign Exchange Management Act and the Income-tax Act at the Mumbai and
Vadodara premises of the Sterling group’s promoters and the group companies. In
2018, the Enforcement Directorate (ED) passed orders for provisional attachment
of the properties of PMT Machines.

The company was
admitted for insolvency resolution by the Mumbai Bench of the National Company
Law Tribunal in 2018.

The Resolution
Professional approached the appellate authority under PMLA with the plea that
the properties were wrongly attached by the ED. This plea was made on the
premise that the attached properties were acquired before the ‘alleged
commission of offences and charges on the properties were created prior to the
date of alleged offences’.

The Resolution
Professional submitted that because of the attachment by the ED, the Corporate
Insolvency Resolution Process cannot achieve its objective of maximisation of
value of the stressed assets. He pleaded that the attachment of properties by
the ED was delaying the Corporate Insolvency Resolution Process of the company.

 

Upholding the
prevalence of the Code over the PMLA, the appellate authority (PMLA) released
the properties of the company which had been attached by the ED. The appellate
authority (PMLA) observed that since the properties attached had no relation to
the alleged crime committed by the management of the corporate debtor, the same
must be released to the Resolution Professional to ensure quick insolvency
resolution for the company.

 

Holding that the
recovery proceeding initiated by the banks was ‘valid and legal’ and that the
same could not be ‘blocked for years without valid reasons’, the PMLA appellate
authority observed that the ED is not precluded from attaching other private
properties and all other assets of the alleged accused.

 

The appellate authority, however, clarified that the ruling will ‘have
no bearing in any proceedings initiated against the alleged accused including
extradition proceedings pending or proposed to be initiated in any part of the
world’.

 

In response to the
ED plea that banks were the victim of the alleged fraud perpetrated by the
management of the corporate debtor and that the banks were entitled to recover
their dues, the PMLA appellate authority held that the banks should approach
the special court set up for that purpose.

 

The judgment, thus,
paves the way to achieve the desired objective of the insolvency process.

 

JSW Steel case

In the case of JSW
Steel (‘the Company’), the main issue was whether PMLA has overriding effect
on the Code?

 

The National
Company Law Tribunal (‘NCLT’) approved JSW Steel’s resolution plan for Bhushan
Power & Steel – one of the 12 big cases mandated by the Reserve Bank of
India for resolution under the Code. This should have ended the two-year-long
Corporate Insolvency Resolution Process for the stressed company. Instead, an
appeal was filed by JSW seeking protection from attachment and from the
liability resulting from criminal proceedings, highlighting conflict between
two apparently overlapping laws, the PMLA and the Code.

 

The company
explained its concern to NCLT about the main issue, viz., whether the PMLA
has overriding effect on the Code, in the following words:

 

‘What is concerning
us is that contrary judgments are coming up in some ongoing PMLA cases. Today,
no bidder is aware of criminal liabilities. Criminal liability will be on the
person who has done it and the new management in no way would be responsible
for it. But can the assets of the corporate debtor be attached, that is the
main question’.

 

The company’s offer
for Bhushan Power was Rs 19,350 crores. Certain issues about the overriding
provisions of the PMLA and the Code had caused apprehensions to the bidders and
creditors of the stressed steel assets under the Code.

 

One of the bidders
expressed concern over the attachment of assets under the PMLA. The bidder
sought to secure the bid amount and creditors were concerned about recovering
their money.

 

THE CODE AND PMLA – OPERATE IN DIFFERENT SPHERES

In Deputy
Director, Directorate of Enforcement, Delhi vs. Axis Bank9,
the Delhi High Court has held that both the PMLA and the Code have non-obstante
clauses but since they do not operate in the same sphere, they can co-exist.

 

It was observed
that the objective of the PMLA being distinct from that of the Recovery of
Debts Due to Banks and Finance Institutions Act, the SARFAESI Act, and the
Code, these three legislations do not prevail over the PMLA. By virtue of
section 71 of the PMLA, PMLA has overriding effect on other existing laws in
the matter of dealing with ‘money laundering’ and ‘proceeds of crime’.

 

In two differing
judgments, however, the NCLAT in Rotomac Global10 and
the PMLA Appellate Authority in PMT Machines11 had dealt with
the issue of overlap between PMLA and the Code. In the Rotomac Global case,
it was held by the NCLAT that section 14 of the Code (moratorium) is not
applicable to proceedings under the PMLA and that neither law has an overriding
effect on the other because both the laws operate in different spheres.

 

In the case of PMT
Machines, however, the PMLA appellate authority had upheld the prevalence
of the Code over the PMLA and set aside the order of attachment under PMLA and
released the properties on the ground that the properties were acquired much
prior to the date of the alleged offence of money laundering.

 

GROUND REALITIES

Indeed, banks will
have to establish that the security interest was created prior to the crime
period. The issue is: ‘Operationally, how would a creditor establish that
its charge on the property was created before the crime period?’

 

Bidders, too, are
awaiting clarity. In some cases, change of control had already taken place but
yet there was litigation. If the assets of the corporate debtor are allowed to
be attached, it will pose huge risk if, after paying a substantial sum, there
is no assurance about possession of the asset.

 

Sterling SEZ and Infrastructure Finance case

In this case12,
the Corporate Insolvency Resolution Process had commenced. The application of
the financial creditor initiating the Corporate Insolvency Resolution Process
was admitted, the Resolution Professional was appointed and moratorium was
declared.

 

The Enforcement
Directorate attached the assets of the corporate debtor. The Resolution
Professional informed the ED about the declaration of moratorium and sought
withdrawal of the attachment. However, the ED contended that the attached
properties constituted ‘proceeds of crime’ and, therefore, moratorium would not
be applicable to the proceedings under the PMLA. The adjudicating authority
under the Code was called upon to decide whether proceedings before the PMLA
Court in respect of attachment of properties were merely civil proceedings and,
accordingly, the adjudicating authority under the PMLA had no jurisdiction to
attach properties of the corporate debtor undergoing the Corporate Insolvency
Resolution Process.

 

After examining the relevant provisions of the Code and the PMLA, the
Adjudicating Authority under the Code held that the Adjudicating Authority
under the PMLA had no jurisdiction to attach properties of the corporate debtor
undergoing the Corporate Insolvency Resolution Process.

 

It also held that
the attachment order passed under the PMLA was non-est in law since it
was hit by declaration of moratorium under the Code. Accordingly, it was
finally held that the Resolution Professional could proceed to take charge of the properties as if there was no attachment order.

 

GOVERNMENT’S APPROACH

After completing
the resolution under the Code, several bidders faced demands from different
government authorities. The biggest concern, however, was the threat of
attachment under PMLA.

 

A number of
representations have been made by bidders to the Ministry of Corporate Affairs
on the issues pertaining to the PMLA, especially with regard to the attachment
of property.

 

In a holistic view
of the matter, it is suggested that the PMLA should either be amended or the
bidder should be allowed to revise the bid to the extent of the liability in
respect of the alleged ‘proceeds of crime’. The amount may be put in an escrow
account.

 

Government has taken cognisance of
this issue and has sought to amend the Code in December, 2019 to ring-fence the
prospective bidder for stressed assets against the liability for prior
offences.

 

__________________________________________-

1   Neeraj Jain vs. Yes Bank Ltd. (2019) 106
taxmann.com 35 (NCLAT)

2   Solidaire India Ltd. vs. Fair Growth AIR 2001
SC 958; Raman Ispat (P) Ltd. vs. Executive Engineer (Paschimanchal Vidyut
Vitran Nigam Ltd.) (2018) 97 taxmann.com 223 (NCLT-All).

3   Bank of India vs. Ketan Parekh AIR 2008 SC
2361; (2008) 8 SCC 148

4      Siddhi Vinayak Logistic Ltd. vs. Dy.
Director, DoE, Mumbai (2019) 101 taxmann.com 491 (PMLA-AT)

5   Anil Goel, Liquidator, Rotomac Global (P)
Ltd. vs. Ms Ramanjit Kaur Sethi, Dy. Director, DoE (2019) 102 taxmann.com 152
(NCLT-All)

6   Varrsana Ispat Ltd. vs. Dy. Director, DoE
(2019) 108 taxmann.com 96 (NCL-AT) Per contra Asset Reconstruction Co. (India)
Ltd. (ARCIL) vs. Dy. Director (2019) 109 taxmann.com 192 (NCLT-Hyd.)

7   Varrsana Ispat Ltd. vs. Dy. Director, DoE
(2019) 108 taxmann.com 96 (NCL-AT)

8      PMT Machines Ltd. vs. Dy. Director, DoE
(2019) 111 taxmann.com 362 (PMLA-AT)

9 (2019] 104 taxmann.com 49 (Delhi)

10 Rotomac Global (P) Ltd. vs. Dy. Director, DoE
[2019] 108 taxmann.com 397 (NCLAT)


11 PMT Machines Ltd. vs. Dy. Director, DoE (2019) 111 taxmann.com 362
(PMLA-AT)

12 SREI Infrastructure Finance Ltd. vs. Sterling SEZ
& Infrastructure Finance Ltd. [2019] 105 taxmann.com 167 (NCLT – Mum.)

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

19. JP Morgan Chase Bank N.A. vs. DCIT
ITA No. 3747/Mum/2018 & 363/Mum/2019
A.Ys.: 2011-12 and 2012-13

Date of order: 30th December, 2019

Article 7 of India-US DTAA – Explanation (a) to section 9(1)(v)(c) of the Act – Interest paid by an Indian branch of a foreign bank to its head office / overseas branches was not taxable under the Act – Explanation (a) to section 9(1)(v)(c) deeming such interest as income is prospective in nature

FACTS

The assessee, an Indian branch (BO) of a US banking company, paid interest to its head office (HO) and sister branches abroad. The HO contended that the payment by the BO to the HO was payment to self and was covered under the principle of mutuality. Hence, interest received by it was not taxable in India. The AO accepted the contention of the assessee and completed the assessment on that basis.
Administrative CIT exercises power u/s 263 of the Act. According to the CIT, under the India-USA DTAA, interest is taxable in the source country. Since the assessee had its PE in India (i.e., the BO), interest was taxable in India. He further held that since the assessee had opted to be governed under beneficial provisions of the DTAA, the single entity approach under the Act gave way to the distinct and independent entity or separate entity approach under the DTAA. Hence, the BO and the HO were two separate entities. The CIT further referred to Explanation (a) to section 9(1)(v)(c) of the Act which was effective from 1st April, 2016 and mentioned that since the amendment was clarificatory in nature, it applied retrospectively. He also referred to the CBDT Circular No. 740 dated 17th April, 1996 mentioning that a branch of a foreign company in India is a separate entity for taxation under the Act. The CIT distinguished the Tribunal Special Bench decision in Sumitomo Mitsui Banking Corporation vs. DDIT [2012] 19 taxmann. com 364 (Mum.) on the ground that the Tribunal had no occasion to consider the reasoning mentioned by him in the context of the DTAA. The CIT concluded that interest received by the HO and other branches abroad was taxable in India.
Aggrieved, the assessee filed an appeal with the Tribunal.
HELD
The Special Bench of the Tribunal in the case of Sumitomo Mitsui Banking Corporation vs. DCIT1 held that since the interest paid by the BO to the HO is in the nature of payment made to self, it will be governed by the principle of mutuality. Hence, it was not taxable under the Act. Applying the same principle, interest received by the HO (and other branches) from the BO was not taxable in India.
Explanation (a) to section 9(1)(v)(c) of the Act, which deems that interest paid by the BO of a bank to its HO is taxable in India, applies prospectively from 1st April, 2016 and cannot be invoked to tax interest of any earlier financial year.

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

18. ACIT vs. M/s FCI Asia Pte. Ltd.
ITA Nos. 2588 & 2589/Del/2015
A.Ys.: 2009-10 and 2010-11

Date of order: 6th January, 2020

Article 12 of India-Singapore DTAA – Receipt from Indian group companies towards information technology and business support services did not qualify as royalty / FTS under India- Singapore DTAA

FACTS
The assessee, a Singapore company, was engaged in providing IT support services as well as business support services to its affiliates in India. The IT support services included services such as centralised data centre, disaster recovery management and backup storage. The business support services included common services towards purchasing, communications and international relationship matters, legal and insurance
support services.
The assessee contended that the services rendered by it were standardised IT-related services. Although the affiliates were provided access to IT infrastructure, they were not conferred with any use or right to use the equipment which remained under the control of the assessee. Thus, payment for such services did not amount to royalty under the Act as well as the India- Singapore DTAA. Besides, the IT support services as well as business support services did not enable the affiliates to apply technical knowledge independently or to perform such services independently without any recourse to the assessee. Hence, in the absence of a ‘make available’ clause under the India-Singapore DTAA being satisfied, such services did not qualify as Fees for Technical services under the India-Singapore DTAA.
However, the AO contended that in the course of rendering services, the assessee granted a right to its affiliates to access the data centre / storage capacity maintained by
it. Thus, payments made by the affiliates were towards the use of, or the right to use, industrial, commercial and scientific equipment. Hence, the payments were in the nature of royalty under the Act as well as under Article 12 of the India-Singapore DTAA.
Aggrieved, the assessee appealed before CIT(A) who ruled in his favour. The aggrieved AO preferred an appeal before the Tribunal.
HELD
The services rendered by the assessee in relation to the centralised data centre, WAN bandwidth management, disaster recovery management, backup and offsite storage management and security management merely involved provision of a ‘facility’ and not a right to use the equipment. Hence, the payment received for such services did not qualify as royalty.
Support services such as purchasing, communications and international relationship matters, legal and insurance support services did not enable the service recipient to make use of the said technical or managerial services independently. Further, there was no training involved under the agreement. Thus, consideration for such services did not qualify as FTS.


Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

17. TS-810-ITAT-2019 (Mum.)
Trimble Solutions Corporation vs. DCIT
ITA No. 6481/Mum/2017; 6482/Mum/2017
A.Y.: 2011-12

Date of order: 16th December, 2019

Article 12 of India-Finland DTAA – Consideration for distribution, updation and maintenance of software, without right of exploitation of intellectual property, was not in nature of royaltyunder India-Finland DTAA

FACTS

The assessee, a company incorporated in Finland, was engaged in the business of developing and marketing specialised off-the-shelf software products. The assessee appointed non-exclusive distributors for the distribution of the software to end-customers in India. In addition, the assessee also provided software upgrades, maintenance and support services with regard to such software.
During the year under consideration, the assessee received income from the sale of software as well as payments for maintenance and support services from the distributors in India. The assessee contended that the software was provided to its distributors for the purpose of resale / distribution to the end-customers for use as copyrighted article but no right was granted to use copyright in software. Further, the payments received for software upgrades, maintenance and support services with regard to software were also not for transfer of any right in copyright of a copyrighted article. Thus, payments received from distributors cannot be characterised as royalty under the India-Finland DTAA.
The AO, however, was of the view that distribution of software to end-customers through distributors resulted in transfer or use of copyright in software. In any case, postinsertion of Explanations 4 and 5 to section 9(1)(vi), grant of a license was also ‘royalty’. The AO read the definition of royalty under the Act into the India-Finland DTAA and held that payments received from distributors would qualify as royalty even under the India-Finland DTAA. The AO further held that payments received for maintenance and support services (including upgrades) were part of, and inextricably linked to, supply and use of software. Hence, payment for such services was also in the nature of royalty.
Aggrieved, the assessee approached the Dispute Resolution Panel (DRP), which rejected the objections of the assessee.
Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

  •  Article 12 of the India-Finland DTAA envisages consideration for the use of, or the right to use, certain specific works which could include intellectual properties (such as copyright, patents, etc.) by the owner of such intellectual properties from any other person.
  •  The Tribunal noted the following factors from the agreement entered into between the assessee and the distributors:
• Distributors were granted non-exclusive license to market and distribute software products developed by the assessee;
• Distributors did not have the right to use the source code of such software products;
• Distributors were not permitted to modify, translate or recompile, add to, or in any way alter software products (including its documentation);
• Distributors were not permitted to create source code of software products supplied under the agreements;
• Distributors were not expressly permitted to reproduce or make copies of software products under the agreements (except backup copy as required by the customer);
• Distributors were not vested with rights of any nature in intellectual property developed and owned by the assessee in software products;
• All trademarks and trade names which distributors used in connection with products supplied, remained the exclusive property of the assessee. At all times, the assessee had title to all rights to intellectual property, software and proprietary information, including all components, additions, modifications and updates.
The assessee had granted only the right to distribute software products and not the right to reproduce or make copies of software. Thus, in the absence of vesting of any right of commercial exploitation of intellectual property contained in copyrighted article (i.e., software product), the amount received by the assessee from its distributors was in the nature of business income.
In terms of Article 3(2) of the India-Finland DTAA, the definition of a term under domestic law can be applied only if it is not defined in the DTAA. Royalty is defined in the India-Finland DTAA. Hence, amendment of its definition under domestic law had no bearing on the definition under the DTAA. Therefore, the contention of the AO / DRP that the definition of ‘royalty’ under the Act was to be read into the DTAA was incorrect.
Accordingly, payments received by the assessee from distributors were not in the nature of royalty under Article 12 of the DTAA.

Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India

16. TS-803-ITAT-2019 (Ahm.)
J. Korin Spinning Pvt. Ltd. vs. ITO
ITA No. 2734/Ahm/2016
A.Y.: 2015-16
Date of order: 13th December, 2019

Article 15 of India-Korea DTAA – Technical advisory services provided by non-resident individual to Indian company were in nature of IPS under Article 15 of India-Korea DTAA which, in absence of fixed base in India, were not taxable in India
FACTS
The assessee, an Indian company, entered into an agreement with Mr. L, a resident of  South Korea, under which he was required to act as technical adviser and provide technical advice in relation to certain aspects of the production process of the assessee. The assessee paid a consideration to Mr. L for the said services.
According to the assessee, the services provided by Mr. L were in the nature of Independent Personal Services (IPS) in terms of Article 15 of the India-Korea DTAA. Since Mr. L did not have a fixed base available to him in India, consideration for the  services was not taxable in India. Hence, the assessee did not withhold tax u/s 195 from the payments made to him.
The AO, however, contended that the services rendered by Mr. L were industrial in ature since they related to setting up of the assessee’s factory and cannot be categorised as IPS. Hence, they qualified as fee for technical services (FTS) u/s 9(1)(vii) as well as Article 13 (Royalties and FTS) of the DTAA.
The CIT(A) dismissed the assessee’s appeal. Aggrieved, the assessee filed an appeal before the Tribunal.

HELD

  •  Mr. L was a technical expert in certain fields of textiles. He was engaged by the assessee to provide technical advice on some aspects of the assessee’s production process.
  •  Mr. L was an individual and resident of Korea.
  •  The agreement was between the assessee and Mr. L individually and not with any ‘firm’ or ‘company’.
  •  The agreement mentioned Mr. L as ‘Technical Adviser’ to the assessee. Hence, the services rendered by him qualified as IPS.
  •  Mr. L and his technical team were required to fly to India on need basis for rendering services to the assessee. This indicated that Mr. L did not have a fixed base in India.
  •  Since Mr. L did not have a fixed base in India, the consideration received by him was not taxable in India as per Article 15 of the India-Korea DTAA.

Section 56(2)(viib) – When there was no case of unaccounted money being brought in the garb of share premium, the provisions not attracted

11. Clearview Healthcare Pvt. Ltd. vs. ITO
(Delhi) Member: H.S. Sidhu (J.M.) ITA No. 2222/Del/2019 A.Y.: 2014-15 Date of order: 3rd January, 2020 Counsel for Assessee / Revenue: Kapil Goel /
Pradeep Singh Gautam

 

Section 56(2)(viib) – When there was no
case of unaccounted money being brought in the garb of share premium, the
provisions not attracted

 

FACTS

The issue before the Tribunal was about taxability or otherwise of share
premium received on shares issued by the assessee company u/s 56(2)(viib). The
assessee was incorporated on 29th January, 2010. During the year
under appeal, the company had issued shares at premium. According to the AO,
the difference between the share premium received and the share valuation
determined under Rule 11UA amounting to Rs. 9.20 lakhs was the income of the
assessee as per the provisions of section 56(2)(viib). On appeal, the CIT(A)
confirmed the AO’s order.

 

Before the Tribunal, the assessee referred to the Explanatory Memorandum
to the Finance Act, 2012 and contended that the legislative intent was to apply
the said provisions only where, in the garb of share premium, money was
received which was not clean and was unaccounted. According to the assessee,
the lower authorities have applied the provisions of section 56(2)(viib)
without any finding that the money was not clean money. It was also pointed out
that in the subsequent year, on 1st December, 2014, the company’s
shares were sold by one of its shareholders to a non-resident at a price which
was higher than the price at which the shares were issued by the company. And
the said price was accepted by the tax authorities in the shareholder’s tax
assessment.

HELD

The Tribunal agreed with the assessee that the provisions of section
56(2)(viib) would apply only when money received was not clean and was
unaccounted money, received in the garb of share premium as mentioned in the
Explanatory Memorandum to the Finance Act, 2012.

 

According to the
Tribunal, a subsequent transaction with a foreign buyer which was at a higher
amount and on the basis of detailed due diligence, also justified that the
share premium received by the assessee was not excessive and was fair.

 

Keeping in view the facts and circumstances of the case and by applying
the principles from the decision of the Chennai Tribunal in the case of Lalithaa
Jewellery Mart Pvt. Ltd. (ITA Nos. 663, 664 and 665/Chennai/2019
decided on 14th June, 2019) and legislative intent behind
the insertion of section 56(2)(viib), the Tribunal held that the addition made
by the AO on account of alleged excess share premium was unjustified when those
very shares were sold in the next financial year at a much higher amount after
proper due diligence to a non-resident buyer; and further there was no case of
unaccounted money being brought in in the garb of the stated share premium,
hence the addition made u/s 56(2)(vii) was deleted.

Proviso to section 2(15) r/w/s 11 and 12 – As part of running an educational institution and imparting training to the students, the assessee had undertaken research projects for the industry and earned consultancy fees from them – Since the dominant object was to impart education, the proviso to section 2(15) does not apply

10. Institute of Chemical Technology vs. ITO
(Mum.) Members: Saktijit Dey (J.M.) and Rifaur Rahman
(A.M.) I.T.A. Nos. 6111 and 6922/Mum/2016 A.Ys: 2011-12 and 2012-13 Date of order: 15th January, 2020 Counsel for Revenue / Assessee: Nishant Thakkar
and Jasmine Amalsadwala / Kumar Padmapani Bora

 

Proviso to
section 2(15) r/w/s 11 and 12 – As part of running an educational institution
and imparting training to the students, the assessee had undertaken research
projects for the industry and earned consultancy fees from them – Since the
dominant object was to impart education, the proviso to section 2(15)
does not apply

 

FACTS

The assessee was
established as the Department of Chemical Technology by the University of
Bombay on 1st October, 1933. With the passage of time, the assessee
was granted autonomy and subsequently got converted into an independent
institution in January, 2002. In September, 2008 the assessee was granted
deemed university status. When the assessee was a part of Mumbai (earlier
Bombay) University, the income earned by it formed part of the income of Mumbai
University and was exempt u/s 10(23C). For the impugned assessment years, the
assessee in its return of income declared nil income after claiming exemption
u/s 11.

 

During the year
under consideration the assessee had received consultancy fees. Applying the
provisions of section 2(15) read with 
sections 11 and 12, the AO disallowed its claim of exemption with regard
to the consultancy fee received. The assessee’s claim of exemption u/s 11 in
respect of other income was allowed by the AO.

 

The assessee explained that as a part of the curriculum and with a view that the students / fellows of the Institution gain
actual working experience, the assessee had undertaken research projects for
the industry and earned consultancy fees from the industry clients. Out of the
fees received, only 1/3rd amount was retained by the assessee and
the balance amount was paid to the faculty who undertook the research projects.
The amount retained by the assessee was mainly to cover the cost of
infrastructure / laboratory facilities provided for undertaking the research
and administrative expenditure. Thus, it was submitted, the activities undertaken
by the assessee were not in the nature of business but only for research and
training purposes and therefore were part of its main activity of imparting
education on the latest technical developments in the field of chemical
technology. However, the AO didn’t agree with the explanation offered by the
assessee.

 

Relying on the
decision of the Tribunal in the assessee’s own case for the assessment year
2010-11, the Commissioner (Appeals) upheld the disallowance / addition made by
the AO.

 

Before the Tribunal,
the assessee submitted that in respect of the aforesaid decision of the
Tribunal relied on by the CIT(A), the Tribunal had no occasion to consider the
assessee’s argument that the proviso to section 2(15) was not
applicable. According to the assessee, the proviso to section 2(15)
would be applicable only when the activity was for ‘advancement of any other
object of general public utility’. The assessee contended that the
consultancy service provided was part of its educational activity, therefore ancillary
and incidental to its main object of providing education. Therefore, even
though the assessee had received consultancy fee, the same was received in
furtherance of its object of educational activity, hence it cannot be treated
as an activity in the nature of trade, commerce or business and thereby treat
the same as for a non-charitable purpose.

 

HELD

The Tribunal agreed
with the assessee that applicability or otherwise of the proviso to
section 2(15) in the case of the assessee was not examined or dealt with by the
Tribunal in A.Y. 2010–11. According to it, the contention of the assessee
regarding applicability of the proviso to section 2(15) does require
examination keeping in view the decision of the Bombay High Court in DIT(E.)
vs. Lala Lajpatrai [2016] 383 ITR 345, wherein the Court held that the
test to determine as to what would be a charitable purpose within the meaning
of section 2(15) was to ascertain what was the dominant object / activity.
According to the Court, if the dominant object was the activity of providing
education, it will be charitable purpose under section 2(15) even though some
profit arose from such activity. Since the aforesaid claim of the assessee was
not examined by the Departmental authorities, the Tribunal restored the matter
to the file of the AO for re-examination and directed him to adjudicate the
issue keeping in view the additional evidence filed by the assessee and the
decisions cited before him.

 

Note: Before the Tribunal, the assessee had also alternatively claimed
exemption under sections 10(23C)(iiiab) and / or 10(23C)(vi) and furnished
additional evidence. The Tribunal directed the AO to also consider the same.

Section 80P(4): Provisions of section 80P(4) exclude only co-operative banks and the same cannot be extended to co-operative credit societies

20. [2019] 107 taxmann.com 53
(Trib.)(Ahd.)(SB) ACIT vs. People’s Co-op. Credit Society Ltd. ITA Nos. 1311, 2668 to 2670, 2865, 2866,
2871 & 2905 (Ahd.) of 2012 A.Ys.: 2007-08 to 2009-10 Date of order: 18th April, 2019

 

Section 80P(4):
Provisions of section 80P(4) exclude only co-operative banks and the same
cannot be extended to co-operative credit societies

FACTS

The assessee, a
co-operative credit society, providing credit facilities to its members and
carrying on banking business, claimed deduction u/s 80P(2)(a)(i). The AO
disallowed the same holding that provisions of section 80P(4) are applicable to
the assessee.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal.

 

The Revenue then
preferred an appeal to the Tribunal.

 

HELD

In view of the
contrary decisions by various benches of the Tribunal, a Special Bench (SB) was
constituted by the President to consider the question whether a co-operative
credit society is to be considered as a co-operative bank and whether by virtue
of the provisions of section 80P(4), a co-operative credit society shall be
disentitled to claim deduction u/s 80P(2)(a)(i).

 

At the time of
hearing before the Tribunal, the learned representatives agreed that the issues
before the SB of the Tribunal are now covered in favour of the assessee by
various decisions of the Hon’ble Jurisdictional High Court – including in the
cases of Pr. CIT vs. Ekta Co-operative Credit Society Ltd. [2018] 91
taxmann.com 42/254, Taxman 33/402 ITR 85 
and CIT vs. Jafari Momin Vikas Co-operative Credit Society
Ltd. [2014] 49 taxmann.com 571/227, Taxman 59 (Mag.) 362 ITR 331 (Guj.).

 

The Tribunal, having considered the ratio of the decisions of the
Jurisdictional High Court in the cases of Pr. CIT vs. Ekta Co-operative
Credit Society Ltd. (Supra) and CIT vs. Jafari Momin Vikas
Co-operative Credit Society Ltd. (Supra), held that the legal position
is quite clear and unambiguous. As held by the Jurisdictional High Court, the
benefit of section 80P(2)(a)(i) cannot be denied in the case of co-operative
credit societies in view of their function of providing credit facilities to
the members and the same are not hit by the provisions of section 80P(4).

 

The appeals filed
by the Revenue were dismissed.

Rule 37BA(3) r/w/s 199: Credit for Tax Deducted at Source has to be allowed in the year in which the corresponding income is assessed even though the tax is deposited by the deductor in the subsequent assessment year

19. [2019] 112 taxmann.com 354 (Trib.)(Pune) Mahesh Software Systems (P) Ltd. vs. ACIT ITA No. 1288/Pune/2017 A.Y.: 2011-12 Date of order: 20th September, 2019

Rule 37BA(3) r/w/s 199: Credit for Tax Deducted at Source has to be allowed in the year in which the corresponding income is assessed even though the tax is deposited by the deductor in the subsequent assessment year

FACTS
The assessee raised an invoice and offered to tax income arising therefrom in March, 2011. The assessee claimed credit for tax deducted thereon. However, the deductor deposited TDS only in April, 2011, i.e., in the succeeding financial year. Consequently, the TDS claimed by the assessee did not appear in Form 26AS for the year in which the income was booked. The AO, relying on sub-rule (1) of Rule 37BA, did not allow the credit in A.Y. 2011-12.

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

The assessee then filed an appeal to the Tribunal.

HELD
The Tribunal observed that the AO had relied on sub-rule (1) of Rule 37BA for denying the benefit of TDS during the year under consideration. It provides that credit for TDS shall be given to the person to whom payment has been made or credit has been given on the basis of information furnished by the deductor. Thus, what is material for sub-rule (1) is the beneficiary of credit and not the time when credit ought to be allowed. The CIT(A), in addition, had relied on sub-rule (4) of Rule 37BA which again provides that credit for TDS shall be granted on the basis of information relating to TDS furnished by the deductor.

The Tribunal observed that the point of time at which the benefit of TDS is to be given is governed by  sub-rule (3) of Rule 37BA which very clearly provides that – ‘credit for tax deducted at source and paid to the Central Government, shall be given for the assessment year for which such income is assessable.’

In view of the above, the Tribunal held that the credit of TDS had to be allowed in the year under consideration even though the TDS was deposited by the deductor in the subsequent assessment year.

The Tribunal allowed the appeal filed by the assessee.

Section 142A(6): It is mandatory for the Valuation Officer to submit the Valuation Report within six months from the date of receipt of the reference – Delay in filing the report cannot be condoned

18. [2019] 75 ITR (Trib.) 219 (Hyd.) Shri Zulfi Revdjee vs. ACIT ITA No. 2415/Hyd/2018 A.Y.: 2013-14 Date of order: 5th September,
2019

 

Section 142A(6): It is mandatory for the
Valuation Officer to submit the Valuation Report within six months from the date
of receipt of the reference – Delay in filing the report cannot be condoned

 

FACTS

The assessee sold a
property during F.Y. 2012-13. He filed the return of income disclosing capital
gains arising from the sale of the said property. The AO sought to make an
addition u/s 50C of the Act. However, since the assessee objected to it, he
referred the file to the Departmental Valuation Officer (DVO) for valuation of
the property. The DVO submitted the report after the expiry of the period
stipulated u/s 142A(6). Further, he also considered the value of the house as
on the date of registration of agreement. The assessee, inter alia,
raised an objection that the report submitted by the DVO is beyond the
stipulated time limit of six months, as specified u/s 142A(6), and consequently
the assessment is barred by limitation.

 

The assessee
preferred an appeal to the CIT(A) who dismissed the appeal. Aggrieved, the
assessee filed an appeal to the Tribunal.

 

HELD

The Tribunal
observed that u/s 142A the valuation report by the DVO has to be submitted
within six months from the date of receipt of the reference. However, the DVO
submitted his report after 15 months from the end of the month in which
reference was made to him. The Tribunal considered whether the time limit for
submission of report could be enlarged or condoned. It noted that the word used
in sub-section (6) of section 142A is ‘shall’, while in other sub-sections it
is ‘may’. In B.K. Khanna & Co. vs. Union of India and others, the
Delhi High Court [156 ITR 796 (Del.)] has held that where the words
‘may’ and ‘shall’ are used in various provisions of the same section, then both
of them contain different meanings and the word ‘shall’ shall mean ‘mandatory’.
In sub-section (6), since the word ‘shall’ is used, the time limit specified
therein is mandatory and, thus, delay cannot be condoned. The Tribunal held
that the report of the DVO had to be filed within the time limit prescribed
under section 142A(6) and, thus, the Assessment Order passed on the basis of
the DVO’s report is not sustainable.

 

The Tribunal
allowed this ground of appeal filed by the assessee.

 

INTERMINGLING OF INCOME TAX AND GST

Tax laws are not made in a vacuum.
They are expected to be legislated keeping in mind the prevailing social,
economic and legal structure of a State. Yet, once legislated, taxing statutes
are to be implemented strictly and literally without consequences under other
tax laws. It is for the limited purposes of resolving any ambiguity over
undefined terms and / or unclear obligations of transaction where the Courts
have resorted to ancillary tax laws. It becomes imperative for tax subjects to
reconcile multiple laws prior to concluding transactions. This approach
involves a conceptual study and a cautious application of the respective laws
and their precedence.

 

Enactment of the Goods and Services
Tax laws in India would certainly have parallel implications under the existing
Income tax enactment. The business practices and accounting methodology under
the pre-existing enactments would need to be examined under the GST lens. We
are aware that gross income / receipts / turnover in the Profit and Loss
account of an Income tax return does not equate to aggregate turnover of a GSTR
annual return. Why is this so? Fundamentally, supply represents rendering of
service / sale of goods (outward obligation), while income is the consequence
flowing back from such supply (also called consideration); in other words,
supply of goods is the outward flow of a benefit and the consideration emerging
from such supply is termed as income.

 

 

Therefore, supply and income are two
facets of the same coin (one being the source and the other being the
consequence) and are to be viewed differently. They meet only when both
parameters, i.e., outward benefit and corresponding consideration are present
in a transaction; the absence of one any of these elements causes a divergence
in treatment under the respective laws. The other fundamental difference is the
geographical spread of the legislation – Income tax is a pan-India legislation
and GST is a hybrid of both national and State-level legislations.

 

An attempt has been made in this
article to identify variances and consistencies between both the tax enactments
from a conceptual perspective under four broad baskets: Charge, Collection,
Deductions / Benefits and Procedures.

 

A)  CHARGE OF TAX

Income
perspective

Income tax is a direct tax on the
income from a transaction (see pictorial representation). The tax can be said
to be outcome-based since it is imposed on the end result, i.e., net business
profit, net capital gains, net rental income, etc. The basis of charge of
Income tax is ‘accrual’ or ‘receipt’ of ‘income’ depending on the accounting
methodology or specific provisions. Income is a term of wide import and has
been defined in section 2(24) in a very wide manner. Its normal connotation
indicates a periodical money return with some sort of expected regularity from
a definite source. It implies the net take-away from a transaction or series of
transactions. Yet, this definition has been the subject matter of scrutiny at
all levels in judicial fora. Every passing Finance Act has only widened the
scope of this term to include artificial items which do not fall in the normal
connotation of income. Certain extensions to this definition overcome general
understanding such as capital receipts, chance-based (lotteries, etc.)
receipts, absence of consideration, etc. For instance, courts have held that
capital receipts do not fall within the natural scope of the definition of
income. As a consequence, compensation on destruction of capital assets was
held to be capital in nature and included in Income tax only by artificial
extension. Capital receipts are thus an extended feature of income, and
therefore any capital receipt not specified in the enactment is outside the net
of Income tax.

 

GST, on the other hand, is a
transaction-based indirect tax. Transaction of ‘supply’ forms the basis of
charge. However, the term supply appears to be widely defined; it is fenced
with the requirement of being in the nature of sale, lease, exchange, barter,
license, etc. in the course or furtherance of business. Business has been
extended to include occasional, set-up related and closure-related
transactions. The transaction of supply is not significantly influenced by the
intention behind holding the asset. The behavioural aspect may be with
reference to the contractual terms but not behind the ownership of the asset.
For instance, GST may not concern itself with the intention behind holding the
asset but would lay higher emphasis on whether, in fact, the asset was sold or
not. To elaborate this with an example, a manufacturer temporarily leasing an
asset during its construction phase prior to its set-up may not be considered
as generating an income from business but reducing its capital expenditure (a
capital receipt), though such transaction would still be liable to GST. GST
does not treat capital and revenue transactions too differently; sale of
capital assets (or even salvage value), though capital in nature, would be
taxable under the said law.

 

On the other hand, Income tax
permits deduction of bad debts since it follows the ‘income’ approach. As a
corollary, the write-back of a revenue liability is also income. Since the
charging event of GST ends with the completion of supply, recovery of the
consideration, though relevant for Income tax, may be inconsequential for GST.
On the other hand, there may be certain transactions which are supply but may
not result in any income to the supplier. Recovery of costs may not necessarily
impact the income computation as they are generally netted off, but the very
same transaction could have implications under GST (say, freight costs).

 

Schedule I transactions certainly
pose a challenge when juxtaposed between Income tax and GST. Take the example
of the movement of goods between principal and agents. While for Income tax
this movement would not have any implications in either hand, under GST this
would be treated as an outward supply from the principal to its agent and a
corresponding inward supply to the agent, akin to a sale and purchase between
these parties. This would be the case even for a transaction between principal
and job-worker crossing the statutory threshold. The principal would have to
forcefully record this as an outward supply but would not give any
corresponding effect in its Income tax records. Therefore, while all GST
consequences would follow, Income tax would refrain from recognising these
transactions, leading to permanent variance between two values for the
taxpayer; for example, Income tax books would report this as stock held with
the job-worker, while the goods would strictly not form part of inventory of
the principal for GST purposes.

 

Apart from such variances, the
general phenomena of income and supply would more or less reconcile with each
other. The net consequence of the above-cited difference is that a
comprehensive coverage of either Income tax or GST cannot be made only by
reviewing the Profit and Loss account or Income tax computation of the
taxpayer. Transactions beyond Income tax records would need to be examined from
a GST perspective as well.

 

Characterisation
perspective

The other linkage is the
characterisation of transactions under both laws. Income tax u/s 14 provides
for five broad heads of income: (a) salary, (b) income from house property, (c)
business or profession, (d) capital gains and (e) other sources. The Supreme
Court in the famous case of East Housing & Land Development Trust
Ltd. vs. Commissioner of Income Tax (1961) 42 ITR 49(SC) held that:

 

‘The classification of income
under distinct heads of income is made having regard to the sources from which
the income is derived. Moreover, Income tax is levied on total taxable income
of the taxpayer and the tax levied is a single tax on aggregate tax receipts
from all sources. It is not a collection of taxes separately levied under
distinct heads but a single tax’.

 

The distinct heads are for the
purpose of differential computation methodologies of income depending on the
source of income. Income tax would treat computation of gains on sale from
capital assets differently from that of gains on sale of a stock. In fact, any
conversion of capital assets into stock in trade or vice versa would
have Income tax implications but no GST implications. A trader reclassifying an
asset from one balance head to another would not have any GST implications. The
reason for this difference is probably that GST does not look through the
intention of supply; it rather looks at the fact of a supply taking place for
taxation.

 

Income resulting from an
employer-employee / master-servant relationship is separately taxable under the
head ‘Salaries’ under Income tax. The litmus test of master-servant
relationship would be the extent of supervisory control of the master over the
individual while rendering the said service – independence in functioning would
provide the extent of control exercised by the master [Ram Prashad vs.
CIT (1972) 86 ITR 122 (SC)]. Under Income tax, the definition of salary
includes wages, allowances, accretion to recognised provident funds, etc.
Though the definition of salary u/s 17(1) does not include ‘perquisites’ within
its fold, it is nevertheless taxable under the head ‘Income from salary’ u/s
17(2). The Supreme Court in Karamchari Union vs. Union of India (2000)
243 ITR 143 (SC) stated that the definition of salary itself includes
any allowance, perquisite, advantage received by an individual by reason of his
employment. The perquisites are valued based on the net benefit being provided
to the employee (i.e., gross value of benefit minus the recoveries, if any).

 

The above analogy could be extended
to GST in matters involving examination of services rendered between the
employer and the employee in the course of employment. From an employee’s
perspective, the commissions, bonuses, monetary / non-monetary benefits arising
on account of employment even received after termination would be excluded from
the net of GST. But one should be cautious to ascertain the capacity under
which the individual is rendering these services. A director, for instance, can
hold two capacities – as an employee and as a director (agent of the company).
Services rendered as an agent of the company would not fall within the
exclusion but those rendered out of a master-servant relationship would stand
excluded.

 

Under the GST law both employer and
employee are treated as related persons in terms of the explanation to section
15. Schedule I deems certain services between related persons as taxable even
in the absence of a consideration. Therefore, from an employer’s perspective,
in cases where he is providing services for a subsidised charge to an employee
on duty (say subsidised rent accommodation, transport facility, etc.), there
appears to be some ambiguity whether such transaction entails GST. This is
because Schedule III excludes services by an employee to an employer in the
course of, or in relation to, employment, but not the reverse.

 

Certain services by an employer to
his employee arise on account of the obligations he takes over as part of the
employment agreement (such as providing rented accommodation, transport,
medical facilities, etc.). In the view of the authors, such activity is in the
nature of a ‘self-service’ and the recovery if any is towards the costs of such
activity rather than an independent supply, or an outward flow of benefit to
the employee. We can view this as follows:

 

 

The employer provides such benefits
as a condition (express or implied) of the employment. Some activities may also
be gratuitous / implied in nature, such as serving tea during official hours.
Some activity may be either provided free of cost or chargeable at a subsidised
cost (factory lunch). The benefits which are made available to the individual
have emerged from the status of a master-servant relationship. These benefits
are provided by the employer as a means for improving efficiency, productivity,
retention, etc. for his business. Though these actions provide some benefit to
the employee, such benefits are not solely for exclusive personal consumption.
In such cases it can be stated that there is no independent supply from the
employer to the employee, rather, a non-monetary benefit provided to the
individual. Even in case an amount is charged (either at cost or subsidised
rate), it represents a cost recovery / reduction in the quantum of non-monetary
benefit, but not a supply.

 

Such a view resonates from the fact
that while computing the value of perquisites in the hands of the employee, any
costs recovered by the employer towards the provision of such non-monetary
benefit is reduced from the valuation of salary. Such costs are not treated as
an expense of the employee, rather, they are reduced from the gross value of
monetary benefit received during the course of employment. The employer also
does not treat this transaction as part of his income generation activity but
considers this a reduction of his salary costs.

 

We should distinguish the above
scenario from a case where an employer provides benefits beyond the contract of
employment, or renders exclusive benefits to individuals in their personal
capacity. 

 

Situs
perspective

Income tax is imposed on income
which accrues or arises or is received in India, or deemed to accrue or arise,
or received in India. The situs of accrual and receipt of such income
plays an important role in deciding the tax incidence under the Act. Indian
Income tax follows a hybrid of residence and source-based taxation and where
multiple sources exist, the principle of apportionment comes to the fore for
taxation. The Supreme Court in Ahmedbhai Umerbhai [1950] 18 ITR 472 (SC)
held that the place of accrual need not necessarily be the place where the sale
is consummated (i.e., the transfer of property in goods takes place) and income
can be attributed between different places depending on the acts committed at
these places.

 

Income tax has a recognised
principle of profit attribution where cross-border transactions are attributed
to each nation based on Transfer Pricing principles (involving functions
performed, assets employed and risks assumed). In Anglo-French Textile
Company Ltd. vs. Commissioner of Income-tax [1954] 25 ITR 27 (SC), the
Court stated that sale is merely a culmination of all acts to realise the
profit earned therefrom. The terms accrue and arise themselves have an inherent
principle of apportionment within them and in the absence of a specific
statutory provision (as it was then), general principles of apportionments
would be applicable; of course, subject to application of international treaty
covenants.

 

GST, on the other hand, taxes all
supplies in their entirety even if such supply takes place partly in India
(section 5-14 of the IGST Act). Being a transaction-based levy, the trigger of
supply takes place in terms of the place of supply provisions. Unlike the
Income tax law, the place of supply would be the particular place as stated in
the statute (rather than a spread) which would closely replicate the place of
probable consumption of the goods or services. Place of supply cannot be spread
across geographies and subjected to apportionment principles. For example, the
Indian branch of a foreign bank may be contracting for banking and financial services
with a multinational group directly but with active assistance from its
headquarters outside India. Income tax would require the profit from this
activity to be attributed to all the relevant jurisdictions based on a
functional analysis, but GST would treat this contractual consideration as
taxable entirely in India. It’s a different matter that the headquarters may
separately raise a GST invoice on the branch office to recover its costs.

 

IGST law has specific provisions for
identifying the location of supplier or recipient based on the business
establishments across jurisdictions. The term ‘business establishment’ is
defined to involve people, places and permanence and it forms the basis to
decide the location of supplier or recipient (usually residence-driven). The
terms ‘business establishment’ and ‘permanent establishment’ (business
connection) are on similar platforms to some extent. ‘Permanent establishment’
also uses these three parameters (such as a Fixed Place PE, Service PE,
Equipment PE, etc.) to decide the extent of income attributable to a
jurisdiction. The variance is because (a) Income tax has already experienced
significant evolution with changing business dynamics due to which the
permanent establishment concept is quite enlarged to agency functions, etc.;
(b) Income tax does not treat the condition of permanence, place or people as
cumulative and has, over the years, diluted this to significant economic
presence (say, presence of internet users). It may not be totally incorrect to
say that ‘business establishment’ under GST would necessarily entail a
permanent establishment for the overseas enterprise under Income tax, but the
reverse may not always be true.

 

B)  COLLECTION OF TAX

Income tax is an annual tax. It is
imposed for each year called the assessment year based on the income which is
accrued or received in the preceding year (called previous year). Section 4 of
Income tax prescribes a unique methodology of taxing income of a particular
year (previous year) in the subsequent assessment year. Taxes paid during the
previous year take the form of advance tax and the tax paid during the
assessment year is termed as final self-assessed tax. The liability to charge
arises not later than the close of the previous year but the liability to pay
tax is postponed based on the rates fixed by the yearly Finance Act after the
close of the previous year.

 

The Supreme Court in CIT vs.
Shoorji Vallabhdas & Co. [1962] 46 ITR 144 (SC) held:

 

‘Income-tax is a levy on income. No
doubt, the Income-tax Act takes into account two points of time at which the
liability to tax is attracted, viz., the accrual of the income or its receipt;
but the substance of the matter is the income. If income does not result at
all, there cannot be a tax, even though in book-keeping an entry is made about
a “hypothetical income” which does not materialise. Where income has, in fact,
been received and is subsequently given up in such circumstances that it
remains the income of the recipient, even though given up, the tax may be payable.
Where, however, the income can be said not to have resulted at all, there is
obviously neither accrual nor receipt of income, even though an entry to that
effect might, in certain circumstances, have been made in the books of
account.’

 

Similarly in CIT vs. Excel
Industries 2013 38 taxmann.com 100 (SC) and Morvi Industries Ltd.
vs. CIT (Central), [1971] 82 ITR 835 (SC) the Court considered the
dictionary meaning of the word ‘accrue’ and held that income can be said to
accrue when it becomes due. It was then observed that: ‘……. the date of
payment ……. does not affect the accrual of income. The moment the income
accrues, the assessee gets vested with the right to claim that amount even
though it may not be immediately’.

 

GST is a transaction-based tax with
reporting and tax payments being made on a monthly basis. Time of supply
provisions (sections 12 and 13) fix the relevant month in which taxes are
payable. The leviability of GST is on supply of goods / services and charge of
tax is applicable even on an agreement of supply (section 7). In view of this,
goods sold but rejected on quality parameters prior to its acceptance itself,
may be a supply in terms of section 7 but would certainly not be an income to
the taxpayer. For example, the taxpayer has removed goods on 31st January
for sale which are subject to quality approval at the customer’s end for
payment; this would be a supply for the taxpayer for the month of January but
would be income for the very same taxpayer only when the goods are accepted by
the customer and the right to receive the consideration comes into existence in
favour of the supplier. It would be a different case that in case of rejection
the taxpayer can seek a refund of the GST already paid, but one would
appreciate that the GST law is distinct insofar as it imposes taxes and then,
subsequently, grants refund, while Income tax would refrain from imposing tax
itself.

 

Under Income tax the year of accrual
(other than specified exceptions) determines the relevant assessment year.
Importantly, each assessment year is a water-tight compartment and accruals
pertaining to a particular assessment year have to be considered in the
computation of Income tax for that year only and cannot be adopted in any other
assessment year. This is because Income tax is a single tax (refer preceding
discussion) of an assessment year and can be determined only when all incomes
are reporting in tandem. But GST is a transaction tax and reporting of each
transaction is independent of the other. GST, hence, has this peculiar feature
of permitting transactions of a tax period to cross over to other tax periods
and even financial years. Reporting of transactions in subsequent periods is
not fatal to taxation as each transaction is independent and does not impact
the overall taxability.

 

C)  DEDUCTIONS / BENEFITS

Income tax law is required to grant
deduction of expenses or costs as a matter of statutory limits and
Constitutional mandate. This is because the entry for taxation in terms of
Entry 82 is with reference to income and not receipts (for example, income by
way of diversion of overriding title would not be income in its true sense
though it may be received by the taxpayer). Section 28 levies a tax on the
‘profit and gains’ from business, section 45 taxes capital ‘gains’, etc.; no
doubt, the Legislature exercised its liberty in denying certain deductions
(penal expenses) and limiting the quantum of deductions (30% deduction in case
of house property income), but the law is drafted to ascertain the income and
not the gross receipts of a taxpayer. As a consequence, it may not be illegal
for assessing officers to grant deduction of expenses from the records
available even if the same were not availed by the taxpayer.

 

GST also grants a deduction in the
form of input tax credit – this benefit does not emerge from the Constitution
but from the underlying principle of value-added taxation and statutory
provisions made therefrom. The Legislature has a wider latitude insofar as
barring input tax credit on certain inputs (such as motor vehicle, building /
civil structures, etc.) as part of Legislative liberty and one cannot question
this discretion. A theoretical understanding of the statute may also suggest
that the Legislature may have the discretion to deny all input tax credit if it
decides to do so as a matter of policy. Given this, it may not be imperative
for the assessing authority to grant input tax credit if such a claim has not
been put forward. The statute believes that unavailed input tax credit
represents a tax burden passed on to the next person in the value-chain and
hence there is no obligation to grant input tax credit suo motu while
performing an assessment.

 

As regards the scope of deductions,
both these laws seem to have reconciled on the principle of business purpose.
Income tax permits deductions of business expenses while calculating profits
and gains from business or profession. Apart from specific deductions, there is
also a residuary category for claiming deduction of business expenses u/s 37. GST
has also followed a similar path and granted benefit of input tax credit on
most business inputs / expenses. Both the Income tax deduction and GST credit
are fettered with respective ancillary conditions, but these laws seem to have
aligned themselves as a matter of principle. Therefore, a disallowance u/s 37
on personal expenses may also result in a corresponding disallowance of input
tax credit and vice versa. On the capital assets front, while Income tax
grants depreciation on ownership and use of assets, GST does not concern itself
with ownership of assets and mere business use would be sufficient for claim of
input tax credit.

 

D)  PROCEDURES

Under Income tax the law prevailing
as on the first day of an assessment year would be the relevant law for taxability,
but in the case of GST the law prevailing as on the date of the transaction
would be the basis of chargeability.

 

Income tax has adopted a concept of
self-assessment on an annual basis. Being a Central legislation, state-level
reporting is not relevant and entity-level compliance has to be performed. GST
has adopted a monthly assessment methodology with registration-level compliance
for each State, respectively. This makes GST data much more granular in
comparison to the Income tax data collation.

 

On the assessment front, Income tax
has a tested system of summary assessment, scrutiny assessment, best judgement
assessment, reassessment, review, etc. A taxpayer can be assessed multiple
times for the same assessment year. GST has adopted a hybrid system of
adjudication and assessment (borrowed partially from Excise and VAT laws).
Unlike Income tax where the assessment involves both fact-finding and
adjudication of law, GST has kept the fact-finding exercise under audit
procedures which is independent of legal adjudication (show cause proceedings)
and probably performed by different officers.

 

CONCLUSION

Income and GST certainly meet and part at
multiple points. This diversity would cause variance in differential tax
treatments and hence need careful examination. Supply may or may not be backed
by an income and similarly an income may or may not arise from a supply. With
increasing interchange of information of GSTR9/9C and Income tax return
(comprising the P&L and balance sheet) between Government departments, it
is expected that taxpayers should reconcile these variances as a matter of
preparedness before assessing authorities under both laws. It is suggested that
Government implement exchange programmes among tax departments for field
formations in order to effectively administer these tax laws.

Article 13(4) of India-Mauritius DTAA – Capital gains exemption under pre-amended India-Mauritius DTAA is not available to shareholder Mauritius SPV upon transfer of shares of Indian company, as Mauritius SPV was set up as a tax-avoidance device, interposed solely for obtaining treaty benefit

4.       [2020]
114 taxmann.com 434 (AAR-Mum.)

Bid Services Division (Mauritius) Ltd., In re.

AAR No. 1270 of 2011

A.Y.: 2012-13

Date of order: 10th February, 2020

 

Article 13(4) of India-Mauritius DTAA – Capital gains
exemption under pre-amended India-Mauritius DTAA is not available to
shareholder Mauritius SPV upon transfer of shares of Indian company, as
Mauritius SPV was set up as a tax-avoidance device, interposed solely for
obtaining treaty benefit

 

FACTS

The Airports Authority of India (AAI)
undertook an international bidding process for the purpose of inviting bids to
acquire 74% stake in an Indian joint venture company (JV Co.) proposed to be
formed for the purpose of undertaking development, operation and maintenance of
airports at Mumbai and Delhi.

 

A South African entity (SA Co.),
together with other independent entities, formed a consortium and was
successful in acquiring the contract with AAI. The other two entities which
participated with SA Co. were incorporated in India and SA.

 

During the entire bidding process, it
was understood that SA Co. would be a direct investor in the shares of JV Co.
However, ten days prior to submission of final bids, SA Co., through its
wholly-owned subsidiary in South Africa, incorporated an entity in Mauritius
(Mau Co. / Applicant) and invested the funds in JV Co. through Mau Co. The
other two entities in the consortium also invested vide their group entities,
without change in jurisdiction of the entities, i.e., vide entities located in
India (I Co) and SA (SA Co. 2).

 

After a period of approximately five
years of holding, during the A.Y. 2012-13, Mau Co. transferred JV Co.’s shares
to the extent of 13.5% to another existing shareholder of JV Co. while
retaining the balance 13.5% of shares. Mau Co. earned capital gains upon such transfer.

 

A diagrammatic depiction of JV Co.’s
shareholding is as follows:

 

 

Mau Co. claimed that the amount of
capital gains arising from such transfer was not taxable in India by virtue of
exemption granted under Article 13(4) of the India-Mauritius DTAA (treaty).

 

The issue before the AAR was whether
Mau Co. was eligible to claim the capital gains exemption provided under the
treaty.

 

HELD

The AAR held that Mau Co. was not
entitled to treaty benefit as it was a device employed to carry out tax avoidance,
without any commercial substance.

 

®  Mau
Co. was set up close to the project being finalised and was not in existence
from the very start of the bidding process. The other joint venture parties
(including from SA and India) also did investments through their group
concerns, but there was no change in jurisdiction of the principal entities and
the investor entities, being SA Co. 2 and I Co., were from the same
jurisdiction, i.e., SA and India, respectively, unlike SA Co. which interposed
Mau Co. and there was a change in jurisdiction from SA to Mauritius;

®  Mau
Co. did not have any fiscal independence, i.e., no independent source of funds,
and it relied on its holding entity for the same. Further, Mau Co. had no
independent collaterals to secure the funds from third parties;

®  Mau
Co. did not have any independent source of income;

®  Mau
Co. did not have any tangible assets, employees, office space, etc.;

®  While SA Co. as a member of the consortium was to
provide strategic input, advice on various aspects such as structured finance,
ancillary services, corporate governance and cargo and logistics development
services, Mau Co., as its substitution, did not even employ any management
experts or financial advisers to carry out the same tasks;

®  Mau
Co. was not involved in the decision-making process w.r.t the development
process of the project or for resolving the implementation issues that were
encountered;

®  Mau
Co. was set up only to hold the investments in the JV Co.;

®  Mau
Co. merely endorsed the decisions taken by the SA Co.;

®  Mau Co. did not provide any value addition in the
JV Co.

The AAR also held that even if
investments were proposed to be carried out by the SA Co. vide setting up of an
individual SPV, commercially, it could have been set up in South Africa or
India, rather than a third jurisdiction, Mauritius, which was neither a
financial hub nor a provider of low-cost capital.

 

The AAR applied the doctrine of
‘substance over form’ and followed the observations of the Apex Court in the
case of Vodafone International Holdings BV (2012) 341 ITR 1 which
state that treaty benefits should be denied, if a non-resident achieves
indirect transfer through abuse of legal form and without reasonable business
purpose, which results in tax avoidance. In such a case, the tax authority can
re-characterise the equity transfer as per its economic substance and impose
tax directly on the non-resident rather than the interposed entity.

 

Accordingly, the AAR held that Mau Co. was
merely set up as a tax-avoidance device by the SA Co. without having any
independent infrastructure or resources and interposed for the dominant purpose
of avoiding tax in India; thus it cannot be granted any treaty benefits.

Article 12 and Article 5 read with Protocol of India-Swiss DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

3.       [2020]
114 taxmann.com 51 (Mum.)

AGT International GmbH vs. DCIT

ITA No. 7465/Mum/2018

A.Y.: 2015-16

Date of order: 31st January, 2020

 

Article 12 and Article 5 read with Protocol of India-Swiss
DTAA – Tax in India cannot exceed 10% even if Swiss Co has service PE in India

 

FACTS

The assessee, a tax resident of
Switzerland, received fees for technical services from an Indian company and
offered the said income to tax @ 10% on gross basis under Article 12(2) of the
India-Swiss DTAA.

 

The Indian company had withheld tax @
42.024% on the entire amount.

 

The A.O. was of the view that the
services rendered by the assessee (by rendering services in India) did not
amount to fees for technical services as defined in Article 12 and that the
assessee had a Service PE in India. The A.O. computed the income by allowing
expenditure @ 40% on estimated basis and taxed the remaining 60% amount at the
normal income tax rates applicable to foreign companies. As against 10%, the
assessee was assessed effectively at 24% (being 40% of 60).

 

Aggrieved by the stand taken by the
A.O., the assessee raised objections before the DRP but without any success.
Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

The Tribunal referred to the Protocol
of the India-Swiss Treaty which states that furnishing of services covered by
sub-paragraph (l) of paragraph 2 (i.e., Service PE) shall be taxed according to
Article 7 or, on request of the enterprise, according to the rates provided for
in paragraph 2 of Article 12.

In light of the said Protocol, the Tribunal held
that the assessee has a choice to be taxed on gross basis at the rates provided
under article 12(2) or on net basis under article 7. A combined reading of the
above provision of article 5(2)(l) along with the related Protocol clause is
that on Service PE being triggered on account of rendition of services by a
Swiss entity in India, or vice versa, it can never make the assessee
worse off so far as the tax liability in source jurisdiction is concerned.
Unless the assessee has a lower tax on PE profits on net basis under article 7 vis-à-vis
taxability of FTS on gross basis under article 12(2), the PE trigger does not
trigger higher tax.

Article 13 of India-Belgium DTAA – Gain arising on indirect transfer of shares of Indian company not taxable in India as per Article 13(6) of India-Belgium DTAA

2.       TS-129-ITAT-2020

Sofina S.A. vs. ACIT

ITA No. 7241/Mum/2018

A.Y.: 2015-16

Date of order: 5th March, 2020

 

Article 13 of India-Belgium DTAA – Gain arising on indirect
transfer of shares of Indian company not taxable in India as per Article 13(6)
of India-Belgium DTAA

 

FACTS

The assessee is a tax resident of
Belgium and is a venture capital investor who invested in Startups in India
such as Myntra, Freecharge, etc.

 

The assessee owned 11.34% stake in
preference shares of Sing Co, a company tax resident of Singapore. In turn,
Sing Co held 99.99% shares in an Indian company (ICO). The assessee sold its
entire 11.34% stake in Sing Co to J, an unrelated Indian company. J, while
making the payment, deducted TDS u/s 195 of the Act. The assessee claimed refund
of TDS in its return of income relying on Article 13(6) of the India-Belgium
DTAA as per which gains arising from the alienation of shares of Sing Co are
taxable in the contracting state of which the alienator is a resident, i.e.,
Belgium.

 

The
A.O. held that the assessee carried out an indirect transfer of shares which is
taxable in India. As per Explanation 5 to section 9(1)(i) of the Act, shares of
Sing Co derived value substantially from ICO and therefore the shares of Sing
Co are deemed to be situated in India. The A.O. imported the Explanation 5 to
section 9(1)(i) in order to deem Sing Co as a company resident in India.
Accordingly, in his view, the transfer of shares of Sing Co was covered under
Article 13(5) and was taxable in India.

 

On appeal, the DRP approved the view
of the A.O. Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

Article 13(5) of the India-Belgium
Tax Treaty applies if the following two conditions are cumulatively satisfied:
(i) the transfer of shares should represent the participation of at least 10%
in the capital stock of the company; and (ii) the company whose shares are
transferred should be a resident of a contracting state. As the assessee
transferred shares of a Singapore resident company, the second condition is not
satisfied and, accordingly, Article 13(5) is not applicable.

 

Unlike Explanation 5 to section
9(1)(i) and Article 13(4) (providing for indirect transfer tax of company
deriving value from immovable property in India), Article 13(5) of the
India-Belgium Tax Treaty did not adopt a see-through approach. It does not
refer to ‘direct or indirect transfer’. Accordingly, the transfer of the shares
of Sing Co cannot be regarded as shares of its subsidiary ICO.

 

Explanation 5 to section 9(1)(i) of
the Act does not define residence of a person and only deems shares of a
foreign company to be located in India. In the absence of any provision for
deeming a Singapore resident company as a treaty resident of India either in
the DTAA between India and Singapore, or in the DTAA between India and Belgium,
Sing Co cannot be held to be a company resident of India so as to get covered
by Article 13(5).

 

The Tribunal upheld the assessee’s contention
that the transfer will be governed by residuary clause Article 13(6) and will
be taxable in the state of the alienator, i.e., Belgium.

Article 12 of India-US DTAA – Deputation of skilled employee results in making technology available and satisfies FIS article under India-US DTAA

1.      
[2020] 115 taxmann.com 129 (Mum.)

General Motors Overseas Corporation
vs. ACIT

ITA Nos. 1282 of 2009; 1986, 2787 of
2014; 381 (Mum.) of 2018

A.Ys: 2004-05, 2008-09 to 2010-11

Date of order: 6th March,
2020

 

Article 12 of India-US DTAA –
Deputation of skilled employee results in making technology available and
satisfies FIS article under India-US DTAA

 

FACTS

The assessee, a US resident company,
entered into a Management Provision Agreement (MPA) with its Indian group
company G engaged in the business of manufacture, assembly, marketing and sale
of motor vehicles and other products in India. Under the MPA, the assessee
agreed to provide executive personnel to assist G in its activities of
development of general management, finance, purchasing, sales, service,
marketing and assembly / manufacturing. Further, the assessee agreed to charge
salary and other direct expenses related to such personnel from G.

 

Past proceedings before AAR

The assessee had made an application
to AAR in the past to ascertain the tax liability of the amount received under
MPA. In the circumstances and on the basis of the facts on record, AAR had
concluded that the services are ‘managerial’ and not ‘technical or consultancy’
in nature and accordingly are not within the scope of charge of Article 12. AAR
had, however, indicated that the amount received by G may trigger taxation if
the assessee has a Permanent Establishment (PE) in India and accordingly the
receipts may constitute business profits. AAR had, however, caveated
(conditioned) its ruling by stating that it had no information or material to
indicate that the employees were rendering services of a nature falling beyond
the terms of the MPA and whether, in fact, there was a PE trigger. AAR also
clarified that the tax authorities can examine the factual position and take
appropriate action if they find the factual situation to be otherwise.

 

Assessment and appeal proceedings

During the course of assessment, the
facts noted by the A.O. were as follows:

(i)   The
assessee had deputed two employees, viz., (i) Mr. A – President and MD of G and
responsible for overall management and direction of G operations; and (ii) Mr.
S – Vice-President (Manufacturing), responsible for overall management of G
facilities to manufacture and assemble products of G according to required
standards;

(ii)   The
A.O. also called for a copy of the service agreement of the deputationists
which the assessee failed to produce. The A.O. held that the services rendered
by Mr. S satisfied the make-available requirement and constituted FIS;

(iii)
Seeking to follow the AAR ruling, the
A.O. concluded that the assessee had a PE in India and computed its business
profit by taxing gross receipt at 20% u/s 44D r.w.s. 115A without providing
deduction for any expenses;

(iv) On
appeal, the CIT(A) upheld the A.O.’s order. Being aggrieved, the assessee
preferred an appeal before the Tribunal.

 

HELD

Services rendered by Mr. A

It was not disputed by the parties
that the services rendered by Mr. A were managerial in nature and in the
absence of charge for managerial service in the FIS Article of the India-US
Treaty, the said payment did not constitute FIS and hence was not chargeable to
tax in India.

 

Services rendered by Mr. S

The ruling given by the AAR, although
binding on the Commissioner and income tax authorities subordinate to the
Commissioner, is, however, not binding on the Tribunal and only has a
persuasive value for the reason that the Tribunal is not an authority coming
under the Commissioner. However, the dispute can reach the Tribunal when the
authorities bound by the ruling do not follow the ruling for valid or invalid
reasons. Hence, the Tribunal is required to examine the reasons given by the
authorities for not following the AAR ruling.

 

The caveat portion of the AAR ruling
makes it clear that this ruling was not an absolute and unqualified one. The
AAR ruling on the services rendered by Mr. S was a general, non-conclusive
finding. The power was given to the tax authorities to examine the transaction
/ actual conduct of parties. In the absence of the assessee providing the
service agreement or other documents showing the actual services rendered by
Mr. S, the A.O. had no other option but to examine the MPA and determine the
scope of services provided by Mr. S.

 

Mr. S, Vice-President
(Manufacturing), was working with the assessee before being sent as an employee
to India. It was obvious that Mr. S had sufficient knowledge and experience of
the technology and its standards used by the assessee in the US. In the
automobile industry, assembly of products and the standards of the company are
patented / protected technology and the owner of the technology charges royalty
for the same. But in the present case no royalty had been charged by the
assessee from G because the assessee had sent its employee to India. This
person was an expert in the technology, experienced in the assembly of products
and well aware of the standards of the company.

 

The
technology / expertise lay in the technical mind of an employee/s and if key
employee/s having the requisite knowledge, experience and expertise of
technology are transferred from one tax jurisdiction to another tax
jurisdiction, then it is transfer of technology. By sending Mr. S, technology
was made available in India by the assessee.

 

Computation of income

As regards computation of business profits, the
Tribunal on a co-joint reading of Article 7(3) and section 44D, ruled that
profits need to be taxed at 20% on gross basis as section 44D prohibits
deduction for any expenses.

Section 10AA – Profit of eligible unit u/s 10AA should be allowed without set-off of loss of other units

2.      
Genesys
International Corporation Limited vs. DCIT –-Mum.

Members: G. Manjunatha (A.M.) and Ravish Sood (J.M.)

ITA No. 7574/Mum/2019

A.Y.: 2011-12

Date of order: 4th March, 2020

Counsel for Assessee / Revenue:
V. Chandrasekhar & Harshad Shah / V. Vinod Kumar

 

Section 10AA – Profit of eligible unit u/s 10AA should be
allowed without set-off of loss of other units

 

FACTS

The assessee had filed its
return of income declaring total loss at Rs. 3.20 crores. The assessment was
completed u/s 143(3) determining the total loss at Rs. 1.68 crores. The case
was subsequently reopened u/s 147 and the assessment was completed u/s 143(3)
r.w.s. 147 determining the total income at Nil
after set-off of loss from business against profit of eligible unit
u/s 10AA.

 

Before the CIT(A) the assessee, relying on the decision of
the Supreme Court in the case of CIT vs. Yokogawa India Ltd. (2017) 77
taxmann.com 41, contended that the profit of the eligible unit u/s 10AA
should be allowed without set-off of loss of other units. The CIT(A) rejected
the arguments of the assessee on the ground that the findings of the Supreme
Court were based on the computation of deduction provided u/s 10A, not on
computation of deduction provided u/s 10AA.

 

Revenue submitted before the Tribunal that the CIT(A) had
clearly distinguished the decision of the Supreme Court and, hence, the
findings of the Supreme Court are not applicable.

 

HELD

Referring to the decisions
of the Supreme Court in the case of CIT vs. Yokogawa India Ltd. and
of the Bombay High Court in the case of Black & Veatch Consulting
Pvt. Ltd. (348 ITR 72), the Tribunal held that the sum and substance of
the ratio laid down by the Supreme Court and the Bombay High Court is
that the profit of eligible units claiming deduction u/s 10A / 10AA, shall be
allowed without setting off of losses of other units. Therefore, it was held
that the lower authorities erred in set-off of loss of business from the profit
of eligible units claiming deduction u/s 10AA before allowing deduction
provided u/s 10AA. Accordingly, the appeal filed by the assessee was allowed.

Section 54 / 54F – Exemption not denied when the property was purchased in the name of the spouse instead of the assessee Two conflicting High Court decisions – In case of transfer of case between two jurisdictions, the date of filing of appeal is the material point of time which determines jurisdictional High Court

1.       Ramphal
Hooda vs. Income Tax Officer (Delhi)

Members: Bhavnesh Saini
(J.M.) and
Dr. B.R.R. Kumar (A.M.)

ITA No. 8478/Del/2019

A.Y.: 2014-15

Date of order: 2nd
March, 2020

Counsel for Assessee /
Revenue: Ved Jain & Umung Luthra / Sanjay Tripathi

 

Section 54 / 54F – Exemption not denied when the property
was purchased in the name of the spouse instead of the assessee

Two conflicting High Court decisions – In case of transfer
of case between two jurisdictions, the date of filing of appeal is the material
point of time which determines jurisdictional High Court

 

FACTS

During the year the assessee had earned long-term capital
gain of Rs. 1.42 crores on the sale of property. This gain had been invested in
purchasing another property for Rs. 1.57 crores in the name of his wife. The
assessee claimed exemption of long-term capital gains u/s 54 / 54F. Relying on
the judgment of the jurisdictional High Court, i.e., the Punjab and Haryana
High Court, in the case of CIT Faridabad vs. Dinesh Verma (ITA No. 381 of
2014 dated 6th July, 2015) wherein it was held that ‘the
assessee is not entitled to the benefit conferred u/s 54B if the subsequent
property is purchased by a person other than the assessee…’ the A.O. had
denied the exemption.

 

It was submitted before the CIT(A) that the case of the
assessee is covered by the judgment of the Delhi High Court in the case of CIT
vs. Kamal Wahal (351 ITR 4) wherein, on identical facts, the issue had
been decided in favour of the assessee. The CIT(A), however, noted that the
assessee had filed the return with the ITO, Rohtak and the assessment was also
framed at Rohtak. Therefore, the judgment of the Punjab and Haryana High Court
was binding on the assessee and the A.O. Accordingly, the appeal of the
assessee was dismissed.

 

The assessee submitted before the Tribunal that his PAN was
transferred from Rohtak to Delhi because he was residing in Delhi. The case of
the assessee had also been transferred to Delhi, therefore the jurisdictional
High Court should be the Delhi High Court. He relied upon the judgment of the Delhi
High Court in the case of CIT vs. AAR BEE Industries [2013] 357 ITI 542
wherein it was held that ‘It is the date on which the appeal is filed which
would be the material point of time for considering as to in which court the
appeal is to be filed’. He further pointed out that the appeal of the
assessee had been decided by the CIT(A)-28, New Delhi and the address of the
assessee was also in Delhi. Therefore, it was submitted that the Delhi High
Court is the jurisdictional High Court and its decisions are binding on the
CIT(A).

 

HELD

The Tribunal noted that the jurisdiction and PAN
of the assessee had been transferred to Delhi and the appeal was also decided
by the CIT(A), New Delhi. Therefore, the Tribunal accepted the submission of
the assessee and held that the CIT(A) was bound to follow the judgments of the
Delhi High Court. Accordingly, relying on the judgments of the Delhi High Court
in the cases of CIT-XII vs. Shri Kamal Wahal (Supra) and of CIT
vs. Ravinder Kumar Arora [2012] 342 ITR 38, the Tribunal allowed the
appeal of the assessee.

Section 143(2) – The statutory notice u/s 143(2) of the Act issued by the non-jurisdictional A.O. is void ab initio – If there are discrepancies in the details as per notice issued and details as per postal tracking report, then that cannot be considered as valid service of notice

5.       [2019]
76 ITR (Trib.) 107 (Del.)

Rajeev Goel vs. ACIT

ITA No. 1184/Del/2019

A.Y.: 2014-15

Date of order: 26th September, 2019

 

Section 143(2) – The statutory notice u/s 143(2) of the Act
issued by the non-jurisdictional A.O. is void ab initio – If there are
discrepancies in the details as per notice issued and details as per postal
tracking report, then that cannot be considered as valid service of notice

 

FACTS

The assessee’s case was selected for scrutiny by issuing
statutory notice u/s 143(2). The notice was issued by the non-jurisdictional
A.O., i.e., A.O. Circle 34(1), and without any order u/s 127 for transfer of
the case from one A.O. to another. Without prejudice to the assessee’s
contention that the notice was issued by non-jurisdictional A.O., notice u/s
143(2) was not served upon the assessee. While serving notice u/s 143(2), there
were discrepancies in the address stated in the notice and the address
mentioned in the tracking report of the post. The address mentioned in the
notice was with Pin Code 110034 and the Pin Code as per the tracking report was
110006.

 

The assessee had filed an affidavit before the A.O. claiming
that no notice u/s 143(2) was served upon him. He had produced all possible
evidences to prove that there were discrepancies while serving the said notice
and also that the assessment was initiated by non-jurisdictional A.O. These
contentions were not accepted by the A.O.

 

Aggrieved, the assessee preferred an appeal to the CIT(A)
claiming that the statutory notice u/s 143(2) was issued by the
non-jurisdictional A.O. and, thus, the assessment was void ab initio.
Without prejudice to this, the statutory notice u/s 143(2) was not validly
served upon the assessee. The CIT(A) held that the notice was served upon the
assessee and the assessee had failed to raise objections within the stipulated
period prescribed u/s 124(3) of the Act and hence dismissed the assessee’s
appeal.

Aggrieved, the assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that there was a difference between the
address mentioned in the PAN database and the address mentioned in the return
of income filed by the assessee. The jurisdiction of the assessee as per his
address in the PAN database was with the A.O. Ward 39(1), whereas the
jurisdiction of the assessee as per his address in his return of income was
with A.O. Circle 47(1). However, the notice was issued by the A.O. Circle 34(1)
who had no jurisdiction over the assessee either on the basis of his
residential address or on the basis of his business address. Further, no order
u/s 127 of the Act was passed either by the Commissioner of Circle 34(1), or
the Commissioner of Circle 47(1) for transfer of the case from one A.O. to
another A.O. Thus, the notice issued by the A.O. Circle 34(1) was held to be void
ab initio as it was issued by the non-jurisdictional A.O.

 

Further, the Tribunal observed that even if the notice u/s
143(2) issued by the A.O. Circle 34(1) was considered to be valid, the notice
was not duly served upon the assessee. The address mentioned in the notice was
one of Delhi with Pin Code 110034, whereas the notice had been delivered to a
Delhi address with Pin Code 110006. As regards service of notice, the assessee
had filed an affidavit before the A.O. Circle 47(1) claiming that no notice u/s
143(2) was served upon him. The assessee had produced all possible evidences to
prove that there were discrepancies while serving notice u/s 143(2). Besides,
there was also a difference in the name mentioned in the notice which was
Rajeev Goel, whereas that mentioned in the tracking report was Ranjeev Goel.
Hence, on the basis of the aforementioned discrepancies, the notice was held to
be not validly served upon the assessee.

 

The Tribunal decided this ground of appeal in
favour of the assessee.

Section 153(1) r/w clause (iv) of Explanation 1 – Extension of time is provided to complete the assessment in a case where A.O. makes reference to the Valuation Officer only u/s 142A(1) – Where a reference is made to the Valuation Officer u/s 55A or 50C, there is no extension of time to complete the assessment

4.       [2019]
76 ITR (Trib.) 135 (Luck.)

Naina Saluja vs. DCIT

ITA No. 393/LKW/2018

A.Y.: 2013-14

Date of order: 25th October, 2019

 

Section 153(1) r/w clause (iv) of Explanation 1 – Extension
of time is provided to complete the assessment in a case where A.O. makes
reference to the Valuation Officer only u/s 142A(1) – Where a reference is made
to the Valuation Officer u/s 55A or 50C, there is no extension of time to
complete the assessment

 

FACTS

The assessee had sold her
two properties and derived income under the head ‘Capital Gains’ during the
relevant A.Y. 2013-14. While computing long-term capital gain, the assessee had
worked out the cost of acquisition on the basis of the circle rates as on 1st
April, 1981. For this purpose, the A.O. had referred the matter to the
Valuation Officer for estimating the correct fair market value of the properties
as on that date. In the meanwhile, the assessee had challenged the Stamp Duty
Value adopted and requested to refer the matter to the Valuation Cell for
valuation of the property as on the date of transfer. As the transaction was
falling under ‘capital gains’, the reference made by the A.O. to the Valuation
Officer was u/s 55A and the reference made by the assessee for valuation was
u/s 50C. The A.O. had received the second valuation report on 21st
March, 2016 and had thereafter called for objections from the assessee on the
second valuation report. The A.O. concluded the assessment and passed an
assessment order on 19th May, 2019 making an addition to the capital
gains on the basis of the said valuation report.

 

Aggrieved, the assessee preferred an appeal to the CIT(A)
claiming that the assessment completed was beyond the time period prescribed in
section 153 of the Act and, thus, the assessment order was barred by
limitation. However, the CIT(A) held that both the references were made u/s
142A of the Act and thereby concluded that the assessment order was not barred
by limitation. The CIT(A) upheld the assessment order and dismissed the
assessee’s appeal.

 

The assessee preferred an appeal to the Tribunal.

 

HELD

The Tribunal observed that the reference to the Valuation
Officer u/s 142A can be made for the purpose of assessment or reassessment
where the valuation is required for the purpose of section 69, 69A, 69B or
section 56(2), whereas the references u/s 55A or u/s 50C are specific for the
purpose of computation of capital gains. The provisions of section 142A do not
govern the provisions of computation of capital gains.

 

The first reference to the Valuation Officer was made for
ascertaining the value of the asset as on 1st April, 1981 when it
was sold, and the second reference was made for valuation of property as on the
date of transfer which can only be made under the provisions of section 50C(2)
of the Act. Thus, neither of the references was made u/s 142A of the Act.

 

Further, as per the provision of section 153(1) r/w
Explanation 1, the provision for extension of time for completing the
assessment is available only if the reference is made to the Valuation Officer
u/s 142A. There is no provision for extension of time for completing the
assessment in case the reference is made u/s 55A or u/s 50C. Hence, the
assessment order was to be passed by 31st March, 2016 for the
relevant assessment year. The assessment order was, however, passed on 19th
May, 2016 which was beyond the period of limitation, hence the Tribunal quashed
the assessment order.

 

The Tribunal decided this ground of appeal in
favour of the assessee.

I.Section 194H – Benefit extended by assessee to the distributor under an agreement for supply of mobile phones cannot be treated as commission liable for deduction of tax at source u/s 194H as the relationship between the assessee and the distributor was not of a principal and agent II.Section 37 – Expenditure incurred on Trade Price Protection to counter changes in price of handsets by competitors, life of model, etc. was incurred wholly and exclusively for the purpose of business and was an allowable expenditure u/s 37(1)

11.
[2020] 114 taxmann.com 442 (Delhi) Nokia
India (P) Ltd. vs. DCIT ITA Nos.:
5791 & 5845(Del)2015 A.Y.:
2010-11 Date of
order: 20th February, 2020

 

I.   Section 194H – Benefit extended by assessee
to the distributor under an agreement for supply of mobile phones cannot be
treated as commission liable for deduction of tax at source u/s 194H as the
relationship between the assessee and the distributor was not of a principal
and agent

 

II.  Section 37 – Expenditure
incurred on Trade Price Protection to counter changes in price of handsets by
competitors, life of model, etc. was incurred wholly and exclusively for the
purpose of business and was an allowable expenditure u/s 37(1)

 

FACTS I

The assessee
company had extended certain benefits / post-sale discounts to the
distributors. These discounts / trade offers did not form part of the agreement
between the assessee and the distributors. The A.O. disallowed the expenditure
u/s 40(a)(ia) considering the fact that no TDS u/s 194H was deducted from these
amounts.

 

HELD I

Upon perusal of the
agreement, the Tribunal observed that the relationship between the assessee and
HCL is that of principal to principal and not that of principal and agent. The
Tribunal held that the discount which was offered to distributors is given for
promotion of sales. This element cannot be treated as commission. There is
absence of  principal-agent relationship
and the benefit extended to distributors cannot be treated as commission u/s
194H of the Act.

 

As regards the applicability of section 194J, the A.O. has not given any
reasoning or finding that there is payment for technical service liable for withholding
u/s 194J. Marketing activities had been undertaken by HCL on its own. Merely
making an addition u/s 194J without the actual basis for the same on the part
of the A.O. is not just and proper.

 

As regards the
contention of the Revenue that discounts were given by way of debit notes and
the same were not adjusted or mentioned in the invoice generated upon original
sales made by the assessee, the Tribunal observed that this contention does not
seem tenable after going through the invoice and the debit notes. In fact,
there is clear mention of the discount for sales promotion.

 

The Tribunal
allowed this ground of appeal and deleted the addition made.

 

FACTS II

The assessee
company had incurred certain expenditure on Trade Price Protection which was
extended to distributors to counter changes in the price of handsets by
competitors, protect them against probable loss, etc. The A.O. had disallowed
the expenditure questioning the commercial expediency involved in incurring the
same.

 

HELD II

The Tribunal held
that the expenditure can be treated as being incurred on account of commercial
expediency considering the modern-day technological changes which are very
fast. It observed that as per the submission made before the A.O., this
expenditure had been covered in a special clause in the Trade Schemes filed.
The Tribunal further held that expenditure incurred for Trade Price Protection
was allowed as deduction since the same was considered as being incurred wholly
and exclusively for the purpose of business.

This ground of
appeal filed by the assessee was allowed.

Section 10(13A), Rule 2(h) of Fourth Schedule – For the purpose of computing qualifying amount u/s 10(13A) of the Act, the amount received as performance bonus does not assume character of salary

17. [2020] 113
taxmann.com 295 (Trib.)(Kol.) Sudip Rungta vs.
DCIT ITA No.
2370/Kol/2017 A.Y.: 2011-12 Date of order: 10th
January, 2020

 

Section 10(13A), Rule 2(h) of Fourth Schedule – For the purpose of
computing qualifying amount u/s 10(13A) of the Act, the amount received as
performance bonus does not assume character of salary

 

FACTS

The assessee was a salaried employee who, for the year under
consideration, filed his return of income declaring total income of Rs.  2,61,97,296. During the year under
consideration, he had received a basic salary of Rs. 30,00,000 and performance
bonus of Rs. 1,50,00,000. In the return he had claimed exemption of HRA of Rs.
8,47,742. The AO called for details of the rent paid and calculation of the
amount of exemption. In response, the assessee submitted that the total rent
paid during the year was Rs. 8,20,000 and for the purposes of computing
exemption, only the basic salary had been regarded as ‘salary’.

 

The AO held that
‘performance bonus’ is covered under the term ‘salary’ as per the meaning
assigned to the definition of ‘salary’ for the purpose of calculating exemption
u/s 10(13A). ‘Performance bonus’ cannot be comprehended as an allowance or
perquisite as defined in Rule 2(h) of the Fourth Schedule to be excluded from
the purview of ‘salary’. Thus, the assessee’s total salary for computation of
exemption u/s 10(13A) for the year under assessment comes to Rs. 30,00,000 plus
Rs. 1,50,00,000, which totals Rs. 1,80,00,000; and 10% of this comes to Rs.
18,00,000. Since the assessee has paid rent of Rs. 8,20,000 which is much less
than the amount of Rs. 18,00,000, the assessee is not entitled to any benefit u/s
10(13A) of the Act. Thus, the AO denied the benefit u/s 10(13A) of the Act.

 

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

 

The assessee then
preferred an appeal to the Tribunal where it was submitted that clause (h) of
Rule 2A  specifically provides that
‘salary’ includes dearness allowance if the terms of employment so provide, but
excludes all other allowances and perquisites. Accordingly, the performance bonus
received by the appellant did not form part of ‘salary’ for the purposes of
computing exemption u/s 10(13A) of the Act.

 

HELD

The Tribunal noted
that the decision of the Hon’ble Kerala High Court in the case of CIT vs.
B. Ghosal (125 ITR 444) is on identical facts wherein on the same set
of facts, the Court had held that ‘performance bonus’ does not form part of
‘salary’ as defined in clause (h) of Rule 2A for the purposes of section
10(13A) of the Income tax Act, 1961.

 

Considering the facts narrated above, the Tribunal noted that total rent
paid by the assessee during the year is Rs. 8,20,000. The basic salary for the
purpose of computation of house rent disallowance is Rs. 3,00,000 (10% of Rs.
30,00,000 being basic salary). Therefore, excess of rent paid over 10% of
salary is Rs. 5,20,000 (Rs. 8,20,000 minus Rs. 3,00,000). Therefore, the
assessee is entitled for house rent allowance at Rs. 5,20,000 u/s 10(13A) of
the Act. The AO is directed to allow the exemption of HRA at Rs. 5,20,000.

 

The Tribunal
allowed the appeal filed by the assessee.

 

ITP-3(1)(4) vs. M/s Everlon Synthetics Pvt. Ltd. [ITA No. 6965/Mum/2013; Date of order: 23rd May, 2016; A.Y.: 2006-07; Mum. ITAT] Section 147: Reassessment – Within four years – Regular assessment u/s 143(3) – Issue of one-time settlement with bank and consequential relief granted by the bank was discussed and deliberated by the AO – Reopening notice issued on same ground is bad in law

12. The Pr.
CIT-3 vs. M/s Everlon Synthetics Pvt. Ltd. [Income tax Appeal No. 1039 of 2017] Date of order:
4th November, 2019 (Bombay High
Court)

 

ITP-3(1)(4) vs.
M/s Everlon Synthetics Pvt. Ltd. [ITA No. 6965/Mum/2013; Date of order: 23rd
May, 2016; A.Y.: 2006-07; Mum. ITAT]

 

Section 147:
Reassessment – Within four years – Regular assessment u/s 143(3) – Issue of
one-time settlement with bank and consequential relief granted by the bank was
discussed and deliberated by the AO – Reopening notice issued on same ground is
bad in law

 

The assessee is
engaged in the business of manufacture of polyester and texturised / twisted
yarn and management consultancy. The assessee filed its return of income on 29th
November, 2006. The AO completed the assessment on 24th November,
2008 u/s 143(3) of the Act, accepting ‘Nil’ return of income as filed by the
assessee. Thereafter, on 28th March, 2011, a notice was issued u/s
148 of the Act to the assessee, seeking to re-open the assessment. The reason
in support of the re-opening notice was in regards to cessation of liability
u/s 41 of the Act.

 

The assessee
objected to the re-opening notice on the ground that it was based on ‘change of
opinion’ and, therefore, without jurisdiction. However, this contention was not
accepted by the AO. This resulted in the assessment order dated 30th
August, 2011 u/s 143(3) r/w/s 147 of the Act, adding the sum of Rs. 1.37 lakhs
to the income of the assessee by holding it to be a revenue receipt.

 

Aggrieved by
this order, the assessee company filed an appeal to the CIT(A). The CIT(A)
recorded a finding of fact that during the course of regular scrutiny
proceedings u/s 143(3), the issue of the assessee’s one-time settlement with
the bank and consequential relief granted by the bank was discussed and
deliberated by the AO. In fact, queries were raised by the AO with regard to
the one-time settlement; the assessee, by its communication dated 11th
November, 2008, responded with complete details of the one-time settlement with
its bankers, including the details of relief / waiver obtained. The CIT(A) held
the settlements to the extent of Rs. 2.06 crores as revenue receipt, as
reflected in the Profit and Loss Account, and the fact that the amount of Rs.
1.37 crores was transferred to the capital account was deliberated upon by the
AO before passing an order u/s 143(3) of the Act. Thus, the CIT(A) held that
the re-opening notice was without jurisdiction as it was based on a mere change
of opinion.

 

Being aggrieved
by the order of the CIT(A), the Revenue filed an appeal to the Tribunal. The
Tribunal held that the issue of one-time settlement with the bank and the
treatment being given to the benefit received on account of settlement, was a
subject matter of consideration by the AO. It found on facts that during the
regular assessment proceedings, the issue of one-time settlement was inquired
into by the AO and the appellant had furnished all details in its letter dated
11th November, 2008. It also records the fact that the impugned
notice was only on the basis of audit objection and the AO had not applied his
mind before issuing a re-opening notice and merely acted on the dictate of the
audit party. In the circumstances, the Tribunal upheld the view of the CIT(A)
that the re-opening notice is without jurisdiction.

 

Aggrieved by
the order of the ITAT, the Revenue filed an Appeal to the High Court. The
Revenue submitted that the issue of one-time settlement found no mention in the
assessment order passed u/s 143(3). Thus, no opinion was formed by the AO while
passing the regular assessment order. Therefore, there was no bar on him on
issuing the re-opening notice. It was, thus, submitted that the issue requires
consideration and the appeal be admitted.

 

The Court
observed that during the scrutiny assessment proceedings, queries were raised
and the petitioner filed a detailed response on 11th November, 2008
giving complete details to the AO of the one-time settlement and the manner in
which it was treated. This finding of fact was not shown to be perverse in any
manner. The re-opening notice is not based on any fresh tangible material but
proceeds on the material already on record with the AO and also considered before
passing the order u/s 143(3). The submission
of Revenue that consideration of an issue by the AO must be reflected in the
assessment order, is in the face of the decision of the Court in GKN
Sinter Metals Ltd. vs. Ms Ramapriya Raghavan 371 ITR 225 which approved
the view of the Hon’ble Gujarat High Court in CIT vs. Nirma Chemicals
Ltd., 305 ITR 607, to the effect that an assessment order cannot deal
with all queries which the AO had raised during the assessment proceedings. The
AO restricts himself only to dealing with those issues where he does not agree
with the assessee’s submission and gives reasons for it. Otherwise, it would be
impossible to complete all the assessments within the time limit available.

 

Thus, the Court held that once a query is raised during assessment
proceedings and the assessee has responded to the query to the satisfaction of
the AO, then there has been due consideration of the same. Therefore, issuing
of the re-opening notice on the same facts which were considered earlier,
clearly amounts to a change of opinion and is, thus, without jurisdiction.
Accordingly, the Revenue appeal is dismissed.

 

 

Sections 2(47), 45 – Amount received by assessee, owner of a flat in a co-operative housing society, from a developer under a scheme of re-development was integrally connected with transfer of old flat to developer for purpose of re-development, in lieu of which assessee received the said amount and a new residential flat – To be treated as income under head ‘capital gain’

3.       [2020]
115 taxmann.com 7 (Mum.)

Pradyot B. Borkar vs. ACIT

ITA No. 4070/Mum/2016

A.Y.: 2011-12

Date of order: 17th January, 2020

 

Sections 2(47), 45 – Amount received by assessee, owner of a
flat in a co-operative housing society, from a developer under a scheme of
re-development was integrally connected with transfer of old flat to developer
for purpose of re-development, in lieu of which assessee received the
said amount and a new residential flat – To be treated as income under head
‘capital gain’

 

FACTS

The assessee, an individual, filed his return of income
declaring total income of Rs. 32,30,000. The A.O., in the course of assessment
proceedings noted that the assessee has offered long-term capital gain of Rs.
31,12,638, towards sale of residential flats at C-20, 179, MIG, Bandra, Mumbai,
and has simultaneously claimed deduction u/s 54 of the Act.

 

The A.O. found that the
assessee owned a flat in the housing society which was given for development
under a scheme of re-development. As per the terms of the development agreement
between the housing society and its members, in addition to receiving a new
residential flat after re-development, each member was also entitled to receive
an amount of Rs. 53,80,500, comprising of the following:

 

Rs. 25,00,000

Compensation for
non-adherence by the re-developer to the earlier agreed terms and that the
member should be required to vacate the old flat.

 

 

Rs. 28,50,500

Beneficial right and interest
in corpus and income of the society and nuisance annoyance and hardship that
will be suffered by the members during the re-development.

 

 

Rs. 30,000

Moving or shifting cost.

 

 

The A.O. held that the amount received is not in any way related
to transfer of capital asset giving rise to capital gain. He assessed the
amount of Rs. 53,30,500 under the head ‘Income from Other Sources’.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) who
confirmed the action of the A.O. The assessee then preferred an appeal to the
Tribunal.

 

HELD

The Tribunal noted that in the return of income the assessee
has offered the amount of Rs. 53,50,500 as income from long-term capital gain.
But the A.O. has held that the amount is in the nature of compensation received
due to some specific factors and not related to transfer of capital asset. He
also observed that as per the terms of the development agreement, any capital
gain arising due to re-development would accrue to the housing society.
Therefore, the compensation received, Rs. 53,50,500, cannot be treated as
capital gain.

 

The Tribunal held that the amount of Rs. 53,50,500 was
received by the assessee only because of handing over the old flat for the
purpose of re-development. Therefore, the said amount is integrally connected
with the transfer of his old flat to the developer for re-development in
lieu of which he received the said amount and a new residential flat.
Therefore, the amount of Rs. 53,50,500 has to be treated as income under the
head ‘Capital Gain’. The Tribunal observed that the decision of the Co-ordinate
Bench in Rajnikant D. Shroff [ITA No. 4424/Mum/2014, dated 23rd September,
2016] supports this view. It held that the amount of Rs. 53,50,500 has
to be assessed under the head ‘Capital Gain’.

 

This ground of appeal filed by the assessee was allowed.

AMENDMENT IN FOREIGN DIRECT INVESTMENT RULES

(A)   BACKGROUND

Under the erstwhile
FEMA regulations governing Foreign Direct Investment into India (‘FDI’), i.e.
FEM 20(R), Foreign Exchange Management (Transfer of Issue of Security by a
Person Resident outside India) Regulations, 2017 (‘FDI Regulations’) dated 7th
November, 2017, the RBI had powers to govern FDI which included equity
investments into India.

 

However, the above
position governing FDI has been overhauled since then. The Government of India,
with effect from 15th October, 2019, assumed power from RBI to
regulate non-debt capital account transactions which would include equity
instruments, capital participation in LLP, etc. by issuing the Foreign Exchange
Management (Non-Debt Instruments) Rules, 2019 (‘Non-Debt Rules’) for governing
non-debt transactions.

 

Therefore, upon
issuance of the above Non-Debt Rules, the power to regulate FDI into India was
taken over by the Central Government from RBI.

 

(B)   AMENDMENTS TO NON-DEBT RULES BY NOTIFICATION
DATED 27TH APRIL, 2020

 

(I)   Acquisition of equity shares by purchasing
rights entitlement from person resident in India

The Government of
India issued the above notification for amending Rule 7 of the Non-Debt Rules
which deals with investment by a person resident outside India in equity shares
(other than share warrants) issued by an Indian company on rights issue which
are renounced by the person to whom it is offered.

 

The amendment now
inserts Rule 7A which provides that whenever a person resident outside India
purchases rights for investing in equity shares (other than warrants) from a
person resident in India who has renounced it, investment by the person
resident outside India has to follow the applicable pricing guidelines laid
down in Rule 21 of the Non-Debt Rules. The pricing guidelines are given as
under:

(i)   In case of listed companies – As per SEBI
guidelines;

(ii)   In case of unlisted companies – As per
internationally accepted pricing methodology.

 

The earlier
Non-Debt Rules did not provide for any different pricing guidelines in case of
investment by person resident outside India in rights shares by purchase of
rights renounced by person resident in India. The earlier Non-Debt Rules
provided for following conditions in case of investment by person resident
outside India through either subscription to rights shares or purchase of
rights renounced by person resident in India:

 

Sr.
No.

Rights
issued by

Pricing
guidelines for rights issue and subscription pursuant to purchase of rights
renounced

1

Listed Indian company

Price determined by Indian company

2

Unlisted Indian company

Price not less than price offered to
person resident in India

 

Implications
of above amendment to Non-Debt Rules

Under the erstwhile
Non-Debt Rules which were similar to the FEMA 20(R) provisions governing FDI,
where a person resident outside India purchased rights entitlement to equity
shares which were renounced by a person resident in India, such non-resident
could invest at the same price at which they were offered to the person
resident in India. However, there are no pricing guidelines which are
applicable on issuance of shares on rights basis under the Companies Act, 2013.

 

Hence, whether a
non-resident purchased rights entitlement which was renounced by a person
resident in India or participated in rights issue as it was holding equity
shares, there was no change in pricing guidelines related to issuance of rights
shares.

 

However, post amendment to the Non-Debt Rules, a new criterion has been
drawn for a person resident outside India who purchases rights entitlements
from a person resident in India wherein pricing guidelines will be different as
compared to a person resident outside India who invests in rights issue. The
same is summarised as under:

 

Sr.
No.

Investment
by person resident outside India

Rights
issued by

Pricing
guidelines for rights issue

1

Participation in rights issue

Listed Indian company

Price determined by Indian company

2

Unlisted Indian company

Price not less than price offered to
person resident in India

3

Participation in rights issue through
purchase of rights entitlement

Listed Indian company

As per SEBI guidelines

4

Unlisted Indian company

As per internationally accepted
valuation methodology

 

The above amendment
will result in a peculiar situation which can be explained by way of the
following example:

 

Mr. NRI is a person
resident outside India who is holding 1,000 equity shares in an existing
unlisted Indian company, X Ltd. which has undertaken rights issue wherein Mr.
NRI will be eligible for 100 equity shares on rights basis. Equity shares are
issued on rights basis at the same price of Rs. 20 per equity share to both
resident as well as non-resident shareholders. Accordingly, Mr. NRI will
purchase his entitlement, i.e. 100 rights equity shares at the rights price of
Rs. 20 per share.

 

Further, Mr. NRI
also purchases rights entitlements for 50 equity shares from a person resident
in India. In such a scenario, the investment by Mr. NRI for purchasing 50
equity shares by way of rights entitlement would be at a price based on an
internationally accepted valuation methodology which can be different from the
price at which X Ltd. has issued the rights shares.

 

Hence, in a rights issue by an Indian company to the same non-resident
investor, there would be two different prices, one price for the purchase of
rights shares and another price for the purchase of rights shares acquired
through acquiring rights entitlement from a person resident in India.

 

Further, the new
Rule 7A does not cover situations where a person resident outside India has
purchased rights entitlement from persons resident outside India. In such a
situation the amendment does not apply.

Additionally, as per section 62(1) of the Companies Act, 2013, where a
shareholder to whom rights offer is made declines to exercises his right, the
Board can dispose them in a manner which is not disadvantageous to the company.
In such a situation, if the Board allocates those rights to an existing foreign
investor, the same cannot be considered to be purchase of rights renounced by
Indian investor and hence the amendment will not apply. Thus, a foreign
investor can acquire shares in the Indian company at the rights issue price
even if it is below fair market value.

 

(II)  Amendment in sourcing
norms for single brand product retailing

Earlier regulations
provided that sourcing norms shall not be applicable up to three years from
commencement of the business, i.e., opening of the first store for entities
undertaking single brand retail trading of products having ‘state-of-art’ and
‘cutting-edge’ technology and where local sourcing is not possible.

 

The amendment now
clarifies that exemption from sourcing would be applicable for three years
starting from the opening of the first store or the start of online retail,
whichever is earlier.

 

(III) Amendment in FDI limit
for insurance intermediaries

FDI in insurance
intermediaries, including insurance brokers, re-insurance brokers, insurance
consultants, corporate agents, third-party administrators, surveyors and loss
assessors and such other entities, as may be notified by the Insurance
Regulatory and Development Authority of India from time to time, is now
permitted up to 100% under the Automatic Route.

 

(IV) Amendment for FPIs

The amendment has
now provided that where FPI’s investment breaches the prescribed limit,
divestment of holdings by the FPI and its reclassification into FDI shall be
subject to further conditions, if any, specified by SEBI and RBI in this
regard.

 

SUMMARY OF
RECENT COMPOUNDING ORDERS

An analysis of some
interesting compounding orders passed by RBI in the months of January and
February, 2020 and uploaded on the website1  are given below. Article refers to regulatory
provisions as existing at the time of offence. Changes in regulatory
provisions, if any, are noted in the comments section.

_________________________________________

1   https://www.rbi.org.in/scripts/Compoundingorders.aspx

 

 

FOREIGN DIRECT INVESTMENT (FDI)

 

A. M/s Congruent Info-tech Pvt. Ltd.

Date of order:
19th December, 2019

Regulation: FEMA
20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2000]

 

ISSUE

(1) Violation of pricing guidelines in issue of
shares,

(2) Delay in refund of consideration,

(3) Transfer of shares from resident to
non-resident by way of gift without RBI’s approval,

(4) Taking on record transfer of shares in the
books of the company without RBI’s approval.

 

FACTS

  •     Applicant company was
    engaged in the business of writing, modifying, testing of computer programmes
    to meet the needs of a particular client excluding web-page designing.
  •     The company received
    foreign inward remittance of Rs. 13,32,900 from Mr. Mani Krishna Murthy, USA
    towards subscription to shares which was duly reported to RBI.
  •     The applicant company
    allotted 10,000 equity shares at a face value of Rs.10 each amounting to Rs.
    1,00,000 as against their Fair Value of Rs. 92.50 to a person resident outside
    India on 9th October, 2003. The shortfall of Rs. 8,25,000 was
    brought in by way of inward remittance on 1st July, 2019 after a
    delay of approximately 15 years and 8 months.
  •     Further, the company
    refunded an amount of Rs. 10,30,900 without the permission of RBI on 5th
    April, 2011 (approximately three years from its deemed date of receipt, i.e. 29th
    November, 2007).
  •     The resident shareholder,
    Mr. V.S. Krishna Murthy, had transferred 20,000 equity shares of fair value Rs.
    92.50 each, amounting to Rs. 18,50,000, to a non-resident Mr. Mani Krishna
    Murthy on 9th October, 2003 by way of gift without RBI’s approval.
  •     The above transfer of
    shares was also taken on record by the applicant company without obtaining
    RBI’s approval.

 

Regulatory provision

  •     Paragraph 5 of Schedule I
    to Notification No. FEMA 20/2000-RB, ‘the price of shares issued to persons
    resident outside India shall not be less than the fair value of shares.    ’
  •     Paragraph 8 of Schedule I
    to Notification No. FEMA 20/2000-RB read with A.P. (DIR Series) Circular No. 20
    dated 14th December, 2007, ‘the shares have to be issued / amount
    refunded within 180 days from the date of receipt of the inward remittance    .’
  •     Regulation 10A(a) of
    Notification No. FEMA 20/2000-RB, ‘a person resident in India who proposes
    to transfer to a person resident outside India any security by way of gift
    shall make an application to Reserve Bank    .’
  •     Regulation 4 read with
    Regulation 10(A)(a) of Notification No. FEMA 20/ 2000-RB, ‘the company can
    take the transfer of shares by way of gift, on record, after the approval of
    Reserve Bank    .’

 

CONTRAVENTION

Relevant
Paragraph of FEMA 20 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default (approximately)

Paragraph 5 of Schedule I

Violation of pricing guidelines in issue
of shares to non-resident

Rs. 8,25,000

15 years, 8 months and 22 days

Paragraph 8 of Schedule I read with A.P.
(DIR Series) Circular No. 20

Delay in refund of receipt of
consideration

Rs. 10,32,900

2 years, 10 months and 9 days

Regulation 10(A)(a)

Transfer of shares by way of gift from
resident to non-resident without prior approval from RBI

Rs. 18,50,000

15 years, 10 months and 18 days

Regulation 4 read with Regulation
10(A)(a)

Taking on record transfer of shares by
way of gift without RBI approval

Rs. 18,50,000

15 years, 10 months and 17 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,15,519 was levied.

 

Comments

Under the erstwhile FEMA 20 Regulations as well as under Non-Debt
Rules, transfer of shares from resident to non-resident by way of gift requires
prior approval of RBI. Hence, unless approval from RBI is obtained, the Indian
company whose shares are being transferred should also not record the transfer
from resident to non-resident by way of gift.

 

B. Atrenta (India) Private Limited

Date of order:
30th January, 2020

Regulation: FEMA
20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2000]

 

ISSUE

Transfer of shares
of the applicant from NRI to Non-Resident company without prior approval of
RBI.

 

FACTS

  •     Applicant Company had
    allotted 96,600 and 4,600 fully paid up equity shares to M/s Atrenta Inc. (NR)
    and Mr. Ajoy Kumar Bose (NRI), respectively, as part of subscription to the
    memorandum on 26th May, 2001.
  •     Further, the applicant
    company allotted 2,35,620 and 80 fully paid equity shares to M/s Atrenta Inc.
    and Mr. Ajoy Kumar Bose, respectively, on 10th October, 2001.
  •     Mr. Ajoy Kumar Bose (NRI)
    transferred 4,598 and 80 equity shares on 26th May, 2011 and 17th
    October, 2001 to M/s Atrenta Inc. (NR) without obtaining prior approval of RBI.
  •     The applicant company also
    took the transfer of shares from NRI to NR on record.

 

Regulatory
provision

•    Regulation 4 of FEMA 20, ‘save as
otherwise provided in the Act or Rules or Regulations made thereunder, an
Indian entity shall not issue any security to a person resident outside India
or shall not record in its books any transfer of security from or to such
person. Provided that the Reserve Bank may, on an application made to it and
for sufficient reasons, permit an entity to issue any security to a person
resident outside India or to record in its books transfer of security from or
to such person, subject to such conditions as may be considered necessary.’

 

CONTRAVENTION

Relevant
paragraph of FEMA 20 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default (approximately)

Regulation 4

Transfer of shares of the applicant from
NRI to Non-Resident Company without prior approval of the Reserve Bank of
India

Rs. 46,780

16 years and 5 months

 

Compounding
penalty

Compounding penalty
of Rs. 79,526 was levied on the applicant company.

 

Comments

It is interesting
to note that the above penalty was levied on the applicant company for taking
on record transfer of shares from NRI to non-resident without prior approval of
RBI. Additionally, the NRI2 
was also levied penalty of similar amount for transferring its shares to
non-resident company without prior approval of RBI. Thus, penalty was levied
twice on the same transaction, one which was levied on the company, and the
second which was levied on the NRI.

 

It should also be
noted that under the earlier FEMA 20 Regulations (which were applicable till
November, 2017), an NRI could transfer equity shares by way of sale or gift to
another NRI only and not to any other non-resident. However, post November,
2017 under the erstwhile FEMA 20(R) as well as under the revised Non-Debt Rules
governing FDI from October, 2019 an NRI can transfer shares to any person
resident outside India by way of sale or gift without any approval from RBI.

 

ESTABLISHMENT
IN INDIA OF A BRANCH OFFICE OR A LIAISON OFFICE OR A PROJECT OFFICE OR ANY
OTHER PLACE OF BUSINESS

 

C. M/s Quanticate
International Limited, Branch Office

Date of order:
27th June, 2019

Regulation: RBI
approval letter dated 24th September, 2010 and Master Direction –
Establishment of Branch Office (BO) / Liaison Office (LO) / Project Office (PO)
or any other place of business in India by foreign entities, FED Master
Direction No. 10/2015-16

 

ISSUE

Payment of expenses
of the branch office directly by the parent company to the third party.

 

FACTS

  •     The applicant company was
    engaged in the business of statistical consultancy, statistical programming,
    pharmaco-vigilance, analysing and data management services to its head office.
  •     The applicant company
    established a branch office in India with the permission of RBI vide
    letter No. FE.CO.FID/7508/10.83.318/2010-11 dated 24th September,
    2010.
  •     The branch office (BO) had
    an account with RBS Bank to carry out its transactions. After the closure of
    RBS operations in India, the branch office closed this account on 19th
    August, 2016 and opened a new account with Standard Chartered Bank on 19th
    September, 2016.

______________________________________________

2   Ajoy Kumar Bose – CA. No 5047 / 2019 dated 12th
February, 2020

 

  •     Although the BO had an
    account with Standard Chartered Bank, the remittances of Rs. 5,40,42,300 were
    made directly by the parent company of the BO to a third party account for
    payment of expenses, particularly their staff, landlord and supplier in India
    during the period 21st September, 2016 to 23rd March,
    2017.

 

Regulatory
provisions

  •     Paragraph 6 of the
    permission letter states that the entire expenses of the office in India will
    be met either out of the funds received from abroad through normal banking
    channels or through income generated by it in India by undertaking permitted
    activities.
  •     Paragraph 11 of the
    permission letter states that the office may approach AD Bank in India to open
    an account for its operation in India. Credits to the account should represent
    the funds received from the head office through normal banking channels for
    meeting the expenses of the office and profit made by the BO. Debits of this
    account shall be for the expenses incurred by the BO and towards remittance of
    profit / winding up proceeds.
  •     Paragraph 3(ii) of FED
    Master Direction No. 10/2015-16 dated 1st January, 2016 also
    reiterates what was stated in paragraph 11 of the permission 11.

 

CONTRAVENTION

Relevant
provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Paragraph 6 and Paragraph 11 of RBI
approval letter read with Paragraph 3(ii) and 2(i) of FED Master Direction
No. 10/2015-16

Payment of expenses of the Branch Office
directly by the parent company to third party

Rs. 5,40,42,300

2 years, 3 months and 27 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,46,169 was levied.

 

Comments

The companies which
have set up branch offices in India need to closely monitor their activities
and it needs to be ensured that all payments of branch offices should be
undertaken only through the branch’s Indian bank account and not  directly from its parent company.

 

D. M/s ETF Gurgaon Project Office (MG-SE-17)

Date of order:
11th October, 2019

Regulation: FEMA
22(R)/2016-RB [Foreign Exchange Management (Establishment in India of a branch
office or a liaison office or a project office or any other place of business)
Regulations, 2016]

 

ISSUE

Inter-project
transfer of funds and transfer of project assets from one project to another.

 

FACTS

  •     The applicant, M/s ETF, a
    company incorporated and registered under the laws of France, specialises in
    construction and maintenance of railway networks, urban transport networks and
    industrial siblings. It was involved in the development of railway
    infrastructure, high-speed lines, concrete slab tracks, metal and rubber
    wheeled tramway systems, etc.
  •     The applicant had
    established the following project offices in India for executing the following
    contracts:

i.    Contract MG-SE-17 with IL&FS Rail
Limited (referred to as MG-SE-17, Gurgaon);

ii.   Railway Infrastructure contract awarded by
Rail Vikas Nigam Limited (RVNL) – Construction contract with SEW-ETF-AIL JV2
(referred to as RVNL Kanpur);

iii.  Contract CT19A (referred as CT-19A Noida).

 

  •     Project expenses relating
    to a particular contract were met from the contract receipts relating to the
    said contract, or from remittances obtained from the Head Office in France
    depending upon the requirement of funds.
  •     There were, however,
    occasions where funds available in the bank account for a particular contract
    were insufficient to meet the expenses of the said contract necessitating
    inter-project transfer of funds.
  •     During the F.Y. 2016-17, ETF has obtained approval from RBI for
    inter-project transfer of funds up to Rs. 1,00,00,000 from the project office
    of MG-SE-17 to CT-19A.
  •     During the F.Ys. 2016-17
    and 2017-18, the Gurgaon project office did inter-project utilisation of funds
    and allocation of common expenditure amounting to Rs. 4,60,55,459.
  •     The above activity
    (inter-project utilisation of funds) of the Gurgaon project office did not
    relate to the contract secured by the foreign entity for which the project office
    was established.
  •     In the Annual Activity
    Certificates (AAC) for the years ended 31st March, 2017 and 31st
    March, 2018, the auditor had qualified the AACs by observing that the
    inter-project transfers were done without RBI approval.
  •     Further, transfer of
    project assets from the Gurgaon project office to another amounting to Rs.
    1,06,44,273 was also done without RBI approval.
  •     The applicant was granted post
    facto     approval subject to compounding of the contravention.

 

Regulatory
provisions

  •     Regulation 4(k) of
    Notification No. FEMA.22(R)/RB-2016 dated 31st March, 2016 states
    that a person resident outside India permitted under these Regulations to
    establish a branch office or liaison office or project office may apply to the
    Authorised Dealer Category-I bank concerned for transfer of its assets to a
    joint venture / wholly owned subsidiary or any other entity in India.
  •     Regulation 4(l) (Annex D)
    of Notification No. FEMA.22(R)/RB-2016 dated 31st March, 2016 states
    that the branch office / liaison office may submit the Annual Activity
    Certificate (Annex D) as at the end of 31st March along with the
    audited financial statements, including receipt and payment account on or
    before 30th September of that year.

 

CONTRAVENTION

Relevant
provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation 4(k), Regulation 4(f) read
with Annex D of Regulation 4(l) of Notification No. FEMA.22(R)/RB-2016

Inter-project utilisation of funds and
transfer of project assets from one project to another

Rs. 5,66,99,732

2 years, 9 months and 9 days

 

Compounding
penalty

Compounding penalty
of Rs. 2,56,799 was levied.

 

Comments

Where foreign companies have set up more than one project office in
India, adequate care needs to be taken to ensure that funds of these project
offices are not transferred amongst themselves without prior approval of RBI.

 

EXPORT OF GOODS AND SERVICES

E. M/s Dalmia Cement (Bharat)
Limited (Legal Successor of OCL India Ltd.)

Date of order:
28th January, 2020

Regulation: FEMA
23/2000-RB [Foreign Exchange Management (Export of Goods and Services)
Regulations, 2000]

 

ISSUE

Failure to realise
the export proceeds (by the erstwhile OCL India Ltd.) within the stipulated
time period.

 

FACTS

  •     The applicant company, M/s
    Dalmia Cement (Bharat) Limited (the legal successor of M/s OCL India Limited,
    consequent upon a merger ordered by NCLT vide order dated 18th
    July, 2019) was engaged in the business of export of refractory materials,
    cement, etc.
  •     The erstwhile M/s OCL India
    Limited, a ‘Star Export House’ engaged in the business of export of refractory
    materials, cement, etc., had made exports under 13 different invoices between
    February, 2008 and May, 2012.
  •     M/s OCL India Limited was
    not able to realise and repatriate the export proceeds pertaining to 13
    invoices within the stipulated time.
  •     Subsequently, M/s OCL India
    Limited had written off the amount in its books.
  •     However, as the company was
    under investigation by the Directorate of Enforcement, the above bills could
    not be written-off by the applicant on its own or by its AD bank.
  •     The applicant filed a
    petition in the Hon’ble High Court of Delhi for regularising the above
    write-off.
  •     The Hon’ble Court disposed
    of the matter with directions to the applicant to apply for compounding again
    to the RBI along with fresh fee for compounding.

 

Regulatory
provisions

  •     Regulation 9 of
    Notification No. FEMA.23/2000 which states that the amount representing the
    full export value of goods or software exported shall be realised and
    repatriated to India within six months (applicable up to 3rd June,
    2008) and twelve months (as applicable subsequently) from the date of export.

 

CONTRAVENTION

Relevant
Provision

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation 9 of FEMA 23/2000-RB

Failure to realise export proceeds
within stipulated time period

Rs. 39,22,447

Approximately 11 years

 

Compounding
penalty

Compounding penalty
of Rs. 79,419 was levied.

 

Comments3

In the instant
case, the applicant company had initially filed a compounding application with
RBI for write-off of export proceeds. However, the said compounding application
was returned by RBI on the ground that compounding application can be filed
only after transactions are regularised by RBI. Further, RBI advised the
applicant company to approach the Trade Division of RBI for regularising its
export transactions. However, as the applicant company was under investigation
by ED, it could not write off its export receivables and hence had initially
filed compounding application before RBI. As RBI returned its compounding
application, it filed a writ petition with the Delhi High Court for writing off
export receivables.

_________________________________________________________________________

3   Based on Delhi High Court order in case of
OCL India Limited [W.P.(C) 8265/2018 & CM Nos. 31684/2018 dated 18th
July, 2019]

 

 

During the
hearing before the Delhi High Court, counsel for RBI submitted that there is no
provision which precluded RBI from considering and processing compounding
application where investigation is pending. Accordingly, based on RBI’s
submission that the matter be remanded back to RBI for fresh consideration, the
Court dismissed the writ petition and directed RBI to consider the compounding
application of the applicant afresh and not reject it on the basis of
approaching another department of RBI. Interestingly, the Delhi High Court also
stayed proceedings initiated by ED till
the applicant’s compounding application was considered by RBI.

Banking as a Service

Have you opened a bank
account or a Demat account at a bank recently? Signatures are required at ten
to twelve places. Some time back I opened an account for a minor and 12
signatures were required and for a Demat account 32 signatures. Signatures on
pages and pages of ‘fine print’ that no one can fathom nor has a choice to
change – this is a cumbersome chore for a fundamental service like banking.
Much of it is like pressing ‘I Agree’ when downloading apps and like someone
put it – ‘I Agree’ is the biggest lie ever.

A few months back a top
private sector bank relationship manager said that they would open a Demat
account for an NRI customer only if there was in-person verification (which
later I found was wrong even as per the internal guidelines). Finally the
non-resident people came in after a few months, and a very junior person did
‘in-person verification’ and the bank opened the account after daily follow-up.

Another case is that of a
charitable trust. A 167-year-old MNC bank gave a list of acceptable address
proofs. This list of some 13 items did not include a single proof that was
applicable to a non-business charitable entity. Therefore, they said you won’t
be KYC compliant and therefore your account could be blocked or closed. A
charitable trust is often registered at the office of the Trustees. The bankers
could offer only one option – to take the address of the trustees to be the
address of the charitable trust for KYC purposes, which meant that the trust
communication would go to trustees’ residential address instead of the office.
It felt like being a hostage since the trust had deposits u/s 12, and there was
no option but to bend.

In another case, a European
bank, since eight months are unable to close a LO bank account after MCA has
approved the LO closure and tax department has given an NOC. The bankers are
asking for documents that the LO has already submitted on a yearly basis
because the bank cannot find them. And all this is for a meagre sum. In another
case, another top private sector bank is asking for Physical Copies during
COVID lockdown (when no post or courier is working) to change the address in
bank records in spite of providing documents through registered email and in
spite of ROC records updated for a local address change. 

Today, after more than a
decade of the Satyam scam, I can say that most bankers do not send direct
confirmations to auditors in spite of client instructions and authorisation.
The RBI perhaps is looking for a bigger corporate fatality to learn the lesson!
Can RBI not formulate a regulation to ensure that a comprehensive confirmation
of all the facilities is sent to auditors? 

An
over-the-top example is that of credit card interest and finance charges of
3-4% per month that most banks charge on delayed payments. Only Dilbert
cartoons can explain this. Most of us have come across such appalling service
levels, extreme nit-picking, and unreasonable attitude of bankers and banks.
These, from my experience, are deep and pervasive across the sector.

No doubt
that the banks have done a lot of good work too but they have lost loads of
money as well. Banks as a sector is a huge boulder blocking ease of doing
business for small and medium players especially. NPA track record shows a
dismal performance of PSBs when it comes to protecting money of depositors. For
most people, money is life, because people spend days and months and years to
earn it. The present Rs. 5 lakhs DICGC insurance cover which I am told has not
yet come into effect  (and was raised
from Rs. 1 lakh after 27 years) is paltry. In the event of a bank failure, this
insurance gets paid post all investigation process, which takes a lifetime,
literally. Every taxpayer deserves better service from banks and better cover
for her wealth in a bank. This is a big taxpayer concern: service of the bank
and the safety of her tax-paid money with the bank. If tax-paid money is unsafe
in a bank, then taxes are not working for taxpayers!

 

 

 

 

 

Raman
Jokhakar

Editor

INTERLINKING BETWEEN GST AND CUSTOMS

LEGISLATIVE FRAMEWORK – GST  VIS-À-VIS CUSTOMS

The levy of GST finds its genesis under
Articles 246A and 269A of the Constitution of India. Article 246A confers
powers on both Parliament and the State Legislature to make laws with respect
to goods and services tax imposed by the Union or such State. Two points to be
noted here are:

 

(a) Vide the proviso to
Article 246A, Parliament has been given the exclusive power to make laws with
respect to goods and services tax where the supply of goods or services or both
is in the course of interstate trade or commerce. The mechanism for levy,
collection and sharing of tax on such supplies is provided under Article 269A.
Explanation 1 to Article 269A further provides that the supply of goods or
services in the course of import into the territory of India shall be deemed to
be a supply in the course of interstate trade or commerce.

(b) Article 286 restricts the states from
levying tax on sale or purchase of goods or services or both if such supply
takes place outside the state or in the course of import into or export out of
the territory of India.

 

It is by virtue of the above framework that
Parliament has enacted the Integrated Goods & Services Tax (IGST) Act, 2017
and the Central Goods & Services Tax (CGST) Act, 2017 for levy and
collection of tax on interstate supplies and intrastate supplies, respectively.
Similarly, the states have enacted the State Goods & Services Tax (SGST)
Act, 2017 for levying tax on intrastate supplies. The determination whether or
not a supply is in the course of interstate trade or commerce is dealt with
under sections 7 and 8 of the IGST Act, 2017. Section 7 thereof provides that
supply of goods imported into the territory of India till they cross the
customs frontiers of India shall be treated as supply of goods in the course of
interstate trade or commerce.

 

There is an apparent dual levy on import of
goods under the Constitution in view of Article 269A treating import of goods
as interstate supply of goods or commerce and Article 246 empowering the levy
of customs duties. It is for this reason that the charging section for levy of
IGST u/s 5 specifically excludes the levy and collection of integrated tax on
goods imported into India from its purview and provides that the same shall be
levied and collected in accordance with the provisions of section 3 of the CTA,
1975 on the value determined under the said Act at the point when the duty of
customs is levied on the said goods u/s 12 of the Customs Act, 1962.

 

Therefore, when dealing with a cross-border
transaction involving goods, there is a close interplay between the provisions
of GST and Customs requiring determination of the statute under which the duty
/ tax has to be discharged. It therefore becomes important to understand the
meaning of the terms ‘imported goods’, ‘importer’ and the process to be
followed in the case of importation of goods.

 

‘IMPORTED GOODS’ AND ‘IMPORTER’

‘Imported goods’ is defined u/s 2(25) of the
Customs Act, 1962 to mean any goods brought into India from a place outside
India but does not include goods which have been cleared for home consumption. Similarly,
section 2(26) defines the term ‘importer’ in relation to any goods at any
time between their importation and the time when they are cleared for home
consumption, includes [any owner, beneficial owner] or any person holding
himself out to be the importer.

 

When goods are imported into India, there
are generally two sets of transactions which are undertaken, one being the
filing of Bill of Entry for Home Consumption, in which case the importer has to
pay duty as applicable on the said goods and get the goods cleared from the
Customs Authorities. Once this is done, the goods are no longer imported goods
and therefore, on all subsequent transfers the tax will be levied and collected
under the GST mechanism by classifying the transaction either as intrastate or
interstate. The second option is to file Bill of Entry for Warehousing, in
which case the goods shall be stored either at a public or a private warehouse
by executing a bond. In the second option, the goods continue to be classified
as imported goods and the payment of duty on such goods gets deferred till the
time the goods are kept in the bonded warehouse and the same shall be assessed
to tax when a bill of entry for home consumption in respect of such warehoused
goods is presented.

 

In other words, till the time the goods are
cleared for home consumption, i.e., an order permitting clearance of such goods
for home consumption is passed, the goods would be treated as imported goods
and will be subjected to levy and collection of tax u/s 12 of the Customs Act,
1962.

 

TAX
TREATMENT OF HIGH SEAS SALES

In the case of high seas sales, the sale
takes place before the goods are cleared for home consumption, i.e., a bill of
entry for home consumption is filed and an order permitting the clearance of
such goods is issued by the proper officer. This position has also been
accepted by the Board vide Circular 33/2017 – Customs dated 1st
August, 2017 wherein they have clarified that in case of high seas sales
transactions (single or multiple), IGST shall be levied and collected only at
the time of importation, i.e., when declarations are filed before the Customs
Authorities for clearance purposes after considering the value addition on
account of such high seas transactions. Even the Authority for Advance Ruling
has held so in BASF India Private Limited [2018 (14) GSTL 396 (AAR –
GST)].

 

Further, Schedule III has been amended
w.e.f. 1st February, 2019 vide the insertion of Entry 8(b) to
provide that supply of goods by the consignee to any other person, by
endorsement of documents of title to the goods, after the goods have been
dispatched from the port of origin located outside India but before clearance for
home consumption, shall be treated as neither being supply of goods nor supply
of services.

 

TAX
TREATMENT OF WAREHOUSED GOODS

A similar treatment will be accorded to
goods where a bill of entry for warehousing is filed, i.e., goods are kept at a
bonded warehouse which falls within the purview of customs area defined u/s
2(11) of the Customs Act, 1962 as any area of a customs station or a warehouse.
This is because when a bill of entry is filed for warehousing, the goods are
not cleared for home consumption and therefore such goods continue to be
classified as imported goods and subject to levy and collection of tax under
the Customs Act, 1962. This view has been followed by the AAR in Sadesa
Commercial Offshore De Macau Ltd. [2019 (21) GSTL 265 (AAR – GST)] and Bank
of Nova Scotia [2019 (21) GSTL 238 (AAR – GST)]. In fact, in Sadesa
Commercial the AAR has also held that if they are engaged exclusively
in undertaking such supplies, i.e., sale of warehoused goods, they would not be
liable to obtain registration under GST.

 

Prior to the amendment referred to above,
the Board had issued Circular 46/2017-Cus. dated 24th November, 2017
wherein it was clarified that tax will be levied on multiple occasions, one at
the time when the warehoused goods are sold before clearance for home
consumption, and secondly when the bill of entry for home consumption of such
warehoused goods is presented for clearance. However, vide a later
Circular 3/1/2018 dated 25th May, 2018, it was clarified that
integrated tax shall be levied and collected at the time of final clearance of
the warehoused goods for home consumption only.

 

In addition, Circular 46/2017-Cus. was
withdrawn to align with the amendment to Schedule III of the CGST Act, 2017
which deemed supply of warehoused goods to any person before clearance for home
consumption as neither a supply of goods nor supply of services w.e.f. 1st
April, 2018.

 

IMPORTS BY
SEZ DEVELOPERS / UNITS

A similar analogy will apply for the purpose
of goods imported into a Special Economic Zone as well. Section 53(1) of the
SEZ Act, 2005 provides that SEZs shall be deemed to be a territory outside the
Customs territory of India for undertaking the authorised operations. However,
this does not imply that the provisions of the Customs Act, 1962 shall not
apply to SEZs as held by the Gujarat High Court in the case of Diamond
& Gem Development Corporation vs. Union of India [2011 (268) ELT 3 (Guj.)].
It is for this reason that when goods are imported into an SEZ, a bill of entry
for re-warehousing has to be filed. Of course, in view of section 26 of the SEZ
Act, 2005 which provides exemption from duties of customs on goods imported
into India to carry on the authorised operations, no duty of customs –
including IGST – is leviable on such imports.

 

However, a challenge arises when the said
goods are cleared for use in DTA. The goods imported into an SEZ are under a
Bill of Entry for re-warehousing. However, since an SEZ is deemed to be outside
the customs territory of India, section 30 of the SEZ Act, 2005 provides that
any goods removed from an SEZ to the DTA shall be chargeable to duties of
customs, including anti-dumping, countervailing and safeguard duties under the
CTA, 1975 (51 of 1975), where applicable, as leviable on such goods when
imported. In other words, if goods imported into an SEZ are cleared into DTA, a
fresh Bill of Entry for Home Consumption would have to be filed in view of the
fact that the same would be treated as import of goods from a territory outside
India. The Bill of Entry can be filed either by the SEZ unit or by the buyer of
the goods.

 

TAX TREATMENT OF DUTY FREE SHOPS

The levy of tax on goods sold by Duty Free
Shops (DFS) has always been a subject matter of scrutiny, first under the
pre-GST regime and now under the GST regime. DFS are shops which are set up at
airports / sea ports within the customs territory, i.e., after a person goes
through customs formality if he is commencing an international travel, or
before a person goes through customs formality if he is returning from an
international travel.

 

The DFS are treated as warehouses licensed
u/s 58A of the Customs Act, 1962. Once the goods reach the DFS, there are two
possibilities –the goods may be bought by an outbound passenger or the goods
may be bought by an inbound passenger. But the fact remains that the goods have
been sold by the DFS before a Bill of Entry for home consumption was filed.
Thus the question that remains is whether or not such sales would be liable to
GST, irrespective of whether the same is from the departure area or the arrival
area. In this context, it would be imperative to refer to the following
decisions of the Supreme Court:

 

(A) In the case of J.V. Gokal &
Co. (Pvt.) Ltd. vs. Assistant Collector of Sales Tax [1990 (110) ELT 106 (SC)],
the Court explained the phrase ‘in the course of import of goods into the
territory of India’ to mean

(1) The course of import of goods starts at
a point when the goods cross the customs barrier of the foreign country and
ends at a point in the importing country after the goods cross the customs
barrier,

(2) The sale which occasions the import is a
sale in the course of import,

(3) A purchase by an importer of goods when
they are on the high seas by payment against shipping documents of title (Bill
of Lading) is also a purchase in the course of import, and

(4) A sale by an importer of goods, after
the property in the goods passed to him either after the receipt of the
documents of title against payment or otherwise, to a third party by a similar
process is also a sale in the course of import.

 

(B) In the case of Hotel Ashoka vs.
Assistant Commissioner of Commercial Taxes [2012 (276) ELT 433 (SC)],
specifically in the context of DFS, the Court had held that the sale of goods
from DFS was from outside India and therefore, they were not liable to sales
tax. The Court further held that the sale of goods was before they were cleared
for home consumption, i.e., it was a sale of goods in the course of import into
India and for this reason the state did not have the power to levy tax on such
transactions.

 

Even in the context of GST, reference to the
decision of the Bombay High Court in the case of Sandip Patil vs. Union
of India [2019 (31) GSTL 398 (Bom.)] is important. In this case, not
only did the Court agree with the above contention, it also held that supply of
goods to outbound passengers would be treated as export of goods and in case of
supply of goods to inbound passengers such inbound passengers would be treated
as importers and they would also not be liable to pay any duty in view of
Notification 43/2017-Cus. dated 30th June, 2017 and 2/2017-IT (Rate)
dated 28th June, 2017 r.w. duty-free allowance under the Baggage
Rules. The High Court further held that the DFS would be entitled to claim
refund of accumulated ITC on account of export of goods u/r 89 of the CGST
Rules, 2017. A similar view has also been taken in the case of A1
Hospitality Services Private Limited vs. Union of India [2019 (22) GSTL 326
(Bom.)] as well as Atin Krishna vs. Union of India [2019 (25)
GSTL 0390 (All.)].

 

One should, however, note that the AAR has,
in the case of Rod Retail Private Limited [2018 (12) GSTL 206 (AAR –
GST)] on the contrary held that the supply of goods from DFS would be
liable to GST. However, this AAR, while referring to the decision of the
Supreme Court in the case of Ashoka Hotel referred above, has
held it to be not applicable since ‘under GST law, scenario has changed and
therefore decision of Apex Court not applicable’. Instead, it refers to the
decision in the case of Collector vs. Sun Industries [1988 (35) ELT 241
(SC)] which was completely on a different footing. It is imperative to
note that the High Court had in the case of Sandeep Patil
distinguished this ruling on the grounds that the facts in the case of Rod
Retail were different since the same was a ‘Duty Paid Shop’ and not a
‘Duty free shop’ as clarified by the Board vide Circular dated 29th
May, 2018 and therefore the dispensation allowed to DFS would not be affected
in any manner.

 

Reference is also invited to the recent
decision of the Supreme Court in the case of Nirmal Kumar Parsan vs.
Commissioner of Commercial Taxes [SCA No. 7863 of 2009] wherein in the
case of warehoused goods the Court upheld the liability to pay VAT on goods
sold as stores to foreign-going vessels. However, in this case, the Court made
a peculiar observation that the appellant had not shown anything to demonstrate
that the subject bonded warehouse came within the customs port / customs land
station area and, more so, the state sales occasioned the import of goods
within the territory of India.

 

INPUT TAX CREDIT IMPLICATIONS

In view of the amendment to section 17(3),
it is further provided that the supply of goods covered under Schedule III
would not be treated as exempted supply and therefore there is no requirement
to reverse Input Tax Credit on account of the same.

 

RCM ON OCEAN FREIGHT

Generally, when a contract for sale of goods
is executed, the parties need to agree when the risk and rewards associated
with the goods would get transferred. There are two commonly used terms,
namely, CIF – i.e., cost, insurance and freight included; and FOB – i.e., Free
on Board, meaning once the goods reach the port at the foreign country, the
risks and rewards associated with such goods are transferred to the buyer in
which case he shall make arrangements to bring the goods from the foreign port
to a port in India by entering into a separate contract for such services.

 

For customs, depending on the agreed terms,
the assessable value is generally adjusted, either for actual freight incurred
or on notional basis. For example, if freight cost is not available, the same
is assumed at 20% of the FOB value and the same is added to the transaction
value for determining the assessable value. [Refer Rule 10 of the Customs
Valuation (Determination of Value of Imported Goods) Rules, 2007]. This implies
that the customs duty along with IGST is paid not only on the transaction value
but also on the actual various or notional value of expenses incurred during
the import of such goods. This would also mean that tax is charged indirectly
on the transportation cost in the CIF contracts as well, though the service
provider (shipping line) and the service receiver (foreign seller) may not be
in India.

 

Despite the transaction being indirectly
taxed, Entry 10 of Notification 10/2017-IT (Rate) dated 28th June,
2017 imposes a liability on the importer, as defined in section 2(26) to pay
tax on ‘services supplied by a person located in non-taxable territory by
way of transportation of goods by a vessel from a place outside India up to the
customs station of clearance in India’. The Notification further provides
that where the value of taxable service provided by a person located in
non-taxable territory to a person located in non-taxable territory by way of
transportation of goods by a vessel from a place outside India up to the
customs station of clearance in India is not available with the person liable
for paying integrated tax, the same shall be deemed to be 10% of the CIF value
(sum of cost, insurance, and freight) of imported goods.

 

Therefore, it is apparent that there is a
dual taxation of the freight component, once at the time of clearance of goods
with the customs authorities where the value of freight is included in the
assessable value, and secondly, the tax liability created through the
Notification 10/2017-IT (Rate). Similar provisions existed under the Service
Tax Regime as well where the Gujarat High Court had struck down the entry
imposing liability to pay tax under reverse charge in the case of Sal
Steel Limited vs. Union of India [R/SCA No. 20785 of 2018]. The levy
was struck down primarily because section 94 did not permit the Central
Government to make rules for recovering service tax from a third party who is
neither the service provider nor the service receiver. The Court further held
that there was no machinery provision to demand the tax from the importer.

 

Under GST, the AAR has on multiple occasions
such as India Potash Limited [2020 (32) GSTL 53 [AAR – AP)]; M.K.
Agrotech Limited [2020 (32) GSTL 148 (AAR – KA)]; E-DP Marketing Private
Limited [2019 (26) GSTL 436 (AAR – MP)] held that there is a liability
to pay GST under RCM on such transactions. However, the Gujarat High Court has
in the case of Mohit Minerals Private Limited vs. UoI
[2020-TIOL-164-HC-AHM-GST] struck down Entry 10 as ultra vires
for the following reasons:

(a) The importer is not the service
recipient since the GST law defines the service recipient as the person liable
to pay consideration,

(b) The place of supply provisions apply
only in case where either the location of supplier or the recipient of services
is outside India. In this case, both the location of supplier as well as
recipient are outside India,

(c) The point of taxation would never get
triggered since neither the payment to the supplier would be reflected in the
books of accounts of the importer, nor the invoice of the shipping line would
be in the name of the importer.

 

While the levy has been struck down, one
should note that the Revenue is likely to file an appeal before the Supreme
Court and therefore reliance on this decision should be placed keeping in mind
other aspects as well. For instance, in case the decision is overturned by the
Court and the liability to pay tax is confirmed, the same would be along with
consequential interest and probably no Input Tax Credits. Penalty can be
contested on bona fide belief, but it would be a long way away,
especially considering the fact that the payment of tax might in many cases be
a revenue-neutral exercise.

 

INTERNATIONAL JOB WORK

Section 2(68) of the CGST Act, 2017 defines
the term ‘job work’ as ‘any treatment or process undertaken by a person on
goods belonging to another person’. This activity is deemed to be a supply
of service under GST in view of Entry 3 of Schedule II of the CGST Act, 2017.

 

The modus operandi in this kind of
transaction is that the owner of goods (generally known as principal) desirous
of getting some work done on his goods, sends the said goods to his job-worker
without any consideration. The said job-worker shall work on the said goods and
return the goods to the principal and recover the charges for carrying out the
said activities from the principal.

 

Therefore, there are three different events
involved in a transaction of job work, namely, receipt of goods, working on the
said goods (treatment / process) and lastly, return of the said goods. When
both the parties, i.e., principal and job-worker are in the same territory,
there are no tax implications at the time of receipt of goods and sending back
the goods. However, when in the same transaction one of the parties is outside
India, customs duty comes into the picture because there is either an import of
goods, i.e., goods coming into India from a territory outside India in case of
inbound job work or export of goods, i.e., goods being taken out of India in
case of outbound job work.

 

Under the Customs Act, 1962 the import of
goods for job work is dealt with by Notification 32/1997-Cus. dated 1st
April, 1997. This Notification exempts goods imported for jobbing from payment
of customs duty leviable under the First Schedule and additional duty leviable
u/s 3 of the CTA, 1975 subject to satisfaction of the condition prescribed.
However, it is imperative to note that vide Notification 26/2017-Cus.
dated 29th June, 2017 in the context of additional duties u/s 3 of
the CTA, 1975, the exemption is restricted only to the extent of additional
duties leviable under sub-sections (1), (3) and (5) thereof. This would imply
that the integrated tax on import of goods, which is leviable u/s 3(7) of the
CTA, 1975 would be liable to IGST in case of goods imported for job work
purposes, though no consideration is payable by the importer job worker on such
import of goods. The same applies in case of outbound job work, where goods are
re-imported. Notification 45/2017-Cus. dated 30th June, 2017 exempts
additional duties leviable u/s 3 in the case of re-import.

 

The first question that would need
consideration is whether the job-worker importing the goods would be liable to
claim credit of integrated tax paid on such imports? For the same, one would
need to refer to section 16 of the CGST Act, 2017 to ensure that the conditions
prescribed therein are satisfied or not. The primary conditions to be satisfied
in this set of transactions are that the goods should have been received in the
course or furtherance of business, the recipient should be in possession of
such tax-paying document as may be prescribed, the recipient should have actually
received the goods, and lastly, he should have furnished the return u/s 39. It
is beyond doubt that the above conditions are getting satisfied and therefore,
the claim of integrated tax paid on receipt of goods for job work by the
job-worker as importer should be allowed. This view has also been accepted by
the AAR in Chowgule & Co. Pvt. Ltd. [2019 (27) GSTL 405 (AAR)].

 

The next question that would need
consideration is in two parts, taxability of services provided by the job
worker, and secondly whether sending back of goods would amount to exports or
not? As discussed above, the commercial transaction in the current case is
undertaking activity on goods owned by the principal for which the job worker
recovers charges from the said principal. Since this is deemed to be a supply
of service, section 13 of the IGST Act, 2017 shall come into play which deals
with determination of place of supply in case where either the location of the
supplier of service or the location of the recipient of service is outside India,
which applies to the current transaction. Accordingly, one needs to refer to
the various scenarios laid down u/s 13 thereof to identify the applicable rule
for determining the place of supply.

 

The most directly concerned rule for this
kind of service appears to be section 13(3)(a) which provides that the place of
supply of service in case where the services supplied in respect of goods which
are required to be made physically available by the recipient of services to
the supplier of services, or to a person acting on behalf of the supplier of
services in order to provide the services, shall be the location where such
services are actually performed. In this sense, it would have implied that the
goods on which job work services are being performed being located in India,
the place of supply u/s 13(3) shall be India and accordingly the same would be
liable to tax and not treated as export of services. Similarly, in case of an
outbound job work transaction, the situation would be reverse and job work charges
paid to the foreign job worker would not be liable to GST under import of
services since place of supply would be outside India.

 

This situation would apply till 31st
January, 2019 post which the proviso to section 13(3) has come into
force. The proviso provides that section 13(3)(a) shall not apply to
cases where goods are temporarily imported into India for repairs or for any
other treatment or process and are exported after such repairs or treatment or
process without being put to any use in India, other than that which is
required for such repairs or treatment or process. Therefore, w.e.f. 1st
February, 2019, in case of inbound job works, the place of supply shall be the
location of the recipient of service, i.e., outside India and subject to the
satisfaction of conditions u/s 2(6) of the IGST Act, 2017 shall be treated as
export of service. That being the case, such job-worker may be entitled to
claim refund of accumulated ITC or tax paid on supply of such Zero-Rated
Services. However, in case of an outbound job work transaction, the Indian
principal would now be liable to pay tax under import of services.

 

It is important to note that this proviso
does not impose any time limit within which the goods have to be exported after
the repairs / process and therefore, no such time limit can be enforced for
return of such goods. One may refer to the recent decision of the Supreme Court
in Bombay Machinery Works [2020–VIL16–SC] which was on a similar
aspect, though in the context of section 6(2) of the Central Sales Tax Act,
1956.

 

Notification 32/1997-Cus. dated 1st
April, 1997 requires that the goods should be re-exported within six months
from the date of clearance of such goods or within such extended time period as
the Assistant Commissioner of Customs may allow. It may be noted that the
definition of exports, under GST as well as Customs, is similar and means taking
out of India to a place outside India. Therefore, the sending back of goods
would qualify as export for the purpose of Customs as well as GST.

One important issue which was taken up in
the AAR case of Chowgule & Co. Pvt. Ltd. was that of
eligibility of refund claim. In the said case, the applicant was engaged in
undertaking job work on iron ore which attracts nil rate of duty. In this case,
the AAR held that since the goods being exported are liable for export duty,
the refund of accumulated ITC would not be available in view of the second proviso
to section 54. However, this appears to be on a wrong footing because the
supply undertaken by the applicant was that of supply of services to which the
restriction does not apply.

 

TAXATION OF INTANGIBLES

Section 2(22) of the Customs Act, 1962
defines the term ‘goods’ to include, among other things, any other kind of
movable property. The Supreme Court has, in the case of TCS vs. State of
Andhra Pradesh [2004 (178) ELT 2 (SC)] dealt with what shall constitute
goods. While dealing with this subject, the Constitution Bench held that goods
may be tangible or intangible property. A property becomes goods provided it
has the attributes having regard to utility, capability of being bought and
sold and capability of being transferred, transmitted, delivered, stored and
possessed.

 

There can be
different types of intangibles, such as patents, designs, copyrights,
trademarks, etc. Each of these is governed by specific statutes. Such rights
can be transferred either by way of license or assignment. License is a
temporary transfer of rights without any change in the ownership, which would
amount to rendition of service in view of Entry 5(c) of Schedule II of the CGST
Act, 2017, while assignment would mean a change in ownership of the rights and
therefore would be treated as supply of goods in view of Entry 1(a) of Schedule
II. This distinction has been explained in the case of CST vs. Dukes
& Sons Private Limited [1988 (SCC) Online Bom 448].

 

However, an issue that arises is with
respect to the situs in case of assignment of intangibles. What shall be
the situs of such transfer, i.e., whether the location where the
intangible is registered shall be the situs, or the location of the
owner of such intangible shall be considered the situs? In this regard,
one may refer to the decision of the Bombay High Court in the case of Mahyco
Monsanto Biotech India Private Limited vs. Union of India [2016 (44) STR 161
(Bom).] where the Court has followed the principle of mobilia
sequuntur personam, i.e., location of owner of intangible asset would be
closest approximation of situs of his intangible asset and the location
where agreement is entered would not be relevant.

Given this background, it may be argued that
in case the rights owned by a person outside India are assigned, the same would
be treated as import of goods and therefore no tax can be levied on the same
u/s 5 of the IGST Act, 2017. However, the bigger issue would be whether or not
such imports would be liable to tax u/s 12 of the Customs Act, 1962, especially
when the document of title evidencing assignment of rights is received
electronically? In case the document of title is brought into India, either as
a courier or baggage, there may be customs duty implications on such imports,
but on what value would the same be payable would be a subject matter of
dispute.

 

A similar challenge would be seen in case of
export transactions, i.e., assignment of rights from India to a person outside
India. Whether such person would be liable to treat such assignment as export
of goods without there being a corresponding shipping bill and, accordingly,
the consequential impact on adjudication of refund claims?

 

IMPORTS VIS-À-VIS TRANSFER OF RIGHT TO USE
GOODS

Another aspect to be noted is that of cases
where there is a transfer of right to use goods and in pursuance of which goods
are imported into India. Entry 5(f) of Schedule II of the CGST Act, 2017 treats
activities of transfer of right to use goods for any purpose as supply of
services. Therefore, when such service of transfer of right to use such goods
is provided by a foreign party, which would trigger bringing goods from outside
India to India, there will be a dual challenge, one being the levy of IGST on
the rental payments under import of service, and the second being the levy of
IGST u/s 12 of the Customs Act, 1962 which would be on the value of goods and
therefore highly disproportionate to the transaction being undertaken.

 

To avoid this dual levy of tax, Notification
72/2017-Cus. dated 16th August, 2017 provides exemption from the
levy of basic customs duty and integrated tax. While 100% exemption is not
provided for under basic customs duty, integrated tax u/s 3(7) of CTA, 1975 is
granted, provided the importer gives an undertaking that he shall discharge the
tax on the said services as import of services.

 

GOODS SENT FOR EXHIBITIONS

Various exhibitions are held all over India
where people participate and display their goods. There can be a scenario where
an exhibition is being held in India and a person from outside India showcases
his product, in which case he shall bring the goods from outside India to
India; and secondly, a case where a person in India intends to showcase his
products at an exhibition being held outside India.

 

The procedure for import of goods for
exhibition purposes is dealt with under Notification 8/2016-Cus. dated 5th
February, 2016. The said Notification provides for exemption from payment of
customs duty and additional customs duty subject to conditions, such as
execution of bond, re-export of goods within the prescribed period of six
months, etc. At times it so happens that the goods are sold at such exhibitions
and therefore, instead of re-exporting the said goods, the same have to be
cleared for home consumption by paying the appropriate customs duty.

 

However, in such cases such person will have
to apply for registration as a non-resident taxable person and discharge the
applicable tax on the sale value after claiming Input Tax Credit only of the
tax paid on goods imported by him u/s 16. Such non-resident taxable person
shall not be allowed credit of any other inward supplies, except for tax paid
on goods imported by him. Similarly, in case of goods sent for exhibition
abroad, Notification 45/2017-Cus. dated 30th June, 2017 provides
that no tax shall be payable on re-importation of such goods. This has also
been clarified by the Board Circular 21/2019-Cus. dated 24th July,
2019.

 

BRANCH TRANSFER

Branch transfer is a common terminology used
when a branch sends goods to another branch. Under GST, Entry 2 of Schedule I
of the CGST Act, 2017 deems supply of goods or services or both between related
persons or between distinct persons as specified in section 25 when made in the
course or furtherance of business as supply, even though made without
consideration which would require the transaction to be valued at arm’s length
and tax discharged.

 

The application of this entry in the context
of international branch transfer needs to be analysed. The term ‘distinct
persons’ is dealt with u/s 25(4) which provides that a person who has
obtained or is required to obtain more than one registration, whether in one
State or Union territory or more than one State or Union territory shall, in
respect of each such registration, be treated as distinct persons for the
purposes of this Act.

 

In other words, it is only the domestic
branches of an entity which come within the purview of distinct persons.
Similarly, a domestic H.O. and foreign branch, or vice versa would not
come within the purview of related persons, since the same would have entailed
existence of more than one person, which is not so in the case of branch transfers.
It is for this reason that in case of domestic transactions the concept of
‘distinct person’ has been introduced.

 

In this background, one would need to
analyse the tax implications when international branch transfer is undertaken,
i.e., goods are sent to foreign branch / H.O. or vice versa, goods are
received from foreign branch / H.O.

 

In an outward branch transfer case, it would
be a transaction of export of goods – both under customs as well as GST since
goods are actually going out of India. The supplying branch would have an
option to export the goods under LUT / Bond or on payment of duty.

 

However, in case of inward branch transfer,
the importer would be required to pay the applicable duty – customs as well as
integrated tax on such imports, subject to specific exemptions or cases where
the import of goods fall under specific scenarios.

 

CONCLUSION

While both the
Customs and the GST laws operate in different domains with different objectives
in mind, in view of the disconnect in certain cases, one finds instances of
overlap and interplay between these two laws.

 

LEARNINGS FOR AUDIT FIRMS IN THE ERA OF PCAOB AND NFRA

INTRODUCTION

Audit firms have
always been subject to regulatory review by both the ICAI as well as the
regulators. Whilst initially they only underwent scrutiny by the ICAI in terms
of the disciplinary mechanism, over a period of time ICAI introduced the
concept of review of individual audits undertaken by the firms, as also the
firm itself through the FRRB, Peer Review and QRB mechanism.
Recently, the QRB Reviews have been substituted through oversight and
regulation by the NFRA for firms involved in auditing a certain class of
entities, whereas the QRB will be involved in other matters.

 

Accordingly,
it would be pertinent to note the background and role played by the NFRA and
its implications on the future of audit firms.

 

NFRA

After the
Satyam scandal took place in 2009, the Standing Committee on Finance proposed
the concept of establishing a National Financial Reporting Authority (NFRA) for
the first time in its 21st Report. The Companies Act, 2013
subsequently gave the regulatory framework for its composition and constitution.
The Union Cabinet approved the proposal for its establishment on 1st
March, 2018. The establishment of NFRA as an independent regulator is an
important milestone for the auditing profession and will improve the
transparency and reliability of financial statements and information presented
by listed companies and large unlisted companies in India.

 

The NFRA
was  constituted on 1st
October, 2018 by the Government of India u/s 132(1) of the Companies Act, 2013.
As per the said section, NFRA is responsible for recommending accounting and
auditing policies and standards in the country, undertaking investigations and
imposing sanctions against defaulting auditors and audit firms in the form of
monetary penalties and debarment from practice for up to ten years.

 

APPLICABILITY

As per Rule 3
of the NFRA Rules, 2018, the Authority shall have power to monitor and enforce
compliance with accounting standards and auditing standards and oversee the
quality of service u/s 132(2) or undertake investigation u/s 132(4) in respect
of auditors of the following class of companies and bodies corporate, namely:

 

(a) Companies whose securities are listed on any
stock exchange in India or outside India;

(b) Unlisted public companies having paid-up
capital of not less than Rs. 500 crores or having annual turnover of not less
than Rs. 1,000 crores, or having, in aggregate, outstanding loans, debentures
and deposits of not less than Rs. 500 crores as on the 31st of March
of the immediately preceding financial year;

(c) Insurance companies, banking companies,
companies engaged in the generation or supply of electricity, companies
governed by any special Act for the time being in force or bodies corporate
incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of
sub-section (4) of section 1 of the Act;

(d) Any body corporate or company or person, or any
class of bodies corporate or companies or persons, on a reference made to the
Authority by the Central Government in public interest; and

(e) A body corporate incorporated or registered
outside India, which is a subsidiary or associate company of any company or
body corporate incorporated or registered in India as referred to in clauses
(a) to (d) above, if the income or net worth of such subsidiary or associate
company exceeds 20% of the consolidated income or consolidated net worth of
such company or body corporate, as the case may be, referred to in clauses (a)
to (d).

 

Thus, the
NFRA has stepped into the shoes of the QRB to concentrate on audit firms involved
in entities which are perceived as public interest entities. Currently
all private limited companies even if they satisfy the thresholds as per clause
(b) above are not covered. Consequently, the QRB will henceforth be
involved in the review of audits firms involved in undertaking audits other
than those covered above.

 

The concept
of establishing the NFRA has been greatly influenced by the establishment and
functioning of the PCAOB in the USA and hence it would not be out of place at
this stage to briefly discuss its role.

 

PCAOB

The Public
Company Accounting Oversight Board (‘PCAOB’) is a private-sector, non-profit
corporation created by the US Sarbanes-Oxley Act of 2002 (‘SOX’) to oversee
accounting professionals who provide independent audit reports for publicly
traded companies only, unlike NFRA which covers large unlisted public entities,
too. The annual budget of PCAOB for the year 2019 is $273.7 million for a
market cap of $9.8 trillion. The PCAOB’s responsibilities include the
following:

 

(i)   registering public accounting firms;

(ii) establishing auditing, quality control, ethics,
independence and other standards relating to public company audits;

(iii) conducting inspections, investigations and
disciplinary proceedings of registered accounting firms; and

(iv) enforcing compliance with SOX.

 

Registered
accounting firms that issue audit reports for more than 100 issuers (primarily
public companies) are required to be inspected annually. This is usually around
ten firms. Registered firms that issue audit reports for 100 or fewer issuers
are generally inspected at least once every three years. Many of these firms
are international non-U.S. firms who are involved in the audit of
publicly-traded companies on the US Stock Exchanges. Consequently, some
Indian audit firms who are involved in issuing audit reports are required to be
registered with PCAOB and hence be subject to PCAOB inspections.

 

INSPECTION REPORTS

The PCAOB periodically issues inspection reports
of registered public accounting firms. While a large part of these reports are
made public (called ‘Part I’), portions of the inspection reports that deal
with criticisms of, or potential defects in, the audit firm’s quality control
systems are not made public if the firm addresses those matters to the Board’s
satisfaction within 12 months of the report date.

 

Those portions are made public (called ‘Part II’)
only if (1) the Board determines that a firm’s efforts to address the
criticisms or potential defects were not satisfactory, or (2) the firm makes no
submission evidencing any such efforts.

 

IL&FS OUTBURST

After having understood the role of NFRA and to a
certain extent PCAOB, it would be pertinent at this stage to examine the public
outbursts against the closely-held financial sector giant ILFS which piled up
huge debts amounting to around Rs. 90,000 crores by September, 2018. The
problems initially surfaced with defaults in the repayment of the most liquid
and known safest form of debt, viz., commercial paper, followed by a domino
effect which threatened and called into question the stability of the entire
NBFC sector. This understandably led to a public outburst on various aspects
and called into question the role of the government, the RBI and the auditors,
amongst others. The following were some of the key matters which triggered the public outburst:

 

(1) What was the RBI doing all these years as a
part of its inspection process, considering that there were reports of breach
of NOF, group exposure and capital adequacy norms in case of one of the group
entities?

(2) How did the Credit Rating Agencies fail to see
through the high leverage and the potential defaults without any warnings and
suddenly downgraded the rating from stable to default?

(3) The impact of the defaults on the mutual funds
which had heavily invested in the debt instruments and the consequential impact
on the common investors;

(4) The bailing out by the government through
investments by LIC and SBI and other similar profitable PSUs (‘family jewels’)
thereby potentially jeopardising the savings of millions of investors and
policy-holders;

(5) As is always the case, the role of the auditors
was also called into question on many fronts like adherence to independence
requirements, maintaining professional scepticism, failure to comply with
regulatory requirements, provide early warning signals, etc.

 

It would be
pertinent at this point to dwell on NFRA and assess its role and duties in
conducting Audit Quality Review (AQR) of CA firms. The first such
AQR was completed in December, 2019 in respect of the audit undertaken by a
firm of one of the IL&FS group entities, which is an NBFC, being the first
such within that group which is in the public domain and which has been used as
a basis for the discussion hereunder.

 

AQR PROCESS

This is one of the important tools provided to the
NFRA to regulate and monitor audit firms as covered in the Rules referred to
earlier, which was conducted by the Quality Review Board. The QRB Review and
AQR can also be considered as equivalent to the PCAOB reviews conducted in the
case of the US-listed entities referred to earlier.

Scope
and regulatory force

The scope and
the regulatory force for the AQR are provided in Rule 8 of the NFRA Rules,
2018. The said Rules provide that the NFRA may, for the purpose of
enforcing compliance with the Auditing Standards, undertake the following
measures which would broadly constitute the scope for the AQR:

(A) Review working papers and other documents and
communications related to the audit;

(B) Evaluate the sufficiency of the quality control
system followed by the auditor; and

(C) Perform such other testing of the audit,
supervisory and quality control procedures of the auditor as may be considered
necessary or appropriate.

 

Though Section 133 of the Companies Act, 2013 requires
the NFRA to inter alia monitor and enforce compliance with both the
Accounting and the Auditing Standards, the main focus of the AQR, which
we will discuss in the subsequent section, is on compliance with the auditing
and quality control standards.

 

Steps
involved in undertaking the AQR

The AQR which
is undertaken is not a one-way traffic but follows an elaborate process of
seeking information from the audit firm, followed by the draft findings against
which the replies of the audit firm are sought before the final report is
issued. The following are the various steps which are broadly undertaken before
the final report is issued and the same are included in a separate Annexure to
the report so that there is no ambiguity:

(a) Formal letter sent by NFRA to the engagement
partner (EP) asking for the audit file of the client selected for review.

(b) Subsequent letter sent to the EP asking for the
list of related parties and the details of the audit and non-audit revenue of
the selected client under affidavit.

(c) NFRA’s letter sent to the EP containing a
questionnaire sent via email and the replies against the same by the audit
firm.

(d) NFRA’s letter to the EP conveying its prima
facie observations against the various issues in the questionnaire referred
to in (c) above and the reply there against.

(e) Issuance of the Draft AQR Report (DAQR).

(f) Presentation made by the EP and the other team
members to the NFRA in pursuance of the observations in the DAQR.

(g) Written replies furnished by the EP to NFRA in
response to the observations in the DAQR.

(h) Issuance of the final AQR Report by NFRA.

 

Summary
of the NFRA’s conclusions in the AQR

The culmination of the above process resulted in
several findings, recommendations and conclusions covering a wide spectrum of
issues which were analysed under the following broad categories as tabulated
hereunder. Whilst a detailed discussion thereof is beyond the scope of this
article, the main findings as discussed here would not only provide an insight
into the thinking of the NFRA but also serve as an eye-opener to the audit
firms, especially the small and medium-sized ones, to enable them to ramp up
their audit quality keeping in mind the current circumstances.

 

Area

Key Findings / Observations
and Conclusions

 

 

Compliance with independence requirements

The NFRA has come down heavily on the independence requirements
violated by the audit firm, as evidenced by the following matters:

a) The audit firm had grossly violated the provisions of section
144 of the Companies Act, 2013 by providing various prohibited services
and also not taking the approval of the Audit Committee, including in
respect of services provided by associated / connected firms / companies
to both the company and its holding or subsidiary companies. The total
fees for such non-audit engagements in excess of the corresponding audit fees
has, in the words of the NFRA used in the Report, ‘undoubtedly fatally
compromised the windependence in mind required by the Audit Firm’

b) The approval of the Board of Directors for such
services is not permissible where the company has an Audit Committee and the
same would amount to an override of controls

c) There was a clear violation of the RBI Master
Directions since the EP was involved in the audit for a period of five
years as against the mandatory rotation after a period of three
years

d) The Senior Audit Engagement team comprising of the Audit
Director and Audit Senior Manager were involved in the audit for a period
in excess of seven years which is against the spirit of the staff
rotation and familiarity threat principles enshrined in SQC-1. The
contention of the audit firm that such requirements were applicable only to
the EP and the Engagement Quality Control Review (EQCR) Partner
was not acceptable to the NFRA since the EQCR is an entirely independent
exercise. This clearly compromised on the audit firm’s independence both in
letter and in appearance

 

 

Role of the EP

The reference by NFRA to the role of the EP is both interesting
as well as insightful, as reflected through the following key observations:

a) The practice of the audit firm in designating two partners
as EPs is clearly a violation of SQC-1 as well as SA-220 – Quality control
for an Audit of Financial Statements, which clearly mandates that member
firms should have only one EP, which aspect was also clearly laid down even
in the audit firm’s Internal Quality Manual

b) The time spent by the signing partner (who is
considered by the NFRA as the EP) and the evidence of the review of
documentation by him during the course of the audit, clearly shows
that almost all the important work of audit, i.e., independence evaluation,
risk assessment, audit plan, audit procedures, audit evidence, communications
with management or those charged with governance (TCWG) was not adequately
directed / supervised / reviewed
by the EP

 

 

Communication with TCWG

Since an ongoing two-way communication between the audit firm
and TCWG is an important element in the audit process, the following
observations by the NFRA in this regard merit attention:

a)The audit firm was not able to produce a single document
minuting the discussions held with TCWG

b) The assertion of the audit firm that they have
exercised their professional judgement in making their written communications
cannot be taken as a justification that nothing was required to be
communicated. This also runs contrary to the fact that the RBI
inspections and subsequent correspondence had revealed serious
non-compliances relating to NOFs, CRAR, NPAs and Group entity exposures,
amongst others, which are significant and require to be communicated under
SA-250 on Consideration of Laws and Regulations in an Audit of Financial
Statements and SA-260 on Communication to Those Charged with Governance

c) As per the minutes of the meetings of the Board of
Directors and the Audit Committee, there was also nothing on record to
demonstrate that the audit firm representatives had attended any meetings at
which the above matters were discussed, except the meeting at which the
accounts were approved and adopted. Further, even at the said meeting the
contention of the audit firm that there were no serious non-compliances with
laws and regulations does not hold water, considering the correspondence
referred to above and the non- disclosure in the
financial statements

 

 

Evaluation of Risk of Material Misstatement
(ROMM) Matters

Assessment of ROMMs being an important component in the entire
audit process has naturally received due attention by NFRA and the following
are some of the important observations in respect thereof:

a) The reference in the audit work papers to
compliance with International Auditing Standards is a clear
non-compliance with section 143(9) of the Companies Act, 2013. The Report
further states that ‘the Companies Act refers only to SAs prescribed by
that statute and to no other. Hence, any reference to any SAs other than so
prescribed is clearly non-compliant with the Companies Act. NFRA, as a body
constituted under the Companies Act, 2013,

obligated to consider only what is compliant with
that Act.’

b) The audit firm failed to appropriately deal with
identification, categorisation and minimisation of engagement risk,
especially looking at the size, nature and economic significance of the
auditee company. The risk of misstatement due to fraud was also ruled out by
the audit firm, especially with regard to revenue recognition which is a
presumed fraud risk as per SA-240. This led to inadequate audit responses.
Some specific instances to highlight the same are discussed in points
(d) to (f) below

c) There were significant contradictions in the assessment of
ROMM which lead to the conclusion that the assessment had been carried out in
so casual a manner as to result in a complete sham

d) There is no reference in the audit file to the fact that
the audit firm has noted the SI – NBFC character of the entity whilst
undertaking a risk assessment and the consequential risk classification as
normal which is reflective of an inadequate understanding of the
financial and business sectors of the economy. The NFRA has further
remarked that ‘the RBI, as the chief regulator of financial and
monetary matters, makes this determination, which
needs to be

respected and not treated
cavalierly.’

e) There were several inadequacies found in the testing and
evaluation of NPAs, including the requirement of early recognition of
financial distress and the resolution thereof and the classification of
Special Mention

Accounts in terms of the RBI guidelines

f) The audit firm should have maintained professional
scepticism throughout the audit by recognising the possibility that a
material misstatement due to fraud could exist as per SA-240, notwithstanding
the auditor’s past experience of the honesty and integrity of the entity’s
management and TCWG, by performing specific and adequate procedures to
address the following matters, amongst others:

(i) Suppression of defaults due to regular
‘ever-greening’ of loans,

(ii) Manual overriding of controls for a substantial
portion of loans sanctioned during the year as evidenced by the statement /
analysis in the audit file and the corresponding observations in respect
thereof in the

RBI Inspection Report,

(iii) 
Procedures to test the completeness and accuracy of the listing of
NPAs,

(iv) Testing of journal entries, especially those
pertaining to items posted after the closing date, significant period end
adjustments and estimates, inter-company transactions, etc.

Testing / disclosure of specific matters arising
out of RBI Inspection Reports

a) The audit firm did not question the management and challenge
the inflation of profit by a material amount through inclusion of the value
of a derivative asset which was entirely unjustified. The Report mentions
that ‘the actions of the auditor in not having done so, and having
accepted the stand of the management without question, shows clearly a gross
dereliction of duty and negligence on the part of the audit firm’

b) The audit firm accepted the stand of the management
about not disclosing the fact that the Net Owned Funds (NOF) and the Capital
to Risk Assets Ratio (CRAR) of the entity as on 31st March, 2018
were both negative, based on the RBI Inspection Report and related
communications and that this situation could lead to cancellation of the NBFC
license of the entity. The audit firm also certified the accounts as showing
positive NOF and CRAR, accepting the explanations of the management which
were clearly contrary to law. The explanation of the audit firm seems to
imply that this communication of the RBI was not available to them. This
explanation was held to be unacceptable for the reason that this clearly
showed the complete lack of due diligence and professional scepticism on the
part of the audit firm. Had proper inquiries been made both with TCWG and the
RBI, it is certain that this communication would have been formally made
available to the audit firm

c) Consequent to the above matter, the audit firm did not
adequately question the going concern assumption on the basis of which
the management had prepared the financial statements

 

 

Learnings
and challenges for audit firms

A careful
evaluation of the findings arising out of the above report provides several
learnings as well as challenges, especially for the small and medium-sized
firms, considering that the observations have been made in respect of an
international firm which is supposed to have robust processes. The challenges
before the SMPs are broadly analysed under the following headings:

 

Adverse
publicity / reputational risk:

Unlike the
earlier QRB Review Reports, the NFRA shares its findings and publishes the
reports on its website and hence the same are available in the public domain,
which immediately leads to bad publicity and adverse reputational risk for both
the audit firm and the client / entity concerned. This is in line with the authority
provided to it in terms of Rule 8(5) of the NFRA Rules. It may,
however, be noted that Rule 8(6) of the NFRA Rules provides that no confidential
or proprietary information should be so published unless there are
reasons to do so in the public interest which are recorded in writing. However,
what constitutes confidential or proprietary information has not been defined.

 

One of the
ways in which this can be achieved is by dividing its report into two parts as
is done by the PCAOB as discussed earlier.

 

EMPHASIS ON AUDIT INDEPENDENCE AND AUDIT ADMINISTRATION /
COMMUNICATION

There is now
a growing expectation of independence both in letter and in spirit.
Whilst prima facie the requirements under the statute may appear to have
been complied with, independence of the mind in the eyes of the external
stakeholders / users of the audit report is also important. This may be a challenge
to smaller firms who have a limited number of audits and staff to perform the
same, making them vulnerable to the familiarity threat. Accordingly, in
future audit firms would have to keep in mind these aspects before they accept
fresh audit engagements since the ICAI / QRB has the power to regulate all
entities. Further, the general tendency of being an all-weather friend and
trusted adviser would need to be carefully calibrated with the regulatory
guidelines. Finally, a lot of emphasis would have to be placed on the extent
of the role played by the EP as against the tendency to rely on the work done
at the junior level due to both time and technical constraints (e.g. the EP
being a tax specialist). In this context, the observation of the NFRA of the audit
firm designating two EPs may not help since the concept of shared
responsibility did not cut ice with the NFRA. To mitigate these
problems, small and medium-sized firms would do well to undertake external
consultation on a more formalised and frequent basis since it is
also recognised as an important element in the overall quality control process
in terms of SQC-1.

 

IMPORTANCE OF FRAUD AND RISK ASSESSMENT

The
importance of these two aspects cannot be overemphasised. The current
environment of regulatory overdrive makes audit firms vulnerable to greater
scrutiny on these aspects. Several specific observations by NFRA on granular
aspects of fraud and risk assessment in the audit report like ever-greening of
loans, valuation of derivatives, testing of related party and inter-company
transactions, manual override of controls, etc. makes it imperative for audit
firms to exercise greater degree of professional scepticism since their
professional judgements would come under greater scrutiny. To mitigate these
problems, audit firms, especially the small and medium-sized ones, should have
regular training and orientation programmes, both external and internal, so
that apart from sharpening the technical skills the necessary soft skills are
also developed. Such training costs should not be considered as a cost but as
an investment.

 

COMPLIANCE WITH AND ATTENTION TO REGULATORY MATTERS

The NFRA Report has sent out a clear message that
audit firms ignoring regulatory matters do so at their own risk. Further, NFRA
has taken a strict view on certain matters like risk classification in case of
Systemically Important (SI) – NBFCs as greater than normal, which is
questionable. Another area flagged by them involves inadequate
communication and dialogue with the management and TCWG on regulatory matters.
Accordingly, it is important for audit firms to rigorously follow the
requirements laid down under SA-250 and SA-260 even though the primary
responsibility for compliance with laws and regulations rests with the management
and TCWG.

 

Robust
documentation of the audit engagement and firm level policies

The oft-used
phrase what is not documented is not done and also the fact that
audit documentation should be self-explanatory and be able to stand on its own,
has been clearly in evidence in the NFRA’s findings in several places,
e.g. reference to International Standards on Audit (this provides a subtle
message to the firms with an international affiliation that compliance with
international requirements is no substitute for compliance with the local
regulations, guidelines and pronouncements), non-availability of minutes of
meetings of discussions / communication with the management on important
matters, no specific documentation evidencing performance of key audit procedures
in respect of certain transactions having greater risk and fraud potential and
so on.

 

One of the
most important learnings for audit firms involved in the audit of covered
entities is to streamline and standardise routine audit documentation
by laying down clear policies, checklists and other documentation for execution
of audit engagements in general and keeping in mind the specific documentation
requirements as laid down in the various Standards on Auditing, as also on the
various elements of the system of quality control, as under, as laid down in
SQC-1:

 

(I)   Leadership responsibilities for quality within
the firm;

(II)   Ethical requirements (including independence
requirements);

(III)  Acceptance and continuance of client
relationships and specific engagements;

(IV) Human Resource policies covering recruitment,
training, performance evaluation, compensation, career development, assignment
of engagement teams, etc.;

(V)  Engagement performance, including
consultation, engagement quality review, engagement documentation retention and
ownership, etc.

 

Whilst
framing policies in respect of the above and any other related matters, care
should be taken to avoid mechanically copying the requirements laid down in the
Standards. The policies should be framed keeping in mind, among other things,
the size of the firm, the nature and complexity of the clients served and the
competence of the personnel to implement the same.

 

How
small and medium-sized firms can prepare for NFRA review

One of the
most important elements is to have an audit manual in place covering the
policies and procedures, with all templates, formats, and checklists in place
to ensure compliance with the applicable Auditing Standards. The structure and
significant content of the audit manual could be as follows:

 

  • INTRODUCTION AND FUNDAMENTAL PRINCIPLES:

This chapter
introduces the fundamental principles related to reasonable assurance,
objective of an audit, audit evidence, documentation, financial reporting
framework, quality control, ethics, professional scepticism, technical
standards.

  •   PRE-ENGAGEMENT
    ACTIVITIES:

In this chapter the
manual deals with the basic engagement information, engagement evaluation:
client acceptance / continuance, independence declarations, staff assessment
and audit budget, planning meetings, terms of the engagement.

  •   PLANNING THE AUDIT:

This chapter covers
the audit approach, gathering knowledge of the business, laws and regulations
and understanding the accounting systems and internal controls, fraud risk
discussions and indicators, related parties.

  •  RISK ASSESSMENT PROCEDURES:

This chapter will
help auditors comply with the standards of auditing related to the
identification and mitigation of risk of material misstatement, fraud risk and
going concern risk at the initial stage of audit.

  • PLANNING MATERIALITY:

Planning
materiality is one of the most critical elements of an audit as it determines
the coverage of the audit. Planning materiality should be determined at the
planning stage and should be updated if required during the execution phase.

  •   AUDIT PROGRAMMES:

A well-designed
audit programme ensures compliance of auditing standards and quality standards
while performing the audit and also acts as a guiding checklist for the
engagement team.

  • TEST OF CONTROLS AND SUBSTANTIVE TESTS:

This chapter guides
the team in determining the reliance on the test of controls vis-a-vis the test
of details, resulting in a balanced approach between the two to ensure an
efficient and effective audit.

  •   PERFORMING THE AUDIT:

This chapter is the
heart of the audit documentation. It deals with documentation of the execution
of the entire audit, determining the audit sampling, audit sampling procedures,
consideration of applicable laws and regulations, inquires with management and those
charged with governance, external confirmation procedures, analytical
procedures, procedures to audit accounting estimates and fair value
measurements, identification of related parties, going concern considerations,
considering the work of internal audit or experts, physical verification
procedures, etc.

  •  FINALISATION: AUDIT CONCLUSIONS AND
    REPORTING:

The auditor needs
to ensure the adequacy of presentation and disclosure, subsequent event and
going concern consideration, final analytical review, evaluation of audit test
results, issue of the auditor’s report, communicate with those charged with
governance and coverage of management representations.

 

 

 

CONCLUSION

What is
not documented is not done has been the age-old mantra! Audit documentation helps the auditors to prove to the user of the
financial statements, usually the authorities, that a proper audit was
conducted. The data that has been recorded can help in ensuring and encouraging
that the quality of the audit is maintained. It also provides an assurance that
the audit that was performed was in accordance with the applicable auditing
standards.  

 

 

WORKING CAPITAL CHALLENGES FOR CA FIRMS IN COVID TIMES

Historically, in India Chartered Accountants
have practised as proprietary concerns or partnership firms. But since the
introduction of the Limited Liability Partnership Act (LLP) and the permission
of the ICAI for Chartered Accountants to practise as LLPs, many members of the
Institute in practice have either formed LLPs or have converted their
partnership firms into LLPs. Most of the Chartered Accountant practising units
(the firms) were small or of medium size and their working capital needs were
fully taken care of by funding from the partners and the retained profits.

 

As the size of many of these firms grew and
the number of partners increased, they started needing more space to operate.
Given that the investment for purchase of office premises, especially in
metropolitan cities, was high, many firms started using rented premises.
Furnishing of these offices was carried out using partners’ capital and
borrowing from banks and other lenders. In many cases, the purchase of vehicles
was also done by borrowing from banks or from Non-Banking Finance Companies
(NBFCs). Most of the firms hardly needed to borrow for their working capital as
their income was in the nature of service income being generated from a number
of clients and spread uniformly. Borrowing for office premises, furniture,
equipment or vehicles was common but if a firm borrowed for working capital
needs, it could have been an indication that either the proprietor or one or
more of the partners had overdrawn their capital.

 

REVENUE CYCLE TURNS
CYCLICAL: With the mandate to compulsorily follow
the fiscal year by the government, the revenue cycle of Chartered Accountant
firms also became somewhat cyclical. The major part of the work is required to
be performed between April and November and the major billing starts happening
between May and December every year. This has resulted in a majority of the annual
cash inflow of the firms coming in during the second and third quarter of a
financial year. Generally, the months of February, March and April are ‘dry’
with regard to billing and recovery of funds. This results in low liquidity in
firms after the payment of advance taxes in March, which lasts till the end of
May / June, depending on the practice areas of the firms. However, the firms
are conscious about this unevenness of the fund flow and they accumulate the
required cash during the peak work season to pay for taxes as well as expenses
in the lean months. This discipline keeps most of the firms away from borrowing
for working capital.

 

However, Covid-19 has changed the scenario
for firms and even the individual practices of professionals. The lockdown,
starting from 25th March, 2020, potentially has serious
repercussions on the working capital of firms. Most of the firms are cushioned
until the month of May as they have provided for low recoveries in the
beginning of the year as usual. However, due to postponement of the due date of
completion of audits, tax audits and filing of various returns, the billings
are getting postponed by at least two to three months. Further, most of the
clients may not be able to pay the expected fees promptly due to the squeeze on
their working capital and profitability on account of the prolonged lockdown.
Small businesses are suffering due to temporary closures and a steep fall in
demand. The competition from online suppliers and from certain larger
suppliers, who can manage the logistics of home delivery, has further eroded
their business.

 

FATE OF SMALL-SCALE
MANUFACTURERS: The fate of small-scale
manufacturers is no different. This has substantially affected the capacity of
small clients to pay fees to their chartered accountants, though generally
their fees are cleared promptly. The larger businesses in key sectors have also
suffered due to the lockdown and this may result in delay in payment of the
bills of the firms. The clients will use their funds primarily for their
business priorities before allocating them to payments for services such as
those of chartered accountants. This is likely to result in delayed recovery of
fees, and in some cases even bad debts. It is likely that as in many other
businesses or professions, the F.Y. 2020-21 is likely to be tough for chartered
accountants in practice.

 

The delay in recovery of fees and some
recoveries turning doubtful can cause strain not only on the profitability of
the firms but also on their working capital. The laws have not reduced any
compliances or any complications but many due dates are deferred due to the
lockdown. Therefore, the same volume of services needs to be delivered by the
firms to the client, though with extended deadlines. This scenario will keep
the expenditure of the firms at the same level as that of the earlier years, as
they will not be able to get their work done with fewer man-hours or overheads,
unless well-directed efforts are made in that direction. However, income for
the firms may come down and be likely to be recovered late. This may result in
a major working capital gap for the firms, especially between the months of
June and December.

 

It appears for now that the need of working
capital will be temporary in nature. The squeeze may last the current financial
year with the possibility of spilling over to the next year. Generally, the
need of working capital augmentation should be around 50% of the annual
expenditure of the firm, though in many cases depending upon the size and
practice areas, an amount equal to 25-30% of such expenditure should allow the
firm to sail through smoothly. This is so mainly because the lag of billing and
recovery is likely to be around three to four months but in
case of some firms it can extend to six months. The working capital of firms
can be augmented from the following sources:

 

BORROWING FROM THE
PARTNERS: This is the simplest way of raising
working capital if one or more partners are willing to contribute the required
amount. Interest can be paid to such contributing partners based on the
partnership agreement, or based on the prevailing bank rate, or as mutually
agreed by the partners. It may also be possible to borrow against the fixed
deposits of the partners from banks if facilitated by one or more partners.
Such an arrangement can result in low interest cost and it may prevent
disturbing the personal finances of the partners. The partners may also agree
to bring deposits from their family members or even from friends which may be
interest-bearing or interest-free, based on the mutual agreement between the
partners.

 

BORROWING FROM
BANKS: Most of the banks are willing to extend
working capital facility to Chartered Accountant firms but the question of
security may crop up. Banks are not happy to grant such loans without any
security and it may not be easy for the firm to provide such security because
the firm may not have such acceptable assets and it may not be desirable to
request one or some of the partners to give security of their personal assets.
These borrowings can come under MSME loans and in that case may be subject to a
charge of reduced rate of interest. If the firm already has existing loans
taken for its premises or its furniture and fixtures, it may be possible to
take a top-up loan on the said loan, with accelerated equal monthly
instalments, or by increasing the term of the loan. In such a case, the
security remains the same and the documentation can be quick and easy. While
borrowing from banks it is essential to keep in mind that the borrowing should
be done just in time to reduce the interest liability. The working capital need
is not going to be front-loaded and it will be consumed month after month for
monthly expenses. Therefore, a staggered drawing of the loan amount would be
more desirable as against securing an upfront term loan.

 

BORROWING FROM
NBFCs: Non-Banking Finance Companies can be a good
source of borrowing for the short-term working capital needs of a firm. A loan
from an NBFC is generally more expensive than that from a bank, but it can be
procured faster with fewer formalities. Similarly, partners can negotiate and
combine their individual unsecured borrowing limits into the borrowing limit of
the firm, but such a loan will attract personal guarantees of all the partners.
Borrowing against security of assets can be much easier if a firm or its
partners can offer the same. Such an arrangement can be made with an
appropriate understanding between the partners. As the expected working capital
requirement is for a short term, in case of insistence of security by the
lender, it is advisable to grant security of moveable properties, which can be
pledged faster and at less cost as compared to an immoveable property.

 

USE OF CREDIT
CARDS: A firm can use credit cards of the firm or
those of its partners for making various payments for utilities, telephone
bills, stationeries, books, etc. Though these expenses do not make up the major
working capital needs of a firm, they can partially mitigate the working
capital gap. When the working capital cycle improves, the firm can repay the
credit outstanding along with interest. It should be kept in mind that funding
from credit cards is the easiest, but it is one of the most expensive avenues.
Further, credit card liability would have to be paid in instalments as per the
terms of the credit card and delays can attract substantial penal charges and
can also affect the CIBIL rating of the card-holder.

 

REDUCING,
STAGGERING OR POSTPONING WITHDRAWALS BY PARTNERS:
In most of the firms, partners draw fixed amounts every month to meet their
normal expenses. The excess credit balance in their capital account is drawn
either towards the end of the year or at the beginning of the following year.
Though it is difficult to get back the money paid earlier to the partners as
such amount may be invested, committed or spent, the partners can agree to not
draw their normal drawings for a few months, or draw lower amounts for those
months so as to conserve the working capital of the firm. Such an arrangement
does not change the profit share of the partners but it does postpone the
outflow of funds from the firm. This arrangement can help the firm to partly
cover its working capital gap.

 

POSTPONING PART
SALARIES OF SENIOR STAFF: The partners of a firm
can also make arrangements with senior staff of the firm who are drawing
salaries above a certain threshold, to defer a part of the salary payments for
a certain period to overcome the working capital gap. The arrangement can be different
from employee to employee. They should take appropriate care of the minimum
monthly needs of the employees, including their respective loan instalments. In
the current times of lockdown and gradual unlocking, the actual expenditure of
many people has reduced because there are fewer avenues for meaningful
spending. People are also in the mood to save as the future remains uncertain.
Therefore, this type of arrangement may not be out of place. Further, in case
of specific needs of an employee, some flexibility or modifications in the
payment schedule can be made by the partners of the firm.

 

DEFERMENT OF BONUS
FOR THE YEAR: Many firms give an annual bonus at
the time of Diwali. It is possible that the financials of the firms at this
year’s Diwali may not be strong enough to pay out a large amount as annual
bonus. This difficulty can be overcome by partly or fully deferring the bonus
payment till the end of the financial year, by which time the finances of the
firms are likely to improve. Such a deferment can only give partial relief to
the firm by reducing its working capital gap at a crucial time.

 

RECEIVING FEES IN
ADVANCE FROM SOME CLIENTS: A firm can also request
a few large net worth clients or companies to pay their fees in advance, or
grant an advance against future billings. The long-standing clients of a firm
with good liquidity may be able and willing to oblige. However, such advances
should be avoided from audit clients – and the provisions of the Companies Act
and the Code of Ethics of the ICAI should be properly observed. While taking
such advances, GST repercussions may also be considered.

The Covid-19 pandemic has raised several
issues related not only to the physical and mental well-being of people, but
also related to the financial stability of individuals, businesses, companies
and even the government. The financial planning of many individuals and
families has suffered a serious setback and nobody has a clear answer as to
when things will improve. In the current situation, the Chartered Accountant
professionals are comparatively more protected as the major part of their
revenue is earned out of statutory compliances that have not been done away
with.

 

Medical professionals are working very hard
and they can expect their finances to remain steady as their services are in
high demand. However, other professionals providing legal, architectural,
engineering, designing services, etc. may have much more serious working
capital problems as compared to a firm of chartered accountants. Their mismatch
of working capital may not get resolved by the end of the current financial
year and it may take longer to get back on track. Such professionals and their
firms will need to secure long-term working capital arrangements from banks or
NBFCs to tide over their needs, unless the partners can make up the deficit in
the working capital by capital induction or otherwise.

 

Undoubtedly, Covid-19 has caused and is
going to cause even further disruption in our professional activities. It may
cause a turnover of the staff as many may prefer to work at places as near as
possible to their homes. Senior staff may be ready to take temporary reductions
in their take-home salaries. Clients are likely to feel the pinch in their
businesses and requests for reduction in fees are going to be very common. The
work volume may not be reduced at least during F.Y. 2020-21 as most of us will
be working on the transactions of the clients entered into in F.Y. 2019-20,
which were at normal levels. The request for lower fees may continue for one
more year as the turnover and activities of F.Y. 2020-21 are likely to be on
the lower side as compared to the previous year. So the pain is likely to last
for a couple of years for our profession. In the given circumstances, our
profession needs to rationalise and control costs and stand by our clients
gracefully, accepting reduction of fees in deserving cases. This will result in
a lower bottom line for the profession, but the gesture may go a long way with
the client.

 

The times are
unprecedented, tough and full of uncertainties. In such times, innovation,
caution and thrift will go a long way to take the professionals out of the
crisis, physically, mentally and financially, without much damage. 

CURRENT THEMES IN CORPORATE RESTRUCTURINGS AND M&As

This article attempts to consolidate recent key commercial and regulatory developments having a bearing on Corporate Restructurings and Mergers & Acquisitions. It could help decision-makers in preparing for the expected resurgence of corporate actions as we step into ‘Mission Begin Again’.

BACKDROP

The F.Y. 2019-20 was hampered by a global structural slowdown which got further amplified with the novel Covid-19 pandemic bearing significant impact on business models and corporate actions.

From a sustenance stand-point, raising fresh capital for organic and inorganic needs is clearly the need of the hour. We are seeing the outlier transaction of Jio Platforms’ Rs. 115,693 crores aggregate fund raise1  and then we have the flurry of announcements for rights issues, NCDs, venture debts and loan top-ups. From the startups’ perspective, pricing and dilution issues are forcing them towards debt and venture debt with unique situations around collaterals and dynamic business models with cash burn.

With Unlock 1.0 and the expectation of ‘normal’ monsoon2  serving as a confidence-booster, markets and industries are moving in a green zone, at least on a month-on-month basis, including for capital markets.

Index Current levels (1st June, 2020) % change from 1st Jan to 31st Mar % change from 31st Mar to 1st June
SENSEX 33,303 – 29% + 13%

Subject to the possibility of Covid continuing to lash out again and again in waves, Q3FY21 and Q4FY21 may provide some clarity on business feasibilities, cash runways, etc. which could act as a direct feeder for potential internal and external restructurings and M&A actions and consolidation across sectors.

1   https://www.bseindia.com/xml-data/corpfiling/AttachHis/715b628f-8f44-413a-b509-2943a2dd3f22.pdf
2  http://internal.imd.gov.in/press_release/20200601_pr_827.pdf

Each corporate action, irrespective of its nature, size and scale, has its unique internal and external challenges, including:

From the preparedness point of view, the above agenda clearly needs at least two to four months of planning before actual execution of corporate action. So, the time is NOW.

With almost all the businesses exposed due to the pandemic, it is absolutely essential to take a hard look / relook at the story, rephrase it and create a platform for market participants for ease of deal-making.

On the M&A horizon, we are seeing re-negotiations of live transactions, revalidating offerings and numbers to see if strategic reasons still hold good, to re-assess deal valuations, covenants, etc. For already ‘closed’ transactions, re-negotiations are expected in the capital structure (cap tables, as they are known commonly), earn-out targets, valuation covenants, agreed business plans and covenants in the shareholder / transaction agreements. Such re-negotiations may also get extended to ESOPs and sweat equity allocations and agreed benchmarks.

For us professionals, we can add significant value on both sides of the table, especially keeping tax and regulatory requirements in mind.

RIGOROUS OPERATIONAL ASSESSMENTS COULD LEAD TO RESTRUCTURINGS AND DEALS

An assessment of costs, commitments, scenario analyses, markets and stakeholders’ concerns during the lockdown could help in identifying ‘good apples’ and ‘bad apples’.

Consolidation (mergers) and hive-offs (de-mergers or slump sale or itemised sale) can be evaluated for the following scenarios:

Indicator Possible solution
New-age business or product Hive-off to attract new-age capital
Excess capacities, facilities and assets Hive-off and sale / leases, white-labelling arrangements, joint ventures
Unviable undertakings / companies Consolidation with parent to optimise on costs going forward
Business succession issues due to shifting of talent, labour and resources Merger / consolidation with other market participants

 

Creating group or sector-level outsourcing vehicles with independent business plan
High-performing businesses Separating from common hotchpotch and value realisation

At times, segregation of businesses with distinct cash flows could help could lead the way forward for the company, investor interest and fund-raising. Such a raise also helps promoters to bring their contribution in the bank settlements which are generally in 20%-25% ratio of restructuring and thereby helping and working on an overall bailout plan.

The Insolvency and Bankruptcy Code, 2016 (‘IBC’) has fast-tracked the insolvency and resolution process requiring swift action on the part of management in the rescue attempt. It is often seen that viable assets / businesses are drawn into distress if not segregated in time.

By way of example, recently Gold’s Gym filed for bankruptcy protection in the US3. Interestingly, they have closed company-owned gyms; however, licensing (franchising) business is expected to keep the company a going concern. We have had many such examples in India in the past.

Global companies and investors are looking out for replacing China with India and other developing countries. In times like these, corporates which are placed well from the structure, clarity of business plan, readiness and compliance point of view could be the preferred choice for external investors and also help in faster ‘closing’ of deals.

3   https://www.goldsgym.com/restructure/

Even a simple decision of choice of a legal entity between Limited Liability Partnership vs. Private Limited Company could have significant impact on the IRR of the project merely due to the difference in applicable income tax rates.

In October, 2019 RIL created a structural as well as technological platform providing flexibility in deal-making4.

Structures like these provide significant flexibility in deal-making or primary listing at a multiple level, like platform company, telecom company, investees or even any combination thereof.

The current slowdown and the ability to go back to the drawing board can certainly be leveraged to prepare for M&As, restructurings and the expected resurgence in Q3FY21 onwards. Going by experience, we often find ourselves hard-pressed for availability of sufficient time to implement the most effective structure and thereby compromising on possible savings even in time value of money terms.

From the balance sheet optics point of view, historically, companies have also used the capital reduction process u/s 66 of the Companies Act to adjust negative reserves or assets which have lost value against the capital. Companies can evaluate such strategies to right-size the balance sheet, especially absorbing the Covid impact.

IMPACT OF COVID-SPECIFIC ANNOUNCEMENTS

As announced under the Atmanirbhar Bharat initiatives and further ratified by the IBC (Amendment) Ordinance, 2020 dated 5th June, 2020:

  • No application for IRP shall be filed for any default arising on or after 25th March, 2020 for a period of six months or such further period not exceeding one year from such date; and
4   https://www.ril.com/DownloadFiles/Jio%20Presentation_25Oct19.pdf

(ii)   there shall be a permanent ban on filing of applications for any default which may occur during the aforesaid period.

Separately, government also intends to raise the minimum threshold to initiate fresh IBC proceedings to Rs. 1 crore.

Corporates can use this for their benefit in multiple ways, including:

(a)   Design and negotiate a restructuring strategy directly with lenders and creditors;

(b) Speedy disposal of internal restructuring schemes involving merger, de-merger, capital reduction, etc. due to expected reduction in the burden of cases on NCLTs.

The Government of India has also proposed multiple schemes such as the Rs. 3 lakh crores Collateral-free Automatic Loans for Business5, including MSMEs; Rs. 20,000 crores Subordinate Debt for MSMEs; Rs. 50,000 crores equity infusion through MSME Fund of Funds. Ultimately, financing under any such scheme will be subject to the strength of the business and balance sheet. Corporates have been using mergers as a tool to demonstrate higher asset and capital base.

Other recent initiatives announced by the government giving impetus to transactions include:

(1)   Direct listing of securities by Indian public companies in foreign jurisdictions;

(2)   Sector-specific initiatives and reforms in agriculture, defence, space, coal, food processing, aircraft MRO, logistics, education, etc.;

(3)   Private companies which list NCDs on stock exchanges need not be regarded as listed companies.

OVERSEAS LISTING OF PUBLIC COMPANIES – A NEW PARADIGM

In December, 2018 SEBI published the Expert Committee Report6 suggesting a framework for listing shares of Indian companies on overseas exchanges and vice versa.

In March, 2020 the Companies (Amendment) Bill, 2020 introduced in the Lok Sabha proposed to amend section 23 and provide for – such class of public companies may issue such class of securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions or such other jurisdictions, as may be prescribed.

5   https://www.eclgs.com/
6   Report of the Expert Committee for Listing of Equity Shares of companies incorporated in India on Foreign Stock Exchanges and of companies incorporated outside India on Indian Stock Exchanges, dated 4th December, 2020As of today, Indian companies can access the equity capital markets of foreign jurisdictions through the American Depository Receipts (‘ADR’) and Global Depository Receipts (‘GDR’) regimes. Indian companies can list their debt securities on foreign stock exchanges directly through the masala bonds and / or foreign currency convertible bond (‘FCCB’) / foreign currency exchangeable bonds (‘FCEB’) framework.

The proposed framework is expected to provide:

As stated in the Expert Committee Report, over the period 2013-2018, 91 companies with business operations primarily in China raised US $44 billion through initial public offerings on NYSE and NASDAQ in the USA. This indicated the potential for Indian companies, especially unicorns, to tap additional capital in the new structure.

The report also listed jurisdictions where listing could be allowed – USA, China, Japan, South Korea, UK, Hong Kong, France, Germany, Canada and Switzerland.

Key beneficiaries of this could be IT/ITES, unicorns, healthcare, infrastructure, companies having significant global exposure, companies having strong corporate governance and having third-party investors such as PE, VC investors.

From the process point of view, some of the critical aspects of the process include:

Key nuances of overseas listings include:

  1. Relatively higher process and adviser costs;
  2. Approximately six months of overall timelines;

iii.         Potential class action suits for significant drops in the prices, etc.;

  1. Understanding of and compliance with foreign regulations such as stock exchange regulations, regulations such as FCPA (anti-corruption regulations), FATF compliances; and
  2. Enhanced disclosures and continuous investor, market engagements.

Before this becomes a reality, substantial changes are expected across the spectrum from corporate law to securities law and tax laws.

OTHER RECENT REGULATORY DEVELOPMENTS

With the number of new proposals, disclosure requirements could also lead to re-assessment of group structures.

CARO 2020

Under CARO 20207, a disclosure is required whether a company is a Core Investment Company (‘CIC’) as per RBI regulations and whether the group has more than one CIC. As a fallout, if at such group level the aggregate asset of the CICs exceeds Rs. 100 crores, such CICs are required to be registered with RBI as ‘Systematically Important CICs’ (CIC-ND-SI).

Some of the legacy groups could unintentionally run into unwanted, tedious registration or compliance requirements with such new disclosures and focused assessment. It could even be reason enough to liquidate or consolidate unwanted holding / operating companies with the objective to cut costs and streamlining operations to reduce the regulatory burden.

7   Applicability extended from financial year 2019-20 to financial year 2020-21 onwards

Minority squeeze-outs

On 3rd February, 2020 sub-sections 11 and 12 were introduced in section 2308  to provide for compromise or arrangement to include takeover offers made in such manner as may be prescribed (except for listed companies where SEBI regulations are to be followed).

The MCA also notified the National Company Law (Amendment) Rules 2020 (‘NCLT Rules’) and the Companies (Compromises, Amalgamations and Arrangements) Amendment Rules, 2020 (‘Companies Rules’) to deal with the rules and procedures.

This will certainly provide an additional and specific window for companies looking to delist and provide them with a framework to eliminate the minority shareholders completely. This will help them to effectively take 100% control over operations and help in decision-making during corporate actions.

SEBI’s Press Release for Listed Companies having Stressed Assets9 and other relaxations

The timing of SEBI’s Press Release (PR No./35/2020) could not have been better. It principally deals with relaxation in the pricing of preferential issues and exemption from making an open offer for acquisitions in listed companies having ‘Stressed Assets’ (as per the eligibility criteria set out) by way of:

  1. Relaxation of pricing guidelines and limiting the pricing calculation based on past two weeks’ data only. Existing regulations also mandate considering 26 weeks’ price data which may not capture the Covid disruption;
  2. Exemption from making an open offer even if the acquisition is  beyond  the  prescribed threshold or if the open offer is warranted due to change in control.

The above proposal comes with conditions such as non-applicability for allotment to promoters, approval of majority of the minority shareholders, disclosure and monitoring of proposed use and lock-in period of three years.

8   https://tinyurl.com/ycdc3tvs
9. https://www.sebi.gov.in/media/press-releases/jun-2020/relaxations-for-listed-companies-having-stressed-assets_46910.html

Further, SEBI also issued PR No./ 36 / 2020 temporarily relaxed pricing guidelines (up to 31st December, 2020) for all the corporates and provided an additional option to price the preferential allotments at the higher of 12-week or two-week prices with lock-in of three years.

The above decisions could help in faster resolution of stress and avert liquidation proceedings under IBC and large M&As and also provide an incentive to the promoters to provide liquidity to the companies at current prices.

Peculiar situations arising in deals

Declining valuations create opportunities to seek deals that create long-term value and total shareholder returns

 

In fact, the numbers of buyers could also be limited in today’s times. This could be the single most important reason for deals to return soon and chase companies that have survived the impact of Covid-19

Valuation and volatility issues around primary markets are expected to spur secondary market deals and M&As at least for the rest of F.Y. 2020.

Ex-IBC M&A activity itself has seen a lull even in F.Y. 2019. For various reasons, transactions also take too long to close. Limited partners of PE Funds have also advised the general partners and fund managers to tread with caution and focus on situations in existing portfolio companies during Covid.

Key discussions amongst the investment community are revolving around the following points:

(a) Re-negotiations are rampant;

(b) Decision-making has slowed across the globe and parties are trying to fully understand the impact of Covid-19 on businesses;

(c) M&A deal-making teams need to identify what would be the ‘new normal’;

(d) Sectors like healthcare, agri, logistics and technology would get more investments in the near future, as their inherent need has been clearer due to the Covid situation. On the other hand, discretionary spends like luxury goods, hotels, tourism, etc. might have longer downturns;

(e) The deal-making process will change to more virtual meetings, online DDs, etc., managements may not be immediately comfortable in taking such strategic decisions through virtual meetings, leading to slower deal-making processes;

(f) Companies / business models which are cash-positive will be more in demand and would attract buyers’ interest;

_____________________________________________________________

8   https://tinyurl.com/ycdc3tvs
9   https://www.sebi.gov.in/media/press-releases/jun-2020/relaxations-for-listed-companies-having-stressed-assets_46910.html
10  MINISTRY OF FINANCE (Department of Economic Affairs) NOTIFICATION, New Delhi, 22ndApril, 2020

(g) Keeping a tab on regulatory changes, compliance timelines, ability to avail of fiscal benefit has been an area of concern. For example, post-22nd April, 202010 , foreign investment from neighbouring countries will require prior government approval.

Key changes in some of the deal-making aspects are dealt with as under:

Constrained due diligences with renewed focus areas:

The security of supply chains, possible crisis-related special termination rights in important contracts and other issues that were considered low-risk in times of economic growth will become more important.

Areas requiring special focus or an expert opinion during the diligences include:

(i)   Business Continuity Plan,

(ii) IT infrastructure and data security,

(iii) Insurance and Risk Mitigation policies,

(iv) Impact and scenario analysis, especially for fiscal benefits,

(v) Strength of supply chain.

One solution here could be ready with a vendor due diligence (‘VDD’) report upfront.

Pricing and instrument structuring: Pricing is generally a forward-looking exercise on the back of the latest financial performance.

Earnings / profitability-based pricing models are more relevant in case of established businesses, whereas indicators such as Daily Active Userbase (DAU), Merchandise Value or traction are used in valuing new-age businesses.

Due to changing dynamics and demand / supply chain disruptions, the problem is around sustainability of earnings of F.Y. 2020 and the estimation of earnings for F.Y. 2021.

In such situations, pricing based on a stable period which could be F.Y. 2021 or even F.Y. 2022, could be looked at whereby consideration can be back-ended or involving escrow arrangements. Such structures would also necessitate careful structuring from the income tax point of view.

Further, in case of FDI / cross-border transactions, transfer of equity instruments between an Indian resident and a non-resident, an amount not exceeding 25% of the total consideration –

(A) may be deferred or settled through escrow for a period not exceeding 18 months from the date of transfer agreement; or

(B) may be indemnified by the seller for a period not exceeding 18 months from the date of the payment of the full consideration.

While point (A) is often seen in practice, it does provide limited flexibility of 18 months. To address this, one can consider structuring staggered acquisition of shares over a period of time where performance needs to be comforted with an appropriate legal documentation or even using dilutive convertible instruments to the extent possible.

Disclosure lists, indemnities, representation and warranties:

While some of the risks are still not insurable, significant reliance and discussions could be around various disclosures since some of the standard representations may not hold good; let’s say the possibility of one of the largest customers calling off a contract, or a vendor renegotiating prices causing material adverse effect, etc.

It is imperative to provide for sufficient headroom for financial covenants typically agreed in shareholder agreements, especially for credit or quasi-credit deals.

Transaction structuring-related aspects:

Most often we see peculiar structuring needs around optimising tax costs, timelines, low compliances, etc. Table A (See below) provides a quick view of key parameters of some basic structuring ideas.

CONCLUSION

At the cost of many innocent lives, these unprecedented times are expected to bring in significant focus on sustainability and on an essentially minimalist and fundamental approach for any action or decisions. The ongoing fiscal, regulatory and geo-political changes are expected to add to the vibrancy for a living or corporal person.

Depending upon the strategy a business may adopt, defensive measures could help to protect the future and aggressive actions could actually help in transforming or even re-writing the future. On this positive note, we continue to look forward to some interesting corporate actions and decision-making.

Table A

Important Covid-19 Parameters Share Acquisition / Slump Sale Scheme of Arrangement (NCLT Route)
Consideration Cash flows or share swaps More flexible & comprehensive. Issue shares, convertible instruments, other securities or cash flow
Valuation Limited flexibility on account of certain taxation and commercial aspects and related costs Ability to structure the valuation subject to going concerns and future parameters
Tax Outflow Immediate tax liability – could put pressure on cash flows Could be structured as tax neutral combination or divestment, thereby postponing actual tax incidence to the liquidity event
Timelines 1 to 2 months

 

(Could increase in case of regulatory involvement)

 4 to 8 months subject to NCLT process
Stamp Duty Costs Subject to state-specific laws

 

Could range between 0.25% to 3%, depending upon transfer of shares or transfer of business

 Subject to state laws

 

Example, in Maharashtra – It is higher of 0.7% of value of shares issued and 5% of value of immoveable property situated in the state, subject to overall cap of 10% in the value of shares issued
GST Share transfers excluded. Asset sale subject to GST Transfer of business undertakings may not be subject to GST

TAX AND TECHNOLOGY: ARE TAX PROFESSIONALS AT RISK?

INTRODUCTION


There is a curious
story unfolding in the technology environment today. While dramatic advances
are being made in emerging spaces such as 5G communication, artificial intelligence
(AI), virtual reality (VR) and augmented reality (AR), these tectonic shifts
are erupting at dizzying speeds, triggering confusion at individual levels.
Paradigm shifts, game-changing breakthroughs and once-in-a-lifetime events are
now converging in the same time frame, adding to the hype on the timeline for
benefits.

 

The developments
bring to mind an oft-repeated quote of Microsoft founder Bill Gates: ‘We always
overestimate the change that will occur in the next two years and underestimate
the change that will occur in the next ten.’

 

Admittedly, there are barriers and impediments such as concerns about
privacy and data security, combined with natural reluctance and resistance to
change, that will slow the progress. However, public interest in transparency
and accountability is likely to settle the competing objectives of transparency
and confidentiality with appropriate regulatory restrictions on the use,
storage and transfer of data.

 

While the debate
about the pace at which the quantum leaps in technology will develop and how
quickly they will affect the tax professions continues, there is no doubt that
markets are already moving: preparing for and indeed expecting to see progress
and adoption of these technologies and these changes.

 

META-TRENDS IN TECHNOLOGY IMPACTING TAX
PROFESSION

In any case,
regardless of the current experience, developments in various technologies will
continue to be transformational, influencing both professional and personal
lives. The following are the five meta-trends in technology that will
materially affect the tax profession in the future:

 

(1) Data – big data
sets, massively improved performance and memory capacity at scale;

(2) Process automation –
robotic process automation and integration of financial and other systems;

(3) Decision-making –
AI augmenting compliance and consulting capabilities;

(4) Democratisation of knowledge – publicly available and easily accessible knowledge and
information: A ‘Google for tax rules’;

(5) Open networks –
talent sourcing, crowd problem-solving and sharing eco-systems.

 

These patterns will
characterise the way tax regulators change and how organisations must react.
These patterns are, likewise, open doors for organisations and may frame the
establishment of any digital tax strategy and associated transformation.

 

(1) DATA

The phenomenon of
‘big data’ is having a dramatic impact on the way tax work is undertaken. The
increasing processing power and capacity of machines removes any limitation on
the amount of data that can be analysed.

 

The granularity of
data that is usable; the way transactions are recorded and accessed; real-time
reporting; and unlimited time-periods for data retention and storage will
transform the application of tax rules regulation. Instead of data sampling,
estimating and extrapolating, the professionals will be working with precise
and complete data sets. Very soon, the businesses will be at a point where the
details of all transactions can be quickly and easily classified and
investigated for tax purposes.

 

Besides, the way
transactions are effected will change with greater digital impact on
transactions and dealings between taxpayers and tax authorities and judicial
bodies. For example, the Income-Tax Department has already started deploying
data-mining and data analytics by linking various big data from internal as
well as external sources such as Statement of Financial Transaction (SFT), data
received from Investigation Wing, information received under Automatic Exchange
of Information (AEOI), FATCA, Ministry of Corporate Affairs and GSTN to identify
persons / entities who have undertaken high-value financial transactions but
have not filed their returns. Several tax administrations around the world have
started providing pre-filled returns and automating various tax compliances
based on comprehensive and accurate third-party data available with them.

 

In some territories, tax authorities already
require full accounts payable (AP) and receivable (AR) ledgers (with
invoice-level detail) and subsequent periodic trial balance financial ledgers
to be submitted. These countries include Brazil, Poland, France and Spain
(where AP and AR ledger details are required to be provided within four days of
the invoice issuance). India, too, will join this club once e-invoicing is
rolled out.

 

The Organisation
for Economic Co-operation and Development (OECD) in its report on ‘Advanced
Analytics for Better Tax Administration – Putting Data to Work (2016)’
highlights that several tax administrations (including Ireland, Malaysia, the
Netherlands, New Zealand and Singapore), in addition to building statistical
models to predict VAT fraud or error, are carrying out Social Network Analysis
(SNA) to help detect VAT carousel fraud (a VAT carousel is a complex form of
missing-trader fraud which exploits the VAT-free treatment of cross-jurisdictional
sales) and other group-level risks. SNA helps administrations to identify risky
groups in situations where individual-level assessments may fail to detect
anything of concern. It identifies links between individuals (for instance, through
company directorships, joint bank accounts, or shared telephone numbers) and
assembles connected individuals into easily visualised networks. Case-workers
can then browse these networks to profile individual risks. Equally, the
networks can be scored for risk using either a rules-based assessment or a
statistical model trained on historical data. This report also provides an
overview of the application of advanced analytics by various tax
administrations for:

 

(i) audit case selection,

(ii) filing and payment compliance,

(iii) taxpayer
service,

(iv) policy
evaluation,

(v) taxpayer segmentation.

 

(2) PROCESS AUTOMATION

In the past data
collection has often been ad hoc and laborious. It typically requires
analysis and rework of data to classify for tax purposes. Businesses have
worked on structuring their data and recording it in their financial and other
systems, and more recently have adopted technologies such as robotic process
automation to streamline collection processes.

 

Today, multiple tax
compliance solutions help in generating accurate tax returns by leveraging data
collected as part of core business functions. In future, this is likely to
change dramatically. Increasingly, the classification of transactions will be
automated using machine learning applications that perform text-based search
and apply preset rules, learning from previous analysis to predict the
appropriate tax treatment.

 

AI will do the job
without needing to rely on upfront recording in structured accounting ledgers
or after-the-event manual review and allocation in spreadsheets. Combined with
the increase in the extent of data to work with, these cognitive technologies
will produce a much higher degree of accurate tax classification for all
transactions and business events that taxpayers undertake.

 

(3) DECISION-MAKING

AI will have a
similarly dramatic impact on the application of tax judgement. These same
cognitive technologies improving data classification will enhance the
professional’s decision-making capabilities: machine learning, pattern
matching, fuzzy logic and natural language processing will allow complex tax
analysis to be undertaken by technology. These developments pose a significant
opportunity to reduce time and effort, improve quality and accuracy and
ultimately to raise the bar of what can be achieved.

 

A leading firm has
developed a tax-related application for large organisations with complex tax
affairs in the area of classifying expenses for correct treatment in the
corporate or indirect tax returns. This application goes beyond rules-based
solutions, using ‘human eye matching’ (fuzzy) and artificial intelligence,
where the tool ‘learns’ from the user’s tax decisions. The tool can rapidly
analyse complete sets of data, eliminating the risk of both human error and
sampling. In addition to its versatility which allows it to cater to a variety
of compliance-related needs, this tool offers a fully documented process that
reports on the decisions made and tax positions taken. Software features allow
the reviewer to focus on the most important or contentious decisions, which can
be manually overridden if the reviewer is uncomfortable with the machine’s
decision. Time savings are realised immediately as analyses that would
otherwise be done manually have been automated, while the evolving rule set can
be rolled forward to future years which builds further efficiency over time.
All in all, the tool makes a considerable contribution to effective tax risk
management at a time when tax authorities are bringing increased pressure to
bear on taxpayers.

 

 

 

In the US, there
is now a system that can predict the outcome of the US Supreme Court decisions
as accurately as leading legal scholars. It ‘knows’ or ‘understands’ nothing
about the law. Instead, it makes a prediction based on 200 years of case data,
each one described by up to 240 variables (the nature of the case, the justices
involved and so on).

 

The eighth edition
of the OECD’s Tax Administration Series Report (2019) provides insight into how
several tax administrations have adopted the use of behavioural insights and
analytics to better understand how and why taxpayers act and to use these
insights to design practical policies and interventions. It cites the example
of the Inland Revenue Authority of Singapore (IRAS) and how it complemented the
use of Business Intelligence (BI) with analytics to encourage taxpayers to pay
their overdue taxes as early as possible. IRAS built predictive models to
identify taxpayers with high payment compliance risk, before incorporating
uplift modelling to select and contact taxpayers who were more likely to
respond to interventions, i.e., outbound calls which enabled IRAS to focus its
compliance efforts on the high-risk taxpayer group and to apply BI
interventions strategically to achieve greater impact and efficacy.

 

(4) DEMOCRATISATION OF KNOWLEDGE

Some 15 years ago,
an in-house US tax team might have approached an adviser and asked what the tax
rate was in, say, India. The adviser would have looked it up and maybe checked
with its local contacts in India and then written back with the answer – for
which he would have charged a time-based fee. Today this seems very unlikely.
Unless there are some severe complications, the in-house tax team would have
direct access to this information through a variety of online sources. This
trend will continue and, over the next five years, practitioners will get ever
more sophisticated access to information and knowledge of the tax rules and
regulations to which they are subject. Besides, increasing transparency and
access to information and knowledge will have implications for global tax
policy and will change the interaction between authorities and taxpayers.

 

(5) OPEN NETWORKS

Online work
platforms have grown significantly in many areas of the economy. Labour
platforms such as Guru.com with some 1.5 million people, Upwork.com and
Mechanical Turk (mturk.com) are creating widespread networks of freelancers
available for task-based work. Tax teams are no longer entirely based on
traditional or full-time employees.

 

However,
crowd-sourcing or open talent models in the tax market seem further off when
compared to the use in IT, graphic design and finance. This situation is likely
to change over the next three to five years as three distinct developments in
tax converge. The tax professionals will require new skills around data,
analytics and technology. The breaking down of tax processes into individual
tasks through automation and standardisation will highlight specific work
routines that could be allocated to new workers not needing deep tax skills.
The evolution of the sharing and social economy will better connect potential supply
and demand and open new resource pools keen to work in different, remote and
virtual ways and within different reward models.


TOMORROW’S TAX WORLD

The combined effect
of these broader technology developments will bring about a sea change in the
way tax authorities and other regulators meet their objectives and manage their
responsibilities.

 

There has already
been a significant shift towards e-administration with increasing options and
uptake of online filing of tax returns as well as online payments and the full
or partial pre-filling of tax returns. Digital contact channels (online, email,
digital assistance) now dominate and the number of administrations using or
developing mobile applications continues to grow. Electronic data from third
parties, including other tax administrations, as well as internally generated
electronic data, is used in an increasingly conjoined way across tax
administration functions for improving services and enhancing compliance. This
trend also shows in the large number of administrations that now employ data
scientists.

 

Revenue authorities
already require large volumes of data to be filed. They have defined the
structure and format in which data needs to be maintained and provided. For
example, filing schemas and standard audit files like SAF-T, an international
standard for the electronic exchange of reliable accounting data from
organisations to a national tax authority or external auditors, defined by the
OECD, are being widely adopted.

 

Gradually, most tax
authorities will be requiring fuller data sets to be filed or made available
and in real-time or close to it. Indeed, they are likely to move beyond this.
Rather than require the data to be filed and managing the transfer and storage
of large volumes of data, they may simply mandate the algorithmic routines that
they require to be run across data sets and then review the results.

 

This real-time
access to the taxpayer’s financial data will save the effort of data transfer
and rely on taxpayers to maintain a digital record. Such a development will
also accelerate the time at which revenue authorities can review and
investigate a client’s information.

 

TOMORROW’S TAX PROFESSION

These developments
pose an essential question: What will be the nature and volume of future work
for professionals? When the impact of automation and augmentation increases,
what will tomorrow’s workforce do to replace the time currently spent on
today’s processes? Ultimately, what will be the right balance between human and
machine?

Daniel Susskind and
Richard Susskind also raise the following profound questions in their book ‘The
Future of the Professions’:

 

  • Might there be entirely new ways of organising professional work,
    ways that are more affordable, more accessible and perhaps more conducive to an
    increase in quality than the traditional approach?
  •     Does it follow that
    licensed experts can only undertake all the work that our professionals
    currently do?
  •     To what extent do we trust
    professionals to admit that their services could be delivered differently, or
    that some of their work could responsibly be passed on to non-professionals?
  •     Are our professions fit for
    purpose? Are they serving our societies well?

 

They have
identified the following changes that are taking place across various professions
that are relevant to the tax profession:

 

  •     More-for-less challenge
    – Across the professions, institutions and individuals are being asked to
    deliver more service, with fewer resources at their disposal.
  •     Existence of new
    competition     – Many of the technology-driven changes are being driven by
    people and institutions outside the boundaries of the traditional professions
    (often tech startups), with very different training and experience to
    traditional professionals.
  •     Productisation of
    services     – Many professionals think of their work as a form of craft, like
    an artist starting each project afresh with a blank sheet of paper, or akin to
    a tailor stitching a suit to fit the particular bodily contours of his clients.
    Now we see a move away from that view, recognising that professional work does
    not have to be handled in this bespoke way.

 

  •     Increasing decomposition
    of professional work     – Many professionals think of their work as solid,
    indivisible lumps of endeavour that must all be handled by particular types of
    professionals, working in certain ways, organised in specific forms of
    institutions. Increasingly, however, we are instead seeing professional work
    being broken down into composite tasks and activities. Once this is done, it
    often becomes clear that the work can either be performed by non-professionals
    or can be automated.
  •     Increasing
    commoditisation of professional work     – When professional work is broken
    down in this way, it transpires that many of the tasks involved in it are not
    particularly complicated, they are relatively ‘routine’ and can be automated
    accordingly.

A TECHNOLOGY-BASED INTERNET SOCIETY

The Susskinds see a
different set of models for producing and sharing practical expertise emerging
as we evolve into a technology-based internet society:

(A) Networked experts or ‘workers on tap’ model –
Here, it is still professionals that are involved in producing practical
expertise. However, rather than being employed in a particular brick-and-mortar
institution (a firm, hospital or school), professionals instead use online
platforms to work in a far more flexible, more ad hoc way in solving
professional problems. Doctors-on-Demand in medicine and Axiom Law in the legal
world are two examples.

(B) Para-professional model – Here, less
expert people, using new technologies, can perform tasks that would have
required more expert people in the past. Take the medical diagnostic system
developed at Stanford. It is entirely conceivable that in primary care of the
future, one may not necessarily be treated by a doctor but by a nurse
practitioner who, using one of these systems, can offer the sort of diagnostic
support that might have required a more expert person in the past.

 

(C) Knowledge-engineering model – This is
what we were doing in the 1980s: engineering systems, derived from the
knowledge of experts, for non-experts to use (in our case, to help solve legal
problems). Many readily-available online DIY tax preparation software and
contract-drafting tools rely on this model.

(D) Communities of experience model – Social
networks are now a ubiquitous feature of contemporary life. Also familiar are
professional networks, where practitioners gather to share their expertise.
Less familiar, though, are communities of experience – where patients, rather
than practitioners, meet to share their experience and advice. Take, for
example, PatientsLikeMe, an online network of more than 600,000 patients who
come together to share experiences of their symptoms and treatments, receiving
support and solving problems that might have required more expert medical
professionals in the past.

 

(E) Embedded knowledge model – To grasp
this, consider the card game Solitaire (also known as Patience). If this game
is played with physical playing cards and a player tries to put a red five
under a red six, this is possible (even if it is called ‘cheating’). Putting
two cards of the same colour on top of one another is, of course, against the
rules. Now imagine a player who is playing the same game but on a smartphone.
If the player tries the same move, it is not possible for him to do so because
the system simply returns the offending card. The rules are embedded in the
system. A breach is not merely prohibited, it is impossible to perform.
Likewise, as more of our lives become digitised, practical expertise will not
be invoked through the intervention of human beings but will be embedded in our
everyday systems instead.

(F) Machine-generated model – Here,
increasingly capable systems and machines produce and share practical expertise
without any human involvement. Of the six models, this is the most radical,
where traditional recipients of professional work would have access to
technologies that obviate the need for human experts altogether. Although this
scenario is the most widely discussed in the popular debate, it is essential to
keep in mind that this model is only one of six.

 

While digital transformation will require significant change and pose
considerable challenges, that future will also offer significant opportunities.
It seems clear that revenue authorities will embrace technological change and
use it to gain access to global data sets and thereby create more tax
transparency. This development will increase the demands on tax professionals
coming from increased complexity, rapid change and heightened risk. However, by
embracing the new technologies for handling and analysing data, tax
professionals will be able to improve compliance processes, enrich their tax
analysis and provide greater understanding and value to their organisations.

 

Over the short
term, it appears that there will be more work to do in both managing the change
and the consequences it will lead to: The greater accuracy that the new
technologies will offer and require for both tax processes. Moreover, the
nature of that work will be different. The digital transformation will reduce
time spent processing, improve analytical capabilities and create significant
new opportunities for businesses to manage their tax obligations.

 

It’s difficult to
be precise about what the tax digital future will be like, but certain
characteristics seem clear. As a society and as professionals:

(a) We will be data-driven, leading to a more
holistic approach at the enterprise level. We will manage that data better. We
will harness its power to act faster, provide richer insights and create
business value for the organisations we serve.

(b) Big data will lead to greater granularity,
precision and accuracy. We will work with integrated data sets, including all
aspects of the underlying transactions – both the structured and unstructured
data elements. It will result in enhanced analysis in detail rather than
sampling and estimation.

(c)   Algorithms will increasingly be the way we
apply our expertise, our knowledge and experience. Furthermore, we will need to
apply that expertise earlier in processes as real-time reporting takes hold and
accelerates the times at which data is submitted.

(d) Robots will take more of the strain. Robotic
process automation technologies will evolve, become easier and cheaper to
deploy and as a result will become ubiquitous tools for professionals to use to
streamline processes. Besides, they will become smarter, infused with AI, and
therefore have a greater impact.

(e) The user experience will be more digital. We
will consume information in a more personalised way through the video and other
mixed reality media. At the moment, work in systems such as email involves
interacting through a keyboard. In the future, we can expect much more use of
natural language processing, talking to virtual agents and connecting through
online forums.

 

TOMORROW’S TAX PROFESSIONAL

With these dramatic
changes will come a significant impact on the tax professionals’ lives – how we
work and what we do. The relationships and roles within our organisations and
with advisers will be different. They will be expected to do more work earlier
in the process as transactions are recorded, or internal controls put in place,
and also in the later stages, in areas of controversy and dispute resolution.

 

Consequently, the
skills and capabilities required will be very different from today with a blend
of ‘automation and augmentation’ impacting the workforce. Manual processes will
be replaced by automation of data flows and the impact of robotic process
automation. At the same time, professionals will be augmented by AI
technologies embedded in the ways knowledge is accessed and experience used to
apply it to business circumstances. An example of this is an AI-driven tool
that can act as a virtual research assistant that can help in searching for
relevant case laws, analysing rulings and assessing whether a tax case is
likely to be successful.

 

The above
transformation will trigger a complete overhaul of the processes and the
resource models to get tax work done. Tax processes will be broken down into
individual tasks and allocated to new workers not always needing deep tax
skills. For example, several BPO firms carry out tax return compilation and
filing work on a large scale by employing graduates who work with the tax
return preparation software with minimal training. The evolution of the sharing
and social economy will open up talent networks, crowd-sourcing models and the
so-called ‘gig’ economy to the tax marketplace on the lines of examples given
under the networked expert or workers on tap model above.

 

The skills required
for tomorrow’s tax professional will continue to include the traditional skills
such as core technical expertise (to deal with increasing complexity in the
ever-changing tax and regulatory landscape) and professional ethics; the tax
professional will need to imbibe additional skills such as:

(I)   Increased technology skills specifically with
respect to the familiarity with continuously changing applications such as
specialist tax software, electronic tax administration platforms and also other
disruptive technologies, such as artificial intelligence / digital assistants,
to augment their output.

(II) Business and commercial skills to think and
align tax and business strategy.

(III) Risk assessment and management skills in
respect of tax positions taken, corporate structures, existing and emerging
laws, regulations, political initiatives and shifting public perceptions.

(IV) Communication and collaboration to manage
relationships – engage, interact, influence and inform stakeholders in finance,
statutory audit and tax administrations. Ability to translate tax jargon for
non-technical stakeholders such as boards, management, investors, clients and
media.

(V)  Advocacy and negotiation. Advocacy for tax
policy and strategy. Dispute resolution – internal and external.

 

SUM IT

Change for tax professionals is just round the corner. Like other
professionals, they, too, will continue to ride the rapid wave of technology
changes and associated risks as humankind continues to pursue the digital
future. While it is difficult to predict decisively what the future holds, the
meta-trends are recognisable in the technologies today as we try to anticipate
and shape our plans accordingly.

 

At the same time,
we must also realise that in five years we may be working with technologies
that are yet to be invented. Hence, riding the crest implies tireless
monitoring of developments and agility in experimenting with and adopting new
technologies. The new road for tax professionals could be fraught with no speed
limits as the pace of digital transformation hastens. The professionals must
map out the potential impact of all disruptive technology and actively engage
with the emerging trends. Relentless evolution and adaptability will continue
to be the cornerstones, while yet retaining their core strengths.

 

In this context, it
may be worth remembering Mahatma Gandhi’s recommendation: ‘The future
depends on what we do in the present‘.

 

REFERENCES

1.   Deloitte (2019), ‘Our digital future – A
perspective for tax professionals’; https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Tax/dttl-tax-deloitte-our-digital-future.pdf

 

2.   OECD (2019), Tax Administration 2019:
Comparative Information on OECD and other Advanced and Emerging Economies;
https:/doi.org/IO.1787/74d162b6-en

 

3.   OECD (2016), Advanced Analytics for Better
Tax Administration: Putting Data to Work;
http://dx.d0i.org/10.1787/9789264256453-en

 

4.   Susskind R. and Susskind D. (2015), ‘The
Future of the Professions: How Technology will transform the Work of Human
Experts’

 

5.         Diamandis
P. and Kotler S. (2020), ‘The Future Is Faster Than You Think’

 

THE RUN-UP TO AUDIT IN THE 2030s

Sometime in the 2030s, if not earlier, most
of the functions involved in a financial audit will be automated and the team
size will drop by half. Automation, AI and machine learning will do a majority
of accounting work and it is only logical that this will have an impact on
audits. The accountants and auditors aren’t going to die soon; we will need
them to orchestrate the maelstrom of change.

 

SEVEN things are discernible in the run-up
to the 2030s and those in the attest function will have to see how to stay
afloat.

 

TREND 1: THE RISE OF
AUTOMATION

Ever since the Industrial Revolution kicked
off more than 175 years ago, the human fascination for technology has
multiplied. Companies have automated a lot of their manufacturing and service
processes. Over the years, these have affected the staid old professions of
accounting and audit, too. From 13 columnar sheets to an AI-driven data
analysis pack, we have come a long way.

 

Let us not associate technology only with
large publicly-listed companies. In fact, it is the smaller entities that are
far more nimble. MSMEs, which are characterised by a high degree of
centralisation in decision-making and deficiency in internal controls, too, embrace
technology as they step onto the growth highway. Auditors, too, must keep pace
with the times and embrace new audit technologies. Since these tools and audit
laboratories can be expensive, small and medium firms will use cloud-based
tools on pay-per-use model.

 

IPA (Intelligent Process Automation), which
is the next upgrade from RPA (Robotic Process Automation), has come to stay as
an advanced data extraction tool, with its inbuilt artificial intelligence
module helping in decision-making. Such changes compel us to evaluate our
competency levels. Are auditors prepared to do it in the areas they specialise
in: audit, accounting, consultancy, tax and compliance? The ICAI has stepped in
to help in this direction. Recently, it released Version 2.0 of the Digital
Competency Maturity Model for Professional Accounting Firms (DCMM), which helps
accounting firms make these self-assessments. DCMM provides implementation
guidance on how far one should move ahead. However, being competent and mature
enough to handle digitalisation is just the beginning. There is a long way to
travel on the road to execution.

 

The winners will emerge from among those who
assess themselves, make the necessary shift and go the full distance on
technology.

 

TREND 2: WE WILL HAVE TO DEFINE AUDIT QUALITY

Judging audit quality is both subjective and
challenging. It is beyond compliance with standards and processes, adherence to
legislation and zero defects. Today, we are unable to define ‘quality.’ We go
back to an oft-quoted statement on photography: ‘I don’t know what’s good
quality photography, but I know it when I see one.’ We have taken a similar
stand on what constitutes audit quality. This stand must stand (pun
intended).

 

In the next two years, we must have a
generally accepted definition of Audit Quality. By the way, the ICAI has
initiated steps to establish a framework for an Audit Quality and Audit Quality
Maturity Model. Apart from the auditors, the clients, too, must take cognisance
of this development. If that happens, it will add cheer to the auditors’
efforts and minimise the audit-expectation gap.

 

Thankfully,
audit reporting has slowly moved from template-based reporting to a more
‘entity-specific’ reporting. The SA-706 ‘Emphasis of Matter and Other Matters’
and SA-701 ‘Key Audit Matters’ have been the key differentiators. These have
helped improve the quality of audit and enhanced the relevance of audit opinion
to users. CARO 2020, which is exhaustive and looks onerous, is also a step
toward reducing the expectation gap.

 

It’s crucial to define the expectation gap
and identify the reasons for it. ‘Expectation gap’ is the difference in
perception between ‘what the public thinks auditors do’ and ‘what the
public wants auditors to do.’ This gap hasn’t narrowed with time and
there are three reasons for this.

 

First, Knowledge Gap: What auditors do is different from what the public thinks they are
doing and this is called Knowledge Gap. Professional bodies communicate with
audit firms by making available updated information on changes in regulations
and the need for change. Audit firms, in turn, interact with clients and sound
them out on these changes. But, somewhere down the line, the message the public
receives is feeble and not forceful because there is a perceived absence of
wide-reaching platforms.

 

Second, Performance Gap: What auditors are supposed to do
differs from what they actually do and this is known as Performance Gap. Let us
underscore one aspect. ICAI, as a standard setter, has been continuously
responsive by updating standards on accounting, audit and ethics and by providing
implementation guidance. The action on lax and inefficient auditors is not as
fast as some would have wished it to be and so the public perception is one of
laxity.

 

Third, Evolution Gap: What the public wants the auditors to do and what the auditors are
supposed to do, is called Evolution Gap. Society is unmindful of what the
auditors are supposed to do. True, regulatory changes are taking place at
breakneck speed. New legislations, new standards or revisions in the existing
ones have been coming in at a rapid pace. The auditors are also not lagging in
compliance with the amended laws. Despite this, the public expects audits to
evolve in a way so as to prevent the failure of the audited-client. We in the
profession must look at this expectation gap and narrow it down.

 

The winners will emerge from among those who
can bridge the performance gap fully and the other two gaps as much as they
can.

 

TREND 3: SEPARATE GRAMMAR FOR A SEPARATE CLASS OF
COMPANIES

Standards are the grammar of both accounting
and auditing. There will be a different set of financial reporting guidelines
for ‘Less Complex Entities’ (LCEs). The auditing standards now apply to all
audits irrespective of their nature, size and structure. This practice is
leading auditors to focus on ‘compliance’ and not on ‘judgement.’ In the years
ahead, we will most likely have a different set of standards for auditing. Such
a package would make documentation and risk assessment disclosures easy.
Judgement will be back in auditing.

 

Limited internal controls and management
override characterise several MSME audits. These are demanding situations that
affect efficient audit performance. Worse still, these situations come with low
remuneration. If an auditor assumes that the examination of an SME client
carries lower engagement risk compared to that of a large entity, the auditor
is mistaken. SMEs most often scale at a high growth rate and do not have robust
internal control systems and other governance oversights to manage the pace of
growth. It is nobody’s case that work should be done only to the extent of fees
received. But if truth be told, that’s an overriding reality in at least some.
We will see audit firms agree upon and insist on a minimum fee commensurate
with the nature and size of the engagement.

 

Winning firms will be those that realise the
engagement risk in every engagement – small, medium, or large – and who either
cover it or seek a price for it.

 

TREND 4: FRAUD IS AUDITOR’S OBLIGATION

‘Fraud’ will be the biggest challenge in the
future. An auditor of financial statements has a fraud detection
responsibility, especially if it leads to a material misstatement in the
financial statements. Remember, SA-240 lays the primary responsibility for
preventing fraud at the door of the management. But the auditor is responsible
for providing reasonable assurance. The truth is that there are certain
limitations in audit and even if the audit is planned appropriately, some
material misstatements may remain undetected. If we want to be in the attest
function, we must learn to live with this reality.

 

Look at the challenges. Under the Companies
Act, 2013 the auditor has to report the fraud to the Central Government. But it
does not require the auditor to carry out a roving investigation to detect
fraud. A reading of the Auditing Standards and the Companies Act, 2013 throw up
a couple of aspects. First, an audit engagement requires the auditor to express
a ‘true and fair’ view on the financial statements. But such a commitment does
not envisage that all frauds would be detected. Second, a fraud not being
exposed does not mean that the auditor has not carried out his engagement
correctly.

 

When no fraud is reported or comes to light,
we don’t compliment the auditor for a job well done. But at the faintest hint of
scandal, the stakeholders descend on the auditor like a tonne of bricks and
bombard him with a barrage of questions. We in the audit profession must never
lose sight of this reality.

 

While auditing, an auditor maintains the
mindset that fraud is always possible. When the auditor is a fraud examiner, he
begins his / her assignment with the belief that someone is committing fraud
and affirms that belief unless the evidence shows no signs of fraudulent
activity. In a regular audit, we must be alert towards the perpetrators and the
impact on the defrauded organisation. The best practices would include:

 

(i)    Implementing audit procedures that throw up
warning signals.

(ii)   Recognising that submission of financial
results is merely the end-result of an audit process that runs through the
year, during which the integrity of auditing should be unquestionable.

(iii) No member of the audit team can entertain the
view that detecting fraud is not an auditor’s job. If this were the case, then
compliance with auditing standards on fraud detection may become a rote
exercise.

(iv) Being alert to factors that may create
incentives or pressures for management to commit fraud and might permit
opportunities to do so.

(v)   Recognising that improper revenue recognition
is a fraud risk in particular where estimates and judgement involved is high.

(vi) Evaluating transactions and events in which
management override has been applied over internal control matters, causing a
dent on reliability.

(vii) If the audit process determines that evidence
of fraud may exist, the auditor should consider the organisation’s position and
report it to appropriate authorities.

 

Often, there have been concerns about the
independence of auditors. These arose in the context of the appointment
methodology, a significant part of the audit market space being occupied by a
few firms, the high cost of audit of Public Interest Entities (PIE) and the
increasing complexity of business operations. Besides, one can perceive changes
in personal value systems because of the increased materialism that the world
has chosen.

 

There is also
the increasing awareness that the line between profession and business is
thinning. For a pure Chinese wall to be built, audit firms must focus only on
certifications and assurance. Everything else should be under a different
entity that maintains an arm’s length distance. Mere departmentalisation won’t
do in this regard.

 

The earlier firms understand these technical
niceties and make the necessary adjustments, the faster they will step onto the
growth track.


TREND 5: CODE OF ETHICS

Professional independence should be felt,
experienced and be visible, however tough that may be. This is the hallmark of
any profession and this is what will bring in public trust. As with the profession
of medicine, ours is the profession of trust and so our work must be executed
without a hint of interdependence.

 

The new version of the Code of Ethics,
effective 1st July, 2020, is a significantly large document. By
imposing restrictions in particular for PIE, on taxation services to audit
clients, by introducing assessments for ‘threat to independence’ and specifying
reporting obligations for non-compliance with laws and regulations (NOCLAR),
the document shows that its heart is in the right place. For it to succeed, we
need to follow it both in letter and in spirit. Many a time, we do see
instances of bending of the law without breaking it. Some of the provisions,
especially relating to networks, might appear onerous but if we have to pass
the test of public scrutiny on independence, we must follow them. Independence
is the foundation for trust in an Audit Opinion and it is worth walking the
extra mile to protect the respect for and enhance the stature of the audit
profession. As the profession evolves more fully, we will see a lot more
changes to the Code to keep it current and modern, not archaic and ancient.

 

The firms that traverse the distance from
being good to great will practice both value and ethics in thought, deed and
action.

 

TREND 6: GLOBAL TRENDS WILL AFFECT INDIA

Two reports merit attention: the Brydon
Report and the three-year strategic plan of the International Forum of
Independent Audit Regulators (IFIAR).

 

At the instance of the Department for
Business, Energy & Industrial Strategy, UK (BEIS), Sir Donald Brydon
undertook an in-depth review of audit quality and effectiveness. In December,
2019 his report was placed in the public domain. It contains path-breaking
suggestions, calling for extensive reforms for accomplishing improved audit
quality.

 

Here are some of its suggestions that give
you a heads-up of what you can experience in the coming years.

(a) Redefine the purpose of audit: The purpose of an audit is to help establish and maintain the
deserved level of confidence in a company, its directors and the information
they report, including the financial statements.

(b) Introduce the concept of suspicion: Auditors exercise professional judgement and appropriate scepticism
and suspicion throughout their work. Auditors must act in the public interest
and should consider the interest of all users and not just the shareholders.

(c) Enhance
the informative nature of the audit report: Auditors need to create continuity between
successive audit reports, provide greater transparency over differing
estimations, perhaps disclosing graduated findings, and call out
inconsistencies in the information made public.

 

The second is the set of initiatives taken
by the International Forum of Independent Audit Regulators (IFIAR). In its
three-year strategic plan, IFIAR is focusing on achieving ‘significantly
improved audit quality on a global basis’. It has revisited the role of Audit
Committees (AC) in different jurisdictions and is actively reviewing whether
ACs should select the external auditor, determine their fees and assess audit
performance. A set of Audit Quality Indicators for evaluating external auditors
is also under evolution.

 

The audit firms that are 2030-ready will
keep a constant vigil on the global best practices and developments and
internalise them to the extent possible.

 

TREND 7: ANYWHERE, ANYTIME, ANYONE

This was waiting to happen. The
infrastructure was in place and the competence was there; it only needed a push
and societal acceptance. Covid-19 gave us just that. Even as audits have gone
beyond the paper-and-pen phase and with global audits already being done from
remote locations, the next jump will be carrying out reviews from anywhere you
may be: office, home or cafeteria. As the world steps into a new order of
freelancing as opposed to full-time employment, as travel becomes increasingly
cumbersome, as Generation Z steps into the workplace, audits from anywhere and
anytime will become the norm. Footfalls in clients’ places will drop just as
footfalls in audit offices dropped during the last 20 years.

 

 

With AI, RPA,
Blockchain, big data and machine learning, the world of accounting is changing.
People will not log data; machines will. Already, many accounting applications
today can put the smartest of analysts to shame with the speed of execution and
dexterity of operations. Neither accounting nor auditing is so quickly going to
disappear. As long as there is cricket, there will be scorekeepers and umpires.
Accounting is about scorekeeping and auditing is about umpiring. What’s
changing is how frequently we want to see the scores, in what mediums we want
to see them and how many of the documents can be digitalised. The firms that
will lose out are the ones that are not seeing the gathering storm and not
preparing for it: the Kodaks of the world. Have an influential culture,
modernise and use emerging technology and you will win.

 

Today is perhaps the best time in history to be
in accounting and audit as the world of work around us is changing incredibly,
right before us.

OVERCOMING THE CHALLENGE OF RISK MANAGEMENT IN PROFESSIONAL SERVICES

In his seminal tome
‘Against the Gods – The Remarkable Story of Risk’, Peter L.
Bernstein says that the revolutionary idea that defines the boundary between
modern times and the past, comprising thousands of years of history, is that of
the mastery of risk: the notion that the future is more than a whim of the gods
and that humans are not passive before nature. The book weaves across
generations to tell stories of thinkers whose remarkable vision showed the
world how to understand risk, measure it and weigh its consequences, converting
risk-taking itself into one of the prime catalysts that drives modern society.

 

This article is an
attempt to expose to a professional (other than one who has made risk
management itself as her professional calling) some facets of risk and give
pointers to develop an integrated risk management framework in which risk can
be understood and managed, if not entirely mitigated. While my experience has
almost wholly been as a professional practising in the area of taxation and my
thoughts will therefore reflect that bias, I am sure some of what I say may
have universal application for all professional service providers.

 

Globalisation of
the market place, advances in information technology, rapidly changing laws,
growing intolerance of compliance being only in letter but not in spirit, with
a simultaneous emphasis on good corporate governance, proliferation of
litigation and increased diversity in services offered and even the emerging
global megatrend of ‘tax morality’ are some of the current issues faced by a
professional. When one reflects on professional services firms, even as they
often are called in by clients to advise them on risk management, they
themselves are struggling to keep risks at bay in this Volatile, Uncertain,
Complex and Ambiguous (‘VUCA’) world.

 

Accounting firms
traditionally provide services to clients in three major areas: Audit or
Assurance, Tax, and Advisory Services. The business risk associated with each
of these three services includes loss of future income, loss of reputation and
exposure to legal liability. These risks are not mutually exclusive and, given
the inter-dependent way in which one or more services are often provided to the
same client, a professional firm may be exposed to one or more of the above
risks simultaneously. While external insurance protection is indeed available
and can, to an extent, mitigate financial risk, it cannot protect against loss
of reputation, which in my view is the biggest risk.

 

Fundamental to a
professional’s engagement is the premise that she will deliver quality services
and besides meeting clients’ expectations on this count, this is now more often
demanded by regulators and other third parties who may have relied on a
professional’s work. Though quality is often difficult to precisely define in
the professional services arena, professionals can and should ensure that they
adhere to the guiding principles on quality. A few of these are listed below (see
tabulation):

 

(a)

Proper scoping of the work laying down,
wherever possible, scope limitations and caveats;

(b)

Matching of the work to what has been
contracted for;

(c)

Proper planning of the engagement;

(d)

Involvement and engagement of partner or
other senior resources;

(e)

In complex situations or where stakes
are very high, involvement of a Quality Review Partner;

(f)

Where necessary, involvement of internal
or external experts, including counsel;

(g)

Where necessary, appropriate engagement
with regulators or authorities;

(h)

Appropriate and adequate documentation;

(i)

Suitable communication with clients;

(j)

Periodic and regular Quality Performance
Reviews and corrective actions.

 

A robust risk
management framework will also contain thoughtfully designed processes,
encompassing the entire life-cycle of a professional engagement. Some of these
are as follows:

 

(A) Independence

The importance of
being independent cannot be overemphasised. From very basic concepts such as
not performing a management or an employee function, this concept straddles
almost all situations, real or perceived, which can lead to compromising a
professional’s independence. The risk of blurring professional and personal and
financial relationships is sometimes fatal to continuing to serve clients
objectively.

 

(B) Client acceptance

This process is
critical to the long-term sustainability of a professional firm. In today’s
environment where perceptions often cloud reality, association with dubious
clients to whom a professional may have provided professional services can be a
significant barrier to maintain and enhance a spotless professional reputation.
Appropriate background checks before accepting a client has rightly become a
mandatory hygiene process. Firms may introduce additional filters on the basis
of their experience and expertise, for example, high-risk industries,
politically-connected persons, cash-based businesses, etc. to narrow down their
universe of serviceable clients. Further, the client acceptance process is not
a static one-time task. It needs to be renewed and reviewed periodically,
preferably at least once each year to check that nothing has adversely changed,
either with the client’s business or in the environment.

 

(C) Engagement acceptance

This is a document
created for every new engagement of an existing or new client and contains all
background information on the engagement and the nature of work to be
performed. It will document the applicable statutory provisions to be
considered, e.g., auditor independence and standards applicable to the
engagement; for example, the ICAI Code of Ethics. It will also lay out unusual
risk factors, if any, and their impact, as also steps taken to mitigate or
manage such risks. It will document third-party involvement, such as counsel
opinions to be obtained. It will also contain the names, designations and
experience of team members who will execute the engagement. And it will lay out
the range of fees that is usually charged by the firm for the type of
engagement.

 

(D) Engagement contract or letter

Externally, this is
perhaps the most important document, second only to the actual engagement
deliverable, and it forms the very basis of the contract for performance of
professional service. Having a well-laid-out clear and simple engagement
contract, containing the complete scope of work with all scope exclusions,
limitations and caveats, as also the fees that would be charged and the
milestones at which these would be charged, and the liability assumed for the
deliverable, reduces the possibility of disagreements later. It also restricts
the liability of any deliverable so long as the deliverable is properly
referenced to the engagement contract. And it contains usual clauses governing
the professional relationship, including a force majeure clause, and
lays down the roles and responsibilities of each party to the contract.

 

(E) Evaluation and on-boarding of third-party service
providers

This is assuming a
very important dimension because very often service providers are being held
responsible for not only their own deliverables but also for the actions and /
or inactions of other service providers who may have played a part in the
engagement. The processes described above, viz., independence, client
acceptance, etc., must also be carried out for each third-party service
provider. It must be ensured that third parties working together either as
co-partners or sub-contractors, share the same value systems as the
professional. Wherever necessary and feasible, the third-party service provider
must be imparted the relevant risk trainings to avoid any misunderstanding.
Clear documentation of the role, risks and rewards that will be shared with the
third-party service provider must be documented and assented to by that
provider as well.

 

(F) Data protection
– safeguards and developments in legal obligations

Professional firms possess and process a lot of sensitive professional
and personal data, especially of their clients and employees. Many clients,
too, expect adequate processes and compliance with local and global legal
regulations (like the European GDPR) as a pre-condition for engaging professionals.
These obligations span rules for gathering, storing, protecting and processing
of personal information as well as mechanisms to deal with breaches.

 

(G) Mandatory risk management trainings

Devising and
implementing risk management trainings frequently to all relevant staff
members, regardless of their designation and standing in a professional firm is
a sine qua non for the risk management strategy to survive in any
organisation. Over-communication of a professional firm’s risk management
policy and processes is a virtue and should not be viewed as an evil to be
tolerated. Here the tone must be set from the top, with senior-most partners
taking the lead on rolling out these trainings and frequently setting out
screensavers, posters, etc. in the workplace to keep reminding everyone about
the basic concepts.

(H) Insider-trading and other statutory regulations

Today, more than
ever, regulations are increasing the burden on professional firms and must be
followed in order to continue to discharge honourably the obligation that
society has cast on professionals. However, the ‘Gold Standard’ in a risk
framework must go beyond statutory compulsions and must inculcate a ‘smell
test’ foundation. The question, ‘What if this act is reported on the front page
of leading newspapers or anywhere in the media?’ must be the idea that needs to
be brought to life in any risk management framework.

 

(I) Mandatory
escalation of any breaches or perceived violations

The risk management
framework must be designed in a manner to encourage anyone in the firm to
independently report any real or perceived violations without any fear of
sanctions. Many risk-laden situations can be mitigated if escalated at the very
beginning of any breach or perceived violation.

 

(J) Zero tolerance

There ought to be
zero tolerance within the firm for anyone breaching risk rules, either
explicitly or impliedly, with graded financial sanctions to be imposed or even
dismissals and separations to be considered and enforced in serious situations
(especially where there is a violation of the firm’s ethics and / or involves
committing acts of moral turpitude).

 

(K) Risk management framework review process

It is a good practice to have at least two or three types of reviews
done periodically. The first is to internally refresh the entire Risk
Management Framework – ideally at least once thoroughly every two years and a
refresh to be carried out every year. This is in addition to external events
which can necessitate an immediate modification or addition to the framework.
The second is to have another independent firm peer-review the risk framework
and mutually share best practices. Yet another could be to adopt and customise
a few best practices that one may pick up in international professional
seminars and conferences.

 

RISK OF OBSOLESCENCE AMIDST CHANGE

Finally, one of the
biggest risks that a tax professional faces today is the rapidly changing
landscape of tax services. The quest to stay relevant to society is now more
acute than ever before. Going forward, in my opinion the entire platform of tax
services will rest on three main pillars. These will broadly define how tax
professionals may need to specialise their skill sets and garner focused
experience. These are (1) Technology-enabled tax compliance, (2) High-end
advisory services, including on complex transactions, and (3) Litigation.

 

 

The astute
professional realises that tax services can no longer be delivered in the same
fashion as has endured for some years now. Technology is ruthlessly being
embraced – not only by clients but also by the authorities. The professional
must learn to adapt and even master technology to stay ahead of the game.
Technology tools using Artificial Intelligence (AI) and Machine Learning (ML)
must take over a considerable number of repetitive tasks; and leveraging on cost-effective
resources will be the new normal soon. Further, non-professional technology
firms already have disrupted and usurped the lower end of the compliance
market.

 

Simultaneously,
there are attempts to achieve a global consensus on the tax basis and methodologies
on the back of a relentless drive to stop tax-base erosion. This has resulted
in radical changes in domestic and international laws and the emergence of and
seeping in of transaction tax type levies, giving rise to fresh challenges for
the professional to overcome. Today’s professional reality is the coming
together of accounting and tax principles, giving clear preference to the
doctrine of substance over form and with new and ever-changing company law,
foreign exchange and SEBI regulations. A clear need has arisen for
professionals who have experience in more than just one or two core areas and
also for those professionals who can collaboratively work together with other
professionals in different disciplines to evolve solutions to overcome complex
problems which do not fall foul of any regulations. In this arena, too, it is
common experience that sister professions are nibbling away at pieces of work
that Chartered Accountants traditionally performed. This calls for a
longer-term strategy to develop and nurture appropriate talent.

 

Given the complexity in tax laws and the tendency of both taxpayers and
tax assessors to be aggressive, a professional will need to master Litigation
Strategy, if she must perfect the tools of her trade. Today, more than ever,
clients need hand-holding and guidance on which litigations to pursue and which
ones not to, having regard to the alternate forums of dispute resolution
available under domestic laws as well as under India’s tax treaties.

 

Both individuals
and firms are busy meeting many of the challenges highlighted above. Broadly,
any strategy must include devising a detailed compliance framework, including
establishing a crisis management plan, purchasing appropriate insurance cover,
implementing the right technology and systems, and creating a culture of
compliance throughout the organisation.

 

Finally, managing
risk is very different from devising economic strategy to grow and be
successful. Risk management must focus on the negative – dangers and failures rather
than opportunities and achievements. And it’s tempting to relegate risk
management as a ‘good to have’ rather than a ‘must have’. Instances of failure
of other professionals is often viewed as being specific to those sets of
individuals and is rarely acknowledged as a shortcoming of the way a
professional firm is run on a daily basis. It’s also antithetic to a culture of
‘winning more and winning bigger’, hence tends to find few takers willing to
invest both time and money now, in order to avoid an unknown future problem
that may not even occur. However, as the history of humankind has shown,
vulnerabilities have existed through various times – good and bad – and the
foundation of any long-term sustainable and successful strategy must include a
robust risk management system. After all, any firm’s ability to weather a storm
depends very much on how seriously top management takes its risk-management
function when the sun is shining brightly, with scarcely a cloud on the
horizon.

DEDUCTIBILITY OF FOREIGN TAXES

ISSUE FOR CONSIDERATION

Section 40 of the Income Tax Act, 1961 deals with amounts
that are not deductible in computing income under the head ‘Profits and Gains
of Business or Profession’. This section, in particular clause (a)(ii)
thereof,  reads as under:

 

‘Notwithstanding
anything to the contrary in sections 30 to 38, the following amounts shall not
be deducted in computing the income chargeable under the head “Profits and
gains of business or profession”, –  

(a) in the case of any assessee—

(i)  ………..

(ia) …………….

(ib) ……………

(ic)  …………….

(ii)  any sum paid on account of any rate or tax
levied on the profits or gains of any business or profession or assessed at a
proportion of, or otherwise on the basis of, any such profits or gains.

Explanation 1. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes and
shall be deemed always to have included any sum eligible for relief of tax
under section 90 or, as the case may be, deduction from the Indian income-tax
payable under section 91.

Explanation 2. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes any sum
eligible for relief of tax under section 90A.’

 

Explanations 1 and
2 were inserted with effect from Assessment Year 2006-07. Prior to that there
was much litigation on whether income taxes paid in a foreign country were an
allowable deduction or not. These explanations were added to prevent a double
relief or benefit , since in most cases such foreign taxes for which deduction
was being claimed were also entitled to tax relief under sections 90, 90A or
91. After the amendment, the issue still remains alive insofar as taxes which
are not entitled to the relief or even a partial relief under sections 90, 90A
or 91, and under the rules only a part of the foreign taxes paid may be
entitled to the relief u/s 90 or u/s 90A in some cases.

 

An issue has arisen
involving the deductibility of the foreign tax paid on account of the profits
or gains of a foreign business or profession in computing the income under the
head ‘profits and gains of business and profession’ under the Income-tax Act,
1961. While there have been conflicting decisions on the subject, of the Ahmedabad
bench of the Tribunal post amendment, to really understand the controversy one
would need to understand the two conflicting decisions of the Bombay High Court
on the issue, one of which was rendered after the amendment but dealt with a
period prior to the amendment.

 

THE S. INDER SINGH GILL CASE

The issue came up before the Bombay High Court in the case
of S. Inder Singh Gill vs. CIT 47 ITR 284.

 

In this case,
pertaining to assessment years 1946-47 to 1951-52, under the Income-tax Act,
1922 the assessee was a non-resident. A resident was treated as the assessee’s
statutory agent u/s 43 of the 1922 Act (corresponding to representative
assessee u/s 163 of the 1961 Act).

 

In the original
assessments, income from certain Bombay properties was assessed to tax in
computing the total income. The Income Tax Officer later found that the
assessee owned certain other properties also in the taxable territories whose
income had escaped assessment, and therefore initiated re-assessment
proceedings. In response to the notice, the assessee filed his return of
income.

 

In the return,
among other deductions the assessee claimed that in computing his world income,
the tax paid by him to the Uganda government on his Ugandan income should be
deducted. This claim of the assessee was disallowed by the tax authorities. The
assessee’s first appeal was dismissed by the Appellate Assistant Commissioner.
The Tribunal also rejected the contention that tax paid to the Uganda
government on his foreign income should be deducted in determining his foreign
income and in including it in his total world income.

 

The Bombay High
Court in deciding the issue, noted that the Tribunal had observed as under:

 

‘We are not
aware of any commercial practice or principle which lays down that tax paid by
one on one’s income is a proper deduction in determining one’s income for the
purposes of taxation’.

 

The Bombay High
Court held that no reason had been shown to it by the assessee to differ from
the conclusion that the Tribunal had reached. The Court therefore rejected the
reference made to it by the assessee.

 

A similar view was
taken by the Calcutta High Court in the case of Jeewanlal (1929) Ltd. vs.
CIT 48 ITR 270, also a case under the 1922 Act, where the issue was
whether business profits tax paid in Burma was an allowable deduction.

 

Again, a similar
view was taken by the Karnataka High Court in Kirloskar Electric Co. Ltd.
vs. CIT 228 ITR 676, prior to the amendment, by applying section
40(a)(ii). Besides, the Madras High Court, in CIT vs. Kerala Lines Ltd.
201 ITR 106, has also held that foreign taxes are not allowable as a
deduction.

 

THE RELIANCE INFRASTRUCTURE CASE

Recently, the issue
again came up before the Bombay High Court in the case of Reliance
Infrastructure Ltd. vs. CIT 390 ITR 271.

 

This was a case
pertaining to A.Y. 1983-84. During the year, the assessee executed projects in
Saudi Arabia. The income earned in Saudi Arabia had been subjected to tax in
Saudi Arabia. While determining the tax payable under Indian tax laws, the
assessee sought the benefit of section 91, claiming relief from double taxation
of the same income, i.e., the Saudi income which was included in the total
income of the assessee.

 

The assessee
claimed the benefit of double taxation relief on the amounts of Rs. 47.3 lakhs,
otherwise claimed as deduction u/s 80HHB, and Rs. 5.59 lakhs on which a
weighted deduction was otherwise claimed u/s 35B. The A.O. dismissed the
assessee’s claim for relief u/s 91 on the ground that the relief u/s 91 would
be possible only when the amount of foreign income on which the foreign tax was
paid was again included in the taxable income liable to tax in India, i.e., the
relief was possible only where the same income was taxed in both the countries.

 

The Commissioner
(Appeals) rejected the assessee’s appeal, holding that the assessee had, in
respect of his Saudi income, 
claimed  deductions u/s 80HHB and
section 35B and such income did not suffer any tax in India and was therefore
not eligible for the benefit of relief u/s 91.

 

Before the
Tribunal, the assessee urged that the Commissioner (Appeals) ought to have held
that in respect of such percentage of income which was deemed to accrue in
India, and on which the benefit of section 91 was not available, the tax paid
in Saudi Arabia should be treated as an expenditure incurred in earning income,
which was deemed to have accrued or arisen in India, and reduced therefrom.

 

The Tribunal
dismissed the assessee’s appeal, holding that the issue stood concluded against
the assessee by the decision of the Andhra Pradesh High Court in the case of CIT
vs. C.S. Murthy 169 ITR 686. The Tribunal also held that the tax paid
in Saudi Arabia on which even where no double tax relief could be claimed, was
not allowable as a deduction in computing the income under the provisions of
the Income-tax Act. As regards tax in respect of income which had accrued or
arisen in India, the Tribunal rejected the assessee’s contention on two grounds
– that such a claim had not been raised before the Commissioner (Appeals), and
that the disallowance  was as per the
decision of the Bombay High Court in S. Inder Singh Gill’s case
(Supra).

 

It was claimed on
behalf of the assessee before the Bombay High Court inter alia that the
assessee  should be allowed a deduction
of the foreign tax paid in Saudi Arabia, once it was held that the benefit of
section 91 was not available for such tax. It was emphasised that the deduction
was claimed only to the extent that tax had been paid in Saudi Arabia on the
income which had been deemed to have accrued or arisen in India.

 

It was pointed out
to  the Bombay High Court that such a
deduction had been allowed by the Tribunal in the assessee’s own case for A.Y.
1979-80 and therefore the principle of consistency  required the Tribunal to adopt the same view
as it did in A.Y. 1979-80. It was pointed out that Explanation 1 added to
section 40(a)(ii) with effect from A.Y. 2006-07 was clarificatory in nature, as
was evident from the fact that it began with the words ‘for removal of doubts’.
It should therefore be deemed to have always been there and would apply to the
case before the High Court. It was argued that if it was held that section 91
was not applicable, then the bar of claiming deduction to the extent of the tax
paid abroad would not apply.

 

Reference was made
on behalf of the assessee to the commentary on ‘Law and Practice of Income
Tax’ by Kanga & Palkhivala (8th Edition), wherein a
reference was made to the decisions of the Bombay High Court in CIT vs.
Southeast Asian Shipping Co. (IT Appeal No. 123 of 1976) and CIT
vs. Tata Sons Ltd. (IT Appeal No. 209 of 2001)  holding that foreign tax did not fall within
the mischief of section 40(a)(ii) and that the assessee’s net income after
deduction of foreign taxes was his real income for the purposes of the
Income-tax Act.

 

It was therefore
argued on behalf of the assessee that the decision of the Bombay High Court in S.
Inder Singh Gill (Supra) would not apply and the tax paid in Saudi
Arabia on the income accrued or arising in India was to be allowed as a
deduction to arrive at the real profits which were chargeable to tax in India.

 

On behalf of the
Revenue, it was submitted that the issue stood concluded against the assessee
by the decision of the Bombay High Court in S. Inder Singh Gill (Supra).
It was submitted that the real income theory was inapplicable in view of the
specific provision of section 40(a)(ii) which prohibited deduction of any tax
paid. It was submitted that in terms of the main provisions of section
40(a)(ii), any sum paid on account of any tax on the profits and gains of
business or profession would not be allowed as a deduction.

 

It was argued on
behalf of the Revenue that the Explanation 2, inserted with effect from A.Y.
2006-07, only reiterated that any sum entitled to tax relief u/s 91 would be
covered by the main part of section 40(a)(ii). It did not take away the taxes
not covered by it out of the ambit of the main part of section 40(a)(ii).

 

The Bombay High
Court held that the Tribunal was justified in not following its order in the
case of the assessee itself for A.Y. 1979-80, as it noted the decision of the
Bombay High Court in S. Inder Singh Gill (Supra) on an identical
issue. The Court observed that the decisions in South Asian Shipping Co.
(Supra) and Tata Sons Ltd. (Supra) were rendered not at
the final hearing but while rejecting the applications for reference u/s 256(2)
and at the stage of admission u/s 260A, unlike the judgment rendered in a
reference by the Court in S. Inder Singh Gill, and therefore
could not be relied upon in preference to the decision in S. Inder Singh
Gill.

 

Further, the Court
observed that it was axiomatic that income tax was a charge on the profits or
income. The payment of income tax was not a payment made or incurred to earn
profits and gains of business. It could therefore not be allowed as an
expenditure to determine the profits of the business. Taxes such as excise
duty, customs duty, octroi, etc., were incurred for the purpose of doing
business and earning profits or gains from business or profession and
therefore, they  were allowable as
deduction to determine the profits of the business. It is the profits and gains
of business, determined after deducting all expenses incurred for the purpose
of business from the total receipts, which were subjected to income tax as per
the Act. The main part of section 40(a)(ii) did not allow deduction of tax to
the extent the tax was levied  on the
profits or gains of the business. According to the Court, it was on this
general principle, universally accepted, that the Bombay High Court had
answered the question posed to it in S. Inder Singh Gill in
favour of the Revenue.

 

The Bombay High
Court went on to observe that it would have followed the decision in the case
of S. Inder Singh Gill. However, it noticed that that decision
was rendered under the 1922 Act and not under the 1961 Act. The difference
between the two Acts was that the 1922 Act did not contain a definition of
‘tax’, unlike the 1961 Act where such term was defined in section 2(43) as
‘income tax chargeable under the provisions of this Act’. In the absence of any
definition of ‘tax’ under the 1922 Act, the tax paid on income or profits and
gains of business or profession anywhere in the world would not be allowable as
a deduction for determining the profits or gains of the business u/s 10(4) of
the 1922 Act, and therefore the decision in S. Inder Singh Gill
was correctly rendered on the basis of the law then prevalent.

 

Proceeding on the
said lines,  the Bombay High Court held
that by insertion of section 2(43) for defining the term ‘tax’, tax which was
payable under the 1961 Act on the profits and gains of business that alone was
not allowed to be deducted u/s 40(a)(ii), notwithstanding sections 30 to 38.
According to the Court, the tax, which had been paid abroad would not be
covered within the mischief of section 40(a)(ii), in view of the definition of
the word ‘tax’ in section 2(43). The Court said that it was conscious of the
fact that section 2, while defining the various terms used in the Act,
qualified it by preceding the definition with the words ‘in this Act, unless
the context otherwise requires’. It noted that it was not even urged by the
Revenue that the context of section 40(a)(ii) would require it to mean tax paid
anywhere in the world and not only tax payable under the Act.

 

The Court analysed
the rationale for introduction of the Explanations to section 40(a)(ii), as set
out in the Explanatory Memorandum to the Finance Act, 2006, recorded in CBDT
Circular No. 14 of 2006 dated 28th December, 2006. It  recorded the fact that some assessees, who
were eligible for credit against the tax payable in India on the global income
to the extent that the tax had been paid outside India u/s 90/91, were also
claiming deduction of the tax paid abroad as it was not tax under the Act. In
view of the above, the explanation would require in the context thereof that
the definition of the word ‘tax’ would also mean tax which was eligible to the
benefit of section 90/91. However, as per the High Court, this departure from
the meaning of the word ‘tax’ as defined in the Act was  restricted to the above-referred section 90/91
only and gave no license to widen the meaning of the word ‘tax’ to include all
taxes on income or profits paid abroad for the purposes of section 40(a)(ii).

 

The Court further
noted that it was undisputed that some part on which tax had been paid abroad
was on income that had been deemed to have accrued or arisen in India. To that
extent, the benefit of section 91 was not available for such tax so paid
abroad. Therefore, such tax was not hit by the Explanation to section 40(a)(ii)
and was to be considered in the nature of an expenditure incurred to earn
income. The Court then held that the Explanation to section 40(a)(ii) was
declaratory in nature and would have retrospective effect.

 

The Bombay High
Court therefore held that the assessee was entitled to deduction for foreign
taxes paid on income accrued or arisen in India in computing its income, to the
extent that such tax was not entitled to the benefit of section 91.

 

OBSERVATIONS

Before looking at
the applicability of section 40(a)(ii), one first needs to examine whether
income tax is at all an expenditure, and if so, whether it is a business
expenditure. Accounting Standard 22, issued by the Ministry of Corporate
Affairs under the Companies Act, provides that ‘Taxes on income are
considered to be an expense incurred by the enterprise in earning income and are accrued
in the same period as the revenue and expenses to which they relate.’ It
therefore seems that income tax is an expenditure under accounting principles.

 

Since only certain
types of business expenditure are allowable as deductions while computing
income under the head ‘Profits and Gains of Business or Profession’, the
question that arises is whether tax is a business expenditure. Accounting
Standard 22 states that ‘Accounting income (loss) is the net profit or loss
for a period, as reported in the statement of profit and loss, before deducting
income tax expense or adding income tax saving.’ Ind AS 12 issued by the
Ministry of Corporate Affairs states ‘The tax expense (income) related to
profit or loss from ordinary activities shall be presented as part of profit or
loss in the statement of profit and loss.’

 

However, if one
looks at the manner of presentation in the final accounts, it is clear that
income tax is treated quite differently from business expenditure, being shown
separately as a deduction after computing the pre-tax profit. Therefore, it
appears that while tax is an expense, it may not be a business expenditure.
This is supported by the language of AS 22, which states that ‘Accounting
income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income tax expense or adding
income tax saving.’

 

Further, the
fundamental issue still remains as to whether such foreign income taxes can
ever be a deductible expenditure under sections 30 to 38. Even on basic
commercial principles, income tax is not an expenditure for earning income; it
is a consequence of earning income. Whether such income tax is a foreign tax or
tax under the 1961 Act is irrelevant – it is still an application of income
after having earned the income. This view is supported by the decision of the
Madras High Court in the Kerala Lines case (Supra),
where the High Court observed that the payment of foreign taxes could not be
regarded as an expenditure for earning profits; they could at best be
considered as an application of profits earned by the assessee.

 

In the Reliance
Infrastructure case, the decision of the Bombay High Court was primarily
focused and based on the language of section 40(a)(ii), the Explanation thereto
read with the definition of ‘tax’ u/s 2(43). However, it needs to be kept in
mind that section 40 is a section listing out expenses, which are otherwise
allowable under sections 30 to 38, but which are specifically not allowable.
The provisions of section 40(a)(ii) will therefore come into play where an item
of expenditure is otherwise allowable as a business expenditure under sections
30 to 38. If such expenditure is in any case not allowable under sections 30 to
38, the question of applicability of section 40(a)(ii) does not arise.

 

The Bombay High
Court, in the case of CIT vs. Plasmac Machine Mfg. Co. Ltd. 201 ITR 650,
considered a situation of payment of tax liability of a transferor firm by the
transferee company, where the company had taken over the business of the
transferor firm. It held that the expenditure representing the liability of the
transferor, which was discharged by the transferee, was a capital expenditure
forming part of the consideration for the acquisition of the business and was
therefore not deductible in the computation of income. Hence, the question of
applicability of section 40(a)(ii) did not arise.

 

Under what clause
would foreign income taxes be allowable under sections 30 to 38? The only
possible provision under which such income taxes may fall for consideration as
a deduction would be section 37(1). Section 37(1) allows a deduction for
expenditure (not being in the nature of capital expenditure or personal
expenses) incurred wholly and exclusively for the purpose of business or
profession. Is a foreign income tax an expenditure incurred wholly and
exclusively for the purpose of business or profession, or is it an application
of the income after it has been earned?

 

The House of Lords,
in the case of Commissioners of Inland Revenue vs. Dowdall O’Mahoney
& Co. Ltd. 33 Tax Cases 259, had occasion to consider this issue in
the case of an Irish company which had branches in England; it claimed that in
computing the English profits, it was entitled to deduct that proportion of the
Irish taxes attributable to those profits. The House of Lords held that payment
of such taxes by a trader was not a disbursement wholly and exclusively laid
out for the purposes of the trade and this was so whether such taxes were
United Kingdom taxes or foreign or Dominion taxes. The House of Lords further
observed that taxes like these were not paid for the purpose of earning the
profits of the trade; they were the application of those profits when made and
not the less so that they were exacted by a Dominion or foreign government. It
further observed that there was not and never was any right under the
principles applicable to deduct income tax or excess profits tax, British or
foreign, in computing trading profits. According to the House of Lords, once it
was accepted that the criterion is the purpose for which the expenditure is
made in relation to the trade of which the profits are being computed, no
material distinction remained between the payment to make such taxes abroad and
a payment to meet a similar tax at home. A similar view was taken by the Madras
High Court in Kerala Lines (Supra).

 

In the Reliance
Infrastructure case, the Bombay High Court, while referring to this
basic principle, also accepted by it in the S. Inder Singh Gill
case, did not lay down any rationale for departing from this principle while
deciding the matter. It perhaps was swayed by the Explanation to section 90/91
and section 2(43), both of which had no application on the subject of allowance
of deduction of the foreign tax in computing the business income in the first
place.

 

The issue of
deductibility of foreign taxes had also come up recently before the Ahmedabad
Bench of the Tribunal, in which the Tribunal took differing views. In both
these cases the assessee had claimed foreign tax credit under section 90/91 on
the basis of the gross foreign income, but was allowed tax credit on the basis
of net foreign income taxable in India. It alternatively claimed deduction for
such foreign taxes not allowed as credit. In the first case, DCIT vs.
Elitecore Technologies (P) Ltd., 165 ITD 153, the Tribunal held, after
a detailed examination of the entire gamut of case laws on the subject, that
foreign taxes were not a deductible expenditure. It pointed out aspects which
had not been considered by the Bombay High Court in the Reliance
Infrastructure case. In the subsequent decision in Virmati
Software & Telecommunication Ltd. vs. DCIT, ITA No 1135/Ahd/2017 dated 5th
March, 2020, the Tribunal took a contrary view, following the Bombay
High Court decision in the Reliance Infrastructure case, that
such foreign taxes not allowed credit u/s 91 were deductible in computing the
income. The Mumbai Bench of the Tribunal, in the case of Tata Motors Ltd.
vs. CIT ITA No. 3802/Mum/2018 dated 15th April, 2019, has
also followed the Bombay High Court decision in Reliance Infrastructure
and held that the deduction for foreign taxes not entitled to relief under
section 90/91 could not be the subject matter of revision u/s 263.

 

The Mumbai Bench of
the Tribunal, on the other hand, in the case of DCIT vs. Tata Sons Ltd.
43 SOT 27, has, while disallowing the claim for deduction of foreign
taxes u/s 37(1), observed that if it was to be held that the assessee was
entitled to deduction of tax paid abroad, in addition to admissibility of tax
relief u/s 90 or section 91, it would result in a situation that on the one
hand double taxation of income would be eliminated by ensuring that the
assessee’s total income-tax liability did not exceed the income-tax liability
in India or the income-tax liability abroad, whichever was greater, and, on the
other hand, the assessee’s domestic tax liability would also be reduced by tax
liability in respect of income decreased due to deduction of taxes. Such a
double benefit to the assessee was contrary to the scheme of the Act as well as
the fundamental principles of international taxation.

 

Interestingly, the
Mumbai Bench of the Tribunal, in Tata Consultancy Services Ltd. vs. ACIT
203 TTJ 146, considered a disallowance of US and Canadian state taxes
and held that such taxes were not covered by section 40(a)(ii) and were
therefore allowable.

 

A question arose in
Jaipuria Samla Amalgamated Collieries Ltd. 82 ITR 580 (SC) where
the assessee, a lessee of mines, incurred statutory liability for the payment
of road and public works cess and education cess, and claimed deduction of such
cess in its computation of income. The A.O. disallowed such claim relying on
section 10(4) of the 1922 Act, corresponding to section 40(a)(ii) of the 1961
Act. In that decision, the Supreme Court held that the words ‘profits and gains
of any business, profession or vocation’ which were employed in section 10(4),
could, in the context, have reference only to profits or gains as determined
u/s 10 and could not cover the net profits or gains arrived at or determined in
a manner other than that provided by section 10. Can one apply the ratio
of this decision to foreign income taxes, which are levied on income computed
in a manner different from that envisaged under the 1961 Act?

 

Subsequently, the
Supreme Court itself in the case of Smithkline & French India Ltd.
vs. CIT 219 ITR 581 has taken a different view in the context of surtax.
The Supreme Court observed in this case:

‘Firstly, it may
be mentioned, s.10(4) of the 1922 Act or s.40(a)(ii) of the present Act do not
contain any words indicating that the profits and gains spoken of by them
should be determined in accordance with the provisions of the IT Act. All they
say is that it must be a rate or tax levied on the profits and gains of
business or profession. The observations relied upon must be read in the said
context and not literally or as the provisions in a statute…’

 

This argument
therefore seems to no longer be valid. In this case, the Supreme Court has also
approved the Bombay High Court decision in Lubrizol India Ltd. vs. CIT
187 ITR 25, where the Bombay High Court noted that section 40(a)(ii)
uses the term ‘any’ before ‘rate or tax’. The High Court had observed:

 

‘If the word “tax” is to be given the meaning
assigned to it by s.2(43) of the Act, the word “any” used before it will be
otiose and the further qualification as to the nature of levy will also become
meaningless. Furthermore, the word “tax” as defined in s.2(43) of the Act is
subject to “unless the context otherwise requires”. In view of the discussion
above, we hold that the words “any tax” herein refers to any kind of tax levied
or leviable on the profits or gains of any business or profession or assessed
at a proportion of, or otherwise on the basis of, any such profits or gains’.

 

This view is in
direct contrast to the view expressed in the Reliance Infrastructure
case, and having been approved by the Supreme Court in the case of Smithkline
& French (Supra), this view should prevail. Perhaps, the ratio
of the Reliance Infrastructure case was largely governed by the
fact that the non-applicability of section 2(43) to section 40(a)(ii) was never
urged by the Department before it.

 

Therefore, the better view is that foreign
income taxes are not a deductible expenditure in computing income under the
1961 Act, irrespective of whether they are eligible for credit under sections
90, 90A or 91.

Reopening – Beyond four years – Assessment completed u/s 143(3) – A mere bald assertion by the A.O. that the assessee has not disclosed fully and truly all the material facts is not sufficient – Reopening is not valid

6. M/s. Anand Developers vs. Asst.
Commissioner of Income Tax Circle-2(1) [Writ Petition No. 17 of 2020] Date of order: 18th February,
2020 Bombay High Court (Goa Bench)

 

Reopening –
Beyond four years – Assessment completed u/s 143(3) – A mere bald assertion by
the A.O. that the assessee has not disclosed fully and truly all the material
facts is not sufficient – Reopening is not valid

 

The petition challenged the
notice dated 29th March, 2019 issued u/s 148 of the Income-tax Act,
1961 and the order dated 17th December, 2019 disposing of the
assessee / petitioner’s objections to the reopening of the assessment in
pursuance of the notice dated 29th March, 2019.

 

The
petitioner had submitted its return of income within the prescribed period for
A.Y. 2012-13 declaring total income of Rs. 62,233. The case was selected for
scrutiny through CASS and notice was issued u/s 143(2) of the Act and served
upon the petitioner on 28th August, 2013. Based on the details
furnished by the petitioner, the A.O. passed the assessment order dated 16th
March, 2015 u/s 143(2).

 

It was the case of the
petitioner that vide its own letter dated 20th February, 2015
in the course of the assessment proceedings before the A.O., it had itself
submitted that a few flats may have been allotted to persons in violation of
Clause 10(f) of section 80IB. It was also contended that this ought not to be
regarded as any breach of the provisions of section 80IB; in any case, this
ought not to be regarded as any breach of the provisions of section 80IB in
its entirety and at the most benefit may be denied in respect of the
transfers made in breach of Clause 10(f) of section 80IB.

 

The petitioner submitted that
through this letter it had made true and complete disclosures in the course of
the assessment proceedings itself. It was upon consideration of these
disclosures that the A.O. finalised the assessment order of 16th
March, 2015 u/s 143(3). Under the circumstances, merely on the basis of a
change of opinion, the A.O. lacked jurisdiction to issue notice u/s 148 seeking
to reopen the assessment. Since there was absolutely no failure to make true
and full disclosures, there was no jurisdiction to issue such notice u/s 148
after the expiry of four years from the date of assessment.

 

The Department submitted that
since the petitioner had admitted vide its letter dated 20th
February, 2015 that it had violated the provisions of section 80IB and further
failed to make true and full disclosures, there was absolutely no
jurisdictional error in issuing the impugned notice or making the impugned
order.

 

The High Court observed that
the factum of the address of the letter dated 20th February,
2015 is indisputable because the respondents had themselves not only referred
to it but also quoted from it in the show cause notice dated 17th December,
2019 issued to the petitioner along with the impugned order of the same date by
which the objections of the petitioner to the reopening of the assessment came
to be rejected. Even the impugned order dated 17th December, 2019
rejecting the petitioner’s objections makes a specific reference to the
petitioner’s letter of 20th February, 2015 submitted during the
assessment proceedings u/s 143(3). Both the show cause notice dated 17th
December, 2019 and the impugned order of the same date specifically state that
the petitioner in the course of the assessment proceedings had furnished a list
of flat-owners to whom flats were sold in the project ‘Bay Village’.

 

The notice and the impugned
order proceed to state that upon perusal of this list, coupled with the letter
dated 20th February, 2015, it transpires that there was non-compliance
on the part of the petitioner with the provisions of section 80IB at least
insofar as some of the sales were concerned. Since it is virtually an admitted
fact that the petitioner had submitted a list of the flat-owners and vide
its letter dated 20th February, 2015 pointed out that there may be
breach insofar as the sale of some of the flats are concerned, it cannot be
said by the respondents that there was no truthful or complete disclosure on
the part of the petitioners in the course of the assessment proceedings itself.

 

The Court observed that
merely making of a bald statement that the assessee had not disclosed fully and
truly all the material facts is really never sufficient in such matters. In the
present case as well, apart from such a bald assertion, no details have been
disclosed as to the material which was allegedly not disclosed either truly or
fully. Rather, the record indicates that the entire list of flat-owners was
disclosed. Further, vide the same letter disclosures were made in
relation to the sale transactions and it was even suggested that some of the
transactions may not be compliant with the provisions of Clause 10(f) of
section 80IB. Clearly, therefore, the Department had failed to make out any
case that there was no true and full disclosure.

 

Further, section 147 of the
IT Act empowers the A.O. who has reason to believe that any income chargeable
to tax has escaped assessment for any A.Y. to reassess such income, no doubt
subject to the provisions of sections 148 to 153 of the Act. The proviso
to section 147, however, makes clear that where an assessment under sub-section
(3) of section 143 has been made for the relevant A.Y., no action shall be
taken u/s 147 after the expiry of four years from the end of the relevant
assessment year unless any income chargeable to tax has escaped assessment for
such assessment year by reason of failure on the part of the assessee, inter
alia ‘to disclose fully and truly all material facts necessary for its
assessment for that assessment year’. This means that normally, the limitation
period for re-assessment u/s 147 is four years. However, in a case where the
assessment has been made u/s 143(3) where, inter alia, the assessee
fails to disclose fully and truly all material facts necessary for assessment
for that assessment year, re-assessment can be made even beyond the period of
four years in terms of section 148. Therefore, in order to sustain a notice
seeking to reopen assessment beyond the normal period of four years it is
necessary for the respondents to establish, at least prima facie, that
there was failure to disclose fully and truly all material facts necessary for
the assessment for that assessment year.

 

In the present case, the
respondents have failed to establish this precondition even prima facie.
Rather, the material on record establishes that there were full and true
disclosures of all material facts necessary for the assessment for the A.Y.
2012-13. Despite this, the impugned notice seeking to reopen the assessment for
that year has been issued beyond the normal period of four years. On this short
ground, the impugned notice dated 29th March, 2019 and the impugned
order dated 17th December, 2019 were quashed and set aside. The
Court relied on the decisions of the Division Bench of this Court in the case
of Mrs. Parveen P. Bharucha [(2012) 348 ITR 325] and Zuari Foods and
Farms Pvt. Ltd. (WP No. 1001 of 2007 decided on 11th April, 2018).

 

The Court
observed that the decision in Calcutta Discount Co. Ltd. [(1961) 41 ITR
191 (SC)] in fact assists the case of the petitioner rather than the
respondents. In that decision, the Hon’ble Supreme Court has held that it is
the duty of the assessee to disclose fully and truly all primary relevant
facts, and once all primary facts are before the assessing authority, he
requires no further assistance by way of disclosure and it is for him to decide
what inference of facts can be reasonably drawn and what legal inferences have
ultimately to be drawn. However, if there are some reasonable grounds for
thinking that there had been under-assessment as regards any primary facts
which could have a material bearing on the question of under-assessment, that
would be sufficient to give jurisdiction to the ITO to issue notice for
re-assessment. In the present case, as noted earlier, there is absolutely no
reference to any alleged material facts which the petitioner failed to disclose
in the course of the assessment proceedings. Rather, the impugned notice refers
to the list as well as the letter issued by the petitioner itself which is
sought to be made the basis for the reopening of the assessment. For the
aforesaid reasons the petition is allowed and the impugned notice dated 29th
March, 2019 and the impugned order dated 17th December, 2019
are quashed and set aside. 

 

Revision – TDS – Non-resident – Shipping business – Section 263 and section 172, r/w sections 40(a)(ia), 194C and 195 of ITA, 1961 – Where assessee had paid export freight to a shipping agent of non-resident ship-owner or charter without deduction of tax at source, provisions of section 172 would be applicable and provisions of section 194C or section 195 which provide for deduction of tax at source shall not be applicable; A.Y.: 2014-15

26. Principal
CIT vs. Summit India Water Treatment and Services Ltd. [2020]
116 taxmann.com 107 (Guj.) Date
of order: 3rd February, 2020 A.Y.:
2014-15

 

Revision –
TDS – Non-resident – Shipping business – Section 263 and section 172, r/w sections
40(a)(ia), 194C and 195 of ITA, 1961 – Where assessee had paid export freight
to a shipping agent of non-resident ship-owner or charter without deduction of tax at source, provisions of section 172 would
be applicable and provisions of section 194C or section 195 which provide for
deduction of tax at source shall not be applicable; A.Y.: 2014-15

 

For the A.Y. 2013-14, the assessee filed its return of income declaring
total loss of Rs. 1,35,18,193. By an order dated 22nd March, 2016,
the A.O. finalised the assessment u/s 143(3). The Principal Commissioner of
Income-tax (‘the PCIT’) invoked the power of revision u/s 263 of the Act, 1961
on the ground that without deducting TDS on the export freight, the assessee
company had paid export freight amounting to Rs. 2,03,66,683 to Inter-Ocean
Shipping and Logistic Services. According to the PCIT, as no TDS return showing
the details of deduction of any tax in respect of the aforesaid export freight
had been filed and as the A.O. had not verified the same, the scope of
provisions of TDS on export freight, the entire amount was required to be
disallowed u/s 40(a)(ia) of the Act. By an order u/s 263 dated 21st
March, 2018, the PCIT directed the A.O. to pass a fresh assessment order after
providing an opportunity of being heard to the assessee in view of the
observations made in the order u/s 263.

 

The Tribunal
came to the conclusion that the A.O. has accepted the total loss declared by
the assessee in the return of income and passed order u/s 143(3) dated 22nd
March, 2016. The Tribunal considered the materials placed before it and found
that the respondent assessee had made payment for export freight to the Indian
Ocean Shipping and Logistics Services, which was an Indian agent acting on
behalf of the non-resident shipping company for collecting freight demurrage
and other charges and reimbursing the same to the shipping company. Therefore,
relying on the CBDT Circular No. 723 dated 19th September, 1995, the
Tribunal held that where payment is made to the shipping agents of the
non-resident ship-owner or charter, the agent steps into the shoe of the
principal, i.e. the shipping company, and according to the provisions u/s 172
of the Act, which provides for shipping business in respect of non-residents
would be applicable and the provisions of section 194C or 195 which provides
for deduction of tax at source shall not be applicable. The Tribunal,
therefore, held that the PCIT failed to consider that the assessee had
furnished the relevant materials in respect of export freight payment and it is
also not controverted by the PCIT; and therefore, it cannot be said that the
assessment order is erroneous or prejudicial to the interest of the Revenue in
any manner. The Tribunal set aside the order of the PCIT passed u/s 263 of the
Act.

 

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

 

‘i)   In view of the facts emerging
from the record and the finding of facts arrived at by the Tribunal, none of
the questions can be termed as substantial questions of law from the impugned
order passed by the Tribunal.

 

ii)   The appeal, therefore, fails
and is accordingly dismissed.’

 

INTERPLAY BETWEEN DEEMING FICTIONS OF SECTIONS 45(3) AND 50C

ISSUE FOR
CONSIDERATION

Section
45(3) of the Act provides for taxation of the capital gains on transfer of a capital
asset by a person to a firm in which he is or becomes a partner, by way of
capital contribution or otherwise, in the year of transfer and further provides
that the amount recorded in the books of accounts of the firm shall be deemed
to be the full value of the consideration received or accruing as a result of
such transfer of the capital asset for the purposes of section 48. Section 50C
of the Act provides that the value adopted or assessed or assessable by the
stamp valuation authority for the purpose of payment of stamp duty in respect
of transfer of a capital asset, being land or building or both, shall for the
purposes of section 48 be deemed to be the full value of the consideration
received or accruing as a result of such transfer if it is higher than its
actual consideration.

 

Whether both
the aforesaid provisions of the Act can be made applicable in a case where the
capital asset transferred by a partner to his firm by way of his capital
contribution is land or building or both is the issue that is sought to be
examined here. Whether for the purposes of section 48 the full value of
consideration should be the amount as recorded in the books of the firm in
accordance with the provisions of section 45(3), or whether it should be the
value as adopted or assessed or assessable by the stamp valuation authority in
accordance with the provisions of section 50C? Whether in computing the capital
gains, the higher of the two is to be adopted or not?

 

The Lucknow
bench of the Tribunal has held that the provisions of section 50C shall prevail
over the provisions of section 45(3) in a case where the stamp duty value was
higher than the value recorded in the books of the firm. As against this, the
Mumbai, Kolkata, Hyderabad and Chennai benches of the Tribunal have held that
the provisions of section 45(3), ignoring the provisions of section 50C, alone
can apply in a case where land or building has been introduced by a partner by
way of his capital contribution.


THE CARLTON HOTEL
(P) LTD. CASE

The issue
first came up for consideration of the Lucknow bench of the Tribunal in the
case of Carlton Hotel (P) Ltd. vs. ACIT 35 SOT 26 (Lucknow) (URO).
In this case, during the previous year relevant to A.Y. 2004-05 the assessee
company entered into a partnership with two other persons. The assessee company
contributed 2,40,000 sq. ft. of land as its capital contribution which was
valued at Rs. 7,81,96,735 and was so recorded in the books of the partnership
firm. The assessee was given 5% share in the partnership firm, whereas the
other two partners were given 95% share.

 

For the
purposes of computing capital gains in the hands of the partner assessee on
transfer of the land to the partnership firm, the A.O. invoked the provisions
of section 50C and applied circle rates for the purpose of calculating the
consideration for transfer. He valued the consideration at Rs. 29,75,46,468
instead of Rs. 7,81,96,735 and on that basis he calculated the long-term
capital gains. The A.O. inter alia doubted the genuineness of the
introduction of land and noted that the assessee has contributed 88% of capital
in lieu of only 5% share in profits which was beyond the normal business
prudence and the transfer of the land to the firm was as good as a sale. For
the purpose of holding so, he referred to the clauses of the partnership deed
and observed that the assessee had little role to play in the partnership
business, the assessee was not a managing partner in the firm, construction on
the plot was to be carried out by another partner of the firm, the assessee was
not having any civil, criminal or financial liability, the business of the
partnership was to be exclusively carried out by other partners of the firm,
the bank account could be independently operated only by the other two
partners, whereas the assessee could operate only with joint signatures of the
other two partners; it was only the other partners who had been empowered to
introduce new partners, the assessee did not have any right over the goodwill
of the firm, was not authorised to make any change in the composition of the
board which had controlling interest in its share capital, etc.

 

Thus, the A.O. alleged that the
assessee had adopted a device to evade capital gains tax by showing lower value
of sale consideration in the books of the firm, whereas the actual market value
of the land was much higher as reflected from the circle rate. He relied on the
decisions of the Supreme Court in the case of McDowell & Co. Ltd. vs.
CTO 154 ITR 148 for the proposition that if an assessee adopts a tax
avoidance scheme, then the form can be ignored. Thus, by taking the substance
of the transaction into consideration, the market value of the land transferred
to the firm as capital contribution was adopted by invoking section 50C,
contending that mere reliance on section 45(3) in isolation would defeat the
intent and purpose of the taxing statute.

 

Importantly, the A.O. also took a
view that section 50C was applicable even in a situation covered by section
45(3). The A.O., ignoring the facts that the transfer of land as capital
contribution was not through a registered document and that the provisions of
section 50C were amended only thereafter to rope in even the transfer of
immovable property otherwise than through a registered document, applied the provisions
of section 50C.

 

Upon further appeal, the CIT(A)
confirmed the order of the A.O. confirming that the value adopted by the
assessee for transferring the land to the firm was a collusive one and that the
provision of section 50C being a specific provision was applicable even where
provisions of section 45(3) had been invoked.

 

Upon further appeal to the
Tribunal, it was contended on behalf of the assessee that the provisions of
section 45(3) and section 50C were mutually exclusive; where section 45(3) was
applicable, section 50C would not be applicable and vice versa. It was
further submitted that section 45(3) created a deeming fiction whereby the
consideration recorded by the firm in its books was deemed to be the full value
of consideration for the purpose of computing capital gains. Section 50C was
another deeming section which empowered the A.O. to substitute the valuation
done by the stamp valuation authority as sale consideration in place of
consideration shown by the parties to the transaction. Once one deeming section
was invoked, another deeming section could not be made to nullify the effect of
the earlier deeming section. The application of section 50C in such a situation
would render section 45(3) otiose. Regarding the allegation that the assessee
had entered into a collusive transaction and accordingly had shown lower value
of consideration in the books of the firm, it was submitted that the firm would
be paying tax upon its further sale by adopting the value of land as recorded
in the books and, hence, there would not be any revenue loss.

 

On the other hand, the Revenue
supported the order of the A.O. and the CIT(A) and claimed that the form of the
transaction had to be ignored and its substance had to be considered, since the
assessee had entered into a collusive transaction.

 

The Tribunal
for the reasons recorded in the order rejected one of the contentions of the
Revenue that since section 50C required adoption of the circle rates for the
purpose of levy of the stamp duty which rates, once declared, could be
‘adopted’ for the purpose of substituting the full value of consideration for
section 48 and it was not necessary that the document for transfer of asset was
actually registered before invoking section 50C.

 

On the issue under consideration,
however, the Tribunal held that the provisions of section 50C could be invoked
even though the case was otherwise covered under section 45(3); section 50C
would override section 45(3). Section 45(3) was a general provision, while
section 50C was a special provision which would override section 45(3). In the
final analysis, however, the Tribunal rejected the action of the A.O. in
applying the provisions of section 50C on the ground of non-registration and
non-payment of the stamp duty.

 

It may be noted for the record
that the Revenue had filed a further appeal before the Allahabad High Court
against the decision of the Tribunal mainly for pleading that the transaction
was a colourable transaction executed with the intention to evade the tax
liability. And the High Court upholding the contention held that there existed all
the facts and circumstances to show prima facie that the entire
transaction of contribution to partnership was a sham and fictitious
transaction and an attempt to devise a method to avoid tax and remanded the
matter back to the Tribunal to look into this aspect of the matter, which was
an issue directly raised by the Revenue right from the stage of assessment. No
findings have been given by the High Court with respect to the issue of
applicability of section 50C to the transaction of introduction of capital
asset by the partner in the firm which is otherwise covered by section 45(3).


AMARTARA PVT. LTD.
CASE

Thereafter,
the issue came up for consideration of the Mumbai bench of the Tribunal in DCIT
vs. Amartara Pvt. Ltd. 78 ITR (Trib.)(S.N.) 46 (Mum).

 

In this
case, during the previous year relevant to A.Y. 2012-13 the assessee entered
into a limited liability partnership with the object of developing,
constructing and operating resorts, hotels and apartment hotels and / or for
carrying out such other hospitality businesses. The assessee transferred an
immovable property, being a plot of land admeasuring 6,869.959 metres situated
at Powai, Mumbai, as its capital contribution to the newly-created LLP vide
a supplementary agreement dated 29th December, 2011.

 

The said
plot of land was valued at Rs. 5.60 crores on the basis of the valuation report
obtained and it was recorded at that value in the books of the LLP. The
assessee, while computing capital gains on transfer of land into the
partnership firm in accordance with the provisions of section 45(3), had taken
the value as recorded in the books of the firm, i.e., Rs. 5.60 crores, as the
full value of the consideration deemed to have been received or accrued as a
result of transfer of capital asset to the partnership firm. The supplementary
agreement through which the said plot of land was introduced by the assessee
into the LLP was registered on 24th April, 2012 and the stamp duty
authority had determined the market value of the property for the purpose of
payment of stamp duty at Rs. 9,41,78,500.

 

The A.O.
invoked the provisions of section 50C and adopted the amount of Rs.
9,41,78,500, being the value determined by the stamp valuation authority at the
time of registration of the supplementary partnership deed, as the full value
of consideration for the purpose of computing capital gains. He observed that
the provisions of section 45(3) did not begin with a non-obstante clause
and, therefore, there was no specific mention of non-applicability of section
50C in the cases covered by section 45(3). He also relied upon the Lucknow
Tribunal decision in the case of Carlton Hotel (P) Ltd. (Supra)
for the proposition that section 50C, being a specific provision, would
override the provisions of section 45(3). The CIT(A) confirmed the order of the
A.O. by following the said decision in the case of Carlton Hotel (P) Ltd.
(Supra).

 

On further
appeal before the Tribunal, the assessee contended that sections 45(3) and
45(4) were special provisions for computation of capital gains on transfer of
capital assets between the partnership firm and the partners and that both the
provisions were deeming fictions created for the purpose of taxation of
transfers of capital assets in such special cases; importing another deeming
fiction to determine the full value of consideration in such special cases was
incorrect in view of the decision of the Hon’ble Supreme Court in the case of CIT
vs. Moon Mills Ltd. 59 ITR 574. It was submitted that the decision
rendered by the Lucknow bench of the Tribunal was per incuriam, in the
light of the decision of the Hon’ble Supreme Court in the case of CIT vs.
Moon Mills Ltd. (Supra), as per which a deeming fiction could not be
extended by importing another deeming fiction for the purpose of determination of
the full value of consideration.

 

It was also
contended on behalf of the assessee that section 50C of the Act had no
application where no consideration was received or accrued, and hence,
computing full value of consideration by applying the provisions of section 50C
in a case where there was a transfer between partners and the partnership firm
without there being any actual consideration received or accrued, was
incorrect.

 

In reply,
the Revenue heavily relied upon the said decision of the Lucknow bench of the
Tribunal in the case of Carlton Hotel (P) Ltd. (Supra) and
contended that section 50C overrode the provisions of section 45(3) once the
document of transfer was registered as per the provisions of the Registration
Act, 1908 and the stamp duty was paid for the registration of such document.

 

The Tribunal held that the
purpose of insertion of section 45(3) was to deal with cases of transfer
between a partnership firm and partners and in such cases the Act provided for
the computation mechanism of capital gains and also provides for consideration
to be adopted for the purpose of determination of full value of consideration.
Since the Act itself provided for deeming consideration to be adopted for the
purpose of section 48 of the Act, another deeming fiction provided by way of
section 50C could not be extended to compute the deemed full value of
consideration as a result of transfer of capital asset. It held that the
Lucknow bench had simply observed that the provisions of section 50C overrode
the provisions of section 45(3) but had not given a categorical finding.
Accordingly, the addition made towards the long-term capital gain by invoking
the provisions of section 50C
was deleted.

 

This decision of the Mumbai bench
of the Tribunal has been subsequently followed by the Tribunal in the cases of ACIT
vs. Moti Ramanand Sagar (ITA No. 2049/Mum/2017); ACIT vs. Kethireddy Venkata
Mohan Reddy (ITA No. 259/Hyd/2019); and ITO vs. Sheila Sen (ITA No.
554/Kol/2016).

 

OBSERVATIONS

The issue
under consideration arises due to two conflicting provisions of the Act which
can be invoked for a given transaction wherein the capital asset transferred by
a partner to his firm, as a capital contribution or otherwise, is land or
building. Section 45(3) provides for the amount recorded in the books of
accounts of the firm as deemed consideration. Section 50C provides for the
value adopted, assessed or assessable by stamp valuation authorities as deemed
consideration, if it exceeds the consideration received or accruing. Thus, both
the provisions deal with the determination of the full value of consideration
for the purpose of computation of capital gains by creating a deeming fiction.
Apart from considering the legislative intent behind both the provisions in
order to resolve the conflict between these two provisions, there are various
other aspects which are also required to be considered, like whether two
deeming fictions can operate simultaneously with respect to the same component
of the computation; whether one of these two provisions can be considered as a
general provision and the other one as a special provision whereby it can
override the general one; and which one will prevail if both the provisions are
required to be considered as special provisions.

 

Sub-section (3) was inserted in
section 45 by the Finance Act, 1987 with effect from A.Y. 1988-89. Prior to the
insertion of sub-section (3), the issue of taxability of the transfer of
capital asset by a partner to his firm was decided by the Supreme Court in the
case of Sunil Siddharthbhai vs. CIT 156 ITR 509. In this case,
the Supreme Court held that when the assessee brought his personal assets into
the partnership firm as his contribution to the capital, there was a transfer
of a capital asset within the meaning of the terms of section 45. This was
because the asset which was, till the date of such bringing in as firm’s
capital, an individual asset, after bringing it in became a shared asset. The
Supreme Court further held that the transfer of asset by the partner to the
firm as capital contribution would not necessarily result in receipt of any
consideration by the assessee so as to attract section 45 and the credit entry
made in the partner’s capital account in the books of the partnership firm did
not represent the true value of consideration. It was a notional value only,
intended to be taken into account at the time of determining the value of the
partner’s share in the net partnership assets on the date of dissolution or on
his retirement.

Therefore,
according to the Supreme Court, it was not correct to hold that the
consideration which a partner acquires on making over his personal asset to the
partnership firm as his contribution to its capital can fall within the
provisions of section 48. Since section 48 was fundamental to the computation
machinery incorporated in the scheme relating to determination of charge
provided in section 45, the Supreme Court held that such a case must be
regarded as falling outside the scope of capital gains taxation altogether.

 

It was in
this background that the legislature had introduced a specific provision so as
to bring the transfer of the capital asset by a partner to his firm to tax, as
is evident from Circular No. 495 dated 22nd September, 1987, the
extract from which is reproduced below:

 

Capital
gains on transfer of firms’ assets to partners and vice versa and by way of compulsory acquisition

24.1 One of
the devices used by assessees to evade tax on capital gains is to convert an
asset held individually into an asset of the firm in which the individual is a
partner. The decision of the Supreme Court in Kartikeya V. Sarabhai vs. CIT [1985] 156 ITR 509 has set at rest the controversy as to whether such a conversion amounts
to transfer. The Court held that such conversion fell outside the scope of
capital gains taxation. The rationale advanced by the Court is that the
consideration for the transfer of the personal asset is indeterminate, being
the right which arises or accrues to the partner during the subsistence of the
partnership to get his share of the profits from time to time and on
dissolution of the partnership to get the value of his share from the net
partnership assets.

 

24.2 With a
view to blocking this escape route for avoiding capital gains tax, the Finance
Act, 1987 has inserted new sub-section (3) in section 45. The effect of this
amendment is that profits and gains arising from the transfer of a capital
asset by a partner to a firm shall be chargeable as the partner’s income of the
previous year in which the transfer took place. For purposes of computing the
capital gains, the value of the asset recorded in the books of the firm on the
date of the transfer shall be deemed to be the full value of the consideration
received or accrued as a result of the transfer of the capital asset.

 

In view of
the above, it is clear that but for the specific provision of section 45(3),
the transfer of any capital asset by a partner to his firm could not have been
charged to tax under the head capital gains. In addition to providing for the
chargeability, section 45(3) also addresses the lacuna of the inability of
section 48 to cover such transfer within its ambit which was noticed by the Supreme
Court in the case of Sunil Siddharthbhai (Supra), by deeming the
amount recorded in the books of accounts of the firm as the full value of
consideration received or accruing as a result of such transfer.

 

Therefore,
it is obvious that section 45(3) needs to be invoked in order to charge the
capital gains tax in respect of transfer of a capital asset by a partner to his
firm. Having invoked the provisions of section 45(3) for the purpose of
chargeability, it needs to be applied in full and the alteration in the
computation mechanism as provided in that section also needs to be considered.
It would not be possible to invoke the provisions of section 45(3) only for the
purpose of creating a charge and, then, compute the capital gain in accordance
with the other provision, i.e., section 50C, by ignoring the computational
aspect of section 45(3) altogether.

 

The Mumbai
bench of the Tribunal in the case of ACIT vs. Prem Sagar (ITA No.
7442/Mum/2016) has held that both the limbs of section 45(3), i.e.,
charging provision and deeming fiction providing for the full value of
consideration, go hand in hand for facilitating quantification of the capital
gains tax. In case the quantification of the capital gains tax as envisaged in
section 45(3) is substituted by section 50C, then the charging to tax of the
transaction under consideration would in itself stand jeopardised and the
section would be rendered inoperative.

 

Having said
that the computation of capital gains needs to be made in accordance with the
provisions of section 45(3), the question may arise as to whether the amount of
consideration as decided in accordance with it can then be amended by invoking
the provisions of section 50C, in a case where the valuation adopted, assessed
or assessable by the stamp valuation authority is found to be higher than the
amount recorded in the books of the firm. For the purpose of section 50C the
comparison is required to be made between the consideration received or
accruing as a result of the transfer of the capital asset and the value
adopted, assessed or assessable by the stamp valuation authority for the
purpose of payment of stamp duty in respect of such transfer. Here, the
consideration received or accruing should be the real consideration received or
accruing, and not the consideration which is deemed to have been received or
accrued. This is because the expression ‘the consideration received or accruing
as a result of the transfer’ cannot be construed to include the consideration
deemed to have been received or accrued.

Wherever
required, the legislature has included a specific reference to something which
has been deemed to be so, in addition to the reference of the same thing in
simple terms. For example, section 9 provides for incomes which shall be deemed
to accrue or arise in India under certain circumstances. For the purpose of
including such income which is deemed to accrue or arise in India within the
scope of total income, clause (b) of section 5(1) makes specific reference to
it in addition to referring to the income which accrues or arises (in real and
not on deemed basis). The relevant clause is reproduced below:

 

(b) accrues
or arises or is deemed to accrue or arise to him in India during such year

 

There was no
need to make such a specific reference to the income which is deemed to accrue
or arise in India, if a view is taken that the income which accrues or arises
in India will in any case include the income which is deemed to accrue or arise
in India. As a corollary, the expression ‘the consideration received or
accruing as a result of the transfer’ as used in section 50C cannot include the
consideration deemed to be received or accrued in terms of the provisions of
section 45(3).

 

Further,
section 45(3) deems the amount recorded in the books of accounts of the firm as
a consideration only for the purpose of section 48. Therefore, the deeming
fiction created in section 45(3) has limited applicability and it cannot be
extended to section 50C, to deem the amount so recorded in the books of
accounts of the firm as consideration received or accruing for the purpose of
making its comparison with the valuation adopted, assessed or assessable by the
stamp valuation authorities. As a result, the provisions of section 50C cannot
be made applicable to the transfer of a capital asset by a partner to his firm
for which the true value of consideration received or accruing cannot be
determined, as held by the Supreme Court in the case of Sunil
Siddharthbhai (Supra).

 

The Supreme
Court in the case of CIT vs. Moon Mills Ltd. 59 ITR 574 has held
that one fiction cannot be imported within another fiction. Two different
provisions of the Act are providing for a fiction by deeming certain amounts as
the full value of consideration for the purpose of computation of capital gains
as per section 48. Section 45(3) deems the amount recorded in the books of the
firm as the full value of consideration and section 50C deems the value
adopted, assessed or assessable by the stamp valuation authority as the full
value of consideration. If section 50C has been made applicable over the amount
deemed to be the full value of consideration in terms of section 45(3), then it
will amount to superimposing a fiction upon a fiction – which would be contrary
to the decision of the Supreme Court.

 

In the case
of ITO vs. United Marine Academy 130 ITD 113 (Mum)(SB), a special
bench of the Tribunal has dealt with the interplay of deeming fictions as
provided in sections 50 and 50C and has observed as under:

 

For the
reasons given above and on interpretation of the relevant provisions of
sections 48, 50 and 50C, we are of the view that there are two deeming fictions
created in section 50 and section 50C. The first deeming fiction modifies the
term ‘cost of acquisition’ used in section 48 for the purpose of computing the
capital gains arising from transfer of depreciable assets, whereas the deeming
fiction created in section 50C modifies the term ‘full value of the
consideration received or accruing as a result of transfer of the capital
asset’ used in section 48 for the purpose of computing the capital gains
arising from the transfer of capital asset being land or building or both. The
deeming fiction created in section 50C thus operates in a specific field which
is different from the field in which section 50 is applicable. It is thus not a
case where any supposition has been sought to be imposed on any other
supposition of law. On the other hand, there are two different fictions created
into two different provisions, and going by the legislative intentions to create
the said fictions, the same operate in different fields. The harmonious
interpretation of the relevant provisions makes it clear that there is no
exclusion of applicability of one fiction in a case where another fiction is
applicable. As a matter of fact, there is no conflict between these two legal
fictions which operate in different fields and their application in a given
case simultaneously does not result in imposition of one supposition on another
supposition of law.

 

Thus,
insofar as transfer of an asset forming part of a block is concerned, the
Tribunal has held that both the provisions of the Act, i.e. sections 50 and
50C, can operate simultaneously. This is primarily for the reason that they
operate in different fields of the computation of capital gains. It was
categorically observed by the Tribunal that it was not a case where any
supposition has been sought to be imposed on another supposition of law.
Therefore, the inference which can be drawn indirectly on the basis of these
observations of the special bench is that two deeming fictions cannot operate
simultaneously if they operate in the same field like in the issue under
consideration.

 

It is also a
settled principle of interpretation that if a special provision is made on a
certain matter, the matter is excluded from the general provisions. This
principle is expressed in the maxims Generalia specialibus non derogant
(general things do not derogate from special things) and Generalibus
specialia derogant (special things derogate from general things).

 

However, it won’t be correct to
claim here that either of the two sections is a special one and, hence, it
overrides the other. Section 45(3) is a special provision insofar as
computation of capital gains resulting from capital contribution made by a
partner to the firm is concerned, and section 50C is a special provision
insofar as transfer of immovable property is concerned. Therefore, the issue
can better be resolved having regard to the other considerations as discussed
instead of merely relying upon these principles of interpretation.

 

In Canora
Resources Ltd., In Re 180 Taxman 220, the AAR was dealing with a case
where the transfer pricing provisions contained in sections 92 to 92F were also
becoming applicable to the transaction of the type which was covered by section
45(3). In this case, the AAR rejected the contention of the assessee that
section 45(3) being a special provision shall prevail over the general
provisions of sections 92 to 92F with regard to the transfer pricing.
Considering the purpose for which the transfer pricing provisions have been
made, the AAR held that section 45(3) would not apply to international
transactions and they should be dealt with in accordance with the transfer
pricing provisions. Insofar as such purposive interpretation is concerned with
respect to the issue under consideration, recently, the Chennai bench of the
Tribunal in the case of Shri Sarrangan Ashok vs. ITO (ITA No.
544/Chny/2019) has held that had it been the intention of the
legislature to make section 50C applicable even to the transaction of the
contribution of immovable property by a partner into the firm, the Parliament
could have repealed section 45(3) while introducing the provisions of section
50C. However, the fact that Parliament in its wisdom had retained section 45(3)
shows that Parliament intended to apply only the provisions of section 45(3) to
such transfer of capital assets by the partner to his firm.

 

The better view in our considered opinion, therefore,
is that the provisions of section 50C cannot be made applicable to a
transaction which falls within the scope of the provisions of section 45(3).

Domestic Tax Considerations Due To Covid-19

Background

The intensifying Covid-19
pandemic and the looming uncertainty on future business outlook have put the
emergency brakes on India Inc. Sudden lockdown, supply side disruption, adverse
foreign exchange rate, travel restriction as also uncertainty on vaccine to
cure the misery have added to the uncertainty, pushing Captains of India Inc.
into rescue mode. Clearly, while the immediate focus is to save the ship from
sinking, tax considerations also require due consideration in time to come.
This article focuses on some of the direct tax issues which are likely to be
faced by Indian taxpayers.

 

Deduction
of expenses incurred on Covid 19

As the pandemic increased its
spread into the country, India Inc. rose to the occasion and started supporting
various noble causes of the society in terms of supplying food, medical
supplies, setting up of quarantine centres, etc. Most of the corporates joined
hands in the national interest and contributed to PM CARES and CM Covid-19
Funds to support frontline workers and assist in the medical war. MCA, with a
noble intention, amended Schedule VII of the Companies Act, 2013 (‘Cos Act’) to
include Covid-19 expenditure as eligible CSR expenditure in compliance with CSR
law.

 

Explanation 2 to section 37(1) of
the Income-tax Act, 1961 (‘the Act’) provides that any expenditure incurred by
an assessee on the activities relating to corporate social responsibility referred
to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed
to be an expenditure incurred by the assessee for the purpose of the business
or profession.

 

The amendment to Schedule VII of
the Companies Act read with the Explanation 2 to section 37(1) of the Act
raises the following issues:

 

a)   Whether the expenditure on Covid-19 is tax deductible for an
assessee not required to comply with CSR regulations of the Companies Act,
2013?

b)   Can an assessee claim business expenditure for
Covid -19 related expenditure which he does not claim to be CSR for the purpose
of compliance with section 135 of Cos Act?

It is possible to take a view
that Explanation 2 to section 37(1) of the Act is applicable only to those
assessees who are covered by section 135 of the Companies Act. Thus, if an
assessee is not covered by the said regulation, the limitation of Explanation 2
to section 37 is not applicable. Courts have held that factors like meeting
social obligation, impact on goodwill on contribution to society, etc. meet the
test of commercial expediency and deduction has been granted1. Thus,
onus will be on the assessee to prove nexus of the expenditure with the
business and the positive impact on business to perfect the claim of deduction.
Branding of company on distribution of food and essential requirements, images
of employees wearing company branded shirts and supporting larger cause, media
reports, posting on social websites will all support the claim for deduction.

 

The issue arises in the second
category i.e. an assessee who is otherwise covered by section 135 of Companies
Act who does not claim Covid-19 related expenditure for compliance with CSR
laws. The difficulty arises as Explanation 2 to section 37(1) disallows
expenditure ‘referred to in section 135’. Referred to would mean ‘mentioned’ in
section 135 of the Companies Act. Explanation 2 to section 37(1) fictionally
deems such expenditure as not being for business purpose. Whilst argument in
favour of deduction seems a better view of the matter, it is recommended that
assessee should take fact-specific legal advise before claiming deduction.

 

Impact on lease rental

Lockdown and
social distancing are likely to have significant impact on lease rentals. The
impact may be deep for let-out properties in shopping malls and hotels.
Further, the sudden lockdown may have resulted in economic disruption of
business of the lessee, impairing its ability to pay rent. Following situations
are likely to arise:

 

a)   Lessee does not pay rent for lockdown period by invoking force
majeure, which is accepted by the lessor;

b)   Lessee invokes force majeure which is not accepted by the
lessor;

c)   Lessor and lessee defer rent for a mutually
agreed period;

d)   Lessee is unable to pay rent and vacates the
premises;

e)   Lessor is subsequently unable to find a
lessee for the property either on account of lockdown or lower rental yield;

 

In case of situation a), act of force
majeure goes to the root of the contract making the contract unworkable. On
account of the said event, a view could be taken that the property ceases to be
a let-out property. Accordingly, it may be possible for the lessor to seek
benefit of vacancy allowance u/s 23(1)(c). The said provision states that in
case actual rent received or receivable is less than deemed Annual Let out
Value (ALV) on account of vacancy then, actual rent received or receivable will
be deemed to be ALV. In this case, vacancy arises contractually. In other
words, even though goods or assets of lessee may continue to be lying in said
property but still it has to be treated as not let out, absolving the  lessee from the liability to pay rent.
Vacancy in the context in which it is used in section 23(1)(c) will need to be
interpreted as the antithesis of let out.

 

Situation b) is tricky as there
is a rent dispute during the lockdown period. Section 23(1)(b) provides that
when actual rent received or receivable is higher than ALV, then said amount
will be treated as ALV. ‘Receivable’ postulates concept of accrual. As per one
option, lessor may treat same amount as unrealised rent and offer the same in
the year of receipt u/s 25A. However, if it is required to keep rent as
receivable in books of accounts to succeed under the Contract Act, then in such
an event, tax liability will arise.

 

Situation c) involves mere
deferment of payment of rent and accordingly lessor will be required to pay tax
on rent component as it fulfils the test of receivable u/s 23(1)(b). 

 

Situation d) is a case comparable
to unrealised rent. Explanation to section 23 read with Rule 4 provides for
exclusion of such rent if the conditions prescribed in Rule 4 are complied
with.

 

Issue in case of situation e)
arises as section 23(3) permits only two houses to be treated as self-occupied.
Situation narrated in e) needs to be distinguished from a situation wherein
assessee in past years has offered income from more than two houses under the
head Income from house property. Conclusion does not change for such assessee.
Situation e) deals with a situation wherein assessee desires to actually let
out his house but could not find a tenant. In such situations, the Tribunal2  has held that even if the house remains
vacant for the entire year despite the best attempts of the assessee, then
benefit of vacancy allowance u/s 23(1)(c) should be granted to the assessee and
accordingly ALV for such property would be Nil. Against this proposition, there
is also an adverse decision in the case of Susham Singla [2016] 76
taxmann.com 349 (Punjab & Haryana)3. Perhaps a
distinguishing feature could be that in cases where vacancy allowance was
granted by the Tribunal, the assessee was able to demonstrate efforts made to
let out property.

 

Impact on business income


Revenue
recognition

Revenue recognition for computing
income under the head ?profits and gains of business or profession’ is governed
by the principles of accrual enshrined in section 4 as also ICDS IV dealing
with revenue recognition. ICDS IV permits revenue recognition in respect of
sale of goods only if the following criteria are met:

 

  •     Whether significant risks and rewards of ownership have been
    transferred to the buyer and the seller retains no effective control
  •     Evaluate reasonable certainty of its ultimate collection

 

These criteria are relevant for
revenue recognition for F.Y. 2019-20. On account of lockdown and logistics
issues, it is possible that goods dispatched could not reach the customer.
Contractually, even though the transaction may have been concluded, the seller
was obliged to deliver goods to the buyer. In such a case, because of lockdown,
goods may be in transit or in the seller’s warehouse. In such a situation,
significant risk and reward of ownership continues to be with the seller.
Accordingly, the seller may not be required to offer the said amount to tax.
Further, economic stress may change the credit profile of the customer, raising
a question on the realisability of sale proceeds of the goods sold even
pre-Covid-19 outbreak. In such a case, even though the test of accrual would be
met, since there is uncertainty in ultimate collection, the assessee may not
recognise such revenue. This criterion is also important as the customer may
invoke force majeure clause or material adverse clause and turn back
from its commitment. 

 

Section 43CB of the Act read with
ICDS IV requires the service industry to apply Percentage of Completion Method
(POCM). If duration of service is less than 90 days, the assessee can apply
Project Completion Method (PCM) and offer revenue to tax on completion of the
project. Disruption caused due to pandemic and work from home is likely to
impact numerous service contracts. Assessee will have to determine stage of
completion of contract on 31st March 2020 for each open contract at
year end to determine its chargeable income. It is equally possible that a
contract which was estimated to be completed in less than 90 days may take more
time and accordingly move from PCM to POCM basis of recognition. Thus, it is
possible that an income which was estimated to be offered to tax in F.Y.
2020-21 may partially be required to be taxed in F.Y. 2019-20, changing the
assumptions at the time of computing advance tax. An issue which judiciary is
likely to face is whether the 90 days period should be read as a rigid test or
exceptional events like Covid-19 can be excluded for computing the 90 days’
periods. 

 

Provision
for onerous contract

Ind AS 37 requires recognition of
provision for onerous contract. An onerous contract is a contract in which the
unavoidable costs of meeting the obligations under the contract exceed the
economic benefits expected to be received under it. If an entity has a contract
that is onerous, the present obligation under the contract shall be recognised
and measured as a provision.

 

Section 36(1)(xviii) of the Act
provides that mark to market (M2M) loss or other expected loss shall be
computed in accordance with ICDS. Section 40A(13) of the Act provides that no
deduction or allowance shall be allowed in respect of any M2M loss or expected
loss except as allowable u/s 36(1)(xviii). ICDS 1 provides that expected loss
shall not be recognised unless the same is in accordance with other ICDS. ICDS
X provides that no provision shall be recognised for costs that need to be
incurred to operate in the future. On co-joint reading of aforesaid law, no
deduction shall be allowed for onerous contract under normal provisions.
However, for MAT purposes, such provision will be deductible as it cannot be said
that such provision is for unascertained liability. This treatment will require
an assessee to accurately track expenses incurred on such contract in future
years and claim it as deduction in year of incurrence.

 

Liquidated
damages

Disruption in the supply chain
may result in claims or counter claims as it is possible that the assessee
would not be in a position to meet its contractual obligations. The contract
may provide for payment of liquidated damages. Courts have held that such
payment is tax deductible4.

 

Remeasurement
of provision

Lockdown and social distancing
have resulted in India Inc. rethinking on extension of warranty and service
period in respect of goods sold prior to Covid-19. This is likely to result in
change in warranty provision. Provision for warranty is tax deductible if
otherwise the requirements of ICDS X are met. Practically for companies
following Ind AS, warranty provisions are discounted to fair value. However,
ICDS X expressly prohibits deduction based on discounting to net present value
basis. This mismatch will require an assessee to accurately reconcile claims
made in the past ignoring NPV basis, revise the provision and ignore NPV
discounting for claiming deduction. This is much easier said than done.

 

Further, companies following Ind
AS are required to make provision for debtors based on Expected Credit Loss
(ECL) method. This method requires consideration of not only the historic data
but also of the future credit risk profile of debtor. In turbulent times like
these, making an estimate of the future profile of a customer is likely to be
challenging since the business outlook is uncertain. Further, the impact of
lockdown on each customer, its ability to raise finances and stay afloat
involves significant assumptions and customer-specific data. Normative
mathematical models cannot be relied upon. It is possible that ECL provision
may increase for F.Y. 2019-20. Such provision may not be tax deductible under
normal computation provisions [Explanation 1 to section 36(1)(vii)]. As regards
MAT, the issue is debatable. Gujarat High Court’s Full Bench in case of CIT
vs. Vodafone Essar Gujarat Ltd5  has held that if the provision is accounted
as reduction from debtor / asset side and not reflected separately in
liabilities side then, in such case said provision is not hit by any limitation
of Explanation 1 to section 115JB and is tax deductible.

 

Inventory
valuation

ICDS 2 permits valuation of
inventory at cost or Net Realisable Value (NRV) whichever is lower. It is
possible that on account of prolonged shutdown, disruption in supply chain,
overhaul of non-essential commodities, some of the inventory which may be lying
in warehouse or stuck in transport may no longer be marketable e.g perishable
goods, inventory with short shelf life (food products) may be required to be
disposed of. In such case, it should be possible to recognise NRV at Nil. Care
should be taken to obtain corroborative 
evidence in terms of internal technical reports, subsequent measures to
dispose of, etc. to substantiate Nil realisable value.

Fixed
Asset

The spread of Covid-19 has had a
differing impact on various nations. It is possible that some of the fixed assets
acquired could not be installed on account of cross border travel prohibitions
not only in India but across the globe. In such a case, such assets which were
earlier contemplated to start active use in F.Y. 2019-20 will miss the
deadline. In absence of satisfaction of the user test, no depreciation can be
claimed in F.Y. 2019-20. Further in terms of ICDS V – tangible fixed assets,
cost attributable to such fixed asset may also be required to be capitalised.
Further, if such asset is purchased out of borrowed funds, interest expenditure
will be required to be capitalised. Unlike Ind AS 23, ICDS IX does not suspend
capitalisation when active development is suspended. This mismatch will require
the assessee to accurately determine interest cost which is expensed for books
purpose and capitalise it as part of borrowing for tax purposes. It is equally
possible that unexpected delay may impact advance tax projections made for F.Y.
2019-20.

 

Shares and securities

The Act provides special
anti-abuse provisions in respect of dealing in shares and securities. Sections
50CB and  56(2)(x) regulate transactions
where actual consideration is less than fair market value. Rule 11UA provides a
computation yardstick to compute fair market value. The economic downturn may force
some promoters to sell their shares at less than Rule 11UA value to genuine
investors either to repay debts borrowed on pledge of shares or to raise
capital for future survival. Provisions of sections 50CB and 56(2)(x), if
invoked, may result in additional tax burden. Fortunately, Mumbai Tribunal in ACIT
vs. Subhodh Menon  relying on the
Supreme Court decision in the case of K P Varghese  read down the provision to apply only in
abusive situations.

 

Further, the pandemic may require
promoters to pump in capital into the company. Section 56(2)(viib) regulates
share infusion by a resident shareholder. The provision proposes to tax
infusion of share capital above the fair market value as computed by a merchant
banker. DCF is a commonly accepted methodology to value business. DCF requires
reasonable assumption of future cash flows, risk premium, perpetuity factor
etc. Considering that the present situation is exceptional, it may involve
significant assumptions by the valuer as also the company. Further, there will
be an element of uncertainty, especially when the business outlook is not
clear. It is possible that the actual business achievements may be at material
variance with genuine assumptions.

 

In contrast, the existing
situation may have an impact on capital infused in the past, say 2-3 years,
which were justified considering the valuation report availed from the Merchant
Banker at the said time. Tax authorities may now rely upon actual figures and question
the valuation variables used by the Merchant Banker. Tax authorities may
attempt to recompute fair value considering actual figures. In such a
situation, the onus will be on the assessee to demonstrate impact of Covid-19
on valuation assumptions made in the past. Evidence such as loss of major
customer, shutdown in major geographies, increased cost of borrowing, capacity
underutilisation will support the case of the assessee to justify valuation
done before Covid-19 breakout. 

 

Conclusion

One hopes normalcy returns soon.
Aforesaid are some of the issues which, in view of the authors, are only the
tip of the iceberg. If the pandemic deepens its curve, it is likely to result
in significant business disruption. Every impact on business has definite tax
consequences and tax professionals have a special role to play.   

 

________________________________________________

1   CIT vs. Madras Refineries Ltd., (2004) 266 ITR 170 (Mad);
Orissa Forest Development Corporation Ltd. vs. JCIT, (2002) 80 ITD 300
(Cuttack); Surat Electricity Co. Ltd. vs. ACIT, (2010) 5 ITR(Trib) 280 (Ahd)

2   Sachin R. Tendulkar vs.
DCIT [2018] 96 taxmann.com 253 (Mumbai – Trib.); Empire Capital (P.) Ltd vs.
DCIT [2018] 96 taxmann.com 253 (Mumbai – Trib.); Ms. Priyananki Singh Sood vs. ACIT [2019] 101 taxmann.com 45 (Delhi –
Trib.)

3   SLP dismissed by Supreme Court [2017] 81 taxmann.com 167 (SC)

4    PCIT vs. Green
Delhi BQS Ltd [2019] 417 ITR 162 (Delhi); CIT vs. Rambal
(P.) Ltd [2018] 96 taxmann.com 170 (Madras); PCIT vs. Mazda Ltd
[2017] 250 Taxman 510 (Gujarat) ; Haji Aziz and Abdul Shakoor Bros [1961] 41
ITR 350 (SC)

5    [2017] 397 ITR 55 (Gujarat)

6    [2019] 103 taxmann.com 15 (Mumbai)

7    [1981] 131 ITR 597 (SC)

Always Clean the Light

When we
are no longer able to change a situation, we are challenged to change
ourselves. – Viktor E. Frankl

 

As we have
progressed economically, we have started measuring our joy with what we
possess. External objects and experiences are ‘the cause’ of our happiness. We
also justify this approach as ‘normal’ and ‘obvious’. Therefore, when the
situation doesn’t measure up to our past expectation and experience, we feel on
edge. We feel our goals and dreams have blurred and even shattered by
uncertainty. The challenge of the downturn is both real and psychological.
The real challenges include matters such as cash crunch, difficulties in
getting things done, people backing out on commitments, disruption, and the
like. Such problems have actual consequences. These challenges require actual
resolution through skills, persuasion and patience.

 

On the other side, there are psychological
challenges which are the ‘real’ challenges (pun intended). They accentuate real
challenges with a sticky layer of fear and anger that smear our thinking. The
psychological challenges are constructed by thoughts, but since they are inside
us and are impulsive, they have more power over us.

 

Take the example of uncertainty relating to the
reduction of fees, loss of clients, clients folding up, looking for
alternatives, or loss of profit. These by themselves are actual real challenges
as they could result in cash flow issues. However, the ‘obvious’ anxiety about
it is like putting slimy dirt on a wound which makes it harder to cure.

 

The following pages carry nine wonderful articles
on the impact of Covid-19. So this longer editorial is dedicated to some
principles and practices to face challenging times with understanding and
resolve and make the most out of it:

 

1. Freedom
of Response

Viktor Frankl
spent three years in four Nazi concentration camps including Auschwitz. His
father, mother and brother were killed during that time. He saw people taken to
gas chambers knowing he could be next.

Viktor
survived to write one of the most influential books of our times – Man’s
Search for Meaning – where he wrote some of the most exceptional thoughts ever
expressed.

 

We who lived in concentration camps can remember
the men who walked through the huts comforting others, giving away their last
piece of bread. They may have been few in number, but they offer sufficient
proof that everything can be taken from a man but one thing: the last of the
human freedoms – to choose
one’s attitude in any given set of circumstances, to choose one’s own way.

 

If we think
about it, we can’t change circumstances every time; however, we can choose our
response to them. The quality of our response can change our experience
completely. Viktor calls this the last of human freedoms. Most of us
would have seen this in the movie Life is Beautiful. Lives of the great
ones such as Mandela demonstrated it when he was in prison in a seven square
foot cell for 18 years with the floor as his bed and a bucket for a toilet.

 

Viktor wrote:
Life is never made unbearable by circumstances, but only by lack of meaning
and purpose.

 

2.
Gratitude

If you are
reading this, you are undoubtedly better off than millions of others who are in
a much worse situation than you are. Vala Afshar of Salesforce wrote: If you
have a family that loves you, a few good friends, good health, food on your
table and roof over your head, you are richer than you think.

 

If one were
to sit down and think of the blessings one has – caring people, events,
moments, things we have in varying measures deserve an appropriate response of
gratitude. What we take for granted or even disregard, is nothing short of a
blessing if we know how to value it. The feeling of gratitude is also
associated with a beneficial chemical effect – it activates a neurotransmitter
and hormone called dopamine which has a massive influence on both body and
brain.

 

3.
Acceptance

What is
can only be accepted. Just as one cannot deny the existence of a tree outside
the window, we cannot deny what is. Once we look at things this way and accept
them as they are – not how we feel about them or how we would want them to be –
a miracle unfolds. One comes out of psychological clutches. And acceptance does
not mean turning off effort. It means being in the right spot before the effort
to change the situation.

 

4. Cycle
of Impermanence 

What we see
is there, but not forever. We have heard that change is permanent. The likeable
and resentful is temporary. Almost everything you have experienced or possessed
– age, people, time, health, money, people, objects – are subject to
impermanence.

 

Joy or sorrow
fades with time – be it a new house, a new car or new phone or a nasty notice
from the tax office. Transitory nature of things has a positive side, ?this too
shall pass keeps us going’ wrote a Chartered Accountant recently. All
unpleasant situations are more likely to pass, as movement is the nature of the
universe.

 

5.
Learning

My teacher
had once told me: If you keep learning, you will always remain young. Being
young means growing, fresh, curious and full of energy. Learning means staying
away from stagnation, in touch with the context and ever ready to face
challenges.

 

No one will
deny that this has been the best time to learn. Just look at the webinars
taking place on all topics all over the world. Look at the quiet time we have
at our disposal due to slow client response. Learning develops a learning
mindset, not just skills.

 

This is the most durable shield we have. The
lowest 20-30% of skills that are available for a charge today will vanish due
to low demand or technology takeover. Our existing saleable skill sets can
vanish too. Imagine Google with your permission throwing up a simple bank
summary or tax return based on reading what is there in your inbox. So we need
to learn the skills of the future to stay relevant.

 

We better up-skill
ourselves even if it is outside our existing area of interest or expertise.
Let’s broaden our spectrum and come out of that ‘specialised’ area and learn
about digital technologies, law, management, and new areas of practice. A great
idea is where we can blend two or three different areas.

6. Take
care of yourself

a. Meditate:
Just sit comfortably for 20-60 minutes with back upright, close your eyes and
do nothing. If thoughts come, watch them. If you need to hold on to something,
focus on the breath.

 

b. Exercise:
Take care of the body with three different types of exercises (health
permitting) – aerobic training (increase heart rate depending on age and body
parameters), strength training (work muscles, especially doable at home) and
flexibility training (yoga asanas).

 

c. Read:
Reading opens the mind to the perspectives and wisdom of others. Today we don’t
even have to read. The technology reads most written material, or we can see a
video of that subject. All of this for free or little cost. Find the most
encouraging authors and catch up with all that you wanted to read or listen to.

 

d. Thoughts
and Words: Watch the narrative inside the mind. Choose the track that is
uplifting and gives strength. Best way to find strength is to give comfort to others.
Use those that you would like to hear – words of strength, appreciation, and
care.

 

7. Act

It’s not
what you know, but what you do with what you know that counts. There is so
much one can do today without going anywhere, without spending money and with
little effort.

 

I have been
reading Naval Ravikant who writes: Doing something is better than doing
nothing. Doing something focused is even better. Doing something focused and
unique is even better. (Paraphrased)

 

We can do a
lot – master a subject, learn a health hack, update processes and policies,
take training, learn better communication, take on to writing and start a blog
or a YouTube channel, take online long duration courses, build something with
technology, overcome a bad habit, develop healthy new habits, check-in with
people and see how they are doing. And of course, the routine work.

 

8. Always
clean the light first

I heard an
African American tell her story. Since the age of twelve, she worked after schools
hours, cleaning homes and banks. On her way back from cleaning jobs, she would
talk to older women who did similar jobs at the bus stop. She asked them about
how to clean, what to clean, what were the best ways to clean.

One woman never took part in the conversation. But one day
she spoke: ‘Girl, always clean the light first. Always take care of the lights.
Every house when you go in has a big chandelier that nobody has cleaned. Get a
ladder, climb up to the light, take your solution and clean each crystal, each
bulb. Make sure you clean the light because nobody cleans the light, and if
you take care of the light, everything shines‘.

The young girl did exactly that on her next cleaning visit.
That day the woman of the house came out and asked: ‘What did you do?
Everything looks amazing in here!’ The husband came in the evening and said
whoever this girl is, get her back here and make sure you pay her extra.

That little girl, who is now a doctor, was telling her story
on a video, concluded: ‘There is a light inside each one of us that must be
nurtured. That must be cared for, that must shine brightly. That light hasn’t
been addressed, it hasn’t been talked to. We are given this time to take care
of this light.’

She is spot on! This inner light changes everything –
not on the outside, but the way we see it, and the way we feel. The reality is
‘shaped’ by this light within each one of us.

BEYOND NATIONALISM

Thousands
of years ago, many different tribes lived along the Yellow River (the river
Huang He), which was their source of survival and sustenance. But they also
suffered from occasional floods and periods of drought. Individually they were
powerless against the fury of nature, but collectively they could perhaps tame
the mighty river. So they came together to build dams and canals to regulate
the river and mitigate the ravages of floods and droughts. Then, in a long and
complicated process over many decades, the tribes coalesced together to form
the Chinese nation which controlled the entire Yellow River and raised the
level of prosperity and safety for everybody.

 

From
clans to tribes to nation states, homo sapiens has evolved. Perhaps it
is time for him to take the next collective leap and come together as one
humanity.

 

The
problems faced by the world today require global, collaborative solutions. Yet,
paradoxically, we are leaning towards extreme nationalism. US President Donald
Trump announced that he is not a ‘globalist’ but a ‘nationalist’. He said,
‘…globalist is a person that wants the globe to do well, frankly, not caring
about our country so much, and you know what? We can’t have that’.

 

Rabindranath
Tagore and Mahatma Gandhi had some deeply philosophical discussions on the
perils of nationalism. World War I showed the havoc that extreme nationalism
can create and Tagore urged nationalists to rise from ‘Self-interest’ and
instead work for ‘Welfare of the world’. From now onward, he said, ‘Any nation
which takes an isolated view of its own country will run counter to the spirit
of the New Age and know no peace’.

 

In stark
contrast to the sentiments expressed by Trump, H.G. Wells said, ‘Our true
nationality is (and should be) mankind’.

 

The need
of the hour is to encourage people to be loyal to humankind and to planet Earth
in addition to their own countries. We can have deep affinity to our family,
our village, our profession, our country and also to the whole human species.
Occasionally, there may be conflicts in maintaining this balance; but there is
no contradiction. In fact, provoking the sentiment of ‘othering’ or ‘we’
against ‘them’ can be dangerously destabilising.

Sometimes
we put work before family, sometimes family before work. Similarly, sometimes
we need to put the national interest first, but there are occasions when we
need to privilege the global interests of humankind. Loyalty to one’s country
and to the world are not mutually exclusive sentiments.

 

Like the
tribes along the Yellow River, humanity is now living alongside the cyber ocean
which no single nation can regulate by itself. Climate change, technological
disruption, bioengineering and the most recent Covid-19 pandemic are all global
problems that make a mockery of all national borders and cry out for global
co-operation.

 

Take just
one example of the impact of genetic engineering on humanity. Assume that the
US chooses to outlaw all genetic experiments in humans on ethical grounds, but
if North Korea continues to pursue that agenda, the US will very quickly have
to re-evaluate its priorities. If even one country follows this high-risk
experiment, the other countries will be under tremendous pressure to follow suit
as no country can afford to be left behind in this dangerous race.

 

We take tremendous pride in our
countries, forgetting that large nations appeared in the history of mankind
only in the last few thousand years – just yesterday morning in the time
scale of evolution. As Tagore put it, ‘There is only one history – the history
of man. All national histories are merely chapters in the larger one’. Indeed,
nation states developed to deal with large-scale problems that small tribes
could not solve by themselves.

 

Now, in
the 21st century, we face problems that even large nations cannot
solve by themselves. It may have been the Yellow River then and the cyber ocean
now that require taming through global co-operation. So let’s heed the words of
Tagore, ‘Nationalism cannot be our final spiritual shelter; my refuge is
humanity’.

 

A true
patriot is equally a global citizen.

 

Note: A lot of thoughts,
including the analogy of the Yellow River, have been taken from the books of
Yuval Noah Harari and a recent interview with him

ACCUMULATION OF INCOME U/S 11(2) – STATEMENT OF PURPOSES

ISSUE FOR CONSIDERATION

A
charitable institution registered u/s 12A or 12AA of the Income-tax Act, 1961
can claim exemption of its income from property held for charitable or
religious purposes u/s 11(1) to the extent of such income applied or deemed to
be applied for charitable or religious purposes. In addition, exemption is also
available in respect of income not so applied but accumulated or set apart u/s
11(2), for such purposes for a period not exceeding five years, by filing a
statement of such accumulation in form No. 10. Section 11(2) requires the
institution to state the purpose for which the income is being accumulated or
set apart and the period for which the income is to be accumulated or set apart
in form No 10.

 

One of the longest running
controversies for the last 29 years has been about whether the purpose required
to be stated in form No. 10 can be general in nature, such as mere reference to
or reproduction of the objects of the trust, or that the statement has to be
specific in nature. In other words, should it be held to be a sufficient
compliance where the accumulation is stated to be for any medical and / or
educational purpose, or the statement should specify that the accumulation is
for the building of a hospital or a school, or anything else. While the
Calcutta and Madras High Courts have taken a view that a mention of a specific
purpose, and not just the general objects, is necessary, a majority of other
Courts, including the Delhi, Karnataka, Punjab and Haryana, Gujarat and Andhra
Pradesh and Telangana High Courts, have taken a contrary view holding that a
mere specification of the broad objects in the statement would suffice for this
purpose.

 

THE SINGHANIA CHARITABLE
TRUST CASE

The issue first came up for
discussion before the Calcutta High Court in the case of DIT(E) vs.
Trustees of Singhania Charitable Trust 199 ITR 819.

 

In this case, the assessee, a public
charitable trust, had claimed exemption u/s 11 for A.Y. 1984-85, including for
accumulation u/s 11(2), for which purpose it had filed form No. 10. In the said
form, as purposes of accumulation of income, the assessee had listed all the charitable
objects for which it was created.

 

These were:

(i) To
assist, finance, support, found, establish and maintain any institution meant
for the relief of the poor, advancement of education and medical relief;

(ii) To open, found, establish or finance, assist and contribute to the
maintenance of hospitals, charitable dispensaries, maternity homes, children’s
clinics, family planning centres, welfare centres, schools, colleges and / or
institutions for promotion of research and education in medical science,
including surgery;

(iii) To maintain beds in hospitals and make research grants for the
promotion and advancement of medical science in India;

(iv) To help needy people in marriage, funeral and cremation of the
dead;

(v) To
found, establish, maintain and assist leper asylums or other institutions for
the treatment of leprosy;

(vi)  To open, found, establish, assist and maintain schools, colleges
and boarding houses;

(vii) To open, found, establish contribute to the maintenance of
orphanages, widows’ homes, lunatic asylums, poor houses;

(viii) To open, found, establish and assist schools, colleges and
hospitals, for the physically or mentally handicapped, spastics, the blind, the
deaf and the dumb;

(ix) To distribute dhotis, blankets, rugs, woollen clothing,
quilts or cotton, woollen, silken or other varieties of clothes to the poor;

(x) To
grant fees, stipends, scholarships, prizes, books, interest-free loans and
other aid for pursuing studies, training or research;

(xi) To establish, found and maintain libraries, reading rooms for the
convenience of the public;

(xii) To establish scholarships, teaching and research chairs in Indian
universities and contribute towards installation of capital equipment in
educational and research institutes;

(xiii) To print, publish, distribute journals, periodicals, books and
leaflets for the promotion of the objects of the society;

(xiv) To establish or support or aid in the establishment or support
of any other associations having similar objects;

(xv) To assist, support and to give monetary help to any individual in
distress, poor or poor(s) for his or their medical treatment, advancement of
education;

(xvi) To start, maintain and assist in relief measures in those parts
of India which are subjected to natural calamities such as famine, epidemics,
fire, flood, dearth of water, earthquake.

 

The resolution passed by the Board
of Trustees of the trust was to the effect that the balance of unapplied income
of the year was to be accumulated and / or set apart for application to any one
or more of the objects of the trust as set out in item numbers (i) to (xvi)
under paragraph 1 of the deed of the trust.

 

Its
assessment was completed, allowing the exemption u/s 11, including accumulation
u/s 11(2). Subsequently, a notice was issued by the Commissioner for revision
u/s 263. According to the Commissioner, section 11(2) contemplated only
specific or concrete purposes and since those were not specified by the
assessee, the assessment order was erroneous and prejudicial to the interests
of the Revenue. The Commissioner called for the revision of the order of
assessment u/s 263, setting aside the assessment order and directing the A.O.
to redo the assessment taking into account the correct position of facts and
law. The Commissioner observed that it would be a mockery of the section if, in
the application for accumulation, all the objects of the trust were listed out
and the period was mentioned as ten years, which was the maximum then
permissible under law.

 

On appeal, the Tribunal held that on
an examination of the scheme of the Act since a plurality of charitable
purposes was not ruled out under it, no objection could possibly be taken to
the assessee’s listing out all the objects of the trust in form No. 10. The Tribunal
held the act of the assessee to be in compliance with the provisions of the Act
and disagreed with the findings of the Commissioner.

 

Before the Calcutta High Court, it
was contended on behalf of the assessee that one purpose of accumulation was
interlinked with the other and, therefore, the mention of all the purposes did
not make any difference and satisfied the requirements of section 11(2).

The Calcutta High Court observed
that the Tribunal’s decision overlooked the scheme relating to the accumulation
of income for a particular future use. It noted that section 11(1) itself
provided for marginal setting apart and accumulation of up to 25% (now 15%) of
the income of the trust. According to the High Court, section 11(1)
accumulation could be taken for the broad purposes of the trust as a whole and
that is why the statute in section 11(1) did not require an assessee to state
or specify the purpose. Such setting apart u/s 11(1) for any of the purposes of
the trust was, however, a short-term accumulation, in view of the Court, not to
exceed beyond the subsequent year. The High Court noted that it was sub-section
(2) which provided for the long-term accumulation of the income where it was
obvious that the long-term accumulation thereunder should be for a definite and
concrete purpose or purposes.

 

The High Court noted that the
assessee had sought permission to accumulate not for any determinate purpose or
purposes, but for the objects as enshrined in the trust deed in a blanket or
global manner which, in its view, was definitely not in the contemplation of
section 11(2) when it was construed in its setting. The High Court held that
accepting the assessee’s contention that saving and accumulation of income for
future application of the income was for the purposes of the trust in the
widest terms so as to embrace the entirety of the objects clause of the trust
deed, would render the requirement of specification of the purpose for
acquisition in that sub-section redundant.

 

The High Court observed that the
purpose of accumulation could not tread beyond the objects clause of the trust,
the legislature could not have provided for the period of accumulation if it
did not have in mind the particularity of the purpose or purposes falling
within the ambit of the objects clause of the trust deed. The High Court was of
the view that when section 11(2) required the specification of the purpose, it
did so with the objective of calling an assessee to state some specific purpose
out of the multiple purposes for which the trust stood; had it not been so,
there would have been no mandate for such specification since, in any case, a
charitable trust could, in no circumstances, apply its income, whether current
or accumulated, for any purposes other than the objects for which it stood; the
very fact that the statute required the purpose for accumulation to be stated
implied that such a purpose be a concrete one, an itemised purpose or a purpose
instrumental or ancillary to the implementation of its object or objects; the
very requirement of specification of purpose predicated that the purpose must
have an individuality.

 

According to the High Court, the
provision of section 11(2) was a concession provision to enable a charitable
trust to meet the contingency where the fulfilment of any project within its
object or objects needed heavy outlay calling for accumulation to amass
sufficient money to implement it and, therefore, specification of purpose as
required by section 11(2) admitted of no amount of vagueness about such
purpose.

 

The
High Court observed that it was not necessary that the assessee had to mention
only one specific object; there could be a setting apart and accumulation of
income for more objects than one, but whatever the objects or purposes might
be, the assessee must specify in the notice the concrete nature of the purposes
for which the application was being made; plurality of the purposes of
accumulation might not be precluded, but it must depend on the exact and
precise purposes for which the accumulation was intended; the generality of the
objects of the trust could not take the place of the specificity of the need
for accumulation.

 

The Calcutta High Court, therefore,
remanded the matter to the Tribunal to allow the assessee to adduce fresh
evidence, whether in the form of any resolution or otherwise, showing that the
specific purpose for which the trust required the accumulation of the income
existed and, if such resolution or evidence was placed before the Tribunal, the
Tribunal was directed to consider whether the obligation cast on the assessee
u/s 11(2) had been discharged and the exemption might accordingly be granted to
the assessee.

 

This decision of the Calcutta High
Court was referred to with approval by the Madras High Court in the case of CIT
vs. M. CT. Muthiah Chettiar Family Trust 245 ITR 400, though the Court
did not decide on the issue under consideration, since the issue before it
pertained to the taxation of the unutilised accumulation u/s 11(3), and it was
conceded by the Department that it was not in a position at a later date to
challenge that the form No. 10 filed in the year of accumulation was invalid
for not having stated a specified purpose for accumulation.

 

THE HOTEL AND RESTAURANT
ASSOCIATION’S CASE

The issue subsequently came up
before the Delhi High Court in the case of CIT vs. Hotel and Restaurant
Association 261 ITR 190.

In this case, pertaining to A.Y.
1992-93, the assessee, a company registered u/s 25 of the Companies Act, 1956
was also registered u/s 12A of the Income-tax Act. For the relevant year the
assessee accumulated its income for a period of ten years for fulfilment of the
objects for which it had been created. Notice to that effect was given by
filing form No. 10, giving particulars of the income sought to be accumulated.

 

During the assessment proceedings,
the A.O. declined to take into consideration the amount so accumulated on the
ground that in form No. 10 the specific object for which the income was sought
to be accumulated was not indicated. Accordingly, exemption in respect of such
accumulation was not allowed.

 

The Commissioner (Appeals) held that
the assessee was entitled to the exemption for the accumulation since the
assessee had passed a resolution to accumulate income so as to apply the same
in India in the next ten years to achieve the objects for which it had been
incorporated, and notice of this fact had been given to the A.O. in the
prescribed format. The Tribunal confirmed the view taken by the Commissioner
(Appeals).

 

Before the High Court, it was
submitted on behalf of the Revenue that the appellate authorities had failed to
appreciate that in the prescribed form the assessee had failed to indicate the
specific purpose for which the income was sought to be accumulated and,
therefore, the statutory requirement had not been strictly complied with,
disentitling the assessee from relief u/s 11(2).

 

The Delhi High Court, disagreeing
with the Revenue’s contentions, observed that while it was true that
specification of a certain purpose or purposes was needed for accumulation of
the trust’s income u/s 11(2), the purpose or purposes to be specified could not
have been beyond the objects of the trust; plurality of purposes of
accumulation was not precluded but depended on the precise purpose for which the
accumulation was intended.

 

The Delhi High Court noted that the
appellate authorities below had recorded a concurrent finding that the income
was sought to be accumulated by the assessee to achieve the objects for which
the assessee was incorporated. It further noted that it was not the case of the
Revenue that any of the objects of the assessee company were not for charitable
purposes. The findings of fact by the Tribunal gave rise to no question of law.
The Delhi High Court therefore declined to entertain the appeal.

This decision of the Delhi High
Court was followed in subsequent decisions of the same High Court and other
High Courts in the following cases:

 

(1) DIT(E)
vs. Daulat Ram Education Society 278 ITR 260 (Del.) – in this case, out
of 29 objects stipulated in the Memorandum of Association, the assessee had
specified eight objects;

 

(2) DIT(E)
vs. Mamta Health Institute for Mother and Children 293 ITR 380 (Del.) –
in form No. 10, the purpose of accumulation was stated to be as per the  resolution passed by the assessee; and in the
resolution the purpose specified was that of financing of the ongoing
programmes and of furtherance of the objects of the society;

 

(3) Bharat
Kalyan Pratishthan vs. DIT(E) 299 ITR 406 (Del.) – in this case the
resolution was to the effect that the amount accumulated be utilised for the
purposes of the trust, where the trust had only three objects, viz., medical
relief, help to the poor and educational purposes;

 

(4) DIT
vs. Mitsui & Co. Environmental Trust 303 ITR 111 (Del.) – in form
No. 10 it was mentioned that the amount accumulated would be utilised for the
objects of the trust;

 

(5) Bharat
Krishak Samaj vs. DDIT(E) 306 ITR 153 (Del.) – here, the accumulation
was for the objects of the trust;

 

(6) CIT
vs. National Institute and Financial Management 322 ITR 694 (P & H)
– the purpose of the accumulation stated was for expenditure on the building
fund and equipment fund;

 

(7) DIT(E)
vs. NBIE Welfare Society 370 ITR 490 (Del.) – in form No. 10, the
purpose stated for accumulation was for ‘further utilisation’;

 

(8) Samaj
Seva Nidhi vs. ACIT 376 ITR 507 (AP & T) – form No. 10 stated that
the accumulation was for general objects, but by a subsequent letter it was
stated that the amount was for the welfare of Scheduled Castes, Scheduled
Tribes, Vanvasis and socially and economically weaker sections of the society
as mentioned in a specific clause of the trust deed;

 

(9) DIT(E)
vs. Envisions 378 ITR 483 (Kar.) – in this case, three out of the 14
objects were reproduced in form No. 10, viz., conduct of various activities in
the field of academics, architecture, music and literature for preservation of
heritage; to run and maintain educational or other institutions for providing
and promoting education for the poor and weaker sections of society; and to
run, maintain or assist any medical institution to grant assistance to indigent
needy people for meeting the cost of medical treatment;

 

(10) CIT(E) vs. Gokula Education Foundation 394 ITR 236 (Kar.)
– in form No. 10, the purpose of accumulation stated was to improve / develop
the buildings of the trust and to conduct educational / charitable activities;
a special leave petition against the order of the High Court has been granted
to the Income Tax Department by the Supreme Court [248 Taxman 13(SC)];

 

(11) CIT(E) vs. Ohio University Christ College 408 ITR 352 (Kar.) –
three purposes were stated in form No. 10, which were all charitable, but
details of such purposes were not given;

 

(12) CIT(E) vs. Bochasanwasi Shri Akshar Purshottam Public Charitable
Trust 409 ITR 591 (Guj.) – in form No. 10, the purpose stated was for
providing medical facilities at various centres; the resolution had specified
purposes such as for future hospital of the trust, for purchase of necessary
equipment, ambulance van, furniture and fixtures and further expenditure for
modernisation of the hospitals.

 

OBSERVATIONS

Section 11(2) of the Income -tax Act
permits accumulation or setting apart of an income of a charitable institution
which is otherwise not applied or is not deemed to have been applied for the
charitable or religious purposes during the year. The income so accumulated or
set apart for application to such purposes is not included in the total income
for the year, provided the conditions specified in section 11(2) are complied
with. These conditions are:

 

(a) a
statement is furnished, in the prescribed form and manner, to the A.O. (form
No. 10 under Rule 17), stating therein the purpose for which the income is so
accumulated or set apart and the period for which the income is to be
accumulated or set apart and which period shall not exceed five years;

(b) the
money so accumulated or set apart is invested or deposited in the specified
form or mode;

(c) the
statement in form No. 10 is furnished by the due date for furnishing the return
of income u/s 139(1);

(d) form
No. 10 is furnished electronically under the digital signature or an electronic
verification code.

 

On
an apparent reading of the provision, it is gathered that an assessee, in cases
where the income is accumulated or set apart, is required to state the purpose
of accumulation and also state the period of accumulation in form No. 10. Once
this is dutifully complied with, no other prescription is provided for in the
Act. In other words, the assessee is to state the purpose of accumulation and
the period thereafter. The law apparently does not limit the purpose of
accumulation to a single purpose and further does not require such accumulation
for a dedicated project or a task within the objects of the institution. It
also does not call for passing of a resolution or enclosing of a copy of such
resolution with form No. 10.

 

There is no disagreement amongst the
High Courts about the need for a trust to spend its income, including the
accumulated income, only for those charitable or religious purposes specified
in its objects as per the Trust Deed. While granting registration u/s 12A/12AA,
the Commissioner would already have examined whether such objects qualify as
public charitable and religious purposes. It is also not in dispute that the
accumulation can be for more than one purpose; plurality of purposes is not
prohibited; there is no prohibition on a trust accumulating its income for all
of its activities. The obvious corollary to this undisputed position is that
while stating the purpose of accumulation in form No. 10, the assessee instead
of reproducing the list of all such activities, specifies that it is for its
objects, which have already been found to be charitable or religious in nature,
that should suffice for the purposes of section 11(2).

 

The 25% (now 15%) accumulation u/s
11(1) is not a short-term accumulation only for one year but is in fact for the
life-time of the trust and this factor should not have influenced the Calcutta High
Court to hold that for the purposes of section 11(2) accumulation there was a
need to state a specific purpose and not the general one by simply referring to
the objects clause.

 

If one examines the various types of
exemption u/s 11, one can see that all of these are for any of the objects of
the trust – the spending during the year u/s 11(1), the 15% accumulation u/s
11(1), the option to spend in the subsequent year under the explanation to
section 11(1). If that be the position, the legislature cannot be said to have
intended to restrict only the accumulation u/s 11(2) to a limited part of the
objects.

 

The requirement to specify the
purposes of accumulation can perhaps have been intended to ensure that the
accumulation is spent within the specified time and to tax it u/s 11(3) if it
is not spent within that time. But that purpose would be met even if all the
objects are specified for accumulation or setting apart.

 

In any case, almost all the High
Courts, except the Calcutta and the Madras High Courts, have held that so long
as the purpose of accumulation is clear from either the resolution or
subsequent correspondence or surrounding circumstances, that should suffice as
specification of the objects. This also seems clear from the fact that while
the Supreme Court has admitted the special leave petition against the Karnataka
High Court decision in Gokula Education Foundation (Supra), it
has rejected the special leave petition against the decision of the Gujarat
High Court in the case of Bochasanwasi Shri Akshar Purshottam Public
Charitable Trust (Supra).

 

The Tribunal in the case of Associated
Electronics Research Foundation 100 TTJ 480 (Del.) has held that it
would be a sufficient compliance of section 11(2) where the purpose of
accumulation can be gathered from the minutes of the meeting wherein a decision
to accumulate is taken and such decision is recorded in the minutes.

 

In the end, the assessee, in the
cases of deficiency or failure, may consider the possibility of making up for
such deficiency or failure by prescribing the purpose of accumulation or
setting apart during the course of assessment or before or thereafter. The
Gujarat High Court in the case of Bochasanwasi Shri Akshar Purshottam
Public Charitable Trust (Supra) has permitted the institution to
specify and to state the purpose of accumulation, subsequent to the filing of
the return of income. The special leave petition filed by the Income-tax
Department has been rejected by the Supreme Court in 263 Taxman 247 (SC).

 

The Calcutta High Court view seems to require
reconsideration, or should be read in the context of the matter, and the view
taken by the other High Courts seems to be the better view. One can only hope that the Supreme Court speedily decides this long-standing controversy which
has resulted in litigation for so many trusts.

C: CORONA ! C: CYBER CRIME !! C: CAREFUL !!!

With new
technological innovations all over the place, when I heard for the first time
about corona I thought it was a system virus. Somewhere, I correlated corona
with computers. My interest to know about the coronavirus increased when I saw
in the news that it’s a disease born in China. Now I’m afraid of the letter ‘C’
as it denotes ‘Corona’, ‘China’ and so on.

 

I went back to
the history behind this virus and something interesting came out of it. This
virus is similar to SARS (Severe Acute Respiratory Syndrome) born in China in
2003. SARS-COV-1 was a virus from the animal kingdom, generally bats, that
spread to other animals and impacted humans as well. Corona-2019 is quite
similar to SARS-2003.

 

How it is
going to impact companies or individuals and why we must all be extra vigilant
and careful in this situation.

 

Someone’s fear
becomes an opportunity for someone else. But who? Any views?

 

it’s cyber
criminals!

 

It’s very
obvious that in the environment of fear about corona which came up suddenly in
December, 2019, people will be eager to know about the cure for corona disease,
the medicines, treatments and so on.

 

Suddenly,
millions of people started searching cures for the disease and these searches
gave an opportunity to cyber criminals to earn money out of this fear. Cyber
criminals are always a step ahead of the general public. And coronavirus is an
excellent opportunity for them to launch their nefarious activities while the
world is busy searching for a cure for the disease.

 

How will the
cyber criminals achieve their objectives?

 

Through phishing
and malware.

 

Phishing is a cyber crime in which a target or targets are contacted by
email, telephone or text message by someone posing as a legitimate institution
to lure individuals into providing sensitive data such as personally
identifiable information, banking and credit card details and passwords.
Through emails, hackers send malicious emails containing malicious URL’s. Once
a person clicks the URL, his personal information gets shared with the hackers.

 

Another way to
send malicious messages is by inserting an exciting link on the websites that
people are searching. Once someone has searched for ‘Cure for coronavirus
disease’, a malicious window gets opened; and if the person clicks that window
he will lose his personal information, in fact, he might even lose his entire
computer database.

Why we must
be extra vigilant and ‘C’: Careful while searching about coronavirus.

 

Hackers are
writing city-specific malware to trap curious citizens. As governments across
the world are trying to minimise the risk of coronavirus, steps are being taken
to limit gatherings of people by cancelling public events, closing malls,
halls, schools, etc. Hackers have been using city-specific messages which
contain information about these government orders and asking users to click on
a link which takes them to an outside page.

 

In this example,
an email intimating the closure of schools, colleges and cinema halls in Mumbai
is used to lure the user and draw him into clicking on a suspicious link. Once
you click on any one of the outside links, it will prompt the system to open a
new outside web-page which might contain harmful malware.

 

How to be
safe in such a situation.

 

1.     Don’t click on Links: Avoid the habit of
clicking on links shared via social media, instant messaging applications, or
any other source;

2.     
Don’t open unfamiliar emails: Do not open
emails if you don’t trust the sender. Don’t click on links in emails with
coronavirus in the subject line under any circumstances;

3.    Reporting fake emails:  Report such mails to your email service
provider or to your organisational security team;

4.     
Updates on government websites: Rely only on
known sources for healthcare updates (these include the official websites and
social media channels of government health departments, union or state
governments, news publications of repute and your local healthcare
professionals);

5.     
Important thought: In today’s environment,
if someone cares for you and wants to reach out to you with some emergency
communication, they will call you or text you.

They will not
share any URLs;

6.   Updating of software: Do update all your software,
Operating Systems and mobile applications. Don’t skip updates;

7.     
HTTPS: Check the URL of websites very
vigilantly every time. A single typo could lead you to an infected website.
Refer only https websites and not ‘http’ websites.

 

These are a few suggestions which we must implement in our day-to-day
life as well.

 

BE AWARE! BE ATTENTIVE!! AND BE SAFE!!!

SELF-QUARANTINE YOUR MIND WHILST ‘WORKING FROM HOME’

Uncertain times call for decisive
actions, and decisions need to be taken at a much quicker pace than one would
do in the normal course. Both data points and market news point to a
catastrophe with the coronavirus (COVID-19) outbreak; there are public health
challenges confronting the leaderships of several countries and nearly all
businesses at large. As leaders of professional service firms, how we respond to
the challenges will largely drive our respective firms’ growth and positioning
in the market and ensure that our teams and the communities around us remain
safe and healthy. As part of a functioning society, the question to ask is:
have we done our bit as a responsible firm and as a responsible professional?

 

Increasingly, either by safety
concerns or by regulatory enforcement, most firms have already grounded their
teams to a partial or a complete work from home (WFH) mode, or are in the
process of doing so. By definition, WFH means that one needs to be working from
one’s confines and not be ‘surrounded’ by people. This also means that teams
will need to be effective in their pursuits whilst working from home.
Can we therefore practice quarantine in its truest form, i.e., meditation,
which is nothing but quarantine of the mind, and to think better? Aligning
one’s mindset to WFH needs practice and some good refreshing ideas.

 

TECHNOLOGY

Here are some thoughts on increasing
effectiveness during these WFH times.

Imagine a situation where you are
not allowed to access your office servers or data files for a prolonged period of time.

(i) How
will you conduct your professional engagements?

(ii) How will you discharge your tax and regulatory compliance obligations?

(iii) How will you ensure data protection and exchange of client
information without running the risk of privacy breach, or confidentiality
invasions?

 

Using cloud technology has
never been more needed than in today’s times.

Experts have long argued for
cloud-based systems to address efficiencies that help in remote working and
active collaboration. Hosting your data on the cloud and having virtual
desktops seems to be the right way to think. A lot of products are available in
the market for cloud servers, right from IBM to Alibaba Cloud and a host of
local service providers.

 

Collaboration and conferencing tools
such as Zoom, Google Meet, Skype and Microsoft Teams and many others allow
teams sitting remotely to interact with each other on a real-time basis,
without having the need to meet physically.

 

Technology
is all-pervasive and, during such times when we have no choice, the adversities
bring out solutions that help firms to adapt and align their practices to be
benchmarked to global standards. It may need a change in mindset and a
commitment to unlearn and relearn, but in the end it is all worth the while.
Imagine, if everything you can do in your physical office is now available in
the comfort of your homes and your teams don’t have to commute or travel for
getting their work done, the additional productivity would mean that so much
more work can be accomplished.

 

Traditional VPN-based models may
also be effective with static IPs. There could be challenges of too many people
trying to access the network at the same time and resultant delays and output.
For this, Microsoft Office 365 itself provides a host of applications.

 

ROBUST PROCESSES

Of course, you may explore any
technology that works for the firm. Being smart about it and investing the
right mind space and resources in technology usage will yield good dividends
for the practice in times to come, much beyond the WFH period.

When a firm is adopting WFH, one of
the key elements to a successful strategy is to ensure that it has robust
processes in place for exchange of information, planning for an engagement,
conduct of fieldwork, review of work performed by the team members and final
delivery of an engagement. Processes should include the following:

(a) Planning
for remote working, rules and to-do’s: HR teams should send out early
notifications of what teams should do whilst a WFH is in place;

(b) The
fieldwork stage of engagements during WFH would mean that you are not monitored
at every step, nor can you expect to reach out for assistance ‘on call’. You
will have to brace for individual efforts much more than what you are normally
accustomed to in a team environment. This calls for processes for increasing
individual performance such as:

(1) Planning
the day for specific and achievable goals and targets whilst having to WFH;

(2) Prioritisation
of what comes first and focusing on the task at hand;

(3) Organising
conference calls with the team lead / manager to ensure that you have a
sign-off on the work you are performing;

(4) Challenging
your abilities to work individually by extensive reading and applying your
knowledge to a given client solution;

(5) Writing
down areas of the work product that need a review during the collaborative
phase of the day;

(6) Scheduling
those reviews such that the time spent is optimised without impairing the
manager’s schedule for his / her own tasks of the day.

 

DATA PRIVACY AND CONFIDENTIALITY

Quite often, firms have got into
trouble for breach of data, data leakages, confidentiality breaches and similar
violations, mostly inadvertently and something that is discovered much later in
the day. Clients have strict clauses and firms have an obligation to protect
client data as much as the firm’s own data.

 

How do you do it? The first
step is to sensitise team members to your data privacy and your confidentiality
policies. These would have pre-existed the current catastrophe in most firms.
For firms where these policies were not well articulated, now is the time to do
it.

 

The next step is to ensure that
these policies are implemented. Get the best minds in the firm to work on
these. Give them the tools they need to achieve 100% compliance to standards
such as GDPR. Encourage them to benchmark best practices from the market. Get
outside technical help as and when necessary.

 

Clients don’t like any of their
stuff to be discussed or leaked outside. They will sue for breaches. They will
fire your firm if it is found guilty of violation. You may end up losing an
account if motives are ascribed. This has happened in a public company in India
in 2019. There are many past instances of data breaches.

 

And finally, ensure that these
actions are monitored and a monthly review is undertaken to make course
corrections when needed. There are current standards in place and there will be
stricter norms prescribed; the firms need to take this very seriously.

 

TEAM ALIGNMENT

Getting
your teams ready and with a mindset to work from home is all about alignment.
Just like when you are forced to sit at home to prepare for an event or to run
an errand, when professionals have to sit at home and think about delivery of
work, there could be an initial mental block. That’s where the mindset to be
effective has to be upper-most. There will be challenges and this is when the
firm’s leaders, HR teams and technology champions all have to collaborate and
communicate constantly, to reassure the teams to be in alignment at all times.
A help-desk should be established to mentor and guide the team members with
answers to their questions. When team members know who to turn to for help,
half the crisis is solved.

 

It is the firm’s leadership’s job to
set the tone on alignment during WFH. It is the manager’s job to monitor
execution. It is the team member’s job to ensure that he gives his all to be in
alignment for achieving effective results.

 

REFLECT ON PAST LEARNINGS

Reflect on past learnings, on what
lies ahead and channelize available time into research.

(A)   What lies ahead:

(i) Firms
will need to reorient their processes;

(ii) Setting
billing goals, with billable hours for advisory engagements;

(iii) Setting goals on completing specific audit areas for the day, along
with conducting audit steps / audit procedures as needed;

(iv) Tax teams will need to think about aspects of their engagements that
will need discussions and use online databases to good effect;

(v) Firms
will need to communicate with clients to expect disruptions in delivery and to
convey the firm’s preparedness;

(vi) How will the firm want to appear before its clients?

(vii) How can you increase your effectiveness in such a situation?


(B)   Past learnings:

We
have all had our fair share of experiences with managing crises, managing
turbulent times, managing stressful clients, facing challenging times and so
on. Can we put that to good effect when we are designing our WFH days?

(a)
What does the market want?

(b)
What does the client expect?

(c)
Is the firm equipped to service the
client?

(d)
What needs to change?

(e)
What will I do to make a difference?

(f) What will my partners need to do to
achieve the results we seek?

 

(C)   Research:

Can we self-quarantine our mind
whilst at home and focus on some interesting ideas, such as completing projects
that were long conceived but could not be finished:

 (I) That
new product or new service offering?

(II) Video podcasts of strategic insights for clients?

(III) Evolving latest thinking and converting it into frameworks?

(IV) That thought leadership article?

(V) That
white paper on latest developments in your area of expertise (Vivad se
Vishwas, GST interpretations, MLI, etc.)?

 

But above all we must remember at all times to
stay safe, to stay healthy and to stay effective.

LIMITATION ON FILING A PROBATE PETITION

INTRODUCTION

A probate means a copy of a Will
certified by the seal of a Court. A probate of a Will establishes the
authenticity and finality of that Will and validates all the acts of the
executors. It conclusively proves the validity of the Will; after a probate has
been granted, no claim can be raised about the genuineness or otherwise of the
Will.

 

One of the important questions
that often arises in relation to a probate is till when can a probate petition
be lodged? Is there a maximum time limit after the death of the testator within
which the executors must lodge the petition before the Courts? The Bombay High
Court had an occasion to consider this question in the case of Suresh
Manilal Mehta vs. Varsha Bhadresh Joshi, 2017 (1) AIR Bom R 487. Let us
examine this issue.

 

NECESSITY
FOR A PROBATE


The Indian Succession Act,
1925 deals with the law relating to Wills. According to this Act, no
right as an executor or a legatee can be established in any Court unless a
Court has granted a probate of the Will under which the right is claimed. This
provision applies to all Christians. In the case of any Hindu, Buddhist, Sikh
or Jain, it applies to:

(a) any Will made within the local limits of the ordinary original civil
jurisdiction of the High Courts of Madras or of Bombay, or within the
territories which were subject to the Lieutenant-Governor of Bengal;

(b) to all such Wills made outside those territories and limits so
far as it relates to immovable property situated within those territories or
limits.

 

Thus, for Hindus, Sikhs, Jains
and Buddhists, who are / whose immovable properties are situate outside the
territories of West Bengal or the Presidency Towns of Madras and Bombay, a
probate is not required. Similarly, where a Will is made outside Mumbai (say,
in Ahmedabad) and it makes no disposition of any immovable property in Mumbai
or other designated town, then such a Will would not require a probate.


An executor of such a Will may
need to do so only on the occurrence of a certain event, for instance, on a
suit being filed challenging that Will. However, a Will made in Mumbai or
pertaining to property in Mumbai needs to be compulsorily probated,
irrespective of whether or not there is an actual need for it.

 

DOES
THE LAW OF LIMITATION APPLY?

Coming back to the issue at hand,
the question which arises is whether the filing of a probate petition is barred
by any law of limitation, i.e., is there an outer time limit for filing the
petition? In this respect, one may consider the provisions of the Limitation
Act, 1963 which provides for periods of limitations for various suits.
Article 137 of the schedule to this Act states that in respect of any other
application for which no specific period of limitation is provided elsewhere in
that Act, the period of limitation is three years from when the right to apply
accrues. Further, Rule 382 of the Bombay High Court (Original Side) Rules
provides that in any case where an application for probate is made for the
first time after the lapse of three years from the death of the deceased, the
reason for the delay shall be explained in the petition. If the explanation is
unsatisfactory, the Prothonotary and Senior Master may require such further
proof of the alleged cause of delay as he may deem fit.

 

In Vasudev Daulatram
Sadarangani vs. Sajni Prem Lalwani, AIR 1983 Bom 268, the Court dealt
with the issue of whether Article 137 was applicable to applications for
probate, letters of administration or succession certificate. The Court held
that there was no warrant for the assumption that this right to apply accrued
on the date of death of the deceased. It held that the right to apply
may therefore accrue not necessarily within three years from the date of the
deceased’s death but when it becomes necessary to apply, which may be any time
after the death of the deceased, be it after several years. However,
reasons for delay must be satisfactorily explained to the Court. Further, such
an application was for the Court’s permission to perform a legal duty created
by a Will or for recognition as a testamentary trustee and was a continuous
right which could be exercised any time after the death of the deceased, as
long as the right to do so survived.

 

This view of the High Court was
approved by the Supreme Court in Kunvarjeet Singh Khandpur vs. Kirandeep
Kaur & Ors (2008) 8 SCC 463. However, the Supreme Court also held
that the application for grant of a probate or letters of administration was
covered by Article 137 of the Limitation Act. In Krishna Kumar Sharma vs.
Rajesh Kumar Sharma (2009) 11 SCC 537 the Supreme Court once again reiterated
this view and also held that the right to apply for a probate was a continuous
right.

 

WHAT
IS THE MAXIMUM TIME LIMIT?

In Suresh Manilal Mehta
(Supra) a daughter opposed her father’s probate petition. Here, the
probate petition was filed 33 years after the testator died. She argued that
such a long delay in seeking the probate was itself a sufficiently suspicious
circumstance to warrant the dismissal of the suit, especially if there was no
explanation for the delay. The explanation for this delay was that under the
husband’s Will, a majority of his estate devolved upon his wife and some
portion on his son. Further, his daughter was to take in the residuary estate
only if both her parents and her brother were no more and if her brother died
before turning 21 years of age. Since that was not the case the daughter did
not get the residuary estate. When the mother got the father’s estate under his
Will, no dispute was raised. However, when she died and her Will was sought to
be probated, her daughter argued that first the father’s Will must be probated
since the mother derived her entire estate from the father. Thus, the act of
probating the father’s Will was a good 33 years after his death.

 

The High Court held that the view
that Article 137 would have no application at all in any case to any
application for probate was incorrect. However, neither of the aforesaid two
Supreme Court decisions had held that the date of death of the deceased would
invariably provide the starting point of limitation. On the contrary, both the
decisions confirmed that the right to apply for a probate was a continuing
right so long as the right to do so survived.

 

Giving the analogy of two Wills,
one made in Mumbai and the other outside Mumbai, the High Court explained that
it could not be that the three-year limitation from the testator’s death would
apply to one of those two Wills, the one made in Mumbai, and not to the other
Will, i.e., the one made outside Mumbai. The date of death of the deceased
could not, therefore, be the starting point for the limitation in two otherwise
identical situations separated only by geographies, or else there would be
different starting points of limitation!

 

Accordingly, the Court held that
the only consistent view was that the right to apply for a probate was a
continuing right and the application must be made within three years of
the time when the right to apply accrued. An executor named in the Will could
apply for probate at any time so long as the right to do so survived.

 

CONCLUSION

This
is an extremely essential judgment which would help ease the process of
obtaining probates. There are numerous cases where probates have not been
obtained and this has led to the properties / assets getting stuck. In all such
cases it should be verified whether a probate petition could now be launched,
even if it is many years after the testator’s death.

IS IT FAIR TO PUNISH TAXPAYERS FOR A FAULTY GSTN?

BACKGROUND

When the GST (Goods and Services
Tax) law was introduced in India in 2017, sufficient time was not given to
taxpayers, professionals, technical teams and the country as a whole to
understand it. Adapting to something new takes its own time to understand and
implement at the ground level; GST has been no exception to this thumb rule.
Every new reform will require an initial learning experience and will also face
some resistance; clearly, the government could have managed its implementation
better had it given sufficient time to build the GSTN portal.

 

Earlier, taxpayers were so
disappointed with VAT compliances and multiple State taxes that they adopted a
welcoming approach to GST and were willing to embrace it wholeheartedly. The
government had spoken so much about it and boosted it so much that there was a
hope in the taxpayers that the new law would be easy to understand and
implement and that the return-filing process would be smooth. However, the
frequent changes in the GST law has led to delays in technical implementation
at the GSTN portal which has made it cumbersome to comply with and resulted in
the wasting of thousands of person-hours of both taxpayers and professionals.

 

In this article, we have
highlighted some of the technical problems faced by taxpayers in compliance due
to bugs and errors in the GSTN portal; although it has been about 31 months
since its introduction, the GSTN portal has not been functioning very well.

 

ISSUES
AT HAND

Taxpayers cannot be expected to
have enough technical knowledge of the GSTN portal and the concept behind it.
Still, since it has now become a law, or kanoon, both taxpayers and professionals
are making valiant attempts to carry on business and adhere to the compliances
in accordance with the law.

 

Registering on the GSTN portal is
a lengthy and time-consuming process. It is a very stringent procedure and
requires too many details and specific formats for uploading documents; so is
the case with various other forms and returns. The businessman is being forced
to spend more hours fulfilling compliances, accumulating various data points,
most of which could have been avoided, rather than focusing on his business and
growth prospects. This is followed by a continuous process of filing
back-to-back returns either monthly or quarterly, as applicable, instead of a
single return having all the details. Moreover, there are no revision / amendment
facilities for the returns filed.

 

Limitless updates and
notifications have now become the norm 
and there is no clarity; instead, things are becoming more complicated
and cumbersome, thanks to the Advance Ruling Authority. The constant updates,
notifications, etc. have become a nightmare and any single unintentional missed
update of notification results in penalty and interest. Frequent changes and
revisions in the GST rates have led to uncertainty for both businessmen and
government. Further, the new Input Tax Credit (ITC) rule limiting ITC from 20%
to 10%, and managing all the calculations has become difficult for SMEs and
also for large corporates. Besides, there is a severe lack of natural
justice as the burden to prove the purchase details is placed on the
purchasers instead of punishing the defaulting sellers. The increase of
government tax revenue by curbing the working capital has thereby created
unfair business practices and pressure of paying tax on honest taxpayers; and this
might have even led to an increase in the black economy because many small
businesses have started to do business in cash, not to avoid GST but to avoid
compliance because of the torturous procedures of GST.

 

The GSTN portal is faulty and
weak and no repair has been done thanks to which both taxpayers and
professionals are facing problems. There is a lack of clarity and knowledge
with the technical support team. The helpline numbers have turned out to be
helpless. There is so much pressure on the GSTN portal that it is always down
or under maintenance. In spite of the faulty system, it is the taxpayer who has
to bear the burden of paying late fees even if payment is done within
the due date but there were system issues while filing the returns. The faulty
and delayed release of forms and utilities without proper testing has added
further to the existing problems. There are many bugs and tech issues in
various forms and returns, creating hurdles in filing the returns within the
due date. Extensions given by the government can be a temporary solution;
however, it will not help unless the system is upgraded to optimum capacity to
handle taxpayers’ logins. Despite all these facts, government continues to
levy penalty and interest for late filing of returns, in spite of knowing
that very often the GSTN portal is out of service.

 

Separate due dates for filing of
returns and payment of tax should be taken into consideration. Further, extreme
importance is given to set-off of tax instead of considering the date of
deposit of tax as the date of payment. Very few resources are available to deal
with the plethora of problems. Solutions to problems are offered quite late and
are not effective enough to deal with those problems. Moreover, the opinions
of ground-level experts are neglected and more trust is placed on the
bureaucracy.

 

THE QUESTION IS – IS IT FAIR?

Is it fair for the taxpayers to
shift their focus from business to adhering to innumerable compliances? The new
ITC rule which has added to the unfairness and its working has worsened things
even further. Is it right for purchasers to be burdened and punished for
defaulting sellers? Let’s understand this with an illustration.

 

Mr. A has a business selling
goods and pays GST on the same. He purchases goods from Mr. B and these goods
are eligible for claiming of ITC. But Mr. B defaults in making GST payments to
the government and filing his returns, which results in non-reflection of the
transaction on Mr. A’s  GSTR2A. Mr. A has
honestly paid his share of tax to the government but is unable to claim his
rightful share due to the default by Mr. B. Is this fair to Mr. A?

 

Similarly, with the new ITC rule
it has become practically impossible to do the workings and track the entries
of those that are reflecting in GSTR2A on a month-on-month basis. If a dealer
is filing monthly returns of GSTR3B and quarterly returns of GTSR1, the entire
working capital is curbed and the taxpayer is at times paying taxes from his
savings instead of his business because entries are not reflecting in GSTR2A.

Is it fair for professionals to
have so many continuous updates and notifications with so much ambiguity?

 

PROBLEMS (AND SOLUTIONS) WITH THE GSTN
PORTAL

(i) Rectification and revision of all GST returns to be made available,
say once a quarter;

(ii) Increasing the capacity of the portal from the existing 1.5 lakh
to 50 lakhs (in line with the Income Tax Portal) to handle the login for one
crore taxpayers;

(iii) Ensure effective functioning of the helpdesk and helpline numbers
and also provide training to the assigned staff, thus providing immediate and
effective solutions to grievances;

(iv) Immediate solutions of glitches and drawbacks on the GSTN portal
within ten days;

(v) Waiver of late fees, especially when the fees are levied due to
the faults and failures of the GSTN system;

(vi) Refund of late fees paid earlier by those whose deadlines and due
dates were later extended;

(vii) Simple procedures and format of filing GST returns; 50% of data
sought in various tables of annual returns forms are unnecessary and can be
avoided for smoother filing;

(viii) Separate due dates for payment of tax and filing of returns so that
downloading system reports like GSTR2A and reconciliation become easier;

(ix) Scrap the GSTR3B form and take the summary of sales and purchase
from both purchasers’ and sellers’ quarterly returns instead of bill-wise
summary;

(x) Provide a solution to the illogical sections of 16(4) and 36(4)
of the IGST;

(xi) Date of tax deposit to be considered as the payment date;

(xii) System testing and checking prior to the release of any new form
or process;

(xiii) Waive late fees until the GST portal turns smooth and efficient;

(xiv) Single return to be introduced consisting of all the details of receipts
and supply;

(xv) Amendments and notifications without ambiguity;

(xvi) ITC rules to be amended in an effective manner, thus making it fair
to practice business for taxpayers and shifting the burden on to defaulting
sellers;

(xvii) Furnish and publish telephone and email ids that are working and
reachable of officers concerned on the website;

(xviii) Self-adjustments of balances in cash ledger and electronic credit
ledger across multiple GSTNs of a single legal entity;

(xix) GSTR3B filing for earlier period without late fees;

(xx) E-Act – there are so many changes, there should be a mandatory
updated legal position, Act, Rules, Notifications all incorporated at one
place. We do have such daily updated laws under the Companies Act, 2013;

(xxi) Bringing out amendments only once a month (with reasonable
exceptions) like a master circular rather than uncontrolled rolling out of
changes.

 

CONCLUSION

Even today, GSTN portal is not
glitch-free; it would still be a bumpy ride for taxpayers and professionals who
are dealing with it; Infosys Chairman Nandan Nilekani has promised to solve all
technical issues by July, 2020. However, by that time the new forms are
expected to be live (by October, 2020) with new challenges.

 

The demand
from taxpayers and professionals is very simple and can be met if there is
willingness on the part of the government to act fast rather than acting only
when the problems are highlighted by professionals and taxpayers.

 

The
government would do well to work upon making the frameworks and the GSTN portal
more user-friendly; the present situation and scope of GST leads to varied
interpretations, thereby resulting in possible litigations in the GST regime in
the near future. With the new forms deadline deferred by the government, we
hope the forms are made live with proper testing and feedback from all
stakeholders.

 

IS IT FAIR?

The
question remains, is it fair to punish taxpayers for a faulty GSTN?

SEBI’S RECENT ORDER ON INSIDER TRADING – INTERESTING ISSUES

SEBI recently passed an interim
order in an alleged case of insider trading and ordered impounding of profits
running into several crores of rupees, along with interest on it. This order
was apart from other adverse directions in the form of restrictions and also
such further other action that may be initiated later in the form of penalty,
etc. While the order by itself has several points which are analysed here,
there are certain other issues arising out of this order, as also a settlement
order in a related matter of the company, which also need a look.

 

Insider trading is something that
every securities regulator across the world seeks to prevent and strictly
punish and, as an offence, stands second perhaps only to blatant market
manipulation. Insider trading is a breach of trust by insiders with
shareholders and the public generally and by itself also leads to loss of faith
in stock markets. When persons are placed in positions of power and access to
sensitive information, they are duty-bound not to profit illegitimately from
it. If, for example, a Chief Financial Officer learns something from sensitive
information relating to accounts / finance made available to him due to his
position of power and trust, he is duty-bound not to exploit it for his
personal profit. For instance, if he comes to know that his company has made
substantial profits, he is expected not to buy shares based on this information
that is not yet public and also not to share such information.

 

The
offence of insider trading – whether dealing on the basis of such unpublished
sensitive information or sharing such information – is so difficult to prove,
that the law has been drafted very widely and presumptively. Many aspects are
presumed in law even if some of these presumptions can be rebutted by persons
accused of insider trading. The tools of punishment for insider trading
available with SEBI are varied and far-reaching. The profits made can be
disgorged, penalty up to three times the profits made, or Rs. 25 crores,
whichever is higher, can be levied, the guilty persons can be debarred from
capital markets and so on.

Let us examine and analyse a recent
order which is a good test study of how the legal concepts are applied in an
actual case (Order No. WTM/GM/IVD/55/2019-20 in the matter of PC Jeweller
Limited, dated 17th December, 2019).

 

BASIC FACTS

SEBI has made certain allegations of
findings relating to this listed company, PC Jeweller Limited (‘PC Jeweller /
Company’). These allegations of findings are given below as the basic facts and
then we will see how SEBI established the guilt of insider trading, how the
alleged illegitimate profits from insider trading have been calculated and what
initial directions have been issued.

 

To
broadly summarise, the company had proposed a substantial buyback of its shares
and obtained approval of its board of directors. The announcement resulted in a
sharp rise in its share price. Later, however, when the company approached the
lead banker / lender for approval, it was rejected. The rejection was
reconfirmed when the lender was approached a second time. Consequently, the
company had no choice but to withdraw the buyback decision. In the meanwhile,
during this period certain insiders not only sold shares in the company at the
then ruling high price but even squared off certain buy futures and also
entered into fresh sell futures. Each of these resulted in the insider
allegedly avoiding significant loss and even profited. The buy / long future
was for purchase of shares and if squared off at the ruling high price, it
saved the insider from suffering loss that would have arisen when the share
price fell after the announcement of withdrawal of the buyback decision.
Similarly, the put option was for sale of shares at the ruling high price and
when squared off when the price fell, profits were made.

 

Several issues arose. Whether the
company should have initiated the buyback proposal without duly disclosing that
it was subject to approval of lenders? Whether this was a case of insider
trading and, if yes, what action should be taken?

 

The following are some specific
facts as per findings in this interim order (note that the interim order is issued
without giving parties a hearing, which is given after the order and
which may result in modification of facts / directions):

 

(i) There
were two directors who were brothers and promoters. There was another brother
who was ex-Chairman. There were certain relatives of such persons who were the
sons and wives of such sons. There was also a private limited company (QDPL) in
which a family member held 50% shares. One of the brothers passed away by the
time this order was passed;

(ii) The company initiated the buyback proposal on 25th April,
2018 after internal discussions followed by discussions with auditors and
merchant bankers. Thereafter, it convened a Board meeting on 10th
May, 2018 when the Board approved the buyback;

(iii) The buyback proposed was at a significant price and of a
significant amount. It was for 1.21 crore shares at a price up to Rs. 350 (the
ruling market price of shares just before the Board meeting was about Rs. 216).
The total buyback consideration would have been approximately Rs. 424 crores;

(iv) The company also had in the meantime initiated approval of
shareholders for the buyback through postal ballot. However, it appears that
the outcome of the voting of the ballot was not announced, although it appears
that more than 99% of votes were in favour of the buyback;

(v) However,
on 7th July, 2018, the lead banker rejected the request to allow the
buyback of shares. A request to reconsider was also rejected. Consequently, the
company convened a Board meeting on 13th July, 2018 to withdraw the
buyback proposal and duly announced the decision;

(vi) Certain relatives of the promoter-directors and QDPL (the
private company in which a relative held 50% shares) entered into certain
transactions during the time after the announcement of the buyback
proposal but before the announcement regarding the withdrawal of the
buyback. Fifteen lakh shares were sold. A long position in futures of 2.25 lakh
shares was squared off by a similar put future. A fresh short position of three
lakh shares was also entered into.

 

FINDINGS BY SEBI

SEBI made the following findings in
its interim order: The relations and transactions between the
promoter-directors and the relatives / QDPL who traded in the shares / futures
were laid down in detail. These relatives / QDPL were thus held to be insiders
/ beneficiaries of inside information. The timing of the transactions was
specified as being during the time after the buyback was announced and
information about the rejection by the lead banker, but before the time
when the announcement of withdrawal of buyback was published.

 

SEBI worked out the notional gains /
losses avoided by such transactions by taking the price when such transactions
were undertaken and the price quoted in the markets after the announcement of
withdrawal of buyback was made. This was calculated at about Rs. 7.10 crores.
To this, interest @ 12% per annum was added till the date of order which
amounted to Rs. 1.21 crores. The total came to Rs. 8.31 crores.

 

ORDERS BY SEBI

SEBI held that the
promoter-directors were insiders and they communicated the price-sensitive
information to persons connected to them who traded in the shares / futures.
Thus, there were two sets of alleged violations. One was by the
promoter-directors who were alleged to have shared the price-sensitive
information to persons connected to them. The second was by such connected
persons who dealt in the shares / futures based on such information and avoided
a large amount of losses.

 

SEBI directed the persons who traded
in the shares / futures to deposit the notional gains along with interest in an
escrow account pending final orders. Till that time, no transactions were
allowed in their bank, demat and other accounts and they were not allowed to
dispose of any of their other assets, except for complying with such directions
and till such deposit was made.

 

Further, they were asked to show
cause why such notional gains should not be formally disgorged, along with
interest, and why they should not be restrained from accessing securities
markets / dealing in securities for an appropriate period. The
promoter-director was also asked to show cause why he should also not be
restrained similarly from accessing securities markets / dealing in securities.

 

SETTLEMENT ORDER

Interestingly, a settlement order
was passed a few weeks before the interim order. Vide this, the company agreed
to pay Rs. 19,12,500 as settlement charges for certain alleged defaults in
disclosures. These mainly related to not informing in time about the objections
of the lenders to the buyback offer which was stated to be material information. SEBI had initiated
proceedings to levy a penalty. However, the company came forward for a
settlement and paid the agreed amount.

 

OBSERVATIONS

There
are several interesting issues here. Some are lessons for companies and persons
associated with such companies generally. The other is about concerns over such
interim orders and findings and their implications.

 

It
is critical that companies and managements should consider carefully the
implications of major decisions and disclose to public meticulously all
relevant information in that regard. In this case, the issue was not so much
that the buyback had to be cancelled because of lack of approval from the lead
lender, but that such condition was not disclosed beforehand. It may be that
often such approvals ordinarily do come in due course. But in this particular
case, it mattered significantly, so much so that the buyback had to be called
off and the share price seems to have crashed because of this.

 

Promoters
/ insiders need to be generally very careful in dealing in shares. There are
many safeguards provided in law. For example, prior approval of the Compliance
Officer ensures a check on whether any price-sensitive information remains
undisclosed. However, even in such cases, the promoters / management may have
as much, if not more, knowledge of what critical issues may arise.

 

There
are also concerns about such an interim order and some very general
observations can be made for academic analysis. In this case, it appears that
the promoters held more than 60% shares and even after the sale, the holding
was 57.59%. It is not as if a very significant portion of the shares was sold.
One does not know whether there was a particular reason for such sale other
than what SEBI has alleged for the sale of the shares. Interim orders, it is
well settled, have to be made sparingly. The SEBI order states that if an
interim order is not passed, it would ‘result in irreparable injury to the
interests of the securities markets and the investors’. From the facts stated
in the order itself, the promoter holding is very significant even after such
sale. It is not clear how then such an order would have prevented such
‘irreparable injury’. An interim order of such a nature is stigmatic and
restrictions placed can affect day-to-day business. One wonders whether first
issuing a show-cause notice giving all alleged facts as presented and giving
due opportunity to the parties would have been a better course.

 

Be that as it may, such orders continue to
provide and reinforce lessons for companies, promoters and insiders generally
for exercising due care.

OVERVIEW OF AMENDMENTS TO THE ARBITRATION AND CONCILIATION ACT, 1996: ONE STEP FORWARD AND TWO STEPS BACK

INTRODUCTION

In recent years, the volume and intensity of cross-border
investment, trade and commerce have become the key indicators for defining the
developmental growth index of a sovereign state. The Government of India has
implemented a myriad legislations and policies to attract investments and make
it easier to do business in India.

 

A key impediment of doing business in India has been the
difficulty of enforcing contracts and the time taken by courts and tribunals to
give determinations. An effective and efficient dispute resolution mechanism is
critical for instilling confidence in investors and to achieve the goals of a
growing economy.

 

Against this backdrop, the Government of India (GoI) after a
period of almost 20 years, in the year 2015 made much-needed amendments to the
Arbitration and Conciliation Act, 1996 (the 1996 Act) to ensure that
arbitrations are quicker and smoother. The amendments were indeed
path-breaking, since some of the amended provisions went well beyond what the
law in even arbitration-friendly countries provided for. These included
disclosures of impartiality (adopting the International Bar Association’s
Guidelines on Conflicts of Interest in International Arbitration, in the Act
itself) and providing for strict timelines within which an arbitration is to be
completed.

 

However, the GoI and the stakeholders in the arbitration
process felt that various provisions required clarifications or amendments. The
GoI, which has been closely watching the situation, was eager to provide
necessary support to the legislative framework for arbitrations in India.

 

A high-level committee under the chairmanship of Justice B.N.
Srikrishna, former judge of the Supreme Court of India, was constituted by the
Central Government to submit a report on how to achieve the goal of making
India an arbitration hub, to explore the lacunae in the effective
implementation of the 1996 Act and the Arbitration and Conciliation
(Amendment), 2015 (2015 Amendment) and also to provide a robust scheme of
legislation aligned with the letter and spirit of the UNCITRAL Model Law and
the Convention on the Recognition and Enforcement of Foreign Arbitral Awards
(the New York Convention).

 

Based partly on the report of the high-level committee, the
Arbitration and Conciliation (Amendment) 2019 Bill (the Bill) was framed and
placed before both the Houses of Parliament for approval. Both Houses swiftly
approved the Bill and the Arbitration and Conciliation (Amendment Act) 2019
(2019 Amendment) was passed. The 2019 Amendment received Presidential assent on
9th August, 2019 and by a Gazette Notification dated 30th
August, 2019 bearing No. S.O. 3154(E) (Gazette Notification), certain
provisions, namely, section 1, section 4-9 (both inclusive), sections 11-13
(both inclusive) and sections 15 of the 2019 Amendment were brought into force.
Some of the other provisions are yet to be notified. The speed at which such
amendments were passed and came to be implemented makes GoI’s intention to
support arbitrations clear. But has the GoI been successful? Some of the
amendments have given rise to mystifying questions which will be explored in
this article.

 

KEY
AMENDMENTS UNDER THE 2019 AMENDMENT

 

Definition of arbitral institution

Section 1(ca) inserted by the 2019 Amendment provides for the
definition of ‘arbitral institution’ to mean ‘arbitral
institutions designated by the Supreme Court / High Court under the Act’.
This would mean that the established arbitral institutions such as the
International Court of Arbitration (ICC), the Singapore International
Arbitration Centre (SIAC), the London Court of International Arbitration
(LCIA), etc., would have to necessarily be designated to fall within the scope
of the definition of arbitral institution under the amended 1996 Act. This
section has been notified under the Gazette Notification. However, it is
unclear how arbitral institutions of the world will be designated and what
criteria will be required to be met to be recognised under the 1996 Act.

 

Arbitral appointments u/s 11

Sub-section 3A, inserted by the 2019 Amendment, empowers the
Supreme Court and High Court to designate arbitral institutions graded by the
Arbitration Council of India (ACI) u/s 43-I to make arbitral appointments. It
further provides that in cases where the High Court concerned does not have any
graded arbitral institutions within its jurisdiction, the Chief Justice of such
High Court is empowered to maintain a panel of arbitrators to discharge the
functions within the meaning of ‘arbitral institution’ under the amended 1996
Act. The arbitrators shall be entitled to fees as prescribed under the Fourth
Schedule of the amended 1996 Act.

 

The 2019 Amendment provides an explanation to sub-section 14
of section 11 that the rates as per the Fourth Schedule shall not be applicable
in cases of international commercial arbitration and in arbitrations (other
than international commercial arbitration) where parties have agreed for
determination of fees as per the rules of the arbitral institution. It may be
inferred from this that parties can agree to determination of fees by an
arbitral institution which is designated by the Supreme Court / High Court.
However, what happens in cases where an arbitral institution is not designated
with the Supreme Court / High Court remains unanswered.

 

The amendment also states that such panel of arbitrators as
maintained by the High Court is subject to review by the Chief Justice of the
High Court concerned. Although it may seem that the intention behind the
amendment to section 11 is to popularise institutional arbitration in India,
however, the intervention and excessive supervision may hamper party autonomy.
These provisions have not been notified as yet. There are several
representations pending with the GoI to revisit these provisions.

 

TIMELINES

The 2015 Amendment introduced a timeline of 12 months from
the date an arbitrator entered reference to complete the arbitration. This was
extendable by six months by consent of the parties. Further extensions could be
granted only by the courts.

 

The 2019 Amendment now provides that an arbitral tribunal has
to render an award within 12 months from the date of completion of pleadings
u/s 23(4) in cases of domestic arbitrations. Section 23(4) has been introduced,
providing a timeline for filing of the pleadings as six months from the date of
the arbitrator/s receiving notice of appointment. It may be noted that this
provision does not take into account the timelines for filing counterclaims and
defence thereto, rejoinders and sur-rejoinders. This provision has been
notified under the Gazette Notification. There could be challenges in some
cases, especially since there are times when parties seek additional time to
permit settlement talks, even once an arbitrator is appointed. The 12-month
timeline does not apply to international commercial arbitration. It is not
clear why international commercial arbitrations have been excluded from such
timelines and such distinction between domestic and international arbitrations
seems artificial. It is unlikely that foreign parties choosing arbitration in
India would appreciate this, since they would also desire that the arbitration
is concluded within the timeframe.

 

The Delhi High Court in its recent judgment in the matter of Shapoorji
Pallonji & Co. Pvt. Ltd. vs. Jindal India Thermal Power Limited1
 has clarified that the new
timelines set out in the 2019 Amendment would be applicable not only to
arbitration proceedings which have commenced after the 2019 Amendment, but also
to arbitration proceedings which are pending as on the date of enactment of the
2019 Amendment. This will add to additional uncertainty, since there may be
pending arbitrations in which pleadings have not been filed within six months.

 

Amendment to section 34

The amendment to section 34 provides that the challenge to an
arbitral award could be established only on the basis of the record of the
Arbitral Tribunal.

 

The amendment was a welcome step to ensure speedy disposal of
challenges by losing parties, wherein the parties seek to produce new /
additional documents and lead evidence before the courts at the stage of
challenge to an award, thus fundamentally trying to re-open the arbitral
dispute itself. However, in September, 2019 the Supreme Court in Canara
Nidhi Limited vs. M. Shashikala2  clarified the legal position that a challenge
u/s 34 ‘will not ordinarily require anything beyond the record that was
before the arbitrator and that cross-examination of persons swearing into the
affidavits should not be allowed unless absolutely necessary.’ It will be
interesting to see how this judgment is used further as it provides for an open
field for the practitioners to adduce additional evidences, by proving that
their case falls within the exceptional circumstances contemplated under the Canara
judgment.

 

CONFIDENTIALITY

The issue of confidentiality pertaining to arbitral
proceedings has been debated extensively in international arbitrations. The
1996 Act did provide for confidentiality to be maintained in cases of
conciliation, but not in arbitration. In international arbitrations, the
parties have the option to apply the confidentiality provisions under the
International Bar Association (IBA) Guidelines and Rules; however, the IBA
Rules and Guidelines can only act as a soft law. The insertion of section 42A
provides the disclosure of the arbitral award to be made only where it is
necessary for implementing or enforcing the award. It is a welcome move to
provide statutory backing to the concept of confidentiality in arbitral
proceedings and ensuring that the stand taken by the Indian legislation is akin
to the international best practices. However, the interplay between the ACI’s
power to keep a depository of arbitral awards and confidentiality provisions is
something to be seen in future.

 

Protection afforded to an arbitrator for action taken in
good faith

Under the newly-inserted section 42B of the 2019 Amendment,
immunity is now provided to the arbitrators against liabilities for acts
performed in their capacity as arbitrators, so long as they are in good faith.
This section should act as an incentive for more people to act as arbitrators.

 

Arbitration Council of India

The 2019 Amendment sought to insert an altogether new Part
‘1A’ to the 1996 Act for the establishment and incorporation of an independent
body corporate, namely, the Arbitration Council of India (ACI) for the purposes
of grading of arbitral institutions as per the qualifications and norms
contained in the Eighth Schedule (as inserted vide the 2019 Amendment) which
includes criteria relating to the infrastructure, quality and calibre of
arbitrators, performance and compliance of time limits for disposal of domestic
or international commercial arbitrations, etc., formulating policies and training
modules to adept professionals in the field of arbitration and ADR mechanisms.

 

Section 43C(1) provides that the ACI shall be composed of a
retired Supreme Court or High Court judge, appointed by the Central Government
in consultation with the Chief Justice of India, as its Chairperson; an eminent
arbitration practitioner nominated as the Central Government Member; an eminent
academician having research and teaching experience in the field of
arbitration, appointed by the Central Government in consultation with the
Chairperson, as the Chairperson-Member; Secretary to the Central Government in
the Department of Legal Affairs, Ministry of Law and Justice and Secretary to
the Central Government in the Department of Expenditure, Ministry of Finance,
both as ex-officio members; one representative of a recognised body of
commerce and industry, chosen on rotational basis by the Central Government, as
a part-time member; and Chief Executive Officer-Member-Secretary,
ex-officio.

 

The Ministry of Law and Justice has, in its press release
dated 12th February, 2020, enlisted the draft rules prepared to set
in motion the proposal of the ACI and has invited comments from various
stakeholders on the following:

 

(1)   The
Arbitration Council of India (the Salary, Allowances and other Terms and
Conditions of Chairperson and Members) Rules, 2020;

(2)   The
Arbitration Council of India (the Travelling and other Allowances payable to
Part-time Member) Rules, 2020;

(3)   The
Arbitration Council of India (the Qualifications, Appointment and other Terms
and Conditions of the service of the Chief Executive Officer) Rules, 2020;

(4)  The
Arbitration Council of India (the Number of Officers and Employees of the
Secretariat of the Council and the Qualifications, Appointment and other Terms
and Conditions of the officers and employees of the Council) Rules, 2020.

 

This provision has received vastly
differing views from the arbitration fraternity. On the one hand, it is said to
enhance the use of institutional arbitration over ad hoc, as well as an
attempt to ensure that there is some quality control over institutions and
arbitrators. On the other hand, stakeholders have taken the view that being
accredited by government officials amounts to regulation and excessive control
of arbitrators. This is all the more significant, given that the government is
one of the largest litigants in India. The provisions relating to the ACI have
not been notified yet.

 

The Eighth Schedule

One of the biggest benefits for
parties opting for arbitration rather than a court process to dispute
resolution is the right to nominate an arbitrator of their choice. This gives
flexibility in the process and often parties can nominate domain experts to
determine a particular matter, rather than someone who may be a qualified
lawyer or a retired judge but who may not be as well versed in the subject
matter of the dispute. The 2019 Amendment has introduced an Eighth Schedule
setting out the eligibility requirements for the accreditation and
qualification of an individual as an arbitrator. These provisions have not been
notified as yet.

 

RESTRICTING FOREIGN LAWYERS?

While such accreditation and
qualification of individuals acting as arbitrators may, at first glance, seem
attractive as a measure for quality control, some of the eligibility criteria
are highly restrictive and will infringe on a party’s right to appoint an
arbitrator of its choice, keeping in mind the nature of the dispute.

 

Some qualifications under the Eighth
Schedule require an arbitrator to, inter alia, have knowledge of the
laws in India such as the Constitution of India and the labour laws. Such
knowledge may not have any connection with a dispute at hand, such as, say,
whilst determining a matter relating to a contractual dispute governed entirely
by foreign law.

 

The Eighth Schedule also speaks of
appointment of advocates having ten or more years’ experience and being
registered under the Advocates Act in India. This throws open the question
whether this would potentially restrict foreign lawyers from acting as
arbitrators in India. This may prove to be an issue in a contract in disputes
having smaller value. A lawyer of ten or more years’ experience may charge an
amount that is a substantial portion or even more than the amount in dispute.
Besides, the ban on foreign qualified lawyers acting as arbitrators would be
contrary to the ethos of international arbitration and could discourage foreign
parties from seating their arbitrations in India since they would be prevented
from appointing an arbitrator of their choice. This may be more significant if the arbitration itself is
governed by foreign law (although seated in India).

 

Of the changes and standards
introduced under the 2019 Amendment, the Eighth Schedule by far contains the
most restrictive provisions which might take a toll on the promotion of
arbitrations in India. In the interest of promoting India as a hub for
arbitration, it is hoped that the government will reconsider this amendment
and, inter alia, allow foreign lawyers to act as arbitrators.

Insertion of section 87

When
the 2015 Amendment came into force, there was a huge debate as to whether the
amendments would apply retrospectively or prospectively. This was ultimately
settled by the Supreme Court in Board of Control for Cricket in India vs.
Kochi Cricket Private Limited and Ors3. Interestingly, the
GoI had filed an affidavit in the matter stating that its intention was to have
the 2015 Amendment apply only to arbitrations invoked after the 2015 Amendment
came into force. However, in the judgment, despite the position of the GoI stated
on affidavit, on an interpretation of a plain reading of the language used in
the 2015 Amendment it was ultimately held, inter alia, that the 2015
Amendment applied to applications which were pending in various courts
challenging an award in an arbitral proceeding which commenced before the
enactment of the 2015 Amendment. The judgment also went on to analyse and hold
exactly which section of the amendment would apply to ongoing arbitrations and
proceedings arising therefrom and which amendments would apply to arbitrations
invoked after the 2015 Amendment came into force.

 

The 2019 Amendment attempted to undo
the position held in the above judgment. The 2019 Amendment provides that,
unless otherwise agreed by parties, it shall not apply to:

(a)   the
arbitral proceedings commenced prior to the 2015 Amendment;

(b) the
Court proceedings arising out of or in relation to such arbitral proceedings
irrespective of whether such court proceedings have commenced prior to or after
the commencement of the 2015 Amendment.

 

MAKING INDIA AN ARBITRATION HUB?

It was further clarified that the
2015 Amendment shall only apply to arbitral proceedings that have commenced on
or after the introduction of the 2015 Amendment and to court proceedings
arising out of or in relation to such arbitral proceedings.

 

However, in the matter of Hindustan
Construction Company Limited & Anr vs. Union of India4
the Supreme Court has now held that section 87 of the 2019 Amendment is
manifestly arbitrary and unconstitutional. This judgment goes on to clarify
that the 2015 Amendment, in its original form, shall be applicable as held in
the Board of Control for Cricket in India matter.

Observing the latest arbitration
trends in India, there is not an iota of doubt that the GoI is leaving no stone
unturned to try to make India an arbitration hub. However, the continuous
change in the position of the arbitration law has left many questions
unanswered. Some well-intentioned amendments also have underlying issues that
need to be revisited.

It
is also noteworthy that the Constitutional validity of the 2019 Amendments is
under challenge before the Supreme Court in Writ Petition (Civil) No. 76 of 2020
filed under Article 32 of the Constitution. The main challenge is to the
provisions relating to the qualification required to be an arbitrator and the
mandatory requirement for the Arbitral Institutions to register themselves
before the High Courts and the Supreme Court of India. This petition is subjudice
before the Supreme Court. It would be interesting to follow the developments in this matter as they might
lead to defining the arbitration regime in India.

 

The 2019 Amendment, however well intentioned,
clearly has some challenges. We will have to wait and see whether these issues
are addressed by the GoI or interpreted by the Supreme Court so that there is
clarity on them.


__________________________________________

1   OMP (Misc) (Comm) 512/2019

2   2019 SCC OnLine SC 1244

3   (2018) 6 SCC 287

4   Writ Petition (Civil) No. 1074 of 2019

Section 56 read with sections 22 and 23 – Compensation received under an agreement entered into with a tenant granting him an option to take on lease other units which belonged to the assessee is taxable under the head Income from Other Sources

10.
[2020] 116 taxmann.com 223 Redwood
IT Services (P) Ltd. vs. ITO(10)(2)(2), (Mum.) ITA No.
1309(Mum) 2018 A.Y.:
2011-12 Date of
order: 28th February, 2020

 

Section 56 read with sections 22 and 23 –
Compensation received under an agreement entered into with a tenant granting
him an option to take on lease other units which belonged to the assessee is
taxable under the head Income from Other Sources

 

FACTS

The assessee acquired an immovable property which was divided into four
units of which two units, viz. Unit Nos. 3 and 4, were let out. In terms of the
agreement entered into by the assessee with the tenant, the assessee had
granted an option to the tenant to take the other two units, viz. Units 1 and 2,
on lease. Under the option agreement, the assessee agreed to lease the property
in future and restrained itself from leasing it to any other person during the
period for which the option was granted. In consideration of such a covenant,
the assessee received from the tenant a compensation of Rs. 33,75,000 which was
offered by him under the head Income from Other Sources.

 

The A.O. considered
the two units in respect of which option was granted to be deemed let-out units
and charged tax on their market rent, and after allowing the standard deduction
taxed a sum of Rs. 76,64,328 under the head ‘Income from House Property’.

 

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

 

HELD

The Tribunal held that for income to be assessable under the head Income
from House Property, it should be out of the property let out or deemed to be
let out for the relevant period. In this case the property is neither let out
nor vacant. The compensation cannot, therefore, be assessed under the head
Income from House Property.

 

The amount received
by the assessee is in the nature of compensation for not letting out property
to any third party for a specified period. The meaning thereof is that by
entering into an option agreement, the assessee had renounced its right to let
out Unit Nos. 1 and 2 for a period of nine months from the date of the option
agreement and any amount received in pursuance of the said agreement is in the
nature of compensation which is assessable under the head Income from Other
Sources.

 

The Tribunal held
that the A.O. as well as the CIT(A) were incorrect in coming to the conclusion
that the property is deemed to be let out and income from the said property
needs to be computed u/s 22 of the Act.

 

The Tribunal directed
the A.O. to delete the additions made towards Income from House Property.

 

This ground of appeal filed by the assessee was
allowed.

Business expenditure – Obsolescence allowance – Sections 36 and 145A of ITA, 1961 – Assessee following particular accounting policy from year to year consistent with provisions of section 145A – Concurrent finding of fact by appellate authorities that stock had been rendered obsolete – Loss allowable

1. CIT vs. Gigabyte
Technology (India) Ltd.

[2020] 421 ITR 21 (Bom.)

Date of order: 7th
January, 2020

 

Business expenditure –
Obsolescence allowance – Sections 36 and 145A of ITA, 1961 – Assessee following
particular accounting policy from year to year consistent with provisions of
section 145A – Concurrent finding of fact by appellate authorities that stock
had been rendered obsolete – Loss allowable

 

In its return, the assessee
claimed losses towards stock obsolescence in respect of laptops and
motherboards. The A.O. held that the laptops and the motherboards which had a
long shelf life could not be considered to have become obsolete and disallowed
the losses in his order passed u/s 143(3) of the Income-tax Act, 1961.

 

The Commissioner (Appeals)
allowed the appeal filed by the assessee. The Tribunal held that the obsolete
stock which was not disposed of or sold was allowable as expenditure and
dismissed the appeal filed by the Department.

 

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

 

‘i)    There were concurrent findings of fact recorded by the
Commissioner (Appeals) as well as the Tribunal that the laptops and
motherboards had been rendered obsolete. There were findings of fact in respect
of the assessee consistently following a particular accounting policy from year
to year, which was consistent with the provisions of section 145A.

 

ii)    The Tribunal was right in holding that the obsolete stock which
was not disposed of or sold was allowable as expenditure.’

REMUNERATION BY A FIRM TO PARTNERS: SECTION 194J ATTRACTED?

From the remuneration payable by a
firm to its partners in pursuance of section 40(b) of the Income-tax Act, 1961
(‘the Act’), the firm does not deduct any tax at source (hereinafter also
referred to as ‘TDS’) under any provision of the Act. This position has been
undisputedly settled and accepted by the Income-tax Department for over 25
years since the new scheme of taxation of firms and partners was brought on the
statute book by the Finance Act, 1992 from the assessment year 1993-94.

But in a recent case I came across an
overzealous officer of the Income-tax Department adopting the stand that a firm
is liable to effect TDS u/s 194J of the Act @ 10% from the remuneration payable
to its partners as, in their view, the services rendered by the partners to the
firm are in the nature of ‘managerial services’ which fall within the scope of
the term ‘technical services’ employed in section 194J. Apart from a huge demand
of tax u/s 201(1), a substantial amount of interest u/s 201(1A) is also being
charged. This is playing havoc with the taxpayers, especially when the partners
have already paid tax on their remuneration in their respective individual
returns and the credit for such tax paid allowable under the first proviso
to sub-section (1) of section 201 is being denied on procedural technicalities.

Therefore, before proceeding further,
it is fervently pleaded that to alleviate the hardships faced by the taxpayers
and to avoid unnecessary litigation, the Central Board of Direct Taxes (‘CBDT’)
needs to urgently issue a circular clarifying the position on this subject, to
be followed (if necessary) by an appropriate legislative amendment in section
194J expressly excluding such remuneration from the purview of section 194J.

 

CLEAR LEGISLATIVE INTENT

Principally, it is submitted that the
remuneration payable by a firm to its partners cannot be subjected to TDS u/s
194J. In this regard the following propositions are submitted:

(1)  Firstly,
the legislative intent has always been clear beyond doubt that under the new
scheme of taxation of firms and partners, interest and remuneration payable by
a firm to its partners are not liable to TDS since by nature, character and
quality any such payment by a firm to its partners is nothing but a share in
the profits of the firm, though called interest or remuneration and though
deductible u/s 40(b). This legislative intent is manifestly evident from the
following:

 

ACCEPTED FOR OVER 25 YEARS

(a)  When
the new scheme of taxation of firms and partners was introduced by the Finance
Act, 1992 with effect from A.Y. 1993-94, section 194DD1 was also
proposed to be inserted in the Act which provided for TDS2 both from
interest and remuneration payable by a firm to its partners. But section 194DD
was dropped during the process of the Finance Bill, 1992 becoming an Act,
because the legislature was conscious that, conceptually, under the new scheme
of taxation of firms and partners, both interest and remuneration payable by a
firm to its partners are only a mode of transferring profits from the firm to
the partners for tax. This is fortified from the statutory provision that the
remuneration (as well as interest) received by a partner from the firm is treated
as business income in the individual hands of the partner u/s 28(v)3
of the Act4;

(b)  Explanation
2 below section 15 unambiguously provides that any salary, bonus, commission or
remuneration, by whatever name called, due to, or received by, a partner from
the firm shall not be regarded as ‘salary’. Consequently, provisions of section
192 relating to TDS from salaries are not attracted. This is statutory
recognition of the principle that there cannot be an employer-employee
relationship between a firm and its partners and as such no tax is required to
be deducted from such remuneration u/s 192;

(c)  Section
194A(3)(iv), likewise, expressly provides that no tax is to be deducted at
source from the interest payable by a firm to its partners;

(d) As
a matter of fact, any firm deducting tax at source under any provision of the
Act, including section 194J, from the remuneration payable to its partners is
unheard of in India and this position has been undisputedly, ungrudgingly and
eminently accepted by the Income-tax Department for over 25 years since the new
scheme of taxation of firms and partners came on the statute book;

(e)  Section 194J was introduced in the Act by the
Finance Act, 1995 with effect from 1st July, 1995 for TDS from fees
for professional services5  and fees for technical services6.
Later, by the Finance Act, 2012 a new category was added by inserting clause
(ba) in sub-section (1) of section 194J with effect from 1st July,
2012 which mandates TDS from ‘any remuneration or fees or commission, by
whatever name called, other than those on which tax is deductible u/s 192, to a
director of a company’. Thus, whenever the legislature intended that tax should
be deducted u/s 194J from the remuneration payable, it has expressly provided
for it in so many words as is the case with clause (ba) above applicable to
remuneration payable by a company to its directors. But no such specific clause
is inserted with regard to the remuneration payable by a firm to its partners;
while inserting clause (ba), the Memorandum explaining the provisions in the
Finance Bill, 2012 ([2012] 342 ITR [St] 234, 241) visibly
acknowledges that there is no specific provision for deduction of tax on the
remuneration paid to a director which is not in the nature of salary.
Furthermore, it is also judicially held7  that prior to insertion of the above referred
clause (ba) with effect from 1st July, 2012, no tax was deductible
u/s 194J from the commission / remuneration payable by a company to its
directors. It follows, therefore, that in the absence of any such specific
clause in section 194J postulating TDS from the remuneration payable by a firm
to its partners, the legislative intent is loud and clear – that no tax is
deductible u/s 194J by a firm from such remuneration.

 

A FIRM HAS NO LEGAL EXISTENCE

(2)  A
firm and its partners are treated as separate assessable entities for the
limited purpose of assessment under the Act, but, in law, as is settled
judicially for ages, a firm has no legal existence of its own, separate and
distinct from the partners constituting it, and the firm name is only a
compendious mode of describing the partners constituting the partnership. As
such, a person cannot render services to himself and there cannot be a contract
of service between a firm and its partners. Therefore, a firm cannot be
expected or made liable to deduct tax at source u/s 194J from such remuneration.


In CIT vs. R.M. Chidambaram
Pillai [1977] 106 ITR 292 (SC) the Apex Court observed that a firm is
not a legal person even though it has some attributes of a personality; and
that in income-tax law a firm is a unit of assessment by special provisions,
but not a full person.

The Supreme Court then unequivocally
held that since a contract of employment requires two distinct persons, viz.,
the employer and the employee, there cannot be a contract of service, in
strict law, between a firm and its partners8.

 

SHARE OF PROFITS OF THE FIRM

(3)  A
partner works for the firm since he is duty-bound to do so under the deed of
partnership as well as in terms of the provisions of the Indian Partnership
Act, 19329  and therefore
there is no relationship of service provider or consultant and client between
the partners and the firm.

(4)  Under
the Indian Partnership Act, 1932 since there is a relationship of ‘mutual
agency’ among the partners, there cannot be a relationship between a firm and
its partners which could give rise to a liability to deduct tax at source u/s
194J.

(5)  Conceptually,
whatever may be the amount received by a partner from the firm, whether called
salary or remuneration, it is not expenditure of the firm (though allowed as
such u/s 40[b]), nor in the nature of compensation for services in the hands of
the partner, but it is in the nature of a share of profits from the firm as is
settled judicially, including by the Supreme Court. In CIT vs. R.M.
Chidambaram Pillai (Supra) it was categorically held that payment of
salary to a partner represents a special share of the profits of the
firm and salary paid to a partner retains the same character of the
income of
the firm.

(6)  Even
under the statutory provisions embodied in section 28(v) of the Act, both
interest and remuneration received by a partner from the firm are expressly
assessed as business income in the hands of the partner and as such interest
and remuneration both are statutorily recognised as in the nature of a share of
profits from the firm10.

 

RULE OF CONSISTENCY

(7)  Since
generally the remuneration payable to the partners is a percentage of the
profits of the firm determined at the end of the year, which keeps on varying with
the amount of profits and is not reckoned with with reference to the quantity
and quality of services rendered by the partners to the firm, the same is a
mode of transferring a share of the profits of the firm to the partners and not
a compensation for the services rendered by the partners to the firm, and hence
the question of invoking section 194J does not arise.

(8)  Inasmuch
as the position that no tax is required to be deducted by a firm from the
remuneration payable to its partners is undisputedly and consistently accepted
by the Income-tax Department for over a quarter of a century now, even the rule
of consistency11 obligates
that this position should not be disturbed by the Income-tax Department at this
stage.

(9) It
can also be contended that by nature the services rendered, if any, by a
partner to the firm do not fall within the connotation of either ‘professional
services’ or ‘technical services’ as defined and understood for the purposes of
section 194J.

(10) No tax is levied under the laws
relating to Goods and Services Tax (‘GST’) on the remuneration received by a
partner from the firm. Thus, the remuneration received by a partner from the
firm is not treated as consideration for the supply of services to the firm but
as a share of profits even under the GST laws.

One arm of the Union Government (the
Income-tax Department) cannot adopt a stand conflicting with the view accepted
by another arm of the same Union Government (GST Department). In Moouat
vs. Betts Motors Ltd. 1958 (3) All E R 402 (CA) it was held that two
departments of the government cannot, in law, adopt contrary or inconsistent
stands, or raise inconsistent contentions, or act at cross purposes. Lord
Denning in this case succinctly summed up the principle in his inimitable
style: ‘The right hand of the government cannot pretend to be unaware of what
the left hand is doing.’ To the same effect was the Supreme Court decision in M.G.
Abrol, Addl. Collector of Customs vs. M/s Shantilal Chhotelal & Co. AIR
1966 SC 197, holding, to the effect, that the customs authorities12
cannot, in law, take a stand or adopt a view which is contrary to that taken by
the licensing authority under the Export (Control) Order, 195413.
This principle of law has been consistently applied for income-tax purposes as
well in a variety of contexts under the Act14.

In view of the foregoing discussion,
it is submitted that the remuneration payable by a firm to its partners cannot
suffer TDS u/s 194J of the Act.  

__________________________________________________________________

1   Clause 74 of the Finance Bill, 1992: [1992]
194 ITR (St) 68-69

2   At the average rate of income-tax computed on the basis of the
rates in force for the financial year concerned

3   Read with section 2(24)(ve)

4      See
also CBDT Circular No. 636 dated 31st August, 1992: [1992] 198
ITR (St) 1, 42-43

5   Clause (a) of sub-section (1) of section 194J

6   Clause (b) of sub-section (1) of section 194J

7      See, among others, Dy. CIT vs. ITC
Ltd. [2015] 154 ITD 136 (Kol.) and Dy. CIT vs. Kirloskar Oil
Engines Ltd. [2016] 158 ITD 309 (Pune). See also Bharat Forge
Ltd. vs. Addl. CIT [2013] 144 ITD 455 (Pune) (pre-2012 period) (sitting
fees to directors not ‘fees for professional services’ u/s 194J)

8   While reaching this conclusion, the Supreme
Court referred to, among others, Dulichand Laxminarayan vs. CIT [1956] 29
ITR 535 (SC); CIT vs. Ramniklal Kothari [1969] 74 ITR 57 (SC); and
Addanki Narayanappa vs. Bhaskara Krishnappa AIR 1966 SC 1300

9      See sub-sections (a) and (b) of section 12
along with sub-section (a) of section 13 of the Indian Partnership Act, 1932

10  See also CBDT Circular No. 636 dated 31st
August, 1992: [1992] 198 ITR (St) 1, 42-43

11     The rule of consistency is settled by
countless judicial precedents. See, for example, Radhasoami Satsang vs.
CIT [1992] 193 ITR 321 (SC); Berger Paints India Ltd. vs. CIT [2004] 266 ITR 99
(SC); Bharat Sanchar Nigam Ltd. vs. UOI [2006] 282 ITR 273 (SC); CIT vs. Neo
Poly Pack (P) Ltd. [2000] 245 ITR 492 (Del.); CIT vs. Leader Valves Ltd. [2007]
295 ITR 273 (P & H); CIT vs. Darius Pandole [2011] 330 ITR 485 (Bom.);
and Pr. CIT vs. Quest Investment Advisors Pvt. Ltd. [2018] 409 ITR 545
(Bom.)

12  Under the Sea Customs Act, 1878

13  Issued under the Import and Export (Control)
Act, 1947

14  See, for instance, Mobile
Communication (India) P. Ltd. vs. Dy. CIT [2010] 33 DTR (Del) (Trib) 398, 416

VIRUS AND US

There are
decades where nothing happens; and there are weeks where decades happen – Lenin

When I
called people in Italy, UK, Australia and America, they had three words to say:
‘It’s not good’. The news has been about infections, deaths and recoveries. An
invisible sub-microscopic agent stops the mighty and haughty China and America
and halts the unstoppable global industrial machine. The evolved and progressed
homo sapiens finds himself under house arrest.

The
pollution in Mumbai in the first seven days (since the lockdown) is down by 40%
(AQI PM 2.5 levels from 118 to 70). Clear skies, fresh air, zero noise. As I
write this, I can hear the Tibetan chimes playing in the breeze outside my
balcony. A Dutch client wrote that nature has put humans on notice. Earth,
which was on ventilator, seems to be breathing again, taking a break from human
disregard, entitlement and greed. On the other side there is pain and loss – of
lives and livelihoods, of wealth and income, and displacement and disarray.

The wise
must have had a thought as to why this is happening to us. The word virus
phonetically sounds like why us. What is all this telling us
individually and collectively? What is happening? Here are some immediate
reflections:

One focus: The distorted and fragmented humanity – in thought and action – was
never so cohesive in focusing on a single agenda. If one took the ‘point of
focus’ out and just became aware of the ‘focus’ itself, it is astounding.
Imagine working with such focus together on an issue like climate change that
affects every single person. (About 12.4 lakh people die in India and 16 lakhs in
China each year due to pollution). But can we? The past has shown that we are
just as likely to carry on as before. Someone wrote that perhaps the virus will
save as many or more lives of people dying from pollution and road accidents as
it takes away.

Leveller: Royalty to movie stars, all fell prey to the virus. The virus doesn’t
differentiate between rich and poor, known and unknown. Humanity as a whole
never seemed so vulnerable, overpowered and scuffling to keep its mortality
away. Each one, despite every manmade division, feels equally susceptible.

Decision,
action and speed: Economic leverage seemed less critical,
whereas action and speed are the real levers! Those who acted faster fought
better, those who were casual are trapped. The decisions India took wisely put
life over economy, survival over everything else. The PM pleaded with gentle
persuasiveness, with folded hands, to stay indoors. The administration brought
out extensions in compliance deadlines with speed and sensibility. Food, cash
and waivers for the marginalised came out with care and clarity. The central
banker was emphatic and reassuring and put money in the hands of the banks to
lend. Governance, the health care system and social capital are at their
ultimate acid test.

Illusions: Albert Einstein said that Reality is merely an illusion, albeit
a very persistent one. Many illusions we loved and lived with are busted.
Someone wrote: Coronavirus has proved that most corporate jobs are just
exchanges of emails, texts and calls and nothing else. Everything – from
‘values’ and ‘ways’ – will be subjected to deep inquiry. Many narratives could
stand on their heads. The hypothetical is now the reality. Washing hands, which
was difficult to enforce even in hospitals, is more important than shaking
hands. Social distancing is more important than bridging distances.
Mathematically put, namaskar > hugs, and social capital >
capital market valuations. Eighteen million people have viewed the TED talk by
Bill Gates on a pathogen attack, in October 2019 John Hopkins Centre for Health
Security gamed a germ war, America ranked at the top in Global Health Security
Index and today it has highest infections. Context changes everything,
including ‘reality’!

The next few
months, the end game and aftermath will be long and difficult. It won’t be a
balance that we can write off with a journal entry.

I will leave
you to complete the reflective thoughts of Anand Mahindra in your own words:
‘After the pandemic, we will …….’

Meanwhile, may you remain free from affliction

Raman Jokhakar

Editor

TRUTH AND TAX PRACTICE

What is the connection between
truth and tax practice? There are two answers to this question.

Truth is a matter of philosophy.
Its right place is in temples and books. It has no place in tax practice. (1.1)

Truth is applicable to every
human being. Taxpayers, tax practitioners and tax officers are all human
beings. They should also understand and practice truth. (1.2)

Does this mean that there are
two answers to one question? Hence truth depends upon one’s belief?

No. There is only one answer.
But people have different beliefs. And it is no use entering into arguments
with people holding contrary beliefs. People who have similar beliefs and want
to understand the deeper meanings of philosophical concepts, can discuss and
learn together.

Query: Is there any
difference between ‘Truth in Substance’ and ‘Truth in Form’?

Answer: The question
itself is baseless The form must always
represent substance. If form does not represent substance, that form has to be
discarded like a dead body without an Atma.

The entire litigation about ‘Form vs. Substance’ has been possible
because certain people believe in the answer 1.1 and not in the answer 1.2 as
mentioned above. If all the taxpayers, tax consultants and tax officers
practised answer 1.2, then 95% of tax litigation would not take place. There
may be genuine differences of opinion between two honest individuals. For them,
the courts would act as arbiters to decide which opinion is correct. This may
form 5% of litigation today.

The
entire debate about ‘BEPS’, anti-avoidance provisions and digital taxation
would not be necessary. SAAR, GAAR and harsh penalty provisions would be
unnecessary. Just imagine – how many intelligent brains are being wasted today
on obviously useless issues!
(The issues are useless from the point of view of society as a whole.)

Issue: Such a belief is Utopian.
It exists only in the minds of dreamers. People will act greedily. They will
avoid and evade taxes. Only the fear of harsh punishment keeps them
disciplined. Society will always need laws and regulations with harsh
punishment provisions.

Responses: Greed is as
prevalent as gravity. People will act greedily. Greed applies to taxpayers,
tax advisers, tax officers and law-makers – politicians, equally. Law
makers’ and regulators’ greed, corruption and ego get boosted with harsh
laws. We have experienced that society cannot throw out the corrupt politicians
even in elections. Harsh laws and punishment have, in reality, failed. Society
becoming spiritual is the only solution. A spiritual person will not abuse law,
will not avoid / evade taxes; nor will he take bribes. Today, a majority of the
global society is not spiritual. The BEPS project is proof. As the late Shri
Nani Palkhiwala said: Society will choose the right solution only after it
experiences failure of all available wrong solutions.

A comment from Maharshi Ved Vyas
in the Mahabharata on ‘Substance vs. Form’: Bhishma Pitamaha did not protect
Draupadi from her extreme humiliation at the time of her Vastra Haran.
He even said, ‘Dharma’s secret is complex Then Draupadi told the Sabha:

                                             

Where there are no wise old
men, it is not a conference. Those who do not support Dharma are not wise old
men. That which is not based on Truth is not Dharma. That which is obtained by
twisted interpretations is not Truth.

When to tell the truth and when
to maintain silence? This shloka provides the answer:

Speak pleasant truth. Do not tell a lie. Do not
tell an unpleasant truth. Never tell untruth even if it is pleasant. This is
Sanatan / Eternal dharma. However, this restriction does not apply to
‘Activists’. They have to tell unpleasant truths to the authorities and others.
Activists are doing a different kind of Karmayog.

Article 12 of India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by American company for provision of cloud hosting services to Indian customers was not royalty or fees for included services within meaning of Article 12 since the assessee was in physical control or possession over, and operating and managing, equipment without having granted its lease to customers – Since the assessee did not have PE in India, income could also not be taxed as business profits

22 [2020] 113 taxmann.com 382 (Mum.)(Trib.) Rackspace, US Inc. vs. DCIT ITA Nos. 4920 & 6195 (Mum.) of 2018 A.Ys.: 2010-11 & 2015-16 Date of order: 28th November,
2019

 

Article 12 of
India-USA DTAA; Section 9(1)(vi), (vii) of the Act – Payment received by
American company for provision of cloud hosting services to Indian customers
was not royalty or fees for included services within meaning of Article 12
since the assessee was in physical control or possession over, and operating
and managing, equipment without having granted its lease to customers – Since
the assessee did not have PE in India, income could also not be taxed as
business profits

 

FACTS

The assessee was a
company incorporated in, and a tax resident of, the USA. During the relevant
year, the assessee had earned income from provision of cloud services (cloud
hosting and other supporting and ancillary services) to Indian customers. The
assessee had not filed return of its income.

 

The A.O. issued
notice u/s 148 of the Act. In response, the assessee filed the return of its
income and contended that cloud hosting services were not taxable as
‘royalties’ under Article 12 of the India-USA DTAA because of the following
reasons:

 

  •     The customers do not
    operate the equipment and do not have physical access to or control over the
    equipment used by the assessee to provide cloud support services.
  •     The assessee does not ‘make
    available’ technical knowledge, experience, skill, know-how, etc. to its
    customers. Further, the cloud support services are not in the nature of
    managerial, technical or consultancy services. Consequently, they do not
    constitute included services under Article 12 of the India-USA DTAA.
  •     Hence, income from cloud
    hosting services was business profits. Since the assessee did not have a PE in
    India under Article 5 of India-USA DTAA, the income was not taxable in India
    under the provisions of Article 7(1) of the India-USA DTAA.

 

However, in
accordance with the direction of the DRP, income from cloud services was
treated as ‘Royalty’ and taxed @ 10% under the India-USA DTAA.

 

HELD

  •     Customers of the assessee
    had only availed hosting services. They had not used, possessed or controlled
    equipment (which was owned and controlled by the assessee) used for providing
    hosting services. Hence, the payment for hosting services made by Indian
    customers did not fall within the ambit of the definition of royalty in
    Explanation 2 to section 9(1)(vi) of the Act.
  •     Amendment to the said
    definition by the Finance Act, 2012 clarified that irrespective of possession
    or control of equipment with payer, or use by payer, or location of equipment
    in India, any payment made for ‘use of equipment’ would be classified as
    ‘royalties’.
  •     Since the assessee was a
    tax resident of the USA, it qualified for beneficial provisions under the
    India-USA DTAA.
  •     The definition of royalties under Article
    12(3) of the India-USA DTAA is in pari materia with the pre-amendment
    definition of royalty under the Act. The definition under the India-USA DTAA
    being exhaustive and not inclusive, its meaning should be only that given in
    the Article.
  •     The assessee was providing
    hosting services to Indian customers. The data centre and infrastructure
    therein which was used to provide services belonged to, and was operated and
    managed by, only the assessee.
  •     The term ‘use’ or ‘right to
    use’ in the context of the DTAA contemplates that the payer has possession /
    control over the property or the property is at its disposal. However, the
    assessee did not give any equipment to the customers nor did it allow them to
    have control over equipment. Customers did not have physical control or
    possession over servers and other equipment used to provide cloud hosting
    services. Customers did not even know the location of either the data centre or
    the location of the server in the data centre.
  •     The assessee had provided
    cloud hosting services which were standard services provided to customers.
    Agreement between the assessee and its customers was only a service level
    agreement for providing hosting and other ancillary services simpliciter
    to customers and not for use, or hire, or lease, of any equipment.
  •       Accordingly,
    payments received by the assessee could not be said to be royalty within the
    meaning of Explanation (2) to section 9(1)(vi) of the Act and also Article
    12(3)(b) of the India-USA DTAA. Besides, in the absence of a PE of the assessee
    in India, in terms of the India-USA DTAA its income could not be taxed as
    business profits in India.

 

Articles 7, 14 and 23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or 14 (though not taxable under those Articles), Article 23 is not applicable Article 14 of India-Spain DTAA – Merely because companies are engaged in real estate development, it could not be concluded that their assets ‘principally’ consist of immovable properties; therefore, capital gain earned on sale of shares of such companies not taxable under Article 14

21 [2019] 112
taxmann.com 119 (Mum.)(Trib.) JCIT vs. Merrill
Lynch Capital Market Espana SA SV ITA No. 6109 (Mum.)
of 2018 A.Y.: 2013-14 Date of order: 11th
October, 2019

 

Articles 7, 14 and
23 of India-Spain DTAA – As gains from hedging were covered under Article 7 or
14 (though not taxable under those Articles), Article 23 is not applicable

 

Article 14 of
India-Spain DTAA – Merely because companies are engaged in real estate
development, it could not be concluded that their assets ‘principally’ consist
of immovable properties; therefore, capital gain earned on sale of shares of
such companies not taxable under Article 14

 

FACTS I

The assessee was a
company incorporated in, and tax resident of, Spain. It was registered as a
Foreign Institutional Investor (FII) in India. During the relevant year, the
assessee had undertaken certain transactions to hedge its exposure in foreign
exchange on Indian investments and earned gains therefrom.

 

During the course
of assessment proceedings, the A.O. noticed that the assessee had earned gain
from hedging which it had claimed was exempt under Article 14 of the
India-Spain DTAA. The A.O. observed that being an investor, the assessee could
not carry on any business activity. Accordingly, the A.O. held that the receipt
was in the nature of other income, which was taxable in India in terms of
Article 23(3) of the India-Spain DTAA.

 

In appeal, the
CIT(A) followed the orders of his predecessors in the assessee’s own case.
Further, the CIT(A) also relied on the decision in Citicorp Banking
Corpn., Bahrain vs. ACIT (IT Appeal No. 6625/{Mum.} of [2009]). Accordingly,
the CIT(A) observed that hedging contracts had nexus with the investment in
India because forex transactions were to hedge investment in securities. Hence,
gains from hedging were capital gains. As investment income of the FII was not
taxable in India in terms of Article 14(6) of the India-Spain DTAA, gains from
hedging were also not taxable in India.

 

HELD I

  •     Article 23 comes into play
    only if an item of income is ‘not expressly dealt with’ in the preceding
    articles (i.e. Articles 6 to 22) of the DTAA. The Revenue has not contended
    that as the gains are not covered by Article 7 (Business Income) or Article 14
    (Capital Gain), they should be taxable under Article 23 (Other Income) which
    gives residuary taxation rights to source jurisdiction.
  •     Income cannot be brought
    within the ambit of Article 23 only because it cannot be taxed as the
    conditions for taxability in source jurisdiction were not fulfilled. However,
    income which is otherwise not covered under Articles 6 to 22 (such as alimony,
    income from chance, lottery or gambling, rent paid by resident of a contracting
    state for the use of an immovable property in a third state, and damages which
    do not pertain to loss of income covered by Articles 6 to 22, etc.) only will be
    covered by Article 23.
  •     Income from gains from
    hedging was covered by Article 7 or Article 14. It was taxable if conditions
    were satisfied. Hence, Article 23 would not have any application.
  •     If hedging contracts were
    entered into in the course of business, notwithstanding regulatory
    permissibility, such contracts could either be revenue or capital in nature.
  •     If gains were capital in
    nature, they will be capital gains and would be subject to Article 14 of the
    India-Spain DTAA. A perusal of Article 14(1) to 14(5) shows that none of the
    clauses could be invoked. Accordingly, in terms of Article 14(6), the gains
    were not taxable in source jurisdiction.
  •     If gains were revenue in
    nature, they will be business profits and would be subject to Article 7. They could
    be taxed in source jurisdiction only if the assessee has a PE in India. Article
    7 of the India-Spain DTAA merely mentions ‘profits of an enterprise’. The A.O.
    has mentioned that ‘as an investor, the assessee cannot carry out any business
    activity’ and, therefore, it cannot be said to be a business activity. However,
    Article 7 does not even remotely suggest compliance with regulatory conditions
    for qualifying under the DTAA. Whether with regulatory approval or without
    regulatory approval, and whether legal or illegal, business profits are taxable
    nevertheless.
  •     Even if these were not
    hedging contracts but the assessee was dealing in forward exchange contracts simplicter,
    by itself it could not make gains taxable under Article 7 if the assessee did
    not have a PE in India, or under Article 14 if the gains were not covered in
    Article 14(1) to 14(5). Merely because gains though covered under Article 7 or
    14 but not taxable, would not be covered by Article 23. Hence, gains from
    hedging could not be taxed as non-business income.
  •     Accordingly, the assessee
    was not liable to tax on gains under the India-Spain DTAA.

 

FACTS II

The assessee had invested in shares of certain companies engaged in
development of real estate. Shares of these companies were listed on the stock
exchange (and the taxpayer held them as portfolio investment such that the
holding in each company was less than 7%). During the relevant year, the
assessee earned capital gains on sale of these shares. In India, such gain
could be taxed in terms of the India-Spain DTAA only if the property of such
company, directly or indirectly, consisted of immoveable properties in India
and the shares of such company derived their value principally from such
immovable properties.

 

The A.O. observed that these companies were in the real estate sector,
including development of residential and commercial properties, and further,
the value of the shares of the companies was derived from the value of
immovable properties held by them.

 

Accordingly, the A.O. concluded that capital gain on the sale of their
shares was taxable in India under Article 14(4) of the India-Spain DTAA.

 

In appeal, the
CIT(A) observed that the assessee had minuscule shareholding which could not
have given any right, either in stock-in-trade of those companies, or to occupy
immovable properties of those companies. The CIT(A) further observed that
Article 14(4) was meant to cover cases of indirect transfer of immovable
properties through transfer of shares of companies holding properties. It would
not cover cases where commercial investments were made in shares of companies
engaged in the real estate sector. Hence, the CIT(A) held that gains on the
sale of shares were not taxable in India in terms of Article 14(6) of the
India-Spain DTAA.

 

HELD II

  •     The assessee had sold no
    more than 2% shares in any of the six realty companies. It did not hold any
    controlling interest or even significant interest in these companies which
    could provide any right to occupy properties. All the companies were engaged in
    the business of real estate development and not in holding of real estate per
    se    .
  •     Under Article 14(1), gains
    from immovable property may be taxed in source state. The purpose of Article
    14(4) is to cover gains from shares of a company holding immovable property
    which would not have been covered in Article 14(1).
  •     The India-Spain DTAA does
    not specifically define the expression ‘principally’. From clarifications in
    model convention commentaries, in the absence of anything to suggest a
    different intention, the threshold test should be 50% of total assets. Only
    such companies where holding of immovable property directly or indirectly
    comprises at least 50% of aggregate assets are covered.
  •     Merely because a company is
    engaged in real estate development it would not imply that over 50% of its
    aggregate assets consist of immovable properties. Apparently, the A.O. has
    presumed that just because these companies are dealing in real estate
    development the assets of these companies ‘principally’ consist of immovable
    properties.
  •     Accordingly, the CIT(A) had
    correctly held that cases where commercial investments were made in shares of
    companies engaged in the real estate sector were not covered. Hence, gains on
    sale of shares were not taxable in India in terms of Article 14(6) of the
    India-Spain DTAA.

 

Article 11 of India-Mauritius DTAA; sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt) are fulfilled – Transfer pricing provisions cannot apply to tax an amount which had neither accrued to, nor was received by, the taxpayer

20 [2020] 113 taxmann.com 79 (Mum.)(Trib.) Gurgaon Investment Ltd. vs. DCIT ITA Nos. 1499 (Mum.) of 2014, 7359 (Mum.) of
2016 & 6821 (Mum.) of 2017 A.Y.: 2008-09, 2011-12 & 2012-13 Date of order: 15th November,
2019

 

Article 11 of India-Mauritius DTAA;
sections 4, 92 of the Act – As per Article 11(1), interest can be taxed only if
twin conditions of ‘arising’ (i.e., accrual) and ‘paid’ (i.e., actual receipt)
are fulfilled – Transfer pricing provisions cannot apply to tax an amount which
had neither accrued to, nor was received by, the taxpayer

 

FACTS

The assessee was a
non-resident company incorporated in Mauritius. It was engaged in the business
of holding of investments. It was a member company of an international group of
financial management and advisory companies. The assessee had purchased
compulsorily convertible debentures (CCDs) of an Indian company (I Co) from its
AE based in Mauritius.

 

In course of transfer pricing proceedings, the assessee furnished
details of interest on debentures due from I Co. The assessee submitted that it
had waived interest that was due from I Co and I Co had also not claimed
deduction of interest on CCDs. Therefore, no income had accrued to the
assessee. The TPO observed that the assessee had waived interest to help its
AE. Therefore, such interest was to be reduced from the income of the assessee.

 

CIT(A) upheld the
transfer pricing adjustment made.

 

HELD

  •     Article 11(1) of the
    India-Mauritius DTAA reads: ‘Interest arising in a Contracting State and
    paid to a resident of the other Contracting State may be taxed in that other
    State.’
  •     The expression ‘paid’ has
    been used in several other DTAAs, in similar as well as different contexts.
    Several judicial authorities have interpreted the expression ‘paid’ and held1  that in such cases the relevant income is to
    be taxed on paid basis and not accrual basis.
  •     Article 11(1) of the India-Mauritius DTAA
    requires fulfilment of the twin conditions of ‘arising’ (i.e., accrual) and
    ‘paid’ (i.e., actual receipt) for taxability of interest. Unless both
    conditions are fulfilled, interest will not be taxable.
  •     Once interest is not
    taxable as per Article 11(1) of the DTAA, section 4 of the Act will have no
    application. Section 92 and other provisions in Chapter X are in the nature of
    machinery provisions, which are subject to charging provision in section 4 of
    the Act. If a particular item of income does not come within the purview of the
    charging provision, the machinery provisions would not be applicable.
  •     Chapter X containing TP
    provisions is in the nature of anti-avoidance provisions applicable in case of
    transactions between related parties. However, when income itself is not
    chargeable to tax because of DTAA provisions, there is no question of tax
    avoidance / evasion being applicable.
  •     It was only because of
    difficulties in the real estate sector that investee companies had requested
    for waiver of interest.
  •     For taxing interest, it was
    necessary to satisfy the twin conditions of accrual and payment. However, the
    TPO / A.O. had sought to tax what the assessee was supposed to
    receive     (but, factually had not received).
  •     Transfer pricing adjustment
    was made on this hypothetical amount. In Vodafone India Services (P.)
    Ltd. vs. Union of India [2014] 50 taxmann.com 30 (Bom.)    , the Bombay
    High Court held that even income arising from an international transaction must
    satisfy the test of income under the Act and must find its home in one of the
    charging provisions. The TPO / A.O. had not established that notional interest
    satisfied the test of income arising or received under the charging provision
    of the Act. Transfer pricing adjustment in respect of interest which was
    neither received by, nor had accrued to, the assessee could not be made.

_________________________________________________________________

 

1 DIT vs. Siemens Aktiengesellscharft, [IT Appeal No.
124 of 2010, dated 22nd October, 2012]
[India-Germany DTAA];
Johnson & Johnson vs. Asstt. DIT; Johnson & Johnson vs. ADIT [2013] 32 taxmann.com
102 (Mum.)(Trib.) [India- USA DTAA]; Pramerica ASPF 11 Cyprus Holding Ltd. vs.
Dy. CIT [2016] 67 taxmann.com 368 (Mum.)(Trib.) [India-Cyprus DTAA].

Section 56(2)(vii)(b) dealing with receipt of immovable property for inadequate consideration will not apply to a case where the agreement for purchase was made before amendment of this section, substantial obligations discharged and rights accrued in favour of assessee but merely registration was on or after amendment of said section Interest under sections 234A and 234B is chargeable with reference to the returned income and not the assessed income

12. Bajrang Lal Naredi vs. ITO (Ranchi) Pradip Kumar Kedia (A.M.) and Madhumita Roy
(J.M.) ITA No. 327/Ran/2018 A.Y.: 2014-15 Date of order: 20th January, 2020

Counsel for Assessee / Revenue: Anand Pasari
with Nitin Pasari / Nisha Singhmarr

 

Section
56(2)(vii)(b) dealing with receipt of immovable property for inadequate
consideration will not apply to a case where the agreement for purchase was
made before amendment of this section, substantial obligations discharged and
rights accrued in favour of assessee but merely registration was on or after
amendment of said section

 

Interest under sections 234A and 234B is
chargeable with reference to the returned income and not the assessed income

 

FACTS I

The assessee, in the year under consideration, registered in his name an
immovable property on 17th June, 2013 against the actual purchase of
property done on 15th April, 2011 in financial year 2011-12. The
purchase consideration was determined at Rs. 9,10,000 at the time of agreement
for purchase in financial year 2011-12; accordingly, the payment was made at
the time of such agreement to the vendor. The registration was, however,
carried out at a belated stage on 17th June, 2013 on which date the
stamp duty valuation stood at a higher figure of Rs. 22,60,000. The A.O.
noticed the alleged under-valuation in the purchase price of the property qua
stamp duty valuation and applied provisions of section 56(2)(vii)(b) of the Act
and worked out the adjusted purchase consideration of Rs. 18,89,350. The A.O.,
accordingly, treated the difference of Rs. 9,79,350 as ‘deemed income’ having
regard to the provisions of section 56(2)(vii)(b) of the Act as amended by the
Finance Act, 2013 and applicable from assessment year 2014-15 onwards.

 

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed
the action of the A.O. Next, the aggrieved assessee preferred an appeal to the
Tribunal.

 

HELD I

The Tribunal noted
that it is the applicability of section 56(2)(vii)(b) of the Act as amended by
the Finance Act, 2013 and applicable to A.Y. 2014-15 which is in question. The
Tribunal observed that as per the pre-amended provisions of section
56(2)(vii)(b) of the Act, where an individual or HUF receives from any person
any immovable property without consideration, the provisions of amended section
56(2)(vii)(b) of the Act would apply. This position was, however, amended by
the Finance Act, 2013 and made applicable to A.Y. 2014-15 onwards. As per the
amended provisions, the scope of the substituted provision was expanded to
cover the purchase of immovable property for inadequate consideration as well.

 

It observed that there is no dispute that purchase transactions of
immovable property were carried out in financial year 2011-12 for which full
consideration was also parted with the seller. Mere registration at later date
would not cover a transaction already executed in the earlier years and
substantial obligations already been discharged and a substantive right accrued
to the assessee therefrom. The Tribunal held that pre-amended provisions will,
thus, apply and therefore the Revenue is debarred to cover the transactions
where inadequacy in purchase consideration is alleged. The Tribunal deleted the
addition made by the A.O. and confirmed by the CIT(A).

 

The Tribunal allowed this ground of appeal filed by the assessee.

 

FACTS II

The second issue in
the appeal filed by the assessee was raised by filing an additional ground. The
issue for consideration of the Tribunal was whether interest u/s 234B of the
Act is chargeable on assessed income qua return income.

 

HELD II

The Tribunal noted that an identical issue had come up before the coordinate
bench of the ITAT in ITO vs. M/s Anand Vihar Construction Pvt. Ltd. ITA
No. 335/Ran/2017 order dated 28th November, 2018. Having
noted the ratio of the decision of the coordinate bench of the Tribunal,
it held that interest under sections 234A and 234B of the Act is chargeable
with reference to returned income only.

 

 

Sections 32, 37, 45, 50 – Where the business of the assessee came to a halt, expenses incurred by the assessee for maintaining its legal status and disposing of the assets are allowable u/s 37(1) of the Act Assessee owned leasehold rights in the land and a building was constructed thereon; on transfer of the same, capital gains were to be bifurcated as long-term capital gains on transfer of land u/s 45 and short-term capital gains on transfer of building u/s 50 Unabsorbed depreciation is deemed to be current year’s depreciation and it can therefore be set off against capital gains

25. [2019] 202 TTJ (Bang.) 893 Hirsh Bracelet India (P) Ltd. vs. ACIT ITA No. 3392/Bang/2018 A.Y.: 2015-16 Date of order: 3rd July, 2019

 

Sections 32,
37, 45, 50 – Where the business of the assessee came to a halt, expenses
incurred by the assessee for maintaining its legal status and disposing of the
assets are allowable u/s 37(1) of the Act

 

Assessee owned
leasehold rights in the land and a building was constructed thereon; on
transfer of the same, capital gains were to be bifurcated as long-term capital
gains on transfer of land u/s 45 and short-term capital gains on transfer of
building u/s 50

Unabsorbed
depreciation is deemed to be current year’s depreciation and it can therefore
be set off against capital gains

 

FACTS

The assessee company was engaged in the
business of manufacturing wrist watch straps. The assessee had taken land on
lease for a period of 99 years and set up a unit for designing, importing,
exporting, dealing in and manufacturing wrist watch straps. In view of
continued losses and several operational difficulties, the business of the
assessee had to be closed down. The assessee had declared capital gains on the
sale of leasehold rights in land and building as short-term capital gain in the
return of income and, after adjusting current year’s expense and depreciation,
returned a total income.

 

During the course of the assessment
proceedings, the assessee claimed that sale of leasehold rights in land would
result in long-term capital gains. But the A.O. taxed the capital gains as short-term
and did not allow set-off of brought forward business losses. Further, the A.O.
had disallowed the expenditure u/s 37(1), contending that the same could not be
allowed as there was no business in existence.

 

Aggrieved, the assessee preferred an appeal
to the CIT(A) who dismissed the appeal.

 

HELD

The various expenses incurred by the
assessee were to maintain its legal status as a company until the assets were
disposed of and the liabilities paid. The Tribunal held that it was essential
for the assessee to incur these expenses and neither the A.O. nor the CIT(A)
has doubted the incurring of the expenditure. The assessee held leasehold
rights in land and it required permission from the Government for transfer of
such rights. This permission was received by the assessee only in the previous
year, 2013-2014. Therefore, even though the business of the assessee had come
to a halt in 2010, it was necessary to maintain the legal status until all the
assets were liquidated. Thus, the expenses incurred by the assessee were to be
allowed as a deduction in computation of income.

 

The assessee had made a claim for the
bifurcation of capital gains into long-term capital gains on transfer of
leasehold rights in land and short-term capital gains on transfer of building,
being a depreciable asset, in accordance with the provisions of section 50. The
assessee was entitled to bifurcate the capital gains and the provisions of
section 50 would be made applicable in computation of capital gains arising
from transfer of building.

 

Unabsorbed depreciation is deemed to be
current year’s depreciation and the same can be set off against capital gains
under the provisions of section 71.

 

These grounds of appeal filed by the
assessee were allowed.

 

TRANSITION TO CASH FLOW-BASED FUNDING

HISTORY

The Indian
banking industry is centuries old. A peep into its recent past is replete with
milestone events of change. Notable among them, starting with social control
over banks, have been nationalisation of commercial banks; identification of
priority sector for lending; an annual credit plan; diversification of
institutions and setting up of the Exim Bank to focus on export financing;
regional rural banks to introduce the hybrid of commercial bank strength with
local government participation; the creation of local area banks; micro-finance
companies; and so on. Clearly, banks have been an important tool to facilitate
the development of the Indian economy for decades. Foreign direct investment
norms in the banking sector were relaxed and the cap raised to 74%. The
financial needs of the rapidly-growing economy were catered to by government
banks, private banks and foreign banks, with a major share taken by government
banks. The Reserve Bank of India (RBI) issued guidelines for banks and ensured
compliance of BASEL-I norms in a phased manner between 1991 and 1999.

 

The growing economy needed more
finance and advanced banking. The ever-increasing need for strengthening of the
banking sector was further underlined as Lehman Brothers collapsed in the
Sub Prime Crisis (it filed for bankruptcy in 2008 – the largest in US
history). Around that time, commercial banks in India were in the process of
implementing BASEL-II norms which were completed by March, 2009. With the
advent of Information Technology, the retail industry boom and modernisation of
communication and data transfer, there have been rapid changes in the way
people and corporates do banking. The most recent development in the banking
business was in 2016 when RBI approved ten entities to set up small finance
banks.

 

Reserve Bank of India is the
regulatory body of Indian banking. With the adoption of BASEL norms, the
functioning of Indian banks is more standardised and in line with international
practices.

 

PRESENT SCENARIO

There have been various business strategies
in corporate lending followed by bankers. Banks with large balance sheets have
shown an appetite for taking large exposures and have been also daring to play
long term. On the other hand, Non-Banking Financial Corporations (NBFCs) have
exercised quick entry and timely exit compromising on collateral covers but
snatching from banks the opportunity of making good profit margins. Whatever
the form of these loans, all of these are asset-backed financing models.

 

By and large, all public sector
banks in India are disbursing loans (long–term, short-term loans, working
capital loans / cash credits) on the basis of assets as security. For term
loans, the primary security are assets like property, plant, equipment (fixed
assets) owned by the company. For short-term loans and working capital loans,
normally stock and debtors (current assets) are the primary security. The
liquidation value of an asset is the primary focus and projected cash flows are
the secondary focus. Cash flows are part of project proposals; however, such
inflows are not linked directly to loan eligibility or repayment / servicing
frequency and mode. This involves a lot of documentation and mortgage of the
asset in the name of the banker till the loan remains outstanding.

 

Post-disbursal, borrowers submit
periodic performance reports and provisional financials to the bankers as per
agreed terms. This information is not real-time information and in many cases
there are delays in submission of these documents. Banks lack the advanced
analytical tools and bandwidth to assess these reports regularly on a real-time
basis. Non-performance of an asset, i.e., borrower account, gets noticed quite
late when risk exposure is already very high. Increase in non-performing assets
is worrisome not only for the banker but for the economy at large as public
funds are at stake.

 

One may find that the practice of
asset-based lending has not helped us in timely identification of likely
non-performing credit and immediate reconstruction to put them back on track. A
question therefore arises whether it is time to go for alternate methods of
credit appraisal and adopt international best practices in banking in general
and lending in particular.

 

PROPOSED CHANGE

Assets don’t help companies to
repay loans. Often, the disposal of assets, primarily immovable property, poses
great difficulty in selling. It’s their cash flow that makes a difference. The
need for mitigation of risk is inherent to the banking business – new
technologies, policies and strategies are adopted from time to time for this.
Under the new mechanism, banks would be able to prioritise their fund
deployment programme. The public sector major, State Bank of India (SBI), has
announced that it will shift to the cash flow-based lending model beginning April,
2020. Other PSUs will not lag behind in following suit; some banks are already
doing it for a portion of their products.

 

Banks in India have traditionally
lent to companies against their assets. Cash flow-based lending is widely
considered to be a more efficient and safe way of mitigating risk as it reduces
discretion on the part of the lender. The new framework for loan sanctions will
apply to large companies as well as small enterprises.

 

THE MECHANISM

Cash flow-based lending (CFL)
envisages a shift in the bank’s appraisal system from traditional balance
sheet-based funding to a more objective appraisal system of leveraging the cash
flows of the unit. In CFL, loan requirement is based on actual revenue
generation and capacity to repay. Further, the repayment schedule is based on
the timing of the entity’s cash inflows. Company’s cash conversion cycle is
calculated. Based on cash conversion cycle, the ability of the borrower to pay
back the loan is calculated. With better negotiated terms with vendors / creditors,
the cash conversion cycle will shrink; and with increase in credit period to
the customer, the cash conversion cycle will be longer. While 25% of the
working capital gap (the difference between assessed gross working capital
assets minus gross working capital liabilities) is met by the company, banks
fund the remainder. Most of the working capital finance is in the form of cash
credit, a system where companies freely draw (and service interest) within a
certain limit or drawing power fixed by the lender. Drawing power is arrived at
on the basis of inventory volume minus margin therein. Cash flow lending, then,
is essentially lending to repeated asset conversion cycles and payback is
dependent on the firm’s ability to generate (and retain in the business)
sufficient cash over a number of years of profitable operations to make
required interest and principal payments on the loan. The loan amount as well
as mode of repayment is adjusted with cash inflows based on the cash conversion
cycle. Documented cash flows and the credit rating of the borrower will play an
important role.

 

A system of determining monthly /
quarterly utilisation limits for credit drawings can be fixed. Actual drawings
should be confined to determine limits. Deviations are not allowed and, when
allowed, they are always with approval from higher levels. The quarterly
monitoring system should ensure no diversion of bank credit for purposes other
than the sanctioned purpose.

 

NATURE
OF CHANGE IN BASIS OF LENDING

India’s government-owned banks
are likely to change the way they lend. Since the 1970s, public sector banks
have given out most working capital loans and short-term loans required for the
day-to-day operations of a business. Public sector banks have a more than 55%
share of the loan market. These loans were disbursed on the basis of the net
current assets of corporate borrowers. This is considered as a flawed system
that is believed to have resulted in over-funding to some and under-funding to
others. A system which does not focus on entity cash inflows as the primary
basis of loan availment and mode of repayment, often results in delayed
repayments, thus adversely affecting the NPA ratio. The outdated practice may
soon change with the country’s largest lender State Bank of India proposing a
transition from an ‘asset-based lending’ model to ‘cash flow-based lending’, a
mechanism that, among other things, may reduce diversion of funds by borrowers
and enable banks to assess the ability of borrowers to service loans on time.
The shift will require borrowing entities to share their cash flow statements
more frequently with banks.

 

NATURE OF LOAN PORTFOLIOS

Except for
some seasonal industries such as sugar, public sector banks arrive at a
company’s working capital requirements by considering the difference between
the borrower’s current assets (receivables, raw material stock, finished goods)
and current liabilities (payables like loan interest, taxes, payment to vendors
and workers). While 25% of the working capital gap (the difference between
assessed gross working capital assets minus gross working capital liabilities)
is met by the company, banks fund the remainder, although in many cases they
end up funding more. Most of the working capital finance is in the form of cash
credit, a system where companies freely draw (and service interest) within a
certain limit or drawing power fixed by the lender. Such asset-based lending
ignores the manipulation of the actual value of the assets pledged.

In a country like India a major
portion of the short-term loan portfolios of PSU banks consists of Cash Credit
(CC) accounts. As mentioned above, these loans are disbursed on the basis of
current assets as primary security. These assets themselves are not cash but
there is always conversion time in which these assets will generate cash. On a
broader basis, there would be the cash conversion cycle of every company. These
types of loans are most suited for cash flow-based funding. This is further
suited for MSMEs (Medium, Small and Micro Enterprises). Cash flow-based lending
envisages a shift in the banks’ credit appraisal mechanism and monitoring
system from the traditional balance sheet-based funding to a more objective
appraisal system. In CFL, loan requirement is based on actual revenue
generation and capacity to repay. Furthermore, the repayment schedule is based
on the timing of the MSME’s cash inflows. The advantages of CFL are that the
loan amount and repayment are based on the MSME’s actual cash generation,
reduction in credit risk, reduced monitoring costs for banks, reduction in
turnaround time and ability to serve entities that don’t have adequate
collaterals.

 

CHANGE IN ASSESSMENT OF BORROWER
BUSINESS

The primary focus in assessment
of business will no longer be the asset base of the balance sheet. The primary
focus will be cash inflows and the cash conversion cycle. Assets will be only
secondary support. Proven past cash flow generation data and credit ratings
will play an important role. Various databases and information available on the
cloud platform will be considered for data analysis. TransUnion CIBIL data will
by and large be considered a reliable source. Nowadays this data is available
at one’s fingertips, thanks to linking of the data base of PAN, Udyog Aadhaar,
Credit Cards. This data is more reliable and available independently for
verification.

 

IMPACT

Banking disbursement is expected
to rise. As asset backing is no more a primary criterion, companies not having
a large fixed capital base or real estate but having past record of operations
and margins can now avail cash flow-based loans. Various Startups which are in
the category of service sector will be benefited as these cash flow-based
funding loans will be available to these units, thereby increasing the size of
the disbursement portfolios of banks and financial institutions.

 

IMPACT – On NPA and bank balance
sheet

As mentioned earlier, due to lack
of expertise and bandwidth to assess various financial data real time, the
monitoring was not very effective. Since there was no direct linking of the
timing of cash inflows, the cash conversion cycle and repayment mode and
frequency, there used to be delays and at times diversion of funds, too. With
the shift to cash flow-based funding, these drawbacks will no more result in
NPAs growing without any control as drawings can be stopped when cash flows are
affected. The framework is already available for analysis of data. Databanks
are ready with authenticated data linked to the borrower and access to such
information is available to bankers. Loan amount and repayment frequency when
tied up with cash inflow working and timing, loan disbursal will be more
scientific and will cover the cyclical nature of business. All these will
facilitate timely servicing of loans, thereby improving overall NPA ratio.

 

IMPACT – On borrowing cost

Since the primary security is
future cash flows based on past records and credit ratings, there is no
tangible security in many cases. The cost of borrowing will tend to be higher
than asset-backed lending. With favourable performance and consistency in
repayment, this cost will also tend to ease out for standard portfolios.

 

IMPACT – On sectors

Service-oriented businesses with
minimum fixed or tangible capital with proven business model Startups – which
do not have any past record but are in a tie-up with payment gateways for
capturing sales inflows which can be reliably assessed for funding.

 

Financial Technology Companies
which provide various financial solutions to traders and service providers for
capturing the data real time and for producing various complex reports needed
for assessment will be benefited and the impact will be positive.

 

INTERNATIONAL PRACTICE

Cash flow-based financing may be
a recent development in India; however, all over the world this is a settled
method of financing, specially to small and medium enterprises, or to
organisations which do not have collateral but have a strong margin business
model, or organisations which do not have past track records and hence
appraisal risks are high; in such cases also, cash flow-based funding is in
vogue.

 

Key Features:

Lending to finance an entity’s
permanent (long-term) needs, seasonal needs;

Usually medium-term, with loan
terms of up to seven or eight years in most cases;

Covenants in the loan agreement
are often included as a ‘trigger’ to signal to the lender a deteriorating
situation so that corrective action may be taken.

 

While there are pronounced
advantages in CFL over asset-based lending, the emphasis is on the process of
the lending method. This presupposes a dedicated and purpose-oriented
policy-making personnel equally supported by an alert team of front-end staff.

 

CONCLUSION

From the foregoing paragraphs one
may conclude that the rapid growth of the Indian economy needs to be
continuously supported by an efficient system of banking dedicated to lend with
care and identify the potential risk much in advance; and also to mitigate the
risk by suitably hedging with a cash flow-based lending in place of asset-based
lending with all its limitations.

 

In
the short run, or even in the long run, cash is the only factor that repays a
loan; the cash conversion cycle is the only correct method to decide the mode
and frequency of repayments. Collateral is the buffer in case cash is not
generated to repay a loan. Cash flow control is the need of the times. In order
to be in line with government policies and also to reap the benefits of a
win-win situation for bankers and small and medium enterprises, cash flow-based
loans appear more appropriate as the supporting infrastructure framework is
already ready.

PANEL DISCUSSION ON UTILITY OF FINANCIAL STATEMENTS AND RELEVANCE OF AUDIT AT THE 10TH Ind AS RSC

A panel discussion on the ‘Utility
of Financial Statements and Relevance of Audit’ was the highlight of the 10th
Ind AS Residential Study Course (RSC) held at the Alila Diwa
Hyatt in Goa from 5th to 8th March, 2020.

 

The panellists represented
various stakeholder groups related to financial statements: Mr Raj Mullick,
Senior Executive Vice-President at Reliance Industries Ltd. from the preparers’
side; Mr. Nilesh Vikamsey, Past President of the ICAI representing the auditor
fraternity; Mr. Jigar Shah, CEO, Kimeng Securities India Pvt. Ltd. and
also an analyst; and Mr. Prashant Jain, Chief Investment Officer of HDFC
AMC (a fund manager). The discussion was moderated by Mr. Sandeep Shah,
CA. This report on the panel discussion is for the readers of the BCAJ
who would benefit immensely considering the present situation relating to audit
of financial statements.

 

INITIAL
REMARKS

Preparers’ Perspective:

Mr. Raj Mullick began by
indicating that the utility of the financial statements lay at two extreme
ends; whilst they provide a lot of value to certain classes of users such as
analysts, government authorities and bankers, they are often relegated to the
dustbin by certain other users, including some shareholders. However, generally
financial statements are relevant to various stakeholders like shareholders,
government authorities, bankers, analysts, suppliers and customers, each of
whom looks at specific aspects as per their requirements and serve as an
important communication tool on various matters like vision, mission and
strategy of the entity, its leadership, dividend policy and CSR activities,
amongst others.

 

He highlighted that there are
several challenges which could hamper their utility, including the sheer size
of the content, the use of several technical jargons like MAT, Deferred Tax,
OCI, ESOP, etc. Some of these challenges could be overcome by disclosure of
sufficient qualitative and quantitative information covering impact analysis of
future events and other explanatory and proactive disclosures so as to meet the
varying needs of lenders, analysts and also credit rating agencies.

 

On the role of the finance team
in making the financial statements more relevant and reliable, he highlighted
various steps which could be taken as under:

(a) Working closely with the CEO;

(b) Establishing appropriate accounting policies;

(c) Reflecting the nature of the business in the financial statements;
and

(d) Disclosing critical estimates and judgements.

 

Finally, Mr. Mullick
stated that the role of the auditors is of paramount importance since they
provide an assurance on the completeness of the financial statements and their
compliance with the generally-accepted accounting principles. He also
emphasised that by performing systematic, in-depth reviews of corporate
controls, the auditors help ensure that a company avoids coming under
regulatory scrutiny. He cautioned that going forward, for auditors to be
relevant they need to go much beyond numbers and be more tech-savvy and exhibit
a better understanding of the business.

 

Auditors’ Perspective:

Mr. Nilesh Vikamsey began by
stating that for (this) audience the relevance of the financial statements and
the utility of audit is a no-brainer in spite of some recent
‘accidents’. He indicated that financial statements are relevant to the
following sets of users:

(i) Shareholders, managements, potential investors and promoters;

(ii) Lenders, analysts, rating companies and potential lenders;

(iii) Government and tax authorities;

(iv) Regulators like SEBI, MCA
and RBI.

 

He lamented
the fact that in the past even when the auditors had qualified the financial
statements of a particular company on several counts, including on ‘going
concern’ issues, large funding was provided to it mainly on the security of its
brand, which raised a doubt as to whether the intended users took the financial
statements seriously.

According to him, the financial
statements reflect on matters involving governance, risks, estimates,
contingencies, etc. which may not always be a focus point of the various users,
and hence their relevance and utility could get diluted. Besides, the credit
and market risk disclosures need improvement from the current boiler plate /
template-ised disclosures.

 

Another area where there was
enough ammunition provided by the financial statements was the red flags (which
may not be always acted upon by the users), on issues such as:

(1)   Rising debt-equity ratio;

(2)   Capitalising revenue expenditure;

(3)   Rising fixed assets without corresponding increase in production
and / or sales;

(4)   Large ‘other expenses’ in the P&L account;

(5)   Rising accounts receivable and inventory compared with sales;

(6)   Higher or lower ‘other income’ as compared to ‘revenue from operations’.

 

Mr. Vikamsey also
touched upon disclosure initiatives at the international level to address
issues around which accounting policies need to be disclosed, defining
materiality, better organised entity-specific disclosures on performance,
working capital management, etc., improving the structure and content of
financial statements with new sub-totals (EIBDTA) and notes on management
performance measures.

 

He pointed out that in spite of
the recent aberrations due partly to the greed of some members and which needed
to be tempered, the role of auditors will always remain relevant. However, they
would need to embrace greater digitisation which would result in sampling
getting replaced with AI and routine operations like reconciliation being
automated. Going forward, the auditors would need to adopt a middle path
between scepticism and investigation. Various reporting initiatives like
KAMS, ICFR CARO, LFAR, etc. provide useful insights to analysts, investors and
regulators. Moreover, independent directors need to see greater value in the
audit process and need to don the auditor’s hat to keep pushing the management.

 

Analysts’ Perspective:

Mr. Jigar Shah stressed
that the utility and relevance of the financial statements can be improved by
building ‘additional, relevant, non-conventional’ disclosures,
especially around predicting future events, diversity and ESG (Environment,
Social and Corporate Governance) which would be a win-win situation for all
stakeholders. Earnings may not always necessarily represent the bottom line and
may not have a correlation to the market capitalisation of the entity due to
various reasons like contingent liabilities, whistle-blower complaints, etc.

 

On the question of asset
impairment, he observed that it is generally done only in times of an extreme
business cycle, or when the business is about to be sold. He emphasised a more
regular and vigorous assessment of asset impairment due to various
technological changes like 5G, IOT and other matters like climate change and
sustainability which could have an impact on industries like automobiles
(emission norms, electric vehicles), cement (penalties for flouting pollution
norms), real estate (climate change and global warming resulting in destruction
of real estate in coastal cities due to floods), general insurance (impact of
climate change on underwriting models) and IT (impact due to water crisis in
cities like Bangalore and Chennai).

 

Another area where he felt that
more granular disclosures were needed was with regard to intangibles in certain
specific industries like pharma, banks / finance companies, consumer goods
companies and so on on matters like expenses on brands, digital initiatives,
customer acquisition, technology development (because as per the current
accounting standards, any expenses on self-generated intangibles need to be
expenses off and may not always be completely disclosed).

 

On audit quality and its
relevance, Mr. Jigar Shah felt that the same is largely maintained and
it would not be proper to paint everyone with the same brush. The role of audit
is also likely to increase in the coming days due to various additional
reporting requirements under CARO. He also felt that auditors should not resign
immediately but must report.

 

Fund Managers’ / Investors’
Perspective:

Mr. Prashant Jain started by
stating that as an investor there are two mistakes which need to be guarded
against: the first is to avoid investments in entities whose value is likely to
fall, and the other is to miss investing in entities whose value is likely to
rise. Whilst the financial statements generally provide clues to the first
situation if one reads the notes and other information in detail and identifies
any aggressive accounting policies and other red flags, the same may not be
true in the case of the latter. In his view the balance sheet and the cash
flows are more important and relevant from their long-term value perspective
than the Profit and Loss statement which is more temporary in nature. He
recalled that one of his earliest learnings from a senior fund manager was that
the bottom line is sanity, the top line is vanity but cash
is reality!

 

It would be wrong to link
failures entirely to the financial statements, except in situations like severe
ALM mismatches or aggressive accounting policies since they could arise due to
various other reasons like government policies, competitor actions, failed
acquisitions and incorrect capital allocation, amongst others.

 

Mr. Jain felt that
there could be better quality disclosures on certain matters such as:

(A) Impact on the financial statements due to non-routine matters like
significant changes in oil prices, foreign exchange volatility in case an
entity has operations in several geographies;

(B) The reasons for recording huge amounts as goodwill in tune with the
underlying performance of the group companies;

(C) The impact on the financial statements due to long-term leases where
there is a lower profitability in the initial years, and in situations where
the entity keeps on entering into new leases continuously.

 

PANEL DISCUSSION

After the above observations,
moderator Sandeep Shah put forth various questions arising out of them
and on certain other matters, resulting in a healthy discussion amongst the
panellists. A summary of the views of the panellists on various matters is
provided here:

 

(i) Whether rigorous examination by auditors
is undertaken: The primary responsibility for the preparation of the
financial statements is that of the management and the auditors generally
conduct a rigorous examination thereof. However, the quality of disclosures
could improve and greater scepticism on their part is warranted in view of the
recent failures;


(ii) Whether audit is a commodity: There
were differing views on this. The views in support thereof arose primarily from
the growth expectations and undercutting of fees due to rotation, especially
amongst the larger firms. However, firms are now evaluating their risk
profiling of clients and increasingly resorting to resignations within the
regulatory framework. On the other hand, since in certain cases the auditors
grow with the companies, there is no commoditisation and it is up to the entity
whether it wants to do so;


(iii) Competitiveness of audit fees: On the
question whether the fees paid to the auditors are reasonable vis-a-vis
the complexity involved, it was felt that there was scope for improvement since
the lower fees are partly due to the lower rate of growth in the compensation
levels of the white-collar employees in the past 20 years compared to the
blue-collar employees, such as drivers;


(iv) Audit quality and related disclosures: The
quality of the audit firms is primarily driven by the partners and the staff
both in terms of their brand value and technical competence. However, adequate
disclosures are not made in respect of the credibility of the team members
except for the name of the signing partner. It was felt that a rating of the
audit firms is the need of the hour. The AQI proposed in the MCA consultation
paper could also be a step in that direction, though the ICAI has not made much
progress in the matter. Many small firms are quite meticulous in undertaking
their assignments. In sum, it was noted that in many cases, at the time of
acquisition the acquirer insists on firms of a certain standing to ensure quality;


(v) Role of auditors in evaluation of business and industry impact: It is not
the responsibility of the auditors to evaluate the future impact on the
entity’s business since they are not industry experts, except that they may
only highlight the risks. It was suggested that the management may, as part of
the annual report, give specific disclosures about the possible pricing and
financial implications due to the impact of technology changes on their
business in the foreseeable future;


(vi) Role of technology and digitisation on the audit function: This will
result in a revised set of skills on the part of the auditors around data
inputs / querying which would be very dynamic in nature;


(vii) Relevance and utility of the MD&A: There
were mixed reactions on its utility. Whilst, on the one hand, it serves as a
useful communication tool especially for the larger companies, on the other it
always tends to be optimistic and a report card of the present without
providing a meaningful analysis of the future plans of the business.
Accordingly, it was felt that it does not merit more than a passing interest;


(viii) Relevance of investor presentations: Since
they generally tend to be more detailed than the MD&A, they are more
relevant to the analysts due to their interactive nature which helps them in
updating their valuation models. However, the forward-looking statements made
therein are quite often not substantive and tend to be optimistic and biased;
hence they should be read in conjunction with the detailed notes in the
financial statements, because the devil lies in the details;


(ix) Transition to Ind AS – whether beneficial: Whilst
there is no doubt that Ind AS provides better quality of disclosures, it was
felt that the earlier format of the balance sheet was more reader-friendly
since it provides the sum total of the various line items at a glance as
against the ‘Current’ and ‘Non-Current’ classification of all line items under
Ind AS, which could be summarised. Further, the concept of ‘Mark to Market’ presents
challenges in analysing the financial position and results in a meaningful
manner;


(x) Earnings management: The greatest challenge therein
lies in managing the expectation mismatch. In certain situations, it could be
used as a legitimate tool by the management by cutting certain discretionary
costs like advertising or delaying capital expenditure; in other situations, it
may not be justified, especially if it is achieved through aggressive and
questionable accounting policies. It was, however, agreed that over a period of
time the same would be mitigated through a natural process of reconciliation
and tie-up with the market forces coupled with greater regulatory scrutiny;


(xi) Sufficiency of the current financial statements framework to all
industries: Whilst it was largely felt that the current financial statements
framework is sufficient for most industries, in certain industries such as
media, real estate, airlines, multiplexes, pharma, etc., it may not always
provide meaningful and relevant information like the extent of land parcels
(real estate), products, USFDA inspections (pharma), impact of long-term leases
(airlines, multiplexes) and IPR (media);


(xii) Usefulness of joint audit: It does provide value and add to
the quality of the audit, especially in the case of larger entities; the
experience has been generally good in countries which have mandated it.
However, care needs to be exercised that whilst allocating the work no
significant areas are left out. For the smaller companies it may result in
increased cost;


(xiii) Incentives for auditors: The main incentive and
motivating factor for an auditor is being a member of the ICAI. However,
considering his role as a solution provider, one of the motivating factors
would be that his recommendations are accepted. There can be no greater feather
in the cap than when the financial statements certified by him get an award
from the ICAI for the best-presented accounts.

 

CONCLUSION

There
was unanimity that the discussion provided a 360-degree view of various matters
from the perspectives of a preparer, auditor, investor and analyst. However,
concerns remain on overregulation and the existence of a trust
deficit which would in the coming days play a greater role in determining
the efficacy of the financial statements and the role of the auditors.

DISCONTINUED OPERATIONS

BACKGROUND

Ind AS 105 Non-current
assets held for sale and discontinued operations requires discontinued
operations to be presented separately in the profit and loss account, so that
the users of financial statements can separate the profits or losses from
continuing and discontinued operations. Such a segregated presentation helps
users of financial statements to determine the maintainable profits or losses
that arise from continuing operations.

 

Ind AS 105 (paragraph 32) defines
a discontinued operation as a component of an entity that either has been
disposed of, or is classified as held for sale, and

(a)   represents a separate major line of business or geographical area
of operations,

(b)  is part of a single co-ordinated plan to dispose of a separate
major line of business or geographical area of operations, or

(c)   is a subsidiary acquired exclusively with a view to resale.

 

Paragraph 33 of Ind AS 105
requires an entity to disclose:

(a)   a single amount in the statement of profit and loss comprising the
total of:

(i)    the post-tax profit or loss of discontinued operations; and

(ii)   the post-tax gain or loss recognised on the measurement to fair
value less costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation.

(b)   an analysis of the single amount in (a) into:

(i)    the revenue, expenses and pre-tax profit or loss of discontinued
operations;

(ii)   the related income tax expense;

(iii) the gain or loss recognised on the measurement to fair value less
costs to sell or on the disposal of the assets or disposal group(s)
constituting the discontinued operation; and

(iv) the related income tax expense.

A common question that is
generally raised is with respect to a parent transferring an operation to a
subsidiary and whether in the parent’s separate financial statements the
disposal of the operation will be presented as a discontinuing operation. In
the consolidated financial statements, since the business remains within the
group, there is no discontinued operation which is required to be presented separately. Consider the detailed fact pattern below:

 

FACT PATTERN

A Ltd. (‘the Company’ or ‘the
parent’) enters into an arrangement whereby it will transfer an operation that
qualifies as an operation (as defined earlier) under Ind AS 105 to a
newly-set-up company (NewCo). The transfer is a slump sale and is set out in a
Business Transfer Agreement (BTA). NewCo is a wholly-owned subsidiary of the
company when it is set up.

 

The transfer is done with a
pre-requisite that an investor will concurrently invest in NewCo. to the extent
of 30%. The company has not lost control due to the said infusion, because it
still holds majority (70%) ownership. The investor will have significant
influence over NewCo.

 

There is no impairment on the
assets transferred.

 

Should the transferred operation
be classified as discontinued operations in the Separate Financial Statements
of A Ltd.?

 

ANALYSIS

There is no guidance with respect
to this specific issue either under Ind AS 105 or other Ind AS’s. In the stated
fact pattern, there are two possible views for the classification of the
transferred operation.

 

View 1: The
transferred operation is a discontinued operation in the parent’s separate
financial statements

In the fact pattern, an investor
will be investing to the extent of 30% shareholding in NewCo. There will be no
loss of control for the parent, because the parent still owns a majority stake
in NewCo. Nonetheless, running the operations by the company on its own as
against transferring it to a subsidiary, in which a potential investor has
significant influence, are two different things. Essentially, in the separate
financial statements of the parent the business is getting converted into an
investment in a subsidiary in which an independent investor will play a
significant role.

 

Earlier, the parent was running
the operations. After the transfer, the parent will have to manage the
investment in the subsidiary. The relevant decisions at the separate financial
statement level will be whether to retain the investment or dispose of the
investment, whether the investment should be further diluted, the proposal with
respect to dividends, etc. The parent and the subsidiary are two separate
entities with independent boards and subjected to a regulatory framework. This
suggests that the appropriate classification of the transferred operation
should be discontinued operation.

 

Accordingly, the transferred
operations should be classified as a discontinued operation.


View 2: The
transferred operation is not a discontinued operation in the parent’s separate
financial statements

The transfer
of operations to NewCo is simply a change in the geography of the operations,
because the operations continue to remain with the group. The transferred
operations are still controlled by A Ltd. In substance, A Ltd. continues to
control the operations though there will be significant influence exercised by
the independent investor in NewCo. There is a very thin line between managing
the investment in a subsidiary vs. running the operations represented by that
investment. Consequently, the transferred operations are not discontinued
operations in the separate financial statements of the parent.

 

The author believes that both the above views are
acceptable. However, View 1 may be preferred keeping in mind the concept
of ‘substance over form’. View 1 also represents faithfully the fact
that the profit and loss in the separate financial statements will not include
the results of the operation going forward. A segregated presentation will help
users of financial statements to determine the maintainable profits or losses
that arise from continuing operations in the separate financial statements. 

Deemed income – Section 41(1) of ITA, 1961 – Section 41(1) will not apply to waiver of loan as waiver of loan does not amount to cessation of trading liability; A.Y.: 2003-04

25. Principal CIT vs. SICOM Ltd. [2020] 116 taxmann.com 410 (Bom.) Date of order: 21st January, 2020 A.Y.: 2003-04

 

Deemed income – Section 41(1) of ITA, 1961 – Section 41(1) will not
apply to waiver of loan as waiver of loan does not amount to cessation of
trading liability; A.Y.: 2003-04

In the
assessment proceedings for the A.Y. 2003-04, the A.O. considered the issue of
waiver of loan by the Government of Maharashtra and held that an amount of Rs.
114.98 crores covered by the loan given by the Government of Maharashtra is
taxable under sections 28(iv) and 41(1) of the Income-tax Act, 1961.
Accordingly, the said amount was treated as income of the assessee for the year
under consideration and added back to its total income.

 

The CIT(A)
and the Tribunal allowed the assessee’s claim and deleted the addition.

 

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

 

‘i)    The first appellate authority had followed
the decision of this Court in Mahindra & Mahindra Ltd. (Supra)
in deleting the addition made by the A.O. on account of remission of loan. The
decision of this Court in Mahindra & Mahindra (Supra) was
contested by the Revenue before the Supreme Court in Commissioner vs.
Mahindra & Mahindra Ltd. [2018] 404 ITR 1. The issue before the
Supreme Court was whether waiver of loan by the creditor is taxable as
perquisite u/s 28(iv) of the Act or taxable as remission of liability u/s 41(1)
of the Act. The Supreme Court held as under:

(a)   Section 28(iv) of the IT Act does not apply
in 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.

 

ii)    On careful examination of the matter, we are
of the considered opinion that the decision of the Supreme Court is squarely
applicable to the facts of the present case.

 

iii)    Consequently, we do not find any merit in
the appeal to warrant admission. Appeal is accordingly dismissed.’

Section 147, Explanation 3 & Section 154 – The powers conferred on the A.O. by Explanation 3 to section 147 cannot be extended to section 154 – Any discrepancy that was not a subject matter of reassessment proceedings cannot, subsequently, upon conclusion of reassessment proceedings, be brought up by the A.O. by recourse to section 154

24 [2019] 202 TTJ (Del.) 1014 JDC Traders (P) Ltd. vs. DCIT ITA No. 5886/Del/2015 A.Y.: 2007-2008 Date of order: 11th October, 2019

 

Section 147,
Explanation 3 & Section 154 – The powers conferred on the A.O. by
Explanation 3 to section 147 cannot be extended to section 154 – Any
discrepancy that was not a subject matter of reassessment proceedings cannot,
subsequently, upon conclusion of reassessment proceedings, be brought up by the
A.O. by recourse to section 154

 

FACTS

The assessee was a company engaged in the
business of trading, export and printing. For A.Y. 2007-2008 it submitted its
return of income and the same was processed u/s 143(1) of the Act. Reassessment
proceedings were initiated against the assessee for the assessment year in
question after recording reasons for the same. Certain travel expenditure
claimed by the assessee was disallowed and addition was made for the same. On
conclusion of the reassessment proceedings and perusal of the assessment
records by the A.O., he noticed a discrepancy in the amount of stock appearing
in the statement of profit and loss and in the notes to financial accounts. The
A.O. issued a notice u/s 154 to the assessee as regards the difference. The
assessee submitted that the amount stated as closing stock at the time of
preparation of accounts had been inadvertently missed out to be corrected
post-finalisation of accounts and stock reconciliation. The assessee also
submitted that after reconciliation the mistake was detected and corrected. The
A.O. made an addition for the amount of difference in the amounts of closing
stock stated at different values.

The assessee preferred an appeal with the CIT(A).
However, the CIT(A) did not agree with its contention and stated that under the
provisions of Explanation 3 to section 147, the A.O. was justified in assessing
/ reassessing the income which had escaped assessment. Further, there was
nothing wrong in the A.O. rectifying the mistake in the order under sections
147 / 143(3). The assessee then filed an appeal with the ITAT.

 

HELD

The issue relating to the discrepancy in the
value of closing stock was not taken up by the A.O. at the time of reassessment
proceedings u/s 147. A reading of section 147 shows that it empowers the A.O.
to assess or reassess income in respect of any issue which had escaped
assessment, irrespective of the fact whether such aspect was adverted in the
reasons recorded u/s 147. The A.O. had resorted to section 154 to make addition
in respect of the issue of discrepancy in closing stock on conclusion of the
reassessment proceedings. The powers under Explanation 3 to section 147, if
extended to section 154, would empower the A.O. to make one addition after the
other by taking shelter of Explanation 3 to section 147. It was also not the
case that the A.O. had invoked section 154 with respect to the original
assessment finalised u/s 143(3).

 

Thus, the powers of Explanation 3 to section
147 cannot be extended to section 154, and the addition made by the A.O. for
discrepancy of closing stock values upon conclusion of reassessment proceedings
was beyond his jurisdiction.

 

The appeal filed by the assessee was
allowed.

 

Section 64 – Entire loss arising to wife of assessee in the business of Futures and Options (F&O) which business was started by her during the previous year with contribution from assessee in shape of gifts, was liable to be clubbed in hands of assessee in terms of Explanation 3 read in conjunction with section 64(1)(iv) – Assessee was entitled to club full loss from business of F&O in his personal income

8. [2020] 113 taxmann.com 378 (Pune)(Trib.)

Uday Gopal Bhaskarwar vs. ACIT

ITA No. 502/Pune/2019

A.Y.: 2014-15

Date of order: 20th January, 2020

 

Section 64 – Entire loss arising to wife of assessee in the
business of Futures and Options (F&O) which business was started by her
during the previous year with contribution from assessee in shape of gifts, was
liable to be clubbed in hands of assessee in terms of Explanation 3 read in
conjunction with section 64(1)(iv) – Assessee was entitled to club full loss
from business of F&O in his personal income

 

FACTS

The assessee, in the return of
income filed by him, clubbed the loss from the business of his spouse amounting
to Rs. 31,56,429 in view of the provisions of section 64. In the course of
assessment proceedings, on being called upon to justify such a claim, the
assessee submitted that during the year under consideration he gifted a sum of
Rs. 94.50 lakhs to Mrs. Priti Bhaskarwar, his wife, who started a business of
Futures and Options (F&O) on 18th September, 2013. The assessee
claimed that she incurred a loss of Rs. 31,56,429 in the business which was
clubbed in his hands.

 

The A.O. accepted the primary claim
of the assessee of his wife having incurred a loss of Rs. 31.56 lakhs in the
business of F&O, which was set up on 18th September, 2013, and further that
the loss from such business was eligible for set-off against the income of the
assessee in terms of section 64(1)(iv) read with Explanation 3 thereto. He,
however, did not accept the assessee’s contention that the entire loss of Rs.
31.56 lakhs be set off against his (the assessee’s) income. Considering the
mandate of Explanation 3 to section 64(1), the A.O. held that only that part of
the business loss incurred by the assessee’s wife could be set off against the
assessee’s income which bears the proportion of amount of investment out of the
gift on the first day of the previous year to the total investment in the
business as on the first day of the previous year.

 

He, therefore, computed the amount
of loss eligible for set-off against the assessee’s income at Rs. 9,72,563 by
multiplying Rs. 31,56,429 (loss incurred by wife in the business) with Rs.
25.00 lakhs (gifts made by the assessee to his wife up to 18th
September, 2013) as divided by Rs. 81,13,648 (opening capital as on 1st April,
2013 as increased by the gift of Rs. 25.00 lakhs given by the assessee up to 18th
September, 2013).

 

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

 

Still aggrieved, the assessee
preferred an appeal to the Tribunal.

 

HELD

The Tribunal noted that the core of
controversy is the computation of eligible amount of loss incurred by the
assessee’s wife which is eligible for set-off against the assessee’s income.

 

On going through the mandate of
section 64(1)(vi) of the Act in juxtaposition with Explanation 3 to the
sub-section, it transpires that there can be two possible situations of
utilisation of the assets transferred by husband to wife triggering the
clubbing provision. The first situation can be where the amount of assets
received by the wife is exclusively invested in an asset and further there is
no investment by the wife in such a new asset. The full income resulting from
such an exclusive investment is liable to be clubbed with the total income of
the husband. An example of such a situation can be a wife making a fixed
deposit with a bank, etc. out of the gift of money received from her husband.
The full amount of interest income arising on such FDR is liable to be clubbed
with the income of the husband.

 

The second situation can be where
the amount of assets received by the wife as a gift from her husband is not the
exclusive investment in the business carried on by her. Rather, she has also
made separate investment in the said business. In such a situation of a common
pool of unidentifiable investments in the business, there arises difficulty in
precisely attributing the income of such a business to the investments made out
of the gift received from the husband attracting clubbing and to investments
made out of funds other than the gift received from the husband not attracting
the clubbing provision. It is in such a scenario that the prescription of
Explanation 3 comes into play by providing that the amount of income from the
combined business as relatable to the assets transferred by the husband should
be computed by taking the income from such business earned during the year as
multiplied with the amount of assets received by the wife from her husband as
invested in the business and divided by her total investment in the business,
including the amount of assets received from the husband.

 

In a nutshell, there are three
components in this formula. The first component is the income of the business,
which is to be considered for the year. The second is the amount of assets
received by the wife from her husband as invested in the business, and the
third is the total investment in the business including the amount of assets
received from the husband. The latter two figures are required to be taken as
on the first day of the previous year. Section 3 defines ‘Previous year’ to
mean ‘the financial year immediately preceding the assessment year.’ The proviso
to section 3 states that, in the case of a business newly set up in a financial
year, the previous year shall be the period beginning with the date of the
setting up of the business and ending with the said financial year. Since the
wife of the assessee started the new business of F&O on 18th
September, 2013, the extant case is, ergo, covered by the proviso
to section 3.

 

Having examined the factual position
in detail, the Tribunal held that the entire amount of loss resulting from the
business of F&O started by Mrs. Priti Bhaskarwar with the gifts received
from the assessee is liable to be clubbed in the hands of the assessee.

 

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

M/s JSW Steel Ltd. vs. Dy. CIT; [ITA Nos. 33, 34 & 35/Mum/2015; Date of order: 28th September, 2016; A.Y.: 2008-09; Mum. ITAT] Section 153A – Once the assessment gets abated, the original return filed u/s 139(1) is replaced by the return filed u/s 153A – It is open to both parties, i.e., the assessee and Revenue, to make claims for allowance or disallowance – (Continental Warehousing Corporation 374 ITR 645 Bom. referred)

16. The Pr. CIT-2 vs.
M/s JSW Steel Ltd. (Successor on amalgamation of JSW Ispat Steel Ltd.) [Income
tax Appeal No. 1934 of 2017] Date of order: 5th
February, 2020 (Bombay High Court)

 

M/s JSW Steel Ltd. vs.
Dy. CIT; [ITA Nos. 33, 34 & 35/Mum/2015; Date of order: 28th
September, 2016; A.Y.: 2008-09; Mum. ITAT]

 

Section
153A – Once the assessment gets abated, the original return filed u/s 139(1) is
replaced by the return filed u/s 153A – It is open to both parties, i.e., the
assessee and Revenue, to make claims for allowance or disallowance – (Continental
Warehousing Corporation 374 ITR 645 Bom. referred)

 

The assessee is a widely-held public
limited company engaged in various activities, including production of sponge
iron, galvanised sheets and cold-rolled coils through its steel plants located
at Dolve and Kalmeshwar in Maharashtra. The company filed its original return
of income on 30th September, 2008 for A.Y. 2008-09 declaring loss at
Rs. 104,17,70,752 under the provisions of section 139(1) of the Act.

 

During pendency of the assessment
proceedings, a search was conducted u/s 132 on the ISPAT group of companies on
30th November, 2010. Following the search, a notice u/s 153A was
issued. In response, the assessee filed return of income declaring total loss
at Rs. 419,48,90,102 on 29th March, 2012. In this return, the
assessee made a new claim for treating gain on pre-payment of deferred VAT /
sales tax on the Net Present Value (NPV) basis for an amount of Rs.
318,10,93,993 as ‘capital receipt’.

 

This new / fresh claim of the assessee
was disallowed by the A.O. while finalising the assessment u/s 143(3) r/w/s
153A of the Act by considering the same as ‘revenue receipt’ instead of
‘capital receipt’. The reasoning given by the A.O. was that the assessee had
availed of the sales tax deferral scheme and the State Government had permitted
premature re-payment of deferred sales tax liability on the NPV basis.
Therefore, according to the A.O., the assessee treated this as capital receipt
even though the same was credited to the assessee’s profit and loss account
being the difference between the deferred sales tax and its NPV.

 

However, the
primary question that arose before the A.O. was whether the claim which was not
made in the earlier original return of income filed u/s 139(1) could be filed
and considered in the subsequent return filed by the assessee in pursuance of
notice u/s 153A of the Act (which was consequent to the search action conducted
u/s 132). The A.O. held that the assessee could not raise a new claim in the
return filed u/s 153A which was not raised in the original return of income
filed u/s 139(1). Thereafter, the claim was disallowed and was treated as
‘revenue receipt’.

 

Aggrieved by the aforesaid order, the
assessee preferred an appeal before the CIT(A) who upheld the order passed by
the A.O.

 

Still aggrieved, the assessee filed an
appeal to the Tribunal. The Tribunal held that the assessee could lodge new
claims, deductions, exemptions or relief (which the assessee had failed to
claim in his regular return of income) which came to be filed by the assessee
under the provisions of section 153A of the Act.

 

But the Revenue, aggrieved by the order
of the ITAT, filed an appeal to the High Court. The Court held that in view of
the second proviso to section 153A of the Act, once assessment got
abated, it meant that it was open for both the parties, i.e., the assessee as
well as Revenue, to make claims for allowance, or to make disallowance, as the
case may be. That apart, the assessee could lodge a new claim for deduction,
etc. which remained to be claimed in his earlier / regular return of income.
This is so because assessment was never made in the case of the assessee in
such a situation. It is fortified that once the assessment gets abated, the
original return which had been filed loses its originality and the subsequent return
filed u/s 153A of the Act (which is in consequence to the search action u/s
132) takes the place of the original return. In such a case, the return of
income filed u/s 153A(1) would be construed to be one filed u/s 139(1) and the
provisions of the said Act shall apply to the same accordingly. If that be the
position, all legitimate claims would be open to the assessee to raise in the
return of income filed u/s 153A(1).

 

The Court further emphasised on the
judgment passed by it in the case of Continental Warehousing (Supra) which
also explains the second proviso to section 153A(1). The explanation is
that pending assessment or reassessment on the date of initiation of search if
abated, then the assessment pending on the date of initiation of search shall
cease to exist and no further action with respect to that assessment shall be
taken by the A.O. In such a situation, the assessment is required to be
undertaken by the A.O. u/s 153A(1) of the Act.

 

In view of the second proviso to
section 153A (1), once assessment gets abated, it is opened both ways, i.e.,
for the Revenue to make any additions apart from seized material, even regular
items declared in the return can be subject matter if there is doubt about the
genuineness of those items, and similarly the assessee also can lodge new
claims, deductions or exemptions or relief which remained to be claimed in the
regular return of income, because assessment was never made in the case /
situation. Hence, the appeal filed by the Revenue is liable to be dismissed.

 

DCIT-1(1) vs. M/s Ami Industries (India) Pvt. Ltd. [ITA No. 5181/Mum/2014; Date of order: 28th August, 2016; A.Y.: 2010-11; Mum. ITAT] Section 68 – Share application money – The assessee had furnished PAN, ITR of the investors to prove genuineness of the transactions – For credit worthiness of the creditors, the bank accounts of the investors showed that they had funds – Not required to prove ‘source of the source’ – Addition is justified [PCIT vs. NRA Iron & Steel 412 ITR 161 (SC) distinguished]

15. The Pr. CIT-1 vs. M/s Ami
Industries (India) Pvt. Ltd. [Income tax Appeal No. 1231 of 2017] Date of
order: 29th January, 2020 (Bombay High Court)

 

DCIT-1(1) vs. M/s Ami Industries
(India) Pvt. Ltd. [ITA No. 5181/Mum/2014; Date of order: 28th
August, 2016; A.Y.: 2010-11; Mum. ITAT]

 

Section 68 – Share application money –
The assessee had furnished PAN, ITR of the investors to prove genuineness of
the transactions – For credit worthiness of the creditors, the bank accounts of
the investors showed that they had funds – Not required to prove ‘source of the
source’ – Addition is justified [PCIT vs. NRA Iron & Steel 412 ITR 161
(SC) distinguished]

 

In the assessment proceedings, the A.O.
noted that the assessee had disclosed funds from three Kolkata-based companies
as share application money amounting to Rs. 34.00 crores (Parasmani Merchandise
Pvt. Ltd. Rs. 13.50 crores; Ratanmani Vanijya Pvt. Ltd. Rs. 2.00 crores and
Rosberry Merchants Pvt. Ltd. Rs. 18.50 crores).

The A.O. issued a
notice to the assessee on the ground that the whereabouts of the above
companies were doubtful and their identity could not be authenticated. Thus,
the genuineness of the companies became questionable.

 

After considering the reply submitted
by the assessee, the A.O. treated the aforesaid amount of Rs. 34 crores as
money from unexplained sources and added the same to the income of the assessee
as unexplained cash credit u/s 68 of the Act.

 

Aggrieved by the order, the assessee
preferred an appeal before the CIT(A). The CIT(A) held that the assessee had
discharged its burden u/s 68 by proving the identity of the creditors; the
genuineness of the transactions; and the credit worthiness of the creditors.
Consequently, the first appellate authority set aside the addition made by the
A.O.

 

Being aggrieved by the order of the
CIT(A), the Revenue filed an appeal to the Tribunal. The Tribunal noted that
the A.O. had referred the matter to the investigation wing of the Department at
Kolkata for making inquiries about the three creditors from whom share
application money was received. Though the report from the investigation wing
was received, the Tribunal noted that the same was not considered by the A.O.
despite mentioning of the same in the assessment order; besides, he had not
provided a copy of the same to the assessee. In the report by the investigation
wing, it was mentioned that the companies were in existence and had filed income
tax returns for the previous year under consideration but the A.O. recorded
that these creditors had very meagre income as disclosed in their returns of
income and, therefore, he doubted the credit-worthiness of the three creditors.

 

Finally, the Tribunal held that as per
the provisions of section 68 of the Act, for any cash credit appearing in the
books of an assessee, the assessee is required to prove the following: (a)
Identity of the creditor, (b) Genuineness of the transaction, and (c)
Credit-worthiness of the party. In this case, the assessee had already proved
the identity of the share applicants by furnishing their PAN and copies of
their IT returns filed for the A.Y. 2010-11.

 

Regarding the genuineness of the
transaction, the assessee had filed a copy of the bank accounts of the three
share applicants from which the share application money was paid and the copy
of the account of the assessee in which the said amount was deposited and which
had been received by RTGS. Regarding the credit-worthiness of the parties, it
has been proved from the bank accounts of the three companies that they had the
funds to make payments for the share application money and a copy of the
resolution passed in the meetings of their Boards of Directors. Regarding ‘the source
of the source’, the A.O. has already made inquiries through the DDI
(Investigation), Kolkata and collected all the materials required which proved
‘the source of the source’, though as per the settled legal position on this
issue the assessee need not prove ‘the source of the source’. The A.O. has not
brought any cogent material or evidence on record to indicate that the
shareholders were benamidars or fictitious persons, or that any part of
the share capital represented the company’s own income from undisclosed
sources. Accordingly, the order of the CIT(A) was upheld.

 

Aggrieved by the order of the ITAT, the
Revenue filed an appeal to the High Court. The Revenue submitted that it cannot
be said that the assessee had discharged the burden to prove the
credit-worthiness of the three parties. Further, it contented that the assessee
is also required to prove ‘the source of the source’. In this connection, the
Department placed reliance on a decision of the Supreme Court in Pr. CIT
vs. NRA Iron & Steel Pvt. Ltd.

 

The assessee submitted that from the
facts and circumstances of the case, it is quite evident that the assessee has
discharged its burden to prove the identity of the creditors, the genuineness
of the transactions and the credit-worthiness of the creditors. The legal
position is very clear inasmuch as the assessee is only required to explain the
source and not ‘the source of the source’. The decision of the Supreme Court in
NRA Iron & Steel Pvt. Ltd. (Supra) is not the case law for
the aforesaid proposition. In fact, the said decision nowhere states that the
assessee is required to prove ‘the source of the source’. Further, it is also a
settled proposition that the assessee is not required to prove ‘the source of
the source’. In fact, this position has been clarified in the recent decision
in Gaurav Triyugi Singh vs. Income Tax Officer-24(3)(1)2 dated 22nd
January, 2020.

 

The Court found that the identity of
the creditors was not in doubt. The assessee had furnished the PAN, copies of
the income tax returns of the creditors, as well as copies of the bank accounts
of the three creditors in which the share application money was deposited in
order to prove the genuineness of the transactions. Insofar as the
credit-worthiness of the creditors was concerned, the Tribunal had recorded
that the bank accounts of the creditors showed that they had funds to make
payments for share application money and, in this regard, resolutions were also
passed by the Board of Directors of the three creditors. Although the assessee
was not required to prove ‘the source of the source’, nonetheless, the Tribunal
took the view that the A.O. had made inquiries through the investigation wing
of the Department at Kolkata and collected all the materials which proved ‘the
source of the source’.

 

In NRA Iron & Steel Pvt. Ltd.
(Supra), the A.O. had made an independent and detailed inquiry,
including survey of the investor companies. The field report revealed that the
shareholders were either non-existent or lacked credit-worthiness. It is in
these circumstances that the Supreme Court had held that the onus to establish
the identity of the investor companies was not discharged by the assessee. The
aforesaid decision is, therefore, clearly distinguishable on the facts of the
present case. Therefore, the first appellate authority had returned a clear
finding of fact that the assessee had discharged its onus of proving the
identity of the creditors, the genuineness of the transactions and the
credit-worthiness of the creditors, which finding of fact stood affirmed by the
Tribunal. There are, thus, concurrent findings of fact by the two lower
appellate authorities. Under these circumstances, the appeal is dismissed.

 

Reassessment – Sections 147 and 148 of ITA, 1961 – Notice after four years – Failure to disclose material facts necessary for assessment – No duty to disclose investments – Notice for failure to disclose investment – Not valid

36. Bhavik
Bharatbhai Padia vs. ITO; [2019] 419 ITR
149 (Guj.) Date of order:
19th August, 2019 A.Y.: 2011-12

 

Reassessment –
Sections 147 and 148 of ITA, 1961 – Notice after four years – Failure to disclose
material facts necessary for assessment – No duty to disclose investments –
Notice for failure to disclose investment – Not valid

 

For the A.Y. 2011-12, the assessee-petitioner received a notice u/s 148
of the Income-tax Act, 1961 dated 30th March, 2018. The reasons
assigned by the AO for reopening are as under:

‘As per information available with this office during the year under
consideration the assessee had made investment of Rs. 50,00,000 in the pension
policies of LIC of India. The assessee has filed his return of income for the
A.Y. 2011-12 declaring total income at Rs. 72.78 lakhs. The information was
received from the Income-tax Officer (I & CI)-1, Ahmedabad on 27th
March, 2018. On a perusal of the information, it is found that the assessee has
made investment of Rs. 50,00,000 in the pension policies of LIC of India during
the F.Y. 2010-11 relevant to the A.Y. 2011-12. During the inquiries conducted
by the Income-tax Officer (I & CI), the investment of Rs. 50,00,000 made by
the assessee remains unexplained. Thus, there is an escapement of Rs. 50,00,000
and the case requires to be reopened u/s 147 of the Act.’

 

The assessee filed his objections to the notice
issued u/s 148 of the Act pointing out that he had disclosed all the income
liable to be offered and to be brought to tax in its return of income. The
assessee further pointed out in his objections that as the assessee did not
have any business income during the A.Y. 2011-12, he was not obliged to
disclose his investment of Rs. 50,00,000 in the pension policies of the LIC of
India in his return of income. The assessee further pointed out that he had
salary, income from other sources and capital gains and in such circumstances,
he was required to file form ITR-2 for the A.Y. 2011-12. It was also pointed
out that the Form ITR-2 does not include the column for the disclosure of
investments. In such circumstances, the assessee could not have been expected
to disclose his investments in his return of income. The assessee further
pointed out that his total income for the A.Y. 2011-12 was Rs. 71.50 lakhs. He
had sufficient past savings and the current year’s income to make an investment
of Rs. 50,00,000 in the LIC policies. He also pointed out to the respondent
that just because he had made an investment of Rs. 50,00,000 his case should
not be reopened, as he could be said to have made full and true disclosure of
his income. By an order dated 8th October, 2018, the AO rejected the
objections. The assessee filed a writ petition and challenged the order.

 

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

 

‘The notice for reassessment had been issued after four years on the
ground that the assessee had failed to disclose investments. It was not in
dispute that the form of return of income, i.e., ITR-2, then in force had no
separate column for the disclosure of any investment. The notice was not
valid.’

 

 

Income Declaration Scheme, 2016 – Scope of – Amount paid as advance tax can be adjusted towards amount due under Scheme

35. Alluri
Purnachandra Rao vs. Pr. CIT; [2019] 419 ITR
462 (Tel.) Date of order:
18th September, 2019 A.Ys.: 2010-11
to 2015-16

 

Income
Declaration Scheme, 2016 – Scope of – Amount paid as advance tax can be adjusted
towards amount due under Scheme

The petitioner filed the subject declaration under the Income
Declaration Scheme, 2016 in Form 1 on 30th June, 2016 for the A.Ys.
2010-11 to 2015-16 declaring undisclosed income of Rs. 40,98,706. In terms of
the Income Declaration Scheme, the petitioner was liable to pay a sum of Rs.
18,44,418 towards tax, surcharge and penalty on this undisclosed income. In
that regard, the petitioner claimed credit of a sum of Rs. 12,11,611 being his
tax deducted at source (TDS). He also claimed credit of a sum of Rs. 1,10,000,
being the advance tax / prepaid tax paid by him for the assessment year
2013-14. After adjusting the aforesaid credits, he paid the balance sum of Rs.
5,22,807 in three instalments as required.

 

The Principal Commissioner of Income Tax-6, Hyderabad, rejected the
declaration filed by the petitioner on the ground that he had failed to pay the
tax, surcharge and penalty on the undisclosed income declared by him before the
due date, i.e., 30th September, 2017. This was because he did not
give credit to the advance tax of Rs. 1,10,000 paid by the petitioner for the
A.Y. 2013-14. The petitioner filed a writ petition and challenged the order of
the Principal Commissioner.

 

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

 

‘i)   The Income Declaration
Scheme, 2016, was promulgated under sections 184 and 185 of the Finance Act,
2016 enabling an assessee to pay tax at 30% on undisclosed income along with
surcharge and penalty at 25% on the tax payable. Under section 187 of the Act,
read with Notification No. S. O. 2476(E) dated 20th July, 2016
([2016] 386 ITR [ST] 5), the tax, surcharge and penalty were to be paid in
three instalments between 30th November, 2016 and 30th
September, 2017.

 

ii)   The Central Board of Direct
Taxes issued Circular No. 25 of 2016, dated 30th June, 2016 ([2016]
385 ITR [ST] 22), furnishing clarifications on the Income Declaration Scheme;
question No. 4 thereunder was whether credit for tax deducted at source, if
any, in respect of the income declared should be allowed. The answer to this
was in the affirmative and to the effect that credit for tax deducted at source
should be allowed in those cases where the related income was declared under the
Scheme and credit for the tax had not already been claimed in the return of
income filed for any assessment year. Once the tax deducted at source relevant
for the period covered by the declaration filed under the Income Declaration
Scheme is given credit in accordance with the clarification of the Central
Board of Direct Taxes itself, there is no reason why advance tax paid for the
very same period, which has not been given credit to earlier, should not be
adjusted against the amount payable under the Scheme.

 

iii)  The assessee’s declaration
pertained to the A.Ys. 2010-11 to 2015-16. Advance tax of Rs. 1,10,000 had been
paid by him for the A.Y. 2013-14. Admittedly, there was no regular assessment
for that year, whereby the advance tax could have been adjusted. Therefore,
there was no rationale in denying the assessee credit of this amount while
computing the amount payable by him under the Income Declaration Scheme. If the
amount paid by the assessee for the A.Y. 2013-14, being a sum of Rs. 1,10,000,
were adjusted, the payments made by him on 21st November, 2016 (Rs.
1,50,000), 28th March, 2017 (Rs. 1,50,000) and 27th
September, 2017 (Rs. 2,22,807) would be sufficient to discharge his liability
in respect of the tax, surcharge and penalty payable by him towards his
undisclosed income declared under the Income Declaration Scheme. Hence the
rejection of the declaration was not valid.

 

iv)  The writ petition is
accordingly allowed setting aside the impugned proceedings dated 6th
February, 2018 passed by the Principal Commissioner of Income Tax-6, Hyderabad,
rejecting the declaration filed by the petitioner under the Income Declaration
Scheme, 2016. The said declaration shall be considered afresh by the Principal
Commissioner of Income Tax-6, Hyderabad, duly giving credit not only to the tax
deducted at source but also to the advance tax paid by the petitioner for the
A.Y. 2013-14. This exercise shall be completed expeditiously and, in any event,
not later than four weeks from the date of receipt of a copy of the order, be
it from whatever source.’

 

 

Exemption u/s 10(10AA) of ITA, 1961 – Leave salary (government employees) – Government employees enjoy protection and privileges under Constitution and other laws which are not available to other employees and government employees form a distinct class; they are governed by different terms and conditions of employment – Consequently, retired employees of PSUs and nationalised bank cannot be treated as government employees and, thus, they are not entitled to get full tax exemption on leave encashment after retirement / superannuation u/s 10(10AA)

34. Kamal Kumar
Kalia vs. UOI; [2019] 111
taxmann.com 409 (Delhi) Date of order:
8th November, 2019

 

Exemption u/s
10(10AA) of ITA, 1961 – Leave salary (government employees) – Government
employees enjoy protection and privileges under Constitution and other laws
which are not available to other employees and government employees form a
distinct class; they are governed by different terms and conditions of
employment – Consequently, retired employees of PSUs and nationalised bank
cannot be treated as government employees and, thus, they are not entitled to
get full tax exemption on leave encashment after retirement / superannuation
u/s 10(10AA)

 

The petitioners, who were employees of Public Sector Undertakings and
nationalised banks, filed a writ contending that although they were Central and
State Government employees, they were discriminated against. They were granted
complete exemption in respect of the cash equivalent of leave salary for the
period of earned leave standing to their credit at the time of their
retirement, whether on superannuation or otherwise. However, all others,
including the employees of PSUs and nationalised banks, are granted exemption
only in respect of the amount of leave salary payable for a period of ten
months, subject to the limit prescribed.

 

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

 

‘i)   So far as the challenge to
provisions of section 10(10AA) of the Income-tax Act, 1961 on the ground of
discrimination is concerned, there is no merit therein. This is because
employees of the Central Government and the State Government form a distinct
class and the classification is reasonable having nexus with the object sought
to be achieved. The Central Government and State Government employees enjoy a
“status” and they are governed by different terms and conditions of employment.
Thus, Government employees enjoy protection and privileges under the
Constitution and other laws, which are not available to those who are not
employees of the Central and State Governments.

 

ii)   There is no merit in the
submission of the petitioner that the employees of PSUs and nationalised banks
are also rendering services for the government and such organisations are
covered by Article 12 of the Constitution of India as “State”. Merely because
PSUs and nationalised banks are considered as “State” under article 12 of the
Constitution of India for the purpose of entertainment of proceedings under
Article 226 of the Constitution and for enforcement of fundamental rights under
the Constitution, it does not follow that the employees of such public sector
undertakings, nationalised banks or other institutions which are classified as
“State” assume the status of Central Government and State Government employees.

 

iii)  Therefore, the instant
petition is rejected, insofar as the petitioners’ challenge to the provisions
of section 10(10AA) is concerned.’

 

Charitable purpose – Meaning of – Sections 2(15) and 11 of ITA, 1961 – Preservation of environment is an object of general public utility – Polluting industries setting up company for prevention of pollution – Object not to earn profit – Fact that members of company would benefit is not relevant – Company entitled to exemption u/s 11

33. CIT vs.
Naroda Enviro Projects Ltd.; [2019] 419 ITR
482 (Guj.) Date of order:
29th July, 2019 A.Ys.: 2009-10

 

Charitable
purpose – Meaning of – Sections 2(15) and 11 of ITA, 1961 – Preservation of environment
is an object of general public utility – Polluting industries setting up
company for prevention of pollution – Object not to earn profit – Fact that
members of company would benefit is not relevant – Company entitled to
exemption u/s 11

 

The assessee company was incorporated on 19th October, 1995
and was later converted into a company limited by shares incorporated u/s 25 of
the Companies Act, 1956. The assessee company was engaged in the activity of
preservation of environment by providing pollution control treatment for
disposal of liquid and solid industrial waste. The assessee company was
registered u/s 12AA of the Income-tax Act, 1961 as a charitable institution.
For the A.Y. 2009-10 the assessee had filed its return of income declaring total
income (loss) of Rs. 258 (Rupees two hundred and fifty eight only) along with
the auditor’s report u/s 12A(b) of the Act in Form 10B claiming exemption u/s
11 of the Act. The AO took the view that the assessee company is not entitled
to seek exemption u/s 11 and held as under:

 

‘i)   The assessee is carrying on
business activity under the pretext of charitable activity. The incidental
profit cannot be for all the years and not to the extent reflected in the table
given in the order.

 

ii)   The objects specified in the
memorandum of association are important but the same have to be considered with
reference to the real practice adopted for running the activity, i.e., whether
it is charitable or for the purpose of making profit. The object included in
definition of “charitable purpose” as defined in section 2(15) should be
evidenced by charity; otherwise even environment consultant will also claim
exemption u/s 11 being a trust or a company u/s 25.

 

iii) The action is carried out for
the benefit of members to discharge their onus of treatment of chemicals, etc.
with substantial charge with intention to earn profit under the shelter of
section 25 of the Companies Act.

 

iv) Hence it is held that the assessee is rendering service of pollution
control as per the norms laid down by the Gujarat State Pollution Control Board
or any other authority responsible for the regulation of pollution in relation
to any trade, commerce or business carried out by the industries located in the
industrial area of Naroda, Vatva and Odhav for a uniform cess or fee or any
other consideration, irrespective of the nature of use or application, or
retention, of the income of such activity. Since the aggregate value of
receipts are more than Rs. 10,00,000 both the provisos to section 2(15)
are applicable to the assessee company and it is not entitled for exemption.’

 

The Commissioner (Appeals) and the Tribunal held that taking an overall
view, the dominant objects of the assessee were charitable as the dominant
object was not only preservation of the environment, but one of general public
utility and, therefore, the assessee was entitled to seek exemption u/s 11 of
the Act.

 

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

 

‘i)   The assessee was a company
engaged in the activity of preservation of the environment by providing
pollution control treatment for disposal of liquid and solid industrial waste.
The benefit accrued to the members of the company. The members were none other
than the owners of the polluting industries. These members were obliged in law
to maintain the parameters as prescribed by the Gujarat Pollution Control Board
and in law for the purpose of discharge of their trade effluents, in other
words, discharge of solid and liquid waste. If they did not do so, they would
be liable to be prosecuted and their units would also be liable to be closed.

 

ii)   However, this, by itself, was
not sufficient to take the view that the company had not been set up for a
charitable purpose. The birth of this company also needed to be looked into
closely. The fact that the members of the assessee company were benefited was
merely incidental to the carrying out of the main or primary purpose and if the
primary purpose was charitable, the fact that the members of the assessee
benefited would not militate against its charitable character nor would it make
the purpose any less charitable.

iii)  Prior to the introduction of
the proviso to section 2(15) of the Act, the assessee company was
granted registration u/s 12A of the Act. From this it was clear that prior to
the introduction of the proviso to section 2(15) of the Act, the
authority, upon due consideration of all the relevant aspects, had arrived at
the satisfaction that the assessee company was established for charitable
purposes. The company continued to be recognised as a charitable institution.
The certificate issued u/s 12A, after due inquiry, was still in force.

 

iv)  The driving force was not the
desire to earn profit, but the object was to promote, aid, foster and engage in
the area of environment protection, abatement of pollution of various kinds
such as water, air, solid, noise, vehicular, etc., without limiting its scope.
In short, the main object was preservation and protection of the environment.

 

v)   The Commissioner (Appeals) and
the Appellate Tribunal had concurrently held that taking an overall view, the
dominant objects of the assessee were charitable as the dominant object was not
only preservation of the environment, but one of general public utility and,
therefore, the assessee was entitled to seek exemption under section 11 of the
Act. The Tribunal was the last fact-finding body. As a principle, this court
should not disturb the findings of fact in an appeal under section 260A of the
Act unless the findings of fact are perverse.’

 

Capital gains – Exemption u/s 54 of ITA, 1961 – Scope – Additional cost of construction incurred within stipulated time though not deposited in capital gains account – Entitled to deduction

32. Venkata Dilip Kumar vs. CIT; [2019] 419 ITR 298 (Mad.) [2019] 111 taxmann.com 180 (Mad.) Date of order: 5th November, 2019

 

Capital gains – Exemption u/s 54 of ITA, 1961 – Scope – Additional cost
of construction incurred within stipulated time though not deposited in capital
gains account – Entitled to deduction

 

The assessee had long-term capital gain on transfer of a residential
house and invested the same in a new residential house. The assessee claimed
deduction u/s 54 of the Income-tax Act, 1961, an amount of Rs. 1.5 crores being
paid to the builder for the new house. This was allowed by the AO. The assessee
had also claimed further deduction of Rs. 57.25 lakhs u/s 54 contending that
though such sum was not deposited in the capital gains deposit account, it was
utilised for the purpose of additional expenditure towards the construction
cost and that the sum was drawn out of the capital gains deposited in the same
bank branch, although in a savings bank account. The AO refused to grant
deduction u/s 54. This was confirmed by the Tribunal.

 

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

 

‘i)   Section 54 of the Income-tax
Act, 1961 deals with profits on sale of property used for residence. The
capital gains so arising in the hands of the assessee, instead of being dealt
with as income, will be dealt with by giving deduction to such capital gains,
provided the assessee satisfies the requirement contemplated under the
provision. For seeking benefit of deduction u/s 54, the assessee should have
purchased one residential house either one year before the transfer or two
years after the date of such transfer, or constructed a residential house
within a period of three years after the date of such transfer. Meeting the
expenses towards the cost of construction of the house within a period of three
years entitles an assessee to the deduction u/s 54.

 

ii)   Section 54(2) contemplates
that if the amount of the capital gains is not appropriated by the assessee
towards purchase of the new asset within one year before the date on which the
transfer of the original asset took place, or is not utilised by him for the
purchase of the new asset before the date of furnishing the return of income
u/s 139, he has to deposit the sum in an account in any such bank and utilise
in accordance with any scheme which the Central Government may, by
notification, frame in that behalf. In other words, if the assessee has not
utilised the amount of the capital gains either in full or part, such
unutilised amount should be deposited in a capital gains account to get the
benefit of deduction in the succeeding assessment years. Section 54(2) cannot
be read in isolation and on the other hand, application of section 54(2) should
take place only when the assessee fails to satisfy the requirement u/s 54(1).
While the compliance with the requirement u/s 54(1) is mandatory and if
complied with, has to be construed as substantial compliance to grant the
benefit of deduction, the compliance with the requirement u/s 54(2) could be
treated only as directory in nature. If the assessee with material details and
particulars satisfies that the amount for which deduction is sought u/s 54 is
utilised either for purchasing or constructing the residential house in India
within the time prescribed u/s 54(1), the deduction is bound to be granted
without reference to section 54(2). Mere non-compliance with a procedural
requirement u/s 54(2) itself cannot stand in the way of the assessee getting
the benefit u/s 54, if he is, otherwise, in a position to satisfy that the
mandatory requirement u/s 54(1) is fully complied with within the time limit
prescribed therein.

iii)  The
assessee had claimed that it had utilised the disputed sum towards the cost of
the additional construction within the period of three years from the date of
the transfer and therefore, if such contention were factually correct, the
assessee had to be held to have satisfied the mandatory requirement u/s 54(1)
to get the deduction.

iv)  Matter remanded to verify
whether the sum was utilised by the assessee within the time stipulated u/s
54(1) for the purpose of construction. If such utilisation was found to have
been made within such time, the Department was bound to grant deduction.’

 

Reimagining Financial Reporting

The accrual system of accounting was one of the
biggest turning points in financial reporting. Everything changed once it was
adopted and accountants came to be counted upon more than ever before. In a
lighter vein, an accountant is someone most likely to know what is actually
going on in a business!


While we have come a long way indeed, churning out
literally tons of paper on financial reporting – both information and analysis
– with a view that the reader must know what the preparer knows, however, the
semantics of this information hasn’t been more incomprehensible than it is
today from the perspective of a lay investor. The test of understandability is
not yet bridged.


The auditor is also part of this financial
reporting quagmire. Reporting by auditors has expanded in extent and
significance but perhaps not in reaching the minds of the lay reader. There are
facts, definitions, information, laying down of responsibilities, KAM and
auditor’s response, and so on and so forth.


The grapevine has it that a new CARO 2020 is about
to come, and hence this thought process. Today, the auditors’ report (AR) for
most companies contains the independent auditor’s report with two annexures in
the form of the CARO and the report on ICFR. A word count comparison of
Microsoft (2018) and TCS (2019) audit reports shows 75% more words in the
latter (470 vs. 1966) – and this is excluding CARO, KAM and ICFR reports! But
that is just the size of the content.


The general feeling in India is that size will
cover up for shortcomings in quality of content. Or that size reflects
effective content. People are looking for effective, clear, simple, succinct
content. Often, investors complain that auditors word their reports
defensively. Of course, this was called for considering that the profession is
blamed for many things for which it is not even responsible! We need something
better and clearer because everything that needs to be communicated cannot be
written, and what is written is often not understood if it is long and complex.


For all these years, till F.Y. 2017-18, the opinion
came only towards the end. In F.Y. 2018-19, it was upgraded to the top in the
main report (we have to follow the international standards). But the ICFR
report still has opinion at the end. As if this wasn’t enough, we got ‘Other
Information’ recently that adds to the confusion, and even managements had to
be explained what it really meant.


The auditor signs the AR at three places and
financials at four to five. Signature is important, but one wonders if it would
make any difference if an auditor signed just once instead of thrice in the AR.


Considering the many difficult words in use, we
perhaps need a Glossary of Words as a standard part of an Annual Report for lay
readers to try to understand the meaning of these words. Consider ‘Other
Comprehensive Income’. Literally, it means nothing, at least the first two
words. There are also words such as ‘management’ and ‘those charged with
governance’. To a lay reader this is out of bounds, especially in the words of
FMs, 99% companies are SME. Section 134(5) doesn’t even segregate the two.


There is some conflicting verbiage under the
‘responsibility of management…’ – the words used are financial position and
financial performance in the context of the preparation of financial
statements. While these words refer to the same thing referred to elsewhere,
but they confuse a lay reader. We do have a concept of Nature and Function in
accounting, and here both are at play talking about the same financials.


While we have heavier reporting, we need not have
heavier jargonised lingo. We need better naming and a glossary to be a standard
part of an Annual Report to make sense of financial information. After all, the
financial information is for the reader and not the accountant or
administrator. The understanding gap of GAAPs is wide! This gap must be
bridged, and soon!

 

 

 

Raman Jokhakar

Editor

 

FIRST SIGNS OF EVOLUTION

We are experiencing
the first signs of evolution of the GST law and who would have imagined that
the beginning would be from a property dispute matter! A recent decision of a
single-member bench of the Hon’ble Bombay High Court in Bai Mamubai Trust
vs. Suchitra 2019 (31) GSTL 193 has set the tone for the upcoming years
of GST. This article is an attempt to decode the decision and examine its
application.

 

ISSUE AT HAND

The Bombay High
Court was hearing a suit between a landlord (plaintiff) and a tenant (defendant)
under the Maharashtra Rent Control Act, 1999 regarding adverse possession of a
commercial property. In view of the strong prima facie case of the
landlord to obtain possession of the property, the Court granted interim
protection by placing a condition of payment of an ad hoc royalty by the
defendant to be deposited with the Court Receiver under an agency agreement.
The Court Receiver was directed to invest the royalty received as a fixed
deposit with a nationalised bank. This direction raised three questions for the
plaintiff and the Court Receiver:

(a) Whether the royalty paid by the defendant was
liable to GST during the period of dispute?

(b) If yes, who was liable to collect the GST from
the tenant and pay the same to the Government – whether the Court Receiver or
the landlord?

(c) Whether the Court Receiver is separately
taxable for the agency services being rendered under this arrangement?

 

The primary issue
before the Court was the applicability of GST on the royalty payment by the
defendant to the Court Receiver during the pendency of the dispute. This
required examination of the following entries:

* Provisions of
section 7 defining the scope of supply for the purpose of GST;

* Schedule III –
Entry 2: Services by any Court or Tribunal established under any law for the
time being in force; and

* Applicability of
reverse charge provisions on receipt of services from the Central Government in
terms of Notification 13/2017-CGST(Rate).

 

Submissions
of amicus curiae: The Court appointed an amicus curiae to assist it in
resolving the issue on legal principles. The submissions made by him were as
follows:

(i)   Any amount paid under a Court’s order / decree
or an out-of-Court settlement is taxable only if it is towards an underlying
taxable supply; where the payment is towards restitution of a loss or damage,
i.e. compensatory in nature, such payment would lack the tenets of supply, i.e.
enforceable reciprocity in actions.

(ii)   The method adopted for quantifying the
damages, i.e. equating to the commercial rental value should not be confused
with the underlying purport of the payment {Citing Senairam Doongarmall
vs. Commissioner of Income Tax [(1962) SCR 1 257]}.

(iii) Services provided by the Court Receiver were to
be treated as ‘Services by any Court or Tribunal established under any law for
the time being in force’ within the meaning of paragraph 2 of schedule III to
the CGST Act and is, accordingly, not within the ambit of GST.

(iv) Section 92 of the CGST Act provides for
collection and discharge of tax liability by a Court Receiver from the estate
in its control. The Court Receiver would be a convenient point for the Revenue
to collect its tax being the person who is in direct receipt of the
consideration / royalty, where such payment itself is liable to be taxed under
the provisions of the CGST Act. The Court Receiver can discharge the liability
as an agent of the supplier in terms of section 2(105) of the said Act.

 

Court
Receiver’s submissions: The Court Receiver also
made its submission on the specific question on taxability of the royalty as
follows:

(1) There is a distinction between fees or
remuneration of the Court Receiver under Rule 591 of the Bombay High Court
(Original Side) Rules, 1980 and the moneys paid by a litigant towards the matter
under litigation.

(2) The Court Receiver is an adjunct of the Court
and a permanent department of the Court and its role is to implement interim
protection to litigants. Therefore, the former is clearly covered under
schedule III and not taxable.

(3) Monies paid in the Court of litigation as part
of interim protection are to be examined based on the underlying relationship
between the litigating parties – taxable event of supply cannot be applied on a
notional contract between either of the parties and the Court Receiver.

(4) For example, during the tenure of permissive
use of a property, what is paid by the occupier to the right owner is the
contractual consideration. If such permissive use or occupation is terminated
or comes to an end and the occupation becomes unlawful, the nature of payment
to be paid to the right owner changes from contractual consideration to
damages or mesne profits for unauthorised use and occupation of the
property. GST is payable on the former contractual consideration, but
not on damages payable for unauthorised use and occupation of the property. The
fact that the measure of damages is to be based on market rent should not
influence the nature of the payment being made, i.e. a payment to compensate
the right owner for violation of his legal right. Royalty is towards
compensation and not a contractual consideration.

(5) The Court Receiver may discharge the GST by
including this obligation in the agency agreement. This may obviate the
requirement of the Court Receiver from having to obtain separate CGST
registration for each matter or transaction in respect of which it is appointed
to act by the Court; (though) it is preferable from an audit and administrative
perspective to obtain separate GST registration for each matter, where the same
is paid for by the Court Receiver.

 

Submissions
of State Government / Union of India

(I) GST may be
recovered from the Court Receiver u/s 92 only if it is conducting a business of
a taxable person. A binding contract has come into existence under the
directions of the Court (i.e. the defendant has to either accept the offer to
retain possession and pay royalty, or vacate the premises).There is an offer,
its acceptance and consideration for forming a valid contract.

(II) The order
permitting the defendant to remain in possession of the suit premises is
essentially a contract and payment of royalty is ‘consideration’ for this
‘supply’ of premises to the defendant pursuant to an order of
the Court. GST will be liable to be paid under the MGST Act. The Learned
Advocate-General relied on a judgment of the Supreme Court in Assistant
Commissioner, Ernakulam vs. Hindustan Urban Infrastructure Ltd. [(2015) 3 SCC
745] (which considers Rule 54 of the Kerala Sales Tax Rules which is in
pari materia with section 92 of the MGST Act) to contend that akin to an
official liquidator who was termed to be a dealer of company assets even though
the express consent of the Company in Liquidation was not present, the Court
Receiver represents the plaintiff and is a supplier of services.

(III) As per the
decision of the Supreme Court in Humayun Dhanrajgir vs. Ezra Aboody
(2008) Bom C.R. 862, royalty is a compensation payable by the occupier
to the right owner in the property towards the use of his rights in his
property. There is a clear supply of service of providing premises (subject, of
course, to the final determination of the rights of the parties to the suit).
Such letting or providing of premises is clearly covered in the scope of
‘supply’ u/s 7 of the CGST Act as also under the definition of ‘services’ u/s
2(102) of the CGST Act.

(IV) The Court
Receiver wears two hats, one as an agent of the Court and another as an agent
of the plaintiff on whose application he is appointed. Tax is only levied
on the services rendered by the Court Receiver as an agent / on behalf of the
plaintiff u/s 92 of the CGST Act.

 

The findings of the
Court can be segregated into the following sub-headings:

(A) Status of
the Court Receiver and its Court fee: The
Court cited the decision of Shakti International Private Limited vs.
Excel Metal Processors Private Limited 2018 (4) Arb LR 17 (Bom.) which,
in turn, relied on certain Supreme Court decisions and effectively approved the
submission of the amicus curiae that the Court Receiver is a permanent
department of the Court, implements orders of the Court and functions under the
supervision and direction of the Court, hence to be concluded as a ‘Court’1.
Accordingly, the fee of the Court Receiver is clearly excludible in terms of
Entry 2 to Schedule III of the GST enactments.

(B) GST
liability on income from estate under control of Court Receiver: The Court held that ‘supply’ being an essential ingredient of
taxability, has to be identified for each case; the present case being royalty
payments for use of commercial premises.

 

On the aspect
of supply: The royalty payment was held as not
being towards a taxable supply for the following reasons:

 

(a) It was being paid towards damages or compensation
or towards securing any future determination of compensation or damages for a violation
of the legal rights of the landlord (plaintiff) in the tenanted
premises;

(b) The basis of payment is illegal
possession or trespass and hence lacked necessary reciprocity to make it a
supply;

(c) The plaintiff is not in agreement with
continuing possession and hence seeking damages for loss and such loss closely
resembles in monetary terms the rental value of the property;

(d) In contrast, had there been a money suit for
recovery of unpaid rent, certainly the tax is liable on the unpaid
consideration as it represented an agreed reciprocal obligation where one of
the litigating parties was seeking relief of its rights in the contract;

(e) Damages represent an award in money for a civil
wrong which is in contrast to ‘consideration’. While damages are towards
restitution for loss caused on account of violation, consideration is towards
an identifiable supply;

(f)   The law of damages is not restricted to only
unpaid consideration, i.e. what ought to have been paid, but also expands to
compensating the loss to a party which may not even be privy to the agreement
(e.g. in torts);

(g) The decision of the Supreme Court in Hindustan
Urban Infrastructure (Supra) is distinguishable as the said decision
pertained to an official liquidator being termed as a dealer of goods of the
company it represents in the course of liquidation;

(h) Royalty for the demise of a property itself has
many colours and the true character is to be determined from specific facts –
the ratio of the decision of the Supreme Court in Humayun
Dhanrajgir vs. Ezra Aboody (2008) Bom C.R. 862 clearly distinguishes
the rent paid for a tenancy as being in the nature of (a) consideration during
the tenure of the tenant; (b) compensatory after the tenure as a disputed
occupant; and (c) mesne profits as being towards the occupancy in spite
of being declared as illegal by a Court;

(i)   The Court also accepted the submission that
the measure for computation cannot be the litmus test for ascertaining the
character of a supply;

(j)   Contractual obligations would dominate over
consideration while deciding the character of a supply. Even though business
and supply definitions are inclusive, a positive act of supply is a necessary
concomitant of a supply transaction;

(k) The Court cited an example of a Court Receiver
being deputed to make an inventory of goods, collect rents with respect to
immovable property in dispute, or where the property has to be sealed, or the Receiver
is appointed to call bids for letting out the premises on leave and license,
the fees or charges of the Court Receiver are exempt. In providing these
services, the office of the Court Receiver is acting as a department of the
Court and therefore no GST is payable.

 

Interestingly, as
an obiter, the Court specifies some instances where GST may be
applicable – it may be observed that each of them has a positive act with
reciprocity and hence includible as supply:

(i)   Where the Court Receiver is appointed to run
the business of a partnership firm in dissolution, the business of the firm
under the control of receivership may generate taxable revenues.

(ii)   Where the Court authorises the Court Receiver
to let out the suit property on leave and license, the license fees paid may
attract GST.

(iii) Where the Court Receiver collects rents or
profits from occupants of properties under receivership, the same will be
liable to payment of GST.

(iv) Consideration received for assignment, license
or permitted use of intellectual property.

 

On the aspect
of representative capacity of Court Receiver:

Curiously, having
decided that the said royalty is not towards a supply, the Court need not have
examined the provisions designating the Court Receiver as a representative
assessee. Yet, the Court specifically stated that section 92 would be
applicable where the Court Receiver was in control of the business of the
taxable person, a taxable event of supply takes place with respect to such
business on account of which the estate of the taxable person would be liable
to tax, interest or penalty under the CGST Act. Therefore, in the event the
supply is taxable, the Court Receiver would have to take registration and
discharge the tax liability as an agent of the supplier [Court directed that a
clause in the standard form of the agency agreement to the effect may be
included] – the agent appointed by the Court Receiver must obtain registration
and make such payment on behalf of the Receiver and indemnify the Receiver for any
liability that may fall upon the Receiver u/s 92 of the GST Act concerned.

 

Ratio Decidendi

The following are
the key takeaways from this decision:

(1) Reciprocal obligations arising from positive
actions are necessary for an arrangement to be a supply;

(2) Consideration should be examined as a
reciprocal of a positive act and distinguished from compensations for
restituting a loss;

(3) Measure cannot fix the character of the
payment, it has to be ascertained from contractual obligations and substance of
the agreement;

(4) Schedule II was not invoked as a starting point
for deciding supply, and naturally so in view of the retrospective amendment
setting the role of schedule II as being classificatory and not directory, in
deciding the scope of supply u/s 7 of the GST enactment;

(5) In case of representative persons, distinguish
the receipt while acting as a representative and those on its own account. In
the present facts, the Court Receiver acted as a representative while
collecting royalty payments but acted on its own account in respect of the fee
as a Court Receiver. The former was not taxable on account of not falling
within the scope of supply u/s 7 itself, while the latter was held as being
exempt on account of schedule III of the GST law.

 

CAUTION OVER APPLICATION

However, the
following should not be immediately concluded from this decision:

(I)   All court-directed payments are not
compensatory and damages are to be identified in their true sense based on
facts of the case;

(II)   Scope of the term ‘business’ and whether Court
Receiver is in ‘business’ – the Court directly invoked schedule III to hold
that it was exempt under GST and has not examined section 7 on this aspect;

(III) GST implications if the Court in this civil
suit ultimately holds that tenant has rightful possession under the tenancy and
the royalty previously deposited as a fixed deposit (even partially) is
appropriated towards the rent to the landlord;

(IV) Whether or not
there is a supply inter se between the Court Receiver and the principal
in case of supply of goods, especially in the context of schedule I entry 3
which deems transactions between principal and agent as supplies even in the
absence of consideration.

 

The Hon’ble High Court has delivered a
well-reasoned order and even if the same is to be challenged before higher
forums, the principles set out in this decision seem to be on a solid
foundation. The Court has certainly placed some boundaries over the seemingly
unfenced scope of supply u/s 7. This decision would have implications on
matters involving liquidated damages, demurrage / detention charges, notice pay
recovery, etc. and the underlying character of the obligation would have to be
minutely studied prior to taking support of this decision.  

COVID-19 IMPACT ON INDIAN ECONOMY AND THE FINANCIAL MARKETS

INTRODUCTION:
THE ECONOMIC IMPACT

It was mid-January when we
started to hear stories about a virus in China which had locked down the entire
Wuhan city, the epicentre of the virus. Its effect had also spread to other
Asian countries and by 30th January, 20201 India reported
its first Covid-19 case. After two and a half months of the first reported
case, India is now in the second phase of lockdown. India took early calls to
go for a complete lockdown and implemented strict guidelines due to the
experience of other countries, the rate of transmission of the virus from one
person to another and also the strain which this virus could cause on the
healthcare system of the country.

 

Observers state that the lockdown
slowed the growth rate of the virus by 6th April to a rate of
doubling every six days, from a rate of doubling every three days earlier. The
metric called R-Naught or R-Zero, estimates that the infection rates in India
have fallen to 1.55 on 11th April from 1.83 on 6th April,
further indicating that lockdowns could be helping2.

 

This article seeks to explore the
consequences and impact of the current health crisis on the overall Indian
economy and the Indian financial markets.

 

Looking back to the situation
till a couple of years ago, India was going through its own economic slowdown:

(i) The primary reasons were the ‘shocks’ of demonetisation in 2016 and
the introduction of the Goods and Services Tax (GST) in 2017.

(ii) India recorded the lowest quarterly GDP growth rate in the last
decade of 4.7% in Q3FY203 and the growth outlook (pre-Covid-19) for
FY21 was upwards of 5%.

(iii) The economy had started to show some signs of recovery when the
index of industrial production (IIP) grew by 2% on a y-o-y basis in January,
2020. The manufacturing index also improved by 1.5%.

 

(iv) To boost the economy, the Finance Minister reduced the base
corporate tax rate to 22% (effectively ~ 25%) for companies which do not seek
to take certain exemption benefits. This led to earnings recovery for many
companies and a boost to the stock markets as well.

 

What impact will the current
crisis have on the GDP growth rate?3

(a) It has been estimated by various rating agencies that the advanced
economies will contract by 0.5% to 3% in 2020 as against a global growth of
1.7% in 2019.

(b) China is estimated to grow ~ 3% in 2020, while India’s growth
forecast for FY21 has been revised downwards and is estimated to be between
1.8% and 2.5% from more than 5% estimated before the lockdown was announced.

(c) Having said that, even a 2% growth rate is still good news for
India. Due to the low base rate, the expected GDP growth in FY22 is expected to
be upwards of 7%.

 

With what is now happening across
the world (post the Covid-19 outbreak), including India, a slowdown in each and
every economy is imminent. The extent of impact in different geographies will
vary based on the severity of the virus, the stimulus packages by the
governments to revive the economy and how fast a nation is able to commence its
economic activities.

 

MEASURES
TAKEN SO FAR BY THE GOVERNMENT OF INDIA

Though India has been very slow
in announcing economic packages for industry, there have been three major
announcements – two by the RBI (monetary policy) and one by the Finance
Ministry (fiscal policy).

 

(1) On 26th March, Finance Minister Nirmala Sitharaman
announced a Rs. 1.7 lakh-crore fiscal package for the poor, including cash
transfers, free food grains and free cooking gas.

(2) On 27th March, the RBI announced a 75-basis points cut in
the policy rate and a 100-bps cut in the cash reserve ratio for banks to inject
liquidity in the system and provide moratoriums for loan repayments for three
months (March to May, 2020).

(3) On 17th April, RBI freed up more capital for banks to
lend, announced a fresh Rs. 50,000-crore targeted long-term repo operation to
address the liquidity stress of NBFCs and microfinance institutions and hinted
at the possibility of further rate cuts going forward. RBI also announced a Rs.
50,000-crore special finance facility to NABARD, SIDBI and NHB for onward
lending to NBFCs in the space. The RBI Governor also announced that India would
do ‘whatever it takes’.

 

To sum up, the government has
first prioritised the containment of the virus and providing relief to the
poorest sections of society. In the days to come, it will dole out sector- and
industry-specific packages as well.

 

IMPACT ON VARIOUS INDUSTRIES

It
goes without saying that the lockdowns will certainly have an impact on each
and every industry in varying degrees.

S.No.

Industry

Impact

Likely nature of effect

1

Auto and auto components

High

  • Weak PV and CV demand due to
    liquidity shortage with NBFCs, economic uncertainties, weaker consumer
    purchasing power, likely NPAs in the sector
  •  Stuck with inventories of
    unsold BS-IV vehicles with the original deadline of selling     them before 31st March, 2020

2

Aviation and tourism

High

  • Uncertainty over travel
    restrictions which can extend or remain restricted for a longer period of
    time, borders might remain closed
  • Loss of jobs and pay cuts
  • 102 of 137 airports managed
    by AAI have recorded losses to the tune of Rs. 1.6 billion
  • Estimated to render more than 50% of tourism industry workforce
    jobless in hospitality industry4

3

Agriculture

Low

  • Since agriculture is the
    backbone of the country and part of government-announced essential category,
    the impact is likely to be low on both primary agricultural production and
    usage of     agri-inputs like seeds, pesticides and fertilisers
  • Agro-chemicals: Companies
    that depend on exports for finished goods sale and imports of raw ingredients
    will be impacted

  • Food exports: Major
    destinations like the U.S., Europe expected to grapple with Covid-19     for the next few months and Indian export-based companies will be impacted
    due to low consumer demand and port hurdles
  • The economic packages likely
    to be announced will provide relief to farmers and the allied sectors and,
    hence, the overall impact on agriculture will be low

4

Chemicals and petrochemicals

Medium

  • Weakening in crude oil
    prices and cascading impact on petrochemicals, coupled with uncertain
    domestic and global demand; petrochemicals prices are likely to remain low
  • Uncertain demand outlook and weak prices are
    expected to lead to weak market     sentiments and delayed investments in the sector

5

Consumer, retail & internet business

Low to medium

Essential commodities:

  • Growth seen for essential
    commodities players, with possible margin improvements, unless there is price
    control by government
  • There will be increased
    pressure on supply chain for deliveries of products amidst the lockdown

Non-essential commodities:

  • Markets likely to crash due to low discretionary
    demand. Overdependence on imports     could pose a threat
  • Industries facing severe challenges: Apparel, durables, restaurants and other on-premise services like gyms / salons, etc.

6

Banking and NBFC’s

Medium to high

  • Banking sector to be under
    pressure due to reduced off-take of loans in expected recessionary market
    conditions and cautious lending
  • Possibility of increased delinquencies post the
    moratorium period, and may also result in depressed NIMs in a low interest
    rate regime
  • Drop in transaction fee-based income due to lower cross-border
    trade

  • Affordable housing, two-wheeler financing,
    micro-finance and gold loans     exposures to be adversely impacted

7

Insurance

Low

  • Fresh demand for health insurance and life
    insurance witnessed a surge in the current scenario
  • Renewals may get delayed due
    to shortage of money in the hands of policyholders
  • Usage of AI / ML / technology can assist in
    reduction of operating costs, increasing customer satisfaction and policy
    management

8

MSMEs

High

  • Many MSMEs to face closure of business if the
    lockdown continues for more than eight weeks due to heavy leverage costs and
    no production output for more than eight weeks

  • More than 114 million people
    are likely to get affected, with a dent in     their contribution to GDP (~ 30-35% of GDP)

9

Transport and logistics

Medium to high

  •  Crude price reduction is
    likely to positively impact the     transportation costs in the short term
  • Freight traffic volume is expected to slow down

  • Post-monsoon, the demand is
    anticipated to spike on account of accrued consumer     savings as well as onset of festive season
  •  Lower utilisation of ports
    infra, road and rail infra, storage infra due to reduced cargo traffic in     short to medium term

10

Healthcare and pharmaceuticals

Low to medium

  • Generic drugs are most impacted – reliance is high on imports (~
    70%) from China

  • Non-availability of labour,
    transport of ingredients and supply side issues     could impact production volume

  • High exports demand for
    certain products over the short term – as developed countries    (U.S., EU, etc.) look to stockpile medicines
  • Probable price controls of essential drugs
  • Online pharmacies – medicine
    delivery has been affected due to non-availability of delivery staff

11

Construction and real estate

High

  • The housing sector is
    expected to see muted demand with significant reduction in new launches

  • The existing demand for
    commercial real estate may either get curtailed or     postponed till H2 of the current year
  • One of the largest employment generators in the
    country, it will have a multiplier     effect on around 250 allied industries
  • There is a likelihood of the
    government providing relief to the sector in terms of relaxation for project
    delays in residential housing sector, easing financial stress by extending
    loan repayment, etc.

12

Overall imports and exports

High

  •  India’s merchandise exports
    slumped by a record 34.6% in March, 2020 while imports declined 28.7% as
    countries sealed their borders to combat the Covid-19 outbreak5
  • Business Process
    Outsourcing, one of the India’s largest exports, will be severely affected as
    lockdown measures, both in origin and destination countries, have forced
    offices to close. It will be further accelerated with the cost-cutting
    measures by the destination countries
  • However, it is likely that India’s balance of
    payments position may improve. Weak domestic demand, low oil prices and
    Covid-19-related disruptions are expected to narrow the current account deficit
    to 0.2% in FY21 and to keep it low in the following years

Source: KPMG report, news articles

 

 

Some general and overarching
impacts on the overall economy could be:

(i) Unemployment – The unemployment in
India has shot up from 7% to 23% in the last two weeks of March, 20206

(ii) Poverty – As per the estimates of the Indian Labour
Organisation, more than 400 million people in India are at the risk of sinking
back below the poverty line.

 

While the current lockdown will
be ending on 3rd May and some relaxations have been offered post 20th
April, if the number of infections surges, there could be further lockdowns.
This could further affect the businesses and the economy and we should be
prepared for the same.

 

 

THE IMPACT ON THE FINANCIAL MARKET

Let us now look at how the Indian
financial markets have been impacted in the past during various crises – from
the Harshad Mehta and Ketan Parekh scams to the Global Financial Crisis (GFC)
and the recent China-US trade wars. Table 2 (next page) denotes the time
required for the market (Nifty) to bottom out from its peak and then the time
taken to reach back to its peak:

 

Peak

Trough (Bottom)

Peak to Trough

Recovery Month and  Value

Months to

Recovery

Month

Value

Month

Value

Months

Extent (%)

Month

Value

Mar-92

1262

Apr-93

622

13

-50.7

Feb-94

1,349

23M

Feb-94

1349

Nov-96

830

33

-38.5

Aug-99

1,412

66M

July-97

1222

Nov-98

818

16

-33.1

July-99

1,310

24M

Feb-00

1655

Sept-01

914

19

-44.8

Dec-03

1,880

46M

Dec-03

1880

May-04

1,484

5

-21.1

Nov-04

1,959

11M

Dec-07

6139

Nov-08

2,755

11

-55.1

Dec-10

6,135

36M

Dec-10

6135

Dec-11

4,624

12

-24.6

Oct-13

6,299

34M

Feb-15

8902

Feb-16

6,987

12

-21.5

Mar-17

9,174

25M

Aug-18

11681

Aug-19

10,793

6

-7.6

Apr-19

11,748

8M

Jan-20

12362

23-Mar-20

7,610

2

-38.4

??

??

??

Source: Nifty historical data

 

 

The Indian equities reached the
trough (bottom) on 23rd March, 2020. The current down-turn is still underway
and has shown the trough as on 23rd March, 2020.

 

What has happened to the Indian
financial markets since the start of the crisis?7

  • The valuations have corrected significantly
    on a trailing PE basis – from a high of 29.9 a few months back to ~ 16-17 now.
    During the GFC, the Nifty PE had touched a low of ~ 11-12 trailing PE.
  • The long-term EPS growth has been 13%
    year-on-year and in the quarter ended December, 2019 the EPS growth was ~ 15%.
    This was mainly due to the tax cuts which led to recovery in Q3 FY20.
  • The long-term average of Nifty Earnings has
    been ~ 12.5% while in the last five years the average has fallen to ~ 3-4%.
    There was a marginal recovery in the last financial year but now the recovery
    has been deferred to FY22.
  • The benchmark indices – Nifty50 and the
    Sensex – have fallen ~ 25% year-to-date (YTD), 2020.
  • Within the large-cap, mid-cap and small-cap
    space, the fall has been as under:

•    small
cap has fallen ~ 33%

•    followed
by mid-cap at ~ 26% and

•    large
cap at ~ 19% on a YTD, 2020 basis.

  • Nifty Bank has fallen the most during this
    crisis, plunging almost 50% and certain NBFCs falling more than 50% as well.
    The markets recovered somewhat in the first two weeks of April, 2020 and today
    the Nifty Bank is sitting at a 40% discount to its peak valuation.
  • While Nifty Bank has fallen significantly,
    Nifty Pharma has been the biggest beneficiary and is the only index with a
    positive YTD return of ~ 16%. The rest of the indices (sectors) have seen
    negative returns, the least negative being Nifty FMCG at ~ (-)5%.
  • In the credit scenario the investment grade
    ratings have fallen from 40% earlier to ~ 30% now. The downgrades are much higher
    in value – ~ Rs. 1,990 billion worth papers have been downgraded.
  • On the global front, the US Dow Jones has
    fallen by ~ 20% on YTD, 2020 basis, while most of the European markets have
    fallen upwards of 20% on YTD, 2020 basis. The China market has been the most
    resilient and has fallen only ~ 8% on YTD, 2020 basis.

 

Before the Covid-19 crisis, the
banking and financial services were facing massive problems with the collapse
of IL&FS and DHFL and the Yes Bank fiasco. In the current market scenario,

  • NPAs are likely to increase as the private
    banks, NBFCs and even micro-finance institutions have aggressively built their
    retail loan book and there will likely be massive layoffs
  • Further, these loans are majorly unsecured
    and there can be a slew of defaults, especially on the MFI side, and can also
    bring the mid and smaller NBFCs to the brink of collapse
  • Some of the new-age digital financial
    startups which simply opened the liquidity tap to trap the young earners with
    huge interest rates, may be forced to shut shop
  • However, the liquidity and moratoriums
    provided by RBI will come to the rescue
  • More clarity in this regard will emerge only
    after three to six months when the economic activity resumes
  • Meanwhile, credit off-take can be low for
    the next couple of quarters as companies rework on their capex plans due to
    weak demand and the uncertain global environment.

 

ANY
SILVER LINING IN THE MIDST OF THIS CRISIS?

While all of the above sounds
quite alarming, there are many positives in India’s current state of affairs:

 

  • Forex reserves: India has forex reserves to
    the tune of USD 476.5 billion as on 10th April, 2020 and in a
    worst-case scenario this will take care of 11.8 months of India’s import bills8.

  • Crude prices: The crude prices have fallen
    to record lows, lower than $10 per barrel as on 20th April, 2020. If India can
    import and store additional crude at this level, it will save huge import bills
    once normalcy kicks in and crude prices rise. Since 80% of India’s oil
    requirement is met through imports, a fall in crude oil prices can save USD 45
    billion on crude oil imports9.
  • MSCI Index re-jig: Indian stocks are
    expected to see an inflow of more than USD 7 billion on account of a likely
    increase in their weight on the MSCI Index. FIIs have been net sellers and they
    have sold more than Rs. 30,000 crores in the last four weeks. Therefore, a
    re-jig of the MSCI index will bring in fresh FII inflows10.
  • Low inflation: The food inflation is on a
    declining trajectory and has eased ~ 160 basis points from its peak in January,
    2020. The CPI inflation as on 19th March, 2020 was 5.9% and the RBI is
    confident of bringing it below 4% by the second half of 2020.
  • Normal monsoons: The Indian Meteorological
    Department has forecast a normal monsoon in 2020. This will benefit agriculture
    which is the backbone of the Indian economy.
  • Shift from China to other geographies: Many
    countries are envisaging a shift of dependency from China and also to shift
    their manufacturing bases from China to either their home country or to find a
    suitable alternative. Japan has announced packages for its companies bringing
    back manufacturing home. India can benefit a lot if some of this shift happens
    from China to India. It will significantly improve FDI flows into India.


FOOD FOR THOUGHT

The way the economy will recover
or fall will depend on how the pandemic plays out. No doubt a vaccine is the
need of the hour, but that will take a minimum of nine months to a year to
develop and then to be distributed to every human being on the planet. While
there may be some medicinal cure which could be developed, there will be
uncertainties in the interim. During these times, the following possibilities
could emerge:

 

  • Will there be de-globalisation? Will
    countries close borders – partially or completely?
  • Will India gain a lot of market share with
    a shift in manufacturing base to India?
  • Will there be a V-shaped, U-shaped,
    W-shaped or L-shaped recovery of the Indian and global financial markets?
  • Will there be disruption in existing
    industries – Will Information Technology be the new king? Will the pharma
    sector be the best performer index in the market?

 

We are fighting with an ‘unknown
unknown’ phenomenon and only over time will we be able to get the answers to
the above questions.

 

I would like
to conclude with a quote from Joel Osteen – ‘Quit worrying about how
everything is going to turn out. Live one day at a time’. This, too, shall
pass and we will emerge as a stronger and better economy in the end. 

 

Disclaimer: The views, thoughts and opinions expressed
in this article belong solely to the author; the data has been gathered from
various secondary sources which the reader needs to independently verify before
relying on it. The information contained herein is not intended to be a source
of advice or credit analysis with respect to the material presented, and does
not constitute investment advice

________________________________________________________

1   Ministry of Health, https://www.mohfw.gov.in/, News Articles

2   https://theprint.in/science/r0-data-shows-indias-coronavirus-infection-rate-has-slowed-gives-lockdown-a-thumbs-up/399734/

3   IMF estimates,
Various rating agencies
4   https://economictimes.indiatimes.com/news/economy/indicators/indias-tourism-sector-may-lose-rs-5-lakh-cr-4-5-cr-jobs-could-be-cut-due-to-covid-19/articleshow/74968781.cms?from=mdr

5   https://www.livemint.com/news/india/india-s-trade-deficit-narrows-to-9-8-bn-in-march-exports-dip-34-6-11586955282193.html

6   CMIE
database,
https://www.cmie.com/kommon/bin/sr.php?kall=warticle&dt=2020-04-07%2008:26:04&msec=770

7   Newspaper Articles, Nifty50 Returns

9   https://www.energylivenews.com/2020/03/24/india-to-save-45bn-on-crude-oil-imports-next-financial-year/

10  https://www.bloombergquint.com/markets/morgan-stanley-sees-71-
billion-inflows-into-india-on-msci-rejig

 

SOME REFLECTIONS ON COVID-19 AND THE ECONOMY: RESET TIME

I am presenting a few thoughts on
the reasons for the pandemic, how to stop future pandemics, its impact on the
economy and steps for its revival, the oil shock and its domino effect and
other related issues.

 

PANDEMIC REASON – VIRUS AND STRESS IN
ANIMALS

I have seen
a video on the reasons for pandemics published by the Nutrition Facts Organisation
of the USA in 2010. Dr. Michael Greger, M.D., FACLM, explains that (i)
this is a zoonotic disease and the virus which is present in animals infects
mankind, (ii) most viruses are completely neutralised within 30 minutes under
direct sunlight; however, in dark, damp and shaded conditions they can survive
for weeks, (iii) viruses which have existed for thousands of years innocuously
have now become deadly.

 

Why is this so? Clearly, the stress
and the pain suffered by animals results in even an innocent virus turning
into a deadly one. When these stressed animals / birds are eaten by men,
they get infected. If we don’t stop industrial animal farming for food, then we
should be prepared for a pandemic of deadly proportions equivalent to the
Indonesian tsunami of 2004 simultaneously hitting all the major cities around
the world. In case a pandemic hits the USA, it may be necessary to lockdown
the whole country for 90 days. This prediction was made in the year 2010. (See
the video: https://nutritionfacts.org/video/pandemics-history-prevention/)

 

In short, extreme cruelty by
mankind on animals and birds has caused this pandemic. And all nations are
responsible for this cruelty. Industrial farming of pigs and chicken, of cows
for milk, etc., several such cruel practices were started in the capitalist western
countries and this is the chief cause of this virus.

 

According to me, in the same way,
globally, half the human population lives in stress because of poverty and wars
inflicted by greedy lobbies and nations. This stress also affects world peace
and welfare. It is time we take notice of this fact.


PREVENTING FUTURE VIRAL PANDEMICS

To prevent such pandemics, one
should not only turn vegetarian, one should turn vegan. It is a simple
philosophy. Love your animals as you love your family. Love your employees as
your own family. Love is a great strength. The absence of love or callousness
has immeasurable negative power. Philosophy includes the principles of how to
live happily in society and the world. In Hindi it is called: In English, it’s ‘The
relationship amongst: Individuals, Universe and God’.

 

A useless plastic straw that we
throw away travels a few thousand miles through the ocean and hurts a tortoise.
The tortoise is in stress. Its stress affects world peace. We do not give
cognition to the stress suffered by billions of lives around the world. It is
high time that we recognise the philosophy that the stress caused in the
tiniest of lives will one day come back to haunt us. We have ignored the
warnings of numerous environmentalists. Let us now hear this warning by Mother
Nature or This is the time to RESET
everything and challenge all our assumptions. The virus has proved that we
have to live as one family, The solution to this virus and many other
problems may be found by the world in co-operation and not in competition. All
national boundaries are man-made and artificial. The ultimate truth is – We Are
All One,

 

If someone
had said before seeing the above video, ‘Don’t be cruel with animals’, the mass
commercialised industrialist as well as the consumer would not have listened to
him. The government would not interfere considering ‘philosophy and ethics as a
matter of personal choice’. But after seeing the video anyone who believes in prevention
of pandemics and other mass tragedies may want to practice and spread the
message of Universal Love and Truth.

 

A reader may ask, ‘Okay. I have
understood that the cause of the current pandemic is human cruelty to animals
and birds. But as an individual, what can I do?’ The answer to that is,
‘One individual cannot change the world. He cannot stop industrialised animal
farming. But he can stop eating animals and consuming dairy products.’ When
many individuals stop buying any product which involves cruelty, businesses
will have to change their practices. If we do not reset our business practices
and our personal lives, nature may (or may not) give us another warning.

 

PANDEMIC’S IMPACT ON ECONOMY

Both the Indian and the global
economies have suffered a serious setback due to the current pandemic.
How serious is it? How long will it take to recover? As recently stated by Mr.
Sanjiv Mehta, CA, Chairman of Hindustan Unilever, no one can provide a proper
answer to these questions. Economics is a social subject. Unlike the laws of
physics, the results of actions in economics cannot be predicted. They depend
upon society’s psychology, culture, readiness to put in hard work and so on.

 

To explain the issue in simple
terms, one can use the analogy of a person who has suffered a heart attack.
He knows the reasons of the attack: Lack of exercise, an over-indulgent
lifestyle, and so on. ‘Can he or will he recover? How good will be the
recovery?’ The answer to these questions is, ‘Of course he will recover.’ ‘How
well he will recover depends upon whether he has learnt his lesson. Will he
change his over-indulgent lifestyle? Will he start exercises? And does he have
the will power to return to a healthy life? Is he a positive thinker? Does his
positivity translate into action?’

 

This analogy can be applied not
only to individuals hit by disease, but also to nations hit by disasters.

 

The current pandemic has already
caused serious damage to economies. And the damage will continue for some time.
Nations and the world are not going to die. We will all recover. How well do we
recover is the issue. The quality of recovery depends upon how well we reset
our businesses and our personal lives.

 

Supply chains have been broken
and damaged. The demand for many goods and capital assets has evaporated. When
both supply and demand go down, there is necessarily a contraction of the
economy. There is no alignment between reduction in supply and demand. In other
words, the supply of goods A, B and C has stopped. The demand for goods C, Y
and Z has evaporated. Hence the contraction in the economy can be even worse.

 

In agriculture, tea gardens and
mango and grape orchards, vegetables and so on are adversely affected.
Agriculture has been exempted from the lockdown. But then a lot of migrant
workers have gone back to their native places. Transport is affected. Even the
manufacture of medicines is seriously affected.

 

Where does a nation start with relief
and recovery actions? The Government of India (GOI) and the RBI have
already announced different packages of financial relief – all together
amounting to Rs. 5 trillions. (One trillion is a short term for one lakh
crores.) Food Security is provided to 80 crores of Indians. The
GOI has started with ensuring that the poor daily wage-earners do not stay
hungry. They are being provided food and fuel in different ways. It is my
personal knowledge that, at least in Gujarat, the GOI is reaching the poor.

 

Having discussed stress and the
pain in animals, let us turn to the stress and the pain in human beings.
Let us take an example. The Covid-19 virus has spread in the Dharavi slum.
Hundreds of people are infected. This has raised fears of community spread. The
Central and the State Governments are worried. They do not see any practical
solution. They are frustrated. Imagine an invisible tiny virus frustrating the
Government of India. Why has this situation arisen?

 

In Mumbai, some flats are sold at
a price of Rs. 1,00,000 per square foot, or even more. In the same city,
several million people live in slums, on footpaths and in chawls. Many
people just do not have a roof over their heads.

 

Why is there such a wide
difference in incomes and wealth?

 

We do not ask this question.
Society in general doesn’t care. The government has excellent schemes for slum
development. Market forces will make it practical to give decent homes to
many slum-dwellers. And instead of spending money on slum redevelopment, the
government will get revenue. And yet, the Dharavi redevelopment scheme has not
taken off for so many years. Why? Because of corruption and greed.

 

Imagine a poor person living in
Dharavi. Most people there do not have toilets and bathrooms within their tiny
homes. They use common facilities. Imagine their fear of viral infection. They
can’t leave Dharavi due to the lockdown. And they can’t live in Dharavi because
of the abysmal living conditions. What amount of fear and stress are the people
living in Dharavi suffering from right now? Won’t that stress affect us and our
governments? Nature has already provided the answer. It will affect all of us.

There are many individuals and
NGOs who question the current pitiable condition of the poor. They work on the
ground in helping the poor. Many of them have achieved good success. May their
tribe grow; may their enthusiasm to help the poor infect society and
governments. May we see a day when every family in India has a home. One
such dreamer is Prime Minister Narendra Modi. He has already planned a
scheme for this purpose. I remember saying in my presentation at the BCAS
Economics Study Circle in 2015: ‘If all the welfare schemes planned by Mr. Modi
are executed in reality (not just on paper), then India can have 12% GDP growth
for the next 20 years.’ This is the solution and the answer to the question,
’How will the economy be affected by the present pandemic?’

 

India has a huge unsatisfied
need. And India has sufficient natural resources to provide food, clothing and
homes to every individual in the country. But the market system will not permit
it. Under a capitalist market system, farmers, teachers and doctors earn less
than share market speculators and tax consultants. A producer of goods and
services earns less than a film star and a sportsman. This market system has
to be reset.

 

GDP

GDP is a
misleading statistical figure that has become popular to such an extent that it
has become harmful. When a jungle is destroyed and factories are set up, GDP
goes up. But there is no consideration for the damage to the environment, the
loss of life of animals, the huge difficulties to tribals and so on. If the
Indian rupee rises to Rs. 36 per dollar, our GDP will jump from $2.8 trillion
to $5.6 trillion. This shows that the exchange conversion market is an
illusion. When liquor and cigarette production goes up, the GDP goes up. Share
market speculators speculate and GDP goes up with zero contribution to the real
economy. I am not worried if the GDP falls, but the people would be free from
pollution and the resultant diseases.

 

There is none and there will be
no direct relationship between welfare and GDP.

 

THE
CORONA SHOCK: NEGATIVE OIL PRICE

On Monday, 20thApril,
and also on Thursday, 23rd April, 2020, the price for a barrel of
crude oil on the New York Commodity Exchange dropped to negative $38. What is a
negative oil price? Why did it happen? And what can be the consequences?

 

This has happened because of
excess supply of crude oil and lack of storage capacity for the excess. Global
production (extraction from oil wells) is 100 million barrels per day (MBD).
With the almost global lockdown, the entire transport system and factories have
stopped. Now only domestic and agricultural consumption of power continues. As
per oil experts’ opinion, the demand has gone down by at least 25%. However,
production of crude oil continues at the same pace. Saudi Arabia, Russia and
the USA have agreed to cut down production by about 10.3 MBD. This cut will be
effective from 1st May, 2020. But the surplus of supply over
consumption will continue. Global storage tanks are almost full. In the USA,
people holding a ‘Buy’ contract have no storage space. Assume that a buyer has
already paid the full price. Now, either he has to lift the oil, or pay $38 per
barrel to cancel the contract. A negative price reflects the cost of storage
for an indefinite period. However, these negative prices will not last. It is
estimated that in the short term the price may settle around $20/barrel.

 

Crude oil is the most important
component of energy today. Hence, the USA has used it as an instrument in its currency
war. Its government insists that all global trade must happen in US
Dollars. Some nations refused. They were ready to sell their oil in Euros.
Hence the attacks on Iraq, Lebanon and Libya and the sanctions on Venezuela and
Iran. This is a classic illustration of a currency war using commodities as
weapons. When the opponents do not succumb to sanctions, the USA starts a
weapons war. [See a clip of the news on CNN dated 23rd April, 2020:
New York (CNN Business) 22nd April, 2020.]

 

The report said, ‘The Trump
administration ordered Chevron to halt oil production in Venezuela, dealing
another blow to the nation. The directive is part of President Donald Trump’s
effort to pressure the regime of Venezuelan President Nicolas Maduro by starving
it of cash. Despite having more oil reserves than any other country on earth,
Venezuela’s production has imploded because of tough sanctions imposed by the
United States and other reasons.’

 

But there are other factors to be
considered. When oil was sold at $100 per barrel, the USA started shale oil
production on such a scale that it became free from imports of crude oil. The
average cost of production of shale oil is estimated to be $40 per barrel
(estimates vary). When the oil price was high, shale gas producers took huge
loans on small capitals and did business. Now, with the oil price being less
than $40 per barrel, most of them are making losses. Because of the viral
pandemic, the global economy has slowed down. The demand for oil may remain low
in the short term. Hence prices may remain under $40 for many months. Some
shale oil producers may even go insolvent.

 

Domino Effect: When an
oil producer goes insolvent, the following people also suffer losses:
Speculators in oil prices, speculators in shares of oil companies, banks and
institutions that lent to the oil producers, speculators in bank shares;
employees of all of the above entities suffer and ultimately the government
loses tax revenues.
When these loss-making companies are bailed out, the common man, the taxpayer,
suffers. Thus, one loss has a domino effect.

 

We have seen this oil industry
projection at some length. There are many other enterprises that are also
highly leveraged. The airline industry is a capital intensive, high
revenue cost industry with widely fluctuating profit margins. The lockdown may
have caused huge losses for all airline companies. Some may go insolvent. Many
other enterprises will also go insolvent. That means huge losses for banks
and the financial system. Will it result in banks going insolvent? Will central
bankers around the world be able to save the banking system?

 

In Maharashtra, mango and
grape orchard owners can’t export their fruits. All over the country, many
farmers cannot sell their products even within India. Most of their products
are perishable. They will suffer huge losses. Who will bear these losses? The
list can go on.

 

Suddenly, the force majeure
clause is being invoked by parties for not fulfilling their part of the
performance. Everyone looks at themselves. As if the ship is sinking! If this
happens on a very large scale, then the economy can come crashing down. The
economy is really like a giant machine with several wheels within wheels.
All these wheels are connected by bearings, gears and chains. Some wheels
stopping or slowing down may disrupt the machine. But if several wheels stop
functioning, then the bearings can break down and the machine stop. We need to
identify all the wheels, bearings, gears and chains in the economic machine.
Observe them, help them, and ensure that almost all parts function.

 

SOLUTION: ECONOMIC ACTION

Confidence at the highest level
is crucial. The US and European economies have been built over a few hundred
years. The Indian and Chinese economies and societies have been built over a
few thousand years. How can these economies be destroyed if a pandemic
disturbs them for a few months? Only when an economy has its fundamentals
seriously wrong can it be damaged. Probably, all countries, including communist
countries, are working on Capitalist Market Economics. These need to be RESET.
In other words, extreme disparities in income, wealth and welfare have to be
reduced. Every producer of goods and services must get at least a living wage.
There should be no or minimum stress caused by unfair economics at the human
level. Poor people constitute the base of the economic pyramid. When the base
is strong, the structure will be steady. And it can come up fast. If the poor
at the base die due to starvation, the whole economy will be badly affected And
it cannot recover fast enough.

 

The Government of India has
effected a large financial relief package. And the Prime Minister has
his heart in the right place. First priority is being given to the poor, daily
wage earners, hawkers and others. Cooked and uncooked food is reaching the poor
in villages through the government machinery. There are corners where the government
may not reach. These are being reached by NGOs. Cash is reaching the poor under
‘Direct Benefit Scheme’. Tax refunds are being expedited. Banks are asked to
release more loans. Provident fund claims are being released quickly. Through
all practical measures the government is ensuring that cash flow in the nation
must continue. Cash in the society is like blood in the body. It must remain
circulating. Otherwise the body parts will get numb. And even the smallest part
going numb will affect the whole body.

 

One big relief this time is from
the tax departments. Every year, from January to March, Income-tax and
GST officers get into overdrive to collect tax revenues, whether departmental
claims were right or wrong. Big refund claims, howsoever legitimate, are
withheld for the 4th quarter. That pressure is off this year. And revenue
targets have naturally gone for a toss.

 

Will this huge expenditure of Rs.
5 trillion cause a budgetary deficit? Yes, certainly the budgetary
deficit will increase. Will it cause inflation? May be, maybe not. The
Food Corporation of India (FCI) has over 70 million tonnes of food stocks.
Every year, substantial quantities of food rot and have to be disposed of. If
this stock of food is used, the market demand-supply equations will not be
affected. There need not be any inflation in the price of food. There are some
other items whose demand has fallen. In the case of some other items, it is the
supply that has fallen. All together, as a combined figure, there may be a
minor inflation. (Any guess for the future is to be taken with a pinch of
salt.) But in times of recession, it will help the economy rather than damage
it.

 

ON TOP OF THE ECONOMIC CHAIN

Man is at the top of the food
chain. No other animal eats man. Man eats almost every animal and plant.
Man contributes little to the nature, but he exploits nature to the maximum
extent. Similarly, there are many people within mankind who are on top of the
economic chain. They contribute little to the economy / society and yet earn
disproportionately large incomes. It is for governments to identify the
enterprises on the top of the economic chain. Do not spend a single rupee
and a single minute on these people. They will manage.

 

BAILOUT PACKAGES

All nations
have announced huge bailout packages. Most of the funds for these packages will
come simply by ‘printing money’. How long can money supply influence and when
does it become useless or even counter-productive? To understand this point,
consider an extreme hypothesis: Indian GDP is Rs. 190 trillion. Can we
say, ‘Just print Rs. 190 trillion and no one has to do any work? They can relax
and enjoy.’ We cannot do that. People have to work and produce goods and
services. A currency note that cannot buy anything has no value. Having
ruled out the extreme hypothesis, one needs to work out the right balance.
Every enterprise that breaks down due to the pandemic will be a wheel that
stops functioning. Save that wheel. Lend it sufficient cash to make it turn
again. Once it starts running, stop lending. Slowly take back the loans. On the
other hand, the daily wage earner can be given food free as long as the
lockdown runs. Probably, for one more week. Then stop all free doles. His
hunger will make him hunt for work. And those millions of wheels will start
functioning once again. Bailout packages is a huge subject by itself. But I
will not go into that right now.

 

There should be no central
command in the sense of planning from top-down. A central command will make
mistakes and commit blunders. Let everyone find their own way. Ensure
continuity of infrastructure. Those who need help should be helped. Give
priority to very small enterprises, then to small and medium, and finally to
large. Let individual spirits find individual solutions. Open up the market
with safety. Planning by every individual and every enterprise, with the
government supporting them, is the best approach.

 

Note: This
article was written on 24th April. Before it gets published in our
journal, I had the opportunity to listen to the Economic Wizard – Mr. Mohandas
Pai on BCAS Webinar on 9th May. I am adding a few more notes.

 

i)  When India works for full year, it generates
GDP of say Rs. 200 Trillions. It is clear that Indian economy will not work for
at least two months due to Covid 19 Pandemic. As simple arithmetics, GDP should
fall by 17%. There are many variables. Some things continued even during lock
down. Some things will not work even after the lock down is lifted. On the
whole, Indian GDP for the financial year 2020-21 can fall by 20%. From an
estimated growth rate of 5% if there is a fall of 20%, our GDP may fall by 15%.
This can cause massive repercussions. As discussed earlier, Government, RBI
& peoples’ job is to ensure that the wheels within wheels work with minimum
damage. Otherwise the domino effect can cause far more losses.

ii) Long term stability lies in
Indian economy being an independent economy. Neither based on exports, nor
based on imports. In still longer terms, when we all – Government to people are
sensitive to the weakest of the lives; and when we ensure welfare of all lives;
we can have a truly satisfied, peaceful India.

 

CONCLUSION

India
and the world have suffered huge personal and economic losses. All this because
of a tiny, invisible organism which probably does not even have life. This is a
warning that Mother Nature has given to Mankind. If we learn the lesson, if we
reset our lifestyle and our capitalist market economics, we can prevent future
pandemics. If we ensure that every individual and every fit enterprise survives
this pandemic, then the human spirit will ensure that in the short term the
economy will be functioning well. Ignore the share market indices and GDP
statistics. Focus on welfare of all – ‘Unto The Last’. Adopt Gandhiji’s and
Vinobaji’s concept of SARVODAYA.

IMPACT OF COVID-19 ON CORPORATE AND ALLIED LAWS

Prior to the manifestation of the
Covid-19 pandemic, most of us would have heard about a disaster recovery plan
or business continuity plan as part of the risk management plans. Such disaster
recovery plans would seldom have envisaged a situation of countrywide, or even
global, lockdowns which most of the world is currently experiencing. Therefore,
it is unwise to expect that such a well-thought-out disaster recovery or
continuity plan would have been prepared for a country as a whole. No doubt,
there are certain legislations like the Disaster Management Act, 2005 and the
Epidemic Diseases Act, 1897 which have come handy to the government in this
unprecedented calamity.

 

Coming to the specific subject of
the impact of Covid-19 on the Corporate and Allied Laws, we need to briefly
touch base with the typical limitations that all of us are suffering from. The
current situation of countrywide lockdown and social distancing norms is making
most of us feel handicapped at not being able to attend office as we would
generally do, have free access to the enabling office environment of accessing
computers, the internet, physical records, printing and scanning documents, DSCs
and all other tools that create a smooth working environment and enable the
ease of working. For most of our working lives easy availability of such basic
office infrastructure has been taken for granted and we did not pause and think
even for a minute what would happen if the easy availability of such office
infrastructure is interrupted for any length of time.

 

These aspects are highlighted to
pinpoint the limitations which business enterprises are facing today as far as
operational aspects are concerned. Apart from these operational limitations or
micro issues, there are many substantive effects or macro issues which Covid-19
has triggered globally. Therefore, in the context of Corporate and Allied Laws
we would need to dissect the Covid-19 impact from two broad perspectives, viz.,
(1) Operational or micro issues; and (2) Substantive or macro issues.

 

Various operational or micro
issues are more to do with operational difficulties currently faced by
corporates causing hindrances in timely and adequate compliances for the short
time span during the ongoing lockdown. On the other hand, the substantive or
macro issues would require a much deeper understanding of certain provisions of
the Corporate and Allied Laws in the context of the unique environment created
by Covid-19 and its possible effects, which would have a long-lasting impact on
Indian corporates in the medium to long term, say over a period of six to 18
months.

 

Many relaxations announced
address the operational or micro issues under the Companies Act, 2013, FDI
norms to check opportunistic takeovers of Indian companies and reducing the
post buyback period for raising further capital from 12 months to six months
under SEBI Regulations amongst others. Therefore, as the Indian corporates
battle the disruptions caused by Covid-19 and endeavour to revive and
streamline business operations post relaxations of the lockdown measures, there
would be a greater need to evaluate the Corporate and Allied Laws provisions
which could create hindrances or pose substantive or macro limitations to
effective recovery and announce enabling relaxations to provide a free runway
for a smooth take-off.

 

Most of us would be aware about
these relaxations by now given the quick spread of such updates on social media
platforms (even faster than coronavirus). Therefore, without getting into the
details, I would like to briefly summarise most of the relaxations as a quick
refresher for ease of reference.

 

I.   Companies Act, 2013 and related rules

 

1. Board meeting permitted through video conferencing or other
audio-visual means in respect of certain matters for which mandatory
physical meeting is otherwise required, which includes approval of financial
statements, Board’s report, prospectus and matters relating to mergers,
amalgamations, demergers, acquisitions and takeovers – up to 30th
June, 2020.

 

2. Maximum time gap between two consecutive Board meetings
relaxed from the existing 120 days to 180 days for the next two quarters, i.e. till
30th September, 2020.

 

3. Non-holding of at least one meeting of Independent Directors in
a financial year without the attendance of Non-Independent Directors will
not be treated as violation for F.Y. 2019-20.

 

4. Non-compliance of residency in India for a minimum period
of 182 days by at least one director of every company will not be treated as
violation for F.Y. 2019-20.

 

5. Implementation of reporting by auditors as per the Companies
(Auditor’s Report) Order, 2020 deferred by one year to F.Y. 2020-21.

 

6. The time limit for (i) creating Deposit Repayment Reserve of
20% of deposits maturing during F.Y. 2020-21; and (ii) making specified
investment or deposit of at least 15% of the amount of debentures maturing during
F.Y. 2020-21 extended from 30th April to 30th June,
2020.

 

7. The time limit for filing of declaration for commencement of
business by newly-incorporated companies extended from 180 days to 360
days.

8. Contribution to newly-formed PM CARES Fund covered
under CSR spending of corporates and FAQs released in relation to CSR
spending in view of the peculiar situation of the Covid-19 pandemic.

 

9. Conduct of Extraordinary General Meetings through video
conferencing or other audio-visual means permitted till 30th June,
2020 in unavoidable cases, subject to certain safeguards and protective
mechanisms as detailed in MCA Circular No. 14/2020 dated 8th April,
2020 as further clarified by MCA Circular No. 17/2020 dated 13th
April, 2020.

 

10. Extension of due date of AGM to 30th September, 2020
for companies whose financial year has ended on 31st December,
2019, i.e. time limit extended from six months from the end of the
financial year to nine months.

 

11. Companies Fresh Start Scheme, 2020 (CFSS) has been announced
in order to enable certain eligible defaulting companies to regularise their
filings without payment of additional fees and granting immunity from launching
prosecution or proceedings for imposition of penalty on account of delay
associated with certain filings. The detailed guidelines and operational
procedures have been laid out in MCA Circular No. 12/2020 dated 30th March,
2020.

 

12. LLP Settlement Scheme, 2020 (LSS) which was announced through
MCA Circular No. 06/2020 dated 4th March, 2020 has been modified vide MCA
Circular No. 13/2020 dated 30th March, 2020 keeping in mind the
prevalent situation.

 

II.  Securities and Exchange Board of India (SEBI)
Regulations applicable to listed companies

 

A. SEBI (Listing Obligations and Disclosure Requirements) Regulations,
2015 (‘LODR’)

1. The following relaxations, in the form of extension of timeline
for certain compliance requirements / filings by entities whose equity
shares are listed, have been announced (Refer Table A).

Further, vide a separate
circular1, SEBI has granted similar relaxations to issuers who have
listed their debt securities, non-convertible redeemable preference shares and
commercial papers, and to issuers of municipal debt securities.

 

2. As per Regulations 17(2) and 18(2)(a), the Board of directors and
the audit committee need to meet at least four times a year, with a maximum
time gap of 120 days between two meetings. The listed entities are exempted
from observing this maximum time gap for the meetings held / proposed to be
held between 1st December, 2019 and 30th June, 2020.
However, listed entities need to ensure that there are at least four Board and
audit committee meetings conducted in a year.

 

3. The effective date of operation of the new SEBI circular on
Standard Operating Procedure (SOP) dated 22nd January, 2020 in
relation to imposition of fines and other enforcement actions for
non-compliance with provisions of the LODR, has been extended to compliance
periods ending on or after 30th June, 2020 instead of 31st
March, 2020. Thus, the existing SEBI SOP Circular dated 3rd May,
2018 would be applicable till such date.

 

4. Publication of newspaper advertisements for certain
information such as notice of Board meetings, financial results, etc. as
required under Regulations 47 and 52(8) has been exempted for all events
scheduled till 15th May, 2020.

Table A

No.

Regulation
No.

Compliance
requirement / filings

Relaxations
w.r.t. quarter / F.Y. ending
31st March, 2020

 

 

 

Due date

Extended date

1.

7(3)

Half-yearly compliance certificate on share
transfer facility

30th April, 2020

31st May, 2020

2.

13(3)

Quarterly statement of investor complaints

21st April, 2020

15th May, 2020

3.

24A

Annual secretarial compliance report

30th May, 2020

30th June, 2020

4.

27(2)

Quarterly corporate governance report

15th April, 2020

15th May, 2020

5.

31

Quarterly shareholding pattern

21st April, 2020

15th May, 2020

6.

33

Quarterly financial results

15th May, 2020

30th June, 2020

Annual financial results

30th May, 2020

30th June, 2020

7.

40(9)

Half-yearly certificate from practicing CS on
timely issue of share certificates

30th April, 2020

31st May, 2020

8.

44(5)

Holding of AGM by top 100 listed entities by
market capitalisation

31st August, 2020

30th September, 2020

9.

19(3A), 20(3A) and 21(3A)

Nomination and Remuneration Committee, Stakeholders
Relationship Committee and Risk Management Committee need to meet at least
once in a year

31st March, 2020

30th June, 2020

10.

Circular issued in terms of Regulation 101(2)

Disclosure requirement by large corporates

 

 

Initial disclosure

30th April, 2020

30th June, 2020

Annual disclosure

15th May, 2020

30th June, 2020



5. Regulation 29(2) specifies that listed entities should give prior
intimation to stock exchanges about Board meeting (i) at least five days
before the meeting wherein financial results are to be considered, and
(ii) two working days for all other matters. This requirement of prior
intimation has been reduced to two days in all cases for Board meetings
to be held till 31st July, 2020.

 

6. Any delay in submission of information to stock exchanges
regarding loss of share certificates and issue of duplicate share certificates
within two days of receiving such information as required under Regulation
39(3) will not attract penal provisions for intimations to be made between 1st
March, 2020 and 31st May, 2020.

 

7. In line with the relaxations announced by the MCA for allowing
companies whose financial year ended on
31st December, 2019 to hold their AGM till 30th
September, 2020, SEBI has granted similar relaxation to top 100 listed
entities, whose financial year ended on 31st December, 2019,
for holding their AGM within a period of nine months instead of within a period
of five months from the year-end.

 

8. SEBI has further clarified that authentication / certification of
any filing / submission made to the stock exchanges under LODR may be done
using digital signature certificate (DSC) until 30th June, 2020.

 

Suggested relaxations: Apart from the above
relaxations proactively given by SEBI, the following further relaxations may be
considered by it:

 

1. There were a few amendments made to the LODR based on the
recommendations of the Kotak Committee which came into effect from 1st
April, 2020, mostly relating to Board of directors and its meetings. These
include (i) requirement of having at least one Independent woman director by
the top 1,000 listed entities [Reg. 17(1)(a)]; (ii) requirement of having at
least six directors on the Board by top 2,000 listed entities [Reg. 17(1)(c)]
and (iii) a person shall not be a director in more than seven listed entities
(Reg. 17A). While most of these provisions were introduced well before time for
listed entities to be compliant beforehand, the current situation warrants
reconsideration in extending the effective date of these provisions.

2. Regulation 25(3) of LODR requires Independent directors to hold at
least one meeting in a year without the presence of Non-Independent directors
and members of management. Here, too, relaxation should be granted by extending
the due date to 30th June, 2020 as done for compliance of
Regulations 19(3A), 20(3A) and 21(3A) in respect of committee meetings. It is
worthwhile to recall that the MCA has waived the similar requirements under the
Companies Act as stated above.

 

B.  SEBI (Substantial Acquisition of Shares and Takeovers) Regulations,
2011 (‘SAST’)

The time limit for filing annual
disclosures under Regulations 30(1) and 30(2) by persons holding 25% or more
shares / voting rights in a listed company and by promoters (including persons
acting in concert), respectively, regarding aggregate shareholding and voting
rights held in the listed company, have been extended till 1st June,
2020 instead of seven working days from the end of the financial year. Further,
a similar time limit extension has been granted for disclosure to be made by
promoters under Regulation 31(4) regarding non-encumbrance of shares held by
them, other than those already disclosed during the financial year.

 

C.  SEBI (Issue of Capital and Disclosure Requirements) Regulations,
2018 (‘ICDR’)

1. Rights Issues: SEBI has proactively announced certain
much-needed relaxations to listed entities in order to create an enabling
environment for fund-raising through rights issues that open on or before 31st
March, 2021. SEBI, vide a Circular2 , has granted relaxations
from strict application of certain provisions relating to rights issues, which
broadly include the following:

 

a) Eligibility conditions relating to Fast Track Rights Issues:
Certain eligibility conditions have been relaxed, inter alia, in the
form of reduction of certain time periods and monetary caps so that companies
can find it easy to comply with such conditions and come out with Fast Track
Rights Issues for quick fund raising.

b) Relaxation with respect to minimum subscription amount: The
requirement of receipt of minimum subscription amount in a rights issue has
been relaxed from the existing 90% to 75%, provided that such companies
need to ensure that at least 75% of the issue size is utilised for the objects
of the issue other than general corporate purpose.

c) Relaxation with respect to minimum threshold required for
non-filing of draft offer document with SEBI for its observations: The
listed entities with a rights issue size of up to Rs. 25 crores (instead of Rs.
10 crores as earlier applicable) need not file draft letter of offer with SEBI
and can directly proceed to issue letter of offer to shareholders.

 

2. Validity of Observations issued by SEBI: As per the
existing provisions, a public issue / rights issue may be opened within a
period of 12 months from the date of issuance of Observations by SEBI. This has
been relaxed vide a SEBI Circular3  which provides that the validity of the SEBI
Observations, where the same have expired / will expire between 1st March,
2020 and 30th September, 2020 has been extended by six months from
the date of expiry of such Observations, subject to a requisite undertaking
from the lead manager to the issue.

 

3. Relaxation from fresh filing of offer document with SEBI in
case of increase / decrease in fresh issue size: As per the existing
provisions, fresh filing of the draft offer document along with fees is
required in case of any increase or decrease beyond 20% in the estimated fresh
issue size. This has been relaxed vide a SEBI Circular3
whereby issuers have been permitted to increase or decrease the fresh issue
size by up to 50% of the estimated fresh issue size without the requirement to
file a fresh draft offer document with SEBI subject to fulfilment of certain
conditions. This relaxation is applicable for issues (IPO / Rights Issues /
FPO) opening before 31st December, 2020.

 

D. SEBI (Buy-back of Securities) Regulations,
2018 (‘Buy-back Regulations’)

Regulation 24(i)(f) of the
Buy-back Regulations imposes a restriction that companies shall not raise
further capital for a period of one year from the expiry of the buy-back
period, except in discharge of their subsisting obligations. Vide a SEBI
Circular4, this restrictive timeframe of one year has been reduced
to six months in line with the provisions of section 68(8) of the Companies
Act, 2013. This relaxation is applicable till 31st December, 2020.
This is a welcome relaxation, much needed in the current scenario where many
companies had announced buy-back prior to the outbreak of Covid-19 and may now
need capital to survive these difficult times.

 

III. Insolvency and Bankruptcy Code, 2016 (‘IBC’)

The provisions of the IBC can
play a crucial role to make or break an entity in this turbulent business
environment. It is obvious that many businesses would find it difficult to
honour their financial obligations on time due to loss of business, revenue and
profit, as well as due to lack of liquidity in the market. In this regard, the
government has already announced its intention to put in place requisite
safeguards so that business entities are not dragged to insolvency proceedings
to further worsen the ongoing business crisis. The following few key decisions
/ announcements have already been made or are at an advanced stage of
consideration:

 

1.    
The threshold limit of debt default for invoking the Corporate
Insolvency Resolution Process (CIRP) has been increased to Rs. 1 crore from Rs.
1 lakh.

 

2. An amendment has been made to the IBBI CIRP Regulations to provide
that the period of lockdown imposed by the Central Government due to Covid-19
shall not be counted for the purposes of the time-line for any activity that
could not be completed due to such lockdown in relation to a CIRP.

 

3. As per a news article, the provisions of
sections 7, 9 and 10 relating to initiation of CIRP is proposed to be suspended
for a period of six months which can be extended up to one year through
promulgation of an ordinance.


To conclude,
we must acknowledge the proactive relief measures announced by the government
and Regulators as far as Corporate and Allied Laws compliances are concerned,
which would provide a much-needed breather to India Inc. to successfully sail
through these difficult times. It would be imperative to continuously evaluate
and announce further substantive reliefs that should be provided till business
normalcy is achieved.

 

Let
me recall the words of Swami Vivekananda, ‘To think positively and
masterfully, with faith and confidence, life becomes more secure, richer in
achievement and experience’ in the hope that all of us would imbibe this
thought in these difficult times; and once we overcome this situation, we will
cherish this novel experience for the rest of our lives.


___________________________________________________

1   SEBI Circular No. SEBI/HO/DDHS/ON/P/2020/41 dated 23rd March,
2020

2     SEBI Circular No.
SEBI/HO/CFD/CIR/CFD/DIL/67/2020 dated 21st April, 2020

3     SEBI Circular No.
SEBI/HO/CFD/DIL1/CIR/P/2020/66 dated 21st April, 2020

4     SEBI Circular No.
SEBI/HO/CFD/DCR2/CIR/P/2020/69 dated 23rd April, 2020


FINANCIAL REPORTING AND AUDITING CONSIDERATIONS ON ACCOUNT OF COVID-19

Most countries, businesses and
companies are expected to be impacted by the Covid-19 pandemic and the
increased economic uncertainty may have major financial reporting consequences.
Supply-chains,distribution-chains, cash-flows, demand, price variations,
facility access, workforce availability, debt obligations, contract
cancellations, are experiencing turbulence. 
Such a holistic and cumulative impact on different spheres of business
operations carries a definite, and acute consequence on the financial reporting
by the entity.

 

The role of preparers of
financial statements, audit committees, auditors and regulators become critical
in this situation. Distilling the impact through the requirements of existing
accounting and auditing requirements frameworks and communicating it
effectively will enable financial markets to base their decisions on such
robust and dependable inputs.

 

Auditors’ role will require
special attention in relation to appropriate treatment of the financial impacts
and disclosures thereof. The Institute of Chartered Accountants of India has
issued an ‘Accounting & Auditing Advisory on Impact of Coronavirus on
Financial Reporting and the Auditors Consideration’ to help its members in
effectively discharging their obligations.

 

There will be issues to consider
for this year’s reporting as well as in future years. Every entity would need
to consider the financial impact on itself and the areas of the financial
statements that will be affected along with determining the required
disclosures. Financial reporting areas that are likely to require close
consideration include the following:

 

(1)  Impairment of assets

Impairment of assets becomes the
foremost financial reporting consideration, given that testing of impairment is
predominantly based on the earnings realisation from a group of assets.

 

The assumptions such as
the fall in demand, impact of lockdown, fall in commodity prices, decrease in
market interest rates, manufacturing plant shutdowns, shop closures, reduced
selling prices for goods and services, cost of capital, etc. may have a
meaningful impact on the impairment testing performed by entities. Whilst most
entities would perform impairment testing on an annual basis, the current
Covid-19 situation would qualify for being an ‘indicator’, thereby requiring
entities to test for impairment even in the interim.

 

(2)  Going concern

Financial statements are prepared
on a going concern basis unless management intends either to liquidate the
entity or to cease trading, or has no realistic alternative but to do so.

 

With business models being
challenged especially in the travel, hospitality, leisure and entertainment
segments, companies may need to consider the implications on the assessment of
going concern and whether these circumstances will result in prolonged
operational disruption which will significantly erode the financial position of
the entity or otherwise result in failure.

 

It is the
responsibility of management to make an assessment as to whether the entity is
a going concern or otherwise. The unprecedented and uncertain nature of the
pandemic makes it imperative for an entity to evaluate various scenarios that
are possible and assess their impact on the assumption of going concern.
Inability to satisfy the assumptions of going concern would lead to deviation
from historical cost-based accounting and other impacts.

 

Management should also expect an informed
and sometimes contrarian dialogue with auditors on the aspect of going concern.

 

(3)  Valuation of inventory

With social distancing norms in
place, entities may not have been able to carry out their annual physical
inventory count fully or even partially on the cut off date. Due to the
lockdowns, auditors and companies may need to rely on additional alternate
procedures to gain comfort on the position and valuation as on 31st March,
2020.

Companies would need to assess
whether, on their reporting date, an adjustment is required to the carrying
value of their inventory to bring them to their net realisable value in
accordance with the principles of Ind AS 2 –Inventories and AS 2 – Valuation
of Inventories.

 

Given the pandemic, net
realisable value calculation will likely require more detailed methods and
assumptions, e.g. write-down of stock due to lesser expected price realisation,
reduced movement in inventory, expiry of perishable products, lower commodity
prices, or inventory obsolescence. The usability of raw materials and work in
progress may also require close consideration.

 

A typical question arises in
relation to allocation of overheads to the valuation of inventory. If an entity
ceases production or reduces production for a period of time, significant
portions of unallocated fixed production overheads (e.g., rent, depreciation of
assets, some fixed labour, etc.) will need to be expensed rather than
capitalised, even if some reduced quantity of inventory continues to be
produced.

 

(4)  Lease and onerous contracts

The implications of force
majeure provisions on contracts and leases remain to be tested. It is
possible that there may be changes in the terms of lease arrangements or
lessors may grant concession to lessees with respect to lease payments,
rent-free holidays, additional days in subsequent period, etc. Such revised
terms or concessions shall be considered while accounting for leases which may
lead to the application of accounting relating to the modification of leases.
However, generally anticipated revisions are not taken into account.

 

Some entities may encounter
situations wherein certain contracts may become onerous to perform. Ind AS 27
defines an onerous contract as a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits
expected to be received under it. Price erosions, long-term commitment, salvage
discount, commitment of additional performance are certain triggers to evaluate
whether a contract has turned onerous. As soon as a contract is assessed to be
onerous, a company applying Ind AS 37 records a provision in its financial
statements for the loss it expects to make on the contract.

 

(5)  Expected credit loss (ECL)

ECL is an expectation-based
probability weighted amount determined by evaluating a range of possible
outcomes. It enables entities to make adequate provisions for non-realisation
of financial assets including trade receivables.

 

Ind AS 109 – Financial
Instruments requires an entity, amongst other matters, to also evaluate the
likelihood of the occurrence of an event if this would significantly affect the
estimation of expected losses of financial assets. In assessing the expected
credit loss, management should consider reasonable and supportable information
at the reporting date. Covid-19 impact would require to be factored in the ECL
probability model of entities.

 

Expected credit losses may
increase due to an increase in the probability of default for financial assets.
Additionally, the effects of the coronavirus may trigger a significant increase
in credit risk, and therefore the recognition of a lifetime ECL provision on
many financial assets.

 

Event-based provisioning in
relation to specific instances, like a customer turning insolvent or a specific
financial investment getting affected, would continue to be factored in
irrespective of the ECL.

 

(6)  Revenue recognition and borrowing costs

Ind AS 15 – Revenue from
Contracts with Customers often requires a company to make estimates and
judgements determining the timing and amount of revenue to be recognised.
Covid-19 may result in a likely increase in sales returns, decrease in volume
discounts, higher price discounts, etc. Entities may need to account for
returns and refund liabilities towards the customers whilst recognising the
revenue.

 

Ind AS 115 requires an entity to
defer a component of revenue to be recognised when the contract includes
variable consideration. This may result in some entities recognising a contract
liability rather than revenue, if significant uncertainty exists surrounding
whether the entity will realise the entire consideration.

 

Separately, the guidance on
borrowing costs requires an entity to suspend the capitalisation of borrowing
costs to an asset under construction for such extended periods that the actual
construction of the asset is suspended.

 

(7)  Government grant

Governments may support entities
with monetary and non-monetary measures, but such benefits may be one-time
events or spread over time.

 

Entities may need to establish an
accounting policy regarding government assistance which needs to be appropriate
and in line with the requirements of Ind AS 20 – Accounting for Government
Grants and Disclosure of Government Assistance. It is essential to distinguish
between government assistance and government grants and ensure that grants are
recognised only when the recognition criterion in Ind AS 20 is met. Some of the
government assistance may involve deferral of tax payments or other tax
allowances. The accounting treatment of tax allowances may need to be accounted
for under Ind AS 12 –  Income Taxes
rather than Ind AS 20.

 

The current relaxation by the
Reserve Bank of India allowing a moratorium on loan instalments may not qualify
as a government grant.

 

(8)  Deferred tax

Ind AS 12 – Income Taxes
requires that the measurement of deferred tax liabilities and deferred tax
assets shall reflect the tax consequences that would follow from the manner in
which the entity expects, at the end of the reporting period, to recover or
settle the carrying amount of its assets and liabilities.

 

Covid-19 could affect future
profits and / or may also reduce the amount of deferred tax assets or create
additional deductible temporary differences due to various factors (e.g. asset
impairment, non-utilisation of available losses, change in projections).
Entities having deferred tax assets on account of accumulated tax losses would
need to reassess their measurement with a newer set of business projections.

 

Entities may have considered the
assumption of ‘indefinite reinvestment’ and not recognised deferred tax on
accumulated undistributed earnings of subsidiaries. Such assumptions may need
to be revisited to determine if they remain appropriate given the entity’s
current cash flow projections.

 

(9)  Fair value and hedge accounting

Ind AS 113 – Fair Value
Measurement recognises the fact that observable inputs being considered for
deriving fair value may be either of (i) observable market price (quoted price
in an active market – Level 1) or (ii) application of valuation techniques
(Level 2 and Level 3).

 

With 1,500 companies trading at
their 52-week low on the Bombay Stock Exchange, the fair value measurement
considered by entities may need a re-look across all three methods of observable
inputs.

While volatility in the financial
markets may suggest that the prices are aberrations and do not reflect fair
value, it would not be appropriate for an entity to disregard market prices at
the measurement date, unless those prices are from transactions that are not
orderly.

 

The financial assumptions in a
valuation model like discounting rate, weighted average cost of capital, etc.
that are considered in a Level-3 valuation would need a reassessment.

 

Hedge effectiveness assessment is
required to be performed at the inception and on an on-going basis at each
reporting date or in case of a significant change in circumstances, whichever
occurs first. The current volatility in the markets may result in an entity
requiring to either re-balance the hedge where applicable, or discontinuing
hedge accounting if an economic relationship no longer exists, or the
relationship is dominated by credit risk. Certain opportunistic and speculative
transactions may also take place.

 

When a hedging relationship is
discontinued because a forecast transaction is no longer highly probable, a
company needs to determine whether the transaction is still expected to occur.
If the transaction is:

(i) still expected to occur, then gains or losses on the hedging
instrument previously accumulated in the cash flow reserve would generally
remain there until the future cash flows occur; or

(ii) no longer expected to occur, then the accumulated gains or losses
on the hedging instrument need to be immediately reclassified to profit or
loss.

 

(10) Disclosures and management guidance

Transparent disclosures should be
made on the effects and risks of this outbreak on the entity. The Securities
and Exchange Commission instructed publicly traded companies to provide
‘robust’ disclosures on the impact of Covid-19 on their operations and results.
Entities would need to disclose the impact of Covid-19 on their performance,
including qualitative aspects of the business.

 

Difficult times also warrant
accuracy in guidance; in an uncommon move, leading Indian bell-wether companies
like Wipro and Infosys have refrained from giving any annual guidance to
their shareholders for F.Y. 2020-21, citing the uncertain impact of Covid-19.

 

The relevance of an audit effort
on the financial statements is further emphasised in uncertain times like
these. Some of the common questions that auditors could encounter would
include:

 

(A) Have the risk considerations relevant to an entity changed, thereby
requiring an amendment to the audit approach?

Standards on auditing require an
auditor to identify and assess the risk of material misstatements and
materiality in planning and performing an audit. This assessment may have been
made during the earlier half of the financial year 2019-20 and the audit
procedures tailored on the basis of such earlier assessment. Due to Covid-19
and its far-reaching implications, the risk considerations relevant to an
entity may change significantly, thereby requiring an auditor to revisit the
audit plan, materiality and the approach to testing.

 

The perfect storm that Covid-19
offers has the potential to usurp good and healthy business models and push
profitable companies into a survival challenge. It would be important for
auditors to revisit the audit plan and the risk considerations once again given
the exposure an entity would have to Covid-19.

 

(B) Have the audit procedures been compromised on account of
restrictions, lockdowns and social distancing?

Auditors may face a challenge in
performing routine audit procedures during times of lockdown, social
distancing, travel restrictions, lesser access to management teams, etc.
Typically, audit procedures that have either a physical work-stream or
dependency on a third party are likely to get impacted. These could include
physical verification of inventory, cash on hand reviews, seeking external
balance confirmations, requiring comfort from component auditors, etc.

 

SA 501 requires the auditor to
observe some physical inventory counts on an alternative date if the attendance
of physical counting cannot be performed at the year-end date, or perform
alternative audit procedures where attendance of physical inventory counts is
impracticable. The standard also requires an auditor to perform roll-back procedures
to derive the desired comfort on inventory level on a reporting date.

 

Audit procedures should be
simulated to understand the potential impacts on such procedures to be
performed and alternate procedures identified to supplement or otherwise replace
such an audit procedure.


(C) How does an auditor provide comfort on the operating effectiveness
of internal financial controls given the altered way of working, such as work
from home, no wet signatures, cloud dependency, etc.?

Standards on auditing require an
auditor to assess the design and implementation along with the operating
effectiveness of internal controls over financial reporting. The sudden impact
of Covid-19 and the precautionary measures taken by governments across the
world have resulted in newer work models of work from home, no wet signatures,
cloud dependency, etc.

 

Auditors would need to evaluate
the impact of such differentiated working models on the internal control
framework and the desired reliance by the auditor on their operating
effectiveness. If the level of expected controls reliance changes, it is
important to document this and any other resulting changes to the planned audit
response.

 

(D) Is Covid-19 an adjusting event or a non-adjusting event?

According to Ind AS 10 – Events
after the reporting date, events occurring after the reporting period are
categorised into two, viz. (a) Adjusting events, i.e. those that require
adjustments to the amounts recognised in the financial statements for the
reporting period, and (b) Non-adjusting events, i.e. those that do not require
adjustments to the amounts recognised in the financial statements for the
reporting period.

 

Entities and auditors would need
to ascertain the impact of Covid-19 as either an adjusting or non-adjusting
event given the peculiarity that the effects of Covid-19 and lockdown were
prevalent in March, 2020 itself. Entities impacted by the Covid-19 pandemic
will need to assess how these events have, and may in future impact their
operations. Managements will need to consider the facts and apply critical
judgement in assessing what specific events and, more importantly, the timing
of those events, provide evidence of conditions that existed at the end of the
reporting period in order to determine if an adjustment is required. If it is
concluded as non-adjusting, the entity will need to determine if disclosure of
the event is required.

 

(E) Does Covid-19 require added consideration to emphasis of matter and
in relation to going concern uncertainty?

If the auditor considers it
necessary to draw users’ attention to a matter presented or disclosed in the
financial statements that in the auditor’s judgement is of such importance that
it is fundamental to users’ understanding of the financial statements, the
auditor shall include an ‘Emphasis of Matter’ paragraph in the Auditor’s
Report. SA 706 also cites instances that may warrant an emphasis of matter
observation by the auditor. One such instance is ‘A major catastrophe
that has had, or continues to have, a significant effect on the entity’s
financial position.’ Depending on the circumstances of the entity, the
auditor may consider appropriate reporting as emphasis of matter.

 

When
preparing financial statements, management is required to make an assessment of
an entity’s ability to continue as a going concern. In line with SA 570
(Revised), the auditor’s responsibilities are to obtain sufficient appropriate
audit evidence regarding, and conclude on, the appropriateness of management’s
use of the going concern basis of accounting in the preparation of the
financial statements, and to conclude, based on the audit evidence obtained,
whether a material uncertainty exists about the entity’s ability to continue as
a going concern.

 

Depending
on the circumstances, the auditor would need to consider whether to include a
separate section ‘Material Uncertainty Related to Going Concern’ in the
auditor’s report.

 

COVID AND FAIR VALUE MEASUREMENT

Fair value measurements are
required or permitted under Ind AS for many financial instruments and
non-financial assets and liabilities. They are required for quoted and unquoted
investments in shares, bonds, receivables, payables, derivatives, etc. As also
in certain situations for non-financial items, such as in determining
impairment of property, plant, equipment or goodwill. This article attempts to
discuss whether the current markets post the Covid outbreak can be considered
as not being orderly and therefore ignored for determining the fair values for
the year ending 31st March, 2020 financial statements.

 

Before we attempt to address the
moot question, whether markets as on 31st March, 2020 were orderly
or not, let us first look at the various provisions of Ind AS 113 Fair Value
Measurement.

(i)
Paragraph 2 of Ind AS 113 states that ‘Fair value is a market-based
measurement, not an entity-specific measurement. For some assets and
liabilities, observable market transactions or market information might be
available. For other assets and liabilities, observable market transactions and
market information might not be available. However, the objective of a fair
value measurement in both cases is the same – to estimate the price at which an
orderly transaction to sell the asset or to transfer the liability would take place
between market participants at the measurement date under current market
conditions (i.e., an exit price at the measurement date from the
perspective of a market participant that holds the asset or owes the
liability).’

(ii) Paragraph 3 of Ind AS 113
states that ‘When a price for an identical asset or liability is not
observable, an entity measures fair value using another valuation technique
that maximises the use of relevant observable inputs and minimises the use of
unobservable inputs. Because fair value is a market-based measurement, it is
measured using the assumptions that market participants would use when pricing
the asset or liability, including assumptions about risk. As a result, an
entity’s intention to hold an asset or to settle or otherwise fulfil a
liability is not relevant when measuring fair value.’

(iii) Paragraph 61 of Ind AS 113
states as follows ‘An entity shall use valuation techniques that are
appropriate in the circumstances and for which sufficient data are available to
measure fair value, maximising the use of relevant observable inputs and
minimising the use of unobservable inputs.’

(iv) Ind AS 113 defines orderly
transaction as ‘A transaction that assumes exposure to the market for a
period before the measurement date to allow for marketing activities that are
usual and customary for transactions involving such assets or liabilities; it
is not a forced transaction (e.g. a forced liquidation or distress sale.).’

 

IDENTIFYING TRANSACTIONS THAT ARE NOT
ORDERLY

Ind AS 113.B38 states that ‘If
an entity concludes that there has been a significant decrease in the volume or
level of activity for the asset or liability in relation to normal market
activity for the asset or liability (or similar assets or liabilities), further
analysis of the transactions or quoted prices is needed. A decrease in the
volume or level of activity on its own may not indicate that a transaction
price or quoted price does not represent fair value or that a transaction in
that market is not orderly.’

 

Ind AS 113.B43 provides guidance
for determination of whether a transaction is orderly (or is not orderly).
Whether there has been a significant decrease in the volume or level of
activity requires comparison to normal market activity level. B43 lists down
the following circumstances that may indicate that a transaction is not
orderly:

(a) There was not adequate
exposure to the market for a period before the measurement date to allow for
marketing activities that are usual and customary for transactions involving
such assets or liabilities under current market conditions.

(b) There was a usual and
customary marketing period, but the seller marketed the asset or liability to a
single market participant.

(c) The seller is in or near
bankruptcy or receivership (i.e., the seller is distressed).

(d) The seller was required to
sell to meet regulatory or legal requirements (i.e., the seller was forced).

(e) The transaction price is an
outlier when compared with other recent transactions for the same or a similar
asset or liability.

 

OBSERVATIONS AND CONCLUSIONS

Fair value is a measurement of a
date-specific exit price estimate based on assumptions (including those about
risks) that market participants would make under current market conditions.
The fair value measurement objective is to determine an exit price at the
measurement date from the perspective of a market participant. Fair value of
the asset or liability reflects conditions as of the measurement date and not
a future date. It would not be appropriate for an entity to disregard
market prices at the measurement date, unless those prices are from
transactions that are not orderly. The concept of an orderly transaction is
intended to distinguish a fair value measurement from the price in a distressed
sale or forced liquidation. The intent is to convey the current value of
the asset or liability at the measurement date, not its potential value at a
future date.

 

The current situation may make it
challenging to estimate the price that would be obtained due to highly volatile
markets and / or a lack of an active market existing for certain instruments
(e.g. derivatives that are not traded on an exchange). However, the objective
of ‘fair value’ will continue to be to determine a price at which an orderly transaction
would take place between market participants under conditions that existed at
the measurement date. It would not be appropriate to adjust or disregard
observable transactions unless those transactions are determined to be not
orderly. There is a high bar to conclude that a transaction price is not
orderly under Ind AS 113.B43, which provides a list of factors to consider if a
transaction is not orderly. The author believes that there is an implicit
rebuttable presumption that observable transactions between unrelated parties
are orderly. In almost all instances, such transactions are considered orderly.
Therefore, the evidence necessary to conclude an observable transaction between
unrelated parties is not orderly should be incontrovertible. Accordingly,
the fair value of an investment in an active market (e.g. BSE, NSE, etc.) would
continue to be calculated as the product of the quoted price for the individual
instrument times the quantity held (commonly referred to as ‘P times Q’), even
in times of significant market volatility. Volatility may raise questions
as to whether current pricing is reflective of fair value. However, the
standard does not permit current market evidence to be dismissed on the basis
of volatility alone.

 

Some may argue that in the
current environment there is an element of forced selling and that fair value
measurement is not intended to reflect prices in a forced or distressed sale.
Nevertheless, the presence of distressed or forced sellers in a market may
influence the price that could be obtained by a non-distressed seller in an
orderly transaction.

 

Fair value measurement would
consider how the Covid outbreak and any actions taken by governments at the
reporting date would have impacted market participants’ valuation assumptions.
Current market conditions may appear to be a ‘distress sale’, however, if such
conditions exist broadly in the market, then those factors should be
incorporated into a fair value measurement. It would be incorrect to adjust a
measure for expected ‘rebounds’ in value. For financial instruments with level
1 prices (those that are quoted on an active market), even if there is a
significant decline in activity on that market, this does not mean that the
price has become unobservable or that it was 
under a distress sale or a forced liquidation.

 

Whilst determining a valuation
for other than level 1 category of instruments (i.e., those that are quoted in
an active market), preparers of financial statements may have to use valuation
techniques. This may be the case for several unquoted shares or derivatives or
bonds, etc. Preparers using valuation techniques may have to consider the
impact of Covid-19 on various assumptions including discount rates,
credit-spread / counter-party credit risk, etc. In doing so, the aim will
be to maximise observable inputs and minimise unobservable inputs. The
observable inputs will reflect current market conditions at the balance sheet
date and should not be ignored.

 

The
ICAI guidance ‘Impact of Corona Virus on Financial Reporting and the
Auditors Consideration’ states that ‘It may not be always appropriate to
conclude that all transactions in such a market are not orderly. Preparers
should be guided by the application guidance in Ind AS 113 that indicates
circumstances in which the transaction is not considered an orderly
transaction.’ Though the ICAI guidance does not provide any detailed
guidance, it makes no exception to complying with the requirements of the
Standards. For Indian GAAP, similar considerations will apply in respect of
financial assets within the scope of AS 13 Accounting for Investments.

‘MUTUALLY ASSURED DESTRUCTION’ IN CORPORATE LENDING

Mutually assured
destruction is a term normally associated with nuclear war.


Its origins go back
to the post-World War II era when the then three superpowers of the world – the
USA, the Soviet Union and China – engaged in a race to spend billions of
dollars to build nuclear weapons. Other countries including India followed
suit. But these countries quickly realised that if and when there is a nuclear
engagement between two nuclear-armed countries, it will lead to disruption and
destruction on such a large scale that perhaps it would destroy life for
generations to come. And the destruction may not be limited only to the
countries engaged in the war, but perhaps to the entire humanity. This
potential destruction caused by a nuclear war is what came to be known in the
US as ‘mutually assured destruction’. The acronym for this, ‘MAD’, is very,
very apt!

 

‘MAD’ is a term
which today can be widely applied in several areas, including the Indian
Corporate Lending scenario. Just as in nuclear war everyone destroys everyone
else, the stakeholders in this industry have acted in such a way that they have
ended up in a ‘MAD’ state.

 

WHY THE PLETHORA OF NPAs

Today in the
lending industry in India there is a plethora of NPAs. We have seen the biggest
names in the industry crumble, we have seen insolvencies like never before and
we have seen unprecedented destruction of wealth. The question to be asked is
how did we land up in this scenario? What was it that led to this? To answer
this question, we need to start by looking at corporate lending prior to the
NPAs and prior to the build-up of all those bad loans. To understand this
better, there is a need to comprehend a very simple methodology that any lender
uses while lending money to a corporate. This model is called EIC – basically,
economy, industry and company. A lender will look at not only the company, its
promoters, its business, cash flows, etc., but also look at it in reference to
the industry in which it operates. Thereafter, the industry is analysed based
on the prevalent economic scenario.

 

There is now one
more ‘E’ to this model and that is environment or the global environment /
economic state. The key point is that none of these elements, i.e., company /
industry / economy can or should be analysed in a silo. The analysis always has
to be comprehensive (or in toto, if you wish).

 

Statements such as
‘India should grow at 5% or 8% or 10%’ are very naïve, to say the least. All we
need to do is to look around and ask which countries have grown at this pace,
or have even grown at all over the last decade? And, what has growth brought?
Has it ensured equal distribution of wealth amongst all people? Has it pulled
people out of poverty? If not, what good is this growth? India, after all, is
not a bubble which floats around by itself. Its economic state is a result of
what happens around the world. This is typically what is called ‘big picture
dynamics’. Unfortunately, when we forget the big picture and try to look at the
short term and view things in a silo, it inevitably leads to trouble and
destruction.

 

So, along with the
EIC model, traditionally any lender would also looked at the all-important
three Cs – Company (promoters, business, products, etc.), Cash flow
(serviceability) and Collateral (back-up). This EIC+3 Cs pretty much worked
fine for many years.

 

Then there was a
huge change in the demand-supply dynamic that came in with licenses being
distributed to a huge number of NBFCs, small finance banks, MFIs, etc. All
these players wanted a piece of the very under-penetrated but very attractive
Indian market. The Indian market though very large, had a certain segment that
the whole industry was after. This segment was already being catered to by
banks. But now these new players also wanted to break in. The question for
these new lenders was what USP could they offer to lure these customers away? Then
began a rat race to grab the all-coveted market share of borrowers.

 

And this is what
led to the creation of a series of new, innovative, flashy, unthought-of
financial solutions under the domain of structured finance. Structured finance
typically features off-balance sheet funding, name-lending, zero coupon bonds,
etc. Some of these structures were very attractive to the borrowers because
they allowed them to raise debt without disclosing additional leverage on their
financials. While there was nothing inherently wrong with these structures,
what went wrong was that the lenders who were lending under these models
completely forgot and ignored the EIC+3 Cs model. The big picture dynamics also
seemed to have been forgotten. That is what has led us to this mess.

 

‘NAME-LENDING’ BECOMES
A PROBLEM

While there is no
dearth of examples to prove this, if we can just pick a couple of very well
written and publicised cases which went bad, we will realise how aptly the term
‘MAD’ fits in the corporate lending business. Both of these cases can
technically fall under the domain of ‘name-lending’ which is basically lending
to a reputed customer without thorough analysis and without collaterals (in
most cases).

 

The corporate
lending business has five critical elements – the borrowing entity, the
promoter, the lender, the auditors and the rating agencies. The best example of
how these five elements collaborated to ensure ‘MAD’ is the downfall of the
IL&FS group. In this particular case, the reason that it stands as one of
the largest NPAs in history is that almost all the stakeholders acted with no
vision, no big-picture dynamics and with a complete ignorance of basics. The
lack of integrity from the management and a total lack of accountability from
the auditors and rating agencies allowed IL&FS to become the mess that it
is today. The lenders, on the other hand, were guilty of showing blind faith in
the name, in the rating agencies and lending without thorough analysis and
collaterals in some cases. This all but ensured their own destruction in the
process, along with the destruction of several corporate entities within the
IL&FS group. This is a classical example of ‘MAD’.

 

The second apt
example would be Kingfisher Airlines. If we look at this case carefully through
the lens of the EIC+3 Cs model, some glaring, unfortunate decision-making on
the part of the promoter, the company and other stakeholders comes to the fore.

 

The Indian aviation
industry was booming at the time when KFA was launched. However, for years
together it has been a known fact that globally only five to ten airlines have
ever shown sustainable profitability; and there is a reason for this – this
industry, along with telecom, is completely marred by cut-throat competition.
The fact is the players in this industry cannot really control or decide a
floor price for themselves. Besides, to enter aviation you have to invest large
sums of money and you have to operate almost completely at the mercy of your
competitors who decide the price that customers are willing to pay, on the one
hand, and the ATF and other costs, on the other. There is very little an
aviation company can control on its own. Now, the important thing to note is
that any company to be sustainable has to make profits; possibly after a few years
of operations in industries where there are longer gestation periods. But in
the long run making profits is a must. The revenue model has to be robust
enough to make sustainable profits. In aviation, the only thing you can perhaps
control is a few peripheral costs. But really, without any predictability of a
top line, it is extremely difficult to run a profitable company and to make
sure that it sustains. That’s where the KFA story is very interesting.

 

At the time of its
launch, we had a reputed promoter who had run a very successful liquor
business. When he launched the airline, he seems to have had this vision that
his airline would resonate the King of Good Times slogan. With that in
mind, KFA was launched with a brand-new fleet, best in-flight entertainment,
best available crew and amazing meals; in short, a fully satisfying customer
experience. All seemed hunky dory for a while. While the airline was not making
too much money, it still seemed to be able to sustain its debt and operate
comfortably. What happened next was just naked ambition – the decision to take
over Air Deccan which was a low-cost carrier.

 

HIGH COST FOR A
LOW-COST BUY

As it turns out,
this was the starting point of all troubles for KFA. With this takeover, the
airline had a low-cost carrier under its brand and was still trying to match
its ‘best in industry’ service and the other standards that it was known for.
With the pricing of the low-cost carrier being about 30 to 40% lower than the
full-cost carrier, it was a simple case of costs outweighing revenues. It was
unabashedly a failed business model. Typically, any low-cost airline is
supposed to only fly its passengers from point A to point B. No value-added
services are provided because the cost of the tickets is not enough to cover
any other expenses. But KFA Red, which was the low-cost carrier, ignored this
and started operating in its own silo. Again, a case of losing sight of the
basics and losing sight of the big picture. While this happened, to cover the
deficit between income and costs, KFA kept leveraging its balance sheet more
and more and more. The lenders, knowingly or unknowingly, played a crucial role
in allowing this leverage to build up, eventually leading to destruction of
both the company and of themselves.

 

This was done
through the use of another common concept of corporate lending, i.e.,
‘refinancing’, which is a common end-use stated on the sanction letters of
borrowers in several industries, including real estate. What it means is that
when a Rs. 100-crore loan is up for repayment in the next two to three months,
the borrower approaches another banker and asks for a Rs. 100-crore loan to
repay the first one. And if this cycle continues to go on, it basically means
the borrower never actually repays the principal amount to any lender from his
own pocket. It is like one lender financing another through the borrower’s
balance sheet. This eventually ensures ‘mutually assured destruction’ because
the banker intentionally or unintentionally helps the borrower get
into a habit of never having to repay the principal amount.

 

MONEY LENT FOR ALL THE WRONG REASONS

Then there is
over-leveraging, another demon that has led to the downfall of most companies.
It is high time the lending industry restrains itself when it realises the
company has passed its ‘sustainable debt’. This is another concept which seems
to be lost on the industry. Lenders keep lending to the same company over and
over again even though its cash flows simply can’t keep up with the piling
debt. What makes it worse is that the money is lent for all the wrong reasons,
such as meeting quarterly targets, eating into another lender’s market share,
name-lending because the promoter is reputed and so on. None of these loans are
lent on the basis of any analysis. Once again, a case of moving away from the
basics, not thinking of the big picture and eventually mutually destructing.

 

A very important
point to note here is that bankers or lenders are not meant to be in the
business of invoking securities. It is the least productive thing a lender can
do. It basically means that your entire assessment has failed and you are now
relying totally on your back-up. A collateral is just that, a back-up. Yet
today, most lenders spend substantial amounts of time and money in trying to
invoke securities and recover their money.

 

Now, we can ask
whether all this is too idealistic. Shouldn’t we look at being practical? Who
cares which company survives and which doesn’t? But the problem with this
approach is that it has created a systemic issue of ‘bad credit’. And the
inconvenient thing about ideals is that they are difficult to chase, they
require resilience, they require courage, they require character. But we also
need to remember that if we have all these and we reach our ideals, or even
close to our ideals, very few things can topple us.

 

Therefore, a lender
needs to have the will and the vision to say ‘no’ when a borrower inches
towards over-leveraging or is struggling with a flawed revenue model.

 

No promoter who has
built his or her business from the ground up wants to see it destroyed. And
therefore, lenders and rating agencies and other stakeholders need to also
think about sustainability of the businesses they are dealing with and, in
turn, their own sustainability. The sooner this realisation of interdependence
and responsibility comes, the sooner will we start digging ourselves out of our
graves. Perhaps, then, we will automatically also see that there is enough
credit available for the people who need it.

 

GST ON PAYMENTS MADE TO DIRECTORS – SOME CLARITY

In my article ‘GST
on payments made to Directors’ published on Page 24 of the BCAJ
issue of June, 2020, I had discussed in detail the various types of payments
made to Directors (whether Whole-Time Directors or Independent Directors) and
the GST implications of the same. That was on the basis of some judicial
precedents and a few contradictory Advance Rulings.

 

The inconsistent
Advance Rulings and the representations made by the trade and industry seeking
finality in the matter may have prompted the GST Policy Wing of the Central
Board of Indirect Taxes and Customs (the Board) to issue a clarification and to
avoid unnecessary confusion and costly litigation. The clarification was issued
vide Circular No. 140/10/2020-GST dated 10th June, 2020.

 

The clarification
has categorised the payments made to Directors under two scenarios – the applicability
of GST on remuneration paid by companies to:

(a) Independent Directors or those Directors who
are not employees of the company; and

(b) Whole-Time Directors, including Managing
Director, who are employees of the company.

 

The clarification
has laid emphasis on the relation of the Director with the company to decide
the leviability of GST and relied on the definition of Independent Directors
and Whole-Time Directors from the Companies Act, 2013. The same is summarised
hereunder.

 

Independent
Directors or those Directors who are not employees of the company

As per section
149(6) of the Companies Act, 2013, read with Rule 12 of the Companies (Share
Capital and Debentures) Rules, 2014, ‘independent directors’ are such Directors
who have not been an employee or proprietor or a partner of the said
company in any of the three financial years immediately preceding the financial
year in which he is proposed to be appointed in the said company.

 

And a ‘whole
time-director’ is defined u/s 2(94) of the Companies Act, 2013 in an inclusive
manner, to include a person who may not be an employee of the company.

 

In both the cases
mentioned above, where the Directors are not employees of the company, the
amounts paid to them for the services provided to the company would be outside
the scope of Schedule III of the CGST Act and would thus become taxable under
GST. As mentioned in the article earlier, such services would get covered under
Entry 6 of Notification No. 13/2017-CT (Rates) and No. 10/2017-IT (Rates), both
dated 28th June, 2017, effective from 1st July, 2017,
issued under the CGST Act (‘Reverse Charge Notification’) and, consequently,
GST shall become payable under Reverse Charge Mechanism by the company being
recipient of the services.

 

Whole-Time Directors, including Managing Director, who are employees
of the  company

The clarification
provides that if a Director has been considered to be an employee of the
company, it would be pertinent to examine whether the activities performed by
the Director are in the course of an employer-employee relation. The
clarification emphasises that the services provided should be ascertained to be
under a ‘contract of service’ or ‘contract for service’ since the remuneration
under the latter would become taxable under GST.

 

To classify the
service being provided under the above categories, the Board has taken
cognisance of the treatment given to the remuneration under the Income-tax Act,
1961 (‘IT Act’) wherein the salaries are subjected to Tax Deducted at Source
(‘TDS’) u/s 192 of the Act and fees other than salaries, is liable for TDS u/s
194J.

 

Accordingly,
remuneration which is subjected to TDS u/s 192 shall be treated as
consideration for ‘services by an employee to the employer in the course of or
in relation to his employment’ and would get covered under Schedule III of the
CGST Act, 2017.

 

It has also been
clarified that if an amount paid to the Director is declared as Fees for
Professional or Technical Services and subjected to TDS u/s 194J, it shall be
treated as consideration for providing services and become taxable under GST.
In such cases, the liability shall be of the recipient of services, i.e., the
company, under the Reverse Charge Notification.

Provided
below is a comparative table for a quick reference on the applicability of GST
/ RCM on payments to Directors:

 

Payments
to Directors

Employer–Employee
Relationship

TDS
u/s

Applicability
of GST

Applicability
of RCM

Remark

Salary

Yes

192

No

No

Entry I of Schedule III of
CGST Act, 2017

Commission, Professional Fees,
Sitting Fees

Yes

192(2B)

No

No

Commission

No

194-H

Yes

Yes

Entry 6 of Reverse Charge
Notification

Contract Payment

No

194-C

Yes

Yes

Professional Fees, Sitting
Fees

No

194-J

Yes

Yes

Rent

No

194-IB

Yes

Yes

 

 

[Appellate Tribunal in I.T.A. No. 5535/Mum/2014; Date of order: 11th January, 2017; A.Y.: 2003-04; Bench ‘F’ Mum.] Appeal u/s 260A – Penalty u/s 271(1)(c) – The question relating to non-striking off of the inapplicable portion in the section 271(1)(c) show cause notice goes to the root of the lis and is a jurisdictional issue – Issue can be raised first time before High Court – Penalty cannot be imposed for alleged breach of one limb of section 271(1)(c) of the Act while proceedings are initiated for breach of the other limb of section 271(1)(c) – Penalty deleted

7. Ventura Textiles Ltd. vs. CIT –
Mumbai-11 [ITA No. 958 of 2017 Date
of order: 12th June, 2020 (Bombay
High Court)

 

[Appellate
Tribunal in I.T.A. No. 5535/Mum/2014; Date of order: 11th January,
2017; A.Y.: 2003-04; Bench ‘F’ Mum.]

 

Appeal u/s 260A – Penalty u/s 271(1)(c) – The question relating to
non-striking off of the inapplicable portion in the section 271(1)(c) show
cause notice goes to the root of the lis and is a jurisdictional issue –
Issue can be raised first time before High Court – Penalty cannot be imposed
for alleged breach of one limb of section 271(1)(c) of the Act while
proceedings are initiated for breach of the other limb of section 271(1)(c) –
Penalty deleted

 

The issue involved in the
above appeal related to the imposition of penalty of Rs. 22,08,860 u/s
271(1)(c) of the Act by the A.O. on account of disallowance of Rs. 62,47,460
claimed as a deduction u/s 36(i)(vii) on account of bad debt and subsequently
claimed as a deduction u/s 37 as expenditure expended wholly and exclusively
for the purpose of business.

 

The assessee company filed
its ROI declaring total loss at Rs. 4,66,68,740 for A.Y. 2003-04. During the
assessment proceedings, it was found amongst other things that the assessee had
debited Rs. 62,47,460 under the head ‘selling and distribution expenses’ and
claimed it as bad debt in the books of accounts, thus claiming it as a
deduction u/s 36(1)(vii). Subsequently it was found that the aforesaid amount
was paid to M/s JCT Ltd. as compensation for the supply of inferior quality of
goods. Thus, the A.O. held that the amount of Rs. 62,47,460 claimed as bad debt
was not actually a debt and therefore it was not allowable as a deduction u/s 36(1)(vii).
The A.O. further held that the said claim was also not admissible even u/s
37(1), with the observation that payment made to M/s JCT Ltd. was not wholly
and exclusively for business purposes but for extraneous considerations. In
view thereof, the assessee’s claim was rejected. The A.O. initiated penalty
proceedings u/s 271(1)(c) of the Act for furnishing inaccurate particulars of
income.

The A.O. issued notice u/s
274 r/w/s 271 on the same day, i.e., on 28th February, 2006, to the
assessee to show cause as to why an order imposing penalty should not be made
u/s 271. It may, however, be mentioned that in the pertinent portion of the
notice the A.O. did not strike off the inapplicable portion.

 

The assessee had challenged
the disallowance of bad debt along with other disallowances in the assessment
order by filing an appeal before the CIT(A) who, by an order dated 14th
November, 2012, confirmed the disallowance of bad debt while deleting other
disallowances.

 

In the penalty proceedings,
the A.O. took the view that the assessee’s claim was not actually bad debt but
represented payment made to M/s JCT Ltd. which was also not incurred wholly and
exclusively for the purposes of business. Thus, by the order dated 14th
February, 2014, the A.O. held that by making an improper and unsubstantiated
claim of bad debt of Rs. 62,47,460, the assessee had wilfully reduced its
incidence of taxation, thereby concealing its income as well as furnishing
inaccurate particulars of income. Therefore, the A.O. imposed the minimum
penalty quantified at Rs. 24,99,200 which included penalty on another
disallowance.

 

The CIT(A) deleted the
penalty on the other disallowance. Regarding the penalty levied on Rs.
62,47,460 claimed as bad debt in the assessment proceedings, the CIT(A) held
that the assessee had made a wrong claim by submitting inaccurate particulars
of income by claiming bad debt which was not actually a debt and also not an
expenditure allowable u/s 37(1). Thus, it was held that the assessee had
wilfully submitted inaccurate particulars of income which had resulted in
concealment. Therefore, the penalty amount of Rs. 62,47,460 levied was upheld.

 

The Tribunal upheld the order
of the CIT(A) and rejected the appeal of the assessee. According to the
Tribunal, it was rightly held by the CIT(A) that the assessee had made a wrong
claim by submitting inaccurate particulars of income by claiming a bad debt
which was not actually a debt and also not an expenditure allowable u/s 37(1).
Therefore, the finding recorded by the CIT(A) that the assessee had wilfully
submitted inaccurate particulars of income which had resulted in concealment
was affirmed.

 

Before the High Court the
first contention was raising a question of law for the first time before the
High Court though it had not been raised before the lower authorities; the
Court referred to a series of decisions, including of the Supreme Court in
Jhabua Power Limited (2013) 37 Taxmann.com 162 (SC) and of the Bombay
High Court in Ashish Estates & Properties (P) Ltd. (2018) 96
Taxmann.com 305 (Bom.) wherein it is observed that it would not
preclude the High Court from entertaining an appeal on an issue of jurisdiction
even if the same was not raised before the Tribunal.

 

The Court further noted and
analysed the two limbs of section 271(1)(c) of the Act and also the fact that
the two limbs, i.e., concealment of particulars of income and furnishing
inaccurate particulars of income, carry different connotations. The Court further
noted that the A.O. must indicate in the notice for which of the two limbs he
proposes to impose the penalty and for this the notice has to be appropriately
marked. If in the printed format of the notice the inapplicable portion is not
struck off, thus not indicating for which limb the penalty is proposed to be
imposed, it would lead to an inference as to non-application of mind.

 

Therefore, the question
relating to non-striking off of the inapplicable portion in the show cause
notice which is in printed format, thereby not indicating therein as to under
which limb of section 271(1)(c) the penalty was proposed to be imposed, i.e.,
whether for concealing the particulars of income or for furnishing inaccurate
particulars of such income, would go to the root of the lis. Therefore,
it would be a jurisdictional issue. Being a jurisdictional issue, it can be
raised before the High Court for the first time and adjudicated upon even if it
was not raised before the Tribunal.

 

The Hon. Court relied on
decisions of SSA’s Emerald Meadows (2016) 73 Taxmann.com 241 (Karnataka);
Manjunath Cotton & Ginning Factory 359 ITR 565 (Kar.); and
Samson Pernchery (2017) 98 CCH 39 (Bom.) wherein the issue was
examined, i.e. the question as to justification of the Tribunal in deleting the
penalty levied u/s 271(1)(c). It was noted that the notice issued u/s 274 was
in a standard proforma without having struck off the irrelevant clauses
therein, leading to an inference as to non-application of mind.

 

A similar view had been taken
in Goa Coastal Resorts & Recreation Pvt. Ltd. (2019) 106 CCH 0183
(Bom.); New Era Sova Mine (2019) SCC OnLine Bom. 1032; as well as Shri
Hafeez S. Contractor (ITA Nos.796 and 872 of 2016 decided on 11th
December, 2018).

 

On the facts of the present
case, the Court noticed that the statutory show cause notice u/s 274 r/w/s 271
of the Act proposing to impose penalty was issued on the same day when the
assessment order was passed, i.e., on 28th February, 2006. The said
notice was in printed form. Though at the bottom of the notice it was mentioned
‘delete inappropriate words and paragraphs’, unfortunately, the A.O. omitted to
strike off the inapplicable portion in the notice. Such omission certainly
reflects a mechanical approach and non-application of mind on the part of the
A.O. However, the moot question is whether the assessee had notice as to why
penalty was sought to be imposed on it?

 

The Court observed that in
the present case, the assessment order and the show cause notice were both
issued on the same date, i.e., on 28th February, 2006, and if they
are read in conjunction, a view can reasonably be taken that notwithstanding
the defective notice, the assessee was fully aware of the reason as to why the
A.O. sought to impose penalty. It was quite clear that the penalty proceedings
were initiated for breach of the second limb of section 271(1)(c), i.e., for
furnishing inaccurate particulars of income. The purpose of a notice is to make
the noticee aware of the ground(s) of notice. In the present case, it would be
too technical and pedantic to take the view that because in the printed notice
the inapplicable portion was not struck off, the order of penalty should be set
aside even though in the assessment order it was clearly mentioned that penalty
proceedings u/s 271(1)(c) had been initiated separately for furnishing
inaccurate particulars of income. Therefore, this contention urged by the
appellant / assessee was rejected.

 

Having held so, the Court
went on to examine whether in the return of income the assessee had furnished
inaccurate particulars. As already discussed above, for the imposition of
penalty u/s 271(1)(c) either concealment of particulars of income or furnishing
inaccurate particulars of such income are the sine qua non. In the
instant case, the penalty proceedings u/s 271(1)(c) were initiated on the
ground that the assessee had furnished inaccurate particulars of income.

 

The Court observed that in
the assessment proceedings the explanation of the assessee was not accepted by
the A.O. by holding that the subsequent payment made to M/s JCT Ltd. would not
be covered by section 36(1)(vii) since the amount claimed as bad debt was
actually not a debt. Thereafter, the A.O. examined whether such payment would
be covered u/s 37(1) as per which an expenditure would be allowable as a
deduction if it pertains to that particular year and has been incurred wholly
and exclusively for the purpose of business. The A.O. held that the assessee’s
claim was not admissible even u/s 37(1) as the circumstances indicated that the
payments were not made wholly and exclusively for business purposes. While
disallowing the claim of the assessee, the A.O. took the view that since the
assessee had furnished inaccurate particulars of income, penalty proceedings
u/s 271(1)(c) were also initiated separately.

 

The Court noticed that in the
statutory show cause notice the A.O. did not indicate as to whether penalty was
sought to be imposed for concealment of income or for furnishing inaccurate
particulars of income, although in the assessment order it was mentioned that
penalty proceedings were initiated for furnishing inaccurate particulars of
income. In the order of penalty, the A.O. held that the assessee had concealed
its income as well as furnished inaccurate particulars of income.

 

But concealment of
particulars of income was not the charge against the appellant, the charge was
of furnishing inaccurate particulars of income. As discussed above, it is trite
that penalty cannot be imposed for alleged breach of one limb of section 271(1)(c)
while penalty proceedings are initiated for breach of the other limb of the
same section. This has certainly vitiated the order of penalty. In the appeal,
the CIT(A) took a curious view, that submission of inaccurate particulars of
income resulted in concealment, thus upholding the order of penalty. This
obfuscated view of the CIT(A) was affirmed by the Tribunal.

 

While the charge against the
assessee was of furnishing inaccurate particulars of income whereas the penalty
was imposed additionally for concealment of income, the order of penalty as
upheld by the lower appellate authorities could be justifiably interfered with,
yet the Court went on to examine whether there was furnishing of inaccurate
particulars of income by the assessee in the first place because that was the
core charge against the assessee.

 

The Court referred to the
decision of the Supreme Court in Reliance Petroproducts Pvt. Ltd. 322 ITR
158 (SC) wherein it was held that mere making of a claim which is not
sustainable in law by itself would not amount to furnishing inaccurate
particulars regarding the income of the assessee. Therefore, such claim made in
the return cannot amount to furnishing inaccurate particulars of income.

The Court noted that this
decision was followed by the Bombay High Court in CIT vs. M/s Mansukh
Dyeing & Printing Mills, Income Tax Appeal No. 1133 of 2008, decided on 24th
June, 2013. In CIT vs. DCM Ltd., 359 ITR 101, the Delhi
High Court applied the said decision of the Supreme Court and further observed
that law does not debar an assessee from making a claim which he believes is
plausible and when he knows that it is going to be examined by the A.O. In such
a case, a liberal view is required to be taken as necessarily the claim is
bound to be carefully scrutinised both on facts and in law. Threat of penalty
cannot become a gag and / or haunt an assessee for making a claim which may be
erroneous or wrong. Again, in CIT vs. Shahabad Co-operative Sugar Mills
Ltd., 322 ITR 73, the Punjab & Haryana High Court held that the
making of a wrong claim is not at par with concealment or giving of inaccurate
information which may call for levy of penalty u/s 271(1)(c) of the Act.

 

In view of the above, in the
present case it is quite evident that the assessee had declared the full facts;
the full factual matrix of facts was before the A.O. while passing the
assessment order. It is another matter that the claim based on such facts was
found to be inadmissible. This is not the same thing as furnishing inaccurate
particulars of income as contemplated u/s 271(1)(c).

 

Thus, on an overall
consideration, the appeal was allowed and the order of penalty as affirmed by
the appellate authorities was set aside. 

 

 

 

 

 

Search and seizure – Assessment u/s 153A of ITA, 1961 – Scope of section 153A – Assessee can raise new claims for deduction in return filed u/s 153A; A.Y. 2008-09

33. Principal
CIT vs. JSW Steel Ltd. [2020]
422 ITR 71 (Bom.) Date
of order: 5th February, 2020 A.Y.:
2008-09

 

Search and
seizure – Assessment u/s 153A of ITA, 1961 – Scope of section 153A – Assessee
can raise new claims for deduction in return filed u/s 153A; A.Y. 2008-09

 

The assessee is a widely-held public limited company engaged in various
activities including production of sponge iron, galvanised sheets and
cold-rolled coils through its steel plants located at Dolve and Kalmeshwar in
Maharashtra. For the A.Y. 2008-09, the assessee had filed return of income on
30th September, 2008 under the provisions of section 139(1) of the
Income-tax Act, 1961, declaring loss at Rs. 104,17,70,752. The assessee’s case
was selected for scrutiny and notice u/s 143(2) was issued on 3rd
September, 2009. During the pendency of the assessment proceedings, a search
was conducted u/s 132 of the Act on the ISPAT group of companies on 30th
November, 2010. Following the search, notice u/s 153A was issued. In response,
the assessee filed return of income declaring total loss at Rs. 419,48,90,102
on 29th March, 2012. In this return of income, the assessee made a
new claim for treating gain on prepayment of deferred value added tax / sales
tax on the net present value (NPV) basis for an amount of Rs. 318,10,93,993 as
‘capital receipt’. This new / fresh claim of the assessee was disallowed by the
A.O. while finalising the assessment u/s 143(3) read with section 153A. The
primary question that arose before the A.O. was whether the claim which was not
made in the earlier original return of income filed u/s 139(1) could be
considered in the subsequent return filed by the assessee in pursuance of
notice u/s 153A? The A.O. held that the assessee could not raise a new claim in
the return filed u/s 153A which was not raised in the original return of income
filed u/s 139(1). Thereafter, the claim was disallowed and was treated as
‘revenue receipt’.

 

The Tribunal
allowed the assessee’s claim.

 

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

 

‘i)   Section 153A of the Income-tax Act, 1961
provides for the procedure for assessment in search cases. The section starts
with a non-obstante clause stating that it is notwithstanding anything
contained in sections 147, 148 and 149. Further, clause (a) of section 153A(1)
provides for issuance of notice to the persons in respect of whom search was
conducted u/s 132 to furnish a return of income. However, the second proviso
to section 153A makes it clear that assessment relating to any assessment year
filed within a period of the six assessment years pending on the date of search
u/s 132 of the Act shall abate.

 

ii)   Thus, if on the date of initiation of search
u/s 132 any assessment proceeding relating to any assessment year falling
within the period of the six assessment years is pending, it shall stand abated
and the assessing authority cannot proceed with such pending assessment after
initiation of search u/s 132. The crucial expression is “abate”. To
“abate”, as applied to an action, is to cease, terminate, or come to an
end prematurely. Once the assessment abates, the original return which had been
filed loses its originality and the subsequent return filed u/s 153A takes the
place of the original return. In such a case, the return of income filed u/s
153A(1) would be construed to be one filed u/s 139(1) and the provisions of the
Act shall apply to it accordingly.

 

iii)  If that be the position, all legitimate claims
would be open to the assessee to raise in the return of income filed u/s
153A(1). It is open for the assessee to lodge a new claim in a proceeding u/s
153A(1) which was not claimed in his regular return of income.’

 

Loss – Set-off of – Sections 72(2), 72A and 263 of ITA, 1961 and sections 18 and 32(2) of SICA, 1985 – Amalgamation of companies – Provision for carry forward by amalgamated company of accumulated loss and unabsorbed depreciation of amalgamating company – Sick industrial company – Sanction of scheme by Board for Industrial and Financial Reconstruction implies that requirements of section 72(2) satisfied; A.Y. 2004-05

32. CIT
vs. Lakshmi Machine Works Ltd. [2020]
422 ITR 235 (Mad.) Date
of order: 13th February, 2019 A.Y.:
2004-05

 

Loss –
Set-off of – Sections 72(2), 72A and 263 of ITA, 1961 and sections 18 and 32(2)
of SICA, 1985 – Amalgamation of companies – Provision for carry forward by
amalgamated company of accumulated loss and unabsorbed depreciation of
amalgamating company – Sick industrial company – Sanction of scheme by Board
for Industrial and Financial Reconstruction implies that requirements of
section 72(2) satisfied; A.Y. 2004-05

 

Two spinning
units of a company amalgamated with the assessee under a rehabilitation scheme
under the Sick Industrial Companies (Special Provisions) Act, 1985 by an order
of sanction by the Board for Industrial and Financial Reconstruction. The
assessee claimed the carried forward loss u/s 72A of the Income-tax Act, 1961
in its return. The A.O. issued notices under sections 142(1) and 143(2) of the
1961 Act and required the assessee to show compliance with the conditions laid
down u/s 72A. The assessee submitted that it was entitled to the claim for
carry forward of loss u/s 72A by virtue of the scheme having been sanctioned by
the Board for Industrial and Financial Reconstruction which took into account the
provisions of that section as well. The A.O. agreed with the view of the
assessee and allowed the claim in his order u/s 143(3). But the Commissioner
was of the view that there was no application of mind by the A.O. while he
allowed the claim made by the assessee u/s 72A and that there were no reasons
in support thereof. Accordingly, he passed a revision order u/s 263 of the 1961
Act.

 

The Tribunal
held that the very fact that the Board for Industrial and Financial
Reconstruction had sanctioned the scheme was sufficient and no further
compliance was called for in regard to the conditions set out u/s 72A as the
provisions of the 1985 Act overrode those of the 1961 Act, and confirmed the
order of the A.O. allowing the claim of the assessee for the carry forward of
loss. Accordingly, the Tribunal set aside the order of the Commissioner passed
u/s 263.

 

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

 

‘i)   The financial viability or otherwise of the
amalgamating company has to be determined first in order to attract the
provisions of section 72A of the Income-tax Act, 1961. After the enactment of
the Sick Industrial Companies (Special Provisions) Act, 1985 and the
constitution of the Board for Industrial and Financial Reconstruction, the
question of sickness or robust health of the entity is to be determined by the
Board. It is only when the Board is satisfied that it would have entertained
applications for revival, sanctioning an appropriate scheme for rehabilitation.
Thus, a sanction by the Board for the scheme of amalgamation implies that the
requirements of section 72A have been met.

 

ii)   The view taken by the A.O. to the effect that
the claim of the assessee u/s 72A of the 1961 Act was liable to be allowed in
the light of the provisions of section 32(2) of the 1985 Act and its
interpretation by the Supreme Court was the correct one. Section 263 of the
1961 Act empowered the Commissioner to revise an order of assessment if it was
erroneous or prejudicial to the interests of the Revenue. Both conditions were
to be satisfied concurrently. The action of the A.O. though prejudicial, could
hardly be termed “erroneous” insofar as the A.O. had followed the dictum laid
down by the Supreme Court in the case of Indian Shaving Products Ltd. vs.
BIFR [1996] 218 ITR 140 (SC). Thus, in the absence of concurrent
satisfaction of the two conditions u/s 263 of the 1961 Act, the action of the
Commissioner was contrary to the statute and was therefore to be set aside.

 

iii)  The appeal filed by the Revenue is dismissed.
The substantial question of law is answered in favour of the assessee and
against the Revenue.’

Exemption u/s 10(17A) of ITA, 1961 – Award for meritorious service in public interest – Scope of section 10(17A) – Approval of State Government or Central Government – Formal approval not mandatory – Approval may be implied; A.Y. 2010-11

31. K.
Vijaya Kumar vs. Principal CIT [2020]
422 ITR 304 (Mad.) Date
of order: 26th February, 2020 A.Y.:
2010-11

 

Exemption
u/s 10(17A) of ITA, 1961 – Award for meritorious service in public interest –
Scope of section 10(17A) – Approval of State Government or Central Government –
Formal approval not mandatory – Approval may be implied; A.Y. 2010-11

 

The
petitioner has had a distinguished career in the Indian Police Service and is
at present engaged as a senior security adviser to the Union Home Ministry. In
the course of his service, he had been appointed as the Chief of the Special
Task Force (STF) leading ‘Operation Cocoon’ against forest brigand Veerappan,
leading to Veerappan’s fatal encounter on 18th October, 2004. In
recognition of the special and commendable services of the STF, the Government
of Tamil Nadu had issued G.O. Ms. No. 364, Housing and Urban Development
Department, dated 28th October, 2004 instituting an award in
national interest to STF personnel for the valuable services rendered by them
as part of the team. Pursuant thereto, the petitioner had received a cash award
of Rs. 1,08,43,000 in the F.Y. 2009-10, relevant to A.Y. 2010-11. This amount
was sought to be assessed as income by the Commissioner u/s 263 of the
Income-tax Act, 1961 for which the assessee claimed exemption u/s 10(17A). The
Commissioner directed the A.O. to allow the claim of exemption u/s 10(17A) only
if the assessee was able to produce an order granting approval of exemption by
the Government of India u/s 10(17A)(ii).

 

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

 

‘i)   The object of section 10(17A) of the
Income-tax Act, 1961 is to reward an individual who has been recognised by the
Centre or the State for rendition of services in public interest. While clause
(i) of section 10(17A) is concerned with an award whether in cash or in kind,
instituted in public interest by the Central or any State Government or
instituted by any other body and approved by the Central Government in this
behalf, clause (ii) refers to a reward by the Central or a State Government for
such purposes as may be approved by the Central Government in this behalf in
public interest.

 

ii)   No specification or prescription has been set
out in terms of how the approval is to be styled or even whether a formal
written approval is required. Nowhere in the rules or forms is there reference
to a format of approval to be issued in this regard. That apart, one should
interpret the provision and its application in a purposive manner bearing in
mind the spirit and object for which it has been enacted. It is clear that the
object of such a reward is by way of recognition by the State of an
individual’s efforts in protecting public interest and serving society in a
significant manner. Thus, the reference to “approval” in section 10(17A) does
not only connote a paper conveying approval and bearing the stamp and seal of the
Central Government, but any material available in the public domain indicating
recognition for such services rendered in public interest.

 

iii)  The assessee had been recognised by the
Central Government on several occasions for meritorious and distinguished
services and from the information available in the public domain, it could be
seen that he was awarded the Jammu and Kashmir Medal, Counter Insurgency Medal,
Police Medal for Meritorious Service (1993) and the President’s Police Medal
for Distinguished Service (1999). Specifically for his role in nabbing
Veerapan, he was awarded the President’s Police Medal for Gallantry on the eve
of Independence Day, 2005. The assessee was entitled to exemption on the awards
received from the State Government. The writ petition is allowed.’

Deduction u/s 80-IB(10) of ITA, 1961 – Housing projects – Scope of section 80-IB(10) – Not necessary that developer should be owner of land – Joint venture agreement showing assessee was developer – Assessee entitled to special deduction u/s 80-IB(10); A.Y. 2010-11

30. Bashyam
Constructions P. Ltd. vs. Dy. CIT [2020]
422 ITR 346 (Mad.) Date
of order: 30th January, 2019 A.Y.:
2010-11

 

Deduction
u/s 80-IB(10) of ITA, 1961 – Housing projects – Scope of section 80-IB(10) –
Not necessary that developer should be owner of land – Joint venture agreement
showing assessee was developer – Assessee entitled to special deduction u/s
80-IB(10); A.Y. 2010-11

 

A claim for deduction u/s 80-IB(10) of the Income-tax Act, 1961 was
allowed by the Commissioner (Appeals) but denied by the Tribunal. The reason
assigned by the Tribunal for reversing the order passed by the Commissioner
(Appeals) was that the assessee could not be considered a developer of the
housing project, as a joint venture would happen only when the owner, that is,
the assessee, treated the land as stock-in-trade in its books of accounts.

 

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

 

‘i)   A plain reading of section 80-IB(10) of the
Income-tax Act, 1961 makes it clear that deduction is available in a case where
an undertaking develops and builds a housing project. The section clearly draws
a distinction between “developing” and “building”. The provision does not
require that the ownership of land must vest in the developer for it to qualify
for such deduction.

 

ii)   The joint venture agreement clearly showed
that the assessee was the developer and ETA was the builder and mutual rights
and obligations were inextricably linked with each other and undoubtedly, the
project was a housing project. Therefore, the assessee would be entitled to
claim deduction u/s 80-IB(10).’

 

Business expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Amounts not deductible – Payments liable to deduction of tax at source – Failure to deduct tax at source – Law applicable – Effect of amendment of section 40(a)(ia) with effect from 1st April, 2013 providing for cases where recipient has declared income in question and paid tax thereon – Amendment retrospective – Non-deduction of tax at source not causing loss to Revenue – Disallowance not applicable; A.Y. 2005-06

29. CIT
vs. S.M. Anand [2020]
422 ITR 209 (Kar.) Date
of order: 23rd August, 2019 A.Y.:
2005-06

 

Business
expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Amounts not deductible
– Payments liable to deduction of tax at source – Failure to deduct tax at
source – Law applicable – Effect of amendment of section 40(a)(ia) with effect
from 1st April, 2013 providing for cases where recipient has
declared income in question and paid tax thereon – Amendment retrospective –
Non-deduction of tax at source not causing loss to Revenue – Disallowance not
applicable; A.Y. 2005-06

 

In the
appeal by the Revenue, the following question of law was raised:

 

‘Whether the
second proviso to section 40(a)(ia) of the Act inserted by the Finance
Act, 2012 is clarificatory and retrospective in nature and cancellation of the
disallowance u/s 40(a)(ia) by the Tribunal is justifiable where the recipient
of the amount has already discharged his tax liability therein?’

 

The
Karnataka High Court held as under:

 

‘i)   The scheme of section 40(a)(ia) of the
Income-tax Act, 1961 is aimed at ensuring that an expenditure should not be
allowed as deduction in the hands of an assessee in a situation in which income
embedded in such expenditure has remained untaxed due to tax withholding lapses
by the assessee. It is not a penalty for tax withholding lapse but a sort of
compensatory deduction restriction for an income going untaxed due to tax
withholding lapse. The penalty for tax withholding lapse per se is
separately provided for in section 271C and section 40(a)(ia) does not add to
it. The provisions of section 40(a)(ia), as they existed prior to insertion of
the second proviso thereto, went much beyond the obvious intentions of
the lawmakers and created undue hardships even in cases in which the assessee’s
tax withholding lapses did not result in any loss to the exchequer.

 

ii)   In order to cure these shortcomings of the
provision, and thus obviate the unintended hardships, an amendment in law was
made. In view of the well-settled legal position to the effect that a curative
amendment to avoid unintended consequences is to be treated as retrospective in
nature even though it may not state so specifically, the insertion of the
second proviso must be given retrospective effect from the point of time
when the related legal provision was introduced. The insertion of the second proviso
to section 40(a)(ia) is declaratory and curative in nature and it has
retrospective effect from 1st April, 2005, being the date from which
sub-clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

 

iii)  It was not disputed that the payments made by
the assessee to the sub-contractors had been offered to tax in their respective
returns of income, uncontroverted by the authorities. There was no actual loss
of revenue. Hence, section 40(a)(ia) was not applicable.

 

iv)  Accordingly, we answer the substantial
question of law against the Revenue and in favour of the assessee.’

 

Business expenditure – Section 37 of ITA, 1961 – General principles – Donations made by company under corporate social responsibility – Deductible u/s 37; A.Y. 2010-11

28. Principal CIT vs. Gujarat Narmada
Valley Fertilizer and Chemicals Ltd. [2020]
422 ITR 164 (Guj.) Date
of order: 16th July, 2019 A.Y.:
2010-11

 

Business
expenditure – Section 37 of ITA, 1961 – General principles – Donations made by
company under corporate social responsibility – Deductible u/s 37; A.Y. 2010-11

 

The assessee
was engaged in the business of manufacturing, sale and trading of chemical
fertilizers and chemical industrial products. The company was also engaged in
the business of information and technology. For the A.Y. 2010-11 the assessee
claimed expenditure of Rs. 17,50,36,756 u/s 37(1). Such claim was put forward
in fulfilment of its corporate social obligation and responsibility. The A.O.
disallowed the claim. The Appellate Tribunal relied on its order passed for
A.Y. 2009-10 and took the view that the assessee was entitled to claim
deduction towards the expenditure incurred for discharging its corporate social
responsibility u/s 37(1).

 

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

 

‘The word
“business” used in section 37(1) in association with the expression “for the
purposes of” is a word of wide connotation. In the context of a taxing statute,
the word “business” would signify an organised and continuous course of
commercial activity, which is carried on with the end in view of making or
earning profits. Under section 37(1), therefore, the connection has to be
established between the expenditure incurred and the activity undertaken by the
assessee with such object. The concept of business is not static. It has
evolved over a period of time to include within its fold the concrete
expression of care and concern for society at large and the people of the
locality in which the business is located in particular. It is not open to the
Court to go behind the commercial expediency which has to be determined from
the point of view of a businessman.

 

The test of
commercial expediency cannot be reduced to a ritualistic formula, nor can it be
put in a water-tight compartment. As long as the expenses are incurred wholly
and exclusively for the purpose of earning income from the business or
profession, merely because some of these expenses are incurred voluntarily,
i.e., without there being any legal or contractual obligation to incur them,
those expenses do not cease to be deductible in nature.

 

Explanation 2 to section 37(1) comes into play with effect from 1st
April, 2015. This disallowance is restricted to the expenses incurred by the
assessee under a statutory obligation u/s 135 of the Companies Act, 2013, and
there is thus now a line of demarcation between expenses incurred by the
assessee on discharging corporate social responsibility under such a statutory
obligation and under a voluntary assumption of responsibility. As for the
former, the disallowance under Explanation 2 to section 37(1) comes into play,
but for the latter there is no such disabling provision as long as the
expenses, even in discharge of corporate social responsibility on voluntary
basis, can be said to be “wholly and exclusively for the purposes of business”.

 

The assessee company was a polluting company. The assessee company was
conscious of its social obligations towards society at large. The assessee
company was a Government undertaking and, therefore, obliged to ensure
fulfilment of all the protective principles of State policy as enshrined in the
Constitution of India. The moneys had been spent for various purposes and could
not be regarded as outside the ambit of the business concerns of the assessee.
The order passed by the Appellate Tribunal was just and proper and needed no
interference in the present appeal.’

Appeal to Appellate Tribunal – Duty of Tribunal to decide appeal on merits – Rule 24 of ITAT Rules, 1963 Rectification of mistakes – Section 254 of ITA, 1961 – Order of Tribunal dismissing appeal ex parte for non-prosecution – Rejection of application for recall on ground of limitation – Not justified – Assessee granted liberty to apply for recall of order; A.Y. 2006-07

27. Golden
Times Services Pvt. Ltd. vs. Dy. CIT [2020]
422 ITR 102 (Del.) Date
of order: 13th January, 2020 A.Y.:
2006-07

 

Appeal to
Appellate Tribunal – Duty of Tribunal to decide appeal on merits – Rule 24 of
ITAT  Rules, 1963

 

Rectification
of mistakes – Section 254 of ITA, 1961 – Order of Tribunal dismissing appeal ex
parte for non-prosecution – Rejection of application for recall on ground
of limitation – Not justified – Assessee granted liberty to apply for recall of
order; A.Y. 2006-07

 

The relevant
year is the A.Y. 2006-07. In an appeal before the Income-tax Appellate Tribunal,
the petitioner company had challenged the addition of Rs. 19,00,000 which was
confirmed by the Commissioner (Appeals). The appeal was filed on 11th
December, 2014 and was heard on 30th August, 2016. The appeal was
dismissed by an order dated 18th October, 2016. In the said order,
the Tribunal, while noting that no one was present on behalf of the assessee at
the time of hearing, proceeded to dispose of the appeal, observing that notice
was sent to the assessee on 15th July, 2016 at the address mentioned
in the memo of appeal but despite that the assessee remained unrepresented. It
was further noted that the notice had come back unserved with a report that the
property was locked for quite some time. It was also noted that the earlier
notice, sent on 1st June, 2016 on the same address of the assessee,
had also been received back unserved with similar comments. The Tribunal, thus,
held that the assessee was presumably not serious in pursuing the appeal and
dismissed the same in limine. At the same time, the assessee was granted
liberty to approach the Income-tax Appellate Tribunal for a recall of the order
if it was able to show a reasonable cause for non-appearance. Thus, there was
no adjudication on the merits of the appeal.

 

On 8th February,
2018 when an inquiry was made about the status of the appeal, the petitioner
came to know that the appeal had been dismissed ex parte for
non-prosecution. Thereafter, on 8th March, 2018 an application was
filed for recall of the order dated 18th October, 2016. The petitioner
filed the application giving the grounds for non-appearance, with an
explanation that the absence was beyond its control. However, the application
was dismissed by an order dated 30th August, 2019 on the ground that
the same is barred by limitation u/s 254(2) of the Act.

 

The
petitioner filed a writ petition and challenged the order of the Tribunal. The
Delhi High Court allowed the writ petition and held as under:

 

‘i)   Rule 24 of the Income-tax (Appellate
Tribunal) Rules, 1963 mandates the Appellate Tribunal to decide the appeal on
its merits. It is the duty and obligation of the Appellate Tribunal to dispose
of the appeal on merits after giving both the parties an opportunity of being
heard. No limitation is provided in Rule 24 of the Rules.

 

ii)   Section 254(2) of the Income-tax Act, 1961
refers to suo motu exercise of the power of rectification by the
Appellate Tribunal, whereas the second part refers to rectification and
amendment on an application being made by the Assessing Officer or the assessee
pointing out the mistake apparent from the record. Section 254(2) was amended
by the Finance Act, 2016 with effect from 1st June, 2016 and the
words “four years from the date of the order” were substituted by
“six months from the end of the month in which the order was passed”.

 

iii)  Section 254(3) stipulates that the Appellate
Tribunal shall send a copy of the order passed by it to the assessee and the
Principal Commissioner. Further, Rule 35 of the Income-tax (Appellate Tribunal)
Rules, 1963 also requires that the orders are required to be communicated to
the parties. The section and the Rule mandate the communication of the order to
the parties. Thus, the date of communication or knowledge, actual or
constructive, of the orders sought to be rectified or amended u/s 254(2) of the
Act becomes critical and determinative for the commencement of the period of
limitation.

 

iv)  The appeal had been dismissed ex
parte for non-prosecution. At the same time, the assessee was granted
liberty to approach the Appellate Tribunal for recall of the order if it was
able to show a reasonable cause for non-appearance. Thus, there was no
adjudication on the merits of the appeal. The dismissal of the application for
recall of the order on the ground of limitation was not valid.

 

v)  The course adopted by the Appellate Tribunal
at the first instance, by dismissing the appeal for non-prosecution, and then
compounding the same by refusing to entertain the application for recall of the
order, cannot be sustained. We, therefore have no hesitation in quashing the
impugned order. Accordingly, the present petition is allowed. The order dated
30th August, 2019 is quashed and the matter is remanded back to the
Income-tax Appellate Tribunal with a direction that they shall hear and dispose
of I.T.A. No. 6739/Del/2014 on merits.’

FAILURE TO CLAIM DEDUCTION IN RETURN OF INCOME AND SECTION 80A(5)

ISSUE FOR CONSIDERATION

Section 80A(5)
provides for denial of deduction under sections 10A, 10AA, 10B, 10BA, or under
any of the provisions of part C of Chapter VIA (‘specified deductions’) of the
Income-tax Act in cases where the assessee fails to make a claim in the return
of income. It is usual to come across cases where assessees have failed to make
a specific claim for deduction in computing the total income and, as a
consequence, in claiming the same in the return of income, or where the
assessees try to cover up the failure by filing a revised return.

 

This disabling
provision has been introduced by the Finance (No. 2) Act, 2009 with
retrospective effect from 1st April, 2003. On introduction of the
new provision, an issue has arisen about the eligibility of an assessee to qualify
for the specified deductions in cases where the assessee has staked the claim
for the specified deduction for the first time in the revised return of income
and such return is filed beyond the time permissible in law but before the
completion of assessment. Conflicting decisions of the Tribunal are available
in the context of the new provision of section 80A(5) on the subject. The ratio
of such decisions is discussed here to highlight the difficulty and the
possible steps that may be taken to mitigate the hardship.

 

THE
OLAVANNA SERVICE CO-OP. BANK CASE

The issue arose in the case of M/s Olavanna Service Co-op. Bank ITA
No. 398/Coch/2014 dated 21st November, 2017 (unreported-Cochin).
The only issue in the appeal for assessment year 2010-11 was with regard to the
denial of deduction u/s 80P by invoking the provisions of section 80A(5). The
assessee, a co-operative bank registered under the Kerala Co-operative
Societies Act, 1969, had failed to file return of income for the A.Y. 2010-11.
The AO had issued notice u/s 142(1) requiring the assessee to file the return
of income but the assessee neither complied with the notice nor filed a return
of income. The AO initiated best judgment proceedings u/s 144 and called for
the details, at which point in time the assessee filed the return of income on
20th March, 2013 which was beyond the time limit prescribed u/s 139
and the time limit prescribed in notice u/s 142(1) and, therefore, the AO treated
the same as invalid. On the basis of the material gathered during the course of
assessment, the AO worked out the total income of the assesse from business and
in completing the assessment he disallowed the claim of deduction u/s 80P by
invoking the provisions of section 80A(5).

 

On appeal, the CIT(A) relied on the decision of the ITAT, Cochin Bench in
the case of Kadachira Service Co-op. Bank Ltd. & Ors., 153 TTJ
(Cochin) 129 wherein it was held that 
the assessee was not entitled for deduction u/s 80P for the A.Y. 2009-10
if the return of income had not been filed within the prescribed time. The
CIT(A) dismissed the appeal as, in his opinion, the factual matrix was the same
in both the cases. Against this order of the CIT(A), the assessee filed an appeal
before the Tribunal.

 

It was contended
before the Tribunal on behalf of the assessee that the assessee had filed the
return of income before the assessment proceedings were completed and,
therefore, the return filed should have been considered for the purpose of
making the assessment. It was further submitted that the AO should have
regularised the return of income u/s 148 of the Act, considering the fact that
the proceedings had been initiated on the basis of the reason to believe that
the income had escaped assessment. Further, it was submitted that since the
income had been assessed u/s 144 relying on all the materials, deeds and
documents submitted by the assessee in the course of the assessment proceedings
in response to the directions of the AO, he should have granted the deduction
as provided u/s 80P of the I.T. Act.

It was explained
that the assessee was a co-operative society coming under the classification of
Primary Agricultural Credit Society or Primary Co-operative Agricultural and
Rural Development Bank carrying on the business of banking, providing credit
facility to its members for agricultural purposes and, therefore, the claim of
exemption u/s 80P should have been allowed and that, even if it was held that
the assessee was doing banking business, proportionate exemption should have
been granted in respect of the agricultural credit facilities given to its
members, instead of disallowing the entire claim of deduction u/s 80P of the
Act.

 

The Tribunal, on
hearing both the sides, noted that a similar issue had come up for
consideration in the case of Kadachira Service Co-op. Bank Ltd. &
Ors., 153 TTJ (Cochin) 129. The relevant portion of the observations in
the said case were referred to by the Tribunal to hold that unless the Central
Government, by a notification in the official gazette, exempted the
co-operative societies from filing the returns, they had to file the return of
income and the co-operative societies could not have been under the impression
that they need not file their returns of income since their income was
exempted; a statutory liability of filing the return under the Income-tax Act
could not be disowned on the ground of a bona fide impression that no
return of income was required to be filed. It was observed that when the language
of the provision was plain and unambiguous, the language employed in the
statute was determinative of the legislative intent.

 

On examination of
section 80A(5), the Tribunal noted that the intention of the legislature in
introducing the provision was to avoid multiple deductions in respect of the
same profit and for that the legislature had imposed three conditions for
claiming deduction under sections 10A, 10AA, 10B, 10BA, or under any provisions
of part C, Chapter VIA. One of the conditions required that there should be a
claim made in the return of income. The legislature, in its wisdom, thought it
fit that implementation of these three conditions would prevent misuse and
avoid multiple claims of deduction under sections 10A, 10AA, 10B, 10BA, or under
any provisions of part C, Chapter VIA. A plain reading of the language of
sections 80A(4) and 80A(5) made clear the purpose and intent of the legislature
in a manner that did not require any further interpretation.

 

The Tribunal
examined the other provisions of the Act that provided for a deduction, to
appreciate the provisions of section 80A(5) of the Act, noting that while other
provisions required filing of return u/s 139(1), section 80A(5) did not carry
any such limitation. That being so, even if a return was filed u/s 139(4) it
would not dilute the infraction in not furnishing the return in due time as
prescribed in section 139(1). In section 80A(5) the legislature obviously
omitted to mention the words ‘in due time’. What it says is that where the taxpayer
fails to make a claim in the return of income, no deduction shall be allowed.
It does not say that the return of income shall be furnished in due time. The
return might be filed either u/s 139(1), or 139(4), or in pursuance of a notice
issued u/s 142(1) or 148 of the Act.

 

On the question of
when there was a failure on the part of the taxpayer to file return of income
within the time limit provided u/s 139(1) or 139(4), or within the time
specified in the notice u/s 142(1) or 148, the Tribunal held that the return of
income filed belatedly could not be treated as return of income.

 

While dealing with
the contention that when the return was filed before completion of the
assessment proceedings, the AO ought to have issued notice u/s 148 for regularising
the returns, the Tribunal held that the AO had no jurisdiction to issue notice
u/s 148 for assessing the income of the taxpayer. In other words, no income
could be said to have escaped assessment at that point of time. Therefore, the
contention of the assessee that notice ought to have been issued u/s 148 had no
merit at all. It referred to the decision in the case of Sun Engineering
Works (P) Ltd., 198 ITR 297, 320 (SC) to hold that proceedings u/s 147
were for the benefit of the Revenue.

 

The Tribunal held
that accepting the plea of the assessee that the deduction be allowed even
where no return was filed, would mean that a person who had not filed a return
would get benefit but a person who filed the return but failed to make a claim
either by ignorance or otherwise may not get the benefit at all. The Tribunal
was of the considered opinion that such could certainly not be the legislative
intent.

 

In conclusion, the
Tribunal held that it was a settled principle of law that in order to avail benefits
under the beneficial provision, the conditions provided by the legislature had
to be complied with, and therefore, the Tribunal was of the considered opinion
that in view of the mandatory provisions contained in section 139(1) r/w/s
80A(5) of the Act, it was mandatory for every co-operative society for claiming
deduction u/s 80P to file the return of income and to make a claim of deduction
u/s 80P in the return itself. If the return was not filed either u/s 139(1) or
139(4), or in pursuance of notice issued u/s 142(1) or 148, the taxpayer was
not entitled for any deduction u/s 80P.

 

CASE OF KAMDHENU BUILDERS AND DEVELOPERS

A similar issue was
examined in yet another case, of Kamdhenu Builders and Developers vs.
DCIT, ITA No. 7010/Mum/2010 (unreported-Mumbai) for A.Y. 2007-08 dated
27th January, 2016. The assessee in that case, a partnership firm,
was engaged in the business of building housing projects and doing real estate
development. The original return of income for A.Y. 2007-08 was filed on 18th
October, 2007 declaring total income from the housing project at Rs.
1,94,12,489. During pendency of assessment proceedings, the assessee had filed
a revised return of income on 31st August, 2009 declaring Nil
income, as the entire profit of Rs. 1,94,12,489 was claimed to be allowable as
deduction u/s 80IB(10) of the Income-tax Act. The AO had not allowed the claim
of deduction on the ground that revised return of income was furnished on 31st
August, 2009, which was beyond the date by which the revised return of
income should have been furnished as per the provisions of law u/s 139(5) of
the Income-tax Act. According to the AO, the claim of deduction u/s 80IB was
also inadmissible on account of the provision of law u/s 80A(5) of the
Income-tax Act.

 

On appeal, the
CIT(A) allowed the assessee’s claim. The Tribunal, on further appeal by the
Revenue, has largely relied upon the order of the CIT(A) and has reproduced
extensively his observations and findings in its order, some of which were as
under:

 

‘I have circumspected
the entire spectrum and circumstances of the case and considered finding of the
AO, remand report, written submission of the appellant and counter
representation vis-à-vis  provision of
law and  various decisions of the Hon’ble
ITAT, High Court and  Supreme Court  relevant to the issue. It transpires from the
assessment order and remand report of AO dated 7th June, 2010 that
Ld. AO had denied or is not willing to give deduction u/s 80IB(10) merely on
the ground of provision of law u/s 80A(5) irrespective of fulfilment of all the
conditions prescribed by the appellant to be entitled for legal claim of
deduction u/s 80IB(10) of the Act. This approach and contention of the Ld. AO
is not tenable because of obvious facts of fulfilment of all the conditions by
the appellant. There is no bar of furnishing of revised return of income u/s
80A(5) and the decision of the Hon’ble ITAT, High Courts and Supreme Court over
such issues support the appellant. Under section 80A(5), there is an insertion
of new provision of law with effect from 1st April, 2003 providing
that where the assessee failed to make claim in his  return of income for any deduction u/s 10(A),
or section 10(AA), or section 10(B), or section 10(BA), or under any provision
of Chapter VIA under the head in C – deduction in respect of certain income, no
deduction shall be allowed to him thereunder, means there is no restriction
about  the revised return of income but
there is a provision of law for claiming such deduction through return of
income only. This provision of law does not limit the date of filing of return
of income to be either as provided u/s 139(1) or 139(4) or 139(5) of the
Income-tax Act. As such, there is no ambiguity regarding interpretation or
understanding of this provision of law. The provision of section 80A(5) does
not provide that return of income through which the deduction has to be claimed
should be filed on or before the due date specified under these sections, it is
worthwhile to mention that whenever legislature intends to provide a law with
reference to the prescribed date of return of income before any specified date, it has
clearly identified and mentioned in expressed word.’

 

The CIT(A) cited
the examples of section 80AC where a return of income had to be filed prior to
due date as per section 139(1) and of section 54(2) which referred to the date
of furnishing return as per section 139 and also of section 139(3) where carry
forward of loss was permitted only if such return of loss was filed within the
time limit provided by section 139(1). He noted that for claiming any such
deduction under these sections, return of income had to be filed within the
specified date  u/s 139(1), whereas u/s
80A(5) there was no such specific limitation of date; therefore, in absence of
any specific limitation of date, the words ‘return of income’ provided u/s
80A(5) had to be construed to mean any such return of income filed prior to the
completion of assessment or a return of income filed during the assessment
proceedings, provided the original return of income was filed within  the time limit prescribed u/s 139(1).

 

He further held: ‘Obviously,
appellant complies with the provision of section 80AC of the Income-tax Act.
When the original return of income has been filed well within the due date, the
revised return filed thereafter before the completion of assessment proceedings
or assessment order is passed, it is a valid return of income to be considered
by the Assessing Officer, otherwise every purpose of giving such right to such
appellant would be frustrated. The revised return of income is essential for
removal of defects of original return. It obviously corrects shortcomings from
which it suffered. The revised return must therefore be considered as it was
originally filed vide Thakur Dharmapur Sugar Mills Ltd. vs. CIT (1973) 90
ITR 236, 239 & 240 (All.) and Gopaldas Parshottamdas vs. CIT
(1941) 9 ITR 130 (All.). It is important to point  out that when a revised return cures the
defects in the original return and does not obliterate the latter, the
assessment means on the basis of original return of income ignoring the revised
return is liable to be set aside vide CIT vs. Chitranjali (1986) 159 ITR 801
(Cal.). Similar view has also been taken in the case of CIT vs.
Bansidhar Dalal and Sons, 207 ITR 494 (Cal.).’

 

The CIT(A) observed
that an AO’s functions encompassed power as well as duty to be exercised within
the ambit of law. Relying on various court pronouncements, he observed that it
was only the true and correct total income of every person which was assessable
u/s 4 of the Act and, consequently, the tax collector was rather duty-bound to
collect the legitimate tax due on such total income – neither a penny less nor
a penny more, and the determination / assessment of total income would depend
on the relevant provisions of the Act irrespective of the nature of return
filed by any person; and that an income which was not taxable could not be
taxed merely because the assessee forgot to claim the exemption / deduction
under some mistaken belief. Rather, it was the duty of the Assessing Officer to
allow such deduction or exemption to which the assessee was entitled on the
basis of material placed on record. Therefore, the assessee was entitled to
claim deduction if such claim was made by the assessee before the completion of
assessment proceedings. He relied on the findings in the case of Anchor
Pressings (P) Ltd., 161 ITR 159 (SC) in which case the claim for
deduction u/s 80-O was made by the assessee before completion of assessment
proceedings by way of a revised return filed after expiry of period specified
u/s 139(5), it was held that the assessee was entitled to the said deduction in
computing his total income.

 

The CIT(A) relying
on the cases of Lucknow Public Educational Society, 318 ITR 223 (All.);
Gujarat Oil & Allied Industries, 109 CTR (Guj.) 272, 201 ITR 325 (Guj.); and
Berger Paints (India) Ltd., 174 CTR (Cal.)269: 254 ITR 503 (Cal.)
held that the mistake was procedural in nature. The mistake was a technical
breach and the AO was duty-bound to ask for details before denying the claim.
In the instant case, the AO had not asked any information before denying the
exemption for which the assessee was legally entitled. On the other hand, he
had rejected the second return which enclosed the necessary documents for
claiming the exemption.

 

The CIT(A) noted
with approval the decision in the case of Emerson Network Power India (P)
Ltd., 122 TTJ/27 SOT/19 DTR where it had been held that any claim made
at the time of assessment but not made in the original return, nor made by way
of valid revised return, could not be denied and the AO was obliged to give due
relief to the assessee or entertain its claim if admissible as per law, even
though the assessee had not filed the revised return, and that the legitimate
claim of the assessee should not be rejected on technical grounds. In the
background of all the decisions and facts of the case, the denial of claim of
deduction of the appellant made through revised return of income during the
course of assessment proceedings and well before the passing of assessment
order, according to the CIT(A), was not tenable in the eye of law.

 

Against the above
order of the CIT(A), the Revenue filed an appeal to the Tribunal on the
following grounds:

 

‘(i)  On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in holding that the assessee is entitled to deduction
u/s 80IB(10) of Rs. 1,94,12,489 in spite of the fact that the claim for
deduction was not made in the original return and was only made in the return
filed for A.Y. 2007-08 on 31st August, 2009, which is not a valid
return in the eye of law and also cannot be treated as revised return u/s
139(5).

(ii) On the
facts and circumstances of the case and law, the Ld. CIT(A) erred in allowing
the deduction u/s 80IB(10) of Rs. 1,94,12,489 as the same is contrary to the
provisions of section 80A(5), effective from 1st April, 2003, which
does not permit allowance of deduction unless the claim for deduction is made
in the return of income.

(iii)  On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in allowing the deduction u/s 80IB(10) as the same
only means that deduction can be claimed just by filling revised return u/s
139(5)… has already elapsed, in the course of assessment proceedings, which is
not at all acceptable in the light of amended provisions of section 80A(5),
vide Finance (No. 2) Bill, 2009.’

 

It was contended by
Revenue that as per the provisions of section 80A(5), effective from A.Y.
2003-04, the assessee was not entitled for deduction unless the claim of
deduction was made in the original return filed by him. On the other hand, the
assessee contended that original return was filed well within the time, and the
revised return was filed to correct the omission in the original return.
Nowhere had the AO alleged that the assessee had not complied with any of the
conditions prescribed for claim of deduction u/s 80IB(10). A legal claim, even
if not made in the original return or even in the revised return, but made by
the assessee before the AO completing the assessment, should be allowed.

 

The Tribunal in its
considered view noted that section 80A(5) only required filing of return.
Nowhere is it suggested that claim should be made in the original return and
not by way of revised return. It further noted that when the original return of
income had been filed well within the due date, the revised return filed
thereafter, before the completion of assessment proceedings, was a valid return
of income to be considered by the AO; that the assessee had been given
opportunity to file revised return u/s 139(4) for removal of any defect in the
original return; the CIT(A), considering the remand report and the written
submission of the assessee, and after applying various judicial pronouncements,
recorded a finding to the effect that the assessee had filed a revised return
claiming deduction u/s 80IB(10) before completion of assessment, and following
the judicial pronouncements laid down by the Allahabad High Court in the case
of Thakur Dharmapur Sugar Mills Ltd. 90 ITR 236, held that
revised return must be considered as it was originally filed; it was the duty
of the AO to allow legal claim if made before him and provided it fulfilled all
the conditions of the claim; nowhere had the AO alleged that the assessee has
failed to comply with any of the conditions of section 80IB(10); the only
grievance of the AO was that the claim was not made in the return filed u/s
139(1); the CIT(A) recorded a finding to the effect that both the original
return was filed well within the time limit prescribed under the law and the
revised return was filed before the AO completed the assessment, that the
assessee had fulfilled all the conditions u/s 80IB(10) and, therefore was
entitled for deduction in respect of the housing project.

 

The Tribunal noted
that the findings recorded by the CIT(A) had not been controverted by the
Department by bringing any positive material on record and the Tribunal did not
find any reason to interfere in the order of the CIT(A) in allowing the
assessee’s claim for deduction u/s 80IB(10) of the Act.

 

OBSERVATIONS

Section 80A(1)
stipulates that in computing the total income of an assessee, there shall be
allowed the deductions specified in sections 80C to 80U of the Act. Section
80A(5) reads as follows: ‘Where the assessee fails to make a claim in his
return of income for any deduction under section 10A or section 10AA or section
10B or section 10BA or under any provision of this Chapter under the heading
“C  Deductions in respect of certain
incomes”, no deduction shall be allowed to him thereunder’.

 

On a plain reading
of the provision it is clear that the disabling provision is activated only in
the case of an ultimate failure to make a claim in the return of income. The claims
though not made in the return of income u/s 139(1), would continue to be valid
as long as the claim for specified deduction is made in any of the returns
filed u/s 139(3), 139(4) and 139(5), or even in response to notices u/s 142(1)
or 148 of the Act, subject to compliance of the independent conditions of the
respective provisions under which a specified deduction is being claimed.

 

In cases where it
is necessary for the taxpayer to file the return of income within a specified
date, the legislature has inserted the words  ‘before the due date specified’ or ‘in due
time’  or ‘within the time limit’. In
section 80A(5), the legislature expressly omitted to include the words ‘within
the time limit’ or ‘before the due date specified’ or ‘in due time’. Therefore,
for the purpose of Chapter VIA the legislature intended not to make compulsory
the filing of return of income within the specified time or in due time as
provided in section 139(1) of the Act. In fact, section 80 r/w/s 139(3) of the
Income-tax Act, which provides for carry forward of losses, requires the
taxpayer to file the return of income within the time allowed u/s 139(1).

 

While introducing
section 80A(5), the legislature was well aware that not only for carry forward
of losses but also for deductions u/s 10A and 10B, the taxpayer has to file the
return of income within the time limit prescribed u/s 139(1) of the Act. In
spite of that, the legislature omitted to mention the words ‘within due time’
in section 80A(5). Therefore, the return of income filed within the time limit
provided in section 139(1) or 139(4), or the time specified in the notice u/s
142(1) or 148 can be considered as return of income. The issue, therefore, is
limited to the belated return filed beyond the time limit provided u/s 139(1)
or 139(4), or the time specified in notice u/s 142(1) or 148 of the Act.

 

The challenge
therefore is in respect of a case where no claim at all is made in the return
of income, or a case where such a claim is made in the return of income that is
filed, not under any of the above referred provisions, but before the
assessment. Nonetheless, such a challenge may also be faced in a case where the
assessee for the first time seeks to claim one of the specified deductions
before the appellate authorities. For brevity’s sake, however, the discussion
here is mainly restricted to a case where a deduction has been claimed in the
revised return of income filed beyond the permissible time but before the
assessment is completed; it is this aspect of section 80A(5) that has been
examined under the conflicting decisions discussed above.

 

The Notes to Clauses and the Explanatory Memorandum issued at the time of
introduction of the provision by the Finance (No. 2) Bill, 2009 are reported in
315 ITR (Stat) 81 and 82. The intention of the legislature in enacting sections
80A(4) and 80A(5) is to avoid multiple deduction in respect of the same profit.
The legislature prescribed three conditions in sections 80A(4) and 80A(5) which
are: (i) If a deduction in respect of any amount was allowed u/s 10A, 10AA
or 10B or 10BA or under provisions of Chapter VIA under the head  ‘C – Deductions in respect of certain
incomes’ in any assessment year, then the same deduction in respect of the same
profit & gains shall not be allowed under any other provisions of the Act
for such assessment year; (ii) The aggregate deduction under various provisions
shall not exceed the profit and gains of the undertaking or unit or enterprise
or the business profit, as the case may be; and (iii) There shall be a claim
made in the return of income. The legislature in its wisdom thought that
the above three conditions would avoid multiple deductions in respect of the
same profit. One of the conditions prescribed by the legislature in section
80A(5) is to make a claim in the return of income. The Delhi High Court in the
case of Nath Brothers Exim International Limited, 394 ITR 577
examined and upheld the constitutionality of the provision of section 80A(5).

 

A reference may also
be made to the Circular No. 37 of 2016 dated 2nd November, 2016
clarifying that an increased claim for deduction would not be denied in cases
where such increase is on account of the additions or disallowances made in
assessment of the total income. In this context, a useful reference may be made
to the decision in the case of Oracle (OFSS) BPO Services Limited, 307
CTR (Delhi) 97, which, independent of circulars, supports such a claim.
[Also see Influence, 55 taxmann.com 192 (Delhi) and E-Funds
International India (P) Limited, 379 ITR 292 (Delhi).]


In a case where the
assessee cannot claim the deduction for want of positive profits, or where the
electronic return does not permit to record the eligibility to the claim for
deduction, or where a return carries a note, as was in the case of DIC
Fine Chemicals Limited, 202 TTJ (Mum.) 378, highlighting its inability
to claim deduction for want of profits, or the inability to disclose, the
deduction should not be denied; the deduction, in such cases, on assessment,
would be well within the provision of section 80A(5) and would in any case be
saved by the said circular and the said decisions. Such cases cannot be
attributed to the failure of the assessee to claim a deduction in the return of
income.

 

The issue of the failure to claim a deduction in the return of income has
in fact been examined by the Delhi and the Bombay High Courts in the cases of Nath
Brothers, 394 ITR 577 and EBR Enterprises, 107 taxmann.com 220,
respectively. The Courts, in these cases, have held that not only the provision
of section 80A(5) is constitutional, as it is based on a reasonable
classification, but it also denies the right to claim the specified deduction
in a case where an assessee fails to claim such deduction in the return of income.
The Bombay High Court in the EBR Enterprises case specifically
disapproved the decision of the Mumbai Bench of the Tribunal in the case of Madhav
Constructions (Supra) where the Tribunal had held that the deduction
was not limited by the provisions of section 80A(5). The High Court, however,
in the very same Madhav Constructions case had refused to admit
the appeal of the Revenue against the order of the Tribunal

 

The case of the
assessee for the claim of deduction is likely to be on a better footing where a
claim is staked before the AO, before completion of assessment, by filing a
return of income, revised or otherwise. Please see Chirakkal Service
Co-op. Bank Ltd., 384 ITR 490 and The Pazhavangadikara Service
Co-op. Bank (Cochin-unreported) ITA No. 200/Coch/2018 dated 9th
July, 2018. In these cases, a claim made vide a belated return of
income, filed in response to notice u/s 148, was allowed as a deduction.

 

Outside of section
80A(5), it is a settled position in law that an AO is duty-bound to allow all
those deductions, reliefs and rebates otherwise allowable irrespective of the
claim by the assessee. This position of law articulated by the CBDT in Circular
No. 14(XL-35) of 1955 dated 11th April, 1955 has been approved by
several decisions of the courts rendered from time to time.

It is also a settled position in law that an assessee is entitled to
place a fresh claim for deduction or relief or rebate before the appellate
authorities, for the first time. Similarly, there is no bar on the AO to
entertain a claim made outside the return of income during the course of
assessment proceedings. Likewise, no special emphasis is required in stating
that a mere failure to stake a claim at a specific point of time or in a
specified format should not result in the frustration of a valid claim.

In view of the overwhelming position in law
in favour of allowance of a lawful claim, we are of the considered view that
the courts should favour an allowance of a lawful claim, even in the cases
where there is an express stipulation for denial of the benefits on the grounds
of non-compliance of a technical requirement, as long as the assessee has
finally corrected himself by compliance before the authorities. The court, in
such cases, should not only entertain the claim but is also obliged to allow
the reliefs to avoid unjust enrichment of the State.

I.Section 43(6), Explanation 2 – In Explanation 2 to section 43(6), deprecation actually allowed shall not include any unabsorbed depreciation – The WDV in the hands of the amalgamated company is to be calculated without considering the unabsorbed depreciation of the amalgamating companies, for which set-off was never allowed II.When a receipt is held to be capital in nature and not chargeable to tax under the normal provisions of the Act, the same cannot be taxed u/s 115JB of the Act as well III.Section 234B r/w/s 115JB – Interest u/s 234B cannot be levied where liability arises on account of retrospective amendment in the Act

16. [2019] 112
taxmann.com 55 (Trib.)(Mum.) ACIT vs. JSW Steel
Ltd. ITA No.
156/Bang/2011; CO No. 59/Mum/2012 A.Y.: 2006-07 Date of order: 29th
November, 2019

 

I.  Section 43(6), Explanation 2 – In Explanation
2 to section 43(6), deprecation actually allowed shall not include any
unabsorbed depreciation – The WDV in the hands of the amalgamated company is to
be calculated without considering the unabsorbed depreciation of the
amalgamating companies, for which set-off was never allowed

 

II. When a receipt is held to be capital in nature
and not chargeable to tax under the normal provisions of the Act, the same
cannot be taxed u/s 115JB of the Act as well

 

III.        Section 234B r/w/s 115JB – Interest u/s
234B cannot be levied where liability arises on account of retrospective
amendment in the Act

 

FACTS I

In the return of
income filed by the assessee for the year of amalgamation, i.e., A.Y. 2006-07,
the assessee computed WDV in respect of the assets transferred by the
amalgamating companies by reducing the amount of deprecation (‘actually
allowed’) in A.Y. 2005-06 in accordance with the provisions of Explanation (2)
to section 43(6) of the Act.

 

The AO observed
that the closing WDV of the amalgamating company becomes the WDV in the hands
of the amalgamated company and accordingly determined the WDV of the assets
acquired on amalgamation after considering normal depreciation allowed on
assets of the two amalgamating companies; consequently, he disallowed excess
depreciation of Rs. 6,81,27,607 (being 15% of the difference in the WDV of Rs.
45,41,84,048).

 

However, the AO was
of the view that Explanation (3) has to be read into Explanation (2) and
accordingly the WDV of the assets transferred on amalgamation has to be
computed after reducing the total depreciation in the hands of the amalgamated
companies.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal and directed
the AO to allow depreciation on the increased written down value of the assets.

 

Being aggrieved,
the Revenue preferred an appeal to the Tribunal.

 

HELD I

The Tribunal
observed that

(i)   the only dispute under consideration is
whether the WDV of the assets transferred on amalgamation was to be computed in
the hands of the amalgamated company considering the unabsorbed depreciation,
i.e., depreciation not given effect to, in the assessment of the amalgamating
companies;

(ii)   the provisions of Explanations (2) and (3) to
section 43(6) explains what will be the WDV of assets in the hands of the
amalgamated company in cases of amalgamation. Similarly, section 32(2) provides
for carry forward of unabsorbed depreciation and section 72A provides for carry
forward of business loss and unabsorbed depreciation in the hands of the
amalgamated company in cases of amalgamation;

(iii) on going through Explanation (2) to section
43(6), it is very clear that it speaks about depreciation ‘actually allowed’ in
relation to the said preceding year in case of the amalgamated company.

 

The Tribunal held
that in view of Explanation (2) to section 43(6) of the Act, the WDV in the
hands of the assessee as on 1st April, 2005 (the appointed date)
would be the WDV of block of assets as on 31st March, 2004 as
reduced by the depreciation ‘actually allowed’ during the said preceding year,
i.e., F.Y. 2004-05, in the hands of the amalgamating companies. Accordingly,
the WDV of assets transferred on amalgamation in the hands of the amalgamating
company has to be necessarily computed in terms of Explanation (2) to section
43(6) of the Act. In terms of this Explanation, while computing the WDV on
amalgamation, the depreciation actually allowed has to be reduced.

 

Since the case of
the AO was that Explanation (3) has to be read into Explanation (2) and,
accordingly, the WDV of assets transferred on amalgamation has to be computed
after reducing the total depreciation in the hands of the amalgamated
companies, the Tribunal found it necessary to read and comprehend as to why the
provision of section (3) to section 43(6) of the Act cannot be applied in the
facts of the present case. It held that Explanation (3) to section 43(6) states
that any depreciation which is carried forward u/s 32(2) shall be deemed to be
depreciation actually allowed. Further, it observed that Explanations (2) and
(3) to section 43(6) of the Act both used the term depreciation actually
allowed. However, as against Explanation (2), Explanation (3) to section 43(6)
of the Act operates as a deeming fiction, wherein depreciation which is carried
forward u/s 32(2) of the Act is deemed to have been actually allowed.

 

The Tribunal held
that in its view Explanation (3) being a deeming fiction, operates only in
particular conditions and in order to remove an anomaly which otherwise would
have been created under the other provisions of the Act. It held that while
interpreting Explanation (3) one needs to be aware of the intention of the
statute. These provisions, along with their intent, have been explained
elaborately by the Hon’ble Bombay High Court in the case of Hindustan
Petroleum Corporation Limited where it was held that Explanation (3) to
section 43(6) seeks to find certain anomalies which would have otherwise
existed under the Act. The intention of Explanation (3) is not simply to
nullify the provision of Explanation (2) to section 43(6), as has been read by
the AO. This is also evident from the fact that Explanation (2) has been
introduced from 1st April, 1988, whereas Explanation (3) was always
on the statute, which clearly implies that Explanation (3), which is a legal /
deeming fiction, was not introduced to nullify the impact of Explanation (2) of
the Act.

 

Accordingly, in
terms of Explanation (3) to section 43(6), in the present case, unless the
unabsorbed depreciation of the amalgamating companies is carried forward in the
hands of the amalgamated company u/s 32(2), Explanation (3) cannot be read into
Explanation (2) to simply conclude that depreciation ‘actually allowed’ also
includes unabsorbed depreciation.

 

It observed that in
view of the ratio of the decision of the Supreme Court in the case of CIT
vs. Doom Dooma India Ltd. [2009] 310 ITR 392, the words actually
allowed under Explanation (2) only mean depreciation, which has been given
effect to in the computation of income of the amalgamating companies and will
not include unabsorbed depreciation. This legal proposition, it observed, is
also supported by the decision in the case of Silical Metallurgic Ltd.
where the Hon’ble Court held that the statutory provision makes it clear that
the WDV of the asset would be the actual cost of the assets of the assessee
less depreciation allowed to the company. Any unabsorbed depreciation, which
was not set off for carry forward could not be taken into account.

 

A similar view was
taken by the Bombay High Court in the case of Hindustan Petroleum Corpn.
Ltd. and a Special Leave Petition filed against the aforesaid High
Court decision has been dismissed by the Hon’ble Supreme Court on merits in SLP
(C) No. 19054 of 2008 (SC). A similar proposition has been laid down by
the Hon’ble Madras High Court in the case of EID Parry India’s vs. CIT
[2012] 209 Taxmann 214. The Courts have, considering the applicability
of provisions of section 72A, held that deprecation actually allowed shall not
include any unabsorbed depreciation.

 

The Tribunal held
that the WDV in the hands of the amalgamated company was to be calculated
without considering the unabsorbed depreciation of the amalgamating companies,
for which set-off was never allowed. The Tribunal upheld the findings of the
CIT(A) and dismissed this ground of the appeal of the Revenue.

 

FACTS II

The assessee
received a sales tax subsidy of Rs. 36,15,49,828 from the Karnataka Government
for setting up a new industrial unit in the backward area of the state. The
refund of sales tax subsidy was routed through the profit and loss account and
hence the same was considered as part of the book profits u/s 115JB of the I.T.
Act, 1961. Subsequently, the assessee realised that sales tax subsidy being
capital receipt as held by the CIT(A), the same is not taxable under the MAT
provisions; accordingly, the issue was raised before the Tribunal and this
ground was taken by the assessee in the cross-objections filed by it.

 

HELD II

The Tribunal noted
that

(i)   the Coordinate Bench of the ITAT, Mumbai
Tribunal, in the assessee’s own case for A.Y. 2004-05 in ITA No. 923/Bang/2009,
had considered an identical issue and held that where a receipt is held to be
capital in nature not chargeable to tax under the normal provisions of the Act,
the same cannot be taxed u/s 115JB of the I.T. Act, 1961;

(ii)   the Hon’ble Kolkata High Court, in the case of
Pr. CIT vs. Ankit Metal & Power Ltd. [2019] 109 taxmann.com
93 had considered an identical issue and after considering the decision
of the Hon’ble Supreme Court in the case of Apollo Tyres Ltd. (Supra)
held that when a receipt is not in the character of income as defined u/s 2(24)
of the I.T. Act, 1961, then it cannot form part of the book profit u/s 115JB.
The Court further observed that the facts of case before the Hon’ble Supreme
Court in the case of Apollo Tyres Ltd. were altogether different,
where the income in question was taxable but was exempt under a specific
provision of the Act, and as such it was to be included as a part of book
profit; but where the receipt is not in the nature of income at all, it cannot
be included in book profit for the purpose of computation u/s 115JB.

 

The Tribunal
further noted that to a similar effect was the ratio of the following
decisions:

(a)   Sutlej Cotton Mills
Ltd. vs. Asstt. CIT [1993] 45 ITD 22 (Cal. Trib.) (SB);

(b)   Shree Cement Ltd. vs.
Addl. CIT (2015) 152 ITD 561 (Jai. Trib.);

(c)   Sipca India (P) Ltd.
vs. Dy. CIT [2017] 80 taxmann.com 87 (Kol. Trib.).

 

As regards the case
laws relied upon, on behalf of the Revenue, the Tribunal held that the Tribunal
or High Court in those cases came to the conclusion that the capital receipt is
in the nature of income, but by a specific provision the same has been exempted
and hence came to the conclusion that once a particular receipt is routed
through the profit and loss account, then it should be part of book profit and
cannot be excluded while arriving at book profit u/s 115JB of the Act, 1961.

 

The Tribunal held
that when a particular receipt is exempt from tax under the Income tax Law,
then the same cannot be considered for the purpose of computation of book
profit u/s 115JB. It directed the AO to exclude the sales tax subsidy received
by the assessee amounting to Rs. 36,15,49,828 from the book profits computed
u/s 115JB.

 

The cross-objection
filed by the assessee was allowed.

 

FACTS III

Section 234B
r/w/s 115JB – Interest u/s 234B cannot be levied where liability arises on
account of retrospective amendment in Act

 

While completing
the assessment, interest of Rs. 9,84,94,367 was levied on total income computed
u/s 115JB on account of retrospective amendment to section 115JB. In the profit
and loss account for the year ended 31st March, 2006, the assessee
had debited provision for deferred tax of Rs. 433.61 crores. In the return of
income filed for A.Y. 2006-07, the aforesaid provision was not added back while
computing book profit u/s 115JB. However, subsequently the Finance Act, 2008
made a retrospective amendment to section 115JB by inserting clause (h) in
Explanation 1 to section 115JB according to which book profits are required to
be increased by an amount of deferred tax and provision thereof; the said
amendment was made with retrospective effect from A.Y. 2001-02. Accordingly,
during the course of assessment proceedings while computing book profits u/s
115JB, the AO, in view of the insertion of clause (h) in Explanation 1 to
section 115JB by the Finance Act, 2008 with retrospective effect, added the
provision for deferred tax liability and consequently interest u/s 234B was
levied which interest arose on account of the retrospective amendment to
section 115JB.

 

Aggrieved, the
assessee preferred an appeal to the CIT(A) who allowed the appeal on the ground
that no liability can be fastened onto the assessee on the basis of
retrospective amendment to the Act.

 

HELD III

The Tribunal noted
that whether interest us/ 234B can be charged on the basis of a retrospective
amendment on recomputed book profit is no longer res integra. The
Coordinate Bench of the ITAT Bangalore Tribunal, in the assessee’s own case for
A.Y. 2005-06 in ITAT No. 924/Bang/2009, had considered an identical issue and
held that no interest can be levied u/s 234 B where liability arises on account
of retrospective amendment in the Act.

 

It observed that in the current year as well, the liability for interest
u/s 234B has arisen only on account of a retrospective amendment to the
provision of section 115JB. Accordingly, the assessee would not have
anticipated the retrospective amendment at the time of making the payments for
advance tax, but would have estimated the liability to pay advance tax on the
basis of the then existing provisions. The Tribunal found no error in the
findings recorded by the CIT(A), while deleting the interest liability u/s 234B
of the Act. The Tribunal upheld the findings of CIT(A) and rejected the ground
taken by the Revenue. This ground of appeal of the Revenue was dismissed.

Section 69C – Unexplained expenditure – Bogus purchases – Mere reliance by the A.O. on information obtained from the Sales Tax Department, or the statements of two persons made before the Sales Tax Department, would not be sufficient to treat the purchases as bogus

5. Pr. CIT-13 vs. Vaman International Pvt. Ltd. [Income tax Appeal
No. 1940 of 2017]

Date of order: 29th January, 2020

ACIT vs. Vaman International Pvt.
Ltd. [ITA No. 794/Mum/2015; Date of order: 16th November, 2016;
A.Y.: 2010-11; Bench ‘F’]

 

Section 69C – Unexplained
expenditure – Bogus purchases – Mere reliance by the A.O. on information
obtained from the Sales Tax Department, or the statements of two persons made
before the Sales Tax Department, would not be sufficient to treat the purchases
as bogus

 

The assessee is a company engaged
in the business of trading and sale of furniture and allied items on wholesale
basis. The A.O. doubted the expenditure of Rs. 4,75,42,385 stated to be on
account of purchases from two parties, viz., Impex Trading Co. (for an amount
of Rs. 2,90,80,292) and Victor Intertrade Pvt. Ltd. (Rs. 1,84,62,093). The A.O.
acted on the basis of information received from the office of the
Director-General of Income Tax (Investigation), Mumbai and from the Sales Tax
Department that in the list of bogus sales parties the names of the two
aforesaid parties were included which rendered the purchase transaction
doubtful.

 

The A.O. observed that the
assessee did not produce lorry receipts and other related documents to reflect
the movement of goods sold and purchased which were crucial for determining the
genuineness of the purchase transaction. In the absence thereof, the A.O. added
the said amounts to the total income of the assessee u/s 69C by treating the
expenditure as bogus purchases.

 

The first appellate authority
held that such addition by the A.O. could not be sustained. Accordingly, he deleted
the addition of Rs. 4,75,42,385. The Tribunal, by an order dated 16th
November, 2016, upheld the order of the first appellate authority and dismissed
the appeal of the Revenue.

 

On further appeal, the Hon. High
Court observed that section 69C deals with unexplained expenditure. But it also
contains a deeming provision which states that if an assessee incurs any
expenditure in the relevant previous year but offers no explanation about the
source of such expenditure or part thereof, or if the explanation provided is
not satisfactory to the A.O., then the amount covered by such expenditure or
part thereof shall be deemed to be the income of the assessee; and once it is
so deemed, the same shall not be allowed as a deduction under any head of
income.

 

The Court relied on the Gujarat
High Court decision in Krishna Textiles vs. CIT, 310 ITR 227  wherein it has been held that u/s 69C the
onus is on the Revenue to prove that the income really belongs to the assessee.

 

The Hon. Court observed that the
A.O. did not doubt the sales and stock records maintained by the assessee. By
submitting confirmation letters, copies of invoices, bank statements, payment
orders, payment by account payee cheques, etc., the assessee had proved that
the sales and purchases had taken place. By highlighting the fact that all the
payments against the purchases were made through banking channels by way of
account payee cheques, the first appellate authority held that the source of
expenditure was fully established by the assessee beyond any doubt. He had
further recorded that during the appellate proceedings the assessee had
furnished complete quantitative details of the items of goods purchased during
the year under consideration and their corresponding sales. Mere reliance by
the A.O. on information obtained from the Sales Tax Department, or the
statements of two persons made before the Sales Tax Department, would not be
sufficient to treat the purchases as bogus and thereafter to make the addition
u/s 69C.

 

The Tribunal also held that if
the A.O. had doubted the genuineness of the purchases, it was incumbent upon
him to have caused further inquiries in the matter to ascertain the genuineness
or otherwise of the transactions and to have given an opportunity to the
assessee to examine / cross-examine those two parties vis-a-vis the
statements made by them before the Sales Tax Department. Without causing such
further inquiries in respect of the purchases, it was not open to the A.O. to
make the addition u/s 69C of the Act. 


_____________________________________________________________________________________________________

 

 

Errata

IN THE HIGH COURTS, March 2020 

 

We regret to point out a typographical error
on Page 51 of the caption issue in respect of the following decision:

The Pr CIT -1 v/s M/s. Ami Industries (India)
P Ltd [ Income tax Appeal no 1231 of 2017 dt : 29/01/2020
(Bombay HighCourt)].

where “Addition is
not justified “ should be replaced in place of “Addition is justified” and be
read accordingly.