2020 Archives

Condonation of delay – 458 days – Belated appeal against section 263 order before ITAT – Appeal filed after consequential assessment order and dismissal of appeal – Delay condoned on payment of costs

4. Procter & Gamble Hygiene and Healthcare Ltd. vs.
Commissioner of Income Tax-8 [Income tax Appeal No. 1210 of 2017]

Date of order: 4^th February, 2020

Procter & Gamble Hygiene
& Healthcare Ltd. vs. CIT, Range-8 [ITA No. 4866/Mum/2015; Date of order:
30th November, 2016; A.Y.: 2008-09; Bench ‘H’ Mum.]

Condonation of delay – 458 days –
Belated appeal against section 263 order before ITAT – Appeal filed after
consequential assessment order and dismissal of appeal – Delay condoned on
payment of costs

The issue involved in the appeal
is condonation of delay in filing of the appeal u/s 254 of the Act by the
appellant before the Tribunal. The A.O. passed the assessment order on 1^stFebruary, 2012 in which certain deductions were allowed u/s 80IC. The
CIT-8, Mumbai was of the view that the A.O. had wrongly allowed deduction u/s
80IC. He was of the further view that the assessment order so made was
erroneous and prejudicial to the interest of the Revenue. Accordingly, he
invoked jurisdiction u/s 263 and vide an order dated 31^st
March, 2014 set aside the assessment order by directing the A.O. to pass a
fresh assessment order by taxing the interest income earned by the petitioner
on the amount covered by the deduction sought for u/s 80IC under the head
‘income from other sources’. The A.O. passed the consequential assessment order
dated 9^th June, 2014. It was against this assessment order that the
assessee preferred an appeal before the CIT(A)-17.

However, by
the appellate order dated 28^thAugust, 2015 the first appellate
authority dismissed the appeal of the assessee, holding that it was not
maintainable as the A.O. had only given effect to the directions given to him
by the CIT, relying on the decision in Herdillia Chemicals Ltd. vs. CIT
[1997] 90 Taxman 314 (Bom.). Aggrieved by this, the petitioner
preferred an appeal before the Tribunal which was registered as ITA No.
5096/Mum/2015. In the meanwhile, the assessee, having realised that the order
passed by the jurisdictional administrative commissioner u/s 263 of the Act had
remained unchallenged, belatedly filed an appeal before the Tribunal which was
registered as ITA No. 4866/Mum/2015. In the process there was a delay of 450
days. The assessee filed an application before the Tribunal for condonation of
delay in filing ITA No. 4866/Mum/2015 and in support thereof also filed an
affidavit dated 12^th September, 2016 explaining the delay. The
assessee stated in its affidavit that the appellant did not prefer an appeal as
the Learned CIT had set aside the assessment so that the issues involved would
be agitated before the A.O. or the appellate authorities, i.e., against the
order of the A.O.

Both the appeals were heard
together and by a common order dated 30^thNovember, 2016 both the
appeals were dismissed. The appeal ITA No. 5096/Mum/2015 was dismissed on the
ground that there was no question of any consequential assessment as per the
revision order. The assessee’s appeal was rightly dismissed by the CIT(A).

Insofar as
ITA No. 4866/Mum/2015 was concerned, the same was dismissed as being
time-barred as the delay in filing the appeal was not condoned. The ITAT
observed that the assessee had clearly, and presumably only on the basis of a
legal opinion, taken a conscious decision not to appeal against the revision
order. No reasonable, much less sufficient, cause had been advanced for
condonation of delay. It also stated that there was no basis for the said bona
fide belief which is stated as the reason for the assessee having not
preferred an appeal against the revision order.

The
Hon. High Court observed that when the Tribunal had entertained the appeal
arising out of the consequential assessment, it was not justified on the part
of the Tribunal to have rejected the appeal filed by the appellant against the
order passed by the jurisdictional administrative commissioner u/s 263 of the
Act because that was the very foundation of the subsequent assessment
proceedings. Therefore, in the interest of justice the delay in filing appeal
was condoned and the said appeal was directed to be heard on merit by the
Tribunal. The appellant was directed to pay costs of Rs. 25,000 to the
Maharashtra State Legal Services Authority.

shailesh.kwebmaker

Complaint filed u/s 276C (1) of the Act – Wilful attempt to evade tax – Appeal pending before CIT(A) – Criminal proceedings kept in abeyance

3. M/s Beaver Estates Pvt.
Ltd vs. The Assistant Commissioner of Income Tax Corporate Circle 1(1);
OP(Crl.) No. 400 of 2019

Date of order: 23^rd
October, 2019

(Kerala High Court)

[Complaint filed CC No. 65/2015
of Additional Chief Judicial Magistrate (E&O), Ernakulam]

Complaint filed u/s 276C (1) of
the Act – Wilful attempt to evade tax – Appeal pending before CIT(A) – Criminal
proceedings kept in abeyance

In the instant case, the
prosecution was launched u/s 276C(1) of the Act for wilful attempt to evade tax
before the Additional Chief Judicial Magistrate’s Court (Economic Offences),
Ernakulam. The first petitioner is a company and the second petitioner is the
Managing Director of the said company.

The plea of the petitioners was
that they have filed an appeal before the statutory authority challenging the
assessment and that the decision in the appeal has got a bearing on the
prosecution against them; therefore, the criminal proceedings pending against
them may be kept in abeyance till the disposal of the appeal. The petitioners
contended that if the statutory appeal filed by them under the Act is allowed,
it would knock down the very basis of the prosecution against them and,
therefore, the criminal proceedings may be ordered to be kept in abeyance.

The Hon. Court noticed that
section 276C provides the punishment for wilful attempt to evade tax, penalty
or interest. Section 278B provides for offences by companies. In the instant
case, the prosecution is u/s 276C(1) for wilful attempt to evade tax. The
decision of the statutory appellate authority regarding the assessment and
computation of tax would have a bearing on the prosecution against the
petitioners.

The Court relied on the decision
of the Apex Court in the case of K.C. Builders vs. Assistant Commissioner
of Income Tax (2004) 2 SCC 731 wherein it held that the levy of
penalties and prosecution u/s 276C are simultaneous and, hence, once the penalties
are cancelled on the ground that there is no concealment, the quashing of
prosecution u/s 276C is automatic. In the instant case, the prosecution is u/s
276C(1) for wilful attempt to evade tax. The decision of the statutory
appellate authority regarding the assessment and computation of tax would have
a bearing on the prosecution against the petitioners.

Similarly, in Commissioner
of Income Tax vs. Bhupen Champak Lal Dalal AIR 2001 SC 1096, the Court
had observed that the prosecution in criminal law and proceedings arising under
the Act are undoubtedly independent proceedings and, therefore, there is no
impediment in law for the criminal proceedings to proceed even during the
pendency of the proceedings under the Act. However, a wholesome rule will
have to be adopted in matters of this nature where courts have taken the view
that when the conclusions arrived at by the appellate authorities have a
relevance and bearing upon the conclusions to be reached in the case,
necessarily one authority will have to await the outcome of the other
authority.

The Department relied on the
decision of the Apex Court in Sasi Enterprises vs. Assistant Commissioner
of Income Tax (2014) 5 SCC 139. The Court held that the decision in Sasi
Enterprises (Supra) has got no application to the present case because
the prosecution against the petitioners is for committing the offence u/s 276C
and not for the offence u/s 276CC.

The
Court held that the decision of the statutory appellate authority regarding the
assessment and computation of tax would have a bearing on the prosecution
against the petitioners for wilful attempt to evade tax. Therefore, the
Additional Chief Judicial Magistrate (Economic Offences), Ernakulam was
directed to keep in abeyance all further proceedings against the petitioners in
the criminal case till the disposal of the appeal filed before the Commissioner
of Income Tax (Appeals), Kochi.

shailesh.kwebmaker

Search and seizure (presumption u/s 132[4A]) – Section 132(4A) of ITA, 1961 – No addition could be made on account of undisclosed income only on basis of presumptions u/s 132(4A) without recording any findings as to how loose sheets found during search were linked to assessee – In absence of corroborative evidence, Tribunal was not justified in reversing finding of CIT(A)

18. Ajay Gupta vs. CIT

[2020] 114 taxmann.com 577 (All.)

Date of order: 13^th November, 2019

Search and seizure (presumption u/s 132[4A]) – Section 132(4A) of ITA, 1961 – No addition could be made on account of undisclosed income only on basis of presumptions u/s 132(4A) without recording any findings as to how loose sheets found during search were linked to assessee – In absence of corroborative evidence, Tribunal was not justified in reversing finding of CIT(A)

The residential premises of the assessee were searched u/s 132 of the Income-tax Act, 1961 on 28^th February, 2000. Pursuant to a notice u/s 158BC, the assessee filed return of income declaring NIL undisclosed income. The A.O. assessed the undisclosed income at Rs. 65,33,302.

The CIT (Appeals) partly allowed the appeal of the assessee. The CIT (Appeals) deleted the addition of Rs. 5,58,870 made by the A.O. on account of papers found during the search. The Tribunal reversed the order of the CIT (Appeals) and restored that of the A.O. The appeal by the assessee was admitted on the following questions of law:

‘1. Whether the presumption u/s 132(4A) of the Income-tax Act can be raised in the assessment proceedings?

2. Whether, apart from section 132(4A) of the Act, the burden to explain the documents seized from the possession of the assessee during search is upon him, and if it is so, then has he discharged the burden?’

The Allahabad High Court allowed the appeal and held as under:

‘i) It is not in dispute that two loose papers were found during search from the premises of assessee, however, during block assessment proceedings, the assessee had denied the documents and statement was recorded by Deputy Director of Investigation; he had submitted that he had no concern with the said documents so seized. Further, the A.O. while passing the assessment order, had only on basis of the loose papers found during search made addition to the undisclosed income of the assessee while the entries of said papers remained uncorroborated.

ii) This Court, in the case of CIT vs. Shadiram Ganga Prasad, 2010 UPTC 840, has held that the loose parchas found during search at the most could lead to a presumption, but the Department cannot draw inference unless the entries made in the documents so found are corroborated by evidence.

iii) As section 132(4A) of the Act provides that any books of accounts, documents, money, bullion, jewellery or other valuable articles or things found in possession of, or in control of any person in course of search may be presumed to be belonging to such person, and further, if the contents of such books of accounts and documents are true. But this presumption is not provided in absolute terms and the word used is “may” and not “shall”, as such the Revenue has to corroborate the entries made in the seized documents before presuming that transactions so entered were made by the assessee. Presumption so provided is not in absolute terms but is subject to corroborative evidence.

iv) In the present case, the Tribunal only on basis of presumption u/s 132 (4A) of the Act, reversed the finding of CIT (Appeals) without recording any finding as to how the loose sheets which were recovered during search were linked with the assessee. In the absence of corroborative evidence, the Tribunal was not justified in reversing the finding by the CIT (Appeals).

v) In view of the above, we are of the considered view that the order passed by the Tribunal reversing the finding of CIT (Appeals) in regard to deletion of the addition made of Rs. 5,58,870 and restoring the order of the A.O. on mere presumption is unsustainable. The order dated 12^th March, 2010 is set aside to that extent and the matter is remitted back to the Tribunal to decide afresh as far as addition of Rs. 5,58,870 is concerned, within a period of three months from today.’

shailesh.kwebmaker

Revision – Business loss – Allowable (as share trading) – Section 28(i) r.w.s. 263 of ITA, 1961 – Assessee company, engaged in business of financing and trading in shares – During assessment, A.O. before accepting assessee’s claim of operational loss in share trading, verified demat accounts, sale, purchase and closing stocks of assessee company and inquired about said loss – Show cause notice u/s 263 for revising assessment could not be issued on the basis that said accounts were to be examined

17. Principal CIT vs. Cartier Leaflin (P) Ltd.

[2019] 112 taxmann.com 63 (Bom.)

[2020] 268 Taxman 222 (Bom.)

Date of order: 15^th October, 2019

A.Y.: 2011-12

Revision – Business loss – Allowable (as share trading) – Section 28(i) r.w.s. 263 of ITA, 1961 – Assessee company, engaged in business of financing and trading in shares – During assessment, A.O. before accepting assessee’s claim of operational loss in share trading, verified demat accounts, sale, purchase and closing stocks of assessee company and inquired about said loss – Show cause notice u/s 263 for revising assessment could not be issued on the basis that said accounts were to be examined

The assessee was engaged in the business of financing and trading in shares. In its return of income, the assessee declared a total loss of Rs. 11.29 crores. In assessment, the A.O. made a few additions / disallowances which resulted in the assessee’s taxable income reaching Rs. 35.50 crores. Subsequently, the Principal Commissioner opined that the amount of Rs. 8.79 crores shown under ‘other operating losses’ seemed to be a trading loss incurred by the assessee company out of its business of financial and capital market activities, which was its main business activity. He opined that on perusal of the assessment records, it was noticed that no examination of the books of accounts, transaction accounts of the share trading activity carried out by the assessee company vis-a-vis the demat accounts was carried out by the A.O. and that the entire operating loss as mentioned was accepted without any verification or proper application of mind. He, thus, held that the assessment order passed by the A.O. appeared to be erroneous and prejudicial to the interest of Revenue. Notice u/s 263 of the Income-tax Act, 1961 was issued by the Principal Commissioner.

On the assessee’s appeal, the Tribunal noted that from the records available it was evident that complete details in support of the claim of operating loss of Rs. 8.79 crores were made available by the assessee company to the A.O. In fact, the manner in which the operating loss was arrived at was submitted in a tabulated form along with item-wise details of all transactions during the assessment proceedings. Thus, the Tribunal concluded that the show cause notice u/s 263 by the Principal Commissioner was issued without examining the assessment records and the view taken by the A.O. after examination of exhaustive details and evidence was a possible view. The Tribunal held that the notice u/s 263 is not valid.

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

‘i) The finding of fact in the order of the Tribunal is that the proceedings u/s 263, on the face of it, have been initiated without examination of records before the A.O. is not shown to be perverse. It is clear that the show cause notice proceeds on the basis that the books of accounts, transaction accounts of share trading carried out by the assessee vis-a-vis demat accounts have not been examined by the A.O. during the course of assessment proceedings. However, in the assessment order dated 28^th March, 2014 itself, the A.O. had recorded that he examined the demat account in order to verify the share trading activities claimed by the assessee. Moreover, before passing the assessment order, sale, purchase and closing stocks were also examined by the A.O.

ii) Thus, the basis to invoke section 263 factually did not exist as there was due inquiry by the A.O. during the assessment proceedings leading to the assessment order. Thus, it is amply clear that the A.O. had applied his mind while accepting the claim of the assessee of operating loss of Rs. 8.79 crores making the proceedings u/s 263 bad in law. In any event, the view taken on facts by the A.O. is a possible view and the same is not shown to be bad.

iii) In the above view, the question as proposed does not give rise to any substantial question of law. Thus, not entertained. And appeal is, therefore, dismissed.’

shailesh.kwebmaker

I – Section 115JB – Provision for leave encashment is not to be added back to the book profit for computation u/s 115JB as it is an ascertained liability determined on actuarial basis II – Provision for wealth tax was not to be reduced from book profit to be computed u/s 115JB

6. [2020] 114 taxmann.com 538 (Mum.)(Trib.)

Caprihans India Ltd. vs. DCIT

ITA No. 4252/Mum/2011

A.Y.: 2005-06

Date of order: 23^rd December, 2019

I – Section 115JB – Provision for leave encashment is not to
be added back to the book profit for computation u/s 115JB as it is an
ascertained liability determined on actuarial basis

II – Provision for wealth tax was not to be reduced from
book profit to be computed u/s 115JB

FACTS I

While assessing the total income of the assessee u/s 153C
r.w.s. 143(3) of the Act, the A.O. for the purpose of computing book profits
added the amount of provision for leave encashment of Rs. 15,30,070 on the
ground that it was an unascertained liability. He held that the liabilities
pertaining to leave encashment were not ascertained by the end of the financial
year, therefore the assessee had made a provision for the same.

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

The assessee then preferred an appeal to the Tribunal where,
relying on the ratio of the decision of the Punjab & Haryana High
Court in the case of CIT vs. National Hydro Electric Power Corporation
Ltd. [2010] 45 DTR 117 (P&H) it was contended that the provision
for leave encashment was made in the books on actuarial basis, therefore the
same could not be held to be in the nature of a provision for an unascertained
liability.

HELD I

The Tribunal held that if a business liability had definitely
arisen in the accounting year, the deduction should be allowed although the
liability may have to be quantified and discharged at a future date.

It observed that this view is fortified by the judgment of
the Hon’ble Supreme Court in the case of Bharat Earth Movers vs. CIT
[2000] 245 ITR 428 (SC). In the said case, it was observed by the
Hon’ble Apex Court that what should be certain is the incurring of the
liability and the fact that the same is capable of being estimated with
reasonable certainty, although the actual quantification may not be possible.
The Apex Court had observed that the provision for meeting the liability for
encashment of earned leave by the employees is not a contingent liability and
is admissible as a deduction.

In view of the above, the Tribunal held that as the provision
for leave encashment had been made by the assessee on actuarial basis,
therefore the same being in the nature of an ascertained liability could not
have been added by the A.O. for the purpose of determining the ‘book profit’
u/s 115JB. This ground of appeal of the assessee was allowed.

FACTS II

The assessee, while computing the ‘book profit’ u/s 115JB had
added back the amount of the wealth tax provision. On appeal, the assessee by
way of a specific ground had assailed the addition of the provision for wealth
tax while computing the ‘book profit’ u/s 115JB. However, the CIT(A) declined
to accept the aforesaid claim. Observing that the said provision was covered
u/s 115JB, the CIT(A) had upheld the view taken by the A.O.

Aggrieved, the assessee preferred an appeal to the Tribunal
where it was contended that as the provision for wealth tax does not fall
within any of the items of the ‘Explanation’ to section 115JB, the same could
not be added back while computing the ‘book profit’ under the said statutory
provision. In support of the aforesaid contention, reliance was placed on the
order of the ITAT, Kolkata, Special Bench in the case of JCIT vs. Usha
Martin Industries Ltd. [2007] 104 ITD 249 (SB).

HELD II

The Tribunal observed that an addition to the
‘book profit’ which during the period relevant to the year under consideration
was computed as per Part II of Schedule VI of the Companies Act, 1956 could be
made only if the same was permissible as per Item No. (a) to (k)
of the Explanation to section 115JB. As contemplated in clause (a) of
the ‘Explanation’ to this section, ‘the amount of Income-tax paid or payable,
and the provision therefor’ was liable to be added for computing the ‘book
profit’ u/s 115JB. However, as there was no such provision for making the
addition with regard to wealth tax, the A.O. could not have added the same for
computing the ‘book profit’ of the assessee company u/s 115JB. It observed that
its view is fortified by the order of the ITAT, Kolkata, Special Bench in the
case of JCIT vs. Usha Martin Industries Ltd. [2007] 104 ITD 249 (SB).
The Tribunal directed the A.O. to rework the ‘book profit’ u/s 115JB after
deleting the provision for wealth tax. This ground of appeal of the assessee
was allowed.

shailesh.kwebmaker

Return of income – Filing of, in electronic form (set-off and carry-forward of losses) – Section 139D r.w.s. 72 of ITA, 1961 and Rule 12 of ITR, 1962 – Procedure of filing electronic return as per section 139D r.w. Rule 12 cannot bar assessee from making claim which he was entitled to – Assessee was directed to make representation before CBDT where he was not able to reflect set-off available in terms of section 72 in prescribed return of income in electronic form

16. Samir Narain Bhojwani
vs. Dy.CIT

[2020] 115 taxmann.com 70
(Bom.)

Date of order: 22^nd
October, 2019

A.Y.: 2019-20

Return of income – Filing of, in
electronic form (set-off and carry-forward of losses) – Section 139D r.w.s. 72
of ITA, 1961 and Rule 12 of ITR, 1962 – Procedure of filing electronic return
as per section 139D r.w. Rule 12 cannot bar assessee from making claim which he
was entitled to – Assessee was directed to make representation before CBDT
where he was not able to reflect set-off available in terms of section 72 in
prescribed return of income in electronic form

The assessee was obliged u/s 139D
of the Income-tax Act, 1961 read with Rule 12 of the Income-tax Rules, 1962 to
file his return of income electronically with his digital signature. However,
he was not able to reflect in the prescribed return of income in electronic
form the set-off available in terms of section 72, i.e., setting off of current
year’s business income against the carry-forward loss from the earlier years.
This was because the return which was filed electronically required certain
columns to be filled in by the petitioner while the other columns were
self-populated. The assessee was thus unable to change the figures and make a
claim for set-off u/s 72 in the present facts. This resulted in excess income
being declared, resulting in an obligation to pay more tax on income which in
terms of section 72 was allowed to be set off against carried-forward losses of
earlier years.

Therefore, the assessee filed a
writ petition under Article 226 of the Constitution of India and sought a
direction from the High Court to the Respondent No. 1, the A.O., and Respondent
No. 2, the CBDT, to accept the petitioner’s return of income for A.Y. 2019-20
in paper form u/s 139(1) of the Act and the same be taken up for assessment in
accordance with the Act.

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

‘i) The claim sought to be urged by the assessee,
viz., set-off of business profits of this year offered to tax under the head
“capital gain” being set off against carried-forward loss is prima facie
supported by the decisions of the Tribunal in the case of M.K. Creations
vs. ITO [IT Appeal No. 3885 (Mum.) of 2014, dated 7^th April, 2017]
and in ITO vs. Smart Sensors & Transducers Ltd. [2019] 104 taxmann.com
129/176 ITD 104 (Mum.–Trib.). It is also not disputed by the Revenue
that the return of income in electronic form is self–populated, i.e., on
filling in some entries, the other entries in the return are indicated by the
system itself. Thus, the petitioner is unable to make a claim which according
to him he is entitled to in law. In case the petitioner is compelled to file in
the prescribed electronic form, it could be declared by the A.O. as defective
(if all entries are not filled), or raise a demand for tax on the basis of the
declared income u/s 143(1), or if the assessment is taken to scrutiny u/s
143(3), then the petitioner will not be entitled to raise a claim of set-off
u/s 72 during the assessment proceedings. This, in view of the decision of the
Hon’ble Supreme Court in the case of Goetze (India) Ltd. vs. CIT [2006]
157 Taxman 1/284 ITR 323 wherein it has been held that if a claim is
not made by the assessee in its return of income, then the A.O. would have no
power to entertain a claim otherwise than by way of revised return of income.
The revised return of income, if the petitioner attempts to file it, would
result in the petitioner not being able to make the claim for which the revised
return is filed as the revised return of income would also have to be filed in
the prescribed electronic form which does not provide for such an eventuality.
Thus, for the purposes of the subject assessment year if the return of income
is filed electronically, it (the assessee) would have given up, at least before
the A.O., his claim to benefit of section 72; this, whether the return of
income is processed u/s 143(1) or undergoes scrutiny u/s 143(3).

ii) The purpose and object of e-filing of return is simplicity and
uniformity in procedure. However, the above object cannot in its implementation
result in an assessee not being entitled to make a claim of set-off which he
feels he is entitled to in accordance with the provisions of the Act. The
allowability or disallowability of the claim is a subject matter to be
considered by the A.O. However, the procedure of filing the return of income
cannot bar an assessee from making a claim under the Act to which he feels he
is entitled.

iii) It is true that in terms of Rule 12 of the Rules the returns are
to be filed by the petitioner only electronically and he is bound by the Act
and the Rules, thus (the Department) cannot accept the paper return. However,
in terms of section 139D, it is for the CBDT to make rules providing for filing
of returns of income in electronic form. This power has been exercised by the
CBDT in terms of Rule 12 of the Rules. However, the form as prescribed does not
provide for (the) eventuality that has arisen in the present case and may also
arise in other cases. Thus, this is an issue to be brought to the notice of the
CBDT, which would in case it finds merit in this submission, issue necessary
directions to cover this gap.

iv) In the normal course, the petitioner would have been directed to
file representation with the CBDT making a demand for justice, before
considering issuing of a writ of mandamus. However, in the peculiar
facts of this case, the petitioner is required to file return of income by 31^stOctober, 2019. It is only when the petitioner was in the process of
filing his return electronically that he realised that he is unable to make a
claim of set-off u/s 72, even though the claim itself is prima facie
allowable in view of the decisions of the Tribunal in M.K. Creation
(Supra) and Smart Sensors & Transducers Ltd. (Supra). In the
absence of the petitioner filing its return of income on or before 31^st
October, 2019, the petitioner is likely to face penal consequences. The issue
raised is a fundamental issue, which needs to be addressed by the CBDT.

v) Therefore, it would be appropriate that the petitioner make a
representation on the above issue to the CBDT, who would then consider it in
the context of the facts involved in the instant case and issue necessary
guidelines for the benefit of the entire body of assessees if the petitioner is
right in his claim that the prescribed return of income to be filed
electronically prohibits an assessee from making its claim. However, in the
meantime, the petitioner, without prejudice to his rights and contentions, would
file the return of income in electronic form on the system before the last
date. Besides, (he would) also file his return of income for the subject
assessment year in paper form with the A.O. before the last date. This return
of income in paper form would be accepted by the A.O. without prejudice to the
Revenue’s contention that such a return cannot be filed.

vi) In the meantime, till such time as the
CBDT takes a decision on the petitioner’s representation, the Revenue would not
act upon the electronically filed return of income so as to initiate any
coercive recovery proceedings.’

shailesh.kwebmaker

Recovery of tax – Stay of demand pending first appeal – Section 220(6) of ITA, 1961 and CBDT Circular No. 530 dated 6th March, 1989 – The Circular stating that a stay of demand be granted if there are conflicting views of High Court can be extended to conflicting views of different Benches of Tribunal as well

15. General Insurance
Corporation of India vs. ACIT

[2019] 111 taxmann.com 412
(Bom.)

[2019] 267 Taxman 596 (Bom.)

Date of order: 14^th
October, 2019

A.Y.: 2017-18

Recovery of tax – Stay of demand
pending first appeal – Section 220(6) of ITA, 1961 and CBDT Circular No. 530
dated 6^th March, 1989 – The Circular stating that a stay of demand
be granted if there are conflicting views of High Court can be extended to
conflicting views of different Benches of Tribunal as well

For the A.Y. 2017-18, the
assessee filed an appeal against the assessment order. The assessee also filed
an application for stay of demand u/s 220(6) of the Income-tax Act, 1961. The
assessee was directed to deposit 20% of tax demand during pendency of appellate
proceedings.

The assessee filed a writ
petition challenging the order and claimed that the assessee is entitled to
unconditional stay till disposal of appellate proceedings in view of the fact
that there were conflicting decisions of co-ordinate Benches of the Tribunal so
far as the merit of the assessee’s case was concerned. The Bombay High Court
allowed the writ petition and held as under:

‘i) The CBDT Circular No. 530 dated 6th March, 1989 states that stay
of demand be granted where there are conflicting decisions of the High Court.
This principle can be extended to the conflicting decisions of the different
Benches of the Tribunal. Thus, in the above facts a complete stay of the demand
on the above head, i.e., Item No. 1 of the above chart, was warranted in the
petitioner’s favour.

ii) Therefore, unconditional stay was to be granted to assessee till
disposal of appellate proceedings.’

shailesh.kwebmaker

Reassessment – Sections 147, 148 and 151 of ITA, 1961 – Where A.O. issued reassessment notice on basis of sanction granted by Chief Commissioner – Since Chief Commissioner was not specified officer u/s 151(2) to grant such sanction, impugned notice was to be quashed

14. Miranda Tools (P) Ltd.
vs. ITO

[2020] 114 taxmann.com 584
(Bom.)

Date of order: 14^th
November, 2019

A.Y.: 2014-15

Reassessment – Sections 147, 148
and 151 of ITA, 1961 – Where A.O. issued reassessment notice on basis of
sanction granted by Chief Commissioner – Since Chief Commissioner was not
specified officer u/s 151(2) to grant such sanction, impugned notice was to be
quashed

The petitioner is a company
engaged in the business of manufacture and marketing of fabrics. The petitioner
filed its return of income for the A.Y. 2014-15 on 22^nd September,
2014 declaring NIL income. The assessment was completed u/s 143(3) of the
Income-tax Act, 1961 by an order dated 1^st September, 2016.
Thereafter, on 26^th February, 2019, the A.O. issued a notice u/s 148
of the Act on the ground that he has reason to believe that the income
chargeable to tax in respect of share application money for the relevant
assessment year has escaped assessment. The petitioner submitted its
objections. The A.O. rejected the objections.

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

‘i) As per the provisions of section 151(2) of the Act, a sanction to
issue notice for reopening u/s 148 of the Act has to be given by the Joint
Commissioner of Income Tax in case the reassessment is sought to be done before
(or within) four years. Under section 2(28C) of the Act, a Joint
Commissioner also means Additional Commissioner of Income Tax. In the present
case, the A.O. submitted a proposal to the Principal Chief Commissioner of Income
Tax for reopening the assessment u/s 148 on 6^th February, 2019.

ii) The question arises whether the sanction granted by the Chief
Commissioner of Income Tax would fulfil the requirement of section 151. It has
long been settled that when the statute mandates the satisfaction of a
particular authority for the exercise of power, then it has to be done in that
manner only. Adopting this principle, the Division Benches of this Court in the
cases of Ghanshyam K. Khabrani vs. Asstt. CIT [2012] 20 taxmann.com
716/210 Taxman 75 (Mag.)/346 ITR 443 and CIT vs. Aquatic Remedies
(P) Ltd. [2018] 96 taxmann.com 609/258 Taxman 357/406 ITR 545 have held
that sanction for issuance of reopening notice has to be obtained from the
authority mentioned in section 151 and not from any other officer, including a
superior officer. In the present case the Chief Commissioner of Income tax is
not the officer specified in section 151 of the Act. There is thus a breach of
requirement of section 151(2) of the Act regarding sanction for issuance of
notice u/s 148 of the Act. Consequently, the impugned notice and the impugned
order cannot be sustained in law. The petitioner, therefore, is entitled to
succeed.

iii) Accordingly, the impugned notice dated
26^th February, 2019 and the impugned order dated 15^th
July, 2019 are quashed and set aside.’

shailesh.kwebmaker

Charitable or religious trust – Registration procedure (Deemed registration) – Sections 12AA and 13 of ITA, 1961 – Where Commissioner (Exemption) did not decide application u/s 12AA within six months from date on which matter was remitted by Tribunal, registration u/s 12AA(2) would be deemed to be granted to assessee society; A.Ys.: 2010-11 to 2014-15

24. CIT(E) vs. Gettwell Health and Education Samiti [2020] 115 taxmann.com 66 (Raj.) Date of order: 15^th March, 2019 A.Ys.: 2010-11 to 2014-15

Charitable
or religious trust – Registration procedure (Deemed registration) – Sections
12AA and 13 of ITA, 1961 – Where Commissioner (Exemption) did not decide
application u/s 12AA within six months from date on which matter was remitted
by Tribunal, registration u/s 12AA(2) would be deemed to be granted to assessee
society; A.Ys.: 2010-11 to 2014-15

The assessee
is a society registered under the Rajasthan Societies Registration Act, 1958 vide
registration certificate dated 3^rd January, 2008. Its main object is
to provide medical facilities in the State of Rajasthan. The assessee is
running a hospital at Sikar in the name of Gettwell Hospital & Research
Centre. The assessee filed an application in Form 10A seeking registration u/s
12AA of the Income-tax Act, 1961 on 19^th January, 2010. The
Commissioner of Income Tax (Exemptions) [‘the CIT(E)’] rejected that
application by an order dated 23^rd July, 2010. By an order dated 22^nd
July, 2011, the Tribunal set aside the order dated 23^rd July, 2010
and remanded the matter back to the CIT(E) on the ground that it had not
communicated the A.O.’s report to the assessee and therefore restored the issue
of registration back on the file of the CIT(E) with a direction that the
assessee should be given an opportunity before deciding the issue of
registration and should be confronted with all the materials which are
considered adverse to the assessee. After remand of the matter, the CIT(E)
passed a fresh order on 9^th October, 2015 and rejected the
application of the assessee, holding that the assessee was running the hospital
for the benefit of the family members of Shri B.L. Ranwa and there was no
charity in it.

The Tribunal allowed the assessee’s appeal.

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

‘i) The Tribunal also noted that once the matter
was remanded back to the CIT(E) then the limitation for passing the order /
decision cannot be more than the limitation provided for deciding the
application u/s 12AA of the Act. There is no dispute that as per the provisions
of section 12AA(2) of the Act the limitation for granting or refusing the
registration is prescribed as before the expiry of six months from the end of
the month in which the application was received. Relying on the judgment of the
Supreme Court in CIT vs. Society for the Promotion of Education [2016] 67 taxmann.com 264/238
Taxman 330/382 ITR 6 which upheld the judgment of the Allahabad High
Court and judgment of this Court in CIT vs. Sahitya Sadawart Samiti
[2017] 88 taxmann.com 703/396 ITR 46 (Raj.), the Tribunal held that
once the limitation prescribed u/s 12AA of the Act expired and the
consequential default on the part of the CIT(E) in deciding the application,
would result in deemed grant of registration is a settled proposition.

ii) Therefore, it has been held
by the Tribunal that the judgment of the CIT(E) is reversed on merits and
registration would stand granted to the assessee by prescription of law made in
section 12AA(2) of the Act. The Tribunal in this behalf relied on the judgment
of the Lucknow Bench of the Tribunal in Harshit Foundation vs. CIT [2013]
38 taxmann.com 309/60 SOT 147 (URO) in which case it was held that
where the Commissioner does not pass any order even after six months from the
receipt of the Tribunal’s order remitting the matter to him, the registration
will be deemed to have been granted.

iii) This is subject to exercise
of the Commissioner’s power u/s 12AA(3) of the Act in appropriate cases.

iv) In view of the above, we
hardly find any justification in admitting this appeal as in our considered
view it does not raise any question of law, much less substantial question of
law. The appeal is therefore dismissed.’

shailesh.kwebmaker

Charitable purpose – Section 2(15) r/w sub-sections 11, 12 and 13 of ITA, 1961 – Where India Habitat Centre, inter alia set up with primary aim and objective to promote habitat concept, was registered as a charitable trust, principle of mutuality for computation of its income was not required to be gone into as income was to be computed as per sections 11, 12 and 13; A.Y.: 2012-13

23. CIT (Exemption) vs. India Habitat Centre [2020] 114 taxmann.com 84 (Del.) Date of order: 27^th November, 2019 A.Y.: 2012-13

Charitable purpose – Section 2(15) r/w sub-sections 11, 12 and 13 of
ITA, 1961 – Where India Habitat Centre, inter alia set up with primary
aim and objective to promote habitat concept, was registered as a charitable
trust, principle of mutuality for computation of its income was not required to
be gone into as income was to be computed as per sections 11, 12 and 13; A.Y.:
2012-13

For the A.Y.
2012-13, the assessee filed its return of income on 28^th September,
2012 in the status of ‘Trust’, declaring ‘Nil income’. Its assessment was
framed u/s 143 (3) of the Income-tax Act, 1961, computing total income as Rs.
5,86,85,490 and holding that the activities of the assessee are hybrid in
nature; they were partly covered by provisions of section 11 read with section
2(15), and partly by the principle of mutuality. It was held by the A.O. that
since the assessee is not maintaining separate books of accounts, income cannot
be bifurcated under the principle of mutuality or otherwise. The entire surplus
in I&E account, amounting to Rs. 5,83,92,860, was treated as taxable income
of the assessee.

The CIT(Appeals) allowed the appeal of the assessee by relying upon the
judgment of the Delhi High Court in the assessee’s own case dated 12^th
October, 2011 for A.Ys. 1988-89 to 2006-07 and the decision of the Hon’ble
Supreme Court in the case of Radha Soami Satsang vs. CIT [1992] 193 ITR
321/60 Taxman 248. The Tribunal confirmed the decision of the
CIT(Appeals).

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

‘i) The fundamental question is
that if the assessee has taken the plea of mutuality, whether it could be
deprived of the benefit of section 2(15) of the Act. On this aspect, the A.O.
has proceeded to classify the assessee’s activities as ?hybrid”, holding that
part of the activities are covered by provisions of section 11 r/w section
2(15) and part by principle of mutuality. The CIT(A), after examining the records,
has given a categorical finding that the activities of the centre fall within
the meaning of the definition of ?charitable activities” as provided u/s 2(15)
of the Act.

ii) Applying the test of profit motive, it was
held that the surpluses generated by the assessee are not being appropriated by
any individual or group of individuals. Merely because the assessee is charging
for certain goods and services it does not render such activities as commercial
activities, and the fact that the A.O. has accepted that the assessee is
promoting public interest as provided in the proviso to section 2(15),
there cannot be any doubt that the assessee should be regarded as a charitable
organisation and given the full benefit of exemption provided to such
organisations under the Act. Relying on this premise, it has been held that
since the assessee has not generated any surpluses from anyone, members or
non-members, it was not correct to say that the assessee has claimed relief
partly as charitable organisation and partly as mutual association.

iii) Further, it was rightly
held that the principle of mutuality becomes superfluous in view of the fact
that the activities were held to be charitable. Applying the principle of
consistency, the CIT(A) held that there is no fundamental change in the nature of
activities of the assessee for the period prior to A.Y. 2008-09 and subsequent
years. The ITAT has confirmed the findings of the CIT(A). Though the principles
of res judicata are not applicable to the income tax proceedings,
however, at the same time, one cannot ignore the fact that there is no dispute
with respect to the consistency in the nature of activities of the assessee.
All the income tax authorities have held that the assessee is a charitable
institution and this consistent finding of fact entitles the assessee to have
its income computed under sections 11, 12 and 13 of the Act.

iv) In this background, we find
no ground to disentitle the assessee to the benefits of section 2(15) of the
Act. This being the position, we find no perversity in the impugned decision
and, therefore, no question of law, much less substantial question of law,
arises for consideration. As a result, the appeal of the Revenue is dismissed.’

shailesh.kwebmaker

COVID-19 AND THE RESHAPING OF THE GLOBAL GEOPOLITICAL ORDER

Geopolitics has been historically
shaped by multiple events in history. Wars, conflicts and occasionally
haphazard events have changed how nations have achieved and lost power on the
international stage. The international system after the Cold War ended has been
characteristically driven by the United States-led global order. The Western
institutions, collectively known as the Bretton Woods system, have been major
institutions shaping the global financial order. In the dying stages of the
Cold War, China’s rise was seldom seen as that of the next big global power fit
enough to challenge the US presence in Asia. The post-Cold War era also saw the
formation and development of the European Union. The diffusion of power and
geopolitics from central power to multiple regional power centres led to the
formation of the multipolar regional order.

Frictions between countries were
commonplace in Asia; an ascendant China was not only challenged by US presence
in the region, but also by the rise of India throughout the 2000s. However,
since the mid-2000’s, the rise of China and the debate on the uneasy decline of
US power in Asia has displayed itself in multiple events and forums across the
region, often with countries such as India and groupings like ASEAN having to
pay the price for choosing sides. The recent episode involving a trade war
between the US and China over supremacy in the technological space exposed the
limits of the structure and tipping points between both the countries in the
region. Eventually, the end of this war was followed by COVID-19, a ‘Black
Swan’ event which has had a huge impact on the global economy and geopolitics.

‘Black Swan’ events are an extremely
negative event or occurrence that is impossibly difficult to predict. In other
words, such events are both unexpected and unpredictable. As the world deals
with the COVID-19 pandemic which has seen 15,361 deaths till 23^rd
March, 2020, reports have indicated faults at multiple levels in controlling
the issue at the right time. While China’s suppression of the information has
surfaced in recent understanding, the drop in its consumption levels has
severely impacted the global economy. Businesses have been clearly hit. Major
among them have been aviation and tourism. The drop in travel and bans on
flights have impacted the two industries, leading to a complete shutdown of
some sectors within these areas. Major global airlines have cut anywhere
between 80 to 90% of their capacity on the backs of travel bans and the lack of
passengers as a result thereof. Some economies reliant on tourism have been
badly hit.

Nevertheless, crisis times call for
astute diplomacy and capitalisation of the issues at hand. Several issues could
be noticed on how states handled the crisis and their response, and how global
markets and the uncertainty were taken advantage of by a few countries. While
China reached the peak of the crisis, global markets had started to respond by
closing down to the outside world systemically. Crashing markets and impacted
supply chains followed by reduced demands were indicative of the coming crisis.
One of the key impacts of the slowing economy was felt in the oil markets. The
reduced demand from China and the rest of the world has led to tumbling prices.
The OPEC, which coordinates and sets global oil prices, fell out with Russia.
This fallout between Russia and Saudi Arabia has sent oil prices crashing,
leading to historical lows, possibly benefiting bigger global consumers.

Japan, which had been continually
struggling to keep its economy afloat, reported one of the slowest growth rates
in many years due to domestic policies. Just staying above the line going into
recession, due to the slowdown caused by the virus, Japan may very well be
heading into an economic crisis. Recent discussions also highlight that Japan
would most likely be postponing the Summer Olympics which could have provided a
great boost to its economy.

Similarly, some other countries have
not failed to showcase their power through diplomacy. India, which has till now
done some of the most extensive relief operations in all affected regions by
bringing back stranded citizens, has also extended its hand to the South Asian
region which has fallen apart after the failure of the South Asian Association
for Regional Co-operation (SAARC); the joint effort call was heeded by all
(except Pakistan). Similarly, India also lifted the ban on the export of all
kinds of personal protection equipment, including masks, and cleared some
consignments of medical gear placed by China, a move seen as a goodwill
gesture; such diplomatic signalling is seen positively as an extending reach in
times of crisis. India’s ability to get back its citizens from Wuhan is also a
demonstration of this extended positive reach.

In the global sense, as the crisis’s
epicentre moves to Europe where the death toll has now overtaken that of China,
and the United States’ healthcare system has showcased its total unpreparedness
to tackle this epidemic, China’s reviving supply lines will surely find a
future market to sell its goods. India, with its developed pharmaceutical
sector, should capitalise on this situation. However, the US lobbies which are
averse to generic substitutes have always scuttled any ideas for the lucrative
markets. China’s companies, including its retail giant Alibaba, have already
started to send across protective medical supplies to all South Asian countries
(excluding India) as well as some countries in Africa. The inability to rely on
existing Western donor systems which have been increasingly challenged by China
since the last decade, may turn out to be a silver lining for China.

The
future of the global order remains uncertain; the COVID-19 crisis has struck at
a time when leaderships have been challenged domestically all over the world.
While the United States is in election season, China’s vulnerability to a
crisis has put a question mark on the strengthening of the power base of
President Xi Jinping within China and that of its ruling Communist Party.
However, India’s handling of the situation has helped quell some negativity for
now about the ongoing domestic issues in the country. Nevertheless, once the
dust settles, the gravest impact would be felt in Europe. As the region was
already battling a refugee crisis, deaths relating to Coronavirus would add a
burden on the regional economies. The inability to rebuild from the economic
impact would invariably shift the burden on the emerging powers within the
grouping, forcing an already delicate line in the grouping; the region’s
economic engine Germany has already recorded no growth in the coming year. The
negative growth rate and the developing internal political crisis within the
country do not hold a positive outlook.

In the second half of 2020, the geopolitical
shifts will be visible through geo-economics outlays. China, which was first in
and is now first out, will continue to rebuild from the economic shocks. It is
bound to benefit most from the post-crisis scenario as the virus spread will
keep it from exhausting its options in supplying the growing needs during the
crisis and its aftermath. India’s chances to plug into this geopolitical
reordering will be crucial. The uncertain political and economic reach of the West
could well make it use a resilient India to assert itself to balance China in
Asia; nevertheless, India will have to once again resort to its delicate
balancing game between the US and China, at the same time being careful not to
tip the scales too much to still be able to plug itself into a reviving Asian
economy.

shailesh.kwebmaker

HOUSEKEEPING FOR BHUDEVI

Nandurbar is one of Maharashtra’s
smaller districts by area (5,955 sq. km.) and its forest cover, according to
the India State of Forest Report, 2019, is just over 20% of its area; which
means that about 1,196 sq. km. of Nandurbar is forest. Far away from Nandurbar
is the district of Kokrajhar in Assam, which has about 1,166 sq. km. of forest
covering a smaller total area (3,296 sq. km.).

For all those who prefer seeing the
wood for the trees, the more forest a district has, the happier it must be.
There are a host of reasons why this is so and many of these reasons have to do
with the idea of ‘environment’, both as the presence of and manifestation of
what in English is called ‘nature’, and also as the provision of many of the
basic materials that are central to our lives.

Our Indic conception transcends
‘environment’ entirely, for our tradition regards the earth as Bhudevi,
whose consort Vishnu incarnates from age to age to rid her of the
accumulation of demonic forces. He does this out of love for the earth and its
inhabitants.

As guardians and practitioners of
this tradition, those who live close to and within the forest tracts of
Nandurbar and Kokrajhar would be the ideal persons to inform us about the worth
and value of the forest to their lives. To even the partially observant
traveller, India’s tribal and rural societies – wondrously variegated though
their individual cultures may be – take much of their identity from the forest
and from nature.

The forest supplies them with
firewood and timber for construction, it is home to the animal and bird prey
they seek for their cooking pots; the forest contains the medicinal plants and
herbs that indigenous and local medicinal traditions depend upon; fruits are
plentiful, cattle are watchfully allowed into the forest to seek the remedies
they are preternaturally aware of; and the forest is home to the wild relatives
of the grasses we call cereals and to the great majority of our vegetables.

If we compare this list of what the
forest supplies its residents with with another list, that of what contemporary
industrial society supplies its residents with, then there is no contest about
which list is the longer one. However, the most elementary materials on both
lists are none too different from each other. What is different is that the
non-forest list supplies each and every one of its items for a fee.

That fee embodies several important
concepts. There is extraction or collection of the primary material (wood, for
example, in the form of whole, uncut logs), movement of the primary material to
a place where some initial transformation to it can take place (such as a saw
mill), movement of the transformed material to a consumption centre (such as a
town or city), further transformation (sections for door and window frames, for
furniture, shaping into ordinary household goods, shaping into crafts items and
curios), final purchase and use in a wholesale or retail transaction.

These concepts communicate with us
in today’s world not as the transformation of a material, not as a reminder of
the origin of a material, but through a number we call the cost that is
connected to either the extraction of a material, the transformation of a
material, or the marketing of a transformed material to its final consumers.

These costs, whether considered once
depending upon where, in this chain of transformation, you stand, or whether
considered two or three times by those tasked with analysing an industry based
on a primary material, satisfy the current frameworks we employ to describe how
value is understood, multiplied and given economic substance. But they are
utterly unable to convey other kinds of valuing, especially the kind that the
tribal societies of Nandurbar and Kokrajhar use when they regard primary
material from their forests.

What are these other kinds of value?
From the point of view of the holders of knowledge about the primary material
in all its aspects, values associated with the forest in their living vicinity
are cultural, social, spiritual and pertain to health and well-being. Their
knowledge relates not to the market worth of a cubic metre of wood and how much
price value can be added to that block of wood by transforming it into a
contemporarily styled cabinet, or an objet d’art. Their knowledge
relates to the numerous physical conditions that need to be maintained and
balanced so that trees in the forest, just as much as the forest’s flora and
non-human residents, continue to be nourished.

The manner in which our system of
national accounts is framed, there is no scope whatsoever for knowledge of this
kind to be recognised, let alone to be valued even if imperfectly. Yet it is
becoming clearer with every passing year that such a valuation is needed. The
clarity comes because several biophysical and geophysical changes are becoming
more intense.

There is the diminishing of
biodiversity, which means fewer species than before. There is the expansion of
the human settlement footprint, which encroaches on nature’s territory, and in
doing so alters natural rhythms (such as when a wetland is filled in to become
a city suburb). There are the effects of climate change and variation, which
affect crop cycles as much as coastal towns or snowfields.

The science that monitors these
changes has led to some sophisticated models being created which, in turn, lead
to estimates of risk (and the corollary, prescriptions for the mitigation of
risk) and therefore estimates of the costs of not acting to reduce risk. This
is where cost sets that can apply to the bewildering complexity of our natural
world make their appearance. A domain dedicated to this nascent art has been
named, too: it’s environmental-economic accounting.

India’s official statisticians have considered
how to ‘cost’ (or ‘price’) nature since the mid-1990s, when experimental
accounts which included ‘nature’s value’ were drawn up for a few states. The
activity has languished at that level since. Had they looked at our wisdom,
they may well have found inspiration, for the Shiva Purana explained to
us that during Kaliyuga, our present age, one of the many signs of
growing chaos is that the merchant class ‘have abandoned holy rites such as
digging wells and tanks, and planting trees and parks’ (II.1.24).

Now, however, India’s obligations to
the large number of multilateral treaties and agreements which have to do with
environment and biodiversity broadly, as well as the effects of climate change,
and moreover to the United Nations Sustainable Development Goals, are running
into the inherent limitations of the system of national accounts that, so far,
excludes nature and knowledge systems associated with nature.

The accounting fraternity in our
country possesses experience and wisdom aplenty, for they know the daily pulse
of a huge and astonishingly variegated economic web. As our companies and
industries learn to lighten the environmental footprint of all their
activities, their need to adopt methods to measure, cost, assess and plan for
the environmental consequences of those activities will only increase.

Yet
it is not for us to adopt, in the name of standardisation, an ‘international’
method that values nature. Rather, what is called for is an Indic
conceptualisation of nature which suits our civilisational economic trajectory
and which is rooted in our scriptures. ‘Heaven is my father; my mother is this
vast earth, my close kin,’ says the Rig Veda (1.164.33).

By taking up such a challenge –
conceiving and imparting a new accounting literacy that sensitively interprets
the wisdom of our rishis and sants to temper the demands of our
era – the accounting fraternity will contribute considerably to renewing our
homage to Bhudeví.

(The author, Rahul Goswami, lives in Goa and is
the Unesco-Asia expert on intangible cultural heritage)

shailesh.kwebmaker

Sections 144C(1), 143(3) – For the period prior to 1st April, 2020 in case of an eligible assessee, draft assessment order u/s 143(3) r.w.s. 144C(1) is not required to be passed in cases in which no variation in returned income or loss is proposed Mere issuance of draft assessment order, when it was legally not required to be issued, cannot end up enhancing the time limit for completing the assessment u/s 143(3)

2. [2020]
115 taxmann.com 78 (Mum.)

IPF India Property Cyprus (No. 1) Ltd. vs. DCIT

ITA No. 6077/Mum/2018

A.Y.: 2014-15

Date of order: 25^th February, 2020

Sections 144C(1), 143(3) – For the period prior to 1^stApril,
2020 in case of an eligible assessee, draft assessment order u/s 143(3) r.w.s.
144C(1) is not required to be passed in cases in which no variation in returned
income or loss is proposed

Mere issuance of draft assessment order, when it was legally
not required to be issued, cannot end up enhancing the time limit for
completing the assessment u/s 143(3)

FACTS

The A.O., for A.Y. 2014-15, passed a draft assessment order
u/s 143(3) r.w.s. 144C(1) even when no variation was proposed therein to the
income or loss returned by the assessee.

The assessee challenged the correctness of the DRP’s order
dated 26^th July, 2018 in the matter of assessment u/s 144(C)(1)
r.w.s. 143(3) of the Act. It contended that the A.O. had erred in passing a
draft assessment order u/s 143(3) r.w.s. 144C(1) of the Act, even when no
variation has been proposed therein to the income or loss returned by the
assessee and in passing the final assessment order u/s 143(3) of the Act, after
the due date provided u/s 153 of the Act, thus making the final assessment
order illegal, bad in law and non-est.

HELD

The Tribunal observed that the short question for
adjudication is whether or not the A.O. was justified in passing a draft
assessment order on the facts of the case, and whether the fact that the A.O.
chose to issue the draft assessment order even though he was not required to do
so, would result in affecting the normal time limit within which the normal
assessment order u/s 143(3) is to be issued. It also observed that there are no
variations in the returned income and the assessee income.

The controversy is thus confined to the question as to what
will be the rate on which income returned by the assessee is to be taxed. While
the assessee has claimed taxation @ 10% under article 11(2) of the India-Cyprus
DTAA, the A.O. has declined the said treaty protection on the ground that the
assessee was not beneficial owner of the said interest and, accordingly,
brought the income to tax @ 40% thereof. The Tribunal observed that there is,
quite clearly, no variation in the quantum of income.

The Tribunal observed that the assessee before it is a
non-resident company incorporated, and fiscally domiciled, in Cyprus.
Accordingly, in terms of section 144C(15)(b)(ii), the assessee is an eligible
assessee but then there is no change in the figure of income returned by the
assessee vis-a-vis the income assessed by the A.O. It held that there
is, therefore, no question of a draft assessment order being issued in this
case. It noted that the Finance Bill, 2020 proposes to make the issuance of
draft assessment orders in the case of eligible assessees mandatory even when
there is no variation in the income or loss returned by the assessee, but then
this amendment seeks to amend the law with effect from 1^st April,
2020. Since the amendment is being introduced with effect from that date, the
Tribunal held that it is beyond any doubt that so far as the period prior to 1^st
April, 2020 is concerned, in the cases in which no variations in the returned
income or loss were proposed, the draft assessment orders were not required to
be issued. The Tribunal upheld the plea of the assessee on this point.

The Tribunal noted that if no draft assessment order was to
be issued in this case, the assessment would have been time-barred on 31^st
December, 2017 but the present assessment order was passed on 17^th
August, 2018. It held that since no draft assessment order could have been
issued in this case, as the provisions of section 144C(1) could not have been
invoked, the time limit for completion of assessment was available only up to
31^st December, 2017. The mere issuance of a draft assessment order,
when it was legally not required to be issued, cannot end up enhancing the time
limit for completing the assessment u/s 143(3). The Tribunal held the
assessment order to be time-barred.

The Tribunal allowed these grounds of appeal filed by the
assessee.

shailesh.kwebmaker

Sections 23, 24(b) – Where assessee is receiving rent from his own son and daughter who are financially independent, property is both a self-occupied and a let-out property – Consequently, interest claim cannot be allowed in full and shall have to be suitably proportioned, restricting the interest claim relatable to the self-occupied part thereof to Rs. 1.50 lakhs

1. [2020]
115 taxmann.com 179 (Mum.)

Md. Hussain Habib Pathan vs. ACIT

ITA No. 4058/Mum/2013

A.Y.: 2009-10

Date of order: 5^th March, 2020

Sections 23, 24(b) – Where assessee is receiving rent from
his own son and daughter who are financially independent, property is both a
self-occupied and a let-out property – Consequently, interest claim cannot be
allowed in full and shall have to be suitably proportioned, restricting the
interest claim relatable to the self-occupied part thereof to Rs. 1.50 lakhs

The children of the assessee were financially independent;
so instead of just transferring some money to their father, they wanted it to
be regarded (by mutual agreement) as rent – They believed that thus he would
receive funds in the shape of rent and that would also help meet their father’s
(the assessee’s) interest burden and help him with some tax savings – It was to
be regarded as a genuine arrangement in order to minimise assessee’s tax
liability

FACTS

The assessee claimed a loss of Rs. 15,32,120 qua his
residential house property in Mumbai. He claimed that he had incurred interest
on borrowed capital of Rs. 21,62,120 which was adjusted against rental income
of Rs. 9,00,000; this (rent), on a field inquiry, was found by the A.O. to be
from the assessee’s major son and major daughter residing in the said property
along with other family members of the assessee.

The A.O. was of the view that nobody would charge rent (for
residence) from his own son and daughter, particularly considering that both
are unmarried and living together with their family at its self-owned abode.
The arrangement was therefore regarded as merely a tax-reducing device adopted
by the assessee and liable to be ignored. Treating the house property as a
self-occupied property, the A.O. restricted the claim of interest u/s 24(b) to
Rs. 1,50,000.

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

Aggrieved, the assessee preferred an appeal to the Tribunal
where he contended that there is nothing to show that the arrangement, which is
duly supported by written agreements furnished in the assessment proceedings,
is fake or make-believe. Rental income cannot be overlooked or disregarded
merely because it arises from close family members. However, on a query from
the Bench, the counsel for the assessee was not able to state the status, i.e.,
self-occupied or rented, of the said premises for the earlier or subsequent
years, though he submitted that this is the first year of the claim of loss. He
was also unable to tell the Bench about the area let out, i.e., out of the
total area available, inasmuch as other family members, including the assessee,
were also residing in the same premises.

The Revenue’s case, on the other hand, was of no cognisance
being accorded to an arrangement which is against human probabilities and
clearly a device to avoid tax.

HELD

The Tribunal observed that the arrangement is highly unusual,
particularly considering that the rent is in respect of a self-owned property
(i.e., for which no rent is being paid), which constituted the family’s
residence, and with the assessee’s son and daughter both being unmarried.
However, the Bench felt that that may not be conclusive in the matter. Being a
private arrangement not involving any third party, not informing the
co-operative housing society was also found to be of not much consequence. It also
observed that the Revenue has rested on merely doubting the genuineness of the
arrangement without probing the facts further. What was the total area, as well
as its composition / profile? How many family members, besides the assessee
(the owner) and the two ‘tenants’, were resided thereat? Has the area let out
been specified, allowing private space (a separate bedroom each) to the son and
the daughter who would in any case be also provided access to or use of the
common area – specified or not so in the agreement/s, viz. kitchen, balcony,
living area, bathrooms, etc.? How had the rent been received, in cash or
through a bank and, further, how had it been sourced, whether from the assessee
(or any other family member), or from the capital / income of the ‘tenants’?
Why was there no attempt even to inquire whether the arrangement was a
subsisting / continuing one, or confined to a year or two, strongly suggestive
in the latter case of a solely tax-motivated exercise?

The Tribunal held that it could, however, well be that the
assessee’s major son and daughter are financially independent (or substantially
so), with independent incomes, sharing the interest burden of their common
residence with their father. As such, instead of transferring funds to him have
decided by mutual agreement to give the amounts as rent as that would, apart
from meeting the interest burden to that extent, also allow tax saving to the
assessee-father. A genuine arrangement cannot be disregarded just because it
results in or operates to minimise the assessee’s tax liability. The Tribunal
found itself in agreement with the assessee’s claim inasmuch as there was
nothing on record to further the Revenue’s case of the arrangement not being a
genuine one, but just that it was an unusual one.

However, on quantum the Tribunal found the stand of the
assessee infirm. It held that the house property, that is, the family residence
of the Pathan family, was both a self-occupied and a let-out property in view
of the rent agreements. It observed that the interest claimed (Rs. 21.62 lakhs)
is qua the entire property, which therefore cannot be allowed in full
against the rental income, which is qua only a part of the house
property. The assessee’s interest claim therefore cannot be allowed in full and
shall have to be suitably proportioned, restricting the interest claim
relatable to the self-occupied part thereof to Rs. 1.50 lakhs as allowed. The
assessee shall provide a reasonable basis for such allocation as well as the
working of the area let out. It observed that it may well be that in view of
the joint residence, no area (portion) is specified in the rent agreements. The
number of family members living jointly; their living requirements – which may
not be uniform; fair rental value of the property; etc. are some of the
parameters which could be considered for the purpose. The Tribunal directed the
A.O. to adjudicate thereon per a speaking order, giving definite reasons for
being in disagreement, whether in whole or in part, with the assessee’s claim
within a reasonable time.

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

shailesh.kwebmaker

VVF Ltd. vs. DCIT-39; [ITA. No. 9030/Mum/2010; Date of order: 31st August, 2016; A.Y.: 2007-08; Bench: F; Mum. ITAT] Section 37 – Business expenditure – Salary paid to director – The expenditure may be incurred voluntarily and without any necessity – So long as it is incurred for the purposes of business, the same is allowable as deduction

The Pr. CIT-3 vs. VVF Ltd.
[Income tax Appeal No. 1671 of 2017]

Date of order: 4^th
March, 2020

(Bombay High Court)

VVF Ltd. vs. DCIT-39; [ITA. No.
9030/Mum/2010; Date of order: 31^st August, 2016; A.Y.: 2007-08;
Bench: F; Mum. ITAT]

Section 37 – Business expenditure
– Salary paid to director – The expenditure may be incurred voluntarily and
without any necessity – So long as it is incurred for the purposes of business,
the same is allowable as deduction

A search and seizure action u/s
132(1) of the Act was carried out by the Department in the case of the assessee
and its group associates, including its directors, on 3^rd January,
2008. In A.Y. 2002-03, the A.O. made an addition of Rs. 13,00,000 which
represented the salary paid to Shri Faraz G. Joshi, its Director.

The A.O. disallowed the salary
paid to Shri Joshi primarily relying on a statement recorded during the course
of the search u/s 132(4) of the Act. The A.O. noted that in the course of the
search it was gathered that Shri Joshi was not attending office on a day-to-day
basis and no specific duties were assigned to him except some consultation.

The assessee had pointed out
before the A.O. that Shri Joshi was a whole-time Director and was performing
his duties as Director of the assessee-company and was being paid remuneration
in accordance with the limits prescribed under the Companies Act, 1956.

The A.O. disagreed with the
assessee and concluded that the payment made to Shri Joshi in the form of
salary was an expenditure not expended wholly and exclusively for the purposes
of business and, therefore, disallowed the same u/s 37(1) of the Act.

The CIT(A) also sustained the
action of the A.O. by noting that Shri Joshi had specifically admitted in the
statement recorded at the time of the search that he was not attending office
for the last six years and no specific duties were assigned to him.

The Tribunal held that the
assessee has appropriately explained the statement rendered by Shri Joshi. His
answer has to be understood in the context of the question raised. In this
context, attention has been drawn to the relevant portion of the statement,
which reads as under:

‘Q.9: What is the nature of
business conducted by the company, i.e., M/s VVF Ltd.?

A.9: The company deals in Oleo-Chemicals. We also
work on contract basis for Jhonson & Jhonson (sic)
& Racket – Colman (sic). (Johnson & Johnson; Reckitt-Coleman.)

Q.10: Who looks after the day to
day activity of that company and what are the duties assigned to you?

A.10: I am not aware about the
person who looks after the day to day business activity. Since last 6 years I
am not attending the office nor any duty is assigned to me except
consultation.’

It has been explained that the
answer by Shri Joshi was in response to the question put to him which was as to
whether he was involved in the day-to-day management of the company. It was in
this context that the answer was given. However, it is sought to be pointed out
that the said Director was rendering consultation and advisory services which,
in fact, is the role of a Director. Therefore, it has to be understood that
services were indeed being rendered by the said Director to the assessee
company. The Tribunal observed that the overemphasis by the Revenue on the
wordings of the reply of Shri Joshi has led to a wrong conclusion.

Further, Shri
Joshi was one of the two main Directors of the assessee company and that
historically such salary payments had been allowed as a deduction. In fact,
there is no negation to the plea of the assessee that for A.Ys. 2009-10 to
2012-13, such salary payments stood allowed and such assessments have been
completed even after the search carried out on 3^rd January, 2008. It
is judicially well settled that it is for the assessee to decide whether any
expenditure should be incurred in the course of carrying on of its business. It
is also a well-settled proposition that expenditure may be incurred voluntarily
and without any necessity and so long as it is incurred for the purposes of
business, the same is allowable as deduction even though the assessee may not
be in a position to show compelling necessity of incurring such expenditure. In
support of the aforesaid proposition, reliance can be placed on the judgment of
the Hon’ble Supreme Court in the case of Sasoon J. David & Co. P.
Ltd., 118 ITR 261 (SC).

Being aggrieved, the Revenue
filed an appeal to the High Court. The Court held that in response to the
specific query the answer given by Shri Joshi was quite reasonable and no
adverse inference could be drawn therefrom. Besides, the Tribunal also found that
in all the assessments made up to the date of the search, the salary payment to
Shri Joshi was allowed. Even post-search, from A.Y. 2009-10 onwards where
assessments have been made u/s 143(3) of the Act, salary paid to Shri Joshi was
not disallowed.

The Supreme Court in the case of Sassoon
J. David & Co. Pvt. Ltd. vs. CIT (Supra), examined the expression
‘wholly and exclusively’ appearing in section 10(2)(xv) of the Income tax Act,
1922 which corresponds to section 37 of the Act. Sub-section (1) of section 37
says that any expenditure not being expenditure of the nature described in
sections 30 to 36 and not being in the nature of capital expenditure or
personal expenses of the assessee, laid out or expended wholly and exclusively
for the purposes of the business or profession, shall be allowed in computing
the income chargeable under the head ‘Profits and gains of business or
profession’.

It was observed that the expression ‘wholly
and exclusively’ appearing in the said section does not mean ‘necessarily’.
Ordinarily, it is for the assessee to decide whether any expenditure should be
incurred in the course of his business. Such expenditure may be incurred
voluntarily and without any necessity. If it is incurred for promoting the
business and to earn profits, the assessee can claim deduction u/s 10(2)(xv)
even though there was no compelling need for incurring such expenditure. The
fact that somebody other than the assessee is also benefited by the expenditure
should not come in the way of an expenditure being allowed by way of deduction
u/s 10(2)(xv) of the Act. In the light of the above, the Revenue appeal was
dismissed.

shailesh.kwebmaker

M/s Sunshine Import and Export Pvt. Ltd. vs. DCIT; [ITA No. 4347/Mum/2015; Date of order: 9th September, 2016; Bench: B; A.Y.: 2008-09 to 2010-11; Mum. ITAT] Section 133A – Survey – Statement of directors of company recorded u/s 133A – No incriminating evidence and material – No evidentiary value – Any admission made in course of such statement cannot be made basis of addition

The Pr. CIT-4 vs. M/s Sunshine Import and Export Pvt. Ltd. [Income
tax Appeal Nos. 937, 1121 & 1135 of 2017]

Date of order: 4^th March, 2020

(Bombay High Court)

M/s Sunshine Import and Export
Pvt. Ltd. vs. DCIT; [ITA No. 4347/Mum/2015; Date of order: 9^thSeptember,
2016; Bench: B; A.Y.: 2008-09 to 2010-11; Mum. ITAT]

Section 133A – Survey – Statement
of directors of company recorded u/s 133A – No incriminating evidence and
material – No evidentiary value – Any admission made in course of such
statement cannot be made basis of addition

The assessee is engaged in the
business of manufacturing and trading in precious and semi-precious stones and
jewellery. It has two Directors, Shri Paras Jain and Shri Saurabh Garg. A
survey u/s 133A of the Act was carried out in respect of the assessee. During
the post-survey proceedings, the statement of one of the Directors, Shri
Saurabh Garg, was recorded. He was reported to have stated that the assessee
company provided only bill entries and there was no actual transaction of
purchase and sale. Subsequently, the statement of the other Director, Shri
Paras Jain, was also recorded. From the latter statement, the A.O. came to the
conclusion that he was a person of no means and drew the inference that the
assessee was engaged in the activity of issuing accommodation bills for the
sale and purchase of diamonds, apart from acting as a dummy for importers.
Holding the transactions as not reliable, the A.O. rejected the books of
accounts of the assessee company. He assessed 2% as the rate of commission of
the assessee on account of import purchases, i.e., for acting as a dummy. That
apart, commission @ 0.75% on sales bills was also assessed.

The CIT(A) confirmed the action
of the A.O., whereupon the assessee filed an appeal to the Tribunal.

The Tribunal held that the
assessee is mainly engaged in the import of diamonds and their sale in local
markets to exporters. The import of diamonds is done through customs
authorities and banking channels in India. The import of diamonds undergoes the
appraisal process by appraisers appointed by the custom authorities. The officers
appointed by the Government of India verify physically each and every parcel of
diamonds in order to ascertain the quality, quantity, rate, value and place of
origin against the declaration made by the importers. Further, all the
transactions of purchase, sales, import are made through account payee cheques
and not a single payment is made to any party by way of cash. All the purchase
and sales transactions are carried out with reputed parties in the diamond
trade and all the payments received from debtors are through account payee
cheques; similarly, all payments to creditors are through account payee
cheques.

As such, the A.O. cannot
allegedly consider the import of goods as providing accommodation bills in the
market when physical delivery of goods was confirmed by the other arm of
government, i.e., the custom authorities. From the record it is noted that the
sales were made to reputed exporters who are assessed to tax and their
identities are known to the Income Tax Department. The customers are registered
under state VAT laws. The company has received payments against sales proceeds
by account payee cheques. The company has also purchased from local parties to
whom payment was made by account payee cheques. To discharge the onus of
proving the transactions as genuine and to substantiate that all purchases and
sales made are genuine, the assessee has submitted various documents and
submissions; copies of bank statement for the relevant year; ledger copies of
various purchases from parties for A.Y. 2008-09 and 2009-10; photo copies of
purchase invoices of parties for A.Y. 2008-09 and 2009-10; the relevant copies
of the daily stock register; confirmation from various sale parties; details of
interest received from various parties; details of unsecured loans along with
confirmation; and so on. These documents prove that the assessee is not engaged
in issuing accommodation bills and acting as a dummy for importing diamonds.
Thus, the contention of the A.O. that the bills issued by the assessee are all
accommodation bills is wrong. Just on the basis of one recorded statement he
cannot reach the conclusion that the assessee has issued accommodation bills
and reject the books of accounts of the assessee.

Being aggrieved by the order of
the ITAT, the Revenue filed an appeal to the High Court. The Court held that in
arriving at such a finding, the Tribunal had noted that the survey party did
not find any incriminating evidence and material that could establish the stand
taken by the A.O. There was no disputing the fact that no incriminating
evidence was found on the day of the survey. It was also noted that merely on
the basis of the statement of one of the directors, Shri Saurabh Garg, and
that, too, recorded after 20 to 25 days of the survey, could not be sufficient
for bringing into assessment and making any addition to the income without
further supporting or corroborative evidence. The statement recorded u/s 133A
of the Act not being recorded on oath, cannot have any evidentiary value and no
addition can be made on the basis of such a statement.

In CIT
vs. S. Khader Khan Son 300 ITR 157, the Madras High Court had concluded
that a statement recorded u/s 133A of the Act has no evidentiary value and that
materials or information found in the course of survey proceedings could not be
a basis for making any addition; besides, materials collected and statements
obtained u/s 133A would not automatically bind the assessee. This was affirmed
by the Supreme Court by dismissing the civil appeal of the Revenue in CIT
vs. S. Khader Khan Son (Supra). In view of the above, the Revenue
appeal fails and is accordingly dismissed.

shailesh.kwebmaker

Settlement of cases – Section 245D of ITA, 1961 – Proceedings for settlement are not adjudicatory proceedings – Assessee disputing liability but offering to pay additional tax – No non-disclosure of full and true facts – Order of Settlement Commission accepting offer of assessee is valid

8. Principal CIT vs.
Shreyansh Corporation

[2020] 421 ITR 153 (Guj.)

Date of order: 7^th
October, 2019

A.Y.: 2004-05

Settlement of cases – Section
245D of ITA, 1961 – Proceedings for settlement are not adjudicatory proceedings
– Assessee disputing liability but offering to pay additional tax – No
non-disclosure of full and true facts – Order of Settlement Commission accepting
offer of assessee is valid

On an application for settlement
after considering the issues put forth by the Principal Commissioner in the
report u/r 9 of the Income-tax Rules, 1962 and the rejoinders of the assessees
and the documents submitted along with the statement of facts and the
submissions of the respective parties, the Settlement Commission noted that
insofar as the addition to partner’s capital was concerned, the assessees had
submitted affidavits made by M and the two assessees and it was further stated
that if at any stage these affidavits were found to be false, it may be treated
as a misrepresentation of facts u/s 245D(6) of the Act and the consequences as
u/s 245D(7) of the Act may follow in the case of the two assessees. The
Settlement Commission further noted that the assessees had offered additional
income for bringing quietus to certain issues in the spirit of a
settlement.

Taking into account all the facts
and discussions on record, the Settlement Commission was of the view that the additional
income offered during the section 245D(4) proceedings by the applicant’s letter
dated 8^th June, 2018 over the additional income disclosed in the
settlement applications could be accepted with reference to the income
disclosed in the settlement applications. It further noted that the
Commissioner and the A.O. also did not make any further submissions. The
Settlement Commission accordingly settled the cases of the assessees on the
terms and conditions set out in the order.

The Principal Commissioner filed
writ petitions and challenged the order of the Settlement Commission. The
Gujarat High Court dismissed the petitions and held as under:

‘i) The proceedings before the Settlement Commission are in the
nature of settlement between the parties and are not strictly speaking
adjudicatory proceedings. On a perusal of the order passed by the Settlement
Commission it was abundantly clear that the assessees had not accepted the
liability of 5% of trading expenses but in the spirit of settlement offered to
pay the amount computed by the A.O. with a view to bring quietus to the
matter and buy peace of mind. The offer to pay such amounts in addition to the
amounts disclosed in the applications u/s 245C of the Act could not be said to
be disclosure of any further amounts under that section as they had been
offered only to bring about a settlement.

ii) The fact that the assessees had offered to pay such amounts, the
liability whereto they had not accepted, could not be termed as non-disclosure
of full and true facts in the applications u/s 245C of the Act.

iii) Under the circumstances, considering
the amounts so offered by way of settlement, which were quite meagre
considering the overall disclosure made, there was no infirmity in the order
passed by the Settlement Commission warranting interference in exercise of
powers under article 226 of the Constitution of India’.

shailesh.kwebmaker

Revision – Section 264 of ITA, 1961 – Application for revision – Powers of Commissioner – Powers u/s 264 are very wide – Mistake in computation of income and revised return barred by limitation – Commissioner finding that mistake was inadvertent and claim for deduction bona fide – Order rejecting application for revision is not valid Income-tax – General principles – Effect of Article 265 of the Constitution of India – No tax collection except by authority of law

7. Sharp Tools vs. Principal
CIT

[2020] 421 ITR 90 (Mad.)

Date of order: 23^rd
October, 2019

A.Y.: 2013-14

Revision – Section 264 of ITA,
1961 – Application for revision – Powers of Commissioner – Powers u/s 264 are
very wide – Mistake in computation of income and revised return barred by
limitation – Commissioner finding that mistake was inadvertent and claim for
deduction bona fide – Order rejecting application for revision is not
valid

Income-tax – General principles –
Effect of Article 265 of the Constitution of India – No tax collection except
by authority of law

The assessee
filed its return of income for the A.Y. 2013-14. It then received an intimation
u/s 143(1) of the Income-tax Act, 1961 accepting the returned income.
Thereafter, the assessee realised that a mistake had inadvertently crept in
while filling up the quantum in column 14(i) of the return. Therefore, on 9^th
January, 2016, the assessee filed a revised return rectifying the mistake. The
return was not processed by the Central Processing Centre, since it was
considered as a revised return filed beyond the specified time u/s 139(5) of
the Act. The assessee made an application to the A.O. for rectification u/s
154. The A.O. rejected the plea, stating
that the claim was belated. Thereafter, the assessee filed a revision petition
u/s 264. Though the Principal Commissioner found that the mistake was inadvertent
and that the claim was bona fide, he rejected the revision petition.

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

‘i) A careful perusal of section 264 of the Income-tax Act, 1961
would show that it empowers the Principal Commissioner or the Commissioner to
exercise the revisional jurisdiction over “any order” other than the
order to which section 263 applies. Such power is wider and confers on such
authority the responsibility to set things right wherever he finds that an
injustice has been done to the assessee. Before passing any order u/s 264 of
the Act, it is open to the authority to make such inquiry or cause such inquiry
to be made. However, such order should not be prejudicial to the assessee.

ii) Article 265 of the Constitution of India specifically states that
no tax shall be levied or collected except by authority of law. Therefore, both
the levy and collection must be with the authority of law, and if any levy or
collection is later found to be wrong or without authority of law, certainly
such levy or collection cannot withstand the scrutiny of the Constitutional
provision and would be in violation of article 265 of the Constitution of
India.

iii) A mere typographical error committed by the
assessee could not cost it payment of excess tax as collected by the Revenue.
The denial of repayment of such excess collection would amount to great
injustice to the assessee. Even though the statute prescribes a time limit for
getting the relief before the A.O. by way of filing a revised return, there was
no embargo on the Commissioner to exercise his power and grant the relief u/s
264. The order rejecting the application for revision was not valid.

iv) Accordingly, this writ petition is
allowed and the impugned order is set aside. Consequently, the matter is
remitted back to the respondent for considering the claim of the petitioner and
to pass appropriate orders in the light of the observations and findings
rendered supra. The respondent shall, accordingly, pass such fresh order
within a period of six weeks from the date of receipt of a copy of this order.’

shailesh.kwebmaker

Recovery of tax – Company in liquidation – Recovery from director – Section 179 of ITA, 1961 – Where A.O. issued a notice u/s 179 against assessee director of a company seeking to recover tax dues of the company, since such notice was totally silent regarding fact that tax dues could not be recovered from company and, further, there was no whisper of any steps being taken against company for recovery of outstanding amount, impugned notice u/s 179 against director was to be set aside

6. Ashita Nilesh Patel vs.
ACIT

[2020] 115 taxmann.com 37
(Guj.)

Date of order: 20^th
January, 2020

A.Ys.: 2011-12 to 2014-15

Recovery of tax – Company in
liquidation – Recovery from director – Section 179 of ITA, 1961 – Where A.O.
issued a notice u/s 179 against assessee director of a company seeking to
recover tax dues of the company, since such notice was totally silent regarding
fact that tax dues could not be recovered from company and, further, there was
no whisper of any steps being taken against company for recovery of outstanding
amount, impugned notice u/s 179 against director was to be set aside

The assessee was a director in
the company TPPL which failed to make payment of outstanding tax demand of
certain amount. The A.O. observed that it was noticed from the records of the
company that there were no recoverable assets in the name of the assessee
company. In such circumstances, proceedings u/s 179 of the Income-tax Act, 1961
were initiated by way of issuing of notice to the assessee treating her as
jointly and severally liable for payment of such tax.

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

‘i) Section 179(1) provides for the joint and several liability of
the directors of a private company, wherein the tax dues from such company in
respect of any income of any previous year cannot be recovered. The first
requirement, therefore, to attract such liability of the director of a private
limited company is that the tax cannot be recovered from the company itself.
Such requirement is held to be a pre-requisite and necessary condition to be
fulfilled before action u/s 179 can be taken. In the context of section 179
before recovery in respect of the dues from a private company can be initiated
against the directors, to make them jointly and severally liable for such dues,
it is necessary for the Revenue to establish that such recovery cannot be made
against the company and then alone can it reach to the directors who were
responsible for the conduct of the business during the previous year in
relation to which liability exists.

ii) There is no escape from the fact that the perusal of the notice
u/s 179 reveals that the same is totally silent as regards the satisfaction of
the condition precedent for taking action u/s 179, viz., that the tax dues
cannot be recovered from the company. In the show cause notice, there is no
whisper of any steps having been taken against the company for recovery of the
outstanding amount. Even in the impugned order, no such details or information
has been stated.

iii) In the circumstances referred to above, the question is whether
such an order could be said to be sustainable in law. The answer has to be in
the negative. At the same time, in the peculiar facts and circumstances of the
case and, more particularly, when it has been indicated by way of an additional
affidavit-in-reply as regards the steps taken against the company for the
recovery of the dues, one chance is to be given to the Department to undertake
a fresh exercise so far as section 179 is concerned. If the show cause notice
is silent including the impugned order, the void left behind in the two
documents cannot be filled by way of an affidavit-in-reply. Ultimately, it is
the subjective satisfaction of the authority concerned that is important and it
should be reflected from the order itself based on some cogent materials.

iv) The impugned notice as well as the
order is hereby quashed and set aside. It shall be open for the respondent to
issue fresh show cause notice for the purpose of proceeding against the writ
applicant u/s 179.’

shailesh.kwebmaker

Income – Business income – Section 41 of ITA, 1961 – Remission or cessation of trading liability – Condition precedent for application of section 41 – Assessee must have obtained benefit in respect of liability – Mere change of name in books of accounts not sufficient – Interest liability of State Government undertaking on government loans converted by order of State Government into equity share capital – No cessation of liability – Section 41 not applicable

5. CIT vs. Metropolitan
Transport Corporation (Chennai) Ltd.

[2020] 421 ITR 307 (Mad.)

Date of order: 9^th
July, 2019

A.Y.: 2001-02

Income – Business income –
Section 41 of ITA, 1961 – Remission or cessation of trading liability –
Condition precedent for application of section 41 – Assessee must have obtained
benefit in respect of liability – Mere change of name in books of accounts not
sufficient – Interest liability of State Government undertaking on government
loans converted by order of State Government into equity share capital – No
cessation of liability – Section 41 not applicable

The assessee was a wholly-owned
Tamil Nadu Government undertaking, operating transport services. The assessee
had taken over the assets and liabilities of the transport services, which were
previously run by the Tamil Nadu State Government. The State Government treated
a part of the net worth of the undertaking as its share capital and the balance
as loan, on which the assessee claimed and was allowed interest payable year
after year as deduction u/s 37 of the Income-tax Act, 1961. The Government of
Tamil Nadu took a decision and issued G.O. (Ms). No. 18, dated 7^th
March, 2001 converting the interest outstanding of Rs. 8,264.17 lakhs payable
by the assessee company on 31^st October, 2000 into equity shares.
The A.O. held that the sum of Rs. 8,264.17 lakhs was assessable u/s 41(1) of
the Act.

The Tribunal held that the amount
was not assessable u/s 41.

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

‘i) It is a prerequisite condition before having recourse to section
41 of the Income-tax Act, 1961 that the assessee must have either obtained the
amount in respect of the loss, expenditure or trading liability incurred
earlier by it, or it should have received any benefit in respect of such
trading liability by way of remission or cessation thereof. The objective is to
tax the amount or benefit received by the assessee, thereby making him pay back
the benefit availed of earlier by him by way of claiming loss, expenditure or
liability in respect of that amount. Remission is a positive conduct on the
part of the creditor. Mere change of nomenclature in the books of accounts
without anything more brings no benefit to the assessee and its liability to
pay to the creditor does not get extinguished. The treatment given in
accounting entries does not give rise to a taxable event. To invoke section 41
of the Act, the initial burden is on the Revenue to establish cessation or
remission of liability.

ii) When there was no writing off of liabilities and only the
sub-head under which the liability was shown in the account books of the
assessee was changed, there could be no cessation of liability. When the
assessee company was liable to pay and it continued to remain liable even after
change of entries in the books of accounts, no benefit would accrue to the
assessee company merely on account of change of nomenclature, and consequently
the question of treating it as profit and gain would not arise.

iii) For all the above reasons, the appeal
filed by the Revenue is dismissed and the substantial question of law is
answered against the Revenue.’

shailesh.kwebmaker

Search and seizure – Block assessment – Sections 132, 158BC, 292CC of ITA, 1961 – Validity of search must be established before block assessment – Computation of income should be based on undisclosed income discovered during search; B.P. 1991-92 to 1998-99

40. Ramnath Santu
Angolkar vs. Dy. CIT [2020] 422 ITR 508 (Kar.) Date of order: 27^th November, 2019 B.P.: 1991-92 to 1998-99

Search and seizure – Block assessment – Sections
132, 158BC, 292CC of ITA, 1961 – Validity of search must be established before
block assessment – Computation of income should be based on undisclosed income
discovered during search; B.P. 1991-92 to 1998-99

The appellant is an individual dealing in real estate and is engaged in
the activity of providing service to landowners for getting compensation in
case of land acquisition for promoting housing schemes, land development and
selling of plots on behalf of the owners on commission or service charges. The
appellant filed his return of income for the A.Ys. 1991-92 to 1998-99. The
aforesaid returns were processed u/s 143(1). On 19^th November, 1998,
a search u/s 132 of the Act was conducted in the residential premises of the
appellant and a notice u/s 158BC was issued to the appellant by which he was
required to file his return of income. In response to the aforesaid notice, the
appellant filed the return of income for the block period, i.e., 1^stApril,
1988 to 19^th November, 1998 and declared an additional income of Rs.
4,53,156. Thereafter, a notice u/s 143(2) was issued to the appellant and he
was directed to produce all the details. The A.O. passed an order of assessment
on 28^th November, 2000 u/s 158BC(c) and determined undisclosed
income of the appellant at Rs. 1,63,54,846.

Being aggrieved, the appellant filed an appeal before the Commissioner
of Income-tax (Appeals). The appeal was decided by an order dated 23^rd
August, 2002 which was partly allowed. The Revenue being aggrieved by this
order, filed an appeal before the Income-tax Appellate Tribunal. The appellant
filed a cross-objection in the aforesaid appeal, to the extent that the appeal
was decided against the appellant. The Tribunal by an order dated 18^th
January, 2007, set aside the order of the Commissioner of Income-tax (Appeals)
and remitted the matter to the Commissioner of Income-tax (Appeals) and
directed the issues to be adjudicated afresh by affording an opportunity of
hearing to the parties in accordance with law. The Commissioner thereafter, by
an order dated 30^th May, 2008, decided the appeal and partly allowed
the appeal filed by the appellant. The appellant and the Revenue being
aggrieved by this order, again filed appeals before the Tribunal. The Tribunal,
by an order dated 9^th September, 2011, partly allowed both the
appeals.

The appellant filed an appeal before the High Court and raised the
following questions of law:

‘(1) Whether the assessment order passed for the block period u/s
158BC(c) of the Act in the name of the individual, when the warrant of
authorisation issued in the joint name of the appellant and others is valid in
law on the facts and circumstances of the case?

(2) Whether the authorities below ought to have examined the validity of
the search and then only proceeded to initiate block assessment proceedings on
the facts and circumstances of the case?

(3) Whether the Tribunal was justified in law in holding that there is
no merit to challenge the action of the A.O. to assess u/s 158BC of the Act
when the conditions precedent are not existing as much as for computation of
income u/s 158BC shall be restricted to seized material on the facts and
circumstances of the case?’

The Karnataka High Court held as under:

‘i) Section 292CC of the
Income-tax Act, 1961 merely provides that it shall not be necessary to issue an
authorisation u/s 132 or make a requisition u/s 132A separately in the name of
each person. However, it is pertinent to note that where an authorisation is
made in the name of more than one person, the section does not provide that the
names of such persons need not be mentioned in the warrant of authorisation.

ii) The authorities are under an
obligation to examine the validity of the search and only thereafter proceed to
initiate the block assessment proceedings.

iii) From a perusal of section
158BC it is evident that while computing the undisclosed income for the block
period, the evidence found as a result of search or requisition of books of
accounts or other books of accounts and such other material or information as
is available with the A.O. and relatable to such evidence, has to be taken into
consideration. In other words, it is evident that the computation of
undisclosed income should be based on such evidence which is seized during the
search which is not accounted in the regular books of accounts.

iv) The assessment order passed
for the block period u/s 158BC(c) of the Act in the name of the individual,
when the warrant of authorisation was issued in the joint names of the assessee
and others, was not valid in law. Moreover the authorities ought to have
examined the validity of the search and only then proceeded to initiate block
assessment proceedings on the facts and circumstances of the case.

v) From a
perusal of the material on record, it was evident that there was no seizure
with regard to the A.Ys. 1988-89 and 1989-90 during the course of the search
and seizure operations. However, the A.O. while computing the undisclosed
income had taken into account the income in respect of these years also and
thus the order passed by the A.O. was in violation of section 158BC(c). The
order of block assessment was not valid.’

shailesh.kwebmaker

Income – Accounting – Section 145 of ITA, 1961 – Rejection of accounts and estimate of income – Discretion of A.O. must be exercised in a judicious manner

4. Rameshchandra Rangildas
Mehta vs. ITO

[2020] 421 ITR 109 (Guj.)

Date of order: 15^thJuly,
2019

A.Y.: 2011-12

Income – Accounting – Section 145
of ITA, 1961 – Rejection of accounts and estimate of income – Discretion of
A.O. must be exercised in a judicious manner

For the A. Y. 2011-12 the
appellant had filed his return of income on 15^th September, 2011
declaring total income at Rs. 5,34,342. The case was selected for scrutiny and notice
u/s 143(2) of the Income-tax Act, 1961 was issued dated 31^st July,
2012. The appellant filed his revised return of income on 30^th
March, 2012, declaring a total income of Rs. 7,44,070 and claimed refund of Rs.
23,26,700. According to the appellant, he derived income from civil contracts
(labour job works). The appellant showed gross business receipts of Rs.
12,00,02,100 and a net profit of Rs. 5,37,942. The refund of Rs. 23,26,700 out
of the prepaid taxes contained tax deducted by M/s PACL Limited against the
payment for labour. The appellant showed labour receipts for income account of
Rs. 12,00,02,100.

The A.O., relying on the
statement of the appellant recorded u/s 131 of the Act and the information
received subsequent to the search in the case of M/s PACL India Limited, came
to the conclusion that the dealings of the appellant with M/s PACL India
Limited were accommodation entries. The A.O. issued show cause notice dated 14^th
March, 2014 calling upon the appellant to show cause as to why the labour
receipt income of Rs. 12,00,02,100 should not be treated as income from other
sources u/s 56 of the Act. The appellant, vide his reply dated 21^st
March, 2014, explained that he had only received commission of Rs. 0.30 on Rs.
100, i.e., Rs. 3,60,000 on Rs. 12,00,02,100 which had already been included in
the net profit and reflected in the profit and loss account. The A.O. rejected
the books of accounts u/s 145(3) of the Act and estimated the income at 10% of
the gross receipts; he made an addition of Rs. 1,20,00,210 as income from other
sources u/s 56 of the Act.

The appellant submitted before
the Commissioner of Income-tax (Appeals) that the estimation of net profit at
10% was on the higher side and he had received commission at 0.45% only. He
also pointed out that the returned income included the profit of Rs. 4,13,742
from the labour contract receipts and set-off should have been granted against
the addition of commission income by the A.O. The Commissioner (Appeals)
estimated the commission at Rs. 24,00,042, i.e., 2% on the basis that the same
is 6.7% of the tax benefit derived by PACL India Limited, i.e., 30%, and the
same was a reasonable estimate. The Commissioner (Appeals) took the view that
the set-off of only the net income from the fictitious contract receipts could
be granted. Further, he reduced the interest income and retail sales from the
net profit to grant the set-off. The set-off granted by the Commissioner
(Appeals) came to only Rs. 1,46,942 [Rs. 5,37,942 (net profit) – Rs. 1,20,000
(interest income) – Rs. 2,71,000 (retail sales)]. Thus, the Commissioner
(Appeals) partly confirmed the addition to the extent of Rs. 22,53,100.

Being dissatisfied with the order
passed by the Commissioner (Appeals), the Department preferred an appeal before
the Income-tax Appellate Tribunal. The appellant preferred cross-objection. The
Appellate Tribunal confirmed the order of the Commissioner (Appeals).

Dissatisfied with the order
passed by the Appellate Tribunal, the appellant filed an appeal before the High
Court and proposed the following substantial question of law:

‘Whether in the facts and
circumstances of the case, the Income-tax Appellate Tribunal was right in law
in confirming addition of Rs. 22,53,100 on account of alleged commission income
at 2% without there being any evidence or material on record for making such
estimate?’

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

‘i) Section 145 of the Income-tax Act, 1961 gives power to the A.O.
to reject the assessee’s accounts. Although sub-section (3) of section 145
gives him the discretion to make an assessment in the manner provided in
section 144, yet this discretion cannot be exercised arbitrarily. The question
to determine in every such case is whether there is any material for the basis
adopted by the A.O. or the Tribunal, as the case may be, for computing the
income of the assessee. The material which is irrelevant or which amounts to
mere guesswork or conjecture is no material.

ii) The A.O. thought it fit to estimate 10% commission for providing
accommodation entries to the tune of Rs. 12,00,02,100. The Commissioner
(Appeals) took the view that the estimation of commission at 10% by the A.O. is
one-third of the benefit, which could be termed as excessive and not a
reasonable estimate. The Commissioner (Appeals), without there being anything on
record, thought it fit to take the view that the estimate by the assessee at 3%
translated to 1% of the benefit derived, which could be termed too low, and in
such circumstances, estimated it at 2%, which would translate to about 6.7% of
the benefit alleged to have been derived by P. This was nothing but pure
guesswork without there being any material or basis for arriving at the same.
The Tribunal was not right in law in confirming the addition.

iii) Ordinarily, we would not have entertained the appeal of the
present nature having regard to the fact that the income has been assessed
based on estimation. However, the way the authorities have proceeded with the
guesswork, it cannot be approved.

iv) In view of the above, this tax appeal
succeeds and is hereby allowed. The question of law is answered in favour of
the assessee and against the Revenue. The impugned order passed by the
Income-tax Appellate Tribunal is hereby quashed and set aside.’

shailesh.kwebmaker

Charitable purpose (objects of general public utility) – Section 2(15) r.w.s. 12A of ITA, 1961 – Where assessee association was engaged in primary aim and objective to organise and arrange all licensed third party administrators (TPAs) to be members of trust for mutual betterment of TPA business, merely because certain benefits accrued to TPA members and certain objects of trust were for advancement of business of TPA, it would not ipso facto render trust to be non-charitable

3. CIT (Exemption) vs.
Association of Third Party Administrators

[2020] 114 taxmann.com 534
(Delhi)

Date of order: 20^th
January, 2020

Charitable purpose (objects of
general public utility) – Section 2(15) r.w.s. 12A of ITA, 1961 – Where
assessee association was engaged in primary aim and objective to organise and
arrange all licensed third party administrators (TPAs) to be members of trust
for mutual betterment of TPA business, merely because certain benefits accrued
to TPA members and certain objects of trust were for advancement of business of
TPA, it would not ipso facto render trust to be non-charitable

On 12^th December, 2005
the assessee association of third party administrators (ATPA) filed an
application seeking registration u/s 12A of the Income-tax Act, 1961. The said
application was rejected by the Director (Exemption) holding that certain
objects of the trust were not charitable and trustees had discretion in
applying the trust’s income to any of the objects. The Director (Exemption)
held that the assessee ATPA was aiming at industry status for third party
administrator (TPA) business and was working for mutual benefit of its members.

The Tribunal allowed the appeal
in favour of the assessee and directed the Commissioner (Exemption) to provide
registration to the assessee u/s 12AA of the Act.

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

‘i) At the initial stage of registration, it is
to be examined whether the proposed activities of the assessee can be
considered charitable within the meaning of section 2(15). On an application
for registration of a trust or institution made under section 12AA, the
Principal Commissioner or Commissioner shall call for such documents or
information from the trust or institution as he thinks necessary in order to
satisfy himself about the genuineness of the activities of the trust or
institution; and the compliance of such requirements of any other law for the
time being in force by the trust or institution, as are material for the
purpose of achieving its objects, and he may also make such inquiries as he may
deem necessary in this behalf. Once he is satisfied about the objects of the
trust or institution and the genuineness of its activities, he shall pass an
order under the said provision. On this aspect the tax authorities have looked
into the aims and objects of the trust.

ii) The primary or dominant object of the trust satisfies the
conditions laid down u/s 2(15). Even if some ancillary or incidental objects
are not charitable in nature, the institution would still be considered as a
charitable organisation. Merely because some facilities were beyond its main
object, that by itself would not deprive the institution of the benefits of a
charitable organisation. If the primary purpose of advancement of objects is
for general public utility, the institution would remain charitable, even if
there are incidental non-charitable objects for achieving the said purpose.

iii) Merely because the objects of the trust are for the advancement of
the business of TPA, it would not ipso facto render the trust to be
non-charitable. The objects of the trust are not exclusively for the promotion
of the interests of the TPA members. The objects were to provide benefit to the
general public in the field of insurance and health facilities. In the course
of carrying out the main activities of the trust, the benefits accruing to the
TPA members cannot, by itself, deny the institution the benefit of being a
charitable organisation.

iv) For
the foregoing reasons, there is no substantial question of law arising.
Accordingly, the appeal is dismissed.’

shailesh.kwebmaker

Business expenditure – Disallowance of expenditure relating to exempted income – Section 14A of ITA, 1961 – Disallowance cannot exceed exempt income earned – Tribunal restricting disallowance to extent offered by assessee – Proper

2. Principal CIT vs. HSBC Invest Direct (India) Ltd.

[2020] 421 ITR 125 (Bom.)

Date of order: 4^th
February, 2019

A.Y.: 2009-10

Business
expenditure – Disallowance of expenditure relating to exempted income – Section
14A of ITA, 1961 – Disallowance cannot exceed exempt income earned – Tribunal
restricting disallowance to extent offered by assessee – Proper

The assessee
is a limited company. In the return of income filed for the A.Y. 2009-10, the
question of making disallowance to the expenditure claimed by the assessee in
terms of section 14A of the Income-tax Act, 1961 read with Rule 8D of the
Income-tax Rules, 1962 came up for consideration. During the assessment in the
appellate proceedings, the assessee offered restricted disallowance of Rs. 1.30
crores. The Department contended firstly that the statutory auditors in the
report had made a disallowance of Rs. 2.53 crores u/s 14A of the Income-tax
Act, 1961, and secondly that in view of the assessee’s income which was exempt,
the disallowance had to be made under Rule 8D of the Income-tax Rules, 1962.
The Tribunal accepted the assessee’s voluntary offer of disallowance of
expenditure.

The Revenue filed an appeal
against the judgment of the Income-tax Appellate Tribunal, raising the
following question for consideration:

‘(i) Whether the order of the
Tribunal is perverse in law as it ignored the disallowance computed by the
auditors of the assessee which was in accordance with section 14A of the
Income-tax Act, 1961 read with Rule 8D of the Income-tax Rules, 1962?’

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

‘i) The disallowance of expenditure incurred to earn the exempt
income could not exceed the exempt income earned. The ratio of the decisions in
the cases of Cheminvest Ltd. vs. CIT [2015] 378 ITR 33 (Delhi) and
CIT vs. Holcim India (P) Ltd. (I.T.A. No. 486 of 2014 decided on 5^th
September, 2014) would include a facet where the assessee’s exempt
income was not nil, but had earned exempt income which was more than the
expenditure incurred by the assessee in order to earn such income.

ii) The order of the Tribunal which
restricted the disallowance of the expenditure to the extent voluntarily
offered by the assessee was not erroneous.’

shailesh.kwebmaker

Section 56 r/w Rule 11UA – Fair Market Value of shares on the basis of the valuation of various assets cannot be rejected where it has been demonstrated with evidence that the Fair Market Value of the assets is much more than the value shown in the balance sheet

22. [2019] 75 ITR (Trib.) 538 (Del.) India Convention & Culture Centre (P)
Ltd. vs. ITO ITA No. 7262/Del/2017 A.Y.: 2014-15 Date of order: 27^th September,
2019

Section 56 r/w Rule 11UA – Fair Market
Value of shares on the basis of the valuation of various assets cannot be
rejected where it has been demonstrated with evidence that the Fair Market
Value of the assets is much more than the value shown in the balance sheet

FACTS

The assessee company issued 70,00,000 equity
shares of Rs. 10 each at a premium of Rs. 5 per share. The assessee company had
changed land use from agricultural to institutional purposes owing to which the
value of the land increased substantially. It contended before the ITO to
consider the Fair Market Value (FMV) of the land instead of the book value for
the purpose of Rule 11UA. However, the ITO added the entire share premium by
invoking section 56(2)(viib). He computed the FMV of shares on the basis of
book value instead of FMV of land held by the assessee company while making an
addition u/s 56(2)(viib) r/w Rule 11UA.

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 observed that the assessee took
refuge of clause (ii) of Explanation (a) to section 56(2)(viib). The counsel
for the assessee argued that the lower authorities have wrongly computed the fair
market value of the shares on the basis of the book value ignoring the fair
market value of the land held by the company; since the assessee had obtained
permission of the competent authority for change of land use from
‘agricultural’ to ‘institutional’ for art, culture and convention centre, its
market value increased substantially. The Tribunal, convinced by the fact of
increase in market value of land, held that valuation of the shares should be
made on the basis of various factors and not merely on the basis of financials,
and the substantiation of the fair market value on the basis of the valuation
done by the assessee simply cannot be rejected where the assessee has
demonstrated with evidence that the fair market value of the asset is much more
than the value shown in the balance sheet.

The Tribunal allowed the appeal filed by the
assessee.

shailesh.kwebmaker

Section 68 r/w/s 194J – Merely because an amount is reflected in Form 26AS, it cannot be brought to tax in the hands of the assessee where an error was made by a third person

21 [2019] 75 ITR (Trib.) 364 (Mum.) TUV India (P) Ltd. vs. DCIT ITA No. 6628/Mum/2017 A.Y.: 2011-12 Date of order: 20^th August, 2019

Section 68 r/w/s 194J – Merely because an
amount is reflected in Form 26AS, it cannot be brought to tax in the hands of
the assessee where an error was made by a third person

FACTS

The assessee filed return of income,
claiming Tax Deducted at Source (TDS) of Rs. 6.02 crores whereas TDS appearing
in the AIR information was Rs. 6.33 crores. During the course of scrutiny
assessment, the ITO concluded that the assessee had not disclosed income
represented by the differential TDS of Rs. 30.88 lakhs. The income was
calculated by extrapolating the differential TDS amount (ten per cent of TDS
u/s 194J) and was taxed as undisclosed income in the hands of the assessee.

Aggrieved, the assessee preferred an appeal
to the CIT(A), claiming that the difference was mainly due to the error made by
one of the clients by wrongly furnishing Permanent Account Number (PAN) of the
assessee instead of that of one of their (other) clients. The assessee produced
all possible evidence to prove that the same was on account of a genuine error
made by its client. The CIT(A) deleted the addition partially and confirmed the
rest of the difference, on the ground that the same was irreconcilable.

Aggrieved, the assessee preferred an appeal
to the Tribunal.

HELD

The Tribunal observed that the assessee’s
client had erroneously quoted the assessee’s PAN in its TDS return owing to
which higher TDS was reflected in the assessee’s Form 26AS. However, the
assessee duly filed all the details to explain the difference between the TDS
amounts before the ITO during remand proceedings as well as before the CIT(A).

It produced evidence by way of emails
exchanged with its client to prove that the error took place while filing TDS
returns by the client. It also filed a revised TDS return as well as ledger
account of the client in the assessee’s books, as well as reconciliation
statements, and offered party-wise explanations. Thus, the assessee discharged
its primary onus as cast under the Income Tax laws.

Neither the ITO nor the CIT(A) conducted
necessary inquiries despite having all information in their possession
submitted by the assessee during appellate / remand proceedings.

It further observed that the assessee has no
control over the database of the Income-tax Department as is reflected in Form
No. 26AS and the best that the assessee could do is to offer bona fide
explanations for the differential which the assessee did in this case during
appellate / remand proceedings. The CIT(A) / ITO ought to have conducted
necessary inquiries to unravel the truth, but asking the assessee to do the
impossible is not warranted. No defects in the books of accounts are pointed
out by the authorities below nor were the books of accounts rejected by them.
No cogent incriminating material was brought on record by the authorities below
as evidence / to prove that the assessee has received / earned any income
outside its books of accounts.

Another important aspect which the Tribunal
considered was that though the principle of res judicata was not applicable
to assessment proceedings under Income tax law, from the assessment orders for
other assessment years indications can be drawn as to the behaviour pattern of
the taxpayer and modus operandi of the taxpayer adopted to defraud
Revenue / conceal income, if any. No such incriminating information is brought
on record by Revenue. Therefore, considering the totality of facts as well as
on the touchstone of preponderance of probabilities, the Tribunal held that no
additions to the income are warranted in the hands of the assessee on account
of the above difference.

The ground of appeal filed by the assessee
was allowed.

shailesh.kwebmaker

GOOGLE MAPS – GETTING BETTER AT 15!

Google Maps is the gold standard
as far as maps are concerned. Wherever you want to go, in any part of the
world, Google Maps guides you through accurately and, in some cases, even
beyond your imagination.

On its 15^th birthday,
Google has announced further updates to this winner App. Here are some of the
updates it has announced. If you do not see some of them in your Google Maps
app, please be patient – they will be selectively rolled out when you refresh
the App from the Play Store within the next few weeks (plans are afoot to roll out in March, 2020), depending upon where you reside.

Google Maps thrives on the data
that it collects through crowd-sourcing, i.e., each of us who has Google Maps
installed, is directly or indirectly supplying data to the Google Maps central
server, to enhance the user experience for the entire population; for example,
when you look for the time estimate to reach a particular destination in real
time, Google has already collected data from thousands of commuters who are
already on that route, or have recently completed their journey. This data is
aggregated and then served to you as an estimate of how much time you will take
to reach your destination. And we all know how accurate that is. The updates
that Google Maps proposes to take this crowd-sourcing of data to the next
level. Let us see what the actual updates are going to be like:

Currently, there are three tabs
at the bottom of the App – Explore, Commute and For You. These
are now transformed into five tabs – Explore, Commute, Saved, Contribute
and Updates. Let us see what they represent and how they are different
from the existing tabs.

EXPLORE
AND COMMUTE

These remain largely unchanged.

Explore
allows you to explore places around you, at the current location. If you are
looking for a place to have lunch, go for a movie or to play games, Explore
will help you find the best place close by. Ratings, reviews and pictures of
more than 200 million places around the world are available, including nearby
attractions and city landmarks.

Commute
checks traffic around you and gives you the estimated time to reach your
favourite destination. If you are at work, it will show you the Commute
time to your home and vice versa. This happens in real time. There is also a
‘crowded-ness’ feature which tells you how crowded public transport is likely
to be at a particular time of the day.

Saved –
this new tab helps you locate your saved places instantly. Users have Saved
more than 6.5 billion places on their individual apps. This tab will help in
planning trips and making travel plans. It will also recommend places based on
the user’s map history.

Contribute: Here, again,
Google is looking at making crowd-sourcing more direct and interactive. You can
share information about a local area, traffic jam, diversions, reviews (for
hotels and businesses), photos, addresses, etc. You can add missing places,
too, and enrich the content of the maps. All your contributions would then be
pooled for the benefit of the entire user community. This could make sites and
apps like Yelp, TripAdvisor, etc. redundant.

Updates will
present to the user the latest trending and must-visit places near him / her.
The latest real-time Updates will always be available so that you do not
miss out on any of the new, popular places. In addition to discovering, saving
and sharing recommendations with your friends and family, you can also directly
chat with businesses and get more information about them.

To help you plan your journey,
Google has also added some cool new features such as:

Temperature –
you can check the current temperature at the destination before you start;

Women’s section –
this will help in commuting in areas where there are special sections for women
in the transportation system. For instance, it will indicate trains which have
women’s compartments, women’s specials, etc.;

Security –
this feature will guide you about security cameras, helpline numbers and
security guards available in a particular area;

Accessibility –
differently-abled people can find accessibility option also listed on the
places they plan to visit, such as special ramps, seating arrangements,
accessibility in public transport, etc.;

Live View – is a built-in feature, which
helps people to quickly decide which way to go, when they start walking with
Google Maps on. By combining StreetView’s real-world imagery, machine learning
and smartphone sensors, it can show you the way, using augmented reality.

Some of the above features are
available only in certain countries, depending on the information available in
the public domain or supplied by the users in their reviews.

In India, Google Maps now
provides information about public toilets around a particular location. The
company is also looking to introduce a mixed-mode commute feature across cities
in India that will show multiple public transportation modes available for
commuting to a specific destination.

Meanwhile, Alphabet and Google
CEO Sundar Pichai has sent his wishes through social media.

‘Happy 15^th Birthday @GoogleMaps! Reflecting today on some of
the ways it’s been helpful to me, from getting around more easily to finding a
good veggie burrito wherever I am:) Thanks to the support of our users, Maps
keeps getting more helpful every day,’ Pichai tweeted.

shailesh.kwebmaker

WHEN LEARNING, RECREATION AND NETWORKING GO HAND-IN-HAND A REPORT ON 53RD BCAS-RRC

A brainchild of the BCAS, the RRC has metamorphosed into an outstanding avenue for collective learning, recreation and networking. The BCAS-RRC has constantly evolved with the changing times; it has brought many refinements over the past several years in its format, content and structure. The depth of technical content, the multi-faceted, integrated approach to burning issues, the experience of professional stalwarts and the actionable knowledge insights made available ensure that every event delivers far, far more than expectations. Now the flagship event of the BCAS, it is an ideal breeding ground for interactive learning where participants with varied seniority and from vastly different cultures, geographies and experiences come under one roof to facilitate some thought-provoking dialogue and discussions.

The 53^rd Edition of the Residential Refresher Course (RRC) of the Bombay Chartered Accountants’ Society (BCAS) was no different. It was held at the pilgrim spot of Tirupati from Thursday the 9th to Sunday the 12th January, 2020. It attracted 138 participants from about 24 cities across the country.

The 2020 BCAS-RRC started with the promise of empowering the participants with the ‘Edge of Knowledge at the Cusp of the New Decade’. The participants reached the temple town of Tirupati on Thursday, 9^th January and straightaway plunged into a unique ice-breaking session. This session was aimed at stimulating interaction between the participants in order to enable far greater bonhomie between them over the course of the next few days.

BCAS President Manish Sampat launched the inaugural session by welcoming the participants and giving them a brief overview about the Society. Narayan Pasari, Chairman of the Seminar, Membership and Public Relations Committee, spoke about the RRC and detailed the schedule. The esteemed Guest of Honour, Ashok Dhere, BCAS Past President, delivered an excellent address on Professional Ethics. Suhas Paranjpe, Vice-President, and Pradeep Thanawala, Co-Chairman and Convener of the Committee, also graced the opening session.

The inaugural session was followed by the curtain-raiser Integrated Panel Discussion wherein Umesh Gala, Sunil Gabhawalla and Khozema Anajwala discussed the intricacies of case studies dealing with burning issues across the domains of direct taxation, indirect taxation and accounting, respectively. The panel was steered by Raman Jokhakar, Past President, and Anand Bathiya. At the end of the discussion, a rapid-fire round followed which showcased the wit and astuteness of the panellists in the face of impromptu questions being shot at them.

The second day, Friday, was the one that many were eagerly looking forward to. A visit to Sri Venkateswara Swamy Vaari Temple (Tirupati Balaji) was specially arranged for all the participants and everyone was blessed with the opportunity to have darshan in traditional attire.

Later that day, it was back to business, with V. Ramnath’s presentation on ‘Taxation Aspects of Capital Receipts’. This was followed by a group discussion on ‘Expert Case Studies in Accounting, Auditing and Company Law’ devised by Santosh Maller and presented by Chirag Doshi. The group discussion truly satiated the knowledge needs on the subject at hand and lived up to expectations as one of the most efficient modes of learning.

The Theme of the 2020 BCAS-RRC was focus on ‘Emerging Areas of Practice’. Handpicked thought-leadership sessions were arranged on various emerging areas of practice of (a) Forensic and Fraud Detection by Chetan Dalal, (b) Financial Re-engineering by Shagun Kumar, and (c) Risk Advisory / Internal Audit by Nandita Parekh.

A unique ‘40-Under-40’ open session was held on Saturday evening wherein 40 young CA attendees had an open house town-hall style discussion and obtained some practical insights from Nandita Parekh. Saturday night featured an entertainment event with participants singing and dancing along some popular retro Bollywood and new-age numbers for the musical housie.

On the final day, the participants discussed the paper on ‘Expert Case Studies on Direct Taxes’ written and presented by T. Banusekar. The participants reported tremendous benefit from the challenging case studies and detailed explanations provided by the paper writer. The concluding session witnessed feedback by a few participants, specially the first-timers, and an extensive vote of thanks to all those who helped in the planning, conduct and success of the RRC.

An event like the RRC facilitates various agendas. It is a common ground for knowledge-sharing, networking and exploring. For the organisers and participants, it is an experience of a lifetime. One more successful RRC
to the credit of team BCAS – till the 54^th RRC event next year!

shailesh.kwebmaker

REGULATION OF RELATED PARTY TRANSACTIONS – PROPOSED AMENDMENTS

BACKGROUND AND CURRENT STATUS OF
REGULATION OF RELATED PARTY TRANSACTIONS

Related party transactions are
transactions by a company with parties that are related to it or to certain
persons having some control over the company. Such transactions present a
classic case of conflict of interest where persons in control of the company
are in a position to approve such transactions where they have interest or
benefit. Related party transactions can thus be termed as a kind of corporate
nepotism. The objective of regulation is to ensure that there is oversight over
such transactions by independent persons, or that they are approved by other stakeholders,
or both. There are requirements also for extensive disclosures.

Thus, the Companies Act, 2013 (‘the
Act’) and the Rules made under it contain elaborate provisions for regulation
of related party transactions. SEBI, too, aims at regulating such transactions
independently through the SEBI LODR Regulations (‘the Regulations’). Since both
these sets of laws govern companies, there is obviously some concern about
conflicting provisions and even duplication / overlap which could result in
excessive compliance needs. Although attempts have been made to harmonise the
two sets of provisions, differences
still remain.

SEBI has recently undertaken an exercise
to review the provisions and a report has been released containing
recommendations for change. After receiving feedback and consultation, SEBI
will notify the final changes.

SCHEME OF PROVISIONS

While this article concerns itself with
the proposed changes in the SEBI LODR Regulations, it is worth reviewing
briefly the scheme of provisions both under the Act and the Regulations.

To begin with, there is the definition
of a ‘related party’. Several persons and entities are listed specifically or
descriptively as related parties. These include relatives and also various
parties with which specified persons in management have control or association.
The Regulations, too, provide a definition which takes the definition under the
Act as the starting point and adds the definition under the relevant accounting
standard.

Then there is the definition of related
party transactions. The Act provides a list of transactions which, if
with a related party, would be subject to regulation. The Regulations, however,
provide a generic descriptive definition and thus are wider in nature.

Next, we have the manner of regulation.
This is in two forms. The first is the manner of approval required. This is
broadly at two levels. All related party transactions require approval of the
Audit Committee and generally the Board. Certain transactions also require the
approval of shareholders. Where approval of shareholders is required, related
parties cannot vote to approve such transactions. Secondly, there are
requirements for disclosures of such transactions which are extensive and also
supplement the disclosures required under the applicable accounting standard.

CONCERNS

The provisions have seen repeated
reviews and changes over the short period since they have been in existence.
SEBI had set up a committee under the Chairmanship of Mr. Ramesh Srinivasan, MD
& CEO of Kotak Mahindra Capital Company Limited, which submitted its report
on 27^th January, 2020. SEBI has invited feedback on this by 26^th
February, 2020 after which one may expect SEBI to implement the changes by
suitably amending the Regulations.

The Committee has reviewed nearly every
major area of the provisions including the definitions of related party and
transactions, the threshold limits, the manner of approval, disclosures, etc.
Amendments, major and minor, have been suggested. The report, apart from giving
a detailed background and reasoning for proposing the changes, also gives the
exact language of the amendments. There are several advantages of these. One
will be able to know the exact language of the proposed amendments in course of
time. Concerns over ambiguities, difficulties, etc. can thus be pointed out
well in advance. Importantly, it will be easier for SEBI to notify the
amendments quickly.

Let us see in the following paragraphs
some of the important amendments proposed.

DEFINITION OF RELATED PARTY TO NOW
INCLUDE ALL PROMOTERS

Unlike many countries in the West, India
has a very large proportion of its companies promoted and controlled by family
groups. They hold a significant percentage of the total share capital, often
nearly half. Needless to add, generally they control the company for all
practical purposes on most matters.

At present, the Regulations define a
related party in two parts. One is the definition under the Act / or applicable
accounting standard, which itself is broad and includes many entities with
which directors / others may be associated. The second part consists of any
promoter who holds 20% or more of the share capital of the company.

However, there is an important lacuna
here. Even these wide definitions may still not include many entities connected
with the promoters. It is proposed that all promoters and members of the
promoter group would be now treated as related parties. Further, any entity
that directly / indirectly, along with relatives, holds 20% or more of the
share capital would also be treated as a related party.

Interestingly, to be considered as a
related party, the promoter will now not have to hold any shares.
Further, the person holding 20% or more may be a total outsider not connected
with the management at all.

There could be difficulties for the
company to compile a comprehensive list of these newly-covered entities. The
list of promoters, of course, should be readily available. However, identifying
persons who hold 20% or more may present some difficulties. Fortunately, a good
starting point would be the disclosures received from persons holding 5% or
more of the shares under the SEBI Takeover Regulations. However, the
definitions under the two laws are different in detail and hence it may still
be difficult for the company to prepare an accurate list of related parties
covered by these amendments.

TRANSACTIONS BETWEEN RELATED PARTIES OF
PARENT AND SUBSIDIARIES

Currently, transactions between the
company and its related parties are covered and to some extent between the
company and its subsidiaries. The concern is that certain sets of transactions
may get left out.

It is now proposed that transactions
between subsidiaries of the company and a related party either of the company
or its subsidiaries will be deemed to be related party transactions. Thus, the
following would now be related party transactions:

(i) Between the company and its related party;

(ii) Between the company and any related party
of any of its subsidiaries;

(iii) Between the subsidiaries of the company
and any related party of the company; and

(iv) Between the subsidiaries of the company
and any related party of any of its subsidiaries.

TRANSACTIONS WHOSE PURPOSE IS TO BENEFIT
RELATED PARTIES

It is now proposed to
cover transactions with any parties, ‘the purpose and effect of which is to
benefit a related party of the listed entity or any of its subsidiaries’.

The intention
obviously is to cover those transactions ostensibly carried out with a
non-related party but the intention and also the effect is to benefit related
parties. In a sense, the intention seems to be to cover indirect transactions.
The requirement is that not just the actual effect, but even the purpose
of the transaction has to be benefit to a related party. Arguably, a
transaction with an unintentional benefit to a related party ought not to be
covered. However, this aspect may need clarification.

No guidance is given
as to how to determine or even detect such transactions. It is very likely that
the management or person who is the related party would know about the benefit
and thus the onus would be on such person to inform the company.

It is also not clear
whether the benefit should be for the entire amount of the transaction or part
of it. For example, a contract may be given to a non-related party X, who may
sub-contract a part of the contract to a related party. If other conditions are
met, it would appear that such a contract should also get covered.

MATERIAL MODIFICATIONS LATER TO RELATED
PARTY TRANSACTIONS

Related party
transactions may be approved and transactions initiated but later they may
undergo modifications. At present, unless the modification is in the form of
entering into a de novo transaction, the modification may not get
covered. To ensure that material modifications also get covered, it is provided
that they require approval in the same manner as original transactions. It is
not clear what does the word ‘material’ mean. As this term is not defined, one
will have to adopt alternative definitions and interpretations of this term.

In case where the
transaction is by a subsidiary with a related party, the modification will
require approval only if certain specified thresholds are exceeded.

PRIOR APPROVAL OF SHAREHOLDERS

Certain material
transactions with related parties that are above the specified thresholds
require approval of shareholders at present. It is proposed that such approvals
should be taken prior to undertaking such transactions. This requirement
will also extend to material modifications to such transactions.

MODIFICATION IN CRITERION FOR DETERMINING
MATERIAL RELATED PARTY TRANSACTIONS

Transactions above a
certain threshold are deemed to be material. It is now provided that the
threshold shall be the lowest of the following:

(a) Rs.
1,000 crores;

(b) 5%
of consolidated revenues;

(d) 5%
of consolidated net worth (if positive).

This will
particularly affect very large companies for whom, as per the present
thresholds, even Rs. 1,000 crores of transactions were not ‘material’.

REVIEW REQUIREMENTS BY AUDIT COMMITTEE
AND DISCLOSURES TO SHAREHOLDERS

The Audit Committee
will now be required to mandatorily review certain aspects of the related party
transactions that are placed before it for approval. This, on the one hand,
provides guidance to the Audit Committee as to what specific factors to take
into account. On the other hand, it places responsibility on the Audit
Committee to go into these details.

It is also proposed
that the notice to shareholders for approval of material related party
transactions should give specific items of information. This again increases
transparency and enables the shareholders to take an informed decision on the
transactions. Interestingly, whether or not the Audit Committee approval was
unanimous has to be stated.

CONCLUSION

There are other
amendments proposed, too. And there are some other aspects of the amendments
apart from those discussed above. The final amendments as notified would be
worth going into in detail taking into account all the amendments.

As mentioned earlier,
SEBI has given some time for feedback on the proposed amendments. Considering
the past track record of SEBI, it is likely that the amendments may be notified
soon thereafter. It will have to be seen whether the amendments are put into
place immediately or phased out and also whether they are made applicable to
all companies or only to some.

The
responsibility of the company, and particularly of the Audit Committee, will
only increase after such amendments. Related party transactions are a source of
concern and even wrongdoings such as siphoning off profits / assets of
companies. The amended provisions may result in increased accountability by all
parties concerned.

For the Board
generally and for the Independent Directors / Audit Committee in particular, it
is not easy to determine whether all related party transactions are covered.
Ideally, the primary onus should be on the management / promoters and
particularly those persons with respect to whom the related party connection
exists with a counter party. If they fail to disclose their interest and
connection, it is possible that others may not even come to know. However, this
is not readily accepted in law and the Board / Independent Directors / Audit
Committee and even the Auditors will have to exercise diligence and care as
expected respectively from them. Their responsibility, and hence liability,
will only increase.

shailesh.kwebmaker

WORKPLACE SPIRITUALITY

Workplace spirituality is a novel
concept with potentially strong relevance to the well-being of individuals,
organisations and societies. The common problems faced by most of the corporates
are stress, absenteeism, organisational politics, absence of teamwork and so
on. And all these can be attributed to the absence of spirituality in the
workplace. Although the term spirituality in the workplace has increasingly
gained popularity in the past few years, there still seems to be too much of a
misconception, predominantly among managers, confusing spirituality with
religion.

However, Workplace Spirituality
(WPS) and Religion are distinctly separate. WPS is more focused on the theme of
tolerance, patience, the feel of interconnectivity, purpose and acceptability
to the norms of the organisation, all of these integrated to shape personal
values; religion, on the other hand, is marked by a specific belief system, a
particular system of faith and set of beliefs¹.

A study undertaken by MIT
University, USA, way back in 2010, wherein they interviewed senior executives,
HR executives and managers, defined ‘spirituality’ as ‘the basic feeling of
being connected with one’s complete self, others and the entire universe’. If a
single word best captures the meaning of spirituality and the vital role that
it plays in people’s lives, that word is ‘interconnectedness’. Those associated
with organisations they perceived as ‘more spiritual’ also saw their
organisations as ‘more profitable’. They reported that they were able to bring
more of their ‘complete selves’ to work. They could deploy more of their full
creativity, emotions and intelligence; in short, organisations viewed as more
spiritual get more from their participants, and vice versa. They believe
strongly that unless organisations learn how to harness the ‘whole person’ and
the immense spiritual energy that is at the core of everyone, they will not be
able to produce world-class products and services.

Benefits for the organisation
that adopts workplace spirituality:

(a) Enhanced trust among people;

(b) Increased interconnectedness;

(d) Job satisfaction;

(e) Positive task output;

(f) Community sense.

Eventually, it leads the
organisation towards excellence.

It will be wrong to say that only
for-profit organisations need to adopt WPS. Contrary to conventional wisdom,
working in a non-profit organisation (NPO) does not automatically make a person
more spiritually inclined. Many NPOs have specific political goals and are even
more concerned with obtaining hard results in the secular world than many
for-profit corporates. Whether an organisation is more or less spiritual
depends on the specific organisation, not its profit status.

What do organisations such as the
Tata Group, HUL, Wipro or Dabur have in common? Apart from other
characteristics, they are among a growing number of organisations that have
embraced workplace spirituality.

Spiritual organisations bring in
a strong sense of purpose to their members. They connect with the values of the
organisation. This helps develop a sense of job security, trust and openness.

Spirituality in leadership also
helps organisations fulfil their goal of effectiveness. When the leader in an
organisation is spiritually strong, it means that the culture prevailing in
that organisation would also be healthy and he
would act as a bridge between the managers and employees (partnership) to
communicate effectively and to feel themselves to be equally responsible for
organisational goals.

One wonders why such an important
topic has been neglected. Though more and more organisations are now accepting
this theory, the academic research gap is vast. It is time that we embrace
Workplace Spirituality at each one of our organisations to achieve overall
organisational, personal and community well-being.

_______________________________________

1 A study by Afsar & Rehman in 2015

shailesh.kwebmaker

‘SWATCHH HELL’

Four
men and four women died together. They were taken before Lord Yama, who does
ultimate justice to every human being after death. Depending upon the good or
bad work done in their lives, he sends them either to heaven or to hell. All
eight of them were pretty sure that they would go to heaven since they had done
a lot of genuine social service in their lives.

He
called the first gentleman and asked him about his deeds on earth. He said, ‘Lord,
I dedicated my entire life to spread education among common people. I founded
many educational institutions and made available value-based education in a
selfless manner. I received many honours from people as well as from the
government. I never accepted any capitation fees for admission. Thousands of
students still express their sense of gratitude to me.’

Lord
Yama asked his office administration about their views in the matter. The
secretary in Yama’s office said one of the trusts of this gentleman had
submitted his tax return two days late. Otherwise, he said, whatever was said
by the gentleman was true.

Instantly,
Lord Yama shouted ‘Send him to hell!’ The poor gentleman tried to explain that
the delay was due to circumstances beyond his control as there was an accident
in the trust’s office. But nobody heard his pleas.

The
second gentleman and a woman were doctors by profession and had been running a
charitable hospital for poor and indigent patients. They did not do any private
practice but only provided genuine health services to tribal people and needy
patients.

The
administration reported to the Lord that their audit report was not filed on
time in one of the years. The law had been changed, but Lord Yama sent them
also to hell. There was no question of hearing their arguments and requests.

Likewise,
all the others who really worked selflessly to serve the poor, the handicapped
and mentally retarded people, supporting destitute women, serving those
suffering from terminal diseases, orphans, preserving the environment and so
on, who had done many socially needed and beneficial things, had failed to
submit some form or other in the prescribed time. Obviously, all of them were
sent to hell.

Lord
Yama’s secretary declared: ‘Doing genuine social work hardly matters to us. How
many lives you saved is not important. Rather, you interfered with the work of
Yamadoots (Yama’s servants). How many poor people or unfortunate children and
women you helped is none of our concern. Even if people suffer or die, it is of
no consequence to us. You should submit all forms in time. We will never
condone any delay.’

Then,
he was overheard sharing a secret, that Lord Yama really wanted some genuine,
good social workers in hell. But he felt that these eight persons were not
enough. To encourage more people to go to hell, he pressured the Minister to
introduce the procedure of re-registration for all the charitable trusts and
their renewal every five years.

It is
reported that many trustees have either died of heart attack or committed
suicide after hearing of this new procedure. And it is believed that they are
also taking their respective CAs along with them!

I’m
sure this will facilitate the process of ‘Swatchh Hell’!

shailesh.kwebmaker

TRANSMISSION OF TENANCY

INTRODUCTION

One of the biggest
questions that invariably crops up when preparing a Will is, ‘Can I bequeath my
tenanted property?’ This is especially true in a city like Mumbai where
tenanted properties are very valuable. Tenanted property could be in the form
of residential flats or commercial properties. A person can make a Will for any
and every asset that he owns. Hence, the issue which arises is, can a person
bequeath a property of which he is only a tenant? In the State of Maharashtra,
the provisions of the Maharashtra Rent Control Act, 1999 (the Act) are also
relevant. Let us analyse this important issue in more detail.

RENT ACT
PROVISIONS

Section 7(15) of the Act defines the
term ‘tenant’ as any person by whom rent is payable for any premises. Further,
when the tenant dies, the term includes:

(a) in the case of residential tenanted
premises, any member of his family who is residing with the tenant at the time
of his death; or

(b) in the case of a tenanted premises
which is used for educational, business, trade or storage purposes, any member
of his family who, at the time of the tenant’s death, is using the premises for
such purpose.

Moreover, in the absence of any family
member of the tenant, any heir of the tenant as may be decided by the Court in
the absence of any agreement will be the tenant. These provisions are
applicable to transmission of tenancy by the original tenant as well as by any
subsequent tenants.

The term family has not been defined
under the Act and, hence, the general definition of the term would have to be
taken. It is a term which is open to very wide interpretation and is quite
elastic. The Bombay High Court in Ramubai vs. Jiyaram Sharma, AIR 1964
Bom 96, has held that the term family would mean all those who are
connected by blood relationship or marriage, married / unmarried / widowed
daughters, widows of predeceased heirs, etc. The Black’s Law Dictionary
defines the term as those who live in the same household subject to general
management and control of the head. Another definition is a group of blood
relatives and all the relations who descend from a common ancestor, or who
spring from a common root, i.e., a group of kindred persons. Hence, it is a
very generic term.

From the above definition of the term
tenant under the Act, it is very clear that only those family members of the
tenant who are residing with him would be entitled to his tenancy after his
demise. It is also relevant to note that the family members need not
necessarily be legal heirs of the tenant and the legal heirs would get the
tenancy only in the absence of any family members and that, too, on
determination by a competent Court. Residing with the tenant means that the
family members must stay, eat and sleep in the same house as the tenant. This
is a question of fact as to whether or not a family member can be said to be
residing with the deceased tenant.

However, in the case of non-residential
premises, the family members must be using the property along with the tenant.
Thus, in case of such premises it is not necessary that they reside with the
tenant but they must use the premises for the purposes for which the tenant was
using the same. In the case of Pushpa Rani and Ors. vs. Bhagwanti Devi,
AIR 1994 SC 774, the Supreme Court held that when a tenant dies, it is
the person who continued in occupation of and carried on business in the
business premises alone with whom the landlord should deal and other heirs must
be held to have surrendered their right of tenancy.

The Supreme Court in the case of Vasant
Pratap Pandit vs. Dr. Anant Trimbak Sabnis, 1994 SCC (3) 481 has held
that the legislative prescription of this provision of the Act is first to give
protection to the members of the family of the tenant residing with him at the
time of his death. The basis for this is that when a tenant is in occupation of
premises, the tenancy is taken by him not only for his own benefit but also for
the benefit of the members of the family residing with him. Therefore, when the
tenant dies, protection should be extended to the members of the family who
were participants in the benefit of the tenancy and for whose needs as well the
tenancy was originally taken by the tenant. It is for this object that the
legislature has, irrespective of the fact whether such members are ‘heirs’ in
the strict sense of the term or not, given them the first priority to be
treated as tenants. All the heirs are liable to be excluded if any other member
of the family was staying with the tenant at the time of his death.

The Bombay High Court was faced with an
interesting question in the case of Vasant Sadashiv Joshi vs. Yeshwant
Shankar Barve, WP 2371/1997. Here, the tenant resided in a premises
along with his brother. The tenant and his brother were part of an HUF. After
the tenant’s death, the brother’s son contended that since the family members
were recognised as tenants, the joint family itself should also be recognised
as a tenant. The High Court negated this plea and held that the term only
included a single person as a tenant and it was not possible that every member
of the HUF would become a tenant. It held that when a landlord grants a tenancy
it is a contract of tenancy as entered into with a specific person (tenant).
The landlord expects fulfilment of legal obligations from the tenant. The law,
therefore, does not envisage that the landlord would be required to deal with
all members of the joint family.

Similarly, in Vimalabai Keshav
Gokhale vs. Avinash Krishnaji Binjewale, 2004 (1) Bom CR 839, the High
Court rejected the contention that the Bombay Rent Act would enable each and
every member of the tenant’s family to claim an independent right in respect of
the tenancy and held that any member would mean ‘any one member.’

The Bombay High Court in Urmi
Deepak Kadia vs. State of Maharashtra, 2015(6) Bom CR 354 considered
whether the Maharashtra Rent Control Act was contrary to the Hindu Succession
Act, 1956 since it provided protection only to those heirs of the deceased who
at the time of his demise were staying with him and not to others. It held that
the field covered by two laws was not the same but entirely different. The Rent
Act sought to prevent exploitation of tenants and ensured a reasonable return
for investment in properties by landlords. In some contingencies u/s 7(15) of
the Rent Act, certain heirs were unable to succeed to a statutory tenancy. To
this extent, a departure was made from the general law. In such circumstances,
the observations of the Apex Court in Vasant Pratap’s case (Supra)
were decisive. Hence, it concluded that the Rent Act did not interfere with the
Hindu Succession Act.

HEIRS OF
TENANT SUCCEED IN ABSENCE OF FAMILY MEMBERS

The Act further provides that in the
absence of family members, it is the heirs of the tenant who would succeed to
the tenanted premises. The term heirs has not been defined under the Act and
hence one needs to have recourse to the usually understood meaning. The Supreme
Court in the case of Vasant Pratap (Supra) has dealt with the
definition of the term heirs. It means the persons who are appointed by law to
succeed to the estate in case of intestacy. It means a person who succeeds,
under law, to an estate in lands, tenements, or hereditaments, upon the death
of his ancestor, by descent and right of relationship. The term is used to
designate a successor to property either by Will or by law. The Court further
held that a deceased person’s ‘heirs at law’ are those who succeed to his
estate by inheritance under law, in the absence of a Will.

The Supreme Court in the case of Ganesh
Trivedi vs. Sundar Devi (2002) 2 SCC 329 had held that the brother of a
male tenant would be his heir. However, an interesting question arose in Durga
Prasad vs. Narayan Ram Chandaani (D) Thr. Lr. CA 1305/2017 (SC) as to
whether the brother of a married female tenant could be treated as her legal
heir and thus become the tenant after her demise? In this case before the
Supreme Court, a person had taken a residential property on rent. After his
demise his son became the tenant and after his son’s demise, his
daughter-in-law became the tenant. The question arose as to who would become
the tenant on her demise as she did not have any children. Her brother claimed
that he was a part of the deceased tenant’s family and hence he should inherit
the property. This was a property located in UP, so the Apex Court considered
the provisions of the U.P. Rent Act. Under that Act, the heirs of a tenant residing
with him succeed to the premises on the tenant’s death.

The Supreme Court held that the
question falling for consideration was whether the brother of the tenant was an
heir under the U.P. Rent Act. Since the term heir was not defined under the
Act, it held that heir was a person who inherited by law. Section 3(1)(f) of
the Hindu Succession Act, 1956 defined an heir to mean any person, male or
female, who was entitled to succeed to the property of an intestate under the
Act. The word heir had to be given the same meaning as would be applicable to
the general law of succession. The deceased tenant being a Hindu female, the
devolution of tenancy would be determined u/s 15 of the Hindu Succession Act.
Sub-section (2) of section 15 carved out an exception to the general scheme and
order of succession of a Hindu female dying intestate without leaving any
children. If such a woman has inherited property from her husband /
father-in-law, then the property devolved upon her husband’s heirs. The Apex Court
held that since she did not have any children and the tenancy in question had
come from the tenant’s father-in-law to her husband and from her husband to the
tenant, the exception contained in section 15(2) of the Hindu Succession Act
would apply. Accordingly, since her brother was not an heir of her husband, he
was not entitled to succeed to the tenancy in question.

CAN THE TENANT
MAKE A WILL?

This brings us to the important
question of whether a tenant can will away his tenanted premises? In the case
of Gian Devi Anand vs. Jeevan Kumar, (1985) 2 SCC 683, a
Constitution Bench of the Supreme Court held that the rule of heritability
(capable of being inherited) extends to statutory tenancy of commercial as well
as residential premises in States where there is no explicit provision to the
contrary under the Rent Act and tenancy rights are to devolve according to the
ordinary law of succession, unless otherwise provided in the statute. In Bhavarlal
Labhchand Shah vs. Kanaiyalal Nathalal Intawala, referring to the
Bombay Rent Control Act, 1974, it was held that a tenant of a non-residential
premises cannot bequeath under a Will his right to such tenancy in favour of a
person who is a stranger, not being a member of the family, carrying on
business. In State of West Bengal vs. Kailash Chandra Kapur, (1997) 2 SCC
387, it was held that in the absence of any contrary covenants in the
lease deed or the law, a Will in respect of leasehold rights in a land can be
executed by a lessee in favour of a stranger.

Hence, if the Rent Control laws of a
State so provide, then a tenant cannot make a Will for his tenanted premises.
In that event, the tenancy would pass on only in accordance with the Rent
Control Act. This proposition is also supported by the Supreme Court’s decision
in the case of Vasant Pratap (Supra). In that case, the tenant
made a Will of her property in favour of her nephew. This was opposed by her
sister’s grandson who was staying with the tenant at the time of her death. The
Apex Court held that normally speaking, tenancy right would be heritable but if
the right to inherit had been restricted by legislation, then the same would
apply. It held that if the word ‘heir’ in the Rent Act was to be interpreted to
include a ‘legatee under a Will’, then even a stranger may have to be inducted
as a tenant for there is no embargo upon a stranger being a legatee under a
Will. This obviously was not the intention of the legislature. Accordingly, it
was held that a bequest could not be made in respect of a tenanted property.

The Supreme Court’s decision in the
case of Gaiv Dinshaw Irani vs. Tehmtan Irani, (2014) 8 SCC 294
succinctly sums up the position after considering all previous decisions on
this issue:

‘…in general
tenancies are to be regulated by the governing legislation, which favour that
tenancy be transferred only to family members of the deceased original tenant.
However, in light of the majority decision of the Constitution Bench in Gian
Devi vs. Jeevan Kumar (Supra), the position which emerges
is that in absence of any specific provisions, general laws of succession to
apply, this position is further cemented by the decision of this Court in State
of West Bengal vs. Kailash Chandra Kapur (Supra) which has allowed
the disposal of tenancy rights of Government owned land in favour of a stranger
by means of a Will in the absence of any specific clause or provisions.’

CONCLUSION

The law as it stands in the State of
Maharashtra is very clear. A tenancy cannot be bequeathed by way of a Will. It
would pass only in accordance with the Rent Act. However, the position in other
States needs to be seen under the respective Rent Acts, if any.

shailesh.kwebmaker

UNCERTAINTY OVER INCOME TAX TREATMENTS

Ind
AS 12 Uncertainty over Income Tax Treatments (Appendix C) is effective
for the financial years beginning 1^st April, 2019. An ‘uncertain tax
treatment’ is a tax treatment for which there is uncertainty over whether the
relevant taxation authority will accept the tax treatment under tax law. For
example, an entity’s decision not to submit any income tax filing in a tax
jurisdiction, or not to include particular income in taxable profit, is an
uncertain tax treatment if its acceptability is uncertain under tax law.

Uncertain
tax treatments generally occur where there is uncertainty as to the meaning of
the law, or to the applicability of the law to a particular transaction, or
both. For example, the tax legislation may allow the deduction of research and
development expenditure, but there may be disagreement as to whether a specific
item of expenditure falls within the definition of eligible research and
development costs in the legislation. In some cases, it may not be clear how
tax law applies to a particular transaction, if at all.

One
of the questions that was not clear in Appendix C was with respect to the presentation
of uncertain tax liabilities / assets. Whether, in its statement of financial
position, an entity is required to present uncertain tax liabilities as current
(or deferred) tax liabilities or, instead, within another line item such as
provisions? A similar question could arise regarding uncertain tax assets.

The
presentation of uncertainty over income tax treatments is very sensitive as it
may lead the Income-tax authorities to draw conclusions on the entities’
conclusion over the outcome of the uncertainty, or may provide information that
may lead to an investigation. Therefore, given a choice, entities would like to
combine uncertain tax provisions with another line item such as provisions.

AUTHOR’S RESPONSE

The
following points are relevant to respond to the question:

(i)
uncertain tax liabilities or assets
recognised applying Appendix C are liabilities (or assets) for current tax as
defined in Ind AS 12 Income Taxes, or deferred tax liabilities, or
assets as defined in Ind AS 12; and

(ii)
neither Ind AS 12 nor Appendix C
contain requirements on the presentation of uncertain tax liabilities or
assets. Therefore, the presentation requirements in Ind AS 1 Presentation of
Financial Statements apply. Paragraph 54 of Ind AS 1 states that ‘the
statement of financial position shall include line items that present:… (n)
liabilities and assets for current tax, as defined in Ind AS 12; (o) deferred
tax liabilities and deferred tax assets, as defined in Ind AS 12…’

Therefore,
applying Ind AS 1, an entity is required to present uncertain tax liabilities
as current tax liabilities (paragraph 54[n]) or deferred tax liabilities
(paragraph 54[o]); and uncertain tax assets as current tax assets (paragraph
54[n]), or deferred tax assets (paragraph 54[o]).

Similarly,
Ind AS Schedule III to the Companies Act 2013 requires separate
presentation of current tax asset, current tax liability, deferred tax asset
and deferred tax liability. Additionally, General Instruction No. 2 for
preparation of financial statements of a company required to comply with Ind AS
clarifies that the requirements of Ind AS will prevail over Schedule III, if
there are any inconsistencies.

In
particular, one should note that:

(a)
when there is uncertainty over
income tax treatments, Appendix C specifies how an entity reflects any effects
of that uncertainty in calculating current or deferred tax in accordance with
Ind AS 12. Paragraph 4 of Appendix C states (emphasis added):

‘This
Appendix clarifies how to apply the recognition and measurement requirements in
Ind AS 12 when there is uncertainty over
income tax treatments. In such a circumstance, an entity shall recognise and
measure its current or deferred tax asset or liability applying the
requirements in Ind AS 12 based on taxable profit (tax loss), tax bases,
unused tax losses, unused tax credits and tax rates determined applying this
Appendix.’

(b)
An entity therefore applies
Appendix C in determining taxable profit (tax loss), tax bases, unused tax
losses, unused tax credits and tax rates when there is uncertainty over income
tax treatments. These amounts are in turn used to determine current / deferred
tax applying Ind AS 12, which in turn flow through to be current / deferred tax
liabilities if the amounts relate to the current or prior periods but are
unpaid / unreversed.

(c)
Appendix C requires an entity to
reflect the effect of uncertainty in determining taxable profit, tax rates,
etc. when it concludes that it is not probable that the taxation authority will
accept an uncertain tax treatment (paragraph 11 of Appendix C). Consequently,
the taxable profit on which current tax, as defined in Ind AS 12, is calculated
is the taxable profit that reflects any uncertainty applying Appendix C. The
definition of current tax in paragraph 5 of Ind AS 12 does not limit the
taxable profit (tax loss) used in determining current tax to the amount
reported in an entity’s income tax filings. Instead, the definition refers to
(emphasis added) ‘the amount of income taxes payable (recoverable) in respect
of the taxable profit (tax loss) for the period’.

(d)
Paragraph 54 of Ind AS 1 states:

‘The
statement of financial position shall include line items that present the
following amounts:…

(l)
provisions;…

(n)
liabilities and assets for current tax, as defined in Ind AS 12 Income Taxes;

(o)
deferred tax liabilities and deferred tax assets, as defined in Ind AS 12;…’

Particularly,
requirements in paragraphs 54(n) and 54(o) of Ind AS 1 will preclude an entity
from presenting some elements of income tax within another line in the
statement of financial position, such as provisions. In particular, paragraph
29 of Ind AS 1 states ‘…an entity shall present separately items of a
dissimilar nature or function unless they are immaterial’. Paragraph 57 of
Ind AS 1 states that ‘…paragraph 54 simply lists items that are sufficiently
different in nature or function to warrant separate presentation in the
statement of financial position.’ Consequently, liabilities for current
(or deferred) tax as defined in Ind AS 12 are sufficiently different in nature
or function from other line items listed in paragraph 54 to warrant presenting
such liabilities separately in their own line item (if material).

CONCLUSION

When
there is uncertainty over income tax treatments, paragraph 4 of Appendix C
requires an entity to ‘recognise and measure its current or deferred tax asset
or liability applying the requirements in Ind AS 12 based on taxable profit
(tax loss), tax bases, unused tax losses, unused tax credits and tax rates determined
applying Appendix C’. Paragraph 5 of Ind AS 12 Income Taxes defines:

(1)
current tax as the amount of income
taxes payable (recoverable) in respect of the taxable profit (tax loss) for a
period; and

(2)
deferred tax liabilities (or
assets) as the amounts of income taxes payable (recoverable) in future periods
in respect of taxable (deductible) temporary differences and, in the case of
deferred tax assets, the carry forward of unused tax losses and credits.

Consequently,
uncertain tax liabilities or assets recognised applying Appendix C are
liabilities (or assets) for current tax as defined in Ind AS 12, or deferred
tax liabilities or assets as defined in Ind AS 12.

Neither
Ind AS 12 nor Appendix C contains requirements on the presentation of uncertain
tax liabilities or assets. Therefore, the presentation requirements in Ind AS 1
apply. Paragraph 54 of Ind AS 1 states that ‘the statement of financial
position shall include line items that present:… (n) liabilities and assets for
current tax, as defined in Ind AS 12; (o) deferred tax liabilities and deferred
tax assets, as defined in Ind AS 12…’.

Paragraph
57 of Ind AS 1 states that paragraph 54 ‘lists items that are sufficiently
different in nature or function to warrant separate presentation in the
statement of financial position’. Paragraph 29 requires an entity to ‘present
separately items of a dissimilar nature or function unless they are
immaterial’.

Accordingly, applying
Ind AS 1, an entity is required to present uncertain tax liabilities as current
tax liabilities (paragraph 54[n]) or deferred tax liabilities (paragraph
54[o]); and uncertain tax assets as current tax assets (paragraph 54[n]) or
deferred tax assets (paragraph 54[o]).

shailesh.kwebmaker

Revision – Section 263 of ITA, 1961 – Diversion of income by overriding title – Interpretation of Will – Testator’s direction to executor of Will to sell property and pay balance to assessee after payment to trusts and expenses – Expenses and payments to trusts stood diverted before they reached assessee – Order of A.O. after due inquiry accepting assessee’s offer to tax amount of sale consideration – Revision erroneous; A.Y. 2012-13

39. Kumar Rajaram vs. ITO(IT) [2020] 423 ITR 185 (Mad.) Date of order: 5^th August, 2019 A.Y.: 2012-13

Revision – Section 263 of ITA, 1961 –
Diversion of income by overriding title – Interpretation of Will – Testator’s
direction to executor of Will to sell property and pay balance to assessee
after payment to trusts and expenses – Expenses and payments to trusts stood
diverted before they reached assessee – Order of A.O. after due inquiry
accepting assessee’s offer to tax amount of sale consideration – Revision
erroneous; A.Y. 2012-13

The assessee was a non-resident. During the
A.Y. 2012-13 he derived income from capital gains and interest income assessed
under the head ‘Other sources’. The assessee’s father bequeathed land and
residential property to him under a Will and testament with directions to the
executor of the Will. The executor was to give effect to the terms and
conditions of the Will and dispose of his properties as stated by him in the
Will. The executor was entitled to professional fees and all expenses for the
due execution of the Will from and out of the estate of the deceased testator.
The executor was to arrange to sell the property after a period of one year
from the date of his demise so as to accommodate his wife for her stay and
distribute the sale proceeds in favour of four charitable institutions
specifying the amount to be paid to each of them after incurring the necessary
expenses towards stamp duty, fees to the executor, etc. The balance sale
consideration was to be paid to the assessee who was to repatriate, according
to the Reserve Bank of India Rules, the amount so received for the education of
his children.

Accordingly, the assessee received a sum of
Rs. 8,19,50,000. The A.O. issued notices under sections 143(2) and 142(1) along
with a questionnaire. In response to the notice u/s 142(1), the assessee
submitted the details including the last Will and testament executed by his
father, a copy of the sale deed, the legal opinion obtained from his counsel
regarding the eligibility for exclusion of the payments to the charitable
institutions and remuneration to the executor in computing the long-term
capital gains on sale of the property. The A.O. accepted the claim of the
assessee in respect of the expenses and passed an order u/s 143(3) and accepted
the sale consideration as mentioned by the assessee in his return of income.
However, the plea raised by the assessee with regard to the indexation of the
cost was not accepted and the A.O. allowed indexation only from the financial
year 2011-12 in accordance with Explanation (iii) in section 48.

The Commissioner issued a notice u/s 263
proposing to disallow the exclusion of the sum of Rs. 68,02,500 being the
payment made to the charitable institutions and the sum of Rs. 8,02,500 being
the professional fees of the executor of the Will and the other expenditure
incurred in connection with the sale of the property. The Commissioner
disallowed the exclusion of Rs. 68,02,500 and directed the A.O. to re-compute
the total income and the tax thereon.

The Tribunal affirmed the order of the
Commissioner that the exclusion of the payments made by the assessee by
applying the diversion of income by overriding the title could not be allowed
and that there was no evidence for professional fee, commission paid, etc.

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

‘i) The Commissioner could not have invoked
the power u/s 263. While issuing the show cause notice u/s 263 he did not rely
upon any independent material or on any interpretation of law but on perusal of
the records and was of the view that the expenditure could not be allowed as
deduction u/s 48(i). The Commissioner had conducted a roving inquiry and
substituted his view for that of the view taken by the A.O. who had done so
after conducting an inquiry into the matter and after calling for all documents
from the assessee, one of which was the last Will and testament executed by the
assessee’s father.

ii) The A.O. after perusal of the copy of
the last Will and testament of the assessee’s father, the sale deed of the
property and the legal opinion given by the counsel for the assessee, had taken
a stand and passed the order. Therefore, it could not be stated that the A.O.
did not apply his mind to the issue. It was not the case of the Commissioner
that there was a lack of inquiry or inadequate inquiry.

iii) The testator bequeathed only a portion
of the sale consideration left over after effecting payments directed to be
made by him. The use of the expression “absolutely” occurring in the Will was
to disinherit the testator’s third wife from being entitled to any portion of
the funds and all that the testator stated was not to sell the property for one
year till his wife vacated the house. The sale deed recorded that the
stepmother of the assessee had in unequivocal terms agreed to the sale and had
vacated the property and granted no objection for transfer of the property.
There was a specific direction to the executor to pay specific sums of money to
the charitable institutions, clear the property tax arrears, claim his
professional fee, meet the stamp duty expenses and pay the remaining amount to
the assessee. The order passed by the Commissioner was erroneously confirmed by
the Tribunal.

iv) The Tribunal erred in holding that the
exclusion of payment to charities by applying the principle of diversion of
income by overriding title could not be allowed. The assessee at no point of
time was entitled to receive the entire sale consideration. The sale was to be
executed by the executor of the Will who was directed to distribute the money
to the respective organisations, defray the expenses, pay the property tax,
deduct his professional fee and pay the remaining amount to the assessee.
Therefore, to interpret the Will in any other fashion would be doing injustice
to the intention of the testator and the interpretation given by the
Commissioner was wholly erroneous. The intention of the testator was very clear
that the assessee was not entitled to the entire sale consideration. The
testator did not bequeath the property but part of the sale consideration which
was left behind after meeting the commitments mentioned in the Will to be truly
and faithfully performed by the executor of the Will. The major portion of the
sale consideration on being received from the purchaser of the property stood
diverted before it reached the assessee and under the Will there was no
obligation cast upon the assessee to receive the sale consideration and
distribute it as desired by the testator.

v) The
assessee had produced the copies of the receipts signed by the respective
parties before the A.O. who was satisfied with them in the absence of any fraud
being alleged with regard to the authenticity of those documents. The order of
the Tribunal in not allowing the sum of Rs. 8,02,500 being expenditure incurred
in connection with the sale alleging that there was no evidence when the
evidence in support was on record, was not justified and the expenditure was
allowable u/s 48(i). The Commissioner could not have revised the assessment by
invoking section 263.’

shailesh.kwebmaker

Reassessment – Sections 124(3), 142(1), 143(3), 147, 148 of ITA, 161 – Notice u/s 148 – Assessment proceedings pursuant to notice u/s 142(1) pending and time for completion of assessment not having lapsed – Issue of notice u/s 148 not permissible – That assessee had not objected to jurisdiction of A.O. not relevant; A.Ys. 2011-12

38. Principal CIT vs. Govind Gopal Goyal [2020] 423 ITR 106 (Guj.) Date of order: 15^th July, 2019 A.Y.: 2011-12

Reassessment – Sections 124(3), 142(1),
143(3), 147, 148 of ITA, 161 – Notice u/s 148 – Assessment proceedings pursuant
to notice u/s 142(1) pending and time for completion of assessment not having
lapsed – Issue of notice u/s 148 not permissible – That assessee had not
objected to jurisdiction of A.O. not relevant; A.Ys. 2011-12

The Directorate of Revenue Intelligence
received information that the assessee had undervalued the import price of polyester films during the A.Y. 2011-12. At the relevant point of time, it was noticed that the assessee had not filed
his return of income for the A.Y. 2011-12. Therefore, a notice dated 1^st December, 2011 u/s
142(1) was issued against the assessee to furnish his return of income for the A.Y. 2011-12 by 9^th December, 2011. The assessee did not file his return of income and submitted a letter dated 3^rd January, 2012,
stating that his books of accounts and other records were seized by the Directorate of Revenue Intelligence and that he had
applied to be provided with a copy of the books of accounts and other records
and informed the A.O. that he would file his return of income once he was
provided with the books and other records. While the assessment proceedings
initiated u/s 142(1) were pending, the A.O. issued a notice dated 16^thJanuary,
2013 u/s 148 against the assessee to file his return of income for the A.Y.
2011-12. The assessment proceedings were completed, making an addition on
account of unexplained expenditure u/s 69C and estimating the net profit.

The Tribunal held that when the assessment
proceedings were already initiated by issuing of notice u/s 142(1) calling for
the return of income, no notice u/s 148 should have been issued and the
assessment was required to be completed within the time limit allowed u/s
143(3) or section 144.

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

‘i) It is settled law that unless the return
of income filed by the assessee is disposed of, notice for reassessment u/s 148
cannot be issued, i.e., no reassessment proceedings can be initiated so long as
the assessment proceedings are pending on the basis of the return already filed
(and) are not terminated.

ii) If an assessment is pending either by
way of original assessment or by way of reassessment proceedings, the A.O.
cannot issue a notice u/s 148.

iii) Section 142(1) and section 148 cannot
operate simultaneously. There is no discretion vested with the A.O. to utilise
either of them. The two provisions govern different fields and can be exercised
in different circumstances. If income escapes assessment, then the only way to
initiate assessment proceedings is to issue a notice u/s 148.

iv) Income
could not be said to have escaped assessment u/s 147 when the assessment proceedings
were pending. If the notice had already been issued u/s 142 and the proceedings
were pending, a return u/s 148 could not be called for. The Tribunal had
applied the correct principle of law and had passed the order holding that the
assessment order passed u/s 143(3) read with section 147 was bad in law and
could not be sustained. Section 124(3) which stipulates a bar to any contention
about lack of jurisdiction of an A.O. would not save the illegality of the
assessment in the assessee’s case.’

shailesh.kwebmaker

Settlement of cases – Section 245C of ITA, 1961 – Black Money Act, 2015 – Jurisdiction of Settlement Commission – Undisclosed income of non-resident Indians – Charge under Black Money Act only from A.Y. 2016-17 – Pending reassessment proceedings order of Settlement Commission for A.Y. 2004-05 to 2015-16 – Order of Settlement Commission is valid

47. Principal CIT vs.
IT Settlement Commission; [2020] 420 ITR 149
(Guj.) Date of order: 8^th
November, 2019 A.Ys.: 2004-05 to
2015-16

Settlement of cases –
Section 245C of ITA, 1961 – Black Money Act, 2015 – Jurisdiction of Settlement
Commission – Undisclosed income of non-resident Indians – Charge under Black
Money Act only from A.Y. 2016-17 – Pending reassessment proceedings order of
Settlement Commission for A.Y. 2004-05 to 2015-16 – Order of Settlement
Commission is valid

A search and seizure operation came to
be carried out at the residential and business premises of the B group of
companies of which the assessees were directors. Pursuant to the search,
notices under sections 148 and 153A of the Income-tax Act, 1961 were issued to
the three assessees for the A.Ys. 2005-06 to 2013-14, 2004-05 to 2015-16, and
2004-05 to 2015-16, respectively. In response thereto, the assessees filed
income tax returns disclosing undisclosed foreign income and assets.
Thereafter, they filed separate applications u/s 245C of the 1961 Act before
the Settlement Commission disclosing additional undisclosed foreign income and
assets. The Settlement Commission passed an order on 30^thJanuary,
2019 settling the cases and granting reliefs. On 18^th February,
2019, the A.O. passed orders giving effect to the order of the Settlement
Commission and determined the additional tax payable and issued notices of
demand u/s 156 of the Act on the same day. Each of the assessees paid the
additional tax payable.

On a writ petition filed by the Department
on 30^th May, 2019 challenging the orders passed by the Settlement
Commission as without jurisdiction since the Settlement Commission had no
jurisdiction to pass an order under the 1961 Act in relation to undisclosed
foreign income and assets covered under the 2015 Act, the Gujarat High Court
dismissed the petition and held as under:

‘i) On a conjoint reading of sections 3 and 2(9)
of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of
tax Act, 2015, it is clear that undisclosed foreign income or assets become
chargeable to tax from the A.Y. 2016-17. However, when undisclosed foreign
assets become chargeable to tax from the A.Y. 2016-17 onwards, the date of
acquisition of such assets may relate to any assessment year prior to the A.Y.
2016-17. Therefore, even after the coming into force of the 2015 Act, insofar
as assessment years prior to the A.Y. 2016-17 are concerned, the undisclosed
foreign income would be chargeable to tax under the relevant provisions of the
Income-tax Act, 1961.

ii) What sub-section (3) of section 4 of the 2015
Act provides is that what is included as income and asset under the 2015 Act
cannot be included in the total income under the 1961 Act. The said sub-section
does not contain a non obstante clause ousting the applicability of the
1961 Act, insofar as undisclosed foreign income and assets are concerned. The
2015 Act is a taxing statute and provides for stringent penalties and
prosecution and it is by now well settled that a taxing statute must be
interpreted in the light of what is clearly expressed. The second proviso
to section 147 of the 1961 Act does away with the limitation of four years as
provided in the first proviso to section 147 in the case of undisclosed
foreign income. By virtue of clause (c) of sub-section (1) of section 149, the
time limit for reopening of assessments has been extended to sixteen years in
respect of any asset, including financial interest in any entity located
outside India, so that the bar applies for periods beyond sixteen years in such
cases. Clearly, therefore, the scheme of the Income-tax Act, 1961 is not meant
to tax only disclosed foreign income but also undisclosed foreign income.

iii) It was an admitted position that the
residential status of two of the assessees was non-resident for the A.Y.
2016-17 and for the third for the A.Y. 2014-15 onwards. Thus, when the 2015 Act
came into force, the assessees were not residents. It could not be said that
the assessees fell within the ambit of the expression ‘assessee’ as defined
under clause (2) of section 2 of the 2015 Act as it stood prior to its
amendment by the Finance (No. 2) Act of 2019. The expression ‘assessee’ was
amended on 1^st August, 2019, albeit with retrospective effect
from 1^st July, 2015, and as on the date when the Settlement
Commission passed the order, namely, 30^thJanuary, 2019, the
assessees were not ‘assessees’ within the meaning of such expression as
contemplated u/s 2(2) of the 2015 Act and were, therefore, not covered by the
provisions of that Act. The search proceedings were conducted after the 2015
Act came into force and, consequently, the notices under sections 148 and 153A
of the 1961 Act were also issued after the 2015 Act came into force. The fact
that these notices under sections 148 and 153A of the 1961 Act were issued in
respect of undisclosed foreign income or assets could be substantiated on a
perusal of the reasons recorded for reopening the assessment for the A.Y.
2000-01.

The Revenue authorities were well aware
of the fact that the provisions of the 2015 Act covered undisclosed foreign
income only from the A.Y. 2016-17 onwards and, therefore, categorically
submitted to the jurisdiction of the Settlement Commission and requested it to
proceed further pursuant to the applications made by the assessees u/s 245C of
the Income-tax Act, 1961. It was only for this reason that notices under the
2015 Act were issued only for the A.Ys. 2017-18 and 2018-19. The A.O. had
issued notices under sections 148 and 153A of the 1961 Act for different
assessment years. Therefore, proceedings for assessment or reassessment as
contemplated under clauses (i) and (iiia) of the Explanation to clause (b) of
section 245A had commenced and were pending before the A.O. when the
applications u/s 245C of the 1961 Act came to be made. Therefore, the
requirements of the provisions of section 245C of the 1961 Act were duly
satisfied when the applications thereunder came to be made by the assessees.
Upon receipt of the applications made u/s 245C of the 1961 Act, the Settlement
Commission proceeded further in accordance with the provisions of section 245D
of the 1961 Act. At the stage when it was brought to its notice that notices
u/s 10 of the 2015 Act had been issued to the assessees, the Settlement
Commission gave ample opportunity to the Revenue to decide what course of
action it wanted to adopt, and it was the Revenue which categorically invited
an order from the Settlement Commission in respect of the undisclosed foreign
income and assets disclosed before it.

The record of the case showed that the
requirements of section 245D of the 1961 Act had been duly satisfied prior to
the passing of the order u/s 245D(4). The proceedings before the Settlement
Commission were taken in connection with notices issued under sections 148 and
153A of the 1961 Act and it was, therefore, that the Settlement Commission had
the jurisdiction to decide the applications u/s 245C of that Act, which related
to the proceedings in respect of those notices. If it was the case of the
Revenue that the undisclosed foreign income and assets of the assessees were
covered by the provisions of the 2015 Act, the notices under sections 148 and
153A of the 1961 Act, which mainly related to undisclosed foreign income, ought
to have been withdrawn and proceedings ought to have been initiated under the
relevant provisions of the 2015 Act. The Settlement Commission had the
jurisdiction to decide the applications u/s 245C.

iv) The Settlement Commission, after considering
the material on record, had given a finding of fact to the effect that there
was a full and true disclosure made by the assessees and that there was no
wilful attempt to conceal material facts. If for the reason that issues which
pertained to past periods could not be reconciled due to lack of further
evidence, the assessees, with a view to bring about a settlement, agreed to pay
a higher amount as proposed by the Revenue, it certainly could not be termed a
revision of the original disclosure made u/s 245C of the 1961 Act, inasmuch as,
there was no further disclosure but an acceptance of additional liability based
on the disclosure already made before the Settlement Commission.

v) Another aspect of the matter was that it was
an admitted position that prior to the presentation of the writ petition, the
order of the Settlement Commission came to be fully implemented. This was not
mentioned in the writ petition. Therefore, there was suppression of material
facts. The order passed by the Settlement Commission was valid.’

shailesh.kwebmaker

Refund – Withholding of refund – Sections 143(2) and 241A of ITA, 1961 – Discretion of A.O. – Scope of section 241A – A.O. must apply his mind before withholding refund – Mere issue of notice for scrutiny assessment for a later assessment year not a ground for withholding refund

46. Maple Logistic P.
Ltd. vs. Principal CIT; [2020] 420 ITR 258
(Del.) Date of order: 14^th
October, 2019 A.Ys.: 2017-18 and
2018-19

Refund – Withholding
of refund – Sections 143(2) and 241A of ITA, 1961 – Discretion of A.O. – Scope
of section 241A – A.O. must apply his mind before withholding refund – Mere
issue of notice for scrutiny assessment for a later assessment year not a
ground for withholding refund

The petitioner, by way of writ petition
under Articles 226 and 227 of the Constitution of India, sought a writ in the
nature of mandamus directing the respondent to refund the income tax
amount on account of excess deduction of tax at source in respect of the
assessment years 2017-18 and 2018-19 and other consequential directions to
adjust the outstanding amount of tax deducted at source and the goods and
services tax payable by the petitioner-company against the pending refund
amount without charging of any interest for the delayed payments. The Delhi
High Court allowed the writ petition and held as under:

‘i) U/s 241A of the Income-tax Act, 1961 the
legislative intent is clear and explicit. The processing of return cannot be
kept in abeyance merely because a notice has been issued u/s 143(2) of the Act.
Post-amendment, sub-section (1D) of section 143 is inapplicable to returns
furnished for the assessment year commencing on or after 1^stApril,
2017. The only provision that empowers the A.O. to withhold the refund in a
given case at present is section 241A. Now refunds can be withheld only in
accordance with this provision. The provision is applicable to such cases where
refund is found to be due to the assessee under the provisions of sub-section
(1) of section 143, and also a notice has been issued under sub-section (2) of
section 143 in respect of such returns. However, this does not mean that in
every case where a notice has been issued under sub-section (2) of section 143
and the case of the assessee is selected for scrutiny assessment, the
determined refund has to be withheld. The Legislature has not intended to
withhold the refunds just because scrutiny assessment is pending. If such had
been the intent, section 241A would have been worded so. On the contrary,
section 241A enjoins the A.O. to process the determined refunds, subject to the
caveat envisaged u/s 241A.

ii) The language of section 241A envisages that
the provision is not resorted to merely for the reason that the case of the
assessee is selected for scrutiny assessment. Sufficient checks and balances
have been built in under the provision and have to be given due consideration
and meaning. An order u/s 241A should be transparent and reflect due
application of mind. The A.O. is duty-bound to process the refunds where they
are determined. He cannot deny the refund in every case where a notice has been
issued under sub-section (2) of section 143. The discretion vested with the
A.O. has to be exercised judiciously and is conditioned and channelised. Merely
because a scrutiny notice has been issued that should not weigh with the A.O.
to withhold the refund. The A.O. has to apply his mind judiciously and such
application of mind has to be found in the reasons which are to be recorded in
writing. He must make an objective assessment of all the relevant circumstances
that would fall within the realm of ‘adversely affecting the Revenue’. The
power of the A.O. has been outlined and defined in terms of section 241A and he
must proceed giving due regard to the fact that the refund has been determined.

iii) The fact that notice u/s 143(2) has been
issued would obviously be a relevant factor, but that cannot be used to
ritualistically deny refunds. The A.O. is required to apply his mind and
evaluate all the relevant factors before deciding the request for refund of
tax. Such an exercise cannot be treated to be an empty formality and requires
the A.O. to take into consideration all the relevant factors. The relevant
factors, to state a few, would be the prima facie view on the grounds
for the issuance of notice u/s 143(2), the amount of tax liability that the
scrutiny assessment may eventually result in vis-a-vis the amount of tax refund
due to the assessee, the creditworthiness or financial standing of the assessee,
and all factors which address the concern of recovery of revenue in doubtful
cases. Therefore, merely because a notice has been issued u/s 143(2), it is not
a sufficient ground to withhold refund u/s 241A and the order denying refund on
this ground alone would be laconic. Additionally, the reasons which are to be
recorded in writing have to also be approved by the Principal Commissioner, or
Commissioner, as the case may be, and this should be done objectively.

iv) The reasons relied upon by the Revenue to
justify the withholding of refund were lacking in reasoning. Except for
reproducing the wording of section 241A of the Act, they did not state anything
more. The order withholding the refund was not valid.’

shailesh.kwebmaker

Reassessment – Sections 147 and 148 of ITA, 1961 – Validity of notice u/s 148 – Conditions precedent for notice – Amount assessed in block assessment – Addition of amount deleted by Commissioner (Appeals) – Notice to reassess same amount not valid

45. Audhut Timblo vs.
ACIT; [2020] 420 ITR 62 (Bom.) Date of order: 27^th
November, 2019 A.Ys.: 2002-03

Reassessment
– Sections 147 and 148 of ITA, 1961 – Validity of notice u/s 148 – Conditions
precedent for notice – Amount assessed in block assessment – Addition of amount
deleted by Commissioner (Appeals) – Notice to reassess same amount not valid

Pursuant to a search
action u/s 132 of the Income-tax Act, 1961, block assessment order u/s 158BC
was passed by the A.O. on 27^th September, 2002 making an addition of
Rs. 10.33 crores as unexplained cash credits. The Commissioner (Appeals), by an
order dated 13^th July, 2006, deleted the addition of Rs. 10.33
crores. On 13^th September, 2006, the Department appealed against the
order of the Commissioner to the Appellate Tribunal. On 18^th
October, 2006, the Department issued notice invoking the provisions of section
147 / 148 of the Act stating that this very income of Rs. 10.33 crores had
escaped assessment and therefore reassessment or reopening of assessment was
proposed for the A.Y. 2002-03.

The Bombay High Court allowed the writ
petition filed by the assessee challenging the notice and held as under:

‘i) The A.O. can reopen an assessment only in
accordance with the express provisions in section 147 / 148 of the Income-tax
Act, 1961. Section 147 clothes the A.O. with jurisdiction to reopen an
assessment on satisfaction of the following: (a) the A.O. must have reason to
believe that (b) income chargeable to tax has escaped assessment and (c) in
cases where the assessment sought to be reopened is beyond the period of four
years from the end of the relevant assessment year, then an additional
condition is to be satisfied, viz., there must be failure on the part of the
assessee to fully and truly disclose all material facts necessary for assessment.

ii) Since there was full disclosure and, in fact,
the amount had even become the subject matter of the assessment both u/s 158BC
and u/s 143(3), there could have been no reason to believe that the income
chargeable to tax had indeed escaped assessment. The notice of reassessment was
not valid.’

shailesh.kwebmaker

Penalty – Concealment of income – Search and seizure – Immunity from penalty – Effect of section 271AAA of ITA, 1961 – Assessee admitting undisclosed income during search proceedings and explaining source – No inquiry regarding manner in which income was earned – Immunity cannot be denied because of absence of such explanation

44. Principal CIT vs. Patdi Commercial and Investment Ltd.; [2020] 420 ITR 308 (Guj.) Date of order: 17^th September, 2019 A.Y.: 2011-12

Penalty – Concealment
of income – Search and seizure – Immunity from penalty – Effect of section
271AAA of ITA, 1961 – Assessee admitting undisclosed income during search
proceedings and explaining source – No inquiry regarding manner in which income
was earned – Immunity cannot be denied because of absence of such explanation

The Tribunal deleted the penalty u/s
271AAA of the Income-tax Act, 1961. On appeal by the Revenue, the Gujarat High
Court upheld the decision of the Tribunal and held as under:

‘i) Section 271AAA of the Income-tax Act, 1961
provides for penalty in cases of search. Sub-section (2) specifies that such
penalty will not be imposed if the following three conditions are satisfied:
(i) in the course of the search, in a statement under sub-section (4) of
section 132, the assessee admits the undisclosed income and specifies the
manner in which such income has been derived; (ii) the assessee substantiates
the manner in which the undisclosed income was derived; and (iii) pays the tax
together with interest, if any, in respect of the undisclosed income. In
accordance with the settled legal position, where the Revenue has failed to
question the assessee while recording the statement u/s 132(4) of the Act as
regards the manner of deriving such income, it cannot raise a presumption
regarding it.

ii) Both the Commissioner (Appeals) as well as
the Tribunal had recorded concurrent findings of fact that during the course of
search the director of the assessee company had admitted undisclosed income of
Rs. 15 crores as unaccounted cash receivable for the year under consideration,
i.e., F.Y. 2010-11. The director of the assessee in his statement had explained
that the income was earned out of booking / selling shops and had specified the
buildings. Thereafter, the assessee could not be blamed for not substantiating
the manner in which the disclosed income was derived. The cancellation of
penalty by the Tribunal was justified.’

shailesh.kwebmaker

Capital gains – Unexplained investment – Sections 50C and 69 of ITA, 1961 – Sale of immovable property – Difference between stamp value and value shown in sale deed – Effect of section 50C – Presumption that stamp value is real one – Section 50C enacts a legal fiction – Section 50C cannot be applied to make addition u/s 69

43. Gayatri
Enterprises vs. ITO; [2020] 420 ITR 15
(Guj.) Date of order: 20^th
August, 2019 A.Y.: 2011-12

Capital gains – Unexplained
investment – Sections 50C and 69 of ITA, 1961 – Sale of immovable property –
Difference between stamp value and value shown in sale deed – Effect of section
50C – Presumption that stamp value is real one – Section 50C enacts a legal
fiction – Section 50C cannot be applied to make addition u/s 69

The assessee purchased a piece of land.
He disclosed the transaction in his returns for the A.Y. 2011-12. This was
accepted by the A.O. Subsequently, the order was set aside in revision and an
addition was made to his income u/s 69 of the Income-tax Act, 1961 on the
ground that there was a difference between the value of the land shown in the
sale deed and the stamp duty value. The order of revision was upheld by the
Tribunal.

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

‘i) Section 50C was introduced in the Income-tax
Act, 1961 by the Finance Act, 2002 with effect from 1^st April, 2003
for substituting the valuation done for the stamp valuation purposes as the
full value of the consideration in place of the consideration shown by the
transferor of the capital asset, being land or building, and, accordingly,
calculating the capital gains u/s 48. Under section 50C when the stamp duty
valuation of a property is higher than the apparent sale consideration shown in
the instrument of transfer, the onus to prove that the fair market value of the
property is lower than such valuation by the stamp valuation authority is on
the assessee who can reasonably discharge this onus by submitting necessary
material before the A.O., such as valuation by an approved valuer. Thereafter,
the onus shifts to the A.O. to show that the material submitted by the assessee
about the fair market value of the property is false or not reliable. Section
50C enacts a legal fiction which is confined to what is stated in the
provision. The provisions of section 50C cannot be applied for the purpose of
making an addition u/s 69.

ii) Section 50C will apply to the seller of the
property and not to the purchaser. Section 69B does not permit an inference to
be drawn from the circumstances surrounding a transaction of sale of property
that the purchaser of the property must have paid more than what was actually
recorded in his books of accounts for the simple reason that such an inference
could be very subjective and could involve the dangerous consequence of a
notional or fictional income being brought to tax contrary to the strict
provisions of Article 265 of the Constitution of India which must be
“taxes on income other than agricultural income”.

iii) There was nothing on record to indicate what
the price of the land was at the relevant time. Even otherwise, it was a pure
question of fact. Apart from the fact that the price of the land was different
from that recited in the sale deed unless it was established on record by the
Department that, as a matter of fact, the consideration as alleged by the
Department did pass to the seller from the purchaser, it could not be said that
the Department had any right to make any additions. The addition was
not justified.’

shailesh.kwebmaker

Business expenditure – Disallowance u/s 40(a)(ia) of ITA, 1961 – Payments liable to deduction of tax at source – Charges paid by assessee to banks for providing credit card processing services – Bank not rendering services in nature of agency – Charges paid to bank not in nature of commission within meaning of section 194H – Disallowance u/s 40(a)(ia) not warranted

42. Principal CIT vs.
Hotel Leela Venture Ltd.; [2020] 420 ITR 385
(Bom.) Date of order: 18^th
December, 2018 A.Y.: 2009-10

Business expenditure
– Disallowance u/s 40(a)(ia) of ITA, 1961 – Payments liable to deduction of tax
at source – Charges paid by assessee to banks for providing credit card
processing services – Bank not rendering services in nature of agency – Charges
paid to bank not in nature of commission within meaning of section 194H –
Disallowance u/s 40(a)(ia) not warranted

The assessee was in the hospitality
business. For the A.Y. 2009-10, the A.O. found that the assessee had not
deducted tax u/s 194H of the Income-tax Act, 1961 on payments made by it to
banks for processing of credit card transactions and disallowed the
corresponding expenditure u/s 40(a)(ia).

The Commissioner (Appeals) deleted the
disallowance and the Tribunal upheld his order.

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

‘i) The Tribunal had not committed any error in holding
that the bank did not act as an agent of the assessee while it processed the
credit card payments and, therefore, the charges collected by the bank for such
services did not amount to commission within the meaning of section 194H. The
Tribunal was justified in upholding the deletion of disallowance made u/s
40(a)(ia) by the Commissioner (Appeals).

ii) No question of law arose.’

shailesh.kwebmaker

Assessment – Notice u/s 143(2) of ITA, 1961 – Limitation – Date of filing of original return u/s 139(1) has to be considered for purpose of computing period of limitation under sub-section (2) of section 143 and not date on which defects actually came to be removed u/s 139(9)

41. Kunal Structure
(India) (P) Ltd. vs. Dy. CIT; [2020] 113
taxmann.com 577 (Guj.) Date of order: 24^th
October, 2019

Assessment – Notice
u/s 143(2) of ITA, 1961 – Limitation – Date of filing of original return u/s
139(1) has to be considered for purpose of computing period of limitation under
sub-section (2) of section 143 and not date on which defects actually came to
be removed u/s 139(9)

The petitioner is a company registered
under the Companies Act, 2013. For the A.Y. 2016-17, the petitioner had filed
its return of income u/s 139(1) of the Income-tax Act, 1961 on 10^th
September, 2016. Thereafter, the petitioner received an intimation of defective
return u/s 139(9) on 17^th June, 2017. The petitioner received a
reminder on 5^th July, 2017 granting him an extension of 15 days to
comply with the notice issued u/s 139(9) of the Act and accordingly, the time
limit for removal of the defects u/s 139(9) of the Act stood extended till 20^th
July, 2017. The petitioner removed the defects on 7^th July, 2017
within the time granted. Subsequently, the return was processed under
sub-section (1) of section 143 of the Act on 12^th August, 2017,
wherein the date of original return is shown to be 10^th September,
2016. Thereafter, the impugned notice u/s 143(2) of the Act came to be issued
on 9^th August, 2018, informing the petitioner that the return of
income filed by it for A.Y. 2016-17 on 7^thJuly, 2017 has been
selected for scrutiny calling upon the petitioner to produce any evidence on
which it may rely in support of its return of income.

The petitioner filed a writ petition
under Articles 226 and 227 of the Constitution of India and challenged the
notice u/s 143(2) dated 9^th August, 2018 and the proceedings
initiated pursuant thereto. The Gujarat High Court allowed the writ petition
and held as under:

‘i) On a plain reading of sub-section (2) of
section 143 of the Act, it is apparent that the notice u/s 143(2) must be
served on the assessee within a period of six months from the end of the
financial year in which such return is furnished. Thus, if, after furnishing a
return of income, the assessee does not receive a notice under sub-section (2)
of section 143 of the Act within the period referred to in the sub-section, the
assessee is entitled to presume that the return has become final and no
scrutiny proceedings are to be started in respect of that return. It is only
after the issuance of notice under sub-section (2) of section 143 of the Act
that the A.O. can proceed further under sub-section (3) thereof to make an
assessment order. Therefore, the notice u/s 143(2) of the Act is a statutory
notice, upon issuance of which the A.O. assumes jurisdiction to frame the
scrutiny assessment under sub-section (3) of section 143 of the Act.
Consequently, if such notice is not issued within the period specified in
sub-section (2) of section 143 of the Act, viz., before the expiry of six months
from the end of the financial year in which the return is furnished, it is not
permissible for the A.O. to proceed further with the assessment.

ii) In the facts of the present case, the
petitioner filed its return of income under sub-section (1) of section 139 of
the Act on 10^th September, 2016. Since the return was defective, the
petitioner was called upon to remove such defects, which came to be removed on
7^th July, 2017, that is, within the time allowed by the A.O.
Therefore, upon such defects being removed, the return would relate back to the
date of filing of the original return, that is, 10^th September, 2016
and consequently the limitation for issuance of notice under sub-section (2) of
section 143 of the Act would be 30^th September, 2017, viz., six
months from the end of the financial year in which the return under sub-section
(1) of section 139 came to be filed. In the present case, it is an admitted
position that the impugned notice under sub-section (2) of section 143 of the
Act has been issued on 9^th August, 2018, which is much beyond the
period of limitation for issuance of such notice as envisaged under that
sub-section. The impugned notice, therefore, is clearly barred by limitation
and cannot be sustained.

iii) For the foregoing reasons, the petition
succeeds and is, accordingly, allowed. The impugned notice dated 9^thAugust,
2018 issued under sub-section (2) of section 143 of the Act and all proceedings
taken pursuant thereto are hereby quashed and set aside.’

shailesh.kwebmaker

Appellate Tribunal – Powers of (scope of order) – Section 254 r/w/s/ 144 of ITA, 1961 – Where remand made by Tribunal to A.O. was a complete and wholesale remand for framing a fresh assessment, A.O. could not deny to evaluate fresh claim raised by assessee during remand assessment proceedings

40. Curewel
(India) Ltd. vs. ITO; [2020] 113
taxmann.com 583 (Delhi) Date of order:
28^th November, 2019 A.Y.: 2002-03

Appellate Tribunal – Powers of (scope of order) – Section 254 r/w/s/ 144
of ITA, 1961 – Where remand made by Tribunal to A.O. was a complete and
wholesale remand for framing a fresh assessment, A.O. could not deny to
evaluate fresh claim raised by assessee during remand assessment proceedings

For the A.Y.
2002-03, the A.O. passed best judgment assessment u/s 144 of the Income-tax
Act, 1961 without examining the books of accounts of the assessee. The Tribunal
set aside the said assessment and remanded the matter to the A.O. to pass a
fresh order after considering the documents and submissions of the assessee.
During remand assessment, the assessee raised a fresh claim regarding
non-taxability of income arising from write-off of liability by Canara Bank
which was earlier offered as taxable income. The A.O. rejected the said claim
holding that in remand proceedings the assessee could not raise a fresh claim.

The
Commissioner (Appeal) and the Tribunal upheld the decision of the A.O.

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

‘i) The remand made by the
Tribunal to the A.O. vide order dated 10^th March, 2011 was a
complete and wholesale remand for framing a fresh assessment. The remand was
not limited in its scope and was occasioned upon the Tribunal finding the
approach of the A.O. and the CIT(A) to be excessive, harsh and arbitrary. The
earlier assessment had been framed on the basis of best judgment without
examining the books of accounts of the assessee, which the assessee has claimed
were available.

ii) That being the position, the
A.O. ought to have evaluated the claim made by the assessee for write-off of
liability by Canara Bank in its favour amounting to Rs. 1,36,45,525 and should
not have rejected the same merely on the ground of it being raised for the
first time. The reliance placed by the Tribunal on Saheli Synthetics (P)
Ltd. (Supra) is misplaced in the light of the scope and nature of
remand in the present case. The findings returned by the Tribunal in paragraphs
8, 9 and 12 of the impugned order are erroneous since the Tribunal has not
appreciated the scope and nature of the remand ordered by it by its earlier
order dated 10^th March, 2011.

iii) We, therefore, answer the
questions framed aforesaid in favour of the assessee and set aside the impugned
order. Since the A.O. has not evaluated the appellant’s claim regarding
non-taxability of income arising from write-off of liability by Canara Bank in
its favour amounting to Rs. 1,36,45,525 on merits, we remand the matter back to
the A.O. for evaluation of the said claim on its own merits.’

shailesh.kwebmaker

Rakesh Kumar Agarwal vs. ACIT-24(1); [ITA. No. 2881/Mum/2015; Date of order: 14th May, 2015; A.Y.: 2010-11; Mum. ITAT] Section 263 – Revision of orders prejudicial to Revenue – No revenue loss – Assessment was completed after detailed inquiry – Revision on same issue is not valid

17. The Pr. CIT-10 vs. Rakesh Kumar
Agarwal [Income tax Appeal No. 1740 of 2017] Date of order: 22^nd January
2020 (Bombay High Court)

Rakesh Kumar Agarwal vs. ACIT-24(1);
[ITA. No. 2881/Mum/2015; Date of order: 14^th May, 2015; A.Y.:
2010-11; Mum. ITAT]

Section 263 – Revision of orders
prejudicial to Revenue – No revenue loss – Assessment was completed after
detailed inquiry – Revision on same issue is not valid

The assessee is a builder and sells
plots of land on short-term as well as on long-term basis. For the A.Y. under
consideration, the assessee filed a return of income showing total income of
Rs. 7,47,25,768. During the assessment proceedings u/s 143 (3) of the Act, the
A.O. inquired into the accounts of the assessee and analysed the various claims
that had been made. The assessment proceedings were concluded by determining
the total assessed income of the assessee at Rs. 7,66,68,582.

However, the CIT invoked jurisdiction
u/s 263 of the Act on various discrepancies in the assessment order. Taking the
view that the order was erroneous inasmuch as it was prejudicial to the
interest of Revenue, the Commissioner of Income Tax set aside the assessment
order u/s 263 of the Act and directed the A.O. to pass a fresh order in the
light of the discussions made in the order passed u/s 263.

Aggrieved by this, the assessee
preferred an appeal before the Tribunal. The Tribunal took the view that the
CIT was not justified in invoking jurisdiction u/s 263 of the Act and set aside
the said order, allowing the appeal. Of the three issues, the Tribunal held
that the first issue did not result in any revenue loss and, therefore,
assumption of jurisdiction u/s 263 of the Act was not justified.

On the second issue relating to
non-disclosure of unaccounted cash of Rs. 6,85,000, the Tribunal held that the
said amount was already disclosed in the return of income filed by the
assessee. The said sum of Rs. 6.85 lakhs is part of the gross total amount of
Rs. 7,83,17,777. At the end of the assessment, the said amount was taxed by the
A.O. under the head ‘income from other sources’. Therefore, the Tribunal stated
that the Commissioner of Income Tax was not justified in treating the said
amount as part of undisclosed income and assuming jurisdiction u/s 263 when it
was already disclosed and assessed.

On the third issue, as regards
applicability of section 45(2), the Tribunal noticed that the CIT had accepted
applicability of the said provision and, therefore, it was held that there is
no error in the order of the A.O.

The Tribunal further held that an
inquiry was made by the A.O. into the disclosures made during the course of the
assessment proceedings by the assessee. When the issue was inquired into by the
A.O., the Commissioner ought not to have invoked jurisdiction u/s 263 of the
Act.

Being aggrieved by the order of the
ITAT, the Revenue filed an appeal to the High Court. The Court held that on a
thorough consideration of the matter and considering the provisions of section
263 of the Act, the impugned order passed by the Tribunal does not suffer from
any error or infirmity to warrant interference. The Department’s appeal was
dismissed.

shailesh.kwebmaker

Explanations 6 and 7 to section 9(1)(i) of the Act – Indirect transfer tests of 50% threshold of ‘substantial value’ (Explanation 6) and small shareholder (Explanation 7) are to be applied retrospectively

12. AAR No. 1555 to 1564 of 2013 A to J, In Re

Explanations 6 and 7 to section 9(1)(i) of
the Act – Indirect transfer tests of 50% threshold of ‘substantial value’
(Explanation 6) and small shareholder (Explanation 7) are to be applied
retrospectively

FACTS

In F.Y. 2013-14,
Applicant 1 (buyer, a Jersey-based company) and Applicant 2 (sellers /
shareholders based in the US, UK, Hong Kong and Cayman Islands) entered into a
transaction for sale of 100% shares of a British Virgin Islands-based company
(BVI Co). Individually, each seller had less than 5% shareholding in BVI Co.

BVI Co was a
multinational company and had subsidiaries across the globe. It indirectly held
100% shares in an Indian company (I Co) through a Mauritian company (Mau Co).
The sellers submitted the valuation report of the shares of BVI Co, as per
which the value derived directly or indirectly from assets located in India was
26.38%. The applicants approached AAR in December, 2013 with respect to
taxability arising in India as regards the transfer of the shares of BVI Co.

Indirect transfer
provisions were introduced in the Act in 2012. These were amended in 2015 by
introducing Explanation 6 and Explanation 7 to section 9(1)(i). The amended
provisions provided the following benchmarks:

50%
value threshold to ascertain substantial value of foreign shares or interest,
from assets in India (50% threshold).

Proportionate
tax (i.e., to the extent of value of assets in India).

Indirect
provisions not to apply to shareholders having less than 5% shareholding, or
voting power, or interest in foreign company or entity, if they have not
participated in management and control during the 12-month period preceding the
date of transfer (small shareholder exemption).

The question before
the AAR was whether amendments made in 2015 could be applied to a transaction
retrospectively?

HELD

From
2012 to 2015, the term ‘substantially’ was statutorily not defined, though it
was interpreted by the High Court¹
and the AAR². Both rulings held that the term ‘substantially’
would only include a case where shares of a foreign company derived at least
50% of their value from assets in India.

The
provision inserted in 2015 begins with the expression ‘for the purposes of
this clause, it is hereby declared…’. Relying on the principles of
statutory interpretation dealing with declaratory states³, AAR held
that declaratory or curative amendments made ‘to explain’ an earlier provision
of law should be given retrospective effect.

Explanation
6 pertaining to 50% threshold is clarificatory in nature. Similarly,
Explanation 7 pertaining to small shareholder exemption is inserted to address
genuine concerns of small shareholders. Hence, both should apply
retrospectively to give a true meaning and make the indirect provisions
workable.

The AAR concluded
on principles and did not adjudicate on valuation. It held that tax authorities
could scrutinise the valuation report to ascertain whether it met the 50%
threshold and satisfied the conditions of small shareholders exemption.

______________________________________________

1 DIT
vs. Copal Research Ltd., Mauritius [2014] 49 taxmann.com 125 (Delhi)

2 GEA Refrigeration Technologies GmbH, In
re [2018] 89 taxmann.com 220 (AAR – New Delhi)

3 Principles
of Statutory Interpretation by Justice G.P. Singh (Sixth Edition 1996)

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Principal Officer (condition precedent) – Section 2(35) of ITA, 1961 – Where neither service of notice nor hearing of petitioner before treating petitioner as a Principal Officer was involved, and connection of petitioner with management and administration of company was also not established, A.O. could not have named petitioner as Principal Officer

13. A. Harish Bhat vs. ACIT (TDS)

[2019] 111 taxmann.com 210 (Karn.)

Date of order: 17^thOctober, 2019

F.Ys.: 2009-10 to 2012-13

Principal Officer (condition
precedent) – Section 2(35) of ITA, 1961 – Where neither service of notice nor
hearing of petitioner before treating petitioner as a Principal Officer was
involved, and connection of petitioner with management and administration of
company was also not established, A.O. could not have named petitioner as
Principal Officer

The petitioner was treated as a
Principal Officer of the company Kingfisher Airlines for the F.Ys. 2009-10 to
2012-13 u/s 2(35) of the Income-tax Act, 1961. The petitioner filed a writ
petition and challenged the order.

He contended
that to come within the ambit of key management personnel, the petitioner had
to be either Managing Director or the Chief Executive Officer, whole-time
director / company secretary / chief financial officer / or in any way be
connected with the management or administration of the company. The Revenue, on
the other hand, justifying the said order, submitted that the petitioner was
the treasurer of the U.B. Group of Companies during the relevant financial
years and hence he was treated as Principal Officer. Further, neither a
personal hearing nor an order was necessary to treat the person as a Principal
Officer. It was sufficient if a notice of the intention of the A.O. of treating
any person as Principal Officer was issued. The petitioner assailed the order
of the Commissioner on the ground that the objections submitted by the
petitioner to the notice had not been duly considered and hence sought to set
aside the said order.

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

‘i) The impugned order deserves to be set aside for the reason that a
Principal Officer, as contemplated u/s 2(35), used with reference to a local
authority or a company or any other public body or any association of persons
or any body of individuals, means the secretary, treasurer, manager or agent of
the authority, company, association or body, or any person connected with the
management or administration of the local authority, company, association or
body upon whom the A.O. has served a notice of his intention of treating him as
the Principal Officer thereof.

ii) It is clear that to treat any person as a Principal Officer, such
person should be connected with the management or administration of the local
authority / company or association or body. Such connection with the management
or administration is the basis for treating any person as a Principal Officer.
Such connection has to be established or to be supported with substantial
material to decide the connection of any person with the management or
administration. Without disclosing the basis, no person can be treated as a
“Principal Officer” of the company recognising him as the Key Management Personnel
of the company. The details of such information on the basis of which the Key
Management Personnel tag is made, have to be explicitly expressed in the notice
of the intention of treating any person as a Principal Officer by the A.O.
Neither in the show cause notice nor in the order impugned was such a
connection of the petitioner with the management or administration of the
company Kingfisher Airlines Limited established. The phrase “Key Management
Personnel” of the company has a wide connotation and the same has to be
supported with certain material; unless such connection is established, no
notice served on the petitioner would empower the respondent authority to treat
the petitioner as a “Principal Officer”.

iii) In the instant case, the question inasmuch as
(sic) neither service of notice nor hearing of the petitioner before
treating the petitioner as a Principal Officer is involved. The fulcrum of
dispute revolves around the aspect whether the petitioner is the person
connected with the management or administration of the company. Such finding
has to be supported by substantial material and has to be reflected in the
notice issued u/s 2(35) to treat a person as a Principal Officer of the company
which will have wider consequences. The said aspect is lacking in the present
order impugned. Merely on surmises and conjectures, no person shall be treated
as a Principal Officer.

iv) The writ petition is to be allowed. The
impugned order is to be quashed.’

shailesh.kwebmaker

Section 45 – Amount received by assessee in its capacity as a partner of a firm from the other partners on account of reduction in profit-sharing ratio of the assessee, is a capital receipt not chargeable to tax

9. [2019] 116 taxmann.com 385 (Mum.) Anik Industries Ltd. vs. DCIT ITA No. 7189/Mum/2014 A.Y.: 2010-11 Date of order: 19^th March, 2020

Section 45 – Amount received by assessee in
its capacity as a partner of a firm from the other partners on account of
reduction in profit-sharing ratio of the assessee, is a capital receipt not
chargeable to tax

FACTS

The assessee was a partner in a partnership firm, namely
M/s Mahakosh Property Developers (the ‘firm’). The assessee was entitled to a
30% share in the profits of the firm. During the year, the assessee received a
sum of Rs. 400 lakhs on account of surrender of 5% share of profit (from 30% to
25%.) This sum was not included in the computation of total income on the
ground that the firm was reconstituted and a right was created in favour of the
existing partners. The existing partners whose share was increased, paid
compensation of Rs. 400 lakhs to the assessee.

The assessee relied
upon the decision of the Hon’ble Madras High Court in A.K. Sharfuddin vs.
CIT (1960 39 ITR 333) for the proposition that compensation received by
a partner from another partner for relinquishing rights in the partnership firm
would be capital receipt and there would be no transfer of asset within the
meaning of section 45(4) of the Act. Reliance was placed on other decisions
also to submit that the provisions of sections 28(iv) and 41(2) shall have no application
to such receipts.

The A.O. held that
the said payment was nothing but consideration for intangible asset, i.e., the
loss of share of partner in the goodwill of the firm. Therefore, this amount
was to be charged as capital gains in terms of the decision of the Ahmedabad
Tribunal in Samir Suryakant Sheth vs. ACIT (ITA No. 2919 &
3092/Ahd/2002) and the decision of the Mumbai Tribunal in Shri
Sudhakar Shetty (2011 130 ITD 197). Finally, the said amount was
brought to tax as capital gains u/s 45(1).

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

Aggrieved, the
assessee preferred an appeal to the Tribunal,

HELD

The Tribunal
observed that the only issue that fell for its consideration was whether or not
the compensation received by an existing partner from other partners for
reduction in profit-sharing ratio would be chargeable to tax as capital gains
u/s 45(1).

As per the
provisions of section 45(1), any profits or gains arising from the transfer of
a capital asset effected in the previous year shall be chargeable to capital
gains tax. The Tribunal noted that the answer to the aforesaid question lies in
the decision of the Hon’ble Karnataka High Court in CIT vs. P.N.
Panjawani (356 ITR 676) wherein this question was elaborately examined
in the light of various judicial precedents.

The Tribunal noted
that the decision of the Karnataka High Court in P.N. Panjawani (Supra) also
takes note of the fact that the firm is not recognised as a legal entity but
the Income-tax Act recognises the firm as a distinct legally assessable entity
apart from its partners. A clear distinction has been made between the income
of the firm and the income of the partner. It is further noted that there is no
provision for levying capital gains on consideration received by the partner
for reduction in the share in the partnership firm. Upon perusal of paragraph
22 of the decision, it is quite discernible that the factual matrix is
identical in the present case. The aforesaid decision has been rendered after
considering the various case laws on the subject as rendered by the Hon’ble
Apex Court. The Tribunal found the decision to be applicable to the given
factual matrix.

The Tribunal held
that the compensation received by the assessee from the existing partners for
reduction in the profit-sharing ratio would not tantamount to capital gains
chargeable to tax u/s 45(1). It deleted the addition made and allowed the
appeal filed by the assessee.

shailesh.kwebmaker

PROSECUTION UNDER THE INCOME TAX ACT, 1961 – LIABILITY OF DIRECTORS

INTRODUCTION

It has been
observed of late that the Income Tax Department has become very aggressive in
initiating prosecution proceedings against assessees for various offences under
the Income-tax Act, 1961. As per a CBDT press release dated 12^th
January, 2018, during F.Y. 2017-18 (up to end-November, 2017) prosecution
complaints increased by 184%, complaints compounded registered a rise of 83%
and convictions marked an increase of 269% compared to the corresponding period
of the previous year. Even the Courts have adopted a proactive approach. In Ramprakash
Biswanath Shroff vs. CIT(TDS) [2018] 259 Taxmann 385 (Bom)(HC), where
the assessee filed a petition contending that Form No. 16 had not been issued
by his employer in time, the Court suggested the Income Tax Department also
invoke section 405 of the Indian Penal Code, 1860 which is a non-cognisable offence.

When the offence is
committed by a company, an artificial juridical person, it is observed that
prosecution is launched against all the directors, including independent
directors, in a mechanical manner. As per section 2(47) r/w/s 149 of the
Companies Act, 2013, independent director means a director other than a
Managing Director, or a whole-time director, or a nominee director. Thus, an
independent director is not responsible for the day-to-day affairs of the
company.

Recently, the Court
of Sessions at Greater Mumbai, in the case of Eckhard Garbers vs. Shri
Shubham Agrawal, Criminal Revision application No. 267 of 2019 dated
16^th December, 2019, quashed prosecution proceedings
launched against Mr. Eckhard Garbers, an independent director and a foreign
national. This decision has received wide publicity in view of several
prosecution proceedings launched against directors who had no role in the
day-to-day affairs of the company. This article looks at the said decision in
addition to analysing section 278B which deals with prosecution against a
person/s in charge of or responsible for the conduct of the business of a
company.

The provisions
regarding the liability of the directors and other persons for offences
committed by the company are enumerated under various Acts such as Industries
(Development and Regulation) Act; Foreign Exchange Regulation Act; MRTP Act;
Securities Contracts (Regulations) Act; Essential Commodities Act; Employees’
Provident Funds and Miscellaneous Provisions Act; Workmen’s Compensation Act;
Payment of Bonus Act; Payment of Wages Act; Environment (Protection) Act; Water
(Prevention and Control of Pollution) Act; Minimum Wages Act; Payment of
Gratuity Act; Apprentices Act; Central Excise and Salt Act; Customs Act, 1961;
Negotiable Instruments Act; etc. The provisions of these Acts are somewhat
identical in nature. Even section 137 of the CGST Act is identical to the
provisions of section 278B of the Income-tax Act, 1961. Hence, when the
provisions qua the directors’ liability are considered under the
Income-tax Act, 1961, or the GST Act, it is also pertinent to note the law as
laid down under other Acts by the Courts.

SCHEME
OF THE INCOME TAX ACT, 1961

PROVISIONS OF
SECTION 278B

As per sub-section
(1) of section 278B, where an offence under this Act has been committed by a
company, every person who, at the time the offence was committed, was in charge
of, and was responsible to, the company for the conduct of the business of the
company as well as the company shall be deemed to be guilty of the offence and
shall be liable to be proceeded against and punished accordingly. The proviso
to sub-section (1) provides that nothing contained in this sub-section shall
render any such person liable to any punishment if he proves that the offence
was committed without his knowledge or that he had exercised all due diligence
to prevent the commission of such offence.

Sub-section (2)
provides that notwithstanding anything contained in sub-section (1), where an
offence under this Act has been committed by a company and it is proved that
the offence has been committed with the consent or connivance of, or is
attributable to any neglect on the part of, any director, manager, secretary or
other officer of the company, such director, manager, secretary or other
officer shall also be deemed to be guilty of that offence and shall be liable
to be proceeded against and punished accordingly.

As per sub-section
(3) where an offence under this Act has been committed by a person, being a
company, and the punishment for such offence is imprisonment and fine, then,
without prejudice to the provisions contained in sub-section (1) or sub-section
(2), such company shall be punished with fine and every person referred to in
sub-section (1), or the director, manager, secretary or other officer of the
company referred to in sub-section (2), shall be liable to be proceeded against
and punished in accordance with the provisions of this Act. The Explanation to
section 278B provides that for the purposes of section 278B, (a) ‘company’
means a body corporate and includes (i) a firm; and (ii) an association of
persons or a body of individuals whether incorporated or not; and (b)
‘director’, in relation to (i) a firm means a partner in the firm; (ii) any
association of persons or body of individuals, means any member controlling the
affairs thereof.

LEGISLATIVE
HISTORY AND ANALYSIS OF THE SECTION

Section 278B was
inserted by the Taxation Laws (Amendment) Act, 1975 reported in [1975]
100 ITR 33 (ST) w.e.f. 1^st October, 1975. The object and
scope of this section was explained by the Board in its Circular No. 179 dated
30^th September, 1975 reported in [1976] 102 ITR 26 (ST).

Under sub-section
(1) the essential ingredient for implicating a person is his being ‘in charge
of’ and ‘responsible to’ the company for the conduct of the business of the
company. The term responsible is defined in the Blacks Law dictionary to mean
accountable. Hence, the initial burden is on the prosecution to prove that the
accused person/s at the time when the offence was committed were ‘in charge of’
and ‘was responsible’ to the company for its business, and only when the same
is proved that the accused persons are required to prove that the offence was
committed without their knowledge, or that they had exercised all due diligence
to prevent the commission of such offence.

Both the
ingredients ‘in charge of’ and ‘was responsible to’ have to be satisfied as the
word used is ‘and’ [Subramanyam vs. ITO (1993) 199 ITR 723 (Mad)(HC)]. Under
sub-section (2) emphasis is on the holding of an offence and consent,
connivance or negligence of such officer irrespective of his being or not being
actually in charge of and responsible to the company in the conduct of the
business. Apart from this, while all the persons under sub-section (1) and
sub-section (2) are liable to be proceeded against, it is only persons covered
under sub-section (1) who, by virtue of the proviso, escape punishment
if they prove that the offence was committed without their knowledge or despite
their due diligence. From the language of both the sub-sections it is also
clear that the complaint must allege that the accused persons were responsible
to the firm / company for the conduct of its business at the time of the
alleged commission of the offence to sustain their prosecution. [Jai
Gopal Mehra vs. ITO (1986) 161 ITR 453 (P&H)(HC)].

Insertion of
sub-section (3) by the Finance (No. 2) Act, 2004 w.e.f. 1^stOctober,
2004 [2006] 269 ITR 101 (ST) was explained by Circular No. 5
dated 15^th July, 2005 reported in [2005] 276 ITR 151 (ST).
The said amendment was brought to resolve a judicial controversy as to whether
a company, being a juristic person, can be punished with imprisonment where the
statute refers to punishment of imprisonment and fine. The Apex Court in Javali
(M.V.) vs. Mahajan Borewell and Co. (1998) 230 ITR 1(SC) held that a
company which cannot be punished with imprisonment can be punished with fine
only. However, in a subsequent majority decision in the case of ACIT vs.
Veliappa Textiles Ltd. (2003) 263 ITR 550 (SC) it was held that where
punishment is by way of imprisonment, then prosecution against the company
would fail. In order to plug loopholes pointed out by the Apex Court in Veliappa
Textiles (Supra), sub-section (3) was introduced whereby the company
would be punished with fine and the person/s in charge of or conniving officers
of the company would be punished with imprisonment and fine. It is also to be
noted that the legal position laid down in the case of Veliappa Textiles
(Supra) was overruled by the Apex Court decision rendered in Standard
Chartered Bank vs. Directorate of Enforcement (2005) 275 ITR 81 (SC).

NATURE
OF LIABILITY

The principal
liability u/s 278B is that of the company. The other persons mentioned in
sub-section (1) and sub-section (2) are vicariously liable, i.e., they could be
held liable only if it is proved that the company is guilty of the offence
alleged.

The Apex Court in Sheoratan
Agarwal vs. State of Madhya Pradesh AIR 1984 SC 1824 while dealing with
the provisions of section 10 of the Essential Commodities Act which are similar
to section 278B, has held that the company alone may be prosecuted. The
person-in-charge only may be prosecuted. The conniving officer may individually
be prosecuted.

The Apex Court in Anil
Hada vs. Indian Acrylic Ltd. A.I.R. 2000 SC 145 while dealing with
section 141 of the Negotiable Instruments Act, held that where the company is
not prosecuted but only persons in charge or conniving officers are prosecuted,
then such prosecution is valid provided the prosecution proves that the company
was guilty of the offence.

The Supreme Court
in Aneeta Hada vs. Godfather Travels and Tours Private Limited (2012) 5
SCC 661 held that the director or any other officer of the company
cannot be prosecuted without impleadment of the company unless there is some legal
impediment and the doctrine of lex non cogit ad impossibilia (the law
does not compel a man to do that which is impossible) gets attracted.

STRICT
CONSTRUCTION

The Supreme Court in the case of Girdharilal Gupta vs. D.N. Mehta,
AIR 1971 SC 2162 has held that since the provision makes a person who
was in charge of and responsible to the company for the conduct of its business vicariously liable for an offence committed by the company, the
provision should be strictly construed.

MENS REA

Section 278B is a
deeming provision and hence it does not require the prosecution to establish mens
rea on the part of the accused. In B. Mohan Krishna vs. UOI 1996
Cri.L.J. 638 AP it is held that exclusion of mens rea as a
necessary ingredient of an offence is not violative of Article 14 of the
Constitution.

DIRECTORS
WHO ARE SIGNATORY TO AUDITED BALANCE SHEET

In Mrs.
Sujatha Venkateshwaran vs. ACIT [2018] 96 taxmann.com 203 (Mad)(HC) it
was held as under: ‘Since assessee had subscribed her signature in profit and
loss account and balance sheet for relevant assessment year which were filed
along with returns, the Assessing Officer was justified in naming her as
principal officer and accordingly she could not be exonerated for offence under
section 277.’

IMPORTANT
JUDICIAL PRECEDENTS

In the case of Girdhari Lal Gupta (Supra),
the Supreme Court construed the expression, ‘person in charge and responsible
for the conduct of the business of the company’ as meaning the person in
overall control of the day-to-day business of the company. In arriving at this
inference, the Supreme Court took into consideration the wordings pertaining to
sub-section (2) and observed:

‘It mentions
director, who may be a party to the policy being followed by a company and yet
not be in charge of the business of the company. Further, it mentions manager,
who usually is in charge of the business but not in overall charge. Similarly,
the other officers may be in charge of only some part of business’.

The Apex Court in State
of Karnataka vs. Pratap Chand & Ors. (1981) 2 SCC 335 has, while
dealing with prosecution of partners of a firm, held that ‘person in charge’
would mean a person in overall control of day-to-day business. A person who is
not in overall control of such business cannot be held liable and convicted for
the act of the firm.

In Monaben
Ketanbhai Shah & Anr. vs. State of Gujarat & Ors. (2004) 7 SCC 15 (SC)
the Apex Court, while dealing with the provisions of sections 138 and 141 of
the Negotiable Instruments Act, 1881, observed that when a complaint is filed
against a firm, it must be alleged in the complaint that the partners were in
active business. Filing of the partnership deed would be of no consequence for
determining this question. Criminal liability can be fastened only on those who
at the time of commission of offence were in charge of and responsible for the
conduct of the business of the firm. The Court proceeded to observe that this
was because of the fact that there may be sleeping partners who were not
required to take any part in the business of the firm, and / or there may be
ladies and others who may not know anything about such business. The primary
responsibility is on the complainant to make necessary averments in the
complaint so as to make the accused vicariously liable. In Krishna Pipe
and Tubes vs. UOI (1998) 99 Taxmann 568 (All) it was held that sleeping
partners cannot be held liable for offence/s.

In Jamshedpur
Engineering & Machine Manufacturing Co. Ltd. & Ors. vs. Union of India
& Ors. (1995) 214 ITR 556 (Pat.)(HC), the High Court of Patna
(Ranchi Bench) held that no vicarious liability can be fastened on all
directors of a company. If there are no averments in the complaint that any
director was ‘in charge of’ or ‘responsible for’ the conduct of business,
prosecution against those directors cannot be sustained.

Justice Mathur,
while dealing with the liability of non-working directors in R.K.
Khandelwal vs. State [(1965) 2 Cri.L.J. 439 (AH)(HC)], very succinctly
stated as under:

‘In companies there can be directors who are not in charge of, and
responsible to the company for the conduct of the business of the company.
There can be directors who merely lay down the policy and are not concerned
with the day-to-day working of the company. Consequently, the mere fact that
the accused person is a director of the company shall not make him criminally
liable for the offences committed by the company unless the other ingredients
are established which make him criminally liable. To put it differently, no
director of a company can be convicted of the offence under section 27 of the
Act [The Drugs Act, 1940] unless it is proved that the sub-standard drug was
sold with his consent or connivance or was attributable to any neglect on his
part, or it is proved that he was a person in charge of and responsible to the
company, for the conduct of the business of the company.’

In Kalanithi
Maran vs. UOI [2018] 405 ITR 356 (Mad)(HC), while dealing with the
liability of the Non-Executive Chairman of the Board of Directors of the
company for the offence of non-deposit of TDS, it was held that merely because
the petitioner is the Non-Executive Chairman, it cannot be stated that he is in
charge of the day-to-day affairs, management and administration of the company.

The Court held in Chanakya
Bhupen Chakravarti and Ors. vs. Rajeshri Karwa and Ors. (4^th
December, 2018) (Del)(HC) Crl. M.C. 3729/2017 that ‘there is some
distinction between being privy to what were the affairs of the company and
being responsible for its day-to-day affairs or conduct of its business.’

In Pooja
Ravinder Devidasani vs. State of Maharashtra & Anr. (2014) 16 SCC 1 (SC),
the Supreme Court ruled thus: ‘17. Non-Executive Director is no doubt a
custodian of the governance of the company but is not involved in the
day-to-day affairs of the running of its business and only monitors the
executive activity.’

In Mahalderam
Team Estate Pvt. Ltd. vs. D.N. Pradhan [(1979) 49 Comp. Cas. 529 (Cal)(HC)],
it was held that a director of a company may be concerned only with the policy
to be followed and might not have any hand in the management of its day-to-day
affairs. Such person must necessarily be immune from such prosecutions.

In the case of Om
Prakash vs. Shree Keshariya Investments Ltd. (1978) 48 Comp. Cas. 85 (Del)(HC),
the Court had held that a distinction has to be made between directors who are
on the board purely by virtue of their technical skill or because they
represented certain special interests, and those who are in effective control
of the management and affairs, and it would be unreasonable to fasten liability
on independent directors for defaults and breaches of the company where such
directors were appointed by virtue of their special skill or expertise but did
not participate in the management. This view has been followed by the Division
Bench of the Bombay High Court in the case of Tri-Sure India Ltd. [(1983)
54 Comp. Cas. 197 (Bom)(HC).

In S.M.S.
Pharmaceuticals Ltd. vs. Neeta Bhalla & Anr. [2005] 148 Taxmann 128 (SC)
the Court, while dealing with provisions of section 141 of the Negotiable
Instruments Act which is similar to section 278B, laid down the following
important law relating to the liability of directors:

(a) It is necessary to specifically aver in a
complaint u/s 141 that at the time the offence was committed, the person
accused was in charge of, and responsible for, the conduct of business of the
company. This averment is an essential requirement of section 141 and has to be
made in a complaint. Without this averment being made in a complaint, the
requirements of section 141 cannot be said to be satisfied.

(b) Merely being a director of a company is not
sufficient to make the person liable u/s 141 of the Act. A director in a
company cannot be deemed to be in charge of and responsible to the company for
the conduct of its business. The requirement of section 141 is that the person
sought to be made liable should be in charge of and responsible for the conduct
of the business of the company at the relevant time. This has to be averred as
a fact as there is no deemed liability of a director in such cases.

(c) The Managing Director or Joint Managing
Director would be admittedly in charge of the company and responsible to the
company for the conduct of its business. When that is so, holders of such
positions in a company become liable u/s 141 of the Act. By virtue of the
office they hold as Managing Director or Joint Managing Director, these persons
are in charge of and responsible for the conduct of the business of the
company. Therefore, they get covered u/s 141.

In Madhumilan
Syntex Ltd. vs. UOI (2007) 290 ITR 199 (SC) the assessee had deducted
TDS but credited the same to the account of the Central Government after the
expiry of the prescribed time limit, thereby constituting an offence u/s 276B
r/w/s/ 278B. A show-cause notice was issued against the company as well as its
four directors as ‘principal officers’. The accused pleaded the ground of
‘reasonable cause’. However, sanction for prosecution was granted as a
complaint was filed against the appellants on 26^th February, 1992 in the Court of the Additional
Chief Judicial Magistrate (Economic Crime), Indore. The accused filed
applications u/s 245 of the Cr.PC, 1973 (the Code) for discharge from the case
contending that they had not committed any offence and the provisions of the
Act had no application to the case. It was alleged that the proceedings
initiated were mala fide. In several other similar cases, no prosecution
was ordered and the action was arbitrary as also discriminatory. Moreover,
there was ‘reasonable cause’ for delay in making payment and the case was
covered by section 278AA of the Act. The directors further stated that they
could not be treated as ‘principal officers’ u/s 2(35) of the Act and it was
not shown that they were ‘in charge’ of and were ‘responsible for’ the conduct
of the business of the company. No material was placed by the complainant as to
how the directors participated in the conduct of the business of the company
and for that reason, too, they should be discharged.

However the prayers
of the accused were rejected. Against this rejection a revision petition was
filed, which was also rejected. And against this, a criminal petition was filed
before the High Court, which was also dismissed. Hence, the accused approached
the Supreme Court. The following important points of law were laid down by the
Apex Court:

1. Wherever a company is required to deduct tax
at source and to pay it to the account of the Central Government, failure on
the part of the company in deducting or in paying such amount is an offence
under the Act and has been made punishable;

2. From the statutory provisions, it is clear
that to hold a person responsible under the Act it must be shown that he / she
is a ‘principal officer’ u/s 2(35) of the Act or is ‘in charge of’ and
‘responsible for’ the business of the company or firm. Where necessary
averments have been made in the complaint, initiation of criminal proceedings,
issuance of summons or framing of charges cannot be held illegal and the Court
would not inquire into or decide the correctness or otherwise of the
allegations levelled or averments made by the complainant. It is a matter of
evidence and an appropriate order can be passed at the trial;

3. No independent and separate notice that the
directors were to be treated as principal officers under the Act is necessary
and when in the show-cause notice it was stated that the directors were to be
considered as principal officers under the Act and a complaint was filed, such
complaint can be entertained by a Court provided it is otherwise maintainable;

4. Once a statute requires to pay tax and
stipulates the period within which such payment is to be made, the payment must
be made within that period. If the payment is not made within that period,
there is a default and appropriate action can be taken under the Act;

5. It is true that the Act provides for
imposition of penalty for non-payment of tax. That, however, does not take away
the power to prosecute the accused persons if an offence has been committed by
them.

Though the Apex
Court did not go into the merits of the case and decided the issue in respect
of the maintainability of the criminal complaint, the decision has given a
clear warning to corporates and their principal officers on the need for strict
adherence to time schedules in the matter of payment of taxes, especially Tax
Deducted at Source.

Analysis of
recent decision of Court of Sessions at Greater Mumbai in the case of Eckhard
Garbers vs. Shri Shubham Agrawal, criminal revision application No. 267 of 2019
dated 16^th December, 2019

FACTS
OF THE CASE

The facts of the
case as can be culled out from the order are as under:

(i) The Income Tax Department had filed criminal
case bearing C.C. No. 231/SW/2018 against the company, its six directors and
Chief Financial Officer on the ground that the company had deducted income tax
by way of TDS from various parties but the said amount was not immediately
credited to the Central Government; subsequently, after a delay of between one
and eleven months, the said amount was credited to the Government; as such,
offences punishable u/s 276B r/w/s 278B of the Income Tax Act, 1961 were
attracted.

(ii) The learned Additional Chief Metropolitan
Magistrate, 38th Court, Ballard Pier, Mumbai, by order dated 24^thJuly,
2018, issued process against the accused persons for offences punishable u/s
276B r/w/s 278B of the Income Tax Act, 1961.

(iii) Being aggrieved by the said order of issue of
process, the applicant / accused No. 7, i.e., Eckhard Garbers, had preferred
criminal revision application before the Sessions Court. He contended that he
is a foreign national and as such he was just a professional and an independent
director. He has not participated in the day-to-day business of the company and
was not in charge of such day-to-day business; as such, as per section 278B of
the Act, he is not liable for criminal proceedings.

FINDINGS
OF THE SESSIONS COURT

(a) The averments regarding the position and the
liability of the accused persons, especially Mr. Eckhard, are vague in nature.
There is nothing in the complaint showing how each of the accused / directors
were in charge of and responsible for the day-to-day business of the accused
No. 1 / Company. The averment in the complaint is as under:

‘8. It is further
respectfully submitted that the accused are… the directors. The accused are
also liable for the said acts of omission and contravention committed by the
accused and therefore they are also liable to be prosecuted and to be punished
for the act committed by the accused… u/s 276B of the I.T. Act, 1961.’

(b) There must be detailed averment showing how
the particular director / accused was participating in the day-to-day conduct
of the business of the company and that he was in charge of and responsible to
the company for its business and if such averments are missing, the Court
cannot issue process against such director. The Sessions Court, while coming to
the said conclusion, has relied on the following two decisions:

# Hon’ble Supreme
Court in the case of Municipal Corporation of Delhi vs. Ram Kishan
Rohtagi and others reported in AIR 1983 SC 67. In paragraph 15 of the
judgment, it is observed by their Lordships as under:

‘15. So far as the
manager is concerned, we are satisfied that from the very nature of his duties
it can be safely inferred that he would undoubtedly be vicariously liable for
the offence, vicarious liability being an incident of an offence under the Act.
So far as the directors are concerned, there is not even a whisper nor a shred
of evidence nor anything to show, apart from the presumption drawn by the
complainant, that there is any act committed by the directors from which a
reasonable inference can be drawn that they could also be vicariously liable.
In these circumstances, therefore, we find ourselves in complete agreement with
the argument of the High Court that no case against the directors (accused Nos.
4 to 7) has been made out ex facie on the allegations made in the
complaint and the proceedings against them were rightly quashed.’

# In Homi
Phiroze Ranina vs. State of Maharashtra [2003] 263 ITR 6 636 (Bom)(HC)
while dealing with the liability of non-working directors, the Bombay High
Court held as follows:

‘11. Unless the
complaint disclosed a prima facie case against the applicants / accused
of their liability and obligation as principal officers in the day-to-day
affairs of the company as directors of the company u/s 278B, the applicants
cannot be prosecuted for the offences committed by the company. In the absence
of any material in the complaint itself prima facie disclosing
responsibility of the accused for the running of the day-to-day affairs of the
company, process could not have been issued against them. The applicants cannot
be made to undergo the ordeal of a trial unless it could be prima facie
showed that they are legally liable for the failure of the company in paying
the amount deducted to the credit of the company. Otherwise, it would be a
travesty of justice to prosecute them and ask them to prove that the offence is
committed without their knowledge. The Supreme Court in the case of Sham
Sundar vs. State of Haryana AIR 1989 SC 1982 held as follows:

… It would be a
travesty of justice to prosecute all partners and ask them to prove under the proviso
to sub-section (1) that the offence was committed without their knowledge. It
is significant to note that the obligation for the accused to prove under the proviso
that the offence took place without his knowledge or that he exercised all due
diligence to prevent such offence arises only when the prosecution establishes
that the requisite condition mentioned in sub-section (1) is established. The
requisite condition is that the partner was responsible for carrying on the
business and was during the relevant time in charge of the business. In the
absence of any such proof, no partner could be convicted…’ (p. 1984).

(c) The Chief Finance Officer, who
was responsible for the day-to-day finance matters, including recovery of TDS
from the customers and to deposit it in the account of the Central Government,
was prima facie responsible for the criminal prosecution for the alleged
default committed, but certainly the Director, who is not in charge of and not
responsible for the day-to-day business of the company is not liable for
criminal prosecution, unless it is specifically described in the complaint as
to how he is involved in the day-to-day conduct of the business of the company.

CONCLUSION

From the analysis
of the provisions of section 278B it could be seen that the scope and the exact
connotation of the expression ‘every person who at the time the offence was
committed was in charge of, and was responsible to, the company for the conduct
of the business of the company’ assumes a very important role. If a person,
i.e., the director or an executive of the company falls within the purview of
this expression, he would be liable for the offence of the company and may be
punished for the same. If, on the other hand, the person charged with an
offence is not the one who falls within the ambit of that expression, the court
will relieve him of the accusation. Therefore, the essential question that
arises is as to who are the persons in charge of, and responsible to, the
company for the conduct of the business of the company. It should be noted that
the onus of proving that the person accused was in charge of the conduct of the
business of the company at the time the contravention took place lies on the
prosecution.

Another essential
aspect is that the complaint must not only contain a bald averment that the
director is responsible for the offence, but the averment must show how the
director who is treated as accused has participated in the day-to-day affairs
of the company. If such an averment is not found and the Magistrate has issued
process and taken cognisance of the complaint, then the accused director can
file a revision application before the Courts of Session. The director can also
file a Writ Petition before the High Court by invoking the provisions of
section 482 of the Cr.PC. The Bombay High Court in Prescon Realtors and Infrastructure
Pvt. Ltd. and Anr vs. DCIT & Anr WP/59/2019 dated 7^th August,
2019 has stayed the proceedings before the trial court against the
company and its directors as self-assessment taxes were ultimately paid by the
company. Thus, in genuine cases the Bombay High is entertaining the Writ
Petitions challenging the processes issued by the Magistrate.

Where the directors
have resigned, or were not involved in the day-to-day affairs of the company,
the directors can also file discharge application u/s 245 of the Cr.PC before
the Magistrate Court. However, one must note that as per section 280C, offences
punishable with imprisonment extending to two years or fine, or both, will be
tried as summons cases and not warrant cases. There is no provision of discharge
in summons triable cases. Hence, in such cases the process may be challenged by
filing revision before the Sessions Court or by filing a Writ Petition before
the Bombay High Court.

The companies must
clearly cull out the responsibilities of directors, Chief Financial Officers,
accountants, etc. so that tax defaults can be appropriately attributed to the
right person in the company and all the key persons of the company don’t have
to face the brunt of prosecution.

shailesh.kwebmaker

MFN CLAUSE: RELEVANCE OF INTERPRETATION BY FOREIGN COURTS

BACKGROUND

A tax treaty is usually bilateral in nature and is limited to two
countries: Resident country and Source country. When two bilateral treaties are
compared, there ought to be substantial or minor differences on account of the
different strategies and the negotiation power of the competent authorities of
the respective countries. The question is whether the taxpayer can rely on
another bilateral tax treaty, one that is not applicable to him. The answer is
clearly ‘No’.

The taxpayer relies on the tax treaty entered into by his resident
country for the income that has arisen in the source country. For his
taxability, the taxpayer is restricted to the applicable tax treaty only.
However, the tax treaty mechanism is such that, if expressly provided for in
his treaty, the taxpayer is permitted to enforce the beneficial provisions of
another bilateral tax treaty, though subject to conditions. This is widely termed
as the Most Favoured Nation clause (MFN clause). It prevents discrimination
amongst the OECD member states. Its application cannot be implicit but has to
be expressly provided for. If not expressed, a tax treaty cannot oblige another
tax treaty to apply its beneficial provisions (whether in terms of scope or tax
rate).

In the Indian context, the MFN clause is usually found in the Protocol to
its tax treaties, for example, the Protocol to the India-Netherlands TT, the
India-France TT, the India-Sweden TT, etc. For instance, article 12(3)(b) of the India-Sweden Tax Treaty
defines the Fees for Technical Services (FTS) as ‘(b) The term “fees for
technical services” means payment of any kind in consideration for the
rendering of any managerial, technical or consultancy services, including the
provision of services by technical or other personnel but does not include
payment for services mentioned in articles 14 and 15 of this Convention’.

If the Indian taxpayer is making payment for commercial service, the
payment would primarily be covered under this FTS article. It would be interesting to then look into the Protocol
to the India-Sweden DTA that reads as under:

‘In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services) if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties, or fees for technical services to a rate
lower or a scope more restricted than the rate or scope provided for in this
Convention on the said items of income, the same rate or scope as provided for
in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.’

Taking benefit of
the FTS clause (or Fees for Included Services) in the India-USA tax treaty or
the India-UK tax treaty, where USA is the OECD member state, the scope for FTS
in the India-Sweden tax treaty would be reduced to make-available
technical services. Where the FTS is not make-available, the FTS would
be subject to tax only when the taxpayer has a permanent establishment in India
in accordance with Article 7 of that treaty. In other words, if the taxpayer
has no permanent establishment, the FTS income that is not make-available
service would not be taxed in India. This is how the MFN clause would apply and
be beneficial to the taxpayer.

FOREIGN
COURT DECISION

In this context,
the author has discussed a recent foreign court decision on the MFN clause. It
is significant in terms of the manner in which this clause should be applied.
The decision articulates the importance of the phrase ‘limits its taxation at
source’, in respect of interpreting the phrase ‘a rate lower or a scope more
restricted’. It looks into the resultant tax effect, rather than the rate or
scope prescribed in another Tax Treaty (referred to as TT). The decision is
explained in detail below:

South Africa

Tax Court in
Cape Town

ABC Proprietary Limited vs. Commissioner (No.
14287)

Date of Order:
12^th June, 2019

(i) FACTS

The taxpayer is a
South African tax resident company and a shareholder of a Dutch company. The
Dutch company declared dividend to the South African taxpayer in respect of
which it withheld dividend tax at the rate of 5% and paid it to the Dutch Tax
Authorities. The taxpayer subsequently requested a refund of the dividend tax
paid to the Dutch Tax Authorities on account of the MFN clause in the
Netherlands-South Africa Tax Treaty (NL-SA TT). It contended as follows:

(a) NL-SA TT
provides for 5% withholding tax;

(b) MFN of NL-SA TT
referred to the South Africa-Sweden Tax Treaty (SA-SW TT) that also provides
for 10% withholding tax; but the second MFN of the SA-SW TT provides for an
effective withholding tax rate of 0% after referring to the South Africa-Kuwait
Tax Treaty (SA-Kuwait TT).

The peculiarity of
this decision is the extent to which the second MFN influences the effective
withholding tax rate in the NL-SA DTA. Coincidentally, the recent judgment of
the Dutch Supreme Court on 18^th January, 2019 in case number
17/04584 is on similar facts with a similar outcome. Both the decisions are
discussed together.

(ii) TT ANALYSIS

To understand the
importance of this decision, it is equally important to have the extract of the
relevant clauses for our benefit.

NL-SA TT

Article 10 of the
NL-SA TT provides for a 5% dividend withholding tax on distribution of
dividends if the beneficial owner is a company holding at least 10% of the
capital in the company paying the dividends. The MFN clause in article 10(10)
is given as under:

(10) If under
any convention for the avoidance of double taxation concluded after the date of
conclusion of this Convention between the Republic of South Africa and a third
country, South Africa limits its taxation on dividends as contemplated in
sub-paragraph (a) of paragraph 2 of this Article to a rate lower, including
exemption from taxation or taxation on a reduced taxable base, than the rate
provided for in sub-paragraph (a) of paragraph 2 of this Article, the same
rate, the same exemption or the same reduced taxable base as provided for in
the convention with that third State shall automatically apply in both
Contracting States under this Convention as from the date of the entry into
force of the convention with that third State.

It can be observed from the above that the MFN clause of the NL-SA TT
has a time limitation to its applicability. Only the OECD member state DTAs,
that are concluded by South Africa after the signing of the NL-SA TT, would be
looked into. Once applied, the beneficial tax rate or scope for taxation of FTS
in third state TTs would also apply in the NL-SA TT. Accordingly, the SA-SW DTA
satisfied the condition. The analysis of the SA-SW DTA is discussed below.

SA-SW TT

Originally, the
SA-SW TT was concluded prior to the conclusion of the NL-SA TT, however, the
Protocol, wherein the 10% dividend withholding tax rate and the second MFN
clause was provided for, was concluded after the conclusion of the NL-SA TT.
The Court and the tax authority did not think that this would be an issue and
both concluded that since the Protocol was concluded after the date of
conclusion of the NL-SA TT, the SA-SW TT would continue to apply.

Article 10 of the
SA-SW TT read with the Protocol did not provide for any concession in the tax
rate (i.e. 5% withholding tax rate in the NL-SA TT; whereas it was 15% in the
SA-SW TT). However, the Protocol introduced Article 10(6) to the SA-SW TT and
read as follows:

(6) If any
agreement or convention between South Africa and a third state provides that
South Africa shall exempt from tax dividends (either generally or in respect of
specific categories of dividends) arising in South Africa, or limit the tax
charged in South Africa on such dividends (either generally or in respect of
specific categories of dividends) to a rate lower than that provided for in
sub-paragraph (a) of paragraph 2, such exemption or lower rate shall
automatically apply to dividends (either generally or in respect of those
specific categories of dividends) arising in South Africa and beneficially
owned by a resident of Sweden and dividends (either generally or in respect of
those specific categories of dividends) arising in Sweden and beneficially
owned by a resident of South Africa, under the same conditions as if such
exemption or lower rate had been specified in that sub-paragraph.

It can be observed from the above that the time limitation present in
the NL-SA TT is not present in the SA-SW TT. Hence, in the absence of any
limitation, the MFN clause of the SA-SW TT is open to all member states (no
time limitation and no OECD member state limitation). This is where the
SA-Kuwait TT was applied wherein the dividend withholding tax rate is 0% when
dividends arise in South Africa.

SA-Kuwait TT

Article 10(1) of
the SA-Kuwait TT provides that the ‘Dividends paid by a company which is a
resident of a Contracting State to a resident of the other Contracting State
who is the beneficial owner of such dividends shall be taxable only in that
other Contracting State.’ In other words, the dividend paid by the South
African company would be exempt from withholding tax. Kuwait is a non-OECD
member and the SA-Kuwait TT was concluded prior to the date of conclusion of
the NL-SA TT and hence direct reference to this TT was not possible.

(iii) TAX AUTHORITIES’ CONTENTION

The tax authorities
denied the benefit of exemption for various reasons: (a) the benefit of the
SA-Kuwait TT is not available directly to the NL-SA DTA; (b) the purpose of the
MFN clause is to provide additional benefit and bring parity with other OECD
member states. The clause should be read literally and not be open to
interpretation on the basis of another MFN in another DTA, i.e., the SA-SW TT;
and (c) the intention of the MFN clause is to look into the tax rates as
specified in other DTAs, without considering any other MFN clause or other
influence. The MFN clause should be interpreted to bring parity with the
‘specified’ tax rate, rather than the ‘applied’ / ‘effective’ tax rate. The tax
authorities refused to exempt the withholding tax rate.

(iv) ISSUE

Whether the
dividend withholding tax rate is exempt under the NL-SA TT, by virtue of the
MFN clause in that TT and in the SA-SW TT?

(v) DECISION

The Tax Court of
South Africa gave its judgment in favour of the taxpayer that dividends arising
from South Africa would be exempt from withholding tax. It is identical to the
one given by the Hon’ble Supreme Court of the Netherlands. It gave the
following reasons:

(a) The MFN clause to be interpreted based on its
plain meaning. It cannot be contended that the MFN clause is not intended to be
triggered by MFN clauses in treaties concluded thereafter.

(b) The South African tax authorities had in
practice exempted the withholding tax on dividends arising from South Africa;
when the SA-SW TT, read with the SA-Kuwait TT, was applied.

(c) From the perspective of the NL-SA TT, the real
tax effect has to be seen while contemplating the beneficial effects of the MFN
clause.

(d) Accordingly, once it was clear that the SA-SW
TT is a qualified TT, the effective / resultant withholding tax rate would
apply to the NL-SA TT. The indirect effect of the SA-Kuwait TT, that was
concluded prior to the NL-SA TT, is purely coincidental.

IN AN INDIAN CONTEXT

From an Indian perspective, we do not have judgments on any similar
issue. Hence, it becomes imperative to analyse the above decision from the
perspective of Indian tax treaties. Let’s take an example of payments being
made by an Indian resident to a Dutch company in the nature of Fees for
Technical Services. We have considered the India-Netherlands Tax Treaty (Ind-NL
TT), the India-Sweden Tax Treaty (Ind-SW TT) and the India-Greece Tax Treaty
(Ind-Gr TT).

Ind-NL TT

Article 12 of the Ind-NL TT provides for a 20% withholding tax rate and
defines FTS as: The term ‘fees for technical services’ as used in this
Article means payments of any kind to any person, other than payments to an
employee of the person making the payments and to any individual for
independent personal services mentioned in Article 14, in consideration for
services of a managerial, technical or consultancy nature.

The extract of the Protocol to the Ind-NL TT is given below:

If after the signature of this Convention under any
Convention or Agreement between India and a third State, which is a member of
the OECD, India should limit its taxation at source on dividends, interest,
royalties, fees for technical services or payments for the use of equipment to
a rate lower or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, then, as from the date on which
the relevant India Convention or Agreement enters into force, the same rate or
scope as provided for in that Convention or Agreement on the said items of
income shall also apply under this Convention.

It can be observed that, like the NL-SA TT, the Ind-NL TT provides for a
time limitation and the OECD member-state condition for applicability of the
MFN clause.

Ind-SW TT

The Ind-SW TT
(conclusion date: 24^th June, 1997) was concluded after the date of
conclusion of the Ind-NL TT (conclusion date: 30^th July, 1988);
accordingly, Ind-SW is a qualified TT for application of the MFN clause.

Article 12 of the
Ind-SW TT provides for a 10% withholding tax rate and defines FTS as: The
term ‘fees for technical services’ means payment of any kind in consideration
for the rendering of any managerial, technical or consultancy services,
including the provision of services by technical or other personnel, but does
not include payments for services mentioned in Articles 14 and 15 of this
Convention.

The extract of the Protocol to the Ind-SW TT is given below:

In respect of
Articles 10 (Dividends), 11 (Interest) and 12 (Royalties and fees for technical
services), if under any Convention, Agreement or Protocol between India and a
third State which is a member of the OECD, India limits its taxation at source
on dividends, interest, royalties or fees for technical services to a rate
lower than or a scope more restricted than the rate or scope provided for in
this Convention on the said items of income, the same rate or scope as provided
for in that Convention, Agreement or Protocol on the said items of income shall
also apply under this Convention.

It can be observed that,
like the SA-SW TT, the Ind-SW TT also does not provide for any time limitation,
although it does specify an OECD member-state condition.

Ind-Gr TT

The Ind-Gr TT was concluded on 11^th February, 1965, that is,
prior to the date of conclusion of the Ind-NL TT dated 30^th July,
1988 and hence, like the above decision, direct reference to this TT was not
possible. But Greece is an OECD member state and, thus, satisfied the MFN
clause of the Ind-SW TT. The Ind-Gr TT does not have the FTS article and hence
the income from performance of services would be taxable under Article 3 for
industrial or commercial services, or under Article 14 for professional
services. The threshold requirements in Article 3 and Article 14 would
accordingly apply in the present case. These provide for a reduced scope that
is ‘more restricted’, resulting in limiting India’s right to tax FTS and,
hence, could be read into the Ind-SW TT and thereafter into the Ind-NL TT.

Another argument that can also come up for analysis is whether the ‘scope
more restricted’ in the Ind-SW TT takes into account a complete absence of the
FTS article or takes into account a mere tax effect on FTS? Reliance can be
placed on another foreign court decision by the Supreme Court of Kazakhstan in
the case of The Kazmunai Services (Case No. 3??-77-16), dated 3^rdFebruary, 2016, wherein the taxpayer applied the MFN clause of
the Kazakhstan-India DTA and wanted to benefit from the missing FTS article in
the Kazakhstan-Germany DTA, the Kazakhstan-UK DTA and the Kazakhstan-Russia
DTA. The Supreme Court denied the benefit of the MFN clause without discussing
its applicability and the issue about the absent FTS article.

In response, it could be stated that the MFN clause refers to the nature
of income (FTS), rather than the FTS article in itself. The phrase used in the
MFN clause of the Ind-SW TT is ‘India limits its taxation at source on
dividends, interest, royalties or fees for technical services to a
rate lower or a scope more restricted than the rate or scope provided for in
this Convention [emphasis] on the said items of income’.
Therefore, in the case of complete absence of FTS, the MFN clause could still
apply when the comparative TT provides for a reduced taxing right on FTS, and
thereby affecting the Source State’s right to ‘taxation at source’.

CONCLUSION

The MFN clause, when applied through the Protocol, is assumed to have an
automatic application, i.e., without the need for a formal approval from tax
authorities¹, similar to the MFN clause in the SA-SW TT above. The
past decisions on the MFN clause²
are usually from the perspective of the scope of FTS, wherein, the scope
for FTS is reduced to either ‘make-available’ technical services or removing
managerial service from FTS, or from the perspective of reducing the tax rate
on FTS; all to the extent of the scope or tax rate as ‘specified’ in the
qualifying TT. None of the Indian decisions goes past the ‘specified’ scope or
tax rate in the qualified TT. The objective of this article is to be aware of
its possibility and its planning opportunities.

Observing the similarities between the above foreign decision and the
above example, the MFN clause in the Ind-NL TT refers to two important terms,
‘limits its taxation at source’ and ‘a rate lower or scope more restricted’.
It highlights the resultant scope or resultant rate that limits India’s taxation at source. We
know that the TT merely provides for an allocation of taxing rights between the
resident and the source country. If another TT with another OECD member state
provides for a reduced scope or a lower rate, and thereby limiting India’s
right to ‘taxation at source’, the MFN clause of the Ind-SW TT will get
triggered. India’s right to taxation at
source is determined after taking into account the final tax rate
and provides for an observation to the resulting tax outcome. The scope of the
MFN clause needs to be seen from the perspective of the net result. Whether we
can derive the same result before the Indian judiciary as in the above foreign
decision, only time will tell.

shailesh.kwebmaker

ASSUMPTION OF JURISDICTION U/S 143(2) OF THE INCOME TAX ACT, 1961

Putting one to notice is one of the most
fundamental aspects of law and adjudication. As we are aware, in scrutiny
proceedings the Assessing Officer (AO), in order to ensure that the assessee
has not understated income or not claimed excessive loss, can call the assessee
to produce evidence to support the return of income filed. To assume proper
jurisdiction, the AO has to satisfy two conditions provided in section 143(2)
of the Income Tax Act (the Act). This section states that where a return of
income has been furnished, the AO shall, if he considers it necessary or
expedient to ensure that the assessee has not understated income or has
computed excessive loss, serve on the assessee a notice requiring him to
adduce evidence in support of his return of income. The proviso to
section 143(2) of the Act states that no notice under the sub-section shall
be served on the assessee after the expiry of six months from the end of
the month in which the return is furnished. It is pertinent to note that the
section, including the proviso, has not gone through any material
changes over the years.

It is clear from the above that it is
incumbent upon the AO to serve a notice u/s 143(2) and the proviso puts
a further limit on the AO to serve the notice within six months from the end of
the month in which the return of income was furnished. Now, one does not
require any authority to support the proposition that when the legislature has
used the word ‘shall’, it has not left any discretion with the AO and that it
is mandatory for him to follow such procedure. The issue eventually boils down
to interpretation of the word ‘serve’ and whether mere issuance of notice u/s
143(2) is sufficient compliance.

SECTIONS AND RULES
DEALING WITH SERVICE UNDER THE ACT

At this point it would be useful to go
through section 282 of the Act as it stood prior to the amendment brought in by
the Finance (No. 2) Act, 2009; it stated that ‘a notice or requisition under
this Act may be served on the person therein named either by post or as if it
were a summons issued by a court under the Code of Civil Procedure, 1908’. Therefore,
notice could have been served either through post or as if it were summons
under the Code of Civil Procedure, 1908 (CPC). It would be pertinent to note
that Order 5 of the CPC deals with issue and service of summons. In Order 5 of
the CPC, Rules 9 to 20 are of relevance and Rules 17 and 20 are of some
importance for the discussion herewith.

Rule 17 of Order 5 of the CPC reads as
follows: ‘Where the defendant or his agent or such other person as aforesaid
refuses to sign the acknowledgement… the serving officer shall affix a copy of
the summons on the outer door or some other conspicuous part of the house in
which the defendant ordinarily resides or carries on business or personally
works for gain, and shall then return the original to the Court from which it
was issued, with a report endorsed thereon or annexed thereto stating that he
has so affixed the copy, the circumstances under which he did so, and the name
and address of the person (if any) by whom the house was identified and in
whose presence the copy was affixed.’

The Rule
provides that if the defendant or his agent refuses to sign the
acknowledgement, then the serving officer can affix a copy of the summons on
the outer door or any conspicuous part of the house and shall return the
original to the Court (in our case the AO) with a report saying under what
circumstances he affixed the copy on the outer door.

Rule 20 of Order 5 of the CPC reads as
under: ‘(1) Where the Court is satisfied that there is reason to believe
that the defendant is keeping out of the way for the purpose of avoiding
service, or that for any other reason the summons cannot be served in the
ordinary way, the Court shall order the summons to be served by affixing a copy
thereof in some conspicuous place in the Courthouse, and also upon some
conspicuous part of the house (if any) in which the defendant is known to have
last resided or carried on business or personally worked for gain, or in such
other manner as the Court thinks fit.

(2) Effect of service substituted by
order of the Court shall be as effectual as if it had been made on the defendant personally.’

From a reading of the above Rule it is
evident that if the Court (in our case the AO) is satisfied that there is
reason to believe that the defendant is keeping out of the way for the purpose
of avoiding service, the Court shall order the summons to be served by affixing
a copy thereof in some conspicuous place. The aforesaid provisions are relevant
to appreciate the point that the Act sufficiently provides remedy to a
situation where the assessee is being evasive in receiving notices either in
order to frustrate the attempts of the AO to serve the notices within the time
limit prescribed under the Act and, as a consequence, to vitiate the entire
proceedings, or to stall the assessment proceedings. Further, the aforesaid
position will not change even under the amended provisions of section 282 of
the Act, as I will point out below.

The Act also deals with how the notice has
to be delivered to the person mentioned therein. Under the amended section
282(2) of the Act, the Board has been empowered to make rules providing for the
addresses to which a communication referred to in sub-section (1) may be delivered.
In view of the same, Rule 127 of the Rules was inserted. Further, the first proviso
states that if the assessee specifically intimates to the AO that notice shall
not be served on the addresses mentioned in sub-clauses (i) to (iv) of Rule
127(1) of the Rules (address in PAN database and return of income of the year
in consideration, or previous year, or in the MCA database) where the assessee
furnishes in writing any other address for the purpose of communication. The
second proviso states that if the communication could not be served on
the addresses mentioned in clauses (i) to (iv) of Rule 127(2) of the Rules as
well as the address mentioned in the first proviso as provided by the
assessee, then the AO shall deliver or transmit the document, inter alia,
to the address available with any banking company, or co-operative bank, or
insurance company, or post-master general, or address available in government
records, or with any local authority mentioned in section 10(20) of the Act. As
evident, the Rules have provided enough avenues to the AO to achieve the same.

The question which one would have to
consider is what would be the position when the assessee has not intimated the
AO of the new address and the notice issued on an old address comes back unserved
and, thereafter, the time limit to issue further notice has expired?

In my opinion, considering the sheer avenues
available with the AO in view of Rule 127 of the Rules, it was incumbent upon
the AO to serve or communicate the notice on any of the addresses provided
therein. The argument with respect to passing of time limit and, therefore, the
AO could not serve notice on the assessee, would not exonerate the AO from
making endeavours much before the passing of the time limit. If the assessee has
to be vigilant enough to meet deadlines, compliances and its rights and
contentions, equally, the AO, with all the resources at its disposal in today’s
technologically advanced environment, is expected to serve notices within the
time limit provided under the Act. If the AO issues a notice at the fag end of
the period of limitation and thereafter the service of the notice is called
into question, in my opinion, as stated above, it may not absolve the AO from
his duty to serve it within time for the simple reason that proceedings ought
to have been initiated a bit earlier on a conservative basis. Further, if, at
the same time, the conduct of the assessee is not forthcoming or is evasive,
the Courts, in my opinion, surely would step in to do justice.

Further, instances have come to light with
regard to E-assessment proceedings where the AO, rather than serving the
notices on the email address provided by the assessee, is merely uploading the
notices on the e-filing income tax portal of the assessee; this, in my opinion,
would also not be valid service of notice. The Rules mandate, as discussed
above, that the electronic record has to be communicated to the assessee on his
email address and not merely uploaded.

After dealing with the sections on modes of
service, it would be suitable to deal with sections mandating service of notice
in addition to section 143(2) of the Act. Section 292BB, which states that
where an assessee has appeared in any proceedings relating to an assessment,
then it shall be deemed that any notice which was required to be served upon
the assessee has been duly served upon him in time in accordance with the
provisions of the Act and such assessee shall be precluded from taking any
objection in any proceedings, inter alia, on the ground that the notice
was not served upon him on time. However, nothing contained in the section
would apply where the assessee raises that objection before the completion of
the assessment itself. The provision impliedly, or rather expressly, recognises
the fact that valid service of notice within the time limit prescribed under
the requisite provisions has been given utmost importance under the Act and
failure to service it within the stipulated time limit would vitiate the entire
proceedings.

Reference can also be made to section
153C(2) to demonstrate that the legislature has been emphasising the point of
service of notice u/s 143(2) and recognising a distinction between service and
issuance of notice. The section provides that where the incriminating material
as mentioned in 153(1) has been received by the AO of the assessee after the
due date of filing of return of the assessment year in which search was carried
out and no notice u/s 143(2) has been served and the time limit to serve the notice
has also expired before the date of receiving the incriminating material, then
the AO shall issue notice as per the manner prescribed u/s 153A.

Therefore, what the section provides is, all
other conditions remaining constant, if notice u/s 143(2) has been issued but
not served and the time limit for serving the notice has also expired, then the
AO can proceed as per the procedure provided u/s 153A. Therefore, the
legislature itself has again made a distinction between issue of notice and
service of notice u/s 143(2) and put beyond the pale of doubt that the
requirement as provided u/s 143(2) is of service of notice and not mere
issuance. It would also be relevant to take note of section 156, which also
puts an embargo of service of the notice of demand. Further, as I point out in
paragraph (vii) below, service of notice is a precondition to assume valid
jurisdiction.

A FEW DECISIONS OF THE
SUPREME COURT / THE COURT

The Supreme Court, in the context of section
156, dealt with the issue whether the subsequent recovery proceedings would
stand vitiated when no notice of demand had been served on the assessee. In the
case of Mohan Wahi vs. CIT (248 ITR 799), the Court, following
the decision in the case of ITO vs. Seghu Setty (52 ITR 528)
rendered in the context of the Income-tax Act, 1922 (1922 Act), held that the
use of the term ‘shall’ in section 156 implies that service of demand notice is
mandatory before initiating recovery proceedings and constitutes the foundation
for recovery proceedings and, therefore, failure to serve the notice of demand
would render the subsequent recovery proceedings null and void.

Reference can also be made to the Three-Judge
Bench decision of the Supreme Court in the case of Narayana Chetty
vs. ITO (35 ITR 388) wherein the Court, dealing with section 34
(providing power to reopen an assessment) of the 1922 Act, held that service of
the notice is a precondition and it is not a procedural irregularity. A similar
analogy, in my submission, can be drawn with regard to section 143(2) as well –
that section 143(2) mandates service of notice on the assessee and the said
notice also forms the bedrock of assessment proceedings, therefore, mere
issuance is not sufficient.

Further, I would like to point out the
decision of the Supreme Court in the case of R.K. Upadhyaya vs. Shanabhai
P. Patel (166 ITR 163) where the
Court has made a distinction between issuance of notice and service of notice.
However, prior to dealing with the same it is appropriate to discuss the
decision of the Supreme Court in the case of Bansari Debi vs. ITO (53 ITR
100). The controversy in that is as follows: Section 34(1)(b) of the
1922 Act provided that the AO may, at any time within eight assessment years
from the end of the assessment year of which reopening is sought to be done,
reopen the assessment by serving a notice on the assessee. The aforesaid
section was amended by section 4 of the Indian Income tax (Amendment) Act, 1959
(Amending Act) which, inter alia, provided that no notice issued u/s 34(1)
can be called into challenge before any court of law on the ground that the
time limit for issuing the notice had expired. The assessee raised a plea that
when the notice is issued within a period of eight years but served beyond the
period of eight years, it would not be saved by the Amending Act, as it only
dealt with issuance of notice.

The Court, rejecting the argument of the
assessee, held that the purpose of bringing the Amending Act was to save the
validity of the notice; if a narrow interpretation of ‘issue’ is given, then
the Amending Act would become unworkable as the time limit prescribed in
34(1)(b) of the 1922 Act was only with regard to service of notice. Therefore,
to advance the purpose of the legislature, which was to save the validity of
notices beyond the time prescribed under the 1922 Act, the Court held that the
word ‘issue’ has to be interpreted as the word ‘service’. The Court held that a
wider meaning of the word ‘issue’ would be consistent with the provisions of
the Act as well. In conclusion, the Court in the aforesaid case held that
‘issue’ can be interchangeably used with ‘service’.

Thereafter, in the context of the 1961 Act,
the Supreme Court in the case of R.K. Upadhyaya (Supra)
was again called upon to decide whether service and issue can be used
interchangeably. The controversy before the Court was that the notice u/s 148
was issued by registered post prior to the date of limitation; however, it was
served after the period of limitation. The assessee / respondent before the
Court argued that though section 149 states that the no notice shall be issued
beyond the period of limitation and section 148 provides that reassessment
cannot be done without service of the notice u/s 148, in view of the decision
of Bansari Debi (Supra), ‘issue’ used in section 149 shall be
interpreted to mean ‘serve’; therefore, service beyond the period of limitation
is not valid in law.

The Supreme Court rejected the argument by
holding that the scheme of the 1961 Act is materially different from the 1922
Act. A clear distinction has been made between ‘issue of notice’ and ‘service
of notice’ under the 1961 Act. The Court held that section 148 provides service
of notice as a condition precedent to making the assessment and section 149
provides for issuance of notice before the period of limitation; therefore,
there is a clear distinction between the two. The decision in the case of Bansari Debi (Supra) could not be applied for the purpose of
interpreting the provisions of reopening under the 1961 Act.

In my view of the aforesaid decisions as
well as the provisions of the Act, it can be contended that service of notice
u/s 143(2) is a condition precedent for assuming jurisdiction u/s 143. The
legislature has made a clear distinction between the term ‘issue’ and ‘service’
and it is manifested from sections 148 and 149 of the Act. Therefore, the two
terms cannot be used interchangeably.

CIRCULARS /
INSTRUCTIONS ISSUED BY THE BOARD

Reference can also be made to Instruction
No. 1808 dated 8^th March, 1989 which deals with the then
newly-inserted proviso u/s 143(2). The proviso is identically
worded as the new proviso, the only difference being the time limit for
service of the notice. The instruction which the Board gave to the authorities
is as follows:

‘4. It may be noted that, under the
aforesaid provision, it is essential that a notice under section 143(2) of the
Act is served on the assessee within the statutory time limit, and mere issue
of the notice within the statutory period will not suffice’. The instruction clearly states that mere issuance of notice within
the statutory period will not suffice, it has to be served. Similar
instructions have been given by the Board for selection of cases u/s 143(2)(i)
vide Instruction No. 5 dated 28^th June, 2002. A similar instruction
has been given in the General Direction issued by the Board vide Notification
No. 3265 (E) 62/2019 dated 12^th September, 2019 with regard to the
new scheme of E-assessment, which has been brought with much fanfare.

In view of the aforesaid interpretation
given by the Board through various circulars and instructions that notice u/s
143(2) has to be served, it would not be open to Revenue to contend otherwise
that mere issuance of notice would suffice the requirement of the section. Considering
the aforesaid provisions, the dictum of the Supreme Court in the aforesaid
decisions and the interpretation given by the Board itself, it would be safe to
conclude that issuance of notice u/s 143(2) will not meet the requirement of
assuming valid jurisdiction to initiate proceedings u/s 143.

RECENT DECISION OF THE
SUPREME COURT

However, the Supreme Court recently,
in the case of Pr. CIT vs. M/s I-ven Interactive Ltd. (418 ITR 662),
has apparently altered the aforesaid position. The Court has not only put a
burdensome finding on the assessee but has also given a distinctive
interpretation of law which I would like to discuss.

Facts

The assessee filed its return of income
online on 28^th November, 2006 for 2006-07 and also filed a hard copy
on 5^th December, 2006. In the return of income, the assessee had
mentioned its new address. Thereafter, a notice u/s 143(2) was issued on 5^th
October, 2007 at the old address, picked up from the PAN database of the
assessee. Though it is not coming out very clearly from the facts as narrated
by the Court in its order, the question of law before the Bombay High Court as
well as the grounds of appeal raised before the Tribunal proceeds on the footing
that the notice was indeed served on the associate entity of the assessee
within the time limit prescribed under the proviso to section 143(2).
Another notice u/s 143(2) was issued on 25^th July, 2008 at the
address available in the PAN database. The assessment order was passed u/s
143(3) on 24^th December, 2008.

The assessee challenged the order before the
Commissioner of Income tax (Appeals) (CIT[A]), inter alia, on the ground
that the notice u/s 143(2) issued on 5^th October, 2007 was not
served on the assessee and the subsequent notices were served beyond the time
limit prescribed u/s 143(2). The CIT(A), vide order dated 23^rdDecember,
2010, allowed the appeal holding that the AO passed the order without assuming a valid jurisdiction u/s 143(2).

Revenue challenged the order of the CIT(A)
before the Income tax Appellate Tribunal (the Tribunal) which, vide its order
dated 19^th January, 2015, confirmed the order of the CIT(A). The
Tribunal, affirming the finding of the CIT(A), inter alia, held that the
assessee had, during the course of the assessment proceedings, brought to the
notice of the AO that the notice u/s 143(2) dated 5^thOctober, 2007
was not served on the appellant, therefore, the proceedings u/s 143(3) were bad
in law.

Revenue challenged the order of the Tribunal
before the Bombay High Court in ITA No. 94 of 2016. The Bombay High Court,
dismissing the appeal, noted that the AO had, in fact, served at the new
address the assessment order u/s 143(3) on 30^th November, 2006 for
assessment year 2004-05 which was very much prior to the notice u/s 143(2)
dated 5^th October, 2007 and 25^th July, 2008. The Bombay
High Court noted that the assessee, in the course of the assessment
proceedings, had raised the issue of valid service of notice u/s 143(2) and, therefore,
the Tribunal rightly held that in view of the proviso to section 292BB,
notice not being served within time was invalid.

Arguments before the Supreme Court

It was submitted that as there was no
intimation by the assessee to the AO of change of address, the notice u/s
143(2) was sent to the assessee at the available address as per the PAN
database. In view of these facts, the AO was justified in sending the notice
u/s 143(2) on the old address. Once the notice has been issued and sent to the
available address as per the PAN database, it is sufficient compliance of
provisions u/s 143(2).

The assessee argued that the AO was aware
about the new address and, therefore, the notice u/s 143(2) ought to have been
served at the new address only. But the notice u/s 143(2) was, in fact, served
on the old address and, therefore, the same was never served on the assessee.
Further, the subsequent notice was served beyond the time limit provided u/s
143(2). The assessee further relied on the decision of the Supreme Court in the
case of ACIT vs. Hotel Blue Moon (321 ITR 362) to submit that
notice u/s 143(2) has to be served within the time limit prescribed under the proviso
to section 143(2).

The assessee further argued that the AO was
aware about the change of address, which is evident from the fact that the AO
had sent assessment orders for the assessment years 2004-05 and 2005-06 to the
new address.

Conclusion of the Supreme Court

The Court held that as there was no
intimation of change of address to the AO, the AO was justified in issuing the
notice u/s 143(2) on the address available in the PAN database. The Court
further held that mere mentioning of the new address in the return of income
without specifically intimating the AO with respect to the change of address
and without getting the PAN database changed is not adequate. In the absence of
any specific intimation, the AO was justified in issuing the notice at the
address available in the PAN database, especially in view of the return being
filed under the e-filing scheme. The Court noted that the notices u/s 143(2)
are issued on selection of cases generated under the automated system of the
Department which picks up the address of the assessee from the PAN database.

The Court, thereafter, held that once a notice
is issued within the time limit prescribed as per the proviso to section
143(2), the same can be said to be sufficient compliance of section 143(2).
Actual service of the notice upon the assessee is immaterial. The Court gave
such an interpretation to the proviso because, in its wisdom, it felt
that in a case it may happen that though the notice is sent within the period
prescribed, the assessee may avoid actual service of the notice till the expiry
of the period prescribed. The Court further held that in the decision relied
upon by the assessee in the case of Hotel Blue Moon (Supra) also,
it was observed that issuance of notice u/s 143(2) within the time limit
prescribed under the proviso to section 143(2) is necessary.

With regard to the argument of the assessee
that the AO was aware of the change of address in view of the fact that the AO
himself had issued assessment orders for earlier assessment years, i.e. 2004-05
and 2005-06 on the new address, the Court held that the matter had been
adequately explained by the Revenue. In view of the aforesaid findings, the
Court set aside the order of the Bombay High Court and remanded the matter back
to the file of the CIT(A) to decide the issue on merits.

Analysis of the aforesaid decision

The Court came to the aforesaid conclusion
that issuance of a notice is sufficient and service is immaterial majorly on
the point that an assessee may deliberately avoid service of notice within the
time limit in order to stall the assessment proceedings. The remedy for the situation
envisaged by the Court has been adequately provided under the Act itself as
pointed out in paragraph (ii) above, that if the assessee is evasive then there
are various modes of effecting service which would be considered as valid forms
of service. Further, the Act has made clear the requirement of service of the
notice, and not mere issuance, as discussed in paragraph (vi) above. The Court
in its previous decisions has also opined that service of notice is a
precondition for assuming valid jurisdiction and also brought out distinction
between issue and service of notice and how it has been used distinctively
under the Act, which we have seen in aforesaid paragraph (viii). In fact,
Revenue itself has interpreted that service of notice is the most crucial point
of assuming jurisdiction u/s 143(2) which we have seen in paragraph (ix) above.

In my submission, it was not open to the
Revenue to contend otherwise. Further, reference can also be made to the
decision of the Supreme Court Three-Judge Bench in the case of UCO
Bank vs. CIT (237 ITR 889) in which the Court dealt with a somewhat
similar issue. To a previous Three-Judge Bench of the Supreme Court, a CBDT
Circular was not pointed out which was in consonance with the provisions of the
Act and the concept of income. The Court held that circulars are issued for the
purpose of proper administration of the Act, to mitigate the rigours of the
application of provisions of the statute, in certain situations by applying
interpretation beneficial to the assessee, and circulars are not meant for
contradicting or nullifying any provision of the law. Such circulars are
binding on the Revenue and when one such circular was not put before the
earlier Three-Judge Bench of the Supreme Court in a correct perspective, the
same would be contrary to the ratio laid down by the decision of the Constitutional
Bench in the case of Navnitlal Jhaveri vs. AAC (56 ITR 198). In
my opinion, this can be similarly submitted with regard to the aforesaid
circulars referred to in paragraph (vi) as well.

Obiter vs.
ratio of the decision

One more aspect
which I would like to highlight with regard to the aforesaid decision and that
can be kept in mind is that the notices were served on the associate of the
assessee within the time limit provided under the proviso to section
143(2) and that may have prompted the Court to reach the aforesaid conclusion.
Looking at it from another angle, we can wonder whether the interpretation
given by the Court is the ratio of the judgment or an obiter dictum?
It is well settled that even the obiter of the Court is binding
throughout the country and no authority is required to support that
proposition. The only point of distinction would be that when the obiter of
the Court contradicts the ratio of a previous decision, then the ratio
laid down in the previous decision has to be followed and not the obiter.

In this regard, I would draw attention to
the decision rendered by the Punjab and Haryana High Court in the case
of Sirsa Industries vs. CIT (178 ITR 437). Even there, the High
Court was dealing with a question in which seemingly a Three-Judge Bench
decision of the Supreme Court in the case of Chowringhee Sales
Bureau vs. CIT (87 ITR 542) had taken a view contrary to the decision
of the Division Bench in the case of Kedarnath Jute Mfg. Co. Ltd.
vs. CIT (82 ITR 363). The facts of the case are noteworthy. The
assessee was following the mercantile system of accounting and claimed
deduction of sales tax payable by taking a view that the liability had accrued
and therefore deduction could be claimed. The AO sought to reopen the
assessment to deny deduction claimed on mercantile basis by taking the view
that in the case of Chowringhee Sales (Supra), the Supreme Court
held, even though that party was following the mercantile system of accounting,
that ‘a party would be entitled to claim deduction as and when it passes it
on to the government’. The High Court held that the Supreme Court in the
case of Chowringhee Sales (Supra) was considering a different
issue and not the allowability or non-allowability of sales tax payable and,
therefore, it cannot be said that there is a conflict between the decision of
the Three-Judge Bench in the case of Chowringhee Sales (Supra)
and the decision of the Division Bench in the case of Kedarnath Jute Mfg.
(Supra), which allowed deduction of sales tax liability on the basis of
accrual of liability. In view of the same, the High Court quashed the reopening
notices.

The facts of the case before the Court in
the case of I-ven Interactive, as narrated above, show that the notice was
served on the associate of the assessee within the time limit provided under
the proviso to section 143(2). Therefore, it is possible to argue that
the Court was called upon to decide only on the point as to whether or not
notice u/s 143(2) served on the associate of the assessee on the old address of
the assessee was a valid service u/s 143(2). Consequently, mere issuance of
notice u/s 143(2) was sufficient compliance of the provision of section 143(2)
was merely an observation made by the Court.

Considering the aforesaid provisions of the
Act, the decisions of the Court itself which the Court did not have the
occasion to deal with sufficiently, as well as the CBDT Circulars, in my
opinion it is still an arguable case that mere issuance of notice u/s 143(2) is
not a sufficient compliance of the provisions of section 143(2). Inversely,
whether service of notice should have been read as issuance of notice has not
been foreclosed.

With regard to the second important finding
which the Court had given, that merely mentioning the new address in the return
of income would not suffice, a specific intimation has to be filed with the AO
bringing to his notice the change of address as well as an application for
change of address has to be made in the PAN database. From 2^nd
December, 2015 (the date from which Rule 127 of the Rules was inserted), the
Act has implicitly recognised the fact that once an address is mentioned in the
return of income, the AO is aware about that address and, thereby, notice can
be served on the said address as well in a given scenario. The second proviso,
inserted from 20^thDecember, 2017, sheds some light on the
controversy dealt with by the Court. Therefore, in my view, after insertion of
Rule 127 of the Rules, failure to specifically bring to the AO’s notice would
not enable the AO to shirk his responsibility of serving the notice to the
assessee.

I have tried to comprehensively deal with
the aspect of issue vs. service as well as what would be the consequences of a
notice coming back unserved. In future on account of electronic transmission of
notices as well as e-assessments, service of notice would throw up innumerable
fresh challenges. It would be interesting to see how the Courts deal with the
same.

shailesh.kwebmaker

INCOME-TAX E-ASSESSMENTS – YESTERDAY, TODAY & TOMORROW

INTRODUCTION

The Government of
India has, over the last few years, taken various steps to reduce human
interface between the tax administration and the taxpayers and to bring in
consistency and transparency in various tax administrative matters through the
use of Information Technology. This has been very pronounced in the matter of
scrutinies being conducted by tax officers under the Income-tax Act, 1961 (the
Act). This article traces the history of E-assessments and takes a peep into
what the coming days will bring.

RECENT
HISTORY

When we look at the
recent past, one of the initial impacts of technology in the income tax
scrutiny assessment procedures was the implementation of the Computer-Assisted
Scrutiny Selection (CASS) scheme for selection of cases. The process of
selection of cases based on scrutiny on random basis was gradually dispensed
with and was replaced by a system-based centralised approach. Under CASS, the
selection of income tax returns for the purpose of scrutiny was based on a
detailed analysis of risk parameters and 360-degree data profiling of the
taxpayers.

The CASS
substantially reduced the manual intervention in the selection process of cases
for assessment proceedings. Nonetheless, some cases were manually picked up by
the taxmen on the basis of pre-determined revenue potential-based parameters.

The CASS provided
greater transparency in the selection procedures as the guidelines of selection
were placed in the public domain for wider information of taxpayers. The entire
process was made quite transparent and scientific.

In order to address
the concerns of taxpayers with respect to undue harassment and to ensure proper
tax administration, the Board, by virtue of its powers u/s 119 of the Act and
in supersession of earlier instructions / guidelines that in cases selected for
scrutiny during the Financial Year 2014-15 under CASS, on the basis of either
AIR data or CIB information or for non-reconciliation with Form 26AS data,
ensured that the scope of inquiry should be limited to verification of those
particular aspects only. The Assessing Officers (AOs) were instructed to
confine their questionnaire and subsequent inquiry or verification only to the
specific point(s) on the basis of which the particular return was selected for
scrutiny.

Apart from this,
the reason(s) for selection of cases under CASS were displayed to the AOs in
the Assessment Information System (AST) application and notices for selection
of cases of scrutiny u/s 143(2) of the Act, after generation from AST, were
issued to the taxpayers with the remark ‘Selected under Computer-Aided Scrutiny
Selection (CASS)’.

PILOT
PROJECT

In order to further
improve the assessment procedures and usher in a paperless environment, the
Department rolled out the E-assessment procedures via a pilot project wherein
the AOs conducted their inquiry by sending queries and receiving responses
thereto through e-mails.

The cases covered under the pilot project were initially those which had
been selected for scrutiny on the basis of AIR (Annual Information Return) /
CIB (Central Information Branch) information or non-reconciliation of tax with
Form 26AS data. However, the Department ensured that the consent of the
taxpayers was sought for their scrutiny assessment proceedings to be carried
out under the newly-introduced E-assessment proceedings and only willing
taxpayers were considered under the pilot run.

New Rule 127 was
inserted by the Income Tax (Eighteenth Amendment) Rules, 2015 w.e.f. 2^nd
December, 2015 which gave the framework for issue of notices and other
communication with the assessee. It prescribes the rule for addresses
(including address of electronic mail or electronic mail message) to which
notices or any other communication may be delivered.

Between the years
2016 and 2018, the CBDT progressively amended rules, notified various
procedures and issued the required guidelines to increase the scope of
E-proceedings on the basis of the pilot study. Notification No. 2/2016 dated 3^rd
February, 2016 and Notification No. 4/2017 dated 3^rd April, 2017
were very important and provided the procedures, formats and standards for
ensuring secured transmission of electronic communications.

The Finance Act,
2016 introduced section 2(23C) in the Act to provide that the term ‘hearing’
includes communication of data and documents through electronic mode.
Accordingly, to facilitate the conduct of assessment proceedings
electronically, CBDT issued a revised format of notice(s) u/s 143(2) of the
Act.

The scope of
E-assessment proceedings was extended vide Instruction No. 8/2017 dated 29^th
September, 2017 to cover all the cases which were getting barred by limitation
during the financial year 2017-18 with the option to the assessees to
voluntarily opt out from ‘E-proceedings’.

The CBDT later
issued Instruction No. 1/2018 dated 12^th February, 2018 through
which the proceedings scheme was stretched to cover all the pending scrutiny
assessment cases. However, exceptions were carved out for certain types of
proceedings such as search and seizure cases, re-assessments, etc., where the
assessments were done through the personal hearing process. Further, there
remained an option to object to the conduct of E-assessment.

Thereafter,
Instruction No. 03/2018 dated 20^thAugust, 2018 issued by the Board
carved out the way for all cases where assessment was required to be framed u/s
143(3) during the year 2018-19. It provided that assessment proceedings in all
such cases should mandatorily be through E-assessment

NEW
E-ASSESSMENT SCHEME

In September, 2019
the CBDT notified the ‘E-Assessment Scheme, 2019’ (scheme) laying down the
framework to carry out the ‘E-assessments’. As anticipated, the scheme was
churned out with the intention to bring about a 360-degree change in the way
tax assessments will be carried out in future.

The scheme is in line with the recommendations of the Tax Administration
Reforms Commission (TARC) which was formed with the intention to review the
application of Tax Policies and Tax Laws in the context of global best
practices and to recommend measures for reforms required in tax administration
in order to enhance its effectiveness and efficiency. An extract of the TARC
report is as under:

‘Currently, the
general perception among taxpayers is that the tax administration is focused on
only one dimension – that of revenue generation. This perception gains strength
from the manner in which goals are set at each functional unit of both the
direct and indirect tax departments. These goals, in turn, drive the
performance of individual tax officials. Therefore, the whole system of goal
setting, performance assessment, incentivisation and promotion appears to be
focused on only this dimension. This single-minded revenue focus can never meet
the criteria of the mission and values mentioned above. What is required is a
robust framework that is holistic in its approach to issues of performance
management.’

As the phrase
‘faceless’ suggests, under this scheme a taxpayer will not be made aware of the
AO who would be carrying out the assessment in his case. It could be an officer
located in any part of the country.

The prime objective
of the Government in introducing the E-Assessment Scheme, 2019 has admittedly
been to eliminate the interface between the taxpayers and the tax department
and to impart greater transparency and accountability. The scheme would also
help in optimising the utilisation of resources of the tax department, be it
human or technical, through economies of scale and functional specialisation.
The scheme envisages a team-based assessment with dynamic jurisdiction. It is
also intended to ensure the tax assessments are technically sound and that
consistent tax positions are taken on various issues to avoid prolonged and
unnecessary litigations for both the taxpayer as well as the tax officers.

The then Hon’ble
Finance Minister, the late Mr. Arun Jaitley, said in his Union Budget speech
for the financial year 2018-19:

‘E-assessment

We had
introduced E-assessment in 2016 on a pilot basis and in 2017 extended it to 102
cities with the objective of reducing the interface between the department and
the taxpayers. With the experience gained so far, we are now ready to roll out
the E-assessment across the country which will transform the age-old assessment
procedure of the income tax department and the manner in which they interact
with taxpayers and other stakeholders. Accordingly, I propose to amend the
Income-tax Act to notify a new scheme for assessment where the assessment will
be done in electronic mode which will almost eliminate person to person contact
leading to greater efficiency and transparency.’

In the above
background, two new sub-sections, (3A) and (3B), were introduced in section 143
of the Act enabling the Central Government to come out with a scheme for the
faceless electronic assessments which was finally notified as ‘E-Assessment Scheme, 2019’ vide Notification No. 61/2019
and 62/2019, dated 12^th September, 2019 to conduct
E-assessments with effect from 12^th September, 2019.

The scheme has laid out a functional structure of the E-assessment
centres at the national and the regional levels. The framework also provides
for specialised units in the Regional E-assessment Centre for carrying out
specific functions related to various aspects of an assessment. The proposed
structure is depicted as under:

The functions of
these centres and units set up under the scheme are discussed below:

NATIONAL E-ASSESSMENT CENTRE (NeAC)

NeAC will be an
independent office and a nodal point which would oversee the work of the
E-assessment scheme across the country. All the communications between the
income tax department and the taxpayers would be made through the NeAC, which
will enable the conduct of tax assessment in a centralised manner.

On 7^th
October, 2019 the Revenue Secretary, Mr. Ajay Bhushan Pandey, inaugurated the
NeAC in Delhi. He stated that the setting up of the NeAC of the Income Tax
Department is a momentous step towards the larger objectives of better taxpayer
service, reduction of taxpayer grievances in line with the Prime Minister’s
vision of ‘Digital India’ and promotion of the Ease of Doing Business.

The NeAC in Delhi
will be headed by the Principal Chief Commissioner of Income Tax (Pr.CCIT) and
would coordinate between the different units in the tax department for
gathering information, coordination of assessment, seeking technical inputs on
tax positions, verification and review of the information submitted by
taxpayers, review of draft orders framed by the assessment units, etc.

REGIONAL
E-ASSESSMENT CENTRE

The Regional
E-assessment centre would comprise of (a) Assessment unit, (b) Review unit, (c)
Technical unit, and (d) Verification unit. Eight Regional E-assessment Centres
(ReAC) have already been set up in Delhi, Mumbai, Chennai, Kolkata, Ahmedabad,
Pune, Bengaluru and Hyderabad. Each of these ReACs will be headed by a Chief
Commissioner of Income Tax (CCIT).

(a) Assessment
units

Assessment units
under the E-Assessment Scheme will perform the function of making assessments,
which will include identification of points or issues material for the
determination of any liability (including refund) under the Act, seeking
information or clarification on points or issues so identified, analysis of the
material furnished by the assessee or any other person, and such other
functions as may be required for the purposes of making assessment. In simple
terms, the Assessment units will largely perform the functions of an AO.

(b) Verification
units

Verification units,
as the name suggests, will carry out the function of verification, which
includes inquiry, cross-verification, examination of books of accounts,
examination of witnesses and recording of statements, and such other functions
as may be required for the purposes of verification. This may also include site
visits for examining and verifying facts for carrying out assessments.

Technical units
will play the role of experts by providing technical assistance which includes
any assistance or advice on legal, accounting, forensic, information
technology, valuation, transfer pricing, data analytics, management or any
other technical matter which may be required in a particular case or a class of
cases under this scheme. This apparently will include the functions of a
Transfer Pricing Officer in a transfer pricing assessment.

(d) Review units

The Review units
would perform the function of review of the draft assessment order, which
includes checking whether the relevant and material evidence has been brought
on record, whether the relevant points of fact and law have been duly
incorporated in the draft order, whether the issues on which addition or
disallowance that should be made have been discussed in the draft order,
whether the applicable judicial decisions have been considered and dealt with
in the draft order, checking for arithmetical correctness of modifications
proposed, if any, and such other functions as may be required for the purposes
of review.

As notified in
Notification No. 61/2019, the Assessment units, Verification units, Technical
units and Review units will have the authorities of the rank of Additional /
Joint Commissioner, or Additional / Joint Director, or Assistant / Deputy
Director, or Assistant / Deputy Commissioner, amongst other staff /
consultants.

The CBDT vide
Notification No. 77/2019 has already notified 609 tax officers to play the role
of Assessment, Technical, Verification and Review Units. As per the said
notification, these officers will concurrently exercise the powers and
functions of the AO to facilitate the conduct of E-assessment proceedings in
respect of returns furnished u/s 139 or in response to notice under sub-section
(1) of section 142 of the said Act during any financial year commencing on or
after the 1^st day of April, 2018.

The E-Assessment
Scheme also provides for levy of penalty for non-compliance of any notice,
direction and order issued under the said scheme on any person including the
assessee. Such penalty order after providing adequate opportunity of being
heard to the assessee, will be passed by the NeAC.

After the
completion of assessment proceedings, the NeAC would transfer all the
electronic records of the case to the AO having jurisdiction over such case to
perform all the other functions and proceedings such as imposition of penalty,
collection and recovery of demand, rectification of mistake, giving effect to
appellate orders, submission of remand report, etc. which are otherwise
performed by an AO.

The notification
has also carved out an exception for cases wherein the NeAC may, at any stage
of the assessment, if considered necessary, transfer the case to the AO having
jurisdiction over such case.

DIGITAL
SERVICE OF NOTICE / RECORDS

All notices or records
or any other communication will be delivered to the assessee by electronic
means, viz. by placing it on the E-proceeding tab available on the income-tax
E-filing portal account of the assessee, or by sending it to the e-mail address
of the assessee or his authorised representative, or by uploading on the
assessee’s mobile application.

Notice or any
communication made to any person other than the assessee would be sent to his
registered e-mail address. It also provides that any delivery would also have
to be followed by a real-time alert to the addressee.

The date and time
of service of notice will be determined in accordance with the provisions of
section 13 of the Information Technology Act, 2000. As per the said section,
the time of receipt of an electronic record shall be, if the addressee has
designated a computer resource for the purpose of receiving electronic records,
the time when the electronic record enters the designated computer resource,
otherwise, the time when the electronic record is retrieved by the addressee.

E-RESPONSE
TO NeAC

Under this scheme, the assessee, in response to notice or any other
communication received from the NeAC, shall file his response only through the
E-proceedings tab on his income-tax e-filing portal account. Any other person
can respond to the NeAC using his registered e-mail address.

PERSONAL HEARINGS

Generally, no personal hearings will be required between the assessee /
authorised representative and the income tax department in the course of the
E-assessment proceedings under this scheme. However, in the following cases,
the assessee by himself or through his authorised representative will be
entitled for hearings which will be conducted exclusively through video
conferencing:

(i) Where a modification is proposed in the draft
assessment order, the assessee or his authorised representative in response to
show-cause notice may request a hearing;

(ii) In the case of examination or recording of the
statement of the assessee or any other person (other than statement recorded in
the course of survey u/s 133A of the Act).

APPELLATE
PROCEEDINGS

The E-Assessment
Scheme has clarified regarding the filing of appeals u/s 246A of the Act
against the E-assessment orders passed by NeAC, which shall be filed with the
Commissioner (Appeals) having jurisdiction over the jurisdictional AO in such
case.

ISSUES
IN E-ASSESSMENT SCHEME

The E-Assessment
Scheme, 2019 is not a separate code by itself. It is a part of the existing
statute and therefore the scheme must gel well with the existing statute. Any
conflict there would create legal friction and attract litigation on the
validity of the very assessment.

Provision of the
newly-inserted sub-sections (3A), (3B) and (3C) to section 143 of the Act:

‘(3A) The
Central Government may make a scheme, by notification in the Official Gazette,
for the purposes of making assessment of total income or loss of the assessee
under sub-section (3) so as to impart greater efficiency, transparency and
accountability by

(a) eliminating
the interface between the Assessing Officer and the assessee in the course of
proceedings to the extent technologically feasible;

(b) optimising
utilisation of the resources through economies of scale and functional
specialisation;

(3B) The Central
Government may, for the purpose of giving effect to the scheme made under
sub-section (3A), by notification in the Official Gazette, direct that any of
the provisions of this Act relating to assessment of total income or loss shall
not apply or shall apply with such exceptions, modifications and adaptations as
may be specified in the notification:

Provided that no
direction shall be issued after the 31^stday of March, 2020.

(3C) Every
notification issued under sub-section (3A) and sub-section (3B) shall, as soon
as may be after the notification is issued, be laid before each House of
Parliament.’

The entire
E-Assessment Scheme, 2019 is born out of the provision of sub-section (3A) of
section 143 of the Act which empowers the Government to make a scheme for the
purposes of making assessments under sub-section (3) of section 143(3) of the
Act. Thus, although the assessments u/s 144, section 147 and section 153A etc.
are carried out conjointly u/s 143(3) of the Act, it appears from the scheme
that such assessment originating from the said sections would currently be
outside the ambit of the said scheme.

The E-Assessment
Scheme is based on the concept of dynamic jurisdiction. The Notifications No.
72 and 77 of 2019 have specified various income tax authorities in the NeAC (9)
and ReAC (609) which have been empowered with the concurrent powers and
functions of an AO in respect of returns furnished u/s 139 and section 142(1)
of the Act during the financial year commencing on or after 1^st
April, 2018.

At this point, it is relevant to refer to the provisions of section 120
of the Act which deals with the jurisdiction of income tax authorities.
Sub-section (5) of the said section deals with concurrent jurisdiction. It
empowers the Board to allow concurrent jurisdiction in respect of any area or
persons or class of persons or incomes or classes of income or cases or classes
of cases, if considered necessary or appropriate. Under the scheme, the Board
has already allowed concurrent jurisdiction to over 600 income tax authorities.
Whether this is in line with the provision of section 120(5) of the Act is the
question that perhaps will be answered by the Courts in course of time.

The scheme in its holistic structure, despite having multiple units,
viz. Verification unit, Review unit, NeAC, Technical unit, still leaves the
entire discretion to complete the assessment to the Assessment unit. The
suggestions of the other units like the Technical unit which also appears to be
performing the functions of a Transfer Pricing Officer will not be binding on
the Assessment unit. This deviates from the existing provision of section 92CA
of the Act.

Under sub-section
(3B) of the Act, the Government has also been authorised to come out with such
notifications till 31^st March, 2020 which may be necessary to give
effect to the E-Assessment Scheme by making exceptions, modifications and
adaptations to any provision of the Act. It still remains to be evaluated
whether this would amount to excessive delegation of power as the power to make
law is the jurisdiction of the Parliament. It is only the implementation of
such law that lies with the Government. Vide this provision, the Government is
allowed to make changes in the Act merely by way of notification. Although the
intention behind such provision is to ensure smooth implementation of the
scheme, one cannot deny the fact that there is also a possibility of it being
misused.

Although
sub-section (3C) of section 143 of the Act requires all such the notifications
to be tabled before each House of Parliament, it has not specified any
time-frame. Further, it does not necessitate discussion of such notifications
in the Parliament, which could prompt insightful debates and allow the Houses
to make necessary changes in the notifications. Thus, this provision appears to
be more routine in nature. Also, this arguably endows the power to make law to
the Board.

Section 144A of the
Act allows an assessee to approach the jurisdictional Joint Commissioner of
Income-tax requesting his authority to examine the case and issue necessary
directions to the AO for completion of assessment. With the advent of the
E-Assessment Scheme, this provision will more likely lose its relevance as all
the specified income tax authorities under the scheme, including Joint
Commissioners, will concurrently hold the power and perform the functions of an
AO.

The scheme provides
for review of assessment orders by the Review unit if considered necessary by
the NeAC. The Review unit, upon perusal of the draft assessment order, would
share its suggestions. However, the scheme does not provide that such
suggestions would be mandatory for the Assessment unit to follow while passing
the final draft assessment order.

At present, the
scheme covers only limited scrutiny cases as all the notices issued u/s 143(2)
of the Act in accordance with the scheme must, as mentioned in the Notification
Nos. 61 and 62 of 2019, have to specify the issue/s for selection of cases for
assessment. However, it is seen in some cases that such issues mentioned in
notices u/s 143(2) of the Act have been very general and vague; for example,
‘business expenses’, ‘import and export’,
etc. Thus, it needs to be seen whether such issues can even be termed as
specific if they are not broad and are imprecise.

Further, it does not visualise conversion of limited scrutiny cases to
complete scrutiny cases. However, it allows the NeAC to transfer cases to the
jurisdictional assessing officer at any given point of time during the course
of assessment. Needless to say but upon transfer, the jurisdictional assessing
officer can take necessary recourse under the Act for conversion of a case to
complete scrutiny. Further, it would require compliance of provision of section
127 of the Act for transfer of cases to the jurisdictional assessing officer.

An assessee under the circumstances specified in the scheme will be
allowed to represent his case in person or through his authorised representative
via video conferencing which will be attended by the Verification unit. It will
be interesting to see whether a recording of the discussion is forwarded to the
Assessment unit to avoid any spillage of information in the process.

The scheme provides for the Assessment unit to share with the NeAC, along
with the draft assessment order, details of penalty proceedings to be initiated
therein, if any. NeAC is then authorised to issue show cause on the assessee
for levy of penalty under the Act. It will have to be seen who, under this
scheme, will be considered to record satisfaction for levy of penalty. If such
satisfaction is held to be recorded by the Assessment unit, a show-cause notice
issued by the NeAC will be held as invalid since as per the current settled
position of laws, recording of satisfaction and issue of show cause notice for
levy of penalty have to be carried out by the same AO.

At present, the provision of section 264 empowers the Pr. Commissioner of
Income Tax or the Commissioner of Income Tax to call for and examine the record
of any assessment proceedings carried out by any income tax authority
subordinate to him, other than cases to which the provision of section 263
applies, and pass such order not being prejudicial to the assessee. With the
advent of faceless E-assessments, it would be interesting to see whether such
an order u/s 264 is passed by the Pr. Commissioner of Income Tax or the
Commissioner of Income Tax having jurisdiction over the Assessment unit, or the
one having jurisdiction over the jurisdictional assessing officer. As yet, the
scheme has not visualised such circumstances.

The provision of section 144C requires mandatory passing of a draft
assessment order in the case of foreign companies and cases involving transfer
pricing assessment. In such cases, the assessee has the option to choose to
file an application before the dispute resolution panel and it is only after
the direction of the dispute resolution panel that the final assessment order
is passed by the AO. It is quite clear that the scheme currently does not have
scope for carrying out assessment in these cases.

CONCLUSION

The scheme has been launched by the Government on 7^thOctober,
2019 and 58,322 cases have already been selected for assessment under it in the
first phase by issue of e-notices on taxpayers for the cases related to tax
returns filed u/s 139 of the Act since 1^st April, 2018.

There is no doubt that the scheme has conceptualised a complete paradigm
shift in the way assessments will be carried out in future. The assessments
have been centralised and made faceless. Exchange of communication between
taxpayers and the tax department as well as amongst the income tax authorities
in the tax department has been centralised. The allocation of cases by the NeAC
would be based on the automated allocation system. Thus, it goes without saying
that both the taxpayers and the tax department will need to gear up their
systems to adapt to the scheme.

shailesh.kwebmaker

THINKING CORRECTLY: THE KEY TO PHENOMENAL SUCCESS

Very often, we come across the expression
‘That person is a very good person’. What actually are we referring to? Is it
any physical characteristic? Does the expression refer to his looks, his
height, his weight, or anything specific about his personal appearance? No, the
expression refers to his good thoughts and his good thinking.

How does one cultivate ‘good’ thinking or
thinking correctly? There is no scientific way, but a very good solution is to
constantly bring in an attitude of positivity, helpfulness and consideration
for others at all times and in all circumstances. ‘This life is for others’ is
a good maxim to begin with. If we can gather all our thoughts around this one
thought, our thinking will automatically correct itself for the better. For
example, amongst aging people one common prayer to God is ‘Please give me
strength to look after myself if my son does not look after me when I have
grown old’. However, consider another prayer, ‘Please give me strength to be
able to look after all those whose sons have deserted them’. If God can grant
the first prayer, he can also grant the second one. In the first case the
person will appear to God as a self-centred person thinking only about himself,
whereas the second prayer will appear to Him as one that has been made by a
considerate, helpful and positive person. While the first prayer is not wrong,
the second prayer symbolises good thinking.

Right from a subordinate to the less
privileged people around us, like drivers, liftmen, janitors, etc., even if we
give them a smile, or an occasional chocolate, or a kind word, such acts can
ensure unbelievable good vibes and divine energy around us which has to be experienced
to be believed. However, the real challenge to thinking correctly is during
adverse circumstances.

A jamaai (son-in-law) was visiting
his in-laws and one of the brothers-in-law teased him and even requested him to
take the garbage out. The natural reaction expected in such circumstances would
have been disastrous. The jamaai would feel hurt and insulted, he would
sulk and would probably fight with his wife and his in-laws. In extreme cases,
his future relationship with his in-laws, his wife, children and others around
him would possibly be severely impacted.

However, consider a case where a jamaai
reverses the situation by willingly doing what is asked of him – and even
more. He readily removes the garbage and smilingly even offers to help his
in-laws with things like ironing their clothes. What is really important is his
cheerful attitude when he does this. The good natured act would win over all
the in-laws and they would be full of admiration. Initially, they might have
imagined him to be a ‘stuck-up’ jamaai, but now he becomes very dear to
them; most importantly, his wife is overjoyed and their marriage becomes very
successful and he lives a happy life.

In any situation in life, even if one has
been insulted and treated badly, returning the act with good-natured behaviour
can reverse the situation and such an attitude fosters good thinking. Once good
thinking is regularly practised, thoughts of jealousy, hatred and negative
feelings will reduce to a point where they will automatically be repelled.
Though this is not easy, it comes with practice and with a single theme in your
life: ‘Everyone around me is God’s creation and whether they like me or not, I
have nothing against them and I will gladly help them in every way’.

Once such good thinking is started, friends,
I guarantee you that life will be immensely happy and enjoyable. This attitude
of thinking positively for others also has a miraculous effect of changing the
world around us. It is the key to real success in life and the world will then
become a much better place to live in.

shailesh.kwebmaker

DEPRECIATION ON GOODWILL ARISING DUE TO AMALGAMATION

ISSUE FOR CONSIDERATION
Depreciation is allowable u/s 32(1) on buildings, machinery, plant or furniture, being tangible assets, and also on knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets, acquired on or after 1st April, 1998. The Supreme Court in the case of CIT vs. Smifs Securities Ltd. 348 ITR 302 has held for assessment year 2003-04 that the goodwill acquired on amalgamation (being excess of consideration paid over the value of net assets acquired) by the amalgamated company would fall under the expression ‘any other business or commercial right of a similar nature’ and qualify to be treated as an intangible asset eligible for depreciation while computing business income. This was decided by the Supreme Court on the basis of the undisputed factual finding as recorded by the lower authorities that such a difference constituted goodwill and that the assessee in the process of amalgamation had acquired a capital right in the form of goodwill because of which the market worth of the assessee had increased.

The sixth proviso to section 32(1)(ii) provides that the aggregate depreciation allowable to the transferor and transferee, in any previous year, in the case of succession or amalgamation or demerger shall not exceed the deduction allowable at prescribed rates, as if such succession or amalgamation or demerger has not taken place and the deduction on account of depreciation shall be apportioned between the transferor and the transferee in the ratio of number of days for which the assets were used by them.

While the Supreme Court has held that the goodwill arising on account of amalgamation falls within the scope of the ‘intangible assets’ and it is entitled for depreciation u/s 32(1), an issue has arisen subsequently as to whether the depreciation on such goodwill can be denied to the amalgamated company by applying the sixth proviso to section 32(1)(ii) on the ground that no such goodwill was held by the amalgamating company. While the Bangalore bench of the Tribunal has held that the amalgamated company was not eligible for depreciation on goodwill due to the restriction placed in the said sixth proviso, the Hyderabad bench of the Tribunal has taken a contrary view, holding that the depreciation was available on such goodwill to an amalgamated company in spite of the restriction of the sixth proviso.

THE UNITED BREWERIES LTD. CASE
The issue first came up for consideration before the Bangalore bench of the Tribunal in the case of United Breweries Ltd. vs. Addl. CIT, TS-553-ITAT-2016 (Bang.). In this case, during the previous year relevant to A.Y. 2007-08, the assessee’s wholly-owned subsidiary, Karnataka Breweries & Distillery Ltd. (KBDL), got amalgamated with the assessee as per the order of the High Court. The shares of the said company were acquired by the assessee in the preceding year for a consideration of Rs. 180.52 crores. The goodwill amounting to Rs. 62.30 crores was shown as arising on account of the amalgamation, being the excess of purchase consideration over fair value of tangible assets and other net current assets received from the amalgamating company. Accordingly, depreciation of Rs. 15.57 crores was claimed by the assessee.

The AO, in the first place, disputed the method of valuing the assets and disallowed the depreciation on the goodwill on the ground that there was no goodwill if proper valuation was assigned to the tangible asset and land. Apart from that, the AO relied upon the sixth proviso (then fifth proviso) to section 32(1) (ii). He noted that the goodwill on which depreciation was being claimed by the assessee arose only on amalgamation and the amalgamating company had no goodwill on which depreciation was allowed to it. Under such circumstances, there would not be any deduction of depreciation on goodwill in the hands of the amalgamated company. Prior to the amalgamation, KBDL could not have claimed any depreciation on such goodwill that came into existence only on amalgamation as it did not own any such goodwill nor was it eligible for depreciation on such goodwill.

The CIT(A), while concurring with the decision of the AO, observed that the value of the goodwill recorded in the books of KBDL was only Rs. 7.45 crores while it had been shown by the assessee at Rs. 62.30 crores. The CIT(A) also questioned the valuation of goodwill in view of the fact that KBDL had not earned sufficient profits in the past to justify the goodwill on the basis of average of profits. The CIT(A) also concurred with the view of the AO that the assessee was not entitled to depreciation in view of the sixth (then fifth) proviso to section 32(1)(ii).

Before the Tribunal, the assessee submitted that the issue of depreciation on goodwill was covered by the judgment of the Supreme Court in the case of Smifs Securities Ltd. (Supra). Insofar as the valuation was concerned, it was contended that when the assessee had produced the valuation report valuing the tangible asset, then without giving the correct value by the AO, the rejection of the valuation report was not justified. Without giving any counter valuation, the claim of depreciation could not have been rejected only by doubting the valuation of the assessee. Insofar as the sixth proviso to section 32(1)(ii) was concerned, it was submitted that it did not apply when the assets were introduced in the books of the assessee at the balancing figure, being the excess consideration over the value of the tangible assets. It was further contended that in none of the cases decided by the Supreme Court as well as the High Courts the Revenue had ever raised the objection of rejecting the claim of depreciation by applying the fifth (now sixth) proviso to section 32(1) of the Act. Therefore, the Revenue could not have raised the objection in the assessee’s case only when it was not raised in the other cases before the courts in the past.

The Revenue, apart from resting its case on the valuation as well as the said proviso to section 32(1)(ii), also relied upon Explanation 3 to section 43(1) and submitted that the AO had the power to examine the valuation of the assets acquired by the assessee if these assets were already in use for business purpose. If the AO was satisfied that the main purpose of transfer of such assets was the reduction of the liability to income tax, then the actual cost of the asset to the assessee was to be such an amount as the AO determined. Therefore, it was claimed that the AO had rightly determined the valuation of the goodwill at NIL. The Tribunal rejected the contention of the assessee that the AO could not have disturbed the valuation of the goodwill in cases where it represented a differential amount between the consideration paid for acquisition of shares and the FMV of the tangible assets. It held that if such claim of goodwill and depreciation was allowed, then it would render the provisions of Explanation 3 to section 43(1) redundant; in every case of transfer, succession or amalgamation, the party would claim excessive depreciation by assigning arbitrary value to the goodwill. However, the Tribunal held that the AO was at fault in choosing to examine the valuation of goodwill alone; the AO ought to have examined the valuation of all the assets taken over by the assessee under the amalgamation and thereby should have determined the actual cost of all the assets to the assessee for the purpose of claim of depreciation.

The Tribunal further held that by virtue of the said proviso to section 32(1)(ii), the depreciation in the hands of the assessee was allowable only to the extent that was otherwise allowable if such succession or amalgamation had not taken place. Therefore, the assessee, being amalgamated company, could not claim or be allowed depreciation on the assets acquired in the scheme of amalgamation of an amount more than the depreciation which was allowable to the amalgamating company. Insofar as the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) was concerned, the Tribunal observed that the said ruling of the Supreme Court was only on the point whether the goodwill fell in the category of intangible assets and the said judgment would not override the provisions of the said proviso to section 32(1)(ii), which restricted the claim of depreciation in the cases specified thereunder. Accordingly, the issue of allowability of depreciation on goodwill was decided against the assessee.

THE MYLAN LABORATORIES LTD. CASE
The issue again arose recently, in the case of Mylan Laboratories Ltd. vs. DCIT TS-691-ITAT-2019 (Hyd.). In this case, during the previous year relevant to A.Y. 2014-15, the assessee had acquired Agila Specialities Ltd. (ASPL) along with its wholly-owned subsidiary, Onco Therapies Ltd. (OTL), vide a share purchase agreement on 5th December, 2013 immediately followed by the merger of both the companies with the assessee under the scheme effective from 6th December, 2013. The assessee, by applying the principles of ‘purchase method of accounting’, considered the difference between the amount of investment (Rs. 4,386 crores) and the fair value / tax WDV value of net assets which was negative (being Rs. -106 crores) as goodwill arising on amalgamation. This goodwill of Rs. 4,492 crores was grouped under the Intangible Assets block as goodwill, and depreciation at half of the eligible rate of 25% was claimed by the assessee, since the assets were put to use for less than 180 days.

The AO disallowed the depreciation on goodwill by relying upon the decision of the Bangalore bench of the Tribunal in the case of United Breweries Ltd. (Supra). The CIT(A) confirmed the order of the AO.

Before the Tribunal, apart from relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) and several other decisions of the High Court holding the goodwill as eligible for depreciation, the assessee also submitted that the sixth proviso to section 32(1)(ii) was only a mechanism of allocation of depreciation otherwise allowable on the WDV of assets owned by the amalgamating company, whereby such depreciation got allocated between the amalgamating and the amalgamated company in the year of amalgamation, and had no applicability for any new asset arising on account of the amalgamation in the hands of the amalgamated company. It was contended on behalf of the assessee that the sixth proviso was introduced to curb the practice of claiming depreciation on the same assets by both the predecessor company and the successor company in the case of a merger or succession, as was evident from the Memorandum explaining the provisions of the Finance Bill, 1996. Therefore, the said proviso should not be made applicable to the goodwill arising by virtue of the amalgamation.

The assessee also submitted that a similar issue was raised before the Hon’ble Kolkata High Court in the appeal by the Revenue in the case of Smifs Securities Ltd. ITA No. 116 of 2010 for the year, i.e., A.Y. 2001-02, and the said question was not pressed by the Department, by conceding that it was covered by the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra). It was submitted that the Revenue had not filed any appeal before the Supreme Court against the decision in the said case and once the Revenue had chosen not to challenge a particular decision, it was bound by the said decision. In this regard, reliance was placed on the decision of the Supreme Court in the case of Narendra Doshi, 254 ITR 606 [SC].

The Revenue, on the other hand, supported the orders of the lower authorities and submitted that the net assets acquired were valued at Rs. -106.8 crores after reducing the liabilities. Thus, when the net asset value was negative, there could not have been any goodwill. It was also pleaded that the amalgamation of whollyowned subsidiary would not lead to transfer of assets u/s 2(47) and therefore, claiming of goodwill as arising out of a transaction not regarded as transfer would be a case of making profit out of oneself. Additionally, it was also claimed that the valuation of the enterprise for purchase of shares could not be equated to the valuation for amalgamation.

On the basis of the arguments raised by both the sides, the Hyderabad bench of the Tribunal ruled in favour of the assessee, holding that the deduction of depreciation on goodwill could not be denied. The reliance placed by the Revenue on the sixth proviso to section 32(1)(ii) did not find favour with the Tribunal. The Tribunal referred to the accounting principles as laid down in AS-14 and observed that, in case of amalgamation in the nature of purchase, the consideration paid in excess of the net value of assets and liabilities of the amalgamating company was to be treated as goodwill. Such goodwill was held to be eligible for depreciation u/s 32(1) by relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra).

OBSERVATIONS

The issue under consideration moves in a narrow compass. Depreciation is allowable in computing the total income by virtue of section 32 on compliance with the conditions of the said provision. One of the conditions is that the asset in question should be acquired and owned by the assessee claiming the depreciation. On satisfaction of the conditions prescribed, the depreciation can be denied only with an express provision for denial of the claim. The provisos to section 32 have the effect of restricting the amount of depreciation, or of sharing it, or denying it in the stated circumstances. We do not find that any of the provisos, including the sixth proviso, denies the claim of depreciation in cases of an amalgamation. In the circumstances for a valid claim of depreciation, the amalgamated company should satisfy the compliance of the main conditions, namely, acquisition and ownership, besides use. Once they are satisfied, the claim could be denied only by an express provision and not by a roundabout or convoluted reading of the sixth proviso that has been inserted much later in the day to ensure that in the year of transfer both the transferor and the transferee do not claim the ‘full’ depreciation; it is introduced to ensure the sharing of the amount of depreciation in the year of transfer, nothing less, nothing more.

In the absence of the sixth proviso, it was not possible to deny the claim of depreciation in full by both the transferor and the transferee, a position that had been confirmed by the courts. Reference can be made to CIT vs. Fluid Controls Mfg. Co. 286 ITR 86 (Guj.), Sita Ram Saluja vs. ITO 1 ITD 754 (Chd.).

The sixth proviso does not deal with the case of an asset that comes into existence and / or is acquired for the first time in the course of amalgamation. It also does not deal with an asset on which one of the parties could not have claimed the deduction for depreciation. Goodwill of the kind being discussed here is one such asset on which it was never possible for the amalgamating company to have claimed depreciation, and therefore it is fruitless to apply the sixth proviso to such a situation or claim.

The enabling provision therefore is the main provision of section 32(1), and once the terms therein stand satisfied, the claim cannot be denied or even be reduced without an express provision to do so. In our considered opinion, there is nothing in the sixth proviso to facilitate the denial of the claim altogether. In the absence of the disabling provision, it is not fair on the part of the Revenue to frustrate the claim otherwise held to be lawful by the Apex Court.

The sixth proviso can have an application, in cases of amalgamation, only where some asset which was owned by the amalgamating company is acquired by the amalgamated company in the course of the amalgamation and the acquiring company is seeking to claim depreciation thereon.

There is no dispute as to whether the goodwill arising on the amalgamation falls within the ambit of business or commercial rights, being intangible assets eligible for depreciation. The only dispute is about the applicability of the sixth proviso to section 32(1)(iia) and invocation thereof by the Revenue so as to deny the benefit of depreciation on such goodwill to the amalgamated company. The sixth proviso to section 32(1)(ii) reads as under:

‘Provided also that the aggregate deduction, in respect of depreciation of buildings, machinery, plant or furniture, being tangible assets or knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets allowable to the predecessor and the successor in the case of succession referred to in clause (xiii), clause (xiiib) and clause (xiv) of section 47 or section 170, or to the amalgamating company and the amalgamated company in the case of amalgamation, or to the demerged company and the resulting company in the case of demerger, as the case may be, shall not exceed in any previous year the deduction calculated at the prescribed rates as if the succession or the amalgamation or the demerger, as the case may be, had not taken place and such deduction shall be apportioned between the predecessor and the successor, or the amalgamating company and the amalgamated company, or the demerged company and the resulting company, as the case may be, in the ratio of the number of days for which the assets were used by them.’

The aforesaid proviso was originally inserted as the fourth proviso by the Finance (No. 2) Act, 1996. The rationale behind insertion of this proviso can be gathered from the Circular No. 762 dated 18th February, 1998, the relevant extract from which is reproduced below:

‘The third proviso to sub-section (1) of section 32 provides that the depreciation allowance will be restricted to fifty per cent of the amount calculated at the prescribed rates in cases where assets acquired by an assessee during the previous year are put to use for the purpose of business or profession for a period of less than one hundred and eighty days in that previous year. Thus, in cases of succession in business and amalgamation of companies, the predecessor in business and the successor or amalgamating company and amalgamated company, as the case may be, are entitled to depreciation allowance on the same assets, which in the aggregate may exceed the depreciation allowance admissible for a previous year at the rates prescribed in Appendix-I of the Income-tax Rules, 1962. An amendment has, therefore, been made to restrict the aggregate deduction for this allowance in a year in such cases to the amount computed at the prescribed rates. It has also been provided that the allowance shall be apportioned in the ratio of the number of days for which the asset is put to use in such cases.’

From the Circular as well as the language of the proviso it becomes clear that the restriction placed is applicable only when it is otherwise possible to claim depreciation on the same asset by both the companies, i.e., the amalgamating company as well as the amalgamated company. In order to trigger the sixth proviso, there has to be an asset, tangible or intangible, on which both the companies could have claimed the depreciation u/s 32(1) in the year of amalgamation. This proviso should not be made applicable to any such asset on which only one of the two companies could have claimed the depreciation otherwise. The goodwill being an offshoot of the amalgamation, the question of claiming depreciation thereon by the amalgamating company does not arise at all.

There can be a case where the amalgamated company is disentitled to claim depreciation on the assets acquired through the amalgamation, even without applying the sixth proviso to section 32(1)(ii). For instance, where the assets acquired through the amalgamation are recognised as inventories of the amalgamated company, though they were depreciable assets of the amalgamating company or where the corresponding income generated from such assets falls outside the scope of business income of the amalgamated company and, therefore, depreciation on such assets cannot be allowed to it on such assets u/s 32(1). In such cases, the question is whether the aggregate depreciation can be determined ignoring the amalgamation and the portion of it can be claimed in the hands of the amalgamated company on the basis of number of days for which the assets were used by it merely by relying upon the sixth proviso to section 32(1)(ii)? The answer obviously is no. This leads us to the conclusion that the sixth proviso to section 32(1)(ii) applies only in a situation where both the companies are eligible to claim the depreciation on the same assets for the year of amalgamation and not otherwise.

Further, this proviso has a limited applicability only to the year in which the succession or amalgamation takes place and it does not apply to the subsequent years. There is no probability of claiming depreciation by two entities in the subsequent years on the same assets exceeding the depreciation otherwise allowable, for the obvious reason that the predecessor or the amalgamating company will cease to own the asset or exist by virtue of the succession or the amalgamation as the case may be. Therefore, if a view is taken that the depreciation on goodwill arising on account of the amalgamation cannot be allowed only because of the sixth proviso to section 32(1)(ii), then it will result into denial of depreciation only for the year of amalgamation and not for subsequent years. It would be quite illogical to consider the amalgamated company as ineligible for depreciation on such goodwill only for the first year and, then, allow it to claim the depreciation from the second year onward.

The better view therefore is the one propounded by the Hyderabad bench of the Tribunal in the case of Mylan Laboratories Ltd. (Supra) that the depreciation should be granted to the amalgamated company on the goodwill recognised by it, being the excess of consideration over the appropriate values of net assets acquired, starting from the year of amalgamation itself.

shailesh.kwebmaker

Sections 2(14), 2(47), 45, 56 – Giving up of a right to claim specific performance by conveyance in respect of an immovable property amounts to relinquishment of capital asset. It is not necessary that in all such cases there should have been a lis pending between the parties and in such lis the right to specific performance has to be given up. The payment of consideration under the agreement of sale, for transfer of a capital asset, is the cost of acquisition of capital gains. Amount received in lieu of giving up the said right constitutes capital gains and is exigible to tax

16. [2020] 117
taxmann.com 520 (Bang.)(Trib.) Chandrashekar
Naganagouda Patil vs. DCIT ITA No.
1984/Bang/2017 A.Y.: 2012-13 Date of order: 29^th
June, 2020

Sections 2(14),
2(47), 45, 56 – Giving up of a right to claim specific performance by
conveyance in respect of an immovable property amounts to relinquishment of
capital asset. It is not necessary that in all such cases there should have
been a lis pending between the parties and in such lis the right
to specific performance has to be given up. The payment of consideration under
the agreement of sale, for transfer of a capital asset, is the cost of
acquisition of capital gains. Amount received in lieu of giving up the
said right constitutes capital gains and is exigible to tax

FACTS

The assessee, an
individual, entered into an agreement dated 9^th February, 2005 to
purchase a vacant site in Amanikere village, Bangalore for a consideration of
Rs. 27,60,000. He paid an advance of Rs. 2,75,000 and agreed to pay the balance
at the time of registration of sale deed. The vendor of the property was
required to make out a marketable title to the property. Under clause 8 of the
agreement, the assessee had a right to enforce the terms by way of specific
performance.

On 8^th
February, 2011, Mr. Channakeshava as vendor, along with the assessee as a
confirming party, sold the property to a third party for a consideration of Rs.
82,80,000. The preamble to the sale deed stated that the assessee has been
added as a confirming party as he was the agreement holder who had a right to
obtain conveyance of the property from the owner. Out of the consideration of
Rs. 1,200 per sq. feet, a sum of Rs. 500 per sq. feet was to be paid to the
vendor, Mr. Channakeshava, and Rs. 700 per sq. feet was to be paid to the
assessee.

The assessee
considered the sale consideration of Rs. 48,30,000 so received under the head
capital gains. The A.O. was of the view that under the agreement dated 9^th
February, 2005, the assessee did not have any right over the property except a
right to get refund of advance paid. Accordingly, he taxed Rs. 45,55,000 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.
by observing that the assessee did not file any suit for specific performance
and did not have any right over the capital asset.

Aggrieved, the
assessee preferred an appeal to the Tribunal.

HELD

The Tribunal noted that
the Karnataka High Court has in the case of CIT vs. H. Anil Kumar [(2011)
242 CTR 537 (Kar.)] held that the right to obtain a conveyance of
immovable property falls within the expression `property of any kind’ used in
section 2(14) and consequently it is a capital asset. The Tribunal held that
the right acquired under the agreement by the assessee has to be regarded as
‘capital asset’. Giving up of the right to claim specific performance by
conveyance in respect of an immovable property amounts to relinquishment of the
capital asset. Therefore, there was a transfer of capital asset within the
meaning of the Act. The payment of consideration under the agreement of sale,
for transfer of a capital asset, is the cost of acquisition of the capital
asset. Therefore, in lieu of giving up the said right, any amount
received constitutes capital gain and it is exigible to tax. It is not
necessary that in all such cases there should have been a lis between
the parties and in such lis the right to specific performance has to be
given up. The Tribunal held that the CIT(A) erred in holding that the assessee
did not file a suit for specific performance and therefore cannot claim the
benefit of the ratio laid down by the Hon’ble Karnataka High Court in
the case of H. Anil Kumar (Supra).

The Tribunal
allowed the appeal filed by the assessee.

shailesh.kwebmaker

IS BEING A PROMOTER A ONE-WAY STREET WITH NO EXIT OR U-TURN?

BACKGROUND – CONCEPT OF FAMILY/ PROMOTER-DRIVEN COMPANIES
IN INDIA

A peculiar and important feature of Indian companies and even
businesses in general is that the ownership and management is largely
‘promoter’-driven. There is usually a ‘founder’, an individual who starts a
business which is then continued by his children / extended family for many
generations. The founder family (which may be more than one) usually holds
controlling stake, often more than 50%. The company and group entities are
usually referred to as the ‘X group’ with X representing such family. This is
unlike most companies in the West where, even if founded by an individual whose
family may continue to hold substantial shareholding, the management is often
‘professional’.

Securities laws in India have rightly acknowledged this
feature and there are a multitude of provisions specifically recognising them
and creating an elaborate set of obligations for them. These persons are called
promoters and the various entities (family members, investment companies held
by them, etc.) are called the ‘Promoter Group’. Thus, for example, Independent
Directors are by definition those who are not from or associated with the
Promoter Group. The promoters may be treated as insiders and their trades in
shares of the company regulated. The ‘Promoter Group’ is required to have a
minimum shareholding (at the time of a public issue) and also a maximum
shareholding. It cannot occupy more than a certain number of Board seats. It
has to make regular disclosure of its shareholding. Indeed, the ‘Promoter
Group’ would generally be deemed to be in charge of the company and the buck
for any violation of laws will usually stop at them.

However, there is one curious and difficult area: How can a
person / entity, once designated a promoter, cease to be a promoter? How does
he get an exit and reclassify himself as a non-promoter? As we shall see, and
as particularly highlighted by a recent ‘informal guidance’ by SEBI, it is
relatively easy to become a promoter but extremely difficult to stop being one.

WHO IS A PROMOTER AND WHO BELONGS TO THE PROMOTER GROUP?

There is an elaborate definition of the terms ‘Promoters’ and
‘Promoter Group’ prescribed in the SEBI (Issue of Capital and Disclosure
Requirements), 2018. The Group includes the promoter family and even many
members of the extended family. It also includes specified investment entities
/ group companies / entities. Over time, this list can turn quite long as the
family expands and various new entities are formed and which are covered by the
definition.

The Promoter Group usually gets defined and identified when a
public issue is made, leading to listing of the shares of the company and all
those who are in control of the company are included. Their specified relatives
and group entities are also included. However, as time passes, new relatives
and new entities would get added. But as we will see later, while inclusion is
easy and even automatic, removing even one person is extremely difficult.

REASONS FOR GETTING OUT OF THE PROMOTERS CATEGORY

It has been seen above how easy and automatic it is to become
a promoter. Just being born in the promoter family or otherwise being related
in any of the specified ways could be enough. However, for several reasons, a
person (or an entity with which he is associated in specified manner) may
desire not to be part of the Promoter Group and be saddled with several
obligations and liabilities. There is, of course, the liability of compliance
and even of violations that he remains subject to just by the fact that he is
on the promoter list. If he is in control of the relevant company, this cannot
be escaped.

But there are various reasons why a person may want to be
excluded. He or she may have left the family and may be in employment elsewhere
or carrying on a separate independent business. He may have actually had
disputes with the company and thus no more be part of the core group. He or she
may have married and now not be connected with the company. He may not be
holding any shares or holding insignificant shares and have no say in the
company. In fact, even the whole Promoter Group or a sub-group thereof may have
reason to be excluded if they are reduced to a minority with someone else
taking a higher stake. There would, of course, be the obvious case where a new
promoter acquires most or all of the existing group’s shareholding in a
transparent way (usually by an open offer) and thus takes control of the
company.

There can be many more situations. The question is can an
existing promoter get his name removed from the list of promoters? If yes, how
and what are the conditions?

CONCERNS OF SEBI IN ALLOWING PROMOTERS TO LEAVE THE
CATEGORY

Certain obligations are imposed on promoters who are in
control of the company. If a person who is otherwise in control of the company
or closely connected with persons who are, and is allowed to represent himself
as not a promoter, he would escape this liability. Shareholders, too, perceive
a particular group as the promoters and take decisions accordingly. Thus,
generally, the regulator would want sufficient assurance before allowing the
exclusion of a person from the Promoter Group. However, as we will see below,
the conditions placed are extremely stringent and it may often be difficult for
persons to exclude themselves even for bona fide reasons.

ONCE A PROMOTER, ALMOST ALWAYS A PROMOTER

As mentioned earlier, a person and entities related to him
are required to be declared as promoters at the time of a public issue. Many
entities / persons connected with him in specified ways would also be deemed to
be part of the Promoter Group. Death would do him apart, but then the successors
to his shares would be deemed to be promoters. Thus, the person to whom shares
are willed or even gifted during the (deceased’s) lifetime would become a
promoter.

REQUIREMENT FOR RECLASSIFICATION FROM PROMOTER TO PUBLIC

The requirements relating to reclassification from promoter
to public category are contained in Regulation 31A of the SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2015 (‘the LODR
Regulations’). These are the outcome of several changes over time and also the
consequence of several discussion papers / committee deliberations. The Kotak
Committee’s report of 2017 on corporate governance had also made detailed
suggestions. SEBI is in the process of proposing yet another round of revision
of the requirements.

There are several conditions that a promoter has to comply
with to be allowed to be reclassified into the public category. Some of these
are obvious and make sense. Such a person (and persons related to him) should
not be holding more than 10% shares in the company. He should not exercise
control, directly or indirectly, over the company. He should not be a director
or key managerial person in the company. He should also not be entitled to any
special rights with respect to the company through formal or informal arrangements.

However, there are further stringent conditions and
requirements if he seeks reclassification. The promoter needs to apply to the
company and needs to demonstrate that he has complied with the other conditions
(i.e., holding 10% or less, not being a director, etc.). The Board of the
company then has to consider this request and place the reclassification
request before the shareholders with its comments. The matter has to be placed
before the shareholders after three months but before six months of the date of
such Board meeting. At such meeting of shareholders, the promoter seeking
reclassification and promoters related to him cannot vote. An ordinary
resolution has to be passed by the remaining shareholders approving such
reclassification. Once so approved, the stock exchanges would then consider the
application and if the requirements are duly complied with, approval would be
granted for reclassification.

Thus, the primary onus and even the decision have been placed
on the Board and the shareholders. In principle, the safeguards may appear
warranted. Leaving the matter to internal decisions also ensures avoidance of
an arbitrary decision by the regulator and also smooth implementation in many
cases. However, the elaborate requirements can make ordinary cases for
exclusion difficult. A family member, for example, may move out of India and
yet he would continue to be a promoter and hence in control unless this
procedure is followed.

There may be disputes
within the family and thus persons seeking exclusion may find their efforts
being sabotaged, even if in principle their requests have to be processed. The
10% shareholding requirement is also too low. At 10% holding, a person / group
has practically no say in the running of the company.

In a recent case (in
re: Mirza International Limited, Informal Guidance dated 10^th June,
2020) it was seen that a promoter gifted shares aggregating to more
than 10% to his daughters who were married and otherwise not involved with the
company. This made them part of the Promoter Group. An informal guidance of
SEBI was sought whether such persons could be reclassified as public instead of
being included in the promoter / Promoter Group. SEBI opined that the fact that
they held more than 10% shares went against the condition prescribed and hence
they could not be reclassified as public.

CONCLUSION AND SUMMARY

There are several
businesses that have seen multiple generations. The businesses may have been
divided. Off-spring may not be interested in the family-controlled companies.
There may be disputes. There may be members of the family who have no say or even interest in the company. The stringent requirements and procedures are
elaborate and have hurdles which seem unjustified when the primary facts may
show that a person does not have any control or even say in the company.
Indeed, they may not even hold a single share. Thus, many persons may continue to be deemed to be
promoters and bear the burden of liability in matters in which they have no
say. Such persons may not be promoters by choice and have no easy avenue to get
out. It is high time that the requirements are changed to make them simple and
practical; it is hoped that the coming set of proposed revisions ensures this.

shailesh.kwebmaker

RELIGIOUS CONVERSION & SUCCESSION

INTRODUCTION

Inter-community / inter-faith marriages are increasing in India. It is
becoming common to see a Hindu woman marrying a person professing Islam or Christianity.
Subsequently, she converts to Islam or to Christianity.

In all such cases, a question often arises: whether the Hindu woman who has
converted to another religion would be entitled to succeed to the property of
her parents? Would she be a member of her father’s HUF? Further, what would be
the position of her children – would they be entitled to succeed to the
property of their maternal grandfather? Let us examine these tricky issues in
some detail.

SUCCESSION TO PARENTS’ PROPERTY

Let us first
consider what would be the position of a Hindu woman who has converted to Islam
/ Christianity in relation to her parents’ property. If the parent has made a
Will, then she can definitely be a beneficiary. This is because a Will can be
made in favour of any person, even a stranger. Hence, the mere fact that the
daughter is no longer a Hindu would not bar her from being a beneficiary under
the Will.

However,
what is the situation if the father dies intestate, i.e., without making a
Will? In such a case, the Hindu Succession Act, 1956 would apply. The Class I
heirs of the father would be entitled to succeed to the property of the Hindu
male dying intestate. The daughter of a Hindu male is a Class I heir under the
Hindu Succession Act. Now the question that would arise is whether the
subsequent religious conversion of such a Class I heir would disentitle her
from succeeding to her father’s estate.

The Gujarat
High Court had occasion to grapple with this interesting problem in the case of
Nayanaben Firozkhan Pathan vs. Patel Shantaben Bhikhabhai, Spl. Civil
Appln. 15825/2017, order dated 26^th September, 2017. In this
case, the child of a Hindu wanted to get her name entered in the Record of
Rights of an ancestral land held in the name of her deceased father. The
Collector allowed the mutation in favour of all children except one daughter
who had converted to Islam. It was held that her conversion disentitled her
from succeeding to her father’s estate. The matter reached the Gujarat High
Court. The Court observed that section 2 of the Hindu Succession Act provides
that the Act applies only to Hindus and to persons who were not Muslims,
Christians, Parsis, Jews or of any other religion. However, this section only
provides a class of persons whose properties will devolve according to the Act.
It is only the property of those persons mentioned in section 2 that will be
governed according to the provisions of the Act. Section 2 has nothing to do
with the heirs. This section does not lay down as to who are the disqualified
heirs.

The Court
further analysed the provisions of section 4 which envisages that any other law
in force immediately before the commencement of the Act shall cease to apply to
Hindus insofar as it is inconsistent with any of the provisions contained in
the Act. While a number of Central Acts were repealed as a consequence of this
section, one Act which has not been repealed is the Caste Disabilities
Removal Act, 1850. This is a pre-Independence Act which consists of one
section which states that:

‘So much of
any law or usage which is in force within India as inflicts on any person
forfeiture of rights or property, or may be held in any way to impair or affect
any right of inheritance, by reason of his or her renouncing, or having been
excluded from the communion of, any religion, or being deprived of caste, shall
cease to be enforced as law in any Court.’

The Gujarat
High Court held that a change of religion and loss of caste was at one time
considered as grounds for forfeiture of property and exclusion of inheritance.
However, this has ceased to be the case after the passing of the Caste
Disabilities Removal Act, 1850. The Caste Disabilities Removal Act provides
that if any law or (customary) usage in force in India would cause a person to
forfeit his / her rights on property or may in any way impair or affect a
person’s right to inherit any property, by reason of such person having
renounced his / her religion or having been ex-communicated from his / her
religion, or having been deprived of his / her caste, then such law or
(customary) usage would not be enforceable in any court of law. Thus, the Caste
Disabilities Removal Act intends to protect the person who renounces his / her
religion.

Further, the
Division Bench of the Madras High Court in the case of E. Ramesh vs. P.
Rajini (2002) 1 MLJ 216 has also taken the same view. It held that the
Hindu Succession Act makes it clear that if the parents are Hindus, then the
child is also governed by the Hindu Law or is a Hindu. It held that the
Legislature might have thought fit to treat the children of the Hindus as
Hindus without foregoing the right of inheritance by virtue of conversion.

Accordingly,
the Gujarat High Court concluded that all that needs to be seen is whether the
daughter was a Class I heir? If yes, then her religion had no locus standi
to her succession to her father’s property.

POSITION OF CONVERT’S CHILDREN

The position
of a person who has converted to Islam is quite clear. Section 26 of the Hindu
Succession Act clearly provides that the descendants of the convert who are born
after such conversion are disqualified from inheriting the property of any of
their Hindu relatives. Thus, the children of a Hindu daughter who converts to
Islam would be disqualified from inheriting the property of their maternal
grandfather.

This section
was explained by the Calcutta High Court in Asoke Naidu vs. Raymond S.
Mulu, AIR 1976 Cal 272. It explained that this section therefore does
not disqualify a convert. The present Act discards almost all the grounds which
imposed exclusion from inheritance and lays down that no person shall be
disqualified from succeeding to any property on the ground of any disease,
defect or deformity. It also rules out disqualification on any ground
whatsoever except those expressly recognised by any provisions of the Act. The
exceptions are very few and confined to the case of remarriage of certain
widows. Another disqualification stated in the Act relates to a murderer who is
excluded on the principles of justice and public policy. Change of religion and
loss of caste have long ceased to be grounds of forfeiture of property. The
only disqualification to inheritance is found in section 26 which disqualifies
the heirs of a converted Hindu from succeeding to the property of their Hindu
relatives. However, the disqualification does not affect the convert himself or
herself.

POSITION OF CONVERT IN FATHER’S HUF

On the
marriage of a Hindu who has converted to Islam or Christianity, his continuity
in an HUF needs to be considered if his marriage is solemnised under the Special
Marriage Act, 1954. In such a case the normal succession laws get
disturbed. This would be so irrespective of whether or not the Hindu converts.
All that is required is that the marriage must be registered under this Act.
Section 19 of this Act prescribes that any member of a Hindu Undivided Family
who gets married to a non-Hindu under this Act automatically severs his ties
with the HUF. Thus, if a Hindu, Buddhist, Sikh or Jain gets married to a
non-Hindu under the Special Marriage Act, he ceases to be a member of his HUF.
He need not go in for a partition since the marriage itself severs his
relationship with his family. He cannot even subsequently raise a plea for
partitioning the joint family property since by getting married under the Act
he automatically gets separated from the HUF. Taking the example of the
daughter who converted to Islam, even though she can now be a member of her
father’s HUF by virtue of the Hindu Succession Amendment Act, she would cease
to be a member due to her marriage being registered under the Special Marriage
Act.

SUCCESSION TO THE CONVERT’S PROPERTY

The last
question to be examined is which succession law would apply to such a convert’s
own property? If she dies intestate, would her heirs succeed under the Hindu
Succession Law (since she was once a Hindu) or the Muslim Shariya Law (since
she died a Muslim)? Section 21 of the Special Marriage Act is by far the most
important provision. It changes the normal succession pattern laid down by law
in case of any person whose marriage is registered under the Act. It states
that the succession to property of any person whose marriage is solemnised
under the Act and to the property of any child of such marriage shall be
regulated by the Indian Succession Act, 1925.

Section 21
makes the Indian Succession Act, 1925 applicable not only for the couple
married under the Act but also for the children born out of such wedlock. Thus,
for such a convert whose marriage is registered under the Special Marriage Act,
the succession law would neither be the Hindu Succession Law nor the Muslim Law
but the Indian Succession Act. The same would be the position for her children.
Of course, if she were to make a valid Will, then the Will would prevail over
the intestate succession provisions of the Indian Succession Act.

CONCLUSION

Till such
time as India has a Uniform Civil Code, succession laws are bound to throw up
such challenges. It would be desirable that the succession laws are updated to
bring them up to speed with such modern developments and issues so that legal
heirs do not waste precious time and money in litigation.

Those who always adhere to truth do
not make false promises.

Keeping one’s promises is,
surely, the mark of one’s greatness.
— (Valmiki
Raamaayan 6.101.52)

shailesh.kwebmaker

THE REAL MEANING OF AHIMSA

There were two old friends Bhaskar and
Avinash who were inseparable. Both became professional lawyers. However, as it
so happens in life, Bhaskar, who was not doing so well in his professional
practice, got an opportunity to provide his services to a big client who was
actually Avinash’s client for several years. The client had approached Bhaskar
to turn over his entire business from Avinash to him in the hope of getting
more economical rates from Bhaskar.

Bhaskar was fully aware that it would be a
deceitful and despicable act if he took over this client’s work and he wrestled
with his conscience for over two days to be able to say ‘no’. Eventually, he
lost the battle with his conscience and agreed to take over the brief. He did
this clandestinely so that Avinash would not know that he had done so.

Avinash initially did not realise that it
was Bhaskar who had taken over the client, but truth always surfaces somehow. A
few days later he came to know from one of his friends working with the client
that it was Bhaskar who had betrayed him. His natural reaction was intense
anger and hatred towards Bhaskar, which was understandable. He wanted to retaliate
by having a showdown with Bhaskar and cutting off all ties with him and
exploring ways of seeking revenge by damaging Bhaskar’s relationship with the
client. He was in a position to do that because in the past he had served that
client for many years and therefore he knew a lot of things about the client
which would have been sufficient to compel him to return to him.

The temptation to take these severe
vindictive steps was very strong and it took him a long time to resist it, but
eventually he did. He decided to look at the past lovely relationship with
Bhaskar and the ‘good’ part within him urged him not to destroy that. When his
mind started thinking such positive thoughts, the creativity of his mind also
increased. He had heard a saying in Gujarati (Sachu bal badlo levama nahin,
pan samhena manas ma badlav lavama chhe) meaning that real strength is not
in taking revenge but in bringing about a change in the other person. He
finally came to the conclusion that he would not retaliate but actually convey his
good wishes to both the client and to Bhaskar.

He met them both pleasantly and cheerfully
wished them the best for the future and assured them of his support in case of
any need. He assured the client that going to Bhaskar was like going to
Avinash’s family member and that he held no grudge or spite. To Bhaskar he
offered him access to all the client’s files, papers, documents and other
things lying in his office and assured him of all help in any matter in future.
Both the client and Bhaskar were deeply touched. Bhaskar, being an old friend,
realised his grave error and broke down and profusely apologised for having
taken this step and offered to step out, which Avinash lovingly refused. Their
friendship became thicker and Bhaskar was a wiser person thereafter.

Can this act of Avinash be considered ahimsa?
Most certainly yes.

Ahimsa, as is
commonly understood, means practising non-violence but it is much more than
that. It is not restricted to the physical dimension. Real ahimsa
is practised in thought, word and deed. Restricting and controlling our
physical violent reactions is fine but it is incomplete without verbal
and mental congruence with that control. Thus if Avinash had not had a
showdown, it was good, but the real ahimsa was achieved when he
harboured no ill feelings in his mind and went to make peace. This was not
easy at all. In fact, mental ahimsa is exponentially more difficult than
physical ahimsa. But when practised and implemented, the power that it
can wield is immeasurable and infinite.

The classic example is that of Mahatma
Gandhi himself. His body was lean and frail and perhaps even a little lad could
have easily knocked him down, but the strength which he drew from his ahimsa
was able to move millions of people across India at his call and for any cause
suggested by him. That was because he practised congruence of thought, word and
deed in ahimsa. Ahimsa was strongly advocated by Mahatma Gandhi
during our freedom movement and there is no doubt that perhaps this was the single
strongest weapon which gave us our independence. It is best illustrated by the Dandi
March when hundreds of Indians stoically endured the Britishers’ beatings
without retaliation.

Though the conduct of ahimsa may
externally appear to be a sign of weakness and surrender, actually it is
exactly the opposite. To practice ahimsa one needs superlative strength
and self-control. It is said that real power or strength is not that which one
can exhibit in a wrestling match or a battle of any kind, but it is that which
is needed to curb one’s anger, hatred, emotions and power itself. Ahimsa
is that supreme power which is needed not to control another person, but one’s
own self. The biggest battle in life is the conquest over one’s own self.

Therefore, friends, let’s try to bring peace
in our minds. Our words and deeds will automatically follow suit. Do not be perturbed by insults, taunts, or situations where anger and hatred are
automatic consequences. The only antidote for such negative emotions is love.

shailesh.kwebmaker

‘INDIA, THAT IS BHARAT’

I hope you and your near and dear ones are well during the most challenging
health emergency that this generation has seen.

A nation is the widest form of society that we identify with and manage.
Individuals form families; and families make a community, a city and a nation
state. Geographically, politically and psychologically we have reached thus far
in the evolution of mankind. A nation is the sum total of all the differences
that we have been able to bring together in a cohesive, interwoven unit. A
nation is meant to bridge differences, like a thread that holds together
different flowers in a garland. Differences assume less importance and get
subsumed in the larger reality of a nation. Backgrounds, ethnicities,
religions, languages, histories and all other nuances must find their
culmination in a nation. This in my view makes ‘India, that is Bharat’,
as per the first Article of our Constitution.

India is the last ancient, continuously surviving civilization, and it
finds its common denominator within an incomparable variety. For example, there
are many scripts and languages which are influenced by or rotted in Sanskrit; a
common set of civilizational values still becomes the binding force – a SamanVayaKaari
Shakti.

We are also faced with threats. As citizens we should be able to see
trouble when politics and media focus on our differences and portray
them as divisions. Unlike the Indian approach, the Cartesian approach
sees the universe made up of smaller fragments that are simply put together but
do not have a common continuum. For example, in ‘modern’ India ‘identity’ is
made to stand out. Identity grants benefits – social and religious identities
get concessions, jobs, educational reservation, and so on. So people keep
lesser identity in the forefront above all else. This sorry state of affairs in
our country also results in throwing merit into the dustbin and accentuating separation
to an unimaginable extent.

Another threat is colonisation of the Indian mind that is perpetuated. In
the words of Shri Amitabh Bachchan, we are still ‘respectful and tolerant to
colonial indoctrination’. He was speaking about branding of words at the
IAA World Congress and gave the example of Thiruvananthapuram which till
recently was known as Trivandrum. He said, Trivandrum meant nothing. Whereas Thiruvananthapuram
means Thiru Anantha Puram – Shelter of the Infinite. Today, many
‘educated’ Indians twist phonetics of Indian words by messing the longs as
shorts and the shorts as longs in imitation. Yog is Yogaa, Raamaayan is
Raamayanaa, Himaalay is Himalaayaa. During a session I attended, this turned
out to be quite embarrassing and funny when a person introduced the next
speaker as Kamini, when her name was Kaamini. Many Dishonest words give
dishonest results, Bachchanji said. He gave the example of Rabindranath Thakur
who is known as Tagore although his family name is Thakur and their house was in
Thakur Baadi. Such usage changes the ‘meaning, perception, concept,
consideration, viewpoint’ of words. We need to pay attention to this and
reclaim the true import of words and their beautiful meanings.

Lastly, as Indians we have to ask – how do we see ourselves and what
makes us feel proud of who we are? A generation ago it was three Es –
English, Education and Employment. But that is changing. The biggest success
stories today are not necessarily rooted in the three Es. In the last three
decades, we have seen a surge in enterprise, education, and confidence despite
government interference and even obstruction. Yet, we are still aspiring to be AtmaNirbhar.
AtmaNirbhar comes from the word Bhar, which means full or
complete – the confidence that comes from the feeling of being full or complete
in one’s true identity. How can we feel full and complete and interact with a
globalised world with a feeling of incompleteness or lack or neediness? How can
we be rooted in our civilizational ethos and apply it to the current context?
These are some questions as we approach our 74^th Independence Day!

Raman
Jokhakar

Editor

shailesh.kwebmaker

Reopening of assessment – Beyond four years – Information from Investigation Wing – Original assessment completed u/s 143(3) – Primary facts disclosed – Reasons cannot be substituted

8. Gateway
Leasing Pvt. Ltd. vs. ACIT (1)(2) & Ors. [Writ Petition No. 2518 of 2019] A.Y.: 2012-13 Date of order: 11^th March, 2020 (Bombay High Court)

[Appellate
Tribunal in I.T.A. No. 5535/Mum/2014; Date of order: 11^th January,
2017; A.Y.: 2003-04; Bench ‘F’ Mum.]

Reopening of assessment – Beyond four years
– Information from Investigation Wing – Original assessment completed u/s
143(3) – Primary facts disclosed – Reasons cannot be substituted

The petitioner is a company registered under
the Companies Act, 1956 engaged in the business of financing and investing
activities as a non-banking financial company registered with the Reserve Bank
of India.

Through this petition, the petitioner sought
quashing of the notice dated 31^st March, 2019 issued u/s 148 of the
Act by the ACIT Circle 1(1)(2), Mumbai as well as the order dated 26^th
August, 2019 passed by the DCIT Circle 1(1)(2), Mumbai, rejecting the
objections raised by the petitioner to the re-opening of its assessment.

For the A.Y. 2012-13 the petitioner had
filed return of income on 20^th September, 2012 declaring total
income of Rs. 90,630. Initially, the return was processed u/s 143(1) of the
Act. But the case was later selected for scrutiny. During the course of
assessment proceedings, details of income, expenditure, assets and liabilities
were called for and examined. After examination of these details, the A.O.
passed an order u/s 143(3).

On 31^st March, 2019 the A.O.
issued a notice u/s 148 stating that he had reasons to believe that the
petitioner’s income chargeable to tax for the A.Y. 2012-13 had escaped
assessment within the meaning of section 147. The petitioner sought the reasons
for issuing the said notice. It also filed return of income u/s 148, returning
the income at Rs. 90,630 as originally assessed by the A.O. u/s 143(3). By a
letter dated 31^st May, 2019, the A.O. furnished the reasons for
re-opening of the assessment.

It was stated that information was received
from the Investigation Wing (I/W) of the Income Tax Department that a search
and seizure action was carried out on the premises of one Mr. Naresh Jain which
revealed that a syndicate of persons was acting in collusion and managing
transactions in the stock exchange, thereby generating bogus long-term capital
gains / bogus short-term capital loss and bogus business loss entries for
various beneficiaries.

From the materials gathered in the course of
the said search and seizure action, it was alleged that the petitioner had traded
in the shares of M/s Scan Steel Ltd. and was in receipt of Rs. 23,98,014 which
the A.O. believed had escaped assessment within the meaning of section 147. It
was also alleged that the petitioner had failed to disclose fully and truly all
material facts necessary for the assessment for the A.Y. 2012-13 for which the
notice u/s 148 was issued.

The petitioner submitted objections to
re-opening of assessment proceedings on 26^th June, 2019. Referring
to the reasons recorded, it was contended on behalf of the petitioner that the
original assessment was completed u/s 143(3) where all the details of purchase
and sale of shares of M/s Scan Steels Ltd., also known as Clarus Infrastructure
Realties Ltd. (earlier known as Mittal Securities Finance Ltd.), were disclosed.
While denying that the petitioner had any dealing with the parties whose names
cropped up during the said search and seizure action, it was stated that the
purchase and sale of shares were done by the petitioner through a registered
broker of the Bombay Stock Exchange. Payment for the purchase of the shares was
made by cheque through the BSE at the then prevailing market price. Thus, there
was no apparent reason to classify the receipt of Rs. 23,98,014 as having
escaped assessment. Therefore, it was contended that the decision to re-open
assessment was nothing but change of opinion, which was not permissible in law.

The A.O. by his letter dated 26^th
August, 2019 rejected the objections raised by the petitioner and stated that
the petitioner had furnished the details of purchase and other material facts
before the A.O. and the latter, in his assessment order, had totally relied on
the said submissions and accepted the same without cross-verification. It was
further stated that the challenge to the impugned notice was untenable.
Besides, the Act provided for a host of remedial measures in the form of
appeals and revisions. Finally, the Department justified issuance of the
impugned notice and re-opening of the assessment and made a reference to the
report of the I/W. As per the I/W, the petitioner had diluted its income by
adopting manufactured and pre-arranged transactions which were never disclosed
to the A.O. Such action was a failure on the part of the petitioner to make
full and true disclosure of all material facts. The petitioner’s contention
that all primary facts were disclosed were thus disputed. That apart, it was
contended that the Pr. CIT-1 had applied his mind and thereafter granted
approval to the issuance of notice u/s 148.

In its rejoinder, the petitioner submitted
that all details about the purchase and sale of shares of Mittal Securities
Ltd. were furnished. The A.O. was not required to give findings on each issue
raised during the course of the assessment proceedings. The A.O. had applied
his mind and granted relief to the petitioner in the assessment order.
Normally, when the submission of an assessee is accepted, no finding is given in
the assessment order.

The Hon’ble Court, after referring to
various decisions, observed that the grounds or reasons which led to formation
of the belief that income chargeable to tax has escaped assessment must have a
material bearing on the question of escapement of income of the assessee from
assessment because of his failure or omission to disclose fully and truly all
material facts. Once there exist reasonable grounds for the ITO to form the
above belief that would be sufficient to clothe him with jurisdiction to issue
notice.

However, sufficiency of the grounds is not
justifiable. The expression ‘reason to believe’ does not mean a purely
subjective satisfaction on the part of the ITO. The reason must be held in good
faith. It cannot be merely a pretence. It is open to the Court to examine
whether the reasons for the formation of the belief have a rational connection
with or a relevant bearing on the formation of the belief and are not
extraneous or irrelevant. To this limited extent, initiation of proceedings in
respect of formation of the belief that income chargeable to tax has escaped
assessment must have a material bearing on the question of escapement of income
of the assessee from assessment because of his failure or omission to disclose
fully and truly all material facts.

The Court further observed that it would be
evident from the material on record that the petitioner had disclosed the above
information to the A.O. in the course of the assessment proceedings. All
related details and information sought by the A.O. were furnished. Several
hearings took place in this regard after which the A.O. had concluded the
assessment proceedings by passing the assessment order u/s 143 (3). Thus it
would appear that the petitioner had disclosed the primary facts at its
disposal for the purpose of assessment. He had also explained whatever queries
were put to it by the A.O. with regard to the primary facts during the
hearings.

In such circumstances, it cannot be said that the petitioner did not
disclose fully and truly all material facts necessary for the assessment.
Consequently, the A.O. could not have arrived at the conclusion that he had
reasons to believe that income chargeable to tax had escaped assessment. In the
absence of the same, the A.O. could not have assumed jurisdiction and issued
the impugned notice u/s 148 of the Act. That apart, the A.O. has tried to
traverse beyond the disclosed reasons in the affidavit which is not
permissible. The same cannot be taken into consideration while examining the validity
of the notice u/s 148. The reasons which are recorded by the A.O. for re-opening an
assessment are the only reasons which can be considered when the formation of
the belief is impugned; such reasons cannot be supplemented subsequently by
affidavit(s). Therefore, in the light of the discussions, the attempt by the
A.O. to re-open the concluded assessment is not at all justified and
consequently the impugned notice cannot be sustained and the impugned order
dated 26^th August, 2019 is also quashed.

shailesh.kwebmaker

ANALYSIS OF RECENT COMPOUNDING ORDERS

Here
is an analysis of some interesting compounding orders passed by the Reserve
Bank of India in the month of December, 2019 and uploaded on the website¹.
This article refers mainly to the regulatory provisions as existing at the time
of offence. Changes in regulatory provisions are noted in the comments section.

FOREIGN
DIRECT INVESTMENT (FDI)

A.
Utkarsh CoreInvest Ltd.

Date
of order: 18^th November, 2019

Regulation:
FEMA 20/2000-RB [Foreign Exchange Management (Transfer or Issue of Security by
a Person Resident Outside India) Regulations, 2000] and FEMA 20(R)/2017 (dated
7^th November, 2017)

ISSUE

FDI
in Indian company engaged in business of investing in other companies and
taking on record transfer of shares of an Indian company between two
non-residents.

FACTS

Issue
1

(i) The applicant company was engaged in the business of micro finance.

(ii) Subsequently, it was issued license to set up a small finance bank
wherein one of the conditions stipulated that the applicant company should be
registered as an NBFC-CIC after transfer of its micro-finance business to the
bank.

(iii) Accordingly, the applicant company applied to RBI for
registering itself as an NBFC-CIC in December, 2016 and incorporated a
subsidiary company to which it transferred the micro-finance business in
January, 2017.

(iv) At the time of filing its application for license to set up a
small finance bank, the applicant company had foreign shareholding of around
84.1%. In order to bring the foreign shareholding below 50%, the applicant
company raised equity capital (by way of rights issue) which was offered to
both resident and non-resident shareholders in November, 2017. The applicant company
received FDI amounting to Rs. 28,68,95,310 at the same time which was not
permissible under the extant FEMA 20(R).

(v) Subsequently, in March, 2018, FDI up to 100% under automatic route
was allowed in investing companies registered as NBFCs with RBI.

Issue 2

(a) In August, 2017, International Finance Corporation (IFC), a
non-resident entity, had transferred 42,69,726 shares of the applicant company
amounting to Rs. 55,50,64,380, to another non-resident entity which was
recorded in the books of the applicant company without obtaining prior approval
of the Government.

(b) The Government of India, MoF, DEA, while according its approval for
another transaction in October, 2018 which involved share transfer between two
non-resident entities had, vide its letter dated 22^nd October, 2018,
advised the applicant company to approach RBI for compounding for ‘past foreign
investments made in UMFL, including share transfers among non-residents,
without GoI approval’.

Regulatory
provisions

Regulation 16(B)(5) of FEMA 20(R) in
November, 2017 states that ‘Foreign investment into an Indian company,
engaged only in the activity of investing in the capital of other Indian
company/ies, will require prior approval of the Government. A core investment
company (CIC) will have to additionally follow the Reserve Bank’s regulatory
framework for CICs’.

The above regulation was amended in March,
2018 which allowed foreign investment up to 100% under automatic route in
investing companies registered as NBFCs with RBI.

Regulation 4 of the erstwhile FEMA 20, which
stated that ‘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.’

CONTRAVENTION

Nature
of default

Amount
involved
(in INR)

Time
period of default

Receiving
FDI in Indian company which is engaged in investing in capital of other
companies

Rs.
28,68,95,310

Seven
months approx.

Taking
on record share transfer between two non-residents when foreign investment
itself was not permitted

Rs.
55,50,64,380

Total

Rs.
84,19,59,690

Compounding
penalty

A compounding penalty of Rs.
43,09,797 was levied.

Comments

It is interesting to note that
generally transfer of shares between two non-residents is not subject to any
reporting requirement by the Indian company. Form FC-TRS regarding reporting
transfer of shares of an Indian company is required to be filed only when
either the transferor or the transferee is an Indian resident. Thus, any
transfer of shares between resident to non-resident or vice versa is required
to be reported in Form FC-TRS but not any transfer of shares between two
non-residents.

However, where FDI itself is not
permitted under the 100% automatic route and is subject to prior approval of
the Government, any transfer of shares between two non-residents would also be
subject to prior approval. Hence, Indian companies engaged in sectors where
prior approval of Government is required should be cautious and ensure that any
transfer of shares between two non-residents is undertaken only after obtaining
prior approval of Government.

B. M/s Star
Health and Allied Insurance Co. Ltd.

Date of order:
29^th November, 2019

Regulation: FEMA
20(R)/2017 [Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2017]

ISSUE

Delay in allotment of shares
within 60 days of receipt of share capital.

FACTS

(i) Applicant company is engaged in the business of non-life insurance.

(ii) It received FDI from two Mauritian companies amounting to Rs.
30,50,00,079 in December, 2018.

(iii) Shares were allotted by the applicant company to the above
shareholders after a delay of three months and ten days (approximately) beyond
the stipulated time of 60 days from the date of receipt of the consideration.

Regulatory
provision

Paragraph 2(2) of Schedule I to
Notification No. FEMA 20(R)/2017-RB, states that capital instruments shall be
issued to the person resident outside India making such investment within 60
days from the date of receipt of the consideration.

Contravention

The amount of contravention is Rs
30,50,00,079 and the period of contravention three months and ten days.

Compounding
penalty

A compounding penalty of Rs.
15,75,000 was levied.

Comments

The above order highlights the
fact that RBI is taking a serious view of contraventions relating to delay in
allotment of shares to foreign investors. Hence, it is absolutely critical that
in respect of foreign investment, shares should be allotted within the
prescribed period of 60 days as per erstwhile FEMA-20(R) and even under the new
Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019
effective from 17^th October, 2019.

EXPORT
OF GOODS AND SERVICES

C. H.F. Metal
Art Private Limited and Azoy Bansal

Date of order: 5^th
November, 2019

Regulation: FEMA
23/2000-RB [Foreign Exchange Management (Export of Goods and Services)
Regulations, 2000] and FEMA 23R/2015-RB [Foreign Exchange Management (Export of
Goods and Services) Regulations, 2015]

ISSUE

(i) Failure to export goods within the prescribed
period of one year from the date of receipt of advance.

(ii) Failure to realise export proceeds within the
stipulated time period.

(iii) Contravention deemed to have been
committed by director who was in charge of the company at the time of
contravention.

FACTS

The applicant company is engaged in the
business of minting and supply of precious metal coins and bars, as well as
high quality medals, gifts and promotional items in non-precious metals.

The company received certain export advances
between January, 2008 and July, 2011 amounting to Rs. 6,30,79,984 but was
unable to make exports within the prescribed time limit. However, the company
has adjusted the export advances against subsequent exports made during the
period from August, 2013 to June, 2014.

The company could not realise export proceeds
against certain exports amounting to Rs 10,58,50,346 within the prescribed time
period 2014-2018.

Regulatory provisions

Regulation 16 of Notification No. FEMA
23/2000- RB, where an exporter receives advance payment (with or without
interest) from a buyer outside India, the exporter shall be under an obligation
to ensure that the shipment of goods is made within one year from the date of
receipt of advance payment.

Regulation 9 of Notification No. FEMA 23/2000-
RB and FEMA 23(R), the amount representing the full export value of goods or
software exported shall be realised and repatriated to India within nine months
from the date of export.

Section 42(1) of FEMA states that, ‘Where a
person committing a contravention of any of the provisions of this Act or of
any rule, direction or order made thereunder is a company, every person who, at
the time the contravention was committed, was in charge of, and was responsible
to, the company for the conduct of the business of the company as well as the
company, shall be deemed to be guilty of the contravention and shall be liable
to be proceeded against and punished accordingly’.

CONTRAVENTION

Relevant
Provision

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation
16 of FEMA 23/2000-RB

Failure
to export the goods within a period of one year from the date of receipt of
advance

Rs.
6,30,79,984

11
months to 4.6 years

Regulation
9 of FEMA 23/2000-RB & FEMA 23(R)

Failure
to realise export proceeds within stipulated time period

Rs.
10,58,50,346

One
day to seven months

Section
42(1) of FEMA

Being
director of company which committed above contravention of FEMA

Rs.
16,89,30,330

11
months to 4.6 years and one day to seven months

Compounding
penalty

Compounding penalty of Rs.
10,32,998 was levied on the company and Rs. 1,03,300 on the director
personally.

Comments

In the instant case, the company
had committed contravention by not exporting goods against advance received
within the prescribed time frame and also by not receiving payment for exports
within the prescribed time. However, the director who was in charge of the
company was also deemed to be guilty u/s 42(1) of FEMA and hence compounding
penalties were levied both on the company as well as the director in respect of
the contraventions. Accordingly, going forward, especially in cases of export
of goods, it is advisable that directors of companies are extremely vigilant
and ensure that their company adheres to the prescribed time lines failing
which both the company as well as the directors would be personally liable for
any contravention.

BORROWING
OR LENDING IN FOREIGN EXCHANGE

D. M/s Tulsea
Pictures Private Limited

Date of order:
28^th November, 2019

Regulation: FEMA
4/2000-RB [Foreign Exchange Management (Borrowing or Lending in Foreign
Exchange) Regulations, 2000]

ISSUE

(i) Borrowings from NRI without issuance of NCDs through public offer.

(ii) Utilising borrowed funds for other than business purposes.

FACTS

The applicant company appointed an NRI as one
of the directors on its board.

The company raised a loan of Rs. 32,96,432
from the NRI director to meet its day-to-day expenses and other liabilities.

The loan in INR had been availed from the NRI
without issuing non-convertible debentures (NCD) through public offer.

Out of the aforesaid amount, the applicant
company had utilised Rs. 5,98,670 for paying the lease rentals for a
residential premise taken for the NRI director and for meeting day-to-day
expenses.

The company was granted permission to convert
the loan amount into equity, subject to lender’s consent and adherence to FDI /
pricing norms for such conversion and reporting requirements.

The company allotted 55,056 equity shares to
the director on 5^th July, 2018 against the outstanding loan amount
of Rs. 26,97,762.

Regulatory
provisions

Regulation 5(1)(i) of Notification No. FEMA
4/2000-RB inter alia states as under:

‘Subject to the
provisions of sub-regulations (2) and (3), a company incorporated in India may
borrow in rupees on repatriation or non- repatriation basis, from a
non-resident Indian or a person of Indian origin resident outside India or an
overseas corporate body (OCB), by way of investment in non-convertible
debentures (NCDs) subject to the following conditions:

i. the issue of Non-convertible Debentures
(NCDs) is made by public offer;…’

Regulation 6 of
Notification No. FEMA 4/2000-RB states that no person resident in India who
has borrowed in rupees from a person resident outside India shall use such
borrowed funds for any purpose except in his own business.

CONTRAVENTION

Relevant
Para of FEMA 4 Regulation

Nature
of default

Amount
involved

(in
INR)

Time
period of default

Regulation
5(1)(i) of Notification No. FEMA 4/2000-RB

Issue
1:
Borrowings from NRI without issuance of NCDs through public offer

Issue
1:

Rs.
32,96,432

Approximately
7 years

Regulation
6 of Notification No. FEMA 4/2000-RB

Issue
2:
Utilising borrowed funds for purpose other than business

Issue
2:

Rs.
5,98,670

Approximately
7 years

Compounding
penalty

A compounding penalty of Rs.
1,29,213 was levied.

Comments

It is important to note that
borrowings in INR by an Indian company from its NRI director, even though
permissible under the Companies Act, 2013, is not permissible under FEMA
regulations. Under FEMA, INR borrowings from NRIs are permitted only through
issuance of NCDs made by public offer under both repatriation as well as
non-repatriation route.

OVERSEAS
DIRECT INVESTMENT (ODI)

E. Ms Pratibha
Agrawal

Date of order:
11^thNovember, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign
Security) Regulations, 2004]

ISSUE

Acquisition of foreign securities
by way of gift from a person resident in India.

FACTS

The applicant was a resident individual and
the spouse of a senior management employee of Sterlite Industries India Limited
from 2001 to 2008.

The senior employee was offered 8,000 shares
of Vedanta Resources Plc, London, in March, 2004 to be issued in two tranches.
The first tranche of 4,000 shares was allotted in March, 2004 and second in
February, 2005.

The consideration paid for the shares allotted
in the second tranche was equivalent to face value, i.e., USD 400 (INR 17,532).

Out of the 4,000 shares of the second
tranche, the senior employee gifted 3,000 to the applicant (Ms. Pratibha
Agrawal) and, accordingly, share certificates for these 3,000 shares were
issued in the name of the applicant.

Regulatory
provisions

As per Regulation 22(1)(i), read
with Regulation 3, a person resident in India being an individual may acquire
foreign securities by way of gift only from a person resident outside India and
not from another Indian resident.

CONTRAVENTION

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved
(in INR)

Time
period of default

Regulation
22(1)(i)

Acquisition
of foreign securities by way of gift from a person resident in India

Rs.
22,49,232

Approximately
13 years

Compounding
penalty

Compounding penalty of Rs. 66,869
was levied.

Comments

In view of the peculiar language
of FEMA 120, it is advisable that appropriate care is taken in respect of gifts
of shares of foreign companies between residents and non-residents. Under the
existing provisions, an Indian resident can acquire shares by way of gift from
only a non-resident and not from a resident.

F. Masibus
Automation and Instrumentation Pvt. Ltd.

Date of order:
26^th November, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign
Security) Regulations, 2004]

ISSUES

(i) Sending remittances to overseas company without submitting Annual
Performance Report (APR);

(ii) Delay in submission of duly completed Part I of the Form ODI;

(iii) Overseas investment undertaken by a method of funding not
prescribed;

(iv) Delayed receipt of proof of investment;

(v) Delayed submission of APRs;

(vi) Disinvestment from the overseas entity without obtaining fair
valuation certificate prior to its divestment;

(vii) Disinvestment undertaken from the overseas entity when it had
outstanding loans;

(viii) Disinvestment without
prior approval of RBI when it was not eligible under the automatic route.

FACTS

The applicant is engaged in the business of
manufacturing of electrical equipment, wiring devices, fittings, etc.

The applicant remitted SGD 990 on 4^th
July, 2008 towards 99% stake in the overseas JV, viz., Masibus Automation and
Instrumentation (Singapore) Pte. Ltd. in Singapore.

Subsequently, the applicant undertook ODI of
SGD 5,000 on 4^th July, 2008 by way of payment by the director of the
applicant company in cash during his visit abroad.

The applicant had sent seven remittances
aggregating SGD 52,000 in 2010-11 without submitting APR.

Further, the applicant submitted Part I of
Form ODI with delay on 11^th January, 2018 in respect of remittance
of SGD 5,000 made through the director on 4^th July, 2008.

Share certificate for the aforesaid
remittance of SGD 990 made in July, 2008 was received with delay (i.e. beyond
the prescribed period of six months under FEMA 120) on 8^th
September, 2014.

The applicant submitted APRs for the years
ending 2009 to 2012 with delay on 12^th January, 2018.

Disinvestment from the overseas entity was
undertaken on 11^th April, 2012 without obtaining fair valuation
certificate and when it had outstanding loans.

Accordingly, as the applicant had outstanding
loans, it was not eligible to undertake the disinvestment under the automatic
route and should have sought prior approval of RBI before disinvestment.

Regulatory
provisions

Regulations 6(2)(iv), 6(2)(vi), 6(3), 15(i),
15(iii), 16(1)(iii), 16(1)(iv), 16(3) of FEMA 120.

CONTRAVENTION

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation
6(2)(iv)

Making
overseas remittances towards share capital without submitting APR of the
overseas entity

Rs. 18,46,500

Five
years

Regulation
6(2)(vi)

Overseas
investment made through director in cash was treated as investment of Indian
company, hence Indian company ought to have filed Part I of Form ODI for
making remittance. There was delay in submission of Part I of the Form ODI in
respect of the
above investment

Rs.
1,60,600

4^th
July, 2008 to
11^th January, 2018

Regulation
6(3)

Overseas
investment undertaken through cash payment made by director is not a
prescribed method of funding

Rs.
1,60,600

4^th
July, 2008 to
13^th May, 2019

Regulation
15(i)

Proof of
investment made in overseas entity should be received and filed with RBI
within six months of making remittance. There was delay in providing share
certificate to RBI in respect of overseas remittances made

Rs.
31,799

4^th
July, 2008
to 8^th September, 2014

Regulation15(iii)

APR of
the overseas entity based on its audited accounts has to be filed annually on
or before 31^st December. Applicant delayed submission of APR in
respect of its
overseas entity

Not
applicable

1^stJuly, 2013 to
21^st September, 2018

Regulation
16(1)(iii)

Any
divestment of overseas entity has to be undertaken at a price which is not
less than its fair value as certified by CA / CPA based on last audited
financials of overseas entity. In the instant case, applicant divested its
overseas entity without obtaining its fair valuation certificate from CA /
CPA

Rs.
31,799

11^th
April, 2012 to
13^th May, 2019

Regulation
16(1)(iv)

An
Indian party can undertake divestment of its overseas entity only when the
overseas entity does not have any amount payable to Indian entity. In the
instant case, the applicant had undertaken disinvestment of the overseas
entity when it still had outstanding loans payable to it

Rs.
23,56,703

11^th
April, 2012 to
13^th May, 2019

Regulation
16(3)

Indian
entity wanting to divest its overseas entity which has any amount payable to
it would need prior approval of RBI before undertaking divestment. In the
instant case, the applicant undertook disinvestment without prior approval of
RBI when not eligible under automatic route

Rs.
23,91,521

11^th
April, 2012 to
13^th May, 2019

Compounding
penalty

Compounding penalty of Rs.
3,61,126 was levied.

Comments

In view of numerous compliances
prescribed under FEMA 120 in respect of overseas investments, it is essential
that adequate care is taken by every Indian entity in respect of its overseas
investment. Specific care should be taken to ensure that overseas investment by
any Indian entity is routed only through Indian banking channels and not made
in cash by any person visiting overseas.

Further, Regulation 16(1)(iv) of
FEMA 120 states that at the time of divestment, the Indian party should not
have any outstanding dues by way of dividend, technical know-how fees, royalty,
consultancy, commission or other entitlements and / or export proceeds from the
overseas JV or WOS. This includes any amount due, including loan payable by the
overseas entity to an Indian entity. Hence, appropriate care should be taken to
ensure that the overseas entity does not have any amount payable to an Indian
entity at the time of its disinvestment.

G. Essar Steel
India Ltd.

Date of order:
22^ndNovember, 2019

Regulation: FEMA
120/2004 [Foreign Exchange Management (Transfer or Issue of any Foreign Security)
Regulations, 2004]

ISSUES

(i) Effecting remittance without prior approval of RBI when the Indian
party (IP) was under investigation by the Department of Revenue Intelligence
(DRI);

(ii) Delayed submission of APRs;

(iii) Disinvestment without obtaining valuation.

FACTS

The applicant company set up a wholly-owned
subsidiary (WOS), Essar Steel Overseas Ltd., in Mauritius by remitting USD 1
(INR 47) on 7^th August, 2010.

Since the applicant company was under
investigation by the DRI at the time of effecting the remittance, it was not
eligible to make ODI under the automatic route.

The WOS was later liquidated on 9^th
March, 2012 and no valuation was done as required. The transactions were taken
on record on 14^th August, 2019.

Further, the applicant had reported Annual
Performance Reports (APRs) for the accounting years 2011 and 2012 with a delay
on 15^thJune, 2013 and 17^thDecember, 2013.

Regulatory
provisions

Regulation 6(2)(iii) of FEMA 120 provides
that Overseas Direct Investment under automatic route is permitted in certain
cases provided ‘the Indian party is not on the Reserve Bank’s exporters
caution list / list of defaulters to the banking system circulated by the
Reserve Bank, or under investigation by any investigation / enforcement agency
or regulatory body.’

Regulation 15(iii) of FEMA 120 states that, ‘An
Indian Party which has acquired foreign security in terms of the Regulation in
Part I shall submit to the Reserve Bank, through the designated Authorised
Dealer, every year on or before a specified date, an Annual Performance Report
(APR) in Part III of Form ODI in respect of each JV or WOS outside India…’. The specified date for filing APR currently
is on or before 31^st December every year.

Regulation 16(1) provides that an Indian
party may disinvest to a person resident outside India subject to the following
conditions:

• (iii)
if the shares are not listed on the stock exchange and the shares are
disinvested by a private arrangement, the share price is not less than the
value certified by a Chartered Accountant / Certified Public Accountant as the
fair value of the shares based on the latest audited financial statements of
the JV / WOS.

CONTRAVENTION

Relevant
Para of FEMA 120 Regulation

Nature
of default

Amount
involved (in INR)

Time
period of default

Regulation

6(2)(iii)

Effecting
remittance and incorporating overseas entity under the automatic route
without obtaining prior approval of RBI when the Indian Party (IP) was under
investigation by DRI

Rs.
47

Seven
years five months, to nine years and one month, approximately

Regulation
15(iii)

Delayed
submission of APRs

Regulation
16(1)

Disinvestment
of the overseas entity without obtaining fair valuation certificate from CA /
CPA at the time of disinvestment

Compounding
penalty

A compounding penalty of Rs. 83
was levied.

Comments

In the instant case, as the
applicant was under investigation by DRI and the Enforcement Directorate (DoE)
in Mumbai and Ahmedabad, the RBI had sought a No-Objection Certificate from the
DoE before proceeding with the compounding application. However, as no reply
was received from the DoE, RBI proceeded for the compounding without prejudice
to any other action which may be taken by the authority under any other laws.
Thus, RBI compounded the above contravention even though it did not receive any
NOC from the DoE.

Besides, Indian entities wishing
to make overseas investments should understand that if there is any
investigation pending against them by any regulatory body or investigation
agency, they cannot make an overseas investment under the automatic route and
need to obtain prior approval of RBI before making such investment.

shailesh.kwebmaker

THE MCA CONSULTATION PAPER

The MCA paper examining the existing provisions and
seeking to make suitable amendments to enhance Audit Independence and
Accountability has been under discussion. Nineteen pages have laid out a
certain thought pattern and invited comments on questions arising out of that
thought pattern.

Over
the years, regulators, government, the corporate sector and auditors have not
been able to solve fundamental core issues about audit and auditors. Some beat
around the bush, others are infected by vested interests, some import and
impose a model from elsewhere, and so on.

Two
functions describe an auditor – a watchdog (or a sniffer dog if you wish) and a
judge – when he carries out the function of oversight and gives a considered
opinion after taking into account a number of factors respectively.

Looking
at complete independence, it’s not achievable because the client decides the
fees of the auditor for reporting on the client’s financial information.
Independence can only be brought to a level where the auditor’s objectivity is
not affected. Secondly, independence is a personal trait and two auditors under
the same circumstances may act differently.

The
paper bundles the two mammoth topics of Independence and Accountability into 19
pages (four are a reproduction from standards without giving any credit) and
believes that these are the only questions there ought to be. For example, an
auditor of a private non-public interest entity cannot be evaluated by the same
yardsticks as auditors of a public interest entity like IL&FS unless one is
absurdly socialist.

The
paper carries a whiff of ‘we have made up our mind’ when it asks questions
based on its thought pattern, which itself needs questioning. It is piecemeal,
not thought-through, has a flavour of control and seems to aim for a quick fix
without getting to the bottom of the whole problem. While urgency is critical,
not dealing with the root cause will only delay the cure. Such papers call for
‘comments’ but never publish what is received, what is accepted, what is
rejected and why. Therefore, they seem more like a ‘procedural formality’ or
‘consultation in appearance’ rather than an exploration of fundamental
problems. For such an important topic as Independence and Accountability,
the MCA should have a country-wide deliberation directly with 30 to 50 firms,
auditees and regulators rather than sending a questionnaire and seeking answers
to questions that it has framed in its (limited) wisdom.

In spite of the Prime Minister talking of creating the
next big 4 firms out of India, there is literally nothing that is being done
either at the strategic or the tactical level by the MCA. The paper has little
vision to offer on this front when auditors actually vet a large part of India’s
economic interests. The question asked is whether or not auditor groups need to
be essentially and substantially Indian? In fact, the MCA paper mocks this idea
by asking whether there are firms outside of the big four who can even carry
out large audits. If MCA had bothered to add up the loss of value and tagged
each debacle to the auditors at that time, they wouldn’t have asked this
question.

The
paper should have mentioned the need to create an ‘ecosystem’ that will
cultivate and protect objectivity. What should auditors do when they report
what should be reported or when they resign and then the auditee files a legal
case for losing market cap? The MCA has no answers, and no questions either,
about this.

Here is one fundamental issue that the paper avoids:
non-audit fees charged by group / network entities of the audit firms to the
clients in spite of a 30-page-long explicit mention in the NFRA Report 1 / 2019
dated 12th December, 2019. What about non-audit fees taken by audit networks
from group entities of an audit client? Perhaps we have come to a situation
where an auditor will need to give his own related party disclosure to the MCA,
to the Board and even to shareholders!

One can answer the questions in the MCA consultation
paper. But one wonders whether they are complete, whether they target the core
issues and whether an objective exploratory discussion is possible in the
spirit of partnership for nation-building!

Raman
Jokhakar

Editor

shailesh.kwebmaker

GST IMPLICATIONS ON BUSINESS RESTRUCTURING

INTRODUCTION

In changing
business dynamics, business restructuring has become a norm whereby businesses
undertake activities of merger – wherein two or more entities come together to
form a new entity, resulting in the old entities ceasing to exist; or
amalgamation – wherein one or more entities are subsumed into an existing
entity such that the subsumed entities cease to exist. The next mode of
business restructuring is de-merger, where only specific business divisions are
transferred to a new entity, or are sold to an existing entity. When the above
activities are undertaken as a corporate, the same are governed by the
provisions under the Companies Act, 1956 (now 2013). In the non-corporate
sector, the restructuring transactions are generally undertaken by way of business
transfer arrangements, lease, leave and license and so on, which may not be
governed under any other statute.

Generally, a
business transaction is structured in such a manner that there is transfer of
assets and liabilities as per the terms of the transfer of the business or part
thereof which is being transferred to the transferee. However, this transaction
has its own set of challenges under GST, ranging from whether the transaction
would be liable to GST u/s 9, liability of transferor and transferee in case of
such transfers, input tax credit implications, registration implications, etc.

In this article, we
will try to decode the above aspects and the issues which revolve around
business restructuring.

TAXABILITY
OF CONSIDERATION RECEIVED FOR BUSINESS RESTRUCTURING TRANSACTIONS

An important aspect
which needs to be looked into while dealing with business restructuring
transactions under GST is whether or not the consideration received for the
said transaction attracts levy of GST u/s 9. This is very important since the
consideration involved is substantial and the applicability of GST on such
transactions may be a game-breaker. To analyse the same, one needs to analyse
from two different perspectives, one being whether transfer of business can be treated
as supply of goods, or supply of services or not, and the second being whether
or not the same can be treated as being in the course or furtherance of
business?

Let us first
discuss whether the activity of sale of business, as part of business restructuring,
can be treated as sale of goods, or sale of services, or none of the two. For
this let us refer to the definition of goods as defined u/s 2(52) of the CGST
Act which is reproduced below for ready reference:

‘goods’ means
every kind of movable property other than money and securities but includes
actionable claim, growing crops, grass and things attached to or forming part
of the land which are agreed to be severed before supply or under a contract of
supply;

On going through
the above definition of goods, it is evident that for any item to be classified
as goods it has to be movable property. Therefore, the question that needs to
be analysed is whether or not a business unit is a movable property. While the
term ‘movable property’ has not been defined under the GST law, one can refer
to the decisions under the pre-GST regime which specifically dealt with this
issue. In this context, reference may be made to the decision in the case of Shri
Ram Sahai vs. CST [1963 (14) STC 275 (Allahabad HC)] wherein the
Hon’ble High Court held that ‘business’ is not a movable property and therefore
it is not covered within the meaning of ‘goods’.

Similarly, in a
recent decision the Hon’ble Andhra High Court in the case of Paradise
Food Court vs. State of Telangana [Writ Petition No. 2167 of 2017] had
held as under:

‘16. Two
important things are to be noted from the definition part of the Statute. (i)
The first is that the sale of a business as such is not covered either by the
charging Section, viz., Section 4(1) or by the definition of the expression
goods. While the sale of a business may
necessarily include a sale of the assets (as well as liabilities) of the
business, the expression business is not included in the definition of the
expression goods under Section 2(16).’

While the above
decisions were in the context of the sales tax / VAT regime, it is important to
note that the definition of goods was similarly worded and, therefore, the
principles laid down by the above judgments should continue to apply even under
GST. For these reasons, it can be concluded that the activity of business
restructuring, by way of amalgamation, merger, de-merger or transfer of
business unit, cannot be treated as supply of goods for the purpose of GST.

We shall now
proceed to analyse whether sale of business, as a part of business
restructuring, can be treated as supply of services. For this, let us refer to
the definition of service as provided u/s 2(102) of the CGST Act, 2017 which is
reproduced below for ready reference:

‘services’ means
anything other than goods, money and
securities but includes activities relating to the use of money or its
conversion by cash or by any other mode, from one form, currency or
denomination, to another form, currency or denomination for which a separate
consideration is charged;

On going through the above, it is evident that service has been very
loosely defined under GST. A literal reading of the definition indicates that
anything which is not classifiable as goods would be service. However, the
question that needs to be analysed is whether such literal interpretation of
the definition of supply can be done or not, or whether one needs to refer to
purposive interpretation. It would be relevant to refer to two decisions of the
Supreme Court to understand when purposive interpretation can be resorted to:

(i) Periyar & Pareekanni Rubbers
Limited vs. State of Kerala [2008 (13) VST 538 (SC)]

28. Tax
liability of the business concern is not in dispute. Correctness of the orders
of assessment is also not under challenge. The Tribunal or for that matter the
High Court were, therefore, not concerned with the liability fastened upon the
dealer. The only question was as to what extent the appellant was liable
therefor. It is impossible for the legislature to envisage all situations. Recourse to statutory interpretations therefore
should be done in such a manner so as to give effect to the object and purport
thereof. The doctrine of purposive construction should, for the said purpose,
be taken recourse to.

(ii) Tata Consultancy Services Limited vs.
State of Andhra Pradesh [2004 (178) ELT (022) SC]

68. It is now
well settled that when an expression is capable of more than one meaning, the
Court would attempt to resolve that ambiguity in a manner consistent with the
purpose of the provisions and with regard to consequences of the alternative
constructions.

See Clark
&Tokeley Ltd. (t/a Spellbrook) vs. Oakes [1998 (4) All ER 353].

69. In Inland
Revenue Commissioners vs. Trustees of Sir John Aird’s Settlement [1984] Ch. 382,
it is stated:

Two methods of
statutory interpretation have at times been adopted by the court. One,
sometimes called literalist, is to make a meticulous examination of the precise
words used. The other, sometimes called purposive, is to consider the object of
the relevant provision in the light of the other provisions of the Act – the
general intendment of the provisions. They are not mutually exclusive and both
have their part to play even in the interpretation of a taxing statute.

70. Although
normally a taxing statute is to be strictly construed, but when the statutory
provision is reasonable akin to only one meaning, the principles of strict
construction may not be adhered to.

[See Commnr.
of Central Excise, Pondicherry vs. M/s Acer India Ltd., 2004 (8) SCALE 169].

As can be seen from
the above, the need to resort to purposive interpretation arises only when the
literal interpretation results in ambiguity. It would therefore need to be
analysed as to whether according a transaction of business restructuring by way
of amalgamation, merger, de-merger or transfer of business assets as supply of
service would lead to absurdity? In general, depending on the terms of each
agreement, a transaction for business restructuring by any of the means referred
above would generally include transfer of assets, liabilities, employees, etc.
It would be difficult to perceive as to how a transaction, which involves
transfer of assets, liabilities, human resources, etc., would constitute
service, especially when there are identified elements of goods, transactions
in money, etc., involved. In other words, merely because all the above items
are sold as a bundle making the transaction take the character of a business
unit and going by the literal interpretation, since the transfer of business
unit is not classifiable as goods, it should be classified as service. This is
where the ambiguity / absurdity comes into the picture. Schedule II only deems
transactions of temporary transfer of right to use goods as service. This is
because in case of temporary transfer, the goods revert back to the owners. But
it is not the case here as the items being transferred would not revert back to
the owners. It is for this reason that such business restructuring activity
cannot be classified as service as well.

It may also be
relevant to note that notification 12/2017 – CT (Rate) exempts services by way
of transfer of a going concern, as a whole or an independent part thereof, from
levy of GST. However, merely because there is an entry in exemption
notification would not mean that the transaction was upfront liable to levy of
tax. However, if the entry is treated as valid, it would mean that the
transferor has made an exempt supply and, therefore, trigger the applicability
of the provisions of section 17(2) r/w/rule 42 / 43 of the CGST Rules.

Liability of
transferor vis-à-vis transferee – in case of
transfer of business by sale, gift, lease, leave and license, hire or in any
other manner whatsoever

In case of business
restructuring transactions, there is also a change of ownership. Section 85(1)
deals with liability to pay tax in such cases where the business restructuring
results in transfer of business by sale, gift, lease, leave and license, hire
or in any other manner whatsoever. The section provides that in case of
transfer of business, there shall be joint and several liability of the
transferor as well as the transferee to pay tax up to the time of such
transfer, whether determined prior to or subsequent to the said transfer.

Therefore, what needs to be analysed first is what is meant by the term
‘transfer of business’. This has been analysed by the Supreme Court in the case
of State of Karnataka vs. Shreyas Papers Private Limited [Civil Appeal
3170-3173 of 2000] while dealing with the scope of section 15(1) of the
Karnataka Sales Tax Act, 1957. In this case, the Court held that business is an
activity directed with a certain purpose, more often towards promoting income
or profit. Mere transfer of one or more species of assets does not bring about
the transfer of ownership of the business, which requires that the business be
sold as a going concern. The above view has been followed in multiple instances
wherein the Court has held that transfer of specific business assets cannot be
treated as transfer of business in itself. One may refer to the decisions in
the cases of Rana Girders Limited vs. UOI [2013 (295) ELT 12 (SC)],
Lamifab Industries vs. UOI [2015 (326) ELT 674 (Guj.)], Chandra Dyeing &
Printing Mills Private Limited vs. UOI [2018 (361) ELT 254 (Guj.)], Krishna
Lifestyle Technologies Limited vs. Union of India [2009 (16) STR 669 (Bom.)].

When comparing with
the provision under the Central Excise Act, 1944 (section 11), one important
distinction which comes to mind is that the proviso of section 11
required that the transferee should have succeeded in the business of the
transferor. This aspect was dealt with by the High Court in the case of Krishna
Lifestyle Technologies (Supra) where the Court held as follows:

‘16. Succession
therefore has a recognised connotation. The tests of change of ownership,
integrity, identity and continuity of a business have to be satisfied before it
can be said that a person succeeded to the business. The business carried on by
the transferee must be the same business and further it must be continuation of
the original business either wholly or in part. It would thus be clear from the
above that these tests will have to be met before it can be said that a person
has succeeded to a business. This would require the facts to be investigated as
to whether there has been transfer of the whole of the business or part of the
business and succession to the original business by the transferee.’

While the
provisions under GST do not require succession in interest by the transferee,
it remains to be seen whether the condition shall still be continued to be
applicable under GST, considering the decision in the case of Shreyas
Papers (Supra) wherein the Supreme Court has brought in the concept of
transfer of business as a going concern though no specific provisions were
contained in the Karnataka Sales Tax Act.

It would also be
relevant to note that there are instances where the business is transferred by
State Financial Corporations after taking over control of defaulting borrowers.
The statute under which the State Financial Corporations were incorporated
provided that in case of sale of such assets, though the sale would have been
executed by the State Financial Corporation, it would have been deemed that the
sale was being done by the defaulting borrowers and, therefore, the liability
to pay tax up to the date of transfer shall be on the transferee (refer Macson
Marbles Private Limited vs. UOI [2003 (158) ELT 424 (SC)].

Treatment of
Input Tax Credit in case of transfer of business, amalgamation, merger,
de-merger, etc.

Another GST aspect which revolves around the above set of transactions,
apart from the attached transfer of liability to the transferee, is the
permission to transfer the balance lying in the electronic credit ledger of the
transferor. Section 18(3) provides that in case of change in constitution of a
registered person on account of sale, merger, de-merger, amalgamation, lease or
transfer of business with specific provision for transfer of liabilities, the
taxable person shall be allowed to transfer the input tax credit which remains
unutilised in his credit ledger in such manner as may be prescribed. The manner
has been prescribed u/r 41 of the CGST Rules. While the provisions are silent
w.r.t. the manner of determining the credit appropriable to the transferee, it
provides that in the case of de-merger the input tax credit shall be
appropriated in the ratio of value of assets of new units as specified in the
de-merger scheme. However, in all other cases there is no method prescribed for
appropriating input tax credit. The only requirements prescribed for the
transfer of balance lying in electronic credit ledger are:

(1) A copy of the chartered accountant’s
certificate certifying that the sale, merger, de-merger, amalgamation, lease or
transfer of business has been done with a specific provision for transfer of
liabilities;

(2) Furnishing of Form GST ITC-02 by the
transferor which shall be accepted by the transferee on the common portal; and

(3) Accounting for the inputs and capital goods so
transferred by the transferee in his books of accounts.

REGISTRATION
IMPLICATIONS IN CASE OF BUSINESS RESTRUCTURING

In case of
transactions of amalgamation or merger, one needs to take note of the fact that
there are two different dates, namely, the effective date from which the scheme
would be given effect (which has to be indicated while filing the application
for the amalgamation or merger) and, second, the date of order, when the scheme
is approved by the Court or Tribunal. Generally, the effective date precedes
the order date and under the Income-tax Act, while till the time the order is
received both companies continue to have separate existence, the receipt of the
order requires them to re-file their tax returns as the company which has
merged or amalgamated into the other company has ceased to exist.

However, it is not
so under the GST regime. Section 87(2) specifically provides that the companies
party to a scheme shall continue to be treated as distinct companies till the
date of receipt of the order, and the registration certificate of the
amalgamated or merged company shall be cancelled only with effect from the date
of the order approving the scheme. This specific provision will help in dealing
with the following situations:

(A) Supply of goods or services, or both, between
the companies which are part of the scheme, and

(B) Supply of goods or services, or both, by the
said companies to other persons who are not part of the scheme.

This would imply
that till the date of the order approving the scheme is received, each of the
companies party to the scheme shall continue to comply with the various
provisions of the law, including filing of periodic tax returns, annual returns
and reconciliation statements prescribed u/s 35.

Similarly, section
22(4) provides that any new company which comes into existence in pursuance of
an order of a Court or Tribunal, as the case may be, shall be liable to get
registered with effect from the date on which the Registrar of Companies issues
a certificate of incorporation giving effect to such order.

Therefore, in case of amalgamation /
merger, one needs to take the registration aspect very seriously, to the extent
that upon receipt of approval of the scheme, the application for cancellation
of certificate of registration of the company which ceases to exist in view of
the order, and the application for fresh registration of the company which
comes into existence, is done within the prescribed time limits, and all future
supplies are made / received under the registration certificate of the
continuing company / new company and the use of the GSTIN of the company which
ceases to exist is discontinued with immediate effect.

shailesh.kwebmaker

Industrial undertaking – Special deduction u/s 80-IA(4) – Industrial undertaking engaged in production of power – Meaning of ‘power’ in section 80-IA(4) – Power would include steam; A.Y. 2011-12

37. Principal CIT vs. Jay Chemical Industries Ltd. [2020] 422 ITR 449 (Guj.) Date of order: 17^th February, 2020 A.Y.: 2011-12

Industrial undertaking – Special deduction
u/s 80-IA(4) – Industrial undertaking engaged in production of power – Meaning
of ‘power’ in section 80-IA(4) – Power would include steam; A.Y. 2011-12

For the A.Y. 2011-12 the assessee had
claimed deduction of Rs. 32,51,080 u/s 80-IA(4) of the ITA, 1961. This claim
was on account of the operation of the captive power plant. The assessee showed
income from sale of power to the tune of Rs. 1,23,10,500 and the sale of vapour
at Rs. 6,59,77,170. The A.O. took the view that ‘vapour’ would not fall within
the meaning of ‘power’.

The Commissioner (Appeals) and the Tribunal
allowed the assessee’s claim.

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

‘i) Section 80-IA(4) of the Income-tax Act,
1961 provides for special deduction to industrial undertakings engaged in the
production of power. The word “power” should be understood in common parlance
as “energy”. “Energy” can be in any form, mechanical, electricity, wind or
thermal. In such circumstances, “steam” produced by an assessee can be termed
as power and would qualify for the benefits available u/s 80-IA(4).

ii) Steam had
to be considered as “power” for the purpose of deduction u/s 80-IA(4).’

shailesh.kwebmaker

Deemed income – Section 41(1)(a) of ITA, 1961 – Remission or cessation of liability – Condition precedent – Assessee, a co-operative society, obtaining loan from National Dairy Development Board for which state government stood guarantee on payment of commission – Commission claimed by assessee as revenue expenditure in earlier assessment years – State government writing off liability and allowing it to be treated as capital grant to be used only for capital and rehabilitation purposes – Assessee continues to remain liable to repay those amounts – No remission or cessation of liability u/s 41(1)(a) – Cannot be treated as deemed income u/s 41(1)(a); A.Y. 2004-05

36. Principal CIT
vs. Rajasthan Co-Operative Dairy Federation Ltd. [2020] 423 ITR 89 (Raj.) Date of order: 23^rd July, 2019 A.Y.: 2004-05

Deemed income – Section 41(1)(a) of ITA,
1961 – Remission or cessation of liability – Condition precedent – Assessee, a
co-operative society, obtaining loan from National Dairy Development Board for
which state government stood guarantee on payment of commission – Commission
claimed by assessee as revenue expenditure in earlier assessment years – State
government writing off liability and allowing it to be treated as capital grant
to be used only for capital and rehabilitation purposes – Assessee continues to
remain liable to repay those amounts – No remission or cessation of liability
u/s 41(1)(a) – Cannot be treated as deemed income u/s 41(1)(a); A.Y. 2004-05

The assessee, a
co-operative society involved in milk and milk product processing, secured a
loan from the National Dairy Development Board for which the government of
Rajasthan stood guarantor subject to payment of commission of Rs. 25 lakhs per annum.
This was claimed as expenditure by the assessee for several years up to the
A.Y. 2004-05. The amount remained outstanding and was shown as payable to the
government of Rajasthan. The state later wrote off that liability and allowed
it to be treated as a capital grant to be used only for capital and
rehabilitation purposes. The A.O. was of the view that the transaction, i.e.,
cessation of liability, involved the utilisation of receipts which had been
treated as revenue all along and, therefore, treated it as deemed income u/s
41(1)(a) of the Income-tax Act, 1961 for the A.Y. 2004-05.

The Commissioner (Appeals) allowed the
appeal and held that the amount payable to the government was to be treated as
capital grant to be used for rehabilitation or capital requirement of the
assessee and could not be used for any further distribution of dividend or
revenue expenditure, and that it was not a case of remission or cessation of
the liability as envisaged u/s 41(1)(a). The Tribunal concurred with the view
of the Commissioner (Appeals) and dismissed the appeal filed by the Department.

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

‘Both the Commissioner (Appeals) and the
Tribunal had rendered concurrent findings on the facts. The record also
supported their findings in that the loan utilised by the assessee was for
capital purposes and the loan was given by the National Dairy Development
Board. The assessee continued to remain liable to repay those amounts. The
state, instead of fully writing off the amounts, had imposed a condition that
they would be utilised only for capital or rehabilitation purposes. This was
therefore a significant factor, i.e., the writing off was conditional upon use
of the amount in the hands of the assessee which was for the purpose of
capital. No question of law arose.’

shailesh.kwebmaker

IS IT FAIR TO TREAT RCM SUPPLIES AS EXEMPT?

HISTORY OF RCM IN INDIA

Reverse
Charge Mechanism or RCM is not a new concept in the Indirect Tax arena. It was
first introduced in India in 1997 on services provided by Goods Transport
Agency and Clearing and Forwarding Agent. Even the erstwhile Sales Tax and VAT
Laws in some states had a tax similar to RCM, the purchase tax wherein the
buyer or recipient of goods had to pay tax on purchase of specified goods; for
example, Maharashtra levied a purchase tax on cotton. The current GST regime
has only taken this forward, bringing in some more categories of goods and
services under the net of RCM.

India
is not the only country with RCM provisions; most of the developing and developed
nations have RCM provisions including EU VAT, Australia, Singapore, etc. The
underlying reason for introducing RCM in India was to map the unorganised
sector and shift the compliance liability regarding the same to the organised
recipients. It was believed that this would lead to increase in tax revenue
and make administration of the small unorganised sector easy.

From
an economy’s perspective, RCM is a robust check mechanism to ensure that all
supplies are taxed and there is minimal evasion. However, the concept has
certain flaws and repercussions that need to be dealt with.

RCM UNDER GST

RCM
under GST is governed by sections 9(3) and 9(4) of the CGST Act, 2017 which
essentially lay down the following:

(a) 9(3): Supply of specified categories of notified
goods and / or services attract GST under RCM where the recipient is liable to
pay tax on such goods and / or services;

(b)
9(4): Supply made by an unregistered person to a registered person, wherein the
registered recipient shall be liable to pay tax.

Further,
Notification No. 13/2017-CT (Rate) dated 28^th June, 2017 notifies
the categories of supplies which shall attract GST under RCM u/s 9(3) of the
CGST Act, 2017. Considering that under the RCM provisions the recipient pays
tax instead of the supplier, the recipient is eligible to avail Input Tax
Credit (ITC) of the tax so paid. However, as per section 17(3) of the CGST Act,
2017 the value of exempt supply shall include reverse charge supplies and
therefore ITC on the inputs and / or input services used for making such
reverse charge supplies is not available. Accordingly, the ITC pertaining to
such supplies stands unutilised and blocked.

While
the recipient certainly bears the brunt of the compliance burden on RCM
supplies, he remains financially unaffected as the tax paid can be availed as
credit (subject to his taxable and exempted supplies). However, this provision
proves to be prejudicial against the supplier who is unable to avail ITC
pertaining to inputs or input services used for supplying RCM supplies and also
leads to double taxation.

Moreover, if such supplier is engaged only in a
single business (i.e., RCM supplies), the entire ITC paid becomes a cost to
him. Let us understand this with the help of a numeric example as given below:

Sr. No.	Particulars	Under normal or forward charge mechanism	Under reverse charge mechanism
1	Value of inputs and / or input services used by the supplier	100	100
2	GST paid on 1 above @ 18%	18	18
3	Value addition made @ 30%	30	30
4	Cost of production (COP)	130	130
5	Profit @ 30% of COP	39	39
6	Selling price	169	169
7	GST on selling price @ 18%	30.42	30.42 (paid by recipient)
8	ITC available for set-off	18	–
9	Net GST paid by the supplier	12.42	18
10	ITC available to recipient	30.42	30.42

Sr. No.

Particulars

Under normal or
forward charge mechanism

Under reverse charge
mechanism

Value of inputs and / or input services used by the supplier

100

GST paid on 1 above @ 18%

Value addition made @ 30%

Cost of production (COP)

130

Profit @ 30% of COP

Selling price

169

GST on selling price @ 18%

30.42

30.42 (paid by recipient)

ITC available for set-off

–

Net GST paid by the supplier

12.42

ITC available to recipient

30.42

In the above example, it is evident
that although the recipient in both cases is eligible to avail the same ITC, it
is the supplier who faces iniquitous treatment.

Under GST, there are exempt,
zero-rated, taxable and non-GST supplies. For supplies that are either taxable
or zero-rated, ITC is available to the supplier. However, for exempt and
non-GST supplies such as essential items, reverse charge supplies, petroleum,
alcohol, etc., the suppliers suffer as they pay GST on the inward side but fail
to avail the set-off of the same as their outward supplies are not taxed. When
GST was being rolled out, the GST Council had received several representations
from sectors such as pharma, poultry, education, etc. to examine the problem of
accumulated ITC on account of exempt supplies. However, the problem remains
unaddressed till now as far as RCM is concerned.

During the Covid-19 outbreak, the
Supreme Court dismissed various pleas which had sought exemption from GST for masks, ventilators, PPE kits and other Covid-19-related equipment
on the premise that granting exemption to these would result in blocked ITC,
thereby increasing the manufacturing cost and occasioning a higher price for
consumers.

The
Council has in the past taken steps to address the issue of inverted duty
structure. However, the businesses which deal in exempted supplies are still
reeling from the impact of accumulated credits. The Council needs to deliberate
on the probable solutions to the above-mentioned concerns. The immediate
actions could include:

(i) Taking stock of items which are
exempt supplies, including the RCM supplies;

(ii) Evaluating the inward supplies used by such suppliers;

(iii) Exempting the inward supplies for the entire
chain of suppliers if feasible, or providing a mechanism of refunds to such
suppliers;

(iv) If not feasible, then
classifying the outward supplies as zero-rated supplies so that ITC is
available to the suppliers;

(v) An
option can be provided to the RCM sellers: whether to be classified as an RCM
supplier or not. This will give an alternative to sellers to evaluate the
trade-off between the cost of compliance and credit lost. Suppliers with
substantial credit can avail the ITC and carry out the compliances themselves
as against the small suppliers who would not like to get into the compliance
hassle. Similarly, this can be indicated in the tax invoice so as to inform the
buyer about whether or not to levy GST under RCM on the basis of the option
chosen by the supplier.

CONCLUSION

Is it fair for the RCM
suppliers to endure the unwarranted loss of credit for the simple reason that
their products or services, viz. sponsorship services, legal services, security
services, GTA services, cashew nuts, silk yarn, raw cotton, etc. are covered by
the said mechanism?

As discussed above, RCM is a tax
concept meant for the small and unorganised sector. Therefore, shouldn’t the
government be extra vigilant about any financial hardships being caused to
these small traders and businesses by the tax mechanism? Every business incurs
certain non-avoidable expenses including rent, audit fees, housekeeping,
business promotion, etc. All these input services are exigible to GST and constitute a large chunk of the
expenditure in the supplier’s profit and loss account. The GST pertaining to these expenses not being allowed as ITC
gives rise to superfluous adversities.

One of the most prominent objectives of GST was to eliminate
cascading effect and double taxation. While the government has, to a large
extent, been able to meet this objective, it remains to be seen whether the RCM
suppliers will also experience the benevolence of the Good and Simple Tax soon
enough!

Wise men say that the root of victory is in consultation with the wise.

— (Valmiki Raamaayan 6.6.5)

shailesh.kwebmaker

Assessment – Notice u/s 143(2) of ITA, 1961 – Limitation – Notice calling for rectification of defects in return u/s 139(9) – Rectification within time allowed in notice – Not a case of revised return but of corrected return which relates back to date of original return – Limitation for notice u/s 143(2) runs from date of original return, not date of rectified return; A.Y. 2016-17

35. Kunal Structure (India) Private Ltd. vs. Dy.CIT [2020] 422 ITR 482 (Guj.) Date of order: 24^th October, 2019 A.Y.: 2016-17

Assessment
– Notice u/s 143(2) of ITA, 1961 – Limitation – Notice calling for
rectification of defects in return u/s 139(9) – Rectification within time
allowed in notice – Not a case of revised return but of corrected return which
relates back to date of original return – Limitation for notice u/s 143(2) runs
from date of original return, not date of rectified return; A.Y. 2016-17

For
the A.Y. 2016-17, the petitioner company had filed its return of income u/s
139(1) on 10^th September, 2016. Thereafter, the petitioner received
an intimation of defective return u/s 139(9) of the Act on 17^th
June, 2017. The petitioner received a reminder on 5^th July, 2017
granting him an extension of fifteen days to comply with the notice issued u/s
139(9) and accordingly, the time limit for removal of the defects u/s 139(9) of
the Act stood extended till 20^th July, 2017. The petitioner removed
the defects on 7^th July, 2017 within the time granted. Subsequently,
the return was processed u/s 143(1) on 12^th August, 2017 wherein the
date of original return is shown to be 10^th September, 2016.
Thereafter, the impugned notice u/s 143(2) of the Act came to be issued on 9^th
August, 2018, informing the petitioner that the return of income filed by it for the A.Y. 2016-17 on 7^th
July, 2017 has been selected for scrutiny.

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

‘i) A study of the provisions of section 139 of
the Income-tax Act, 1961 shows that under sub-section (1) thereof, an assessee
is required to file return on or before the due date. If one looks at the
language employed in sub-sections (1), (3) and (5) of section 139, a common
thread in all the sub-sections is that the assessee is required to file a
return of income under those sub-sections. However, from the language employed
in sub-section (9) of section 139 of the Act, it does not require any return to
be filed by the assessee. All that the section says is that the assessee is
required to be given an opportunity to rectify the defect in the return filed
by him within the time provided, failing which such return would be treated as
an invalid return.

ii) Unlike sub-section (5) of section 139 of the
Act which requires an assessee to file a revised return of income in case of
any omission or wrong statement in the return of income filed under sub-section
(1) thereof, sub-section (9) of section 139 of the Act does not require an
assessee to file a fresh return of income, but requires the assessee to remove
the defects in the original return of income filed by him within the time
provided therein. Once the defects in the original return of income are
removed, such return would be processed further under the Act. In case such
defects are not removed within the time allowed, such return of income would be
treated as an invalid return.

iii) There is a clear distinction between a revised
return and a correction of return. Once a revised return is filed, the original
return must be taken to have been withdrawn and substituted by a fresh return
for the purpose of assessment. There is no concept of corrected return of
income under the Act. Therefore, in effect and substance, what the notice under
sub-section (9) of section 139 does is to call upon the assessee to remove the
defects pointed out therein. Therefore, mere reference to the expression “corrected
income” in the notice under sub-section (9) of section 139 of the Act does not
mean that a fresh return of income has been filed under that sub-section. The
action of removal of the defects would relate back to the filing of the
original return of income and, accordingly, it is the date of filing of the
original return which has to be considered for the purpose of computing the
period of limitation under sub-section (2) of section 143 of the Act and not
the date on which the defects actually came to be removed.

iv) The assessee filed its return of income under sub-section (1) of
section 139 on 10^th September, 2016. Since the return was defective,
the assessee was called upon to remove such defects, which came to be removed
on 7^th July, 2017, that is, within the time allowed by the A.O.
Therefore, upon such defects being removed, the return would relate back to the
date of filing of the original return, that is, 10^thSeptember, 2016
and consequently the limitation for issuance of notice under sub-section (2) of
section 143 of the Act would be 30^th September, 2017, viz., six
months from the end of the financial year in which the return under sub-section
(1) of section 139 was filed. The notice under sub-section (2) of section 143
of the Act had been issued on 9^thAugust, 2018, which was much
beyond the period of limitation for issuance of such notice as envisaged under
that sub-section. The notice, therefore, was barred by limitation and could not
be sustained.’

shailesh.kwebmaker

Assessment – Notice u/s 143(2) of ITA, 1961 – Limitation – Defective return – Rectification of defects – Relates back to date of original return – Time limit for issue of notice u/s 143(2) – Not from date of rectification of defects but from date of return – Return filed on 17th September, 2016 and return rectified on 12th September, 2017 – Notice u/s 143(2) issued on 10th August, 2018 – Barred by limitation; A.Y. 2016-17

34. Atul Projects India (Pvt.) Ltd. vs. UOI [2020] 422 ITR 478
(Bom.) Date of order: 2^nd
January, 2019 A.Y.: 2016-17

Assessment
– Notice u/s 143(2) of ITA, 1961 – Limitation – Defective return –
Rectification of defects – Relates back to date of original return – Time limit
for issue of notice u/s 143(2) – Not from date of rectification of defects but
from date of return – Return filed on 17^th September, 2016 and
return rectified on 12^th September, 2017 – Notice u/s 143(2) issued
on 10^th August, 2018 – Barred by limitation; A.Y. 2016-17

For
the A.Y. 2016-17, the assessee filed its return on 17^th October,
2016 and it was found to be defective. The A.O. issued a notice u/s 139(9) of
the Income-tax Act, 1961 and called upon the assessee to remove the defects
which the assessee did within the permitted period on 12^th
September, 2017. Yet another notice was issued by the Department on 19^th
September, 2017 u/s 139(9) which stated that the return filed on 12^th
September, 2017 in response to the directions for removing the defects, was
also considered to be defective. On 29^th September, 2017, the
assessee electronically represented to the Department that there was no defect
in the return but this communication was not responded to by the Department. On
10^th February, 2018, the A.O. passed an order u/s 143(1).
Thereafter, on 10^th August, 2018, the A.O. issued a notice u/s
143(2) for scrutiny assessment u/s 143(3).

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

‘i)
The date of filing of the return would be the date on which it was initially
presented and not the date on which the defects were removed. The assessee had
filed its return of income on 17^th October, 2016 and it was found to
be defective. The Department had called upon the assessee to remove the
defects, which the assessee did on 12^th September, 2017. On a
representation by the assessee, the Department did not raise this issue further
and thus had impliedly accepted the assessee’s representation that there were
no further defects after the assessee had removed the defects on 12^th
September, 2017. The notice dated 10^th August, 2018 issued u/s
143(2) was barred by limitation.

ii) In the result, the impugned
notice dated 10^th August, 2018 is set aside.’

shailesh.kwebmaker

TAXABILITY OF THE LIAISON OFFICE OF A FOREIGN ENTERPRISE IN INDIA

A liaison
office (LO) has been an important mode of entry into India of many foreign entities
wishing to do business and make investments here.

A dispute
has been going on for quite some time about whether an LO has to be considered
as a Permanent Establishment (PE) of the non-resident in India and be subjected
to tax.

In this
article we have discussed various aspects relating to the taxability of an LO
in India, including the recent decision of the Supreme Court in the case of the
U.A.E. Exchange Centre.

1. BACKGROUND

In many
cases, an enterprise usually tests the waters outside its domestic jurisdiction
in an endeavour to expand business. In the initial phase of establishment of
business in the host country, a multinational corporation (MNC) conducts market
research, develops strategies to explore the foreign market, formulates plans, maintains
liaison with the government officials, etc. After such preliminary activities,
it commences operations in the foreign market, controlled or managed either
from the home country or in the foreign host country.

To undertake
such exploratory or precursory activities, MNCs establish an LO in the host
country. The RBI
also permits this, subject to the condition that it is venturing into certain
limited areas of permitted activities only. Undertaking any activity beyond the
rigours of the permitted activities requires an application for conversion of
such LO into a Branch Office or Project Office, or any other body corporate, as
the case may be.

Thus, an MNC
/ foreign company can do business in India either by opening an LO or a branch
office, or a limited liability partnership ?rm, or a subsidiary or wholly-owned
subsidiary, depending upon its business requirements in India. Each of the
above modes of setting up business presence in India is governed by the Foreign
Exchange Management Regulations.

As per
Schedule II read with Regulation 4(b) of the FEM (Establishment in India of a
Branch Office or a Liaison Office or a Project Office or any Other Place of
Business) Regulations, 2016 [FEMA 22(R)], an LO in India of a person resident
outside India is permitted to carry out the following limited activities:

(i) Representing the parent company / group
companies in India.

(ii) Promoting export / import from / to India.

(iii)
Promoting technical / financial collaborations between parent / group companies
and companies in India.

(iv) Acting
as a communication channel between the parent company and Indian companies.

Thus, an LO
is not permitted to carry out, directly or indirectly, any trading or
commercial or industrial activity in India. The LO can operate only out of
inward remittance received from the parent company in India. When a foreign
company operates through an LO in India, there is no income that is taxable in
India as it is not permitted to earn any income here. The activities mentioned
above are essentially of a preparatory or auxiliary nature.

2. WHETHER AN LO CONSTITUTES A PE IN INDIA?

As mentioned
above, as per the prevailing FEMA regulations, an LO cannot carry on any
activity in India other than activities permitted as per FEMA 22(R). However,
in practice it is observed in some cases that LOs carry out activities which
may not be limited to acting as a communication channel between the parent
company and Indian companies.

Thus, time
and again doubts arise in respect of the business activities carried out by a
foreign company in India through an LO and whether the said activities can be
taxable in India. The actual activities could vary from case to case. It may be
difficult to presume that an LO will not constitute a PE merely because RBI has
given permission for setting up an LO in India on specific terms and
conditions.

To determine
whether an LO constitutes a PE and consequent taxability of the same in India,
it is very important to examine whether it is carrying out an important part of
the business activities of the foreign company, or only the preparatory and
auxiliary activities as permitted under FEMA 22(R).

3. RELEVANT PROVISIONS OF THE INCOME-TAX ACT, 1961 AND
THE DOUBLE TAXATION AVOIDANCE AGREEMENTS (DTAAs)

Section 9 of
the ITA, 1961 contains provisions relating to income deemed to accrue or arise
in India and includes all income accruing or arising, whether directly or
indirectly, through or from any business connection in India. Explanation 1(a)
to section 9(1)(i) provides that in case of a business of which all the
operations are not carried out in India, the income of the business deemed u/s
9(1)(i) to accrue or arise in India shall be only such part of the income as is
reasonably attributable to the operations carried out in India.

Further,
Explanation 1(b) to section 9(1)(i) provides that in the case of a
non-resident, no income shall be deemed to accrue or arise in India to him
through or from operations which are confined to the purchase of goods in India
for the purposes of export.

Under
Article 5(1) and (2) of the DTAAs, an LO may be treated as ‘fixed place of
business’ and accordingly a PE in India. However, relief is provided under
Article 5(4) to exclude the activities which are ‘preparatory or auxiliary’ in
nature.

4. PREPARATORY OR AUXILIARY ACTIVITIES TEST – OECD
COMMENTARY

The terms
‘preparatory’ or ‘auxiliary’ have not been defined under the ITA or under the
DTAAs. Various judicial decisions have attempted to define the same. The term
‘preparatory’ has been explained to mean something done before or for the
preparation of the
main task. Similarly, the term ‘auxiliary’ has been interpreted to mean an
activity ‘aiding’ or supporting the main activity.

The OECD
Commentary on the Model Tax Convention on Income and on Capital dated 21^st
November, 2017 in relevant paragraphs 59, 60 and 71 deals with various aspects
of preparatory auxiliary activities. The said paragraphs read as under:

‘59. It is often difficult to distinguish between
activities which have a preparatory or auxiliary character and those which have
not. The decisive criterion is whether or not
the activity of the fixed place of business in itself forms an essential and
significant part of the activity of the enterprise as a whole. Each individual
case will have to be examined on its own merits. In any case, a fixed place of
business whose general purpose is one which is identical to the general purpose
of the whole enterprise does not exercise a preparatory or auxiliary activity.

60. As a general rule, an activity that has a
preparatory character is one that is carried on in contemplation of the
carrying on of what constitutes the essential and significant part of the
activity of the enterprise as a whole. Since a preparatory activity
precedes another activity, it will often be carried on during a relatively
short period, the duration of that period being determined by the nature of the
core activities of the enterprise. This, however, will not always be the case
as it is possible to carry on an activity at a given place for a substantial
period of time in preparation for activities that take place somewhere else.
Where, for example, a construction enterprise trains its employees at one place
before these employees are sent to work at remote work sites located in other
countries, the training that takes place at the first location constitutes a
preparatory activity for that enterprise. An activity that has an auxiliary
character, on the other hand, generally corresponds to an activity that is
carried on to support, without being part of, the essential and significant
part of the activity of the enterprise as a whole. It is unlikely that an
activity that requires a significant proportion of the assets or employees of
the enterprise could be considered as having an auxiliary character.

71. Examples
of places of business covered by sub-paragraph e) are fixed places of business
used solely for the purpose of advertising or for the supply of information or
for scientific research or for the servicing of a patent or a know-how
contract, if such activities have a preparatory or auxiliary character.
Paragraph 4 would not apply, however, if a fixed place of business used for the
supply of information would not only give information but would also furnish
plans, etc. specially developed for the purposes of the individual customer.
Nor would it apply if a research establishment were to concern itself with
manufacture. Similarly, where the servicing of patents and know-how is the
purpose of an enterprise, a fixed place of business of such enterprise
exercising such an activity cannot get the benefits of paragraph 4. A fixed
place of business which has the function of managing an enterprise or even only
a part of an enterprise or of a group of the concern cannot be regarded as
doing a preparatory or auxiliary activity, for such a managerial activity
exceeds this level. If an enterprise with international ramifications
establishes a so-called “management office” in a State in which it maintains
subsidiaries, permanent establishments, agents or licensees, such office having
supervisory and coordinating functions for all departments of the enterprise
located within the region concerned, sub-paragraph e) will not apply to that
“management office” because the function of managing an enterprise, even if it
only covers a certain area of the operations of the concern, constitutes an
essential part of the business operations of the enterprise and therefore can
in no way be regarded as an activity which has a preparatory or auxiliary
character within the meaning of paragraph 4.’

In order to
determine whether an LO of an MNC constitutes its PE in India, an in-depth
analysis is required to be done based on the factual information available, for
example, considering the nature of the activities undertaken by the LO, the
business of the MNC and the overall facts and circumstances of the case. In
this it is very important to consider the various judicial precedents on the
subject.

5. INDIAN JUDICIAL PRECEDENTS

On the issue
of whether an LO constitutes a PE in India, there are mixed judicial
precedents, primarily based on the facts of each case.

In a few
cases, the Tribunals and Courts have held that an LO does not constitute a
fixed place PE in India because the LO was carrying on activities / operations
within the framework of permitted activities by the RBI, i.e. preparatory or
auxiliary activities. In this regard, useful reference can be made
to the following cases:

• IAC vs.
Mitsui & Co. Ltd. [1991] 39 ITD 59 (Delhi)(SB);

• Motorola
Inc. vs. DCIT [2005] 95 ITD 269 (Delhi)(SB);

• Western
Union Financial Services Inc. vs. ADIT [2007] 104 ITD 40 (Delhi)

• Sumitomo
Corporation vs. DCIT [2008] 114 ITD 61 (Delhi);

• Metal One
Corporation vs. DDIT [2012] 52 SOT 304 (Delhi);

• DIT vs.
Mitsui & Co. Ltd. [2018] 96 taxmann.com 371 (Delhi);

• Nagase
& Co. Ltd. vs. DDIT [2019] 109 taxmann.com 288 (Mumbai-Trib.);

• Kawasaki
Heavy Industries Ltd. vs. ACIT [2016] 67 taxmann.com 47 (Delhi-Trib.).

However, in
a few other cases, Tribunals / Courts have, based on the specific facts of the
cases, held that an LO constitutes a fixed place PE in India because it was
carrying on certain activities which were in the nature of commercial / core
activities of the taxpayer. A list of such cases is
given below:

• U.A.E.
Exchange Centre [2004] 139 Taxman 82 (AAR);

• Columbia
Sportswear Co. (AAR) [2011] 12 taxmann.com 349 (AAR);

• Jebon
Corporation India vs. CIT(IT) [2012] 19 taxmann.com 119 (Karnataka);

• Brown
& Sharpe Inc. vs. ACIT [2014] 41 taxmann.com 345 (Delhi-Trib.) affirmed in
Brown & Sharpe Inc. vs. CIT [2014] 51 taxmann.com 327 (All.);

• GE Energy
Parts Inc. vs. CIT(IT) [2019] 101 taxmann.com 142 (Delhi);

• Hitachi
High Technologies Singapore Pte Ltd. vs. DCIT [2020] 113 taxmann.com 327
(Delhi-Trib.).

Some other
relevant judicial precedents in this regard are as under:

• Gutal
Trading Est., In re [2005] 278 ITR 643 (AAR);

• Angel
Garment Ltd., In re [2006] 287 ITR 341(AAR);

• Cargo
Community Network PTE Ltd., In re [2007] 289 ITR 355 (AAR);

• Sojitz
Corporation vs. ADIT [2008] 117 TTJ 792 (Kol.);

• Mitsui
& Co. Ltd. vs. ACIT [2008] 114 TTJ 903 (Delhi);

• K.T.
Corpn. [2009] 181 Taxman 94 (AAR);

• IKEA
Trading (Hong Kong) Ltd. [2009] 308 ITR 422 (AAR);

• Mondial
Orient Ltd. vs. ACIT [2010] 42 SOT 359 (Bang.);

• M.
Fabricant & Sons Inc. vs. DDIT [2011] 48 SOT 576 (Mum.);

• Nike Inc.
vs. ACIT [2013] 125 ITD 35 (Bang.);

• Linmark
International (Hong Kong) Ltd. vs. DDIT (IT) [2011] 10 taxmann.com 184 (Delhi);

• CIT vs.
Interra Software India (P.) Ltd. [2011] 11 taxmann.com 82 (Delhi).

6. A BRIEF ANALYSIS OF SOME OF THE DECISIONS based on the nature of the activities of the
LOs is given below to understand the judicial thinking on the subject.

(A) Routine
functions of LO

Earlier, the
ITAT, Mumbai considering the specific facts in the case of Micoperi Spa
Milano vs. DCIT [2002] 82 ITD 369 (Mum.) had held that maintenance of a
project office in India and incurring expenses for maintaining such office,
cost of postage, telex, etc., indicates that the MNC has a PE in India.

However,
where routine functions are performed by the LO in India and for the purposes
of performing such routine functions the LO has been given limited powers, it
cannot be held that a MNC has a PE in India in the form of its LO.

In Kawasaki
Heavy Industries Ltd. vs. ACIT [2016] 67 taxmann.com 47 (Delhi- rib.),
the ITAT held that:

(a) The
powers / rights granted by an MNC to its LO in India such as (i) Signing of
documents for renting of premises, equipment, services with any person,
including Municipal bodies, governments, etc., as may be required for the
operation of the LO; (ii) Execution of contracts for purchase of items for
operation of the LO, etc. are specific to the operations of the LO and the
stand of the A.O., that the power of attorney is an ‘open document’ giving
unfettered powers to the LO, would be outside the scope of the initial approval
granted by the RBI.

(b) Prima
facie, a reading of the power of attorney does not demonstrate that the
employees of the assessee at the LO are authorised to do core business activity
or to sign and execute contracts, etc.

(c) The A.O.
has not brought on record any material, other than his interpretation of the
terms of the power of attorney, to demonstrate that the LO is carrying on core
business activity warranting his conclusion that the assessee has a PE in
India.

Thus, in
respect of routine functions of the LO, the same may not be considered as
constituting a PE in India.

(B) Purchase activities for the purposes of
exports

Under
Explanation 1(b) of section 9(1)(i), purchase
functions or a part thereof, performed by an LO in India has been consistently
held as outside the purview of such LO having any taxable income in India.

In Ikea
Trading (Hong Kong) Ltd. [2009] 308 ITR 422 (AAR), the AAR has held that
where the LO’s activities are confined only to facilitate the purchase of goods
in India for the purposes of export outside India, such activities are covered
by restriction / relief provided under Explanation 1(b) to section 9(1)(i) of
the Act and, accordingly, no income is deemed to accrue or arise in India with
respect to the operations carried out by the LO in India. A similar view has
been taken in ADIT (IT) vs. Tesco International Sourcing Ltd. [2015] 58
taxmann.com 133 (Bang.-Trib.).

The Karnataka
High Court in Columbia Sportswear Co. vs. DIT (IT) [2015] 62 taxmann.com
240, reversing the decision of the AAR in Columbia Sportswear Co.
[2011] 12 taxmann.com 349 (AAR), held that all the activities
undertaken by the LO of an MNC such as designing, manufacturing, identifying
vendors, negotiating with vendors, ensuring quality control of the products
manufactured by vendors, quality assurance, on-time delivery, acting as a
conduit or ‘go between’ between the vendors in India / Egypt / Bangladesh and the
MNC situated outside India, are ‘activities necessary’ for carrying out a
purchase function in India, as otherwise the goods purchased from India would
not find any customer outside India. Accordingly, such activities are not the
‘activities other than sale of goods’ as held by AAR, rather, they are an
extension / necessary part of the purchase function itself, so carried out by
the LO in India. Accordingly, appropriate relief as provided under Explanation
1(b) to section 9(1)(i) of the Act is required to be extended to the taxpayer.

Initial
research, information collection and preliminary advertising undertaken by an
LO in India has been held to be in the nature of ‘preparatory’ or ‘auxiliary’
activity, and thus it has been held that the LO does not constitute the PE of
its MNC in India.

The AAR in
the case of K.T. Corporation [2009] 181 Taxman 94 (AAR) held that
the activities in the nature of:

(i) Holding seminars, conferences;

(ii)
Receiving trade inquiries from the customers;

(iii)
Advertising about the technology being used by the MNC in its products /
services and answering the queries of the customers;

(iv)
Collecting feedback from the customers / prospective customers, trade
organisations and not playing any role in pre-bid survey, etc., before entering
into the agreement with its customers, nor involving itself in the technical
analysis of the products / services, are in aid or support of the ‘core
business activity’ of the MNC and, thus, fall under the exclusionary clauses
(e) and (f) of Article 5(4) of the DTAA between India and Korea. It is
pertinent to note that the AAR also noted that the LO is confined to carrying
out preparatory or auxiliary activities only.

The AAR also
said, ‘However, we may add here that if the activities of the liaison office
are enlarged beyond the parameters fixed by RBI or if the Department lays its
hands on any concrete materials which substantially impact on the veracity of
the applicant’s version of facts, it is open to the Department to take
appropriate steps under law. But, at this stage, we proceed to give ruling on
the basis of facts stated by the applicant which cannot be treated as ex
facie untrue.’

Similarly,
the Delhi High Court in the case of Nortel Networks India International
Inc. vs. DIT [2016] 69 taxmann.com 47 held that where the Indian
subsidiary of the MNC negotiated and entered into contracts with the customers
of the MNC, the LO of the same MNC could not be held to be a PE of the MNC in
India, especially when the tax authorities had not brought on record any
evidence that the LO had participated in the negotiation of the contracts.

The ITAT,
Mumbai in the case of Nagase & Co. Ltd. vs. DDIT [2018] 96
taxmann.com 504 (Mum.-Trib.) held that in the absence of any material
or evidence brought on record by the Revenue authorities to the effect that the
LO was executing business or contracts independently with the customers in
India, the plea of the assessee that it was engaged in carrying out only
preparatory or auxiliary activities needs to be accepted and, accordingly, the
taxpayer’s LO in India did not constitute its PE in India.

(D)
Marketing activities

Where the LO
undertakes the preliminary activities of advertising, identification of customers,
attending to queries of customers, such activities would fall within the ambit
of preparatory / auxiliary activities and, accordingly, the LO would not
qualify as a PE of the MNC in India.

However,
where such activities cross the ‘thin-line’ of preparatory / auxiliary
activities and venture into performing income-generating activities, such
activities would require the LO to be treated as the PE of the MNC in India.

The
Karnataka High Court in the case of Jabon Corporation India vs. CIT (IT)
[2012] 19 taxmann.com 119 (Karnataka), while upholding the decision of
ITAT, Bangalore in the case of DDIT (IT) vs. Jebon Corpn. India [2010]
125 ITD 340 (Bang.-Trib.) that the LO has to be treated as the PE of
the Korean parent, held as follows:

‘10. It is on the basis of the aforesaid material, the Tribunal held that
the activities carried on by the liaison office are not confined only to the
liaison work. They are actually carrying on the commercial activities of
procuring purchase orders, identifying the buyers, negotiating with the buyers,
agreeing to the price, thereafter, requesting them to place a purchase order
and then the said purchase order is forwarded to the Head Office and then the
material is dispatched to the customers and they follow up regarding the
payments from the customers and also offer after-sales support. Therefore,
it is clear that merely because the buyers place orders directly with the Head
Office and make payment directly to the Head Office and it is the Head Office
which directly sends goods to the buyers, would not be sufficient to hold that
the work done by the liaison office is only liaison and it does not constitute
a permanent establishment as defined in Article 5 of DTAA. In fact, the
Assessing Officer has clearly set out that what was discovered during the
investigation and the same has been properly appreciated by the Tribunal and it
came to the conclusion that though the liaison office was set up in Bangalore
with the permission of the RBI and in spite of the conditions being
stipulated in the said permission preventing the liaison office from carrying
on commercial activities, they have been carrying on commercial activities.

11. It was further contended that the RBI has not taken any action and
therefore such interference is not justified. Once the material on record
clearly establishes that the liaison office is undertaking an activity of
trading and therefore entering into business contracts, fixing price for sale
of goods and merely because, the officials of the liaison office are not
signing any written contract would not absolve them from liability. Now that
the investigation has revealed the facts, we are sure that the same will be
forwarded to the RBI for appropriate action in the matter in accordance with
law. But merely because no action is initiated by RBI till today would not
render the findings recorded by the authorities under the Income-tax Act as
erroneous or illegal.

12. We are satisfied from the material on record that the finding recorded by
the Tribunal is based on legal evidence and that the finding that the liaison
office is a permanent establishment as defined under Article 5 of the DTAA and
therefore, the business profits earned in India through this liaison office is
liable for tax is established.’

The
Allahabad High Court in the case of Brown & Sharpe Inc. vs. CIT
[2014] 51 taxmann.com 327 (All.) held that the activities such as:

(i)
Explaining the products to the buyers in India;

(ii)
Furnishing information in accordance with the requirements of the buyers;

(iii)
Discussions on the commercial issues pertaining to the contract through the
technical representative, after which an order was placed by the Indian buyer directly to the Korean HO,
would be something more than ‘preparatory’ or ‘auxiliary’ activities and, accordingly, the LO was a PE
of the MNC in India. Further, the incentive plan designed for remuneration of the employees of the LO indicated
that the LO was undertaking not just the ‘advertising’ activities, rather such activities traversed the actual
marketing of products of the MNC in India as it was only on the basis of the
orders generated that an incentive was envisaged / organised for the employees.

In GE
Energy Parts Inc. vs. CIT (IT) [2019] 101 taxmann.com 142 (Delhi), the
Delhi High Court held that the LO of GE Energy Parts Inc. (GE US), established
to act as a communication channel, was carrying out core activity of marketing
and selling highly-sophisticated equipments of the US company, and hence the LO
was a fixed place PE of the assessee company in India. The GE LO was a fixed
place PE of GE due to the fact that (a) There was a fixed place of business;
(b) The fixed place of business was at the disposal of the employees of the LO,
more so when GE had not contested that activities of ‘some form’ were not
carried out from such premises and thus it was reasonable to assume that the
activities were carried through such premises; (c) Though the final word with
respect to the pricing of the products was with the HO, however, that won’t mean
that the LO was for mute data collection / information dissemination. The LO
discharged the vital responsibilities or at least had a prominent role in
contract finalisation, viz., extensive negotiations with its customers,
customisation of the products with respect to the requirements of the
customers, negotiating the financial parameters of the products and not
allowing the overseas entity to alter such terms without the consent of GE
India, etc. Accordingly, the LO was not performing merely liaising activities.
Defining the terms preparatory or auxiliary activities as ‘something remote
from the actual realisation of the profits’, the Court held that the
activities performed by the LO would not fall within the exception provided
under Article 5(3)(e) of the India-USA DTAA.

The Court
also held that GE’s overseas entity had agency PE for the following reasons:
(a) Where the expatriates / employees performed activities for different
entities of the same group, then it could not be construed that activities had
been performed for a single enterprise. Accordingly, the GE India (through the
employees of the LO and Indian subsidiary), constituted a dependent agent of GE
overseas MNC; (b) Relying on the decision of the Italian Court it held that the
active and major participation / involvement of the employees / representatives
in the negotiations / meetings with the customers indicated that the agents had
‘authority to conclude contracts’, even if final contracts were concluded by
the GE HO.

7. FUND REMITTANCE SERVICES – Decision of the Supreme Court in the case of
Union of India vs. U.A.E. Exchange Centre

In respect
of fund remittance services, the Supreme Court in Union of India vs.
U.A.E. Exchange Centre [2020] 116 taxmann.com 379 (SC) held that an
Indian LO of a United Arab Emirates (UAE) company did not constitute a PE in
India.

U.A.E.
Exchange Centre (the assessee), a company incorporated in the UAE, is engaged, inter
alia, in providing to non-resident Indians in UAE the service of remitting
funds to India. For its India-centric business, the assessee had set up four
LOs in Chennai, New Delhi, Mumbai and Jalandhar after obtaining prior approval
from the RBI u/s 29(1)(a) of the erstwhile Foreign Exchange Regulation Act,
1973.

As per the
business practice followed by the assessee, the funds collected from the NRI
remitters are remitted to India by either of the following two modes:

(i)
Telegraphic transfer: Under this mode the amount is remitted telegraphically by
transferring directly from the UAE through normal banking channels to the
beneficiaries in India and the LOs have no role to play except attending to
complaints regarding fraud, etc.

(ii)
Physical dispatch of instruments: Under this mode, on a request from the NRI
remitter, the assessee sends instruments such as cheques / drafts through its
LOs to beneficiaries in India. For this purpose, the LOs download the
particulars of the remittance (while staying connected to the server in the
UAE), and print and courier the instruments to beneficiaries in India.

In this
case, the contract pursuant to which the funds are remitted to India is entered
into between the assessee and the NRI remitter in the UAE. Moreover, the funds
for remittance as well as the commission are collected in the UAE.

From A.Y.
1998-99 to 2003-04, the assessee was filing Nil returns in India on the basis
that no income had accrued or deemed to have been accrued in India under the
ITA or the India-UAE DTAA. However, owing to some doubt expressed by the
Revenue, the assessee filed an application for advance ruling before the
Authority for Advance Rulings (AAR) in 2003 seeking a ruling on ‘whether any
income is accrued / deemed to be accrued in India from the activities carried
out by the company in India’.

AAR decision

The AAR
ruled that the income of the assessee was deemed to have accrued in India on
the basis that it had a ‘business connection’ in terms of section 9(1) of the
ITA insofar as activities concerning physical dispatch of instruments was
concerned. The AAR observed that without the activities of the Indian LOs, the
transaction of remittance would not be complete. Further, the commission earned
by the assessee covers not only the activities carried out in the UAE, but also
the activities carried out by the LOs in India.

The AAR also
held that the ‘preparatory or auxiliary’ exception to formation of a PE under
the India-UAE DTAA would not be applicable in respect of physical dispatch of
instruments. This was on the basis that a transaction for remittance would not
be completed without the activities of the Indian LOs. Specifically, the AAR
noted that the role of the LOs’ physical dispatch of instruments is ‘nothing
short of performing the contract of remitting the amounts at least in part.’

Delhi High
Court decision

The assessee
challenged the AAR ruling by way of a writ petition in the Delhi High Court.
The High Court noted that the AAR’s discussions and findings on the ‘business
connection’ test under domestic law were unnecessary, considering the scope of
section 90 of the ITA which allows for tax treaties to override domestic law
provisions. Accordingly, the High Court restricted its analysis to the
applicable provisions of the India-UAE DTAA, i.e., Articles 5 and 7.

The Court
held that although an LO comes within the inclusive list of fixed places of
business under Article 5(2)(c), it is subject to exclusions under Article 5(3),
including fixed places of business maintained solely for carrying out
activities which are ‘preparatory or auxiliary’ in nature. While relying on the
common meaning of the terms ‘preparatory or auxiliary’ under Black’s law
dictionary (i.e., activities which aid / support the main activity), the Court
concluded that the activities performed in respect of physical dispatch of
instruments were merely ‘preparatory or auxiliary’ in nature. It observed that
the error committed by the AAR was to read the test of ‘preparatory or
auxiliary’ which permits making a value judgment on whether the transaction
would or would not have been completed without the activities of the LOs and
were, therefore, significant activities. The Court indicated that the test of ‘preparatory
or auxiliary’ is not a function only of whether the activities under
consideration led to completion of the transaction.

In arriving
at its conclusion, the High Court applied the judgment of the SC in DIT
(IT) vs. Morgan Stanley & Co. [2007] 162 Taxman 165 (SC) and
accorded a liberal and wide interpretation to the exclusionary clause of PE.
The reason for this was that by invoking clauses of PE, income which otherwise
neither accrues / arises in India becomes taxable in India by virtue of a ‘deeming
fiction.’

Supreme
Court judgment

An SLP was
filed by the Revenue against the High Court decision. The core issue before the
Apex Court was whether the activities carried out by the LOs in India would
qualify the expression ‘of preparatory or auxiliary character’ as mentioned in
Article 5(3)(e) of the India-UAE DTAA.

In
confirming the finding of the High Court that the activities conducted by the
LOs were ‘preparatory or auxiliary’ and hence excludable from the purview of
PE, the Supreme Court also referred to the limited permission granted by the
RBI under FERA to the assessee regarding the activities to be conducted by the
LOs.

The Supreme
Court noted that as per the nature of activities allowed for under the RBI
permission, the LOs were only allowed to provide incidental service of delivery
of cheques / drafts drawn on a bank in India. They were not allowed to perform
business activities such as (i) entering into a contract with any party in
India; (ii) rendering consultancy or any other service directly or indirectly
with or without consideration to anyone in India; (iii) borrowing or lending
any money from or to any person in India without RBI’s permission. Thus, it was
amply clear that the LOs in India were not to undertake any other activity of
trading (commercial or industrial) or enter into any business contracts in its
own name in India. On this basis, the Supreme Court concluded that the nature
of activities conducted by the LOs as circumscribed by the RBI constituted
‘preparatory or auxiliary’ in character, and hence outside the purview of PE.

The Court
noted further that through the LOs the assessee was not carrying on any
business activity in India, but only dispensing with the remittances by
downloading the information from the UAE server and printing the cheques /
drafts. The LOs could not even charge commission / fee for their services.
Therefore, no income actually accrued to the LOs u/s 2(24) of the ITA.

The Supreme
Court further held that the activities of the LO of the taxpayer in India are
limited activities which are circumscribed by the permission given by the RBI
and are of preparatory or auxiliary character and, therefore, covered by
Article 5(3)(e). As a result, the ?xed place used by the respondent as LO in
India would not qualify the de?nition of PE in terms of Articles 5(1) and 5(2)
of the DTAA on account of non-obstante and deeming clause in Article
5(3) of the DTAA. Hence, no tax can be levied or collected from the LO of the
taxpayer in India in respect of the primary business activities concluded by
the taxpayer in the UAE.

The Supreme
Court also observed that after the enactment of the Finance Act, 2003,
Explanation 2 to section 9(1)(i) of the Act was inserted which de?ned business
connection as business activity carried out by a person on behalf of a
non-resident. In this regard, the Court held that even if the stated activities
of the LO of the taxpayer in India are regarded as business activity, the same
being ‘of preparatory or auxiliary character’, by virtue of Article 5(3)(e) of
the DTAA, the LO of the taxpayer in India which would otherwise be a PE, is
deemed to be expressly excluded from being so. Since, by a legal ?ction, it is
deemed not to be a PE of the taxpayer in India, it is not amenable to tax
liability in terms of Article 7 of the DTAA.

At present,
there are few precedents which provide guidelines for the ‘preparatory or
auxiliary’ test such as (i) to check whether the activities performed in the
fixed place of business form an essential and significant part of the
enterprise as a whole as held in Western Union Financial Services Inc.
vs. ADIT [2007] 104 ITD 40 (Delhi); (ii) whether the activities
performed in the fixed place of business form part of the core business
activities of the enterprise, as held in Angel Garments Ltd. [2006] 287
ITR 341 (AAR).

After
analysing the facts, the Supreme Court held the activities of the LOs to be of
‘preparatory or auxiliary’ nature without setting out guidelines for the
application of the ‘preparatory or auxiliary’ test. It would have been
extremely helpful if the Supreme Court would have laid down detailed guidelines
for the application of the ‘preparatory or auxiliary’ test.

The above
ruling is quite relevant for money remittance companies and potentially other businesses
which are primarily operated from outside India with some preparatory or
auxiliary activities in India.

It is to be
noted though that India has introduced an equalisation levy of 2% on certain
non-resident service providers providing services to customers in India, and
its application with respect to the specific facts may need evaluation.

Further, the
above decision is a welcome decision, wherein along with providing comments on
the meaning of ‘preparatory or auxiliary character’, the Court has re-affirmed
the guiding principle of ‘treaty override’ which forms the pillar of the
international tax law in India.

The Supreme
Court has laid emphasis on bringing out the characteristics of what can be
termed as ‘of preparatory or auxiliary character’ which shall be relevant for
future cases. Further, the Court has de?ned the rationale of taxability due to
which the judgment shall hold persuasive value for similar cases.

The decision
seems to lay down a broad guideline that where the activities of an LO are
restricted to the approvals granted by the RBI, such activities should qualify
as preparatory or auxiliary in nature and should not constitute a PE in India.

8. PRECAUTIONS REGARDING LOs FOR NOT BEING
CONSIDERED AS PEs

The
important point here would be to restrict the activities of the LO to
preparatory or auxiliary work only. Further, the LO should not venture into or
towards activities which could be viewed as commercial or core activities
undertaken on behalf of the foreign entity or its group entity. If it does so,
not only could the LO trigger a PE risk in India, but it could also be seen as
going beyond the domain of the activity permissions granted by the RBI.
Further, appropriate documentation should be maintained to prove that the
activities of the LO are preparatory or auxiliary in nature such as, for
instance, the RBI approval letter in the case of the U.A.E. Exchange Centre,
which reflected that the activities of the LO were mere support services to the
foreign parent entity.

In our view,
one should not presume that an LO or place of business will not constitute a PE
merely because the RBI or a government body has given permission for its
establishment in India. To determine the Indian tax implications, it is
critical to examine whether the LO is carrying out an important part of the
business activity of the foreign company (i.e., a commercial activity which is
core income-generating), or whether it is merely aiding or supporting
activities of the main business.

9. BEPS ACTION 7 AND MULTI-LATERAL INSTRUMENT (MLI)

While
analysing the ‘preparatory or auxiliary’ activities, one may additionally need
to be mindful of the BEPS Action Plan 7 and Article 13 of the MLI which deal
with the issue of artificial fragmentation of activities between various group
companies to avail the benefit of ‘preparatory or auxiliary’ activities.

Specific
activity exemption

In relation
to tax treaties to which the provisions of MLI regarding specific
activity-based exemption apply, it will become important to demonstrate that
the stated activity in the exclusion clause (advertising, storage, delivery,
etc.) is indeed ‘preparatory or auxiliary’ in nature. As the world moves
towards complex and innovative business models which rely on limited physical
presence in the country where the customers reside, foreign players must
assess, based on the facts, whether their Indian presence can still be said to
be merely aiding the core business in order to avail exemption under the
respective tax treaty.

Anti-fragmentation
rules

Article 13
is incorporated in the MLI with a view to address the issue of artificial
avoidance of the PE status through fragmentation of activities between
closely-related enterprises. Thus, businesses carrying out more than one
activity in a country which earlier individually were getting covered under the
term ‘preparatory or auxiliary character’ and hence were not forming a PE in
India, could be subject to the provision of Article 13 of the MLI. Accordingly,
such activities may thus form a PE in India if the activities performed when
seen cumulatively exceed what can be considered as of ‘preparatory or auxiliary
character’.

However, one
would have to first check whether Article 13 of the MLI applies to the relevant
DTAA in question.

With MLI
coming into force and India being a signatory thereto, going forward the
business models would need to be independently examined under the provisions of
the MLI for ascertaining whether or not a PE is established. Now, with
implementation of BEPS and signing of MLIs, litigation on this issue may
further intensify as the Indian tax authorities would now have additional
ammunition to target the LOs.

India has
opted for Option A and anti-fragmentation rules. Accordingly, in India no
specific exemption would be available unless the activities are preparatory or
auxiliary in nature and also there should not be artificial fragmentation of
activities within the group.

10. CONCLUSION

Whether or
not the activities of LOs constitute a PE of the non-resident entity is a very fact-speci?c
and vexed issue. In the past, where an LO has exceeded its scope of permitted
activities, courts have held that such an LO can constitute the PE of the
foreign entity in India. Therefore, it is important to ensure at all times that
an LO in India operates within the limits set out by RBI.

The
determination of the question as to whether any activities of an LO qualify as
preparatory or auxiliary in nature would depend upon the facts of each case and
the nature of business of the taxpayer. In order to decide the status of the
LO, a functional and factual analysis of the activities performed by it needs
to be undertaken.

It is very important to
keep in mind that all the aforementioned judicial precedents should be
critically analysed in the light of BEPS Action Plan 7, MLI and changes in the
OECD Commentary, before applying the same on the factual matrix of a particular
case.

Whether in sorrow or in happiness,
a friend is always a friend’s support.

— (Valmiki Raamaayan 4.8.40)

shailesh.kwebmaker

REVERSE FACTORING OR SUPPLIER FINANCING

BACKGROUND

Banks may
offer services to buyers of goods or services in order to facilitate payment of
their trade payables arising from purchases from suppliers. In a reverse
factoring arrangement, a bank agrees to pay amounts an entity owes to its
suppliers and the entity agrees to pay the bank at a date later than when the
suppliers are paid. Reverse factoring arrangements can vary significantly in
both form and substance. When the original liability to a supplier has been
extinguished or there is a change in terms, the following issues arise:

(a) Whether the resulting new liability to the
bank should be presented as bank borrowing or ‘trade payables.’ A point to note
is that bank borrowing is required to be separately presented from trade
payables under Ind AS Schedule III requirements. Needless to say that
presentation as bank borrowing may have a significant impact on the gearing
ratios and debt covenants.

(b)
Additionally, the entity is also required to consider various disclosure
requirements. Consequently, this issue is very important.

Whether the
resulting new liability to the bank should be presented as bank borrowing or
‘trade payables’?

REQUIREMENTS OF Ind AS
STANDARDS

Before we
embark on answering these questions, let us consider the various requirements
under Ind AS standards:

1. Paragraph
54 of Ind AS 1 – Presentation of Financial Statements: ‘The
balance sheet shall include line items that present the following amounts:
(a)………….. (k) trade and other payables; (l) provisions; (m) financial
liabilities excluding amounts shown under (k) and (l)……….’

2. Paragraph
57 of Ind AS 1: ‘This Standard does not prescribe the order or format in which
an entity presents items. Paragraph 54 simply lists items that are sufficiently
different in nature or function to warrant separate presentation in the balance
sheet. In addition:

(a) line
items are included when the size, nature or function of an item or aggregation
of similar items is such that separate presentation is relevant to an
understanding of the entity’s financial position; and (b)…’

3. Paragraph
70 of Ind AS 1 explains that ‘some current liabilities, such as trade payables…
are part of the working capital used in the entity’s normal operating cycle’.

4. Paragraph
29 of Ind AS 1 states that ‘…An entity shall present separately items of a
dissimilar nature or function unless they are immaterial …’

5. Paragraph
11(a) of Ind AS 37 – Provisions, Contingent Liabilities and
Contingent Assets states that ‘trade payables are liabilities to pay for
goods or services that have been received or supplied and have been invoiced or
formally agreed with the supplier’.

6. Paragraph
3.3.1 of Ind AS 109 – Financial Instruments states: ‘An entity
shall remove a financial liability (or part of a financial liability) from its
balance sheet when, and only when, it is extinguished – i.e., when the
obligation specified in the contract is discharged or cancelled or expires.’

ANALYSIS

Based on the
various requirements of Ind AS standards presented above, an entity presents a
financial liability as a trade payable only when it:

(i)
represents a liability to pay for goods or services;

(ii) is
invoiced or formally agreed with the supplier; and

(iii) is
part of the working capital used in the entity’s normal operating cycle.

Other
payables are included within trade payables only when those other payables have
a similar nature and function to trade payables; for example, when other
payables are part of the working capital used in the entity’s normal operating
cycle.

A point to
note is that bank borrowing is required to be separately presented from trade
payables under Ind AS Schedule III requirements. In assessing whether to
present reverse factoring arrangements as trade payables (whether included with
other payables or not) or bank borrowing, requires further analysis. An entity
will have to assess whether to derecognise a trade payable to a supplier and
recognise a new financial liability to a bank as bank borrowings. Such an
assessment is made in accordance with Ind AS 109 – Financial Instruments.

Under Ind AS
109 if the arrangement results in derecognition of the original liability (e.g.
if the purchaser is legally released from its original obligation to the
supplier), an entity in such a case will have to pay the bank rather than the
supplier. Consequently, in such a case, presentation as a bank borrowing may be
more appropriate. Derecognition can also occur and presentation as bank
borrowing will also be appropriate if the purchaser is not legally released
from the original obligation but the terms of the obligation are amended in a
way that is considered a substantial modification. For example, the payment of
trade payable may not entail transfer of any collateral. However, if collateral
is provided in a supplier financing arrangement, this would mean that the
original agreement to pay to the creditor has been substantially modified. In
such cases, too, presentation of the reverse factoring as a bank borrowing
rather than trade payable may be more appropriate. Even if the original
liability is not derecognised, other factors may indicate that the substance
and nature of the arrangements indicate that the liability should no longer be
presented as a trade payable and a bank borrowing presentation may be more
appropriate.

Analysis of
supply-chain finance is a complex and judgemental exercise. Obtaining an
understanding of the following factors would help in making the decision on the
presentation:

• What are
the roles, responsibilities and relationships of each party (i.e. the entity,
the bank and the supplier) involved in the reverse factoring?

• What are
the discounts or other incentives received by the entity that would not have
otherwise been received without the bank’s involvement?

• Whether
there is any extension of the date by the bank by which payment is due from the
entity beyond the invoice’s original due date?

• Is the
supplier’s participation in the reverse factoring arrangement optional?

• Do the
terms of the reverse factoring arrangement preclude the company from
negotiating returns of damaged goods to the supplier?

• Is the
buyer released from its original obligation to the supplier?

• Is the
buyer obligated to maintain cash balances or are there credit facilities with
the bank outside of the reverse factoring arrangement that the bank can draw
upon in the event of non-collection of the invoice from the buyer?

• Does the
buyer have a separate credit line for these arrangements?

• Whether
additional security is provided as part of the arrangement that would not be
provided without the arrangement?

• Whether
the terms of liabilities that are part of the arrangement are substantially
different from the terms of the entity’s trade payables that are not part of
the arrangement?

Some reverse
factoring arrangements require that a buyer will pay the invoice regardless of
any disputes that might arise over the goods (for example, the goods are found
to be damaged or defective). In the event of a dispute, a buyer who agrees to
such a condition would use other means, such as adjustments on future purchases
from the supplier, to recover the losses. These provisions provide greater
certainty of payment to the bank and may reflect that the arrangement in
substance is a financing to the buyer. However, for a buyer who buys regularly
from a supplier to routinely apply credits for returns against payments on
future invoices, this condition might not be viewed as a significant change to
existing practice. Additionally, this provision may not constitute a
significant change to the terms of the original trade payable if failure by the
buyer to pay on the invoice due date does not entitle the bank to any recourse
or remuneration beyond what is stipulated in the terms of the invoice.

In some
reverse factoring arrangements, the buyer may be required to maintain
collateral or other credit facilities with the bank. These requirements may
indicate a financing arrangement in substance, particularly if a buyer’s
failure to maintain an appropriate cash balance would trigger
cross-collateralisation events on the buyer’s other debt instruments held by
the bank. For the liability to be considered a trade payable, the bank
generally can collect the amount owed by the buyer only through its rights as
owner of the receivable it purchased from the supplier. Some examples are
provided below which help in understanding the above requirements.

Example 1 –
Financing of advances to suppliers made by the buyer

A buyer
makes an advance payment to a supplier for goods to be delivered to the buyer
six months later. For this purpose, the buyer obtains a credit from the bank
based on its own credit rating and credit facility. The supplier is not
involved in the buyer obtaining the credit facility from the bankers. Here, as
far as the buyer is concerned, the buyer obtains credit from a bank and makes
an advance payment to the supplier. The buyer may directly make the advance to
the supplier, or the bank may do so on behalf of the buyer. In this example, it
is not appropriate for the buyer to present the borrowing from the bank and the
advance to the supplier on a net basis. It is also not appropriate for the
buyer to present the borrowing from the bank as trade payable, because no goods
have been received at the date of borrowing.

Example 2:
Bank negotiates with supplier directly on buyer’s behalf

A supplier
approaches a bank for discounting an invoice representing supply of goods to a
buyer. The bank agrees to pay the supplier before the legal due date to obtain
an early payment discount. However, the buyer is not legally relieved from the
obligation under its trade payable. The way the mechanism works is that the
supplier agrees to receive the amount from the buyer net of the early payment
discount at the contractual due date and to pay the bank this same amount only
if it receives the payment from the buyer. If the supplier fails to pay the
bank, the buyer agrees to pay the bank. The bank charges a fee to the buyer,
which is lower than the early payment discount. This effectively results in the
bank and the supplier sharing the benefit of the early payment discount. In
this example, since the buyer is not legally relieved of his obligation to pay
the supplier (or to the bank on behalf of the supplier), the buyer continues to
recognise the trade payable to the supplier. Furthermore, the buyer does not
provide any collateral to the bank, nor is the arrangement substantially
different from the terms of the entity’s trade payable. The buyer will
recognise the liability as trade payable. Additionally, the buyer also
recognises a guarantee obligation, initially measured at fair value, for its
promise to pay the bank if the bank does not receive a payment from the
supplier.

Example 3:
Receivables purchase agreement

In a reverse
factoring arrangement, a bank acquires the rights under the trade receivable
from the supplier. However, the buyer is not legally released from the payable.
The buyer may be involved to some extent in such an arrangement. For example,
the buyer agrees that he is no longer eligible to offset the payable against
credit notes received from the supplier, or the buyer may be restricted from
making direct payments to the supplier. In this fact pattern, the buyer would
need to consider whether the change to the terms of the trade payable is
significant or not.

If there is
a substantial change, the transfer is accounted for as an extinguishment –
which means, the previous liability should be derecognised and replaced with a
new liability to the bank. The impact of any additional restrictions imposed by
the reverse factoring agreement on the buyer’s rights will need to be properly
evaluated. One possibility is that because the buyer selects each payable at
its sole discretion, it will only select those payables where the effect of any
such restriction is not significant. On the other hand, it may be the case that
the buyer, bank and supplier have agreed initially on a minimum amount of
payables / receivables being refinanced by the bank. In such a case, the buyer
has no further discretion to avoid the change in his rights, even when the
change is significant.

Example 4:
Trade structure / supply chain finance / reverse factoring

• Steel
Limited (SL) purchases raw material and other supplies from various suppliers.

• SL has
negotiated 180 days’ extended credit term with all suppliers, which fact will
be stated in the invoice.

• To address
the working capital issues of suppliers, SL’s bankers have agreed to buy bills
endorsed by SL.

• The
suppliers decide whether they need to transfer bills to SL’s bankers as well as
timing and other terms of transfer. The suppliers can also get their bill
discounted from other bankers. However, it may not be cost effective.

• If a
supplier decides to get bill discounted from SL’s banker, the banker will
consider SL’s credit risk to decide the amount payable on transfer.

• Transfer
does not release SL from its liability toward the supplier. Rather, SL
continues to be liable to pay the amount to the supplier.

• If SL
defaults in payment of dues, the banker can use the court process against SL
for payment but only through the involvement of the supplier.

• SL does
not receive any additional benefit except extended credit period as originally
agreed with the supplier.

• SL does
not have a separate credit line with the bank for these arrangements, nor
provides any collateral.

Response

From the
facts it is clear that:

• SL is not released from its obligation towards the supplier.

• Nor is
there a change in the terms of payable.

• Nor has SL
received any discounts or rebates that would not have otherwise been received.

• There is no
extension of the payment date beyond the invoice’s original due date.

• The
supplier’s participation in the reverse factoring arrangement is completely
optional.

• SL does
not have a separate credit line with the bank for these arrangements, nor does
it provide any collateral.

• These
factors indicate that SL should continue to classify its liability as trade
payable.

Example 5:
Trade structure / supply chain finance / reverse factoring

• SL
purchases raw material and other supplies from various suppliers.

• SL has
negotiated 180 days’ extended credit term with all suppliers.

• Within one
month of purchase, SL can select suppliers who need to get their bill
discounted from SL’s bank. The selected suppliers will transfer their bills to
the bank for immediate cash.

• Assume
that the bill amount is Rs. 100; the bank will deduct Rs. 10 as discounting
charge and pay the remaining amount (Rs. 90) to the supplier.

• Through an
agreement signed between SL and the bank, SL:

• Commits itself to pay to the bank the specified
invoice on its due date.

• Pays a service fee for ‘services’ to the
bank.

• Pays finance cost to the bank (as per a
credit line with the bank).

• In
summary, SL will pay to the bank:

• Nominal amount of the invoice (Rs. 100).

• Less discount for immediate payment
included in the payment conditions between the buyer and SL (Rs.
10).

• Plus, the service and finance
commission payable to the Bank (Rs. 5).

Response

• The
supplier appears to have relinquished its obligation to pay to the bank. It
appears that SL has now the obligation for payment to the bank.

• The
substance of the transaction is that SL is paying in advance to the supplier
for getting the benefit of cash discount.

• For this
purpose, it is drawing a credit line from the bank and paying the related
interest expense.

• The
supplier’s participation in the arrangement is decided by SL.

• These
facts indicate that the supplier payable should be reclassified from trade
payable to a bank borrowing.

What are the
various disclosure requirements applicable in a reverse factoring arrangement?

REQUIREMENTS OF Ind AS
STANDARDS

1. Paragraph
6 of Ind AS 7 – Statement of Cash Flows defines: (a) operating activities as
the principal revenue-producing activities of the entity and other activities
that are not investing or financing activities; and (b) financing activities as
activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.

2. Paragraph 43 of Ind AS 7 states: ‘Investing and financing transactions
that do not require the use of cash or cash equivalents shall be excluded from
a statement of cash flows. Such transactions shall be disclosed elsewhere in
the financial statements in a way that provides all the relevant information
about those investing and financing activities.’

3. Paragraph
44 of Ind AS 7 states: ‘Many investing and financing activities do not have a
direct impact on current cash flows although they do affect the capital and
asset structure of an entity. The exclusion of non-cash transactions from the
statement of cash flows is consistent with the objective of a statement of cash
flows as these items do not involve cash flows in the current period.’

4. Paragraph
44A of Ind AS 7 states: ‘An entity shall provide disclosures that enable users
of financial statements to evaluate changes in liabilities arising from
financing activities, including both changes arising from cash flows and
non-cash changes.’

5. Paragraph 122 of Ind AS 1 – Presentation of Financial Statements states: ‘An entity shall disclose,
along with its significant accounting policies or other notes, the judgements,
apart from those involving estimations, that management has made in the process
of applying the entity’s accounting policies and that have the most significant
effect on the amounts recognised in the financial statements.’

6. Paragraph
112 of Ind AS 1 states: ‘The notes shall: …. (c) provide information that is
not presented elsewhere in the financial statements, but is relevant to an
understanding of any of them.’

ANALYSIS

The analysis
below is consistent with the IFRIC tentative agenda decision in June, 2020, ‘Supply
Chain Financing Arrangements – Reverse Factoring – Agenda Paper 2.’

Cash flow
statement

An entity
that has entered into a reverse factoring arrangement determines whether to
classify cash flows under the arrangement as cash flows from operating
activities or cash flows from financing activities. If the entity considers the
related liability to be a trade or other payable that is part of the working
capital used in the entity’s principal revenue-producing activities, then the
entity presents cash outflows to settle the liability as arising from operating
activities in its statement of cash flows. In contrast, if the entity considers
the related liability as borrowings of the entity, then the entity presents
cash outflows to settle the liability as arising from financing activities in
its statement of cash flows.

Investing
and financing transactions that do not require the use of cash or cash
equivalents are excluded from an entity’s statement of cash flows (paragraph 43
of Ind AS 7). Consequently, if cash inflow and cash outflow occur for an entity
when an invoice is factored as part of a reverse factoring arrangement, then
the entity presents those cash flows in its statement of cash flows. If no cash
flows are involved in a financing transaction of an entity, then the entity
discloses the transaction elsewhere in the financial statements in a way that
provides all the relevant information about the financing activity (paragraph
43 of Ind AS 7).

NOTES TO FINANCIAL
STATEMENTS

Paragraph 44A of Ind AS 7 requires an entity to provide ‘disclosures that
enable users of financial statements to evaluate changes in liabilities arising
from financing activities, including both changes arising from cash flows and
non-cash changes’. Such a disclosure is required for liabilities that are part
of a reverse factoring arrangement if the cash flows for those liabilities
were, or future cash flows will be, classified as cash flows from financing
activities.

Ind AS 107 –
Financial Instruments: Disclosures defines liquidity risk as ‘the risk
that an entity will encounter difficulty in meeting obligations associated with
financial liabilities that are settled by delivering cash or another financial
asset’. Reverse factoring arrangements often give rise to liquidity risk
because:

(a) the
entity has concentrated a portion of its liabilities with one financial
institution rather than a diverse
group of suppliers. The entity may also obtain other sources of funding from
the financial institution providing the reverse factoring arrangement. If the
entity were to encounter any difficulty in meeting its obligations, such a
concentration would increase the risk that the entity may have to pay a
significant amount, at one time, to one counter party.

(b) some
suppliers may have become accustomed to, or reliant on, earlier payment of
their trade receivables under the reverse factoring arrangement. If the
financial institution were to withdraw the reverse factoring arrangement, those
suppliers could demand shorter credit terms. Shorter credit terms could affect
the entity’s ability to settle liabilities, particularly if the entity were
already in financial distress.

Paragraphs 33-35 of Ind AS 107 require an entity to disclose how exposures
to risk arising from
financial instruments including liquidity risk arise, the entity’s objectives,
policies and processes for managing the risk, summary quantitative data about
the entity’s exposure to liquidity risk at the end of the reporting period
(including further information if this data is unrepresentative of the entity’s
exposure to liquidity risk during the period), and concentrations of risk.
Paragraphs 39 and B11F of Ind AS 107 specify further requirements and factors
an entity might consider in providing liquidity risk disclosures.

An entity
applies judgement in determining whether to provide additional disclosures in
the notes about the effect of reverse factoring arrangements on its financial
position, financial performance and cash flows. An entity needs to consider the
following:

(i)
assessing how to present liabilities and cash flows related to reverse
factoring arrangements may involve judgement. An entity discloses judgements
that management has made in this respect if they are among the judgements made
that have the most significant effect on the amounts recognised in the
financial statements (paragraph 122 of Ind AS 1).

(ii) reverse
factoring arrangements may have a material effect on an entity’s financial
statements. An entity provides information about reverse factoring arrangements
in its financial statements to the extent that such information is relevant to
an understanding of any of those financial statements (paragraph 112 of Ind AS
1).

shailesh.kwebmaker

DATA-DRIVEN INTERNAL AUDIT – I

BACKGROUND

The basics of Internal Audit remain the same
– add value and manage risk; but it cannot operate in isolation, and just as
technology continues to revolutionise the way we do business in the 21^st
century, Internal Audit is not immune from disruption.

The business environment is changing rapidly
in the face of the data revolution. IDC predicts that worldwide data will
increase by 61% and reach 175 zetta bytes by 2025. What is new is the ubiquity
and volume of data. From big data to data science to predictive analytics, data
is everywhere.

Management today makes use of tools and
technologies like ERP, analytics, visualisation, artificial intelligence, etc.,
and converts available data into information for better, more informed
decisions impacting the business. Should the Internal Auditor be left behind?

Internal Audit is one of the professions
where developments affecting data (data availability, data sources, data
analysis, etc.) are particularly important and impactful.

The opening lines of the popular science
fiction serial of the 1970s, ‘Star Trek – Space, The Final Frontier’,
are: These are the voyages of the Star Ship Enterprise. Its five-year mission
– to explore strange new worlds, to seek out new life and new civilizations, to
boldly go where no man has gone before. Those words are etched in our
minds.

To draw a parallel to that, the future of
Internal Audit is to explore and apply new tools and technologies. Not just for
the sake of ‘me too’ but to be relevant and –

do more (continuously add value) with less
resources;

be in tune with audit tools and
technology, similar to those being adopted by businesses (increasingly,
management is now working with 4^th and 5^th generation
tools and technologies and auditors cannot use 1^st or 2^nd
generation tools and technologies any more);

continuously upgrade skills in the face of
this data revolution.

TOWARDS A DATA-DRIVEN FUTURE – SURVEY

CaseWare IDEA Inc., Canada conducted a
survey in late 2019 wherein about 400 Internal Audit professionals from junior
auditors to the C-Suite level were surveyed and responses were gathered from
around the world on their approach to audit through the lens of technology.

To offer an unbiased assessment of the state
of Internal Audit in 2020, this survey was tool agnostic.

Who was surveyed?

Geographic distribution of the survey

Geographic Distribution

The survey was promoted globally across multiple channels. Although a plurality (42%) of respondents operate out of North America, the survey results reflects the views of audit professionals from all major global geographic regions, including Asia Pacific (20%), Latin America (17%), Europe (11%), Africa (8%), and the Middle East (2%).

Topics covered in
the survey

Feedback was
sought from the respondents on the following areas:

Current and
planned elements of Internal Audit approaches;

Most
significant Internal Audit challenges;

Compliance
demands;

Data
analytics in Internal Audit;

Artificial
Intelligence and Machine Learning in Internal Audit activities;

Cloud
Technology in Internal Audit;

Training and
adoption of audit technology;

Priorities
for 2020, and much more.

Findings
of the survey

The survey
findings suggested that individuals and leadership within the Internal Audit
profession are aware of the unique opportunities that are being offered by new
technologies and data analytics, but they are struggling to:

Embrace and
adopt these new technologies

Train
internal audit staff on technology tools

Move from
traditional, manual processes to data-driven auditing processes.

Compliance
demands – a perennial challenge for Internal Audit – continue to rank as one of
the top priorities for auditors and data ethics is taken seriously by most
respondents.

The year ahead
for Internal Audit will be marked by:

The adoption
of data analysis technology,

The
optimisation of existing audit technology,

Training
auditors on audit technology.

Many of these
challenges and priorities are interconnected and together they represent a
global movement towards data-driven audit.

Top
challenges – an overview

In the survey,
audit professionals were asked to address their biggest audit challenges
currently, and the answers reflect the views of respondents as they stood at
the close of 2019. When asked to name their top Internal Audit challenges,
three clear priorities emerged as the top challenges faced by auditors,
regardless of role or geographic location.

Leading the
charge was the need to move from traditional, manual processes to data-driven
audit, a priority which 62% of respondents named as a top audit challenge.
Close behind were the need to adopt new technology (57%) and addressing the
skills shortage (47%).

Need for
adoption of data-driven audit

Data-driven
audit uses technology, big data, data analytics, and even predictive analytics,
to make auditing a data-centric, risk-sensitive, technology-enabled, continuous
activity.

Data-driven
auditing is an approach marked by:

The use of
data analytics technology;

A decreased
reliance on manual tools and processes (e.g., traditional spreadsheets and
sampling);

Results-based
decision-making that enables both the auditor and the client to find more value
in an audit;

Using these
approaches to enable management to minimise risk.

Data-driven
audit shirks conventional, manual approaches to auditing to realise a future of
data-based decision-making.

BENEFITS OF DATA ANALYTICS – KEY POINTS

Clients,
customers and investors alike have little tolerance when controls fail to
reveal erroneous data used in operational decisions and financial reporting.
Undetected errors in systems and data can also yield opportunities for fraud
and abuse. The best tool that can be used to determine the reliability and
integrity of information systems is data analysis software.

Audit results
gleaned from competent data analysis activities by Internal Audit can shine a
light on the issues lying within the organisation’s data. When properly used by
trained audit staff, data analysis software can be incorporated into audit
plans to provide both assurance and consulting service opportunities to the
organisation’s information systems and thus become the true cornerstone of an
effective audit function.

Some of the key
benefits of the use of data analytics are:

In-depth
review of process-generated data rather than traditional sample checks which
are ineffective and inefficient;

Ability to
reveal surprises and insights which the client management never knew about – true
value add;

Possibility
to go beyond controls and focus on cost saving and revenue maximisation;

Concurrent
use of data analytics in audit significantly reduces compliance costs;

Framework to
automate complex Management Control ‘MIS’ reports through Automatic Routines –
‘Macros’.

DATA ANALYTICS MATURITY DECISION
FOR INTERNAL AUDIT

Different
types of data analytics

Organisations
need to consider different types of data analytics:

Descriptive
analytics interprets historical data;

Predictive
analytics predicts future outcomes based on historical data;

Diagnostic
analytics examines the data and asks ‘why?’

Prescriptive
analytics identifies the best course of action based on the analysis of
data.

The data
analytics maturity scale

Whatever the
benefits of automating data analytics, the organisation needs to determine at
the strategic level how data analytics might best contribute to its audit
goals.

This strategic
activity can benefit from considering data analytics in terms of ‘maturity’
stages below:

Traditional
Auditing: Data
analytics may be used but is mainly descriptive and applied during the planning
phase.

Ad Hoc
Integrated Analytics: This may include both descriptive and diagnostic
analytics at the planning and execution phases (e.g., identifying outliers),
but is carried out in an ad hoc rather than systematic manner.

Continuous
Risk Assessment and Auditing: This may include all types or categories of
data analytics in a pre-defined automated set. This set provides ongoing data
to auditors.

Integrated
Continuous Auditing and Continuous Monitoring: A full set of automated
analytics is deployed and permits continuous monitoring by management, as well
as a continuous data flow to the audit shop. The systems are largely seamless
and integrated.

Continuous
Assurance of Enterprise Risk Management: A full set of automated analytics
is deployed, as with level 4. In addition, there is a further emphasis on
aligning continuous data analysis with strategic enterprise goals. The internal
audit plan is ‘dynamic’ in response to risk fluctuation.

CONCLUSION

The road for
internal auditing in 2020 and beyond would be:

Upgrade
skill-sets and become aware; explore and apply available and emerging tools and
techniques;

Adopt a
data-driven approach to auditing, using tools and technologies like audit apps,
data analytics, machine learning, artificial intelligence, etc.;

To add value
to the organisation and be a trusted business adviser to management.

The second
part of this article will cover practical cases with steps for using analytics
and conducting data-driven audits.

shailesh.kwebmaker

INTERPLAY OF FIXED ESTABLISHMENT WITH PERMANENT ESTABLISHMENT

Business enterprises with
presence in multiple geographical locations either set up an independent legal
entity (recognised under the host state laws) or operate through extended
establishments such as branch offices, installation / project sites, personnel,
etc. (referred to as multi-location entity – MLE). Such MLEs give rise to
critical tax consequences in both the host state and the parent states. While
the general economic principle in framing fiscal laws for such presence is to
ensure avoidance of double taxation and non-taxation, due to a lack of
consensus on international transactions on the VAT / GST front this objective
is far from being achieved. The issue of taxation is relatively simpler when
the business enterprises set up an independent subsidiary and remunerate them
at arm’s length for all their activities. The complexity arises with presence
through extended establishments as the arrangements between the head office and
these establishments are not clearly discernible or documented for comparison
with external world transactions.

VAT laws globally have termed these extensions as
‘fixed establishment’ – this has been used as a tool to assist them in
identifying the end destination of the service or intangibles. The OECD VAT /
GST guidelines have suggested three approaches in taxation of MLEs for services
and intangibles and to reach the end consumption of the service: (i) Direct use
approach where the focus is on the establishment that uses the services; (ii) Direct delivery approach where the focus
is on the establishment to which the services are delivered (with a presumption that delivery is a good reference
point of use); and (iii) Recharge approach which factors the inefficiencies in
both approaches and requires the MLE to recharge the externally procured costs
to the establishment which ultimately uses the services in order to ensure that
the VAT chain continues to the state of consumption¹.

1 It
is probable that the recharge approach has weighed heavily while drafting
Schedule 1 of the CGST Act

The Income Tax law (along with tax treaties) has
recognised the presence of foreign enterprises in India through business
connections / permanent establishments (PE) for the purpose of taxation. The
term ‘permanent establishment’ has been used with a dual purpose – (a) fixing
the taxing rights over the source of income pertaining to the extended presence
in India; and (b) application of Transfer Pricing Regulations for ascertainment
of arm’s length profits of permanent establishments through a process of profit
attribution. Being a nation-wide law, domestic branches really do not alter the
revenue situation from an income tax perspective and have no significance in
this respect.

Under the Indian GST law, not only do we have to
resolve transactions spanning across national borders, we also have to deal
with transactions over state borders. Article 286 of the Indian Constitution
empowered Parliament to play the role of a mediator for inter-state transactions.
Article 286 articulates the location of the supply and also defines the state
which would have exclusive jurisdiction to tax the supply transactions. To give
effect to this geographical jurisdiction, the IGST law, in addition to other
principles, included the concept of ‘fixed establishment’. The objective of
this term is to identify the taxable person, the source and destination of a
supply and the appropriate jurisdiction for taxing the transaction.

Before venturing into a comparative analysis of
fixed establishment (FE) with permanent establishment (PE), it is imperative
that the underlying objectives of both laws are understood clearly. The VAT /
GST laws have introduced the said concept in order to give effect to the
destination principle, i.e., taxation revenues ultimately accrue to the state
in which the services are consumed and the neutrality principle, i.e.,
non-resident and residents are treated in the same manner, while the Income Tax
laws introduced the concept of permanent establishments in line with the
‘source principle’ of taxation, i.e., the country from which the income has
been generated should have the right to tax the said income. This fundamental
divergence would act as a natural impediment to automatic application of the PE
definition to the FE definition.

FIXED ESTABLISHMENT UNDER GST
– CONCEPT

In general, the GST law defines the term FE in
contra-distinction with the term ‘place of business’. The phrase place of
business (PoB) refers to a place from where business is ordinarily carried out
and includes a warehouse, godown or any other place where the supplies are made
or received. FE has been defined to mean a place (other than the registered
place of business) which is characterised with a sufficient degree of permanence
in terms of human and technical resources in order to supply or receive and use
services for its own needs. The terms PoB and FE are relevant to decide the
‘from’ location and the ‘to’ location of the service activity and consequently
the right location of supplier and recipient of service.

The PoB / FE concept also has some background in
the Service Tax enactment and the Place of Provision of Services Rules. With
similarly worded terms, the education guide on service tax explained the
objective behind the concept of fixed establishment as follows. It was stated
in paragraph 5.2.3 that the term ‘location’ was significant from the
perspective of service provider and recipient in order to ascertain the source
or rendition of a particular service. The paragraph also stressed that the
location also assists in identifying the jurisdiction of the field formation
(under Service Tax being a Central enactment) which would have domain to assess
the transaction. This can probably also support the point that the fixed
establishment concept would play a pivotal role in identifying the appropriate
state to which the taxing domain lies.

FIXED ESTABLISHMENT UNDER
EU-VAT – CONCEPT

The Indian GST definition of fixed establishment
has been influenced by the EU-VAT law. The EU Sixth VAT Directive (Article 43)
adopted the term ‘fixed establishment’ for ascertaining the place of supply of
services. The term was objectively expanded in 2011 by virtue of Articles 11(1)
and 11(2) of the implementing regulations (a procedural law). Prior to this
expansion, certain decisions analysed the definition of fixed establishment,
i.e., the Berkholz² and ARO Lease³ cases. The Berkholz
case involved gaming machines installed by the taxpayer on on-going sea vessels
with intermittent presence of personnel for maintenance of the machines. The
ECJ on consideration of the cumulative requirement of permanence of human
and technical resources held that the FE was not established. Similarly, in
the ARO Lease case a company was engaged in leasing of cars to its customers in
Belgium (these cars were purchased by ARO, Netherlands from Belgian dealers and
delivered to the customers directly in Belgium); it was held by the ECJ that
neither the presence of cars of ARO in Belgium nor the self-employed intermediaries
(Belgium dealers) created a sufficient permanent human and technical presence
to constitute an FE.

With Articles 11(1) and (2) of the EU implementing
regulations, the EU-VAT law has categorised fixed establishment into ‘passive’
and ‘active’ fixed establishments⁴. The IGST law has adopted both in
one definition with the use of the disjunctive phrase ‘or’ in the last few
words of the definition (discussed in detail later). This may be considered as
essential because the concept of fixed establishment has been used to ascertain
both the location of cases where services are either received or provided from
the said fixed establishment.

After the introduction of the implementing
regulation, the Welmory case⁵ examined a situation where a Cyprian
company had appointed a Polish company to maintain and operate a website for
online auction. The entire process of auction was functioning through the
website maintained by the Polish company. The ECJ stated that the economic
activities of the Polish company and Polish customers does not by itself
constitute a fixed establishment and the services of the Polish company should
be viewed distinctly from that of the Cyprian company to the Polish customers.

PERMANENT ESTABLISHMENT UNDER
INCOME TAX – CONCEPT

In Income Tax, the domestic legislation used the
phrase ‘business connection’ which is of very wide amplitude, but taxpayers use
the benefit of a narrower term PE⁶ which is used in most tax
treaties (OECD, US or UN model). The term PE has been defined as a fixed place
of business through which the business of an enterprise is wholly or partly
carried out and includes the following: (a) place of management; (b) branch,
office, factory, workshop, warehouse, etc., (c) building, construction or
installation site; (d) provision of services through presence of personnel; and
(e) dependent agency. In case a foreign enterprise constitutes a PE in a host
state, the PE is to be granted a separate entity status and business profits
attributable to the PE at arms’ length are to be taxed in the state in which
the PE is constituted.

Having understood the broad concept of FE and PE in
GST / EU and Income Tax law, we now proceed to identify the points at which the
said terms would converge / diverge through the assistance of illustrations and
then tabulate the same for future reference.

2 ECJ
EC 4^th July, 1985, 168/84, ECLI:EU:C:1985:299 (Günter Berkholz),
European Court Reports, 1985

3 ECJ
EC 17^th July, 1997, C-190/95, ECLI:EU:C:1997:374 (ARO Lease),
European Court Reports, 1997

4 Passive
FEs being those which only receive / procure inputs / services (cost centres)
and Active FEs which also provide services (profit centres)

5 ECJ
EU 15^th October, 2014, C-605/12, ECLI:EU:C:2014:2298 (Welmory),
Official Journal 2014, C 462

6 OECD
Model Convention on Tax Treaties as an example

CONSTITUTION OF A PE / FE –
COMPARATIVE ANALYSIS

(A) Fixed place PE (basic rule): Stability,
productivity and dependence

Article 5 of Income Tax treaties defines a fixed
place PE as ‘fixed place of business’ through which the business of an
enterprise is wholly or partly carried out. The fixed place PE rests on three
primary tests: (a) place of business; (b) location test; and (c) permanence
test. Article 5(2), in fact, enumerates instances such as branch, office,
factory, workshop, warehouse, etc., which by default satisfy the above tests,
especially the place of business test.

The place of business test
postulates that some portion of the business activity of the MLE enterprise is
conducted through the physical office in India. The extent of business activity
conducted in India is ascertained through a FAR analysis (Functions performed,
Assets employed and Risks assumed) of the PE’s operations in India. But there
is one critical exclusion in terms of conduct of preparatory or auxiliary
activities – in effect, where a part of the business activity is conducted in a
territory and such part is preparatory or auxiliary in nature, the MLE is not
considered to have a permanent establishment in the said territory. In the
context of this Basic Rule PE, the Supreme Court in DIT vs. Morgan
Stanley [2007 (7) TMI 201] was examining whether back-office operations
of a subsidiary constitute a place of business of the parent company. The Court
held that the support function performed would not constitute an extension
of the business activity of the parent. Similarly, the mere fact that the
business of the parent company is outsourced or support functions are performed
by the Indian subsidiary, was considered as irrelevant for the purpose of concluding that the parent company is having
an establishment in India [ADIT vs. E Funds IT Solutions Inc. 2017 (10)
TMI 1011]. These decisions imply that the business activity should be
understood as an extension of the set-up already in place in the parent company
rather than an independent entity.

The location test requires that there has to be a
physical presence of the business in a specific place (though the place may be
mobile within the defined territory). This test warrants that the business
activity should be capable of being tagged to the physical territory either as
equipment, branch or any such physical infrastructure.

As for the permanence test,
the OECD commentary states that the term ‘fixed’ itself warrants a certain
degree of permanence at the location in which the physical infrastructure is
placed in the taxable territory. The phrase ‘fixed’, as an adjective, also
attaches a certain degree of permanence to the place of business which is a
prerequisite under this Article (also stated in the OECD commentary)⁷.
In the absence of a defined time period under the treaties, there is some
relativity in the way jurisprudence has developed to identify the degree of
permanence of an activity. While each case produced different results, a recent
decision of the Supreme Court in Formula One World Championship Ltd. vs.
CIT, Delhi [2017] 80 taxmann.com 347 (SC) examined a Formula One race
arrangement which lasted for approximately three weeks and held that such an
arrangement constituted a fixed place PE. The background to the case involved a
Formula One race conducted by FOWC which involved placement of the entire racing
infrastructure / equipment on Budd International Circuit and FOWC had complete
control over the schedule, equipment and personnel at the location. The Supreme
Court stressed on the disposal test (i.e., FOWC having exclusive and complete
control over the racing circuit) rather than the duration test for testing the
permanence of an activity. In other words, ‘fixed’ was interpreted by the
Supreme Court with reference to the exclusivity and control over the place
rather than the duration of usage (which is relative for each business
activity).

In comparison, the FE definition in IGST law also
relies on a ‘sufficient degree of permanence’. The legislature has used a very
subjective term probably keeping in view varied industry practices. For
example, the Formula One race arrangements which last only for three weeks in a
calendar year at a particular location, was considered as a sufficient degree
of permanence by the Court given the peculiarity of the sporting event.
Moreover, the Court stressed on the adequacy of control over the three-week
period rather than the duration of three weeks. Though speculative, it is
probable that the Court might not have reached the same result in case the
facts were for a long duration project (e.g., oil exploration activities,
etc.). Probably, this test would also be applicable for understanding the FE
definition. Whether the phrase ‘sufficient degree of permanence’ has to be
assessed keeping the disposal test or the duration test in mind, is a question
open for debate.

7 CIT
vs. Visakhapatnam Port Trust 1983 (6) TMI 31

Further, the disposal test
should also be addressed factoring in the nature of supply which is under
consideration, for example, presence of a few weeks would be sufficient for
rendering legal advisory services on a particular issue but a presence of even
a few months would not be sufficient while rendering the very same advisory
services for construction of a building. The service tax education guide states
that the relevant factor is the ‘adequacy’ of the human and technical resources
to render the ‘service’ for deciding whether there is sufficient permanence in
the activity. In the absence of detailed jurisprudence on this subject, one may
imbibe the settled principle under Income Tax while interpreting the FE
definition.

(B) Service PE (Extended PE): Physical presence of
employees

The OECD Model Convention
provides for a service PE if the aggregate presence of the personnel in the
taxable territory is beyond 183 days in a 12-month period⁸. The
nature of services that are rendered by the personnel could be wide in range.
Physical presence of personnel in the taxable territory rendering a service,
irrespective of the type of service, would be prominent in deciding the
constitution of a service PE. But the Supreme Court in Morgan Stanley
(Supra) differentiated the services rendered through own employees of
MS USA and deputed employees of MS USA. The Court held that in the case of own
employees performing supervisory / stewardship activities, there is no service being rendered by the presence
of employees in India to the Indian subsidiary, rather the presence of
personnel is for the sole benefit of the parent company in order to ensure
quality control, confidentiality, etc. On the other hand, the employees of MS
India deputed for assisting the operations of MS India were considered as an identifiable service activity to the
Indian subsidiary, hence a service PE was held to be constituted.

8 UN
Model narrows the test to a 6-month period

Under GST, the reference to
personnel is made in the definition of fixed establishment by use of the phrase
‘human resources’. But this aspect is not a stand-alone requirement for
constitution of a fixed establishment. The human capital is required to be
equipped with a degree of permanence and technical resources (depending on the
nature of work) in order to constitute a fixed establishment. The permanence
test applicable to Fixed Place PE may be adopted while examining the FE arising
out of service personnel. It is also important that the human capital should be
‘capable of availing and rendering the service activity’ to the third party
while being present in the taxable territory.

We may recall that the EU-VAT in Berkholz’s case
held that the presence of personnel to maintain the gaming equipment on an
intermittent basis did not constitute a fixed establishment in the foreign
territory. Probably, the IGST law may also have to follow suit and despite a
service PE being constituted under Income Tax, if the human capital is using
technical resources of the end customer there may be a ground to contend that a
fixed establishment is not constituted. From a practical standpoint, many MNCs
appoint personnel for maintenance and on-site repair of machinery. Where repair
and maintenance is partially conducted from the Indian territory with a
significant portion being conducted remotely, one may view the same as not
constituting an FE in India, but where the said personnel (with their
equipment) are capable of rendering the service exhaustively, the said
personnel can be said to have constituted a PE in India.

The concept of agency PE was introduced to address quasi-presence
of foreign enterprises through dependent representatives in the taxable
territory. Notwithstanding the requirements of a basic rule PE, Article 5
provides for formation of a dependent agency PE where, (a) the person
habitually concludes contracts or even possesses the authority to conclude
contracts; (b) maintains inventory of goods on behalf of its principal; or (c)
habitually secures orders wholly or primarily for its principal in India. The
primary requirement is that a principal-agency relationship is visible and such
agent, if at all, should be one who is NOT operating in his independent
capacity in his ordinary course of business. Evidently, a principal-agent
relationship would be established if the agent acts in a representative
capacity with an ability to bind its principal to its actions.

The Bombay High Court in CIT vs. Taj TV
Limited [2020 (3) TMI 500] examined whether revenues under the
exclusive distribution agreement by Taj TV Limited involving fees from cable
operators and granting them viewing and relay rights, were under an agency
relationship. Under the distribution agreement, Taj TV was given independent
rights to market and promote the TV channels and negotiate and conclude
contracts with sub-distributors. In this decision, the Court observed that Taj
TV under sub-distributor agreement and the cable-operator agreement, acted in
its own capacity and the foreign enterprise did not have any privity in
deciding the pricing of the rights. Hence it was concluded that there was a
principal-to-principal relationship. In contrast, the very same Bombay High
Court in DIT Mumbai vs. B4U International Holdings Limited 2015 (5) TMI
277 on those specific facts held that the Indian entity did not have
any authority to conclude contracts on its own and was under the direction and
control of its principal and hence constituted a DAPE in India.

The secondary requirement of constitution of a DAPE
is that the agent should not be of independent status. ‘Legal and economic
independence’ are the two tests which are usually applied for this clause.
International commentaries suggest that if the agent is responsible for its own
actions, takes risks and has its own special skill and knowledge to render the
agency service, such agent would be termed as an independent agent. In certain
AAR rulings⁹ under Income Tax, the dependency agency test was
applied and held not to be fulfilled on the ground that similar services were
being provided to multiple FIIs and not just one principal. Moreover, the
treaties itself provides for an exclusion where the agent renders its services
to multiple principals, evidencing that it has risk abilities, own skill and
knowledge, etc. to act independently.

As regards the authority to conclude contracts,
paragraph 33 of the OECD commentary states that a person who is authorised to
negotiate all elements of a contract in a binding way on the enterprise can be
said to have the authority to conclude contracts and the mere fact that the
person has attended and participated in negotiations is not sufficient
authority under this PE rule¹⁰.

9 XYZ/ABC Equity Fund vs. CIT (2001) 116 Taxman
719 (AAR); Fidelity Services Series VIII in (2004) 271 ITR 1 (AAR)

10 India
has expressed its reservations to the OECD commentary on this aspect and
submitted that mere participation in negotiations is also evidence of authority
to conclude contracts

In contrast, the IGST law does not have a specific
case of agency for the purpose of fixed establishment for a supplier or its
recipient. It would be interesting to note that section 2(105) of the CGST Act
has extended the definition of a supplier to include its agent as well who is
engaged as supplier of services. By virtue of this inclusion, the location of
the supplier would have to be adjudged after taking cognisance of the presence
of an agent in India. As an illustration, if Taj TV was appointed as an agent
of Taj Mauritius for distribution of channels, the location of the supplier for
the services rendered by Taj Mauritius (i.e., channel access fee) would be
liable to be attributed to the Taj TV (as an agent) of Taj Mauritius resulting
in Taj Mauritius being considered as present in India through the FE-agency
relationship. Unlike Income Tax, the agency relationship need not always be one
who is dependent on the principal. The place of business of the agent would be
considered as the place of business of the principal (to the extent of the
agency relationship) and fixed as the location of supplier of such services. Of
course, the basic FE rule under GST such as permanence, human and technical
resources would still have to be satisfied by the agent in order to qualify as
an FE in India.

The location of supplier and
recipient definitions has been limited only for the service activity and not
transactions of supply of goods. One of the reasons may be that the agency FE may
not be applicable to selling / purchasing agents of goods. This is because
agency transactions in respect of supply of goods are covered under Schedule I
of the CGST Act which deems the principal and agent as separate beings. Once
the agent is equated to a purchaser of goods, by way of a deeming fiction, the
agent would be considered as a quasi-supplier for other purposes of the
Act and not as a representative of its principal. Hence, an agency PE under
Income Tax for supply of goods would not translate into an FE for the very same
principal under GST.

(D) Construction / Installation PE

Tax treaties recognises any construction,
installation, project site, etc., including supervisory activities¹¹
of a foreign enterprise as being construction / installation PEs. The treaties
(OECD – 12 months; UN – 6 months) specify the period beyond which the PE is
said to be constituted. All planning and designing activity prior to physical
visit to the site would be included in the PE (UN Model). The Tribunal in SAIL
vs. ACIT (2007) 105 ITD 679 held that supervisory services provided by
a company even though it was itself not engaged in installation activity would
be sufficient to constitute an installation PE.

The IGST law has not carved out a specific instance
of a construction / installation FE. The fixed establishment definition itself
encompasses any presence of human and technical resources as sufficient grounds
to constitute an FE. Moreover, construction activities generally entail direct
procurement and supply of services and hence all the ingredients of
constituting an FE stand established. Unlike the situation in SAIL’s case above
which involved mere provision of supervisory services, such activities may not
constitute an FE in GST law.

11 Only in UN model treaties

(E) Significant Economic Presence (SEP): Digital
footprint

With increasing digital presence globally, BEPS
Action Plan 1 identified the problems of taxation due to advancement of digital
economy. The concept of significant economic presence (SEP), which could be
represented by the digital footprint of an enterprise, was given legal sanctity
in the Income Tax law. The law has prescribed minimum thresholds on the basis
of digital footprint for constituting significant economic presence in the
country – the thresholds could take the form of number of digital users,
revenue per user, etc. The BEPS Action Plan as well as the memorandum
suggesting this amendment stated that the traditional concept of permanent
establishment requiring physical presence in the taxable territory cannot be
possibly applied to digital transactions and hence alternative criteria such as
the above are necessary for viewing significant economic presence.

The Indian GST law has not considered
this aspect for the purpose of defining fixed establishment. The law has
defined a term ‘Online Database and Information Access or retrieval service
activity’ to tax all digital economy transactions. In fact, this law has
alternatively chosen to place a tax liability by adopting a different approach
and treating this transaction as an import of service into India and taxing the
same in the hands of the business user. In case of B2C transactions, the GST
law has placed the obligation on the foreign company to identify a
representative in India for discharging the tax burden on such transaction.

In summary, the GST FE concept and the Income Tax PE concept converge and
diverge at multiple points which can be tabulated as follows (see Table 1):

ATTRIBUTION / RECHARGE
APPROACH

Income Tax attributes income /
profit to the PE based on the FAR approach. This would involve estimations and
approximations; profitability is not traceable to the transaction level.

Table 1

*Aspect*	*Convergence*	*Limited* *Divergence*	*Complete Divergence*
Fixed PE	Degree of permanence	Disposal test which does not seem to be a clear prerequisite in FE; no exclusion for preparatory / auxiliary activity in FE	Capability of receipt and / or supply of services is not required in PE
Service PE	Rendition of services	Duration test for PE and FE may be differently viewed	Presence of technical resources are essential for FE
Agency PE	Agent constituting PE / FE	Agency in respect of goods not part of FE test due to deeming fiction in Schedule I	Dependency not an FE test ~ multi service agents constituting FE
Construction PE	Construction site being place of business	Ancillary activities may form a Construction PE but not an FE	No time limit specified for FE and relative to nature of work
SEP	NIL	NIL	Treated as OIDAR and liable for RCM / FCM as the case may be

Aspect

Convergence

Limited Divergence

Complete Divergence

Fixed
PE

Degree
of permanence

Disposal
test which does not seem to be a clear prerequisite in FE; no exclusion for
preparatory / auxiliary activity in FE

Capability
of receipt and / or supply of services is not required in PE

Service
PE

Rendition
of services

Duration
test for PE and FE may be differently viewed

Presence
of technical resources are essential for FE

Agency
PE

Agent
constituting PE / FE

Agency
in respect of goods not part of FE test due to deeming fiction in Schedule I

Dependency
not an FE test ~ multi service agents constituting FE

Construction
PE

Construction
site being place of business

Ancillary
activities may form a Construction PE but not an FE

No
time limit specified for FE and relative to nature of work

SEP

NIL

Treated
as OIDAR and liable for RCM / FCM as the case may be

In GST, India has adopted the
recharge approach in cases of service transactions. For example, with respect
to services directly connected to an FE, the requirement under GST law is to
‘bill from’ the FE / ‘bill to’ the FE which is most directly concerned with the
supply. The FE would then have to recharge the relevant establishment in the
organisation which has consumed the service even partially. In such a manner,
the tax revenues would follow the contractual obligations (with the presumption
that economics would assist in reaching the point of consumption) and hence the
importance of identification of the relevant FE would assume high significance.

However, in cases of agency of supply of goods, the
requirement of the law is to deem them as distinct entities at the outset
itself and equate them to a seller or purchaser of goods. By this approach, the
VAT chain passes through the agent and attempts to reach the end consumption of
goods. This activity takes place at the transaction level rather than
the entity level which is the case in Income Tax. The global apportionment
approach / FAR analysis adopted for attribution of profits to the PE would not
serve any purpose for GST.

In summary, it is observed that though both the concepts are
interconnected at multiple points, there are bound to be divergent answers in
view of the basic structure of both the Income Tax and the GST laws being
different. This concept would be relevant for outbound as well as inbound
presence and hence a balanced interpretation of this concept is essential from
the perspective of all stakeholders. In any case, the attempt should be to
identify the last point in the value chain where the consumption actually takes
place. This destination principle, though unwritten in the law, is the core of
the GST system in place and violation of this principle at the cost of legal
interpretation may cause chaos in the economic distribution of the wealth of
the nation.

shailesh.kwebmaker

PRAYERS: OUR SEARCH ENGINE

In today’s technology-driven era, people
seeking information use Google or any other search engine. The search engine
being accessed does not have any data, it searches and lists out the websites
where the information being sought is available. The preciseness of such a
search depends on how specific is the question that is keyed in.

Leaving this discussion aside, let me take
up another aspect of our life – Prayers. Let me clarify here that by prayers I
am not referring to the scripted prayers pertaining to any religion or
community whatsoever, that I have been uttering without actually understanding
their meaning. Further, for prayers I don’t know why but I am taught to visit a
temple, stand in front of an idol, and so on.

What I am referring to by prayers here is
the ‘inner conversation’ that we hold with an unseen energy, ‘The Universe’.
May be, the conversation (inner talk) is initiated by the name and with the
imagination of a deity. Going deeper into this inner talk, what exactly am I
doing? Broadly, I am either in a mode of (1) gratitude, (2) seeking help, or
(3) seeking forgiveness.

While in the mode of ‘gratitude’, I
basically express my thankfulness for all that I have attained / achieved.
Being in satiety, my thought process is fine-tuned to the best with the
universe, thereby enabling me to take rational, considered decisions which
further uplifts me in all aspects of life.

In the mode of ‘seeking help’, I am, for
some moments, focusing on a particular issue that is being experienced or faced
by me, trying to narrate it as it is being experienced by me and raising a few
questions thereto which makes me uncomfortable. In the process, my clarity on
the issue magnifies and my thought process is energised on that precise issue.
In such a circumstance, I generate the possibilities which can resolve my
issues. I focus on them, short-list them and undertake that if it so happens,
then I would undertake some sort of sacrifice. Thus, I am committing myself to
work on the path of a possible solution. In this mode, the clearer I am in
focusing on the possible solutions, the higher is the possibility of the issue
getting resolved.

In the mode of ‘seeking forgiveness’, from
my inner-most thoughts I admit my wrong-doings and seek forgiveness from the
Universe. In the process, I realise my wrongs and, having realised them, would
certainly restrain myself from repeating them. This gets me to the mode of
improvement, upliftment, betterment. The more the clarity about my wrong deeds,
the more would be the tendency of avoiding repetition of such deeds.

Now, correlating the two seemingly
independent activities discussed above, viz., a search engine and a Prayer, the
similarity lies in the clarity of the question / issue being raised. Be it a
Google Search or be it a Prayer, clarity in you, your desires, as to what you
are seeking, is what leads you to the path of success. Yes, the analogy between
a ‘search engine’ and a ‘Prayer’ is that what a search engine does in the
‘world wide web (www)’ is what our Prayers do in the ‘Universe’.

This is like making a proper blue-print for
constructing a bridge. However, the blue-print does not give you a bridge. That
is not the result. Taking action in that direction is like constructing a
bridge after making a proper blue-print, leading to the destination and
fulfilment of desires. Without action, it is just a blue-print, lying in a
file, and nothing constructive about it.

To conclude, be it a search engine or a
Prayer, clarity (visualisation) followed by action is what leads to
actualisation. Hein ji, sab sambhav hai!

shailesh.kwebmaker

ACCOUNTING RELIEF FOR RENT CONCESSIONS ON LEASES

On 28^th May, 2020,
the International Accounting Standards Board (the IASB) finalised an amendment
to IFRS 16 Leases titled ‘Covid-19-Related Rent Concessions –
Amendment to IFRS 16’. The Institute of Chartered Accountants of India
(ICAI) has already issued an Exposure Draft mirroring the IFRS 16 amendment.
This will become a standard in India when it is notified by the Ministry of
Corporate Affairs (MCA).

The modified standard
provides lessees with an exemption from assessing whether a Covid-19-related
rent concession is a lease modification. The amendments require lessees that
have elected to apply the exemption to account for Covid-19-related rent
concessions as if they were not lease modifications. It may be noted that
accounting for lease modification can be very cumbersome and time consuming for
many lessees that have significant leases on their balance sheet. If the
modification accounting applies, a lessee does not recognise the benefits of
the rent concession in profit or loss straight away. Instead, the lessee will
recalculate its lease liability using a revised discount rate and adjust its
right-of-use assets. If the modification accounting does not apply, the profit
or loss impact of the rent concession would generally be more immediate.

The practical expedient in
many cases will be accounted for as a variable lease payment. If accounted for
as a variable lease payment, the concession is accounted for in profit or loss
in the period in which the event or condition that triggers those payments
occurs.

It may be noted that the
practical expedient is a choice and it is not mandatory to apply. The practical
expedient is not available to lessors. The practical expedient applies only to
rent concessions that meet all the following conditions (paragraphs 46A and
46B):

Condition 1
– The rent concession occurs as a direct consequence of the Covid-19 pandemic.

Condition 2
– The change in lease payments results in revised consideration for the lease
that is substantially the same as, or less than, the consideration for the
lease immediately preceding the change.

Condition 3
– Any reduction in lease payments affects only payments originally due on or
before 30^th June, 2021.

Condition 4
– There is no substantive change to other terms and conditions of the lease.

Let’s take a few scenarios to
assess the applicability of the practical expedient.

ISSUE

Base fact
pattern

Lessor leases commercial space to lessee,

Lease term is four years and rental is fixed at Rs. 4,000 p.m.

Whether practical expedient
is available in the following scenarios?

Scenario	Facts	Can practical expedient be applied?
1	Year 2020: Rent is reduced to Rs. 3,000 p.m. for May-July, 2020 due to business disruption as a result of Covid-19 No change in subsequent years and no other change in lease contract	Yes, as rent concession is as a direct consequence of the Covid-19 pandemic and all the other three conditions are also met
2	Year 2020: Rent is reduced to Rs. 3,000 p.m. for May-July, 2020 Year 2021: Rent for Aug.-Oct., 2021 is increased by Rs. 1,000 p.m. from the original rent. B will pay Rs. 5,000 p.m. for Aug.-Oct., 2021	Yes, because reduction in lease payments affects only payments originally due on or before 30^th June, 2021. Additionally, the increase in lease rental is beyond 30^th June, 2021 and is in proportion to the concession provided. For Condition 3, amendment acknowledges that a rent concession would meet this condition if it results in reduced lease payments on or before 30^th June, 2021 and increased lease payments that extend beyond 30^th June, 2021
3	Lessor agreed for a six-month rent holiday from May – Oct., 2020, i.e., concession of Rs. 24,000 However, in the month of March, 2021, the lessee pays this amount along with interest of Rs. 3,000, which totals to Rs. 27,000	Here, though there is a rent holiday, but those rents are paid subsequently, along with interest. IASB has noted in their basis of conclusion that if the cash flows have increased to compensate the time value of money, it would appear to be appropriate for entities to assess that Condition 2 is met. Other increases in consideration, such as penalties that are included in the deferral, would cause this criterion to be not satisfied
4	Year 2020 & 2021: Rent is reduced to Rs. 3,000 p.m. for May, 2020 – Dec., 2021 Year 2022 & 2023: Rent for Jan. 2022 – Aug. 2023 is increased by Rs. 1,000 p.m. from original rent. B will pay Rs. 5,000 p.m. for Jan., 2022 – Aug., 2023	No. In this scenario, the rent reduction is as a direct consequence of Covid. However, the reduction of Rs. 1,000 affects the payments originally due for the period even beyond 30^th June, 2021. The timeline prescribed in the amendment is purely rule-based. It would not be appropriate to interpret it in such a way that rental concession can be applied to the rent covering the period up to 30^th June, 2021 and for rent changes beyond 30^th June, 2021 the normal accounting of lease modification can be applied. One should consider the changes in the lease rentals in their entirety. It is not acceptable that rent concessions are accounted such that one portion satisfies the criterion (i.e. May, 2020 – June, 2021, i.e., 30^th June is the date beyond which rent concessions completely disqualify the entity from applying the accounting relief) and the remaining portion, i.e., July, 2021 to August, 2023 does not satisfy the criterion
5	Year 2020: Rent is reduced to Rs. 3,000 p.m. for May-July, 2020 Year 2021: Rent for Aug.-Oct., 2021 is increased by Rs. 4,000 p.m. from original rent. B will pay Rs. 8,000 p.m. for Aug.-Oct., 2021	No, because the reduction is of Rs. 1,000 in 2020 but in 2021 the rent increased by Rs. 4,000 from original rent which is not in proportion to the concession provided
6	Lessor offers to reduce the monthly rent on the condition that its space is reduced from 8,000 sq. ft. to 5,000 sq. ft.	No, it would be a substantive change to other terms and conditions, and therefore the practical expedient would be unavailable for that rent concession
7	Rent holiday for May-July, 2020 At the end of the lease term, it gets extended for three months on the terms and conditions contained in the original lease agreement	Yes, because the lease extension is not considered as a substantive change to other terms and conditions of the lease. This point has been clarified in basis for conclusion of the standard

Scenario

Facts

Can practical
expedient be applied?

Year 2020: Rent is reduced
to Rs. 3,000 p.m. for May-July, 2020 due to business disruption as a result
of Covid-19

No change in subsequent years and no other change in

lease contract

Yes, as rent concession is as a direct
consequence of the Covid-19 pandemic and all the other three conditions are
also met

Year
2020: Rent is reduced to Rs. 3,000 p.m. for

May-July, 2020

Year 2021: Rent for
Aug.-Oct., 2021 is increased by Rs. 1,000 p.m. from the original rent. B will
pay Rs. 5,000 p.m. for

Aug.-Oct., 2021

Yes, because reduction in lease payments affects
only payments originally due on or before 30^th June, 2021.
Additionally, the increase in lease rental is beyond 30^th June,
2021 and is in proportion to the concession provided. For Condition 3,
amendment acknowledges that a rent concession would meet this condition if it
results in reduced lease payments on or before 30^th June, 2021 and
increased lease payments that extend beyond 30^th June, 2021

Lessor agreed for a six-month rent holiday from May – Oct., 2020, i.e.,
concession of Rs. 24,000

However, in the month of March, 2021, the lessee pays this amount along with interest of Rs. 3,000, which totals to Rs. 27,000

Here, though there is a rent holiday, but those
rents are paid subsequently, along with interest. IASB has noted in their
basis of conclusion that if the cash flows have increased to compensate the
time value of money, it would appear to be appropriate for entities to assess
that Condition 2 is met. Other increases in consideration, such as penalties
that are included in the deferral, would cause this criterion to be not
satisfied

Year 2020 & 2021: Rent is reduced to Rs. 3,000 p.m. for May, 2020 – Dec.,
2021

Year
2022 & 2023: Rent for Jan. 2022 – Aug. 2023 is increased by Rs. 1,000
p.m. from original rent. B will pay Rs. 5,000 p.m. for Jan., 2022 – Aug., 2023

No. In this scenario, the rent reduction is as a
direct consequence of Covid. However, the reduction of Rs. 1,000 affects the
payments originally due for the period even beyond 30^th June,
2021. The timeline prescribed in the amendment is purely rule-based. It would
not be appropriate to interpret it in such a way that rental concession can
be applied to the rent covering the period up to 30^th June, 2021
and for rent changes beyond 30^th June, 2021 the normal accounting
of lease modification can be applied. One should consider the changes in the
lease rentals in their entirety. It is not acceptable that rent concessions
are accounted such that one portion satisfies the criterion (i.e. May, 2020 –
June, 2021, i.e., 30^th June is the date beyond which rent
concessions completely disqualify the entity from applying the accounting
relief) and the remaining portion, i.e., July, 2021 to August, 2023 does not
satisfy the criterion

Year 2020: Rent is reduced to Rs. 3,000 p.m. for

May-July, 2020

Year 2021: Rent for Aug.-Oct., 2021 is increased by Rs. 4,000 p.m. from original rent. B will pay Rs. 8,000 p.m. for
Aug.-Oct., 2021

No, because the reduction is of Rs. 1,000 in 2020
but in 2021 the rent increased by Rs. 4,000 from original rent which is not
in proportion to the concession provided

Lessor offers to reduce the monthly rent on the condition that its space is
reduced from 8,000 sq. ft. to 5,000 sq. ft.

No, it would be a substantive change to other
terms and conditions, and therefore the practical expedient would be unavailable
for that rent concession

Rent holiday for May-July, 2020

At the end of the lease term, it gets extended for three months on the terms
and conditions contained in the original lease agreement

Yes, because the lease extension is not considered
as a substantive change to other terms and conditions of the lease. This
point has been clarified in basis for conclusion of the standard

Comparison
between applying the practical expedient and lease modification

Example –
rent abatement

Entity A leases retail space
from Entity B. As at 31^st May, 2020, Entity B grants Entity A a
one-month rent abatement, where rent of Rs. 1 million that would otherwise be
due on 1^st June, 2020 is unconditionally waived. The rent concession
satisfies the criteria to apply the practical expedient. The rent concession is
a lease modification because it is a change in consideration for a lease that
is not part of the original terms and conditions of the lease. The rent
concession meets the definition of a lease modification and it would be
accounted for as such if the practical expedient is not elected by Entity A.

	Practical expedient not applied – lease modification accounting (Ind AS 16.39 – 43)	Practical expedient is applied – variable lease payment accounting [Ind AS 16.38(b)]
Effect on lease liability	Reduced to reflect the revised consideration	Reduced to reflect the revised consideration
Effect on discount rate	The total revised, remaining consideration is re-measured using an updated discount rate as at the effective date of the lease modification	No change in discount rate
Effect on right-of-use asset	The offsetting adjustment is recorded against the carrying value of the right-of-use asset	No effect
Effect on profit or loss	None as at the time of modification; but will result in modified finance expense and depreciation in subsequent periods	The offsetting adjustment is recorded in profit or loss

Practical expedient not applied – lease
modification accounting (Ind AS 16.39 – 43)

Practical expedient is applied – variable lease
payment accounting [Ind AS 16.38(b)]

Effect on
lease liability

Reduced to
reflect the revised consideration

Effect on
discount rate

The total
revised, remaining consideration is re-measured using an updated discount rate
as at the effective date of the lease modification

No change
in discount rate

Effect on
right-of-use asset

The
offsetting adjustment is recorded against the carrying value of the
right-of-use asset

No effect

Effect on
profit or loss

None as at
the time of modification; but will result in modified finance expense and
depreciation in subsequent periods

The
offsetting adjustment is recorded in profit or loss

As is
visible from the above example, the practical expedient provides relief to the
lessee in the following ways:

(a) The lessee does not have to assess each rent
concession to determine whether it meets the definition of a lease
modification;

(b) It also simplifies the
calculations that are prepared by the lessee, since it does not require a revised
discount rate;

(c) The rent concession is accounted in profit or
loss in the period in which the event or condition that triggers the revised
consideration occurs, rather than being reflected in future periods as revised
finance expense and depreciation of the right-of-use asset.

CONCLUSION

The author believes that the
practical expedient is a welcome relief for lessees that have a large number of
leases, for example, airline, telecom, retail and other entities. However,
applying practical expedient may not be as simple as it appears and there could
be numerous complexities in determining what scenarios can be subjected to a
practical expedient, as well as the accounting of the practical expedient.

If the lessee applies the
practical expedient, it shall disclose if it has applied the expedient to all
lease contracts or the nature of the contracts to which it has applied the
expedient. The lessee should also disclose the P&L impact of applying the
practical expedient.

shailesh.kwebmaker

OECD’S ‘GloBE’ PROPOSAL – PILLAR TWO (Tax Challenges of the Digitalisation of the Economy – Part II)

The current international tax
architecture is being exploited with the help of digitalised business models by
the Multinational Enterprises (MNEs) to save / avoid tax through BEPS. To
counter this, the existing tax rules require reconsideration and updation on
the lines of the digitalised economy. Many countries have introduced unilateral
measures to tackle the challenges in taxation arising from digitalisation which
restricted global trade and economy.

Now, OECD has set the deadline of
end-2020 to come out with a consensus-based solution to taxation of
cross-border transactions driven by digitalisation. For this, OECD has
published two public consultation documents, namely (i) ‘Unified Approach under
Pillar One’ dealing with Re-allocation of profit and revised nexus rules, and
(ii) ‘Global Anti-Base Erosion Proposal (GloBE) – Pillar Two’. It is important
to understand these documents because once modified, accepted and implemented
by various jurisdictions, they will change the global landscape of international
taxation in respect of the digitalised economy.

Part I of this article on ‘Pillar
One’ appeared in the January, 2020 issue of the BCAJ. This, the second
article, offers a discussion on the document dealing with GloBE under ‘Pillar
Two’.

1.0 BACKGROUND

Thanks to advances in technology,
the way businesses were hitherto conducted is being transformed rapidly. In
this era of E-commerce, revenue authorities are facing a lot of challenges to
tax Multinational Enterprises (MNEs) who are part of the digital economy. To
address various tax challenges of the digitalisation of the economy, OECD in
its BEPS Action Plan 1 in 2015 had identified many such challenges as one of
the important areas to focus upon. Since there could not be any consensus on
the methodology for taxation, the Action Plan recommended a consensus-based
solution to counter these challenges. OECD has targeted to develop such a
solution by the end of 2020 after taking into account suggestions from the
various stakeholders. Meanwhile, on the premise of the options as examined by
the Task Force on the Digital Economy (TFDE), the BEPS Action Plan 1 suggested
three options to counter the challenges of taxation of the digitalised economy
which could be incorporated in the domestic laws of the countries. It is
provided that the measures to tackle the challenges of taxing digitalised
economy shall not be incompatible with any obligation under any tax treaty or
any bilateral treaty. They shall be complementary to the current international
legal commitments.

OECD issued an interim report in
March, 2018 which examines the new business framework as per the current
digitalised economy and its impact on the international tax system. In January,
2019 the Inclusive Framework group came up with a policy note to address the
issues of taxation of digitalised economy into two complementary ‘pillars’ as
mentioned below:

Pillar 1 – Re-allocation of
Profits and the Revised Nexus Rules

Pillar 2 – Global Anti-Base
Erosion Mechanism

The three proposals suggested under
Pillar 1 are as follows:

(i) New Nexus Rules – Allocation based on sales rather than physical
presence in market / user jurisdiction;

(ii) New Profit Allocation Rules – Attribution of profits based on
sales even in case of unrelated distributors (in other words, allocation of
profits beyond arm’s length pricing, which may continue concurrently between
two associated enterprises);

(iii) Tax certainty via a three-tier mechanism for profit allocation:

(a) Amount A: Profit allocated to market jurisdiction in absence of
physical presence.

(b) Amount B: Fixed returns varying by industry or region for certain
‘baseline’ or ‘routine’ marketing and distributing activities taking place (by
a PE or a subsidiary) in a market jurisdiction.

(c) Amount C: Profit in excess of fixed return contemplated under
Amount B, which is attributable to marketing and distribution activities taking
place in marketing jurisdiction or any other activities. Example: Expenses on
brand building or advertising, marketing and promotions (beyond routine in
nature).

Thus, it highlights potential
solutions to determine where the tax should be paid and the basis on which it
should be paid.

Let us look at the proposals
under Pillar Two in more detail.

2.0 PILLAR TWO – GLOBAL
ANTI-BASE EROSION PROPOSAL (‘GloBE’)

The public consultation document
has recognised the need to evolve new taxing rules to stop base erosion and
profit shifting into low / no tax jurisdictions through virtual business
structures in a digitalised economy. According to the document, ‘This Pillar
seeks to comprehensively address remaining BEPS challenges by ensuring that the
profits of internationally operating businesses are subject to a minimum rate
of tax. A minimum tax rate on all income reduces the incentive for taxpayers to
engage in profit shifting and establishes a floor for tax competition among
jurisdictions.’

The harmful race to the bottom on
corporate taxes and uncoordinated and unilateral efforts to protect the tax
base has led to the increased risk of BEPS, leading to a lose-lose situation
for all jurisdictions in totality. Therefore, the GloBE proposal is an attempt
to shield the tax base of jurisdictions and lessen the risk of BEPS.

Broadly, the GloBE proposal aims
to have a solution based on the following key features:

(i) Anti-Base Erosion and Profit Shifting

It not only aims to eliminate
BEPS, but also addresses peripheral issues relating to design simplicity,
minimise compliance and administration costs and avoiding the risk of double
taxation. Taxing the entities subject to a minimum tax rate globally will seek
to comprehensively address the issue of BEPS. Such a proposal under Pillar Two
will cover the downside risk of the tax revenue of the MNEs globally by
charging a minimum tax rate, which otherwise would lead to a lose-lose
situation for various jurisdictions.

(ii) New taxing rules through four component parts of the GloBE proposal

The four component parts of the
GloBE proposal, proposed to be incorporated by way of changes into the domestic
laws and tax treaties, are as follows:

(a) Income inclusion rule

Under this rule, the income of a
foreign branch or a controlled entity if that income was subject to tax at an
effective rate that is below a minimum rate, will be included and taxed in the
group’s total income.

For example, the profits of the
overseas branch in UAE of a Hong Kong¹ (HK) company will be included in the taxable
income in HK, as the UAE branch is not subjected to tax at the minimum rate,
say 15%. But for this rule, profits of the overseas branch of an HK company
would not have been taxed in HK. Of course, HK may have to amend its domestic
law to provide for such taxability.

Example 1 – Accelerated taxable
income (as given in the public consultation document). In our
opinion, this example throws light on the income inclusion rule.

Application of income inclusion
rule

Example 1

Year 1

Year 2

Inclusion rule (Book)

Country B (Tax)

Inclusion rule (Book)

Country

B (Tax)

Income

100

Expenses

(10)

(20)

(10)

(0)

Net income

(0)

Tax paid

(16)

Minimum tax (15% x net income)

(6)

Excess tax (= Tax paid – Minimum tax)

Tentative inclusion rule tax

–

Excess tax carry-forward
used

–

(6)

Inclusion rule tax

–

Remaining excess tax
carry-forward

(b) Undertaxed payments rule

It would operate by way of denial
of a deduction or imposition of source-based taxation (including withholding tax)
for a payment to a related party, if that payment was not subject to tax at or
above a minimum rate.

(c) Switch-over rule

It is to be introduced into tax
treaties such that it would permit a residence jurisdiction to switch from an
exemption to a credit method where the profits attributable to a Permanent
Establishment (PE) or derived from immovable property (which is not part of a
PE) are subject to an effective rate below the minimum rate.

(d) Subject to tax rule

It would complement the
under-taxed payment rule by subjecting a payment to withholding or other taxes
at source and adjusting eligibility for treaty benefits on certain items of
income where the payment is not subject to tax at a minimum rate.

The GloBE proposal recognises the
need for amendment of the domestic tax laws and tax treaties to implement the
above four rules. However, it also cautions for coordinated efforts amongst
countries to avoid double taxation.

3.0 DETERMINATION OF TAX
BASE

The first step towards applying a
minimum tax rate on MNEs is to determine the tax base on which it can be
applied. It emphasises the use of financial accounts as a starting point for
the tax base determination, as well as different mechanisms to address timing
differences.

3.1 Importance of consistent tax base

One of the simple methods to
start determining the tax base is to start with the financial accounting rules
of the MNE subject to certain agreed adjustments as necessary. The choice of
accounting standards to be applied will be subject to the GloBe proposal. The
first choice to be made is between the accounting standards applicable to the
parent entity or the subsidiary’s local GAAP. The next choice is which of the
accounting standards will be acceptable for the purposes of the GloBE proposal.

As per the public document, it is
suggested to determine the tax base as per the CFC Rules or, in absence of CFC
rules, as per the Corporate Income Tax Rules of the MNE’s jurisdiction. Such an
approach will overcome the limitation of the inclusion of only certain narrow
types of passive income. However, it would mean that all entities of an MNE
will need to recalculate their income and tax base each year in accordance with
the rules and regulations of the ultimate parent entity’s jurisdiction. There
can be differences in accounting standards between the subsidiary’s
jurisdiction and the ultimate parent entity’s jurisdiction, and to address the
same the public document recommends that the MNE groups shall prepare the
consolidated financial statements and compute the income of their subsidiaries
using the financial accounting standards applicable to the ultimate parent
entity of the group as part of the consolidation process.

Accounting standards which are
accepted globally can serve as a starting point for determining the GloBE tax
base.

3.2 Adjustments

Financial accounting takes into
account all the income and expenses of an enterprise, whereas accounting for
tax purposes can be different. Relying on the unadjusted figures in accounts
could mean that an entity’s net profits may be overstated or understated when
compared to the amount reported for tax purposes. Most of the differences among
the accounting standards will be timing differences and some of the differences
may be permanent differences or temporary differences that require further
consideration, and some of the timing differences may be so significant that
they warrant the same consideration as permanent differences.

3.2.1 Permanent differences

Permanent differences are
differences in the annual income computation under financial accounting and tax
rules that will not reverse in the future. Permanent differences arise for a
variety of reasons. The need to adjust the tax base may depend upon the level
of blending ultimately adopted in the GloBE proposal. Inclusions and exclusions
of certain types of income and expenses in domestic tax policy may lead to
permanent differences. Thus, consideration for such differences is of utmost
importance while determining the tax base.

Examples of permanent differences

Dividends received from foreign
corporations and gains on sale of corporate stocks may be excluded from income
to eliminate potential double taxation. Under the worldwide blending approach,
the consolidated financial statements should eliminate dividends and stock
gains in respect of entities of the consolidated group. However, under a
jurisdictional or entity blending approach, the financial accounts of the group
entities in different jurisdictions would be prepared on a separate company
basis and dividends received from a ‘separate’ corporation would be included in
the shareholder’s financial accounting income.

Permanent difference also arises
due to disallowance of certain deductions under the domestic tax laws of a
particular jurisdiction, such as entertainment expenses, payment of bribes and
fines, etc.

3.2.2 Temporary differences

Temporary differences are
differences in the time for taking into account income and expenses that are
expected to reverse in the future. It can lead to a low cash effective tax rate
at the beginning of a period and high cash effective tax rate at the end of a
period, or vice versa. A separate blending approach may lead to
difference volatility in the ETR from one period to another. Temporary
differences are very important in determination of the tax base and also affect
the choice of blending.

Approaches to addressing
temporary differences

The public consultation document
on Pillar Two lists three basic approaches to addressing the problem of
temporary differences, namely,

(i) carry-forward of excess taxes and tax attributes,

(ii) deferred tax accounting, and

(iii) a multi-year average effective tax rate.

It also provides that these basic
approaches could be tailored and elements of the different approaches could be
combined to better or more efficiently address specific problems.

4.0 BLENDING OF HIGH-TAX
AND LOW-TAX INCOME FROM ALL SOURCES

According to the public
consultation document, ‘Because the GloBE proposal is based on an effective
tax rate (“ETR”) test it must include rules that stipulate the extent to which
the taxpayer can mix low-tax and high-tax income within the same entity or
across different entities within the same group. The Programme of Work refers
to this mixing of income from different sources as “blending.”’

Blending means the process of mixing
of the high-tax and low-tax income of an MNE from all the sources of all the
entities in the group. Blending will help to calculate the ETR on which the
GloBE proposal is based. It can be done on a limited basis or a comprehensive
basis, from a complete prohibition on blending to all-inclusive blending.
Limited basis will lead to no or less blending (mixing) of income and taxes of
all different entities and jurisdictions. This would restrict the ability of an
MNE to reduce charge of tax applied on all entities across all jurisdictions
through mixing the high-tax and low-tax income.

It is suggested to apply the
GloBE proposal (minimum tax rate rule) in the following manner:

First Step: Determine
the tax base of an MNE and then calculate the Effective (blended) Tax Rate
[ETR] of the MNE on the basis of tax paid.

Second Step: Compare
the ETR with the Minimum Tax Rate prescribed according to the relevant blending
approach.

Third and the final Step: Use any
of the four components as specified in the GloBE proposal to the income which
is taxed below the minimum tax rate prescribed. [The four components as
discussed above are: (i) Income inclusion rule, (ii) Under-taxed payments rule,
(iii) Switch-over rule and (iv) Subject to tax rule].

Determining the Effective
(blended) Tax Rate [ETR] of the MNEs forms the second step in applying a
minimum tax rate rule. It throws light on the level of blending under the GloBE
proposal, i.e., the extent to which an MNE can combine high-tax and low-tax
income from different sources taking into account the relevant taxes on such
income in determining the ETR on such income.

There are three approaches to
blending:

4.1 Worldwide blending approach

4.2 Jurisdictional blending approach

4.3 Entity blending approach.

The above three different
blending approaches are explained in brief below:

4.1 Worldwide blending approach

In this case, total foreign
income from all jurisdictions and tax charged on it are mixed. An MNE will be
taxed under such an approach if the total tax charged on such foreign income of
an MNE is below a prescribed minimum rate. The additional tax charged on such
income will be the liability of an MNE to bring the total tax charged to the
prescribed minimum rate of tax.

4.2 Jurisdictional blending approach

In this case, blending of foreign
income and tax charged on such income will be done jurisdiction-wise. The
liability of additional tax would arise when the income earned from all the
entities in a particular jurisdiction is below the minimum rate, i.e., if an
MNE has been charged lower tax on the income from a particular jurisdiction
than the minimum rate of tax. The sum of the additional taxes of all the
jurisdictions will be the tax liability of an MNE.

4.3 Entity blending approach

Under this approach blending is
done of income from all sources and tax charged on such income in respect of
each entity in the group. Additional tax will be levied on an MNE whenever any
foreign entity in a group is charged with tax below the minimum tax rate
prescribed for that foreign entity.

All three approaches have the
goal congruence of charging MNEs a minimum rate of tax globally with different
policy choices.

In addition, in respect of
blending, the public consultation document on Pillar Two also explains in
detail the following:

(1) Effect of blending on volatility

(2) Use of consolidated financial accounting information

(3) Allocating income between branch and head office

(4) Allocating income of a tax-transparent entity

(5) Crediting taxes that arise in another jurisdiction

(6) Treatment of dividends and other distributions.

5.0 CARVE-OUTS

Implementation of the GloBE
proposal is fraught with many challenges and therefore, to reduce the
complexity and restrict the application, the Programme of Work²,
through its public consultation document, calls for the exploration of possible
carve-outs as well as thresholds and exclusions. These carve-outs / thresholds
/ exclusions will ensure that small MNEs are not burdened with global
compliances. They would also provide relief to specific sectors / industries.

The Programme of Work calls for
the exploration of carve-outs, including for:

(a) Regimes compliant with the standards of BEPS Action 5 on harmful tax
practices and other substance-based carve-outs, noting, however, that such
carve-outs would undermine the policy intent and effectiveness of the proposal.

(b) A return on tangible assets.

The Programme of Work also calls
for the exploration of options and issues in connection with the design of
thresholds and carve-outs to restrict application of the rules under the GloBE
proposal, including:

(i) Thresholds based on the turnover or other indications of the size
of the group.

(ii) De minimis thresholds to exclude transactions or entities
with small amounts of profit or related party transactions.

(iii) The appropriateness of carve-outs for specific sectors or industries.

6.0 OPEN ISSUES

There are several open issues in
the proposed document, some of which are listed below:

6.1 Appropriate Accounting Standards

Determination of tax base is the
starting point to apply measures given in the GloBE proposal. Thus, the use of
financial accounting is the basis to determine the tax base. Hence, the issue
could be, which of the accounting standards would be appropriate and
recommended for determining the tax base across various jurisdictions?

6.2 Non-preparation of consolidated accounts by smaller MNEs

There can be some instances when
smaller MNEs are not required to prepare consolidated accounts by the statute
for any purpose. In such a case where the information is not consolidated, how
will the tax base be determined?

6.3 Compliance cost and economic effects

The blending process,
irrespective of the policy approach, will have a lot of compliance costs which
may even exceed the economic benefit out of the process. How does the GloBE
proposal deal with this?

6.4 Changes in ETR due to tax assessments in subsequent years

MNEs operate in different
jurisdictions and each jurisdiction may have different tax years, assessment
procedures and so on. It is very likely that tax determined for a particular
year based on self-assessment may undergo significant change post-assessment or
audit by tax authorities. This may change the very basis for benchmarking of
ETR with a minimum tax rate. There should be a mechanism to make adjustments
beyond a tolerable limit of variance.

7.0 CONCLUSION

OECD had asked for public
comments on its document on GloBE not later than 2^nd December, 2020.
However, there are several areas yet to be addressed which are ambiguous and to
find solutions to them within a short span of time till December, 2020 is
indeed a daunting task. However, it is also a fact that in the absence of
consensus and delay in a universally acceptable solution, more and more
countries are resorting to unilateral measures to tax MNEs sourcing income from
their jurisdictions.

In this context, it is important
to note that vide Finance Act, 2016 India introduced a unilateral
measure of taxing certain specified digitalised transactions by way of
Equalisation Levy (EL) @ 6%. The scope of EL is expanded significantly by the
Finance Act, 2020 by providing that E-commerce operators, including
facilitators, shall be liable to pay EL @ 2% on the consideration received
towards supply of goods and services.

Determination
of a tax base globally on the basis of consolidated profits is a very complex
process. To give effect to all the permanent and temporary differences while
determining the tax base along with blending of income from different sources
from all jurisdictions will be a challenging task for the MNEs. It is to be seen
how effectively the four components of the GloBE proposal, individually and in
totality, will be practically implemented. The success of the GloBE proposal
also depends upon the required changes in the domestic tax laws by the
countries concerned. The cost of compliance and uncertainty may also need to be
addressed. A higher threshold of revenue could take care of affordability of
cost of compliance by MNEs, whereas clear and objective rules may take care of
uncertainty.

All
in all, we are heading for a very complex global tax scenario.

shailesh.kwebmaker

COVID-19 AND TRANSFER PRICING – TOP 5 IMPACT AREAS

Starting December, 2019, the
world has witnessed the once-in-a-generation pandemic. Multinational
Enterprises will have to consider the effect of COVID 19 on their transfer
pricing policies due to large scale economic disruption. It will be imperative,
especially in this economic environment, to adhere to and demonstrate arms
length behaviour. Many MNEs have started revisiting transfer pricing policies,
inter company agreements, and documentation standards.

This article highlights the top
five transfer pricing impact areas arising out of Covid-19:

Supply chain restructuring

Renegotiation of pricing and other terms

Cash optimisation

Balancing business uncertainty with tax
certainty

Benchmarking

Towards the end of the article,
some recommendations have also been outlined for consideration of the
government authorities to make it easier for taxpayers to demonstrate
compliance with arm’s length principles.

1. Supply chain restructuring

MNE groups with geographically
diverse supply chains are affected severely due to the pandemic. Any disruption
to any part of the supply chain tends to impact the entire group, though the
extent of the impact depends on the importance of the part of the supply chain
which has been disrupted and the availability of alternatives.

Many MNE groups have discovered
the fragility in their value chains as a result of the disruption caused by the
pandemic. They are faced with one or more of the following situations:

Longer than needed supply chain involving
various countries

Overdependence on a particular supplier /
set of suppliers / region / country for materials / services / manufacturing /
market

Affiliate(s) finding it difficult to sustain
their businesses owing to disruption caused by the pandemic

Unviable non-core businesses.

MNE groups could consider this as
an opportunity to revisit their existing supply chains and also potentially
restructure the supply chain to achieve one or more of the following:

Shorter supply chains involving lesser
number of geographical locations

Creation of alternate sourcing destinations
for materials and services

Setting up of manufacturing / service
facilities in alternate destinations

Closure and / or monetisation of non-core
businesses / entities.

These restructuring transactions
could raise multiple transfer pricing issues, including:

Exit charges for that affiliate which will
be eliminated from the supply chain / will get reduced business because of
creation of an alternate destination

New transfer pricing agreements, policies
and benchmarks to be developed in case of setting up of affiliates in new /
alternate jurisdictions

Valuation issues in case non-core assets are
transferred to affiliates

Issues relating to bearing of closure costs
in case some group entities or part of their businesses face insolvency /
closure

Issues around identification and valuation
of intangibles involved in the restructuring exercise

Appropriate articulation of restructuring
transactions in the local files of the entities concerned and the Master File
of the group.

2. Renegotiation of pricing and other terms

In arm’s length dealings,
businesses are in fact renegotiating prices as well as other terms, mainly with
their vendors.

In the case
of many MNEs it would be perfectly arm’s length behaviour for different
entities within the group to start discussions and re-negotiations regarding
prices and other terms of their inter-company transactions. In fact, in many
cases it might be non-arm’s length for companies to not renegotiate with their
affiliates. In almost all cases, it would be arm’s length behaviour to have
inter-company agreements which mirror agreements that would have been entered
into between third parties.

Renegotiations of existing
arrangements / agreements could be of at least the following types:

2.1. Compensation for limited
risk entities in the group

Many MNEs
have entities which operate as limited risk entities, such as captive service
providers, contract manufacturers, limited risk distributors, etc. As a general
rule, these limited risk entities are eligible for a stable income, all
residual profits or losses being attributed to the Principal affiliate.
However, in today’s dynamic business environment, no-risk entities do not exist
and limited risk entities also bear some risks. For example, limited risks
captive service providers or contract manufacturers have a significant single
customer risk; therefore any adverse disruption to that single customer will
adversely impact the captive as well.

In times of disruption like this,
exceptions to the general rule may be warranted and compensation for limited
risk activities may need to be revisited, depending, inter alia, on the
type of activity performed, type of disruption faced and the control and decision-making
capabilities of each of the parties involved.

In third party situations the
service provider would be better off to agree to reduced income (or even losses
in the short term) from the Principal, especially if the Principal itself is
facing challenges relating to its own survival. Accordingly, on a case-to-case
basis, certain MNEs may have the ability / necessity to revisit their
arrangements with their captive entities for the short to medium term. The
revision in the inter-company agreements could take several forms. For
instance, such revised agreements may provide for compensation for only costs
(without a mark-up), reduced mark-up, compensation for only ‘normal’ costs
(with or without mark-up), etc.

2.2. Renegotiations of other terms

It is common for entities in an
MNE group to negotiate prices of their inter-company transactions from time to
time in line with the prevailing business dynamics. However, in emergencies
like these certain other terms of the agreements between affiliates may also
need to be renegotiated. For example, the commitment relating to quantities
which a manufacturer will purchase from the related raw material supplier may
undergo a significant renegotiation. Given the non-recovery of fixed costs due
to the resulting idle capacity, the raw material cost per unit may increase
which the supplier may want to pass on to the manufacturer. A higher per unit
cost, on the other hand, may make the related supplier uneconomical for the
manufacturer. In the interest of the long-term commercial relationship, the
parties may agree to an in-between pricing mechanism, as is likely to be the
case in third-party dealings. Which party would bear which types of costs would
depend on the characterisation of the parties, the decision-making evidenced
through capabilities of the persons involved, and the options realistically
available to the parties involved.

3. Cash optimisation

Cash optimisation is currently
one of the most important considerations of businesses across the world.

Many MNE groups facing a cash
crunch have started looking at the cash position with different group entities
and trying to optimise the cash available with them. This could lead to some
new funding-related transactions and benchmarking issues such as those relating
to interest and guarantee fees transactions between affiliates.

In some situations, taxpayers
that have borrowed funds from their affiliates and are not in a position to
honour their interest / principal repayment commitments could approach their
affiliate lenders to negotiate for a reduction in interest rate / interest
waiver / moratorium at least for some period of time. On the other hand, the
lender affiliate may want to balance the moratorium with a revision in the
interest rate. Significant movements in exchange rates of currencies primarily
attributable to the pandemic could make this negotiation even more dynamic. Any
kind of negotiation should take into account the perspectives of both parties
and options realistically available to them.

Similarly, payment terms for
goods or services purchased from or sold to AEs or other inter-company
transactions, such as royalties, could also be renegotiated at least for the
short term, to enable different entities within the MNE group to manage their
working capital cycle more efficiently.

4. Balancing business uncertainty with tax certainty

4.1. Advance Pricing Agreements (APAs)

Globally, APAs have been an
effective tool for taxpayers and tax authorities to achieve tax certainty.
However, in times like these businesses go through unprecedented levels of
uncertainty. Therefore, many taxpayers may find it against their interest to be
bound by the terms of the APAs, especially where these provide for a minimum
level of tax profits to be reported by the taxpayer.

If their circumstances warrant
it, taxpayers who have already entered into an APA may consider applying for
revision of the same. The law provides that an APA may be revised if, inter
alia, there is a change in the underlying critical assumptions¹. Most Indian APAs have a critical assumption
of the business environment being normal through the term of the APA. In times
like these, a request for revision may be warranted if the business environment
for the taxpayer is considered to be abnormal based on the specific facts and
circumstances of its case and the impact of the uncertainty on the transaction
under consideration.

If the taxpayer and the
authorities do not agree to the revision, the taxpayer may potentially also
request for cancellation of the agreement². On the other hand, in
case the tax authorities believe that cancellation of the agreement is
warranted due to failure on the part of the taxpayer to comply with its terms,
the taxpayer should utilise the opportunity provided to it to explain the
pandemic-related impact on the APA and the related reason for its failure to
comply with the terms of the agreement.

For taxpayers who are in the
process of negotiating for their APAs, and for whom the business impact is very
uncertain right now, it may be prudent to wait to get some more clarity
regarding the full impact of the pandemic on their business before actually
concluding the APA.

Alternatively,
taxpayers should request for an APA for a shorter term, say a period of up to
Financial Year (F.Y.) 2019-20, even if it means entering into the APA for, say
three or four years. Another APA could then be applied for, starting F.Y.
2021-22, based on the scenario prevailing then.

4.2. Safe harbours

The government has not yet
pronounced the safe harbours for the F.Y. 2019-20. Once these are pronounced,
depending on their industry, extent of business disruption, expected loss of
business / margins and the safe harbours provided for F.Y. 2019-20 and onwards,
taxpayers should evaluate whether or not to opt for safe harbours at least for
the F.Y.s 2019-20 and 2020-21.

5. Benchmarking

The current economic situation is
likely to create some unique benchmarking issues which should be borne in mind.
While some of these issues are common to taxpayers globally, a few issues are
specific to India given the specific language of the Indian transfer pricing
regulations.

5.1. Justification of losses / low margins

Taxpayers are facing several
business challenges including cost escalations / revenue reductions which are
not related to their transactions with affiliates. Taxpayers in several sectors
have recorded sharp declines in revenues due to lockdowns in various parts of
the world, including India. Some taxpayers are faced with the double whammy of
escalated costs even in times of reduced revenues. Escalated costs could
include, for example, additional costs relating to factory personnel who are
provided daily meals and other essentials, additional transportation costs
incurred to arrange special transport for essentials owing to most fleet
operators not plying, etc.

It is pertinent for taxpayers to
identify and record these expenses separately from the expenses incurred in the
regular course of business (preferably using separate accounting codes in the
accounting system). Depending on the transfer pricing method and comparables
selected, taxpayers should explore the possibility of presenting their
profitability statements excluding the impact of these additional costs /
reduced revenues.

Another alternative available to
taxpayers is to justify their transfer prices considering alternative profit
level indicators (PLIs).

In any case, given the fact that
a lot of information about comparable benchmarks is not available in the public
domain currently, business plans, industry reports, business estimates, etc.,
prepared / approved by the management of the organisation should be maintained in
the documentation file and presented to the transfer pricing authorities if
called for.

5.2. Loss-Making Comparables

During times of emergency like
these, for many businesses the focus shifts from growth / profitability to
survival. Therefore, many businesses could try operating at marginal costing
levels to recover committed costs / utilise idle capacity. Therefore, businesses
operating at net operating losses could be a normal event at least in times
like these. Secondly, even the taxpayer could have been pushed into losses
because of completely commercial reasons and even such losses could be arm’s
length and commercially justifiable.

From the
perspective of transfer pricing benchmarking, persistently loss-making
companies are typically rejected as comparables mainly because they do not
represent the normal economic assumption that businesses operate to make
profits. However, in times when business losses are normal events, benchmarking
a loss-making taxpayer with only profit-making comparables would lead to
artificial benchmarks and, potentially, unwarranted transfer pricing additions
in the hands of taxpayers.

In case loss-making comparables
are indeed rejected, it could be more prudent to reject companies making losses
at a gross level.

5.3. Unintended comparables

The current
focus of many businesses is survival. Businesses which have created capacities
to cater to their affiliates may find it difficult to sustain if the impact of
the pandemic lasts longer than a few months. For example, consider the case of
an Indian manufacturer whose manufacturing capacities are created based on
demand projections and confirmed orders from its affiliates. Since the
capacities are completely used up in catering to demand from its affiliates,
the manufacturer does not cater to unrelated parties. In case there is a
disruption in the demand from such affiliates expected in the medium term, in
order to sustain in the short to medium term, the Indian manufacturer could
start using its manufacturing set-up for other potential (unrelated) customers
also. While this appears to be a purely rational business decision by the
Indian manufacturer, a question arises whether such third-party dealings will
be considered as comparable transactions for dealings with affiliates. The
Indian manufacturer in this case would need to be able to document the business
justification for entering into these transactions with unrelated parties and
whether these are economically and commercially different from the routine
related party transactions. Similar issues could arise in respect of other
transactions such as temporary local procurement, local funding, etc.

5.4. Mismatch in years and adjustments

The Indian transfer pricing
regulations provide for the use of three years’ data of comparables to iron out
the impact of cyclical events from the benchmarking analysis. However, data of
the last two years may not be representative of the conditions prevailing in
the current year (in this context, current year could be F.Y. 2019-20 as well
as 2020-21, both years being impacted to different extents due to the
pandemic).

Since the financial data of a lot
of comparables is not available up to the due date of transfer pricing
compliance, this mismatch may lead to a situation where normal business years
of comparables are compared with the pandemic-affected years of taxpayers – a
situation which is very likely to give skewed results.

Adjustments are regularly made to
minimise the impact of certain differences between a tested party (say,
taxpayer) and the comparable benchmarks. Depending on the industry in which the
taxpayer operates and the manner in which its affiliates are impacted,
taxpayers may need to make adjustments, including some unique adjustments, to
more aptly reflect the arm’s length nature of inter-company prices.

However, in the Indian context
the law does not provide for the making
of adjustments to the tested party and the adjustments are to be
necessarily made to comparable data³. Given the lack of reliable
data for making adjustments, the reliability of the adjustments themselves may
be questioned.

It must be borne in mind that the
principle which necessitates downward adjustments to comparables’ margins
currently being made to normal years will also require upward adjustments to
comparables’ margins in respect of pandemic-affected years going forward. This
situation is simplistically illustrated in Table 1 below. For the purpose of
the illustration, it is assumed that:

F.Y. 2017-18 and 2018-19 are considered as
normal business years

F.Y. 2019-20 is impacted by the pandemic,
but to a lesser degree

F.Y. 2020-21 is impacted severely by the
pandemic

F.Y. 2021-22 is a normal business year

At the time of conducting the benchmarking
analysis, comparables’ data is available for only the last two years.

Table 1 – Year-wise comparability⁴
and adjustments⁵

Tested
Financial Year

Comparable
Financial Years

Adjustments
Required (say, adjustments to margins)

Remarks

2019-20

2018-19, 2017-18

Downward

Downward adjustment due to loss of business
compared to normal years (2018-19, 2017-18)

2020-21

2019-20, 2018-19

Downward

Downward adjustment due to loss of business
compared to normal / less impacted years (2019-20, 2018-19)

2021-22

2020-21, 2019-20

Upward

Upward adjustment due to normal business compared
to impacted years (2020-21, 2019-20)

6. Recommendations to government authorities

Government authorities could
consider the following recommendations by way of amendments to the law to relax
adherence to transfer pricing regulations for taxpayers, especially for F.Y.s
2019-20 and 2020-21, i.e., the impacted years:

Expansion of arm’s length range –
Since different industries and different companies in the same industry will
respond to the pandemic in different ways, the margins of comparables over the
next two years could be extremely varied. Therefore, for the impacted years the
arm’s length range may be expanded from the current 35^th to 65^th
percentile to a full range, or inter-quartile range (25^th to 75^th
percentile), as is used globally. Similarly, the applicable tolerance band
could be appropriately increased from the current 1% / 3%.

Extending compliance deadline – In
case the deadline for companies to file their financial statements for F.Y.
2019-20 with the Registrar of Companies (RoC) is extended, the deadline for
transfer pricing compliance should also be extended, to give the taxpayers
their best chance to use comparable data for F.Y. 2019-20.

Extending deadlines for Master File
compliance – It is expected that companies will take time to be able to
fully assess the impact of the pandemic on their business models, value chains,
profit drivers, etc., and then appropriately document the same in their Master
File. Therefore, the due date for Master File compliances may be extended at
least for F.Y. 2019-20.

Adjustment to taxpayer data – At
least for the impacted years, the law could be amended to provide an option to
the taxpayer to adjust its own financial data since the taxpayer will have a
better level of information regarding its own financial indicators.

Multiple year tested party data – As
discussed earlier, the Indian transfer pricing regulations currently provide
for using multiple year data of the comparables as benchmarks for current year
data of the tested party. For F.Y.s 2019-20 and 2020-21, use of multiple year
data could be allowed even for the tested party to average out the impact of
the pandemic to a certain extent.

Safe harbours relaxation – Safe
harbours for F.Y. starting 2019-20 are currently pending announcement. The
authorities could use this opportunity to rationalise these safe harbours to
levels representative of the current business realities and reduce the safe
harbour margins expected of Indian taxpayers. Safe harbours which are
representative of the current business scenario will be very helpful to
taxpayers potentially facing benchmarking issues discussed earlier in the
article.

Relaxation in time period for
repatriation of excess money (secondary adjustment) – Given the cash crunch
being faced by MNEs worldwide, the time period for repatriation of excess money⁶ could be extended from the current period of
only 90 days⁷.

CLOSING REMARKS

While the pandemic has impacted
almost every business in some way or the other in the short term and in many
inconceivable ways in the long term, just this claim alone will not be enough
from a transfer pricing perspective. Taxpayers will need to analyse the exact
impact of the pandemic on their entire supply chain and to the extent possible
also quantify the impact for their specific business. The impact of the
pandemic, steps taken by the management to mitigate the adverse impact,
negotiations / renegotiation (with third parties as well as affiliates),
business plans and business strategies, government policies and interventions
are some of the key factors which will together determine the transfer pricing
impact of the pandemic on the taxpayer.

The pandemic has brought to the
fore the importance of having robust agreements. While the current discussion
revolves mostly around force majeure clauses in third-party agreements,
inter-company agreements are equally important in the context of transfer
prices between the entities of an MNE group. Going forward, for new
transactions with affiliates or at the time of renewal of agreements relating
to existing transactions, care should be taken to draft / revise inter-company
agreements specifically outlining emergency-like situations and the
relationship between the parties in such times. Which party will be responsible
for which functions and would bear what type of risks and costs should be
clarified in detail. Agreements could potentially also include appropriate
price adjustment clauses. MNEs could consider entering into shorter term
agreements till the time the impact of the pandemic is reasonably clear. Having
said that, even if the agreement permits price adjustments, any pricing / price
adjustment decisions taken should also consider the economic situation and the
implication of such decisions under other applicable laws, including transfer
pricing laws of the other country/ies impacted by such decisions.

These times require businesses to
act fast and address several aspects of their business, and often, to keep the
business floating in the near term. Needless to say, taxpayers should
adequately document the commercial considerations dictating these decisions on
a real time basis and be able to present the same to transfer pricing
authorities in case of a transfer pricing scrutiny. Further, in the Master File
taxpayers should include a detailed industry analysis and a description of
business strategies as well as the corporate philosophy in combating the
financial impact of Covid-19, including the relationships with employees,
suppliers, customers / clients and lenders.

Governments and
inter-governmental organisations around the world are closely monitoring the
economic situation caused by the pandemic. Organisations such as OECD are also
monitoring various tax and non-tax measures taken by government authorities to
combat the impact of Covid-19⁸. Taxpayers would do well to
continuously monitor the developments (including issuance of specific transfer
pricing guidelines relevant to this pandemic) at the level of organisations
such as OECD and UN, and also look out for guidance from the government
authorities.

____________________________________________________________

1 Refer Rule 10Q of Income Tax Rules, 1962

2 Refer Rule 10Q of
Income Tax Rules, 1962

3 Refer Rule 10B of Income Tax Rules, 1962

4 Refer Rule 10CA of Income Tax Rules, 1962

5 Refer Rule 10B of
Income Tax Rules, 1962

6 Refer section 92CE of Income-tax Act, 1961

7 Refer Rule 10CB of Income-tax Rules, 1962

8 For instance, the OECD has recently published a report on tax and
fiscal policy in response to the coronavirus crisis. The OECD has also compiled
and published data relating to country-wise tax policy measures. Both, the
report as well as the country-wise data, can be accessed at www.oecd.org/tax

shailesh.kwebmaker

THE IMPACT OF COVID-19 ON INTERNATIONAL TAXATION

The rapid
outbreak of Covid-19 has had a significant commercial impact globally. As
globalisation has led to the world becoming one market (reducing borders and
increasing economic interdependence), the virus knows no borders and the impact
is being experienced by all of us.

Nearly 162 countries and their
governments are enforcing lockdowns and travel restrictions and taking other
measures to control further spread of the virus. The business community across
the world is operating in fear of an impending collapse of the global financial
markets and recession. This situation, clubbed with sluggish economic growth in
the previous year, especially in a developing country like India, is leading to
extremely volatile market conditions. In fact, 94% of the Fortune 1000
companies are already seeing Covid-19 disruptions¹.

Amongst many tax issues (covered
separately in this Journal), this article focuses on cross-border elements in
the new equations. Such cross-border elements include unintended Permanent
Establishment exposure, incidental (and / or accidental) tax residency,
taxation issues relating to cross-border workers and so on. Transfer Pricing
issues have been covered separately in this Journal. In such a background, this
article attempts to throw some light on the impact of the Covid-19 outbreak on
these aspects.

IMPACT
ON CREATION OF PERMANENT ESTABLISHMENT

As the work scenario has changed
across the world due to Covid-19, with most employees working from their homes
while others may have got stuck in foreign countries because of the lockdown,
it has created several questions for companies as to the existence of their
Permanent Establishments in such countries.

The various treaties provide for
several types of PEs such as Fixed Place PE, Agency PE, Construction PE and
Service PE.

Fixed Permanent Establishment
(‘Fixed Place PE’)

A Permanent Establishment is ‘a
fixed place of business through which the business of an enterprise is wholly
or partly carried on’. This is commonly referred to as ‘basic rule of PE’, or
fixed place PE. A fixed place PE exists if the business of the enterprise is
carried out at a fixed place within a jurisdiction, typically for a substantial
period depicting permanence.

For a home office to be
considered the PE of an enterprise, the home office must be used on a
continuous basis for carrying on its business and the enterprise must require
the individual to use that location to carry on the said business.

It is worthwhile to note that the
Hon’ble Apex Court recently in the case of E-funds IT Solutions Inc²
which also relied on the ruling in the case of Formula One³,
held that ‘a Fixed Place PE can be created only if all the tests for the
constitution of a Fixed Place PE are satisfied, i.e., there is a “fixed place
at the disposal of the foreign enterprise”, with some “degree of permanence”,
from which the “business is carried on”’.

The OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis⁴ in paragraphs 5, 8 and 9 provides that under existing
treaty principles it is unlikely that a business will be considered to have a
fixed place PE in a jurisdiction as a result of the temporary presence of its
employees during the Covid-19 crisis. It has stated that ‘individuals who
stay at home to work remotely are typically doing so as a result of government
directives; it is force majeure, not an enterprise’s requirement.
Therefore, considering the extraordinary nature of the Covid-19 crisis, and to
the extent that it does not become the new norm over time, teleworking from
home (i.e., the home office) would not create a PE for the business / employer,
either because such activity lacks a sufficient degree of permanency or
continuity, or because, except through that one employee, the enterprise has no
access or control over the home office’.

A typical
remote work from home scenario in the present crisis is a result of force
majeure, i.e., government travel restrictions or work from home directives
which have been imposed during the pandemic and as such should not result in
the creation of a Fixed Place PE in a foreign jurisdiction. However, time is of
the essence to show how courts and tax authorities interpret Fixed Place PEs
under Covid-19.

Agency Permanent Establishment

The concept of PE has taken birth
in the context of two tax principles, i.e. the residence and source principles
of taxation. As per the source principle, if a tax resident of a particular
country earns income through another person (a separate legal entity) in
another country and where such other person can conclude contracts, then such
person creates an Agency PE in the latter country. The issue which needs to be
addressed is whether the activities of an individual temporarily working from
home for a non-resident employer during the present pandemic could give rise to
a dependent Agent PE.

In the case
of Reuters Limited vs. Deputy Commissioner of Income Tax (ITA No. 7895/Mum/2011)
the concept of Agency PE was discussed in detail wherein it was held that ‘A
qualified character of an agency is providing authorisation to act on behalf of
somebody else as to conclude the contracts’. This means that the presence
which an enterprise maintains in a country should be more than merely
transitory if the enterprise is to be regarded as maintaining a PE, and thus a
taxable presence, in that country.

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘an
employee’s or agent’s activity in a State is unlikely to be regarded as
habitual if he or she is only working at home in that State for a short period
because of force majeure and / or government directives extraordinarily
impacting his or her normal routine’.

Construction Permanent
Establishment

The concept of Construction PE
provides that profits generated from construction works will be taxed in the
country in which the permanent establishment (construction site) is placed or located.

In general, a construction site
will constitute a PE if it lasts more than 12 months under the OECD Model, or
more than six months under the UN Model. However, the threshold may vary in
different tax treaties. It appears that many activities on construction sites
are being temporarily interrupted by the Covid-19 crisis.

In this regard, it has been seen
that the Indian tax authorities do not assume that interruptions of works at
site are to be excluded from the project period. OECD in its Secretariat
Analysis of Tax Treaties and the Impact of the Covid-19 Crisis has stated that ‘it
appears that many activities on construction sites are being temporarily
interrupted by the Covid-19 crisis. The duration of such an interruption of
activities should however be included in determining the life of a site and
therefore will affect the determination, whether a construction site
constitutes a PE. Paragraph 55 of the Commentary on Article 5(3) of the OECD
Model explains that a site should not be regarded as ceasing to exist when work
is temporarily discontinued (temporary interruptions should be included in
determining the duration of a site).’

However, it is questionable
whether this case can be applied to the current pandemic situation which was
simply unpredictable. It is a natural event, but not seasonal. It is not even
predictable with a sufficient probability, as in bad weather. It is simply not
calculable; it is a classic force majeure scenario.

Service Permanent Establishment

Globalisation has led Multinational
Enterprises (MNEs) to increase cross-border secondment of technical, managerial
and other employees to their subsidiaries located in low-cost jurisdictions
such as India. The rationale behind seconding such employees is sometimes to
help the subsidiaries avail the benefit of the skill and expertise of the
seconded employees in their respective fields, and sometimes to exercise
control.

Secondment of employees has
become a really significant area, given that some bank staff or companies’
staff on assignments or secondments may be trapped in their non-native country
due to the travel restrictions, while others may have come back earlier than
expected; such situations might create a Service Permanent Establishment
(Service PE) for the companies.

Forced quarantine may delay the
intended secondment of an employee abroad or make a person employed on a
foreign contract decide to return to India due to reasons beyond control. In
this case, work for a foreign employer will be performed from India. This may
result in the creation of taxability of the employee’s income in India and in
some cases may even create risk of a permanent establishment. It is pertinent
to note, of course, that each case should be analysed on its own merits.

The concept of PE has been
defined extensively in various places but the interpretation of the same
continues to be complex and subjective. The distinct nature of each transaction
makes the interpretation of the law and the judicial precedents worth noting.
There can be no thumb rule which can be inferred from the jurisprudence or OECD
guidelines at present to the current crisis. Whether the virus-induced duration
of interruption would be included in the deadline in individual cases will
depend upon the specific circumstances.

We have
experienced in the recent past that India has been the frontrunner in
implementing the recommendations of OECD G-20 nations which are being discussed
under the initiative of BEPS Action Plans. Examples of this are introduction of
the concept of Significant Economic Presence (SEP) and Equalisation Levy (EL)
in the statute. However, it is important to see whether the same enthusiasm is
shown while implementing the recommendations on Covid-19-related aspects.

IMPACT
ON RESIDENTIAL STATUS OF A COMPANY (PLACE OF EFFECTIVE MANAGEMENT)

A company is generally tax
resident in the country where it is incorporated or where it has its ‘Place of
Effective Management’ (‘POEM’). The residential status of a company dictates
where a company will be taxed on its worldwide profits.

The OECD MC has defined POEM as ‘the
place where key management and commercial decisions that are necessary for the
conduct of the business as a whole are in substance made and that all relevant
facts must be examined to determine POEM’.

In India,
POEM has been recognised by amendment in section 6(3) of the Income-tax Act,
1961 under the Finance Act, 2015 which states that a company is said to be
resident in India in any previous year, if it is an Indian company, or its
place of effective management in that year is in India. The Explanation to
section 6(3) provides that POEM means a place where key management and
commercial decisions that are necessary for the conduct of the business of an
entity as a whole are, in substance, made. POEM is also an internationally
recognised residency concept and adopted in the tie-breaker rule in many Indian
treaties for corporate dual residents and is also adopted in many jurisdictions
in their domestic tax laws.

Due to Covid-19, management
personnel / CEO may not be able to travel to the habitual workplace on account
of restrictions and may have to attend Board meetings via telephone or video
conferencing which will create a concern as to the place / jurisdiction from
which decisions are being taken.

It is pertinent
to note that the Central Board of Direct Taxes (‘CBDT’) had issued POEM
guidelines vide Circular No. 06 dated 24^th January, 2017. In
the context of cases where the company is not engaged in active business
outside India, the Guidelines state that the location of the company’s head
office is one of the key determinant factors.

In this connection, CBDT has
considered a situation where senior management participates in meetings via
telephone or video-conferencing. In such a situation, CBDT states that the head
office would normally be the location where the highest level of management
(e.g., the Managing Director / Financial Director) and their direct support
staff are located.

OECD in its Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 states that ‘it is unlikely that
the Covid-19 situation will create any changes to an entity’s residence status
under a tax treaty. A temporary change in location of the Chief Executive
Officers and other senior executives is an extraordinary and temporary
situation due to the Covid-19 crisis and such change of location should not
trigger a change in residency, especially once the tie breaker rule contained
in tax treaties is applied’.

Although the OECD Guidance
provides relief in this respect, however, taxpayers should be mindful of the
specific clarifications issued by respective tax jurisdictions on this aspect.
Recently, the US IRS has announced⁵ cross-border tax guidance
related to travel disruptions arising from the Covid-19 emergency. In the
guidance, IRS stated that ‘U.S. business activities conducted by a
non-resident alien or foreign corporation will not be counted for up to 60
consecutive calendar days in determining whether the individual or entity is
engaged in a U.S. trade or business or has a U.S. permanent establishment, but
only if those activities would not have been conducted in the United States but
for travel disruptions arising from the Covid-19 emergency’.

Similarly, jurisdictions such as
Ireland, UK and Jersey, Australia have issued guidance providing various
relaxations to foreign companies in view of Covid-19.

While the OECD Secretariat has
done an analysis on treaty impact, it may be worthwhile exploring a
multilateral instrument (on the lines of MLI) for avoiding conflict of
positions while granting treaty benefit to the taxpayers.

IMPACT ON RESIDENTIAL STATUS OF AN
INDIVIDUAL

Generally, number of days
presence is considered as a threshold (the total number of days that an
individual is present in a particular jurisdiction) for determining individual
tax residency. An exception to this principle is where citizens are taxed
irrespective of their presence.

Due to the Covid-19 outbreak,
travel is restricted, which gives rise to two main situations:

i. A
person is temporarily away from his home (perhaps on holiday, perhaps to work
for a few weeks) and gets stranded in the host country because of the Covid-19
crisis and attains domestic law residence there.

ii. A person/s is working in a country (the ‘current home country’)
and has acquired residence status there, but they temporarily return to their
‘previous home country’ or are unable to return to their current home country
because of the Covid-19 situation.

According to
the OECD, in the first scenario it is unlikely that the person would acquire
residence status in the country where he is temporarily staying because of
extraordinary circumstances. There are, however, rules in domestic legislation
considering a person to be a resident if he or she is present in the country
for a certain number of days. But even if the person becomes a resident under
such rules, if a tax treaty is applicable, the person would not be a resident
of that country for purposes of the tax treaty. Such a temporary dislocation
should therefore have no tax implications.

In the second scenario, it is
again unlikely that the person would regain residence status for being
temporarily and exceptionally in the previous home country. But even if the
person is or becomes a resident under such rules, if a tax treaty is
applicable, the person would not become a resident of that country under the
tax treaty due to such temporary dislocation.

However, in litigious countries
like India, and in the context of recent legislative amendments where NRIs have
been targeted for ?managing’ their period of stay in India, the very thought of
having to substantiate to the authorities that as per any tie-breaker test, a
person is non-resident in India is daunting.

With a view to remove genuine
hardships to individuals, CBDT has issued a clarification through Circular No.
11 of 2020 dated 8^th May, 2020 in respect of determination of
residency u/s 6 due to Covid-19. The circular is applicable to individuals who
came on visit to India on or before 22^nd March, 2020 and have
continued to be in India in different scenarios. This circular applies only for
determination of residency for FY 2019-2020.

Accordingly, in case of
individuals who have come on a visit to India on or before 22^nd
March, 2020 and are falling under the following categories, relaxation will be
provided while determining their number of days’ presence in India for the
purpose of section 6 for FY 2019-20, as explained hereunder:

a. Scenario 1: where an
individual (who is on a visit to India) is unable to leave India before 31^st
March, 2020 – the period of stay between 22^nd and 31^st
March, 2020 (both inclusive) shall not be counted for determining presence in
India.

b. Scenario 2: where an individual
has been quarantined in India on account of Covid-19 on or after 1^st
March, 2020 and such individual has departed on an evacuation flight before 31^stMarch, 2020 or is unable to depart – the period starting from the start
of the quarantine period up to 31^st March, 2020 or date of actual
departure shall not be counted for determining presence in India.

c. Scenario 3: where an
individual (who is on a visit to India) has departed on an evacuation flight
before 31^st March, 2020 – the period of stay between 22^nd
March, 2020 and date of his departure shall not be counted for determining
presence in India.

It has also
been stated that another circular will be issued in due course for determining
residency for FY 2020-2021. These pro-active clarifications bring relief to
many individuals facing difficulties in determining their residential status
amidst the measures taken by various governments to contain the impact of
Covid-19. It should be noted that this circular provides relief only from the
residence test u/s 6 of the Act. The issue of an individual’s forced stay in
India playing a role in constituting residence for a foreign company, HUF,
etc.; or determination of a business connection or Permanent Establishment of a
non-resident in India; and other such implications are not covered in the
circular. The US has recently issued a clarification which states that up to 60
consecutive calendar days of presence in the USA that are presumed to arise from
travel disruption caused by Covid-19 will not be counted for purposes of
determining US tax residency.

IMPACT ON CROSS-BORDER WORKERS

Cross-border
workers are persons who commute to work in one state but live in another state
where they are resident.

As per the
Income from Employment Article of the DTAAs, income from employment is taxable
only in a person’s state of residence unless the ‘employment is exercised’ in
the other state. However, there are certain conditions for not taxing
employment income in a state where employment is exercised (presence of employee
in that state not exceeding 183 days; and remuneration is paid by an employer
who is not a tax resident of that state; and such remuneration is not borne by
the employer’s PE in that state).

The issue which will come up here
is the taxation of wages and salaries received by such cross-border workers in
cases where they cross the threshold of 183 days due to travel restrictions.

OECD in the Secretariat Analysis
of Tax Treaties and the Impact of Covid-19 has stated that income should be
attributable to the state where they used to work before the crisis.

THE WAY FORWARD

The issues discussed above are
some of the common issues on which clarification / guidance should be issued by
the respective tax jurisdictions in order to protect taxpayers from unnecessary
hardship. We expect that CBDT will also consider these issues and come out with
relevant relief measures. Though the OECD guidelines have a persuasive value,
they are not binding in any manner, especially to non-OECD member countries. In
fact, taxpayers may have certain other issues on which they may need
clarifications; therefore, a mechanism should be put in place where they can
describe the facts and get redressal from the tax authorities. It is
recommended that companies / individuals must maintain robust documentation
capturing the sequence of facts and circumstances of the relevant presence
inside or outside of India during the Covid-19 crisis to substantiate the bona
fides of their case before the tax authorities if and when they arise in
future.

‘Presume not that I am the thing
I was’ – Shakespeare‘Come what come may, time and the hour run
through the roughest day’ – Shakespeare

____________________________________________

1 https://fortune.com/2020/02/21/fortune-1000-coronavirus-china-supply-chain-impact/
dated 21^st February, 2020

2 ADIT vs. E-funds IT Solution Inc. (Civil Appeal No. 6802 of 2015
SC)

3 Formula One World Championship Ltd. vs. CIT (IT) [2016] 76
taxmann.com 6/390 ITR 199 (Delhi)(SC)

4 https://read.oecd-ilibrary.org/view/?ref=127_127237-vsdagpp2t3&title=OECD-Secretariat-analysis-of-tax-treaties-and-the-impact-of-the-COVID-19-Crisis

5 https://www.irs.gov/newsroom/treasury-irs-announce-cross-border-tax-guidance-related-to-travel-disruptions-arising-from-the-covid-19-emergency

shailesh.kwebmaker

INTERPLAY OF GST & EMPLOYMENT REGULATIONS

INTRODUCTION
– SERVICE BY EMPLOYEES EXCLUDED FROM GST

GST is a tax on all supplies of
goods or services, or both, made in the course or furtherance of business.
However, Schedule III, Entry 1 treats services by an employee to the employer
in the course of or in relation to his employment as neither a supply of goods
nor a supply of services, effectively resulting in the situation that such
services are excluded from the purview of GST.

HOW TO
DETERMINE EMPLOYER-EMPLOYEE RELATIONSHIP

It,
therefore, becomes important to analyse the scope of the abovementioned entry.
Since the exact tests of determination of employment contract are not
specifically listed in the GST law, it will be important to understand the said
tests from legal precedents under the general law including various labour
legislations. To begin this journey it may be worthwhile to refer to the
decision of the larger Bench of the Supreme Court in the case of Balwant
Rai Saluja & others vs. Air India Limited & others [Civil Appeal No.
10264-10266 of 2013]. In this case, the Court laid down the following
tests which are required to be satisfied to demonstrate the existence of an
employer-employee relationship:

(i) Who appoints the workers?

(ii) Who pays the salary / remuneration?

(iii) Who has the authority to dismiss?

(iv) Who can take disciplinary action?

(v) Whether there is continuity of service?

(vi) What is the extent of control and supervision?

Various legislations have been
enacted to safeguard the interest of employees employed by employers. Some of
the key legislations are the Factories Act, 1948, the Industrial Employment
Act, 1946, the Industrial Disputes Act, 1947, the Contract Labour Regulation
Act, 1970, the Workmen’s Compensation Act, 1923, and so on. Each of these
legislations has defined the term employee, identified as worker, workmen, etc.
However, it is important to note that the definition of employee referred
to in one legislation is restricted only to that legislation and merely because
a person is an employee under one legislation he does not become an employee in
general of the employer. The Supreme Court in the above decision has
held that for matters which are not related to the specific legislations, one
needs to satisfy the above test to establish the existence of an
employer-employee relationship.

WHAT IS THE SCOPE OF THE ENTRY?

The next point that needs to be
analysed is what all will be included within the scope of the consideration /
remuneration paid to an employee. Generally, the consideration paid to an
employee carries two components, one being the monetary component which would
cover payouts like salary, wages, allowances, etc., and the other being
non-monetary components such as perquisites, rent-free accommodation, etc.,
which are made available to employees under the terms of the employment
contract. Some components may be mandated by the legislature and some may be
part of the employment policy of the employer.

The legislations referred to
above also deal with the meaning of ‘consideration’. For example, section 2
(rr) of the Industrial Disputes Act, 1947 defines the term ‘wages’ to mean all
the remuneration capable of being expressed in terms of money and payable to a
workman in respect of his employment or work done in such employment, and also
includes (a) allowances that the workman is entitled to, (b) the value of the
house accommodation or of the supply of light, water, medical attendance or
other amenities, or of any service, or of any concessional supply of food
grains or other articles, (c) any travelling concession, and (d) any commission
payable on the promotion of sales or business, or both. However, it also
excludes certain items such as (i) any bonus, (ii) any contribution paid /
payable by the employer to any pension fund / provident fund / for the benefit
of the workman under any law for the time being in force, and (iii) any
gratuity payable on the termination of service.

Similarly, section 2(v) of the
Payment of Wages Act, 1932 defines the term ‘wages’ as all the remuneration
(whether by way of salary, allowances or otherwise) expressed in terms of
money, or capable of being so expressed, which would be payable to a person
employed in respect of his employment, or of work done in such employment and
includes (a) any remuneration payable under any award or settlement between the
parties or order of a Court, (b) overtime remuneration, (c) additional
remuneration payable under the terms of employment, (d) any amount due on
termination of employment, and (e) any sum which the employee is entitled to
under any scheme framed under any law for the time being in force, excluding
any bonus, value of benefits, such as house accommodation, electricity or water
supply, medical attendance or other amenity, or of any service excluded from
the computation of wages by a general or special order of the appropriate
government, any contribution paid by the employer to any pension or provident
fund and the interest accrued thereon, any travelling allowance or the value of
any travelling concession and any sum paid to the employed person to defray
special expenses entitled to him by the nature of work.

The above two definitions in the
context of specific legislations clearly point towards what shall constitute
‘consideration’ and it generally intends to include within its scope all
payments made to the employees, except for specific items which are also
excluded only for the purpose of the specific legislations. But the general
principle laid down in the said legislations indicates that all payments made
or facilities extended to the employees as a part of employment contracts would
be treated as a part of the consideration to the employee. This principle was
laid down by the Supreme Court in the case of Gestetner Duplicators
(Private) Limited vs. CIT [1979 AIR 607 = 1979 SCR (2) 788] wherein the
Court held as under:

It is thus clear that if under
the terms of the contract of employment, remuneration or recompense for the
services rendered by the employee is determined at a fixed percentage of
turnover achieved by him, then such remuneration or recompense will partake of
the character of salary, the percentage basis being the measure of the salary
and therefore such remuneration or recompense must fall within the expression
‘salary’ as defined in Rule 2(h) of Part A of the Fourth Schedule to the Act.
In the instant case before us, admittedly, under their contracts of employment
the assessee has been paying and did pay during the previous years relevant to
the three assessment years to its salesmen, in addition to the fixed monthly
salary, commission at a fixed percentage of the turnover achieved by each
salesman, the rate of percentage varying according to the class of article sold
and the category to which each salesman belonged. The instant case is,
therefore, an instance where the remuneration so recompense payable for the
services rendered by the salesmen is determined partly by reference to the time
spent in the service and partly by reference to the volume of work done. But it
is clear that the entire remuneration so determined on both the basis clearly
partakes of the character of salary.

In fact, while determining what
shall and what shall not constitute consideration, one should refer to the
principle of dominant intention theory, as laid down by the Supreme Court in Bharat
Sanchar Nigam Limited vs. UoI [2006 (2) STR 161 (SC)]. The Court in the
said decision held that one needs to look into the substance of the transaction
in order to determine how the same would get covered. Once it is established
that any payment made to an employee or any benefit / facility made available
to him is in the course of an employment contract, irrespective of whether the
same is a mandatory requirement or not, it gets covered within the purview of
that contract and cannot be distinguished from it.

Employer and employees are
related persons – Does this impact the tax treatment of the facilities /
benefits provided to employees?

Section 15 provides that an
employer and his employee shall be deemed to be related persons. Further, Entry
2 of Schedule I deems certain activities to be supplies even if the same are
without consideration. The entry reads as under:

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:

Provided that gifts not exceeding
fifty thousand rupees in value in a financial year by an employer to an
employee shall not be treated as supply of goods or services or both.

In the normal course, various
facilities / benefits are provided by the employer to his employees. Let us
first analyse whether or not the same constitute a supply under GST (without
considering the scope of entries under Schedule I and Schedule III). It is
imperative to note that generally when an employer makes available any
facilities / benefits to the employee, it is not mandatory in nature. For
example, commutation facility extended by the employer may not be availed of by
employees who prefer to travel on their own. It is upon the employee to decide
whether he intends to avail of the facility. Similarly, it is not necessary
that all employees might avail the canteen facility. Rather, they might want to
make arrangements on their own. It is only as a part of the employer’s HR
policy / statutory requirement that the employer makes available the facilities
/ benefits.

However, once it becomes part of
the employment policy, which the employee would have accepted, it becomes part
of the employment contract, i.e., the employer has made available the
facilities / benefits in pursuance to the services supplied by the employee to
the employer. However, there is no contrary service supplied by the employer.
The employer has merely undertaken the activity of incurring the cost to make
available the benefits / facilities to its employees. However, merely because a
cost is incurred does not necessarily mean that the employer has supplied the
service. In Kumar Beheray Rathi vs. Commissioner of Central Excise, Pune
[2014 (34) STR 139], the Tribunal held that the assessee was acting
merely as a trustee or a pure agent as it was not engaged in providing any
service but only paying on behalf of various flat-buyers to various service
providers. In this particular case, even though there was recovery of cost, the
Tribunal has held that there was no provision of service. The argument would therefore
get stronger in a case where consideration is not involved. Similarly, in the
case of Reliance ADAG Private Limited vs. CST, Mumbai [2016 (43) STR 372
(Tri.)(Mum.)], the Tribunal has held that merely incurring expenses on
behalf of group companies and recovering them would not amount to provision of
service. The principles laid down in the said case should also apply to the
current case.

Another aspect to be noted is
that in certain cases, such as telephone facilities / insurance services, there
is a legal impediment to the employer providing such service since they are
regulated services and only those people who are authorised by the Department
of Telecommunication (DOT) or the Insurance Regulatory Development Authority of
India (IRDAI) can provide such a service. Therefore, this is one more basis to
say that by merely making available the facilities / benefits the employer has
not made a supply to his employees, but rather it is a cost incurred by him in
the course of receiving services from his employee and, therefore, is nothing
but just an employment cost for him. This aspect has also been discussed in our
previous article ‘Decoding GST: Inter-Mingling of Income tax and GST’ (BCAJ,
April, 2020).

Therefore, once a view is taken
that making available benefits / facilities does not constitute supply, Entry 2
of Schedule I which deems an activity of supply of goods or services between a
distinct person / related person as supply, even if made without consideration,
would not be applicable. This would be because Entry 2 pre-necessitates that
the activity has to be treated as supply u/s 7.

Another point to be noted is that
if a view is taken that by incurring the above expenses / making available the
benefits to the employees, there is a supply made by the employer, it could
result in additional unwarranted compliances on the part of the employer. Let’s
take an example of insurance facilities / benefits extended to the employee. If
a view is taken that the employer has indeed provided these services, then they
would be in violation of the IRDAI guidelines since they would be engaged in
providing insurance services without necessary approvals. Similar would be the
situation in case of telecommunication facilities made available to the
employees where one needs to obtain approval from DOT, or in the canteen
facilities from FSSAI. Further, in some cases such an interpretation would
result in an absurd application from other aspects also. For example, in case
of rent-free accommodation provided by the employer to the employee, if a view
is taken that the same is a supply of service in view of Entry 2 of Schedule I,
while there would be no tax liability on the outward side since the services of
renting of residential accommodation is exempted from tax, correspondingly, the
Department might take a view that the employer is engaged in providing exempt
services, thus triggering the applicability of the provisions of sections 17(2)
and 17(3) of the Central Goods & Services Tax Act, 2017 requiring
compliances under Rules 42 and 43 of the Central Goods & Service Tax Rules,
2017.

Therefore,
it is apparent that whether or not any amount is recovered from the employee
for any facilities / benefits made available to him, it would be wrong to treat
the same as a supply itself under GST. In fact, the next proposition would be
important, which is to say that the facilities / benefits which are made
available to the employees is nothing but a part of the employee cost incurred
in the course of receiving the services of the employee in pursuance of the
employment contract. This view finds support from the decision of the Andhra
Pradesh High Court in the case of Bhimas Hotels Private Limited vs. Union
of India [2017 (3) GSTL 30 (AP)] wherein, in the context of canteen
recoveries, the Court held that such recoveries have to be seen as part of any
pay package that workers have negotiated with employers and therefore cannot be
construed as service falling within the definition of ‘service’ u/s 65B(44) of
the Finance Act, 1994. The logic behind the above conclusion was that under
service tax the definition of service excluded any service provided by the
employee to the employer in the course of employment from its purview. Since
the recoveries were made in pursuance of the employment contract, they were
excluded from the scope of the definition of service. It is imperative to note
that even under GST, Entry 1 of Schedule III provides that services provided by
an employee to the employer in the course of the employment contract shall be
treated neither as supply of goods nor as supply of services. Therefore, it can
be said that under GST,

(a) Any facilities / benefits made available to the employees would not
be liable to GST as they do not amount to supply of service itself

(b) The facilities / benefits made available to the employees even if
not a statutory requirement but part of the employment policy, should be
treated as covered under Entry 1 of Schedule III and therefore excluded from the
scope of supply itself

(c) Even if any amounts are recovered from the employees, the same would
also be covered under Entry 1 of Schedule III in view of the decision in the
Bhimas Hotels case (Supra) and should be treated as nothing short of
reduction in the employee cost.

Readers might also take note of
the contrary AARs under GST on this subject. In the case of Caltech
Polymers Private Limited [2018 (18) GSTL 350 (AAR)] and upheld by the
Appellate Authority in [2018 (18) GSTL 373 (AAR)], the Authority
has held that the employer is liable to pay GST on amounts recovered from
employees for the canteen facilities extended to them. However, in the context
of recovery of insurance premia from employees, the authority has held that as
the same do not constitute an activity incidental or ancillary to their
business activity, they cannot be treated as supply of service. One may refer
to the ruling in the case of Jotun India Private Limited 2019 (29) GSTL
778 (AAR).

Eligibility
of Input Tax Credit on employee-related costs

There are
specific provisions which restrict claim of Input Tax Credit u/s 17(5) as
under:

(b) the following supply of goods or services or
both:

(i) food
and beverages, outdoor catering, beauty treatment, health services, cosmetic
and plastic surgery, leasing, renting or hiring of motor vehicles, vessels or
aircraft referred to in clause (a) or clause (aa), except when used for the
purposes specified therein, life insurance and health insurance:

Provided
that the input tax credit in respect of such goods or services or both shall be
available where an inward supply of such goods or services or both is used by a
registered person for making an outward taxable supply of the same category of
goods or services or both or as an element of a taxable composite or mixed
supply;

(ii) membership of a club, health and fitness
centre; and

(iii) travel benefits extended to employees on
vacation such as leave or home travel concession:

Provided
that the input tax credit in respect of such goods or services or both shall be
available, where it is obligatory for an employer to provide the same to its
employees under any law for the time being in force.

(g) goods
or services or both used for personal consumption;

Building on
the above discussion, it is important to note that while making available the
various benefits / facilities to their employees, the employers incur various
costs on which GST would have been charged by their suppliers. Therefore, the
question that needs consideration is whether or not credit shall be available
on such expenses incurred.

The
specific reason for this query is that section 17(5) lists items on which
credit shall not be allowed. These are termed as blocked credits. For various
expenses while there is a restriction on claim of credit, an exception has been
provided when the expense is incurred as a statutory requirement. For example,
while in general ITC on food and beverages is not allowed, however, vide
an exception it has been provided that if it is a statutory requirement to
provide such facilities, Input Tax Credit shall be available. For instance,
under the Factory Act, 1948 every factory employing more than 250 employees is
required to maintain a canteen for them. As discussed earlier, for the purpose
of this Act the employees also include those who are not on the payroll of the
employer, i.e., while in general, an employer-employee relationship does not
exist, for the purposes of the Factory Act, 1948 they are treated as employees
and therefore the question that needs consideration is whether the eligibility
to claim credit will apply for such an outsourced workforce also. This would be
specifically important in cases such as construction contracts where generally
the labour is outsourced.

The same
applies to rent-a-cab services, insurance services, etc., as well. However, at
times there are inward supplies received which facilitate the making available
of benefits / facilities to employees. For example, equipment / crockery
purchased for a canteen. There is no specific restriction on the claim of
credit on such items. The restriction applies only to food and beverages and
these do not constitute food and beverages. Therefore, credit on such items
could be claimed.

Another
area that would need deliberation is clause (g) of section 17(5) which
restricts claim of credit on goods or services or both used for personal
consumption. The scope of this entry has seen substantial confusion as to
whether it would apply to goods or services used for employee consumption. For instance,
the company organises a picnic for its staff. Will this get covered under this
entry or not? To understand this, one needs to analyse the scope of the term
‘personal consumption’. However, before proceeding further it would be relevant
to refer to the similar entry in CENVAT Credit wherein Rule 2 (l) states that
specific services which were meant for ‘personal consumption of any employee’
shall not constitute input service. It is imperative to note that while the CCR
specified whose personal consumption, the same is apparently silent under GST.
This would indicate that in the absence of a specification, a view can be taken
that the term ‘personal consumption’ is to be seen in the context of the
taxable person and not the employees and, therefore, subject to other clauses
of section 17(5), credit would be available even if they were meant for
consumption of the employees.

However,
the answers would change in the above case where the cost of making available
the benefits / facilities, whether wholly or partly, is recovered from the
employees. In such a case, it would result in a reduction of cost for the
employer and therefore, to that extent, the employer would not be entitled to
claim credit. However, there are instances where employers take a view that in
a case where credit is allowable and the corresponding costs are recovered from
the employees, GST should be paid on the recovery amount to avoid complicating
ITC calculations. However, one should take a view that paying GST on the
recovery would mean that the employer has accepted liability under Entry 2 of
Schedule I and there might be challenges on the valuation of the supply claimed
to be made by the employer to his employees because section 15 of the Central
Goods & Services Tax Act, 2017 requires such a transaction to be valued as
per the Valuation Rules.

Applicability of GST on payments made to
directors of a company

Entry 6 of
Notification 13/2017 – CGST Rate requires that the GST in case of service
supplied by a director of a company or a body corporate to the said company /
body corporate shall be paid by the service receiver, i.e., the company in case
the service provider is a director / body corporate. However, this particular
aspect of the GST law has seen its share of controversy, with conflicting
decisions under the Service Tax regime as well as a ruling issued by the
Authority for Advance Ruling.

However, before proceeding further, it would be
necessary to go through the background of the concept of directors. Directors
are individuals who are appointed on the Board of a company to protect the
interests of the shareholders and manage the affairs of the company. Generally,
there are two types of directors: executive directors who are involved in the
day-to-day activities of the business, and non-executive directors, also known
as independent directors, whose role is mainly to ensure that the interest of
the shareholders and other stakeholders is largely protected. The maximum
remuneration that can be paid to each class of directors is also regulated.
However, when determining whether the directors satisfy the test of an
employer-employee relationship, there would be a different outcome which is
evident from the following:

Condition	Executive Director	Non-Executive / Independent Director
Who appoints the workers?	Shareholders, on the recommendation of Board, or Board, to be subsequently ratified by the shareholders
Who pays the salary / remuneration?	Company	Company
Who has the authority to dismiss?	Shareholders
Who can take disciplinary action?	Shareholders
Whether there is continuity of service?	Generally, appointed till end of next general meeting
What is the extent of control and supervision?	Full control and supervision by shareholders	No control / supervision

Condition

Executive Director

Non-Executive / Independent Director

Who appoints the workers?

Shareholders, on the recommendation of Board, or Board, to be
subsequently ratified by the shareholders

Who pays the salary / remuneration?

Company

Who has the authority to dismiss?

Shareholders

Who can take disciplinary action?

Shareholders

Whether there is continuity of service?

Generally, appointed till end of next general meeting

What is the extent of control and supervision?

Full control and supervision by shareholders

No control / supervision

As is apparent from the above, in
the case of Executive Directors, the test of employer-employee relationship
laid down by the Supreme Court in Balwant Rai Saluja (Supra) is
satisfied. However, it is not so in the case of Independent directors as the
key element of existence and control and supervision is missing. It is
therefore sufficient to say that while Executive Directors satisfy the test of
the employer-employee relationship, the same is not so in the case of
Non-executive / Independent directors. Therefore, in case of directors, while
admittedly notification 13/2017 – CT (Rate) imposes a liability on the company
to pay tax on reverse charge, the issue that remains is whether the payment
made to directors who are in an employer-employee relationship will get covered
within this entry or will it be excluded from the purview of Entry 1 of
Schedule III.

Therefore,
since Schedule III itself excludes transactions where an employer-employee
relationship exists from the purview of supply itself, notification 13/2017 –
CT (Rate) imposing the liability to pay tax on the service recipient is ultra
vires of the provisions of the Act and, therefore, not maintainable. This
aspect has already been considered by the Gujarat High Court in the recent
decision in Mohit Minerals Private Limited vs. UoI & others [2020 VIL 36
Guj.].

In fact, it
is imperative to note that a similar entry requiring payment of tax under RCM
was applicable even under the Service Tax regime where there were two
conflicting decisions. The Division Bench of the Mumbai Tribunal in the case of
Allied Blenders & Distillers Private Limited vs. CCE & ST,
Aurangabad [2019 (24) GSTL 207 (Tri.)(Mum.)] held that directors’
salary would be excluded from the purview of service tax and therefore no tax
would be liable to be paid under Reverse Charge. However, the Kolkata Tribunal
(SMB) has, in the case of Brahm Alloy Limited vs. Commissioner [2019 (24)
GSTL 616 (Tri.)(Kol.)] held otherwise and confirmed the liability to
pay tax on directors’ remuneration, described as salary by concluding that an
employer-employee relationship didn’t exist on account of two reasons; firstly,
the resolution of the company confirming the appointment of the directors did
not cover the terms of appointment / hiring of services and also the action to
be taken for non-performance of specified duties without which it cannot be
construed as to whether an individual was appointed as Promoter-Director or an
employee director; and secondly, payments made in a quarterly and not monthly
manner. It is apparent that the decision in the case of Brahm Alloy
Limited is contrary to the established principles and might not survive
if appealed before a higher authority.

It is also
important to note that under the GST regime, the AAR has, in the case of Clay
Craft India Private Limited [Raj/AAR/2019-20/33] also held to the
contrary, that tax is payable under Reverse Charge. The Authority has concluded
that the services rendered by the director to the company are not covered under
Entry 1 of Schedule III as the directors are not employees of the company.

The next
issue relating to directors is the applicability of reverse charge in case of
directors deputed on behalf of investing companies, in which case the
remuneration is paid to the company and not to the representative directors.
The issue revolves around whether such transactions would be covered under
notification 13/2017 – CT (Rate) or not? It is imperative to note that in this
transaction structure, the transaction is between two different companies /
body corporates wherein one body corporate has deputed a person as a director
on the Board of the other company. In other words, both the supplier and the
recipient of service are a body corporate / company. The notification requires
that the service provider must be an individual, being a director of the
company. However, that is not so in the case of the current set of
transactions. In other words, Entry 6 does not get triggered at all and,
therefore, no reverse charge would be applicable on such transactions.

Is GST applicable on notice period
recoveries / claw-back of payments to employees?

Before
looking into the tax implications of notice period recovery / claw-back, let us
understand the background of these transactions.

Notice
period recovery: Generally, the employment contracts have a clause that if an
employee intends to leave the organisation or an employer intends to
discontinue the services of an employee, each party will be required to give a
notice to the other of their intention to do so, and once the notice is served,
the party giving the notice will be required to serve a notice period, i.e., if
the employee is serving notice, he will be required to continue in employment
for a pre-decided period to enable the employer to make alternate arrangements.
Similarly, if the employer has served notice to the employee, he will have to
allow the employee to continue in employment for a pre-decided period to enable
the employee to find new employment, or prepare for transition. This is
generally treated as serving notice period. However, there are times when the
party giving the notice does not intend to honour the commitment in which case
they are required to compensate the other person monetarily. In case the
employee refuses to serve the notice period, he would be required to pay
compensation to the employer, which would be either adjusted from his full and
final settlement or recovered from him, and vice versa; if the employer
abstains from honouring the notice period clause, he would monetarily reimburse
the employee.

Similarly,
claw-back refers to recovering the amounts already paid to the employees. In
case of senior management employees, there are generally clauses in the
agreement which provide that in case of non-satisfaction of certain conditions
of the employment contract, the payments made to the employees shall be
recovered back from them. For example, if a top level employee is joining a
company from another company, in order to lure him to accept the employment he
is offered ‘joining bonus / incentive’ with the condition that if he does not
continue the employment for a specified period, the same would be liable to be
recovered from him. Similarly, even in case of incentives / bonus, there are
clauses for claw-back of the bonus if there is some action on the part of the
employee which is detrimental to the employer.

The issue
that needs consideration is whether recoveries such as the above would
constitute a supply and therefore liable for GST? It is imperative for the
readers to note that the applicability of GST on notice period recoveries has
been a burning issue right from the service tax regime wherein the following
service was declared to be a deemed service u/s 66E: agreeing to the
obligation to refrain from an act, or to tolerate an act or a situation, or to
do an act;…

A similar
entry has continued even under the GST regime with Entry 5(e) of Schedule II of
the Central Goods & Services Tax Act, 2017 which declares the above to be
treated as supply of service under the GST regime as well, thus keeping the
issue alive. Let us analyse the same.

Whether such recoveries would be covered under Entry 1 of Schedule III?

However,
what needs to be noted is that the above recoveries emanate from a contract of
employment which is covered under Schedule III as neither being supply of goods
nor supply of services. A contract is the logical starting point for any
transaction. In any contractual obligation, the contracting parties are under
an onus to perform the contract. The contracting terms determine the
responsibility and enforce the performance on each contracting party. In case
of non-performance by any party, resort has to be taken to the contractual
relationship to determine the scope of recovery, if any. Hence, the contract is
in toto the binding force in any relationship.

A Latin
maxim, Nemo aliquam partem recte intelligere potest antequam totum perlegit,
says that no one can properly understand a part until he has read the whole.
Hence, it is important to analyse the entire transaction matrix, the
contractual relationship between the employer and the employee, the relevant
contracts / documents before diving into a discussion on the applicability of
service tax. An employment contract is a written legal document that lays out
binding terms and conditions of an employment relationship between an employee
and an employer. An employment contract generally covers an overview of job
responsibilities, reporting relationships, salary, benefits, paid holidays,
leave encashment benefits, details of employment termination and also provides
that in case an employee wants to quit, the employee should provide one month’s
notice before resigning or compensation in lieu of notice period.

The
employment contracts are long-term contracts with the employees. The
understanding and expectations from the employer are that the employee should
provide his services on a continuous basis. The employees are working on
important client projects or certain functions important for the operation of
the business; if any employee resigns in between, that impacts the progression
of the project adversely. To avoid such a situation and give sufficient time to
the employer to make alternative arrangements, the mandatory notice period is
prescribed under the employment contract. However, if the employee wishes to
leave without serving the notice period, the contract provides for recovery of
a certain amount which is generally deducted from the amounts due to the
leaving employee earned in the course of employment.

The ‘notice
period recovery’ is a provision for an eventuality that may arise as per
mutually-agreed terms of the employment contract. Notice period recovery is a
condition of the employment contract agreed mutually and hence is intricately
linked with the employer-employee relationship and arises out of an employment
contract only.

In the case
of Lakshmi Devi Mills Limited vs. UP Government [AIR 1954 All. 705, 714]
it has been held that ‘terms and conditions of service’ not only include the
recruitment or appointment but also all aspects like disciplinary matters,
removal from service, dismissal, etc. Therefore, termination or quitting the
organisation on notice or notice period recovery in lieu thereof is an
integral part of the employment contract. Thus, notice period recovery is just
another condition of the contractual relationship of an employer and employee
just like other terms of the same employment agreement. Hence, the notice
period recovery in lieu of not adhering to the notice period emanating
from the employment contract should get covered under Entry 1 of Schedule III
and therefore excluded from the scope of supply itself.

Is there
any service provided by the employer?

Another
point to be noted is that merely because there is recovery would not convert
the same into consideration. In permitting the employee to leave the
organisation, there is nothing that the employer has done to qualify as
service. For treating something as service, there has to be an activity which
requires doing something for another person. In case of notice period
recoveries, there is no rendition of service from the employer in the case of
permitting the employee to leave the organisation before the completion of the
notice period. The events which precede the employee leaving the organisation
are:

(a) The decision to leave is that of the
employee

(b) The request for termination is made by
the employee

(d) If the employer decides not to insist on
the notice period, even then he cannot insist on the recovery of the notice pay
if the employee wants to serve the notice period; he will be required to
continue the employment till that period

(e) Therefore, the employer has no choice to
decide on whether the employee should stay back for the notice period or
whether he should leave early against recovery of notice pay. This choice is
also made by the employee.

From the
above it is evident that all the activities and decisions are actually carried
out by the employee. And the employer does nothing. He neither decides nor is
in a position to decide. Hence, there is no provision of service by the
employer. Merely because the employee is permitted to leave by the employer
does not by any stretch of the imagination get covered by ‘activity performed
for the employee’.

Would mere recovery of amounts characterise it as consideration?

Another
aspect which would need deliberation is whether or not the amounts recovered on
account of notice period recovery / claw-back clauses can be treated as
consideration? Merely because money is received would not give it the
characteristic of consideration. In the case of Cricket Club of India vs.
Commissioner of Service Tax, Mumbai [2015 (40) STR 973] it was held
that mere money flow from one person to another cannot be considered as
consideration for a service. The relevant observations of the Tribunal in this
regard are extracted below:

‘11.
…Consideration is, undoubtedly, an essential ingredient of all economic
transactions and it is certainly consideration that forms the basis for
computation of service tax. However, existence of consideration cannot be
presumed in every money flow. The factual matrix of the existence of a monetary
flow combined with convergence of two entities for such flow cannot be moulded
by tax authorities into a taxable event without identifying the specific
activity that links the provider to the recipient.

12. …Unless
the existence of provision of a service can be established, the question of
taxing an attendant monetary transaction will not arise.’

Even in the celebrated case of UoI
vs. Intercontinental Consultants and Technocrats Pvt. Limited
[2018-TIOL-76-SC-ST], the Apex Court upheld the decision of the Delhi
High Court that observed that ‘…and the valuation of tax service cannot be
anything more or less than the consideration paid as quid pro quo for
rendering such a service’.

In the case of HCL Learning
Limited vs. Commissioner of CGST, Noida [2019-TIOL-3545-CESTAT-All.],
the Hon’ble Tribunal of Allahabad has categorically held as under:

‘1… From
the record, we note that the term of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax… terms of contract between the appellant and his
employee are that employee shall be paid salary and the term of employment is a
fixed term and if the employee leaves the job before the term is over then
certain amount already paid as salary is recovered by the appellant from his
employee. This part of the recovery is treated by Revenue as consideration for
charging service tax.

2. We hold
that the said recovery is out of the salary already paid and we also note that
salary is not covered by the provisions of service tax. Therefore, we set aside
the impugned order and allow the appeal.’

Therefore,
whether recovery is from salary due / retained or salary already paid, the fact
remains that salary is excluded from service tax and such recovery cannot be
termed as consideration.

Will notice period recovery be covered under Entry 5(e) of Schedule II
to treat the same as supply of service?

The
decision to quit the organisation by the employee is a unilateral decision. The
same is forced upon the employer and he has to accept it. The employer cannot
make any employee work without his consent. Article 23(1) of the Indian
Constitution prohibits forced labour in any form. In other words, statutorily
no employee can be forced to work against his wish. In case the employee wishes
not to serve the notice period and opt to leave the organisation before
completion of the notice period, in such a situation the employer can only
recover the notice period dues.

Further,
the employer would not be tolerating any act in such a case. If the employer
has the option to tolerate or not to tolerate, then it can be said to be a
conscious decision. In such cases, in view of the above discussion, the decision
to quit is thrust upon the employer without any option. Therefore, it cannot be
said that the employer has agreed to tolerate the said act of the employee.

A breach of
contract cannot be said to be ‘tolerated’ and that is why an amount is imposed
to deter breach in contracts. The contract of employment is for receipt of
services from the employee and not for the breach. The Court of Appeal (UK) in
the case of Vehicle Control Services Limited [(2013) EWCA Civ 186],
has noted that payment in the form of damages / penalty for parking in wrong
places / wrong manner is not a consideration for service as the same arises out
of breach of contract with the parking manager.

The Madras
HC has critically analysed the levy of service tax on notice period recoveries
in the case of GE T&D India Limited vs. Deputy Commissioner of
Central Excise, Large Tax Payer Unit, Chennai [2020-VIL-39-Mad-ST] wherein
the OIO had confirmed the demand treating the recoveries as consideration for
providing declared service u/s 66E. In this case, the Court held as under:

‘11. The
definition in clause (e) of section 66E as extracted above is not attracted to
the scenario before me as, in my considered view, the employer has not “tolerated”
any act of the employee but has permitted a sudden exit upon being compensated
by the employee in this regard.

12. Though
normally a contract of employment qua an employer and employee has to be read as a whole, there are
situations within a contract that constitute rendition of service such as
breach of a stipulation of non-compete. Notice pay, in lieu of sudden termination, however, does not give rise to the
rendition of service either by the employer or the employee.’

The above
judgment clearly lays down the principle that notice period recovery cannot be
treated as ‘service’ by an employer, more so a ‘declared service’. Some
monetary recovery by an employer from an employee on account of breach of
contract cannot be said to be consideration for any different service. Breach
of contract leading to recovery does not lead to the creation of a new contract
of tolerating any act of the employee. The notice period recovery, at best,
represents nothing but reduction in salary payable which is due to the employee
which emanates only from the employment agreement. To draw an analogy, for
breach of contracts, certain companies recover liquidated damages from the
amounts due to the opposite party who fails to execute his duties as stipulated
under the contract. In case of notice period recoveries, the employer recovers
notice period recovery from the employee for breach of contract conditions as
stipulated in the employment agreement. The Tribunal has in the case of Reliance
Life Insurance Company Limited [2018-TIOL-1308-CESTAT-Mumbai = 2018 (19) GSTL
J66 (Tri.)(Bom.)] held that the surrender / discontinuance charges
represent penalty or liquidated damages and cannot be considered as a
consideration for any services. On a similar footing, in another case of Gondwana
Club vs. Commissioner of Customs & Central Excise, Nagpur
[2016-TIOL-661-CESTAT-Mum.] the club had recovered certain charges from
the employees for the accommodation provided to them. In this case also, the
Tribunal held as under:

‘7… The
contractual privileges of an employer-employee relationship are outside the
purview of service tax and this activity of the appellant does not come within
the definition of the taxable service of “renting of immovable property” sought
to be saddled on the appellant in the impugned order. Accordingly, the demand
under the head “renting of immovable property service” does not sustain.’

In a very
recent decision, the Hon’ble High Court of Bombay had the opportunity to
analyse the concept of ‘supply’ in relation to violation of legal right and
claim of compensation / damages in the context of the Central Goods &
Services Tax Act, 2017. The Hon’ble High Court in the case of Bai Mamubai
Trust & Ors vs. Suchitra Wd/O. Sadhu Koraga Shetty & Ors
[2019-VIL-454-Bom.] observed as under:

56. I am in
agreement with the submissions of the Learned Amicus Curiae that where a dispute concerns price / payment for a
taxable supply, any amount paid under a court’s order / decree is taxable if,
and to the extent that, it is consideration for the said supply or a payment
that partakes that character. In such cases, the happening of the taxable event
of ‘supply’ is not disputed, but the dispute may be in regard to payment for
supplies already made. This could be, for example, where the defendant denies
the liability to pay the price forming consideration for the supply. The order
/ decree of the court links the payment to the taxable supply and the requisite
element of reciprocity between supply and consideration is present.

57.
However, where no reciprocal relationship exists, and the plaintiff alleges
violation of a legal right and seeks damages or compensation from a Court to
make good the said violation (in closest possible monetary terms), it cannot be
said that a ‘supply’ has taken place.

58. The
Learned Amicus Curiae correctly submits that
enforceable reciprocal obligations are essential to a supply. The supply
doctrine does not contemplate or encompass a wrongful unilateral act or any
resulting payment of damages. For example, in a money suit where the plaintiff
seeks a money decree for unpaid consideration for letting out the premises to
the defendant, the reciprocity of the enforceable obligations is present. The
plaintiff in such a situation has permitted the defendant to occupy the premises
for consideration which is not paid. The monies are payable as consideration
towards an earlier taxable supply. However, in a suit, where the cause of
action involves illegal occupation of immovable property or trespass (either by
a party who was never authorised to occupy the premises or by a party whose
authorisation to occupy the premises is determined) the plaintiff’s claim is
one in damages.

The above
judgment of the Hon’ble High Court clearly explains that a contractual
obligation forced out of a contract for legal violation cannot be said to be an
activity on which tax is applicable. Although the context is under the Goods
& Services Tax law, but the same can be very well correlated with the
Service Tax laws. Violation of contractual terms by way of monetary
compensation does not result into a ‘contract’ between the parties on which tax
is payable. Reciprocal relationship is a must, which is missing in the case of
notice period recovery as succinctly explained in the grounds above.

Based on the
above judgments, analogies and justification as to why notice period recovery
cannot be said to be a ‘declared service’, it is apparent that the recoveries
made from employees on account of non-serving of notice period / claw-back
clauses should not be liable to GST.

INTERPLAY WITH PROFESSION TAX ACT

Each
business having a presence in a particular state and employing a specified
number of employees is required to deduct Profession Tax from the salary
payable to the employees and deposit it with the respective State Profession
Tax Authorities of the branch where the employees are based.

In the
pre-GST regime, entities engaged in providing services in multiple states had
an option to take single registration and, therefore, had limited exposure to
the state authorities. In many cases, it was observed that the Profession Tax
deducted from employee’s salary was deposited in only one state though the
employee was based in a branch in a different state. While under the pre-GST
regime the state had no overview over such cases, with the introduction of GST
such entities are under the radar of the authorities of multiple states and
issues such as non-registration under Profession Tax, non-payment of profession
tax in the correct state and so on might start coming to the fore. In case of
non-compliance, there might be repercussions which might need to be taken care
of.

CONCLUSION

In view of the specific exclusion for services
rendered by employees to employers, it may be important to ensure that the said
exclusion is interpreted in the context of the precedents set under other
legislations.

shailesh.kwebmaker

OPERATIONAL IMPACT OF CORONAVIRUS OUTBREAK ON GST

India has been in lockdown mode
in response to the coronavirus pandemic since 24^th March, 2020. It
all started on 30^th January when Kerala confirmed the first case of
the disease. In most of the states a semi-lockdown situation started on 12^th
March with the closure of schools, colleges and cinema halls, malls, night
clubs, marriages and conferences as a precautionary measure. In Maharashtra,
the provisions of the Epidemic Diseases Act, 1897 were invoked on 13^thMarch.
The impact on business houses started when the State Government ordered private
offices to operate with less than 50% of total attendance and allow the rest to
work from home. The orders were given on 17^th March and the
restrictions further tightened on 20^th with the announcement of the
closure of all workplaces excluding essential services.

And on the 24^th of
March, 2020, the Government of India issued a nationwide lockdown order for
containment of the Covid-19 epidemic to be effective for 21 days from the 25^th
of March. This lockdown was further extended up to 3^rd May. It is
thus seen that the lockdown started affecting trade and business operations in
most of the states from 15^th March, a period which coincided with
the compliance period (GST payments and filing of returns) under GST for the
month of February, 2020.

It will not be incorrect to state
that in a country like India, considering the present tax rate structure, tax
collection is one of the indicators of the economic growth of trade and
commerce. The indirect tax, which is a tax imposed on consumption, reflects
directly on the economic health of trade and commerce. With the introduction of
the Goods and Services Tax from July, 2017, the tax rate structures of various
commodities and services have been rationalised multiple times to ensure steady
growth in revenue collection. Over the past few months, the GST has been
contributing over Rs. 1 lakh crores in the indirect tax receipts of the Centre
and the states. However, in March, 2020 the GST collections slipped below the
said psychological mark – a fall that may partially be attributable to the
Covid-19 situation (the government announcement extending the due dates for
making payment of GST for the said month came very late). It is, however,
important to note that the GST collections for March, 2020 are at Rs. 97,597
crores and are still higher as compared to the numbers for September and
October of 2019. Considering the economic lockdown in the entire month of
April, 2020, the collection for this month is certainly going to be a
challenge.

The Hon’ble Finance Minister has
announced various tax compliance-related reliefs / measures for the next few months
to enable the trade and businesses to effectively address this unprecedented
situation while managing their tax compliances and cash flow. Some of the
important relaxations made are given below:

(i) Extension of time limit for filing of GSTR3B for the months of
February, March and April to 30^th June, 2020 for assessees having a
turnover of less than Rs. 5 crores.

(ii) For assesses with a turnover more than Rs. 5 crores (large
assessees), the rate of interest for delayed payment of tax has been conditionally
reduced from 18% to 9% p.a. from 15 days after the due date. However, there is
no extension of the due date. No late fee / penalty shall be charged for delay
relating to this period.

(iii) Time limits for notices, notifications, approval orders, sanction
orders, filing of appeals, furnishing applications, reporting any other
document, etc., or for any other compliance (barring a few exceptions) expiring
between 20^th March and 29^th June are extended to 30^th
June, 2020.

(iv) 24/7 clearance at all customs stations till 30^th
June, 2020 to address any congestion, delay or surge on account of the
prevailing conditions.

(v) RBI extended the time period for realisation and repatriation of
export proceeds for export of goods or software made up to or on 31^st
July to 15 months (from the existing nine months) from the date of export.

(vi) (For a detailed note on GST amendments refer to Recent
Developments in GST in the BCAJ issue dated April, 2020).

The extension in payment of GST
for the months of February to April, 2020 is certainly a big relief to the
taxpayers. However, it is strongly felt that it would have been more
appropriate for the government to completely waive off the interest for those
making the payments for the months of February to May on or before 31^st
July, 2020. As per the said extension, for assessees having a turnover of more
than Rs. 5 crores no interest will be charged if they make the payment on or
before 4^th May. Considering that the lockdown has been extended from
the earlier 14^th April to 3^rd May, a further 15 days’
extension in the said date is the least that trade and commerce can expect.

The lockdown was implemented
without any advance announcement, as a result of which a lot of practical
problems have arisen.

(a) The problem of Invoice / E-way bill
generation and printing: As we all know, under GST the movement of goods is
allowed only with proper supporting documents such as Invoice / E-way bills,
etc. Any goods not accompanied by proper documentation are liable to be seized
and attract a heavy penalty. During the lockdown period and the related mandate
to work from home, many have experienced difficulties in printing invoices /
generating E-way bills due to the lack of a printing set-up at home. In a few
cases, as a temporary measure the transportation was done without adequate
documentation based only on oral information about Invoice No. and E-way bill
Nos. provided by the supplier to the transporter.

(b) Possibility of clandestine movement of goods: There is
a high risk of clandestine movement of goods by certain anti-social tax evaders
during the lockdown period, especially since the tax authorities may not be in
a position to keep a check on in-transit movements of goods due to scaling down
in the mobile squad staff during this period. The government, perhaps in
anticipation of this issue, has not relaxed the requirement of generating E-way
bills and issuing invoices.

(c) Preparation of manual invoices: Many organisations did not
have sufficient IT infrastructure in place to enable access to their accounting
/ invoicing software from home. Therefore, in many cases invoices were prepared
manually (i.e., outside the regular systems), resulting in various control
lapses such as no consecutive system-generated invoice number, the challenge as
to the proper accounting thereof, etc. Further, it’s not unlikely that instead
of paying interest, the large assessees may consider filing of GSTR3B on an ad
hoc basis and prefer to reconcile the amounts later whenever the GSTR1
returns are filed, increasing the compliance burden due to added
reconciliation.

(d) Digital signature: Use of digital signature is a
must for carrying out many important compliances under GST, for example, filing
of GST Returns, making payment of GST using DRC-03, refund applications, etc.
As the duration of the lockdown period and gravity of the situation were
unknown, many employees / consultants working with the GST compliance team did
not carry the digital signature home with them which added to their compliance
hindrances during the lockdown period. To address this issue, as a temporary
measure the GSTIN has permitted filing of returns without digital signature and
only on the basis of EVC code.

(e) Transitional consignments: Many consignments were in
transit during the lockdown period. Since many states sealed their borders from
12^th March onwards, a huge volume of consignments was immobilised.
The problem relating to the expiry of the E-way bill was partially addressed by
the subsequent relief measures extending the validity of the E-way bills
expiring between 20^th March and 15^th April up to 30^th
April, 2020. However, most of the consignments, perishable in nature, resulted
in spoilage of goods. The GST law requires a reversal of Input Tax Credit on
goods lost due to damage / spoilage etc. Unfortunately, no relief has so far
been given in respect thereof. Besides, delays in delivery resulted in many
such orders being cancelled, the tax on which was already paid, adding to the
working capital woes of the trade. In cases involving stock transfers between
different registered units of the same entity, the supplying unit ended up
paying taxes, whereas the receiving unit could not avail the ITC due to
non-receipt of goods.

(f) Cancellation of services: The hospitality, tourism and
airline industries suffered a major setback due to the cancellation of their
services during the lockdown. In many cases, the advance was refunded with some
cancellation charges. The issue as to the applicability of the rate of
cancellation charges is still unsettled and hence is likely to remain in focus
during assessments dealing with the said period.

(g) Delays in processing refunds: Since the
tax department is functioning with limited staff during the lockdown period,
various refund applications are pending processing, thus adding to the
cash-flow problems of the assessees. This has also impacted various other
administrative processes, such as matters dealing with the restoration of GST
registrations, the release of bank account attachment / blockage of electronic
credit ledger, etc.

(h) Goods supplied free under CSR initiative: During
the lockdown period many entities have been involved in CSR initiatives by
donating masks, gloves, sanitizers, food packets, etc. The eligibility of ITC
on such donations is also doubtful in the light of the provisions of section
17(5)(h) of the CGST Act and no tax incentive has been provided for the same.

As part of an administrative
relief package, the time limits for notices, notifications, approval orders,
sanction orders, filing of appeals, furnishing applications, reporting any
other document, etc., as also the time limit for any other compliance expiring
between 20^th March and 29th June is extended to 30^th
June, 2020. However, certain provisions have been excluded from the purview of
such relaxations. For example, no relaxation was given for time limit stated in
section 31 for issue of invoices. Hence, in cases involving continuous supply
of services, if the event obligating the payment falls during the lockdown
period, then the issue of invoice is mandatory and shifting of liability is not
permissible.

Similarly, if during the lockdown
period the turnover of any person exceeds the threshold limit provided for
obtaining GST registration, then such person shall be required to obtain the
registration within 30 days thereof as no relaxation from the same has been
provided. And in cases where the assessee could not make the previous
compliances before the due dates on account of various reasons and the default
continued owing to inability to take any corrective action during the lockdown
period, the imposition of late fees and interest for the lockdown period will
continue. In this background, it would be interesting to see whether an
assessee can exclude the lockdown period from the limitation period citing force
majeure or impossibility of performance?

Unfortunately, in many states
such notifications were not issued by the State VAT / Commercial Tax Departments
as regards pre-GST matters. In an attempt to prevent the spread of coronavirus,
the Maharashtra State Goods and Services Tax Department issued detailed
guidelines to its officers and staff discouraging personal appearances of
assessees / their representatives and completing the time-barring assessments
by obtaining the details through emails and to pass manual orders. However, no
extension of the time limit was given for cases that were getting time-barred
in March, 2020. This may have far-reaching implications, especially where the
orders are passed ex parte and because the Maharashtra VAT Act contains
no provision for cancellation of assessment order and an appeal is not admitted
without depositing 10% of the disputed tax liability by way of pre-deposit.

It also appears that the decision
of the department in not extending the statutory due date is in direct
contravention of the order of the Hon’ble Supreme Court in the suo motu
WP (Civil) No. 3/2020 vide order dated 23^rd March, 2020,
wherein the Apex Court in the exercise of its powers under Article 141 of the
Constitution (binding on all Courts / Tribunals and authorities), has ordered
that the period of limitation in all proceedings, irrespective of the
limitation prescribed under the general law or special law whether condonable
or not, shall be extended with effect from 15^th March, 2020 till
further orders. The service tax audits / inquiries under the pre-GST laws also
continued during the lockdown period (admittedly not on a full scale)
increasing the risk of best-judgment SCNs due to the inability of the assessee
to produce proper data during the said period. In some cases, the authorities
issued notices for conducting personal hearing through video conferencing.

The
economic impact of coronavirus on GST is directly linked to the economic health
of trade, commerce and industry during the said period and will become clearer
in the days to come and could even become permanent. However, the operational
impact and practical difficulties explained above are temporary in nature and
are expected to have a short life. Hopefully, with the re-opening of the
economy these things will come back on track and certain cases of fait
acompli experienced during the said period will be addressed wherever
possible by appropriate administrative orders. The whispers seeking more relief
are getting louder and there is a possibility that the government is likely to
announce further relaxations if the lockdown period is further extended. One only
hopes that this happens sooner rather than later.

shailesh.kwebmaker

Section 9(1)(vii)(b) of Act – On facts, since payments made by assessee to foreign attorneys for registration of IPs abroad were not for services utilised in profession carried on outside India, or for making or earning any income from any source outside India, FTS was sourced in India and not covered by exception carved out in section 9(1)(vii)

7. [2020] TS-117-ITAT-(Kol.)

ACIT vs. Sri Subhatosh Majumder

ITA No. 2006/Kol/2017

A.Y.: 2011-12

Date of order: 26^thFebruary, 2020

Section 9(1)(vii)(b) of Act – On facts, since payments made
by assessee to foreign attorneys for registration of IPs abroad were not for
services utilised in profession carried on outside India, or for making or
earning any income from any source outside India, FTS was sourced in India and
not covered by exception carved out in section 9(1)(vii)

FACTS

The assessee (resident in
India) was a patent attorney who provided IP registration services to its
clients in India. For registration of the IP of his clients abroad, the
assessee had made payments to foreign lawyers and attorneys. According to the
assessee, services were performed abroad and hence the payments were not
chargeable to tax in India. Therefore, the assessee did not withhold tax from
these payments.

But according to the A.O.,
the assessee had obtained technical information or consultancy services from
foreign attorneys. And although services were rendered outside India, they were
essentially connected with the profession carried on by the assessee in India.
Therefore, the payments were in the nature of FTS in terms of section
9(1)(vii), read with Explanation 2 thereto. Accordingly, the A.O. disallowed
the expenses u/s 40(a)(i).

On an appeal, following the
earlier years’ order in the assessee’s case⁵, the CIT(A) deleted the
addition by the A.O.

Being aggrieved, the tax
authority appealed before the Tribunal.

HELD

(1) Foreign attorneys were appointed for
registration of IP under patent laws of foreign countries where products were
sold. They had specialised knowledge and experience of foreign IP laws and
procedures for IPR registrations. Only because of the advice of foreign
attorneys the assessee and / or his clients could prepare the requisite,
technically intricate documentation necessary for preparing IP rights
registration applications in foreign countries. Foreign attorneys also
represented the clients of the assessee before the IP authorities abroad and
provided clarifications and explanations necessary for registrations.

(2) The following facts did not
support the contention of the assessee that he had merely acted as a
pass-through facilitating the payment to foreign attorneys or as an agent:

(a) Perusal of the documents furnished by the assessee did not show the
existence of direct and proximate nexus or direct contact between clients and
foreign attorneys.

(b) Clients had not issued any letters which showed that the appointment
of the foreign attorneys was made by the assessee on their specific
instructions or request.

(c) Perusal of the engagement letter issued by a client showed that it
had engaged the services of the assessee for registration of trade marks in
several foreign countries. It nowhere suggested engaging the services of, or
coordinating with, any particular foreign attorney. The manner of performance
was also left to the sole discretion of the assessee. The contractual terms did
not mention reimbursement of costs by the client.

(d) Copies of invoices raised by foreign attorneys showed that privity
of work was between the assessee and the foreign attorneys who performed their
work in terms of the appointment made by the assessee.

(3) Thus,
the foreign attorneys were engaged by the assessee. Payments to them were also
made by him. Such engagement was in the performance of professional services by
the assessee in India. The source of income of the assessee was solely located
in India. The assessee had engaged the services of foreign attorneys for
earning income from sources in India. Accordingly, the services rendered by the
foreign attorneys were in the nature of FTS in terms of section 9(1)(vii)(b)
and were not covered in the exception carved out therein.

_______________________________________________________________

5 Said
order pertained to years prior to amendment made vide Finance Act, 2010

shailesh.kwebmaker

Section 9(1)(i) of Act – As appearance of non-resident celebrity for promotional event outside India was for the benefit of the business in India, there was significant business connection in India and hence appearance fee paid was taxable in India

6. [2020] 115 taxmann.com 386 (Mum.)(Trib.)

Volkswagen Finance (P) Ltd. vs. ITO

ITA No. 2195/Mum/2017

A.Y.: 2015-16

Date of order: 19^th March, 2020

Section 9(1)(i) of Act –
As appearance of non-resident celebrity for promotional event outside India was
for the benefit of the business in India, there was significant business
connection in India and hence appearance fee paid was taxable in India

FACTS

The assessee was an Indian
member-company of a global automobile group. It organised a promotion event in
Dubai jointly with another Indian member-company of the group for the launch of
a car in India. For this purpose, the assessee paid appearance fees to a
non-resident (NR) international celebrity outside India. In consideration, the
assessee and its group company had full rights to use all the event footage /
material / films / stills / interviews, etc. (event material) for its business
promotion.

The assessee contended before the A.O. that the event took place in
Dubai; the NR made his appearance in Dubai; the NR or his agent had not
undertaken any activity in India in relation to the appearance fee; and hence,
appearance fee could not be treated as accruing or arising in India, or deemed
to be accruing or arising in India. Therefore, the income was not taxable under
the Act. Consequently, no tax was required to be withheld. Accordingly, there
was no question of claiming any DTAA benefit.

But the A.O. held that the
payment was in the nature of royalty u/s 9(1)(vi) and further, Article 12 of
the India-USA DTAA also did not provide any relief. Hence, the assessee was
liable to withhold tax.

On appeal, the CIT(A)
confirmed the conclusion of the A.O. and further held that the sole purpose of
organising the event in Dubai was to avoid attracting section 9(1)(i) relating
to Business Connection in India. Being aggrieved, the assessee filed an appeal
before the Tribunal.

HELD

(i) The Tribunal relied upon the Supreme Court’s observations in the
R.D. Agarwal case⁴ to hold
that business connection is not only a tangible thing (like people, businesses,
etc.), but also a relationship. From the following facts it was apparent that
the event in Dubai and the business of the assessee in India had a
relationship.

(a) The event was India-centric and the benefits thereof were to accrue
to the assessee and its group company in India because the target audience was
in India.

(b) The assessee and its group company were permitted non-exclusive use
of the event material.

(d) The claim of entire expenses of the event by the assessee and its
group company showed that they had treated the same as ‘wholly and
exclusively for the purposes of business’.

(ii) As a consequence of the relationship between the event in Dubai and
the business of the assessee in India, income had accrued to the NR. In this
case, the business connection was intangible since it was a ‘relationship’ and
not an object. However, it was a significant business connection without which
the appearance fee would not have been paid.

Accordingly, the NR had
business connection in India. Hence, the payment made to the NR was taxable in
India. Consequently, the assessee was required to withhold tax.

______________________________

3 Decision
does not mention particulars of circumstantial evidence provided by the
assessee for proving residency

4 (1965)
56 ITR 20 (SC)

shailesh.kwebmaker

Article 15(1) of India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section 90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee otherwise provides sufficient circumstantial evidence

5. [2020] TS-15 -ITAT-(Hyd.)

Sreenivasa Reddy
Cheemalamarri vs. ITO

ITA No. 1463/Hyd/2018

A.Y.: 2014-15

Date of order: 5^th
March. 2020

Article 15(1) of
India-Austria DTAA – Sections 6(1), 90(4) of the Act – Notwithstanding section
90(4), submission of TRC is not mandatory to claim DTAA benefit if assessee
otherwise provides sufficient circumstantial evidence

FACTS

The assessee was deputed by
his employer in India to Austria. He was paid certain foreign allowance outside
India on which the employer had deducted tax in India. The assessee contended
that since he was in India for less than 60 days, he was a non-resident (NR).
Further, he was a tax resident of Austria. Hence, in terms of Article 15(1) of
the India-Austria DTAA, the salary earned by a tax resident of Austria was
taxable only in Austria. Accordingly, he filed a NIL return as an NR in India.
The assessee also expressed his inability to furnish the Tax Residency
Certificate (TRC) on the ground that the issuance of a TRC was dependent upon
the Austrian tax authority.

Therefore, relying on section
90(4)¹ of the Act, the A.O.
denied DTAA benefit on the ground that the assessee could not furnish the TRC.
The assessee preferred an appeal before the CIT(A). Agreeing with the view of
the A.O., the CIT(A) dismissed the appeal. The assessee then filed an appeal before
the Tribunal.

HELD

(i) If, in spite of his best possible efforts, the assessee could not
procure the TRC from the country of residence, the situation may be treated as
impossibility of performance². In such circumstances, the assessee
cannot be obligated to do an impossible task and be penalised for the same.

(ii) If the assessee provides sufficient circumstantial³evidence
for proving residency, the requirement of section 90(4) ought to be relaxed.

(iii) In case of conflict between the DTAA and the Act, DTAA would prevail
over the Act. In terms of the DTAA, the assessee was liable to tax in Austria
for services rendered in Austria. Therefore, notwithstanding the Act requiring
a TRC for proving residency, not providing the same to the tax authorities
cannot be the only reason for denial of DTAA benefit to the assessee.

Note: In the absence of
any such specific mention, it is not clear whether the Tribunal read down
section 90(4) of the Act, impliedly treating it as a case of ‘treaty override’.

____________________________________________________________________________________________

1 Section
90(4) provides that an NR assessee will be entitled to claim relief under DTAA
only if he has obtained a TRC from the government of that country

2 Decision does not mention particulars of
‘best possible efforts’ of assessee or basis on which ITAT considered the
situation to be that of ‘impossibility of performance’. Decision merely
mentions that ‘normally it is a herculean task to obtain certificates from
alien countries for compliance of domestic statutory obligations’

shailesh.kwebmaker

Section 199/205 – Assessee cannot be made to suffer because of non-deposit of tax deducted with the government by the deductor – Under section 205, the assessee / deductee cannot be called upon to pay the tax – Credit for the tax deducted at source has to be allowed in the hands of the deductee irrespective of whether or not the same has been deposited by the deductor to the credit of the Central government

4. Aricent
Technologies Holdings Ltd. vs. Addl. CIT (Delhi)

Sushma
Chawla (J.M.) and Dr. B.R.R. Kumar (A.M.)

ITA. No.
5708/Del/2019

A.Y.:
2015-16

Date of
order: 23^rdDecember, 2019

Counsel
for Assessee / Revenue: Ajay Vohra, Neeraj Jain and Anshul Sachar / Sanjay I.
Bara

Section 199/205 – Assessee cannot be
made to suffer because of non-deposit of tax deducted with the government by
the deductor – Under section 205, the assessee / deductee cannot be called upon
to pay the tax – Credit for the tax deducted at source has to be allowed in the
hands of the deductee irrespective of whether or not the same has been
deposited by the deductor to the credit of the Central government

FACTS

The assessee in its
return of income had claimed credit to the extent of Rs. 18,79,68,945. The
A.O., upon completion of the assessment u/s 144 r.w.s. 143(3), allowed the
credit of TDS of Rs. 16,57,18,029. Thus, credit for TDS was short-granted to
the extent of Rs. 2,22,50,916.

The assessee had, along with the
return of income, furnished complete details including the names of the
parties, the amount paid by them and the tax deducted at source in respect of
the TDS of Rs. 18.79 crores.

HELD

The Tribunal observed that the issue
which has arisen in the present ground of appeal is against the short credit of
tax deducted at source. It noted that the assessee had furnished the party-wise
details of the amounts aggregating to Rs. 18.79 crores deducted out of payments
due to the assessee, which are also furnished as part of the Paper Book.

It also noted that the grievance of
the assessee is two-fold. First of all, it was pointed out that in case
subsequent to the processing of the assessment order, if changes are made in
the Form No. 26AS by the parties who had deducted tax at source out of the
payment made to the assessee, then the credit of the same should be allowed to
the assessee. The Tribunal held that it found merit in the plea of the assessee
though the AR for the assessee has not filed any evidence in this regard. But
in case necessary evidence is available, then it is the duty of the A.O. to
allow the claim as per Revised Form No. 26AS.

As regards the next stand of the
assessee, that in case the deductor deducts tax at source, i.e. withholds tax
out of payments due / paid to the assessee but does not deposit the tax
withheld by it, then why should the assessee suffer? The Tribunal held that

(i) Under
section 199(1) it is provided that if tax has been deducted at source in
accordance with the provisions of Chapter XVII and paid to the Central
government, the same shall be treated as payment of tax on behalf of the person
from whose income the deduction was made; and

(ii) Under
section 205 it is further provided that where the tax has been deducted at
source by the deductor out of the payments due to the deductee, then such
deductee cannot be held liable for payment of such tax which was deducted at
source by the deductor.

Once tax has been deducted then the
deductor is liable to deposit the same into the credit of the Central
government. Such amount which is withheld by the deductor out of the amount due
to the deductee, i.e., the person to whom the payments are made, then the said
deduction shall be treated as payment of tax on behalf of the person from whom
such deduction was made as per the provisions of section 199(1).

It also observed that there are
provisions under the Act dealing with the recovery of tax at source from the
person who has withheld the same. In terms of section 205 of the Act, the
assessee / deductee cannot be called upon to pay tax to the extent to which tax
had been deducted from the payments due.

Consequently, it follows that credit
for such tax deducted at source, which is deducted from the account of the
deductee by the deductor, is to be allowed as taxes paid in the hands of the
deductee irrespective of the fact whether or not the same has been deposited by
the deductor to the credit of the Central government.

The
deductee in such circumstances cannot be denied credit of tax deducted at
source on its behalf. It held that where the assessee is able to furnish the
necessary details with regard to tax deduction at source out of the amounts due
to it, then the action which follows is allowing the credit of such tax
deducted at source to the account of the deductee.

In
case where the deductor deposits the tax deducted at source to the credit of
the Central government and the deduction reflects in Form No. 26AS, may be on a
later date, then it is incumbent upon the assessee to produce the necessary
evidence in this regard and it is also the duty of the A.O. to allow such
credit of tax deducted at source as taxes paid in the hands of the deductee
assessee.

It observed that its view is
supported by the ratio laid down by the Bombay High Court in Yashpal
Sahani vs. Rekha Hajarnavis, Assistant Commissioner of Income-tax [(2007) 165
taxman 144 (Bom.)] and the Gujarat High Court in the case of Sumit
Devendra Rajani vs. Assistant Commissioner of Income-tax [(2014) 49 taxmann.com
31 (Gujarat)].

Applying the same parity of reasoning
in the decision of the Bombay High Court in Pushkar Prabhat Chandra Jain
vs. Union of India [(2019) 103 taxmann.com 106 (Bombay)], the Tribunal
directed the A.O. to allow the credit of tax deducted at source in the hands of
the assessee where the assessee produces the primary evidence of the same being
deducted tax at source out of the amount due to it.

This ground of appeal filed by the assessee was allowed.

shailesh.kwebmaker

Income from undisclosed sources – Section 69 of ITA, 1961 – Addition on basis of statement made by partner of assessee u/s 108 of Customs Act, 1962 – No other corroborative evidence – Addition not justified

12. Principal CIT vs. Nageshwar Enterprises

[2020] 421 ITR 388 (Guj.)

Date of order: 3^rd February, 2020

A.Y.: 2007-08

Income from undisclosed sources –
Section 69 of ITA, 1961 – Addition on basis of statement made by partner of
assessee u/s 108 of Customs Act, 1962 – No other corroborative evidence –
Addition not justified

In the course of a search
conducted by the Customs Department, a partner of the assessee in his statement
recorded on oath admitted before the Directorate of Revenue Intelligence the
undervaluation of goods, part of which pertained to A.Y. 2007-08, the year of
search. He admitted that the undervalued amount was paid in cash to the sellers
which were foreign companies. During the assessment the A.O. rejected the
submissions of the assessee and made additions on account of unaccounted
investment and unaccounted purchases.

The
Commissioner (Appeals) found that the A.O. did not make further inquiries and
that the only evidence with him was in the form of a confessional statement of
the partner of the assessee recorded on oath u/s 108 of the Customs Act, 1962
and that in the absence of any corroborative evidence or finding, no addition
could be made merely on the basis of the admission statement. The Tribunal
found that the addition was made based on the show cause notice issued by the
Revenue Intelligence, that the statement was retracted by the partner and that
the Customs Excise and Service Tax Appellate Tribunal had dropped the
proceedings initiated against the assessee. The Tribunal held that in the
absence of any documentary evidence no addition could be made on the action of
a third party, i.e., the Directorate of Revenue Intelligence.

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

‘i) The Tribunal was correct in holding that no addition could be made
on the basis of the action of the third party, i.e., the Directorate of Revenue
Intelligence. The Department could not start with the confessional statement of
the assessee. The confessional statement had to be corroborated with other
material on record.

ii) The appellate authorities had
concurrently recorded a finding that except the statement of the partner
recorded u/s 108 of the Customs Act, 1962, there was no other evidence. No
question of law arose.’

shailesh.kwebmaker

Income – Exemption u/s 10(24) of ITA, 1961 – Registered trade union – Amount received on settlement of dispute between company and its workers disbursed to workers – Amount not assessable in hands of trade union

11. Gujarat Rajya Kamdar Sabha Union Machiwadi vs. ITO

[2020] 421 ITR 341 (Guj.)

Date of order: 7^th January, 2020

A.Y.: 2009-10

Income – Exemption u/s 10(24) of
ITA, 1961 – Registered trade union – Amount received on settlement of dispute
between company and its workers disbursed to workers – Amount not assessable in
hands of trade union

The assessee was a registered
trade union. Its managing committee passed a unanimous resolution that as a
result of a compromise arrived at between the assessee and a company in the
Labour Court, whatever amount was received from the company would be fully
distributed to the workers of the company. In such circumstances a settlement
was arrived at on 15^th May, 2008, which was reduced into writing in
the form of a memorandum of settlement between the company, i.e, the employer,
and the assessee. In view of the settlement, the assessee received payment of
Rs. 60,96,818. The amount was assessed in the hands of the assessee as income
for the A.Y. 2009-10.

The Tribunal upheld the
assessment and the addition.

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

‘i) Once the factum of settlement was not disputed coupled with
the factum of receipt of a particular amount from the company, and the
amount had been distributed amongst the employees, the case would squarely
stand covered u/s 10(24) of the Income-tax Act, 1961. Though the contribution
from the employer was received as per the settlement agreement, it was only
incidental to the activities of the services of the assessee in resolving the
dispute between the member workers and the employer with the intention of
advancement of welfare of the members.

ii) The amount was not assessable as income of the assessee.’

shailesh.kwebmaker

Income – Accrual of (time of accrual of income) – Section 5 of ITA, 1961 – Where assessee sold a land during relevant assessment year and as per MOU part of sale consideration was payable by purchaser on completion of assessee’s obligation under MOU – Assessee having not met conditions of MOU during relevant year, such amount was not taxable in relevant assessment year

10. Principal CIT vs. Rohan
Projects

[2020] 113 taxmann.com 339
(Bom.)

Date of order: 18^th
November, 2019

A.Y.: 2012-13

Income – Accrual of (time of
accrual of income) – Section 5 of ITA, 1961 – Where assessee sold a land during
relevant assessment year and as per MOU part of sale consideration was payable
by purchaser on completion of assessee’s obligation under MOU – Assessee having
not met conditions of MOU during relevant year, such amount was not taxable in
relevant assessment year

The assessee
is engaged in the business termed Promoter and Developer. It had sold land to
M/s Symboisis which transaction took place in the previous year relevant to the
A.Y. 2012-13. The land was sold under a
Memorandum of Understanding (MOU) dated 2^nd February, 2012 for a
total consideration of Rs. 120 crores. However, the assessee offered only a sum
of Rs. 100 crores for tax in the return for the A.Y. 2012-13. This was because
the MOU provided that a sum of Rs. 20 crores would be paid by the purchaser
(M/s Symboisis) on execution of the sale deed after getting the plan sanctioned
and on inclusion of the name of the purchaser in the 7/12 extract. However, as
the assessee was not able to meet the conditions of the MOU during the subject
assessment year, the sum of Rs. 20 crores, according to the assessee, could not
be recognised as income for the subject assessment year. The A.O. did not accept
this and held that the entire sum of Rs. 120 crores is taxable in the subject
assessment year.

The Tribunal, after recording the
above facts and relying upon the decision of the Supreme Court in Morvi
Industries Ltd. vs. CIT [1971] 82 ITR 835, held that the income accrues
only when it becomes due, i.e., it must also be accompanied by corresponding
liability of the other party to pay the amount. On facts it was found that the
amount of Rs. 20 crores was not payable in the previous year relevant to the subject
assessment year as the assessee had not completed its obligation under the MOU
entirely. Moreover, it also found that Rs. 20 crores was offered to tax in the
subsequent assessment year and also taxed. Thus, the Tribunal allowed the
assessee’s appeal.

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 was justified in holding
that a sum of Rs. 20 crores is not taxable in the subject assessment year?’

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

‘i) We note that the finding of fact arrived at by the Tribunal that
the respondent was not able to comply (with) its obligations under the MOU in
the previous year relevant to the subject assessment year so as to be entitled
to receive Rs. 20 crores is not shown to be perverse. In fact, the issue is
covered by the decision of the Apex Court in the case of CIT vs. Shoorji
Vallabdas & Co. [1962] 46 ITR 144 wherein it is held that “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 ” So also in Morvi
Industries Ltd. (Supra), the Supreme Court has held that income accrues
when there is a corresponding liability on the other party. In the present
facts, in terms of the MOU there is no liability on the other party to pay the
amounts.

ii) In any event, the amount of Rs. 20 crores has been offered to tax
in the subsequent assessment year and also taxed. This Court, in the case of CIT
vs. Nagri Mills Co. Ltd. [1958] 33 ITR 681 (Bom.) has observed as
follows:

“3. We have often wondered why
the Income-tax authorities, in a matter such as this where the deduction is
obviously a permissible deduction under the Income-tax Act, raise disputes as
to the year in which the deduction should be allowed. The question as to the
year in which a deduction is allowable may be material when the rate of tax
chargeable on the assessee in two different years is different; but in the case
of income of a company, tax is attracted at a uniform rate, and whether the
deduction in respect of bonus was granted in the assessment year 1952-53 or in
the assessment year corresponding to the accounting year 1952, that is, in the
assessment year 1953-54, should be a matter of no consequence to the
Department; and one should have thought that the Department would not fritter
away its energies in fighting matters of this kind. But, obviously, judging
from the references that come up to us every now and then, the Department
appears to delight in raising points of this character which do not affect the
taxability of the assessee or the tax that the Department is likely to collect
from him whether in one year or the other.”

Nothing has been shown to us as
to why the above observation will not apply to the present facts.

iii) In the aforesaid circumstances, the
view taken by the Tribunal on facts is a possible view and calls for no
interference. In any event the tax on the amount of Rs. 20 crores has been paid
in the next year. Therefore, the proposed question does not give rise to any
substantial question of law. Hence, not entertained. The appeal is, therefore,
dismissed.’

shailesh.kwebmaker

MANDATORY PAYMENT FOR FILING APPEAL AND ESCAPE THEREFROM

INTRODUCTION

Laws are being so drafted nowadays that even for
preferring an appeal against an order passed by Revenue authorities the
aggrieved assessee has to shell out a minimum 10% or maybe even a higher
proportion of the dues.

In other words, the law makes it compulsory that
for filing / entertaining an appeal, the appellant must pay a minimum amount
upfront.

For example, under the MVAT Act payment of 10% of
tax dues has been made compulsory from 15^th April, 2017. Although
litigation on the said issue is on before the Hon. Bombay High Court, but as of
today no appeal is being admitted without payment of minimum 10% of tax dues.

Recently, the above issue has been dealt with by
the Hon. Supreme Court in the case of Tecnimont Pvt. Ltd. vs. State of
Punjab (67 GSTR 193)(SC).

FACTS OF THE CASE

The case arose from an order and judgment of the
Punjab and Haryana High Court. Under the Punjab Value Added Tax Act, 2005 (PVAT
Act), payment of 25% of additional demand was mandatory for entertaining an
appeal. This was challenged before the High Court.

The following questions arose before the Hon.
Punjab & Haryana High Court while deciding the case of Punjab State
Power Corporation Ltd. vs. State of Punjab (90 VST 66)(P&H):

‘(a) Whether the State is empowered to enact
section 62(5) of the PVAT Act?

(b) Whether the condition of 25% pre-deposit for
hearing first appeal is onerous, harsh, unreasonable and, therefore, violative
of Article 14 of the Constitution of India?

(c) Whether the first appellate authority in its
right to hear appeal has inherent powers to grant interim protection against
imposition of such a condition for hearing of appeals on merits?’

The Court decided the first two issues in favour of
the State, i.e., the State is empowered to make the provision as it has done
and that the provision is not in violation of Article 14 of the Constitution.

However, regarding the third issue, i.e., whether
the appellate authority is empowered to use its discretion for a lower amount,
the Hon. Punjab & Haryana High Court held in the affirmative, observing as
under:

‘It is, thus, concluded that even when no express
power has been conferred on the first appellate authority to pass an order of
interim injunction / protection, in our opinion, by necessary implication and
intendment in view of various pronouncements and legal proposition expounded
above, and in the interest of justice, it would essentially be held that the
power to grant interim injunction / protection is embedded in section 62(5) of
the PVAT Act. Instead of rushing to the High Court under Article 226 of the
Constitution of India, the grievance can be remedied at the stage of first
appellate authority. As a sequel, it would follow that the provisions of
section 62(5) of the PVAT Act are directory in nature, meaning thereby that the
first appellate authority is empowered to partially or completely waive the
condition of pre-deposit contained therein in the given facts and
circumstances. It is not to be exercised in a routine way or as a matter of
course in view of the special nature of taxation and revenue laws. Only when a
strong prima facie case is made out will the first appellate authority
consider whether to grant interim protection / injunction or not. Partial or
complete waiver will be granted only in deserving and appropriate cases where
the first appellate authority is satisfied that the entire purpose of the
appeal will be frustrated or rendered nugatory by allowing the condition of
pre-deposit to continue as a condition precedent to the hearing of the appeal
before it.

Therefore, the power to grant interim protection /
injunction by the first appellate authority in appropriate cases in case of
undue hardship is legal and valid. As a result, question (c) posed is answered
accordingly.’

The above judgment was challenged by the State on
the issue of the answer to question (c) and by the assessee in respect of the
answers to the first two questions.

The Hon. Supreme Court decided the issue under Tecnimont
Pvt. Ltd. vs. State of Punjab (67 GSTR 193)(SC).

CONSIDERATION BY SUPREME COURT

In its judgment, the Supreme Court referred to
various precedents on the issue. The indicative observations of the Supreme
Court can be noted as under:

‘15. In Har Devi Asnani 11 the
validity of proviso to section 65(1) of the Rajasthan Stamp Act, 1998
came up for consideration in terms of which no revision application could be
entertained unless it was accompanied by a satisfactory proof of the payment of
50% of the recoverable amount. Relying on the earlier decisions of this Court
including in Smt. P. Laxmi Devi the challenge was rejected and
the thought expressed in P. Laxmi Devi 10 was repeated in Har
Devi Asnani 11 as under:

“27. In Govt. of A.P. vs. P. Laxmi Devi 10 this
Court, while upholding the proviso to sub-section (1) of section 47-A of the Stamp Act introduced by the Andhra Pradesh Amendment Act 8
of 1998, observed (SCC p. 737, para 29):

29. In our opinion in this situation it is always
open to a party to file a writ petition challenging the exorbitant demand made
by the registering officer under the proviso to section 47-A alleging
that the determination made is arbitrary and / or based on extraneous
considerations, and in that case it is always open to the High Court, if it is
satisfied that the allegation is correct, to set aside such exorbitant demand
under the proviso to section 47-A of the Stamp Act by declaring the
demand arbitrary. It is well settled that arbitrariness violates Article 14 of
the Constitution (vide Maneka Gandhi vs. Union of India 17). Hence,
the party is not remediless in this situation.

…

28. In our view, therefore, the Learned Single
Judge should have examined the facts of the present case to find out whether
the determination of the value of the property purchased by the appellant and
the demand of additional stamp duty made from the appellant by the Additional
Collector were exorbitant so as to call for interference under Article 226 of
the Constitution.”

16. These decisions show that the following
statements of law in The Anant Mills Co. Ltd. have guided
subsequent decisions of this Court:

The right of appeal is the creature of a statute.
Without a statutory provision creating such a right the person aggrieved is not
entitled to file an appeal… It is permissible to enact a law that no appeal
shall lie against an order relating to an assessment of tax unless the tax had
been paid. It is open to the Legislature to impose an accompanying liability
upon a party upon whom legal right is conferred or to prescribe conditions for
the exercise of the right. Any requirement for the discharge of that liability
or the fulfilment of that condition in case the party concerned seeks to avail
of the said right is a valid piece of legislation…’

Observing as above, the Hon. Supreme Court upheld
the validity of two provisions.

In respect of question (c), that is, in spite of
such provisions, whether the appellate authority has discretion, the Hon.
Supreme Court observed as under:

‘18. It is true that in cases falling in second
category as set out in paragraph 11 hereinabove, where no discretion was
conferred by the Statute upon the appellate authority to grant relief against
requirement of pre-deposit, the challenge to the validity of the concerned
provision in each of those cases was rejected.

But the decision of the Constitution Bench of this
Court in Seth Nand Lal was in the backdrop of what this Court
considered to be meagre rate of the annual land tax payable. The decision in Shyam
Kishore attempted to find a solution and provide some succour in cases
involving extreme hardship but was well aware of the limitation. Same awareness
was expressed in P. Laxmi Devi and in Har
Devi Asnani and it was stated that in cases of extreme hardship a writ
petition could be an appropriate remedy. But in the present case the High Court
has gone a step further and found that the appellate authority would have
implied power to grant such solace, and for arriving at such conclusion,
reliance is placed on the decision of this Court in Kunhi 1.

19. Kunhi 1 undoubtedly laid down
that an express grant of statutory power carries with it, by necessary
implication, the authority to use all reasonable means to make such grant
effective. But can such incidental or implied power be drawn and invoked to
grant relief against requirement of pre-deposit when the statute in clear
mandate says no appeal be entertained unless 25% of the amount in question is
deposited? Would not any such exercise make the mandate of the provision of
pre-deposit nugatory and meaningless?

20. While dealing with the scope and width of
implied powers, the Constitution Bench of this Court in Matajog Dubey vs.
H.C. Bhari also touched upon the issue whether exercise of such power
can permit going against the express statutory provision inhibiting the
exercise of such power. The discussion was as under:

“Where a power is conferred or a duty imposed by
statute or otherwise, and there is nothing said expressly inhibiting the
exercise of the power or the performance of the duty by any limitations or
restrictions, it is reasonable to hold that it carries with it the power of
doing all such acts or employing such means as are reasonably necessary for
such execution. If in the exercise of the power or the performance of the
official duty, improper or unlawful obstruction or resistance is encountered,
there must be the right to use reasonable means to remove the obstruction or
overcome the resistance. This accords with common sense and does not seem
contrary to any principle of law. The true position is neatly stated thus in Broom’s
Legal Maxims, 10th Ed., at page 312: It is a rule that when the law
commands a thing to be done, it authorises the performance of whatever may be
necessary for executing its command.

(Emphasis added)”’

Relying upon the above precedents, the Hon. Supreme
Court held that once there is a specific provision, the appellate authority
cannot have discretion and cannot forgo such condition nor lower the amount.

AN ALTERNATIVE

The Hon. Supreme Court, while deciding the issue,
has also given a solution about cases where such condition cannot be complied
with. The said observations are available at many places and in precedents
reproduced by the Hon. Supreme Court.

In the paragraph reproduced above from the judgment
of Har Devi Asnani it can be seen that in case of exorbitant
demand, or in case of demand based on extraneous considerations, it is open to
approach the High Court under its inherent powers for deletion of such demand
as violative of Article 14.

The High Court can consider such a plea. Even in
the present case, the Hon. Supreme Court concluded as under:

‘25. As stated in P. Laxmi Devi and
Har Devi Asnani, in genuine cases of hardship recourse would
still be open to the concerned person. However, it would be a completely
different thing to say that the appellate authority itself can grant such
relief. As stated in Shyam Kishore, any such exercise would make
the provision itself unworkable and render the statutory intendment nugatory.’

Thus, an inference can be drawn that in case of
arbitrary demand one can approach the High Court by writ petition. It can also
be stated that in case of inability to pay the minimum amount, supported by
necessary documents and reasons, one can approach the High Court by writ
petition to waive the condition.

CONCLUSION

The law is now becoming very clear. Once there is a
condition of minimum payment, the appellate authority has no discretion in
spite of great prejudice to the assessee. However, if the circumstances exist,
the assessee can approach the High Court by way of writ petition to waive the
condition or set aside the demand itself.

As of today, the laws are
becoming mechanical and discretions are being done away with. The only hope for
justice will be from the Hon. High Courts in deserving cases.

shailesh.kwebmaker

SAT RULES: WHETHER PUBLIC CHARITABLE TRUSTS CAN BE RELATED PARTIES

Related parties
and transactions with them are a concern of many laws – the Companies Act,
2013, the SEBI Regulations, the Income-tax Act and so on. The core concern is
that when parties are ‘related’, there is a conflict of interest between such
related parties who are involved in taking a decision regarding these
transactions and the interests of other parties who have no say or even
knowledge about it. For example, a firm owned by the daughter of the MD of a
listed company is sought to be given a contract of services. There is obviously
concern whether the terms would be fair, whether such services were indeed
needed by the company, etc. In a sense, thus, transactions with related parties
are a form of corporate nepotism. However, the definition of related parties,
as we will see a little later, is not narrow to include merely relatives of
controlling / deciding person/s. It includes subsidiaries, parent companies,
group entities of a certain type, etc. Business realities require that certain
activities are carried on by the same group in different entities, and even
otherwise transactions between groups or related entities are inevitable. Yet,
concerns would remain about the conflict of interest and whether the
arrangement is on commercial arm’s length terms.

The Companies
Act, 2013 (the Act) and the SEBI (Listing Obligations and Disclosure
Requirements) Regulations, 2015 (the LODR Regulations) both deal with matters
relating to related parties and transactions with them. There is a detailed
accounting standard, too, dealing with this. Generally, these provide for
certain safeguards. There are requirements of approval of shareholders beyond a
particular threshold of materiality, with related parties generally barred from
voting thereon. The Audit Committee also has to approve all related party
transactions. Besides, there are requirements of disclosure of related parties
and transactions with them in the accounts. All of this serves at least two
purposes. Firstly, parties whose interests could potentially be affected would
get a say. Secondly, there is disclosure irrespective of whether such approval
was required. Hence, readers can review the nature and extent of such transactions.

Considering these varied safeguards and considering that parties may
still try to avoid them, an understanding of the provisions relating to such
transactions is important. A recent decision of the Securities Appellate
Tribunal (SAT) provides such an opportunity. Essentially, it held inter alia
that a public charitable trust whose managing trustee was father / father-in-law of the promoter directors of a listed company was
not a related party. Thus, although there were significant transactions with such
trust, the relevant provisions of law governing related parties would not
apply. The decision of SAT is in the matter of Treehouse Education and
Accessories Limited vs. SEBI [(2019) 112 taxmann.com 349 (SAT), order dated 7^th
November, 2019].

BACKGROUND

The facts of
the case are complicated and may even appear to be sordid, involving alleged
criminal acts. The background of what had transpired, as narrated by the
decision of SAT discussed here, an earlier decision of SAT and two orders of
SEBI, is as follows.

Treehouse
Education and Accessories Limited, a listed company (the Company) is engaged in
the business of education that it carries out through its own schools,
franchisees and along with certain public charitable trusts. It develops the
course and curriculum for the purpose. The franchisees and the trusts had
certain commercial arrangements with the company. It appears that there were
proposals and negotiations to merge the company with a company of the Zee group
for which an exchange ratio was also determined. For certain reasons, details
of which are not relevant here, there were disputes to such an extent that the
matter went to the police and the courts and the share exchange ratio was
revised substantially downwards.

The company
suffered very large losses which had allegedly questionable issues. There were
media reports about the company as per the SEBI orders which led to SEBI
initiating a preliminary inquiry.

Soon
thereafter, after making certain preliminary allegations, SEBI passed an
interim order debarring the company and its directors from accessing the
capital markets and ordered a forensic audit into its affairs. The order of
SEBI was appealed against to SAT which asked SEBI to pass a final order within
a specified time after giving due opportunity to the parties to present their
case. SEBI did so and passed a confirmatory order on 16^thNovember,
2018 imposing the same directions as did the interim order. This order was
appealed again and SAT passed the order which is now discussed here.

Two issues of
contention arose. One was whether SEBI was entitled to initiate such
investigations and pass such harsh orders on the facts (more so when they were
admittedly initiated on the basis of media reports). The second issue, and
which is the subject of more detailed discussion here, is whether the company
and the public charitable trust whose managing trustee is a relative of the
promoter directors, can be said to be related parties? And thus, whether the
provisions of disclosure, approval, etc. under the relevant provisions apply to
transactions with them.

Whether
transactions with public charitable trust where relative of promoter directors
is a managing trustee are related party transactions?

Owing to, as
the company explained to SEBI, certain peculiar circumstances / laws relating
to educational institutions / schools, the company had to enter into a tie-up
arrangement with public charitable educational trusts to run certain schools.
The company would provide its name and backing and curriculum, etc. More
importantly, it would provide funds (returnable over certain years, with
interest for a part of this time) that can be used to set up the schools.

One trust, to which large amounts were provided as security deposit, had
a managing trustee who was the father / father-in-law of the promoter director
couple. Owing to losses by the said trust, security deposits of large amounts
had effectively eroded and hence potentially huge losses were faced. The
question thus arose whether the law relating to related party transactions was
violated. For this purpose the moot question was whether the company and the
trust were related parties as understood in law.

The relevant
provisions for this purpose are contained in the Act and the LODR Regulations.
Section 2(76) of the Act defines the term ‘related party’ exhaustively. On a
plain and literal reading of the definition, it appears that a public
charitable trust would not be covered under the said definition. However, since
the company is a listed company, the provisions of the LODR Regulations would
also be applicable. Hence, if a party with whom the company transacts is a
related party under those Regulations, then the relevant requirements contained
therein would also have to be complied with.

Regulation
2(1)(zb) defines related party as follows (emphasis supplied):

‘”related
party” means a related party as defined under sub-section (76) of section
2 of the Companies Act, 2013 or under the applicable accounting standards:…’

Thus, it
includes, first, a related party as defined under the Act that we have seen
does not include a public charitable trust. However, the definition is wider
and has a second leg and includes a person defined as a related party under the
applicable accounting standards. If we apply the Indian Accounting Standards
(Ind AS 24), the definition therein is fairly wide and indeed worded
differently. It includes categories of persons not included in the definition
under the Act. Thus, for example, it includes entities that are controlled by
the persons who control the company or the ‘close relatives’ of such persons.
There are other categories, too. The relevant question would be whether on the
facts of the case a public charitable trust whose managing trustee is the
father / father-in-law of the director couple said to be in control of the
company is a related party. This would have been an interesting analysis.

Here is a case
where a company has commercial relations with a public charitable trust whose
objective is understood to be public welfare. There is a relative of the
promoter director who is stated to be the managing trustee.

SEBI had in its
interim as well as confirmatory orders made a preliminary allegation that the
said trust was a related party, the transactions with whom were carried out
without complying with the relevant provisions of law. And on this and other
grounds, ordered debarment of the parties and a forensic audit of the affairs
of the company. The appellants challenged this order and asserted that the
trust was not a related party.

SAT observed as
follows while holding that the trust was not a related party (emphasis
supplied):

‘18. Similarly,
we are unable to agree with the contentions of SEBI that a trustee of a public
charitable trust is a related party going by the correct reading of the
definition in the Companies Act as well as in the LODR Regulations, unless
there is evidence to show that those Trusts have been set up or (are) operating
for the benefit of the appellant(s). Moreover, there is nothing on
record to show that Mr. Giridharilal, the trustee, has personally benefited in
any manner not only by virtue of being a trustee or in general by any other
means.’

Making this
legal and factual conclusion, the SAT overturned the order of SEBI insofar as
it debarred the appellants.

Interestingly,
neither SEBI nor SAT made any detailed analysis of the definition of related
party under the Act or under the Regulations. SAT merely says that on a
‘correct reading of the definition’ under the Act / Regulations, a trustee of a
public charitable trust is not a related party. It did not explain what this
reading was and how was it correct. Curiously, it places its own additional
condition about the trust being set up or operating for the benefit of the
appellants.

However, it is
respectfully submitted that such a condition is not part of the law relating to
related party transactions.

It is submitted
that the Order of SAT needs reconsideration. The definitions of related party
would need to be analysed, the facts of the case examined in more detail and
only the conditions specified in the law applied. It appears that the second
leg of the definition in the LODR Regulations was not even examined.

Reliance on media
reports by SEBI in making adverse orders against parties

Another
observation SAT made is that SEBI initiated the examination based on media
reports which resulted in passing of adverse orders against the appellants that
remained in place for a very significant time. It is submitted that taking
hasty action relying on media reports is a dangerous way of reacting. Media,
particularly social media, have a tendency to quickly build outrage which a
patient regulator may consider letting pass, focusing instead on the surer
method of meticulous examination. It was particularly noted by SAT that the
appellants have suffered debarment for quite a long period and the
investigation and even the forensic audit has not yet been completed.

CONCLUSION

The SAT order
is only with reference to the interim / confirmatory order. SEBI is yet to
investigate fully and also yet to receive the forensic report ordered.
Thereafter, it may make formal charges, if any, and pass a final order. This
may happen in the near future. It would be interesting to see how SEBI deals
with the issue of related party in the context of these facts since in the
earlier orders it had made preliminary allegations only. More interesting would
be to see how SEBI deals with the reasoning and ruling of SAT on related
parties, which I submit requires reconsideration.

shailesh.kwebmaker

FOREIGN INVESTMENT REGIME: NEW RULES

INTRODUCTION

The Foreign Exchange Management Act, 1999 (the FEMA) governs the law relating to foreign exchange in India. The Reserve Bank of India is the nodal authority for all matters concerning foreign exchange. Under section 6(2) of the FEMA, the RBI was the authority empowered to notify Regulations pertaining to capital account transactions. Pursuant to the same, the RBI had notified the Foreign Exchange Management (Transfer or Issue of any Security to a Person Resident Outside India) Regulations, 2017 (TISPRO Regulations) for foreign investment in Indian securities and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018 (Property Regulations) for foreign investment in Indian immovable property.

However, the Finance Act, 2015 amended FEMA to provide that the RBI would only be empowered to notify Regulations pertaining to Debt Instruments, whereas the Central Government would notify Rules pertaining to the limit and conditions for transactions involving Non-Debt Instruments. While moving the Finance Bill, 2015 the Finance Minister explained the rationale for the same. He stated that capital account controls were more a policy matter rather than a regulatory issue. Accordingly, the power to control capital flows on equity was transferred from the RBI to the Central Government. Hence, a distinction was drawn between Debt Instruments and Non-Debt Instruments. The power to determine what is debt and what is non-debt has also been given to the Central Government.

While this enabling amendment was made in 2015, the actual Rules for the same were only notified on 16^thOctober, 2019 and, thus, the transfer of power took place only recently. Let us analyse some key features of these new Rules.

DISTINCTION

The Department of Economic Affairs, Ministry of Finance is the authority within the Central Government which has been given the above responsibility. The Finance Ministry has, on 16^th October, 2019, determined certain instruments as Debt Instruments and certain others as Non-Debt Instruments as given in Table 1 below:

Debt Instruments	Non-Debt Instruments
Government bonds	Investments in equity in all types of companies
Corporate bonds	Capital participation in LLPs
Securitisation structure other than equity tranches	Investment instruments recognised in the Consolidated FDI Policy, i.e., compulsorily convertible preference shares, compulsorily convertible debentures, warrants, etc.
Loans taken by Indian firms	Investments in units of Investment Vehicles such as Real Estate Investment Trusts (REITs); Alternative Investment Funds (AIFs); Infrastructure Investment Trusts (InVITs)
Depository receipts backed by underlying debt securities	Investment in units of Mutual Funds which invest more than 50% in equity shares
	Junior-most layer of securitisation structure
	Acquisition, sale or dealing directly in immovable property
	Contribution to trusts
	Depository receipts backed by equity instruments, e.g., ADRs / GDRs

Table 1: Classification of Debt vs. Non-Debt Instruments

NOTIFICATION OF RULES AND REGULATIONS

Pursuant to this determination, the Finance Ministry on 17^th October, 2019 notified the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (the NDI Rules) and, correspondingly, the RBI has notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019 (the Debt Regulations). The NDI Rules have superseded the erstwhile TISPRO Regulations and the Property Regulations which were issued by the RBI. While there are no changes in the NDI Rules as compared with the erstwhile Property Regulations, there are several changes in the NDI Rules as compared with the erstwhile TISPRO Regulations which are explained below. The RBI had also notified the Master Direction No. 11/2017-18 on Foreign Investment in India. This was issued pursuant to the TISPRO Regulations. However, section 47(3) of the FEMA states that all Regulations made by the RBI before 15^th October, 2019 shall continue to be valid until rescinded by the Central Government. Now that the TISPRO Regulations have been superseded by the NDI Rules, it stands to reason that this particular Master Direction would also no longer be valid. However, unlike the TISPRO Regulations, this Master Direction has not been expressly rescinded.

The TISPRO Regulations permitted an Indian entity to receive any foreign investment which was not in accordance with the Regulations provided that the RBI gave specific permission for the same. The NDI Rules also contain a similar provision for the RBI to give specific permission but it must do so after consultation with the Central Government. The powers of the RBI to specific pricing guidelines for transfer of shares between residents and persons resident outside India continue under the NDI Rules but they must be made in consultation with the Central Government.

Debt vs. Non-Debt definition: As compared to the TISPRO Regulations, the NDI Rules contain certain changes. Some of the key features of these Rules are explained here. One of the important definitions is the term ‘Non-Debt Instruments’ which has been defined in an exhaustive manner to mean the instruments listed in Table 1 above. Consequently, the term ‘Debt Instruments’ has been defined to mean all instruments other than Non-Debt Instruments.

Equity instruments: The term ‘capital instruments’ has been replaced with the term ‘equity instruments’. It means equity shares, compulsorily convertible debentures (CCDs), compulsorily convertible preference shares (CCPS) and warrants.

FDI: The distinction between foreign direct investment (FDI) and foreign portfolio investment has been continued from the TISPRO Regulations. Accordingly, any foreign investment through equity instruments of less than 10% of the post-issue paid-up capital of a listed company would always be foreign portfolio investment, whereas if it is 10% or more it would always be FDI. Any amount of foreign investment through equity instruments in an unlisted company would always be FDI.

Listed Indian company: The definition of the term ‘listed Indian company’ has undergone a sea change as compared to the TISPRO Regulations. Earlier, it was defined as an Indian company which had its capital instruments listed on a stock exchange in India and, thus, it was restricted only to equity shares which were listed.

The NDI Rules amended this definition to read as an Indian company which has its equity or Debt Instruments listed on a stock exchange in India. This amendment has created several unresolved issues. For example, under the SEBI (Issue and Listing of Debt Security) Regulations, 2008 a private limited company can also list its non-convertible debentures on a recognised stock exchange in India. Now, as per the amended definition under the NDI Rules, such a private company would also have to be treated as a listed Indian company. Accordingly, any foreign investment in such a private company, through equity instruments of less than 10% of the share capital, would now be treated as foreign portfolio investment. Secondly, Rule 21 specifies the pricing guidelines and states that the price of equity instruments issued by a listed Indian company to a person resident outside India would be as per the SEBI Guidelines. Thirdly, in case of a transfer of shares in such a company from a resident to a person resident outside India would have to be as per the SEBI Guidelines. There are no SEBI Guidelines for pricing of unlisted equity shares in case of a company whose debentures are listed. Hence, the Rules require adherence to SEBI pricing Guidelines when, in fact, there are none for private companies whose debt alone is listed! It is submitted that the NDI Rules should be amended to revert to the original position.

Rule 19 of the NDI Rules provides that in case of the merger / demerger of two or more Indian companies, where any of them is a company listed on a stock exchange, the scheme shall be in compliance with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Here Rule 19 does not use the defined phrase of ‘listed Indian company’. Further, while the aforesaid SEBI Regulations apply both to listed equity shares and listed debt, the provisions in Regulation 37 relating to scheme of arrangement apply only to companies which have listed their equity shares. Hence, it stands to reason that this particular provision of Rule 19 only covers companies whose equity shares are listed on a stock exchange.

Separate schedules: Similar to the TISPRO Regulations, the NDI Rules classify the different types of foreign investment which an Indian entity can receive into different schedules. Schedule I deals with FDI in an Indian company; schedule II deals with investment by a Foreign Portfolio Investor; schedule III deals with repatriable investment by NRIs; schedule IV deals with non-repatriable investment by NRIs and other related entities; schedule V deals with investment by other non-resident investors, such as sovereign wealth funds, pension funds, etc.; schedule VI deals with investment in an LLP; schedule VII deals with investment by a Foreign Venture Capital investor; schedule VIII deals with investment in an investment vehicle; schedule IX deals with investment in Foreign Depository Receipts; and schedule X deals with investment in Indian Depository Receipts.

Mutual funds > 50% in equity: One major amendment introduced by the NDI Rules was to classify a mutual fund which invested more than 50% in equity as an investment vehicle along with an REIT, AIF and an InVIT. The implication of this seemingly small amendment is drastic. It would mean that any mutual fund which is owned and / or controlled by non-residents and if it has invested more than 50% in equity, then any investment made by such a fund would be treated as indirect FDI. Thus, any investment by such a fund (even though it is not a strategic investment but a mere portfolio investment) would have to comply with pricing guidelines, reporting, sectoral caps and conditions, etc., specified for indirect FDI. Further, several sectors would be out of bounds for such a fund which are currently off limits for FDI. This move created turmoil within the mutual fund industry since several funds are owned and / or controlled by foreign companies. It also led to a bias against such funds and in favour of purely domestic funds. The SEBI took up this issue with the Finance Ministry and, accordingly, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to drop such mutual funds which invest more than 50% in equity from the definition of investment vehicle. Accordingly, any investment by such mutual funds would no longer be classified as indirect FDI.

Sectoral caps: The NDI Rules amended the definition of sectoral caps to provide the maximum repatriable investment in equity and Debt Instruments by a person resident outside India. Thus, compared to the TISPRO Regulations, Debt Instruments were also added in the definition of sectoral caps. This definition again created an ambiguity since it was not possible to consider debt investment while reckoning the sectoral caps. Accordingly, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to drop Debt Instruments from the definition of sectoral caps and revert to the earlier definition.

Pricing of convertible instruments: Unlike the TISPRO Regulations, the NDI Rules did not provide flexibility in determining the issue price of CCDs and CCPS. Now, the NDI Rules have been amended on 5^th December, 2019 with retrospective effect to provide that the price of such convertibles can either be determined upfront or a conversion formula should be determined at the time of their issue. The conversion price should be ≥ the fair market value as at the date of issue of the convertible instruments.

FPI: The NDI Rules have substantially amended the provisions relating to investments by SEBI Registered Foreign Portfolio Investors or FPIs:

(a) Under the TISPRO Regulations, maximum aggregate FPI investment was 24%. This limit could be increased to the sectoral caps by passing a special resolution. Thus, a company in the software sector which has no sectoral caps could increase the FPI limit to 100%.

(b) The NDI Rules now provide that with effect from 1st April, 2020 the FPI limit for all companies shall be the sectoral caps applicable to a company irrespective of whether or not it has increased the limit by passing a special resolution. The only exception is a company operating in a sector where FDI is prohibited – in which case the FPI limit would be capped @ 24%. This is a new feature which was not found in the TISPRO regime. Thus, in the case of a listed company operating in the casino / gambling sector (where FDI is taboo) the FPI limits would be 24%! This is a unique provision since FDI and FPI are and always were separate ways of investing in a company. Now, FPI would be limited in a company simply because it is ineligible to receive FDI.

(c) In case the Indian company desires to reduce the FPI limit then it can peg it to 24% or 49% or 74% provided that it passes a special resolution to this effect before 31^st March, 2020. Thus, if an Indian company is wary of a hostile takeover through the FPI route, then it may reduce the FPI limit. Such a company which has reduced its FPI limit may once again increase it to 49% or 74% or sectoral cap by passing another special resolution. However, once a company increases its FPI limit after first reducing it, then it cannot once again reduce the same.

(d) If an FPI were to inadvertently breach the limit applicable to a company, then it has five trading days to divest the excess shares, failing which its entire shareholding in that company would be classified as FDI.

(e) The Rules originally provided that FPIs could sell / gift shares only to certain non-residents. This provision has been amended with retrospective effect to provide that FPIs can sell in accordance with the terms and conditions provided by the SEBI Regulations. Thus, the original position prevalent under the TISPRO Regulations has been restored.

FVCI: Under the TISPRO Regulations, a SEBI registered Foreign Venture Capital Investor could invest in the securities of a start-up without any sectoral restrictions. As compared to the TISPRO Regulations, instead of the term ‘securities’, the NDI Rules provide a more detailed description permitting investment in the equity or equity-linked instruments or debt instruments issued by a start-up. However, if the investments are in equity instruments then the sectoral caps, entry routes and other conditions would apply.

Sectoral conditions: The NDI Rules have made certain changes in the sectoral conditions for certain sectors which are as follows:

(i) Coal and lignite: 100% FDI through the automatic route is now allowed in sale of coal and coal mining activities, including associated processing infrastructure, subject to the provisions of the Mines and Minerals (Development and Regulation) Act, 1957 and the Coal Mines (Special Provisions) Act, 2015. This includes coal washery, crushing, coal handling and separation (magnetic and non-magnetic).

(ii) Manufacturing: The 100% automatic route FDI is permissible in manufacturing. The definition of the term manufacturing has been amended to include contract manufacturing in India through a legally tenable contract, whether on principal-to-principal or principal-to-agent basis. In this respect, the Commerce Ministry has clarified that the principal entity which has outsourced manufacturing to a contractor would be eligible to sell its products so manufactured through wholesale, retail or e-commerce on the same footing as a self-manufacturer. Further, the onus of compliance with the conditions for FDI would remain with the manufacturing entity.

(iii) Broadcasting: A new entry has been added permitting FDI up to 26% on the Government approval route in uploading / streaming of news and current affairs through digital media.

(iv) E-commerce: Under the TISPRO Regulations, an e-commerce entity was defined to mean an Indian company or a foreign company covered under the Companies Act, 2013 or an office, branch or agency which is owned or controlled by a person resident outside India and which is conducting e-commerce activities. The NDI Rules have truncated the definition to only cover a company incorporated under the Companies Act, 1956 / 2013. Hence, going forward, branches of foreign companies would not be treated as an eligible e-commerce entity. Further, a new condition has been included that an e-commerce marketplace with FDI must obtain and maintain a report from its statutory auditor by the 30^thday of September every year for the preceding financial year confirming compliance with the FDI Guidelines.

(v) Single Brand Product Retail Trading (SBRT): The original NDI Rules contained some variations compared to the TISPRO Regulations which have now been rectified. However, even though 100% automatic route FDI continues to be allowed in SBRT, there are yet some changes compared to the TISPRO Regulations:

(1) SBRT FDI > 51% requires that at least 30% of the value of the goods procured shall be locally sourced from India. The entity can set off this 30% requirement by sourcing goods from India for global operations. For this purpose, the phrase ‘sourcing of goods from India for global operations’ has been defined to mean the value of goods sourced from India for global operations for that single brand (in rupee terms) in a particular financial year directly by the entity undertaking SBRT or its group companies (whether resident or non-resident), or indirectly by them through a third party under a legally tenable agreement.

(2) As before, an SBRT entity operating through brick and mortar stores can also undertake retail trading through e-commerce. However, it is now also possible to undertake retail trading through e-commerce prior to the opening of brick and mortar stores, provided that the entity opens brick and mortar stores within two years from the date of starting the online retail.

The power to govern the mode of payment and reporting of the non-debt instruments still vests with the RBI and, thus, the RBI has also notified the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019. These lay down the forms to be filed on receipt of various types of foreign investment, the manner of making payment by the foreign investors and the manner of remittance of the sale / maturity proceeds on sale of these foreign investments. These Regulations contain provisions which are the same as those contained in the earlier TISPRO Regulations.

DEBT REGULATIONS

Consequent to the notification of the Debt Rules, the RBI has notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019. These regulate debt investment by a person resident outside India. For instance, the investment by FPIs in corporate bonds / non-convertible debentures is governed by these Regulations. One change in the debt regulations as compared to the TISPRO Regulations is that NRIs are no longer allowed to invest in money market mutual funds on a non-repatriation basis.

CONCLUSION

The FEMA Regulations have been totally revamped in the field of capital instruments. It remains to see whether the Government would amend more FEMA Regulations to transfer power from the RBI to itself. One only wishes that whichever authority is in charge, there is clarity and simplicity in the FEMA Regulations which would lead to a conducive investment climate.

shailesh.kwebmaker

ACCOUNTING FOR OWN EMPLOYEE TRAINING COSTS INCURRED ON CUSTOMER CONTRACTS

This article seeks to provide guidance on
the most appropriate accounting under Ind AS 115 Revenue from Contracts with
Customers to account for own employee training costs incurred on customer
contracts.

FACT PATTERN

Consider the following fact pattern:

1. Ez Co enters
into a contract with a customer, Ti Co, that is within the scope of Ind AS 115.
The contract is for the supply of outsourced services. Ez’s employees take
calls from Ti’s customers and provide them with online assistance for
electronic products purchased from Ti.

2. To be able to
provide the services to Ti, Ez incurs training costs for its employees so that
they understand Ti’s equipments and processes. Applying Ind AS 115, Ez does not
identify the training as a performance obligation.

3. The contract
permits Ez to recharge to Ti the costs of training (i) Ez’s employees at the
beginning of the contract, and (ii) new employees that Ez hires as a result of
any expansion of Ti’s operations. Ez is unable to recharge costs associated
with training replacement employees (i.e., new employees of Ez recruited to
replace those that leave Ez’s employment).

Whether Ez should
recognise an asset for the training costs incurred to fulfil a contract with
the customer (Ti)?

RESPONSE

Training costs
should not be capitalised as a cost to fulfil a contract, regardless of whether
they are explicitly rechargeable in Ez’s contract with its customer.

ANALYSIS

Paragraphs 95-96 of
Ind AS 115 state:

95 If the costs incurred in fulfilling a contract
with a customer are not within the scope of another Standard (for example, Ind
AS 2 Inventories, Ind AS 16 Property, Plant
and Equipment or Ind AS 38 Intangible Assets), an entity shall
recognise an asset from the costs incurred to fulfil a contract only if those
costs meet all of the following criteria:

(a) The costs relate directly to a contract or to an
anticipated contract that the entity can specifically identify (for example,
costs relating to services to be provided under renewal of an existing contract
or costs of designing an asset to be transferred under a specific contract that
has not yet been approved);

(b) the costs generate or enhance resources of the
entity that will be used in satisfying (or in continuing to satisfy)
performance obligations in the future; and

(c) the costs are expected to be recovered.

96 For costs incurred in fulfilling a contract
with a customer that are within the scope of another Standard, an entity shall
account for those costs in accordance with those other Standards.

In this context,
training costs are specifically addressed in Ind AS 38. Ind AS 38.69 requires
that (extract):

‘In some cases,
expenditure is incurred to provide future economic benefits to an entity, but
no intangible asset or other asset is acquired or created that can be
recognised. … Other examples of expenditure that are recognised as an expense
when it is incurred include:

a) …

b) Expenditure on training activities

c) …

d) …’

Paragraph 3 of Ind AS 38 states (extract) – ‘If another Standard
prescribes the accounting for a specific type of intangible asset, an entity applies
that Standard instead of this Standard. For example, this Standard does not
apply to:

(a)….

…….

(i) assets arising from contracts with customers
that are recognised in accordance with Ind AS 115, Revenue
from Contracts with Customers’.

It may be noted
that Ind AS 115 does not apply specifically to training costs. Consequently,
Ind AS 38 will apply. As a result, training costs that are incurred in respect
of a contract with a customer cannot be recognised as an asset and must be
expensed as incurred. A prohibition on capitalising employee training costs is
consistent with the requirement that an asset must be controlled. Since an
employer does not control its employees, it follows that training costs that
enhance the knowledge and performance of employees cannot be capitalised (see
paragraph 15 of Ind AS 38). This is also consistent with the requirements of
paragraph B 37 of Ind AS 103 Business Combinations, which prohibits the
recognition of an asset for an acquired assembled workforce because it is not
an identifiable asset.

The training costs
meet the following requirements of paragraph 95 Ind AS 115:

relate specifically to a
contract that Ez can identify (Ind AS 115.95[a]);

enhance the resources of Ez
that will be used in satisfying performance obligations in the future (Ind AS
115.95[b]); and

are expected to be
recovered (Ind AS 115.95[c]).

A key difference
between Ind AS 115.95 and the criteria in Ind AS 38 is that, under Ind AS
115.95, the entity does not need to control the resource. It is not necessary to demonstrate that the employees are controlled
by Ez; instead, it is sufficient that Ez’s resources (the employees) have been
enhanced by the training.

Paragraph 95 of Ind
AS 115 requires an entity to recognise an asset from the costs incurred to
fulfil a contract with a customer not within the scope of another Ind AS
Standard only if those costs meet all the three criteria specified in paragraph
95. Consequently, before assessing the criteria in paragraph 95, an entity
first considers whether training costs incurred to fulfil a contract are within
the scope of another Standard.

Paragraph 5 of Ind
AS 38 states that ‘this Standard applies to, among other things, expenditure
on advertising, training, start-up, research and development activities’.

Accordingly, in the
fact pattern described, the entity applies Ind AS 38 in accounting for the
training costs incurred to fulfil the contract with the customer. Since an
employer does not control its employees, it follows that training costs that
enhance the knowledge and performance of employees cannot be capitalised.

shailesh.kwebmaker

DCIT (OSD)-8(2) vs. Hotel Leela Venture Ltd.; Date of order: 28th July, 2016; [ITA No. 617/Mum/2014; A.Y.: 2009-10; Mum. ITAT] Section 115JB of the Act – MAT – Forward foreign exchange contract entered into by assessee could not be considered as contingent in nature as it creates a continuing binding obligation on date of contract against assessee

14. The Pr. CIT-10 vs. Hotel Leela Venture Ltd. [Income tax Appeal No.
1097 of 2017] Date of order: 5^th November, 2019 (Bombay High Court)

DCIT (OSD)-8(2) vs. Hotel Leela Venture Ltd.; Date of order: 28^th
July, 2016; [ITA No. 617/Mum/2014; A.Y.: 2009-10; Mum. ITAT]

Section 115JB of the Act – MAT – Forward foreign exchange contract
entered into by assessee could not be considered as contingent in nature as it
creates a continuing binding obligation on date of contract against assessee

The assessee is
a company engaged in the business of five star deluxe hotels. The AO made an
addition of Rs. 10,47,08,044 to the book profit on account of foreign currency
transaction difference.

Being aggrieved
by the order, the assessee filed an appeal to the CIT(A). The CIT(A) partly
allowed the appeal, deleting the addition on the ground that the liability was
not a contingent liability.

Aggrieved by
the order of the CIT(A), the Revenue filed an appeal to the Tribunal. The
Tribunal found that after considering various judicial pronouncements, the
CIT(A) reached the conclusion that the said liability is not contingent. As per
the CIT(A), a contingent liability depends purely on occurrence and
non-occurrence of an event, whereas if an event has already taken place, which
in the present case is of entering into a contract and undertaking of
obligation to meet the liability, and only the consequential effect of the same is to be determined, then it cannot
be said that it is in the nature of a contingent liability.

After applying
the proposition of law laid down by the Hon’ble Supreme Court in the cases of Woodward
Governor India and Bharat Earth Movers, the CIT(A)
recorded a finding to the effect that it was not a contingent liability. Accordingly,
the appeal of the Revenue was dismissed.

Being aggrieved
by the order of the ITAT, the Revenue filed an appeal to the High Court. The
Court held that the Tribunal and the CIT(A) had held that the forward foreign
exchange contract entered into by the assessee to buy or sell foreign currency
at an agreed price at a future date cannot be considered as contingent in
nature as it creates a continuing binding obligation on the date of the
contract against the assessee. The view taken by the Tribunal was correct, that
in the present case where an obligation was undertaken to meet a liability and
only the consequential effect was to be determined, it could not be said that
the amount in question was in the nature of contingent liability.

Further, the
Revenue sought to urge an additional question of law to the effect that the
Tribunal erred in not treating the amount of Rs. 10,47,08,044 as capital
expenditure for computation of book profit u/s 115JB of the Act when this
amount was treated by the AO and accepted by the assessee as a capital
expenditure.

The Court
observed that this point was not urged before the Tribunal nor had it found
reference in the present appeal memo. The appeal was filed before the Tribunal
on the sole ground of the amount in question being a contingent liability. In
view of such a single, focused approach before the Tribunal, the decision of
the Tribunal was restricted only to that ground.

The argument of
Revenue that there was only a mistake in choosing the words, that instead of
capital expenditure, the words contingent liability were used, cannot be
accepted because the reason for the amount being treated as contingent in
nature had also been specified in the said ground, stating that the loss was on
account of foreign exchange fluctuation. It is not permissible for the
appellant to urge the said question for the first time before the Court and
that, too, during the course of the oral arguments.

Accordingly,
the appeal was dismissed.

shailesh.kwebmaker

Sections 11, 12, 139, 148 – A failure on the part of the Trust to file its return of income u/s 139(4A) cannot lead to withdrawal of exemption under sections 11 and 12 – Having filed a return of income u/s 139, subsequently, where a return is furnished in response to notice u/s 148, it replaces the return filed u/s 139, including section 139(4A), and all the other provisions of the Act including sections 11 and 12 are applicable – There was no time limit prescribed for submission of return of income and audit report in respect of a Trust whose income before claiming the exemption exceeded the basic exemption limit Clause (ba) to Section 12A, which prescribes time limit for submission of return of income and audit report to be time available u/s 139(1), is effective from A.Y. 2018-19 and is prospective in its application

23. [2019] 202 TTJ (Del.) 928 United Educational Society vs. JCIT ITA Nos.
3674 & 3675/Del/2017 and 2733 & 2734/Del/2018 A.Ys.: 2006-2007 to 2009-2010 Date of order: 28^th June, 2019

Sections 11, 12, 139, 148 – A failure on
the part of the Trust to file its return of income u/s 139(4A) cannot lead to
withdrawal of exemption under sections 11 and 12 – Having filed a return of
income u/s 139, subsequently, where a return is furnished in response to notice
u/s 148, it replaces the return filed u/s 139, including section 139(4A), and
all the other provisions of the Act including sections 11 and 12 are applicable
– There was no time limit prescribed for submission of return of income and
audit report in respect of a Trust whose income before claiming the exemption
exceeded the basic exemption limit

Clause (ba) to Section 12A, which
prescribes time limit for submission of return of income and audit report to be
time available u/s 139(1), is effective from A.Y. 2018-19 and is prospective in
its application

FACTS

The assessee was an educational society. The
A.O. had received information about huge investments made by the society in
land and building; however, no return of income had been filed. The A.O. issued
notice u/s 148, in response to which the assessee filed return of income
showing ‘nil’ income after application of section 11. There were two sets of
financial statements prepared, one for the purpose of obtaining loan and
another filed along with the return. In view of this, the A.O. ordered a
special audit to be carried out u/s 142(2A). Based on the report of the special
auditor, the A.O. made a computation of the total income of the society by
disallowing the benefit of exemption u/s 11. The income was assessed under the
head ‘Profits & Gains of Business or Profession’ and the assessee was
assessed in the status of an AOP.

Aggrieved, the assessee preferred an appeal
to the CIT(A) who gave partial relief to the assessee.

Still aggrieved, the assessee preferred an
appeal to the Tribunal.

HELD

The A.O. had denied the benefit of exemption
of section 11 to the assessee on account of the fact that the assessee had not
filed its return of income pursuant to section 139(4A). The assessee was a
society which had been granted registration u/s 12A; it engaged in activities
which were within the meaning of charitable purpose, and once so registered,
the computation of income had to be made in accordance with the provisions of
sections 11 and 12.

The fact that the assessee had filed its
return in response to notice issued u/s 148 and not under the provisions of
section 139(4A) cannot be a reason for not granting the benefit of exemption.
Once a return of income is submitted under the provisions of section 148, it
replaces the return filed u/s 139 and all other provisions of the Act,
including sections 11 and 12, become applicable as if it was a return filed
under the provisions of section 139. For a return filed under the provisions of
section 148, the relevant provisions of section 139 have to be applied along
with the procedure for assessment and computation of income, without
restricting it to exclude any procedure. Therefore, the trust was entitled to
claim the exemption u/s 11 in computation of income.

Clause (b) of section 12A mandates that
provisions of sections 11 and 12 shall not apply unless the accounts are
audited and a return is filed along with the audited accounts. Thus, as and
when computation was done these conditions had to be complied with. The issue
of whether or not the return was filed in time is not relevant for clause (b)
of section 12A.

The Finance Act, 2017 has amended section
12A and a new clause has been inserted specifying the time limit in case of such
trusts to furnish their return of income and audit report within the time
specified in section 139(4A). These provisions are prospectively applicable
from A.Y. 2018-19 onwards and cannot be treated as clarificatory amendments.

Note: Clause (ba) to section 12A as inserted
by the Finance Act, 2017 prescribes that the return of income and tax audit
report has to be submitted by a trust within the time provided by section
139(1). Consequently, the ratio of this decision will not apply post
insertion of clause (ba), i.e. for assessment years 2017-18 and thereafter.

The grounds of appeal filed by the assessee
were allowed.

shailesh.kwebmaker

POSSIBLE SOLUTION TO THE PROBLEM OF STRESSED ASSETS

The gross
Non-Performing Assets (NPAs) of all Scheduled Commercial Banks shot up from Rs.
69,300 crores in 2009 to Rs. 9,33,609 crores in 2019. The stress in the industrial
sectors such as power, roads, steel, textiles, ship-building, etc. are mainly
responsible for this huge increase. RBI has time and again come up with various
guidelines to resolve the financial stress in NPAs and reclassify them to
standard assets. The Government of India also brought the Insolvency and
Bankruptcy Code (IBC) into force in 2016 to bring about quick resolution of
NPAs. However, the results have not been very encouraging.

BBBB MODEL OF INFRASTRUCTURE /
PROJECT DEVELOPMENT

Infrastructure
development and financing of green field / brown field projects is generally
plagued with several issues. And it is this area that has significantly
increased the NPAs in the banking sector. Since the opening up of the economy
the nexus between the 4B’s has been at the centre of the problem. One can
term it as the ‘BBBB model’ of infrastructure development wherein the
Bureaucracy, Businessmen, Bankers and the Bench (Judiciary) have played a key
role in creating stress in the project / company and consequently leading to
non-viability of the projects and the rise in NPAs. The role played by
these 4Bs which has led to cost escalation of the projects or delays in their
implementation can be summarised as under:

Bureaucracy: The number of regulatory approvals creating hurdles in doing business,
delays in getting several regulatory approvals, land acquisition delays,
greasing of the palms of bureaucrats and politicians for expediting approvals,
compliance / clearances and licenses, etc.

Businessmen: Aggressive / unrealistic projections, siphoning off of funds and fund
diversion, gold plating the cost of projects, etc.

Bankers: Financing based on aggressive / unrealistic projections, lack of
project monitoring, delays in sanctioning / disbursements, phone banking /
corruption, technical and physical incapability / inefficiency for project
appraisal / analysis, etc.

Bench: The slow process of the judiciary / arbitration / claim settlement and
justice delivery system in India.

The above are some of
the primary reasons for delays in implementation of projects, consequently
leading to cost escalations, increase in the overall cost of the projects and
their non-viability.

Understanding financial stress in the
company / project

We normally hear
about ‘signs of financial stress’ like (1) the company is making losses, (2)
the net worth of the company is negative, (3) the company is not able to meet
its present payment obligations, (4) the company’s rating is downgraded, (5) it
has a high debt-to-equity ratio, (6) there is consistent over-drawl in the cash
credit account, and (7) it has a low current asset ratio.

These are only
‘signs’ of the financial stress in the company. Some of these signs would be
common across sectors, industries or among various companies in distress.
However, the causes of the financial stress among them would vary and could
relate to regulatory approvals, labour, reduction in demand for products /
services, land acquisition, debtors unable to pay, litigations, reduction in
revenues or prices of products or services, increase in input costs,
non-availability of inputs / raw materials, etc.

In order to resolve
the financial stress in companies and for resolving the NPA issue, we can
broadly categorise the solutions adopted by the regulator / government into two
kinds:

(1)
Sweep the dust under the carpet:
Under this, the regulator allowed lenders to defer their interest and principal
payments, allowed lenders to provide additional funding and required promoters
to infuse more capital and provide personal and / or corporate guarantees. The
regulator even allowed regulatory forbearance (i.e., special dispensation to
lenders for not categorising these borrowers / assets as NPAs once the
restructuring plan was implemented) so that the company and existing capital
providers are given enough time to resolve the real cause of the financial
stress and the company can be revived.

The
problem with this approach was that the cause of the financial stress never got
resolved but the payment to lenders got postponed and the build-up of NPAs in
the system did not get reversed. Further, the lenders failed to monitor things
once the restructuring scheme got implemented whether or not the cause of
financial stress was resolved. Lenders with their short-sighted view were only
bothered that they did not have to classify the asset as an NPA or make
additional provisions immediately, and for the time being they could sweep the
dust under the carpet. This led to lenders approving restructuring schemes that
were based on aggressive business assumptions and sometimes even unrealistic
assumptions.

(2) Lift the mat, show the dust to everyone and
let someone else clean it up: Under the second type of solution, the regulator
took away the regulatory forbearance (i.e., special dispensation for not
categorising the account by lenders as NPA on restructuring). The regulator
allowed the lenders to defer their interest and principal payments and required
promoters to infuse more capital and provide personal and / or corporate
guarantees. The lenders were required to reach an agreement for a restructuring
scheme within specified timelines. If the restructuring scheme was not approved
within the specified timelines, lenders either had to change the owner or
resolve the matter under the Corporate Insolvency Resolution Process (CIRP).

The timelines
specified by the regulator again resulted in lenders approving some of the
restructuring schemes that were based on aggressive business assumptions and
sometimes unrealistic assumptions.

Another issue was
that each and every decision of the lenders was viewed and reviewed with
suspicion and the sword of inquiry by various investigative agencies of the
government and its authorities was hanging on the lender’s decision. This led
to lenders not reaching any decision at all in some cases. In such situations,
lenders preferred to let the NCLT, NCLAT or the Supreme Court decide under the
IBC even at the cost of possible value destruction of the asset on referring to
these forums.

These solutions did
not lead to a reversal of the build-up of NPAs or resolving the real cause of
the financial stress in the company. Further, shareholders and depositors of
lenders continued to lose money under both the above methods due to various
reasons.

As
you may have noticed under the above two approaches, the government or the
regulator is only providing a solution for postponing payment of interest and
principal but has failed to provide a solution for resolving the cause of the
financial stress. Resolving the cause of financial stress has been left to the
existing lenders or promoters, and in some cases to new lenders and promoters
where the asset is sold to a new investor. In order to resolve the stress of
NPAs in the economy, the government and various regulators need to step in and
resolve the true cause behind the financial stress. At the same time, it is
virtually impossible for governments and regulators to have a customised
solution for each company for resolving its financial stress. Hence there is a
need to generalise the causes of financial stress in a company and then
government and regulators need to find a solution for resolving these issues
rather than merely postponing interest and principal payments.

The factors leading
to financial stress in a company can be broadly categorised as under:

Table 1

Sr.

Stress factor

Entity responsible

(A)

Revenue

Customers are interested in minimising
the price of the product and consequently revenue for the company

(B)

Variable cost

Raw material, labour costs, etc. directly linked to generating
revenue. Suppliers, labour are interested in maximising or increasing this component and consequently the
cost of production

(C)

Fixed cost

– Revenue-linked

Administration cost, legal, rentals, etc. (other bare minimum fixed
costs which are absolutely necessary)

(D)

Fixed cost

– Capital
provider-related

Depreciation and interest. Capital providers are interested in maximising or increasing this component
in order to maximise their return on capital

(E)

Profit

Capital providers are interested in maximising
or increasing this component in order to maximise their return on capital

Please note: Regulator / government will have a role in all or any of the above
factors directly or indirectly either for minimising or maximising the stress
factor. (Examples: Central Electricity and Regulatory Commission would be
keen on minimising revenue and tariff for customers. NHAI, if it delays in
land acquisition for a road project, it would push the cost of the project
and consequently fixed costs)

Financial stress in a
company can be reduced if the role of any of the above can be reduced or
eliminated. The factors stated in A, B and C above can be difficult to reduce
or eliminate. However, the factors stated in D and E can be reduced or
eliminated to make the operations of the company viable and resolve the
financial stress in the company.

‘Utility
Instruments’: A possible solution for resolving stress / NPAs

One of the solutions
for resolution of stressed assets and reducing the NPAs in the books of lenders
can be the issuing of ‘Utility Instruments’. A typical project which is an NPA,
especially in the infrastructure space, is funded by a mix of debt (from banks)
and equity infused by the promoters / investors in the company. What if an
instrument is introduced which replaces all the debt and equity in the company?

Two questions arise:

(1) Who will
subscribe to these ‘Utility Instruments’?

(2)
What will be the return on these ‘Utility Instruments’ – especially when the
project is not even able to service the interest, forget servicing of principal
and return on equity?

The answers to the
above questions will be explained in detail with the help of an example of a
stressed power-generating company that is an NPA asset in the books of the
bankers.

How it will work

A typical Power
Generation Company POGECO Ltd. has set up a coal-fired thermal power plant of
1,000 MW at Rs. 5 crores per MW with a debt-to-equity ratio of 70:30. When the project is implemented and
operational, the balance sheet of such a company would broadly look as under:

Table 2

Liabilities

Rs. Cr.

Assets

Rs. Cr.

Equity

1,500

Fixed Assets

5,000

Debt

3,500

Total

5,000

Total

5,000

A typical Profit and
Loss account of POGECO Ltd would look as per Table 3, had it been
operating under normal circumstances based on certain assumptions.

These
assumptions are further detailed in Table 4 (for those interested in
understanding the details of calculations).

Table 3

Sr.	Particulars	Total for the year (Amt. Rs. Cr.) (A)	Per unit (Amt. in Rs./Kwh) (B)	% of Tariff (B)
(A)	Revenue	2,973	4.39	100%
(B)	Variable cost – fuel cost	1,929	2.85	65%
(C)	Fixed cost
i	O&M	150	0.22	5%
ii	Depreciation	200	0.30	7%
iii	Interest on long-term loan	420	0.62	14%
iv	Interest on working capital loan	48	0.07	2%
	Total fixed cost	818	1.21	28%
(D)	Profit Before Tax (PBT)	226	0.33	7%

Sr.

Particulars

Total for the year

(Amt. Rs. Cr.)

(A)

Per unit

(Amt. in Rs./Kwh)

(B)

% of Tariff (B)

(A)

Revenue

2,973

4.39

100%

(B)

Variable cost – fuel cost

1,929

2.85

65%

(C)

Fixed cost

O&M

150

0.22

Depreciation

200

0.30

iii

Interest on long-term loan

420

0.62

14%

Interest on working capital loan

0.07

Total fixed cost

818

1.21

28%

(D)

Profit Before Tax (PBT)

226

0.33

Cost components of
POGECO Ltd. and assumptions

Table 4

Sr.

Cost component

Assumption

(A)

Variable costs

Coal purchase cost

Rs. 4,000 per tonne (4,000 gross calorific value – GCV) (including
transportation up to the gate, taxes, etc.)

Secondary fuel purchase cost

Rs. 0.10 per kwh

(B)

Fixed cost

Operation & maintenance (O&M)

Rs. 15 lakhs per MW p.a. (including maintenance capex)

Depreciation on fixed assets

Rs. 200 crores p.a. assuming a 25-year plant life

Interest on long-term debt

12% p.a.

Interest on working capital

12% p.a.

Return on equity

15% – promoter / investor will expect some return on his investment
(or else he will not be interested in carrying out the operations). This is
generally even recovered from the consumers in the tariff in a typical PPA

(C)

Other assumptions

Plant load factor (PLF)

85%

Auxiliary consumption

Station heat rate

2,500 kcal/kWh

Working capital requirement

1 month coal inventory and 1 month receivables

Let us critically
analyse the above cost components.

As you can see (refer
Table 3), 28% of the cost is fixed cost (in the first year). Normally, this
cost would gradually go down over the years as the debt gets paid and the
interest cost on long-term loan would gradually decrease. However, costs of
other components that are fixed will not decrease over the years and will
remain constant throughout the plant life.

Any investor putting
in his time, money and effort would want a normal return on his investment.
Hence, PBT of Rs. 226 crores is nothing but 15% return on Rs. 1,500 crores
equity investment. Accordingly, PBT would represent about 7% of the tariff
which will be charged to the consumers of POGECO Ltd.

From a consumer’s
perspective he will be paying ~ 35% (28%+7%) of the power tariff on account of
O&M, depreciation, interest and return of equity. As a consumer, he would
be interested in reducing these components to the maximum extent.

In India we have also
seen the issue relating to gold plating of projects or cost escalations /
overruns due to delays. In such a scenario, per MW cost of setting up the power
plant is much higher than Rs. 4 crores to Rs. 5 crores per MW (as assumed in
our example). In such an event the consumers would be paying more than 35% of
the tariff in fixed costs component.

To put it in a different
perspective, the stress in POGECO Ltd. will be due to the following conflicting
factors among various parties:

(1)
Consumers and regulator will want to
minimise the tariff / revenue, i.e. component A from tariff (refer
Table 3);

(2) Bankers or debt
providers will want to ensure their
interest and principal gets paid hence they will not be interested in reducing
component Cii, Ciii and Civ (i.e. depreciation and
interest) from the tariff and the Profit & Loss statement (refer Table 3).
The reason for including depreciation here is that although in the P&L it
is a non-cash item, but commensurate cash flows will be utilised to service the
principal portion of the debt.

(3) Investors /
promoters will want to maximise
their return, hence they will try to increase component Cii and D
(i.e. depreciation and PBT) (refer Table 3).

The
conflict among the above factors makes POGECO Ltd. unviable (the example
tariffs are too low or the cost of project is high which has increased the
fixed costs). What could be the solution for making POGECO Ltd. viable which
ensures principal payment to banks, return of investment / equity of promoter /
investor and tariff reduction for consumers?

The key is to
eliminate some of the components of the fixed costs which will benefit the
consumer while ensuring that the investments of the banks and investors are
returned.

How do we reduce the
fixed cost components?

Step 1 – Issue ‘Utility Instruments’ to
the end-consumers of the power

To make it easier to
understand, let us assume a town with 30 lakh consumers / families /
connections is consuming electricity from POGECO Ltd. Further, it is assumed
that distribution lines are already set up and cost related to distribution /
distribution losses is not involved. These consumers are directly purchasing
power from POGECO Ltd. These 30 lakh consumers on an average would consume
about 180-190 units per month which is about 6,776 million units of electricity
requirement.

The net generation of
the 1,000 MW power plant (assuming it operates at 85% PLF and 9% of auxiliary
consumption) would be roughly ~ 6,776 million units.

Hence, POGECO Ltd.
would issue ‘Utility Instruments’ to these 30 lakh consumers. Each instrument
issued by POGECO Ltd. would give the right to the consumer to purchase 10 units
of electricity from POGECO Ltd. at a discounted price per unit.

POGECO
Ltd. will issue 67.76 crore ‘Utility Instruments’ at Rs. 73.79 each to its
consumers. This will enable POGECO Ltd. to generate Rs. 5,000 crores from the
issuance. The calculation can be better explained in the table below:

Table 5

Sr.

Particulars

Quantity

(A)

POGECO Ltd. capacity

1,000 MW

(B)

Net generation @ 85% PLF and 9% auxiliary consumption

6,77,58,60,000 units

(C)

Number of ‘Instruments’ to be issued with right to purchase 10 units
(b/10)

67,75,86,000

(D)

Cost of project for setting up the power plant

Rs. 5,000 crores

(E)

Amount to be raised per ‘Instrument’ (d/c)

Rs. 73.79

Step 2 – Utilise the proceeds received
from these ‘Utility Instruments’ to pay the bankers and the investors

A Board of Trustees
can be appointed to oversee the entire process of getting the proceeds from
consumers and paying the bankers and investors (once the plant is made
operational). An O&M contractor should be appointed who will be managing
the plant and will be operating under the supervision / oversight of the Board
of Trustee and the regulator. With the proceeds from the ‘Utility Instruments’,
POGECO Ltd. will pay back the debt of Rs. 3,500 crores and the equity
investment of Rs. 1,500 crores.

RETURN ON INVESTMENT

The investor will
demand some return on investment up to the date he receives his money from the
‘Utility Instruments’. Further, there will also be a working capital
requirement to fund coal / fuel inventory and receivables. These additional
requirements can always be factored into the amount to be raised from the
consumers through the ‘Utility Instruments’.

Step
3 – Supply electricity to consumers at variable cost

The ‘Utility
Instruments’ will not carry any interest, nor will the amount paid by consumers
for purchase of the same (@ Rs. 73.79 per ‘Instrument’) be repaid to the consumers.
However, with the ‘Instruments’ the consumer has the right to purchase
electricity from POGECO Ltd. at a variable cost. Accordingly, each unit
consumed by the consumer will cost him only Rs. 3.07 per unit vs. Rs. 4.39 per
unit (that he would have otherwise paid to purchase power in our example –
refer Profit & Loss statement in Table 3 above). This is a saving of
about 30% in electricity cost for the consumer!

Let us do the math on
how he is getting the return on his investment of Rs. 73.79 per ‘Utility
Instrument’.

Assuming a family is
consuming 100 units of electricity every month, it consumes 1,200 units every
year. The consumer will need to buy 120 ‘Utility Instruments’. This will
require him to pay or invest Rs. 8,855. Against this investment he will be
saving Rs. 1.32 per unit of his consumption, or Rs. 1,584 in the first year of
investment on consumption of 1,200 units of electricity (i.e. Rs. 1.32 fixed
cost x 1,200 units). This works out to about 17.88% of the amount invested.

These savings would
gradually reduce (i.e. as discussed above due to the impact of the long-term
debt as it gets paid and the interest cost on long-term loan as part of fixed
cost would gradually decrease). The yearly saving gradually reduces to Rs. 861
in the 25th year of the power plant’s life. However, the Internal Rate of
Return for the consumer would still work out to be about ~ 15.5% over the
period of 25 years of the life of the plant.

With the above
analysis, the questions related to (1) Who will subscribe to these ‘Utility
Instruments’, and (2) What will be the return on these ‘Instruments’ are
answered.

Enumerable factors
such as costs related to distribution licensee, distribution and transmission
costs and losses, etc. will also play a role which would pose practical
challenges for implementing this concept. How to deal with these challenges and
issues can be a separate analysis or part of a study.

Applicability to
other sectors

A detailed analysis
of the concept has been presented here using the example of a power company.
However, this principal / concept can be applied to any company / sector that
is capital intensive or any public utility company, or any company having a
substantial component of operating and financial leverage and is catering to a
large number of consumers.

Examples:

(a) ‘Utility
Instruments’ can be issued to truck owners / transport companies / courier
companies wherein they will be paying toll limited to variable and O&M
costs for a road project.

(b) ‘Utility Instruments’
can be issued by Metro projects in urban areas such as Mumbai Metro or Delhi
Metro to its daily travellers / office-goers.

(c) Companies laying
the network of pipelines for the distribution of natural gas in urban areas can
issue ‘Utility Instruments’ to their consumers who would be using piped natural
gas.

(d) Financing for
setting up of infrastructure for charging stations in the city and providing
batteries for electric cars can be done through issuing ‘Utility Instruments’
to consumers using electric cars.

Implementation of the concept

We can always think
of variations to the above principle for implementation of this concept in the
current scenario with limited changes / amendments to the regulations. Let us
assume that Tata Power (i.e. a generation company) issues ‘Utility Instruments’
to the consumers in Mumbai. The proceeds will be utilised to reduce the debt
and / or equity component in their balance sheet.

As a consumer the
holder of a ‘Utility Instrument’ will be paying the normal electricity bill
every month as per the existing mechanism along with other consumers. At the
end of the year, Tata Power can reimburse various cost components (other than
O&M cost and variable cost) to the holders of these instruments. A
Chartered Accountant can play a role here for identifying companies wherein
this structure / concept can be implemented and give necessary advice to the
senior management to this effect.

Under
the current scenario there would be various regulatory challenges for issuance
of ‘Utility Instruments’. This will even require SEBI and RBI to come together
for necessary issuance and / or amendment of guidelines for enabling their
issuance. Several existing guidelines such as ICDR guidelines, the Companies
Act, 2013, etc. will also have to be amended in order to recognise these
‘Instruments’. A Chartered Accountant can play an important role here, too,
initially making necessary representations to various regulatory and industrial
bodies.

These
‘Utility Instruments’ can also be marketable / tradeable, i.e. if in a
given year the consumer shifts location, there is flexibility for him to sell
the same to another consumer. A Chartered Accountant / Merchant Banker can play
a critical role in the valuation of such ‘Instruments’. The
Board of Trustees will also play a key role in ensuring successful
implementation of the concept. The government will have to issue necessary
regulations for the purpose of setting up, functioning and overseeing of the
Board of Trustees in the interest of the consumers and holders of ‘Utility
Instruments’. Here, too, a Chartered Accountant can play an eminent role as a
watchdog and audit the entire process on a continuous basis.

In these unprecedented times, going forward there is going to be significant
stress in the manufacturing, industrial and infrastructure sectors. Companies
which were probably viable prior to Covid-19 may turn unviable due to lack of
demand or various other factors. We need to think of out-of-the-box solutions
in order to cope with the possible crisis. Through implementation of this
concept in sectors wherein wide numbers of consumers are being catered to, we
can attempt to eliminate the fixed costs related to investments.

shailesh.kwebmaker

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

On 12th March, 2020 BCAS made an announcement
deferring my talk scheduled a week hence. The previous
day, WHO had labelled the novel coronavirus disease
or Covid-19 as a pandemic. As a consequence, several
precautions snowballed into locking down half the world’s
population as the deadly virus quickly infected over four
million people in 210 countries and claimed tens of
thousands of lives. Our Prime Minister asked for 22nd
March to be observed as Janata Bandh following which
we are into Lockdown 3.0 (and now 4.0 till 31st May,
2020). Some have termed this outbreak as a Black Swan
event and the biggest challenge humanity has faced
since World War II, seriously impacting lives, earnings,
economies and businesses with a whopping toll on the
markets. We still have to see a flattening of the curve
and estimates are that this will trigger a global recession
for an extended period. The trillion-dollar question…
who could have anticipated this and, more importantly,
prepared for it?

Over the last few decades we have been witness to
quite some events of tremendous gravity such as Ebola,
SARS, Bird Flu, the 2008 meltdown, the 2011 Earthquake
and Tsunami, Brexit… With these abnormal occurrences
occurring with discomforting regularity, is this the new
normal?

But what have all these got to do with internal controls (IC)?
Sound internal controls which encompass identifying and
managing risks both internal and external, are a sine qua
non for running a sustainable business. Conventionally
though, internal controls were more of the order of internal
checks and internal audit (IA). Segregation of duties,
maker-checker procedures, vouching transactions,
physical verification of cash, stocks and so on received
a lot of prominence. And internal audit was seen as a
routine albeit necessary activity, coasting alongside the
main operations in business. Within corporations, too, this
function was never the sought-after role for accounting
and finance professionals. Not so any longer. The everchanging
world in which things are turning more complex
by the day, is only making this entire process difficult and
tricky as we reflect on the Covid-19 pandemic.

INTERNAL CONTROLS

Controls function to keep things on course and internal
controls in any business or enterprise provide the
assurance that there would be no rude surprises. The
Committee of Sponsoring Organisations1 (COSO) has
defined IC as ‘a process, effected by an entity’s board of
directors, management and other personnel, designed to
provide reasonable assurance regarding the achievement
of objectives relating to operations, reporting and
compliance’. As per SIA 120 issued by the Institute of
Chartered Accountants of India2, ICs are essentially risk
mitigation steps taken to strengthen the organisation’s
systems and processes, as well as help to prevent and
detect errors and irregularities. In SA 3153 it is defined
as ‘the process designed, implemented and maintained
by those charged with governance, management and
other personnel to provide reasonable assurance about
the achievement of an entity’s objectives with regard
to reliability of financial reporting, effectiveness and
efficiency of operations, safeguarding of assets and
compliance with applicable laws and regulations’. IC
therefore encompasses entity level, financial as well as
operational controls (Figure 1).

1. COSO Committee of Sponsoring Organisations of the Treadway Commission:
Internal Control – Integrated Framework, May, 2013
2 Standard on Internal Audit (SIA) 120 issued by the Institute of Chartered
Accountants of India
3 Standard on Auditing (SA) 315 ‘Identifying and Assessing the Risks of Material
Misstatement Through Understanding the Entity and its Environment’, issued
by ICAI effective 1st April, 2008

A number of regulatory requirements are in place in the
realm of IC. The Companies Act, 20134 requires the
statutory auditor to report on ‘whether the company has
adequate internal financial controls system in place and
the operating effectiveness of such controls’. It requires
the Board to develop and implement a risk management
policy and identify risks that may threaten the existence
of the company. It imposes overall responsibility on
the Board of Directors with regard to Internal Financial
Controls. The Directors’ Responsibility Statement has to
state that ‘the Directors, in the case of a listed company,
had laid down internal financial controls to be followed by
the company and that such internal financial controls are
adequate and were operating effectively.’ And they have
also devised a proper system to ensure compliance with
the applicable laws and that such systems are operating
effectively. SEBI5 Regulations stipulate the preparation of
a compliance report of all laws applicable to a company
and the review of the same by the Board of Directors
periodically, as well as to take steps (by the company) to
rectify instances of non-compliance and to send reports
on compliance to the stock exchanges quarterly.
Furthermore, listed companies have additional
responsibilities on Internal Controls for Financial Reporting.
A Compliance Certificate is mandated to be signed by the
CEO and CFO to indicate that ‘they accept responsibility for
establishing and maintaining internal controls for financial
reporting and that they have evaluated the effectiveness of
the internal control systems of the listed entity pertaining to
financial reporting and they have disclosed to the auditors
and the audit committee, deficiencies in the design or
operation of such internal controls, if any, of which they are
aware and the steps they have taken or propose to take
to rectify these deficiencies’. The Institute of Chartered
Accountants of India has formulated Standards on Internal
Audit which are a set of minimum requirements that need
to be complied with. Hence, the overall responsibility
for designing, assessing adequacy and maintaining the
operating effectiveness of Internal Financial Controls rests
with the Board and the management (Figure 2).

THE CONTROL S HIERARCHY

Internal Controls is a vast topic in its own right. What we
will examine in this article are the following aspects:
(i) IC in action,
(ii) M anaging Risks, and
(iii) E xcellence in Business

4 The Companies Act, 2013: Sections 134, 143, 149
5 Securities and Exchange Board of India (SEBI) (Listing Obligations and Disclosure
Requirements) Regulations, 2015

Given the enlightened readers’ expert knowledge on the
above, I will dwell on anecdotes from my experience having
been on both sides of the table (auditor as well as auditee)
which could provide perspectives for due consideration.

Internal Controls in action
First, some ground realities:
* IC is commonly perceived as a specialist domain of
auditors whereas fundamentally it is the lookout of every
person in the workforce. Every manager must realise that
s/he has the core responsibility of running operations
consciously abiding by the control parameters. As the
primary owner, every person in charge must provide
assurance that their work domain is under control through
a control self-assessment mechanism;
* IA is perceived as a statutory duty and often deprived
of the credit it deserves. The irony is that this function is
not appreciated when all is well and the first issue to be
frowned upon when something goes amiss!
* O perations get priority and IA, instead of being seen
as a guide and ally to business, is perceived to be an
adversary.

In well-run enterprises there is realisation and
understanding of the importance of IC in running and
growing a sustainable business. Here are some good
practices I have experienced which build and nurture a
healthy control culture in the enterprise.

(i) In Hindustan Unilever (HLL then) there was an
unwritten practice that accountants had to go through a stint in IA. Speaking for myself, I can candidly state that my
appreciation of enterprise-wide business processes grew
during my tenure in Unilever Corporate Audit. I bagged
my first business role to run the Seeds Business in HLL
on the strength of the exposure to various businesses and
functions while in IA. A stint in IA is invaluable in opening
up the mind to the various facets of business;

(ii) U nilever Corporate Audit always reported to the
Board of Unilever and this chain of command percolated
down. In India, we were a resource for the region. IA,
therefore, had the desired independence. Not only did it
give us working exposure in several geographies, we often
worked in teams with members from different countries.
Apart from learning best practices from different parts of
the world, I found the attitude to audit and culture quite
varied. When we came up with issues, in many countries
it would be accepted and debated purely at a professional
level, whereas in some it would be taken as a personal
assault by the auditee! Managing such conflicts by open
communication and objective fieldwork / analytics is a
valuable experience in honing leadership skills;

(iii) IA used to take on deputation team members from
other functions such as Manufacturing, Sales, QA, etc.
This provided a two-pronged advantage. As a primary
owner of controls, such functional members became the
spokespersons for demystifying IA within the organisation.
Equally, these members brought in their domain expertise
to raise the quality within IA, in particular on operational
controls. Involving and engaging team members in
different ways helps in building the control culture;

(iv) A udit always began with a meeting with the Chairman
/ MD / Business Head as the case may be. Not only
did this give a perspective to the business but it also
highlighted for the IA team the priorities and areas where
the business looked for support from IA. This would also
demonstrate the senior leadership’s commitment to IA.
Soon thereafter, we would convert this into a Letter of
Audit Scope outlining the focus areas of the particular
audit. In a sense, it was like giving out the question paper
before the exam! Open communication with the auditee
and a constructive attitude is the core of a productive
outcome.

Managing Risks

At the core of Board functioning in a company is the task
of managing risks. With change and uncertainty being
the order of the day, regulations require listed companies
to have a separate Risk Management Committee at the Board level which is often chaired by an Independent
Director. While identifying and managing financial and
operational risks can be delegated to the management,
the Board focuses on strategic or environmental risks.
A major risk which we find emerging is that of disruptions.
While the other risks which are identified or anticipated can
be reasonably managed, businesses today feel challenged
due to disruptions coming from various quarters. These
could be in the form of Regulatory disruption (e.g. FDI in
multi-brand retail), Market disruption (e- and m-commerce
congruence), Competitive disruption (Jio in the telecom
space), Change in consumer buying behaviour (leasing
or renting vs. buying) or Disruptors in the service space
(Airbnb or Uber). What businesses need to be planning
for is not just combating competition from traditional
competitors, but that coming from the outside as well.

The purport of these external risks become clear, as
pointed out by the World Economic Forum6, as global risks
– an unsettled world, risks to economic stability and social
cohesion, climate threats and accelerated biodiversity
loss, consequences of digital fragmentation, health
systems under new pressures. As for Covid-19, there
were research papers published post the SARS event
warning about such an eventuality. Stretching it further,
even films such as Contagion portrayed this. It is feared
that a number of MSMEs and startups may get seriously
throttled due to this disruption. How seriously do Boards
and managements take the cue from such pointers going
forward and, more important, prepare for such disruptions
is going to be the key in sustaining businesses.

As we learn to work differently during lockdowns, there is
a growing reliance on remote working and heightened use
of technology. Webinars, video chats, video conferences,
e-platforms and Apps have become daily routines and
add another dimension to cyber security, data protection
and data privacy.

In Rallis India Limited, it had been the practice for many
years to have an off-site meeting of the Board devoted
to discussing strategy and long-term plans. It is now
imperative that companies use such fora at a Board and
senior leadership level not only to debate annual and
long-term plans, but also scenario planning simulating
various major risks. These are necessary to strengthen
IC by crafting exhaustive disaster recovery plans not
only for operations or digital disruptions, but also for force majeure events occurring in different magnitudes
across the extended supply chain both within and
externally.

6 World Economic Forum: The Global Risks Report, 2020

Excellence in Business

In the Tata Group, in addition to instilling the Tata Code
of Conduct, all companies adopt the Tata Business
Excellence Model7 (TBEM). Based on the Malcolm
Balridge model of the USA, TBEM encourages Tata
Companies to strive for excellence in every possible
manner. Instituted by Chairman Emeritus Mr. Ratan Tata
in honour of Bharat Ratna Late J.R.D. Tata who embodied
excellence, TBEM is the glue amongst Tata Companies
to share best practices and provide a potent platform
for leadership development. Last year marked the 25th
year of its highest award called the JRD-Quality Value
Award, which was bestowed on companies that reached
a high threshold of business excellence. Rallis won the
JRD-QV Award in 2011 and I benefited hugely having
been an integral part of the TBEM process. This gave
me tremendous perspectives on managing businesses,
especially in the following areas:

(a) T BEM is a wall-to-wall model touching every aspect
of business from leadership to strategy to customer
to results. A trained team comprising members from
different backgrounds and businesses comes together
for an assessment over many man-months. While
assessment is done against a framework, this is not
in the nature of an audit. Evidence and records do not
get as much importance as interactions with people. It
is not uncommon for a team to interact with a thousand
persons connected with the company being assessed,
both workforce as well as other stakeholders. Therefore,
the smell of the company would give a perspective on
governance matters as well. Excellence assessments
is a great discipline for organisations to get an external
assurance on both governance and internal controls;

(b) U nique to TBEM is the practice of having Mentors for
every assessment. I have been privileged to be a longstanding
Mentor. The Mentor essentially assesses the
strategy of the company and also plays the crucial role of
being a bridge between the company and the assessing
team. The Mentor finally presents the assessment finding
to the Chairmen both at the company and at the Group
level. Over the years this has given me exposure to various
industries ranging from steel to battery to insurance to
coffee and retail, not to speak of connecting with scores of people within the Group and beyond. A great tool for
leadership development;

(c) T BEM uses the lens of continuous improvement
to assess businesses. Deep within lies the twin benefit
of this not only sharpening controls but also constantly
improving the effectiveness and efficiency of business
processes. The DNA of excellence in an organisation
leads every individual to keep questioning and enriching
jobs. Excellence is a journey, not a destination and a way
of doing business.

7 www.tatabex.com – About us – Tata Business Excellence Model

Bringing these together

All the three components, viz., risk management, internal
audit and business excellence acting in unison are
crucial to building and nurturing a sustainable business.
In many organisations, however, the degree of maturity
and the level of execution of each of these vary and are
rarely found to be harmoniously in motion. Embedded in
this lies the fact that each of these is driven by different
frameworks, parameters, regulations, formats, reporting systems, teams and so on. A softer aspect is that most
of this is perceived as a theoretical exercise and the
operating management having to fill in tedious forms
while running the business!

Here is an approach (Figure 3) which integrates all
of these driving similar goals and therefore avoiding
repeated exercises involving the operating teams.

The Enterprise Risk Management exercise carried out
across the organisation involving internal and external
stakeholders culminates in the identification of the
environmental, strategic, operational and financial risks
of the business. The Enterprise Process Management
model crafts all the business processes into three
levels which can be aligned and integrated with the
mitigation plans for the risks. These L1, L2 and L3
processes keep getting updated and improved annually
to drive continuous improvement as well as to enhance
controls.

The internal audit self-control checklists as well as audit
plans would be dovetailed with these mitigation plans and
processes. Such an approach will not only ensure that operations are run within the defined control framework
keeping risks within the appetite of the business, but
also strive continuously for excellence as processes
keep improving its efficiencies and effectiveness. This
integrated framework will then flow through populating the
various formats required and help the operating teams
to also address different reviews in a cohesive manner.
Above all, this brings in the desired objective of the entire
workforce viewing and putting into action the entire gamut
of the internal control framework enabling them to register
a superior performance in business.

The Late J.R.D. Tata’s quote sums this up well: ‘One
must forever strive for excellence, or even perfection, in
any task however small, and never be satisfied with the
second best.’

Driving excellence, all businesses will necessarily need
to uphold the highest standards of governance and
internal controls for long-term sustainable value creation,
committed to all stakeholders.

(This article is a sequel to Part 1 published on Page 15 in
BCAJ, March, 2020)

shailesh.kwebmaker

SPECIFIED DOMESTIC TRANSACTIONS: RETROSPECTIVE OPERABILITY OF OMISSION OF CLAUSE (i) TO SECTION 92BA(1)

Section 92BA of
the Income-tax Act, 1961 defines ‘Specified Domestic Transaction’ by providing
an exhaustive list of transactions; this section was introduced through the
Finance Act, 2012 w.e.f. 1^st April, 2013. The transaction for
expenditure payable / paid to certain persons [mentioned u/s 40A(2)(b)], being
one of the specified domestic transactions, was omitted from the statute book
through the Finance Act, 2017 w.e.f. 1^st April, 2017.

The enumeration
of a domestic transaction in section 92BA is a necessary requirement for the
reference of the same to the Transfer Pricing Officer u/s 92CA. Accordingly,
the omission of clause (i) to section 92BA(1) had the effect of restraining
reference to the Transfer Pricing Officer in case of transactions for expenditure
payable / paid to certain persons [mentioned u/s 40A(2)(b)] on and after the
date of enforcement of the omission (1^st April, 2017).

The above said
omission and its effect was clear enough to rule out the scope for any
ambiguities, but incidentally, there exist contradictory findings / judicial
pronouncements by certain Tribunals as well as the High Courts in relation to
(A) applicability of the above said omission since 1^st April, 2013,
i.e. the date of introduction of section 92(BA); (B) on holding that the clause
(i) to be believed to have never existed on the statute book; and (C) holding
the reference to the Transfer Pricing Officer in respect of clause (i)
transactions as void ab initio. Hence, this
article puts forth a synopsis of various judicial decisions on the captioned
issue.

MOOT QUESTION FOR
CONSIDERATION

The moot question
for consideration is whether the provisions appearing in clause (i) to
section 92BA [i.e., the clause that included expenditures relating to clause
(b) of section 40A(2), under Specified Domestic Transactions], which was
omitted vide Finance Act, 2017 with effect from 1^st April,
2017, will be considered as omitted since the date on which section 92BA was
brought into force (i.e., 1^st April, 2013 itself), which makes
clause 92BA(1)(i) inapplicable even in respect of the period of assessment
prior to 1^st April, 2017?

And accordingly, whether
it is a correct and settled position of law to state that when a provision is
omitted, its impact would be to believe that the particular provision did not
ever exist on the statute book and that the said provision would also not be
applicable in the circumstances which occurred when the provision was in force
even for the prior period?

WHAT IS CENTRAL TO THE
ISSUE

Section 92BA, as it
stood prior to the omission of clause (i), and section 92CA are central to the
issue at stake and hence are reproduced hereunder:

Section
92BA(1) – For the purposes of this section
and sections 92, 92C, 92D and 92E, ‘specified domestic transaction’ in case of
an assessee means any of the following transactions, not being an international
transaction, namely,

(i) any
expenditure in respect of which payment has been made or is to be made to a
person referred to in clause (b) of sub-section (2) of section 40A;

(ii) any
transaction referred to in section 80A;

(iii) any
transfer of goods or services referred to in sub-section (8) of section 80-IA;

(iv) any
business transacted between the assessee and other person as referred to in
sub-section (10) of section 80-IA;

(v) any
transaction referred to in any other section under Chapter VI-A or section
10AA, to which provisions of sub-section (8) or sub-section (10) of section
80-IA are applicable; or

(vi) any other
transaction as may be prescribed and where the aggregate of such transactions
entered into by the assessee in the previous year exceeds a sum of [five] crore
rupees.

Section
92CA(1) – Where any person, being the
assessee, has entered into an international transaction or specified domestic
transaction in any previous year, and the Assessing Officer considers it
necessary or expedient so to do, he may, with the previous approval of the
Principal Commissioner or Commissioner, refer the computation of the arm’s
length price in relation to the said international transaction or specified
domestic transaction under section 92C to the Transfer Pricing Officer.

PROSPECTIVE, NOT
RETROSPECTIVE

It is pertinent to
note here that the deletion by the Finance Act, 2017 was prospective in nature
and not retrospective, either expressly or by necessary implication of the
Parliament. At this juncture, the findings of ITAT Bangalore (further
upheld by the High Court of Karnataka in ITA 392/2018) in Texport Overseas Pvt.
Ltd. vs. DCIT [IT(TP)A No. 2213/Bang/2018] are of relevance:

The ITAT held that ‘clause (i) of section 92BA deemed to be omitted from its
inception and that clause (i) was never part of the Act. This is due to the
reason that while omitting the clause (i) of section 92BA, nothing was
specified whether the proceeding initiated or action taken on this continue.
Therefore, the proceeding initiated or action taken under that clause would not
survive at all in the absence of any specific provisions for continuance of any
proceedings under the said provision. As a result if any proceedings have been
initiated, it would be considered or held as invalid and bad in law.’

WIDE ACCEPTANCE

This finding of the
ITAT Bangalore received wide acceptance all over the country and had been
followed by various Tribunals (such as ITAT Indore, Ahmedabad, Cuttack and
Bangalore).

The Tribunal based
its finding completely on the following judicial pronouncements pertaining to
section 6 of the General Clauses Act, 1897:

i. Kolhapur Canesugar Works Ltd. vs. Union of
India in Appeal (Civil) 2132 of 1994 vide
judgment dated 1^stFebruary, 2000 (SC);

ii. General Finance Co. vs. Assistant Commissioner
of Income-tax 257 ITR 338 (SC);

iii. CIT vs. GE Thermometrics India Pvt. Ltd. in ITA
No. 876/2008 (Kar.).

Before looking into
the findings of the Hon’ble Supreme Court in this regard, which were relied
upon by the ITAT Bangalore, sections 6, 6A and 24 of the General Clauses Act,
1897 should be considered. These sections are reproduced hereunder:

Section 6:‘Where this Act, or any Central Act or Regulation made after the
commencement of this Act, repeals any enactment hitherto made or hereafter to
be made, then, unless a different intention appears, the repeal shall not –

(a) revive
anything not in force or existing at the time at which the repeal takes effect;
or

(b) affect the
previous operation of any enactment so repealed or anything duly done or
suffered thereunder; or

(c) affect any
right, privilege, obligation or liability acquired, accrued or incurred under
any enactment so repealed; or

(d) affect any
penalty, forfeiture or punishment incurred in respect of any offence committed
against any enactment so repealed; or

(e) affect any
investigation, legal proceeding or remedy in respect of any such right,
privilege, obligation, liability, penalty, forfeiture or punishment as
aforesaid;

and any such
investigation, legal proceeding or remedy may be instituted, continued or
enforced, and any such penalty, forfeiture or punishment may be imposed as if
the repealing Act or Regulation had not been passed.’

Section 6A:‘Where any Central Act or Regulation made after the commencement of
this Act repeals any enactment by which the text of any Central Act or
Regulation was amended by the express omission, insertion or substitution of
any matter, then, unless a different intention appears, the repeal shall not
affect the continuance of any such amendment made by the enactment so repealed
and in operation at the time of such repeal.’

Section 24: ‘Where any Central Act or Regulation is, after the commencement of
this Act, repealed and re-enacted with or without modification, then, unless it
is otherwise expressly provided, any appointment notification, order, scheme,
rule, form or bye-law, made or issued under the repealed Act or Regulation,
shall, so far as it is not inconsistent with the provisions re-enacted,
continue in force, and be deemed to have been made or issued under the provisions
so re-enacted, unless and until it is superseded by any appointment
notification, order, scheme, rule, form or bye-law, made or issued under the
provisions so re-enacted.’

DEEMED ORDER

The effect of
section 24 insofar as it is material is that where the repealed and re-enacted
provisions are not inconsistent with each other, any order made under the
repealed provisions are not inconsistent with each other, any order made under
the repealed provision will be deemed to be an order made under the re-enacted provisions.

Section 24 of the
General Clauses Act deals with the effect of repeal and re-enactment of an Act
and the object of the section is to preserve the continuity of the
notifications, orders, schemes, rules or bye-laws made or issued under the
repealed Act unless they are shown to be inconsistent with the provisions of
the re-enacted statute. In the light of the fact that section 24 of the General
Clauses Act is specifically applicable to the repealing and re-enacting
statute, its exclusion has to be specific and cannot be inferred by twisting
the language of the enactments – State of Punjab vs. Harnek Singh (2002)
3 SCC 481.

WHERE AN ACT IS
REPEALED

Section 6 applies
to repealed enactments. Section 6 of the General Clauses Act provides that
where an Act is repealed, then, unless a different intention appears, the
repeal shall not affect any right or liability acquired or incurred under the
repealed enactment or any legal proceeding in respect of such right or
liability and the legal proceeding may be continued as if the repealing Act had
not been passed.

As laid down by the
Apex Court in M/s Gammon India Ltd. vs. Spl. Chief Secretary & Ors.
[Appeal (Civil) 1148 of 2006] that, ‘…whenever there is a repeal of
an enactment the consequences laid down in section 6 of the General Clauses Act
will follow unless, as the section itself says, a different intention appears
in the repealing statute. In case the repeal is followed by fresh legislation
on the same subject, the court has to look to the provisions of the new Act for
the purpose of determining whether they indicate a different intention. The
question is not whether the new Act expressly keeps alive old rights and
liabilities but whether it manifests an intention to destroy them. The
application of this principle is not limited to cases where a particular form
of words is used to indicate that the earlier law has been repealed. As this
Court has said, it is both logical as well as in accordance with the principle
upon which the rule as to implied repeal rests, to attribute to that
legislature which effects a repeal by necessary implication the same intention
as that which would attend the case of an express repeal. Where an intention to
effect a repeal is attributed to a legislature then the same would attract the
incident of saving found in section 6.’

Section 6A is to
the effect that a repeal can be by way of an express omission, insertion or
substitution of any matter, and in such kind of repeal unless a different
intention appears, the repeal shall not affect the continuance of any such
amendment made by the enactment so repealed and in operation at the time of
such repeal.

Now, we examine the
observations of the Apex Court in General Finance Co. vs.
ACIT. Therein, the Apex Court has examined the issue of retrospective
operation of omissions and held that the principle underlying section 6 as
saving the right to initiate proceedings for liabilities incurred during the
currency of the Act will not apply to omission of a provision in an Act but
only to repeal, omission being different from repeal as held in different
cases. In the case before the Apex Court, a prosecution was commenced against
the appellants by the Department for offences arising from non-compliance with
section 269SS of the Income-tax Act, 1961 (punishment for non-compliance with
provisions of section 269SS was provided u/s 276DD). Section 276DD was omitted
from the Act with effect from 1^stApril, 1989 and the complaint u/s
276DD was filed in the Court of the Chief Judicial Magistrate, Sangrur, on 31^st
March, 1989.The assessee sought for quashing of the proceedings by filing a
petition u/s 482 of the Code of Criminal Procedure and Article 227 of the
Constitution. The High Court held that the provisions of the Act under which
the appellants had been prosecuted were in force during the accounting year
relevant to the assessment year 1986-87 and they stood omitted from the statute
book only from 1^st April, 1989. The High Court, therefore, took the
view that the prosecution was justified and dismissed the writ petition. But
the Apex Court did not concur with the view of the High Court and ruled that:

‘…the principle
underlying section 6 of the General Clauses Act as saving the right to initiate
proceedings for liabilities incurred during the currency of the Act will not
apply to omission of a provision in an Act but only to repeal, omission being
different from repeal as held in the aforesaid decisions. In the Income-tax
Act, section 276DD stood omitted from the Act but not repealed and hence, a
prosecution could not have been launched or continued by invoking section 6 of
the General Clauses Act after its omission.’

PRINCIPLE OF EQUITY AND
JUSTICE

It is inferable
from the findings of the Apex Court that by granting retrospective operability
to the omission of a penal provision it was merciful and did uphold the
principles of equity and justice. But the moot question here is whether the
findings of the Apex Court in respect of a penal provision can be extended
universally to all kinds of provisions present under any law in force, i.e.
substantive, procedural and machinery provisions. A situation that revolves
around this moot question was before the Karnataka High Court in CIT vs.
GE Thermometrics India Pvt. Ltd. [ITA No. 876/2008] and further in DCIT
vs. Texport Overseas Pvt. Ltd. [ITA 392/2018], which followed the ratio
laid down by the Apex Court in General Finance Co. vs. ACIT and
applied the findings in an identical manner to the cases involving omission of
the provision providing definitions.

The ITAT Bangalore
in Texport Overseas also relied upon the findings of the Apex
Court in Kolhapur Canesugar Works Ltd. vs. Union of India [1998 (99) ELT
198 SC], wherein the sole question before the Hon’ble Court was whether
the provisions of section 6 of the General Clauses Act can be held to be
applicable where a Rule in the Central Excise Rules is replaced by Notification
dated 6^th August, 1977 issued by the Central Government in exercise
of its Rule-making power, (and) Rules 10 and 10A were substituted. The findings
of the Apex Court herein were also similar to those in General Finance
Co. vs. ACIT, as to retrospective operability of the omission.

Section 6A of the
General Clauses Act is central to the captioned issue; it removes the ambiguity
of whether the repeal and omission both have the same effect as retrospective
operability. ‘Repeal by implication’ has been dealt with in State of
Orissa and Anr. vs. M.A. Tulloch and Co. [(1964) 4 SCR 461] wherein the
Court considered the question as to whether the expression ‘repeal’ in section
6 r/w/s 6A of the General Clauses Act would be of sufficient amplitude to cover
cases of implied repeal. It was stated that:

‘The next
question is whether the application of that principle could or ought to be
limited to cases where a particular form of words is used to indicate that the
earlier law has been repealed. The entire theory underlying implied repeals is
that there is no need for the later enactment to state in express terms that an
earlier enactment has been repealed by using any particular set of words or
form of drafting but that if the legislative intent to supersede the earlier
law is manifested by the enactment of provisions as to effect such
supersession, then there is in law a repeal notwithstanding the absence of the
word “repeal” in the later statute.’

REPEAL VS. OMISSION

The captioned issue
in reference to the findings of the Apex Court in Kolhapur Canesugar
Works Ltd. vs. Union of India and General Finance Co. vs. ACIT
was also discussed in G.P. Singh’s ‘Principles of Statutory Interpretation’ [12^th
Edition, at pages 697 and 698] wherein the learned author expressed his
criticism of the aforesaid judgments in the following terms:

‘Section 6 of
the General Clauses Act applies to all types of repeals. The section applies
whether the repeal be express or implied, entire or partial, or whether it be
repeal simpliciter or repeal accompanied by
fresh legislation. The section also applies when a temporary statute is
repealed before its expiry, but it has no application when such a statute is
not repealed but comes to an end by expiry. The section on its own terms is
limited to a repeal brought about by a Central Act or Regulation. A rule made
under an Act is not a Central Act or regulation and if a rule be repealed by
another rule, section 6 of the General Clauses Act will not be attracted. It
has been so held in two Constitution Bench decisions. The passing observation
in these cases that “section 6 only applies to repeals and not to
omissions” needs reconsideration, for omission of a provision results in
abrogation or obliteration of that provision in the same way as it happens in
repeal. The stress in these cases was on the question that a “rule” not being a
Central Act or Regulation, as defined in the General Clauses Act, omission or
repeal of a “rule” by another “rule” does not attract section 6 of the Act and
proceedings initiated under the omitted rule cannot continue unless the new rule
contains a saving clause to that effect…’

In a comparatively
recent case before the Apex Court, M/s Fibre Boards (P) Ltd. vs. CIT
Bangalore [(2015) 279 CTR (SC) 89], the Hon’ble Court reconsidered its
opinion as to retrospective operability of omissions and distinguished the
findings in Kolhapur Canesugar Works Ltd. vs. Union of India, General
Finance Co. vs. ACIT and other similar cases. The Apex Court held that
sections 6 and 6A of the General Clauses Act are clearly applicable on
‘omissions’ in the same manner as applicable on ‘repeals’; it also held that:

‘…29. A reading
of this section would show that a repeal can be by way of an express omission.
This being the case, obviously the word “repeal” in both section 6 and section
24 would, therefore, include repeals by express omission. The absence of any
reference to section 6A, therefore, again undoes the binding effect of these
two judgments on an application of the per incuriam
principle.

…31. The two
later Constitution Bench judgments also did not have the benefit of the
aforesaid exposition of the law. It is clear that even an implied repeal of a
statute would fall within the expression “repeal” in section 6 of the General
Clauses Act. This is for the reason given by the Constitution Bench in M.A. Tulloch & Co. that only the
form of repeal differs but there is no difference in intent or substance. If
even an implied repeal is covered by the expression “repeal”, it is clear that
repeals may take any form and so long as a statute or part of it is obliterated,
such obliteration would be covered by the expression “repeal” in section 6 of
the General Clauses Act.

…32. In fact,
in ‘Halsbury’s Laws of England’ Fourth Edition,
it is stated that:

“So far as
express repeal is concerned, it is not necessary that any particular form of
words should be used. [R vs. Longmead (1795) 2 Leach 694 at 696]. All that is required is that an
intention to abrogate the enactment or portion in question should be clearly
shown. (Thus, whilst the formula “is hereby repealed” is frequently
used, it is equally common for it to be provided that an enactment “shall
cease to have effect” (or, if not yet in operation, “shall not have
effect”) or that a particular portion of an enactment “shall be
omitted”).’

In view of the
above-mentioned judicial pronouncements and the provision of law, it can be
interpreted that insofar as ‘omission’ forms part of ‘repeal’, the omission of
clause (i) to section 92BA(1) does not have retrospective operation and the
omission will not affect the reference to the Transfer Pricing Officer in
respect of transactions u/s 92BA(1)(i) for the accounting years prior to 1^st
April, 2017. But on account of varied findings in this regard by the Tribunals
as well as the High Courts, the matter is yet to be settled.

shailesh.kwebmaker

INTERNAL AUDIT ANALYTICS AND AI

INTRODUCTION

Artificial Intelligence (AI) is set to be the key driver of
transformation, disruption and competitive advantage in
today’s fast-changing economy. We have made an attempt
in this article to showcase how quickly that change is
coming, the steps that Internal Auditors need to take to get
going on the AI highway and where our Internal Audits can
expect the greatest returns backed by investments in AI.

1.0 Artificial Intelligence Defined

While there are many definitions of Artificial Intelligence
/ Machine Intelligence, the easiest to comprehend is
about creating machines to do the things that people are
traditionally better at doing. It is the automation of activity
associated with human thinking:
(A) Decision-Making,
(B) Problem-Solving, and
(C) Learning.
A more formal definition would be, ‘AI is the branch of
computer science concerned with the automation of
intelligent behaviour. Intelligence is the computational
ability to achieve goals in the world’.

1.1 Common AI Terms and Concepts

Machine Learning (ML): This is a subset of AI. Machine
Learning algorithms build a mathematical model based
on sample data, known as ‘training data’, in order to
make predictions or decisions without being explicitly
programmed to perform the task.
* Unsupervised ML – Can process information without
human feedback nor prior data exposure;
* Supervised ML – Uses experience with other datasets
and human evaluations to refine learning.

Natural Language Processing (NLP): A sub-field of
linguistics, computer science, information engineering
and artificial intelligence concerned with the interactions
between computers and human (natural) languages, in
particular how to programme computers to process and
analyse large amounts of natural language data. NLP
uses ML to ‘learn’ languages from studying large amounts
of written text. Its abilities include:

(i) Semantics – What is the meaning of words in
context?
(ii) Machine Translation – Translate from one language
to another;
(iii) Name entity recognition – Map words to proper
names, people, places, etc.;
(iv) Natural Language Generation – Create readable
human language from computer databases;
(v) Natural Language Understanding – Convert text
into correct meaning based on past experience;
(vi) Question Answering – Given a human-language
question, determine its answer;
(vii) Sentiment Analysis – Determine the degree of
positivity, neutrality or negativity in a written sentence;
(viii) Automatic Summarisation – Produce a concise
human-readable summary of a large chunk of text.

Neural Network (or Artificial Neural Network): This
is a circuit of neurons with states between -1 and 1,
representing past learning from desirable and undesirable
paths, with some similarities to human biological brains.

Deep Learning: Part of the broader family of ML methods
based on artificial neural networks with representation
learning; learning can be supervised, semi-supervised
or unsupervised. Deep Learning has been successfully
applied to many industries:
(a) Speech recognition,
(b) Image recognition and restoration,
(c) Natural Language Processing,
(d) Drug discovery and medical image analysis,
(e) Marketing / Customer relationship management.

Leading Deep Learning frameworks are PyTorch
(Facebook), TensorFlow (Google), Apache MXNet,
Chainer, Microsoft Cognitive Toolkit, Gluon, Horovod and
Keras.

1.2 AI Concepts – Context Level (Figure 1)
1.3 Artificial Intelligence Challenges

Many challenges remain for AI which need to be managed
effectively:

(1) What if we do not have good training data?
(2) The world is biased, so our data is also biased;
(3) OK with deep, narrow applications, but not with wide ones;
(4) The physical world remains a challenge for computers;
(5) Dealing with unpredictable human behaviour in the wild.

2.0 Global Developments

There has always been excitement surrounding AI. A
combination of faster computers and smarter techniques
has made AI the must-have technology of any business.
At a global scale, the main business drivers for AI are:
(i) Higher productivity, faster work,
(ii) More consistent, higher quality work,
(iii) Seeing what humans cannot see,
(iv) Predicting what humans cannot predict,
(v) Labour augmentation.

2.1 Global Progress on AI – A few examples

2.2 The Internal Audit Perspective

Robotic Process Automation (RPA) is a key business driver for AI in audit in the sense that it has the potential to achieve significant cost savings on deployment. The goal of RPA is to use computer software to automate knowledge workers’ tasks that are repetitive and timeconsuming.

The key features of RPA are:
* Use of existing systems,
* Automation of automation,
* Can mimic human behaviour,
* Non-invasive.

The tasks which are apt for RPA are tasks which are definable, standardised, rule-based, repetitive and ones involving machine-readable inputs.

Sample listing of tasks for RPA:

2.3 Case Study of Application of RPA for Accounts Payable process (Figure 2; See following page)

2.4 AI Audit Framework for Data-Driven Audits (Figure 3; See following page)

3.0 Internal Audit AI in Practice – Case Study RPA Case Study from India:

A leading automobile manufacturer had the following

environment and challenges:

(a) Millions of vendor invoices received as PDF files;

(b) Requirement for invoice automation, repository build,

duplicate pre-check;

(d) PDF to structured data conversion was inconsistent;

(e) Conclusion: A Generic RPA tool was needed.

The solution proposed entailed:

(1) Both audit analytics and RPA being positioned as one solution,

(2) Live feed to the PDF files from diverse vendors,

(3) Extract Transform Load jobs were scheduled for the PDF files,

(4) Duplicate pre-check metrics were built and scheduled,

(5) Potential exceptions were managed through a convenient and collaborative secure email notification management system plus dashboards,

(6) Benefit – 85% reduction in effort and 10x improvement in turnaround time.

4.0 How you can get started on using AI in your

Internal Audits

You can get started on your AI journey in Internal Audit by bringing your analytics directly into the engagement. With AI in Audit the efficiency, quality and value of decisionmaking gets significantly enhanced by analysing all data pan enterprise as one.

Some of the steps you can take to get along in your Audit AI journey are listed below:

(I) Integrate your audit process / lifecycle;

(II) Collaborate with clients on a single platform;

(III) Make every audit a data-driven audit;

(IV) Use data analytics through all phases of projects;

(V) Use RPA where manual work is an obstacle;

(VI) Use Audit Apps where process is well-defined;

(VII) Augment audits with statistical models and Machine Learning;

(VIII) Evolve to continuous monitoring and Deep Learning.

(Adapted from a lecture / presentation by Mr. Jeffery Sorensen, Industry Strategist, CaseWareIDEA Analytics, Canada, with his permission)

shailesh.kwebmaker

GST ON PAYMENTS MADE TO DIRECTORS

This article
analyses the GST implications of different payments made by companies to their
Directors. Such payments can be broadly categorised into:

(1) Remuneration to Whole-Time Directors

(2) Remuneration to Independent Directors

(3) Payment towards expenses as lump sum or as
reimbursement.

Each of the above
is discussed below.

REMUNERATION TO WHOLE-TIME DIRECTORS

Whole-Time
Directors (who can be professionals or from the promoter group) (‘WTD’) are
those persons who are responsible for the day-to-day operations of the company
and are entitled to a remuneration. The terms of appointment for such WTDs
(including the remuneration and perquisites) are as per the limits laid down by
Schedule V to the Companies Act, 2013. The remuneration can be a fixed minimum
amount per month or a combination of fixed amount plus a commission based on a
percentage of the profits. The said terms are laid down in an agreement
approved by the Board of Directors.

In terms of the agreement between the company and the WTD/s, the WTD is
regarded as having a persona of not only a Director but also an employee
depending upon the nature of his work and the terms of his employment.
Moreover, in all such cases the company makes necessary deductions on account
of provident fund, profession tax and deduction of tax at source under
Income-tax law, treats these Directors as employees of the company in filings
before all statutory authorities and considers the remuneration paid to them as
a salary. Thus, the relationship of the Director vis-à-vis the company would be
that of an employer-employee.

If the same is
analysed from the GST point of view, Schedule III of the Central Goods and
Services Tax Act, 2017 (‘CGST Act’) provides for supplies which are to be
treated neither as a supply of goods nor a supply of services. Entry (1) of the
said Schedule reads as follows, ‘Services by an employee to the employer in
the course of or in relation to his employment’. From this it can be
inferred that the services supplied by an employee to the employer is not a
service liable to GST.

REMUNERATION TO INDEPENDENT DIRECTORS

Independent Directors (‘IDs’), on the other
hand, are not WTDs but are recommended by the Board of Directors and appointed
by the shareholders. They are normally separate and independent of the company
management. These IDs provide overall guidance and do not work under the
control and supervision of the company management and therefore, by inference,
they are not employees of the company. IDs attend the meetings of the Board or
its committees for which they are paid fees, usually referred to as sitting
fees / directors’ fees. In many cases, the Directors are also paid a percentage
of profits as commission.

Analysing these
payments to IDs from the GST perspective, Entry 6 of Notification No.
13/2017-CT (Rates) and No. 10/2017-IT (Rates) both dated 28^th June,
2017, effective from 1^st July, 2017 issued under the CGST Act (‘Reverse
Charge Notification’) provides that the ‘GST on services supplied by
a director of a company or a body corporate to the said company or the body
corporate located in taxable territory shall be paid under reverse charge
mechanism by the recipient of services’.

Thus, in case of
payments to IDs (whether they are located in India or domiciled outside India),
the company will have to pay GST under Reverse Charge Mechanism (‘RCM’),
albeit appropriate credit of such GST paid shall be available to the
company, subject to fulfilment of other terms and conditions of availment of
ITC.

PAYMENT TOWARDS EXPENSES AS LUMP SUM OR AS REIMBURSEMENT

In many companies,
Directors (whether WTDs or IDs) are also paid a lump sum amount towards
expenses, or reimbursed the actual expenses incurred by them in performing
their duties as directors, e.g. travel expenses, accommodation expenses, etc.
The same is as per the terms of appointment for WTDs or the Directors’ Expense
Reimbursement Policy of the company.

Regarding the
applicability of GST on such payments, the Authority on Advance Rulings (‘AAR’)
in the case of M/s Alcon Consulting Engineers (India) Private Limited,
Bengaluru (AR No. Kar ADRG 83/2019) dated 25^th September, 2019,
while responding to the query, whether expenses incurred by employees and later
reimbursed by the company are liable to GST, ruled in the negative and observed
that the expenses incurred by the employees are expenses of the applicant and
therefore this amount reimbursed by the applicant to the employee later on
would not amount to consideration for the supplies received, as the services of
the employee to his employer in the course of his employment is not a supply of
goods or supply of services and hence the same is not liable to tax.

Therefore, any
expense reimbursement to a WTD who is treated as an employee would not be
liable to GST. However, if the reimbursement of expenses is made to an ID, who
also receives sitting fees, the same shall be treated as part of the
consideration and would be liable to GST under the RCM.

Analysis of
the AAR decision in Clay Craft India Private Limited

Whilst the above provisions of the GST law regarding the taxability of
payments made to the Directors were fairly settled, a recent Advance Ruling
issued by the AAR, Rajasthan in the case of Clay Craft India Private
Limited (AR No. Raj/AAR/2019-20/33) dated 20^thFebruary, 2020 held
that consideration paid to Directors by the company will attract GST on Reverse
Charge basis as it is covered under Entry 6 of the Reverse Charge Notification
issued under the CGST Act. Entry 6 of the said Notification provides that the
GST on services supplied by a Director of a company or a body corporate to the
said company or the body corporate located in the taxable territory shall be
paid under RCM by the recipient of services.

SERVICE SUPPLIED BY AN
EMPLOYEE

The applicant in
the above Advance Ruling had sought clarity on ‘whether payment made for
services availed from a Director, in their capacity as an employee, is also
liable to be taxed under GST on RCM basis’. The clarification was sought
keeping in mind Entry (1) of Schedule III of the CGST Act on the basis of which
the ‘Services by an employee to the employer in the course of or in
relation to his employment’ is treated neither as a supply of goods nor
a supply of services. Thus, the service supplied by an employee to the employer
is not a supply for GST purposes.

The aforesaid query
was raised by the applicant pursuant to a decision passed by the AAR, Karnataka
in the case of M/s Alcon Consulting Engineers (Supra) wherein the
Authority provided that the services provided by the Director to the company
are not covered under Schedule III Entry (1) of the CGST Act as the Director is
not an employee of the company and hence the payment made to him is liable to
GST.

In both the
aforesaid rulings, there is no segregation of payments / consideration paid to
the Directors for the services provided by such Directors in their capacity as
an employee or as an agent or as a Director.

EPF DEDUCTED FROM
DIRECTORS

It would be pertinent to note that the applicant in the Clay Craft
case (Supra) was already paying GST under RCM on any commission paid to
its Directors, who were providing services to the company in the capacity of
Director. However, payments for the services received from its Whole-Time
Directors / Managing Directors, who were supplying services in their capacity
as employees of the company, were made in the form of salary and the same were
also offered by the Directors in their personal income tax returns under
‘Income from Salary’. The company was also deducting EPF from their salaries
and all other benefits given to them were as per the policy decided by the
company for its employees.

However, the AAR
did not consider the above and only took note of the RCM entry under GST and
denied treating Directors as employees of the company.

Analysis of
the AAR decision in Anil Kumar Agrawal

In yet another
recent Advance Ruling by the AAR, Karnataka in the case of M/s Anil Kumar
Agrawal (AR No. Kar ADRG 30/2020) dated 4^th May, 2020, the
Authority analysed incomes derived from various sources so as to examine
whether such income in relation to any transaction amounts to supply or not.
One such source of income examined was ‘Salary received as Director from
a Private Limited Company’.

The AAR, Karnataka
at paragraph 7.8 of the ruling explicitly observed that:

‘The applicant
is in receipt of certain amount termed as salary as Director of a private
limited company. Two possibilities may arise with regard to the instant issue
of amount received by the applicant. The first possibility that the applicant
is the employee of the said company (Executive Director), in which case the
services of the applicant as an employee to the employer are neither treated as
supply of goods nor as supply of services, in terms of Schedule III of CGST Act
2017.

The second
possibility that the applicant is the nominated Director (non-Executive
Director) of the company and provides the services to the said company. In this
case the remuneration paid by the company is exigible to GST in the hands of
the company under reverse charge mechanism under section 9(3) of the CGST Act
2017, in the hands of the company, under Entry No. 6 of Notification No.
13/2017-Central Tax (Rate) dated 28^th June, 2017.

…….

In view of the
above, the remuneration received by the applicant as Executive Director is not
includable in the aggregate turnover, as it is the value of the services
supplied by the applicant being an employee.’

OBSERVATIONS

Keeping in view
these contradictory rulings, it would be pertinent to have a look at some of
the observations made in the following judgments / circulars / notifications of
various authorities. Though the judgments are in respect of the erstwhile
Service Tax law, the provisions being identical can also be applied to GST.

(i) Remuneration paid to the Managing Director
is to be considered as salary. A Managing Director may be regarded as having a
persona of not only a Director but also an employee or agent, depending upon
the nature of his work and the terms of the employment¹.

(ii) If an amount paid to an individual was
treated as salary by the Income-tax Department, it could not be held by the
Service Tax Department as amount paid for consultancy charges and to demand
service tax on the same².

(iii) If a Director is performing duties and is
working for the company, he will come within the purview of an employee³.

(iv) Remuneration paid to four Whole-Time Directors
for managing the day-to-day affairs of the company and where the company made
necessary deductions on account of provident fund, professional tax and TDS as
applicable and declared these Directors to all statutory authorities as
employees of the company, remuneration paid to Directors was nothing but salary
and the company was not required to discharge service tax on remuneration paid
to Directors⁴.

(v) The Managing Director of a company may be
executive or non-executive. A Managing Director of a company may or may not be
an ‘employee’ of the company. It was rightly held that for the purpose of ESIC
the company is the owner. The Managing Director is not the ‘owner’. Even if the
Managing Director is declared as ‘Principal Employer’ to ESIC, he can still be
an employee⁵.

(vi) Payments made by a company to the Managing
Director / Directors (Whole-Time or Independent) even if termed as commission,
is not ‘commission’ that is within the scope of business auxiliary service and,
hence, service tax would not be leviable on such amount⁶.

(vii) The Managing Director / Directors (Whole-Time or
Independent) being part of the Board of Directors, perform management functions
and they do not perform consultancy or advisory functions…In view of the above,
it is clarified that the remunerations paid to the Managing Director /
Directors of companies whether Whole-Time or Independent when being compensated
for their performance as Managing Director / Directors, would not be liable to
service tax⁷.

(viii) The service tax (now GST) paid by the company
will be treated as part of remuneration to non-Whole-Time Directors and if it
exceeds the ceiling of 1% / 3%, the approval of the Central Government would be
required – Circular No. 24/2012 dated 9^th August, 2012 of the
Ministry of Corporate Affairs. This entire circular is on the basis that GST is
payable on payments made to non-Whole-Time Directors only. And, as a corollary,
it can be inferred that service tax (now GST) shall not be payable on payments
made to Whole-Time Directors.

1 In Ram Prasad vs. CIT (1972) 2 SCC 696 dated
24th
August,
1972 bound to
cause uncertainty and unnecessary litigation.

2 In Rentworks India P Ltd. vs. CCE (2016) 43
STR 634 (Mum. – Trib.)

3 In Monitron Securities vs. Mukundlal
Khushalchand 2001 LLR 339 (Guj. HC)

4 In Allied Blenders and Distillers P Ltd. vs.
CCE & ST [2019] 101 taxmann.com 462 (Mum. –CESTAT)

5 In ESIC vs. Apex Engineering Ltd. 1997 LLR 1097

6 CBE&C Circular No. 115/09/2009-ST dated 31st July, 2009

7 CBE&C Circular No. 115/09/2009-ST dated 31st July, 2009

MAY LEAD TO NEEDLESS
LITIGATION

From the above it
can be further deduced that a Director may provide services to a company in the
capacity of a Director or agent or employee and may receive consideration /
payments in the form of sitting fees or commission or salary, depending on the
arrangement he / she has with the company. Consequently, tax would be payable
in accordance with the nature of the consideration derived by a company’s
Director providing services in his / her capacity as a Director or agent or
employee. Under such circumstances, considering all payments to Directors under
one category and imposing GST on the same is against the established principles
of law and bound to cause uncertainty and unnecessary litigation.

The AAR seems to have erred in delivering the rulings under the Clay
Craft and the M/s Alcon Consulting Engineers cases (Supra)
and by obvious inadvertence or oversight failed to reconcile the aforesaid
issue with that of some previously pronounced judgments of co-equal or higher
authorities. It also appears that the AAR wanted to differ from the precedents;
however, it was not open to the AAR to completely ignore the previous decisions
on illogical and unintelligible grounds. Regrettably, the ruling delivered by
the AAR without referring to the aforesaid precedents and without consciously
apprising itself of the context of such judgments on similar issues, is per
incuriam, meaning a judgment given through inadvertence or want of
care, and therefore requires reconsideration. Per incuriam judgments are
not binding judgments. Needless to say, the AAR is only binding on the
applicant but carries some reference and, therefore, nuisance value and should
be appealed before the higher forum.

CONCLUSION

While the AARs are not binding on anyone other than the applicants, the
companies may revisit their payments to Directors on which GST is not being
currently paid by them under RCM. Such payments should be analysed on the basis
of the contract / agreement with the Directors and the payment / non-payment of
GST under RCM against such payments to Directors be decided and documented.

There is also an
immediate need for a Central Appellate Authority for Advance Rulings since
contradictory rulings given by different state authorities, and sometimes even
by the same state authority as in the case discussed above (by the AAR,
Karnataka) can result in unnecessary confusion and avoidable litigation.

shailesh.kwebmaker

BCAJ SURVEY ON IMPACT OF COVID-19 ON CHARTERED ACCOUNTANT FIRMS

The BCAJ carried out a
dipstick survey in April, 2020 to identify the challenges faced by
professionals and firms. Respondents were asked to share their perspectives,
challenges and how they are responding.

Attributes of the respondents:

A> Location and Presence

52% respondents had presence in
Non-Metros and about 48% in both Metros and Non-Metros.

B> Nature of Respondents

48% respondents were proprietors,
37% were firms having up to 4 partners, 10% were firms having 5-9 partners and
5% were firms having more than 10 partners.

SURVEY QUESTIONS AND RESPONSES

1. Have you made a systematic assessment of probable impact on the
firm?

2. Time frame you have considered in the above assessment for impact
of lockdown / slowdown?

3. Is downsizing of staff on the horizon or under consideration during
the next 6 months?

4. Increments for FY 2020-21

5. Bonuses for FY 19-20 to staff

6. Partner and Senior Staff pay and payouts: What is the most likely
scenario?

7. Have you considered or are already in the process of renegotiating
rent or other contracted expenses?

8. Based on the Type of Work and Nature of Clients and assuming
lockdown and gradual lifting – do you see your firm’s cash flow:

9. To manage Working Capital, you are likely to

10. Do you expect some clients seeking fees reduction?

shailesh.kwebmaker

HOW TO RESTART THE ENGINE AFTER THE LOCKDOWN

As India is
slowly MOVES towards a step by step removal of national lockdown imposed due to
the Covid-19 pandemic, there have been wide-ranging discussions in government
circles on what should be India’s strategy for an exit scenario. The Ministry
of Home Affairs from time to time has issued various guidelines for managing
with the Covid 19 impacts; Aarogya Setu App, state guidelines,mandatory wearing
of mask, social distancing amongst other
elements in the fight against Covid-19.

With the
restarting of economy and life on the governments’ agenda, various guidelines on ‘restarting’ India and
among these the most important one is to create Standard Operating Procedures
(SOPs) to ensure that preventive measures are executed in a systematic manner post–lockdown; the other guiding principles are as follows:

Guidance
from Central Government, State Government
and WHO

Protection
of personnel and visitors

Social
distancing in travel to and from workplace and during interaction with
suppliers and those in the distribution chain

Business
protection and continuity

Implementing
best practices for safety and prevention

Introducing
audit procedures to monitor and ensure that safe practices are implemented and

Action
plan in the event of persons feeling unwell at the workplace.

PROCESS FOR IMPLEMENTATION
OF SOPS

The
organisation should begin with forming an internal team of Covid-19 fighters

The Covid-19
team should comprise of a factory / warehouse / shop / office in-charge, human
resource manager, business supervisor or head of business, administration /
utility in charge, medical expert on site (or identify the nearest medical
expert and security personnel). In case of local market or mandi
operators, the same can be managed by the market / trade association or local mandi
operator.

Prepare
the SOP and plan for its deployment

Ground Zero: Online involvement of staff, if possible online training, to fight the
disease and restrict / minimal onsite interactions

Week 1: Framing the SOP; the company should get the SOP verified by the local
authorities or an internal / external expert

Week 2: Start operation as per government regulations; however, only staff who
have observed clear 14 days’ quarantine should attend the office; and only
necessary staff should attend in person, the support staff can operate from
home

Week 3: Organisations in manufacturing / trading or service should try and
achieve minimum capacity utilisation

Week 4: Entering this stage, and if all things go well and no additional
positive patients are identified in the organisation, then the capacity
utilisation can be increased by 20% per week moving forward, subject to
government guidelines.

The broader
framework of the SOP should cover at least the following:

1. Identify the risk area

a. Entrance

b. Office meeting room

c. Change room

d. Canteen

e. Shopfloor

f. Restrooms

g. Warehouse / storage areas, etc.

2. Identify / implement the
mitigating measures

3. Define the processes to be
implemented to prevent / report for Covid-19 occurrences based on severity

a. If the locality is Covid-free,
then business as usual

b. If the locality is in the
vicinity of an impacted locality, then business as usual with close monitoring

c. Locality impacted and declared as
hotspot: severe impact

d. Locality declared as containment
zone: highly severe impact

4. Identify the person responsible for
implementation of measures

5. Reporting to local health authorities /
municipal corporation or others

6. Mandatory checklist for business continuity
plan post-lockdown to be implemented

7. Regular monitoring, review and update of the
protocols.

(* Sector-specific
SOPs are recommended)

SUGGESTED ELEMENTS OF SOPS FOR SERVICE INDUSTRY

Client-facing
operations such as banking, insurance, other professional services, etc. should
consider continuing online / mobile servicing of clients where possible. Office
workers to include bare minimum staff required to run back-end operations. As
the risk and rate of infection drops in an area, officer attendance can slowly
be increased.

(A) Delivery of office supplies

All
office supplies should be properly sanitised for each material movement (in /
out / transport)

(B) Labour / employee

Social
distancing norms to be defined and maintained

Mandatory
wearing of face masks at all times

Disposable
facemasks not to be re-used, cloth masks
to be encouraged

All
washrooms to be sanitised, at least twice daily

Each
employee’s temperature to be checked on entry

Staff
showing any symptoms, even a mild cough or low-grade fever, to stay at home

Employees
should maintain hygiene during transport from home to workspace / client’s
place

Avoid
in-person meetings to the extent possible.

Reduce
staff movements onsite

Work
From Home options to be made available to staff

Regular
sanitisation of entire facility, including meeting rooms, offices, canteens,
equipment, washrooms, machine touch points, operating panels, tissue boxes,
hand sanitizers, seats and covers requiring human touch to be sanitized twice a
shift

Social
distancing during lunch break, batch-wise option or similar

Display
posters promoting and instructing about respiratory hygiene

Workshop
/ guidance on maintaining occupational health and safety

Arrange
seats so that employees / participants are at least one metre apart

Maintain
log of names and contact details of all participants of meetings for at least
one month

Identify
a room or area where someone who is feeling unwell or has symptoms can be
safely isolated

Create
follow-up protocol for a situation where a meeting participant / staff member /
service provider tests positive for Covid-19 during or just after the meeting
in conjunction with partner healthcare provider or local health department.

(D) Travel / business trip

Each
employee to be tested before business trips

Avoid
sending employees who may be at higher risk of serious illness or where
Covid-19 is spreading

Employees
should comply with any local restrictions on travel, movement or large
gatherings

Employees
who have returned from an area where Covid-19 is spreading should monitor their
temperature and other symptoms for 14 days.

(E) Dealing with clients and partners

Social
distancing norms to be followed

Promote
video meetings as much as possible

Carry
/ ensure sufficient hygiene equipment such as hand sanitizer for all meeting
participants

Visit
only those client offices who have complied with the necessary requirements of
Covid-19 prevention measures

Self-declaration
at the gate and maintaining traceability and screening of persons entering the
office premises.

(F) Dealing with bank / financial
institutions

Make
effective use of online banking options

(G)
Infrastructure for safety of staff / labour

Surfaces
(e.g. desks and tables) and objects (telephones, keyboards) need to be wiped
with disinfectant regularly

Hygiene
and social distancing to be encouraged for canteens and accommodation usage

Refrain
from usage of ACs as much as possible.

The above is
an illustrative list and not exhaustive; additionally, industry / sector-wise
specific SOPs are recommended.

IMPLEMENT, REVIEW
AND IMPROVE

There still remains significant uncertainty about the
potential for more widespread transmission of Covid-19, hence organisations
should incorporate these practices as part of their Business Continuity Plan
and all the employees and people associated with the business should be trained
to deal with such situations in future. The implementation of the SOP and
checklist should be audited by the organisations as well as local authorities.

shailesh.kwebmaker

MAKING A WILL WHEN UNDER LOCKDOWN

INTRODUCTION

We are currently living in times
of uncertainty due to Covid-19. Hopefully, by the time this issue reaches you
India’s lockdown would have eased. However, it could also be extended or
re-enforced at any time. It is in times such as these that we realise that life
is so fragile and fleeting. This lockdown has also forced several of us to
consider making a Will. During these past 30 days, the author has drafted
several Wills for people who are concerned about what would happen if they
contracted the virus. Through this month’s feature, let us look at the unique
issues and challenges which one faces when drafting a Will during a lockdown.

DECODING
THE JARGON

Wills are usually associated with
a whole lot of jargon which make them appear very complex to the man on the
street. However, most of these legal words are used by legal professionals and
a person making a Will can avoid using them. However, it is beneficial to
understand the meaning of these words in order to understand various other
things. All or some of the following terms are normally involved in a Will:

(a) Testator / testatrix: A person who makes the Will. He
/ she is the person whose property is to be disposed of after his / her death
in accordance with the directions in the Will.

(b) Beneficiary / legatee: The person to whom the
property will pass under the Will. He is the person to whom the property of the
testator would be bequeathed under the Will.

(c) Estate: The property of the testator remaining after his
death. It consists of the sum total of such assets as are existing on the date
of the testator’s death. The estate may also increase or decrease after the
testator’s death due to the actions carried out by the executors. For example,
the executors may carry on the business previously run by the deceased in the
name of the estate.

(d) Executor / executrix: The person who would
administer the estate of the testator after his death in accordance with the
provisions of the Will. The executor is normally named in the Will itself. An
individual, limited company, partnership firm, etc., may be appointed as an
executor. In many cases, a bank is appointed as the executor of a Will. For all
legal and practical purposes, the executor acts as the legal representative of
the estate of the deceased. On the death of the testator, the property cannot
remain in a vacuum and hence the property immediately vests in the executor
till the time the directions contained in the Will are carried out and the
property is distributed to the beneficiaries.

(e) Bequest: The property / benefits which flow under the
Will from the testator’s estate to the beneficiary.

(f) Bequeath: The act of making a bequest.

(g) Witnesses: The persons who witnesses the signing
of the Will by the testator.

BACK
TO BASICS

First things first, making a Will
involves certain basics which one needs to remember. Any adult, owning some
sort of property or assets can and should make a Will. If a Will is not made,
then the personal succession law as applicable would take over. For instance, Hindus
would be governed by the Hindu Succession Act, 1956. Only adults of sane mind
can make a Will. Thus, anyone who is insane or is a lunatic, or has lost
control over his mental faculties cannot make a Will.

A Will is a document which
contains the last wishes of a person as regards the manner and mode of
disposition of his property. A person expresses his will as regards the
disposition of his property. The Indian Succession Act, 1925 (which governs the
making of Wills in India) defines a Will to mean ‘the legal declaration
of the intention of the testator with respect to his property which he desires
to be carried into effect after his death’. However, the intention manifests
only after the testator’s death, i.e., posthumous disposition of his property.
Till the testator is alive, the Will has no validity. He can dispose of all his
properties in a manner contrary to that stated in the Will and such action
would be totally valid.

For example, ‘A’ makes a lockdown
Will bequeathing all his properties to his brother. However, post the lockdown
he, during his lifetime itself, transfers all his properties to his son with
the effect that at the time of his death he is left with no assets. Such action
of the testator cannot be challenged by his brother on the ground that ‘A’ was
bound to follow the Will since the Will would take effect only after the death
of the testator. In this case, as the property bequeathed would not be in
existence, the bequest would fail. The Will can be revoked at any time by the
testator in his lifetime. Hence, it is advisable to at least make a basic Will.
It can always be revised once things improve.

The testamentary capacity of the
testator is paramount in case of a Will. If it is proved that he was of unsound
mind, then the Will would be treated as invalid. What is a ‘sound mind’ is a
question of fact and needs to be ascertained in each case. Hence, if a person
has been so impacted by the Covid-19 that his mental faculties are arrested,
then he cannot make a valid Will.

The most important element of a
Will is its date! The last Will of a deceased survives and hence the date
should be clearly mentioned on the Will.

LOCKDOWN
ISSUES

Let us now consider the singular
situations which arise in making a Will during a lockdown. People making a Will
may experience some or all of these in these testing times:

(a) Format: There is no particular format for making a Will.
Several persons have expressed apprehension that during the lockdown they are
unable to obtain a stamp paper, unable to print a document or unable to get
ledger paper, etc. A Will can be handwritten (provided it is legible
handwriting); it could be on a plain paper and it need not be on a stamp paper.
Thus, there should not be any problems from a format perspective.

(b) Witness: Section 63 of the Indian
Succession Act, 1925 requires that the Will should be attested by two or more
witnesses, each of whom has:

(i) seen the testator sign the Will or affix his mark; or

(ii) received from the testator a personal acknowledgement of his
signature or of the signature of such other person.

Each of the witnesses must sign
the Will in the presence of the testator. No particular form of attestation is
prescribed. It is important to note that the attesting witnesses need not
know the contents of the Will. All that they attest is the testator’s signature
and nothing more.

A problem which many people could
face is getting two Witnesses to witness the Will. Neighbours may be requested
to help out. However, what if the neighbours are reluctant to do so due to
social distancing issues, or in the case of persons living in bungalows? In
such cases, one’s domestic servants, maids, watchmen may be asked to act as
witnesses. They must, as witnesses, either write their name or at least affix
their thumb impression – left thumb for males and right thumb for females.

However, what can people do if
there are no servants also? In such a case, the adult family members of the
testator may be approached. However, a question which arises is that if such
members are beneficiaries under the Will, can they act as witnesses, too?
Generally speaking, No. The Indian Succession Act states that any bequest
(gift) to a witness of a Will is void. Thus, he who certifies the signing of
the Will should not be getting a bequest from the testator. However, there is a
twist to the above provision. This provision does not apply to Wills made by
Hindus, Sikhs, Jains and Buddhists and, hence, bequests made under their Wills
to attesting witnesses would be valid. Wills by Muslims are governed by their
Shariyat Law. Thus, the prohibition on gifts to witnesses applies only to Wills
made by Christians, Parsis, Jews, etc. Accordingly, any Will by a Hindu can
have a witness as a beneficiary.

A related question would be, can
an executor be a witness under the Will? Thus, if a person names his wife as
the executor, can she also be an attesting witness? The answer is, Yes. An
executor is the person who sets the Will in motion. It is the executor through
whom the deceased’s Will works. There is no bar for a person to be both an
executor of a Will and a witness of the very same Will. In fact, the Indian
Succession Act, 1925 expressly provides for the same. Accordingly, people of
all religions can have the executor as the witness.

To sum up, in the case of Hindus,
Sikhs, Jains and Buddhists, the witness can be a beneficiary and an executor.
However, in the case of Wills made by Christians, Parsis, Jews, etc., the
witness can be an executor but not a beneficiary.

Can witnesses practice social
distancing and yet witness the signing of the Will? Some English cases throw
some light on this issue. In Casson vs. Dade (1781) 28 ER 1010 a
testatrix signed her Will in her lawyer’s office and went to sit in her horse
carriage before the witnesses signed it. Since she could, through the
carriage’s window and the office’s window, see the witnesses signing, it was
held that the Will was valid.

This case is an example of where
the circumstances were enough to meet the witnessing requirements. This case
was followed by the UK Court of Protection in Re Clarke in
September, 2011 when a lasting power of attorney in the UK was held to
have been validly executed where the donor was in one room and the witnesses in
another, separated by a glass door. Even though the witness was sitting in the
adjacent room, there were clear glass doors with ‘Georgian bars’ between the
two rooms and it was held that the witness had a clear line of sight through
those glass doors. It was held that the donor would also have been able to see
the witness by means of the same line of sight through the glass doors.

As the Indian law stands today, a
witness cannot witness the execution of a will by Zoom or Skype. Scotland is
one of the places where this is possible. To deal with the witness issue, the
Law Society of Scotland has amended its guidance on witnessing the signing of a
Will. It allows the lawyer to arrange a video link with the client. If this can
be done, the solicitor can witness the client signing each page. The lawyer
should assess the capacity of the client and using his professional judgement,
consider whether any undue influence is being exerted on the client.

The signed Will can then be
returned to the solicitor by post. The lawyer can then sign as witness on the
receipt of the signed Will. This is a truly revolutionary step!

(c) Doctor’s Certificate: Quite
often, a doctor’s certificate as to the mental fitness of the deceased is
attached to a Will. This is especially so in the case of very old persons so as
to show that the Will is valid. The doctor would certify that the testator is a
person who is alert and able to understand what he is doing. A question which
now arises is how to obtain a doctor’s certificate if the testator cannot visit
the doctor? One option to consider if the doctor is being regularly consulted
is that a video conference could be arranged and if the doctor can issue the
certificate on that basis, then that would suffice. Of course, the doctor’s
certificate may not physically reach the testator but the same could be
collected once the lockdown eases and attached to the Will. It is advisable in
the case of very old / feeble persons that the certificate is obtained from a
neurophysician or a psychiatrist.

An alternative to this would be
to obtain a video recording of the Will execution process with the testator
reading out the entire Will. This helps show that he understands what he is
doing and is useful for very old persons who cannot obtain a medical
certificate.

(d) Enumerating all assets: It is generally preferable
that the Will be specific and enumerate all assets of the testator along with
account numbers, etc. so that it would help the beneficiaries in identifying
the assets. However, in a lockdown it may happen that such details are in the
office or in a bank locker and the testator is unable to access them and write
the details in the Will. In such a case, as many details as possible may be
given, or the Will may make a general bequest of the entire estate of the
testator as on the date of his death. On a separate note, it is always a good
idea to keep a complete inventory of assets along with details of nominations,
account numbers, addresses, etc., both at office and at home.

While bequests can be general or
specific, they cannot be so generic that the meaning itself is unascertainable.
For instance, a Will may state ‘I leave all my money to my wife’. This is a
generic bequest which is valid since it is possible to quantify what is
bequeathed. However, if the same Will states ‘I leave money to my wife’ then it
is not possible to ascertain how much money is bequeathed. In such an event,
the entire Will is void.

The Will must also create a
repertoire of digital assets which should enumerate all important passwords,
online accounts, e.g., emails, social media accounts, bank accounts, etc.

(e) Registration: Registration of
Wills is out of the question in a lockdown. However, registration is not
compulsory. Again, a video Will can act as an alternative.

(f) Bequest to minors : In the
case of nuclear families, there is a tendency to leave everything to one’s
spouse and in case of death of the spouse before the death of the testator, to
the children. However, in the case of minor children it is not advisable to
bequeath assets directly to them. In such situations, a trust is advisable. In
times such as these setting up a trust is not possible since it would not be
feasible to obtain a PAN, open a bank account / demat account, etc. What, then,
can one do? A trust under a Will may be considered, in which case the trust
comes into effect only when the Will is executed and no trust is set up at the
time of making the Will. Thus, the act of settling the assets into the trust is
pushed till when the Will is executed. This trust could own all the assets to
be bequeathed to the minors.

If at all assets are to be bequeathed
directly to minors, then a guardian should be appointed under the Will. In this
case, the Hindu Minority and Guardianship Act, 1956 lays down the
law relating to guardianship of Hindus and the powers and duties of the
guardians. A Hindu father who can act as the natural guardian of his legitimate
children can appoint a guardian by his Will. Such a guardian could be for the
minor and / or for his property. Such an appointment would be invalid if the
father dies before the mother, because in such a case the mother would take
over as the natural guardian. However, once the mother dies, and if she dies
without appointing a person as the guardian under her Will, then the father’s
testamentary guardian would be revived. The testamentary guardian is subjected to
a dual set of restrictions. Firstly, those specified in the Will appointing
him, and secondly, those contained in this Act which apply to natural
guardians. Thus, the testamentary guardian is subjected to the restrictions on
sale of immovable property just as a natural guardian would be. The rights of
the testamentary guardian would be the same as those of a natural guardian. In
case the minor is a girl, then the rights of the testamentary guardian would
end on her marriage.

(g) Living Will: A living Will is not recognised
in India. However, as per the Supreme Court’s decision in Common Cause
vs. UOI, WP (Civil) 215/2005 (SC), an Advanced Medical Directive is
possible. This can state as to when medical treatment may be withdrawn, or if
specific medical treatment that will have the effect of delaying the process of
death should be given. However, one of the stringent requirements of such a
document is the requirement of two independent witnesses and the directive
should be countersigned by a Jurisdictional Judicial Magistrate, First Class
(JMFC), so designated by the district judge concerned. This requirement would
not be possible in the case of a lockdown and hence, having an Advanced Medical
Directive is not possible till such time as normalcy returns.

(h) Hospital bed Wills: What happens in case a
person is unfortunate to contract the virus and is placed in a hospital
quarantine? Can such a person make a Will? The above peculiar issues would
apply to him also. As always, the biggest challenge would be getting two
witnesses. He could request the doctors / nurses treating him to help out. That
is the only way out for a patient in the isolation ward.

CONCLUSION

It is evident that a Will under
lockdown would throw up several unique issues. However, as explained above, a
solution exists for even the strangest of problems. An overarching question is,
should one adopt a DIY (Do It Yourself) approach or consult a professional for
preparing the Will? At the risk of sounding biased, I would always suggest consulting
a professional, especially when the Will is being executed during a lockdown.

While
legal planning does not prevent a healthcare crisis, it can and would ensure
that you control who makes decisions. It also prevents your loved ones from
being left with a stressful legal situation to fix in a short time. Getting
one’s legal affairs in order today would give you the peace of mind that you
have taken tangible steps to truly be prepared for an uncertain future. Till
then, stay safe and don’t forgot to wash your hands!

shailesh.kwebmaker

SEBI’S BROAD ORDER ON ENCUMBERED SHARES – REPERCUSSIONS FOR PROMOTERS

In the ongoing Covid-19 crisis,
where the world is reeling and stock markets are crashing three times and then
recovering once, a recent SEBI order on disclosure of encumbered shares could
have widespread repercussions on promoters. Increasingly, over the years, the
regulatory outlook of SEBI has been one of disclosures and self-education
rather than close monitoring and micro-management. Material events relating to
a company should be disclosed at the earliest so that the public can educate
itself and take an informed decision. In this context, an order levying a
fairly stiff penalty in a complex case of encumbrance of shares held by a
promoter company makes interesting reading (Adjudication Order in respect of
two entities in the matter of Yes Bank Ltd. Ref No.: EAD-2/SS/SK/89/252-253
/2019-20, dated 31^st March, 2020).

BRIEF
BACKGROUND

Disclosure of holding of shares
in listed companies by promoters and certain other persons (substantial
shareholders, etc.), is an important feature of the securities laws in India.
Promoters typically have large holdings of shares, they control the company and
their continued involvement in it as substantial shareholders is an aspect
considered by the public as relevant in investment decision-making. Being
insiders with control of the company, their dealings in shares are also closely
monitored. Thus, movements in shareholding of shares are required to be
disclosed by several provisions of the securities laws. These disclosures are
event-based and also periodical. Quarterly / annual disclosures are mandated.
So are disclosures based on certain types of transactions or crossing of
certain values / quantities / percentage of movement in the shares held.

Interestingly, and this is the
topic of this article, disclosure of encumbrance in the shares of promoters and
their release is also a requirement under the provisions of SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (‘the Takeover
Regulations’). Regulation 31 of the Takeover Regulations requires disclosure by
the promoters of the creation, release or invocation of any encumbrance on
their shares.

The definition of what constitutes
‘encumbrance’ has undergone changes over the years and the present case relates
to a matter before the recent amendment made in July, 2019, though the
principle would apply even now. The earlier definition was short – ‘“encumbrance”
shall include a pledge, lien or any such transaction, by whatever name called’.

It is of particular interest to
shareholders whether and to what extent the shareholding of promoters is
encumbered. The Satyam case is often referred to in this regard.

COMPLEXITY
OF ENCUMBRANCES

Pledging and hypothecation of
shares are the classic and most familiar of encumbrances on shares. A
shareholder may, for example, transfer his shares to a lender who would hold
them till the loan is repaid. If there is a default, the lender may simply sell
the shares in the market and realise his dues. But now that shares are held
digitally in demat accounts, a special process has been made to enable pledge /
hypothecation of shares. The shares are not transferred to the lender but a
record is made of the pledge / hypothecation in the demat account.

However, encumbrance, as the
definition shows, is a wider term rather than mere pledge / hypothecation. The
definition is inclusive and also has a residuary clause that says such
transactions ‘by whatever name called’ are also covered. As we will see later,
the parties in the present case, however, claimed that encumbrances should be
limited to pledge / hypothecation.

A question arises whether
restrictions placed on the disposal or other transactions in respect of shares
amounts to encumbrance as so envisaged. The classic case is of giving a
Non-Disposal Undertaking, popularly referred to as an NDU, in respect of the
shares. This means an undertaking is given that the shares held shall not be
disposed of till certain conditions (say, loans / interest are repaid) are met.
Even if a plain vanilla NDU is held to be an encumbrance, there are actually
many variants of an NDU or similar encumbrances as the present case shows. The
question is whether the definition should be treated as a generic catch-all
definition or whether it should be given a restrictive meaning. This has been
the core question addressed in this decision. Let us consider the specific
facts.

FACTS
OF THE CASE

The matter concerns two promoter
companies of Yes Bank Limited. Broadly summarised, the essential facts (though
there is some variation in details) are as follows: Both took loans by way of
differently structured non-convertible debentures from entities. The total
amount of loans taken was Rs. 1,580 crores. The shares held and which were the
subject matter of the alleged encumbrance, constituted 6.30% of the share
capital of Yes Bank. The debenture documents / terms placed certain
restrictions on the promoter entities. They were required to maintain a certain
cover ratio / borrowing cap. If such limits were violated, there were certain
consequences, principally that the promoter entity could be held to have
defaulted. There was, however, some flexibility. The promoter entities could
make certain variations after the approval of debenture holders in a specified
manner or after complying with certain conditions.

SEBI’S
ALLEGATION

SEBI held that the cover ratio /
borrowing cap effectively amounted to an encumbrance on the shares and thus
required disclosures under the Takeover Regulations. It alleged that the
entities would effectively face a restriction on the sale of their shares
because if they sold the shares, the ratios / caps would get exceeded and hence
the terms of the debentures could get violated. It was an admitted fact that no
disclosure of this alleged encumbrance was made as required under the
Regulations. Thus, there was a violation of the Regulations and SEBI issued a
show cause notice as to why penalty should not be levied.

CONTENTIONS
OF THE PROMOTER ENTITIES

The promoters gave several
detailed technical and substantive arguments to support their view that there
was no violation and hence no penalty could be levied. Technical arguments like
inordinate delay in initiating the proceedings were given. It was also argued
that since then the structure had undergone substantial changes, and
particularly on revision of terms, disclosure was required and was duly made.

It was argued that the definition
of encumbrance effectively limited it to things like pledge, hypothecation,
etc. The principle of ejusdem generis applied for the words used ‘by any
other name called’ considering that they were preceded by the words ‘such
transaction’.

Some of the other major arguments
were as follows: It was argued that the structure and terms of debentures did
not amount to encumbrance as understood in law. The caps on borrowings, etc.
were of financial prudence. There were many alternatives for the entities to
sell the shares if they wanted to do so within the terms of the debentures
themselves. References were made to FAQs and press releases where some
clarifications were given about encumbrances. It was argued that examples were
given of the type of encumbrances that were envisaged to be given and the
present facts did not fit those examples.

Incidentally, the parties had
earlier applied for settlement of the alleged violations but the application
was returned due to expiry of the stipulated time under the relevant settlement
regulations.

REPLY
AND DECISION OF SEBI

SEBI rejected all the arguments.
The debenture documents were made in late 2017 / early 2018 and thus SEBI held
that there was no inordinate delay in initiating the proceedings. The mere fact
that the structure was changed later and the disclosures duly made did not
affect the fact that no disclosure was made originally when the alleged
encumbrance was made.

It also rejected the core
argument that ‘encumbrance’ should be given a limited meaning more or less
restricting it to cases like pledge and hypothecation or the like. SEBI pointed
out that the definition was inclusive and even more descriptive than limiting.
The use of the words ‘by any other name called’ could not be restricted to
examples given of pledge / hypothecation. The principle of ejusdem generis
did not apply.

SEBI also traced the history of
the regulations and explained the dilemma that was faced regarding identifying
the many types of encumbrances. It was accepted that encumbrances on shares of
promoters needed disclosure in the interest of the securities markets.
Considering the varied and often sophisticated nature of encumbrances, the
definition was made descriptive / inclusive and not exhaustive. It was well
settled, SEBI argued, that securities laws being welfare regulations, needed
wider beneficial interpretation.

Although the definition was
modified recently whereby some specific instances were further added, it did
not mean that the earlier definition should be construed narrowly.

SEBI noted that the effect of the
conditions regarding limits was that the shares of the entities could not be
sold. This amounted to an encumbrance on shares and hence non-disclosure
amounted to violation of the Regulations.

SEBI thus levied a penalty of Rs.
50 lakhs on each of the two entities.

CONCLUSION

It goes without saying that
disclosure of encumbrances matters at any stage. Indeed, SEBI has required,
over a period, more and more information relating to encumbrances including,
most recently, the purpose for which the encumbrances were made.

However, their effect would be
seen particularly when the encumbrances end up being given effect to with
shares being sold in the market on invoking of the encumbrances, to take an
example. This may particularly happen when the price of the shares goes down
sharply, resulting in a vicious circle. The coverage / margin required by the
encumbrance documents gets violated and there is need to provide more shares as
encumbrance or sale of shares (and) which results in further lowering of price.
This would again affect the interests of shareholders. We are seeing now a huge
crash in share prices. It is possible that there may be many such similar
encumbrances and they may come to light because of the impact of share sale or
other transactions. There may be more cases in which SEBI may have to act.

This decision is relevant even
under the amended regulations. It lays down the principles and intent of the
regulations relating to encumbrances. Thus, unless reversed on appeal, it would
matter particularly (if and) for any fresh encumbrance as understood in a broad
manner in the SEBI order is undertaken. Such encumbrances then would advisably
be disclosed duly in accordance within the time limits and manner prescribed.

There
may be entities that have not disclosed the encumbrances till now, taking a
stand similar to that taken by the entities in the present case. They may need
to revisit their stand and documents and see whether due disclosures need to be
made, even if belatedly, but voluntarily. Better late than never.

shailesh.kwebmaker

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