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Year: 2021

Deduction u/s 80-IA – Electricity undertaking – Expenditure on renovation and modernisation of existing lines – Condition precedent for deduction u/s 80-IA(4) – Work of renovation need not be completed – Expenditure need not be capitalised in accounts – Expenditure need not result in increase in value of assets – Assessee undertaking renovation and modernisation of existing lines more than 50% of book value of assets as on 1st April, 2004 – Assessee entitled to deduction u/s 80-IA(4)

15 Bangalore Electricity Supply Company Ltd. vs. Dy. CIT [2021] 431 ITR 606 (Karn) A.Y.: 2005-06 Date of order: 27th January, 2021

Deduction u/s 80-IA – Electricity undertaking – Expenditure on renovation and modernisation of existing lines – Condition precedent for deduction u/s 80-IA(4) – Work of renovation need not be completed – Expenditure need not be capitalised in accounts – Expenditure need not result in increase in value of assets – Assessee undertaking renovation and modernisation of existing lines more than 50% of book value of assets as on 1st April, 2004 – Assessee entitled to deduction u/s 80-IA(4)

The assessee was a public limited company which was wholly owned by the Government of Karnataka and was engaged in the activity of distribution of electricity. For the A.Y. 2005-06, it claimed deduction of Rs. 141,84,44,170 u/s 80-IA(4)(iv)(c), but the A.O. disallowed the claim. This was upheld both by the Commissioner (Appeals) and the Tribunal.

In its appeal to the High Court, the assessee submitted that its case fell within the third category of undertakings and, therefore, the amount undertaken towards renovation and modernisation had to be considered. Alternatively, it submitted that capital work-in-progress was to be included and should not be restricted only to those amounts which were capitalised in the books and substantial renovation and modernisation could be at any time during the period beginning on 1st April, 2004 and ending 31st March, 2006. It contended that it had undertaken substantial renovation and modernisation of existing lines which was more than 50% of the book value of assets as on 1st April, 2004 under the Explanation to section 80-IA(4)(iv)(c).

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

‘i) From a perusal of section 80-IA(4) it is evident that there are three types of undertakings which are considered by the Legislature eligible for deduction u/s 80-IA, viz., an undertaking which is (i) set up for generation or generation and distribution of power, (ii) starts transmission or distribution by laying network of new transmission or distribution lines, (iii) undertakes substantial renovation and modernisation of the existing network of transmission or distribution lines. Thus, for each type of undertaking the Legislature has used different expressions, viz., “set up”, “starts” and “undertakes”. These words have different meanings. The expression “undertake” has not been defined under the Act. Therefore, its common parlance meaning has to be taken into account. The meaning of the word “undertake” used in section 80-IA(4)(iv)(c) cannot be equated with the word “completion”.

ii) The Circular dated 15th July, 2005 [(2005) 276 ITR (St.) 151] issued by the CBDT clearly states that the tax benefit under the section has been extended to undertakings which undertake substantial renovation and modernisation of an existing network of transmission or distribution lines during the period beginning from 1st April, 2004 and ending on 31st March, 2006. The provisions of section 80-IA(4)(iv)(c) use the expression “any time” during the period beginning from 1st April, 2004 and ending on 31st March, 2006 and do not use the word “previous year”. Wherever the Legislature has intended to use the expression “previous year”, it has consciously done so, viz., in section 35AB, section 35ABB, section 35AC and section 35AD as well as in 77 other sections of the Act.

iii) There is no requirement of capitalisation of the amount in the books of accounts mentioned in section 80-IA(4)(iv)(c) which does not mandate that there has to be an increase in the value of plant and machinery in the books of accounts. Therefore, such a requirement which is not prescribed in the language of the provision cannot be read into it.

iv) The assessee had undertaken substantial renovation and modernisation of existing lines which was more than 50% of the book value of the assets as on 1st April, 2004 under the Explanation to section 80-IA(4)(iv)(c). Thus, it could safely be inferred that the assessee had undertaken the work towards renovation and modernisation of existing transmission or distribution lines. The assessee was entitled to deduction u/s 80-IA(4).’

Appeal to High Court – Court quashing order and remanding matter to Tribunal – Effect – Search and seizure – Appeal arising out of block assessment – Assessee entitled to raise question of limitation in remand proceedings – Tribunal refusing to adjudicate issue of limitation holding it was not subject matter of remand – Not sustainable – Matter remanded to Tribunal

14 Karnataka Financial Services Ltd. vs. ACIT [2021] 432 ITR 187 (Karn) A.Ys.: 1986-87 to 1996-97 Date of order: 8th February, 2021

Appeal to High Court – Court quashing order and remanding matter to Tribunal – Effect – Search and seizure – Appeal arising out of block assessment – Assessee entitled to raise question of limitation in remand proceedings – Tribunal refusing to adjudicate issue of limitation holding it was not subject matter of remand – Not sustainable – Matter remanded to Tribunal

The assessee carried on the business of equipment leasing. Pursuant to a search, a notice was issued to it u/s 158BC for the block period 1986-87 to 1996-97 and the assessee filed its return of income. The A.O. held that the assessee had purchased the assets from one PLF at a higher value with a view to claim depreciation on the enhanced value as against the actual written down value in the books of accounts of PLF and restricted the depreciation to assets of value Rs. 1 crore. The Tribunal deleted the disallowance of depreciation and held in favour of the assessee.

The Department filed an appeal before the High Court against the order of the Tribunal. During the pendency of the appeal, the Court by an order directed the assessee to be wound up and appointed the official liquidator to take charge of its assets. The Court set aside the order of the Tribunal and remitted the matter to the Tribunal for fresh adjudication considering the amended provisions of section 158BB. The Tribunal thereupon passed an order with respect to the question of depreciation but did not adjudicate the ground raised by the assessee with regard to limitation on the ground that it was not the subject matter of the order of remand of the Court.

The Karnataka High Court allowed the appeal of the assessee and held as under:

‘i) The order passed by the Tribunal had been set aside in its entirety by this Court. Therefore, it was open to the assessee to raise the plea of limitation.

ii) Since the Tribunal had not adjudicated the issue with regard to limitation, the order passed by the Tribunal insofar as it pertained to the finding with regard to the issue of limitation was quashed and the Tribunal was directed to decide the issue of limitation with regard to the order of assessment passed by the A.O. for the block period 1986-87 to 1996-97. It would be open to the parties to raise all contentions before the Tribunal on this issue.’

Appeal to High Court – Sections 92CA and 260A – Powers to disturb findings of fact recorded by Tribunal – Only upon specific question being raised as to their being perverse – Transfer pricing – Exclusion of comparables and depreciation on goodwill – High Court cannot go into facts

13 Principal CIT vs. Samsung R&D Institute Bangalore Pvt. Ltd. [2021] 431 ITR 615 (Karn) A.Y.: 2009-10 Date of order: 30th November, 2020

Appeal to High Court – Sections 92CA and 260A – Powers to disturb findings of fact recorded by Tribunal – Only upon specific question being raised as to their being perverse – Transfer pricing – Exclusion of comparables and depreciation on goodwill – High Court cannot go into facts

The assessee was a wholly-owned subsidiary of SECL and rendered software development services to its associate enterprises. In the A.Y. 2009-10 the assessee realised a net profit margin of 15.45% in respect of the international transactions with its associate enterprises. The Transfer Pricing Officer made a transfer pricing adjustment in respect of software development services and passed an order u/s 92CA which was incorporated by the A.O. in his order.

Before the Commissioner (Appeals) the assessee challenged the selection of the entity IL as comparable. The Commissioner (Appeals) excluded IL on account of its enormous size and bulk and partly allowed the appeal. The Tribunal directed the Transfer Pricing Officer to exclude certain companies from the list of comparables on the basis of functional dissimilarity. The Tribunal also held that the assessee was entitled to depreciation on goodwill.

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

‘i) The Tribunal is the final fact-finding authority and a decision of the Tribunal on the facts can be gone into by the High Court only if a question has been referred to it which says that the finding of the Tribunal is perverse.

ii) The issue whether the entity IL was comparable to the assessee and was functionally dissimilar was a finding of fact. The Commissioner (Appeals) had dealt with the findings recorded by the Transfer Pricing Officer and had been approved by the Tribunal by assigning cogent reasons. The findings were findings of fact.

iii) Even in the substantial questions of law, no element of perversity had either been pleaded or demonstrated. The Tribunal was justified in removing certain companies from the list of comparables on the basis of functional dissimilarity and in holding that the assessee was entitled to depreciation on goodwill.’

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Tribunal to restore appeal and afford opportunity of hearing to both parties

12 Rabindra Kumar Mohanty vs. Registrar ITAT [2021] 432 ITR 158 (Ori) A.Y.: 2009-10 Date of order: 18th March, 2020

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Tribunal to restore appeal and afford opportunity of hearing to both parties

The Income-tax Appellate Tribunal issued notice for hearing of the appeal filed by the assessee on 6th July, 2017. On that date, the authorised representative of the assessee filed an adjournment application and the case was placed for hearing on 30th August, 2017. However, on that date neither the assessee nor his authorised representative or his counsel was present. The Tribunal, therefore, dismissed the appeal for want of prosecution.

On a writ petition filed by the assessee the Orissa High Court held as under:

‘i) The Income-tax Act, 1961 enjoins upon the Appellate Tribunal to pass an order in an appeal as it thinks fit after giving both the parties an opportunity of being heard. It does not give any power to the Appellate Tribunal to dismiss the appeal for default or for want of prosecution in case the appellant is not present when the appeal is taken up for hearing.

ii) Article 265 of the Constitution of India mandates that no tax can be collected except by authority of law. Appellate proceedings are also laws in the strict sense of the term, which are required to be followed before tax can legally be collected. Similarly, the provisions of law are required to be followed even if the taxpayer does not participate in the proceedings. No assessing authority can refuse to assess the tax fairly and legally merely because the taxpayer is not participating in the proceedings. Hence, dismissal of appeals by the Income-tax Appellate Tribunal for non-prosecution is illegal and unjustified.

iii) Merely because a person is not availing of his right of natural justice it cannot be a ground for the Tribunal to refuse to perform its statutory duty of deciding the appeal. An appellate authority is required to afford an opportunity to be heard to the appellant.

iv) The Tribunal could not have dismissed the appeal filed by the assessee for want of prosecution and it ought to have decided the appeal on merits even if the assessee or its counsel was not present when the appeal was taken up for hearing. The Tribunal was to restore the appeal and decide it on the merits after giving both the parties an opportunity of being heard.’

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Appeals restored before Tribunal

11 Daryapur Shetkari Sahakari Ginning and Pressing Factory vs. ACIT [2021] 432 ITR 130 (Bom) A.Ys.: 2002-03 to 2004-05 Date of order: 24th November, 2020

Appeal to Appellate Tribunal – Powers of Tribunal – Sections 253 and 254 and Rule 24 – No power to dismiss appeal on ground of non-prosecution – Duty to dispose of appeal on merits – Appeals restored before Tribunal

For the A.Ys. 2002-03, 2003-04 and 2004-05, against the orders of the Commissioner (Appeals), the assessee had filed appeals before the Tribunal. The Tribunal dismissed all three appeals by a common order on the ground that none appeared on behalf of the assessee which meant that the assessee was not interested in prosecuting those appeals.

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

‘i) Rule 24 of the Income-tax (Appellate Tribunal) Rules, 1963 mandates that when an appeal is called for hearing and the appellant does not appear, the Tribunal is required to dispose of the appeal on merits after hearing the respondent.

ii) The order passed by the Tribunal dismissing the appeals in limine for non-appearance of the appellant-assessee holding that the assessee was not interested in prosecuting the appeals was unsustainable. The Tribunal was duty-bound to decide the appeals on the merits after hearing the respondent and the Department according to the mandate under Rule 24 of the 1963 Rules and in terms of the ratio laid down by the Supreme Court.

iii) The order of the Tribunal being contrary to Rule 24 of the 1963 Rules was quashed and set aside. The respective appeals were restored for adjudication on the merits before the Tribunal.’

Appeal to Appellate Tribunal – Section 254 of ITA, 1961 and Rule 24 of ITAT Rules, 1963 – (i) Application for recall of order – Tribunal dismissing appeal for non-prosecution – Duty of Tribunal to decide appeal on merits; (ii) Application for recall of order – Limitation – Amendment in law – First application for restoration of appeal dismissed for non-prosecution within period of limitation – Tribunal dismissing second application invoking amendment to section 254(2) – Erroneous

10 Pradeep Kumar Jindal vs. Principal CIT [2021] 432 ITR 48 (Del) A.Y.: 2008-09 Date of order: 19th February, 2021

Appeal to Appellate Tribunal – Section 254 of ITA, 1961 and Rule 24 of ITAT Rules, 1963 – (i) Application for recall of order – Tribunal dismissing appeal for non-prosecution – Duty of Tribunal to decide appeal on merits; (ii) Application for recall of order – Limitation – Amendment in law – First application for restoration of appeal dismissed for non-prosecution within period of limitation – Tribunal dismissing second application invoking amendment to section 254(2) – Erroneous

The assessee filed an application in March, 2017 before the Tribunal for recall of the order dated 10th December, 2015 dismissing its appeal for non-prosecution. The application was dismissed by the Tribunal in limine by an order dated 7th February, 2018. The Tribunal dismissed the assessee’s contention that between 8th and 10th December, 2015 he was ill and hence could not appear when the appeal was heard on 10th December, 2015, and held that u/s 254(2) as amended with effect from 1st June, 2016, any miscellaneous application had to be filed within six months from the date of the order and that, therefore, the application for restoration of the appeal dismissed on 10th December, 2015 was barred by limitation. Thereafter, the assessee filed another application on 26th February, 2018 for recall of the order dated 7th February, 2018 which was also dismissed by an order dated 23rd December, 2020 on the ground that a second application was not maintainable.

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

‘i) There was no adjudication by the Tribunal of the appeal on merits. Its order dated 10th December, 2015 dismissing the assessee’s appeal was for non-prosecution and not on merits, as it was required to do notwithstanding the non-appearance of the assessee when the appeal was called for hearing, was violative of Rule 24 of the Income-tax (Appellate Tribunal) Rules, 1963 and thus was void. The action of the Tribunal, of dismissing the appeal for non-prosecution instead of on merits and of refusal to restore the appeal notwithstanding the applications of the assessee, was not merely an irregularity. The Tribunal had erred in dismissing the first application of the assessee filed in March, 2017 for restoration of the appeal invoking the amendment to section 254(2) requiring application thereunder to be filed within six months and in not going into the sufficiency of the reasons given by the assessee for non-appearance.

ii) The application filed by the assessee in March, 2017 invoking Rule 24 of the 1963 Rules was within time and could not have been dismissed applying the provisions of limitation applicable to section 254(2).

iii) In view of the aforesaid, the petition is allowed. I.T.A. No. 3844/Del/2013 preferred by the petitioner before the Income-tax Appellate Tribunal is ordered to be restored to its original position, as immediately before 10th December, 2015, and the Tribunal is requested to take up the same for hearing on 15th March, 2021 or on any other date which may be convenient to the Income-tax Appellate Tribunal.’

Section 195 read with section 40(a)(i) – A payment may be treated as reimbursement, and consequently not be subject to TDS u/s 195, if it satisfies twin tests of: (a) one-to-one correlation between outflow and inflow of recipient; and (b) receipt and payment being of identical amount

2 TS-203 ITAT-2021 (Pune) BYK Asia Pacific Pte. Limited vs. ACIT ITA No: 2110/Pun/2019 Date of order: 24th March, 2021

Section 195 read with section 40(a)(i) – A payment may be treated as reimbursement, and consequently not be subject to TDS u/s 195, if it satisfies twin tests of: (a) one-to-one correlation between outflow and inflow of recipient; and (b) receipt and payment being of identical amount

FACTS
The assessee was the branch in India of a Singapore Company (Singapore HO). The Singapore HO was a subsidiary of a German parent company. The assessee was engaged in providing technical support services and testing facility to Asia-Pacific customers of the German parent – although it appears that such services were pursuant to an understanding with the Singapore HO. The assessee operated on cost-plus basis and recovered all its costs (including reimbursement) with a mark-up of 10%. The assessee was treated as a PE of the Singapore HO and was charged to tax on mark-up.

The assessee had made certain payments to Singapore HO which the HO had defrayed towards seminar, IT, training, printing expenses and staff welfare expenses for the assessee branch and which were claimed as deductions from income. Further, the branch had not deducted tax from the said payments on the ground that said payments were reimbursement of expenses. The A.O. disallowed payments u/s 40(a)(i). The DRP upheld the order of the A.O.

The aggrieved assessee appealed before the Tribunal.

HELD

  •  Section 195 applies only if amount is chargeable to tax in the hands of recipient. Chargeability presupposes some profit element. If the recipient merely recovers the amount spent by it, without any profit element, such recovery is reimbursement and not a sum chargeable to tax.
  •  Two conditions should co-exist to fall within reimbursement. First, one-to-one direct correlation between the outgo of the payment and inflow of the receipt must be established. Second, receipt and payment should be of identical amount.
  •  The first condition is satisfied when at the time of incurring the amount is directly identifiable as payment made for the benefit of the other.
  •  The second condition is satisfied when repayment of the amount originally spent is made without any mark-up.
  •  The assessee had provided back-to-back invoices of identical amounts in respect of payments made towards seminar, training and printing expenses. Accordingly, such payments were in the nature of reimbursement of expenses. Consequently, the assessee was not required to deduct tax from the same u/s 195.
  •  As regards IT expenses, it was observed that payments were made on monthly basis. The assessee had contended that payments were apportionment of head office expenditure to the assessee at cost. While the burden of proving ‘reimbursement’ is on the assessee, the assessee had not placed any agreement or evidence on record in support of its contention. Hence, the payments could not be said to be in the nature of reimbursement of expenses. Therefore, the matter was remanded to the A.O. for examining the true nature of the payment.

Note – It is not clear why ‘make available’ argument was not advocated in respect of monthly reimbursements.

 

Sections 22, 56 – Since the nature of services provided by the assessee to the tenants / lessees was linked to the premises and was in the nature of the auxiliary services which were directly linked to the leasing of the property, gross receipts on account of amenities / services provided by the assessee to its tenants are chargeable to tax under the head ‘Income from House Property’ and not ‘Income from Other Sources’

5 ACIT vs. XTP Design Furniture Ltd. Pramod Kumar (V.P.) and Saktijit Dey (J.M.) ITA No. 2424/Mum/2019 A.Y.: 2013-14 Date of order: 19th January, 2021 Counsel for Assessee / Revenue: None / T.S. Khalsa

Sections 22, 56 – Since the nature of services provided by the assessee to the tenants / lessees was linked to the premises and was in the nature of the auxiliary services which were directly linked to the leasing of the property, gross receipts on account of amenities / services provided by the assessee to its tenants are chargeable to tax under the head ‘Income from House Property’ and not ‘Income from Other Sources’

FACTS
The assessee had leased its office premises at Unit Nos. 201, 301 and 401 in Peninsula Chambers to Group Media Pvt. Ltd. and Hindustan Thompson Associates Ltd. The assessee had given the lessees additional common facilities like lift, security, fire-fighting system, common area facilities, car parking, terrace use, water supply, etc. The assessee charged license fees and also amenities fees. Both these amounts were offered by the assessee for taxation under the head ‘Income from House Property’. The A.O. taxed the license fees under the head ‘Income from House Property’, whereas the amenities fees were taxed by him as ‘Income from Other Sources’.

Aggrieved, the assessee preferred an appeal to the CIT(A) who, following the decision of the Tribunal in the assessee’s own case for A.Ys. 2009-10 and 2010-11, decided the appeal in favour of the assessee.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

HELD
The Revenue fairly accepted that the issue under consideration is clearly covered by the decision of the Tribunal, in the assessee’s own case, for A.Ys. 2009-10 and 2010-11 in favour of the assessee. The Tribunal noted that the CIT(A) has decided the issue by following these decisions of the Tribunal wherein for the A.Y. 2009-10 the Tribunal has held as under:

‘We find that the nature of services provided by the assessee to the tenants / lessees were linked to the premises and were in the nature of the auxiliary services which were directly linked to the leasing of the property. Since there is a direct nexus between the amenities and leased premises, the CIT(A) has rightly directed the A.O. to treat the income from amenities under the head, “Income from House Property”’.

The Tribunal while deciding the appeal for A.Y. 2010-11, has in its order dated 9th February, 2016, concurred with the above view by holding that ‘the income of Rs. 4,38,61,486 received by the assessee company from amenities shall be chargeable to tax under the head “Income from House Property”.’

The Tribunal held that it found no reason to take any other view of the matter than the view taken by the co-ordinate bench. It held that there is no infirmity in the order of the CIT(A) in deciding the issue in favour of the assessee in consonance with the decision of the co-ordinate bench.

‘YATHECHCHHASI TATHA KURU’ | DO AS YOU WISH

‘YATHECHCHHASI TATHA KURU’ | DO AS YOU WISH
Giving advice is an integral part of our profession. For that matter, every person, whether a professional or not, has to act as a consultant in some way or other. As a brother, sister, parent, friend, teacher, elderly person, colleague and so on, everyone gives some kind of advice to others.

The ‘title’ above is picked from the greatest advice ever given by anybody in human history – the Shreemad Bhagawad Geeta. As you know, the Bhagawad Geeta is the advice given by Lord Shreekrishna to his favourite and most intelligent disciple, Arjun. It contains 700 shlokas (rhymes) full of philosophy and guidance useful for day-to-day life. Its supremacy in philosophical literature has been recognised by renowned scholars of all countries and religions. It is our true Indian philosophy not restricted to any religion as such.

What is the implication of this – ‘Do as you wish’? This is the 63rd shloka from the concluding, 18th Chapter of the Geeta. Bhagwaan says:

‘(Arjun), thus, I have narrated to you the full knowledge which is the secret of all secrets (deepest knowledge). After listening to all this and thinking over it, Do as you wish!’

Friends, this apparently simple sentence has a great message and teaching for all of us – not only for CAs but for everyone. In fact, this has been the guiding principle for me in not only the 40 years of my professional life, but in my personal life as well. It is capable of giving great peace of mind to us.

What is so great about it? Remember, it has been said by none other than Bhagwaan Shreekrishna whose preachings are considered to be impeccable and irrefutable. The philosophy is told on a battle-field. It symbolises our life which is a constant battle – between two thoughts, good versus evil. Yet, Bhagwaan is not over-insistent on what HE advised. He has no ego. He does not make it a prestige issue. He doesn’t sit on Arjun’s head and say that he should act only according to His advice. In fact, the greater the insistence, the more the resistance. He leaves it to Arjun’s discretion.

As against this, many of us are very possessive about our views. We feel that what we think is the only ultimate truth and that it is the only correct view.

Be it in a family, in office, in institutions or in social groups, everybody puts across his views vehemently on practically every subject ranging from politics, economics, cricket, Covid, interpretation of laws, etc., to social issues… I have seen CAs trying to prevail on their clients and imposing their advice on them.

This is one of the main reasons for disputes and misgivings. One has to understand one’s role. If one is an adviser or consultant and not the decision maker, one needs to stop at a certain stage. Try to express one’s honest views, explain with examples, put them in writing, wherever required, argue with an open mind, explain the consequences if one’s views are not accepted, point out that the advice is in the listener’s interest, but leave the decision to the other person. Just say, ‘I have explained my views. Now it is up to you to decide and act. If anything goes wrong, please don’t blame me’ and then see the results. This has a better impact!

Needless to say, when you know that the other person is weak, or not competent to decide, or dependent on you and you yourself have to face the consequences, the approach could be different. You have to use your discretion and adopt the appropriate strategy.

This ‘Do as you wish’ approach may also develop the decision-making ability of the person concerned, making him aware that the ultimate responsibility is his own. Further, our spiritual thought preaches ‘detachment’ or ‘absence of attachment’.

‘Do as you wish’ is a classic example of not being attached to your views.

Friends, these are my views. And after reading these, Do as you wish!

VACCINATION

Today, corona and vaccination are hitting the front pages of all newspapers. Of course, of late Sachin Waze has started taking precedence over these two. But the main topic of discussion among the general public is still corona and vaccination.

Vaccination stock is over!
Mismanagement at corona vaccination camps;
Vaccine not effective!
Man catches corona despite vaccination;
Bogus and adulterated vaccination stocks held!
Long queues at vaccination centres.

All these reports revolve around the corona virus. And people are flocking to the centres to avail of the facility offered by the Government.

People are taking leave from work, keeping aside other important tasks, to get vaccinated. However, one particular community has no time to take the vaccine. For them, certain things are more important than even their lives and health. This community is engaged in commercial activity but functions like NGOs.

They were keen to keep their offices open even during the pandemic. They incurred heavy expenditure to ensure that their staff should be able to work from home. They worked day and night to meet the deadlines for their clients. Of course, their clients always take it for granted that this community’s charges are never to be paid promptly. And the NGOs consider it inhuman to ask for fees during the pandemic. As soon as the lockdown was relaxed and the unlocking process started, the same clients travelled for ‘outings’. Clients were sure that the NGO would be slogging for them and sacrifice everything for the clients. Not only that, the clients were also sure that since the fees are not received, the NGOs would borrow from banks to run their show. On top of it, the alma mater of these NGOs would tie up with banks and other financial institutions to offer credit facilities for them. And the NGOs kept on slogging, forgetting everything happening around them.

After some time, the Government conducted a review and felt that almost every citizen of the country should get vaccinated. So, it announced the date for closure of vaccination centres.

Suddenly, the NGO community woke up and started representing to the Government for extension of time. They started begging, praying and a few of them even thought of filing writ petitions. They could produce the Object clause of the constitution of many NGOs which prohibited doing things in time. Their object was to start the work only at the eleventh hour, issue certificates based on inadequate data, risk their own licence, work without asking for payment of fees and so on.

Their ‘incidental’ object was to carry all tensions for their clients, sacrifice their personal lives and health, lose their sleep and fight for getting extension of time.

These NGOs are always making some ‘submission’ or other. In the process, they suffer from the virus of ‘submissiveness’. They have lost the energy to be assertive.

The researchers should come out with a new vaccine for the NGOs to make them immune from this virus called ‘submissiveness’.

Note: In case the NGOs described in this article resemble any professional group, it is only a coincidence.

TRIBUTE ARVIND H. DALAL

ARVIND H. DALAL

(2nd July, 1929 – 15th March, 2021)

In the passing away of Shri Arvindbhai Dalal we have lost a great professional. My association with him started more than six decades back. He had a soft corner for junior members of our profession and whenever a junior wanted his help, he was always available.

He served our profession in many different capacities. He was Chairman of WIRC in 1962-63, President of the BCA Society in 1963-64 and President of ICAI in 1989-90. He was also a Founder Trustee of the BCAS Foundation. During his association with all these professional bodies, he rendered exemplary service to the profession.

Some CA friends used to meet every Thursday to discuss the developments in the fields of taxation, accounting, auditing and other professional subjects. And Arvindbhai used to attend these meetings regularly. I came in close contact with him at these meetings. Even when his health was not good, he tried to attend these meetings and gave us the benefit of his knowledge.

He used to attend almost all the lecture meetings, seminars, conferences, and Residential Reference Courses organised by the WIRC, the BCAS, the ICAI and other professional bodies either as a paper writer, speaker or a participant. He always believed that by such participation we can share our knowledge with other professionals and also gain some knowledge. His pet subject was ‘Charitable Trusts’. In fact, he has authored the book ‘Taxation of Charitable Trusts’ published by the BCAS. He has argued several cases of Charitable Trusts before the Income-tax Appellate Authorities.

In 1998, the Golden Jubilee Year of the ICAI, the ICAI Council entrusted the work of writing the history of the accounting profession to me along with Arvindbhai and Shri Harishbhai Motiwala. We had to cover the period from 1973 to 1999 within one year. We completed the task in record time and the book ‘History of the Accounting Profession in India – Vol. II’ was published in January, 2000. Arvindbhai took great care in going through the draft of this publication, which records the achievements of our profession in these 25 years.

It is difficult to believe that Shri Arvindbhai is no more with us. All of us professionals will feel his absence. We pray that this noble soul rests in eternal peace.

– P.N. Shah, Past President, BCAS and ICAI
_____________________________________________

Shri Arvindbhai became known to me as a worthy senior of stature from the day I joined the BCAS. It was indeed a privilege for me to have been, in the years to follow, associated with him at the BCAS, at the ICAI and also at the personal level. In him we have lost a fatherly figure to whom any junior could turn for guidance without any fear.

He was a great human being. He maintained high ethical standards as a professional all through. In his dealings with all he was soft-spoken and humble. His devotion to the Society and to the profession hardly had any parallel. He contributed as much to the development as to the academic profile of the profession. He remained active with the Society almost till the end, despite his uneven health during the last few years. It was so pleasing to see him participate in the lecture meetings as a keen learner till even very recently. In him we have lost a giant personality. He will always be remembered by all those around him.

May the members of his family have courage to bear this loss and may the noble soul rest in peace.

– Pinakin D. Desai, Past President, BCAS
_____________________________________________

Shri Arvindbhai Dalal passed away peacefully on 15th March, 2021.We have lost a genuine well-wisher of the Society and a senior, disciplined guardian of the profession who was always extremely concerned about the image of our profession. His selfless and invaluable contribution with utmost devotion to the development of the profession in various aspects was self-evident and does not require any recognition. His commitment and dedicated approach in this regard were extremely remarkable and for this he remained active till his last days. I still recall that he last participated, despite his advanced age and health challenges, in the virtual post-Budget meeting of the BCAS Taxation Committee on 18th February, 2021, and even prior to that, he kept on checking with me about the BCAS Annual Budget Booklet of which he was one of the main pillars. I salute his dedication and passion for the development of our profession in general and the Society in particular.

I still can’t forget my initial introduction to him during one of the RRCs in the early 1980s at Matheran where I was innocently raising many questions during the reporting session as one of the young group leaders in his paper and the patience with which he was responding and encouraging me in the process. What was even more noteworthy was his approach during the General Assembly Session while giving his replies where, at appropriate relevant stages, he referred to such questions with my name and that shocked me as I had never expected such encouragement for a very junior member from such a senior professional. Of course, subsequently, I also learned that this kind of culture was nurtured by such pillars of the RRCs. This made me an integral part of the Society’s close academic circle, immensely benefiting me in making my academic career in the profession. For me, since then, in addition to a few others, Arvindbhai became a role model.

While I have many personal experiences to share, it is impossible to describe his innumerable qualities and his selfless contribution to the profession here. But I can’t resist mentioning one or two episodes. I still remember when we were revising the Tax Audit Manual of the BCAS around 1989; for that purpose we stayed in a hotel in Mumbai along with the late Shri Narayanbhai to complete the work in a short time – the kind of dedication and humility that I witnessed during that stay and the personal encouragement given to me are both unforgettable and remain etched in my mind even today.

He was a rare human being with such outstanding qualities. On the ethical front, I still recall his extreme resistance to my request to be a Faculty at the seminar following that Tax Audit Manual at Patkar Hall on the ground that since he is the Chairman of the Organising Committee, he can’t be a Faculty. It took a lot of time and effort to persuade him with the help of the late Narayanbhai in the evening discussion session in that hotel room to effectively thrust on him this responsibility for the benefit of the large number of members attending that seminar from various parts of the country. I had similar experiences as part of the Golden Jubilee Celebration Committee of the Society of which he was Chairman, as well as during my association with him as his Co-Chairman of the Taxation Committee.

On a personal note, I was fortunate to have had the privilege of working closely with him in the Society as well as at a personal level and to learn a lot from him, especially on the ethical front. I will be missing travelling with him regularly for punctually attending various BCAS and other meetings and our discussions on various subjects.

On his departure I feel like I have lost an elderly friend, philosopher and guide. He used to mostly call me on my wife’s mobile and would always first affectionately ask her, ‘Ilaben, kem cho?’ We will miss all this now. We sincerely pray to the Almighty that his soul rest in eternal peace.

– Kishor Karia, Past President, BCAS, Editorial Board
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I was fortunate to have come in contact with Arvindbhai in my formative years of practice, a time when he was the doyen of the profession. The association established then, in the early 80s, continued till God recalled him for better things. He was one of the very few persons who shaped and moulded my professional career and beyond. In recent years, since the passing away of my father, I relied on him as a source of inspiration in many matters of life.

The long association, full of fascinating and inspiring instances, is difficult to express in words; surely not in a note that is limited by the number of words. He was a kind of hand-holder for me who was around silently, throughout, without being physically present, and guided my thoughts, at times without expressly communicating it in words. The way he conducted himself and carried on with his life became guiding posts for me.

I first met him in his chamber at Nariman Point when he was already the Past President of the ICAI, a humbling experience which has stayed with me for long; a very unassuming place and the decorum and the person’s all-attentive stance and willingness to help with no desire to impress, in spite of his scholarly insight into the subjects of accounts, auditing and taxation. I was guided by his precision in writing; in editing any text, he would not hesitate to devote long hours to fine-tune any text on complex technical matters and would ensure that the final product is delivered within the deadline. Anyone who has sat with him in meetings of professional associations would have witnessed his immense contribution with humility, patience and persistence; all of these encouraged me to request him to join the Chamber’s Managing Committee. He not only honoured our request but guided the Chamber with exemplary leadership. Dignity was natural to him and those who were present at numerous full court conferences addressed by him would confirm this with respect.

We come across people who inspire our faith in them; but he was one who inspired one’s faith in one’s own abilities. I will always remember him for this. He was not ‘all work and no play’; he was witty and full of Surti humour and was fun to be with. The best example of his dedication to BCAS is that he attended the last meeting of the BCA Foundation.

I had the benefit of presenting several papers under his chairmanship and I have no hesitation in stating that those were the best of the times, where he would very politely but firmly correct mistakes, share valuable suggestions and at times be a shield and would still ensure that he claimed no credit for the same.

I conclude with a fervent hope that his life continues to guide the profession in the right direction and
his soul enlightens our path by being a torchbearer for long.

– Pradip Kapasi, Past President, BCAS
_____________________________________________

Rare are the people who are calm reservoir of knowledge and experience and are generous with it. Rarer are those who inspire those qualities in others with their life example. In spite of many achievements and stature, they remain approachable and accessible. Arvindbhai was such a person ever since I have known him since I was a young boy. Author, speaker, guide, past president of BCAS and ICAI and a friend and elder to so many.

We would have asked several times questions on charitable trust matters and taken his counsel for our clients. At the BCAS he was someone you could call upon and count on. Today many people are very busy and have little time to spare. He shared his time and so his life for the BCAS. At RRCs and on overnight train travels especially, it was a treat to hear him chit chat. He often shared stories of his times. At lecture meetings, one saw him sitting in the first row listening attentively and patiently. As a Chairman of sessions, his words were measured and his comments were not taxing. We will miss his benign demeanor, meticulous counsel. However, above all we will have one person less to go to and look upon as an elder.

– Editor, BCAJ
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Shri Arvind Bhai Dalal was one of the best but unassuming chartered accountants I have seen. I had the pleasure of working with him in Central Council for six years. As President of Institute, he had initiated far-reaching steps for the growth of the professional. He will be missed by the profession.

– Anand Rathi, Central Council Member, ICAI – 1985 to 1991, Ex President, BSE

A LEG-UP FOR INDEPENDENT DIRECTORS – WILL SEBI’S PROPOSALS IMPROVE CORPORATE GOVERNANCE?

SEBI has proposed several changes to the rules relating to corporate governance, mainly to strengthen the status of Independent Directors. The major changes include giving a bigger role to minority shareholders in the appointment / removal of such directors, proposing higher remuneration to them, strengthening the Audit Committee / Nomination and Remuneration Committee (‘NRC’) even further, etc. Views have been sought from the public at large through the release of a Consultation Paper.

The Consultation Paper notes how the requirements relating to corporate governance, introduced formally for the first time in 1999, have, over the years, seen several expert reviews and amendments in law to successively upgrade the requirements. As the paper notes, the Companies Act, 2013 / Rules made thereunder too have corporate governance requirements generally for specified listed and unlisted companies, many of them overlapping with the SEBI requirements. Hence, the fresh proposals are yet another step in that direction, though this time more focused on Independent Directors.

Independent Directors are seen as a pillar that balances the interests of all stakeholders with the primary focus on those of the minority shareholders vis-à-vis promoters. The worry is that promoters with their controlling stake should not be able to usurp the interests of others. This requires that they should not be able to influence the watchdog group – the Independent Directors.

APPOINTMENT AND REMOVAL OF INDEPENDENT DIRECTORS
The first of these important proposals looks at how Independent Directors are appointed and removed. At present, they are usually recommended by the NRC. The next step is appointment by the Board and the validity of their tenure is till the next annual general meeting. At such annual general meeting, the appointment is placed and confirmed by approval of the majority of shareholders who vote. Their removal is also by majority shareholder approval.

It is seen that the promoters who usually have a controlling stake can influence – perhaps decisively – the process at every step. This would mean that at every step they have a direct say and even decision-making ability. Thus, there are fair concerns that their independence may be influenced by the promoters. Hence, adopting the UK model almost wholly, it is proposed that this be corrected and that the appointment at shareholder level should pass two tests; first, approval by a majority of all shareholders including the promoters, and second, approval by the majority of the minority shareholders. Minority shareholders for this purpose would mean shareholders other than the promoters.

Let us understand this better through an example. Say, the promoters of a company hold 60% equity shares. The first test would be achieved when 50.01% of all shareholders approve (the percentage in each case is of shareholders who actually vote). Since promoters hold 60%, they would control this outcome. The second test is majority of the public (40%) shareholding and thus more than half of these – say 20.01% of the total – would also have to approve. If either of these tests fails, the appointment is rejected. There are then two ways out for the management. The first is that it can propose a new person as Independent Director and put him through these tests. Or, it can put the same candidate through a slightly different agni pariksha of sorts after a cooling period of 90 days, but before 120 days. If at least 75% of shareholders (including the promoters) approve, the appointment would be through. A similar process is proposed for the removal of Independent Directors. This ensures a significant role for the public shareholders and the strong influence of the promoters is mitigated to an extent.

SHORTLISTING OF INDEPENDENT DIRECTORS TO BE MORE TRANSPARENT
Even the shortlisting of Independent Directors is given a fillip by requiring more disclosures on how they came to be shortlisted. The process and requirements have to be laid down first and thereafter it is to be seen how each candidate fits these requirements. There have to be extensive disclosures to the shareholders, too.

Higher proportion of Independent Directors in the NRC
Moreover, the NRC that recommends Independent Directors will now have a higher proportion (two-thirds) of Independent Directors instead of just a majority as at present. A higher 67% ratio of Independent Directors would mean even more say to them in the NRC.

Appointment of new Independent Directors only by shareholders
At present the appointment of Independent Directors is made first by the Board and it is only at the later annual general meeting that shareholders get a chance to approve. During this period – which could be as long as a year – the Independent Director functions in office. To avoid this even interim say of the promoters on such appointments, it is now proposed that the appointment of Independent Directors shall only be by shareholders. If an Independent Director resigns / dies, his replacement too has to be made by shareholders, now within three months.

Resignation of Independent Directors to be more transparent and subject to restrictions
Concerns are often expressed that some Independent Directors having issues with the company may prefer to exit quietly without creating a fuss. To tackle this, several proposals have been made. Firstly, the complete resignation letter is required to be published by the company.

Further, if an Independent Director resigns stating ‘personal reasons’, ‘other commitments’ or ‘preoccupation’, he won’t be able to join any other Board for a year. This obviously makes sense since one cannot claim being busy, resign and then promptly join elsewhere. This may encourage them to be more forthright, if that was the real issue.

There is another concern. The management may have offered full-time employment to an Independent Director. This may be for bona fide reasons such as the management being impressed with his work. But obviously there are also concerns that this would affect his independence. A new proposal now states that if an Independent Director desires to join the company as a Wholetime Director, he will have to wait for one year after his resignation. Interestingly, as we will see later, the cooling period to become an Independent Director after having been an employee or KMP is three years, while in this case only one year’s cooling period is given.

Audit Committee to have no promoter / nominee directors or executive directors
The Audit Committee has an important role in approving related party transactions, accounts, etc. At present it is required that two-thirds of the committee should be Independent Directors and the rest can be any director, including promoter directors. Now, several categories are excluded even for the balance one-third of the committee. These may be non-independent directors but cannot be executive directors, nominee directors or those related to the promoters. The influence of both promoters and management is thus sought to be removed.

Excluding further categories of Key Managerial Persons
Persons who may have, in the immediate past, been employees / Key Managerial Persons (or their relatives) of the company and its holding / associate / subsidiary companies, or having material pecuniary relationships with them, may still have loose ties and may be subject to influence, and hence there may be concerns about their independence. Therefore, cooling periods are prescribed whereby they can join as Independent Directors only after specified periods. Two changes are now proposed. Firstly, now, past employees / KMPs of even promoter group companies will have to be subject to the cooling period. Secondly, the cooling period for all categories would now be uniform at three years.

ENHANCED REMUNERATION OF INDEPENDENT DIRECTORS
Finally, there is the proposal to enhance the remuneration of Independent Directors. The dilemma here is that if you pay too little, the Independent Director does not have the incentive to devote sufficient time to the affairs of the company. And if you pay too much, the concern is about him being influenced by the remuneration which may affect his independence. At present, a maximum Rs. 1 lakh per meeting is permitted as sitting fees. Commission based on profits is allowed but this has issues for loss-making companies. Besides, commission linked to profits has obvious concerns of conflict in approving accounts since there is a link between higher profits and higher commission.

A compromise of sorts is now proposed in two ways. One is by increasing the sitting fees, but this would have to be decided by the Ministry of Corporate Affairs. Hence, this proposal would be forwarded to them for their consideration.

The second is by permitting grant of employees stock options (‘ESOPs’) with at least five years vesting period. Thus, those who stay on for five years can possibly be rewarded through appreciation in the value of shares. However, this solution may not resolve the issue well. ESOPs are generally not very common in companies. Apart from this, a waiting period of five years could be too long and many may not benefit.

CONCLUSION
All in all, the changes are positive. However, much more is needed to be done. The powers and liabilities of Independent Directors have not been touched upon. Individually, Independent Directors have very little power. But the liability, on the other hand, is significant and the enhanced status may raise it even more. The remuneration of Independent Directors is still not resolved satisfactorily on at least two counts. First, the amount would still be decided by the Board and thus the promoters would still have a significant, often decisive, say. Second, the amount and manner may still be found to be insufficient to attract the best of talent. The proposal of dual approval tests giving minority shareholders a bigger role could also be applied for appointment of auditors who represent another pillar of safeguards.

It will also have to be seen how companies are required to transition to the new requirements. Will the provisions be effective immediately? Whether only large companies will be required first to change, with later dates being given for successive categories of smaller companies? Will the existing directors be allowed to complete their terms or will they have to be subject to this test immediately?

It is also seen that two laws – the SEBI LODR Regulations and the Companies Act, 2013 – have simultaneous requirements of corporate governance which overlap and even conflict. Perhaps the first step could be to require that listed companies would be regulated in this regard only by SEBI.

There is also another thought. Many principles of corporate governance are borrowed from the West, including a few significant ones from the UK, even in these proposals. India is different in a very vital way. Promoters typically hold a very significant stake, often more than 50%. Investors traditionally invest on the faith of the reputation and entrepreneurship of the promoters, though there would be cases where this trust is broken. While a check on them is always advisable, it should not happen that adopting a relatively alien concept tilts the balance so much that it actually becomes a hindrance.

GIFTS FROM ‘GIFT CITY’

INTRODUCTION

The Gujarat International Financial Tec-City (‘GIFT City’) in Gujarat is India’s first International Financial Service Centre (‘IFSC’). Many nations such as Singapore, the UAE, etc., have successfully developed IFSCs which have become financial service hubs and have attracted foreign investments. India aims to do so through the GIFT City. Several sops have been provided for setting up financial service intermediaries in the GIFT City both by the RBI and by SEBI. While GIFT City is a subject which merits a publication to itself, this article only looks at some of the key features and benefits available to financial service intermediaries for setting up an entity in the GIFT City.

REGULATORY REGIME
Instead of multiple financial services regulators such as SEBI, RBI and IRDA, the GIFT City is regulated by only one body – the International Financial Services Centres Authority set up under the Finance Ministry. The IFSC Authority is based in Gujarat. The unified IFSC Authority aims to ease the business environment for the intermediaries. However, multiple legislations continue to impact the GIFT City.

Units set up in the IFSC are treated as SEZ Units set up under the Special Economic Zones Act, 2005. Accordingly, units set up in an IFSC must conform to the provisions of the SEZ Act and its regulations.

Some of the key regulations pertaining to the setting up of financial institutions in the GIFT City are:

  •  Special Economic Zones Act, 2005
  •  Foreign Exchange Management (International Financial Services Centre) Regulations, 2015
  •  International Financial Services Centres Authority Act, 2019
  •  International Financial Services Centres Authority (Banking) Regulations, 2020
  •  Securities and Exchange Board of India (International Financial Services Centre) Guidelines, 2015
  •  SEBI’s Operating Guidelines for Alternative Investment Funds in International Financial Services Centres of 2018
  •  IFSCA’s Guidelines of 2020 for AIFs in IFSCs.

PERSON RESIDENT OUTSIDE INDIA
One of the most salient features of the GIFT City is that any entity set up here would be treated as a Person Resident Outside India under the Foreign Exchange Management Act, 1999. Thus, even though the unit is physically incorporated in India, it would be treated as if it is a non-resident under the FEMA. A financial institution is an entity engaged in rendering financial services or carrying out financial transactions and includes banks, NBFCs, insurance companies, brokerages, merchant bankers, securities exchanges, mutual funds, etc. On the other hand, a financial service is defined to mean any activity allowed to be carried out by SEBI / RBI / IRDA or any authority empowered to regulate the financial institution.

Consequently, a financial institution set up in the GIFT City must conduct business only in foreign currency and not in Indian Rupees. This feature has certain unique consequences which are explained below.

Any SEBI-registered intermediary may provide financial services relating to the securities market in the IFSC without forming a separate company.

FOREIGN PORTFOLIO INVESTORS
SEBI has liberalised the regime for foreign investors operating in the GIFT City as well as for FPIs to operate in it. Any applicant incorporated in the GIFT City shall be deemed to be appropriately regulated for the purposes of being registered as an FPI with SEBI. Hence, such an entity can apply for registration as a Category-I FPI.

Eligible Foreign Investors (EFIs) operating in IFSCs / GIFT City shall not be treated as entities regulated by SEBI. Further, SEBI-registered FPIs shall be permitted, without undergoing any additional documentation and / or prior approval process, to operate in the IFSC. The following are eligibility and KYC norms for EFIs:

Eligibility norms: EFIs are those foreign investors who are eligible to invest in IFSCs by satisfying the following conditions:
a) the investor is not resident in India,
b) the investor is not resident in a country identified in the public statement of the Financial Action Task Force as a deficient jurisdiction, and
c) the investor is not prohibited from dealing in the securities market in India.

KYC norms: An intermediary operating in an IFSC needs to ensure that the records of its clients are maintained as per the Prevention of Money-Laundering Act, 2002 and the rules made thereunder. The following KYC norms may be made applicable to EFIs:

  •  In case of participation of an EFI, not registered with SEBI as an FPI but desirous of operating in the IFSC, a trading member of the recognised stock exchange in the IFSC may rely upon the due diligence carried out by a bank which is permitted by RBI to operate in the IFSC during the account opening process of the EFI.
  •  In case of EFIs that are not registered with SEBI as FPIs and also not having bank accounts in the IFSC, KYC as applicable to Category-II FPI as per the new FPI categorisation shall be made applicable. However, PAN shall not be applicable for KYC of EFIs in the IFSC.
  •  In case of participation of FPIs in the IFSC, due diligence carried out by a SEBI-registered intermediary during the time of account opening and registration shall be considered.

Segregation of accounts: FPIs who operate in the Indian securities market and also propose to operate in the IFSC shall be required to ensure clear segregation of funds and securities. The custodians shall, in turn, monitor compliance of this provision for their respective FPI clients. Such FPIs shall keep their respective custodians informed about their participation in the IFSC.

AIFs IN THE GIFT CITY
Alternative Investment Funds (AIFs) are investment vehicles set up in India which privately pool funds / monies from domestic as well as foreign investors and invest such funds / monies in securities as per a defined investment policy. In India, an AIF along with its constituents is regulated by SEBI under the SEBI (AIF) Regulations, 2012 (SEBI AIF Regulations). SEBI has provided several incentives for setting up an AIF in the GIFT City / IFSCs. The IFSC Authority has further liberalised the framework for setting up AIFs in the GIFT City. The combined regulations for setting up an AIF are explained below.

Incorporation of the AIF
Any trust / LLP / company set up in the IFSC can be registered with SEBI as an AIF. If the sponsor / manager of an Indian AIF wishes to set up an AIF in the IFSC, it must first set up a branch / company in the IFSC which will act as the sponsor / manager of the AIF. Thus, the Indian sponsor cannot directly sponsor the IFSC AIF. It must first set up a foreign branch / foreign company in the IFSC. The investment in the IFSC sponsor would be treated as an overseas direct investment in a Joint Venture / Wholly-Owned Subsidiary under the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (FEMA No. 120/RB-2004). Since this would be an investment in the Financial Services Sector, the provisions of Regulations 6 and 7 of these Regulations would need to be adhered to.

The SEBI IFSC guidelines along with the SEBI AIF Regulations recognise the following types of AIFs:
(a) Category-I AIF: Funds which invest in startups, early-stage ventures, social ventures, small and medium enterprises, infrastructure sector, etc. These include Venture Capital Funds.
(b) Category-II AIF: Residual category, i.e., other than Category I and III AIFs and which do not undertake leverage other than to meet day-to-day operational requirements as per SEBI AIF Regulations. These include Private Equity Funds / Debt Funds.
(c) Category-III AIF: Funds which employ diverse or complex trading strategies and leverage including through investments in listed or unlisted securities / derivatives. These would include Hedge Funds.

Each scheme of the AIF shall have a corpus of at least US $3 million. The manager or sponsor shall have a continuing interest in the AIF of not less than 2.5% of the corpus or US $750,000, whichever is lower, in the form of investment in the AIF and such interest shall not be through the waiver of management fees. Further, for Category-III AIFs the continuing interest shall be not less than 5% of the corpus or US $1.5 million, whichever is lower. The AIF must raise money only in foreign currency and not in Indian Rupees.

Investments permissible by the AIF
SEBI has harmonised the provisions governing investments by AIFs incorporated in IFSCs with the provisions regarding investments applicable for domestic AIFs. Accordingly, AIFs set up in the IFSC can invest in

  •  Securities which are listed in the IFSC
  •  Securities issued by companies incorporated in the IFSC
  •  Securities issued by companies in India or belonging to foreign jurisdictions
  •  Units of other AIFs located in India as well as in the IFSC
  •  Any company, Special Purpose Vehicle or Limited Liability Partnership or body corporate or Real Estate Investment Trust or Infrastructure Investment Trust in which a domestic AIF can make an investment
  •  It can also co-invest in a portfolio company through a segregated portfolio by issuing a separate class of units. However, the investments by such segregated portfolios shall, in no circumstances, be on terms more favourable than those offered to the common portfolio of the AIF and appropriate disclosures must be made in the placement memorandum regarding creation of the segregated portfolio.

AIFs operating in India are subject to leverage restrictions under the SEBI Regulations. Accordingly, AIF Category-I cannot borrow, while Category-II can only borrow for meeting daily expenses. However, these restrictions have been removed for AIFs set up in the GIFT City. An AIF in an IFSC may borrow funds or engage in leveraging activities without any regulatory limit, subject only to the following conditions:
(a) The maximum leverage by the AIF, along with the methodology for calculation of leverage, shall be disclosed in the placement memorandum;
(b) The leverage shall be exercised subject to consent of the investors;
(c) The AIF employing leverage shall have a comprehensive risk management framework appropriate to the size, complexity and risk profile of the fund.

Further, AIFs operating in India have a maximum investment diversification rule. Thus, under the SEBI Regulations a Category-I AIF can invest a maximum of  25% of its investible funds in one investee company. Similarly, a Category-II AIF can invest a maximum of 10% of its investible funds in one investee company. The guidelines for AIFs in the IFSC have removed these diversification rules. Accordingly, they shall not apply to AIFs in IFSCs, subject to the conditions that appropriate disclosures have been made in the placement memorandum and the investments by the AIFs are in line with the risk appetite of the investors.

Most offshore financial centres do not have restrictions on leveraging or diversification guidelines. This is a very welcome move since now AIFs in IFSCs can set up tailor-made schemes for investing in a very select pool of companies. These guidelines should encourage more foreign institutions to set up AIFs in India.

Lastly, Indian AIFs are subject to a monetary limit when they want to invest abroad. AIFs set up in the IFSC are exempt from this limit since they are treated as set up in an offshore jurisdiction.

Nature of Indian investments by the AIF
Under the FEM (Non-Debt Instruments) Rules, 2019 an AIF is treated as an Investment Vehicle. If the control and management of the sponsor and manager of the AIF are ultimately with resident Indian citizens, then the entire investment made in India by such an AIF is treated as a domestic investment. It does not then matter whether the corpus of the scheme is foreign or Indian. Thus, if the AIF in the GIFT City is set up by and managed by another Indian entity which in turn is ultimately controlled and managed by resident Indian citizens, then the downstream investment by such an AIF in Indian entities would be treated as domestic investment. Such investment would then be outside the purview of the FEMA Regulations and would not be subject to pricing / sectoral conditions / sectoral caps under the FEM (Non-Debt Instruments) Rules, 2019 even if the entire corpus is raised from non-residents.

Eligible investors in the AIF
The following persons can make investments in an AIF operating in the IFSC:

  •  A person resident outside India;
  •  A non-resident Indian;
  •  Institutional investor resident in India who is eligible under FEMA to invest funds offshore, to the extent of outward investment permitted;
  •  A person resident in India having a net worth of at least US $1 million during the preceding financial year who is eligible under FEMA to invest funds offshore, to the extent  allowed in the LRS (US $250,000) of RBI. The minimum investment by an investor in an AIF is US $40,000 for employees or directors of the AIF or its manager and US $150,000 for all other investors.

The RBI has recently expressly allowed resident individuals to make remittances under LRS to IFSCs set up in India. Resident individuals may also open non-interest-bearing Foreign Currency Accounts (FCAs) in IFSCs for making the above permissible investments under LRS. Any funds lying idle in the account for a period up to 15 days from the date of receipt into the account shall be immediately repatriated to the domestic Rupee account of the investor in India. This is an example of express round-tripping being permissible by the RBI ~ Indian money under LRS would go abroad to an offshore AIF (although physically the AIF is in India) and could be routed back into India since such an AIF can invest in Indian companies!

Under the International Financial Services Centres Authority (Banking) Regulations, 2020 Qualified Resident Individuals (meaning an individual who is a person resident in India having net worth not less than US $1 million or equivalent in the preceding financial year) are permitted to open, hold and maintain accounts in a freely convertible foreign currency, with a banking unit, for undertaking transactions connected with or arising from any permissible transaction specified in the Liberalised Remittance Scheme of the Reserve Bank of India. The IFSCA has clarified that the net worth criteria shall not be applicable for an individual, being a person resident in India who opens an account with the bank for the purpose of investing in securities under the LRS. This is because of the fact that the purpose of such remittance under the LRS is investment in securities and the opening of a bank account with a banking unit is incidental to the same.

Triple role of the AIF
The AIF set up in the IFSC can also invest in India under the FDI Route, the FPI Route or the Foreign Venture Capital Investor (FVCI) Route. If it desires to come under the FPI or the FVCI Route, then it must get a separate registration for the same with SEBI. All such investments would be subject to the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 administered by the RBI and the relevant SEBI Regulations.

CONCLUSION
The GIFT City at Gujarat is an excellent idea to attract foreign investment and foreign financial institutions to set up shop in India. Along with the regulatory concessions provided to AIFs, there are several income-tax benefits which are also afforded to AIFs established in the IFSC. While the Government has given a strong impetus to the GIFT City, it remains to be seen whether financial institutions actually set up shop.

 

CLASSIFICATION CONUNDRUM

INTRODUCTION
The charging section for the levy of GST provides that the tax shall be levied on supply of goods / services or both. This entails the need for determination of whether a particular activity undertaken by a supplier is for supply of goods or supply of services? While dealing with this question, one may need to refer to the principles of composite supply or mixed supply as defined u/s 2 of the CGST Act, 2017 to determine whether the supply is that of goods or of services.

Once the determination of the nature of supply is done, the next question that arises is the rate applicable on such supply. There is a lot of confusion about the entry under which a particular goods / service should be classified in view of conflicting rates prescribed under the respective Rate Notifications, coupled with conflicting rulings by the Authority for Advance Ruling from different locations. This, despite the Rate Notifications specifically providing that rules for the interpretation as provided for under the Customs Tariff Act, 1975 shall also apply for the interpretation of headings covered under the said Notification.

In one of our earliest articles, ‘Principles of Classification’ (BCAJ, November, 2017), we had discussed in detail the subject of Classification under GST. In this article, we have attempted to identify a few instances dealing with Classification – both of a supply as goods vs. services, and the applicable rate on a supply along with conflicting AARs’ which add fire to this controversy.

GOODS VS. SERVICES – INTANGIBLES
The perennial controversy about determining what constitutes goods and what constitute services, although settled by the Supreme Court in the case of Tata Consultancy Services vs. State of Andhra Pradesh [2004 (178) ELT 22 (SC)] (the ‘TCS case’), used to be a burning issue under the earlier regime and continues to be so even under the new GST regime. This is because the definition of the said terms u/s 2 of the CGST Act, 2017. Section 2 (52) defines ‘goods’ to mean 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. Similarly, section 2(102) defines ‘services’ to mean 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.

The first controversy which pertains to the issue of goods vs. services is in relation to intangibles. The issue of whether software, being an intangible property, is goods or service was already settled by the Apex Court in the TCS case wherein the Hon’ble Court had laid down the conditions for treating an intangible property as goods. Keeping that in mind, in view of the provision of Schedule II of the CGST Act, 2017, if the supply results in transfer of title in goods, the same would constitute supply of goods; while if there is transfer of right in goods without transfer of title thereof, the same would constitute supply of services. However, while dealing with this aspect another recent decision of the Supreme Court in the case of Engineering Analysis Centre of Excellence Private Limited vs. The Commissioner of Income Tax [Civil Appeal Nos. 8733-8734 of 2018], though in the context of income-tax, will always have an important bearing. In this case, the Court had held that licenses granted by way of End-User License Agreements were nothing but sale of goods. The relevant extracts of the decision are reproduced below for reference:

52. There can be no doubt as to the real nature of the transactions in the appeals before us. What is ‘licensed’ by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services vs. State of A.P., 2005 (1) SCC 308 (see paragraph 27).

In view of the above decision, an issue arises in case of import / export transactions through online mode. Such import / export transactions are not regulated through the Customs channel, and therefore, when payment is made for import of software or received for export of software, the nature of the transaction, i.e., whether the same pertains to purchase / sale of goods or service becomes particularly important. For example, if a person purchases all the rights which subsist in an intangible property / a license, the same would undoubtedly amount to supply of goods. The question that would arise in case of import of such goods is whether GST would be payable treating the same as ‘import of services’ or the same would be liable to tax under the proviso to section 5 of the IGST Act, 2017, i.e., the tax would be levied and collected under the Customs Act, 1962? If the latter view is taken, perhaps such transaction would not attract any IGST since there is no mechanism for levy of tax on intangibles under the Customs Act.

An even larger issue may crop up in the case of export transactions, especially when supply is under payment of IGST where there is a system for automated refund. Since the supply of intangibles is not routed through the customs system, the refund for such transactions may not be automatically processed and would therefore necessitate such exporters to file separate refund applications which can give rise to challenges as the Jurisdiction Officer may reject the refund claim on the simple ground that the same falls within the purview of Customs who may not at all be aware of the entire transaction.

GOODS VS. SERVICES – SALE VS. SERVICE
Entry 3 of Schedule II presumes an activity of job-work as service. While under the earlier regime job-work was defined to mean any activity amounting to manufacture, GST law defines the same to mean any treatment or process undertaken by a person on goods belonging to another registered person and the expression ‘job worker’ shall be construed accordingly. However, it would be incorrect to read this definition on a standalone basis, especially when the statute provides for concepts relating to composite supply / mixed supply which needs to be used when determining the nature of supply. Based on this, one would need to arrive at a conclusion whether a particular activity amounts to supply of goods or supply of service as job-work.

This discussion becomes important since there are specific instances where if the activity is treated as supply of goods, the same attracts tax at a different rate, while when treated as supply of service the applicable rate is different. At times where credit is not available fully, this would also involve cost ramifications. One such instance is observed in the context of newspapers. Supply of newspaper attracts nil rate of tax. However, the activity of printing of newspaper, which is classified as service, attracts tax @ 5%. Therefore, it becomes important to determine whether the supply being made is classifiable as supply of goods / services. Of course, while the answer to this question would depend on the facts of each case, the issue becomes more controversial in view of Circular 11/11/2017-GST dated 20th October, 2017 wherein the Board has clarified as under:

4. In the case of printing of books, pamphlets, brochures, annual reports and the like, where only content is supplied by the publisher or the person who owns the usage rights to the intangible inputs, while the physical inputs including paper used for printing belong to the printer, supply of printing [of the content supplied by the recipient of supply] is the principal supply and therefore such supplies would constitute supply of service falling under heading 9989 of the scheme of classification of services.
5. In case of supply of printed envelopes, letter cards, printed boxes, tissues, napkins, wall paper, etc. falling under Chapter 48 or 49, printed with design, logo etc. supplied by the recipient of goods but made using physical inputs including paper belonging to the printer, the predominant supply is that of goods and the supply of printing of the content [supplied by the recipient of supply] is ancillary to the principal supply of goods, and therefore such supplies would constitute supply of goods falling under respective headings of Chapter 48 or 49 of the Customs Tariff.

While in the first case the Board has clarified that the supply of printing service is the principal service, in the second case it has been clarified that supply of goods is the predominant supply. It is difficult to fathom how both the transactions can be dealt with differently as in both the cases the intention of the recipient is to receive back printed material from the job-worker. It is common for publishers to outsource printing activity and the dominant intention is to receive the printed content which is used by them to further supply such printed content.

In fact, this Circular also appears to be contrary to the principles of job-work which have been laid down by the Supreme Court in the case of Prestige Engineering (India) Ltd. vs. CCE Meerut [1994 (73) ELT 497 (SC)] which explained what shall and what shall not constitute job work. The primary rule laid down by the Court was that job work should not be narrowly understood as requiring the job worker to return the goods in the same form as this would render the Notification itself redundant since the definition specifically contemplated ‘a manufacturing process’, but it also cannot be so widely interpreted as to allow an arrangement where the process involved substantial value addition. It is imperative for the readers to note that the above clarification has also been followed by the Authority for Advance Ruling in the case of Sri Venkateswara Enterprises [2019 (30) GSTL 83 (AAR – GST)]. However, in another case, that of Ashok Chaturvedi [2019 (21) GSTL 211 (AAR – GST)], the Authority has held that the principal supply was that of goods and therefore the printed content would be classified under Chapter 49 and taxed accordingly.

A similar issue exists in the hospitality sector where there is confusion as to whether tobacco products such as cigarettes, hookah, etc., supplied and consumed in a restaurant shall be classified as supply of goods or supply of service as a part of restaurant services? The Advance Authority has, in the case of MFAR Hotels & Resorts Private Limited [2020 (42) GSTL 470 (AAR – GST – TN)], held that cigarettes supplied in the restaurant will be treated as supply of goods as the same is not naturally bundled with the service of the restaurant. However, it would appear that the ruling has not taken into consideration Entry 6(b) of Schedule II which deems a composite supply by way of or as part of any service or in any other manner whatsoever, of goods, being food or any other article for human consumption or any drink as supply of service. If aerated beverages, which also attract the higher rate of tax as well as compensation cess supplied in a restaurant can be treated as supply of service, there is no logical reasoning to not extend the same benefit to tobacco as the same also falls within the basket of goods supplied for human consumption, irrespective of whether or not the same is injurious to health!

RATE CLASSIFICATION – GOODS
As discussed in the earlier article also, the Rate Notifications under GST provide that the classification of any goods / services in a particular rate / exemption entry shall be done applying the rules for interpretation as provided for under the Customs Tariff Act, 1975. The said rules were discussed in detail in the said article. However, since the introduction of GST there have been several items the classification of which has continued to be under dispute. In this article, we have attempted to identify and discuss such cases.

The first class of goods which has seen substantial classification dispute is ‘tobacco’ which comes in different forms and varied rates have been notified depending on the nature of the product. The following table summarises the different rates applicable to different types of tobacco:

Schedule

Entry
No.

HSN

Description
of product

Rate

I

109

2401

Tobacco Leaves

5%

IV

13

2401

Unmanufactured tobacco; tobacco refuse [other
than tobacco leaves]

28%

IV

15

2403

Other manufactured tobacco and manufactured
tobacco substitutes; ‘homogenised’ or ‘reconstituted’ tobacco; tobacco
extracts and essences [including ‘biris’]

28%

A particular area of dispute has been as to what constitutes tobacco leaves. The Board has, vide Circular 332/2/2017 – TRU clarified that tobacco leaves shall mean leaves of tobacco as such, broken tobacco leaves and stems. This issue has been examined in detail in the context of Central Excise. The Tribunal has, in the case of Yogesh Associates vs. CCE, Surat II [2006 (195) ELT 196 (Tri – Mum)] wherein the Tribunal held that raw leaf treated with tobacco solution Quimam and other flavours including saffron water did not result in the leaf undergoing any irreversible change and the same continued to remain raw, unmanufactured tobacco leaf. This decision was also approved by the Apex Court in 2006 (199) ELT A221 (SC). However, there have been conflicting decisions from the Authority for Advance Ruling in the context of GST w.r.t. classification of tobacco products in different forms.

In the case of Shailesh Kumar Singh [2018 (13) GSTL 373 (AAR – GST)] and Pragathi Enterprises [2018 (19) GSTL 327 (AAR – GST)]), the Authority has held that dried tobacco leaves which have undergone the process of curing are not covered under Schedule I Entry 109 but will be covered under Schedule IV Entry 13. In Sringeri Yogis Pai [2019 (31) GSTL 357 (AAR – GST)] the Authority has further held that cured tobacco leaves would also get covered under Schedule IV Entry 13.

However, in Suresh G. [2019 (023) GSTL 0483 (AAR – GST)], the Authority has held that sun-cured tobacco leaves would get covered under Schedule I and therefore attract GST at 5%. The Authority held as under:

‘6. It is well-known fact that the fresh or green leaves are having no commercial marketability. Only after the long process of curing the tobacco leaves become capable for marketing. Therefore legislature imposed tax only on cured tobacco leaves which are capable of being traded. As per serial number 13 of Schedule-IV of Notification No. 1/2017-Central Tax (Rate), dated 28-6-2017 “un-manufactured tobacco” is brought under 28% taxable category. But the entry itself clearly specified that unmanufactured tobacco, tobacco refuse (other than tobacco leaves) is taxable at the rate of 28%. Since tobacco leaves are specifically excluded from Schedule-IV Sl. No. 13 it will squarely come under Schedule-I of Sl. No. 109 and taxable at the rate of 5%. Therefore tobacco leaves including the leaves cut from plant, dry leaves, cured leaves by applying natural process ordinarily used by the farmers to make them fit to be taken to market shall qualify for 5% tax rate. It is common knowledge that without curing tobacco leaves cannot be consumed. The curing in relation to tobacco leaves means removal of moisture from the tobacco leaves. Section 2(c) of the Central Excise Act, 1944 specified that the term “curing” includes wilting, drying, fermenting and any process for rendering an unmanufactured product fit for marketing or manufacture. Hence, the unavoidable process of curing of tobacco leaves to make it fit for marketing will qualify the word “curing” mentioned in Chapter 24 of the Customs Tariff Act, 1975.’

The above view has also been followed in the case of Alliance One Industries Private Limited [2020 (32) GSTL 216 (AAR – GST – AP)] and K.S. Subbaih Pillai & Co. (India) Pvt. Ltd. [2020 (32) GSTL 196 (AAR – GST – AP)].

It is therefore clear that there is a lot of confusion with regard to the correct classification of tobacco under GST. Further, with tobacco being liable to tax under Reverse Charge also, the need for a correct solution becomes more important since if a wrong classification is applied there will be an effect on both fronts, outward supplies as well as inward supplies. It therefore becomes more important for the taxpayer to determine the correct classification of the product being dealt with by him to avoid future litigation. In other words, it would be safe to say that applying a wrong classification would not only be injurious to customers’ health, but also to the taxpayers’ health!

The next controversy revolves around classification of fryums. This is because while there is no specific entry for fryums under GST, Entry 96 of Notification 2/2017 – CT (Rate) exempts papad, by whatever name known, from GST except when served for human consumption. On the other hand, there are different entries in the Rate Notification so far as namkeen is concerned. The following table summarises the different rates applicable to namkeen in different forms:

Schedule

Entry
No.

HSN

Description
of product

Rate

I

101A

2106 90

[Namkeens, bhujia, mixture, chabena and
similar edible preparations in ready for consumption form, other than those
put up in unit container and, –

(a)…. bearing a registered brand name; or

(b)…. bearing a brand name on which an
actionable claim or enforceable right in a court of law is available (other
than those where any actionable claim or any enforceable right in respect of
such brand name has been voluntarily foregone, subject to the conditions as
specified in the Annexure)]

5%

II

46

2106 90

[Namkeens, bhujia, mixture, chabena and
similar edible preparations in ready for consumption form (other than roasted
gram), put up in unit container and, –

(a)…. bearing a registered brand name; or

(b)…. bearing a brand name on which an
actionable claim or enforceable right in a court of law is available (other
than those where any actionable claim or any enforceable right in respect of
such brand name has been voluntarily foregone,

12%

II
[continued]

46

2106 90

subject to the conditions as specified in
the Annexure)]

12%

III

23

2106

[Food preparations not elsewhere specified
or included (other than roasted gram, sweetmeats, batters including idli /
dosa batter, namkeens, bhujia, mixture, chabena and similar edible
preparations in ready for consumption form, khakhra, chutney powder, diabetic
foods)]

18%

Therefore, the questions which need deliberation are:
* Whether fryums can be treated as papad?
* If not, under which entry will fryums qualify?

The reason behind the need to determine whether fryum can be classified as papad or namkeen arises in view of the decision of the Tribunal in the case of Commissioner of Central Excise vs. TTK Pharma Ltd. [2005 (190) ELT 214 (Tri – Bang)]. The Tribunal had held that fryums can be marketed as namkeen only after they are fried, just like papad. However, the tax implication if this classification is not accepted is substantial because if fryums are classified as papad, the same are exempted from GST, while if classified as namkeen, the same would get classified under Schedule III and become liable to GST at 18%. Thus, the difference is substantial and therefore one needs to be careful while deciding the classification of fryums.

This aspect has also been dealt with by the AAR in the case of Sonal Products [2019 (23) GSTL 260 (AAR – GST)] and Alisha Foods [2020 (33) GSTL 474 (AAR – GST)]. In both instances, the Authority has held that fryums are classifiable as namkeen and not papad and therefore the same would be taxable at 18%. The Authority relied on the decision in the case of TTK Pharma Ltd. vs. Collector of Central Excise [1993 (63) ELT 446 (Tribunal)]. However, it has failed to appreciate that the Tribunal had used the word namkeen / papad interchangeably while dealing with the applicability of an exemption Notification. The Authority further referred to the decision in the case of Commissioner of Commercial Taxes, Indore vs. TTK Healthcare Ltd. [2007 (21) ELT 0197 (SC)]. However, the Authority has again failed to appreciate that the dispute in the said case was whether or not fryums could be treated as cooked food. The Authority has further concluded that the classification was to be done as per the meaning construed in the popular sense and as understood in common language.

It is important to note that the Authority has failed to appreciate that the process followed for making of papad / fryums is similar. In fact, both become ready for human consumption only when fried and when fried, both rather partake the character of namkeen. In this sense, the decision of the Authority to not treat fryums as papad appears to be on shaky ground.

The next item which has seen its fair share of controversy is parantha. Entry 97 of Notification 2/2017-CT (Rate) exempts bread (branded or otherwise) from tax, except when served for consumption, and pizza bread. Bread is something which is generally an accompaniment with the main meal of the day and is cooked in different styles using different ingredients. It is known by different names across the globe. If one does a search for ‘List of Breads’ on Wikipedia, it can be seen that even the roti, chapati, naan, kulcha, dosa, etc., which are consumed in different parts of India and known by different names are also types of bread. However, there is a separate entry for plain chapati or roti under Schedule I of Notification 2/2017-CT (Rate) and the same is taxed at 5%. But other forms of Indian bread do not find a specific entry in the Rate Notifications. This gives rise to the classification issue.

The first such issue reported was in the classification of ‘Classic Malabar parota’ or ‘Whole Wheat Malabar parotta’. The Authority for Advance Ruling has in the case of Modern Food Enterprises Private Limited [2018 (18) GSTL 837 (AAR – GST)] held that there is a substantial distinction between parotta and bread in terms of preparation, use and digestion and, therefore, exemption given to bread cannot be extended to parotta. However, in Signature International Foods India Private Limited [2019 (20) GSTL 640 (AAR – GST)], the Authority has held that paratha was similar to roti and therefore classifiable under Schedule I of Notification 1/2017-CT (Rate) and therefore attracts GST @ 5%. Surprisingly, in this case the Authority proceeded to conclude that naan / kulcha which were not defined anywhere would be classifiable under the residuary entry in Schedule III of Notification 1/2017-CT (Rate) and therefore attract GST @ 18%.

RATE CLASSIFICATION – SERVICES
Let us now look at similar issues while determining the applicable tariff entry for services. The first issue which arises is with classification of certain services provided to Government, whether Central Government, State Government, Union Territory, a local authority, a Governmental Authority or a Government Entity. The relevant entry for discussion is Entry 3(vi) of Notification 11/2017-CT (Rate) which provides for tax at 12% on composite supply of works contract as defined in clause (119) of section 2 of the Central Goods and Services Tax Act, 2017 provided to the Central Government, State Government, Union territory, a local authority or a Governmental Authority or a Government Entity by way of construction, erection, commissioning, installation, completion, fitting out, repair, maintenance, renovation, or alteration of a civil structure or any other original works meant predominantly for use other than for commerce, industry, or any other business or profession. Vide the explanation, it has also been clarified that the term ‘business’ shall not include any activity or transaction undertaken by the Central Government, State Government or any local authority in which they are engaged as public authorities.

Despite the above clarification, there has been substantial confusion as to when a service would be classified under this entry, because when services are being provided to Government it is difficult to distinguish whether the service is for use other than for commerce, industry or any other business or profession. There have been conflicting AARs on this issue as well. In A2Z Infra Engineering Ltd. [2018 (18) GSTL 760 (AAR – GST)], the Authority held that services provided to a Power Distribution Company would be covered under the scope of ‘for use other than for commerce, industry, or any other business or profession’ and therefore concessional tax rate would not be applicable in such a case. A similar view was also followed in the case of Madhya Pradesh Madhya Kshetra Vidyut Vitaran Company Limited [2019 (020) GSTL 0788 (AAR – GST)] as well. In fact, in a recent decision the Appellate AAR in the case of Vijai Electricals Ltd. [2020 (42) GSTL 153 (App. AAR)] wherein despite the appellants submitting an opinion from the Government Departments that the activities of the recipient were non-commercial in nature, the denial of benefit of concessional rate of tax was upheld.

In the case of Tata Projects Limited [2019 (24) GSTL 505 (AAR – GST)], service provided to the Nuclear Fuel Complex engaged in the manufacture and enrichment of nuclear fuel for production of electricity which is a business and commercial activity, the concessional rate of 12% will not be available.

However, the Appellate AAR has in the case of ITD Cementation India Limited [2019 (25) GSTL 315 (AAAR)] set aside the order of the AAR and held that supply of service for construction of multi-modal terminal was for infrastructural development of waterways of India and not meant for commerce and business. A similar view was taken in the case of Vikram Sarabhai Space Centre [2019 (25) GSTL 129 (AAR – GST)] also.

There are many taxpayers who are providing service of this kind to Government and in many cases the contract values are inclusive of GST. Prompt clarification on what constitutes ‘commerce, industry, business or profession’ would be most welcome as there would be severe financial consequences if the end conclusion is not beneficial to the taxpayers.

Another burning issue in the context of services provided to Government is what constitutes ‘pure services’? Entry 3 of Notification 12/2017-CGST (Rate) provides exemption to pure services (excluding works contract service or other composite supplies involving supply of any goods) provided to the Central Government, State Government or Union territory, or local authority, or a Governmental authority, or a Government Entity by way of any activity in relation to any function entrusted to a Panchayat under Article 243G of the Constitution, or in relation to any function entrusted to a Municipality under Article 243W of the Constitution. However, what constitutes ‘pure service’ has not been defined either under the Notification or the Act / Rules.

This has resulted in substantial confusion since taxpayers intend to claim the benefit of the exemption Notification while the tax authorities look at ways to deny the same. In fact, the AAR has on multiple occasions held that only such service where there is no involvement of even an incidental supply of goods would be covered within the scope of ‘pure service’. In fact, in the case of Harmilap Media (P) Limited [2020 (33) GSTL 89 (AAR – GST)], while determining whether or not advertising service would classify as pure service, the Authority held in the negative since there is an element of supply of goods involved, though not material. Fortunately, this anomaly has been sought to be removed by way of insertion of Entry 3A to the Notification which now provides that the exemption shall extend to composite services also, provided that the value of goods involved in the supply is not more than 25% of the total value. This amendment will perhaps put the dispute to rest.

The next dispute revolves around classification of services relating to transport of goods. There are two rates notified for the service of GTA, one being 5% in case the service provider opts to not claim ITC and 12% where the service provider opts to claim ITC. What constitutes ‘GTA’ has been defined to mean any person who provides service in relation to transport of goods by road and issues a consignment note, by whatever name called. The first controversy which prevails is whether for classification as a GTA is the supplier compulsorily required to issue a consignment note? A perusal of the Rate Notification does indicate towards the same. However, the Appellate AAR has in the case of K.M. Trans Logistics Private Limited [2020 (35) GSTL 346 (AAAR -– GST)] while dealing with this issue held that once the possession of goods is transferred to the transporter, irrespective of whether the consignment note is issued or not, he becomes a GTA and would therefore be liable to tax accordingly.

However, in the case of Liberty Translines [2020 (41) GSTL 657 (App. AAR – GST)], in a case involving sub-contracting in transportation business, the Authority held that issuance of a consignment note by the sub-contractor transporter to the main transporter would not make him a GTA and the service would be classified under the entry of ‘renting of vehicles’ and would therefore attract tax at 18%, irrespective of whether the main contractor opts to pay tax under the 5% scheme / 12% scheme, thus involving substantial cost implications for the main contractor. It is, however, important to note that in the case of Saravana Perumal [2020 (33) GSTL 39 (AAR – Kar)] involving a similar fact matrix, the AAR has held that the services provided by the sub-contracting transporter to the main transporter would also get classified as GTA.

CONCLUSION
The above discussion clearly indicates that the classification issue will continue even under the GST regime. Of course, the same will be on multiple fronts, ranging from classifying an activity as that of goods or service or none, and then proceeding to determine the correct tariff classification. The controversy will get more pronounced with conflicting decisions from the AAR which will only add fuel to the fire. However, the taxpayers will need to be more cautious and careful, especially where there is confusion on the classification, because incorrect classification may have serious ramifications on the business.

REVENUE ADJUSTMENT ON ACCOUNT OF TRANSFER PRICING

BACKGROUND
The finalisation of transfer price between an assessee and the Income-tax Authorities with respect to related party transactions could take several years. In the meantime, the related party transactions are priced on a provisional basis. This article deals with the accounting of the adjustments required when there is finality on the transfer pricing between the assessee and the Income-tax Authorities.

ISSUE

  •  An Indian subsidiary bills the parent and recognises revenue for services provided @ 10% margin;
  •  Three years later, the Income-tax Department settles transfer pricing @ 15% margin as per the Advance Pricing Agreement (APA);
  •  The parent contributes to the subsidiary the 5% difference for the past three years, let’s say, INR 100;
  •  Whether INR 100 is an equity contribution by the parent to the subsidiary in the books of the subsidiary under AS?
  •  What are the disclosures required in the financial statements of the subsidiary?


REFERENCES

Paragraph 11 Ind AS 32 – Financial Instruments: Presentation
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Paragraph 51 Ind AS 115 – Revenue from Contracts with Customers
An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. The promised consideration can also vary if an entity’s entitlement to the consideration is contingent on the occurrence or non-occurrence of a future event. For example, an amount of consideration would be variable if either a product was sold with a right of return or a fixed amount is promised as a performance bonus on achievement of a specified milestone.

Ind AS 12 Appendix C – Uncertainty over Income-tax treatments
4. 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.

Ind AS 115 – Revenue from Contracts with Customers
118  An entity shall provide an explanation of the significant changes in the contract asset and the contract liability balances during the reporting period. The explanation shall include qualitative and quantitative information. Examples of changes in the entity’s balances of contract assets and contract liabilities include any of the following:
(a) …….;
(b) cumulative catch-up adjustments to revenue that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained) or a contract modification;
(c) ………………….;
(d) ………………….; and
(e) …………………….

119 An entity shall disclose information about its performance obligations in contracts with customers, including a description of all of the following:
(a) …………..;
(b) the significant payment terms (for example, when payment is typically due, whether the contract has a significant financing component, whether the consideration amount is variable and whether the estimate of variable consideration is typically constrained in accordance with paragraphs 56 – 58);
(c) ………………..;
(d) …………………; and
(e) ……………………

122 An entity shall explain qualitatively whether it is applying the practical expedient in paragraph 121 and whether any consideration from contracts with customers is not included in the transaction price and, therefore, not included in the information disclosed in accordance with paragraph 120. For example, an estimate of the transaction price would not include any estimated amounts of variable consideration that are constrained (see paragraphs 56 – 58).

126  An entity shall disclose information about the methods, inputs and assumptions used for all of the following:
(a) determining the transaction price, which includes, but is not limited to estimating variable consideration, adjusting the consideration for the effects of the time value of money and measuring non-cash consideration;
(b) assessing whether an estimate of variable consideration is constrained;
(c) allocating the transaction price, including estimating stand-alone selling prices of promised goods or services and allocating discounts and variable consideration to a specific part of the contract (if applicable); and
(d) ………………..

RESPONSE


The APA between the Indian subsidiary and the Income-tax Authorities will require the Indian subsidiary to raise an invoice for the amounts under-invoiced earlier. The Indian subsidiary will now have to bill the difference in margin of 5% to the parent entity, i.e., INR 100. The parent entity will have to remit this amount to the Indian subsidiary. If the parent does not remit this amount to the subsidiary, it would be treated as a deemed loan to the parent in the hands of the subsidiary, and the subsidiary will have to pay tax on deemed interest income.

As per paragraph 11 of Ind AS 32, an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. They are, therefore, non-reciprocal in nature. In the fact pattern, the invoicing of the incremental 5% margin, INR 100, is not a non-reciprocal transfer. The parent is transferring INR 100 to the Indian subsidiary because it was under-invoiced in the past. In accordance with paragraph 51 of Ind AS 115, this would constitute variable consideration and the billing by the subsidiary to the parent company would be included in the current year revenue of the subsidiary as a cumulative catch-up adjustment. This will not constitute a prior-period error as there was no error in the given fact pattern. The earlier years invoicing was provisional and the final invoicing, once a conclusion was reached with the Income-tax Authorities, was based on the contractual arrangement between the parent and the subsidiary. The final billing of an additional INR 100 reflected the arrangement between the parent and the subsidiary as a supplier and a customer, rather than in the capacity as a shareholder.

Appendix C of Ind AS 12 – Uncertainty over Income-tax treatments applies when the uncertainty is with respect to income-tax treatment by Income-tax Authorities. From the perspective of the subsidiary, there is no uncertainty over income-tax treatments since it is fully compensated by the parent as per their agreement. However, there is uncertainty over variable consideration. Therefore, from a disclosure perspective in the financial statements of the subsidiary, the disclosure as required by paragraphs 118, 119, 122 and 126 of Ind AS 115 will be required.

ISSUES IN TAXATION OF DIVIDEND INCOME, Part – 1

The Finance Act, 2020 has reintroduced the classical system of taxation on dividends moving away from the Dividend Distribution Tax (‘DDT’) system. The DDT tax system was first introduced by the Finance Act, 1997, abolished by the Finance Act, 2002 and reintroduced by the Finance Act, 2003 before being abolished in 2020. This reintroduction of the earlier, traditional system of taxation, while not necessarily more beneficial to a resident shareholder, can be more favourable to a non-resident shareholder on account of the benefit of the tax treaty as compared to the erstwhile DDT system of taxing dividends. For example, under the DDT regime the dividends were subject to tax at the rate of 15% plus surcharge and education cess. Under the classical system of taxation, this rate of tax can now be reduced to a lower DTAA rate, depending on the DTAA.

Article 10 of the DTAAs, dealing with dividends, was not of much significance in the past. However, now one would need to understand the intricacies of the benefits available for dividends in tax treaties and the various issues arising therefrom. It is important to note that the Multilateral Instrument (MLI), of which India is a signatory and which modifies various Indian DTAAs, also contains certain clauses which impact the taxation of dividends. In this two-part article we seek to analyse part of the international tax aspects of the taxation of dividends. In the first part we analyse the taxation of dividends under the domestic tax law and the construct of the DTAAs in the case of dividend income. The second part would contain various specific issues arising in the taxation of dividends in an international tax scenario.

1. INTRODUCTION

Debt and equity are two main options available to a company to raise capital, with various forms of hybrid instruments having varying degrees of characteristics of each of these options. The return on investment from such capital structure is generally termed as ‘dividend’ or ‘interest’ depending on the type of structure, i.e., whether classified as a primarily equity or a debt instrument.

‘Dividend’ in its ordinary connotation means the sum paid to or received by a shareholder proportionate to his shareholding in a company out of the total sum distributed. Dividend taxation in a domestic scenario typically involves economic double taxation – the company is taxed on the profits earned and the shareholders are taxed on such profits when they are distributed by the company by way of dividends.

While DTAAs generally relieve juridical double taxation, some DTAAs also relieve economic double taxation to a certain extent, in cases where underlying tax credit is provided.

The ensuing paragraphs evaluate various domestic tax as well as DTAA aspects of inbound as well as outbound dividends, specifically from the international tax perspective. In other words, tax implications on dividends paid by a foreign subsidiary to an Indian resident and on dividends paid by Indian companies to foreign shareholders are sought to be analysed.

Most DTAAs as well as both the Model Conventions – the OECD as well as the UN Model – follow a similar pattern in terms of the language of the article on dividends. For the purposes of this article, the UN Model Convention (2017) is used as a base.

2. TAXATION OF DIVIDEND AS PER DOMESTIC TAX LAW

There are various options available to a country while formulating its tax laws for taxation of dividends. In the past India was following the DDT system of taxing dividends. From A.Y. 2021-22 India has moved to the classical system of taxing dividends. Under the classical system of taxation, the company is first taxed on its profits and then the shareholders are taxed on the dividends paid by the company.

2.1    Definition of the term ‘dividend’
The term ‘dividend’ has been defined in section 2(22) of the Income-tax Act, 1961. It includes the following payments / distributions by a company, to the extent it possesses accumulated profits:
a.    Distribution of assets to shareholders;
b.    Distribution of debentures to equity shareholders or bonus shares to preference shareholders;
c.    Distribution to shareholders on liquidation;
d.    Distribution to shareholders on capital reduction;
e.    Loan or advance given to shareholder or any concern controlled by a shareholder.

The domestic tax definition of dividend as compared to the definition under the DTAA has been analysed subsequently in this article.

2.2    Outbound dividends
Dividend paid by an Indian company is deemed to accrue or arise in India by virtue of section 9(1)(iv).

Section 8 provides for the period when the dividend would be added to the income of the shareholder assessee. It provides that the interim dividend shall be considered as income in the year in which it is unconditionally made available to the shareholder and that the final dividend shall be considered as income in the year in which it is declared, distributed or paid.

The timing of the taxation of interim dividend as per the Act, i.e., when it is made unconditionally or at the disposal of the shareholder, is similar to that provided in the description of the term ‘paid’ above. However, the timing of the taxation of the final dividend may not necessarily match with that of the description of the term.

For example, in case of final dividend declared by an Indian company to a company resident of State X in September, 2020 but paid in April, 2021, when would such dividends be taxed as per the Act?

In this regard, it may be highlighted that the source rule for taxation of dividends ‘paid’ by domestic companies to non-residents is payment as per section 9(1)(iv) and not declaration of dividend. The Bombay High Court in the case of Pfizer Corpn. vs. Commissioner of Income-tax (259 ITR 391) held that,

‘….but for 9(1)(iv) payment of dividend to non-resident outside India would not have come within 5(2)(b). Therefore, 9(1)(iv) is an extension to 5(2)(b)……. in case where the question arises of taxing income one has to consider place of accrual of the dividend income. To cover a situation where dividend is declared in India and paid to non-resident out of India, 5(2)(b) has to be read with 9(1)(iv). Under 9(1)(iv), it is clearly stipulated that a dividend paid by an Indian company outside India will constitute income deemed to (be) accruing in India on effecting such payment. In 9(1)(iv), the words used are “a dividend paid by an Indian company outside India”. This is in contradiction to 8 which refers to a dividend declared, distributed or paid by a company. The word “declared or distributed” occurring in 8 does not find place in 9(1)(iv). Therefore, it is clear that dividend paid to non-resident outside India is deemed to accrue in India only on payment.’

Therefore, one can contend that dividend declared by an Indian company would be considered as income in the hands of the non-resident shareholder only on payment.

Earlier, dividends declared by an Indian company were subject to DDT u/s 115O payable by the company declaring such dividends. The rate of DDT was 15% and in case of deemed dividend the DDT rate from A.Y. 2019-20 (up to A.Y. 2020-21) was 30%. Further, section 115BBDA, referred to as the super-rich tax on dividends, taxed a resident [other than a domestic company, an institution u/s 10(23C) or a charitable trust registered u/s 12A or section 12AA] earning dividends (from Indian companies) in excess of INR 10 lakhs. In case of such a resident, the dividend in excess of INR 10 lakhs was taxed at the rate of 10%.

From A.Y. 2021-22, dividends paid by an Indian company to a non-resident are taxed at the rate of 20% (plus applicable surcharge and education cess). Further, with the dividend now being taxed directly in the hands of the shareholders, section 115BBDA is now inoperable.

Payment of dividend to non-residents or to foreign companies would require deduction of tax at source u/s 195 at the rates in force on the sum chargeable to tax. The rates in force in respect of dividends for non-residents or foreign companies as discussed above is 20% (plus applicable surcharge or education cess) or the rate as per the relevant DTAA (subject to fulfilment of conditions in respect of treaty eligibility), whichever is more beneficial.

2.3    Inbound dividends
Dividends paid by foreign companies to Indian companies which hold 26% or more of the capital of the foreign company are taxable at the rate of 15% u/s 115BBD. Further, such dividends, when distributed by the Indian holding company to its shareholders, were not included while computing the dividend distribution tax payable u/s 115O. However, section 80M also provides such a pass-through status to the dividends received to the extent the said dividends received by an Indian company have been further distributed as dividend within one month of the date of filing the return of income of the Indian company. The tax payable would be further reduced by the tax credit, if any, paid by the recipient in any country.

Let us take an example, say F Co, a foreign company in country A distributes dividend of 100 to I Co, an Indian company which further distributes 30 as dividend to its shareholders (within the prescribed limit). Assuming that the withholding tax on dividends in country A is 10, the amount of tax payable would be computed as below:

 

Particulars

Amount

A

Dividend received from F Co

100

B

(-) Deduction u/s 80M for dividends distributed by I Co

(30)

C

Dividend liable to tax (A-B)

70

D

Tax u/s 115BBD (C * 15%)

10.5

E

(-) Tax credit for tax paid in country A (assuming full tax
credit available)

(10)

F

Net tax payable (D-E) (plus applicable surcharge
and education cess)

0.5

Dividends received by other taxpayers are taxable at the applicable rate of tax (depending on the type of person receiving the dividends).

2.4 Taxation in case the Place of Effective Management (‘POEM’) of foreign company is in India
a. Dividend paid by foreign company having POEM in India to non-resident shareholder
As highlighted earlier, section 9(1)(iv) deems income paid by an Indian company to accrue or arise in India. In the present case, as the deeming fiction only refers to dividend paid by an Indian company, one may be able to take a position that the deeming fiction should not be extended to apply to foreign companies even if such foreign companies are resident in India due to the POEM of such companies in India. One may be able to argue that if the Legislature wanted such dividend to be covered, it would have specifically provided for it as done in respect of the existing source rules for royalty and fees for technical services in section 9, wherein a payment by a non-resident would deem such income to accrue or arise in India. Accordingly, the dividend paid by the foreign company to a non-resident shareholder may not be taxable in India even though the foreign company, declaring such dividend, is considered as a resident of India due to the POEM of the foreign company in India.

b. Dividend paid by foreign company having a POEM in India to resident shareholder
Such dividend would be taxed in India on account of the recipient of the dividend being a resident of India. Further, section 115BBD provides a lower rate of tax on dividends paid by a foreign company to an Indian company, subject to the Indian company holding at least 26% in nominal value of the equity share capital of the foreign company. Accordingly, such lower rate of tax would apply to dividends received by an Indian company from a foreign company (subject to the fulfilment of the minimum holding requirement) even if such foreign company is considered as a resident in India on account of its POEM being in India.

c. Dividend received by a foreign company
The provisions of section 115A apply in the case of receipt by a non-resident (other than a company) and a foreign company. Accordingly, dividend received by a foreign company would be taxed at the rate of 20% (plus applicable surcharge and education cess) even if the foreign company is considered as a tax resident of India on account of its POEM being in India.

3. ARTICLE 10 OF THE UN MODEL CONVENTION OR DTAAs DEALING WITH DIVIDENDS
As discussed above, dividends typically give rise to economic double taxation. However, the dividends may also be subject to juridical double taxation in a situation where the income, i.e., dividend is taxed in the hands of the same shareholder in two different jurisdictions. Article 10 of a DTAA typically provides relief from such juridical double taxation.

Article 10 dealing with taxation of dividends is typically worded in the following format:
a.    Para 1 deals with the bilateral scope for the applicability of the Article;
b.    Para 2 deals with the taxing right of the State of source to tax such dividends and the restrictions for such State in taxing the dividends;
c.    Para 3 deals with the definition of dividends as per the DTAA or Model Convention;
d.    Para 4 deals with dividends paid to a company having a PE in the other State;
e.    Para 5 deals with prohibition of extra-territorial taxation on dividends.

4. ARTICLE 10(1) OF THE UN MODEL CONVENTION OR DTAAs
Article 10(1) of a DTAA typically provides the source rule for dividends under the DTAA and also provides the bilateral scope for which the Article applies.

Article 10(1) of the UN Model (2017) reads as under: ‘Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.’

4.1. Bilateral scope
Paragraph 1 deals with the bilateral scope for applicability of the Article. In other words, for Article 10 to apply the company paying the dividends should be a resident of one of the Contracting States and the recipient of the dividends should be a resident of the other Contracting State.
4.2. Source rule
Paragraph 1 also provides the source rule for the dividends, which helps in identifying the State of source for the Article. The paragraph is applicable to dividends ‘paid by a company which is a resident of a Contracting State’. Therefore, the State of source in the case of dividends shall be the State in which the company paying the dividends is a resident.
4.3. The term ‘paid’
Article 10 provides for allocation of taxing rights of dividends paid by a company. Therefore, it is important to understand the meaning of the term ‘paid’.

The description of the term in the OECD Commentary is as follows, ‘The term “paid” has a very wide meaning, since the concept of payment means the fulfilment of the obligation to put funds at the disposal of the shareholder in the manner required by contract or by custom.’

The issue of ‘paid’ is extremely relevant in the case of a deemed dividend u/s 2(22).

Section 2(22)(e) provides that the following payments by a company, to the extent of its accumulated profits, shall be deemed to be dividends under the Act:
a.    Advance or loan to a shareholder who holds at least 10% of the voting power in the payee company;
b.    Advance or loan to a concern in which the shareholder is a member or partner and holds substantial interest (at least 20%) in the recipient concern.

While a loan or advance to a shareholder, constituting deemed dividend u/s 2(22)(e), would constitute dividend ‘paid’ to the shareholder and, therefore, covered under Article 10(1) (subject to the issue as to whether deemed dividend constitutes dividend for the purposes of the DTAA, discussed in subsequent paragraphs), the question arises whether, in case of advance or loan given to a concern in which the shareholder has substantial interest, would be considered as ‘dividend paid by a company’.

Let us take the following example. Hold Co, a company resident in Singapore has two wholly-owned subsidiaries in India, I Co1 and I Co2. During the year, I Co1 grants a loan to I Co2. Assuming that neither I Co1 nor I Co2 is in the business of lending money, the loan given by I Co1 to I Co2 would be considered as deemed dividend.

The Delhi High Court in the case of CIT vs. Ankitech (P) Ltd. & Ors. (2012) (340 ITR 14) held that while section 2(22)(e) deems a loan to be dividend, it does not deem the recipient to be a shareholder. This view was upheld by the Supreme Court in the case of CIT vs. Madhur Housing & Development Co. & Ors. (2018) (401 ITR 152).

Therefore, the deemed dividend would be taxed in the hands of the shareholder, i.e., Hold Co in this case, and not I Co2, being the recipient of the loan, as I Co2 is not a shareholder. Would the dividend then be considered to be ‘paid’ to Hold Co as the funds have actually moved from I Co1 to I Co2 and Hold Co has not received any funds?

The question to be answered here is how does one interpret the term ‘paid’? In this context, Prof. Klaus Vogel in his book, ‘Klaus Vogel on Double Tax Conventions’ (2015 4th Edition), suggests,

‘“Payment” cannot depend on the transfer of money or “monetary funds”, nor does it depend on the existence of a clearly defined “obligation” of the company to put funds at the disposal of the shareholder; instead, in order to achieve consistency throughout the Article, it has to be construed so as to cover all types of advantages being provided to the shareholder covered by the definition of “dividends” in Article 10(3) OECD and UN MC, which include “benefits in money or money’s worth”. It has been argued that the term “payment” requires actual benefits to be provided to the shareholder, so that notional dividends would automatically fall outside the scope of Article 10 OECD and UN MC. This view has to be rejected, however, in light of the need for internal consistency of the provisions of the OECD and UN MC, which rather suggests that the terms “paid to”, “received by” and “derived from” serve only the purpose to connect income that is dealt with in a certain Article to a certain taxpayer, so that any income that falls within the definition of a “dividend” of Article 10(3) OECD and UN MC needs to be considered to be so “paid”. Indeed, it would make little sense to define a “dividend” with reference to domestic law of the Source State only to prohibit taxation of certain such “dividends” because they have not actually been “paid”.’

Accordingly, one may take a view that in such a scenario dividend would be considered as ‘paid’ under the DTAA.

4.4.    The term ‘may be taxed’
The paragraph provides that the dividend ‘may be taxed’ in the State of residence of the recipient of the dividends. It does not provide an exclusive right of taxation to the State of residence.

The interpretation of the term ‘may be taxed’ still continues to be a vexed issue to a certain extent even after the CBDT Notification No. 91 of 2008 dated 28th August, 2008. This controversy would be covered by the authors in a subsequent article.

5. ARTICLE 10(2) OF THE UN MODEL CONVENTION OR DTAAs
Article 10(2) of a DTAA typically provides the taxing right of the State of source for dividends under the DTAA.

Article 10(2) of the UN Model (2017) reads as under:
‘However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:
a. __ per cent of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends throughout a 365-day period that includes the day of the payment of the dividend (for the purpose of computing that period, no account shall be taken of changes of ownership that would directly result from a corporate reorganisation, such as a merger or divisive reorganisation, of the company that holds the shares or pays the dividend);
b. __ per cent of the gross amount of the dividends in all other cases.
The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations.
This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.’

While the UN Model does not provide the rate of tax for paragraphs 2(a) and 2(b) and leaves the same to the individual countries to decide at the time of negotiating a DTAA, the OECD Model provides for 5% in sub-paragraph (a) and 15% in sub-paragraph (b).

5.1. Right of taxation to the source State
Paragraph 2 provides the right of taxation of dividends to the source State, i.e., the State in which the company paying the dividends is a resident. The first part provides the right of taxation to the source State and the second part of the paragraph restricts the right of taxation of the source State to a certain percentage on the applicability of certain conditions.
5.2. The term ‘may also be taxed’
Paragraph 2 provides that dividends paid by a company may also be taxed in the State in which the company paying the dividends is a resident.
5.3. Beneficial owner
The benefit of the lower rate of tax in the source State is available only if the beneficial owner is a resident of the Contracting State. Therefore, if the beneficial owner is not a resident of the Contracting State, the second part of the paragraph would not apply and there would be no restriction on the source State to tax the dividends.

The beneficial ownership test is an anti-avoidance provision in the DTAAs and was first introduced in the 1966 Protocol to the 1945 US-UK DTAA. The concept of beneficial ownership was first introduced by the OECD in its 1977 Model Convention. However, the Model Commentary did not explain the term until the 2010 update.

The term ‘beneficial owner’ has not been defined in the DTAAs or the Model Conventions.

However, the OECD Model Commentary explains the term ‘beneficial owner’ to mean a person who, in substance, has a right to use and enjoy the dividend unconstrained by any contractual or legal obligation to pass on the said dividend to another person.

In the case of X Ltd., In Re (1996) 220 ITR 377, the AAR held that a British bank was the beneficial owner of the dividends paid by an Indian company even though the shares of the Indian company were held by two Mauritian entities which were wholly-owned subsidiaries of the British bank. However, the AAR did not dwell on the term beneficial owner but stressed on the fact that
the Mauritian entities were wholly-owned by the British bank.

Some of the key international judgments in this regard are those of the Canadian Tax Court in the cases of Prevost Car Inc. vs. Her Majesty the Queen (2009) (10 ITLR 736) and Velcro Canada vs. The Queen (2012) (2012 TCC 57) and of the Court of Appeal in the UK in the case of Indofood International Finance Ltd. vs. JP Morgan Chase Bank NA (2006) (STC 1195).

In the case of JC Bamford Investments vs. DDIT (150 ITD 209), the Delhi ITAT held (in the context of royalty) that the ‘beneficial owner’ is he who is free to decide (i) whether or not the capital or other assets should be used or made available for use by others, or (ii) on how the yields therefore should be used, or (iii) both.

Similarly, the Mumbai Tribunal in the case of HSBC Bank (Mauritius) Ltd. v. DCIT (International Taxation) (2017) (186 TTJ 619) has explained the term ‘beneficial owner’, in the context of interest as, ‘“Beneficial owner” can be one with full right and privilege to benefit directly from the interest income earned by the bank. Income must be attributable to the assessee for tax purposes and the same should not be aimed at transmitting to the third parties under any contractual agreement / understanding. Bank should not act as a conduit for any person, who in fact receives the benefits of the interest income concerned.’

The question that arises is, how does one practically evaluate whether the recipient is a beneficial owner of the dividends? In this case, generally, dividends are paid to group entities wherein it is possible for the Indian company paying the dividends to evaluate whether or not the shareholder is merely a conduit. A Chartered Accountant certifying the taxation of the dividends in Form 15CB can ask for certain information such as financials of the non-resident shareholder in order to evaluate whether the recipient shareholder is a conduit company, or whether such shareholder has substance. In the absence of such information or such other documentation to substantiate that the shareholder is not a conduit company, it is advisable that the benefit under the DTAA is not given. It is important to highlight that an entity, even though a wholly-owned subsidiary, can be considered as a beneficial owner of the income if it can substantiate that it is capable of and is undertaking decisions in respect of the application of the said income.

6. ARTICLE 10(3) OF THE UN MODEL CONVENTION AND DTAAs
Article 10(3) of a DTAA generally provides the definition of dividends.

Article 10(3) of the UN Model (2017) reads as under: ‘The term “dividends” as used in this Article means income from shares, “jouissance” shares or “jouissance” rights, mining shares, founders’ shares or other rights, not being debt claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.’

Therefore, the term ‘dividends’ includes the income from the following:
a.    Shares, jouissance shares or jouissance rights, mining shares, founders’ shares;
b.    Other rights, not being debt claims, participating in profits;
c.    Income from corporate rights subjected to the same tax treatment as income from shares in the source State.

6.1 Inclusive definition
The definition of the term ‘dividends’ in the DTAA as well as the OECD and UN Model is an inclusive definition. Further, it also gives reference to the definition of the term in the domestic law of the source State. The reason for providing an inclusive definition is to include all the types of distribution by the company to its shareholders.

6.2 Meaning of various types of shares and rights
The various types of shares referred to in the definition above are not relevant under the Indian corporate laws and, therefore, have not been further analysed.

6.3 Deemed dividend
The OECD Commentary provides that the term ‘dividends’ is expansively defined to include not only distribution of profits but even disguised distributions. However, the question that arises is whether such deemed dividend would fall under any of the limbs of the definition of dividends in the Article.

The Mumbai ITAT in the case of KIIC Investment Company vs. DCIT (2018) (TS – 708 – ITAT – 2018) while evaluating whether deemed dividend would be covered under Article 10(4) of the India-Mauritius DTAA (having similar language to the UN Model), held,

‘The India-Mauritius Tax Treaty prescribes that dividend paid by a company which is resident of a contracting state to a resident of other contracting state may be taxed in that other state. Article 10(4) of the Treaty explains the term “dividend” as used in the Article. Essentially, the expression “dividend” seeks to cover three different facets of income; firstly, income from shares, i.e. dividend per se; secondly, income from other rights, not being debt claims, participating in profits; and, thirdly, income from corporate rights which is subjected to same taxation treatment as income from shares by the laws of contracting state of which the company making the distribution is a resident. In the context of the controversy before us, i.e. ‘deemed dividend’ under section 2(22)(e) of the Act, obviously the same is not covered by the first two facets of the expression “dividend” in Article 10(4) of the Treaty. So, however, the third facet stated in Article 10(4) of the Treaty, in our view, clearly suggests that even “deemed dividend” as per Sec. 2(22)(e) of the Act is to be understood to be a “dividend” for the purpose of the Treaty. The presence of the expression “same taxation treatment as income from shares” in the country of distributor of dividend in Article 10(4) of the Treaty in the context of the third facet clearly leads to the inference that so long as the Indian tax laws consider “deemed dividend” also as “dividend”, then the same is also to be understood as “dividend” for the purpose of the Treaty.’

Therefore, without dwelling on the issue as to whether deemed dividend can be considered as income from corporate rights, the Mumbai ITAT held that deemed dividend would be considered as dividend under Article 10 of the DTAA.

In this regard it may be highlighted that the last limb of the definition of the term in the India-UK DTAA does not include the requirement of the income from corporate rights and therefore is more open-ended than the OECD Model. It reads as follows, ‘…as well as any other item which is subjected to the same taxation treatment as income from shares by the laws …’

7. ARTICLE 10(4) OF THE UN MODEL CONVENTION AND DTAAs


Article 10(4) of a DTAA provides for the tax position in case the recipient of the dividends has a PE in the other Contracting State of which the company paying the dividends is resident.

Article 10(4) of the UN Model (2017) reads as under, ‘The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply.’

The difference between the OECD Model and the UN Model is that the OECD Model does not provide reference to Article 14 as the Article dealing with Independent Personal Services is deleted in the OECD Model.

7.1 Need to tax under Article 7 or Article 14
The paragraph states that once the bilateral scope in Article 10(1) is met, if the beneficial owner of the dividends has a PE in the source State and the holding in respect of which the dividends are paid is effectively connected to such PE, then the provisions of Article 7 or Article 14 shall override the provisions of Article 10.

To illustrate, A Co, resident of State A, has a subsidiary, B Co, as well as a branch (considered as a PE in this example) in State B. If the holding of B Co is effectively connected to the branch of A Co in State B, Article 7 of the A-B DTAA would apply and not Article 10.

The reason for the insertion of this paragraph is that once a taxpayer has a PE in the source State and the dividends are effectively connected to such PE, they would be included in the profits attributable to the PE and taxed as such in accordance with Article 7 of the DTAA. Therefore, taxing the same dividends on a gross basis under Article 10 and on net basis under Article 7 would lead to unnecessary complications in State B. In order to alleviate such unnecessary complications, it is provided that the dividends would be included in the net profits attributable to the PE and taxed in accordance with Article 7 and not Article 10.

7.2 The term ‘effectively connected’
The OECD Model Commentary provides a broad
guidance as to when the holdings would be considered as being ‘effectively connected’ to a PE and provides the following circumstances in which it would be considered so:
a.    The economic ownership of the holding is with the PE;
b.    Under the separate entity approach, the benefits as well as the burdens of the holding (such as right to the dividends attributable to ownership, potential exposure of gains and losses from the appreciation and depreciation of the holding) is with the PE.

8. ARTICLE 10(5) OF THE UN MODEL CONVENTION AND DTAAs
Article 10(5) of a DTAA deals with prevention of extra-territorial taxation.

Article 10(5) of the UN Model (2017) reads as under, ‘Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.’

Each country is free to draft source rules in its domestic tax law as it deems fit. Paragraph 5, therefore, prevents a country from taxing dividends paid by a company to another, simply because the dividend is in respect of profits earned in that country, except in the following circumstances:
a.    The company paying the dividends is a resident of that State;
b.    The dividends are paid to a resident of that State; and
c.    The holding in respect of which the dividends are paid is effectively connected to the PE of the recipient in that State.

Let us take an example where A Co, a resident of State A, earns certain income in State B and out of
the profits from its activities in State B (assume constituting PE of A Co in State B), declares dividend to X Co, a resident of State C. This is provided by way of a diagram below.

While State B would tax the profits of the PE of A Co, State B can also seek to tax the dividend paid by A Co to X Co as the profits out of which the dividend is paid is out of profits earned in State B. In such a situation, the DTAA between State C and State B may not be able to restrict State B from taxing the dividends if the Article dealing with Other Income does not provide exclusive right of taxation to the country of residence. In such a scenario, Article 10(5) of the DTAA between State A and State B will prevent State B from taxing the dividends on the following grounds:
a.    A Co, the company paying the dividends, is not a resident of State B;
b.    C Co, the recipient of the dividends, is not a resident of State B; and
c.    The dividends are not effectively connected to a PE of C Co (the recipient) in State B.

9. CONCLUSION
With the return to the classical system of taxing dividends, dividends may now be a tax-efficient way of distributing the profits of a company, especially if the shareholder is a resident of a country with a favourable DTAA with India. In certain cases, distribution of dividend may be a better option as compared to undertaking buyback on account of the buyback tax in India.

However, it is important to evaluate the anti-avoidance rules such as the beneficial ownership rule as well as the MLI provisions before applying the treaty benefit. As a CA certifying the remittance in Form 15CB, it is extremely important that one evaluates the documentation to substantiate the above anti-avoidance provisions and, in the absence of the same, not provide benefit of the DTAA to such dividend income. In the next part of this article, relating to international tax aspects of taxation of dividends, we would cover certain specific issues such as whether DDT is restricted by DTAA, MLI aspects and underlying tax credit among other issues in respect of dividends.

Section 220 – Collection and recovery of tax – Assessee contended that total demand was to be kept in abeyance till disposal of appeal by CIT(A) – It was noted that said addition was made primarily on basis of statement – No cross-examine granted – Thus making additions to income of assessee was highly questionable – Financial hardship to meet demand even to extent of 20% – The entire demand was to be kept in abeyance till disposal of appeal on merits by CIT(Appeals)

2. Mayur Kanjibhai Shah vs. ITO-25(3)(1) [Writ Petition No. 812 of 2020, dated 12th March, 2020 (Bombay High Court)]

Section 220 – Collection and recovery of tax – Assessee contended that total demand was to be kept in abeyance till disposal of appeal by CIT(A) – It was noted that said addition was made primarily on basis of statement – No cross-examine granted – Thus making additions to income of assessee was highly questionable – Financial hardship to meet demand even to extent of 20% – The entire demand was to be kept in abeyance till disposal of appeal on merits by CIT(Appeals)

The assessee had filed his return of income for A.Y. 2012-13 on 28th September, 2012 declaring a total income of Rs. 5,05,981.00, which was processed u/s 143(3).

Subsequently, it was decided to reopen the assessment u/s 147 for which notice u/s 148 was issued. Following assessment proceedings on re-opening culminating in the assessment order passed u/s 143(3) r/w/s 147, the A.O. held that an amount of Rs. 3.25 crores was extended by the petitioner to one Nilesh Bharani which was treated as unexplained money u/s 69A and was added to the total income of the assessee.

Pursuant to the order of assessment, the A.O. issued notice of demand dated 21st December, 2019 to the assessee u/s 156 calling upon him to pay an amount of Rs. 2,17,76,850 within the period prescribed.

An appeal was preferred before the CIT(A)-37. Simultaneously, the assessee filed an application before the A.O. for complete stay of demand. Under an order passed u/s 220(6) the A.O. rejected the stay application, giving liberty to the assessee to pay 20% of the demand in which event it was stated that the balance of the outstanding dues would be kept in abeyance.

Aggrieved by the above order, the assessee filed the writ petition.

Revenue filed a common affidavit. Reopening of the assessment in the case of the petitioner for A.Y. 2012-13 was justified and it was contended that the said re-assessment order suffers from no error or infirmity. In paragraph No. 17 it was stated that summons u/s 131 was issued to Nilesh Bharani, but he, instead, had sent a copy of a letter dated 14th October, 2014 addressed to the Director of Income Tax-2, Mumbai.

The Court observed that the assessment order on reopening had been made primarily on the basis of certain entries (in coded language) made in the diary recovered from the premises of Nilesh Bharani in the course of search and seizure u/s 132. The finding that the petitioner had lent / provided cash amount of Rs. 3.25 crores to M/s Evergreen Enterprises / Nilesh Bharani was also reached on the statement made by Nilesh Bharani. Nilesh Bharani was not subjected to any cross-examination by the petitioner; rather, in the affidavit of the Revenue it is stated that Nilesh Bharani has retracted his statement. Prima facie, on the basis of coded language diary entries and a retracted uncorroborated statement of an alleged beneficiary, perhaps the additions made by the A.O. are highly questionable. In such circumstances, instead of taking a mechanical approach by directing the petitioner to pay 20% of the tax demand or providing instalments, the Revenue ought to have considered the case prima facie, balance of convenience and financial hardship, if any, of the petitioner.

In such circumstances, in the interest of justice the demand raised was kept in abeyance till disposal of the appeal by the CIT(A). The appeal should be decided by the CIT(A) within a period of four months from the date of receipt of an authenticated copy of the order. Till disposal of the appeal within the said period, notice of demand shall be kept in abeyance. Accordingly, writ petition is allowed.

Section 54F – Exemption cannot be denied merely because the sale consideration was not deposited in a bank account as per ‘capital gain accounts scheme’ when the investment in acquisition of a residential house was made within the time prescribed

1. Ashok Kumar Wadhwa vs. ACIT (New Delhi) Amit Shukla (J.M.) and O.P. Kant (A.M.) ITA No. 114/Del/2020 A.Y.: 2016-17 Date of order: 2nd March, 2021 Counsel for Assessee / Revenue: Raj Kumar Gupta and J.P. Sharma / Alka Gautam

Section 54F – Exemption cannot be denied merely because the sale consideration was not deposited in a bank account as per ‘capital gain accounts scheme’ when the investment in acquisition of a residential house was made within the time prescribed

FACTS

The assessee, along with a co-owner, sold a residential plot on 15th April, 2015 for Rs. 6.26 crores. He deposited the sale proceeds in a savings bank account maintained with Axis Bank. Subsequently, he purchased a residential house for a sum of Rs. 2.48 crores on 12th April, 2017 under his full ownership. The due date for filing of the return of income was 31st July, 2016, which was extended to 5th August, 2016, but the assessee filed his return of income belatedly on 5th June, 2017 u/s 139(4). In the said return, the assessee claimed exemption u/s 54F against capital gain on sale of property. But according to the A.O., the assessee was not entitled to the benefit of exemption because the sale consideration was not deposited in a bank account maintained as per the ‘capital gain accounts scheme’ before the due date of filing of return of income u/s 139(1), i.e. 5th August, 2016. On appeal, the CIT(A) confirmed the order of the A.O.

Before the Tribunal, the assessee submitted that he has made an investment in the residential house within the specified period of two years from the date of the sale of the property and thus he has substantially complied with the provision of section 54F(1). Therefore, exemption should be allowed. However, the Revenue relied on the orders of the lower authorities.

HELD


The Tribunal noted that the assessee had made an investment in a new house on 12th April, 2017, i.e., within the two years’ time allowed u/s 54F(1). The benefit was denied only because the assessee had failed to deposit the sale consideration in the specified capital gains bank deposit schemes by 5th August, 2016, i.e., the time allowed u/s 139(1), as required u/s 54F(4).

Analysing the provisions of section 54, the Tribunal observed that the provisions of sub-section (1) are mandatory and substantive in nature while the provisions of sub-section (4) of section 54F are procedural. According to it, if the mandatory and substantive provisions stood satisfied, the assessee should be eligible for benefit u/s 54F. For this purpose, the Tribunal relied on the decisions of the Karnataka High Court in the case of CIT vs. K. Ramachandra Rao (56 Taxmann.com 163) and of the Delhi Tribunal in the case of Smt. Vatsala Asthana vs. ITO (2019) (110 Taxmann.com 173). Therefore, the Tribunal set aside the findings of the lower authorities and directed the A.O. to allow the exemption u/s 54F.

NAMING OF BENEFICIARIES IN TRUST DEED – EXPLANATION TO SECTION 164(1)

ISSUE FOR CONSIDERATION
Section 160(1) treats the trustee as a representative assessee in respect of the income which he receives or is entitled to receive on behalf of or for the benefit of any person due to his appointment under a trust declared by a duly executed instrument in writing. Section 161 provides that tax on the income in respect of which the trustee is a representative assessee shall be levied upon and recovered from him in like manner and to the same extent as it would be leviable upon and recoverable from the person represented by him, i.e., the beneficiary.

Section 164(1) provides an exception to this general rule of taxation of the income of a trust. It provides that the tax shall be charged at the maximum marginal rate in certain cases and not the tax that would have been payable had it been taxed in the hands of the beneficiaries. The taxability at maximum marginal rate in the manner provided in section 164(1) will get triggered in a case where the income (or any part thereof) is not specifically receivable on behalf of or for the benefit of any one person or where the individual shares of the persons on whose behalf or for whose benefit such income is receivable are indeterminate or unknown. Such trusts are commonly referred to as discretionary trusts. Further, the Explanation 1 to section 164 provides as follows:

• Where the person on whose behalf or for whose benefit the income (or any part thereof) is receivable during the previous year is not expressly stated in the instrument of the trust and is not identifiable as such on the date of such instrument, it shall be deemed that the income is not specifically receivable on behalf of or for the benefit of any one person.
• Where the individual shares of the persons on whose behalf or for whose benefit the income (or part thereof) is receivable are not expressly stated in the instrument of the trust and are not ascertainable as such on the date of such instrument, it shall be deemed that the individual shares of the beneficiaries are indeterminate or unknown.

An issue has arisen about the applicability of the provisions of section 164(1) read with the aforesaid Explanation in the case of trusts (such as venture capital funds or alternative investment funds) where the persons who contribute the capital (contributors) under the scheme become beneficiaries of the income derived by the trust in proportion to the capital contributed by them. In such cases it is not possible to identify the beneficiaries and their share in the income of the trust at the time when the trust has been formed. Therefore, the trust deed does not list out the names of the beneficiaries and their respective shares in the income of the trust. Instead, it provides for the mechanism on the basis of which the beneficiaries and also their shares in the income of the trust can be identified from time to time.

The Bengaluru Bench of the Tribunal has held that it is sufficient if the basis to identify the beneficiaries and their share in the income of the trust is specified in the trust deed and it is not left to the discretion of the trustee or any other person. As against this, the Chennai Bench took the view that the income of the trust would be liable to tax at the maximum marginal rate in the absence of identification of the beneficiaries and their share in the income in the trust deed at the time of its formation.

THE INDIA ADVANTAGE FUND CASE

The issue had first come up for consideration of the Bengaluru Bench of the Tribunal in the case of DCIT vs. India Advantage Fund – VII [2015] 67 SOT 5.

In this case, the assessee was a trust constituted under an instrument of trust dated 25th September, 2006. The settlor (ICICI Venture Funds Management Company Limited) had, by the said instrument, transferred a sum of Rs. 10,000 to the trustee (The Western India Trustee and Executor Company Limited) as initial corpus to be applied and governed by the terms and conditions of the indenture of trust. The trustee was empowered to call for contributions from the contributors which were required to be invested by the trustee in accordance with the objects of the trust. The objective of the trust was to invest in certain securities called ‘mezzanine instruments’ and to achieve commensurate returns for the contributors. The trust was to facilitate investment by the contributors who should be resident in India and achieve returns for such contributors. The trust deed provided that the contributors to the fund would also be its beneficiaries.

For the assessment year 2008-09, the trust filed its return declaring income of Rs. 1,81,68,357 and, further, submitted a letter to the A.O. that it had declared the income out of extreme precaution and in good faith to provide complete information and details about the income earned by it but offered to tax by the beneficiaries. It was claimed that the income declared had been included in the return of income of the beneficiaries and offered to tax directly by them pursuant to the provisions of sections 61 to 63 of the Act, which mandated that the income arising from revocable transfers was to be taxed in the hands of the transferors (i.e., the contributors). Accordingly, the Fund had not offered the same to tax again in its hands.

The A.O. was of the view that the individual shares of the persons on whose behalf or for whose benefit the income was received or was receivable by the assessee, or part thereof, were indeterminate or unknown. He was also of the view that the mere fact that the deed mentioned that the share of the beneficiaries would be allocated according to their investments in the Fund, did not make their shares determinate or known. Accordingly, the A.O. invoked the provisions of section 164(1) and held that the assessee would be liable to be assessed at the maximum marginal rate on its whole income. Apart from that, the A.O. also held that the assessee and the beneficiaries joined in a common purpose or common action, the object of which was to produce income, profits and gains, and therefore constituted an AOP. On that count also, the income was brought to tax in the hands of the assessee in the status of an AOP and charged at the maximum marginal rate.

The assessee raised the following contentions before the CIT(A):
1. It should not have been treated as an AOP as there was no inter se arrangement between one contributory / beneficiary and the other contributory / beneficiary, as each of them had entered into separate contribution arrangements with the assessee. Therefore, it could not be said that two or more beneficiaries had joined in a common purpose or common action;

2. The beneficiaries could not be said to be uncertain so long as the trust deed gave the details of the beneficiaries and the description of the person who was to be benefited. Reliance was placed on the CBDT Circular No. 281 dated 22nd September, 1980 wherein it was clarified that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the instrument of trust on the date of the instrument. With regard to ascertainment of the share of the beneficiaries, it was contended that it was enough if the shares were capable of being determined based on the provisions of the trust deed and it was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. Attention was drawn to the relevant clauses of the trust deed where it was specified who would be the beneficiaries and the formula to determine the share of each beneficiary.

3. The assessee was set up as a revocable trust as the trustees were given power to terminate the trust at any time before the expiry of the term. Therefore, the income of the trust had to be assessed in the hands of the beneficiaries, being the transferors.

The CIT(A) treated the assessee trust as a revocable trust and held that it need not be subjected to tax as the tax obligations had been fully discharged by the beneficiaries of the assessee trust. Aggrieved by the order of the CIT(A), the Revenue preferred an appeal to the Tribunal.

Before the Tribunal, the Revenue, apart from reiterating its stand as contained in the assessment order, drew attention to Circular No. 13/2014 whereby the CBDT had clarified that Alternative Investment Funds which were subject to the SEBI (Alternative Investment Funds) Regulations, 2012 which were not venture capital funds and which were non-charitable trusts where the investors’ name and beneficial interest were not explicitly known on the date of its creation – such information becoming available only when the funds started accepting contribution from the investors – had to be treated as falling within section 164(1) and the fund should be taxed in respect of the income received on behalf of the beneficiaries at the maximum marginal rate. It was claimed that the case of the assessee would fall within the above CBDT Clarifications and therefore the action of the A.O. was correct and had to be restored.

On behalf of the assessee, however, attention was drawn to the clause of the trust deed which contained the following definition:
‘“Contributors” or “Beneficiaries” means the Persons, each of whom have made or agreed to make Contributions to the Trust, in accordance with the Contribution Agreement.’

It was claimed that it was possible to identify the beneficiaries and their share on the basis of the mechanism provided in the trust deed. Reliance was placed on CBDT Circular No. 281 dated 22nd September, 1980 and the decisions in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad); CIT vs. Manilal Bapalal [2010] 321 ITR 322 (Mad); and Companies Incorporated in Mauritius, In re [1997] 224 ITR 473 (AAR). Insofar as the Circular No. 13/2014 relied upon by the Revenue was concerned, it was argued that it was not applicable for the assessment year under consideration and reliance was placed on the decision of the Bombay High Court in the case of BASF (India) Ltd. vs. W. Hasan, CIT [2006] 280 ITR 136 wherein it was held that Circulars not in force in the relevant assessment year cannot be applied.

The assessee also raised the issue of the nature of the trust being revocable and, hence, the income could be assessed only in the hands of the transferors in terms of the provisions of section 61. As far as the status of the trust as an AOP was concerned, the assessee relied upon several decisions including that of the Supreme Court in the case of CIT vs. Indira Balakrishnan [1960] 39 ITR 546 and claimed that the characteristics of an AOP were completely absent in its case.

After considering the contentions of both the parties, the Tribunal inter alia held as follows:
• The trust deed clearly laid down that beneficiaries means the persons, each of whom have made or agreed to make contributions to the trust in accordance with the Contribution Agreement. This clause was sufficient to identify the beneficiaries. It was clarified by Circular No. 281 dated 22nd September, 1980 that it was not necessary that the beneficiary in the relevant previous year should be actually named in the instrument of trust and all that was necessary was that the beneficiary should be identifiable with reference to the order of the instrument of trust on the date of such instrument.

• It was not the requirement of law that the trust deed should actually prescribe the percentage share of the beneficiary in order for the trust to be determinate. It was enough if the shares were capable of being determined based on the provisions of the trust deed. In the case of the assessee, the clause details the formula with respect to the share of each beneficiary and the trustee had no discretion to decide the share of each beneficiary. Reliance was placed on the decision of the AAR in the case of Companies Incorporated in Mauritius, In re (Supra) wherein it was held that the persons as well as the shares must be capable of being definitely pinpointed and ascertained on the date of the trust deed itself without leaving these to be decided upon at a future date by a person other than the author either at his discretion or in a manner not envisaged in the trust deed. Even if the trust deed authorised the addition of further contributors to the trust at different points of time, in addition to the initial contributors, then the same would not make the beneficiaries unknown or their share indeterminate. Even if the scheme of computation of income of beneficiaries was complicated, it was not possible to say that the share income of the beneficiaries could not be determined or known from the trust deed.

• CBDT’s Circular No. 13/2014 dated 28th July, 2014 was not in force in the relevant assessment year for which the assessment was made by the A.O. The Circulars not in force in the relevant A.Y. cannot be applied as held by the Bombay High Court in the case of BASF (India) Ltd. (Supra).

On the basis of the above, the Tribunal held that the income of the assessee trust was determinate; its income could not be taxed at the maximum marginal rate; the income was assessable only in the hands of the beneficiaries as it was a revocable transfer; and that there was no formation of an AOP.

TVS INVESTMENTS IFUND CASE

Thereafter, the issue came up for consideration before the Chennai Bench of the Tribunal in the case of TVS Investments iFund vs. ITO (2017) 164 ITD 524.

In this case, the assessee was a trust which was formed to receive unit contributions from High Net-Worth Individuals (HNIs) towards the capital amount committed by them as per the terms of Contribution Agreements and provided returns on such investments. For the A.Y. 2009-10, the assessee declared Nil income by treating itself as a representative assessee and claimed that the entire income was taxable in the hands of the beneficiaries. However, the A.O. subjected the entire receipts to tax. He concluded that the assessee was not a Determinate Trust and when not found eligible for deduction u/s 10(23FB) as an alternative investment fund, it could not be extended the benefit of section 164. The ‘pass-through’ status was denied since the assessee was neither a determinate trust nor a non-discretionary trust and therefore the income was taxed in the hands of the representative assessee and not in the hands of the beneficiaries.

In appeal, the CIT(A) held that the assessee trust could not be categorised as a Determinate Trust so as to gain pass-through status. Further, pass-through status was available only when the trust was an approved fund u/s 10(23FB). When the assessee was not a SEBI-approved Alternate Investment Fund, it could not claim pass-through status. The CIT(A) opined that if every trust were to become eligible for pass-through status automatically, then there was no need for an enactment under the Act in the form of 10(23FB) r.w.s. 115U. Accordingly, the CIT(A) dismissed the appeal of the assessee. On being aggrieved, the assessee went in further appeal before the Tribunal.

The Tribunal held that the income of the trust would be chargeable to Maximum Marginal Rate if the trust does not satisfy two tests, i.e., the names of the beneficiaries are specified in the trust deed and the individual shares of the beneficiaries are ascertainable on the date of the trust deed. If the trust has satisfied these tests, then the trust would be treated as a pass-through conduit subject to the provisions of section 160. For getting pass-through treatment the trust should be a determinate and non-discretionary trust. In order to form a determinate trust, the beneficiaries should be known and the individual share of those beneficiaries should be ascertainable as on the date of the trust deed. But in the case under consideration the beneficiaries were not incorporated in the trust deed. The identities of the contributors / beneficiaries were unknown. The investment manager gathered the funds from the contributors and the benefit was passed on to the contributors based on the proportion of their investments in the assessee trust. The exception to this rule, and providing pass-through status to a Trust, even though the contributing beneficiaries were not mentioned in the deed of trust, was only extended to AIF(VCF) which were registered with SEBI and eligible for exemption u/s 10(23FB) r.w.s. 115U.

The Tribunal distinguished the decision of the Madras High Court in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 which was relied upon by the assessee on the ground that in that case the beneficiaries were incorporated on the day of institution of the trust deed and, moreover, they did not receive any income in that year. Further, the individual share of the beneficiaries was also ascertainable on the date of the trust. As against this, in the assessee’s case neither the names of the beneficiaries were specified in the trust deed nor were the individual shares of the beneficiaries ascertainable on the date of the institution of the trust. Therefore, the Tribunal upheld the order of the A.O. taxing the income of the assessee trust at the maximum marginal rate under the provisions of section 164(1).

OBSERVATIONS


The taxation of discretionary trusts at maximum marginal rate was introduced in section 164(1) by the Finance Act, 1970 with effect from 1st April, 1970. The objective behind its introduction was explained in Circular No. 45 dated 2nd September, 1970 which is reproduced below:

Private discretionary trusts. – Under the provisions of s. 164 of the IT Act before the amendment made by the Finance Act, 1970, income of a trust in which the shares of the beneficiaries are indeterminate or unknown, is chargeable to tax as a single unit treating it as the total income of an AOP. This provision affords scope for reduction of tax liability by transferring property to trustees and vesting discretion in them to accumulate the income or apply it for the benefit of any one or more of the beneficiaries, at their choice. By creating a multiplicity of such trusts, each one of which derives a comparatively low income, the incidence of tax on the income from property transferred to the several trusts is maintained at a low level. In such arrangements, it is often found that one or more of the beneficiaries of the trust are persons having high personal incomes, but no part of the trust income being specifically allocable to such beneficiaries under the terms of the trust, such income cannot be subject to tax at a high personal rate which would have been applicable if their shares had been determinate.

Thus, it can be seen that the objective was to curb the practice of forming multiple trusts, whereby each of them derived minimum income, so that it did not fall within the higher tax bracket.

Thereafter, the Explanation was added by the Finance (No. 2) Act, 1980 with effect from 1st April, 1980 deeming that, in certain situations, beneficiaries shall be deemed to be not identifiable or their shares shall be deemed to be unascertained or indeterminate or unknown. The legislative intent behind insertion of this Explanation has been explained in the Circular No. 281 dated 22nd September, 1980 which is reproduced below:

Under the provisions as they existed prior to the amendments made by the Finance Act, the flat rate of 65 per cent was not applicable where the beneficiaries and their shares are known in the previous year although such beneficiaries or their shares have not been specified in the relevant instrument of trust, order of the court or wakf deed. This provision was misused in some cases by giving discretion to the trustees to decide the allocation of income every year and in several other ways. In such a situation, the trustees and beneficiaries were able to manipulate the arrangements in such a manner that a discretionary trust was converted into a specific trust whenever it suited them tax-wise. In order to prevent such manipulation, the Finance Act has inserted Explanation 1 in section 164 to provide as under:

a. any income in respect of which the court of wards, the administrator-general, the official trustee, receiver, manager, trustee or mutawalli appointed under a wakf deed is liable as a representative assessee or any part thereof shall be regarded as not being specifically receivable on behalf or for the benefit of any one person unless the person on whose behalf or for whose benefit such income or such part thereof is receivable during the previous year is expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and is identifiable as such on the date of such order, instrument or deed. [For this purpose, it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed, all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed;]

b. the individual shares of the persons on whose behalf or for whose benefit such income or part thereof is receivable will be regarded as indeterminate or unknown unless the individual shares of such persons are expressly stated in the order of the court or the instrument of trust or wakf deed, as the case may be, and are ascertainable as such on the date of such order, instrument or deed.

As a result of the insertion of the above Explanation, trust under which a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will all be regarded as discretionary trusts and assessed accordingly.

The following points emerge from a combined reading of both the Circulars, clarifying the objective behind amending the provisions of section 164(1) to provide for taxability of discretionary trusts at the maximum marginal rate and inserting the Explanation providing for deemed cases of discretionary trust:

• There was a need to tax the income of the discretionary trusts at the maximum marginal rate to curb the practice of creating multiple trusts and thereby avoiding tax by ensuring that they earn low income, so that they do not get taxed at the maximum marginal rate.
• To overcome this issue, the provisions of section 164(1) were amended to provide that the income of the discretionary trust (where the beneficiaries or their share are not known or determinate) is liable to tax at the maximum marginal rate.
• Even after providing for taxability of such discretionary trusts at the maximum marginal rate in section 164(1), the practice of avoiding it continued in some cases, as there was no requirement under the law that the beneficiaries or their shares should have been specified in the relevant instrument of trust, order of the court or wakf deed.
• Although the discretion was given to the trustees to decide the allocation of income every year, the affairs of the trusts were so arranged whereby it was claimed that the beneficiaries and their shares were known in the concerned previous year and, therefore, the provisions of section 164(1) were not applicable to that previous year.
• To plug this loophole, the Explanation was inserted to provide that the beneficiaries and their shares should be expressly stated in the relevant instrument of trust, order of the court or wakf deed.
• It has been expressly clarified that it is not necessary that the beneficiary in the relevant previous year should be actually named in the order of the court or the instrument of trust or wakf deed and all that is necessary is that the beneficiary should be identifiable with reference to the order of the court or the instrument of trust or wakf deed on the date of such order, instrument or deed.
• Only cases where a discretion is given to the trustee to decide the allocation of the income every year or a right is given to the beneficiary to exercise the option to receive the income or not each year will be regarded as discretionary trusts and assessed accordingly.

In the background of these legislative developments, it can be inferred that the requirement is not to name the beneficiaries in the instrument of trust but to provide for the identification of the beneficiaries on an objective basis. This has been made expressly clear in the aforesaid Circular itself. These aspects had not been pointed out to the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra). The Bengaluru Bench of the Tribunal considered the legislative intent and the aforesaid Circulars to hold that it would be sufficient if the trust deed provided that the contributors would be beneficiaries and further it provided for the formula to arrive at the individual share of each beneficiary.

It may be noted that both the above decisions of the Tribunal had been challenged before the respective High Courts. The Revenue had filed an appeal before the Karnataka High Court against the decision of the Bengaluru Bench in the case of India Advantage Fund (Supra). Before the High Court it was contended on behalf of the Revenue that the exact amount of share of the beneficiaries and its quantification should have been possible on the date when the trust deed was executed or the trust was formed. If such conditions were not satisfied, then the shares of the beneficiaries would turn into non-determinable shares. The High Court rejected this argument by holding as under:

10. In our view, the contention is wholly misconceived for three reasons. One is that by no interpretative process the Explanation to section 164 of the Act, which is pressed in service can be read for determinability of the shares of the beneficiary with the quantum on the date when the Trust deed is executed, and the second reason is that the real test is the determinability of the shares of the beneficiary and is not dependent upon the date on which the trust deed was executed if one is to connect the same with the quantum. The real test is whether shares are determinable even when or after the Trust is formed or may be in future when the Trust is in existence. In the facts of the present case, even the assessing authority found that the beneficiaries are to share the benefit as per their investment made or to say in other words, in proportion to the investment made. Once the benefits are to be shared by the beneficiaries in proportion to the investment made, any person with reasonable prudence would reach to the conclusion that the shares are determinable. Once the shares are determinable amongst the beneficiaries, it would meet with the requirement of the law, to come out from the applicability of section 164 of the Act.

11. Under the circumstances, we cannot accept the contention of the Revenue that the shares were non-determinable or the view taken by the Tribunal is perverse. On the contrary, we do find that the view taken by the Tribunal is correct and would not call for interference so far as determinability of the shares of the beneficiaries is concerned.

12. Once the shares of the beneficiaries are found to be determinable, the income is to be taxed of that respective sharer or the beneficiaries in the hands of the beneficiary and not in the hands of the trustees which has already been shown in the present case.

Thus, the view of the Bengaluru Bench of the Tribunal was affirmed by the Karnataka High Court.

The decision of the Chennai Bench of the Tribunal in the case of TVS Investments iFund (Supra) was challenged by the assessee before the Madras High Court. Before deciding the issue, the Madras High Court had already dealt with it in the case of CIT vs. TVS Shriram Growth Fund [2020] 121 taxmann.com 238 and decided it in favour of the assessee by relying on its own decision in the case of CIT vs. P. Sekar Trust [2010] 321 ITR 305 (Mad). It was noted by the Madras High Court that the Chennai Bench had wrongly disregarded the decision in the case of the P. Sekar Trust. The relevant observations are reproduced below:

In fact, the Tribunal ought to have followed the decision of the Division Bench of this Court in the case of P. Sekar Trust (Supra). However, the same has been distinguished by the Tribunal in the case of TVS Investments iFund (Supra) by observing that the said judgment is not applicable to the facts of the case because in it, the beneficiaries are incorporated on the day of the institution of the Trust Deed and, moreover, they did not receive any income in that year. Unfortunately, the Tribunal in the case of TVS Investments iFund (Supra), did not fully appreciate the finding rendered by the Hon’ble Division Bench of this Court and post a wrong question, which led to a wrong answer.

The Madras High Court in this case concurred with the view of the Karnataka High Court in the case of India Advantage Fund (Supra) and decided the issue against the Revenue. The same view was then followed by the Madras High Court in the case of TVS Investments iFund and overruled the decision of the Chennai Bench of the Tribunal.

A similar view had been taken by the Authority for Advance Rulings in the case of Companies Incorporated in Mauritius, In re (Supra).

The better view of the matter therefore is the view taken by the Bengaluru Bench of the Tribunal in the case of India Advantage Fund, as affirmed by the Karnataka and Madras High Courts, that it is not necessary to list out the beneficiaries and their exact share in terms of percentage in the trust deed. It is sufficient if the trust deed provides both for the manner of identification of the beneficiaries as well as a mechanism to compute their respective shares in the income of the trust for any year, without leaving it to the discretion of the trustee or any other person.

Reserve credited in the books of amalgamated company on account of acquisition of assets and liabilities in a scheme of amalgamation is in the nature of capital reserve only and not revaluation reserve

7. (2020) 82 ITR (T) 557 (Del)(Trib) Hespera Realty Pvt. Ltd. vs. DCIT ITA No.: 764/Del/2020 A.Y.: 2015-16 Date of order: 27th July, 2020

Reserve credited in the books of amalgamated company on account of acquisition of assets and liabilities in a scheme of amalgamation is in the nature of capital reserve only and not revaluation reserve

FACTS

The assessee company took over (acquired) certain other companies under a scheme of amalgamation. The assets and liabilities were taken over at fair value which was higher than their cost in the books of the amalgamating companies. The difference was recorded in the assessee’s books as ‘capital reserve’. These also included shares of Indiabulls Housing Finance Limited. Some of the said shares acquired in the scheme of amalgamation were sold by the assessee company at a profit. While accounting for the said profit in the books, the assessee company considered the cost of acquisition as the actual cost at which they were acquired in the course of amalgamation, which value was necessarily the fair value of the shares (calculated at closing price on NSE on the day prior to the appointed date for the amalgamation).

It was the contention of the Revenue that the scheme of amalgamation was a colourable device to evade tax on book profits u/s 115JB. The A.O. held that the reserve credited in the books was not capital reserve and was essentially revaluation reserve which ought to be added back while computing book profits in view of clause (j) to Explanation 1 of section 115JB. Thus, the difference between the cost of shares in the books of the amalgamating company and their fair value was added back in the hands of the assessee while computing book profits (pertaining to sale of shares).

The CIT(A) concurred with the findings of the A.O. and upheld his order.

Aggrieved, the assessee preferred an appeal before the ITAT.

HELD


The ITAT observed that a ‘Revaluation Reserve’ is created when an enterprise revalues its own assets, already acquired and recorded in its books at certain values. In the instant case, the assessee has not revalued its existing assets but has only recorded the fair values of various assets and liabilities ‘acquired’ by the assessee from the transferor / ‘amalgamating companies’ pursuant to the scheme of amalgamation as its ‘cost of acquisition’ in accordance with the terms of the Court-approved scheme of amalgamation and the provisions of AS 14.

The ITAT examined the provisions of section 115JB vis-à-vis accounting treatment of capital reserve / revaluation reserve.

It was observed that section 115JB requires an assessee company to prepare its P&L account in accordance with the provisions of Parts I and II of Schedule III of the Companies Act, 2013. The section further says that for computing book profits under the said section, the same accounting policy and Accounting Standards as are adopted for preparing the accounts laid before the shareholders at the Annual General Meeting in accordance with the provisions of section 129 of the Companies Act, 2013 (corresponding to section 210 of the Companies Act, 1956) shall be adopted.

Section 129 of the Companies Act provides that the financial statements of the company shall be prepared to give a true and fair view of the state of affairs and the profit or loss of the company and shall comply with the Accounting Standards as prescribed by the Central Government.

As per the above provisions, for accounting for amalgamation, AS 14 is applicable. As per AS 14 pooling of interest method and purchase method are recognised. In the instant case, as per sections 391 to 394 of the Companies Act, amalgamation was regarded as amalgamation in the nature of purchases and hence purchase method of AS 14 is applicable to the assessee.

As per AS 14 ‘If the amalgamation is an “amalgamation in the nature of purchase”, the identity of the reserves, other than the statutory reserves dealt with in paragraph 18, is not preserved. The amount of the consideration is deducted from the value of the net assets of the transferor company acquired by the transferee company. If the result of the computation is negative, the difference is debited to goodwill arising on amalgamation and dealt with in the manner stated in paragraphs 19-20. If the result of the computation is positive, the difference is credited to Capital Reserve.’

Based on the above examination of the requirements of AS 14 and the provisions of section 115JB, the ITAT ruled in favour of the assessee by holding that the reserve credited in the books of the assessee is not in the nature of revaluation reserve but is a capital reserve. In doing so, the Tribunal relied on the order of the co-ordinate Bench in the case of Priapus Developers Pvt. Ltd. 176 ITD 223 dated 12th March, 2019 which had made similar observations on the issue of reserve arising out of the purchase method adopted in the scheme of amalgamation.

Where receipt of consideration was dependent upon fulfilment of certain obligations, the income cannot be said to have accrued in the year in which relevant agreement is entered

6. (2020) 82 ITR (T) 419 (Mum)(Trib) ITO vs. Abdul Kayum Ahmed Mohd. Tambol (Prop. Tamboli Developers) ITA No.: 5851/Mum/2018 A.Y.: 2009-10 Date of order: 6th July, 2020

Where receipt of consideration was dependent upon fulfilment of certain obligations, the income cannot be said to have accrued in the year in which relevant agreement is entered

FACTS

The assessee, an individual, civil contractor, transferred certain development rights for a total consideration of Rs. 3.36 crores vide agreement dated 23rd July, 2008 out of which Rs. 1 crore was received during F.Y. 2008-09. The assessee calculated business receipts after deducting expenditure incurred in connection with the above and finally offered 8% of the net receipts as income u/s 44AD. The A.O. brought to tax the entire consideration of Rs. 3.36 crores on the basis that, as per the terms of the agreement, the assessee parted with development rights and the possession of the land was also given. Therefore, the transfer was completed during the year and the taxability of business receipts would not be dependent upon actual receipt thereof. On further appeal to the CIT(A), the latter concluded the issue in the assessee’s favour. Aggrieved, the Revenue filed an appeal before the ITAT.

HELD

The whole controversy in this matter pertained to year of accrual of the afore-mentioned income and consequent year of taxability of the income. The ITAT took note of an important fact that only part payment, as referred to above, accrued to the
assessee in the year under consideration since the balance receipts were conditional receipts which were payable only in the event of the assessee performing various works, obtaining requisite permissions, etc. The payments were, thus, subject to fulfilment of certain contractual performance by the assessee. The said facts were confirmed by the payer, too, in response to a notice u/s 133(6).

The ITAT also confirmed the view of the CIT(A) that the term ‘transfer’ as defined in section 2(47)(v) would not apply in the case since the same is applicable only in case of capital assets held by the assessee. The development rights in the instant case were held as business assets. The assessee had also offered to tax the balance receipts in the subsequent years. It concluded that since the balance consideration was a conditional receipt and was to accrue only in the event of the assessee performing certain obligations under the agreement, the same did not accrue to the assessee.

Thus, the ITAT dismissed the appeal of the Revenue.

Section 54F of the Income-tax Act, 1961 – Exemption to be granted even if investment in new residential property is made in the name of legal heir – Section 54F does not require investment to be made in assessee’s name

5. 125 taxmann.com 110 Krishnappa Jayaramaiah IT Appeal No. 405 (Bang) of 2020 A.Y.: 2016-17 Date of order: 22nd February, 2021

Section 54F of the Income-tax Act, 1961 – Exemption to be granted even if investment in new residential property is made in the name of legal heir – Section 54F does not require investment to be made in assessee’s name

FACTS

The assessee filed his return of income showing, among other things, income under capital gains from sale of a property acquired on account of partition of the HUF. The assessee claimed a deduction u/s 54F by investing the sale consideration in a new residential property purchased in the name of his widowed daughter. The assessee’s daughter had no independent source of income and was entirely dependent on him. The A.O. denied the claim of deduction to the assessee and determined the total assessed income at Rs. 2,07,75,230. The CIT(A) upheld the A.O.’s order. Aggrieved, the assessee filed an appeal with the Tribunal.

HELD

It was held that there is nothing in section 54F to show that a new residential house should be purchased only in the name of the assessee. The section merely says that the assessee should have purchased / constructed a ‘residential house’. Noting that purposive consideration is to be preferred as against literal consideration, the Tribunal held that the word ‘assessee’ should be given a wide and liberal interpretation and include legal heirs, too. Thus, the A.O. was directed to grant exemption u/s 54F to the assessee for the amount invested in the purchase of a residential house in his daughter’s name.

The assessee’s appeal was allowed.

 

Sections 250, 251 – The appellate authorities are obligated to dispose of all the grounds of appeal raised before them so that multiplicity of litigation may be avoided – There can be no escape on the part of the CIT(A) from discharging the statutory obligation cast upon him to deal with and dispose of all the grounds of appeal on the basis of which the impugned order has been contested by the assessee before him

4. TS-48-ITAT-2021 (Mum) DCIT vs. Tanna Builders Ltd. ITA No. 2816 (Mum) of 2016 A.Y.: 2011-12 Date of order: 19th January, 2021

Sections 250, 251 – The appellate authorities are obligated to dispose of all the grounds of appeal raised before them so that multiplicity of litigation may be avoided – There can be no escape on the part of the CIT(A) from discharging the statutory obligation cast upon him to deal with and dispose of all the grounds of appeal on the basis of which the impugned order has been contested by the assessee before him

FACTS

For A.Y. 2011-12, the assessee company, engaged in the business of builder, masonry and general construction contractor, filed its return of income declaring a total income of Rs. 26,41,130. The assessee had constructed two buildings, viz. Tanna Residency (Phase I) and Raheja Empress. The assessee had made buyers of units / houses shareholders of the company and allotted shares of Rs. 10 each to them. The assessee had issued debentures to those purchasers / shareholders equivalent to the value of the sale consideration of the units / houses sold. Debentures with a face value of Rs. 1,00,000 each were issued and an amount of Rs. 99,990 was collected on each debenture and shown as a liability in the Balance Sheet of the company. This was the case for all the 27 allottees / purchasers of the houses / units in the two buildings on the date of commencement of the respective projects.

During the year under consideration the assessee issued debentures of Rs. 4.20 crores towards the sale of certain units / spaces. The A.O. held that the assessee had been accounting the sale proceeds of its stock as a liability in its Balance Sheet instead of as sales in the P&L account. He called upon the assessee to explain why the amounts received on issuing the debentures during the year under consideration may not be taxed as sales and be subjected to tax. The assessee submitted that it continued to own the buildings and the construction cost had been raised through the shareholders by issuing unsecured redeemable debentures to them. It was also submitted that issuing of debentures by the company and raising money therefrom was neither held as sale of units nor sale of parking spaces by the Department while framing its assessments of preceding years. It was submitted that the assessee has issued 60 debentures to International Export and Estate Agency (IEEA) on the basis of holding 180 shares of the assessee company. On the basis of this holding, the assessee company had given IEEA the right to use, possess and occupy 60 basement parking spaces in its building. Debentures were issued pursuant to a resolution passed in the Board of Directors meeting held on 4th October, 2010 and the resolution passed by the shareholders in the Extraordinary General Meeting held on 29th October, 2010.

The A.O. held that the assessee has sold the units / houses in the aforesaid buildings to the shareholders / debenture holders who were the actual owners of the said properties and the claim of the assessee that it was the owner of the buildings and the debentures / shares were issued for raising funds was clearly a sham transaction that was carried out with an intent to evade taxes. The A.O. also held that the amount received by the assessee company by issuing shares / debentures to the purchasers of the houses / units / spaces was supposed to have been accounted by it as its income in its P&L account. He treated the amount of Rs. 4.20 crores received by the assessee on issuing debentures / shares during the year as the sales income of the assessee company.

Aggrieved, the assessee preferred an appeal to the CIT(A) who found favour with the contentions advanced by the assessee and vacated the addition.

Aggrieved, the Revenue preferred an appeal to the Tribunal.

HELD


The Tribunal observed that the assessee had, in the course of appellate proceedings before the CIT(A), raised an alternative claim that the A.O. erred in not allowing cost of construction against the amount of Rs. 4.20 crores treated by him as business income. The assessee had filed additional evidence in respect of corresponding cost of parking space. In view of the fact that the CIT(A) had deleted the addition of Rs. 4.20 crores made by the A.O., he would have felt that adjudicating the alternative claim would not be necessary. The Tribunal held that in its opinion piecemeal disposal of the appeal by the first Appellate Authority cannot be accepted.

The Tribunal held that as per the settled position of law the appellate authorities are obligated to dispose of all the grounds of appeal raised by the appellant before them so that multiplicity of litigation may be avoided. For this view it placed reliance on the decision of the Madras High Court in the case of CIT vs. Ramdas Pharmacy [(1970) 77 ITR 276 (Mad)] that the Tribunal should adjudicate all the issues raised before it.

The Tribunal restored the matter to the file of the CIT(A) with a direction to dispose of the alternative ground of appeal that was raised by the assessee before him.

Sections 2(24), 45, 56 – Compensation received by the assessee towards displacement in terms of Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment

3. 2021 (3) TMI 252-ITAT Mumbai Smt. Dellilah Raj Mansukhani vs. ITO ITA No.: 3526/Mum/2017 A.Y.: 2010-11 Date of order: 29th January, 2021

Sections 2(24), 45, 56 – Compensation received by the assessee towards displacement in terms of Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment

FACTS

During the course of appellate proceedings the CIT(A) found, on the basis of details forwarded by M/s Calvin Properties, that the assessee has been given compensation for alternative accommodation of Rs. 2,60,000 as per the terms of the Development Agreement. According to the CIT(A), the amount received was over and above the rent actually paid by the assessee and, therefore, the same has to be taxed accordingly. The CIT(A) having issued notice u/s 251(2) qua the proposed enhancement and considering the reply of the assessee that she received monthly rental compensation during the year aggregating to Rs. 2,60,000 for the alternative accommodation which is a compensation on account of her family displacement from the accommodation and tremendous hardship and inconvenience caused to her, the said compensation is towards meeting / overcoming the hardships and it is a capital receipt and therefore not liable to be taxed.

The assessee relied on the decision of the co-ordinate Bench in the case of Kushal K. Bangia vs. ITO in ITA No. 2349/Mum/2011 for A.Y. 2007-08 wherein the A.O. did not tax the displacement compensation as it was held to be a receipt not in the nature of income. The CIT(A) rejected the contentions of the assessee and enhanced the assessment to the extent of Rs. 2,60,000 by holding that the assessee has not paid any rent.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal held that compensation received by the assessee towards displacement in terms of the Development Agreement is not a revenue receipt and constitutes capital receipt as the property has gone into redevelopment. It observed that in a scenario where the property goes into redevelopment, the compensation is normally paid by the builder on account of hardship faced by owner of the flat due to displacement of the occupants of the flat. The said payment is in the nature of hardship allowance / rehabilitation allowance and is not liable to tax. It observed that the case of the assessee is squarely supported by the decision of the co-ordinate Bench in the case of Devshi Lakhamshi Dedhia vs. ACIT ITA No. 5350/Mum/2012 wherein a similar issue has been decided in favour of the assessee. The Tribunal in that case held that the amounts received by the assessee as hardship compensation, rehabilitation compensation and for shifting are not liable to tax. Accordingly, the Tribunal set aside the findings of the CIT(A) and directed the A.O. to delete the addition made of Rs. 2,60,000.

Sections 120 and 250 – CIT(A) has no jurisdiction to pass orders after a direction from DGIT(Inv.) not to pass any further orders during the pendency of the explanation sought from him on the lapses in adjudicating the appeals – The order passed by him contrary to the directions of the superior officer cannot be said to be an order passed by a person having proper jurisdiction

2. TS-90-ITAT-2021 (Bang) DCIT vs. GMR Energy Ltd. ITA No. 3039 (Bang) of 2018 A.Y.: 2014-15 Date of order: 22nd February, 2021


 

Sections 120 and 250 – CIT(A) has no jurisdiction to pass orders after a direction from DGIT(Inv.) not to pass any further orders during the pendency of the explanation sought from him on the lapses in adjudicating the appeals – The order passed by him contrary to the directions of the superior officer cannot be said to be an order passed by a person having proper jurisdiction

 

FACTS

In the appeal under consideration filed by the Revenue and 82 other appeals and cross-objections filed before the Tribunal, the Revenue requested by way of an additional ground that the orders impugned in these appeals which had all been passed by the CIT(A)-11, Bengaluru should be held to be orders passed without proper jurisdiction and should be set aside and remanded to the CIT(A) for fresh decision by the CIT(A) with competent jurisdiction.

 

It was stated that the CIT(A)-11, Bangalore who passed all the impugned orders committed serious lapses and he was directed by the Director-General of Income-tax, Investigation, Karnataka & Goa, Bengaluru by direction dated 18th June, 2018 not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals. It was the plea of the Revenue that all the orders impugned in these appeals were passed after 18th June, 2018 and are therefore orders passed without jurisdiction and on that ground are liable to be set aside.

 

Without prejudice to the above contention, it was the further plea of the Revenue that by Notification dated 16th July, 2018, issued u/s 120 by the Principal Chief Commissioner of Income-tax, Karnataka & Goa, the appeals pending before the CIT(A)-11 were transferred to the CIT(A)-12, Bengaluru.

 

It was the case of the Revenue that

(i) the CIT(A)-11, disregarding the directions issued by the Principal CCIT, has passed orders that are impugned in all these appeals;

(ii) though the impugned orders are purported to have been passed on dates which are prior to 16th July, 2018, they were in fact passed after those dates but were pre-dated. In support of this claim, the Revenue relied on the circumstance that the date of despatch of the impugned orders has not been entered in the dispatch register maintained by the CIT(A)-11;

(iii) in view of the fact that the date of dispatch is not specifically entered during the period when CIT(A)-11 was directed not to pass any orders, the only inference that can be drawn is that the impugned orders were passed after the appeals were transferred u/s 120 to the CIT(A)-12. By implication, the Revenue contended that the orders impugned were back-dated so as to fall before or on the cut-off date of 16th July, 2018;

(iv) since the orders passed in all these appeals are dated after 18th June, 2018 when the DGIT (Investigation), Karnataka & Goa, Bengaluru directed the then CIT(A)-11, Bengaluru not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals, therefore the orders passed after 18th June, 2018 are illegal and are orders passed without jurisdiction and liable to be set aside.

 

HELD

It is undisputed that the impugned orders in all the appeals were passed after 18th June, 2018. The order by which the DGIT (Investigation), Karnataka & Goa, Bengaluru directed the then CIT(A)-11, Bengaluru not to pass any further appellate orders during pendency of the explanation sought on the lapses in adjudicating the appeals was dated 18th June, 2018. The CIT(A)-11 thus had no jurisdiction to pass any orders in appeal on or after the aforesaid date. The orders passed by him contrary to the directions of the superior officer cannot be said to be orders passed by a person having proper jurisdiction. The Tribunal noted that the CBDT has in paragraph 7 of its instruction dated 8th March, 2018 [F. No. DGIT (Vig.)/HQW/SI/Appeals/2017 – 18/9959] instructed all Chief Commissioners of Income-tax to conduct regular inspections of the CIT(A)s working under them and keep a watch on the quality and quantity of orders passed by them. The instructions further lay down that failure on the part of the Chief Commissioners of Income-tax to do so would be viewed adversely by the CBDT.

 

The Tribunal held that the very action of then CIT(A)-11 in ignoring the binding directions given by the DGIT and proceeding to pass orders resulted in a serious lapse on his part in administering justice. The Tribunal noticed that all the orders impugned in these appeals had been passed between the 5th and the 13th of July, 2018; they numbered around 50 orders, involving different assessees and different issues, which was a difficult task for any appellate authority. The Tribunal agreed with the submission of the standing counsel that the interests of Revenue were prejudiced by the said action of the then CIT(A)-11. The Tribunal held that all these factors vitiate the appellate orders passed by him after 18th June, 2018, even if the allegation of pre-dating of orders is not accepted / proved.

 

Following the decision of the Delhi Bench of the Tribunal in the case of ACIT vs. Globus Constructions Pvt. Ltd. (ITA No. 1185/Delhi/2020; AY 2015-16; order dated 8th January, 2021) on almost similar facts, the Tribunal set aside the orders of the CIT(A) to the respective jurisdictional CIT(A) to decide the appeals afresh in accordance with law after due opportunity of hearing to the parties.

Section 37 – Input service tax credit is deductible u/s 37(1) when such Input Tax Credit is written off in the books of accounts

1. TS-113-ITAT-2021 (Chny) FIH India Private Limited vs. DCIT ITA No. 1184 (Chny) of 2018 A.Y.: 2010-11 Date of order: 8th February, 2021

Section 37 – Input service tax credit is deductible u/s 37(1) when such Input Tax Credit is written off in the books of accounts

FACTS

The assessee engaged in the business of manufacturing, assembling and trading of parts and accessories for mobile phones operated from two units, both located in SEZs. The assessee filed its return of income after setting off brought-forward losses and unabsorbed depreciation under normal provisions of the Act and book profit of Rs. 80,25,61,835 under the provisions of section 115JB.

The assessee followed the method of accounting wherein expenses were debited to the Profit & Loss account excluding service tax. The service tax paid on expenses was shown as ITC adjustable against output service tax payable on the services rendered by it. Since output services rendered by the assessee were exempt from service tax, the assessee made a claim for refund. Upon the rejection of the claim of refund by the Service Tax Department, the assessee reversed the ITC and debited the P&L account with a sum of Rs. 51,65,869 towards service tax written off and claimed it as an expenditure u/s 37(1). The A.O. called upon the assessee to explain why service tax written off should not be disallowed u/s 37(1).

The A.O. was of the opinion that
(i) rejection of the claim of refund of service tax credit cannot impact the P&L account;
(ii) even if it is to be treated as a P&L account item, it was never treated as income at any point of time for it to be written off;
(iii) if the same is treated as claim of deferred expenditure, the same pertains to earlier years and is therefore a prior period item which is not eligible to be claimed as an item of expenditure.

For the above-stated reasons, the A.O. rejected the claim of Rs. 51,65,869 made by the assessee.

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 A.O. has not disputed the fact that the assessee has not debited the service tax component paid on input services into the P&L account. Therefore, there is no merit in his observation that it is not an item of P&L account. The assessee has paid service tax on input services and hence the question of treating the said service taxes as an item of income does not arise because any taxes paid on purchase of goods or services is part of the cost of goods or services which can be either debited to the P&L account when the assessee has not availed ITC, or if the assessee avails ITC then the service tax component is taken out from the P&L account and treated as current assets pending adjustment against output taxes payable on goods or services.

When the application filed by the assessee for refund was rejected by the Department, the assessee had written off the said ITC and debited it to the P&L account. Therefore, the second observation of the A.O. also fails. When the input service tax credit is carried forward from earlier financial year to the current financial year, it partakes the nature of taxes paid for the current financial year and hence deductible as and when the assessee has debited it into the P&L account.

Further, it is a well-settled principle of law by the decision of various Courts and Tribunals that ITC / CENVAT is deductible u/s 37(1) when such ITC is reversed or written off in the books of accounts. The Tribunal relied upon the decision of the Gujarat High Court in the case of CIT vs. Kaypee Mechanical India (P) Ltd., (2014) 223 taxmann 346 and the decision of the Ahmedabad Bench of the Tribunal in the case of Girdhar Fibres (P) Ltd. vs. ACIT in ITA No. 2027/Ahd/2009. The Tribunal held that input service tax credit is deductible u/s 37(1) when such ITC is written off in the books of accounts.

The Tribunal set aside the issue to the file of the A.O. for the limited purpose of verification of the claim of the assessee regarding rejection of refund claim.

COVID IMPACT AND TAX RESIDENTIAL STATUS: THE CONUNDRUM CONTINUES

The last 12 months have resulted in people facing challenges and difficulties coming at them from all sides, and often all at once. At the very inception of the lockdown in late March, 2020, a panic had set in amongst a large number of NRIs and PIOs stuck in India, despite wishing to leave the country to avoid becoming tax resident in India.

The CBDT came out with a welcome Clarification on 8th May, 2020 vide Circular No. 11/2020 and provided relief to such persons becoming accidental and unintentional residents. The accompanying press release, dated 9th May, 2020, provided further assurance from the Government that relief for F.Y. 2020-21 would be given in due course of time.

‘Further, as the lockdown continues during the Financial Year 2020-21 and it is not yet clear as to when international flight operations would resume, a Circular excluding the period of stay of these individuals up to the date of normalisation of international flight operations, for determination of the residential status for the previous year 2020-21, shall be issued after the said normalisation.’

By the time of the actual normalisation of international flight operations, the 182-day mark had already been crossed, thereby resulting in a situation in which a non-resident who was stranded in India due to the lockdown became a tax resident for F.Y. 2020-21. There was indeed a pressing need for a proactive step from the Government to provide a breather to such people stranded in India, or to instruct the CBDT to issue the necessary guidelines for them. However, our Government, recognising tax as a major source for revenue, felt it appropriate to leave the matter untouched and was busy in other priority matters not concerning the hardship that people would face. Accordingly, people had to make several representations to the Government for clarity, since the so-called commitment to issue a relief-granting Circular was never met, nor any statement or indication given by the Government as to its plans.

Finally, after multiple representations to the Government, an SLP had to be filed before the Supreme Court. While hearing the SLP filed by an NRI who gained involuntary residency in India, the Court pronounced that the CBDT was the appropriate body to grant relief and directed it to issue a Circular within three weeks. But despite all these efforts, the CBDT came out with an ineffective Circular and reasoning. On the international platform, the Government is trying to co-operate with OECD countries to tackle tax nuances whereas, on the other hand, this action of the Government reflects its fickle mind-set in relation to tax levy. It is important for the Government to understand that ‘trust is earned when actions meet words’. They should learn from the ancient days when kings collecting bali from the people were considerate not to collect such bali during the periods of drought / floods.

Circular No. 2/2021 was issued on 3rd March, 2021 and instead of granting any relief or concession, as was expected, it was merely a summarisation of the existing provisions of section 6 of the Income-tax Act, 1961 (‘ITA’) and a short explanation of how Articles 4 and 16 of the India-US tax treaty work, amongst other things.

What was the CBDT trying to clarify through this Circular – the provisions of the ITA and the Tax treaty, or guidelines for stranded people in India? It is a perfect example of how CBDT easily discharged its obligation without considering the practical applicability of the Circular. No relief through this Circular means that non-residents have to again make representations and file SLPs before the due date to file returns in India, resulting in prolonged litigation for these NRIs. It is believed that this Circular will severely harm NRIs stranded in India.

On an examination of the reasons in the Circular for not granting any relief, the following points emerge:

ONE. There is no ‘short-stay’ in India
The first reason given by the Circular for not granting relief was that a ‘Short stay will not result in Indian residency’. This reason shows that the CBDT has not considered the situation that by the time international flights were normalised and stranded NRIs could leave the country and return to their country of usual residence, they had already exceeded the threshold of 183 days’ stay in India and become residents. Therefore, for most persons who were stranded in India as on 1st April, 2020 the terminology of a ‘short stay’ in India during F.Y. 2020-21 introduced by the CBDT is highly irrelevant, especially as it was evident that NRIs were forced to remain in India till at least July (when limited flights to the US and France were commenced) and in most other cases till October. Further, in case of several other countries such as Hong Kong and Singapore, flights have yet not resumed.

TWO. Possibility of dual non-residency is no reason for not granting relief
The Circular, while further explaining the rationale for not granting relief, raised an issue which has become a hot topic and a sore point for the Indian Government – the inequity and injustice of double non-taxation. The Indian Government has been focused on non-residents, especially NRIs, avoiding tax in India by ‘managing’ their residential status to remain outside India. Section 6 was significantly amended to tackle this scourge on the Indian exchequer. The Circular states that granting relief for the forced period of stay in India could result in a situation where ‘a person may not become a tax resident in any country in F.Y. 2020-21 even after staying for more than 182 days or more in India resulting in double non-taxation and end up not paying tax in any country.’ Therefore, the Government deems it fit to not grant any general relief.

Never mind that this aspect was not considered relevant while granting relief for F.Y. 2019-20, or that the Government had already committed to granting relief in May, 2020.

Coming back to the reasoning, even if a person ends up becoming a ‘stateless’ person (if relief were hypothetically provided), they would then be unable to seek recourse to any beneficial position under a tax treaty and have all their India-sourced income subject to tax in India anyway. The only tax revenue that the Indian Government would forgo would be in respect of foreign-sourced income, which anyway it has no right to tax. The reasoning defines the intention of the CBDT to tax global income of the NRI stranded in India due to the lockdown. Is the Indian Government morally right to levy tax on such foreign-sourced income under the ‘residence-based’ taxation rules?

Clearly, the answer to this must be an emphatic ‘No’. However, the knife is in the hands of the Indian Government and they would try to tax (i.e., cut) everything which comes their way in the name of legitimate tax collection. Just because NRIs have got stranded in India due to the lockdown by virtue of which they became residents in India satisfying the condition of section 6, the Government feels it has the right to tax their worldwide income. This shows that the Government interprets Indian laws as per its convenience. Further, if the source-country has ‘source-based’ taxation rules like India, then it will levy tax on such income, irrespective of the fact that the income-earner is a non-resident there. If the source-country has given up its right to tax such income arising and originating therein, then that should be of no concern to the Indian Government and remain a matter solely relevant to that Sovereign State.

It is also unfair for the involuntary period of stay in India to be considered while determining residential status. The Delhi High Court in its decision in CIT vs. Suresh Nanda [2015] 375 ITR 172 has articulated this point very well as follows:

‘It naturally follows that the option to be in India, or the period for which an Indian citizen desires to be here, is a matter of his discretion. Conversely put, presence in India against the will or without the consent of the citizen should not ordinarily be counted adverse to his chosen course or interest, particularly if it is brought about under compulsion or, to put it simply, involuntarily. There has to be, in the opinion of this Court, something to show that an individual intended or had the animus of residing in India for the minimum prescribed duration. If the record indicates that – such as for instance omission to take steps to go abroad, the stay can well be treated as disclosing an intention to be a resident Indian. Equally, if the record discloses materials that the stay (to qualify as resident Indian) lacked volition and was compelled by external circumstances beyond the individual’s control, she or he cannot be treated as a resident Indian.’

Besides, the newly-inserted section 6(1A) should have automatically addressed the concerns of the Indian Government of double-non-taxation of ‘stateless’ Indian citizens, if that is the thinking behind non-granting of relief.

The Indian Government seems to be taking a position that because some persons may get too much of a benefit, no relief should be granted to anyone, a position which is both disingenuous and inconsistent. By granting relief, the Indian Government would not have done any favour; instead, it would simply be forgoing a right it normally would, and should, never have had in the first place.

In addition to exposing the income of stranded foreign residents to tax in India, they shall be burdened with the additional responsibility of the disclosures and compliances in India as applicable to residents. In case the foreign assets’ disclosures are not made by such persons, then the Indian Assessing Officer has been given unfettered powers under the Black Money Act wherein he can levy penalties and prosecutions.

Further, they would also lose the benefit of concessional or beneficial tax provisions available to non-residents both under the ITA and a tax treaty. And, if they are engaged in a business or profession outside India or take part in the management of a company or entity outside India, they would risk the income arising to them through such business or profession becoming taxable in India, or the company being considered a resident in India by virtue of its place of effective management being in India. Compliances with tax audit provisions, transfer pricing provisions, etc., also become applicable to such persons and their business transactions when they become resident in India. Additionally, whatever payments such persons would make, whether personal in nature or for their business or profession, would also be subject to evaluation for taxability in India – for example, if a person who becomes resident in India due to being stuck here during the lockdown makes royalty payments in respect of his foreign business to a non-resident, then such royalty would be deemed to accrue and arise in India and be chargeable to tax in India.

These follow-on consequences of becoming a resident are completely ignored by the Government while evaluating the impact of not granting relief, since there is nothing which is going from its pocket instead of falsely piling up the case for taxing such income.

THREE. No tie to break
The Circular explains that the tie-breaker test under tax treaties will come to the rescue of dual-residents. This clarity completely misses its own stand as stated in the Circular in the earlier section, that if someone becomes a resident of India by virtue of their period of stay in India, they will not be able to access the tie-breaker test of the tax treaty because they may not qualify as residents of the country of their usual or normal tax residency. So, how would the tie-breaker test come to the rescue? The Government should take the trouble to explain in detail the difference in stand taken by it in the same Circular. Was the Circular drafted by two different persons applying their minds independently? Further, India does not have a tax treaty with each and every country and any person who is resident of such a country with which India does not have a tax treaty would have no such recourse available, even if he were to become a dual resident. In case of any non-compliance, the Government comes with retrospective clarifications to tax such people. Isn’t this a kind of tax terrorism?

The Circular further states that: ‘It is also relevant to note that even in cases where an individual became resident in India due to exceptional circumstances, he would most likely become not ordinarily resident in India and hence his foreign sourced income shall not be taxable in India unless it is derived from business controlled in or profession set up in India.’

If this is indeed the case, and eventually relief will anyway be granted by operation of the tie-breaker test or MAP (Mutual Agreement Procedure), or foreign source income will anyway not be subject to tax in India, then there should be no reason for the Indian Government to not grant relief pre-emptively and reduce the genuine hardship and burden on accidental residents. By the very reasoning adopted in the Circular, granting relief will not confer any additional benefit upon anyone and therefore the Government should not have had any reluctance and objection to granting such relief.

The issue of tie-breaker also raises the practical difficulty in claiming tax treaty based on non-residential status while filing the return of tax (‘ITR’) in India. There is no provision in the ITR for individuals to claim status as tax treaty non-residents if they are residents under the provisions of the ITA. It has become mandatory to provide details of period of stay in India in the ITR and, therefore, issues shall arise in cases where stay in India exceeds 182 days but the tie-breaker results in non-residence in India.

In such cases, the options are that the filer simply claims all foreign source income as exempt even though his status is disclosed as a resident, or the filer does not fill in the period of stay and files as a non-resident. Filing as a resident may expose him to the need to make unnecessary additional disclosures and compliances, such as in respect of foreign assets. However, if such disclosures are rightly not made, this may attract additional scrutiny and also the potential for proceedings under the Black Money law. Even if the proceedings may not eventually result in any consequence, the nuisance and additional effort and financial burden due to the scrutiny will nonetheless arise. Filing as a non-resident without providing details of period of stay may result in the ITR being considered defective, which has its own consequences. In the absence of any changes to the ITR or clarification on this subject from the CBDT, the fact that such difficulty has not been addressed will add to the anguish and confusion.

FOUR. Employment income
The Circular reiterates the current legal position that employment-related income of an accidental resident will only be subject to tax in India if his stay exceeds 183 days in India or if a PE of the foreign employer bears the salary.

Therefore, the Circular itself acknowledges the fact that many persons will be in India for 183 days or more when it talks about dual non-residency, (but) it ignores this very aspect while discussing taxation of salary and wages.

The salary structure of any employee is designed based on the applicable taxation and labour laws of the jurisdiction where the employee was expected to be exercising his employment. The tax deductions and taxability of perquisites, employment benefits such as pension, social security and retirement benefit contributions, stock options and similar reward schemes, etc., vary greatly from country to country and the calculation is extremely sensitive to the specific tax considerations under which the remuneration package was designed.

Therefore, all those persons stuck in India and exercising their employment in India will unnecessarily have their employment income subjected to tax in India. While there may not be an instance of double taxation, there surely will be instances of unforeseen and unexpected tax consequences on account of differing tax treatments and employment-related tax breaks not being available in India as against the jurisdiction of the employer.

Not merely this, the rates of tax applicable in India may be much higher than the rates of tax applicable in the person’s home country, and given the relatively weaker purchasing power of the Indian Rupee, it is likely that a major portion of the employment-related income would be subject to tax under the 30% tax slab, while the income would not have been subject to such high rates of tax in the home country. This will have a serious cash flow impact due to the additional tax liability to be borne in India.

FIVE. No credit-worthiness
This brings up the next matter which the Circular addressed, i.e., credit of foreign taxes. The Government’s argument is that even if there is a case of double taxation, credit of foreign taxes would be available in India as per Rule 128.

This ignores the concern of many of the accidental residents, that the real problem may not be double taxation but the overall rate of taxation. If the foreign tax liability and effective rate of tax is greater that the Indian rate of tax, there would be no concern. However, in most cases the Indian rate of tax is higher due to which even after eliminating double taxation there would be an additional tax cost borne in respect of Indian taxes. In this respect, the CBDT in its Circular could have clarified that such additional burden shall be refunded to the people taxed overly. On a serious note, if you want to tax people considering a certain scenario, then the Tax Department should also consider a scenario in which it has to refund money to them.

Apart from this, the elimination of double taxation through tax credit is irrelevant to the many Indian emigrants living and working abroad in lower tax or zero-tax rate countries such as the UAE, Bahrain, Oman, Qatar, Kuwait, Bahamas, Singapore, Cyprus, Mauritius, Hong Kong, etc. In such a scenario, the Indian Government is taxing something which it never had the right to tax. Clearly, the Government is taking undue advantage of the pandemic by deriving revenue from the stranded people.

SIX. International inexperience
The Circular then goes on to quote from the OECD Policy Responses to Coronavirus (Covid-19), which stated that the displacement that people would face would be for a few weeks and only temporary and opined that acquiring residency in the country where a person is stranded is unlikely.

This reference to the OECD’s analysis is of 3rd April, 2020, less than a week into India’s lockdown. The Circular relying on a projection in April, 2020 of people being stranded for a few weeks only is absurd given that this Circular is issued in March, 2021 and it is abundantly clear that people were stranded for several months (or even a year) and in almost all cases acquired residency in India.

A majority of OECD countries are in Europe where inter-country and cross-continental travel by road is fairly common and convenient due to the short distances involved. If a person working in France gets stranded in the Netherlands or Belgium, he could simply travel back to France by his own private car – this convenience is surely not available to a person working in the US and stranded in India.

If the Government really did want to rely on international experience to justify its actions, it should have fallen back on something more recent, which considers the situation as it is today, not on what it was in April, 2020 and definitely not an invalidated forecast from the past.

The Circular then mentions what other countries have done and states that the UK and the USA have provided an exclusion or relief of 60 days, subject to fulfilment of certain conditions, while some countries have not provided any relief or have undertaken to provide relief based on the circumstances of each case. The Indian tax authorities often argue that India is not bound by the actions, decisions and interpretations of other countries. This is done especially while denying benefits or adopting positions that are not aligned with the international experience and best practices. Conveniently in this case, the CBDT has taken its cue from international experience!

What is also relevant is the difference in circumstances between India and the other countries. A large number of Indians normally reside and work in other countries – estimated to be more than 13 million NRIs / PIOs globally. The US, the UK, Germany or Australia are more likely to host foreign citizens than have their own citizens working and living overseas. Therefore, these countries are less likely to be concerned about their emigrants accidentally re-acquiring residency under their domestic tax laws from being stranded due to the lockdown. The Indian Government, however, ought to have been more considerate to the plight of some of these 13 million people.

Another argument relied upon by the Circular is the position adopted by Germany which has held that ‘in the absence of a risk of double taxation, there is basically no factual inequity if the right to tax is transferred from one contracting state to another due to changed facts.’

However, this presumes that the taxation system and tax burden faced by the person in either jurisdiction will be similar or comparable. As has been argued above, there are real possibilities that accidental residents will suffer a much greater tax burden as compared to what they would have suffered had they continued to reside in the country of normal residence.

CONCLUSION
The position of the Government is correct to the extent that there are reduced chances of double taxation and that double taxation through dual residency can be mitigated and relieved through operation of tax treaties and credit for foreign taxes. The Circular also provides that persons suffering double taxation and not receiving relief can make an application to the CBDT for specific relief. It, however, ignores several other issues.

It neither acknowledges nor addresses the concerns of the large number of NRIs and PIOs who are normally residing in lower tax or zero-tax jurisdictions and will suffer a much higher tax burden only because an unforeseen global lockdown forced them to be physically present in India. It also ignores the implications arising out of residency in India that go beyond being subject to tax in India.

There would be a large number of persons who were resident in India previously but have recently emigrated to another country, but they become not just resident but also ordinarily resident in India because of their current year’s presence along with their past status and stay. This exposes their global income to tax in India, which is patently unfair.

Such forced residential status may also require them to disclose all their foreign assets in India and if they are unable to do so accurately and exhaustively, it exposes them to implications under Black Money law and severe non-disclosure related penalties. It will also restrict their access to beneficial tax provisions available to non-residents under the ITA simply because they were stranded in India.

Most importantly, however, none of the arguments made by the CBDT in the Circular are new or were not already known before. They were also known in May, 2020 when the Government provided relief for F.Y. 2019-20 and explicitly committed that it would issue a Circular to provide relief in respect of the period of stay in India till the normalisation of international flights.

The second petition filed against the Circular before the Supreme Court by the same NRI who had filed the original SLP makes the argument that the Government is obligated to provide relief based on its earlier promise. It relies on the Supreme Court’s ruling in the case of Ram Pravesh Singh vs. State of Bihar that there was a legitimate expectation of relief based on the fact that under similar facts relief had been provided for F.Y. 2019-20 and it had been promised for F.Y. 2020-21. The doctrine of ‘legitimate expectations’, although not a right, is an expectation of a benefit, relief or remedy that may ordinarily flow from a promise or established practice. The expectation should be legitimate, i.e., reasonable, logical and valid. Any expectation which is not based on established practice, or which is unreasonable, illogical or invalid cannot be a legitimate expectation. It is a concept fashioned by courts for judicial review of administrative action. It is procedural in character based on the requirement of a higher degree of fairness in administrative action, as a consequence of the promise made, or practice established. In short, a person can be said to have a ‘legitimate expectation’ of a particular treatment if any representation or promise is made by an authority, either expressly or impliedly, or if the regular and consistent past practice of the authority gives room for such expectation in the normal course.

In addition to this, the petition argues that the Circular is unconstitutional because it violates the principle of equality before law under Article 14 – there is inconsistency in not granting relief for F.Y. 2020-21, although under similar circumstances relief had been granted for F.Y. 2019-20. Another argument is that not granting relief from being a non-resident violates Article 19 because it interferes with the freedom to practice a trade or profession and places undue restrictions on the same. Lastly, it argues that the Constitution guarantees protection to life and personal liberty and the lockdown was a force majeure situation, where the appellant was forced to remain in India in order to protect his life and liberty – the Circular penalises him for merely exercising this Constitutional right because, if not for the pandemic, he would have travelled back to the UAE and not remained in India.

The fresh petition makes other arguments which have also been made here to seek justice from the Supreme Court in the matter. The CBDT was also possibly aware that it may have to provide additional relief since it has stated in the Circular that based on the applications that will be received it shall examine ‘whether general relaxation can be provided for a class of individuals or specific relaxation is required to be provided in individual cases’. We can only hope that given the almost universally negative response to the Circular, the CBDT relents and provides the much needed, and previously promised, general relief and exclusion. Else, the soon-to-be-heard petition seems to be the last resort for any equitable relief for the NRI and PIO community.

UNDERSTANDING PREPACK RESOLUTION

BACKGROUND OF IBC AND NECESSITY OF PREPACKING THE RESOLUTION
The Insolvency and Bankruptcy Code, 2016 (IBC) was passed four years ago with the objective ‘to consolidate and amend the laws relating to reorganisation and insolvency resolution in a time-bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith and incidental thereto.’ The NCLAT in Binani Industries Limited vs. Bank of Baroda & Anr. laid down the objective of the code as ‘reorganisation and insolvency resolution of Corporate Debtor (CD), maximising value of assets of the company and promoting entrepreneurship, availability of credit and balancing the interests of all stakeholders’.

Since then, the IBC has moved on and benefited with the help of the rich source of knowledge as provided by jurisprudence. After all, it was time for Government to take steps that would further improve the ease of doing business. Especially with the impact of the pandemic, there is every possibility that businesses will suffer from greater stress due to external reasons beyond their control. This could also put many businesses into greater trouble, making them go through the stress of insolvency through the Courts.

The IMF, through its ‘Special Series on Covid’, identifies three potential phases of the crisis, viz., a first phase where there is a need for interim measures to halt insolvency and debt enforcement activity; a second phase, in cases of severe crisis, where transitional measures may be required to respond to the wave of insolvency cases, including special out-of-court restructuring mechanisms; and a third phase in which countries strengthen their regular debt resolution tools to address the remaining debt overhang and support economic growth.

While the harsh truth of such turmoil is flailing and failing businesses, the pressing need is to allow genuine businesses to sustain themselves and provide options for them to recoup and bounce back. Legislative options may create a lucrative, conducive environment to rescue those affected in these challenging times. ‘Prepack’ emerges in the midst of all this as a decoction which combines the formal and informal option to lessen the burden. Addressing this necessity, the Ministry of Corporate Affairs constituted a sub-committee on 24th June, 2020 to propose a detailed scheme for implementation of prepacked and prearranged resolution processes.

As of today a company in stress in India has four options: the Compromise and Arrangement scheme under the Companies Act, 2013; the Corporate Insolvency Resolution Process (CIRP) under the IBC; RBI’s prudential framework for early recognition, reporting and time-bound resolution of stressed assets; and fourth, the out-of-court settlement framework. The then Finance and Corporate Affairs Minister, the Late Mr. Arun Jaitley, once said, ‘I think today may not be the right time to go in for this discussion (informal option) because of the huge rush of companies coming to the insolvency process, but once this rush is over over the next couple of years, and business comes back to usual, honest creditor-debtor relationship is restored on account of IBC, a situation may arise when we may then have to consider a need to marry the two processes together so they may well exist simultaneously’. Thus, the necessity to introduce an ecosystem of informal options was foreseen at the time of legislation of the IBC and prepack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings1.

GETTING TO KNOW ABOUT PREPACK
Prepack is a process to conclude in advance an agreement by a company which is stressed before moving for statutory administration of the same. This provides it an opportunity to continue its business as a going concern and enables the promoter to rationally decide the options, and to save the time and money cost, along with erosion of goodwill, had this been routed through the CIRP channel.

The United Nations Commission on International Trade Law (UNCITRAL) in its ‘Legislative Guide on Insolvency’ uses the word ‘Expedited reorganisation proceedings’ and Paragraph 76 defines prepack as ‘to involve all creditors of the debtor and a reorganisation plan formulated and approved by creditors and other parties in interest after commencement of the proceedings. Reorganisation may also include, however, proceedings commenced to give effect to a plan negotiated and agreed by affected creditors in voluntary restructuring negotiations that take place prior to commencement, where the insolvency law permits the court to expedite the conduct of those proceedings’.

The USA was the first to introduce prepack in the Bankruptcy Reform Act of 1978. It soon gained momentum with more than 20% of the bankruptcies going through prepack2.The plan ‘is negotiated, circulated to creditors and voted on before the case is filed’3.

With a slight variation, the United Kingdom requires an administrator to conclude the sale. The Insolvency Practitioners Association issued a Statement of Insolvency Practice which defines prepack sale as ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an Administrator and the Administrator effects the sale immediately on, or shortly after, appointment.’

In Singapore, the Insolvency, Restructuring, and Dissolution (Amendment) Bill, 2020 proposes to introduce a new prepack scheme for micro and small companies in the Covid-19 environment. An automatic moratorium would come into play when a company is accepted into the scheme. There would be no requirement to convene a meeting of the company’s creditors. Instead, the Court can approve the scheme, provided that the company can satisfy it that if a meeting had been called a majority representing at least two-thirds in value of the creditors would have approved the proposed scheme.

BENEFITS OF PREPACK
Faster resolution and cost effective: The greatest advantage of prepack lies in early disposal of the case. A majority of the terms are negotiated at the stage before the same are administered by the courts, which allows sufficient time for the debtor to fructify the negotiations. The time taken in courts reduces substantially, together with an increase in the possibility of a resolution. This eventually reduces the cost of administrator / Insolvent Professional (IP) consultant. On the other hand, increase in the time involved in the process of resolution would mean that the CD may have to sustain the stress until the resolution, which in turn reduces the value of the business and also the overall chances of resolution. After introduction of the IBC, the time for resolving insolvency also came down significantly from 4.3 years to 1.6 years. Now, prepack intends to bring it down even further. In countries which are in advanced stages of implementation of the insolvency law, such as the UK and the USA, the time of resolution in prepack can be as low as a few hours!

Goodwill retention and value maximisation: The threat to any business during the resolution process is the disruption that it causes on its normal business, which eventually threatens and hampers its goodwill. Even the Act tries to resolve this concern by introducing a moratorium on admission of CIRP, but the concern is that of loss of goodwill which would otherwise impact the right resolution options. Prepack as an option would enable the CD to safeguard the goodwill which otherwise would be impacted in the formal process.

Increases the possibility of resolution: Once a debtor opts for CIRP, he loses control of the decision-making process which goes to the creditors. It is believed that the defaulting debtor must not be in control of the decision-making process, but then this reduces the possibility of resolution and leads to liquidation. The incidental option for a defaulting debtor in CIRP is that of liquidation, but the statistics reveal that debtors that stay long at CIRP are more prone to end in liquidation. Liquidation is a consequence of failed resolution and a non-desirable situation for the debtor, the creditors, the employees, etc. With prepack invoking informal methods, the chances of resolution increase with intent to move with commercial wisdom, which the debtor can assist and resolve.

Less reliance on courts: The report of the sub-committee of the Insolvency Law Committee on prepacked Insolvency Resolution process mentions withdrawal of applications filed for initiation of CIRP in respect of 14,510 Corporate Debtors at pre-admission stage, closure of CIRPs of 218 CDs u/s 12A of the Code, 27 terminations of CIRPs by the Adjudicating Authority (AA), closure of CIRPs on taking note of settlement recorded by the mediator, and even settlements at the level of the Apex Court. The volume of cases is testimony to the success of out-of-court settlements which if nurtured and guided can enable courts to decide and resolve.

CONCERNS IN PREPACK
Transparency: In the existing CIRP, section 29A of the IBC, 2016 imbibes the importance of transparency and concern of involvement of the related party in the process. Over the concerns of serial prepacking or phoenix companies hangs the fear of failure of prepack. This may also necessitate the Government to work the whole process in a controlled environment to ensure that any unscrupulous elements do not fail the process.

Defaulting debtor in decision-making: The process of CIRP shifts the decision-making power from the CD to professionals who are independent and work for the common commercial good of all. This ensures that the CD is not in control of but only a part of the decision-making process. The RP and the COC decide the course of action which is further supervised by the Courts. Prepack in contract empowers the defaulting corporate to decide on the course of resolution, whereas administrator / RP / IP have a limited role in the resolution process, that of overseeing and approval. This ensures that the CD does not hijack the resolution in his favour if left unchecked.

Framework on prepackaged Insolvency Resolution Process as suggested by the sub-committee
Different jurisdictions have legislated prepack under insolvency with various options; but it is necessary to make a law which is country-specific because one size may not fit all. The three principles that the sub-committee suggested to guide the design of the prepack framework are,
(i)    the basic structure of the Code should be retained;
(ii)  there should be no compromise of the rights of any party; and
(iii) the framework should have adequate checks and balances to prevent any abuse.

The report mentions the following as the main features of prepack:

  •  Prepack as an option must be part of the same law which governs IBC and also part of the same legislation.
  •  Prepack as an option must be available to all CDs for any stress, pre-default and post-default.
  •  The CD shall initiate prepack with consent of simple majority of (a) unrelated FCs and (b) its shareholders. No two proceedings – prepack and CIRP – shall run in parallel.
  •  Promoters and management of the CD to be in control of the decision-making process, except for decisions on matters enumerated u/s 28 of the Code, including interim finance, which shall be taken by the CD with the approval of the CoC.
  •  List of documents and reports like outstanding claims, including contingent and future claims, and a draft Information Memorandum, etc., shall be prepared by the CD and certified by the MD.
  •  The moratorium u/s 14 shall be available from the Prepack Commencement Date (PCD) till closure or termination of the process.
  •  IP shall be appointed by unrelated FC’s who shall not run the business like in CIRP but only administer / conduct the process of prepack.
  •  Similar to CIRP, RP shall make public announcements but on electronic platform, he shall verify the claim, constitute CoC (Committee of Creditors), get valuation report, conduct due diligence, make application to AA (Adjudication Authority) in case of avoidance transaction, etc.
  •  As in CIRP, the CoC shall take decisions with regard to approval by majority of votes except that of liquidation which requires 75% vote.
  • ? Section 29A related to persons not eligible to be resolution applicants to remain sacrosanct even in the prepack process.
  •  Prepack to have the Swiss challenge method to counter the first offer to ensure better proposals. Two-option approach: (i) without Swiss challenge but no impairment to Operational Creditors (OCs), and (ii) with Swiss challenge with rights of OCs and dissenting FCs subject to minimum provided u/s 30(2)(b). Prepack should allow 90 days for market participants to submit the resolution plan to the AA and 30 days thereafter for the AA to approve or reject it.

BRIEF ABOUT THE PREPACK INSOLVENCY RESOLUTION PROCESS (PIRP) PASSED BY ORDINANCE DATED 4TH APRIL, 2021


The Government, aware of the urgent need for prepack, has inserted a Prepackaged Insolvency Resolution Process (PIRP) under Chapter III-A in Part II of the IBC through the ordinance route. The following is a brief, along with some highlights, about the process:

  •  An application for initiating a PIRP may be made in respect of a CD classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.
  •  Restrictions have been placed on the CDs who have recently concluded CIRP / PIRP within three years or are undergoing CIRP, or those against whom liquidation order is passed u/s 33.
  •  An FC, not being a related party of more than 66% in value, has to propose an IP to be appointed as the Resolution Professional (RP). The CD shall also obtain approval for filing the PIRP from its FC not being its related parties representing not less than 66% in value of the financial debt due to such creditors.
  •  The majority of directors / partners have to declare that the CD shall file an application for PIRP within the timeframe not exceeding 90 days along with other declarations as required u/s 54A(2)(f).
  •   The special resolution in case of companies should have three-fourths of the total number of partners approving for filing the PIRP.
  •  The IP to be appointed as RP in PIRP is duty-bound to confirm whether the CD confirms the eligibility requirement for application under PIRP.
  •  Fees paid to the IP to perform his duties shall form part of the PIRP costs.
  •  The AA shall, within a period of 14 days of the receipt of the application under PIRP, either accept or reject it after providing seven days’ time to rectify the defects, if any.
  •  The PIRP shall commence from the date of admission of the application by the AA. The PIRP shall be completed within 120 days from its commencement and the RP shall submit the resolution plan within 90 days from the prepackaged insolvency commencement date. If the resolution plan is not approved by the CoC within the stipulated time, then the RP shall file for termination of the PIRP.
  •  Moratorium as provided in sub-section (1) read with sub-section (3) of section 14 shall be applicable and shall cease to exist upon termination of PIRP.
  •  CD shall submit within two days of commencement of PIRP a list of claims and preliminary information memorandum relevant to formulate the Resolution Plan.
  •  Unlike in CIRP, the management of affairs shall vest with the Board of Directors. However, the management may be handed over to the RP if the Committee by a vote of not less than 66% of the voting share in value decides to do so, or the AA is of the opinion that the affairs had been conducted in a fraudulent manner or there has been gross mismanagement.
  •  The CoC shall be constituted within seven days of the prepackaged insolvency commencement date and its first meeting shall be held within seven days of its constitution.
  •  The CD shall submit the base resolution plan, referred to in clause (c) of sub-section (4) of section 54A, to the RP within two days of the prepackaged insolvency commencement date and the RP shall present it to the CoC.
  •  The CoC may approve the base resolution plan for submission to the AA if it does not impair any claims owed by the CD to the operational creditors.
  •  The RP shall invite prospective resolution applicants to submit a resolution plan or plans, to compete with the base resolution plan, in such manner as may be specified.
  •  Sub-section (2) section 14, sub-section 2A of 14, section 14(3(c), section 17, section 19(3), section 18 clause g to e, section 19(2), section 21, section 25(1), clauses (a) to (c) and clause (k) of sub-section (2) of section 25, section 28, section 29, sub-sections (1), (2) and (5) of section 30, sub-sections (1), (3) and (4) of section 31, sections 24, 25A, 26, 27, 28, 29A, 32A, 43 to 51, provisions of Chapters VI and VII of Part II have been applied mutatis mutandis to the PIRP.
  •  If the AA is satisfied that the resolution plan as approved by the CoC under sub-section (4) or sub-section (12) of section 54K, as the case may be, subject to the conditions provided therein, meets the requirements as referred to in sub-section (2) of section 30, it shall, within 30 days of the receipt of such resolution plan, by order approve the resolution plan.

Prepack is a great way if India can take a leaf out of the book of countries which have legislated, administered and have learnt from experience. It may also be necessary to implement the law in a controlled environment but with the caution of not excessively restricting the eco-system which the law would promulgate. This law would stretch to the fullest strength when it is allowed to resolve the stress, provided that it is allowed to be experimented with within the framework, with little interference from courts. Excess legislation and restrictions may dilute the intent of faster resolution; this requires that those involved in the process of prepack are sensitive to the consensus-building mechanism of debtors and creditors. This also means that creditor-debtor must also act maturely during this process as they must realise that the success of this process depends on its negotiation and approval of the same. On the point of restriction, such as the one in section 29A, views are divided on transparency and genuine related-party buyer.

References
1 Bo Xie (2016), Comparative Insolvency Law: The Prepack Approach in Corporate Rescue, Edward Elgar Publishing
2 Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd ed., Cambridge University Press, 2009) 454
3 John D. Ayer et al, ‘Out-of-court Workouts Prepacks and Pre-arranged Cases, a Primer’, (April, 2005), ABI Journal <https://www.abi.org/abijournal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer> [2] (2020) 8 Supreme Court Cases 531

REVISITING AUDITING STANDARDS

EXECUTIVE SUMMARY

Section 149(3) of the Companies Act, 2013 makes a short statement to the effect that, ‘Every auditor shall comply with the Auditing Standards’. This proviso legalised the necessity for auditors to follow Auditing Standards. The recent reports of the National Financial Reporting Authority (NFRA) on the work of the auditors raise a lot of questions about how (and also whether they should) Regulators look at Auditing Standards and whether the expectations of the Regulators from the auditing fraternity are changing.

Background to Auditing Standards

As mentioned earlier, section 143(9) of the Companies Act states that ‘Every auditor shall comply with the Auditing Standards’. This is followed by section 143(10) which clarifies that the Institute of Chartered Accountants of India, in consultation with the National Financial Reporting Authority (NFRA) would recommend Auditing Standards for adoption by the Central Government. Till that time, the Auditing Standards issued by the ICAI would have to be followed.

The ICAI has issued 40 Auditing Standards segregated into seven different areas:

Sl. No.

Area

No. of standards

1

General
principles and responsibilities

9

2

Risk
assessment and response to assessed risks

6

3

Audit
evidence

11

4

Using
the work of others

3

5

Audit
conclusions and reporting

6

6

Specialised
areas

3

7

Standards
on review engagements

2

 

Total

40

These standards cover an eclectic variety of areas and are comprehensive in their coverage to enable auditors of any type of entity to discharge their duty with confidence. The standards within the above broad areas are detailed below:

General principles and responsibilities

The nine Auditing Standards on general principles and responsibilities lay down the foundation for the Auditing Standards on other topics. These Standards cover an eclectic array of areas such as the terms of the audit engagement, quality control, documentation and the auditor’s responsibilities relating to fraud. In addition, they also provide guidance on consideration of other laws and regulations, communicating with Those Charged With Governance (TCWG) and communicating deficiencies in internal control. These are considered to be the general responsibilities of the auditor. While the terms of the audit engagement are best left to the auditor and the client, there should not be a situation where there is no engagement entered into at all just because of familiarity. In a similar vein, both the quality and quantity of the audit documentation maintained are equally important for the audit.

Risk assessment and response to assessed risks

One of the greatest risks in the preparation and presentation of financial statements is that of material misstatement. The six Auditing Standards on risk assessment and response to the risks that have been assessed by the auditor mandate planning the audit of financial statements and understanding the entity and its environment to assess risks of material misstatement. Since no audit can cover a comprehensive review of all transactions, one of the Auditing Standards covers the concept of materiality. It is also important that the auditor conduct some procedures as a response to the risks that he has assessed. The auditor would also have to evaluate the action to be taken on misstatements that have been identified during the audit.

Audit evidence

The importance of reviewing and retaining evidence that has been gathered during an audit can never be over-emphasised. The series of Auditing Standards on audit evidence describes what is audit evidence and provides specific considerations for specific items. External confirmations (such as bank balances and balances of trade receivables) would have to be obtained. As there would be a lot of audit evidence available regarding the entity being audited, the auditor has to use analytical procedures and sampling techniques to ascertain the quantum of evidence that he would need. The set of Auditing Standards on audit evidence provides guidance on transactions with related parties, subsequent events, assessing the going concern concept and obtaining written permissions.

Using the work of others

Many a time during an audit, the auditor has to use the work of other auditors such as Internal Auditors, Concurrent Auditors and Stock Auditors. It is also possible that the auditor may have to use the work of experts such as fair valuers for land and building and financial assets. These areas have been covered in the three Auditing Standards on using the work of others.

Audit conclusions and reporting

The finished product or the end result of an audit assignment is the issuance of the Audit Report. The Audit Report contains different paragraphs such as forming an opinion and reporting on the financial statements, communicating Key Audit Matters in the independent auditors’ report, communicating matters that in the opinion of the auditors need emphasis (Emphasis of Matter) and modification to the opinion in the Independent Auditors’ Report. All of the above areas have been covered in separate Auditing Standards.

Specialised areas

Often, auditors are engaged to attest financial statements prepared in accordance with special purpose frameworks. For example, the Securities and Exchange Board of India (SEBI) mandates auditors to attest the financial statements presented in the draft red herring prospectus that precedes an IPO. The 800 series of Auditing Standards provides guidance on how these should be conducted and reported.

Standards on review engagements

On some occasions, auditors are asked to review historical financial statements and review interim financial information. SEBI requires auditors to perform a limited review of the quarterly results of listed companies. The standards on review engagements have been issued with the intention of enabling auditors to carry out these engagements. Since the review engagements are not audits, it is necessary that the Audit Report states these facts – these and other matters have been covered in the standards on review engagements.

The opinion of the auditors in their Audit Report is based on their conducting the audit on the basis of Auditing Standards prescribed by section 143(10) of the Companies Act, 2013.

In the present environment where business transactions are becoming complex and technology drives almost everything, the task of auditing becomes riskier. Recently, Regulatory investigations and interventions have also focused on compliance with Auditing
Standards.

IS THERE A CHANGE IN THE EXPECTATIONS OF AUDITORS FROM USERS OF FINANCIAL STATEMENTS?

One of the contexts in which the importance of Auditing Standards needs to be viewed is whether there is a change in the expectations of auditors from users of financial statements. In 1896, Justice Lopez ruled in the case of Kingston Cotton Mills that the auditor is a watchdog and not a bloodhound. Those days are long gone. To take an analogy from cricket, auditors these days are more like an umpire who needs to report on anything that needs to be reported by the laws or regulations without fear or favour. Auditing Standards are the tools that the auditor will use to report. Although there is a vast array of Auditing Standards, the users of financial statements cannot expect the auditor to detect well-conceived fraudulent transactions. However, the auditor would be able to sensitise the users of financial statements on areas that are of concern to him. It is up to the management to take note of these and ensure that corrective action is taken. Using Key Audit Matters, Emphasis of Matter and other paragraphs permitted by Auditing Standards, the auditor should be able to red-flag issues that could snowball into a crisis later.

AUDIT RISKS

In the present environment, audit risks have increased manifold. Over the last decade or so, most Regulators all over the world have had to issue negative comments on auditors who failed to report on entities that were deteriorating rapidly and ultimately had to either apply for bankruptcy or be sold at a bargain. A leading real estate company in the UK and a company in the infrastructure development and financing space in India are cases in point. In both these cases, auditors were auditing these companies for a very long time and hence were aware of the pain points. Yet, they failed to report on these. An extract from the report of the NFRA on the auditors of one of the companies reads:

‘This AQR has the objective of verifying compliance with the Requirements of Standards on Auditing (SAs) by the audit firm relevant to the performance of the engagement. The AQR also has the objective of assessing the Quality Control System of the audit firm and the extent to which the same has been complied with in the performance of the engagement.’

As a part of the conclusion, the report states:

‘The instances discussed below of failure to comply with the requirements of the SAs are of such significance that it appears to the NFRA that the audit firm did not have adequate justification for issuing the Audit Report asserting that the audit was conducted in accordance with the SAs. In this connection, the NFRA wishes to draw attention to Response 12 in the ICAI’s Implementation Guide on Reporting Standards (November, 2010 edition) that says that “A key assertion that is made in this paragraph is that the audit was conducted in accordance with the SAs”; and that “If during a subsequent review of the audit process, it is found that some of the audit procedures detailed in the SAs were not in fact complied with, it may tantamount to the auditor making a deliberately false declaration in his report and the consequences for the auditor could be very serious indeed”. It bears emphasis that the very serious consequences referred to would ensue irrespective of whether such non-compliance was or was not associated with a proved financial reporting misstatement. Failure to comply with any of the requirements of applicable SAs indicates that the audit firm has failed to achieve the central purpose of the audit and that there was not an adequate basis to issue the report that it did.’

Even if we assume that such cases should be treated as an exception, the conclusions reached by the NFRA should be a matter of concern to the auditing fraternity.

An issue that needs to be discussed is whether Regulators and Government agencies should be given the power to prescribe Auditing Standards and also review whether auditors have followed these standards. Auditing Standards are a part of the Companies Act, 2013 and auditors who do not comply with these Standards are violating the Act. The Act itself has a number of penal provisions for non-compliance. Hence, getting other Regulators also to penalise auditors would not only result in multiplication of roles but also cause confusion as to who takes the action first. Auditing Standards are best left to the Institute of Chartered Accountants and taking action for non-compliance is best left to the Companies Act.

COVERAGE OF AUDITING STANDARDS

As can be seen from the list tabulated above, Auditing Standards cover an eclectic variety of topics from audit risks to documentation to sampling. If applied in toto, the present set of Auditing Standards should be able to cover all risks that an auditor may face during the audit – the standards would also enable auditors to minimise their risks. However, since Regulators seem to be raising their expectations from the auditors, auditors would need to take extra care to ensure that the audit team has followed all Auditing Standards.

CONCLUSION

From the above discussion it can be concluded that auditors need to focus their attention on the applicability of Auditing Standards to the entity under audit and how they have documented the manner in which the requirements of the particular Auditing Standard have been carried out. The Public Company Accounting Oversight Board (PCAOB) in the United States carries out regular inspections in accordance with the provisions of the Sarbanes Oxley Act. A cursory analysis of their reports reveals that auditors have two options to prove that they have followed all Auditing Standards in an audit:

  •  Maintain and produce documentary evidence that they have followed all auditing standards; and

 

  •  Produce persuasive other evidence, other than oral assertions and explanations.

 

ROLLING OUT ‘COACHING’ IN PROFESSIONAL SERVICES FIRMS

In today’s world of information overload and entertainment addiction, the attention span of most of the younger generation and our grandkids is going down. They are amazingly tech-savvy, smarter and faster than us and even those before us. The ones joining / doing their professional courses are also very clear on the balance between work and life. Those who are joining these professional courses now are comparatively more affluent with time. They are also clear on the need to set aside space to grow.

The earlier understanding of in-depth knowledge and rattling off the sections, sub-sections, clauses and explanations is no longer in vogue. Practical problem-solving in the shortest time is the call of the day.

The advanced world is adapting rapidly to the needs of being able to empower the students to be able to meet the unknown future. The ability to communicate and present effectively have been the most-sought-after skills in the past decade. This decade is seeing ‘coaching / mentoring’ as the most important key to success in the workplace, be it in services, startups, or in professional firms. Lakhs of life coaches are available today on commercial basis but a few do it out of passion. Mentors are few and far between. Readers may Google for the difference between them. Suffice it to say that mentoring is normally longer term and may not be specific to ‘growth’ or ‘profession’ and could be said to lean towards the ‘gurukul’ system.

There can be different coaches for different aspects like profession, sport, life itself.

This article attempts to provide some thoughts on ‘how to’ take up steps that one can adopt for putting a coaching plan in action in a CA firm. It is based on the exercise undertaken in the past two decades with the concentration being on the last year. (The ongoing pandemic gives us the time for both sides!)

WHO CAN BE COACHED?
Anyone can be coached if they are willing. However, most employees / partners may opt out as they see it as an exercise for additional responsibility, intrusion into their privacy, etc. The advantages of getting coached to be more effective (smart), fast-track their growth and reach their potential early could reduce the resistance.

There can be no coaching without the student / professional (hereinafter called student) being convinced that they need to be coached and by that particular person. Their view that distinguished seniors / friends may not be ideal as they could be carrying baggage which can come in the way of open listening needs to be assuaged. Suggestions would include the need to change their thought process, take on disciplined habits which would need them to step out of their comfort zone. The resistance can come in the implementation of suggestions like ‘deliberate gratitude’ where they may need to have open oral acknowledgements with their parents / others.

The objective could be to be able to reach limitation due to past / present events, reframe the ‘stories’ to recognise that they were mere events and nothing more… rather, they were a guide for a broader ‘world view’. It is important to ensure that it is not mixed up with the objective of being advantageous to the firm.

It may also be important to set (a) the purpose, (b) the limits and (c) have a broad agreement on how it would go along as it is a strong commitment of time and proactive effort on both sides.

If there is too much resistance then the student may have to be encouraged to find out more by watching various coaching videos, read articles / books on the subject and learn like ‘Eklavya’.

WHO CAN COACH?
There is no one born to coach but those having good interpersonal skills and compassion could find it easier. Both these skills can be cultivated and one can learn about them on the internet. The competencies which can be focused on and which are needed to be a coach / mentor could be:

1) Listening deeply to what is being shared without distractions, disturbances and interruptions. The coach should even be able to catch some of the unsaid things.
2) Learning to ask the appropriate questions to understand the student / professional’s mental make-up and possible ‘block’ which they cannot see (reading between the lines, as they say). Avoid judging in the interaction.
3) Be aware of the general characteristics of the generation (a result of the environment) but not to be judgmental while listening. Understand Maslow’s Hierarchy of needs for arriving at the real reasons for decisions taken.
4) Get to understand possible and available ‘tools’ such as workbooks for coaching.
5) Understand that even managers / partners have a need to be loved, belonging, worthiness, constant validation and at times feeling that they are not enough.
6) Dealing with coaching setbacks with the belief that one is striving to make a difference.
7) Need to be self-motivated as well as motivating all the time and avoid blame and complaints about the students.
8) A coach who is in a rush or insists on completion of one stage can get a student disconnected.
9) If possible, the coach should have mindfulness (being aware of his feelings, thoughts and sensations), heartfulness (being sincere and warm in feelings / emotions) and soulfulness (expressing deep feelings and emotions).

ALTERNATE WAYS / MEANS OF COACHING
The need to understand the ways and means (tools) to coach gives us the needed confidence to take up this onerous contributing exercise. Some of the ways could be as under:

I   Learning to be a good coach as explained above is most important;
II  Listen to clients – are they holding back – past, present or future? Where excited, sad, body language, listen for frustrations / challenges / what is holding them back, demotivating factors;
III Thinking to spark ideas / alternatives for them to be even better. Insightful real self-stories along with well-known stories of others could strike a chord. Use of metaphors is found relatable and acceptability is high;
IV Communicating – how we reply (judging vs. empathetic); absolute truth vs. relative truth – circumstances / environment being considered;
V  Long-term habits / behaviour changes and sticking to it by journaling, habit tracker, daily empowering routine can be emphasised;
VI Emotional Awareness / Mapping: +ive / -ive emotions ranked. Those below the average improved (issue may be self-esteem, negative environment, meaning given to events) and those with high marks also sharpened;
VII    Emotional Training.

All emotions to be detailed as and when felt – not vague. Once labelled, suggestions could be:
1. Distance self from the incident / communication – as if it is happening to someone else;
2. If in five years it would not mean anything, do not spend more than five minutes on it;
3. Look at the incident from the other person’s point of view if something keeps coming back.

POSSIBLE METHODOLOGY OF COACHING (HOW TO?)
a) Categorise the professional into the five major types of human beings to be able to customise the coaching. (A = Director; B = Socialiser; C = Thinker; D = Supporter; and X = Combination of two or more.)

b) Understand the past, present with possibly a strength / weakness assessment.

c) Understand / agree on the need for coaching and acceptability of the coach.

d) Establish ‘connect’ by listening actively.

e) Set framework and periodicity as per mutual convenience of the student / professional.

f) In the physical meeting (preferred) or virtual one be open and transparent as a coach and if some resistance is observed, do not hurry or decide, probe sensitively – give time.

g) Getting the understanding of the emotional intelligence which rules each and every one of us by self and later the students’ / professionals’ ranking. This could lead to self-realisation and the beliefs / areas where one may like to focus to be more balanced.

h) Ability to reframe the issue by placing for consideration the possibilities is vital. The shame, incompetence, helplessness expressed to be presented that one is enough, one is as good as the next or the opportunity to grow, respectively.

i) Guide in the setting up of SMART goals by looking at ‘wow’ goals, why that goal is important (three to five reasons), sub-goals to achieve the goal, how one needs to ‘be’ to achieve the goals. Finally, how to achieve to-dos with timelines on yearly, quarterly, monthly, weekly and daily action points.
(a)    This is a crucial part where sharing of incidents in one’s life, being vulnerable connects one better.
(b)    Arriving at achievable goals with areas of ‘higher calling’ may be vital: envisioning a better world, being an inspirational person, believing that small daily acts can lead to the astounding results that one wants.

j) Look at facilitating the goals set with genuine positive celebratory acknowledgements for the improvement as perceived by the student / professional is a key to continuation.

k) Seek out the challenges and see the alternatives as identified by the student. Do not be in a hurry to provide the solutions. Rather, guide them to the answers to ensure ownership of the solution.
l) Proven technologies such as focus on being rather than doing, deliberate gratitude, regular exercise, breathing properly, meditation, journaling, letting go of the past and learning to forgive could be part and parcel of this coaching.

m) Follow through at least for six months to one year on a monthly basis to get the desired results.

n) Much more by involving and growing in coaching.

CONCLUSION
The world, India and our profession, all of them need heroes. Everyone has the capacity and potential to be that in at least one area. One cannot think of a better contribution / legacy than leaving the world better off  with committed, professional global citizens / leaders. Coach yourself and coach all at the office for an empowered and happy office with no limits on growth of the individual or firm.

COGNIZANCE OF THE OFFENCE OF MONEY-LAUNDERING

INTRODUCTION
.
Newspaper reports show that, on an average, every week in two to three cases a businessman, politician, banker or bureaucrat is booked under the Prevention of Money-Laundering Act (PMLA). Apart from attachment of property and freezing of bank accounts, another action started simultaneously against such a person is initiation of criminal proceedings. On a complaint made u/s 44 of the PMLA, investigation commences and the Special Court may take cognizance of the offence of money-laundering.

However, the terms ‘cognizance of offence’ and ‘cognizable offence’ are not defined in the PMLA. Indeed, section 65 provides that the provisions of the Code of Criminal Procedure, 1973 (CrPC) shall apply insofar as they are not inconsistent with the provisions of the PMLA for arrest, search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Accordingly, in the absence of any provision in the PMLA, one may refer to the provisions of the CrPC on a given aspect such as the definition of ‘cognizable offence’. This
term is defined in section 2(c) of the CrPC as follows:

‘Cognizable offence’ means an offence for which, and ‘cognizable case’ means a case in which, a police officer may, in accordance with the First Schedule or under any other law for the time being in force, arrest without warrant.

From a review of the above-mentioned definition one can see that where the offence is covered under the First Schedule of the CrPC or under any other law for the time being in force, the police officer may arrest without a warrant.

A reference to the First Schedule shows that it provides the following classification of offences:
• cognizable or non-cognizable,
• bailable or non-bailable, and
• the court which will try the offence.

Part II of the First Schedule refers to ‘classification of offences under other laws’. It provides that offences punishable with imprisonment for more than three years would be cognizable and non-bailable.

A reference to section 4 of the PMLA shows that the offence of money-laundering is punishable with rigorous imprisonment for more than three years which may extend up to seven years (ten years in the case of NDPS offences).

Accordingly, on the basis of the criteria specified in the First Schedule of the CrPC, the offence of money-laundering is cognizable.

WHETHER THE OFFENCE OF MONEY-LAUNDERING IS COGNIZABLE?
The issue whether the offence of money-laundering is cognizable had come up for consideration before the Courts in the following cases:
•  Jignesh Kishorebhai Bhajiawala vs. State of Gujarat [2018] 90 taxmann.com 320 (Guj);
• Rakesh Manekchand Kothari vs. UoI (Manu/Guj/0008/2015);
• Chhagan Chandrakant Bhujbal vs. UoI [2017] 78 taxmann.com 143 (Bom);
• Vakamulla Chandrashekhar vs. ED [2019] 356 ELT 395 (Del);
• Virbhadra Singh vs. ED (Manu/Del/1813/2015);
• Moin Akhtar Qureshi vs. Union of India [2017] 88 taxmann.com 66 (Del);
• Rajbhushan Omprakash Dixit vs. Union of India [2018] 91 taxmann.com 324 (Del).

The Courts gave views which were divergent and in many cases the matter was carried to the Supreme Court by way of SLPs which are pending.

However, an Explanation to section 45 has now settled the issue. The Explanation was added to section 45 w.e.f. 1st August, 2019 to clarify the meaning of ‘offence to be cognizable and non-bailable’. It reads as follows:

‘Explanation. – For the removal of doubts, it is clarified that the expression “Offences to be cognizable and non-bailable” shall mean and shall be deemed to have always meant that all offences under this Act shall be cognizable offences and non-bailable offences notwithstanding anything to the contrary contained in the Code of Criminal Procedure, 1973 (2 of 1974), and accordingly the officers authorised under this Act are empowered to arrest an accused without warrant, subject to the fulfilment of conditions under section 19 and subject to the conditions enshrined under this section’.

Thanks to this clarification, the controversies faced by the Courts in the above-mentioned decisions have been put to rest.

COGNIZANCE OF THE OFFENCE OF MONEY-LAUNDERING – PRECONDITION

There are two provisions which refer to the precondition to take cognizance of the offence of money-laundering.

Section 44(1)(b) of the Prevention of Money-Laundering Act, 2002 (PMLA) provides that, notwithstanding anything contained in the CrPC, a Special Court may take cognizance of the offence of money-laundering upon a complaint made by an authority authorised in this behalf under the Act, without the accused being committed to it for trial.

The second Proviso to section 45(1) lays down the basic precondition for taking cognizance of an offence punishable u/s 4. It categorically provides that the Special Court cannot take such cognizance except upon a written complaint by the Director or any officer of the Central or State Government authorised by a general or special order.

‘Taking cognizance of’ – connotation of
The expression ‘taking cognizance of’ is not defined or explained in the PMLA. In section 44, too, there is no clarification as regards the meaning of this expression. However, its meaning has been examined by the Supreme Court and the High Courts in various decisions. The propositions laid down by the Courts may be reviewed as follows:

• Whether a Magistrate has taken cognizance of an offence depends on the facts and circumstances of each case and no rule of universal application can be laid down on this issue1.
• Taking cognizance means cognizance of an offence and not of an offender. ‘Cognizance’ indicates the point of time when a Magistrate takes judicial notice of an offence. It is different from initiating a proceeding. Rather, it is a condition for initiating a proceeding2.
• Taking cognizance does not involve any formal action but occurs as soon as a Magistrate applies his mind to the suspected commission of an offence and takes first judicial notice of an offence on a complaint or police report or on his own information.3
• The Magistrate takes cognizance once he makes himself fully conscious and aware of the allegations made in the complaint and decides to examine or test the validity of the said allegation4.
• At the stage of taking cognizance, only the prima facie case is to be seen. It is not open to the Court to appreciate the evidence at this stage with reference to the material5.
• For taking cognizance of an offence, the Court has to merely see whether prima facie there are reasons for issuing process and whether the ingredients of an offence are on record6.
• ‘Taking cognizance of offence’ means taking notice of an offence which would include the intention of initiating judicial proceedings. It is not the same thing as issuance of process. It is entirely different from initiation of judicial proceedings; rather, it is a condition precedent to the initiation of proceedings by the Magistrate7.

Private complainant has no locus standi
Having regard to the provisions of section 44(1)(b) and section 45 of the PMLA dealing with a complaint to the Special Court to take cognizance of an offence punishable under the PMLA, an important question that frequently arises is whether a complaint filed by a private complainant can be entertained by the Special Court.

This question was addressed by the Delhi High Court in the Raman Sharma case8. While answering it in the negative, the High Court made the following observations:

‘The question before the learned Trial Court was whether the Trial Court can entertain a complaint filed by a private party for the offence committed under the Prevention of Money-Laundering Act. On this issue, section 44(b) of the Act clearly stipulates that the Special Court may, upon a complaint made by an authorised person in this behalf under this Act, take cognizance of an offence under section 3. Further, the second Proviso to section 45 makes it clear that the Special Court shall not take cognizance of offence except upon a complaint in writing made by the Director, or any officer of the Central Government or State Government authorised in writing in this behalf by the Central Government.

_________________________________________________________________________________

1   Nupur Talwar vs. CBI [2012] 1 SCC (Cr) 711

2   Ajit Kumar vs. State of WB; AIR 1963 SC 765

3   Anil Sawant vs. State of Bihar (1995) 6 SCC 142; R.R. Chari vs.
State of
UP 1951 CrLJ 775(SC); Darshan Singh Ram Kishan vs. State of Maharashtra 1971
CrLJ 1697 (SC)

4   Narayandas Bhagwandas Madhavdas vs. State of WB; 1959 CrLJ
1368(SC)

5   Kishan Singh vs. State of Bihar 1993 CrLJ 1700 SC

6   Chief Enforcement Officer vs. Videocon International Ltd.
[2008] 2 SCC 492

7   State of Karnataka vs. Pastor P. Raju: AIR 2006 SC 2825; State
of WB vs. Mohd Khalid AIR 1995 SC 785

8   Raman Sharma vs. Director, Directorate of Enforcement (2020)
113
taxmann.com 114 (Del)

Accordingly, the learned Trial Court opined that the aforesaid two provisions make it clear that the Court cannot entertain a complaint filed by a private complainant for the offence committed under the Act’.

Cognizance of supplementary complaint
In the context of a supplementary complaint, a question arises whether cognizance is required to be taken again on the filing of a supplementary complaint? This question has been addressed by the Delhi High Court in Yogesh Mittal vs. Enforcement Directorate (2019) 105 taxmann.com 336 (Del). While answering it in the negative, the Delhi High Court made the following observations:

‘It is thus trite law that cognizance is taken of the offence and not the offender. It is also well settled that cognizance of an offence / offences once taken cannot be taken again for the second time. Since this Court has already taken a view that a supplementary complaint on additional evidence qua the same accused or additional accused who are part of same larger transactions / conspiracy is maintainable, however, with the leave of the Court and cognizance is taken of the offence / offences, not the offender and in case no new offence is made out from the additional material collected during further investigation, supporting an earlier offence on which cognizance has already been taken or additional accused are arrayed, no further cognizance is required to be taken’.

Procedural aspect of the cognizance of the offence of money-laundering
Apart from the above-mentioned substantive aspects of cognizance of the offence of money-laundering, it is equally necessary to be aware of procedural aspects relating to the same. Such procedural aspects are not specified in the PMLA.

Section 65 of the PMLA provides that the provisions of the CrPC shall apply, insofar as they are not inconsistent with the provisions of the PMLA, for search and seizure, attachment, confiscation, investigation, prosecution and all other proceedings under the PMLA.

Hence, a reference may be made to Chapter XII of the CrPC [Information to the Police and their Powers to Investigate]. This Chapter lays down the procedure to be followed for investigation of cognizable or non-cognizable offences.

A reference may be made to the following provisions relating to a cognizable offence:
• Section 154 – Information in case of cognizable offence,
• Section 157 – Procedure for investigation of cognizable offence,
• Section 158 – Report to Magistrate, how submitted,
• Section 159 – Power to hold investigation or preliminary inquiry,
• Section 160 – Police officer’s power to require attendance of witnesses,
• Section 161 – Examination of witnesses by Police,
• Section 167 – Procedure when investigation cannot be completed in twenty-four hours,
• Section 172 – Diary of proceedings in investigation,
• Section 173 – Report of police officer on completion of investigation.

A review of the above-mentioned provisions of the CrPC in the context of certain provisions of the PMLA would show that the PMLA does contain the following provisions which are analogous to corresponding provisions of the CrPC:
• Section 19 of the PMLA empowers the ED to arrest a person u/s 19 if, on the basis of material in its possession, it has reason to believe that a person is guilty of an offence punishable under the PMLA.
• Proviso to section 44(1)(b) of the PMLA (inserted w.e.f. 1st August, 2019) requires that upon completion of investigation where it is found that no offence of money-laundering was committed, just like section 173 of the CrPC, the ED is required to submit a closure report to the Special Court.
• However, in respect of the other provisions of Chapter XII of the CrPC, such as filing of FIR, maintaining a case diary, etc., the PMLA does not contain analogous provisions.

CONCLUSION
Often, clients approach their chartered accountants with the show cause notice received by them from an Enforcement Officer alleging that an offence under the PMLA has been committed. The clients seek advice on the manner of giving a reply. That apart, a number of questions are raised by clients in respect of the consequences of various actions under the PMLA, such as provisional attachment of property, arrest, search and seizure, etc.

To advise clients on the proper course of action it is necessary for us to familiarise ourselves with basic knowledge of the main provisions of the PMLA. This will facilitate proper steps to be taken by the client during adjudication and other proceedings under the PMLA and briefing the arguing Counsel engaged by the client for representation before the Special Court.

I HAD A DREAM

The intensity was brewing slowly in the court. Spectators were biting their nails, not knowing which shot will be fired next. Both players were not letting their guard down. The crowd was silent, the referee’s movement oscillated with the player’s delivery and the linesman kept a check on every movement. The match was telecast live on various channels. Young aspirants were seeing their heroes showcasing their skills – and just then the siren went berserk.

I woke up shaking, shut the alarm and realised that it was a dream. Although it might have seemed like that, but it was not a match at the Australian Open, rather, it was two learned tax experts arguing their case in the Income Tax Appellate Tribunal. It was telecast live on the ITAT’s channel and subscribers could watch any hearing going on across the country. ‘What a dream’, I whispered to myself, considering that it might have been the after-effect of the recent budget proposal of turning the ITAT faceless. However, instead of ruminating on the bizarre story, I thought about daydreaming and penned down my thoughts on my wish list for the future of the Income Tax Appellate Tribunal (ITAT).

The ITAT was established in 1941 and has been the torch-bearer of judicial fairness in the country. It can be compared to cricketer M.S. Dhoni in his heydays. It is the last fact-finding authority (the finisher), the first appellate authority outside the Income Tax Department (the ’keeper) and has led the way for being the Mother Tribunal of all the other tribunals in the country (the Captain). And the fact that the Department winning ratio in ITAT is just 27%1, it overturns many high-pitched assessments (the DRS winner) and it keeps on doing its work without making much of a fuss (the cool-headed).

I still remember the first day when I entered the Tribunal as a first-year article assistant. Though my only contribution to the paper book at that time was numbering the pages, I realised the holiness of the inner sanctum of the Tribunal when my manager insisted that I be meticulous on page numbering and he even reviewed the same after I finished it. The showdown was spectacular and I was awestruck by the intellect and inquisitiveness shown by the Honourable Tribunal members.

_______________________________________________________________________________
1    Economic Survey, 2017-18
That was the story of the past; now let’s focus back on the dream. The ITAT has stood the test of time and it is only possible because it is agile and adaptive to changes. Keeping with that spirit, I present my 7-point wish list for the future of the ITAT.

1. Less-Face and not Face-Less: Changes which might not have been sought by a Chief Technical Officer of an entity in a decade have been brought by Covid-19. Companies adapted and learnt to work from home and now are seeing multiple ways of saving costs through technical upgradation. Similarly, all cases in the Tribunal should be categorised into three: (a) Basic – Does not require a hearing and can be judged just based on submission; (b) Complex – Requires video hearing; and (c) Complex and high value – Requires in-person hearing. This will be cost and time-efficient for the Tribunal, the tax practitioners and the clients. Since in-person attendance will not be required, it will open a lot of opportunities for tax practitioners from tier-2 and tier-3 cities to grow their litigation practice.

2. One Nation – One Law – One Bench: In spite of numerous benches, currently there is a huge backlog of cases (88,0002). With the technological upgradation (mentioned at point 1 above) in place, Tribunal members from across the country could preside over hearings related to any jurisdiction. This will not only reduce the workload from overloaded benches but will also reduce the hectic travelling of Tribunal members who go on a tour to set up benches in several locations. This may also result in a spurt in the setting up of additional benches and Tribunals which can work in two shifts, having separate members if required.

3. Jack of all trades and master of one: A decade back, the accounting profession was mostly driven by general practitioners who were masters in all subjects. With rising complexities and frequent changes in the law, very few can now deal with all the intricacies of even a single income tax law. Most of the big firms have separate teams for Transfer Pricing, International Taxation, Individual Taxation, Corporate Taxes and so on. Owing to these complexities, the Honourable Tribunal members must spend a lot of time studying minute details of every case. If a ‘dynamic jurisdiction’ is in place (see point 2), judges of a specialised area / section can preside over all similar cases. This will ensure detailed, in-depth discussion on each topic and the results will be similar and swifter.

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2

https://timesofindia.indiatimes.com/business/india-business/88000-appeals-pending-before-income-tax-appellate-tribunal-chairman/articleshow/74322517.cms

4. OTT platform: Online telecasts of Tribunals can be done for viewers which will not only help tax practitioners and students learn some technical aspects, but will also help them to learn court craft. This will give confidence to newcomers and more lawyers and chartered accountants would be inclined to join litigation practice.

5. ETA: Currently, a lot of the time of a professional is spent waiting for his hearing. Once full digitisation kicks in with video conferencing facility, an ETA (Expected Time of Appeal!) could be provided. This would help tax professionals to schedule their day better.

6. Error 404 – Page not found: Many times, digitisation leads to further problems rather than solutions. A robust internal technical system which allows uploading of documents without size limit, writing of replies without word limit and allowance of documents to and from in the hearing would help the cause of e-hearing. Additionally, the facility of explaining through a live digital whiteboard and PowerPoint presentation would be the cherry on the cake.

7. Circular reference: Often, a case is remanded back to the Assessing Officer for finding the facts. Then, the whole circular motion of the A.O., CIT(A) and ITAT starts once again, which delays the decision-making. With the help of technological advancement, if a special cell is created at the ITAT level to finalise the facts and present them to the bench, it would surely ensure speedy justice.

The list can go on and on with the emphasis on technological upgrading and efficient utilisation of resources. However, the one thing that I don’t want to be changed is the way in which ITAT has upheld the principle of natural justice. This is one thing by which I was mesmerised as a young kid and I want any other person joining the profession to feel the same. I would be extremely grateful if some portion of my dream does come true.

Jai Hind! Jai Taxpayers!

INTRODUCTION AND BACKGROUND OF MLI, INCLUDING APPLICABILITY, COMPATIBILITY AND EFFECT

The development and roll-out of Multilateral Instruments or MLI is the latest global tax transformational process under the BEPS initiative. The BCAJ, in this Volume 53, will run a series of articles by practitioners to bring out basic concepts, de-jargonise terminology and bring out practical implications and deal with hurdles that they bring in our day-to-day practice. We would welcome your comments and suggestions and even generic questions which can be taken up by the authors.

A. INTRODUCTION TO MLI
1. The Action Plan on Base Erosion and Profit Shifting (the BEPS Action Plan), published by the Organisation for Economic Co-operation and Development (OECD) at the request of the G20, identified 15 actions to address BEPS in a comprehensive manner and set deadlines to implement those actions. Action 15 of the BEPS Action Plan provided for the development of a Multilateral Instrument (MLI).

2. As per the Explanatory Statement to the MLI, its object is to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting i.e., tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid.

3. FAQ 1 of Frequently Asked Questions on MLIs explains that the MLI helps fight BEPS by implementing the tax-related treaty measures developed through the BEPS Project in existing bilateral tax treaties in a synchronised and efficient manner. These measures will prevent treaty abuse, improve dispute resolution, prevent the artificial avoidance of permanent establishment status and neutralise the effects of hybrid mismatch arrangements.

B. IMPORTANT EVENTS OF MLI AND MLI STATISTICS
1. Background of MLI – from conception to entry-into-effect1: On 12th February, 2013 the report ‘Addressing Base Erosion and Profit Shifting’ (BEPS) was published recommending the development of an ‘Action Plan’ to address BEPS issues in a comprehensive manner. In July, 2013 the OECD Committee on Fiscal Affairs (CFA) submitted the BEPS Action Plan to the G20 identifying 15 actions to address BEPS in a comprehensive manner and set out deadlines to implement those actions. Action Plan 15 interim report provided for an analysis of the possible development of a Multilateral Instrument (MLI) to implement tax treaty-related BEPS measures. Based on the Action 15 interim report, a mandate was developed by the CFA in February, 2015 to set up an Ad hoc Group for the development of an MLI which was also endorsed by the G20 Finance Ministers and the Governors of Central Banks. The development of MLI was open for participation of all interested countries on an equal footing. On 24th November, 2016 the Ad hoc Group concluded the negotiations and adopted the text of the MLI as well as its accompanying Explanatory Statement which was signed by representatives of over 70 governments on 7th June, 2017 at a high-level signing ceremony in Paris. Thus, on 1st July, 2018, the MLI began its legal existence. However, the MLI would enter into force with respect to each of its parties on the first day of the month following three calendar months after the deposit of their instrument of ratification, acceptance or approval.

2. Applicability of MLI: As stated earlier, the MLI and its explanatory statement were adopted by the Ad hoc Group on 24th November, 2016 and MLI began its legal existence on that date. The first high-level signing ceremony took place on 7th June, 2017 when India signed the MLI by depositing its provisional document of notifications and ratifications. Thereafter, it filed its final document of notifications and ratifications on 25th June, 2019. As on 18th February, 2021, 95 tax jurisdictions are signatories to the MLI as per the website2 of OECD. Out of these, the MLI has come into effect qua 57 tax jurisdictions, including India. With reference to India, as per the MLI Matching database available on the OECD website3, out of its 90 tax treaties with other countries, 60 tax treaties are Covered Tax Treaties (CTAs). In other words, 60 tax treaties would stand modified by the MLI. Out of the said 60 treaties, MLI has already come into effect or is to come into effect qua India with respect to 42 tax treaties as the treaty partners have already deposited their final instrument of notifications and ratifications. Thus, with regards to the other 18 treaties (60 minus 42), the MLI would come into effect only when the necessary procedures with regard to deposit of final instruments of notifications and ratifications are complied with by the treaty partners.

1   https://www.oecd.org/tax/treaties/multilateral-instrument-BEPS-tax-treaty-information-brochure.pdf

  1. Global list of countries in respect of which MLI has come into effect as on 18th February, 2021:As stated earlier, MLI has already come into effect qua 57 countries globally as on 18th February, 2021. To get a detailed list of countries and to be updated with the latest position, one may go to the OECD website4 and click on ‘Signatories and Parties (MLI Position)’.

4. Countries with which MLI is in effect qua India or is to come into effect for India5:


Sl. No.		 Contracting jurisdiction Entry into effect with respect to withholding Entry into effect with respect to other taxes Sl. No. Contracting jurisdiction Entry into effect with respect to withholding Entry into effect with respect to other taxes
1 Albania 01.04.2021 01.07.2021 22 Latvia 01.04.2020 01.08.2020
2 Australia 01.04.2020 01.04.2020 23 Lithuania 01.04.2020 01.04.2020
3 Austria 01.04.2020 01.04.2020 24 Luxembourg 01.04.2020 01.04.2020
4 Belgium 01.04.2020 01.04.2020 25 Malta 01.04.2020 01.04.2020
5 Canada 01.04.2021 01.06.2020 26 Malaysia 01.04.2022 01.12.2021
6 Croatia 01.04.2022 01.12.2021 27 Netherlands 01.04.2020 01.04.2020
7 Cyprus 01.04.2021 01.11.2020 28 New Zealand 01.04.2020 01.04.2020
8 Czech Republic 01.04.2021 01.03.2021 29 Norway 01.04.2020 01.05.2020
9 Denmark 01.04.2021 01.07.2020 30 Poland 01.04.2020 01.04.2020
10 Egypt 01.04.2021 01.07.2021 31 Portugal 01.04.2021 01.12.2020
11 Finland 01.04.2020 01.04.2020 32 Qatar 01.04.2020 01.10.2020
12 France 01.04.2020 01.04.2020 33 Russia 01.04.2021 01.04.2020
13 Georgia 01.04.2020 01.04.2020 34 Saudi Arabia 01.04.2021 01.11.2020
14 Iceland 01.04.2021 01.07.2020 35 Serbia 01.04.2020 01.04.2020
15 Indonesia 01.04.2021 01.02.2021 36 Singapore 01.04.2020 01.04.2020
16 Ireland 01.04.2020 01.04.2020 37 Slovak Republic 01.04.2020 01.04.2020
17 Israel 01.04.2020 01.04.2020 38 Slovenia 01.04.2020 01.04.2020
18 Japan 01.04.2020 01.04.2020 39 Ukraine 01.04.2020 01.06.2020
19 Jordan 01.04.2021 01.07.2021 40 United Arab Emirates 01.04.2020 01.04.2020
20 Kazakhstan 01.04.2021 01.04.2021 41 United Kingdom 01.04.2020 01.04.2020
21 Korea 01.04.2021 01.03.2021 42 Uruguay 01.04.2021 01.12.2020

2   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

3   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

4   http://www.oecd.org/tax/treaties/multilateral-convention-to-implement-tax-treaty-related-measures-to-prevent-beps.htm

5              https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions

  1. India’s significant treaties which are not CTAs under the MLI:
Sl. No. Country Remarks
1 Mauritius Kept India out of its CTA list
2 China Though no CTA, but treaty with China amended recently on lines of MLI
3 United States of America MLI not signed
4 Germany Kept India out of its CTA list
  1. ENTRY INTO EFFECT OF MLI, i.e., EFFECTIVE DATE OF APPLICABILITY OF MLI BETWEEN INDIA AND ITS TREATY PARTNER
  2. MLI 34 deals with ‘entry into force’ and MLI 35 deals with ‘entry into effect’. There is a difference between the two. ‘Entry into force’ indicates the date of adoption of the MLI by a country which is determined with reference to the date of filing the instrument of ratification by it. By itself, ‘entry into force’ does not make MLI applicable. It only signifies the MLI position adopted by a particular country. On the other hand, ‘entry into effect’ indicates the date of applicability of MLI between two countries. The ‘entry into effect’ makes MLI applicable and effective qua the two contracting states. The ‘entry into effect’ is determined by taking into consideration the dates of ‘entry into force’ of two contracting states.

2. MLI 35(1)(a) and (b) provide for different timelines for entry into effect of MLI in respect of taxes withheld at source and entry into effect of MLI in respect of all other taxes, respectively. The application of different timelines for withholding and other taxes could vary based on the interpretation of principles of levy of tax and its recovery and the domestic tax laws of contracting states dealing with the levy and recovery of tax.

3. We may consider one possible interpretation while being mindful of contrary views. In the Indian context, withholding in respect of payments to non-residents u/s 195 would apply in respect of all sums which are chargeable to tax. Ordinarily, chargeability to tax and withholding are inseparable. The obligations of a non-resident do not get discharged merely because taxes are liable to withholding. Recourse can be had to non-resident where tax is not withheld or short withheld. Compliance obligations like filing return and other reporting requirements would apply to such non-resident as well as be subject to specific exceptions, viz., sections 115A(5), 115AC(4) and 115BBA(2).

4. This may not be the position in case of India’s DTAA partner country. In such DTAA partner country, the domestic law may have two ‘boxes’ of incomes. The ‘first box’ would consist of incomes which are subject to withholding by the payer with no recourse to the recipient in case of non- / short deduction. The ‘second box’ consists of incomes which are not subject to withholding but are liable to be taxed directly in the hands of the person earning the income. The first box would be similar to the case of equalisation levy version 1 introduced by the Finance Act, 2016 which levies tax on a non-resident but enforces the same through deduction by the resident payer. The second box would be similar to the case of equalisation levy version 2 introduced by the Finance Act, 2020 whereby the liability is on the non-resident to pay the levy directly.

5. In this regard, reference may be made to Paragraph 4 of the OECD Commentary on Article 31 (Entry into force) of the OECD Model Tax Convention, 2017. The said Paragraph recognises that the relevant Article dealing with ‘entry into force’ of certain treaties provides, as regards taxes levied by deduction at the source, a date for the application or termination which differs from the date of application of the treaty to taxes levied by assessment. This would indicate that there may be countries whose domestic laws may have two boxes of incomes as referred to in the previous paragraph.

6. Consider Article 30(2)(a) of the Indo-USA DTAA which provides for a different time point for entry into effect of the DTAA in respect of taxes withheld as compared to other taxes. This may be because as per the US domestic taxation law, income of a non-resident in the US that is effectively connected with the conduct of a trade or business in the US is not subject to NRA withholding.[Source: https://www.irs.gov/individuals/international taxpayers/withholding-on-specific-income.]

At this juncture, a reference may be made to Paragraph 60 of the recent judgment of the Supreme Court in the case ofEngineering Analysis Centre of Excellence Private Limited vs. CIT [2021] 125 taxmann.com 42 (SC) where, after referring to the OECD Model Commentary and Article 30(2)(a) of the Indo-USA DTAA, the Court concluded that adoption of such different dates for application of the treaty was for reasons connected with USA’s municipal taxation laws.

7. Now, consider a case where the MLI has come into effect only in respect of taxes withheld. In such a case, the CTA as amended by the MLI may be applied by the DTAA partner country for determining the taxes to be withheld (incomes of first box). However, the CTA amended by the MLI cannot be applied by the DTAA partner country in respect of incomes not subject to withholding but that are taxed directly in the hands of the person earning the income (incomes of second box). In such cases, the provisions of the CTA unamended by MLI will be applied till such time as the MLI comes into effect for the purposes of all other taxes.

8. Thus, in the Indian context the different timelines would not be relevant as non-residents earning Indian income are subject to comprehensive obligations. However, in a given case, from the DTAA partner country’s context, different timelines would matter.

D. SYNTHESISED TEXTS

  • Every CTA will have to be read along applicable protocol and applicable portions of the MLI. The said exercise would be complex and cumbersome particularly when the applicability of the MLI depends on reservations and notifications by contracting states.

2. The OECD encourages the preparation of consolidated texts or synthesised texts which would reproduce the
text of each CTA as modified by the MLI. The same has been explained in Paragraph 1 at Page 9 of the ‘Guidance for the development of synthesised texts’ issued by OECD.

3. However, the parties to the MLI are under no obligation to prepare synthesised texts. This has been clarified in Paragraph 13 of the Explanatory Statement on the MLI. This paragraph is referred to in Paragraph 4 at Page 9 of ‘Guidance for the development of synthesised texts’ issued by OECD.

4. In Paragraph 3 at Page 9 of the ‘Guidance’, it has been noted that the purpose of synthesised texts is to facilitate the understanding of the MLI. However, for legal purposes the provisions of the MLI must be read alongside Covered Tax Agreements as they remain the only legal instruments to be applied, in light of the interaction of the MLI positions of the contracting jurisdictions.

5. Thus, the synthesised texts would only help the users in better understanding of the CTA as modified by the MLI. In case of conflict between the synthesised text and the CTA read independently with applicable portions of the MLI, the latter would prevail.

6. As of date, India has synthesised texts in respect of tax treaties with the following jurisdictions:

Sl. No. Country Sl. No. Country Sl. No. Country
1 Australia 11 Latvia 21 Slovak Republic
2 Austria 12 Lithuania 22 Slovenia
3 Belgium 13 Luxembourg 23 UAE
4 Canada 14 Malta 24 UK
5 Cyprus 15 Netherlands 25 Ukraine
6 Czech Republic 16 Poland 26 France
7 Finland 17 Portuguese Republic
8 Georgia 18 Russia
9 Ireland 19 Serbia
10 Japan 20 Singapore
  1. MINIMUM STANDARDS
  2. In the final BEPS Package, in order to combat the issues relating to Base Erosion and Profit Shifting, it was agreed that a number of BEPS measures are minimum standards, meaning that countries have agreed that the standard must be implemented. Thus, countries which are parties to the OECD / G20 inclusive framework on BEPS are required to comply with the following five minimum standards:
  •  Action Plan 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments (Adoption of a fixed ratio rule which limits an entity’s net deductions for interest to a percentage of EBITDA to entities in a multinational group is a minimum standard as per the Executive Summary to this Action Plan, AP4);
  •  Action Plan 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance;
  •  Action Plan 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances;
  •  Action Plan 13: Transfer Pricing Documentation and Country-by-Country Reporting;
  •  Action Plan 14: Making Dispute Resolution Mechanisms More Effective.
  1. While some of these minimum standards in BEPS Actions 6 and 14 have been implemented through MLI, others have been implemented via domestic amendments.

3. The following are the minimum standards implemented by way of domestic amendments:

Section of IT Act Particulars BEPS Action Plan
94B Thin capitalisation – Limitation on interest deduction Action Plan 4
115BBF Patent box regime Action Plan 5
90/90A (India has entered Tax Information Exchange Agreements with several non-DTAA jurisdictions) Exchange of information on tax rulings Action Plan 5
286 Country-by-country reporting Action Plan 13
  1. The following are the minimum standards implemented through MLI:
Article Provision
6(1) Preamble text to tax treaties
7(1) Principal Purpose Test (PPT)
16(1) to 16(3) Improving dispute resolution through Mutual Agreement Procedure (MAP)
17(1) Corresponding adjustment
  1. Paragraph 14 of the Explanatory Statement to the MLI explains the flexibility with respect to the provisions relating to minimum standards. It has been stated that opting out of provisions that reflect minimum standards is possible only in limited circumstances where the provisions of the Covered Tax Agreement already meet the minimum standard. However, it clarifies that where a minimum standard can be met in several alternative ways, the convention gives no preference to any particular way of meeting such minimum standard.6. MLI 6(1) dealing with the ‘preamble text’ is a minimum standard. Opting out is possible only if the CTA already contains the text which is equal to or broader than the said ‘preamble text’. Therefore, MLI 6(4) provides for an exit option only where the CTA already contains preamble language which is similar to the preamble text of MLI 6(1) or is broader than the said preamble text of MLI 6(1).7. MLI 7(1) dealing with the ‘Principal Purpose Test (PPT)’ is also a minimum standard. Opting out is possible only if parties to the CTA intend to reach a mutually satisfactory solution which meets the minimum standard, or if the CTA already contains a PPT. MLI 7(15)(a) provides an exit option where parties to a CTA intend to reach a mutually satisfactory solution which meets the minimum standard for preventing treaty abuse under the OECD / G20 BEPS package. MLI 7(15)(b) provides for an exit option only where the CTA already contains a PPT.8. MLI 17(1) dealing with the ‘corresponding adjustments’ is another minimum standard. Opting out is possible only if the CTA already contains a provision providing for corresponding adjustment or on the basis that it shall make appropriate corresponding adjustment as referred to in MLI 17(1), or that its competent authority shall endeavour to resolve the case under the provisions of the CTA. This is accordingly provided in MLI 17(3).

    9. India has reserved its right under MLI 17(3)(a) for the entirety of MLI 17 not to apply to those of its CTAs that already contain a provision described in MLI 17(2).

    10. India has notified the list of DTAAs which contain a provision for corresponding adjustment. One such example is Canada where Article 9(2) of the DTAA already provides for corresponding adjustment. Hence, the same would remain unamended by MLI 17(1). One may notice this from the synthesised text of the Indo-Canada DTAA published by the CBDT.

    11. One may also take note of the DTAA between India and France. Article 10 of the DTAA which deals with ‘Associated Enterprises’ does not provide for corresponding adjustment. Hence, India has not notified the DTAA with France under MLI 17. Thus, in the absence of a provision providing for corresponding adjustment, MLI 17(1) would get added to Article 10 of the Indo-France DTAA. This may be observed from the synthesised text of the Indo-France DTAA published by the CBDT.

    F. COMPATIBILITY

  2. MLI provisions may either be newly added into CTA or may overlap with the existing provisions of CTA. While in the former the provisions of the MLI can be applied without any conflict with the provisions of the CTA, in the latter there is a conflict between the provisions of the MLI and the provisions of the CTA.

2. In order to address such conflicts, the provisions of the MLI contain compatibility clauses which may, for example, describe the existing provisions which the Convention is intended to supersede, as well as the effect on CTAs that do not contain a provision of the same type. This has been explained in Paragraph 15 of the Explanatory Statement to the MLI.

3. The Glossary to the Frequently Asked Questions on the Multilateral Instrument defines ‘compatibility clause’ as ‘clauses which define the relationship between the provisions of the MLI and existing tax treaties in objective terms and the effect the provisions of the MLI may have on Covered Tax Agreements.’

4. We may understand the application of compatibility clauses with reference to MLI 4:

4.1 MLI 4(1) deals with tie-breaker test in the case of dual-resident entities (person other than individual). MLI 4(2) provides that the text of MLI 4(1) would apply in place of or in absence of a clause in the existing text of the CTA which provides for a tie-breaker in the case of person other than individuals.

4.2 MLI 4(3) provides various reservations including reservation of right for the entirety of MLI 4 not to apply to the CTAs, under MLI 4(3)(a).

4.3 MLI 4(4) provides for notifications by the parties to the Depository where reservations under MLI 4(3)(a) have not been made. It provides that the text of MLI 4(1) would replace the existing provision of CTA where all parties have made such a notification. In all other cases, the provisions of the CTA would be superseded by the text of MLI 4(1) only to the extent that those provisions are incompatible with MLI 4(1).

4.4 If both the parties to the CTA notify the same Article number of the CTA, the text of MLI 4(1) would replace the existing text of such Article. Otherwise, the text of MLI 4(1) would supersede the text of the CTA only to the extent that those provisions are incompatible with MLI 4(1). The latter situation may arise, for example, when there is a mismatch in the notification of Articles by the parties.

4.5 In the Indian context, the applicability of MLI 4 is as per the following table:

Row Labels Count of Article 4
A.4(3) would be replaced by Article 4(1). 22
Article 4 would not apply. 34
The last sentence of Article 4(1) would be replaced with the text described in Article 4(3)(e). A.4(2) would be replaced by Article 4(1). 1
Japan

The last sentence of Article 4(1) would be replaced with the text described in Article 4(3)(e). A.4(3) would be replaced by Article 4(1).

 1

3
Australia

Fiji
Indonesia

 1

1

1
Grand Total 60

4.6 As may be seen from the above table, there is no notification mismatch. Therefore, there is no compatibility issue.

4.7 MLI 4(1) deals with cases of persons other than individuals. However, some CTAs may contain a common tie-breaker test in respect of both individuals and non-individuals. In such a case, Paragraph 52 of the Explanatory Statement to the MLI observes that where a single tie-breaker rule exists in the tax treaty for both individuals and persons other than individuals, the text of MLI 4(1) shall modify only that portion of the rule which deals with determination of residence for persons other than individuals. In other words, that portion of the tie-breaker rule dealing with individuals would remain unaltered or unaffected by MLI 4(1). One such example is Article 4(2) of the Indo-Japan DTAA. One can observe from the synthesised text of the Indo-Japan DTAA that the text of Article 4(2) would remain modified by the text of MLI 4(1) only to the extent that it deals with tie-breaker tests in the case of non-individuals.

5. We can understand the application of compatibility clauses with reference to MLI 6:

5.1 MLI 6(2) provides that the text of MLI 6(1) would apply in place of or in the absence of the preamble language of the Covered Tax Agreement referring to an intent to eliminate double taxation, whether or not that language also refers to the intent not to create opportunities for non-taxation or reduced taxation.

5.2 Paragraph 81 of the Explanatory Statement to the MLI explains that the preamble text in MLI 6(1) replaces the existing preamble language of CTAs that refers to an intent to eliminate double taxation (whether or not that language also refers to an intent not to create opportunities for non-taxation or reduced taxation), or is added to the preamble of CTAs where such language does not exist in the preamble of the Covered Tax Agreements.

5.3 MLI 6(5) provides that each party shall notify the Depository of whether each of its CTAs, other than those that are within the scope of a reservation under MLI 6(4), contains preamble language described in MLI 6(2), and if so, the text of the relevant preamble paragraph. Where all contracting jurisdictions have made such a notification with respect to the preamble language, such preamble language shall be replaced by the text described in MLI 6(1). In other cases the text described in MLI 6(1) shall be included in addition to the existing preamble language.

5.4 It may be noted that India has not made a reservation under MLI 6(4). India has also not made any notification under MLI 6(5). Other contracting states may have notified the existing preamble texts. For example, France has notified the existing preamble text with its treaty with India. Thus, there is a notification mismatch (i.e., India has not notified while France has notified). In such a case, the text of MLI 6(1) being a minimum standard would be added to the existing preamble text contained in the CTAs.

5.5 We may also refer to some of the following CTAs of India where the text of MLI 6(1) has been added to the text of the CTA:

5.5.1 Indo-Luxembourg DTAA:

DTAA LUXEMBOURG – Preamble – Relevant Extract
Existing The Government of the Republic of India and the Government of the Grand Duchy of Luxembourg, desiring to conclude an Agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital and with a view to promoting economic co-operation between the two countries, have agreed as follows:
Added ‘Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),’

5.5.2 Indo-Japanese DTAA:

DTAA JAPAN – Preamble – Relevant Extract
Existing The Government of Japan and the Government of the Republic of India,

Desiring to conclude a new Convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income,

have agreed as follows:
Added ‘Intending to eliminate double taxation with respect to the taxes covered by this agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions),’

  1. RESERVATION
    1. It would be pertinent to note that the MLI cannot impinge upon the sovereign taxing rights of a contracting jurisdiction.

2. Thus, where a substantial provision of the MLI does not reflect a minimum standard, a party (contracting jurisdiction) is given the flexibility to opt out of the provision entirely, or in some cases partly.

3. Reservation means a party opts out of a provision of the MLI. When reserved, the relevant provision of the MLI so reserved would not amend the CTA. A reservation of an MLI provision would thus mean the CTA provision applies as it is. More and more of reservation means less and less of MLI affecting the CTA.

4. However, a reservation is not permitted for a minimum standard unless the CTAs contain clauses which meet the minimum standard. This has been dealt with in Paragraphs E6-E11 above.

5. It may be noted that MLI 28 deals with reservations. MLI 28(5) provides that reservations shall generally be made at the time of signature or when depositing the instrument of ratification, acceptance or approval, subject to certain exceptions. After such deposit, no further reservation is permissible. This would prevent further dilution of the impact of MLI by subsequent reservations.

6. At the same time, MLI 28(9) permits a party to withdraw a reservation made earlier at any time or to replace it with a more limited reservation. This would mean that it is permissible to further enhance the impact of MLI by subsequent withdrawal of reservations.

7. On reservation, in the Indian context, an example is the reservation made by India under MLI 3(5)(a). By virtue of this, India has reserved its right for MLI 3 not to apply in entirety to its CTAs. Thus, irrespective of whether contracting jurisdictions choose to apply MLI 3 qua India, the provisions of MLI 3 would not amend the provisions of India’s CTAs.

8. Consider the impact of reservation under MLI 12(4) by Australia on Article 5(PE) of the Indo-Australia DTAA. Though India has notified the relevant article numbers of the Indo-Australia DTAA under provisions of MLI 12(5) and MLI 12(6), Article 5 of the Indo-Australia DTAA would remain unamended by MLI 12 as Australia has reserved the application of MLI 12 in its entirety with respect to all its CTAs.

9. A party cannot make a reservation with respect to a particular CTA. It has to either be across-the-board or with respect to a subset of CTAs based on an objective criterion. This has been taken note of at Page 5 of the Explanatory Statement to the MLI. In other words, reservations cannot be country-centric but must be parameter-centric.

10. A country may still achieve the desired result in certain cases in light of specific reservation clauses. One such example could be of MLI 4(3)(f) which enables a party to reserve the right for MLI 4 not to apply in its entirety to those of its CTAs where the other party to the CTA has opted for MLI 4(3)(e). Thus, where a reservation is made under MLI 4(3)(f) it would only seek to target those treaties where the treaty partners exercise option under MLI 4(3)(e).

11. It may be noted that qua India, three countries, namely, Australia, Fiji and Indonesia, have exercised reservation under MLI 4(3)(e). If India wished it could have exercised reservation under MLI 4(3)(f). However, India has not chosen to make such a reservation.

H. NOTIFICATION

  • Notification represents an expression of choice of option by a party to the MLI or it ensures clarity about existing provisions that are within the scope of compatibility clauses.

2. This is clear from Page 11 of the FAQs to the MLI which provides that it is the information submitted to the Depository to ensure clarity and transparency on the application of alternative or optional provisions of the MLI and on the application of provisions of the MLI, and on the provisions that supersede or modify specific types of existing provisions of a CTA.

3. Notification is thus a communication by a contracting state who is party to the MLI. Notifications are issued for expressing reservations or exercising options or indicating the provisions of CTA to be amended by MLI.

I. INDIA’S MLI POSITION AS ON 18TH FEBRUARY, 2021

  1. India’s MLI position as per the MLI Matching Database available on the OECD Website6 stands as follows:
Particulars Count of countries
Agreements that would be CTAs:
1. Notification mismatch. Need to check whether both jurisdictions have identified the same agreement 10
2. The agreement would be CTA with an amending instrument in force:

 

Austria

Belgium

Morocco

Spain

 4
3. The agreement would be a CTA 46
Sub-total (A) = 1 + 2 + 3 60
Agreements that would not be CTAs:
4. The agreement would not be a CTA because Germany has not included it in its notification 1
5. The agreement would not be a CTA because Hong Kong (China) has not included it in its notification 1
6. The agreement would not be a CTA because Mauritius has not included it in its notification 1
7. The agreement would not be a CTA because neither jurisdiction has included it in its notification 28
8. The agreement would not be a CTA because neither jurisdiction has included it in its notification

 

Bahrain

 1
9. The agreement would not be a CTA because Oman has not included it in its notification 1
10. The agreement would not be a CTA because Switzerland has not included it in its notification 1
Sub-total (B) = (4) + (5) + (6) + (7) + (8) + (9) + (10) 34
Total (A) + (B) 94
  1. As per MLI 2(1)(a)(ii), in order for a tax treaty to be a CTA, it will have to be notified by each party to such treaty. From the above table it is clear that in the case of ten tax treaties there seems to be a notification mismatch as to the relevant tax treaty sought to be modified by the MLI. Thus, one will have to check whether both India and the corresponding treaty partner have notified the same treaty sought to be modified by the MLI before applying the MLI.

6   https://www.oecd.org/tax/treaties/mli-matching-database.htm#:~:text=MLI%20Matching%20Database%20(beta)%20The%20Multilateral%20Convention%20to,MLI%20by%20matching%20information%20from%20Signatories’%20MLI%20Positions.

  1. CONCLUSION

MLI is a reality and is in effect or is to come into effect in respect of treaties with 42 jurisdictions qua India. While examining the tax consequences under the treaty one will have to be mindful of the provisions of the MLI and the interaction between the provisions of the MLI and the provisions of the treaty. In doing so, one will have to refer to the compatibility clauses. One may also have to refer to the Explanatory Statement to the MLI which would explain each provision of the MLI and the object behind such insertion, the BEPS Actions which have formed the basis for conclusion of the MLI, the Frequently Asked Questions on MLI, the OECD Model Tax Conventions and Commentaries thereon.

Highlights of Volume 52 (YE March 31, 2021)

BCAJ

THE BOMBAY CHARTERED ACCOUNTANT JOURNAL

• 70 Articles / Surveys in addition to our 24 regular features
• Special Issue on ‘Impact of Covid-19’ [May 2020]
• Annual Special Issue – ‘Risk and Technology Challenges for Professionals’ [July 2020]
• New Section on Technology under the title ‘Practice Management and Technology’ from November 2020
• Regulatory Referencer: Feature in new avatar bringing a curated set of changes in Tax, Company Law, Accounting and Audit, and FEMA
At a Glance: Listing of Articles Published in Volume 52

Direct Taxes
•    Remuneration by a Firm to Partners: Section 194J Attracted? [April 2020]
•    Domestic Tax Considerations Due to Covid-19 [May 2020]
•    Specified Domestic Transactions; Retrospective Operability of Omission of Clause (I) To Section 92Ba(1) on GST [June 2020]
•    Tax and Technology: Are Tax Professionals at Risk? [July 2020]
•    The Finance Act, 2020 [September 2020]
•    Report: Role of the Professional in a Changing Tax Landscape [September 2020]
•    New TCS Provisions – An Analysis [October 2020]
•    Taxability of Transfer Fee Received by a Co-Operative Housing Society [November 2020]
•    Taxability of Forfeiture of Security Deposit [November 2020]
•    Taxability of Private Trust’s Income [February 2021]

International Tax
•    The Impact of Covid-19 on International Taxation [May 2020]
•    Covid-19 and Transfer Pricing – Top 5 Impact Areas [May 2020]
•    Transfer Pricing Databases – Requirements, Usage and Review [November 2020]
•    Taxing the Digital Economy – The Way Forward [January 2021]
•    The Conundrum of ‘May be Taxed’ in a DTAA [January 2021]
•    OECD’s Pillar One Proposals: A Solution Trapped in Web of Complexities [March 2021]

Indirect Taxes
•    Operational Impact of Coronavirus Outbreak on GST [May 2020]
•    GST on Payments Made to Directors [June 2020]

Accountancy & Audit

•    Financial Reporting and Auditing Considerations on Account of Covid-19 [May 2020]
•    Governance & Internal Controls: The Touchstone of Sustainable Business – Part II [June 2020]
•    Internal Audit Analytics and AI [June 2020]
•    Financial Reporting Dossier [June 2020]
•    The Run Up to Audit in the 2030s [July 2020]
•    Learnings for Audit firms in the Era of PCAOB and NFRA [July 2020]
•    Data Driven Internal Audit -1 [August 2020]
•    Data Driven Internal Audit -II Practical Case Studies [September 2020]
•    Fraud Analytics in Internal Audit [October 2020]
•    Provisioning for Expected Credit Losses for
Financial Institutions and NBFCs Post Covid-19 [October 2020]
•    Integrated Reporting – A Paradigm Shift in Reporting [December 2020]
•    Value Addition in Internal Audit [December 2020]
•    CARO 2020 – Enhanced Auditor Reporting Requirements [December 2020]
•    Fraud Risk Management in Internal Audit
[January 2021]
•    The Long Form Audit Report for Banks Gets Even Longer [February 2021]

Corporate and Other Laws

•    Overview of Amendments to the Arbitration and Conciliation Act 1996: One Step Forward and Two Steps Back [April 2020]
•    Transition to Cash Flow Based Funding [April 2020]
•    Housekeeping for Bhudevi [April 2020]
•    Covid-19 and the Reshaping of the Global Geopolitical order [April 2020]
•    Impact of Covid-19 on Corporate and Allied Laws [May 2020]
•    Some Reflections on Covid-19 and the Economy: Reset Time [May 2020]
•    Covid-19 Impact on Indian Economy and the Financial Markets [May 2020]
•    Possible Solution to the Problem of Stressed Assets [June 2020]
•    Current Themes in Corporate Restructurings and M&As [July 2020]
•    Mutually Assured Destruction in Corporate Lending [August 2020]
•    Corporate Law in India Promoting Ease of Doing Business without Diluting Stakeholder Interests [December 2020]
•    Statement Recorded Under PMLA and Other Laws: Whether Admissible as Evidence? [December 2020]
•    PFUTP Regulations – Background, Scope and Implications of 2020 Amendment [January 2021]
•    Offence of Money Laundering: Far-reaching Implications of Recent Amendment [January 2021]
•    ‘Proceeds of Crime’ – PMLA Definition Undergoes Retrospective Sea Change [February 2021]
•    CSR Rules Amendment – An Analysis [March 2021]
•    Daughter’s Right in Coparcenary – Part VI [March 2021]

Practice Management and Technology
•    Self-Quarantine your mind whilst working from Home [April 2020]
•    Overcoming the Challenge of Risk Management in Professional Services [July 2020]
•    Working Capital Challenges for CA Firms in Covid Times [July 2020]
•    Excel in What you Do – Some Personal Tips [August 2020]
•    ‘Collaborate to Consolidate’ – A Growth Model for Professional Services Firms [September 2020]
•    Benefits for SMPs Under MSME Act & Other Statutes [October 2020]
•    Executive Presence [October 2020]
•    Whether Practising CAs can Deal in Derivatives on Stock exchanges [November 2020]
•    Personal Data Protection [November 2020]
•    Effective use of Quora for a Professional [January 2021]
•    Digital Marketing? Naah, It’s Digital Branding [February 2021]
•    Initiatives During Pandemic – Personal Experiences [February 2021]
•    Podcasting – The Novel Mode of Storytelling for Your Professional Brand [March 2021]
•    Strategy: The Heart of Business – Part I (March 2021)

Others

•    How to Restart the Engine after the Lockdown [May 2020]
•    India: The Land of Creativity [August 2020]
•    The New Edge Banking [November 2020]
•    WHO Controversy: Lack of Global Leadership in Corona Crisis [September 2020]

Surveys


•    Impact of Covid-19 on Chartered Accountant Firms [May 2020]
•    Digital Gearing of Chartered Accountant Firms [October 2020]

SALTY… IS IT?

There was a sugar anthill in which numerous ants lived. Each of them was leading a very happy life and, being in a sugar anthill, everything was sweet in their lives.

One day, an ant from this colony moved out and met another ant. As they started talking, the ant from the sugar anthill (let’s call it the sugar ant) was surprised to hear the sad tale of the other ant.

It so happened that the other ant lived in a salt anthill (let’s call it the salt ant). The salt ant was disappointed with salt all around. She exclaimed, ‘This life is very salty.’ She had never tasted sugar.

Hearing this, the sugar ant replied, ‘What’s wrong? Life is so beautiful and full of sweetness all around.’

This was difficult for the salt ant to digest. She responded, ‘Impossible!’

‘Come with me, I shall show you,’ so saying, the sugar ant led the salt ant to her colony at the sugar anthill. Once there, the sugar ant asked, ‘Now tell me, isn’t life sweet?’

The salt ant tasted the sugar and responded, ‘What? This is salty, too!’

The sugar ant coaxed the salt ant to try once again. The salt ant did try but gave the same response. It was difficult for the sugar ant to understand. She decided to take the salt ant to the Mother sugar ant to resolve the issue. The Mother sugar ant was also perplexed when she heard the sugar ant’s predicament.

‘How could it be?’ she wondered.

In an attempt to unravel the mystery, the Mother sugar ant asked the salt ant to take a bite of sugar and asked her to respond.

‘Salty,’ the salt ant asserted.

The Mother sugar ant thought for a while. Then she smiled and her eyes brightened like those of a child who had suddenly spotted his mother in a group of strangers.

She told the salt ant to take another bite of the sugar and the salt ant obediently did so. As the salt ant opened her mouth to consume the sugar, the Mother sugar ant said, ‘Stop! Wait for a moment. Let me see your mouth.’”

The Mother sugar ant peeped into the mouth of the salt ant and exclaimed, ‘There you are! A piece of salt is already there in your mouth. How will anything taste any different but salty?’

As professionals, many a time we may commence our work with presumptions and / or prejudices which may influence our actions and decisions. They may sour our results and relations. However, professional scepticism should not translate into distrust, cynicism and suspicion. Further, it would be dangerous to carry such scepticism into our personal lives.

Would it not be wise to always begin with the question – ‘Have I removed the piece of salt (in the form of prejudices, etc.) before I set out to see the world soaked in sugar?’

THE IMPORTANCE OF STRONG PASSWORDS

We have all been there – any website that we visit wants us to share our email id and insists that we create a userid and password. The normal tendency is to use our regular email id and password on all sites. This is the primary mistake we commit while accessing the online world.
 

At the same time, if you are a business owner and have a website of your own, you need to know the people who visit your website and have their email ids. Besides, you would not like anyone and everyone to access and nose through your website without proper authentication.

 

Unauthorised access to your digital world is a major problem for anyone who uses computers or any other devices, especially if connected to the internet. The effects for victims of these break-ins can include the loss of valuable data, including bank account information, money, or even having their identity stolen. Moreover, unauthorised users may use someone else’s computer to break the law which could put the victim in legal trouble.

 

Surprisingly, although strong passwords are the most important in keeping our information secure online, this fact is often also the most overlooked. It may surprise you to know that in 2013, 90% of all online passwords were considered vulnerable to hacking. It was also found that 70% of people do not use a unique password for each website they access and more than 33% users share their password with others!

 

Another study showed that a majority of users use passwords which are so easy to guess – e.g., 123456 or ‘password’ or 111111. Using such passwords is suicidal as they are easiest to guess and hack.

 

The following points need to be kept in mind for ensuring your password security:

* Passwords must be long and complex – never use personal information like name of self or spouse, kids, pets, birthdays, etc. They are very easy to guess. Never use common words.

* Passwords should contain at least twelve characters. It has been calculated that if a hacker generates 1 billion passwords per second, a 5-digit password can be cracked in 0.38 seconds, while a 12-digit password would take 12,386.42 years to crack!

* Passwords must have at least one upper case, one lower case, one numeric and one special character (like !@#$%^&) each.

* Never write down passwords, as that makes it easier for the passwords to be stolen and used by someone else.

* Never use the same password for two or more devices, as someone who breaks into one machine will try to use the same password to take control of the others.

* Never use the same password on multiple sites, especially banking or transactional sites.

* Try and change all your passwords periodically – preferably once in six months.

* Use a good password manager (like LastPass) to manage all your passwords, since it is impossible to remember so many passwords.

 

Passwords are undoubtedly essential to security, but they are not the only method that can or should be used to protect one’s computers and devices. In addition to creating a good password, Windows 10 allows face recognition (Hello Windows / Hello Asus / Hello HP). Facial Recognition uses the FIDO (Fast Identity Online) protocol. Many laptops have fingerprint and / or iris recognition devices also, which provide an additional layer of security for your devices.

 

SECURITY FOR MOBILE DEVICES

On mobile devices, a PIN or passcode is used. This is like a password for a computer, but it may have a minimum of four characters or digits and should be something that is not personal or easily guessable. Passcodes for devices should also be set to time out after a short period of time. On time-out, the code will then need to be re-entered. Ideally, the timeout should occur in no more than ten minutes, although shorter periods between time-outs are best. Besides, these days many cell phones allow fingerprint and face recognition options which make your device more secure.

 

2 FACTOR AUTHENTICATION (2FA)

The use of 2 Factor Authentication (2FA) adds another layer to your security. For every large / reputed site you visit, this option is always there. To enable 2FA, you need to download an app like Authy or Google Authenticator.

 

In the case of Google, for example, once you have the app installed, go to your Google / Gmail account (myaccount.google.com/security) and look for 2-Step verification. Once you enable it and link your phone to your Google account, every time you login to your account from a different device, in addition to your password, it will also ask you for the 2FA code. You will have to go to your Authenticator App, read the code there for Google and enter it when prompted on your computer. This ensures that even if your password is hacked, the hacker cannot get into your account without the 2FA code which is unique to you and your device. Similarly, for your Amazon account – go to your account, login & security, enable 2-step verification and follow the same process as prompted. Facebook has similar options in Settings & Privacy, Settings, Security & Login – Two-Factor Authorisation.

 

The online world is dangerous and unforgiving. Sensible use of passwords, face recognition, 2FA all add to your security levels and allow you to conduct your online affairs safely. Stay safe, stay protected in this hazardous world by using the above tools sensibly and effectively.

 

Happy Browsing!

CONTRADICTIONS BETWEEN COMPANIES ACT AND SECURITIES LAWS: COMPOUNDED BY ERRANT DRAFTING

BACKGROUND
A listed company is subject to dual regulation. First, by the Companies Act, 2013 which is the parent act under which it is incorporated and which lays down the basic rules about how companies should be governed. And second, the multiple regulations notified under the SEBI Act. The regulator under each of these sets of laws is also different.

It is not as if the objectives of the two laws are clearly distinct and non-overlapping. Unfortunately, however, neither regulator would like to cede to the other and agree that some areas are best regulated exclusively by the other. Thus, several areas are regulated by both the regulators. And these areas actually keep increasing. Whether the concept and requirements relating to Independent Directors, whether the issue of shares and debentures, whether the setting up of various committees, their constitution and scope, etc., each regulator makes its own set of provisions.

This article attempts to look at this overlap and the resultant consequences. It also highlights the attempts made periodically to harmonise and even cede control. It also differentiates the nature of enforcement by the two regulators.

But this article arises primarily out of a recent informal guidance issued by SEBI. In this case, not only is there dual regulation, but owing to what appears to be poor drafting, certain harsh consequences have arisen which SEBI has merely reinforced without accepting.

AREAS OF DUAL GOVERNANCE

The objectives of the Companies Act, 2013 (‘the Act’) / Rules notified therein and the Securities Laws (consisting of the SEBI Act and several regulations notified by it) do have common areas. Both have as one of their objectives the governance of companies, even if SEBI primarily regulates companies that have listed, or propose to list, their securities. Both regulate the issue of securities, even if SEBI basically regulates the issue of securities to the public.

Thus, for example, the whole area of corporate governance is regulated minutely by both the laws. The definition of ‘Independent Directors’ is enunciated elaborately and separately by each of the two regulators. The constitution of committees such as the Audit Committee and the Nomination and Remuneration Committee is similarly laid down independently by the two laws. And the manner of issue of securities is also regulated independently by each of the two sets of laws.

Both sets of laws also regulate related party transactions. However, the definition of related parties, the nature of related party transactions governed, the manner of their approval, the quantum limits beyond which special approvals are required, etc., are all framed with differences, some major and some minor.

The result obviously is many differences, big and small, which companies have to carefully navigate through.

CONSEQUENCES OF DIFFERENT PROVISIONS

What happens when the same issue has differently-worded provisions under the Act / Rules and the Securities Laws? For example, the minimum number of Independent Directors required. The Act has made a simple rule which may result in a lower number of minimum Independent Directors, while the Securities Laws (the LODR Regulations) would require more. Or, say, the definition of related party transactions. The definition of related parties under the SEBI LODR Regulations is wider and covers groups of persons who are not covered as related parties under the Act. Similarly, the definition of related party transactions under the SEBI LODR Regulations is wider. So, again, the question is how will the differences be reconciled?

Primarily, the answer is that (i) both the sets of provisions have to be complied with, and (ii) in case of overlap / difference, the narrower or stricter provision will apply. If the LODR Regulations require more Independent Directors while the Act prescribes a lower number, the LODR Regulations will apply. Similarly, the wider definition of related party transactions under the SEBI LODR Regulations will apply.

But while this may be a good basic principle, the provisions of each set of laws should be carefully examined.

ATTEMPTS TO HARMONISE AND CEDE CONTROL

It is not as if the two regulators are always deliberately confrontational and engaged in a turf war. There is actually a tendency to carefully review what the other regulator has already provided in its corresponding provisions. Indeed, from time to time reviews are carried out and attempts are made to harmonise wherever possible. However, often a fresh set of amendments is made which widens the gap further. Since the provisions governed by SEBI are generally in the Regulations which can be easily amended, SEBI is able to update the provisions to current requirements and also take care of the difficulties faced. The amendments to the Act require approval of Parliament, although, interestingly, we have also seen a series of amending acts over the years.

DUAL ENFORCEMENT ACTION

Each of the two sets of laws has differing consequences in case of violation. Even the process of enforcement can be different. A violation of the provisions in the Act may result in fine and / or prosecution and, at times, other action. SEBI, however, generally has a wider arsenal of actions. It may be in the form of levying a penalty, directing persons not to deal in securities, barring persons from accessing securities markets, disgorgement, etc.

Companies and other persons in default alleged to have violated the provisions may face dual proceedings, one by each regulator, even for substantially the same violation!

Interestingly, under section 24 of the Act, certain specified provisions of the Act relating to listed / to be listed companies are to be ‘administered’ by SEBI. Ideally, such a provision would have ensured not only that dual provisions are either eliminated or harmonised, but even the action is by a single regulator. However, the provisions of this section have a narrow scope.

MANAGERIAL REMUNERATION – DUAL PROVISIONS AND CONSEQUENCE OF POOR DRAFTING

Let us take up a specific case that provides a good example of overlapping provisions with certain anomalous results owing to poor drafting. This case relates to payment of ‘managerial remuneration’, i.e., remuneration paid to directors. Traditionally, the Act has regulated payment of managerial remuneration in fair detail. The persons who can be appointed as Managing / Wholetime Directors, the manner of their appointment, the upper limits of their remuneration, etc., are all regulated in detail. Earlier, payment of remuneration beyond the specified limits required approval of the Central Government. However, now the Act requires approval of the shareholders instead. But even the shareholders cannot grant approval for remuneration that exceeds certain limits. The Act places limits on managerial remuneration in terms of percentage of net profits (as calculated in a prescribed manner) and, in case where profits are inadequate, or there are losses, in absolute terms.

SEBI had, till recently, not provided for limits on managerial remuneration but dealt with the subject by requiring the Nomination and Remuneration Committee to recommend managerial remuneration. However, with effect from 1st April, 2019 it made several requirements relating to certain managerial remuneration. One such requirement related to Promoter Executive Directors and became an area of confusion and a company approached SEBI for an ‘informal guidance’. It may be recalled that SEBI grants ‘informal guidance’ on provisions (for a relatively small charge) which, although it has limited binding effect, often helps know the view that SEBI may generally take.

The relevant provision is Regulation 17(6)(e) of the SEBI LODR Regulations which reads as under:

(e) The fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if –
(i)    the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or
(ii)    where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:

Provided that the approval of the shareholders under this provision shall be valid only till the expiry of the term of such director.

Explanation. – For the purposes of this clause, net profits shall be calculated as per section 198 of the Companies Act, 2013.

As can be seen, the provision states that the upper limit on annual remuneration in case of one such Promoter Executive Director is Rs. 5 crores or 2.50% of the net profits, whichever is higher. In case there is more than one such director, the corresponding limit on the aggregate remuneration to all such directors is 5% of the net profits.

The anomaly is apparent. The limit on remuneration in case of one director is given in an absolute amount as well as in a percentage. However, in case of more than one such director, the limit is given only in percentage terms. To take an example, if the net profit is Rs. 50 crores, then the company may pay Rs. 5 crores as managerial remuneration to one such director, being the higher of Rs. 5 crores and Rs. 1.25 crores (2.50% of Rs. 50 crores). If there are two or more such directors, however, the company can pay only Rs. 2.50 crores, since in such a case the company cannot pay more than 5% of its net profits as aggregate remuneration to all such directors. Thus, even the single director, who could have otherwise received up to Rs. 5 crores, would now get a far lesser remuneration since the aggregate limit for all the directors put together is Rs. 2.50 crores! Of course, if the net profits are very large (say, beyond Rs. 100 crores), the difficulty arising out of such an anomaly would be diluted. But if the profits are less, the anomaly becomes even more glaring.

For a company that needs more than one such director, the provision creates difficulties. When SEBI was approached for an informal guidance on this, it confirmed the above view and said that the remuneration would be limited to 5% of net profits (see informal guidance dated 18th November, 2020 to Manaksia Aluminium Company Limited). Thus, the company would be required to approach the shareholders for a special resolution.

To be fair, SEBI could not have resolved a drafting anomaly through an informal guidance since this would generally require an amendment.

CONCLUSION


A careful consideration is needed whether at all there is a need for dual sets of provisions on the same subject which result in overlap, conflict and even confusion, apart from double proceedings and double punishment. A fleet-footed SEBI could be given exclusive jurisdiction over listed / to be listed companies in several areas. This will ensure that companies have a single set of provisions to apply and that there is a single regulator who will take action in case of violation and the regulator is one who has several different enforcement actions that it can take that are suited to the violation/s.

HINDU LAW: THE RIGHTS OF AN ILLEGITIMATE CHILD

INTRODUCTION
The codified and uncodified aspects of Hindu Law deal with several personal issues pertaining to a Hindu. One such issue is the rights of an illegitimate child in relation to inheritance of ancestral property, self-acquired property of his parents, right to claim maintenance, etc.

 

VOID / VOIDABLE MARRIAGE

The Hindu Marriage Act, 1955 applies to and codifies the law relating to marriages between Hindus. It states that an illegitimate child is one who is born out of a marriage which is not valid. A valid marriage is one which does not suffer from the disabilities mentioned in this Act, viz., neither partner has another spouse living at the time of the marriage; neither of them is of unsound mind / has a mental disorder / is insane; they are not under the marriageable age; the parties are not within prohibited degrees of relationship as laid down in Hindu law; the parties are not sapindas (defined common relationships) of each other. For all void marriages, the Act provides that a decree of nullity can be obtained from a court of law. Hence, the marriage is treated as null and void. Thus, if there is a marriage which suffered from any of these defects then the same would be void. Certain marriages under the Act are voidable at the option of the party who is aggrieved.

 

ILLEGITIMATE CHILD – MEANING

A child born out of such a void or voidable wedlock would have been treated as an illegitimate child prior to the amendment of the Hindu Marriage Act in 1976. From 1976, the Hindu Marriage Act has been amended to expressly deal with an illegitimate child. Section 16(1) provides that even if a marriage is null and void, any child born out of such marriage who would have been legitimate if the marriage had been valid, shall be considered to be a legitimate child. This is true whether or not such child is born before or after the commencement of the Marriage Laws (Amendment) Act, 1976. This would also be the case whether or not a decree of nullity is granted in respect of that void marriage under this Act.

 

It also provides that if a decree of nullity is granted in respect of a voidable marriage, any child begotten or conceived before the decree is made, who would have been the legitimate child of the parties to the marriage if at the date of the decree it had been dissolved instead of being annulled, shall be deemed to be their legitimate child notwithstanding the decree of nullity.

 

Hence, now all children of void / voidable marriages under the Act are treated as legitimate. The Act also provides that such children would be entitled to rights in the property of their parents.

 

The Supreme Court in Bharatha Matha & Anr. vs. R. Vijaya Renganathan, AIR 2010 SC 2685 has held that ‘it is evident that Section 16 of the Act intends to bring about social reforms, conferment of social status of legitimacy on a group of children, otherwise treated as illegitimate, as its prime object.’

 

In Jinia Keotin & Ors. vs. Kumar Sitaram Manjhi & Ors. (2003) 1 SCC 730, the Apex Court explained the meaning behind the Amendment as follows:

‘4 … Under the ordinary law, a child for being treated as legitimate must be born in lawful wedlock. … The legitimate status of the children which depended very much upon the marriage between their parents being valid or void, thus turned on the act of parents over which the innocent child had no hold or control. But for no fault of it, the innocent baby had to suffer a permanent setback in life and in the eyes of society by being treated as illegitimate. A laudable and noble act of the legislature indeed in enacting section 16 to put an end to a great social evil.’

 

In S.P.S. Balasubramanyam vs. Suruttayan @ Andali Padayachi & Ors. AIR 1992 SC 756 the Supreme Court held that if man and woman are living under the same roof and cohabiting for a number of years, there will be a presumption u/s 114 of the Evidence Act that they live as husband and wife and the children born to them will not be illegitimate. Thus, even children born out of a live-in relationship were accorded legitimacy.

 

In Rameshwari Devi vs. State of Bihar & Ors. AIR 2000 SC 735 the Supreme Court dealt with a case wherein after the death of a government employee, the children born illegitimately to the woman who had been living with the said employee, claimed a share in the pension / gratuity and other death-cum-retirement benefits along with children born out of a legal wedlock. The Court held that u/s 16 of the Act, children of a void marriage are legitimate. As the employee, a Hindu, died intestate, the children of the deceased employee born out of the void marriage were entitled to a share in the family pension, death-cum-retirement benefits and gratuity.

 

SUCCESSION TO PROPERTIES OF OTHER RELATIVES

However, the Amendment Act has also introduced an interesting caveat, that while such a child born out a void or voidable wedlock would be deemed to be legitimate, the Amendment would not be treated as conferring any rights in the property of any person other than its parents.

 

In Smt. P.E.K. Kalliani Amma & Ors. vs. K. Devi & Ors. AIR 1996 SC 1963 the Apex Court held that section 16 of the Act was not ultra vires of the Constitution of India. In view of the legal fiction contained in section 16, the illegitimate children, for all practical purposes, including succession to the properties of their parents, had to be treated as legitimate. They could not, however, succeed to the properties of any other relation on the basis of this rule which in its operation was limited to the properties of the parents.

 

Again, in Jinia Keotin & Ors. vs. Kumar Sitaram Manjhi & Ors. (2003) 1 SCC 730 the Supreme Court held that section 16 of the Act, while engrafting a rule of fiction in ordaining the children, though illegitimate, to be treated as legitimate, notwithstanding that the marriage was void or voidable, chose also to confine its application, so far as succession or inheritance by such children is concerned, to the properties of the parents only. It held that conferring any further rights upon such children would be going against the express mandate of the Legislature.

 

This view was once again endorsed by the Supreme Court in Bharatha Matha (Supra) where it held that a child born of a void or voidable marriage is not entitled to claim inheritance in ancestral coparcenary property but is entitled only to claim share in self-acquired properties, if any.

 

CONTROVERSY IN THE ISSUE

The above issue of whether illegitimate children can succeed to ancestral properties or claim a share in the HUF was given a new twist by the Supreme Court in 2011 in the case of Revanasiddappa and Anr. vs. Mallikarjun and Ors. (2011) 11 SCC 1. The question which was dealt with in that case was whether illegitimate children were entitled to a share in the coparcenary property or whether their share was limited only to the self-acquired property of their parents u/s 16(3) of the Hindu Marriage Act? It disagreed with the earlier views taken by the Supreme Court in Jinia Keotin (Supra), Bharatha Matha (Supra) and in Neelamma & Ors. vs. Sarojamma & Ors. (2006) 9 SCC 612, wherein the Court had held that illegitimate children would only be entitled to a share of the self-acquired property of the parents and not to the joint Hindu family property.

 

The Court observed that the Amendment had used the word ‘property’ and had not qualified it with either self-acquired property or ancestral property. It has been kept broad and general. It explained that if they have been declared legitimate, then they cannot be discriminated against and they will be at par with other legitimate children and be entitled to all the rights in the property of their parents, both self-acquired and ancestral. The prohibition contained in section 16(3) will apply to such children only with respect to property of any person other than their parents. Qua their parents, they can succeed to all properties. The Court held that there was a need for a progressive and dynamic interpretation of Hindu Law since the society was changing. It stressed the need to recognise the status of such children who had been legislatively declared legitimate and simultaneously recognise the rights of such children in the property of their parents. This was a law to advance the socially beneficial purpose of removing the stigma of illegitimacy on such children who were as innocent as any other children.

 

The Supreme Court also explained the modus operandi of succession to ancestral property. Such children will be entitled only to a share in their parents’ property, but they could not claim it in their own right. Logically, on the partition of an ancestral property the property falling in the share of the parents of such children would be regarded as their self-acquired and absolute property. In view of the Amendment, such illegitimate children will have a share in such property since such children were equated under the amended law with the legitimate offspring of a valid marriage. The only limitation even after the Amendment was that during the lifetime of their parents such children could not ask for partition, but they could exercise this right only after the death of their parents.

 

Hence, the Court in Revanasiddappa (Supra) concluded that it was constrained to take a view different from the one taken earlier by it in Jinia Keotin (Supra), Neelamma (Supra) and Bharatha Matha (Supra) on section 16(3) of the Act. Nevertheless, since all these decisions were of two-member Benches, it requested the Chief Justice of India that the matter should be reconsidered by a larger Bench.

 

CURRENT STATUS

It has been close to ten years since the above request for a larger Bench, but the matter has not yet been resolved. This issue once again cropped up in the Supreme Court in the case of Jitender Kumar vs. Jasbir Singh CA 18858/2019 order dated 21st October, 2019. The Supreme Court observed that since this issue has been referred to a larger Bench, the current case would be decided only after its hearing.

 

MAINTENANCE

Section 20 of the Hindu Adoptions and Maintenance Act, 1956 also needs to be noted; it provides for maintenance of children by a Hindu. A Hindu is bound, during his or her lifetime, to maintain his or her legitimate or illegitimate children during their minority. In addition, an unmarried Hindu daughter (even if illegitimate) can claim maintenance from her father till she is married relying on section 20(3) of this Act, provided that she pleads and proves that she is unable to maintain herself from her own earnings. This is also the view expressed by a three-Judge Bench of the Supreme Court in Abhilasha vs. Parkash, Cr. Appeal No. 615/2020, order dated 15th September, 2020.

 

GUARDIANSHIP

Who would be the natural guardian of such an illegitimate child is another interesting question. The Hindu Minority and Guardianship Act, 1956 states that a natural guardian of a Hindu minor (if he is a boy or an unmarried girl) and / or his property, is the father and after him the mother. In case the minor is below the age of five years, the child’s custody ordinarily vests with the mother. However, the Act provides an exception to this Rule that in the case of an illegitimate boy or an illegitimate unmarried girl, the mother would be the natural guardian and only after her can the father be the natural guardian. Recently, the Bombay High Court in Dharmesh Vasantrai Shah vs. Renuka Prakash Tiwari, 2020 SCC OnLine Bom 697, reiterated that in case of an illegitimate child it is only the mother who can be the natural guardian under Hindu Law. The only exception is if the mother has renounced the world by becoming a hermit or has ceased to be a Hindu. The Court held that since it was the father’s own case that the child was an illegitimate child, it was difficult to see how he could claim the custody of the child over the biological mother. The Supreme Court has taken a similar view in the case of the guardianship of an illegitimate Christian child in the case of ABC vs. State of Delhi (NCT) (2015) 10 SCC 1.

 

CONCLUSION

The issue relating to various rights of illegitimate children has been quite contentious and litigation prone. One eagerly awaits the constitution of the larger Supreme Court Bench. Clearly, it is high time for a comprehensive legislation dealing with all issues pertaining to such children. In the words of the Apex Court, ‘they are as innocent as any other children!’  

 

STIGMA OF ATTACHMENT(S)

Lord Dunedin famously quoted in Whitney vs. IRC [LR 1926 AC 37, 51 (HL): 10 TC 79, 110: (1924) 2 KB 602] – ‘Now, there are three stages in the imposition of a tax: there is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. Next, there is the assessment. Liability does not depend on assessment. That, ex hypothesi, has already been fixed. But assessment particularises the exact sum which a person liable has to pay. Lastly, come the methods of recovery, if the person taxed does not voluntarily pay.’
 

In this era of digitisation, self-assessment, self-compliance, self-policing and self-vigilance, recovery provisions of taxes are directed to act as deterrence tools rather than being tyrannical. In a democratic set-up with a progressive vision of nation-building, these provisions are considered as a measure of last resort, adopted only in extreme cases. Yet, in the GST scheme of things attachment provisions have been invoked on multiple occasions and the taxpayers have faced the wrath of this power, especially in cases of fake invoicing. This article discusses the attachment provisions under GST with specific reference to attachments of bank accounts and debtors of tax defaulters.

 

CONSTITUTIONAL BACKGROUND

The recovery provisions have a Constitutional background in terms of Articles 265 and 300-A. Article 265 sets out the cardinal rule that no taxes can be levied or collected except under authority of law. Recovery provisions fall under the powers of collection by the Executive of the state. On similar lines, Article 300-A protects the right of ownership of the property of the citizen except under authority of law. These articles when applied together frame two important principles under recovery: (a) Taxes recoverable should be under authority of law; and (b) Recovery process infringes ownership rights and should be backed by legal provisions. In District Mining Officer vs. Tata Iron & Steel Co. and Anr. (2001) 7 SCC 3581 , the three-judge Bench observed that not only should the levy of taxes have the authority of law but also its recovery should be under due authority of law. It is in this backdrop that recovery provisions under the GST law should be understood and applied by Revenue authorities.

 

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1 This
decision has been referred to the larger Bench in Asst. Director of Mines
and Geology vs. Deccan Cements (2008) 3 SCC 451


SUMMARY OF GST PROVISIONS ON RECOVERY

Chapter 15 of the CGST / SGST enactments provide for demands and recovery of taxes. Recovery proceedings can be initiated under the following circumstances:

(i) Taxes not paid, short paid or erroneously refunded,

(ii) Ineligible availment or utilisation of input tax credit,

(iii) Taxes which are not due but collected on supplies,

(iv) Admitted taxes (including turnover reported in GSTR1)2,

(v) Disputed taxes (to the extent of mandatory pre-deposit),

(vi)   Disputed taxes to the extent stay is not obtained, and

(vii) Interest and penalties on all or any of the above.

 

Section 78 provides that recovery proceedings can be initiated at any time after three months from the date of service of the demand order. This time limit coincides with the maximum time limit of three months to file an appeal before the appellate forums. In effect, if the assessee fails to utilise the time to file an appeal within the prescribed limit, it is generally presumed that the matter is not being agitated and powers are thrust on the Revenue to proceed for recovery of taxes due to the Government. As an exception, section 78 permits the proper officer to advance the recovery actions where the circumstances warrant that the collection of taxes may be adversely affected if the entire duration of three months is permitted to the assessee, such as disposal of assets, diversion of funds, etc.

 

Section 79 provides for various methods of recovery of taxes such as:

(1) Adjustment of refunds held by the said proper officer or any other specified officer,

(2) Sale of goods under detention by the above authorities,

(3) Garnishee proceedings (evaluated below),

(4) Distraint and sale of any movable or immovable property,

(5) Recovery as land revenue, and

(6) Recovery of any amount under bond or security executed before the officer.

 

Garnishee powers u/s 79 enable the proper officer to serve upon the taxpayer’s debtors (banks, trade debtors / receivables, etc.) a notice (in DRC-14) directing them to deposit the amount specified to the account of the Government and such deposit would be treated as a sufficient discharge of their debt to the taxpayer. Although the Revenue has powers to recover taxes from other assets of the taxpayer, the circumstances may warrant that Revenue would have to protect its interest before the assets are alienated by the taxpayer. In such cases, Revenue would resort to attachments of the properties of the taxpayer in anticipation of a demand to be recovered in future.

 

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2 Amendment proposed by Finance Bill, 2021

RECOVERY POWERS ARE NOT SEQUENTIAL

The CGST Act provides multiple alternatives to the Revenue officials for recovery of taxes which include attachment of properties (refer above). Are Revenue officials required to exhaust the remedies sequentially prior to proceeding for attachment of properties? Section 79 itself states that recovery can be performed by ‘one or more of the following modes’. This implies that the choice of modes of recovery is purely with the Revenue and it cannot be insisted that each mode has to be exhausted prior to proceeding with an alternative mode of recovery3. Revenue can simultaneously invoke recovery from multiple debtors / assets as long as the overall recovery is capped to the tax arrears.

 

ATTACHMENT AS A PRECURSOR TO RECOVERY

Attachments of property of the tax defaulter can be a prelude to subsequent recovery of tax arrears. ‘Attachment’ in this context refers to prohibition of transfer, conversion, disposition or movement of property by an order issued under law. It is used to hold the property for the payment of debt [Kerala State Financial Enterprises vs. Official Liquidator (2006) 10 SCC 709]. It is also well established that attachment creates no charge or lien upon the attached property. It only confers a right on the holder to have the attached property kept in custodia legis for being dealt with by the Court in accordance with law. It merely prevents and avoids private alienations; it does not confer any title on the attaching creditors. The objective is to protect the interest of Revenue until completion of proceedings and enforcing realisation of taxes in arrears to the debtor. On the other hand, the process of recovery involves the actual realisation / liquidation of the property for meeting the tax dues either from assets already under attachment or other properties of the tax defaulter.

 

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3 2000 (126) E.L.T. 222 (A.P.) G.
Lourdha Reddy vs. District Collector, Warangal


Attachment of fixed deposits before the maturity date

Disputes have emerged whether Revenue can attach and recover fixed deposits prior to their maturity. In Vysya Bank Ltd. vs. Jt. CIT [2000] 109 Taxman 106/241 ITR 178 (Kar.), the Court held that fixed deposits which are lying with banks can be encashed even before their maturity since the Department steps into the shoes of the tax defaulter and can invoke pre-closure of such deposits. On the other hand, rents which are not yet due from the landlord cannot be subjected to attachment or recovery from the debtor.

 

Attachment of Overdraft / Cash Credit accounts

Overdraft / Cash Credit facilities do not create a debt by the third party in favour of the tax defaulter. Therefore, unutilised overdraft or cash credit facilities cannot be attached by the Revenue for realisation of tax dues. In a recent decision, the Court went a step further and stated that future credits after attachment would also not be subjected to the freeze contemplated in law [2020 (5) TMI 193 – RCI Industries & Technologies Ltd. vs. DGGSTI] – ‘6. In the circumstances, we dispose of this petition with a direction that the attachment would be limited to the amounts which were lying to the credit of the petitioner in CC A/c at the time of freezing and any further credit which may come would not be under attachment.’

 

Provisional attachment of property

As an exception to the regular course of attachment after confirmation of tax demands, section 83 enables provisional attachment of any property, including bank accounts, of the taxable person for a maximum period of one year during pendency of adjudication / assessment proceedings (as per extant provisions). Rule 159 provides the procedure for provisional attachment of any property, including bank accounts, as follows:

* Commissioner shall pass an order in DRC-22 to that effect mentioning therein the details of the property which is proposed to be provisionally attached,

* Commissioner shall send a copy of the order of attachment to the authority concerned to place encumbrance on the said movable or immovable property, which shall be removed only on the written instructions from the Commissioner to that effect,

* In case of perishable or hazardous goods, the taxable person can obtain an immediate release of the goods on payment of the market price. In case of failure of payment, such goods may be disposed of and adjusted with the recoverable dues, and

* Any objection to attachment should be filed within seven days of attachment and the Commissioner may release the property after hearing the aggrieved.

 

Drastic nature of provisional attachment

The power of provisional attachment has been held to be drastic in the sense that such actions infringe the liberty of the taxpayer in running its business operations and is to be exercised before any judgement or decision is made. The authority exercising this power should have strong compelling reasons for this extraordinary action with the objective of protecting the interest of Revenue. Generally, taxpayers who have a compliant track record and tangible asset base without any indication of diversion of funds should not be saddled with such drastic actions. The High Court in 2019 (30) GSTL 396 (Guj.) Pranit Hem Desai vs. ADGGI made very assertive observations about the use / misuse of the power of provisional attachment. Though section 83 does not provide any safeguards against misuse of powers (except the approval of a Commissioner, which is generally a routine exercise), the Court stated that the very nature of action warrants circumspection and extreme care and not (its use as) a routine tool for harassment:

 

‘Further, the orders of provisional attachment must be in writing. There must be some material on record to indicate that the Assessing Authority had formed an opinion on the basis thereof that it was necessary to attach the property in order to protect the interest of the Revenue. The provisional attachment provided under section 83 is more like an attachment before judgment under the Code of Civil Procedure. It is a liability on the property. However, the power conferred upon the Assessing Authority under section 83 is a very drastic, far-reaching power and that power has to be used sparingly and only on substantive, weighty grounds and for valid reasons. To ensure that this power is not misused, no safeguards have been provided in section 83. One thing is clear, that this power should be exercised by the Authority only if there is a reasonable apprehension that the assessee may default the ultimate collection of the demand that is likely to be raised on completion of the assessment. It should, therefore, be exercised with extreme care and circumspection. It should not be exercised unless there is sufficient material on record to justify the satisfaction that the assessee is about to dispose of the whole or any part of his property with a view to thwarting the ultimate collection of the demand. Moreover, attachment should be made of the properties and to the extent it is required to achieve the above object. It should neither be used as a tool to harass the assessee nor should it be used in a manner which may have an irreversible detrimental effect on the business of the assessee.’

 

POWER OF PROVISIONAL ATTACHMENT IS NOT ABSOLUTE

The power of the Commissioner in attaching any property including bank accounts is not absolute. In Bindal Smelting Pvt. Ltd. vs. ADGGI [2020 (1) TMI 569 – P&H] the Court held that the expression ‘is of the opinion’ or ‘has reason to believe’ is of the same connotation and is indicative of subjective satisfaction of the Commissioner which depends upon the facts and circumstances of each case. It is settled law that the opinion must have a rational connection with or relevant bearing on the formation of the opinion. Rational connection postulates that there must be a direct nexus or live link between the protection of interest and available property which might not be available at the time of recovery of taxes and after final adjudication of the dispute. The opinion must be formed in good faith and should not be a mere pretence. The Courts are entitled to determine whether the formation of opinion is arbitrary, capricious or whimsical. In Valerius Industries vs. Union of India 2019 (9) TMI 618 Gujarat High Court, the Court held the following:

 

* The order of provisional attachment before the assessment order is made may be justified if the assessing authority or any authority empowered in law is of the opinion that it is necessarily to protect the interest of Revenue. A finding to the effect should be recorded prior to pursuing this remedy.

* The above subjective satisfaction should be based on some credible materials or information and should also be supported by some supervening factor.

* The power u/s 83 of the Act could be termed as a very drastic and far-reaching power. Such power should be used sparingly and only on substantive weighty grounds and reasons.

* Such power should be exercised only if there is a reasonable apprehension that the assessee may default the ultimate collection of the demand that is likely to be raised on completion of the assessment. It should, therefore, be exercised with extreme care and caution.

* This power should neither be used as a tool to harass the assessee nor should it be used in a manner which may have an irreversible detrimental effect on the business of the assessee.

* The attachment of bank accounts and trading assets should be resorted to only as a last resort or measure. The provisional attachment u/s 83 should not be equated with the attachment in the course of the recovery proceedings.

* The authority before exercising power u/s 83 for provisional assessment should take into consideration two things,

a) Whether it is a revenue-neutral situation, and

b) The statement of ‘output liability or input tax credit’.

* Having regard to the amount paid by reversing the input tax credit if the interest of the Revenue is sufficiently secured, then the authority may not be justified in invoking such power for the purpose of provisional attachment.

 

Similar views were voiced in Automark Industries (I) Ltd. vs. State of Gujarat [2016] 88 VST 274 (Guj.) where such provisions were held to be drastic and extraordinary in nature. These decisions consistently hold that these powers should be used sparingly and not as a matter of routine practice.

 

PROVISIONAL ATTACHMENT OF ENTIRE BUSINESS PREMISES

Revenue authorities were performing attachment of business premises u/s 71 at the time of their visit on the ground of tax evasion. Section 83 is applicable only in specified sections and since section 71 does not form part of the list therein, it does not permit Revenue to invoke attachment of assets on a visit of premises. In Proex Fashion Private Limited [2021 (1) TMI 365], the Court held that attachment pursuant to visit to business premises u/s 71 is not permissible.

 

This limitation of section 83 is sought to be overcome by the proposed substitution of section 83 (vide Finance Bill, 2021) which encompasses all the sections under Chapters XII, XIV and XV of the CGST Act for invoking provisional attachment. Under the amended section 83, officers would be empowered to provisionally attach the business premises at the time of visit, inspection or search rather than waiting for adjudication of the tax demands.

 

DISCLOSURE OF REASONS / CIRCUMSTANCES FOR PROVISIONAL ATTACHMENT

Section 83 does not require that the necessary circumstances be communicated to the taxpayer prior to invoking provisional attachment. But such formation of belief can be examined by the Court on being questioned by the tax defaulter. The Court can examine the materials to find out whether an honest and reasonable person can base his reasonable belief upon such materials although the sufficiency of the reasons for the belief cannot be investigated by the Court (Sheonath Singh’s case [AIR 1971 SC 2451]).

 

Continuation of attachment after one year

Pendency of proceedings is a sine qua non for provisional attachment of any property. Where the provisional attachment has been initiated, the conclusion of the proceedings warrants that the provisional attachment should be lifted and cannot be continued. Revenue authorities would have to lift the encumbrance over the property and invoke other recovery provisions based on the outcome of the adjudication / assessment.

 

In UFV India Global Education vs. UOI 2020 (43) GSTL 472 (P&H), the Court held that provisional attachments are not valid after completion of the proceedings on the basis of which attachments were initiated. In other words, where the attachment was initiated on the basis of an inspection u/s 67, the attachment would cease to operate on the completion of the proceedings under the said section. As a corollary, where the inspection proceedings migrate to adjudication under sections 73 or 74, a fresh provisional attachment is required to be initiated during the pendency of such adjudication proceedings. However, this position in law is also undergoing alteration by substitution of section 83 where the provisional attachment has been sought to be extended until the conclusion of proceedings of adjudication or one year, whichever is earlier.

 

Renewal of provisional attachment

In Amazonite Steel Pvt. Ltd. vs. UOI 2020 (36) GSTL 184 (Cal.), the Court reprimanded officers who failed to withdraw the provisional attachment of the property beyond the time limit of one year and imposed heavy costs on the officials concerned. But this does not mean that the Commissioner is not empowered to renew the provisional attachment after the expiry of one year. In Shrimati Priti vs. State of Gujarat [2011 SCC Online Guj. 1869], the Court interpreted the scope of section 45 of the Gujarat Value Added Tax Act, 2003 (similar to section 83) and held that on the one hand section 45 requires the competent officer to review the situation compulsorily at least upon completion of the period, while so doing, it does not limit his discretion to exercise such powers again if the situation so arises. Other things remaining the same, the Court also held that there is nothing in the express wording of section 83 which prohibits the Commissioner from issuing a fresh order for provisional attachment on expiry of one year. Therefore, as long as there is pendency of proceedings under a specified section, Commissioners can form an opinion and renew the provisional attachment of the property. In the context of Income-tax law, the provisional attachment has been specifically stated as not being extendable beyond two years. It is in this context that the Delhi High Court in VLS Finance Ltd. vs. ACIT [2011] 331 ITR 131 (Delhi) held that attachment of property cannot extend the limit specified in law and hence distinguishable from the position under GST.

 

Though in theory these provisions are held to be extreme actions, it is not unknown that Revenue officers have used this tool to arm-twist taxpayers in recovery of taxes. Apprehension of business breakdown compels enterprises to succumb to such demands. Despite their bona fides being proved during investigations, certain taxpayers also find the removal of attachment to be a herculean task. The tool of deterrence has in certain instances become a tool of harassment. Indeed, with great power comes great responsibility!

TAXATION OF DIGITISED ECONOMY – SIGNIFICANT ECONOMIC PRESENCE AND EXTENDED SOURCE RULE

In our earlier articles of January and May, 2020, we had covered the proposals discussed between the countries participating in the Inclusive Framework to tax the digitised economy. Closer home, India has introduced several provisions to bring into the tax net the income of the digitised economy – Equalisation Levy (EL), Significant Economic Presence (SEP) and Extended Source Rule for business activities undertaken in or with India.

This article seeks to analyse the provisions introduced in the Income-tax Act, 1961 (the Act) to tax the income in the digitised economy era – Explanation 2A, i.e., SEP, and Explanation 3A, i.e., the extended source rule, to section 9(1)(i). While there are other measures and provisions relating to taxation of the digitalised economy, such as EL and provisions related to deduction and collection of taxes, this article does not deal with such provisions.

1. BACKGROUND

Taxation of the digitised economy has been one of the hotly debated topics in the international tax arena in the recent past, not just amongst tax practitioners and academicians but also amongst governments and revenue officials. The existing tax rules are not sufficient to tax the income earned in the digital economy era. The existing rules of allocation of taxing rights in DTAAs between countries rely on physical presence of a business in a source country to tax income. However, with the advent of technology, the way businesses are conducted is different from that a few years ago. Today, it is possible to undertake business in a country without requiring any physical presence, thereby leading to no tax liability in the country in which such business is undertaken.

The urgency and importance of this topic became evident when OECD included taxation of the digital economy as the first Action Plan out of 15 in the BEPS Project. More than 130 countries, as part of the Inclusive Framework of the OECD, have been seeking to arrive at a consensus-based solution to tax the transactions in the digitised economy era for the past few years. In this regard, a two-pillar Unified Approach has been developed and the blueprints for both the Pillars were released for public comments in October, 2020.

While countries in the Inclusive Framework are hopeful of arriving at a consensus amongst all members this year, there are various policy considerations which need to be taken into account. Further, the UN Committee of Experts on International Co-operation in Tax Matters has also tabled a proposal seeking to insert a new article in the UN Model Double Tax Convention to tax the digitised economy.

India has been a key player in the global discussions to tax the digitised economy. While BEPS Action Plan 1 dealing with taxation of the digital economy did not provide a recommendation in the Final Report released in October, 2015 on account of the lack of consensus amongst the participating countries, the Report analysed (without recommending) three options for countries until consensus was arrived at – withholding tax, a digital permanent establishment in the form of SEP, or equalisation levy. It was also concluded that member countries would continue to work on a consensus-based solution to be arrived at at the earliest.

DEVELOPMENTS IN INDIA

India was one of the first countries to enact a law in this regard and EL was introduced as a part of the Finance Act, 2016. The EL applicable to online advertisement services was not a part of the Act and therefore, arguably, not restricted by tax treaties. The Finance Act, 2018 introduced the SEP provisions in the Act. Further, the scope of ‘income attributable to operations carried out in India’ was extended by the Finance Act, 2020. While introducing the extended scope, the Finance Act, 2020 also amended the SEP provisions and postponed the application of these provisions till the F.Y. 2021-22. Further, the Finance Act, 2020 also expanded the scope of the EL provisions.

Unlike the EL provisions, SEP by insertion of Explanation 2A to section 9(1)(i) and the Extended Source Rule by insertion of Explanation 3A to section 9(1)(i), were introduced in the Act itself and hence the taxation of income covered under these provisions may be subject to the beneficial provisions of the tax treaties.

In other words, the application of these provisions would be required in a scenario where the non-resident is from a jurisdiction which does not have a DTAA with India, or where the non-resident is not eligible to claim benefits of a DTAA, say on account of application of the MLI provisions, or due to the non-availability of a Tax Residency Certificate (TRC).

In addition to scenarios where benefit of the DTAA is not available, it is important to note that one of the possible methods for implementation of Pillar 1 of the Unified Approach is the modification of the existing DTAAs through another multilateral instrument (MLI 2.0) to provide for a nexus and the amount to be taxed in the Country of Source or Country of Market. Therefore, the reason for introduction of these provisions in the Act is to enable India to tax such transactions once the treaties are modified because without charge of taxation in the domestic tax law, mere right provided by a tax treaty may not be sufficient.

2. EXPLANATION 2A TO SECTION 9(1)(I) (SEP)

The SEP provisions were introduced by way of insertion of Explanation 2A to section 9(1)(i) of the Act. It reads as follows:

‘Explanation 2A. – For the removal of doubts, it is hereby declared that the significant economic presence of a non-resident in India shall constitute “business connection” in India and “significant economic presence” for this purpose, shall mean –
(a) transaction in respect of any goods, services or property carried out by a non-resident with any person in India, including provision of download of data or software in India, if the aggregate of payments arising from such transaction or transactions during the previous year exceeds such amount as may be prescribed; or
(b) systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India, as may be prescribed:

Provided that the transactions or activities shall constitute significant economic presence in India, whether or not –
(i) the agreement for such transactions or activities is entered in India; or
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
Provided further that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India.’

Therefore, Explanation 2A seeks to extend the definition of ‘business connection’ to certain transactions where the business is undertaken ‘with’ India as against the traditional method of creating a business connection only in cases of transactions undertaken ‘in’ India.

The thresholds in respect of the amount of payment for goods and services and in respect of the number of users have not yet been prescribed, therefore the provisions of SEP, although applicable from A.Y. 2022-23, are not yet operative.

2.1 Whether SEP would apply only in case of digital transactions
It is important to note that under Explanation 2A, the definition of SEP is an exhaustive one and therefore a transaction which does not satisfy the above criteria would not be considered as constituting an SEP.

It is also important to note that the definition of SEP is not restricted to only digital transactions but seeks to cover all transactions which are undertaken with a person in India. This is in line with the proposed provisions of Pillar 1 of the Unified Approach and the discussion of the same in the Inclusive Framework. Pillar 1 of the Unified Approach seeks to bring to tax automated digital businesses as well as consumer-facing businesses. On the other end of the spectrum, the proposed Article 12B in the UN Model Tax Convention seeks to tax only automated digital businesses and does not cover consumer-facing businesses.

Further, at the time of introduction of the SEP provisions in the Finance Act, 2018, the Memorandum explaining the provisions of the Finance Bill (Memorandum) referred to taxation of digitalised businesses and thus the intention seems to be to tax transactions undertaken only through digital means. However, the language of the section does not suggest the taxation only of digital transactions. This is also evident in the CBDT Circular dated 13th July, 2018 (2018) 407 ITR 5 (St.) inviting comments from the general public and stakeholders, specifically comments on revenue threshold for transactions in respect of physical goods.

Further, with regard to clause (a) what needs to be prescribed is the threshold for the amount of payment and not the type of transactions covered. Therefore, even a transaction undertaken through non-digital means would constitute an SEP in India and hence a business connection in India if the aggregate transaction value during the year exceeds the prescribed amount.

An example of a transaction which may possibly be covered subject to the threshold could be the service provided by a commission agent in respect of export sales, wherein no part of the service of such agent is undertaken in India. Various judicial precedents have held that export sales commission is neither attributable to a business connection in India in such a scenario, nor does it constitute ‘fees for technical services’ u/s 9(1)(vii) of the Act. However, now the activities of such an agent, providing services to a person residing in India (the seller), could possibly constitute an SEP in India.

Further, clause (b) above refers to systematic and continuous soliciting of business or engaging in interaction with a prescribed number of users. At the time of the introduction of the SEP provisions by the Finance Act, 2018, this activity was required to be undertaken ‘through digital means’ in order to constitute an SEP. This additional condition of the activity being undertaken ‘through digital means’ was removed by the Finance Act, 2020. Accordingly, any activity which is considered
as soliciting business or engaging with a prescribed number of users could result in the constitution of an SEP in India.

For example, a call centre of a bank outside India which deals with a number of Indian customers could result in the entity owning the call centre to be considered as having an SEP in India if the number of customers solicited exceeds the prescribed threshold.

Accordingly, every type of transaction undertaken with India may be covered as constituting an SEP in India, not in accordance with what is provided in the Memorandum.

2.2 Transaction in respect of any goods, services or property carried out by a non-resident with any person in India
The first condition for constitution of an SEP is a transaction in respect of any goods, services or property carried out by a non-resident with any person in India, the payments for which exceed the prescribed threshold.

The term ‘goods’ has not been defined in the Act. While one may be able to import the definition of the term from the Sale of Goods Act, 1930, it may not be of much relevance as the SEP provisions also apply to transactions in respect of ‘property’. Therefore, all assets, tangible as well as intangible, would be covered under this clause subject to the discussion below regarding SEP covering only transactions whose income is taxed as business profits.

Thus, offshore sale of goods to a person in India may now be covered under the SEP provisions (subject to the fulfilment of the threshold limit). Interestingly, the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. vs. DIT [2007] 288 ITR 408, held that income from sale of goods by a non-resident concluded outside India would not be considered as income accruing or arising in India. The SEP provisions, specifically covering such transactions, could now override the decision of the Apex Court in cases where the SEP provisions are triggered.

Another question that arises is whether a transaction of sale of shares is covered. Let us take as an example the sale of shares of a US Company by a US resident to a person in India. Such a sale, not being sale of shares of an Indian company, assuming that the US Company does not have an Indian subsidiary to trigger indirect transfer provisions, was not considered as accruing or arising in India and therefore is not taxable in India.

In the present case, one may be able to argue that even if the transaction value exceeds the threshold limit, the SEP provisions would not be triggered if the sale is not a part of the business of the US resident seller. This would be so as the constitution of an SEP results in the constitution of a business connection. Therefore, for SEP to be constituted, the transaction needs to be in respect of business income and not in respect of a capital asset. Section 9(1)(i) clearly differentiates between business connection and an asset situated in India.

In other words, SEP would only apply to transactions, the income from which would constitute business income. Accordingly, income from sale of shares, not being the business income of the US resident seller, would not trigger SEP provisions.
It is important to highlight that what is sought to be covered under the SEP provisions is business income and a transaction of sale of property which is not a part of the business of the non-resident seller may not be covered. However, this does not mean that a single transaction is outside the scope of SEP provisions. Let us take the example of a heavy machinery manufacturer in Germany who sells his machines globally. If the price of a single machine exceeds the threshold value, a single sale by the German manufacturer to a person in India may trigger the SEP provisions as the income from such sale is a part of his business income. While the Supreme Court in the case of CIT vs. R.D. Aggarwal & Co., (1965) (56 ITR 20, 24), held that a stray or isolated transaction is normally not to be regarded as a business connection, this position may no longer hold good for transactions triggering SEP as the SEP provisions require fulfilment of subjective conditions.

But then, what is meant by a ‘person in India’? While most of the sections in the Act refer to a ‘person resident in India’, Explanation 3A refers to a ‘person who resides in India’. Given the intention to tax a non-resident on account of the economic connection with India, there needs to be a semblance of permanent connection of the transaction with India. This permanent connection may not be satisfied in the case of a person who is visiting India for a short visit and is, say, availing the services from the non-resident. Therefore, one may argue that a person in India in Explanation 2A would mean a person resident in India. Further, the term ‘resides’ may connote a continuous form of residence and, therefore, in such a scenario also, one may be able to argue that the term refers to a person resident in India.

2.3 Systematic and continuous soliciting of business activities or engaging in interaction with such number of users in India
The second condition for the constitution of an SEP is systematic and continuous soliciting of business activities or engaging in interaction with a prescribed number of users in India.

There are two types of transactions which would be covered under the condition (subject to the fulfilment of the number of users in India threshold):
a) Systematic and continuous soliciting of business activities; and
b) Engaging in interaction.

There is ambiguity as to what constitutes ‘users’, ‘soliciting’ as well as ‘engaging in interaction’. As highlighted earlier, while the conditions required the above activities to be undertaken through digital means at the time SEP provisions were introduced by the Finance Act, 2018, the Finance Act, 2020 removed the requirement of digital means, thereby possibly expanding the scope of the transactions covered.

We need to wait and see how the threshold limits along with conditions, if any, are prescribed.

Some of the activities which may be covered under this condition would be social media companies, support services which engage with multiple users in India, online advertisement services, etc.

2.4 Profits attributable to SEP
The second proviso to Explanation 2A provides that only so much of income as is attributable to the transactions or activities referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India. Explanation 1(a) to section 9(1)(i), on the other hand, seeks to cover income attributable to operations carried out in India.

Given the peculiar language used in the 2nd proviso to Explanation 2A, this may result in a scenario where the entire income arising out of a transaction or activity would be considered as accruing or arising in India.

Let us take an example to understand the impact and such a possible absurd outcome in detail. A non-resident who manufactures certain goods outside India sells such goods in India under two scenarios – through a sales office in India and directly without any physical presence in India. Assuming that in both scenarios the sale of the goods is concluded outside India, in the first scenario the activities undertaken by the sales office could result in the constitution of business connection under Explanation 2 if the employees in the sales office habitually play a principal role in the conclusion of contracts of the non-resident in India. In such a scenario, Explanation 3 provides that only the income as is attributable to the activities of the sales office would be deemed to accrue or arise in India. Therefore, only a part of the profits of the non-resident, which represents the amount attributable to the activities of the sales office, let us say xx% on the basis of various judicial precedents, would be taxable in India.

However, in the second scenario, assuming that the threshold as prescribed in Explanation 2A is met, the transaction of the sale of goods to a person resident in India could constitute an SEP in India. In such a scenario, the moot question that arises for consideration is whether on a literal reading of the 2nd proviso to Explanation 2A, it can be said that in such a transaction the entire income is attributable to the ‘transaction’ and shall be deemed to accrue or arise in India?

In other words, if a business connection is constituted on account of operations carried out in India, only part of the profits would be taxed in India, whereas if the business connection is constituted on account of the SEP in India, it is open to question as to whether the entire income of the non-resident could be attributed and deemed to accrue or arise in India.

Similarly, the entire income of a social media company outside India engaging with a large number of users in India could be taxed in India if the number of users exceeds the threshold and results in the constitution of an SEP in India.

Such a view, on a literal interpretation of the amended provisions, would not be in consonance with the global discussion on the subject currently in progress at various international fora.

Such a view would also not be in line with the discussion contained in the BEPS Action Plan 1 Report which provides:
‘Consideration must therefore be given to what changes to profit attribution rules would need to be made if the significant economic presence option were adopted, while ensuring parity to the extent possible between enterprises that are subject to tax due to physical presence in the market country (i.e., local subsidiary or traditional PE) and those that are taxable only due to the application of the option.’

Further, the BEPS Action Plan 1 Report analyses three options while attributing profits to the SEP:
a) Replacing functional analysis with an analysis based on game theory that would allocate profits by analogy with a bargaining process within a joint venture. However, the Report appreciates that this method would mean a substantial departure from the existing standard for allocation of profits on the basis of functions, assets and risks and, therefore, unless there is a substantial rewrite of the rules for the attribution of profits, alternative methods would need to be considered;
b) The fractional apportionment method wherein the profits of the whole enterprise relating to the digital presence would be apportioned either on the basis of a predetermined formula or on the basis of variable allocation factors determined on a case-by-case basis. However, this method is not pursued further as it would mean a departure from the existing international standard of attributing profits on the basis of separate books of the PE;
c) The deemed profit method wherein the SEP for each industry has a deemed net income by applying a ratio of the presumed expenses to the taxpayer’s revenue derived in the country. While this option is relatively easier to administer, it has its own set of challenges, such as, if the entity on a global level has incurred a loss, would the deemed profit method still allocate a notional profit to the SEP?

Similarly, the draft Directive, introduced by the European Commission on ‘significant digital presence’, provided for a modified profit-split as the method to attribute the profits to the SEP. The draft Directive, introduced in 2018, was not enacted due to lack of consensus amongst the members of the European Union.

In both the examples above, in the context of profits attributable to the SEP, one may be able to argue that taxing activities undertaken outside India result in extra-territorial taxation by India and, therefore, go beyond the sovereign right of the country to tax such income.

The CBDT has recognised this need to provide clarity for profit attribution to the SEP and has included a chapter on the same in its draft report on Profit Attribution to Permanent Establishments (CBDT Press Release F 500/33/2017-FTD.I dated 18th April, 2019) (draft report).

The draft report provides that in the case of an SEP, in addition to the traditional equal weightage given to assets, employees and sales, one can consider giving weightage to users as well in the case of digitised businesses depending on the level of user intensity. The draft report proposes the weight of 10% to users in business models involving low / medium user intensity and 20% in business models involving high user intensity.

It is important to note that the report, when finalised and notified, would be forming a part of the Rules and in the absence of any reference to attribution of profits to the SEP in Explanation 2A, one may need to further analyse the application on finalisation of the rules.

2.5 Summary of SEP provisions
The SEP provisions have been summarised below:

3. EXPLANATION 3A TO SECTION 9(1)(i) (EXTENDED SOURCE RULE)
Following global discussions, the Finance Act, 2020 extended the source rule for income attributable to operations carried out in India by inserting Explanation 3A to section 9(1)(i), which reads as under:
‘Explanation 3A. – For the removal of doubts, it is hereby declared that the income attributable to the operations carried out in India, as referred to in Explanation 1, shall include income from –
(i)    such advertisement which targets a customer who resides in India or a customer who accesses the advertisement through an internet protocol address located in India;
(ii)    sale of data collected from a person who resides in India or from a person who uses an internet protocol address located in India; and
(iii)    sale of goods or services using data collected from a person who resides in India or from a person who uses an internet protocol address located in India.’

The following proviso has been inserted in Explanation 3A to clause (i) of sub-section (1) of section 9 by the Finance Act, 2020 w.e.f. 1st April, 2022:
‘Provided that the provisions contained in this Explanation shall also apply to the income attributable to the transactions or activities referred to in Explanation 2A.’

3.1 Whether Explanation 3A creates nexus?
Unlike Explanation 2A, which equates SEP to a business connection, the language used in Explanation 3A is different.

Explanation 3A to section 9(1)(i) provides,
‘For the removal of doubts, it is hereby declared that the income attributable to the operations carried out in India, as referred to in Explanation 1, shall include….’

Explanation 1 provides that in the case of a business of which all the operations are not carried out in India, only part of the income as is reasonably attributable to the operations carried out in India shall be deemed to accrue or arise in India.

Further, the nexus for income deemed to accrue or arise in India in the form of business connection in India or property in India or source of income in India, etc., is provided in the main section 9(1)(i).

Now, the question arises whether Explanation 1 can be applied without a nexus in section 9(1)(i)? One may argue that having established a nexus in the form of business connection, asset or source of income in India, Explanation 1 merely provides the amount of income attributable to the said nexus and, therefore, in the absence of a nexus u/s 9(1)(i), Explanation 1 cannot be applied.

In this regard, the role of ‘Explanation’ in a tax statute has been explained by the Karnataka High Court in the case of N. Govindraju vs. ITO (2015) (377 ITR 243) in the context of Explanation vs. proviso, wherein it was held,
‘37. Insertion of “Explanation” in a section of an Act is for a different purpose than insertion of a “proviso”. “Explanation” gives a reason or justification and explains the contents of the main section, whereas “proviso” puts a condition on the contents of the main section or qualifies the same. “Proviso” is generally intended to restrain the enacting clause, whereas “Explanation” explains or clarifies the main section. Meaning, thereby, “proviso”’ limits the scope of the enactment as it puts a condition, whereas “Explanation” clarifies the enactment as it explains and is useful for settling a matter or controversy.
38. Orthodox function of an “Explanation” is to explain the meaning and effect of the main provision. It is different in nature from a “proviso” as the latter excepts, excludes or restricts, while the former explains or clarifies and does not restrict the operation of the main provision. It is true that an “Explanation” may not enlarge the scope of the section but it also does not restrict the operation of the main provision. Its purpose is to clear the cobwebs which may make the meaning of the main provision blurred. Ordinarily, the purpose of insertion of an “Explanation” to a section is not to limit the scope of the main provision but to explain or clarify and to clear the doubt or ambiguity in it.’

The above decision lends weight to the argument that in the absence of a nexus in section 9(1)(i), Explanation 1 cannot apply. Having taken such a view, one may therefore possibly conclude that as Explanation 1 does not create a nexus and as Explanation 3A merely extends the scope of Explanation 1 in terms of income as is attributable to the operations carried out in India, Explanation 3A shall not apply unless the non-resident has a business connection. In other words, Explanation 3A merely acts like a ‘force of attraction’ provision in the Act and does not create a nexus by itself.

It may be highlighted that the above view that in the absence of a nexus u/s 9(1)(i), Explanation 1 shall not apply, is not free from doubt. Another possible view is that Explanation 1 refers to the income which is deemed to accrue or arise in India and therefore creates a nexus by itself irrespective of the fact as to whether or not there exists a business connection. One will have to wait for the judicial interpretation in this regard to see whether the judiciary reads down the extended source rule in Explanation 3A.

3.2  What is sought to be taxed through Explanation 3A
Explanation 3A seeks to extend the scope of income attributable to operations carried out in India in the case of three scenarios:
a) Sale of advertisement;
b) Sale of data; and
c) Sale of goods or services using data.

In respect of (a) and (b) above, the same is also covered by the extended EL provisions as applicable to e-commerce supply or services. Further, section 10(50) of the Act, as proposed to be amended by the Finance Bill, 2021, provides that income other than royalty or fees for technical services shall be exempt under the Act if the said transaction is subject to EL. Therefore, in respect of transactions covered under (a) or (b), the provisions of EL would apply and Explanation 3A may not be applicable.

Therefore, only the provisions of (c) have been analysed.

While Explanation 2A seeks to cover a transaction of a non-resident with a person residing in India, Explanation 3A does not require such conditions. In other words, even transactions between two non-residents may be subject to tax under Explanation 3A if the transaction:
a)    In the case of sale of advertisement, targets a customer residing in India;
b)    In the case of sale of data, is in respect of data collected from a person residing in India; or
c) In the case of sale of goods or services, is using data collected from a person residing in India.

For example, ABC, a foreign company owning a social media platform having various users all over the world, including India, is engaged by FCo, a foreign company engaged in the business of apparels, to provide data analytics services to enable FCo to understand the consumption pattern in Asia in order to enable it to target customers in Europe. It is assumed that the data analytics service is undertaken outside India.

In this scenario, as ABC is providing a service to FCo, both non-residents, using data collected from persons residing in India in addition to other countries, Explanation 3A may apply and, therefore, deem the income from sale of services to be accruing or arising in India. While, arguably, only the portion of the income which relates to the data collected from India should be taxed in India, it may be practically difficult, if not impossible, in such a scenario to bifurcate such income on the basis of data collected from every country.

Moreover, as this would be a transaction between two non-residents, the question of extra-territoriality as well as the practical difficulty of implementing the taxation of such transactions may need to be evaluated in detail.

The issues relating to the attribution of income – whether the entire income is deemed to accrue or arise in India or is only a part of the income (and if so, how is the same to be computed) is to be taxed, as explained above in the context of SEP would equally apply here as well. In fact, as the CBDT draft report on profit attribution to PE was released before the Finance Act, 2020, there is no guidance available to provide clarity in this matter.

4. CONCLUSION


Currently, the provisions of SEP are not yet operative as the thresholds have not yet been prescribed. Further, the SEP provisions as well as those related to extended scope have limited application due to the benefit available in the DTAAs. However, with treaty eligibility being questioned in various transactions in the recent past and with the application of the MLI, these provisions may be of greater significance. Therefore, it is imperative that some of the aforementioned ambiguities, such as the amount of income attributable to the SEP and extended scope, be clarified at the earliest by the authorities.

RATE OF TAX ON DEEMED SHORT-TERM CAPITAL GAINS U/S 50

ISSUE FOR CONSIDERATION
Section 50 of the Income-Tax Act, 1961 provides for the manner of computation of capital gains arising on sale of depreciable assets forming part of a block of assets and for deeming such gains as the one on transfer of the short-term capital assets. The section reads as under:

‘Special provision for computation of capital gains in case of depreciable assets

50. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications: –

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely: –
(i) expenditure incurred wholly and exclusively in connection with such transfer or transfers;
(ii) the written down value of the block of assets at the beginning of the previous year; and
(iii) the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.’

In a situation where an asset which is otherwise held for more than three years but is deemed short-term capital asset, on application of section 50, for the reason such an asset forming part of the block of assets and depreciated is transferred, the issue has arisen as to the rate of tax applicable to the gains on transfer of such assets – whether such gains would be taxable in the manner prescribed u/s 112 at a concessional rate of 20%, or at the regular rates prescribed for the total income. While a few benches of the Tribunal have held that the rate applicable would be the regular rate applicable to total income including the short-term capital gains, in a number of decisions various benches of the Tribunal have taken the view that the rate applicable on such deemed short-term capital gains would be the rate applicable to long-term capital gains, i.e., the rate of 20% prescribed u/s 112. This controversy has been discussed in the BCAJ Vol. 48-B, November, 2016, Page 51, but the latest decision in Voltas Ltd. has added a new dimension to the conflict and some fresh thoughts on the subject are shared herein.

THE RATHI BROTHERS’ CASE

The issue had come up before the Pune bench of the Tribunal in the case of Rathi Brothers (Madras) Ltd. vs. ACIT, ITA No. 707/PN/2013 dated 30th October, 2014.

During the previous year relevant to A.Y. 2008-09, the assessee sold its office premises for Rs. 98,37,000. Since depreciation had been claimed on such asset in the past, the assessee computed its capital gains u/s 50 at Rs. 93,40,796, disclosed such capital gains as short-term capital gains but computed tax thereon at the rate of 20%.

It was contended before the A.O. that the tax rate u/s 112 was being applied on the gains treating the gains as long-term capital gains, though the resultant capital gains were in the nature of short-term capital gains as per the provisions of section 50 based on the decision of the Bombay High Court in CIT vs. Ace Builders (P) Ltd. 281 ITR 210. The assessee also placed reliance on the decision of the Mumbai Tribunal in the case of P.D. Kunte & Co. vs. ACIT (ITA No. 4437/Mum/05 dated 10th April, 2008).

However, the A.O. observed that the said ITAT decision was in the context of eligibility of exemption u/s 54EC in respect of capital gains computed u/s 50 on transfer of an asset held for more than three years. It was pointed out to the A.O. that in response to a miscellaneous application filed in that case the order was modified to hold that on the reasoning of the Bombay High Court in the case of Ace Builders (Supra), it naturally followed that even the tax rate applicable while bringing capital gain to tax would be as per the provisions of section 112.

However, attempting to distinguish this interpretation, the A.O. stated that section 50 was a special provision inserted to compute capital gains in respect of depreciable assets with an intention to prevent dual concession to the assessee in the form of depreciation as well as concessional rate of tax. It was also emphasised by the A.O. that even in the case decided by the Bombay High Court, the larger issue involved was the eligibility to claim deduction u/s 54E against capital gains arising on transfer of an asset on which depreciation was being claimed, even if such gains were to be computed in accordance with the provisions of section 50.

The A.O. accordingly taxed the capital gain as short-term capital gain and declined to apply the tax rate prescribed u/s 112.

The Commissioner (Appeals) dismissed the assessee’s appeal, holding that section 50 was enacted with the objective of denying multiple benefits to the owners of assets. According to him, the rationale behind enacting such a deeming provision u/s 50 was that the assessee had already availed benefits in the form of depreciation in case of depreciable assets, and it was not equitable to extend dual benefit of depreciation as well as concessional tax rate of 20% to capital gains arising on transfer of depreciable assets.

On behalf of the assessee it was argued before the Tribunal that since the asset was held for more than three years, it was a long-term capital asset as defined in section 2(14), and capital gain computed even u/s 50 is to be treated as long-term capital gain. The Bombay High Court in Ace Builders (Supra) had held that section 50 is a deeming provision, hence the same is to be interpreted to the extent to achieve the object of the said provision. Reliance was also placed by the assessee on the Mumbai Tribunal decision in the case of P.D. Kunte & Co. (Supra).

The Tribunal refused to accept the argument that in case of Ace Builders the Bombay High Court had held that even capital gain computed u/s 50 is to be treated as long-term capital gain. According to the Tribunal, the High Court had explained that if the capital gain was computed as provided u/s 50, then the capital gains tax would be charged as if such capital gain had arisen out of a short-term capital asset. The Tribunal also did not follow the Mumbai Tribunal decision in the case of P.D. Kunte & Co. on the ground that this ground had remained to be adjudicated in that case.

The Tribunal therefore held that such capital gains was not eligible for the 20% rate of tax applicable to long-term capital gains u/s 112.

A similar view has been taken by the Mumbai bench of the Tribunal in the cases of ACIT vs. SKF Bearings India Ltd. (ITA No. 616/Mum/2006 dated 29th December, 2011), SKF India Ltd. vs. Addl. CIT (ITA No. 6461/Mum/2009 dated 24th February, 2012) and Reckitt Benckiser (India) Ltd. vs. ACIT, 181 TTJ 384 (Kol.).

THE VOLTAS CASE

The issue came up again recently before the Mumbai bench of the Tribunal in the case of DCIT vs. Voltas Ltd. TS-566-ITAT-2020(Mum).

In this case, the assessee had sold buildings which were held for more than three years. The assessee claimed that the capital gains on the sale of the buildings should be taxed at 20% u/s 112 instead of at 30%, the rate applicable to short-term capital gains.

It was argued on behalf of the assessee before the Tribunal that the issue was covered in favour of the assessee by the Mumbai Tribunal decision in the case of Smita Conductors Ltd. vs. DCIT 152 ITD 417. Reliance was also placed on the decision of the Bombay High Court (actually of the Supreme Court, affirming the decision of the Bombay High Court) in the case of CIT vs. V.S. Dempo Company Ltd. 387 ITR 354 and the decision of the Supreme Court (actually of the Bombay High Court) in the case of CIT vs. Manali Investment [219 Taxman 113 (Bombay)(Mag.)] and it was argued that both Courts had held that the deeming provision of the section could not be extended beyond the method of computation of the cost of acquisition involved.

It was argued on behalf of the Revenue that section 50, being a special provision for computation of capital gains in case of depreciable assets, specifically provides in the concluding paragraph that the income accrued or arising as a result of such transfer shall be deemed to be income from transfer of a short-term capital asset. It was submitted that the language of the Act was very clear and unambiguous. It was argued that there would have been scope for ambiguity only if the term ‘short term’ was not used. It was submitted that when the Act provides that such gain would be gain arising from short term capital asset, there was no reason why the term ‘short term’ appearing in that provision should be regarded as superfluous. It was argued that when the Act was so clear there could not be any dispute about the rate of tax applicable for short-term capital gain.

The Tribunal analysed the provisions of section 50 and the decisions in the cases of V.S. Dempo (Supra) and Manali Investment (Supra). It noted the observations of the Bombay High Court (actually the Supreme Court) that section 50 is only restricted for the purpose of sections 48 and 49 as specifically stated therein, and the fictions created in sub-sections (1) and (2) have limited application only in the context of the mode of computation of capital gains contained in sections 48 and 49. The fictions have nothing to do with exemption that is provided in a totally different provision, viz., section 54EC. The Tribunal cited with approval the observations of the Bombay High Court in the case of Ace Builders (Supra) and noted that the Gujarat and Gauhati High Courts had taken a similar view in the cases of CIT vs. Polestar Industries 221 Taxman 423 and CIT vs. Assam Petroleum Industries (P) Ltd. 262 ITR 587, respectively. It also noted the Supreme Court (Bombay High Court) decision in the case of Manali Investment where the Supreme Court (Bombay High Court) permitted set-off of brought forward long-term capital loss against gains computed u/s 50 on sale of an asset which had been held for more than three years.

The Tribunal observed that the higher Courts had held that the deeming fiction of section 50 was limited and could not be extended beyond the method of computation of capital gain and that the distinction between long-term and short-term capital gains was not obliterated by this section. The Tribunal, therefore, allowed the appeal of the assessee on this ground.

A similar view has been taken by the Tribunal in the cases of Smita Conductors vs. DCIT 152 ITD 417 (Mum.), Poddar Brothers Investments Pvt. Ltd. vs. DCIT [ITA 1114/Mum/2013 dated 25th March, 2015), Castrol India Ltd. vs. DCIT [ITA 195/Mum/2012 dated 18th October, 2016], Yeshwant Engineering Pvt. Ltd. vs. ITO [ITA 782/Pun/2015 dated 9th October, 2017], DCIT vs. Eveready Industries Ltd. [ITA 159/Kol/2016 dated 18th October, 2017], BMC Software India Pvt. Ltd. vs. DCIT (ITA 1722/Pun/2017 dated 12th March, 2020), Mahindra Freight Carriers vs. DCIT, 139 TTJ 422 and Prabodh Investment & Trading Company vs. ITO (ITA No. 6557/Mum/2008). In most of these cases, the view taken by the Tribunal in the case of Smita Conductors (Supra) has been followed.

OBSERVATIONS

Section 50 provides for modification to provisions of sections 48 and 49, while giving the mode of computation as well as stating that such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets. Both sections 48 and 49 are computation provisions and therefore section 50 really only modifies the manner of computation of capital gains.

This aspect has been clarified by various Courts as under:

In Ace Builders (Supra), the Bombay High Court has observed:
‘21. On perusal of the aforesaid provisions, it is seen that section 45 is a charging section, and sections 48 and 49 are the machinery sections for computation of capital gains. However, section 50 carves out an exception in respect of depreciable assets and provides that where depreciation has been claimed and allowed on the asset, then, the computation of capital gain on transfer of such asset under sections 48 and 49 shall be as modified under section 50. In other words, section 50 provides a different method for computation of capital gain in the case of capital assets on which depreciation has been allowed.

22. Under the machinery sections the capital gains are computed by deducting from the consideration received on transfer of a capital asset, the cost of acquisition, the cost of improvement and the expenditure incurred in connection with the transfer. The meanings of the expressions “cost of improvement” and “cost of acquisition” used in sections 48 and 49 are given in section 55. As the depreciable capital assets have also availed depreciation allowance under section 32, section 50 provides for a special procedure for computation of capital gains in the case of depreciable assets. Section 50(1) deals with the cases where any block of depreciable assets do not cease to exist on account of transfer and section 50(2) deals with cases where the block of depreciable assets cease to exist in that block on account of transfer during the previous year. In the present case, on transfer of depreciable capital asset the entire block of assets has ceased to exist and, therefore, section 50(2) is attracted. The effect of section 50(2) is that where the consideration received on transfer of all the depreciable assets in the block exceeds the written down value of the block, then the excess is taxable as a deemed short-term capital gain. In other words, even though the entire block of assets transferred are long-term capital assets and the consideration received on such transfer exceeds the written down value, the said excess is liable to be treated as capital gain arising out of a short-term capital asset and taxed accordingly.
…………………………

25. In our opinion, the assessee cannot be denied exemption under section 54E because, firstly, there is nothing in section 50 to suggest that the fiction created in section 50 is not only restricted to sections 48 and 49 but also applies to other provisions. On the contrary, section 50 makes it explicitly clear that the deemed fiction created in sub-section (1) and (2) of section 50 is restricted only to the mode of computation of capital gains contained in sections 48 and 49. Secondly, it is well established in law that a fiction created by the Legislature has to be confined to the purpose for which it is created. In this connection, we may refer to the decision of the Apex Court in the case of State Bank of India vs. D. Hanumantha Rao 1998 (6) SCC 183. In that case, the Service Rules framed by the bank provided for granting extension of service to those appointed prior to 19th July, 1969. The respondent therein who had joined the bank on 1st July, 1972 claimed extension of service because he was deemed to be appointed in the bank with effect from 26th October, 1965 for the purpose of seniority, pay and pension on account of his past service in the army as Short Service Commissioned Officer. In that context, the Apex Court has held that the legal fiction created for the limited purpose of seniority, pay and pension cannot be extended for other purposes. Applying the ratio of the said judgment, we are of the opinion that the fiction created under section 50 is confined to the computation of capital gains only and cannot be extended beyond that.’

These observations of the Bombay High Court in paragraph 25 of the Ace Builder’s decision have been reproduced and approved of by the Supreme Court in the V.S. Dempo case, thereby confirming that the fiction of section 50 is confined to the computation of capital gains only and cannot be extended beyond that.

However, in paragraph 26, the Bombay High Court has observed:
‘26. It is true that section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. In other words, where the long-term capital asset has availed depreciation, then the capital gain has to be computed in the manner prescribed under section 50 and the capital gains tax will be charged as if such capital gain has arisen out of a short-term capital asset, but if such capital gain is invested in the manner prescribed in section 54E, then the capital gain shall not be charged under section 45 of the Income-tax Act.’

The Mumbai bench of the Tribunal in the SKF cases as well as the Pune bench of the Tribunal in the Rathi Brothers case has relied on these observations for holding against the assessee. However, since the issue before the Bombay High Court was regarding the availability of the exemption u/s 54E, the observations regarding charge of capital gains tax should be regarded as the obiter dicta. Further, the Tribunal in these cases did not have the benefit of the Supreme Court’s decision in the V.S. Dempo case, where it had approved of the fact that the applicability of section 50 is confined to the computation of capital gains only.

The observations of the Gauhati High Court, which had also been approved by the Supreme Court in the V.S. Dempo case, can also be referred to:

‘7. Section 2(42A) defines “short-term capital asset” which means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer. Thus the assets, which have been already held for more than 36 months before it is transferred, would not be short-term capital assets. Section 2(29A) defines “long-term capital asset” means a capital asset which is not short-term capital asset. Therefore, the asset, which has been held for more than 36 months before the transfer, would be long-term capital asset. Section 2(29B) provides for “long- term capital gain”, which means capital gain arising from the transfer of a long-term capital asset.

8. All capital gains on the transfer of the capital asset whether short-term capital asset or long-term capital asset except otherwise provided in mentioned sections in section 45 of the Income-tax Act are chargeable to income-tax. How the capital gains shall be computed is laid under sections 48 and 49 of the Income-tax Act, 1961. The capital gain arising from the transfer of short-term assets under section 48 (as it stands at the relevant time) are wholly assessable to be as ordinary income after deduction as provided under section 48(1)(e) whereas the capital gain arising from the transfer of long-term capital assets are partially assessable as provided under section 48(b), which reads:

“(b) where the capital gain arises from the transfer of a long-term capital asset (hereinafter in this section referred to, respectively, as long-term capital gain and long-term capital asset) by making the further deductions specified in sub-section (2).”

9. Thus by virtue of this section, long-term capital assets would be entitled for further deduction as provided in sub-section (2) of section 48. Section 49 is a provision whereunder the general principle is laid down for computing capital gains and certain exceptions are engrafted in the section. Thus, sections 48 and 49 provide for the principles on which the capital gains shall be computed and the benefit which can be given for transfer of long-term capital assets while calculating the capital gain by virtue of sub-section (2) of section 48 wherein the assessee transferring long-term capital assets can claim further deduction as specified under sub-section (2). Section 50…….

10. By virtue of this section, notwithstanding anything contained in clause (42A) of section 2, where the short-term capital asset has been defined, if the depreciation is allowed, the procedure for computing the capital gain as provided under sections 48 and 49 would be modified and shall be substituted as mentioned in section 50. Section 50 only provides that if the depreciation has been allowed under the Act on the capital asset then the assessee’s computation of capital gain would not be under sections 48 and 49 of the Income-tax Act and it would be with modification as provided under section 50. Section 54E is the section which has nothing to do with sections 48 and 49 or with section 50 of the Income-tax Act, 1961 wherein the mode of computation of capital gain is provided.
…………………..

12. Section 50 is a special provision where the mode of computation of capital gains is substituted if the assessee has claimed the depreciation on capital assets. Section 50 nowhere says that depreciated asset shall be treated as short-term assets, whereas section 54E has an application where long-term capital asset is transferred and the amount received is invested or deposited in the specified assets as required under section 54E.’

The observations of the Madras High Court in the case of M. Raghavan vs. Asst. CIT 266 ITR 145, in the context of the purpose of section 50, are also relevant:

‘22. It would appear that the object of introducing section 50 in order to provide different method of computation of capital gain for depreciable assets was to disentitle the owners of such depreciable assets from claiming the benefit of indexing, as if indexing were to be applied, there would be no capital gain available in most cases for being brought to taxation. The value of depreciable asset in most cases comes down over a period of time, although there are cases where the sale value of a depreciated asset exceeds the cost of acquisition. The result of allowing indexing, if it were to be allowed, is to regard the cost of acquisition as being very much higher than what it actually is, to the assessee. If such boosted cost of acquisition is required to be deducted from the amount realised on sale, in most cases it would result in a negative figure, resulting in the assessee being enabled to claim a capital loss. Clearly, it could not have been the legislative intent to confer such multiple benefits to the assessees selling depreciable assets.’

Therefore, from the above it is clear that the deeming fiction of section 50 is for the limited purpose of computation in case of sale of depreciable assets where the computation has to be in the same manner as that applicable to short-term capital assets, i.e., without indexation of cost and with substituted cost of acquisition, being the written down value of the block of assets. The deeming of short-term capital gains can therefore be viewed in the context of the manner of computation of the capital gains, i.e., without the indexation of cost available u/s 48.

It may also be noted that one of the factors that weighed with the Pune bench of the Tribunal in Rathi Brothers for not following the Mumbai Tribunal decision in the P.D. Kunte & Co. case (which was the first case on the issue) was that this issue had not been decided in the P.D. Kunte & Co. case. However, the Tribunal failed to take note of the order in the Miscellaneous Application in the P.D. Kunte & Co. case (MA 394/Mum/2008 dated 6th August, 2008), where the Tribunal had allowed this ground by observing as under:

‘On the reasoning of the Hon’ble Bombay High Court in the case of Ace Builders (P) Ltd. (Supra), it naturally follows that even the tax rate applicable while bringing capital gain to tax will be as per the provisions of section 112 of the Act. The Assessing Officer is directed to apply the same’.
 
The decision of the Pune bench of the Tribunal in the said case would have been different had the amended decision delivered in the Miscellaneous Application been brought to its notice.

The better view of the matter therefore is the view taken by the Tribunal in the cases of P.D. Kunte & Co., Smita Conductors, etc., that the provisions of section 50 do not take away the benefit of the concessional rate of tax, where available, for the capital gains based on its period of holding.

[DCIT vs. S.R.A. Systems Ltd.; ITA Nos. 1497 to 1499/Mds/2009, A.Y. 2000-01 to 2001-02 (Mds.) ITAT] Section 234D – Levy of interest u/s 234D came into force from 1st June, 2003 – Prospective nature – After the commencement of the assessment year – Interest could be levied only from 1st April, 2004, i.e., from the A.Y. 2004-05 – The law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date Deduction u/s 10B – Undertaking – Not be formed by splitting up or reconstruction of a business already in existence – Merely by shifting business from one place to another and keeping some of the plant and machinery as those were bearing charge of financial institution – Clauses (ii) and (iii) of sub-clause (2) to section 10A were not violated

8. Commissioner of Income Tax, Chennai vs. S.R.A. Systems Ltd. [T.C. Appeal Nos. 1470 to 1472 of 2010, dated 19th January, 2021 (Bom.)]

[DCIT vs. S.R.A. Systems Ltd.; ITA Nos. 1497 to 1499/Mds/2009, A.Y. 2000-01 to 2001-02 (Mds.) ITAT]

Section 234D – Levy of interest u/s 234D came into force from 1st June, 2003 – Prospective nature – After the commencement of the assessment year – Interest could be levied only from 1st April, 2004, i.e., from the A.Y. 2004-05 – The law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date

Deduction u/s 10B – Undertaking – Not be formed by splitting up or reconstruction of a business already in existence – Merely by shifting business from one place to another and keeping some of the plant and machinery as those were bearing charge of financial institution – Clauses (ii) and (iii) of sub-clause (2) to section 10A were not violated

For the A.Y. 2000-01, the assessee had filed its return of income on 29th November, 2000. The assessee claimed that it was eligible for deduction u/s 10B. The return was processed on 28th March, 2002. Subsequently, the A.O. had reason to believe that income chargeable to tax had escaped assessment on account of the assessee company being ineligible for deduction u/s 10A. A notice dated 22nd March, 2007 was issued u/s 148 disallowing the entire claim of deduction u/s 10B. Further, the expenditure incurred for the renovation and repairs of the rented premises of the assessee company was disallowed by the A.O. on the ground that such expenses were in the nature of capital expenditure. The A.O. in his reassessment order noted that in terms of section 10B(ii) an undertaking in order to be eligible for deduction u/s 10B must not be formed by splitting up or reconstruction of a business already in existence. Further, he held that deduction u/s 10B was not available to the assessee in view of the provisions of section 10B(iii) which stipulate that eligible business is not formed by transfer to a new business of plant and machinery previously used for any purpose. The A.O. found that the assessee had not complied with both these conditions, hence it was not entitled to any deduction u/s 10B.

While completing the assessment u/s 143(3) r/w/s 147 for the A.Ys. 2000-01 and 2001-02, the A.O. disallowed the claim of deduction made by the assessee under sections 10A and 10B on the ground that an undertaking was formed by splitting up / reconstruction of the business already in existence. Similar disallowance was made in A.Y 2002-03 while passing an order u/s 143(3) r/w/s 263. The A.O. levied interest u/s 234D.

For the A.Y. 2002-03, on challenge the Tribunal set aside the order of the CIT after taking into consideration the decision of the Apex Court reported in 107 ITR 195 [Textile Machinery Corporation Limited vs. CIT] that held as follows:

‘… This is not a case of setting up of a new business, but only transfer of business place of existing business to a new place located in STPI area and thereafter, getting the approval from the authorities, the assessee becomes entitled to deduction u/s 10A. Merely because by shifting the business from one place to another and keeping some of the plant and machinery as those are bearing charge of financial institution, does not violate clauses (ii) and (iii) of sub clause (2) to section 10A.’

The order passed by the Income-tax Appellate Tribunal was challenged by the Department in T.C.A. No. 1916 of 2008 and the Division Bench of this Court by its judgment dated 26th October, 2018 confirmed the order of the ITAT dated 16th May, 2008 made in I.T.A. No. 2255/Mds/06 for the A.Y. 2002-03 and dismissed the appeal.

Aggrieved by the assessment order for the A.Ys. 2000-01 and 2001-02, the assessee filed appeals before the CIT(A). The Appellate Authority allowed the appeals by following the order of the Tribunal for A.Y. 2002-03. The Appellate Authority, while dealing with the levy of interest u/s 234D, held that the said section comes into effect only after the commencement of the assessment year and interest could be levied only for the A.Y. 2004-05, and therefore deleted the interest for the A.Ys. 2000-01, 2001-02 and 2002-03.

Aggrieved over the order of the CIT(A), the Department filed appeals before the Appellate Tribunal which confirmed the CIT(A) order and dismissed the appeals. While dismissing the appeals, the Tribunal held that interest u/s 234D cannot be levied for the A.Ys. 2000-01, 2001-02 and 2002-03. Further, while dismissing the appeals, the Tribunal followed the order in I.T.A. No. 2255/Mds/06 dated 16th May, 2008.

Still aggrieved, the Department filed the appeals before the High Court. The Court held that, in view of the judgment of the Division Bench of this Court, it is clear that the applicability of clauses (ii) and (iii) of sub-clause (2) to section 10B, the impugned order passed by the ITAT is proper. In view of the order passed by the ITAT of 16th May, 2008 in I.T.A. No. 2255/Mds/06 and the judgment passed by the Division Bench of this Court on 26th October, 2018 in Tax Case Appeal No. 1916 of 2008, the assessee company would be entitled to deduction u/s 10A and the disallowance made by the A.O. was not correct. For A.Y. 2002-03, since the order passed u/s 263 itself had been set aside, the cause of action for reassessment does not survive.

So far as the levy of interest u/s 234D is concerned, the Court held that the section came to be inserted by the Finance Act, 2003 with effect from 1st June, 2003. Prior to that, no interest was payable on refund in the event of an order for refund being set aside and the assessee is made to pay the same from the date of rectification order or the orders passed by the Appellate Authorities. A reading of the provisions of section 234D makes it clear that there is no indication in the language employed in the entire section that the Parliament intended to make this levy of tax on excess refund retrospective. On the contrary, after inserting this provision in the Act it is specifically stated that it comes into effect from 1st June, 2003. Though the amendment is by insertion, the Parliament has expressly stated that the amendment comes into effect from 1st June, 2003. Parliament has made its intention clear and unambiguous. In other words, it is not retrospective. Merely because the order of assessment was passed subsequent to the insertion of the said provision in the Act, would not make the said provision retrospective. The provision providing imposition of interest is a substantive provision. It is settled law that in the absence of any express words used in the provision making levy of interest retrospective, it can only be prospective (i.e.) from the date on which it came into force, viz., 1st June, 2003.

The Constitution Bench of the Apex Court in the case of Karimthuravi Tea Estate Ltd. vs. State of Kerala reported in 1966 60 ITR 262 SC held as follows:

‘…It is well settled that the Income-tax Act as it stands amended on the first day of April of any financial year must apply to the assessments of that year. Any amendments in the Act which come into force after the first day of April of a financial year would not apply to the assessment for that year even if the assessment is actually made after the amendments come into force.’

The amended provision shall come into force only after the commencement of the assessment year and cannot be applied retrospectively unless it is specifically mentioned. Therefore, the law to be applied is the law as on the date of commencement of the assessment year and not the change in law amended subsequent to that date. Section 234D having come into force only on 1st June, 2003, i.e., after the commencement of the assessment year, interest could be levied only from 1st April, 2004, that is, from the A.Y. 2004-05, and no interest u/s 234D could be chargeable prior to the A.Y. 2004-05. Since all the three assessment years are prior to the A.Y. 2004-05, the provisions of section 234D cannot be applied. Accordingly, the Revenue appeals were dismissed.

CSR – WHETHER A DAY 1 OBLIGATION?

BACKGROUND
The main provisions of section 135 of the Companies Act, 2013 as amended can be summarised as under:
* Certain specified companies are required to spend 2% of the average net profit made in the immediately preceding three years on CSR activities as specified in the relevant schedule;
* Earlier, in case of unspent CSR amounts, Boards were required to specify the reasons for not spending the amount in the Board report;
* On the basis of the recent amendment notified in the Official Gazette, in case of unspent CSR amounts, the companies are required to transfer these to a separate government fund within six months of the expiry of the financial year, unless that unspent amount pertains to ongoing CSR projects;
* In case of unspent CSR amounts pertaining to ongoing CSR projects, the companies are required to transfer such amounts within a period of thirty days from the end of the financial year to a special account opened
with a scheduled bank and to be called ‘Unspent Corporate Social Responsibility Account’; such amount shall be spent by the company within a period of three financial years from the date of such transfer, failing which they are required to transfer the unspent CSR amount in a separate government fund;
* Further, if the company spends an amount in excess of its obligation in a year, the excess amount so incurred can be set off against the CSR obligation of the immediately succeeding three financial years subject to certain conditions.

QUESTION

On the basis of this amendment, the company has a clear statutory obligation as at balance sheet date to transfer the unspent amount to the government fund / special account; accordingly, a liability for unspent amount needs to be recognised in the financial statements. If the company decides to adjust such excess incurred amount against future obligation, then to the extent of such excess an asset as prepaid expense needs to be recognised in the financial statements.

How should the amount required to be spent on CSR in a financial year be accounted for? Can it be recognised evenly over the four quarters or on an as-incurred basis, or should the obligation be provided for on Day 1 of the financial year?

RESPONSE

The following references in Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets are relevant for the purpose of responding to the question.

Definitions under Paragraph 10

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

Appendix C Levies

1. A government may impose a levy on an entity. An issue arises when to recognise a liability to pay a levy that is accounted for in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets.

4. For the purposes of this Appendix, a levy is an outflow of resources embodying economic benefits that is imposed by governments on entities in accordance with legislation (i.e. laws and / or regulations), other than:
a)    those outflows of resources that are within the scope of other Standards (such as income taxes that are within the scope of Ind AS 12, Income Taxes); and
b)    fines or other penalties that are imposed for breaches of the legislation.

8. The obligating event that gives rise to a liability to pay a levy is the activity that triggers the payment of the levy, as identified by the legislation. For example, if the activity that triggers the payment of the levy is the generation of revenue in the current period and the calculation of that levy is based on the revenue that was generated in a previous period, the obligating event for that levy is the generation of revenue in the current period. The generation of revenue in the previous period is necessary, but not sufficient, to create a present obligation.
    
11. The liability to pay a levy is recognised progressively if the obligating event occurs over a period of time (i.e., if the activity that triggers the payment of the levy, as identified by the legislation, occurs over a period of time). For example, if the obligating event is the generation of revenue over a period of time, the corresponding liability is recognised as the entity generates that revenue.

ANALYSIS

On the basis of paragraph 4, Appendix C Levies, CSR liability is a levy. The obligating event for incurring CSR expenditure occurs on Day 1 of the financial year, because if the company is in existence on that day and had an average net profit in the preceding three financial years, the liability is crystallised. The company is liable to incur the CSR expenditure, even if later during the financial year it was wound up or merged with another company or incurred heavy losses.

Accordingly, although the CSR expenditure would be incurred throughout the financial year, the obligating event that gives rise to the CSR liability isthe existence of the company on Day 1 of the financial year, and the average net profit of the preceding three financial years of the Company should be a positive number. This analysis is clear from a combined reading of Paragraphs 8 and 11 of Appendix C Levies.

The expenditure on the CSR liability may occur evenly or unevenly throughout the financial year. That is of no relevance to the recognition of the liability. The liability will be recognised on Day 1 of the financial year. The actual expenditure is the adjustment of the already crystallised CSR liability.

Even if a company does not incur the expenditure in the financial year, it will have to transfer the unspent amount to an ‘Unspent CSR’ account. Such amount shall be spent by the company in pursuance of its obligation towards the CSR policy within a period of three financial years from the date of such transfer, failing which, the company shall transfer the same to a Fund specified in Schedule VII within a period of thirty days from the date of completion of the third financial year.

CONCLUSION


Currently there appears to be a mixed practice on when a CSR liability is recognised. Some listed companies recognise the liability on Day 1, whereas others recognise the liability over four quarterly periods. This has to change, and the CSR liability should be recognised on Day 1 of the financial year. For companies that are not listed and do not present quarterly accounts, this issue will be largely theoretical.  

CREATING YOUR DIGITAL PERSONA ON TWITTER #tweetandgrow

Before we even talk about how Twitter can build a brand for you, let’s take a look at a story. Mr. A has been regularly active on his and his firm’s Twitter account. He shares regular updates, reposts important messages from official handles and is quick to even put up notifications and circulars as and when they are released. He is passionate about staying updated and also keeping others updated. Mr. B, who follows Mr. A on Twitter, gets a notification every time Mr. A posts or tweets. Mr. B has now become so comfortable with all this that he relies on Mr. A for updates and himself doesn’t keep checking Government portals. He even asks his acquaintances to do that. This has indeed helped Mr. A build a brand on social media.

The above-mentioned story is replicating real-life incidents which we would have come across on social media (emphasising Twitter here).

So what exactly is Twitter?

Theoretically, Twitter is a ‘microblogging’ system that allows you to send and receive short posts called tweets. Tweets can be up to 280 characters long and can include links to relevant websites and resources. Interestingly, many had underestimated the power of 140 characters (when it started). However, the way Twitter is changing the world currently is well documented. The US election or influencing movie reviews and its rating speak for it. So when we have such a powerful medium in our hands (Mobile App), is it not wise to utilise it to the fullest extent? As the saying goes, the biggest risk we take is not taking any (‘life me sabse bada jokhim hai, koi jokhim na lena’). We might even say that not being on Twitter during this time is the biggest risk we may face.

Over the past few issues, we have covered various topics on ‘Branding for Chartered Accountants’ in a series of articles. However, Twitter is one of the most important but complex social media, in our opinion. It is powerful, gives you direct access to almost anyone in the world but it is very personalised and needs attention on a real-time basis. For example, your other social media accounts may be managed by your team, and they can post lovely greetings messages on various festivals and give news updates. However, if the same is repeated on Twitter it may be considered as boring and irrelevant. We are not saying that you cannot share the same updates here, too, but sharing only those updates hardly works here and that’s what makes Twitter unique – it needs personalisation.

To keep it crisp and short, let’s look at how we can master this social medium (from scratch):

Step 1: Create an account on Twitter

 
 
Obviously, this is a very basic step but unlike some social media, you can visit tweets and view the comments on Twitter without even having a valid account. Many of the news channels today add links and references to tweets which you can visit on the Twitter page sans an account. So, the first part in Digital Branding is to have your own Twitter account. A good username is a must to start with. A Twitter @name is basically a handle where the ‘@’ sign is followed by words and numbers. Ideally, a professional Twitter handle will use the Twitter user’s name or company. For example, the user account of ICAI is @theicai and it conveys to whom it belongs.

Step 2: Choose profile photo and background


 
As an Individual, use a headshot or candid, doing something related to the message or brand. For example, a public speaker can select a photo with a microphone in hand addressing a gathering. Twitter recommends this photo be roughly 400×400 pixels in size to avoid distortion when the image is resized to fit in the assigned area. On the other hand, a Background Image consists of the entire upper portion of the Twitter profile page and the large rectangular section above the profile photo on the Twitter user’s home page. Twitter recommends the header background photo be around 1500×500 pixels. Pro Tip: Keeping your account without Image or Background Image reduces both impact and reach.

Step 3: Write a good Bio
Bio is a short introduction of the user. Ideally, Twitter allows 160 characters to tell something about users. Use it well to convey your message to readers. About who you are, your past achievements / designations, interests and so on. A good Bio can help in enhancing your SEO and Twitter’s AI. Even the Google Search engine picks up words from users’ Bios to divide them into relevant categories.

Step 4: Other settings
There are other small but significant settings that can improve your Twitter Profile, such as:

Share your location: There is an option to add your location information to each tweet. This is switched Off by default for privacy reasons. But users who want to communicate where they are to their followers (like a speaker who is travelling to different places to address gatherings) will probably want to keep it On to convey the message.

Pin tweet: Once you are regular on Twitter, there is generally a tweet which defines you or a particularly important aspect for you or your profile which you want everyone who visits your profile to see. Such tweets can be pinned to the top of your Twitter timeline so that anyone who visits your timeline will see that tweet first.

Step 5: Be a content creator instead of only a content consumer
There is a famous saying, ‘The biggest mistake you could ever make is being afraid to make one.’ We do that when it comes to using social media. We avoid tweets with many thoughts in our minds. However, it is essential to start using social media to add value and share opinions. While apps like Instagram, YouTube may not be easier to start as not everyone is tech-savvy to create a good image and upload it, Twitter is a bit easier compared to the apps of other social media. All you need is to have an opinion and express the same. Besides, remember that the limit of one tweet is 280 characters. So it is indeed easy to start and express yourself. However, you also need to remember while tweeting – why are you on Twitter. You may be diverted to many topics like politics, religion and so on. Some of these are hot topics and you can spend hours and hours but it becomes very important to be aware of what is your ultimate goal.

Step 6: Enhancing reach and creating a brand
This is the most important step in using any social media. The ultimate goal of being on social media for digital branding has to be that reach where you can convey your message to the masses. Twitter, unlike other social media, is very difficult for beginners. Twitter AI works differently from TikTok or Instagram, where the app automatically promotes smaller accounts or new accounts based on content marketing. Twitter is like going into the gym and losing weight. You need to have a definite strategy and be consistent with it. For the first few weeks / months you may not see the results but once it starts gaining momentum, the user gets returns for all the previous months.

We are happy to share some strategies which can help you build a brand on Twitter (without violating the Code of Ethics):

a. Talk on trending topics daily:
Twitter shows daily trending topics on its app as well as browser. You can check the same on Twitter Mobile App as well as browsers. Trending topics are the ones that everyone is talking about as of today. If you feel it is related to one of your interests, do add your tweets that give a perspective. For example, if you are trading in shares and the share market is up or down and it’s trending today, you can talk about your experience and perhaps offer some general tips without getting into the role of an investment adviser.

b. Create an interesting thread on trending topics and topics of your expertise:
A thread on Twitter is a series of tweets that talks about particular topics. While primarily Twitter’s USP is limited words, sometimes it’s not possible to convey everything in one tweet. In that case, users create multiple tweets in reply to create a thread. Looking at its importance even Twitter redesigned its app to permit thread options by adding a small + sign just before the ‘Tweet’ button. This allows users to create all tweets at once and send them all at the same time.


 
Today, many journalists and influencers are using Threads to convey their message in a crisp and systematic manner, such as explaining the timeline of the Tata vs. Mistry case with details or screenshots of orders. These threads are becoming a very important part of the Twitter journey now.

c. Reply on influencers’ post:
When you start your Twitter journey and you have limited followers, your tweets won’t have that reach or interaction that can look attractive. So one of the easiest ways to gain followers and build a brand is replying to already known influencers on Twitter. One of the most important aspects is to avoid trolling and public shaming, specifically when you are building a professional brand on Twitter. Industry leaders like Mr. Anand Mahindra, Mr. Harsh Goenka and others are usually very active on Twitter and they generally tweet engaging content where many users reply. Adding a reply to these kinds of accounts giving your perspective is the easiest way to grow. Try to find other influencers with a not very large following so that they have replies but not in thousands; your replies will then be visible and there is a chance of getting into conversations.

P.S.: Twitter is a public platform and your opinion can be read by anyone, so be careful about posting an opinion as it can go viral at a time when you are least expecting it – and in this digital world everything is permanent thanks to screenshots and virtually unlimited storage capacity.

d. Create a separate account for your business / firm:
Don’t mix your personal account with business as you may have a different agenda for the two. Your business account can be limited to updates regarding your business and industry. Your personal account can talk about your business, your interests, your hobbies and so on.

Ideally, your strategy should be specific to your brand and firm. But following the above tips will definitely get you started on the right foot. Keep in mind that building a brand will take time, but with a branding strategy in place, branding is well within your reach.

FACELESS REGIME UNDER INCOME-TAX LAW: SOME ISSUES AND THE WAY FORWARD

INTRODUCTION
With a view to making the tax system ‘seamless, faceless and painless’, the Government of India had introduced the Faceless Assessment Scheme, 2019 (Faceless Assessments) in September, 2019. The purpose behind it was to ensure fair and objective tax adjudication and to make sure that some of the flaws in the operation of physical assessment proceedings (such as the element of subjectivity in assessment proceedings, non-consideration of written submissions, granting of inadequate opportunities to the taxpayers for filing responses, etc.) do not recur. What is equally commendable is the phased manner in which Faceless Assessments have been introduced (first, by introducing e-proceedings on a pilot basis, then on a country-wide basis, and lastly introducing Faceless Assessments).

All these steps were aimed in the right direction to impart greater efficiency, transparency and accountability by (a) eliminating the human interface between taxpayers and tax officers; (b) optimising the utilisation of resources through economies of scale and functional specialisation; and (c) introducing a team-based assessment with dynamic jurisdiction.

Currently, all income tax assessments [subject to certain exceptions viz., (a) assessment orders in cases assigned to central charges; and (b) assessment orders in cases assigned to international tax charges] are being carried out in a faceless manner. For the purpose of carrying out Faceless Assessments, the Government had set up different units [i.e., National Faceless Assessment Centre (NaFAC), Regional Faceless Assessment Centres, Assessment Units, Verification Units, Technical Units and Review Units].

However, as it is still in its nascent stage, the taxpayers have had to grapple with several challenges / issues (as discussed below) during the course of Faceless Assessments. The Government needs to resolve these teething issues so that the objective of having a fair, efficient and transparent taxation regime is met. Nevertheless, there are some good features in the Faceless Assessment proceedings but these are not being fully utilised. There are some tabs in the e-proceedings section of the e-filing portal which provide details as to the date on which the notice was served to the taxpayer, the date on which the taxpayer’s response was viewed by the field authorities, etc., but such functionalities are not yet operational.

The following are some practical problems / issues faced by the taxpayers and the suggested changes:

  •  Requests for personal hearings and written submissions are not being considered before passing of assessment orders: A salient feature of Faceless Assessments is that personal hearing (through video conferencing) would be given only if the taxpayer’s request for such hearing is approved by the prescribed authority. Unfortunately, in some of the cases, written submissions were not considered at all. Moreover, it has come to light that some taxpayers’ request for personal hearings were also not granted before passing of the assessment order despite the fact that the frequently asked questions (FAQs) uploaded by the Income-tax Department on its website require the field authorities to provide reasons in case a request for personal hearing is rejected. In many such cases, taxpayers were forced to file writ petitions in courts to seek justice on the ground of violation of the ‘principles of natural justice’.

Fortunately, the courts came to their rescue and stayed the operation of such faceless assessment orders1 / directed the Department to grant personal hearing2 and do fresh assessments. One of the basic tenets of tax adjudication / tax proceedings is that the taxpayer should get a fair and reasonable hearing / chance to explain its case and make its submissions to present / defend its case. Written submissions are, perhaps, the most critical tool of taxpayers through which they can actualise this right. Needless to say, in Faceless Assessments the importance and vitality of written submissions grow manifold.

While the underlying objective of Faceless Assessments – to eliminate human interface – is certainly a commendable reason, it cannot be denied that on many occasions (especially for complex matters such as eligibility of tax treaty benefits, etc.), face-to-face hearings are needed for the taxpayer to properly and effectively represent its case and put forth its submissions / arguments as well as for the tax Department to understand and appreciate such arguments / merits. During a personal hearing, the taxpayer / its authorised representatives would generally gauge whether the Assessing Officer (AO) / tax authorities are receptive to their arguments and averments. This is helpful because it gives them an opportunity to make further submissions, oral or written, or to adopt a different line of reasoning / arguments in support of their case. This distinct advantage is lost under the faceless regime. From the perspective of the tax Department also, personal hearings are helpful as it not only saves their time, energy and effort in understanding the facts and merits of the case, but also gives them an opportunity to ask more effective / relevant questions of the taxpayers for doing an objective assessment.

Thus, the Government may consider amending Faceless Assessments and provide a threshold (say income beyond a particular amount, turnover beyond a particular amount, etc.) wherein the taxpayers’ right for personal hearing will not be denied / will not be at the discretion of the prescribed authority. Given that the Government’s focus is on digital push, it may consider allowing an oral-cum-video submission also in addition to filing of written submissions. This will improve the efficiency and efficacy of tax adjudication proceedings.

  •    Taxpayers’ requests for adjournment are not being considered before passing of assessment orders: One of the grievances of many taxpayers who faced Faceless Assessments has been that their adjournment requests (filed in time / before the expiry of due date fixed for compliance) were not considered before passing of the assessment order. This is certainly not fair and is against the core principles of tax adjudication. In this regard, certain taxpayers also knocked the doors of courts on the ground of violation of the ‘principles of natural justice’ and sought quashing of such assessment orders and consequent tax demands raised on them. Fortunately, the courts3 ruled in favour of the taxpayers and directed the tax Department to consider their written submissions and to do fresh assessments.

Further, instances have also come to light where very short deadlines were provided to taxpayers to comply with notices (sometimes only three to four days’ time was given). Since currently the service of notices is done electronically, the possibility of the taxpayers missing out on such notices or realising very late that such a notice has been issued, cannot be ruled out. This is even more critical in the current Covid pandemic situation wherein the functioning of offices is already disturbed. It is thus advisable that the tax Department should give a reasonable time period (at least ten to 15 days) to taxpayers for filing their explanations – written submissions / comply with the notices.

  •   Draft assessment orders are not sent to taxpayers before passing the final assessment order: Under Faceless Assessments, the tax Department is required to serve a show cause notice (SCN) along with a draft assessment order in case variations proposed in the same are prejudicial to the interests of the taxpayers. It has been reported that final assessment orders were passed in some cases without providing such draft assessment orders to the taxpayers. Such orders have been quashed / stayed by the courts4 in writ proceedings.

  •   Passing of assessment orders prior to the expiry of time allowed in SCN: One of the intentions of Faceless Assessments was to hasten the assessment proceedings and to ensure time-bound completion. This objective gets reflected in the annual budgetary amendments wherein the time limits for passing assessment orders are gradually being reduced. But on a practical basis, it has come to light that in some taxpayers’ cases Faceless Assessment orders were passed even before the expiry of the time allowed in the SCN. What has added to this grievance is that in some cases, taxpayers were not able to upload their written submissions also because the assessments orders were passed and the tab on the e-filing portal was closed. Again, this is neither fair nor pragmatic. In such cases also, the courts5 have granted relief to taxpayers by quashing such orders by observing that with the issuance of an SCN, the taxpayers’ statutory right to file a reply and seek a personal hearing kicks in and which cannot be curtailed.

  •   Notices are not getting uploaded / reflected on e-filing portal on real-time basis: As part of Faceless Assessments, notices issued by NaFAC in connection with the Faceless Assessment proceedings are to be uploaded on the taxpayers’ account on the e-filing portal. But cases have come to light where notices issued by NaFAC were getting reflected on the e-filing portal after one or two days – perhaps due to technical glitches. Due to such delays, taxpayers are left with less time to comply with such notices and as a consequence, they are left with no option but to file adjournment requests. One hopes that these technical glitches get resolved soon so that the notices are reflected on the e-filing portal on a real-time basis. This step will increase the efficiency of Faceless Assessments significantly. Even as per Faceless Assessments, every notice / order / any electronic communication should be delivered to the taxpayer by way of:

•    Placing authenticated copy thereof in taxpayer’s registered account; or
•    Sending an authenticated copy thereof to the registered email address of the taxpayer or its authorised representative; or
•    Uploading an authenticated copy on the taxpayer’s mobile app.
and followed by a real-time alert6.

It has been further specified that the time and place of dispatch and receipt of electronic record (notice, order, etc.) shall be determined in accordance with the provisions of section 13 of the Information Technology Act, 2000 (21 of 2000) which inter alia provides that receipt of an electronic record occurs at the time when the electronic record ‘enters’ the designated computer resource (that is, the taxpayer’s registered account on the e-filing portal) of the taxpayer. Thus, the crucial test for determining service / receipt of any notice / order, etc., is the time when it ‘enters’ the taxpayer’s registered account on the e-filing portal. Since there is a time lag between uploading of notice by the tax Department and its viewability by the taxpayer, an issue can arise as to what will be the date of service of notice.

The first step in a communication process is intimating the taxpayer about the issuance of any notice / order, etc. Thus, unless a taxpayer is informed, it will not be possible for the taxpayer to comply with the same. Further, in the case of reopening of assessments, there has been litigation on the aspect of issuance and service of reopening notice. The Supreme Court in the case of R.K. Upadhyaya vs. Shanabhai P. Patel [1987] 166 ITR 163 (SC) ruled that service of reopening notice u/s 148 is a condition precedent to making the order of assessment. Thus, service of a notice is an important element and
to avoid any unnecessary litigation it is advisable that the technical glitch gets resolved and notices are reflected on the e-filing portal on a real-time basis. Given that short messaging service (SMS) is one of the most effective ways of putting the other person on notice about some communication, it is advisable that sending of real-time alert to taxpayers by SMS be made mandatory.

  •   Certain restrictions / glitches on the e-filing portal: There are certain other technical restrictions or glitches on the e-filing portal which cause practical difficulties in the effective and efficient implementation of the Faceless Assessments. The same are discussed below:

•    Attachment size restriction: Currently, the e-filing portal has a restriction wherein attachment size cannot exceed 10 MB. This means that if the size of the response (written submissions / annexures) exceeds this limit, the same is required to be split into different parts such that each attachment size does not exceed 10 MB. While the tax Department is expected to read the entire response (written submissions and annexures) and assess the taxpayers’ income accordingly, practically it becomes difficult for the Department to open multiple files and read them in continuation when written submissions including annexures run into a number of pages (especially in case of large taxpayers). This difficulty for the tax Department becomes a cause of suffering for the taxpayers. Thus, the Government should consider investing in improvement of digital infrastructure and increase the attachment size limit (say to 40 to 50 MB per attachment).

•    Issuance of reopening notices: It is seen that reopening notices are issued by the tax Department asking the taxpayers to file their return of income. There is no window / tab available to the taxpayers to object to such reopening notice which was otherwise allowed under the physical assessment proceedings as per the settled position of law. Further, there is no window / option available on the e-filing portal to ask for reasons for reopening of an assessment even after filing the return of income in response to reopening notices.

•    All file formats are not allowed: Currently, the taxpayers can upload the documents / responses only in certain file formats – .pdf, .xls, .xlsx and .csv format. Other commonly used file formats, viz., .doc, .docx, .ppt, .pptx, etc., cannot be uploaded. The Government should consider investing in improvement of digital infrastructure on this count so that all types of file formats get supported by the e-filing portal.

•    Special characters are not allowed: The e-filing portal does not allow use of certain special characters. However, the problem occurs at the time when taxpayers are submitting their response in the respective fields, and just then they are given a message that special characters are not allowed. It is advisable that the disallowed special characters are highlighted, and the taxpayers get a pop-up as and when such special characters are used by them.

•    Other glitches: It has also been observed that taxpayers faced other technical glitches such as e-filing portal was not working at certain times, video conferencing link was not working, documents were not getting uploaded, etc.

CONCLUSION

One of the apprehensions of the entire taxpayer community is that with Faceless Assessments coming into force, proper hearing may not be given and this could lead to erroneous / unfair assessments. In this regard, attention is invited to the decision of the Supreme Court in the case of Dhakeswari Cotton Mills Ltd. vs. CIT [1954] 26 ITR 775 (SC) wherein it was held that the ‘principle of natural justice’ needs to be followed by the tax Department while passing assessment orders. The Court also ruled that the taxpayer should be given a fair hearing and aspects like failure to disclose the material proposed to be used against the taxpayer, non-granting of adequate opportunity to the taxpayer to rebut the material furnished and refusing to take the material furnished by the taxpayer to support its case violates the fundamental rules of justice. Thus, it is crucial that in doing Faceless Assessments, (a) proper hearing is afforded to the taxpayer; (b)‘written submissions’ filed are duly taken into account before passing the assessment order; and (c) adjournment is allowed in genuine cases.

The Government should resolve these teething issues (as discussed above) so that this fear / apprehension does not turn into reality. With revenue of Rs. 9.32 lakh crores7 already stuck in direct tax litigation in various forums, and considering the vision of the Government in making India a US $5 trillion economy, it will not be prudent if such teething issues are not resolved at the earliest. If not done, Faceless Assessments may need to pass through various litmus tests in courts8. Further, one hopes that the Central Board of Direct Taxes comes up with some internal instructions (such as writing proper reasons in the assessment order in case field authorities do not accept / reject judicial precedents cited by the taxpayer in its support) to the field authorities for fair, smooth and effective functioning of Faceless Assessments.

The Government is also on a spree to digitise the tax administration system in India which is evident from the fact that Faceless Assessments; Faceless Appeal Scheme, 2020; and Faceless Penalty Scheme, 2021 are already in force. Besides, enabling provisions have been introduced under the Income-tax Act, 1961 to digitise other aspects of tax adjudication, viz., faceless inquiry, faceless transfer pricing proceedings, faceless dispute resolution panel proceedings, faceless collection and recovery of tax, faceless effect of appellate orders, faceless Income Tax Appellate Tribunal, etc. Thus, it becomes all the more important to resolve the aforesaid teething issues at this stage itself so that other faceless schemes (existing as well as upcoming) are free of such shortcomings / gaps.

One hopes that the new, revamped e-filing portal of the Government will bring a new ray of hope to the taxpayers wherein such issues are taken care of.

(The views expressed in this article are the personal views of the author/s)

SLUMP SALE – AMENDMENTS BY FINANCE ACT, 2021

BACKGROUND
The sale of a business undertaking on a going concern basis for a lump sum consideration is referred to as ‘slump sale’ and section 50B of the Income-tax Act, 1961 (the Act) provides for a mechanism to compute capital gains arising from such a slump sale. Section 50B has for long remained a complete code to provide the computation mechanism for capital gains with respect to only a specific transaction, being the ‘slump sale’.

The essence of this amendment seems to be to align this method of transfer of capital assets with other methods (such as transfer of shares, gifts, assets), wherein a minimum value has been prescribed and such prescribed minimum value did not apply to transfer of capital assets forming part of an undertaking transferred on a slump sale basis. For example, an immovable property could be transferred as an indivisible part of an undertaking under slump sale at any value, without having any reference to the value adopted or assessed by the stamp valuation authority, which if otherwise transferred on a stand-alone basis would need to be transferred at any value higher than the value adopted or assessed by the stamp valuation authority. In addition, the Finance Act, 2021 also expands the scope of section 50B from merely ‘sale’ of an undertaking to any form of transfer of an undertaking, whether or not a ‘sale’ per se, essentially to include ‘slump exchanges’ within its ambit.

Section 50B was inserted by the Finance Act, 1999 with effect from 1st April, 2000 and since then this amendment by the Finance Act, 2021 is the first major amendment to this code of taxing profits and gains arising from slump sales. This article evaluates the following amendments in the ensuing paragraphs:

i. Amendment in section 2(42C) of the Act;
ii. Substitution of sub-section 2 of section 50B of the Act;
iii. Insertion of clause (aa) in Explanation 2 to section 50B of the Act; and
iv. The date of enforcement of these amendments and whether these amendments will have retrospective effect.

LIKELY IMPACT OF THE AMENDMENT ON M&As / DEALS

Sale of business undertakings has been one of the prominent methods of deal consummation in India, since the buyers usually find it cleaner to acquire an Indian business without acquiring the legal entity / company and therefore keep the acquisition free of any legacy legal, tax or commercial disputes. In such transactions, it is hard to believe any transaction being consummated at a value less than its fair value, unless the transaction is consummated with the mala fide intention of transferring the assets for a value less than their fair value. Therefore, such transactions with independent parties are likely to remain un-impacted except the compliances attached with slump sale under the new provisions like obtaining a valuation report in compliance with the prescribed rules as on the date of the slump sale.

The amended section 50B is, however, likely to impact internal group restructurings wherein intra-group transfers were resorted to at book values which would often be less than the prescribed fair values. Such internal transfers of ‘undertakings’ or divisions from one company to another are often resorted to to get to the deal-ready structure (e.g., one company has two divisions and a deal is sought with respect to only one division – the other division will need to be moved out) and such transactions could have remained tax neutral if made within the group, similar to the way amalgamations / de-mergers remain tax neutral. Such restructurings could at times also be driven by regulatory changes or external factors and imposing tax consequences on such internal restructurings will discourage such transfers and the companies will need to resort to time-consuming structures like amalgamations / de-mergers which require a long-drawn process under sections 230 to 232 of the Companies Act, 2013, including approval by the National Company Law Tribunal.

Moreover, in case of transactions where the sale consideration against transfer of the undertaking is discharged in the form of shares / securities (‘slump exchange’), the seller would no more be able to walk away without paying its dues to the taxman.

ANALYSIS OF THE AMENDMENTS BY THE FINANCE ACT, 2021
(a) Amendment in section 2(42C) of the Act
Section 2(42C) defines the term ‘slump sale’ and read as follows before amendment by the Finance Act, 2021: ‘slump sale’ means the transfer of one or more undertaking as a result of the sale, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sale.

The text underlined above is being substituted by the Finance Act, 2021 with ‘undertaking by any means’. Therefore, the amended definition of slump sale reads as follows: ‘slump sale’ means the transfer of one or more undertaking by any means, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sale.

Thus, the amendment replaces the words ‘as a result of sale’ with ‘by any means’, thereby expanding the scope of the term ‘slump sale’ from merely ‘sale’ to ‘any transfer’. This amendment seeks to neutralise the judicial precedents like CIT vs. Bharat Bijlee Ltd. (365 ITR 258) (Bom) wherein the assessee transferred its division to another company in terms of the scheme of arrangement u/s 391 of the Companies Act, 1956 and that consideration was not determined in terms of money but discharged through allotment or issue of bonds / preference shares; it was to be regarded as ‘exchange’ and not ‘sale’ as envisaged under the then section 2(42C), and therefore could not be taxed as a ‘slump sale’. In other words, judicial precedents established the principle that a ‘sale’ must necessarily involve a monetary consideration in the absence of which a transaction, though satisfying all other conditions, will not qualify as a ‘slump sale’ and would merely be an ‘exchange’. Therefore, with the expanded scope of the term ‘slump sale’ to mean transfer ‘by any means’, transactions of varied nature will get covered including but not limited to slump exchanges.

Effective date of the amendment
The Finance Act, 2021 provides that the amendment shall be effective from 1st April, 2021 and shall accordingly apply to the assessment year 2021-22 and subsequent years.

With its applicability for A.Y. 2021-22 one could argue that the amended provisions are applicable to transactions executed on or after 1st April, 2020 and to this effect the amendment is retrospective in nature.

Could this amendment be considered merely clarificatory and therefore retrospective?
The Explanatory Memorandum to the Finance Act, 2021 while explaining the rationale of this amendment, begins the last paragraph with ‘In order to make the intention clear, it is proposed to amend the scope of the definition of the term slump sale by amending the provision of clause (42C) of section 2 of the Act so that all types of transfer as defined in clause (47) of section 2 of the Act are included within its scope.’ The language is suggestive that the amendment is merely clarificatory in nature which is also abundantly clear from the language used in the Explanatory Memorandum with respect to this amendment, claiming that the pre-amended definition also included transactions like slump exchanges. A paragraph from the Explanatory Memorandum to the Finance Act, 2021 is reproduced hereunder:

‘For example, a transaction of – sale may be disguised as – exchange by the parties to the transaction, but such transactions may already be covered under the definition of slump sale as it exists today on the basis that it is transfer by way of sale and not by way of exchange. This principle was enunciated by the Supreme Court in CIT vs. R.R. Ramakrishna Pillai [(1967) 66 ITR 725 SC]. Thus, if a transfer of an asset is in lieu of another asset (non-monetary), it can be said to be monetised in a situation where the consideration for the asset transferred is ascertained first and is then discharged by way of non-monetary assets.’

In the absence of a retrospective operation having been expressly given, the courts may be called upon to construe the provisions and answer the question whether the Legislature had sufficiently expressed that intention of giving the statute retrospective effect. On the basis of Zile Singh vs. State of Haryana [2004] (8 SCC 1), four factors are suggested as relevant:
(i) general scope and purview of the statute; (ii) the remedy sought to be applied; (iii) the former state of the law; and (iv) what it was that the Legislature contemplated. The possibility cannot be ruled out that Indian Revenue Authorities (IRA) could contest this amendment to be clarificatory in nature to have always included ‘slump exchanges’. However, since the change doesn’t specifically call itself clarificatory nor does it give itself a retrospective operation, a reasonable view can be that the said change is prospective.

Essential characteristics of slump sale
With the modified definition, the Table below compares the essential characteristics of a transfer to qualify as a slump sale under the pre-amendment definition vis-à-vis the post-amendment definition u/s 2(42C) of the Act:

Characteristic

Pre-amendment

Post-amendment

Transfer

Yes

Yes

Of one or more undertaking(s)

Yes

Yes

As a result of sale

Yes

No

For a lump sum

Yes

Yes

Consideration

Yes

Yes

Without values being assigned

Yes

Yes

As one can see, all the essential characteristics of a transfer of an undertaking to qualify as a ‘slump sale’ continue, the only change being a transfer through sale vs. by any means.

By any means could have a very wide connotation when read with the newly-inserted Explanation 3 which provides that for the purposes of this clause [being section 2(42C)], ‘transfer’ shall have the meaning assigned to it in section 2(47).Therefore, this will include transactions or transfers wherein an undertaking is transferred for a lump sum consideration like an amalgamation which does not satisfy the conditions prescribed u/s 2(1B) of the Act or a de-merger which does not satisfy the conditions prescribed u/s 2(19AA) of the Act. A ‘gift’ of an undertaking will also be included within the meaning of ‘transfer’, but in the absence of the ‘lump sum consideration’, may not qualify to be a ‘slump sale’ even under the amended definition.

(b) Substitution of sub-section 2 of section 50B of the Act
The Finance Act, 2021 also substituted sub-section 2 of section 50B and the substituted text reads as follows:

[(2) In relation to capital assets being an undertaking or division transferred by way of such slump sale –

(i) The ‘net worth’ of the undertaking or the division, as the case may be, shall be deemed to be the cost of acquisition and the cost of improvement for the purposes of sections 48 and 49 and no regards shall be given to the provisions contained in the second proviso to section 48;

(ii) The fair market value of the capital assets as on the date of transfer, calculated in the prescribed manner, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital asset.]

Essentially, the clause (ii) above has been newly inserted through substitution of the sub-section 2 as the clause (i) above existed in the form of previous sub-section 2 itself.

Section 50B provides for a complete code in itself for computation of profits and gains arising from transfer of ‘capital asset’ being an undertaking in case of slump sale. The erstwhile sub-section 2 provided that the ‘net worth’ of the undertaking would be considered as the cost of acquisition and there was no provision deeming the value of sale consideration or overriding the consideration agreed between the transferor and transferee. The newly-inserted sub-section 2 continues to provide that the ‘net worth’ of the undertaking shall be considered as the cost of acquisition and includes a deeming provision to impute the consideration, being the prescribed fair market value.

Rule 11UAE has been inserted in the Income-tax Rules, 1962 vide a notification dated 24th May, 2021 providing a detailed methodology for arriving at the deemed consideration of the ‘undertaking’ as well as a methodology for arriving at the value of non-monetary consideration received, if any (slump exchange transaction or amalgamation / de-mergers which may qualify as slump sale if they do not meet their respective prescribed conditions). The prescribed valuation rules provide for valuation of specific assets in line with already existing valuation methodologies under Rule 11UA and in this specific context, the Rule provides for value to be the value determined in accordance with the Rule or agreement value, whichever is higher.

Sub-rule (2) of the newly-inserted Rule 11UAE provides for determining the fair market value of the ‘capital assets’ transferred by way of slump sale and that could imply that the prescribed rules will not apply to value any asset other than ‘capital assets’ and such other assets will need to be taken at book values, for example, a parcel of land held as stock-in-trade and not as capital asset. Notably, even the newly-inserted sub-section (2) in clause (ii) refers to ‘fair market value of capital assets as on the date of transfer’ which supports the interpretation that Rule 11UAE would apply only to value ‘capital assets’ forming part of the undertaking being transferred through slump sale. However, one would need to be careful while applying this interpretation, as the specific clauses of Rule 11UAE do not distinguish between the assets as ‘capital assets’ or otherwise.

(c) Insertion of clause (aa) in Explanation 2 to section 50B of the Act
Explanation 2 to section 50B of the Act provides the mechanism to arrive at the value of total assets for computing the net worth. The said Explanation provides guidance on determination of values of respective assets forming part of the undertaking, in order to arrive at the ‘net worth’ being cost of acquisition for the purposes of section 50B of the Act. The Finance Act, 2021 inserted clause (aa) in Explanation 2 to section 50B which reads as follows:

(aa) in the case of capital asset being goodwill of a business or profession which has not been acquired by the assessee by purchase from a previous owner, nil.

Consequent to the insertion of the above-mentioned clause (aa), if ‘goodwill’ is one of the assets on the books of the undertaking, its value shall be considered to be ‘Nil’ for computation of net worth if it is not acquired by way of purchase which will result in its book value not being considered for computing the cost of acquisition. The amendment seems to be one of the consequential amendments made by the Finance Act, 2021 with respect to ‘goodwill’.

In a situation where the goodwill is appearing on the books by virtue of a past amalgamation or a de-merger, its value shall be taken as nil for computing the net worth of the undertaking. Whereas, if the goodwill was purchased prior to 1st April, 2020 and depreciation has been allowed thereof, it would be considered as a depreciable asset and its written down value shall be considered while computing the ‘net worth’. Similarly, if the goodwill is acquired on or after 1st April, 2020, it will not be considered as a depreciable asset pursuant to other amendments made by the Finance Act, 2021 and its book value shall be considered while computing the net worth of the undertaking.

CONCLUSION


Going forward, the expansion of scope of slump sale from merely ‘sale’ to any mode of transfer will bring transactions like ‘slump exchanges’ under the scanner. One needs to carefully consider the impact of this amendment on past slump exchange transactions and whether the amendment will be read as clarificatory and hence retrospective. The expanded scope of the definition will also cover amalgamations / de-mergers where the respective prescribed conditions are not met. In a situation where during the assessment proceedings the Indian Revenue Authorities challenge a specific condition not being satisfied, it could consequentially lead to the transaction being taxed as slump sale.

From a commercial perspective, the amendments do not impact genuine transactions. Even in genuine transactions where there are valuation gaps, the current law does not put the buyer in any adverse position and the tax risks seem to be restricted to the seller, primarily because section 56(2)(x) does not tax ‘undertaking’ as a property in the hands of the buyer.

One will still need to deal with challenges in application of the prescribed valuation methodology, especially valuation required to be as on the date of the slump sale, and the availability of the financials and data points to apply the rule.

AUDITOR’S REPORTING – UNVEILING THE ULTIMATE BENEFICIARY OF FUNDING TRANSACTIONS

Corporate frauds have emerged as the biggest risk that companies are exposed to and are increasingly becoming a major threat not only to the corporates but equally to the economy at large. Such unwanted incidents have a domino effect on the economy since they cause severe financial stress, loss of investor confidence, erosion of investor wealth and serious reputational damage. It has been observed that most of these incidents involve round-tripping of funds undertaken through a complex chain of pass-through entities for the benefit of the ultimate beneficiary.
The Ministry of Corporate Affairs (MCA) has been cognizant of this ever-increasing threat and has regularly been tightening the framework under the Companies Act, 2013 (‘2013 Act’) through appropriate monitoring, vigilance and disclosure mechanisms. One such mechanism included imposing restrictions on the number of layers that can be created by companies where they create shell companies for diversion of funds or money laundering. Section 2(87) of the 2013 Act read with the Companies (Restriction on Number of Layers) Rules, 2017 imposes a limit of two layers of subsidiaries except for certain exemptions. Similarly, section 186(1) provides that a company can make investments through not more than two layers of investment companies unless prescribed otherwise. The approval mechanism has been prescribed u/s 185 for granting (directly / indirectly) of loans, guarantees, etc., to prescribed persons including any person in whom any of the directors of the company is interested.
In furtherance of this objective and to reduce opacity and enhance transparency, the MCA has further strengthened the framework under the 2013 Act by amending the Companies (Audit and Auditors) Rules, 2014 and Schedule III to the 2013 Act by introducing reporting requirements for the auditors and by providing enabling disclosures in the financial statements, respectively. The new auditors’ requirements are summarised below:
  •  Whether the management has represented that, to the best of its knowledge and belief (other than as disclosed in the notes to the accounts):

– No funds have been advanced or loaned or invested (either from borrowed funds or share premium or any other sources or kinds of funds) by the company to or in 1Intermediaries;

– No funds have been received by the company from Funding Parties1 with the understanding, recorded in writing or otherwise, that the intermediary (or company – in case of receipt of funds) shall, whether directly or indirectly, lend or invest in Ultimate Beneficiaries2 or provide any guarantee, security or the like on behalf of the Ultimate Beneficiaries.

  • Based on audit procedures considered reasonable and appropriate by the auditor, nothing has come to his / her notice that has caused the auditor to believe that the above representations contain any material misstatement.

Through the above amendment, the MCA is attempting to unveil the ultimate beneficiary behind camouflaged funding where transactions relating to loans, investments, etc., are undertaken by a company for some identified beneficiary. The reporting requirements cover transactions that do not take place directly between the company and the ultimate beneficiary but are camouflaged by including a pass-through entity in order to hide the ultimate beneficiary. The pass-through entity acts on the instructions of the company for channelling the funds to the ultimate beneficiary as identified by the company. It might be noted that the reporting obligation includes inbound as well as outbound funding transactions. In a world where financial transactions are used for money-laundering transactions or other suspicious activities, carrying illicit transactions, it is important that the trail of financial transactions is transparent. Hence, it is important to unveil the identity of the end beneficiary and the amendments are a means to address this issue.

________________________________________________________________

1   Intermediaries / Funding
Parties means – any other person(s) or entity(ies), including foreign entities

2   Ultimate Beneficiaries
means – other persons or entities identified in any manner whatsoever by or on
behalf of the company

The auditor is required to obtain management representation that the management has not identified any camouflaged transactions other than those disclosed in the notes to the financial statements. Further, the auditor is also required to assess that the representation is not materially misstated by performance of appropriate audit procedures. Accordingly, MCA requires the auditor to not only obtain management representation but also independently assess that the representation provided by the management is appropriate. Such an assessment would require the use of judgement and professional scepticism by the auditor.

This article provides an overview of the new reporting requirements and attempts to highlight some of the key aspects in order to generate wider discussion among various stakeholders.

Applicability

The amendments to the Companies (Audit and Auditors) Rules, 2014 and Schedule III issued by the MCA state that these amendments will come into force with effect from 1st April, 2021. The amendment notification does not link these requirements to any particular financial year. One possible view could be that the financial statements should be prepared as per the requirements existing as at the year-end and the audit report should include comments on the reporting obligations which are applicable on the date of issuance of the audit report. It may be noted that the amended rules require the auditor to obtain management representations for transactions ‘other than as disclosed in the notes to the accounts’ thereby implying that relevant disclosures in the financial statements would be essential to enable the auditor to comply with the reporting obligations. Accordingly, if this view is taken then the implications of the above amendments, i.e., relevant disclosures, should be included in the financial statements and audit report for the financial year 2020-21.

Another possible view could be that these requirements would apply from the financial year beginning on or after 1st April, 2021. It has been observed that the MCA in the past has been consistently taking a view that the reporting requirements (or relaxations) do not apply to the year ending on or before the date of the notification of the new requirements / relaxations. For example, similar challenges arose when a large majority of the sections of the 2013 Act were made effective on 1st April, 2014. The MCA had clarified that these provisions would apply in respect of financial years commencing on or after 1st April, 2014. In another instance, the MCA had, in June, 2017, provided exemption to the auditor from reporting on internal financial controls of certain private companies. It clarified that this relaxation would apply from the financial years commencing on or after 1st April, 2016.

Pursuant to the consistent position of the MCA in the past it may be possible to take a view that the aforesaid reporting requirements and disclosures in the financial statements would apply from financial years beginning on or after 1st April, 2021.

In order to ensure consistency regarding the applicability and to support seamless implementation, a clarification from the MCA / Institute of Chartered Accountants of India (ICAI) may help the corporates and auditors.

The companies are required to make these disclosures in Schedule III as part of ‘Additional regulatory information’ and amendments have been made to Division I (Indian GAAP), Division II (Ind AS) and Division III (Non-Banking Financial Companies which are required to comply with Ind AS).

Class of companies on which these requirements would apply

The reporting requirements have been prescribed for auditors under the 2013 Act. Accordingly, auditors of all classes of companies, including section 8 companies, would be required to report on these matters. It might be worth mentioning that as per the Companies (Registration of Foreign Companies) Rules, 2014 the provisions of Audit and Auditors (i.e., Chapter X of the 2013 Act) and the Rules made thereunder apply, mutatis mutandis, to a foreign company. Accordingly, these new reporting requirements would be applicable to auditors of foreign companies as well.

Reporting in auditor’s report

In accordance with the requirements of section 143(2) of the 2013 Act, an auditor reports to the members of the company on the accounts examined by him / her and on every financial statement to be laid before the company in the general meeting. An auditor should prepare the report after considering the provisions of the 2013 Act and the requirements specified in the accounting and auditing standards.

Section 143 of the Act read with Rule 11 of the Audit Rules prescribes matters to be included in an auditor’s report. This additional reporting requirement is required under Rule 11 in the section titled ‘Report on Other Legal and Regulatory Requirements’ in the statutory audit report.

Pre-existing transactions

It may be noted that reporting obligations do not provide any transitional provision, i.e., whether these reporting obligations would apply to pre-existing transactions or whether these reporting requirements would apply to transactions initiated on or after 1st April, 2021. As these reporting requirements (and the corresponding disclosures in Schedule III) apply prospectively, it would be logical to argue that the reporting requirements would apply to transactions initiated from the date of notification of the requirements (i.e., 1st April, 2021).

Transactions covered

The funding transactions as envisaged would primarily include three steps: 1) A company raising funds from any source or any kind of fund, e.g., borrowings, share premium (i.e., lender); 2) Lender provides loan / invests funds in intermediary with an understanding that these would be used for the ultimate beneficiary; 3) Such funds are lent / invested by the intermediary to the ultimate beneficiary. The following is one such example:

 

The following key principles may be kept in mind to understand the transactions covered:

  •  The intent is to cover funding transactions. Accordingly, normal business transactions such as supplier advance would not be covered. However, advances in the nature of loans would be covered as these are in-substance loan transactions. Whether an advance is in the nature of a loan would depend upon the circumstances of each case, for example, a normal advance against an order in accordance with the normal trade practice would not be an advance in the nature of a loan. But if an advance is given for an amount that is far in excess of the value of an order or for a period which is far in excess of the period for which such advances are usually extended as per the normal trade practice, then such an advance may be in the nature of a loan to the extent of such excess.
  •  The ultimate beneficiary must have been identified by the lender at the inception itself. This is evident from the wording that the intermediary (or company – in the case of receipt of funds) ‘shall, whether, directly or indirectly’, lend, etc., in the ultimate beneficiaries.

  •  An understanding with the intermediary that it would transfer funds to the ultimate beneficiary should exist. The words ‘with the understanding, whether recorded in writing or otherwise’ makes it amply clear about such intent and emphasises that all forms of understanding (in writing or otherwise) should be considered by the auditor.

  •  In some cases, there might be a time gap between the receipt of funds by the intermediary and the transfer of funds to the ultimate beneficiary as illustrated below:

 

A narrow reading of the requirements might indicate that the reporting obligations envisage back-to-back funding transactions and hence the above transaction is not covered as there is a time gap. Such a reading may not be in line with the overall objective of the MCA of identifying camouflaged funding transactions. The time gap between the receipt of funds by the intermediary and providing loan, etc., to the ultimate beneficiary has no relevance while reporting under this clause.

Amount to be reported – whether discounted amount or nominal amount

Loans, guarantees, etc., should be understood from a legal perspective. The accounting requirements / definitions have no relevance while reporting under this clause, e.g., Ind AS 109, Financial Instruments which provides that accounting considerations for financial guarantee contracts should be ignored. Accordingly, amounts reported by the auditor (if any) should be the nominal amount and not the discounted amount as per the relevant Ind AS. This is also supported by the Guidance Note on CARO issued by ICAI which states that it may happen that under the Ind AS framework certain term loans (for example, mezzanine loans) may either be classified as equity or may be compound instruments and, therefore, are split into equity and debt components. However, such instruments will be classified as debt under the AS framework. It is clarified that the basic character of such loans is debt and accordingly the auditor should consider utilisation of the entire amount for the purpose of reporting under this clause irrespective of the accounting treatment.

Audit procedures – key considerations

The auditor is required to perform appropriate audit procedures and state that nothing has come to notice that has caused the auditor to believe that these representations contain any material misstatement. The inherent complexities in auditing camouflaged funding transactions might pose significant challenges to the auditor in conducting audit procedures, for example, the auditor is required to assess understanding of the company with the ultimate beneficiary (which may not be in writing in certain cases). This would require the auditor to perform additional audit procedures to obtain sufficient appropriate audit evidence. However, the auditor should consider that these procedures are to be performed in relation to audit of financial statements and should be in the course of performance of his duties as an auditor. It may be noted that u/s 143(9) read with section 143(10), the duty of the auditor, inter alia, in an audit is to comply with the Standards on Auditing (SAs). Further, section 143(2) requires the auditor to issue his / her report in accordance with the SAs and accordingly the auditor should consider the requirements of the SAs in planning and performing the audit procedures to address the risk of material misstatement as stated above. The auditor may perform the following auditing procedures:

  • Obtain representations from management that to the best of its knowledge and belief there are no camouflaged funding transactions other than those disclosed in the financial statements. These representations should be provided by those responsible for the preparation and presentation of the financial statements and knowledge of the matters concerned, for example, chief executive officer, chief financial officer.

  • Identification of sample funding transactions undertaken during the year (refer SA 530 Audit Sampling).

  • Critical assessment of the internal controls including controls regarding approval process and assessment of management’s rationale in approving the funding transaction, e.g., assessment of genuineness of funding needs of the borrower, clearly defined purpose for proposed use of the funds.

  • Relationship with the borrower, e.g., related party. If funding is provided to an unrelated party, then auditor is required to understand and evaluate the strategic reason for funding.


 

  • Financial credentials of the borrower.

  • Compliance with the approval matrix and compliance with applicable laws and regulations, such as section 185 / 186 of the 2013 Act and the relevant RBI norms.

  • Internal controls to track usage of funds, that is, whether periodic report obtained to indicate the usage of funds.

  • Written representations should be dated as near as practicable to, but not after, the date of the auditor’s report.

Applicability of reporting – if no instances identified

The auditor is required to obtain management representation for every audit report issued under the 2013 Act. This is evident from the words which state ‘Whether the management has represented that…’ Accordingly, the auditor would need to obtain management representations and assess its appropriateness even where no instances of camouflaged funding transactions have been identified by the management during the year under audit.

BOTTOM LINE


These new reporting obligations pose onerous responsibilities on the auditor. The auditor would need to carefully assess the implications as the ambit of the reporting matters is wide and covers all inbound and outbound funding transactions. It may be noted that section 186(4) requires a company to disclose in the financial statement the full particulars of the loans, etc., given and the purpose for which these are proposed to be utilised by the recipient. The amendment to Schedule III and auditors’ reporting obligations supplements the existing disclosure requirements. In order to meet these enhanced requirements, the management would need to establish an adequate internal control mechanism so that adequate information is made available to the auditor. These amendments further highlight the importance of establishing a proper mechanism to track the end use of the funds. Considering all these aspects, the auditor should engage with the stakeholders to iron out implementation challenges if any and ensure strict compliance with the reporting requirements.  

INTO THAT HEAVEN OF FREEDOM, MY FATHER…

(The author is Founder Trustee of the Shraddha Rehabilitation Foundation and
recipient of the Ramon Magsaysay Award, 2018)

While the Covid pandemic has been raging for a full year or more, so has the deluge of articles about the psychological implications of the same. Scores of articles have appeared in almost all media. Many of them have psychiatric textbook technical jargon embedded in them which is Greek to the untutored innocent minds. To add one more to it would be adding fuel to the flames. So I thought of going about this task differently.

To the constitution of a human being’s personality, ego and self-confidence, goes a lot of stability in the outer environment of that human being. From birth through childhood, this stability continues in the majority of us. The Indian child is closeted, buffered, cushioned, buttressed and ensconced against all anxieties by parents and in rural India by the joint Indian family system. Childhood in a country like India lasts almost till a person is 23 to 25 years old. There is giving of psychological-emotional strokes and receiving of the same. By the time we have grown into true adults, innate maturity has developed and we somehow survive the rest of our lives on our own steam. But we still continue to receive stable, positive emotional strokes. Starting from the immediate family circle, going on to distant relatives, friends, the workplace, the society at large, our teachers, mentors, our heroes, we continue to receive all psychological strokes from just about everyone who matters to our psyche as human beings, to make us believe that life was worth the living and that we had a special place under the sun.

It is this stability and sense of self which has taken a major hit because of Covid.

No longer is the world surrounding us the same. People are afraid to touch one another, to hug one another, to give physical comfort to one another. Young children are not just getting separated from their parents when the parent is critical and admitted, the young are often losing the parent as well to the Covid illness. Many families have lost their earning member, many individuals have lost jobs, many are unable to cope with EMIs, many have been downgraded in their pay scale, many are morbidly scared (a real possibility) of contracting the Covid virus during their travel to and back from work. Work from home has become a nightmare. Others have no social outings, with parks, playgrounds and beaches closed to the public. Physical isolation, an unheard-of entity earlier, has become the norm. The TV is incessantly showing negative (albeit realistic) news and seemingly focusing relentlessly on Covid. Children studying (supposedly) online has become akin to reaching the moon, given the technicalities and the glitches in internet services involved.

All in all, just about everything that went into the development and consolidation of the human psyche right from childhood onwards has been turned upside down.

The net outcome is perhaps the slow insidious wood-ant approach of the destruction of the stability of the psyche and / or the cataclysmic collapse of that same stability of the psyche, given the sudden loss of a family member to the illness. Self-worth, self-image, self-confidence are all going south. And these entire tectonic shifts in psychological planes are conducive to the production of anxiety and depression within the individual.

Where anxiety (as an increase in the adrenergic-fight response of the mind-body to the on-going crisis) ends, and where depression (a giving-up response of the mind-body to the on-going crisis) begins, the edges are blurred.

But the symptoms which prevail in differing intensities in different human beings during the anxiety phase are insomnia, chest pain, tremulousness, palpitations, excessive urination, repetitive visits to the toilet, altered menstrual cycle, repetitive thoughts, multiple random ruminations, brooding tendencies, repetitive cross-checking of small issues (mundane events like the shutting of a door), repetitive compulsive acts (like the arranging or wearing of clothes in a specific order), dryness of the mouth, blurring of vision, dizziness, an actual recorded rise in blood pressure or heart rate, irritation, agitation, temper outbursts, an unjustified fear of body illness of any kind, a constant nagging, prickling fear of suffering from a heart attack or meeting with an accident, etc.

The ceaseless protection of the elderly with their attendant medical co-morbidities (coupled with their un-noticed penchant for allowing their masks to slip off their noses on the slightest pretext) has become an obsessive panic-inducing daily ritual by itself.

The symptoms which prevail in depression are dullness, inability to cope with work, lack of alertness, diminished sex drive, inability to look after day-to-day hygiene, crying spells, suicidal thoughts along with the final giving-up-given-up complex, all these with their different levels of subtlety colouring the presentations.

All of us have distinctly different sets of fingerprints and accordingly have different responses to an onslaught on our sense of completeness and identity.

And at the very end of the spectrum of depression (at the loss of or a possible incapacitation of a loved one) are grief, denial of reality, continuous outbursts of crying spells, the holding of one’s own self responsible for the turn of events, the feelings of having done inadequately in the situation, a sense of impotency (all summed up in a very poignant term given in psychiatric lingo – the ‘Survivor’s Guilt’), a sense of anger / rage at the system / society at large.

The children have their own distinct display of something-is-wrong at their fragile-mind levels. From surfing incessantly and randomly on the internet, to picking of one’s hair, to going out of the way to feeding / befriending / being physically assaultive to stray animals, to picking fights with siblings / peers / elders, to watching excessive porn, to caricaturing images of death, to sleeping throughout the day in an oblique attempt at bypassing of all the bad news and the disturbing events, the presentations take different levels and different tangents altogether.

But the mooring point in all of the above manifestations is the same. It is the sense of the self taking a beating.

And each one of these manifestations draws the person further down into the quagmire of confusion, frustration and depletion of psychological reserves, further eroding the sense of self-worth and self-confidence.

Going a step further, in some unlucky few the sufferers may lose absolute touch with reality, start visualising images, hearing non-existent sounds / voices, may become violent, may become catatonically mute, unresponsive, may exhibit gross disorganised behaviour and become what in psychiatric parlance is called psychotic.

All of the above constitute manifestations of the turbulence within our own minds, from one end of the spectrum of psychological imbalance to the other. Suicide (the destruction of self) and homicide (the destruction of others) become the absolute extremes of the pendulum.

Even when Covid was not around, a sense of the graveness of the prevalence of mental illness worldwide was reflected by WHO estimates which claimed that by 2030 Depression would be the leading global disease burden.

The same WHO study said that 81% of people with severe mental disorders received no treatment at all in low-income countries, a category in which India fell, suggesting the vast need for mental health facilities in India.

Insofar as the Indian workforce goes, there is less than one psychiatrist for every 100,000 Indians. Paradoxically, there are more Indian psychiatrists in the US and the UK than in India, a sign of the ubiquitous Indian brain-drain. Topping that, the expenditure on the National Mental Health Programme (NMHC) in the Indian Union Budget 2021-22 was a mere Rs. 40 crores, or 0.06% of the total health budget.

Coming to specifics, an average of 381 suicides were reported daily in 2019.

The mentally ill often become homeless, which only increases their marginalisation and precariousness. Over 50% of the homeless are mentally ill.

Over a third of prison inmates in India have mental health issues.

There are gross violations of human rights of the mentally ill in India. They are often denied the right to work and the right to education. Severe mental illness is associated with the highest rate of unemployment in India – 90%.

And in the final analysis, mental illness leads to a spiralling whirlpool, viz., worsening of poverty and impacting economic development at the national level.

And this in a country which, according to a Lancet study, even otherwise had 197 million Indians with mental illness in 2017, of which a staggering 30 million had severe mental illness.

And, believe it or bust, this was our paradoxical ‘Shining’ India before the stork of the Covid came-a-visiting.

Keeping all of the above in mind, the golden questions are – How long will all these psychological fallouts of Covid continue? How do we overcome all of these? Can we actually overcome them?

To the first, I would say that the Coronavirus is unpredictable. Despite all the assertions and presumptions by world-renowned virologists, government bodies and health organisations, I, for one, believe that if there has been one constant Truth right from the time that the virus sprang upon us, it is that there is no constant or fixed pattern to the functioning of the virus, and despite all the proclamations of different world vaccinations, the virus seems to be ahead in the battle for existence as of now; and with multiple mutations available to it, it would seem to continue to be ahead for some years to come. We have a long-drawn, unending war ahead of us. We would be living in a fool’s paradise were we to presume otherwise.

Then comes the next million-dollar question. How do we get out of this fear-loneliness-defeated triad in our minds?

By realising that if ever there was a moment when we, and when I mean we, I mean WE, each and every one of us on the face of this Earth, have to hold hands and come together, then that moment is NOW.

In one of the most stimulating passages that I have read in a long, long time, the legendary activist and the drafter of the Constitution of India, Dr. B.R. Ambedkar, while pleading for humanity per se has mentioned in his book ‘The Buddha and his Dhamma’, that ‘Men are born unequal. Some are robust, others are weaklings. Some have more capacity, more intelligence, others have less. Some are well-to-do, others are poor. All have to enter into what is called the struggle for existence. And if, in this struggle for existence, inequality is recognised as the rule of the game, the weakest will always go to the wall.’ And as far as mental health goes, the most vulnerable and fragile amongst the populace succumb to mental illness. A case of survival of the fittest. Those who are mentally sensitive, unfit, unwanted, are out of the rat race.

Going beyond mental health statistics, a 2020 study from the World Economic Forum found 363 million Indians below the poverty line (BPL meaning earning less than Rs. 32 per day in rural India and Rs. 47 per day in urban India), 27 million Indians were disabled as per the New Disabilities Act, 2016 and the population of India classified as ‘tribals’ was a staggering 110 million.

Even assuming that there is an overlap between various categories, I would roughly estimate that 350 to 400 million people in India are underprivileged in some form or other.

And to top all these numbing, demoralising statistics, we now have the ravaging Covid pandemic. Keeping aside actual figures let out by the government official machinery, the plausible reality is that the second wave of Covid is rampaging through towns and villages of the remotest interiors of India, leaving death and destruction in its wake.

While all these statistics existed earlier, too, perhaps the learned and the lost-in-their-own-sacrosanct-world naive amongst us never paid attention to these grim tragedies of life. Poverty, hardships and deprivation may have been in abundance, but not within us. So, while we tut-tutted the migration of daily labourers across miles of the countryside during the first Covid wave, we (or quite a few among us) never truly empathised with their plight, having been taught to keep these underprivileged people of our beloved country in the blind spot of our vision.

But now, with the second wave of the Covid, young and old across all age groups have got afflicted with or have succumbed to Covid. It is no longer an affliction of the underprivileged or the elderly-medically-compromised amongst us. Stinko-rich, robustly-healthy young have fallen victim and have been ground to the dust. Names of diseases such as Black Fungus which were alien to even the medical community, have now become common day-to-day terms. So, it is now that we realise that this is happening to us, you, me and all of us, yes, US. And in this moment of insight and introspection we, as citizens of the world, need to reorient our strategies and the ways of dealing with the crisis.

One of the most important psychological defence mechanisms to mitigate self-pain is to understand that I am not alone in my suffering, there are many others, not just in thousands but millions in number. Anxiety and depression affect at some point in time approximately 40% of the world population. One can take it for granted that this number, post Covid, just spiralled northwards.

Keeping this in mind, and on a philosophical note, the great searcher of Truth, Gautam Buddha, had mentioned at the end of his prolonged sojourn with the dilemma of existence that ‘All Life is Dukhaa (Sadness)’, reflective of the commonality of emotional and psychiatric problems in human existence. Perhaps we, immersed as we were in our own self-goals, had lost sight of this existential Truth. Now we realise that this is closer home than we had envisaged. And this acceptance in itself brings and will bring renunciation. A great deal of pain becomes mitigated and its sharpness dulled on realising its omnipotence. Each one of us has to understand that we alone have not lost a loved one, we alone have not hit upon bad times or are finding it difficult to make ends meet.

All of us are sailing in the same boat.

In the 1955 Satyajit Ray classic Pather Panchali, the protagonist, a young girl, dies at the end of the movie. In a stoicism unbelievable in today’s times of instant gratification, the father of the girl accepts it, forfeits his home, his village and his childhood dreams to move to Kashi (present-day Varanasi) to make ends meet. We have to draw inspiration from such examples.

On a more pragmatic daily individual ritual, to break the cycle of anxiety-despondency-depression, as a psychiatrist I believe that each human mind has its own stress busters. Some enjoy an hour of music, others yoga, some others monotonous exercises like walking, running, cycling, and still others enjoy callisthenic exercises. Some enjoy reading philosophical books, others may want to curl up with a fiction-suspense novel. Some enjoy knitting, others cooking. To each one his or her own cup of solace.

At group levels, to delink from that feeling of loneliness, one can have family groups spending time in playing cards or the non-draining eternal pastimes of monopoly, dumb-charades, antakshari, scrabble and so on. Amongst groups of relatives, friends or classmates (blurring political affiliations and consciously avoiding the in-vogue political confrontations) on social media platforms such as FB / WhatsApp, one can have the sharing of moments of joy, either of the past or of the present. Sharing of photos, poems, anecdotal experiences, jokes, all give a meaning of that much-desired existentialism to our existence. Always following the golden dictum that each fingerprint has got its own particular cocoon of solitude to want to reach out to, to be on terms with oneself. To each his own nectar for the continuum of existence.

On a personal counselling note, what more or less always works is to try to inculcate the cognitive changes in a person’s negative thinking pattern and make him think broad-spectrum into ‘There, but for the grace of a God above, go I’ modality of looking at any situation, which given a country like India with the huge, huge divide between the haves and the have-nots, and with the vast numbers of have-nots involved, is not a difficult goal to achieve. Covid-specific instances can be cited and these do create the necessary emotional catharsis for the mitigation of emotional upheavals in the sufferer / listener. I very often recount the case of our own Karjat Centre nurse who was pregnant with her second baby and her husband passed away because of Covid on the very next day of her delivery. Or of an IIT Mumbai Civil Engineer who succumbed to Covid and who was not just the sole provider of his own family, but also the provider for the entire family of his in-laws who unfortunately were afflicted with mental illness and were non-earners. Often in such situations, post the gut-wrenching disclosures, risking Covid norms, the very act of reaching out and holding hands for some time, without speaking a further word, suffices.

But all throughout the journey, to be surrounded by some rays of sunshine may make all the difference and is a must. Whether they will ward off all future Covid attacks on our bodies is anybody’s guess, but to give the vaccines their just due, they do instil hope. And sometimes hope is all that is required to prevent the final descent into oblivion. Actual psychiatric experiments are witness to the power of positivity. Newspapers often have columns such as Beacons of Hope. There is an outstanding inspirational-anecdotal-stories-filled internet newsletter called The Better India. Occasional homage is paid to altruistic human behaviour on TV screens, too. But such depictions of courage and humanity are too few and far between. There have to be many, many more. Depicting stoicism, depicting both the acceptance of the odds and the fight against the odds. Buddha’s teachings have to be revisited once again.

The entire Covid pandemic is traumatising, marooning and swamping all of society and with it our collective memories and our collective conscience. To preserve and rebuild our innate sense of self-worth and self-confidence, to promulgate an ingrained human instinctual belief of truth over evil, justice over injustice, society and community at large over the self, the greater common good over individual tunnel-visioned interest, all of us can do our bit.

Yes, all of us can do our bit. Not just the psychiatric fraternity.

The private sector can do their individual minimalistic worthy contributions, the corporate sector their mega contributions, the NGOs can do their often selective (but effective) coordination and outreach to the interiors of India, the pharmaceutical sector can do its bit by giving medicines at cost or a little above, the funding agencies can chip in, the local governing authorities can do their bit by easing rules to meet priorities, the nursing colleges can do their bit, the social work institutes can pitch in by providing socially-minded manpower, the youth organisations can add their infectious, optimistic joie-de-vivre, the print media / the electronic media / the social media can spread morale, the foreign funding agencies can pump in their super-mega-financials, the UN agencies can add their might, the inter-governmental agencies can do their bit, the religious organisations can add their salvation balms, the advertising agencies their outreach programmes, the HR development experts their professionalism, the CSR funds reaching out vide either the NGO branches of the individual corporates or vide other ground-zero NGOs, the tax exemption schemes drive contribution incentives, the educational institutes can do the consolidations of social foundations, the vocational guidance organisations can do their counselling, the employment bureaux re-direct appropriately suitable applicants.

And so can the human contributions for survival and succour go on. All of us can do our bit. On different, pragmatic, point-driven available fronts.

We have to, we simply have to, display a one-for-all and all-for-one wisdom, tenacity and sagacity.

But this is going to be a long haul. From whatever little medical science I have learnt, this is going to be one nerve-sapping long haul.

Coming to the last but most important question simmering in our subconscious – Can we actually overcome this? And the answer is yes, we can and we will.

The human spirit will endure. We endured the ‘Spanish Flu’ of 1918 with its 50 million worldwide deaths, we endured the brutalities thrust upon us by the English Empire for over 150 years. But we endured. In pursuit of that dream within the quintessential Tagore poem, ‘Where the mind is without fear…’, we endured.

To end on a very personal note and a very personal example of inspiration which I came across in history – Vinoba Bhave gave talks on the Gita when he was in Wardha jail during the freedom struggle. Why? To increase the morale of all the freedom fighters incarcerated in jails. No one knew how long it would take India to attain freedom. But till then, why not boost the spirituality of India’s imprisoned freedom fighters? That was Vinoba Bhave’s greatness of thought.

Coincidentally, or call it Maharashtra’s great destiny, during the same period (from 7th October, 1930 to 6th February, 1931) Pandurang Sadashiv Sane, popularly known as Sane Guruji, was imprisoned by the British in the same jail. He was very good at long-hand writing of dictated matter. During the above period, from October, 1930 to February, 1931, he could have been transferred from that jail to any other jail by the British. But he was not. Again, this is Maharashtra’s great destiny. He actually wrote down in long-hand the entire explanations of all the chapters of the Gita as professed by Vinoba Bhave and finally this was published as ‘The Gitai’. And such is the power of goodness that in the year 2020 when we were surrounded by the bad news of Covid all around, I read ‘The Gitai’ and drew inspiration from it. So, what started as a seed in 1930 by Vinoba Bhave has continued to bear fruit in the year 2020 in my soul.

For you, and me, and all of us who care for human beings and humanity, who believe that we are God’s creations (be they different Gods whom we worship and be they different religions that we follow), it is our moral, just and compassionate obligation to Indian society that we focus on each other’s goodness, hold on to each other’s arms and swim against the current of pain surrounding us, giving each other hope and optimism for the future. We owe this to the memory of Vinoba Bhave and Sane Guruji who are sons of the soil of our hallowed India.

Immortalising in our hearts the words ‘Such are the ways that human lives must untwine, and darkest is the hour before the coming of the Light’.

EFFECT OF COVID ON ECONOMY

 

(The author is an economist. He is Research Director of the IDFC Institute and a member of the Academic Advisory Board of the Meghnad Desai Academy of Economics)

 

The coronavirus pandemic has not only left behind millions of dead, but also a trail of economic destruction throughout the world. India has suffered as well. The big question is: Will the on-going economic pain persist through the next decade, or will a strong economic recovery offer hope of sunshine after the storm? Economic forecasting is always a fragile business, more so during events that the world has rarely faced before. What follows is an attempt to detect silver linings to the dark clouds that have dominated the scene since the pandemic began in China.

Let us first count the economic costs of the pandemic. The latest estimates suggest that the size of the Indian economy in the current financial year will be around the same as it was in 2019-20, or the last financial year before the pandemic struck. This means that the Indian economy has, in effect, stagnated for two years because of the pandemic shock.

These economic losses have been borne unequally in India as those living at the bottom of the pyramid have suffered significant income losses because they have either become unemployed or have seen their wages fall. At the same time, large enterprises in the organised sector have managed to weather the storm far better than smaller ones and have perhaps gained market share in some sectors. In sum, people who have been able to work from home have protected their incomes better than those who need to step out of the house to bring home money.

There is another way to look at the same facts. Let us assume that there had been no pandemic and the Indian economy had managed to grow at 6.5% a year in 2020-21 and 2021-22. Then, the size of our economy at the end of the current financial year would have been around $400 billion larger than it will be in reality. In other words, the permanent output loss because of the pandemic is huge – equal to the size of the economy in 1998. It may sound harsh, but one entire year of 1998-level output has disappeared down the sinkhole because of the pandemic.

Large shocks such as the one that the world is facing right now often have a lasting impact and their effects linger even after the rubble is cleared away. Let me give one example that is relevant to India. The ‘Spanish Flu’ ripped through the Indian countryside in 1918, killing an estimated 18 million people in undivided India. Two economic historians, Dave Donaldson and Daniel Keniston, have shown in recent work that the pandemic had a lasting impact.

In the districts where the death toll was very high, the survivors were left with additional agricultural land. This land was quickly put to use by the survivors. The resultant increase in incomes had an interesting consequence. The survivors invested in both ‘child quantity’ as well as ‘child quality’. In other words, they had more children and they also took better care of them. The two economists show that children born in these districts after the pandemic ended were taller and better educated than the children born before the pandemic.

These were big changes at the level of the household. There are examples from other countries of broader macroeconomic shifts. For example, the US economy had a great run in the decade after the end of World War I and the boom only ended with the stock market crash of 1929. Europe emerged from the destruction of World War II to experience at least 25 years of strong economic growth.

Economic theory tells us that economies grow from a combination of three sources – a growing labour force, a higher level of capital investments and increases in productivity. More specifically, economist Barry Eichengreen wrote in an essay published in July, 2020: ‘The crisis will influence potential growth through four channels, three negative and one positive. On the negative side, it will interrupt schooling, depress public investment and destroy global supply chains. Positively, by disrupting existing industries and activities, it will open up space for innovative new entrants, through the process that the early 20th century Austrian economist and social theorist Joseph Schumpeter referred to as “creative destruction”.’

It is worth asking whether these four channels are relevant to India as well, and especially whether three of them will have a negative impact and the fourth will have a positive one.

First, the pandemic is likely to disrupt the Indian education system for two years in a row. Millions of students will have had to make do with online instruction. It is quite likely that students who have access to good personal electronics as well as secure broadband connections will be able to learn enough. Evidence collected from across the country shows that children in poor households have struggled to keep up. The chances of an increase in school dropout levels cannot be ignored.

Even in colleges, students whose training depends on practical work may find themselves missing out on a key part of their professional education. India already suffers from a skills deficit. The quality of human capital is already a problem because of malnutrition, illiteracy and lack of new skills. The impact of the pandemic adds to the problem, even if we assume that the education system goes back to normal after the pandemic ends. These are important considerations for economic growth at a time when the Chinese population has peaked and India is the only comparable country that has a growing labour force.

Second, public finances have come under pressure because of the pandemic. The ratio of public debt to GDP for India is now estimated at around 90%, the highest in living memory. It is unlikely to come down significantly at least in the next five years. What this means in effect is that a large slice of domestic tax collections will have to be used to service the interest costs on the debt. This will weigh down on the annual government budget. The government will have relatively fewer resources available to spend on other items such as infrastructure.

This need not be a dead-end. The government has other options such as asset monetisation to raise resources. It can also ask the Reserve Bank of India to buy its bonds by printing new money. But all these options will have to be exercised in the shadow of a mountain of public debt. The complicated task for the government is to increase public spending right now to make up for the weak private sector demand in India while also withdrawing once corporate investment begins to pick up. The increase in capital stock over the next ten years will be a key factor, but for now, companies seem more comfortable deleveraging rather than increasing capacity.

Third, Eichengreen expects the disruption of global supply chains to be a negative for the global economy. But some economists in the Indian government expect it to be a positive for India. There are three possible reasons why global supply chains will begin to shift out of China in this decade. The Chinese themselves are trying to recalibrate their economy from cheap industrial goods to technology products. The growing geopolitical tensions with the US have led to growing restrictions on trade with China. The pandemic has exposed the risks of supply chain concentration in one country or one company; the organising principle of global production is expected to shift to the principle of resilience.

The Indian government has a clear focus on getting global supply chains into India. Some of the recent subsidies for domestic manufacturing are a step in that direction. However, the growing protectionist sentiment in India is at odds with becoming an important part of global supply chains, since the latter assumes that inputs can move across national borders with ease. The Apple iPhone has components from 43 countries that are assembled in large factories in China. High import tariffs will not make such a complex manufacturing system possible.

Fourth, disruptive innovation can unleash a new round of productivity growth. The impulses for such innovation can come from sources as diverse as the formalisation of the economy to meeting the growing challenge of climate change. A recent report by investment bank Credit Suisse says that India is the third-largest home to unicorns, or startups that have been valued at more than $1 billion. There are now 100 Indian unicorns with a combined valuation of $240 billion. The number of listed companies with a market capitalisation of more the $1 billion is 336. Most of the unlisted unicorns have been set up after 2005.

The growth of Indian unicorns suggests a deeper change as a new generation of Indian entrepreneurs drives growth. However, there is also the harsh reality of the crisis in the unorganised sector at one end of the spectrum, to the growth of domestic oligopolies at the other end. A surge in productivity can be sustained only with economic policies that encourage job creation in enterprises that are efficient rather than protected by the government – market capitalism rather than crony capitalism. The government itself will have to build infrastructure, maintain macroeconomic stability, build a social safety net and ensure that economic growth creates inclusive opportunities.

India was a poor country in 1991. It is a lower middle income country in 2021. Economic growth has to accelerate if we are to become a higher middle income country when the Republic turns a hundred. The pandemic has been a huge setback and a lot depends on how we negotiate the challenges through the rest of the decade. Neither empty optimism nor overpowering pessimism is warranted.

CA PROFESSION IN THE POST-COVID ERA: DOOM OR BOOM?

The digital world has changed everything around us – the way we live, the way we work and, indeed, the way we think. If there was any reluctance in the minds of any professional in embracing the digital world, the Covid pandemic has ensured that this gets dissipated. Digital is no longer on the periphery, it has now become mainstream. Importantly, these changes are permanent. So, is it time to write the obituary for the analogue world?

These profound changes will impact all professions, including CAs. But is it ‘doomsday’ for the CA profession, or will this herald a new way of working and throw up some new opportunities?

REDEFINE IDENTITY & MODALITIES OF DELIVERY

A quick dive into the history of digital adoption shows that the BFSI sector (banking, financial services and insurance) has been quick off the block to rapidly implement digitisation, not just in its peripheral functions but also in its core activities. Banking business has gone through a churn and progressive bankers now say that they are in the technology business, with banking services slapped on technology. As a general rule, professions have been reluctant digital adopters. However, now that they are left with no other option, all professionals are rapidly implementing technology in their work. The scenario for CAs is also changing swiftly. Like banks, will CAs need to make a paradigm shift in their outlook and embrace a narrative of ‘being in the technology business with their professional services slapped on the technology backbone’? If this happens, will it herald a paradigm shift in the way in which services are offered by CAs to their clients?Models

The recent lockdowns and travel restrictions have altered the way of working for all professionals. From heading to office on Monday mornings, CAs now head to their workstations. ‘Work from home’ is the new reality and in fact, has now evolved into ‘work from anywhere’. All future homes of CAs will need to be designed to accommodate some space to allow work from home. Commuting for hours within the city and also travelling for work will come down dramatically, leading to an improvement in productivity. Even after the restrictions are removed, it is unlikely that CAs will go back to the normal routine of going to office every day. Eventually, a hybrid model will evolve, where CAs will go to office only when required. In fact, some CAs have sold their offices or given up high rent offices situated at prime locations. There are anecdotes of some CAs from industry, unable to work from home, who have decided after the end of the first lockdown to hire shared space nearer to home instead of travelling again. And they are doing this by individually bearing the cost of renting the space. Will this continue as a strong trend? Will a new model emerge of comparing per square foot rent with digital assets provided to teams? Will a 100 square feet / person average multiplied by Rs. 100 make the hybrid model more economical?New taxonomy

‘Face to face’ meeting has a new meaning – it does not require a physical meeting and a digital video meeting is now considered as a ‘face to face’ meeting in the new taxonomy. Audits are now done remotely and will continue to evolve with greater use of data analytics, robotics process automation (RPA) and artificial intelligence (AI). Faceless assessments will become de facto standard and the demand for knowledge-based professionals will increase. It is a moot question as to whether the quantum of disputes will reduce.Court hearings are also now on video and there is a renewed thrust from the government to go entirely digital in all their interactions with the taxpayers, citizens and their representatives. Most of the compliances like accounting, filing of returns, registrations could be fully automated and software solutions would enable reasonable level of service at a minimal cost. It is likely that government may provide utilities for common compliances free of cost. This trend will only exacerbate and the new breed of CAs who now qualify will treat this as the ‘new normal’.

It would be important to be able to track the tasks being done and the time spent by the employees in a central online workspace collaboration. Other tools which can be implemented are in the space of improving productivity, employee monitoring and online signing of documents.

All these will be useful in improving productivity for routine and quantitative work. As AI begins to create self-learning systems which are then integrated into accounting tasks, technology will take on the repetitive and time-consuming jobs, leaving the analytical and managerial tasks to humans.

What are the implications of all these tectonic changes?

CAs who do not adapt to this new reality will find it extremely challenging. ‘I am a tech illiterate’, romantic as it may have sounded once, this phrase will now mean that any CA who says or believes in this is taking the road that has a dead-end. On the other hand, this new world will throw up many more opportunities. With less travel and commuting, productivity will be on the rise and with that a chance to grow the profession. Since the digital world has no physical boundaries, it will open up new vistas for CAs to provide service and represent clients from across India and probably anywhere in the world. Technologies that are available to an SMP are increasingly affordable. The collapse of geographical boundaries could be used advantageously by CAs in Tier II and III cities. With rapid improvement in the quality of internet connectivity, this advantage will only increase. The inherent lower cost of operations and people cost along with time to learn will put them at a comparative advantage if they quickly upgrade themselves with the relevant skills.

Productivity increase, clients across the globe, new avenues for services outside the Indian geography – the list of the opportunities that will open up is endless. The pandemic has brought the idea of ‘professional of the future’ into the present – an eternal learner, constantly up-skilling, actively involved in automation and use of big data, and adaptable to disruption.

So, what are the likely changes that will continue in some of the traditional areas of work in the post-Covid era?

Accounting and attest functions (evidence-based certification / opinion)

The demand for mandatory ‘attest function’ is likely to considerably come down, with a trend of limits for such functions being raised on a regular basis and also exclusion of some categories. The pandemic has forced the adoption of ‘virtual audit’ with reliance on scanned documents and video calls with clients’ personnel. It has extended the ‘desk review’ substantially. Post-pandemic, the need for visits will reduce dramatically. The audit process would continue to evolve with greater use of data analytics, automated means to corroborate evidence, robotic process automation (bots culture) [RPA], artificial intelligence [AI] and internet of things [IOT]. More data-driven audit work is already a reality, perhaps large volumes of data as compared to samples end up delivering better results. Due to the pandemic, technology is used to perform routine, rule-based tasks and searches that would enable professionals to focus on exceptions and anomalies to evaluate risk as well as value creation.In the recent past, audit firms have been working on risk assessment tools that layer machine-based learning – which is a subset of artificial intelligence – on top of rules-based algorithms. Once the system ingests massive data sets, it can flag additional anomalies or risky transactions based on parameters that it ‘learns’ on its own. This technology can also provide insights into a company’s processes, possibly in real time, and flag outliers that might not be caught otherwise.

Businesses have already recast their internal controls considering remote work arrangements with increased data sharing for employees and other stakeholders. This has made them more vulnerable to fraud and cyber-attacks and therefore hunt for increased data protection and disaster recovery plans.

Major software vendors now offer automated data entry and reconciliation options using AI and machine learning technologies.

Tax functions (litigation, advisory, compliance)

On the litigation front, there is a tectonic shift. Faceless assessments and appeals will change everything. The era of extensive travel to tax offices, waste of time in seeking appointments and the need for personal meetings and connect will be buried soon. It is expected that going forward, litigation, except the ones in the pipeline (last two years), would decrease. Possibly, only high-value issues on law and its interpretation would continue after seven years or so. Implementation of technology in e-governance invariably leads to more transparency and the scope for dispute resolution practice will reduce over the longer term.For advisory services, CAs are already using audio and video calls extensively now, thereby saving time and cost. Personal meetings are now done only in exceptional cases. This trend is irreversible and would ensure greater productivity at work and better quality of life.

THE KNOWLEDGE EXPERT IN THE NEW SCENARIO

Over time, a ‘knowledge expert’ located in any place will be preferred. Taxation reforms done over a period would slowly reduce the number of doubts as complexities will be ironed out.Rapid implementation of technology will increase compliance and reduction of the grey economy. The increased collection in GST as well as income-tax in the middle of the pandemic (April-June, 21) indicates this new reality. A new orientation towards tax compliance is likely to reduce the need for traditional compliance advisory services.

For filing of tax returns, there is a clear direction of the government to provide facilities for uploading with ease and in the next couple of years, the need for professional services by a taxpayer to file the tax returns will greatly reduce. One can expect this trend to further accelerate where a lot more data will be available with the Tax Department and dependency on assessee and professional will be reduced.

Technology is already supporting in identifying the errors and omissions and with AI, even frauds are being located. The fact that the speed of collection of information would be in minutes compared to the earlier months / years, would enable the tech-savvy CA as well as the Tax Department to identify exceptions early and accurately.

The focus will be more on value addition and merging of the review audits in tax to a comprehensive operations and financial audit, including tax.

Digital systems and practices are driving and forcing changes in the CAs’ Business Models, Skills and Operations:

• IT-driven tools and systems for regulatory / statutory compliances are already in use. All taxes, submissions, responses and work-tracking are progressively IT-driven.
• Operations are based on collaborative tools such as video conferences and shared systems with centralised IT systems driven through cloud-based IT environments as well as technologies like blockchain.
• Increasing dependency on fluency and in-depth knowledge in the usage of office work product tools such as emails, document writers, spreadsheets, presentations, etc.
• Collaborative sessions using IT tools, organising and structuring workloads as well as assignments. In case of history files, using IT Systems, Management Information Systems being entirely IT-driven.
• Increasing dependency on documentation vs. oral communications and face-to-face communications.

Intellectual Property and Confidential Information storage systems means moving away from having things in physical form to virtual and software-defined formats. Clear organisation of information in digital formats is the new norm. Building processes and security for both IT infrastructure as well as access and user credential systems, as against maintenance of physical document libraries and safe rooms, has happened during the last year.

Changing skillsets of CAs will include experience and knowledge in Data Analytics, use of Workflow Application tools, proficiency in usage of spreadsheet tools and presentation tools like macros, executive communication skills and articulation, ability to search for information from the internet landscape in an effective manner and socialising skills with social media tools. Building relationships through social media and collaborative tools rather than in-person meetings and gatherings alone has already been accomplished.

NEW NORMAL TO STAY

Centrally manage and securely share audit and tax files, track audit-consultancy, dispute resolution related activities and communicate using chat, voice and video meetings. This new normal is not likely to get reversed. Clients, even the reluctant ones, have had to securely share data in a digital format and share platforms.In this maelstrom of changes, is it also a ripe time to make BCAS truly global and relook at dropping ‘Bombay’ and embracing a more global name?

AUDITORS’ REPORT – BCAJ SURVEY OF AUDITORS, USERS AND PREPARERS

PROTECH: ‘VIRTUAL’ IS NOW ‘REAL’

I very frequently get the question: ‘What’s going to change in the next ten years?’
I almost never get the question: ‘What’s not going to change in the next ten years?’
I submit to you that the second question is actually the more important of the two.
The above statement is attributed to Jeff Bezos of Amazon.

This issue of the BCAJ (launched in 1969), is our Annual Special Issue and it commemorates the Founding Day of the BCAS which was established on 6th July, 1949. This special issue carries special articles on contemporary issues in addition to the normal articles and features. It is based on the theme ‘Effect of the pandemic: What has changed and what is unlikely to get reversed’.

Three of our special articles are on the Profession, the Economy and the Human Psychology. They are authored by CAs (in practice and in the industry), an economist and a psychiatrist, respectively. They have woven their thoughts lucidly and with great perspicacity. I hope you will enjoy reading their perspectives on the effect of Covid and how much of this change is likely to stay.

We all know how much has changed (and much of this may not reverse):
• Running to the train station has changed to running to the work station;
• Couriering is replaced by scan and email;
• Signing with pen on paper is replaced by affixing a digital signature certificate;
• Office is replaced by digital workspace / cloud;
• WFH could become WFA (work from anywhere);
• Occasionally WFH will be flipped to occasionally work from the office;
• Paper is substituted by PDF;
• So far as the BCAS is concerned, the meaning of ‘residential’ has changed to taking a ‘residential’ course from our residences rather than going out to a resort.

Just as there is Fintech – a finance and technology portmanteau – it is time that we have ProTech or Professional Services and Technology. Practice sans technology will eventually add up to zero. Knowledge is no longer a sufficient condition. Technology will make much of it redundant. Being an ACA (associate CA) or FCA (fellow CA) will not be enough – we will have to re-qualify to become TCAs where ‘T’ stands for technology. Lapping up technology into all our offerings or being ‘slapped’ by technology are the only two options!

In the words of Naval Ravikant – ‘Your company may not be in the software business, but eventually, a software company will be in your business.’ Let me rephrase that – ‘If you do not bring a software company into your business, one day a software company will take over your business.’

We are seeing this already. Tax filing portals are valued in India at attractive valuations. What used to be optional and ‘adjournable’, cannot be postponed, and the pandemic could be the last and final call as the future gets fast-tracked to become the present.

But there is also a positive side of Covid. Today, I would believe that one may not need an office in a swanky, expensive location. With the tax office becoming redundant, the proximity angle has ended up in the recycle bin. Firms may not need offices all over the country. One can operate from an ‘address’, and one will not have restrictions of ‘location’ as digital regulators and digital clients will interact flawlessly with accounting firms. This could result in more competition. Many firms may even lose out to tech companies as much of the profession is ‘open’ to non-COPs or non-CAs because exclusivity has diminished.

Clearly, ‘Virtual’ is now ‘Real.’  


Raman Jokhakar
Editor

THE JOURNEY AWAY FROM DEFICIENCY DELUSIONS

A man went to a saint and said, ‘I have been endowed with everything that a man can yearn for – abundant wealth, a good family, a coveted position in society, name and fame. However, I still feel a vacuum, a deficiency – a feeling of something missing, an emptiness. I have not been able to understand this and I do not know what to do about it. Please tell me what I need to do’.

The saint took a good, long look at the man, took a deep breath and stated, ‘From your statement, it is clear that you had presumed that your ultimate goal would be achieved after you had got name, fame, wealth and family, etc.; and that, thereafter, you shall not require anything. However, you are now accepting that you still feel incomplete and unfulfilled. But the fact is that you were complete even before you acquired all these things and you are complete even now’.

The world is full of living beings that live in this state of want – a feeling of lacking something. These beings do not live in their true state and are always in search of that something that is missing. In that search, they do not focus on what they possess, their unbound richness, but instead, revel in what is missing.

There are two types of suffering – one that is the creation of circumstances outside of you and the other that is created or caused by your own mind. The surprising thing is that only 10% of the suffering is from the first cause while the balance 90% of suffering comes from your own mind. This is the truth, shocking though it is!

There could be two approaches to address the 10% suffering – either eliminate the source of that suffering or move away from that source of suffering.

To illustrate, say the lack of an air conditioner is the cause of your suffering. Here, you can either get an air conditioner so that the lack is eliminated, or you can move away from that need.

However, for the 90% suffering which is mind-triggered, the aforesaid approaches do not work. But our scriptures have made this difficult job easier if only we follow them.

The lack of compassion (karuna) towards all living beings is the first of these. Absence of compassion is manifested in anger. When you react in anger, you can safely presume the lack of compassion.

The lack of communication (samvaad) with people around you is the next cause, bringing in suffering through the mind. All non-harmonious and difficult relationships reflect the lack of communication.

The lack of a sense of co-existence (sahjeewan) is the third cause. The attitude of ‘my way or the highway’ or ‘I, me, myself’ is the cause of a significant part of our suffering.

The lack of a feeling of gratitude (kritagyata) is the fourth cause. Try being thankful for everything happening in your life and you will witness a transformation.

The fifth is the lack of restraint (sanyam). We witness this lack day in and day out. However, the unfortunate part is that more often than not, the realisation of this lack comes after it has already caused suffering.

The beauty is that these five elements are available with us since birth. As we grow older, a lot of dust gathers over them. Let us devote ourselves to removing that dust and touching base with these elements and see the transformation.

CORONA? IT’S A MINOR PROBLEM!

A Chartered Accountant was under a lot of tension. He had lost quite a few friends and relatives due to Corona. Many others known to him had tested positive and were hospitalised. Although he had stopped watching news channels, the negativity in his mind refused to subside. When the stress became unbearable, he surrendered to a Sadhu Maharaj. The following was the dialogue between the two:

CA: Pranaam, Sadhu Maharaj.

Sadhu: Vatsa, kaunsi chinta tumhe mere paas laayi hai? (My child, what’s brought you here to me?)

CA: Guruji, you may be aware that this Corona is playing havoc everywhere in our country.

Sadhu:    It is world-wide.

CA: Yes, but this second wave in India is more disastrous than in any other country. I have lost my sleep. Even in my dreams I see Corona viruses all around.

Sadhu: I wonder why we Indians are so afraid of Corona. There is another virus which is very familiar to you and it has been killing the country over the last seven decades.

CA: Achchha! I was not aware. What is that?

Sadhu: Surprising! Are you really a CA?

CA: Maharaj, I was so much engrossed with my practice that I never read anything about any other virus which is so serious.

Sadhu: That other virus is so dangerous that this Corona is nothing before it.

CA: In what way, Guruji?

Sadhu: See, Corona stays with a person for just eight to 15 days. After that, either the Corona goes or the person goes. And some money also goes. But the other virus stays with you all your life and takes away your money every day.

CA: How is it that I never heard about it?

Sadhu: That other virus is omnipresent. It is present in Corona testing. It decides whether you are Covid positive or negative. It decides whether you should be hospitalised. Without it you cannot even get a hospital bed. That other virus decides what treatment to give. It arranges for medicines, including Remdesivir. Without it, how can you get oxygen?

CA: You mean it is some Government Authority? Or some Minister?

Sadhu: Arey nahi, vatsa. It is neither a Minister nor an authority. But it is there with every Minister and authority.

CA: (Completely puzzled) Maharaj?

Sadhu: Not only this, but that other virus decides whether or not there is a Corona wave. It decides whether vaccines are available. It decides how much gap should be there between two doses of the vaccine.

CA: Guruji, it was after a lot of effort that I have only now come to understand GST and other tax laws; and even Accounting Standards to some extent. I attempted to know even ICDS. But what you are telling me is simply baffling. I can’t even imagine how I never learnt about the other virus. And you are saying it is even more dangerous.

Sadhu: Many times more dangerous than this Covid-19. It has many variants and mutations. There is no place in our country where it is not there. It is in cities as well as in villages, in every walk of life – education, health, administration, judiciary and defence.

CA: Maharaj, it also comes in waves?

Sadhu:    No, it is constant. It never dies. It is ever increasing. If you try to suppress it, it bounces back, it grows. Even the statistics of this Corona are controlled by that other virus.

CA: Please give me some clue.

Sadhu: What more do you want? It is there even in our spiritualism. It kills many things at a time. It kills many men, it kills our character, it destroys our values, it spoils our social and personal life. I will give you a clue. The first three letters of the other virus are the same as those of Corona.

CA: Maharaj, I understood! That other virus is  ‘CORruption!’ Thank you. I am aware that this Corona can be treated, cured or at least controlled, but the other one has no remedy. Now, my fear about this Corona has completely vanished. Once again, Pranaam to you, Maharaj!

FIT AND PROPER PERSON (A widely worded test to refuse entry in the securities market)

BACKGROUND
Persons desiring to do business in the securities markets are usually required to obtain a license of sorts – a registration – from the Securities and Exchange Board of India (‘SEBI’). This is especially so for those who are known as ‘intermediaries’ and who render various forms of services. They may be stock-brokers, portfolio managers, those handling mutual funds, etc. Each category has a different set of requirements for being eligible to be registered which may include qualifications, net worth requirements, etc. Once registered, they also have to follow prescribed rules and usually a Code of Conduct. Failure to follow such rules / Code may result in action which may include penalties, suspension or even cancellation of certificates.

However, there is one overriding requirement and test common across almost all intermediaries. And that is the ‘Fit and Proper Person’ test. A person needs to be ‘fit and proper’ to obtain registration. Unlike other requirements which are well defined and strictly applied, the ‘fit and proper’ requirement may appear at first glance as vague, broadly defined and subjectively applied. In several cases, entities have been debarred or refused entry in the securities market on the ground that they failed this ‘fit and proper’ test.

So what is this test and requirement? Is it as arbitrary as it appears to be? There have been several rulings of the Securities Appellate Tribunal (‘SAT’) and orders of SEBI over the years in this regard. This article describes the legal provisions and discusses, in the light of several precedents, how this test has been applied. While some areas of doubt and concern still remain, the rulings have been generally on similar lines applied consistently.

THE LEGAL DEFINITION OF ‘FIT AND PROPER’ UNDER SECURITIES LAWS

This term has different connotations and definitions under different laws. The Reserve Bank of India, for example, has a different connotation of this test for appointment of directors in public sector banks. Further, without using this term, other laws, too, apply similar principles while granting or rejecting licenses / registration. However, we shall focus here on the definition under Securities Laws.

The definition has seen significant change over the years and the current definition and criteria are given in Schedule II to the SEBI (Intermediaries) Regulations, 2008 (‘the Regulations’) which reads as under:

CRITERIA FOR DETERMINING A ‘FIT AND PROPER PERSON’

For the purpose of determining as to whether an applicant or the intermediary is a ‘fit and proper person’ the Board may take account of any consideration as it deems fit, including but not limited to the following criteria in relation to the applicant or the intermediary, the principal officer, the director, the promoter and the key management persons by whatever name called –

(a) integrity, reputation and character;
(b) absence of convictions and restraint orders;
(c) competence, including financial solvency and net
        worth;
(d) absence of categorisation as a wilful defaulter.

Earlier, there were full-fledged and separate Regulations focused on this aspect – the Securities and Exchange Board of India (Criteria for Fit and Proper Person) Regulations, 2004. The wordings in the earlier Regulations were similar but lengthier. The general pattern and essence remain the same in the new criteria and, hence, the rulings thereon can be generally relied on and are indeed followed for the Intermediaries Regulations.

BROAD AND VAGUE WORDING OF THE CRITERIA

The test applies not just to the applicant / intermediary but also to its director, promoter, key managerial person, etc. The criteria are striking in their wideness and even vagueness in wording. The ‘integrity, reputation and character’ of the person is examined, but no specific benchmark has been provided as to how it would be measured or judged. And whether it would be limited to the person’s work or even his personal life can be considered.

‘Absence of convictions and restraint orders’ may sound clear at first glance but becomes complicated when looked at closely. If there is a conviction for which punishment or a restraint order is continuing, it would be obvious that he cannot be registered in violation of such orders. However, does the conviction / restraint have to be on acting as such intermediary? Or is it, and which is more likely, that the conviction / restraint may be on any area that may reflect adversely on the character of the person? In any case, it is not clear whether the conviction or restraint needs to be subsisting in the sense that it is being undergone or is a past one. If a past one, whether even a conviction / restraint from the distant past is also to be considered?

Competence, including financial solvency and net worth, is to be considered. But, again, no benchmarks are given – whether any specific qualification or area of experience would be considered. The term ‘financial solvency’ is easy to understand in a negative way as not being insolvent. But considering that it is used with the term ‘net worth’, perhaps the intention, to judge from context, may be that the net worth may be commensurate with the nature of registration sought.

As we will see later, there is a reason why the criteria are broadly worded with lack of specific, measurable parameters. The intention seems to be to judge the person in a subjective manner on such parameters. However, subjectivity is compensated in a different manner by ensuring that only those adverse aspects that are serious are considered.

PRECEDENTS

This subject has again come to the fore due to a recent Supreme Court ruling (reported in the media) on certain on-going appeals before SAT on decisions of SEBI on brokers in the NSEL matter. However, there is a longer history of precedents and generally there has been consistency in them following the principles laid down in an early SAT ruling of 2006.

Jermyn LLC vs. SEBI [2007] 74 SCL 246 (SAT – Mum.)
This was one of the earliest rulings (affirmed by the Supreme Court in the second appeal) that laid down the basic principles for application of the criteria. The matter related to the alleged Ketan Parekh scams. Simplified a little bit, the broad issue was whether persons who have been subjected to bans and investigations of serious violations could re-enter the market through a different name. The question was about determining whether a non-resident entity registered with SEBI was indeed associated with the KP group that faced serious allegations. It was alleged that there was commonality / association with persons allegedly connected with the KP group and several factors were placed on record. The entity contended that the allegations against the KP group were not finally proved, that many investigations were still going on, and so on. SAT took a broader view of the requirements relating to ‘fit and proper person’. It held that it was fair to consider serious allegations as relevant even if the proceedings do not yet have a final outcome. It also held that subjective judgment was acceptable. The following words can be usefully referred to since they have been applied in later cases (emphasis supplied):

‘9. A reading of the aforesaid provisions of the Regulations makes it abundantly clear that the concept of a fit and proper person has a very wide amplitude as the name “fit and proper person” itself suggests. The Board can take into account “any consideration as it deems fit” for the purpose of determining whether an applicant or an intermediary seeking registration is a fit and proper person or not. The framers of the Regulations have consciously given such wide powers because of their concern to keep the market clean and free from undesirable elements… In other words, it is the subjective opinion or impression of others about a person and that, according to the Regulations, has to be good. This impression or opinion is generally formed on the basis of the association he has with others and / or on the basis of his past conduct. A person is known by the company he keeps. In the very nature of things, there cannot be any direct evidence in regard to the reputation of a person whether he be an individual or a body corporate. In the case of a body corporate or a firm, the reputation of its whole-time director(s) or managing partner(s) would come into focus.

The Board as a regulator has been assigned a statutory duty to protect the integrity of the securities market and also interest of investors in securities apart from promoting the development of and regulating the market by such measures as it may think fit. It is in the discharge of this statutory obligation that the Board has framed the Regulations with a view to keep the marketplace safe for the investors to invest by keeping the undesirable elements out… One bad element can not only pollute the market but can play havoc with it which could be detrimental to the interests of the innocent investors. In this background, the Board may, in a given case, be justified in keeping a doubtful character or an undesirable element out from the market rather than running the risk of allowing the market to be polluted.

We may hasten to add here that when the Board decides to debar an entity from accessing the capital market on the ground that he / it is not a fit and proper person it must have some reasonable basis for saying so. The Board cannot give the entity a bad name and debar it. When such an action of the Board is brought to challenge, it (the Board) will have to show the material on the basis of which it concluded that the entity concerned was not a fit and proper person or that it did not enjoy a good reputation in the securities market. The basis of the action will have to be judged from the point of view of a reasonable and prudent man. In other words, the test would be what a prudent man concerned with the securities market thinks of the entity.’

This ruling and the principles it laid down were followed in many later cases such as:
1. Mukesh Babu Securities Limited vs. SEBI (Appeal No. 53 of 2007, dated 10th December, 2007, SAT);
2. SEBI’s order in case of Motilal Oswal Commodities Broker Private Limited dated 22nd February, 2019;
3. SEBI’s order in case of Anand Rathi Commodities Limited dated 25th February, 2019;
4. SEBI’s order in case of Phillip Commodities India Pvt. Ltd. dated 27th February. 2019.

ISSUES AND CONCLUSION


The series of decisions shows that the application of the criteria to determine whether a person is a fit and proper person is seen from a different perspective. The core objective is that persons with dubious reputation and image should not be allowed entry in the capital market. A person may have several cases against him about alleged scams, serious wrongdoing, etc. The final outcome of these cases may take years, even decades. Can such person enter or continue in the securities markets? Would it be sufficient that he discloses on-going cases? The governing principles as laid down suggest that SEBI can take into account such allegations even if there is no final outcome. In its subjective view, it can refuse entry to such persons. For this purpose, SEBI may take into account developments which may occur at various intermediary stages – observations of courts, reports of investigative agencies, etc. Many of the principles of natural justice such as right of cross-examination, providing of all underlying information / documents, etc., may not be strictly applied. The material SEBI has relied on is seen in a more substantive manner.

That said, this does not mean that SEBI has indiscriminate and unquestionable powers. Each of the cases has shown that the allegations on record have been fairly serious and multifarious. Such serious allegations are enough to put a person in a bad enough light to be refused entry in securities markets at least in the interim. SEBI as a gatekeeper thus has broader powers.

The test of ‘fit and proper person’ at present has application to intermediaries under the Regulations. However, it may not be surprising if such test, or at least the principles thereof, may get wider application to other persons associated with the capital markets and who play a key role. One example that can be thought of is Independent Directors.

FAMILY SETTLEMENTS: OPENING UP NEW VISTAS

INTRODUCTION
As families grow, new generations join the business, new lines of thinking emerge and disputes originate between family members regarding assets, properties, businesses, etc. Finally, these lead to a family settlement. Such a family arrangement is one of the oldest alternative dispute resolution mechanisms. The scope of a family arrangement is extremely wide and is recognised even in ancient English Law. This is because the world over, courts lean in favour of peace and amity within the family rather than on disputes. In the last 60 years or so, a good part of the law in India relating to family settlements is well settled through numerous court decisions. In recent years, both the Supreme Court and the High Courts have delivered some important judgments on this very vital issue. The key tenets from these decisions have been culled out and analysed in this month’s feature.

PRINCIPLES SETTLED SO FAR

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

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

(b) An oral family settlement involving immovable property needs no registration. Registration (where immovable property is involved) is necessary only if the terms of the family arrangement are reduced to writing. Here, a distinction should be made between a document containing the terms and recitals of a family arrangement made under the document and a mere memorandum prepared after the family arrangement has already been made either for the purpose of the record, or for information of the court for making necessary mutation. In such a case the memorandum itself does not create or extinguish any rights in immovable properties and it is, therefore, not compulsory to register it.

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

(d) By virtue of a family settlement or arrangement, the members of a family descending from a common ancestor or a near relation seek to sink their differences and disputes, settle and resolve their conflicting claims or disputed titles once and for all in order to buy peace of mind and bring about complete harmony and goodwill in the family.

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

The decision in the case of Sita Ram Bhama vs. Ramvatar Bhama, (2018) 15 SCC 130 is different from the scores of decisions which have held that family settlements do not require registration. However, this difference is on account of the facts of this case. Here, a father agreed to divide his self-acquired properties between his two sons. He died without doing so and also did not make a Will. Consequently, the two brothers, their two sisters and mother all became entitled to the properties under the Hindu Succession Act. The brothers executed a document titled ‘Memorandum of Family Settlement’ dividing the properties between the two of them as per their late father’s wishes. This document was also signed by their sisters and mother. The question was whether the instrument was to be registered or whether stamp duty was to be paid on the same? Distinguishing (on facts), the catena of decisions on the issue, the Supreme Court held that the document was to be registered and duly stamped. This was because it was not a memorandum of family settlement. The properties in question were the self-acquired properties of the father in which all his legal heirs had a right. The instrument took away the rights of the sisters and the mothers. It was a relinquishment of rights by them in favour of the brothers. It did not merely record the pre-existing rights of the brothers. Hence, it was held that the properties could not be transferred on the basis of such an instrument.

When on this subject, one must also consider the three-judge bench decision in the case of Vineeta Sharma vs. Rakesh Sharma, CA 32601/2018, order dated 11th August, 2020. Though not directly on the issue, it is equally relevant. It held that a daughter would not have a coparcenary right in her father’s HUF which was partitioned before 20th December, 2004. For this purpose, the partition should be by way of a registered partition deed / a partition brought about by a Court Decree. The Supreme Court held that the requirement of a registered deed was mandatory. The intent of the provisions was not to jeopardise the interest of the daughter but to take care of sham or frivolous transactions set up in defence unjustly to deprive the daughter of her right as coparcener. In view of the clear provisions of section 6(5), the intent of the Legislature was clear and a plea of oral partition was not to be readily accepted. However, in exceptional cases where the plea of oral partition was supported by public documents and partition was finally evinced in the same manner as if it had been effected by a decree of a Court, it may be accepted. A plea of partition based on oral evidence alone could not be accepted and had to be rejected outright.

Another relevant decision is that of the Delhi High Court in the case of Tripta Kaushik vs. Sub-Registrar, Delhi, WP(C) 9139/2019, order dated 20th May, 2020. In that case, a Hindu male died intestate and his wife and son inherited his property. The son renounced his share in favour of his mother by executing an instrument. The issue was one of stamp duty on such instrument. It was contended that the son had inherited half share in the property on the death of his father under the Will left by his father and, therefore, the Relinquishment Deed be considered as a family settlement not chargeable to Stamp Duty. It was held that the Relinquishment Deed did not make any reference to the Will of the late father of the petitioner, or to any purported family settlement. Accordingly, it was held that the instrument was a Release Deed liable to stamp duty and registration.

MEMORANDUM OF FAMILY SETTLEMENT NEEDS NO REGISTRATION

As opposed to the above case, the decision of the Supreme Court in Ravinder Kaur Grewal vs. Manjit Kaur, CA 7764/2014, order dated 31st July, 2020 is diametrically opposite. In this case, a family settlement was executed in relation to a dispute between three brothers and their families. There was a specific recital in the memorandum that the appellant was accepted as the owner in possession of the suit property. He had constructed 16 shops and service stations on the same. In other words, it proved that he was being considered as the owner in possession of the suit property. Prior to execution of the memorandum on that day the family compromised not to raise any dispute regarding his ownership. Accordingly, the Court held that the document in question was a writing with regard to a fact which was already being considered and admitted by the parties. Hence, it could not be said that the document itself created rights in immovable property for the first time. Further, the parties to the document were closely related and hence the instrument did not require any registration. It was only a memorandum of family settlement and not a document containing the terms and recitals of a family settlement. Accordingly, the Court concluded that the document was valid and all parties were bound to act in accordance with the same. This decision reiterates the principle laid down by the Supreme Court in Kale’s case (Supra). Further, the case held that once the memorandum is acted upon, the same is binding upon the parties even though it is unregistered.

VALIDITY OF UNSTAMPED, UNREGISTERED DOCUMENT FOR OTHER PURPOSES

In the above case of Sita Ram (Supra), the Supreme Court also examined whether such an instrument which was required to be registered and stamped could be used for any collateral purpose. It held that it was not possible to admit such an instrument even for any collateral purpose till such time as the defect in the instrument was cured. It relied on Yellapu Uma Maheswari and another vs. Buddha Jagadheeswararao and others, (2015) 16 SCC 787 for this purpose. The documents could be looked into for collateral purpose provided the parties paid the stamp duty together with penalty and got the document impounded.

However, the Supreme Court in the recent case of Thulasidhara vs. Narayanappa, (2019) 6 SCC 409 and also in the earlier case of Subraya M.N. vs. Vittala M.N. and Others, (2016) 8 SCC 705 has held that even without registration, a written document of family settlement / family arrangement can be used as corroborative evidence as explaining the arrangement made thereunder and the conduct of the parties.

PARTIES WITH WHOM A HINDU WOMAN CAN ENTER INTO A FAMILY SETTLEMENT

The decision in Khushi Ram vs. Nawal Singh, CA 5167/2010, order dated 22nd February, 2021 is a landmark decision. It has examined the scope of the term family when it comes to a Hindu woman. The issue here was whether a married woman could execute a valid family settlement with the heirs from her father’s side. The woman had executed a memorandum of family settlement with the sons of her late brother, i.e., her nephews. The Court referred to an old three-judge bench decision in Ram Charan Das vs. Girjanandini Devi, 1965 (3) SCR 841 which had analysed the concept of family with regard to which a family settlement could be entered. It was held that every party taking benefit under a family settlement must be related to one another in some way and have a possible claim to the property, or a claim, or even a semblance of a claim. In Kale’s case (Supra) it was held that ‘family’ has to be understood in a wider sense so as to include within its fold not only close relations or legal heirs, but even those persons who may have some sort of antecedent title. In the Kale case, a settlement between a person and the two sisters of his mother was upheld.

The Court looked at the heirs who could succeed to Hindu women. It held that the heirs of the father are covered in the heirs who could succeed. When the heirs of the father of a woman were included as persons who can possibly succeed, it could not be held that they were strangers and not members of the family qua the woman. Hence, the settlement between the aunt and her nephews was upheld.

This decision, along with the vital three-judge bench decision in the case of Vineeta Sharma vs. Rakesh Sharma, CA 32601/2018, order dated 11th August, 2020, has upheld the rights of Hindu daughters in their father’s family. While this case reiterates her right to enter into settlements with the heirs from her father’s side, the latter decision has explicitly laid down that a Hindu daughter, whenever born, has a right as a coparcener in her father’s HUF.

As an aside, a settlement from an aunt in favour of her nephews is covered by the exemption for relatives u/s 56(2)(x) of the Income-tax Act but a reverse case is not covered since a nephew is not a relative for an aunt. In such a case, reliance would have to be placed on the family settlement itself to show that the receipt of property is not without adequate consideration.

BENAMI LAW AND FAMILY ARRANGEMENTS

In the case of Narendra Prasad Singh vs. Ram Ashish Singh, SA No. 229/2002, order dated 4th July, 2018, the Patna High Court was faced with the question whether a property purchased in the name of one family member out of joint family funds would be hit by the provisions of the Benami Transaction (Prohibition) Act, 1988. The Court held that this proposition could not at all be accepted since acquisition of the land in the name of a member of a family from the joint family property was not regarded as a benami transaction within the meaning of section 2 of that Act. A benami transaction had been defined u/s 2(a) of the Act as any transaction in which property is transferred to one person and a consideration is paid or provided by another person. In the present case, the consideration had been found to have been provided by the joint family fund which could not be treated as the fund of another person. In any event, the owner claimed his title purely on the basis of a family arrangement and not as a benamidar and, therefore, the case was not said to be hit by the Act.

In this respect it should be noted that the Act requires that the property should be purchased out of ‘known sources of funds’. Earlier, the Bill contained the words ‘known sources of income’ which were replaced with the present wordings. The Finance Minister explained the reason for this change as follows:

‘…. The earlier phrase was that you have purchased this property so you must show money out of your known sources of income. So, the income had to be personal. Members of the Standing Committee felt that the family can contribute to it, ……which is not your income. Therefore, the word “income” has been deleted and now the word is only “known sources”. So, if a brother or sister or a son contributed to this, this itself would not make it benami, because we know that is how the structure of the family itself is….’

CAN MUSLIMS ENTER INTO A FAMILY SETTLEMENT?


This issue was dealt with by the Karnataka High Court in Smt. Chamanbi and Others vs. Batulabi and Others, RSA No. 100004/2015, order dated 15th March, 2018. An oral family settlement was executed between a Muslim family and pursuant to the same a Memorandum of Family Settlement was executed for mutation of rights in the land records. The plea was that the document was unenforceable since Muslims could not execute a family settlement. The Court held that it was true that there was no joint family under Mohammedan Law but family arrangement was not prohibited. The Court referred to the Supreme Court’s decision in Shehammal vs. Hasan Khani Rawther, (2011) 9 SCC 223 which had held that a family arrangement would necessarily mean a decision arrived at jointly by the members of a family. Accordingly, the memorandum was upheld.

CONCLUSION


From the above discussion it would be obvious that our present laws relating to family settlement, be it stamp duty, registration, income-tax, etc., are woefully inadequate. Rather than making possible a family settlement, they do all they can to hamper it! India is a land of joint families and family-owned assets and yet we have to run to the courts every time a family settlement is to be acted upon. Consider the precious time and money lost in litigations on this count. It is high time amendments are made to various laws to facilitate family settlements.

DEFERRED TAX LIABILITY ON GOODWILL DUE TO AMENDMENT IN FINANCE ACT, 2021

As per an amendment carried out by the Finance Act, 2021, from 1st April, 2020 (F.Y. 2020-21), goodwill (including existing goodwill) of a business or profession will not be considered as a depreciable asset and depreciation on the same would not be allowed as a tax deduction. Whilst depreciation of goodwill is no longer tax-deductible, the tax goodwill balance is tax-deductible when the underlying business is sold on a slump sale basis – except where goodwill has not been acquired by purchase from previous owner. This article deals with the accounting for the deferred tax liability (DTL) on account of abolition of goodwill depreciation for tax purposes consequent to the Finance Act amendment.

ISSUE
An entity acquired a business on a slump sale basis and recorded goodwill in its stand-alone accounting books maintained under Ind AS, which was hitherto deductible for tax purposes. On 1st April, 2020 the carrying amount of goodwill in the balance sheet was INR 1,000 and the tax written down value (tax base) for tax purposes was INR 750. Consequently, a DTL was recorded on INR 250 (INR 1,000 carrying amount-INR 750 tax base) by applying the applicable tax rate on INR 250. From 1st April, 2020, with the amendment coming into effect, the amount of INR 750 is no longer tax-deductible (other than in a slump sale). Whether an additional DTL is required to be created on the difference of INR 750, i.e., carrying amount (INR 1,000) minus tax base (zero) minus already existing DTL on temporary difference (INR 250) in the preparation of Ind AS financial statements for the year ended 31st March, 2021)?

RESPONSE
To address the above question, the following paragraphs in Ind AS 12 Income Taxes are relevant:

Paragraph 15
A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from:
a. the initial recognition of goodwill; or
b. the initial recognition of an asset or liability in a transaction which:
i. is not a business combination; and
ii. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).

Paragraph 51
The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.

Paragraph 51A
In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:
    
a. the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (liability); and
b. the tax base of the asset (liability).

In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement.

Paragraph 60
The carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from:
(a) a change in tax rates or tax laws;
(b) a reassessment of the recoverability of deferred tax assets; or
(c) a change in the expected manner of recovery of an asset.

The resulting deferred tax is recognised in profit or loss, except to the extent that it relates to items previously recognised outside profit or loss (see paragraph 63).

ANALYSIS & CONCLUSION
Temporary differences may arise as a result of changes in tax legislation in a variety of ways, for example, when an allowance for depreciation of specified assets is amended or withdrawn [Ind AS 12.60]. The initial recognition exception in [Ind AS 12.15] does not apply in respect of temporary differences that arise as a result of changes in tax legislation. It can only be applied when an asset or a liability is first recognised. Any change in the basis on which an item is treated for tax purposes alters the tax base of the item concerned. For example, if the Government decides that an item of intangible assets that was previously tax-deductible is no longer eligible for tax deductions, the tax base of the intangible assets is reduced to zero. Accordingly, under Ind AS 12 any change in tax base normally results in an immediate adjustment of any associated deferred tax asset or liability and the recognition of a corresponding amount of deferred tax income or expense. In our example, DTL would be created on the additional temporary difference of INR 750, caused by the change in tax law, and which did not arise on initial recognition.

The measurement of deferred tax assets or liabilities reflects management’s intention regarding the manner of recovery of an asset or settlement of a liability. [Ind AS 12.51, 51A]. Some companies may argue that the goodwill continues to be tax deductible if the acquired business were to be sold on a slump sale basis in the future. Consequently, they argue that no additional temporary difference is created as a result of not allowing the amortisation of goodwill for tax deduction. In other words, in our example, they argue, the tax-deductible goodwill (the tax base) continues to be stated at INR 750 because the business along with the underlying goodwill could be sold in the future and tax deduction availed. As a result, there is no additional temporary difference, and therefore no additional DTL is required to be created. This position is not acceptable because where the entity expects to recover the goodwill’s carrying amount through use a temporary difference arises in use. If, however, a number of years after acquiring the business the entity changes its intended method of recovering the goodwill from use to sale, the tax base of the goodwill reverts to its balance tax deductible amount (i.e., INR 750 in our example).

The goodwill’s carrying amount needs to be tested for impairment annually and whenever there is an indication that it might be impaired. Any impairment loss is recognised immediately in profit or loss. Some companies may argue that there might not appear to be an expectation of imminent recovery through use if goodwill impairment is not expected in the foreseeable future. In other words, they argue that goodwill is a non-consumable asset, like land. Such an argument is too presumptuous and does not fit well with the principles in Ind AS 12, particularly paragraph 15 which requires DTL to be recognised on all taxable temporary differences, subject to the initial recognition exception.

Under Ind AS, goodwill is not amortised for accounting purposes but that does not mean that goodwill arising in a business combination is not consumed. It may not be apparent that goodwill is consumed because new goodwill replaces the old goodwill that is consumed. If goodwill is amortised for tax purposes, but no impairment is recognised for accounting purposes, any temporary differences arising between the (amortised) tax base and the carrying amount will have arisen after the goodwill’s initial recognition; so, they should be recognised.

The expected manner of recovery should be considered more closely. When a business is acquired, impairment of the goodwill might not be expected imminently; but it would also be unusual for a sale to be expected imminently. So, it might be expected that the asset will be sold a long way in the future; in that case, recovery through use over a long period (that is, before the asset is sold) should be the expected manner of recovery. If however, the plan is to sell the business (along with the underlying goodwill) in the near term, the expected manner of recovery would be sale. If this was indeed the case, and can be clearly demonstrated, DTL should not be created as a result of change in the tax law. This is because the tax base, INR 750 in our example, continues to remain at INR 750 as this amount would be tax-deductible as cost of acquisition of the underlying business, in the sale transaction which is expected to occur in the near term.

During 2009 and 2010 the IASB received representations from various entities and bodies that it was often difficult and subjective to determine the manner of recovery of  certain categories of assets for the purposes of IAS 12. This was particularly the case for investment properties accounted for at fair value under IAS 40 which are often traded opportunistically, without a specific business plan, but yield rental income until disposed of. In many jurisdictions rental income is taxed at the standard rate, while gains on asset sales are tax-free or taxed at a significantly lower rate. The principal difficulty was that the then extant guidance (SIC 21 – Income Taxes – Recovery of Revalued Non-Depreciable Assets) effectively required entities to determine what the residual amount of the asset would be if it were depreciated under IAS 16 rather than accounted for at fair value, which many regarded as resulting in nonsensical tax effect accounting. To deal with these concerns, in December, 2010 the IASB amended IAS 12 so as to give more specific guidance on determining the expected manner of recovery for non-depreciable assets measured using the revaluation model in IAS 16 and for investment properties measured using the fair value model in IAS 40. An indefinite-life intangible asset (that is not amortised because its useful economic life cannot be reliably determined) is not the same as a non-depreciable asset to which this amendment would apply. Similar considerations apply to goodwill.  

EQUALISATION LEVY ON E-COMMERCE SUPPLY AND SERVICES, Part – 1

The taxation of digitalised economy is a hotly debated topic in the international tax arena at present, with the OECD and its Inclusive Framework trying to come to a consensus-based solution and with the United Nations recently introducing a new article 12B on taxation of Automated Digital Services in the UN Model Tax Convention. In our earlier article (BCAJ, March, 2021, Page 24), we had covered the provisions relating to Significant Economic Presence (‘SEP’) and the extended source rule, introduced by India in order to tax the digitalised economy. While the provisions relating to SEP have now been operationalised vide Notification No. 41/2021 issued on 3rd May, 2021, the Equalisation Levy (‘EL’) was the first provision introduced by India to tackle the issues in the taxation of the digitalised economy. After their introduction in the Finance Act, 2016 to cover online advertisement services (‘EL OAS’), the EL provisions have been extended vide the Finance Act, 2020 to bring more transactions within their scope. Similarly, while the application of the SEP provisions would be limited, in case of non-applicability of the DTAA or absence of a DTAA, the EL provisions may be applied widely. In this two-part article, we seek to analyse some of the intricacies and issues in respect of the Equalisation Levy as applicable to E-commerce Supply or Services (‘EL ESS’).

1. BACKGROUND
The rapid advancement of technology has transformed the digital economy and it now permeates all aspects of the economy; therefore, it is now impossible to ring-fence the digital economy. Today, technology plays an extremely significant role in the way business is conducted globally. This is clearly evident in the on-going pandemic wherein one is able to work within the confines of one’s home without visiting the office in most of the sectors thanks to the use of technology and the various tools available today. However, this technological advancement has also resulted in enabling an entity to undertake business in a country without requiring it to be physically present in the said country. For example, advertising which was done through physical hoardings or boards, can now be done on social media targeting the residents of a particular country without physically requiring any space in that country. Similarly, traditional theatres are being replaced by various Over-the-Top (‘OTT’) platforms which enable a viewer to watch a movie on her device without having to physically visit a theatre.

Another example is the replacement of the physical marketplace by e-commerce sites wherein sellers can sell their goods or services to buyers without having to go to the physical marketplace. Countries realised that the tax rules, which are more than a century old, do not envisage undertaking a business in a country without having physical presence and therefore do not provide for taxing rights to the source or market jurisdictions. ‘Addressing the Tax Challenges of the Digital Economy’ was identified as the 1st Action Plan out of the 15 Action Plans of the OECD Base Erosion and Profit Shifting (‘BEPS’) Project. This signifies the importance given to the issue by the OECD and other countries participating in this Project.

Interestingly, the workflow on digital economy was not included in the BEPS Project as endorsed by the G20 at the Los Cabos meeting on 19th June, 20121. However, it was considered as Action Plan 1 when it released the Action Plans in July, 2013 even though it did not fit under any of the structural headings of the OECD’s Plan of Action of ‘establishing international coherence of income taxation’, ‘restoring the full effects of the international standards’, ‘ensuring tax transparency’ of ‘developing a tool for swift implementation of the new measures’2. In other words, while the other Action Plans specifically dealt with countering BEPS measures, Action 1 seeks to re-align the tax rules irrespective of the fact that such rules give rise to any BEPS concerns.

BEPS Action Plan 1 did not result in a consensus and therefore it was agreed that more work would be done on this subject. However, the Action Plan shortlisted three alternatives for countries to implement as an interim measure. India was one of the first countries to enact a unilateral measure when it introduced the EL OAS in the Finance Act, 2016. Subsequently, several countries introduced similar measures in their domestic tax laws. India introduced the EL ESS in the Finance Act, 2020 to bring to tax e-commerce transactions. Interestingly, while the EL OAS was introduced at the time of introduction of the Finance Bill, 2016 during the annual Union Budget, the EL ESS provisions were not a part of the Finance Bill, 2020 and were introduced only at the time of its enactment. The absence of a Memorandum explaining the provisions of the EL ESS has resulted in a lot of confusion regarding the intention of certain provisions which is an important aspect one needs to consider while interpreting the law. While the Finance Act, 2021 did clarify a few issues, some of the issues are still unresolved. Moreover, the clarification in the Finance Act, 2021, which was made retrospective from 1st April, 2020, has also resulted in some issues. In the first part of this two-part article, the provisions of the EL ESS are analysed. However, before analysing the EL ESS provisions, given the interplay and overlap with the EL OAS, the ensuing paragraph briefly covers the EL OAS provisions.

___________________________________________________________________
1 B. Michel, ‘The French Crusade to Tax the Online Advertisement Business:
Reflections on the French Google Case and the Newly Introduced Digital
Services Tax,’ 59 Eur. Taxn. 11 (2019), Journal Articles & Papers IBFD
(accessed 28th January 2020)
2 Ibid
2. EQUALISATION LEVY ON ONLINE ADVERTISEMENT SERVICES

Recognising the need of the hour and the significance of the issues relating to the taxation of the digital economy, the Finance Ministry constituted the Committee on Taxation of E-commerce. It consisted of members of the Department of Revenue, representatives of some professional bodies, representatives from industry and other professionals, expert in the field. The Committee examined the Action 1 Report as well as the literature from several well-known authors on the subject and released its proposal in February, 2016.

The Finance Act, 2016 introduced the provisions of EL OAS. Unlike the SEP provisions and the extended source rule, the EL OAS (as well as EL ESS) is not a part of the Income-tax Act, 1961 (‘ITA’). EL OAS applies on specified services rendered by non-residents to a person resident in India or to a non-resident having a Permanent Establishment (‘PE’) in India. Specified service for the purpose of EL OAS has been defined in section 164(i) of the Finance Act, 2016 as follows:
‘“specified service” means online advertisement, any provision for digital advertising space or any other facility or service for the purpose of online advertisement and includes any other service as may be notified by the Central Government in this behalf.’

Under the EL OAS provisions, a person resident in India or a non-resident having a PE in India shall deduct EL at the rate of 6% on payment for specified service to a non-resident if it satisfies the following conditions:
a. The service rendered is not effectively connected to a PE of the non-resident service provider;
b. The payment for the specified service exceeds INR 100,000 during the previous year; and
c. The payment is in respect of the specified services utilised in respect of a business or profession carried out by the payer.

Therefore, the EL OAS applies only in respect of Online Advertisement Services or any facility or service for the purpose of online advertisement. Further, EL OAS provisions place the onus of responsibility of collection of the levy on the payer being a resident or on the payer being a non-resident having a PE in India.

While there are various issues and intricacies in relation to the EL OAS, we have not covered the same as the objective of this article is to cover the EL ESS provisions and the issues arising therefrom. However, some of the common issues, such as whether EL provisions are restricted by a tax treaty, have been covered in the second part of this two-part article.

3. EQUALISATION LEVY ON E-COMMERCE SUPPLY OR SERVICES

3.1 Scope and coverage
The Finance Act, 2020 extended the scope of EL to cover consideration received by non-residents on E-commerce Supply or Services (‘ESS’) made or facilitated on or after 1st April, 2020.

EL ESS applies at the rate of 2% on the consideration received by a non-resident on ESS, which has been defined in section 164(cb) of the Finance Act, 2016 to mean:
(i) Online sale of goods owned by the e-commerce operator; or
(ii) Online provision of services provided by the e-commerce operator; or
(iii) Online sale of goods or provision of services, or both, facilitated by the e-commerce operator; or
(iv) Any combination of activities listed in clauses (i), (ii) or (iii).

Further, the Finance Act, 2021 has also extended the definition of ESS for this clause to include any one or more of the following online activities, namely,
(a) Acceptance of offer for sale; or
(b) Placing of purchase order; or
(c) Acceptance of the purchase order; or
(d) Payment of consideration; or
(e) Supply of goods or provision of services, partly or wholly.

Moreover, EL ESS applies for consideration received or receivable by a non-resident in respect of ESS made or provided or facilitated by it to the following persons as provided in section 165A(1) of the Finance Act, 2016 as amended by the Finance Act, 2020:
(i) A person resident in India; or
(ii) a person who buys such goods or services, or both, using an internet protocol (IP) address located in India; or
(iii) a non-resident under the following specified circumstances:
a. sale of advertisement which targets a customer who is resident in India, or a customer who accesses the advertisement through an IP address located in India;
b. sale of data collected from a person who is resident in India, or from a person who uses an IP address located in India.

Further, the provisions of EL ESS shall not apply in the following circumstances:
(i) Where the non-resident e-commerce operator has a PE in India and the ESS is effectively connected to the PE;
(ii) Where the provisions of EL OAS apply; or
(iii) Whether the sales, turnover, or gross receipts of the e-commerce operator from the ESS made or provided or facilitated is less than INR 2 crores during the previous year.

Lastly, section 10(50) of the ITA provides an exemption from tax on the income which has been subject to EL OAS and EL ESS.

3.2 Non-resident
EL ESS applies in respect of consideration received or receivable by a non-resident from ESS made or provided or facilitated. The term ‘non-resident’ has not been defined in the Finance Act, 2016.

However, section 164(j) of the Finance Act, 2016 provides that words and expressions not defined in it but defined in the ITA shall have the meanings assigned to them in the Finance Act, 2016 as well. In other words, in respect of undefined words and expressions, the meaning as ascribed in the ITA would apply here as well.

Accordingly, one would import the meaning of the term ‘non-resident’ from section 2(30) read with section 6 of the ITA.

3.3 Online sale of goods
The EL ESS provisions apply in respect of ESS which has been defined in section 164(cb) of the Finance Act, 2016 as provided in paragraph 3.1 above. Accordingly, EL ESS applies in respect of consideration on online sale of goods made or facilitated by a non-resident. The term ‘online sale of goods’ has not been defined in the Finance Act, 2016 and therefore some of the issues in respect of various aspects of the term have been provided in the paragraphs below.

3.3.1 What is meant by ‘online’
The first condition in respect of the term ‘online sale of goods’ is that the goods have to be sold ‘online’. The term ‘online’ has been defined in section 164(f) of the Finance Act, 2016 to mean the following,
‘…a facility or service or right or benefit or access that is obtained through the internet or any other form of digital or telecommunication network.’

Therefore, the term is wide enough to cover most types of transactions undertaken through means other than physically. Thus, goods sold through a website, email, mobile app or even through the telephone would be considered as sales undertaken ‘online’.

3.3.2 What is meant by ‘goods’
The term ‘goods’ has not been defined in the Finance Act, 2016 or in the ITA. Therefore, the question arises as to whether one can import the term from the Sale of Goods Act, 1930 (‘SOGA’).

Section 2(7) of the SOGA provides that
‘“goods” means every kind of movable property other than the actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before the sale or under the contract of sale;’

On the other hand, section 2(52) of the Goods and Services Tax Act, 2017 (‘GST Act’) refers to a different definition of the term as follows,
‘“Goods” means every kind of movable property other than money and securities but includes actionable claims, 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.’

The issue in this regard is whether one should consider the definition of the term under the SOGA or the GST Act, with the major difference in the definition under both the laws being that SOGA includes shares and stock as ‘goods’, whereas the GST Act does not do so. This issue is relevant while evaluating the applicability of the EL ESS provisions to the sale of shares and stock. While an off-market sale of shares may not trigger the EL provisions as there may be no consideration paid or payable to an e-commerce operator, one may need to evaluate whether the provisions could apply to a transaction undertaken on an overseas stock exchange (assuming that the overseas stock exchange is considered as an e-commerce operator).

In the view of the authors, it may be advisable to consider the definition under SOGA as this is the principal law dealing with the sale of goods, whereas the GST Act is a law to tax certain transactions. In other words, the transaction of sale of shares and stock on a stock exchange may be considered as an online sale of goods and may be subject to the provisions of EL provided that the stock exchange satisfies the definition of ‘e-commerce operator’ and other conditions are also satisfied. An analysis of whether an overseas stock exchange would be considered as an ‘e-commerce operator’ has been undertaken in paragraph 3.5.3 below.

However, in respect of an aggregator for booking hotel rooms or a hotel situated outside India providing online facility for booking hotel rooms, it would not be considered as undertaking or facilitating sale of goods as rooms would not be considered as ‘goods’. The issue of whether the said facility would constitute a covered provision of services for the application of the EL provisions in respect of booking of hotel rooms is discussed in subsequent paragraphs.

3.3.3 What is meant by ‘online sale of goods’?
Having analysed the meaning of the terms ‘online’ and ‘goods’, the crucial aspect that one may need to consider is whether the ‘sale’ of the goods has been undertaken online as the EL ESS provisions refer to consideration received or receivable for online ‘sale’ of goods made or facilitated by the non-resident e-commerce operator. This term has been generating a lot of confusion and uncertainty as one needs to understand as to whether the goods have been sold online. In other words, the issue that needs to be addressed is whether the EL provisions could apply in a situation where the goods are sold online but the delivery of the goods is undertaken offline.

In this regard, section 19 of the SOGA provides,
‘(1) Where there is a contract for the sale of specific or ascertained goods, the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred.’

Therefore, SOGA provides that the title in the goods is transferred when the parties to the contract intend it to be transferred. Moreover, the terms and conditions of various e-commerce sites provide that the risk of loss and title passes to the buyer upon delivery to the carrier.

Hence, one could possibly argue that in such situations there is no online sale of goods made or facilitated by the e-commerce operators which merely facilitate the placement of the order for the said goods, and therefore the provisions of EL do not apply.

One could also take a similar view in the case of certain sites which offer e-bidding services for the goods.

However, this issue has been covered in the Finance Act, 2021 with retrospective effect from 1st April, 2020 wherein it has been provided that for the purpose of the definition of ESS, ‘online sale of goods’ shall include any one or more of the following online activities (‘extended activities’):
a. Acceptance of offer for sale; or
b. Placing of purchase order; or
c. Acceptance of the purchase order; or
d. Payment of consideration; or
e. Supply of goods or provision of services, partly or wholly.

Therefore, now, if any of the above activities are undertaken online, the transaction may be considered as ESS and may be subject to the provisions of EL (refer to the discussion in paragraph 3.5 as to whether the definition of e-commerce operator is satisfied in case the non-resident only undertakes the above activities online).

3.4 Online provision of services
The provisions of EL ESS apply in case of online sale of goods or online provision of services. Having analysed some of the nuances regarding the online sale of goods, let us now consider some of the nuances of online provision of services. Generally, the applicability of EL ESS to online provision of services may pose complexities which are significantly higher than those related to online sale of goods.

Some of the issues have been explained by way of an example in two scenarios.

(Scenario 1) Let us first take the example of a person resident in India booking a room in a hotel outside India (the ‘Hotel’), owned and managed by a non-resident, through its website. Let us assume that payment for the booking of the room is made immediately on booking itself. Now, the question arises whether the said transaction would be considered as an online provision of services by the Hotel and whether the provisions of EL would apply on the same.

The first question is whether there is any sale of goods or provision of services. Arguably, the renting out of rooms may be considered as a service rendered by the Hotel. Now, the question is whether any service is rendered online.

In this case, one may be able to argue, and rightfully so, that the service rendered by the Hotel of rental of rooms is not provided online but is rendered offline and, therefore, this is not a case of online provision of services. However, it is important to note that the Hotel is also providing a facility for booking the rooms online, which in itself is a service, independent of the rental of the rooms. This booking service is rendered online and, therefore, may be considered as an online provision of service by the Hotel to the person resident in India.

On the other hand, one may be able to argue that no consideration is received by the Hotel for providing the online facility and that the entire consideration received is that for the letting out of the rooms (this may be the case, for example, if the rate for the rooms is the same irrespective of whether booked online or directly at the hotel). In such a case, one may be able to argue that in the absence of consideration received or receivable, the provisions of EL cannot apply. Further, even if one were to counter-argue that the consideration received towards the rental of the room includes consideration towards providing the service of provision of online booking and the same can be allocated on some scientific basis, the dominant nature of the activities for the composite service is that of letting out of the hotel room, which is not provided online. Accordingly, in the view of the authors, the provisions of EL shall not apply in such a scenario.

(Scenario 2) Let us now take the same example wherein a person resident is booking a room in a hotel, situated outside India, but the same is booked through a room aggregator called ABC. Let us further assume that the entire consideration for the room is paid by the customer to ABC at the time of booking and then ABC, after deducting its commission or fees, pays the balance amount to the hotel.

Now, the first question to be evaluated here is whether the service rendered by ABC falls under sub-clause (ii) or (iii) of section 164(cb) of the Finance Act, 2016. Sub-clause (ii) of section 164(cb) refers to online provision of services by the e-commerce operator, whereas sub-clause (iii) of section 164(cb) refers to facilitation for online provision of services.

One may take a view that given that there is a specific clause relating to facilitation, which is what is provided by the aggregator ABC, one should apply sub-clause (iii). However, the said sub-clause applies only in respect of facilitation of online provision of services and the services which are being facilitated are in respect of letting out of the rooms of the hotel which are not rendered online. Therefore, the provisions of sub-clause (iii) may not apply.

Alternatively, one could argue that the service rendered by ABC is through an online facility and therefore it would fall under sub-clause (ii) relating to online provision of services. In such a case, the question arises whether the service is rendered to the customer booking the room or to the hotel. In case the service is considered as rendered to the hotel, the provisions of EL may not apply as it may be considered as a case of services rendered to a non-resident. However, in the view of the authors, the service rendered by ABC, of facilitating the letting out of the rooms of the hotel, is a service rendered by ABC to both, to the hotel and the customer who is booking the rooms. This would be the case even though the commission / fees for the services rendered by ABC is paid for by the hotel and the customer is not aware of the commission payable to ABC for facilitation out of the total amount paid by her.

3.5 E-commerce operator
Having analysed some of the issues relating to online sale of goods or online provision of services, this paragraph covers some issues in respect of the e-commerce operator.

3.5.1 Who is considered as an e-commerce operator?
An e-commerce operator is defined in section 164(ca) of the Finance Act, 2016 to mean the following:
‘“E-commerce operator” means a non-resident who owns, operates or manages digital or electronic facility or platform for online sale of goods or online provision of services, or both;’

Therefore, in order for a non-resident to be considered as an e-commerce operator, the following cumulative conditions are required to be satisfied:
a. There should be a digital or electronic facility or platform; and
b. The said facility or platform should be for online sale of goods or online provision of services, or both; and
c. The non-resident should own, operate or manage the said facility or platform.

3.5.2 Will sale of goods or providing services via e-mail be subject to the provisions of EL?
The biggest concern most non-residents were facing at the time of the introduction of the EL ESS provisions was whether the sale of goods concluded over exchange of emails could be subject to the provisions of EL ESS.

If such a transaction were to be covered under the provisions of EL ESS, there could be major repercussions for a lot of MNCs as a lot of intra-group transactions are undertaken over email. The confusion increased significantly after the amendments undertaken in the Finance Act, 2021 wherein the definition of ‘online sale of goods’ or ‘online provision of services’ has been extended to include acceptance of offer, placing of purchase order, acceptance of purchase order, payment of consideration, etc.

In this case, while ‘email’ may be considered as an online facility, the seller of the goods is not operating, owning or managing the email facility which is managed by the IT company (such as Microsoft or Google). Further, even if one considers that the seller is operating the facility, it is a facility for communication and it is not a facility for online sale of goods or for online provision of services. Moreover, it is important to highlight that there is a difference in the operation of the facility or platform and the operation of an account on the platform. Therefore, if one is operating an email account, it may not be appropriate to contend that one is operating the entire facility.

Accordingly, in the view of the authors, the transactions undertaken through email may not be subject to EL ESS as the seller of goods over exchange of emails may not come within the definition of ‘e-commerce operator’.

This would also be the case for services rendered through email, say an opinion given by a foreign lawyer to a client on email. In such a scenario, the lawyer cannot be considered as an ‘e-commerce operator’.

The absurdity of considering transactions undertaken through email as subject to EL is magnified in the case of transactions undertaken through a telephone. As telecommunication is considered as an online facility u/s 164(f) of the Finance Act, 2016, would one consider goods ordered through a telephone as being subject to the provisions of EL?

In this regard, it may be highlighted that even if one takes a view as explained in paragraph 3.5.4 below that the extended activities list should also apply to the definition of ‘e-commerce operator’, the argument that email is a facility or platform for communication and not for online sale of goods or provision of services, including the extended activities, should hold good.

Similarly, in the case of teaching services rendered online by universities, or conferences organised by various organisations online, the question arises whether the said services rendered by the universities or the organisations could be subject to the provisions of EL ESS. If the platform through which the services are rendered is owned, operated or managed by the university or organisation, such entities may be considered as e-commerce operators, and therefore the fees received by them may be subject to the provisions of EL ESS. However, if these entities are merely using the platform or facility owned and managed by a third party and only operate as users of the platform, then such entities cannot be considered as owning, managing or operating the facility or platform but merely operating or managing an account on the platform. In such cases, they may not be considered as e-commerce operators and the consideration received by them shall not be subject to the provisions of EL.

3.5.3 Will sale of shares on a stock exchange be subject to the provisions of EL?
As evaluated in paragraph 3.3.2 above, ‘shares’ may be considered as ‘goods’. Further, the platform through which the sale is undertaken in most overseas stock exchanges could be considered as an online facility as it would be undertaken through the internet, digital or telecommunication network. Now the question arises whether the platform is for the purpose of online sale of goods, the answer to which would be in the affirmative.

Therefore, if the platform or facility is owned, operated or managed by the overseas stock exchange, the non-resident owning the overseas stock exchange may be considered as an ‘e-commerce operator’ and the transaction may be subject to the provisions of EL.

3.5.4 Can a transaction be subject to EL only because the payment of consideration is undertaken online?
In this regard an interesting point to note is that while the terms ‘online sale of goods’ and ‘online provision of services’ have been extended to include certain online activities as provided in the Explanation to section 164(cb) (extended activities), the terms are provided in two clauses in section 164, namely:
a) Clause (ca) of section 164 defining the term ‘e-commerce operator’ wherein the facility or platform is for online sale of goods or online provision of services, or both.
b) Clause (cb) of section 164 defining the term ESS which means online sale of goods or online provision of services made or facilitated by the e-commerce operator.

The Finance Act, 2021 extended the terms ‘online sale of goods’ and ‘online provision of services’ only in respect of clause (cb), dealing with definition of e-commerce supply or services and not in clause (ca). The Explanation to clause (cb) provides as follows,
‘For the purposes of this clause “online sale of goods”…..’

Further, the definition of the term ‘e-commerce operator’ in clause (ca) does not include the term ‘e-commerce supply or services’ which is defined in clause (cb). Therefore, on a literal reading of the language, one may be able to argue that for a non-resident to be considered as an e-commerce operator, the sale of goods or the provision of services needs to be undertaken online. Moreover, the provisions of EL ESS may not apply in a scenario where only the extended activities are undertaken online without the actual sale of goods or provision of services undertaken online as the extended definition of the term ‘online sale of goods’ or ‘online provision of services’ applies only for the definition of ESS and not for an e-commerce operator.

While this is a literal reading of the provision, the above view may be extremely litigious and may not be accepted by the courts as it may result in the above amendment in the Finance Act, 2021 being made infructuous and would be against the intention of the Legislature.

However, if one takes a view that the extended activities would apply even to the definition of ‘e-commerce operator’ and therefore can result in the application of the EL ESS provisions, it may result in a scenario where EL ESS provisions could possibly apply even when none of the activities of the provision of services or sale of goods is undertaken online but only the payment is done online.

Let us take the earlier example of a foreign lawyer rendering advisory services over email to an Indian client, who would make the payment online through an app operated by a non-resident. In this regard, as discussed in paragraph 3.5.2, as the lawyer would not be considered as an ‘e-commerce operator’, the transaction may be subject to EL ESS as one of the extended activities, i.e., payment of consideration is undertaken online and the e-commerce operator is providing an online service of facilitating the payment. However, in this case the e-commerce operator would be the non-resident operating the app through which the payment is made and not the lawyer.

3.5.5 Can there be multiple e-commerce operators for the same transaction?
If one takes a view that the extended activities shall apply to the definition of ‘e-commerce operator’ as well, the question arises whether there can be multiple e-commerce operators for the same transaction?

One can evaluate this with an example. Let us consider a scenario where the goods of ABC, a non-resident, are sold through its website and the payment for the goods is done by the resident customer through a payment gateway, owned by XYZ, another non-resident. In this case, both ABC and XYZ would be considered as e-commerce operators. Further, the same amount may be subject to EL in the hands of multiple e-commerce operators. Continuing the above example, the consideration paid by the resident customer to ABC through the payment gateway would be subject to EL ESS. Further, if one considers that the payment gateway of XYZ has rendered services to both, the resident customer as well as ABC, the consideration received by XYZ from ABC would also be subject to EL ESS as it is consideration received by an e-commerce operator for services rendered to a resident.

3.6 Amount on which EL to be levied
EL ESS applies on consideration received or receivable by an e-commerce operator from ESS. The ensuing paragraphs deal with some of the issues in respect of consideration.

3.6.1 Whether EL to be applied on the entire amount
One of the key issues that require to be addressed is what would be the amount which would be subject to EL. The issue is explained by way of an illustration.

Let us take an example wherein goods are sold online by the e-commerce operator. Further, while the sale of the goods is concluded online, the e-commerce operator does not own the goods but merely facilitates the online sale of the goods. Let us assume that the price of the goods is 100 and the commission of the e-commerce operator is 15. In this scenario, the e-commerce operator may receive 100 from the Indian buyer of the goods and transfer 85 to the seller of the goods after retaining its fees or commission. The question which arises is, as EL is applicable on the consideration received, would the EL apply on the 100 received by the e-commerce operator, or would it apply on the 15 which is the income earned by the e-commerce operator?

Earlier, one could take a view that the EL ESS provisions seek to tax the e-commerce operator and the consideration is compensation paid to the e-commerce operator for his services and, therefore, the EL ESS provisions should apply on the 15 and not the entire 100. Another argument for this view was that the 85 received by the e-commerce operator does not belong to it and by the principles of diversion of income by overriding title, one can argue that the amount of 85 is not consideration which is subject to EL ESS.

However, the Finance Act, 2021 has provided, with retrospective effect from 1st April, 2020, that the consideration which is subject to EL ESS would include the consideration for sale of goods irrespective of whether or not the goods are owned by the e-commerce operator. Therefore, in the above example, now the entire 100 would be subject to EL ESS.

This may result in a scenario wherein offshore sale of goods, not sold through an e-commerce operator or facility, would not be subject to tax in India on account of the decision of the Supreme Court in the case of Ishikawajima-Harima Heavy Industries Ltd. (2007) 288 ITR 408, goods sold through an e-commerce operator would now be subject to EL on the entire amount.

Further, this may result in various practical challenges as the margin of the e-commerce operator may not be sufficient to bear the levy on the entire consideration received.

3.6.2 Consideration received in respect of sale of goods by a resident
When the EL ESS provisions were introduced for F.Y. 2020-21, the provisions of section 10(50) of the ITA provided an exemption to any income arising from ESS which has been subject to EL ESS.

The provisions did not specify to whom the exemption belonged. Therefore, one could possibly take a view that if a resident is selling goods through a non-resident e-commerce operator and the entire consideration for the sale of goods is subject to EL ESS, the exemption u/s 10(50) would exempt the income of the resident seller as well. This is due to the fact that while the consideration is changing hands twice – once from the customer to the e-commerce operator and then from the e-commerce operator to the resident seller – there is only one transaction, sale of goods by the resident seller to a resident buyer through the e-commerce operator.

On the other hand, there was concern that if the resident seller is taxed on the income and the exemption u/s 10(50) does not apply, it could result in double taxation for the same transaction.

The Finance Act, 2021 has amended the provisions of the Finance Act, 2016 with retrospective effect from 1st April, 2020 to provide that the consideration which is subject to EL ESS shall not include the consideration towards the sale of goods or the provision of services if the seller or service provider is a resident or is a non-resident having a PE in India and the sale or provision of services is effectively connected to the PE.

Therefore, in such a situation now, only the consideration as is attributable to the e-commerce operator would be subject to EL ESS.

3.6.3 Levy on consideration received by e-commerce operator
It is important to highlight that for the EL ESS provisions to apply, consideration needs to be received or receivable by the e-commerce operator. While the amendment in the Finance Act, 2021 extends the coverage of the term ‘consideration’ to include the consideration for the sale of goods as well (100 from the example in paragraph 3.6.1), the extended scope would apply only if the entire consideration is received by the e-commerce operator. Therefore, even after the amendment, if the entire consideration (100 in the example used in paragraph 3.6.1) is paid by the buyer directly to the non-resident seller, who pays the fees or commission to the e-commerce operator, EL ESS shall apply only on the amount of commission or fees received by the e-commerce operator (15). This is due to the fact that EL ESS applies on consideration received or receivable by the e-commerce operator, and if the e-commerce operator does not receive the entire consideration for the sale of goods or provision of services but only receives a sum as facilitation fees or commission, EL ESS shall apply only on the portion received by the e-commerce operator.

4. CONCLUSION
Due to the absence of the Memorandum at the time of introduction of the EL ESS provisions, a lot of ambiguity and confusion exists in respect of various aspects. While the Finance Act, 2021 has made certain amendments with retrospective effect in order to clarify certain issues, the ambiguity in various other aspects continues to exist. In the next part of this two-part article, we shall seek to cover various other issues in respect of the EL ESS such as issues relating to residence and the situs of the consumer, issues relating to the turnover threshold, issues relating to the sale of advertisement and the sale of data, interplay of the EL ESS provisions with various other provisions such as the SEP provisions, EL OAS provisions, royalty / FTS and section 194-O of the ITA.

Revision u/s 264 – Offering income inadvertently – Not liable to be taxed – Revision provisions are meant for the benefit of the assessee and not to put him to inconvenience – Commissioner should have examined the existing material in the light of Circular No. 14 (XL – 35) of April, 1955 and Article 265 of the Constitution of India

5 Aafreen Fatima Fazal Abbas Sayed vs. Assistant Commissioner of Income Tax & Ors. [W.P. (L) No. 6096 of 2021, date of order: 08/04/2021 (Bombay High Court)]

Revision u/s 264 – Offering income inadvertently – Not liable to be taxed – Revision provisions are meant for the benefit of the assessee and not to put him to inconvenience – Commissioner should have examined the existing material in the light of Circular No. 14 (XL – 35) of April, 1955 and Article 265 of the Constitution of India

The petitioner challenged the order dated 12th February, 2021 passed by the Principal Commissioner of Income Tax, rejecting the revision petition filed by it u/s 264.

For the A.Y. 2018-19, the assessment year under consideration, the petitioner, who is an individual, declared a total income of Rs. 27,05,646 and after claiming deductions and set-off on account of TDS and advance tax, the refund was determined at Rs. 34,320. However, while filing the return of income on 20th July, 2018 for A.Y. 2018-19, the figure of long-term capital gain of Rs. 3,07,60,800 was purported to have been wrongly copied by the petitioner’s accountant from the return of income filed for the earlier A.Y., i.e., 2017-18, which had arisen on surrender of tenancy rights by the petitioner for that year. It is submitted that the assessment for A.Y. 2017-18 was completed u/s 143(3) vide assessment order dated 24th December, 2019. The petitioner has not transferred any capital asset and there can be no capital gains in the assessment year under consideration and therefore no tax can be imposed on such non-existent capital gains for A.Y. 2018-19.

The returns filed by the petitioner for A.Y. 2018-19 were processed u/s 143(1) vide order dated 2nd May, 2019 and a total income of Rs. 3,34,66,446, including long-term capital gains of Rs. 3,07,60,800 was purported to have been inadvertently shown in the return of income, thereby leading to a tax demand of Rs. 87,40,612. It is the case of the petitioner that the Central Processing Centre (‘CPC’) of the Department at Bengaluru accepted the aggregate income for the year under consideration at Rs. 25,45,650 as presented in column 14; however, the taxes were computed at Rs. 87,40,612 on the total income of Rs. 3,33,06,450 as described above. It is submitted that upon perusal of the order u/s 143(1) dated 2nd May, 2019, the petitioner realised that the amount of Rs. 3,07,60,800 towards long-term capital gains had been erroneously shown in the return of income for the year under consideration.

Realising the mistake, the petitioner filed an application u/s 154 on 25th July, 2019 seeking to rectify the mistake of the misrecording of long-term capital gains in the order u/s 143(1) as being an inadvertent error as the same had already been considered in the return for the A.Y. 2017-18, assessment in respect of which had already been completed u/s 143(3). It was submitted that the application for rectification was still pending and Respondent No. 1 had not taken any action with respect to the same, although it appears that the same has been rejected as per the statement in the Respondent’s affidavit in reply.

In the meanwhile, the petitioner also made a grievance on the E-filing portal of the CPC on 4th October, 2019 seeking rectification of the mistake where the taxpayer was requested to transfer its rectification rights to AST, after which the petitioner filed various letters with Respondent No. 1, requesting him to rectify the mistake u/s 154.

In order to alleviate the misery and bring to the notice of higher authorities the delay being caused in the disposal of the rectification application, the petitioner approached Respondent No. 2 u/s 264 on 27th January, 2021 seeking revision of the order dated 2nd May, 2019 passed u/s 143(1) narrating the aforementioned facts and requesting the Respondent No. 2 to direct Respondent No. 1 to recalculate tax liability for A.Y. 2018-19 after reducing the amount of long-term capital gains from the total income for the said year.

However, instead of considering the application on merits, vide order dated 12th February, 2021 the Respondent No. 2, Principal Commissioner of Income Tax-19, dismissed the application filed by the petitioner on the ground that the same was not maintainable on account of the alternate effective remedy of appeal and that the assessee had also not waived the right of appeal before the Commissioner of Income Tax (Appeals) as per the provisions of section 264(4).

Being aggrieved by the order of rejection of the application u/s 264, the petitioner moved the High Court.

The Court observed that in the petitioner’s return for A.Y. 2018-19, the figure of long-term capital gains of Rs. 3,07,60,800 on surrender of tenancy rights in respect of earlier A.Y. 2017-18 had inadvertently been copied by the petitioner’s accountant from the return for A.Y. 2017-18. The assessment for A.Y. 2017-18 was completed u/s 143(3) vide assessment order dated 24th December, 2019. In the financial year corresponding to A.Y. 2018-19, the petitioner declared a total income of Rs. 27,05,646 and after claiming deductions and set-off on account of TDS and advance tax, a refund of Rs. 34,320 was determined. No capital asset transfer had taken place during A.Y. 2018-19, therefore no tax on capital gains can be imposed. The error had crept in through inadvertence. There is neither any fraud nor malpractice alleged by the Revenue. The rectification application u/s 154 filed earlier was stated in the Respondent’s affidavit to have been rejected. The application u/s 264 has been dismissed / rejected on the ground that the application was not maintainable as an alternate effective remedy of appeal was available and there was no waiver of such appeal by the assessee.

The Court referred to the Delhi High Court decision in the case of Vijay Gupta vs. Commissioner of Income Tax [2016] 386 ITR 643 (Delhi), wherein the assessee in his return of income had erroneously offered to tax gains arising on sale of shares as short-term capital gains, instead of the same being offered as long-term capital gains exempt from tax, where the section 154 application of the assessee was refused / not accepted and when the assessee filed a revision application u/s 264, the same was rejected on the ground that section 143(1) intimation was not an order and was not amenable to the revisionary jurisdiction u/s 264. The Delhi High Court negated these contentions of the Revenue and further held in Paragraph 39 as under:

‘39:- When the Commissioner was called upon to examine the revision application u/s 264 of the Act, all the relevant material was already available on the record of the Assessing Officer, the Commissioner instead of merely examining whether the intimation was correct based on the material then available should have examined the material in the light of the Circular No. 14(XL-35) of 1955, dated April, 1955 and article 265 of the Constitution of India. The Commissioner has erred in not doing so and in failing to exercise the jurisdiction vested in him on mere technical grounds.’

The Court observed that in the facts of the present case, the Commissioner has failed to exercise the jurisdiction vested in him on fallacious grounds which cannot be sustained. In the facts of the present case also, the Commissioner has not considered the petitioner’s case on merits and simply on the ground of availability of an alternate remedy of filing appeal had rejected the application u/s 264. Therefore, on the basis of the above decision, the Commissioner’s order was liable to be set aside.

Under section 264, the Principal Commissioner is mandated not to revise any order in two situations: first, where an appeal that lies to the Commissioner (Appeals) but has not been made and the time within which such appeal may be made has not expired, and second, where the assessee has not waived his right of appeal. What emerges from this is that in a situation where there is an appeal that lies to the Commissioner (Appeals) and which has not been made and the time to make such an appeal has not expired, in that case the Principal Commissioner or Commissioner cannot revise any order in respect of which such appeal lies. The language is quite clear, that the two conditions are cumulative, viz., there should be an appeal which lies but has not been made and the time for filing such appeal has not expired; in such a case, the Principal Commissioner cannot revise. However, if the time for making such an appeal has expired, then it would be imperative that the Principal Commissioner would exercise his powers of revision u/s 264.

The other or second situation is when the petitioner assessee has not waived off his right of appeal; even in such a situation, the Commissioner cannot exercise his powers of revision u/s 264(4)(a). In clause (a) of section 264(4), in the language between filing of an appeal and the expiry of such period and the waiver of the assessee to his right of appeal, there is an ‘or’, meaning thereby that there is an option, i.e., either the assessee should not have filed an appeal and the period of filing the same should have expired, or he should have waived such right. Therefore, there are two situations which are contemplated in the said sub-section(4)(a) of section 264. The section cannot be interpreted to mean that for the Principal Commissioner to exercise his powers of revision u/s 264 not only that the time for filing the appeal should have expired but also that the assessee should have waived his right of appeal. In the facts of the case, the petitioner has not filed an appeal against the order u/s 143(1) u/s 246-A and the time of 30 days to file the same has also admittedly expired.

The Court held that a plain reading of the section suggests that it would not then be necessary for the petitioner to waive such right. That waiver would have been necessary if the time to file the appeal would not have expired. The Court also observed that in matters like these, where the errors can be rectified by the authorities, the whole idea of relegating or subjecting the assessee to the appeal machinery or even discretionary jurisdiction of the High Court was uncalled for and would be wholly avoidable. The provisions in the Income-tax Act for rectification, revision u/s 264 are meant for the benefit of the assessee and not to put him to inconvenience. That cannot and could not have been the object of these provisions.

The order dated 12th February, 2021 passed by Respondent No. 2 was set aside. The Writ Petition was allowed, directing the Pr.CIT to decide the application on merits.

Vivad se Vishwas Scheme – Objective of scheme – Beneficial nature – Search case – Circulars are to remove difficulties and to tone down the rigour of law and cannot be adverse to the assessee

4 Bhupendra Harilal Mehta vs. Pr. Commissioner of Income Tax & Ors.
[W.P. No. 586 of 2021, date of order: 05/04/2021 (Bombay High Court)]

Vivad se Vishwas Scheme – Objective of scheme – Beneficial nature – Search case – Circulars are to remove difficulties and to tone down the rigour of law and cannot be adverse to the assessee

The petitioner was an individual; his assessment for A.Y. 2015-16 was completed vide an order dated 27th December, 2017 u/s 143(3), wherein one addition of Rs. 84,25,075 was made u/s 68 and another addition of Rs. 11,75,901 u/s 69C. The additions were made by the A.O. on the basis that the petitioner had booked artificial long-term capital gains of Rs. 5,73,23,123 and claimed exemption u/s 10(38) thereon by selling shares of M/s Lifeline Drugs and Pharma Limited for a total consideration of Rs. 5,87,95,055. The case of the A.O. was that the price of this share was artificially rigged by certain operators; the details of this were divulged in the course of a search u/s 132 carried out by the Kolkata Investigation Wing of the Income-tax Department during which some statements were recorded u/s 132(4), and in the course of a survey action u/s 133A on the premises of M/s Gateway Financial Service Limited and Korp Securities Limited where also statements of directors were recorded. By an order dated 18th February, 2019 u/s 154, the addition u/s 68 was revised to Rs. 5,87,95,055. Aggrieved by both the aforesaid orders, the petitioner filed appeals to the Commissioner (Appeals).

While the aforesaid appeals were pending, the Direct Tax Vivad se Vishwas Act, 2020 (‘DTVSV Act’) was passed, giving an option to taxpayers to settle their income tax disputes by making a declaration to the designated authority and paying varying percentages of the disputed tax as specified u/s 3 of the new Act.

On 22nd April, 2020, the Central Board of Direct Taxes issued Circular No. 9 of 2020 and on 4th December, 2020 another Circular, No. 21, making further clarifications in the form of Questions and Answers. While the petition was pending, the CBDT issued yet another Circular, No. 4/2021 dated 23rd March, 2021, further clarifying the answer to Q. No. 70.

The petitioner filed a declaration in Form No. 1 u/s 4(1) of the DTVSV Act read with Rule 3(1) of the DTVSV Rules on 16th December, 2020. The disputed income was declared to be Rs. 5,98,90,960 and the disputed tax thereon Rs. 2,02,69,581. The petitioner submitted that the gross amount payable by it was 100% of the disputed tax, i.e., Rs. 2,02,69,581, out of which a sum of Rs. 69,31,892 was declared to have been paid and the balance of Rs. 1,33,37,689 was declared to be payable by the petitioner.

By an order dated 26th January, 2021, the Designated Authority passed an order in Form No. 3 u/s 5(1) of the DTVSV Act read with Rule 4 of the DTVSV Rules, determining the tax payable by the petitioner to be Rs. 2,57,67,714, being 125% of the disputed tax as against Rs. 2,02,69,581 being 100% of the disputed tax declared by the petitioner.

Being aggrieved by the aforesaid order, the petitioner challenged it before the High Court by way of a Writ Petition including the Circular No. 21.

The petitioner submitted that for A.Y. 2015-16 the assessment was not made on the basis of any search but the addition was made only on the basis of certain information obtained in the course of a search conducted on the premises of other entities. The petitioner contended that he has not been subjected to any search action. As per section 3 of the DTVSV Act, sub-clause (a) is applicable to its case as the tax arrear is the aggregate amount of disputed tax, interest chargeable or charged on such disputed tax, and penalty leviable or levied on such disputed tax and, therefore, the amount payable by the petitioner would be the amount of the disputed tax. Only in a case as contained in sub-clause (b) of section 3, where the tax arrears include tax, interest or penalty determined in any assessment on the basis of a search u/s 132 or section 132A of the Income-tax Act, only then would the amount payable under the DTVSV Act be 125% of the disputed tax and in no other case.

It was submitted that the Circular has been issued under sections 10 and 11. Sub-section (1) of section 11 states that an order can be passed by the Central Government to remove difficulties; however, the same cannot be inconsistent with the provisions of the Act. Although section 3 of the DTVSV Act states in unequivocal terms that 125% of the disputed tax is payable only in those cases where an assessment is made on the basis of a search, the impugned order based on the Circular would make it contrary to the provisions of the Income-tax Act and also to several judgments of the Supreme Court; to that extent, the Circular is liable to be quashed. In any event, in interpreting the scope of a provision of a statute, the Courts are not bound by the Circulars issued by the CBDT.

The petitioner further relied on Circular No. 4/2021 dated 23rd March, 2021 with respect to the clarifications issued by the CBDT with reference to FAQ No. 70 of Circular No. 21/2020. It was submitted that to remove any uncertainty it is clarified that a search case means an assessment or reassessment made u/s 143(3)/144/147/153A/153C/158BC in the case of a person referred to in sections 153A, 153C, 158BC or 158BD on the basis of a search initiated u/s 132, or a requisition made u/s 132A, modifying FAQ No. 70 of Circular 21/2020 to that extent. It was submitted that the petitioner is not a person referred to in section 153A or 153C.

For their part, the respondents submitted that since the assessment order was framed based on search / survey inquiries conducted by the Directorate of Income Tax (Investigation), Kolkata on 2nd July, 2013, the designated authority has rightly computed the petitioner’s liability under the Vivad se Vishwas Act by adopting the rate of 125% of disputed tax applicable to a search case in accordance with section 3 of the DTVSV Act. The assessment order passed u/s 143(3) is on the basis of the search and seizure action and the statement recorded u/s 132(4), coupled with post-search inquiries, and as the petitioner had failed to demonstrate the genuineness of the transactions, the addition was made.

In other words, the Department submitted that as per the DTVSV Act, 2020 it is not material that a ‘search case’ essentially should be a case wherein a warrant is executed u/s 132. To emphasise this, it relied on FAQ No. 70 and stated that it was identical to section 153C wherein cases are considered as ‘search case’ even though a warrant is not executed but transaction or information is found from the person subjected to search action u/s 132.

The Court referred to the statement of objects and reasons of the DTVSV Act and observed that this Act is meant to provide a resolution for pending tax disputes which have been locked up in litigation. Taxpayers can put an end to tax litigation by opting for the scheme and also obtain immunity from penalty and prosecution by paying percentages of tax as specified therein. This would bring peace of mind, certainty, saving of time and resources for the taxpayers and also generate timely revenue for the Government.

Referring to the answer to Q. No. 70, it was observed that the said question and its answer in Circular No. 21 was clarified vide Circular No. 4/2021 dated 23rd March, 2021 that a ‘search case’ means an assessment or reassessment made u/s 143(3)/144/147/153A/153C/158BC in the case of a person referred to in section 153A, section 153C, section 158BC or section 158BD on the basis of a search initiated u/s 132, or a requisition made u/s 132A. Thus, the answer to FAQ No. 70 of Circular No. 21/2020 has been replaced by the above meaning.

The Court observed that to be considered a search case, the assessment / reassessment should be:
(i) under sections 143(3)/144/147/153A/153C/153BC; and
(ii) be in respect of a person referred to in section 153A, section 153C, section 158BC or section 158BD; and
(iii) should be on the basis of a search initiated u/s 132, or a requisition made u/s 132A.

If all the three elements / criteria as above are satisfied, the case is a search case.

The Court held that it is not the case of the Revenue that action pursuant to sections 153A or 153C had been initiated in the case of the petitioner. These facts are not disputed. Therefore, criterion No. (ii) necessary for a case to be a search case is not satisfied. Admittedly, no search has been initiated in the case of the petitioner. The assessment order dated 22nd December, 2017 also suggests that the case of the petitioner was selected for scrutiny under ‘CASS’ selection and notices under the Act were issued to the petitioner not pursuant to any search u/s 132 or requisition u/s 132A. Assessment refers only to section 143(3) and is not read with any provision of search and seizure contained in Chapter XIV-B of the Income-tax Act where the special procedure for assessment of a search case is prescribed. The name of the petitioner figures nowhere in any of the statements u/s 132(4) of the searches referred to in the assessment order, nor in the statements pursuant to the survey action of persons under search or survey.

In view of Circular No. 4/2021 modifying / replacing the answer to FAQ No. 70 in Circular No. 21, the case of the petitioner would not be a search case. The Court further observed that these Circulars are to remove difficulties and to tone down the rigour of the law and cannot be adverse to the assessee, especially keeping in mind the beneficial nature of the legislation carrying a lot of weight. Since the petitioner’s case cannot be regarded as a search case, consequently the order dated 26th January, 2021 in Form No. 3, passed by the Designated Authority, would be unsustainable. The Writ Petition filed by the assessee was accordingly allowed.

Penalty – Mistake in notice not to affect validity – Scope of section 292B – Mistake in specifying assessment year for which penalty was levied – Mistake could not be corrected u/s 292B

28 SSS Projects Ltd. vs. Dy. CIT [2021] 432 ITR 201 (Karn) A.Y.: 2008-09; Date of order: 01/02/2021 Ss. 221 and 292B of ITA, 1961

Penalty – Mistake in notice not to affect validity – Scope of section 292B – Mistake in specifying assessment year for which penalty was levied – Mistake could not be corrected u/s 292B

The assessee is a company and for the A.Y. 2008-09 it had paid the tax on the assessed income. However, the A.O. passed an order dated 9th February, 2009 and levied a penalty of Rs. 50,00,000 u/s 221 for the A.Y. 2008-09. The assessee pleaded that it appeared that the A.O. had considered the facts of the case for the A.Y. 2007-08 for levying the penalty for the A.Y. 2008-09 and had passed an order u/s 221 to raise the demand of Rs. 50,00,000.

Both the Commissioner (Appeals) and the Tribunal dismissed the appeals filed by the assessee.

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

‘i) From a close scrutiny of section 292B it is evident that no return of income, assessment, notice, summons or other proceeding, furnished or made or issued or taken or purported to have been furnished or made or issued or taken in pursuance of any of the provisions of this Act shall be invalid or shall be deemed to be invalid merely by reason of any mistake, defect or omission in such return of income, assessment, notice, summons or other proceeding if such return of income, assessment, notice, summons or other proceeding is in substance and effect in conformity with or according to the intent and purpose of this Act. In other words, any clerical or typographical error or omission in the return of income, assessment, notice, summons or other proceeding shall not invalidate the proceedings. When there is no confusion or prejudice caused due to non-observance of technical formalities, the proceedings cannot be invalidated and therefore, a defective notice to an assessee u/s 292B of the Act is not invalid.

ii) The order of penalty referred to the A.Y. 2008-09. The order by which the penalty was levied by the A.O. had been affirmed by the Commissioner (Appeals) and similarly, the Tribunal had held that the penalty had been levied in respect of the A.Y. 2008-09. From a perusal of the memorandum of appeal it was evident that the assessee had paid tax in respect of the A.Y. 2008-09. The assessee had committed a default in respect of the A.Y. 2007-08 and did not pay the tax on account of financial hardship. However, the authorities under the Act had taken into account the facts in respect of the A.Y. 2007-08 and had held the assessee to be in default in respect of the A.Y. 2008-09 and had levied the penalty u/s 221 in respect of the A.Y. 2008-09.

iii) The mistake could not be condoned u/s 292B under which only clerical error or accidental omissions can be protected. The order of penalty was not valid.’

Limitation – Assessment u/s 144C – Section 144C does not exclude operation of section 153 – Notice by DRP four years after direction by Tribunal – Barred by limitation

26 ROCA Bathroom Products Pvt. Ltd. vs. DRP [2021] 432 ITR 192 (Mad) A.Ys.: 2009-10 and 2010-11; Date of order: 23/12/2020 Ss. 144C and 153 of ITA, 1961

Limitation – Assessment u/s 144C – Section 144C does not exclude operation of section 153 – Notice by DRP four years after direction by Tribunal – Barred by limitation

For the A.Y. 2009-10, by an order dated 18th December, 2015, the Tribunal had set aside the order passed u/s 144C and remanded the matter to the Dispute Resolution Panel (DRP) for fresh examination. For the A.Y. 2010-11, by an order dated 23rd September, 2016, the Tribunal had set aside the order passed u/s 144C and remanded the matter to the A.O. for passing a fresh order. No further proceedings were initiated by the DRP and the A.O. pursuant to the order of the Tribunal. Therefore, on 21st August, 2019, the assessee wrote to the A.O. seeking refund of the tax paid for both the years. The aforesaid letter triggered notices dated 6th January, 2020 from DRP calling upon the assessee to appear for a hearing. The assessee filed writ petitions and challenged the notices on the ground of limitation.

The Madras High Court allowed the writ petitions and held as under:

‘i) Section 144C is a self-contained code of assessment and time limits are in-built at each stage of the procedure contemplated. Section 144C envisions a special assessment, one which includes the determination of arm’s length price of international transactions engaged in by the assessee. The Dispute Resolution Panel (DRP) was constituted bearing in mind the necessity for an expert body to look into intricate matters concerning valuation and transfer pricing and it is for this reason that specific timelines have been drawn within the framework of section 144C to ensure prompt and expeditious finalisation of this special assessment. The purpose is to fast-track a specific type of assessment.

ii) This does not, however, lead to the conclusion that overall time limits have been eschewed in the process. In fact, the argument that proceedings before the DRP are unfettered by limitation would run counter to the avowed object of setting up of the DRP, a high-powered and specialised body set up for dealing with matters of transfer pricing. Having set time limits at every step of the way, it does not stand to reason that proceedings on remand to the DRP may be done at leisure sans the imposition of any time limit at all. Sub-section (13) to section 144C imposes a restriction on the A.O. and denies him the benefit of the more expansive time limit available u/s 153 to pass a final order of assessment as he has to do so within one month from the end of the month in which the directions of the DRP are received by him, even without hearing the assessee concerned. The specific exclusion of section 153 from section 144C(13) can be read only in the context of that specific sub-section and, once again, reiterates the urgency that sets the tone for the interpretation of section 144C itself.

iii) The notices issued by the Dispute Resolution Panel after a period of four years from the date of order of the Tribunal would be barred by limitation by application of the provisions of section 153(2A). The writ petitions are allowed.’

Income – Income or capital – Receipt from sale of carbon credits – Capital receipt – Amount not assessable merely because of erroneous claim for deduction u/s 80-IA

25 S.P. Spinning Mills Pvt. Ltd. vs. ACIT [2021] 433 ITR 61 (Mad) A.Y.: 2011-12; Date of order: 19/01/2021 S. 4 of ITA, 1961

Income – Income or capital – Receipt from sale of carbon credits – Capital receipt – Amount not assessable merely because of erroneous claim for deduction u/s 80-IA

The assessee, a private limited company, had claimed deduction of Rs. 3,17,77,767 u/s 80-IA for the A.Y. 2011-12 in respect of the revenue generated for adhering to the clean development mechanism. This included receipts on sale of carbon credits. The A.O. found that the assessee is engaged in the generation of electrical power which is used for its own textile business and the remaining is wheeled to the Tamil Nadu Electricity Board. He held that the income from generation of electricity and the carbon credit earned by the assessee are totally separate and the source of the income is also separate. Therefore, the income derived from the generation of electrical power alone can be construed as income from the eligible business for the purpose of deduction u/s 80-IA. Therefore, the assessee is not entitled to deduction u/s 80-IA in respect of the carbon credit.

Before the Commissioner (Appeals), the assessee contended that without prejudice to its claim for deduction u/s 80-IA, the carbon credit revenue is to be held as a capital receipt and ought to have been excluded from the taxable income. The Commissioner (Appeals) noted the decision of the Chennai Tribunal relied on by the assessee in the case of Ambika Cotton Mills Ltd. vs. Dy. CIT [2013] 27 ITR (Trib) 44 (Chennai) ITA No. 1836/Mds/2012, dated 16th April, 2013, wherein it was held that carbon credit receipts cannot be considered as business income and these are a capital receipt. Hence, the assessee’s claim u/s 80-IA is untenable as deduction u/s 80-IA is allowable only on profits and gains derived by an undertaking. The Tribunal took note of the submission made by the assessee and the decisions relied on and confirmed the finding of the Commissioner (Appeals) largely on the ground that the assessee itself regarded it as a business income and claimed deduction u/s 80-IA.

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

‘i) The task of an appellate authority under the taxing statute, especially a non-departmental authority like the Tribunal, is to address its mind to the factual and legal basis of an assessment for the purpose of properly adjusting the taxpayer’s liability to make it accord with the legal provisions governing his assessment. Since the aim of the statutory provisions, especially those relating to the administration and management of Income-tax is to ascertain the taxpayer’s liability correctly to the last pie, if it were possible, the various provisions relating to appeal, second appeal, reference and the like can hardly be equated to a lis or dispute as arises between two parties in a civil litigation.

ii) The assessee while preferring the appeal before the Commissioner (Appeals), had specifically raised a contention that the receipts from sale of carbon credits was a capital receipt and could not be included in the taxable income. Though this ground had been recorded in the order, the Commissioner (Appeals) did not take a decision thereon. A similar ground was raised by the assessee before the Tribunal, which was not considered by the Tribunal, though the Tribunal referred to all the decisions relied on by the assessee, and rejected the assessee’s claim made u/s 80-IA.

iii) This finding of the Tribunal was wholly erroneous and perverse. The Tribunal was expected to apply the law and take a decision in the matter and if the Commissioner (Appeals) or the A.O. had failed to apply the law, then the Tribunal was bound to apply the law. The receipt by way of sale of carbon credits had been held to be a capital receipt. Therefore, it was of little consequence to the claim made by the assessee u/s 80-IA or in other words, the question of taking a decision as to whether the deduction was admissible u/s 80-IA was a non-issue. Receipt from sale of carbon credits is a capital receipt.’

Deemed income u/s 56(2)(viib) – Company – Receipt of consideration for issue of shares in excess of their fair market value – Determination of fair market value – General principles – Assessee valuing shares following prescribed method – No evidence that method was erroneous – Addition based on estimate by A.O. – Not justified

24 Principal CIT vs. Cinestaan Entertainment Pvt. Ltd. [2021] 433 ITR 82 (Del) A.Y.: 2015-16; Date of order: 01/03/2021 S. 56(2)(viib) of ITA, 1961

Deemed income u/s 56(2)(viib) – Company – Receipt of consideration for issue of shares in excess of their fair market value – Determination of fair market value – General principles – Assessee valuing shares following prescribed method – No evidence that method was erroneous – Addition based on estimate by A.O. – Not justified

For the A.Y. 2015/16, the assessee had filed its return of income declaring Nil income. The case of the assessee was selected for ‘limited scrutiny’ inter alia for the reason ‘large share premium received during the year [verify applicability of section 56(2)(viib)(b)]’. By an order dated 31st December, 2017, the assessment was framed u/s 143(3) determining the total income of the assessee at Rs. 90,95,46,200, making an addition u/s 56(2)(viib).

The Tribunal deleted the addition and held that neither the identity nor the creditworthiness and genuineness of the investors and the pertinent transaction could be doubted. This fact stood fully established before the A.O. and had not been disputed or doubted. Therefore, the nature and source of the credit stood accepted. It held that if the statute provides that the valuation has to be done as per the prescribed method and if one of the prescribed methods had been adopted by the assessee, then the A.O. had to accept it.

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

‘i) Section 56(2)(viib) lays down that amounts received by a company on issue of shares in excess of their fair market value will be deemed to be income from other sources. Valuation is not an exact science and therefore cannot be done with arithmetic precision. It is a technical and complex problem which can be appropriately left to the consideration and wisdom of experts in the field of accountancy, having regard to the imponderables which enter the process of valuation of shares.

ii) The shares had not been subscribed to by any sister concern or closely related person, but by outsider investors. The methodology adopted was a recognised method of valuation and the Department was unable to show that the assessee adopted a demonstrably wrong approach, or that the method of valuation was made on a wholly erroneous basis, or that it committed a mistake which went to the root of the valuation process. The deletion of addition was justified.’

Deemed business income u/s 41(1)(a) – Remission or cessation of liability – Scope of section 41(1)(a) – Amount obtained mentioned in provision refers to actual amount obtained – Royalty payment claimed as expenditure in A.Y. 1990-91 – Tax deducted at source on such payment and interest paid to treasury – Royalty amount written back in accounts in A.Y. 1995-96 – Tax deducted at source and interest not refunded – Such amounts not includible u/s 41(1)(a)

23 Carbon and Chemicals (India) Ltd. vs. CIT [2021] 433 ITR 14 (Ker) A.Y.: 1995-96; Date of order: 01/03/2021 S. 41(1)(a) of ITA, 1961

Deemed business income u/s 41(1)(a) – Remission or cessation of liability – Scope of section 41(1)(a) – Amount obtained mentioned in provision refers to actual amount obtained – Royalty payment claimed as expenditure in A.Y. 1990-91 – Tax deducted at source on such payment and interest paid to treasury – Royalty amount written back in accounts in A.Y. 1995-96 – Tax deducted at source and interest not refunded – Such amounts not includible u/s 41(1)(a)

The assessee claimed a deduction of Rs. 53,71,650 for the A.Y. 1990-91 as expenditure, being royalty payable to a foreign collaborator. Though the deduction was allowed, the amount was not actually remitted outside India. In the meantime, an amount of Rs. 13,65,060 was paid towards tax deducted at source on the royalty amount and a further amount of Rs. 9,38,438 towards interest, under orders passed u/s 201(1A). Thus, a total amount of Rs. 23,03,498 was paid by the assessee towards tax and interest due to the Department against the deduction claimed towards royalty payable to the foreign collaborator. In the A.Y. 1995-96, the amount claimed as deduction for the A.Y. 1990-91, excluding the tax deducted at source and interest paid, was written back by the assessee into its accounts on account of the cessation of liability. Thus, in the return filed for the A.Y. 1995-96, the assessee had written back only Rs. 30,68,152 u/s 41(1). The A.O. held that the entire amount of Rs. 53,71,650 ought to be treated as a deemed profit u/s 41(1)(a) due to cessation of liability with the foreign collaborator.

The Tribunal upheld the addition.

On a reference by the assessee, the Kerala High Court allowed its claim and held as under:

‘i) A reading of section 41(1)(a) indicates that a legal fiction is created to treat the amount which was once deducted as an expenditure, if received back in another assessment year, as income from profits and gains of business. For the purpose of attracting section 41(1) it is necessary that the following conditions are satisfied: (i) the assessee had made an allowance or any deduction in respect of any loss, expenditure, or trading liability incurred by him; (ii) any amount is obtained in respect of such loss or expenditure or any benefit is obtained in respect of such trading facility by way of remission or cessation thereof; and (iii) such amount or benefit is obtained by the assessee in a subsequent year. Once these conditions are satisfied, the deeming provision enacted in the closing part of section 41(1)(a) gets attracted and the amount obtained becomes chargeable to Income-tax as profits and gains of business or profession.

ii) The purpose behind creating a fiction u/s 41(1)(a) is to tax the amount, earlier deducted but subsequently received back, to the extent recouped. It is a measure of taxing the amount recouped. Though a legal fiction must be given full effect, it should not be extended beyond the purpose for which it is created. It is true that Income-tax is a portion of the profits payable to the State and the tax payable is not a permissible deduction. Section 198 provides that all sums deducted for the purpose of computing income of an assessee, including the tax deducted at source, shall be treated as income received. However, this principle cannot be applied while determining the amount to be deemed as profits and gains u/s 41(1)(a). Such an interpretation, if adopted, will in fact be expanding the fiction created and even transform the chargeability.

iii) The words employed in section 41(1)(a) are “amount obtained by such person or the value of benefits accruing to him”. The “amount obtained” can only mean the actual amount obtained. The fiction created under the provision cannot be expanded to include amounts that may be obtained in the future. The legal fiction is intended to deem the actual amount obtained as profits and gains from business and to tax the actual amount. Section 41(1) employs, on the one hand, words such as “allowance” or “deduction”, and on the other hand “loss”, “expenditure”, or “trading liability”. These words are of general import and are understandably employed to take care of several fluid dynamics. These expressions are relatable to words used in section 41(1)(a), i. e., “the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits, gains, etc.” Therefore, an entry made in one previous year as an allowance or deduction towards “loss”, “expenditure” or “trading liability” when written back in a subsequent previous year, on account of the cessation of such liability, becomes taxable as profit or gains of business. But the tax liability should be commensurate with the actual amount received or the value of benefit accrued to the assessee in that financial year and not on the unrecovered amount or unacknowledged benefit by the assessee. The unrecovered amount becomes taxable only in the previous year when it is recovered or actually obtained.

iv) The amount of tax deducted at source and interest could be deemed to be profits and gains and chargeable to tax only on refund. The amounts paid as tax had not been obtained in 1995-96 as they had not been refunded. Until the amount of tax deducted at source was refunded, that amount could not be treated as an amount obtained by the assessee. The addition made by the A.O. was not justified.’

Charitable purpose – Registration of trust – Loss of all records in respect of registration due to floods in 1978 – Exemption granted in assessments up to A.Y. 2012-13 – Absence of documents cannot be ground to presume registration never granted and to deny exemption – Other contemporaneous records to be scrutinised to ascertain issuance of registration certificate

22 Morbi Plot Jain Tapgachh Sangh vs. CIT [2021] 433 ITR 1 (Guj) A.Ys. 2013-14 to 2016-17; Date of order: 25/03/2021 Ss. 11, 12A, 12AA of ITA, 1961

Charitable purpose – Registration of trust – Loss of all records in respect of registration due to floods in 1978 – Exemption granted in assessments up to A.Y. 2012-13 – Absence of documents cannot be ground to presume registration never granted and to deny exemption – Other contemporaneous records to be scrutinised to ascertain issuance of registration certificate

The assessee was a charitable trust established in 1967 and registered with the Charity Commissioner. Thereafter, it was registered u/s 12A. In orders passed u/s 143(3) for the A.Ys. 1977-78 to 1982-83, the Department had accepted the assessee’s claim for exemption u/s 11 and for the A.Ys. 1986-87 to 2012-13, the exemption u/s 11 was allowed accepting the return of income u/s 143(1) under the provisions applicable to a registered trust drawing the benefits of registration u/s 12A.

The entire records of the assessee, including the books of accounts, registration certificate as trust and other documents related thereto were destroyed in the devastating flood in the year 1978. From A.Y. 2013-14, the assessee was required to E-file its return of income in which the details as regards the registration of trust u/s 12A/12AA were to be furnished. If the registration number was not mentioned an error would be indicated and the assessee would not be able to upload the return of income. In the absence of the registration certificate and the registration number, the Department did not grant the exemption u/s 11 for the period between 2013-14 and 2016-17. The assessee was granted a fresh certificate from A.Y. 2017-18 onwards.

The assessee filed a writ petition seeking a direction to grant the benefit of exemption for the A.Ys. 2013-14 to 2016-17. The Gujarat High Court allowed the writ petition and held as under:

‘i) Though in the absence of the registration number to be mentioned in the course of E-filing of the return, the benefit of exemption u/s 11 could not be granted, the assessee trust should not be denied the benefit of exemption u/s 11 only on account of its inability to produce the necessary records which got destroyed during the floods of 1978. There was nothing doubtful as regards the assessee. The stance of the Department that as the record was not available with the assessee or with the Department, it should be presumed that at no point of time the certificate of registration u/s 12A was granted, could not be accepted.

ii) There was contemporaneous record available with the assessee which could be produced by it and should be considered minutely by the Department so as to satisfy itself that the assessee had been issued a registration certificate u/s 12A and had been availing of the benefit of exemption over a period of time u/s 11.

iii) The Department is expected to undertake some homework in this regard seriously. The trust should not be denied the benefit of exemption u/s 11 only on account of its inability to produce the necessary records which got destroyed during the floods of 1978. We do not find anything doubtful or fishy as regards the trust.

iv) In such circumstances, we are of the view that whatever record is available with the trust, as on date, should be produced before the Department and the Department should look into the records minutely and also give an opportunity of hearing to the trust or its legal representative and take an appropriate decision in accordance with law.

v) We dispose of this writ application with a direction that the writ applicant-trust shall produce the entire record available with it as on date before the Department and the Department shall look into the entire record closely and threadbare and ascertain whether the trust being a registered charitable trust had been issued the registration certificate u/s 12A. A practical way needs to be found out in such types of litigation. Let this entire exercise be undertaken at the earliest and be completed within a period of four weeks from the date of receipt of the order by the Department.

vi) We hope and trust that the controversy is resolved by the parties amicably and the trust may not have to come back to this Court.’

Capital gains – Computation – Deeming provision in section 50C – Applicable only when there is actual transfer of land – Assessee acquiring right in land under agreement to purchase land – Sale of land to third party with consent of assessee – Section 50C not applicable

21 V.S. Chandrashekar vs. ACIT [2021] 432 ITR 330 (Karn) A.Y.: 2010-11; Date of order: 02/02/2021 Ss. 45 and 50C of ITA, 1961

Capital gains – Computation – Deeming provision in section 50C – Applicable only when there is actual transfer of land – Assessee acquiring right in land under agreement to purchase land – Sale of land to third party with consent of assessee – Section 50C not applicable

The assessee was a dealer in land. On 23rd December, 2005, it had entered into an unregistered agreement with ‘N’ for purchase of land measuring 3,639.60 square metres for a consideration of Rs. 4.25 crores. Under the agreement, the assessee was neither handed over possession of the land nor was the power of attorney executed in his favour. ‘N’ sold the land in question by three sale deeds. In the first two transactions the assessee was not a party to the deed, whereas in the third transaction the assessee was a consenting witness. The assessee claimed the loss arising from the transaction as a business loss. The A.O. applied section 50C and made an addition to his income. This was upheld by the Tribunal.

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

‘i) It is a well settled rule of statutory interpretation with regard to taxing statutes that an assessee cannot be taxed without clear words for that purpose and every Act of Parliament has to be read as per its natural construction of words.

ii) From a perusal of sections 2(47) and 50C it is axiomatic that Explanation 1 to section 2(47) uses the term “immovable property”, whereas section 50C uses the expression “land” instead of immovable property. Wherever the Legislature intended to expand the meaning of land to include rights or interests in land, it has said so specifically, viz., in section 35(1)(a), section 54G(1), section 54GA(1) and section 269UA(d) and Explanation to section 155(5A). Thus, section 50C applies only in case of transfer of land.

iii) Section 50C was applicable only in case of a transferor of land which in the instant case was ‘N’ and not a transferor or co-owner of the property. The provisions of section 50C were not applicable to the case of the assessee.

iv) The question whether the loss sustained by the assessee fell under the head “Business” or “Capital gains” required adjudication of facts.’

DEDUCTION FOR PENALTIES AND FINES UNDER THE MOTOR VEHICLES ACT, 1988

ISSUE FOR CONSIDERATION
Section 37 allows a deduction for any revenue expenditure, laid out or expended wholly and exclusively for the purposes of business or profession, in computing the income under the head Profit and Gains from Business and Profession, provided the expenditure is not of a nature covered by sections 30 to 36.

Explanation 1 to section 37(1) provides that no deduction or allowance shall be made in respect of an expenditure incurred for any purpose which is an offence or which is prohibited by law; such an expenditure shall not be deemed to have been incurred for the purposes of business and profession.

Explanation 1, inserted for removal of doubts with retrospective effect from 1st April, 1962, has been the subject matter of fierce litigation even before it was inserted by the Finance No. 2 Act, 1998. Disputes regularly arise about the true meaning of the terms ‘for any purpose which is an offence’ or ‘which is prohibited by law’ in deciding the allowance of an expenditure incurred. The courts have been disallowing expenditure incurred against the public policy or payments that were made for serious violation of law even before the insertion of Explanation 1. Issues also arise about the legislative intent of Explanation 1 and about the scope of Explanation 1; whether the Explanation has limited the law as it always was or whether it has expanded its scope, or has reiterated what was always there.

In the last few years, the legislatures, Central and State, have increased the fines and penalties many-fold for violation of traffic laws and with this enormous increase the issue of allowance or deduction of such payments has also attracted the attention of the taxpayers who hitherto never viewed these seriously. The issue has been considered on several occasions by the courts and is otherwise not new, but it requires consideration in view of the sizeable increase in the quantum of expenditure and the dexterous implementation of the new fines by the traffic authorities with vigour hitherto unknown in this vast country. The recent decision of the Kolkata Bench of the Tribunal holding that such an expenditure is not allowable as a deduction in contrast to many decisions regularly delivered for allowance of such payments, requires us to examine this conflict once more, mainly with the intention to recap the law on the subject and share some of our views on the same.

THE APARNA AGENCY LTD. CASE

The issue recently came up for consideration in Aparna Agency Ltd. 79 taxmann.com 240 (Kolkata-Trib). In that case the assessee was engaged in the business of clearing and distribution of FMCG products and of forwarding agents and had claimed deduction for expenses in respect of payments made to State Governments for violating the provisions of the Motor Vehicles Act, 1988 (M.V. Act) for offences committed by its employees. The A.O. disallowed the payments by holding that such payments were made for infraction of law and could not be allowed as a deduction. The Commissioner (Appeals) confirmed the action of the A.O. but reduced the quantum of disallowance.

In an appeal to the Tribunal, the assesse challenged the orders of the A.O. and the Commissioner (Appeals). It submitted that the payments were made to the traffic department for minor traffic violations committed by its delivery vans, and the payments were not against any proved violation or infraction of law but were made in settlement of contemplated governmental actions that could have led to charging the assessee with an offence. It submitted that the payment did not prove any guilt and was made with a view to avoid prolonged litigation, save time and litigation cost.

The assessee relied on the decision of the Madras High Court in CIT vs. Parthasarathy, 212 ITR 105 to contend that the payment that was compensatory in nature should be allowed as a deduction so long as the said payment was not found to be penal in nature.

The Tribunal examined the provision of the M.V. Act, 1988, and in particular the relevant sections concerning the offence and the levy of the fine, namely, sections 119, 122, 129 and 177. It noted that the term ‘offence’ though not defined under the Income-tax Act, 1961, was, however, defined exhaustively by section 3(38) of the General Clauses Act, 1887 to mean ‘any act or omission made punishable by any law for the time being in force’. It was also noted that even the expression ‘prohibited by law’ has not been defined in the I.T. Act. Under the circumstances, the Tribunal held that the expression should be viewed either as an act arising from a contract which was prohibited by statute or which was entered into with the object of committing an illegal act. The Tribunal quoted with approval the following paragraph of the decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. vs. CIT 41 ITR 350:

‘In our opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business’.

The Tribunal, on perusal of various statutory provisions of the M.V. Act under which the payments in question were made, for offences committed by the employees for which the assessee was vicariously liable, held that such payments were not compensatory in nature and could not be allowed as a deduction by upholding the order of the Commissioner (Appeals) to that extent.

BHARAT C. GANDHI’S CASE


A similar issue had arisen in the case of DCIT vs. Bharat C. Gandhi, 10 taxmann.com 256 (Mum). The assessee in the case was an individual and the proprietor of Darshan Roadlines which specialised in transporting cargo consignments of huge or massive dimensions where the weight and the size of the same exceeded the limits laid down under the M.V. Act and the rules thereunder. The assessee paid compounding fees aggregating to Rs. 73,45,953 to the RTO on various trips during the year for transportation of the massive consignments on its trailers by way of fines at the check-post at Bhachau, Gujarat on various trips during the year for Suzlon Energy Ltd. The A.O. disallowed the assessee’s claim in respect of the said payments, holding that it was in the nature of penalty and, thus, not allowable u/s 37(1). The Commissioner (Appeals), however, held that the expenditure was not in violation of the M.V. Act and the payments could not be termed as penalty. He further relied on the clarifications given by the Central Government vide letter dated 3rd August, 2008 and allowed the expenditure.

On Revenue’s appeal, the Departmental Representative submitted that the issue was not of nomenclature but the intention of the Legislature in not allowing the amounts paid for violation of law. It was further submitted that it was nowhere stated that the assessee satisfied the conditions of the Circular referred to by it before the Commissioner (Appeals). It was submitted that the payment was a penalty for violating the law and could not be allowed.

In reply, the assessee contended that the massive (or over-dimensioned) consignment was indivisible and could not be divided into parts and pieces and hence there was no other way to transport it except by exceeding the permitted limits. It was submitted that transportation in such a manner was a business necessity and commercial exigency and did not involve any deliberate intention of violating any law or rules. It was further submitted that even though it was a compounding fees paid u/s 86(5) of the M.V. Act to the RTO, it was an option given to the assessee and hence payment could not be referred to as a penalty. It was further submitted that such over-dimension charges were also paid to Western Railways for crossing the railway tracks and an amount of Rs. 2,71,380 was allowed by the A.O. It was highlighted that the Central Government vide letter dated 3rd August, 2008 had clarified that transport could take place on payment of the fines.

The assessee further referred to section 86(5) of the M.V. Act and relied on the precedents on the issue in the following cases:
(i) Chadha & Chadha Co. in IT Appeal No. 3524/Mum/2007
(ii) CIT vs. Ahmedabad Cotton Mfg. Co. Ltd. 205 ITR 163(SC)
(iii) CIT vs. N.M. Parthasarathy 212 ITR 105 (Mad)
(iv) ACIT vs. Vikas Chemicals 122 Taxman 59 (Delhi)
(v) CIT vs. Hero Cycles Ltd. 17 Taxman 484 (Punj. & Har.)
(vi) Kaira Can Co. Ltd. vs. Dy. CIT 32 DTR 485 (Mum-Trib)
(vii) Western Coalfields Ltd. vs. ACIT, 27 DTR 226 (Nag-Trib)

The Tribunal noted that the issue was elaborately discussed by the ITAT in the case of Chadha & Chadha Co., IT Appeal No. 6140/Mum/2009, dated 17th September, 2010 relied upon by the assessee wherein the ITAT in its order has considered as under:

‘9. The liability for additional freight charges was considered in the case of ITO vs. Ramesh Stone Wares by the ITAT Amritsar Bench in 62 TTJ (Asr.) 93 wherein the additional freight charges paid to Railway Department for overloading was considered and held that the expense was not penal in nature because it is not the infringement of law but same is violation of contract that too not by the assessee but by his agent, i.e., Coal Authority of India. In terms of an agreement, if coal is finally found by the authorities to be overloaded then the assessee has to pay additional freight charges which according to the terminology of the contract is called penalty freight. This liability was not considered as penal nature and allowed. In the assessee’s case also the overloading charges are to be incurred regularly in view of the nature of goods transported for the said steel company and since the nature of the goods is indivisible and generally more than the minimum limit prescribed under the Motor Vehicles Act, the assessee has to necessarily pay compounding charges for transporting goods as part of the business expenses. These are not in contravention of law and the RTO authorities neither seized the vehicle nor booked any offence but are generally collecting as a routine amount at the check-post itself while allowing the goods to be transported. In view of the nature of collection and payment which are necessary for transporting the goods in the business of the assessee, we are of the opinion that it does not contravene the M.V. Act as stated by the A.O. and the CIT(A).

10. Similar issue also arose with reference to fine and penalty paid on account of violation of National Stock Exchange Regulations in the case of Master Capital Services Ltd. vs. DCIT and the Hon’ble ITAT Chandigarh “A” Bench in ITA No. 346/Chd/2006, dated 26th February, 2007 108 TTJ (Chd) 389 has considered that fines and penalties paid by the assessee to NSE for trading beyond exposure limit, late submission of margin certificate due to software problem and delay in making deliveries of shares due to deficiencies are payments made in regular course of business and not infraction of law, hence allowable. In the assessee’s case also these fines are paid regularly in the course of the assessee’s business for transportation of goods beyond the permissible limit and these payments are being made in the regular course of business to the same RTO authorities at the check-post every year, in earlier years and in later years also. Accordingly, it has to be held that these payments are not for any infraction of law but paid in the course of assessee’s business of transportation and these are allowable expenses under section 37(1).’

In view of the legal principles established by the decisions referred to and noticing that the assessee had made about 230 trips by paying compounding fees, as per the rules in the M.V. Act, the Tribunal held that it could not be stated that the assessee’s payments of compounding fees was in violation of law. Since the assessee was engaged in transporting of over-dimensioned goods, in excess of specified capacities in its transport business, it was a necessary business expenditure, wholly and exclusively incurred for the purpose of business, and the same was allowable u/s 37(1). The order of the Commissioner (Appeals) on the issue was confirmed and in the result, the appeal of the Revenue was dismissed.

OBSERVATIONS
Section 37 is a residual provision that allows a business deduction for an expenditure not specified in sections 30 to 36, provided that the expenditure in question is incurred wholly and exclusively for the purposes of business, an essential precondition for any allowance under this section. Any expenditure that cannot be classified as such a business expenditure gets automatically disallowed under this provision unless it is specifically allowed under other provisions of the Act. Likewise, under the scheme of the Act, an expenditure of capital nature or a personal nature is also not allowable in computing the total income. The sum and substance of this is that a payment which cannot be construed as made for the purposes of business gets disallowed.

In the context of the discussion here, it is a settled position in law that the purpose of any ordinary business can never be to offend any law or to commit an act that violates the law and therefore any payments made for such an offence or as a consequence of violating any law is not allowable; such an allowance is the antithesis of the business deduction. Allowance for such payments has no place for the deduction in the general scheme of taxation. Such payments would be disallowed irrespective of any express provision, like Explanation 1, for its disallowance. It is for this reason that the payments of the nature discussed have been disallowed even before the insertion of Explanation 1 by the Finance (No. 2) Act, 1998 w.r.e.f. 1st April, 1962. It is for this reason that the insertion of this Explanation has been rightly labelled as ‘for removal of doubts’ to reiterate a provision of law which was always there.

Under the circumstances, the better view of the law is that the insertion of the Explanation is not to limit the scope of disallowance; any expenditure otherwise disallowable would remain disallowable even where it is not necessarily provided for by the express words of the Explanation. It is with this understanding of the law that the courts have been regularly disallowing the expenditure against public policy, for committing illegal acts, for making payments which are crimes by themselves and even, in some cases, expenditure incurred for defending the criminal proceedings. The disallowance here of an expenditure is without an exception and the principle would apply even in respect of an illegal business unless when it comes to the allowance of a loss of such business, in which case a different law laid down by the courts may apply.

The decisions chosen and discussed here are taken with the limited objective of highlighting the principles of the law of disallowance, even though they may not be necessarily conflicting with each other and maybe both may be correct in their own facts. The settled understanding of the law provided by the decisions of the Supreme Court in a case like Haji Aziz and Abdul Shakoor Bros. 41 ITR 350 has been given a new dimension by the subsequent decisions of the said court in the cases of Prakash Cotton Mills, 201 ITR 684 and Ahmedabad Cotton Manufacturing Co. Ltd., 205 ITR 163 for making a distinction in cases of payment of redemption fine or compounding fees. The court in these case held that it was required to examine the scheme of the provisions of the relevant statute providing for payment of an impost, ignoring its nomenclature as a penalty or fine, to find whether the payment in question was penal or compensatory in nature and allow an expenditure where an impost was found to be purely compensatory in nature. It was further held that when an impost was found to be of a composite nature, the payment was to be bifurcated and the part attributable to penalty was to be disallowed.

Following this distinction, many courts and tribunals have sought to allow those payments that could be classified as compensatory in nature. Needless to say, the whole exercise of distinguishing and separating the two is discretionary and at times results in decisions that do not reconcile with each other. For example, some courts hold that the penalty under the Sales Tax Act is not disallowable while a few others hold that it is disallowable. At times the courts are led to decide even the payment admittedly made for an offence or violation of law was allowable if it was incurred under a bona fide belief out of commercial expediency.

The other extreme is disallowance of payments that are otherwise bordering on immorality as perceived by society. The Supreme Court in the case of Piara Singh 124 ITR 40 and later in the case of Dr. T.A. Qureshi 287 ITR 647 held that there was a clear distinction between morality and law and the decision of disallowance should be purely based on the considerations rooted in law and not judged by morality thereof. These decisions also explain the clear distinction in principle relating to a loss and an expenditure to hold that in cases of an illegal business, the loss pertaining to such a business may qualify for set-off against income of such business.

As noted earlier, the Income-tax Act has not defined the terms like ‘offence’ or ‘prohibited by law’ and it is for this reason, in deciding the issue, that the taxpayer and the authorities have to necessarily examine the relevant statute under which the payment is made, to determine whether such a payment can be classified to be made for any purpose which is an offence or which is prohibited by law under the respective statutes.

Needless to reiterate, the scope of disallowance is not restricted by the Explanation and the expenditure otherwise held to be disallowed by the courts should continue to be disallowed and those covered by the Explanation would surely be disallowed. In applying the law, one needs to appreciate the thin line of distinction between an infraction of law, an offence, a violation and a prohibition, each of which may carry a different connotation while deciding the allowance or otherwise of a payment. In deciding the issue of allowance or otherwise, it perhaps would be appropriate to examine the ratio of the latest and all-important decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd., 229 ITR 534 where the Court held that a penalty for an infraction of law is not deductible on grounds of public policy, even if it is paid for an act under an inadvertence. The Full Bench of the Punjab and Haryana High Court in the case of Jamna Auto Industries, 299 ITR 92 held that a penalty imposed for violation of any law even in the course of business cannot be held to be a commercial loss allowable in law. One may also see the latest decision in the case of Confederation of Indian Pharmaceutical Industry vs. CBDT, 353 ITR 388 (HP) wherein the Court examined the issue of payment by the pharmaceutical company to the medical practitioners in violation of the rules of the Indian Medical Council.

It appears that the plea that the payment was made during the course of business and the businessman was compelled to offend or violate the law out of commercial expediency is no more tenable and, in our considered opinion, not an attractive contention to support a claim for a business deduction. A payment to discharge a statutory obligation, for correcting the default when permitted under the relevant statute, can be viewed differently and favourably in deciding the allowance of such payment, but such a payment may not be allowed when it is otherwise for an offence or for violating the law inasmuch as it cannot be considered as an expenditure laid out for the purpose of the business. An infraction of law cannot be treated as a normal occurrence in business.

Having noted the law and the developments in law, it is advisable to carefully examine the relevant law under which the payment is made for ascertaining whether the payment can at all be classified as a compensatory payment, for example interest, including those which are labelled as fines and penalties but are otherwise compensatory in nature and have the effect of regularising a default. Surely a payment made for compounding an offence to avoid imprisonment is not one that can be allowed as a deduction, even where such a compounding is otherwise permitted under the relevant statute?

The tribunal and courts in the following decisions, too, have taken a stand that payments made for traffic violations were not allowable as deductions:

  •  Vicky Roadways ITA No. 38/Agra/2013,
  •  Sutlej Cotton Mills ITA 1775/1991 (Del) HC, dated 31st October, 1997,
  •  Kranti Road Transport (P) Ltd. 50 SOT 15 (Visakhapatnam).

However, the tribunal and courts in the following cases have allowed the deduction for expenditure made for violation of the M.V. Act, 1988 in cases where the payment was made for overloading the cargo beyond the permissible limit, on the ground that the cargo in question was indivisible and there was a permission from the Central Government to allow the overloading on payment of fines:

  •  Ramesh Stone Wares, 101 Taxman 176 (Mag) (Asr),
  •  Vishwanath V. Kale ITA/20181/Mum/2010,
  •  Chetak Carriers ITA 2934/Delhi/1996,
  •  Amar Goods Carrier ITA 50 and 51/Delhi/199.

Limitation – Order of TPO – Mode of computing limitation

27 Pfizer Healthcare India Pvt. Ltd. vs. JCIT [2021] 433 ITR 28 (Mad) Date of order: 07/09/2020 Ss. 92CA, 144C and 153 of ITA, 1961

Limitation – Order of TPO – Mode of computing limitation

The petitioners filed returns of income, including income from transactions with associated entities abroad, thus necessitating a reference of issues arising under Chapter X to the Transfer Pricing Officer. The TPO has, after issuance of notices, passed orders dated 1st November, 2019. The petitioners filed writ petitions and challenged the validity of the orders of the TPO on the ground of limitation that there was a delay of one day.

The Madras High Court allowed the writ petitions and held as under:

‘i) The provisions of section 144C prescribe mandatory time limits both pre- and post- the stage of passing of a transfer pricing order. In this scheme of things, the submission that the period of 60 days stipulated for passing of an order of transfer pricing is only directory or a rough and ready guideline cannot be accepted. Section 153 states that no order of assessment shall be made at any time after the expiry of 21 months from the end of the assessment year in which the income was first assessable.

ii) In computing the limitation for passing the order in the instant case, the period of 21 months expired on 31st December, 2019. That must stand excluded since section 92CA(3A) stated “before 60 days prior to the date on which the period of limitation referred to in section 153 expires”. Excluding 31st December, 2019, the period of 60 days would expire on 1st November, 2019 and the transfer pricing orders thus ought to have been passed on 31st October, 2019 or any date prior thereto. The Board in the Central Action Plan also indicated the date by which the Transfer Pricing orders were to be passed as 31st October, 2019.

iii) The orders of the Transfer Pricing Officer passed on 1st November, 2019 were barred by limitation.’

Business expenditure – Disallowance u/s 40(a)(ia) – Payments liable to deduction of tax at source – Royalty: (i) Amendment to definition in 2012 with retrospective effect from 1976 – Assessee could not be expected to foresee future amendment at time of payment – Disallowance not called for; (ii) Disallowance attracted only for royalty as defined in Explanation 2 to section 9 – Channel placement fee of Rs. 7.18 crores to cable operators – Not royalty – Explanation 6 cannot be invoked to disallow payment

20 CIT vs. NGC Networks (India) Pvt. Ltd. [2021] 432 ITR 326 (Bom) A.Y.: 2009-10; Date of order: 29/01/2018 Ss. 9(1)(vi), 40(a)(ia), 194C, 194J of ITA, 1961

Business expenditure – Disallowance u/s 40(a)(ia) – Payments liable to deduction of tax at source – Royalty: (i) Amendment to definition in 2012 with retrospective effect from 1976 – Assessee could not be expected to foresee future amendment at time of payment – Disallowance not called for; (ii) Disallowance attracted only for royalty as defined in Explanation 2 to section 9 – Channel placement fee of Rs. 7.18 crores to cable operators – Not royalty – Explanation 6 cannot be invoked to disallow payment

During the previous year relevant to the A.Y. 2009-10, the assessee paid channel placement fees of Rs. 7.18 crores to cable operators deducting tax at source u/s 194C at the rate of 2%. The A.O. was of the view that the tax had to be deducted at source on payment at the rate of 10% u/s 194J as the payment was in the nature of royalty, as defined in Explanation 6 to section 9(1)(vi) and disallowed the entire expenditure of Rs. 7.18 crores u/s 40(a)(ia) for failure to deduct tax u/s 194J. The Dispute Resolution Panel upheld the assessee’s objections holding that deduction of tax at source was properly made u/s 194C. The A.O. passed a final assessment order accordingly.

On appeal by the Department, the Tribunal held that the assessee was not liable to deduct the tax at source at higher rates only on account of the subsequent amendment made in the Act, with retrospective effect from 1976.

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

‘i) The view taken by the Tribunal that a party could not be called upon to perform an impossible act, i. e., comply with a provision not in force at the relevant time but introduced later by retrospective amendment, was in accordance with the legal maxim lex non cogit ad impossibilia (law does not compel a man to do what he cannot possibly perform). The amendment by introduction of Explanation 6 to section 9(1)(vi) took place in the year 2012 with retrospective effect from 1976. It could not have been contemplated by the assessee when it made the payment during the assessment year that the payment would require deduction u/s 194J due to some future amendment with retrospective effect.

ii) Under section 40(a)(ia), royalty is defined as in Explanation 2 to section 9(1)(vi) and not in Explanation 6 to section 9(1)(vi). Undisputedly, the payment made for channel placement as a fee was not royalty in terms of Explanation 2 to section 9(1)(vi). Therefore, no disallowance of expenditure u/s 40(a)(i) could be made.’

The assessee being wholly managed and controlled from UAE, qualified for benefit under India-UAE DTTA – Limitation of benefit provision not applicable as it has been conducting bona fide business since years, long before start of India business

3 Interworld Shipping Agency LLC vs. DCIT [2021] 127 taxmann.com 132 (Mum-Trib) A.Y.: 2016-17; Date of order: 30th April, 2021 Articles 4 and 29 of India-UAE DTAA

The assessee being wholly managed and controlled from UAE, qualified for benefit under India-UAE DTTA – Limitation of benefit provision not applicable as it has been conducting bona fide business since years, long before start of India business

FACTS
The assessee was a tax resident of the UAE. Since 2000, it was engaged in business as a shipping agent and
also providing ship charters, freight forwarding, sea cargo services and so on. From March, 2015 it commenced shipping operations by chartering ships for use in transportation of goods and containers. Relying upon Article 8 of the India-UAE DTAA, the assessee claimed that freight earned by it from India was not taxable in India.

The A.O. denied benefit under the DTAA on the grounds that: (i) the assessee was a partnership in the UAE; (ii) it was controlled and managed by a Greek national (Mr. G) who was being paid 80% of profits; (iii) no evidence was brought on record to show either that there was any other manager or that Mr. G was in the UAE for a period exceeding 183 days and since Mr. G was a Greek national, the business was not managed or controlled wholly from the UAE; (iv) TRC was obtained based on misrepresentation of facts. Hence, invoking Article 29 of the India-UAE DTAA1, the A.O. concluded that the assessee was formed for the main purpose of tax avoidance and denied the DTAA benefit. The DRP upheld the order of the A.O.

Being aggrieved, the assessee appealed before the Tribunal.

HELD

  •  From a perusal of the license issued by the Department of Economic Development, the annual accounts, Memorandum of Association and Articles of Association, it was evident that the assessee was a company and not a partnership firm.

  •  The following facts showed that the assessee was controlled or managed from the UAE:

* The assessee had 14 expatriate employees who were issued work permits by the UAE Government for working with the assessee.
* Mr. G was in the UAE for 300 days during the relevant previous year. Hence, it was reasonable to assume that he was running the business from the UAE.
* Without prejudice, the presence of the main director will be material only if there is something to show that the business was not carried out from the UAE.
* The assessee was carrying on business since 2000 from its office in the UAE, while operations with Indian customers commenced much thereafter.
* The assessee had provided reasonable evidence to support the view that the business was wholly and mainly controlled from the UAE. The assessee cannot be asked to prove a negative fact, especially when such facts are warranted to be proved by the documents which the assessee is not required to maintain statutorily2.

  •  Considering the following reasons, it was not proper to invoke limitation of benefits under Article 29 of the India-UAE DTAA:

* The assessee was in business since 2000.
* While the assessee commenced shipping operations for transportation of goods and containers much later, in 2015, it cannot be said that the ‘main purpose of creation of such an entity was to obtain the benefits’ under the India-UAE DTAA.
* Article 29 cannot be invoked unless the purpose of creating the entity was to avail the India-UAE DTAA benefits.
* Even otherwise, the assessee was carrying on bona fide business activity.

Note: With effect from 1st April, 2020, Article 29 of the India-UAE DTAA is substituted with Paragraph 1 of Article 7 (PPT clause) of multilateral instrument (MLI).

__________________________________________________________
1    Article 29 provides for ‘Limitation of Benefits’. It reads as follows:
 ‘An entity which is a resident of a Contracting State shall not be entitled to the benefits of this Agreement if the main purpose or one of the main purposes of the creation of such entity was to obtain the benefits of this Agreement that would not be otherwise available. The cases of legal entities not having bona fide business activities shall be covered by this Article’

2    During assessment, the assessee did not provide Board minutes. It was represented that documents are not available and the UAE law does not mandate keeping Board of Directors’ Resolutions

In the absence of any incriminating and corroborative evidence, extrapolation of on-money received in one transaction cannot be done to the entire sales Addition u/s 68 in respect of unsecured loans cannot be made merely on the basis of statement of entry operators Only real income can be subject to tax – Addition cannot be made on the basis of notings in loose sheets which are not corroborated by any credible evidence

21 Mani Square Ltd. vs. Asst. CIT [2020] 83 ITR (T) 241 (Kol-Trib) A.Ys.: 2013-14 to 2017-18; Date of order:  6th August, 2020 Sections 132, 68, 5 and 145

In the absence of any incriminating and corroborative evidence, extrapolation of on-money received in one transaction cannot be done to the entire sales
Addition u/s 68 in respect of unsecured loans cannot be made merely on the basis of statement of entry operators
Only real income can be subject to tax – Addition cannot be made on the basis of notings in loose sheets which are not corroborated by any credible evidence

FACTS
1. The assessee was engaged in real estate development. A search action u/s 132 was undertaken on the assessee. Prior to this, a search action was undertaken on one of the buyers (an HUF) wherefrom certain documents were seized which suggested that the assessee had received on-monies for sale of the flat to that buyer. Based on those documents, the A.O. concluded that a certain percentage of the actual sale consideration for the flat and car parking was received in cash and was unaccounted. Thereafter, the A.O. extrapolated the on-money on the entire sales. The CIT(A) confirmed the addition in respect of the single flat sold to the HUF but deleted the balance addition in case of all other buyers on the ground that a singular instance cannot be extrapolated without evidence.

2. Addition was also made u/s 68 in respect of loans taken from parties allegedly linked to entry operators.

3. A further addition was made by the A.O. in respect of interest income receivable from a party. To put it briefly, in the course of the search at the assessee’s premises a document was recovered, containing notings which suggested a unilateral claim raised by the assessee against a third party. However, there was nothing in these documents which proved that the third party had ever accepted such claim of the appellant and nothing was brought on record by the A.O., too, to prove acceptance of the appellant’s claim by the third party. However, the A.O. made an addition on the basis of notings contained in the recovered document.

HELD
1. Addition u/s 68 on account of alleged on-money on sale of flats
The ITAT observed that the documents found in the course of third party search were loose sheets of paper which could not be construed as incriminating material qua the assessee. These documents neither contained the name of the assessee nor any mention of the assessee’s project, nor did it suggest that the seized document was prepared at the instance of the assessee and hence there was no mention of any cash payment to the assessee. No additions were made in the case of assessments of the parties, alleged to have given cash to the assessee, and hence addition was not warranted in the hands of the assessee, too.

In a subsequent search on the assessee’s premises, no corroborative material was found and in the absence of any incriminating material no addition was warranted. The extrapolation of unaccounted sales across all units sold by the assessee had no legs to stand on.

The A.O. had made an independent inquiry from each flat purchaser; however, he did not find any statement or material which could even suggest receipt of cash consideration not disclosed by the assessee. Therefore, based on legal as well as factual grounds, the ITAT upheld the CIT(A)’s decision to hold that the theory of extrapolation could not be applied on theoretical or hypothetical basis in the absence of any incriminating and corroborative evidence or material brought on record by the A.O.

2. Addition u/s 68 in respect of unsecured loans (from parties linked to entry operators)
The ITAT observed that, other than recording the statement of entry operators on oath, the A.O. had not shown any credible link between the person whose statement was relied upon and the company from whom loans were received by the assessee; the A.O. had neither personally nor independently examined even a single entry operator to verify the correctness of facts contained in the statement and to establish the link with the assessee if any, neither had he allowed the assessee to cross-examine the witnesses whose statements were extracted in the assessment order. The A.O. had also failed to objectively take into consideration the financial net worth of the creditors having regard to the facts and figures available in the audited accounts. Based on these grounds, the ITAT deleted the impugned additions.

3. Addition in respect of interest income
The ITAT held that the subject matter of tax under the Act can only be the ‘real income’ and not hypothetical or illusory income. The two methods recognised in section 145 only prescribe the rules as to when entries can be made in the assessee’s books but not the principles of time of ‘revenue recognition’. The same has to be judged with reference to the totality of the facts and surrounding circumstances of each case. Hence, the overall conduct of the third party and the fact that it has till date not made any payment whatsoever to the assessee indicates that notings on loose papers did not represent ‘real’ income accrued to the assessee and was rightly not offered to tax. The ITAT, accordingly, held that the alleged interest income was not taxable.

Evidence of data transmission and export of software by an assessee outside India is not a requirement to claim deduction u/s 10AA RBI approval for bank account maintained outside India not a requirement to be fulfilled to claim deduction u/s 10AA No requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by assessee are sufficient to compute profits of various STPI / SEZ units

20 IBM (India) Pvt. Ltd. vs. Asst. CIT [2020] 83 ITR(T) 24 (Bang-Trib) A.Y.: 2013-14; Date of order: 31st July, 2020 Section 10AA

Evidence of data transmission and export of software by an assessee outside India is not a requirement to claim deduction u/s 10AA

RBI approval for bank account maintained outside India not a requirement to be fulfilled to claim deduction u/s 10AA
No requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by assessee are sufficient to compute profits of various STPI / SEZ units

FACTS

The assessee company was engaged in the business of trading, leasing and financing of computer hardware, maintenance of computer equipment and export of software services to associated enterprises. It filed its return of income after claiming exemption u/s 10AA. However, the A.O. and the Dispute Resolution Panel denied the said exemption on various grounds which inter alia included the following:
a) There was no evidence of data transmission and export of software by the assessee outside India.
b) The assessee had not obtained RBI approval for the bank account maintained by it outside India with regard to export earnings.
c) Unit-wise P&L account of assessee did not reflect true and correct profits of its SEZ units.

Aggrieved by the above action, the assessee filed an appeal before the ITAT.

HELD


With regard to the objection that there was no evidence of data transmission and export of software by the assessee outside India, the ITAT held that declaration forms submitted before the Software Technology Park of India (STPI) or Special Economic Zone authority were sufficient evidence of data transmission / export of software. Further, it was held that for the purpose of claiming exemption u/s 10AA, such an objection did not have any relevance. Accordingly, this objection was rejected.

Another objection of the Revenue was that since the assessee was crediting export proceeds in a foreign bank account which was not approved by the RBI, therefore exemption could not be granted. The ITAT held that approval of the RBI was required only in order to claim benefit of Explanation 2 to section 10A(3) according to which export proceeds would be deemed to have been received in India if the same were credited to such RBI-approved foreign bank account within the stipulated time. It was held that even though the assessee cannot not avail exemption based on Explanation 2 to section 10A(3), but it could not be denied exemption under the main provision of section 10A(3) which only requires the export proceeds to be brought to India in convertible foreign exchange within the time stipulated in the said section. Accordingly, if the export proceeds were brought to India (even though from the non-approved foreign bank account) within the stipulated time period in convertible foreign exchange, then the exemption as per the main provision of section 10A(3) could not be denied.

As for the objection that the unit-wise profit & loss account of the assessee did not reflect the true and correct profits of its SEZ units and hence exemption u/s 10AA could not be granted, the ITAT held that there was no requirement of maintaining separate books of accounts for various STPI / SEZ units if the primary books of accounts maintained by the assessee are sufficient to compute the profits of various STPI / SEZ units. It was held that since Revenue had not disputed the sale proceeds claimed by the assessee against each STPI / SEZ unit, it could be said that bifurcations of profits of various STPI / SEZ units as given by the assesse were correct. Reliance was also placed on CBDT Circular No. 01/2013 dated 17th January, 2013 which clarifies that there is no requirement in law to maintain separate books of accounts and the same cannot be insisted upon by Revenue.

Capital gain – Investment in residential house – The date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken

19 ACIT vs. Mohan Prabhakar Bhide ITA No. 1043/Mum/2019 A.Y.: 2015-16; Date of order: 3rd March, 2021 Section 54F

Capital gain – Investment in residential house – The date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken

FACTS

The assessee filed his return of income claiming a deduction of Rs. 2,38,30,244 u/s 54F. The A.O., in the course of assessment proceedings, noted that the assessee had advanced a sum of Rs. 1,00,00,000 for purchase of new house property on 20th April, 2012, whereas the sale agreement for five commercial properties sold by the assessee was made in 2014 and 2015.

The A.O. held that the investment in question should have been made within one year before the sale of property or two years after the sale of property. Since this condition was not satisfied, he disallowed the claim for deduction of Rs. 2,38,30,244 made u/s 54F.

Aggrieved, the assessee preferred an appeal to the CIT(A) who noted that the date of agreement for purchase of the new residential house was 22nd July, 2015 and the assessee had taken possession of the new residential house on 22nd July, 2015; both these dates were within two years from the date of transfer. Relying on the decision in CIT vs. Smt. Beena K. Jain [(1996) 217 ITR 363 (Bom)], he allowed the appeal filed by the assessee.

Aggrieved, Revenue preferred an appeal to the Tribunal.

HELD


The Tribunal noted that the issue in appeal is squarely covered by the decision of the Bombay High Court in CIT vs. Smt. Beena K. Jain (Supra). The Tribunal held that the date relevant for determining the purchase of property is the date on which full consideration is paid and possession is taken. It observed that there is no dispute that this date is 22nd July, 2015 which falls within a period of two years from the date on which the related property was sold. However, the A.O. had proceeded to adopt the date on which the initial payment of Rs. 1,00,00,000 was made. The Tribunal held that the approach so adopted by the A.O. was ex facie incorrect and contrary to the law laid down by the jurisdictional High Court in the case of Beena K. Jain (Supra).

Penalty – Search case – Specified previous year – Addition made by taking the average gross profit rate cannot be considered to be assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA

18 Ace Steel Fab (P) Ltd. vs. DCIT TS-311-ITAT-2021 (Del) A.Y.: 2010-11; Date of order: 12th April, 2021 Section 271AAA

Penalty – Search case – Specified previous year – Addition made by taking the average gross profit rate cannot be considered to be assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA

FACTS

In the course of a search operation u/s 132(1), the value of stock inventory on that particular day was found to be lower than the value of stock as per the books of accounts. The A.O. concluded that the assessee made sales out of the books. He called upon the assessee to show cause why an addition of Rs. 15,53,119 be not made by taking a gross profit rate of 4.6% on the difference of stock of Rs. 3,13,12,889. In response, the assessee submitted that the discrepancy in stock was only due to failure of the accounting software. The A.O. did not accept this contention and made an addition of Rs. 11,52,314. The quantum appeal, filed by the assessee to the CIT(A), was dismissed.

The A.O. imposed a penalty u/s 271AAA which was confirmed by the CIT(A).

Aggrieved by the order of the CIT(A) confirming the imposition of penalty u/s 271AAA, the assessee preferred an appeal to the Tribunal.

HELD


The Tribunal noted that the question for its consideration is whether an addition made by taking the average gross profit rate can be considered to be the assessee’s undisclosed income for the purpose of imposition of penalty u/s 271AAA.

Although the A.O. had not accepted the contention of the assessee that the discrepancy in stock was due to malfunctioning of the ERP software, the assessee had demonstrated with evidence that due to malfunction of the software the accounts could not be completed in time and the assessee had had to approach the Company Law Board with a petition to extend the date for adoption of audited accounts. The petition of the assessee was accepted and the offence was compounded. The Tribunal held that the assessee had a reasonable explanation for the discrepancy found in stock and due credence should have been given to this explanation. It cannot be said that the assessee had no explanation to offer regarding the difference in stock. It also noted that penalty has been imposed only on an ad hoc addition made based on average gross profit rate and does not relate directly to any undisclosed income unearthed during the course of the search. In such a situation, penalty u/s 271AAA was not sustainable, hence the Tribunal set aside the order passed by the CIT(A) and deleted the impugned penalty.

Limited Scrutiny – Revision – Order passed in a limited scrutiny cannot be revised on an issue which was not to be taken up in limited scrutiny – Action of A.O. in not examining an issue which was not to be taken up in limited scrutiny cannot be termed as erroneous

17 Spotlight Vanijya Ltd. vs. PCITTS-310-ITAT-2021 (Kol) A.Y.: 2015-16; Date of order: 9th April, 2021 Sections 143(3), 263

Limited Scrutiny – Revision – Order passed in a limited scrutiny cannot be revised on an issue which was not to be taken up in limited scrutiny – Action of A.O. in not examining an issue which was not to be taken up in limited scrutiny cannot be termed as erroneous

FACTS
In the present case, for the assessment year under consideration the assessee’s case was taken up for limited scrutiny under CASS and a notice u/s 143(2) was issued. Limited scrutiny was taken up for the following three reasons, viz.,
i) income from heads other than business / profession mismatch;
ii) sales turnover mismatch;
iii) investments in unlisted equities.

The A.O., after going through the submissions of the assessee, completed the assessment u/s 143(3), assessing the total income of the assessee to be Rs. 91,95,770 under normal provisions and Rs. 94,94,533 u/s 115JB.

Upon completion of the assessment, the PCIT issued a show cause notice (SCN) u/s 263 wherein he expressed his desire to interfere and revise the assessment order passed by the A.O. on the ground that a deduction of Rs. 10,02,198 has been claimed in respect of flats in Mumbai for which rental income of only Rs. 4,20,000 is offered under the head ‘Income from House Property’ and a standard deduction of Rs. 1,80,000 has been claimed.

The assessee, in response to the SCN, objected to the invocation of revisional jurisdiction on the ground that insurance premium was not one of the three items on which the case was selected for limited scrutiny. It was further stated that the insurance premium for flats is only Rs. 2,198 which has been added back while computing income under the head ‘Profits & Gains of Business or Profession’. The balance amount of Rs. 10,00,000 was premium for Keyman Insurance policy which is allowable as a deduction u/s 37. Consequently, the assessment order was not erroneous or prejudicial to the interest of the Revenue.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD


The A.O.’s action of not looking into the issue of insurance premium (Keyman policy) cannot be termed as erroneous as such omission is in consonance with the dictum of CBDT on the subject, viz., CBDT Instruction No. 2/2014 dated 26th September, 2014, which directs the field officers to confine their inquiries strictly to CASS reasons and they were not permitted to make inquiries in respect of issues for which a case was not selected for limited scrutiny. Therefore, the order passed by the A.O. cannot be termed as erroneous and prejudicial to the interest of the Revenue and consequently the PCIT could not have invoked revisional jurisdiction.

The Tribunal held that the impugned action of the PCIT is akin to doing indirectly what the A.O. could not have done directly. It said the very initiation of jurisdiction by issuing an SCN itself is bad in law and, therefore, quashed the SCN issued by the PCIT. For this, the Tribunal relied upon the decisions in
i) Sanjib Kumar Khemka [ITA No. 1361/Kol/2016, A.Y. 2011-12, order dated 2nd June, 2017]; and
ii) Chengmari Tea Co. Ltd. [ITA No. 812/Kol/2019, A.Y. 2014-15, order dated 31st January, 2020].

Consequently, all further actions / proceedings, including the impugned order of the PCIT, were held to be non est in the eyes of the law.

Income from Other Sources – Interest on enhanced compensation for acquisition of agricultural land is a capital receipt not chargeable to tax u/s 56(2)(viii) r.w.s. 57(iv)

16 Nariender Kumar vs. ITO TS-298-ITAT-2021 (Del) A.Y.: 2014-15; Date of order: 12th April, 2021 Section 56(2)(viii) r.w.s. 57(iv)

Income from Other Sources – Interest on enhanced compensation for acquisition of agricultural land is a capital receipt not chargeable to tax u/s 56(2)(viii) r.w.s. 57(iv)

FACTS

The assessee filed his return of income for A.Y. 2014-15 declaring a total income of Rs. 12,250 and agricultural income of Rs. 3,50,000. During the previous year relevant to the assessment year under consideration, he had received Rs. 1.42 crores as enhanced compensation on land acquisition which included compensation of Rs. 56.90 lakhs and interest of Rs. 85.32 lakhs. The A.O. made an addition of Rs. 42.66 lakhs being 50% of interest of Rs. 85.32 lakhs u/s 56(2)(viii) r.w.s. 57(iv).

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 capital receipt, unless specifically taxable u/s 45 under the head Capital Gains, in principle is outside the scope of income chargeable to tax and cannot be taxed as income unless it is in the nature of revenue receipt or is specifically brought within the ambit of income by way of a specific provision of the Act. Interest received on compensation to the assessee is nothing but a capital receipt.

The Tribunal observed that:
(i) The CIT(A) has not given a finding as to why the A.O. is justified in making the addition;
(ii) The Apex Court in Union of India vs. Hari Singh (Civil Appeal No. 15041/2017, order dated 15th September, 2017) has held that on agricultural land no tax is payable when the compensation / enhanced compensation is received by the assessee;
(iii) The assessee received compensation in respect of his agricultural land which was acquired by the State Government;
(iv) The ratio of the decision of the Apex Court in the case of Hari Singh (Supra) is applicable to the present case.

The Tribunal held the addition to be against the law.

AUDIT: BUILDING PUBLIC TRUST

The spotlight has been sharply focused in the recent past on corporate failures and consequential loss of public trust. Various regulators and authorities, such as the Ministry of Corporate Affairs, the National Financial Reporting Authority, the Reserve Bank of India, SEBI’s Committee on Corporate Governance and Committees of the Institute of Chartered Accountants of India, have advised several measures with a clear focus on enhancing audit quality and improving the standards of corporate governance. In that context, this article traces various enablers relevant to audit quality.

ASSESS THE ECOSYSTEM

Audit framework and bridging the expectation gap on the role of an auditor
It is important to articulate what stakeholders should legitimately expect from the audit profession. This should be translated into an appropriate audit framework: should auditors merely opine in a limited manner on management’s financial statements, or should they go further and, if so, how far and which way? This will allow a course to be charted where the audit profession becomes a part of the national solution. It can contribute to fixing, maintaining and raising the standards of audit quality, as necessary, rather than being stigmatised as ‘guilty until proven innocent’.

The environment in which public company audits are conducted has changed drastically for several reasons, including increased business complexities, use of technology and intricate local and global regulations. However, the primary objective of an audit has remained the same over time, i.e., to provide stakeholders with a reasonable, though not absolute, assurance that the financial statements prepared by the management are fairly presented. The current audit framework continues to be based on the concept of watchdog and not bloodhound. However, the auditors’ responsibilities are continuously increasing and the expectation gap continues to remain unaddressed in terms of setting up or awareness of standards, and a level of audit outcome that is understood and acceptable to all concerned.

For creating trust, there is a need to educate the stakeholders, too. Some of the initiatives that may help bridge the gap include: (i) review of framework by the ICAI and mandatory inclusion of elements of technology and periodic forensic reviews, and auditors’ reporting thereon, (ii) disclosure of Audit Quality Indicators of an audit firm, (iii) a wider message that not every ‘business failure’ means that there was an ‘audit failure’, and (iv) an active platform between ICAI / auditors and various regulators to provide clarity in case of large-scale conflicts.

Enhanced role and accountability of audit committee

An audit committee, as a representative of the wider group of stakeholders, and not the management, is the client of the auditor. The audit committee should lead discussions around capability evaluation and, accordingly, decide on the appointment of auditors. In order to ensure transparency, disclosures to stakeholders may include detailed criteria for evaluation, selection and competitive analysis. The audit committee should monitor the auditor’s performance to ensure that auditors maintain professional scepticism, challenge management and deliver high quality audits. The audit committee should affirmatively confirm to the board periodically that the audit is adequately resourced, independent to undertake a quality audit, with commensurate fees.

Capacity-building and encouraging creation of large audit firms

There is a strong need to develop a forward-looking approach towards the growth of the audit profession in India. There is a need for larger and consolidated audit firms, with adequate skills, capacity, size and reach to deal with large corporations and conglomerates. The current capacity of audit firms in India is fragmented, with individual practitioners making the bulk and a minuscule number of large firms. It is important to encourage consolidation of the existing landscape of small and medium-sized firms. The current business / economic scenario and rapidly evolving technology in the country demand multiple skillsets for any business or regulatory propositions. Audit is not restricted to simple accounting and certainly needs support from specialised professionals skilled in the fields of law, taxation, information technology, forensics, cyber security and secretarial services. Given the environment, there is a strong need to encourage networking and consolidation. Multi-disciplinary firms, as already acknowledged by the Companies Act, 2013, will contribute immensely in this direction. Clarity of networking regulations for chartered accountants, including with overseas accounting firms, would also help in achieving this objective.

Centre of Excellence for Audit Quality

The creation of a Centre of Excellence for Audit Quality, with an objective to develop standards and parameters of audit quality, technology, tools, consistency of methodology and training to teach the highest levels of professional scepticism, would help in creating awareness and enhancing skills. The main objectives of the Centre could be to:

  • encourage and support capacity-building
  •  create opportunities to network and share best practices and views among firms
  •  enhance audit quality through use of technology, especially to provide better insights to stakeholders
  • knowledge dissemination to professionals on key matters
  •  contribute to harness talent and build relevant skills
  •  drive inclusive and balanced growth across the country
  •  enhance excellence in the audit profession.

Use of tools and technology in audits

The situation created by Covid-19 has established that technology can play a crucial role in any audit. The audit profession needs to evolve and respond to similar challenges by upskilling and adopting technology / tools and artificial intelligence in the audit process. Data & Analytics may play a significant role in achieving a higher satisfaction level in audits. In the current situation, even virtual audits may be as effective as traditional techniques. No doubt one has to be cautious, as would be the case in any technology-driven process. This also requires a shift in mindset to adopt technology and facilitate the process through extensive training programmes for practitioners.

There are two essential components for adopting technology in the audit process, viz., a Smart Audit Platform and a Data Analytics Tool. A Smart Audit Platform contains (i) an audit workflow; (ii) audit methodology, based on the regulatory framework; and (iii) document management system. A Data Analytics Tool helps in moving away from a limited sample testing to covering a larger population in many fields. Overall, this approach supports data extraction using scripts; smart analytics using the Tool; and exception reporting using visualisation techniques which helps assessing the existence / effectiveness of controls. To make it a success, we require a multi-disciplinary approach to invest in resources and related technology.

Auditor’s independence and conflict management

It is always presumed that any large-scale audit failure is due to the lack of independence of the auditors. While this may be true in certain cases, there may be a strong perception in many others. The existing statutory restrictions, comparable with international standards, are well established in this area. The new Code of Ethics issued by the ICAI is aligned to the International Code of Ethics issued by the IESBA. These, along with self-regulated safeguards exercised by auditors, monitoring by audit committees and enhanced disclosures required by SEBI should generally suffice to ensure independence.

Certain reforms and a strong monitoring mechanism to implement them would help in enhancing governance. For example, SEC requires every non-audit relationship with an audit client to be pre-approved by the audit committee. Further, instead of varying interpretations by stakeholders and regulators, clarity from the MCA on terms like Management Services would be appropriate. Any ambiguities in this area may be clarified by the ICAI through the Code of Ethics and Networking Guidelines. Certain regulators globally (such as PCAOB and SEC in the USA) have a process of regular interaction with the auditors / corporates. They do provide an opportunity to the auditors and corporates to objectively consult and provide guidance / solutions in case of issues of independence and professional conflicts. This consultative process is not only efficient and objective, it also creates an atmosphere of trust between the auditors and the regulators. It would be fruitful to have a similar arrangement here, instead of creating conflicting interpretations and prolonged legal resolution.

Strengthening whistle-blower mechanism

A strong whistle-blower mechanism with strong legal protection goes a long way in keeping a check on potential unethical and corrupt practices. Several corporate frauds have been unearthed based on a good whistle-blower mechanism.

Increasing the role, responsibility, independence and accountability of internal auditors
An internal audit function provides much needed assurance on the effectiveness and reliability of internal controls and governance in any company. The internal audit team is uniquely positioned to provide early warning signals of impending failures. The recent reinstatement in CARO requiring an auditor to evaluate the internal audit system of a company is a step in the right direction. Audit committees should be responsible to ensure that the function is robust, independent and adequately resourced, with the scope of the work sufficient to provide the desired level of assurance. Internal auditors’ scope should move away from a transactional approach to substantive matters like design and operating effectiveness of critical controls.

DEEP DIVE IN CRITICAL AREAS

Recent experiences indicate certain critical aspects that require a deep dive and critical evaluation by the auditors. There is no alternative to the diligence and continuous scepticism of an auditor. An auditor is expected to consider and evaluate the economic substance of transactions while carrying out an audit.

Accountability and extent of reliance placed on others and management representations
While discharging their duties, auditors must critically evaluate the extent of reliance they intend to place on various elements, e.g., Regulatory Oversight (such as inspections carried out by Banking or Market Regulators), Specialists (such as Valuation or Information Technology Experts), Joint and Component auditors, Credit Rating agencies and Internal Auditors. Auditors are obligated to assess and critically evaluate such evidence before placing reliance on them.

Further, while a written representation from the management may provide audit evidence, it may not be ‘sufficient appropriate audit evidence’ on its own. Unwillingness to provide underlying evidence, replaced by a management representation, may be treated as a red flag and auditors would need to exercise scepticism in such cases. Accordingly, auditors must evaluate a management representation critically and obtain sufficient and appropriate underlying evidence. While ICAI’s existing guidance deals with the matter, ICAI may consider issuing case studies to clarify situations and showcase that accepting a management representation is not an alternative to appropriate audit procedures.

Related party transactions
It is the responsibility of a company’s management to identify and ensure an appropriate mechanism for related party transactions. However, this has been a matter of concern and governance in many ways. There are enhanced reporting requirements in the recently amended CARO also, which support an objective and deeper evaluation of related party transactions.

In this context, there have been instances of (i) incorrect / incomplete identification of related parties, (ii) lack of economic substance in related party transactions, and (iii) consequent inadequate or lopsided disclosures. Irrespective of these anomalies, such transactions may meet the regulatory and disclosure requirements.

Audit committees and auditors are well equipped to address the root cause. For example, (i) auditors have an obligation to exercise a high degree of scepticism and challenge the management on the economic substance of a related party transaction; (ii) auditors of a component in a group must have visibility of transactions with the group companies; (iii) the audit committees should affirmatively confirm to the Board on identification and adequate evaluation of such transactions; and (iv) related party transactions should mandatorily be included in the scope covered by internal auditors’ review.

Going concern
The appropriateness of going concern assumption in any audit is a fundamental principle. This forms the foundation for any stakeholder to place reliance on a company before making any decisions. There is a responsibility on a company’s management to assess its position and on the auditors to challenge and obtain appropriate evidence to support the same. There have been instances where the auditors failed to assess and report such situations and companies failed soon thereafter. This may be attributable to several reasons, including lack of transparency, or inadequate skills to assess. Specific situations like Covid-19 continue to pose additional challenges, creating responsibility on the auditors to maintain an appropriate level of scepticism.

There are certain measures that may help address these concerns, e.g., (i) auditors are supposed to challenge management assumptions of future projections, to avoid fatal errors and consequent sudden downfall of a company; (ii) in case auditors do not have expertise to validate future assumptions, sector experts, as specialists in audit process, must be involved to address the issue; and (iii) composition and skills of independent directors and the audit committee to understand the business and challenge management.

All this would involve a cost and skill-set worth investing in.

Third party complaints / whistle-blow mechanism
While the prime responsibility of addressing whistle-blower complaints is of the management, for auditors such complaints may lead to additional information, critical to assess any assertion in the financial statement audit. Even if such complaints are anonymous, it would not be wise for an auditor to ignore them without logical conclusions. The recent amendment in CARO, requiring an auditor to consider whistle-blow complaints, is a step in the right direction.

Documentation of audit evidence
While appropriate audit diligence is essential, an auditor’s work cannot be demonstrated without adequate documentation of evidence. Each audit essentially requires a logical sequence of work papers, demonstrating the work carried out at each stage of an audit. These may primarily include audit eligibility / independence requirements, acceptance of audit engagement, adequacy of planning and timing of proposed audit steps, team composition and appropriate delegation of work according to skills, control and substantive testing procedures to obtain sufficient / appropriate evidence, evaluation of work of any experts or component auditors involved, legal consultations, recording of audit observations and their resolutions, communications with those charged with governance, minutes of meetings with management, engagement with quality control review steps, supervisory controls including accountability and review of work done, management confirmations / representations and final opinion.

The framework clearly recognises that ‘if the work has not been documented, it has not been done’. At the same time, excessive expectation, focusing merely on audit documentation, could have an adverse effect where auditors may focus more on gathering documentary evidence than exercising professional scepticism given the limited time available. A balanced approach in this regard is necessary.

ENABLERS, CONDUCIVE ENVIRONMENT AND ROLE OF REGULATORS


A constructive role of a regulator, with the focus on remediation instead of disproportionate punishment and prolonged litigation, is important. The regulatory regime should provide greater confidence through effective policy measures. The recent move to decriminalise certain offences will help create the basis for consultation and a compromise and settlement approach. In a profession with scattered capacity, undertaking rapid investigation and constructive resolution, including commensurate punitive measures and remediation, will encourage audit quality. Certainly, there is a need to distinguish between criminality and professional negligence. In addition, clarity on the role, jurisdiction and multiplicity of regulators needs re-evaluation.

There have been significant efforts by the Government in the past few years to assess the adequacy of the current Regulatory Framework and clarify overlaps or areas of needed coordination among the regulators. A few such examples are (i) Recommendation by the MCA’s Committee of Experts, pursuant to the Supreme Court’s order; (ii) Consultation Paper by the MCA to look at critical areas relating to auditors and auditor independence; and (iii) Formation of the National Financial Reporting Authority (NFRA) as a new audit regulator. These activities demonstrate much-needed regulatory attention. There is a need to implement some of the measures recommended and that have been awaited since long.

In substance, a few initiatives will help establish trust between the regulators and the auditors, e.g., (i) a balanced approach towards time-bound penal action proportionate to the offence and / or negotiated settlements so that deterrence may be accomplished with minimal disruption; (ii) coordination amongst various regulators governing the auditors to provide uniform guidance and to avoid multiplicity and overlap; (iii) implementation of well-deliberated recommendations of committees formed in the past; and (iv) time-bound clarity and guidance on matters of interpretation or conflicts.

While there are no alternatives to the professional scepticism and diligence of an auditor to ensure audit quality, an overall ecosystem and a constructive role of the regulators are essential enablers in that direction.

(The views expressed here are the personal views of the author)

UNFAIRNESS AND THE INDIAN TAX SYSTEM

In a conflict between law and equity, it is the law which prevails as per the Latin maxim dura lex sed lex, meaning ‘the law is hard, but it is the law’. Equity can only supplement law, it cannot supplant or override it. However, in CIT vs. J.H. Gotla (1985) 156 ITR 323 SC, it is held that an attempt should be made to see whether these two can meet. In the realm of taxes, the tax collector always has an upper hand. When this upper hand is used to convey ‘heads I win, tails you lose’, the taxpayer has to suffer this one-upmanship till all taxpayers collectively voice their grievance loud and clear and the same is heard and acted upon. In this article, the authors would be throwing light on certain unfair provisions of the Income-tax Act.

Case 1: Differential valuation in Rule 11UA for unquoted equity shares, section 56(2)(x)(c) vs. section 56(2)(viib); section 56(2)(x)(c) read with Rule 11UA(1)(c)(b)

Section 56(2)(x)(c) provides for taxation under ‘income from other sources’ (IFOS), where a person receives, in any previous year, any property, other than immovable property, without consideration or for inadequate consideration. ‘Property’, as per Explanation to section 56(2)(x) read with Explanation (d) to section 56(2)(vii), includes ‘shares and securities’.

Section 56(2)(x)(c)(A) provides that where a person receives any property, other than immovable property without consideration, the aggregate Fair Market Value (FMV) of which exceeds Rs. 50,000, the aggregate FMV of such property shall be chargeable to tax as IFOS. Section 56(2)(x)(c)(B) provides that where a person receives any property, other than immovable property, for consideration which is less than the aggregate FMV of the property by an amount exceeding Rs. 50,000, the aggregate FMV of such property as exceeds such consideration shall be chargeable to tax.

The FMV of a property, as per the Explanation to section 56(2)(x) read with Explanation (b) to section 56(2)(vii) means the value determined in accordance with a prescribed method.

Rule 11UA(1)(c)(b) provides for determination of FMV of unquoted equity shares. Under this Rule, the book value of all the assets (other than jewellery, artistic work, shares, securities and immovable property) in the balance sheet is taken into consideration. In case of the assets mentioned within brackets, the following values are considered:
a) Jewellery and artistic work – Price which it would fetch if sold in the open market (OMV) on the basis of a valuation report obtained from a registered valuer;
b) Shares and securities – FMV as determined under Rule 11UA;
c) Immovable property – Stamp Duty Value (SDV) adopted or assessed or assessable by any authority of the Government.

SECTION 56(2)(viib) READ WITH RULE 11UA(2)(a)

Section 56(2)(viib) provides for taxation of excess of aggregate consideration received by certain companies from residents over the FMV of shares issued by it, when such consideration exceeds the face value of such shares [angel tax].

Explanation (a) to the said section provides that the FMV of shares shall be a value that is the higher of the value
a) As determined in accordance with the prescribed method; or
b) As substantiated by the company to the satisfaction of the Assessing Officer based on the value of its assets, including intangible assets.

Rule 11UA(2)(a) provides for the manner of computation of the FMV on the basis of the book value of assets less the book value of liabilities.

DISPARITY BETWEEN RULES 11UA(1)(c)(b) AND 11UA(2)(a)

Section 56(2)(x)(c) deals with taxability in case of receipt of movable property for no consideration or inadequate consideration. Thus, the higher the FMV of the property, the higher would be the income taxable u/s 56(2)(x). Hence, Rule 11UA(1)(c)(b) takes into consideration the book value, or the OMV or FMV or SDV, depending on the nature of the asset.

Section 56(2)(viib) brings to tax the delta between the actual consideration received for issue of shares and the FMV. Therefore, the lower the FMV, the higher would be the delta and hence the higher would be the income taxable under the said section. Rule 11UA(2) provides for the determination of the FMV on the basis of the book value of assets and liabilities irrespective of the nature of the same.

One may note the disparity between the two Rules in the valuation of unquoted shares. Valuation for section 56(2)(x)(c) adopts FMV or OMV, so that higher income is charged to tax thereunder. Valuation for section 56(2)(viib) adopts only book value so that a higher delta would emerge to recover higher angel tax.

The levy of angel tax is itself arbitrary, because such tax is levied even if the share issue has passed the trinity of tests, i.e., genuineness, identity and creditworthiness of section 68. No Government can invite investment as it wields this nasty weapon of angel tax. Adding salt to the wound, the NAV of unlisted equity shares is determined by insisting on adopting the book value of the assets irrespective of their real worth.

It is time the Government takes a bold move and drops section 56(2)(viib). Any mischief which the Government seeks to remedy may be addressed by more efficiently exercising the powers under sections 68 to 69C. In the meanwhile, the aforesaid disparity in the valuation should be immediately removed by executive action.

Case 2: Indirect transfer – Rule 11UB(8)
Explanation 5 to section 9(1)(i) provides that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be, and shall always be deemed to have been, situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India (underlying asset).

Explanation 6(a) to section 9(1)(i) provides that the share or interest, referred to in Explanation 5, shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India if, on the specified date, the value of such assets
a) Exceeds Rs. 10 crores; and
b) Represents at least 50% of the value of all the assets owned by the company or entity, as the case may be.

Explanation 6(b) to section 9(1)(i) provides that the value of an asset shall be its FMV on the specified date without reduction of liabilities, if any, determined in the manner as prescribed.

Rule 11UB provides the manner of determination of the FMV of an asset for the purposes of section 9(1)(i). Sub-rules (1) to (4) of Rule 11UB provide for the valuation of an asset located in India, being a share of an Indian company or interest in a partnership firm or association of persons.

Rule 11UB(8) provides that for determining the FMV of any asset located in India, being a share of an Indian company or interest in a partnership firm or association of persons, all the assets and business operations of the said company or partnership firm or association of persons are taken into account irrespective of whether the assets or business operations are located in India or outside India. Thus, even though some assets or business operations are not located in India, their value would be taken into account, thereby resulting in a higher FMV of the underlying asset in India and hence a higher chance of attracting Explanation 5 to section 9(1)(i).

This is contrary to the scheme of section 9(1)(i) read with Explanation 5 which seeks to tax income from indirect transfer of underlying assets in India. Explanation 5 codifies the economic concept of location of the asset. Such being the case, Rule 11UB(8) which mandates valuation of the Indian asset ignoring the downstream overseas investments by the Indian entity, is ultra vires of Explanation 5. It offends the very economic concept embedded in Explanation 5.

Take the case of a foreign company [FC], holding shares in an investment company in India [IC] which has step-down operating subsidiaries located outside India [SOS]. It is necessary to determine the situs of the shares of the FC in terms of Explanation 5.

Applying Explanation 6, the value of the shares of IC needs to be determined to see whether the same would exceed Rs. 10 crores and whether its proportion in the total assets of FC exceeds 50%.

Shares in FC derive their value not only from assets in India [shares of IC] but also from assets outside India [shares of the SOS]. However, Rule 11UB(8) mandates that while valuing the shares of the IC, the value of the shares of the SOS cannot be excluded. It seeks to ignore the fact that the shares of IC directly derive their value from the shares of the SOS, and thus the shares of FC indirectly derive their value from the shares of the SOS. This is unfair inasmuch as it goes beyond the scope of Explanation 5 and seeks to tax gains which have no economic nexus with India.

This is a classic case of executive overreach. By tweaking the rule, it is sought to bring to tax the gains which may have no nexus with India, whether territorial or economic. It is beyond the jurisdiction of the taxman to levy tax on gains on the transfer of the shares of a foreign company which derive their value indirectly from the assets located outside India.

Taxation of indirect transfer invariably results in double taxation. Mitigation of such double taxation is subject to the niceties associated with complex FTC rules. Such being the case, it is unfortunate that the scope of taxation of indirect transfer is extended by executive overreach. Before this unfair and illegal action is challenged, it would be good for the Government to suo motu recall the same.

MLI SERIES ANTI-TAX AVOIDANCE MEASURES FOR CAPITAL GAINS: ARTICLE 9 OF MLI

(This is the third article in the MLI series that started in April, 2021)

This article in the on-going series on the Multilateral Instrument (MLI) focuses on Article 9 of the MLI, which brings in anti-tax avoidance measures related to capital gains earned by sale of immovable property through indirect means.

A break-up of the various DTAAs signed by India, whether or not modified by the MLI, appears later in this article along with what a Chartered Accountant needs to keep in mind in the post-MLI scenario. However, the first requirement is to understand the provisions and what changes have been brought about by them. Owing to a multitude of options and different ways in which they can apply, the language of Article 9 of the MLI is quite difficult to decipher, leave alone explain. Therefore, we have attempted to simplify the provisions with the help of a story, a narrative that can provide a basic understanding about the concepts. The reader should refer to the respective DTAAs and the application of the MLI on those DTAAs before forming any opinion.

1. ‘The Story’
Mr. A is a wealthy Australian businessman with interests in real estate around the world, including India. He wants to sell shares in an Australian Company and therefore approaches his tax consultant, Mr. Smart, to get an opinion on his tax liabilities. Here is the transcript of a conversation between Mr. A and Mr. Smart:

Mr. A – Hi, did you calculate my taxes on the sale of shares?

Mr. Smart – Yes, I did. And for your information, we also have to pay tax in India.

Mr. A – Why in India? This company is incorporated in Australia. What does India have to do with it?
Mr. Smart – Well, you’re right. Capital gains on transfer of shares of a company are generally taxed in the country of its incorporation which in this case is Australia. However, your company’s value is majorly derived from that immovable property you had once purchased in India1. Therefore, as per the Indian tax laws, read with Article 13(4) of the India-Australia Treaty, India has a right to tax such shares. Let me read out the excerpt of the India-Australia Treaty…

Article 13(4) reads: ‘Income or gains derived from the alienation of shares or comparable interests in a company, the assets of which consist wholly or principally of real property referred to in Article 6 and, as provided in that Article, situated in one of the Contracting States, may be taxed in that State’.

Mr. A – Ah! Though I know that I will get credit for those taxes paid against my Australian taxes, but I do not want the hassle of paying tax in another country. Is there any way out? You said that the company should derive value wholly or principally from the immovable property. Could we plan in a manner that we contribute other assets, shortly before the sale of the shares, to overcome this? That would dilute the proportion of the value of the shares that is derived from immovable property situated in India. For example, if my company has a total asset size of AUD 100, which currently includes AUD 90 of immovable property in India, the gain on the sale of such company’s shares would be taxable in India. However, just before such sale, can I infuse AUD 100 in the company and park it in a fixed deposit? Then, the share of immovable property in my company’s value will be reduced to 45% and the transaction of such sale of shares would be taxed only in the state of incorporation of the company (Australia) and not in the state where the immovable property is situated (India).

Mr. Smart – Where the businessman leads, the taxman follows! Well, this planning might have worked if you would have come to me before 1st April, 2020. Knowing that many taxpayers plan their affairs in such a manner, the India-Australia Treaty has to be read along with the Multilateral Instrument which now reads as follows:

The following paragraph 1 of Article 9 of the MLI
applies to paragraph 4 of Article 13 of this agreement:

ARTICLE 9 OF THE MLI – CAPITAL GAINS FROM ALIENATION OF SHARES
OR INTERESTS OF ENTITIES DERIVING THEIR VALUE PRINCIPALLY FROM IMMOVABLE
PROPERTY

Paragraph 4 of Article 13 of the agreement:

(a)

shall apply if the relevant value threshold is met at any time during
the 365 days preceding the alienation; and

(b)

shall apply to shares or comparable interests, such as
interests in a partnership or trust (to the extent that such shares or
interests are not already covered), in addition to any shares or rights
already covered by the provisions of the agreement

______________________________________________________________
1 Readers are requested to place FEMA issues aside for this story

As per clause (a), keeping money in a fixed deposit or any other asset for a short period of time would not work. If at any point of time during the preceding 365 days (period threshold), your company majorly derives value (proportion threshold) from immovable property situated in India, then the sales of shares would be taxable in India (source country).

Mr. A – Oh! Oh! They have plugged this loophole. I also see that in clause (b) comparable interest has been added. Does that mean that even if I hold immovable property in LLP, partnership firms, trust or any other similar forms, selling of those shares would also be under the ambit of India’s (source country) taxation?

Mr. Smart – You catch up really fast! Yes, that’s the case.
Mr. A – But how did this treaty change so quickly? Normally, treaty negotiations continue for decades. And till the time the taxman decides on taxing rights, technology and the way of doing business have already moved ahead.
Mr. Smart – It seems you don’t really catch up fast enough. You missed a small word in our conversation. I said that the treaty has to be read with the MLI, i.e., Multilateral Instrument, which has been signed by many countries [contracting jurisdictions (‘CJ’)] to prevent double non-taxation, or treaty abuse, or treaty-shopping arrangements. This way, instead of long bilateral negotiations, treaties could quickly be adapted to changes.
Mr. A – That’s interesting, so now all the signatory countries would have similar treaties. Things would become so simple in cross-border trade. Isn’t it?
Mr. Smart – I wish I could say that. See, this MLI is like a holy book. Every time you read it, you get a new perspective, or a new interpretation in technical terms. It is not that all the countries subscribe to one treaty, there are multiple options to choose from.
Mr. A – Options?
 
Mr. Smart – Let me explain. Imagine a dinner party which serves a lavish buffet. Not every guest is expected to talk to or sit with everyone. Only if there is mutual consent between two or more guests may they sit together. Even when they are sitting together, not all of them are expected to eat the same food. Everyone can pick their choices and only by mutual consent can they eat the same food together.

The same is true with MLI. You have various options on the menu. Whenever a country notifies that MLI should be applied to its treaty with another country, it is only if the other country reciprocates equivocally would their treaty be read with MLI (sit together). Similarly, even when the countries have decided that the treaty position will change, they still have options to not change all clauses and selectively they can choose and pick their options (eat together the same food).

Mr. A – Ok, that sounds delicious. What kind of options the countries have in case of such transaction of shares having underlying immovable property in another country?

Mr. Smart – You really want to understand that! This will take some time.
Mr. A – I am all ears. Go on
.
Mr. Smart – So any of the two countries who are MLI signatories have two broad options to choose from. Either to be governed by Article 9(1) or by Article 9(4). While article 9(4) prescribes the period threshold at a standard 50%, Article 9(1) allows countries to decide the relevant threshold or even usage of more general terms such as ‘the principal part’, ‘the greater part’, ‘mainly’, ‘wholly’, ‘principally’, ‘primarily’, etc.

Further, Article 9(1) provides a choice for inclusion / exclusion of the comparable interest condition [vide para 6(c)], whereas Article 9(4) makes comparable interest an integral and inseparable part of it. A country can select Article 9(4) or Article 9(1), but both cannot exist at the same time as they are alternatives to each other.

The Articles read as follows:
Article 9(1)
‘Provisions of a Covered Tax Agreement providing that gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or other rights of participation in an entity may be taxed in the other Contracting Jurisdiction provided that these shares or rights derived more than a certain part of their value from immovable property (real property) situated in that other Contracting Jurisdiction (or provided that more than a certain part of the property of the entity consists of such immovable property (real property):

a. shall apply if the relevant value threshold is met at any time during the 365 days preceding the alienation; and
b. shall apply to shares or comparable interests, such as interests in a partnership or trust (to the extent that such shares or interests are not already covered) in addition to any shares or rights already covered by the provisions.’

Article 9(4)
‘For purposes of a Covered Tax Agreement, gains derived by a resident of a Contracting Jurisdiction from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting Jurisdiction if, at any time during the 365 days preceding the alienation these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property (real property) situated in that other Contracting Jurisdiction.’

Mr. A – So only two options to choose from. That is not so complex.

 
Mr. Smart – You jumped the gun. I wish it was that simple. A country may reserve the right for provisions of the MLI to not apply to its tax treaties in their entirety or a subset of its tax treaties, i.e., it may choose not to have dinner with all or a select group of other guests. Further, once the countries have chosen to be governed by Article 9, both the countries may decide on the following options:

1. Where both countries choose to apply the 365-day period threshold coupled with value threshold at a standard 50% under Article 9(4), then in such a case the more flexible option for anti-tax avoidance tests under Article 9(1) would not apply. [Article 9(8)]

2. However, even after choosing to apply Article 9(4) as above, a country may choose not to apply Article 9(4) to treaties with certain select countries. [Article 9(6)(f)] In that case, nothing changes for treaties with these countries and the treaty reads as it was pre-MLI.

3. Where no such reservation is made as per the above option, Article 9(4) applies. However, the countries need to choose which exact provision does Article 9(4) apply to in their existing Covered Tax Agreements. [Article 9(8)] If the other country also cites the same provision, then the language of the existing provision between treaties of both countries changes as per Article 9(4).

4. In the case where the same provision is not notified by the other country, even then Article 9(4) applies – as the countries have already agreed to apply it as per point No. 1 above. But in such a case, the wording of Article 9(4) would supersede the existing provisions of the Covered Tax Agreement to the extent it is incompatible with the present text of the Agreement. Thus, for example, if the Covered Tax Agreement at present cites a period threshold of only 60 days, as both countries have accepted to apply article 9(4), but not notified the same provision, the 365-day threshold will supersede the 60-day threshold.

5. Now, consider a situation where the countries notify that they do not want to apply the more flexible options under Article 9(1) to their treaties; and have also chosen not to apply the provision as per Article 9(4) – then in such a case there will be no change at all in their treaty language due to the provisions of Article 9 of the MLI. [Article 9(6)(a)] In essence, the anti-tax avoidance tests would not be part of the treaty.

6. Even where a country has chosen to apply Article 9(1), it can make a choice of applying only one of the anti-tax avoidance mechanisms, i.e., either the time threshold test or the comparable interest condition; or both. [Para 9(6)(b) to (e)] The other country can also make a similar choice and only the matching choices will get implemented. Thus, where a country chooses to apply both mechanisms, but the other country chooses to apply only the time threshold test, then only the time threshold test gets matched.

7. To the extent the choices made in respect of either or both of the mechanisms matches between both countries, the countries next need to specify which provision under their Covered Tax Agreement stands modified. [Article 9(7)] If the provision specified by both countries does not match, then the treaty language stands unchanged. Thus, even after choices have been made as per Article 9(6), such choices would apply only if the same provisions are earmarked by both countries for applying the changes.

So, as I said earlier, it is like even if the countries decide to sit at one dinner table, they can still reserve their right to not eat certain food items from the menu.

Mr. A – Gosh! That’s one dinner party I don’t want to be invited to. That’s too much to take in one day. As many of my friends the world over have properties in India, can you send me a note on the application of Article 9 with respect to India?

Mr. Smart – Sure, will do that. Have a nice day.
Mr. A – You, too, and keep reading ‘Multi-Level Inception’ (MLI). It’s really as thrilling and confusing as any of Christopher Nolan’s movies and in the end all people may have their own different opinions!
Mr. Smart – Ha, ha! Yes, it is!

2. Article 9 in the Indian?context
As can be seen from the above write-up, Article 9 has various permutations and combinations spelt out to deal with the tax avoidance schemes it seeks to target. Their relevance with respect to Indian treaties is as under:
* India has opted to apply Article 9(4). So where other Contracting Jurisdictions have also made such a notification, Article 9(4) will apply.
* In treaties, where a provision similar to Article 9(1) is already present, India has opted for application?of Article?9(1).
* The Indian position as on 30th?March, 2021 has been tabulated for ease of reference. Please do check the updated position while applying the same in practice.?Currently, India has DTAAs with 95 countries / territories and their position post-MLI is as under:

Conditions

Countries covered

No. of countries

No change in the existing
provision of the treaty due to MLI

Countries not signatories to MLI

Bangladesh, Belarus, Bhutan, Botswana, Brazil, Ethiopia, Kyrgyz
Republic, Libya, Mongolia, Montenegro, Mozambique, Myanmar, Namibia, Nepal,
Philippines, Sri Lanka, Sudan, Syrian Arab Republic, Taipei, Tajikistan,
Tanzania, Thailand, Trinidad and Tobago, Turkmenistan, Uganda, USA,
Uzbekistan, Vietnam, Zambia

29

Countries which have no CTA with India

China, Germany, Hong Kong, Mauritius, Oman, Switzerland

6

Where both the CJs didn’t agree upon the application of the
provision either by reservation or by notification

Albania, Austria, Cyprus, Czech Republic, Finland, Georgia,
Greece, Hungary, Iceland, Jordan, Latvia, Lithuania, Luxembourg, Malaysia,
Norway, Qatar, Saudi Arabia, Singapore, South Korea, Sweden, United Arab
Emirates, United Kingdom

22

Existing provision changed
due to MLI

Treaties where Article 9(4) is applied

Croatia, Denmark, Estonia, France, Indonesia, Ireland, Israel,
Kazakhstan, New Zealand, Poland, Portuguese Republic, Serbia, Slovak
Republic,

16

[Continued]

 

– which have similar provision to Article 13(4) – either
replaced or supersede the existing provision

Slovenia, Ukraine, Oriental Republic of Uruguay

 

Treaties where Article 9(4) is applied – which don’t have
similar provision to Article 13(4) – additional provision added

Canada, Japan, Malta, Russia, UAR (Egypt)

5

Treaties where Article 9(1) applied (both comparable interest
and testing period applied)

Australia,?Netherlands

2

Treaties where only comparable interest condition applied from
Article 9(1)

Belgium

1

Treaties whose conditions of
MLI are provisional

Not yet deposited ratified MLI instruments

Armenia, Bulgaria, Columbia, Fiji, Italy, Kenya, Kuwait,
Macedonia, Mexico, Morocco, Romania, South Africa, Spain, Turkey

14

Total

95

3. Applicability to transactions
Finally, what are the points to be taken care of by a Chartered Accountant while reviewing the application of Article 9 of the MLI to specific transactions? These are as under:

a. Review of transaction – Check whether foreign company’s shares derive value from Indian immovable property? If yes, then the transaction falls in the scope of this Article.
b. Review of respective DTAA – Check whether India’s DTAA with country of residence has various thresholds for attribution of taxation rights of such shares in India. If yes, whether the transaction meets the threshold?
c. Review of MLI – Check whether the country of residence has notified the application of Article 9. If yes, then apply the provisions as per the matching principle explained above. Synthesised text2, if available, could be used for ease of interpretation.

4. Authors’ remarks
1) A country-specific example (that of Australia) has been taken here to make the article practical and easy to understand. Specific country positions need to be understood for in-depth analysis.
2) Definition ambiguity: Immovable property is not defined by the DTAA and by MLI only additional description provided as real property; therefore, one needs to see the definition of immovable property / real property from domestic law.
3) Article 9(6) has given various combinations of reservations to the countries, thereby providing flexibility but also leading to complexity when applying the provision.
4) MLI’s position qua India indicates that most Contracting Jurisdictions have opted out of this Article, thereby choosing to stick to the existing position.
5) A Chartered Accountant while issuing a certificate u/s 195 on the payment made by a buyer, needs to consider the Act, DTAA and MLI in combination before considering the final tax liability.

CONCLUSION

As can be seen from the above, applying a simple anti-tax avoidance measure like Article 9 of the MLI becomes complex when it is sought to be made at one go through the MLI. A professional applying the provisions must bear in mind the intricacies and read the treaty correctly before going ahead with a transaction which involves Article 9 of the MLI.

______________________________________________________________
2 https://incometaxindia.gov.in/Pages/international-taxation/dtaa.aspx – select
DTAA Type as Synthesised text

CARO 2020 SERIES: NEW CLAUSES AND MODIFICATIONS PROPERTY, PLANT AND EQUIPMENT & INTANGIBLE ASSETS

“CARO 2020 is applicable for the statutory
audit of financial statements for periods beginning on or after 1st
April, 2021. ICAI had issued a detailed Guidance Note (GN) on the same
in June, 2020. A module is also available on the ICAI Digital Learning
Hub. Schedule III was also recently amended inter alia to align the
reporting requirements under CARO 2020 by statutory auditors. BCAJ is
pleased to bring you a clause-by-clause analysis via a series of
articles authored by four audit practitioners who have been auditors all
their lives. Each article will zoom into a clause or two and provide a
‘commentary’ on reporting issues and practices, views, and perspectives
to supplement the broad guidance covered by the GN. The purpose of this
series is to bring out practical nuances to the reader. The series will
cover only new clauses and modifications and exclude those already
covered by CARO 2016. We hope this will steer and support the readers
towards better understanding and reporting. – Editor”

MODIFICATIONS / ADDITIONAL REPORTING REQUIREMENTS

The
clause on reporting in respect of fixed assets has been there in the
earlier versions, too. CARO 2020 has modified parts of the first clause
and added reporting requirements as given below:

Modifications
a. Change in the terminology to Property, Plant and Equipment (PPE) in line with Accounting Standards and Schedule III.

b. Separate reporting requirement on maintenance of proper records for Intangible Assets.
c.
No reporting required for non-availability of title deeds, where the
company is a lessee and the lease agreement is executed in favour of the
company.
d. In
cases where title deeds of immovable properties are not held in the
name of the company, additional details in a prescribed format as under
are required to be given:

Description of the property

Gross
carrying value

Held in
the name of

Whether
promoter, director, their relative or employee

Period
held –
indicate range where
appropriate

Reason
for not being held in the name of the company

(also
indicate if in dispute)


Additional reporting

a.
Whether the company has revalued its PPE (including Right of Use Assets)
or intangible assets or both during the year and, if so –
  •  whether the revaluation is based on valuation by a Registered Valuer, and
  •  if change is 10% or more in the aggregate of the net carrying value of each class of PPE or intangible assets.

b. Whether any proceedings have been initiated or are pending against the company for holding any benami property under the Benami Transactions (Prohibition) Act, 1988 and rules made thereunder; and if so, whether the company has appropriately disclosed the details in its financial statements.

SPECIFIC CONSIDERATIONS

Specific considerations to be kept in mind whilst reporting on the above changes are discussed under the following broad heads:

Additional disclosures under amended Schedule III

While reporting on these matters, the auditor will have to keep in mind the amended Schedule III disclosures as under:
a.
The auditor will have to ensure that there is no material inconsistency
between the financial statement disclosures and his reporting under the
Order. Disclosure of changes in the aggregate net carrying value due to revaluation of each class of PPE and Intangible Assets by 10% or more in the aggregate and whether revaluation is based on the valuation by a Registered Valuer as defined in Rule 2 of the Companies (Registered Valuer and Valuation) Rules, 2017.

b. The information as specified earlier in respect of title deeds of Immovable Properties not held in the name of the company, except that the
disclosure should be given in the aggregate for the following line
items in the Balance Sheet, separately for Land and Building, as against the description of each individual property as per the Order:

 

  •  PPE
  •  Investment property
  •  PPE retired from active use and held for sale, non-current assets held for sale (Ind AS entities)
  •  Others

As disclosures under Schedule III are along the lines required to be given, it is imperative for the auditor to reconcile the information disclosed therein for completeness and accuracy.

c. In respect of proceedings initiated or pending in respect of benami property held, the following details are required to be disclosed:

i. Details of such property, including year of acquisition,
ii. Amount thereof,
iii. Details of beneficiaries,
iv. If held in the books, reference thereof to the item in the Balance Sheet,
v. If not held in the books, then the facts along with reasons thereof,
vi.
Where there are proceedings against the company as an abettor of the
transaction or as the transferor, details thereof shall be provided,
vii. Nature of proceedings, status thereof and company’s view of the same.

Practical challenges in reporting
The reporting requirements outlined above entail certain challenges which are discussed below:

a. In respect of properties owned jointly with others where the title deeds are not held in the name of the company, the above details are required to the extent of the company’s share.

b.
Similarly, if the company has changed its name, this will require
reporting under this clause till the new name is updated in the title
deed.

c. Identification of benami properties: The reporting on proceedings in respect of benami properties may pose challenges, especially if the properties are not reflected in the books.
In such cases, apart from the normal procedures like review of the
minutes, scrutiny of legal expenses, review of minutes of board of
directors, audit committee, risk management committee, other secretarial
records, listing of all pending litigations and also obtaining
management representation (which have been referred to in the Guidance
Note). The auditor may also obtain independent confirmation from the legal counsel as to whether any such proceedings, other than those in respect of properties reflected in the books are pending, as per SA 501 – Audit Evidence – Specific Considerations for Selected Items.

d. The reporting under this clause is required only in cases where proceedings are initiated or pending against the company as ‘benamidar’
and not otherwise. Hence, even if notice is received but no proceedings
have been initiated, reporting is not warranted. The reporting is
required by the auditor of the company holding any benami property but not as an auditor of the company which is the beneficial owner.

e. Compilation of data for Intangible Assets: Since the requirement for reporting on maintenance of records for intangible assets has been newly introduced, many companies may not have a proper inventory thereof, except the details of the payments made or expenses capitalised on an individual basis. This could pose challenges to prepare a comprehensive itemised listing of all intangible assets and reconciling the same with the books. It is imperative that in such cases a one-time exercise is undertaken
to reconstruct the records and the nature of documentary evidence like
licences, agreements, internal SOPs (for internally generated
intangibles) which is available is also specified. This would also
facilitate easy identification in future. Wherever required, an
appropriate management representation should be obtained regarding the completeness of the data.

f. Awareness of the legal requirements: There
are certain situations where the auditor would have to familiarise
himself with the legal requirements. These mainly pertain to the
following:

i. The provisions of the Benami Property Transactions Act, 1988 and the related Rules.
Though relevant extracts of current regulations are given in the ICAI
Guidance Note, the auditor will have to keep abreast with the changes
therein, if any.

ii. Identifying the list of promoters of the company and their relatives:
Promoter and Relative have not been defined under the Order. However,
amended Schedule III (for disclosures related to holder of title deeds)
states that both ‘Promoter’ and ‘Relative’ will be as defined under the Companies Act, 2013.
Though a few promoters could be traced to those named in the prospectus
or identified in the annual return, the auditor will have to rely on
secretarial and other records and / or management representation to
determine those who have control over affairs of the company directly or
indirectly, whether as a director or shareholder or otherwise, or in
accordance with whose advice, directions, or instructions the Board is
accustomed to act and can be considered as promoters. In case there is
no such party, even then a specific representation should be obtained.

iii.
Ascertaining whether the requirements under the Trade Mark, Copyright,
Patents, Designs and IT Acts as well as the licensing requirements under
telecom, aviation, pharma and other similar industries have been
complied with in respect of the Intangible Assets.

iv. Being aware of the laws dealing with registration of immovable properties, including those pertaining to specific states.

In case of doubt, the auditor should seek the views of the company’s legal counsel or their own expert. This will be in line with SA 500 – Audit Evidence regarding using the Managements’ Expert
(by assessing the complexity, materiality, risk, independence,
competence, capability and objectivity, amongst other matters) and SA
620 – Using the Work of an Auditors’ Expert (by assessing the
complexity, materiality, risk, adherence to quality procedures,
competence, capability and objectivity, amongst other matters),
respectively. In either case, the requirements of SA 250 – Consideration
of Laws and Regulations in an Audit of Financial Statements should be
complied with.

g. Business combinations and acquisitions: The following matters need to be considered in case of such situations:

i.
In case a company has acquired another entity and the same is merged in
terms of an approved scheme, immovable properties of the transferee
company are considered deemed to be transferred in the name of the
acquiring company. However, till the time the acquiring company complies
with local / state-specific procedures, including payment of stamp
duty, etc., it would not be actually transferred in the name of the
acquiring company and, hence, would require factual reporting.

ii. In case of business combination as per Ind AS 103, where the acquiring company has identified intangible assets acquired as
a part of the transaction, the nature, and basis, whether or not the
same is in the books of the transferor needs to be evaluated and
recorded. Further, for intangible assets recorded on consolidated
financial statements, though there is no requirement for reporting by
the auditor, as the Order is only applicable on standalone financial
statements, it would be a good practice for the company to separately
list them in the intangible asset register.

h. Revaluation:
As per the ICAI Guidance Note, this clause is applicable only to the
entity which adopts the revaluation model. Hence, fair valuation of PPE
on first-time adoption, acquisition of assets / business on slump sale
basis or under business combination, change in ROU asset due to lease
modification as per Ind AS 116, re-measurement due to changes in foreign
exchange rates, etc., will not require reporting under this clause.
Further, impairment of PPE accounted under cost model is outside the
purview of reporting.

In case an entity adopts the revaluation model for PPE and Intangible Assets, there could be two scenarios as under:

i. Valuation by an external valuer:
In such cases, the fact should be indicated and the auditor should
check the necessary documentation as to whether he is registered under
Rule 2 of the Valuation Rules specified earlier. In such cases, the
auditor needs to ensure that the management ensured that the principles
laid down in Ind AS 113 on Fair Valuation are adhered to by the valuer.
The auditor should keep in mind the requirements under SA 500 – Audit
Evidence regarding using the Managements’ Expert, indicated earlier.
ii. Internal valuation: The
Order does not seem to mandate that a company needs to get a valuation
done by an external valuer. In such cases, the auditor will have to
exercise a greater degree of professional scepticism and review
the basis and assumptions for arriving at the revised fair value keeping
in mind the requirements of Ind  AS 113 as indicated earlier,
irrespective of the accounting framework. The requirements under SA 540 –
Auditing Accounting Estimates, Including Fair Value Accounting
Estimates and Related Disclosures (covering the extent of use of market
specific inputs and their relevance, assessment of comparable
transactions, basis and justification of unobservable inputs, amongst
others) also need to be kept in mind. In case of any doubt, the auditor should seek the assistance of their own valuation expert keeping in mind the requirements under SA 620 – Using the Work of an Auditors’ Expert, discussed earlier.

CONCLUSION

The
above changes have cast onerous responsibilities on the auditors and in
many cases the auditors would need to go beyond what is stated in the
Order because the devil lies in the details!

REGULATORY SCEPTICISM

The Reserve Bank of India (RBI) issued a Circular on 27th April, 2021. Its aim was to improve audit quality, strengthen independence and accountability. Considering the short timeline for implementation and the rigour of the guidelines, it appears that the RBI regarded these matters as critical. Therefore, the degree of urgency is justified by the necessity.

These guidelines seem to carry the scars of the IL&FS, Yes Bank, DHFL and other failures. Failures in the banking and financial services sector (BFS) need to be distinguished from other business failures. BFS functions like the veins and arteries in the human body and many institutions are the edifice on which other sectors stand. A few pillars crumbling or blockages in arteries could have an overarching spiral effect.

Audit Quality is ‘sterilised’ by Independence and gets ‘infected’ by conflicts of interest. Just as a doctor or a hospital cannot have ‘interest’ in a pharmaceutical company and a judge cannot be a partner at a law firm that litigates in the court, by the same token impaired independence weakens the objectivity of a professional. The central bank seems to have become mindful of this root cause.

Considering the above, a more stringent test for BFS in terms of number of years of appointment, number of entities that can be audited, the cooling-off period, mandatory joint audits, inclusion of NBFCs and the bar on services to group entities is only an expected response by the regulator.

The RBI has raised the bar through these guidelines by not allowing non-audit services one year prior to and after the appointment and even imposed a bar on conducting any audit/non-audit engagements with ‘group’ entities. Covering NBFCs of a certain size within the ambit of the above guidance is also a noteworthy step.

Some reports in the public domain have equated auditor eligibility norms with prescriptions of the Companies Act, 2013 and the Code of Ethics. A trade body wrote that the principles stated by the RBI are sector-agnostic and therefore must be aligned. One would think that regulations (which are practices, unlike principles) have to be dependent on context. In this case, it is hard to disregard the nature and function of BFS and the scale, spread and shock of recent failures. A concerned regulator will therefore raise the bar in display of its ‘regulatory scepticism’ about auditors. Mandatory joint audits also seem to arise from the same thought process.

Taking NBFCs into the fold is a step worth examining. The NBFCs are part of the nervous system of BFS. The IL&FS collapse and AQR findings by NFRA must have been ringing in the regulator’s mind till today. I would infer that this move is to firm up a more comprehensive monitoring of the entire BFS by the central bank.

The uproar from some circles routed through trade bodies is understandable. A ban on services to group entities and ‘take over’ of NBFCs’ auditor appointments by the RBI will have adverse commercial consequences for current incumbents. A sudden disqualification of auditors and the additional burden of fresh appointments at a short notice will be tough, but surely not impossible. Some clarifications are also wanting from RBI.

For systemically important entities, a heightened level of regulation seems necessary. The concern about this entire matter must have caused the insistent exigency in the central banker’s action. RBI is one of the finest regulators – tough, erudite and not infiltrated by vested interests. One can be reasonably sure about RBI having done its homework before rolling out these changes.

 
Raman Jokhakar
Editor

STORY OF THE GLORY

It is very nice to hear a speaker
at a conference describe ours as a ‘glorious’ profession! But what is the
reality? Here is an interesting (and frightening) true story.

 

A very big bank lent rupees one
thousand crores to a company. The bank had a ‘positive’ name. But there was a
scandal in the company. The bank had given huge advances to many such
companies. The bank went into deep trouble and the negative side of the
positive bank was exposed in the media. The bank’s high-profile CMD was
arrested. Many were put behind bars.

 

As usual, the question asked in the
public was ‘What was the auditor doing?’ As if the auditor is sitting
in the company the whole day and managing it!? It is the tradition in the
banking sector to make the auditor of the borrower a scapegoat regardless of
the person who may be at fault. The bank filed a complaint of professional
misconduct with the ICAI. Although ICAI is aware of the scandals in the banks
and the motivation behind such complaints, it has no choice but to entertain
such complaints. The reason is, it is a ‘glorious’ profession!

 

It was later revealed that the
auditor had signed the correct financial statements, made disclosures and
maintained good working papers. However, the borrower company had manipulated
the audited statements by masking certain figures and adverse observations and
qualifications. A photocopy which was not signed by the auditor was presented
to the bank for the loan. And since the bank was ‘positive’ it sanctioned the
loan of Rs. 1,000 crores. Please don’t ask stupid questions such as why did the
bank not insist on original signed statements, why it did not verify them in
the public domain, and so on. As per the banking norms, such questions are to
be asked only to small borrowers of Rs. 5 lakhs. If you want Rs. 1,000 crores,
the processing is very ‘simple’ and quick – on ‘a fast track’.

 

The poor auditor, despite doing a
fairly good job, was dragged into the investigations. Needless to say, he never
received his fees. On top of it, he has to face inquiries by CBI, SFIO, EOW,
etc., etc.

 

The poor auditor is made to visit
the investigators’ offices every day, answer the same questions, spend on his
lawyers’ fees, conveyance, humongous paperwork and what not. Everyone is
puzzled why the auditor carried out the audit properly and gave a qualified
report. Everybody feels that he could have given a clean report and shared some
Rs. 25 crores from the loan. He could have had a share in that sum!

 

And the beauty is that in the
inquiry, on some very technical grounds, the auditor may be held guilty of
professional misconduct. In other words, the auditor is the only person who
really suffers. The huge scam, the fraudulent people around, all that is irrelevant.
The reason is that ‘ours is a dignified and respectable profession’. Hence,
vulnerable.

 

Friends,
this is the common story of the ‘glory’ of our profession.

TRADING ON SELF-GENERATED RESEARCH – SEBI’S ORDERS MAKE IT ILLEGAL UNDER CERTAIN CIRCUMSTANCES

BACKGROUND
One would think that trading in shares based on one’s own research based on publicly available information is the commonest and the most logical thing to do and cannot imaginably be held to be illegal. Of course, many also trade on the advice of others such as professionals or even friends; equally obvious now is that trading on the basis of inside information is self-evidently illegal. And so is front-running illegal. But it would seem absurd to say that if one does meticulous research from publicly available information and then trades on it, it could be held to be illegal – and invite serious consequences! But, curiously, that is precisely one of the legal conclusions that the Securities and Exchange Board of India (SEBI) has drawn in at least two recent orders. To be clear, the facts as found by SEBI are peculiar. But, as a ruling in law, it does sound to be flawed. There are a couple of other similar issues in these orders which are also of concern.

The cases relate to recommendations for trading in scrips by persons (‘Hosts’) on a financial news channel and dealings by persons alleged to be closely associated with such hosts. The primary questions are three: Whether dealing by such persons (the host / persons closely associated with such host) themselves with advance knowledge of such recommendations is illegal under securities laws and hence punishable? Whether creation of momentum in the market by dealing in advance of such recommendations is illegal? The third question, which partly overlaps with the earlier two, is whether such dealings and practices are so unethical and unfair that they amount to violation of securities laws?

THE SEBI ORDERS
There are primarily two orders that SEBI has issued in this matter. The first order, an interim one, is in the case of Hemant Ghai (the host) and his relatives (order dated 13th January, 2021). This interim order and directions issued thereunder were confirmed by an order dated 2nd September, 2021.

The second order (dated 4th October, 2021), also an interim one, is in the case of Pradeep Pandya and certain members / HUFs of the Furiya family.

It may be added that these orders are / may be further contested and in any case be under further investigation / response from parties, being interim orders. Hence, the alleged findings of SEBI as discussed here are as per the SEBI orders. The focus here is to highlight the important and interesting legal issues involved and the possible ramifications of such cases.

SUMMARY OF ISSUES AND ORDER PASSED
Television channels (and even social media / streaming services) commonly have programmes where a host discusses and often makes recommendations to buy / sell a particular security. The recommendation is usually accompanied by a detailed presentation / graphics, etc., giving the justification for such recommendations. This recommendation may be made in an exclusive show by such a host who is associated with such channel or in general news where an ‘external expert’ is interviewed and who gives his recommendation.

As stated, there were two orders. In the first case, Hemant Ghai hosted / co-hosted various shows on news channel CNBC Awaaz. Recommendations about buying or selling a particular scrip were made on one such show. It was observed that as soon as the recommendation was made, the price of the scrip moved sharply in the direction recommended. That is to say, for example, if the recommendation was to buy a particular scrip, the price of that scrip immediately rose sharply in the market, obviously, as SEBI pointed out, because of such recommendation. Even the volumes rose very significantly on that day. The rise in price was far higher than the comparative movement in the stock index and there was no specific news from the company whose shares were recommended justifying such a rise. SEBI compared the price before and after the recommendation and noted that the rise in price (and volumes, too) was highest on the day of such recommendation. Similar findings were made by SEBI in the second order in the case of Pradeep Pandya’s show.

What was, however, found was that certain persons alleged to be associated with such hosts (‘associates’) repeatedly carried out trading to profit from such recommendation. Such persons bought (in the case of a buy recommendation) on the day before (or earlier on the same day) of the recommendation. When the price of the shares rose sharply after the recommendations, the associates sold the shares and made handsome profits.

Furthermore, such trades were carried out under the Buy-Today-Sell-Tomorrow (BTST) mechanism. This ensured that there was no need to even make payment for the purchase and take delivery.

SEBI made detailed inquiries on how the hosts and the respective associates were linked by taking into account family relations, call data records, addresses, etc. Accordingly, it held that the associates were aware in advance what recommendation was going to be made and hence traded in advance of such recommendation. When the price moved in the desired direction after the recommendations were released, the trades were reversed and profits made.

In the order in the matter of Hemant Ghai, calculations were made alleging that aggregate profits of about Rs. 2.95 crores were generated. In the case of Pradeep Pandya, similar calculations were made alleging profits of Rs. 8.39 crores.

The parties concerned were directed to impound these profits and deposit them in an escrow account. The hosts were also debarred from continuing to make any such recommendations till further orders. The parties were also debarred from dealing in securities till further orders. As stated earlier, the interim order in the matter of Hemant Ghai was confirmed after giving the parties a hearing.

INTERESTING POINTS ARISING OUT OF THE ORDERS
SEBI held, under the interim order, the parties (the hosts / associates) prima facie guilty of violation of multiple provisions of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, 2003 (‘the Regulations’). It was held that they traded on the basis of advance information that was not public. It was further held that trading in such manner, particularly without intimating the public that they have carried out such trades, was an unethical / unfair practice which in the light of several rulings amounted to violation of the Regulations. It was also held, in the Pradeep Pandya case, that by trading in advance, a momentum was created which contributed to price movement which, too, was in violation of the Regulations.

SEBI held, on the basis of the preponderance of probability, that the parties were guilty. For this purpose it relied on the decisions of the Supreme Court in the following cases: SEBI vs. Rakhi Trading (P) Ltd. [(2018) 143 CLA 15 (SC)]; and SEBI vs. Kishore R. Ajmera [134 SCL 481 (SC)].

SEBI also relied on the decision of the Supreme Court in SEBI vs. Kanaiyalal Baldevbhai Patel [(2017) 141 CLA 254 (SC)] for taking a broader and contextual view of what constitute unfair trade practices under the Regulations. Accordingly, it held that the practices alleged to have been carried out by the parties were in violation of the Regulations.

A few interesting points arise. The primary issue is whether trading on material self-generated information / analysis can be a violation of the Regulations? Can it be said that to have such advance information and trading on it amounts to such violation?

It is respectfully submitted that such ruling is absurd. Persons trading in markets, particularly informed and expert persons, often collate information of a wide nature and arrive at their own conclusion. There is no duty in law to publish such self-generated analysis and conclusions in advance to the public before carrying out trading on their own account. Investing and speculation in the market would, it is submitted, come to a standstill if this was held to be a requirement. Let us compare this aspect with two other types of dealings which are now well settled to be violations – insider dealing and front-running. In case of insider dealing, a person has access to unpublished price-sensitive information about a company and he deals on the basis of such information. It does not need elaborate explanation as to why this is illegal and indeed specific regulations make such dealings illegal. In the case of front-running, persons entrusted with price-sensitive information carry out trades on their own account first and then carry out the trades of the persons who have entrusted them with such information. They, too, thus profit and now such dealings are well settled to be violations of the Regulations.

In the case of self-generated information, there can hardly be a case of having advance information illegitimately obtained on the basis of which trades were carried out and that this is violation of the Regulations. It is submitted that this finding of SEBI has no basis in law or logic and the order needs to be reconsidered on this point.

Let us take the next issue which is a bit more contentious. The parties did not disclose to the public that they had already carried out the trades in advance of the time when they made the recommendations. To begin with, SEBI has not pointed out any specific provision in law which requires them to make such declaration. Interestingly, in most of the transactions, it was not even as if the parties made trades opposite to what they recommended. In other words, it was not as if the parties were, for example, selling while recommending to the public to buy. They did sell but after having bought first and after the price rose.

It was not even the case of SEBI that the price fell sharply after the parties sold the shares. Indeed, SEBI gave data in several cases which did not show any fall and the only point which was made was that the price did not rise as much in the days after the day of the recommendations. So it was not even a case of what is commonly known as ‘pump-and-dump’, which is a well-known fraudulent practice where unscrupulous persons by various means make the price rise to artificially high levels and then offload the shares, leaving the buyers in the lurch as the price falls soon thereafter.

Moreover, SEBI has not even claimed that the recommendation was deliberately manipulative and there was no informed basis for the recommendation. Indeed, as the SEBI orders point out, often the scrips recommended were large, well-known companies.

The allegation that in the Pradeep Pandya order the parties carried out heavy trades with an intention to thereby (even without the recommendation) result in an artificial momentum in one direction and this is thus a violation of the Regulations, of course does make sense. It would indeed be a case of pump-and-dump.

CONCLUSION
It would indeed be disturbing for the public to know that hosts of TV shows buy (or sell, as the case may be) first for themselves the scrips they recommend and sell when the price rises when there is a heavy rush to buy following the recommendation. Cynics would, of course, argue that there is no free lunch and indeed their own buying the very scrips they recommend to buy is actually having faith in their own recommendations. But holding that this is illegal and hence punishable is, it is submitted, a flawed view.

The matters are under further investigation. There could be prolonged proceedings resulting in a final order which could then be appealed against at various levels. It would be interesting to see how SEBI and appellate authorities deal with the issues. A wide range of persons, formally and informally, make recommendations about scrips. The final ruling could make such persons change the manner in which they make recommendations, what disclosures they make and perhaps debar certain types of trades.

LIABILITY OF NON-EXECUTIVE DIRECTORS FOR BOUNCED CHEQUES

INTRODUCTION
Section 138 of the Negotiable Instruments Act, 1881 (‘the Act’) is one of the few provisions which is equally well known both by lawmen and laymen. The section imposes a criminal liability in case of a dishonoured or bounced cheque. In cases where the defendant is a company, there is a tendency on the part of the plaintiff to implicate all the Directors of the company, irrespective of whether they are professional Directors / Independent / Non-Executive Directors. There have been numerous representations from chambers of commerce and professional / trade bodies to the Government that this section should be amended to exempt Independent and Non-Executive Directors who are not connected with the day-to-day management of the company. However, there has been no action on this front. Interestingly, the Act was amended in 2002 to provide that the provisions of section 138 would not apply to a Nominee Director appointed by the Central / State Government or by a financial corporation owned / controlled by the Central / State Government. One wonders why a similar exemption was not provided to other professional Directors.

SECTION 138 OF THE ACT
Let us pause for a moment and examine the impugned section. Section 138 provides that if any cheque is drawn by a person to another person and if the cheque is dishonoured because of insufficient funds in the drawer’s bank account, then such person shall be deemed to have committed an offence. The penalty for this offence is imprisonment for a term which may extend to two years and / or with a fine which may extend to twice the amount of the cheque. Earlier, the maximum imprisonment was for one year; however, it was extended to two years by the Amendment Act of 2002.
    
In order to invoke the provisions of section 138, the following three steps are necessary:
(i) the cheque must be presented to the bank within a period of six months from the date on which it is drawn or within the period of its validity, whichever is earlier;
(ii) once the payee is informed by the bank about the dishonour of the cheque, he (the payee) must, within 30 days of such information, make a demand for the payment of the amount of the cheque by giving a notice in writing to the drawer of the cheque; and
(iii) the drawer of such cheque fails to make the payment of the said amount of money to the payee of the cheque within 30 days of the receipt of the said notice. Earlier, the time given to the drawer for responding to the notice was 15 days; but this was extended to 30 days by the Amendment Act of 2002.

A fourth step is specified under section 142 which provides that a complaint must be made to the Court within one month of the date from which the cause of action arises (i.e., the notice period). A rebuttable presumption is drawn by the Act that the holder of the cheque received it for the discharge, in whole or in part, of any debt or other liability.
    
VICARIOUS LIABILITY OF PERSONS IN CHARGE
Section 141 provides that in case the drawer of the cheque is a company then every person who at the time the offence was committed was in charge of and was responsible for the company’s conduct of business, shall be deemed to be guilty of the offence and liable to be proceeded against and punished. However, 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, then he would not be liable to the punishment. The section also exempts Government Nominee Directors. Although the section speaks about a company, the explanation to the section extends the same position to a firm, any other body corporate or association of individuals.
    
In almost all cases of cheque-bouncing involving companies, firms, etc., the complainant files a case and implicates all the Directors of the company, including the Independent and Non-Executive Directors. Thus, professionals such as Chartered Accountants, lawyers, etc., who are only involved in broader policy and strategic decisions of the company, or with the Audit Committee or Shareholders’ Grievance Committee and are in no way connected with the day-to-day management of the company, are also made a party to the criminal proceedings.
    
SUPREME COURT JUDGMENTS
The Supreme Court has passed a landmark decision in the case of S.M.S. Pharmaceuticals Ltd. vs. Neeta Bhalla (2005) 8 SCC 89. This decision is by a three-Member Larger Bench in response to a reference application made to it by a two-Member Bench of the Supreme Court. Three very important issues were placed before the Court for its consideration:
(a)  Whether while making a complaint under the Negotiable Instruments Act must the complaint specifically state that the persons accused were in charge of, or responsible for, the conduct of the business of the company?
(b) Whether merely because a person is a Director of a company would he be deemed to be in charge of and responsible to the company for the conduct of its business and, therefore, deemed to be guilty of the offence unless he proves to the contrary?
(c) Would the signatory of the cheque and / or the Managing Directors / Joint Managing Director always be responsible to the company for the conduct of its business and hence could be proceeded against?
    
The Court held that since the provision fastens criminal liability, the conditions have to be strictly complied with. The conditions are intended to ensure that a person who is sought to be made vicariously liable for an offence of which the principal accused is the company, had a role to play in relation to the incriminating act and further that such a person should know what is attributed to him to make him liable. Persons who had nothing to do with the matter need not be roped in. A complaint must contain material to enable the Magistrate to make up his mind for issuing the process. A ground should be made out in the complaint for proceeding against the respondent. At the time of issuing of the process the Magistrate is required to see only the allegations in the complaint, and where the allegations in the complaint or the chargesheet do not constitute an offence against a person, the complaint is liable to be dismissed.

The Supreme Court observed that there is nothing in the Act to suggest that simply by being a Director in a company, one is supposed to discharge particular functions on its behalf. It may happen that a Director may not know anything about the day-to-day functioning of the company. He may only attend Board meetings, decide policy matters and guide the course of business of a company. The role of a Director in a company is a question of fact depending on the peculiar facts in each case. There is no universal rule that a Director of a company is in charge of its everyday affairs.

A very fitting comment made by the Court was that ‘…there is no magic as such in a particular word, be it Director, Manager or Secretary.’ What is relevant is the roles assigned to the officers in a company and not the mere use of a particular designation of an officer. Thus, merely mentioning all Directors in a compliant without anything more may not be enough. The accused should be in charge of and responsible to the company for the conduct of its business and a person cannot be subjected to liability of criminal prosecution without it being averred in the complaint that he satisfies those requirements. It is not that all and sundry connected with a company are made liable u/s 141. A person who is in charge of and responsible for the conduct of the business of a company would naturally know why the cheque in question was issued and why it was dishonoured. Specific allegations in the complaint would also serve the purpose that the person sought to be made liable would know what is the case that is alleged against him. This will enable him to meet the case at the trial.

When it came to the position of a Managing Director or a Joint Managing Director, the Court took a different view since these are persons in charge of a company and are responsible for the conduct of its business. In respect of such persons, the onus is on them to prove their innocence, i.e., when the offence was committed they had no knowledge of the offence or that they exercised all due diligence to prevent the commission of the offence.

The Supreme Court laid down another important principle, that the liability arises from being in charge of and responsible for the conduct of the business of the company at the relevant time when the offence was committed and not on the basis of merely holding a designation or office in a company. Conversely, a person not holding any office or designation in a company may also be liable if he satisfies the main requirement of being in charge of and responsible for the conduct of the business of a company at the relevant time. It once again reiterates that liability depends on the role he plays in the affairs of a company and not on the designation or status. If being a Director or Manager or Secretary was enough to cast criminal liability, the section would have said so. Instead of ‘every person’ the section would have said ‘every Director, Manager or Secretary in a Company is liable’ …etc. The Court held that the Legislature was aware that a case of criminal liability has serious consequences for the accused. Therefore, only persons who can be said to be connected with the commission of a crime at the relevant time have been subjected to action. Thus, even a non-Director can be liable u/s 141.

Ultimately, the Supreme Court answered the queries posed to it as under:

(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 the business of the company. This averment is an essential requirement of section 141 and has to be made in the 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. 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 in charge of the company and responsible to the company for the conduct of its business. Holders of such positions in a company become liable u/s 141. Merely by virtue of being a 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. So far as the signatory of a cheque which is dishonoured is concerned, he is clearly responsible for the dishonour and will be covered u/s 141.

This very vital decision has been followed by the Supreme Court in cases such as S.K. Alagh vs. State of Uttar Pradesh, 2008 (5) SCC 662; Maharashtra State Electricity Distribution Co. Ltd. vs. Datar Switchgear Ltd., 2010 (10) SCC 479; GHCL Employees Stock Option Trust vs. India Infoline Limited, 2013 (4) SCC 505, etc.
    
RECENT SUPREME COURT DECISION
This issue was again examined recently by the Supreme Court in the case of Ashutosh Ashok Parasrampuriya vs. M/s Gharrkul Industries Pvt. Ltd., Cr. A, No. 1206/2021, order dated 27th September, 2021. In this case, the respondent filed a complaint u/s 138 with specific averments in the complaint that all the Directors (including those who were not signatories to the bounced cheque) were involved in the day-to-day management / business affairs of the company whose cheque had bounced.

Accordingly, the trial court issued summonses against all the Directors. The Directors contended that they were only Non-Executive Directors and, hence, no complaint could lie against them. Against this argument, the respondent proved that the Form filed with the Ministry of Corporate Affairs showed the Directors as Executive Directors. Hence, the matter was a fit case for a trial which needed to be decided by the Court and the entire process needed to be gone through without quashing the summons at source.

The Court held that the settled principle was that for Directors who were not signatories / not MDs, it was clear that it was necessary to aver in the complaint filed u/s 138 that at the relevant time when the offence was committed the Directors were in charge and were actually responsible for the conduct of the business of the company.

The Court further held that this averment assumed more importance because it was the basic and essential averment which persuaded the Magistrate to issue a process against the Director. If this basic averment was missing, the Magistrate was legally justified in not issuing a process. In the case on hand, the Court observed that the complainant had specifically averred that all the Directors were in charge. Further, the MCA Forms also demonstrated the same. Hence, this was an issue on which a trial is appropriate and the complaint cannot be quashed at source.

EPILOGUE
Although this is a judgment under the Negotiable Instruments Act, it has several far-reaching consequences and its ratio descendi can be applied under various other statutes which affix a vicarious criminal liability on Directors in respect of offences committed by a company.
    
One can only hope that taking a cue from this epoch-making Supreme Court judgment, the Government would amend the Negotiable Instruments Act to exempt Independent and Non-Executive Directors. In fact, such an amendment is also welcome in other similar statutes prescribing a criminal liability on the Directors.

SAFE HARBOUR RULES – AN OVERVIEW (Part 1)

Over the years, Safe Harbour Rules in the context of Transfer Pricing have assumed significance. In this two-part article, we deal with Safe Harbour Rules under Transfer Pricing Regulations In Part 1 of this article, we focus on giving an overview of the Safe Harbour Rules, including background, objective and various other important aspects relating to them

1. BACKGROUND
Determination of Arm’s Length Price [ALP] is often time-consuming, burdensome and costly if an Associated Enterprise [AE] provides a range of intra-group services. It may impose a heavy administrative burden on taxpayers and tax administrations that can be intensified by both complex rules and resulting compliance requirements in respect of Transfer Pricing [TP]. Further, in recent times we have seen a substantial increase in litigation on transfer pricing issues, especially in developing countries like India. This has led to consideration of Safe Harbour(s) [SH] in the services sector like KPO services, Contract R&D services, ITES, certain low value-adding services, etc., along with the manufacture and export of core and non-core auto components (which is not a service) in the TP arena to provide certainty for the taxpayers and tax administrators. As per the amended Indian SH rules, low value-adding intra-group services have also been added in the eligible international transactions. SH rules have generally been applied to smaller taxpayers and / or less complex transactions. They are generally evaluated favourably by both tax administrations and taxpayers, which indicates that the benefits of SH outweigh the related concerns when such rules are carefully targeted and prescribed and when efforts are made to avoid the problems that could arise from poorly designed SH regimes.

A substantial number of cases in litigation on transfer pricing issues in India are in respect of selection of comparables while determining the ALP. An SH may significantly ease the compliance burden, reduce compliance costs for eligible taxpayers in determining and documenting appropriate conditions for qualifying controlled transactions and eliminating the need to undertake benchmarking exercises and selection of comparables which may be questioned by the tax authorities. It will also provide certainty to the taxpayers by ensuring that the price charged or paid on qualifying transactions will be accepted by the tax administrations with a limited audit or even without an audit, increase the level of compliance by small taxpayers and enable the tax authorities to use their resources to concentrate on TP review in which the tax revenue at stake is more significant.

2. OBJECTIVES OF SAFE HARBOUR
The importance of SH in TP has increased because of the following reasons:
a) Globalisation of markets and firms,
b) Development of powerful IT and efficient communication systems leading to increasing amounts of intercompany transactions,
c) Tax disputes on account of Base Erosion and Profit Shifting,
d) Complex regulatory compliances,
e) Documentation requirements, complexity in application, deadlines, stringent penalties in case of non-compliance, burden of audit and various other factors to be taken care of by the taxpayer,
f) Resource constraints of tax authorities and assessment of risk by them in order to focus their limited resources on large and significant cases.

SH has been introduced with the objective of assisting the tax authorities as well as reducing the compliance burden on the taxpayers. It has also been designed to reduce the amount of litigations in cases where there is a difference of opinion between the tax authorities and the taxpayers and also to provide certainty.

3. SAFE HARBOURS AS PER OECD TP GUIDELINES
As per the OECD, SH are expected to be most appropriate when they are directed at taxpayers and / or transactions which involve low TP risks and when they are adopted on a bilateral or multilateral basis, as against unilateral SH which may have a negative impact on the tax revenues of the country implementing them, as well as on the tax revenues of the countries whose AEs engage in controlled transactions with taxpayers electing a SH. A bilateral or multilateral SH would involve multiple countries agreeing on a fixed set of SH, thereby enabling the taxpayer to select and implement the SH without undertaking a risk of transfer pricing adjustment in all such jurisdictions.

Some of the difficulties that arise in applying the ALP may be avoided by providing circumstances in which eligible taxpayers may elect to follow a simple set of prescribed TP rules in connection with clearly and carefully defined transactions, or may be exempted from the application of the general TP rules. In the former case, prices established under such rules would be automatically accepted by the tax administrations that have expressly adopted such rules. These elective provisions are often referred to as ‘safe harbours’.

4. DEFINITION AND CONCEPT OF SAFE HARBOUR
4.1 OECD TP Guidelines
As per OECD TP Guidelines 2017, an SH in a TP regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations which are otherwise imposed by a country’s general TP rules. An SH provides simpler obligations in place of those under the general TP regime. Often, eligible taxpayers complying with the SH provisions will be relieved from burdensome compliance obligations, including some or all associated TP documentation requirements.

Such a provision could, for example, allow taxpayers to establish transfer prices in a specific way, e.g., by applying a simplified TP approach provided by the tax administration. Alternatively, an SH could exempt a defined category of taxpayers or transactions from the application of all or part of the general TP rules.

4.2 UN TP Manual
The UN TP manual defines SH as follows:
‘A provision in the tax laws, regulations or guidelines stating that transactions falling within a certain range will be accepted by the tax authorities without further investigation.’

As per the UN TP Manual, a practical alternative for a tax authority is to provide taxpayers with the option of using an SH for certain low value-adding services, provided it results in an outcome that broadly complies with the ALP. The SH may be based on acceptable mark-up rates for services. Several countries provide an SH option for certain services.

4.3 Toolkit for addressing difficulties in accessing comparables data for Transfer Pricing analyses [Toolkit]
The Toolkit prepared in 2017 in the framework of the Platform for Collaboration on Tax under the responsibility of the Secretariats and staff of the four mandated organisations, namely, International Monetary Fund, OECD, United Nations and World Bank Group, explains SH as follows:

‘An SH in a TP regime is a simplification measure through a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country’s general TP rules. One of the merits of a well-framed SH is that it can reduce the need to find data on comparables and to perform a benchmarking study in every case.’

An SH may refer to two types of provisions:
‘Safe Harbour for TP’ – A mechanism to allow a tax administration to specify an appropriate TP method and an associated level or range of financial indicators that it considers to fulfil the requirements of the TP rules. Such an SH is applicable only in respect of a defined category of transactions.
‘TP Safe Harbour on process’ – The specification by a tax administration of a process that, when applied in respect of a defined category of transactions, is considered to produce a result that fulfils the requirements of the TP rules.

Both types of SH provide potential benefits to the tax administration and to taxpayers. In practice, SH may be appropriate in respect of a wide range of transactions, including:
* Manufacturing, especially in cases where the manufacturer does not have a right to valuable intangibles and does not assume significant risk. This is likely to include manufacturers that are in substance toll manufacturers or contract manufacturers;
* Sales and distribution entities, including sales agents, again in cases where the function does not exploit valuable intangibles or assume significant risk;
* Provision of services that do not involve the exploitation of valuable intangibles or the assumption of significant risk.

5. BENEFITS OF SAFE HARBOUR
5.1 Compliance relief
Application of the ALP may require collection and analysis of data that may be difficult or costly to obtain and / or evaluate. In certain cases, such compliance burdens may be disproportionate to the size of the taxpayer, its functions performed, and the TP risks inherent in its controlled transactions. A properly designed SH may significantly ease compliance burdens by eliminating data collection and associated documentation requirements in exchange for the taxpayer pricing qualifying transactions within the parameters set by the SH. Especially in areas where TP risks are small, and the burden of compliance and documentation is disproportionate to the TP exposure, such a trade-off may be mutually advantageous to both taxpayers and tax administrations.

5.2 Certainty
Another advantage of an SH is the certainty that the taxpayer’s transfer prices will be accepted by the tax administration, provided they have met the eligibility conditions of, and complied with, the SH provisions. The tax administration would accept, with limited or no scrutiny, transfer prices within the SH parameters. Taxpayers could be provided with relevant parameters which would provide a transfer price deemed appropriate by the tax administration for the qualifying transaction.

5.3 Administrative simplicity
An SH would result in a degree of administrative simplicity for the tax administration. Once eligibility for the SH has been established, qualifying taxpayers would require minimal examination with respect to the transfer prices of controlled transactions qualifying for the SH. This would enable tax administrations to secure tax revenues in low-risk situations with a limited commitment of administrative resources and to concentrate their efforts on the examination of more complex or higher risk transactions and taxpayers. An SH may also increase the level of compliance among small taxpayers that may otherwise believe their TP practices will escape scrutiny.

6. ADVERSE CONSEQUENCES
The availability of SH for a given category of taxpayers or transactions may have adverse consequences such as:
6.1 Divergence from the Arm’s Length Principle
Where an SH provides a simplified TP approach, it may not correspond in all cases with the Most Appropriate Method [MAM] applicable to the facts and circumstances of the taxpayer under the general TP provisions. SH involves a trade-off between strict compliance with the ALP and administrability. They are not customised to fit exactly the varying facts and circumstances of individual taxpayers and transactions. Any potential disadvantages to taxpayers diverging from ALP by electing SH are avoided when taxpayers have the option to either elect the SH or price transactions in accordance with the ALP. With such an approach, taxpayers that believe the SH would require them to report an amount of income that exceeds the ALP could apply the general TP rules. While such an approach can limit the divergence from ALP under an SH regime, it would also limit the administrative benefits of the SH to the tax administration.

The question of whether to opt for SH regime would actually depend on the scale of operations vis-à-vis the resultant tax impact.

Example
In the case of two assessees A & B who are engaged in the provision of Contract R&D relating to software development (where the SH Rules provide that the operating profit margin declared in relation to operating expense should not be less than 24%), the decision to opt for the SH regime may have to be considered based on the following:

Amount in crores

Sr. No.

Particulars

A

B

1.

Operating Revenue

Rs. 50

Rs. 190

2.

Operating Expense

Rs. 42

Rs. 160

3.

Operating Profit

Rs. 8

Rs. 30

4.

Operating Profit margin (3 ÷ 2)

19.05%

18.75%

5.

SH margin required

24%

24%

6.

Operating profit as per SH Rules (5 x 2)

10.08

38.40

7.

Assumed margin likely to be approved by the ITAT

22%

22%

8.

Operating profit as per assumed margin (7 x 2)

9.24

35.20

9.

Incremental cost for opting SH (6 – 8)

0.84

3.20

As we can observe from the above example, assessee A might consider opting for operating profit margin of 24% as provided in the SH Rules since the incremental cost which he might bear in India for opting for SH in exchange of having peace and certainty in a scenario where he could have got a resolution from the ITAT at, say, 22% of operating expenses, may not be quite large, being Rs. 0.84 crore approximately

However, for assessee B the situation may not warrant opting for the SH regime as the incremental costs based on the same assumptions as mentioned above could be quite significant over the years. It is, therefore, unlikely that the large captive payers would opt for such SH Rules.

Further, as the scale of operation increases and in cases where the data of comparable transactions is easily available, the determination of ALP would not be difficult, thus making the SH option less lucrative in such cases.

6.2 Risk of double taxation, double non-taxation and mutual agreement concerns
One major concern raised by an SH is that it may increase the risk of double taxation. If a tax administration sets SH parameters at levels either above or below ALP in order to increase reported profits in its country, it may induce taxpayers to modify the prices that they would otherwise have charged or paid to controlled parties in order to avoid TP scrutiny in the SH country. The concern of possible overstatement of taxable income in the country providing the SH is greater where that country imposes significant penalties for understatement of tax or failure to meet documentation requirements, with the result that there may be added incentives to ensure that the TP is accepted in that country without further review.

If the SH causes taxpayers to report income above arm’s length levels, it would work to the benefit of the tax administration providing the SH, as more taxable income would be reported by such domestic taxpayers. On the other hand, the SH may lead to less taxable income being reported in the tax jurisdiction of the foreign AE that is the other party to the transaction. The other tax administrations may then challenge prices derived from the application of an SH, with the result that the taxpayer would face the prospect of double taxation. Accordingly, any administrative benefits gained by the tax administration of the SH country would potentially be obtained at the expense of other countries, which in order to protect their own tax base would have to determine systematically whether the prices or results permitted under the SH are consistent with what would be obtained by the application of their own TP rules.

For example, let us consider Assessee A engaged in the provision of Contract R&D relating to software development to its AE in the US, where the SH provides that the operating profit margin declared in relation to operating expense should not be less than 24%. If the US considers 20% to be an appropriate ALP for payment by the US entity to Assessee A and if Assessee A opts for SH and offers a margin of 24%, such margin may not be accepted by the tax authorities in the US and may result in litigation there.

Where SH are adopted unilaterally, care should be taken in setting SH parameters to avoid double taxation, and the country adopting the SH should generally be prepared to consider modification of the SH outcome in individual cases under mutual agreement procedures to mitigate the risk of double taxation. Obviously, if an SH is not elective and if the country in question refuses to consider double tax relief, the risk of double taxation arising from the SH would be unacceptably high and inconsistent with the double tax relief provisions of treaties.

6.3 Possibility of opening avenues for tax planning
SH may also provide taxpayers with tax planning opportunities. Enterprises may have an incentive to modify their transfer prices in order to shift taxable income to other jurisdictions. This may also possibly induce tax avoidance, to the extent that artificial arrangements are entered into for the purpose of exploiting the SH provisions. For instance, if SH apply to ‘simple’ or ‘small’ transactions, taxpayers may be tempted to break transactions into parts to make them seem simple or small.

6.4 Equity and uniformity issues
SH may also raise equity and uniformity issues. By implementing an SH, one would create two distinct sets of rules in the TP area. Insufficiently precise criteria could result in similar taxpayers receiving different tax treatment: one being permitted to meet the SH rules and thus to be relieved from general TP compliance provisions, and the other being obliged to price its transactions in conformity with the general TP compliance provisions. Preferential tax treatment under SH regimes for a specific category of taxpayers could potentially entail discrimination and competitive distortions. The adoption of bilateral or multilateral SH could, in some circumstances, increase the potential of a divergence in tax treatment, not merely between different but similar taxpayers but also between similar transactions carried out by the same taxpayer with AEs in different jurisdictions.

7. EXAMPLES OF SAFE HARBOUR IN RESPECT OF INTRA-GROUP SERVICES
As per the UN TP Manual, two SH that may be used by tax authorities in respect of intra-group services are as follows:

(a) Low value services that are unconnected to an AE’s main business activity. This SH is usually available for low value-adding services. The rationale for an SH is that there may be difficulties in finding comparable transactions for low value-adding services and the administrative costs and compliance costs may be disproportionate to the tax at stake.
(b) Safe harbours for minor expenses (i.e., amounts below a defined threshold). These are for situations in which the costs of services provided or received are relatively low, so the tax authority may agree to not adjust the transfer prices provided they fall within the acceptable range. The rationale for this SH is that the cost of a tax authority making adjustments is not commensurate with the tax revenue at stake and therefore the taxpayer should not be expected to incur compliance costs to determine more precise ALP.

8. SAFE HARBOUR FOR LOW VALUE-ADDING SERVICES
Low value-adding services are services which are not part of an MNE group’s main business activities from which it derives its profits but are services that support the AE’s business operations. A determination of an AE’s low value-adding services would be based on a functional analysis of the enterprise which would provide evidence of the main business activities of an AE and the way in which it derives its profits.

Low value-adding intra-group services are services performed by one or more than one member of an MNE group on behalf of one or more other group members which:
a) Are of a supportive nature;
b) Are not part of the core business of the MNE group (i.e., not creating the profit-earning activities or contributing to economically significant activities of the MNE group);
c) Do not require the use of unique and valuable intangibles and do not lead to the creation of unique and valuable intangibles;
d) Do not involve the assumption or control of substantial or significant risk by the service provider and do not give rise to the creation of significant risk for the service provider.

Some common examples of low value-adding services for most MNE groups (i.e., provided they do not constitute the core business of the group) are human resources services, accounting services, clerical or administrative services, tax compliance services and data processing.

For an AE that is a distributor and marketer of an MNE’s products, marketing services would fail to qualify as administrative services as they are directly connected to the enterprise’s main business activity. Similarly, for an MNE whose core business is recruitment and human resources management, human resources services of a kind similar to those provided to independent customers would not qualify for the low value-adding SH despite the mention of human resources services in the section above.

9. MINOR EXPENSE SAFE HARBOUR
In the Minor Expense SH option, a tax authority agrees to refrain from making a TP adjustment if the total cost of either receiving or providing intra-group services by an AE is below a fixed threshold based on cost and a fixed profit mark-up margin is used.

The aim is to exclude from TP examinations services for which the charge is relatively minor. The rationale is that the costs of complying with the TP rules would outweigh any revenue at stake. It also considers the potential administrative savings for a tax authority by avoiding TP examinations of minor expenses. An important requirement is that the same fixed profit margin should be used for inbound and outbound intra-group services for a country. The SH provides taxpayers and tax authorities with certainty. The minor expense SH may contain the following requirements:
* A restriction on the relative value of the service expense (e.g., less than X per cent of total expenses of the AE receiving the services) or alternatively, a restriction on the absolute value of the service expense,
* A fixed profit margin,
* The requirement that the same profit margin is used in the other country,
* The documentation requirements that are expected.

An example of an SH for services is set out as follows.

For inbound intra-group services:
a) The total cost of the services provided is less than X per cent of the total deductions of the AEs in a jurisdiction for a tax year, or less than a defined absolute amount in the local currency;
b) The transfer price is a fixed profit mark-up on total costs of the services (direct and indirect expenses); and
c) Documentation is prepared to establish that the SH requirements have been satisfied.

For outbound intra-group services:
a) The cost of providing the services is not more than X per cent of the taxable income of the AE providing the services, or not more than a defined absolute amount in the local currency;
b) The transfer price charged is based on a fixed profit mark-up on the total costs of the services (direct and indirect expenses);
c) The same profit margin is used in the other country; and
d) Documentation is created to establish that these SH requirements have been satisfied.

At present there is no minor expense safe harbour rule prescribed as part of the SH regime in India.

10. RECOMMENDATIONS ON USE OF SAFE HARBOUR AS PER OECD TP GUIDELINES
TP compliance and administration is often complex, time-consuming and costly. Properly designed SH provisions, applied in appropriate circumstances, can help to relieve some of these burdens and provide taxpayers with greater certainty.

SH provisions may raise issues such as potentially having perverse effects on the pricing decisions of enterprises engaged in controlled transactions and a negative impact on the tax revenues of the country implementing the SH, as well as on the countries whose AEs engage in controlled transactions with taxpayers electing an SH. Further, unilateral SH may lead to the potential for double taxation or double non-taxation.

However, in cases involving smaller taxpayers or less complex transactions, the benefits of SH may outweigh the problems raised by such provisions. Making such SH elective to taxpayers can further limit the divergence from ALP. Where countries adopt SH, willingness to modify SH outcomes in mutual agreement proceedings to limit the potential risk of double taxation is advisable.

Where SH can be negotiated on a bilateral or multilateral basis, they may provide significant relief from compliance burdens and administrative complexity without creating problems of double taxation or double non-taxation. Therefore, the use of bilateral or multilateral SH under the right circumstances should be encouraged.

It should be clearly recognised that an SH, whether adopted on a unilateral or bilateral basis, is in no way binding on or precedential for countries which have not themselves adopted the SH.

For more complex and higher risk TP matters, it is unlikely that SH will provide a workable alternative to a rigorous, case-by-case application of the ALP under the provisions of these Guidelines.

11. RANGACHARY COMMITTEE – INDIAN SAFE HARBOUR COMMITTEE
The Prime Minister’s Office issued a press release on 30th July, 2012 announcing the constitution of a Committee to Review Taxation of Development Centres and the IT Sector under the Chairmanship of Mr. N. Rangachary, former Chairman, CBDT & IRDA (the Rangachary Committee), for seeking resolution of tax issues through an arm’s length exercise in the form of a review by the Committee including, inter alia, SH provisions announced but yet to be operationalised having the advantage of being a good risk mitigation measure and provide certainty to the taxpayer.

The Committee was mandated to engage in sector-wide consultations and finalise the SH provisions announced sector-by-sector. The Committee was also to suggest any necessary circulars that may need to be issued.

The Committee has submitted six reports including specific sector-wise / activity-wise reports for the following:
1) IT Sector,
2) ITES Sector,
3) Contract R&D in the IT and Pharmaceutical Sector,
4) Financial Transactions-Outbound Loans,
5) Financial Transactions-Corporate Guarantees,
6) Auto Ancillaries-Original Equipment Manufacturers.

12. OVERVIEW OF INDIAN SAFE HARBOUR
Businesses flourish only if there is certainty and SH provisions offer that certainty. These SH provisions of the Income-tax Act, 1961 [the Act] specify that from the perspective of TP provisions, if the assessee fulfils certain defined conditions, the Tax Authorities shall accept the TP declared by the taxpayer.

SH Rules benefit assessees by allowing them to adopt a TP mark-up in the range prescribed, which would be acceptable to the Income Tax Department with benefits of compliance relief, administrative simplicity and certainty and hence would avoid protracted litigation.

After its enactment vide the Finance (No. 2) Act 2009, the first set of rules was notified on 18th September, 2013 – Rules 10TA to 10TG and Form 3CEFA (for international transactions), and Rules 10TH to 10THD and Form 3CEFB (for domestic transactions) for a period of three years, followed by a revision in 2017 in the SH Rules, which were made applicable till F.Y. 2018-19.

The CBDT vide Notification No. 25/2020 dated 20th May, 2020 extended the applicability of Rule 10TD(1) and (2A) (applicable for A.Y. 2017-18 to A.Y. 2019-20) for A.Y. 2020-21 also. Of the categories of the eligible international transactions, the category of software development, ITES and KPO appears to have been popularly opted for.

The CBDT has issued Notification No. 117/2021 dated 24th September, 2021 to extend the applicability of SH Rules under Rule 10TD of the Income-tax Rules to A.Y. 2021-22. The amended rule is deemed to come into force from 1st April, 2021.

Considering that the TP References in smaller cases has substantially reduced, it would have been good to revise these SH limits downward by around 2 per cent points to make it a more attractive option.

A comparison of the erstwhile and revised SH is given below:

Sr. No.

Eligible International
Transactions

Old SH Rules for

01-04-12 to 31-03-17

Revised SH Rules for

01-04-16 to 31-03-21

Threshold

Margin

Threshold

Margin

1

Provision of software development services and information
technology-enabled services

Up to Rs. 500 crores

Not less than 20% on total operating costs

Up to Rs. 100 crores

Not less than 17% on total operating costs

Above Rs. 500 crores

Not less than 22% on total operating costs

Above Rs. 100 crores up to
Rs. 200 crores

Not less than 18% on total operating costs

2

Provision of KPO services

NA

Not less than 25% on operating costs

Up to Rs. 200 crores

Not less than 24% and employee cost at least 60%

Not less than 21% and employee cost is 40%
or more but less than 60%

Not less than 18%, and employee cost up to 40%

3

Advancing of intra-group loans where loan is denominated in
Indian Rupees

Loan up to
Rs. 50 crores

Base rate of State Bank of India + 150 basis points

One year marginal cost of funds lending rate
of SBI as on 1st April of relevant previous year plus:

CRISIL rating between AAA to A or its equivalent

175 basis points

3

 

(continued)

 

CRISIL rating of BBB-, BBB, BBB+ or its equivalent

325 basis points

Loan above Rs. 50 crores

Base rate of State Bank of India + 300 basis points

CRISIL rating of BB to B or its equivalent

475 basis points

CRISIL rating between C & D or its equivalent

625 basis points

Credit rating is not available, and amount of loan does not exceed
Rs. 100 crores as on 31st March of relevant previous year

425 basis points

4

Advancing of intra-group loans where loan is denominated in
foreign currency

NA

NA

6 month LIBOR interest rate as on
30th September of relevant previous year plus:

CRISIL rating between AAA to A

150 basis points

CRISIL rating of BBB-, BBB, BBB+

300 basis points

CRISIL rating of BB to B

450 basis points

CRISIL rating between C & D

600 basis points

Credit rating is not available, and amount of loan does not
exceed equivalent of Rs. 100 crores as on 31st March of relevant previous
year

400 basis points

5

Providing corporate guarantee

Up to Rs. 100 crores

Not less than 2% p.a.

NA

Not less than 1% p.a. on the amount guaranteed

Above Rs. 100 crores

Not less than 1.75% p.a.

6

Provision of contract R&D services relating to software
development

NA

Not less than 30% on operating expense

Up to Rs. 200 crores

Not less than 24% on the operating expense

7

Provision of contract R&D services relating to generic
pharma drugs

NA

Not less than 29% on operating expense

Up to Rs. 200 crores

Not less than 24% on the operating expense

8

Manufacture and export of core auto components

NA

Not less than 12% on operating expense

NA

Not less than 12% on operating expense

9

Manufacture and export of non-core auto components

NA

Not less than 8.5% on operating expense

NA

Not less than 8.5% on operating expense

10

Receipt of low value-adding intra-group services (New)

NA

NA

Up to Rs. 10 crores including mark-up

– 5% mark-up; and

– Cost pooling method, exclusion of shareholders cost, duplicate
costs and reasonableness of allocation keys is certified by an accountant

A.Y. 2017-18 is the overlapping year for which the taxpayers had an option to exercise either of the two SH rules depending upon whichever was most beneficial to them.

The downward revision of SH margins in case of software development and ITES, Contract R&D and KPO in the revised SH Rules was long overdue and a welcome move. The revised margins are also closer to the margin range being concluded in the vast majority of APAs concluded in the IT-ITES space. As a result of the reduction in the margins, the expected savings of taxpayers due to avoidance of litigation is likely to outweigh the premium paid (if any) due to higher than arm’s length margins especially for small and medium taxpayers with lower cost bases.

This move also highlights the Indian Revenue’s intention to attract appropriate cases to the SH scheme and away from the APA scheme thereby covering the higher value and non-routine cases for the more complex cases that need a deeper understanding and negotiation by the Indian Revenue.

Another interesting feature of the revised SH rules is the gradation of the SH margin thresholds for the KPO sector based on the percentage of employee cost incurred rather than covering all the KPO activities under a single umbrella. The streamlining of margins prescribed for KPO on the basis of employee cost ratio may not be the best course of action but it does seek to align with the premise that a technically skilled workforce would lead to a higher employee cost and signify a higher value addition commanding a higher operating margin. The employee cost has been defined comprehensively.

The definitions of ITES and KPO are very broad and general and the revised SH rules did not modify / clarify them. Keeping in view the litigations that have occurred, detailed definitions would have been welcome as they would have set a clearer line of distinction between KPO and ITES. The applicability of SH for transactions of software development and ITES, contract R&D and KPO has been reduced to Rs. 200 crores. Hence, after F.Y. 2016-17, taxpayers having transaction values greater than Rs. 200 crores cannot opt for SH but can only opt for APAs to attain certainty.

13. CONCLUDING REMARKS
Complying with the ALP can be burdensome. Even good faith efforts to ensure compliance result in uncertainty because the Tax Authorities may analyse the transaction in a different way and come to a different conclusion. Though it is important for the Government to be diligent, and the enterprises to be honest, easing out more on compliance procedures would enable enterprises to focus more on their core activities and in turn generate more business and profits, thereby keeping the wheel of taxation turning and intact.

A fair and transparent SH regime goes a long way in plugging tax leakage and leads to significant tax certainty. Country tax administrations should carefully weigh the benefits of and concerns regarding safe harbours, making use of such provisions where they deem it appropriate.

In Part 2 of this Article, we will deal with the remaining aspects of Indian SH Rules and jurisprudence.

Reopening of assessment – Precondition to be satisfied – Reasons recorded cannot be substituted

Peninsula Land Limited vs. Assistant Commissioner of Income Tax Central Circle-1(3), Mumbai & Ors. [Writ Petition No. 2827 of 2021; Date of order: 25th October, 2021 (Bombay High Court)]

Reopening of assessment – Precondition to be satisfied – Reasons recorded cannot be substituted

The petitioner challenged the notice u/s 148 dated 30th March, 2019 and the order dated 5th September, 2019 on the ground that the reasons recorded in support of the impugned notice do not indicate the manner in which the A.O. has come to the conclusion that income chargeable to tax has escaped assessment in the hands of the petitioner. It has also alleged that in the reasons for reopening, there is not even a whisper as to what was the tangible material in the hands of the A.O. which made him believe that income chargeable to tax has escaped assessment and in the notice issued four years after the assessment order, what was the material fact that was not fully and truly disclosed.

The Court observed that the law on this is well settled. To confer jurisdiction u/s 147(a), two conditions were required to be satisfied, firstly, the A.O. must have reasons to believe that income, profits or gains chargeable to income tax had escaped assessment, and secondly, he must also have reason to believe that such escapement has occurred by reason of either omission or failure on the part of the assessee to disclose fully or truly all material facts necessary for his assessment of that year. Both these conditions had to be satisfied before the A.O. could assume jurisdiction for issue of notice u/s 148 read with section 147(a). But under the substituted section 147 the existence of only the first condition suffices. In other words, if the A.O. has reason to believe that income has escaped assessment, it is enough to confer jurisdiction upon him to reopen the assessment.

Also, the reasons for reopening of assessment tested / examined have to be stated only on the basis of the reasons recorded at the time of issuing a notice u/s 148 seeking to reopen the assessment. These reasons cannot be improved upon and / or supplemented, much less substituted by affidavit and / or oral submissions. Moreover, the reasons for reopening an assessment should be that of the A.O. alone who is issuing the notice and he cannot act merely on the dictates of any another person in issuing the notice. Moreover, the tangible material upon the basis of which the A.O. comes to believe that income chargeable to tax has escaped assessment can come to him from any source; however, the reasons for the reopening have to be only of the A.O. issuing the notice.

It is also settled law that the A.O. has no power to review an assessment which has been concluded. If a period of four years has lapsed from the end of the relevant year, the A.O. has to mention what was the tangible material to come to the conclusion that there is an escapement of income from assessment and that there has been a failure to fully and truly disclose material facts. After a period of four years even if the A.O. has some tangible material to come to the conclusion that there is an escapement of income from assessment, he cannot exercise the power to reopen unless he discloses what was the material fact which was not truly and fully disclosed by the assessee.

In the reasons for issuance of notice in this case it is recorded that the return of income for the assessment year under consideration was filed on 28th September 2012, further revised return of income was filed on 28th March, 2014 and on 9th May 2015 the return of income was processed u/s 143(1) and the assessment order u/s 143(3) read with section 153A was passed by the A.O. on 30th December, 2016. The entire basis for issuance of the notice is that information was received from the Deputy Director of Income Tax, Mumbai that a search and survey action u/s 132 was carried out in the case M/s Evergreen Enterprises and based on the statement recorded of the partner of M/s Evergreen Enterprises and documentary evidences found in the search of its premises, it unearthed an undisclosed activity of money-lending and borrowing in unaccounted cash being operated at the premises of M/s Evergreen Enterprises. It is also recorded in the reasons that based on the statements recorded of the partners of M/s Evergreen Enterprises and its employees, it came to light that one of the individuals / business concerns has lent cash of Rs. 30,00,000. It is alleged that the petitioner has lent cash loan of Rs. 30,00,000 in F.Y. 2011-12 and therefore the petitioner has been indulging in lending of cash loan and hence the amount of Rs. 30,00,000 has escaped assessment within the meaning of section 147.

The Court observed that there is absolutely no mention as to how either the partners of M/s Evergreen Enterprises or its employees or one Mr. Bharat Sanghavi are connected to the petitioner. The affidavit in reply of the respondent stated that Bharat Sanghavi was an employee of the  petitioner and, therefore, the reasons have been correctly recorded and the A.O. has reason to believe that income had escaped assessment.

As noted earlier, the reasons for reopening of assessment have to be tested / examined only on the basis of the reasons recorded and those reasons cannot be improved upon and / or much less substituted by an affidavit and / or oral submission. In the reasons for the reopening, the A.O. does not state anywhere that Bharat Sanghavi was an employee of the petitioner. Further, in the reasons for reopening, the A.O. does not even disclose when the search and survey action u/s 132 was carried out in the case of M/s Evergreen Enterprises, whether it was before the assessment order dated 30th December, 2016 in the case of the petitioner was passed or afterwards. The reasons for reopening are absolutely silent as to how the search and survey action on M/s Evergreen Enterprises or the statement referred to or relied upon in the reasons have any connection with the petitioner.

In the circumstances, the Court held that the impugned notice dated 30th March, 2019 and the impugned order dated 5th September, 2019 had been issued without jurisdiction and hence were quashed and set aside.

 

Reopening notice u/s 148 – Notice issued to non-existing entity – Notice could not be corrected u/s 292B

5 Implenia Services and Solutions Pvt. Ltd. vs. Deputy / Asst. Commissioner of Income Tax [Writ Petition (L) No. 14088 of 2021; Date of order: 25th October, 2021 (Bombay High Court)]

Reopening notice u/s 148 – Notice issued to non-existing entity – Notice could not be corrected u/s 292B

The impugned notice dated 27th March, 2021 has been issued to a non-existing entity. In the affidavit in reply, it is admitted that the notice has been issued to a non-existing entity but the respondents state that it ought to be treated as a mistake and the name in the notice could be corrected u/s 292B.

The respondents relied upon a judgment of the Delhi High Court in the case of Skylight Hospitality LLP vs. Assistant Commissioner of Income Tax, Circle-28(1), New Delhi (2018) 405 ITR 296 (Delhi) which has been subsequently affirmed on 6th April, 2018 by a two-Judge Bench of the Supreme Court.

The Court observed that this cannot be a general proposition as the Apex Court has expressly stated in Skylight Hospitality LLP (Supra) that ‘in the peculiar facts of this case, we are convinced that the wrong name given in the notice was merely a clerical error which could be corrected under section 292B of the IT Act (emphasis supplied)’.

The Apex Court in its recent judgment on this subject in Principal Commissioner of Income Tax vs. Maruti Suzuki India Ltd. (2019) 416 ITR 613 (SC) has considered the judgment of Skylight Hospitality and said that it has expressly mentioned that in the peculiar facts of that case the wrong name given in the notice was merely a clerical error. In Maruti Suzuki India Ltd. (Supra) the Court has also observed that what weighed in the dismissal of the Special Leave Petition was the peculiar facts of that case. It has reiterated the settled position that the basis on which jurisdiction is invoked is u/s 148 and when such jurisdiction was invoked on the basis of something which was fundamentally at odds with the legal principle that the amalgamating entity ceases to exist upon the approved scheme of amalgamation, the notice is bad in law.

The High Court noted that the Apex Court in Maruti Suzuki India Ltd. (Supra) had observed that the basis on which jurisdiction was invoked was fundamentally at odds with the legal principle that the amalgamating entity ceases to exist upon the approved Scheme of amalgamation. Participation in the proceedings by the appellant in the circumstances cannot operate as an estoppel against law. The stand now taken in the affidavit in reply is nothing but an afterthought by the respondent after having committed a fundamental error. Therefore, the stand of the respondent that it was an error which could be corrected u/s 292B was not acceptable to this Court.

The Court followed the decision in the case of Alok Knit Exports Ltd. vs. Deputy Commissioner of Income Tax in its order dated 10th August, 2021 in WP No. 2742 of 2019.

In the circumstances, notice dated 27th March, 2021 issued u/s 148 was quashed and set aside.

Search and seizure – Assessment of third person – Income-tax survey – Assessment based on documents seized during survey at assessee’s premises – No incriminating material found against assessee during search of third parties – Absence of satisfactory note by A.O. that any seized document belonged to assessee – Search warrant not issued against assessee – Assessment and consequent demand notice were unsustainable

24 Sri Sai Cashews vs. CCIT [2021] 438 ITR 407 (Ori) A.Y.: 2016-17; Date of order: 23rd August, 2021 Ss. 132, 133A, 153C and 156 of ITA, 1961

Search and seizure – Assessment of third person – Income-tax survey – Assessment based on documents seized during survey at assessee’s premises – No incriminating material found against assessee during search of third parties – Absence of satisfactory note by A.O. that any seized document belonged to assessee – Search warrant not issued against assessee – Assessment and consequent demand notice were unsustainable

The assessee processed cashewnuts into cashew kernel. A survey operation was conducted u/s 133A against it. The A.O. invoked the jurisdiction u/s 153C for making a block assessment for the A.Ys. 2010-11 to 2016-17 as a result of searches which were conducted in the premises of two persons JR and JS u/s 132. He passed an order u/s 143(3) read with section 153C for the A.Y. 2016-17 and issued a notice of demand u/s 156.

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

‘i) In the absence of incriminating materials against the assessee having been found in the course of the search of the searched persons JR and JS, the order passed u/s 143(3) read with section 153C and the consequential demand notice issued u/s 156 were unsustainable and, therefore, set aside.

ii) The documents relied upon by the A.O. were found in the course of survey of the assessee u/s 133A and not during the search of the parties against whom the search authorisation was issued u/s 132 and search was conducted. The Department had not been able to dispute any of the factual averments. No incriminating materials concerning the assessee were found in the premises of the two persons against whom search was conducted and the absence of satisfaction note of the A.O. of the persons against whom search was conducted about any such incriminating material against the assessee, were not denied. The order only related to disallowance of expenditure u/s 140A(3) that was payable to the cultivators, expenses towards hamali, i.e., labour charges, unexplained money u/s 69A, negative cash and unaccounted stock which was not on account of the discovery of any incriminating materials found in the course of the search concerning the assessee and there was no search warrant u/s 132 against the assessee.’

LOST IN CREDIT LOSS!

Indirect tax legislations across the globe introduce input credits to eliminate tax cascading in the downstream value chain of goods / services. An idealistic VAT system envisages tax as a ‘pass-through’ so that the tax itself would not be a component of product / service pricing. Yet this idealistic VAT system has been tampered with, time and again, and one is forced to ponder over the robustness of the VAT system. Inefficiencies have crept into this system through the introduction of credit blocks in respect of motor vehicles, construction activity, etc. One such inefficiency is the reversal of input tax credit (ITC) in respect of goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples [section 17(5)(h)]. None of these terms has been defined under the Act and one would have to examine the general and contextual meaning of these terms. This article seeks to articulate the plausible meanings intended by the Legislature and their impact in determining the credit eligibility. The relevant clause(s) under examination has / have been extracted below:

‘16(1). Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course of furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person…..
17(5) Notwithstanding anything contained in sub-section (1) of section 16 and sub-section (1) of section 18, input tax credit shall not be available in respect of the following, namely: -….
(h) goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples, and; ….’

GENERAL UNDERSTANDING OF IMPORTANT TERMS
The key terms under consideration in section 17(5)(h) and their respective meanings from the Law Lexicon (5th Edition) are given below:
Lost – A thing is said to be lost when it cannot be found or when ordinary vigilance will not regain it.
Stolen – ‘To steal’ means to take by theft and ‘Intent to steal’ refers to permanently deprive and defraud another of the use and benefit of property and permanently to appropriate the property to his own use or the use of any person other than the true owner.
Destroyed – ‘Destroyed’ occurring in section 32(1) of the Income-tax Act has a wider connotation than mere physical destruction. It would also cover loss arising on the theft of a vehicle. The term ‘destroyed’ in section 41(2) of the Income-tax Act would not cover items partly destroyed in fire and which have been retained by the assessee. In another context, the term destroyed means to ‘demolish’, i.e., to render a thing useless for the purpose for which it was intended.
Written off – ‘Write down’ means to reduce the book value of. ‘Write off’ means to carry or remove. ‘Write-off’ also means to delete an asset from the accounts because it has been depreciated (or been written-down) so far that it no longer has any book value. It can also mean to charge the whole of the value of an asset to expenses or loss (i.e., assign it zero value on the balance sheet).
Disposed of by way of gift or free sample – Dispose means to transfer to the control or ownership of another; or transfer or alienate. ‘Gift’ means to transfer by one person to another of any existing movable property voluntarily and without consideration in money or money’s worth. ‘Sample’, both in its legal and popular acceptance,  means that which is taken out of a large quantity and is a fair representation of the ‘whole’, a part shown as a specimen. The transfer ought to be by way of gift or free sample. The entire phrase can be interpreted as ‘to transfer the control or ownership over goods either by way of love / affection or by taking out a small quantity from a larger group and such transfer being without consideration’.

JUDICIAL INTERPRETATION
The phrase ‘lost’ can be understood in the sense that the taxpayer has lost possession over the goods on account of any external incident. It represents a total annihilation of the goods and does not appear to be encompassing situations where the goods are present but there is a loss (economic and / or physical loss) which is partial in nature. This expression should be understood in contradistinction to the phrase ‘loss’ which would be wider and include partial loss of goods concerned. Superior Court of Pennsylvania in Dluge vs. Robinson1, while considering an issue relating to ‘negotiable instruments destroyed, stolen or otherwise lost’, referred to the definition of the term ‘lost’ in the Black’s Law Dictionary (4th edition) which reads as follows:

‘An article is “lost” when the owner has lost the possession or custody of it, involuntarily and by any means, but more particularly by accident or his own negligence or forgetfulness, and when he is ignorant of its whereabouts or cannot recover it by an ordinarily diligent search.’

In Sialkot Industrial Corporation vs. UOI2 the phrase ‘lost or destroyed’ was examined and it means a complete deprivation of the property involved. This decision is important as it highlights the commonality in the phrases lost, destroyed, disposition as that in which there is loss of possession over the goods:

‘10. According to the Webster’s Third New International Dictionary, the word “Loss” means, the act or fact of losing, failure to keep possession, deprivation, theft of property. In the same dictionary, the word “lost” is defined as meaning “not made use of, ruined or destroyed physically or morally, parted with, no longer possessed, taken away or beyond reach of attainment”. According to the Law Lexicon, Vol. 2 page 44, the word “loss” has no precise hard and fast meaning. It is a generic and comprehensive term covering different situations. Loss results when a thing is destroyed. But it is also caused when the owner has been made to part with it although the thing remains intact. In this sense, loss means and implies “a deprivation”. It is synonymous with damage resulting either in consequence of destruction, deprivation or even depreciation and when a party is dispossessed of a thing, either when it can never be recovered or when it is withheld from him, he is deemed to suffer the loss.’

The said decision was distinguished in BEML vs. CC Madras3 in the context of the Customs Act which had distinct provisions for goods lost or destroyed and those that are pilfered. In that context the Court held that goods stolen cannot be included in the phrase lost or destroyed. But this distinction does not alter the interpretation in section 17(5)(h) since they are subject to similar implications under the GST law.

In CIT vs. Sirpur Paper Mills Ltd. [1978] 112 ITR 776 (SC) the word ‘destroy’ came up for consideration – Destroyed is a word in common usage, with well-defined non-technical meaning. As used in law, it does not in all cases necessarily mean complete annihilation or total destruction. But in the context and under particular circumstances the word many times has been defined as meaning totally obliterated and done away with as also made completely useless for the purpose intended – vide Corpus Juris Secundum, Volume 26, page 1246.

‘We are not concerned in this case with a situation where two independent machineries which are separable have to work combined for the purpose of business. We, therefore, need not answer as to what would happen in such a case. We are concerned in this case with the part of the machinery which admittedly was inseparable and had no independent existence as machinery. The context in which the words “sold”, “discarded”, “demolished” or “destroyed” are used and for the purpose for which they are used, to our mind, clearly suggest that it is to the whole machinery that they apply and not to any part of the machinery.’

OTHER LEGAL PROVISIONS
One may recollect the contextual use of the phrase lost and / or destroyed under the Central Excise Rules, 1944. The provision read as follows:

‘21. Remission of duty – (1) Where it is shown to the satisfaction of the Principal Commissioner or Commissioner, as the case may be that goods have been lost or destroyed by natural causes or by unavoidable accident or are claimed by the manufacturer as unfit for consumption or for marketing, at any time before removal, he may remit the duty payable on such goods, subject to such conditions as may be imposed by him by order in writing:’

Similar expressions were used in sections 22 and 23 of the Customs Act in the context of remission of Customs duty prior to clearance of goods for home consumption. The extract reads as follows:

‘SECTION 22. Abatement of duty on damaged or deteriorated goods. – (1) Where it is shown to the satisfaction of the Assistant Commissioner of Customs or Deputy Commissioner of Customs –
(a) that any imported goods had been damaged or had deteriorated at any time before or during the unloading of the goods in India; or
…..
(c) that any warehoused goods had been damaged at any time before clearance for home consumption on account of any accident not due to any wilful act, negligence or default of the owner, his employee or agent,
SECTION 23. Remission of duty on lost, destroyed or abandoned goods. – (1) Without prejudice to the provisions of section 13, where it is shown to the satisfaction of the Assistant Commissioner of Customs or Deputy Commissioner of Customs that any imported goods have been lost (otherwise than as a result of pilferage) or destroyed, at any time before clearance for home consumption, the Assistant Commissioner of Customs or Deputy Commissioner of Customs shall remit the duty on such goods.’

The specific use of the phrases ‘damage’ / ‘deterioration’ in company with ‘destroyed’ conveys that the Legislature has in the past assigned a distinct connotation to these phrases and the degree of damage or the condition of damage plays an important role in ascertaining whether there is destruction. It appears that only complete damage rendering the goods unusable would be considered as destruction and not otherwise.

RULE OF ‘NOSCITOR A SOCII’
While understanding the above phrase individually, the Noscitor rule of construction ought to be applied. According to the rule, where two or more words which are susceptible to analogous meaning are coupled together, they are understood to be used in their cognate sense. On application of this rule, it would be impermissible to extract a phrase and give it a meaning which is at divergence or wider in amplitude than the other phrases. They are to take colour from each other.

In the present context, the phrases ‘lost’, ‘stolen’, ‘destroyed’, ‘written off’ or ‘disposed of’ appear to have a common thread. The phrase lost and stolen is undoubtedly to be understood as a situation where the owner is deprived of the goods in its entirety. On the other end, the phrases ‘disposed of by gift or free sample’ also represents transfer of goods in its entirety to another person. Accordingly, the intermittent phrases ought to also be understood in the same sense. The phrases ‘destroyed’ and ‘written off’ should also be interpreted in the same sense. Destroyed ought to imply such destruction which completely extinguishes the goods. Partial damage or spoilage of goods which continue to have a physical existence and can be recovered or used partially should not be construed as destroyed. Moreover, write-off of goods represents a permanent write-off of goods which are not having any use to the business enterprise. Partial write-off due to technological obsolescence, etc., cannot be intended to have been included in the said enumeration.

Moreover, these are instances which are unforeseen or non-recurring in nature. If the business practice recognises foreseeable losses (such as evaporation, seasonal damage, etc.), such events may not fall within the strict construction of section 17(5)(h). Losses which arise out of business necessity, conscious efforts, budgeted / identified events, factored into product costs, etc., ought not to be considered as an unforeseen loss. Though there may be involvement of incidents of destruction of the goods, such destruction (being recognised and forecast) would not contextually adhere to the intent of the entire phrase. While one may contend that the phrases ‘disposed of by gift or free sample’ is a voluntary act, the fabric of the phrase evidently necessitates that the events have an unforeseen character inherent in them.

In Symphony Services Corp. India Pvt Ltd. vs. CC Bangalore4 the Court examined a situation where the goods have become entirely useless due to seepage of water, thereby concluding that they were destroyed goods, rejecting the contention of the Department that the said goods were ‘damaged goods’ and not ‘destroyed goods’. This decision is important for the proposition that only complete damage would fall within the expression destruction of goods and the physical condition of the same should be such that it renders them utterly unusable. It is only when such an interpretation is adopted that section 17(5)(h), in its entirety, would one be able to adhere to the Noscitor rule and ensure a consistent understanding of the phrase.

‘In respect of’
Before we move further, it is also important to study the phrase ‘in respect of’ standing at the preamble of section 17(5)(h). One understanding of this phrase is that it has a wide connotation and the Legislature intends to use this phrase in an expansive sense. The popular decision cited in this context is the case of Renusagar Power Co. Ltd. vs. General Electric Co., (1984) 4 SCC 679 where the Courts examined the scope of the arbitration clause in an agreement and held as follows:

‘(2) Expressions such as “arising out of” or “in respect of” or “in connection with” or “in relation to” or “in consequence of” or “concerning” or “relating to” the contract are of the widest amplitude and content and include even questions as to the existence, validity and effect (scope) of the arbitration agreement.’

The said interpretation was followed in a recent decision of the Supreme Court in the context of section 8 of the IBC (Macquarie Bank Limited vs. Shilpi Cable Technologies Limited5) which stated that the phrase ‘in relation to’ is of wide import and consequently interpreted in an expansive sense. In Doypack Systems Pvt. Ltd. vs. UOI (1988) 2 SCC 299, the Court was examining the expression ‘in relation to’ (so also ‘pertaining to’) and held that these expressions are intended to include matters of both direct and indirect significance depending on the context. The Court also stated that the expression ‘relate’ is to be understood as bringing into association or connection with and the said expression is synonymous with ‘concerning to’ and ‘pertaining to’. These are expressions of expansion and not of contraction. Similar views were echoed in other decisions in the context of Central Excise laws6. The above conclusions convey that section 17(5) should be read in its expansive sense with complete play being given to the scope of blocked credits. Accordingly, while interpreting the provisions in respect of goods which are lost, destroyed, etc., they must be applied in an expansive sense rather than a narrow sense.

But a more proximate context was considered in State of Madras vs. Swastik Tobacco Factory7 where the Court was examining the phrase ‘in respect of’ used while granting deduction of excise duty paid in respect of goods sold. While the Revenue argued that ‘in respect of’ here is synonymous with ‘on’ and narrows down the scope of the phrase to only those goods ‘on’ which excise duty was paid, the assessee argued the phrase was wide enough to cover even cases where excise duty paid on raw materials can be attributed to the finished goods. The Court rejected the argument of the assessee and held ‘in respect of’ in the context can only mean goods on which excise duty was paid and not on raw materials which are attributable to the final product. This decision narrowed down the ambit of the phrase and limited the scope of a ‘deduction provision’ to only cases having a direct significance with the subsequent events. Accordingly, the provisions of section 17(5) [more specifically clause (h)] should mandate that the ITC is denied only in respect of those goods which are lost, stolen, destroyed, etc., and not extend itself to goods contained in the finished goods after being put to use.

IDENTITY TEST OF GOODS
The above analysis takes us to the important juncture of whether there has to be a matching of the identity of goods on which credit is taken and the goods on which credit is being denied. In other words, whether a manufactured tyre which is lost, destroyed, stolen can be subjected to reversal ‘in respect of’ the ITC availed on the rubber used as raw material for manufacture of the tyre.

We should reflect back to the CENVAT Credit Rules, 2004 which contained certain provisions on reversal of ITC on removal, loss, destruction, etc.

Rule

Situation

Reversal

Inference

3(5)

Inputs or capital goods removed as such

Complete

Prior to usage

3(5A)

Capital goods removed after use

Depreciated

Subsequent to usage

3(5B)

Input or capital goods wholly or partially
written off

Complete

Non-usage

3(5C)

Inputs on which excise duty remitted (lost
or destroyed)

Input contained in finished goods

Used and contained in a finished product on
which duty was not collected

The said rules captured the cases where the inputs were not put to the intended use of manufacture of goods. In rule 3(5), removal ‘as such’ was interpreted to apply only to cases where the goods were removed without putting them to any use. There have been multiple decisions on the specific point8 that ‘as such’ implies goods in their original condition without having been put to use. Courts have opined that alteration of the form, usage of goods into production process for a reasonably long period would not amount to removal of goods ‘as such’. This leads to the introduction of Rule 3(5A) which addresses the removal of capital goods after usage on a depreciated value. Such an interpretation appeared to be in harmony with the underlying basis for credit, i.e., use or intended for use. Importantly, the law refrained from introducing any reversal on removal of inputs contained in finished goods after the usage of such inputs. Rule 3(5B) was also introduced to address cases where goods, even though in non-usable condition, were retained in the premises and hence did not trigger removal of goods. The said rule therefore mandated reversal of credit where the write-off in the books of accounts was undertaken as a consequence of non-usage of goods. The proviso in the said rule entitled re-credit of this reversed amount the moment the same were again put back to use by the manufacturer.

Rule 3(5C) was introduced to address cases where goods were used and contained in the finished goods which were either lost or destroyed and the excise duty on the same was remitted under the Central Excise Rules. The crucial point worth noting is that these Rules distinctly provided for cases where goods on which credit was taken were ‘contained’ in the manufactured product. Until this Clause was inserted, courts have taken the view that CENVAT rules did not provide for reversal of goods used in the manufacturing process which were ultimately lost or destroyed and duty was remitted in terms of Rule 219. Even subsequent to the introduction of this Clause, Courts have held that the reversal of credit is not automatic and one has to establish remission of excise duty on such goods for reversal under 3(5C) to be triggered10.

The above interpretation rules out many cases of goods which are lost or destroyed or removed after use in production process. Even in cases where the identity of goods is altered / processed into finished products, the mere fact of inputs being contained in such lost / destroyed finished goods does not warrant a reversal unless there are specific provisions to perform the same. In summary, the identity test definitely played an important role in reversal of CENVAT credit.

In the context of GST law, the conclusion ought to remain constituted in view of legacy understanding of credit provisions and the literal wordings of section 17(5)(h). The preliminary conclusion derived on application of the Noscitor rule is further fortified when one reflects upon the background of legacy provisions.

Therefore, the wide interpretation of ‘in respect of’ may not be palatable to taxpayers and there may be an inclination to highlight the context in which this phrase is to be interpreted. They would claim that the expansive nature of section 16(1) should not be defeated by a wider interpretation of section 17(5). Goods lost, destroyed, etc., should be understood as an exception to the positive intent to allow tax credits in case of business use. Where business use has been met and the taxpayer is able to establish the necessity for use of the product in a particular manner (generally framed as commercial expediency), Revenue ought not to question the business acumen behind the use of such goods. And this is where Courts will have to also take cognizance of the ‘commercial expediency test’ while interpreting the said phrase.

The most profound appreciation of this test was stated in an Income-tax matter in S.A. Builders case11 which was examining a matter of allowability of interest for the purpose of business. The Court stated (in para 23-25 and 31) that expenses incurred out of business expediency do not limit themselves to earning profits or one’s own business. It would also include matters undertaken out of a business necessity or prudence even though it does not appear to render an immediate or a visible benefit to the said business. Most importantly, the A.O. cannot sit in judgement over the commercial expediency of a business decision [Hero Cycles (P) Limited vs. CIT12]. The said test was also expounded in J.K. Cotton Spg. & Wvg. Mills Co. Ltd. vs. Sales Tax Officer in the context of Cenvat / Modvat Credits under the erstwhile laws. The Supreme Court stated that credit ought to be extended to equipment in manufacture of goods if it aids any particular process and the said process is so integrally connected with the manufacturing that its absence would render the same commercially inexpedient.

The applicability of the above analysis under GST is visible with the decision of ARS Steel & Alloy International (P) Ltd. where the Madras High Court while addressing the Revenue’s contention that finished goods contained a substantially lower quantity of inputs in comparison with the raw material consumed, stated that loss of inputs which is inherent to the manufacturing process cannot be denied u/s 17(5)(h). The Court relied on the decision in Rupa & Co. Ltd. vs. CESTAT13 and observed that the phrase ‘Inputs of such finished product’ and ‘contained in finished products’ are distinct phrases and they cannot be viewed theoretically as mere semantics. It must be viewed in the context of the manufacturing process which necessarily entails loss of goods at various stages and such loss cannot be equated to loss of the inputs as such. Therefore, the legacy principle that the identity of the goods and the identity of the credit in respect of the goods for which reversal is being sought on the eventuality of being ‘lost’, ‘destroyed’, etc., u/s 17(5)(h) should be mapped and only on such identification would the reversal be permissible under law.

APPLICATION
The above analysis can now be applied to a set of cases where there has been a constant tug-of-war between the taxpayer and his Officer. The Table below has been divided into distinct instances based on events:

Stage

Event

Analysis for 17(5)(h)

Reasoning

Pre-receipt stage

In-transit normal loss – Foreseeable

Threshold conditions u/s 16(2) need to be satisfied and only
then 17(5) to be applied

Section 16(2) mandates receipt of goods but unavoidable
evaporation loss in transit may not disentitle credit. Receipt here is being
applied as ‘legal receipt’ and not merely physical receipt. Once legal
receipt is satisfied then 17(5)(h) test may not bar credit on normal loss

In-transit abnormal loss (pilferage)

Same as above

Section 16(2) may not place a bar on legal receipt, but
pilferage would be covered by section 17(5)(h) and hence inadmissible

Weighment

Short receipt recorded due to weighing scale calibration
differences

This is more a recognisable financial loss on account of
technical reasons and not in the sense understood by section 17(5)(h) which
are unforeseeable in nature

RM – store / shop floor

Spillages, residues, etc., due to handling

Quantitative loss but not complete loss

Generally attributable to mishandling or loss within tolerable
limits. May not be

(continued)

 

 

 

(continued)

 

‘lost or destroyed’ if an accepted business practice

Natural causes

Arising on account of floods, fire, etc.

Could fall within the scope based on degree – if goods can be
revived even partially may not fall within the phrase

Spoilage / Damage

Weather, season, handling, etc.

May not fall within the scope of destroyed or lost if goods in
usable condition partially

Pilferage

Stolen

Not eligible for credit

In-process

Normal loss – manufacturing activity

Business expediency

Eligible not covered in exigencies of 17(5)

Spillages, etc., physical handling

Part
of manufacturing process

Eligible to the extent of foreseeable or budgeted losses (normal
loss)

In-process damage

Part
of manufacturing process

Eligible to the extent of foreseeable or budgeted losses (normal
loss)

Qualitative Testing (QC)

Part
of manufacturing process

Eligible on account of business expediency

FG/
Captive consumption

Pilferage

Stolen

In view of the phrase ‘in respect of’, the ingredients of the
finished goods may be susceptible to reversal though difference of opinion
would arise

Normal loss

Inherent
nature of product

Eligible based on it being a foreseeable loss

Physical handling damage

Lost
or destroyed

May be considered as ‘lost’ where unforeseeable and complete
loss of goods

CONCLUSION
This is a topic where the Courts may have to draw a balance between the purported widespread application of section 17(5) and the business wisdom of taxpayers to treat their purchases in a particular manner while doing business. In the context of clause (h), one should be cognizant of the fact that the Government’s stake is limited to the tax component on such goods, whereas the taxpayer himself is committed to the base value of goods involved and if the taxpayer has made a decision to treat the goods in a particular way and recover their costs from the value chain, that decision ought to be respected by the Government while granting tax credits. Moreover, in mathematical terms where the taxpayer has factored in and loaded such losses onto the product pricing and the enhanced sale price, the loss is factored therein and tax revenue attributable to such loss has been passed on as a value addition down the value chain. Ultimately, in the legal sense the maxim ‘Ex praecedentibus et consequentibus optima fit interpretatio’ is apt here – the best interpretation is made from the context!

Search and seizure – Assessment in search cases – Validity – Assessment completed on date of search – No incriminating material found during search – Invocation of section 153A not valid – Assessment order and consequent demand notice set aside

23 Smt. Jami Nirmala vs. Principal CIT [2021] 437 ITR 573 (Ori) A.Y.: 2015-16; Date of order:10th August, 2021 Ss. 132, 153A and 156 of ITA, 1961

Search and seizure – Assessment in search cases – Validity – Assessment completed on date of search – No incriminating material found during search – Invocation of section 153A not valid – Assessment order and consequent demand notice set aside

A search and seizure operation was conducted u/s 132 at the assessee’s residential premises and on a locker jointly held with another person. According to the panchanama prepared for the search and seizure, nothing was found or seized. A notice was issued to the assessee u/s 153A. The assessee requested the A.O. to treat the original return of income as the return filed in response to such notice. Thereafter, notices u/s 143(2) and 142(1) were issued. Although nothing was found during the course of the search, the order passed u/s 143(3) read with section 153A referred to the cash book found during the survey conducted two weeks prior to the date of search, and stated that during the course of the search operation it was found that the assessee company had made expenditure during the year which was paid in the mode of cash of beyond the prescribed limit of Rs. 20,000 or above in a single day to a single party. The A.O. also disallowed the payments made to the cultivators and hamalis and accordingly raised a demand u/s 156 along with interest.

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

‘i) The assessment u/s 153A pursuant to a search u/s 132 has to be on the basis of incriminating material gathered or unearthed during the course of the search.

ii) The order passed u/s 143(3) read with section 153A was without jurisdiction. The order did not refer to any document unearthed during the course of the search conducted u/s 132. Therefore, the assumption of jurisdiction u/s 153A for assessment of the A.Y. 2015-16 was without legal basis. The panchanama of the search proceedings unambiguously showed that nothing incriminating was recovered in the course of the search. The assessment order and the consequential demand notice u/s 156 are set aside.’

Interest on excess refund – Law applicable – Effect of amendment of section 234D by F.A. 2012 – Section 234D applies to regular assessment – Meaning of regular assessment – Regular assessment refers to first order of assessment u/s 143, u/s 147 or u/s 153A – Order of assessment u/s 143(3) on 31st March, 2006 and order of reassessment passed on 26th December, 2008 – Section 234D not applicable – Interest could not be levied u/s 234D

22 CIT vs. United India Insurance Co. Ltd. [2021] 438 ITR 301 (Mad) A.Y.: 2001-02; Date of order: 24th August, 2021 S. 234D of ITA, 1961

Interest on excess refund – Law applicable – Effect of amendment of section 234D by F.A. 2012 – Section 234D applies to regular assessment – Meaning of regular assessment – Regular assessment refers to first order of assessment u/s 143, u/s 147 or u/s 153A – Order of assessment u/s 143(3) on 31st March, 2006 and order of reassessment passed on 26th December, 2008 – Section 234D not applicable – Interest could not be levied u/s 234D

The appellant Revenue had raised the following three substantial questions of law for consideration:

‘1. Whether on the facts and in the circumstances of the case the Income-tax Appellate Tribunal was right in deleting the interest levied u/s 234D?

2. Whether on the facts and in the circumstances of the case, no interest can be charged even for the period subsequent to the introduction of section 234D merely on the ground that the said section was introduced by the Finance Act, 2003 with effect from 1st June, 2003?

3. Whether on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was right in holding that interest levied u/s 234D cannot be charged for the A.Y. 2001-02, especially when the assessment order was made after introduction of the said section?’

The Madras High Court held as under:

‘i) Section 234D deals with “interest on excess refund”. Explanation 1 to section 234D states that where, in relation to an assessment year, an assessment is made for the first time u/s 147 or section 153A, the assessment so made shall be regarded as a regular assessment for the purposes of section 234D of the Act. Explanation (2) was inserted for the removal of doubts and declared that the provisions of section 234D shall also apply to an assessment year commencing before 1st June, 2003 if the proceedings in respect of such assessment year are completed after that date. Explanations (1) and (2) were inserted by the Finance Act, 2012 with retrospective effect from 1st June, 2003.

ii) “Regular assessment” has been defined u/s 2(40) to mean the assessment made under sub-section (3) of section 143 or section 144. Explanation (1) would stand attracted if an assessment is made for the first time u/s 147 or section 153A and the assessment, if it is done for the first time, shall be regarded as a “regular assessment” u/s 2(40).

iii) Admittedly, the assessment order dated 26th December, 2008 u/s 143(3) read with section 147 was not the first assessment, as an assessment was made u/s 143(3) dated 31st March, 2004 which fact was not disputed. Since the assessment framed u/s 143(3) read with section 147 dated 26th December, 2008, was not the assessment made for the first time, it could not be regarded as a “regular assessment” for the purposes of section 234D and, therefore, no interest could be levied on the assessee.’

Income Declaration Scheme – Failure to pay full amount of tax according to declaration – Declaration would be rendered void and non est – Part of tax already paid under scheme cannot be forfeited by Revenue authorities – Such amount must be returned to assessee

21 Pinnacle Vastunirman Pvt. Ltd. vs. UOI [2021] 438 ITR 27 (Bom) A.Y.: 2016-17; Date of order: 11th August, 2021 Income Declaration Scheme, 2016 – Effect of S. 181 of Finance Act, 2016

Income Declaration Scheme – Failure to pay full amount of tax according to declaration – Declaration would be rendered void and non est – Part of tax already paid under scheme cannot be forfeited by Revenue authorities – Such amount must be returned to assessee

The assessee had made a declaration under the Income Declaration Scheme, 2016 concerning the A.Y. 2016-17. However, it could not make full payment of tax according to the declaration. Therefore, the declaration had become void and non est. The petitioner therefore applied for refund of the taxes so paid under the declaration or to give adjustment or credit of the amount so paid. The application was rejected.

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

‘i) Article 265 of the Constitution of India provides that no tax shall be levied or collected except by authority of law. This would mean there must be a law, the law must authorise the tax and the tax must be levied and collected according to the law. Sub-section (3) of section 187 of the Finance Act, 2016 which deals with the Income Declaration Scheme, 2016 categorically provides that if the declarant fails to pay the tax, surcharge and penalty in respect of the declaration made u/s 183 on or before the dates specified in sub-section (1), the declaration filed by him shall be deemed never to have been made under the Scheme. This would mean that the declaration will be non est. When the scheme itself contemplates that a declaration without payment of tax is void and non est and the declaration filed by the assessee would not be acted upon [because section 187(3) says the declaration filed shall be deemed never to have been made under the Scheme], the question of retention of the tax paid under such declaration will not arise. The provisions of section 191 cannot have any application to a situation where the tax is paid but the entire amount of tax is not paid. The Scheme does not provide for the Revenue to retain the tax paid in respect of a declaration which is void and non est.

ii) The assessee was entitled to an adjustment by giving credit for the amount of Rs. 82,33,874 paid under the Income Declaration Scheme.’

Capital gains – Long-term or short-term capital asset – Period of holding – No distinction between unlisted and listed shares for classifying as short-term capital asset

20 CIT vs. Exim Rajathi India Pvt. Ltd. [2021] 438 ITR 19 (Mad) A.Y.: 2007-08; Date of order: 7th September, 2021 S. 2(42A) proviso of ITA, 1961

Capital gains – Long-term or short-term capital asset – Period of holding – No distinction between unlisted and listed shares for classifying as short-term capital asset

For the A.Y. 2007-08, the Commissioner invoking his power u/s 263 held that the order passed by the A.O. u/s 143(3) was erroneous and prejudicial to the interests of the Revenue on the ground that the shares held by the assessee in a company, which was not a listed company when sold, should be treated as ‘short-term capital asset’ as defined u/s 2(42A) and not as ‘long-term capital asset’. Accordingly, the A.O. computed the short-term capital gains.

The Commissioner (Appeals) directed the A.O. to treat the shares as long-term capital asset, allow indexation and tax the resultant capital gains at the special rate of 20%. The Tribunal concluded that there was no distinction between unlisted and listed shares for classifying them as short-term capital asset under the Act and affirmed the decision of the Commissioner (Appeals).

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

‘i) In terms of the definition u/s 2(42A), short-term capital asset would mean a capital asset held by an assessee for not more than 36 months immediately preceding the transfer. The provision does not make a distinction between shares in a public company, a private company, a listed company or an unlisted company. The use of the word “or” in between each of the categories is very important and such distinction needs to be borne in mind. Although “securities” as defined u/s 2(h) of the Securities Contracts (Regulation) Act, 1956 includes shares, scrips, stocks, bonds, etc., that by itself cannot have an impact to give a different interpretation to the distinction of “short-term capital asset” as defined in section 2(42A).

ii) According to the Explanatory Notes to the provisions of the Finance (No. 2) Act, 2014, in Circular No. 1 of 2015 dated 21st January, 2015 [(2015) 371 ITR (St.) 22] issued by the Central Board of Direct Taxes, all shares whether listed or unlisted enjoy the benefit of shorter period of holding, and investment in shares of private limited companies enjoy long-term capital gains on transfer after 12 months.

iii) The Tribunal was right in holding that the shares and debentures not listed could be treated as a long-term capital asset u/s 2(42A) of the Act read with its proviso.’

Assessment – Duty of A.O. to consider normal and special provisions relating to assessee – Company – Computation of book profits – A.O. must take into account provisions of section 115JB

19 CIT vs. Kerala Chemicals and Proteins Ltd. [2021] 438 ITR 333 (Ker) A.Y.: 2002-03; Date of order: 19th July, 2021 S. 115JB of ITA, 1961

Assessment – Duty of A.O. to consider normal and special provisions relating to assessee – Company – Computation of book profits – A.O. must take into account provisions of section 115JB

The assessee is engaged in the business of manufacturing and trading of ossein, compound glue, gelatine, etc. On 31st October, 2002, it filed the Income-tax return for the A.Y. 2002-03 declaring a total loss of Rs. 3,59,10,946. The A.O., through an assessment order dated 3rd March, 2005 made u/s 143(3), computed the total income of the assessee at Rs. 2,99,81,060.

The Commissioner (Appeals) partly allowed the appeal. The Tribunal allowed the assessee’s appeal.

In the appeal by the Revenue, the following questions were raised:

‘1. Whether on the facts and in the circumstances of the case and also in the light of section 80AB, the Tribunal is right in holding that while computing the book profit u/s 115JB the deduction u/s 80HHC is to be computed as per minimum alternate tax provisions and not as per the normal provisions of the Income-tax Act, 1961?

2. Whether on the facts and in the circumstances of the case, the Tribunal is right in law and fact,
(i) in presuming that the A.O. has considered clause (c) of Explanation to section 115JA in the A.Ys. 1997-98 and 1998-99;
(ii) in holding that merely because proper working is not available on record, it cannot be said that the A.O., has not considered the same; and are not the approach and the conclusion based on presumptions and suppositions perverse, arbitrary and illegal?

3. (a) Whether on the facts and in the circumstances of the case, the Tribunal is justified in directing the A.O. to reduce the net profit by the sum of Rs. 3,29,27,056 in place of Rs. 1,42,02,335 as has been done by the A.O.?
(b) Whether on the facts and in the circumstances of the case, the Tribunal is right in law in directing the A.O. to allow an amount of Rs. 1,87,24,721 being the provision for excise duty written back on the “presumption” that even though the provisions of minimum alternate tax were not considered as the assessments were completed applying the normal provisions of the Act; and the A.O. has considered clause (c) of Explanation to section 115JA in the A.Ys. 1997-98 and 1998-99?’

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

“i) Once the return is filed by the assessee, it is the responsibility of the A.O. to compute the income of the assessee under normal provisions and special provisions. The income tax is collected on the income whichever is higher in these two methods, i. e., either normal provision or special provision.

ii) In the A.Ys. 1997-98, 1998-99 and 1999-2000, provision for disputed excise duty was made by the assessee. The assessment orders for the first two years were made referring to the normal provisions of the Act and the necessity to refer to the special provisions was not noticed by the A.O. The Tribunal, taking note of the fact that the assessee was subject to the slab rate of 30% for the A.Ys. 1997-98 and 1998-99, computed the tax under normal provisions.

iii) The Tribunal had rightly found that the fact that the proper working was not reflected in the respective assessment orders or the record could not lead to the conclusion that the A.O. had not considered the applicability of the special provision as well and that the omission on the part of the A.O. in referring to the special provisions ought not to deny the writing-back provision available under the second proviso to sub-section (2) of section 115JB. The denial of the benefit of writing back the provision to the assessee in these assessment years was illegal and the finding recorded by the Tribunal was valid and correct in the circumstances of this case.’

Assessment – International transactions – Section 144C mandatory – Assessment order passed without following procedure laid down in section 144C – Not a procedural irregularity – Section 292B not applicable – Order not valid

18 SHL (India) Pvt. Ltd. vs. Dy. CIT [2021] 438 ITR 317 (Bom) A.Y.: 2017-18; Date of order: 28th July, 2021 Ss. 144C and 292B of ITA, 1961

Assessment – International transactions – Section 144C mandatory – Assessment order passed without following procedure laid down in section 144C – Not a procedural irregularity – Section 292B not applicable – Order not valid

The petitioner is an Indian company incorporated under the Companies Act, 1956. It is a part of the SHL Group, United Kingdom, and primarily a trading entity that provides SHL products (psychometric test), assessment, consultancy and training services (‘SHL Solutions’) to clients in India in various industries. The petitioner had filed the return of income on 30th March, 2018 declaring a total income of Rs. 1,01,31,750. Its case is that during the A.Y. 2017-18 it had entered into an international transaction with its associated enterprise (the ‘AE’) whereby it was granted a licence to market, distribute and deliver the SHL Solutions to clients in India from its associated enterprise, for which the petitioner made payments towards support services charges incurred by the associated enterprise. It submitted that along with the return of income filed for the said year, in view of the various international transactions with the associated enterprise, Form 3CEB was filed along with the return of income.

The petitioner’s case was selected under the computer-aided scrutiny selection (CASS) pursuant to which, on 5th September, 2018 a notice was issued u/s 143(2). Thereafter, on 6th August, 2019, a reference was made to the Transfer Pricing Officer (TPO) by the first respondent. A notice was issued on 16th August, 2019 by the TPO and an order dated 29th January, 2021 was passed by the TPO proposing transfer pricing adjustments of Rs. 10,74,54,337 considered as Nil by the petitioner. On 10th March, 2021, the second respondent, viz., National e-Assessment Centre, Delhi requested the petitioner to provide rebuttal to the proposed adjustments to the arm’s length price made by the TPO. On 15th March, 2021, the petitioner filed a reply and on 6th April, 2021, a final assessment order was passed u/s 143(3) read with sections 143(3A) and 143(3B), determining the total income at Rs. 11,75,86,087. A notice of demand for Rs. 1,17,60,810 was also issued. A notice initiating penalty proceedings also came to be issued u/s 274 read with section 270A.

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

‘i) Section 144C(1) is a non obstante provision, which requires its compliance irrespective of the other provisions that may be contained in the Act. The requirement u/s 144C(1) to first pass a draft assessment order and to provide a copy thereof to the assessee is a mandatory requirement which gives a substantive right to the assessee to object to any variation that is prejudicial to it. The procedure prescribed u/s 144C is a mandatory procedure and not directory. Failure to follow the procedure would be a jurisdictional error and not merely a procedural error or irregularity but a breach of a mandatory provision. Therefore, section 292B cannot save an order passed in breach of the provisions of section 144C(1), the same being an incurable illegality.

ii) The assessee was an eligible assessee and there was no dispute as to the applicability of section 144C. It was also not in dispute that the final assessment order had been passed without the draft assessment order as contemplated u/s 144C(1). The order was not valid.’

Assessment – Draft assessment order – Objections – Powers of DRP – DRP must consider merits of objections – Objections cannot be rejected for mere non-appearance of party at time of hearing

17 Sesa Sterlite Ltd. vs. DRP [2021] 438 ITR 42 (Mad) A.Y.: 2011-12; Date of order: 29th July, 2021 S. 144C of ITA, 1961

Assessment – Draft assessment order – Objections – Powers of DRP – DRP must consider merits of objections – Objections cannot be rejected for mere non-appearance of party at time of hearing

The issue raised in this writ petition is whether the Dispute Resolution Panel (DRP) is competent to reject the objections on account of non-appearance of the assessee on the hearing date. The Madras High Court allowed the writ petition and held as under:

‘i) Under section 144C, on receipt of the draft order the assessee gets a right to file his objections, if any, to such variations with the DRP and the A.O. The DRP consists of three Commissioners of the Income-tax Department. They undoubtedly have certain expertise in the tax regime. Thus, adjudication before the DRP is a valuable opportunity provided both to the assessee as well as to the A.O. Either of the parties may get guidance for the purpose of completion of the assessment proceedings. Thus, the importance attached to the DRP under the Act can in no circumstances be undermined.

ii) When the Act contemplates a right to the assessee, such right must be allowed to be exercised in the manner prescribed under it. The manner in which objections are to be considered by the DRP are well defined both under the Act as well as under the Income-tax (Dispute Resolution Panel) Rules, 2009. Sub-section (6) of section 144C unambiguously states that the DRP is bound to consider the materials denoted as the case may be and issue suitable directions as it thinks fit. Therefore, the DRP has no option but to deal with objections, if any, filed by an eligible assessee on merits and, in the event of non-consideration, it is to be construed that the right conferred to an assessee has not been complied with.

iii) The language employed is “shall” both under sub-sections (5) and (6) of section 144C. Therefore, the DRP has no option but to strictly follow sub-sections (5) and (6) of section 144C which are mandatory provisions as far as the DRP is concerned; sub-sections (7) and (8) of section 144C are discretionary powers. Sub-section (11) is to be linked with sub-section (2)(b)(i) and (ii) of section 144C because an opportunity is bound to be given to the assessee as well as to the A.O. Sub-section (11) is also significant with reference to the opportunities to be granted to the parties before the DRP. The DRP is a quasi-judicial authority. This being the case, the DRP is bound to pass orders as it thinks fit only on the merits and such quasi-judicial authorities are not empowered to reject the objections merely by stating that the assessee had not appeared before the DRP. The DRP is legally bound to adjudicate the objections and pass orders on the merits, even in case of the assessee or the A.O. failing to appear for personal hearing.

iv) An order passed rejecting the objections submitted by the assessee, merely on the ground that the assessee has not appeared on the hearing date, is infirm and liable to be quashed.’

Section 3(1), Black Money (Undisclosed Foreign Income & Assets) and Imposition of Tax Act 2015 (‘BMA’) – Relevant point of time for taxation of an undisclosed foreign asset under BMA is point of time when such asset comes to notice of Government – It is immaterial as to whether it continued to exist at time of taxation, or at the time when provisions of BMA came into existence

2 Rashesh Manhar Bhansali vs. ACIT [(2021) 132 taxmann.com 20 (Mum-Trib)] BMA Nos. 3 and 5 (Mum) of 2021 A.Y.: 2017-18; Date of order: 2nd November, 2021

Section 3(1), Black Money (Undisclosed Foreign Income & Assets) and Imposition of Tax Act 2015 (‘BMA’) – Relevant point of time for taxation of an undisclosed foreign asset under BMA is point of time when such asset comes to notice of Government – It is immaterial as to whether it continued to exist at time of taxation, or at the time when provisions of BMA came into existence

FACTS
The assessee (RMB) and his wife (ARB) were Directors and shareholders in a company incorporated in the British Virgin Islands (‘BVI Co’). The assessee had not disclosed this information in the Return of Income (‘ROI’) filed in India.

The Investigation Wing of the Income-tax Department received information regarding two accounts held in the UBS Bank, Singapore branch by BVI Co. On further probe, including information received through exchange of information provisions under the India-Singapore DTAA, the Department found that RMB and ARB were the beneficiaries and operators of the said accounts. Further, the said accounts showed gross credit entries of US $147 million (INR 999.74 crores @ US $1 = INR 68) over a period of time (which also included intra-bank and contra entries).

The KYC documents related to these bank accounts revealed that passport copies of RMB and ARB were submitted along with handwritten instructions for operating the bank accounts. One of the bank accounts was closed in 2008 and the other one in 2011.

The chronology of investigation by the Tax Authorities is as follows.

Year

Investigation

2013 and 2014

 

Summons for investigation were sent asking for details of
foreign asset, beneficial ownership, etc.

2016

Search conducted in premises of assessee

2017

BMA proceedings initiated by A.O.

At all the above-mentioned stages, the assessee denied having any knowledge of the said foreign bank accounts. Just three days prior to the completion of the assessment, RMB admitted that these accounts were opened in his and his wife’s name by his late father by taking their signatures on papers in the past. He submitted that the credit entries in the accounts were loans taken from UBS Bank which were repaid with interest.

The A.O. rejected various explanations offered by the assessee and held that the assessee is the beneficial owner of the undisclosed foreign bank accounts and computed total income of INR 56 crores. On appeal, CIT(A) gave partial relief of US $3.2 million (roughly, INR 21.8 crores) on account of credits in respect of redemption of investments held earlier.

Being aggrieved, both parties appealed to the ITAT.

HELD1
Applicability of BMA to undisclosed assets held, and income earned, prior to the enactment of the law (i.e., 1st July, 2015)
• The two foreign bank accounts were closed in 2008 and 2011. The assessee contended that an asset which did not exist at the time when BMA came into force cannot be assessed under the said Act.
• Section 3(1) of BMA specifically provides that an undisclosed asset located outside India shall be charged to tax in the year in which it comes to the notice of the A.O.
• It is immaterial whether the asset existed at the point of time of taxation or even at the time when the provisions of BMA came into existence. The only relevant date for levying tax is when the undisclosed asset comes to the notice of the A.O.
• The assessee further contended that BMA cannot be invoked in respect of a foreign asset which was already in the knowledge of Revenue authorities (i.e., Investigation Wing of the Income-tax Department) before the said Act came into force. The assessee relied upon the CBDT Circular2 which prohibited assessees from making a one-time voluntary declaration of foreign assets in respect of which the Government has prior information on the specified date.
• The said Circular is relevant only for voluntary declaration under BMA and it cannot be relied upon for making assessments under BMA.
• For taxation under BMA what is relevant is that either such foreign income is not disclosed in the ROI filed, or that the ROI is not filed at all by the assessee in India.

Bank account is an asset under BMA
• The assessee contended that an undisclosed foreign bank account is not an asset u/s 2(11) of BMA. The assessee argued that though Black Money Rules provide for valuation of undisclosed bank accounts, section 2(11) of the BMA does not cover a foreign bank account which does not exist.
• The assessee also contended that since section 2(11) of the BMA refers only to such assets having ‘cost of acquisition’ (i.e., source of investment), a bank account cannot be treated as an undisclosed foreign asset.
• Amount receivable from the bank in respect of a bank account is an asset of the person holding that account. If the owner of a bank account can substantiate the source of investment which is duly disclosed to Revenue authorities, to that extent, the source of investment is explained and the requirements of section 2(11) can be satisfied even in respect of a bank account.

Beneficial owner of asset
• The assessee contended that section 2(11) of the  BMA defines an undisclosed asset as one in which the assessee is a ‘beneficial owner’. Since this term is not defined under the BMA, it must derive its meaning from section 139(1) of the Income-tax Act, 19613.
• Merely because the expression ‘beneficial owner’ is defined under the Income-tax Act, 1961, per se, it cannot as well apply to BMA. Reliance was placed on the ITAT decision in the Jitendra Mehta case4 where it was held that beneficial owner can be interpreted with reference to the dictionary meaning and the provision in other statues keeping in mind the object and purpose of the BMA. The ITAT rejected the above arguments and held the assessee to be the beneficial owner of the foreign bank accounts under the BMA.

_____________________________________________________________________
1    For ease of reference, the issue raised by the assessee is mentioned before the observations of the ITAT
2    CBDT Circular No. 13 of 2015
3    Explanation 4 to section 139(1) provides that a ‘beneficial owner’ in respect of an asset is someone who has directly / indirectly provided for consideration for the asset
4    (BMA No. 1/Del/20; order dated 6th July, 2021)

An assessee who has voluntarily surrendered the registration granted to it u/s 12A cannot be compelled, by action of or by inaction of Revenue authorities, to continue with the said registration

18 Navajbai Ratan Tata Trust vs. Pr.CIT [(2021) 88 ITR(T) 170 (Mum-Trib)] ITA No.: 7238 (Mum) of 2019 A.Y.: Nil; Date of order: 24th March, 2021

An assessee who has voluntarily surrendered the registration granted to it u/s 12A cannot be compelled, by action of or by inaction of Revenue authorities, to continue with the said registration

FACTS
The assessee, a charitable trust, was granted registration u/s 12A. The trust vide letter dated 11th March, 2015 addressed to the CIT indicated that it did not desire to continue to avail the benefits of the registration made by the trustees in 1975. The trust was called for a hearing on 20th March, 2015 on which date the trust confirmed its agreement to the cancellation / withdrawal of the registration. Returns of income filed subsequent thereto were filed without claiming exemption under sections 11 and 12.

The CIT cancelled the registration of the assessee trust, as granted u/s 12A, with effect from the date of his order, i.e., 31st October, 2019.

The assessee filed an appeal with the ITAT.

HELD
The ITAT tried to ascertain the objective behind the Income-tax Department’s keenness to extend registration u/s 12A for the extended period from March, 2015 to October, 2019, when the assessee did not want it.

It then considered the relevant legislative amendments to ascertain the objective. First, it considered the amendment in section 11. By insertion of sub-section (7) in section 11 with effect from 1st April, 2015, tax exemption u/s 10(34) for ‘dividends from Indian companies’, on which dividend distribution tax was already paid by the company distributing dividends which was available to every other taxpayer, was denied to charitable trusts registered u/s 12A.

It also observed that the continuance of registration u/s 12A, even when the assessee does not want exemption u/s 11, may result in higher tax liability for a trust which has earned dividends from domestic companies otherwise eligible for exemption u/s 10(34), as in the given case. However, the ITAT also took into consideration the rationale behind the said amendment which was to ensure that the assessee does not have the benefit of choice between special provisions and general provisions. The ITAT also noted the Circular No. 1/2015 dated 21st January, 2015 explaining the above amendment. As against this, the ITAT observed the way this provision was interpreted by the tax authorities. The Revenue authorities opined that once an assessee is a registered charitable institution, irrespective of admissibility or even claim for exemption u/s 11, the exemption u/s 10(34) was inadmissible. This put the assessee at a disadvantage since the scheme of sections 11 to 13 which were intended to be an optional benefit to the charitable institutions, in the present case, became a source of an additional tax burden for the trusts in question because of the interpretation given by the Revenue.

The ITAT also noted that introduction of section 115TD would also have a bearing on the tax liability of the trust which would depend on the date of cancellation of registration.

From the above-mentioned Circular the ITAT inferred that the assessee has an inherent right to withdraw from the special dispensation of the scheme of sections 11, 12 and 13, unless such a withdrawal is found to be mala fide. It also observed that the disadvantageous tax implications on the assessee [non-application of section 10(34) and section 115TD] are only as a result of a much later legislative amendment which was not in effect even when the assessee informed the CIT of his disinclination to continue with the registration; an assessee unwilling to avail the ‘benefit’ of registration ‘obtained’ u/s 12A could not be compelled, by action of or by inaction of the Revenue authorities, to continue with the said registration.

The ITAT observed that registration u/s 12A was obtained by the assessee in 1976 and registration u/s 12A simply being a foundational requirement for exemption u/s 11 and not putting the assessee under any obligations, is in the nature of a benefit to the assessee. Referring to the decision of the Supreme Court in the case of CIT vs. Mahendra Mills (2000) 109 taxmann 225 / 243 ITR 56, it held that ‘a privilege cannot be a disadvantage and an option cannot become an obligation’. Thus, in the instant case, registration u/s 12A cannot be thrust upon the unwilling assessee.

It also held that wherever a public authority has a power, that public authority also has a corresponding duty to exercise that power when circumstances so warrant or justify it. Accordingly, in the instant case when the assessee communicated to the CIT of inapplicability of exemptions under sections 11 to 13, the CIT was duty-bound to pass an order in writing withdrawing the registration. In the instant case, not only was the procedure of cancellation of registration kept pending but also the proceedings conducted earlier were ignored and fresh proceedings were started after a long gap, on a standalone basis de hors the pending proceedings. This is more so considering the fact that delay in cancellation of registration has tax implications to the disadvantage of the assessee.

The ITAT thus concluded by holding that the CIT was under a duty to hold that the cancellation of registration is to take effect from the date on which the violation of the statutory requirements for grant of exemption occurred, the date on which such a violation or breach was noticed, or at least the date on which hearing in this regard was concluded. That is, the cancellation of registration was required to be effective, at the most, from 20th March, 2015, i.e., the date fixed for hearing. The inordinate delay in cancellation of registration, which is wholly attributed to the Revenue authorities, cannot be placed to the disadvantage of the assessee. Finally, it was held that the cancellation was effective from 20th March, 2015 and the appeal of the assessee was allowed.

Re-opening of assessee’s case merely on basis of information from Director (Investigation) pertaining to receipt of huge amount of share premium by assessee and the opinion that the amount of share premium was not justifiable considering its lesser income during the year was unjustified

17 Future Tech IT Systems (P) Ltd. vs. ITO [(2021) 89 ITR(T) 676 (Chd-Trib)] ITA Nos. 543, 548 and 549 (Chd) of 2019 A.Y.: 2010-11; Date of order: 22nd April, 2021

Re-opening of assessee’s case merely on basis of information from Director (Investigation) pertaining to receipt of huge amount of share premium by assessee and the opinion that the amount of share premium was not justifiable considering its lesser income during the year was unjustified

FACTS
The assessee-company filed its return of income on 20th September, 2010 declaring an income of Rs. 2,55,860 which was accepted and an assessment order was passed.

Subsequently, the A.O. received information from the Director (Intelligence & Criminal Investigation) that the assessee had received share premium of a huge amount during the year. Notice u/s 148 was issued. The assessee’s objections to the same were disposed of by the A.O. and assessment order was passed after making additions of Rs. 1,17,00,000 in respect of share premium by invoking provisions of section 68. On appeal before the CIT(A), the assessee argued that the A.O. did not mount a valid base for the reasons to come to a rational belief that the income of the appellant has escaped assessment and that there was lack of material to prove that the transaction of receipt of share application money was not genuine. The A.O. acted only on the borrowed satisfaction.

The CIT(A) observed that the A.O. noticed that the book value of the share of the company was Rs. 10 and the company had nothing in its balance sheet to attract such huge share premium. He also observed that the A.O. initiated the proceedings on the basis of specific information, so it could not be said that his action was on the basis of certain surmises and conjectures only and it could also not be said that the material in his possession could just give him reason to suspect and not reason to believe that the income had escaped assessment. Another observation made by him was that the A.O. applied his mind to the information by verifying from the assessment record that the assessee had very low income as against which it received huge share premium and hence his action is valid.

Aggrieved, the assessee preferred an appeal before the ITAT.

HELD
The assessee argued before the ITAT that the A.O. while issuing the notice u/s 148 doubted the share premium only and accepted the share capital received by the assessee, therefore, the initiation of the proceedings u/s 147 were based on suspicion. It was also submitted that the investor company explained the source and the assessee furnished relevant documents to the A.O. The documents furnished by the assessee proved the source of credit for share application money. Thus, according to the assessee, it had proved the identity, genuineness and the credit-worthiness of the shareholders.

The ITAT observed that an identical issue was decided by the ITAT in ITA No. 1616/Chd/2018 for the A.Y. 2010-11 vide order dated 15th June, 2020 in the case of Indo Global Techno Trade Ltd. vs. ITO. Relevant findings of the said case that were considered by the ITAT in the instant case were that mere information (without recording of any details) of the assesse receiving a high premium could not be said to be a reason to form the belief that the income of the assessee had escaped assessment. There is no dispute to the well-settled proposition that reason to believe must have a material bearing on the question of escapement of income. It does not mean a purely subjective satisfaction of the assessing authority, such reason should be held in good faith and cannot merely be a pretence. There could be no doubt that the words ‘reason to believe’ suggest that the belief must be that of an honest and reasonable person based upon reasonable grounds and that the Income-tax Officer may act on direct or circumstantial evidence but not on mere suspicion, gossip or rumour.

The other decision relied on by the assessee and considered by the ITAT was of the Chandigarh Bench of the Tribunal in the case of D.D. Agro Industries Ltd. vs. ACIT ITA Nos. 349 & 350/Chd/2017 order dated 7th September, 2017, wherein, on identical facts and circumstances, the A.O. recorded identical reasons to form belief for re-opening of the assessment. The Tribunal held that the A.O. assumed jurisdiction relying upon the non-specific routine information blindly without caring to first independently consider the specific facts and circumstances of the case and that the assumption of jurisdiction by the A.O. under the circumstances was wrong.

Thus, the ITAT followed the decision in Indo Global Techno Trade Ltd. vs. ITO (Supra).

The ITAT also considered the following other rulings on the issue:

• Rajshikha Enterprises (P) Ltd. vs. ITO for A.Y. 2005-06 vide order dated 23rd February, 2018 (Del ITAT);
• Pr.CIT vs. G&G Pharma India Ltd. (2016) 384 ITR 147 (Del HC);
• Pr.CIT vs. Meenakshi Overseas (P) Ltd. (2017) 395 ITR 677 (Del HC);
• Pr.CIT vs. Laxman Industrial Resources Ltd. (2017) 397 ITR 106 (Del HC); and
• Signature Hotels (P) Ltd. vs. ITO (2011) 338 ITR 51 (Del HC).

The ITAT applied the rationale of the above decisions to the facts of the instant case to conclude that the re-opening initiated by the A.O. was invalid. Thus, the ITAT allowed the appeal of the assessee.