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Year: 2021

Writ – Article 226 of Constitution of India and sub-sections 10(10C)(viii), 89(1), 154, 246A – Existence of alternative remedy not a bar to issue of writ where proceedings are without jurisdiction – Amounts received under voluntary retirement scheme – Denial of claim for deduction u/s 10(10C)(viii) and relief u/s 89(1) on basis of letter issued by CBDT – Decision of court quashing letter of Board – Order of denying relief – Proceedings without jurisdiction – Assessee entitled to relief

9. V. Gopalan vs. CCIT [2021] 431 ITR 76 (Ker) Date of order: 5th January, 2021 A.Y.: 2001-02

Writ – Article 226 of Constitution of India and sub-sections 10(10C)(viii), 89(1), 154, 246A – Existence of alternative remedy not a bar to issue of writ where proceedings are without jurisdiction – Amounts received under voluntary retirement scheme – Denial of claim for deduction u/s 10(10C)(viii) and relief u/s 89(1) on basis of letter issued by CBDT – Decision of court quashing letter of Board – Order of denying relief – Proceedings without jurisdiction – Assessee entitled to relief

The assessee claimed deduction u/s 10(10C)(viii) and under the provisions of section 89(1) on the amounts received by him under the voluntary retirement scheme of the State Bank of Travancore. The A.O. held that the assessee was not entitled to claim deduction u/s 10(10C)(viii) and also u/s 89(1).

The assessee filed an application u/s 264 for revision of the order but the Commissioner denied relief. Thereafter, the assessee filed an application to the Commissioner u/s 154 for rectification of his order relying on a decision in State Bank of India vs. CBDT [2006] (1) KLT 258 wherein the Court had held that the amounts received by employees under a voluntary retirement scheme were entitled to benefit u/s 89(1) in addition to the exemption granted u/s 10(10C)(viii) and quashed letter / Circular No. E.174/5/2001-ITA-I dated 23rd April, 2001 issued by the CBDT which held to the contrary. Since recovery proceedings were initiated in the meanwhile, the assessee paid certain amounts to the Department to satisfy the demand that arose out of the denial of relief u/s 89(1).

On a writ petition filed by the assessee, the single judge relegated the assessee to the alternative remedy of appeal u/s 246A. The Division Bench of the Kerala High Court allowed the appeal and held as under:

‘i) On the facts the assessee need not have been relegated to the alternative remedy of filing an appeal u/s 246A.

ii) Admittedly, the assessee had taken voluntary retirement in the year 2001. He had also claimed deduction u/s 10(10C)(viii) and benefit u/s 89(1) in his return of income for the relevant assessment year and the claim was rejected on the basis of the letter issued by the Board on 23rd April, 2001. The letter of the Board had been quashed by the Court in State Bank of India vs. CBDT. In that decision it was also declared that the assessee was entitled to deduction of amounts received under a voluntary retirement scheme u/s 10(10C)(viii) and u/s 89(1) simultaneously. That being the position, the entire proceedings initiated against the assessee were without jurisdiction.

iii) When the proceedings were without jurisdiction the existence of an alternative remedy was not a bar for granting relief under Article 226 of the Constitution. The assessee was entitled to deduction u/s 10(10C)(viii) and benefit u/s 89(1) (as the provision stood at the relevant point of time) in respect of the amounts received by him under the voluntary retirement scheme. If any amounts had been paid by the assessee pursuant to demands which arose on account of denial of deduction u/s 10(10C)(viii) and benefit u/s 89(1), such amounts should be refunded to the assessee.’

OECD’S PILLAR ONE PROPOSAL – A SOLUTION TRAPPED IN A WEB OF COMPLEXITIES

1. TAXATION OF DIGITAL ECONOMY (DE) – A GLOBAL CONCERN
The
digital revolution has improved business processes and bolstered
innovation across all sectors of the economy. With technological
advancements, businesses can operate in multiple countries remotely,
without any physical presence. However, the current international tax
system, which dates back to the 1920s, is primarily driven by physical
presence and hence is obsolete and incapable of effectively taxing the
DE1.

In the absence of efficient tax rules, taxation of DE has
become a key Base Erosion and Profit Shifting (BEPS) concern all over
the world. While the Organisation for Economic Co-operation and
Development’s (OECD) BEPS 1.0 project resolved several issues, the
project could not iron out the concerns of taxation of the DE. Hence,
OECD and G20 launched the BEPS 2.0 project wherein OECD along with 135
countries is working towards a global consensus-based solution under the
ambitious ‘Pillar One’ project.

2. BLUEPRINT OF PILLAR ONE PROPOSAL – A DISCUSSION DRAFT TO BE WORKED FURTHER
OECD’s
Pillar One project proposes to modify existing profit allocation rules
in such a way that a portion of the profits earned by a Multinational
Enterprise (MNE) group is re-allocated to market jurisdictions (even if
the MNE group does not have any physical presence in such market
jurisdictions), thereby expanding the taxing rights of market
jurisdictions over MNEs’ profits.

As part of the Pillar One
project, a report titled ‘Tax Challenges Arising from Digitalisation –
Report on the Pillar One Blueprint’ (referred to as ‘Blueprint’ or
report hereafter) was released in October, 2020 which represents the
extensive technical work done by OECD along with members of the BEPS
inclusive framework (BEPS IF)2 on Pillar One.

Being a Blueprint,
it is more in the nature of a discussion draft. It does not reflect
agreement of BEPS IF members who participated in the discussion on
Pillar One proposals and there are many political and technical issues
which still need to be resolved. However, this Blueprint will act as a
solid basis for future discussions. Further, BEPS IF members have agreed
to keep working on Pillar One proposals reflected in the Blueprint with
a view to bring the process to a successful conclusion by mid-2021.

 

1   https://www.europarl.europa.eu/RegData/etudes/STUD/2016/579002/IPOL_STU(2016)579002_EN.pdf

3.  EVENTUAL IMPLEMENTATION OF PILLAR ONE REPORT – A CHALLENGING TASK

The
implementation of Pillar One proposals, if and when concluded, will
require modification of domestic law provisions by member countries, as
also the treaties signed by them. The proposal is to implement ‘a new
multilateral convention’ which would co-exist with the existing tax
treaty network. However, the architecture of the proposed multilateral
convention is still being developed by OECD and is not discussed in this
Blueprint.

4. OVERVIEW OF PILLAR ONE REPORT

The Pillar One report primarily focuses on three proposals:

(a) Amount A – New taxing right:
To recollect, Pillar One aims to allocate certain minimum taxing rights
to market jurisdictions where MNEs earn revenues by selling their goods
/ services either physically or remotely. In this regard, new profit
allocation rules are proposed wherein a portion of the MNEs’ book
profits would be allocated to market jurisdictions on formulary basis.
The intent is to necessarily allocate a certain portion of MNE profits
to a market jurisdiction even if sales are completed remotely. Such
portion of MNE profit recommended by Pillar One to be allocated to
market jurisdictions is termed as ‘Amount A’.

(b) Amount B – Safe harbour for routine marketing and distribution activities:
Arm’s length pricing (ALP) of distribution arrangements has been a key
area of concern in transfer pricing (TP) amongst tax authorities as well
as taxpayers. In order to enhance tax certainty, reduce controversy,
simplify administration under TP laws and reduce compliance costs, the
framework of Amount B is proposed. ‘Amount B’ is a fixed return for
related party distributors that perform routine marketing and
distribution activities. Unlike Amount A which can allocate profits even
if sales are carried out remotely, Amount B is applicable only when an
MNE group has some form of physical presence carrying out marketing and
distribution functions in the market jurisdiction. Currently, the report
suggests that Amount B would work independent of Amount A and there is
no discussion on the inter-play of the two amounts in the report.
Besides, even if Amount A is inapplicable to an MNE group (for reasons
discussed below), the MNE group may still need to comply with Amount B.

(c) Dispute prevention and resolution mechanism:
The report recognises that it would be impractical if tax
administrations of all affected market jurisdictions assess and audit an
MNE’s calculation and allocation of Amount A. It is also unlikely that
all disputes concerning Amount A rules could be resolved by existing
bilateral dispute resolution tools such as Mutual Agreement Procedure
(MAP) and Advanced Pricing Agreement (APA). To remove uncertainty, a
clear and administrable mandatory binding dispute prevention process is
proposed in the report to prevent and resolve disputes specifically
related to Amount A. Under this process, a detailed consultation would
take place amongst taxpayers and tax authorities of market jurisdictions
before tax adjustments are made to the MNE’s assessment.

Considering
that Amount A is the heart of the Pillar One report, this article
focuses on the concept, computation and taxation of Amount A.

 

2              BEPS
IF was formed by OECD in January, 2016 wherein more than 135 countries
participate on equal footing in developing standards on BEPS-related issues and
reviewing and monitoring its consistent implementation


5. CONDITIONS FOR APPLICABILITY OF AMOUNT A TO MNE GROUP – IMPACT OF MATERIALITY
To
recollect, Amount A represents the amount recommended by the Pillar One
report to be allocated, for the purpose of taxability, to market
jurisdictions even if, as per existing taxation rules, no amount may be
allocable to the market jurisdiction. Some fundamental conditions are
proposed on the applicability of Amount A and subject to these
conditions alone Pillar One recommends allocation of MNE profits of a
group to market jurisdictions.

Each of the following conditions
needs to be satisfied by the MNE group for triggering of Amount A
allocation. Non-compliance with any of the conditions may result in
complete non-trigger of allocation:
a) MNEs having consolidated
global revenues (from all businesses) exceeding €750mn as per
consolidated financial statement (CFS) prepared at the parent entity
level under the applicable accounting standards;
b) MNEs engaged in ‘Automated digital service’ (ADS) and ‘Consumer-facing business’ (CFB);
c)
MNEs earning revenues of more than €250mn from ADS and CFB activities
carried out outside their home jurisdiction. The definition of an MNE’s
home jurisdiction is still being developed. For instance, one option
being explored is where the group is headquartered or where the ultimate
parent entity is a tax resident; and
d) MNEs earning more than routine profits.

Some further comments / elaborations of the conditions enumerated above are as under:

Pre-condition
for allocation of Amount A to market jurisdictions

Comments
/ observations

a.
MNEs having consolidated global revenues (from all businesses) exceeding
€750mn as per consolidated financial statement (CFS) prepared at the parent
entity level under the applicable accounting standards; and

This addresses the factor of materiality
– small and medium-sized MNEs are proposed to be excluded from the Amount A
regime in order to ensure the compliance and administrative burden is
proportionate to the expected tax benefits

b.  MNEs engaged in ‘Automated digital service’
(ADS) and ‘Consumer-facing business’ (CFB); and

•   Given
globalisation and the digitalisation of the economy, these businesses can,
with or without the benefit of local physical operations, participate in an
active and sustained manner in the economic life of a market jurisdiction

•   ADS is defined
to mean services which require minimal human intervention on part of service
provider through a system (i.e., automated) and such services are provided
over internet or an electronic network (i.e., digital). To illustrate, ADS
cover online advertising services, digital

    content
services, online gaming

 

    services, cloud
computing services, etc.

•   CFB is defined
as businesses that supply goods or services, directly or indirectly, that are
of a type commonly sold to consumers, and / or license or otherwise exploits
intellectual property that is connected to the supply of such goods or
services. It primarily covers business of sale of goods and services which
are not regarded as ADS. It also extends to cover licensing and franchising
businesses

•   Specific
exclusion from Amount A is provided to certain sectors such as natural
resources; banking and financial services; construction, sale and leasing of
residential property; and international airline and shipping businesses

c.  MNEs earning revenues of more than €250mn
from ADS and CFB activities carried out outside the MNE group’s home
jurisdiction. Definition of MNE’s home jurisdiction is still being developed.
For instance, one option being explored is where the group is headquartered
or where the ultimate parent entity is tax resident; and

Where MNEs primarily earn revenue from
ADS and / or CFB businesses carried out in the home jurisdiction itself and
the business in market countries is only meagre, applying Amount A is likely
to have a limited tax impact because the Amount A formula may allocate
profits to the same jurisdiction that already has taxing rights under
existing tax rules

d.
MNEs earning more than routine profits. While the discussions are still
ongoing, a profitability ratio (i.e., ratio of profit to sales) of 10% is
being considered as routine profit and hence, MNEs which carry on in-scope
business but have losses3 or have profitability margin of less
than 10% as per books need not compute Amount A

MNEs that earn only routine profits are
outside the scope of Pillar One. Routine profit is a reward for undertaking
usual business taking risks. Usually, if there is physical presence of an MNE
group in any market jurisdiction for the purpose of effecting sales in the
market, under transfer pricing rules, routine profits are usually allocated
to such market jurisdictions

However, Pillar One is built on the
basis that where an MNE group earns bumper profits, market jurisdiction
contributes to accrual of more than routine profit to the MNE group
(irrespective of whether or not the MNE group has any physical presence in
such market jurisdiction) and hence,

 

market jurisdictions deserve a share in
such bumper profit. But if the MNE group does not earn super profits, the
issue of allocation of additional profits to market countries does not arise

 

 

3   If an MNE has losses,
such MNE need not compute Amount A but instead the losses may be allowed to be
carried forward. In this regard, a special loss carry-forward regime for Amount
A will be developed by OECD which is currently under discussion

MNEs who do not fulfil any of the above conditionswill be
outside the Amount A profit allocation rules. However, where the above
conditions are fulfilled, the MNE would need to determine Amount A as
per the proposed new profit allocation rules (which would be determined
on formulary basis at the MNE level, refer Para 7) and allocate Amount A
to eligible market jurisdictions as discussed in Para 6.

The above conditions on applicability of Amount A to MNE groups can be understood by the following examples:

Particulars

Scenario
1

Scenario
2

Scenario
3

Facts

Name of MNE group

ABC group

PQR group

MNO group

Nature of business

ADS

CFB

ADS

Home jurisdiction of group

France

Germany

Spain

Consolidated global revenue of the group

500 mn

1000 mn

1000 mn

Revenue earned by the group from outside
home jurisdiction

100 mn

200 mn

500 mn

Profitability ratio of the group

8%

15%

-5%

Analysis of satisfaction of conditions

Global revenue test (€750mn) as per
books

Q

R

R

Foreign revenues from ADS and CFB test (€250mn)

Q

Q

R

Routine profitability test (whether
profit as per books exceeds 10%)

Q

R

Q

Impact

Amount A not applicable to ABC group

Amount A not applicable to PQR group
since revenue from outside home jurisdiction is not more than €250mn

Amount A not applicable to MNO group
since group is incurring losses

6. AMOUNT A ALLOCABLE ONLY TO ELIGIBLE MARKET JURISDICTIONS

MNE
groups that pass all the tests mentioned in Para 5 will need to
determine Amount A and allocate the same to market jurisdictions.

(i) Sales, marketing and distribution activities pre-requisite to qualify as market jurisdiction:
At the outset it should be noted that Amount A is a specific regime for
allocation of super profits to market jurisdictions. Market
jurisdiction is defined as jurisdictions where an MNE group sells its
products or services, or in the case of highly digitalised businesses,
jurisdictions where the MNE provides services to users or solicits and
collects data or content contributions from users. Thus, if an MNE is
carrying out manufacturing function or research and development which
are completely unrelated to sales, marketing and distribution functions
in a jurisdiction and there is no sales function carried out there, such
jurisdictions would not qualify as a ‘market jurisdiction’ and, hence,
not eligible for Amount A.
(ii) Not all market jurisdictions will be eligible for Amount A allocation:
As aforesaid, Amount A is applicable only to the MNEs engaged in ADS
and CFB activities. Amount A will be allocable to a market jurisdiction
only where an MNE group has a reasonable level of ADS and CFB activity
in that market jurisdiction and such markets are termed as ‘eligible
market jurisdictions’. In order to determine a reasonable level of
activity, certain tests are proposed as discussed below.

6.1 Likelihood of threshold for ADS business per market jurisdiction

a.
To recollect, ADS business means services provided with minimal or no
human involvement over Internet or an electronic network. These
businesses may include online advertising services, online search
engines, social media platform, digital content service, etc.
b. The
very nature of ADS is such that these businesses will always have a
significant and sustained engagement with market jurisdictions remotely,
i.e., without physical presence. Hence, for ADS businesses a simple
revenue threshold test is being proposed to determine whether the MNE
has a nexus with that market jurisdiction. The revenue threshold that
can be prescribed is still being negotiated.
c. For example, assume
that per market nexus revenue threshold for ADS business is proposed to
be €50mn. In such a case, even where the MNE group turnover from the ADS
business may be €1000mn but revenue in India from ADS only €10mn, India
being a relatively insignificant market contributing revenue cannot be
considered as an eligible market jurisdiction to which Amount A is
allocable as chargeable profit.
d. Alternatively, if revenue in India
from ADS is €100mn (and the MNE fulfilled other conditions as stated in
Para 5), India qualifies as eligible market jurisdiction entitled to
tax a proportion of Amount A – regardless of the fact that there is no
physical presence in India, or regardless of the fact that the
traditional taxation rules would have failed to capture such taxability.

6.2 Likelihood of threshold for CFB business per market jurisdiction

a.
Unlike ADS, the ability of an MNE to participate remotely in a market
jurisdiction is less pronounced in the CFB model. MNEs usually have some
form of presence in market jurisdictions (for example, in the form of
distribution entities) to carry out consumer-facing businesses.
b.
Hence, countries participating in the discussions believe that a mere
revenue threshold test may not denote the active and sustained
engagement with the market jurisdiction and the presence of certain
additional indicators (‘plus factors’) may be necessary. These plus
factors which can be used to establish a nexus are still being debated
and developed at the OECD level.

Market jurisdictions that meet
the nexus test will qualify as ‘eligible market jurisdictions’ for the
MNE group and will be eligible for a share of Amount A of such MNE group
to be taxed in the market jurisdiction. Such allocation of Amount A
will yield tax revenue for that market jurisdiction irrespective of
whether the MNE group has an entity or PE in that market country, or
whether any profits are offered to tax in that market country under
existing tax laws.

7. DETERMINATION OF AMOUNT A OF MNE GROUP THAT WILL BE ALLOCABLE TO MARKET JURISDICTIONS

a.
The norms of profit allocation suggested in the Blueprint are very
different from the taxability norms which are known to taxpayers as of
now. Hence, the exercise suggested in the report should be studied on an
independent basis without attempting to rationalise or compare it with
the conclusion to which one would have arrived as per traditional norms
of taxation.

b. The philosophy behind the report is that no MNE
group can make sizeable or abnormal or bumper profit without the
patronage and support that it gets from the market jurisdiction. There
is bound to be some contribution made by the market jurisdictions to the
ability of the MNE group to earn more than routine4 (abnormal) profit.
Hence, in relation to MNE groups which have been successful enough to
secure more than 10% routine (i.e., abnormal / bumper profits), some
part of such bumper profits should be offered to tax in every market
jurisdiction which has contributed to the ability to earn profit at the
group level. Consequently, if the MNE group’s profits are up to routine
or reasonable, or if the MNE is in losses, the report does not seek to
consider any allocation of profits to the market jurisdiction.

c.
As to how much profit of an MNE group qualifies as normal or reasonable
or routine profit and how much qualifies as abnormal or bumper or
non-routine profit is yet to be decided multilaterally amongst all
countries participating in the Pillar One discussions. Currently, (but,
provisionally) the report suggests that countries are in favour of
considering a profit margin of 10% of book revenue as normal profits,
i.e., 10% profit margin will be considered as ‘routine profits’
warranting no allocation, and any profit earned by the MNE group above
10% alone will be considered as ‘non-routine profits’ warranting
allocation to the market jurisdiction.

d. For example, if the
consolidated turnover of an MNE group as per CFS is €1000mn on which it
has earned book profits5 of €50mn as per CFS, its profit margin is only
5%. Since the profit earned by the MNE group is only 5% (i.e., within
the routine profit margin of 10%), the MNE group is considered to have
earned profits due to normal / routine entrepreneurial risk and efforts
of the MNE group and nothing may be considered as serious or abnormal
enough to permit market jurisdictions to complain that, notwithstanding
traditional taxation rules, some income should be offered to tax in the
market jurisdiction.

 

4   The report uses the
expression ‘residual profits’ to convey what we call here abnormal or
non-routine or super profit

5   The report also proposed
adjustments to the book profits by adding back of income tax expenses, expenses
incurred against public policy like bribes, penalty, reducing dividend and
gains on transfer of asset, etc., to arrive at a standardised base of profits

e.
Alternatively, if the consolidated turnover of the MNE group as per CFS
is €1000mn on which it has earned book profit of €400mn as per CFS, its
profit margin as per the books is 40%. In such a case, the profits
earned by the group beyond 10% (i.e., 40%-10%=30%) will be considered as
non-routine profits. Some part of such non-routine profits will be
considered as having been contributed by market jurisdictions and need
to be allocated to the eligible market jurisdiction as discussed in the
Para below6.

f. Once it is determined that the MNE group has
received non-routine profit in excess of 10% (in our example, excess
profit is 30% of turnover), the report is intended to carry out an
exercise where a portion of the excess profit is to be allocated to the
market factor of a market jurisdiction.

g. It is the philosophy
that the consumers of the country, by purchasing the goods or enjoying
the services, contribute to the overall MNE profit and but for such
market and consumers, it would not have been possible to effect the
sales. However, at the same time it is not as if the entirety of the
non-routine or super profit is being earned because of the presence of
the market. There are many other factors such as trade intangibles,
capital, research, technology, etc., which may have built up the overall
success of the MNE group.

h. As per present estimates and
thinking discussed in the report, about 80% of the excess profit or
super profit (in our example, 80% of super profit of 30%) may be
recognised as pertaining to many different strengths of the MNE group
other than the market factor. It is the residual 20% of the super profit
component which is recognised as being solely contributed by the
strength of the market factor. Hence, the present report on Pillar One
discusses how best to allocate 20% of the super profit (in our example,
20% of 30%) to market jurisdictions. The report is not concerned with
allocation or treatment of the 80% component of the super profit which
is, as per the present text of Pillar One, pertaining to factors other
than market forces.

 

6   Throughout the article,
this is assumed to be the applicable fact pattern of excess or more than
routine profit

i. A tabulated version of the illustrative fact pattern and proposed allocation rules of Amount A is as under:

Particulars

Amount

Consolidated turnover of MNE group

1000 mn

Consolidated book profit

400 mn

% of book profit to turnover

40%

Less: Allowance for routine profit

(10%)

Excess profit over routine profit, also
loosely for abnormal or super profit

30%

Of this, 80% of super profit of 30% is
considered as pertaining to the strength of non-market factors and having no
nexus with contribution of the market jurisdiction (and hence out of Pillar
One proposal)

24% of 1000 mn

20% of super profit of 30% being
considered as fair allocation having nexus with contribution of market
jurisdictions – known also as Amount A recommended by the report – to be
allocated to different market jurisdictions

6% of 1000 mn

j. Some countries participating in the discussion are of the
view that allocation of 20% of non-routine profits to market countries
is minuscule and a higher margin should be allocated since the overall
success of the MNE group can be accomplished only as a result of
consumption in the markets. This article goes by the ball-park
recommendations of 20% discussed in the report for the purpose of
understanding the concept – though it may be noted that the
multilaterally agreed allocation percentage may be different.

k.
Even if under existing tax norms no profits are taxable in a market
jurisdiction (say due to no physical presence), Amount A will ensure
market countries get right to tax over 20% of non-routine profits of the
MNE group and that the market jurisdictions should not be left high and
dry without right to tax income.

8. CORRELATION OF INTERIM MEASURE ALREADY IMPLEMENTED BY INDIA, PENDING FINAL OUTCOME OF PILLAR ONE REPORT AND / OR BEPS ACTIONS

As
we are aware, even without waiting for the final outcome of the Pillar
One recommendations, India has already introduced in its domestic law
the equalisation levy which seeks to tax 2% of the digital or remote
sales as taxable profit of a non-resident and 6% of advertisement
services rendered by a non-resident.

It may be noted that all
countries participating in Pillar One discussions have agreed to
withdraw relevant unilateral actions introduced by them in their
domestic laws once Pillar One recommendations are successfully
implemented. Hence, India will hopefully withdraw the equalisation levy
once a Pillar One consensus-based solution is reached.

It is,
therefore, submitted that the Pillar One discussions may be studied as
an independent exercise rather than trying to compare them with the
interim measures. No attempt has, therefore, been made in this article
to explain or review the provisions of the equalisation levy. The
article concentrates on Pillar One proposals which are likely to
substitute the present levy.

9. FACTORS WHICH INFLUENCE QUANTUM OF ALLOCATION TO MARKET JURISDICTIONS
Broadly,
and with respect to marketing and sales activity, an MNE can carry out
operations in a market jurisdiction in the following manner:
(a)    Sales through remote presence
(b)    Presence in form of Limited risk distributor (LRD)
(c)    Presence in form of Full risk distributor (FRD)
(d)    Presence in dependent agent permanent establishment (DAPE).

Assuming
that there is no physical presence of the MNE group in a market
jurisdiction, say, India, Amount A of the MNE group determined as per
Para 7 above would be allocated to market jurisdictions on the basis of
revenue generated from each market jurisdiction. If, for example,
turnover from India is €100mn, 6% of India turnover, which equals to
€6mn, will be allocated for taxability to India.

However, if the
MNE group has a physical presence in India as well (say in the form of
LRD or FRD or DAPE), there may be a trigger for taxability in India even
as per existing taxation rules. In any such case, there could be some
variation in the rules relating to the allocation of Amount A to India.
Taxation of Amount A under each form of business presence is explained
below.

Sales is only through remote presence:
a.
Consider an example where an MNE group engaged in providing standard
online teaching services earns subscription revenue from users across
the world. In India, the group does not have any form of physical
presence and all the functions and IPs related to the Indian market are
performed and owned by a Swiss company (Swiss Co).

b. The financials of the MNE group suggest as under:

Facts:

MNE group turnover as per CFS

€1000 mn

Profit before tax (PBT) as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

c. Under existing tax rules, Swiss Co’s income is outside
the tax net [since the service is not in the nature of fees for
technical services (FTS) and Swiss Co does not have a permanent
establishment (PE) in India], thus all profits earned from the India
market (routine as well as non-routine) are taxed only in Switzerland in
the hands of Swiss Co.
d. Though India does not have taxing rights
under the existing tax rules (due to no physical presence), the
Blueprint would ensure that Amount A be allocated to India. As explained
in Para 7, Amount A recommended by the report to be allocated to
different market jurisdictions would come to 6% of the turnover. Since
turnover from India is €100mn, 6% of India turnover, equal to €6mn, will
be allocated for taxability to India.
e. However, an issue arises as
to which entity will pay taxes on Amount A in India. In this regard,
the report recognises that Amount A will co-exist with the existing tax
rules and such overlay of Amount A on existing tax rules may result in
double taxation since Amount A does not add any additional profit to the
MNE group but instead reallocates a portion of the existing non-routine
profits to market jurisdictions.
f. In the given example, all
profits (routine as well as non-routine) from the India business are
taxed in the hands of the Swiss Co under the existing tax rules. In
other words, the €6m allocated to India under Amount A is already being
taxed in Switzerland in the hands of Swiss Co due to the existing
transfer pricing norms. Hence, Swiss Co may be identified as the ‘paying
entity’ in India and be obligated to pay tax on Amount A in India.
Subsequently, Swiss Co can claim credit of taxes paid in India in its
residence jurisdiction (i.e., Switzerland).

9.2 Presence in form of limited risk distributor (LRD)
a.
There are a number of cases where an MNE group may not have full-scale
presence in the market jurisdiction but may have an LRD who is assisting
in the conclusion of sales. In a way, the LRD’s presence is
contributing to routine sales functions on a physical basis in such a
market jurisdiction. It is not a category of work which contributes to
any super profit but is taking care of logistics and routine for which
no more than routine profits can be attributed.
b. Consider an
example; a Finland-based MNE group is engaged in the sale of mobile
phones across the world. The headquarter company (FinCo) is the
intellectual property (IP) owner and principal distributor. The group
has an LRD in India (ICo) which performs routine sales functions under
the purview of the overall policy developed by FinCo. The financials of
the MNE group suggest as under:

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

c. Under existing TP principles, assume that ICo is
remunerated @ 2% of India revenue for its routine functions and the
balance is retained by FinCo which is not taxed in India. In other
words, all profits attributable to non-routine functions are attributed
to FinCo and hence not taxable in India.
d. As explained in Para 7,
Amount A recommended by the report to be allocated to different market
jurisdictions would come to 6% of the turnover. Since the turnover from
India is €100mn, 6% of Indian turnover equal to €6mn will be allocated
for taxability in India.
e. India also has taxability right with
regard to the LRD function @ 2% of India turnover. This right is shared
by India so as to compensate for the routine functions carried out in
India. No part of the super profit element is contained therein, whereas
Amount A contemplates allocation of a part of the super profit.
Considering this, there is no concession or reduction in the allocation
of Amount A merely because there is taxability @ 2% of turnover for
routine efforts in the form of an LRD. The overall taxability right of
India will comprise of compensation towards LRD function as increased by
allocation of super profits in the form of Amount A.
f. Besides,
even if Indian tax authorities, during ICo’s TP assessment, allege that
ICo’s remuneration should be increased from 2% to 5% of India turnover,
there would still not be any implication on Amount A allocable to India
since ICo’s increase in remuneration for performing more routine
functions and no element of super profit forms part of such
remuneration.
g. While tax on compensation towards LRD function will
be payable by ICo, an issue arises as to which entity should pay tax on
Amount A allocable to India. Since FinCo is the IP owner and principal
distributor, existing TP rules would allocate all super profits
pertaining to the India market to FinCo. Thus, the super profits of €6mn
allocated to India under Amount A are already being taxed in Finland in
the hands of FinCo on the basis of the existing TP norms. Hence, the
Blueprint suggests that FinCo should be obligated to pay tax on Amount A
in India and then FinCo can claim credit of taxes paid in India in its
residence jurisdiction (i.e., Finland) against income taxable under
existing tax laws. Accordingly, ICo would pay tax in India on LRD
functions (i.e., routine functions) whereas FinCo would pay tax on super
profits allocated to India in the form of Amount A.

9.3 Presence in form of Full risk distributor (FRD)
a.
As a variation to the above, an MNE group may appoint an FRD in a
market jurisdiction. An FRD performs important functions such as market
strategy, pricing, product placement and also undertakes high risk qua
the market jurisdiction. In essence, the FRD performs the marketing and
distribution function in entirety. Hence, unlike an LRD, an FRD is
remunerated not only with routine returns but also certain non-routine
returns.
b. Consider an example where a French headquartered MNE
group engaged in the business of fashion apparels carries out business
in India through an FRD model. All key marketing and distribution
functions related to the Indian market are undertaken by the FRD in
India (ICo). Applying TP principles, ICo is remunerated at 10% of India
sales.
c. The financials of the MNE group are as under:

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin as per CFS

40% of group turnover

India turnover

€100 mn

d. To recollect, Amount A contemplates allocation of a part of
an MNE’s super profits to market jurisdictions, India being one of them.
Had there been no physical presence in India, as per calculations
indicated at Para 9.1, part of the super profits allocable to India as
Amount A would come to 6% of the India turnover (i.e., €6mn).
e. Now,
ICo as an FRD is already being taxed in India. This represents
taxability in India as per traditional rules for performing certain
marketing functions within India which contribute to routine as also
super profits functions in India. This is, therefore, a case where, in
the hands of ICo, as per traditional rules, part of the super profit
element of the MNE is separately getting taxed in the hands of ICo.
f.
In such a case, the report assumes that while up to 2% of India
turnover the taxability can be attributed towards routine functions of
ICo (instead of towards super profit functions), the taxability in
addition to 2% of India turnover in the hands of ICo is attributable to
marketing functions which contribute to super profit.
g. Since India
is already taxing some portion of the super profits in the hands of ICo
under existing tax rules, allocation of Amount A to India (which is a
portion of super profits) creates the risk of double counting. In order
to ensure there is no double counting of super profits in India under
Amount A regime and the existing TP rules, the Blueprint recognises that
Amount A allocated to India (i.e., 6%) should be adjusted to the extent
super profits are already taxed in the market jurisdiction. In order to
eliminate double counting, the following steps are suggested7:
(i)
Find out the amount as would have been allocable to market jurisdiction
as per Amount A (in our illustration, 6% of India turnover of €100mn).
(ii)
Fixed routine profit which may be expected to be earned within India
for routine operations in India. While this profit margin needs to be
multilaterally agreed upon, for this example we assume that additional
profit of 2% of India turnover will be expected to be earned in India on
account of physical operations in India. Additional 2% of India
turnover can be considered allocable to India in lieu of routine sales
and marketing functions in India – being the allocation which does not
interfere with the super profit element.
(iii) The desired minimum
allocation to market jurisdiction of India for routine and non-routine
activities can be expected to be 8% of the India turnover, on an
aggregate of (i) and (ii) above.
(iv) This desired minimum return at
step (iii) needs to be compared with the allocation which has been made
in favour of India as per TP analysis.

?    If the amount
allocated to FRD in India is already more than 8% of turnover, no
further amount will be allocable under the umbrella of Amount A.
?  
 On the other hand, if the remuneration taxed under TP analysis is <
8%, Amount A taxable will be reduced to the difference of TP return and
amount calculated at (iii).

?    However, if the return under TP
analysis is < 2%, then it is assumed that FRD is, at the highest,
taxed as if it is performing routine functions and has not been
allocated any super profit under TP laws. The allocation may have been
considered towards super profit only if it exceeded 2% of India
turnover. And hence, in such case, allocation of Amount A will continue
to be 6% of India turnover towards super profit elements. There can be
no reduction therefrom on the premise that TP analysis has already been
carried out in India. It may also be noted that since Amount A
determined as per step (i) above is 6% of India turnover, an allocation
in excess of this amount cannot be made under Amount A.

 

7   Referred to as marketing
and distribution safe harbour regime in the report

h. Once the adjusted Amount A is determined as per the steps above, one would need to determine
which entity would pay tax on such Amount A in India. In this case, since France Co and ICo both perform function
asset
risk (FAR) activities that result in revenue from the India market, the
Blueprint recognises that choosing the paying entity (i.e., entity
obligated to pay tax on Amount A in India) will require further
discussions / deliberations. Further, the report also recognises that
taxes may have been paid in the market country on royalty income.
However, whether and how such taxes paid can be adjusted against tax on
Amount A is currently being deliberated at the OECD level.

i. In the fact pattern below, ABC group, engaged in CFB business, carries out sale in India under the FRD model.

Facts:

Group turnover as per CFS

€1000 mn

PBT as per CFS

€400 mn

Group profit margin

40%

India turnover

€100 mn

TP remuneration to FRD in India

•     Scenario 1

•     Scenario 2

•     Scenario 3

 

10% of India turnover

5% of India turnover

1% of India turnover

Amount A allocable to India
(6% of 100 mn)

6 mn

Elimination of double counting of non-routine profits in India under different scenarios:

 

 

Particulars

Scenario
1

Scenario
2

Scenario
3

a.

Amount A allocable to India (as
determined above)

6%

6%

6%

b.

Return towards routine functions (which
OECD considers tolerable additional allocation in view of presence in India)

2%

2%

2%

c.

Sum of a + b (This is the sum of the
routine and non-routine profits that the OECD expects Indian FRD to earn)

8%

8%

8%

d.

TP
remuneration to FRD in India

10%

5%

1%

e.

Final Amount A to be allocated to India

No Amount A allocable since FRD in India
is already remunerated above OECD’s expectation of 8%

3%,

OECD expects Indian FRD to earn 8% but
it is remunerated at 5%. Hence, only 3% to be allocated as Amount A [instead
of 6% as determined at (a)]

 

6%,

No reduction in Amount A since OECD
intends only to eliminate double counting of non-routine profits and
where existing TP returns is less than fixed return towards routine
functions, it is clear that no non-routine profit is allocated to India under
existing tax laws

9.4 Presence in form of DAPE

a.
The report recognises that the MNE groups may have a presence in a
market jurisdiction in the form of PE as well. A DAPE usually is an
agent in the market jurisdiction who undertakes sales or secures orders
for its non-resident principal.
b. The manner in which Amount A would
be taxed in a market jurisdiction where an MNE group operates through a
DAPE model would depend on the functional profile of the DAPE. If the
DAPE only performs minimum risk-oriented routine functions, the
taxability of Amount A may be similar to the LRD scenario discussed at
Para 9.2. On the other hand, where the DAPE performs high-risk
functions, the taxability of Amount A would be similar to the FRD
scenario discussed at Para 9.3.

10. COMPREHENSIVE CASE STUDY ON WORKING AND ALLOCATION OF AMOUNT A
FACTS
?    ABC group is a German headquartered group engaged in the sale of mobile phones which qualifies as CFB activity.
?  
 The ultimate parent entity is German Co (GCo) which owns and performs
development, enhancement, maintenance, protection and exploitation
(DEMPE) functions related to the MNE group’s IP.
?    ABC group makes sales across the world. As per ABC group’s CFS,
o    Global consolidated group revenue is €1000mn
o    Group PBT is €400mn
o    Group PBT margin is 40%
?    ABC group follows a different sale model in the different countries in which it operates:

Particulars

France

UK

India

Brazil

Sales model

Remote presence

LRD

FRD

DAPE performing all key functions and
risk-related Brazil market

Sales

100

200

400

300

TP remuneration

NA

2%

10%

5%

? All countries (France, UK, India, Brazil) qualify as eligible market jurisdictions

Computation of Amount A at MNE level:

Particulars

 

Profit margin

Amounts

PBT of the group

(A)

40%

400

Less: Routine profits
(10% of €1000Mn)

(B)

10%

100

Non-routine profits

C = A-B

30%

300

Profits attributable to non-market
jurisdiction

D = 80% of C

24%

240

Profits attributable to market
jurisdictions (Amount A)

E = C-D

6%

60

Allocation of Amount A to respective market jurisdictions:
   

 

Particulars

France

UK

India

Brazil

 

Sales
model

Remote presence

LRD

FRD

DAPE

a.

Amount A allocable (as determined above)

6%

6%

6%

6%

b.

Fixed return towards routine functions
(as calibrated by OECD)

Marketing and distribution safe harbour
regime – NA since MNE has no presence or limited risk presence

2%

2%

c.

Sum of a + b

8%

8%

d.

TP
remuneration to FRD in India

10%

5%

e.

Final Amount A to be allocated

6%

6%

NIL since FRD in India is already
remunerated above OECD’s expectation of 8%

3%

OECD expects DAPE to earn 8% but it is
remunerated at 5%. Hence, only 3% to be allocated as Amount A

f.

Entity obligated to pay Amount A

GCo (FAR analysis would indicate that
GCo performs all key functions and assumes risk related to France and UK
market which helps to earn non-routine profits from these markets)

NA, since there is no Amount A allocated
to India

Depending on FAR analysis, Amount A may
be payable by GCo or DAPE or both on pro rata basis

11. UNITED NATION’S EFFORTS TOWARDS TAXATION OF DIGITAL ECONOMY
While
OECD is working with BEPS IF members to develop a solution to
effectively tax the digital economy, some members of the United Nations
(UN) digital taxation sub-committee have raised concerns on OECD’s
proposed solution. For example, concerns are raised that Pillar One will
introduce a great deal of complexity. Besides, the expected modest
revenue impact of Pillar One does not justify the large-scale changes in
the system of taxing MNEs8.

As an alternate solution, UN has
proposed to introduce a new Article in the United Nations Model
Convention which would apply to income from ADS (automated digital
services, i.e., services provided with minimal or no human involvement
over Internet or an electronic network). A specific inclusion of the ADS
article would ensure that such highly-digitalised services do not fall
under the general business profits article (i.e., Article 7) and hence
the source countries may be able to tax such income even in the absence
of a PE.

The ADS Article proposed by the UN is designed along the
lines of royalty, dividend, FTS articles, i.e., taxing rights to source
state, gross basis taxation, concept of beneficial owner, payer and PE
source rule, ALP adjustment, etc. Additionally, an optional net basis
taxation is proposed where the beneficial owner of the ADS income will
be taxed on a net basis instead of on gross income. Under the net basis,
the taxable amount will be determined on the basis of a normative
formula which is currently being discussed at the UN level.

A comparison of UN’s proposal for digital taxation and OECD’s Amount A proposal indicates as under:

Particulars

ADS
Article proposed by UN

OECD’s
proposed Amount A

Level of taxability

Entity level

MNE group level

Taxes remote presence beyond
conventional PE

Yes

Yes

Activities covered9

ADS

ADS and CFB

Monetary threshold for applicability

No threshold (countries may adopt local
thresholds if required)

Global revenue threshold and in-scope
foreign de minimis threshold

Gross vs. Net

Provides option to taxpayer to choose
between tax on gross consideration and taxation on net basis

Net basis (Amount A is a share of MNE
profits)

Taxable amount

Gross basis: Gross consideration

Net basis: Taxable amount to be
determined on formulary basis

Taxable amount to be determined on
formulary basis

Rate of tax

Gross basis: 3-4% of transaction value

Net basis: Domestic tax rate

Domestic tax rate of market jurisdiction

Taxing right allocated to

Source country

Eligible market jurisdictions

Source rule

Payer or PE-based source rule

Market jurisdictions that meet tests as
discussed in Para 6

Tax-bearing entity

Recipient or beneficial owner of ADS
income

MNE group entity identified as paying
entity

Treatment of losses

Gross basis: Not considered

Net basis: No tax in case of losses (No
clarity on treatment of past losses)

No Amount A allocation when MNE is in
losses, losses would be carried forward and past losses can be considered

Implementation

New MLI approach or bilateral

New MLI to be drawn to implement Amount
A

Dispute resolution

Existing MAP or domestic route

Customised tax certainty or dispute
resolution process being formalised

Inter-play with existing business
profits rule

Where Article 12B would apply, income
would fall outside PE taxation

Amount A to work alongside existing tax
rules

12. CONCLUDING THOUGHTS
The reports published by OECD
and UN as proposals to effectively tax the digital economy indicate that
international taxation norms are at the cusp of a revolution. MNEs will
have a daunting task of understanding the nuances of the proposals and
their impact on their businesses, though on a positive note there may be
relief from unilateral measures taken by countries to tax the digital
economy once the OECD / UN proposals are implemented.

While tax
authorities will be eager to have another sword in their armoury, it may
be noted that the OECD / UN proposals are still far from the finishing
line. Though the Blueprint released by OECD is more than 200 pages, the
report mainly provides the broad contours of the structure and working
of Amount A. Most of the aspects of Amount A are still under discussion
and debate. With 135countries participating in the OECD discussions, the
biggest challenge will be to achieve multilateral
consensus. While
countries have committed to arrive at a consensus-based solution by
mid-2021, it will be interesting to see how it is accomplished within
such a short span of time.

 

7   Referred to as marketing
and distribution safe harbour regime in the report

8   Note submitted by
Committee member Rajat Bansal as published in UN Doc E/C.18/2020/CRP.25 dated
30th May, 2020

9   Definition of ADS is the
same in the UN as well as in the OECD proposal

TDS – Sections 197 and 264 and Rule 18AA of IT Rules, 1962 – Certificate for Nil deduction or deduction at lower rate – Application by assessee for certificate for Nil withholding rate – Issuance of certificate at higher rate than Nil rate without recording reasons – Copy of order supported by reasons to be furnished to assessee – Matter remanded to Dy. Commissioner (TDS)

48. Tata Teleservices (Maharashtra) Ltd. vs. Dy. CIT [2020] 430 ITR 273 (Bom.) Date of order: 17th December, 2020 A.Y.: 2021-22


 

TDS – Sections 197 and 264 and Rule 18AA of IT Rules, 1962 – Certificate for Nil deduction or deduction at lower rate – Application by assessee for certificate for Nil withholding rate – Issuance of certificate at higher rate than Nil rate without recording reasons – Copy of order supported by reasons to be furnished to assessee – Matter remanded to Dy. Commissioner (TDS)

 

For the A.Y. 2018-19, the assessee was issued Nil withholding rate certificates u/s 197. However, those certificates were cancelled. The assessee filed a writ petition which was allowed, and the cancellation order was quashed. Thereafter, fresh certificates for deduction of tax at Nil rate were issued to the assessee for the A.Y. 2018-19. For the A.Ys. 2019-20 and 2020-21, the assessee submitted applications for tax withholding certificates at Nil rate. However, certificates u/s 197 were issued at rates higher than Nil rate. The assessee stated that it did not contest such certificates because it was focused on providing various wire-line voice, data and managed telecommunications services and therefore had opted for demerger of the consumer mobile business. Under the scheme of demerger, the consumer mobile business of the assessee stood transferred to BAL. The assessee filed an application seeking issuance of Nil rate tax withholding certificates u/s 197 on various grounds for the A.Y. 2021-22 and furnished the details that had been sought. However, the authorities issued certificates at rates higher than Nil. The assessee sought the order sheet / noting on the basis of which such certificates were issued but it did not get a response.

 

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

 

‘i) The procedure for issuance of certificate u/s 197 for deduction at lower rates or no deduction of tax from income other than dividends is laid down in Rule 28AA of the Income-tax Rules, 1962.

 

ii) Since the authorities were required to pass an order u/s 197 either rejecting the application for such certificate or allowing such application resulting in issuance of certificates which may be at rates higher than Nil as sought by the assessee, such an order must be supported by reasons. Not only that, a copy of such an order had to be furnished to the assessee so that it could be challenged u/s 264 if it was aggrieved. Not passing an order to that effect or keeping such an order in the file without communication would vitiate the certificates.

 

iii)   The reasons for not granting Nil rate certificates to the assessee were not known. The contemporaneous order required to be passed u/s 197 was also not available. The order was set aside, and the certificates were quashed. The matter was remanded to the Deputy Commissioner (TDS) for passing fresh order and issuing consequential certificates u/s 197 complying with the requirements of rule 28AA.’

Business expenditure – Section 37(1) – Capital or revenue expenditure – Payment made by assessee under agreement to an entity for additional infrastructure for augmenting continuous supply of electricity – No asset acquired – Expenditure revenue in nature and allowable

34. CIT vs. Hanon Automotive Systems India Private Ltd. [2020] 429 ITR 244 (Mad.) Date of order: 16th October, 2020 A.Y.: 2010-11

Business expenditure – Section 37(1) – Capital or revenue expenditure – Payment made by assessee under agreement to an entity for additional infrastructure for augmenting continuous supply of electricity – No asset acquired – Expenditure revenue in nature and allowable

Under an agreement to establish additional infrastructure facility to ensure uninterrupted power supply to it, the assessee made a lump sum payment to a company. The A.O. held that the amount paid by the assessee was to improve its asset and was non-refundable and even if the assessee received ‘services’ from the company in future, it would be separately governed by a ‘separate shared services agreement’ and hence the amount paid was not ‘wholly and exclusively’ for the assessee’s business and that it was spent towards the acquisition of a capital asset. The A.O. disallowed the expenditure claimed u/s 37(1) and also rejected the assessee’s alternate claim to depreciation.

The Commissioner (Appeals) held that the expenditure was capital expenditure, but allowed depreciation. The Tribunal held that the expenditure was revenue in nature and allowed the assessee’s claim for deduction.

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

‘i)    The Tribunal had rightly examined the nature of the transaction and held that the lump sum payment made by the assessee for the development of infrastructure for uninterrupted power supply to it was revenue expenditure u/s 37(1).

ii)    Though the assessee had parted with substantial funds to the company, the capital asset continued to remain the property of the company.’

Appeal to High Court – Territorial jurisdiction – Section 260A of ITA, 1961 and Article 226 of Constitution of India – Company located in Karnataka and assessed in Karnataka – Appeal to Appellate Tribunal in Bombay – Appeal from order of Tribunal – Bombay High Court had no jurisdiction to consider appeal

33. CIT vs. M.D. Waddar and Co. [2020] 429 ITR 451 (Bom.) Date of order: 27th October, 2020 A.Y.: 2008-09


 

Appeal to High Court – Territorial jurisdiction – Section 260A of ITA, 1961 and Article 226 of Constitution of India – Company located in Karnataka and assessed in Karnataka – Appeal to Appellate Tribunal in Bombay – Appeal from order of Tribunal – Bombay High Court had no jurisdiction to consider appeal

 

The assessee company was located in Raichur District, Karnataka. Its registered office, too, was in Karnataka. For Income-tax purposes, the assessee fell within the jurisdiction of the Assistant Commissioner, Belgaum, Karnataka. For the A.Y. 2008-09, the A.O., Belgaum reopened the assessment u/s 147, issued a notice u/s 148 and completed the reassessment in March, 2013.

 

Assailing that assessment order, the assessee appealed to the Commissioner (Appeals), Bangalore. Eventually, both the assessee and the Revenue further appealed to the Appellate Tribunal, Panaji Bench. The Tribunal held in the assessee’s favour.

 

The Revenue then filed an appeal before the Bombay High Court. The question before the High Court was as under:

 

‘An Income-tax Appellate Tribunal exercises its jurisdiction over more than one State, though it is located in one of those States. Its order is sought to be challenged. Which High Court should have the jurisdiction to rule on the Tribunal’s order? Is it the High Court in whose territorial jurisdiction the Tribunal is located? Or is it the High Court in whose territorial jurisdiction the authority that passed the preliminary order operates?’

 

The High Court held as under:

 

‘i)    In the Ambica Industries case the Supreme Court has held that in terms of Article 227 as also clause (2) of Article 226 of the Constitution of India, the High Court will exercise its discretionary jurisdiction and also issue writs of certiorari over orders passed by the subordinate courts within its territorial jurisdiction. Besides, if any cause of action arises within its territorial limits, it will exercise its jurisdiction. According to Ambica Industries, when the appellate court exercises jurisdiction over a Tribunal situated in more than one State, the High Court located in the State where the first court is located should be considered to be the appropriate appellate authority. The mere physical location of an inter-State Tribunal cannot be determinative of the High Court’s jurisdiction for an aggrieved party to challenge that Tribunal’s order.

 

ii)    The assessee was located in Karnataka and so were the Income-tax authorities. The primary order, too, emanated from Karnataka; so did the first appellate order. All challenges, including the appeal before the Tribunal were in continuation of that primary adjudication or consideration before the Assessing Officer at Belgaum, Karnataka. The Bombay High Court had no jurisdiction to entertain the appeal.’

Article 15, India-UAE DTAA – Section 5, section 17(2)(vi) of the Act – ESOP benefit had accrued at the stage of grant when assessee was resident – Section 17(2)(vi) provides time when ESOP is to be taxed – Hence ESOP benefit will be taxable notwithstanding that assessee is non-resident on exercise date – ESOP benefit is taxable in country where services are rendered – Residential status at the time of exercise of ESOP is not relevant

10. [2021] 123 taxmann.com 238 (Mum.)(Trib.) Unnikrishnan V.S. vs. ITO ITA Nos.: 1200 & 1201 (Mum) of 2018 A.Ys.: 2013-14 and 2014-15 Date of order: 13th January, 2021


 

Article 15, India-UAE DTAA – Section 5, section 17(2)(vi) of the Act – ESOP benefit had accrued at the stage of grant when assessee was resident – Section 17(2)(vi) provides time when ESOP is to be taxed – Hence ESOP benefit will be taxable notwithstanding that assessee is non-resident on exercise date – ESOP benefit is taxable in country where services are rendered – Residential status at the time of exercise of ESOP is not relevant

 

FACTS

The assessee was an employee of an Indian bank. He was deputed to the UAE Representative Office (RO) from 1st October, 2007. Since deputation, the assessee was a non-resident, including in the years in dispute. During the relevant years, the assessee was granted stock options by the Indian bank in June, 2007 which vested equally in June, 2008 and June, 2009. The assessee exercised the vested options in F.Ys. 2012-13 and 2013-14 when he was a non-resident. On exercise of options, the employer had withheld tax which the assessee claimed as refund in his tax return. According to the assessee, he was granted ESOP benefit in consideration of services rendered to the RO outside India and hence the income neither accrued nor arose in India, nor was it deemed to accrue or to arise in India or received in India. Alternatively, it was not taxable in India as per Article 15(1) of the India-UAE treaty since the employment was not exercised in India.

 

But as per the A.O., ESOP benefit was granted in consideration of services rendered in India in 2007 when the assessee was a resident. Accordingly, the A.O. held that ESOP benefit was taxable in India under the Act as also under the DTAA.

 

The CIT(A) upheld the order of the A.O. Being aggrieved, the assessee filed an appeal before the Tribunal.

 

HELD

Taxability under Act

•    While ESOP income had arisen to the assessee in the year of exercise, admittedly the related rights were granted to the assessee in 2007 and in consideration of the services which were rendered by the assessee prior to the rights being granted – which were rendered in India all along.

•    At the stage when the ESOP benefit was granted in 2007, the income may have been inchoate, yet it had accrued or arisen in India in the year of exercise.

•    Section 17(2)(vi) decides the timing of taxation of the ESOP in the year of exercise but does not dilute the fact that ESOP benefit had arisen at the time when the ESOP rights were granted when the assessee was a resident. Section 17(2)(vi) merely deferred its taxability to the year of exercise. Accordingly, income was taxable in the year of exercise notwithstanding that the assessee was a non-resident during those years.

•    Reference to the UN Model Convention 2017 Commentary also makes it clear that ESOP benefit relates back to the point of time, and even periods prior thereto, when the benefit is granted. Hence, it cannot be considered as accruing or arising at the point of exercise.

 

Taxability under Article 15 of DTAA

•    ESOP benefit could be taxed as ‘other similar remuneration’ appearing alongside salaries and wages in Article 15 of the India-UAE DTAA.

•    Article 15(1) provides that other remuneration (which includes ESOP benefit) can be taxed in the state where employment is exercised. Accordingly, ESOP benefit in respect of employment in the UAE was taxable in the UAE even if the ESOP was exercised after returning to India and on cessation of non-resident status. Similarly, ESOP benefit in respect of service rendered in India was taxable in India notwithstanding that ESOP benefit was exercised when the assessee was a non-resident.

•    The decisions such as in ACIT vs. Robert Arthur Kultz [(2013) 59 SOT 203 (Del.)] and Anil Bhansali vs. ITO [(2015) 53 taxmann.com 367 (Hyd.)] relied upon by the taxpayer, in fact, favour the Revenue since they lay down the proposition that if ESOP benefit is received for rendering services partly in India and partly outside India, only the pro-rata portion relatable to services rendered in India is taxable in India.

 

Note: The Tribunal seems to have premised its decision on the fact that ESOP benefit in the present case was granted in lieu of services rendered in India prior to the date of grant. Hence, the Tribunal did not consider employment exercised in the UAE (October, 2007 to June, 2009) during substantial part of grant to vest period (June, 2007 to June, 2009) as diluting accrual of the salary income in India. Incidentally, during the erstwhile Fringe Benefits Tax (FBT) regime, FAQs 3 to 5 of CBDT Circular No. 9/2007 dated 20th December, 2007 clarified that FBT on ESOPs will trigger on pro-rata basis for employment exercised in India during grant to vest period. This Circular is not referred to in the Tribunal decision.

 

 

     I begin to speak only when I’m certain what I’ll say isn’t better left unsaid

– Cato

 

I attribute my success to this: I never gave or took any excuse

– Florence Nightingale

Article 12(4), Article 14, Article 23(2) of India-Japan DTAA – The words ‘tax deducted in accordance with the provisions’ of Article 23 of DTAA mean taxes withheld by source state which are in harmony, or in conformity, with provisions of DTAA – Article 12(4), read with Article 14, of DTAA as exclusion of FTS in Article 12(4) is attracted only if services were covered under Article 14, scope of which is limited to individuals – Income earned by partnership firm was plausibly taxable under Article 12 and bona fide view adopted by a source country is binding on country of residence while evaluating tax credit claim

9. [2020] 122 taxmann.com 248 (Mum.)(Trib.) Amarchand & Mangaldas & Suresh A. Shroff  & Co. vs. ACIT ITA No.: 2613/Mum/2019 A.Y.: 2014-15 Date of order: 18th December, 2020

Article 12(4), Article 14, Article 23(2) of India-Japan DTAA – The words ‘tax deducted in accordance with the provisions’ of Article 23 of DTAA mean taxes withheld by source state which are in harmony, or in conformity, with provisions of DTAA – Article 12(4), read with Article 14, of DTAA as exclusion of FTS in Article 12(4) is attracted only if services were covered under Article 14, scope of which is limited to individuals – Income earned by partnership firm was plausibly taxable under Article 12 and bona fide view adopted by a source country is binding on country of residence while evaluating tax credit claim

FACTS
The assessee was a law firm assessed as a partnership firm in India. It had received fee from Japanese clients after withholding tax @10% under Article 12 of the India-Japan DTAA.

The A.O. denied Foreign Tax Credit (FTC) on the ground that the income was covered under Article 14 – Independent Personal Service (IPS) Article. In terms of Article 14, income from professional services can be taxed in Japan only if the assessee has a fixed base in Japan. Since the assessee did not have a fixed base in Japan, the A.O. held that withholding of tax was not in accordance with the DTAA provisions.

On appeal, the CIT(A) upheld the order of the A.O. Being aggrieved, the assessee appealed before the Tribunal.

HELD
•        Article 23(2)(a) of the India-Japan DTAA requires India to grant credit for tax deducted in Japan in accordance with the provisions of the DTAA. The words ‘in accordance with the provisions’ would mean taxes withheld in the source state which could be reasonably said to be in harmony, or in conformity, with provisions of the DTAA.
•        While interpreting the above words, one is required to take a judicious call as to whether the view adopted by the source jurisdiction was reasonable and bona fide, though such a view may be or may not be the same as the legal position in the residence jurisdiction.
•        Article 12 and Article 14 overlap as regards coverage of professional service. However, Article 12(4) excludes payment made to an individual for independent personal services mentioned in Article 14.
•        Since the income was received by a partnership firm, exclusion in Article 12(4) was not applicable. Therefore, income was rightly subjected to tax in Japan. Accordingly, the assessee was qualified to claim FTC under the India-Japan DTAA.

Third proviso to section 50C(1) – Insertion of the proviso and subsequent enhancement in its limit to 10% is curative in nature to take care of unintended consequences of the scheme of section 50C, hence relate back to the date when the statutory provision of section 50C was enacted, i.e., 1st April, 2003

13. Maria Fernandes Cheryl vs. ITO (Mumbai) Pramod Kumar (V.P.) and Saktijit Dey (J.M.) ITA No. 4850/Mum/2019 A.Y.: 2011-12 Date of order: 15th January, 2021 Counsel for Assessee / Revenue: None / Vijaykumar G. Subramanyam

Third proviso to section 50C(1) – Insertion of the proviso and subsequent enhancement in its limit to 10% is curative in nature to take care of unintended consequences of the scheme of section 50C, hence relate back to the date when the statutory provision of section 50C was enacted, i.e., 1st April, 2003

FACTS

During the year under appeal, the assesse had sold her flat for a consideration of Rs. 75 lakhs. The valuation of the property for the purpose of charging stamp duty was Rs. 79.91 lakhs. She computed capital gains based on the sale consideration of Rs. 75 lakhs. But according to the A.O., the assessee had to adopt the Stamp Duty Valuation (SDV) which was Rs. 79.91 lakhs for the purpose of computing the capital gains. The CIT(A), on appeal, confirmed the A.O.’s order.

On appeal by the assessee, the Tribunal noted that the variation in the sale consideration as disclosed by the assessee vis-à-vis the valuation adopted by the SDV authority was only 6.55%. The Tribunal then queried the Departmental Representative (DR) as to why the assessee not be allowed the benefit of the third proviso to section 50C(1) as the variation was much less than the prescribed permissible variation of up to 10%.

In reply, the DR contended that the said provision is applicable by virtue of the Finance Act, 2018 with effect from 1st April, 2019. And for the permissible variation of 10%, as against variation of 5% as per the originally enacted third proviso to section 50C, it was contended that the enhancement is effective only from 1st April, 2021. Reference was also made to the Explanatory Notes to the Finance Act, 2020 with regard to increase in the safe harbour limit of 5% under sections 43CA, 50C and 56 to 10%. According to the DR, the insertion of the third proviso to section 50C could not be treated as retrospective in nature.

In conclusion, the DR also submitted that in case the Tribunal was in favour of granting relief to the assessee, then the relief may be provided as a special case and it may be clarified that this decision should not be considered as a precedent.

HELD


According to the Tribunal if the rationale behind the insertion of the third proviso to section 50C(1) was to provide a remedy for unintended consequences of the main provision, then the insertion of the third proviso should be considered as effective from the same date on which the main provision, i.e., section 50C, was brought into effect.

The Tribunal noted that the CBDT itself, in Circular No. 8 of 2018, has accepted that there could be various bona fide reasons explaining the small variations between the sale consideration of immovable property as disclosed by the assessee vis-à-vis the SDV. Further, it also noted that the Tribunals as well as the High Courts in the following cases have held that a curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not state so specifically:
•    Agra Bench of the Tribunal in the case of Rajeev Kumar Agarwal vs. ACIT (45 taxmann.com 555);
•    Delhi High Court in CIT vs. Ansal Landmark Township Pvt. Ltd. (61 taxmann.com 45);
•    Ahmedabad Tribunal in the case of Dharmashibhai Sonani vs. ACIT (161 ITD 627); and
•    Madras High Court in CIT vs. Vummudi Amarendran (429 ITR 97).

According to the Tribunal, the insertion of the third proviso to section 50C(1) was in the nature of a remedial measure to address a bona fide situation, where there was little justification for invoking an anti-avoidance provision – a curative amendment to take care of unintended consequences of the scheme of section 50C.

As for the enhancement of the tolerance band to 10% by the Finance Act, 2020, the Tribunal noted that the CBDT Circular itself acknowledges that it was done in response to the representations of the stakeholders for enhancement in the tolerance band. According to the Tribunal, once the Government acknowledged this genuine hardship of the taxpayer and addressed the issue by a suitable amendment in law, there was no reason to justify any particular time frame for implementing this enhancement of the tolerance band or safe harbour provision.

Therefore, the Tribunal held that the insertion of the third proviso to section 50C and the enhancement of the tolerance band to 10% were curative in nature and, therefore, the same relate back to the date when the related statutory provision of section 50C, i.e., 1st April, 2003, was enacted.

The Tribunal did not agree with the DR’s submission to mention in the order that ‘relief is being provided as a special case and this decision may not be considered as a precedent’. According to the Tribunal, ‘Nothing can be farther from a judicious approach to the process of dispensation of justice, and such an approach, as is prayed for, is an antithesis of the principle of “equality before the law,” which is one of our most cherished constitutional values. Our judicial functioning has to be even-handed, transparent, and predictable, and what we decide for one litigant must hold good for all other similarly placed litigants as well. We, therefore, decline to entertain this plea…’

Section 56(2)(vii) – Prize money received in recognition of services to Indian Cricket from BCCI is exempt

12. Maninder Singh vs. ACIT (Delhi) N.K. Billaiya (A.M.) and Sudhanshu Srivastava (J.M.) ITA No. 6954/Del/2019 A.Y.: 2013-14 Date of order: 6th January, 2021 Counsel for Assessee / Revenue: G.S. Grewal and Simran Grewal / Rakhi Vimal

Section 56(2)(vii) – Prize money received in recognition of services to Indian Cricket from BCCI is exempt

 

FACTS

The assessee is a former Indian cricketer. During the year under appeal, he received an award of Rs. 75.09 lakhs from the BCCI in recognition of his services to Indian Cricket. Placing reliance on the CBDT Circular No. 447 dated 22nd January, 1986, the assessee did not include this amount in his return of income. But, according to the A.O., CBDT Circular No. 2 of 2014 supersedes Circular No. 447 relied upon by the assessee. Therefore, he added the amount of Rs. 75.09 lakhs to the total income of the assessee. The CIT(A), on appeal, confirmed the order of the A.O.

 

HELD

The Tribunal referred to the second proviso to section 56(2)(vii). As per the said provisions, section 56(2)(vii) does not apply to any sum of money or any property received from any trust or institution registered u/s 12AA. The Tribunal noted that the BCCI is registered u/s 12AA. Therefore, it did not find any merit in the impugned addition made by the A.O. Accordingly, the Tribunal directed the A.O. to delete the addition of Rs. 75.09 lakhs made by him.

Section 115JB – Where additional revenue was not shown by assessee in books of accounts, the A.O. could not tinker with book profit by adding additional revenue on account of subsequent realisation of export while computing book profit u/s 115JB

26. [2020] 80 ITR (Trib.) 528 (Bang.)(Trib.) DCIT vs. Yahoo Software Development (P) Ltd. ITA No.: 2510 (Bang.) of 2017 A.Y.: 2009-10 Date of order: 27th April, 2020


 

Section 115JB – Where additional revenue was not shown by assessee in books of accounts, the A.O. could not tinker with book profit by adding additional revenue on account of subsequent realisation of export while computing book profit u/s 115JB

 

FACTS

The assessee filed a revised return of income by including certain additional revenue in the total income (and claimed deduction u/s 10A in respect of the additional revenue).

 

But it did not modify the books of accounts, nor did it modify the calculation of book profit u/s 115JB.

 

However, the A.O. increased the book profit by adding the additional revenue on account of subsequent realisation of export. The CIT(A) sustained the addition made by the A.O. Aggrieved, the assessee preferred an appeal before the ITAT.

 

HELD

The ITAT, following the ratio of the Supreme Court decision in Apollo Tyres Ltd. vs. CIT [2002] 122 Taxman 562/255 ITR 273, allowed the assessee’s appeal.

 

In the said decision, the Court was concerned with the issue of the power of the A.O. to question the correctness of the profit and loss account prepared by the assessee in accordance with the requirements of Parts II and III of Schedule VI to the Companies Act (in the context of section 115J as then applicable).

 

In Apollo Tyres (Supra), the Court observed that it was not open to the A.O. to re-scrutinise the accounts and satisfy himself that these accounts had been maintained in accordance with the provisions of the Companies Act. Sub-section (1A) of section 115J did not empower the A.O. to embark upon a fresh inquiry in regard to the entries made in the books of accounts of the company and to probe into the accounts accepted by the authorities under the Companies Act. If the statute mandates that income prepared in accordance with the Companies Act shall be deemed income for the purpose of section 115J, then it should be that income which is acceptable to the authorities. If the Legislature intended the A.O. to reassess the company’s income, then it would have stated in section 115J that ‘income of the company as accepted by the A.O. Thus, according to the Apex Court, the A.O. did not have the jurisdiction to go behind the net profit shown in the profit and loss account except to the extent provided in the Explanation to section 115J.’

 

Thus, applying the ratio of the abovementioned judgment, the ITAT took the view that the A.O. cannot tinker with / re-compute book profit arrived at on the basis of books maintained in accordance with the Companies Act.

 

Section 54F – Where possession of flat was taken within period of two years from date of transfer of original asset, assessee was entitled to benefit of section 54F irrespective of the date of agreement

25. [2020] 80 ITR(T) 427 (Del.)(Trib.) Rajiv Madhok vs. ACIT ITA No.: 2291 (Del.) of 2017 A.Y.: 2012-13 Date of order: 29th May, 2020

Section 54F – Where possession of flat was taken within period of two years from date of transfer of original asset, assessee was entitled to benefit of section 54F irrespective of the date of agreement

 

FACTS

The assessee offered to tax long-term capital gain (LTCG) on sale of shares effected on 2nd September, 2011. He also claimed deduction u/s 54F on purchase of a new residential house, on the premise that the property was constructed within the time allowed u/s 54F. However, according to the A.O. the residential house was purchased prior to the time period provided in section 54F. The CIT(A) upheld the addition. Consequently, the assessee filed an appeal before ITAT.

 

HELD

The only dispute arising in this case was pertaining to the date of purchase of the new residential property as contemplated u/s 54F – whether the date of agreement with the builder was to be considered as the date of purchase of the new asset or the date of payment in entirety and the date of possession received subsequently was to be considered as the date of purchase of the new asset. The stand taken by the Department was that the date of agreement with the builder was to be considered as the date of purchase of the new asset, while that of the assessee was that the date of payment in entirety and the date of possession received subsequently was to be considered as the date of purchase of the new asset.

 

In the instant case, the assessee sold shares on 17th August, 2011 and entered into an agreement with the builder on 29th September, 2009. However, the final amount of consideration was paid to the builder in April, 2012 and possession of the flat received in July, 2012.

 

The ITAT took into consideration the relevant clause in the deed for purchase of the new house which read as under:

‘46.0 The allottee understands and confirms that the execution of this agreement shall not be construed as sale or transfer under any applicable law and the title to the allottee hereby allotted shall be conveyed and transferred to the allottee only upon his fully discharging all the obligations undertaken by the allottee, including payment of the entire sale price and other applicable charges / dues, as mentioned herein and only upon the registration of the conveyance / sale deed in his favour. Prior to such conveyance, the allottee shall have no right or title in the apartment.’

 

The ITAT observed that in the backdrop of the aforesaid clause the date of possession of the flat was the date of actual purchase for the purpose of claiming exemption u/s 54F. In arriving at the decision, the ITAT analysed the decision rendered by the Bombay High Court in the case of CIT vs. Smt. Beena K. Jain [1994] 75 Taxman 145 [1996] 217 ITR 363, upholding the decision of the ITAT. In the said decision, the High Court observed that: ‘the Tribunal has looked at the substance of the transaction and come to the conclusion that the purchase was substantially effected when the agreement of purchase was carried out or completed by payment of full consideration on 29th July, 1988 and handing over of possession of the flat on the next day.’

 

The ITAT also observed that clause 46.0 of the buyer’s agreement in the assessee’s case was identical to clause 12 of the deed of agreement between the assessee and the builder as noted in the case of Ayushi Patni vs. DCIT [2020] 117 taxmann.com 231 (Pune-Trib.) ITA No. 1424 & 1707 (Pune) of 2016 and held that in view of identical facts and circumstances, the ratio of the above decision in the case of Ayushi Patni (Supra) was squarely applicable to the facts of the instant case.

 

Thus, the ITAT concluded that the new asset was purchased within two years from the date of transfer of the original asset, i.e., shares, and thus the assessee was entitled to benefit of section 54F.

Section 54 – Exemption from capital gains cannot be denied where the assessee sold more than two residential properties and made reinvestment in one residential property

FACTS
The assessee, an individual deriving income from various heads of income, had submitted his return of income for the year under consideration. The return was duly processed u/s 143(1). Subsequently, the assessment was sought to be reopened based on information about the sale of immovable property and the assessee was asked to reconcile the same. The assessee filed a reply stating that he had not made any transaction for the year concerned and the transaction might have been wrongly reflected using his PAN. The assessee further requested the A.O. to recheck with the sub-registrar. Accordingly, the A.O. issued notice u/s 133(6) to the Sub-Registrar and received information that the assessee had effected sale of an immovable property being a residential flat for which no capital gains tax had been offered. The assessee furnished a capital gains working, submitting that the amount had been reinvested in purchasing another residential property. The A.O. contented that since the claim of capital gains and reinvestment thereof was not made in the return of income, the same was to be rejected and made an addition of Rs. 35 lakhs.

The A.O. also received information from the ITO that during the assessment proceedings of the assessee’s wife, it was found that a property jointly owned by the two had been sold during the year and the proceeds were reinvested in acquiring the same property for which exemption was claimed in the assessee’s case.

On appeal before the CIT(A), the CIT(A) accepted the capital gains workings submitted by the assessee and held that the assessee is eligible for exemption, even though the same was not claimed in the return of income. The A.O. had relied on the Supreme Court decision in the case of  Goetze (India) Ltd. vs. CIT to deny the claim for exemption. The CIT(A) held that the decision had categorically held that the appellate authorities could accept such a claim.

As far as the jointly owned property was concerned, the CIT(A) observed that since the capital gains on the same had been reinvested, the assessee would be eligible for capital gains exemption. Thus, the CIT(A) held that the assessee would be eligible for exemption u/s 54 on the sale of the second property also.

Aggrieved, the Revenue filed an appeal before the Tribunal.

HELD
The Tribunal held that exemption u/s 54 is granted to the assessee for reinvestment made in the residential house. The section nowhere restricts that the assessee should have sold only one property and claimed the exemption u/s 54 for only one property. In the instant case, the assessee has sold two residential properties and reinvested in one residential property. The entire conditions of section 54, both pre and post the amendment to section 54 [vide Finance Act (No. 2) of 2014, w.e.f. A.Y. 2015-16] had been satisfied. Thus, the order of the CIT(A) was upheld and Revenue’s appeal was dismissed.

Section 56(2) – The A.O. was erroneous in mechanically applying the provisions of section 56(2) to the difference between the stamp duty value and the actual sale consideration – The addition made by the A.O. without making a reference to the DVO despite the assessee submitting valuation report was unjustified

23. [2020] 208 TTJ 835 (Mum.)(Trib.) Mohd. Ilyad Ansari vs. ITO A.Y.: 2014-15 Date of order: 6th November, 2020

Section 56(2) – The A.O. was erroneous in mechanically applying the provisions of section 56(2) to the difference between the stamp duty value and the actual sale consideration – The addition made by the A.O. without making a reference to the DVO despite the assessee submitting valuation report was unjustified

FACTS

The assessee was engaged in the business of readymade garments. During the year under consideration, he purchased a flat jointly with his wife for a total consideration of Rs. 40,00,000 which was part of an SRA project. The builder, unable to complete the project, decided to exit from it at the half-way stage. An attempt to revive the project also failed, leading to the flat being sold at a distress price of Rs. 40,00,000 to the assessee. The sale was registered and thereafter the builder disappeared without completing the project. The agreement was made by the builder for a flat admeasuring 1,360 sq. feet. However, when the assessee got the possession, he found that it had been sold to two persons. The actual area of the flat, too, was only 784 sq. feet against the agreement area of 1,360 sq. feet. During the course of assessment proceedings, the A.O. noticed that the stamp duty valuation of the flat is Rs. 2,20,49,999 but the assessee had purchased it only for Rs. 40,00,000.

The assessee was required to explain why the difference is not to be treated as income u/s 56(2)(vii). The assessee filed a valuation report of Perfect Valuation & Consultants, a Government registered valuer, who valued the flat at Rs. 82.60 lakhs. During the assessment proceedings, the assessee filed this valuation report disputing the valuation made by the Stamp Valuation Authority (SVA). However, the A.O. did not refer the matter of valuation to the District Valuation Officer, though the valuation of the SVA was disputed by the assessee by way of the valuation report. The A.O. made an addition of Rs. 1,80,49,999 u/s 56(2)(vii)(b) in the hands of the assessee. The assessee filed an appeal before the CIT(A) against this order. But the CIT(A) also did not consider the valuation report submitted by the assessee, holding that the assessee had not disputed the valuation made by the SVA and confirmed the addition. Aggrieved, the assessee filed an appeal before the Tribunal.

HELD


The A.O. ignored the valuation report of the Government registered valuer submitted by the assessee. The provisions of section 56(2) had been mechanically applied without making any effort to determine the actual cost of the property. It ought to have been done since the property was acquired in semi-construction stage and later abandoned due to disputes amongst the builders. Besides, there was a dispute as regards the area acquired by the assessee as the same flat had been sold to two parties. In view of these circumstances, it was even more necessary for the A.O. to refer it to the valuation officer. Even at the stage of appellate proceedings when the assessee produced the valuation officer’s report that valued other flats in the very same building at Rs. 1,00,76,000, the CIT(A) should have called for remand report and in turn the valuation officer’s report which the CIT(A) had failed to do.

Thus, it was held that the addition made by the A.O. was totally unjustified and the assessee’s appeal was allowed.

Section 36(1)(iii) – Interest on funds borrowed for acquisition of land held as inventory is allowable u/s 36(1)(iii) – The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations. It is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail – There is no restriction in the provisions of section 36(1)(iii) that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16

22. [2020] 118 taxmann.com 541 (Bang.)(Trib.) DCIT vs. Cornerstone Property Investment (P) Ltd. A.Ys.: 2013-14 and 2014-15 Date of order: 14th August, 2020

Section 36(1)(iii) – Interest on funds borrowed for acquisition of land held as inventory is allowable u/s 36(1)(iii) – The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations. It is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail – There is no restriction in the provisions of section 36(1)(iii) that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16

FACTS

The facts as observed by the A.O. in the assessment order were that the assessee held land as inventory. It utilised the proceeds from the issue of debentures for acquiring lands and for making advances for purchase of lands and repayment of loans borrowed earlier. The A.O. also observed that in the earlier year, too, the borrowed funds were utilised for purchase of lands. The total interest expenditure of Rs. 16,39,35,373 being interest on ICDs, interest on NCDs and other ancillary borrowings was directly attributable to purchase of lands. There was no dispute about the use of borrowed funds for which the entire interest expenditure of Rs. 16,39,35,373 was incurred.

Of this total interest expenditure, the assessee claimed deduction for only a part, i.e., Rs. 6,81,01,384, which was disallowed by the A.O.

The CIT(A) deleted the amount of interest disallowed by the A.O. relying on various judgments.

Aggrieved, the Revenue preferred an appeal to the Tribunal where the assessee contended that the facts of the present case are squarely covered by the order of the Tribunal rendered in the case of DLF Ltd. vs. Addl. CIT [IT Appeal No. 2677 (Delhi) of 2011, order dated 11th March, 2016].

HELD


Inventory is a qualifying asset as it is held for more than 12 months and therefore interest attributable to it is required to be capitalised in the books of accounts as per AS 16. The Tribunal rejected the argument of the authorised representative of the assessee that AS 16 does not apply to inventory. It held that the provisions of Accounting Standards are the provisions which are applicable for the maintenance of the accounts of the company and interest is allowable according to section 36(1)(iii). The provisions of Accounting Standards and the provisions of the Act are two different sets of regulations and it is well settled that if there is a contradiction between the two, the provisions of the Act shall prevail. Since in the present case the interest is paid not for the purpose of acquisition of any capital asset but for inventory, the Tribunal did not find any restriction in provisions contained in section 36(1)(iii) which provide that the interest can be disallowed if incurred for the purpose of inventory as provided in AS 16. The Tribunal noted that there is not even an allegation that the interest is not paid on capital borrowed for the purpose of business. The Tribunal noted the observations in the case of DLF Ltd. (Supra) and also the ratio of various benches of the Tribunal where deduction of interest has been allowed u/s 36(1)(iii) even where the assessee has followed project completion method.

The Tribunal, following the decision of the Bombay High Court and also of various co-ordinate benches of the Tribunal, declined to interfere with the order of the CIT(A).

‘PROCEEDS OF CRIME’ – PMLA DEFINITION UNDERGOES RETROSPECTIVE SEA CHANGE

The concept of ‘proceeds of crime’ is most vital and pervades the entire fabric of The Prevention of Money-Laundering Act, 2002 (PMLA). Previously, it was an exhaustive definition and consisted of only the following three constituents:
•    Any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence;
•    The value of any such property;
•    The property equivalent in value held within the country or abroad (where property considered proceeds of crime is taken or held outside the country).

The erstwhile definition was found narrow and inadequate to deal with the ever-growing menace of money-laundering. Therefore, the Enforcement Directorate had consistently represented to the Government that the definition of ‘proceeds of crime’ was ambiguous. The ambiguity adversely impacted three important aspects, viz., the ability of the Directorate to investigate the money trail, the adjudication of attachments by the PMLA Adjudicating Authority and Tribunal, and also the trial of the offence of money-laundering under PMLA. Accordingly, amendment in the definition of ‘proceeds of crime’ was long called for.

RETROSPECTIVE AMENDMENT

The erstwhile definition was eventually amended by the Finance (No. 2) Act, 2019 by adding the Explanation to the definition w.e.f. 1st August, 2019. The definition of ‘proceeds of crime’ in section 2(1)(u) after such amendment reads as under:

‘Proceeds of crime’ means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence, or the value of any such property, or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad.
Explanation – For the removal of doubts, it is hereby clarified that ‘proceeds of crime’ include property not only derived or obtained from the scheduled offence but also any property which may directly or indirectly be derived or obtained as a result of any criminal activity relatable to the scheduled offence.

A review of the Explanation shows that the purpose of inserting it was to expand the parameters of ‘proceeds of crime’. The Explanation seeks to widen the scope of the definition by bifurcating the same into the following two properties as stand-alone constituents of the ‘proceeds of crime’:
•    Property derived or obtained from a scheduled offence;
•    Property which is directly or indirectly derived or obtained as a result of any criminal activity relatable to the scheduled offence.

From the initial words in the Explanation, ‘For the removal of doubts, it is hereby clarified that’, it is evident that the Explanation is intended to apply retrospectively.

The Supreme Court has held1 that an Explanation may be added in declaratory form to retrospectively clarify a doubtful point of law and to serve as proviso to the main section.

 

1   Y.P. Chawla vs. M.P. Tiwari AIR 1992 SC 1360,
1362

INGREDIENTS OF ‘PROCEEDS OF CRIME’

A review of the definition of ‘proceeds of crime’ in section 2(1)(u) as expanded by the new Explanation calls for a detailed examination of the following terms and expressions:
•    property [section 2(1)(v)]
•    person [section 2(1)(s)]
•    derived or obtained
•    directly or indirectly
•    as a result of criminal activity relating to
•    scheduled offence [section 2(1)(y)]
•    value (of property) [section 2(1)(zb)]

‘property’ is defined in section 2(1)(v). Its specific constituents: corporeal, incorporeal, movable, immovable, tangible and intangible are self-explanatory;
‘person’ is defined in section 2(1)(s). Its constituents are largely similar to its definition in the Income-tax Act with which all of us are familiar;
‘derived’ is a term that has been interpreted in the context of the expression ‘attributable to’ in a number or tax cases. The word ‘derived’ means ‘derived from a source’, or means ‘arise from or originate in’2.
Black’s Law Dictionary (Sixth Edition) defines ‘obtain’ as ‘to get hold of by effort; to get possession of; to procure; to acquire in any way.’
‘indirect’ has been defined in Black’s Law Dictionary (Sixth Edition) as follows:
‘Not direct in relation or connection; not having an immediate bearing or application; not related in natural way. Circuitous, not leading to aim or result by plainest course or method or obvious means, roundabout, not resulting directly from an act or cause but more or less remotely connected with or growing out of it’.
The expression ‘as a result of criminal activity relatable to’ is connected with ‘scheduled offence’. The expression ‘as a result of criminal activity relatable to’ is wider in scope than the expression ‘as a result of the scheduled offence’. A property may be derived or obtained from commission of a scheduled offence. Alternatively, it may be directly / indirectly derived or obtained as a result of criminal activity relatable to a scheduled offence. Both types of properties are now clarified to be considered ‘proceeds of crime’ on a stand-alone basis.

Accordingly, it stands to reason that property and receipts arising from any and every crime are not covered in this definition. Only the following kinds of receipt and property would be covered in the definition of ‘proceeds of crime’:
•    Property / receipts which are derived or obtained from the scheduled offence;
•    Property / receipts which are the result of criminal activity relatable to a scheduled offence.

‘scheduled offence’ is defined in section 2(1)(y). This definition consists of Part A, Part B and Part C with a clear mention of the statutes and matters covered therein. These do not call for any interpretation.
‘value’ (of property) is defined in section 2(1)(zb) to mean the fair market value of any property on the date of its acquisition.

In view of the expanded definition of ‘proceeds of crime’, a few important aspects are reviewed as follows:

 

2   CIT vs. Jameel Leathers and Uppers 246 ITR 97

CONSTITUTIONAL VALIDITY OF DEFINITION OF ‘PROCEEDS OF
CRIME’

The Constitutional validity of the definition of ‘proceeds of crime’ has been examined by courts in several cases.

Thus, in B. Rama Raju vs. Union of India (2011) 12 taxmann.com 181 (AP), the vires of the definition of ‘proceeds of crime’ in section 2(1)(u) was called in question on the following ground:

‘Section 2(u) of the Act defines “proceeds of crime” expansively to include property or the value thereof, derived or obtained, directly or indirectly, as a result of criminal activity relating to scheduled offence even if in the hands of a person who has no knowledge or nexus with such criminal activity allegedly committed by others. The expansive definition thus inflicts grossly unreasonable consequences on innocent persons and is, therefore, unconstitutional offending Articles 14, 20, 21 and 300A of the Constitution’. [Emphasis supplied.]

After examining various aspects, the Andhra Pradesh High Court held that section 2(1)(u) which defines the expression ‘proceeds of crime’ is not unconstitutional.

Similarly, in Alive Hospitality & Foods vs. Union of India (MANU/GJ/1313/0013), it was contended before the Gujarat High Court that the definition of ‘proceeds of crime’ was too broad and, therefore, arbitrary and invalid. While rejecting this contention, the High Court made the following observations:

‘The contention that the definition of “proceeds of crime” [section 2(u)] is too broad and is therefore arbitrary and invalid since it subjects even property acquired, derived or in the possession of a person not accused, connected or associated in any manner with a crime and thus places innocent persons in jeopardy, is a contention that also does not merit acceptance’. [Emphasis supplied]

Likewise, in Usha Agarwal vs. Union of India (MANU/SIK/0040/2013), the High Court of Sikkim held that the definition of ‘proceeds of crime’ has the object of preventing and stemming criminal activities related to money-laundering at its very inception and could not be considered arbitrary.

TAINTED PROPERTIES HELD OUTSIDE INDIA – DEEMED
‘PROCEEDS OF CRIME’

In several cases, it is found that properties derived or obtained by committing a scheduled offence are taken away and held outside India. In such situations, the question arises whether the Enforcement Directorate can initiate proceeding against any property of the accused which is held in India to the extent of the value of the proceeds of crime held overseas. This question was addressed by the Delhi High Court in Abdullah Ali Balsharaf vs. Directorate Enforcement (2019) 101 taxmann.com 466 (Delhi). The High Court held that the Enforcement Directorate would be entitled to initiate proceedings against any property held in India to the extent of the value of the ‘proceeds of crime’ held overseas.

It may be noted that the definition of ‘proceeds of crime’ was amended by the Finance Act, 2015 w.e.f. 14th May, 2015 which inserted the words ‘or where such property is taken or held outside the country, then the property equivalent in value held within the country’. Thus, the conclusion of the Delhi High Court is consistent with the said amendment.

In Deputy Director vs. Axis Bank (2019) 104 taxmann.com 49 (Delhi), the Delhi High Court considered a similar situation and came to the same conclusion by making observations to the following effect:

‘The empowered enforcement officer has the authority of law in PMLA to attach not only a “tainted property” – that is to say a property acquired or obtained, directly or indirectly, from proceeds of criminal activity constituting a scheduled offence – but also any other asset or property of equivalent value of the offender of money-laundering, the latter not bearing any taint but being alternative attachable property (or deemed tainted property) on account of its link or nexus with the offence (or offender) of money-laundering’. [Emphasis supplied.]

CLAIM OF BANK – A VICTIM OF FRAUD – CANNOT BE
DEFEATED EVEN IF PROPERTY REPRESENTS ‘PROCEEDS OF CRIME’

In Indian Bank vs. Government of India (2012) 24 taxmann.com 217 (Madras), the question before the Madras High Court was whether the claim of a bank that was a victim of fraud committed by its borrower can be defeated on the ground that the property represented ‘proceeds of crime’?

While answering this question in the negative, the High Court explained the material facts and rationale underlying its conclusion as follows:
•    Nationalised banks are the victims of a fraud committed by the company and its officers. It is the banks’ money which has actually been made use of by the company and its directors to buy properties in their names. Where do these victims stand vis-a-vis the accused in such cases?
•    The PMLA, thus, not only seeks to punish the offenders, but also seeks to punish the victims of such offences.
•    Section 8(6) and section 9, which seek to punish the victims of crime along with the accused, appear to be a disincentive for the victims.
•    For the victims of crime, there would virtually be no difference between the accused and the Central Government, as in any case they would have to lose their property to either of the two.
•    If the order of adjudication made by the Adjudicating Authority becomes final, after the conviction of the company and its directors by the criminal Court, the Central Government would confiscate such property in terms of section 8(6). Thereafter, the property would vest in the Central Government free of all encumbrances u/s 9. In other words, the banks, who were the victims of fraud, may have to lose the property to the Central Government for no fault of theirs except that they were defrauded by the company.
•    If a property is proved to be involved in money laundering, the Adjudicating Authority has only one choice, viz., to make the attachment absolute, wait for the final adjudication by the criminal Court and either release the property to the accused if he is acquitted in the criminal Court, or confiscate the property to the Central Government if the accused is convicted by the criminal Court. Therefore, section 8 in its entirety is accused-centric and Central Government-centric. It does not take into account the plight of the victims of crime.
•    In view of the inherent lacuna in the Act, I think the banks cannot be left high and dry.
•    The Statement of Objects and Reasons of the Act would show that the primary object for which the Act came into existence was for prevention of laundering of proceeds of drug crimes committed by global criminals / terrorists, involved in illicit trafficking of narcotic drugs and psychotropic substances. The more the Act is used for tackling normal offences punishable under the Indian Penal Code, committed within the territories of India, the more the result would be disastrous for the victims of crime. Therefore, sections 5, 8 and 9 cannot be used by the respondents to inflict injury upon the victims of the crime.

PROPERTIES REGARDED AS NOT ‘PROCEEDS OF CRIME’

In a number of cases, Courts and Tribunals have rejected the claim of the Enforcement Directorate that a particular property is ‘proceeds of crime’. A few illustrative cases may be reviewed as follows:

(i) Mortgaged properties acquired prior to fraud – not ‘proceeds of crime’
Often, circumstances show that mortgaged properties were acquired by owners much before the alleged fraud was committed by the accused persons. In such a situation, a question that needs to be addressed is whether such properties were purchased out of the ‘proceeds of crime’ as defined in section 2(1)(u). This question was addressed in Bank of Baroda vs. Deputy Director (2019) 103 taxmann.com 30 (PMLA-AT). In that case, it was held that mortgaged properties which were acquired by owners much before the alleged fraud was committed by the accused person cannot be considered ‘proceeds of crime’.

(ii) Amount of loan received against mortgage of property – not ‘proceeds of crime’
Obtaining loan on mortgage of property is a common business transaction. Often, the allegation is made that the property mortgaged for the loan is acquired from the ‘proceeds of crime’. However, in Branch Manager, Central Bank of India vs. Deputy Director (2019) 107 taxmann.com 102 (PMLA-AT), it was held that where property was mortgaged with the bank much prior to the date of commission of the offence of money-laundering, the property so mortgaged cannot be regarded as acquired out of the ‘proceeds of crime’.

(iii) Amount of loan obtained by misrepresentation – not ‘proceeds of crime’
In Smt. Nasreen Taj vs. Deputy Director (2017) 88 taxmann.com 287 (PMLA-AT), a loan was taken for purchase of land. It was found that the land was purchased before the grant of loan. It was also found that the loan was obtained by misrepresentation in collusion with a bank employee. It was held that the amount of such loan could not be regarded as ‘proceeds of crime’. While reaching this conclusion, the High Court explained the material facts and rationale underlying its conclusion as follows:
•    The complainant in the criminal case is the bank who is the victim. Had the bank not filed a criminal complaint, perhaps the conspiracy might not have been discovered.
•    In a case like the present one if the security of the bank is treated as ‘proceeds of crime’ and is confiscated under the Act, in future no bank in such circumstances would make a complaint to the authorities.
•    The trial in the prosecution complaint would take a number of years. The victim cannot wait for such a long period of time, although after trial and final determination the victim is entitled to recover the amount by selling immovable properties u/s 8(8).
•    The intention of the Act could not have been to affect a third person or an innocent person as is sought to be done in the instant case.
•    If the impugned order is correct, it would be a patently absurd situation that not only substantial securities of the Bank are not available for the benefit of the bank but are vested in the Central Government as ‘proceeds of crime’. Such a result does not advance the objects of the Act.

CONCLUSION

The recent amendment to the definition of ‘proceeds of crime’ has expanded the list of properties considered as involved in the offence of money-laundering or in a scheduled offence. Consequent to the amendment, the area of scrutiny of substantive transactions by a Chartered Accountant while reporting compliance of statutory laws, applicable to transactions involving properties, is widened substantially.

The said amendment makes it incumbent upon a Chartered Accountant to modify his checklist of forensic audit of substantive transactions to ensure that he fully complies with his reporting obligations.

Intaxication: Euphoria at getting a refund from the IRS, which lasts until you realise it was your money to start with
– From a Washington Post word contest

INITIATIVES DURING PANDEMIC – PERSONAL EXPERIENCES

INTRODUCTION

The pandemic was / is unprecedented, a time of extraordinary change for everyone in every facet of life. It has affected people in most parts of the world directly or indirectly. People have lost their near and dear ones, their occupation / livelihood, or limited their lifestyle with the focus only on basic needs. It has changed drastically how we think and behave. It has bought most families nearer (in some cases even caused strife). Life used to be very mechanical in metros while we were chasing our materialistic / professional dreams. It was challenging irrespective of our educational qualifications, the profession or occupation in which we were engaged. The fear of contracting the virus and uncertainty thereafter created a tremendous scare in all of us. However, for us professionals commitment to clients is paramount and in their time of need we need to support them even more.

At our firm we went back to the basics – our purpose, vision and mission. We took a month to understand that this is a long haul and saw how we could support the clients as our first job and then looked at support to all other stakeholders; we also got what we call our knowledge edge initiatives. We started immediately as most of the staff and partners were suddenly free. Many of the measures taken by us in this period have been adverted to in this article which had a positive impact on the entire eco-system of stakeholders. In retrospect, however, there was much more that we could have done.

 
ASSESSING THE SITUATION

The first thing to be done in such uncertain times is to take stock of the things on hand, understand how the lockdown would impact everyone. Some of the areas we chose to concentrate on were as follows:

* Ensuring the safety of the employees. Some might have been stuck on outstation assignments. Arrangement of the basic needs, stay and travel was essential for them.

* Assessing the work in progress and completing the services possible for clients.

* Getting each and every employee in the firm updated and given in-depth knowledge – level wise.

* Suo motu reducing the fees of the first quarter work as a signal of support to the clients on 1st April, 2020.

* Looking at what value-added service to provide to all clients without visiting them. This was focused more on specific training / knowledge dissemination.

* Improving the connect of the team leaders with their teams and also with the partners. Understanding their needs and seeing how we could fill the gap.

* Restricting the drawals and deferral of salaries for a period of five months. Once the situation was in control, adding the deferral month-wise.

* Investing in automation for office use as well as for clients’ use.

* Faster geographical as well as size expansion was possible. Virtual opening / puja done.

Assessment of possible support to clients in the difficult situation

We believed that once a client engaged us, it was our moral responsibility to provide all possible value-addition during the difficult time. When a firm has been retained for regular advice or periodic audit, even a small value addition would make a big difference. The CA profession is based on trust and these measures would build / enhance trust. We voluntarily reduced the fee to the extent of 25% for three months and gave other support of value-added services based on information already with us without charging any fee.

Assessment of the possible inflow of information from the client

As a CA firm, we need to get the relevant information on time from our clients for delivery of quality service. Whatever problems we had faced in terms of manpower, infrastructure, etc., the same or even more has been the case with our clients, too. Further, the clients had many other priorities and therefore follow-up on calls and recording of the conversations on email was encouraged. Based on the correct assessment of the possible reduced inflow of cash from the clients, the working capital was planned and even a loan was taken.

Assessment of jobs which can be done and which can be deferred

The statutory compliances did get postponed. It was important for us as well as for our clients to assess what jobs could be done during the lockdown and what jobs could be deferred. Some parts of the jobs could be completed and the rest would have to await the opening up for completion.

Assessment of jobs nearing due dates and action plan

Since the lockdown was announced suddenly, the work stopped abruptly. There were many time-bound assignments / compliances. It was certain that the due dates of all the compliances would be extended, but there could have been other implications. In business many things are inter-related. If one task gets delayed, then another one also gets delayed, and so on, and at the end the impact is on the financials and the cashflow. All jobs like review of ledgers, reconciliations, online verifications, even examination of documents / agreements where available, were taken up. Advice on best practices in the lockdown was also shared with every client.

Assessment of manpower availability and action plan

Just before the complete lockdown, or immediately after the announcement, many employees and workers left for their hometowns by whatever means they could find. The trade / industry employer had to assess how many employees were available for working from their homes during the lockdown and what infrastructure they had in their place of stay. For us, articles / assistants from rural areas somehow reached their hometown but of them some are still (even after nine months) to get back to office.

Assessment of the IT infrastructure availability and action plan

The CA firms can use technology to some extent but the profession cannot be fully automatised. The CA profession is intellect-driven and not machine-driven. Our firm has been using office management software and servers for many years for data management, albeit partially. We were able to catch up on that. We were able to adapt partially to the work-from-home philosophy. We quickly prepared a policy for that and a standard operating programme for the same. As we were maintaining most of the data in the cloud, the employees could get the same and helped us to continue with quite a few of the jobs on hand. However, we had some issues where data was in servers.

Assessment of the working infrastructure at the homes of the employees

Work-from-home has its own challenges, especially in metros where houses are generally small. If everyone works from home, there has to be a proper place to sit and work. Continuous working in uncomfortable positions leads to health issues and reduces productivity. Normally, internet bandwidth is not very high at homes. The internet speed available on cell phones is not sufficient for office work, making conference calls, etc. Further, even to make simple calls there could be a challenge when someone else in the home is talking.

We informed our employees to go for best possible internet connection and also for a basic working table and chair. However, those employees who had gone to their villages where internet facilities are not available, just couldn’t work from home.

 
PLANNING AND THE EXECUTION OF THE JOB

Having assessed the available resources, the infrastructure and the jobs to be done, proper planning had to be done to execute the same. Since the situation was unusual, the execution of the regular jobs was also a challenge. Further, as a CA firm we have to maintain the quality of the deliverables. The quality was to be achieved through more involved monitoring. In the work-from-home situation, the monitoring also needs extra planning and efforts. The seniors in the firms made the plan for the effective monitoring of the execution and the deliverables through regular conference calls, video calls, etc. The use of office management software like Windows Office 365, iFirm and such other software has been of great use. Sharing the data and monitoring have been both convenient and effective. The hands-off approach (delegation) was given up and micro-management with daily calls and follow-up was taken up till the employees started coming back to office.

MANAGING THE CASHFLOW

One of the most challenging aspects has been managing the cashflow. Where the clients have cashflow issues, the CA firm cannot expect timely payments from them. The biggest expense in a CA firm is the employee payouts. A cut in the salary was inevitable for not only the employees but also for drawings of the partners. However, a cut in the salary should not result in an employee leaving the firm. An efficient employee is an asset to the firm. Retaining an efficient employee is very important for its growth. The salary cut was based on the ‘Manu Principle’, i.e., more cut in case of an employee earning more and less cut in case of an employee earning less. Striking the balance between cashflow and keeping the morale of the employees high has been very important. We brought down the targets to ensure that bonus would be possible for most based on performance. However, we did defer the increments this year.

 
KNOWLEDGE ENHANCEMENT INITIATIVES

As a CA firm, knowledge / skill across the firm was a key to our success. However, in the normal course the knowledge acquired tended to be on the need-to-have basis. This pandemic gave us an opportunity due to the availability of time. The explosion of online education, most of it freely available, supported this endeavour.

HEALTH ADVISORY TO THE EMPLOYEES AND MENTORING

An abrupt change in lifestyle affects health, especially in the case of senior citizens at home. The employees were advised to be very health-conscious, maintaining hygiene, social distancing, using face masks, avoiding crowded places, etc. This pandemic has created huge mental pressure due to a lack of knowledge about its spread and its impact. We believed that moral support by the employer to the personal health of the employees and their family members would boost their morale. Getting an adequate insurance cover for all for Covid-19 was done to provide some succour.

 
Regular mentoring of the employees during such times is very important. Not only does it enhance the capability of the employee, but it also improves the productivity and loyalty to the firm. Though mentoring was an irregular activity in our firm earlier, its importance was felt even more during this pandemic. Confidence-building, personality development, knowledge enhancement have been achieved to a reasonable extent through training and mentoring. Many took on longer period commitment to paid coaching to enhance themselves.

Daily discussion on the clause-by-clause analysis of the tax laws

Every day, two hours (for two months intermittently) of discussion through video call among the employees on clause-by-clause analysis of the tax laws has enhanced the knowledge of the employees tremendously. A lot of clarity emerged on the provisions of the laws. Such discussions helped us, in spite of our presence in multiple locations, to have a uniform view on the provisions of the laws.

 
Deliberation on the landmark decisions

The regular deliberation on landmark case laws among the core group in the advisory and litigation team of the firm was very useful. Such discussions helped us in the interpretation of the ratio of the judgment and its effective use in the given situation.

Preparation or updating of the audit programme, checklist and process document

We used the available time for updating the audit programme, the checklist and standard operating procedure in all streams of operations, such as audit, advisory, dispute resolution, etc. We also looked at various operations like human resources management, client engagement, deliverables, data management, accounts administration, all of which are a must for efficient management and growth of the firm and to deliver quality service. These had been on the backburner for years.

Office re-organisation

In normal times, everyone in the firm would be busy. Once the deliverables are delivered, the file is closed. There will be no time to re-look at the file except when there is a requirement subsequently. This added up to the quantity of paper in the office and data in the hard disc / server. Such unwanted accumulation of data would make it difficult to retrieve the relevant data in the future. During the pandemic, the spare time was used for cleaning of the unwanted papers / files in the office, unwanted data in the hard disc / server and proper organisation of the relevant data and audit papers / documents in some of our offices.

 
Training the employees of the client

Efficient service to the clients sometimes depends on the quality of data provided by the employees of the client. Where the employee of the clients is properly trained about the compliance required, the form in which the data is to be provided would certainly help the CA firm. During the pandemic, time was utilised for training either all the employees of our clients, or through tailor-made training programmes. Such knowledge enhancement of the employees of the clients has been a value-added activity.

 

Webinar – Knowledge sharing

Continuous education is a must for every chartered accountant. Sharing knowledge is a good way of learning. A well-structured webinar delivered by an expert would always be well attended. However, it should be as per the Code of Conduct of the ICAI. We conducted several webinars on various subjects inviting our clients and known CAs. We also ensured that we took the opportunity to accept any invitation to speak, especially if it was a challenging subject.

 

Certificate courses

Since time was available and employees of companies / professionals were available at home, we conducted a number of GST certificate courses. We allowed / mandated / encouraged the employees to attend such courses. Many senior employees were allowed to teach in internal learning sessions and then joined the seniors for public seminars.

 
Book-writing, revisions and writing, updating the articles

During the pandemic, we could reconsider updating our old books and take on some planned books. We were able to write more than 70 articles and update several existing articles on the website. The updation of the website to some extent has also been done.
 

Self-empowerment initiatives

The pandemic has provided a great opportunity to introspect and take self-empowerment initiatives. Many great institutions all over the world have been offering online courses in various subjects. Some of them are free and others are for a fee. It was time to set goals and make positive choices and take control of our own lives. It was time to understand our strengths and weaknesses and to develop the belief within. It is true that every challenge is an opportunity to grow. Some of us have participated in a few such self-empowerment programmes.

Expansion

As we were able to spare some time, we started a branch in a metro city (on 10th August, 2020). Mentoring was possible because of the slack and now we are ready to open offices in three Tier II cities before March, 2021. We also decided to have smaller offices due to the focus on online training and seminars.

 
CONCLUSION

It is a fact that we could choose to react to this dreadful epidemic by focusing on professionalising the firm, empowering ourselves and our employees. The future might not be the same as was the past. The future appears to be more virtual. We believe that it is better to invest in technology, adapt to the change and go digital. The flip side of the pandemic was that it provided a lot of time to introspect and look at the issues on the backburner. The familiar ‘I am too busy’ trope was not available and professionals like us did much more to strengthen the depth of knowledge, catching up with training, took up updating books and articles and, importantly, the one-to-one interpersonal activities increased significantly.

On the whole, we got better prepared for the delivery of services remotely as well as attracting clients due to higher visibility and sharing. Our multi-locational presence has helped us to leverage and support each other because the situation was not so bad in a few locations. Thanks to all these foundation-strengthening activities, we are poised for major growth in F.Y. 2021-22 even though the pandemic is still affecting some locations.


Money is like a sixth sense – and you can’t make use of the other five without it

– William Somerset Maugham

DIGITAL MARKETING? NAAH, IT’S DIGITAL BRANDING

A practising Chartered Accountant is bound by the Code of Ethics (‘CoE’) and is not permitted to advertise herself or her services. Honestly, a CA’s service holds dignity and doesn’t require any kind of solicitation. However, it must be noted that many other entities hire CAs and can brand for more or less all services that a Chartered Accountant offers and market and brand them. From that perspective, a Chartered Accountant is at a disadvantage as she is not on a level playing field. Therefore, we cannot ignore the fact that building a brand for oneself is equally important in today’s world.

I’m sure all of you have come across the following kinds of questions:
•        I am not sure if my firm or I can be on social media or digital platforms because our Code of Ethics does not allow that;
•        CA, as a profession, runs purely on referrals and social or digital media may not help;
•        I know few people who are on these platforms but I’m not sure how effective that is;
•        I feel it’s a waste of time and I have better technical things to concentrate on.

Let us now quickly look at answering these questions by simply understanding the basics of Digital Branding.

WHAT IS DIGITAL
BRANDING?

Today, for everything we search on Google, but do you know Google is merely a search engine and it does not create most of the content? All it does is smartly present to you content which is created by millions of users and subject matter experts like us.

Digital Branding is a process of creating an online identity and brand story of your firm or of yourself. It involves using online channels like websites, social media, SEOs, etc., so that when someone is in need of answers she can get them via Google search or other social media.

To put it simply, Digital Marketing is like pulling customers to you by advertising which is restricted and against the code of ethics, whereas Digital Branding is like creating a digital presence so that those who are in need of advice / service get contact details to approach you.

In the current professional services era, you can think of your brand as the visibility of your digital reputation.

WHY IS DIGITAL
BRANDING IMPORTANT?

Technology is something that disrupts every industry every now and then and firms that do not adjust with technology may cease to exist. We have so many examples of mobile giants like Blackberry, Nokia, etc. However, being professionals we are assured that our knowledge and expertise will not be replaced just like Kodak paper was replaced with Digital Photography. But does that mean technology will not disrupt how CAs are working or getting new clients?

Let us take a look at just the last six months. How many of us had earlier heard about Zoom (a company that was set up in 2011)? But today we will hardly find any professionals who have not heard of or used Zoom. Yes, the pandemic was unprecedented and the entire world was under lockdown so we were all forced to switch to the Digital World. And everyone co-operated in the switch. However, does every change follow the same process? What if, after a few years of working, we suddenly realise that something else has changed slowly but certainly and that we are now the odd person out?

Do we need to wait for a pandemic to teach us the next lesson or do we start blending in with a five-year plan? It’s high time to envisage the importance of digital branding. Agreed, that our profession runs on a referral model, but imagine someone referring you to a potential client and they do not find any digital presence while Googling (searching your firm’s name on Google). There are high chances they may not even approach you. Secondly, the belief that ICAI COE doesn’t allow us to be on digital / social media platforms, or that it’s a risky thing to do, isn’t true.

Currently, there are around 1.5 lakh practising CAs but the real competition is online companies which place advertisements and many other semi-qualified CAs or other professionals offering to do the same work as CAs. Not that all users are interested in hiring those online companies or the semi-qualified individuals – but their ability to approach professionals is limited to Google and other social media, but we are virtually not present there.

WHY HAVING A DIGITAL BRAND WILL
WORK FOR US

Digital Media has its own set of advantages and we have already witnessed one of its major advantages in the pandemic. It was a Eureka! moment for a lot of people who realised that we may not need to travel all the way to just speak face-to-face. We can just do a video call, have negotiations, meetings and discussions and close the deal. Let us try and understand the various advantages that the Digital Platform offers us:

• Cost-effective – Unlike other traditional modes of branding, it is cost-effective. About 90% of the digital media platforms are free to use. The cost, most of the time, is the ‘TIME’ that you invest in using the Digital Platform;
• Global market – With the www revolution, we are not bound by physical boundaries. Anything we post on social media can be accessed by anyone in the world. Connecting has become seamless. For example, a website of a person working in a remote village can be accessed by a person sitting in the US or Europe, vs. the physical billboard outside our office;
• Flexibility – A user can access the details while travelling or early in the morning, or late night, whether on laptop or mobile; digital platforms give flexibility to users to read, watch or listen at a time and place of their choice, as well as it gives us the flexibility to post or just simply schedule the posting as well;
• Interactive – All digital platforms are much more interactive than traditional modes. Websites offer chatbox option, social media provide Direct Message Option and hence when the interaction is quick, there are high chances that users with queries can turn into clients with consultancy;
• Tracking results and analytics – A majority of the digital platforms provide analytics which can help track the results of each post.

Clause (6) of the First Schedule, Code of Ethics, says that a ‘Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or interview or by any other means’.

Often, a practising CA is reluctant to use digital or social media believing it to be a push mode and an indirect way of soliciting. This is where Digital Branding wins over Digital Marketing. Before we look at different modes of digital branding, let us understand the difference with some quick examples:

Digital
Marketing / Push Mode

Digital
Branding / Pull Mode

Updating status on various social media or sending direct
messages to your connects asking them for collaboration or direct work

Regularly updating status on various notifications which show
your expertise to readers which may ultimately (in the long run) help win a
client

Yourself writing client reviews or attaching screenshots which
may brag about your work

Your clients tagging you or giving you a review on ‘Google My
Business’ page of how happy they were with your services

Replying to comments on your posts with ‘Reach out to us to
avail services’

Replying to comments with your knowledge and leaving an ‘In case
you have further queries, you may feel free to reach out to us’

When we talk about having a digital presence, we are nowhere soliciting or advertising our services but just building a brand on digital platforms by generating rich and useful content.

 

WHAT ARE THE VARIOUS MODES OF
DIGITAL BRANDING?

In this section of the article, we will sketchily look at the modes of Digital Branding and how it may help to build your brand to eventually help you / your firm grow.

Mode I: Search Engine Optimisation
Search engine optimisation (SEO) is the process of growing the quality and quantity of website traffic by increasing the visibility of a website or a web page to users of a web search engine like Google Search or other Social Media Search. In short, SEO is utilising specific goal-oriented strategies to ensure that we rank higher up in search results pages. Firms using SEOs to optimise their content (whether websites or Google My Business) will be the ones clients get their answers from when they first Google and eventually land up assigning their work to the firms. The broad channel categories of SEO Branding include these modes:

A) Website:
Your firm’s website should be optimised with words that show your niche. A good website should ideally be mobile-friendly as well as optimised for computer screens. Your website is your first digital impression; a poorly designed one is like having an office in an area where no one prefers to travel. Websites should be easy to navigate and should answer basic questions like what’s your specialisation, your location and what information and tools you provide and, most importantly, the call to action button, i.e., where a visitor can contact you in case she has a query. If words in a website are used wisely, it can enrich the SEO and provide better search results.

B) Google My Business Account:
The fact is that around 65% of the CA firms do not have their own Google My Business (‘GMB’) account. A GMB account basically is Google’s way of verifying small businesses. So when someone searches exactly about your business, Google shows details about the business on the right-hand side of the search result. If a GMB account is not created, it may show other firms’ results instead. Besides, a verified GMB account means your official website appears first in search results when someone searches your firm’s name instead of some random online aggregator websites.

Having a GMB account builds your brand in multiple ways – it improves SEO for a professional web page, helps you build reputation by taking reviews from clients and colleagues for your page and all of this is absolutely without charge. To summarise, a GMB account is a ‘should have’ and not a ‘good to have’.

Mode II: Social Media Branding
Social Media (‘SM’) Branding is the use of social media platforms to connect with your audience. This involves publishing great and engaging content with your SM profiles, listening to and engaging your followers and analysing your results. Co-reading this with paragraph 2.14.1.7(vii) & (x) of Clause 7, First Schedule of COE, it is to be noted that though one can use the prefix ‘CA’ on SM profiles and have a firm page on SM accounts, utmost care should be taken that no exaggerated claims are made (such as, Best CA for GST, Best CA in Mumbai and so on). Hence, the perception that as a practising CA one may / should not have an SM presence doesn’t really hold true. Let’s quickly look at the channels of SM and how these may help in branding:

(a) LinkedIn / Twitter / Facebook / Instagram:
It is a known fact that the number of users on the above SM in India (including professionals, too, considering LinkedIn and Twitter) are in their billions and not having a presence on these SM won’t really help. These platforms work in an easy way: Every time you publish a post or share an update which the readers find useful, they tend to share the same and the reach increases. The more content you generate on SM, the more people will know you and the better brand you will build for yourself. Firms regularly sharing relevant updates build a reputation which in the long run will get them more clients. (Think about it like this – Since childhood you have seen ads and hoardings of Activa two-wheelers and as a first-time user when you plan to buy a two-wheeler, Activa would be the first brand that will come to your mind. The same happens with clients who look for services the first time.) So, if you have regularly maintained your brand on SM, they will be inclined towards you.

(b) Quora:
This is my personal favourite SM platform. Quora has a competitive edge as only about 500 practising CAs are currently using it. What makes it unique is the purpose of the user visiting it. It’s neither search nor social media but somewhere in between. The content posted here is easy to find even months and years later, unlike other SM where it gets buried or disappears. If any potential clients using Quora find an answer posted by you / your firm, there are 85% chances of them connecting with you when they look for any formal consultancy. This is primarily because of the satisfaction they received with your simple answers. Practising professionals who are active on Quora create an avenue to get new clients for themselves simply by answering questions. Needless to add, the brand is also worth cultivating because the platform has a global reach.

Mode III: Content Branding
Content branding is a strategic approach focused on creating and distributing valuable, relevant and consistent content to attract and retain a clearly defined audience. In our profession, content branding entails writing books, articles, blogs or any kind of write-ups (collectively defined as write-up). Paragraph 2.14.1.6(iv)D of Clause (6), First Schedule of COE countenances using the designation CA in the write-ups. So, every time a person reads your write-up which shows your specialisation, they are building an image of you and next time they wish to have a consultancy on that topic, they may be inclined to approach you because you created a reputation on the topic with your content.

Mode IV: Audio / Visual Branding
If truth be told, the modern generation prefers audio / visual stimulus that is easily accessible and gets to the point over the idea of having to read something, and hence audio / visual branding these days becomes imperative. It’s really simple – a random user (who may be a potential client) wanting to learn how to log-in to the GST portal will prefer to watch a video on the same or attend a webinar rather than reading about it. So, when it’s about technical substance, people prefer reading write-ups, but when it comes to practical stuff, a webinar or an educational video will have the upper hand. And this is what audio / visual branding is all about – creating a marquee for yourself / your firm.

And this definitely works, given the following motives:
•        Hosting a webinar or uploading a video gives you an opportunity to position yourself as an expert in the topic;
•        It is an indirect way of soft sales;
•        The level of interaction it provides gives comfort to the audience; and
•        Lastly, it’s the new trend and we do not want to stay out of sync with it.

While we have delved into how audio / visual branding helps strengthen our Digital Presence, it is also to be noted that there is no violation of the code of ethics here provided we are cautious about not mentioning the firm’s name in the videos [ruled by Paragraph 2.14.1.6(iv) – Q of Clause 6, First Schedule of COE]. However, sharing videos on your own SM profile still does the work.

To summarise, while the COE does restrict direct ways of advertising, we should avoid Digital Marketing but definitely cannot avoid having a Digital Brand for ourselves or our firm. The modes of digital branding discussed here, when used with the correct strategies for each digital / SM platform, can work wonders for us even without soliciting work.

As a first step, this is what should be done:
•        Creating, reviewing and revamping your individual and your firm’s digital / SM channels (redesigning website to enrich the SEO, having a GMB account, initiating and start using Quora, review each of the SM profiles);
•        Plan your first webinar / YouTube video which can showcase your expertise and make it reach more people;
•        Stop hard-selling, rather work on building a reputation on these channels; and
•        Connect with relevant professionals on LinkedIn / Twitter and follow them.

For, it goes without saying that
NETWORK = NET WORTH

Do you think you’re sitting still right now?
– You’re on a planet orbiting a star at 30 km/s
– That star is orbiting the centre of a galaxy at 230 km/s
– That galaxy is moving through the universe at 600 km/s
Since you started reading this, you have travelled about 3,000 km

If your hate could be turned into electricity,
it would light up the whole world
– Nikola Tesla

 

THE LONG FORM AUDIT REPORT FOR BANKS GETS EVEN LONGER

INTRODUCTION

The Long Form Audit Report (LFAR) has for long been used as a tool by the RBI through the Statutory Auditors to identify and assess gaps and vulnerable areas in the working of banks. According to the RBI, the objective of the LFAR is to identify and assess the gaps and vulnerable areas in the business operations, risk management, compliance and efficacy of internal audit and provide an independent opinion on the same to the Board of the bank.

As recently as on 5th September, 2020, RBI notified a revised format of the LFAR, applicable from the financial year 2020-21, which repeals the earlier format and other instructions issued on 17th April, 2002. Whilst almost all the earlier requirements have been retained, there have been several specific matters which have been included for reporting keeping in mind the large-scale changes in the size, complexities, risks and business models related to banking operations in the last two decades.

The LFAR is an integral part of the statutory audit of banks which needs to be factored right from the planning to the reporting stage of the audit process. In designing the audit strategy and plan, the auditor should consider the LFAR requirements and conduct need-based limited transaction testing.

The following are the main sources of information for the purpose of compiling the information for LFAR reporting:
a) Audited financial statements and the related groupings, trial balances and account analysis / schedules;
b) Minutes of the meetings of the Board and the various committees;
c) Internal and concurrent and other audit reports;
d) RBI inspection reports;
e) Other supporting MIS data / information produced by the entity which should be verified for accuracy /completeness as per the normally accepted audit procedures in terms of the SAs;
f) Policies and procedures laid down by the management.

This article attempts to provide an overview of the major changes in the reporting so as to sensitise both the Central Statutory Auditors and the Branch Auditors.


COVERAGE

As was the case with the earlier format, the indicative areas of coverage are separately indicated for the Central Statutory Auditors and the Branch Auditors. However, in cases where there is only one Statutory Auditor, which is generally the case with private sector banks or the branches of foreign banks, the auditors should ensure that the contents under both the sections are read harmoniously such that nothing significant is missed out. Since the areas to be covered are only indicative, the RBI in its Circular has made it clear that any material additions / changes in the scope may be done by giving specific justification and with prior intimation to the Audit Committee. Accordingly, the auditors should not adopt a boilerplate approach.

Major changes in the indicative content are discussed and analysed in the subsequent sections.


FOR CENTRAL STATUTORY AUDITORS

Credit Risk areas
Credit Risk in the context of banking refers to the risk of default or non-payment or non-adherence to contractual obligations by a borrower. The revenue of banks comes primarily from interest on loans and thus loans form a major source of credit risk. Whilst the basic reporting requirements are the same as before, there are several additional areas which need to be reported / commented upon and which can be broadly categorised as under:

Area

 

Additional areas to be
commented / reported upon

 be commented / reported
upon

Loan policy

Specific observations are required regarding the business model /
business strategy as per the policy as against the actual business / income
flow of the bank

Review / monitoring / post-sanction follow-up / supervision

The following are some of the additional matters requiring
specific comments / reporting:

•      Comments on the overall effectiveness of
credit monitoring system covering both on-balance sheet and off-balance
sheet exposures, along with the quality of reporting both within the bank and
to outside agencies (like RBI, CRILC,
CIBIL), etc.

•     
Comments on the functioning and effectiveness of the system of
identifying and reporting of Red-Flagged Accounts based on Early
Warning System (EWS) indicators for which reference should be made to the
Master Directions on Frauds-Classification and Reporting dated 1st
July, 2016 issued by the RBI (also applicable to Branch Auditors)

Restructuring / resolution of stressed accounts

This is an entirely new section which has been introduced
keeping in mind the emphasis on restructuring in the backdrop of the enhanced
level of stressed assets in the banking system. The specific matters on which
comments are required are summarised hereunder:

•     
Deviations observed in restructured accounts / stressed accounts under
resolution with reference to internal / RBI guidelines

•    
Special emphasis should be given on the stance of the bank with
respect to the following matters:

a)   
formulation of board-approved policies including timelines for resolution;

b)    the
manner in which decisions are taken during review period;

c)   
board-approved policies regarding recovery, compromise settlements,
exit of exposure through sale of stressed assets, mechanism of deciding
whether a concession granted to a borrower would have to be treated as
restructuring or not, implementation of resolution in accordance with the
laid-down conditions, among others;

Special attention would have to be paid in the current financial
year regarding the relaxations and concessions provided as a result of
COVID-19

Asset quality (also applicable to branch auditors)

This is also an entirely new section given the emphasis
on asset classification and the consequential provisioning and attempts by banks
and borrowers to subvert the same. The specific matters on which comments are
required are summarised as below:

•       
Continuous monitoring of classification of accounts into Standard,
SMA, Sub-standard, Doubtful or Loss as per the Income Recognition and Asset
Classification Norms by the system, preferably without manual intervention,
determining the effectiveness of identifying the consequential NPAs and the
appropriate income recognition and provisioning thereof;

Asset quality (continued)

•      Procedure followed by the bank in
upgradation of NPAs, updation of the value of securities with reference to
RBI regulations and compliance by the bank with divergences observed during
earlier RBI inspection(s) with requisite examples of deviations, if any

It is imperative for the auditors to thoroughly review the
latest RBI Guidelines and Circulars and also read the latest RBI inspection
reports since greater granularity in reporting is now expected vis-a-vis
the earlier reporting requirements

Recovery policy (also applicable to branch auditors)

The following are some of the additional matters requiring
specific comments / reporting dealing with the Insolvency and Bankruptcy
Resolution Process:

•     
System of monitoring accounts under Insolvency and Bankruptcy Code,
2016 (IBC)

•     
Verifying the list of accounts where insolvency proceedings had been
initiated under IBC, but subsequently were taken out of insolvency u/s 12A of
the
IBC by the Adjudicating Authority based
on the approval of 90% of the creditors.
The auditors may satisfy themselves regarding the reasons of the creditors,
especially the bank concerned, to agree to exiting the insolvency resolution
process, and may comment upon deficiencies observed, if any

Large advances

The Guidelines now specifically require comments on adverse
features considered significant in top 50 standard large advances and the
accounts which need management’s attention. In respect of advances below
the threshold, the process needs to be checked and commented upon, based on a
sample testing. This is a very onerous responsibility which has been
cast on the auditors and needs to be factored in whilst selecting their
sample for testing. Earlier there was no specific quantitative threshold laid
down for reporting. Care should be taken to ensure that the sample which is
selected also covers cases beyond the top 50 standard accounts. Further, it
appears that this threshold is for the bank as a whole

(Attention is also invited to the reporting requirements for
Branch Auditors discussed subsequently wherein different quantitative
thresholds are specified for individual branches)

Audit reports

Major adverse features observed in the reports of all audits / inspections,
internal or external, carried out at the credit department during the
financial year should be suitably incorporated in the LFAR, if found
persisting

Market risk areas
Market risk mostly occurs from a bank’s activities in capital markets, commodities markets and dealings in foreign currencies. This is due to the unpredictability of equity markets, movement of exchange and interest rates, commodity prices and credit spreads. The major components of a bank’s market risk include interest rate risk, equity risk, commodity price risk and foreign exchange risk.

This section covers reporting on investments and derivatives (the latter being specifically added) apart from CRR / SLR and ALM reporting requirements. Some of the specific additional areas requiring comments / reporting are as under:

•    Merit of investment policy and adherence to the RBI guidelines.
•    Deviations from the RBI directives and guidelines issued by FIMMDA / FIBIL / FEDAI which primarily deal with valuation of investments and foreign exchange exposures should be suitably highlighted.
•    With respect to the RBI directives, special focus should be placed on compliance with exposure norms, classification of investments into HTM / AFS / HFT category and inter-category shifting of securities.
•    Veracity of liquidity characteristics of different investments in the books, as claimed by the bank in different regulatory / statutory statements.
•    The internal control system, including all audits and inspections, IT and software being used by the bank for investment operations should be examined in detail.

Since there is a lot of emphasis on compliance with the RBI guidelines, it is important for auditors to be aware of the relevant guidelines dealing with investments and derivatives, the important ones being as under:

•    Master Circular – Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks dated 1st July, 2015 and other related matters.
•    General Guidelines for Derivative Transactions vide RBI Circulars dated 20th April, 2007, 2nd August, 2011 and 2nd November, 2011 together with specific operational guidelines for Currency Option, Exchange Traded Interest Rate Futures, Interest Rate Options and Commodity Hedging vide separate Master Directions.
•    Guidelines for Inter-Bank Foreign Exchange Dealings vide Master Directions on Risk Management and Inter-Bank Dealings dated 5th July, 2016.

 Governance, assurance functions and operational risk areas
This is a new section introduced in place of the existing section on Internal Controls. Whilst the basic reporting requirements are the same as before, there are several additional areas which need to be reported / commented upon and which can be broadly categorised as under:

Area

Additional areas to be commented /
reported upon

Governance and assurance functions

This is an entirely new section given the emphasis on
proper and robust governance and risk management keeping in mind the large-scale
changes in the business model of banks. The specific matters on which
comments are required are summarised hereunder:

•     
Observations on governance, policy and implementation of
business strategy and its adequacy vis-à-vis the risk
appetite statement of the bank

•     
Comments on the effectiveness of assurance functions (risk management,
compliance and internal audit)

•     
Comments on the adequacy of risk-awareness, risk-taking and
risk-management, risk and compliance culture

 

The following are some of the specific matters which are
relevant for an effective governance, assurance and risk management system in
a bank:

a)    Oversight
and involvement in the control process by the Board, Audit Committee and
Those Charged With Governance, some of which are specifically mandated
by the RBI, like framing of policies on specific areas,
constitution of specific Board Level Committees and undertaking calendar of
reviews.

b)    Mandatory
Risk Based Internal Audit vide RBI Circular Ref: DBS.CO.PP.BC.
10/11.01.005/2002-03, 27th December, 2002.

c)    Mandatory
Concurrent Audit vide RBI Circular Ref: DBS.CO.ARS. No. BC.
2/08.91.021/2015-16 dated 16th July, 2015

Balancing of books / Reconciliation of control and subsidiary
records

Item-wise details of system-generated transitory accounts not
nullified at the year-end should be given separately with ageing of such
items

Inter-branch reconciliation, suspense accounts, sundry deposits,
etc.

The following are some of the additional matters requiring
specific comments / reporting:

•     
Sufficiency of audit trail with respect to entries in such accounts

•     
Age-wise analysis of unreconciled entries for each type of entry as on
balance sheet date along with subsequent clearance thereof, if any, should be
provided

Frauds / vigilance (also applicable to branch auditors)

Special focus should be given to the potential risk areas which
might lead to perpetuation of fraud. For this purpose, reference should be
made to Early Warning System (EWS) indicators as per the Master Directions
on Frauds-Classification and Reporting dated 1st July, 2016 issued
by the RBI

KYC / AML requirements (also applicable to branch auditors)

This is also an entirely new section given the need and
importance for banks to comply with various AML regulations and also
regulations countering the financing of terrorism and to prevent them from
becoming involved with criminal or terrorist activity. The specific matters on
which comments are required are summarised hereunder:

•     
Whether the bank has duly updated and approved KYC and AML policies in
synchronisation with RBI circulars / guidelines.

•     
Whether the said policies are effectively implemented by the bank.

•       
Assessment of the effectiveness of provisions for preventing money
laundering and terrorist financing.

The KYC and AML Guidelines are prescribed in the Master
Directions on KYC dated 8th December, 2016 as amended from time to
time issued by the RBI.

As per the directions, all banks are required to frame a KYC
policy which must contain at least the following key elements as laid down in
the Master Directions:

a)    
Customer Acceptance Policy.

b)    Risk
Management.

c)    Customer Identification Procedures.

d)   
Monitoring of Transactions.

e)   
Maintenance of Records under the PML Act.

f)    
Reporting Requirements to Financial Intelligence Unit – India and
sharing of information.

Para-banking activities

There is now a separate section which has been included in
respect of such activities which are specifically permitted to be undertaken
by the RBI, either departmentally or through subsidiaries. These activities
are generally non-fund based and are a major source of revenue for banks. The
specific matters on which comments are required are summarised hereunder:

•     
Whether the bank has an effective internal control system with respect
to para-banking activities undertaken by it.

•        A
list of such para-banking activities undertaken by the bank should also be
provided.

The RBI has issued a Master Circular dated 1st July,
2015 as amended from time to time on such activities. Some of the main
para-banking activities which banks are permitted to undertake either
departmentally or through subsidiaries in terms of the aforesaid Circular are
Equipment Leasing, Hire Purchase and Factoring, Primary

Para-banking activities (continued)

Dealership Business, Mutual Fund Business, Insurance Business,
etc.


CAPITAL ADEQUACY

Whilst the existing requirement of attaching the Capital Adequacy computation certificate in accordance with the BASEL III guidelines along with the comments on the effectiveness of the system of calculating the same and reporting of any concerns relating thereto are retained, there is now an additional requirement to give certain comments with regard to the International Capital Adequacy Assessment Process (ICAAP) Document, which is briefly discussed hereunder.

ICAAP Document
ICAAP is a process which needs to be undertaken by banks in terms of BASEL III under Pillar 2 Supervisory Review Process (SRP), which envisages the establishment of suitable risk management systems in banks and their review by the RBI. One of the principles under SRP envisages that the RBI would review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with the regulatory capital ratios which gets reflected in the ICAAP document, which is required to be submitted to the Board of Directors for review and then forwarded to the RBI based on which it would take appropriate supervisory action if they are not satisfied with the result of this process. In this context, the following matters are required to be specifically commented upon:
•    Whether stress test is done as per RBI Guidelines;
•    Whether assumptions made in the document are realistic, encompassing all relevant risks;
•    Whether the banks’ strategies are aligned with their Board-approved Risk Appetite Statement.

The ICAAP requirements are part of the BASEL III Guidelines as prescribed in the Master Circular dated 1st July, 2015 as amended from time to time issued by the RBI.


GOING CONCERN AND LIQUIDITY RISK ASSESSMENT

Going concern assessment
This is an entirely new section which has been introduced keeping in mind the specific reporting responsibilities and considerations under the SAs. The matters which need to be commented upon are as under:
•    Whether the going concern basis of preparation of financial statements is appropriate;
•    Evaluation of the bank’s assessment of its ability to continue to meet its obligations for the foreseeable future (for at least 12 months after the date of the financial statements) with reasonable assurance for the same;
•    Any material uncertainties relating to going concern.

For considering the above matters the auditors should consider the guidance in SA-570 (Revised), Going Concern, issued by the ICAI. Further, an important indicator to assess the Going Concern assumption is whether the bank has been placed under the Prompt Corrective Action (PCA) framework as laid down under the RBI guidelines vide RBI Circular Ref: RBI/2016-17/276 DBS.CO.PPD.BC. No. 8/11.01.005/2016-17 dated 13th April, 2017 which gets triggered on breach of certain thresholds on Capital Adequacy, Profitability and Leverage Ratio. The auditors should verify the correspondence with the RBI and other documentary evidence to ensure / identify the status of the supervisory actions indicated / initiated by the RBI, as per the above-referred Circular.

Liquidity assessment
This is also an entirely new section which has been introduced considering its linkage with the going concern assessment and the recent guidelines framed by the RBI relating to Liquidity Coverage Ratio (LCR) and Net Stability Funding Ratio (NSFR). The matters which need to be commented upon are as under:
•    As a part of the assessment of the bank on going concern basis, the auditor should consider the robustness of the bank’s liquidity risk management systems and controls for managing liquidity;
•    Identifying any external indicators that reveal liquidity or funding concerns;
•    Availability of short-term liquidity support;
•    Compliance with norms relating to LCR and NSFR (as and when applicable).

The RBI has issued Guidelines for Maintenance of LCR vide RBI Circular Ref: RBI/2013-14/635 DBOD.BP.BC. No. 120 / 21.04.098/2013-14 dated 9th June, 2014 and related Circulars in terms of which banks are required to maintain an LCR, computed as the ratio of HIGH QUALITY LIQUID ASSETS TO THE NET CASH OUTFLOW OVER THE NEXT 30 DAYS which should be >= 100% effective 1st January, 2019.


INFORMATION SYSTEMS

The reporting under this section has been modified to include comments and reporting on certain specific matters, in addition to the existing requirements. These are briefly indicated hereunder:

Robustness of IT Systems:
•    Whether the software used by the bank were subjected to Information System & Security Audit, Application Function testing and any other audit mandated by RBI.
•    Adequacy of IS Audit, migration audit (as and where applicable) and any other audit relating to IT and the cyber security system.
•    Compliance with the findings of the above audits.

The following are the main RBI Circulars which are relevant in the context of the above reporting:
•    RBI Circular Ref: DBS.CO.OS MOS.BC. /11/33.01.029 / 2003-04 dated 30th April, 2004 on Information System Audit;
•    RBI Circular Ref: DBS.CO.ITC.BC. No. 6/31.02.008/2010-11 dated 29th April, 2011 Guidelines for IS Audit.

IT Security Policy (Including Cyber Security Policy)
•    Whether the bank has a duly updated and approved IT Security and IS Policy;
•    Whether the bank has complied with the RBI advisory / directives relating to IS environment / cyber security issued from time to time.

The following are the main RBI Circulars which are relevant in the context of the above reporting:
•    RBI Circular Ref: DBS.CO.ITC.BC. No. 6/31.02.008/2010-11 dated 29th April, 2011 (covering the IT Security Framework);
•    RBI Circular Ref: RBI/2015-16/418 DBS.CO/CSITE/BC. 11/33.01.001/2015-16 dated 2nd June, 2016 (covering the Cyber Security Framework).

Critical systems / processes
•    Whether there is an effective system of inter-linkage including seamless flow of data under Straight Through Process (STP) amongst various software / packages deployed.
•    Outsourced activities – Special emphasis has been placed on outsourced activities and bank’s control over them, including bank’s own internal policy for outsourced activities. In determining the reporting obligations in respect of outsourcing activities, the auditors should refer to the RBI Circular Ref: RBI/2006/167 DBOD.NO.BP. 40/ 21.04.158/ 2006-07 dated 3rd November, 2006. The said Circular requires the bank to put in place a comprehensive outsourcing policy, duly approved by the Board, which needs to cover the following aspects:
    a) Selection of activities;
  b) To ensure that core management functions including Internal Audit, Compliance function and decision-making functions like determining compliance with KYC norms for opening deposit accounts, according sanction for loans (including retail loans) and management of investment portfolio are not outsourced;
    c) Selection of service providers;
    d) Parameters for defining material outsourcing;
    e) Delegation of authority depending on risks and materiality;
    f) Systems to monitor and review the operations.

OTHER MATTERS
The specific additional areas requiring comments / reporting are as under:
Depositor Education and Awareness Fund (DEAF) Scheme 2014
Specific comments are required on the system related to compliance with the DEAF norms, which are laid down in the RBI Circular Ref: DBOD. DEAF Cell. BC. No. 101/ 30.01.002/2013-14 dated 21st March, 2014 the salient features of which are as under:
(a) Under the provisions of section 26A of the Banking Regulation Act, 1949 the amount to the credit of any account in India with any bank which has not been operated upon for a period of ten years or any deposit or any amount remaining unclaimed for more than ten years shall be credited to the Fund, within a period of three months from the expiry of the said period of ten years;
(b) The Fund shall be utilised for promotion of depositors’ interests and for such other purposes which may be necessary for the promotion of depositors’ interests as specified by RBI from time to time;
(c) The depositor would, however, be entitled to claim from the bank the deposit or any other unclaimed amount or operate the account after the expiry of ten years, even after such amount has been transferred to the Fund;
(d) The bank would be liable to pay the amount to the depositor / claimant and claim refund of such amount from the Fund.

Customer Services
Specific comments are required on business conduct including customer service by the bank describing instances, if any, of wrong debit of charges from customer accounts (also applicable to Branch Auditors), mis-selling, ineffective complaint disposal mechanism, etc. In this context, reference should be made to the RBI Master Circular on Customer Service in Banks dated 1st July, 2015 in terms of which banks are required to have a proper Customer Services Governance Framework coupled with Board Approved Customer Service Policies on specific aspects like Deposits, Cheque Collection, Customer Compensation, Grievance Redressal, amongst others.

In respect of all the above matters, involving compliance with the specific RBI guidelines, it is imperative for the auditors to thoroughly review the latest RBI Guidelines and Master Circulars / Directions and also read the latest RBI Inspection reports since greater granularity in reporting is now expected vis-a-vis the earlier reporting requirements.

FOR BRANCH AUDITORS

Whilst the basic reporting requirements are similar to those before, there are several additional areas which need to be reported / commented upon which can be broadly categorised as under:

Area

Additional areas to be commented /
reported upon

Cash, balances with the RBI, SBI and other banks

•     
Reconciliation of the balance in the branch books in respect of cash
with its ATMs with the respective ATMs, based on the year-end scrolls
generated and differences, if any

•      
Bank Reconciliation entries remaining unresponded for more than 15
days

•     
Unresponded entries with respect to currency chest operations

Large advances

 

 

 

 

 

 

 

•     
Details in the specified format for all outstanding advances in
excess of 10% (earlier 5%) of outstanding aggregate balance of fund-based
and non-fund-based advances of the branch or Rs. 10 crores (earlier Rs. 2
crores), whichever is less

•    
Comment on adverse features considered significant in top 5
standard large advances and which need management’s attention

Credit appraisal

•      
Cases of quick mortality in accounts, where the facility became
non-performing within a period of 12 months from the date of first sanction;

•       
Whether the applicable rate of interest is correctly fed into the
system;

Credit appraisal (continued)

•     
Whether the interest rate is reviewed periodically as per the
guidelines applicable to floating rate loans linked to MCLR / EBLR

      
(External Benchmark Lending Rate). [Refer to RBI Circular Ref: RBI
/2019-20/53 DBR. DIR. BC. No. 14/13.03.00/2019-20 dated 4th September,
2019 for Benchmark-Based Lending].

•     
Whether correct and valid credit rating,
if available, of the credit facilities of
bank’s borrowers from RBI accredited Credit Rating Agencies has been fed into
the system

Deposits

•     
Whether the scheme of automatic renewal of deposits applies to FCNR(B)
deposits;

•     
Where such deposits have been renewed, whether the branch has
satisfied itself as to the ‘non-resident status’ of the depositor and whether
the renewal is made as per the applicable regulatory guidelines and the
original receipts / soft copy have been dispatched

Gold / bullion

•      Does
the system ensure that gold / bullion is in effective joint custody of two or
more officials, as per the instructions of the controlling authorities;

Gold / bullion (continued)

•      Does
the branch maintain adequate and regular records for receipts, issues and
balances of gold / bullion.

•      Does
the periodic verification reveal
any excess / shortage of stocks as
compared to book records which have been promptly reported to the controlling
authorities

Books and records

•     
Details of any software / systems (manual or  otherwise) used at the branch which are not
integrated with the CBS;

•     Any
adverse feature in the IS audit having an impact on the branch accounts;

•    
Prompt generation and expeditious
clearance of entries in the exception reports generated


CONCLUSION

The amendments / additional reporting requirements seem to reflect the mindset of the regulators to place enhanced responsibilities and expectations on the auditors in the already existing long list of reporting requirements in the LFAR which has become longer and more onerous with correspondingly longer sleepless nights!

 

Neediness: The need to be approved by others highlights the
fact that you do not approve of yourself
– Strategic Revolt

We don’t control our body, property, reputation, position,
and, in a word, everything not of our own doing
– Epictetus

TAXABILITY OF PRIVATE TRUST’S INCOME – SOME ISSUES

Taxability as to the income of the trustees of a private trust is something which at times eludes answers. This is despite the fact that most of the taxation law in this regard is contained in just a few sections, viz., sections 160 to 167.

SPECIFIC TRUST VS. DISCRETIONARY TRUST

Section 161 provides inter alia that tax shall be levied upon and recovered from the representative assessee in the like manner and to the same extent as it would be leviable upon the person represented. This phrase, ‘in like manner and to the same extent’, came to be interpreted by the Hon’ble Supreme Court in the case of C.W.T. Trustees of H.E.H. Nizam’s Family (Remainder Wealth) Trust, 108 ITR 555, page 595 in which the Court explained the three-fold consequences:

a) There must be as many assessments on the trustees as there are beneficiaries with determinate and known shares, though for the sake of convenience there may be one assessment order specifying separately the tax due in respect of the income of each of the beneficiaries;
b) The assessment of the trustees must be made in the same status as that of the particular beneficiary whose income is sought to be taxed in the hands of the trustee; and
c) The amount of tax payable by the trustees must be the same as that payable by each beneficiary in respect of the share of his income, if he were to be assessed directly.

Thus, it is clear that income in case of specific trust cannot be taxed in the hands of the trustees as one unit u/s 161(1) and tax on the share of each beneficiary shall be computed separately as if it formed part of the beneficiaries’ income. It is because of this reason that the Madras High Court in the case of A.K.A.S. Trust vs. State of Tamil Nadu, 113 ITR 66, held that a single assessment on the trustees by clubbing the income of all beneficiaries whose shares were defined and determined was not valid.

As opposed to specific trust there is a discretionary trust which means that the trustees have absolute discretion to apply the income and capital of the trust and where no right is given to the beneficiary to any part of the income of the trust property. Section 164 of the Act itself provides that a discretionary trust is a trust whose income is not specifically receivable on behalf of or for the benefit of any one person, or wherein the individual shares of the beneficiaries are indeterminate or unknown.

Therefore, section 161(1) can apply only where income is specifically received or receivable by the representative assessee on behalf of or for the benefit of the single beneficiary, or where there are more than one, the individual shares of the beneficiaries are defined and known. Tax in such a case would be levied on the representative assessee on the portion of the income to which any particular beneficiary is entitled and that, too, in respect of such portion of income. On the other hand, if income is not receivable or received by the representative assessee specifically on behalf of or for the benefit of the single beneficiary, or where the beneficiaries being more than one, their shares are indeterminate or unknown, the assessment on the representative assessee qua such income would be in accordance with the provision of section 164.

APPLICABILITY OF MAXIMUM MARGINAL RATE

The next issue is that relating to the interpretation of sub-section (1A) of section 161 which provides that in case of a specific trust where income includes profits and gains of business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum marginal rate. Therefore, whenever there is any income of profits and gains of business in the case of specific trust, the whole income would suffer the tax at the maximum marginal rate irrespective of the tax which could have been levied upon the beneficiary as per the plain text of that section. But it has been held in CIT vs. T.A.V. Trust 264 ITR 52, 60 (Kerala) that where there are business income as well as other income in case of specific trust, then, too, income from the business earned by the trust alone shall be taxed at the maximum marginal rate and the other income has to be assessed in the hands of the trustees in the manner provided in section 161(1), i.e., in the hands of the beneficiaries. It would be appropriate if the observations of the High Court are extracted:

‘Now reverting to section 161(1A) of the Act it must be noted the sub-section (1A) only says, “notwithstanding anything contained in sub-section (1)”: in other words, it does not say “notwithstanding anything contained in this Act”. Thus, though the provisions of sub-section (1A) override the provisions of sub-section (1) of section 161, it does not have the effect of overriding the provisions of section 26 of the Act and consequently computation of the income from house property has to be made under sections 22 to 25 of the Act since the Tribunal had entered a categorical finding that the shares of the beneficiaries are definite. As already noted, as per sub-section (1A), where any income in respect of which a representative assessee is liable consists of, or includes, income by way of profits or gains of business, tax shall be charged on the whole of the income in respect of which such person is so liable at the maximum rate. The income so liable referred to in the said sub-section is only the business income of the trust and not any other income. It is only the income by way of profits and gains of business that can be charged at the maximum marginal rate. Any other interpretation, according to us, is against the very scheme of the Act and further such an interpretation will make the provisions of sub-section (1A) of section 161 unconstitutional. It is a well settled position that if two constructions of a statute are possible, one of which would make it intra vires and the other ultra vires, the Court must lean to that construction which would make the operation of the section intra vires (Johri Mal vs. Director of Consolidation of Holdings, AIR 1967 SC 1568).

This was an important interpretation placed by the Kerala High Court which is available to the taxpayers and can be pressed in appropriate cases.

According to section 164(1), income of the discretionary trust shall suffer tax at the maximum marginal rate, meaning that there would not be any basic exemption available except in situations provided under the provisos appended thereto. However, the Gujarat High Court in Niti Trust vs. CIT 221 ITR 435 (Guj.) has held that if there is a long-term capital gain, the maximum marginal rate applicable is 20% and such income would suffer the tax @ 20%. A similar position has been explained and taken by the Mumbai Bench of the Income-tax Appellate Tribunal in the case of Jamshetji Tata Trust vs. JDIT (Exemption) 148 ITD 388 (Mum.) and in Mahindra & Mahindra Employees’ Stock Option Trust vs. Additional CIT 155 ITD 1046 (Mum).

It may, however, be noted that the maximum marginal rate (MMR) as per the existing tax structure otherwise would work out to approximately 42.74%. Therefore, it can be taken in case of discretionary trust that if income includes any income on which special tax rate is applicable, that special rate being MMR for that income would be applicable qua such income and the rest of the income would suffer the tax rate (MMR) of 42.74% approximately.

‘ON BEHALF OF’ ‘FOR THE BENEFIT OF’


Private trust in itself is not a ‘person’ under the Act. Trustees who receive or are entitled to receive income ‘on behalf of’ or ‘for the benefit of any person’ are assessed to tax as taxable entities. Although section 160(1) uses the twin expressions ‘on behalf of’ and ‘for the benefit of’, but section 5(1)(a) which prescribes the scope of total income, uses the expression ‘by or on behalf of’ and therefore the question arises as to whether the implications of both the expressions are similar or are different.

The Supreme Court in the case of W.O. Holdswords & Ors. vs. State of Uttar Pradesh, 33 ITR 472, had occasion to examine both the phrases in the context of the position of trustees. The Court held that trustees do not hold the land from which agricultural income is derived on behalf of the beneficiary but they hold it in their own right though for the benefit of the beneficiary. Besides, a trust is defined in the English Law as ‘A trust in the modern and confined sense of the word is the confidence reposed in a person with respect to property of which he has possession or over which he can exercise a power to the intent that he may hold the property or exercise the power for the benefit of some other person or objects’ (vide Halsbury’s Laws of England, Hailsham Edition, Volume 33, page 87, para 140).

Thus, it is more than evident that legal estate is vested in the trustees who hold it for the benefit of the beneficiary. Section 3 of the Indian Trust Act, 1882 is also clear and categorical on this point to the effect that the trustees hold the trust property for the benefit of the beneficiaries but not ‘on their behalf’.

Section 56(2)(x) introduced by the Finance Act, 2017 provides inter alia that any sum of money and / or property received by a person without consideration, or property received by a person without adequate consideration, would constitute income. There is some threshold limit in certain situations given under that section but that is not relevant for the purpose of the present discussion. Exceptions given in the proviso to section 56(2)(x) provide inter alia that money or property received from an individual by a trust created or established solely for the benefit of a relative of an individual would not be hit by clause (x) of section 56(2). Thus, if the settlor is an individual and the beneficiary is a relative of such individual, receipt of money and / or property by the trustees for the benefit of the relative would not be hit by the provisions of section 56(2)(x).

But whether the property settled by the individual settlor for the benefit of a non-relative would become taxable income u/s 56(2)(x) is a question which would engage all of us.

Section 4, which is the charging section, provides inter alia that income tax shall be charged for any assessment year in accordance with and subject to the provisions of the Act in respect of total income of the previous year of every person. Section 5 provides inter alia that total income of any previous year of a person includes all income from whatever source derived which is received or deemed to be received in India in such year by or on behalf of such person. Therefore, any income which is not received by the person or on behalf of such person cannot be brought within the scope of total income. In other words, income received for the benefit of such person is not contemplated to be covered u/s 5 and cannot be brought to tax in the hands of such person. Therefore, when the trustees receive the property for the benefit of the beneficiary, such receipt falls outside the scope of total income even if the beneficiary is a non-relative qua the settlor as the receipt of the property by the trustees cannot be said to be received by the beneficiary or received on behalf of the beneficiary. Therefore, the applicability of section 56(2)(x) even in the case of a non-relative beneficiary in the light of the above interpretation may not be easy for the Revenue. However, such interpretation is liable to be fraught with strong possibility of litigation.

In sum, taxability of private trust has been saddled with lots of controversies many of which have been sought to be given quietus with amendments made from time to time, but such controversies are never-ending.

 

The point of modern propaganda isn’t only to misinform or push an agenda. It is to exhaust your critical thinking, to annihilate truth
– Gary Kasparov

Teachers should prepare the student for the student’s future, not for the teacher’s past
– Richard Hamming

BURDEN OF DEALING WITH GOVERNMENT AND LESSONS FOR PROFESSIONALS

The recent compliance season of FYE 2019-20 in Covid’s shadow was another instance in the uninterrupted tradition of inciting difficulty in dealing with the government BY the government. The late announcement of extension for the due date of 31st October when the FM had earlier postponed dates except this tax audit date much in advance, appeared to display deep and vehement disregard for income-tax payers by the CBDT in spite of announcements such as ‘honouring the honest taxpayer’.
 

The unceasing inefficiencies, digital dysfunctionalities and lack of service require no summary. The point here is to nudge those vested with exclusive power, responsibility and obligation to make amends.

 

Let’s also look in the mirror and relearn some lessons. I have divided them under three groups:

 

REMEMBER:

1. Our job often is to report and help compliance.

2. Beyond a point, we need not call for extensions as much as we like to uphold what we believe is right.

3. The client is the primary owner of the compliance responsibility.

4. Signing off with a client doesn’t mean ‘delivering anyhow’ or ‘delivering no matter what’. That happens only in super-hero movies.

5. Promises and rhetoric are for optics. The final test of one’s word is the resultant experience. (GST, for example – great idea, terrible implementation!)

6. We ‘suffer’ when something goes wrong; but government cannot ‘suffer’ or ‘feel’.

7. Government has low commitment. Its words are need-based and breaches have no consequence1.You and I have a personal honour to keep our word, unlike the government.

8. Vote banks are more important than taxpayer banks. The taxpayers and tax professionals are at the bottom of their priority list.

 

 

1   Remember the FM adding
LTCG on STT-paid securities sale or MAT on SEZ profits that were tax-free


NEVER:

9. Carry the burden of clients. Few understand the pain that professionals go through.

10. Breach the ‘respectable distance’ we must keep from clients.

11. Emotionally identify (like doctors) with client problems, rather, identify their problems, give solutions and offer assistance.

12. Compromise on health. Your health is of paramount importance. Health once damaged can be irreparable and even(tually) fatal.

13. Feel that a contract of service by a Chartered Accountant is a contract of guarantee or insurance.

14. Work without an engagement letter defining scope and fees, timelines, deliverables and client readiness as a precondition. Never.

 

ALWAYS:

15. Explain the rules of services – Compliance is a sub-set of client preparedness and provision of useable data well in time.

16. Let clients sense that you cannot be taken for granted, especially for those perennial late-comers, shabby record-keepers, and low quality hirers.

17. Remind clients of their responsibilities, timelines to supply data and the consequences of not doing so.

18. Keep educating clients on the difference between products and services – products can be delivered off the shelf, not services.

19. Let clients know that delays have a ripple effect. Delay or breaking the tempo impacts other assignments. Have a start date and an end date.

20. Know the difference between material and immaterial for both amounts and issues in an assignment.

21. Consider variable fees – benefits for early birds.

 

Till we don’t do enough of the above, compliance professionals will be sinking deeper into a hole – health-wise and money-wise. Increasing compliances may seem lucrative and remunerative but will be taken over by machine. The role of CAs in our mind must be re-imagined and recalibrated constantly. This is not a guess, estimate or premonition. It is written on the wall!

 

 

 

 

Raman Jokhakar

Editor

 

ARE YOU CHASING THE GOLDEN DEER?

The pandemic brought us on our knees. In the name of growth, development and progress, mankind has gotten itself to a juncture where we are made to ponder – Are we chasing a golden deer? A few words about the legendary golden deer shall be in place.

Fulfilling the wish of Kaikeyi, King Dashrath sent Ram to forest exile for 14 years. Travelling through the woods, Ram, accompanied by his wife Sita and brother Laxman, reached the banks of the river Godavari and built an ashram there.

Ravana, to fulfil the wish of his sister Surpanakha who wanted Sita to be abducted to avenge the humiliation of her nose being cut off, was ready to do as desired by her. He requested Maricha, his uncle, to turn into a golden deer and graze around Ram’s ashram. Reluctantly, Maricha agreed to disguise himself and turn into a golden deer. As the golden deer grazed near Ram’s ashram, Sita noticed the enchanting beauty of the deer. The ‘Aranyakanda’ from Valmiki’s Ramayana describes the deer thus:

‘A beautiful golden deer with silver spots.
A deer that glowed as it moved with the sparkle of a hundred gems.
Sapphires, moonstones, black jets and amethysts,
studded on its lithe, golden body’.

Lured by its beauty, Sita insisted on having the deer and convinced Ram to chase it and bring it to her. Much against the wishes of Laxman, Ram chased the deer. After a long chase away from the ashram, Ram shot the deer, at which point of time it took the original form of Maricha and cried out for help in Ram’s voice. The rest of the narrative is history. However, for the purpose of the present contemplation I think we as professionals need to do some soul-searching in answer to this question at an individual level.

Our endeavour or life-long pursuit is seeking a state of everlasting happiness for ourselves and our near and dear ones. In this pursuit, we set out to achieve our degrees, get ourselves on a career path, slog our backs out without respite from dawn to dusk, making huge sacrifices in the process, bring up our families though finding it difficult to spend time with them, make money (the limits of which are never set) – but by the time we start feeling that we have ‘arrived’, it is time to ‘depart’!

The following lines are deeply entrenched in my mind’s eye right from the days when I commenced my career as a Chartered Accountant –

‘You’re counted among the best in your profession.
Because you’ve got talent, you’ve used it.
But have you been using yourself up in the process?
You slogged and made sacrifices –
Remember all those late nights at the office
And those hectic afternoons when you almost went mad with the tension?
Those skipped lunches, those fried snacks,
Those endless cups of coffee to keep the adrenalin flowing? Cigarettes? Booze?
Success has its price. You’ve paid it.
That’s why you are where you are.
Fair enough. But what lies ahead?
A long roll downhill? Hypertension? Heart disease? Ulcers? Diabetes?
A fragile old age, brought about prematurely’?

Does it sound like a rollercoaster ride bereft of all thrills, leaving you tired and exhausted? Do you think you have been successful but have no sense of accomplishment? Is it a futile attempt to reach the horizon?

What are you consumed by in your daily grind?
Is there a sense of accomplishment in what you do?
What gives meaning to what you do?
Does your success bring you fulfilment?
Are your goals aligned to a higher purpose?

At whatever stage of life you may be at, it’s never too late to answer the question, Are You Chasing The Golden Deer? because an unexamined life is not worth living.

USHERING IN UTOPIA

Your Editorial, EPIC SPEECH ON ‘BABUCRACY’ (BCAJ, December, 2020), is really an eye-opener. If such conditions are ushered in, we will be in UTOPIA. You have wonderfully brought out the quintessence of the Minister’s lamentations. Standards of general honesty are very low in our country. One Nitin Gadkari cannot bring in sweeping changes. People should raise their levels of integrity. Rama Rajyam cannot be established overnight. So many years of Independence have not made any marked change of attitude… You have done well, Editor, and let us hope for a transformation.

                                                                                                                   – R. Krishnan

WHO OR WHAT’S A CAP?

Mr. Thinkeshwar was a senior Chartered Accountant in practice for many years. His real name was Ishwar. However, he used to think so much that people started calling him ‘Thinkeshwar’. He was very sensitive and quite aware of social issues. He had genuine sympathy for the pains and miseries of the people, was a social activist and a good writer, too.

In the months of June and July, 2020 when Covid-19 was at its peak, he read a news item about how ‘Corona Afflicted People’ (CAP) were treated in society. One person tested Corona positive while he was in his office. Immediately, the boss asked him to leave. The CAP said there was no conveyance available. He was working in an essential service office – in a bank. But the boss ordered him to quit immediately and refused to even meet him. The driver refused to take him home in the car. The poor fellow walked about six km. to reach home. The security person was surprised to see him back so early. The news had already reached all the occupants of the society and the watchman was instructed not to let him enter the building. His family members were watching from their balcony. They threw his clothes and personal things down and asked him to go and stay in some hotel or any other place. He pleaded with each one of them – boss, colleagues, bank customers, driver, watchman, family members – about how he had done good things for them. But no one was in a mood to listen.

Thinkeshwar was moved by such true stories and started writing a very emotional article.

Suddenly, a thought occurred to him which gave him the shivers – what would happen if he himself became a CAP! He imagined certain scenes and dialogues:

With partners: ‘I slogged for the development of the firm with utmost good faith and sacrificed my personal life.’

Partners: ‘See, our agreement is to share only the profits of the firm, not each other’s personal difficulties’.

With articles: ‘I was generous to you – granting leaves, giving concessions in timings, imparting good training’.
Articles: ‘That’s nothing. It was your duty and our right.’

With staff: ‘I treated you so nicely and affectionately. Never did any bossing, paid salaries and bonus on time.’
Staff: ‘So what? We worked on lower salary. We would have earned much more outside (although everybody had tried outside). On the contrary, we obliged you by working with you.’

To clients: ‘I sacrificed my personal life to provide better service to you, carried all your anxieties on my head and remained in stress always. I helped you in many difficult situations on low fees, which were never received promptly, and undertook so much risk in certifying your accounts.’
Clients: ‘Sorry. That was your professional duty. We could have hired some other CA at a much cheaper cost but due to our “relations” we kept on obliging you. And we believe there is some law that prohibits prompt and regular payment of fees to CA’s!’

To family members: ‘I slogged at the cost of my health and sacrificed all personal pleasures. I committed so many sins to provide you a happy life.’
Family: ‘What’s great about that? It is the fate of all CAs. It’s your destiny. We are not going to share your sins and pains.’

Many similar scenes took place in Mr. Thinkeshwar’s vivid imagination – with Revenue Officers, friends, relatives and neighbours, but everybody disowned him.

Poor CAP’s, he thought to himself. He remembered the story of ‘Valya the dacoit’ who became Valmiki to write the Ramayan. And then suddenly he trembled as he realised that CAP also stands for CA’s in Practice.

He smiled to himself and happily started writing ‘Light Elements’ for BCAJ with a heavy heart.

SEBI: REVISING ITS OWN ORDERS AND ENHANCING PENALTIES

BACKGROUND
One of the many penal powers that SEBI has under the SEBI Act, 1992 (‘the Act’) is to levy fairly hefty penalties on those who have violated the provisions of various securities laws. The penalty is often up to three times the gains or Rs. 25 crores, whichever is higher. A person on whom a penalty has been levied can appeal to the Securities Appellate Tribunal (‘SAT’) and, if he does not succeed, further to the Supreme Court.

However, the question is, can SEBI review and revise its own orders?

The penalty is levied by an Adjudicating Officer (‘AO’) who, though subordinate to SEBI, is expected to act independently. It may happen that the ‘AO’ has, in the eyes of SEBI, made an error and thus the alleged wrongdoer escapes with a lower or even no penalty. Can this error be corrected? An incorrect order not only lets a wrongdoer escape but also creates a precedent for related matters in similar context and future cases.

The Act provides for a review and revision of the orders passed by the ‘AOs’. The Act was amended in 2014 with effect from 28th March, 2014 and sub-section (3) was introduced to section 15-I to permit such revision. Broadly stated, SEBI can initiate proceedings to revise an adjudication order and enhance the penalty if the order is found erroneous and not in the interests of the securities markets. The review proceedings have to be initiated within three months of the original order, or disposal of appeal by SAT against such order, whichever is earlier.

SEBI has passed several review orders under this provision. In fact, it recently enhanced the penalty on credit rating agencies in the matter of IL&FS from Rs. 25 lakhs as per the original order to Rs. 1 crore. Let us analyse the provision in more detail and consider briefly some pertinent cases.

SECTION 15-I(3) ANALYSED

Section 15-I of the SEBI Act lays down the procedure for adjudication by an ‘AO’ under various provisions that prescribe the penalty for specific wrongs. Section 15-I(3) lays down the provisions relating to revising orders passed by the ‘AO’ and reads as under (emphasis supplied):

Power to adjudicate
…
(3) The Board may call for and examine the record of any proceedings under this section and if it considers that the order passed by the adjudicating officer is erroneous to the extent it is not in the interests of the securities market, it may, after making or causing to be made such inquiry as it deems necessary, pass an order enhancing the quantum of penalty, if the circumstances of the case so justify:

Provided that no such order shall be passed unless the person concerned has been given an opportunity of being heard in the matter:

Provided further that nothing contained in this sub-section shall be applicable after expiry of a period of three months from the date of the order passed by the adjudicating officer or disposal of the appeal under section 15T, whichever is earlier.

Specific aspects of this provision are discussed in the following paragraphs.

ORDER SHOULD BE ‘ERRONEOUS’

This is the basic and most important prerequisite for enabling SEBI to take up revision of such orders. There has to be a manifest error in the order. The error may be of fact or of law. The error may be of not levying a penalty where the law requires it, or levying a lower penalty. An error must also be distinguished from taking a different view from amongst two or more views plausible. It is submitted that the view taken by the ‘AO’ has to be erroneous in the sense that such view could not possibly be taken. An error may not be very difficult to identify and demonstrate. However, in case of law there may be some subtleties. If two views are possible on reading the relevant provision of law, merely because the ‘AO’ took one of the plausible views does not mean that the order is erroneous. However, if the view in law is not possible to be taken, then the order is erroneous.

The other issue is, when can the amount of penalty levied be said to be erroneous? Certain provisions levy a minimum penalty and thus if the ‘AO’ levies penalty below this statutory minimum, the order is obviously erroneous. There can be other similar errors. The interesting question is that if the ‘AO’ levies penalty within a certain range permissible under law, can the order be held to be erroneous and a higher penalty be levied? As we shall see later, SEBI has levied higher penalty, albeit on facts, in certain orders.

THE ORDER IS ‘NOT IN THE INTEREST OF SECURITIES MARKETS’

The error should be of such a nature that it is not in the interests of securities markets. This provision is obviously very broad in nature and gives a wide brush for the SEBI to paint with. The securities markets consist of investors, companies, various intermediaries, exchanges, etc. There is also generally the credibility of the securities markets. Further, and more importantly (as also pointed out in orders under this provision), an error whereby a wrongdoer escapes with lower or no penalty creates an unhealthy precedent for others and indirectly serves as a disincentive for those who scrupulously follow the law.

The two conditions are simultaneous
The order should be erroneous and such error should be one that is not in the interests of the securities markets. Both these conditions have to be shown by SEBI before it can take up review of such an order and pass a revised one.

Opportunity of being heard
This is a basic principle of natural justice and is inbuilt in the provision. The party should be given a fair opportunity of being heard since the revision may result in enhancement of the penalty.

Enhancement of the quantum of penalty
The order can be revised and the amount of penalty can be increased. An interesting contention was raised in a couple of cases that enhancement means that the earlier order should have levied at least some penalty. And, therefore, if there was no penalty levied, there is no question of enhancement! SEBI has rejected this technical argument and has held that a penalty can be levied even if no penalty was levied earlier.

Interestingly, SEBI has even taken a view in some orders that the revision need not necessarily be for enhancing the penalty. It may even be for correcting a wrong interpretation of law by the ‘AO’.

Time limit
The provision shall not apply after a period of three months from the date of the original order or disposal of the appeal by SAT in relation to such order, whichever is earlier. While the wording is not wholly clear on this point, SEBI has taken a view that the time limit applies to initiation of the proceedings and the final revised order may be passed in due course even after such time.

Whether appeal to SAT against original order would bar such revision till appeal is disposed of?
SAT has refused to bar the continuation of such proceedings for revision even when the original order was under appeal before it (in the case of India Ratings and Research Private Limited vs. SEBI, order dated 1st July, 2020). However, it also ordered in that case that the revised order should not be given effect to.

Whether the provisions relating to revision under the Income-tax Act, 1961 are pari materia with the provisions under the Act?
A stand often raised by parties when faced with such revision proceedings is that the provision under the Act should be interpreted and applied in the same strict manner as the provision for revision of orders under the Income-tax Act for which there are numerous precedents laying down principles. However, SEBI has rejected this stand generally. It has taken a view that the scheme, object and even wording of the provision under the Income-tax Act are sharply different. Hence, section 15-I(3) of the (SEBI) Act has to be viewed independently and broadly.

SOME ORDERS PASSED UNDER THIS PROVISION

Over the years, SEBI has passed several orders revising the original order. Some of those orders are worth reviewing briefly.

In an order dated 13th November, 2014 in the case of Crosseas Capital Services Private Limited, no penalty was levied in a certain case of self-trades through automated trading. On facts, SEBI reviewed this order and held that a penalty was leviable and also directed the party to review its systems to ensure that such acts are not repeated. SEBI also rejected the argument that ‘enhancement’ can be only where the earlier order had levied at least some penalty. Orders of similar nature were passed against a stock-broker and his client in two other cases –

a) In the case of broker Adroit Financial Services Private Limited and its client AKG Securities and Consultancy Limited, vide order dated 13th January, 2015, and
b) In the case of broker Marwadi Shares and Finance Limited and its client Chandarana Intermediaries Brokers Private Limited, vide order dated 13th October, 2015.

Vide order dated 11th January, 2017, in the matter of Saradha Realty India Limited, SEBI passed an interesting direction. The original order of the ‘AO’ had let off certain directors of the company who had resigned although they were directors at the time when the violations took place. The penalty was thus levied, jointly and severally, only on the existing directors. SEBI passed a revised order levying such penalty on all the persons who were directors at the time when the violations took place. The amount of penalty itself was not enhanced.

In a recent order (dated 20th November, 2020 in the matter of Oxyzo Financial Services Private Limited), SEBI held that the ‘AO’ had made a wrong interpretation of the applicable provision and thus revised it as per the correct interpretation. However, since even otherwise there was no violation by the party of the applicable law, no penalty was levied even in the revised order.

In three recent orders, all dated 22nd September, 2020, SEBI enhanced the penalty levied from Rs. 25 lakhs to Rs. 1 crore in each case. These were the cases of credit rating agencies in respect of credit rating in the matter of IL&FS. SEBI held that, especially in view of the significant amounts involved and the impact on investors, a higher penalty was deserved.

CONCLUSION


Often, adjudication proceedings are initiated many years after an alleged violation. These proceedings themselves may take a long time to conclude. The revision proceedings would then add yet another layer to the time and proceedings. Thankfully, there is a short time limit of a maximum of three months of the original order to initiate such proceedings.

However, the wordings of the provision for revision are broad and even vague at places. The scope ought to be narrow particularly considering that the original order has to be ‘erroneous’. Merely because SEBI holds another, different view should not result in invocation of this provision if the view in the original order is also an alternate and acceptable one. Further, merely because a higher penalty was leviable by itself should not result in invocation of this provision. One hopes that, in appeal, clearer principles would be laid down.

SUPREMACY OF THE DOMESTIC VIOLENCE ACT

INTRODUCTION
The Protection of Women from Domestic Violence Act, 2005 (‘the DV Act’) is a beneficial Act and one which asserts the rights of women who are subject to domestic violence. Various Supreme Court and High Court judgments have upheld the supremacy of this Act over other laws and asserted from time to time that this is a law which cannot be defenestrated.

In the words of the Supreme Court (in Satish Chander Ahuja vs. Sneha Ahuja, CA No. 2483/2020), domestic violence in this country is rampant and several women encounter violence in some form or other or almost every day; however, it is the least reported form of cruel behaviour. The enactment of this Act of 2005 is a milestone for protection of women in the country. The purpose of its enactment, as explained in Kunapareddy Alias Nookala Shankar Balaji vs. Kunapareddy Swarna Kumari and Anr. (2016) 11 SCC 774 was to protect women against violence of any kind, especially that occurring within the family, as the civil law does not address this phenomenon in its entirety. In Manmohan Attavar vs. Neelam Manmohan Attavar (2017) 8 SCC 550, the Supreme Court noticed that the DV Act has been enacted to create an entitlement in favour of the woman of the right of residence. Considering the importance accorded to this law, let us understand its important facets.

WHO IS COVERED?

It is an Act to provide for more effective protection of the rights, guaranteed under the Constitution of India, of those women who are victims of violence of any kind occurring within the family.

It provides that if any act of domestic violence has been committed against a woman, then she can approach the designated Protection Officers to protect her. In V.D. Bhanot vs. Savita Bhanot (2012) 3 SCC 183, it was held that the Act applied even to cases of domestic violence which have taken place before the Act came into force. The same view has been expressed in Saraswathy vs. Babu (2014) 3 SCC 712.

Hence, it becomes essential to find out who can claim shelter under this Act. An aggrieved woman under the DV Act is one who is, or has been, in a domestic relationship with an adult male and who alleges having been subjected to any act of domestic violence by him. A domestic relationship means a relationship between two persons who live or have, at any point of time, lived together in a shared household, when they are related by marriage, or through a relationship in the nature of marriage, or are family members living together as a joint family.

WHAT IS DOMESTIC VIOLENCE?

The concept of domestic violence is very important and section 3 of the DV Act defines the same as an act committed against the woman which:
(a) harms or injures or endangers the health, safety, or well-being, whether mental or physical, of the woman and includes causing abuse of any nature, physical, verbal, economic abuse, etc.; or
(b) harasses or endangers the woman with a view to coerce her or any other person related to her to meet any unlawful demand for any dowry or other property or valuable security; or
(c) otherwise injures or causes harm, whether physical or mental, to the aggrieved person.

Thus, economic abuse is also considered to be an act of domestic violence under the DV Act. This term is defined in a wide manner and includes deprivation of all or any economic or financial resources to which a woman is entitled under any law or custom or which she requires out of necessity, including household necessities, stridhan property, etc.

SHARED HOUSEHOLD

Under the Act, the concept of a ‘shared household’ is very important and means a household where the aggrieved lives, or at any stage has lived, in a domestic relationship with the accused male and includes a household which may belong to the joint family of which the respondent is a member, irrespective of whether the respondent or the aggrieved person has any right, title or interest in the shared household. Section 17 of the DV Act provides that notwithstanding anything contained in any other law, every woman in a domestic relationship shall have the right to reside in the shared household, whether or not she has any right, title or beneficial interest in the same. Further, the Court can pass a relief order preventing her from being evicted from the shared household, against others entering / staying in it, against it being sold or alienated, etc. The Court can also pass a monetary relief order for maintenance of the aggrieved person and her children. This relief shall be adequate, fair and reasonable and consistent with her accustomed standard of living.

In S.R. Batra and Anr. vs. Taruna Batra (2007) 3 SCC 169 a two-Judge Bench of the Apex Court held that the wife is entitled only to claim a right u/s 17(1) to residence in a shared household and a shared household would only mean the house belonging to or taken on rent by the husband, or the house which belongs to the joint family of which the husband is a member.

Recently, a three-Judge Bench of the Supreme Court had an occasion to again consider this very issue in Satish Chander Ahuja vs. Sneha Ahuja, CA No. 2483/2020 and it overruled the above two-Judge decision. The Court had to decide whether a flat belonging to the father-in-law could be restrained from alienation under a plea filed by the daughter-in-law under the DV Act. The question posed for determination was whether a shared household has to be read to mean that household which is the household of a joint family / one in which the husband of the aggrieved woman has a share. It held that shared household is the shared household of the aggrieved person where she was living at the time when the application was filed or in the recent past had been excluded from its use, or she is temporarily absent. The words ‘lives or at any stage has lived in a domestic relationship’ had to be given its normal and purposeful meaning. The living of a woman in a household has to refer to a living which has some permanency. Mere fleeting or casual living at different places shall not make a shared household. The intention of the parties and the nature of living, including the nature of household, have to be looked into to find out as to whether the parties intended to treat the premises as a shared household or not. It held that the definition of shared household as noticed in section 2(s) did not indicate that a shared household shall be one which belongs to or (has been) taken on rent by the husband. If the shared household belongs to any relative of the husband with whom the woman has lived in a domestic relationship, then the conditions mentioned in the DV Act were satisfied and the said house will become a shared household.

The Supreme Court also noted with approval the decisions of the Delhi Court in Preeti Satija vs. Raj Kumari and Anr., 2014 SCC Online Del 188, which held that the mother-in-law (or a father-in-law, or for that matter ‘a relative of the husband’) can also be a respondent in the proceedings under the DV Act and remedies available under the same Act would necessarily need to be enforced against them; and in Navneet Arora vs. Surender Kaur and Ors., 2014 SCC Online Del 7617, which held that the broad and inclusive definition of the term ‘shared household’ in the DV Act was in consonance with the family patterns in India where married couples continued to live with their parents in homes owned by the parents. However, the Supreme Court also sounded a note of caution. It held that there was a need to observe that the right to residence u/s 19 of the DV Act was not an indefeasible right of residence in a shared household, especially when the daughter-in-law was pitted against an aged father-in-law and mother-in-law. Senior citizens in the evening of their lives were also entitled to live peacefully and not be haunted by marital discord between their sons and daughters-in-law. While granting relief the Court had to balance the rights of both the parties.

LIVE-IN RELATIONSHIPS

A live-in relationship is also considered as a domestic relationship. In D. Velusamy vs. D. Patchaiammal (2010) 10 SCC 469 it was held that in the DV Act Parliament has taken notice of a new social phenomenon which has emerged in India, known as live-in relationship. According to the Court, a relationship in the nature of marriage was akin to a common law marriage and must satisfy the following conditions:
(i)   The couple must hold themselves out to society as being akin to spouses;
(ii)    They must be of a legal age to marry;
(iii)   They must be otherwise qualified to enter into a legal marriage, including being unmarried;
(iv) They must have voluntarily cohabited and held themselves out to the world as being akin to spouses for a significant period of time; and
(v)  The parties must have lived together in a ‘shared household’.

SEPARATED COUPLES

The Supreme Court had an interesting issue to consider in the case of Krishna Bhattacharjee vs. Sarathi Choudhury, Cr. Appeal No. 1545/2015 ~ whether once a decree of judicial separation has been issued, could the woman claim relief under the DV Act. The Supreme Court held after considering various earlier decisions in the cases of Jeet Singh vs. State of U.P. (1993) 1 SCC 325; Hirachand Srinivas Managaonkar vs. Sunanda (2001) 4 SCC 125; Bai Mani vs. Jayantilal Dahyabhai, AIR 1979 209; Soundarammal vs. Sundara Mahalinga Nadar, AIR 1980 Mad 294, that there was a distinction between a decree for divorce and a decree of judicial separation; in divorce there was a severance of the status and the parties did not remain as husband and wife, whereas in judicial separation the relationship between husband and wife continued and the legal relationship continued as it had not been snapped. Accordingly, the Supreme Court held that the decree of judicial separation did not act as a deterrent for the woman from claiming relief under the DV Act since the relationship of marriage was still subsisting.

SENIOR CITIZENS ACT

Just as the DV Act is a beneficial statute meant for protecting the rights of women, so also the ‘Maintenance and Welfare of Parents and Senior Citizens Act, 2007’ is a Central Act enacted to provide for more effective provisions for the maintenance and welfare of parents and senior citizens. More often than not, there arises a divergence between the DV Act and the Senior Citizens Act and hence it is essential to understand this law also.

The Senior Citizens Act provides for the setting up of a Maintenance Tribunal in every State which shall adjudicate all matters for their maintenance, including provision for food, clothing, residence and medical attendance and treatment. Section 22(2) of this Act mandates that the State Government shall prescribe a comprehensive action plan for providing protection of the life and property of senior citizens. To enable this, section 32 empowers it to frame Rules under the Act. Accordingly, the Maharashtra Government has notified the Maharashtra Maintenance and Welfare of Parents and Senior Citizens Rules, 2010. Rule 20, which has been framed in this regard, provides that the Police Commissioner of a city shall take all necessary steps for the protection of the life and property of senior citizens.

Section 23 covers a situation where property has been transferred by a senior citizen (by gift or otherwise) subject to the condition that the transferee must provide the basic amenities and physical needs to the transferor. In such cases, if the transferee fails to provide the maintenance and physical needs, the transfer of the property is deemed to have been vitiated by fraud, coercion or under undue influence and can be held to be voidable at the option of the transferor.

Eviction from house under Senior Citizens Act
One of the most contentious and interesting facets of the Act has been whether the senior citizen / parent can make an application to the Tribunal seeking eviction from his house of the relative who is harassing him. Can the senior citizen / parent get his son / relative evicted on the grounds that he has not been allowing him to live peacefully? Different High Courts have taken contrary views in this respect. The Kerala High Court in C.K. Vasu vs. The Circle Inspector of Police, WP(C) 20850/2011 has taken the view that the Tribunal can only pass a maintenance order and the Act does not empower the Tribunal to grant eviction reliefs. A single Judge of the Delhi High Court in Sanjay Walia vs. Sneha Walia, 204 (2013) DLT 618 has held that for an eviction application the appropriate forum would be a Court and not the Maintenance Tribunal.

However, another single Judge of the Delhi High Court in Nasir vs. Govt. of NCT of Delhi & Ors., 2015 (153) DRJ 259 has held that the object of the Act had to be kept in mind and which was to provide simple, inexpensive and speedy remedy to the parents and senior citizens who were in distress by a summary procedure. The provisions had to be liberally construed as the primary object was to give social justice to parents and senior citizens. Accordingly, it upheld the eviction order by the Tribunal. It held that directions to remove the children from the property were necessary in certain cases to ensure a normal life for the senior citizens. The direction of eviction was a necessary consequential relief or a corollary to which a senior citizen would be entitled and it accordingly directed the police station to evict the son.

A similar view was taken in Jayantram Vallabhdas Meswania vs. Vallabhdas Govindram Meswania, AIR 2013 Guj. 160. The Division Bench of the Punjab & Haryana High Court in J. Shanti Sarup Dewan vs. Union Territory, Chandigarh, LPA No. 1007/2013 held that there had to be an enforcement mechanism set in place, especially qua the protection of property as envisaged under the said Act, and that the son was thus required to move out of the premises of his parents to permit them to live in peace and civil proceedings could be only qua a claim thereafter if the son so chose to make one, but that, too, without any interim injunction.

Senior Citizens Act or D.V. Act – Which reigns supreme?
What happens when a woman claims a right under the DV Act to a shared household belonging to her in-laws in which she and her husband resided and at the same time the in-laws seek to evict her by resorting to the Senior Citizens Act? We have already seen that the Supreme Court in the case of Satish Chander (Supra) has categorically established that a shared household would even include a house owned by and belonging to the in-laws. In such a scenario, which Act would reign supreme? A three-Judge Bench of the Supreme Court had an occasion to consider this very singular issue in Smt. S. Vanitha vs. The Deputy Commissioner, Bengaluru Urban District & Ors., CA 3822/2020 Order dated 15th December, 2020. The facts were that the in-laws sought to evict their estranged daughter-in-law from their house by resorting to the Senior Citizens Act. The Tribunal issued an eviction order. The woman claimed that as the lawfully-wedded spouse she could not be evicted from her shared household in view of the protection offered by section 17 of the DV Act. By relying on the decision in Satish Chander (Supra) she claimed that the authorities constituted under the Senior Citizens Act had no jurisdiction to order her eviction.

J. Dr. Chandrachud, speaking on behalf of the Bench, observed that the Maintenance Tribunal under the Senior Citizens Act may have the authority to order an eviction, if it is necessary and expedient to ensure the maintenance and protection of the senior citizen or parent. Eviction, in other words, would be an incident of the enforcement of the right to maintenance and protection. However, this remedy could be granted only after adverting to the competing claims in the dispute.

The Bench observed that section 36 of the DV Act contained a non-obstante clause to ensure that the remedies provided were in addition to other remedies and did not displace them. The Senior Citizens Act was undoubtedly a later Act and also stipulated that its provisions would have effect, notwithstanding anything inconsistent contained in any other enactment. However, the Court held that the provisions of the Senior Citizens Act giving it overriding force and effect would not by themselves be conclusive of the intent to deprive a woman who claimed a right in a shared household under the DV Act. It held that the principles of statutory interpretation dictated that in the event of two special acts containing non-obstante clauses, the later law typically prevailed and here the Senior Citizens Act, 2007 was the later statute. However, interestingly, the Apex Court held that in the event of a conflict between two special acts, the dominant purpose of both statutes would have to be analysed to ascertain which one should prevail over the other. In this case, both pieces of legislation were intended to deal with salutary aspects of public welfare and interest.

It held that a significant object of the DV Act was to provide for and recognise the rights of women to secure housing and to recognise the right of a woman to reside in a matrimonial home or a shared household, whether or not she has any title or right in the shared household. Allowing the Senior Citizens Act to have an overriding force and effect in all situations, irrespective of competing entitlements of a woman to a right in a shared household within the meaning of the DV Act, 2005, would defeat the object and purpose which the Parliament sought to achieve in enacting the latter legislation. The law protecting the interest of senior citizens was intended to ensure that they are not left destitute, or at the mercy of their children or relatives. Equally, the purpose of the DV Act could not be ignored by a sleight of statutory interpretation. Both sets of legislations had to be harmoniously construed.

Hence, it laid down a very important principle, that the right of a woman to secure a residence order in respect of a shared household could not be defeated by the simple expedient of securing an order of eviction by adopting the summary procedure under the Senior Citizens Act! It accordingly directed that, in deference to the dominant purpose of both the legislations, it would be appropriate for a Maintenance Tribunal under the Senior Citizens Act to grant only such remedies of maintenance that do not result in obviating competing remedies under other special statutes such as the DV Act. The Senior Citizens Act could not be deployed to override and nullify other protections in law, particularly that of a woman’s right to a shared household u/s 17 of the DV Act.

CONCLUSION


It is evident that the DV Act is a very important enactment and a step towards women’s empowerment. Courts are not hesitant to uphold its superiority over other laws and under various scenarios.  

DEPARTMENT AUDIT

INTRODUCTION
For long taxes in India and the world over have worked on the principle of self-assessment, meaning a registered taxpayer (RTP) would himself assess his liability and discharge the same as per the provisions applicable under the respective statute by filing the prescribed returns. Once the self-assessment process is concluded, the tax authorities initiate the process of verifying the correctness of the taxes paid by the RTP under the self-assessment scheme which involved interaction with the RTPs / their consultants.

Under the pre-GST regime, with the presence of multiple taxes, there were multiple assessments in different forms that an RTP had to undergo. The VAT law provided for a concept of assessment which was done on a year-on-year basis requiring the RTP to visit the tax department with box-loads of files to demonstrate various claims and positions taken by him, while the Central Excise / Service tax followed a detailed Audit structure, which was commonly known as EA-2000 Audit, and in respect of which a detailed manual for the tax officials on how an Audit on taxpayer records should be carried out was also issued.

Apart from these, there were provisions for investigation, special audits, etc., under the respective statutes which empowered the tax authorities to undertake further verification. The same practice has also been followed under the GST regime with the law providing for different methods of assessment such as Provisional Assessment (section 60), Scrutiny in different scenarios (sections 61 to 64), Audit by Tax Authorities (section 65), Special Audit (section 66) and investigation (section 66).

ASSESSMENT VS. SCRUTINY VS. AUDIT VS. INVESTIGATION

The term assessment has been defined u/s 2(11) to mean determination of tax liability under this Act and includes self-assessment, re-assessment, provisional assessment, summary assessment and best judgment assessment. The above definition demonstrates that while there can be different forms of assessments, their purpose is to determine the tax liability of a person, whether or not such person is registered.

But while the term ‘scrutiny’ has not been specifically defined, the way the provisions u/s 61 have been worded indicate that scrutiny is to be seen vis-à-vis the correctness of the particulars furnished in the returns. Therefore, the scope of scrutiny would generally cover cases where there is a mismatch between GSTR1 and GSTR3B or non-disclosure of certain information in the returns, etc. In other words, the basis for scrutiny proceedings should only be the returns filed and nothing else. In that sense, this is similar to intimation issued u/s 143 (1) of the Income-tax Act.

The term ‘audit’, on the other hand, has been defined u/s 2(13) to mean the examination of records, returns and other documents maintained or furnished by the registered person under this Act or the rules made thereunder or under any other law for the time being in force to verify the correctness of turnover declared, taxes paid, refund claimed and input tax credit availed, and to assess his compliance with the provisions of this Act or the rules made thereunder.

Lastly, the term investigation, which generally encompasses ‘inspection, search, seizure and arrest’, is undertaken by the tax authorities when they have reason to suspect suppression by an RTP whether of liability on supply of goods / services or claim of input tax credit. Any proceedings under this category can be initiated only after approval by the competent authority and empowers the tax authorities to confiscate the records of the RTP.

A plain reading of the above clearly indicates the distinction in the concept behind each of the steps and the very distinction needs to be respected. The same can be summarised as under:

•    Assessment – determination of tax liability,
•    Scrutiny – to verify the correctness of the returns filed,
•    Audit – to verify the overall compliance with the provisions of GST, including returns filed, credits / refunds claimed, etc.,
•    Investigation – to undertake verification based on specific information received relating to suppression by an RTP– either in respect of liability or input tax credit.
A primary question which generally arises and is also experienced in daily proceedings is whether there can be parallel proceedings. For example, can scrutiny of an RTP be undertaken when the audit for the same period is already going on? Or can an RTP be subjected to parallel proceedings – audit by one wing and investigation by another? In a recent decision in the case of Suresh Kumar PP vs. Dy. DGGI, Thiruvananthapuram [2020 (41) GSTL 308 (Ker.)], the single-member Bench had refused to intervene when parallel proceedings, audit u/s 65 and investigation were initiated. In fact, the HC held that interferences in process issued for auditing of books as well as order of seizure of the documents would help the Department in correlating the entries in document and at the time of auditing of the account.

When appealed before the Division Bench [reported in 2020 (41) GSTL 17 (Ker.)], while the High Court held that there was no infirmity in the audit and investigation proceedings being continued simultaneously, the Revenue itself submitted that once the investigation proceedings are initiated, the audit proceedings shall stand vacated. This is an important takeaway from this judgment (although in favour of Revenue) for RTPs who are facing parallel proceedings at the same time for the same period. The RTP can always contend that since the Department has taken a stand in one case that once investigation commences audit proceedings shall be discontinued, the same should be followed in other cases as well. However, it remains to be seen whether or not the Revenue follows this stand in all the cases.

In this background, we shall now discuss the provisions relating to audit u/s 65 for which many RTPs have already started receiving notices and some important aspects which revolve around the same.

SCOPE OF AUDIT

The term ‘audit’ has been defined u/s 2(13) and reproduced above. On going through the same, it is apparent that the scope of audit is to be restricted to ‘examination of records, returns and other documents maintained or furnished by the registered person’.

While the term ‘record’ has not been defined, the term ‘document’ has been defined u/s 2(41) to include written or printed record of any sort and electronic record as defined in clause (t) of section 2 of the Information Technology Act, 2000 (21 of 2000). Section 145 further provides that any document, which is maintained in a microfilm or reproduced as image embodied in a microfilm or a facsimile copy of a document or statement contained in a document and included in printed material produced by a computer or any information stored electronically in any device or media including hard copies made of such information, shall be deemed to be a document for the purposes of this Act. It is, therefore apparent that all documents which are stored in a scanned copy should be sufficient during the audit purpose. This should apply also for copies of purchase invoices, sales invoices, etc., which, during the audit, tax authorities generally insist upon for physical verification.

The second important takeaway from the definition of ‘audit’ which to some extent also defines the scope of ‘audit’, is that the examination is to be of the documents maintained or furnished by the registered person, i.e., things which are within the reach of the RTP being audited. Therefore, what can be the subject matter of audit is only such documents / records which are maintained / furnished by the RTP and are within his control. Therefore, the audit team cannot insist on a reconciliation based on figures appearing in form 26AS and demand tax on the mismatch since the form 26AS is not maintained / furnished by the RTP, but prepared by the Government based on disclosures made by the RTPs’ clients / suppliers. This view finds support from the decision of the Tribunal in the case of Sharma Fabricators & Erectors Private Limited vs. CCE, Allahabad [2017 (5) GSTL 96 (Tri. All.)] where the Tribunal had set aside the demand raised based on TDS certificates issued by the clients and not the books of accounts of the RTP.

A similar issue is likely to arise in case of mismatch between GSTR3B and GSTR2A. GSTR3B is the monthly return wherein an RTP also lodges a claim for input tax credit while GSTR2A is the document wherein the supplies disclosed by the supplier in GSTR1 are disclosed and auto-populated and made available to the recipient. A strong view can be taken that GSTR3B and GSTR2A are not comparable documents as GSTR2A is not maintained / furnished by the recipient. However, such a stand may not be accepted by the Department after the introduction of Rule 36(4) as the scope of audit is to look at the overall correctness of the returns furnished by the RTP and compliance with the various provisions of the Act and Rules framed therein.

In fact, on the issue of whether an audit can be conducted when there is apprehension that certain amounts were kept outside of the accounts, the Supreme Court has, while admitting the appeal in the case of Commissioner vs. Ranka Wires Private Limited [2006 (197) ELT A83 (SC)], sought an affidavit from the Revenue as to why the audit was conducted when the show cause notice alleged that certain amounts were kept out of the accounts. This indicates that even the Supreme Court is of the view that in a case where the dispute revolves around transactions outside the books of accounts of the RTP, the same is a fit case for investigation and not audit.

LEGAL VALIDITY

Under the Service Tax regime, the power to conduct audit was derived from Rule 5A of the Service Tax Rules, 1994. However, there were no enabling powers under the Finance Act, 1994 empowering the Central Government to frame rules relating to Department Audit. For this reason, the Delhi High Court has, in the case of Mega Cabs Private Limited vs. UoI [2016 (43) STR 67 (Del. HC)] held Rule 5A as ultra vires the provisions of the Finance Act, 1994. This dispute continued even after the introduction of GST where the notice for conducting audits was challenged on the grounds that the savings clause under the CGST Act, 2017 did not save the right of the Revenue to conduct audit u/r 5A of the Service Tax Rules, 1994. There have been conflicting decisions of the High Courts in this regard and therefore the dispute will reach finality only with a judgment of the Apex Court.

However, the above decision may not continue to apply under GST. The basis for the conclusion in the case of Mega Cabs (Supra) was that there was no enabling provision under the Finance Act, 1994 which empowered the Central Government to make Rules relating to audit. However, under the GST regime there are specific provisions which empower the Government to undertake Department Audit and frame rules in regard to the same.

AUDIT U/S 65 – PROCEDURAL ASPECTS
The detailed procedure to be followed while conducting audit has been provided for u/s 65 of the CGST Act, 2017. In addition, the CBIC has also issued a detailed Manual for steps to be followed before, during and after the audit.

Selection of registered person for audit

This is the first step of the audit process. This requires following of the risk-assessment method for selection of the RTP who shall undergo audit. The entire process would be facilitated based on the available registered person-wise data, the availability of which would be ensured by the Audit Commissionerate. Based on the process of risk assessment undertaken, the list of RTPs selected for the audit would be shared with the Audit Commissionerate, along with the risk indicators, i.e., area of focus for the Audit Team. The Audit Commissionerate would also be at liberty to select RTPs at random for undertaking of audit based on local risk perception in each category of small, medium and large units as well as those registered u/s 51 and 52 to verify compliance thereof.

The Manual also speaks of accrediting such RTPs, who have a proven track record of compliance with tax laws, though the procedure for such accreditation is yet to be provided. RTPs who have received accreditation shall not be subjected to audit up to three years after the date of the last audit.

Authorisation for conducting audit

The first formal step after selection of the RTP liable to be audited is authorisation u/s 65(1) to conduct the said audit, either by the Commissioner or any officer authorised by a general or specific order. U/r 101 it has been provided that the period of audit shall be a financial year or part thereof, or multiples thereof. This is the enabling provision for initiating the audit process and unless a valid authorisation has been obtained, the entire proceedings would be treated as null and void.

One may refer to the decision of the Karnataka High Court in the case of Devilog Systems India vs. Collector of Customs, Bangalore [1995 (76) ELT 520 (Kar.)] where a notice not issued by a ‘proper officer’ was held to be invalid. On the other hand, recently the Delhi High Court has, in the case of RCI Industries & Technologies Limited vs. Commissioner, DGST [2021-VIL-31-Del.], held that if an officer of the Central GST initiates intelligence-based enforcement action against an RTP administratively assigned to a State GST, the officers of the former would not transfer the said case to their counterparts in the latter Department and they would themselves take the case to its logical conclusion.

A question might arise as to whether or not the auditee should be given an opportunity of being heard before his name is selected for the purpose of conducting audit u/s 65(1). This aspect has been dealt with by the High Court in the case of Paharpur Cooling Towers Limited vs. Senior Joint Commissioner [2017 (7) GSTL 282 (Cal.)] wherein, in the context of VAT, the Court held that subjecting an assessee to audit does not result in adverse civil consequence and therefore the question of giving a hearing before selection does not arise.

However, while selecting an RTP for special audit, the Delhi High Court has held in the case of Larsen & Toubro Ltd. [2017 (52) STR 116 (Del.)] that since an order for special audit is likely to cause prejudice, hardship and displacement to the assessee, the requirement of issuance of a show cause notice ought to be read into section 58A of the Delhi Value Added Tax Act, 2004 so as to grant reasonable opportunity for representation.

Pre-Audit preparation

This is where the actual audit process concerning an RTP commences. The first step is to prepare the Registered Person Master Profile (RPMF) which contains details that can be extracted from the Registration Certificate, such as application for registration, registration documents and returns filed by the registered person as well as from his annual return, E-way Bills, reports / returns submitted to regulatory authorities or other agencies, Income-tax returns, contracts with his clients, audit reports of earlier periods as well as audits conducted by other agencies, like office of the C&AG, etc., most of which will be available in the GSTN.

The Manual speaks about a utility ‘RTPs at a Glance’ made available to the Audit Team which would contain a comprehensive data base about an RTP. It appears primarily to be a facility exclusively for the Audit Team and not for the auditee. The Manual also requires that before the start of each audit the RPMF should be updated based on the details available or sourced from the auditee and the same should be updated periodically after completion of audit. Various documents gathered during the audit, such as audit working papers, audit report duly approved during Monitoring Meeting, etc., along with the latest documents should also form part of the RPMF.

AUTHORS’ VIEWS

The Audit Manual speaks about RPMF which needs to be collated and updated by the Jurisdictional Audit Commissionerate. This is a novel concept aimed at improving the quality of the process and would also help the Audit Team become aware about the auditee. However, maintenance of records in the specified format prescribed in the Audit Manual is not something new but one that was also used during the EA 2000 Audit. Past experience indicates that the Audit Teams generally shift the onus to compile and collect the basic details which is cast on them on to the auditees and such an exercise is started only when the audit nears completion and the file is to be put before the monitoring committee for review.

In fact, in the notices currently received it is seen that even the RPMF is being sent to the auditee for submission along with intimation in Form GST ADT 01 and the list of documents required for the audit. Therefore, perhaps to this extent, the process laid down by the Manual appears to have failed to achieve the stated objective. This is because only after the profiling activity is undertaken is the audit allocated to the audit parties.

Audit intimation

The next step, after undertaking profiling of the RTP / auditee, is to allocate the audit to the audit parties. The audit parties are expected to issue intimation in Form GST ADT 01 giving the auditee at least 15 days to provide the details required for the audit as provided for u/s 65(3). An indicative list of information to be requisitioned by the audit party has been provided in Annexure III of the Audit Manual.

Section 65 clearly requires that a general / specific order be issued by the Commissioner / an officer authorised by him stating that the RTP has been selected for Department Audit for the period specified therein. Such a list has already been released by the Maharashtra State authorities where the audit will be conducted by the respective State Audit Team. Any RTP receiving intimation for audit should check:

•    Whether the notice has been received from his jurisdiction, i.e., an RTP allotted to State cannot be audited by Central authorities and vice versa;
•    The second point to check is whether the general order specifically mentions the RTP. If not, a request for a specific order should be made in writing to the Audit Team as absence of the same would render the entire proceedings being without the authority of law and any proceedings emanating from such an exercise might not survive the test of law.

Vide Explanation to section 65, it has been clarified that the term ‘commencement of audit’ shall be the date on which the records and other documents called for by the tax authorities are made available by the registered person, or the actual institution of audit at the place of business, whichever is later. This is important because section 65 provides that once the audit process commences, the same must be concluded within three months which period can be extended by the Commissioner for a further period of up to six months for reasons to be recorded in writing.

It is therefore of utmost importance that the RTP under audit maintain proper communication regarding submission of documents and once all the documents sought by the Audit Team are submitted, a formal letter intimating them about the same should be filed. This is important because under the service tax regime, while dealing with the issue of what constitutes commencement of audit, the Tribunal has in the case of Surya Enterprises vs. CCE & ST, Chennai II [2020 (37) GSTL 320 (Tri. Che.)] held that mere issuance of a letter requesting for submission of documents could not be considered as initiation of audit. The Department had to demonstrate that the audit was commenced by producing its register of audit visit.

Desk Review

On the basis of the response of the auditee, the Audit Party is expected to undertake a Desk Review to understand the operations, business practice and identify potential audit issues. The Desk Review proposed in the Manual is an exhaustive process to be undertaken by the Audit Party for the preparation of the audit plan, which includes:
•    Referring to RPMF which would throw up various points meriting inclusion in the audit plan;
•    Analysis of exports turnover, turnover of non-taxable / exempted goods and service to obtain a clear picture of the transactions not considered for tax payment and arrive at a prima facie opinion on the correctness of such claims;
•    Determine the various mismatches, such as GSTR1 vs. GSTR3B, credits as per 3B vs. 2A, etc., which should be discussed in the Audit Plan for verification at the time of audit;
•    Undertake ratio analysis, trend analysis and revenue risk analysis based on the documents obtained up to that stage and reconciling the same with the Third Party Information, such as Form 26AS, ITR, etc., and analysing the variances;
•    Prepare a checklist (different checklists have been prescribed for traders and composite dealers)

Audit plan

The next activity is to prepare the audit plan based on the above activities undertaken by the Audit Team. The Manual specifically highlights the importance of the Audit Plan and the steps preceding its preparation. It also specifies the preferable format in which the Audit Plan is to be prepared and requires that the same should be discussed with the Assistant / Deputy Commissioner and finalised after approval of the Commissioner / Joint or Additional / Deputy or Assistant, as the case may be.

Audit verification

The next step is to undertake audit verification. Section 65(2) provides that the audit ‘may’ be conducted at the POB of the RTP or in their office. The purpose of audit verification, as per the Manual, is to perform verification activities and obtain audit evidence by undertaking verification of data / documents submitted at the time of desk review and verification of points mentioned in the Audit Plan.

The primary activity to be carried out during Audit Verification is evaluation of internal controls which has been dealt with extensively in the Manual as it lays down different techniques to be followed for this process, including walk-through, ABC analysis, etc., and requires the various findings to be recorded in the working papers, the formats of which have also been specified in Annexure VIII of the Manual.

Additionally, the auditor is also required to undertake verification of all the points mentioned in the Audit Plan. The primary point to verify is whether any weakness in internal control of the auditee has resulted in loss of revenue to the Government. The Audit Team is also expected to verify various documents submitted to Government Departments which can be used for cross-verification of information filed for the assessment of GST.

Audit observations
The next step as per the Manual is to communicate the various audit observations to the auditee and obtain his feedback on the same. The Manual categorically states that an audit observation is not a show cause notice but only an exercise for understanding the perspective of the auditee on a particular issue and clearly states that wherever a suitable reply is provided by the auditee, the same may be removed from the findings and excluded from the draft audit report after approval of the seniors.

However, the Manual further states that where the response of the auditee is not forthcoming, the observation should be included in the draft audit para specifically stating the non-submission of response by the auditee.

This is an important step in the Manual. Even under the EA 2000 Audit it has been seen that whenever an observation letter is shared with the auditee, it is more in the nature of a show cause notice, rather than seeking the viewpoint of the auditee on a particular issue and in the observation para itself there is a statement saying that the payment of the tax amount, along with interest and penalty, be made and compliance be reported to the Audit Team. This contrasts with the purpose of the concept of communication of observation as it takes the shape of a recovery notice rather than a routine communication.

Unless the Audit Team is sensitised about this aspect, the Audit Manual will lose its purpose as it is unlikely the approach of the Audit Team would change even after issuance of this Manual. It has also been seen that the Team expects a reply to the observation para, at times in one to two days. The Audit Team needs to be sensitised to the fact that the auditee resources must also carry out their regular activity and they can, at no point of time, be fully dedicated only to the Department Audit process. Even otherwise, certain observation paras may involve legal issues that may need more time, including the auditee obtaining legal advice for drafting a reply to the same in which case a reply at such a short notice may not be feasible. Therefore, it is essential that a standardised format for sharing of audit observation and sufficient time to the auditee for replying to the same be prescribed.

Preparation of audit report

Once the above exercise is concluded, the Audit Team is expected to prepare a draft audit report for onward submission to senior officers and should be placed before the Monitoring Cell Meeting (MCM) for discussion on various points raised therein. It is during the MCM that the decisions of issuing notices, including invocation of extended period of limitations, are taken or issuance of a show cause notice can be waived.

Based on the decisions taken during the MCM, a Final Audit Report (FAR) has to be prepared which will also be conveyed to the auditee. Section 65(6) provides that on conclusion the ‘Proper Officer’ shall within 30 days inform the auditee about the findings, the reasons for such findings and his rights and obligations. The same shall be intimated in form GST ADT 02 as notified vide Rule 101(5). It is only after the issuance of the final audit report u/s 65(6) that recovery proceedings u/s 73 or 74 can be initiated.

It is imperative to note that generally the recovery proceedings are initiated before the issuance of the FAR. At the time of receipt of a show cause notice, the auditee needs to ensure whether the same is received prior to the issuance and receipt of the FAR or afterwards. It is imperative to note that even under the pre-GST regime, (recently) in Sheelpa Enterprises Private Limited vs. Union of India [2019 (367) ELT A17 (Guj.)] the High Court has admitted a writ petition challenging the validity of a show cause notice issued prior to the issuance of the FAR.

The Final Audit Report shall comprise of the decision taken on the audit paras, including cases where the show cause notice is issued / to be issued and cases where a decision to not initiate proceedings has been taken.

Respecting timelines

Section 65, Rule 101 of the CGST Rules, 2017 and the Audit Manual issued by the CBIC strongly reiterate the importance of adhering to timelines, both for initiation of audit as well as conclusion. The fact that this aspect has been specifically included in the statute demonstrates the intention of the Legislature to ensure timely compliance of the proceedings. This is a positive aspect because under the EA 2000 there were no strict timelines prescribed, but rather only guidelines which meant that the EA 2000 audit in many cases kept going on for a long stretch of time.

While this is a positive move on the part of the Legislature to include the timelines in the statute itself, it will also cast an onerous responsibility on the auditees to ensure that they have submitted all the information sought by the Audit Team within the prescribed time. Besides, proper documentation and acknowledgement of submission of documents would also be important since it is possible that the Audit Team might dispute the date of ‘commencement of audit’ itself citing receipt of incomplete data. It is therefore advisable that the fact of non-availability of certain details (for instance, state-wise trial balance) be intimated to the Audit Team at the initial stage itself.

The RTP should also note that in case of delay in submission, there might be adverse action taken on account of non-submission. For example, if an RTP has claimed certain exemption and the supporting documents for which are not submitted within the timelines prescribed by the Audit Team, it is possible that they may end up with an observation letter which would result in unnecessary initiation of a protracted litigation since the experience suggests that an observation para generally culminates in issuance of a show cause notice.

Therefore it is imperative that an RTP who has already received audit notice or is likely to receive one, prepares basic documentation which can be shared immediately with the Audit Team as and when asked, such as state-wise trial balances, details of exports along with FIRC details, basis for claim of exemption, reconciliation of earnings / expenditure in foreign currency with GST filings, etc. Perhaps a lot of the information sought by the Audit Team is generally required during the audit u/s 35. It would therefore be prudent that the RTP / consultants prepare the supporting file during the audit u/s 35 itself so that not only is there no duplication of work, but they also become aware of any specific issues.

An assessee, who was also registered under service tax, will agree that a lot of litigations under that tax were on account of non-submission of the above information. Of course, the Courts have time and again held that demand cannot be based merely on account of a difference in two figures and should be supported with proper evidence. One may refer to the decision of the Tribunal in the case of Go Bindas Entertainment Private Limited vs. CST, Noida [2019 (27) GSTL 397 (Tri. All.)].

Other points to note

An audit process involves substantial human element and therefore needs to be handled carefully on all fronts, be it sharing of information or interacting with the Audit Team owing to the subjectiveness of the auditor. The auditee / their consultants must bear this aspect in mind while interacting. It is important that at no point of time should they antagonise the Audit Team. This is important because if such a situation arises, it is likely that the Audit Team might raise meritless observations which would culminate in the issuance of show cause notices and the initiation of unnecessary protracted litigations.

One important aspect which needs to be noted by the readers, although out of context but arising from the Department Audit process, is that whenever a notice is issued by the Audit Team it is generally issued invoking the extended period of limitation alleging fraud, wilful misstatement, etc., with the intention to evade payment of tax. Such audit notices generally allege that ‘had the audit not been conducted, the fact of the said contravention, which can be either non-payment of tax / excess claim of input tax credit and so on, would have gone unnoticed’. It is imperative to note that merely making such a statement is not sufficient for invocation of extended period of limitation. There must be some demonstration that there prevailed an intention to evade payment of tax and the allegation of fraud, wilful misstatement, etc., should be demonstrated with supporting documentation by the Audit Team. The Mumbai Bench of the Tribunal has, in the case of Popular Caterers vs. Commissioner, CGST, Mumbai West [2019 (27) GSTL 545 (Tri. Mum.)], held that suppression can’t be alleged merely because the Audit Team found certain credits inadmissible.

The High Court has, in the case of Haiko Logistics Private Limited vs. UoI [2017 (6) GSTL 235 (Del.)] raised serious questions on the act of seizure of documents undertaken during the audit process.

Similarly, no summons can be issued in pursuance of the audit process. The Tribunal in the case of Manak Textiles vs. Collector of Central Excise [1989 (42) ELT 593 (Tri. Del.)] held that a statement made to an audit party is not valid as the Audit Party has no authority to record any statement. This principle should apply under GST also as audit is conducted u/s 65 while powers to record statements are governed u/s 70.

CONCLUSION

While the Audit Manual indicates the intention of the CBIC to make the entire process smooth and systematic, it remains to be seen how the same is implemented. Past experience shows that the Department Audit is generally an exhausting process resulting in unwarranted litigation, which in India is protracted and costly. It is therefore important that the RTP prepare for audit on an annual basis, irrespective of whether a notice for the same is received or not, and keep the documentation ready to the extent possible.  

ACCOUNTING FOR CROSS HOLDING

INTRODUCTION

There is no existing guidance under Ind AS for the accounting of cross holdings. This article provides guidance on the accounting of cross holdings between two associate companies. Consider the following fact pattern:

Entity Ze has an associate Ve (20% of Entity Ve and significant influence).

Entity Ve has an associate Ze (20% of Entity Ze and significant influence).

Both Entity Ze’s and Entity Ve’s share capital is 200,000 shares at 1 unit each.

Entity Ze’s profit excluding its share in Ve = INR 1000; Entity Ve’s profit excluding its share in Ze = INR 1000.

ISSUES

•    How does an entity account for cross holdings in associates in accordance with paragraph 27 of Ind AS 28 Investments in Associates and Joint Ventures in the Consolidated Financial Statements?
•    Does an entity adjust EPS calculation for the cross holdings?

RESPONSE
References to Ind AS
Paragraph 26 of Ind AS 28 applies consolidation procedures to equity method of accounting as follows:

‘Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture.’

Paragraph 27 of Ind AS 28 states:

‘A group’s share in an associate or a joint venture is the aggregate of the holdings in that associate or joint venture by the parent and its subsidiaries. The holdings of the group’s other associates or joint ventures are ignored for this purpose. When an associate or a joint venture has subsidiaries, associates or joint ventures, the profit or loss, other comprehensive income and net assets taken into account in applying the equity method are those recognised in the associate’s or joint venture’s financial statements (including the associate’s or joint venture’s share of the profit or loss, other comprehensive income and net assets of its associates and joint ventures), after any adjustments necessary to give effect to uniform accounting policies (see paragraphs 35 and 36A).’

Paragraph B86 of Ind AS 110 Consolidated Financial Statements states:

‘Consolidated financial statements:… (c) eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full).’

Paragraph 33 of Ind AS 32 Financial Instruments: Presentation states:

‘If an entity re-acquires its own equity instruments, those instruments (“treasury shares”) shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.’

GROSS APPROACH
Entity Ze’s profit and Entity Ve’s profit are dependent on each other, which can be expressed by simultaneous equations as follows:

a = INR 1000 + 0.2b
b = INR 1000 + 0.2a

Solving the simultaneous equation results in:

a = INR 1250 and b = INR 1250

Therefore, Entity Ze’s profit is INR 1250, and Entity Ve’s profit is INR 1250.

NET APPROACH

This approach ignores the cross holding and simply takes up the investor’s share of the associate’s profit, excluding the equity income arising on the cross shareholding. Thus, the additional profit in the financial statements of both Entity Ze and Entity Ve is limited to INR 200 each (1000*20%).

A literal view of paragraph 27 of Ind AS 28 is that Entity Ze recognises its share of Entity Ve’s profits, including Entity Ve’s equity accounted profits. However, in the case of cross holdings this approach results in a portion of Ze’s profits being double counted. Consequently, the net approach, which only accounts for 20% of the associate’s profit, is more appropriate. In this fact pattern, the net approach results in Entity Ze and Entity Ve both recognising profit of INR 1200 (rather than INR 1250 as per the gross approach). The difference of INR 50 represents the equity effect of the cross holdings and therefore is not recognised in profit. In other words, the INR 50 represents (with respect to the associate that is preparing its consolidated accounts) a portion of its own profit being double counted.

Additionally, the equity method of accounting employs consolidation-type procedures such as the elimination of unrealised profits. Income arising on an investment held by a subsidiary in a parent is eliminated under paragraph B86(c) of Ind AS 110 Consolidated Financial Statements. Consequently, in applying consolidation procedures in equity accounting, income arising from associate’s investment in the investor should also be eliminated.

Consequently, the net approach is the only acceptable method.

EPS CALCULATION

The number of ordinary shares on issue is adjusted using the net approach. Consequently, an adjustment reduces the entity’s equity balance and its investment  in the associate by its effective 4% interest (20*20%) in its own shares. The result is similar to the treatment of treasury shares that are eliminated from equity and, accordingly, excluded in determining the EPS. In calculating earnings per share, the weighted average number of ordinary shares is reduced by the amount of the effective cross holding. Therefore, Entity Ze’s and Entity Ve’s ordinary shares are reduced to 192,000 (200,000*[100-4]; i.e. 96%) for the purpose of the earnings per share calculation.

Some may argue that the associate is not part of the group and therefore the shares held in the investor are not ‘treasury shares’ as defined in Ind AS 32. However, it may be noted that the view in the preceding paragraph does not rely on viewing the associate’s holding as treasury shares. Rather, it relies on the fact that Ind AS 28.26 states that many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. If a subsidiary holds shares in a parent, these are eliminated under paragraph B86(c) of Ind AS 110. The same procedure should therefore apply to equity accounting.

Though this issue is discussed in the context of cross holdings between associates, it will apply equally to jointly controlled entities that are equity accounted.

OFFICE ON YOUR PHONE!


We are all used to working
on Office (earlier Microsoft Office) on
our desktops and laptops. Most of us use Microsoft Word, Excel and PowerPoint
routinely without even having heard of anything else. They are a natural part
of our computing life.

 

And now, Microsoft has come
up with an Android and iOS version of Office. Anyone can download the Office app on phones for Android and iOS.
The app is free to use, even without signing in. An Office 365
or Microsoft 365 subscription
will also unlock various premium features, consistent with those in the current
Word, Excel, and PowerPoint apps. Just head to the Play Store or App Store and
download the version appropriate for your use.

 

Now, who will think of
typing letters on his mobile phone? Or making spreadsheets? Welcome to Office
on your phone – Word, Excel and PowerPoint, all rolled into one. On your phone
you can open all original Word documents, Excel spreadsheets and PowerPoint
presentations which you may have received by email, WhatsApp or SMS. But you
can do even more. Let’s explore.

 

In Word, you can scan text directly into a Word
document. So, if you read any printed text in a letter or book or newspaper,
you can just point your camera to the text and scan it right into your Word
document. This allows you to edit, save or forward the document for further
use. This is a real cool feature which helps you create Word documents without
having to type them.

 

Besides, if you wish to
create a totally new document, apart from typing it (boring and cumbersome) on
your phone, you may just dictate it directly. Just tap on Dictate and you will
be able to create a new Word document seamlessly. A few spelling errors, when
the microphone does not accurately catch what you are saying, may just need to
be edited and you will have your document ready in a jiffy. An easy way to
dispense with your secretary or at least not be fully dependent on him / her!
You can dictate while you are travelling or even on a Sunday when you get
bursts of inspiration.

 

Of course, the traditional
methods of creating a document right from scratch or using a pre-configured
template are also available, just in case you want to type out your document.

 

Coming to Excel, you have the option to create a
new spreadsheet the old, boring way – by entering the cells manually or from a
pre-configured template. But now you have another exciting way to create a
spreadsheet – just scan a printed table on your phone and get your cells
populated instantly into an Excel file. If the original is well printed and
your phone has a reasonably good camera, you may not even have to edit the file
– else a bit of editing may be required. But the very idea of having a full,
ready table imported directly into an Excel sheet is a dream come true – you
have to try it to experience the joy of importing.

 

PowerPoint has
the option to create a new presentation right from scratch or from a
pre-configured template. You may choose pictures from your phone and also
create an outline for the presentation. It’s a bit difficult, but still doable.
The best part is that you can Rehearse your PowerPoint presentation with a
built-in coach. Just run the PowerPoint presentation and start speaking as if
you are presenting it live. The Rehearsal Coach will analyse what you are
speaking and give you tips to improve your speaking skills – it could give you
hints such as ‘Do not read out your presentation verbatim’ or ‘Vary your tone
and pitch’ or ‘Don’t use too many filler words like “umm”, or “you see”’ or
even help you with the speed of your speech – whether you are too fast or too slow
or just right. Indeed, a wonderful in-built tool to help you prepare a
perfectly timed and worded presentation.

 

Apart
from the expected tools of Word, Excel and PowerPoint, Office also helps you
with PDFs in a variety of ways. It allows you to sign any PDF document with your
signature and you can scan a document directly to a PDF file on your phone. You
can even convert your pictures to PDF, convert your document to PDF, or convert
PDF files to Word documents. Extremely useful for day-to-day functioning.

 

With QR
codes becoming more and more prevalent, Office allows you to scan a QR code and
decipher what it says – you can save it as Text or even save it as a Note.

 

Office also allows you to
create Surveys and other Forms which you
can share and solicit responses to from your clients, suppliers or co-workers.

 

And finally, Office helps
you create Yellow Post-it Notes
which can be stored on your phone and are searchable instantly.

 

The Search function in Office is very
powerful. It allows you to Search for keywords in your Office files, your media
(including text within images) and in your notes. The Search works on all your
folders within your  phone, or on
One-Drive, or on your Google Drive or any other drive that you connect it with
(e.g. even Dropbox or Box.net).

 

Now,
with so many wonderful, unique and time-saving features, why would you not use
Office on your phone regularly?

 

You have brains in your head. You have feet in your
shoes. You can steer yourself any direction you choose. You’re on your own. And
you know what you know. And YOU are the one who’ll decide where to go…

—  Dr. Seuss,
Oh, the Places You’ll Go!

INTERIM ORDERS – POWERS OF SEBI RESTRICTED BY SAT

BACKGROUND

Three
consecutive recent rulings of the Securities Appellate Tribunal (SAT) have
placed limitations on the powers of SEBI to pass interim / ex parte
orders which restrain parties from accessing stock markets, require them to
deposit allegedly illegal profits in escrow accounts, etc. These precedents
also lay down guidelines and specify the circumstances under which such powers
may be exercised by SEBI and hence will help other parties obtain relief when
faced with similar arbitrary orders passed based on little or no credible
evidence. One of the decisions of SAT has been affirmed by the Supreme Court on
facts.

 

SUMMARY
OF RELEVANT LAW

SEBI does have
wide powers to pass penal, remedial and other orders / directions against those
who have been found to have committed violations of securities laws. Such
violations may include fraud on markets, insider trading, front-running, etc.
SEBI may pass orders to disgorge illegally made profits. However, there may be
concerns that while the investigation and due process is ongoing, the parties
may continue the frauds or other violations. They may even transfer the assets,
illegally made profits, etc., in such a way that their recovery later may not
be possible. SEBI has powers to pass interim orders to prevent such things from
happening and thus may restrain parties from continuing such violations,
transfer assets, etc. SEBI may also pass interim orders to impound the
estimated amounts and require that such monies be deposited in an escrow
account pending final orders of disgorgement.

 

Such interim
orders may be passed after giving an opportunity of hearing, or even without
such opportunity which may instead be given after the interim order. The
interim order in the case may be confirmed, modified or reversed after the
hearing. If confirmed, it may stay in place till the investigation is
completed, show cause notices issued to parties and after giving due opportunity
to respond, including a personal hearing, and then a final order may be passed.

 

Such interim
orders may be of various types and SEBI has wide general and specific powers in
this regard. SEBI may prohibit a person from accessing the securities markets.
It may prohibit a person from dealing in securities in such markets. It may
impound the proceeds or securities in respect of transactions that are under
investigation. Usually, such orders to impound such amounts are accompanied by
orders to freeze assets of such persons till such impounded amounts are duly
deposited in escrow accounts.

 

However, orders
that stop access to or stop dealing in securities markets may be economically
fatal. The amounts directed to be impounded may be far higher than the actual amount
later found to be correct, or may be directed on the wrong persons. Depositing
of such amounts at such short notice may be difficult or even impossible.
Considering that such orders are usually accompanied by directions freezing the
assets of parties, the effects may be even more far reaching.

 

Such orders are
also indefinite in nature in the sense that there is no statutory outer time
limit by which time the final orders have to be passed. Thus, the restrictions
may continue indefinitely. It is no solace to the parties if it is found later
that they have not committed any violations, or no or a lower amount can be
disgorged. At best, the amounts in the escrow account would be returned with
the minimal bank interest paid by nationalised banks, the parties being allowed
to resume their activities.

 

As the three
case studies summarised here will show, the orders have been arbitrary with
harsh consequences which SAT had no hesitation in setting aside or modifying.
In one case where the interim order has been finally disposed of, SEBI has
actually reversed the order stating that no purpose would be served in issuing
such interim directions. The Supreme Court affirmed the view that such orders
can be passed only in urgent cases, which the facts must bear out.

 

Case 1 – Cases
relating to ‘trading in mentha oil contracts’ on a commodity exchange

A unique
concern of commodity exchanges is the cornering of the market in a commodity by
a person / group. Such dominance may result in price distortion which could
also harm other participants in the market. In this case, SEBI had concerns
that a group of parties had accumulated a substantial percentage of mentha
oilstock [North End Foods Marketing (P) Ltd. vs. SEBI (2019) 105 taxmann.com
69 (SAT)]. It was prima facie believed that this was done to
manipulate the mentha oil market and dominate the price of mentha oil futures.
SEBI passed an interim order prohibiting the parties from dealing in or
accessing the securities markets and from being associated with it.

 

The parties
filed an appeal before SAT which recorded several findings. It noted that there
was no prima facie finding that the parties had accumulated large
quantities of mentha oil or that they had dominated the market. There was
merely suspicion to that effect. Further, no urgency was found for passing of
such orders. In any case, the order was passed at a much later stage when the
execution of trades was over and the facts did not show the alleged
manipulation. SAT thus set aside the said interim order.

 

This decision
of SAT has become a precedent for future cases and lays down guidelines,
restrictions and also circumstances under which such interim orders may be
passed.

 

At the outset,
SAT recognised that SEBI has wide powers to pass such orders. SAT also
confirmed that the opportunity to respond / of personal hearing may be given
later. That said, SAT noted that such orders can have serious consequences and
hence have to be passed only in urgent cases and sparingly. In particular,
there has to be prima facie evidence and finding of wrong-doing and its
continuance. Since none of this was present in the present case, SAT set aside
the order.

 

SAT observed, ‘In our opinion, the respondent is empowered to
pass an ex parte interim order only
in extreme urgent cases and that such power should be exercised sparingly.
In the instant case, we do not find that any extreme urgent situation existed
which warranted the respondent to pass an ex parte interim order. We
are, thus, of the opinion that the impugned order is not sustainable in the
eyes of law as it has been passed in gross violation of the principles of
natural justice as embodied in Article 14 of the Constitution of India.’

 

Interestingly,
SEBI, after the interim order was set aside, re-examined the matter and
confirmed that there was no urgency or purpose served for passing the interim
directions. Hence, it desisted from passing any fresh interim order and also
vacated the interim order against those who had not gone in appeal. The
investigations, of course, continue.

 

Case 2 –
Alleged insider trading case

SEBI found that
the Managing Director of Dynamatic Technologies Limited (DTL) had sold some
shares during a time when it was alleged that there was unpublished
price-sensitive information of reduced profits. SEBI computed the reduction in
market price after such information was made public and accordingly computed
the losses allegedly avoided which amounted to Rs. 2.67 crores. SEBI added
interest thereon from such date and passed an interim order that an aggregate
amount of Rs. 3.83 crores be impounded and accordingly deposited by such person
in an escrow account. Till such time as this amount was so deposited, his
accounts were frozen.

 

The MD appealed
to SAT. SAT applied its own ruling in the North End Foods case (Supra),examined
the basic facts and noted that the sale of shares was in 2016. The
investigation commenced in 2017 and the interim order was passed in 2019. No
evidence was put forth on how the appellant had tried to divert the alleged
notional gains. SEBI in its order had expressed a mere possibility of diversion
of such gains. SAT affirmed that such orders can be passed only if there is
some evidence to show and justify the action taken. Accordingly, SAT set aside
the direction but it asked the appellant to file a reply within four weeks and
that SEBI shall give a personal hearing and thereafter pass a final order
within six months. However, SAT also required the appellant to give an
undertaking that he shall not alienate 50% of his holding in the company
[Dr. Udayant Malhoutra vs. SEBI (2020) 121 taxmann.com 326 (SAT)].

 

SEBI appealed
to the Supreme Court against the SAT order and the Court affirmed the decision
on facts [SEBI vs. Udayant Malhoutra (2020) 121 taxmann.com 327 (SC)].
It affirmed the view of SAT that such orders could be passed only in urgent
cases. Since the facts of this case did not demonstrate such urgency, the Court
refused to interfere with the SAT order.

 

Case 3 –Prabhat
Dairy Limited

In this case the company had sold its holding in its subsidiary and a
unit to another company. The sale proceeds were substantial and the company
had, while seeking approval of shareholders for such sale, stated that it will
use the net proceeds for distribution to its shareholders in an appropriate
form. It appears that such distribution was delayed. In the meantime, the
promoters of the company, who held about 51% shares, proposed to acquire the
shares held by the public and thereby de-list the shares of the company. This
de-listing proposal was approved by 99.13% of the shareholders and the
application was pending disposal by stock exchanges / SEBI.

 

SEBI received
complaints about this and there were media reports, too. SEBI asked stock
exchanges to examine the matter; the exchanges expressed some concerns and also
recommended appointment of a forensic auditor. The primary concern was whether
the proceeds may have been diverted.

 

SEBI appointed
a forensic auditor who inter alia reported that several matters of
information / documents were not made available to them. The company responded
that inter alia the pandemic had slowed down responses. SEBI,
considering all these factors, passed an interim order directing the company to
deposit Rs. 1,292.46 crores, being sale proceeds less certain adjustments /
expenses, in an escrow account. Since this direction was not complied with in
the time given, SEBI attached the bank / demat accounts of certain promoters.

 

The company /
promoters appealed to SAT. SAT found several issues with the SEBI order. It
noted that SEBI itself had recorded that a sum of Rs. 1,002 crores was already
lying in fixed deposits. Secondly, SEBI had ordered the whole sum of Rs.
1,292.46 crores to be deposited in an escrow account when the fact was that
more than half of it would go to the promoters who held about 51% shares. The
de-listing offer itself could have resulted in an attractive price paid to
public shareholders. Mandating deposit of such an unreasonably high sum in the
escrow account would cause severe disruption in the company and bring it to its
knees. It also found issue with the fact that SEBI had kept the de-listing
application on hold.

 

Taking all this
into account, SAT ordered the company to deposit Rs. 500 crores in an escrow
account which would not be used till the forensic audit was completed and SEBI
gave a decision regarding distribution of the amount and / or the de-listing
application. It directed the company to provide information to the forensic
auditor within ten days and he would thereafter give his report within four
weeks. SEBI was also directed to process the de-listing application within six
weeks. On deposit of the said Rs. 500 crores, the bank / demat accounts of the
promoters were directed to be defreezed (Prabhat Dairy Limited and others
vs. SEBI, order dated 9th November, 2020).

 

CONCLUSION

The series of
fairly consistent rulings of SAT has substantially settled the law relating to
the powers of SEBI to pass directions by interim orders. SEBI will have to
balance the interests of the securities markets / investors with the
inconvenience caused to those who are given such directions and also pass
orders in exceptional cases only where at least prima facie evidence is
available. Further, as the Supreme Court also affirmed, urgency for passing
such orders would have to be demonstrated.

 

However, it continues to be seen that such interim orders are being
passed and restrictions / impounding directed. Not all such parties can afford
to quickly approach SAT for relief. One hopes that SEBI itself will exercise
self-restraint and pass orders in accordance with the guidelines laid down by
the Supreme Court and SAT in their rulings.

 

ANCESTRAL OR SELF-ACQUIRED? THE FIRE CONTINUES TO RAGE…

INTRODUCTION

One of the favourite riddles of all time is ‘Which came first – the chicken or the egg?’ There is no clear answer to this question. Similarly, one of the favourite questions under Hindu law is ‘Whether a property is ancestral or self-acquired?’ This column has on multiple occasions examined the question in the light of decisions of the Supreme Court of India. However, every time there is a new decision on this point, it becomes necessary to re-examine this very important issue and consider the earlier case law on the subject.

 

Under the Hindu Law, the term ‘ancestral property’ as generally understood means any property inherited from any of the three generations above of male lineage, i.e., from the father, grandfather, great grandfather. In fact, two views were prevalent with regard to ancestral property: View-1: Ancestral property cannot be alienated. According to this, if the person inheriting it has sons, grandsons or great-grandsons, then it automatically becomes joint family property in his hands and his lineal descendants automatically become coparceners along with him. View-2: Ancestral property can be alienated since it becomes self-acquired property in the hands of the person inheriting it. Thus, he can alienate it by Will, gift, transfer, etc., or in any other manner he pleases.

 

EARLIER IMPORTANT DECISIONS

CWT, Kanpur and Others vs. Chander Sen and Others (1986) 3 SCC 567

In this case, the Supreme Court concluded that property inherited by a Hindu by way of intestate succession from his father under the Hindu Succession Act, 1956 would not be HUF (or ancestral) property in the son’s hands vis-à-vis his own sons. This position was also followed in Yudhishter vs. Ashok Kumar (1987) AIR SC 558.

 

Bhanwar Singh vs. Puran (2008) 3 SCC 87

Here, the Supreme Court followed the Chander Sen case (Supra) and various subsequent judgments and held that having regard to the Hindu Succession Act, 1956, property devolving upon the sons and daughters of an intestate Hindu father ceased to be joint family property and all the heirs and legal representatives of the father would succeed to his interest as tenants-in-common and not as joint tenants. In a case of this nature, the joint coparcenary did not continue.

 

Uttam vs. Saubhag Singh AIR (2016) SC 1169

This was a case where a Hindu died intestate in 1973 (after the commencement of the Hindu Succession Act). The Court held that on a conjoint reading of sections 4, 8 and 19 of the Hindu Succession Act, once the joint family property has been distributed in accordance with section 8 on principles of intestacy, the joint family property ceases to be joint family property in the hands of the various persons who have succeeded to it and they hold the property as tenants in common and not as joint tenants.

 

Arshnoor Singh vs. Harpal Kaul, AIR (2019) SC (0) 3098

A two-member Bench of the Supreme Court analysed various earlier decisions on the subject and held that after the Hindu Succession Act, 1956 came into force, the concept of ancestral property has undergone a change. Post-1956, if a person inherited a self-acquired property from his paternal ancestors, the said property became his self-acquired property and did not remain coparcenary property.

 

However, the Apex Court held that if the succession opened under the old Hindu law, i.e., prior to the commencement of the Hindu Succession Act, 1956, then the parties would be governed by Mitakshara law. In that event, the property inherited by a male Hindu from his paternal male ancestor would be coparcenary property in his hands vis-à-vis his male descendants up to three degrees below him. Accordingly, the nature of property remained coparcenary even after the commencement of the Hindu Succession Act, 1956. Incidentally, the comprehensive decision of the Delhi High Court in the case of Surender Kumar vs. Dhani Ram, AIR (2016) Delhi 120 had taken the very same view.

 

The Supreme Court further analysed that in the case on hand, the first owner (i.e., the great-grandfather of the appellant in that case) died intestate in 1951 and hence the succession opened in 1951. This was a time when the Hindu Succession Act was not in force. Hence, the nature of property inherited by the first owner’s son was coparcenary and thereafter, everyone claiming under him inherited the same as ancestral property. The Court distinguished its earlier ruling in the case of Uttam (Supra) since that dealt with a case where the succession was opened in 1973 (after the Hindu Succession Act, 1956 came into force) whereas the present case dealt with a situation where the succession was opened in 1951. The Supreme Court reiterated its earlier decision in the case of Valliammai Achi vs. Nagappa Chettiar AIR (1967) SC 1153 that once a person obtains a share in an ancestral property, then it is well settled that such share is ancestral property for his male children. They become owners by virtue of their birth. Accordingly, the Supreme Court did not allow the sale by the father to go through since it affected his son’s rights in the property. Thus, the only reason why the Supreme Court upheld the concept of ancestral property was because the succession had opened prior to 1956.

 

Doddamuniyappa (Dead) through LRsv Muniswamy (2019) (7) SCC 193

This decision of the Supreme Court also pertained to the very same issue. The Court held that it was well settled and held by in Smt. Dipo vs. Wassan Singh (1983) (3) SCC 376 that the property inherited from a father by his sons became joint family property in the hands of the sons. Based on this principle, the Court concluded that property inherited by a person from his grandfather would remain ancestral property and hence his father could not sell the same. In this case, neither did the Supreme Court refer to its earlier decisions cited above nor did it go into the issue of whether the succession had opened prior to 1956. It held as a matter of principle that all ancestral property inherited by a person would continue to be ancestral property for his heirs.

 

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

 

LATEST DECISION

One more Supreme Court decision has been added to this roster of cases. The decision in the case of Govindbhai Chhotabhai Patel vs. Patel Ramanbhai Mathurbhai, AIR (2019) SC 4822 has given quite a definitive pronouncement. In this case, a property was purchased by the father of the Donor and it is by virtue of a Will executed by the father that the property came to be owned by the Donor in 1952-1953. Subsequently, the Donor executed a gift deed in favour of a person. Subsequent to the demise of the Donor, his sons objected to the gift on the ground that what their father received was ancestral property; moreover, since he got it by way of partition, hence it could not be gifted away. The sons relied upon an earlier Supreme Court decision in the case of Shyam Narayan Prasad vs. Krishna Prasad, (2018) 7 SCC 646 to contend that self-acquired property of a grandfather devolves upon his son as ancestral property.

 

The Supreme Court considered its earlier decision in the case of C.N. Arunachala Mudaliar vs. C.A. Muruganatha Mudaliar, AIR (1953) SC 495 where, while examining the question as to what kind of interest a son would take in the self-acquired property of his father which he receives by gift or testamentary bequest from him, it was held that a Mitakshara father has absolute right of disposition over his self-acquired property to which no exception can be taken by his male descendants. It was held that it was not possible to hold that such property bequeathed or gifted to a son must necessarily rank as ancestral property. It was further held that a property gifted by a father to his son could not become ancestral property in the hands of the Donee simply by reason of the fact that the Donee got it from his father or ancestor. It further held that a Mitakshara father is not only competent to sell his self-acquired immovable property to a stranger without the concurrence of his sons, but he can make a gift of such property to one of his own sons to the detriment of another. When the father obtained the grandfather’s property by way of gift, he received it not because he was a son or had any legal right to such property but because his father chose to bestow a favour on him which he could have bestowed on any other person as well.

 

To find out whether or not a property is ancestral in the hands of a particular person, not merely the relationship between the original and the present holder but the mode of transmission also must be looked into. The Court held that property could ordinarily be reckoned as ancestral only if the present holder had got it by virtue of his being a son or descendant of the original owner. The Court further held that on reading of the Will as a whole, the conclusion becomes clear that the testator intended the legatees to take the properties in absolute rights as their own self-acquired property without being fettered in any way by the rights of their sons and grandsons. In other words, he did not intend that the property should be taken by the sons as ancestral property. Thus, the intention arising from the document / transfer / transmission was held to be an important determining factor in that case.

 

The Court in Govindbhai’s case (Supra) also referred to its earlier decision in Pulavarthi Venkata Subba Rao & Ors. vs. Valluri Jagannadha Rao (deceased) by LRs, AIR (1967) SC 591. In that case, a life interest benefit was given by a father to his two sons. The Court concluded that the properties taken by the two sons under the Will were their separate properties and not ancestral since there was no such intention in the Will.

 

The Court in Govindbhai’s case (Supra) also examined the reliance placed on Shyam Narayan’s case (Supra) and held that in that case the Apex Court did not question the issue of whether the property was ancestral property. It only held that once ancestral property was partitioned it continued to be ancestral in the hands of the recipient sons and grandsons. Hence, that case was not applicable to the facts of the case on hand. In that case, the Trial Court and the High Court had held that property received on partition of an HUF in 1987 was ancestral property. The Supreme Court found no reason to disagree with this conclusion. While the facts emerging from the Supreme Court decision are not fully clear, it is humbly submitted that the conclusion reached in the Shyam Narayan case (Supra) requires reconsideration.

 

Ultimately, in the case on hand (Govindbhai), the Supreme Court held that since the grandfather purchased the property and he was competent to execute a Will in favour of any person, including his son, the recipient (i.e., his son) would get it as his self-acquired property. The burden to prove that the property was ancestral was on the plaintiffs alone. It was for them to prove that the Will of their grandfather intended to convey the property for the benefit of the family so as to be treated as ancestral property. In the absence of any such averment or proof, the property in the hands of Donor has to be treated as self-acquired property. Once the property in the hands of the Donor is held to be self-acquired property, he was competent to deal with his property in such a manner as he considered proper, including by executing a gift deed in favour of a stranger to the family. Accordingly, the gift deed was upheld.

 

CONCLUSION

A conjoined reading of the Hindu Succession Act, 1956 and the plethora of decisions of the Supreme Court shows that the customs and traditions of Hindu Law have been given a decent burial by the codified Act of 1956! To reiterate, the important principles laid down by various decisions are that:

 

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

(b) Ancestral property can become an HUF property only if inheritance / succession is before 1956 and such HUF property which came into existence before 1956 continues as ancestral property even after 1956;

(c)  If a person dies after passing of the Hindu Succession Act, 1956 and there is no HUF existing at the time of his death, inheritance of a property of such a person by his heirs is as a self-acquired property in the hands of the legal heirs. They are free to deal with it in any manner they please.

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

(e) Self-acquired property received by way of gift / Will / inheritance continues to remain self-acquired in the hands of the recipient and he is free to deal with it in any manner he pleases.

Considering that this issue regularly travels all the way to the Supreme Court time and again, is it not high time that the Parliament amends the Hindu Succession Act to deal with this burning issue? If the Income-tax Act can be amended every year, and now even the Companies Act is amended regularly, why cannot this all-important law be amended with regular frequency? This Act touches many more lives and properties as compared to several other corporate statutes but yet it was last amended in 2005 and that, too, suffered from a case of inadequate drafting! One wishes that there is a comprehensive overhaul of the Hindu Succession Law so that valuable time and money are not lost in litigation.

OVERVIEW OF BENEFICIAL OWNERSHIP REGULATIONS (INCLUDING RECENT UAE REGULATIONS)

1. INTRODUCTION

Tax
transparency continues to be a key focus of governments and the public, as
demonstrated by the continuing media coverage surrounding data leaks in recent
years. The availability of beneficial ownership information, i.e., the natural person
behind a legal entity or arrangement, is now a key requirement of international
tax transparency and the fight against tax evasion and other financial crimes.

 

The recent
movement towards transparency has its origins in international standards adopted
primarily to combat cross-border money laundering, corruption and financial
crimes.

 

One of the most
pressing corporate governance issues today is the growing trend towards
increased corporate transparency. Public and private companies around the world
are being mandated to identify and disclose the details of their Ultimate
Beneficial Owners (‘UBOs’) i.e., the individuals who ultimately own or control
them. Corporate transparency has also made its way into mainstream discourse.

 

Data leaks such
as the Panama Papers in 2016 and the Paradise Papers in 2017 have thrown the
spotlight on complex corporate structures, the identity of ‘true’ owners and
general tax avoidance.

 

In April, 2016 the public as well as media commentators were taken by
surprise by the leak of over 11.5 million confidential documents from Mossack
Fonseca, a Panamanian law firm. The so-called ‘Panama Papers’ scandal serves as
an example of how the rich and powerful in some cases may have used complex
legal structures to conceal their beneficial ownership in offshore
subsidiaries. The Panama Papers scandal has provided an opportunity to
policy-makers the world over to call for stricter rules to promote the
disclosure of ultimate beneficial ownership.

Legislators and
regulators have renewed their focus on corporate transparency, extending their
reach beyond anti-money laundering measures solely applicable to the financial
sector.

 

GLOBAL MEASURES TO IMPROVE TRANSPARENCY

The G8 Summit
in 2013, as a part of the fight against money laundering, tax avoidance and
corruption, exerted enormous pressure on countries to improve transparency to
ensure that the true owners of a corporate body or other entities can be
traced, instead of remaining hidden behind complex structures.

 

The Financial
Action Task Force (FATF), which is playing a significant role in respect of the
establishment of beneficial ownership regulations in various jurisdictions
across the globe, is an independent inter-governmental body that develops and
promotes policies to protect the global financial system against money
laundering, terrorist financing and the financing of weapons of mass
destruction. The FATF currently comprises 37 member jurisdictions and two
regional organisations, i.e., the European Commission and the Gulf Co-operation
Council, representing major financial centres in all parts of the world. India
is also a member of the FATF.

 

The ‘International
Standards on Combating Money Laundering and the Financing of Terrorism &
Proliferation’ issued by the FATF (FATF Recommendations) are recognised as
the global Anti-Money Laundering (AML) and Counter-Terrorist Financing (CFT)
standards. Various amendments have been made to the FATF recommendations since
the text was adopted by the FATF Plenary in February, 2012, the latest
amendments being made in October, 2020. In addition, in respect of ‘Beneficial
Ownership’ the FATF has also published the following:

 

a) Best
Practices on Beneficial Ownership for Legal Persons (in October, 2019);

b) The Joint
FATF and Egmont Group Report on Concealment of Beneficial Ownership (July,
2018);

c) The FATF
Horizontal Study: Enforcement and Supervision of Beneficial Ownership
Obligations (2016-17); and

d) FATF
Guidance on Transparency and Beneficial Ownership (October, 2014).

 

‘FATF Recommendation
# 24’ requires jurisdictions to ‘ensure that there is adequate, accurate and
timely information on the beneficial ownership and control of legal persons
that can be obtained or accessed in a timely fashion by competent authorities’.

 

OECD VIEW

OECD considers
beneficial ownership information at the heart of the international tax
transparency standards: both the exchange of information on request (the EOIR
Standard) and the automatic exchange of information (the AEOI Standard).

 

OECD considers
that from a tax perspective, knowing the identity of the natural persons behind
a jurisdiction’s legal entities and arrangements not only helps that
jurisdiction preserve the integrity of its own tax system, but also gives
treaty partners a means of better achieving their own tax goals. Transparency
of ownership of legal entities and arrangements is also important in fighting
other financial crimes such as corruption, money laundering and terrorist
financing so that the real owners cannot disguise their activities and hide
their assets and the financial trail from law enforcement authorities using
layers of legal structures spanning multiple jurisdictions.

 

In this regard
OECD has published ‘A Beneficial Ownership Toolkit’ prepared by the Secretariat
of the Global Forum on Transparency and Exchange of Information for Tax
Purposes.

 

However, in the
context of beneficial ownership referred to in Articles 10, 11 and 12 of the
Model Tax Convention, OECD’s view on ‘beneficial ownership’ is a little
different. For example, in the context of the Commentary on Article 10,
paragraph 12.6 explains as under:

 

‘12.6 The above
explanations concerning the meaning of “beneficial owner” make it clear that
the meaning given to this term in the context of the Article must be distinguished
from the different meaning that has been given to that term in the context of
other instruments1 that concern the determination of the persons
(typically the individuals) that exercise ultimate control over entities or
assets. That different meaning of “beneficial owner” cannot be applied in the
context of the Article. Indeed, that meaning, which refers to natural persons
(i.e. individuals), cannot be reconciled with the express wording of
subparagraph 2 a), which refers to the situation where a company is the
beneficial owner of a dividend. In the context of Article 10, the term
“beneficial owner” is intended to address difficulties arising from the use of
the words “paid to” in relation to dividends rather than difficulties related
to the ownership of the shares of the company paying these dividends. For that
reason, it would be inappropriate, in the context of that Article, to consider
a meaning developed in order to refer to the individuals who exercise “ultimate
effective control over a legal person or arrangement.”’

 

Let us look at
specific measures taken by some key jurisdictions for improving transparency
through enhanced disclosures regarding beneficial ownership and control of
legal ownership.

 

2. DISCLOSURE REQUIREMENTS IN CERTAIN KEY JURISDICTIONS

One key measure
introduced by various countries is the requirement to prepare and maintain a
register identifying the ‘owners’ of the company. Specific reporting and
disclosure requirements vary by jurisdiction, with some countries requiring the
register to be publicly filed and others allowing for the register to be
privately held but accessible to government authorities.

 

a)         India

Section 89(10)
of the Companies Act, 2013 defining ‘beneficial interest’ was inserted and
section 90 dealing with the Register of Significant Beneficial Owners (‘SBOs’)
in a company was substituted by the Companies (Amendment) Act, 2017 w.e.f. 13th
June, 2018. Section 90 as amended by the Companies (Amendment) Act, 2019
contemplates a statutory piercing of the corporate veil to find out which
individuals are SBOs of the reporting company. Section 90 has an
extra-territorial operation and would apply to foreign registered trusts and
persons who are residents outside India. Hence, its remit is very broad and
affects a number of stakeholders.

 

The Companies
(Significant Beneficial Owners) Rules, 2018 were prescribed effective from 13th
June, 2018 and have been substantially amended by the Companies
(Significant Beneficial Owners) Amendment Rules, 2019 w.e.f. 18th February,
2019. Whilst the amended SBO Rules are a marked improvement over the previous
ones, there still exists a considerable amount of ambiguity with regard to
determination of the SBO in certain situations.

 

b) Mauritius

The Mauritian
Companies Act, 2001 was amended in 2017 to provide that the share register of
companies should disclose the names and last known addresses of the beneficial
owners / ultimate beneficial owners where shares are held by a nominee. By the
Finance (Miscellaneous Provisions) Act, 2019 the requirement was further
amended to provide that the company shall also keep an updated record of (a)
beneficial ownership information, and (b) actions taken to identify a
beneficial owner or an ultimate beneficial owner. The 2019 definition is far-reaching
and brings thereunder persons who would otherwise not have been considered as
beneficial owners under the 2017 definition.

 

The Registrar
of Companies issued Practice Direction (No. 3 of 2020) pursuant to sections
12(8) and 91(8) of the Companies Act, 2001 on 16th March, 2020
regarding Disclosure of Beneficial Owner or Ultimate Beneficial Owner to the
Registrar of Companies and to assist stakeholders to better understand the
provisions of the law relating to Beneficial Owners.

 

c) Singapore
(private register)

In Singapore,
the measures to improve the transparency of ownership and control are included
in legislation regulating all entities having a separate legal personality,
such as companies, limited liability partnerships and trusts and are contained
in the latest versions of the Companies Act, Limited Liability Partnerships Act
and the Trustees Act.

 

The disclosure
requirements came into force on 31st March, 2017. Under the Companies
Act the disclosure requirements require Singapore companies to maintain a
Register of Registrable Controllers (‘RORC’) and a Register of Nominee
Directors (‘ROND’). Foreign companies registered to carry on business in
Singapore (which includes Singapore branches of foreign companies) are also
required to maintain an RORC as well as a Singapore-based Register of Members.

 

The term controller
refers to an individual or legal entity that has a ‘significant interest’ or
‘significant control’ over a company. Controllers have an obligation to provide
their data for the Register.

 

The RORC is a
private company document listing all controllers and beneficial owners of a
company. It is not available to the public. The Register must include the
beneficial owners’ names and identifying details, as well as information about
their citizenship or places of registration in the case of legal entities.

 

The Accounting
and Corporate Regulatory Authority (ACRA), the national regulator of business
entities, has issued guidelines to help companies understand and comply with
the requirements pertaining to the RORC.

 

d) United
Kingdom (public register)

Since April,
2016 most companies incorporated in England and Wales have been required to
keep a register of ‘people with significant control’ and to file a copy of the
same with Companies House, the local registrar. These requirements were first
introduced in the Companies Act, 2006 and the Register of People with
Significant Control Regulations, 2016, before being extended to comply with
the EU Directive through the Information about People with Significant
Control (Amendment) Regulations, 2017. Each company’s register is public
and there is no charge to access the register.

 

e) The EU
Directive

The Fourth
Money Laundering Directive [(EU) 2015/849] as supplemented and amended by
the Fifth Money Laundering Directive [(EU) 2018/843] (together, the ‘EU
Directive’) came into force in the European Union in 2017. The EU Directive
leads the largest multinational effort to harmonise measures against money
laundering and financial crime across the member states. Article 30, in
particular, requires member states to ensure that companies incorporated within
their jurisdiction obtain and hold adequate, accurate and current information
on their beneficial owners, including details of the beneficial interests held.
Such information should be held in a central register (in the relevant member
state) and be accessible to specified authorities, firms carrying out customer
due diligence and any other person or organisation able to demonstrate a
legitimate interest. The EU Directive also provides that mechanisms to verify
that such information is adequate, accurate and current should be put in place
and breaches should be subject to effective, proportionate and dissuasive
measures or sanctions.

 

Although the EU
Directive applies to all member states, as a minimum harmonising directive,
each member state must adopt national implementing legislation that is equally
or more stringent than the EU Directive. The majority of member states have yet
to implement adequate centralised registers and for those countries that have
implemented the registers, the regime looks slightly different in each
jurisdiction.

 

f) France
(private register)

The EU Directive
was transposed into French law by Ordinance No. 2016-1635 in December,
2016, clarified by the Decree No. 2017 – 1094 in June, 2017 and
re-enforced by Decree No. 2020-118 in February, 2020. Companies and
other entities registered with the Trade and Companies Registry (Registre du
Commerce et des Societes) have to obtain and maintain up-to-date and
accurate information on their UBOs. This information must then be sent to the
court clerk office.

 

g) United
States of America (no register)

There are
currently no specific requirements to disclose information on ‘beneficial
owners’ of US corporations or limited liability companies. However, on 22nd
October, 2019 the US House of Representatives passed the Corporate
Transparency Act of 2019 (HR 2513) (CTA). If passed in the Senate, the CTA
would bring the US in line with international standards governing the
disclosure of beneficial ownership and would require applicants seeking to form
a corporation or limited liability company to file a report with the Financial
Crimes Enforcement Network (FinCEN) listing the beneficial owners of the entity
and to update this report annually.

 

If enacted, the
CTA would cover any corporation or limited liability company formed under any
state law as well as any non-US entity eligible to register to do business
under any state law. Certain exceptions would apply for entities such as
issuers of registered securities.

 

The CTA defines
a beneficial owner as ‘a natural person who, directly or indirectly, through
any contract, arrangement, understanding, relationship or otherwise exercises
substantial control over a corporation or limited liability company, or owns
25% or more of the equity interests of a corporation or limited liability
company, or receives substantial economic benefits from the assets of a
corporation or limited liability company’. The definition excludes certain
natural persons, including employees of corporations or limited liability
companies whose control of the entity is a result of their employment.

 

h) Canada
(private register)

By way of
background, Canadian corporations can be governed under the federal corporate
statute in Canada, the Canada Business Corporations Act (CBCA),
or under the corporate statute in any province or territory in Canada.
Corporations organised and existing under the CBCA are required to prepare and
maintain a register of individuals with significant control since June, 2019.

 

i) China
(private register)

The Measures
for the Reporting of Foreign Investment Information issued by the Ministry
of Commerce (MOFCOM) and the State Administration for Market Regulation (the
AMR) effective from January, 2020 (the Measures) prescribe disclosure
requirements for the ‘ultimate actual controller’ of a foreign-investment
entity in the People’s Republic of China. Details of the ultimate actual
controller must be provided using the AMR’s online enterprise registration
system. The information will then be shared with the MOFCOM.

 

j) Brazil
(private register)

Provisions
similar to the EU Directive came into force in May, 2016 through the Normative
Instruction No. 1,634 (NI 1,634/2016) as amended by Normative
Instruction No. 1,863 (NI 1,863/2018) (the Normative Instruction). Pursuant
to the Normative Instruction, upon enrolment with the National Corporate
Taxpayers Registry (Cadastro Nacional da Pessoa Juridica or CNPJ) or
upon request by the tax authorities, certain entities must disclose old and new
registers of UBOs.

 

k) British
Virgin Islands

The Beneficial
Ownership Secure Search System Act, 2017 (the BOSS Act) came into force in the
BVI on 30th June, 2017. The BOSS Act was almost immediately amended
by the Beneficial Ownership Secure Search System (Amendment) Act, 2017, which
also came into force on 30th June, 2017.

 

This BOSS Act
facilitates the effective storage and retrieval of beneficial ownership
information for all BVI companies and legal entities using the Beneficial
Ownership Secure Search system.

 

The BVI Government signed an exchange of notes agreement with the UK
Government in April, 2016. The Beneficial Ownership Secure Search system is
built to ensure that the BVI can efficiently exchange that information in
relation to the exchange of notes. The beneficial ownership information in the
system will also be available to other authorities in the BVI to ensure that
they are able to meet their international obligations. Importantly, the system
will not be accessible by the public.

 

Under section
9(6) of the BOSS Act, the obligation to provide updated beneficial ownership
information rests on the BVI company. A BVI company that fails to comply with
this section commits an offence and may be subject to a fine of up to US
$250,000 or to imprisonment for a term not exceeding five years, or both.

 

l) Jersey

Jersey adopted
the Financial Services (Disclosure and Provision of Information) (Jersey) Law
2020 (Disclosure Law) on 14th July, 2020 and registered it in the
Royal Court of Jersey on 23rd October, 2020.

 

The intention
of the Disclosure Law is to place on a statutory footing the ‘FATF’s
Recommendation # 24’ relating to the beneficial ownership of legal persons. The
Disclosure Law seeks to maintain the current situation whereby the Jersey
Financial Services Commission (Commission) collects and makes public certain
information, but enables the State of Jersey to make regulations which
determine additional information which may be made public.

 

The Disclosure
Law will come into effect on 6th January, 2021 and, consequently,
the filing deadline for the new annual confirmation statement will be 30th
April, 2021.

 

m) Cayman
Islands

Under the Cayman Islands beneficial ownership legislation, i.e., The Companies
Law (Revised), The Limited Liability Companies Law (Revised), The Beneficial
Ownership (Companies) Regulations, 2017, The Beneficial Ownership (Companies)
(Amendment) Regulations, 2018, The Beneficial Ownership (Limited Liability
Companies) Regulations, 2017 and The Beneficial Ownership (Limited Liability
Companies) (Amendment) Regulations, 2018 (the Legislation), certain Cayman
Islands companies are required to maintain details of their beneficial owners
and relevant legal entities on a beneficial ownership register. The registers
are not publicly available, although they can be searched in limited
circumstances by the competent authority in the Cayman Islands.

 

n) Isle of Man

The Isle of
Man’s ‘Beneficial Ownership Act, 2017’ (the Act) came into effect on 21st
June, 2017 repealing the previous 2012 legislation. Subsequently, the new
central database for the storage of the data to be collected under the Act (the
Isle of Man Database of Beneficial Ownership) went live on 1st July,
2017. The Act has been introduced in response to the global initiative to
improve transparency as to asset ownership and control, similar to legislation
introduced in other jurisdictions. The Act introduces important changes which
affect legal entities incorporated in the Isle of Man, the main objective of
which is to ensure that the beneficial ownership of Isle of Man bodies
(companies) can be traced back to the ‘ultimate beneficial owners’.

 

The Beneficial
Ownership (Civil Penalties) Regulations, 2018 contain civil penalties for
contravention of the various provisions of the Act.

 

o) Guernsey

The Beneficial
Ownership of Legal Persons (Guernsey) Law, 2017 came into force on 15th
August, 2017. Since that date, all Guernsey companies have been required to
file beneficial ownership information. New companies must file beneficial
ownership information on incorporation. All companies must ensure that any
changes in the beneficial ownership information are submitted to the Registry
within 14 days. Resident-agent exempt entities are not required to file a
beneficial ownership declaration.

 

The definition
of beneficial ownership for the purposes of registration is set out in The
Beneficial Ownership (Definition) Regulations, 2017.

 

From the above
discussion it is evident that most of the tax heavens have done away with
bearer securities and now the disclosure of the BO is mandatory.

 

3. UNITED ARAB EMIRATES (UAE)

A. UAE
Anti-Money Laundering Law

The UAE Federal
Decree law No. (20) of 2018 dated 23rd September, 2018 (which was
issued on 30th October, 2018) on Anti-Money Laundering and Combating
the Financing of Terrorism and Financing of Illegal Organisations (UAE
Anti-Money Laundering Law) together with Cabinet Decision No. (10) of 2019
concerning the implementing regulation of Decree law No. (20) of 2018 comprises
the UAE Anti-Money Laundering Law.

 

Article 9 of
the Cabinet Decision No. (10) of 2019 placed an obligation on corporate
entities to disclose any individual ownership (whether beneficial or actual) in
an entity which owns 25% or more of the company, to the relevant regulator.

 

B. Regulation
of the Procedures of the Real Beneficiary

(i)         The UAE on 24th
August, 2020 issued Cabinet Resolution No. 58 of 2020 (Resolution 58) on the Regulation
of the Procedures of the Real Beneficiary (RB Regulations).

 

Let us study
some of the salient features of these Regulations.

 

(ii)        Entry into effect

The RB
Regulations came into effect on 28th August, 2020. Article (19) of the
Regulations repealed the earlier Cabinet Resolution No. 34 of 2020 on the
Regulation of the Procedures of the Real Beneficiary (issued earlier in 2020)
as well as any provision that violates or contradicts the provisions of the
Resolution No. 58.

 

One of the main
drivers for the introduction of the RB Regulations is the above-referred
Federal Decree Law No. 20 of 2018 and its implementing regulation, Cabinet
Decision No. (10) of 2019, which deals with anti-money laundering crimes and
combating the financing of terrorism and of unlawful organisations and is
generally in accordance with the UAE’s recent legislation to increase
transparency in its business environment.

 

(iii)       Objectives of the Regulations

The stated aim
and objective of the RB Regulations is (a) to contribute to the development of
the business environment, the state’s capabilities and its economic standing in
accordance with international requirements, by organising the minimum
obligations of the registrar and legal persons in the state, including
licensing or registration procedures, and organising the real beneficiary
register and the partners or shareholders register, and (b) develop an
effective and sustainable implementation and regulatory mechanism and
procedures for the real beneficiary data.

 

The RB Regulations address the disclosure requirements at the corporate
registration stage as well as the requirement to subsequently maintain ‘The
Partners or Shareholders Register’ and the ‘Real Beneficiary Register’.

 

(iv) Compliance
requirements

Article 8(1) of
the RB Regulations provides that ‘The Legal Person shall, within sixty (60)
days from the date on which this Resolution is effective or the date the Legal
Person’s presence, keep the information of each Real Beneficiary in the Real
Beneficiary Register he creates. The Legal Person shall also update this
Register and include any change occurring thereto within fifteen (15) days from
the date of being aware thereof.’

Further,
Article 11(1) provides that a legal person shall, within 60 days from the date
of the publication of the Resolution, i.e., 28th August, 2020 or the
date of the Legal Person’s registration or license, provide the Registrar with
the information of the Real Beneficiary Register or the Partners or Shareholders
Register. The Legal Person shall take reasonable measures to preserve its
registers from damage, loss or destruction.

 

Since the
Resolution 58 became effective from 28th August, 2020, within 60
days therefrom, i.e., by 27th October, 2020, all the existing
companies were required to file the beneficial ownership information with the
relevant Registrar.

 

(v) Scope of
the Regulations

The RB
Regulations cover all corporate entities that are licensed or registered in the
UAE (including in any commercial free zones) (an Entity / a legal person).

 

The only
entities that are not covered by the RB Regulations are wholly-owned government
entities (and their subsidiaries) and entities that are established within the
UAE’s two financial free zones, i.e., the Dubai International Financial Centre
and the Abu Dhabi Global Market. However, corporate entities licensed in these
financial free zones should nevertheless take note of the disclosure
requirements of Resolution 58 if they have shareholdings in onshore or other
commercial free zone companies in the UAE.

 

The RB
Regulations provide a more robust and prescriptive regime to record and
disclose ultimate beneficial ownership of UAE entities.

 

(vi) Meaning of
‘Real Beneficiary’

Article 1
defines the term ‘Real Beneficiary’ as follows:

‘A Legal Person who has the ultimate ownership or exercises ultimate control over a
Legal Person, directly or through a chain of ownership or control, or other
indirect means, as well as the Natural Person who conducts transactions
on behalf thereof, or who exercises
ultimate effective control over a Legal Person, that is determined according
to the provision of Article (5) hereof.’

 

Thus, the term
Real Beneficiary is used in the RB Regulations to describe an Ultimate Beneficial
Owner.

 

Article 5
contains the provisions relating to Real Beneficiary Identification. Article
5(1) provides that whoever either

(i)         owns or finally controls 25% or more of
an entity’s shares directly or indirectly; or

(ii)        has the right to vote representing 25% or
more of an entity’s shares directly or through a chain of ownership and
control; or

(iii)       controls the entity through any other
means, such as by appointing or dismissing the majority of directors

shall be
considered as the Legal Person’s Real Beneficiary.

 

While
determining whether someone is a ‘real beneficiary’, it is important to look
through any number of legal persons or arrangements of any kind, intermediaries
or other entities that are used in a chain of ownership / control so as to
identify the ultimate natural person.

 

It is
worthwhile to note that the term ‘Legal Person’ is not defined in the Federal
Law No. 2 of 2015 on Commercial Companies, or the UAE Anti-Money Laundering
Law, or the RB Regulations. Therefore, it has to be understood in its ordinary
meaning as compared to a natural person and meaning as companies or corporate
entities.

 

However, in the
context of Article 5(2) for real beneficiary identification which uses the term
legal ‘arrangements’, in Article 1 of the UAE Anti-Money Laundering Law, the
term ‘Legal Arrangement’ has been defined as under:

 

‘Legal
Arrangement: A relationship established by means of a
contract between two or more parties which does not result in the creation of a
legal personality such as trust funds or other similar arrangements.’

 

Further, ‘real
beneficiary’ includes any joint or co-owners of particular shares (such as
family members holding shares through a trust or similar structure). The RB
Regulations are clear that it is both direct and indirect ownership / control
that are to be considered.

 

If it is not
possible to ascertain whether anyone is considered to be a ‘real beneficiary’
based on any of the tests set out above, then the natural person who occupies
the senior management position (i.e., the decision-making authority of an
entity) will be deemed to be the ‘real beneficiary’ under the RB Regulations.

 

Given the
breadth of the RB Regulations, specifically, the definition of ‘real
beneficiary’, there is a view that a beneficiary under a nominee arrangement
would be within the scope of the RB Regulations, i.e., the beneficiary would be
considered as holding shares or exercising control in spite of it doing so
through a nominee.

(vii)
Disclosure requirements and registers

As per Articles
8 and 10 of the RB Regulations, from 27th October, 2020 all entities
covered within the scope of the Regulations must keep the Real Beneficiary
Register and Partners or Shareholders Register (the Registers).

 

a) Real
Beneficiary Register

However,
Article (8)(2) of the RB Regulations sets out specific information that should
now be maintained in relation to each Real Beneficiary. The Real Beneficiary
Register must include the following information for each Real Beneficiary of an
entity:

  •             the name,
    nationality, date and place of birth;
  •             the place of
    residence or address to which notifications can be sent;
  •             the Emirates ID
    number or passport number and its date of issuance and expiration;
  •             the basis for, and
    the date upon which, the individual became a real beneficiary; and if
    applicable, the date upon which the individual ceases to be a real
    beneficiary.

 

b) Partners or
Shareholders Register

The requirement
to keep a Shareholder Register is not new in the UAE as Article 260 of the UAE
Federal Law No. 2 of 2015 on Commercial Companies provides that ‘Private
Joint Stock Companies shall have a register where the names of the shareholders,
the number of shares held by them and any dispositions of the shares are
entered. Such register shall be delivered to the shares register secretariat.’

 

Now under the
RB Regulations, the following information is required to be kept in the
Partners or Shareholders Register:

  •             the number and
    class of shares held and the voting rights associated with such shares;
  •             the date on which
    the partner / shareholder became the owner of such shares;
  •          For every partner /
    shareholder who is a person:

•           the nationality;

•           address;

•           place of birth;

•           name and address of employer; and

•           a true copy of a valid Emirates ID or
passport.

  •          For every partner /
    shareholder that is a legal entity:

•           the name, legal form and a copy of
its Memorandum of Association;

•           the address of the main office or
headquarters of the entity, and if it is a foreign entity, the name and address
of its legal representative in the UAE and the supporting documentation
providing proof of such information;

•           the ‘statute’ or any other similar
documents approved by the relevant authorities concerned with the
implementation of the UAE’s anti-money laundering laws and regulations; and

•           the details of the person(s) who hold
senior management positions.

 

(viii) Trustees
and nominal management members

In addition to
the details of partners / shareholders, a legal person, i.e., corporate entity,
must also maintain the same information required for real beneficiaries, for
any trustees or board nominal members (nominal members) as part of its Partners
or Shareholders Register.

 

The RB
Regulations broadly define a ‘Board nominal member’ as a natural member
acting in accordance with the guidelines, instructions or will of another
person. A ‘Trustee’ means a natural or legal person enjoying the rights
and powers granted to him by the testator or the trust fund under which he
manages, uses and disposes of the testator’s funds in accordance with the
conditions imposed on him by any of them.

 

As per the
provisions of Article 9(1), all nominal members must notify and submit the
required information to the legal person within 15 days of being appointed as a
nominal member. In addition, a legal person is required to disclose the details
concerning the interests or shares and identity of the holders of any shares
issued in the names of persons or nominee members within 15 days of such
issuance to the relevant authority.

 

All existing
nominal members are required to notify the legal person and submit the relevant
information for recording their data in the Partners or Shareholders Register
within 30 days of the RB Regulation’s publication date, 28th August,
2020, i.e., by 27th September, 2020.

 

Any changes to
nominee members (including their particulars) must be notified by the nominee
members to the Entity within 15 days of such a change taking place.

 

(ix)
Compliances deadlines

The Registers
need to be created and filed with the Registrar from 27th October,
2020 onwards. Newly-incorporated legal persons will need to file the Registers
with the Registrar within 60 days of incorporation.

 

A legal person
is primarily responsible for maintaining and filing the Registers and must take
reasonable measures to obtain accurate and updated information regarding its
real beneficiaries on an ongoing basis. However, if a real beneficiary is
licensed or registered in the UAE or is listed (or owned by a company that is
listed) on a reputable exchange that has adequate disclosure and transparency
rules, then a legal person can rely on the information that such a company may
have filed or disclosed to the relevant regulators without having to make
further investigations as to the validity of such information.

 

Any change to
the information contained in the Registers must be updated and notified to the
Registrar within 15 days of such change. A legal person must also appoint, and
subsequently notify the Registrar, of a person who is resident in the UAE and
is authorised by the legal person to submit all information and Registers
required under the RB Regulations.

 

It is worth
noting that there is a positive obligation on legal persons to act if they
become aware of a person that could be a real beneficiary but who is not listed
as such in the Registers.

 

In those
circumstances, a legal person must send an inquiry to the suspected real
beneficiary and, if they do not receive a response within 15 days, must send a
formal notice (with certain prescribed information included) asking the person
to confirm whether he is a real beneficiary. If the suspected real beneficiary
fails to respond to such notice within 15 days, then the details of that person
must be entered on the Registers. If a person/s thinks they have been
incorrectly recorded as a real beneficiary on a legal person’s register, then
an application to a competent court in the UAE can be made to correct the
information.

 

Article 11(5)
of the RB Regulations provides that no legal person who is licensed or
registered in the UAE may issue bearer share guarantees.

 

In regard to
companies that are under dissolution or liquidation, the appointed liquidator
has an obligation to provide a true copy of the updated Real Beneficiary
Register to the Registrar within 30 days of the liquidator’s appointment.

 

(x)
Confidentiality

The Registrar
is required to keep information that is disclosed to it under the RB
Regulations confidential and not to disclose such information without approval
from the person involved. However, the UAE Government may disclose information
it receives under the RB Regulations to third parties in order to comply with
international laws and agreements that are in place, in particular those aimed
at countering money laundering and the financing of terrorism.

 

(xi) Penalties

At present, the
RB Regulations do not include specific penalties for violations. However,
Article 17 provides that the Minister of Economy or the delegated authorities
may impose one or more sanctions from the Administrative Sanctions Regulations.

 

It is expected
that a list of penalties and sanctions for non-compliance will be issued soon
along with a framework and additional guidance on how information is to be
collected and submitted.

 

(xii) Local and
international co-operation

Article 16 of
the RB Regulations provides that the Ministry of Economy will share the
information and data provided by a legal person, including from the legal
person’s Real Beneficiary and Partners or Shareholders Register, with the
Government entities tasked with enforcing the UAE anti-money laundering regime.

 

Besides, the Ministry of Economy will facilitate international
co-operation by allowing foreign authorities access in certain circumstances to
the data from the Real Beneficiary Register and the Partners or Shareholders
Register.

 

4. THE ROAD AHEAD – RECOMMENDED STEPS FOR THE MNES

It is undeniable that there is a trend towards increased corporate
ownership transparency around the world. However, despite the international
push towards transparency, local frameworks for determining and reporting
beneficial ownership remains inconsistent, with specific requirements varying
from jurisdiction to jurisdiction.

The current
lack of consistency poses unique challenges for multinationals managing the
various compliance requirements in different jurisdictions, including the
different information that needs to be provided and timelines imposed for
reporting.

 

In addition,
the underlying legislation in many jurisdictions remains new and subject to
refinement through interpretative guidance and accompanying regulations that
have yet to be published.

 

As with all
disclosure obligations, companies need to strike a balance between providing
sufficient and accurate information while avoiding over-disclosure that can
cause confusion.

 

5.  CONCLUSION

UAE’s RB
Regulations’ objective is to bring the country’s company registration process
in line with international standards and further enhance the State’s
co-operation with its international counterparts in the common effort of
combating money laundering, terrorism and criminal financing. It does not seek
to recognise or regulate a new legal concept such as equitable interests but
merely acknowledges that such type of interest exists and is recognised under
the legal framework of some of its international counterparts.

 

In this article
we have given brief information about some of the illustrative jurisdictions
where beneficial ownership regulations have been introduced / expanded. While
incorporating any entity in any foreign jurisdiction, it would be advisable to
keep in mind the beneficial ownership regulations in those jurisdictions.

 

Readers would be well advised to carefully look into applicable
Beneficial Ownership Regulations along with Guidance, clarifications, etc.,
provided thereon, before taking necessary action in respect of the same.

 

 

 

2020
Returns in US Markets

Tesla $TSLA: +743%

Peloton $PTON: +434%

Moderna $MRNA: +434%

Zoom $ZM: +396%

Bitcoin: +304%

 

$AAPL: +82%

$AMZN: +76%

Nasdaq 100 $QQQ: +49%

$MSFT: +43%

$GOOGL: +31%

 

Gold: +24%

Small Caps $IWM: +20%

S&P $SPY: +18%

LT Treasuries $TLT: +18%

Oil: -21%

 

— via @charliebilello

 

 

 

[Income Tax Appellate Tribunal, Chennai ‘A’ Bench; dated 24th July, 2006, passed in I.T.A. Nos. 490/MDS/2000, 352/MDS/2000 and 353/MDS/2002 for A.Ys. 1996-1997, 1997-1998 and 1998-1999] Business expenditure – Provision made for site restoration – Contingent liability – Commercial expediency – Allowable expenditure u/s 37

5. M/s Vedanta Limited vs.
The Jt. CIT, Special Range-I [Tax
Case Appeal Nos. 2117 to 2119 of 2008; Date of order: 23rd January,
2020] (Madras High Court)

 

[Income
Tax Appellate Tribunal, Chennai ‘A’ Bench; dated 24th July, 2006,
passed in I.T.A. Nos. 490/MDS/2000, 352/MDS/2000 and 353/MDS/2002 for A.Ys.
1996-1997, 1997-1998 and 1998-1999]

 

Business
expenditure – Provision made for site restoration – Contingent liability –
Commercial expediency – Allowable expenditure u/s 37

 

The
assessee is engaged in the business of oil exploration in India and as per the
Product Sharing Contract between the Government of India, Oil and Natural Gas
Corporation Limited (ONGC), Videocon Petroleum Limited, Command Petroleum
(India) Pte. Limited, Ravva Oil (Singapore) Pte. Ltd. with respect to the
contract area identified as Ravva Oil & Gas Fields. The assessee company
undertaking the oil exploration is obligated under Clauses 1.77 and 14.9 of the
contract to restore the site by filling up the pits after the oil exploration
work is over.

 

The provision for such expenditure to be incurred in future for site
restoration work was made on a scientific and rational basis depending upon the
quantum of oil expected to be explored, based on production of the oil which
was worked out depending upon the share of the oil of various companies of
which the assessee had 22.5% of the total oil explored, and over the expected
production of the oil in barrels and abandonment costs computed by the company.
The assessee company computed the said expected liability of site restoration
charges and accordingly made provisions for the three A.Ys. in question.

 

The
Tribunal disallowed the provisions made by the assessee for site restoration
cost for the A.Ys. in question by holding that ‘an expenditure which is
deducted for income-tax purpose is one which is towards a liability actually
existing at the time, but putting aside some money which may become an
expenditure on the happening of an event is not an expenditure.’ In other
words, the Tribunal held that since the provision made under site restoration
fund is a contingent liability incurred by the assessee, the same is not an
allowable expenditure. The Tribunal held that the provision for site
restoration fund cannot be allowed even u/s 37(1) of the Act.

 

The
Tribunal also referred to the provisions of section 33ABA inserted by the
Finance (No. 2) Act, 1998 with effect from 1st April, 1999 from
which date such a provision for site restoration made by the assessee cannot be
allowed unless an actual deposit is made in the Site Restoration Fund u/s
33ABA. But the A.Ys. in question before the Court are prior to this amendment
of law.

 

Before the
Hon’ble High Court the only question left for deciding the controversy on hand
was whether such deduction of ‘Provision made for Site Restoration’ by the
assessee can be allowed as a business expenditure u/s
37(1).

 

Section
37(1) of the Act is a residual provision and apart from various deductions for
business expenditure prescribed under sections 32 to 36 which are specific in
nature, section 37(1) provides that any expenditure (not being expenditure of
the nature described in sections 30 to 36 and not being in the nature of
capital expenditure or personal expenses of the assessee), ‘laid out or expended’ ‘wholly and exclusively’
for the purposes of the business or profession shall be allowed in computing
the income chargeable under the head ‘Profits and gains of business or
profession’. Thus, the expenditure incurred by the assessee or a provision made
for the same are both allowable u/s 37(1), provided such expenditure is
incurred wholly and exclusively for the purpose of business and is laid out or
expended for the purpose of business.

 

The
assessee urged that the Supreme Court in the case of Calcutta Company Limited vs. CIT (1959) 37 ITR 1 (SC)
has laid down that inasmuch as the liability which had accrued during the
accounting year was to be discharged at a future date, the amount to be
expended in the discharge of that liability would have to be estimated in order
that under the mercantile system of accounting the amount could be debited
before it was actually disbursed.

 

Further,
relying upon another judgment of the Supreme Court in the case of Bharat Earth Movers vs. CIT (2000) 245 ITR 428 (SC),
it was submitted that the law is settled – if a
business liability has definitely arisen in the accounting year, the deduction
should be allowed although the liability may have to be quantified and
discharged at a future date.

 

It was
further submitted that the three yardsticks, criteria or parameters for
allowing the ‘Provisions made for future expenditure’ were discussed by the
Supreme Court in the case of Rotork Controls India
(P) Ltd. vs. Commissioner of Income-tax reported
in 2009 314 ITR 0062. Thus,
the three criteria of the provision are recognised when (a) an enterprise has a present obligation as a result of a past
event; (b) it is probable that an outflow of resources will be required to
settle the obligation; and (c) a reliable estimate can be made of the amount of
the obligation.

 

It was
urged that all the three criteria are satisfied by the assessee in the present
cases and there is no dispute from the side of the Revenue that the assessee
has incurred an obligation under the contract. The question of restoring the
site of exploration after the work is over for which the said provision is made
is based on a scientific method and relevant materials.

 

The High
Court observed that for the three assessment years in question the provision
made by the assessee was clearly an allowable expenditure u/s 37(1). The only
ingredient required to be complied with for section 37(1) is that the
expenditure in question should be laid out or expended wholly for the purpose
of the business of the assessee. There is no dispute that the provision in
question was made wholly and exclusively for the purpose of business. The only
dispute was that the expenditure was not actually incurred in these years and
the amount was to be spent in future out of the provisions made during those
assessment years, viz., 1996-1997 to 1998-1999.

 

The Court
observed that there was no prohibition or negation for making a provision for
meeting such a future obligation and such a provision being treated as a
revenue expenditure u/s 37(1). The Supreme Court in the case of Calcutta Company Limited (Supra) had
clearly held that the words ‘Lay’ (laid out) or ‘Expend’ include expendable in
future, too. The making of a provision by an assessee is a matter of good
business or commercial prudence and it is to set apart a fund computed on
scientific basis to meet the expenditure to be incurred in future. There is no
time frame or limitation prescribed for the said provisions to be actually
spent. Merely because in the context like the one involved in this case the
contract period is long, viz., 25 years, which, too, now stands extended by a
period of ten years or more, and therefore the actual work of site restoration
may happen after 35 years depending upon the actual exploration of oil reserves
and the site restoration would be undertaken only if there is no longer some
oil to be explored or drawn out, therefore, it cannot be said that the
provision made for the three assessment years at the beginning of the contract
period was irrational or a disallowable expenditure.

 

The
question of commercial expediency is a usual business and economic decision to
be taken by the assessee and not by the Revenue authorities, therefore the
provision made on a reasonable basis cannot be disallowed u/s 37(1) unless it
can be said to have no connection with the business of the assessee. The words
‘wholly and exclusively for the purpose of business’ is a sufficient safeguard
and check and balance by the Revenue authorities to test and verify the
creation of provisions for meeting a liability by the assessee in future and its
connectivity with the business of the assessee. Assuming that such set-apart
provision is not actually spent in future or something less is spent on site
restoration, nothing prevents the Revenue authorities and the assessee himself
from offering it back for taxation in such future year, the unspent provision
to be thus brought back to tax as per section 41(1).

 

In view of the aforesaid facts, the appeals
filed by the assessee were allowed.

Scientific research – Special deduction u/s 80-IB(8A) – Jurisdiction to examine nature of research – Prescribed authority under Act alone has power to examine nature of scientific research and determine whether assessee is entitled to special deduction u/s 80-IB(8A) – A.O. has no power to determine questions

32. CIT vs. Quintiles Research (India) Private Ltd. [2020]
429 ITR 4 (Kar.) Date
of order: 14th October, 2020 A.Y.:
2008-09

 

Scientific
research – Special deduction u/s 80-IB(8A) – Jurisdiction to examine nature of
research – Prescribed authority under Act alone has power to examine nature of
scientific research and determine whether assessee is entitled to special
deduction u/s 80-IB(8A) – A.O. has no power to determine questions

 

aged in
pharmaceutical research and development as well as clinical research for
pharmacy products. For the A.Y. 2008-09 the assessee claimed deduction of Rs.
31,32,49,090 u/s 80-IB(8A). The A.O. held that the assessee is not undertaking
any scientific research and development on its own as specified under rule
18DA(1)(c) of the Rules. It was further held that the assessee has not been
able to sell any output / prototype till date and undertakes the activities as
specified in the agreement and transfers the data / information to the customer
who in turn may use the same to develop a technology product / patent and the
assessee itself is not engaged in scientific research and development
activities leading to development / improvement / transfer of technology. Thus,
it was held that the assessee does not meet the prescribed conditions u/s
80-IB(8A). Accordingly, the claim of the assessee for deduction under the
aforesaid provision was disallowed.

 

The
Dispute Resolution Panel rejected the objections of the assessee. The Tribunal
allowed the appeal preferred by the assessee and set aside the order of the
A.O. In the appeal filed by the Revenue, the following question of law was
raised before the Karnataka High Court:

 

‘Whether,
on the facts and in the circumstances of the case, the Tribunal is right in law
in holding that the conditions of rule 18DA can be looked into only by the
prescribed authority and not by the A.O., whereas the said rule prescribes the
conditions necessary for allowing deduction u/s 80-IB(8A) and the A.O. is well
within his jurisdiction to accept or reject the same based on the conformity
adhered to by the assessee?’

 

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

 

‘i)    Section 80-IB provides for
deduction in respect of profits and gains from certain industrial undertakings
other than infrastructure development undertakings. Under sub-section (8A) in
the case of an assessee engaged in scientific research and development, there
would be 100% deduction of the profits and gains of such business for a period
of ten consecutive assessment years subject to the condition that the company
satisfied the conditions enumerated in sub-section (8A) of section 80-IB. From
a conjoint reading of rules 18D and 18DA of the Income-tax Rules, 1962 it is
axiomatic that it is for the prescribed authority to examine the nature of
research and scientific development proposed to be or being carried out by the
company who seeks approval or extension of approval. Once under sub-rule (2)
approval is granted which enures for a period of three years, it can be
extended only on satisfactory performance of the company, which has to be
assessed on periodic review by the prescribed authority. The prescribed
authority is also empowered to call for such information or documents which may
be found necessary for consideration of the application for grant of approval.
Even during the currency of the approval granted by the prescribed authority,
the company has to satisfy several conditions in terms of rule 18DA(2) of the
Rules. The prescribed authority is also empowered to withdraw the approval.
Thus, the statutory scheme of the Rules mandates the prescribed authority to be
a body which can minutely examine the highly technical and scientific
requirements in the case of a company.

 

ii)    Therefore, once the
prescribed authority grants approval and such approval holds the field, it
would not be open to the A.O. or any other Revenue authority to sit in appeal
over such approval certificate and re-examine the issue of fulfilment of
conditions mentioned in sub-rule (1) of rule 18DA of the Rules. The prescribed
authority is a specialised body having expertise in the field of scientific
research and development and the requirements being extremely complex,
scientific requirements have, therefore, been rightly placed in the hands of
the expert body.

 

iii)   There is no plausible reason
why the A.O. should be allowed to sit in appeal over the decision of a body
which is prescribed under the Rules. An issue with regard to violation of
conditions mentioned in rule 18DA can be looked into only by the prescribed
authority and not by the A.O.’

Non-resident – Income deemed to accrue or arise in India – Section 9(1)(vii) – Fees for technical services – Effect of Explanation 2 to section 9(1)(vii) – Agreement for export of garments – Non-resident company inspecting garments, ensuring quality and export within stipulated time – No technical services performed by non-resident – Income received by non-resident not taxable in India

31. DIT (International
Taxation) vs. Jeans Knit Pvt. Ltd. [2020]
428 ITR 285 (Kar.) Date
of order: 10th September, 2020 A.Y.: 2007-08

 

Non-resident
– Income deemed to accrue or arise in India – Section 9(1)(vii) – Fees for
technical services – Effect of Explanation 2 to section 9(1)(vii) – Agreement
for export of garments – Non-resident company inspecting garments, ensuring
quality and export within stipulated time – No technical services performed by
non-resident – Income received by non-resident not taxable in India

 

The assessee was
engaged in the business of manufacturing and export of garments and was a 100%
export-oriented undertaking. The assessee company imported accessories from
other countries, mostly from Europe. For this purpose it had engaged a Hong
Kong company to render various services at the time of import such as
inspection of fabrics and timely dispatch of material. The assessee paid 12.5%
of the import value as charges to the non-resident company. The assessee made
payments to the non-resident company in the A.Y. 2007-08 without deduction of
tax at source. The A.O., by an order, inter alia held that the non-resident company was a service provider and was
not an agent of the assessee and the services rendered by the non-resident
company had to be treated as technical services and were squarely covered under
the scope and ambit of section 9(1)(vii). The assessee failed to deduct tax at
source at the rate of 10% and therefore the assessee was treated as an assessee
in default.

 

The Commissioner
(Appeals) upheld the order of the A.O. But the Tribunal set aside the order.

 

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

 

‘i)    From the agreement executed by the assessee
with the non-resident company it was evident that the non-resident company was
required to inspect the quality of fabrics and other accessories in accordance
with the sample approved by the assessee and coordinate with the suppliers to
ship the goods within the stipulated date. The assessee in consultation with
the exporters identified the manufacturers as well as the quality and price of
the material to be imported.

ii)    The non-resident company was nowhere involved
either in identification of the exporter or in selecting the material and
negotiating the price. The quality of material was also determined by the
assessee and the non-resident company was only required to make physical
inspection to see if it resembled the quality specified by the assessee. For
rendering this service, no technical knowledge was required.

 

iii)   The Tribunal on the basis of meticulous
appreciation of the evidence on record had recorded a finding that the
non-resident company was not rendering any consultancy service to the assessee.
Therefore, it would not fall within the services contemplated u/s 9(1)(vii).

 

iv) The substantial
questions of law framed by a Bench of this Court are answered against the
Revenue and in favour of the assessee.’

 

Export – Exemption u/s 10A – Effect of section 10A and Notification No. S.O. 890(e) of CBDT – Assessee carrying on back-office work and preparation of applications for patent in USA – Assessee entitled to exemption u/s 10A

30. CIT vs. Narendra R. Thappetta [2020]
428 ITR 485 (Kar.) Date
of order: 10th September, 2020 A.Ys.: 2009-10 and 2010-11

 

Export –
Exemption u/s 10A – Effect of section 10A and Notification No. S.O. 890(e) of
CBDT – Assessee carrying on back-office work and preparation of applications
for patent in USA – Assessee entitled to exemption u/s 10A

 

The
assessee received back-office work from the legal department of software
companies in the USA. For the A.Ys. 2009-10 and 2010-11 he claimed deduction
u/s 10A of Rs. 3,24,74,124 and Rs. 3,34,41,151, respectively. The A.O. held
that section 10A applies only in respect of profits and gains derived from
export of articles, or things or computer software and, therefore, the assessee
is not entitled to deduction u/s 10A as his activities do not constitute
development of a computer programme as defined u/s 10A. It was further held
that the activities of the assessee do not fall in any of the categories as
mentioned in Notification No. 890 dated 26th September, 2000 ([2000] 245 ITR (St.) 102) issued by
the CBDT and rejected the claims of deduction of the assessee u/s 10A.

 

The
Commissioner of Income-tax (Appeals) allowed the appeals filed by the assessee
and held that the assessee is entitled to deduction u/s 10A in the light of the
Notification issued by the CBDT which is applicable to the case of the assessee
as the services rendered by him can broadly be classified as office operations,
data processing, legal databases and the same can be termed as information
technology-enabled services. The Tribunal held that the activities of the
assessee can be categorised as back-office operations, data processing, legal
databases or even under remote maintenance and the same can be termed as
information technology-enabled products or services. The Tribunal therefore
held that the assessee is entitled to claim deduction u/s 10A.

 

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

 

‘i)    Section 10A provides for
exemption of profits derived from export of computer software. The CBDT issued
a Notification No. S.O. 890(E), dated 26th September, 2000 ([2000] 245 ITR (St.) 102) to specify the information technology-enabled products /
services as provided u/s 10A. The Notification is clarificatory in nature and
has been issued to clarify the expression “computer software” used in
Explanation 2(i)(b) of section 10A. The Notification specifies that information
technology-enabled products or services mentioned in the Notification shall be
treated as information technology-enabled products or services for the purposes
of Explanation 2(i)(b) of section 10A, which includes back-office operations
and data processing
as well.

 

ii)    The assessee received back-office work from
the legal department of software companies in the US. These companies assigned
back-office work of registering their technology in the US patent office. The
applications were prepared and finalised and signatures were obtained in the
declaration. For development of work product as patent application, the US
patent application contained drawings and specifications. The drawings were
generated using computer-aided design software and specifications were written
using word processing software. The back-office standard required a level of
control over formulation of the editing of the content of the application which
was possible only with the use of information technology.

 

iii)  The activities of the assessee could be
classified as data processing, legal databases and remote maintenance in terms
of the Notification issued by the CBDT. The assessee was transmitting the
patent application and related data which was stored in electronic form and
therefore, such data was customised data and the assessee was eligible for
deduction u/s 10A. The Appellate Tribunal was justified in holding that the
assessee was entitled to the benefit of deduction u/s 10A.’

TRANSITIONAL CREDIT TUSSLE

India’s
policy-makers introduced the GST law with the objective of removing the
cascading effect of taxes and replacing it with a single value-added tax across
the country. The Statement of Objects and Reasons for the Constitutional (One
Hundred and Twenty Second Amendment) Bill, 2014 and the memorandum introducing
the GST Bill(s) had as their objective a seamless transfer of Input Tax Credit
along the value chain of a product and consequently to reduce the cost of
production and inflation in the economy.

 

Effective
1st July, 2017, the key compliance for a taxpayer was to prepare and
file his Transition Forms (in Form Tran-1 and / or Tran-2).The transition
credit became a critical entry step for taxpayers to avail the benefit of GST
and commence their journey into an idealistic value-added tax system. Many
large enterprises had blocked their working capital in such taxes and were
seeking early utilisation of their credit against their output taxes. Despite
the lack of robust legal and technical support from the regulatory authorities,
most business houses succeeded with the advice of tax practitioners, but there
was a set of businesses (a small percentage of the total GST registrations) who
struggled to perform their transition obligations. The eligibility or
ineligibility of transition credit is not the subject of discussion of this
article – and nobody denies a rightful claimant this transition credit; what is
under debate is the strict time limit imposed by the Revenue authorities in
complying with the transition credit formalities.

 

A
significant number of taxpayers failed to exercise their transitional credit
rights. The reasons were varied and we may categorise the taxpayers into broad
categories of those (a) unaware of the entitlement of transition credit (MSMEs,
rural and semi-urban entities, etc.); (b) aware but clueless about filling up
the transition forms due to lack of appropriate advisers and regulatory
support; (c) facing technical challenges (at their end or at the GSTN portal
end); and (d) those who genuinely missed the bus due to multiple extensions,
the peculiar due date of 27th December, 2017 and so on.

 

Thus,
taxpayers are in a tussle before the Courts to resolve this deadlock where they
are pleading for condonation but the Revenue is contending that 180 days was
sufficient time and no leniency is to be given to taxpayers on this subject.
Revenue also claims that the plea of technical difficulties is a mere alibi and
the sole proof of a genuine attempt to file a transition is the GSTN system log
and nothing else.

 

BACKGROUND TO TRANSITION COMPLIANCE

Section
140 provided for the claim of transition credit under multiple scenarios.
Unlike the time limits prescribed for availing GST Input Tax Credit (ITC) u/s
16, there was a clear absence of any time limit under the primary enactment.
Rule 117 of the CGST Rules notified that the declaration ought to be filed
electronically within 90 days from the appointed date. The proviso provided for an extension by the
Commissioner by another 90 days based on the recommendations of the GST
Council. Accordingly, the initial time limit stood at 28th September,
2017 which was subsequently extended by Order Nos. 3/2017, 7/2017 and 9/2017 to
31st October, 30th November and finally to 27th
December, 2017. In fact, 27th December, 2017 was the last
permissible date for extension of filing Tran-1 under Rule 117 of the CGST
Rules. The said orders were issued by the Commissioner of GST in terms of
powers exercised under Rule 117 read with section 168 of the CGST Act. The
transition forms were disabled on the GSTN portal immediately after (on 28th
December, 2017) and hence taxpayers who could not file their returns were
not permitted to make any electronic submission of their transition data.

 

Apart from
the taxpayers in general, to give effect to Court directions (discussed later),
Rule 117(1A) was introduced which provided case-specific extensions to taxpayers
who proved their bona fides of facing
technical difficulties. The overall time limit of Rule 117(1A) was frequently
extended until 31st March, 2020 and effectively stood extended up to
31st August, 2020 (under the general Covid Notifications).

 

BONE OF CONTENTION

The
primary grievance of taxpayers on the legal front was that the time limit
specified in Rule 117 was beyond the powers delegated to the Central Government
u/s 140 of the CGST Act. The section provided for prescription of rules for the
limited purpose of defining the manner or form in which the declaration u/s 140
was to be made by the taxpayers. The section did not delegate the powers of
fixing or extending time limits for filing the Transition declaration. Revenue,
on the other hand, considered section 164 as empowering them to make rules for
any purpose of the Act. The matter was challenged in multiple High Courts and
contrary rulings have been delivered (discussed later). Revenue authorities
quickly recognised the deficiency in the provisions of section 140 and
introduced a retrospective amendment vide
Finance Act, 2020 empowering the Central Government to validate the time limits
specified in Rule 117. Interestingly, the amendment was brought in to validate
a time limit which had already expired / lost its utility and is certainly
questionable before the Courts.

 

The other
grievance of taxpayers was that the multiple extensions were on account of a
lack of readiness of the GST portal and sufficient time was not provided for
filing the Transition returns. Those taxpayers who had the available data were
facing technical difficulties either with the web portal or the Transition
form. Revenue acknowledged that taxpayers faced technical difficulties and
quickly formed an IT Grievance Redressal Committee (ITGRC) on the directions of
the High Courts of Allahabad and Bombay.

 

Revenue
issued Circular No. 39/13/2018-GST dated 3rd April, 2018 setting up
a committee on the basis of the approval granted by the GST Council vide its 26th  meeting held on 10th March,
2018. The Circular defined a very narrow entry point to approach the ITGRC,
i.e.,

  •    Where
    the taxpayer has made a     bona fide
    attempt to file the Tran return and recorded by the system logs maintained by
    GSTN;
  •    No
    amendment is permissible to the data already available in the GSTN servers and
    ITGRC cannot be used as a forum to revise Transition claim data;
  •    Field
    formations were directed to verify the data and collection of information at
    the time of seeking special permission to open the GSTN portal;
  •    ITGRC
    would approve the opening of the GST portal for the specified taxpayers who met
    the criteria set forth by the ITGRC and established technical difficulties
    conclusively.

 

Seeing
this ray of hope, many taxpayers approached the ITGRC with their grievances and
sought filing of the Tran returns. But much to their disappointed, many
taxpayers failed to meet the stringent criteria set forth by the ITGRC and once
again knocked at the door of the Courts for justice. The following applications
were rejected by the ITGRC:

  •    Lack
    of digital evidence like screenshots, help-desk correspondence, etc.;
  •    Unawareness
    about the due date;
  •    Lack
    of knowledge of computer systems;
  •    Mistakes
    committed while filing online; and
  •    Ignorance
    with the hope that the due date would be extended,
    etc.

 

The tussle
regarding Transition credit is now before several Courts and case-specific
decisions are being delivered on this front to resolve the issue. The decisions
would be clubbed based on the similarities of the issues and the decision
rendered.

 

DIVERGENT VIEWS OF THE COURT

Type 1
decisions: Recognised that transition credit is a
vested right and procedural lapses cannot submerge this right.

In Siddharth Enterprises (2019) (9) TMI 319,
the Gujarat High Court was examining a matter where the taxpayer did not file
the transition return due to technical challenges and challenged the time limit
provisions under Rule 117 as being ultra vires
the statute. The taxpayer argued that the intention of the Government is not to
collect tax twice on the same goods; section 140(3) grants a substantive right
which cannot be curtailed by procedural lapses; right accrued / vested under
the existing law and is saved under GST; right of credit is a constitutional
right; doctrine of legitimate expectation is applicable to such credit. The
Court laid down a very elaborate order and affirmed that credit is due to the
taxpayer in terms of section 140. The key findings of the Court were as
follows:

  •    Credit
    legally accrued under the erstwhile laws is a vested right and cannot be taken
    away by virtue of Rule 117 with retrospective effect on failure to file the
    Transition form. The provision of credit is as good as tax paid and such right
    cannot be offended on failure to file the form;
  •    The
    denial of transition credit is against the policy of avoiding the cascading
    effect of taxes which has been explicitly set out in the Statement of Objects
    and Reasons of the Constitutional Amendment bill;
  •    Section
    16 grants time until September, 2018 to claim the ITC while the transition
    credit has been limited until 27th December, 2017 which is
    discriminatory and without any rationale;
  •    The
    doctrine of legitimate expectation mandates that a person would have a
    legitimate expectation to be treated by any administrative authority in a
    particular manner based on the representations or promises made by such
    authority. The vested right of ITC cannot be withdrawn after compliance of
    conditions under the erstwhile laws;
  •    Input
    Tax Credit is a property right in terms of Article 300A and cannot be denied on
    procedural lapses.

 

These
views were subsequently adopted in Heritage
Lifestyles & Developers Private Limited (2020) (11) TMI 236 wherein
the coordinate bench of the Bombay High Court observed the divergent decision
of NELCO (discussed below) and yet held
that the substantive right of credit cannot be denied on procedural grounds and
technicalities cannot hinder substantial justice.

 

Type 2
decisions: Input Tax Credit is a concession and not
a right and hence prescription under rule 117 is valid law which mandates
strict compliance.

In NELCO Ltd. (2020) (3) TMI 1087, the
Bombay High Court examined the challenge to the time limit under Rule 117. The
taxpayer had attempted filing the Transition return, submitted their browsing
history and communicated their grievance via email multiple times but failed to
receive a suitable response. The line of argument adopted in this case was more
on the vires of Rule 117 and the phrase
‘technical difficulties’ in 117(1A). The taxpayer contended that the said
phrase would refer to difficulties both at the taxpayer’s end as well as the
GSTN end. Revenue contended that presumption of legality of law and subordinate
legislation cannot be negated until it is arbitrary or unreasonable. Section
164(2) has granted a general rule-making authority to the Government for the
implementation of the Act which includes, amongst others, the right to specify
the time limit for filing of transition declarations. The Court finally upheld
Revenue’s contentions as follows:

 

  •    Section
    164 grants rule-making powers of the widest amplitude and is sufficient to
    validate Rule 117. It does not rule contrary to the parent enactment. Once the
    rule is held to be valid, the time limit prescribed therein     operates strictly;
  •    Rule
    117(1A) has been inserted to address genuine technical difficulties and
    provides for a uniform and technically capable criterion for ascertaining the
    claim and the taxpayer should follow this process;
  •    Input
    Tax Credit being a concession should be utilised in a time-bound manner;
  •    ‘Technical
    difficulty’ should be understood as those at the GSTN server-end and not
    elsewhere. When multiple taxpayers succeeded in filing the form, there was no
    reason for citing technical reasons for non-filing. The system log is an
    unquestionable criterion for ascertaining the genuineness of the claim of
    technical difficulty and the absence of such a criterion may make the
    examination subjective.

 

These
views were subsequently followed in P.R.
Mani Electronics (2020) (7) TMI 443.

 

Type 3
decisions: Recognised technical glitches at the
taxpayer’s end and granted a time limit of three years from introduction of GST
to claim the transition credit.

In Brand Equity (2020) (7) TMI 443 which
included many other matters as a batch, the claim of transition credit could
not be complied with due to various reasons (such as a genuine lapse, system
error, preoccupation, etc.). In such cases, taxpayers admittedly did not have
any evidence of a GSTN error and Courts were examining the cases on meritorious
grounds rather than technical grounds. Taxpayers argued that GST being a new
levy suffering from technical glitches, the procedures should be applied
liberally. The Courts observed as follows:

 

  •    Evidently,
    the GSTN portal was riddled with shortcomings and inadequacies. The online
    portal should be able to perform all functions of the law with all
    flexibilities / options. The Government cannot be insensitive to the
    difficulties faced by trade;
  •    Credit
    duly accumulated under the erstwhile laws are vested rights and in the absence
    of a mechanism to claim refund under the said laws, taxpayers rightly entitled
    to migrate this credit into GST;
  •    There
    is nothing sacrosanct in the time limit of 90 days since it has been extended
    multiple times on account of an inefficient network. The Act does not specify a
    strict time limit for claiming the transition credit;
  •    The
    classification of extending the time limit to specified taxpayers faced
    challenges at the GSTN and not extending to taxpayers in general is arbitrary
    without reasonable basis;
  •    Government
    cannot adopt different standards for itself and for the taxpayers when both
    were facing technical issues at their respective ends;
  •    Taxpayers
    cannot be robbed of their vested rights within 90 days when civil laws grant
    the right for three years;
  •  Rule 117 is directory and cannot
    take away a substantive right. The phrase ‘in the manner prescribed’ can be
    prescription of the form and the content but not the time limit;
  •    But
    it is also not permissible to claim this transition credit as being a perpetual
    right and as a guiding principle subject to the civil law limitation of three
    years. Accordingly, all transition credit claims until June, 2020 would be
    valid in law. Government has been directed to open the portal in order to
    implement this decision.

 

The said
decision was a breakthrough for the taxpayers struggling to seek admittance of
their transition credit claims. The decision cut across all arguments of
technicalities, etc., and addresses the root point that vested rights ought to
be granted and time limit cannot be a garb for denial of such rights.

 

Type 4
decisions: Recognised that GSTN
had technical difficulties and taxpayers ought to be granted an opportunity to
file the transition returns.

In Tara Exports (2020) (7) TMI 443, the
taxpayer pleaded that there was an attempt to file the Tran-1 online but faced
technical difficulties due to which a manual Tran-1 was filed within one month
of the expiry of the due date. It was contended that GST is in a ‘trial and
error phase’ and inefficiencies of the system cannot debar the claim of credit.
Other arguments on vested right and procedural lapses were also adopted. The
Court recognised that GST was a progressive levy with several technical
glitches in the early stages. Credit which was legitimately accrued to the
taxpayers ought not to be denied on such grounds. Filing of transition return
was procedural in nature and the substantive right of credit should prevail
over procedural lapses. The Court held that since genuine efforts were made by
the taxpayer and evident from records, Revenue was directed to allow the
transition credit. These views were echoed in multiple decisions that followed.

Type 5
decisions: Recognised that GSTN
was underprepared and taxpayers need not submit proof of technical
difficulties.

In Garuda Packaging Pvt. Ltd. (2019) (10) TMI 556 and Kun United Motors Pvt. Ltd. (2020) (9) TMI 251,
the taxpayers made an attempt to file the return online but faced portal
challenges. The taxpayers filed a letter one year later about their inability
to file Tran-1 but the application was rejected by the ITGRC on the ground that
no such record was available. The taxpayers submitted letters of the details of
eligible credit since they were unable to file the transition form and made
multiple personal visits to the range offices. The High Court held that
non-filing of screenshots cannot be a ground to reject the plea of technical
difficulties. The GST system being still in a trial and error phase, it will be
too much of a burden to expect the taxpayer to comply with the requirements of
the law where they are unable to even connect to the system on account of
network failures or other failures. The Court finally directed the Revenue to
re-open the portal and enable filing of the Tran-1 return. These views were
relied upon in several decisions which followed later.

 

POSITION OF THE TAXPAYER

The taxpayer is now in a slightly tricky position with divergent views
from multiple High Courts across the nation. The Bombay High Court in NELCO applies the time limitation very strictly and denies credit to
non-vigilant taxpayers but also agrees that taxpayers who have evidence to
substantiate the technical difficulties at the GSTN portal end are permitted to
apply to the ITGRC for re-opening of the portal for claim of credit. The vast
majority of Courts have taken a liberal view on account of the early stage of
the GST law and permitted the transition credit as a substantive right of the
taxpayers. Of course the above decisions would be subject to challenge from
either side before the Supreme Court and the last word on this is awaited. The
taxpayers until then would have to await the outcome and make suitable
provisions / contingencies in the financial statements in case of any
unforeseen decision. The following Table can be a guiding factor for
ascertaining the contingency levels:

 

 

Type of
assesse

Grounds
for claim

Unaware
of entitlement as on 27th December, 2017

Substantive
right and plead condonation of compliance

Attempted
logging onto system but lack proof and made alternative claims within 27th
December, 2017

Substantive
right claimed within time and plead procedural deviation of filing on common
portal

Attempted
logging / filing onto system but lack proof and made alternative claims after
27th December, 2017 – no evidence in form of screenshots

Substantive
right claimed within time and plead genuine attempt but admit lack of proof.
Rely on High Court decisions as above

Attempted
filing onto system but lack proof and made alternative claims after 27th
December, 2017 – possess evidence in form of screenshots

Same
as above but strong case despite NELCO

Successfully
filed but short claimed transition credit in the form

Same
as above

Reported
the data but in wrong data field

Same
as above

 

 

The objective behind the
GST revolution was certainly commendable and generated euphoria in the country.
There was high expectation from the regulatory authorities of a smooth
transition and handholding of the business enterprises into this tectonic
change in the indirect taxation systems in India. Naturally, the size and
complexity of the Indian economy placed a challenge before the regulatory
authorities to educate and empower small, medium and large business houses.
Help desks / grievance centres were expected to be well in place before the
opening bell – but unfortunately it was the litigation floodgates that were
opened.

 

This
tussle is far from closure and the divergent views of Courts are certainly
subject to the decision of the Supreme Court. It is hoped that the Apex Court
views the spirit of the law and also appreciates the genuine difficulties
prevailing at the time of introduction of GST on the technical front. Apart
from pure interpretation of law, it would also be important to appreciate the
economics of the subsumation of erstwhile laws and transition into a single
consolidated value-added tax regime. If the new law is not implemented in the
spirit of the VAT system, a critical objective of this change would be diluted.
One may view this tussle as prolonged but it also reminds taxpayers to be
vigilant and cautious in complying with the law promptly.

Dividend – Deemed dividend – Section 2(22)(e) – Sum shown as unsecured loan obtained by assessee firm from company in which one partner shareholder – Nature of transaction – Deferred liability – Assessee not shareholder of lender company – Loan not assessable as deemed dividend in hands of assessee

29. CIT vs. T. Abdul Wahid and Co. [2020]
428 ITR 456 (Mad.) Date
of order: 21st September, 2020 A.Ys.: 2005-06 and 2006-07

 

Dividend
– Deemed dividend – Section 2(22)(e) – Sum shown as unsecured loan obtained by
assessee firm from company in which one partner shareholder – Nature of
transaction – Deferred liability – Assessee not shareholder of lender company –
Loan not assessable as deemed dividend in hands of assessee

 

One of the
partners of the assessee firm with a 35% stake in the assessee was also a
shareholder in a company with 26.25% shareholding in it. A sum of Rs. 2 crores
was shown as unsecured loan obtained from the company by the assessee. For the
A.Ys. 2012-13 and 2014-15, the A.O. considered this sum as deemed dividend
attracting the provisions of section 2(22)(e).

 

The
Tribunal held that the deemed dividend u/s 2(22)(e) was to be assessed in the
hands of the shareholder and not in the hands of the assessee firm and allowed
the appeals filed by the assessee.

 

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

 

‘i)    Section 2(22)(e) would stand attracted when
a payment is made by a company in which public are not substantially interested
by way of advance or loan to a shareholder being a person who is the beneficial
owner of the shares.

 

ii)    On the facts it is clear that the payment
has been made to the assessee, a partnership firm. The partnership firm is not
a shareholder in the company. If such is the factual position, the decision in
the case of National Travel Services
relied on by the Revenue cannot be applied, nor can the case of Gopal and Sons, as they are factually
distinguishable. The records placed before the A.O. clearly show the nature of
the transaction between the firm and the company and it is neither a loan nor
an advance, but a deferred liability. These facts have been noted by the A.O.
In such circumstances, this Court is of the view that the Tribunal rightly
reversed the order passed by the Commissioner of Income-tax (Appeals) affirming
the order of the A.O.

 

iii)   For the above reasons, we find no grounds to
interfere with the order passed by the Tribunal and, accordingly, dismiss the
present appeals and answer the substantial question of law against the
Revenue.’

 

Depreciation – Section 32 – Rate of depreciation – Assessee running a hotel – Additional floor space index granted – Not an intangible right – Consideration for additional floor space index payable in instalments – One instalment paid and entire amount debited in accounts – Assessee entitled to depreciation on entire amount at rate applicable to buildings

28. Principal CIT vs. V. Hotels Ltd. [2020]
429 ITR 54 (Bom.) Date
of order: 21st September, 2020 A.Y.: 2006-07

 

Depreciation
– Section 32 – Rate of depreciation – Assessee running a hotel – Additional
floor space index granted – Not an intangible right – Consideration for additional
floor space index payable in instalments – One instalment paid and entire
amount debited in accounts – Assessee entitled to depreciation on entire amount
at rate applicable to buildings

 

The
assessee was running a hotel. For the A.Y. 2006-07 the assessee claimed
depreciation of Rs. 63,90,248 on floor space index; on an opening written down
value of Rs. 2,55,60,990 depreciation at 25% was claimed. The A.O. rejected the
claim of the assessee and added back the sum to the total income of the
assessee. He took the view that grant of floor space index was not in the
nature of any asset but only a payment made to the Government for increasing
the size of the building.

 

The
Commissioner (Appeals) held that the amount spent was for the purpose of
business and being of enduring nature, it would add value to the existing
building as additional floor space index would enable the company to add more
floors over and above the existing structure. Since it related to the building
block of assets, the overall cost of the building block would increase by this
amount. Accordingly, the A.O. was directed to add the amount spent during the
year, i. e., Rs. 68,16,264, to the building block of assets and allow
depreciation as per law. The Tribunal held that on payment of the first
instalment, rights in the form of additional floor space index were capitalised
in the books of accounts. The Tribunal held that the assessee would be entitled
to depreciation at 10% on the whole of the consideration towards floor space
index and not at 25%.

 

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

 

‘Floor
space index relates to the right to construct additional floor to the assessee
which enhances the value or cost of the existing building. It strictly pertains
to addition to the building and therefore depreciation allowable would be at
the rate applicable to buildings and not to intangible rights u/s 32(1)(ii).’

Deduction of tax at source – Section 190 – Liability to deduct tax at source only if there is income – Reimbursement of expenses – No income arises – Tax not deductible at source

27. Zephyr Biomedicals vs. JCIT [2020]
428 ITR 398 (Bom.) Date of order: 7th October, 2020

 

Deduction
of tax at source – Section 190 – Liability to deduct tax at source only if
there is income – Reimbursement of expenses – No income arises – Tax not
deductible at source

 

In the
appeal by the assessee before the Bombay High Court against the order of the
Tribunal the following question of law was raised:

 

‘Whether
on the facts and in the circumstances of the case, the Hon’ble Tribunal was
right in law in holding that the appellant is liable to deduct tax at source
u/s 194C on the payments made to clearing and forwarding agents which is
outright reimbursement of freight charges having no element of profit?’

 

The Bombay
High Court held as under:

 

‘i)    Income-tax is a tax payable in respect of
the “total income” of the previous year of every person. Further, such
Income-tax shall have to be deducted at source or paid in advance, where it is
so deductible or payable under any of the provisions of the Income-tax Act,
1961.

 

ii)    From this it follows that unless the paid
amount has any “income element” in it, there will arise no liability to pay any
Income-tax upon such amount. Further, in such a situation there will also arise
no liability of any deduction of tax at source upon such amount.

 

iii)   Again, the liability to deduct or collect
Income-tax at source is upon “such income” as referred to in section 190(1).
The expression “such income” would ordinarily relate to any amount which has an
“income element” in it and not otherwise.’

 

 

Capital gains – Sections 45 and 50C – Computation – Law applicable – Amendment of section 50C w.e.f. 1st April, 2017 – Amendment retrospective

26. CIT vs. Vummudi Amarendran [2020]
429 ITR 97 (Mad.) Date
of order: 28th September, 2020 A.Y.:
2014-15

 

Capital
gains – Sections 45 and 50C – Computation – Law applicable – Amendment of
section 50C w.e.f. 1st April, 2017 – Amendment retrospective

 

The
assessee owned 44,462 sq. ft. of land and entered into an agreement for sale on
4th August, 2012 to sell the land for a total sale consideration of
Rs. 19 crores. He received a sum of Rs. 6 crores as advance consideration by
cheque payment from the purchaser. The sale deed was registered on 2nd
May, 2013. The A.O. found that on the date of execution and registration of the
sale deed, i.e., on 2nd May, 2013, the guideline value of the
property as fixed by the State Government was Rs. 27 crores. Applying the
provisions of section 50C, the A.O. adopted the full value of consideration at
Rs. 27 crores and recomputed the capital gains and raised a tax demand.

 

The case
of the assessee was that the guideline value on the date of the agreement i.e.,
4th August, 2012 should be taken as per proviso
to section 50C(1). The Commissioner (Appeals) and the Tribunal accepted the
assessee’s claim.

 

In appeal
by the Revenue, the following questions of law were raised:

 

‘(1)
Whether on the facts and in the circumstances of the case, the Tribunal was
right in holding that the amendment to section 50C which was introduced with
effect from A.Y. 2017-18 prospectively was applicable retrospectively from the
A.Y. 2014-15 when the language used in the proviso
does not indicate that it was inserted as a clarification?

 

(2) Is not
the reasoning and finding of the Tribunal bad by holding that the prospective
amendment to provisions of section 50C for the A.Y. 2017-18 are applicable
retrospectively to A.Y. 2014-15 without appreciating the fact that unless
explicitly stated a piece of legislation is presumed not to be intended to have
retrospective operation based on the principle lex
prospicit non respicit, meaning that the law looks
forward and not backwards?’

 

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

 

‘i) Once a
statutory amendment is made to remove an undue hardship to the assessee or to
remove an apparent incongruity, such an amendment has to be treated as
effective from the date on which the law, containing such an undue hardship or
incongruity, was introduced.

 

ii) The proviso to section 50C(1) deals with
cases where the date of the agreement, fixing the amount of consideration, and
the date of registration for the transfer of the capital assets are not the
same and states that the value adopted or assessed or assessable by the stamp
valuation authority on the date of agreement may be taken for the purposes of
computing full value of consideration for such transfer. The amendment by
insertion of the proviso seeks to
relieve the assessee from undue hardship.

 

iii) The Commissioner
(Appeals) and the Tribunal were justified in setting aside the order of the
A.O.’

 

Capital gains – Computation of capital gains – Cost of acquisition – Section 115AC – Conversion of foreign currency convertible bonds into equity shares – Subsequent sale of such shares – Cost of acquisition of shares to be calculated in terms of Issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993

25. DIT (International Taxation) vs. Intel Capital (Cayman) Corporation [2020]
429 ITR 45 (Kar.) Date
of order: 6th October, 2020 A.Y.: 2008-09

 

Capital
gains – Computation of capital gains – Cost of acquisition – Section 115AC –
Conversion of foreign currency convertible bonds into equity shares –
Subsequent sale of such shares – Cost of acquisition of shares to be calculated
in terms of Issue of Foreign Currency Convertible Bonds and Ordinary Shares
(through Depository Receipt Mechanism) Scheme, 1993

 

The
assessee was a non-resident company. It filed its return of income for the A.Y.
2008-09. The A.O. held that the assessee had acquired foreign currency
convertible bonds and after conversion thereof into shares, sold the shares
during the previous year relevant to the A.Y. 2009-10 and disclosed short-term
capital gains from the transaction and paid tax thereon at the prescribed rate.
He further held that the cost of acquisition of equity shares on conversion of
foreign currency convertible bonds was shown to be at Rs. 873.83 and Rs. 858.08
per share whereas in fact the assessee converted the bonds into shares at Rs.
200 per share. The A.O. therefore concluded that the cost of acquisition of
shares had to be assessed at Rs. 200 per share and not at Rs.873.83 and Rs.
858.08 per share as claimed by the assessee and completed the assessment.

 

This was
upheld by the Commissioner (Appeals). The Tribunal held that u/s 115AC the
Central Government had formed the Issue of Foreign Currency Convertible Bonds
and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993
permitting some companies to issue foreign currency convertible bonds which
could at any point of time be converted into equity shares. It further held
that the subscription agreement was approved by the Reserve Bank of India, the
regulatory body, and under the terms and conditions for the issuance of foreign
currency convertible bonds between the NIIT and the assessee, the bonds were to
be initially converted into shares at Rs. 200 per share subject to adjustments
under clause 6(c) of the agreement. Therefore, the assessee was rightly
allotted 21,28,000 shares at the rate of Rs. 200 in accordance with the bond
agreement at the prevalent convertible foreign currency rate. Accordingly, the
orders passed by the Commissioner (Appeals) and the A.O. were set aside and the
appeal preferred by the assessee was allowed.

 

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

 

‘i)    The Central Government made the Issue of
Foreign Currency Convertible Bonds and Ordinary Shares (through Depository
Receipt Mechanism) Scheme, 1993 applicable for the assessment year 2002-03
onwards by Notification dated 10th September, 2002 ([1994] 208 ITR [St.] 82). Clause
2(f) of the Scheme provides that the words and expressions not defined in the
Scheme but defined in the Income-tax Act, 1961 or the Companies Act, 1956 or
the Securities and Exchange Board of India Act, 1992 or the Rules and
Regulations framed under these Acts, shall have the meanings respectively
assigned to them, as the case may be, in those Acts. Clause 7 of the Scheme
deals with transfer and detention. Thus, the cost of acquisition has to be
determined in accordance with the provisions of clause 7(4) of the Scheme for
computation of capital gains. Clause (xa) of section 47 of the Income-tax Act,
1961, which refers to transfer by way of conversion of bonds, was inserted with
effect from 1st April, 2008 and is applicable to the A.Y. 2009-10
onwards. There is no conflict between the provisions of the Scheme and the
Income-tax Act or the Income-tax Rules.

 

ii)   The bonds were issued under the 1993 Scheme
and the conversion price was determined on the basis of the price of shares at
the Bombay Stock Exchange or the National Stock Exchange on the date of
conversion of the foreign currency convertible bonds into shares. The
computation of capital gains by the assessee was right.’

Business expenditure – Service charges paid to employees in terms of agreement entered into under Industrial Disputes Act – Evidence of payment furnished – Amount deductible

24. New Woodlands Hotel Pvt. Ltd. vs. ACIT [2020]
428 ITR 492 (Mad.) Date
of order: 4th September, 2020  A.Ys.:
2013-14 and 2014-15

 

Business
expenditure – Service charges paid to employees in terms of agreement entered
into under Industrial Disputes Act – Evidence of payment furnished – Amount
deductible

 

The
assessee is in the hotel business. For the A.Ys. 2013-14 and 2014-15 it claimed
deduction of amounts paid as service charges to its employees. The explanation
was that tips were being given to the room boys and they alone were benefited
and the other employees and workers raised objections; the matter was discussed
in several meetings and ultimately a settlement was arrived at between the
employees’ union and the assessee’s management. The A.O. rejected this claim.

 

The
Commissioner (Appeals) allowed it partially. The Tribunal dismissed the appeals
filed by the assessee and allowed the appeals filed by the Revenue.

 

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

 

‘i)    The A.O. while rejecting the assessee’s
contention had not disbelieved any of the documents submitted by the assessee.
The payments effected in cash were sought to be substantiated by the assessee
by producing vouchers. Due credence should be given to the memorandum of
settlement dated 2nd August, 2012 recorded in the presence of the
Labour Officer. The settlement could not have been brushed aside. The register
of wages of persons employed was a statutory form under the Payment of Wages
Act and there was a presumption to its validity. The bulk of the materials
produced by the assessee before the A.O. could not have been rejected.

ii)    The A.O., going merely by the statements of
a few employees, could not have disbelieved statutory registers and forms as
there was a presumption to their validity and the onus was on the person who
disputed their validity or genuineness to prove that the documents were bogus.

 

iii)   The Tribunal ought not to have interfered
with the relief granted by the Commissioner (Appeals) and the Commissioner
(Appeals) ought to have interfered with the orders passed by the A.O. in their
entirety and not restricted the same to a partial relief.’

Section 9(1)(vii) – Scope of FTS service includes professional service – Independent Personal Service (IPS) Article of DTAA – Professional services are taxable in resident state if service provider is person specified in IPS Article of DTAA and satisfies exemption conditions – Services are taxable in source state if service provider is not person specified in IPS Article – Benefit of non-taxation in absence of PE under Article 7 is not available

8. [2020] 121 taxmann.com 189 (Del.)(Trib.) Hariharan Subramaniam vs. ACIT ITA No.: 7418/Del/2018 A.Y: 2015-16 Date of order: 6th
November, 2020

 

Section
9(1)(vii) – Scope of FTS service includes professional service – Independent
Personal Service (IPS) Article of DTAA – Professional services are taxable in
resident state if service provider is person specified in IPS Article of DTAA
and satisfies exemption conditions – Services are taxable in source state if
service provider is not person specified in IPS Article – Benefit of non-taxation
in absence of PE under Article 7 is not available

 

FACTS

The
assessee is an advocate practising in the field of intellectual properties law.
It obtained the services of foreign legal professionals who were individuals,
law firms and companies for filing of various patent applications in foreign
countries. Payment was made without deduction of taxes. Therefore, the A.O.
disallowed payment u/s 40(a)(ia). On appeal, the CIT(A) upheld the order of the
A.O.

 

Before the
Tribunal the assessee contended that (a) services are professional in nature
and are not in the nature of managerial, technical or consultancy services to
fall within section 9(1)(vii); reliance was placed on section 194J to contend
that the Act consciously differentiates professional services and FTS; and (b)
under the DTAA, services falls within the Independent Personal Services (IPS)
article and unless the specified conditions are satisfied, exclusive taxing
right is with the resident state.

 

HELD

Scope
of FTS u/s 9(1)(vii)

  •   Professional services fall
    within the ambit of FTS.
  •   Section 194J is applicable
    to payments made to a resident. The distinction between professional services
    and FTS in section 194J has no relevance to determination of taxability of a
    non-resident.
  •   Section 9 includes income
    which is deemed to accrue or arise in India. It enlarges the scope for
    taxability of non-resident income.

 

Scope
of IPS article under DTAA

  •   Services falls within the
    IPS article of the DTAA. Payment will not be taxable in India if (a) the NR
    does not have fixed base in India, and (b) NR is not present in India for a
    specified number of days (exemption conditions).

 

Service
provider is specified person as per IPS Article1

  •   Services will not be
    taxable in India if the service provider satisfies exemption condition and he
    is a specified person as provided under the IPS article of the respective treaty.
    The treaties vary in terms of scope and applicability of persons to whom the
    IPS articles apply.
  •   Matter remanded to A.O. for
    verification of treaty residence and satisfaction of exemption conditions.

 

Service
provider is not specified person as per IPS Article2

  •   Service provider will not
    be entitled to benefit of the IPS Article under the DTAA.
  •   The Tribunal rejected the assessee’s argument
    of non-taxation of business profit in the absence of PE as in the view of the
    Tribunal, the DTAA has classified service recipient in two separate categories,
    viz., Article 7 and Article 15, for taxability of two types of income streams.
  •   Income continues to be professional service
    but does not satisfy the exemption condition of the IPS Article resulting in
    taxation in the source state.

 

Note: The decision has not dealt with the interplay of the FTS Article
with the IPS Article.

_________________________________________________________________________________________________

1   DTAA with countries Brazil, China, Czech
Republic, Japan, Philippines, Thailand and Vietnam covers within its scope
individual, company, partnership firm; DTAA with Australia covers individual,
partnership firm (other than company); DTAA with Korea covers only individuals

2   Norway, Denmark, Sri Lanka, Malaysia, Russia,
Luxembourg, Australia, Republic of Korea, South Africa, New Zealand, Mexico,
Indonesia, Colombia and Serbia cover only individuals. Other categories of taxpayers are not covered

 

Articles 11 and 7, India-Germany DTAA – Once entire interest was taxed on gross basis under Article 11, no taxation survived in respect of subsidiary and incident commitment fees and agency fees under article 7 as PE income even assuming the foreign bank had office which supported earning of such interest income – Once tax liability is discharged in respect of interest income under Article 11, the taxpayer is relieved of obligation to file ROI in terms of Article 11 read with section 115A(5)

 7. [2020] 122 taxmann.com 65 (Mum.)(Trib.) DZ Bank AG – India Representative Office vs. DCIT ITA No.: 1815 (Mum.) of 2018 A.Y.: 2014-15 Date of order: 4th
December, 2020

 

Articles 11 and 7, 
India-Germany DTAA  –  Once entire interest was taxed on gross basis
under Article 11, no taxation survived in respect of subsidiary and incident
commitment fees and agency fees under article 7 as PE income even assuming the
foreign bank had office which supported earning of such interest income – Once
tax liability is discharged in respect of interest income under Article 11, the
taxpayer is relieved of obligation to file ROI in terms of Article 11 read with
section 115A(5)

 

FACTS

The
assessee was a German banking company. It had set up a representative office
(‘RO’) in India after obtaining approval of the RBI, subject to the conditions
that: the RO will function only as a liaison office; it will not undertake
banking business; and all expenses of the RO will be met out of inward
remittances from the head office (‘HO’). The assessee had filed its return of
income in the name of the RO (apparently treating the RO and the HO as separate
entities) disclosing Nil income.

 

The A.O.
noticed that during the relevant previous year, the HO had provided foreign
currency loans to Indian companies from which payers had withheld tax. As
regards filing of returns, the assessee explained that as per section 115A(5)
of the Act a foreign company is exempt from furnishing return of income in
India if it only earns interest from foreign currency loans provided to Indian
companies. The A.O. asked the assessee to show cause why the RO should not be
considered as the PE of the HO in India and why interest and any other income
earned by the HO from operations in India should not be taxed @ 40%.

 

The
assessee argued that the RO did not constitute a PE of the HO under the basic
rule as no business activities were carried out from the RO. At best, the RO
was a fixed place of business engaged in ‘any
activity of preparatory or auxiliary character’, which
was excluded from the definition of PE, Article 5(4) of the India-Germany DTAA.
Besides, the RO cannot be said to be a dependent agent PE (‘DAPE’) as it had no
authority to conclude contracts on behalf of the HO or its other branches.

 

However,
after noting the activities undertaken by the RO on behalf of the HO, the A.O.
concluded that the business transactions of the HO with Indian clients could
not have been completed without the involvement of the RO. Thus, there was a
real relation between income-earning activity carried on by the assessee and
the activities of the RO which directly or indirectly contributed to earning of
income by the assessee. Therefore, income should be deemed to accrue / arise to
the assessee from ‘business connection’ in India.

 

Further,
‘auxiliary’ means helping, assisting or supporting the main activity.
Therefore, the issue was whether activities carried on by the RO only supported
the main business. Even if some functions of the RO might have been auxiliary,
the RO played a significant part in the lending business of the assessee in
India which could not be said to be auxiliary activity. Hence, the RO was a PE
of the assessee and profits attributable to the PE were deemed to accrue or
arise to the assessee.

 

The A.O.,
accordingly, taxed the entire interest income, commitment fees and agency fees
as income of the assessee as PE income on net basis, after allowing deduction
of expenses of the RO instead of gross basis of taxation suffered by the HO
under Article 11.

 

HELD

As
regards HO and RO being separate taxable entities under the Act

  •   The entire proceedings by
    the A.O. were on the premise that the HO and the RO were two distinct taxable
    entities. However, under the Act the taxable unit is a foreign company and not
    its branch or PE in India. The profit attributable to the PE is taxable in the
    hands of the HO. In     CIT vs. Hyundai Heavy
    Industries Co. Ltd. [(2007) 291 ITR 482 (SC)],     the
    Supreme Court observed that     ‘it is clear that under the
    Act a taxable unit is a foreign company and not its branch or PE in India’.
  •   The assessee filed the return
    in the name of the RO excluding interest received by the HO. Tax on interest
    was withheld and paid by payers under Article 11 of the India-Germany DTAA.
    Hence, there was no loss of revenue from such error. Further, the Department
    had also not objected. Hence, to avoid inconvenience to the assessee, a
    pragmatic view required to be adopted.

 

As regards taxability under Article 11 vis-à-vis Article
7

  •   Interest is taxable on
    gross basis under Article 11. It may be taxed on net basis under Article 7 if exception
    in Article 11(5) is triggered upon two conditions being fulfilled, namely, (a)
    the HO carries on business in the source state through a PE, and (ii) debt
    claim in respect of which interest was paid is effectively connected with such
    PE.
  •   There is a subtle
    distinction between     carrying on business
    of banking     vis-a-vis carrying on activities which
    contribute directly or indirectly to earning of income     from the business of banking.
  •   Even if an assessee
    maintains a fixed place of business, and even if there is a real relation
    between the business carried on by the assessee and the activities of the RO
    which directly or indirectly contribute to earning income, as observed by the
    A.O., that relationship     per se will
    not make that place a PE or activities taxable in India, if that place is so
    maintained solely for the purpose of the activity of preparatory or auxiliary
    character.

 

As
regards A.O. seeking to tax under Article 7

  •   The A.O. sought to tax
    income on net basis under Article 7. This income was already taxed on gross
    basis under Article 11.
  •   Further, the conditions
    stipulated for triggering the exception under article 11(5) for taxing interest
    under Article 7 on net basis were also not satisfied.
  •   Whether or not there was a
    PE, the debt claim in question could not be said to be effectively connected to
    the alleged PE. Therefore, exclusion of Article 11(5) could not have been
    triggered. Consequently, taxability under Article 7 could not have come into
    play.

 

As
regards ALP adjustment for service by the RO to the HO

  •   If the representative
    office of a foreign enterprise performs certain activities, suitable ALP
    adjustment for such activities could be in order.
  •   Even if RBI restricts the
    representative office of a foreign enterprise from transacting any banking
    business, such representative office does carry on economic activities. Hence,
    ALP adjustment for the same could be made.
  •   Once the entire revenue
    earned in India is taxed on gross basis under Article 11, no income survives
    for taxation under Article 7. In such a case, making any ALP adjustment will
    result in taxing previously taxed income. It will also result in taxable income
    being more than revenue in India.

 

As regards taxability of commitment fee and agency fee

  •   Commitment fee and agency
    fee were paid in connection with loan guarantee. Accordingly, they were not
    taxable under Article 11(3)(b) of the India-Germany DTAA.
  •   In Hindalco Industries Ltd.vs. ACIT [(2005) 94 ITD 242 (Mum.)],
    the Tribunal noted that     ‘…when principal transaction
    is such that it does not generally give rise to taxability in the source
    country, the transaction subsidiary and integral to such a transaction also
    does not give rise to taxability in the source country. In other words, the
    subsidiary and integral transactions have to take colour from the principal
    transaction itself and are not to be viewed in isolation’.
  •   Commitment charges and
    agency fees were, in fact, an integral part of the loan arrangements. They were
    relatable to the same loan and were part of consideration for the same loan. If
    the principal transaction (i.e., interest) did not result in taxable income in
    India, the subsidiary transaction (i.e., commitment fees and agency fees) could
    not result in taxable income in India.

 

As
regards filing return in India

  •   On the facts and in the circumstances of this
    case and in law, the assessee had no income other than interest from its
    clients in India.
  •   Tax liability on interest was already
    discharged under Article 11. Hence, the assessee had no obligation to file
    return of income under section 115A(5) of the Act.

 

Section 50 – Expenditure incurred on account of stamp duty, registration charges and society transfer fees, as per the contractual terms, is an allowable expenditure u/s 50(1)(i)

11. DCIT vs. B.E. Billimoria & Co. Ltd. Saktijit Dey (J.M.) and Manoj Kumar
Aggarwal (A.M.) ITA No.: 3019/Mum/2019 A.Y.: 2015-16 Date of order: 11th November,
2020 Counsel for Assessee / Revenue: Satish Modi / Oommen Tharian

 

Section
50 – Expenditure incurred on account of stamp duty, registration charges and
society transfer fees, as per the contractual terms, is an allowable
expenditure u/s 50(1)(i)

 

FACTS

For the assessment year under consideration, in the course
of assessment proceedings the A.O. noticed that the assessee sold an office
premises vide agreement dated 31st March, 2015 for a consideration of Rs.
19 crores and offered short-term capital gains of Rs. 11.49 crores. However,
since the stamp duty value of the premises was Rs. 20.59 crores, the A.O.,
invoking the provisions of section 50C, added the differential amount of Rs.
1.59 crores to the income of the assessee.

 

Aggrieved, the assessee preferred an appeal to the CIT(A)
where, in the course of the appellate proceedings, the assessee drew the
attention of the CIT(A) to the fact that it incurred aggregate expenditure of
Rs. 160.26 lakhs on account of stamp duty, registration charges and society
transfer fees as per the contractual terms which was an allowable expenditure
u/s 50(1)(i). The said claim was restricted to Rs. 159.23 lakhs, i.e., to the
extent of difference in stamp duty value and actual sale consideration.
Therefore,it was submitted that there was no justification for the addition of
Rs. 159.23 lakhs. The CIT(A), concurring with this, directed the A.O. to delete
this addition.

 

HELD

The
Tribunal upon due consideration of the issue found no reason to interfere in
the impugned order in any manner. It held that the expenditure incurred by the
assessee on transfer of property was an allowable expenditure while computing
short-term capital gains and the same has rightly been allowed by the CIT(A).
The appeal filed by the assessee was allowed.

 

Section 244A – Refund is to be adjusted against the correct amount of interest payable thereof to be computed as per the directions of the CIT(A) and only the balance amount is to be adjusted against tax paid. Accordingly, unpaid amount is the tax component and therefore the assessee would be entitled for claiming interest on the tax component remaining unpaid. This would not amount to granting interest on interest

10. Grasim Industries Ltd. vs. DCIT and DCIT
vs. Grasim Industries Ltd. C.N. Prasad (J.M.) and M. Balaganesh
(A.M.) ITA Nos.: 473/Mum/2016 and 474/Mum/2016;
1120/Mum/2016; and 1121/Mum/2016 A.Ys.: 2007-08 and 2008-09 Date of order: 11th November,
2020 Counsel for Assessee / Revenue: Yogesh Thar /  V. Vinodkumar

 

Section
244A – Refund is to be adjusted against the correct amount of interest payable
thereof to be computed as per the directions of the CIT(A) and only the balance
amount is to be adjusted against tax paid. Accordingly, unpaid amount is the
tax component and therefore the assessee would be entitled for claiming
interest on the tax component remaining unpaid. This would not amount to
granting interest on interest

 

FACTS

The
only issue to be decided in this set of cross-appeals filed by the assessee and
the Revenue was about calculation of interest u/s 244A. The Tribunal, vide its common order for the A.Ys. 2006-07,
2007-08 and 2008-09 dated 19th June, 2013, passed an order granting
relief to the assessee with a direction to reduce certain items from the value
of fringe benefits chargeable to tax.

 

Subsequently,
the A.O on 14th August, 2013 passed an order giving effect to the
Tribunal’s order for the A.Y. 2006-07 wherein he correctly allowed interest on
advance tax u/s 244A from the first day of the assessment year till the date of
payment of the refund as per law.

 

However,
the A.O. on 16th September, 2013 while passing the order giving
effect to the Tribunal’s order for the A.Ys. 2007-08 and 2008-09 did not grant
interest u/s 244A(1)(a) from the first day of the assessment year till the date
of receipt of the Tribunal order (i.e., 23rd July, 2013) but granted
interest on advance tax only from the date of receipt of the Tribunal order
till the passing of the refund order. In this order dated 6th
September, 2013, the A.O. did not even grant any interest on self-assessment
tax paid by the assessee u/s 244A(1)(b).

 

Aggrieved
by the action of the A.O. in granting interest on advance tax from the date of
the Tribunal order till the passing of the refund order, and also by non-grant
of interest on self-assessment tax paid, the assessee preferred an appeal to
the CIT(A) for the A.Ys. 2007-08 and 2008-09. The assessee also took the ground
that the amount of refund received be adjusted first towards the correct amount
of interest and the balance towards tax, and that on the amount of refund of
tax not received, the assessee be granted interest.

 

The CIT(A), vide his order dated 11th December, 2016, allowed
interest u/s 244A on advance tax and self-assessment tax paid by the assessee
from the first day of the assessment year and the date of payment of the
self-assessment tax, respectively, for both the years till the date of the
grant of refund. However, the CIT(A) dismissed the assessee’s ground for
allowing interest on the said amount for the period of delay on the alleged
ground that it amounts to compensation by way of interest on interest.

 

Aggrieved,
the assessee preferred an appeal to the Tribunal seeking correct allowance of
interest u/s 244A.

 

The
Revenue preferred an appeal challenging the order of the CIT(A) directing the
A.O. to grant interest on self-assessment tax u/s 244A(1)(b) on the ground that
the delay was attributable on the part of the assessee.

HELD

The
Tribunal observed that since the Revenue has not preferred any appeal
challenging the direction of the CIT(A) to grant interest on advance tax from
the first day of the assessment year u/s 244A(1)(a), hence this matter has
attained finality.

 

The
assessee had raised the ground stating that refund granted to the assessee is
to be first adjusted against the correct amount of interest due on that date
and, thereafter, the left over portion should be adjusted with the balance tax.
The Tribunal found that in the instant case refund was granted to the assessee vide a refund order in October, 2013 and it was
pleaded by the assessee that the said refund is to be adjusted against the
correct amount of interest payable thereof to be computed as per the directions
of the CIT(A) and only the balance amount is to be adjusted against tax paid.
Accordingly, unpaid amount is the tax component and, therefore, the assessee
would be entitled to claim interest on the tax component remaining unpaid. The
Tribunal held that in its considered opinion the same would not tantamount to
interest on interest as alleged by the CIT(A) in his order. The Tribunal
observed that this issue is already settled in favour of the assessee by the
following decisions of this Tribunal:

a.  Union
Bank of India vs. ACIT reported in 162 ITD 142 dated 11th August,
2016;

b.
Bank
of Baroda vs. DCIT in ITA No.646/Mum/2017 dated 20th December, 2018.

 

The
Tribunal directed the A.O. to compute the correct amount of interest allowable
to the assessee as directed by the CIT(A) as on the date of giving effect to
the Tribunal’s order, i.e., 6th September, 2013. It further held
that the refund granted on 6th September, 2013 be first appropriated
or adjusted against such correct amount of interest and, consequently, the
shortfall of refund is to be regarded as shortfall of tax and that shortfall
should then be considered for the purpose of computing further interest payable
to the assessee u/s 244A till the date of grant of such refund.

 

The
grounds raised by the assessee for both the years were allowed.

 

The Revenue was in appeal against the direction of the
CIT(A) granting interest on self- assessment tax paid u/s  244A(1)(b).The Revenue alleged that interest
on self-assessment tax is not payable as the delay is attributable to the
assessee because the assessee did not claim refund in the return of income. The
Tribunal found merit in the submission made on behalf of the assessee that the
delay was not attributable to the assessee as the assessee while filing its
return for A.Ys. 2007-08 and 2008-09 had indeed made a claim in the return of
income by way of notes to the return of income and had also clarified in the
said note that tax has been paid on certain fringe benefits only out of
abundant caution. The Tribunal held that the notes forming part of the return
should be read together with the return. Hence, it cannot be said that the
assessee never made such a claim of interest in the return of income for the
respective years. The Tribunal held that no delay could be attributable on the
part of the assessee in this regard.

 

Both the
appeals filed by the assessee were allowed and both the appeals filed by the
Revenue were dismissed.

 

Section 80JJAA – Assessee cannot be denied deduction u/s 80JJAA, provided that such employees fulfil the condition of being employed for 300 days for the year under consideration, even though such employees do not fulfil the condition of being employed for 300 days in the immediately preceding assessment year

9. Tata Elxsi Ltd. vs. JCIT B.R. Baskaran (A.M.) and Beena Pillai (J.M.) ITA
No.3445/Bang/2018 A.Y.: 2014-15 Date of order: 29th October, 2020
Counsel for Assessee / Revenue: Padamchand Khincha / Muzaffar Hussain

 

Section 80JJAA
– Assessee cannot be denied deduction u/s 80JJAA, provided that such employees
fulfil the condition of being employed for 300 days for the year under
consideration, even though such employees do not fulfil the condition of being
employed for 300 days in the immediately preceding assessment year

 

 

FACTS

The assessee, a
company engaged in the business of distributed systems, design and development
of hardware and software and digital content creation, filed its return of
income for the assessment year under consideration declaring total income of
Rs. 98,28,88,380. In the return of income, the assessee claimed deduction of
Rs. 10,51,99,796 u/s 80JJAA.

 

The A.O. rejected the claim of the assessee for non-fulfilment of the
following two conditions:

i)          that the assessee is
not engaged in the manufacture or production of an article or thing as per the
conditions laid down u/s 80JJAA; and

ii)         the condition of 300
days to be fulfilled by the regular workmen as per the provisions does not
stand fulfilled.

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

 

The aggrieved
assessee then preferred an appeal to the Tribunal where it was submitted that
this was the third year of such a claim by the assessee and that the employees
against whose wages the deduction has been claimed satisfy the necessary conditions.
Reliance was placed on the observations of the coordinate bench of the Tribunal
in Texas Instruments (India) Pvt. Ltd. vs. ACIT (2020) 115 Taxmann.com
154 regarding allowability of the claim to the assessee.

 

HELD

The Tribunal noted that the A.O. denied benefit to the assessee on the
reasoning that the assessee was denied benefit against the employees in the
first year of their employment and that the assessee being a software
development company was not eligible for deduction.

 

The Tribunal noted the view of the Tribunal in the case of Texas
Instruments (India) Pvt. Ltd. vs. ACIT (Supra)so far as the first
objection of the A.O. regarding non-satisfaction with respect to additional
wages paid to new employees in the first year of employment is concerned. The
Tribunal held that from the observations of the Tribunal in that case, there is
no doubt that the assessee cannot be denied deduction u/s 80JJAA provided that
such employees fulfil the condition of being employed for 300 days for the year
under consideration even though such employees do not fulfil the condition of
being employed for 300 days in the immediately preceding assessment year.

However, since
the details of fulfilment of the number of days of such employees, on whose salary
deduction has been claimed by the assessee, was not available on record, the
Tribunal was unable to verify whether the necessary condition of 300 days stood
fulfilled. It agreed with the DR that nothing on record placed before the bench
reveals that this is the third year of claim by the assessee as has been
submitted at page 223 of the paper book. The Tribunal, therefore, remanded the
issue to the A.O. to verify these details in terms of new employees having
satisfied the 300 days’ criterion during the year. It directed the assessee to
provide all details regarding number of regular workmen / employees, number of
new workmen / employees added for each of the immediately three preceding
assessment years to the A.O. who shall then analyse fulfilment of the condition
in respect of new employees / workmen against whom the claim has been made by
the assessee u/s 80JJAA and allow deduction under that section.

 

This ground of
appeal filed by the assessee was allowed.

 

Contributors’ comments: The Finance Act, 2018 has
added a second proviso to the definition of additional employee in
Explanation (ii) to section 80JJAA. So, the ratio of the above decision
would be relevant for the period prior to the amendment by the Finance Act,
2018.


HOW AND FOR WHAT PURPOSE?

The interpretation of ‘How and for what purpose’ to determine whether a contractual arrangement contains a lease under Ind AS 116 Leases can be very tricky and complex. This article includes an example to explain the concept in a simple and lucid manner.

The provisions in Ind AS 116 Leases relevant to analysing whether an arrangement contains a lease are given below:

9. At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

B9 To assess whether a contract conveys the right to control the use of an identified asset for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following:

(a) the right to obtain substantially all of the economic benefits from use of the identified asset; and

(b) the right to direct the use of the identified asset.

B24 A customer has the right to direct the use of an identified asset throughout the period of use only if either:

a. the customer has the right to direct how and for what purpose the asset is used throughout the period of use; or

b. the relevant decisions about how and for what purpose the asset is used are predetermined and:
 

i) the customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use, without the supplier having the right to change those operating instructions; or

ii) the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

B25 A customer has the right to direct how and for what purpose the asset is used if, within the scope of its right of use defined in the contract, it can change how and for what purpose the asset is used throughout the period of use. In making this assessment, an entity considers the decision-making rights that are most relevant to changing how and for what purpose the asset is used throughout the period of use. Decision-making rights are relevant when they affect the economic benefits to be derived from use. The decision-making rights that are most relevant are likely to be different for different contracts, depending on the nature of the asset and the terms and conditions of the contract.
 

B26 Examples of decision-making rights that, depending on the circumstances, grant the right to change how and for what purpose the asset is used, within the defined scope of the customer’s right of use, include:

a. rights to change the type of output that is produced by the asset (for example, to decide whether to use a shipping container to transport goods or for storage, or to decide upon the mix of products sold from retail space);

b. rights to change when the output is produced (for example, to decide when an item of machinery or a power plant will be used);
 
c. rights to change where the output is produced (for example, to decide upon the destination of a truck or a ship, or to decide where an item of equipment is used); and

d. rights to change whether the output is produced, and the quantity of that output (for example, to decide whether to produce energy from a power plant and how much energy to produce from that power plant).

B30 A contract may include terms and conditions designed to protect the supplier’s interest in the asset or other assets, to protect its personnel, or to ensure the supplier’s compliance with laws or regulations. These are examples of protective rights. For example, a contract may (i) specify the maximum amount of use of an asset or limit where or when the customer can use the asset, (ii) require a customer to follow particular operating practices, or (iii) require a customer to inform the supplier of changes in how an asset will be used. Protective rights typically define the scope of the customer’s right of use but do not, in isolation, prevent the customer from having the right to direct the use of an asset.

Example – ‘How and for what purpose’ analysis in a hotel stay

Fact pattern

A customer books a room in a hotel for a one-day stay. As per the terms and conditions of the hotel, the customer cannot use the hotel for any illegal activities or cannot sub-lease the room. The room is a specific identified asset, the substitution rights (if any) are not substantive and the customer obtains significant economic benefits from occupying the room. Whether the arrangement between the hotel and the customer contains a lease?

Analysis

Having determined that the room is a specific identified asset, the substitution rights are not substantive and the customer obtains significant economic benefits from occupying the room; the next step in the lease analysis is whether the customer has the right to direct how and for what purpose the asset is used throughout the period of use, as required by B24.
 
The room can be used only for the purposes of room stay; it cannot be sub-let by the customer. To that extent, the how and for what purpose is predetermined. Additionally, the customer cannot use the room for illegal activities. Those are protective rights that the hotel has and do not impact the assessment of whether an arrangement contains a lease in accordance with B30.

The following how and for what purpose decisions are not predetermined and are controlled by the customer and affect the economic benefits to be derived by the customer from the use of the room during the period of stay:

  •        Use of air-conditioner or refrigerator or television or other devices in the room;
  •        Use the room to sleep or to make conference calls;
  •        Use the room to have lunch or dinner, etc.

Therefore, the customer has the right to direct how and for what purpose the asset is used (to the extent those are not predetermined) throughout the period of use (see B25).

CONCLUSION

The arrangement between the hotel and the customer contains a lease. The customer is a lessee and would be entitled to the exemption with respect to short-term lease or low value lease. Additionally, the lessee will have to comply with certain presentation and disclosure requirements as required by Ind AS 116.
 
The hotel (lessor) is not entitled to exemptions from short-term lease or low value lease. From the perspective of the hotel, the single-day lease would qualify as an operating lease. The lessor will have to comply with certain presentation and disclosure requirements as required by Ind AS 116.

Whilst the above example may not have any significant implications for the hotel or its customer, the example is provided to explain the concept of ‘How and for what purpose’ in evaluating whether a contract includes a lease arrangement.

Realisation is not acquisition of anything new, nor is it a new faculty. It is only removal of all camouflage

—  Ramana Maharshi

One who neglects or disregards the existence of earth, air, fire, water and vegetation disregards his own existence which is entwined with them

—  Mahavira

TAX EXEMPTION FOR A REWARD

ISSUE FOR CONSIDERATION

A  reward by the Central
Government or a State Government for purposes approved by the Central Government
in the public interest, is exempted from taxation under clause (ii) of section
10(17A) of the Income-tax Act, 1961. Likewise, a receipt of an award instituted
in the public interest by the Central Government or any State Government or by
any other body and approved by the Central Government, is exempt from taxation
as per clause (i) of section 10(17A) of the Act.

 

Section 10(17A) reads as under;

‘Any payment made, whether in cash or in kind –

(i) in pursuance of any award instituted in the public interest by
the Central Government or any State Government or instituted by any other body
and approved by the Central Government in this behalf; or

(ii) as a reward by the Central Government or any State Government
for such purposes as may be approved by the Central Government in this behalf in
the public interest’.

 

A controversy has arisen in the context of the eligibility of a
reward by the Central Government or a State Government for the purposes of
exemption from tax under clause (ii) of section 10(17A) where the reward so
conferred is not expressly approved by the Central Government. The issue is
whether such approval can be construed to be implied in a reward so
conferred.

 

The Patna and Delhi High Courts in the past had held that the awards
instituted by the Government required approval by the Central Government, while
recently the Madras High Court, following an earlier decision, has held that
express approval is not required for the awards so instituted by such Government
and the approval can be implied also and can be gathered from the facts in the
public domain or can be read into a reward.

 

S.N. SINGH’S CASE

The issue before the Patna High Court first arose in the case of
S.N. Singh, 192 ITR 306 followed by a case before the Delhi High Court in the case of
J.C. Malhotra, 230 ITR
361.

 

In this case, the assessee, an individual,
was working as an ITO at the material time.. In
appreciation of the meritorious work done by the Income-tax personnel for the
success of the Voluntary Disclosure Scheme, 1975 the Government of India decided
to grant a reward of an amount equal to one month’s basic pay (vide Notification dated 16th January, 1976). In pursuance of
the Notification, the assessee received a sum by way
of a reward during the assessment year 1976-77. The assessee claimed exemption from income-tax of this amount
under the then section 10(17B). The ITO rejected that claim.

 

On appeal, the AAC upheld the contention advanced on behalf of the
assessee that the amount of reward could not be
included in computing his total income in view of the provisions of then section
10(17B). On further appeal, the Tribunal agreed with the finding of the AAC and
dismissed the appeal. Aggrieved by the order passed by the Tribunal, the Revenue
sought reference and it was at the instance of the Revenue that the following
question of law had been referred to the Patna High Court for its
opinion:

 

‘Whether, on the facts and in the circumstances of the case, the
Tribunal has rightly held that the award of Rs. 1,150
received by the assessee is exempt from income-tax u/s
10(17B) of the Income-tax Act, 1961?’

 

At the time of hearing, no one appeared on behalf of the assessee. From a perusal of the provision it was clear to
the Court that a payment made as reward by the State or Central Government was
not includible in computing the total income only when the reward was for such
purposes as might be approved by the Central Government in that behalf in the
public interest. The Court found that there was no material on record for
holding that the purpose for which the reward in question had been given had
been approved by the Central Government in public interest for the applicability
of clause (17B) of section 10. The Court noted that it was no doubt true that
the payment had been made by the Central Government to the assessee as a reward and that the said payment was also in
the public interest. However, unless and until it was shown by the assessee that such reward had been approved by the Central
Government for purposes of exemption u/s 10(17B), the Court held that such
reward would not qualify for exemption under that section  and that the Tribunal, therefore, was
not right in holding that the reward received by the assessee was exempt from income-tax u/s 10(17B).

 

In the case of CIT vs. J.C. Malhotra, 230 ITR 361
(Delhi) the assessee, who was an ITO at the
relevant time, had been given a reward by the Central Government directly in
connection with the Voluntary Disclosure Scheme. The Tribunal had upheld the
claim of exemption holding that the cash award was exempt from taxation u/s
10(17B). On further appeal by the Revenue, the Delhi High Court observed that a
separate approval of the Central Government for the purpose of exemption u/s
10(17B) was not given and that that being the position, the reward was not
eligible for exemption from Income-tax by relying upon the decision in the case
of CIT vs. S.N. Singh, ITO (Supra).

 

THE K. VIJAYA KUMAR CASE

Recently, the issue again arose in the case of K. Vijaya Kumar, 422 ITR
304.

 

In this case, the petitioner in the Indian Police Service had been
appointed as Chief of the Special Task Force (STF) leading ‘Operation Cocoon’
against forest brigand Veerapan, leading to the
latter’s fatal encounter on 18th October, 2004. In recognition of the
special and commendable services of the STF, the Government of Tamil Nadu had
issued G.O.Ms. No. 364, Housing and Urban Development Department dated
28th October, 2004 instituting an award in national interest to
personnel of the STF for the valuable services rendered by them as part of the
team. In consequence thereof, G.O.Ms. No. 16, Housing
and Urban Development Department dated 12th January, 2006 was issued
sanctioning a sum of Rs. 54,29,88,200 towards the cost of 773 plots to be allotted to
STF personnel, including the petitioner. A specific
G.O.Ms. 368, Housing and Urban Development dated 29th October,
2004 read with G.O.Ms. No. 763 was issued for first allotting an HIG Plot
bearing No. 1A-642 at Thiruvanmiyur Scheme to the
petitioner, subsequently modified to Plot No. 1 adjacent to Andaman Guest House
at Anna Nagar West Extension. A registered deed of sale had been executed on
27th November, 2009 in consideration of Rs.
1,08,43,000 paid by the Government of Tamil Nadu on his
behalf to the Tamil Nadu Housing Board.

 

It appears that the assessee had sold the
plot of land and had offered the capital gains for taxation, computed after
deducting the cost of the land that was paid by the Government. The assessment
was completed u/s 143(3) r.w.s. 147 and the capital
gain as computed by the assessee was accepted by the
A.O.

 

The order of the A.O. was sought to be revised by the Commissioner
u/s 263. In the said order u/s 263, the exemption granted u/s 10(17A) in respect
of the reward of land was questioned by the Commissioner.

 

At paragraph 8 of the order, the Assessing Authority was directed to
allow the claim of exemption u/s 10(17A) only if the assessee was able to produce an order granting approval of
exemption by the Government of India u/s 10(17A)(ii).

 

Admitting the writ petition challenging the order, the single judge
of the Madras High Court noted that the question that arose related to whether
the reference to ‘approval’ in section 10(17A) included an implied approval or
whether such approval had to be express.

 

The Court, referring to the legislative history of the provision,
observed that the erstwhile clause (17A) contained a proviso that required that the ‘effective date’ from which the approval was
granted was to be specified in the order of the Central Government granting such
approval. Noting that the proviso had been omitted in the substituted provision, effective
1st April, 1989 onwards, it appeared to the Court that while
enlarging the clauses generally, by obviating specific reference to the purposes
for which the awards could be given, the Legislature had also done away with the
specification of a written approval from the Central Government with effect from
1st April, 1989.

 

The Madras High Court, approving the decision of the Division Bench
of the Court in the case of CIT vs. J.G. Gopinath, 231 ITR
229 held that the amount of reward received by the assessee was not taxable and was exempt from tax. The single
judge of the Court noted with approval the following part of the decision in the
case of CIT vs. J.G. Gopinath
(Supra):

 

‘To quote the Ministry of Finance letter F. No. 1-11015/1/76 Ad. IX,
dated January 16, 1976, the first paragraph itself explains the circumstances
under which it is granted, “I am directed to state that in appreciation of the
meritorious work done by the Income-tax personnel for the success of the
voluntary disclosure schemes, the Government have decided to grant them reward
of an amount equal to one month’s basic pay.”

 

The above extract makes it clear that such reward was granted in
public interest. It would be surprising if the Government were to grant rewards
for reasons other than public interest. It is, therefore, evident that the terms
of section 10(17B) are completely satisfied in the present case as the circular
gives the circumstances under which the rewards are granted. The voluntary
disclosure scheme could only have been conceived in public interest as we do not
see any other reason for this scheme coming into existence. If any person
rendered sincere work to make this scheme a success, and if he is rewarded for
it, such grant of reward cannot but be in public interest. There is no specific
mode of approval indicated in the statute. No further approval is necessary or
called for. The section is clear in its language and does not raise any problem
of construction. Therefore, we do not find that any question of law arises out
of the Tribunal’s order. Even assuming that a question of law arises, the answer
is self-evident and, therefore, the reference shall be wholly academic and
unnecessary. The petition is accordingly dismissed.’

 

The Court also took note of the contrary view expressed by the Patna
High Court in CIT vs. S.N. Singh (Supra) and the Delhi High Court in CIT vs. J.C. Malhotra (Supra).
The Court observed that the Division Bench of the Patna High Court
took a view directly opposed to the view expressed by the Madras High Court in
the J.G. Gopinath case and the said order delivered prior to the decision of this
Court in the J.G. Gopinath case had not been taken into consideration by the Madras High Court.
It was noted that the Patna High Court had proceeded on a strict interpretation
of the provision rejecting the claim of exemption on the ground that though the
reward by the Central Government to the assessee was
indisputably in public interest, approval by the Central Government was
mandatory for the purpose of exemption u/s 10(17B).

 

The single judge of the Court observed that sitting in Madras, he was
bound by the view taken by the jurisdictional High Court to the effect that
‘approval’ of the Centre might either be express or implied, and in the latter
case, gleaned from surrounding circumstances and events. Thus, that was the
perspective from which the eligibility of the petitioner u/s 10(17A) to
exemption or otherwise should be tested and decided.

 

On a reading of section 321 of the Criminal Procedure Code and the
judgment of a three-Judge Bench in the case of Abdul Karim vs. State of Karnataka [2000] 8
SCC 710, the issue faced by the country because of the operations carried on
by Veerapan and his associates was found to be grave
and enormous by the single judge of the Madras High Court. The categorical
assertion of the Apex Court that Veerapan was acting
in consultation with secessionist organisations with the object of splitting
India, in the Court’s view, was a vital consideration to decide the present
lis.

 

The object of section 10(17A), the Court noted, was to reward an
individual who had been recognised by the Centre or the State for rendition of
services in public interest. The Court noted that no specification or
prescription had been set out in terms of how the approval was to be styled or
even as to whether a formal written approval was required and nowhere in the
Rules / Forms was there reference to a format of approval to be issued in this
regard.

 

One should, in the Court’s view, interpret the provision and its
application in a purposive manner bearing in mind the spirit and object for
which it had been enacted. It was clear that the object of such a reward was by
way of recognition by the State of an individual’s efforts in protecting public
interest and serving society in a significant manner. Thus, in the Court’s
considered view, the reference to ‘approval’ in section 10(17A) did not only
connote a paper conveying approval and bearing the stamp and seal of the Central
Government, but any material available in public domain indicating recognition
for such services, rendered in public interest.

 

Allowing the petition of the assessee, the
Court in the concluding paragraph held as under: ‘The petitioner has been recognised by the Central Government on
several occasions for meritorious and distinguished services and from the
information available in public domain, it is seen that he was awarded the Jammu
& Kashmir Medal, Counter Insurgency Medal, Police Medal for Meritorious
Service (1993) and the President’s Police Medal for Distinguished Service
(1999). Specifically for his role in nabbing Veerapan,
he was awarded the President’s Police Medal for Gallantry on the eve of
Independence Day, 2005. What more! If this does not constitute recognition by
the Centre of service in public interest, for the same purposes for which the
State Government has rewarded him, I fail to understand what is. The reward
under section 10(17A)(ii) is specific to certain “purposes” as may be approved
by the Central Government in public interest and the “purpose” of the reward by
the State Government has been echoed and reiterated by the Centre with the
presentation of the Gallantry Award to the petitioner in 2005. This aspect of
the matter is also validated by the Supreme Court in Abdul Karim (Supra) as can be seen from the judgment extracted earlier, where the Bench
makes observations on the notoriety of Veerapan and
the threat that he posed to the country as a whole.

 

Seen in the context of the recognition by the Centre of the
petitioners’ gallantry as well as the observations of the Supreme Court in
Abdul Karim (Supra) and the ratio of the decision in J.G. Gopinath (Supra), the approval of the Centre in this case, is rendered a
fait accompli.’

 

OBSERVATIONS

At the outset, for the record it is noted that in the original scheme
of the Act of 1961, section 10(17A) [inserted by the Direct Taxes (Amendment)
Act, 1974] provided for tax exemption for an award w.r.e.f. 1st April, 1973 and a separate provision
in the form of section 10(17B) [inserted by the Direct Taxes (Amendment) Act,
1974] provided for tax exemption for a reward w.r.e.f.
1st April, 1973. The two reliefs are now conferred under a new
provision of section 10(17A) made effective from 1st April, 1989.
Clause (i) of the said new section provides for exemption for an award, while
clause (ii) provides for exemption for a reward. While both the clauses provide
for some approval by the Central Government, the issue for the present
discussion is limited to whether such approval should be specifically obtained
or such approval should be presumed to have been granted when a reward is
conferred, especially by the Central Government.

The issue under consideration moves in a very narrow compass. There
is no dispute that a reward, to qualify for exemption from tax, should be one
that is approved by the Central Government. The debate is about whether such an
approval should necessarily be in writing and express under a written order or
whether such an order of approval can be gathered by implication, and whether
implied approval can be gathered by referring to the facts of the services of
the recipient available in public domain. In other words, by the very fact that
a person has been rewarded for his services to the public, it should be
construed that it was in public interest to do so and the availability of
information of his services in public domain should be a fact good enough to
imply a tacit approval by the Central Government of such a reward, and no
insistence should be pressed for a written approval.

 

It is possible to hold that the requirement of a written order has
been done away with by the deletion of the proviso w.e.f. 1st April, 1989 in the then prevailing 10(17A), which
removed the requirement of referring to the purpose and the assessment year in
the order, implying that the Legislature has done away with the specification of
written approval from that date.

 

The legislative intent behind the exemption, no doubt, is not to tax
a person in receipt of a reward from the Central or State Government. The
approval for the purpose is incidental to the main intention of exempting such
receipts. The need for such approval in writing is at the most a procedural or
technical requirement, the non-compliance of which should not result in total
denial of the exemption, defeating the legislative intent.

 

The very fact that the reward is conferred by the Government along
with the fact that the facts of the rewards are in the public domain, should be
sufficient to determine the grant of exemption from tax in public
interest.

 

A purposive and liberal interpretation here advances the cause
of justice and public good.

 

 

Writing is
the process by which you realize that you do not
understand what you are
talking about

—  Shane Parrish

 

There is no
austerity equal to a balanced mind, and there is no happiness equal
to
contentment; there is no disease like covetousness, and no virtue like
mercy

—  Chanakya

 

Proceedings under the Income-tax Act cannot be continued during the moratorium period declared under the Insolvency and Bankruptcy Code, 2016

21. [2020] 78 ITR(T) 214 (Del.)(Trib.) Shamken Multifab Ltd. vs. DCIT ITA (SS) Nos. 149, 150, 3549, 3550 &
3551 (Delhi) of 2007 A.Y.: 2003-04 Date of order: 22nd October,
2019

 

Proceedings
under the Income-tax Act cannot be continued during the moratorium period
declared under the Insolvency and Bankruptcy Code, 2016

 

FACTS

A petition
to initiate Corporate Insolvency Resolution Process (CIRP) in accordance with
provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) against the
assessee was admitted by the National Company Law Tribunal and the CIRP had
commenced w.e.f. 29th May, 2018; accordingly, a moratorium period
was declared.

 

The
assessee contended that the appeals filed by the Income-tax Department against
the company cannot continue in view of the provisions of section 14 of the IBC.

 

Revenue
argued that the expression ‘proceeding’ envisaged in section 14 of the IBC will
not include Income-tax proceedings and hence it can be continued even during
the moratorium period. Citing Rule 26 of the Income-tax Appellate Tribunal
Rules, 1963 it was contended that the proceedings before the ITAT can continue
even after the declaration of insolvency.

 

The
question before the Tribunal was whether Income-tax proceedings can be
continued during the moratorium period declared under the IBC.

 

HELD

Considering
section 14 of the IBC, the Tribunal held that the institution of suits or
continuation of pending suits or proceedings against the corporate debtor
(i.e., the assessee), including execution of any judgment or decree or order in
any court of law, tribunal, arbitration panel or other authority,is prohibited
during the moratorium period.

 

Reliance
was placed on the decision of the Supreme Court in the case of Alchemist Asset Reconstruction Co. Ltd. vs. Hotel Gaudavan (P)
Ltd. [2017] 88
taxmann.com 202 wherein it was held that even
arbitration proceedings cannot be initiated after imposition of the moratorium
period.

 

The
Tribunal held that the Apex Court in the case of Pr.
CIT vs. Monnet Ispat & Energy Ltd. [SLP (C) No. 6487 of 2018, dated 10th
August, 2018] had upheld the overriding nature
and supremacy of the provisions of the IBC over any other enactment in case of
conflicting provisions, by virtue of a non-obstante
clause contained in section 238 of the IBC; and hence even proceedings under
the Income-tax Act cannot be continued during the period of moratorium.

 

Reference
was also made to a recent amendment in the IBC according to which any
resolution plan or liquidation order as decided by the competent authority will
be binding on all stakeholders, including the Government. This amendment
prevents even the Direct & Indirect Tax Departments from questioning the
Resolution Plan or liquidation order as well as the jurisdiction of Tribunals
with regard to IBC. Accordingly, all the appeals filed by the Revenue were
dismissed by the Tribunal.

 

It was
also held that even appeals filed by the assessee cannot be sustained as the
assessee did not furnish any permission from the National Company Law Tribunal
in this regard. [Reliance was placed on the decision of the Madras High Court
in the case of Mrs. Jai Rajkumar vs. Standic Bank Ghana
Ltd. [2019] 101
taxmann.com 329 (Mad.).].

 

Accordingly,
all the appeals of the Revenue as well as of the assessee were dismissed.

Non-furnishing of Form 15G/15H before CIT by the deductor is merely procedural defect and cannot lead to disallowance u/s 40(a)(ia)

20. [2020] 79 ITR(T) 207 (Bang.)(Trib.) JCIT
vs. Karnataka Vikas Grameena Bank ITA Nos.: 1391 & 1392 (Bang.) of 2016
A.Ys.: 2012-13 and 2013-14 Date of order: 23rd January, 2020

 

Non-furnishing
of Form 15G/15H before CIT by the deductor is merely procedural defect and
cannot lead to disallowance u/s 40(a)(ia)

 

FACTS


The assessee
was engaged in the business of banking. As per the provisions of section 194A,
the assesse was liable to deduct tax at source on interest paid in excess of
Rs. 10,000 to its depositors. However, some depositors had provided Form
15G/15H to the assesse and hence tax was not deducted from interest paid to
such depositors. The A.O. contended that the assessee ought to have furnished
those Forms 15G/15H to the Commissioner of Income-tax within the prescribed
time which the assessee failed to do and hence the interest paid to such
depositors was subject to disallowance u/s 40(a)(ia) on account of failure to
deduct tax at source.

 

The CIT(A)
deleted the disallowance made by the A.O. by holding that there was no breach
committed by the assessee by not filing Form No. 15G/H before the Commissioner
of Income-tax.

 

HELD

The issue was covered by the decision of the Tribunal in the assessee’s
own case for A.Y. 2010-11 in ITA Nos.: 673 & 674/Bang/2014.
In this case, the Tribunal had relied upon the decision of the Karnataka High
Court in CIT vs. Sri Marikamba Transport Co. [ITA No. 553/2015; order
dated 13th April, 2015] wherein, in the context of section
194C, it was held that once the conditions of section 194C(3) were satisfied,
the liability of the deductor to deduct tax at source would cease and,
accordingly, disallowance u/s 40(a)(ia) would also not arise; filing of Form
No. 15-I/J was held as directory and not mandatory.

 

Accordingly,the Tribunal held that no disallowance can be made u/s
40(a)(ia) merely because the assessee did not furnish Form 15G/15H to the
Commissioner. The requirement of filing of such forms before the prescribed
authority is only procedural and that cannot result in a disallowance u/s
40(a)(ia). Accordingly, disallowance u/s 40(a)(ia) was held unsustainable.

 

Section 56(2)(viia) – Where share in profits of a firm during its subsistence and share in assets after its dissolution were consideration for capital contribution, such ‘consideration’ was ‘indeterminate’ – The provisions of section 56(2)(viia) could not be applicable to determine inadequacy or otherwise of such consideration and also to capital contribution of a partner made in the firm

19. [2020] 121 taxmann.com 150 (Hyd.)(Trib.) ITO vs. Shrilekha Business Consultancy
(P) Ltd. A.Ys.: 2014-15 and 2015-16 Date of order: 4th November, 2020

 

Section
56(2)(viia) – Where share in profits of a firm during its subsistence and share
in assets after its dissolution were consideration for capital contribution,
such ‘consideration’ was ‘indeterminate’ – The provisions of section
56(2)(viia) could not be applicable to determine inadequacy or otherwise of
such consideration and also to capital contribution of a partner made in the
firm

 

FACTS

The
assessee, a partnership firm later converted into a private company, was
engaged in financing and holding investments. Certain capital contribution was
made by Piramal Enterprise Ltd. (PEL) during A.Y. 2015-16. PEL had decided to
acquire 20% stake in Shriram Capital Ltd. (SCL) through investment in the
assessee (Rs. 6.22 crores recorded as partner’s capital and Rs. 2,111.23 crores
as capital reserve representing 75% share). This capital contribution was then
utilised to make investment in the shares of Novus (a group company of SCL)
which in turn invested in SCL through private placement and got ultimately
merged with SCL in 2014.

 

The A.O.
observed that the assessee’s Group as a whole was supposed to pay tax on the
aggregate consideration received of Rs. 2,100 crores from PEL and that in order
to avoid tax liability on the same, SCL and the assessee firm had devised a new
method to avoid tax liability. The A.O. made an addition of amounts credited in
capital reserve, treating the same as income u/s 56.

 

Aggrieved,
the assessee preferred an appeal to the CIT(A) who deleted the said addition.

 

HELD

The
Tribunal held that even though the assessee firm had acted as an intermediate
entity, it could not be construed as a conduit between PEL and SCL and the
entire transactions are to be understood in a holistic manner and cannot be
construed as a colourable device or a sham transaction as admittedly there is
no element of any income within the meaning of section 2(24) in the entire
gamut of the transaction.

 

As far as the applicability of section 56(2)(viia) was concerned, it was
observed that when a partner retires from the firm, he does not walk away with
the credit balance in his capital account alone, instead, he would be entitled
to the share of the profits / losses, besides the assets of the firm. The
provisions of the section 56(2)(viia) deal with transaction / contract between
the existing ‘firm’ and ‘any person’ which are not in the nature of capital
contribution. The term ‘person’ mentioned in section 56(2)(viia) does not cover
‘partner’ in respect of capital contribution and, accordingly, section
56(2)(viia) cannot be made applicable in the case of capital contribution made
by a partner to the firm. The provisions of section 56(2)(viia) could not be
made applicable at all in the case of capital contribution made by a partner in
kind.

 

The appeal
of the Revenue was dismissed.

Section 56(2)(vii)(b)(ii) – The provisions of section 56(2)(vii)(b)(ii) will apply if they were on the statute as on the date of entering into the agreement

18. [2020] 118 taxmann.com 463
(Visak.)(Trib.) ACIT vs. Anala Anjibabu A.Y.: 2014-15 Date of order: 17th August, 2020

 

Section
56(2)(vii)(b)(ii) – The provisions of section 56(2)(vii)(b)(ii) will apply if
they were on the statute as on the date of entering into the agreement

 

FACTS

In the course of assessment
proceedings, the A.O. found that the assessee has purchased an immovable
property at Srivalli Nagar from Smt. Simhadri Sunitha for a consideration of
Rs. 5 crores and the transaction was registered on 28th October,
2013. The value of the said property for registration purpose was fixed at Rs.
12,67,82,500. The A.O. invoked the provisions of section 56(2)(vii)(b) and
taxed the difference between the consideration paid and the SRO value as on the
date of agreement and completed the assessment.

 

Aggrieved, the assessee
preferred an appeal to the CIT(A) who allowed the appeal following the ratio of the decision of the
Visakhapatnam Bench of the Tribunal in the case of M. Siva Parvathi vs. ITO [2010] 129 TTJ 463 (Visakhapatnam),
rendered in the context of section 50C. He held that since the agreement for
sale was entered into by the assessee for the purpose of purchase of the
property in August, 2012 related to the F.Y. 2012-13, relevant to the A.Y.
2013-14, which is prior to insertion of section 56(2)(vii)(b), section
56(2)(vii)(b) has no application in the assessee’s case.

 

Aggrieved, the Revenue
preferred an appeal to the Tribunal contending that section 50C and section
56(2)(vii)(b) are independent provisions related to different situations and
the case law decided for the application of section 50C cannot be applied for
deciding the issue relating to the provisions of section 56(2)(vii)(b).

 

HELD

The Tribunal observed –

(i) that the question to be decided is whether or
not, in the facts and circumstances of the case, the provisions of section
56(2)(vii)(b)(ii) are applicable;

(ii)         that the provisions of section
56(2)(vii)(b)(ii) came into the statute by the Finance Act, 2013 w.e.f. 1st
April, 2014, i.e., A.Y. 2014-15. In the instant case, the assessee had
entered into the agreement for the purchase of the property on 13th
August, 2012 for a consideration of Rs. 5 crores and paid part of the sale
consideration by cheque. In the assessment order, the A.O. acknowledged the
fact that the assessee had entered into an agreement for purchase of the
property and paid the advance of Rs. 5 crores on 13th August, 2012.
There is no dispute with regard to the existence of the agreement;

(iii) from
the order of the CIT(A) it became clear that the property was in dispute due to
a bank loan and the original title deeds were not available for complying with
the sale formalities. Therefore, there was a delay in obtaining the title deeds
for completing the registration. Thus, there is a genuine cause for delay in
getting the property registered;

(iv) As
per the provisions of the Act, from the A.Y. 2014-15, sub clause (ii) has been
introduced so as to enable the A.O. to tax the difference in consideration if
the consideration paid is less than the stamp duty value. The A.O. is not
permitted to invoke the provisions of section 56(2)(vii)(b)(ii) in the absence
of sub-clause (ii) in the
Act as on the date of agreement.

 

The
Tribunal held that in this case the agreement was entered into on 13th
August, 2012 for purchase of the property and part consideration was paid.
Hence, the provisions existing as on the date of entering into the agreement
required to be applied for deciding the taxable income. The Tribunal in the
case of D.S.N. Malleswara Rao has held
that the law as applicable as on the date of agreement required to be applied
for taxing the income. The Department has not made out any case for application
of 56(2)(vii)(b) and since the provisions of section 56(2)(vii)(b)(ii) were not
available in the statute as on the date of entering into the agreement,
following the reasoning given in the case of M.
Siva Parvathi (Supra), the same cannot be made
applicable to the assessee. The Department has not brought any evidence to show
that there was extra consideration paid by the assessee over and above the sale
agreement or sale deed.

 

It held that the CIT(A) has rightly applied the
decision of this Tribunal in the assessee’s case and deleted the addition

Section 56(2)(viia), Rule 11UA – Valuation report prepared under DCF method should be scrutinised by the A.O. and if necessary he can carry out a fresh valuation either by himself or by calling for a determination from an independent valuer to confront the assessee – However, he cannot change the method of valuation but has to follow the DCF method only

17. [2020] 120 taxmann.com 238
(Bang.)(Trib.) Valencia Nutrition Ltd. vs. DCIT A.Y.: 2015-16 Date of order: 9th October, 2020

 

Section
56(2)(viia), Rule 11UA – Valuation report prepared under DCF method should be
scrutinised by the A.O. and if necessary he can carry out a fresh valuation
either by himself or by calling for a determination from an independent valuer
to confront the assessee – However, he cannot change the method of valuation
but has to follow the DCF method only

 

FACTS

During the financial year
relevant to A.Y. 2015-16, the assessee company, engaged in the business of
manufacturing of energy drinks with the brand name ‘Bounce & Vita-Me’,
collected share capital along with share premium to the tune of Rs. 1.55 crores
by issue of 24,538 shares having a face value of Rs. 10 each at a share premium
of Rs. 622 per share.

 

The A.O. noticed that the
assessee has followed the ‘Discounted Cash Flow’ method (DCF method) for
determining the share price. As per the valuation report prepared under the DCF
method, the value of one share was determined at Rs. 634. Accordingly, the
assessee had issued shares @ Rs. 632 per share, which included share premium of
Rs. 622. The A.O. held that the value of the share @ Rs. 632 was an inflated
value since the share valuation under the DCF method has been carried out on
the basis of projections and estimations given by the management. He held that
the value of the share should be based on ‘Net Asset Method’ mentioned in Rule
11UA of the Income-tax Rules. Accordingly, the A.O. worked out the value of the
shares at Rs. 75 per share under the Net Asset Method. Since the par value of
the share is
Rs. 10, the A.O. took the view that the assessee should have collected a
maximum share premium of Rs. 65 per share. He held that the share premium
collected in excess of Rs. 65, i.e., Rs. 557 per share, is excess share premium
and he assessed Rs. 1,36,67,666 being the total amount of excess share premium
u/s 56(2)(viib).

 

Aggrieved, the assessee
preferred an appeal to the CIT(A) who confirmed the addition made by the A.O.

 

Aggrieved, the assessee
preferred an appeal to the Tribunal and prayed that this issue may be restored
to the file of the A.O. with a direction to examine the valuation report furnished
by the assessee under the DCF method.

 

HELD

The Tribunal noticed that
the coordinate bench has examined the issue of valuation of shares under the
DCF method in the case of Innoviti Payment Solutions
(P) Ltd. [ITA No. 1278/Bang/2018 dated 9th January, 2019]
and has followed the decision rendered by the Bombay High Court in the case of Vodafone M Pesa Ltd. vs. PCIT 164 DTR 257
and has held that the A.O. should scrutinise the valuation report prepared
under the DCF method and, if necessary, he can carry out fresh valuation either
by himself or by calling for a final determination from an independent valuer
to confront the assessee. The A.O. cannot change the method of valuation and he
has follow only the DCF method.

 

The decision rendered in
the case of Innoviti Payment Solutions (P) Ltd.
(Supra) was followed by another coordinate bench in the case of Futura Business Solutions (P) Ltd. [ITA No. 3404 (Bang.) 2018].

 

The Tribunal noted that in
the case of this assessee,too, the A.O. has proceeded to determine the value of
shares in both the years by adopting different methods without scrutinising the
valuation report furnished by the assessee under the DCF method. Accordingly,
following the decisions rendered by the coordinate benches, the Tribunal set
aside the order passed by the CIT(A) and restored the impugned issue to the
file of the A.O. with the direction to examine it afresh as per the directions
given by the coordinate bench in the case of Innoviti
Payment Solutions (P) Ltd. (Supra).

Section 56(2)(vii)(b)(ii) – Even if there is no separate agreement between the parties in writing, but the agreement which is registered itself shows that the terms and conditions as contained in the said agreement were agreed between the parties at the time of booking of the flat

16. [2020] 120 taxmann.com 216 (Jai.)(Trib.) Radha Kishan Kungwani vs. ITO A.Y.: 2015-16 Date of order: 19th August, 2020

 

Section
56(2)(vii)(b)(ii) – Even if there is no separate agreement between the parties
in writing, but the agreement which is registered itself shows that the terms
and conditions as contained in the said agreement were agreed between the
parties at the time of booking of the flat

 

FACTS

The assessee, vide sale agreement dated 16th
September, 2014 purchased a flat from HDIL for a consideration of Rs.
1,38,03,550. The stamp duty value of the flat at the time of the registration
of the sale agreement was Rs. 1,53,43,036. The A.O. invoked the provisions of
section 56(2)(vii) for making an addition of the differential amount between
the stamp duty valuation and purchase consideration paid by the assessee.

 

The
assessee claimed that he booked the flat on 6th September, 2010 and
made advance payments of Rs. 2,51,000 on 10th October, 2010 and Rs.
9,87,090 on 14th October, 2010, the total amounting to Rs. 12,38,090,
and contended that the stamp duty value as on the date of agreement be
considered instead of the stamp duty value as on the date of registration. The
A.O. rejected this contention and made an addition of Rs. 15,39,486, being the
difference between the stamp duty value on the date of registration of the agreement and the amount of
consideration paid by the assessee u/s 56(2)(vii).

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

 

The assessee then preferred
an appeal to the Tribunal.

 

HELD

The
Tribunal noted that vide letter dated 16th October, 2017, the builder
has specifically confirmed that the cost of the flat is Rs. 1,38,03,550 and the
booking was done by payment of Rs. 2,51,000 by cheque dated 10th
October, 2010 drawn on Andhra Bank. This fact was not disputed by the A.O. This
payment is even reflected in the final sale agreement which is registered. The
terms and conditions which are reduced in writing in the agreement registered
on 16th September, 2014 relate to the performance of both the
parties right from the beginning, i.e., the date of booking of the flat. All
these facts are duly acknowledged by the parties in the registered agreement,
that earlier there was a booking of the flat and the assessee made part payment
of the consideration.

 

The Tribunal held that all
these facts clearly established that at the time of booking there was an
agreement between the parties regarding the sale and purchase of the flat and
payment of the purchase consideration as per the agreed schedule. Thus, even if
there is no separate agreement between the parties in writing but the agreement
which is registered itself shows that the terms and conditions as contained in
the said agreement were agreed between the parties at the time of the booking.
On this basis, part payment was made by the assessee on 10th
October, 2010 and subsequently on 14th October, both through cheque.

 

In view of the above, the
Tribunal held that the first and second provisos
to section 56(2)(vii) would be applicable in this case and the stamp duty
valuation or the fair market value of the property shall be considered as on
the date of booking and payment made by the assessee towards the booking.

 

The Tribunal set aside the
order passed by the CIT(A) and remanded the matter to the record of the A.O. to
apply the stamp duty valuation as on 10th October, 2010 when the
assessee booked the flat and made the part payment. Consequently, if there is
any difference on account of the stamp duty valuation being higher than the
purchase consideration paid by the assessee, the same would be added to the
income of the assessee under the provisions of section 56(2)(vii)(b).

Section 56(2)(vii)(c) – The provisions of section 56(2)(vii)(c) get attracted only when a higher than proportionate allotment of fresh shares issued by a company is received by a shareholder

15. [2020] 119 taxmann.com 362 (Jai.)(Trib.)
DCIT vs. Smt. Veena Goyal A.Y.: 2013-14 Date of order: 15th September,
2020

 

Section 56(2)(vii)(c) – The provisions of section
56(2)(vii)(c) get attracted only when a higher than proportionate allotment of
fresh shares issued by a company is received by a shareholder

 

FACTS

The assessee was allotted 11,20,000 shares @ Rs. 10
per share, whereas the A.O. determined the fair market value of each share to
be Rs. 20.37. He made an addition of Rs. 1,16,14,400 being the difference
calculated between fair market value and face value u/s 56(2)(vii)(c).

 

The aggrieved assessee preferred an appeal to the
CIT(A) who, observing that the shareholding percentage of the appellant in the
company was the same both before and after the allotment, allowed the appeal.

 

Aggrieved, Revenue preferred an appeal to the
Tribunal.

 

HELD

The Tribunal observed that the issue was the
subject matter of dispute before the ITAT, Mumbai bench in the case of Sudhir
Menon HUF vs. ACIT [2014] 148 ITD 260 wherein the Tribunal held that as
long as there is no disproportional allotment of shares, there was no scope for
any property being received by the taxpayer as there was only an apportionment
of the value of the existing shareholder over a larger number of shares,
consequently no addition u/s 56(2)(vii)(c) would arise.

 

The Tribunal also noted
that in the case of ACIT vs. Subhodh Menon [2019] 175 ITD 449
(Mum.-Trib.) it has held that only when a higher than proportionate
allotment of fresh shares issued by a company is received by a shareholder do
the provisions of section 56(2)(vii) get attracted.

 

In the present case, since
the percentage of shareholding before and after the allotment of new shares
thereof remained the same, the Tribunal upheld the order passed by the CIT(A)
and dismissed the appeal filed by the Revenue.

 

IF TOMORROW COMES…

(This
article appeared in the BCAJ edition of February, 2002.
It is as delightful to read today as it was 19 years ago. As we read about the
tomorrow written 19 years ago, we can see that today was visualised, with
uncanny precision)


Stanley
Kubrick was a maverick film director. In his movie 2001: A space Odyssey, he had
predicted that man would finally encounter extra-terrestrial intelligence in
the year 2001. Nothing like that happened. It did, however, inspire Steven
Spielberg to make the critically acclaimed movie AI.

 

What are
the technologies that will drive our tomorrow? Will we live in twilight
‘sci-fi’ zone where everything is virtual? How will technologies affect our
daily lives? As a chartered accountant, should you really bother? So here they
are. A wild walk into the future – Technologies that will reshape you and your
future.

 

1. Wireless world:

Bet your
last paisa on wireless technology. There is no doubt that wireless will change
our lives dramatically. The only question being asked is – ‘when will it
happen?’

 

Today, the
biggest impact of wireless is in mobile phones. Can you imagine your daily life
without your Nokia or Samsung mobile phone? Mobile phones will proliferate with
‘amoeba-like’ growth. And this is just the beginning.

 

The next
big application of wire-less technology will be wireless Internet.
Third-generation (3G) wireless Internet will roll out soon, with capability of
high bandwidth Internet and streaming audio, video and multi-media. Do-Co-Mo in
Japan has already started giving these services and has met with an exciting
response.

 

Wireless
Internet will become ubiquitous. Your laptop, your mobile phone and your
personal digital assistant (PDA) will have wireless Internet. What will be the
impact on business? Any employee located anywhere in the world will be able to
access the latest corporate information, the latest news and will communicate
with the office and colleagues. Imagine a scenario where you communicate with
all your articled clerks and employees spread all over the globe on a real-time
basis. Imagine being able to update them with the latest notifications and
amendments, whilst they are at a client site rendering advice. Imagine the
endless potential for large companies with a huge sales force. Truly, geography
will become history – unlike Iridium, which coined the tagline ‘Geography is
history’, only to find itself in the history books.

 

2. Byte a chip!

Today, to
access the Internet you need a carrier – typically, a computer. Tomorrow, you
won’t!

 

Everything
you can truly conceive of will have the capability to connect to the Internet –
your lassi-maker, your refrigerator, your
toaster and your car – all your devices. But, what the hell! How does this
impact business?

 

A chip has
the embedded ability to receive, crunch and send data. Imagine a small chip on
all inventory parts in the factory, communicating constantly with wireless
Internet. You will know all details about the entire supply chain, without
having to do any physical check. With embedded intelligence, such chips will be
able to send alerts if certain parameters are breached. It could be an e-mail
alert or an SMS.

 

3. Distribute your computing:

When you
press the switch to start your fan, you expect the electricity to come on
instantly. You do not own a power generation unit either at home or in your
building. Then why do you need to have a huge PC or invest in a server to have
access to computing power? Much like the electricity grid, can’t you have a
computing grid?

 

Distributed
computing gives you the power of a super computer, without having to invest in
one. The processing power of thousands of PCs is aggregated. A central server
sub-divides a large task into bits and assigns it to thousands of computers.
These computers do their processing job and return the results to the server,
which aggregates the results. This kind of computing is ideal for large
processing tasks and is already used in research. Large tasks involving
financial transactions are amenable to distributed computing.

 

4. Move over B2B, it’s time for P2P:

Imagine a
large network with thousands and millions of persons with a commonality of
interest, sharing data and information, creating databases and communicating
instantly. All this without the need to invest in expensive servers. Through
the medium of the Internet, you can communicate and share your files without a
centralised server. Numerous workgroups can create their own space and work
efficiently.

 

The most
famous commercial application of P2P technology is Napster, which allows anyone
to share music files on their computers.

 

Stanley
Kubrick’s futuristic prediction that man will encounter extra-terrestrial
intelligence went awry. But that will not halt the progress of some
technologies which will aptly respond to Sydney Sheldon’s famous best seller If tomorrow comes. The
question you need to ask yourself is – Are
you ready?

 

 

EFFECTIVE USE OF QUORA FOR A PROFESSIONAL

Quora is a place (a website, actually) to gain and share knowledge. It is
a platform to ask questions and connect with people who contribute unique
insights and quality answers. Though it is a social media platform, it works
quite differently. Users do not visit Quora to check
Notifications or ‘Likes’. Quora is a platform where a
user can ask a question and it is answered by various industry experts. In
comparison, on Instagram a celebrity or an
‘Influencer’ (the buzzword in today’s time) posts a photo and / or video and
users interact and give responses based on such videos or photos. In the same
way, Quora is a platform where the basic content is a
question. So, a user can ask questions and industry leaders and experts answer
them.

 

INTRODUCTION

Quora was founded in 2009 by Adam D’Angelo,
former CTO of Facebook, and Charlie Cheever, a former Facebook employee. Based
in Mountain View, California, it is published by Quora
Inc. Although launched in 2009, the website was made public only in June, 2010.
In short, Quora is a question-answer platform that
allows people to ask questions and seek answers from real people. It has nearly
70 crore active monthly users and there are nearly
four lakh open ‘topics’ on it.

 

Now, the new generation has started using Quora to search for answers. For example, when someone wants
to start a new company, they will ask questions on Quora; when they are looking for an income tax idea, they
will seek advice on Quora. It is not a paid
consultancy programme or a platform on which an individual can sell anything
like Just Dial, but the user traffic it generates can help in getting the right
connection.

 

A survey shows that about 1,000 Chartered Accountants have their
profiles on Quora and we can assume that 500 may be
practising. Imagine the competitive edge they have by using this platform. Quora can indeed be an avenue to get new clients. Let us
deep-dive and ask some questions of our own!

 

What is Quora and how can it help
professionals like CAs?

 

Quora provides a platform to share your experience and expertise. People
can follow you and share your ideas within their social network, thus building a
brand for you or your business. The content built on Quora can be shared
on various digital platforms which in a way is ‘Search
Engine Optimisation’ (SEO) fodder; whatever you write is indexed by Google,
relates back to you, which again relates to your business and brand.

 

For example, if you are a ‘GST on healthcare services expert’ and you
provide a good answer to a question on input tax credit, Google brings the users
to your answer and there are high chances that the user may take the next step
of going to your website or social media page and calling your firm for an
estimate. It is through participation on sites like Quora that you add more value to that relationship and help
build count and trust with your audience. Quora is one
tool that can help you do this.

 

Why does using Quora make
sense?

 

What makes Quora unique is the purpose of
the user visiting it. It is neither a search nor a social medium but somewhere
in between, with over 30 crore people visiting it
every month asking for tips and answers and learning about the world around
them. Quora has an edge over other platforms because
the content posted here is easy to find even months and years later, unlike
other social media platforms where it gets buried or disappears.

 

Now that we have explored why Quora is a
powerful channel for your brand awareness and distributing content, let us look
at some steps to get started on Quora.

 

Step 1: Contribute to the conversation

Quora is used by people who are actively looking for answers and are
genuinely interested in what you have to say. Your answers can, of course,
enrich the SEO since many of these answers show up in Google searches. Quora uses an algorithm to pick up your answer and match it
with people interested in the topic. It sends out answers to users following the
topic and there are chances it may reach hundreds or thousands of people.

 

Step 2: Building appropriate content on Quora

To get started, answer questions relevant to your expertise. You may
start providing additional information to the already answered questions by
looking at the missing information. The content on Quora is different from other social media because here the
primary goal is not about the number of views but providing the best answers to
your audience’s questions. Below are quick tips that can help you make useful
content on Quora:

 

? Include facts and personal stories (could be of success or even
failure) to make it relatable;

? Credibility plays a vital role, so make sure that what you write is
factually correct;

? The quickest one to answer has more chances to get up-voted by
users.

 

Step 3: Have a rocking Quora
profile

When you start writing answers, it is important to convey your
expertise and build trust by filling out your Quora
credentials and bio. Unlike other user-generated Q&A sites, users on Quora create profiles based on their real identities. Quora has active moderation policies in place to ensure that
discourse is civil, content quality is high and people feel safe sharing their
knowledge.

 

By adding your title, company, bio, interests and website links, you
signal who you are and why readers should trust your answers. It also helps
people find you when searching for experts and / or the best person to answer
their questions. And be sure to include important links (your website, your
LinkedIn URL, your blogs, or YouTube channels).

 

Step 4: Gain authority and establish your trust with
followers

You are doing amazing well till now on Quora. Your flywheel is picking up speed as you consistently
answer questions and engage with the community. It is now time to gain authority
on the platform. Provide answers that are out of the box and establish trust
with followers.

 

So if someone asks, ‘What is the revised due
date for filing XYZ return?’ you can answer with the due date and add something
else – ‘Companies may face challenges with this’. When you do this, not only
will your audience be interested in reading an answer that could help them, but
you will also earn their trust and gain credibility.

 

There have been professionals who have built such an amazing presence
on Quora that their posts have been viewed lakhs of
times.

 

Step 5: Content distribution

If you are looking to increase awareness about your Quora content, you can cross-distribute your answers.
Consider the following two ideas:

 

Amplify distribution with other social media networks:
If you have answered a good question, why not brag about it on social
media? Consider posting your answers on social media strategically. You can do
this simply by writing – ‘Check out my views on this question’.

 

Send it to the broadcast list: You can consider sending out an update to your broadcast list (email
list) asking them to check your views and provide feedback.

 

To summarise, while Quora is a platform to
build your brand, remember, do not sell anything on Quora or any social media. But that does not stop you from
sharing your experience in the right way and helping the needy. Remember, your
sharing can help even more people.

FRAUD RISK MANAGEMENT IN INTERNAL AUDIT

BACKGROUND

The incidence of fraud is increasing every day. With more frauds and their consequences befalling the stakeholders (shareholders, employees and the government, among others), the regulators are increasing the level of regulation, including disclosures to either prevent or get red flags at an early stage, or to highlight cases to set examples to deter others. The current environment is increasing the pressure on the internal auditor.

In this article we shall discuss the current regulations in India and the steps to be taken by the internal auditor to manage the ‘fraud risk’ and add value to the internal audit function.

In our opinion, frauds may be classified into two types – first, a fraud perpetrated by owners / top management and, second, all cases other than the first one. In case the internal auditor encounters a fraud perpetrated by management, he or she has few options – either become a whistle-blower and report the fraud, or walk away. Each action of the internal auditor will have consequences which he / she may have to decide based on choice and circumstances. Failure to act with integrity and to be just a bystander, or become knowingly or unknowingly a part of the management fraud, has its own set of risks and consequences.

We have a number of cases which have been discussed in the public domain to understand the above, some of the major cases being the ‘Satyam case’, ‘Cox & Kings’ and so on. One major high-profile case cited for an internal auditor to be a whistle-blower is that of ‘Enron’.

FRAUD DEFINITION

As per Webster’s Dictionary, a fraud is (a) deceit, trickery, specifically: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right; (b) an act of deceiving or misrepresenting.

Fraud is defined by Black’s Law Dictionary as A knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.

Consequently, fraud includes any intentional or deliberate act to deprive another of property or money by guile, deception or other unfair means.


Types of fraud

The Association of Certified Fraud Examiners (ACFE) has given the following classification for ‘types of fraud’ which summarises the various types as follows –

Fraud against a company can be committed either internally by employees, managers, officers or owners of the company, or externally by customers, vendors and other parties. Other schemes defraud individuals rather than organisations.

Internal fraud

Internal fraud, also called occupational fraud, can be defined as ‘the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the organisation’s resources or assets.’ Simply stated, this type of fraud occurs when an employee, manager or executive commits fraud against his or her employer.

Although perpetrators are increasingly embracing technology and new approaches in the commitment and concealment of occupational fraud schemes, the methodologies used in such frauds generally fall into clear, time-tested categories.

External fraud

External fraud against a company covers a broad range of schemes. Dishonest vendors might engage in bid-rigging schemes, bill the company for goods or services not provided, or demand bribes from employees. Likewise, dishonest customers might submit bad cheques, falsified account information for payment, or might attempt to return stolen or knock-off products for a refund. In addition, organisations also face threats of security breaches and theft of intellectual property perpetrated by unknown third parties. Other examples of fraud committed by external third parties include hacking, theft of proprietary information, tax fraud, bankruptcy fraud, insurance fraud, healthcare fraud and loan fraud.

Fraud against individuals

Numerous fraudsters have also devised schemes to defraud individuals. Identity theft, Ponzi schemes, phishing schemes and advance fee frauds are just a few of the ways criminals have found to steal money from unsuspecting victims.

Regulatory drivers in India necessitating action by internal auditors

Irrespective of the regulations given below, the internal auditor has to work along with management towards building a structure for prevention and / or detection of fraud in an organisation and build fraud prevention and / or detection objectives in the internal audit programmes.

The Companies Act, 2013 has introduced a requirement under sub-section 12 of section 143 which requires the statutory auditors to report to the Central Government about the fraud / suspected fraud committed against the company by the officers or employees of the company. It states, ‘Notwithstanding anything contained in this section, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within such time and in such manner as may be prescribed.’

The procedures for reporting to the Board or the Audit Committee, reporting to the Central Government, replies and observations of the Board or the Audit Committee and reporting to the Central Government with the external auditor’s comments and other procedures are laid out in the law.

Primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and the management. In the context of the 2013 Act, this position is reiterated in section 134(5) which states that the Board report shall include a responsibility statement, inter alia, that the directors had taken proper and sufficient care for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities.

Requirement of CARO 2020 With Respect to Fraud – According to a clause in CARO 2020 with regard to fraud and whistle-blower complaints, an auditor needs to report whether any fraud on or by the company has been noticed or reported during the year; if yes, the nature and amount involved is to be indicated; in case of receipt of whistle-blower complaints, whether the complaints have been considered by the auditor.

The Securities and Exchange Board of India has issued the SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2020 w.e.f. 8th October, 2020 whereby, inter alia, in case of initiation of forensic audit (by whatever name called) a listed company is required to make the following disclosures to the stock exchange:

Initiation of a forensic audit along with the name of the entity initiating the audit and reasons for the same, if available; and

Final forensic audit report (other than for forensic audit initiated by regulatory / enforcement agencies) on receipt by the listed entity along with the comments of the management, if any.

This has been included under events which shall be disclosed without any application of the guidelines for materiality. Enhancing disclosure requirements is one more step by the regulator, done with a view to disclose potential financial mismanagement to the stock market and the public at large.

Institute of Chartered Accountants of India (ICAI) to come out with Forensic Accounting and Investigation Standards

The Digital Accounting and Assurance Board of the ICAI has issued Exposure Drafts on Standard on Forensic Accounting and Investigation (FAIS) such as FAIS-110 – Understanding the Nature of Engagement; FAIS-120 – Understanding Fraud Risk, and a number of others. These would naturally be the standard in times to come.

As we can see, the regulators are increasing the regulations with the increase in the incidence of fraud. Since the statutory / external auditors are required to report on fraud they necessarily look to internal auditors and expect them to have fraud prevention and / or detection built into their internal audit programmes.

FRAUD RISK MANAGEMENT BY INTERNAL AUDITOR

We have discussed the regulatory drivers but at the same time the Audit Committee and top management does not like any surprise on this count. It is not unheard of now to look to the internal auditor if any untoward incident is uncovered. It is seen that the questions immediately raised are…

When was this area last internal audited?

What was the sample size or why was the entire universe not covered?

Why a particular test could not be built into the internal audit programme to prevent the same?

Why a particular control was not suggested to be designed to prevent such an incident?

What is the size of the incident and for how long is this continuing?

(And many such questions.)

 

We are sure that the internal auditor also would not like any surprises. Frauds cannot be totally prevented but adequate care can be taken to ensure that unless the fraud is a complex one which would have been difficult to be detected under reasonable circumstances, an internal audit exercise should be able to take care of raising the red flag.

 

We would classify the action to be taken by the internal auditor in two parts. First, where the internal auditor is independent but part of the top management team and has a consulting role to play. He or she has negotiated the role of internal auditor as a business adviser to the enterprise. The internal auditor would then be part of designing or testing the design of policies / controls on anti-fraud, etc., which we shall discuss below. The second part is where the internal auditor may not be sufficiently high up but would still have to use / build fraud analytics and other tests into the audit programmes.

 

Where the internal auditor is part of the top management team, he or she would take an active part in designing or testing the design and reviewing the mechanism for anti-fraud controls which would work like a bulwark and deter incidence of fraud or help in raising early warning signals / red flags. Some policies / controls and the mechanisms in place would be –

 

Code of conduct;

Continuous data monitoring / analysis;

Surprise audits;

Regular system of management review;

Anti-fraud policy;

Fraud training for employees;

Job rotation / compulsory vacation;

Whistle-blower policy and rewards for whistle-blowers;

Proper design and review of key controls in ‘Internal Controls over Financial Reporting’.

For internal controls and risk management, the COSO Internal Control and Risk Management guidelines (both are separate guidelines) would be a good source to start looking at understanding and building internal controls, including building anti-fraud controls. The five components of an internal control framework are: control environment, risk assessment, control activities, information and communication, and monitoring.

Each business would have specific controls but to repeat the generic COSO internal control guidelines would be a healthy starting point to understand, build and review internal controls for an internal auditor.

Let us now move to the second part on operational internal auditing where fraud analytic tests based on data analytics are built into each and every individual programme for the internal auditor.

WHAT IS FRAUD ANALYTICS?

Fraud analytics combines analytic technology and techniques with human interaction to help detect potential improper transactions, such as those based on fraud and / or bribery, either before the transactions are completed or after they occur. The process of fraud analytics involves gathering and storing relevant data and mining it for patterns, discrepancies and anomalies. The findings are then translated into insights that can allow a company to manage potential threats before they occur as well as develop a proactive fraud and bribery detection environment.

Case study of a payroll internal audit using Fraud Analytics

The main objective of Fraud Analytics in Payroll is to test the validity and existence of employees and the correctness of pay elements.

 

An illustrative listing of Fraud Analytics in Payroll is –

  •      Map the payroll transaction file to payroll master file to determine if there are ‘ghost’ employees on record and being paid;

  •      Sort employees by name, address, location and other master fields to identify conflict-of-interest scenarios where managers (supervisors) have relatives working for them;

  •     Check for duplicate employees in the master list of employees by name, date of birth, address, bank account number, permanent account number (PAN No.) as a combination of fields or even independent field level duplicate checks;

  •      Perform a pattern-based fuzzy duplicate match in the master list of employees by name and address to identify potential pattern matches on employee name and address;

  •      Compute plant-wise, machine centre-wise, location-wise, correlation score between wage (pay element outgoes) and overtime payments to identify centres with negative correlation scores like falling wage outgoes and rising overtime payouts;

  •      Extract all payroll payments where the gross amount exceeds the set grade threshold limits as per masters;

  •      Compare time-card (attendance) entries to payroll and check for variances like unaccounted ‘leave without pay’;

  •      De-dup checks to identify employees getting the same net pay at multiple locations of the company in the same month;

  •      Profile employees who have not availed any leave in the last one year;

  •      Isolate individuals continuing to get payroll benefits after retirement;

  •      Detect employees getting signing-on bonus payments and leaving before the minimum service period, where signing-on bonus is not recovered;

  •      Filter out payroll payments to employees where nil deductions (including statutory deductions) have been made;

  •      Employees who have re-joined after leaving and continue to get retirement benefits with standard payroll payments;

  •      Inconsistent payroll master allowances within the same groups like grade, designation, location, etc.;

  •      Inconsistent payroll master deductions within the same groups such as grade, designation, location, etc.;

  •      Capture payments to active employees where leave availed is more than the leave balance on hand;

  •     Outliers in payroll payments where the ratio of the highest to the next highest net payroll payment to employees is irregular and excessive;

  •     Locate employees getting multiple increments and bonus payments within the same payroll period;

  •      Compare vendor addresses / phone numbers and employee addresses / phone numbers to identify conflict-of-interest situations.

 

It is important to note that though fraud analytics plays an important role today in any tests to be performed for an internal audit area like payroll, procure to pay cycle, etc., the other activities like interviews, meetings with vendors and employees, physical verification, etc., play an equally important role. Soft issues like body language of the auditee and dealing with auditees and others to understand the issues at hand for the area under audit, are quite important for an internal auditor.

CONCLUSION

It is clear that the responsibility with regard to fraud prevention and detection is increasing for the internal auditor. The regulators are increasing disclosure requirements and the Audit Committee and top management expect that the internal auditor be on guard to continuously help build and review the controls to prevent any incidence of fraud. In case any fraud incident/s does take place, the management would like to have it detected at an early stage.

A proactive internal auditor has to be on top of all this at all times and would most likely have a good fraud risk management programme to –

– increase the bottom line for the organisation (add value to corporate performance);

– ensure compliance with laid-down policies (internal), laws and regulations (external);

– send a clear anti-fraud message;

– enhance the organisation’s image and reputation; and

– get early warning signals / red flags to take pre-emptive action/s.

OFFENCE OF MONEY-LAUNDERING: FAR-REACHING IMPLICATIONS OF RECENT AMENDMENT

Section 3 of The Prevention of Money-Laundering Act, 2002 (PMLA) is
the most important provision and the pivot for many other provisions of the Act.
It deals with the crucial concept of the offence of money-laundering. This
definition was recently amended w.e.f. 1st
August, 2019 by inserting Explanation to section 3.

Section 3 after such
amendment reads as follows.

3.         Offence of
money-laundering

Whosoever directly or
indirectly attempts to indulge or knowingly assists or knowingly is a party or
is actually involved in any process or activity connected with the
1[proceeds of crime including its concealment, possession,
acquisition or use and projecting or claiming] it as untainted property shall be
guilty of offence of money-laundering.

 

2[Explanation – For the removal of doubts, it is
hereby clarified that

(i)         a person shall be guilty of offence of
money-laundering if such person is found to have directly or indirectly
attempted to indulge or knowingly assisted or knowingly is a party or is
actually involved in one or more of the following processes or activities
connected with proceeds of crime, namely –

(a) concealment; or

(b) possession; or

(c) acquisition; or

(d) use; or

(e) projecting as untainted property; or

(f)  claiming as
untainted property;

(g) in any manner whatsoever.

 

(ii)        the process or
activity connected with proceeds of crime is a continuing activity and continues
till such time a person is directly or indirectly enjoying the proceeds of crime
by its concealment or possession or acquisition or use or projecting it as
untainted property or claiming it as untainted property in any manner
whatsoever.]

Explanation
retrospectively brings a sea change

The Explanation has
been inserted in section 3 by the Finance (No. 2) Act, 2019 w.e.f. 1st August, 2019. It begins with the words
‘for the removal of doubts, it is hereby clarified that’. These words
suggest that the Explanation is intended to apply retrospectively. The
Supreme Court has held3  that an Explanation may be
added in declaratory form to retrospectively clarify a doubtful point of law and
to serve as proviso to the main section.

 

There are two parts in the
Explanation. While the first part seems to refine and modify the concept
of money-laundering given in section 3, the second part adds a new angle by
making the offence of money-laundering a continuous offence.

 

Earlier, some ambiguity
was found to exist in section 3. It was contended by the Directorate of
Enforcement that such ambiguity handicapped investigation of the money trail,
the adjudication of attachment by the PMLA Adjudicating Authority and Tribunals,
as also the trial of the offence of money-laundering under PMLA.

 

The handicap was created
by the words ‘and projecting or claiming it as untainted property’ in the
main part of section 3. Due to this, unless it was established in every case
that there was a further act of ‘projecting or claiming’ the
proceeds of crime as untainted property, section 3 could not be invoked. This
was a compulsory pre-condition that was required to be fulfilled due to the word
‘and’ preceding the words ‘projecting or claiming’. In other
words, money-laundering was regarded merely as projection or claiming proceeds
of crime as untainted property. This infirmity in the language of section 3
created a handicap. A person would fall in the earlier part of section 3 but
would escape the rigours of section 3 merely because it could not be
further proved in every case that he ‘projected or claimed’
the proceeds of crime as untainted property.

 

Explanation
(i) now seeks to remove this
lacuna by clarifying vide placement of (e) and (f) as merely one of the
processes or activities the existence of which alone no longer remains a
pre-condition to attract the charge of money-laundering.

 

Having regard to the said
handicap, the Government considered it necessary to widen the scope of ‘proceeds
of crime’. This was done by inserting the Explanation to section 3. The
Explanation clarified the extent to which a person is guilty of the
offence of money-laundering where he is found to have directly or indirectly
attempted to indulge or knowingly assisted or knowingly was a party to or was
actually involved in any manner whatsoever in one or more of the processes or
activities specified in section 3 Explanation (i). The following two
activities have been mentioned in the list of processes or activities in
Explanation (i):

  •             projecting as untainted
    property,
  •             claiming as
    untainted property.

 

The words in
Explanation (i), viz., ‘one or more of the following’ and
‘in any manner whatsoever’ signify that Explanation (i) is
intended to widen the scope of section 3.

 

1   Substituted for ‘proceeds
of crime and projecting’ by the Prevention of  Money-Laundering (Amendment) Act,
2012, w.e.f. 15th February,
2013

2   Inserted by the Finance
(No. 2) Act, 2019, w.e.f. 1st August,
2019

3   Y.P. Chawla vs. M.P. Tiwari AIR 1992 SC
1360, 1362

 

INGREDIENTS OF OFFENCE OF MONEY-LAUNDERING

A broad analysis of
section 3 as amended shows the following ingredients:

  •             The persons regarded as guilty of
    money-laundering – mens rea implied in the definition of
    money-laundering.
  •             Actions must be connected with
    specified processes or activities.
  •             Specified processes or
    activities.
  •             Nexus of the processes or activities
    with ‘proceeds of crime’.
  •             ‘Proceeds of crime’ – defined in
    section 2(1)(u).
  •             Projecting or claiming proceeds of
    crime as untainted property – no longer an essential ingredient of the offence
    of money-laundering.

 

The above six ingredients
of the concept of money-laundering are reviewed as follows:

 

The persons regarded
as guilty of money-laundering – mens rea implied in the definition of
money-laundering

The following four types
of persons are covered in section 3:

 

The person who directly or
indirectly

 

 

 

A review of the four types
of persons mentioned above in relation to the specified processes and activities
gives rise to the question whether mens
rea or a guilty mind is implied in the definition
of money-laundering.

 

Mens rea is
defined in Black’s Law Dictionary (Sixth Edition) as under.

Mens rea

An
element of criminal responsibility; a guilty mind; a guilty or wrongful purpose;
a criminal intent. Guilty knowledge and wilfulness.

 

The aspect of mens rea has been
subject of intensive debate before Courts under Income-tax law in respect of
penal provisions. The Supreme Court has held4  in a number of tax cases that a penal
provision must be strictly construed and that mens rea is a
necessary ingredient for the imposition of penalty.

 

Under the criminal law,
too, unless it is found that the accused had the guilty intention to commit
crime, he cannot be held guilty of committing the crime. Thus, mens rea is
considered an essential ingredient of criminal offence5. The nature
of mens rea
may be implied in a statute creating an offence if the object and the wordings
of the provisions of the statute so suggest.

 

The
Parliamentary debate on the Money-Laundering Bill, 1999 shows that the word
‘knowingly’ did not exist in the definition of
money-laundering. Hence, the
Parliamentary Committee observed that without the word ‘knowingly’, the
provision creating liability for money-laundering was harsh and could result in
a situation where anyone who unintentionally commits the offence of
money-laundering will be regarded as guilty. To avoid such a situation, the
Committee recommended adding the word ‘knowingly’ to indicate that mens rea is an
essential ingredient of the definition of the offence of money-laundering. Thus,
where there is prima facie evidence of a guilty state of mind, the
accused will have the opportunity to disprove the allegation of offence by
presenting satisfactory evidence of honesty of his belief in the action that he
undertook innocently. This principle is now incorporated in section 24 (burden
of proof) that was amended w.e.f. 15th
February, 2013 to provide that in the case of a person not charged with the
offence of money-laundering, the mandatory opportunity to prove the contrary is
not available to such person. This is evident from the absence of the words
‘unless contrary is proved’ before the word ‘presume’ in section
24(b).

 

Accordingly, all four
types of persons who directly or indirectly

 

 

would be guilty
of money-laundering on the premise of their attempt, knowledge and actual
involvement. Section 24 gives such person an
opportunity to prove that he did not commit the offence of money-laundering as
defined in section 3.

 

‘Attempt – connotation
of’

The expression ‘attempt
to indulge in’ in the main part of section 3 and the newly-inserted
Explanation is suggestive of the intention to widen the scope of the
definition of ‘offence of money-laundering’ in section 3.

 

The wording of section 3,
particularly the expression ‘directly or indirectly’ and the expression ‘attempt
to indulge in’, leaves no doubt that even where the attempt does not reach the
stage of completion of the action for which the attempt was made, the charge of
offence u/s 3 would be attracted in the same way as if the criminal act was
consummated.

 

What constitutes an
attempt is indeed a mixed question of law and fact and it depends on the
circumstances of each case to ascertain whether an attempt was made. When the
word ‘attempt’ is juxtaposed with the word ‘prepare’, it is clear that attempt
begins after the preparation is complete.

 

Actions must be
connected with specified processes or activities

To attract the guilt of
offence of money-laundering in section 3, it must be established that the
above-mentioned actions of the person were linked to the specified processes or
activities.

Specified
processes or activities

 

The following processes or
activities connected with proceeds of crime are covered by section 3

•           concealment

•           possession

•           acquisition

•           use

•           projecting as untainted
property

•           claiming as untainted
property.

 

The concepts underlying
the above processes and activities may be reviewed as follows:

The first process
or activity connected with the proceeds of crime is concealment.
Black’s Law Dictionary (Sixth Edition) defines ‘concealment’ as
follows:

To
conceal. A withholding of something which one knows and
which one, in duty, is bound to reveal. Concealment implies intention to
withhold or secrete information so that one entitled to be informed will remain
in ignorance.

 

The second process
or activity connected with proceeds of crime is possession. The
word ‘possession’ is defined in Black’s Law Dictionary (Sixth
Edition) as follows:

Possession. Having control
over a thing with the intent to have and to exercise control.

 

The term ‘possession’ has
been examined by Courts in a number of decisions. A reference may be made, in
particular, to the following decisions:

  •             Union of India vs. Hassan Ali
    Khan (2011) 14 taxmann.com 127 (SC);
  •             Radha Mohan Lakhotia vs. Dy. Director (2010) (5) Bom. Cr 625;
  •             Hari Narayan Rai vs. State of Jharkhand (2011) (6) R Cr
    1415;
  •             Vikash Kumar Sinha vs. State of Jharkhand (2011) (2) J Cr 395 (Jhr).

 

The third process
or activity connected with proceeds of crime is
acquisition.

The word ‘acquisition’ is
derived from the word ‘acquire’ which is defined in Black’s Law
Dictionary (Sixth Edition) as under:

To
gain by any means, usually by one’s own exertions; to get as one’s own; to
obtain by search, endeavour, investment; practice or purchase; receive or gain
in whatever manner; come to have, to become owner of property; to make property
one’s own; to gain ownership of.

 

The term ‘acquisition’ has
also been examined by Courts in various decisions. A reference may be made, in
particular, to the following:

  •  State of
    Maharashtra vs. Mahesh P. Mehta 1985 CrLj 453 (Bom.);
  •  Devilal Ganeshlal vs. Director
    1982 CrLj 588 (Bom.).

 

The fourth process
or activity connected with the proceeds of crime is use. The term
‘use’ is defined in Black’s Law Dictionary (Sixth Edition)
as under:

To make use of; to convert
to one’s service; to employ; to avail oneself of; to utilise; to carry out a
purpose or action by means of; to put into action or service, especially to
attain an end.

 

The fifth process
or activity connected with proceeds of crime is projecting as untainted
property. It is self-explanatory.

 

The sixth process
or activity connected with proceeds of crime is claiming as untainted
property. This, too, is self-explanatory.

 

It may be noted that the
fifth and sixth activities connected with proceeds of crime have been placed in
Part (i) of the Explanation inserted in section 3 w.e.f. 1st August, 2019 to plug a loophole in the
language of section 3. Earlier, ‘projecting or claiming as untainted
property’ of proceeds of crime was a pre-condition to attract section
3.

 

It
was difficult to prove the existence of this fact of projecting or claiming.
This loophole has been plugged by bifurcating the projecting or claiming of
proceeds of crime as untainted property into two separate activities. The
existence of none of these two bifurcated activities is now a pre-condition to
attract the guilt of money-laundering u/s 3.

 

Nexus of the
processes or activities with ‘proceeds of crime’

To attract section 3 it is
necessary to establish that the specified processes or activities are connected
with the proceeds of crime. Without such a nexus of the processes or activities
with the proceeds of crime, section 3 cannot be invoked.

 

“Proceeds of
crime” – defined in section 2(1)(u)

The definition of
‘proceeds of crime’ in section 2(1)(u) needs to be dealt with in detail
to understand significant aspects of the definition on the basis of the legal
position considered by Courts in respect of significant aspects.

 

Projecting or
claiming proceeds of crime as untainted property – no longer an essential
ingredient of offence of money-laundering

All the above-mentioned
constituents of ‘proceeds of crime’ are interlinked and the presence of
any constituent in a given case will attract section 3. According to the law
prior to insertion of the Explanation to section 3
w.e.f. 1st August, 2019, even if a
single one of the above constituents was not found to exist in a given case, the
liability u/s 3 was not attracted to that case. Thus, despite the presence of
all other constituents of ‘proceeds of crime’, if there was no projection
or claiming the proceeds of crime as untainted property, the charge u/s 3 was
considered unsustainable. This position has undergone a sea change after the
insertion of the Explanation to section 3 w.e.f. 1st August, 2019 as explained in
the first paragraph.

 

Apart from the above six
ingredients, the following important aspects of the offence of money-laundering
may also be noted.

 

The offence of
money-laundering – now a ‘continuing’ offence

Explanation (ii)
adds a new dimension to the
rigours of section 3. Now, the offence of money-laundering is not to be
interpreted as a one-time offence that ceases with the processes or activities
specified in Explanation (i). The effect of Explanation (ii) is
that a person shall be considered guilty of the offence of money-laundering so
long as he continues to enjoy the proceeds of crime, thereby making the offence
of money-laundering a continuing offence.

 

The scope of the
Explanation is better understood when read with various amendments made
to the definition of ‘proceeds of crime’.

 

Definition of
“offence of money-laundering” strengthened by Explanation
– observes the
Bombay High Court

In a recent decision, the
Bombay High Court6 
has dealt with the implications of the newly-inserted
Explanation w.e.f. 1st August, 2019.
In this connection, the High Court made the following significant
observations:

 

‘The offence of money laundering as defined in
section 3 of the PMLA is wide enough to cover an act of a person who directly or
indirectly attempts to indulge or knowingly assists or knowingly is a party or
is actually involved in any process or activity connected with the proceeds of
crime including its concealment, possession, acquisition or use and projecting
or claiming it as untainted property. The Explanation appended to the said
section clarifies that a person shall be held guilty of the offence of money
laundering if such person is found to have directly or indirectly attempted to
indulge or knowingly assisted or knowingly is a part or is actually involved in
one or more of the following processes or activities connected with proceeds of
crime, i.e., concealment or possession or acquisition or use or projecting or
claiming as untainted property, in any manner whatsoever. The process or
activity connected with proceeds of crime is a continuing activity and continues
till such time a person directly or indirectly enjoys the proceeds of crime by
various acts referred to in the sub-clause (i)’.

 

 

4              Dilip N. Shroff vs. CIT 291 ITR 519
(SC): (2007) 6 SCC 329; Ram Commercial Enterprise Ltd. vs. CIT 246 ITR 568; CIT
vs. Reliance Petroproducts Pvt. Ltd. 322 ITR 158 (SC):

5   Nathulal vs. State of MP AIR 1966 SC
43

6   Dheeraj Wadhawan vs. Directorate
of Enforcement (Anticipation Bail Appl. No. 39 & 41 decided by Bombay High
Court on 12th May, 2020).

CONCLUSION

While making due diligence to report compliance with various
statutory laws, as a part of forensic audit or internal audit function as
regards compliance with the provisions of the Prevention of Money-Laundering
Act, 2002, the new definition of the offence of money-laundering in section 3 as
amended w.e.f. 1st August, 2019 will have
to be kept in mind. The compliance checklist will have to be modified
appropriately to cover all the limbs of section 3 and, in particular, the
newly-inserted Explanation.

 

If there is a lapse made
by a Chartered Accountant entrusted with reporting the compliance of all
statutory laws, including the Prevention of Money-Laundering Act, 2002, he may
be held liable for negligence in his professional duties.

THE CONUNDRUM OF ‘MAY BE TAXED’ IN A DTAA

INTRODUCTION

The liability to pay tax on global income of a resident assessee u/s 4 r/w/s 5 of the Income -tax Act, 1961 (the
Act) is subject to Double Taxation Avoidance Agreements (DTAA) entered into by
the Government with foreign countries u/s 90 of the Act.

 

As per section 90(1), the Government may enter into agreements with
foreign countries for (a) granting of relief in respect of income on which have
been paid both income-tax under the Act and income-tax in that country, (b) for
avoidance of double taxation of income, (c) for exchange of information for the
prevention of evasion or avoidance of income tax, and (d) for recovery of
income-tax under the Act and under the corresponding law in force in that
country.

 

In order to achieve the object of avoidance of double taxation, two
rules are generally adopted under a DTAA:

  •  Allocating taxing rights between contracting States with respect to
    various kinds of income, called distributive rule, and
  •  Obligating the State of residence to give either credit of taxes
    paid in the source State or to exempt the income taxed in the source
    State.

 

In this regard, DTAAs are found to use one or more of the following
phrases:

‘shall be taxable only’

‘may be taxed’

‘may also be taxed’.

 

The expression ‘shall be taxable only’ indicates that exclusive right
to tax is given to one contracting State. The expression ‘may also be taxed’
indicates that the right to tax is given to both contracting States.

 

As regards the expression ‘may be taxed’, it has been the subject
matter of interpretation as to whether it would mean the right to tax is given
only to the source State or to both contracting States.

 

In CIT vs. R.M. Muthaiah [1993] 292 ITR 508
(Kar.), the Honourable Karnataka High Court interpreting Article 6(1) of
the Indo-Malaysia DTAA which provides that ‘Income from immovable property may
be taxed in the contracting State in which such property is situated’ held that ‘when a power is specifically recognised as vesting in one,
exercise of such a power by others, is to be read as not available; such a
recognition of power with the Malaysian Government would take away the said
power from the Indian Government’. Thus, the Court held that as the immovable property is situated in
Malaysia, the power to tax income vested with the Malaysian Government and not
with the Indian Government.

 

The aforesaid decision is approved by the Supreme Court in UOI vs. Azadi Bachao Andolan [2003] 263 ITR 706
(SC) (see page 724).

 

In CIT vs. P.V.A.L. Kulandagan Chettiar [2004] 267 ITR 654 (SC), on the basis of the decision in Muthaiah (Supra), it was argued that the expression ‘may be taxed’ should be read as
‘shall only be taxed in the source State’. The Supreme Court held that when a
person resident in India is deemed to be a resident of Malaysia by virtue of his
personal and economic relations, his residence in India will become irrelevant
under the DTAA. The Court held that the assessee is
liable to tax only in Malaysia and not in India as his income from estate is not
attributable to a permanent establishment in India. Thus, the decision was
rendered on an altogether different ground. In fact, the residence of the assessee therein was never put to question before any
appellate authority / court including the Supreme Court. Although the Supreme
Court did not deliberate upon the phrase ‘may be taxed’, it did not upset the
decision in Muthaiah (Supra).

 

The decision of Kulandagan Chettiar (Supra) was understood [albeit incorrectly, if we may say so with utmost respect] by various Courts
as holding that the term ‘may be taxed’ has to be read as ‘shall be taxed only
in source State’. The following is the illustrative list of such
cases:

 

Dy. CIT vs. Turquoise Investment & Finance Ltd. [2006] 154 Taxman
80 (Madhya Pradesh) affirmed in Dy. CIT vs. Turquoise Investment & Finance Ltd. [2008] 168
Taxman 107 (SC);

Bank of India vs. Dy. CIT [2012] 27 taxmann.com 335 (Mum.)
upheld in CIT vs. Bank of India [2015] 64 taxmann.com 215 (Bom.);

Emirates Fertilizer Trading Co. WLL, In re [2005] 142 Taxman 127 (AAR);

Apollo Hospital Enterprises Ltd. vs. Dy. CIT [2012] 23 taxmann.com
168 (Chennai);

Daler Singh Mehndi vs. DCIT [2018] 91
taxmann.com 178 (Delhi-Trib.);

Ms Pooja Bhatt vs. CIT
2008-TIOL-558-ITAT-Mum.;

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.).

 

The Legislature introduced sub-section (3) to section 90 by the
Finance Act, 2003 w.e.f. 1st April, 2004.
As per section 90(3), any term used but not defined in the Act or in the DTAA
shall, unless the context otherwise requires, and is not inconsistent with the
provisions of the Act or the DTAA, have the same meaning as assigned to it in
the Notification issued by the Central Government in the Official Gazette in
this behalf.

 

In exercise of powers under the aforesaid section, CBDT issued
Notification No. 91 of 2008 dated 28th August, 2008 wherein it
clarified that where the DTAA provides that any income of a resident of India
‘may be taxed’ in the other country, such income shall be included in his total
income chargeable to tax in India in accordance with the provisions of the Act
and relief shall be granted in accordance with the method for elimination or
avoidance of double taxation provided in such agreement.

 

In this article, an attempt is made to address the question whether
the decision in Muthaiah (Supra) is upset by the aforesaid Notification.

 

ANALYSIS

Analysis of Notification 91 of 2008

It may be noted that the scope of section 90(3) is to enable the
Central Government to only ‘define’ any term used but not defined in the Act or
in the DTAA. The memorandum to the Finance Bill, 2003 also clarifies that the
aforesaid provision is inserted to empower the Central Government to define such
terms by way of a Notification.

 

However, Notification No. 91 of 2008 does not define ‘may be taxed’.
It rather seeks to clarify the stand of the Government when such a phrase is
used. The said Notification in seeking to clarify the stand of the Government
has traversed beyond the scope of section 90(3). The words ‘may be taxed’ are at
best a phrase and not a term so that the definition of a phrase is not even in
the contemplation of section 90. Therefore, the validity of the aforesaid
Notification is open to challenge. Even if its validity is not put to challenge,
its enforceability may be doubted by the Courts.

Certain benches of the Tribunal have held that the legal position
understood as adumbrated in Kulandagan Chettiar (Supra) has undergone a sea change after the issue of the aforesaid
Notification and the words ‘may be taxed’ will not preclude the right of the
State of residence to tax such income. The following is the illustrative list of
such cases:

 

Essar Oil Limited vs. ACIT [2011] 13 taxmann.com 151
(Mumbai);

Essar Oil Ltd. vs. Addl. CIT [2014] 42 taxmann.com 21
(Mumbai);

Technimont (P) Ltd. vs. Asst. CIT [2020] 116 taxmann.com 996
(Mumbai-Trib.);

N.V. Srinivas vs. ITO [2014] 45 taxmann.com
421 (Hyderabad-Trib.)

 

As stated earlier, Kulandagan Chettiar did not lay down such principle. In fact, such principle was laid
down in Muthaiah which was approved in Azadi Bachao Andolan
(Supra). Further, as stated earlier, the principle of Muthaiah could not have been upset by the Notification No. 91 of 2008.
Therefore, it is trite to say that the principle of Muthaiah as approved in Azadi Bachao
Andolan holds the field as of date.

 

IMPACT OF MLI

India has signed Multi-Lateral Convention to Implement Tax
Treaty-Related Measures to Prevent Base Erosion and Profit Shifting
(‘Multi-Lateral Instrument’ or ‘MLI’).

 

MLI enables the contracting jurisdictions to modify their bilateral
tax treaties, i.e., DTAAs, to implement measures designed to address tax
avoidance. Therefore, the DTAAs have to be read along with the MLI.

 

MLI 11 deals with ‘Application of Tax Agreements to Restrict a
Party’s Right to Tax its Own Residents’. India has not reserved MLI
11.

 

The countries which have chosen MLI 11(1) with India (as on
29th September, 2020) are as under [source:
https://www.oecd.org/tax/beps/mli-matching-database.htm]:

Sl. No.

Name of countries

1

Armenia

2

Australia

3

Belgium

4

Colombia

5

Denmark

6

Fiji

7

Indonesia

8

Kenya

9

Mexico

10

New Zealand

11

Norway

12

Poland

13

Portugal

14

Romania

15

Russia

16

Slovak Republic

17

United Kingdom

 

As per MLI 11(1) a Covered Tax Agreement shall not affect the
taxation by a Contracting Jurisdiction of its residents, except with respect to
the benefits granted under provisions of the Covered Tax Agreement which are
listed in clauses (a) to (j).

 

Clause (j) deals with the provisions of DTAA which otherwise
expressly limit a Contracting Jurisdiction’s right to tax its own residents or
provide expressly that the Contracting Jurisdiction in which an item of income
arises has the exclusive right to tax that item of income.

 

For example, Article 7(1) of the Indo-Bangladesh DTAA provides that
‘The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If the
enterprise carries on business as aforesaid, then so much of the profits of the
enterprise as is attributable to that permanent establishment shall be taxable
only in that other Contracting State.’

 

The aforesaid article expressly takes away the right of the resident
country to levy tax on profits attributable to its PE.

 

Thus, in the absence of an express provision, the right of the
resident country to tax its residents cannot be taken away under the DTAA.
Therefore, the expression ‘may be taxed’ cannot be construed to mean ‘shall be
taxable only in the source state’, unless it is expressly stated. It may be
noted that the aforesaid proposition would apply only with respect to countries
which have opted for MLI 11 with India. It cannot be applied to countries which
have not chosen MLI 11 and which have not signed the MLI.

 

Now, the question that arises is whether the decision in Muthaiah would apply with respect to countries which have not chosen MLI 11
or countries which have not signed the MLI.

 

It may be noted that in certain DTAAs a clarification has been given
to the expression ‘may be taxed’ through protocols by stating that the said
expression should not be construed as preventing the resident country from
taxing the income. For example:

 

Indo-Malaysia DTAA: In paragraph 3 of the protocol signed on 9th May, 2012 it
has been stated that the term ‘may be taxed in the other State’ should not be construed as preventing the country of residence from
taxing the income.

 

Indo-South Africa DTAA: In paragraph 1 of the protocol signed on 26th July, 2013
it has been stated that wherever there is reference to ‘may be taxed in the other Contracting State’, it should be understood that income may, subject to the provisions
of Article 22 (Elimination of Double Taxation), also be taxed in the
first-mentioned Contracting State.

 

Indo-Slovenia DTAA: Under paragraph 2 of the protocol signed on 13th January,
2013 it has been stated that with reference to Article 6(1) and Article 13(1) it
is understood that in case of India income from immovable property and capital
gains on alienation of immovable property, respectively, may be taxed in both
Contracting States subject to the provisions of Article 23.

 

Thus, with respect to DTAAs like those above, the decision in
Muthaiah would not apply. With respect to the rest of the DTAAs, the decision
in Muthaiah would continue to apply.

 

CONCLUSION

With respect to countries which have adopted MLI 11, the right of
India to tax its residents cannot be taken away unless such right is expressly
taken away under a DTAA. This would mean that with respect to such cases the
decision in Muthaiah would not apply.

With respect to countries which have not adopted MLI 11 and which
have not signed MLI:

(a) India cannot tax its residents with respect to income derived
from source State, unless such right is expressly provided under the DTAA as in
the Indo-Malaysia DTAA, the Indo-South Africa DTAA, the Indo-Slovenia DTAA, etc.
This would mean that with respect to such cases the decision in Muthaiah would apply.

(b) Notification No. 91 of 2008 does not
apply as the said Notification has been issued beyond the scope of section
90(3).

 

TAXING THE DIGITAL ECONOMY – THE WAY FORWARD

The economy today is truly digital; from
business and entertainment, to food and travel, everything is accessible online.
To veterans in business, everything digital is a revolution and is often termed
Industry 4.0; to a school kid, it’s the way of life that they were born into.
Commerce and business is no longer limited by territorial
boundaries.

 

The digital economy is growing at an exponential rate while countries
are still debating mechanisms for taxation of the digital economy. On the
entertainment front, films moved from reels to disks and have now become content
that is streamed. Music moved from records to tapes to disks to downloads and is now streamed live. It is important to note
that while the modus of conducting business has changed, it is still the
same products and services that are supplied, albeit in a different
form.

 

Digital means of communication and social interaction are giving rise
to new businesses that did not exist very long ago. Many of these businesses
that have developed only in the last two decades have taken over a considerable
share of market segments and form a significant part of the economy and tax
base. Their growth in India has also reached proportions that make them
significant actors in the Indian economy1
.

 

Laws that are currently in place are at the behest of metrics that
were designed to tackle the then available modes of conducting business.
Developments in businesses with the aid of technology only means that they
function in a niche area where there is little or no governance and
countries have started expressing the view that they are not getting their fair
share of revenue and there is a demand for taxing rights across the
world.

 

Debates and deliberations on taxing the digital economy have been
taking place throughout the world; international organisations like the OECD and
the UN and even others that are meant for regional co-operation have involved
stakeholders and other key parties in the debates; they even adopted a
Multi-Lateral Instrument (MLI) – and yet, any consensus on arriving at a
suitable legal framework remains elusive.

Important and interesting questions are inevitable on who gets such
rights; or whether a number of nations who participate in the transactions
should pool such taxing rights; what would be the profits that would be
available for taxation, etc.– all these are questions in search of
answers.

 

When these questions are attempted to be answered, one realises that
the existing laws are woefully inadequate and the elusive consensus in the OECD,
the non-participation of the USA in the entire discussion and the new initiative
from the UN only amplify the cacophony of confusion. Unilateral initiatives such
as digital taxes, equalisation levies and cross-border wars have only made
things more difficult.

 

__________________________________________________________________________________________________________________________________

1   CBDT, Proposal for
Equalization Levy on Specified Transactions, Report of the Committee on
Taxation of E-Commerce (2016)

POSSIBLE SOLUTIONS

In this article, an attempt has been made to think out of the box and
explore new solutions based on some past tested practices, apart from ensuring
that taxing rights are adequately conferred without compromising the tax credit
through the DTAA.

 

Solution
No. I: Theory of
Presumptive Taxation – Payment for Digital Business

Presumptive taxation exists for certain businesses through provisions
in the domestic statutes. In India, section 44BB of the Income-tax Act, 1961
provides that where a non-resident provides services or facilities in connection
with or supplying plant and machinery used or to be used in prospecting,
extraction, or production of mineral oils, the profit and gains from such
business chargeable to tax shall be calculated at a sum equal to 10% of the
aggregate amounts paid or payable to such non-residents. This presumptive
taxation has been extended to the business of operating aircraft (section 44BBA)
and to civil construction and erection of plants under certain turnkey projects
(section 44BBB). An interesting feature of these presumptive taxation provisions
is that an assessee can claim lower profits than the
profits specified in the presumptive mechanism provided he maintains books of
accounts and other records and furnishes a tax audit report u/s
44AB.

 

This presumptive taxation can have the following
features:

(i)         It can be a
provision in the domestic statute and apply to non-residents who are engaged in
identified digital businesses which involve B2C transactions;

(ii)        The MLI route
should be adopted to ensure that the source State gets a right to tax digital
business in addition to the resident State without diluting the eligibility to
claim set-off of taxes in the said State;

(iii)       ‘Digital business’
can be defined to mean the activity of supply of goods or services over the
internet or electronic network either directly or through an online platform,
and includes supply of digital goods or digital services, digital data storage,
providing data or information retrievable or otherwise in electronic form. This
category should be a separate category apart from Fees for Technical Services
and Royalty;

(iv)       ‘Digital goods’ can
be defined to mean any software or other goods that are delivered or transferred
or accessed electronically, including via sound, images, data, information, or
combinations thereof, maintained in digital format where such software or other
goods are the principal object of the transaction as against the activity or
service performed or rendered to create such software or other
goods;

(v)        ‘Digital service’
can be defined to mean any service that is provided electronically, including
the provision of remote access to or use of digital goods, and includes
electronic provision of the digital service to the customer;

(vi)       The tax would be on
the deemed income which in turn would be a specified percentage of the payments.
A percentage of the amounts paid or payable by the customer to the overseas
supplier of digital goods or services can be identified as income deemed to
accrue or arise in a market jurisdiction;

(vii)      A clear definition
of the businesses covered in this segment would be required to ensure
transparency, compliance, ease of business, simplicity in tax administration,
etc.;

(viii)     While the tax would
remain a tax on income, there can be two models for collection:

  •             The first model
    would require the non-resident to obtain a special and simple registration in
    the source jurisdiction and pay tax at the presumptive rates;
  •             The second model
    would require that the tax be paid by the bank or financial institution or
    payment gateway or financial intermediary. This identified party shall pay the
    tax at the time of remittance of the payment itself. Assuming that USD 100 is
    payable for digital goods or services, that the presumed income is 10% and the
    tax rate 20%, the identified intermediary would be
    bound to release only USD 98 and remit USD 2 as taxes on behalf of the
    non-resident. This amount should be available as credit to the non-resident
    under the DTAA;

(ix)       It has to be ensured
that the payment by the identified intermediary is not in the nature of
withholding taxes but payment of taxes on behalf of the non-resident. This will
ensure that issues with reference to grossing up of payments are
avoided.

 

Solution No. II: Theory of Apportionment based on FARE

One of the methods that can be debated and examined in order to
arrive at a solution for taxing digital transactions would be based on the
theory of apportionment. Apportionment as a concept exists in many indirect tax
laws across the world. Typically, in GST input tax credit is apportioned in the
context of taxable and exempt supplies. While FAR is an established
principle which covers Functions, Assets and Risk, FARE would cover
Functions, Assets, Risk and Economic Presence.

 

In the context of property taxes, the Oregon Supreme Court in the
case of Alaska Airlines Inc. vs. Department of
Revenue2 upheld the position adopted by the Revenue
where the assessment was based on the presence, as reflected in air and ground
time, of aircraft property in that State. The taxes were proportionate to the
extent of the activities of the airlines’ units of aircraft properties within
the State. While engaging in these activities, the airlines enjoyed benefits,
opportunities and protection conferred or afforded by the State’s search and
rescue services, opportunities for further commerce and the protection of Oregon
criminal laws, and so could be made to bear a ‘just share of State tax burden’.
The taxes were fairly related to services provided by the State.

 

In the USA, questions arose as to the right of States in the context
of taxes and a four-pronged test was laid down by the US Supreme Court in the
case of Complete Auto Transit Co. vs. Brady3
wherein it was observed that this Court in a number of decisions has sustained a
tax against Commerce Clause challenge when

(i)         The tax is applied
to an activity with a substantial nexus with the taxing State,

(ii)        The tax is fairly
apportioned,

(iii)       The tax does not
discriminate against interstate commerce, and

(iv)       The tax is fairly
related to the services provided by the State.

 

This four-pronged test is an interesting test which can be the
starting point for working out provisions for taxing the digital economy.
The traditional concept of exclusive taxation by one State or double
taxation with credits which is established through DTAA may have to give way to
a new system wherein there will be a fair apportionment of tax between the
source State as well as the residence
State.

 

The challenges would be to identify a fair apportionment between the
countries. There could be complications where multiple countries are involved.
Insofar as the US is concerned, there are statutory apportionment formulae which
are based on property, payroll and sales.

 

The Functions, Asset, Risk (FAR) Test can be expanded to a Functions,
Asset, Risk, Economic Presence (FARE) Test. The Economic Presence could, of
course, mean Significant Economic Presence and would be a combination of revenue
thresholds and number of transactions. Accordingly, FARE would represent the
following.

 

  •  Functions can cover the access and penetration
    in the market;
  •  Assets deployed could cover the website, the
    artificial intelligence solutions, the technology platforms which are used in
    the transaction delivery mechanism to the market instead of focusing on their
    physical location;
  •  Risks inherent to digital businesses such as
    privacy, security, vulnerability of data, etc., can be given adequate
    weightage;
  •  Economic Presence could be based on threshold
    in terms of sales or volume of transactions.

 

In this model, countries will have to debate and arrive at a
consensus on what would constitute Significant Economic Presence. The solutions
so arrived at should be implemented through a Multi-Lateral Instrument
(MLI).

 

It may be possible to apply Solution No. II for B2B
transactions and Solution No. I for B2C
transactions. Further, B2C should not be confined merely to customers but
should be comprehensive enough to cover businesses that are
end-users.

 

Solution
No. III: Theory of
Access – ePE (Digital PE)

A building site or construction, installation or assembly project or
supervisory activities in connection therewith constitutes a PE under Article 5
based on breaching a period threshold. Similarly, an installation or structure
used for exploration or exploitation of natural resources constitutes a PE when
it breaches a particular period threshold. The period differs between the UN
Model and the OECD Model.

 

Where the number of days or months can be the basis for determination
of PE, it should be possible to arrive at a new concept of ePE (Digital PE) based on the number of users who have
accessed the goods or services provided by a non-resident through digital
means. In effect, this would seek to identify nexus to a market jurisdiction
based on access exercised by the customers in that jurisdiction through
electronic means for procurement of goods and services. A new definition or an
additional category to the existing Permanent Establishment definition will have
to be agreed upon and developed.

 

Care must be taken to ensure that a digital PE is clearly linked with
the breach of the number of users threshold. There must
not be any reporting requirements or compliance requirements from a user’s
perspective but a non-resident business which transacts in a market jurisdiction
digitally will have to report the number of users of its website linked with
transactions consummated. A customer-driven reporting may not work given the
fact that the customer can access the website through multiple devices and from
anywhere in the world. Once a PE is established the normal principles for
attribution of profits will come into play.

 

This is based on the premise that any supply of goods or services by
way of electronic commerce would necessarily involve intermediaries such as
banks, payment gateways, internet service providers, etc. The number of
transactions consummated in a particular jurisdiction can be easily identified
based on data provided by the various institutions. One of the key elements in a
transaction of procurement of goods or services through the internet is the
payment. This payment is also made online.

 

For example, if this logic is extended, one possible solution for
taxing digital entertainment in the country where it is downloaded or
viewed is to identify that the income arises or accrues or deems to arise or
accrue in the country in which the said digital content is downloaded or
streamed. Insofar as download or streaming of entertainment content is
concerned, there would be data points such as a customer having a registration;
having a user ID and password; network login details; payment for the content
and downloading / streaming data.

There are two challenges in this solution, namely,

(i)         Identification of
profits attributable to the country in which the content is downloaded or
streamed; this could be addressed by a deemed agreed percentage, and

(ii)        Illegal download or
streaming of content, payment through non-banking channels, payment through
unregulated virtual currencies, free services.

 

Solution
No. IV: OIDAR – The
Direct Tax Twin

Drawing an analogy from India’s GST provisions which identify OIDAR
(online information database access and retrieval) services that are supplied to
a non-taxable online recipient, or even the same model, can be emulated from a
direct tax perspective. Insofar as OIDAR services which are automated and
provided by a supplier who is a resident of another nation are concerned, the
said supplier can be required to pay income tax in the nation where the
recipient resides. Care should be taken to ensure that the levy retains the
character of direct tax and does not convert itself into a consumption tax. The
identification of taxability can be linked with the GST provisions but the tax
should be only on the profits. Nations can agree upon a certain percentage of
the receipts / payments on account of such supplies to be deemed as the income
accruing or arising in the recipient country. This would also meet the
requirement of nexus to the market jurisdiction. Tax credit has to be
ensured.

 

Solution
No. V: Tax
Collection at Source (TCS)

Section 206C provides that a seller at the time of debiting the
amount payable by the buyer to the account of the buyer, or at the time of
receipt of amounts from the buyer, whichever is earlier, has to collect as
income tax a specified percentage of the amount in respect of specified goods.
For example, a seller of scrap will have to collect 1% as TCS from the buyer.
The amount collected represents the income tax payable by the buyer. The buyer
will get the credit of tax so collected against his income-tax liability. This
model can be examined and modified in the following manner:

 

(i)         Any person who
facilitates payment for supply of digital goods or services shall be liable to
collect tax at source at a specified percentage. This tax shall be collected as
income-tax and should be available as credit to the non-resident supplier of
goods and services;

(ii)        Person facilitating
payment would mean the bank or financial institution or financial intermediary
or e-wallet service provider;

(iii)       To illustrate, if a
non-resident supplies digital content and the resident uses his credit card for
making payment of USD 100, the bank becomes responsible for making the payment
by way of TCS. Assuming that TCS is notified at the rate of 1%, the bank, at the
time of transfer of funds to the non-resident supplier, will deduct 1% being the
tax, apart from any other applicable transaction charges;

(iv)       The supplier will have
to obtain a simplified registration in the market jurisdiction and will have a
tax account which will reflect the payments by way of TCS;

(v)        The system should
automatically generate a certificate for payment by way of tax in the market
jurisdiction which would be available for claiming credit of taxes in the
country of residence under the treaty.

 

The
solutions referred to above are ideas which can be debated and developed into
effective and sustainable solutions. A solution to be effective has to be
certain and simple with uniform application. The aspirations of the market
jurisdiction in seeking taxing rights and the concerns of nations which are
worried about losing revenue will have to be balanced to ensure that the new
system that is created benefits one and all. At the end of the day, the levy of
taxes should not end up in scuttling new ideas and growth in the digital
environment.

PFUTP REGULATIONS – BACKGROUND, SCOPE AND IMPLICATIONS OF 2020 AMENDMENT

Fraud shakes investor
confidence and damages both the capital markets and capital-raising because
people develop long memories when they lose a large part of their hard-earned
savings because of fraud. The disillusionment with the markets, a consequence
of the Harshad Mehta scam in the early 1990s, lingers even today. Though the
Harshad Mehta scam was really a massive banking scandal, it was the securities
markets which took the blame for it as the tainted and stolen money was put
into the securities markets on a huge scale leading to market manipulations and
disruptions. Another scam with Ketan Parekh at its helm towards the beginning
of this century, and later India’s most (in)famous corporate scam in recent
years, at Satyam Computers Limited, have shaken investor confidence in the
capital markets and corporate India. Fraud has a system-wide impact on the
economy and society, and not just on those defrauded. Where fraud exists,
honest companies’ cost of raising capital becomes higher, whether it’s issuing
debt or equity securities.

 

1.     BACKGROUND
TO REGULATION OF FRAUD AND MANIPULATION BY SEBI

Almost invariably,
successful economic times hide many problems including fraud to take root even
more easily in times of economic bubbles. The beta
of the market hides the negative alpha
of frauds. As the economic waters recede, many frauds are uncovered as it is no
longer possible to skim off returns without being noticed when the markets
can’t hide your fraud. Such phases are invariably followed by reports,
committees, investigations and, finally, new regulations.

 

After periods of fraud like
the ones led by Charles Ponzi, Harshad Mehta, Enron and WorldCom, and Ramalinga
Raju of Satyam Computers Limited, a host of new regulations were brought in.
The Harshad Mehta scam helped mould the outlook of the modern regulator of
India, SEBI, on the need for a robust regulatory environment.

 

SEBI recognised that in
order to ensure confidence, trust and integrity in the securities market, there
was a need to ensure fair market conduct. Fair market conduct can be ensured by
prohibiting, preventing, detecting and punishing such market conduct that leads
to market abuse. Market abuse is generally understood to include market
manipulation and insider trading and such activity is regarded as an
unwarranted interference in the operation of ordinary market forces of supply and
demand and thus undermines the integrity and efficiency of the market1
which, in turn, erodes investor confidence and impairs economic growth2.

 

It was for this purpose,
i.e., to ensure fair market conduct, to deal with fraudulent and unfair trade
practices related to the securities market, and to provide for the means of
detection, prohibition and prevention thereof3 that SEBI framed the
Prohibition of Fraudulent and Unfair Trade Practices relating to Securities
Markets, Regulations, 1995. These were thereafter reviewed and replaced with
the SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to
Securities Market) Regulations, 2003 (PFUTP
Regulations) which were notified on 17th July, 2003 and thereafter
amended in 2012, 2013, 2018 and 2020, respectively4.

 

The Supreme Court has
highlighted5  that the object
and purpose of the PFUTP Regulations is to safeguard the investing public and
honest businessmen. It is established6 that the aim of the
Regulations is to prevent exploitation of the public by fraudulent schemes and
worthless securities through misrepresentations, to place adequate and true
information before the investor, to protect honest enterprises seeking capital
by accurate disclosures, to prevent exploitation against the competition
afforded by dishonest securities offered to the public and to restore the
confidence of the prospective investor in his ability to select sound
securities.

The underlying aim behind
enacting the PFUTP Regulations is thus to preserve market integrity and to
prevent market abuse. The Supreme Court also asserted that in order to
effectively ensure security and protection of investors from fraud and market
abuse, SEBI, as regulator of the securities market must sternly deal with
companies and their directors indulging in manipulative and deceptive devices,
insider trading, etc., or else the regulator will be failing in its duty to
promote orderly and healthy growth of the securities market7.

 

 

__________________________________________________________________________________________________________________________________

1   Palmer’s Company Law, 25th Edition
(2010), Volume 2 at page 11097; Gower & Davies-Principles of Modern Company
Law, 9th Edition (2012) at page 1160

2   T.K. Vishwanathan Committee, Report of
Committee on Fair Market Conduct (8th August, 2018)

3   Munmi Phukon, ‘SEBI’s expanded power to
protect investors’ interest’ < http://vinodkothari.com/2019/01/sebis-expanded-power-to-protect-investors-interest/>

4   Id

5   SEBI vs. Kanhaiyalal Baldevbhai Patel,
2017 (8) SCJ 650

vinodkothari.com/2019/01/sebis-expanded-power-to-protect-investors-interest/>

6   Id

7   Id

 

2.     WHAT
CONSTITUTES FRAUD AND UNFAIR TRADE PRACTICES?

When one speaks of fraud in
general, it could include all forms of unfair behaviour starting from the
morally improper to the legally prohibited. However, fraud when legally defined
is a term of art used to describe a wide variety of conduct which is
fraudulent, deceptive or manipulative. At the same time, all conduct which may
be unfair may not be fraudulent.

 

Fraud

A subject like fraud which
attracts a lot of careful attention because of the stigma attached to it must
be read and interpreted carefully so that non-fraudulent conduct does not get
caught in its net. The definition of fraud under the PFUTP Regulations thus
requires a closer scrutiny and better understanding. It says that ‘“fraud” includes any act, expression, omission or
concealment committed whether in a deceitful manner or not by a person or by
any other person with his connivance or by his agent while dealing in
securities in order to induce another person or his agent to deal in
securities, whether or not there is any wrongful gain or avoidance of any loss…’

 

However,
this definition of fraud under Regulation 2(1) of the PFUTP Regulations does
not clearly delineate the scope of fraud. What is stated therein is only part
of the expanse of the definition. If anything, the definition is not exhaustive
but only indicative by example. And the examples outlined by SEBI include, inter alia, a knowing misrepresentation of truth, active concealment of material
facts, suggesting as a fact something known to be untrue by the person making
it, a promise made without any intention of performing it and other deceptive
behaviour with a view to induce another person to act to his detriment or to
deprive him of informed consent and full participation. Further,
the definition includes within its ambit representations made in a reckless or
careless manner (irrespective of whether or not the same are true), acts or
omissions specifically declared to be fraudulent, false statements made without
reasonable ground for believing them to be true. Further, acts of an issuer of
securities involving misinformation affecting the market price of the
securities in a misleading manner also falls within the scope of the definition
as explicitly laid down thereunder.

 

However, general comments
made in good faith in regard to the economic policy of the government, the
economic circumstances of the country, trends in the securities market or any
other matter of like nature, whether such comments are made in public or in
private, are excluded from the definition of fraud.

 

Thus, the scope of
definition of fraud provided by SEBI is not exhaustive. Regulations 3 and 4
enlist ingredients of fraudulent and unfair trade practices. The term fraud has
been interpreted by the Supreme Court in SEBI
vs. Kanhaiyalal Baldevbhai Patel8
to be wider than ‘fraud’ as used and understood under the Indian Contract Act.
The term ‘unfairness’ has been interpreted to be even broader than and
inclusive of the concepts of deception and fraud. Unfair trade practices, the
Supreme Court has noted, are not subject to a single definition but require
adjudication on a case-to-case basis. Conduct undermining good faith dealings
may make a trade practice unfair. The Supreme Court has defined unfair trade
practices as follows:

 

‘having
regard to the fact that the dealings in the stock exchange are governed by the
principles of fairplay and transparency, one does not have to labour much on
the meaning of unfair trade practices in securities. Contextually, and in
simple words, it means a practice which does not conform to the fair and
transparent principles of trades in the stock market.’

 

Prohibited
dealings

By
virtue of Regulation 3 of the PFUTP Regulations, certain dealings in securities
including buying, selling or otherwise dealing in securities in a fraudulent
manner are prohibited. These dealings include using or employing any
manipulative or deceptive devices or contrivances in contravention of the
provisions of the SEBI Act or the rules of the regulations made thereunder in
connection with the issue, purchase or sale of listed or to-be-listed
securities. Further, it includes employing any device, scheme or artifice to
defraud as well as engaging in any act, practice, course of business which
operates or would operate as fraud or deceit upon any person in connection with
any dealing in or issue of securities which are listed or proposed to be listed
on a recognised stock exchange in contravention of the provisions of the SEBI
Act or rules or regulations made thereunder are prohibited dealings.

 

Regulation
4

Regulation 4 prohibits
manipulative, fraudulent and unfair trade practices. It provides indicative
examples of what constitutes fraud under the scope of the PFUTP Regulations.
The following are examples of instances of fraud governed under the
aforementioned provisions of the PFUTP Regulations:

 

Market
manipulation

The
regulations describe two classic forms of volume manipulation, one of which is
creation of an appearance of trading volume in the market. Regulation 4(2)(a)
deems dealings which knowingly create a false or misleading appearance of trading to be
fraudulent. The false appearance of trading is intended to create an impression
amongst gullible investors that the securities are traded frequently and are
therefore highly liquid. The illusion of liquidity fools investors to purchase
the securities, only to be left holding illiquid securities when the artificial
trading ceases.

 

The second form of
classical volume manipulation pertains to another type of volume manipulation
where the same person is on both sides of the transaction. This is dealt with
under Regulation 4(2)(b) which provides that dealing in a security where parties
do not intend to effect transfer of beneficial ownership but intend to operate
only as a device to inflate, depress or cause fluctuations in the price of such
security for wrongful gain or avoidance of loss, is fraudulent.

 

In simple terms, the manipulator
(person), wearing the buyer’s hat, puts in successive bids of higher and higher
prices. Wearing the seller’s hat, the same person or his nominee sells at the
higher price. The false trade would give the appearance of a price higher than
is in fact the true value of the security. Similarly, a buyer can put
successively lower bids to reduce the price artificially.

 

Under-cutting
minimum subscription norms

The SEBI Act provides for
minimum subscription of shares on issue. There are people who try to undercut
these requirements by advancing money to potential subscribers so as to induce
them to subscribe to the shares for fulfilment of the minimum subscription on
issue requirement. Regulation 4(2)(c) classifies these kinds of transactions as
fraudulent and unfair trade practices. Such frauds are committed when a company
or its promoters seek to fill subscription of shares in a public offer through
fictitious trades to satisfy the minimum subscription requirements.

 

Price
manipulation

There are several forms of
fraudulent conduct leading to price manipulation of shares, some of which are
dealt with specifically in the regulations as provided below.

 

Regulation 4(2)(d) deals
with inducing someone to deal in securities with the objective of artificially
inflating, depressing, maintaining or causing fluctuation in the price of a
security by any means, including by paying, offering or agreeing to pay or
offer any money or money’s worth, directly or indirectly, to any person. This
form of fraud is a variation of classical manipulation described in Regulation
4(2)(b), with the difference being that it includes price manipulation using
another person.

 

Secondly, Regulation
4(2)(e) provides that any act, omission amounting to manipulation of the price
of a security, including influencing or manipulating the reference price or
benchmark price of any securities is fraudulent. This is also a variation of
volume manipulation described in Regulation 4(2)(b) with the significant
difference being that it does not require the person to be on both sides of the
transaction.

 

For example, a person can
inflate or depress the price of securities without being on both the buy and
the sell sides. This can be done by simply purchasing a large number of
securities for a nefarious purpose. In other words, there is a possibility of a
buyer (or a seller) putting in successively higher (or lower) prices in the
market driving up (or down) the prices artificially without the other side
knowing that such person is manipulating the market. Such actions amount to
manipulation.

 

Spreading
false information

PFUTP Regulations prohibit
spreading rumours or false information about a company and then profiting from
such information. This prohibition is dealt with by Regulation 4(2)(f) which
covers the knowing publication of false information relating to securities,
including financial results, financial statements, mergers and acquisitions,
regulatory approvals, which is not true or which the publisher does not believe
to be true, prior to or in the course of dealing in securities.

The
classic example is when a promoter talks up the prospectus of a company’s
performance and sells the shares of the company while it is in an inflated
state of informational being. However, it has more complex forms.

 

Another form of propagation
of false information has been prohibited in Regulation 4(2)(k) that pertains to
disseminating information or advice through the media, knowing such information
to be false and / or misleading and which is designed or likely to influence
the decision of investors dealing in securities.

 

Moreover, Regulation
4(2)(r) pertains to knowingly planting false or misleading news which may
induce sale or purchase of securities. This can range from false rumours about
a company to placing a wrong advertisement about an event of a company to
modify the price of its security.

 

Instances
of unauthorised trading

The following set of
regulations deal with different circumstances of unauthorised trading in the
market.

 

Regulation 4(2)(g) deems
any act of entering into a transaction in securities without the intention of
performing it or without the intention of change of ownership of such security;
this is a variation of regulation 4(2)(a) and is often described as ‘painting
the tape’. It is a form of market manipulation whereby market players attempt
to influence the price of a security by buying and / or selling it among
themselves so as to create the appearance of substantial trading activity in
it.

 

While Regulation 4(2)(h)
deals with stolen, fraudulently issued or counterfeit securities, persons
selling, dealing in such securities who are holders in due course, or
situations where such securities were previously traded on the market through a
bona fide transaction are, however,
excluded from this provision.

 

Regulation 4(2)(m) pertains
to churning. Churning means entering into repeated buy and sell transactions
merely to generate more commission income. It involves unauthorised trades that
may be made by a portfolio manager and suppressed from the client.

 

Regulation 4(2)(o) pertains
to market participants fraudulently inducing any person to deal in securities
with the objective of enhancing their brokerage or commission or income. And
Regulation 4(2)(t) pertains to illegal mobilisation of funds by carrying on or
facilitating the carrying on of any collective investment scheme by any person.

 

Circular
transaction

Circular trading is a
fraudulent scheme where sell orders are entered by a broker who knows that
offsetting buy orders for the exact same number of shares at the same time, and
at the same price, have either been or will be entered.

 

The
Regulation 4(2)(n) pertains to circular transactions in respect of a security
entered into between persons including intermediaries to artificially provide a
false appearance of trading in such security or to inflate, depress or cause
fluctuations in the price of such security.

 

Intermediary
predating

This
pertains to a broker or any other intermediary providing bogus records to
inflate the price a purchaser of security pays to such broker. Similarly, a
mutual fund may change the date of investment to give a favoured investor a
superior price (say of the previous date); these would be clearly fraudulent.
Regulation 4(2)(p) pertains to intermediary predating or otherwise falsifying
records, including contract notes, client instructions, balance of securities
statement, client account statements and so on.

 

Front-running

Front-running pertains to
any order in securities placed by a person on the basis of unpublished
price-sensitive information. It is a serious and common malpractice involving a
broker or other intermediary who knows about the client’s order and placing an
order ahead of the client.

 

Thus, a broker who knows
that his client wants to place an order of one million shares of Infosys
punches in his own order ahead of the client’s order. This front-running order
would increase the price available to his client and thus hurt his client.
Regulation 4(2)(q) prohibits front-running.

 

Misselling
of securities

Regulation 4(2)(s) pertains
to misselling of securities or services related to the securities market, which
means sale of securities or services related to the securities market by any
person directly or indirectly, by knowingly making a false or misleading
statement, or concealing or omitting material facts, or concealing the risk
associated with the securities, or by not taking reasonable care to ensure the
suitability of the securities or service, as the case may be, to the purchaser.

 

__________________________________________________________________________________________________________________________________

8   SEBI vs. Kanhaiyalal Baldevbhai Patel,
2017 (8) SCJ 650

 

3.     POWERS
FOR ENFORCEMENT OF PFUTP REGULATIONS

In order to effectively
enforce the provisions of the PFUTP Regulations, SEBI is empowered to inter alia restrain persons from accessing
the securities market and prohibit any person associated with the market to
buy, sell or deal in securities, and to impound and retain the proceeds or
securities in respect of any transactions which are in violation or prima facie in violation of these
regulations. Further, SEBI is also empowered to prohibit the person concerned
from disposing of any of the securities acquired in contravention of these
regulations and to direct such person to dispose of the securities acquired in
contravention of these regulations in such manner as the Board may deem fit,
for restoring the status quo ante.

 

Disgorgement

It is well established that
the power to disgorge is an equitable remedy and is not a penal or even quasi-penal action. It differs from
actions like forfeiture and impounding of assets or money. Unlike damages, it
is a method of compelling a defendant to give up the amount by which he was
unjustly enriched. Disgorgement is intended not to impose on defendants any
demand not already imposed by law, but only to deprive them of the fruit of
their illegal behaviour. It is designed to undo what could have been prevented
had the defendants not outdistanced the investors in their unlawful project. In
other words, disgorgement merely discontinues an illegal arrangement and
restores the status quo ante.
Disgorgement is a useful equitable remedy because it strips the perpetrator of
the fruits of his unlawful activity and returns him to the position he was at
before he broke the law. But merely requiring a defendant to return the ‘stolen
goods’ does not penalise him for his illegal conduct.

 

In its order dated 4th
October, 2012 in the matter of Shailesh
S. Jhaveri vs. SEBI, the Securities Appellate
Tribunal (‘SAT’) ruled that disgorgement proceedings do not amount to
punishment and are merely an equitable monetary remedy. In this case, SEBI had
issued orders barring the persons concerned for a period of two years from
accessing the securities market and also issued a disgorgement order for
violation of Regulations 4(2) and 4(d) of the erstwhile PFUTP Regulations9.

 

By
virtue of Regulation 11(1)(d) of the PFTUP, SEBI is now expressly empowered to
impound, retain and order disgorgement of the proceeds or securities in respect
of transactions which are in violation or prima facie in
violation of the PFUTP Regulations. In the Morgan Industries price rigging case10, SEBI had charged
Alka Synthetics and some other entities with having rigged the prices of the Magan Industries scrip. SEBI had directed the stock exchange concerned to impound the
proceeds totalling Rs. 10 crores (Rs. 100 million). Alka Synthetics challenged
this decision in the Gujarat High Court. The Bench held that SEBI was within its rights to issue directions to impound the auction proceeds and
that this did not amount to deprivation of property and hence did not violate
Article 300(A) of the Constitution. The Supreme Court remanded the ruling back
to the High Court, though the setting aside was not on the merits.

 

Debarring
from accessing capital markets

In case of manipulation of
a public issue, debarring a person from accessing and associating with the
capital markets was upheld as a preventive measure while distinguishing cases
where similar orders were passed even though manipulation was not connected to
raising of capital from the public11.

 

Further, in the matter of Polytex India Limited12,
SEBI observed violation of the provisions of Regulations 3 and 4 of the PFUTP
Regulations as a consequence of manipulation of the price of the Polytex scrip.
It barred various noticees thereunder for periods ranging from five to seven
years from accessing the securities market and from buying, selling or
otherwise dealing in securities, directly or indirectly, or being associated
with the securities market in any manner whatsoever. It also passed directions
with regard to disgorgement of an amount of Rs. 3,05,99,174 with interest
accrued at 12% per annum from 17th December, 2012 till the date of
payment. Notably, this order was issued by SEBI on 31st January,
2019.

 

In the matter of Chetan Dogra & Ors13,
SEBI passed an order barring noticees therein from accessing the securities
market for six months to one year, as well as imposing disgorgement of unlawful
gains made to the tune of Rs. 2,14,85,115 for violation of Regulations 3(a),
(b), (c), (d), 4(1), (2a), (b) and (g) of the PFUTP Regulations.

The Supreme Court in SEBI vs. Pan Asia Advisors Ltd.14 affirmed SEBI’s power to pass
orders debarring respondents for a period of ten years in dealing with
securities while considering the role played by the respondents as lead
managers relating to the GDRs issued by six companies which had issued them.

 

Moreover, section 11(2)(e)
of the SEBI Act, 1992 expressly enables SEBI to take measures to prohibit
fraudulent and unfair trade practices. Regulations 3(a), (b) and (c) mirror the
provisions u/s 12A of the SEBI Act, 1992. Section 12A prohibits the use of
‘manipulative and deceptive devices’ and section 15HA provides for a penalty
for fraudulent and unfair trade practices u/s 12A.

 

__________________________________________________________________________________________________________________________________

9   Shailesh S. Jhaveri vs. SEBI [2012] SAT
180

10  SEBI vs. Alka
Synthetics, [1999] 19 SCL 460

11  Manu Finlease vs.
SEBI, [2003] 48 SCL 507 (SAT)

12  SEBI Whole-Time member
order dated 31st January, 2019 in the matter of Polytex India
Limited, Gemstone Investments Limited and KGN Enterprises Limited and Ors.

13  SEBI Whole-Time member order dated 31st
August, 2020 in the matter of  Chetan
Dogra & Ors.

 

4.     SEBI
PFUTP (SECOND AMENDMENT) REGULATIONS, 2020

By way
of the SEBI (Prohibition of Fraudulent and Unfair Trade Practices) (Second
Amendment) Regulations, 2003, an explanation has been inserted under Regulation
4(1) which clarifies that any act
of diversion, misutilisation or siphoning off of assets or earnings of a
company whose securities are listed or any concealment of such act or any
device, scheme or artifice to manipulate the books of accounts or financial
statement of such a company that would directly or indirectly manipulate the
price of securities of that company, shall be and shall always be deemed to
have been considered as manipulative, fraudulent and an unfair trade practice
in the securities market.

 

This explanation clarifies
that SEBI has always held inherent powers to take appropriate action under the
PFUTP Regulations for violations involving fudging of books of accounts and
financial statements of listed companies where such fudging, directly or indirectly, results
in manipulation in the price of the company’s securities. The explanation has
far-reaching effects and addresses questions pertaining to SEBI’s
jurisdictional prowess that remained unanswered for years.

 

Jurisdictional
conundrum – PwC

After
the unfolding of the large-scale accounting fraud in Satyam Computers Limited (‘Satyam Computers’), SEBI had initiated proceedings against PriceWaterhouse Cooper (‘PwC’) since the accounting firm had conducted the audit in Satyam Computers
and their alleged failure to detect financial misdoings within the company of
momentous scale in turn resulted in severe losses to Satyam’s shareholders. The
financial wrongdoing by PwC included, inter alia,
overstatement of cash and bank balances and misstatements in the books of
accounts.

 

When SEBI attempted to
charge the auditors involved in this massive accounting fraud by initiating
show cause proceedings against PwC under sections 11, 11B and 11(4) of the SEBI
Act and Regulation 11 of the PFUTP Regulations, it was faced with critical
uncertainty about its jurisdiction over such matters and the entities involved
therein.

 

In PricewaterhouseCoopers and Co. and Ors. vs. SEBI15, PwC challenged SEBI’s
initiation of proceedings against it and argued that SEBI did not have the
jurisdiction to initiate action against auditors who are discharging their
duties as professionals. It was also argued that the scope of SEBI’s power is
limited to entities forming part of the securities markets and that auditors
cannot be considered to be associated directly with the securities markets.

 

The Bombay High Court,
however, affirmed that SEBI has jurisdiction under provisions of the SEBI Act
and Regulations framed therein to inquire into and investigate matters in
connection with manipulation and fabrication of books of accounts and the
balance sheets of listed companies. It was further held that SEBI is empowered
to take regulatory measures under the SEBI Act for safeguarding the interest of
investors and the securities market. The Court held that in order to achieve
the same SEBI can take appropriate remedial steps which may include debarring a
Chartered Accountant from auditing the books of a listed company.

 

This resulted in the
implication that, even if indirectly, auditors owed a duty to shareholders and
investors. The High Court stated that ‘The auditors in the company are
functioning as statutory auditors. They have been appointed by the shareholders
by majority. They owe a duty to the shareholders
and are required to give a correct picture of the financial affairs of the
company.’

 

This decision of the Bombay
High Court was appealed against and is pending before the Supreme Court of
India.

 

SEBI’s
deliberations

In its report16,
the Committee on Fair Market Conduct under the chairmanship of Dr. T.K.
Viswanathan (ex-Secretary-General Lok Sabha and ex-Law Secretary) had inter alia noted that financial statement
frauds in a listed company has resulted in the loss of confidence by domestic
and international investors not only in the listed company in question but also
the entire industry to which that listed company belonged.

 

The committee had also
noted that there is a need for SEBI to take direct action against the
perpetrators of such financial fraud since it not only has an adverse impact on
the shareholders of the company but also impacts investor confidence in the
securities markets.

 

SEBI
felt17 that artificially inflating a company’s revenue, profits and
receivables, or hiding diversion of funds, will impact the price of its shares
and would influence the investment / disinvestment decisions of the investors.
In cases relating to diversion of funds or misstatements in disclosures of a
listed company and its management, the intention of the perpetrators has a
direct bearing on the interest of the investors as they remain invested or deal
in securities without having any information of such diversion. Therefore, such
diversion of funds or misstatements in disclosures are unfair trade practices
and the element of dealing in securities or the element of inducing others to
deal in securities need not be specifically proved in such cases.

 

SEBI felt that it was
important that gullible investors were not duped by such manipulative diversion
or misstatements and that the trust reposed in the securities markets was not
eroded by such fraudulent and manipulative activity18.

 

For the purpose of removal
of doubts, SEBI has now clarified that the existing provisions of the FUTP
Regulations always provided for effectively dealing with such fraudulent
activities of manipulating the prices of listed securities or diverting,
misutilising or siphoning off or hiding the diversion, misutilisation or
siphoning off of public issue proceeds or assets or earnings.

 

IMPLICATION

It is pertinent to note
that SEBI has acted upon the Report of the Committee on Fair Market Conduct for
issuing the clarification under the SEBI (Prohibition of Fraudulent and Unfair
Trade Practices) (Second Amendment) Regulations, 2020. Notably, the Committee
had observed that SEBI had powers u/s 11B of the SEBI Act, 1992 to issue
various directions, including directions to bar persons involved in financial
statement frauds, from associating with listed companies as promoter / director
/ auditor of any listed company, impounding and disgorgement of any illegal
gain made by such person, etc.19

 

Thus, SEBI has clarified that it was and is empowered to take action against
listed companies, their promoters, directors and auditors or any person
responsible for fudging and fraudulent actions pertaining to books of accounts
and financial statements of listed companies, where such actions result in or
have potential to mislead investors.

 

__________________________________________________________________________________________________________________________________

 

14  SEBI vs. Pan Asia Advisors Ltd., AIR 2015
SC 2782

15  PricewaterhouseCoopers and Co. and Ors.
vs. SEBI, 2011 (2) Bom CR 173

16  Report of the Committee on Fair Market Conduct
under the Chairmanship of Dr. T.K. Viswanathan (8th August, 2018)

17  SEBI Board Meeting dated 29th
September, 2020

18  Id

19 Report of the Committee on Fair Market Conduct
under the Chairmanship of Dr. T.K. Viswanathan (8th August, 2018)

 

TOP-NOTCH HABIT

I read one to two hours a day. That puts me in the top
0.00001%. I think that alone accounts for any material success that I’ve had in
my life and any intelligence that I might have – Naval Ravikant

Why do the wise
attribute such importance to this singular habit? A well known figure of the
our times has this to say:

‘In
my whole life, I have known no wise people (over a broad subject matter area)
who didn’t read all the time –  none,
zero’ – Charlie Munger

Yet, we see an
alarming situation today where Chartered Accountants are drifting further and
further away from being voracious readers. With mounting pressures of
timelines, exponential client expectations, the complexity void of clear reason
and excessive, meaningless ‘compliances’, many Chartered Accountants in
practice are fast becoming sarkari chaprasis. It’s a zero-sum game –
where knowledge out of the knowledge worker dilutes and then diminishes. And
then there are some Chartered Accountants who generally read more of
existential stuff like ‘decisions’ and ‘amendments’ and less of ‘discoveries’
and ‘developments’, where ‘curiosity’ gets traded to buy ‘certainty’. And there
is yet another class of new entrants who choose to read what is of ‘immediate’
use because they want to ‘succeed’ fast, just as companies that build P&L
to the detriment of Balance Sheet.

What exercise does to
the body and meditation for the Atman, so does reading to the mind. And Humans
are minds minds are thoughts, and
thoughts are words. To read is to strengthen,
refresh, redeem, challenge, validate and free our thoughts from becoming stale
in a fast-changing world. Reading is as underemphasised a discipline as it is
vital.

All human progress
that we know, or are yet to know, is nothing but discovery, articulation and
expression. So we can perhaps judge this discipline by its benefits. And the
benefits are such that they cannot be plundered or degenerate. Here is a
summary of thoughts about this singular atomic habit and what reading
can do to us.

Opens
our eyes – Nuances, facts, perspectives, makes us see more of what is
visible. It means that we can look at what is before us but cannot see till our
brains are refined, baked and moulded. The eyes cannot see what the mind
does not know. A child can see a murderer walking towards it with a knife
and think of the instrument of pain to be a toy. The mind is only as good as
its capabilities to recognise. It’s the difference between hearing and
listening, between looking at something and seeing it.

Enter the best minds – We cannot meet the legends and icons as most are out of
reach or have existed in the past. However, when we read their writings we get
to enter their minds. Imagine, Buffet or Chanakya or Abhinavgupta – we can’t
meet them, but their writings tell us about how they formed their world view,
dealt with it and put their potential to use. One can experience what another
person felt through their writings and therefore it becomes part of one’s
internal architecture and often makes one empathetic and socially aware.

Perception
and prescription – Reading also overcomes its own
side-effects. We are often blinded by what we know. Our knowledge is limited
and what we know is always less than what we don’t know. Our perception is
coloured by our prescription. Thus, we have to constantly change the
prescription of our perception to be able to see new reality. The moment we
perceive things differently, our reality changes. It’s like having a zoom and a
wide angle lens – reading makes you do both. One can expand an idea and stretch
it in infinite directions or zoom into each of its dimensions.

Decipher, analyse and decide – Reading changes our ability to decode and decide. The
moment of choice before action is vital. The sharper our intellect, built with
new situations and examples of those who have faced similar challenges before
us, the greater is our decision-making.

Brain
health – New thoughts and ideas develop neural pathways. It’s like
vitamins for the brain, and strengthens the intrinsic makeup of the brain so as
to keep it fresh and young. Like muscle-building, reading changes the cognitive
structure and serves like ammunition for peak performance.

Cut
the clutter – Reading overemphasises the long-term
and underemphasises the short-term. It cuts out the noise of things like news,
gossip, mobile chatter and focuses on what’s important in a distracting and
distracted world.

Data – As someone said, for everything else other than trusting God,
we need data. As we read we can look through patterns. Long streaks of data
allow us to see what others can’t!

Relaxes – Studies have shown that readers sleep better – certainly better
than those who stare at phones before sleep. It’s a therapy to unwind, expand
and slide into a calm state of being.

Everyone
can do it – The best part is that everyone can do it. Today, most books are
online. Many are even read by someone else for you. You can buy books, listen
to them, often for free. And once you have read them, pass them on.

Communicate – Profession is all about expression. Essentially, we have to get
a handle on things, understand what is happening, what it means in a given
context and communicating. I have often won work due to two reasons: a trust
that people feel when you talk to them, and the way you articulate their pain
point and give a purposeful, empathetic way out to them. Competence, of course,
is basic, but so many have it these days. Someone has said that readers are
writers, communicators, persuaders and therefore makers of better societies.
And generally the best writers are regular readers.

Overcome
stupidity, perhaps – Politely put, humans can
be stupid in spite of not wanting to be so. Each day we choose pleasurable over
beneficial to our own detriment. We choose short term over long term. Reading
real life stories makes us less stupid, literally, for we don’t have to go
through things ourselves to learn but we can learn from the experiences of
others. Reading drills better habits and smarter approaches.

Priceless– It cannot be stolen by thieves, nor can it be taken away by
the kings. It cannot be divided among brothers, it is not heavy to carry. If
spent regularly, it keeps growing. The wealth of knowledge is superior wealth
amongst all forms of wealth! And if one is blessed, one will be able to
share it and therefore multiply it exponentially.

A great tool that we
have today is the e-book reader. I seriously recommend it
even to those like me who love to flip pages and have books around them. Yes,
there is nothing like printed, bound books, but equally there is nothing like
e-book readers. It’s like the ITR volumes that we used to have and now ITR is
online! E-book readers can carry nearly your entire library in your pocket, you
can mark what you like, change the size of fonts, share parts that you want and
search within text.

While reading is a
necessary condition, it is not sufficient. Perhaps one book a week would be
great for 2021. But remember, till knowledge is digested it doesn’t become
wisdom. How these new thoughts take shape and what effort do we make to
actualise them is the crux.

I leave you with a
list of books on personal growth, business and
investment that I think are worth your time. Take a break from busy-ness and
decide to spend an hour a day with books like we do with our family. That’s my
personal wish for 2021 (like I had planned a few years back to read two books a
month and actually did it!). Wishing you a great calendar year 2021!

Some good books on Personal Growth and Financial
Growth

 

(Not in any particular order, and not recently published but still
relevant)

 

1.   The
Joys of Compounding by Gautam Baid

2.   To
Pixar and Beyond by Lawrence Levy

3.   Bulls
bears and Other Beasts by Santosh Nair

4.   Alchemy:
The Dark Art and Curious Science of Creating Magic in Brands, Business and Life
by Roy Sutherland

5.   CEO
Factory: Management Lessons from Hindustan Unilever by Sudhir Sitapati

6.   Capital
Returns Investing through capital cycle: A Money Manager’s Reports 2002-15
by Edward Chancellor 

7.   HDFC
Bank 2.0 by Tamal Bandhopadhyay

8.   Intelligent
Fanatics: Standing on the Shoulders of Giants by Sean Iddings and Ian
Cassel

9.   Titan:
Inside India’s most successful consumer brand by Vinay Kamath

10. Intelligent
Fanatics Project: How Great Leaders build sustainable businesses by Sean
Iddings

11. The
Pschology of Money by Morgan Housel

12. The
Sixth Extinction: An unnatural history by Elizabeth Kolbert

13. Zero
to One by Peter Thiel

14. The
Ride of a Lifetime by Robert Iger

15. Daily
Rituals: How Artists Work by Mason Currey

 


 

Raman
Jokhakar

Editor

 

PROCRASTINATION – THE IMMEDIATE GRATIFICATION MONKEY

There is a saying in Hindi derived from the well-known Kabir doha (poem),‘Kal kare so aaj kar,
aaj kare so ab, pal mey pralay hoyegi bahuri karego kab’. Words to that effect in English would be ‘tomorrow
never comes’. In fact, the word ‘procrastinate’ comes from the Latin word
meaning ‘belonging to tomorrow.’

 

Procrastination is an exercising
of choice, i.e., not to do
something now and pushing it to the backburner. Studies have found that even
the procrastinators who feel bad about their habit, procrastinate more and more
in the future. Since we all try to avoid negative feelings in life, i.e.,
fear of falling short, boredom, anxiety, frustration and guilt, we’re more
likely to put off work that makes us feel negative emotions. Thus, it can
be said that procrastination has less to do with time management and more about
our emotions.

 

The impact of procrastination: A study has shown that the habit of delaying on a regular
basis can have devastating effects as listed below:

 

  •    A long-lasting impact on our brain such that
    we permanently lose the ability to work on complex tasks which require deep
    focus, creativity, an analytical mindset, problem-solving ability, etc.
  •    Quality work is not accomplished because it
    is done at the last minute and in a hurry.
  •    Erodes our self-confidence and we also lose
    the confidence and respect of others.
  •    Loss of a wonderful opportunity to reiterate
    / exhibit our capability, discipline, sincerity, professionalism, etc.
  •    Adds stress to the self which impacts our
    mental health.
  •    Adds to frustration, anxiety, which impacts
    our relationships at work as well as at home.
  •    Most important, the long-term impact over
    years is disliking ourselves, disliking the practice / life itself, getting
    frustrated, disillusioned, demotivated and depressed.

 

Types of procrastinators: Now, we shall look at various types of procrastinators and attempt to
understand different types of people (although this is not an exhaustive list):

  •    Type
    1- Pressure worker:     Believes
    that he / she works best under pressure. The attitude is that ‘I can manage
    pressure’ and therefore they would not start off till the deadline is near.
  •    Type
    2 – Blames oneself:     Keeps
    believing himself wrong and berating himself. May be working very hard. May
    assume that he is a good multi-tasker and considers that he is among the 2% of
    human beings who are effective, which may not be true.
  •    Type
    3 – Busy bee:     Always busy and restless
    type, whose calendar is always full and overflowing. May be full of
    almost-done, half done and at times routine works mixed with important works.
    His life is quite cluttered.
  •    Type
    4 – Entrepreneur outlook:     Always
    looking for challenges. If anything new comes along, he parks the present and
    launches into the new project till something else interesting comes on.

 

How to avoid Procrastination: The key question is, how can we break this terrible habit? Once we accept
that we do have it, we should understand why we delay; possibly, there are some
ways to overcome this challenge and live a full, confident and effective
professional life. Some actions to resolve it could be as under:

  •    Use
    technology to your advantage     and let it
    not control your life. Have a dedicated time for its usage and keep the device
    away from you when not needed. Marrying into mindless serials and entertainment
    with no time limits would be at the cost of education.
  •    A
    5-minute rule     can be applied, i.e., if
    you don’t want to do something, make a deal with yourself to do at least five
    minutes of it. After that, it’s more probable that you will end up doing the
    whole thing.
  •    Break
    goals and tasks down into smaller chunks.     Whenever you notice a task leading to negative emotions or anxiety, take
    a minute and ask yourself,‘What is the smallest step I can take to move forward
    with this?’
  •    Build
    the habit     to stop procrastinating, i.e., once a habit
    loop is developed, then tasks would no more be emotionally taxing. For us, one
    hour of deep reading.
  •    Use
    the power of accountability     – Commit to
    your client, friend, boss, colleague, employee about the clear time at which
    you would accomplish a particular task.
  •    Time-blocking
    technique     – This is one of the most powerful techniques
    used by achievers. In the blocked time do not do any other task.
  •    Do
    the hard and important tasks first:     Our daily biological clocks, known as our Circadian Rhythm, ensure that
    we are often at our most alert state in the morning.
  •    Developing
    hobbies:     Add some exercise / game to your life to give
    a chance to reorient and get the right chemicals released to improve.
  •    Declutter
    and organise workspace / area     and mind. A
    desk full of books, files, papers does not inspire much confidence.

 

My wish:

  •    Don’t postpone your greatness – strive to be
    your best self,
  •    Don’t postpone speaking the truth [without
    hurting others unnecessarily],
  •    Don’t postpone being the biggest optimist in
    office and at home,
  •    Don’t postpone loving and being
    compassionate, and
  •    Don’t postpone being authentic, even if
    nervous.