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Year: 2023

Audit Documentation – The Evidence Of Audit

There is an old saying in Hindi, that reflects the importance of documentation This saying perfectly applies to the audit profession, wherein all the actions taken by the auditors are essentially the result of a careful evaluation. For instance, before accepting the appointment, the auditor is required to ensure independence and client and engagement evaluation, before starting the audit he needs to complete the engagement formalities and audit planning, and before issuing the audit report he needs to ensure the performance and documentation of his audit procedures.

The relevance of documentation is so high for the auditors, that it is usually said that the work not documented is not done. The audit documentation acts as evidence for the auditor to demonstrate that the audit was performed in accordance with the provisions of the Companies Act, Standard on Auditing, and various other guidelines issued by the Institute of Chartered Accountants of India (ICAI), from time to time.

However, in the current complex environment, performing audit procedures and documenting them is not an easy task to perform. The audit team is now expected to be more vigilant and require to apply a greater degree of professional skepticism while planning and performing the nature, timing, and extent of audit procedures, and as such the expectation of high-quality audit documentation has also increased to a greater extent.

Per the Standard on Auditing, the audit documentation is not limited only to the extent of documenting the verification of samples that are selected by the auditors, but it is also requires to include the evaluation and conclusion of all the possible factors that can have an implication on the financial caption. The audit documentation is expected to be so comprehensive that it should be self-explanatory to the reviewer.

Keeping in view the increasing relevance of audit documentation and the inadequacies in audit documentation highlighted by the regulators, ICAI has issued an Implementation Guide to Standard on Auditing 230, Audit Documentation, in December 2022, wherein the ICAI has provided guidance on the various frequently asked questions with respect to the audit documentation.

The objective of this article is also to highlight certain documentation aspects for the critical areas of audit that can assist the auditors in ensuring robust audit documentation and avoid common review findings from the regulators to a certain extent.

INDEPENDENCE, CLIENT AND ENGAGEMENT EVALUATION

The independence of audit firm is one of the initial steps that the audit firms need to ensure before accepting the appointment as a statutory auditor of a company. An audit firm is required to assess and document, how it has ensured independence with reference to the proposed audit client, in accordance with the requirements of the Code of Ethics issued by the Institute of Chartered Accountants of India (ICAI), and the relevant provisions of the Companies Act.As part of its documentation, the audit firm should maintain independence declarations from all of its employees and also the independence evaluations and their conclusions with a date and time stamp, with respect to its existing and prospective audit engagements, to demonstrate that all the compliances were done in a timely manner.

Similarly, the client and engagement evaluation should also be documented keeping in mind the requirements of SQC 1, which should be able to demonstrate the assessment of whether accepting a new client or an engagement from a new or an existing client may give rise to an actual or perceived conflict of interest, and where a potential conflict is identified, evaluation of whether it is appropriate to accept the client and the engagement.

The documentation for the above evaluations should be maintained by the audit firm, with a date and time stamp to demonstrate that they are performed in a timely manner.

AUDIT PLANNING

Audit planning is a comprehensive process and requires the audit team to exercise significant professional judgment to determine the nature, timing and extent of audit procedures required to complete the audit, and as such it is critical that these professional judgments are adequately documented.For instance, the determination of audit materiality is one of the most important steps in audit planning that require significant professional judgement, and as such it is imperative that its documentation is robust. The audit team should ensure that a detailed analysis for all the critical aspects of determination of audit materiality like the selection of appropriate benchmark, the percentage used for performance materiality, materiality levels for particular classes of transactions, account balances, and disclosures, etc. are adequately documented in the audit file.

Similarly, detailed documentation demonstrating all the critical aspects of audit planning like, audit procedures to address the client and engagement risks identified during client and engagement evaluations and previous financial statements, selection of account and related assertions, areas of significant management estimates, timing and extent of audit procedures, team size, work allocation, audit timelines, etc. should also be maintained in the audit file, as part of audit planning.

The above documentation should also contain the evidences of review by significant engagement partner, evidences for consultation from audit partners who audit clients in the similar industry, and the quality control partner, if any.

SIGNIFICANT AUDIT RISK AREAS

As part of audit planning and at the time of audit execution, audit team usually identify audit risk areas that are significant to audit. The audit team should ensure that while they document an audit area as significant audit risk in the audit file, they should also document the rational for identifying it as significant risk, the related assertions that are subject to risk and the audit procedures designed and performed to address the risk of related assertions, adequately. For example, if the revenue is identified as significant audit risk area, the audit team should document the factors that has resulted its identification as significant audit risk, the type of risk i.e., if it’s a fraud risk, financial statement level risk or assertion level risk, the audit procedures designed and performed to address the risk, i.e. if Completeness is identified as the assertion that is subject to risk, audit procedures that are performed to address the completeness should be documented, the conclusion of audit procedures performed and if there are any adverse findings, its implications on the financial statements and the audit report.The audit team should also ensure that there is sufficient evidence in the audit file that demonstrates the timely preparation and review of audit documentation at various levels. For example, in case the auditor is using any software to maintain the audit documentation, there should be a functionality to demonstrate the preparer and reviewer signoffs along with name, date and designation. In the case of physical files, it should be physically signed by the preparer and reviewer along with name, date, and designation.

SUBSTANTIVE AUDIT PROCEDURES

The documentation of test of details usually includes the details of the samples and the relevant parameters tested; however, the documentation should also include details like, procedures performed to ensure the completeness and accuracy of the information provided by the client from which samples are selected, sample selection methodology, the audit assertions that are getting addressed with the audit procedure, compliance of applicable Standard on Auditing, for example, SA 620 ‘Using the work of an expert, and related Accounting Standard, for example, Ind AS 19 / AS 15 on employee benefits, date and name of the preparer and reviewer of the audit work paper, testing conclusion, and implications on the financial statements and the audit report in case there are exceptions identified.Similarly, in the case of substantive analytical procedures, the documentation should clearly state the source of input data, the expectation the audit team is trying to build and the range of acceptable variation.

INVOLVEMENT OF SUBJECT MATTER EXPERTS (SMEs)

Audit clients and audit teams often involve SMEs like actuaries, legal counsels, tax experts, valuers, etc. to quantify and obtain comfort on the management judgment of various estimates and disclosures made in the financial statements, such as valuation of financial assets, employment benefits, contingent liabilities, taxes, etc. While documenting the audit procedures performed for these financial captions, the audit team should ensure the documentation and verification of a few of the important aspects related to the involvement of SMEs that includes their competency assessment i.e., if they are professionally qualified to provide the services, their level of experience, their independence declarations for the audit client, etc., audit procedures performed to validate the address and email ids of SMEs where direct confirmations has been obtained, audit procedures performed to validate the methodology and assumptions used by SMEs, minutes of meetings with SMEs, etc.

 

IMPORTANCE OF CHECKLIST

It is often seen that audit teams fill various checklists like Checklists for Accounting Standard, Standards on Auditing, Schedule III, Companies Act, etc. These checklists are filled in with the objective to ensure, that all the applicable compliances have been audited and documented by the audit team. However, these are usually long checklists that flow in hundreds of pages and are often filled near the closure of the audit, when all the required audit procedures are already performed and reviewed. This practice of filling the checklist at the end may not assist the audit team in achieving the desired objective of filling the checklist. It will be more prudent to fill out any such checklist and document it along with their related audit areas. For example, a checklist related to Accounting Standard on investments should be filled and documented along with the related audit documentation, so that both the preparer and the reviewer can identify the gaps in a timely manner. Similarly, checklists related to Standard on auditing that are relevant to independence, engagement formalities, etc., should be filled once they are done and are ready for the reviewer to review.Appending requirements of applicable auditing and accounting standards in the respective workpapers, along with the responses that how they have been complied with will make the documentation watertight and will provide greater comfort to both the preparer and the reviewer.

ICAI has released various such checklists like Indian Accounting Standards (AS) : Disclosures Checklist (Revised November, 2022), Accounting Standards (AS) : Disclosures Checklist (Revised October, 2022), E-Booklet on Sample Checklist on SAs, which should be referred and used by the audit firms.

MAPPING OF AUDIT DOCUMENTATION TO FINANCIAL STATEMENTS

At times it happens that the audit team performs the audit procedures, on all the significant audit areas that were identified for audit but at the time of assembling the audit file some of the documentation is missed to be filed or is missed to be covered in the audit. As a practice, a working paper should be prepared by the audit team wherein all the financial captions that were identified for audit have been referenced to their related audit workpapers along with the location where these workpapers are filed. The workpaper so prepared should be reviewed by the senior audit team members and audit partners before the issuance of the audit opinion, to ensure that all the required audit procedures are performed and related audit workpapers are in the file.

 

AUDIT OPINION

Issuance of the audit report is the final step for the completion of an audit, however, in cases where there are modifications in the audit report it becomes very critical for the auditor to document the factors that resulted into a modified opinion and an assessment concluding the basis of modification i.e., qualified opinion, adverse opinion, or a disclaimer of opinion.While preparing the above documentation the audit team should ensure that all the adjusted and unadjusted audit differences as identified during the audit, and as documented in the respective work papers are summarized adequately, and an assessment has been performed and documented assessing the implication of these audit differences, both on the main audit report and the audit report on internal controls with reference to financial statements.

Similarly, adequate documentation should be maintained for assessing the key audit matters that in auditor’s opinion are required to be reported in the audit report, the audit team should also ensure that the key audit matters and the audit procedures performed to address them are adequately cross-referenced to the related work papers and coincide with the audit risk areas identified during the audit planning stage and thereafter.

Further, there should be sufficient audit evidence in the file that the document so prepared is reviewed by the engagement partner and the quality control partner, if any, before the issuance of the audit opinion.

SUBSEQUENT MODIFICATIONS IN THE AUDIT DOCUMENTATION

As per SA 230, only administrative changes can be made to audit documentation after the date of the auditor’s report, at the time of the assembly of the final audit file, and should not involve the performance of new audit procedures. Examples of administrative changes include, removing review notes, Removing or replacing incorrect cross-references within the engagement files, accepting revisions in Word documents when the track changes functionality was used, sorting, collating and cross-referencing working papers, etc. However, adding signoffs to the audit work papers represents a change that is not administrative because the documentation did not meet requirements i.e., reviewer did not sign and date the work paper to evidence his or her review at the right time.Further, circumstances may arise that require changes or additions to audit documentation that are not administrative in nature after the date of the auditor’s report. In such scenarios, the audit team should document the explanation describing what information was added or changed, date the information was added and reviewed, the name of the person who prepared and reviewed the additional information, circumstances encountered and the reasons for adding the information, new or additional audit procedures performed, any new audit evidence obtained and conclusions reached, and its effect on the auditor’s report. The Implementation Guide to Standard on Auditing 230, Audit Documentation, has covered this aspect in a greater detail.

CONCLUSION

In the recent review reports of various review authorities like NFRA, QRB, FRRB, etc. we can observe that their observations are related to audit documentation that is inadequate to demonstrate the adequacy of the audit procedures performed and evidences obtained, that means that while the audit team might be performing the audit procedures with full diligence, they are not documenting it adequately so as to cover all the aspects of audit, for example, inadequate documentation related to materiality, untested population or financial captions, checklists demonstrating compliances of all the requirements of applicable laws and regulations, evidences of timely reviews and signoffs, rational for modification in audit documentation post issuance of the audit opinion, etc.There are two primary reasons that I can visualize that contribute significantly to the inadequate documentation i.e., lack of training and inadequate time and resources. I strongly believe that if the audit firms can train their resources adequately, in light of the recent developments, and deploy adequate resources and follow timelines that are reasonable to achieve, the observations from regulators will significantly reduce.

From The President

Dear BCAS Family,

We have been hearing about the government’s protracted efforts to bring about “Ease of Doing Business” in India for the last few years. However, do we know that this is a country where apart from agriculture, business was regarded as a holy cow? India was one of the leading exporters in the world, with various Indian kingdoms giving due respect to its businessmen vying to make things easy for them to facilitate trade and commerce. It will be interesting to examine how the wheel has turned a full circle from the ugly past of colonial rule in terms of ease of doing business in India.

I recently stumbled upon an authoritative report from an eminent British economist Angus Maddison who established India as the wealthiest country in 1 AD, with 34% of the world’s GDP. In 1700, plundering and exploitation sent India’s share down to 24.5% — interestingly UK’s GDP then was a minuscule 2.1%. By 1800, India’s GDP declined to 20%; in 1900, it had plummeted to 1.7%. The systematic wealth stripping and exploitative initiatives by colonial powers and invaders, interspersed with a string of severe famines, took a deadly toll on India’s economic exuberance. Ease of doing business? Yes, but only for the trade that was against the interest of India and her citizens.

Decades of an exasperating freedom struggle, coupled with the unwavering adoption of socialist policies, kept India’s economic growth lacklustre and stunted. It was only in the early nineties, when India was gasping for foreign exchange, that a modicum of sense sprouted and the economy was gently opened. The shackles of protectionism and red tape were shattered, but it took decades to shift the gears of a lugubrious economy. After much pruning and finetuning, the economy got into a slow trot. With the change in government and a massive revamping of numerous archaic policies and procedures, the economy is back on track and coasting from one milestone to another.

Gauging the necessity of nurturing businesses across all sizes, the government adopted a minimum government and maximum governance policy. Pivotal to streamlining the lumbering economy was the arduous task of rationalising and decriminalising 25,000 compliances and repealing 1486 union laws. The government had no choice but to switch to widespread use of digitisation of manual processes to accelerate services across multiple geographies.

These initiatives have seen results – the World Bank has recognised India’s efforts and has seen India advance spectacularly from 142 in 2015 to 63 (out of 190 economies) in 2020 in ease of doing business. Very enthusiastic on the subject Prime Minister said, “Our target is to push India into $5 Trillion ‘Economy Club’. For this, every sector of the economy has to upscale. AI & IT have become vitals of our manufacturing ecosystem and the Government is working on the new ‘Industrial Policy’ to accommodate the realities into development.”

The focus has been comprehensively thought through, efforts are being made to develop manufacturing facilities as well as to gain and penetrate global markets. In recent years, there have also been serious efforts and reforms in the sphere of trade facilitation. These concrete measures have borne fruit – India’s global ranking has escalated from 146th in 2018 to 68th in 2020. Initiatives such as the paperless compliance system and greater clearances through Risk Management System have enabled lower dwell time and transaction costs for both exporters and importers.

A good start has been made, but it is critical that the pace of reform be continued – particularly in continued digitisation and ensure speedy clearances of cargo. Even the task of introducing uniformity of customs procedures across geographical locations; and enhancing grievance redressal mechanisms should be tackled on a war footing.

What key challenges must India address to make it truly the most sought-after manufacturing and trading hub? Here are a few…

Ease of Doing Business

In some countries, it takes just half a day for a new business to register and commence operations. In contrast, a new company can take anywhere from one to four months to begin operations in India.

Land Acquisition & Registration

Land registration is one of the biggest hurdles for businesses in India. There are several difficulties in establishing legal ownership, litigation due to inheritance, demand for cash payments by sellers, fragmented holdings, etc.

Electricity Connection & Shortages

The time has dropped to 45 days, but it involves lengthy waiting time and complicated fire-safety procedures.

Complicated Tax Laws

The tax laws and their implementation leave much to be desired. They not only need to be simplified but administered fairly.

Uneven Infrastructure Development

India is a vast country. As a result, infrastructure development has not progressed uniformly across the country. The government’s focus on boosting road and rail connectivity is commendable, but much more needs to be done.

Bribery and Corruption

India currently ranks 81 on the Global Corruption Perception Index and this is a significant challenge faced by businesses at all levels, with malpractices like corruption and bribery. The government has taken multiple steps to thwart these malpractices and provide firms with a safe and transparent working environment.Enforcing contracts and resolving insolvency are two more areas of concern which have not escaped the eye and efforts of the government.With an economy that’s performing well above the average and a proactive government at the helm, improving the ease of doing business is not a distant dream, but a reality that is gaining rapid ground!

Developments

There are a few important developments that have impacted our profession. First is the inclusion of CAs under PMLA as reporting entities necessitating due diligence of their clients and reporting of specific categories of transactions. As we know, penalties and prosecution are extremely harsh for any offence under this act. So we need to be very careful about the compliances. Secondly, bringing credit card transactions in foreign currency under the ambit of TCS at 20% if they exceed Rs seven lakh. This steep charge will likely block funds in refund cases for a long time until the income tax assessment is finalised. Also, for corporate executives spending for business travel, there will be an anomaly where TCS credit will be in their personal name showing as recoverable in their employer records at the yearend unless paid by the cardholder. We must remember that corporate cards are not easy for the SME sector.BCAS is releasing its publication on FAQs for Charitable Trust. This exhaustive book covers issues pertaining to Charitable Trust regarding direct and indirect tax, Maharashtra Public Trust Act, FCRA and CSR. I highly recommend that all CAs who deal with their Charitable Trust clients to have this book in their library.

Events

Exciting events are coming up in June 2023. There is a Residential Study Course on Indirect Tax, lecture meetings on Will and Succession Planning, TDS and TCS provisions, Decoding ESG through an Internal Auditor’s Lens, Use of Technology in Audit and many more such events. Please keep a tab on the announcement to participate in the meetings of your preference.Finally, June is a month when rain gods shower their blessings. May I sign off with prayers for good rains in our country!

Thank You!
Best Regards,

CA Mihir Sheth
President

E-Commerce/Start-ups

An e-commerce set-up is integral to every sector – FMCG, Electronics, Logistics, Banking and Financial services, etc. Integration of e-commerce operations with the respective industry can throw up intriguing issues. Conventional business practices are squandered by fluid business models (without appropriate legal documentation) being adopted by new-gen start-ups, hence posing difficulty in the ascertainment of the true nature of the transaction (sometimes even identifying its true supplier). In an earlier article, we discussed some of the challenges faced in the implementation of GST for the said sector. Certain further conceptual issues have been discussed in the ensuing paragraphs.

STATE WISE REGISTRATION

E-commerce marketplaces operate on a time-sensitive delivery model to end consumers. For this purpose, local hubs are being set up nearest to the customers’ locations in every part of the country. The said marketplaces operate the hub for logistical and last mile delivery of goods by suppliers spread across various locations. Goods from multiple parts are picked up and stocked at their locations. Marketplaces claim that they merely provide e-commerce and logistical support services to the vendors enlisted on their portal. Yet, the question of the requirement of registration of the hubs by (a) Marketplace and/or (b) Listed vendor falls into consideration. The said analysis requires the application of the definition of ‘place of business’ with registration provisions under section 22-25.

A. Normal registration of Enlisted Vendor @ Hub location

Listed vendors fall into two broad baskets (a) those availing end-to-end fulfillment and logistic services and store goods at the Hubs across the country (Category 1 Vendors); (b) those performing direct dispatch from origin to customer location through logistical support in which case goods arrive at the Hubs only for sorting, transshipment and consolidation without any intent for storage (Category 2 Vendors).‘Place of Business’ has been defined to include any premises where the “taxable person” stores “his goods” or “makes/ receives supplies therefrom”. A taxable person is liable for registration under section 22 ‘from’ where he makes the taxable supply of goods or services. A vendor would be required to obtain registration at the Hubs in cases where he himself stores goods and makes supplies therefrom. Mere storage by marketplaces as a part of their overall logistical support activity (say for consolidation, transshipment or any other temporary purposes) would not constitute storage by the taxable person.
While this is a very theoretical statement, the differentiating factor between Category 1 and 2 vendors could be the surrounding factual circumstances. Category 1 vendors who dispatch goods based on expected demand for storage at hub locations, without any pre-determined order from customers, with the objective of providing last mile time-sensitive delivery, may have to ‘stock and then sell’ the goods. They have to perform ‘branch billing’ for stock transfers and ‘local billing’ for end-customer delivery. Such models are generally adopted for standard and fast-moving products (such as electronics, packed consumer edible products, etc.) with state-level registrations at the hubs.
Category 2 vendors dispatch goods from their base location with overall logistical services being provided by the marketplace. The storage of the goods at the intermediary location is a part of the logistic activity by the marketplace and not the vendor. Moreover, the vendor has already identified the customer and raised the invoice to the end customer, appointing the marketplace to execute the delivery. In such cases, category 2 vendors may not be required to obtain state-level registrations at the hub locations.

However, this situation spurs two primary challenges. Firstly, section 24(ix) mandates compulsory registration for every person who makes supplies through an e-commerce operator. It suggests that the listed vendors should register in every state in which the e-commerce operator has presence/takes registration. This may not be a reasonable conclusion as it would make IGST supplies irrelevant for e-commerce operators. It would also become burdensome for a supplier to avail/comply with as many registrations as taken by the e-commerce operator. . A more practical interpretation should be adopted to such machinery provisions. Section 24 should be interpreted as mandating registration only for states ‘from’ where the e-commerce operators’ dispatch goods on behalf of the supplier. Despite e-commerce operator’s presence is spanning in multiple states, the location ‘from’ where the goods are being originally on-boarded by the e-commerce operator should form the basis of registration. Intermediate halts/ breaks in logistics should not alter the origin of goods. Hence, one could view section 24(ix) as a mandatory condition only for states of origin/ dispatch and not states of delivery.

The second challenge is with respect to the validity of e-way bill in cases where stoppage time for goods crosses the time limit; due to delays in transshipment/ consolidation at the Hub locations. The validity of e-way bills is designed assuming average speeds for continuous movement of consignments. Logistics partners (especially in low frequency routes) could consume time in identification of appropriate conveyance and consolidation of small consignments for operational efficiency. Many a times overload in the supply chain also results in delay in shipments. At the last mile, delivery at customer location could fail due to lack of response at the door and goods have to return to the warehouse for re-attempted delivery on a subsequent date. Such logistical challenges pose a practical risk of expiry of validity of e-way bills. With multiplicity in shipments by marketplaces and lack of specific knowledge about the delivery timelines at each warehouse, suppliers are also unable to track the validity of the e-way bills making them susceptible to expiry. NASSCOM has represented about both these practical challenges to the GST council. However, the Council is yet to take action on this aspect.

B. Normal registration of Market Place @ Hub location

Here again, market-places operate under distinct modes (a) those who perform the logistic support through own/ leased premises (Fulfillment Services) and (b) those who outsource the entire activity to a separate logistics arm (Listing Services). While performing fulfillment services, the marketplace procures the consignments, ships to hub locations, packs/repacks, stocks and performs last mile delivery. This is performed at warehouse locations of the market place. In such cases, both the vendor as well as the marketplace obtain registration in every state of warehouse presence. Where marketplace services are limited only to listing services with logistics being provided by a delivery partner (say BlueDart, Delhivery, etc.) and the marketplace does not by itself perform any logistics, then in such cases the marketplace generally avails a single state registration (regular) i.e. state from where they monitor/operate the entire e-commerce operations. In these cases, the logistics backend partner avails pan-India registrations for all the warehouse/transshipment centres set-up across the country for the services rendered by him. These models are feasible only for smaller e-commerce operations, not involved in time-sensitive delivery and for vendors making IGST supplies from their home state. In any case, TCS compliance for the e-commerce operator warrants TCS registration for such e-commerce operator in every state where the vendors are located i.e. states where the supply originates (refer discussion below).

C. E-commerce registration of Market Place for State-level operation

Questions arise in respect of marketplaces (a.k.a. e-commerce operators) whether they are liable to discharge the TCS on the collections from the supplies effected through their portal. There has been confusion on whether e-commerce registration is required for the marketplace in every state to which the supplies are made. Government FAQon this aspect proposes the following:

“8. Whether e-Commerce operator is required to obtain registration in every State/UT in which suppliers listed on their e-commerce platform are located to undertake the necessary compliance as mandated under the law?

As per the extant law, registration for TCS would be required in each State/UT as the obligation for collecting TCS would be there for every intra-State or inter-State supply. In order to facilitate the obtaining of registration in each State/UT, the e-commerce operator may declare the Head Office as its place of business for obtaining registration in that State/UT where it does not have physical presence. It may be noted that each State/UT has indicated one administrative jurisdiction where all e-commerce operators having business (but not having physical presence) in that State/UT shall register. The proper officer for the purpose of registration of ECOs has also been notified by each State/UT.”

The above FAQ does not provide much guidance on the legal position of requirement of TCS registration in every state. Compulsory registration provisions (under section 24(4)) under central and state enactment mandate such operators to take registrations at the respective state irrespective of whether they make any taxable supplies from a particular state. A strict reading of section 24, which overrides section 22, mandates the supplier to collect TCS under section 52 to obtain registration for every state irrespective of having any physical presence in that state. Section 52 places the responsibility of TCS on the e-commerce operator for cases where the supplies are effected through it and their collection is made by the e-commerce operator. Section 52 is merely a collection provision rather than levy on the e-commerce operator – the section should stand triggered only if there is an underlying levy of supply and corresponding TCS is payable by the e-commerce operator. Therefore, one could interpret the registration provision to piggyback the applicability of TCS in such state which in turn is dependent on the supply location. This could be elaborated through the said table:

Location of Supplier MH MH MH with Branch in KA
Type of Supply –
Inter-state / Intra-state		 Inter-state with POS TN Intra-state POS MH Intra-state POS KA
Location of e-commerce
operator		 KA KA KA
Relevant GST law
applicability		 IGST – POS TN C/MHGST C/KAGST
Underlying levy IGST-POS TN C/MHGST C/KAGST
TCS collection Yes on IGST Yes on C/MHGST Yes on C/KAGST
Registration of
E-commerce operator		 MH registration
necessary for TCS on IGST originating from MH		 MH registration
necessary for TCS on C/MHGST originating from MH		 Separate KA TCS
registration necessary for TCS on C/KAGST originating from TN

Therefore, from the above table it can be observed that the state in which the dispatch to customer location is performed, would form the basis of ascertaining the state from which TCS would have to be discharged and consequently the applicability of TCS registration may be ascertained. E-commerce operators would take TCS registrations only if they dispatch from a particular state and the underlying supply originates from
that state.

ONLINE INFORMATION AND DATABASE RETRIEVAL SERVICES (OIDAR)

The scope of OIDAR was outlined in the previous article (February 2023 issue). Essentially, OIDAR services have been carved out and granted distinct tax status. B2B OIDAR services have been placed under the RCM mechanism, while B2C OIDAR services have been placed under the forward charge provisions, placing the liability on the overseas service provider to take registration and discharge the tax liability. The definition was significantly wide and the Finance Act, 2023 has further obscured an already delusionary definition. The definition prior to and post amendment has been tabulated below:

Pre-amendment Post-amendment
(17) “online information and database access or
retrieval services” means services whose delivery is mediated by
information technology over the internet or an electronic network and the
nature of which renders their supply essentially automated and involving
minimal human intervention and impossible to ensure in the absence of
information technology and includes electronic services		 (17) “online information and database access or
retrieval services” means services whose delivery is mediated by
information technology over the internet or an electronic network and the
nature of which renders their supply essentially automated and involving minimal
human intervention and impossible to ensure in the absence of information
technology and includes electronic services such as,-

It can be observed that the shelter of services being ‘essentially automated’ and involving ‘minimal human intervention’ for a service to be excluded from OIDAR has been removed. The revised definition now states that any service rendered through information technology would amount to an OIDAR service as long as it is necessarily performed through information technology. Thus, the pre-requisite of a human intervention being at the minimal possible level has been removed, implying that the level of human intervention does not have any bearing on classifying a service as OIDAR.On the basis of this phrase, taxpayers hitherto claimed that online video content (like Youtube) would be OIDAR but live video content (such as coaching or live streaming on Youtube) was not OIDAR since human intervention in the latter was significant, albeit, it was routed through the use of information technology. The legislature on the other hand believed that the defense of minimal human intervention was artificial and subjective and hence it was necessary to broadbase the definition of OIDAR to all information technology-driven services. Though the said definition was originally adopted from EU laws, it was believed that service providers increased human intervention for claiming exclusion from the taxation net (particularly in B2C supplies) even though the services were ultimately consumed in India.

Interestingly, the removal of the phrase “supply being essentially automated and involving minimal human intervention” brings into its ambit many more activities beyond the scope of pure information technology-driven services. Take for example two services conducted on the same platform (a) online subscription services to Zoom platform (b) service of online video meetings through Zoom from outside India to business recipients in India.

The former (i.e. Zoom subscription services) was always includible as OIDAR since the services on Zoom platform were essentially automated through information technology involving minimal human intervention. The individual logs onto the Zoom platform and schedules the meetings which are auto-configured to provide the meeting address and credentials to the user’s email accounts. Zoom Inc. (the service provider) does not individually schedule or fix the meetings and this takes place through an automated process at the backend. No specific individual is assigned for the issuance of the digital address or operating the Zoom meeting. Hence, one could easily conclude that these are OIDAR services.

On the other hand, advisory services performed through these online video meetings were excludible on the claim that an individual across the other screen is actively involved in rendition of the service though information technology. The individual interacts (through digital network) with the recipient of services with back-and-forth conversations at both ends, increasing the human intervention. Information technology was a medium of delivery but the services were predominantly driven by human intervention, and hence akin to rendering the services physically to the recipient. This very same service now falls prey to the wide scope thrown open by the amendment.

The EU directives as well as CBEC’s own circular1 (during the service tax regime) provided fair guidance on demarcating the territory of automated services v/s person-driven services. EU directive had juxtaposed automated troubleshooting of computer and classical troubleshooting by an individual through remote connections to explain the comparative degree of human intervention in both activities. The latter displayed a higher degree of human intervention and possibly outside the scope of OIDAR services. But all this guidance material would now be made redundant leaving the field wide open for host of unwanted litigation on this front. The essence of OIDAR being oriented only for automated services has now been given a “go by” and certainly intervention of the Board is critically essential to stop the surge of litigation on this front.

1. Circular No. 202/12/2016-S.T., dated 9th November, 2016

With the amendment now in place, the only pre-requisite left available for a service to be excluded from the definition is the ‘impossibility of ensuring such service’ in the absence of information technology. The impossibility of performance of a service without the use of information technology is a highly subjective term. Taxpayers may claim that personalised services can alternatively be rendered even over physical means. The use of technology saves time and cost. Hence, they cannot be said to be impossible to perform without information technology. Revenue may on the other hand contend that technology has made such services possible, since without such technology an individual across the border cannot render services to anyone. This means that the services are impossible to deliver except through information technology.

Take another example of medical report examination by overseas offices. An individual at the backend examines medical reports and uploads its conclusion through information technology. Though the human intervention was substantial, the revenue could now easily claim that the services are OIDAR since such remote examination of medical reports would be impossible to ensure without information technology. In times where information technology has granted accessibility across borders, it would be very soon difficult for anyone to even fathom an activity which is not driven by information technology.

At the end, one can conclude that this amendment would largely impact B2C transactions where the overseas suppliers are required to obtain OIDAR registration in India and pay tax under forward charge mechanisms. B2B transactions were anyway liable to tax under reverse charge provisions and would have to pay the tax irrespective of if being classified as an OIDAR service.

LOYALTY PROGRAMS

E-commerce entities offer loyalty points/coins to customers on transactions made through their portals. The loyalty points / coins accumulated by these users are convertible into monetary discounts or redeemable vouchers for purchases made through its web-portal. The transactions that need examination here include (a) issuance/accumulation of loyalty points/ coins; (b) monetary discounts on redemptions of such loyalty points / coins against future purchase and (c) expiry of loyalty points / coins.

Nature of these Loyalty points/ coins:– Loyalty coins are a digital representation of future discounts which a customer can avail on the purchase through specified e-commerce portals (say 25 paise / coin). These coins are accumulated by the customer on every purchase through the application through a pre-determined formula and are redeemable after crossing specified thresholds by conversion into a monetary discount. These coins do not have direct money value, are not convertible into cash or any other mode of cash but can be used against transactions over the same web platform or even multiple platforms. CRED is a classic example of an application where every credit card payment through their application generates loyalty points. Flipkart also runs similar programs

Accumulation of Loyalty Points/ Coins: – Coins/ Points at the time of its issuance represent a contingent benefit that may arise in the future to its beneficiary. In a traditional sense, it is a legal entitlement for larger discounts on increasing volume of purchases – it is like saying “Come back to me next time and I will give you a larger discount on your next purchase”. But the digital set-up gives it an obscure appearance resulting in contradictory conclusions. Generally, the T&C of such programs entitle abrupt termination of these schemes and make such points worthless. Therefore, a mere accumulation represents a contingent promise on fulfillment of the purchase criteria at a future point of time. It may be difficult to even term these coins as ‘property’ more-so ‘transferable property’. But it is also difficult to counter-claim this as ‘sums of money’ because they are not equivalent to money itself. Mere accumulation of points should not result in any tax liability as there is no supply of any ‘property’ or ‘service’ being rendered by issuer to the end user. Importantly, there is no flow of any consideration against issuance of such coins. The trigger for issuance of coins is a purchase transaction which has been fully subjected to tax. Consideration being sine qua non of supply is absent at the time of issuance of coins and hence, such issuance could stand excluded from the tax net.Issuers also take an additional defense that this represents an ‘actionable claim’ since a future debt arises in favor of the end-user where the Issuer is expected to honor the monetary value/ discount against redemption of coins. But critically, this debt is not in monetary terms (as the T&C of the scheme do not fix a permanent ratio for conversion and have rights to withdraw the scheme at any point of time). However, such arguments were summarily rejected by the Appellate Authority of Advance Ruling in Loyalty Solutions and Research Pvt. Ltd2.

2. 2019 (22) G.S.T.L. 297 (App. A.A.R. – GST)

Expiry of Loyalty Points/ Coins

Loyalty coins come with a particular shelf-life. Unless the user utilises the coins within the shelf life, they would be termed as worthless. Expiry of such loyalty coins is recorded as a reduction from the coins pool on a FIFO basis. This act of expiry/cancellation of coins is a unilateral act by the issuer without any specific approval for the same. Clearly such a unilateral act arose on account of non-usage by the beneficiary of such coins. Since the said coins did not result in any flow of consideration, the said expiry of coins may be viewed as an inconsequential event from a GST perspective. In summary, loyalty schemes are not taxable as either ‘goods or services’ but the finer aspects of the agreement may be worth examining to reach such a conclusion.

DISCOUNT/ PREPAID VOUCHER SCHEMES

Issuance of Vouchers – Varied business practices are adopted under the voucher scheme. Four participants are involved in this scheme (A) Scheme operator who brands/ displays the scheme; (B) Issuer which issues and manages the scheme (C) Merchant Outlet who accepts these vouchers (D) Beneficiary who benefits from the discounts specified therein. In most cases, the vouchers are issued by “Third Party Issuers” against payments made to them by the scheme operator (say a Raymond voucher is issued by Third-party Issuer on redeeming points loaded on the HDFC card – HDFC Bank makes a specified payment to the Issuer at the time of issuance).

The GST law has granted legal recognition to Vouchers as payment instruments issued for settlement of considerations against supply of goods or services. Though the potential supplies settled against such vouchers may be enlisted by the issuing authority, the exact identity of the future supply need not be known at the time of its issuance. In the digital world, challenges are faced in ascertaining whether these digital vouchers (as are being claimed) are truly vouchers as envisaged under the definition under the GST law. Of course, this would require examination of the T&C and the backend understanding between the Issuer and the scheme operator.

RBI has classified such vouchers under the Payments & Settlements Act 2007 – (i) closed-ended (acceptable only at own outlets), (ii) semi-closed ended (acceptable at third party outlets on-boarded under the scheme); (iii) open-ended (prepaid vouchers representing money equivalent and acceptable at any outlet). Each scheme category would have to be examined distinctly from a tax perspective.

Open-ended vouchers (prepaid debit cards) recognised by RBI are equivalent to money and do not have any GST implications. ‘Semi-closed payment instruments’, in terms of the Payments & Settlement Act have been treated as forms of settlement of consideration. These vouchers are issued for redemption with affiliated merchants against specified discounts. In the backend, the issuer is funding these discounts (partly by itself and rest by an affiliated merchant) as part of their marketing activity.

Taxability of such payment vouchers as prepaid payment instruments has been dealt in detail in certain decisions of the AAR3 and the Karnataka High Court in Premier Sales Corporation4. These decisions were heavily guided by the Supreme Court’s decision in Sodexco’s case issued in the context of applicability of redeemable food coupons. The driving principle has been that there is no sale/ supply of vouchers by the issuer to the users/ customers. They are payment instruments for the settlement of payment obligations and cannot be treated as either goods or services. With this legal clarity provided under the law and judicial decisions in the said context, such semi-closed vouchers may not be taxable as an independent supply. The tax due on such transactions would be collectible through the underlying supply against which they are redeemed.

3. 2022-TIOL-111-AAR-GST in Myntra Designs Pvt Ltd & 2019-TIOL-499-AAR-GST in Kalyan Jewellers Pvt Ltd
4. 2023-TIOL-158-HC-KAR-GST

Redemption of Voucher on Merchant portals: – Users redeem the voucher against supplies at third party outlets/ web-portals. In the frontend, the consumer receives the specified value/ discount on utilisation of the vouchers against supply by the merchant. In the back-end, the issuer and the third-party affiliates may collaborate with each other and share the discounted / redemption value at a pre-determined ratio. The objective is to jointly promote each other’s offerings to the end consumer.At the merchant’s end, the sale of goods/ services would take place at the gross value with the payments being settled partly in the form of actual payment and partly by redemption. The Gross sale value (i.e. including the amount settled through vouchers) would be considered as the taxable value of the transaction with consideration being received from two sources (a) customer for the actual payment and (b) from the Issuer for honoring the voucher and giving the discount. As an example, a product being sold for Rs. 100 with a 10 per cent redemption voucher being used, GST would be discharged on the entire Rs. 100 with consideration being received partly from the customer and balance from the issuer to the extent of the discount value against which the voucher is redeemed. Alternative practices may be prevalent in the trade depending on the schemes which operate in the back-end between the Issuer, Operator and the Merchant.

Expiry of Redemption Vouchers: Vouchers also have a shelf-life (say 1 year, etc.). Issuers expect, from their statistical analysis, that certain vouchers would stand expired before redemption and become redundant with collected sums (if any) being credited as income of the Issuer. Two theories could exist on the taxability of GST on such incomes. Vouchers considered as payment instruments (or actionable claims) at the time of issuance would now be treated as cancelled and treated on par with forfeiture of any debt. The AAAR in Loyalty Solutions and Research (supra) has unfortunately held that the expired voucher gets converted from an actionable claim to a service and is liable to tax as GST. But the true position should be that the vouchers continue to be an actionable claim even on expiry and fall outside the tax ambit completely and hence not liable to GST. This seems to be sustainable legal position on following additional grounds:

– Underlying supply is a sine-qua-non for taxability of GST;
– Income and Supply have separate legal connotations and cannot always be equated;
– Schedule II can be invoked only on identification of supply under section 7(1). Forfeiture does not amount to a Schedule II supply as being toleration of any act – this stand remotely clarified vide Circular 178/10/2022-GST, dated 3th August, 2022
– HSN/ SAC schedule do not enlist any such activity as being a service or goods and hence rate does not seem to be prescribed.

Of course this position could come under challenge by the revenue on the simple contention that ‘supply’ is all encompassing, and the residuary entries of the rate schedule are sufficient to capture such transactions in the tax net. Therefore, the last word on this issue is far from being said.

PRODUCT RETURN CHALLENGES

E-commerce operations have advanced to providing customers with a national returns policy where customers can purchase anywhere and return the products anywhere. The inter-play with a fragmented state level GST operation poses certain challenges. Take the example of a case where an MH supplier sells goods on IGST basis to a GJ customer with the same being returnable in GJ. IGST with POS GJ would be leviable on such transactions at the time of original supply. On return, the goods are taken back at the e-commerce’s GJ facility and continue to remain in GJ either for re-sale or return to the state of origin.

In case of re-sale from Branch – GST provisions have not possibly envisaged such situations. Section 34 which permits raising of credit notes on such returns does not strictly mandate ‘receipt of goods’. The only condition of reducing turnovers through CNs is to ensure that the recipient does not avail input tax credit. In B2C sales, such input tax credit is anyway not available and hence CNs can be easily accounted on the GST portal. In B2B sales, the MH supplier could establish compliance through reporting CNs in GSTR-1 and reduce the input tax credit reflecting in the buyer’s end. Prior to re-sale, MH branch should internally raise an invoice on GJ branch for retention of goods (in terms of section 31) and comply with the distinct person concept prescribed under section 25 read with Schedule I of GST law. Section 31 permits invoices to be raised where goods are made available to the recipient even without movement involved. Therefore, MH Branch can claim that the goods on return have been directed to be re-delivered back to its GJ Branch, hence making the same available to the GJ Branch for further supplies. On re-sale, the goods having been held by the GJ branch, GJ Branch could perform the supply in normal course.

In case of re-transfer from Branch – In many cases the goods are in open condition and not resalable immediately. They would have been sold directly by the MH Branch to the end customer without the involvement of the GJ Branch of the supplier. The GJ Branch is now in possession of the returned goods without originally having made the supply to the end customer. It would be holding stock of goods which never belonged to it. The GJ Branch would have to now raise a delivery challan for return of such goods back to the origin against the cover of the Credit note raised by MH to the end consumer. The Credit Note would have to place the pick-up location of goods from the customer end and dispatch being made by the GJ branch back to the MH Branch. An e-way bill would have to be raised by GJ Branch on MH Branch without any inward source of such goods at the GJ Branch. The delivery challan and e-way bill would have to capture the transaction chain from the customer location for delivery to the MH Branch. This would pose certainly logistical challenges even-though there is no legal impediment in such movement.

ONLINE GAMING

The booming online gaming industry is already facing the wrath of taxation under the GST law. Under Online Gaming model, the gaming company charges two fees – one Platform Fee and the other which is Pot Money or Prize Money. The platform fee is retained by the company while the Pot money is collected from each player/participant and pooled into an Escrow Account which ultimately gets distributed amongst the players/participants as ‘Prize Money or Pot Money’ immediately upon conclusion of the game.On the platform fee, there is largely a consensus that the same is payable since this is retained by the company as a service. The core issue is about the rate of GST which further depends on the nature of online games, whether it is a game of chance or a game of skill. The game of chance attracts 28 per cent in comparison to the game of skill which is at 18 per cent. The defining line which has been stated in Courts5 is the level of skill in the activity rather than the preponderance of chance which is beyond the control of the user.

5. 2022-TIOL-111-AAR-GST in Myntra Designs Pvt Ltd & 2019-TIOL-499-AAR-GST in Kalyan Jewellers Pvt Ltd Ravindra Singh Chaudhary vs. UOI and Ors 2019; Avinash Mehrotra vs. State of Rajasthan & Ors 2021; Junglee Games India Pvt Ltd vs. State of Tamil Nadu 2021; Head Digital Works & Ors vs. State of Kerala (2021); AIGF & Ors vs. State of Karnataka (2022)

On the Pooled Money / Prize Money kept in Escrow Account, there is uncertainty over which is a higher amount since revenue authorities contend that this forms a part of consideration of the overall gaming activity under section 15. The claim is that the entire sum is the price being paid for online gaming activity and the prize money received is a separate appropriation from the collections made by the Gaming Company to the winners. The test of pure agency also fails in such transactions because gaming companies do retain some components of the pot money leaving behind profit on such collections. Moreover, section 15(2) prescribes inclusion of incidental costs as well for the purpose of valuation. In the context of lottery, betting, gambling, Rule 31A prescribes that the value of the entire ticket for the basis of computation of GST. However, this stand of the revenue seems to have been overturned in the context of horse races in the case of Bangalore Turf Club6 vs. State of Karnataka where the Court quashed Rule 31A as being ultra-vires by delving on the concept of receipts in fiduciary capacity and receipts towards consideration for services. It was emphasised that even with the introduction of GST, tax is imposable only on the consideration for services and not on the entire amount collected against the game. However, in a contradictory decision of the Delhi High Court in Skill Lotto Solutions Pvt Ltd (2020-TIOL-176-SC-GST-LB), the challenge to valuation rule was rejected on the premise that valuation is a specification of the statute. If the statute specifies a particular valuation, it cannot be a subject matter of challenge. Rule 31A r.w.s 15 clearly specifies that the tax is to be imposed on the ‘face value’ of the ticket (i.e. including the prize money). If such is the case, one cannot claim an exclusion against such specific provision. Hence, it was concluded that while determining the taxable value of supply the prize money is not to be excluded for the purpose of levy of GST.

6. 2021-TIOL-1271-HC-KAR-GST

The GST Council in its 47th Council meeting subtly recognised the gross irregularity in including the ‘prize money’ for the purpose of taxation. It has directed that Group of Ministers on Casino, Race-Course and Online Gaming re-examine the issues in its terms of reference based on further inputs from States and submit its report. News of a distinction in ‘games of chance’ and ‘games of skill’ is being made at the policy level. The likelihood is that games of chance would be taxed at the highest bracket at par with lottery, betting, gambling, etc. (as a Sin Tax) but exclusion may be granted to the prize money component involved therein. Games of skill would be treated as a service being rendered by the operator to the user rather than stake money contests and hence be subjected to the base line rate of 18 per cent on the entire valuation. However, the debate on this subject is highly complex and a balance of legal principles and revenue augmentation is going to be attempted.

PARITY IN TAXATION

In an interesting judicial update, the Delhi High Court in Uber Systems India Pvt Ltd7 had the opportunity to examine the argument of discrimination in taxation on auto-rides/hotel bookings, etc. when performed through physical mode versus those performed through the e-commerce operator (‘ECOs’). Aggregators were aggrieved with the imposition of taxes on auto-rides when booked through the e-commerce application even-though the very same auto-ride hailed directly with the auto driver continued to be exempt. Notification 12/2017-CT(R) excluded services notified under section 9(5) from the scope of exemptions when the same where provided through the ECO. In our previous article, we had delved upon the Tax-shift mechanism prescribed under section 9(5) and the significance of the phrase ‘services through e-commerce operator’.

7. 2023-TIOL-426-HC-DEL-GST

Broadly, the arguments of the aggregators were that section 9(5) is merely a tax-shift mechanism where the tax liability rests upon the aggregator merely for the role of assisting the booking on the application. The underlying service is still being performed by auto driver himself i.e. all the legal facets of a service transaction: supplier, recipient and the underlying service/HSN are the same. The ‘mode of booking’ i.e. direct hail of auto-rickshaw and booking through Uber app, has resulted in imposition of taxes on e-commerce operator.The court however negated the arguments of tax discrimination on the following grounds:

– Consumers obtain additional benefits (such as convenience, ride tracking, payment options, supervisory role) through the application. Though the user fee charges of Uber are taxable separately, the said services are distinct from a traditional ride-hailing service. They fall under a separate category and hence can be treated as a different class of tax-payers. Moreover, the consumers who book the auto-rickshaw through the application fall in a different category from those booking the same directly;

– Section 9(5) has placed the responsibility of taxation on the e-commerce operators. Through statutory fiction, they step into the shoes of the service provider, and it is this fiction that has resulted in the imposition of tax on the ECOs. Traditional auto-rickshaw and e-commerce operators are a different class of suppliers;

– The position that ECOs are merely a platform that facilitate a mode of booking, is incorrect as the ECOs assume responsibility for the discharge of services assured by the ECOs to the consumer, which are rendered by the ECO. The ECOs provide a bundle of services and partake a charge/commission from both the consumers and the individual supplier. Therefore, for all purposes, the ECOs are independent suppliers of service to the consumer. And, the service provided by the individual supplier is only one facet of the bundle of services assured by the ECOs to the consumer booking through it. Hence, a supply activity through the application is distinct from the supply performed directly with the supplier.

– Exemptions are not a vested right and the exemptions granted can be withdrawn at any point of time; because taxation is the rule and exemptions are only an exception which is to be kept at the minimum.

In the end, the court also took a socialistic stand by stating that if similar treatment is granted to both activities, it would result in gross inequality to the auto-riders who are not enrolled on the application. This decision hails a very important juncture in e-commerce taxation. It indicates that Courts distinguish between activities performed physically from those performed with the assistance of technology, even though the end delivery may be virtually the same. With the onset of this principle in GST law, we would see a larger list of services being shifted to the tax net if the same were rendered through the e-commerce application.

CASH BURN

During early stages, e-commerce operators offer their goods/ services at penetrative discounts involving investment of substantial capital into their business. On account of these penetrative discounts, some of them face consistent operating losses and accumulation of input tax credit. In economic sense, the private equity capital is being used to subsdise the offerings of the start-up and build a market presence. Government is issuing notices to such start-ups on the ground of “HIGH ITC” utilisation (i.e. greater than 95 per cent) and lack of any cash payment, hence subjecting them to intense scrutiny. Section 15 provides for transaction value (i.e. price payable on the supplies) to be the basis for ascertaining the taxable supply. Transaction value could be adopted only if price is the ‘sole consideration’ for the supply and there is no flowback of any benefit back to the supplier. This reminds us of the legacy Fiat decision of the Supreme Court8 where it was stated that the transaction value cannot be adopted under a market penetrative pricing model since ‘price is not the sole consideration’ for a supply. Hence, the Court directed imputation of the price to the market prevailing prices. Subsequently, the CBIC stepped in to clarify that merely because sale is below cost, such cost/ imputed value cannot be adopted as the basis of assessment. The said ambiguity appeared to arise on account of absence of a legal definition of ‘sole consideration’. Excise law was designed to ascertain the duty on manufacturing activity rather than sale value. Moreover, even free supplies were amenable to excise duty at the time of their removal. In this backdrop, the Supreme Court believed that the true value of goods should be ascertained for imposition of the excise duty on manufacture.

The GST law is quite distinct and has been framed on the sales tax/VAT platform. Emphasis under this law is on the contracted price i.e. transaction value rather than the inherent value of goods. Since this was a multi-point levy (unlike a single point excise levy), free market perpetrators believe that any undervaluation would be compensated along the value chain and hence, value distortion in the chain may be avoided. This is in contrast with the Excise levy where goods are outside the tax net after its removal from the factory. Moreover, under the extant law, the term ‘consideration’ has been well defined to refer to any monetary value in response to or inducement of a supply. With a well-defined term present in the statute, the erstwhile decisions rendered under the excise regime can be certainly distinguished. In fact, the Supreme Court in a sales tax decision9, rejected any notional attribution to the transaction value and emphasised the adoption of actual sale price for purpose of taxation. This conceptual difference between excise and the GST law should be differentiating factor while applying the Fiat principle.

8. 2012 (283) E.L.T. 161 (S.C.)
9. Moriroku UT India (P) Ltd. Vvs. State of UP 2008 (224) E.L.T. 365 (S.C.)

The other risk would be for the revenue to allege that prices are subsidised by investment capital and hence, the said subsidy is includible as a part of the consideration in terms of section 15(2)(e). However, this remote issue can be addressed by establishing that investment capital is not directly relating to price, rather as part of the fixed capital of the start-up. Technology is omnipresent and one certainly cannot escape the use of technology in trade. Traditional business practices are being challenged and forced to extinction. GSTN has itself been built on a technology platform. The GST law is certainly catching up on the technological advancements and attempting to tax every possible aspect of transaction. While the services are intangible, tracing the flow of funds seems to be the key to identifying the transaction trail and the Income tax law is playing the Big Brother’s role in assisting GST to tax such transactions. Certainly, legal challenges would erupt and the judiciary would be entrusted with the daunting task of fixing the legal implication of e-commerce transactions. Though the earlier moral was to stick to the fundamentals of the transactions and avoid being influenced with the participation of technology, it now must undergo re-thinking and rejuvenation. The e-commerce generation surely views them differently, then why not the Government!!!!

12 Mantras of Effortless Leadership

Author: CA PAWAN KR AGARWAL

Reviewer: CA ZUBIN F. BILLIMORIA

CA Pawan Agarwal, a first-time author besides being a Chartered Accountant, also completed his LLB and LLM at the age of 57 and 60. He is also a member of Lions International, the world’s largest NGO. The initial reaction of any reader could well be – one more book on leadership! However, once you start a deep dive into the book, a realisation dawns on you that this book is different from several other books on the topic.

The author makes it clear that the book is a simple amalgamation of his understanding gained from reading more than a hundred books comprising autobiographies and biographies of Indian heroes and leaders. The book is divided into three parts – part one being the introduction in which he describes the woes of a first-time author in all humility; the second part is the heart of the book in which he encapsulates 12 mantras of successful leadership that stand out for their simplicity and common sense, without getting into complicated theoretical research which several management thinkers and gurus are prone to do, and the third part is the bonus mantras from Dr. Habil Khorakiwala; reproduced from his book Odyssey of Courage: The Story of an Indian Multinational.

In the first part, the author candidly admits that the book is a reflection of his learnings from hundreds of accomplished people, experts, books, and leaders. This finds reference at several places throughout the book, as also his habit of taking notes whilst reading; having more than 1,000 pages of handwritten notes jotted down over the last decade! His habit struck an immediate chord with me, being similar to my habit, but may not go down well with the current millennials who are glued to the electronic and digital media, as well as with the environmentalists who want to conserve natural resources like paper! The spiritual side of the author is articulated when he states that leadership is a mindset that is the source of one’s motivation. He indicates that The Shrimad Bhagavad Gita (SMB) is his favorite scripture, the quotes from which find a place in several of his leadership mantras in part two. In order to strike a chord with the common reader, the following extract from the book is pertinent to note. “Leadership does not mean that you are a manager, CEO, politician, or the president of a social organisation. You can lead everywhere and wherever you are at present. You lead in your personal life, job, business, and peer group. Even a child is a leader if he is passionate and eager to learn and grow. A housewife is a leader who manages a family and the household, nurtures kids, and is aware of social surroundings.”

The author begins the second and main part of the book discussing the 12 mantras (a term which he specifically emphasizes instead of chapters) of effortless leadership by setting the tone as under:

“Mantras, to be effective, must be understood properly.”

“Read the chapter three times and then make the mantras your daily ritual. Let them penetrate the depths of your unconscious mind. It does not matter whether you chant aloud, mentally, or just listen to them.”

“Soon you will begin to see your leadership skills in each area of your life reach a new level.”

Each of the mantras mentioned subsequently begins with a quotation in the context of the mantra by renowned spiritual and political leaders and motivational thinkers like Guru Mahatriaji, Mahatma Gandhi, Lal Bahadur Shastri, Sardar Patel, Dr. Abdul Kalam, Dale Carnegie, etc. The summary or takeaways at the end of each chapter is a unique way to help readers digest the content of that mantra, which the readers are encouraged to follow to gain the maximum.

Mantra 1 – “I Have a Mindset of Positive Thinking” is at the core of the rest of the mantras since according to the author without the adoption of this mantra the rest of the mantras would be of no use. It talks of the power of positive thinking in the form of a positive response which makes one proactive as opposed to negative thinking which is a reaction to a situation, the choice of either being with each of us.

Mantra 2 – “I Lead by Example by Leading Myself First” refers to several leaders in different fields who lead by example and mandate a detailed and concrete plan and policy, and practice walk the talk to implement the same. It emphasizes the authenticity of a leader whereby actions should speak louder than words. Reference to the famous incident of Dr. Kalam wherein he went to the house of a scientist and took his son for an exhibition since the scientist father was engrossed in his work, bears testimony to this mantra.

Mantra 3- “I Am a Motivating Force Behind My Team” emphasises the need for human connections and interactions together with undertaking a SWOT analysis to increase the effectiveness of the entire team and treating it like his family. It concludes by prescribing one golden rule; delegate but do not micro-manage.

Mantra 4- “I Have a Questioning Mind- I Question Every Answer” puts into focus asking the right type of open-ended empowering questions which elicit positive replies coupled with the art of active listening without which questions are powerless.

Mantra 5- “I Use My Sentiments to My benefit; I am Emotionally Intelligent” would help a leader to deal with people from different cultures and ignite hope and optimism despite challenges, by touching upon the concepts of self-awareness, self-management, social awareness, and relationship management as propounded by psychologist Daniel Goleman and emphasizes that one should never ignore emotional discomfort and suffocation amongst team members.

Mantra 6- “I Give More Than I Receive; I Am Servant Leader” is a mantra that particularly interested me as it is based on the author’s nearly three-decades-long association with Lions International. It touches upon temptations to receive awards, gifts, honours, etc. as being detrimental to effective leadership and talks of service to humanity and always giving more than what you receive. The concluding takeaway of “to be a master, first, you have to be a servant” has a very profound message.

Mantra 7- “Personal Initiative Is My Dictum; I Take Massive Action” starts with the importance of self-education particularly in the context of our education system and touches on the importance of a positive mindset and having a goal to know your why as well as a burning desire to alleviate one’s self from the ordinary to the sublime. He introduces the concept of the wheel of life or the life balance wheel to understand which parts of our life need more energy.

Mantra 8- “I Have Absolute Faith in My Beliefs; I Know My Purpose!” touches on the path of spirituality, humility, and prayers as a positive force and knowing your why which acts as a guiding light to keep track of our leadership journey. He concludes that Enthusiasm is the Electricity of Life which provides us the springboard to develop confidence and excel as a leader.

Mantra 9- “I Believe in the Culture of the Community- I Am connected!” is relevant in the current digital age whereby according to the author “we are more connected digitally than ever before but we seem to feel isolated and disconnected more personally than ever. We need community.” The author draws inspiration from the Buddhist Sangha which means a group of friends, community, or an affinity group that in the context of our diverse culture, will lead to a proper alignment of values, beliefs, mission, and goals.

Mantra 10- “The Only Thing constant in Life is Change; I Evolve Daily!” makes it imperative for us to reinvent, re-create and change consistently and adopt out-of-box thinking. The author exhorts us to use the left brain and the right brain simultaneously; representing the creative side and the imaginative side, respectively resulting in a golden brain ultimately helping us to consistently innovate and adapt to changes.

Mantra 11- “I Am Quick to Give Credit and Take Responsibility!” is very difficult to adopt in practice since a majority of us use blame as a handy defence mechanism. Applying this mantra in practice requires us to forego our ego.

Mantra 12- “I Enjoy Financial Freedom. I always Live in Abundance!” is a unique mantra that brings out the CA in the author and deals with financial empowerment. He discusses this mantra by giving his own 12 sub-mantras such as having a rich mindset; tax planning, investing wisely, tracking and creating wealth, and having multiple sources of income, amongst others. Two takeaways stand out; firstly, financial planning is each person’s individual responsibility even if you hire the best of brains and secondly, never fall into a debt trap and use credit cards only in emergencies which may not be music to the ears of financial consultants and the millennials!

To conclude the 12 mantras are age-old pearls of wisdom that are very much a simple reflection of our regular life and would help to bring out a perfect leader in each of us, without having to dwell into complex theories by management thinkers and gurus! Reading this book would bring back one to the basics in the midst of the complications and stress that one is forced to deal with.

Productivity Apps for Professionals

In this issue, we look at some productivity apps which can be useful in our day-to-day professional activities. So here goes…..

AIS FOR INCOME TAX

The Income Tax Department has launched a mobile app for taxpayers to view their individual Annual Information Statement (AIS). As you may be aware, the AIS presents to you the information on TDS/TCS, SFT, Payment of Taxes, Demand and Refund and other information. All this at the tip of your fingers.

The AIS has been available, for a while, from the normal Income Tax Website (incometax.gov.in) accessible after several clicks. The AIS app gets you all this information on your mobile, instantaneously. After you install the app, you need to verify your email and mobile no. (as per your profile registered with the Department) with OTP and you can set a 4 digit PIN. You can then track your taxes paid, refunds due, TDS, and more, on the app. All this information is available for your current Financial Year and also for the previous couple of years.

It is extremely simple to use and very fast for easy access to your information. Just use it once to see the power of the system – Download AIS Now.

Android: https://bit.ly/3TS0Lff

QR Code:


PRINTFRIENDLY.COM

Many times we visit a webpage that we would like to print and preserve for future reference. When we try to print any webpage, you will notice that we get a lot of junk, advertisements, and distortions. To avoid getting a jumbled page in print, just head to printfriendly.com

Once you are on that website, you can just paste the URL of the webpage that you wish to print, and it will present a Print Preview for you. You can make some more edits / deletions to the webpage as per your requirements and then print. It is that simple.

If you are using Chrome, they also have a Chrome Extension, which does the same thing for the page you are on. This makes the whole process faster, better, and easier – there is no need to copy and paste.

The best part of this is that there is no registration, no login, and no storage of your web pages on their servers. There is a paid, pro version, but most of the stuff that you need is already there in the free version.

Go ahead, and make your web pages Print Friendly, with PrintFriendly.com


IRIS PERIDOT – GSTIN SEARCH

In all business transactions, you get an invoice from your supplier (or even restaurant) which includes its GST Identification No. (GSTIN). If you need to verify the accuracy of the GSTIN, whether supplier is genuinely a GST-registered enterprise, whether GST dues have been paid, and whether GST returns are filed up to date, use this Peridot app.

You can just point to the GSTIN on the invoice or on supplier’s name board (or even enter the GSTIN manually), and the app will give you all the details of the supplier – You not only get the taxpayer details but also other information such as the filing status of the returns and places of businesses registered with the GST system.

A snapshot view also highlights the eligibility of taxpayer to collect taxes and an option to report any non-compliance by taxpayer to the Government.

A very simple but effective app to ensure that you will get credit for your GST when you pay it.

Android: http://bit.ly/2WTIhg5
iOS: https://apple.co/2X3U8YI

QR Code: Android:

IOS:

CALCULATOR.NET


This is a great website for calculators of all kinds – financial, health, fitness, math and others.

Financial Calculators are pretty exhaustive dealing with multiple aspects such as Mortgage Calculator, Loan Calculator, Auto Loan Calculator, Interest Calculator, Payment Calculator, Retirement Calculator, Amortization Calculator, Investment Calculator, Inflation Calculator, Finance Calculator, Compound Interest Calculator, Salary Calculator, etc.

Fitness & Health Calculators include BMI, Calorie, Body Fat and Ideal Weight Calculators. Other calculators include Age Calculator, Date Calculator, Time Calculator, Conversions and much more.

Overall an excellent website for all your life calculations!

Major Changes in the Functioning of Listed Companies Imminent

BACKGROUND

SEBI has recently, on 21st February, 2023, circulated a consultation paper (“the Paper”) proposing amendments relating to topics that fall under what is commonly understood as corporate governance. These have also been approved by SEBI at its Board meeting on 29th March, 2023. The actual amendments have not yet been notified, and hence the text of the new provisions is awaited.

The amendments are proposed to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“the LODR Regulations”). These can be categorised into four broad areas:

a.    Agreements binding the listed entity, directly or indirectly.

b.    Special rights to certain shareholders.

c.    Sale, disposal or lease of assets outside the “scheme of arrangement route.”

d.    Certain directors having a tenure which does not require them to put themselves up for reappointment from time to time, which the Paper calls Board Permanency.

Other than (c), the remaining three effectively give some shareholders special rights, thus creating a category of shareholders that has more rights than others. This is against the principles of shareholder’s democracy where all the shareholders are equal in the sense of one share-one vote. The proposed amendments seek to correct this to some extent. The category in (c) is meant to place some checks on the transfer or lease of assets otherwise through the approval of NCLT under a scheme of arrangement.

It needs to be recollected and emphasised that these requirements will be over and above those contained in the Companies Act, 2013, for listed entities. Hence, the stricter of the two would apply in case of overlapping requirements.

As is generally the case, when SEBI decides to make amendments, it circulates a consultation paper for public comments, takes feedback, and then finalizes the amendment which SEBI has done this time too.

Some of the amendments proposed are far-reaching and have retrospective effect in the sense that they apply even to existing arrangements. These arrangements may end up being reversed if certain requirements are not complied with. Much also depends on the exact final wording of the new requirements in the law. In some cases, the wording proposed or otherwise used to describe changes, are capable of multiple interpretations. This could lead to confusion and possibly litigation.

Let us discuss each of the proposed amendments in detail as to their implications, if given effect to.

AGREEMENTS BINDING THE LISTED ENTITY, DIRECTLY OR INDIRECTLY

Agreements that bind the company and are not in the ordinary course of business, if they have material implications, are something shareholders and the general investor public would want to know about. Under certain circumstances, where required in law, these may even require approval of the shareholders. The LODR Regulations do contain certain disclosure requirements relating to shareholder agreements and similar or other agreements.

However, SEBI has realized that there may be many more categories of such agreements where the company is not even a party but yet there may be material implications on the company. The promoters, management, etc., for example, may enter into such agreements. SEBI has now desired that certain agreements where, even if the company is not a party but if there are certain specified implications on it, there should be disclosure, approvals, etc. This is required where such an agreement, for example, “impacts management or control, whether or not entered into in the normal course of business” or if they “intend to restrict or create any liability” on the listed entity.

SEBI is of the view that such agreements require screening as to whether they are in the interests of the company. For this purpose, three requirements are now being proposed to be made.

Firstly, it is required that there should be disclosure to the company and the stock exchanges of such agreements.

Secondly, the Board of the company should examine such agreements and give its opinion “along with detailed rationale’ whether the agreement is “in the economic interest of the company.”

Thirdly, the agreement would be subject to the approval of the shareholders, by a “majority of the minority”, and that too by a special resolution. It is not specifically made clear what is ‘minority’ here but, taking a cue from other SEBI Regulations, it may mean shareholders other than the promoters.

Importantly, these requirements will also have an effect on existing agreements. Thus, even agreements that continue to be in force will have to undergo such disclosure and screening requirements.

The proposed new provisions would obviously have far-reaching effects. The fact that they apply to subsisting agreements made in the past can create difficulties for the company, for the parties, particularly for the counterparties. The company may have benefitted from such agreements which in many cases would have brought in issue proceeds to the company. This may enable the company/promoters/management to back out of commitments after having enjoyed the gains. But this could lead to litigation since the affected parties may seek recourse in law.

The terms used in the Paper such as “intend to create”, “economic interest”, “impact management or control”, etc. are not defined and in any case, are not precise. The term “control” has already been the subject of past controversy and grey areas still remain. These uncertainties may further compound the difficulties.

It remains to be seen whether the actual text of the amendments resolve these issues, or adds to them!

SPECIAL RIGHTS TO CERTAIN SHAREHOLDERS

Very often, agreements are entered into with investors whereby certain rights are given to them. This may include a right to nominate one or more directors on the Board, consent/veto rights on important matters, etc. To give fuller binding effect to such clauses, they are usually incorporated in the Articles of Association of the company.

SEBI has pointed out, and to this extent rightly so, that such rights put certain shareholders on a pedestal. Though all the shareholders of the same class are meant to be equal, particularly in the sense of one share-one vote, these shareholders are more equal than the others and get special treatment. They get a right, for example, to nominate a director on the Board which otherwise only shareholders having a majority of the voting shareholders would have. They can block certain decisions proposed by the company that ordinary shareholders, even those holding relatively substantial holdings, may not have.

SEBI has now proposed that such special rights shall be subject to review by way of approval of shareholders once every five years. This proposal applies even to existing agreements, and companies would be bound to take such approval within five years of the notification of the amendments.

This requirement too is well intended. But it suffers from the same issues as the preceding proposal. It enables the company to take benefits from an investor but the rights may lapse after five years if the shareholders do not approve at the time of such renewal. Considering that the proposals apply even to existing arrangements, the impact is wider and again, like the preceding proposal, may create difficulties for the investors as also the company, promoters, etc.

SALE, DISPOSAL OR LEASE OF ASSETS OUTSIDE THE “SCHEME OF ARRANGEMENT” ROUTE

Disposal of substantial assets can be carried out either through the scheme of arrangement route through approval by the National Company Law Tribunal or by the shareholders, depending on the nature of the transaction. Certain disposal of assets may not attract either approval though, but in the present case, we are concerned with those that require such approval.

Where approval of the NCLT is required, SEBI has no further suggestions. However, in case of “slump sale” outside this NCLT route, SEBI has recommended that there should be a disclosure of “the objects and commercial rationale” for such transactions.

Moreover, it is required that there should be approval of the shareholders in the form of the majority of the minority. This is in addition to the requirement of special resolution under the Companies Act, 2013. SEBI believes that this would give a say to the minority shareholders and thus they would be able to reject a proposal that would affect their interests adversely.

END TO ‘PERMANENCY’ OF CERTAIN DIRECTORS

SEBI has noted that certain directors are not required by law, contractual arrangements, etc. to retire and hence, for all practical purposes, are ‘permanent’. What is effectively meant is that shareholders do not have an opportunity to consider from time to time whether they are giving worthwhile services on the Board and whether they should be continued. Other directors ‘retire by rotation’ and hence shareholders have a chance to deny them reappointment. The law itself permits part of the Board to be non-retiring. The articles may even provide that some directors are for ‘lifetime’. SEBI considers this position as not a desirable one. Hence, it has proposed that all directors should be required to present themselves for reappointment at least once in five years. This applies even to existing directors and those directors who would have completed tenure of five years as on 31st March, 2024 without having been subject to reappointment by shareholders, may be required to present themselves for reappointment at the first general meeting of the company after 1st April, 2024. However, since the amendments, as this article is being written, are still not notified, it is possible that this date may be extended.

Technically speaking and in law, no director is really ‘permanent’ and ordinarily any director can be removed by a simple/special majority. Hence, in this sense, the position may appear the same that if a majority of shareholders are required to approve the reappointment, the same majority can remove him or her.

However, this does not always solve the problem. Firstly, removal of the directors is not always easy since an attempt by shareholders to remove a director may be met with resistance and litigation and thus, at the very least, delays. Secondly, the articles may provide for a complex procedure including a supermajority to remove a particular director or directors. Whether such a provision is valid in law and also in due compliance with requirements, may become another point of litigation and hence yet another hurdle in the removal of a director. The new requirements of SEBI, if implemented, may effectively overcome such difficulties and thus every director may end up having to regularly present himself before shareholders for reappointment.

CONCLUSION

The recommendations are noteworthy, to say the least and could create difficulties for many listed companies, and may even be partly counterproductive. One also hopes that SEBI has received extensive feedback on this and that in the actual final amendments, there will be some relief.

The Competition that can Beat You!

AI will not replace you. A person using AI will.
– @Svpino

Why an article about AI?

You are reading this article because it is overdue! BCAJ has carried articles on voice commands. We also have a feature called Tech Mantra, which carries short tech quarks. In February 2023, there was a webcast on Chat GPT, which you can view on the BCAS YouTube channel.

However, this article is different. It is from a non-expert stoked by what he is seeing. My sole reason to write is: AI is reaching us faster, and intermingling and integrating with what we do – in its pace and reach. AI has come out from ‘data and code rooms’ to ‘living rooms’ that even accountants are writing about AI. The entire experience for me, which involved looking at the AI landscape and trying different Apps and portals, was like sitting in a magic show. It was so fascinating, that I could not stop myself from writing an article leading to a call for action for fellow BCAJ readers.

Today, our best estimates suggest that at least 2.5 quintillion bytes of data are produced every day (that’s 2.5 followed by 18 zeros!).1  A more reliable report by Statista, said that data created, captured, and replicated on the internet was approximately 64.2 zettabytes2 in 2020. (one zettabyte = one trillion gigabytes).

1. Google Search, cloudtweaks.com
2. equal to 2 to the 70th power or 1 billion terabyte or 1 trillion gigabytes

AI has the potential to transform the way we use such data (obviously parts of it). With that potential, AI can enable us to make better decisions, better analysis, improve performance, make models, automate, make predictions, and help provide better services to customers. Of course, the list is longer, but due to my own limitation and for the sake of focus, I am restricting it to one feature that is emerging today.

AI

AI stands for Artificial Intelligence. A system that acts like humans (Alan Turing). It refers to the development of computer systems that can perform tasks that typically require human intelligence, such as visual perception, speech recognition, decision-making, and natural language understanding.

In its simplest form, artificial intelligence is a field, which combines computer science and robust datasets, to enable problem-solving. It also encompasses sub-fields of machine learning and deep learning, which are frequently mentioned in conjunction with artificial intelligence.

If, all this sounds too unfamiliar – then you are doing too much technical work. You need to catch up!

What can AI do for us?

Why spend time on AI? What can it do for me? Well, today the question is what can it not do for you? You have known Siri, or Speech to Text on WhatsApp. You have seen customer bots / virtual agents on websites, which answer basic questions say on a bank site.

Countless applications today can ease our life. Let us look at one area: content generation. Would you like assistance with drafting a visa application letter? Or use an AI portal that creates instant content in a PPT format. Perhaps write a poem for someone’s birthday!

There is an open AI platform that does all of this plus more. When I used it, it seemed like a Gin (I meant the Ginie in Alladin story) you can summon and get stuff done. All you need to do is give clear instructions as to what you want and how you want it. There are instructions called ‘PROMPTS’ and they trigger suggestions and answers. One needs to learn how to write Prompts. Let’s take an example of you having written an article. Now you want to make it humourous! AI will do that for you. Want to sound like an EXPERT, tell AI to change the tone of the article to make it sound more like an expert. Make that article a bit shorter from 4000 to 2400 words, sure get a draft in seconds. Put an extension on your browser, and it will create a draft response after reading an incoming email. Want to summarise a long decision you are tired of reading, AI will summarise it. Let’s go to the famous and easy-to-reach, AI tool then!

CHAT GPT

While we were busy meeting some timeline, and we read a bit about it in the news in the passing, most people I talked to never used it firsthand. So, do go to chat.openai.com and create a login. Start by asking anything – your next travel plan in Himachal, make it, give it as day-wise literary, tell it how many days you have and what local sightseeing can be done. Well, all the basic stuff you like to test out. See how it gets back with answers and suggestions.

But when you come to content – say a post on a topic or a 1200 words summary from a decision, it starts to roll out magic. It helps with content in many ways: suggestive answers, restyle writing (make it entertaining or educational or sound simpler or like an expert etc.). Want it to translate the entire article – ask for it.

Caveat: This platform accepts inputs only in text format when I checked last. It is also updated till September 2021, but a new version 4 is out in March 2023. You also have to fine-tune and update its first cut content, which in most cases is pretty good for all basic purposes.

The skills you need: you must know how to ASK to get the right output. These are called PROMPTS as I said earlier. Bad questions, trash answers. Prompts are clear instructions about what you want and how you want it. If you need columns then write that you want columns. Look online at effective PROMPTS and learn about them separately. Perhaps the next short article can be on Prompts.

Well, here is some cool stuff it can do for you as a CA (just in case the above para didn’t enthuse you enough). I am giving the first few examples along with PROMPTS.

1. Make a Checklist

PROMPT: make a checklist for the interview of an experienced CA for the tax department

PROMPT: make a checklist of things to carry and things to be prepared for travelling to Madhya Pradesh for seven days in December with a family consisting 2 children between ages 7-9

2. Make a Scorecard

PROMPT: Make a scorecard comparing in a table format years wise comparison of growth of PBT of Reliance Industries Limited versus SENSEX PBT growth from 2000 to 2022.

PROMPT: Can you provide details of the last 5 IPL winners and runners-up? I want the following to include the month, runners-up name, winner name, the score made by the winning team, and stadium name.

3. Rewrite

PROMPT: Rewrite the following paragraph in a more inspiring manner…

4. Creating Replies

PROMPT: Respond to the <<<URL of a post>>>

Those are a few examples of PROMPTS. You can make use of Chat GPT for these actions too followed by PROMPTS in some cases:

a) Summarise – “Summarize this article into a bulleted list of the most important information [paste article]”

b) Brainstorm – “Brainstorm 20 trending ideas for a Twitter thread on recent breaking AI news”

c) Rewrite for a Beginner -”Rewrite the response as if I was a beginner”

d) Create an Outline, and expand outline points thereafter – “Create an outline for an article on Ergonomics at Office and then expand each point with a 100 words’ description”

e) Convert YouTube script into tweets

f) Copy the script, and ask Chat GPT to summarise it for you into tweets.

g) Suggest titles – “Suggest a title for the Article [paste the article]”

h) Ask for Blog Ideas on a topic

i) Create a short training session for example on Ind AS 115

j) Adopt a writing tone (Formal, Sarcastic, Persuasive, Descriptive)

k) Make a Table– Create a table with the 15 biggest Indian temple towns. In the first column put the name of the town, in the second the area of the city, and in the third the state in which it is located.

Caveat: Chat GPT is already outdated although still in use. The next version of sorts, called AUTO GPT is the new IN THING!!! Also, know that there are tools, where your AI generated content can be detected. This means that there is a risk of plagiarism, so check that. Some tools that detect AI generated content are: Contentatscale.ai ; Writer.com; Copyleaks.com ; Smodin.io ; Originality.ai etc..

AI: Present Prospects and Future estimates

Goldman Sachs has estimated that 30 Cr full times jobs may be affected by AI.3 On the other hand, there is some good news: A report said 45000 job openings4 in AI as of February 2023 for data scientists and machine learning engineers. Currently, 400,000 people are employed in AI. Bangalore has the second largest AI talent pool in the world. $136B is the global market. $115B revenue AI can contribute to the global economy. $12.3B in revenue was generated in India in 2022. Salaries are Rs. 10-14 Lac for freshers5.

3. March 30, 2023, NDTV Web Portal
4. Times News Network, 23rd March 2023
5. Teamlease Report, Business Standard 21st March, 2023

Call for action

The above content and thoughts are like peeking into the door. One will need to open the door and step inside. Each one of us will have to make a special effort to see how we can integrate AI into our practice and life. If you are making your firm’s budget, keep a new line item for investments/expenses on AI. Consider adding metrics such as AI-related expenses as a percentage of revenue/total expenses or AI investments as a percentage of total investments/assets. It is important to include these new line items in your budget and track their actual financial impact on your company’s performance and position. There are numerous courses online and the one I did was a lot of fun too! Although you might not get structured CPE for this, but the value you will derive will be extraordinary.

Finally, let me end with the disclosure that what you have read is NOT written by an AI and I have no interest in any website/apps stated earlier nor do I recommend them.

Cross-Border Succession: Indian Assets Of A Foreign Resident

INTRODUCTION

We live in a global village and cross-border acquisition of assets has become an extremely common phenomenon. Cases of both, Indians acquiring assets abroad and foreign residents acquiring Indian assets, are increasing. With this come issues of cross-border succession and Wills. What happens when a person living abroad dies leaving behind Indian assets and when an Indian resident dies, leaving behind foreign assets? Which law should apply and which Wills would prevail? These are some of the myriad complex questions which one grapples with in such scenarios. Let us, in this month’s Feature, examine some such posers in the context of a foreign resident leaving behind Indian assets.

APPLICABLE LAW OF SUCCESSION

The first question to be addressed is which law of succession applies to such a foreign resident? The Indian Succession Act, 1925 (“the Act”) provides that succession to the immovable property in India, of a person deceased shall be regulated by the law of India, wherever such a person may have had his domicile at the time of his death. However, succession to his moveable property is regulated by the law of the country in which such person had his domicile at the time of his death. For example, A, having his domicile in England, dies in UK, leaving property, both moveable and immovable, in India. The succession to the immovable property would be regulated by the law of India but the succession to the moveable property is regulated by the English rules which govern the succession to the moveable property of an Englishman. The Act further provides that a person can have only one domicile for the purpose of the succession to his moveable property. If a person dies leaving the moveable property in India, then, in the absence of proof of any domicile elsewhere, succession to the property is regulated by the law of India.

The Act provides that the domicile of origin of every person of legitimate birth is in the country in which at the time of his birth his father was domiciled; or, if he was born after his father’s death, then in the country in which his father was domiciled at the time of the father’s death. However, the domicile of origin of an illegitimate child is in the country in which, at the time of his birth, his mother was domiciled. The domicile of a minor follows the domicile of the parent from whom he derived his domicile of origin. Except as provided by the Act, a person cannot, during minority, acquire a new domicile.

By marriage a woman acquires the domicile of her husband, if she had not the same domicile before. A wife’s domicile during her marriage follows the domicile of her husband.

The domicile of origin prevails until a new domicile has been acquired which can be done by taking up his fixed habitation in a country which is not that of his domicile of origin. The law further provides that a man is not to be deemed to have taken up his fixed habitation in India merely by reason of his residing in India or by carrying or the civil, military, naval or air force service of Government, or in the exercise of any profession or calling. Thus, a person who comes to India for business does not ipso facto acquire an Indian domicile. There must be intent to remain in India forever and for an uncertain period of time. The Act gives an example of A, whose domicile of origin is in England, comes to India, where he settles as a barrister or a merchant, intending to reside there during the remainder of his life. His domicile would now be in India.

However, if A, whose domicile is in England, goes to reside in India to wind up the affairs of a partnership which has been dissolved, and with the intention of returning to England as soon as that purpose is accomplished, then he does not by such residence acquire a domicile in India, however long the residence may last. But if in the same example, A, having gone to reside in India, afterwards alters his intention, and takes up his fixed habitation in India, then he has acquired a domicile in India.

The Act provides that any person may acquire a domicile in India by making and depositing before the State Government, a declaration of his desire to acquire such domicile; provided that he has been resident in India for one year immediately preceding the time of his making such declaration. A new domicile continues until the former has been resumed or another has been acquired.

The Act also provides that the above provisions pertaining to domicile would not apply to a Hindu / Buddhist / Sikh / Jain or to a Muslim since they are governed by their personal law of succession. Hence, the above provisions would apply mainly to Christians, Parsees, Jews, etc. However, even though the Act does not apply to these five communities, the Rules of Private International Law (on which the provisions of the Act are based) would apply to them.

ONE WILL OR SEPARATE INDIAN WILL?

Is it advisable to make one consolidated Will for all assets, wherever they may be located or should a person make a separate Will for each country where assets are situated? The International Institute for the Unification of Private Law or UNIDROIT has a Convention providing a Uniform Law on the Form of an International Will. Member signatories to this Convention would recognise an International Will if made as per this Format. Thus, a person can make one consolidated Will under this Convention which would be recognised in all its signatories. This would preclude the need for making separate Wills for different countries.

However, only a handful of countries such as, Australia, Canada, Italy, France, Belgium, Cyrpus, Russia, etc., have accepted this Convention. India is not a signatory to this Convention.

Considering the limited applicability of the UNIDROIT Convention, it is a better idea to have a ‘horses for courses’ approach, i.e., a distinct Will for each jurisdiction where assets are located. Thus, a foreign resident should make a separate Indian Will for his Indian assets.

PROBATE OF A FOREIGN WILL IN INDIA

International Wills

Consider a situation of a person who is domiciled in the UK but also has several immovable properties and assets in India. This individual dies in the UK and has prepared a Will for his UK estate. This also includes a bequest for his Indian properties. How would this Will be executed in India?

According to the Indian Succession Act, 1925, no right as an executor or a legatee of a Will can be established in any Court unless a Court has granted a probate of the Will under which the right is claimed.

A probate means the copy of the Will certified by the seal of a Court along with the list of assets. Probate of a Will establishes its authenticity and finality, and validates all the acts of the executors. It conclusively proves the validity of the Will and after a probate has been granted no claim can be raised about its genuineness.. This probate provision applies to all Christians and to those Hindus, Sikhs, Jains and Buddhists who are / whose immovable properties are situated within the territory of West Bengal or the Presidency Towns of Madras and Bombay (i.e., West Bengal or Tamil Nadu or Maharashtra). Thus, for Hindus, Sikhs, Jains and Buddhists who are / whose immovable properties are situated outside the territories of West Bengal or Tamil Nadu or Maharashtra, a probate is not required.

Section 228 of the Indian Succession Act deals with a case where the Will has been executed by a non-resident. It provides that where a Will has been proved in a foreign court and a properly authenticated copy of such Will is produced before a Court in India, then letters of administration may be granted by the Indian Court with a copy of such Will annexed to the same. A letters of administration is at par with a probate of a Will and it entitles the holder of the letters of administration to all rights belonging to the deceased as if the administration had been granted at the moment after his death. Basically, while a probate is granted for a testate succession (i.e., one where there is a will), a letters of administration is granted for an intestate succession (i.e., one where there is no will). However, in case of a foreign Will, instead of a probate, a letters of administration is granted.

FEMA AND INDIAN ASSETS OF A FOREIGN RESIDENT

Section6 (5) of the Foreign Exchange Management Act, 1999 provides that a person resident outside India may hold, own, transfer or invest in Indian currency, security or any immovable property situated in India if such currency, security or property was acquired, held or owned by such person when he was resident in India or inherited from a person who was resident in India. Thus, a non-resident (whether of Indian origin or not) has been given express permission to inherit such Indian assets from a resident Indian.

Further, Rule 24 of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 provides that an NRI or an OCI may acquire any immovable property in India by way of inheritance from a person resident outside India who had acquired such property:

(i) in accordance with the provisions of the foreign exchange law in force at the time of acquisition by him; or

(ii) from a person resident in India.

When contrasted with Section 6(5), it would be evident that the general permission under Rule 24 is only for NRIs and Overseas Citizens of India, whereas Section 6(5) is for all persons resident outside India. Thus, a foreign citizen of Indian origin, who does is not an OCI, i.e., he is only a Person of Indian Origin, would not be eligible for automatic permission to inherit the property mentioned under Rule 24.

RBI’s Master Direction on Remittance of Assets provides that a Citizen of a foreign state may have inherited assets in India from a person resident outside India who acquired the assets (being immovable property, securities, cash, etc.) when he was an Indian resident or is a spouse of a deceased Indian national and has inherited assets from such Indian spouse. Such a Foreign Citizen can remit an amount not exceeding US$ 1 million per year if he produces documentary proof in support of the legacy, e.g., a Will. “Assets” for this purpose include, funds representing a deposit with a bank or a firm or a company, provident fund balance or superannuation benefits, amount of claim or maturity proceeds of insurance policies, sale proceeds of shares, securities, immovable properties or any other asset held in accordance with the FEMA Regulations.

Further, a Non-Resident Indian or a Person of Indian Origin, who has received a legacy under a Will, can remit from his Non-Resident Ordinary (NRO) Account an amount not exceeding US$ 1 million per year if he produces documentary proof in support of the legacy, e.g., a Will. The meaning of the term “Assets” is the same as that above. In addition, a similar amount is also allowed to be repatriated in respect of assets acquired by the NRI / PIO under a deed of settlement made by either of his/ her parents or a relative as defined in Companies Act, 2013. The settlement should take effect on the death of the settler. Relative for this purpose means, spouse, siblings, children, daughter-in-law and son-in-law. Further, step-parents, step-children and step-siblings are also included within the definition. There is no express mention about adoptive parents. However, various Supreme Court decisions have held that once all formalities of adoption are validly completed, the adopted child becomes as good as the biological child of the adoptive parents. The term settlement is not defined under the FEMA Regulations and hence, one may refer to definitions under other laws. The Indian Stamp Act, 1899 defines a settlement to mean any non-testamentary disposition (i.e., not by Will), in writing, of moveable or immovable property made–

(a) in consideration of marriage,

(b) for the purpose of distributing property of the settler among his family or those for whom he desires to provide, or for the purpose of providing for some person dependent on him, or

(c) for any religious or charitable purpose;

and includes an agreement in writing to make such a disposition.

The Specific Relief Act, 1963 defines a settlement to mean an instrument (other than a Will or codicil as defined by the Indian Succession Act, 1925), whereby the destination or devolution of successive interests in movable or immovable property is disposed of or is agreed to be disposed of.

A declaration of Trust has also been held to be a settlement in the case of Sita Ram vs. Board of Revenue, AIR 1979 All 301. In the case of Chief Controlling Revenue Authority vs P.A. Muthukumar, AIR 1979 Mad 5, the Full Bench examined the question of whether a deed was a settlement or a trust? The Court held that the quintessence of the definition of the word ‘settlement’ in Section 2(24)(b) of the Indian Stamp Act was that the property should be distributed among the members of the family of the author of the trust or should be ordained to be given to those near and dear to him. In the absence of any such clause express or implied to be culled out by necessary implication from out of the instrument to conclude about distribution of property, either movable or immovable among the settlor’s heirs or relatives, it would be difficult to hold that an instrument should be treated as a settlement.

In case of a remittance exceeding the above limits, an application for prior permission can be made to the Reserve Bank of India.

TAX PROVISIONS

Inheritance Tax / Estate Duty is applicable in several nations, such as, the USA, UK, Germany, France, etc. These provisions apply to the global assets of a resident of these countries.

The USA has the most complex and comprehensive Estate Duty Law. A US Resident leaving behind Indian assets would be subject to US Estate Duty on the Indian Assets. Currently, the US has a Federal Estate Duty exemption of US$12.92 million which can be utilized by the estate of a person even for foreign assets. In addition, there is no estate duty on marital transfers, i.e., between US spouses. Hence, if a US person leaves his global assets to his Wife (who should also be a US person), then there is no estate duty. However, if the spouse is a non-US person, then the estate duty exemption is only US$175,000. US Federal Estate duty rates are as high as 40 per cent above the exemption limit.

Further, several US States, such as, NY, Illinois, Washington, etc., levy a State Estate Duty for its residents who die leaving behind estate. Key states which do not levy Estate Duty, include, Texas, Florida, etc.

In addition, six  states (Iowa, Kentucky,  Maryland, Nebraska, New Jersey and Pennsylvania) levy a State Inheritance Tax, i.e., a tax paid by the recipient on the assets received from a deceased. Thus, for recipients staying in these six states, the estate of the deceased would be subject to a Federal Estate Tax, may have to pay a State Estate Duty and then the recipients would also pay State Inheritance Tax.

There is no Estate Duty / Inheritance tax in India on any inheritance/succession/transmission. Section 56 (2) (x) of the Income-tax Act, 1961 also exempts any receipt of an asset / money by Will / intestate succession. This exemption would also be available to receipt by non-residents in cases covered by Section 9 (1) of the Income-tax Act, 1961, i.e., receipt of sum of money by a non-resident from a resident.

CONCLUSION

Estate planning, per se, is a complex exercise. In a cross-border element, one is faced with a very dynamic, multi-faceted scenario which requires due consideration of both Indian and foreign tax and regulatory provisions.

Select Practical Issues in Certification of Taxability of Foreign Remittances in Form 15CB – Part 1

BACKGROUND

The certification of taxability of foreign remittances in Form 15CB remains one of the most practiced areas in international taxation for a Chartered Accountant (‘CA’) in India. While the entire gamut of tax treaties and interplay with domestic tax provisions would apply while analysing the taxability of foreign remittances, there are various practical issues a CA faces while issuing Form 15CB. While it is impossible to cover all such practical issues, the authors, through this article, divided into multiple parts, seek to cover some issues that one comes across, and possible practical solutions for such issues. At the outset, it may be highlighted that as in the case of legal issues, multiple views and solutions may be possible on a particular issue.

With the increase in the rate of tax for royalty and FTS, the claim for treaty benefit becomes a far more crucial issue. In the first part of the article, the authors seek to cover some of the issues related to the tax residency certificate and the issue of Form 10F.

ISSUES RELATING TO TAX RESIDENCY CERTIFICATE (‘TRC’)

Issue 1: Whether TRC is mandatory?

Section 90(4) of the Income Tax Act, 1961 provides that the benefit of a Double Taxation Avoidance Agreement (‘DTAA’) shall be available to a non-resident only in case such non-resident obtains a TRC from the tax authorities of the relevant country in which such person is a resident.

While the provision seeks to deny benefits of a DTAA to a non-resident who does not provide a valid TRC, the Ahmedabad Tribunal, in the case of Skaps Industries India (P) Ltd vs. ITO [2018] 94 taxmann.com 448, held as follows,

“9. Whatever may have been the intention of the lawmakers and whatever the words employed in Section 90(4) may prima facie suggest, the ground reality is that as the things stand now, this provision cannot be construed as a limitation to the superiority of treaty over the domestic law. It can only be pressed into service as a provision beneficial to the assessee. The manner in which it can be construed as a beneficial provision to the assessee is that once this provision is complied with in the sense that the assessee furnishes the tax residency certificate in the prescribed format, the Assessing Officer is denuded of the powers to requisition further details in support of the claim of the assessee for the related treaty benefits. …..

10….. Our research did not indicate any judicial precedent which has approved the interpretation in the manner sought to be canvassed before us i.e. Section 90(4) being treated as a limitation to the treaty superiority contemplated under section 90(2), and that issue is an open issue as of now. In the light of this position, and in the light of our foregoing analysis which leads us to the conclusion that Section 90(4), in the absence of a non-obstante clause, cannot be read as a limitation to the treaty superiority under Section 90(2), we are of the considered view that an eligible assesse cannot be declined the treaty protection under section 90(2) on the ground that the said assessee has not been able to furnish a Tax Residency Certificate in the prescribed form.”

Therefore, the ITAT held that section 90(4) of the ITA does not override the DTAA. In a recent decision, the Hyderabad Tribunal in the case of Sreenivasa Reddy Cheemalamarri vs. ITO [2020] TS-158-ITAT-2020 has also followed the ruling of the Ahmedabad Tribunal of Skaps (supra). Similar view has also been taken by the Hyderabad ITAT in the cases of Vamsee Krishna Kundurthi vs. ITO (2021) 190 ITD 68 and Ranjit Kumar Vuppu vs. ITO (2021) 190 ITD 455.

However, it is also important to highlight that in the absence of a TRC, the onus is on the recipient taxpayer to substantiate that the said taxpayer is a resident of a particular country. Therefore, if the taxpayer can substantiate, through any other document, the eligibility to claim the benefit under the DTAA, the said benefit should be granted. An example of the document to be provided would be the certificate of incorporation wherein the domestic law of the particular country treats companies incorporated in that jurisdiction to be tax residents of that jurisdiction such as Germany, UK, etc. Similarly, in the case of individuals, one may consider the number of days one has stayed in a particular jurisdiction if the test of residence of that jurisdiction is the number of days stay in that jurisdiction.

However, the deductor, who is required to evaluate the eligibility of the recipient for treaty benefit, would need to exercise caution while considering a document other than the TRC as proof of tax residency as the ITA places an onerous responsibility, of withholding the tax due from the non-resident recipient, on the payer.

Further, it is also important to highlight that in Form 15CB, one is required to clearly state as to whether TRC is available. Given the fact that a CA is certifying the taxability of the foreign remittance and in the absence of any provision in the form to provide an explanation, in the view of the authors, the CA would clearly need to state whether TRC is available or not and in the absence of a TRC, one will need to select ‘No’ in the said form.

Issue 2: Is the TRC sufficient to claim the benefits of the DTAA?

Having analysed whether TRC is mandatory to avail the benefits of the DTAA, the next issue which needs to be addressed is whether TRC is sufficient to avail the benefits of the DTAA. In other words, can the beneficial provisions of the DTAA be availed only on the basis of the DTAA. In the context of the India – Mauritius DTAA, there are various judicial precedents which have followed the CBDT Circular No. 789 of 2000 which provides that a TRC issued by the Mauritius tax authorities will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership or to avail the exemption of tax on capital gains.

However, in today’s post-BEPS world, it is extremely important to satisfy the economic substance in claiming the benefits of a DTAA. Further, there is also a school of thought that such requirement to satisfy substance over form through conditions such as the Principal Purpose test (‘PPT’) could also apply even where such DTAA is not modified by the Multilateral Instrument (‘MLI’). This school of thought has been followed in a number of judicial precedents wherein the courts have sought to apply the substance over form approach even prior to the implementation of the MLI or the General Anti-Avoidance Rules (‘GAAR’).

Therefore, in such a scenario, in the view of the authors, while TRC, which merely provides that the said taxpayer is a tax resident of the said country, is mandatory, it may not be sufficient on its own to justify claim of beneficial provisions of a DTAA. In other words, one would need to satisfy the other tests such as beneficial ownership test, PPT, GAAR, Limitation of Benefit test, as may be applicable, to justify the claim of the benefit of the DTAA. However, it is also important to note that as a payer or as a CA issuing Form 15CB, one may not have sufficient information to evaluate the application of the above anti-avoidance measures. Therefore, one should consider obtaining an appropriate declaration from the recipient after having reasonable care and undertaken analysis on the basis of the facts available. One may also refer to an article by the authors in the February 2021 edition of this Journal wherein the issue of application of subjective measures such as PPT test to section 195 of the ITA have been discussed in detail.

Issue 3: Period covered under TRC

Generally, the TRC provides a specific period for which it is applicable. While the TRC of some jurisdictions provide the period for which the taxpayer may be considered as a resident of that jurisdiction, some provide the residential status as on a particular date. While India follows April to March as the financial year, most countries follow the calendar year as the tax year and therefore, the question arises is which period should the TRC cover.

Section 90(2) of the ITA enables the taxpayer to choose between the provisions of the DTAA and the ITA, whichever is more beneficial. Further, section 90(4) of the ITA provides that a non-resident is not entitled to claim the benefit of the DTAA unless TRC has been obtained.

Similarly, section 195 of the ITA provides that tax has to be deducted at source at the rates in force at the time of payment or credit, whichever is earlier. Therefore, on a combined reading of the above sections, one can reasonably conclude that the TRC should cover the period when one is applying the  beneficial provisions of a DTAA i.e. at the time when tax has to be deducted at source on the particular transaction.

This is important as the requirement for furnishing the certificate in Form 15CB under section 195(6) of the ITA is only at the time of payment.

Let us take an example of payment of consultancy fees to a French company for consultancy services rendered in the month of September 2022 where the invoice is provided in the month of October 2022, expense is booked in the same month and the payment for such fees is made in the month of February 2023. As France follows the calendar year for tax purposes, the TRC required would be of 2022, even though the Form 15CB would be issued in February 2023 at the time of payment.

Now, the next question which arises is how one should deal with a situation where the TRC is of an earlier period and the TRC of the relevant period is not available with the vendor or the vendor has applied for the TRC and is awaiting the same. This could typically be in situations where the tax deduction is made in the beginning of the calendar year where most taxpayers would be in the process of applying for the TRC for that year with their tax authorities and hence, the latest TRC may not be available.

In such a situation, so long as one is able to justify the tax residency by way of any other document, the payer can consider providing the benefit of the DTAA to the recipient following the decisions of the Ahmedabad and Hyderabad ITAT mentioned above.

However, similar to the above situation, as a CA who is certifying the taxability in Form 15CB, it is important that the correct TRC is obtained before the issue of the certificate as one is required to state whether TRC has been obtained and in the context of the form, the TRC would need to be the one which is corresponding to the date of deduction of TDS. If the applicable TRC is not available, it may be advisable for the CA to certify that ‘No’ TRC is available and deny treaty benefits or alternatively it may be advisable to obtain a lower withholding certificate from the tax authorities under section 197 or section 195 of the ITA.

ISSUES RELATING TO FORM 10F

Issue 4: Interplay of requirement of TRC and Form 10F

Section 90(5) of the ITA read with Rule 21AB of the Income Tax Rules, 1962 (‘Rules’) provide that the taxpayer who wishes to apply the beneficial provisions of the DTAA shall also submit a self-declaration in Form 10F in case the TRC obtained from the tax authorities of the country of residence does not contain all the necessary information required. Namely, the legal status of the taxpayer, the nationality or country of incorporation / registration, the unique tax identification number in the country of residence, the period for which the TRC is applicable and the address of the taxpayer.

Generally, the TRC issued by most countries contains most of the information such as unique tax identification number, period for which the TRC is applicable and the address of the taxpayer. Further, the TRC issued by a few countries such as the Netherlands, Germany, Mauritius, etc. contain all the information as required in Rule 21AB. Therefore, the need for obtaining a Form 10F in the case of taxpayers who are residents of such countries does not arise.

It is important to highlight that Form 10F is to be used to supplement the TRC by providing information in addition to that provided in the TRC, and it is not to be used as a replacement for the TRC itself. In other words, Form 10F without the TRC has no value. On the other hand, beneficial provisions of a DTAA can be applied even in the absence of a Form 10F if the TRC contains all the necessary information (such as the case with the countries mentioned above).

Further, in the view of the authors, even if the TRC does not contain all the required information, benefits of the DTAA may still be availed even in the absence of Form 10F if one can substantiate on the basis of any other documents, the said information. However, such a situation may be more from a theoretical perspective than a practical one, as Form 10F is a self-declaration from the taxpayer.

Issue 5: Requirement of furnishing Form 10F online

Prior to July 2022, Form 10F, being a self-declaration, was to be issued physically. However, CBDT vide Notification No. 3/2022 dated 16th July, 2022 mandated online furnishing of the said form. This issue has been dealt with in detail in the September 2022 edition of this Journal and therefore, not being discussed here.

Subsequently, in December 2022, the CBDT exempted the mandatory online furnishing of Form 10F to 31st March, 2023. Now, the said exemption has been extended till 30th September 2023 vide Notification No. F. No. DGIT(S)-ADG(S)-3/e-Filing Notification/ Forms/2023/13420 dated 28th March, 2023.

However, it is important to note that this relaxation only applies to those taxpayers who do not have a PAN and are not required to obtain PAN. Section 139A of the ITA mandates every person having income in excess of maximum amount not chargeable to tax, to obtain a PAN in India. Therefore, the Notification above only exempts those non-residents from mandatory furnishing Form 10F online, who do not have income in excess of maximum amount not chargeable to tax.

In order to understand the impact of the above Notification and the situations wherein the exemption applies, one can consider the following scenarios:

a.    Scenario A – Income taxable under the Act and taxable under the DTAA at the same rate of tax i.e. no benefit available in the DTAA – such as capital gains on sale of shares in the case of India – US DTAA .In this situation, as there is no treaty benefit availed, the question of furnishing Form 10F itself does not arise.

b.    Scenario B – Income not taxable under the ITA itself. In this situation as well, in the absence of any treaty benefit availed, Form 10F need not be furnished.

c.    Scenario C – Income taxable under the ITA but exempt under the DTAA – such as fees for technical services rendered by a resident of the US and which do not make available technical know-how, skill, experience, etc. In this situation, due to the exemption under the DTAA, the income of the taxpayer does not exceed the maximum amount not chargeable to tax and therefore, the taxpayer is not required to obtain PAN. Here, one would be able to apply the exemption as provided in the Notification and need not furnish Form 10F online till 30th September, 2023. However, one may also need to consider the recent amendment vide Finance Act 2020, wherein a non-resident earning certain income such as dividend, interest, royalty or FTS, is exempt from filing the return of income only if tax has been deducted at the rates prescribed in section 115A of the ITA.

d.    Scenario D – Income taxable under the ITA as well as the DTAA with a lower rate of tax under the DTAA – such as dividends in most DTAAs have a rate of tax lower than the 20% under section 115A of the ITA. In this situation, while the DTAA benefit is claimed, the taxpayer is still liable to tax (albeit at a lower rate of tax) in India and therefore, if the income exceeds the maximum amount not chargeable to tax, the exemption in the said Notification may not apply and one may need to furnish Form 10F online only.

Issue 6: Whether Form 10F is required in case of no PAN

As discussed above, Form 10F supplements the TRC by providing additional information. However, TRC is used not only for availing benefits under the DTAA but is also one of the prescribed documents/ information required to be furnished by a non-resident who is taxable in India; and does not have a PAN under section 206AA of the ITA read with Rule 37BC of the Rules. With the increase in the tax rate for royalty and FTS, there could be limited situations wherein the provisions of section 206AA would apply in the case of payments to non-residents or foreign companies.

Nevertheless, the question arises is whether Form 10F is required to be obtained for satisfying the conditions as provided in Rule 37BC, in case the TRC obtained does not contain all the necessary information. In this regard, as highlighted earlier, the genesis for furnishing Form 10F arises from section 90(5) of the ITA and therefore, its application should only be limited to claim the benefits of the DTAA and not to the provisions of section 206AA of the ITA. In other words, if the TRC does not contain all the necessary information, one may still provide the balance information as required in Rule 37BC and in such a situation, the higher tax rate under section 206AA should not apply even if Form 10F is not furnished, while Form 10F may be required to obtain the treaty benefits, if any.

CONCLUSION

Section 161 r.w.s 163 of the ITA places an onerous responsibility on the payer for recovery of the taxes due from a non-resident recipient. It means, taxes can be recovered from a payer if the payee fails to discharge his obligation. This is in addition to the disallowance of expenses for non-deduction of tax at source. Further, section 271J of the ITA also provides for a penalty on a CA in respect of any incorrect information provided in any certificate including in Form 15CB. On the one hand, the complexities in the international tax world are increasing. On the other hand, one sees a significant increase in litigation in India on international tax issues. Therefore, it is extremely important for a CA to remain updated and to independently analyse the taxability of the foreign remittances before issuing Form 15CB. In the subsequent part of the article, the authors shall cover various practical issues which arise while issuing Form 15CB such as multiple dates of deduction of tax at source, the role and responsibility of CA in issuing Form 15CB, precautions to be taken, etc.

Accounting of a Demerger Scheme that is Not a Common Control Transaction

In this article, we deal with the date and other aspects of accounting for a demerger scheme that is not a common control transaction in the books of the transferor and the transferee, and its interaction with the MCA General Circular 9/2019 dated 21st August, 2019 on clarification on “appointed date” referred to in section 232(6) of the Companies Act, 2013.

FACT PATTERN

a)    Oz Co (“transferor”) transfers one of the business divisions to a shell company, New Co (“transferee”).

b)    Oz Co is a widely held company and there are no controlling shareholders.

c)    New Co issues shares to the shareholders of Oz Co on a proportionate basis as a consideration for the demerger.

d)    The demerger is undertaken through a court scheme that will need to be approved by the NCLT.

e)    The appointed date in the scheme is dated 1st April, 20X2, though the scheme is filed later.

f)    Oz Co and New Co follow the financial year.

g)    NCLT approves the scheme on 1st May, 20X3, i.e., F.Y. 20X3-X4. The financial statements for year ended 31st March, 20X3, were approved and circulated to shareholders prior to 1st May, 20X3.

How will the scheme be accounted for in the books of the transferor and transferee companies? At what date the transferor will account for the profit or loss from the transfer?

RESPONSE

Technical Literature

MCA General Circular 9/2019 dated 21st August, 2019: Paragraph 6

a)    The provision of section 232(6) of the Act enables the companies in question to choose and state in the scheme an ‘appointed date’. This date may be a specific calendar date or may be tied to the occurrence of an event such as grant of license by a competent authority or fulfilment of any preconditions agreed upon by the parties, or meeting any other requirement as agreed upon between the parties, etc., which are relevant to the scheme.

b)    The ‘appointed date’ identified under the scheme shall also be deemed to be the ‘acquisition date’ and date of transfer of control for the purpose of conforming to accounting standards (including Ind-AS 103 Business Combinations).

c)    Where the ‘appointed date’ is chosen as a specific calendar date, it may precede the date of filing of the application for scheme of merger/amalgamation in NCLT. However, if the ‘appointed date’ is significantly ante-dated beyond a year from the date of filing, the justification for the same would have to be specifically brought out in the scheme and it should not be against public interest.

d)    The scheme may identify the ‘appointed date’ based on the occurrence of a trigger event which is key to the proposed scheme and agreed upon by the parties to the scheme. This event would have to be indicated in the scheme itself upon occurrence of which the scheme would become effective. However, in case of such event being based on a date subsequent to the date of filing the order with the Registrar under section 232(5), the company shall file an intimation of the same with the Registrar within 30 days of such scheme coming into force.

Ind AS 10 Events after the Reporting Period – Appendix A Distribution of Non-cash Assets to Owners

5. This Appendix does not apply to a distribution of a non-cash asset that is ultimately controlled by the same party or parties before and after the distribution. This exclusion applies to the separate, individual and consolidated financial statements of an entity that makes the distribution.

10. The liability to pay a dividend shall be recognised when the dividend is appropriately authorised and is no longer at the discretion of the entity, which is the date:

(a) when declaration of the dividend, e.g., by management or the board of directors, is approved by the relevant authority, e.g., the shareholders, if the jurisdiction requires such approval, or

(b) when the dividend is declared, e.g., by management or the board of directors, if the jurisdiction does not require further approval.

11. An entity shall measure a liability to distribute non-cash assets as a dividend to its owners at the fair value of the assets to be distributed.

13. At the end of each reporting period and at the date of settlement, the entity shall review and adjust the carrying amount of the dividend payable, with any changes in the carrying amount of the dividend payable recognised in equity as adjustments to the amount of the distribution.

14. When an entity settles the dividend payable, it shall recognise the difference, if any, between the carrying amount of the assets distributed and the carrying amount of the dividend payable in profit or loss.

ANALYSIS AND CONCLUSION

Accounting in the books of the Transferor, Oz

  • The transaction is not a common control transaction because it is not controlled by the same party before and after the transaction. Therefore, in accordance with paragraph 5 of Appendix A to Ind AS 10, Oz is scoped into the said Appendix and need to comply with its requirements.
  • As per paragraph 11, the liability for dividend payable is recognised at fair value, which in this case, is the fair value of the business division that is demerged.
  • As per paragraph 10, the liability to pay a dividend shall be recognised when the dividend is appropriately authorised and is no longer at the discretion of the entity. The question is whether such a liability is recognised at the appointed date; i.e., 1st April, 20X2 or when the NCLT approves the scheme, i.e. 1st May, 20X3
  • As per paragraph 14, when an entity settles the dividend payable, it shall recognise the difference, if any, between the carrying amount of the assets distributed and the carrying amount of the dividend payable in profit or loss. The question is should this date be the appointed date or date when NCLT approves the scheme; i.e., 1st May, 20X3?
  • As per paragraph 13, at the end of each reporting period and at the date of settlement, the entity shall review and adjust the carrying amount of the dividend payable, with any changes in the carrying amount of the dividend payable recognised in equity as adjustments to the amount of the distribution. For this purpose, should the settlement of dividend be considered to have occurred at 1st April, 20X2 or 1st May, 20X3. If the settlement date is considered as 1st May, 20X3, then is any adjustment required in accordance with paragraph 13, at 31st March, 20X3?

Paragraph 6(b) of the MCA circular makes it clear that the schemes for which circular is issued are not only for business combination schemes under Ind AS 103. The MCA circular applies to other schemes as well such as a demerger scheme undertaken in accordance with the Company Law. The author believes that the MCA circular clearly lays down the path, for the recording of such transactions at the appointed date. Consequently, the dividend payable should be recorded at the appointed date; i.e., 1 April, 20X2.

The other related question is when should  the dividend settlement be recorded along with the corresponding adjustment to the statement of profit and loss. Again, the author believes that it is the appointed date from which the settlement takes place, and therefore the dividend settlement too should be recorded at the appointed date, though the NCLT approval is received on 1st May, 20X3.

The recognition of profit (assuming fair value of business division is greater than book value) on the dividend distribution is a tricky issue. Should it be recognised on the appointed date, and therefore recorded in retained earnings at 1 April, 20X2 or F.Y. 20X2-X3, i.e., the year in which the appointed date falls or financial year in which the NCLT approval is received, i.e., 20X3-X4.

The author believes that the profit should not be recognised at the appointed date in retained earnings, because that would be a clear violation of Appendix A of Ind AS 10, paragraph 14. Rather the profit shall be recognised in F. Y. 20X2-X3, which is the financial year in which the appointed date falls. Since the settlement of the dividend is recognised in the F. Y. 20X2-X3, the requirement of paragraph 13 to adjust the dividend payable amount at 31st March, 20X3 does not arise.

ACCOUNTING IN THE BOOKS OF THE TRANSFEREE, NEW CO

Though this is not a common control business combination, which requires pooling of interest method to be applied, the transferee may record the business transferred using the pooling of interest method. Essentially, the transfer of the division entails division of the company, but with the same set of shareholders. From the transferee’s perspective, the transfer of the business division is merely a change in geography of the assets, lacking meaningful substance, and therefore should be accounted for using the pooling of interest method.

However, some may argue, that the accounting in the books of the transferor and the transferee should be reciprocal. Therefore, since the transferor records the dividend payable at fair value, there is no reason why the transferee should not record the transaction at fair value. The other argument that supports accounting at fair value is that the demerger transaction should not be seen as a division simpliciter, but a transaction that unlocks value, such that the results achieved are greater than sum of the parts.

The author believes that the book value method (may also be referred to as pooling of interest or continuation method) is the most appropriate representation in the books of the transferee. An analogy can be drawn from the book value accounting applicable to common control business combination.

[Arising out of order dated 9th February, 2022 passed by the ITAT “C” Bench Kolkata in ITA Nos. 87/Kol/2019 A.Y. 2015-2016] Section 50C: Compulsory acquisition of a capital asset being land or building or both – No room to suspect the correct valuation – the provisions of Section 50C will not be applicable:

5 PCIT, Asansol vs. M/s The Durgapur Projects Ltd
[ITAT No. 282 Of 2022, (G. A. No. 02 OF 2022)
 Dated: 24th February, 2023]

[Arising out of order dated 9th February, 2022 passed by the ITAT “C” Bench Kolkata in ITA Nos. 87/Kol/2019 A.Y. 2015-2016]

Section 50C: Compulsory acquisition of a capital asset being land or building or both – No room to suspect the correct valuation – the provisions of Section 50C will not be applicable:

The Assessee filed its original return of income on 28th September, 2015declaring a loss of Rs.591,64,96,295. Subsequently revised return was filed on 16th January, 2017 declaring a loss of Rs.581,04,07,134. The case was selected for scrutiny and notices under section 143(2) and 142(1) of the Act were issued and the AO completed the assessment under section 143(3) of the Act by order dated 30th December, 2017. The AO inter alia amongst other additions added a sum of Rs. 5,48,43,584 to the total income being capital gain on transfer of land to the National Highways Authority of India (NHAI) and also initiated penalty proceedings under section 271(1)(c) of the Act;

The assessee preferred appeal before the CIT (Appeals), Durgapur. The CIT(A) held that the AO was not justified in invoking Section 50C of the Act on the land which was compulsorily acquired for NHAI and directed to re-compute the capital gains without applying Section 50C of the said Act. The revenue challenged the said order by filing the appeal before the Tribunal. The appeal was dismissed by the Tribunal.

Before the Honorable High Court the Appellant Revenue contended that the Tribunal affirmed the decision of the CIT(A) to hold that the AO was not justified in invoking Section 50C of the Act by relying upon an order passed by the Hyderabad Tribunal in ITA No. 1680, 1681/Hyd/2018 dated 27th July, 2020, without noting that the said decision cannot be applied to the facts of the case, as in the said case the assessee had not transferred therein own property consisting of land and building but had only transferred their right to receive the amount of compensation. Reliance was placed on the judgment of the Hon’ble Division Bench of the High Court of Madras in Ambattur Clothing Company Ltd vs. ACIT, 1 for the proposition that the AO was justified in treating value adopted by the stamp valuation authority as deemed sale consideration received as a result of the acquisition.

The Respondent assessee referred to Section 96 of the Right to Fair Compensation and Re-Settlement Act, 2013 and submitted that the said provision states that no income tax or stamp duty shall be levied on any award or agreement made under the said Act except under section 46 and no person claiming under any such award or agreement shall be liable to pay any fee for the copy of the same. Therefore, it is submitted that the department is not justified in levying the tax as was done by the AO. The Respondent assessee referred to Circular No. 36 of 2016 issued by the Central Board of Direct Taxes (CBDT) dated 25th October, 2016 which dealt with the taxability of compensation received by the land owners for the land acquired under the 2013 Act. It is submitted that the circular clearly states that such compensation received by the land owners on account of compulsory acquisition of land under the said provision is not taxable. Further attention was drawn to the various proceedings initiated by NHAI as also the cheques given in favour of the assessee towards payment of compensation.

The Respondent assessee placed reliance on the decision of the High Court of Rajasthan in Gopa Ram vs. Union of India and Others in Civil Writ Petition No. 12746 of 2017 dated 22th January, 2018 for the proposition that Section 24 of the Acquisition Act, 2013 has no application in the acquisition proceedings under National Highways Act, 1956.

The Honourable High Court observed that admittedly, the land in question was compulsorily acquired for the NHAI. The assessee received compensation of Rs. 4,47,17,396 from NHAI and valuation of the stamp valuation authority was Rs. 9,95,60,980.The AO adopted the full value of sale consideration under section 50C and calculated the capital gains in the hands of the assessee at Rs. 548,43,584.

The Honourable High Court observed that in the instant case the transfer of the land was not on account of the agreement between the parties, but it was the case of the compulsory acquisition under the provisions of the 2013 Act. Therefore, the transaction cannot be treated to be a transaction between two private parties where there may be room to suspect the correct valuation and the apparent sale consideration which was reflected in the sale documents. It is common knowledge that when compensation is determined by the authorities under the said Act, it is invariably lesser than the market value of the property as the determination is done in a particular manner by taking note of several factors.

This is precisely the reason that the Act provides for an appellate remedy and further remedies in case the erstwhile land owner is of the view that the compensation paid/offered was inadequate.

The Honourable High Court observed that this provision has been designed to control the transactions where the correct market value is not mentioned and there is suppression of the correct value by the parties to the transactions. As in the instant case, it is an acquisition of land by the Government by way of compulsory acquisition, the appellant department cannot be heard to say that there was suppression of the value and consequently the question of invoking Section 50C of the Act does not arise.

The case of Ambattur Clothing Company Ltd relied on by revenue has no application to the facts of the case of hand. The facts of the case are entirely different and it was not a case of any compulsory acquisition of land as in the case on the hand.

Thus, in a case of compulsory acquisition of land by the Government there is no room for suppressing the actual consideration received on such acquisition.

In cases of transactions between the private parties, quite often the actual sale consideration paid for acquiring the immovable property is more than the .sale consideration disclosed in the sale deed. With a view to curb such transactions, Section 50C of the Act was introduced so as to adopt the market value determined by the stamp duty authorities as the sale consideration for the purpose of computing capital gains under the provisions of the Income Tax Act.

The said provision therefore provides for referring the matter to the valuation officer of the revenue to determine the actual market value of the property sold and all other relevant factors which may be considered by the State Valuation Authority.

The Honourable High Court further held that the principle culled out by the Hyderabad Tribunal is a correct interpretation of the provisions of Section 50C in the case of the compulsory acquisition of land. Thus, the findings rendered by the CIT(A) as affirmed by the Tribunal on this issue do not call for any interference.

The Honourable High Court observed that for the taxability of the compensation received by the assessee for the lands compulsory acquired under the 2013 Act, it is relevant to take note of the circular issued by the CBDT dated 25th October, 2016 in Circular No. 36/2016. It was pointed out that under the existing provisions of the Income Tax Act an agricultural land which is not situated in a specified urban area is not regarded as a capital asset, and hence capital gain arising from the transfer (including compulsory acquisition) of such agricultural land is not taxable. It is further stated that Finance (No. 02) Act, 2004 inserted Section 10(37) in the Act from 1st April, 2005 to provide specific exemption to capital gains arising to an individual or a HUF from compulsory acquisition of an agricultural land situated in specified urban limited subject to fulfilment of certain conditions.

Thus, it was ordered that the compensation received from the compulsory acquisition of an agricultural land is not taxable under the Income Tax Act subject to the fulfilment of certain conditions for specified urban land.

 It was further stated that the 2013 Acquisition Act came into effect from 1st January, 2014 and Section 96 inter alia provides that income tax shall not be levied on any award or agreement made except those made under section 46 of the said Act. Therefore, it was directed that compensation for compulsory acquisition of land under the 2013 Acquisition Act except those made under section 46 of the said act is exempted from the levy of income tax. Further, it was ordered that as no distinction has been made between compensation received for compulsory acquisition of agricultural land and non-agricultural land in the matter of providing exemption from income tax under 2013 Acquisition Act, the exemption provided under section 96 of the 2013 Acquisition Act is wider in scope than the tax exemption provided under the existing provisions of the Income Tax Act, 1961. It was pointed out that this aspect has created uncertainty in the matter of taxability of compensation received on compulsory acquisition of land especially those relating to acquisition of non-agricultural land.

This matter was examined by the CBDT and it was clarified that compensation received in respect of award or agreement which has been exempted from the levy of income tax under section 96 of the 2013 Acquisition Act, shall also not be taxable under provisions of the Income Tax Act, 1961 even if there is no specific provision of exemption for such compensation in the Income Tax Act, 1961. The said Circular No. 36 of 2016 would come to the aid and assistance of the assessee and the compensation received by the assessee on account of the compulsory acquisition of land under the 2013 Acquisition Act is exempt from the tax.

The Honourable Court also observed that the object and purpose behind insertion of the said provision in the Act was to curb the menace of the use of unaccounted cash in transfers of capital assets. Upon a plain and literal interpretation of the words used in Section 50C, it is amply clear that the legislature intended to take the valuation adopted by the stamp valuation authorities as the benchmark for the purpose of payment of stamp duty in respect of transfer of the capital asset as the deemed full value of consideration.

Keeping in mind the canons of interpretation and the object behind inserting the said provision, it appears that the legislature used the words and expressions in Section 50C of the Act consciously to give the same a restricted meaning. In view thereof, the term “transfer” used in Section 50C has to be given a restricted meaning and the same does not have a wider connotation so as to include all kinds of transfer as contemplated under Section 2(47) of the Act. The Court accordingly held that the provisions of Section 50C shall be applicable in cases where transfer of the capital asset has to be effected only upon payment of stamp duty.

In case of a transfer by way of compulsory acquisition, the capital asset being land or building or both vests upon the government by operation of the provisions of the relevant statute governing such acquisition proceeding and subject to the terms and conditions laid down in the said statute being followed.

In case of compulsory acquisition the transfer of property takes place by operation of law and the provisions of the Transfer of Property Act or the Indian Registration Act do not have any manner of application to such transfers. The question of payment of stamp duty also does not arise in such cases.

The Court held that in case of compulsory acquisition of a capital asset being land or building or both, the provisions of Section 50C cannot be applied as the question of payment of stamp duty for affecting such transfer does not arise.

In the instant case, the property was acquired under the provisions of the National Highways Act, 1956. The property vests by operation of the said statute and there is no requirement for payment of stamp duty in such vesting of property. As such there was no necessity for an assessment of the valuation of the property by the stamp valuation authority in the case on hand. For the reasons as aforesaid, it is held that the provisions under section 50C of the Income Tax Act cannot be applied to the case on hand.

Consequently the appeal filed by the revenue was dismissed and the substantial questions of law were answered against the revenue.   

[Arising from order dated 13th April, 2011 passed by the Income Tax Appellate Tribunal, “B” Bench, Kolkata (Tribunal) in ITA No. 92/Kol/2010 A.Y.: 2005-06. ] Section 28 viz a viz 45: Development agreement – capital gain or income from business:

4 CIT, Kolkata IV vs. M/s  Machino Techno Sales Ltd
[ITA no 160 of 2011 Dated: 20th February, 2023, (Cal.) (HC)][Arising from order dated 13th April, 2011 passed by the Income Tax Appellate Tribunal, “B” Bench, Kolkata (Tribunal) in ITA No. 92/Kol/2010
A.Y.: 2005-06. ]

Section 28 viz a viz 45:  Development agreement – capital gain or  income from business:

The appeal of the Revenue was admitted on the following substantial question of law:-

“Whether the learned Tribunal below committed substantial error of law in holding that the income, derived by way of return from a Development Agreement in favour of the owner of the land, should be treated as capital gain instead of income from business ?”

The Hon court observed that in the absence of any evidence to show that the land purchased by the assessee during 1985/1990 was intended for resale or was converted into stock-in-trade,  the earnings of the assessee pursuant to a development agreement entered into with the developer could not be assessed as business  income . The court observed  that the Tribunal had taken into consideration the factual position which was not disputed by the revenue that the said land and factory shed was used by the assessee as its workshop and was shown as capital asset in its balance-sheet.

Further, the revenue did not dispute the fact that the purchase prices were debited by the assessee under the head ‘land account’. On 13th November, 1994 the assessee entered into a development agreement with the developer under which the assessee in exchange of the land in question was entitled to get 45 per cent of the constructed area and the remaining portion of the land and shed continued to be used by the assesse for its own workshop purchase. The Tribunal noted that no documents have been referred to by the revenue to show that the assessee had treated the asset as stock-in-trade.

On the other hand, the assessee continued to show the land as capital asset even after 1994, which fact was accepted by the department. The Tribunal had distinguished the decisions cited by the revenue by noting the facts of the case that the land was purchased by the assessee during 1985/1990 and used as capital asset for its business purposes and continued to treat the same as capital asset in the accounts. Thus, the Tribunal correctly held that there was no intention on the part of the assessee to enter into an adventure in the nature of trade to deal in the land.

The court observed that in view of the cogent reasons assigned by the Tribunal on the undisputed factual position, there were no grounds to interfere with the order passed by the Tribunal.

Accordingly, the appeal was dismissed and the substantial questions of law were answered against the revenue.

‘Charitable Purpose’, GPU Category- Post 2008 Amendment – Eligibility for Exemption under Section 11 – Section 2(15) – Part II

INTRODUCTION

4.1    As mentioned in Introduction in Part I of this write-up (BCAJ April, 2023), special provisions dealing with income derived by charitable trusts were present in section 4(3) of the Indian Income-tax Act, 1922 (“1922 Act”). The term “charitable purpose” was defined in the 1922 Act to include relief of the poor, education, medical relief and the advancement of any other object of general public utility. The last limb – ‘advancement of any other object of general public utility’ (“GPU” or “GPU category”) did not contain any conditions which restricted a charitable trust from carrying on business activities.

4.2    As mentioned in Part I of the write up, provisions dealing with charitable trusts were amended from time to time in the Income-tax Act, 1961 (“1961 Act”). As stated in Para 1.3 of Part I, the words ‘not involving the carrying on of any activity for profit’ were added in the GPU category at the time of enactment of the 1961 Act. These words were interpreted by several decisions of the Supreme Court. To reiterate in brief, the Supreme Court in Sole Trustee, Loka Shikshana Trust vs. CIT [1975] 101 ITR 234 (“Loka Shikshana Trust”) held that a GPU category charitable trust should show that its purpose is the advancement of any other object of general public utility and that such purpose does not involve the carrying on of any activity for profit. The Supreme Court in Indian Chamber of Commerce vs. CIT [1975] 101 ITR 796 (SC) (“Indian Chamber”) held that it is not sufficient that a trust has the object of general public utility but the activities of the trust should also not be for profit. The Constitutional bench of the Supreme Court in Surat Art’s case overruled its earlier decision and held that it was the object of general public utility that must not involve the carrying on of any activity for profit and not its advancement or attainment.

4.3    Further amendments, as stated in para 1.4 and 1.5 of Part I of this write up, were made in the 1961 Act from time to time. A significant amendment was made by the Finance Act, 2008 (‘2008 amendment’) whereby a proviso was added to the definition of ‘charitable purpose’ stating that advancement of any other object of general public utility shall not be a charitable purpose if it involves carrying on of any activity in the nature of trade, commerce or business or any activity of rendering service in relation thereto [Commercial Activity/Activities] for a cess or fee or any other consideration irrespective of the nature of use or application, or retention, of the income from such activity. The Finance Minister’s speech at the time of introduction of the 2008 amendment and the CBDT Circular explaining the provisions are referred to at para 1.8 of Part I of this write-up. Subsequently, further amendments were made from time to time specifying that the proviso introduced by the 2008 amendment would not apply if the receipts from activities in the nature of trade, commerce or business are below a specified limit.

ACIT(E) VS. AHMEDABAD URBAN DEVELOPMENT AUTHORITY
(449 ITR 1 -SC)

5.1    As stated in Part I of this write up, appeals were filed before the Supreme Court challenging the decisions of several High Courts. As mentioned in Para 2.1 of Part I, the Supreme Court in the case of ACIT(E) vs. Ahmedabad Urban Development Authority and connected matters (449 ITR 1) divided the assessee into six categories namely – (i) statutory corporations, authorities or bodies, (ii) statutory regulatory bodies/authorities, (iii) trade promotion bodies, councils, associations or organisations, (iv) non-statutory bodies, (v) state cricket associations and (vi) private trusts. The arguments of the Revenue and that of the assessees are summarised in Paras 3.1 to 3.3 Part I of this write up. After considering the contentions of both the sides, Supreme Court proceeded to decide on the issue.

5.2    At the outset, the Supreme Court set out the legislative history of the provisions and the amendments made from time to time so as to determine the intention of the law makers. The Court further observed that the speeches made in the legislature or Parliament can also be looked into for determining the rationale for the amendments. The Court then proceeded to deal with certain contentions raised by the assessees on the general principles and interpretation of the language employed in the proviso to Section 2(15)

5.3    The Court dealt with the assessee’s reliance on CBDT Circular Nos. 11 of 2008 (308 ITR 5 (St.)) and 1 of 2009 (310 ITR 42 (St.)) and the argument that considering the objectives of amendments and binding effect of the Circulars, the 2008 amendment would not affect genuine trusts but only entities operating on commercial lines where the GPU object is only a device to hide the true purpose of trade, commerce or business. The Court distinguished the decisions in the case of Navnit Lal Jhaveri, UCO Bank, etc. which were relied upon by the assessee for the binding effect of the Circular and stated as under [pages 87/88]:

“In the opinion of this court, the views expressed in Keshavji Ravji, Indian Oil Corporation and Ratan Melting and Wire Industries (though the last decision does not cite Navnit Lal Jhaveri), reflect the correct position, i.e., that circulars are binding upon departmental authorities, if they advance a proposition within the framework of the statutory provision. However, if they are contrary to the plain words of a statute, they are not binding. Furthermore, they cannot bind the courts, which have to independently interpret the statute, in their own terms. At best, in such a task, they may be considered as departmental understanding on the subject and have limited persuasive value. At the highest, they are binding on tax administrators and authorities, if they accord with and are not at odds with the statute; at the worst, if they cut down the plain meaning of a statute, or fly on the face of their express terms, they are to be ignored.”

5.3.1    While dealing with the argument of assessees’ being statutory corporations that they are agencies of the ‘State’ and the activities of such corporations cannot be characterised as motivated by profit, the Court observed that every activity resembling commerce cannot be considered per se to be exempt from Union taxation and that the crucial or determinative element is whether performance of a function is actuated by profit motive.

5.3.2    Considering the meaning of the expressions ‘fee, cess or consideration’, the Court stated that they should receive a purposive interpretation and also laid down the following guiding principles as to when a ‘fee, cess or consideration’ would or would not be treated as being towards an Commercial Activity i.e. in the nature of trade, commerce or business [pages 97/98]:

“Fee, cess and any other consideration” has to receive a purposive interpretation, in the present context. If fee or cess or such consideration is collected for the purpose of an activity, by a state department or entity, which is set up by statute, its mandate to collect such amounts cannot be treated as consideration towards trade or business. Therefore, regulatory activity, necessitating fee or cess collection in terms of enacted law, or collection of amounts in furtherance of activities such as education, regulation of profession, etc., are per se not business or commercial in nature. Likewise, statutory boards and authorities, who are under mandate to develop housing, industrial and other estates, including development of residential housing at reasonable or subsidized costs, which might entail charging higher amounts from some section of the beneficiaries, to cross-subsidize the main activity, cannot be characterized as engaging in business. The character of being ‘state’, and such corporations or bodies set up under specific laws (whether by states or the centre) would, therefore, not mean that the amounts are ‘fee’ or ‘cess’ to provide some commercial or business service. In each case, at the same time, the mere nomenclature of the consideration being a “fee” or “cess”, is not conclusive. If the fee or cess, or other consideration is to provide an essential service, in larger public interest, such as water cess or sewage cess or fee, such consideration, received by a statutory body, would not be considered “trade, commerce or business” or service in relation to those. Non-statutory bodies, on the other hand, which may mimic regulatory or development bodies – such as those which promote trade, for a section of business or industry, or are aimed at providing facilities or amenities to improve efficiencies, or platforms to a segment of business, for fee, whether charged by subscription, or specific fee, etc, may not be charitable; when they claim exemption, their cases would require further scrutiny.”

5.3.3    The Court then held that the ‘predominant test’ laid down by the Constitution bench of the Supreme Court in Surat Art’s case would cease to apply after the 2008 amendment. In this context, the Court expressed its views as under [page 101]:

“The paradigm change achieved by Section 2(15) after its amendment in 2008 and as it stands today, is that firstly a GPU charity cannot engage in any activity in the nature of trade, commerce, business or any service in relation to such activities for any consideration (including a statutory fee etc.). This is emphasized in the negative language employed by the main part of Section 2(15). Therefore, the idea of a predominant object among several other objects, is discarded. The prohibition is relieved to a limited extent, by the proviso which carves out the condition by which otherwise prohibited activities can be engaged in by GPU charities.”

In the above context, the Court further explained effect of the amendments from 2008 as under [page 108]:

“….. Thus, the test of the charity being driven by a predominant object is no longer good law. Likewise, the ambiguity with respect to the kind of activities generating profit which could feed the main object and incidental profit- making also is not good law. What instead, the definition under Section 2(15) through its proviso directs and thereby marks a departure from the previous law, is – firstly that if a GPU charity is to engage in any activity in the nature of trade, commerce or business, for consideration it should only be a part of this actual function to attain the GPU objective and, secondly – and the equally important consideration is the imposition of a quantitative standard – i.e., income (fees, cess or other consideration) derived from activity in the nature of trade, business or commerce or service in relation to these three activities, should not exceed the quantitative limit of Rs. 10,00,000 (w.e.f. 01.04.2009), Rs. 25,00,000 (w.e.f. 01.04.2012), and 20% (w.e.f. 01.04.2016) of the total receipts. Lastly, the “ploughing” back of business income to “feed” charity is an irrelevant factor – again emphasizing the prohibition from engaging in trade, commerce or business.”

5.4    The Court then noted the distinction between a case where business undertaking itself is held as a property under trust to which section 11(4) applies and a case where a trust carries on business which is governed by section 11(4A) of the Act.

5.4.1    Considering the distinction between the provisions contained in the section 11(4) and section 11(4A) and after considering certain relevant judicial precedents including its judgment in the case of J K Trust vs. CIT [(1957) 32 ITR 535 (SC)] and summarizing the position in this respect, the Court observed as under [page 105]:

“Therefore, to summarise on the legal position on this – if a property is held under trust, and such property is a business, the case would fall under section 11(4) and not under section 11(4A) of the Act. Section 11(4A) of the Act, would apply only to a case where the business is not held under trust. There is a difference between a property or business held under trust and a business carried on by or on behalf of the trust. This distinction was recognized in Surat Art Silk (supra), which observed that if a business undertaking is held under trust for a charitable purpose, the income from it would be entitled to exemption under section 11(1) of the Act.”

5.4.2    In the context of section11(4A), the Court considered the ratio of its judgment in Thanthi Trust’s case [referred to in para 1.4.2 of part- I] and noted that in the context of interpretation of section 11(4A) as amended w.e.f 1st April, 1992 [the third period referred to therein], it is stated that the provision [i. e. section 11(4A)] requires that for a business income of a trust to be exempt, the business should be incidental to the attainment of objectives of the trust or institution. While explaining the effect of this, the Court stated as under [page 107]:

“The above observations have to be understood in the light of the facts before the court. Thanthi Trust carried on newspaper business which was held under trust. The charitable object of the trust was the imparting of education – which falls under section 2(15) of the Act. The newspaper business was incidental to the attainment of the object of the trust, namely, that of imparting education. This aspect is important, because the aim of the trust was a per se charitable object, not a GPU object. The observations were therefore made, having regard to the fact that the profits of the newspaper business were utilized by the trust for achieving the object of education. In the light of such facts, the carrying on of newspaper business, could be incidental to the object of education- a per se category. The Thanthi Trust (supra) ratio therefore, cannot be extended to cases where the trust carries on business which is not held under trust and whose income is utilized to feed the charitable objects of the trust.”

5.4.3 The Court observed that section 11(4A) of the Act exempts profits and gains of business of a trust or institution provided such business is incidental to the attainment of the objectives of the trust and separate books of accounts are maintained in respect of such business. Having taken a view that the interpretation of that expression in Thanthi Trust was in the context of per se charity [i.e. specific category- education] and not for the GPU category, the Court stated that what then is the interpretation of the expression “incidental” profits, from “business” being “incidental to the attainment of the objectives” of the GPU category [which occurs in Sec 11(4A)]? In this context, interpreting the meaning of the term ‘incidental’, the Court stated as under (page 108):

“….. The proper way of reading reference to the term “incidental” in Section 11(4A) is to interpret it in the light of the sub-clause (i) of proviso to Section 2(15), i.e., that the activity in the nature of business, trade, commerce or service in relation to such activities should be conducted actually in the course of achieving the GPU object, and the income, profit or surplus or gains can then, be logically incidental. The amendment of 2016, inserting sub clause (i) to proviso to Section 2(15) was therefore clarificatory. Thus interpreted, there is no conflict between the definition of charitable purpose and the machinery part of Section 11(4A). Further, the obligation under section 11(4A) to maintain separate books of account in respect of such receipts is to ensure that the quantitative limit imposed by sub-clause (ii) to section 2(15) can be computed and ascertained in an objective manner.”

5.5    For the purpose of concluding on interpretation of definition ‘charitable purpose’ under the Act, the Court observed that charity as defined has a wider meaning where it is the object of the institution which is in focus. As such, the idea of providing services or goods at no consideration, cost or nominal consideration is not confined to the provisions of services or goods without charging anything or charging a token or a nominal amount. Referring to the judgment of Indian Chamber’s case [referred to in para 1.3.2 of part- I of this write-up], the Court also noted that a little surplus may be left over at the end of the year- the broad inhibition against making profit is a good guarantee that the carrying on of an activity is not for profit. In this context, the Court observed as under [pages 109/110]:

“Therefore, pure charity in the sense that the performance of an activity without any consideration is not envisioned under the Act. If one keeps this in mind, what section 2(15) emphasizes is that so long as a GPU’s charity’s object involves activities which also generates profits (incidental, or in other words, while actually carrying out the objectives of GPU, if some profit is generated), it can be granted exemption provided the quantitative limit (of not exceeding 20%) under second proviso to section 2(15) for receipts from such profits, is adhered to”

5.5.1    In the above context, the Court further observed as under [page 110]:

“Yet another manner of looking at the definition together with sections 10(23) and 11 is that for achieving a general public utility object, if the charity involves itself in activities, that entail charging amounts only at cost or marginal mark up over cost, and also derive some profit, the prohibition against carrying on business or service relating to business is not attracted – if the quantum of such profits do not exceed 20% of its overall receipts.”

5.5.2    The Court concluded on the interpretation of this section 2(15) by stating as under [page 110]:

“It may be useful to conclude this section on interpretation with some illustrations. The example of Gandhi Peace Foundation disseminating Mahatma Gandhi’s philosophy (in Surat Art Silk) through museums and exhibitions and publishing his works, for nominal cost, ipso facto is not business. Likewise, providing access to low-cost hostels to weaker segments of society, where the fee or charges recovered cover the costs (including administrative expenditure) plus nominal mark up; or renting marriage halls for low amounts, again with a fee meant to cover costs; or blood bank services, again with fee to cover costs, are not activities in the nature of business. Yet, when the entity concerned charges substantial amounts- over and above the cost it incurs for doing the same work, or work which is part of its object (i.e., publishing an expensive coffee table book on Gandhi, or in the case of the marriage hall, charging significant amounts from those who can afford to pay, by providing extra services, far above the cost-plus nominal markup) such activities are in the nature of trade, commerce, business or service in relation to them. In such case, the receipts from the latter kind of activities where higher amounts are charged, should not exceed the limit indicated by proviso (ii) to section 2(15).”

5.5.3 While arriving at the above conclusion, the Court further stated as under [page 111]:

“In the opinion of this court, the change intended by Parliament through the amendment of section 2(15) was sought to be emphasised and clarified by the amendment of section 10(23C) and the insertion of section 13(8). This was Parliaments’ emphatic way of saying that generally no commercial or business or trading activity ought to be engaged by GPU charities but that in the course of their functioning of carrying out activities of general public utility, they can in a limited manner do so, provided the receipts are within the limit spelt out in clause (ii) of the proviso to section 2(15).”

[To be continued]

Search and seizure — Block assessment — Undisclosed income — Appeal to CIT (Appeals) — Failure to furnish all material in department’s possession to assessee except documents relied upon — Directions issued to CIT (Appeals).

14 Deepak Talwar vs. Dy. CIT

[2023] 452 ITR 61 (Del.)

A. Ys. 2011-12 to 2017-18

Date of order: 27th January, 2023

Sections 132, 143(3), 153A and 246A of ITA 1961

Search and seizure — Block assessment — Undisclosed income — Appeal to CIT (Appeals) — Failure to furnish all material in department’s possession to assessee except documents relied upon — Directions issued to CIT (Appeals).

Pursuant to a search, the AO passed orders under section 143(3) r.w.s.153A of the Income-tax Act, 1961 for the A. Ys. 2011-12 to 2017-18 making additions and accordingly raising demand. The assessee’s appeal under section 246A was pending before the CIT (Appeals) against such orders. The assessee requested the Department to furnish the material and information in the possession of the Department. That was not done. The assessee filed a writ petition for a direction to that effect.

The Department’s case was that since the documents were voluminous and collating them would involve a long time, the documents relied upon were furnished and if some of them were not furnished they would be furnished shortly and that in respect of the documents which were in the possession of the Department but were not relied upon, there was no legal obligation on its part to furnish them to the assessee.

The Delhi High Court directed the CIT (Appeals) to take a decision in the matter with regards to the documents which, although, in the possession of the Department had not been relied upon and before proceeding further placed on record a list of those documents, whereupon, the assessee would have an opportunity to make a submission, as to the relevance of those documents for the purposes of prosecuting the assessee’s appeal. However, the CIT (Appeals) would not pass a piecemeal order. The order would be composite and would deal with the aforesaid aspect and the merits of the appeal.

Reassessment — DTAA — Effect of section 90 — Tax residency certificate granted by another country — Binding on income-tax authorities in India — Amount not assessable in India under DTAA — Notice of reassessment in respect of such income — Not valid.

13 Blackstone Capital Partners (Singapore) Vi FDI Three Pvt Ltd vs. ACIT (International Taxation)

[2023] 452 ITR 111 (Del)

A. Y. 2016-17

Date of order: 30th January, 2023

Sections 90, 147 and 148 of ITA 1961

Reassessment — DTAA — Effect of section 90 — Tax residency certificate granted by another country — Binding on income-tax authorities in India — Amount not assessable in India under DTAA — Notice of reassessment in respect of such income — Not valid.

The petitioner- Blackstone Capital Partners (Singapore) VI FDI Three Pvt Ltd was a non-resident in India and majority of its directors were residents of Singapore.  During the A. Y. 2016-17, the petitioner sold the equity shares purchased in the A. Y. 2014-15. For the A. Y. 2016-17, the petitioner filed the return of income on 29th September, 2016. In terms of the said return of income, the petitioner claimed that the gains earned by it on sale of Agile shares were not taxable in India by virtue of Article 13(4) of the Double Tax Avoidance Agreement entered into and subsisting between India and Singapore based on the Tax Residency Certificate. In its return of income, the petitioner made all the requisite disclosures with regard to the investment and sale of shares like the petitioner was a non-resident in India and majority of its directors were residents of Singapore. The petitioner’s return of income was processed under section 143(1) of the Income-tax Act, 1961 with no demand, on 8th October, 2016. On 31st March, 2021 a notice was issued to the petitioner under section 148 of the Act for the A. Y. 2016-17. The petitioner filed a return of income on 28th April, 2021 and also filed objections which were rejected.

The Petitioner filed a writ petition challenging the notice and the order rejecting the objections. The Delhi High Court allowed the writ petition and held as under:

“i)    The core issue that arises for consideration in the present writ petition is whether the respondent-Revenue can go behind the tax residency certificate issued by the other tax jurisdiction and issue reassessment notice u/s. 147 of the Income-tax Act, 1961 to determine issues of residence status, treaty eligibility and legal ownership.

ii)    The Income-tax Act, 1961, recognizes and gives effect to Double Taxation Avoidance Agreements. Section 90(2) of the Act stipulates that in case of a non-resident taxpayer with whose country India has a Double Taxation Avoidance Agreement, the provisions of the Act would apply only to the extent they are more beneficial than the provisions of such Agreement. On March 30, 1994, the CBDT issued Circular No. 682 emphasising that any resident of Mauritius deriving income from alienation of shares of an Indian company would be liable to capital gains tax only in Mauritius in accordance with Mauritius tax law and would not have any capital gains tax liability in India. This circular was a clear enunciation of the provisions contained in the Double Taxation Avoidance Agreement, which would have overriding effect over the provisions of sections 4 and 5 of the Act by virtue of section 90. The Supreme Court, in the case of UOI v. Azadi Bachaa Andalon , upheld the validity and efficacy of Circular No. 682 dated March 30, 1994 ([1994] 207 ITR (St.) 7) and Circular No. 789 dated April 13, 2000 ([2000] 243 ITR (St.) 57), issued by the CBDT. The court further held that the certificate of residence is conclusive evidence for determining the status of residence and beneficial ownership of an asset under the Double Taxation Avoidance Agreement.

iii)    The assessee had a valid tax residency certificate dated February 3, 2015 from the Inland Revenue Authority of Singapore evidencing that it was a tax resident of Singapore and thereby was eligible to claim tax treaty benefits between India and Singapore. The tax residency certificate is statutorily the only evidence required to be eligible for the benefit under the Double Taxation Avoidance Agreement and the respondent’s attempt to question and go behind the tax residency certificate was wholly contrary to the Government of India’s consistent policy and repeated assurances to foreign investors. In fact, the Inland Revenue Authority of Singapore had granted the assessee the tax residency certificate after a detailed analysis of the documents, and the Indian Revenue authorities could not disregard it as that would be contrary to international law.

iv)    Accordingly, the tax residency certificate issued by the other tax jurisdiction was sufficient evidence to claim treaty eligibility, residence status, legal ownership and accordingly the capital gains earned by the assessee was not liable to tax in India. No income chargeable to tax had escaped assessment and the notice of reassessment was not valid.”

Reassessment — Notice — Initial notice issued in the name of deceased assessee — Invalid — Notice and order under section 148A(d) set aside

12. Prakash Tatoba Toraskar vs. ITO
[2023] 452 ITR 59 (Bom)
Date of order: 10th February, 2023
Sections 147, 148, 148A(b) and 148A(d)
of ITA 1961

Reassessment — Notice — Initial notice issued in the name of deceased assessee — Invalid — Notice and order under section 148A(d) set aside

The AO issued a notice under section 148 of the Income-tax Act, 1961 dated 30th June, 2021for reopening the assessment under section 147 in the name of the assessee who had died on 4th November, 2019.. Pursuant to the judgment in UOI vs. Ashish Agarwal [2022] 444 ITR 1 (SC) the AO treated the notice issued under section 148 in the name of the deceased assessee to be a show-cause notice under section 148A(b). By that time the assessee had died. The legal heir of the the deceased assessee objected and did not participate in the assessment proceedings. The AO passed an order under section 148A(d).

The legal heir filed a writ petition and challenged the reassessment proceedings and the order under section 148A(d). The Bombay High Court allowed the writ petition and held as under:

“i)    Notwithstanding the objection having been taken by the legal heir of the deceased assessee, an order u/s. 148A(d) was passed on June 30, 2022. The initial notice issued u/s. 148 and the subsequent communication dated May 20, 2022 purporting to be a notice u/s. 148A(b) were in the name of the deceased assessee. The notice issued u/s. 148 against a dead person would be invalid, unless the legal representatives submit to the jurisdiction of the Assessing Officer without raising any objection.

ii)    The petition is allowed. The notice dated June 30, 2021 issued u/s. 148, the communication dated May 20, 2022 purporting to be a notice u/s. 148A(b) and the order dated June 30, 2022 u/s. 148A(d) were set aside.”

Reassessment — Notice under section 148 — Jurisdiction — Notice issued by officer who had no jurisdiction over the assessee — Notice defective and invalid — Notice and order rejecting objections of the assessee set aside.

11 Ashok Devichand Jain vs. UOI

[2023] 452 ITR 43 (Bom) A. Y.: 2012-13

Date of order: 8th March, 2022

Sections 147 and 148 of ITA 1961

Reassessment — Notice under section 148 — Jurisdiction — Notice issued by officer who had no jurisdiction over the assessee — Notice defective and invalid — Notice and order rejecting objections of the assessee set aside.

The petitioner assesee filed a writ petition challenging a notice dated 30th March, 2019 issued by the Income Tax Officer under section 148 of the Income-tax Act, 1961 for the A. Y. 2012-13 and an order passed on 18th November, 2019 rejecting the petitioner’s objection to reopening on various grounds.

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

“i)    The primary ground that has been raised is that the Income-tax Officer who issued the notice u/s. 148 of the Act, had no jurisdiction to issue such notice. According to the petitioner as per CBDT Instruction No. 1 of 2011 dated January 31, 2011, where income declared/returned by any non-corporate assessee is up to Rs. 20 lakhs, then the jurisdiction will be of Income-tax Officer and where the income declared/returned by a non-corporate assessee is above Rs. 20 lakhs, the jurisdiction will be of Deputy Commissioner/Assistant Commissioner.

ii)    The petitioner has filed return of income of about Rs. 64,34,663 and therefore, the jurisdiction will be that of Deputy Commissioner/Assistant Commissioner and not Income-tax Officer. Mr. Jain submitted that since notice u/s. 148 of the Act has been issued by the Income-tax Officer, and not by the Deputy Commissioner/Assistant Commissioner that is by a person who did not have any jurisdiction over the petitioner, such notice was bad on the count of having been issued by an officer who had no authority in law to issue such notice.

iii)    The notice u/s. 148 of the Income-tax Act, 1961 for reopening the assessment u/s. 147 is a jurisdictional notice and any inherent defect therein is not curable.

iv)    On the facts that the notice u/s. 148 having been issued by an Income-tax Officer who had no jurisdiction over the assessee had not been issued validly and without authority in law. The notice and the order rejecting the assessee’s objections were set aside.”

International transactions — Draft assessment order — Limitation — Effect of sections 153 and 144 — Issue of directions by Commissioner has no effect on limitation — Direction of Commissioner does not extend limitation.

10 Pfizer Healthcare India Pvt Ltd vs. Dy. CIT

[2023] 452 ITR 187 (Mad)

A. Y. 2015-16

Date of order: 11th November, 2022

Sections 144, 144C and 153 of ITA 1961

International transactions — Draft assessment order — Limitation — Effect of sections 153 and 144 — Issue of directions by Commissioner has no effect on limitation — Direction of Commissioner does not extend limitation.

The assessee was engaged in the business of manufacture, research, development and export to its group entities. It had filed its return for the A. Y. 2015-16. The time limit for completion of regular assessment in terms of section 153(1) of the Act, being 21 months from the end of the relevant assessment year, was 31st December, 2017. A reference was made to the Transfer Pricing Officer, since the business of the assessee included transactions that related to entities abroad for which a proper determination of arm’s length price was to be made. There was a request by the Transfer Pricing Officer for exchange of information and a reference was made to the competent authority in terms of section 90A of the Act. The reference for exchange of information was made by the Transfer Pricing Officer on 29th October, 2018 and the last of the information sought was received by him on 27th March, 2019. The order of the Transfer Pricing Officer was passed on 24th May, 2019. The draft assessment order dated 26th July, 2019, was passed in terms of section 143(3) r.w.s 144C(1).

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

“i)    Section 92CA of the Income-tax Act, 1961, is only a machinery provision that provides for the procedure for passing of a transfer pricing order and does not constitute a prescription for computing limitation. Section 153 deals exclusively with limitation and the statutory extensions and exclusions therefrom, as set out under the Explanation thereto. Section 92CA(3A) sets out the specific time periods to be adhered to in completion of the transfer pricing proceedings and works as limitation within the period of overall limitation provided u/s. 153 for the completion of assessment. The limitations set out under sub-section (3A) of section 92CA are to be construed in the context of, and within the overall limitation provided for, u/s. 153. There is no situation contemplated that would alter the limitation set out u/s. 153C save the exclusions set out under Explanation 1 to section 153C itself. The time limits set out under sub-section (3A) of section 92CA are thus subject to the limitation prescribed u/s. 153 that can, under no circumstances, be tampered with.

ii)    The second proviso to Explanation 1 to section 153 states that the period of limitation available to the Assessing Officer for making an order of assessment shall be extended to 60 days. The 60 days period, thus, must run from the date of the transfer pricing order to provide for seamless completion of assessment. The transmission of a transfer pricing order from the Transfer Pricing Officer to the Assessing Officer is an internal administrative act and cannot impact statutory limitation, which is the exclusive prerogative of section 153.

iii)    Power is granted to the Joint Commissioner to issue directions u/s. 144A for completion of assessment. That provision states that the Joint Commissioner, on his own motion or on reference made to him by the Assessing Officer or assessee, may call for and examine the record of any proceedings in which the assessment is pending. If he considers that having regard to the nature of the case, amount involved or any other reason, it is necessary or expedience to issue directions for the guidance of the Assessing Officer, he may do so and such directions shall be binding upon the Assessing Officer. The issuance of the direction and the communication of such direction by the Joint Commissioner to the Assessing Officer to aid in the completion of assessment is expected to be within the overall limits provided for completion of assessment u/s. 153 and Explanation 1 thereto and nowhere is it contemplated that such reference would extend the limitation.

iv)    The last of the information in this case was received by the Transfer Pricing Officer on March 27, 2019, by which time, the time for completion of regular assessment had itself long elapsed, on December 31, 2018. The order was barred by limitation.

v)    In the light of the detailed discussion as above, the impugned order of assessment is held to be barred by limitation and is set aside. This writ petition is allowed.”

Union Budget Receipt Side Movement Trends of Last 20 Years

An analysis of the Abstract of Receipts side of the Union Budget reveals some very interesting macro trends impacting federalism, fiscal prudence and impact of the decisions of Ministry of Finance (both at Centre and states) leadership.

Please see the Tables below which set the stage for study and discussions. Note that the values considered for study are ‘Revised Estimates’ of the completing year, given in the Budget booklet for the upcoming year. The details are:

A) Budget Statement details of Gross Receipts.

All Values are in Rupees Crores.

Abstract of Budget Revenues — Revised Estimates (RE) for the year coming to an end.

Details

RE 2002/03

RE 2012/13

RE 2022/23

CAGR % – 20 Years

REVENUE RECEIPTS

 

 

 

 

Total Tax Revenue collection (refer Note 1 below)

221918

1038037

3043067

14.00

Calamity Contingency

-1600

-4375

-8000

 

Share of States

-56141

-291547

-948406

15.18

Centre – Net Tax Revenue (refer Note 2 below)

164177

742115

2086661

13.56

Non Tax Revenue (dividends, profits, receipts of union
territories, others)

72759

129713

261751

6.61

Total Centre Revenue Receipts

236936

871828

2348412

12.15

Total Centre Capital Receipts

161779

564148

1842061

12.93

Draw-down of cash

 

-5150

 

 

Total Budget Receipts

398715

1430826

4190473

12.48

 

 

 

 

 

RATIOS

 

 

 

 

1. Share of states in gross
tax revenue – %

25.30

28.09

31.17

 

2. Composition of Total
Revenue Receipts

 

 

 

 

A. Centre Net Revenue Receipt

41.18%

51.87%

49.80%

 

B. Non Tax Revenue

18.25%

9.07%

6.25%

 

C. Capital Receipts

40.58%

39.43%

43.96%

 

3. Taxes contribution to
Total Revenue Receipts

 

 

 

 

Direct Tax

 

 

 

 

Corporate Tax

44700

358874

835000

15.76

Income Tax

37300

206095

815000

16.67

Expenditure & Wealth Tax

445

866

0

 

Cumulative Gross Direct Taxes

82445

565835

1650000

16.16

% of Gross Direct Tax to Total Tax Collection

37.15

54.51

54.22

 

Direct Tax

 

 

 

 

Customs Duty

45500

164853

210000

7.95

Union Excise Duty

87383

171996

320000

 

Service Tax

5000

132687

1000

 

GST

0

0

854000

 

Cumulative – ED, ST, GST

92383

304683

1175000

13.56

Cumulative Indirect Tax

137883

469536

1385000

12.23

% of Gross Indirect Tax to Total Tax Collection

62.13

45.23

45.51

 

Notes:

1.    Total Tax Revenue Collection = Cumulative Gross Direct Tax Plus Cumulative Indirect Tax plus other minor tax receipts.

2.    Centre –– Net Tax Revenue = Total Tax Revenue Collection minus Share of states as per agreed devolution per GST Committee and Finance Commission.

3.    RE 2022/23 represents the year of receipt of GST Taxes. Cumulative Indirect Tax = Customs Duty plus Union Excise Duty plus Service Tax plus GST.

4.    The above figures are taken from budget documents on a government website. Minor rounding off is ignored for the purpose of this article.

B)    20 Years Trends analysis of Union Budget Receipts side. It needs to be noted that 3 Prime Ministers were in Power at the Centre.

1.    The share of states from Central Tax Collection Pool has increased over 20 years, from 25.30 per cent of Gross Tax to 31.17 per cent. This higher devolution of funds is also borne out by the Compound Annual Growth Rate percentage (CAGR %) increase in states share being higher than CAGR % increase in Total Tax Collection by the Centre. This trend is good for India’s federal polity since many crucial spending actions happen at States’ end. GST compensations for 5 years started from July 2017. It has to be seen whether this trend of States percentage share is maintained. In the personal view of the author, the answer is YES.

2.    The increase in non-tax revenues is a weak link. It represents dividends, profits etc. That it’s CAGR % growth trajectory is restricted is evident since the growth percentage is just 6.61 per cent. The Central Public Sector Undertakings do not appear to be pulling their weight. It would be interesting to see what these receipts are as a percentage of Capital Invested on Govt of India Undertakings. Perhaps, that’s a separate topic but on the face of it – contrary to tax revenues, the non-tax revenues are not showing desired escalation. Also, the Customs Duty CAGR % growth is quite low, maybe because of high import tariffs in the past and duty rates adjustments under WTO requirements.

3.    Gross Direct Tax Growth in CAGR% at 16.16 per cent is faster than Gross Indirect Tax growth at 12.23 per cent. This is also borne out by the percentage of Direct Tax and Indirect Tax to Total Tax Revenue collected. Direct Tax percentage collection is improving and is now higher in percentage terms than Indirect Taxes collection. Interestingly, over 20 years the Direct Tax collection percentage has improved from 37.15 per cent to 54.22 per cent. One may say that Income Tax in India is quite regressive (due to exclusion of income from agriculture) but even then, through the effective use of tax deducted at source / tax collected at source mechanism and computerization, the income tax collections have spurted.

4.    It is the belief of many progressive economists that a Nation must have a superior Direct Tax collection than Indirect Tax collection, because Direct Tax is considered egalitarian and equitable since based on income levels while Indirect Tax does not consider income levels but is based on nature of Goods and Services sold. The more the shift to Direct Taxes improved collection, that nation’s tax structure is considered progressive.

5.    The Capital Receipts side (mainly in the nature of Borrowings / Debt) has stayed constant over 20 years at between 39 – 44 per cent of Total Central Receipts for the relevant year. Despite almost 3 years of Covid pandemic impact, the Debt taken in India Budget workings has not gone overboard. The high infrastructure spending, the Covid impact slowdown and the Russia / Ukraine war have given India a jolt on inflation. However, we seem to be escaping the banking sector financial security issue. While India is facing a sticky core inflation (mainly imported), it is in much better shape than many other economies – facing concurrent inflation and slowdown and now banking sector instability. This is due to fiscal prudence practiced over 20 years.

6.    For the purpose of taking such decadal comparatives (this is a 2 decades’ period) of Budget Receipts – it would help if some improved indexation criteria were released and implemented. The value of the Indian Rupee in 2002/03 is certainly not the same as the value in 2012/13 and 2022/23. Inflation has eaten away a lot of value. For a proper comparative of 2022/23, 2012/13 to 2002/23, an indexed value for both years compared to year 2002/03, would give a much more revealing outcome. Constant and comparative Rupee values for all 3 years 2002/03, 2012/13 and 2022/23 would make this a much more sensible comparative analysis. At indexed values (removing the effect of inflation), the comparatives of the 3 years across 2 decades would yield a much better comparative analysis since numbers value is constant.

Interest under section 201(1A) – TDS – Interest for delay in remitting tax deducted at source – No liability for interest if tax is not deductible at source.

9 Special Tahsildar, Land Acquisition (General) vs. GOI[2023] 451 ITR 484 (Ker)

Date of order: 15th September, 2022

Section 201(1A) of ITA 1961Interest under section 201(1A) – TDS – Interest for delay in remitting tax deducted at source – No liability for interest if tax is not deductible at source.

Special Tahsildar, Land Acquisition (General) paid compensation to persons from whom the land was acquired for establishing the Government Medical College and deducted tax at source from the compensation paid. The tax deducted in the month of January 2014 was paid to the credit of the Government only in the month of June 2014 and the reason for the delay was explained to be the fact that Tahsildar was deputed for election duty during the period January 2014 to May 2014 in connection with the General Elections. However, the AO levied interest under section 201(1A) of the Income-tax Act, 1961.

The Tahsildar filed a writ petition and challenged the demand for interest.

It was then contended on behalf of the Tahsildar that the liability to deduct tax and pay it to the Department is only in respect of sums for which the tax is required to be deducted at source. Since the lands which were the subject matter of acquisition were agricultural lands, which fell outside the definition of capital asset under section 2(14) of the Act, there was no question of deducting tax at source in respect of compensation paid to the land owners and therefore levy of interest under section 201(1A) was unwarranted.

The Department contended that levy of interest under section 201(1A) was statutory and the moment there was delay in payment of tax deducted, interest had to be levied.

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

“i)    It is clear from a reading of section 201 of the Income-tax Act, 1961, that the liability to deduct tax arises only when it is required to be deducted under the provisions of the Act. In other words, where there is no liability to deduct tax at source, the mere fact that tax was deducted at source and paid to the Income-tax Department belatedly, cannot give rise to a claim for interest u/s. 201(1A) of the Act. Interest u/s. 201(1A) of the Act is obviously to compensate the Government for the delay in payment of taxes, which are rightfully due to the Government.

ii)    Since the Department itself had refunded the amount of tax deducted at source, it could not be said at this point of time that the land in question was not agricultural land falling outside the definition of capital asset u/s. 2(14).

iii)    The delay in remitting the amounts deducted as tax at source arose only on account of the fact that the Officer in question was deputed for election duty for the period from January 2014 to May 2014 in connection with the Lok Sabha Elections of 2014. Cumulatively, these facts made it clear that the levy of interest under 201(1A) was wholly unwarranted in the facts and circumstances of this case.”

Section 115-O read with Dividend Article of DTAA – Dividend Distribution Tax (DDT) rate prescribed under section 115-O cannot be reduced to rate mentioned in Dividend Article of DTAA rate applicable to a non-resident shareholder.

20. DCIT vs. Total Oil India (Pvt) Ltd
[2023] 149 taxmann.com 332 (Mumbai-Trib.) (SB)
[ITA No: 6997/Mum/2019]
A.Y.: 2016-17
Date of order: 20th April, 2023

Section 115-O read with Dividend Article of DTAA – Dividend Distribution Tax (DDT) rate prescribed under section 115-O cannot be reduced to rate mentioned in Dividend Article of DTAA rate applicable to a non-resident shareholder.

FACTS

Taxation of dividend income under the Act has been subject to various amendments from time to time. Pre-1997, classical system of taxation was prevalent wherein the dividends were taxed in the hands of shareholders and companies declaring these dividends were required to withhold taxes on dividend income. From the year 1997 to 2020 (except for April 2002 to March 2003) the classical system was done away with and DDT regime existed. As per this regime, the company declaring dividend was made liable to pay taxes on dividends declared/distributed or paid. Consequently, such dividend income was regarded as exempt in the hands of the shareholders under the ITL. Vide Finance Act, 2020, DDT regime was abolished, and the classical system of taxation was restored.

On the judicial front, various Courts and ITAT have ruled on the DDT issue. Notably, given below are the relevant observations for the present controversy:

  • The SC in the case of Tata Tea4 held that the entirety of income distributed by the company engaged in the business of growing and manufacturing tea is dividend subject to DDT even if it is partially paid out of the exempt agricultural income of the company. A dividend distributed by a company, being a share of its profits declared as distributable among the shareholders, does not partake in the character of profits from which it reaches the hands of the shareholder. Since dividend income is not agricultural income, the same will be chargeable to tax.
  • Further, the SC in the case of Godrej & Boyce5 held that the dividend income was exempt in the hands of the shareholder and, hence, any expense in relation to such exempt income cannot be regarded as deductible. The SC held that tax incidence on dividend income was in the hands of the payer company. A domestic company is liable to pay DDT as a distinct entity and not as an agent of the shareholders. Accordingly, the income is not taxable in the hands of recipient shareholders and, thus, the same did not form part of the total income of the shareholder.
  • Delhi ITAT in the case of Giesecke & Devrient6 and Kolkata ITAT in the case of Indian Oil Petronas Pvt Ltd7, held that the DDT rate on dividend paid to non-resident shareholders needs to be restricted to the rates prescribed under the DTAA, if the conditions for DTAA entitlement are satisfied. The Tribunal noted that DDT is effectively a tax on dividend income, the incidence of which needs to be seen from the perspective of the recipient shareholder. Accordingly, the income tax should be charged at the lower of rate specified under the Act or DTAA for the recipient.
4    (2017) 398 ITR  260 (SC)
5    394 ITR 449 (SC),
6    [TS-522-Tribunal-2020]
7    [TS-324-Tribunal-2021(Kol)]

Later, Mumbai ITAT in the case of Total Oil India Pvt Ltd8 expressed its apprehensions about the correctness of the Tribunal decisions in the case of Giesecke & Devrient and Indian Oil Petronas Pvt Ltd and directed for the constitution of a Special Bench

Question for consideration before the Special Bench was:

“Where dividend is declared, distributed or paid by a domestic company to a non-resident shareholder(s), which attracts additional income-tax (tax on distributed profits) referred to in section 115-O of the Income-Tax Act,1961 (in short ‘the Act’), whether such additional income-tax payable by the domestic company shall be at the rate mentioned in Section 115-O of the Act or the rate of tax applicable to the non-resident shareholder(s) with reference to such dividend income”

HELD

Though dividend is an income in the hands of the shareholder, taxability need not necessarily be in the hands of the shareholder. The sovereign has the prerogative to tax the dividend, either in the hands of the recipient9 of the dividend or otherwise10.

Section 115-O is a complete code in itself, in so far as levy and collection of tax on distributed profits is concerned. Charge in the form of additional income tax (i.e., DDT) is created on amount declared, distributed or paid by domestic company by way of dividend. Further, DDT is a tax on “distributed profits” and not a tax on “dividend distributed”. The non-obstante nature of provision is an indication that the charge under the DDT provisions is independent and divorced from the concept of “total income” under the ITL.

DDT is liability of the company and not payment on behalf of the shareholders as DDT paid by the company shall be treated as the final payment of tax in respect of the amount declared, distributed or paid as dividends. The fact that no further credit or deduction can be claimed by the company or by any other person also suggests that shareholder does not enter the domain of DDT. The payee’s right to recover excess taxes which are deducted/collected at source or the right of subrogation in the event when payer pays excess over and above what he/she has to pay to the payee, is absent in the entire scheme of DDT provisions under the Act.

8    (ITA No. 6997/Mum/2019)
9    Classical/progressive system
10    Simplistic system where the company which distributes the dividend is required to discharge the tax liability on the sum distributed by way of dividend as an additional income tax on the company itself and consequently such dividend income was exempt in the hands of shareholders
  • The SC in the case of Tata Tea Co. Ltd11 did not deal with the nature of DDT, i.e., whether it is tax on the company or a tax on the shareholder. Reliance placed by the assessee on the said SC decision to suggest that DDT is a tax paid on behalf of the shareholder is not valid. The decision of SC in Tata Tea (supra) does not support that DDT is tax paid on behalf of the shareholders or that DDT is not the liability of the company. The SC, in that case, upheld the constitutional validity of DDT levy in respect of dividend paid out of that portion of profit of tea manufacturing company which is regarded as agricultural income of the company. The SC held that dividend does not bear the same character as profits from which it is paid and ruled that dividend is included within the definition of ‘income’ under the ITL.
  • Assessee’s reliance on the SC ruling in case of Godrej & Boyce Mfg. Co Ltd.12 to contend that DDT is paid on behalf of the shareholder and has to be regarded as payment of liability of the shareholder, discharged by the domestic company paying DDT is also not correct. The observation of the underlying Bombay HC decision regarding the legal characteristics of DDT is that it is tax on a company paying the dividend, is chargeable to tax on its profits as a distinct taxable entity, the domestic company paying DDT does not do so on behalf of the shareholder, and nor does it act as an agent of the shareholder in paying DDT. The conclusion cannot be said to have been diluted or overruled by the SC. The SC by taking a different basis reached the same conclusion that DDT is not a tax paid by the domestic company on behalf of the shareholder.
11    [(2017) 398 ITR  260 (SC)]
12    394 ITR 449
  • As against above, the Bombay HC in the case of Small Industries Development Bank of India13 (SIDBI) held that DDT is not a tax on dividend in the shareholder’s hands but an additional income-tax payable on the company’s profits, more specifically on that part of the profits which is declared, distributed or paid by way of dividend.
  • Interplay of DDT and DTAA
  • DTAAs need to be considered from the perspective of the recipients of income, i.e., shareholders. Where DDT paid by the domestic company in India, is a tax on its income distributed and not tax paid on behalf of the shareholder, the domestic company does not enter the domain of DTAA at all.
  • The DTAAs should specifically provide for treaty benefit in case of DDT levied on domestic company. Illustratively, the protocol to India-Hungary DTAA has extended the treaty protection14 to DDT wherein it has been stated that when the company paying the dividends is a resident of India then tax on distributed profits shall be deemed to be taxed in the hands of shareholder and will be eligible for reduced tax rate as provided in the DTAA.
  • Thus, wherever the Contracting States intend to extend the treaty protection to the domestic company paying dividend distribution tax, only then, the domestic company can claim benefit of the DTAA.
13    133 taxmann.com 158
14    Protocol to India-Hungary DTAA provides: “When the company paying the dividends is a resident of India the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders and it shall not exceed 10 per cent of the gross amount of dividend”

Article 28 of India-Malaysia DTAA – Article 28 cannot be invoked if the company is having substance in the form of employees, revenue and is set up for valid business reasons; Article 12 of India-Malaysia DTAA – Sub-licensing payment to a Malaysian company for: (a) Logo Rights; (b) Advertising Privileges; (c) Promotion Activities Rights; and (d) Rights to Complimentary Tickets, in respect of the cricket matches outside India, is not in nature of royalty under Article 12 of India-Malaysia DTAA.

19. ITO vs. Total Sports & Entertainment India Pvt Ltd
[TS-145-ITAT-2023(Mum)]
[ITA No: 5717 & 6129/Mum/2016]
A.Y.: 2014-15
Date of order: 27th March, 2023

Article 28 of India-Malaysia DTAA – Article 28 cannot be invoked if the company is having substance in the form of employees, revenue and is set up for valid business reasons; Article 12 of India-Malaysia DTAA – Sub-licensing payment to a Malaysian company for: (a) Logo Rights; (b) Advertising Privileges; (c) Promotion Activities Rights; and (d) Rights to Complimentary Tickets, in respect of the cricket matches outside India, is not in nature of royalty under Article 12 of India-Malaysia DTAA.
 
FACTS

Assessee, an Indian company, was engaged in the business of seeking rights sponsorships for any sports and entertainment event. It is a WOS of a Cayman Islands company (Cayman Hold Co). Cayman Hold Co was a holding company of 11 companies around the world including the assessee and a Malaysia company.

Cayman Hold Co had acquired advertisement rights of the Sri Lanka National Cricket Team1. The rights included: (a) Logo Rights; (b) Advertising Privileges; (c) Promotion Activities Rights; and (d) Rights to Complimentary Tickets. Cayman Hold Co had sub-licensed these rights to the Malaysian company which in turn further sub-licensed them to the assessee.

The Assessee monetized these rights to an Indian company and made sub-licensing payment to Malaysian company without deducting TDS.

Article 28 of India-Malaysia DTAA provides that a person shall not be entitled to its benefits if its affairs were arranged in such a manner as if the main purpose or one of the main purposes was to take the benefits of India-Malaysia DTAA. On the footing that: a) payments were in nature of royalty and b) Malaysian Company was interposed between the assessee and Cayman Hold Co to avail DTAA benefits of India-Malaysia DTAA, AO invoked Article 28 of India-Malaysia DTAA. Accordingly, AO held the assessee to be in default. CIT(A) held that Article 28 was not applicable to case of the assessee. CIT(A) bifurcated the payments in two parts in the ratio of 60:40. He considered 60 per cent of payment as advertisement charges for display of logo and content of billboard and held they were not in nature of royalty. He considered balance 40 per cent of payment as for the use of name ‘official partners’ or ‘official advertisers’ providing links on the website of the assessee and use of various items (which included photographs, etc.) of the teams for promoting products related to the assessee’s clients, and regarded them as royalty. Being aggrieved both parties appealed to ITAT.

HELD

Article 28 of India-Malaysia DTAA

After considering the following facts, the ITAT held the that Malaysian company was not a conduit or paper company set up to avail benefits under India-Malaysia DTAA.

  • All the senior management team members (CEO, COO, CFO, etc.) were located in Malaysia.
  • Rights obtained by Hold Co or other companies in the group were generally sub-licensed to the Malaysia company as the head office entity.
  • Practice of sub-licensing was followed for companies across world and not only for India.
  • Turnover of the Malaysian company was much higher than the revenue earned by it from the assessee.
  • The Malaysian company was in existence much prior to the Hold Co and the assessee.
  • Conclusion could have been different if the entire setup would have been in Cayman Islands and the Malaysian entity would have been a mere name lender in this set of transactions with no role to play.
1. Similar was the arrangement in arrangement in case of sponsorship rights of the West Indies Cricket Team.

ROYALTY TAXATION

  • ITAT followed Delhi HC judgment in the case of Sahara India Financial Corporation Ltd2, in which it was held as follows.
  • Payment towards various sponsorship rights in respect of ICC tournament was not in connection with the right to use, or by way of consideration for the right to use, any of the three categories3 mentioned in Article 13 of the DTAA.
  • There was no transfer of, copyright or, the right to use the copyright, flowing to the assessee. Therefore, payment made by the assessee would not fall within article 13(3)(c) of the said DTAA.
2     [2010] 321 ITR 459 (Delhi)
3    (a) any patent, trademark, design or model, plan, secret formula or process;
(b) industrial, commercial or scientific equipment or information concerning industrial, commercial or scientific experience; and
(c) any copyright of literary, artistic or scientific work cinematographic films and films or tapes for radio or television broadcasting.

Important Amendments by the Finance Act, 2023

This article, divided into 4 parts, summarises key amendments carried out to the Income-tax Act, 1961 by the Finance Act, 2023. Due to space constraints, instead of dealing with all amendments, the focus is only on important amendments with a detailed analysis. This will provide the readers with more food for thought on these important amendments. – Editor

PART I | NEW Vs. OLD TAX REGIME w.e.f. AY 2024-25

DINESH S. CHAWLA I ADITI TIBREWALA

Chartered Accountants

“The old order changeth yielding place to new and God fulfils himself in many ways lest one good custom should corrupt the world”.

Lord Alfred Tennyson wrote these famous lines several decades back.

In the present context, the old order in the world of Income tax in India is changing. And it is changing very fast. The new order is here in the form of the “new tax regime”. The new regime that was brought in vide the Finance Act 2020 has already been replaced now by a newer tax regime vide Finance Act 2023.

This article aims at simplifying the newest new tax regime for readers while comparing it with the erstwhile “old” regime.

I. APPLICABILITY AND AMENDMENTS

The Indian Government has introduced an updated new tax regime that will come into effect from AY 2024-25. This new regime can be exercised by Individuals, HUF, AOP (other than co-operative societies), BOI, and AJP (Artificial Juridical Person) under Sec 115BAC.

This new regime is a departure from the erstwhile regime that has been in place for several decades.

The 5 major amendments that affect the common man are:

1. Rebate limit increased from Rs. 5 lakh to Rs. 7 lakh;

2. Tax Slabs updated to 5 slabs with new rates (as given below);

3. Standard deduction for salaried tax payers would now be available even under the new regime;

4. Reduction in the top rate of surcharge from 37% to 25%, bringing the effective tax rate to 39% as compared to the erstwhile 42.74%;

5. Leave encashment limit for non-government salaried employees enhanced to Rs. 25 lakhs.

II. NEW SLABS & RATIONALE

New Tax Regime (Default Regime, w.e.f. AY 2024-25)

As per the amended law, the new regime has become the default regime w.e.f. AY 2024-25. Any taxpayer
who wishes to continue to stay in the old tax regime will have to opt-out of the new regime. In the original avatar of the new tax regime, the situation was exactly the opposite whereby the old regime was the default regime and anyone wanting to opt for the new regime had to do so in the ITR or by way of a separate declaration in case of persons having business/professional income.

The rationale behind the tweaks in the new tax regime is that it is expected to benefit the common-man with 20% lesser tax out-flow due to lower tax rates and streamlining of the tax slabs, when compared to the old regime. The catch here is that taxpayers will have to forego many investment-based deductions and exemptions vis-à-vis the old regime except the following:

1. Standard deduction of INR 50,000 under Sec 16,

2. Transport allowance for specially abled,

3. Conveyance allowance for travelling to work,

4. Exemption on voluntary retirement under Sec 10(10C),

5. Exemption on gratuity under Sec 10(10D),

6. Exemption on leave encashment under Sec 10(10AA),

7. Interest on Home Loan under Sec 24b on let-out property,

8. Investment in Notified Pension Scheme under Sec 80CCD(2),

9. Employer’s contribution to NPS,

10. Contributions to Agni veer Corpus Fund under Sec 80CCH,

11. Deduction on Family Pension Income,

12. Gift up to INR 5,000,

13. Any allowance for travelling for employment or on transfer.

The tax slabs under the new regime under Sec 115BAC(1A) are as follows:

Total Income Tax Rate
Up to 3 lakh Nil
From 3 lakh to 6 lakh 5%
From 6 lakh to 9 lakh 10%
From 9 lakh to 12 lakh 15%
From 12 lakh to 15 lakh 20%
Above 15 lakh 30%

Note: Surcharge and Cess will be over and above the tax rates.

Old Tax Regime

The old regime continues to be available to the taxpayers but, as mentioned earlier, they must now opt-in to be covered under this regime. Any taxpayer who has been claiming investment-based deductions may continue to opt for this regime, and may switch back & forth between the new regime and old regime (except for persons with income chargeable under the head “Profits and Gains of Business or Profession” (PGBP) as per their choice, on a yearly basis.

The tax slabs under the old regime are as follows:
Note: Surcharge and Cess will be over and above the tax rates.

Key Differences:

One of the key differences between the new regime and the old regime is the lower tax rates under the new regime. Taxpayers will be able to save money by way of lesser tax outflow, which will come at the cost of foregoing of deductions for investment-based savings.

Under the new regime, the taxpayers will not be able to claim investment-based deductions (Sec 80C, Sec 80D, etc.,) as well as certain exemptions that were available under the old regime. This means that taxpayers will have to pay taxes on their gross income without any deductions, with few exceptions (standard deductions, etc.).

This means that taxpayers will not be able to claim deductions for investments in tax-saving instruments like PPF, NSC, tuition fees for children, life & health insurance premium etc.

Taxpayers will also not be able to claim any deductions for home loan interest payments (in case of SOP), medical expenses, and education expenses, etc.

III. BENEFITS

The new regime has several benefits for taxpayers/tax department. Here are some of the key benefits:

1. Simpler structure (from the department’s perspective): The new regime has a simpler tax structure with lower tax rates. Taxpayers will no longer have to navigate the complex system of tax slabs and deductions that was prevalent under the old tax regime.

2. Lower rates: Under the new regime, taxpayers will be able to save money on taxes as the tax slabs are wider and tax rates are lower than the old regime. This will result in more disposable income (cash availability) for taxpayers.

3. No need for documentation: Since taxpayers are not allowed to claim deductions and exemptions under the new regime, they will no longer have to keep track of various tax-saving investments and deductions.

4. No investment proofs: Under the old regime, taxpayers had to submit investment proofs to claim tax deductions. Under the new regime, taxpayers will not be required to submit any investment proofs, as they are not allowed the deductions.

5. Encourages greater tax compliance: The simpler tax structure and lower tax rates under the new regime will encourage more people to file their tax returns, which will increase the tax base for the government.

6. Higher Rebate: Full tax rebate up to Rs. 25,000 on an income up to Rs. 7 lakh under the new regime, whereas, the rebate is capped at Rs. 12,500 under the old regime up to an income of Rs. 5 lakh. Effectively NIL tax outflow for income up to Rs. 7 lakh.

7. Reduced Surcharge for Individuals: The surcharge rate on income over Rs. 5 crore has been reduced from 37% to 25%. This move will bring down their effective tax rate from 42.74% to 39%.

IV. WHAT SHOULD YOU CHOOSE?

A salaried employee has to choose between the new regime and old regime at the beginning of each Financial Year by communicating in writing to the employer. If an employee fails to do so, then the employer shall deduct tax at source (TDS) as computed under the new regime. However, once the regime (new or old) is opted, it is not clear as to whether any employer will permit an employee to change the option anytime during the year. Therefore, salaried tax payers need to be very careful about what they chose at the beginning of the year.

An Individual who is earning income chargeable under the head “Profits and Gains of Business or Profession” has the option to opt out of the new regime and choose the old regime only once in a lifetime. Once such a taxpayer opts for the old regime, then he can opt out of it only once in his lifetime. Thereafter, it would not be possible to opt back into the old regime again as long as he is earning income under the head PGBP.

WHICH SCHEME IS MORE BENEFICIAL FOR A TAXPAYER?

1. Under the old regime, taxpayers can claim deductions and exemptions to save money (cash flows) on their taxes. However, the tax rates under the old regime are significantly higher than the tax rates under the new regime.

2. Under the new regime, taxpayers will not be able to claim most deductions and exemptions. However, the tax rates are lower, which can result in lower tax outflow, especially for those with lower / no deductions.

3. Taxpayers with lower deductions may benefit from the new regime as the lower tax rates will offset the lack of deductions. On the other hand, taxpayers with significant deductions may find the old regime more beneficial.

4. The parameters to effectively evaluate and select the tax regime (new or old) shall significantly depend on the tax profile of the taxpayer. Whichever regime is more beneficial in terms of better cash flows and their immediate financial needs, the taxpayers can evaluate and get a comparison done from the following link: https://incometaxindia.gov.in/Pages/tools/115bac-tax-calculator-finance-bill-2023.aspx.

5. The above link can also be accessed by scanning the following QR Code

PART II | CHARITABLE TRUTS

GAUTAM NAYAK

Chartered Accountant

In the context of taxation of charitable trusts, there were high expectations from the budget that the rigours of the exemption provisions would be relaxed, in the backdrop of the strict interpretation given to these provisions by the recent Supreme Court decisions in the cases of New Noble Education Society vs CCIT 448 ITR 594 and ACIT vs Ahmedabad Urban Development Authority 449 ITR 1. However, such hopes were dashed to the ground, as no amendment has been made in relation to the issues decided by the Supreme Court – eligibility for exemption of educational institutions, interpretation of the proviso to section 2(15) and the concept of incidental business under section 11(4A). On the other hand, some of the amendments further tighten the noose on charitable trusts, whereby their very survival may be at stake due to small mistakes.

Exemption for Government Bodies

The availability of exemption under section 11 to various government bodies and statutory authorities and boards, was also disputed in the case before the Supreme Court of Ahmedabad Urban Development Authority (supra). While the Supreme Court decided the issue in favour of such bodies, a new section 10(46A) has now been inserted, exempting all income of notified bodies, authorities, Boards, Trusts or Commissions established or constituted by or under a Central or State Act for the purposes of dealing with and satisfying with the need for housing accommodation, planning, development or improvement of cities, towns and villages, regulating or regulating and developing any activity for the benefit of the general public, or regulating any matter for the benefit of the general public, arising out of its objects. The notification is a one-time affair, and not for a limited number of years. Once such a body is notified, its entire income would be exempt, unlike under section 10(46) where only notified incomes are exempt, irrespective of the surplus that it earns without any controversy. Under this section, there is also no restriction on carrying on of any commercial activity, as contained in section 10(46). In case exemption is claimed u/s 10(46A), no exemption can be claimed u/s 10(23C).

Time Limit for Filing Forms for Exercise of Option/Accumulation

Under Clause (2) of explanation 1 to section 11(1), a charitable organisation can opt to spend a part of its unspent income in a subsequent year, if it has not applied 85% of its income during the year. This can be done by filing Form 9A online. Under section 11(2), it can choose to accumulate such unspent income for a period of up to 5 years, by filing Form 10 online. The due date for filing both these forms was the due date specified u/s 139(1) for furnishing the return of income, which is 31st October.

This due date for filing these two forms is now being brought forward by two months, effectively to 31st August. Since this amendment is effective 1st April 2023, it would apply to all filings of such forms after this date, including those for AY 2023-24. Therefore, charitable organisations would now have to keep in mind 3 tax deadlines – 31st August for filing Form No 9A and 10, 30th September for filing audit reports in Form 10B/10BB (in the new formats), and 31st October for filing the return of income.

The ostensible reason for this change is stated in the Explanatory Memorandum to be the difficulty faced by auditors in filling in the audit report, which requires reporting of such amounts accumulated or for which option is exercised, with the audit report having to be filed a month before the due date of filing such forms. Practically, this is unlikely to have been a problem in most cases, as generally auditors would also be the tax consultants who would be filing the forms, or where they are different, would be in co-ordination with the tax consultants.

The purpose could very well have been served by making the due date for filing these forms the same as the due dates for filing the audit reports. Since the figures for accumulation or for the exercise of the option can be determined only on the preparation of the computation of income, which is possible only once the audited figures are frozen, practically the audit for charitable organisations would now have to be completed by 31st August to be able to file these 2 forms by that date.

Of course, in case these forms are filed belatedly, an application can be made to the CCIT/CIT for condonation of delay – refer to CBDT Circular No. 17 dated 11.7.2022.

A similar change is made in section 10(23C) for seeking accumulation of income.

Exemption in Cases of Updated Tax Returns

A charitable trust is entitled to exemption u/s 11 only if it files its return of income within the time stipulated in section 139. An updated tax return can be filed u/s 139(8A) even after a period of 2 years. The Finance Act 2023 has now amended section 12A(1)(b) to provide that the exemption u/s 11 would be available only if the return is filed within the time stipulated under sub-sections (1) or (4) of section 139, i.e. within the due date of filing return or within the time permitted for filing belated return. Effectively, a trust cannot now claim exemption by filing an updated tax return, unless it has filed its original return within the time limits specified in section 139(1) or 139(4).

Exemption for Replenishment of Corpus and Repayment of Borrowings

The Finance Act 2021 had introduced explanation 4 to section 11(1), which provided that application from the corpus for charitable or religious purposes was not to be treated as an application of income in the year of application, but was to be treated as an application of income in the year in which the amount was deposited back in earmarked corpus investments which were permissible modes. Similar provisions were introduced for application from borrowings, where only repayment of the borrowings would be treated as an application of income in the year of repayment.

Such treatment of recoupment of corpus or repayment of loans has now been made subject to various conditions by the Finance Act, 2023 with effect from AY 2023-24 – i) the application not having been for purposes outside India, ii) is not towards the corpus of any other registered trust, iii) has not been made in cash in excess of Rs 10,000, iv) TDS having been deducted if applicable, has been actually paid, or v) has not been for provision of a benefit to a specified person.

Further, such treatment as the application would now be permitted with effect from AY 2023-24, only if the recoupment or repayment has been within 5 years from the end of the year in which the corpus was utilised. The reason stated for this amendment is that availability of an indefinite period for the investment or depositing back to the corpus or repayment of the loan will make the implementation of the provisions quite difficult. However, this time restriction brought in by the Finance Act 2023 would create serious difficulty for trusts who undertake significant capital expenditure by borrowing or utilising the corpus. Recoupment of such large expenditure or repayment of such a large loan may well exceed 5 years, in which case the recoupment or repayment would not qualify to be treated as an application of income, though the income of that year would have been used for this purpose. Such a provision is extremely harsh and will seriously hamper large capital expenditure by charities for their objects. A longer period of around 10 years would perhaps have been more appropriate.

Besides, recoupment or repayment of any amount spent out of corpus or borrowing before 31st March 2021 would also not be eligible to be treated as an application in the year of recoupment or repayment with effect from AY 2023-24. This is to prevent a possible double deduction, as a trust may have claimed such spending as an application of income in the year of spending since there was no such prohibition in earlier years.

Similar amendments have been made in section 10(23C).

Restriction on Application by Way of Donations to Other Trusts

Hitherto, a donation to another charitable organisation by a charitable organisation was regarded as an application of income for charitable purposes. An amendment was made by the Finance Act 2017, effective AY 2018-19, by insertion of explanation 2 to section 11(1) to the effect that a donation towards the corpus of another charitable organisation shall not be treated as an application of income. The Finance Act 2023 has now further sought to discourage donations to other charitable organisations by insertion of clause (iii) to explanation 4 to section 11(1). Henceforth, any amount credited or paid to another charitable organisation, approved under clauses (iv),(v),(vi) or (via) of section 10(23C) or registered under section 12AB, shall be treated as an application for charitable purposes only to the extent of 85% of such amount credited or paid with effect from AY 2024-25.

The Explanatory Memorandum states the justification for the amendment as under:

“3.2 Instances have come to the notice that certain trusts or institutions are trying to defeat the intention of the legislature by forming multiple trusts and accumulating 15% at each layer. By forming multiple trusts and accumulating 15% at each stage, the effective application towards the charitable or religious activities is reduced significantly to a lesser percentage compared to the mandatory requirement of 85%.

3.3 In order to ensure intended application toward charitable or religious purpose, it is proposed that only 85% of the eligible donations made by a trust or institution under the first or the second regime to another trust under the first or second regime shall be treated as application only to the extent of 85% of such donation.”

From the above explanatory memorandum, it is clear that, while the section talks of payments or credits to other trusts, it would apply only to such payments or credits which are by way of donation. The restriction would not apply to medical or educational institutions claiming exemption under clause (iiiab), (iiiac), (iiiad) or (iiiae) of section 10(23C), i.e. those organisations who are wholly or substantially financed by the government or whose gross receipts do not exceed Rs 5 crore, who are not registered u/s 12AB. It will also not apply to donations to charitable organisations, who may have chosen not to be registered u/s 12AB or u/s 10(23C).

This provision would obviously apply only in a situation where the donation is being claimed as an application of income, and would not apply to cases where the donation is not so claimed, on account of it being made out of the corpus, out of past accumulations under section 11(1)(a), etc.

The important question which arises for consideration is whether the balance 15% can be claimed by way of accumulation under section 11(1)(a), or whether such amount would be taxable, not qualifying for exemption under section 11. One view of the matter is that accumulation contemplates a situation of funds being available, which are kept back for spending in the future. If the funds have already been spent, it may not be possible to accumulate such amount u/s 11(1)(a).

The other view is that the 15% amount, though donated, would still qualify for the exemption. Reference may be made to the observations of the Supreme Court in the case of Addl CIT vs A L N Rao Charitable Trust 216 ITR 697, where the Supreme Court considered the nature of accumulation under sections 11(1)(a) and 11(2), as under:

“A mere look at Section 11(1)(a) as it stood at the relevant time clearly shows that out of total income accruing to a trust in the previous year from property held by it wholly for charitable or religious purpose, to the extent the income is applied for such religious or charitable purpose, the same will get out of the tax net but so far as the income which is not so applied during the previous year is concerned at least 25% of such income or Rs.10,000/- whichever is higher, will be permitted to be accumulated for charitable or religious purpose and will also get exempted from the tax net…..If 100 per cent of the accumulated income of the previous year was to be invested under section 11(2) to get exemption from income-tax then the ceiling of 25 per cent or Rs. 10,000, whichever is higher which was available for accumulation of income of the previous year for the trust to earn exemption from income-tax as laid down by section 11(1)(a) would be rendered redundant and the said exemption provision would become otiose. Out of the accumulated income of the previous year an amount of Rs. 10,000 or 25 per cent of the total income from property, whichever is higher, is given exemption from income-tax by section 11(1)(a) itself. That exemption is unfettered and not subject to any conditions. In other words, it is an absolute exemption. If sub-section (2) is so read as suggested by the revenue, what is an absolute and unfettered exemption of accumulated income as guaranteed by section 11(1)(a) would become a restricted exemption as laid down by section 11(2). ….Therefore, if the entire income received by a trust is spent for charitable purposes in India, then it will not be taxable but if there is a saving, i.e., to say an accumulation of 25 per cent or Rs. 10,000, whichever is higher, it will not be included in the taxable income.”

Since 15% of the donation is not considered to be applied for charitable purposes, it should be capable of accumulation, as per this decision.

The first interpretation does seem to be a rather harsh interpretation and does not seem to be supported by the intention behind the amendment, as set out in the Explanatory Memorandum. The figure of 85% also seems to have been derived from the fact that the balance 15% would in any case qualify for exemption under section 11(1)(a).

Consider a situation where a trust having an income of Rs. 100 donates its entire income to other charitable trusts. Had it not spent anything at all, it would have been entitled to the exemption of Rs. 15 under section 11(1)(a). Can it then be taxed on Rs. 15 merely because it has donated its entire income to other trusts? Based on the Explanatory Memorandum rationale, what is sought to be prohibited is the trust claiming accumulation of Rs. 15, and donating Rs. 85 to other trusts, who in turn claim 15% of Rs. 85 as accumulation. A possible view, therefore, seems to be that the trust should be entitled to the 15% accumulation u/s 11(1)(a), even though it has donated its entire income.

Similar amendments have been made in section 10(23C).

Registration u/s 12AB in case of New Trusts

Where a trust has not been registered under section 12AB and is applying for fresh registration, section 12A(1)(ac)(vi) provided that such a trust would have to apply for registration at least one month prior to the commencement of the previous year relevant to the assessment year from which registration was being sought. In such cases, section 12AB(1)(c) provided that such a trust would be granted provisional registration for a period of three years. Subsequently, as per section 12A(1)(ac)(iii), the trust would have to apply for registration 6 months prior to the expiry of a period of provisional registration, or within 6 months of commencement of its activities, whichever is earlier.

The law is now being amended with effect from 1.10.2023 to divide such cases of fresh registration into 2 types – those cases where activities have already commenced before applying for registration, and those cases where activities have not commenced till the time of applying for registration. The position is unchanged for trusts where activities have not yet commenced, with application having to be made one month prior to commencement of the previous year and provisional registration being granted.

In cases where activities have commenced, and such trust has not claimed exemption u/s 11 or 12 or section 10(23C)(iv),(v),(vi) or (via) in any earlier year, such trust can directly seek regular registration by filing Form 10AB, instead of Form 10A. Such trust may be granted registration, after scrutiny by the CIT, for a period of 5 years.

Unfortunately, the problem of a new trust (which has not commenced activities) having to seek registration prior to the commencement of the previous year has not been resolved even after this amendment. Take the case of a trust set up in May 2023. This trust would not be able to get exemption for the previous year 2023-24, since it has not applied one month prior to the commencement of the previous year (by 28th February 2023), a date on which it was not even in existence.

Similar amendments have been made in respect of approvals under clauses (iv),(v),(vi) and (via) of section 10(23C).

Cancellation of Registration u/s 12AB

The Explanation to section 12AB(4) provided for specified violations for which registration could be cancelled. Rule 17A(6) provided that if Form 10A had not been duly filled in by not providing, fully or partly, or by providing false or incorrect information or documents required to be provided, etc., the CIT could cancel the registration after giving an opportunity of being heard. The Finance Act 2023 has now amended section 12AB(4) with effect from 1.4.2023 to add a situation where the application made for registration/provisional registration is not complete or contains false or incorrect information, as a specified violation, which can result in cancellation of registration under section 12AB. In a sense, prior to this amendment, the provision in rule 17A(6) was ultra vires the Act. This amendment, therefore, removes this lacuna.

This provision is however quite harsh, where, for a simple clerical mistake while filling up an online form or forgetting to attach a document, the registration of a trust may be cancelled. Cancellation of registration can have severe consequences, attracting the provisions of Tax on Accreted Income under section 115TD at the maximum marginal rate on the fair market value of the assets of the trust less the liabilities. One can understand this provision applying to a situation where a trust makes a blatantly incorrect statement to falsely obtain registration, but the manner in which this provision is worded, even genuine clerical mistakes can invite the horrors of this provision. One can only wish and hope that this provision is administered with caution and in a liberal manner, whereby it is applied only in the rarest of rare cases.

Deletion of Second and Third Provisos to section 12A(2)

The second and third provisos to section 12A(2) provided a very important protection to charitable entities which had been in existence earlier, but had not applied for registration earlier u/s 12A/12AA/12AB. When such entities made an application for registration, they could not be denied exemption u/s 11 for earlier years for which assessment proceedings were pending, or reassessment proceedings could not be initiated in respect of earlier years on the ground of non-registration of such entity. These two provisos have been deleted by the Finance Act 2023, with effect from 1.4.2023.

The ostensible reason given for such deletion, as explained in the Explanatory Memorandum, is as under:

“4.5 Second, third and fourth proviso to sub-section (2) of section 12A of the Act discussed above have become redundant after the amendment of section 12A of the Act by the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020. Now the trusts and institutions under the second regime are required to apply for provisional registration before the commencement of their activities and therefore there is no need of roll back provisions provided in second and third proviso to sub-section (2) of section 12A of the Act.

4.6 With a view to rationalise the provisions, it is proposed to omit the second, third and fourth proviso to sub-section (2) of section 12A of the Act.”

The statement that these provisions have become redundant does not seem to be justified, as even now, a trust already in existence, which seeks registration for the first time, may desire such exemption for the pending assessment proceedings or protection from reassessment for earlier years. A very important protection for unregistered trusts, which was inserted with a view to encourage them to come forward for registration, has thus been eliminated.

These provisions had been inserted by the Finance (No 2) Act, 2014, which at that time, had explained the rationale as under:

“Non-application of registration for the period prior to the year of registration causes genuine hardship to charitable organisations. Due to absence of registration, tax liability gets attached even though they may otherwise be eligible for exemption and fulfil other substantive conditions. The power of condonation of delay in seeking registration is not available under the section.

In order to provide relief to such trusts and remove hardship in genuine cases, it is proposed to amend section 12A of the Act to provide that in case where a trust or institution has been granted registration under section 12AA of the Act, the benefit of sections 11 and 12 shall be available in respect of any income derived from property held under trust in any assessment proceeding for an earlier assessment year which is pending before the Assessing Officer as on the date of such registration, if the objects and activities of such trust or institution in the relevant earlier assessment year are the same as those on the basis of which such registration has been granted.

Further, it is proposed that no action for reopening of an assessment under section 147 shall be taken by the Assessing Officer in the case of such trust or institution for any assessment year preceding the first assessment year for which the registration applies, merely for the reason that such trust or institution has not obtained the registration under section 12AA for the said assessment year.”

This amendment, therefore, seems to be on account of a change in the approach of the Government towards charitable entities, rather than on account of redundancy.

Extension of Applicability of S.115TD

Section 115TD provides for a tax on accreted income, where a trust has converted into any form not eligible for grant of registration u/s 12AB/10(23C), merged with any entity other than an entity having similar objects and registered u/s 12AB/10(23C), or failed to transfer all its assets on dissolution to any similar entity within 12 months from date of dissolution. By a deeming fiction contained in section 115TD(3), cancellation of registration u/s 12AB/10(23C), and modification of objects without obtaining fresh registration are deemed to be conversion into a form not eligible for grant of registration, and therefore attract the tax on accreted income. The tax on accreted income is at the maximum marginal rate on the fair market value of all the assets less the liabilities of the trust, on the relevant date.

The Finance Act, 2023 has now added one more situation in sub-section (3) with effect from 1.4.2023, where the trust fails to make an application for renewal of its registration u/s 12AB/10(23C) within the time specified in section 12A(1)(ac)(i),(ii) or (iii). Therefore, if a trust now fails to apply for renewal of its registration u/s 12AB at least 6 months prior to the expiry of its 5-year registration or 3-year provisional registration, the provisions of section 115TD would be attracted, and it would have to pay tax at the maximum marginal rate on the fair market value of its net assets.

This is an extremely harsh provision, whereby even a few days’ delay in making an application for renewal of registration can result in wiping out a large part of the assets of the trust. There is no provision for condonation of delay, except by making an application to the CBDT u/s 119. There is also no provision for relaxation of the provisions even if the delay is on account of a reasonable cause.

One can understand the need for such a provision in cases where the trust effectively opts out of registration by not seeking renewal at all – but a mere delay in seeking renewal of registration should not have been subjected to the applicability of section 115TD. Most charitable trusts in India are not professionally managed but are run on a part-time basis as an offshoot of social commitments felt by persons who may be engaged in employment or other vocations. To expect such absolute time discipline from them seems to reflect the Government’s intention of ensuring that only well-managed charitable organisations claim the benefit of the exemption. On the other hand, if an organisation is professionally run in order to be well managed, it would necessarily need to carry on an income-generating activity to meet its expenses, which may be treated as business attracting the proviso to section 2(15)!
Looking at the amendments in recent years and the stand taken in litigations, it appears that the Government seems to view all charitable entities with suspicion. The Government needs to adopt a clear position as regards tax exemption for charitable trusts – whether it wishes to encourage all genuine charitable trusts, which can at times reach far corners of India where even the Government machinery cannot reach, or whether it wishes to restrict the exemptions only to certain large trusts, which it monitors on a regular basis. Accordingly, given the complications introduced in the last few years, it is perhaps now time to decide whether there should be a separate tax exemption regime for small charities, just as there is a separate taxation regime for small businesses.

 

PART III | SELECT TDS / TCS PROVISIONS

BHAUMIK GODA | SHALIBHADRA SHAH

CHARTERED ACCOUNTANTS

Background

The purpose of TDS/TCS provisions is two-fold a) to enable the government to receive tax in advance simultaneously as the recipient receives payment b) to track a transaction which is a subject matter of taxation. In recent years, major amendments have been made in Chapter XVII of the Income-tax Act, 1961 (Act) dealing with the deduction and collection of taxes.

Finance Act 2023 is no different. Amendments are likely to have far-reaching implications.

Increase in the tax rate on Royalty & FTS for Non-residents

Amendment in brief

Erstwhile Section 115A of the Act provided that royalty & FTS income of Non-residents (NR) shall be taxable in India at the rate of 10% (plus applicable surcharge & cess). Surprisingly, at the time of passing the Finance Bill in Lok Sabha, the rate of tax on royalty & FTS has been increased from the existing 10% to 20% (plus applicable surcharge & cess). A corresponding increase in TDS rates has also been provided in Part II of the First Schedule to FA, 2023. Hence effective 1 April 2023, any payment of royalty or FTS by a resident to a non-resident will invite TDS at the rate of 20% (plus surcharge & cess) under the Act.

Implications

  • Increase in tax rate

There is a sharp increase in FTS/royalty rate under the Act from 10% to 20% plus cess and surcharge. The amendment does not grandfather existing agreements or arrangements. Accordingly, any payment made after 1st April 2023 will attract a higher TDS rate of 20%. In the case of net of tax arrangements, it is likely to result in additional cash outflow, especially payments made to countries where the DTAA rate provides for a rate higher than 10% (e.g. DTAA of India – USA – 15%; India-UK – 15%; India-Italy -20%). It will impact cost, profitability and project feasibility which perhaps was not factored in by parties at the time of entering the arrangement.

  • Treaty superiority

With the increase in tax rate from 10% to 20%, the DTAA rate which ranges from 10% to 15% is advantageous. Non-residents will rely upon DTAA benefits to reduce their tax liability in India. The FTS clause in DTAA with Singapore, USA, UK, is narrow as it includes a make-available clause. In other words, even if services are FTS under Act, it needs to be demonstrated that there is a transfer of knowledge and the recipient is enabled to perform services independently without support from the service provider. India’s DTAAs with the Philippines, Thailand etc. do not have an FTS clause. In that case, a view is possible that in the absence of PE in India, FTS payment is not taxable. In the context of royalty, India-Netherland DTAA does not have an equipment royalty clause, India-Ireland DTAA excludes aircraft leasing from the scope of royalty. Supreme Court in the case of Engineering Analysis Centre of Excellence v CIT (2021) 432 ITR 471 held that payment for shrink-wrapped software where the owner retains IP rights is not taxable under DTAA.

Treaty benefit is subject to the satisfaction of numerous qualifying conditions – both under the Act as also under DTAA. Failure to satisfy qualifying conditions will entail a higher TDS rate of 20% [apart from section 201 proceedings and payment of interest under section 201(1A)].

Section 90(4) provides that non-residents to whom DTAA applies, shall not be entitled to claim any relief under DTAA unless a certificate of his being a resident in any country outside India or specified territory outside India, is obtained by him from the Government of that country or specified territory. Ahmedabad ITAT in the case of Skaps Industries India (P.) Ltd v ITO1 held that requirement to obtain TRC does not override tax treaty. Thus, failure to obtain TRC does not stop non-residents from availing of DTAA benefits. This decision was followed by under noted decisions2. In practice, one encounters a number of situations where TRC is not available at the time of remittance – a) Transaction with Vendor is a one-off transaction and the cost of TRC outweighs the cost of services b) TRC is applied for but the Country of Residence takes time to process and issue TRC c) Vendor provides incorporation certificate, VAT certificate and states that his Country does not issue TRC d) TRC is not in the English language. In such situations, case by case call will be required to be taken. Considering the steep rate of 20%, decision-making becomes difficult if the tax liability is on the payer. In case reliance is placed on favourable decisions, the payer must maintain alternative documents which prove that the vendor is a resident of another Contracting State.

1 [2018] 94 taxmann.com 448 (Ahmedabad - Trib.)
2 Ranjit Kumar Vuppu v ITO [2021] 127 taxmann.com 105 (Hyderabad - Trib.); Sreenivasa Reddy Cheemalamarrim (TS-158-ITAT-2020)

On the DTAA front, Article 7 of MLI incorporates Principal Purpose Test (PPT) in DTAA. It provides that benefit under the DTAA shall not be granted in respect of an item of income if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Agreement. Similarly, India-USA DTAA has a Limitation of Benefits (LOB) clause contained in Article 24 of DTAA; Article 24 of the India-Singapore DTAA contains a Limitation Relief article requiring remittance to be made in Singapore to avail DTAA benefits. It is necessary that the recipient satisfies the stated objective and subjective conditions laid down by DTAA. From a deductor standpoint, some conditions are subjective (e.g. principal purpose of arrangement). It will be difficult to reach objective satisfaction. The payer may obtain declarations to prove that he acted in a bonafide manner.

Section 90(5) mandates NR to provide prescribed information in Form 10F. Notification No 3/2022 dated 16 July 2022 (‘Notification’) requires Form 10F to be furnished electronically and verified in the manner prescribed. NR will be required to log in to the income tax portal and submit Form 10F in digital manner. This will require NR to have PAN in India and also the authorised signatory to have a digital signature. This requirement was deferred for NR not having PAN and who is not required to obtain PAN in India till 30 September 20233. Read simplicitor, NR having PAN in India – irrespective of the year and purpose for which PAN is obtained, needs to furnish Form 10F in digital format. Practical challenges arise as NR is not comfortable obtaining PAN in India to issue digital Form 10F. A question arises whether NR is not entitled to DTAA benefits if Form 10F is furnished in a manual format as against digital format. For the following reasons, it is arguable that the Notification requiring Form 10F in digital format is bad in law as it amounts to treaty override4:

  • Genesis of the requirement to obtain Form 10F is section 90(5) read with Rule 21AB. Rule 21AB(1) prescribes various information, which is forming part of Form 10F (e.g. Status, Nationality, TIN, Period of TRC, address). Importantly, Rule 21AB(2) provides that the assessee may not be required to provide the information or any part thereof referred to in sub-rule (1) if the information or the part thereof, as the case may be, is contained in TRC.
  • Thus, if the information contained in Form 10F is contained in TRC, then Form 10F is not required. Most of the TRCs contains prescribed information (the exception being Ireland and Hong Kong which does not contain address). Some information like PAN and status are India specific and accordingly, the absence of such information should not be read as mandating obtaining of Form 10F.
  • Section 139A read with Rule 114 / Rule 114B does not require NR to obtain PAN if income is not chargeable to tax pursuant to favourable tax treaty. AAR in under noted decisions5 has taken a view that the assessee is not required to file the return of income if capital gain income is exempt under India-Mauritius / India – Netherlands DTAA.
  • Notification requiring digital Form 10F is issued under Rule 131 which in turn is issued under section 295. Notification is not issued under section 90(5) and accordingly cannot override tax treaty.
  • Article 31 of the Vienna Convention provides that a treaty is to be interpreted “in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. The domestic legislature cannot override tax treaty.
  • In spite of section 90(4), the Tribunal has held that TRC is not mandatory if otherwise, NR can prove his residence6. A similar conclusion can be drawn for the Form 10F requirement.
  • Section 206AA prescribed a steep rate of 20% for payment made to a person not having PAN or invalid PAN. The question arose whether section 206AA overrides tax treaties. Tribunal/Court took a unanimous view7 that section 206AA cannot override tax treaty. In fact, Delhi High Court in Danisco India (P.) Ltd. v. Union of India [2018] 404 ITR 539 struck down the operation of section 206AA for cases involving tax treaties.
  • Section 206AA(7) read with Rule 37BC provides that the section is inapplicable if NR provides specified details. Details are identical to ones prescribed in Form 10F. Thus, it can be contended that the Notification mandating digitalization of Form 10F contradicts the provisions of Rule 37BC.
3 [Notification dated 12 December 2022 read with Notification dated 29 March 2022
4 Readers may refer to BCAJ – September 2022 Article – Digitalisation of Form 10F – New Barrier to Claim tax treaty?
5 Dow Agro Sciences Agricultural Products Limited [AAR No. 1123 of 2011 dated 11 January 2016] and Vanenburg Group B.V. (289 ITR 464)
6 Skaps Industries India (P.) Ltd v ITO [2018] 94 taxmann.com 448 (Ahmedabad - Trib.); Ranjit Kumar Vuppu v ITO [2021] 127 taxmann.com 105 (Hyderabad - Trib.)]
7 Infosys Ltd. v DCIT [2022] 140 taxmann.com 600 (Bangalore - Trib.); Nagarjuna Fertilizers & Chemicals Ltd. v. Asstt. CIT [2017] 78 taxmann.com 264 (Hyd.)

• Interplay with Transfer Pricing Provisions

Indian-based conglomerate makes royalty/FTS to its group companies deducting tax at DTAA rate. In the DTAA framework, this rate is subject to the rider that the concessional rate is available only to the extent of arm’s length payment. DTAAs contain following limitation clause:

“Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties or fees for technical services paid exceeds the amount which would have been paid in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Agreement”.

OECD Commentary states that excess amount shall be taxable in accordance with domestic law. From the Indian context, the excess amount shall be taxable at higher rate of 20%. Following are some illustrative instances of ongoing transfer pricing litigation that is factual and legal in nature:

  • Benchmarking of royalty payment
  • Management cross charge – the satisfaction of benefits test, service v/s shareholders function, duplicated cost, and adequate backup documents to prove the performance of the service.
  • Allocation of group cost – relevance to Indian companies, cost driver, appropriateness of markup charged by AEs.

In case, it is ultimately concluded (in litigation) that the Indian company has paid higher than ALP price, then the Indian company will be liable to pay tax at 20%. Thus, the transfer pricing policy adopted by Companies needs to factor in increased tax risk. The amendment is also likely to have an impact on Advance Pricing Agreement (APA). It typically takes 4-5 years to conclude APAs. Assume the Indian Company pays cost plus 10% to its German AEs. In APA it is concluded that services are low-value services and appropriate ALP is cost plus 5%. In such a case, the Indian Company will have to get an additional 5% back from German AE (secondary adjustment) and pay tax at 20% on excess 5%.

  • Interplay with section 206AA

Section 206AA provides that person entitled to receive any sum or income or amount, on which tax is deductible under Chapter XVIIB shall furnish his PAN to the person responsible for deducting such tax failing which tax shall be deducted at higher of a) at the rate specified in the relevant provision of this Act b) at the rate or rates in force c) 20%.

Section 2(37A)(iii) defines ‘rates in force’ to mean rate specified in the relevant Finance Act or DTAA rate. It is judicially held that 20% rate prescribed in section 206AA need not be increased by surcharge and cess8. Part II to Schedule to Finance Act 2023 specifies a 20% rate which needs to be increased by the cess and a surcharge. Thus, non-submission of PAN in a situation not covered by section 206AA(7) read with Rule 37BC will entail a higher withholding rate.

8 Computer Sciences Corporation India P Ltd v ITO (2017) 77 taxmann.com 306 (Del)
  • NR obligation to file a return of income

Section 115A(5) provides for exemption from filing return of income to non-residents if the total income of a non-resident consists of only interest, dividend, royalty and/or FTS and the tax deducted is not less than the rate prescribed under Section 115A(1) of the Act. The royalty and FTS rate prescribed in the majority of India’s DTAA is 10%. Prior to the amendment, NRs availing DTAA benefits adopted a position that they are not required to file tax returns in India as the rate at which tax is deducted is not less than 115A rate. Due to an increase in tax rate from 10% to 20%, non-residents availing DTAA benefits will have to file income-tax returns in India.

TDS on benefit or perquisites – Section 194R

Amendment in brief

Section 194R provides that any person responsible for providing to a resident, any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession, by such resident, shall, before providing such benefit or perquisite, as the case may be, to such resident, ensure that tax has been deducted in respect of such benefit or perquisite at the rate of ten percent of the value or aggregate of value of such benefit or perquisite. Explanation 2 to section 194R is inserted by Finance Act 2023 to clarify that the provisions shall apply to any benefit or perquisite whether in cash or in kind or partly in cash and partly in kind.

Implications

Prior to Explanation 2 to section 28(iv), the language of section 194R was identical to section 28(iv). Supreme Court in Mahindra & Mahindra Ltd. vs. CIT [2018] 404 ITR 1 (SC) (‘M&M) held that section 28(iv) does not cover cash benefits. Taking an analogy from it, it was possible to contend that cash benefit does not fall within section 194R. In contrast to this popular view, CBDT in Circular No 12 of 2022 mentioned that provisions of section 194R would be applicable to perquisite or benefit in cash as well. Insertion of Explanation 2 to section 194R gives legislative backing to Circular.

Transactions like performance incentives in cash, gift voucher, prepaid payment instrument like amazon cards etc. will be subject to TDS. The applicability of section 194R to transactions like bad debt and loan waiver is not clear. Section 194R requires a) deductor to ‘provide’ benefit b) benefit to arise to the recipient from business or exercise of the profession. These conditions indicate that both parties agree to the benefit being passed on from one party to another. The word ‘provide’ is used in the sense of direct benefit being passed on. The indirect or consequential benefit is not what is envisaged by the provisions. In case of bad debt, there is no benefit intended to be provided. In fact, the benefit is the consequence of a write-off. In one sense there is no benefit. A write-off is merely an accounting entry as the party would retain his right to recover. Further, there is no valuation mechanism prescribed to value the impugned benefit. Question 4 of Circular No 12 of 2022 does not deal with such a situation.

As regards loan waiver, CBDT Circular No 18 of 2022 has exempted Bank from the applicability of section 194R to loan settlement/waiver. No similar exemption is given to other similarly placed transactions (e.g. loan by NBFC, private parties, parent-subsidiary loans). The rationale for exempting the bank was to give relief to the bank as subjecting it to section 194R would lead to extra cost in addition to the haircut already suffered. It can be argued that other similarly placed assessee should also merit exemption as the legislature cannot distinguish between two similarly placed assessees.

TDS on online Gaming – Section 194BA

In recent times there has been a surge in online gaming. Hence the government proposed to introduce TDS on online gaming with effect from 1 July 2023. Section provides that any person responsible for paying to any person any income by way of winnings from online games shall deduct tax on net winnings in user account computed as per prescribed manner (yet to be prescribed). Tax on net winnings from online games is to be deducted as per rates in force (i.e., 30%+ surcharge + cess). The Section is applicable to all users including non-residents. No threshold limit is provided for TDS. TDS is to be deducted at the time of withdrawal of net winnings from the user account or at the end of the FY in case of net winnings balance in the user account.

Implications

  • Computation of Net winnings

The section provides for the deduction of tax on net winnings. However, the computation mechanism of TDS is yet to be prescribed. Typically, online gaming requires a user to initially deposit cash in the wallet at the time of registration. This cash deposit can be utilised for playing games. However, such cash deposits are practically non-refundable and users can only withdraw the money out of winnings. Hence a question arises whether the initial cash deposit or losses in games can be permitted to be set off against the winning balance as the section uses the word net winnings. The dictionary meaning of “net” means after adjustment or end result. Thus, the plain language of the section seems to indicate that winnings can be offset against losses. Similarly, cash deposits which are also not refundable should be permitted to be set off against the winnings and tax should be deducted only on net winnings. However, one would have to wait for the computation mechanism which shall be prescribed by the government.

TDS on interest on specified securities – Section 193

The existing clause (ix) of the proviso to Sec. 193 of the Income-tax Act, 1961 (“the Act”) prior to 1st April, 2023 provided that no tax shall be deducted on interest payable on any security issued by a company to a resident payee, where such security is in dematerialised form and is listed on a recognised stock exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 and the rules made thereunder. However, vide Finance Act 2023, the amendment has been made to omit the above clause with effect from 01-04-2023 and accordingly tax is required to be deducted w.e.f. 1st April, 2023 on interest payable to resident payee on such listed securities issued by a company.

In view of the above amendment and with effect from 1st April, 2023, tax will be deducted on any interest payable / paid on listed NCD held by respective investors.

Prior to the amendment, borrowers were deducting tax on interest payments to non-resident investors. Now, the tax will have to be deducted on the interest paid to resident investors. TDS will not be applicable to investors like insurance companies, mutual funds, National Pension Funds, Government, State Government who are exempt recipient under section 193, section 196, section 197(1E).

TCS on overseas remittances for overseas tour packages and other prupsoes (other than medical and education purposes) – Section 206C

TCS rate on overseas remittance is enhanced to 20% as against the existing rate of 5%. Accordingly, remittances towards overseas tour package or for any other purposes (other than remittances towards medical and educational purposes), TCS shall be collected at the rate of 20% as against earlier 5%. Further in respect of other purposes, the threshold of INR 7 lakhs has also been removed.

TCS will be applicable whenever any foreign payment is made through debit cards, credit cards and travel cards etc. without any threshold limit. This will result in a higher cash outflow for LRS remittance and overseas tour packages. Though the taxpayer will be eligible for a credit of tax collected or claim a refund by filing a return of income, it may lead to blockage of funds till the credit is availed or refund is received.

Concluding Thoughts

One important amendment which was expected by the taxpayers was an extension of the sunset date for concessional rate forming part of section 194LC/194LD. The sunset clause sets in from 1 July 2023. This will make the raising of capital in the form of ECB and other debt instruments costly.

Amendments are likely to have far-reaching implications. An inadvertent slippage is likely to be expensive. It is advisable that tax implication and consequential TDS implications are factored in at the time of entering into a transaction. It is recommended that positions adopted in the past are revalidated on a periodic basis in light of various developments.

PART IV | MUTUAL FUNDS

ANISH THACKER

Chartered Accountant

Introduction

Finance Acts in recent years have had their fair share of amendments which have focused on the financial services sector and in particular, funds, i.e., collective investment schemes. The Securities and Exchange Board of India (SEBI) has permitted various types of collective investment schemes such as Mutual Funds (MFs), Alternative Investment Funds (AIFs), Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), etc. to harness foreign and domestic investment. As these funds are set up with the specific purpose of channelizing investments into particularly designated sectors of the economy, and because these have certain peculiar features, these funds also have their own specific taxation provisions in the Income-tax Act, 1961(the Act). The taxation law as regards these funds continues to evolve with experience. Each Finance Act in recent times, therefore, has contained provisions which have amended the taxation scheme of these funds and their investors.

In this article, the key provisions of the Finance Act, 2023 that deal with Mutual Funds (for the sake of convenience, these are collectively called ‘Mutual Funds’ (admittedly loosely) for the sole purpose of this article only) have been discussed. It is submitted that the law as regards ‘Mutual Funds is still evolving, and one may well see a further amendment to the provisions of the Income-tax Act, 1961 (Act) dealing with ‘Mutual Funds’ going forward.

Amendments Impacting the Taxation of Specified Mutual Funds

The Finance Bill, 2023 (FB 2023), when it was tabled before the Parliament, on 1st February 2023, sought to introduce a deeming fiction, by way of section 50AA in the Act, to characterize the gains on transfer, redemption, or maturity of Market Linked Debentures (MLDs) as ‘short-term capital gains’ (STCG), irrespective of the period for which the MLDs are held9.

Such gains are to be computed by reducing the cost of acquisition of such debentures and expenses incurred in connection with the transfer. However, as these are deemed to be ‘short term’, the benefit of indexation is not available while computing such gains.

At the time of moving of the FB 2023 before the houses of the Parliament for discussion, an amendment was made to Section 50AA of the Act10 whereby it was sought to extend the scope of the special deeming provisions applicable to MLDs to a unit of a Specified Mutual Fund (SMF) purchased on or after 1 April 202311. A SMF is defined to mean a mutual fund (by whatever name called) of which not more than 35% of total proceeds are invested in the equity shares of domestic companies. The percentage of holding in equity shares of domestic companies is to be computed by using the annual average of the ‘daily averages’ of the holdings unlike in the case of Equity Oriented Funds where to construe a fund as an equity-oriented fund, to calculate the percentage of holdings in equity shares of domestic companies (at least 65%), the annual average of the ‘monthly averages’ has to be used.

9 This article does not deal with the taxation of income from MLDs.
10 The Finance Act 2023 (after incorporating the amendments at the time of moving of the Finance Bill, 2023, has received the assent of the President of India.
11 Unlike in the case of MLDs where the new tax provision applies to existing MLDs already issued, I n case of units of a specified mutual fund, the application is prospective, i.e., section 50 AA of the Act applies only to units of a specified mutual fund acquired on or after 1 April 2023.

One very important point to note here is that the ‘mutual fund’ referred to in section 50 AA of the Act is not merely a ‘mutual fund’ as is commonly understood. Unlike the provisions of section 10(23D) of the Act or section 115R thereof, where a reference can reasonably be drawn that these apply only to a mutual fund registered with the SEBI, section 50AA does not make such a reference. In fact, it uses the expression ‘by whatever name called’ when it defines the term ‘Specified Mutual Fund’ in Explanation (ii) to the said section. A question therefore arises as to what does the expression ‘Specified Mutual Fund’ as contained in this section, bring within its ambit.

The SEBI Mutual Funds Regulations, 1996 (SEBI MF Regulations) define ‘mutual fund in regulation 2 (22q) to mean a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities, money market instruments, gold or gold related instruments, silver or silver related instruments, real estate assets and such other assets and instruments as may be specified by the Board from time to time

This definition only covers a trust but does not cover a fund set up as a company. Also, it is unclear as to whether a fund set up outside India is covered by the expression ‘specified mutual fund’ or not. It will thus remain to be seen and debated and indeed litigated, as to what a ‘specified mutual fund’ would include, within its fold. Unfortunately, as this addition to the scope of section 50 AA of the Act was done not at the time of tabling the FB 2023 but later, there is no mention of this in the memorandum explaining the provisions of the FB 2023, which may guide taxpayers as to what position to take in respect of funds other than SEBI registered mutual funds. The Government may therefore be requested to issue guidance in this regard to avoid ambiguity and avoid potential litigation.

Coming back to the nature of the capital gains on the transfer of the units of this specified mutual fund, these are admittedly only ‘deemed’ to be STCG. Considering the judicial precedents12 in the context of capital gains arising on depreciable assets under a comparable provision (section 50 of the Act), it may be possible to take view that the section 50 AA of the Act merely modifies the method of computation of gains (by denying indexation benefit in case of SMF units) and does not change the ‘long term’ character of the assets mentioned in section 50AA of the Act, (MLD or SMF units) for other purposes like subjecting the gains to a lower rate of tax on long term capital gains, (section 112 of the Act) or roll over capital gains exemption (section 54F) and set off of losses. This is another area where taxpayers will need to take considered decisions on the positions to be taken in their return of income and brace themselves for a potential difference of opinion from their assessing officer (now the Faceless Assessment Centre for most).

Amendments relating to business trusts (REITs/ InvITs) and their unit holders:

Computation of certain distributions to be taxed as “other income” in the hands of business trust unit holders:

Section 115UA of the Act accords a partial ‘pass-through’ status to business trusts in terms of which certain specific incomes (i.e., interest, dividend, and rent) are taxed in the hands of the unit holders on distribution by the business trusts13 whereas other incomes are taxed in the hands of the business trust.

12 Illustratively, CIT v. V. S. Demo Co. Ltd (2016)(387 ITR 354)(SC), Smita Conductors v. DCIT (2015)(152 ITD 417)(Mum)
13 Comprising REITs and InvITs

From the memorandum explaining the provisions of the FB 2023, it could be inferred that the intention behind amending the scheme of taxation of business trusts and the unitholders thereof was to take care of a situation where, if a business trust received money by way of repayment of a loan from the Special Purpose Vehicle (SPV) set up to acquire the property, the same arguably, was neither taxable in the hands of the business trust nor in the hands of the unitholders. This was due to the ‘pass through’ mechanism available under the provisions of the Act as they then prevailed.

It was apprehended that the business trusts were using these repayments to distribute money to the unitholders thereby increasing the internal rate of return (IRR) to these unitholders. The said ‘return’ was however ostensibly escaping tax, from the Revenue’s viewpoint.

Accordingly, amendments were proposed to sections 2(24), 115UA and 56(2) to seek to tax the repayment of loans.

The FB 2023 proposed to introduce a new set of provisions whereby any other distributions (such as repayment of debt) by business trusts that presently do not suffer taxation either in the hands of business trust or in the hands of unit holders, will henceforth be taxed as “other income” in the hands of unit holders.

Further, where such distribution is made on redemption of units by business trusts, then the distribution received shall be reduced by the cost of acquisition of the unit(s) to the extent such cost does not exceed the distribution so received.

Stakeholders represented for reconsideration of the proposal – more particularly, in respect of the treatment of redemption proceeds as normal income instead of capital gains.

At the time of the moving of the FB 2023 for discussion, an amendment was proposed to the said section, which has now been enacted, which provides a revamped version of the new provision. The revamped provisions provide the manner of computing the distribution which is taxable as “other income” in the hands of unit holders (referred to as “specified sum”). As per this computation, the “specified sum” shall be the result of ‘A – B – C’, where:

‘A’ Aggregate sum distributed by the business trust during the current Taxable Year (TY) or past TY(s), w.r.t. the unit held by the current unit holder or the old unit holder.

However, the following sum shall not be included in ‘A’:

 

–  Interest or dividend income from the SPV

 

–  Rental income

 

–  Any sum chargeable to tax in the hands of business trusts
‘B’ Issue price of the units
‘C’ Amount charged to tax under this new provision in any past TY(s).

If the result of the above is negative (i.e., where ‘B’ + ‘C’ is more than ‘A’), the “specified sum” shall be deemed to be zero.

The above computation mechanism indicates that specified sum is to be computed by taking into account the distribution made in the past Assessment Years (AY), including the distribution made to the old unit holders who were holding units prior to the current distribution date. Thus, while the levy as per the revamped provision applies prospectively w.e.f. AY 2024-25, the provision has a retroactive impact since it factors the distributions made prior to the previous year relevant to the said assessment year.

Furthermore, at the time of the movement of the FB 2023 for discussion an amendment was proposed, which now finds place in the Act, which omits the proposal of FB 2023 to reduce the cost of acquisition of units by the amount of distribution for computing “other income”. To this extent, the unitholders do get some kind of ‘relief’ (the term is used tongue in cheek, here).

The set of amendments brings forth their own interpretational issues, which can form the subject matter of another detailed article. Also, if we look at the interplay between the provisions of Double Tax Avoidance Agreements (DTAA), certain other interesting issues are likely to emerge.

Since these are not issues that affect a large number of taxpayers, these are not elaborated here. Suffice it to say that again this is not the last, one will hear on this topic.

Notified Sovereign Wealth Fund (SWF) and pension funds to be exempted from the above revamp provision:

The Act provides an exemption to notified SWF and pension funds by way of section 10(23FE), in respect of certain incomes including distribution received from business trusts.

The amended FB 2023, (this provision is now enacted) extends the exemption in respect to “other income” received by notified SWF and pension fund as per the revamped business trust taxation provisions mentioned above. For notified SWFs and pension funds therefore, the provisions discussed above will not apply and the existing exemption regime will continue to apply.

Computation of cost of acquisition of units in business trusts:

The Finance Act 2023 (at the enactment stage, this amendment was moved) introduces a provision to determine the cost of acquisition of units of a business trust. In determining the cost of acquisition any sum received by a unit holder from business trust w.r.t. such units, is to be reduced, except the following sums:

  • Interest or dividend income from the SPV
  • Rental income
  • Any sum not chargeable to tax in the hands of business trusts

Any sum not chargeable to tax in the hands of unit holders under revamped provision.

Furthermore, it provides that where units are received by way of transaction not considered as a transfer for capital gains, the cost of acquisition of such unit shall be computed by reducing the sum received from the business trust (as explained above), whether such sum is received before or after such transaction.

The above provision requires a reduction of all sums received from the business trust even prior to 1 April 2023, and to this extent, the provisions have a retroactive impact.

Amendments to the taxation of funds located in the International Financial Services Centre (IFSC)

Tax exemption for non-residents on distribution of income from Offshore Derivative Instruments (ODIs) issued by an IFSC Banking Unit (IBU)

The endeavor of the provision of exemption under section 10(4D) of the Act has been to provide parity in tax treatment to IFSC Funds as compared to Funds in offshore jurisdictions (of course, the overseas funds typically issue ODIs, popularly called P Notes or participatory notes to offshore investors). These notes are contracts which allow investors a synthetic exposure to income from Indian securities. To hedge the exposure that the funds take on, the funds typically hold the said securities in their own books. The same also applies to an IFSC fund including IFSC Banking units (IBUs). The discussion below is in the context of the IBUs.

Under the ODI contract, the IBU makes investments in permissible Indian securities. Such income may be taxable/ exempt in the hands of IBU as per the provisions of the ACT. The IBU would pass on such income to the ODI holders.

Presently, the income of non-residents on the transfer of ODIs entered with IBU is exempt under the Act. However, there is no similar exemption on the distribution of income to non-resident ODI holders. Resultantly, such distributed income may be taxed twice in India i.e., first when received by the IBU, and second, when the same income is distributed to non-resident ODI holders.

In order to remove double taxation, FB 2023 proposed an exemption to any income distributed on ODI entered with an IBU provided that the same is chargeable to tax in the hands of the IBU.

The condition of chargeability of such income to tax in the hands of IBU could have resulted in practical difficulties for non-residents to claim the exemption. Considering the various representations made on this aspect, the Amended FB 2023 addresses this anomaly by removing the said condition.

Non-applicability of surcharge and cess on income from securities earned by Category III AIFs and investment banking division of an Offshore Banking Unit (OBU) (i.e., “Specified Fund” as per section 10(4D) of the Act)

The Amended FB 2023 intends to remove the burden of surcharge and cess on income from securities earned by a Specified Fund. Under the Act, Specified Fund is inter alia defined to mean a Category III AIFs (which meets specified conditions) and investment banking division of an OBU (meeting specified conditions). In this context, a fact-specific evaluation may be required considering the nature of technical amendments.

The objective of the amendment appears to be to bring the taxation of Specified Funds in IFSC at par with the tax regime applicable for Fund investing from a jurisdiction with which India has a Tax Treaty.

Relocation of an off-shore Fund – Expansion of the definition of ‘Original Fund’

Presently, the Act provides for a tax-neutral relocation of offshore Funds to IFSC [i.e., assets of the Original Fund, or of its wholly owned special purpose vehicle, to a resultant Fund in IFSC] for promoting the Fund Management ecosystem in IFSC.

The definition of ‘Original Fund’ under the Act is now expanded to include:

  • an investment vehicle, in which Abu Dhabi Investment Authority (ADIA) is the direct or indirect sole shareholder or unit holder or beneficiary or interest holder and such investment vehicle is wholly owned and controlled, directly or indirectly, by ADIA or the Government of Abu Dhabi, or
  • a Fund notified by the Central Government in the Official Gazette (subject to such conditions as may be specified).

Shares issued by a private company to specified fund located in IFSC will not be subjected to angel taxation i.e., section 56(2) (viib) of the Act.

Prior to the FB 2023, shares issued by a closely held company to non-resident in excess of the company’s prescribed fair market value was not liable to tax in the hands of the closely held company issuing the shares under section 56(2)(viib) of the Act (popularly called by the media and now even more popularly called by most people as “angel tax”). Additionally, angel tax i.e., section 56(2) (viib) of the Act, did not apply with respect to (i) shares issued to a resident being a venture capital fund or a specified fund14; or (ii) shares issued by a notified start-up.

14 Being a fund established in India which has been granted a certificate of registration as Category I or II AIF and is regulated by Securities and Exchange Board of India (‘SEBI’) or IFSC Authority

FB 2023 extended the provisions of “angel tax” i.e., section 56(2)(viib) of the Act in respect of shares issued by closely held companies to non-residents also with effect from Financial Year 2023-24 i.e. Assessment Year 2024-25.
However, considering that a specified fund located in IFSC is now governed by the International Financial Services Centre Authority (Fund Management) Regulations, 2022, amended FB 2023 provides that shares issued by closely held companies to specified fund located in IFSC governed by said Regulations, 2022 will not be subject to “angel tax” i.e., section 56(2)(viib) even in its expanded avatar, would continue to be not applicable.

Conclusion

At a policy level, the importance of encouragement of collective investment, both domestic and foreign, be it from retail investors, or from private equity or institutional investors, is clearly brought out by repeated encouraging interviews given by senior Government officials to the media. Investors have also positively responded to this encouragement by looking at India’s growth trajectory and growth potential and committing significant investment in sectors where the Government has clearly felt the need for infusion of capital. The Government’s bold initiative of conceiving and developing the International Financial Services Centre has been welcomed, albeit initially with cautious optimism, but investment therein is steadily showing good progress. Investors are already dealing with unpredictable macro-economic and political situations in the recent past. In this situation, they look to the Government for a stable, certain, and unambiguous tax regime supporting the policy decision to encourage collective investment. On its part, the Government has also been giving them its full ear and trying to make the investment climate as conducive to them as possible. Some challenges, however, persist when amendments with rationalization and protection of tax base are made with retroactive effect. This creates some doubt in the minds of the investors. Also, to foster a stable and predictable tax regime, adequate guidance to taxpayers on contentious issues should be regularly published so as to encourage and incentivise tax compliance and result in a consequential increase in the tax base.

Section145 r.w.s.68 and section 133–where the AO had not found a single defect in assessee’s books of account and enquiry made by him under section 133(6) had been properly explained by the assessee then addition made by the AO on the basis of the difference between amount reflected in books of account and in Form 26AS should be deleted.

9. Shri Jeen Mata Buildcon (P) Ltd vs. ITO

[2022] 97 ITR(T) 706 (Jaipur – Trib.)

ITA No.: 397 (JP.) of 2019

A.Y.: 2013-14

Date: 08th March, 2022

Section145 r.w.s.68 and section 133–where the AO had not found a single defect in assessee’s books of account and enquiry made by him under section 133(6) had been properly explained by the assessee then addition made by the AO on the basis of the difference between amount reflected in books of account and in Form 26AS should be deleted.

FACTS

The assessee was a company engaged in the business of labor contractor supplier with machinery under affordable housing policy for the year under consideration. The assessee company filed its return of income declaring income at Rs. 5,21,007 on 30th March, 2015 through e-filing portal and the same was processed under section 143(1) of the Income-tax Act, 1961. Later on, the case was selected for scrutiny through CASS due to the difference in turnover reflected in Form 26AS and disclosed in books of accounts. During the course of the assessment proceedings, the AO had observed that turnover declared by the assessee for the year under consideration was Rs. 67,84,050. Whereas the turnover reflected in Form 26AS was Rs. 86,62,800

Accordingly, the difference of Rs. 18,78,750/- pertaining to the contract received from M/s Sidhi Vinayak Affordable Homes was added back to the total income of the assessee. The addition was made on the basis of the confirmation received from the said party during the course of the enquiry under section 133(6) of the Income-tax Act. The said party had confirmed that the amount of Rs.18,78,750 was booked in the books of accounts.

In another case, the addition in respect of M/s Bhairav Township Pvt Ltd, the AO had observed that there was a difference between income offered and expense booked. Accordingly, the AO made an addition to the total income of the assessee to the tune of Rs. 15,23,978 being the difference between the expenses booked and income offered.

The CIT (Appeals) had confirmed these two additions made by the AO.

Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

HELD

The Authorised Representative of the assessee argued that merely because there was a difference in the figures mentioned in Form 26AS and the books of accounts, there cannot be an addition to the returned income when the books of accounts of the assessee were duly audited. The AO had not found any single defect in the books of accounts that had been produced before the AO. Even the inquiry made under section 133(6) had been properly explained by the Authorised Representative of the assessee during the course of the assessment proceedings. The main contentions raised during the course of the assessment proceedings that merely because the other party had booked the expenses, cannot be the reason while making the assessment in the case of the assessee when the contract receipt got reflected in the subsequent year as per the regular method of accounting followed.

The income offered for the parties, M/s Sidhi Vinayak Affordable Homes and M/s Bhairav Township Pvt Ltd in respect of which addition was made, was almost reconciled and offered for tax in the regular books of accounts which was not rejected by the AO. Therefore, it was not required to disturb the books which had been audited by an independent auditor. Thus, the addition made for an amount of Rs. 18,78,750 and Rs. 15,23,978- totalling to Rs. 34,02,728 were deleted.

Section 40(b) r.w.s 263–Where the assessee-firm had mentioned in its partnership deed that the partners shall be entitled to draw salary to the extent allowable under Income-tax Act but shall be drawing salary to maximum of Rs. 24 lakhs each per annum and accordingly the AO had allowed Rs. 36 lakhs of remuneration paid by assessee-firm to its three partners at the rate of Rs. 12 lakhs each under section 40(b)(v), Commissioner was not justified in invoking revisionary proceedings under section 263 on the basis that such remuneration of partners was not quantified in the partnership deed.

8. H.R. International vs. PCIT
[2022] 97 ITR(T) 129 (Amritsar – Trib.)
ITA No.:675 (ARS.) of 2019
A.Y.: 2015-16
Date of order: 19th May, 2022

Section 40(b) r.w.s 263–Where the assessee-firm had mentioned in its partnership deed that the partners shall be entitled to draw salary to the extent allowable under Income-tax Act but shall be drawing salary to maximum of Rs. 24 lakhs each per annum and accordingly the AO had allowed Rs. 36 lakhs of remuneration paid by assessee-firm to its three partners at the rate of Rs. 12 lakhs each under section 40(b)(v), Commissioner was not justified in invoking revisionary proceedings under section 263 on the basis that such remuneration of partners was not quantified in the partnership deed.

FACTS

The assessee was a partnership firm. While filing its return of income for A.Y. 2015-16, the assessee claimed partner’s remuneration under section 40(b)(v) of the Income-tax Act, 1961 to the extent of Rs. 36 lakh i.e. Rs. 12 lakh for each of its three partners. The original assessment was carried out under section 143(3). The jurisdictional PCIT initiated revisionary proceedings under section 263 of the Income-tax act, 1961. During the course of revisionary proceedings, the PCIT observed that in the partnership deed of the assessee, the partner’s remuneration was not quantified. On the basis of this observation, the PCIT concluded that the assessee was not eligible to get the benefit of section 40(b)(v) in respect of remuneration paid to its three partners and accordingly concluded the revisionary proceedings by holding that the order passed by the AO under section 143(3) was erroneous and prejudicial to the interest of revenue.

Aggrieved by the order of PCIT passed under section 263, the assessee filed further appeal before the ITAT.

HELD

It was observed by the Tribunal that section 263 had two limbs which are erroneous order and prejudicial to the interest of revenue. The assessee in its partnership deed had mentioned that the drawing power of the salary was Rs.24 lakh per annum for each partner. In fact, the salary in excess of Rs. 24 lakh will be disallowed as per section 40(b)(v) of the Income-tax Act, 1961. Accordingly, the Tribunal concluded that it cannot be said that the specific salary was not quantified. Although the assessment order had not pointed out about anything related to partnership deed, during calculation of total income, the said deed was considered and documents were within the record of the proceeding. The remuneration of Rs.12 lakh paid to each of its three partners was within the limit permissible under section 40(b)(v).

The beauty of section 40(b)(v) was that the remuneration to the partner was fully regulated by the book profit. More the book profit, more remuneration of partner will be allowed. So as per the Act, the assessee can claim more remuneration but it will be allowed subjected to provision of section 40(b)(v) of the Act depending upon its book profit.

The PCIT had, during the issuance of notice under section 263 and during the passing of the revision order under the said section, not taken cognizance of the calculation of tax and the benefit of revenue. The revision order passed under section 263 was considered and the Tribunal observed that two opinions were formed by two authorities in the question of acceptance of clause of partnership deed related to partner’s remuneration.

Consequently, it was held that the view of the Assessing Officer being a plausible view could not be considered erroneous or prejudicial to the interest of revenue. Accordingly, the order of the AO cannot be considered erroneous or prejudicial to interest of the revenue.

In result the appeal filed by the assessee was allowed.

Sum received towards undertaking restrictive covenant of non-imparting service to any other person and not to share associated goodwill of medical practice, being in the nature of non-compete fee, is a capital receipt and not taxable as business or professional income. Non-compete fee related to profession is made taxable only w.e.f. A.Y. 2017-18 and the non-compete fee in relation to profession for period prior to A.Y. 2017-18 would be treated as capital receipt. Changing of Section from 28(va) to 28(i) without confronting the Assessee is a fatal mistake.

7. Nalini Mahajan vs. ACIT
TS-180-ITAT-2023(DEL)
A.Y.: 2014-15
Date of Order: 06th April, 2023
Sections: 28(i), 28(va)

Sum received towards undertaking restrictive covenant of non-imparting service to any other person and not to share associated goodwill of medical practice, being in the nature of non-compete fee, is a capital receipt and not taxable as business or professional income.

Non-compete fee related to profession is made taxable only w.e.f. A.Y. 2017-18 and the non-compete fee in relation to profession for period prior to A.Y. 2017-18 would be treated as capital receipt.

Changing of Section from 28(va) to 28(i) without confronting the Assessee is a fatal mistake.

FACTS

The assessee, a doctor by profession was running a clinic by the name of Mother & Child, New Delhi. On 28th October, 2012, the assessee, executed a `Service Agreement’ with Nova Pulse IVF Clinic Pvt Ltd (“the Company”) whereunder the assessee agreed to be exclusively engaged with the Company for providing her professional services. Under the agreement, the consideration was a fee for her professional services, an amount for exclusive engagement with the Company and an amount for her bringing her associated Goodwill to the Company. During the year under consideration, the assessee received a professional fee and a sum of Rs. 3.20 crore for exclusive engagement with the Company and for bringing her associated Goodwill to the Company. The AO held the sum of. Rs. 3.20 crore to be taxable under section 28(va) of the Act being the value of any benefit or perquisite arising from business or exercise of a profession.

Aggrieved, the assessee preferred an appeal to CIT(A) who confirmed the action of the AO but held that the amount under consideration is chargeable to tax not under section 28(va) but under section 28(i) of the Act. He rejected the plea of the amount under consideration is a capital receipt.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD

The Tribunal noted that there is a proper agreement which provides for the non-compete fee/goodwill. The agreement has been turned down by the authorities below as it is a colorable device. This observation, the Tribunal held, is not backed by any proper reasoning. The case laws relating to the proposition is that the Revenue should only look at the agreement and not look through the binding agreements between the parties. The Tribunal further noted that the AO made addition under section 28(va) of the Act. The amendment to bring profession also, into the said clause was brought in w.e.f. A.Y. 2017- 18. Hence, non-compete fee related to profession is made taxable only w.e.f. A.Y. 2017-18 and the non-compete fee in relation to profession for period prior to A.Y. 2017-18 would be treated as capital receipt.

Furthermore, the CIT(A) has changed the section from 28(va) to section 28(i) of the Act without confronting the assessee. The Tribunal held this to be a fatal mistake. The Tribunal held that in view of the decisions of the Supreme Court in the case of Excel Industries [358 ITR 295 (SC)] and in the case of Radhasoami Satsang Saomi Bagh vs CIT [193 ITR 321 (SC)], the assessee also deserves to succeed. Also, on the principle of consistency in as much as for A.Ys. 2013-14, 2015-16 and 2016-17, the same was treated as capital receipt and the same had been accepted by the Revenue.

The Tribunal held that the sum of Rs.3.20 crore received towards undertaking restrictive covenant of non-imparting service to any other person, and not to share associated goodwill of medical practice, being in the nature of non-compete fee is a capital receipt and not taxable under the provisions of the Act. Hence, the assessment by the AO under 28(va) is not sustainable and similarly, the order of the CIT(A) whereby he changed the head from section 28(va) to section 28(i) without confronting the assessee is also not sustainable. The CIT(A)’s view that the same is taxable under the normal professional income is also not sustainable in the background of the aforesaid discussion, the agreement and the case law referred above. The Tribunal decided this ground of appeal in favour of the assessee.

Provisions of section 68 cannot be invoked as the assessee, offering income under presumptive tax provisions, was not required to maintain books of account.

6. Sunil Gahlot vs. ITO
ITA No. 176/Jodh./2019 (Jodh.-Trib.)
A.Y.: 2015-16
Date of Order: 24th March, 2023
Sections: 44AD, 68, 115BBE

Provisions of section 68 cannot be invoked as the assessee, offering income under presumptive tax provisions, was not required to maintain books of account.

FACTS

The assessee, an individual carrying on trading activity, returned a total income of Rs.2,63,920, under section 44AD of the Act. In the course of scrutiny assessment proceedings, the AO asked the assessee to furnish details of sundry debtors and creditors. The AO made an addition of Rs. 67,743 towards unexplained opening capital balance and Rs. 28,964 for unexplained creditors.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD

The Tribunal having noted that the assessee had opted for presumptive taxation under section 44AD of the Act held that the assessee is not required to maintain proper books of accounts. The Tribunal observed that it does not find any merit in the action of the AO calling for the details of sundry creditors and further making addition under section 68 of the Act for unexplained creditors of Rs. 28,964. Since the assessee was not required to maintain books of accounts, the Tribunal deleted the addition under made by the AO under section 68 of the Act towards unexplained sundry creditors.

As regards the addition for opening capital balance of Rs. 67,463, the Tribunal held that it failed to find any merit in the action of the AO because the minimum amount not taxable for the preceding years i.e A.Y. 2014-15 and A.Y. 2013-14 was Rs. 2.00 lakhs and the assessee filed return regularly and having regular source of income from the business and, therefore, it can safely be presumed that he had sufficient accumulated profits to explain the opening capital balance of Rs. 67,463/-. The Tribunal deleted this addition as well.

As regards application of section 115BBE, the Tribunal held that section 115BBE comes into operation only in case of income referred in sections 68/69/69A/69B/69C and 69D of the Act, which is not applicable on the issues raised in the instant case, therefore, there is no justification for invoking the provisions of Section 115BE of the Act.

An addition made under the Black Money Act cannot be made on a protective basis under the Income-tax Act. This has been so held even though the assessment under section 10(3) of the Black Money Act had not attained finality and was subjudice.

5. DCIT vs. Ashok Kumar Singh
ITA No. 426 & 427/ Del/2022 (Delhi-Trib.)
A.Ys.: 2013-14 and 2014-15
Date of Order: 19th April, 2023
Sections : 68 and 10(3) of the Black Money Act

An addition made under the Black Money Act cannot be made on a protective basis under the Income-tax Act. This has been so held even though the assessment under section 10(3) of the Black Money Act had not attained finality and was subjudice.

FACTS

A search action was carried out on 7th April, 2016 and notices were issued and served upon the assessee. During the course of assessment proceedings certain information was available on the website of International Consortium of Investigative Journalists (ICIJ) regarding Indians having undisclosed foreign companies and assets offshore. Investigation was carried out by the Investigation Wing, Delhi. Information was also received from BVI under Information Exchange Agreement and thereafter information was also received from competent authority of Singapore.

The AO noticed that there were huge credits in the bank accounts, details whereof were received pursuant to Information Exchange Agreements. The AO, in the assessment order, mentioned that the Proceeding under the Black Money (Undisclosed Foreign Income and Assets) and imposition of Tax Act 2015 (“BM Act”) have also been initiated after examining the details / materials (including the information relating to foreign bank accounts which were not disclosed in the returns of income) by issuing notices under section 10(1) of the BM Act, and that the final orders are yet to be passed under the BM Act. The AO also stated that “But, it is also clearly understood that the same income cannot be added twice-(i) once under the Incometax Act and then (ii) in the BM Act, as a measure of abundant precaution, income is assessed protectively in the hands of the assessee under income tax act.”

Aggrieved, the assessee preferred an appeal to the CIT(A) who deleted the addition so made on protective basis.

Aggrieved, the revenue preferred an appeal to the Tribunal where the Revenue conceded that the additions made under the Black Money Act are subjudice before the first appellate authority and to safeguard the interest of revenue protective addition has been made under the IT Act.

HELD

The Tribunal held that once additions have been made under the Black Money Act, the same cannot be made under the IT Act on the same set of facts. The Tribunal held that the deletion of the addition by the CIT(A) does not call for any interference.

Interest on delayed payment of TDS is compensatory in nature and is allowable as deduction under section 37(1) of the Act.

4. Delhi Cargo Service Centre vs. ACIT
2023 Taxscan (ITAT) 778 (Delhi – Trib.)
A.Y.: 2015-16
Date of order: 24th March, 2023
Sections: 37, 43B

Interest on delayed payment of TDS is compensatory in nature and is allowable as deduction under section 37(1) of the Act.

FACTS

The assessee, a company engaged in cargo handling services at Cargo Terminal – 2, Indira Gandhi International Airport, e-filed its return of income for A.Y. 2015-16 declaring therein a loss of Rs. 13,29,41,858. The AO passed a draft assessment order on 18th December, 2018 under section 143(3) r.w.s. 92C of the Act inter alia proposing an addition of Rs. 1,28,605 under section 43B being late payment towards statutory dues.

Aggrieved, the assessee preferred an application under section 144C(2) before the Dispute Resolution Panel (DRP) objecting to the additions proposed by the AO. Regarding disallowance of Rs.1,28,605 under section 43B, the DRP directed the Ld. AO to examine the evidence and allow to the extent supported by the evidence. The Ld. AO, however maintained the disallowance of interest of Rs. 94,662 paid on late payment of TDS and Rs.26,465 being PF arrear payments as challans in support were not filed.

The AO held that the entire amount pertained to A.Y. other than A.Y. 2015-16 and thus cannot be allowed. Liability for interest being in the nature of penalty, the AO disallowed the same under section 37(1) of the Act.

Aggrieved, the assessee preferred an appeal to the Tribunal where on behalf of the assessee it was contended that the liability for interest incurred by the assessee is compensatory in nature and for this proposition reliance was placed on the decision of Supreme Court in Lachmandas Mathuradas vs. CIT 254 ITR 799 (SC), decision of Hon’ble Madras High Court in Chennai Properties and Investment Ltd. vs. CIT 239 ITR 435 (Mad) and the decisions of Mumbai, Calcutta and Jaipur Benches of the Tribunal.

HELD

The Tribunal observed that the AO proposed the impugned disallowance under section 43B which allows deduction of statutory dues in the year of actual payment irrespective of the year in which the liability was incurred. The case of the assessee all along has been that the impugned interest has been paid in A.Y. 2015-16 and therefore it is an allowable deduction. However, after receipt of the direction of the DRP to verify the evidence of payment and allow the same as deduction, the AO made the impugned disallowance under section 37(1) of the Act assigning the reason that impugned interest liability is penal in nature.

The Tribunal held that the impugned disallowance for the reason assigned now is also not sustainable. It observed that an identical issue arose for consideration before Mumbai Bench of the Tribunal in M/s M L Reality vs. ACIT in ITA No. 796/Mum/2019 and the Tribunal vide its order dated 24th March, 2021 held that interest paid on late payment of TDS is compensatory in nature and is an allowable deduction under section 37(1) of the Act.

The Tribunal following the decision in M L Realty Ltd (supra) and the ratio decidendi of the decisions relied upon by the assessee decided found substance in the contentions of the assessee and decided this ground of appeal in favour of the assessee.

कामये दुःखतप्तानाम्

(Bhaagwat 9:21)

In Bhagwat Purana (story of 10 incarnations of Bhagwan Vishnu, this story appears, Shukdev (a sage) was narrating the glorious history of Bharat-vansh (dynasty) to King Parikshit. There he described the nobility of King Rantidev. In those days, the kings used to perform yagnas (yagya) – sacrifices in which they used to give away whatever any person wanted. They did not mind even if their treasures got emptied. They used to then rebuild the treasure by conquering other kingdoms. This tradition of earning and giving away everything was indeed very unique and interesting in Indian ancient history. It was a sin if the king could not satisfy anybody.

Once, after he gave away everything, King Rantidev himself faced starvation for 49 days. On 50th day, he could get something to eat. However, just when he was to start eating, some people (Atithi) arrived there with the hope of getting some food, Rantidev sacrificed his food for them. Those people were actually Gods who had come to test Rantidev’s integrity and commitment. They blessed him and asked what he wanted. They were willing to give anything and everything he would ask for (vardaan or boon).

What desire Rantidev expressed is contained in this beautiful shloka (verse). This was a favourite shloka of Gandhiji and so is mine.

– Na twaham kaamaye raajyam

– Na swargam Naapunarbhavam

 – Kaamaye Duhkha taptaanaam

 – Praninaam Aarti naashanam

Meaning –

I do not desire the kingdom, nor do I want heaven. I do not wish even to get moksha (salvation) i.e., freedom from rebirth! (Then what do I want?)

I wish to relieve the pain of all those who are suffering! I want to wipe the tears of all those who are suffering from any pain or difficulty!

Such was the noble thinking of many kings in our history. Moksha was and is considered the ultimate good thing in one’s life, as per Indian thought or Indian belief. Human life is full of difficulties and sorrow. They say happiness is as small as a grain whereas sorrow is as big as a mountain! So, it was and is considered desirable that one should be free from this cycle of rebirth (punarnbhava).

– (apunarbhava) is the absence of rebirth. So the correct wording is Naapuinarbhava .

Gautam Buddha was a prince (Siddhartha). His father was scrupulously avoiding showing him any negative thing or sorrow in human life. But one day, young Siddhartha saw sufferings – like poverty (beggar), ill-health (a sick man) and a dead man. That very day he renounced everything – his kingdom, his wife and his son – who was then a kid. Siddhartha then got divine knowledge (bodha) after a long penance, and he founded Buddhism. He preached a humanitarian approach and empathy. He dedicated his life to the eradication or alleviation of misery from human life. However, the reality is that it is an endless process. Our saints like Dnyaneshwar and Tukaram dedicated their lives for the same noble cause. That is why we still remember them with reverence.

After Mr. Rockfeller met Swami Vivekananda, he donated his entire wealth for the cause of humanity.

! Our sensitivity backed by action is important.

We also should in some way or the other, depending upon, our ability strive to help needy people who are suffering from misery or pain. All religions preach this very principle. We have such examples even today – like Baba Amte or Dr. Prakash Amte. Their four generations, leaving aside their qualifications, are serving the tribals and animals in the forests. One should emulate these idols in one’s own way. That is the ultimate satisfaction and the real meaningful purpose of life.

We offer our Namaskaar to such noble people!

From Finance Bill to Finance Act, 2023

(Emerging Trends in Passing the Finance Bills)

The Finance Bill 2023 proposed 120 amendments to the Income-tax Act, 1961. However, the Finance Act, 2023 was eventually passed with 64 amendments to the Finance Bill. The Finance Bill was passed amidst uproar in Parliament without any discussion at all.

These days there is hardly any debate (for various reasons) in Parliament while passing the Finance Bill, with the result that not only amendments proposed by the Finance Bill get passed, but also additional amendments moved by the Government, which are not part of the original Finance Bill, also get passed easily.

It is suggested that provisions of a Finance Bill having significant impacts should be discussed and debated in Parliament or a select committee thereof and/or with various stakeholders, as it is always a good practice to have a consultative process before making significant amendments that have far-reaching impacts. This would prevent piecemeal amendments to the Income-tax Act, which are often carried out to reverse the judgments favouring assesses, or amendments to curb exceptional misuse of provisions by a few.

Recent amendments to the taxation of Charitable Trusts are a classic example of how amendments without a consultative process could result in enormous compliance burden and complexities. These amendments are a death knell to small and medium size trusts doing yeoman services at grassroots levels where the government has failed to reach.

Two significant amendments made by the Finance Act, 2023, which will have far-reaching impact, and which were not part of the original proposals, are:

(i) increase in the rate of TDS on Fees for Technical Services (FTS) and Royalty payments to non-residents from 10% to 20%, and

(ii) Gains on the sale of investments in Debt Mutual Funds to be taxed as short-term capital gains.

As far as TDS rates on FTS and Royalty are concerned, it will result in an increase in the cost of import of technology/services where the payment terms are net of tax, as the burden will be passed on to the Indian entrepreneur. The lower rate prescribed in a tax treaty may apply, but that claim is subject to a host of compliances such as beneficial ownership, obtaining of Tax Residency Certificate, filing form 10F, and/or obtaining PAN, filing of income-tax return in India etc. The amendments to the TDS rates on FTS and Royalty payments to non-residents have been quite frequent and which only shows that government is not sure of what it means by the ease of doing business. The Memorandum explaining provisions of the Finance Bill 2013 stated that the rate is increased from 10% to 25% because most treaties provide rates ranging from 10% to 25%. However, realizing the burden of TDS on Indian entrepreneurs (in cases of “net of tax” payments), the Finance Act 2015 again reduced the rate from 25% to 10%. The rate is again increased from 10% to 20% vide the Finance Act, 2023. These flip flops, that too without any explanation this time, raise doubts about the stability of tax laws in India.

Another significant amendment carried out by the Finance Act, 2023, was the expansion of the scope of section 50AA to specified Mutual Funds which was originally restricted to only Market Linked Debentures. Memorandum explaining the provisions in the Finance Bill, 2023 provided that “In order to tax the capital gains arising from the transfer or redemption or maturity of these securities as short-term capital gains at the applicable rates, it is proposed to insert a new Section 50AA in the Act…”. It then proposed to tax gains on the “Market Linked Debentures” (predominantly in the form of a debt where the returns are linked to market returns) as short-term capital gains at applicable rates, instead of long-term gains @ 10% without indexation. However, vide the Finance Act 2023, this tax treatment is also extended to units of specified mutual funds (having investments in equity shares of 35% or less) acquired on or after 1st April 2023. This change, having a significant impact on the Mutual Fund industry, AMCs, and investors; was not part of the Finance Bill 2023 and hence there is no explanation or stated logic.

Frequent changes in the tax regime defy one of the basic canons of a fair tax system, namely, “Certainty”. And this is not an aberration, but a repeated trend. The same thing happened with the taxation of dividends and the failed experiment with the Fringe Benefits Tax (FBT). With so many changes, the Income-tax Act, 1961 looks like a bridge with innumerable repair patches. To illustrate, there are fifty-nine sections in section 80 series, from 80A to 80U with many subsections, and similar is the case with section 115 series which has almost 108 sections (115A to 115VZC) spanned over fifteen chapters. There are many such provisions in the Income-tax Act, 1961 that have sub-sections, several explanations, provisos, sub-provisos, and so on, with the result that they look like a Banyan tree, where it is difficult to trace their origin. A classic case is section 10(23C) with over 20 provisos, some with their own explanations. We hope that going forward major changes will be made only after proper debate, discussion, and consultation with the stakeholders, that too once in a few years instead of every year, and assessee-friendly decisions are not reversed as a matter of routine.

Best Regards,

Dr. CA Mayur B. Nayak

Editor

Law and Order

Yogesh was an intelligent but a simple young boy. He belonged to an educated and cultured middle-class family. His girlfriend Priya was also from a similar family background. Both were doing their post-graduation.

Once, Yogesh’s father bought a new two-wheeler for Yogesh. He took a bank loan for buying it. Yogesh was very excited and took Priya with him to a garden. He parked the scooter on the road and they sat on a bench from where they could see the scooter. He was especially careful since it was new.

Unfortunately, an auto-rickshaw driver knocked down the scooter while parking his auto, causing some damage to it. Yogesh ran there and started shouting. People around came to help and caught the auto-driver. The auto driver had no regrets on his face. On the contrary, he started giving bad words at the top of his voice. He was drunk and blamed all those who had parked their vehicles!

The matter went to the police station. Both Yogesh and Priya were nervous and upset since their new scooter was damaged. That was their first occasion to go to the police station.

They were not afraid because they were honest and had not done anything wrong!

The policeman looked at them, realising what had happened. He looked at the auto driver who was cool and smiling. The police officer shouted at Yogesh: –

Police Officer: Show me your driving licence.

Yogesh showed it.

Police Officer: What do you do ?

Yogesh: Study at the University for Post-graduation.

Police Officer: Where is your identity card?

Yogesh: Sir, but my scooter was knocked down by this fellow. I have come to complain.

Police Officer: Shut up. Only answer my questions. Tell me, what does your father do?

Yogesh: He is a school teacher.

Police Officer: Then how did you get the money to buy a new scooter?

Yogesh: Sir, he took a bank loan,

Police Officer Bring all the papers of the scooter – the bill, delivery note, payment receipt, bank loan sanction letter….

Yogesh: Sir, what has that to do with the present episode?

Police Officer: Don’t argue with me. Have you got insurance and PUC?

Yogesh: Yes Sir. Everything is there.

Then Police Officer turned to Priya.

Police Officer: Tell me, what were you doing with this boy?

Priya: Sir, we are friends in the same class.

Police Officer: But what were you doing here in the garden? You should be studying for the exam.

Priya: Sir, why don’t you ask questions to the auto-wala?

Police Officer: Don’t teach me. Does your father know that you are roaming with this boy?

Priya: Yes, Sir. Our families are known to each other for long.

The police officer was getting a little nervous. All his attempts to intimidate or catch the young boy and girl were failing! As a last resort, he asked both Yogesh and Priya to bring their Parents. He told gently to the auto-wala that he could go since his business would suffer.

Next day, the fathers of Yogesh and Priya came to the police station. The police officer talked to them rudely and told them that their children were not behaving properly. He also scolded the children in front of their fathers.

They said – “Sir, we will take care of our children. But in this case, what is their fault?

In fact, they approached you for help since their scooter was damaged”

Police Officer “These children are enjoying sitting in the garden and unnecessarily troubling the poor rickshaw driver. We are so busy and have no time for such petty matters!

The fathers coolly went home. Children were very much upset!

Victims were themselves treated as criminals; and the real wrongdoer was scot-free! They did not even record the complaint!

SCENE 2

Same evening, the police officer and auto-wala called at Priya’s residence; and literally fell on her father’s feet! He was working as a PA to the Commissioner of Police!!

We CAs are often victims of wrong doings of others. We need to keep this story in mind.

BCAS 56th Residential Refresher Course

 

The flagship event of the Bombay Chartered Accountants’ Society (BCAS), the Residential Refresher Course (RRC), was held at Coimbatore or Kovai as it is called in the local language, from Thursday, 23rd February, 2023 to Sunday, 26th February, 2023..

The preparations for the RRC commenced in July 2022 with the formation of the Seminar, Public Relations and Membership Development (SPR&MD) Committee for 2022-23. Countless calls and meetings followed, even a recce to finalise the venue – after all, the 56th RRC was a special one. The previous RRC (the 55th RRC) had been a hybrid one (given that many of the participants were shy of travelling since the economy was slowly opening up after the onslaught caused by the global pandemic). The Committee was also conscious of the fact that they needed to deliver a program that was contemporary, relevant, and thought-provoking. The time-tested mix of panel discussion, paper presentations and group discussions were successfully adopted.

In Hindi, 56 is ‘chhappan’. The word evokes the memory of Chhappan Bhog, the special prasad offered to Lord Krishna during the Janmashtami festival. The preparation of the Chhappan Bhog is, by itself, an homage paid to the Divine. With great reverence and veneration, the bhog is lovingly cooked by the devotees with their hands – the rasas in the fingers slowly blending into the food. It is said that our five fingers have five rasas – sweet, salty, sour, spicy and savory. To the uninitiated, rasa is basically a source of emotion – it brings joy, brings back memories and opens up conversations.

To the participants of the 56th RRC this year – 138 participants drawn from 20 states and 38 cities – the event was akin to a Chhappan Bhog. Many of these participants have been devout bhakts of this annual pilgrimage, and the RRC gave them an opportunity to rekindle old friendships and reminisce over the past editions. For the first timers, the RRC gave a chance to experience the charm and bonhomie of this much-awaited event. Another unique feature was the four couple participants.

The excitement in the air on the 23rd February was palpable as delegates poured in from all corners of the country. Day 1 began with the inaugural session, with the CA Kinjal Bhuta, Convenor, SPR&MD Committee, welcoming everyone CA Mihir Sheth, President, BCAS officially opening the RRC. This was followed by an address by CA Chirag Doshi, Vice President, BCAS who spoke about the benefits of groups, associations, and local communities in the profession. CA Narayan Pasari, Chairman, SPR &MDSPR spoke about the relevance of the RRC, selection of its venue, detailed schedule and statistics of the RRC. The esteemed Chief Guest and Past President, CA Uday Sathaye, regaled the audience on the previous RRCs and how his involvement over the past decades has taught him precious life lessons, which have in turn contributed to his professional successes as well. He further noted how his passion for BCAS has led him to be crowned with the moniker, ‘BCAS che ladke vyaktimatva’ (the lovable personality at BCAS). The inaugural session was also graced by the presence of the Past President of ICAI, CA G Ramaswamy and the Officer Bearers of The Auditors’ Association of Southern India (TAASI) and SIRC members.

The inaugural session was followed by the curtain-raiser, the presentation paper on the contemporary topic “Handholding Startups – An emerging area of practice” by CA Eshank Shah. The session was chaired by CA Priya Bhansali. This was followed by a group discussion on “Case Studies in Direct Taxes” which saw the break-out groups discuss threadbare challenging and compelling case studies.

Day 2 saw the break-out groups continue their deliberations, followed by the erudite Adv. K.K. Chythanya who discussed the intricacies of the case studies at great length. The session was chaired by CA Phalguna Kumar Enukondla. Post a sumptuous lunch, the eager delegates set out to pay obeisance to Lord Shiva at the Perur Pateeswarar Temple. The temple traces its origins to the 2nd century CE, making it one of the oldest temples in the state and also India. This was followed by a visit to the Isha Foundation. Thanks to local participant, CA V Ramnath, both the visits went off smoothly. A special mention must be made of the Coimbatore team of Yuva participants, ably led by CA R Harish, who took it upon themselves to assist all the other delegates during the entire visit.

Day 3 witnessed the participants appreciate the complexities in the paper presentation on the topic “Additional Reporting Intricacies – Special focus on CARO, IFC & NOCLAR” by CA Mohan Lavi, ably chaired by CA Zubin Billimoria. Post lunch, the break-out groups gathered for yet another stimulating group discussion on the topic “Case Studies in penalty and prosecution in Direct & Indirect Taxes”. The evening ended with an engrossing brains trust session on multi-disciplinary areas of practice. The intellectual team comprising Past President CA Anil Sathe, CA Chinnsamy Ganesan, CA Rutvik Sanghvi and Past President CA Sunil Gabhawalla had a very engaging discussion, where they presented their individual views on the case studies at hand. The session was ably moderated by CA Kinjal Bhuta and CA Mandar Telang. The evening ended with some first-time participants sharing their feelings about the RRC. Post dinner, the young at heart and in age found themselves on the dance floor, grooving to the beat of the music which transcended all borders.

Day 4 commenced with Adv. Raghvan Rambhadran giving his replies on the topic, “Case Studies in penalty and prosecution in Direct & Indirect Taxes”. The session was chaired by CA Sanjeev Lalan. This was followed by the Presentation Paper, “Practice Automation Tools” by CA Druman Patel, ably chaired by CA Chirag Doshi. In the concluding session, Chairman Narayan Pasari once again acknowledged all those who had worked towards delivering a successful RRC, especially Committee member and local participant, CA Priya Bhansali who played an active role in making all the logistic arrangements. Apart from others, the ever energetic four Convenors – CA Kinjal Bhuta, CA Mrinal Mehta, CA Manmohan Sharma, and CA Preeti Cherian deserve credit – they were ably guided by Past President CA Uday Sathaye.

And as the curtains came down on yet another successful RRC, one was reminded of the passion that courses through the veins of the die-hard RRC fans, and the beautiful doha composed by the 15th century mystic poet and saint, Kabir:

“कबीरा कुंआ एक हैं, पानी भरैं अनेक। बर्तन में ही भेद है, पानी सबमें एक।।.”

 Meaning –

Kabira, the well is but one, from which many draw water,

Only the pots differ, the water they hold within is the same.

In the context of the RRC, the ‘well’ can be likened to the inexhaustible source of knowledge that the BCAS is – where the thirsty gather and meet; the ‘pots’ represent the diversity among the participants – drawn as they are from different corners of the country; and the ‘water’ is the knowledge that the participants and stakeholders of the RRC partake and emerge invigorated with.

 

Solutions to Climate Change

[This essay won the Best Essay Prize at Tarang 2k23 (CA Students Annual Day), organised by BCAS]

Climate change – A phenomenon of minor insignificant changes in seasons which piles up and accumulates to be a bigger issue. Many experts have presented their concern on this matter – a matter which if not resolved would become a black demon in the disguise of small, minor, ignorable changes.

The phenomenon of climate change is not a one-day event. It happens over time through subtle changes in seasons which are difficult to identify. But now these subtle changes have accumulated to be a big issue. We all have now experienced winters that are not as cold as they used to be earlier and hotter summers. It is now December and still, a majority of people are without their sweaters which is a matter of concern.

Talking about the reasons multiple factors are contributing to climate change be it depletion of the Ozone layer, pollution of air, water, and soil, or be it excess extraction of minerals, deforestation plays no lesser role in climate change. Lack of awareness amongst people and increase in industrialization are among the other contributors.

Talking about the ill effects that the environment has on society the first and foremost is the increased diseases among the people. The exposure of ultraviolet rays on humans has exposed them to various skin and eyes related diseases not only humans but animals, birds, and microorganisms and the entire ecosystem is a victim of such climate change. The Antarctician glaciers are melting day by day at an increasing rate which surely will drown down the coastal cities in water some or other day.

Considering the solution that can be bought to tackle this issue, the first thing to keep in mind is that it is not solely and exclusively the government’s responsibility to take care of the entire ecosystem, being affected by climate change the following changes need to be brought by all to be capable to solve the problem of climate change.

Stricter norms should be introduced to keep a check on untreated disposal of industrial influents. Though industrialization is important the waste it generates is not. Proper guidelines should be in place to regulate contamination of the environment, for instance, the manufacturing of single denim jeans consumes and contaminates water that can be consumed by an individual for 3 years.

Viable means of manufacturing should be introduced. Companies should be encouraged to install more pollution-controlling equipment. Companies should be given a rating on a per annum basis based on their contribution to polluting the environment and such rating needs to be disclosed on their packaging. Companies with below-expectation eating should be given a determined holiday period to improve their system and thus their ability to protect the environment. Their rating will not be publicly disclosed during this holiday period.

Another major contributor named plastic needs to be brought under control. Plastic takes considerable time to be disposed off thereby degrading the environment. Emphasis shall be placed on reusable bags rather than plastic bags. Also, the government can introduce a plastic tax on corporates that consume plastic above a pre-set limit or whose quality of plastic is below a pre-set limit.

The generation of electricity consumes many resources and contributed to the depletion of the Ozone layer. Awareness about solar panels, extension tax benefits for further periods, and government subsidies will help in the upbringing of solar panels thereby conserving electricity. Windmills are also a good substitute for generating electricity.

Motor Vehicles contribute about 20 per cent of total environmental pollution. The introduction of E- vehicles and the case of accessibility will help in controlling pollution we all witnessed the clarity in the environment during the lockdown owing to restrictions on traveling and industrialisation. Emphasis on shared public transportation and building good infrastructure therein can also help to tackle the issue.

Chloro Fluoro Carbon (CFC) has a major share in the depletion of the Ozone layer. CFC is emitted by equipment like air conditioners, refrigerators, etc. Purchasing  environment-efficient equipment can help in controlling CFC.

Due to increased population and urbanization the extent of deforestation has also increased. The scarcity of trees affects the entire ecosystem and thus the climate. Trees are natural machines that cut bad pollution and emit fresh air in the environment. Tree plantation should be instilled in citizens.

Education plays a vital role in conserving the climate and thus the planet Earth. Reforms should be brought into the educational system to make people in urban and rural areas aware of the environmental changes and the human duty to protect the same.

Thus, it can be said that the responsibility to protect the environment cannot be instilled upon the government only and citizens sitting with folded hands. People should keep aside their self-centric approach and work towards creating a better  tomorrow.

As a concerned citizen, every individual should take early steps to protect the environment with the
latest technology available we should work towards creating a sustainable environment for a better tomorrow.

Thank You!

SEBI Acts against Pump-N-Dump Operations through Telegram Channels

BACKGROUND

SEBI, on 25th January, 2023, passed a detailed interim order (in the matter of Superior Finlease Ltd) against persons allegedly involved in market manipulation through the popular messaging app, Telegram. This followed several search and seizure operations conducted about a year ago at multiple locations where SEBI seized, amongst other things, mobiles, hard disks, etc. SEBI found that a well-organized scam using the age-old “pump and dump” method was being carried out with illicit gains of Rs. 3.89 crores generated. SEBI carried out an elaborate and methodical investigation to join the various dots together. This revealed several interesting facts and issues, legal and otherwise. While such scams are regularly seen and even predictable now in their pattern, this was perhaps one unique case where the bare bones of the modus operandi were exposed in detail. SEBI carried out searches that enabled it to get its hands on mobile devices which contained lurid and explicit details of the scam.

At the outset, though, it must be emphasised that this was an interim order. Interim orders are usually passed in cases where the regulator cannot wait for the investigation and further proceedings to be wholly completed and only final orders are passed. Waiting a long time may not only mean that the scam could go on, but the illicit profits may also be diverted and the evidence destroyed, etc. However, this also means that the order lays down findings of SEBI to which the parties may have had no opportunity of presenting their side. Thus, it would be a one-sided case at that stage. Often, such orders are appealed against particularly if it is found that they contain grave errors and charges, and would result in injustice and even besmirching of the names of innocent parties. Appellate authorities do give relief in case of obvious errors or if it is found that the losses caused to parties may be irreversible and more than the benefit obtained by such order. Hence, the findings and conclusions in this order (and the discussion here) should be treated as mere allegations at this point.

Nonetheless, SEBI deserves due credit not just for the elaborate investigation and detective work including of technical aspects, but also for expressing its findings well in the order with graphs, transcripts of conversations and even sharing their recordings.

WHAT IS PUMP-AND-DUMP?

Pump and dump operations are age-old. And, sadly, they work again and again. Even SEBI has recognized the human psychology involved, where, the public and particularly lay investors, get a Fear of Missing Out (FOMO, as how this has become part of today’s popular slang) and act. This is partly because of greed which blinds them to rational and skeptical analysis and partly because of the sense of urgency created by the operators.

Pump and dump involve, as is obvious from the term, two parts. One is the initial part of pumping up the price. This involves two aspects. One is, of course, the steady raising of the price of the shares of the concerned company. This is done by a group of operators trading amongst themselves at a successively higher price. The second is creating volumes, though this may not always be the case. Nevertheless, high volumes create an appearance of credibility that there are many buyers even at higher prices.

Usually, most of the shares of the company are in the hands of this group of persons since otherwise, the public shareholders who see the price rising may sell their holding which could not only result in a fall in prices but also increase the cost of the operations. Thus, such operations are often carried out in companies that have little operations. Having said that, such operations are also seen in fully functioning companies where the idea is to pump up the price to enable a further issue of shares/securities at a higher price or simply to offload holdings to raise funds.

The second part involves dumping the shares at the higher price to the unsuspecting and expectant public who are eager to acquire these shares since they are promised a much higher price later. At this stage, the operators are selling and the public is buying. Of course, as was actually seen in this case too, the operators may have to step in if the price falls due to reasons such as some sellers coming in. Shares are thus offloaded within a price range and then the operators pack their bags and leave the investors high and dry.

SUMMARY OF THE INVESTIGATION AND FINDING IN THIS CASE INCLUDING INTERESTING ASPECTS

SEBI received complaints that certain telegram channels were giving out tips for dealings in shares through telegram channels. Telegram, as is well known, is a popular messaging application with others including WhatsApp, Signal, etc., and of course, the regular SMS services. Interestingly, action has already been taken in respect of stock manipulation scams through SMS messages by restricting messages with the use ‘buy’, ‘sell’, etc. However, acting against apps is more difficult as they are privately owned and also have secrecy features built in. Telegram has become more popular since it has many more features including anonymity, larger size of groups, etc.

SEBI followed such channels and noted that they did engage in giving out tips. Importantly, it was found that just the two channels put together had a subscriber base of more than 23 lakh persons. This was the ready audience the operators had and, as SEBI notes, even if a minuscule number of these people fell to the scam, it was enough for it to succeed and illicit gains of crores be made.

What is more, the channels also had paid subscribers. For getting periodic tips in various ranges, the subscribers paid periodic (weekly/fortnightly/monthly) subscriptions of Rs. 5000-10000. This by itself was a money-making operation. It may be noted that several SEBI regulations deal with such giving of tips, whether for money or otherwise, and if these are given by unregistered persons or against regulations, they are illegal. SEBI has, in recent times, passed numerous orders against such unregistered persons making recommendations.

SEBI found that there was an alleged mastermind who controlled a listed company and a broking firm. He approached certain intermediaries who in turn involved other persons including those who operated such telegram channels. SEBI found that the mobiles they seized had actual recordings of telephonic conversations between the parties where they summarized how broadly the scam would be managed and how they would share the profits. SEBI found that the parties had agreed that the portion of the price above Rs. 100 would be paid as a commission by the sellers to the other persons involved. There was discussion of even how a certain percentage of this commission would be retained for contingencies. The alleged mastermind was said to have even stated in this regard, justifying the retention, that “Mein beimaan aadmi nahi hu lekin…” (“I am not a cheat but…”). Considering that the whole operation was allegedly for making fraudulent profits from unsuspecting lay public investors, the irony cannot be missed.

Then there were messages of the actual working of the profits made and the amounts to be shared along with how they were paid or to be paid.

SEBI investigated methodically several things in this regard. It tracked the movement of the prices of the shares, their volumes and the persons who engaged in the trading leading to D-day when the offloading was to happen. It gave findings of a connection between these parties including how the trading was financed by the alleged mastermind. Thereafter, screenshots of the recommendations through messages in the telegram channel to buy such shares with the high target prices (and also the stop loss price) were found and given in the order. SEBI also not only tracked the number of calls between the parties including the total time of such calls, but it also traced the mobile locations to further support its case of connections between the parties. The bank account statements of some of the parties were analysed to show the flow of funds which were then linked with the agreed plan of financing and also sharing of the illicit profits.

Statements of parties were taken, and certain parties were said to have confessed and also explained the modus operandi and the role of various parties.

At the end, in this 93-page long order, SEBI concluded that multiple violations of law appeared to have taken place and also there was a need for immediate interim order giving directions. Accordingly, SEBI gave certain directions against 19 parties. It required that the total illicit profits of about Rs. 3.89 crores be impounded and incidental directions to banks, etc. not to permit debits to accounts till the money was paid, were given. It directed the parties not to buy or sell, such securities till further orders. Finally, the interim order was also to be treated as a show cause notice to parties asking them to give their responses as to why final adverse directions such as that of disgorgement, debarment, penalty, etc. not be passed.

SOME LEGAL ISSUES

As stated, the order is interim and comprises a set of allegations that do not give parties an opportunity to present their case. SEBI may also carry out further investigations and place them before the parties. It is thus possible that as the case progresses, perhaps also in appeals, there may be changes in the stated findings, conclusions, allegations, etc. Nonetheless, several legal questions can be considered at this stage itself that may be raised and ultimately resolved either by SEBI or by appellate authorities. Hence, the progress of this order would be worth tracking to see how such a case, perhaps the first of its kind in many aspects such as use of messaging apps, search and seizure, telephone recording, etc., progresses.

One issue is that the order is a combined one against 19 parties, who may be placed in unequal positions. Though SEBI has divided the roles of certain groups of parties, the law would require that each person’s guilt be individually established. An important aspect here is placing joint and several liabilities on a group of persons who are alleged to have jointly acted – and profited – from a part of the alleged scam. This has been questioned in the past and rightly so.

Then there are alleged confessions and statements. These may be retracted, possibly on grounds that they were made under duress, and the question of their validity would thus arise. In any case, other parties may seek cross-examination particularly if these statements are implicating them.

There are voice recordings taken from the mobile. There may be questions raised whether they are indeed of the persons that SEBI claims they were. And whether there would be a need under the law of expert voice analysis.

The transactions in the bank have been alleged to be for financing the trades, sharing illicit gains, etc. While there may be other corroborating evidences, the question in law would be whether other explanations may be plausible.

Also open to challenge are the reasons for mobile calls between the parties. Since, except for the recording found on the mobile itself, there are no details of what was discussed in the call, whether allegations that these show connections between parties would stand in law.

There are many other issues. Having said that, the Supreme Court (in Rakhi Trading ((2018) 143 CLA 15)) and Kishore R. Ajmera ((2016) 131 CLA 187) has created strong precedents to enable SEBI to apply lower benchmarks of proof in civil proceedings. However, if SEBI also initiates prosecution against these parties, the higher benchmark of proof may be applied, and hence the aforesaid issues may need stronger countering.

Finally, there is the issue of disgorgement of the illicit profits. These profits clearly correspond to the losses incurred by investors who fell prey to the scam. However, there are no explicit provisions in law to enable return of these profits to these investors.

CONCLUSION

While there is no solution to the greed amongst the public, which will regularly result in cases of cheating, it is also true that new technologies have made it even easier to reach a larger populace, anonymously and cheaply. Even right now, a simple search on telegram or even google, shows up multiple telegram channels, Twitter handles, etc. which claim to give ‘hot tips’ for stocks, futures and options. Close down one, and many more may crop up. However, SEBI’s making an example of a few may lead not only to a strong disincentive to others, but also awareness amongst the public. However, in practice, pursuing such cases could take longer and require evidence that stands up in law.

IBC & SC in Vidarbha Industries: NCLT May or Should Admit a Financial Creditor’s Application?

INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 (“the Code”) provides for the insolvency resolution process of corporate debtors. The Code gets triggered when a corporate debtor commits a default in payment of a debt, which could be financial or operational. The initiation (or starting) of the corporate insolvency resolution process under the Code, may be done by a financial creditor (in respect of default in respect of financial debt) or an operational creditor (in respect of default in respect of an operational debt) or by the corporate itself (in respect of any default).

An interesting question has arisen as to whether the National Company Law Tribunal (NCLT) is bound to admit a plea for a Corporate Insolvency Resolution Process (“CIRP”) filed by a financial creditor against a corporate debtor or does it have the discretion to refuse to admit it, if the debtor is otherwise financially healthy? The Supreme Court in the case of Vidarbha Industries Power Ltd vs. Axis Bank Ltd, [2022] 140 taxmann.com 252 (SC) has given a very interesting reply to this very crucial question. A subsequent review petition has upheld the earlier decision of the Apex Court. Now, once again in an appeal filed before the Supreme Court, this decision has been questioned. This shows the importance of this decision to matters under the Code. Let us examine the issue at hand.

FINANCIAL CREDITOR’S APPLICATION

To refresh, the following terms are important under the Code:

a)    A corporate debtor is a corporate person (company, LLP, etc.,) who owes a debt to any person. Here it is interesting to note that defined financial service providers are not covered by the purview of the Code. Thus, insolvency and bankruptcy of NBFCs, banks, insurance companies, mutual funds, etc., are not covered by this Code. However, if these financial service providers are creditors of any corporate debtor, they can seek recourse under the Code.

b)    A debt means a liability or an obligation in respect of a claim and could be a financial debt or an operational debt. Financial debt is defined as a debt along with an interest, if any, which is disbursed against the consideration for the time value of money. An operational debt is defined as a claim for the provision of goods or services or employment dues or Government dues.

c)    It is also relevant to note the meaning of the term default which is defined as non-payment of debt when the whole or any part has become due and payable and is not repaid by the debtor.

The process for a CIRP filed by a financial creditor is as follows:

(a)    Financial creditors can file an application before the NCLT once a default (for a financial debt) occurs for initiating a corporate insolvency resolution process against a corporate debtor.

(b)    The NCLT would decide within 14 days whether or not a default has occurred.

(c)    Section7 (5)(a) of the Code provides that -if the NCLT is satisfied that a default has occurred and the application filed by the financial creditor is complete, it may, by order, admit such an application.

SUPREME COURT’S VERDICT IN VIDARBHA

In the case of Vidarbha (supra), the corporate debtor was a power-generating company which due to a fund crunch defaulted in its dues to a bank. It had however, received an Order from the Appellate Tribunal for Electricity in its favour which when implemented would result in an inflow of Rs.1,730 crores and would take care of its liquidity position. The NCLT admitted the application of the bank and held that all that was required to check whether there was a default of debt and whether the application, was complete. This Order was upheld by the Appellate Tribunal (NCLAT). Both the forums held that they were not concerned with the abovementioned favourable order which the debtor had received.

A Two-Judge Bench of the Supreme Court observed that the objective of the Code was to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals, in a time-bound manner, inter alia, for maximization of the value of the assets of such persons, promoting entrepreneurship and availability of credit, balancing the interest of all the stakeholders and matters connected therewith or incidental thereto.

It held that both, the NCLT and the NCLAT proceeded on the premises that an application must necessarily be entertained under section7(5)(a) of the Code, if a debt existed and the corporate debtor was in default of payment of debt. In other words, the NCLT found section 7(5)(a) of the IBC to be mandatory.

Thus, the Supreme Court framed the question before it as whether section 7(5)(a) was a mandatory or a discretionary provision. In other words, could the expression ‘may’ be construed as ‘shall’?

It proceeded to answer the question by holding that there was no doubt that a corporate debtor who was in the red should be resolved expeditiously, following the timelines in the IBC. No extraneous matter should come in the way. However, the viability and overall financial health of the Corporate Debtor were not extraneous matters. When the corporate debtor had an Award of Rs. 1,730 crores in its favour, such a factor could not be ignored by the NCLT in considering its financial health. It laid down a principle that the existence of a financial debt and default in payment thereof only gave the financial creditor the right to apply for initiation of CIRP. The Adjudicating Authority (NCLT) was required to apply its mind to relevant factors and the overall financial health and viability of the Corporate Debtor under its existing management.

It strongly relied upon the fact that the Legislature had, in its wisdom, chosen to use the expression “may” in section 7(5)(a) of the IBC and had it been the legislative intent that section 7(5)(a) of the IBC should be a mandatory provision, the Legislature would have used the word ‘shall’ and not the word ‘may’.

It compared the position of a financial creditor with that of an operational creditor. Section 8 of the Code provided for the initiation of a resolution by an operational creditor. There were noticeable differences between the procedure by which a financial creditor could initiate resolution and the procedure by which an operational creditor could do so. The operational creditor, on occurrence of a default, was required to serve on the corporate debtor, a demand notice of the unpaid operational debt. If payment is not received within 10 days of this Notice, the operational creditor could file a petition before the NCLT. The Supreme Court observed the wordings of s.9(5)(i) of the Code in this respect

“9(5) The Adjudicating Authority shall, within fourteen days of the receipt of the application under sub-section (2), by an order

(i) admit the application……………..”

The Court concluded that the Legislature had used the word ‘may’ in section 7(5)(a) of the Code in respect of an application initiated by a financial creditor against a corporate debtor but had used the expression ‘shall’ in an otherwise almost identical provision of section 9(5) relating to the initiation of insolvency by an operational creditor. The Court gave an explanation on when the word “may” could be construed as “shall” and when it remained “may”.

The Legislature intended section 9(5)(a) to be mandatory but section 7(5)(a) to be discretionary. The rationale for this dichotomy was explained and it held that the law consciously differentiated between financial creditors and operational creditors, as there was an innate difference between financial creditors, in the business of investment and financing, and operational creditors in the business of supply of goods and services. Financial credit was usually secured and of much longer duration. Such credits, which were often long-term credits, on which the operation of the corporate debtor depends, could not be equated to operational debts which were usually unsecured, of shorter duration and of a lesser amount.

The financial strength and nature of business of a financial creditor were not comparable with that of an operational creditor, engaged in the supply of goods and services. The impact of the non-payment of admitted dues could be far more serious on an operational creditor than on a financial creditor.

In the case of financial debt, there was flexibility. The NCLT was conferred the discretion to admit the application of the financial creditor. If facts and circumstances so warranted, it could keep the admission in abeyance or even reject the application. A very telling statement was that it was certainly not the object of the Code to penalise solvent companies, temporarily defaulting in repayment of their financial debts, by the initiation of insolvency.

It however, concluded that the discretionary power of the NCLT could not be exercised arbitrarily or capriciously.

REVIEW PETITION

A review petition was filed before the Supreme Court in the case of Axis Bank Ltd vs. Vidarbha Industries Power Ltd, Review Petition (Civil) No. 1043 of 2022. It was contended that the above judgment was rendered per incuriam since it ignored an earlier Two-Judge Decision in E. S. Krishnamurthy vs. Bharath Hi-Tech Builders Pvt Ltd (2022) 3 SCC 161. In that case, the Court had held that NCLT must either admit or reject an application. These were the only two courses of action which were open to the NCLT in accordance with s. 7(5).

The NCLT could not compel a party to the proceedings before it to settle a dispute. Thus, it was contended that the NCLT had no discretionary power. The Supreme Court rejected the Review Application by holding that the question of whether section7(5)(a) was mandatory or discretionary was not an issue in the above judgment. The only issue was whether the NCLT could foist a settlement on unwilling parties. That issue was answered in the negative.

In the Review Application, the Solicitor General also contended that Vidarbha’s decision could be interpreted in a manner that might be contrary to the aims and objects of the Code and could render the law infructuous. The Apex Court held that such an apprehension appeared to be misconceived. Hence, the review petition was dismissed.

FOLLOWED BY NCLAT

Subsequently, Vidarbha’s decision was followed by the NCLAT in Jag Mohan Daga vs Bimal Kanti Chowdhary, CA (AT) (Insolvency) No. 848 of 2022. The NCLAT held that the dispute was a family dispute which was given the colour of a financial creditor’s dues.

The NCLAT set aside the admission of the plea by the NCLT on the grounds that the Supreme Court in Vidarbha has clearly laid down that it was not mandatory that s. 7 applications were to be admitted merely on proof of debt and default. Petitions should not be allowed to continue when the financial creditor proceeded under the Code not for the purposes of resolution of insolvency of the corporate debtor but for other purposes with some other agenda. The NCLAT held that the NCLT should not permit such an insolvency petition to go on which had been initiated to settle an internal family business dispute.

APPEAL AGAINST NCLAT / VIDARBHA AGAIN QUESTIONED

An appeal was filed before the Supreme Court (Maganlal Daga HUF vs. Jag Mohan Daga, CA 38798/2022) against the above-mentioned NCLAT decision. The matter was heard by a Three-Judge Bench and it noted that the NCLAT relied on Vidarbha’s decision against which the review petition was rejected. Once again the Petitioners contended that Vidarbha’s decision ran contrary to the settled position of law. The Solicitor General again pleaded that the principle which was enunciated in Vidarbha was liable to dilute the substratum of the Code. This appeal is still pending.

MCA’S DISCUSSION PAPER

Realising the gravity of the decision in Vidarbha’s case, the Ministry of Corporate Affairs (MCA) issued a Discussion Paper on 18th January, 2023 highlighting the proposed changes to the Code. One of the key changes is a proposed amendment to s. 7(5)(a) making it mandatory to admit the application if other conditions are met. Thus, the disparity between section 7(5) and section 9(5) is sought to be removed.

The MCA has stated that Vidarbha’s decision has created confusion and hence, to alleviate any doubts, it was proposed that section 7 may be amended to clarify that while considering an application for initiation of the insolvency process by the financial creditors, the NCLT was only required to be satisfied about the occurrence of a default and fulfilment of procedural requirements for this specific purpose (and nothing more). Where a default was established, it would be mandatory for the NCLT to admit the application and initiate the insolvency process.

CRITIQUE

It is submitted that the Supreme Court’s analysis in Vidarbha’s case is spot on and cannot be faulted. The objective of the Code must be to create and enhance value for all stakeholders and not merely send an otherwise sound company to the gallows. A discretionary power to the NCLT would empower it to provide for other remedial measures in case of a default on a debt. Rather than making the powers mandatory under section7(5)(a), the MCA could provide for alternative remedies which the NCLT can suggest in case of a default. It is true that several unscrupulous promoters have hoodwinked the financial system under the earlier laws, but it is also true that an overzealous law may in fact harm otherwise good companies.

If the MCA proposals are implemented then this discretionary power would be taken away from the NCLT. Also, the outcome of the Supreme Court appeal would be interesting. It could impact several NCLT cases, including the recent insolvency plea of IndusInd Bank against Zee Entertainment Ltd.

In conclusion, the words of the Supreme Court sum up the situation aptly ~ “It is certainly not the object of the IBC to penalize solvent companies, temporarily defaulting in repayment of its financial debts, by initiation of CIRP.”

Sectoral Analysis: Banking Sector

INTRODUCTION

 

The banking sector is the backbone of an economy. It not only acts as the guardian of monetary wealth but also aids in the economic growth of the nation by lending to various sectors of the economy. The sector is consumer-centric and therefore, a bank must be present where its consumer is. Therefore, a bank is required to have a branch in multiple locations across the country and at times, even outside India. This necessarily means that a bank must have sufficient human resources, apart from its’ technical resources which can serve its customer.

Considering the economic importance of the banking sector, it has always been regulated across the globe. In India, the banking sector is regulated by the Reserve Bank of India. The RBI has prescribed various norms for banks to follow, such as capital adequacy norms, assets classification, etc. A bank is required to hold a certain class of investments and therefore, there are frequent transactions of purchase / sale of securities. The complex network within which the sector operates results in peculiar issues from the GST perspective. In this article, we have attempted to analyse the various issues which plague the sector.

 

TAXABILITY OF REVENUE STREAMS

Interest Income

 

A bank carries out a range of activities for its clients and therefore, has different streams of revenue. Its core revenue is interest earned from lending activities, which has been exempted by entry 27 of notification 12/2017-CT (Rate). However, interest earned on credit cards is liable for payment of GST.

Processing charges

The next core revenue earned by the bank is processing charges levied when a customer applies for a loan or credit facility, or on an ongoing basis to service the loan. The said services are taxable. However, along with the processing charges, the bank also recovers a host of expenses from the account holder which it incurs while processing the application for loan/credit facility. For instance, in case of a loan against property or a loan for property, banks obtain a title search report to verify the ownership and title of the property. This service is generally obtained through an “on panel” advocate who provides the service, though the charges are recovered from the customer at actuals. The question that arises is whether such recovery is includible in the “value of service” provided or it qualifies as reimbursement on a “pure-agent basis”?Section 15(2)(c) of the CGST Act, 2017 which deals with inclusions in the value of supply provides that the value of supply shall include incidental expenses, including commission and packing, charged by the supplier to the recipient of a supply and any amount charged for anything done by the supplier in respect of the supply of goods or services or both at the time of, or before delivery of goods or supply of services. Therefore, while determining whether the reimbursement of expense needs to be included in the value of supply, it needs to be seen as to whether such expenses are charged by the bank to the customer or the advocate directly raises the invoice to the customer and the bank is only the medium through which the processing of payment takes place?

While one may be tempted to claim the benefit of pure agent under rule 33 of the CGST Rules, 2017, in most cases, the third parties are appointed by the bank, and as such, it may be difficult to demonstrate compliance with all the conditions of a pure agent. Further, the need for such third-party services is essentially necessitated by the banks, and as such the services can be said to be used by the banks. Therefore, it would be prudent to treat such reimbursement of expenses as part of the value of the services rendered by the bank and discharge GST accordingly.

Other charges recovered

Once a loan/credit facility is sanctioned, the bank starts receiving the revenue in the form of interest which is recovered from the client as per agreed terms. As discussed earlier, interest from lending activity is exempted from the purview of GST. However, at times, there are instances where the client defaults in making payment of the instalment, or the cheque given by the client towards payment of the instalment is not honored, etc. This also applies in the context of default in credit card payments. There are also instances where a client approaches the bank for repayment of loan/credit facility before its term, i.e., pre-closure which the bank permits on payment of charges termed in the industry as foreclosure charges. Banks also levy charges on pre-mature withdrawal of fixed deposits. The question revolves around taxability of such charges. We shall analyse the same as under:

a) Additional interest on delayed instalment/cheque bounce: When a customer delays payment of his loan instalment, banks levy additional/penal interest for such delay along with charges for cheque dishonour/ECS mandate rejection. The question that remains is whether such interest/charges are liable to GST or will they be covered under the exemption notification? So far as the additional/penal interest is concerned, it is apparent that the same is directly linked with the service of extending deposits, loans or advances and therefore, should be eligible for the benefit of exemption. This has also been clarified by the Board vide Circular 102/21/2019-GST.

Similarly, for cheque dishonor/ECS mandate rejection charges as well, the loan agreement itself provides that in the event of cheque dishonor/ECS mandate rejection, the bank shall levy charges on the customer. Such charges are also levied while providing the service of extending deposits, loans, or advances and therefore, should be eligible for the benefit of exemption. In fact, the Board has vide Circular 178/10/2022-GST clarified that such charges recovered are not a consideration for any service as they are like a fine or penalty imposed for penalizing/deterring/discouraging such an act or situation in the future.

b) Loan foreclosure charges: The Larger Bench of the Tribunal had in the case of Repco Home Finance Ltd. [2020 (42) GSTL 104 (Tri-LB)] had an opportunity to examine the taxability of such charges in the context of taxability under service tax. In this case, the Tribunal had held that the foreclosure charges are compensation for loss of future interest and therefore, cannot be considered as consideration for the performance of lending services, but imposed as a condition of the contract to compensate for the loss of “expectations interest” when the loan agreement is terminated prematurely. Therefore, foreclosure charges are nothing but damages that the banks are entitled to receive when the contract is broken. The Board has also examined the taxability of such charges in the context of GST and vide Circular 178/10/2022-GST clarified that such charges are not taxable. Therefore, a view can be taken that such charges are not taxable.

c) Fixed deposit foreclosure charges: A person deposits money in a fixed deposit account with a bank for a defined tenure. This is a commitment by the person that he shall not withdraw the money during the defined tenure. For the same, the bank offers a higher rate of interest as compared to the interest paid on the savings account. If a customer opts to close the fixed deposit before the expiry of the said term, the bank levies foreclosure charges, which are levied on the interest of the FD amount, i.e., the same will be deducted from the interest accrued/paid on account of the customer. In other words, the charges are more in the nature of a reduction in the interest paid to the customer, which is the cost for the bank. Therefore, the question of such foreclosure charge being a consideration for supply does not arise.

d) Interest on credit card charges: However, when a credit card customer defaults on making payment of a credit card bill and the bank levies penal interest/charges, the same will not be eligible for the exemption as the notification specifically excludes credit card interest. Therefore, such recoveries are liable to GST.

AUCTION ACTIVITY

In case of default in repayment of loans, the banks take possession of the mortgaged assets and auction the same to recover the outstanding amounts. Section 2(5) of the CGST Act, 2017 defines an agent to include an auctioneer and as such, the bank would be liable for payment of GST on behalf of the defaulting borrower by determining the applicable rate on the underlying product in case the auctioned asset is a moveable property.When banks undertake auctions, as a practice, the goods are auctioned on a “as is, where is” basis, i.e., the successful bidder is required to take the delivery of the goods from the location where the goods are warehoused. This concept of delivery on a ‘as is, where is’ basis presents certain challenges in view of the dual GST framework.

It is possible that the goods may be located in a State where the bank does not have an existing registration. In such a situation, the Department may argue that the supply is originating from the said State and therefore the bank should obtain a registration (maybe as a casual taxpayer) to discharge the GST Liability while the bank may plead that it is already registered in some other state and would discharge the GST liability from the said State. A similar issue in the context of an importer was presented before the Advance Ruling Authorities in the case of Gandhar Oil Refinery India Ltd 2019 (26) GSTL 531 (AAR), wherein the Authority has opined that the importer storing goods in a warehouse in Tamil Nadu need not register in Tamil Nadu and can discharge the GST liability from its existing registration in Maharashtra.

Another situation could be one where an Indian bank branch is auctioning goods located outside India. In view of Entry 7 of Schedule III, such an auction may not attract any GST.

A third situation could be that the goods being auctioned are located/stored in an SEZ Area. Since the goods are generally imported into a warehouse by filing a BOE for warehousing, they will qualify as warehoused goods and therefore, banks can take shelter under entry 8(a) of Schedule III of the CGST Act, 2017. However, the buyer will have to pay the applicable customs duty when after taking delivery; he is clearing the goods for home consumption.

In case the successful bidder is located outside India and intends to take the goods out of India after participating in an auction of goods located in India, in view of the terms of the auction contract, the delivery of goods vis-à-vis the bank terminates in the territory of India. The bank itself does not carry out the process of export and even on the shipping bill; the exporter details would not mention the IEC of the bank. In such a situation, the supply through the auction process may not qualify as export for the bank and GST would be payable.

 

ASSET RECONSTRUCTION ACTIVITY

 

One of the main challenges faced by banks is Non-Performing Assets (NPAs), i.e., cases where banks have advanced loans to their clients who have defaulted in repayment of these loans. In such cases, under the RBI framework, the banks transfer such non-performing debts to the Asset Reconstruction Companies at a mutually agreed value. For instance, a bank has an NPA of Rs. 100 crores. Post evaluation, it receives an offer from an ARC to purchase the NPA for Rs. 75 crores. In this scenario, the bank sells its’ NPA of Rs. 100 crores for Rs. 75 crores, i.e., at a loss of Rs. 25 crores and thus clearing its’ asset book of such NPA. On the other hand, the ARC starts the process of realizing the debt, and any excess amount recovered by them is treated as its’ profits.

A two-fold issue arises in the above transaction, namely:

1. Is the bank liable to pay GST on the sale of stressed assets to the ARC? 

Entry 6 of Schedule III specifies that actionable claims would be considered as neither supply of goods nor supply of services. The term ‘actionable claims’ is defined under section 3 of the Transfer of Property Act, 1882 as under:

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent

As can be seen from the definition above, an actionable claim includes a debt that is not secured. In most of the cases, the debt is a secured debt and therefore a doubt arises whether such a sale of stressed assets can be considered as actionable claims and excluded from the purview of GST. It may be important to note that the term ‘actionable claim’ also includes a beneficial interest in the moveable property not in possession of the claimant. A mortgage in goods creates such a beneficial interest in the moveable property and at the time of sale of stressed assets, the said assets are not in possession of the bank therefore, it can be argued that the second limb of the definition of ‘actionable claim’ can cover such stressed assets and accordingly, the transaction should not be liable for GST

Even the FAQ issued by CBIC clarifies that where sale, transfer or assignment of debts falls within the purview of actionable claims, the same would not be subject to GST.

2. Is the ARC liable to pay GST on the profits earned by it?

The ARC, upon assignment of debt by the bank, would undertake efforts to recover the outstanding from the defaulting borrowers. Any amount realized directly from the borrowers would not be liable to GST as the same is a mere transaction in money. If the ARC ends up realizing a higher amount as compared to the consideration paid to the ARC for the acquisition of the stressed assets, no GST would be payable on the differential amount as the same is profit from its’ business activity and not a consideration for a supply.

However, if amounts are not directly recovered by the ARC, they will also have to take additional steps, such as taking possession of the assets (moveable/immovable), invoking guarantees, etc., against which the loan was given by the bank. If the moveable assets, possession of which is taken by the ARC are sold, the ARC would be liable to pay GST on the same as it would amount to supply of goods. However, in case of immovable assets, the liability to pay GST would not arise as the same do not constitute goods / services.

 

CHARGES FOR CROSS-BORDER TRANSACTIONS

 

Banks are the medium for cross-border monetary transactions and all payments to/from outside India need to be routed through banks. For facilitating such transactions, banks levy charges from their customers on which GST is levied.

However, in the case of inbound remittances, the originating banks/intermediate banks also levy charges which are deducted from the gross payments made, i.e., the ultimate recipient receives less money to that extent. For example, ABC, an exporter has raised an invoice of USD 100 to their customer in the US. The customer remits the amount through their bank in the US which levied USD 1 as bank charges and remits only USD 99 to ABCs’ account. The issue that remains is w.r.t liability of payment of GST on the same. Is the bank liable to pay GST under reverse charge and then charge to the customer or is it the customer himself who is liable to pay GST under reverse charge? This issue was examined by the Larger Bench of Tribunal in the case of Tata Steel Ltd [2016 (41) STR 689 (Tri-Mum)] wherein it was held that the liability to pay GST was on the recipient, i.e., ABC in this case under reverse charge mechanism.

 

CUSTOMER LOYALTY PROGRAMS

 

Banks generally undertake customer loyalty programs under two different models, which can be briefly explained as under:

a) The points can be redeemed at any approved store for the purchase of goods/services. The customer utilizes the accumulated points towards making payment for the said purchase. The store will recover the amount from the loyalty partner who will further raise the invoice to the bank with the applicable tax.

b) The bank, either directly or through their loyalty partner, gives the customer option of goods/services against which the accumulated points can be encashed. The loyalty partner will raise the invoice to the bank and arrange to deliver the goods/service to the customer.

c) In many cases, banks provide their customer access to lounge at airports. In this case, the service providers charge bank based on use of service by customer and charge GST for the same.

In each of the above cases, the question that arises is whether the bank will be entitled to claim the input tax credit. To determine the answer to the said question, the bank needs to first qualify as a “recipient”. Section 2(93)(a) defines the term recipient to mean the person who is liable to pay the consideration. This is not disputable in the current case and therefore, a view can be taken that the bank qualifies as a recipient. This takes us to other conditions prescribed under section 16 for claiming credit, and more specifically the condition relating to the receipt of goods/services (satisfaction of other conditions though relevant, are not analysed here). This is a classic example where the supply is being made under the Bill To / Ship To concept for which, it has been clarified vide explanation that in such scenarios, it shall be deemed that the recipient has received the goods/services.

This takes us to the next question of whether the input tax credit would be hit by provisions of section 17 (5) (h), i.e., goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples. A conservative view would be that the supplies received are given as a gift to the customer and therefore, are not eligible for an input tax credit. However, a more aggressive view that can be taken is that the supplies are not given free of cost to the customer. The points accrue to the customer on account of various transactions done by him with the bank (through which the bank receives bank charges). In other words, the bank charges levied by the bank factor the cost incurred towards the promotion activity. This is because the basis for the accrual of points is generally a part of the bank–customer agreement. A gift is generally meant to be something given out of ex-gratia. On the contrary, the rewards are arising out of a contractual obligation and therefore, it would be incorrect to treat them as a gift to deny input tax credit.

 
SAFE DEPOSIT LOCKERS

 

Banks also provide the service of safe deposit lockers to their customers for storing their valuables. Generally, the services are provided on payment of annual rent. However, banks also insist that the customer make a fixed deposit at the time of allotting the locker which will not be withdrawn during the period locker services are availed by the customer. Such services attract GST @ 18 per cent and may give rise to the following issues:

a) Determination of place of supply: Whether the place of supply will be determined under the property-based rule, i.e., section 12(3), i.e., services directly in relation to an immovable property or under the specific rule for banking sector, i.e., section 12(12)? While the applicability of section 12(3) itself is debatable as the services are storage services provided by the bank and not directly in relation to immovable property, the more plausible argument for section 12(12) would be that it is a specific provision and therefore, the same shall prevail over section 12 (3).

b) Valuation issue: It is possible that where the banks insist for a hefty/long term deposit, the officers may argue that the notional interest on the same is includible in the value of supply of the bank. However, such an interpretation is defendable as the deposit itself is interest-bearing, i.e., banks pay interest on such deposits at the same rate at which other customers, i.e., customers not operating a safe deposit locker with the bank are paid. Therefore, it can be argued that both transactions are unlinked and should be analysed independently.

 

FREE SUPPLIES AGAINST HUGE DEPOSITS / SATISFACTION OF CONDITIONS

 

In many cases, banks offer free services to their customers provided they invest a particular amount with the banks as a FD. For instance, various charges, such as NEFT/RTGS, chequebook issuance, etc., are waived for customers maintaining a minimum balance with the bank.

Similarly, for credit card customers, the annual charges for a particular year are refunded/for the next year are waived upon customer spending crossing the specific threshold limit.

The question that arises in the above scenarios is whether the bank has agreed to supply service to the customer where the price is not the sole consideration in which case the bank shall need to value the supply as per the valuation rules. In this case, one may refer to the decision of the Hon’ble SC in the case of Metal Box India Ltd [1995 (75) ELT 449 (SC)] wherein it has been held that when a lower price was charged to the customer on account of the huge deposit made by him, notional interest was includible in the assessable value. However, later on, in VST Industries Ltd [1998 (97) ELT 395 SC], the Court distinguished the above decision and held that where the deposit has no influence on the price charged from the customer, the notional interest is includible in the value of supply. The above principles would squarely apply in the context of GST as well since the Department is likely to argue that price is not the sole consideration and therefore, transaction value cannot be accepted. Infact, the AAR under GST has in the case of Rajkot Nagrik Sahakari Bank Ltd [2019 (28) GSTL 536 AAR] already held that the monetary value of the act of providing refundable interest-free deposit is the consideration for the services provided by the bank and therefore the same shall be treated as supply and chargeable to tax in the hands of the applicant.

To overcome the above, can the bank claim that the waiver granted is a pre-supply discount and therefore, eligible for deduction from the value of supply under section 15(3)? This would be a situation where the bank raises an invoice to the customer and on the invoice itself, discloses the waiver as a discount / subsequently raises a Credit Note claiming it as a pre-supply discount? This may not be a feasible solution as there cannot be an agreement for providing free service and the absence of consideration would render the contract void.

However, in the credit card example, the claim of pre-supply discount may sail through as the bank wants to encourage the customer to spend through credit cards, which gives a higher revenue to the bank in the form of charges from merchants and therefore, a view can be taken that the bank receives consideration from the third party for services rendered to the customer. Therefore, the waiver granted is a subsequent reduction in the value of supply in view of a pre-supply agreement with the customer.

 

GUARANTEE TRANSACTIONS

 

Banks also act as a guarantor to the transaction between two different parties. For instance, A (supplier) and B (recipient) intend to enter into a contract for supply of goods/services. However, B insists that A furnish a bank guarantee before the supply commences. Therefore, A approaches his bank and requests them to furnish a guarantee to B on behalf of A. For issuing the said guarantee, the bank levies a charge from A on which GST is applicable.

The above is a simple model of guarantee. There can also be instances where a customer approaches the bank to issue a guarantee in respect of transactions between different persons. For instance, A is a company incorporated in India. Its’ UK subsidiary, B intends to supply services to another UK-based company, C. For the transaction between B & C, C insists that A’s bank issues a guarantee to C since being a parent company, it has sufficient assets to provide such a guarantee. The question that arises is who is the recipient of the supply, A or B? A perusal of the definition of recipient would indicate that it is A who is the recipient by virtue of being liable to pay to the supplier of service, i.e., bank. Therefore, the Bank will be required to discharge GST on the same. Further, this may necessitate A to consider the transaction as a further supply by A to B (in the nature of a deemed supply) and raise an invoice to B. Similarly, in case of a reverse transaction, i.e., where A is outside India and provides guarantee for B, an Indian entity, the liability to pay tax under reverse charge would get triggered with corresponding valuation issues.

So far as government providing guarantees for its undertakings / PSUs is concerned, notification 11/2017 – CT(Rate) dated 28th June, 2017 exempts such services w.e.f. 27th July, 2018. However, for the prior period, the levy of GST is an open issue as the undertakings /PSUs would be liable to pay GST under reverse charge unless one is able to substantiate that such transactions are essentially sovereign functions.

 

SERVICE BY BUSINESS FACILITATOR / CORRESPONDENTS

 

Notification 12/2017-CT(Rate) dated 28th June, 2017 provides an exemption to services provided in the capacity of business facilitator/correspondent to a banking company with respect to accounts held in rural area branch and any person acting as an intermediary to a business facilitator / correspondent referred above.

 

DEEMED SUPPLY: INTERPLAY OF ENTRY 2 OF SCHEDULE I

 

As discussed earlier, a bank needs to have a multi-locational presence to cater to the various needs of its clients. This is not only in the form of branches, but also ATMs where the bank charges for use beyond the set limit. There can always be instances where the customer linked with a particular state uses the services of branch linked in a different state. In these cases, while the revenue lies in the home state, the expense for the execution of services is incurred by the executing state. The question that arises is whether the executing state has supplied any service to the home state in view of entry 2 of Schedule I of the CGST Act, 2017? In an earlier article (July 2019 BCAJ), the interpretation of Entry 2 of Schedule I has been elaborately discussed. The said principles will apply to the banking sector as well.

 

FOREIGN BRANCH – DOMESTIC BRANCH

 

A bank may also have branches in foreign countries. Indian citizens / Person of India origin may operate NRI/NRE accounts with the said branches. The foreign branches also provide services to domestic customers. For instance, a domestic customer travelling abroad avails the ATM facility installed in the foreign branch. Extending the above argument, such services shall be treated as import of services, and are liable for GST under Reverse Charge Mechanism.

If the transaction was reverse, i.e., customer of foreign branch availing the same service at Indian ATM, it would be a case of Indian branch providing service to foreign branch. In view of Section 2(v)(e) of the IGST Act, 2017, which provides that a service shall not be treated as export of service where the service provider and service recipient are distinct establishment of same person, export benefit cannot be claimed and there would be a GST liability on such a transaction. This aspect has also been clarified in the banking sector FAQs issued by the Board. However, notification 15/2018-IT (Rate) dated 26th July, 2018 exempts services supplied by an establishment of a person in India to any establishment of that person outside India, which are treated as establishments of distinct persons in accordance with Explanation 1 in section 8 of the Integrated Goods and Services Tax Act, 2017 provided the place of supply of the service is outside India in accordance with section 13 of Integrated Goods and Services Tax Act, 2017.

 

CROSS CHARGE VS. ISD

 

Similar issue would also arise in case of expenses incurred by the Head Office, such as administrative expense, advertising/marketing costs, etc. Logically, the expenses are incurred by the HO and the receipt of services is also by them, though the benefit is enjoyed across the board by the company. The question that remains to be considered is whether such expenses incurred would also require cross-charges or the ITC claimed needs to be distributed under the ISD mechanism? It may be noted that there is already a controversy on the issue of ISD vs. cross-charge on which the Board had shared a draft circular and then withdrawn it. In fact, in certain Commissionerates, taxpayers have received show cause notices denying ITC on cross-charge invoices alleging non-receipt of service, despite the tax being paid by the same legal person. Therefore, the issue is far from resolved and it remains to be seen as to how the Board and ultimately the Courts deal with the same.

 

RELATED PARTY TRANSACTIONS

 

In many situations, the bank is a part of a group transacting businesses in various financial services. Through its subsidiaries/group companies, the group engages in a host of other businesses, such as insurance, share broking, mutual funds, merchant banking, etc. While each of these businesses operates through separate legal entities, on a practical front, some facilities/services are used in common:

a)    Use of common trade name /logo / stationery

b)    Employees of the various entities operate out of the bank branch for easy access to the customers, thus using common premises.

c)    Bank employees promoting the products of the group entities and vice – versa

d)    Certain services received commonly for the group (for instance, insurance policy for all employees is under the cover of a single policy)

e)    Common management overview over the operations of each entity and IT infrastructure

Apparently, there is an activity done by the bank for its’ subsidiary / vice-versa. In view of valuation provisions, it becomes necessary that each transaction be valued and applicable GST be discharged. Further, since the entities have an element of exempt supply, proviso to Rule 28 which provides that the transaction value shall be accepted in cases where full input tax credit is available may not be available and therefore, the banks will have to determine the value of such supplies at arms-length.

 

LOCATION OF SUPPLIER, RECIPIENT AND THE PLACE OF SUPPLY – THE NEVER-ENDING CONUNDRUM 

 

As mentioned above, a bank is required to have multiple branches across the country, and at times, even outside India. A customer of the bank can obtain the services from any of its branches, which at times may not be in the same state. For instance, A holds an account with the Ahmedabad branch of PQR Bank Ltd. However, during his travel to Maharashtra, he approaches its Worli branch and carries out various transactions, such as generation of Demand Draft-based on balance in his account, offline NEFT/RTGS transfers, cash withdrawals, etc. The Worli branch provides the necessary service to Mr. A.

The above simple transaction gives rise to following GST implications:

a. Who is the supplier of services? PQR Maharashtra or PQR Gujarat?

b. What shall be the place of supply?

c. What shall be the consequences of incorrect LOS/ POS?

d. How shall PQR comply with entry 2 of Schedule I?

 

DETERMINING SUPPLIER OF SERVICE

 

The primary question that arises is who is the supplier of service for each type of service? Section 2(15) of the IGST Act, 2017 defines the location of supplier of service as under:

“location of the supplier of services” means, –

(a) where a supply is made from a place of business for which the registration has been obtained, the location of such place of business;

(b) where a supply is made from a place other than the place of business for which registration has been obtained (a fixed establishment elsewhere), the location of such fixed establishment;

(c) where a supply is made from more than one establishment, whether the place of business or fixed establishment, the location of the establishment most directly concerned with the provision of the supply; and

(d) in absence of such places, the location of the usual place of residence of the supplier;

In the instant case, the supply is made contractually from Ahmedabad since the valid contract is executed at the time of opening of the account. However, the supply is made physically from Mumbai since the actual performance of activity is in Mumbai. In such a case, it can be argued that the Ahmedabad establishment is the most directly concerned with the provision of the service and the tax will be discharged under the Gujarat registration. However, in cases where the nature of service rendered is not interlinked with the operation of accounts, the location of the supplier can be considered as Mumbai.

 

DETERMINING PLACE OF SUPPLY

 

This takes to the next question of place of supply. Section 12 & 13 contains specific provisions for determining the place of supply in relation to services provided by banks. The same provides that the determination of place of supply depends on the location of recipient/supplier of services.

On perusal of the same, it appears that the definitions indicate that whether a recipient is registered or not, the intention is to attribute the place of supply to the location of the recipient. However, services being intangible in nature, it is generally not possible to pin-point the location where the services are actually received, especially in cases like banking services. To overcome such a situation, clause (d) provides that the location of the usual place of residence of the recipient shall be treated as “location of recipient of services.” Therefore, in the context of above example where services provided are linked to the account of Mr. A, his location is available to the bank in its records and therefore, the place of supply will be Ahmedabad, Gujarat irrespective of where the services are availed.

Complications might arise in cases where there are multiple addresses available on record of the bank. There can always be instances where an account holder provides two different set of addresses, one being permanent address and second being correspondence address. The issue that arises is which of the two shall determine the place of supply, especially when both the addresses are in different states? Can a view be taken that the correspondence address is more relevant towards determining the place of supply as it is likely that the customer is residing at such location? This remains an issue for the sector as it is very common that customers change their place of residence temporarily without any change in permanent address.

 

WRONG / INCORRECT LOS/POS

 

The next issue which the bank faces is the consequences of wrong location of the supplier / place of supply tagging for the customer. For instance, what would be the consequences if in the above scenario the bank considers the Worli branch as the location of supplier instead of Ahmedabad? The answer in most likelihood would be a likely recovery of tax on the same amount by the Gujarat Officer even though the bank would have discharged IGST from the Maharashtra declaring Gujarat as the place of supply, i.e., the tax would have ultimately flown to the coffers of Gujarat Government only under the settlement mechanism. In this scenario, it is also possible that the bank might not be in a position to even claim refund of tax paid in Ahmedabad in view of time-barring.

Similarly, if in the above scenario, the invoice was correctly raised from the Ahmedabad branch but since the services were “consumed” in Mumbai branch, the bank ended up determining the place of supply as Maharashtra and therefore, paid IGST on the supply. In such an instance also, the bank would end up with a demand notice for recovery of GST as per correct place of supply, i.e., CGST + SGST. Of course, the only saving grace would be the fact that it would be able to claim refund of the IGST paid (Section 21 of IGST Act, 2017 r.w. Section 77 of the CGST Act, 2017) This was so held by the Telangana High Court in Ola Fleet Technologies Pvt Ltd [(2023) 2 Centax 69 (Telangana)].

 

INPUT TAX CREDIT
Exempt income – restrictions on claiming of input tax credit
A seamless flow of the input tax credit is essential for a successful implementation of a value added tax like GST. However, this flow of input tax credit is hampered when the inward supplies received are used for making both, taxable as well as exempt supplies. As discussed earlier, the core revenue of a bank, i.e., interest from lending activity is exempted under notification 12/2017 CT (Rate) dated 28th June, 2017. To add to this, banks generally have substantial securities transaction, which though not leviable to GST (as securities are neither goods nor services for the purpose of GST), the value of transactions in such securities is includible in the value of exempt supply, thus triggering the need for reversal of proportionate input tax credit.For the same, the bank has two options, one is to follow the rigours of reversal of credits under section 17(3) r.w. Rule 42/ 43 of the CGST Rules, 2017. However, under this option, even the ITC accruing on account of cross-charge will be available on a proportionate basis. The second option available to the bank is to avail only 50 per cent input tax credit monthly. However, under this option, it has been clarified that the ITC on a cross-charge invoice shall be allowed in entirety. The bank has to choose which option it intends to exercise at the start of the financial year and once exercised, it cannot change its stance. 

 

PROCEDURAL ASPECTS

 

1.    Banks have been exempted from complying with the provisions relating to e-invoicing and dynamic QR Code.2.    Normal taxpayers must raise the invoice within 30 days of completion of service while banks can raise the invoice within 45 days of completion of service. Therefore, the banks have an option to raise a single invoice for all charges levied during the month on a customer, instead of raising an invoice for each transaction.

3.    Services provided by recovery agents to banking company are covered under reverse charge under notification 13/2017-CT(Rate) dated 28th June, 2017.

 

CONCLUSION

 

The BFSI sector is a very vast sector and has a substantial impact on the overall economy. While in this article, we have predominantly dealt with the banking sector, we shall deal with financial services and insurance sector in the subsequent article.

Qualifications Regarding Constraints and Limitations Highlighted By the Forensic Auditor Appointed Due To Resignation of Independent Directors

PTC INDIA FINANCIAL SERVICES LTD (31ST MARCH, 2022) (REPORT DATED 16TH NOVEMBER, 2022 FROM AUDITORS’ REPORT

Qualified Opinion

We have audited the standalone financial statements of PTC India Financial Services Ltd (“the Company”), which comprise the Balance Sheet as on 31st March, 2022, and the Statement of Profit and Loss, Statement of Changes in Equity and Statement of Cash Flows for the year then ended, and notes to the standalone financial statements, including a summary of significant accounting policies and other explanatory information.

In our opinion and to the best of our information and according to the explanations given to us, except for the possible effect of the matters described in the Basis for Qualified Opinion section of our report, the aforesaid standalone financial statements give the information required by the Companies Act, 2013 (“the Act”) in the manner so required and give a true and fair view in conformity with the Indian Accounting Standards prescribed under section 133 of the Act read with Companies (Indian Accounting Standards) Rules, 2015 as amended and other accounting principles generally accepted in India, of the state of affairs of the Company as at 31st March, 2022, and its total comprehensive income (comprising of profits and other comprehensive income), changes in equity and its cash flows for the year ended on that date.

Basis for Qualified Opinion

On 19th January, 2022, three independent directors of the Company resigned mentioning lapses in governance and compliance. The Company, on the basis of directions of the audit committee in its meeting held on 26th April, 2022, appointed an independent firm (the “Forensic auditor”), vide engagement letter dated 18th July, 2022, to undertake a forensic audit in relation to the allegations raised by ex-independent directors.

On 4th November, 2022 the forensic auditor submitted its final report to the Company which included, in addition to other observations, instances of modification of critical sanction terms post sanction approval from the Board, non-compliance with pre-disbursement conditions, disbursements made for clearing overdue (ever greening), disproportionate disbursement of funds and delayed presentation of critical information to the Board. The Company’s management appointed a professional services firm (the “External Consultant”) to assist the management in responding to such observations and subsequently. It also obtained a legal opinion contesting certain matters with respect to the contents, including matters highlighted as ever greening in the forensic audit report, and approach adopted by the forensic auditor. Accordingly, the management, has rebutted the observations made by the forensic auditor and confirmed that, in their view, there is no additional impact on the Company’s standalone financial statements for F.Y. 2021-22 and that there are no indications of any fraud or suspected fraud. The Company has uploaded the forensic audit report, the management’s responses, report from the External Consultant and legal opinion on the website of stock exchanges.

In the adjourned audit committee meeting held on 13th November, 2022, the committee considered the forensic audit report and management’s responses thereon and accepted the findings in the report, by a majority but with dissent of two out of five directors. We have been informed about the discussions held in the meeting and reasons for dissent expressed by the two directors as set out in the Company’s communication to us dated 15th November, 2022, as attached in Annexure A accompanying our report.

In the board meeting held on 13th November, 2022, the board of directors of the Company (with the absence of Chairperson of the Audit Committee in the meeting, who recorded a dissent on the matters being discussed in his absence) considered the Forensic audit report, Management’s responses, and Report of External Consultant and legal opinions. We have been informed about the observations and views expressed in the meeting as set out in the Company’s communication to us dated 16th November, 2022, as attached in Annexure B accompanying our report.

Due to resignation of the former independent directors, the Company has not complied with the various provisions of Companies Act, 2013 and Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 related to constitution of committees and sub-committees of the Board, timely conduct of their meetings and filing of annual and quarterly results with respective authorities. The Company intends to file for condonation of delay for non-compliance of such provisions with respective authorities. The Company has also not finalized the minutes of audit committee meetings held since 9th November, 2021 which results in non-compliance with applicable provisions. (Refer Note 55(c) of the Standalone Financial Statements)

In light of the constraints and limitations highlighted by the forensic auditor while preparing the forensic audit report and as also noted by the Audit Committee, several concerns raised therein as described in the second paragraph above (including observations around ever greening) and lack of specific procedures and conclusions thereon, divergent views among directors regarding forensic audit report (as further detailed in Annexure A and B, accompanying our report), we are unable to satisfy ourselves in relation to the extent of forensic audit procedures and conclusion thereon, including remediation of the additional concerns raised therein.

Considering the above and indeterminate impact of potential fines and/ or penalties due to non-compliance of various provisions as mentioned above, we are unable to obtain sufficient and appropriate audit evidence to determine the extent of adjustments, if any, that may be required to the standalone financial statements for the year ended 31st March, 2022.

We conducted our audit in accordance with the Standards on Auditing (SAs) specified under section 143(10) of the Act. Our responsibilities under those Standards are further described in the Auditor’s Responsibilities for the Audit of the Standalone Financial Statements section of our report. We are independent of the Company in accordance with the Code of Ethics issued by the Institute of Chartered Accountants of India together with the ethical requirements that are relevant to our audit of the standalone financial statements under the provisions of the Act and the Rules thereunder, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the Code of Ethics. We believe that the audit evidence obtained by us is sufficient and appropriate to provide a basis for our qualified opinion.

ANNEXURE A

Resolution as agreed by (adjourned) the Audit Committee in meeting dated 13th November, 2022 and confirmed by all members.

“It is noted that the Forensic Auditor has given his findings in the Final Forensic Audit Report submitted by him on 4th November 2022. It is also noted that the forensic auditor has concluded that the findings as given by him in the draft report are not significantly altered by the explanations given by the management. The Audit Committee discussed these findings in reasonable detail and noted that the audit committee can go into even further detail in giving its observations on the forensic audit report. However as emphasized repeatedly by the management, considering the urgency of adoption of the annual accounts for the year ended March 22, it is felt that the significant and salient aspects of the forensic audit report have been brought out in the discussion and also the statutory auditor, who was present as an invitee during this discussion has taken note of these observations and examined the report of the forensic auditor in complete detail. Therefore, at this stage, the audit committee decides not to go into a further detailed discussion of the contents of the forensic audit report, its findings and conclusions in light of the priorities mentioned by the management. Accordingly, the audit committee takes on record Final Forensic Audit Report submitted by…. and thanks them for their services. After this discussion it was resolved that:-

The audit committee accepts findings of the forensic auditor as given in the Final Forensic Audit Report. The committee recommends them to the Board for appropriate follow up action. The Committee notes the constraints and scope limitations operating on the forensic auditor, which find mention in the Forensic Audit Report and that but for such limitations the forensic auditor would probably have been able to give even more specific findings. The Committee has also taken note of the responses given by the management. The Committee also notes that an external agency was appointed by the management to act as advisors to the management in responding to the findings given by the forensic auditor. It is noted that the views expressed by the said advisors contain many reservations, disclaimers and limitations. Some of the salient disclaimers are mentioned in the email dt 8th Oct 22 sent by the Chairman of the Committee to the board members. It is seen that the advisors state that they have relied on the justification provided by the management; and it is possible that there are factual inaccuracies where we have not been provided with the complete picture/information/documentation on a particular matter by the process owners. In turn the management states that it has relied upon the consultant’s findings to prepare their response to the forensic audit report. The audit committee therefore has given limited weightage to the recommendations of the consultant. The committee also notes that the statutory auditor assures that all significant aspects of the forensic audit report have been taken into consideration by them and further, that these aspects have been taken into consideration in auditing the financial results for the year ended March 22, and that appropriate modifications based on these findings have been suitably incorporated in their reports.

The above resolution was proposed by the Chairman (D1) and approved of by D4 & D5.

D2 expressed his dissent stating that in addition to the other points as mentioned by him during the course of discussions, he did not agree with the concept of ever greening as interpreted / applied by the forensic auditor. He also felt that the forensic auditor had Annexure A (continued) been selective in the presentation of certain facts and also, he was not in agreement with the findings given by the forensic auditor in regard to …. and related matters. He was not in agreement with scope limitation or constraints mentioned by Forensic Auditor. The Forensic Auditor has not done weekly discussions with the management as stipulated in the engagement letter, which is legally binding on him. He also pointed out that the limitations mentioned in the Advisor’s Report should be read in full, not selectively and the limitations as expressed are as per generally accepted norms.

D3 recorded his dissent on the basis of numerous issues mentioned by him in the course of earlier discussion including all the points specifically stated by D2. Further, Advisors has clarified that the facts mentioned in their note were based on independent review of supporting documents in relation to reply submitted by PFS. Thus, it was their independent assessment.

Basis the above, the Resolution was adopted and passed with a majority of 3 against 2 dissents.”

This is issued on specific requirement of Statutory Auditors and above resolution was passed during the meeting and minutes will be finalised shortly.

ANNEXURE B

Resolution as agreed by the Board Meeting dated 13th November, 2022 and confirmed by all members present in the meeting (except one Director – Audit Committee Chairman who was not present in the meeting)

The Board considered the forensic audit report of … along with management replies, … remarks, legal opinion by Former CJI, legal opinion of CAM and Former Director (Finance) of PFC. The Board noted that the Audit Committee considered the forensic audit report of … on 11th 12th and 13th Nov and accepted the report by majority (3:2).

The Board deliberated the report and observed that;

i.  _____ report is that has not identified any event having material impact on the financials of the Company. Hence not quantified.

ii.  _____ has not identified any instance of fraud and diversion of funds by the company.

iii.    Procedural / operational issues identified by … needs to dealt with expeditiously.

iv.    The Issue related to …. has already been examined by RMC committee of PTC (Holding Company) and approved by Board of PTC India. The report is already submitted to the regulators.

The Company has already complied by SEBI (LODR) by submitting the same to Stock Exchanges along with management comments and … remarks. The management is directed to submit the report of Forensic Audit with management comments, … remarks, legal opinion by Former CJI, legal opinion of CAM and former Director (Finance) of PFC and this Board resolution to SEBI. The Board is of the view that recommendation of … may be obtained by management to strengthen the business processes & operational issues and submit to the Board at the earliest.

This is issued on specific requirement of Statutory Auditors and above resolution was passed during the meeting and minutes will be finalised shortly.

From Directors’ Report

The Statutory Auditors in their Audit Reports on the Financial Statements of the Company for the F.Y.2021-22, provided certain qualification, which forms a part of the Annual Report. In this connection this is to inform that:

a)    On 19th January, 2022, three (3) independent directors of the Company resigned mentioning lapses in corporate governance and compliance. Since then RBI, SEBI and ROC (the ‘Regulators”) have reached out to the Company with their queries regarding the allegations made by the then independent directors and directed the Company to submit its response against such allegations. SEBI also directed the Company to submit its Action Taken Report (ATR) together with the Company’s response against such allegations. On the basis of the forensic audit report received by the Company on 4th November, 2022 and other inputs from professional services firm retained by the management, it has been decided that the management shall take necessary corrective actions and submit its ATR, if required, to the satisfaction of SEBI.

On 11th February, 2022, RBI sent its team at the Company’s office to conduct a scrutiny on the matters alleged in the resignation letters of ex-independent directors. While the RBl’s team completed its scrutiny at Company’s office on 14th February, 2022 and the Company satisfactorily responded to all queries and requests for information but has not received any further communication from RBI in this regard.

On 4th November, 2022 the forensic auditor appointed by the Company, submitted its forensic audit report. The Company engaged a reputed professional services firm to independently review the management’s response and independent review of the documents supporting such response and comments on such observations, including financial implications and any indications towards suspected fraud. The management’s responses and remarks of professional services firm, together with the report of the forensic auditor, have been presented by the management to the Board in its meeting held on 7th November, 2022 and 13th November, 2022..

b)    Onwards …. Not reproduced

‘Charitable Purpose’, GPU Category- Post 2008 Amendment – Eligibility for Exemption under Section 11- Section 2(15) – Part I

INTRODUCTION

1.1    The Indian Income-tax Act, 1922 (“1922 Act”) contained and the Income-tax Act, 1961 (“1961 Act”) contains, specific provisions to deal with income derived by a person from property held under trust wholly for charitable or religious purposes.

1.2    Section 4(3) of the 1922 Act provided that any income derived from the property held under trust or other legal obligation wholly for religious or charitable purposes shall not be included in the total income of the person receiving such income subject to fulfillment of conditions stated therein. The term “charitable purpose” was defined in the 1922 Act to include relief of the poor, education, medical relief and the advancement of any other object of general public utility. The last limb of the definition of charitable purpose– ‘advancement of any other object of general public utility’ (hereinafter referred to as “GPU” or “GPU category”) has been subject of matter of litigation and has been subjected to several amendments from time to time.

1.2.1    In the case of The Trustees of the ‘Tribune’, In re (7 ITR 415) (“Tribune”), the assessee claimed exemption under section 4(3) of the 1922 Act for the assessment year 1932 – 33 in respect of income earned by the trust which was created to maintain Tribune Press and Newspaper in an efficient condition, keeping up the liberal policy of the newspaper and devoting the surplus income in improving the said newspaper. The question before the Privy Council was as to whether the property was held under trust wholly for the GPU. The Privy Council took the view that the objects of the trust fell within the GPU category and held that the trust was entitled to exemption under section 4(3) of the 1922 Act.

1.2.2    In the case of CIT vs. Andhra Chamber of Commerce [1965] 55 ITR 722 (SC) (“Andhra Chamber”), the Supreme Court allowed the claim of the assessee for exemption under section 4(3) of the 1922 Act for six assessment years 1948 – 49 to 1951- 52, 1953-54 and 1954-55. The Court held that the principal objects of the assessee were to promote and protect, and to aid, stimulate and promote the development of trade, commerce and industries in India, which would fall within the GPU category. The Court further held that the expression “object of general public utility” is not restricted to objects beneficial to the whole of mankind but would also cover objects beneficial to a section of the public. The Court further held that if the primary object of the assessee was GPU, the assessee would remain a charitable entity despite the presence of an incidental political object being in the nature of promotion of or opposition to legislation affecting trade, commerce or manufacture.

1.3    Upon repeal of the 1922 Act and enactment of the 1961 Act, the term “charitable purpose” is defined in section 2(15) of the 1961 Act. The words ‘not involving the carrying on of any activity for profit’ [profit making activity] were added in the GPU category. ‘Charitable purpose’ as per section 2(15) of the 1961 Act included relief of the poor, education, medical relief (Specified Categories), and the advancement of any other object of general public utility “not involving the carrying on of any activity for profit”. Subsequently, from 2009 onwards, the list of Specified Categories (with which we are not concerned in this write-up) was expanded to include preservation of environment, yoga, etc.

1.3.1    The issue before the Supreme Court in the case of Sole Trustee, LokaShikshana Trust vs. CIT [1975] 101 ITR 234 (“LokaShikshana Trust”) was whether an assessee trust set up with the object of educating people inter alia by (i) setting up and helping institutions in educating people by the spread of knowledge on matters of general interest and welfare (ii) founding and running reading rooms and libraries and keeping and conducting printing houses and publishing or aiding the publication of books, etc. (iii) supplying Kannada speaking people with an organ or organs of educated public opinion, etc. and (iv) helping similar societies and institutions; would be entitled for exemption under section 11 of the 1961 Act for the assessment year 1962- 63. At the outset, the Court held that the object of the assessee trust was not education [by adopting narrower meaning of the term education] but would fall within the GPU category. The Court rejected assessee’s argument that the newly added words ‘not involving the carrying on of any activity for profit’ in the GPU category merely qualified and affirmed the position as it was under the definition of ‘charitable purpose’ in the 1922 Act and observed that there was no necessity for the Legislature to add the new words in the definition if such was the intention. The Court observed that to fall within the GPU category it was to be shown that the purpose of the trust is the advancement of any other object of general public utility, and that such purpose does not involve profit making activity. The Court then observed that the assessee trust was engaged in the business of printing and publication of newspaper and journals which yielded profit and also noted the fact that there were no restrictions on the assessee trust for earning profits in the course of its business. The Court held that the assessee trust did not satisfy the requirement that it should be one not involving profit-making activity and, accordingly, was not entitled to exemption under section 11 of the 1961 Act.

1.3.2    In the case of Indian Chamber of Commerce vs. CIT [1975] 101 ITR 796 (SC) (“Indian Chamber”), the assessee was a company set up under section 26 of the Indian Companies Act, 1913 primarily to promote and protect Indian trade interests and other allied service operations, and to do all other things as may be conducive to the development of trade, commerce and industries or incidental to attainment of its objects. The assessee company for the assessment year 1964 – 65 earned profits from three services rendered by it – arbitration fees, fees for certificate of origin and share of profit in a firm for issue of certificates of weighment and measurement. The issue before the Supreme Court was whether carrying on of the aforesaid three activities which yielded profits involved ‘carrying on of any activity for profit’ within the meaning of section 2(15) of the 1961 Act. The Court held that an institution must confine itself to the carrying on of activities which are not for profit and that it is not enough if the object is one of general public utility. In other words, the attainment of the charitable object should not involve activities for profit. On the facts of the case, the Court denied exemption under section 11 to the assessee.

1.3.3    The interpretation of words ‘not involving the carrying on of any activity for profit’ in section 2(15) of the 1961 Act then came up before a Constitution bench of the Supreme Court in the case of ACIT vs. Surat Art Silk Cloth Manufacturers Association (1978) 121 ITR 1 (“Surat Art”). In this case, while dealing with the category of GPU, the Court laid down what came to be known as ‘pre-dominant test’. Reference may be made to para 1.6 of this column – January 2023 issue of this journal where the aforesaid decision has been explained. The Court in Surat Art’s case overruled its earlier decision in the case of Indian Chamber interpreting the words ‘not involving the carrying on of any activity for profit’ and held that it was the object of GPU that must not involve the carrying on of any activity for profit and not its advancement or attainment. The Court in Surat Art also disagreed with the observation in the case of Sole Trustee, Loka Shikshana Trust and Indian Chamber to the effect that whenever an activity yielding profit is carried on, the inference must necessarily be drawn that the activity is for profit and the charitable purpose involves the carrying on of an activity for profit in the absence of some indication to the contrary.

1.3.4    The Supreme Court followed the principles laid down in Surat Art’s case while deciding the claim for exemption under section 11 of the 1961 Act in CIT vs. Federation of Indian Chambers of Commerce & Industries [1981] 130 ITR 186 (SC)and CIT vs. Bar Council of Maharashtra [1981] 130 ITR 28 (SC).

1.4    Section 11(4) which is a part of the 1961 Act right from the time of its enactment defined the term ‘property held under trust’ to include a business undertaking. Section 13 of the 1961 Act provides certain circumstances in which exemption granted under section 11 or 12 of the Act in respect of income derived from property held under trust for charitable or religious purposes will not be available. Clause (bb) was inserted in section 13(1)by the Taxation Laws (Amendment) Act, 1975 with effect from 1st April, 1977 to provide denial of exemption in respect of any income derived from any business carried on by a charitable trust or institution for the relief of the poor, education or medical relief unless such business is carried on in the course of the actual carrying out of a primary purpose of the trust or institution. Clause (bb) in section 13(1) of the 1961 Act was omitted by the Finance Act, 1983 with effect from 1st April, 1984.

1.4.1    The Finance Act, 1983 also made two further amendments in the 1961 Act with effect from 1st April, 1984 – (i) omission of the words ‘not involving the carrying on of any activity for profit’ in section 2(15) and (ii) insertion of clause (4A) in section 11 of the 1961 Act providing that sub-section (1), (2), (3) or (3A) of section 11 shall not apply in relation to any income being profits and gains of business unless (a) the business of a specified type is carried on by a trust set up only for public religious purposes or (b) business is carried on by an institution wholly for charitable purposes and the work in connection with the business is mainly carried on by the beneficiaries of the Institution and separate books of account are maintained by the trust or institution in respect of such business. Section 11(4A) which was restrictive in nature at the time of insertion was liberalized by the Finance (No. 2) Act, 1991 with effect from 1st April, 1992. Section 11(4A) now provided for two requirements – business should be incidental to the attainment of the objectives of the trust or institution and separate books of accounts are maintained in respect of such business.

1.4.2    The Supreme Court (Three Judges Bench) in the case of ACIT vs. Thanthi Trust [2001] 247 ITR 785 (SC)(“Thanthi Trust”) had adjudicated upon the assessee trust’s claim for exemption under section 11 of the 1961 Act. The business of a newspaper ‘Dina Thanthi’ was settled upon the assessee trust as a going concern. The objects of the trust were to establish the newspaper as an organ of educated public opinion. A supplementary deed was thereafter executed whereby the trust’s surplus income was to be used to establish and run schools, colleges, hostels, orphanages, establish scholarships, etc. The High Court’s decision allowing the assessee’s claim for exemption under section 11 of the 1961 Act was challenged before the Supreme Court by the tax department. The Court divided its decision into three distinct periods depending upon the law in force at the relevant time affecting the issue before it. The Court while deciding the batch of appeals for assessment years 1979 – 80 to 1983-84 (first period) denied exemption under section 11 and held that section 13(1)(bb) of the 1961 Act would apply even where a business is held under trust that is being carried on and is held as a part of corpus of the trust. The Court took the view that the business of the trust did not directly accomplish the trust’s objects of relief of the poor and education as stated in the supplementary deed and was therefore hit by section 13(1)(bb) [referred to in para 1.4.1 above]. With respect to the appeals for assessment years 1984- 85 to 1991-92 (second period), the Court denied exemption under section 11 of the 1961 Act on the basis that the requirements specified in clause (a) or clause (b)of section 11(4A) as in force [referred to in para 1.4.1 above] were not satisfied as the trust is not only for public religious purpose and exemption contained in section 11(4A)(b) does not apply to trust and it applies only to institution. Coming to the third batch of appeals for assessment years 1992-93, 1995-96 and 1996-97 (third period), the Court granted exemption under section 11 and took the view that the substituted section 11(4A) was more beneficial as compared to section 11(4A) as applicable prior to its amendment by the Finance (No. 2) Act, 1991 or as compared to section 13(1)(bb) of the 1961 Act. The Court held that the business income of a trust will be exempt if the business is incidental to the attainment of the objectives of the trust and that a business whose income is utilized by the trust for the purpose of achieving its objectives is surely a business which is incidental to the attainment of its objectives. The Court also observed that in any event, if there be any ambiguity in the language, the provisions must be construed in a manner that benefits the assessee.

1.5    Income of an authority constituted in India by or under any law enacted for the purpose of dealing with the need for housing accommodation or for the purpose of planning, development or improvement of cities, towns and villages was exempt under section 10(20A) of the 1961 Act which was inserted by the Finance Act, 1970 with retrospective effect from 1st April, 1962. Section 10(23) which was a part of the 1961 Act right from the enactment of the Act granted exemption to specified sports association or institutions. Both the aforesaid sections were omitted by the Finance Act, 2002 and the entities claiming exemption under these sections started making a claim for exemption under section 11 of the 1961 Act. In this regard, reference may be made to the decision of Supreme Court in CIT vs. Gujarat Maritime Board [2007] 295 ITR 561 (Gujarat Maritime Board) where it was held that the provisions of section 10(20) which exempted income of local authority and section 11 of the 1961 Act operated in totally different spheres and observed that an assessee that ceases to be a ‘local authority’ as defined in section 10(20) is not precluded from claiming exemption under section 11(1) of the 1961 Act.

1.6    Provisions of section 2(15) were amended by the Finance Act, 2008 (‘2008 amendment’) whereby a proviso was added to the definition of ‘charitable purpose’ stating that advancement of any other object of general public utility (GPU) shall not be a charitable purpose if it involves carrying on of any activity in the nature of trade, commerce or business or any activity of rendering service in relation thereto for a cess or fee or any other consideration [hereinafter, such activities are referred to as Commercial Activity/Activities) irrespective of the nature of use or application, or retention, of the income from such activity. The Finance Minister, in his budget speech for 2008-09 [(2008) 298 ITR (St.) 33 @ page 65] stated that genuine charitable organisations will not be affected by the 2008 amendments and that the amendment was introduced to exclude cases where some entities carrying on regular trade, commerce or business or providing services in relation thereto have sought to claim that their purpose falls under ‘charitable purpose.’ CBDT in its Circular No. 11 of 2008 dated 19th December, 2008 [(2009) 308 ITR (St.) 5] while clarifying the implications arising from the 2008 amendment stated that whether an assessee has a GPU object is a question of fact and if an assessee is engaged in any activity in the nature of trade, commerce or business, the GPU object will only be a mask or a device to hide the true purpose of trade, commerce or business. CBDT in its Circular No. 1 dated 27th March, 2009 [(2009) 310 ITR (St.) 42] explaining the 2008 amendment stated at pages 52 – 53 that it was noticed that a number of entities operating on commercial lines were claiming exemption under sections 10(23C) or 11 of the 1961 Act and that the 2008 amendments were made with a view to limiting the scope of the phrase ‘advancement of any other object of general public utility’ [i.e. GPU]. Finance Act, 2010 introduced second proviso to section 2(15) with retrospective effect from 1st April, 2009 to provide that the first proviso shall not apply if the total receipts from any activity in the nature of trade, commerce or business referred to in the first proviso does not exceed Rs. 10 lakhs in the previous year. This limit of Rs. 10 lakhs was thereafter increased to Rs. 25 lakhs by the Finance Act, 2011 with effect from 1st April, 2012. The current proviso in section 2(15) was introduced in place of the aforesaid first and the second provisos by the Finance Act, 2015 with effect from 1st April, 2016. The proviso as currently in force provides that advancement of an object of GPU shall not be a charitable purpose if it involves carrying on of any activity in the nature of trade, commerce or business, etc. for a fee or cess or any other consideration (i.e. Commercial Activity) unless (i) such an activity is undertaken in the course of actual carrying out of the advancement of any other object of GPU and (ii) the aggregate receipts from such activity or activities during the previous year, do not exceed 20 per cent of the total receipts, of the trust or institution undertaking such activity or activities, of that previous year.

1.7    Recently, Supreme Court in the case of CIT(E) vs. Ahmedabad Urban Development Authority and connected matters (449 ITR 1) has interpreted the last limb of the definition of charitable purpose ‘advancement of any other object of general public utility’ [i.e. GPU] and the provisos inserted by the 2008 and subsequent amendments. Therefore, it is thought fit to consider the said decision in this column. In all these matters, the Supreme Court was concerned with GPU Categories post 2008 amendments.

DIFFERENT CATEGORIES OF APPEALS BEFORE THE SUPREME COURT- BRIEF FACTS

2.1    The assessees in these batches of connected appeals before the Supreme Court were divided into six categories; namely – (i) statutory corporations, authorities or bodies, (ii) statutory regulatory bodies / authorities, (iii) trade promotion bodies, councils, associations or organizations, (iv) non-statutory bodies, (v) state cricket associations and (vi) private trusts. Brief facts of these categories are given hereinafter.

2.2    The lead matter of AUDA, which fell in the first category above, was an appeal filed by the Revenue from the decision of the Gujarat High Court in Ahmedabad Urban Development Authority vs. ACIT(E) (2017) 396 ITR 323 [AUDA]. The Gujarat High Court held that the activities of AUDA which was set up under the Town Planning Act with the object of proper development or redevelopment of urban area could not be said to be in the nature of trade, commerce or business.

2.2.1    In respect of the second category of assessee – statutory regulatory bodies/ authorities, the Delhi High Court in the case of Institute of Chartered Accountants of India vs. DGIT(E), Delhi (2013) 358 ITR 91 [ICAI] held that the assessee institute did not carry on any business, trade or commerce and that the activity of imparting education in the field of accountancy and conducting courses, providing coaching classes or undertaking campus placement interviews for a fee, etc. were activities in furtherance of its objects.

2.2.2    In one of the cases falling within the third category stated above, the Delhi High Court in the case of DIT vs. Apparel Export Promotion Council (2000) 244 ITR 736 [AEPC] dismissed the revenue’s appeal against the order of the Tribunal where the Tribunal had held that the assessee was a public charitable institution entitled to exemption under section 11 of the Act. The objects of AEPC, which was set-up in 1978, include promotion of ready-made garment export and for that to carry out various incidental activities such as providing training to instill skills in the work force, showcase the best capabilities of Indian Garment exports through the prestigious ‘Indian International Garment Fair’ organized twice a year by APEC, etc. It also provides information and market research to the Industry and carries out various related activities to assist the Industry. The tribunal had also held that as the assessee did not carry any activity for earning profit, it could not be said to be carrying on any ‘business’ as understood in common parlance.

2.2.3    In respect of a non-statutory body (fourth category) – GS1 India, the Delhi High Court in GS1 India vs. DGIT(E) (2014) 360 ITR 138 [GS1 India] took the view that the profit motive is determinative to arrive at the conclusion whether an activity is business, trade or commerce. The High Court held that the assessee was a charitable society set up under the aegis of the Union Government with the object of creating awareness and promoting study of Global standards, location numbering, etc. and a mere fact that a small contribution by way of fee was paid by beneficiaries would not convert a charitable activity into business, commerce or trade.

2.2.4    While dealing with the eligibility of a state cricket associations such as Suarashtra, Gujarat, Baroda Cricket Association, etc (fifth category), the Gujarat High Court in the case of DIT(E) vs. Gujarat Cricket Association (2019) 419 ITR 561 (GCA) held that the assessee was set up with the main and predominant object and activity to promote, regulate and control the game of cricket in the State of Gujarat. The GCA’s record revealed that large amount of receipts included income from sale of match tickets, sale of space, subsidy from BCCI, etc., as against which the amount of expenditure was much lower leaving good amount of excess of income for the relevant year. On these facts, the High Court held that the activities of the assessee were charitable in nature as the driving force of the assessee was not a desire to earn profits but to promote the game of cricket and nurture the best of the talent. Similar position was revealed from the records of Saurashtra Cricket Association.

2.2.5    In respect of the sixth category being private trusts, the Punjab & Haryana High Courts in the case of Tribune Trust vs. CIT (2017) 390 ITR 547 (Tribune) held that the assessee’s activity falls within the ambit of the words “advancement of any other object of general public utility” and that the decision of the Privy Council in assessee’s own case (referred to in para 1.2.1 above) still holds good. The High Court, however, held that as the activities of the assessee were carried on with the predominant motive of making a profit and there was nothing to show that the surplus accumulated had been ploughed back for charitable purposes, the assessee did not satisfy the definition of ‘charitable purpose’ in view of the proviso to section 2(15) of the Act.

ACIT(E) VS. AHMEDABAD URBAN DEVELOPMENT AUTHORITY (449 ITR 1 – SC)

3.1    Appeals were filed challenging the aforesaid decisions of the High Courts as well as other decisions in connected matters. Before the Supreme Court, the Revenue contended that the decisions of the Supreme Court in the case of Tribune and Andhra Chamber (referred to in paras 1.2.1& 1.2.2) were rendered in the context of the 1922 Act which did not contain any restrictions forbidding charitable entities from carrying on trade or business activities. Relying on the decisions in the cases of LokaShikshana Trust and Indian Chamber (referred to in paras 1.3.1 &1.3.2), the Revenue highlighted the change brought about by section 2(15) in the 1961 Act and the addition of the words ‘not involving the carrying on of any activity for profit’ and submitted that the intent of the Parliament in changing the law was to expressly forbid tax exemption benefit if an entity was involved in carrying on trade or business. The Revenue placed a reliance upon the speech of the Finance Minister while delivering the budget to bring out the rationale of the amendments. The Revenue also placed reliance on section 13(1)(bb) of the 1961 Act to state that only charities set up for “relief of the poor, education or medical relief” (i.e. specified categories) could claim exemption if they carried on business “in the course of actual carrying out of a primary purpose of the trust or institution” and not charities falling within GPU limb.

3.1.1    The Revenue also contended that the decision in Surat Art’s case had ignored the significance of the addition of the expression “advancement of any other object of general public utility not involving the carrying on of any activity for profit” and that Constitution Bench of the Supreme Court was wrong in laying down the ‘predominant test’. The Revenue also referred to the amendments made in 2008 onwards whereby GPU category charities were permitted to carry on activities in the nature of business up to the specified limits. The Revenue further contended that in view of the proviso to section 2(15), the Commercial Activity the proceeds from which are ploughed back into charity are also impermissible. With respect to the assessees falling within category (i) as stated in para 2.2 above – ‘statutory corporations, etc –the Revenue urged that even though such assessees may trace their origin to specific Central or State laws, they have to fulfill the restrictive conditions laid down in section 2(15) and proviso thereto.

3.2 The assessee in the lead matter, Ahmedabad Urban Development Authority [AUDA], fell within the first category referred in para 2.1 above. It was contended that it was a corporation set up and established by or under statute enacted by the State Legislature and that it did not carry out business activities. Its functions were controlled by the parent enactment under which it was created and that surplus generated was used for furthering its objectives. The assessee placed reliance on the decision in Surat Art’s case to contend that the pre-dominant objective should not be to carry on trade or business but to advance the purpose of general public utility and that surplus arising from some activity would not disentitle the entity from the benefit of tax exemption. Reliance was also placed on CBDT Circular 11 of 2008 and the Finance Minister’s speech to contend that exemption could not be denied to a genuine charitable organization. The assessee further contended that the expressions ‘trade’, ‘commerce’ or ‘business’ were interpreted to mean activities driven by profit motive and that organisations created with a view to earn profit are precluded from claiming exemption as a charitable organization. The assessee statutory corporations in the connected matters further urged that where they perform government functions and operate on a no profit – no loss basis, their activities could not be regarded as trade or business. The assessee – Karnataka Industrial Areas Development Board – also urged that it was a ‘State’ under Article 12 of the Constitution of India (Constitution) and its activities, therefore, could not be regarded as trade or business.

3.2.1 Submissions were also made to contend that the term “for a cess or fee or any other consideration” used in the proviso to section 2(15) was clearly violative of Article 14 as it failed to make a distinction between activities carried out by the State or by the instrumentalities or agencies of the State, and those carried out by commercial entities for which a consideration is charged. The assessee also pointed out that Article 289(1) of the Constitution exempts States’ property and income from Union taxation and, therefore, to permit levy of income tax on cess or fee collected by a State would violate Article 289(1) and, hence, the word “cess” or “fee” in the proviso to section 2(15) of the 1961 Act was liable to be declared unconstitutional and violative of Articles 14 and Article 289 in the context of state undertakings.

3.2.2 In respect of the second category being statutory regulatory bodies/authorities referred to in para 2.1 above, the assessee – Institute of Chartered Accountants of India [ICAI] stated that it was established under the Chartered Accountants Act, 1949 to impart formal and quality education in accounting and, thereafter, to regulate the profession of Chartered Accountancy in India and it was under the control and supervision of the Ministry of Corporate Affairs, Government of India (Corporate Ministry). The assessee submitted that surplus generated due to the fees collected from conducting coaching and revision classes was not a business or commercial activity but wholly incidental and ancillary to its objects which were to provide education and conduct examinations of the candidates enrolled for chartered accountancy courses. The assessee, therefore, submitted that separate books of account were not required to be maintained in terms of section 11(4A) read with the fifth and seventh proviso to section 10(23C) of the 1961 Act. The assessee further contended that as its activities fell within the purview of ‘education’ and not under the GPU category, it was not hit by the proviso to section 2(15) of the 1961 Act inserted by the 2008 amendment. The assessee also submitted that its activities were not driven by profits and that the word ‘profit’ should never be used for a body set up for public purposes to regulate activities in public interest.

3.2.3 In respect of the third category referred to in para 2.1 above, being trade promotion bodies, councils, associations or organizations, one of the assessees being AEPC referred to in para 2.2.2., contended that it was a non-profit organization set up with the approval of the Central Government for promotion of exports of garments from India and did not engage in any activity for profit. The assessee stated that mere earning of income and/or charging any fees is not barred by the proviso to section 2(15).

3.2.4 In respect of the fourth category referred to in para 2.1 above, being non-statutory bodies, one of the assessees, ‘GS1 India’ stated that it was registered as a society in 1996 whose administrative control vests with the Ministry of Commerce, Government of India (Corporate Ministry). The assessee urged that it was not involved in trade, commerce or business and also that the profit motive was absent. Another assessee (NIXI) falling within this category, submitted that it was a company set up under section 25 of the Companies Act, 1956 and was barred from undertaking any commercial or business activity for profit and was bound by strict licensing conditions, including prohibition on alteration in the memorandum of association, without prior consent of the government.

3.2.5    In respect of the fifth category referred to in para 2.1 above, being state cricket associations, one of the assessees Saurashtra Cricket Association submitted that it operated purely to advance its objective of promoting the sport and that it should not be considered as pursuing Commercial Activities. The assessee contended that under the proviso to section 2(15) of the 1961 Act, an organization ceases to be charitable if it undertakes an activity for a cess or a fee or other consideration. The assessee submitted that the term ‘cess’ had to be read down as non-statutory and that levy of any statutory cess or fee authorized or compelled by law, which is within the domain of the state legislature, cannot be construed as taxable. The assessee further submitted that the sport of cricket is a form of education and even if it is not considered as a field of education, it is still an object of general public utility. The assessee further submitted that selling tickets for a sport performance or match is to promote cricket and not trade.

3.2.6    In respect of the sixth category referred to in para 2.1 above, being private trusts, assessee Tribune Trust submitted that its charitable nature was upheld by the Privy Council in its decision referred to in para 1.2.1 above.

3.3 In response to the assessee’s submissions, the Revenue urged that Constitution does not provide immunity from taxation for the State if they carry on trade or business. The Revenue further submitted that one should not merely look at the objects of the trust to determine if it is for a charitable purpose but also whether the purpose of the trust is “advancement of any other object of general public utility”.

[To be continued]

Section 197: Withholding tax certificate – Non application of mind – Binding effect of the Supreme Court judgement – merely filing/pendency of the review petition will not dilute the effect of the decisions

3 Milestone Systems A/S vs.
Deputy CIT Circle Int Tax 2(2) (1) Delhi
[W.P.(C) 3639/2022, A.Y,: 2022 -23;
Dated: 14th March, 2023]

Section 197: Withholding tax certificate – Non application of mind – Binding effect of the Supreme Court judgement – merely filing/pendency of the review petition will not dilute the effect of the decisions

The petitioner is a non-resident company, incorporated under the laws of Denmark. The petitioner, admittedly, has been issued a tax residency certificate by the concerned authorities in Denmark. It is the petitioner’s case that it is in the business of providing IP Video Management Software and other video surveillance related products to entities and persons across the globe. In so far as India is concerned, the petitioner claims, that it has entered into a Distributor Partner Agreement with various companies/entities for sale of its Software. It is the petitioner’s case, that the Distributor Agreement does not confer any right of use of copyright on its partners or the end user. The petitioner claims, that all that the distributor partner acquires under the Distributor Agreement is a license to the copyrighted software. It is, therefore, the petitioner’s case, that this aspect of the matter has been considered in great detail by the Supreme Court in the judgment rendered in Engineering Analysis Center of Excellence Pvt Ltd vs. Commissioner of Income Tax & Anr 2021 SCC OnLine SC 159.

The petitioner, contends that the concerned officer, in passing the impugned order dated 19th May, 2021, has side stepped a vital issue i.e., whether or not the consideration received by the petitioner against the sale of software constituted royalty within the meaning of Section 9(1)(vi) and/or Article 13(3) of the Double Taxation Avoidance Agreement (DTAA) entered into between India and Denmark.

The department contented that while examining an application preferred under section 197 of the Act, the concerned officer is not carrying out an assessment. Therefore, the parameters which apply for assessing taxable income would not get triggered, while rendering a decision qua an application filed under the aforementioned provision. Under the provisions of Section 195, deduction of withholding tax is the rule, and issuance of a lower withholding tax certificate under Section 197 of the Act is an exception.

The Honourable Court observed that, the impugned order does not deal with the core issue which arose for consideration, and was the basis on which the application had been preferred by the petitioner under section 197 of the Act.

The Honourable Court observed that it is the petitioner’s case that the Software sold to its distributor partners under the Distributor Agreement, does not confer, either on the distributor partner or the reseller, the right to make use of the original copyright which vests in the petitioner. This plea was sought to be supported by the petitioner, by relying upon the judgment of the Supreme Court in Engineering Analysis, wherein inter alia, the Court has ruled, that consideration received on sale of copyrighted material cannot be equated with the consideration received for right to use original copyright work. Therefore, this central issue had to be dealt with by the concerned officer. Instead, as is evident on a perusal of the impugned order, the concerned officer has simply by-passed the aforementioned judgement of the Supreme Court by observing that the revenue has preferred a review petition, and that the same is pending adjudication.

The court held that as long as the judgment of the Supreme Court is in force, the concerned authority could not have side stepped the judgment, based on the fact that the review petition had been preferred. It would have been another matter, if the concerned officer had, on facts, distinguished the judgment of the Supreme Court in Engineering Analysis. That apart, the least that the concerned officer ought to have done was to, at least, broadly, look at the terms of Distributor Agreement, to ascertain as to what is the nature of right which is conferred on the distributor partner and/or the reseller.

The court observed that there is no reference whatsoever to any of the clauses of the Distributor Agreement. The concerned officer has, instead, picked up one of the remitters i.e., the distributor partners, and made observations, which to say the least, do not meet the parameters set forth in Rule 28AA of the Income Tax Rules, 1962 for estimating the income, that the petitioner may have earned in the given FY. A erroneous approach is adopted by the concerned officer.

The concerned officer was required to examine the application, in the background of the parameters set forth in Rule 28AA of the Rules. Concededly, that exercise has not been carried out.

The petitioner’s entire case is that the sum that it receives under the Distributor Agreement is not chargeable to tax. It is in that context, that the petitioner has moved an application under section 197 of the Act for being issued a certificate with “NIL” rate of withholding tax.

The Honourable Court set aside the impugned certificate and the order, with a direction to the concerned officer, to revisit the application. While doing so, the concerned officer will apply his mind, inter alia, to the terms of the Distributor Agreement, and the ratio of the judgment rendered by the Supreme Court in Engineering Analysis (supra). In this context, the provisions of Rule 28AA shall also be kept in mind. The concerned officer will not be burdened by the fact that a review petition is pending, in respect of the judgment rendered by the Supreme Court in Engineering Analysis (supra).

The writ petition was, accordingly, disposed off.

Section 179 – Recovery proceedings against the Director of the company – Taxes allegedly due from the company – gross neglect, misfeasance or breach of duty on the part of the assessee in relation to the affairs of the company not proved

1 Geeta P. Kamat vs. Principal CIT-10 & Ors.
[Writ Petition No. 3159 of 2019,
Dated: 20th February, 2023 (Bom) (HC)]

Section 179 – Recovery proceedings against the Director of the company – Taxes allegedly due from the company – gross neglect, misfeasance or breach of duty on the part of the assessee in relation to the affairs of the company not proved:

A show cause notice dated 12th January, 2017 was served upon the petitioner in terms of section 179 of the Act requiring the petitioner to show cause as to why the recovery proceedings should not be initiated against her in her capacity as a director of KAPL. The assessee company was not traceable on the available addresses and further the tax dues could not be recovered despite attachment of the bank accounts as the funds available were insufficient. An amount of Rs.1404.42 lakhs was thus sought to be recovered from the petitioner.

With a view to prove that the non-recovery of the taxes due could not be attributed to any gross neglect, misfeasance, breach of duty on her part, in relation to the affairs of the company, the petitioner took a stand that the petitioner, as a director in the company had no liberty, authorization or independence to act in a particular manner for the benefit of KAPL. She did not have any control over the company’s affairs. It was stated that the petitioner did not have any authority to sign any cheque independently or take any decision on behalf of the company nor did KAPL provide any operational control or space to the petitioner to perform her duties. It was also stated that the petitioner did not have any functional responsibility assigned to her and no one from KAPL reported to her or her husband Prakash Kamat, who was also a shareholder and a director in the company.

The petitioner’s husband, Prakash Kamat is stated to have developed a smart card-based ticketing solution for being used at various public transport organizations like BEST, Central and Western Suburban trains, etc. Trials were run successfully and an agreement was entered into between Prakash Kamat, BEST and Central Railways in 2006. The projects with BEST and Railways were to be implemented on “BOT” model and required funds to the tune of Rs. 50 to 60 crores as an initial investment. Khaleej Finance and Investment, a company registered in Bahrain (hereinafter referred to as “KFI”) agreed to make an investment in the said project subject to certain conditions, according to which a Special Purpose Vehicle was to be incorporated to carry on the said project which lead to incorporation of KAPL on 30th March, 2006. An investment was made by KFI in the said project through its Mauritius-based company “AFC System Ltd (hereinafter referred to as “AFC”)”. A joint venture agreement dated 21st June, 2006 (“JVA”), Deed of Pledge dated 21st June, 2006 (‘”DP”) along with Irrevocable Power of Attorney dated June 2006 (“IPOA”), was entered into between Prakash Kamat, the petitioner, KFI and the said company-KAPL.

The petitioner also stated and highlighted the fact that due to some differences that had cropped up with KFI since January 2009, the petitioner’s husband was removed as the Managing Director of KAPL in September 2009 along with the petitioner herein. It was also stated that while the petitioner was a director during the financial year 2007-08, since the petitioner stood removed as such director in September 2009, she could not be held liable for the liability of KAPL for the financial year 2008-09 relevant to assessment year 2009-10. It was also stated that the petitioner was not at all aware after she had been removed that there was any tax liability which was due and payable by KAPL, and therefore, it was stated that she could not have been held guilty of any gross neglect, malfeasance or breach of duty on her part in relation to the affairs of the company.

The AO by virtue of the order impugned dated 22nd December, 2017 passed under section 179 of the Act rejected the contention of the petitioner. It was held that not only had the petitioner failed to establish that she was not actively involved in the management of the company during the financial year 2007-08 and 2008-09 and further that she had failed to establish that there was no gross neglect, malfeasance or breach of duty on her part. The AO held that there was not a ‘shred of doubt’ that she was actively involved in the day-to-day affairs of the company till she was removed in September 2009. As regards the disputes between the petitioner and KFI, the AO held that it was normal to have such disputes during the working of an enterprise.

The petitioner preferred a revision petition under section 264 of the Act against the said order, which too, came to be dismissed vide order dated 18th March, 2019 simply on the ground that the petitioner was a director for the relevant assessment years and hence was liable.

The petitioner urged that the entire approach adopted by the AO in passing the order under section 179 of the Act was misplaced and the mistake was perpetuated by the revisional authority in dismissing the revision petition filed by the petitioner against the said order. It was urged that the order passed by the AO was perverse in as much as based upon the facts on record no proceedings under section 179 of the Act could have been initiated against the petitioner for the purposes of recovery from the petitioner the liability of the company for the assessment years 2007-08 and 2008-09. It was urged that the petitioner had placed enough material on record reflecting that the petitioner was not the Managing Director of the company and was not at the helm of affairs as such. She did not have any independent authority to take any decision on behalf of the company nor did she have any independent operational control. Yet, the AO proceeded to hold that the petitioner had failed to prove that there was no gross neglect, malfeasance or breach of duty on her part in relation to the affairs of the company.

The Honourable Court observed that Section 179 of the Act inter-alia envisages that where any due from a private company in respect of any income of any previous year cannot be recovered, then every person who was a director of the private company at any time during the relevant previous year, shall be jointly and severally liable for the payment of such a tax; unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company. It therefore follows that if tax dues from a private company cannot be recovered then, the same can be recovered from every person who was a director of a private company at any time during the relevant previous year. However, such a director can absolve himself if he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty in relation to the affairs of the company.

The Honourable Court observed that in so far as the requirement of the first part of the section is concerned, it can be seen from the order passed under section 179 of the Act that steps were taken for recovery against the company M/s Kaizen Automation Pvt Ltd (KAPL) including attachment of its bank accounts which did not yield any results. The company is also stated to be not traceable on the addresses available with the AO, and therefore, according to the AO, the only course left was to proceed against the directors in terms of section 179 of the Act.

The stand of the petitioner is that she could not be proceeded against, in as much as there was no gross neglect, malfeasance or breach of duty on her part in relation to the affairs of the company. The AO, however, did not accept this assertion. It laid emphasis on the fact that the petitioner had actively participated in the affairs of the company at least till the date of her removal in September 2009 and proceeded to hold that the petitioner had failed to prove that there was any gross neglect, misfeasance or breach of duty on her part as regards the affairs of the company. However, in the order impugned dated 22nd December, 2017 passed under section 179 of the Act, although the AO did make a reference to various Board meetings attended by the petitioner from time to time from 2006 till 8th January, 2008, there was no material highlighted by the AO, contrary to the material on record placed by the petitioner, based upon which the petitioner could be held to be guilty of gross neglect, malfeasance or breach of duty in regard to the affairs of the company. The petitioner had brought on record material to suggest lack of financial control and decision making powers. She had a very limited role to play in the company as a director and that the entire decision making process was with the directors appointed by the investors, i.e., KFI which was the single largest shareholder of the JVC. She had sufficiently discharged the burden cast upon her in terms of section 179 to absolve herself of the liability of the company.

The Honourable Court observed that the AO appears to have applied himself more on the issue of the petitioner participating in the affairs of the company for purposes of pinning liability in terms of section 179; rather than discovering the element of ‘gross neglect’, misfeasance or ‘breach of duty’ on the part of the petitioner in relation to the affairs of the company and establishing its co-relation with non-recovery of tax dues. The petitioner, having discharged the initial burden, the AO had to show as to how the petitioner could be attributed such a gross neglect, misfeasance or breach of duty on her part.

Reliance was placed on Maganbhai Hansrajbhai Patel [2012] 211 Taxman 386 (Gujarat) and Ram Prakash Singeshwar Rungta & Ors [2015] 370 ITR 641 (Gujarat)
 
The Honourable Court held that in the present case, the AO has not specifically held the petitioner to be guilty of gross neglect, misfeasance or breach of duty on part in relation to the affairs of the company. Not a single incident, decision or action has been highlighted by the AO, which would be treated as an act of gross neglect, breach of duty or malfeasance which would have the remotest potential of resulting in non-recovery of tax due in future.

The order impugned dated 22nd December, 2017 as also the order dated 18th March, 2019 in revision passed was held to be unsustainable.

Search and seizure — Assessment in search cases — Cash credit — Assessment completed on the date of search — No incriminating document against the assessee found during the search — Long-term capital gains added as unexplained cash based on statement of the Managing Director of searched entity recorded under section 132(4) — Addition unsustainable.

8 Principal CIT vs. Suman Agarwal
[2023] 451 ITR 364 (Del)
A. Y.: 2011-12
Date of order: 28th July, 2022
Sections 68, 132 and 153A of ITA 1961

Search and seizure — Assessment in search cases — Cash credit — Assessment completed on the date of search — No incriminating document against the assessee found during the search — Long-term capital gains added as unexplained cash based on statement of the Managing Director of searched entity recorded under section 132(4) — Addition unsustainable.

Search and seizure operations were conducted under section 132 of the Income-tax Act, 1961 and survey operations were carried out under section 133A in the business and residential premises of one KRP and its group companies which provided bogus accommodation entries. The AO relied upon a letter and the statement recorded under section 132(4) of the Managing Director of KRP and issued a notice under section 153A against the assessee for the A. Y. 2011-12. He held that the amount of long- term capital gains claimed by the assessee in her return of income was an accommodation entry pertaining to shares of a company KGN and treated the amount as unexplained cash credit under section 68 of the Act.

The Tribunal found that there was no incriminating material against the assessee found during the search of the assessee and held that statements recorded under section 132(4) would not by themselves constitute as incriminating material in the absence of any corroborative evidence and accordingly set aside the addition made by the AO.

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

“i)    The Department had not placed on record any incriminating material which was found as a result of the search conducted u/s. 132. There was no reference to the company KGN in either the letter or the statement of the managing director of the company KRP in respect of which search was conducted u/s. 132(4). No other material found during the search pertaining to KGN had been placed on record.

ii)    There was no infirmity in the order passed by the Tribunal setting aside the addition made u/s. 68 by the Assessing Officer. No question of law arose.”

Validity of Reassessment Proceedings

ISSUE FOR CONSIDERATION

The scope and time limits for initiation of reassessment and the procedure of reassessment underwent a significant change with effect from 1st April, 2021, due to the amendments effected through the Finance Act, 2021. Through these amendments, sections 147, 148, 149 and 151 were replaced, and a new section 148A, laying down a new procedure to be followed before issue of notice under section 148, was inserted.

Till 31st March 2021, section 149 laid down the time limit for issue of notice for reassessment as under:

“149. (1) No notice under section 148 shall be issued for the relevant assessment year,—

(a) if four years have elapsed from the end of the relevant assessment year, unless the case falls under clause (b) or clause (c);

(b) if four years, but not more than six years, have elapsed from the end of the relevant assessment year unless the income chargeable to tax which has escaped assessment amounts to or is likely to amount to one lakh rupees or more for that year;

(c) if four years, but not more than sixteen years, have elapsed from the end of the relevant assessment year unless the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.

Explanation.—In determining income chargeable to tax which has escaped assessment for the purposes of this sub-section, the provisions of Explanation 2 of section 147 shall apply as they apply for the purposes of that section.”

The new section 149, effective 1st April, 2021, reads as under:

“149. (1) No notice under section 148 shall be issued for the relevant assessment year,—

(a) if three years have elapsed from the end of the relevant assessment year, unless the case falls under clause (b);

(b) if three years, but not more than ten years, have elapsed from the end of the relevant assessment year unless the Assessing Officer has in his possession books of account or other documents or evidence which reveal that the income chargeable to tax, represented in the form of asset, which has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year:

Provided that no notice under section 148 shall be issued at any time in a case for the relevant assessment year beginning on or before 1st day of April, 2021, if such notice could not have been issued at that time on account of being beyond the time limit specified under the provisions of clause (b) of sub-section (1) of this section, as they stood immediately before the commencement of the Finance Act, 2021:

Provided further that the provisions of this sub-section shall not apply in a case, where a notice under section 153A, or section 153C read with section 153A, is required to be issued in relation to a search initiated under section 132 or books of account, other documents or any assets requisitioned under section 132A, on or before the 31st day of March, 2021:

Provided also that for the purposes of computing the period of limitation as per this section, the time or extended time allowed to the assessee, as per show-cause notice issued under clause (b) of section 148A or the period during which the proceeding under section 148A is stayed by an order or injunction of any court, shall be excluded:

Provided also that where immediately after the exclusion of the period referred to in the immediately preceding proviso, the period of limitation available to the Assessing Officer for passing an order under clause (d) of section 148A is less than seven days, such remaining period shall be extended to seven days and the period of limitation under this sub-section shall be deemed to be extended accordingly.

Explanation: For the purposes of clause (b) of this sub-section, “asset” shall include immovable property, being land or building or both, shares and securities, loans and advances, deposits in bank account.”

The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (TOLA) was enacted to relax certain timelines and requirements, in the light of the COVID-19 pandemic and related lockdowns. Section 3(1) of that Act provided that where, any time-limit had been prescribed under a specified Act which falls during the period from 20th March, 2020 to 31st December, 2020, or such other date after 31st December, 2020, as the Central Government may notify, for the completion or compliance of such action as completion of any proceeding or passing of any order or issuance of any notice, intimation, notification, sanction or approval by any authority under the provisions of the specified Act; , and where completion or compliance of such action had not been made within such time, then the time-limit for completion or compliance of such action shall stand extended to 31st March, 2021, or such other date after 31st March, 2021, as the Central Government may notify. Pursuant to this, notifications were issued from time to time, whereby the time limits up to 31st March 2021 for issue of various notices (including notices under section 148) were extended till 30th June 2021.

Pursuant to such notifications under TOLA, a large number of notices for reassessment were issued from April to June 2021 under the old section 148 r.w.s 149. Many of these notices were challenged in writ petitions before the High Courts. Some High Courts had held that such notices issued after 31st March, 2021 under the old law were invalid, as they could only have been issued under the new law which became effective from April 2021 by following the procedure prescribed under section148A, within the timelines prescribed by section 149.

All cases were then consolidated and heard by the Supreme Court. The Supreme Court, in the case reported as Union of India vs. Ashish Agarwal 444 ITR 1, held that the notices issued under old section 148 to the respective assessees were invalid but should nonetheless be deemed to have been issued under newly inserted section 148A as substituted by the Finance Act, 2021 and treated to be show-cause notices in terms of section 148A (b). With this the Supreme court regularised the defaults of the AOs under the special powers of Article 142 of the Constitution of India. The AOs were directed to provide to the assessees the information and material relied upon by the revenue within 30 days, so that the assessees could reply to the notices within two weeks thereafter. The requirement of conducting any enquiry with the prior approval of the specified authority under section 148A(a) was dispensed with as a one-time measure vis-à-vis those notices which had been issued under the old provisions of section 148 prior to its substitution with effect from 1st April, 2021. The Supreme Court, at the same time directed that such regularised reassessment proceedings should in all cases be subjected to compliance of all the procedural requirements and the defences which might be available to the assessee under the substituted provisions of sections 147 to 151 and which may be available under the Finance Act, 2021 and in law.

Given the fact that these notices issued under old Section148 were deemed to be notices under section 148A(b), and orders under section 148A(d) were to be passed after completion of enquiry along with issue of notice under new Section 148, the issue has arisen about the applicable time limit in such cases – whether the time limits under the pre-amended section 149 apply or whether the time limits under the amended section 149 apply for issue of notice under new Section148. Accordingly, the question that has arisen for the courts is whether notices under the old Section 148 issued after 31st March. 2021, particularly for A.Ys. 2013-14 and 2014-15 and for A.Y. 2015-16 under the new section 148 pursuant to notices issued under the old section 148 are validly issued within the time prescribed in new section 149. While the Delhi High Court has taken the view that such notices were validly issued within the time extended by TOLA, the Allahabad and Gujarat High Courts have held that such notices were invalid as they were not issued within the permissible time limit prescribed under new law.

TOUCHSTONE HOLDINGS CASE

The issue first came up before the Delhi High Court in the case of Touchstone Holdings (P) Ltd vs. ITO 289 Taxman 462.

In this case, a notice under the pre-amended section 148 was issued on 29th June, 2021 for the A.Y. 2013-14 in respect of an item of purchase of shares of Rs 69.93 lakhs. Pursuant to the decision of the Supreme Court in the case of Ashish Agarwal (supra), proceedings continued under section 148A, and an order was finally passed under section 148A(d) on 20th July, 2022, with notice under the amended section 148 being issued on the same date. The assessee challenged this order and notice in a writ petition before the Delhi High Court.

Besides arguing that the assessee had no connection with the concerned transaction, on behalf of the assessee, it was argued that as per the first proviso to Section 149 of the Act (as amended by Finance Act, 2021), no notice for re-assessment could be issued for A.Y. 2013-14 as the time limit for initiating the proceedings expired on 30th March, 2020 as per the provisions of Section 149 (as it stood prior to its amendment by Finance Act, 2021). It was therefore contended that the proceedings pursuant to the notice dated 29th June, 2021 and the judgement of the Supreme Court in the case of Ashish Agarwal (supra), were time barred.

On behalf of the Revenue, it was submitted that Section 3 of TOLA applied to the pre-amended Section 149 and therefore the initial notice dated 29th June, 2021, and the proceedings taken in continuation as per the judgment of Ashish Agarwal (supra) were not time barred. Further submissions were made regarding the merits of the reassessment proceedings.

Examining the submissions on merits of the reassessment proceedings, the Delhi High Court held that these being disputed questions of fact, could not be adjudicated by it in writ proceedings. The Delhi High Court further held that the contention of the assessee that the present proceedings were time barred was not correct in the facts of the case, which pertained to A.Y. 2013-2014 and where reassessment proceedings were initiated during the time limit extended by TOLA. Examining the pre-amended provisions of Section 149, the Delhi High Court noted that the time limit for issuing notice under unamended Section 149, which was falling from 20th March, 2020 till 31st March 2021, was extended by Section 3 of TOLA read with Notification No. 20/2021 dated 31st March, 2021, and Notification No. 38/2021 dated 27th April, 2021, until 30th June, 2021.

The Delhi High Court noted that the initial notice in the proceedings before it was issued on 29th June, 2021 i.e. within extended time limit. The notice was quashed by the Delhi High Court following its judgment in Mon Mohan Kohli vs. ACIT 441 ITR 207, as the mandatory procedure of Section 148A was not followed before issuing the notice. In the judgment, the Delhi High Court had struck down Explanations A(a)(ii) and A(b) to the said notifications. However, the relevant portion of the notification, which extended the time limit for issuance of time barring reassessment notices until 30th June, 2021 was not struck down by the Court and in fact the Court categorically held at paragraph 98 that power of re-assessment that existed prior to 31st March 2021 stood extended till 30th June, 2021. The notice stood revived as a notice under section 148A(b) due to the decision of the Supreme Court in the case of Ashish Agarwal (supra).

In the view of the Delhi High Court, consequently, since the time period for issuance of reassessment notice for the A.Y. 2013-14 stood extended until 30th June, 2021, the first proviso of the amended Section 149 was not attracted in the facts of the case. Since the time limit for initiating assessment proceedings for A.Y. 2013-14 stood extended till 30th June, 2021, consequently, the reassessment notice dated 29th June, 2021, which had been issued within the extended period of limitation was not time barred.

The Delhi High Court also held that the challenge to paragraph 6.2.(i) of the CBDT Instruction No. 1/2022 dated 11th May, 2022 was not maintainable. The contention of the assessee that assessment for A.Y. 2013-14 became time barred on 31st March, 2020 was incorrect. The time period for assessment stood extended till 30th June, 2021.The initial reassessment notice for A.Y. 2013-14 had been issued to the petitioner within the said extended period of limitation. The Supreme Court had declared that the reassessment notice be deemed as a notice issued under section 148A of the Act and permitted Revenue to complete the said proceedings. The income alleged to have escaped assessment was more than Rs 50 lakhs and therefore, the rigour of Section 149 (1)(b) of the Act (as amended by the Finance Act, 2021) had been satisfied.

The Delhi High Court therefore dismissed the writ petition. This decision was subsequently followed by the Delhi High Court in the case of Kusum Gupta vs ITO 451 ITR 142.

RAJEEV BANSAL’S CASE

The issue came up again before the Allahabad High Court in the case of Rajeev Bansal vs. Union of India 147 taxmann.com 549.

A large number of writ petitions involving A.Ys. 2013-14 to 2017-18 were heard by the Allahabad High Court together. In all these cases, notice had been issued under the pre-amended section 148 between 1st April, 2021 to 30th June, 2021. Two legal issues were framed by the court, which would cover the issues involved in all the cases. These were:

(i) Whether the reassessment proceedings initiated with the notice under section 148 (deemed to be notice under section 148A), issued between 1st April, 2021 and 30th June, 2021, can be conducted by giving benefit of relaxation/extension under TOLA upto 30th March, 2021, and then the time limit prescribed in Section 149(1)(b) (as substituted w.e.f. 01st April, 2021) is to be counted by giving such relaxation benefit of TOLA from 30th March, 2020 onwards to the revenue.

(ii) Whether in respect of the proceedings where the first proviso to Section 149(1)(b) is attracted, benefit of TOLA will be available to the revenue, or in other words, the relaxation law under TOLA would govern the time frame prescribed under the first proviso to Section 149 as inserted by the Finance Act, 2021, in such cases?

For the A.Ys. 2013-14 and 2014-15, it was argued by the counsels for the assessees that the assessment for these years cannot be reopened, in as much as, maximum period of six years prescribed in pre-amendment provision of Section 149(1)(b) had expired on 31st March, 2021. No notice under section 148 could be issued in a case for the A.Y. 2013-14 and 2014-15 on or after 01st April, 2021, being time barred, on account of being beyond the time limit specified under the provisions of Section 149(1)(b) as they stood immediately before the commencement of the Finance Act 2021. For the A.Ys. 2015-16, 2016-17, 2017-18, it was contended that the monetary threshold and other requirements of the Income Tax Act in the post-amendment regime, i.e. after the commencement of the Finance Act, 2021 have to be followed. The validity of the jurisdictional notice under section 148 was thus to be tested on the touchstone of compliances or fulfilment of requirements by the revenue as per Section 149(1)(b) and the first proviso to Section 149(1) inserted by the amendment under the Finance Act 2021, w.e.f. 1st April, 2021.

The Allahabad High Court noted that it was undisputed that the notices issued under the pre-amendment section 148 were to be regarded as notices issued under section 148A(b). The High Court analysed the provisions of the pre-amended section 148, the provisions of TOLA and the notifications issued under TOLA. It also analysed the history of the litigation in this regard, commencing from its decision in the case of Ashok Kumar Agarwal vs. Union of India 131 taxmann.com 22 and ending with the Supreme Court decision in the case of Ashish Agarwal (supra). The Allahabad High Court thereafter took note of the CBDT instruction No. 1 of 2022, dated 11th May, 2022, for implementation of the judgement of the Supreme Court in Ashish Agarwal (supra).

The Allahabad High Court thereafter noted the arguments on behalf of the assessees as under:

(i)    After the amendment brought by the Finance Act, 2021, new/amended provisions will apply to reassessment proceedings.

(ii)    TOLA will not extend the time limit provided for initiation of reassessment proceedings under the amended Sections 147 to 151 from 1st April, 2021 onwards.

(iii)    The result is that the revenue has to comply with all the requirements of the substituted/amended provisions of Sections 147 to 151A in the reassessment proceedings, initiated on or after 1st April, 2021. All compliances under the amended provisions will have to be made by the revenue.

(iv)    Simultaneously, all defences under the substituted/amended provisions will be available to the assessee.

(v)    About the impact of TOLA on the amendment by the Finance Act, 2021, no time extension under section 3(1) of TOLA can be granted in the time limit provided under the substituted provisions. Section 3(1) of TOLA saved only the reassessment proceeding as they existed under the unamended law.

(vi)    The scheme of assessment underwent a substantial change with the enforcement of the Finance Act, 2021. The general provisions of TOLA cannot vary the requirements of the Finance Act, 2021, which is a special provision, as the special overrides general.

(vii)    Reassessment notice under section 148 can be issued only upon the jurisdiction being validly assumed by the assessing authority, for which the compliances of substituted provisions of Sections 149 to 151A have to be made by the revenue.

(viii)    New/amended provisions are beneficial in nature for the assessee and provide certain pre-requisite conditions/monetary threshold, etc. to be adhered to by the revenue to issue jurisdictional notice under section 148. The revenue has to meet a higher threshold to discharge a positive burden because of the substantive changes made in the new regime.

(ix)    The pre-requisite conditions to issue notice under section 148 in the pre and post amendment regime demonstrate that for the reassessment notice after elapse of the period of 3 years but before 10 years from the end of the relevant assessment year, notice under section 148 cannot be issued unless the AO has in his possession books of accounts or other documents or evidence which reveal that the income chargeable to tax, represented in the form of assets, which has escaped assessment, amount to or is likely to amount to Rs.50 lakhs or more for that year.

(x)    The monetary threshold for opening of assessment after elapse of three years for the period upto ten years has, thus, been put in place.

(xi)    Further, first proviso to sub-section (1) of Section 149 has been placed to assert that the cases wherein notices could not have been issued within the period of six years as per clause (b) of sub-section (1) of Section 149 under the pre-amendment provision, reassessment notices cannot be issued on or after 1st April, 2021 after the commencement of the Finance Act, 2021, as such cases have become time barred.

(xii)    Such cases cannot be reopened by giving an extension in the time limit by applying the provisions of TOLA.

(xiii)    The Finance Act, 2021 had limited the applicability of TOLA and after amendment, the compliances/conditions under the amended provisions have to be fulfilled.

(xiv)    The Apex Court in Ashish Agarwal (supra) has categorically provided that all defences available to the assessee including those under section 149 and all rights and contentions available to the concerned assessee and revenue under the Finance Act, 2021 and in law, shall continue to be available. The effect of the said observation is that the Revenue though may be able to maintain the notices issued under the unamended Section 148, as preliminary notices under section 148-A as inserted by the Finance Act, 2020, but for issuance of jurisdictional notice under section 148, the requirements of the amended Section 149 under the Finance Act, 2021 have to be fulfilled.

(xv)    TOLA was enacted by the Parliament to deal with the contingency and the extension of time limit under section 3(1) of TOLA and was contemplated not to remain in perpetuity. TOLA had only substituted the limitation that was expiring. The extension under TOLA for the A.Y. 2015-16, 2016-17, 2017-18 was not permissible as the time limit for reopening of assessment proceedings for the said assessment years even under the unamended Section 149 was not expiring at the time of enforcement of the Enabling Act (TOLA 2020).

(xvi)    The findings returned by the Division Bench and the Apex Court as noted above were reiterated that the relaxation granted by the Apex Court to consider Section 148 notices under the unamended Act as preliminary notices issued under Section 148A as inserted by the Finance Act, 2021, was a one time measure treating them as a bona fide mistake of the Revenue. However, it is evident from the said finding that the provisions of the Finance Act, 2021 have to be given their full effect.

(xvii)    TOLA cannot infuse life into the pre-existing law to provide an extension of time to the Revenue in the time limit therein, to reopen cases for the assessment years which have become time barred under the first proviso to Section 149.

(xviii)    As regards Instruction No 1 of 2022, executive instructions cannot limit or extend the scope of the Act or cannot alter the provisions of the Act. Instructions or Circular cannot impose burden on a tax payer higher than what the Act itself as a true interpretation envisages.

(xix)    The direction issued in (clause 6.1, in third bullet point) that the decision of the Apex Court read with the time extension provided by TOLA, will allow extended reassessment notices to travel back in time to their original date when such notices were to be issued and then new Section 149 is to be applied at that point, is based on the wrong interpretation of the judgement of the Apex Court and the High Court. In clause 6.2 (i) of the Circular, it is provided that reassessment notices for A.Ys. 2013-14 and 2014-15 can be issued with the approval of the specified authority, if the case falls under clauses (b) of sub section (1) of Section 149 amended by the Finance Act, 2021. By issuing such instructions contained in clauses 6.1 and 6.2 of the Circular dated 11th May, 2022, the CBDT has devised a novel method to revive the reassessment proceedings which otherwise became time barred under the amended Section 149, specifically for the A.Ys. 2013-14 and 2014-15 being beyond the time limit specified under the provisions of unamended clause (b) of sub section (1) of section 149.

(xx)    Reference was made to the Bombay High Court decision in Tata Communications Transformation Services Ltd vs ACIT 443 ITR 49 for the proposition that section 3(1) of TOLA does not provide that any notice issued under section 148 after 31st March, 2021 will relate back to the original date when it ought to have been issued or that the clock is stopped on 31st March, 2021 such that the provisions as existing on the said date will be applicable to notices issued thereafter, relying on the provisions of TOLA. It was observed therein that the purpose of Section 3(1) of TOLA is not to postpone or extend the applicability of the unamended provisions of the IT Act. Observations were made by the Bombay High Court therein that TOLA is not applicable for A.Y. 2015-16 or any subsequent year as the time limit to issue notice under section 148 for these assessment years was not expiring within the period for which Section 3(1) of TOLA was applicable and hence TOLA could not apply for these assessment years. As a consequence, there can be no question of extending the period of limitation for such assessment years, where the revenue could have issued notice of reassessment by complying with the requirements of the unamended provisions. In a case where the revenue did not initiate proceedings within the time limit under the unamended IT Act extended by TOLA, further extensions for inaction of the revenue cannot be granted by the notifications issued under TOLA on 31st March, 2021 or thereafter, once the amendments have been brought into place on 1st April, 2021, to extend the time limit under the unamended provisions.

On behalf of the Revenue, it was pointed out that TOLA was enacted to provide relaxation of the time limit provided in the Specified Acts, including the IT Act. Issuance of notice under section 148 as per the prescribed time limit in Section 149 was permissible until 30th June, 2021. It was argued that the notices issued on or after 1st April, 2021 under section 148, for reassessment were issued in accordance with the substituted laws and not as per the pre-existing laws and TOLA was only applied for extension in the timeline. TOLA has overriding effect over the IT Act, and will extend the time limit for issue of notice/action under the IT Act. The extension of time granted by TOLA would save all notices issued on or after 1st April, 2021.

It was claimed on behalf of the Revenue that only the time limit for various action/compliances/issuance of notices had been changed in the Finance Act, 2021. In any case, timelines remained under both the enactments, pre and post amendment. The reassessment notices would have been barred by time had there been no extension of the time limit under the IT Act by TOLA. The applicability of Explanation to Clause A(a) of the notification dated 31st March, 2021 and Explanation to clause A(b) of the notification dated 27.4.2021, may have been restricted to reassessment proceedings as in existence on 31.3.2021 and have been read down as applicable to the pre-existing Section 147 to 151-A, but the substantive provisions of extension of time for action/compliances/issuance of notice of the notifications dated 31st March, 2021 and 27th April, 2021, still survive.

It was argued that in Ashok Kumar Agarwal’s case, the explanations which provided that for the notices issued after 1st April, 2021, the time line under the pre-existing provisions would apply, had been held to be offending provisions, but the Allahabad High Court had left it open to the respective assessing authorities to initiate reassessment proceedings in accordance with the amended provisions by the Finance Act, 2021. The extension in time until 30th June, 2021 as granted by the notifications dated 31st March, 2021 and 27th April, 2021 would, thus, apply to the timeline provided under the amended provisions brought by the Finance Act, 2021.

It was submitted that when two Parliamentary Acts were on the statute book, one providing substantive provisions and procedure for initiating reassessment proceeding and the other granting extension of time for action/compliances/issuance of notices under the substantive and procedural provisions of the IT Act, a harmonious construction of both the provisions had to be made. Thus, whatever time limit was provided under the IT Act as on 1st April, 2021, the same had to be extended until 30th June, 2021 to enable the revenue to initiate and process the reassessment proceedings under section 148 as amended by the Finance Act, 2021.

It was argued that in view of the decision of the Apex Court in saving all notices issued by the revenue pan-India by treating them as notices under section 148-A of the amended provisions, all actions of the revenue subsequent to the issuance of notices under section 148-A in compliance of the directions of the Apex Court would have to be saved. The reference to the date of issuance of Section 148 notices, which were quashed by different High Courts, thus, has to be the date of notices under section 148-A of the amended provisions and extension of time, for compliances prescribed under the amended provisions, has to be granted to the revenue, accordingly. As observed by the Apex Court, when all defences remain available to the assessee, all rights of the revenue will have to be preserved/made available.

It was urged that even the Division Bench in Ashok Kumar Agarwal’s case (supra) had recognised that TOLA plainly was an enactment to extend timelines. Consequently, from 1st April, 2021 onwards, all references to issuance of notices contained in TOLA must be read as references to the substituted provisions only. The Allahabad High Court had observed that there was no difficulty in applying the pre-existing provisions to pending proceedings and then proceeded to harmonize the two laws. It was argued that giving this plain and simple meaning to TOLA, the extensions in time limit which were available to the revenue until 31st March, 2021 under TOLA, became available to the revenue after 1st April, 2021 by the Notification No.20 of 2021 dated 31st April, 2021 and the Notification No.38 dated 2th April, 2021, which had not been quashed or held invalid by the High Court or the Apex Court. Thus, extension of three months until 30th June, 2021 in the time limit provided under the IT Act, whether pre or post amendment, had to be granted. The time limit provided in the amended Section 149 of three years and 10 years had to be extended until 30th June, 2021, by virtue of the notifications issued under section 3(1) of TOLA. It was argued that the CBDT Instruction only clarifies the above position of the two provisions – that the time extension provided by TOLA will allow “extended reassessment notices” to travel back in time to their original date when such notices were to be issued, and then the new Section 149 is to be applied at that point of time.

It was submitted that based on the said logic, the “extended reassessment notices” for the A.Ys. 2013-14, 2014-15 and 2015-16 were to be dealt with by issuance of fresh notice under amended Section 148, with the approval of the specified authority, in the cases which fall under clause (b) of Section 149(1) as amended by the Finance Act, 2021. It is further clarified in the CBDT instruction that the specified authority under section 151 of the amended provisions shall be the authority prescribed under clause (ii) of that section. Similarly, for A.Y. 2016-17 and A.Y. 2017-18, fresh notice under Section 148 can be issued with the approval of the specified authority under clause (a) of amended Section 149(1), as they are within the period of three years from the end of the relevant assessment years, because of the extension of time by TOLA.

On behalf of the Revenue, reliance was placed on the decision of the Delhi High Court in the case of Touchstone Holdings (supra), which had relied on the earlier decision of the Delhi High Court in the case of Mon Mohan Kohli vs. ACIT (supra), and had held that with the declaration by the Apex Court that the reassessment notice issued on or after 1st April, 2021 shall be deemed to be the notice under section 148-A, the Revenue was permitted to complete the reassessment proceedings in accordance with the amended provisions of Section 149.

A specific query was raised by the Bench to the revenue to answer the effect of the first proviso to Section 149(1) of the amended provisions inserted by the Finance Act, 2021 which prohibits issuance of notice under section 148, in a case where it has become time barred under the unamended (pre-existing) clause (b) of Section 149(1). The answer on behalf of the revenue was that time limit of 6 years provided in clause (b) of Section 149(1) stood extended by virtue of TOLA until 31st March, 2021, and further extensions in the time limit (of six years) are to be granted under the notifications issued under section 3(1) of TOLA until 30th June, 2021. The result would be that the cases for the A.Ys. 2013-14 and 2014-15, where the period of six years had expired on 31st March, 2020 and 31st March, 2021 respectively, would not be hit by the first proviso to Section 149(1) brought by the Finance Act, 2021. The cases for these assessment years had to be evaluated and the reassessment proceedings had to be conducted for them in accordance with clause (b) of Section 149(1) as amended by the Finance Act, 2021, being beyond the period of three years but within the limitation of ten years. Similarly, for the A.Y. 2015-16, on the expiry of three years on 31st March, 2019, the extension until 30th June, 2021 is to be granted to bring the reassessment proceedings under amended clause (b) of Section 149(1). For the A.Ys. 2016-17 and 2017-18, where the period of three years had expired on 31st March, 2020 and 31st March, 2021 respectively, the extension in the time limit of three years was to be granted under TOLA and these cases would fall under the amended clause (a) of Section 149(1), being within the prescribed limit of three years until 30th June, 2021.

The Allahabad High Court noted the summary of its observations in the case of Ashok Kumar Agarwal (supra) as under:

(i)    By its very nature, once a new provision has been put in place of the pre-existing provision, the earlier provision cannot survive, except for the things done or already undertaken to be done or things expressly saved to be done.

(ii)    In absence of any saving clause to save pre-existing provisions, the revenue authorities could only initiate proceeding on or after 1st April, 2021, in accordance with the substituted laws and not the pre-existing laws. TOLA, that was pre-existing, confronted the IT Act as amended by the Finance Act, 2021, as it came into existence on 1st April, 2021. In both the provisions, i.e. TOLA and the Finance Act, 2021, there is absence, both of any express provision in its effort to delegate the function, to save the applicability of provisions of pre-existing Sections 147 to 151, as they existed up to 31st March, 2021.

(iii)    Plainly, TOLA is an enactment to extend timelines only from 1st April, 2021 onwards. Consequently, from 1st April, 2021 onwards all references to issuance of notice contained in TOLA must be read as reference to the substituted provisions only.

(iv)    There is no difficulty in applying pre-existing provisions to pending proceedings and, this is how, the laws were harmonized.

(v)    For all reassessment notices which had been issued after 1st April, 2021, after the enforcement of amendment by the Finance Act, 2021, no jurisdiction has been assumed by the assessing authority against the assesses under the unamended law. No time extension could, thus, be made under section 3(1) of TOLA read with the notifications issued thereunder.

(vi)    Section 3 of TOLA only speaks of saving or protecting certain proceedings from being hit by the rule of limitation. That provision also does not speak of saving any proceeding from any law that may be enacted by the Parliament, in future. The non-obstante clause of Section 3(1) of TOLA does not govern the entire scope of the said provision. It is confined to and may be employed only with reference to the second part of Section 3(1) of TOLA, i.e. to protect the proceedings already underway. The Act, thus, only protected certain proceedings that may have become time barred on 30th March, 2021 up to the date 30th June, 2021. Correspondingly, by delegated limitation incorporated by notifications, the Government may extend that time limit. That timeline alone stood extended up to 30th June, 2021.

(vii)    Section 3(1) of TOLA does not itself speak of the reassessment proceeding or Section 147 or Section 148 as it existed prior to 1st April, 2021. It only provides a general relaxation of limitation granted on account of the general hardship existing upon the spread of pandemic COVID-19. After the enforcement of the Finance Act, 2021, it applies to the substituted provisions and not the pre-existing provisions.

The reference to reassessment proceedings with respect to pre-existing and new substituted provisions of Sections 147 and 148 has been introduced only by the later notifications issued under TOLA. It was concluded that in absence of any proceedings of reassessment having been initiated prior to the date 1st April, 2021, it is the amended law alone that would apply. The notifications issued by the Central Government or the CBDT Instructions could not have been issued plainly to over reach the principal legislation. Unless harmonised as such, those notifications would remain invalid.

(viii)    On the submission of the revenue that practical difficulties faced by the revenue in initiation of reassessment proceedings due to onset of pandemic COVID-19 dictates that the reassessment proceedings be protected, it was noted that practicality, if any, may lead to litigation. Once the matter reaches the Court, it is the legislation and its language and the interpretation offered to that language as may primarily be decisive to govern the outcome of the proceedings. To read practicality into enacted law is dangerous.

(ix)    It would be oversimplistic to ignore the provisions of, either TOLA or the Finance Act, 2021 and to read and interpret the provisions of Finance Act, 2021 as inoperative in view of the facts and circumstances arising from the spread of the pandemic Covid-19.

(x)    In absence of any specific clause in the Finance Act, 2021 either to save the provisions of TOLA or the notifications issued thereunder, by no interpretative process can those notifications be given an extended run of life, beyond 31st March, 2021.

(xi)    The notifications issued under TOLA may also not infuse any life into a provision that stood obliterated from the statute book w.e.f. 31st March, 2021, in as much as, the Finance Act, 2021 does not enable the Central Government to issue any notification to reactivate the pre-existing law, which has been substituted by the principal legislature. Any such exercise made by the delegate/Central government would be dehors any statutory basis.

(xii)    In absence of any express saving of the pre-existing laws, the presumption drawn in favor of that saving, is plainly impermissible.

(xiii)    No presumption exists by the notifications issued under TOLA that the operation of the pre-existing provisions of the Act had been extended and thereby provisions of Section 148A (introduced by the Finance Act, 2021) and other provisions had been deferred.

On these grounds, in Ashok Kumar Agarwal’s case, the Allahabad High Court had quashed the reassessment notices, leaving it open to the respective assessing authorities to initiate reassessment proceedings in accordance with the provisions of the IT Act as amended by the Finance Act, 2021 after making all compliances, as required by law.

The Allahabad High Court then summarized the Supreme Court findings in Ashish Agarwal’s case (supra) as under:

(I)    By substitution of Sections 147 to 151 by the Finance Act, 2021, radical and reformative changes are made governing the procedure for reassessment proceedings. Under pre-Finance Act, 2021, the reopening was permissible for a maximum period up to 6 years and in some cases beyond even 6 years leading to uncertainty for considerable time. Therefore, the Parliament thought it fit to amend the Income Tax Act to simplify the Tax Administration, ease compliances and reduce litigation. To achieve the said object, by the Finance Act, 2021, Sections 147 to 149 and Section 151 have been substituted.

(II)    Section 148(A) is a new provision, which is in the nature of a condition precedent. Introduction of Section 148A can, thus, be said to be a game changer with an aim to achieve ultimate object of simplifying the tax administration. By way of Section 148A, the procedure has now been streamlined and simplified. All safeguards are, thus, provided before issuing notice under section 148. At every stage, the prior approval of the specified authority is required, even for conducting the inquiry as per Section 148(A)(a).

(III)    Substituted Section 149 is the provision governing the time limit for issuance of notice under section 148. The substituted Section 149 has reduced the permissible time limit for issuance of such a notice to three years and, only in exceptional cases, in ten years. It also provides further additional safeguards which were absent under the earlier regime pre-Finance Act, 2021.

(IV)    The new provisions substituted by the Finance Act, 2021, being remedial and benevolent in nature and substituted with a specific aim and object to protect the rights and interest of the assesses as well as and the same being in public interest, the respective High Courts have rightly held that the benefit of new provisions shall be made applicable even in respect of the proceedings related to past assessment years, provided Section 148 notice has been issued after 1st April, 2021.

The Supreme Court had therefore confirmed the view taken by the High Courts, including by the Allahabad High Court in the case of Ashok Kumar Agarwal (supra). However, the Supreme Court had further observed that:

I)    The judgments of several High Courts would result in no assessment proceedings at all, even if the same are permissible under the Finance Act, 2021 as per substituted Sections 147 to 151. To remedy the situation where revenue became remediless, in order to achieve the object and purpose of reassessment proceedings, it was observed that the notices under section 148 after the amendment was enforced w.e.f 1st April, 2021, were issued under the unamended Section 148, due to bonafide mistake in view of the subsequent extension of time by various notifications under TOLA.

II)    The notices ought not to have been issued under the unamended Act and ought to have been issued under the substituted provisions of Sections 147 to 151 as per the Finance Act, 2021.

III)    There appears to be a genuine non application of the amendments as the officers of the revenue may have been under a bona fide belief that the amendments may not yet have been enforced.

The Supreme Court therefore held that:

“Instead of quashing and setting aside the reassessment notices issued under the unamended provisions of IT Act, the High Courts ought to have passed order construing the notices issued under the unamended Act/unamended provision of the IT Act as those deemed to have been issued under Section 148(A) of the Income Tax Act, as per the new provision of Section 148(A). In that case, the revenue ought to have been permitted to proceed with the reassessment proceedings as per the substituted provisions of Sections 147 to 151 of the Income Tax Act as per the Finance Act, 2021, subject to compliance of all the procedural requirements and the defences which may be available to the assessee under the substituted provisions of Section 147 to 151 of the Income Tax Act, and which may be available under the Finance Act, 2021 and in law.”

The Allahabad High Court observed that while passing the order, it was noted by the Apex Court that there was a broad consensus on the proposed modification on behalf of the revenue and the counsels appearing on behalf of respective assessees.

The Allahabad High Court noted that in Ashok Kumar Agarwal’s case, it had held that if the Finance Act, 2021 had not made the substitution of the reassessment procedure, revenue authorities would have been within their rights to claim extension of time, under TOLA. The sweeping amendments made by the Parliament by necessary implication or implied force limited applicability of TOLA. The power to grant time extension thereunder was limited to only such reassessment proceedings as had been initiated till 31st March, 2021. It was also held that in absence of any specific clause in the Finance Act, 2021 either to save the provisions of TOLA or the Notifications issued thereunder, by no interpretative process, the notifications could be said to infuse life into a provision that stood obliterated from the Statute book w.e.f 31st March, 2021. It was held that the Finance Act, 2021 did not enable the Central Government to issue any notification to reactivate the pre-existing law, the exercises made by the delegate/Central Government would be dehors any statutory basis. It was, thus, categorically held by the Division Bench that the notifications did not insulate or save the pre-existing provisions pertaining to reassessment under the Act and that the operation of the pre-existing provisions of the Act could not be extended.

The Allahabad High Court noted that the contention of the revenue, if accepted, would create conflict of laws. The limitation under the pre-existing provisions would have to be kept alive till 30th June, 2021 with the aid of the extensions granted by the notifications issued by the Central Government, which had been read down by the Co-ordinate Division Bench in Asok Kumar Agarwal’s case. As per the Division Bench judgment, the time limit provided in unamended Section 149, could not be extended beyond 31st March, 2021, so as to render the amended provisions of Section 149 ineffective. The stand of the revenue that TOLA simply extended the period of limitation until 30th June, 2021, due to the disturbances from the spread of pandemic COVID-19, had been categorically turned down by the Division Bench in Ashok Kumar Agarwal’s case (supra) with the above observations.

The Allahabad High Court observed that there was a substantial change in the threshold/requirements which had to be met by the revenue before issuance of reassessment notice after elapse of three years under clause (b) of Section 149(1). Not only monetary threshold had been substituted but the requirement of evidence to arrive at the opinion that the income escaped assessment has also been changed substantially. A heavy burden was cast upon the revenue to meet the requirements of clause (b) of Section 149(1) for initiation of reassessment proceedings after lapse of three years.

Analysing the first proviso to Section 149(1), the Allahabad High Court observed that the time limit in clause (b) of unamended Section 149(1) of six years, thus, cannot be extended up to ten years under clause (b) of amended Section 149(1), to initiate reassessment proceeding in view of the first proviso to Section 149(1). In other words, the case for the relevant assessment year where six years period has elapsed as per unamended clause (b) of Section 149(1) cannot be reopened after commencement of the Finance Act, 2021 w.e.f. 1st April, 2021.

The view in Ashok Kumar Agarwal’s case (supra) that after 1st April, 2021, if the rule of limitation permitted, the revenue could initiate reassessment proceedings in accordance with the new law, after making adequate compliances, had been upheld by the Apex Court in Ashish Agarwal’s case (supra). According to the Allahabad High Court, in case the arguments of the revenue were accepted, the benefits provided to the assessee in the substantive provisions of clause (b) of Section 149(1) and the first proviso to Section 149 had to be ignored or deferred. The defences which may be available to the assessee under section 149 and/or which may be available under Finance Act, 2021 had to be denied.

At the first blush, the argument of the revenue seemed convincing by simplistic application of TOLA, treating it as a statute for extension in the limitation provided under the IT Act, but on a deeper scrutiny, if the argument of the revenue were accepted, it would render the first proviso to Section 149(1) ineffective until 30th June, 2021 and otiose. This view, if accepted, would result in granting extension of time limit under the unamended clause (b) of Section 149, in cases where reassessment proceedings had not been initiated during the lifetime of the unamended provisions, i.e. on or before 31st March, 2021. It would infuse life in the obliterated unamended provisions of clause (b) of Section 149(1), which was dead and removed from the Statute book w.e.f. 1st April, 2021, by extending the timeline for actions therein.

According to the Allahabad High Court, in absence of any express saving clause, in a case where reassessment proceedings had not been initiated prior to the legislative substitution by the Finance Act, 2021, the extended time limit of unamended provisions by virtue of TOLA cannot apply. In other words, the obligations upon the revenue under clause (b) of amended Section 149(1) cannot be relaxed. The defences available to the assessee in view of the first proviso to Section 149(1) could not be taken away. The notifications issued by the delegates/Central Government in exercise of powers under Section 3(1) of TOLA could not infuse life in the unamended provisions of Section 149 by this way.

The Allahabad High Court addressed the argument of the revenue that this interpretation would render TOLA otiose, though it had not been declared invalid by any court, by stating that this argument was misconceived, as the extensions in the time limit under the unamended Sections of the IT Act prior to the amendment by the Finance Act, 2021, would still be applicable to the reassessment proceedings as may have been in existence on 31st March, 2021.

Referring to the CBDT Instruction No 1 of 2022, the Allahabad High Court found that that the third bullet to clause (6.1) which stated that the Apex Court had allowed time extension provided by TOLA and the “extended reassessment notices” will travel back in time to their original date when such notices were to be issued and then Section 149 is to be applied at that point, was a surreptitious attempt to circumvent the decision of the Apex Court. The Supreme Court observations had been given in piecemeal in that bullet to give it a distorted picture. As per the Allahabad High Court, terming reassessment notices issued on or after 1st April, 2021 and ending with 30th June, 2021 as “extended reassessment notices”, within the time extended by TOLA and various notifications issued thereunder, in Para 6.1 was an effort of the revenue to overreach the judgment of that Court in Ashok Kumar Agarwal (supra) as affirmed by the Apex court in Ashish Agarwal (supra).

In any case, the Allahabad High Court observed that this instruction, as per the Revenue itself, was only a guiding instruction – the instructions in the third bullet to clause 6.1 and clauses 6.2(i) and (ii), being contrary to the decision of the Supreme Court, had no binding force.

Referring to the Delhi High Court decision in Touchstone Holdings (supra), the Allahabad High Court observed that the view taken therein was in direct conflict with the view taken by the Allahabad High Court in Ashok Kumar Agarwal (supra) affirmed by the Apex Court in Ashish Agarwal (supra). In fact, the observation in Mon Mohan Kohli (supra) by the Delhi High Court in paragraph ‘98’ that the power of reassessment that existed prior to 31st March, 2021 continued to exist till the extended period, i.e. till 3th June, 2021, and the Finance Act, 2021 had merely changed the procedure to be followed prior to issuance of notice w.e.f. 1st April, 2021, had been misread and misapplied in Touchstone (supra) by the Division Bench of the Delhi High Court. Even in Mon Mohan Kohli’s case (supra), the Delhi High Court had quashed the reassessment notices issued on or after 1st April, 2021 on the grounds that TOLA did not give power to the Central Government to extend the erstwhile Sections 147 to 151 beyond 31st March, 2021 and/or defer the operation of substituted provisions enacted by the Finance Act, 2021. In fact, in Mon Mohan Kohli’s case (supra), the Delhi High Court had concurred with the Allahabad High Court view in Ashok Kumar Agarwal’s case (supra).

The Allahabad High Court observed that it was a settled law that a taxing statute must be interpreted in the light of what was clearly expressed. It was not permissible to import provisions in a taxing statute so as to supply any assumed deficiency. In interpreting a taxing statute, equitable considerations are out of place. Nor can taxing statutes be interpreted on any presumptions or assumptions. The court must look squarely at the words of the statute and interpret them. Taxing statute would need to be interpreted in the light of what is clearly expressed. It cannot imply anything which is not expressed. Before taxing any person it must be shown that he falls within the ambit of the charging section by clear words used in the section, and if the words are ambiguous and open to two interpretations, the benefit of interpretation is given to the subject. There is nothing unjust in the taxpayer escaping if the letter of the law fails to catch him on account of the legislature’s failure to express itself clearly.

The Allahabad High Court therefore held that:

(i)    The reassessment proceedings initiated with the notice under section 148 (deemed to be notice under section 148-A), issued between 1st April, 2021 and 30th June, 2021, could not be conducted by giving benefit of relaxation/extension under TOLA up to 30th March, 2021, and the time limit prescribed in Section 149(1)(b) (as substituted w.e.f. 01st April, 2021) cannot be counted by giving such relaxation from 30th March, 2020 onwards to the Revenue.

(ii)    In respect of the proceedings where the first proviso to Section 149(1)(b) is attracted, benefit of TOLA will not be available to the revenue, or in other words, the relaxation law under TOLA would not govern the time frame prescribed under the first proviso to Section 149 as inserted by the Finance Act, 2021, in such cases.

A similar view was taken by the Gujarat High Court in the case of Keenara Industries (P) Ltd vs. ITO 147 taxmann.com 585, where the Gujarat High Court held that the reassessment notices for A.Ys. 2013-14 and 2014-15, which had become time-barred prior to 1st April, 2021 under the old regime on expiry of 6 years limitation period, could not be revived by TOLA/extension of time notification issued under TOLA. Therefore, reassessment notices for A.Ys. 2013-14 and 2014-15 could not be issued on or after 1st April, 2021 under the new regime effective from 1st April, 2021 even within the extended time-limit of 1st April, 2021 to 30th June, 2021 applicable under the TOLA Notifications.

OBSERVATIONS

In Ashish Agarwal’s case, the Supreme Court had held:

“ 8.However, at the same time, the judgments of the several High Courts would result in no reassessment proceedings at all, even if the same are permissible under the Finance Act, 2021 and as per substituted sections 147 to 151 of the IT Act. The Revenue cannot be made remediless and the object and purpose of reassessment proceedings cannot be frustrated. It is true that due to a bonafide mistake and in view of subsequent extension of time vide various notifications, the Revenue issued the impugned notices under section 148 after the amendment was enforced w.e.f. 01.04.2021, under the unamended section 148. In our view the same ought not to have been issued under the unamended Act and ought to have been issued under the substituted provisions of sections 147 to 151 of the IT Act as per the Finance Act, 2021. There appears to be genuine non-application of the amendments as the officers of the Revenue may have been under a bonafide belief that the amendments may not yet have been enforced. Therefore, we are of the opinion that some leeway must be shown in that regard which the High Courts could have done so. Therefore, instead of quashing and setting aside the reassessment notices issued under the unamended provision of IT Act, the High Courts ought to have passed an order construing the notices issued under unamended Act/unamended provision of the IT Act as those deemed to have been issued under section 148A of the IT Act as per the new provision section 148A and the Revenue ought to have been permitted to proceed further with the reassessment proceedings as per the substituted provisions of sections 147 to 151 of the IT Act as per the Finance Act, 2021, subject to compliance of all the procedural requirements and the defences, which may be available to the assessee under the substituted provisions of sections 147 to 151 of the IT Act and which may be available under the Finance Act, 2021 and in law. Therefore, we propose to modify the judgments and orders passed by the respective High Courts as under:

(i)    The respective impugned section 148 notices issued to the respective assessees shall be deemed to have been issued under section 148A of the IT Act as substituted by the Finance Act, 2021 and treated to be show-cause notices in terms of section 148A(b). The respective assessing officers shall within thirty days from today provide to the assessees the information and material relied upon by the Revenue so that the assessees can reply to the notices within two weeks thereafter;

(ii)    The requirement of conducting any enquiry with the prior approval of the specified authority under section 148A(a) be dispensed with as a one-time measure vis-à-vis those notices which have been issued under Section 148 of the unamended Act from 01.04.2021 till date, including those which have been quashed by the High Courts;

(iii)    The assessing officers shall thereafter pass an order in terms of section 148A(d) after following the due procedure as required under section 148A(b) in respect of each of the concerned assessees;

(iv)    All the defences which may be available to the assessee under section 149 and/or which may be available under the Finance Act, 2021 and in law and whatever rights are available to the Assessing Officer under the Finance Act, 2021 are kept open and/or shall continue to be available and;

(iv)    The present order shall substitute/modify respective judgments and orders passed by the respective High Courts quashing the similar notices issued under unamended section 148 of the IT Act irrespective of whether they have been assailed before this Court or not.”

The Supreme Court therefore held that the new law would apply, even where notices issued under old law were deemed to be valid and the AO was permitted to proceed thereunder, and while so holding, did not exclude the operation of the first proviso to new Section 149(1). On the contrary, it held that all other provisions of the new law would apply and that the defences otherwise available thereunder would be available to the assessee. Further, the Supreme Court was seized with the view taken by the different High Courts, and had agreed with their views particularly that the notices issued under the old law of s. 148, on or after, 31st March, 2021, were invalid. It only modified those decisions to the extent stated above that the notices were deemed to be issued within the time. Therefore, the Allahabad High Court rightly held that the assessee was entitled to the defence that the notices were barred by limitation due to the applicability of the first proviso to the amended section 149(1), and that its order in the case of Ashok Kumar Agarwal (supra) was modified only to the extent of the above.

As observed by the Gujarat High Court, no notification could extend the limitation of a repealed law. The Apex Court in case of Ashish Agarwal (supra) had not disturbed the findings of various High Courts to the effect that the notifications in question were ultra vires the law. The Gujarat High Court also rightly pointed out that in Touchstone Holdings’ case, the Delhi High Court proceeded on the basis that earlier notice was legal, valid and within the time frame. The Delhi High Court had gone on a premise that by virtue of observation in case of Mon Mohan Kohli (supra), the extension to time limit would survive.

Therefore, the view taken by the Allahabad and Gujarat High Courts seems to be the better view of the matter, and that in cases where the notice is barred by limitation on account of the first proviso to new section 149(1), the reassessment notices would be invalid.

Section 153 – Assessment barred by limitation – Refund of the taxes paid

2 Aricent Technologies (Holdings) Ltd vs. Assistant Commissioner Of Income Tax & Anr.
[WP (C) 13765 of 2022, AY 2007-08
Dated: 27th February, 2023, (Del.) (HC)]

Section 153 – Assessment barred by limitation – Refund of the taxes paid:

FSSL (which is now amalgamated with the petitioner company) had filed its return of income for the A.Y. 2007-08 on 26th October, 2007 declaring a total income of Rs. 17,64,76,208. The said return was picked up for scrutiny under section 143(3) of the Income Tax Act, 1961. On 27th September, 2010, the Transfer Pricing Officer passed an order proposing an addition of Rs. 8,96,40,636 on account of corporate charges. Thereafter, on 24th December, 2010, the AO passed a Draft Assessment Order proposing to assess FSSL’s income for the relevant assessment year at Rs. 2,43,55,56,670 by disallowing the project expenses to the extent of Rs. 39,15,46,619 and disallowing deduction under section 10B of the Act quantified at Rs. 177,78,93,207.

The Dispute Resolution Panel upheld the Draft Assessment Order, by its order dated 02nd August, 2011. Pursuant to the said order, the AO concluded the assessment and passed the Assessment Order dated 31st October, 2011 under section 143(3) of the Act r.w.s 144C(13) of the Act, whereby the total income of FSSL was assessed at Rs. 243,55,56,670.

Pursuant to the said assessment, a demand of Rs. 117,22,62,912 was raised. A refund of Rs. 26,01,53,355 relating to assessment year 2006-07 was outstanding and payable to FSSL. The said refund was adjusted against the demand of Rs. 117,22,62,912 raised in respect of the A.Y. 2007-08.

Aggrieved by the assessment order dated 31st October, 2011, the petitioner filed an appeal before the Income Tax Appellate Tribunal (hereafter ‘the Tribunal’). By an order dated 07th January, 2016, the Tribunal partly allowed the appeal and deleted the disallowance of the project expenses to the extent of Rs. 39,15,46,619. However, in respect of the disallowance of deduction of Rs. 1,77,78,93,207 claimed under section 10B of the Act, and the transfer pricing adjustment of corporate charges, the Tribunal set aside the Assessment Order and remanded the matter to the Transfer Pricing Officer/Assessing Officer. The question of the transfer pricing adjustment on account of corporate charges was remanded to the Transfer Pricing Officer for a de novo adjudication and the question regarding disallowance of deduction claimed under section 10B of the Act, was remanded to the AOr to decide afresh in the light of the observations made in the order.

Concededly, the AO has not passed any order pursuant to the order dated 07th January, 2016 passed by the Tribunal. In the aforesaid context, the petitioner contended that the refund due to FSSL (which is now amalgamated with the petitioner company) amounting to Rs. 26,01,53,355 be refunded to the petitioner along with applicable interest. The said claim is founded on the basis that the assessment for the A.Y. 2007-08 is now barred by limitation.

Section 153 of the Act was amended by the Finance Act, 2017 with retrospective effect from 01st June, 2016 and the provision regarding limitation for framing an assessment pursuant to any order passed inter alia under section 254 of the Act was included under sub-section (3) of Section 153 of the Act. Sub-sections (3) and (4) of the Section 153 of the Act as applicable for framing the assessment pursuant to the order dated 7th January, 2016 passed by the Tribunal read as under:

“153. (3) Notwithstanding anything contained in sub-sections (1) and (2), an order of fresh assessment in pursuance of an order under section 254 or section 263 or section 264, setting aside or cancelling an assessment, may be made at any time before the expiry of nine months from the end of the financial year in which the order under section 254 is received by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner or, as the case may be, the order under section 263 or section 264 is passed by the Principal Commissioner or Commissioner.
………… ……………..
(4) Notwithstanding anything contained in sub-sections (1), (2) and (3), where a reference under sub-section (1) of section 92CA is made during the course of the proceeding for the assessment or reassessment, the period available for completion of assessment or reassessment, as the case may be, under the said sub-sections (1), (2) and (3) shall be extended by twelve months.”

Pursuant to the order dated 7th January, 2016 passed by the Tribunal, the Transfer Pricing Officer passed an order dated 24th January, 2017. However, concededly, the AO has not passed any final order.

The Honourable Court observed that in view of the above, the contention that passing fresh assessment order pursuant to the Tribunal’s order dated 07th January, 2016, is barred under the provisions to Section 153(3) and 153(4) of the Act, is merited. In view there of the contention that the income as returned by FSSL for the A.Y. 2007-08 would stand accepted. Consequently, any adjustment made for the refund due to FSSL for the A.Y. 2006-07 is not sustainable. Accordingly, the court directed that the said amount, which was due as a refund for the A.Y. 2006-07 be refunded to the petitioner along with interest as applicable within a period of eight weeks.

The court further expressed displeasure in the manner the present matter has been dealt with by the concerned officer. Despite clear directions from the Tribunal, the AO had failed to pass the assessment order within the prescribed time.

Reassessment — Notice — Validity — Transactions not disclosed in initial notice under section 148A(b) considered in order under section 148A(d) for issue of notice of reassessment — Department cannot travel beyond initial notice — Order under section 148A(d) and consequent notice under section 148 set aside.

7 Prakash Krishnavtar Bhardwaj vs. ITO
[2023] 451 ITR 424 (Chhattisgarh)
Date of order: 1st December, 2022
Sections 147, 148, 148A(b) and 148A(d) of ITA 1961

Reassessment — Notice — Validity — Transactions not disclosed in initial notice under section 148A(b) considered in order under section 148A(d) for issue of notice of reassessment — Department cannot travel beyond initial notice — Order under section 148A(d) and consequent notice under section 148 set aside.

The assessee filed a writ petition and challenged the order under section 148A(d) of the Income-tax Act, 1961, dated 22nd July, 2022, directing the issue of notice under section 148 and the consequent notice under section 148 dated 22nd July, 2022. It was pointed out that the transaction of Rs. 14 lakhs considered by the Department in the order under section 148A(d) was not in the noticeunder section 148A(b) which is not permitted in law. It was contended that if the said Rs. 14 lakh transaction which has been considered by the Department is excluded from the proceedings then the amount would be less than Rs. 50 lakh and would therefore be outside the purview of the assessment proceedings as per the CBDT circular dated 11th May, 2022 ([2022] 444 ITR (St.) 43).

Chhattisgarh High Court allowed the writ petition and held as under:

“i)    From the two notices that were issued on June 29, 2021 and on May 25, 2022, i. e., the notices initially issued u/s. 148 (old provision) and u/s. 148A(b) (new provision), the Department had not disclosed the fact that the assessee had suppressed Rs. 14 lakhs transaction which had also escaped assessment u/s. 147. In the absence of its being stated in the notice the assessment of such amount would prima facie be bad since the Department could not travel beyond the show-cause notice.

ii)    Given the facts and circumstances and in view of the circular dated May 11, 2022, issued by the Central Board of Direct Taxes the order u/s. 148A(d) and the consequent notice u/s. 148 dated July 22, 2022 were unsustainable and therefore were set aside reserving the right of the Department to take appropriate recourse available in accordance with law.”

Reassessment — Notice after four years — Notice should clearly specify material not disclosed by the assessee — Expenditure on account of advertisement and sales promotion allowed by the AO after applying his mind to details furnished by the assessee — No failure on part of the assessee to disclose all material facts truly and fully — Notice under section 148 on the ground that in A. Y. 2015-16, the same has been treated as capital expenditure — Notice unsustainable.

6 Asian Paints Ltd vs. ACIT
[2023] 451 ITR 45 (Bom)
A. Y. 2014-15
Date of order: 9th January, 2023
Sections 147 and 148 of ITA 1961

Reassessment — Notice after four years — Notice should clearly specify material not disclosed by the assessee — Expenditure on account of advertisement and sales promotion allowed by the AO after applying his mind to details furnished by the assessee — No failure on part of the assessee to disclose all material facts truly and fully — Notice under section 148 on the ground that in A. Y. 2015-16, the same has been treated as capital expenditure — Notice unsustainable.

The assessee was a manufacturer and seller. It evolved a marketing strategy or scheme called “colour idea store” which envisaged a specified and designated area in the shops of the dealers for exclusive display of its products. The assessee accordingly entered into agreements with dealers as regards sharing of costs incurred for setting up of the designated area for use and display of its products but the stores continued to belong to the dealers. Such expenditure was claimed as deduction, and advertising and sales promotion expenses. For the A. Y. 2014-15, the AO accepted the assessee’s claim and passed an order under section 143(3) r.w.s. 144C(3) of the Income-tax Act, 1961. On 31st March, 2021, a notice was issued under section 148 to reopen the assessment under section 147 on the basis of assessment proceedings for the A. Y. 2015-16, in which the expenses for “colour idea store” were considered as capital expenditure on which depreciation of 10 per cent was allowed. The assessee’s objections were rejected.

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

“i)    During the scrutiny assessment, the Assessing Officer had sought the relevant details with regard to the advertisement and sales promotion expenses which were furnished by the assessee. The Assessing Officer had also disallowed some of the expenses which were shown in the break-up under the head “details of advertisement and sales promotion expenses” while passing the order of assessment which showed that the Assessing Officer had applied his mind to the assessee’s claim while passing the order u/s. 143(3) read with section 144C(3).

ii)    The reasons for reopening the assessment did not state what material or fact was not disclosed by the assessee. Therefore, it was clear that there was a complete disclosure of all the primary material facts on the part of the assessee and there was no failure on its part to disclose fully and truly all the facts which were material and necessary for the assessment. The notice u/s. 148 did not satisfy the jurisdictional requirement of section 147 and therefore, was unsustainable and accordingly quashed.”

Penalty — Levy of penalty — Limitation — Limitation starts from date of assessment when the AO initiates penalty proceedings and not from date of sanction for penalty proceedings.

5 Principal CIT Vs. Rishikesh Buildcon Pvt Ltd and Ors.
[2023] 451 ITR 108 (Del)
A. Y. 2006-07
Date of order 17th November 2022
Section 275 of ITA 1961

Penalty — Levy of penalty — Limitation — Limitation starts from date of assessment when the AO initiates penalty proceedings and not from date of sanction for penalty proceedings.

For A. Y. 2006-07, the AO passed the assessment order on 17th December, 2008 and recorded that penalty proceedings were to be initiated. A reference was made by the AO to the prescribed authority on 18th March, 2009. The prescribed authority issued a show-cause notice to the assessee on 24th March, 2009. The penalty order was passed on 29th September, 2009.

The Tribunal held that the penalty order was passed after the expiry of the time limit laid down under section 275(1)(c) of the Income-tax Act, 1961 and accordingly set aside the penalty order.

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

“i)    Where the Assessing Officer has initiated penalty proceedings in his/her assessment order, that date is to be taken as the relevant date as far as section 275(1)(c) of the Income-tax Act, 1961 is concerned.

ii)    The quantum proceedings were completed by the Assessing Officer on December 17, 2008, and the Assessing Officer initiated the penalty proceedings in December, 2008. Thus, the last date by which the penalty order could have been passed was June 30, 2009. The six month period from the end of the month in which action of imposition of penalty was initiated would expire on June 30, 2009.

iii)    However, in this case, admittedly, the penalty orders were passed on September 29, 2009, and therefore, the Tribunal rightly concluded that the orders were barred by limitation.”

Offences and prosecution — Willful attempt to evade tax — Failure to produce accounts and documents — Concealment of income — Failure to disclose foreign account opened in year 1991 when the assessee was 55 years of age — Admission regarding foreign bank account after investigation by the department and issue of notices and levy of penalty — Assessee cannot take the benefit of circular recommending no prosecution where the assessee is aged 70 years or more at time of offence — Prosecution justified.

4 Rajinder Kumar vs. State
[2023] 451 ITR 338 (Del)
A. Y.: 2006-07
Date of order: 16th December, 2022
Sections 271, 271(1)(b), 274, 276C(1), 276D and 277 of ITA 1961

Offences and prosecution — Willful attempt to evade tax — Failure to produce accounts and documents — Concealment of income — Failure to disclose foreign account opened in year 1991 when the assessee was 55 years of age — Admission regarding foreign bank account after investigation by the department and issue of notices and levy of penalty — Assessee cannot take the benefit of circular recommending no prosecution where the assessee is aged 70 years or more at time of offence — Prosecution justified.

In the year 2011 based on the information received from France that the assessee had opened an account in a bank in London on 20th August, 1991, a search and seizure was conducted under section 132 of the Income-tax Act, 1961 at various business premises and residence of the assessee on 23rd August, 2011. A notice under section 153A was issued to the assessee to file a return. A penalty was levied for the failure to comply with notices issued under section 142(1). The assessee filed a revised return for the A. Y. 2006-07 declaring the balance in the bank account in London as income from other sources on the basis of details provided at the time of search and assessment proceedings.

A notice under section 277, r.w.s 279(1) was issued and the assessee furnished details of payment of the entire taxes, penalties and interest. Thereafter, criminal complaints under section 276C(1)(ii) and 277 were filed against the assessee. The assessee filed an application under section 245(2) of the Code of Criminal Procedure, 1973 for discharge on the grounds that he was 80 years old citing Instruction No. 5051 dated 7th February, 1991 issued by the CBDT. The application was rejected. Against this, the assessee filed a criminal writ petition.

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

“i)    The assessee could not take benefit of Instruction No. 5051 dated February 7, 1991. He had opened the account in the bank in London on August 20, 1991 and it was only after the Government of France brought to the knowledge of the competent authorities that the assessee disclosed it in the year 2011. During the period relevant to the A. Y. 2006-07 the assessee allegedly had the maximum credit balance in his foreign bank account. The foreign account was opened in the bank in London on August 20, 1991 and was not disclosed.

ii)    Taking the date of birth of the assessee, as claimed by him, as March 30, 1936, at the time of commission of offence in the year 1991 he was 55 years of age. Instruction No. 5051 dated February 7, 1991 stated that prosecution normally be not initiated against a person who has attained the age of 70 years at the time of commission of offence. Therefore, in terms of Instruction No. 5051 dated February 7, 1991, the age of the assessee had to be taken at the time of commission of offence and not when the proceedings were initiated. It was only after the notice u/s. 274 read with section 271 of the Act was issued and penalty u/s. 271(1)(b) of the Act for failure to comply with notice u/s. 142(1) of the Act was also levied on September 26, 2013 that the assessee had chosen to file a revised return on February 16, 2015. By doing so he could not evade the judicial process of law for not disclosing his correct income and foreign account since the year 1991.”

Interest under section 220(2) — Original assessment order set aside and matter remanded — Fresh assessment order — Interest payable from such fresh assessment order.

3 Principal CIT vs. AT and T Communication Services (India) Pvt Ltd
[2023] 451 ITR 92 (Del)
A. Y.: 2004-05
Date of order: 17th November, 2022
Section 220(2) of ITA 1961

Interest under section 220(2) — Original assessment order set aside and matter remanded — Fresh assessment order — Interest payable from such fresh assessment order.

The assessee is engaged in the business of network design, management, communication, connectivity services and related products. For the A. Y. 2004-05, the assessee filed its return of income on 30th October, 2004 declaring an income of Rs. 29,30,15,180. However, the income was assessed at Rs. 32,15,72,740 vide original assessment order dated 28th December, 2006. The Tribunal vide its order dated 30th September, 2014, set aside the original assessment order dated 28th December, 2006 and restored the matter to the file of the AO for determining the issue of taxability of the amounts received as brand building fund, the allowability of brand building expenses as well as a separate claim for other expenses. On 29th March, 2016 the AO reframed the assessment and passed a fresh assessment order under section 143(3) r.w.s 254 of the Act. The AO reconfirmed the disallowance of the brand expenses for a sum of Rs. 2,66,42,537 and the total income was determined as Rs. 31,96,57,720.

In the Income-tax Computation Form (ITNS 50) issued pursuant to the aforesaid assessment order, the AO levied interest under section 220(2) of the Act and raised a demand of Rs. 1,75,74,756 computed on the basis of the original assessment order dated 28th December, 2006.The Tribunal held that the interest under section 220(2) of the Act can be charged only after expiry of the period of 30 days from the date of service of demand notice issued pursuant to the fresh assessment order dated 29th March, 2016.On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i)    Where an issue arising out of the original assessment is restored to the file of the Assessing Officer by the higher appellate authorities, there is an extinguishment of the original demand, i. e, the demand raised under the first assessment order.

ii)    Interest u/s. 220(2) of the Income-tax Act, 1961, can be levied only after expiry of the time limit prescribed in the fresh demand notice issued by the Assessing Officer in pursuance of the fresh reframed assessment order. The reframed order is the subsisting assessment order. Section 220(2) of the Act does not contemplate a levy of interest which relates back to the date of the passing of original order which was subsequently set aside by appellate authorities or applies to pendency of proceedings. This also becomes clear from Circular No. 334 dated April 3, 1982 ([1982] 135 ITR (St.) 10). Para 2.1 of the circular expressly states that if the assessment order is “set aside” by the appellate authority, no interest u/s. 220(2) of the Act can be charged pursuant to the original demand notice. No interest is payable on the demand raised by the original order when the original order of the Assessing Officer is set aside by the appellate authority and a fresh assessment order is passed.

iii)    The Tribunal by order dated September 30, 2014, set aside the original assessment order dated December 28, 2006, and restored the matter to the file of the Assessing Officer for determining the issue of taxability of the amounts received as brand building fund, the allowability of brand building expenses as well as a separate claim for other expenses. On remand, the Assessing Officer on March 29, 2016 reframed the assessment and passed a fresh assessment order u/s. 143(3) of the Act read with section 254 of the Act. The Assessing Officer reconfirmed the disallowance of brand expenses.

iv)    The Tribunal was right in holding that interest u/s. 220(2) of the Act could be charged only after expiry of the period of 30 days from the date of service of demand notice issued pursuant to the fresh assessment order dated March 29, 2016.”

Corporate social responsibility expenditure — Business expenditure — Amendment providing for disallowance of such expenditure — Circular issued by the CBDT stating amendment to have effect from A. Y. 2015-16 onwards — Binding on the Department — Corporate social responsibility expenditure for earlier years allowable.

2 Principal CIT vs. PEC Ltd and Anr
[2023] 451 ITR 436 (Del):
A. Ys.: 2013-14, 2014-15
Date of order: 29th November, 2022
Section 37 of ITA 1961

Corporate social responsibility expenditure — Business expenditure — Amendment providing for disallowance of such expenditure — Circular issued by the CBDT stating amendment to have effect from A. Y. 2015-16 onwards — Binding on the Department — Corporate social responsibility expenditure for earlier years allowable.

For the A.Ys. 2013-14 and 2014-15, the AO disallowed the claim of the assessees under section 37 of the Income-tax Act, 1961 of the expenses on account of corporate social responsibility endeavor undertaken by them. According to the Department, the funds utilized by the assessees to effectuate their corporate social responsibility obligations involved application of income and not an expense incurred wholly and exclusively for carrying on the business.

The Tribunal relied upon Circular No. 1 of 2015 dated 21st January, 2015 issued by the CBDT and held that the amendment brought about in section 37(1) by the way of Explanation 2 was prospective in nature and was not applicable for the A. Ys. 2013-14 and 2014-15, and accordingly deleted the disallowances.

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

“i)    Explanation 2 was inserted in section 37 of the Income-tax Act, 1961 by the Finance (No. 2) Act, 2014 with effect from April 1, 2015. The Memorandum which was published along with the Finance (No. 2) Bill, 2014 clearly indicated that the amendment would take effect from April 1, 2015 and, accordingly, would apply in relation to A. Y. 2015-16 and subsequent years. This position is also exemplified in the circular dated January 21, 2015 ([2015] 371 ITR (St.) 22) issued by the CBDT.

ii)    Circulars issued by the CBDT were binding on the Department. Therefore, the Tribunal had not erred in allowing the deduction claimed by the assessees u/s. 37 of the expenses incurred for their corporate social responsibility endeavours.”

Charitable purpose — Registration — Cancellation of registration — Condition precedent for cancellation — Registration granted after considering genuineness of the institution — Cancellation of registration on same provisions in trust deed — Not valid.

1 Sri Ramjanki Tapovan Mandir vs. CIT(Exemption)
[2023] 451 ITR 458 (Jhar)
Date of order: 3rd November, 2022
Section 12AA of ITA 1961:

Charitable purpose — Registration — Cancellation of registration — Condition precedent for cancellation — Registration granted after considering genuineness of the institution — Cancellation of registration on same provisions in trust deed — Not valid.

The assessee was registered under section 12AA of the Income-tax Act, 1961. By order dated 4th September, 2018 the CIT (Exemptions), Ranchi cancelled the registration. This was upheld by the Tribunal.

On appeal by the assessee the Jharkhand High Court framed the following substantial questions of law:

“(1)    Whether the registration once granted under section 12AA of the Income-tax Act, 1961 could be cancelled on the basis of same set of provision of the trust which were examined earlier ?

(2)    Whether the Income-tax authorities have the jurisdiction under section 12AA(3) of the Income-tax Act, 1961 to question the legality and propriety of the trust deed of the assessee or its inquiry is limited to the conditions stipulated under section 12AA(3) namely,—

(i)    that the activities of the trust are not genuine, or

(ii)    are not being carried out in accordance with the objects of the trust?

(3)    Whether in the facts and circumstances of the case, the findings of the learned Income-tax Appellate Tribunal that the appellant failed to give satisfactory explanation regarding the sale proceeds which is utilized for charitable objects of the trust, is perverse?”

The High Court allowed the appeal and held as under:

“i)    Section 12AA(3) of the Income-tax Act, 1961, contemplates existence of two contingencies for cancellation of the registration already granted, namely: (i) If the activities of the trust are not genuine ; or (ii) are not being carried out in accordance with the objects of the trust.

ii)    The trust deed is an understanding between the author of the trust and its trustee, and, the Income-tax Department is not authorized to comment on execution of the trust deed. Once registration has been granted to a charitable trust u/s. 12AA of the Act after being satisfied about the genuineness of the activities of the trust, it cannot be cancelled on the basis of the same set of provisions of the trust which were examined earlier.

iii)    It is trite law that the Tribunal cannot travel beyond the reasons recorded in the order before it and develop a complete de novo case for the Revenue, which was not the basis of the order passed by the authority.

iv)    It was an admitted fact that registration u/s. 12AA of the Act was granted to assessee-trust on the basis of the trust deed dated September 20, 2005. It was further an admitted fact that in the trust deed dated September 20, 2005, it was specifically recorded, inter alia, that the lands of the trust were under threat of encroachment by local inhabitants, and, in order to save the land in question, it was felt necessary to utilize the land by giving it for development for construction of buildings and flats and the proceeds received from consideration amount were to be utilized for the purposes of the trust. On the basis of the same trust deed, the benefit of exemption u/s. 12A of the Act was granted by granting registration to the trust u/s. 12AA. However, notice was issued to the trust dated December 18, 2017 directing the trust to show cause, inter alia, as to why its registration should not be cancelled for violation of the aims and objectives mentioned in the trust deed and memorandum of association. Thereafter, the CIT (Exemptions) passed order dated September 4, 2018 cancelling the registration granted in favour of the assessee-trust.

v)    The CIT(Exemptions), while cancelling the registration, went beyond the terms of the trust deed and proceeded to cancel the registration recording, inter alia, that the trust deed dated September 20, 2005 was contrary to the wishes of the founder of the trust and the earlier instruments of trust, i. e., trust deeds of the years 1948 and 1987. Thus, the CIT(Exemptions) clearly travelled beyond the scope of inquiry as contemplated u/s. 12AA(3) for declaring that the activities of the trust were not genuine. The Supreme Court, in clear terms, held that u/s. 44 of the Bihar Hindu Religious Trust Act, 1950, a religious trust has power to transfer its immovable property after taking previous sanction, and, that the deity could transfer its land for fulfilling its objectives. Thus, the finding rendered by the CIT(Exemptions) for cancellation of the registration certificate was directly contrary to the order passed by the Supreme Court in the case of the assessee-trust itself.

vi)    The Tribunal had upheld the order of the CIT(Exemptions). The Tribunal despite the order of the Supreme Court, being brought to its notice, held that the activity of the trust was not genuine and bona fide, as the Pujari of the trust changed the original trust deeds and had violated the objects of the trust in transferring the property of the trust. This finding of the Tribunal was not sustainable in the eye of law. That apart, the Tribunal had clearly travelled not only beyond the show-cause notice, but, also the order passed by the CIT(Exemptions). In an earlier proceeding pertaining to the year 2013-14, the Tribunal had clearly held that the trust deeds were not relevant for allowing the benefit of exemption and the income derived from transfer of property was as per the objects of the trust. The CBDT Instruction No. 883-CBDT F. N. 180/54/72-IT (AI) dated September 24, 1975 stated that the investment of net consideration received on the transfer of a capital asset in fixed deposit with a bank for a period of six months or above would be regarded as utilization of the net consideration for acquiring another capital asset within the meaning of section 11(1A) of the Income-tax Act. Admittedly, the assessee-trust had deposited the sale proceeds in fixed deposit with the bank for a period of more than six months and, thus, it could not be said that the assessee-trust had utilised the sale proceeds contrary to the objects of the trust. The cancellation of registration was not valid.

vii)    Accordingly, the instant appeal is allowed and the questions of law framed at the time of admitting the appeal are answered in the affirmative in favour of the appellant.”

Section 69A r.w.s. 115BBE and section 153A – Where cash deposits made in bank accounts of the proprietorship concern during demonetization period were routed through regular books of account of the assessee which were not rejected by AO and no incriminating material was found during the search conducted at the premises of the sister concern of the assessee to point out that she introduced her own unaccounted money in her proprietorship concern in the garb of sale to its sister concern then additions made by the AO in respect of such cash deposit were merely based on surmise and conjectures and, thus, same were to be deleted.

3 Tripta Rani vs. ACIT

[2022] 97 ITR(T) 389 (Chandigarh – Trib.)

ITA No.: 135 (CHD.) OF 2021

A.Y.: 2017-18

Date of order: 13th June, 2022

Section 69A r.w.s. 115BBE and section 153A – Where cash deposits made in bank accounts of the proprietorship concern during demonetization period were routed through regular books of account of the assessee which were not rejected by AO and no incriminating material was found during the search conducted at the premises of the sister concern of the assessee to point out that she introduced her own unaccounted money in her proprietorship concern in the garb of sale to its sister concern then additions made by the AO in respect of such cash deposit were merely based on surmise and conjectures and, thus, same were to be deleted.

FACTS

The assessee was a proprietor of two concerns namely; ‘W’ and ‘S,’ and was engaged in the business of trading of textiles. The assessee was also engaged in the purchase and sale of cloth to its sister concern one R group. A search was conducted at premises of R group under section 132(1). Consequently, notice under section 153A was issued to the assessee. Pursuant to the said notice, the assessee filed return of income which reflected same income as filed in original return.

During the assessment proceedings, the AO observed that during the demonetization period, the assessee deposited Rs. 10 lakhs and Rs. 17 lakhs in the bank accounts of her proprietorship concerns ‘W’ and ‘S’ The AO required the assessee to submit details related to cash deposits along with certified copies of bank statements. The assessee explained to the AO that the cash deposits in the bank accounts of respective proprietorship concerns were out of sales made to its sister concern ‘R’ group. However, despite such explanation, the AO held that in case of proprietorship concern ‘S’, the assessee failed to submit any satisfactory reply and thus made additions under section 69A on the grounds that the assessee introduced own unaccounted money in the garb of sales to sister concern during the demonetization period.

On appeal, the CIT (A) upheld the decision of the AO. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.


HELD
The Tribunal observed that the AO had no sound reason to reject the contention of the assessee especially when the cash deposits in the bank account of ‘S’ have been routed through the regular books of account of the assessee. Even the books of account have not been rejected and the AO had accepted the sales as well as purchases and also the expenses claimed by the assessee and had only found fault with the quantum of cash deposits during the demonetization period. Thus, apparently, this impugned addition had been made without any foundation and the AO had acted on mere surmise and conjectures without duly appreciating the undisputed fact that he himself had accepted the books of account. The CIT (A) had also upheld the findings of the AO without assigning any cogent reason and he also seemed to have simply approved the addition without proper appreciation of facts. Further, on the same set of facts, the AO had accepted the cash deposit of Rs. 17 lakhs in another proprietorship concern of the assessee namely ‘W’ but had proceeded to doubt the cash deposited in the proprietorship concern ‘S’ without any cogent reason.

It was also noted by the Tribunal that the captioned case was a search case and even during the course of search no incriminating material was found which would point out towards the assessee introducing her unaccounted cash into the books of account under the garb of sales or receipts from sister concern.

Therefore, the view taken by the CIT (A) in upholding the addition of Rs. 10 lakhs was set aside by the Tribunal and the AO was directed to delete the same.

Section 80-IB r.w.s 154 and Section 143 – Where the assessee’s claim for deduction under section 80-IB was rejected for want of filing of an audit report, in view of CBDT’s Circular No. 689, dated 24th April, 1984, the AO was required to consider rectification application filed by the assessee-company since a copy of said report in Form 10CCB was uploaded by the assessee on receipt of intimation under section 143(1).

2 Satish Cold Storage vs. DCIT

[2022] 97 ITR(T) 601 (Lucknow – Trib.)

ITA Nos.: 76 & 77 (LKW.) of 2021

A.Y.: 2017-18 & 2018-19

Date of order: 25th May, 2022

Section 80-IB r.w.s 154 and Section 143 – Where the assessee’s claim for deduction under section 80-IB was rejected for want of filing of an audit report, in view of CBDT’s Circular No. 689, dated 24th April, 1984, the AO was required to consider rectification application filed by the assessee-company since a copy of said report in Form 10CCB was uploaded by the assessee on receipt of intimation under section 143(1).

FACTS

The assessee had claimed deduction under section 80-IB of the Income-tax Act, 1961. However, the auditor of the assessee omitted to upload the audit report in FORM-10CCB along with the return of income. The deduction under section 80-IB was denied in the intimation issued under section 143(1). After the receipt of intimation under section 143(1) of the Income-tax Act, 1961, the assessee uploaded the copy of audit report in FORM 10CCB and filed a rectification application under section 154 against the said intimation. The audit report was rejected by the Central Processing Unit (CPC).

Thereafter an appeal was filed before Ld. CIT (A) against the order passed by the CPC under section 154.

The CIT (A) dismissed the appeal by holding that no mistake was apparent from the record. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.


HELD
The Tribunal observed that CIT (As) while rejecting the appeal, had escaped the contents of Circular No. 689 dated 24th August, 1984. which clearly directs the Officers to allow rectification under section 154 for non-filing of audit report or other evidence which could not be filed with the return of income.

The Tribunal, by relying upon the decision of the Hon’ble High Court of Karnataka in the case of Mandira D Vakharia [2001] 250 ITR 432 (Kar.), held that the assessee would be entitled to the deduction in rectification under section 154 to the extent permitted by the Board’s Circular No.669 dated 25th October, 1993 and Circular No.689 dated 24th August, 1984. The AO was not right in law in disallowing the rectification application only on the grounds that the assessee had failed to furnish the audit report along with the return of income.

Section 10 (38) r.w.s. 68 – Where the assessee claimed an exemption under section 10(38) towards long-term capital gains earned on the sale of shares alleged to be penny scrip and furnished various documentary evidences in the form of copies of contract notes, DEMAT account, details of share transactions, etc. in support of the claim, then onus casted upon assessee in terms of section 68 was discharged and therefore impugned addition made against alleged bogus LTCG was to be deleted.

1 Jatinder Kumar Jain vs. ITO

[2022] 97 ITR(T) 403 (Chandigarh – Trib.)

ITA No.: 338 (CHD) OF 2018

A.Y.: 2013-14        

Date of order: 14th June, 2022

Section 10 (38) r.w.s. 68 – Where the assessee claimed an exemption under section 10(38) towards long-term capital gains earned on the sale of shares alleged to be penny scrip and furnished various documentary evidences in the form of copies of contract notes, DEMAT account, details of share transactions, etc. in support of the claim, then onus casted upon assessee in terms of section 68 was discharged and therefore impugned addition made against alleged bogus LTCG was to be deleted.

FACTS

The assessee-company had purchased shares of Maple Goods Ltd (MGL) through cheque and the identity of the broker had been furnished. Due to the order of High Court Kolkata, MGL along with Seaview Supplier Ltd (SSL) and Matrix Barter Pvt Ltd (MBL) were amalgamated and as a consequence, the assessee was allotted 7,900 shares of Access Global Ltd (AGL). Subsequently, the assessee sold these shares of AGL through a bank channel. It claimed long-term capital gain arising on sale of the said shares as exempt under section 10(38).

The AO received the report of the Investigation Wing wherein AGL had been allegedly identified as one of the penny stock companies. In the said report, it was alleged that the price of shares of AGL had been artificially rigged to create a non-genuine long-term capital gain. On the basis of the said report, The AO inferred that the assessee had allegedly earned bogus long-term capital gain on sale of shares of AGL through another alleged bogus client company, namely Ashok Kumar Kayan (AKK) and accordingly, came to conclusion that AKK had provided bogus long term capital gain to the assessee and other companies, and thus denied the assessee’s claim of exemption and made addition of the long term capital gain under section 68.

During the course of the assessment proceedings, the assessee had furnished documentary evidences which included copies of contract notes, DEMAT account, details of share transactions, contract notes giving details like trade number, trade time, contract note number, settlement number, details of service tax payment, securities transaction tax paid and the brokerage paid to the broker. It was also demonstrated by the assessee that the purchase of shares of MGL had been made through cheque in June, 2011. The assessee had also demonstrated that, subsequently, the sale proceeds from the shares of AGL were received again through banking channel. Apart from this, the assessee had also filed the judgment of the High Court ordering amalgamation of three companies MGL, SSL and MBL as a consequence to which the assessee was allotted 7,900 shares of AGL. The assessee had also furnished a copy of letter addressed to the assessee by MGL which showed the distinctive number of shares allotted to the assessee along with the certificate number and the share folio number.

The CIT(A) upheld the addition made by the AO. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

 

HELD

It was observed by the Tribunal that all these documents have apparently been accepted by the lower authorities in as much as neither the AO nor the CIT (A) had pointed out any defect in these documents. The statements of various persons were recorded. But nowhere in the statements, the name of the assessee was referred to.

The assessee had demonstrated with substantial evidence before the AO that the actual purchase and sale of the shares took place, such shares had distinctive numbers, the transactions were routed through the normal banking channels and the shares had been allotted to the assessee subsequently under an order of amalgamation/merger.

The Tribunal also observed that when the AO had received the report of the Investigation Wing, he ought to have conducted an independent enquiry to examine and verify the involvement of the assessee in the alleged bogus long-term capital gain claim rather than simply and blindly following the report and the statement to make a case against the assessee.

Accordingly, the Tribunal held that since the assessee had successfully discharged the onus casted upon him in terms of section 68, the impugned addition had no feet to stand.

How Happy We Are?

Every year the 20th of March is celebrated as the “International Day of Happiness”. In July 2011, the UN General Assembly adopted resolution 65/309 Happiness: Towards a Holistic Definition of Development inviting member countries to measure the happiness of their people and to use the data to help guide public policy.

While the UN makes things global through such means, the timeless scriptures of Bharat have pointed out Joy or Ananda to be the ultimate goal of humans.  We spend our whole life in pursuit of happiness through every activity. A question which remains unanswered despite all progress is: Where is happiness located? How do we find it? Through career, money, wealth, fame, power, and positions we have tried to reach the elusive goal, only to find it fleeting. It is like ordering something that comes with a ‘very near expiry date’. Not only that, when one desire is satisfied,  the other lures us with the powerful force of attraction. This loop is endless. We seek and we lose; we lose, and we seek again. In fact, the constant pursuit wears us out with stress, strife and discontentment. Thus, the eternal question remains: how can we be happy?

In today’s scenario, this question is more relevant for our fraternity than others. We find that practising CAs are facing various challenges on multiple fronts. The level of stress, risk of reputation and harassment by agencies have increased manyfold, which prompts one to think: is it all worth it? What am I doing and why I am doing this and where will it lead me?

Medical research says anatomical happiness comes from four happy hormones, namely, Dopamine, Serotonin, Oxytocin and Endorphins. Each of these hormones has unique qualities, for example, Dopamine is a ‘feel-good’ hormone associated with pleasurable sensations, learning, memory, etc. Serotonin helps to regulate our mood as well as sleep, appetite, digestion, learning ability, and memory. Oxytocin is known as the ‘love hormone’ that helps to promote trust, empathy, and bonding in relationships. Endorphins act as the body’s natural pain reliever, which is produced by our body when we are engaged in physical activities such as eating, exercising, etc. These hormones can be produced and regulated through various activities, meditation, food as well as empowering relationships, etc.

However, bereft of chemistry, what is the source of happiness? Ms. Karen Hamilton writes in her poem:

 

“What is happiness I hear you say,

What helps us smile on dreary days,

What sends a tingle through our bones,

What helps us talk in cheerful tones?+

 

How does it pick and how does it choose

When to arrive or when to move.

How does it know to run right through

Every person, like me and you?

 

Some people try as hard as they can,

To steal it from another man

It’s yours forever, it’s yours to keep

Don’t let them take something so deep

 

You must search within when times are blue

For, Happiness lives inside of you”

 

Many understand this in varied ways. Some through action – being present and fully engaged or in giving. Swami Chinmayananda said, “bring your mind where your hands are”. That’s mindfulness. When we are fully engrossed in our work, we touch our excellence. We all experience this during the peak season of our work. In such work, there is involvement without expectation of the outcome (which causes stress). There is pressure, and there is tremendous expending of energy, but psychologically, we are not drained. Today many tools of technology, practice management software, judicious use of Artificial Intelligence (AI), a good team, and most importantly delegation can help us to reduce stress.

However, we need to maintain a fine work-life balance to reduce stress and lead a meaningful and joyous life. After all, what is the use of all the money that we earn, if we can’t live a happy life? Fortunately, many CAs are engaged in philanthropic activities and contributing a lot to society. They render pro bono services to Charitable Trusts and NGOs. Such activities help secret a happy hormone called Oxytocin. We must spend quality time with our family and should not entertain clients at unreasonable hours unless necessary. We should be objective in rendering our services without getting involved in the business and financial affairs of our clients. We should do our best without getting attached to the outcome. A good Surgeon would operate on his close relative with precision and professionalism; we should also work in that manner. If we are attached to results, then the high-pitched assessments, penalties for late filings, long-lasting litigation, compounding, etc. will make us stressed.

Here are my top 5 activities to reduce stress and live a balanced life:

1. Philanthropy

2. Inner Work like Meditation, Pranayama, Asanas

3. Short vacations

4. Exercise and Walking

5. Loving what I do

We are embarking on the New Financial Year which is coinciding with many traditional Nav Varsha (New Years) in India, like Gudi Padava (Maharashtrian New Year), Bohag Bihu (Assamese New Year), Ugadi (Telugu and Kannada New Year), Baisakhi (Punjabi New Year) or Navroz (Central Asian and Persian New Year). Let’s take stock of our lives, our days, and our happiness. Let’s find and watch our own happiness index! and not trade it for anything! It’s the Index whose gains need not face any tax, its sale should only take it higher!

Wish you all the best for a truly happy new Financial Year!

Best Regards,
Dr. CA Mayur B. Nayak
Editor

Corporate Law Corner Part B: Insolvency and Bankruptcy Law

9. NCLAT, Principal Bench

New Delhi

Company Appeal (AT) (Insolvency) No. 241 of 2022

Arising out of order dated 10th February, 2021 passed by the National Company Law Tribunal, Guwahati Bench, Guwahati in IA No. 32 of 2020 in C.P. (IB) No. 20/GB/2017.

1. Principal Commissioner of Income Tax,

2. Assistant Commissioner of Income Tax,

…Appellants.

vs.

M/s Assam Company India Ltd              …Respondent.

FACTS

Corporate Insolvancy Resolution Process (CIRP) under Section 7 was admitted against the Assam Company/Corporate Debtor (“CD”) on 20th September, 2018. Appellants filed their claim under Form B and claimed the Income Tax for the A.Y. 2013-14 for Rs. 6,69,84,657 and A.Y. 2014-15 for Rs. 9,50,41,296 totalling Rs. 16,20,25,953 before the Resolution Professional (RP). RP via email informed that the NCLT, Guwahati Bench may consider payment of Rs. 1,97,92,084 being 15 per cent of the outstanding dues owed to the Appellants since the Respondent had filed petition for stay of demand before the AO. RP made a payment of Rs. 1,20,23,691 as a tranche payment to the Appellants and told that the rest of the amount would be contingent on the outcome of the appeal filed before the IT appellate authority.

The appellants filed an application for review of the order of the Hon’ble NCLT dated 20th September, 2018 with necessary directions to the Resolution Professional for submission of the revised resolution plan incorporating the entire amount alleged to be due to the Appellants. NCLT, in its order dated 22nd October, 2019 stated that since the RP intimated the Department that the demand after finalization of appeal by CIT(A) would be payable by the new promoter, such a written intimation of the RP is to be read with the new resolution plan and the demand of the Appellants is duly considered and they have a right to lay their claim before the new promoter of the Respondent Company. NCLT dismissed the claims of the Appellants vide its order dated 10th February, 2021.

QUESTION OF LAW

This appeal lies against the order dated 10th February, 2021 with respect to extinguishment of appellants claim. In that order, the Hon’ble NCLT, failed to take into consideration that vide its earlier order dated 22nd October, 2019 it had stated that since the RP intimated the Appellants that the demand after finalisation of appeal by CIT(A) would be payable by the new promoter, such written intimation of the RP is to be read with the new resolution plan; and the demand of the Appellants is duly considered and the Appellants have a right to lay their claim before the new promoter of the Respondent Company.

RULING IN CASE

NCLAT held that as per the judgment passed by the Hon’ble Supreme Court in the case of “State Tax Officer (1) vs. Rainbow Papers Ltd, Civil Appeal No. 1661 of 2020 dated 06th September, 2022”, the dues of the Appellants are ‘Government dues’ and they are Secured Creditors.

HELD

That the impugned order dated 10th February, 2021 passed by the Adjudicating Authority (National Company Law Tribunal, Guwahati Bench, Guwahati) in IA No. 32 of 2020 in C.P. (IB) No. 20/GB/2017 is hereby set aside and the matter is remitted back to the Adjudicating Authority (National Company Law Tribunal, Guwahati Bench, Guwahati) with a request to hear the parties (Appellants and Respondent herein) considering the aforesaid facts and also judgment passed by the Hon’ble Supreme Court in the case of ‘Rainbow Papers Ltd Case (supra)’ and pass fresh orders as expeditiously as possible.

Quality Control

Arjun: (chanting) – Hare Krishna! Hare Krishna! Krishna Krishna Hare Hare!

Shrikrishna: Arey Arjun, I am very much in front of you. What makes you chant my name at this moment?

Arjun: Lord, all my CA friends are fed up with this practice. They say it is frustrating and humiliating.

Shrikrishna: Really?

Arjun: Yes, Bhagwan. They say, we are taken for granted by everybody. We are slogging sleeplessly without commensurate reward. Too much of regulation!

Shrikrishna: What else they feel?

Arjun: They are repenting that they became a CA and entered into this practice.

Shrikrishna: And still they are putting their next generation into the CA course?

Arjun: Many of them have preferred their next generation to study other streams. And those children who have done CA are choosing corporate jobs instead of entering the practice.

Shrikrishna: I understand this situation. One reality is that your practice has become Compliance-oriented without much creativity. Secondly, clients don’t feel that you are indispensable.

Arjun: Lord, we cannot afford to be assertive. We have always to remain submissive and accommodative. In the process, many mistakes occur. Quality suffers.

Shrikrishna: Yes. That’s the reason why there are rampant cases of misconduct for technical defaults.

Arjun: Many regulators are there to harass us. And clients are least bothered about it. They don’t see any value addition to them; and feel that all the work we do is only to protect ourselves. They don’t feel the pinch of it! Hence, no value, no reward!

Shrikrishna: You people lack unity; and don’t use your collective strength. But Arjun, you need to endure what cannot be cured.

Arjun: You mean, there is no solution to this problem?

Shrikrishna: I never said so. But that requires will-power and determination.

Arjun: In what sense?

Shrikrishna: I know a CA who is extremely proactive and strict. He gives a deadline to the clients to submit all the data; and refuses to do their work if they don’t come in time. And if any client comes after the set deadline, he has to pay 10 per cent extra fee and that too, in advance!

Arjun: Oh! So wonderful to hear that! But very difficult to implement.

Shrikrishna: I understand, it is difficult to suddenly adopt this attitude and culture. But at least, there should be a determined and sincere attempt.

Arjun: What exactly should we do? How many years shall we keep on undergoing same stress in tax filing season? Our health suffers, family life suffers; and the clients for whom we do all this is least concerned about it.

Shrikrishna: I feel; you should form a group of 4 or 5 like-minded CAs. This typically is a problem of SME firms – who have limited resources, limited exposure, limited man-power and so on. You should seriously and dispassionately deliberate on what difficulties you face; how to overcome them; how to ensure quality of work, how to maintain working papers, how and when the communication should be made. So on and so forth.

Arjun: We should sit and prepare a checklist, and monitor it strictly and regularly.

Shrikrishna: I feel; this is the appropriate time you set to plan the work. There is no point in planning it too late in May or June! For this, you need to also brush up certain standards of accounting and auditing. Amidst the pressure of work, you are not quite serious about updating your knowledge.

Arjun: I agree. We complete the CPE hours just for compliance. We never understand the spirit and purpose behind it.

Shrikrishna: For quality control, you should devote at least 30 minutes every day to see what was planned today, to what extent it was achieved, why it remained incomplete; whether the quality was up to the mark and so on. This review is essential. There should be timely and clear communication both internally and externally and maintain time-sheets.

Arjun: All this we studied in theory but were never able to implement it.

Shrikrishna: Never take previous auditor’s communication lightly; and ensure that previous auditor’s undisputed audit fees have been really paid. Be particular about written communication everywhere and take proper and comprehensive Management Representation Letter (MRL). Please understand that certain things like this are for your own safety and your own safety is of supreme importance. It cannot be compromised.

Arjun: Yes, Lord. I have realised that the appointment letter and engagement letter are very important. We take it lightly. So also, generation of UDIN. We are also required to follow the KYC guidelines of ICAI.

Shrikrishna: And never ever sign anything in good faith before the client signs the financial statement or other documents.

Arjun: Bhagwan, a few of my friends were held guilty just because they did not put their membership number, FRN number and even the date of signing.

Shrikrishna: Most importantly, you SME people never go for stock verification. You never insist on a third-party evidence. Try to change yourself from this year. Plan the stock checking, write to banks, debtors, creditors, lenders; and all other concerned parties for confirmation of balances. All this forms your working papers. It is a must. Also, insist on company secretarial records and minutes. Further, verify what is available in the public domain.

Arjun: Our attitude is to say ‘who has time to do all this?’ But this is to our own detriment. I should recruit and retain good staff; not just who come through relatives and acquaintances! One good well-paid assistant is better than 3 or 4 mediocre assistants. All are unsatisfied, all of poor calibre; and all equally irresponsible!

Shrikrishna: Arjun, I am happy that you are introspecting. There is no use blaming or cursing others. Change yourself. Just as Charity begins at home, ‘Change’ also should begin at home! Have strict quality control. Be determined that     you will have a stress-free tax filing season!

! OM SHANTI!

This dialogue is based the need for proper planning for ensuring good quality of work.

Tech Mantra

Productivity in the Computer World is managing to do things fast, efficiently and accurately. Sometimes, it is just saving a few clicks, some other times it could mean opening up new possibilities and sometimes it is just a quick and amazing trick. Today, we run through a few Chrome Extensions which do exactly that. So here we go!

CHECKER PLUS FOR GOOGLE CALENDAR

If you use Gmail and Google Calendar, you would be doing a lot of tab-jumping from Gmail to Google Calendar, especially when you are responding to emails. Even otherwise, when you are online and doing some intensive work, jumping to your calendar from time to time can be quite a chore.The Chrome extension – Checker Plus for Google Calendar is a great tool to have the calendar at your fingertips. The extension sits neatly on your Chrome Extension panel and you can pop it up any time to get a quick view of your Calendar. It also lets you view upcoming events, get meeting notifications and reminders, and snooze events – all without opening the Google Calendar page. Convenience at the click of a button!

A very nifty tool to avoid multiple clicks on the Calendar Tab daily.

WHATSAPP (WA) WEB PLUS EXTENSION

We have all got used to using WhatsApp Web on our computers – it is such a breeze to handle! WhatsApp web plus extension for Chrome enhances the utility of WhatsApp Web dramatically.Once installed and running, the WA Web Plus Extension allows you to add more tools and options for WhatsApp Web for more privacy and enhanced reliability. It brings all the missing features of WhatsApp Web for personal and business use.

When you are on WhatsApp Web, just click on the WA Web Plus Extension and you will find a host of options – you can blur recent messages, blur contact names and photos, play audio messages without intimating the sender, disable read receipts, hide online status and much more. You can even password protect the app so that no one can access your WhatsApp web. Many other options for customisation like pin unread messages to top, highlight online contacts, etc. are available for easy access.

Most of the options are free while some are available for a small subscription fee.

A very useful tool for hardcore, daily users of WhatsApp Web!

AMAZON PRICE TRACKER – KEEPA AND BUYHATKE

If you are a regular shopper on Amazon, it may be a good idea to track price changes for any product you desire. Just install this extension on your Chrome browser and whenever you visit Amazon, select a product and scroll down a bit, you will be able to see the price history of that product. It also indicates price drops for lightning deals and for prime members. This will help you identify the lowest price of a product, when it occurred and if you are able to see the trend, you may even be able to grab it at the lowest price!If you shop on amazon.com, there are many more options available – you may visit their website www.keepa.com to see the variety of ways in which you can track products and their prices.

And, if you shop regularly on Flipkart, Myntra and other shopping sites, you may like to look at Buyhatke – Price tracker & Price history. This extension works similarly and is very useful for price tracking and price history.

Go ahead, save some money and buy wisely!

I DON’T CARE ABOUT COOKIES

Whenever we visit a new website, owing to increasing privacy concerns, the website asks us whether we would like to allow cookies. Some websites do not even take ‘No’ for an answer – they insist that you allow cookies, before they allow you to enter. This repeated questioning can get irritating. Most of the time, we allow cookies and move forward.I don’t care about Cookies is an extension which allows you to skip this question for all sites. Just install this extension and it will accept cookies on all websites that you visit. No more clicking Allow Cookies again and again on all the websites you visit!

Save time and make your web surfing super smooth!

Letter of Allotment and Receipt of Immovable Property

ISSUE FOR CONSIDERATION

Section 56(2) provides for the taxability of certain receipts, which inter alia include the receipt of any immovable property, either without consideration or for a consideration which is less than its stamp duty value. When taxability of such receipts was introduced for the first time vide clause (vii) of section 56(2), it was applicable only if the immovable property was received without consideration by the assessee on or after 1st October, 2009. The Finance Act, 2013 amended the provision of clause (vii) with effect from AY 2014-15, expanding its scope to cover the receipt of an immovable property for a consideration, if the consideration was lesser than the stamp duty value of the said immovable property.

The said clause (vii) of section 56(2) was applicable only to individuals and HUFs. However, thereafter, the Finance Act, 2017 made clause (vii) inapplicable to receipts after 31st March, 2017. Receipts subsequent to that date were brought to tax under clause (x) in the hands of all types of assessees. The taxability under both these clauses is subject to further conditions and several exclusions.

In the real estate market, when the immovable property is bought from a builder in a project which is underconstruction, it is a common practice that the builder will first issue a letter of allotment upon finalization of the deal and receipt of the booking amount. Thereafter, it will be followed by execution of a detailed agreement for sale and its registration. Even as per the provisions of the Real Estate (Regulation and Development) Act, 2016, it is obligatory for the promoter to enter into an agreement and to get it registered only when a sum of more than 10 per cent of the total consideration is received from the buyer. Thus, generally, the agreement for sale is not executed and registered immediately when the assessee books any property with the builder in an under-construction project and pays booking amount not exceeding 10 per cent of the total consideration.

If, in such cases, the year in which the assessee booked the property and received the letter of allotment is different from the year in which the agreement for sale has been executed and registered, then the issue arises as to in which year the assessee should be considered to have ‘received’ the immovable property. The Mumbai bench of the tribunal has considered the year in which the agreement for sale was executed as the year in which the property was effectively received by the assessee, and the Jaipur bench of the tribunal has considered the year in which the letter of allotment was issued as the year in which the property was effectively received by the assessee.

SUJAUDDIAN KASIMSAB SAYYED’S CASE

The issue first came up for consideration of the Mumbai bench of the tribunal in the case of Sujauddian Kasimsab Sayyed vs. ITO (ITA No. 5498/Mum/2018). The assessment year involved in this case was 2015-16.

In this case, the assessee had agreed to purchase flat No. 2901 on 29th Floor, C-Wing, in the building named as Metropolis, Andheri (West), Mumbai admeasuring area of 123.36 sq. m (carpet area) for a consideration of Rs. 88,30,008, whereas its stamp duty value was determined at Rs. 1,88,44,959. The assessee had originally booked this flat with M/s Housing Development & Infrastructure Ltd on 27th April, 2012 and an advance payment of Rs. 3,00,000 was also made on 27th April, 2012. The purchase deed was executed and registered on 10th September, 2014 i.e. during the year under consideration, apart from the payment of Rs. 3,00,000 at the time of booking of the flat, the assessee had made the payment of Rs. 14,66,001 till the time of execution of the agreement. The balance amount of Rs. 70,64,007 was still payable, and it was to be paid in instalments as specified in the agreement.

During the course of assessment proceedings, the AO asked the assessee to explain why the difference of Rs.1,00,14,951 (being the stamp duty value) should not be treated as income from other sources under section 56(2)(vii)(b). Not being satisfied with the reply of the assessee, the AO made the addition of such difference while passing the assessment order.

Aggrieved by the order of the AO, the assessee filed an appeal before the CIT(A). Before the CIT(A), it was contended that the assessee had booked the said flat on 27th April, 2012 on which date the letter of allotment was issued as well as the amount of Rs.3,00,000 was also paid. The copies of the allotment letter and receipt were also placed on record. On this basis, it was contended that these dates were falling in the previous year relevant to AY 2013-14, in which year the amended provisions of section 56(2)(vii)(b) were not applicable. The amendment made by the Finance Act, 2013 bringing to tax the receipt of immovable property for a consideration lesser than the stamp duty value was applicable only w.e.f. 01st April, 2014

The CIT (A) dismissed the appeal of the assessee, mainly on the ground that 27th April, 2012 could not be considered to be the date of purchase of the flat, as it was merely an allotment on that date, and the real transaction of purchase of flat had been entered on 10th September, 2014 by a registered deed. It was held that for any purchase or sale deed of immovable property to be covered under section 53A of the Transfer of Property Act, it was required to be a registered instrument enforcing civil law rights. In the absence of registration, the transaction would not fall under section 2(47)(v) of the Act. The CIT (A) placed reliance on the decisions of the tribunal in the case of Saamag Developers Pvt Ltd [TS-26-ITAT-2018(DEL) order dated 12th January, 2018] wherein it was held that registration under section 17(1A) of the Registration Act, 1908 was a pre-condition to give effect to section 53A of the Transfer of Property Act. He also relied upon the decision in Anil D. Lohana [TS-466-ITAT-2017(MUM) order dated 25th September, 2017], wherein it was held that the holding period of the property is to be reckoned from the date on which the assessee got right over the property by virtue of sale agreement.

Before the tribunal, the assessee submitted that the letter of allotment was executed with the builder on 27th April, 2012, which conferred the right to obtain conveyance of the said flat. It therefore became an asset under section 2(14) and therefore, the date of letter of allotment should be considered as the date of receipt of immovable property. Since the allottee would get title to the property on issuance of an allotment letter, and the payment of instalments would be only a consequential action upon which the delivery of possession would follow, it was claimed that the assessee was having a right in the property since 27th April, 2012 i.e. the date of allotment. Therefore, the effective date of agreement was 27th April, 2012, which pertained to A.Y. 2013-14. On this basis, it was argued that no addition should have been made in the assessment year under consideration.

  • The assessee relied upon the following decisions in support of his contentions –
  • Babulal Shambhubhai Rakholia vs. ACIT (ITA No. 338/Rjt/2017 for A.Y. 2014-15),
  • Sanjay Kumar Gupta vs. ACIT (ITA No. 227/JP/2018 for A.Y. 2014-15),
  • Anita D. Kanjani vs. ACIT (2017) 79 taxmann.com 67 (Mumbai-Trib),
  • DCIT vs. Deepak Shashi Bhusan Roy (2018) 96 taxmann.com 648 (Mumbai-Trib),
  • Pr. CIT vs. Vembu Vaidyanathan (2019) 101 taxmann.com 436 (Bombay HC) and
  • ACIT vs. Shri Keyur Hemant Shah (ITA No. 6710/Mum/2017 for AY 2013-14 dated 2nd April, 2019)(Mumbai ITAT).

The tribunal held that the decisions of Anita D. Kanjani, Deepak Shashi Bhusan Roy and Keyur Hemant Shah were not applicable to the case under dispute, since the issue under consideration in those cases was the period of holding of the property – whether to be reckoned from the date of issue of the letter of allotment or from the date when the agreement was executed. With respect to the decision in the case of Vembu Vaidyanathan, the tribunal held that the High Court in that case had considered the date of allotment would be the date on which the purchaser of a residential unit could be stated to have acquired the property for the purposes of section 54. In that case, the High Court had relied upon the CBDT Circular No. 471 dated 15th October, 1986 and Circular No. 672 dated 16th December, 1993 and had observed that there was nothing on record to suggest that the allotment in the construction scheme promised by the builder in that case was materially different from the terms of allotment and construction by DDA as referred to in those circulars. By observing that the issue in the case under consideration was not the allotment in construction scheme promised by the builder which is materially the same as the terms of the allotment and construction by DDA, the tribunal held that the decision in Vembu Vaidynathan was distinguishable.

The decision in Babulal Shambhubhai Rakholia was also distinguished on the grounds that, in that case, the stamp papers were purchased on or before 30th March, 2013 and the transferor as well as the transferee had put their signature on the sale deed on 30th March, 2013. It was on this basis, it was held that section 56(2)(vii)(b) would not be applicable. Similarly, the decision in Sanjay Kumar Gupta was also distinguished as in that case the assessee had claimed to have purchased the property in question vide unregistered agreement dated 28th March, 2013 and the AO considered the date of transaction as of the sale deed which was dated 26th April, 2013. Though the agreement dated 28th March, 2013 was not registered, it was attested by the notary and the payment of part of the consideration on 28th March, 2013 was duly mentioned in the sale deed dated 26th April, 2013. Under these facts, it was held in that case, that the transaction would be treated to have been completed on 28th March, 2013 as the agreement to sell dated 28th March, 2013 had not been held to be bogus.

The tribunal further held that there was no dispute that the “Agreement for Sale” was dated 10th September, 2014. The “Letter of Allotment” dated 27th April, 2012 could not be considered as the date of execution of agreement by any stretch of imagination. The immovable property was not conveyed by delivery of possession, but by a duly registered deed. Further, it was the date of execution of registered document, not the date of delivery of possession or the date of registration of document which was relevant. The tribunal relied upon the decisions in the cases of Alapati Venkataramiah vs. CIT (1965) 57 ITR 185 (SC), CIT vs. Podar Cements Pvt Ltd (1997) 226 ITR 625 (SC).

On the basis of the above, the tribunal upheld the order of the CIT (A) and dismissed the appeal of the assessee.

NAINA SARAF’S CASE

The issue, thereafter, came up for consideration of the Jaipur bench of the tribunal in Naina Saraf vs. PCIT (ITA No. 271/Jp/2020).

In this case, in the previous year relevant ot the AY 2015-16, the assessee had purchased an immovable property i.e. Flat No. 201 at Somdatt’s Landmark, Jaipur for a consideration of Rs.70,26,233 as co-owner with 50 per cent share in the said property. The stamp duty value was determined at Rs.1,03,12,220 as against the declared purchase consideration of Rs.70,26,233.

The case of the assessee was selected under CASS for the reason of “Purchase of property”. During the course of the assessment proceeding, the assessee filed registered purchase deed and other details as required by the AO. Finally, the AO after examining all the details and documents filed, accepted the return of income vide his order dated 21st December, 2017 passed under section 143(3).

Later on, the PCIT observed that the AO had failed to invoke the provisions of section 56(2)(vii)(b) with respect to the difference between the stamp duty value and the purchase consideration amounting to Rs.32,85,987, and, therefore, considered the order of the AO as erroneous and prejudicial to the interest of the revenue by passing an order under section 263 of the Act.

The assessee filed an appeal before the tribunal against the said order of the PCIT passed under section 263. Before the tribunal, the assessee not only challenged the jurisdiction of the PCIT to invoke the provisions of section 263, but also disputed the applicability of section 56(2)(vii)(b) to her case on merits. It was submitted that the assessee applied for purchase of Flat No.201 on 23.09.2006 (as mentioned in allotment letter) and paid Rs.7,26,500 on 3rd October, 2006. The seller company M/s SDB Infrastructure Pvt Ltd issued allotment letter on 06th March, 2009 to the assessee. On 11th November, 2009, by signing the allotment letter as token of acceptance, the assessee agreed to purchase the property measuring 2,150 sq ft at the rate of Rs. 3,050 per sq. ft. for a sum of Rs. 65,57,500 as per terms and conditions mentioned in the allotment letter dated 6th March, 2009. The formal agreement was exceuted and registered on 09th December, 2014. It was also submitted that the consideration of Rs.45,26,233 was already paid before 5th April, 2008 i.e. even prior to the date on which the allotment letter was issued.

On the basis of the above, the assessee contended that the purchase transaction effectively took place in AY 2010-11 itself, and not in AY 2014-15 when the actual registration took place. Therefore, the case of the assessee would be governed by the pre-amended provision of section 56(2)(vii)(b), which applied only where there was a total lack of consideration and not when there was inadequacy of purchase consideration.

Further, the assessee also challenged the denial of benefit of the first proviso to section 56(2)(vii)(b) by the PCIT, on the grounds that the date of the sale deed and the date of its registration were the same. It was contended that a bare perusal of the allotment letter showed that all the substantive terms and conditions which bound the parties, creating their respective rights and obligations were contained therein. The said allotment letter also provided for giving possession of the property within a period of 30 months from the date of allotment (except if due to some unavoidable reasons). Hence, there was an offer and acceptance by the competent parties for a lawful purpose. Thus, such allotment letter was having all the attributes of an agreement as per the provisions of the Indian Contract Act, 1872.

In so far as the PCIT’s observation that the allotment letter was provisional was concerned, it was submitted that the provisional nature of allotment was only to take care of unexpected happenings, such as changes by the sanctioning Authority or by the Architect or by the Builder, which might result in increase or decrease in the area, or absolute deletion of the apartment from the sanctioned plan. But for all intents and practical purposes, it was a complete agreement between the parties, which was even duly acted upon by both of them.

Further, the assessee contended that the relevant provision used the word ‘receives’ but did not use the word ‘purchases’ or ‘transfers’. Therefore, the legislature never contemplated the receipt of the subjected property as a complete formal transfer by way of registration of the property purchased in order to invoke section 56(2)(vii)(b)(ii). This would have had the effect of deferring the taxability, and resulted in late receipt of revenue from the taxpayer. On the contrary, by using the word ‘receives’, the legislature had advanced the taxability (provided the assesse clearly falls within the four walls of the provision as existed on the date of such receipt of the subjected property). The receipt of the property simplicitor happened in AY 2010-11, and not in the subject year i.e. AY 2014-15, where mere registration and other legal formalities were completed. The assesse’s right stood created and got vested at the time of the signing of the allotment letter itself by both the parties, on certain terms and conditions, and on specific purchase consideration. What happened later on was a mere affirmation / ratification by way of registration of the sale transaction in that year.

The tribunal perused the allotment letter and observed that it contained all the substantive terms and conditions which create the respective rights and obligations of the parties i.e. the buyer (assessee) and the seller (the builder) and bind the respective parties. The allotment letter provided detailed specification of the property, its identification and terms of the payment, providing possession of the subjected property in the stipulated period and many more. Evidently the seller (builder) had agreed to sell and the allottee buyer (assessee) had agreed to purchase the flat for an agreed price mentioned in the allotment letter. What was important was to gather the intention of the parties and not go by the nomenclature. Thus, there being the offer and acceptance by the competent parties for a lawful purpose with their free consent, the tribunal found that all the attributes of a lawful agreement were available as per provisions of the Indian Contract Act, 1872. It was also noted by the tribunal that such agreement was acted upon by the parties, and pursuant to the allotment letter, the assessee paid a substantial amount of consideration of Rs.45,26,233, as early as in the year 2008 itself. With respect to the PCIT’s observation that it was a mere provisional allotment, the tribunal held that it was a standard practice to incorporate the provision for increase or decrease in area due to unexpected happening so as to save the builder from unintended consequences. On this basis, it was concluded that the assessee had already entered into an agreement by way of allotment letter on 11th November, 2009, falling in AY 2010-11. Having said so, it was held that the law contained in section 56(2)(vii)(b) as it stood at that point of time, did not contemplate a situation of a receipt of property by the buyer for inadequate construction.

Accordingly, the tribual quashed the order of the PCIT, on the grounds that the assessment order, which was subjected to revision under section 263, was not erroneous and prejudicial to the interest of the revenue.

An identical view has been taken by the Mumbai bench of the tribunal in the case of Indu Kamlesh Jain vs. PCIT (ITA No. 843/Mum/2021) and Siraj Ahmed Jamalbhai Bora vs. ITO (ITA No. 1886/Mum/2019).

With respect to the applicability of section 43CA which has come in force with effect from A.Y. 2014-15, in cases where the allotment letters were issued prior to 1st April, 2013, diagonally opposite views have been taken by the Mumbai and Jaipur benches of the tribunal. In the case of Spenta Enterprises vs. ACIT [TS-63-ITAT-2022(Mum.)], it has been held that the provisions of section 43CA would not apply in such cases. As against this, in the case of Spytech Buildcon vs. ACIT [2021] 129 taxmann.com 175 (Jaipur – Trib.), it has been held that merely because an agreement had taken place prior to 1st April, 2013, it would not take away the transaction from the ambit of provisions of section 43CA. However, in the case of Indexone Tradecone (P) Ltd. vs. DCIT [2018] 97 taxmann.com 174 (Jaipur – Trib.), it was held that the provisions of section 43CA would not apply to a case where the agreement to sell was entered into much prior to 1st April, 2013, though the sale deed was registered after it came in force.

OBSERVATIONS

There are different stages through which a transaction of buying an immovable property passes, particularly when it has been bought from the builder in an ongoing project which is under construction and yet to be completed. These different stages can be broadly identified as under –

  • Allotment – When the person decides to buy a particular property and finalizes the relevant terms and conditions, the builder allots that particular property to that person by issuing a letter of allotment or a booking letter against the receipt of the booking amount. It contains the broad terms and conditions, which are the bare minimum required, such as identification of the property by its unique no., area of the property, total consideration to be paid, the time period within which the possession would be given etc. Normally, it is signed by both the parties i.e. the buyer as well as the seller.
  • Such an allotment letter is normally issued because it may not be feasible to execute the agreement for sale immediately. The execution of the agreement may take time due to its drafting and settlement, payment of stamp duty etc.
  • Agreement – After the necessary formalities are completed, the parties may thereafter proceed to execute an agreement which is popularly called as ‘agreement for sale’ and get it registered also. In order to safeguard the interest of the buyer, the relevant applicable local law may provide for restrictions on receipt of consideration in excess of certain limit, unless the necessary agreement has been executed and registered. For instance, as per the Real Estate (Regulation and Development) Act, 2016, it is obligatory for the promoter to enter into an agreement and to get it registered when a sum of more than 10 per cent of the total consideration is received from the buyer.

Possession – Upon completion of the construction, the builder hands over the possession of the property to the buyer in accordance with the terms and conditions as agreed.

The buyer is required to make the payment of the consideration as per the agreed terms throughout these stages. Normally, if the entire consideration as agreed has been paid, then the receipt of possession of the property is regarded as its deemed conveyance.

The first stage i.e. issuance of the allotment letter, may not be there in every case. But, the other two stages will normally be there in all cases, unless the property has been conveyed at the time of agreement itself and possession has also been handed over simultaneously.

Due to such multiple stages, several issues arise while applying the provisions of the Income-tax Act, some of which are listed below –

  • From what date should the assessee be considered as holding the property for determining whether it is short-term or long-term in accordance with the provisions of section 2(42A)?
  • When should the assessee be considered to have purchased or constructed the residential house for the purpose of allowing exemption under section 54 or 54F?
  • When should the assessee be considered to have received the property under consideration for the purpose of section 56(2)(x)? Whether the first proviso to section 56(2)(x) applies in such case and whether the stamp duty value as on the date of the allotment letter can be taken into consideration?
  • If the assessee is the seller, when should he be considered to have transferred the property for the purpose of attracting the charge of capital gains or business income in his hands? Whether the first proviso to section 50C is applicable in such case and whether the stamp duty value as on the date of the allotment letter can be taken into consideration?

Though the controversies exist on each of the above issues, the scope of this article is to deal with the controversy with respect to the applicability of section 56(2)(x) only. The limited issue under consideration is whether can it be said that the assessee ‘receives’ an immovable property when a letter of allotment is issued to him by the seller or he ‘receives’ it only upon the execution of the agreement for sale. Though one may contend that the assessee does not receive the property on either, and he receives it only upon receipt of the possession of the property, such issue has not been dealt by the tribunals in the cases discussed above.

The primary reason as to why the allotment letter was not considered to be receipt of the immovable property by the Mumbai bench of the tribunal in the case of Sujauddian Kasimsab Sayyed (supra) was that the allotment letter was not considered to be in the nature of an agreement equivalent to an agreement for sale, resuling into receipt of the property in the hands of the assessee. Therefore, first and foremost, it is required to be examined whether the letter of allotment or the booking letter can be considered to be an agreement and is there any material difference between the allotment letter and the agreement for sale, because of which the assessee is considered to have received the property on execution of the agreement for sale but not on issue of the allotment letter.

At the outset, it is clarified that the contents of the allotment letter and other related facts would be very relevant to decide this aspect of the matter. In this article, the attempt has been made to discuss the issues, assuming that the allotment letter contains all the important terms and conditions necessary to be agreed upon in any transaction of purchase and sale of property as per the standard practice of the industry i.e. identification of specific unit no. of the property, its area, total consideration, schedule of payment and possession, etc.

The Indian Contract Act, 1872 simply defines an agreement that is enforceable by law as a contract. It further provides that all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not expressly declared to be void. Further, it also provides that the agreement need not be in writing, unless it is required so to be in writing by any other law in force. All the essential ingredients of a contract are present in the allotment letter, and, therefore, the same needs to be considered as a contract enforceable in the eyes of law.

In the case of Manjit Singh Dhaliwal vs. JVPD Properties Pvt Ltd (No. AT006000000000017 – decision dated 12th April, 2018), the issue before the Maharashtra Real Estate Appellate Tribunal was whether the allottees who had been issued only the letter of allotment and no agreement for sale had been executed could seek relief under the RERA Act or not. While holding that the complaint of the allottees would not fall for want of agreement for sale, the tribunal observed that the letter of allotment in that case stipulated the description of the property to be purchased, description of the payment schedule, the total cost, the necessary requisite permission, obligation to complete the projects and getting clarity to the title and, therefore, the cumulative effect of it would not be short of branding it to be the terms agreed upon between the parties. It was held that the agreement is a form of contract relating to offer, acceptance, consideration, time schedule, clarity of title and as to essence of time. The allotment letter incidentally was couched in such a fashion as to incorporate all the requisite terms. Hence, the absence of an agreement for sale would not scuttle the rights of allottees.

In the case of Shikha Birla vs. Ambience Developers Pvt Ltd (IA No. 418/2008 dated 20th December, 2008), the Delhi High Court was dealing with a suit against the developer for specific performance of the contract contained in the letter of allotment, and for direction to handover possession of the concerned property. In this case, the High Court held that an understanding to enter into a legally binding agreement does not result in a legally enforceable contract, but an understanding or a bargain is legally enforceable, if execution of a further document is to effectuate the manner in which the transaction already agreed upon by the parties is to be implemented. In the former case, execution of the agreement is a condition precedent. An agreement to enter into an agreement is not executable, but in the latter case, execution of a formal document is not a condition precedent and rights and obligations of the parties come into existence. A mere reference to a future formal contract will not in law prevent a binding bargain between the parties. On the facts of that case, the High Court held that, vide the allotment letter, the terms and conditions were ascertained and certain. Nothing was left to be negotiated and settled for future. Terms were agreed and the agreement for sale on a standard format was read and understood. It was a certain and concluded bargain. It was not a case where the parties were entering into a temporary understanding, which may or may not fructify into a binding bargain, and where execution of agreement for sale was a condition precedent for creating permanent obligations. A concluded contract therefore had come into existence. Therefore, the letters of allotment, in that case, were not regarded as in the nature of an understanding which did not create an enforceable agreement in law but only an understanding between the parties to enter into an enforceable agreement in future.

The Delhi High Court in the said case also referred to the decision of the Supreme Court in the case of Poddar Cement Pvt Ltd (supra) and held that the Supreme Court had also referred to with approval the need and requirement to continuously update and construe law in accordance with changes, ground realities to make it a living enactment, in tune with the present state of affairs.

Further, the clause in the allotment letter that the allottee shall not be entitled to enforce the same in a Court of Law was regarded as void by the Delhi High Court in view of section 28 of the Contract Act, 1872, by relying upon the decision of the Supreme Court in the case of Food Corporation of India vs. New India Assurance Company Ltd reported in AIR 1994 SC 1889, wherein it was held that every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to that extent.

In the context of the Income-tax Act, 1961, the Mumbai bench of the tribunal in the case of Indogem vs. ITO (2016) 160 ITD 405 (Mum) has already examined the issue as to whether the letter of allotment could be regarded as agreement giving equivalent benefits to the assessee under the Act and the relevant portion from this decision is reproduced below:

“First point for consideration is whether there is an agreement for acquisition of property between the builder and the assessee. Agreement means set of promises forming consideration for each other. Law does not require that an agreement shall always be in writing or if reduced into writing, it shall be in a particular/specific format. As could be seen from the record, the allotment letter runs into so many clauses and, in our view, it answers the description of an agreement. When all the terms agreed upon by the parties are reduced into writing in detail, nothing more is required than formal compliance with the stamp and registration requirements. On a careful perusal of this allotment letter, we find that it contains all the details that were agreed upon by the parties, as such, by no stretch of imagination could it be said that there is no valid agreement for acquisition of the property.”

In view of the above, it appears that the view taken by the Mumbai bench of the tribunal in the subsequent decision in the case of Sujauddian Kasimsab Sayyed was contrary to what was held in the decision as referred above of the co-ordinate bench.

There can be an equally strong argument to claim that, upon issuance of the allotment letter, what is received is not the immovable property itself, but only the right to receive it in future by executing a registered agreement at a later stage or by receiving its possession. This view can be further justified on the grounds that if the allotment letter is considered to be a receipt of the immovable property, then it would result in taxing the difference in that year itself (in a case where the allotment letter has been issued subsequent to 1st April, 2013 i.e. subsequent to the amendment), irrespective of whether it has then culminated into a registered agreement or has been cancelled due to any reason. In the case of Hansa V. Gandhi vs. Deep Shankar Roy (Civil Appeal No. 4509 of 2007), the Supreme Court has held that mere letter of intent, which was subject to several conditions, would not give any right to the allottee for purchase of the flats in question, till all the conditions incorporated in the letter of intent were fulfilled by the the proposed purchasers. Further, it was also held that if the same flat has been sold to the other buyer upon non-fulfillment of the conditions of the letter of intent, then it cannot be presumed that such subsequent buyer had knowledge about the previous transaction for want of registration of the said letter of intent.

However, even if the provisions of section 56(2)(x) are invoked for taxing the difference between the stamp duty value and the actual consideration in the year in which the agreement has been executed and registered, then the benefit of the first proviso to section 56(2)(x) needs to be extended. The first proviso states that where the date of agreement fixing the amount of consideration for the transfer of immovable property and the date of registration are not the same, the stamp duty value on the date of agreement may be taken for this purpose. In such a case, the letter of allotment is to be considered as the agreement fixing the amount of consideration, subject to fulfillment of the other conditions. Difference of opinion may exist only with respect to the nature of rights which the buyer derives on the basis of the letter of allotment, but certainly not with respect to the fact that the letter of allotment needs to be regarded as the agreement fixing the amount of consideration.

The view that the stamp duty value as on the date of allotment letter should be preferred over the stamp duty value as on the date of registration of the agreement for sale is supported by the following decisions:-

  • ITO vs. Rajni D. Saini (ITA No. 7120/Mum/2018)
  • Sajjanraj Mehta vs. ITO (ITA No. 56/Mum/2021)
  • Radha Kishan Kungwani vs, ITO [2020] 120 taxmann.com 216 (Jaipur – Trib.)

That being the position, where the inadequacy of the consideration has to be judged on the basis of the difference in valuation on a date before the amended law came into force, the better view seems to be that such transactions entered into at that point of time are not intended to be covered by the subsequent amendments.

Section 56(2)(x) and its predecessor clause(vii) provides for bringing to tax the cases of inadequate  consideration on receipt of an immovable property. The term ‘property’  is  defined in vide clause (d) of Explanation to s.56(2)(vii) which in turn includes an immovable property and sub-clause(i) thereof defines an ‘imovable property’ to be  ‘land and building or both’.  There is a reasonable consistency of the judiciary in restricting the scope  of the term immovable property to the cases of land and building  simpliciter and not to the cases of the rights in land and building. Please see Atul G.Puranik, 132 ITD 499 (Mum) which holds  that even leasehold  rights in land are not the ‘land’ simpliciter.  Equating the ‘land and building’ to the case of a rights under a letter of allotment, issued at the time where  the premises are yet under construction, perhaps is far -fetched and avoidable. Secondly, what is required for a charge of tax, under s.56(2). to be complete is the ‘receipt’ of a property ; such a property that can be regarded as land or building. Obviously, the receipt of a right under letter of allotment would not satisfy the requirement for a valid charge of tax. Under the circumstances, it is better to  hold that the provisions of s.56(2)(x) are inapplicable in the year in which an allotment letter is issued in respect of the premises under construction. The charge of tax may be attracted in the year of receipt of the premises, Yasin Moosa Godil, 52 SOT 344(Ahd.),  and in that year the benefit of the Provisos(s.43CA,50C and 56(2)(x)), while determining the inadequacy shall be ascertained w.r.t the allotment letter.

Of Mules and Securities Laws

BACKGROUND

Mules, in common parlance, are understood as beasts of burden. They mindlessly carry out severe labor work often for relatively small rewards. In the narcotic drug business, mules are those who carry/smuggle drugs from one place to another. In securities laws too, now, the term ‘mules’ has acquired a similar meaning. They refer to persons who do illegal work under the instructions of another mastermind. Theyget small rewards for doing such work or allowing their names to be used. The question is how they are treated in securities laws since the violations are carried out in their names?

USE OF MULES TO CARRY OUT NUMEROUS TYPES OF SECURITIES LAWS VIOLATIONS

The typical use of mules is to use their names to carry out certain acts, which if carried out in one’s own name, would be illegal or otherwise help links to be established whereby the acts would be held to be illegal. A corrupt person, for example, would take bribes and build wealth in the name of another person, and thus himself being free of scrutiny. Having wealth in one’s own name could be a presumption of having acquired it through corrupt means. In securities laws, there are similar reasons. An insider having Unpublished Price Sensitive Information (UPSI), for example, may use mules to carry out trades with benefit of such information and make illicit profits. Similarly, a front runner, who has information of impending large orders of clients/employers, may use these mules to carry out transactions in such scrips. Since it is expected that on account of the large orders of his client/employer, there would be significant movement in price, he would use these mules to enter into transactions first and then reverse these transactions when the orders of his employer/client are put through.

Then, there are those who engage in price manipulation. Often a group of persons are needed to carry out such acts. Such group of persons may engage in trades and counter trades, often in a circular manner whereby, at least initially, there may be no movement of shares outside such the group. If the intent is ‘pump and dump’, then, after the price is pumped up to higher levels, there would be off loading of the shares by the master mind to unsuspecting investors. At a later date, when there are complaints and investigations, the master mind may claim to have had no knowledge or connection with the various mules. The mules, assuming they are traceable or appear before SEBI against summons, too may claim having no connection.

Then there were the classic cases of share subscriptions in public issues to take the benefit of reservations for retail investors. It was alleged that share applications in large numbers were made in the names of thousands of such mules, and these were financed by a small group of people. These cases, which came to be popularly referred by one of the alleged persons, Roopalben Panchal, led to investigations and multiple proceedings that lasted for a long time. It was alleged that share applications were made in the name of such mules and shares allotted to such persons were sold and the profits/sale proceeds transferred back to the alleged financiers.

DETECTION/DEMONSTRATING VIOLATIONS OF SECURITIES LAWS USING MULES

The use of mules present a challenge to the regulator in proving and punishing violations of securities laws. The mules and their mastermind may claim no connection with each other and thus argue that there were no violations.

In case of insider trading, the work of SEBI is thus relatively easier as there are deeming provisions that hold several connected persons as insiders. Further, well settled principles of law (as laid down by the Supreme Court and as discussed later herein) help SEBI in using circumstantial evidence. Thus, several such orders are seen to be regularly passed from time to time.

That said, sophisticated capital market operators may use means that make detection and punishment difficult. Digital tools, messengers, etc. may also be used. In some cases, SEBI has meticulously traced mobile calls and established links between persons based on such connections. However, there are just too many ways to pass messages/make calls unless such messages remain on record. Here too, there are sporadic cases where SEBI has even used web archives to excavate deleted websites. But the technical challenges remain formidable.

SEBI does come to know of suspicious transactions through market surveillance. Financial transactions between the parties, introducing such mules in bank or broker accounts, etc. also help establish guilt. SEBI had, in one case, shown extraordinary initiative to track the movement of an alleged front runner through his mobile phone and found that the person used to withdraw cash through ATM from the account of such a mule. However, such cases are one off and do not help wider prevention, detection and punishment of securities laws violations.

SEBI’S ENFORCEMENT ACTION AGAINST SUCH MULES – DIFFICULTIES AND INJUSTICE

Even if detected, the unresolved issue is what action should be treated against mules? The dilemma particularly here is this. The ‘mastermind’ may claim that he has done no wrong, the transactions are not done by him and the rewards of the misdeeds are also not with him. It is the other person, the alleged mule, who has done everything. The mule may claim a similar story of innocence, the counter part. He may say he is just an uneducated person, maybe in the employment of the mastermind at a lower hierarchy earning a small salary or otherwise in a similar job elsewhere and who is recruited. He may claim that the rewards of the misdeeds have been transmitted to the real culprit, either by the way of ‘loans’ or through cash. In some cases, he may admit to have signed various documents on the basis of some small remuneration. It may be difficult for SEBI to ascribe/allocate blame to the “real culprit”. This is more so if it is admitted, or otherwise easily demonstrated, that the mule was aware that wrongful transactions were being done in his name.

Typically, SEBI has been punishing all the persons equally. They may all be debarred from capital markets. A common penalty be levied on them, payable jointly and severally and this stance is particularly justified if the money may be lying with the mule or if SEBI is unable to find out where it has landed.

The difficulties in taking such a uniform stand are several. Firstly, the mule gets punished as an equal to the main person, despite his role being less, maybe a name-lender. Secondly, levying the penalty as fully recoverable from the mule (even if on a joint and several basis) creates far more difficulties on the mule. His bank account and his meagre savings and properties may get attached/recovered. Even if he bears guilt in this regard, such a punishment is clearly disproportionate and unjust. The mastermind may also have bigger resources to fight the matter.

Recently, however, SEBI has been changing its stand for the better. For one, if it is possible to trace how much of the ill-gotten gains went to whom, the recovery is made accordingly from such persons, instead of recovering on a joint basis. Further, in several cases, even if not on a consistent basis with general principles laid down, SEBI has levied penalty/punishment on the basis of demonstrated involvement in the violation. The backgrounds of the parties too have been considered for this purpose. Hence, while some punishment may still be meted out, it may be proportionate to the guilt and involvement.

Admittedly, if it is not easy to find the culprits, then, demonstrate the violations and then go even further and allocate blame. However, SEBI has the benefit of at least two Supreme Court decisions (SEBI vs. Kishore R. Ajmera (2016) 3 Comp. LJ 198 (SC) & SEBI vs. Rakhi Trading (P.) Ltd. ((2018) 207 Comp Cas 443 (SC)) which have made deciding of the guilty easier on the principles of “preponderance of probability.” This principle does not require a proof of beyond reasonable doubt but a lower one based on what is more probable than not. SEBI could see the facts of the case, see the level of sophistication and resources of the persons involved, the cooperation given, etc. and ascribe blame and punishment accordingly.

VISHWANATHAN COMMITTEE REPORT

The SEBI Committee chaired by T. K. Vishwanathan had in August 2018 made certain recommendations on this topic. A method of detecting mule accounts was suggested. For this purpose, a formula was provided that lays down the volumes of trades based on income/net worth of the investor. If the broker finds that the volumes are beyond an “affordability index”, then the broker should exercise special diligence for such client. If the volumes are beyond this and even beyond prescribed levels, the account could be suspected as a mule account. However, though amendments to the Regulations were suggested, they have not yet been made.

SOME CASES

An interesting investigation was carried out by SEBI which culminated in an interim order dated 1st October, 2020. While a detailed analysis of this order could be a separate subject, it is seen that SEBI traced the mobile records and even the location of parties as available from such records. Based on these investigations, it alleged that mule accounts were created for carrying out front running and the primary person withdrew the cash from the bank accounts of such mules. However, SEBI ordered that the profits made be deposited by all the parties including the alleged mules and this liability for deposit was made joint and several. Till this was done, the assets, bank accounts, etc. were required not to be disposed off. Effectively, this meant that the alleged mules too suffered such embargo.

In an order dated 24th December, 2020, in the matter of Viji Finance Ltd, SEBI alleged that 78 parties were ‘mules’ or ‘name lenders’. They were low income/unskilled/uneducated people whose occupations included being a vegetable vendor, house painter, auto drivers, etc. For alleged violation of the Prohibition of Fraudulent and Unfair Trade Practices (PFUTP) Regulations, a penalty of Rs. 15 lakhs was levied jointly and severally on them. The result is that the full amount could be recovered from even any one of them and there would be no mechanism for them to share it between them. It is possible that they may not even know each other.

In an order dated 13th January, 2021, SEBI elaborated the concept of “Family and Friends” mule accounts. It was stated, “Before proceeding to deal with the circumstances, it will be appropriate to elaborate on the concept of “Family and Friends” mule accounts. These are trading accounts which are “lent” by persons known to the person who is effectively controlling / placing the orders in the trading account. For example, family members, extended family members, friends, acquaintances, etc. The person who is controlling the account / placing the orders gets access to the trading accounts based on trust or on the strength of relationship between him and the registered owner of the trading account.” Using this principle, the family members were held equally responsible for the alleged violations. They all were required to deposit the impounded amount their banks.

CONCLUSION

While legal issues of proving and apportioning guilt are difficult enough, the unorganized economy in India where transactions in cash may be made, adds to the difficulties. It is quite possible that the SEBI’s attempt may be barely scratching the surface.

Section 148 –Reopening – beyond the period of four years – Approval for issuance of notice:

24 MA Multi-Infra Development Pvt Ltd vs.

ACIT Circle- 3(2)(1) & Ors

[Writ Petition No. 1650 of 2022,

Date of order: 09th January, 2023, (Bom.) (HC)]

Section 148 –Reopening – beyond the period of four years – Approval for issuance of notice:

The assessee challenges the notice dated 31st March, 2021 under section 148 of the Act, for the A.Y. 2015-16, inter-alia, on the ground that since the same has been issued beyond the period of four years, approval for issuance of the same ought to have been obtained from the Principal Chief Commissioner of Income-tax in terms of section 151(ii) of the Act.

The Court observed that a perusal of the notice dated 31st March, 2021 issued under section 148 of the Act by the AO shows that the same has been issued after obtaining necessary satisfaction of Additional Commissioner of Income Tax, Range (3)(2), Mumbai. As per the objections filed by the revenue, the approval was obtained from the Additional Commissioner of Income Tax, Range (3)(2), Mumbai. The said officer, it is stated, was competent to grant approval in view of the applicability of the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (for the sake of convenience, hereinafter referred to as ‘the Relaxation Act’).

It is stated that in terms of the Relaxation Act, the limitation inter-alia, under provisions of sections 151(i) and 151(ii) of the Act, which were originally expiring on 31st March, 2020, stood extended to 31st March, 2021. It was, thus, urged that since the Relaxation Act had extended the period of limitation, the authority which was otherwise supposed to grant approval in regard to cases falling within the ambit of section 151(i) of the Act could have granted approval beyond the period of three years based upon the Relaxation Act.

The Court in J.M. Financial & Investment Consultancy Services (P) Ltd. vs. Assistant Commissioner of Income Tax & Ors. [Writ Petition No.1050 of 2022 dated.4th April, 2022 ] has already taken a view holding that the Relaxation Act would apply only to cases where the limitation was expiring on 31st March, 2020 and since for the A.Y. 2015-16, the limitation period was six years which was to expire only on 31st March, 2022, the said provisions would not be applicable. It was held that while the time to issue notice may have been extended but that would not amount to amending the provisions of section 151 of the Act.

The petitioner urged that the case of the petitioner fell under section 149(b), and therefore, the period of limitation of six years for issuance of notice under section 148 for the A.Y. 2015-16 would expire on 31st March, 2022. It was, therefore, urged that the case of the petitioner was squarely covered by J.M. Financial & Investment Consultancy Services (P) Ltd.

Accordingly it was held that the approval for issuance of notice under section 148 ought not have been obtained from the Additional Commissioner of Income Tax but from the authority specifically mentioned under section 151(ii) of the Act.

The notice impugned notice dated 31st March, 2021 was quashed. The petition was allowed.

Unaccounted income – Bogus Long Term Capital Gains – Concurrent finding of fact – No substantial question of law :

23 Pr. Commissioner Of Income Tax-10 vs.

M/S. Rajat Finvest & Ors[ITA NO.13 OF 2023,

Date of order: 12th January, 2023, (Del.) (HC)]

[Arising out of ITAT order dated 12th September, 2019 for A.Y. 2010-2011 [ITA 13/2023], A.Y. 2009-2010 [ITA 14/2023] and A.Y. 2008-2009 [ITA 15/2023].

Unaccounted income – Bogus Long Term Capital Gains – Concurrent finding of fact – No substantial question of law :

The respondent/assessee is in the business of trading and investing in scrips. On 7th August, 2012, a survey was carried out by the appellant/revenue in exercise of powers under section 133A of the Income-tax Act, 1961, and according to the appellant/revenue, during investigation, the fact was revealed i.e., that the respondent/assessee had introduced unaccounted income in its books of accounts in the guise of long-term capital gains (LTCG), albeit, by first investing and then selling the shares of two entities i.e., REI Agro Ltd. [in short, “REI”] and REI Six Ten Ltd [in short, “REI Six”]. The respondent/assessee, against the LTCG, had claimed exemption from tax.

It is not in dispute, that REI is a listed company, and its shares were transacted on the stock exchange. The facts also show, that during the course of the survey on 7th August, 2012, the statement of one Mr. Brij Mohan Vyas was recorded. Mr. Brij Mohan Vyas, according to the appellant/revenue, is an employee of REI Agro Group. The shares of REI were bought and sold through brokers, on instructions of one Mr. Sandeep Kumar Jhunjunwala.

The AO has relied upon the details gathered by the Investigation Wing, to conclude that the respondent/assessee had introduced its unaccounted income to purchase and sell the shares of REI. Thus, based on the information gathered by the Investigation Wing, the AO concluded, that the entire set of transactions was a ‘sham’, and that the same had been configured to give the sale and purchase of shares by the respondent/assessee a legal framework. The Assessment Order was passed pursuant to reopening of assessment of the respondent/assessee under section 148 of the Act.

The CIT(A) via order dated 29th June, 2016 partly allowed the respondent/assessee’s appeals. The appellant/revenue preferred an appeal to the Tribunal.

The Tribunal considered the matter in great detail, and came to the conclusion that the order passed by the CIT(A) had to be confirmed.

The Hon. High Court noted that both the CIT(A) and the Tribunal have returned findings of fact. The important fact was that the respondent/assessee traded in shares and the respondent had converted a part of its stock-in-trade as investment. In A.Y. 2008-09, the respondent/assessee had declared profit from trading in shares of REI, and during that very year, the said shares were transferred to opening stock and were purchased under investment portfolio.

Further the statement made by Mr. Brij Mohan Vyas on 7th August, 2012 did not reveal that REI was manipulating share prices on the stock exchange. The involvement of Mr. Sandeep Kumar Jhunjunwala, based on whose instructions Mr. Brij Mohan Vyas acted, was to the extent as to the right time when shares of REI had to be bought and sold.

The observation of the AO, that the funds which flowed from REI in the form of unsecured loans to six companies, which were located in Gujarat, were unaccounted income of the respondent/assessee, appears to be based on assumptions and/or conjectures. No material to back the conclusion arrived at by the AO.

The appellant/revenue could not have bifurcated the purchase and sale transactions. Concededly, when the shares were purchased for trading purposes in earlier years, the profits so generated were accepted, and at the point in time, when these scrips were converted into investment and sold during the Assessment Years in issue, they could not be treated as bogus transactions. The fact that shares were traded on stock exchange after paying securities transaction tax, and that money had been received through banking channels only demonstrated that they were not bogus transactions.

The Court noted that there are concurrent findings of facts returned by the CIT(A) as well as the Tribunal. The proposed questions of law by the appellant/revenue do not state that the findings returned by the Tribunal or the CIT(A) are perverse.

Thus, the appeals were, dismissed, as no substantial question of law arose for consideration.

Section 264 – Revision – amount had been taxed twice – powers under section 264 of the Act were not limited to correcting any errors committed by the authorities but also extended to errors committed by the assessee.

22 Interglobe Enterprises Pvt Ltd vs.

Pr. Commissioner of Income

Tax Delhi -4 & Ors.

[Writ Petition (L) NO. 11708 OF 2021 & CM APP. 36194 OF 2021

Date of order: 20th January, 2023, (Delhi) (HC) ]

Section 264 – Revision – amount had been taxed twice – powers under section 264 of the Act were not limited to correcting any errors committed by the authorities but also extended to errors committed by the assessee.

The controversy, in the present case, relates to the liability to pay tax on the interest received on income tax refund pertaining to the A.Ys. 2009-10 and 2010-11. The assessee had credited interest amounting to Rs. 1,61,38,250 in its books of account for the F.Y. 2013-14. This amount included a sum of Rs. 1,29,01,031 as interest on income tax refund for the A.Y. 2009-10 and Rs. 22,66,836 as interest on income tax refund for the A.Y. 2010-11. Thus, an aggregate amount of Rs. 1,51,67,867, on account of interest on income tax refund(s), was included as income for the F.Y. 2013-14. The assessee included the said amount in its return of income for the A.Y. 2014-15 and paid tax on the same.

The assessee’s return for the A.Y. 2014-15 was picked up for scrutiny and an assessment order dated 28th October, 2016 was passed under section 143(3) of the Act. There is no dispute that income, as assessed, included the said amount of Rs. 1,51,67,867 as interest on income tax refund(s) pertaining to the A.Ys. 2009-10 and 2010-11.

Thereafter, by a notice dated 15th February, 2017, issued under section 148 of the Act, the assessee’s assessment of income for the year 2012-13 was reopened. The interest on refund of tax, for the years 2009-10 and 2010-11, was sought to be included in the taxable income for the A.Y. 2012-13 on the grounds that the said interest was received during the previous year 2011-12.

The petitioner, inter alia, contended that the said amount was included in the income of the assessee for the A.Y. 2014-15 and thus, had not escaped assessment warranting any addition in the income changeable to tax for the A.Y. 2012-13. However, this contention was not accepted and the AO passed an order dated 08th December, 2017, inter alia, adding the amount of Rs. 1,51,67,867 as income for the A.Y. 2012-13.

Although the AO added the amount of Rs. 1,51,67,867 as income for the A.Y.2012-13, he did not pass any order excluding the said amount from the taxable income for the A.Y. 2014-15. Resultantly, the said amount has been taxed twice; once, as income assessed under the assessment order dated 8th December, 2017for the A.Y. 2012-13, and second, in terms of the assessment order dated 28th October, 2016 for the A.Y. 2014-15.

Whilst the appeal under section 246A of the Act was pending before the Commissioner of Income Tax (Appeals), the assessee accepted the addition of Rs. 1,51,67,867 in its income chargeable to tax in the A.Y. 2012-13 and applied under the Direct Tax Vivad Se Vishwas Act, 2020 (hereafter ‘the VSV Act’) for settlement of the dispute. The liability for the A.Y. 2012-13 has been finally settled; the petitioner has received the Form 5 and has paid the necessary tax.

Since a sum of Rs. 1,51,67,867 had been taxed twice, on 16th February, 2018, the petitioner applied for revision of the assessment pertaining to the A.Y. 2014-15. The respondent did not take any steps in regard to the said application for a period of more than 3.5 years.

The assessee filed a writ petition (being WP(C) No.8177/2021) in the Court. The said petition was disposed of by an order dated 11th August, 2021, directing the respondent to dispose of the assessee’s application dated 16th February, 2018, filed under section 264 of the Act. The assessee’s application was rejected by an order dated 04th October, 2021, which was under challenge before the High Court.

The assessee contended that the impugned order is, ex facie, erroneous as it proceeds on the basis that the issue regarding the interest amount does not form a part of the order under section 143(3) of the Act. It is contended on behalf of the assessee that the said reasoning is, ex facie, erroneous as the amount of Rs. 1,51,67,867 (Rs. 1,29,01,031 and Rs. 22,66,836) was subjected to tax for the A.Y. 2014-15 and is included in the income as assessed by the order dated 28th October, 2016, passed under section 143(3) of the Act.

The Hon. Court observed that section 264 of Act enables the Principal Commissioner or Commissioner, on its own motion or on an application made by the assessee, to call for records of any proceedings under the Act or to cause such inquiry to be made and, subject to the provisions of the Act, pass such order thereon as the Commissioner thinks fit. The only condition being that such order cannot be prejudicial to the assessee. Undisputedly, if the records for the A.Y. 2014-15 were recalled, it would reveal that the sum of Rs. 1,51,67,867, received on account of interest on income tax, was assessed as income for the previous year 2013-14 relevant to the A.Y. 2014-15. However, as stated above, the said amount was brought to tax by the Income Tax Authority in the A.Y. 2012-13. Clearly, the same amount cannot be taxed twice.

It is settled law that an assessee is liable to pay income tax only on the income that is chargeable under the Act. Merely because an assessee has offered a receipt of income in his return does not necessarily make him liable to pay tax on the said receipt, if otherwise the said income is not chargeable to tax. InCIT vs. Shelly Products: (2003) 5 SCC 461, the Supreme Court held that if the assessee had, by mistake or inadvertently, included his income or any amount, which was otherwise not chargeable to tax under the Act, the AO was required to grant the assessee necessary relief and refund any tax paid in excess.

It is also well settled that the powers conferred under section 264 of the Act are wide. In Vijay Gupta vs. Commissioner of Income Tax Delhi-XIII & Anr.: 2016 SCC OnLine Del 1961, a Co-ordinate Bench of this Court held that powers under section 264 of the Act were not limited to correcting any errors committed by the authorities but also extended to errors committed by the assessee.

As observed above, it is clear that the amount of Rs. 1,51,67,867 cannot be taxed twice. In the aforesaid view, it was apposite for the Commissioner to have revised the assessment order for the A.Y. 2014-15 in light of the reassessment order dated 08th December, 2017, whereby the amount of Rs. 1,51,67,867 was brought to tax in an earlier assessment year (A.Y. 2012-13).

In view of the above, the impugned order was set aside and the matter was remanded to the concerned Commissioner to pass the fresh order in light of the observations made above. The petition was allowed in the aforesaid terms.

Search and seizure — Assessment in search cases — Condition precedent — Prior approval of prescribed authority in respect of each assessment year — Sanction of prescribed authority for various assessees granted on single day — AO passing draft assessment order and final assessment order on same day of approval — Approval illegal and non est

87 Principal CIT vs. Subodh Agarwal

[2023] 450 ITR 526 (All)

A. Y.: 2015-16

Date of order: 12th December, 2022

Sections 132, 153A, 153D and 260A of ITA 1961

Search and seizure — Assessment in search cases — Condition precedent — Prior approval of prescribed authority in respect of each assessment year — Sanction of prescribed authority for various assessees granted on single day — AO passing draft assessment order and final assessment order on same day of approval — Approval illegal and non est

Pursuant to a search and seizure operation under section 132 of the Income-tax Act, 1961 conducted on 31st August, 2015, the assessment for the A.Y. 2015-16 was completed under section 153A/143(3) of the Act by the Deputy Commissioner of Income-tax, Central Circle-1, Kanpur, vide order dated 31st December, 2017and various additions were made.

The Tribunal set aside the order of the AO. The Tribunal found as under: The AO prepared the draft assessment order on 31st December, 2017 for the A.Y. 2015-16. The approval of the draft assessment order under section153D was given on 31st December, 2017 itself and the final assessment order was passed on the same day, i.e., on 31st December, 2017 by the AO. The Additional Commissioner of Income-tax granted approval of draft assessment orders under section 153D in 38 cases which also included the case of the assessee. The Tribunal having taken note of the said undisputed facts, came to the conclusion that it was humanly impossible for the approving authority to peruse the material based on which, the draft assessment order was passed. It was, thus, concluded that the approving authority granted approval under section 153D of the Act in a mechanical manner which vitiated the entire proceedings.

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

“i)    Section 153D of the Income-tax Act, 1961 requires that the Assessing Officer shall obtain prior approval of the Joint Commissioner in respect of “each assessment year” referred to in clause (b) of sub-section (1) of section 153A which provides for assessment in case of search u/s. 132. The requirement of approval u/s. 153D is a prerequisite to pass an order of assessment or reassessment. A conjoint reading of section 153A(1) and section 153D leaves no room for doubt that approval with respect to “each assessment year” is to be obtained by the Assessing Officer on the draft assessment order before passing the assessment order u/s. 153A. The approval of the draft assessment order being an in-built protection against any arbitrary or unjust exercise of power by the Assessing Officer, cannot be said to be a mechanical exercise, without application of independent mind by the approving authority on the material placed before him and the reasoning given in the assessment order. The prior approval of superior authority means that he should appraise the material before him and appreciate the factual and legal aspects to ascertain that the entire material has been examined by the assessing authority before preparing the draft assessment order. It is trite in law that the approval must be granted only on the basis of material available on record and the approval must reflect the application of mind to the facts on record.

ii)    The Tribunal on undisputed facts had concluded that the approving authority under section 153D had exercised his power mechanically which vitiated the entire proceedings under section 153A and that it was humanly impossible for the approving authority to peruse and apply his independent mind to appraise the material in one day in respect of 38 assessees including that of the assessee based on which the draft assessment order was passed. Therefore, its conclusion was not perverse or contrary to the material on record.

iii)    For the A.Y. 2015-16, the Assessing Officer had prepared the draft assessment order on December 31, 2017, the approval of the draft assessment order u/s. 153D was given on the same date and the final assessment order was also passed on the same day by the Assessing Officer. The submission of the Department that the grant of approval was an administrative exercise of power on the part of the approving authority and that the approval was in existence on the date of the passing of the assessment order and hence it could not be vitiated was a fallacy since the prior approval of superior authority meant that he had appraised the material before him so as to appreciate the factual and legal aspects to ascertain that the entire material had been examined by the assessing authority before preparing the draft assessment order. The appeal was devoid of merit. No question of law arose.”

(A) Salary — Difference between salary and professional income — Factors to be considered whether particular income constituted salary — Remuneration of doctors working in hospital — Contracts between hospital and doctors should be considered — Contracts showing relationship between hospital and doctors not of master and servant — Remuneration not taxable as salary

86 DR. Mathew Cherian vs. ACIT

[2023] 450 ITR 568 (Mad):

A.Y.: 2018-19

Date of order: 1st September, 2022

Sections 15, 28, 147, 148 and 148A of ITA 1961:

(A) Salary — Difference between salary and professional income — Factors to be considered whether particular income constituted salary — Remuneration of doctors working in hospital — Contracts between hospital and doctors should be considered — Contracts showing relationship between hospital and doctors not of master and servant — Remuneration not taxable as salary

(B) Reassessment — Notice — Law applicable — Effect of amendments w.e.f. 1st April, 2021 — Show-cause notice under section 148A and opportunity to assessee to be heard — Notice under section 148A should be based on tangible “information” — Remuneration of doctors working in hospital — Order under section 148A for issue of notice of reassessment without examining contracts between the hospital and doctors — Order under section 148A not valid

The assessee is a practicing doctor. On the basis of documents seized in the course of a survey at a hospital, and consequent inferences, the authorities came to the conclusion that (i) an employer-employee relationship was established between the assessee doctor and the hospital, (ii) the assessee was to be construed as an employee and not full time or visiting consultant, and (iii) the income returned by the doctor had to be assessed under the head “Salary” and not “professional income”. For the A.Y. 2018-19, show-cause notice was issued to the assessee (doctor) under clause (b) of section 148A of the Income-tax Act, 1961. The assessee filed replies objecting to the proposal to treat the income returned under the head “Salary” and not “Professional Income” and submitting that none of the documents found were incriminating or supported the issuance of the notices. An order was passed under section 148(d) of the Act rejecting the arguments.

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

“i)    As on April 1, 2021, the scheme of reassessment under the Income-tax Act, 1961 law has undergone a sea change. While the provisions earlier required the officer to have “reason to believe” that there had been escapement of income from tax, what is now required is “information” that suggests escapement of income from tax. Section 148A stands activated only if the Income-tax Department is in possession of “information”, which suggests that income chargeable to tax has escaped assessment. The definition of “information” is wide and could include just about any material in the possession of the officer. However, the caveat is that such information must enable the suggestion of escapement of tax. Then again, the mandate cast upon the officer u/s. 149A(d) is that he has to decide whether it is a “fit case” for issue of a notice for reassessment, upon a study of the material in his possession, including the response of the assessee. Thus, not all information in the possession of the officer can be construed as “information” that qualifies for initiation of proceedings for reassessment, and it is only such “information” that suggests escapement and which, based upon the material in his possession, that the officer decides as “fit” to trigger reassessment, that would so qualify. The “information” in the possession of the Department must prima facie, satisfy the requirement of enabling a suggestion of escapement from tax. This is not to say that the sufficiency or adequacy of the “information” must be tested, as such an analysis would be beyond the scope of jurisdiction of the court in writ jurisdiction. However, whether at all the “information” gathered could lead to a suggestion of escapement from tax can certainly be ascertained. For the purposes of such ascertainment and to determine “fitness” to reassess, the materials gathered must be seen in the context of the allegation of tax evasion, taking assistance of decided cases to ascertain whether or not the allegation is sustainable. In the present regime of reassessments, an  Assessing Officer must be able to establish proper nexus of information in his possession, with probable escapement from tax. No doubt the term used is “suggests”. That is not to say that any information, however tenuous, would suffice in this regard and it is necessary that the information has a live and robust link with the alleged escapement.

ii)    There is a distinction between a contract for service and one of service, and depends on several factors. The regulations, restrictions, guidelines and control exercised in regard to logistical and administrative functions of the work force have to be considered. It is difficult to identify any establishment that does not exercise some degree of control over the administrative and logistical functioning of the workforce, be they salaried or otherwise. What is vital is that professionals discharge their professional duties and function in a free and fully independent fashion without any interference from the hospital management. Though it is expected that there would be regular quality control measures, this would not lead to the inference that there is control exercised over the discharge of professional functions. The prima facie test for determination of a master-servant relationship is the right of the master to supervise and control the work done by the servant in the matter of not just directing what work is to be done but also the manner in which he shall execute the work. Application of the test of control in the case of skilled employments to decide whether there is relationship of master-servant would be unreal and would not result in a proper conclusion. Thus the question of whether there was “right of control” by the employer would depend on the facts in each case and on the terms of the contracts between the parties.

iii)    In all the cases the entity searched was the KMC hospital. The Assessing Officer had come to the conclusion that the hospital exercised total control over the doctors in regard to their timings of work, holidays, call duties based on the exigencies of work, termination, entitlement to private practice, increments and other service rules. However, the agreements between the hospital and the assessees revealed the following terms : (i) The doctors were referred to as consultants and fell within the category of visiting consultants or full time consultants, as against part-time and special category consultants who also attended the hospital. (ii) The remuneration paid was of a fixed amount along with a variable component depending on the number of patients treated, and was termed “salary”. (iii) The consultants were not entitled to any statutory service benefits such as provident fund, gratuity, bonus, medical reimbursement, insurance or leave encashment. (iv) Working hours were stipulated as 8 a. m. to 5 p. m. and the consultants were expected to be available on call in the night. (v) They were permitted a month’s vacation and leave on a case-to-case basis and depending on need. (vi) Private practice was permitted in the case of both categories, upon the satisfaction of certain conditions, such as service of two years in the hospital and other conditions. (vii) The hospital did not exercise any control, intervention or direction over the exercise of professional duties by the assessees. (viii) The assessees were wholly responsible for professional indemnity insurance and the hospital did not indemnify the doctors from any manner of claims. The intention of the parties appeared to engage in a relationship as equals. The hospital, on the one hand, and the professional, on the other, engaged in a relationship where the former provided the administrative infrastructure and facilities and the latter, the professional skill and expertise to result in a mutual rewarding result. The fact that the remuneration paid was variable, and the doctors were not entitled to any statutory benefits also pointed to the absence of an employer-employee relationship. The mere presence of rules and regulations did not lead to a conclusion of a contract of service.

iv)    Rules and regulations are necessary to ensure that the workplace functions in a streamlined and disciplined fashion. Thus, the mere existence of an agreement that indicated some measure of regulation of the service of the doctors, could not lead to a conclusion that they were salaried employees. The fact that the doctors held full responsibility for their medical decisions and actions and the hospital bore no responsibility in this regard was also of paramount importance, relevant to determine the nature of the relationship as being one of equals, rather than one of master-servant. The order contained clear, categoric and conclusive findings that were adverse to the assessees. There were no disputed facts at play and rather, it was only the interpretation of admitted facts and conclusions arrived at by the officer, that were challenged. The “information” in the possession of the Revenue did not, in the light of the settled legal position lead to the conclusion that there had been escapement of tax. The order u/s. 148A was not valid.”

Accounting of Pre-IPO Instruments

Pre-IPO investors are issued equity instruments at a lower valuation compared to retail investors. However, these equity instruments come with certain restrictions such as lock-in restrictions, and the accounting can be complex. This article deals with the accounting of convertible instruments issued to financial institutions as a part of pre-IPO funding.

FACT PATTERN

The new company will be soon launching its IPO. As a part of its pre-IPO funding, it has issued CCPS (Compulsorily Convertible Preference Shares) to SBI. These instruments are convertible into equity shares on the IPO taking place. The conversion ratio is variable depending upon the timing of the IPO and the valuation of the company at IPO, after deducting from the valuation a discount is typically available to pre-IPO investors. All pre-IPO investors that are issued these instruments are treated equally. The pre-IPO investors are provided a discount over the valuation of the company to compensate for the lock-in restrictions applicable to pre-IPO investors and for the uncertainty on the occurrence of the IPO and the timing of the IPO. If the IPO does not happen by a certain date, then the conversion will occur by a formula predetermined on the date of issue of the CCPS, that will provide as many shares, as are required to settle the liability, for e.g., if the CCPS amount is R100, and the share price is Rs. 1 the liability will be settled by providing 100 shares to the holder of the CCPS.

QUERY

How does the new company, the issuer, account for this instrument? Is the discount on the valuation a one-day loss that needs to be amortised over the period of the instrument?

RESPONSE

Technical Literature

Ind AS 32 Financial Instruments: Presentation

11. A financial liability is any liability that is: (a) a contractual obligation : (i) to deliver cash ………(b) a contract that will or may be settled in the entity’s own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. ………..

Ind AS 109 Financial Instruments

4.2.1 An entity shall classify all financial liabilities as subsequently measured at amortised cost, except for:  (a) financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair value………

4.3.3 If a hybrid contract contains a host that is not an asset within the scope of this Standard, an embedded derivative shall be separated from the host and accounted for as a derivative under this Standard if, and only if: (a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host (see paragraphs B4.3.5 and B4.3.8);  (b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and  (c) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).  

4.3.4 If an embedded derivative is separated, the host contract shall be accounted for in accordance with the appropriate Standards. This Standard does not address whether an embedded derivative shall be presented separately in the balance sheet.  

4.3.5 Despite paragraphs 4.3.3 and 4.3.4, if a contract contains one or more embedded derivatives and the host is not an asset within the scope of this Standard, an entity may designate the entire hybrid contract as at fair value through profit or loss unless:  (a) the embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract; or  (b) it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.  

5.1.1A However, if the fair value of the financial asset or financial liability at initial recognition differs from the transaction price, an entity shall apply paragraph B5.1.2A.

B5.1.2A The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price (i.e., the fair value of the consideration given or received, see also Ind AS 113). If an entity determines that the fair value at initial recognition differs from the transaction price as mentioned in paragraph 5.1.1A, the entity shall account for that instrument at that date as follows: (a) at the measurement required by paragraph 5.1.1 if that fair value is evidenced by a quoted price in an active market for an identical asset or liability (i.e., a Level 1 input) or based on a valuation technique that uses only data from observable markets. An entity shall recognise the difference between the fair value at initial recognition and the transaction price as a gain or loss.  (b) in all other cases, at the measurement required by paragraph 5.1.1, adjusted to defer the difference between the fair value at initial recognition and the transaction price. After initial recognition, the entity shall recognise that deferred difference as a gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability.

ANALYSIS AND CONCLUSION

1. The hybrid instrument comprises two elements, namely, (a) financial liability representing, conversion terms that allow the holder to convert the financial liability into the number of shares equal to the carrying amount of the financial liability at maturity that results in a contractual obligation to deliver a variable number of its own equity instruments and therefore it is a financial liability. [Ind AS 32.11 (b)(i)], and (b) the instrument contains an embedded derivative that provides an upside if an IPO were to happen; this embedded derivative should be viewed as a purchased call option, that is net share settled.

2. As per paragraph 4.2.1 of Ind AS 109, an entity shall classify all financial liabilities as subsequently measured at amortised cost, except for financial liabilities at fair value through profit or loss.

3. In accordance with paragraph 4.3.3 of Ind AS 109, an embedded derivative shall be separated from the host and accounted for as a derivative if, and only if: (a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host;  (b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and  (c) the hybrid contract is not measured at fair value with changes in fair value recognised in profit or loss (i.e. a derivative that is embedded in a financial liability at fair value through profit or loss is not separated).

4. As per paragraph 4.3.4 of Ind AS 109, the embedded derivative will be separated and accounted for separately from the host financial liability contract. However, as per paragraph 4.3.5, if the embedded derivative has a significant impact on the combined instrument, it need not be separated.  In such a case, under paragraph 4.3.5, the entity may designate the entire hybrid contract at fair value through profit or loss (FVTPL).

5. Therefore, the entire CCPS financial liability may be fair valued to profit or loss or the CCPS may be broken up into two, namely, the host contract and the embedded derivative, and each of them accounted for separately. Whichever approach is taken, the overall impact on financial statements will not be materially different.

6. The other question that needs to be addressed is that the new company has issued the instrument at a discount to SBI. Therefore, should it attribute a one-day loss when accounting for the instrument at inception as per paragraph 5.1.1A, followed by amortising such a loss over the contract period in accordance with paragraph B5.1.2A.

7. Typically, the pre-IPO investors are provided a discount over the valuation of the company to compensate for the lock-in restrictions applicable to pre-IPO investors and for the uncertainty on the occurrence of the IPO and the timings of the IPO. Therefore, the discount provided to the pre-IPO investor is not out of any benevolent act. Rather the transaction price is reflective of the fair value of such instruments, keeping in mind the restrictions on such instruments and the uncertainty of the IPO.  Consequently, the author believes there is no one-day loss in the instant case, and the instrument is accounted for at the transaction price, which is the fair value of the instrument.

CONCLUSION

At inception, the instrument is accounted for at the transaction price which in the instant case is the fair value of the instrument. The instrument may be accounted for in its entirety at FVTPL, which is the more straightforward approach compared to splitting the instrument into a host component and an embedded derivative component.

As the entity approaches the IPO and uncertainty diminishes, the fair value of the financial liability will keep increasing, if the valuation of the company keeps increasing, resulting in a corresponding charge to P&L, in the books of the new company.  Assuming the shares are priced at Rs. 200 based on valuation of the company, on IPO date the fair value of the financial liability just before the conversion, will be Rs. 200 less discount.  Once the IPO concludes, the CCPS (financial liability) will get converted into equity shares (equity), therefore, the fair value of the financial liability as determined on the date of conversion is derecognised with corresponding credit being recognised in the equity in the books of the new company. There is no gain or loss on conversion. The fair value gain /loss on CCPS at each reporting period till the conversion date is recognised in the Statement of Profit or Loss.

Namaskaar

Good thoughts are expressed in every language. However, Sanskrit language is specially known for the noble and valuable thoughts intelligently and succinctly expressed in the form of ‘Subhashits’. Compilation of thousands of such Subhashits is a priceless treasure for the world. It is full of deep thinking and wisdom. One such Subhashit is

This sets the priorities in one’s life. It tells how many other things should be left aside for a particularly important thing.

This means, while having food, you should keep aside hundred other things. Today, we see that many so-called high-profile people pretend to be so busy that they don’t take food regularly, at the appropriate time. They take pride in saying that they have no time even to take lunch or dinner.

Further, while eating, many people keep on discussing business, thinking about some work, watching television, or watching their mobile phone. It has been scientifically proven that such distractions while eating are harmful to health. Our Indian culture treats food  as ‘Purna Brahma’ (God). Not eating with concentration is insulting to God. Moreover, if you concentrate, you can enjoy the appearance, smell and taste of the food.

 For having a bath, one should leave aside thousand other things. This underlines the importance of cleanliness and hygiene. Before performing any worship or doing an auspicious thing, having a bath is a must. It is not only physical cleanliness, but this also implies to cleansing and purification of the mind. i.e.

 ‘Daan’ or charity is regarded in very high esteem. One should not leave any opportunity of giving something (good) to others. Today experts teach you the ‘Art of Giving’. It is also said even when a person is in difficulty, he should keep on helping others and giving to others. That is the highest form of Punya, (Good Karma). In Mahabharata, Karna was ready to sacrifice even his life to ‘give’ any person whatever he wanted. There were many kings who performed ‘yagyas’ (sacrifice) to give away their entire treasure. Therefore, leave aside one lakh things to grab an opportunity to ?give’. Even if you are not able to give anything in your lifetime, you can pledge to donate your eyes and other organs or even your whole body to someone after your death. You can also give a part of your wealth to charity through a Will.

Finally,  means leave aside everything else to worship God. This is a message about spirituality. This does not mean that one should be engrossed only in Pooja, bhajans and kirtan. It only means leaving aside one crore of things to do ‘bhakti’ (express devotion to God) or prayers. Performing your duty religiously is also a worship of God.

We Chartered Accountants, should take a message for ourselves. We claim that we are too busy, always slogging and not having time to do any other thing. Actually, food, bath, charity and spirituality give us a lot of strength and energy. This needs to be experienced. That will make us more efficient in many ways.

In the 17th Chapter of Bhagavad Gita, the different categories of food (diet), charity and devotion (bhakti) have been described. Good (sattvik), medium (Rajas) and bad (Tamas). If you select good food, the good donee (Satpatra or deserving) and a good Guru (Mentor) in spiritual pursuits, you will have a healthy and peaceful life. The physical, intellectual and mental energy will keep you fit and agile. That adds to physical, mental and moral strength.

In our ancient Indian culture, each year is given a particular name. The samvat year that commenced from Gudhi Padwa is named ‘Shobhan’ i.e. beautiful. Let us try to make not only the year but the entire life beautiful with good food, cleanliness, charity, and spiritual prayers.

The Retroactive Application of Special Criminal Laws – Recent Supreme Court Decisions

“The entire Community is aggrieved if the economic offenders who ruin the economy of the State are not brought to books. A murder may be committed in the heat of moment upon passions being aroused. An economic offence is committed with cool calculation and deliberate design with an eye on personal profit regardless of the consequence to the Community. A disregard for the interest of the Community can be manifested only at the cost of forfeiting the trust and faith of the Community in the system to administer justice in an even handed manner without fear of criticism from the quarters which view white collar crimes with a permissive eye unmindful of the damage done to the National Economy and National Interest.”

– State of Gujarat v. Mohanlal Jitamalji Porwal & Ors. (1987) 2 SCC 364

The above quote of the Supreme Court (SC) may seem general – but it puts the importance given to economic offenses in context. In the never-ending game of cat and mouse, it is always the law enforcement that seems to play catch up with the offenders. The last decade has seen an increased focus on special laws with the aim of curbing economic offenses. These laws are special – they have special agencies with special powers for investigation, special courts for prosecution and special procedures – for specific offenses, all justified to prevent economic offenders from escaping punishment. However, some of the amendments brought about to these Acts have raised a peculiar problem that gives the public a cause for concern. Can I be punished for an act that was not an offence at the time of its commission? Can criminal liability be fastened upon me by a retrospective amendment? What repercussions does this have for the concept of mens rea?

The SC has examined two different Acts in two different judgments, both in 2022. Both these judgments are considered a landmark in their own field and the legislations that they consider are of particular interest to Chartered Accountants – The Prohibition of Benami Transactions Act,  1988 (the Benami Act) and the Prevention of Money Laundering Act, 2002 (the PMLA). The issue, however, is still live – very recently, the Bombay High Court issued notice on a petition that challenges what it considers the retrospective application of the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 and contends that this Act should not penalize transactions that were entered into before it came into force.

The words “retrospective” and “retroactive” have different meanings in law. However, often these terms work in tandem like in the two SC judgments covered in this article. The SC in the case of Vineeta Sharma v. Rakesh Sharma, 2020 (9) SCC 1, described the nature of prospective, retrospective, and retroactive laws as follows: “The prospective statute operates from the date of its enactment conferring new rights. The retrospective statute operates backwards and takes away or impairs vested rights acquired under existing laws. A retroactive statute is the one that does not operate retrospectively. It operates in futuro. However, its operation is based upon the character or status that arose earlier. Characteristic or event which happened in the past or requisites which had been drawn from antecedent events.”

Readers may read this article and interpret these terms accordingly.

A. THE PROHIBITION OF BENAMI TRANSACTIONS ACT, 1988

The Benami Act was one of those Acts that stood quietly on the sidelines waiting to fulfill its avowed objectives. In 2016, sweeping changes were made to the Act in line with the government’s objective to crack down on economic offences and undesirable practices. The Benami Act has been the subject of much debate and discussion especially as benami transactions in India are neither new nor rare. Traditional civil remedies were often exercised in those transactions that were benami in nature. The courts had dealt with various civil disputes with regard to benami properties. Though the Benami Act was brought out in order to prohibit benami transactions, it was widely considered toothless and was rarely invoked.

Post-2016 amendments, however, the Benami Act is looked upon as having the colour of being criminal legislation. This is primarily because though entering a benami transaction was prohibited even prior to 2016, the criminal provisions lacked teeth. In recent years a variety of legislations have been enacted for special purposes and these are an amalgam of both civil and criminal provisions. The name of the Benami Act is self-explanatory, it seeks prohibition of benami transactions. This is a clear indication that the Act does not exist merely to punish, its raison d’être is to prohibit them altogether. It cannot, however, be doubted that the amending Act brought in wide-ranging changes to the original Act.

The judgment of the SC in UOI v. Ganpati Dealcom Pvt. Ltd. (2023) 3 SCC 315 is a watershed moment for many reasons. The judgment reaffirms the basic principle of the criminal law of not imposing criminality retroactively. How can it be that an act that is not an offence at the time of its commission be considered an offence subsequently? While this may seem like common sense, the manner in which the SC  arrives at this conclusion while considering Sections 3 and 5 of the Benami Act warrants consideration.

What is a Benami Transaction?

Post the 2016 amendment, the definition of ‘benami transaction’ given in section 2(9) of the Benami Act is as follows:

“benami transaction” means,—

(A)    a transaction or an arrangement—

(a)    where a property is transferred to, or is held by, a person, and the consideration for such property has been provided, or paid by, another person; and

(b)    the property is held for the immediate or future benefit, direct or indirect, of the person who has provided the consideration,

except when the property is held by—

(i)    a Karta, or a member of a Hindu undivided family, as the case may be, and the property is held for his benefit or benefit of other members in the family and the consideration for such property has been provided or paid out of the known sources of the Hindu undivided family;

(ii)    a person standing in a fiduciary capacity for the benefit of another person towards whom he stands in such capacity and includes a trustee, executor, partner, director of a company, a depository or a participant as an agent of a depository under the Depositories Act, 1996 (22 of 1996) and any other person as may be notified by the Central Government for this purpose;

(iii)    any person being an individual in the name of his spouse or in the name of any child of such individual and the consideration for such property has been provided or paid out of the known sources of the individual;

(iv)    any person in the name of his brother or sister or lineal ascendant or descendant, where the names of brother or sister or lineal ascendant or descendent and the individual appear as joint-owners in any document, and the consideration for such property has been provided or paid out of the known sources of the individual; or

(B)    a transaction or an arrangement in respect of a property carried out or made in a fictitious name; or

(C)    a transaction or an arrangement in respect of a property where the owner of the property is not aware of, or, denies knowledge of, such ownership;

(D)    a transaction or an arrangement in respect of a property where the person providing the consideration is not traceable or is fictitious.

Explanation.—For the removal of doubts, it is hereby declared that benami transaction shall not include any transaction involving the allowing of possession of any property to be taken or retained in part performance of a contract referred to in section 53A of the Transfer of Property Act, 1882 (4 of 1882), if, under any law for the time being in force,—

(i)    consideration for such property has been provided by the person to whom possession of property has been allowed but the person who has granted possession thereof continues to hold ownership of such property;

(ii)    stamp duty on such transaction or arrangement has been paid; and

(iii)    the contract has been registered;”

What are the broad repercussions of entering into a Benami Transaction?

Chapter II of the Benami Act deals with the prohibitions of benami transactions. Section 3 and Section 5 deal with the repercussions of entering into a benami transaction as amended in 2016 while Sections 4 and 6 deal with certain consequences with regard to civil remedies. Section 5 is punitive in nature while Section 3(2) and 3(3) make entering into a benami transaction a criminal offense.

Sections 3 and 5 are reproduced below:

“Section 3 – Prohibition of benami transactions.

3. (1) No person shall enter into any benami transaction.

(2)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(3)    Whoever enters into any benami transaction on and after the date of commencement of the Benami Transactions (Prohibition) Amendment Act, 2016, shall, notwithstanding anything contained in sub-section (2), be punishable in accordance with the provisions contained in Chapter VII.

“Section 5 – Property held benami liable to confiscation.

5.    Any property, which is subject matter of benami transaction, shall be liable to be confiscated by the Central Government.”

The case for Retroactive Application

Though the amendments were carried out in 2016, the effect of the 2016 amendment Act to the Benami Act (amending Act) was that transactions that could be captured under the definition of ‘Benami Transaction’ entered into before the year 2016 were also liable for prosecution. The stand of the Union of India, in this case, was clear – the 2016 amendments, according to the Union of India, only clarified the unamended 1988 Act (unamended Act) and were made to give effect to the older Act. It was in a sense enacted to fill up certain lacunae in the unamended Act and therefore could be given a retroactive application. It was the case of the Union of India that the 1988 Act had already created substantial law for criminalising the offence of entering into a benami transaction and therefore the 2016 amendments were merely clarificatory and procedural.

The SC’s Judgement with regard to retroactive Application

As the basic argument advanced on behalf of the Union of India was that the amending Act was merely clarificatory in nature, the SC decided to first consider the provisions of Section 3 of the Benami Act as it stood prior to its amendment. It is reproduced for ready reference as hereunder –

“3. Prohibition of benami transactions.—

(1)    No person shall enter into any benami transaction.

(2)    Nothing in sub-section (1) shall apply to—

(a)    the purchase of property by any person in the name of his wife or unmarried daughter and it shall be presumed, unless the contrary is proved, that the said property had been purchased for the benefit of the wife or the unmarried daughter;

(b)    the securities held by a—

(i)    depository as registered owner under sub-section (1) of section 10 of the Depositories Act, 1996

(ii)    participant as an agent of a depository.

Explanation.—The expressions “depository” and “Participants shall have the meanings respectively assigned to them in clauses (e) and (g) of sub-section (1) of section 2 of the Depositories Act, 1996.

(3)    Whoever enters into any benami transaction shall be punishable with imprisonment for a term which may extend to three years or with fine or with both.

(4)    Notwithstanding anything contained in the Code of Criminal Procedure, 1973 (2 of 1974), an offence under this section shall be non-cognizable and bailable.”

The SC observed that the criminal provisions envisaged under the unamended Section 3(2)(a) along with Section 3(3) did not expressly contemplate mens rea and that mens rea is an essential ingredient of a criminal offense.

This observation is interesting because it was the cornerstone for the SC to strike down the retrospective criminality put in place by this act. The importance of the existence of the ‘mental intention’ to be convicted in criminal proceedings is the fundamental cornerstone of criminal law. An individual cannot be said to commit a crime without intent, and where the requirement of intent is whittled down, without knowledge (As in the cases of the second part of Section 304 of the Indian Penal Code – culpable homicide not amounting to murder).

The SC found that the absence of mens rea creates the harsh result of imposing strict liability. The Court further found that ignoring the essential ingredient of beneficial ownership exercised by the real owner also contributes to making the law stringent and disproportionate with respect to benami transactions that are tri-partite in nature and that Section 3 as it stood prior to the amendment was susceptible to arbitrariness. The Court alluded to Article 20(1) of the Constitution of India to emphasise that a law needs to be clear, not vague and should not have incurable gaps that were “yet to be legislated/ filled in by judicial process”. The SC also held that a reading of Section 3(1) with Section 2(a) of the unamended Act would have created overly broad laws susceptible to being challenged as manifestly arbitrary.

It was also considered by the Court that the Union of India fairly conceded that the criminal provision had never been utilised as there was a significant hiatus in enabling the function of the provision.

Having considered the above four broad factors – the SC concluded that Section 3 which contained the criminal proceedings with regard to the unamended benami Act was unconstitutional. The Court held that the criminal provisions in the unamended Act had serious lacunae which could not have been cured by judicial forums, even through harmonious forms of interpretation. Regarding Section 5 of the unamended Act, the Court observed that the acquisition proceedings contemplated therein were in rem against the property itself – and that such rem proceedings transfer the guilt from the person who utilised a property which is a general harm to the society on to the property itself.

The SC held that Section 3 (and Section 5) of the unamended Act did not suffer from gaps that were merely procedural but that the gaps were essential and substantive. In absence of such substantive positions, the omissions in the unamended Act created a law which was both fanciful and oppressive at the same time and that such an overly broad structure would be ‘manifestly arbitrary’ as it did not incorporate sufficient safeguards. The Court held that as the Sections were stillborn (never utilised) in the first place, the said Section 3 was unconstitutional right from the inception.

As a natural corollary to Section 3 (and 5) of the unamended Act being held to be unconstitutional, the SC held that the 2016 amendments are in effect, creating new provisions and offences. The Court held that the law cannot retroactively reinvigorate a still-born criminal offence and therefore, “There was no question of retroactive application of the 2016 Act.”

The Fundamental take away from Ganpati Dealcom

The fundamental takeaway from the judgment of the SC in the case of Ganpati Dealcom with regard to the retroactive application of criminal statutes is that the retroactive application of the amended Section 3 of the Act was struck down not merely on the broadly accepted principles that criminal statutes cannot operate retroactively, but the reasoning was deeper. The primary reason of why the statute could not operate retroactively was that the provisions of the Act prior to the 2016 amendments were held to be unconstitutional and void ab initio. This automatically meant that the 2016 amendment could not claim to be merely ‘procedural or clarificatory’ but gave rise to substantial new offences – for the first time. Given the peculiar nature of the factual matrix of this statute, the retroactive operation of the amended Section 3 was held to be bad in law.

However, the Ganpati Dealcom Judgement is significant for another important reason – the SC had just a few months earlier passed another landmark Judgement in the case of Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92.

The Indian SC does not sit en banc – as a whole, but as a combination of various ‘divisions’ and benches of various strengths. That is the reason why it’s often been called ‘Many Supreme Courts in one.’ Within a few months of the Vijay Choudhary Judgment, some apprehensions were already being cast upon its veracity – one such apprehension has been explicitly mentioned in Ganpati Dealcom.

B. THE PREVENTION OF MONEY LAUNDERING ACT, 2002

The PMLA also seemed to wait in the wings for fulfilling its objectives until post-2014, when it started being invoked in earnest to curb the menace of money laundering. The PMLA, its provisions and its applications have all been criticised in the recent past for their draconian nature. A preventive law rather than a prohibitive one like the Benami Act, it was not ‘still born’. It had been amended from time to time in line with India’s global commitments. The Scheme of the PMLA clearly shows that it does not seek only to punish the offence of money laundering but also to prevent it. A substantive part of the legislation is dedicated to compliance and preventive powers given to the authorities under the PMLA.

While benami transactions were primarily a problem in India (and perhaps in the Indian sub-continent), PMLA is global in its outreach.  Primarily set up to combat some of the greatest evils in the form of drug trade, arms trade and flesh trade, today the framework covers a very wide variety of subjects, each perhaps not as dire as the other. The  PMLA, however, has the most motley assortment of legislations included in its Schedule. Various offences under the Indian Penal Code, Narcotic Drugs and Psychotropic Substances Act, Explosive Substances Act, Unlawful Activities Prevention Act, Arms Act, Companies Act, Wildlife Protection Act, Immoral Traffic (Prevention) Act, Prevention of Corruption Act, Explosives Act, Antiques and Art Treasures Act, Customs Act, Bonded Labour Law, Child Labour Law, Juvenile Justice Law, Emigration, Passports, Foreigners, Copyrights, Trademarks, Biological Diversity, Protection of plant varieties and farmer’s rights, Environment Protection Act, Water / Air Pollution Control law, Unlawful Acts against safety of Maritime Navigation and fixed platforms on Continental Shelf, etc.

What is Money Laundering according to the PMLA?

Section 3 of the PMLA defines the offence of money laundering –

“3.     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 [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.

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,
    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.”

But this definition is incomplete without considering the definition of proceeds of crime as laid out in Section 2(1)(u) of the PMLA:

Proceeds of crime is defined u/s 2(1)(u) of  PMLA as under:

“(u) “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;”

It would be incorrect to assume that the offence of money laundering would be triggered upon the laundering of money. In fact, Section 3 of the PMLA makes even the possession of proceeds of crime a part of the offence of money laundering. If the section as reproduced above are read, it can be observed that both of them contain ‘explanations’. The retrospective application of these explanations were some of the issues that were brought up before the SC.

What are the broad repercussions of the offence of money laundering?

The broad repercussions of money laundering activity are laid down in Section 4 of the PMLA.

What is the most troublesome though is that the maximum punishment for money laundering that may arise out of all the above-assorted activities is the same – up to seven years (not less than three years) and a fine of five lakh rupees, with a single exception of Narcotic Drugs and Psychotropic Substances Act – the money laundering relating to which attracts a sentence of up to ten years (not less than three years) and a fine of up to five lakh rupees. This punishment is not graded based upon the severity of the scheduled offense.

The case for Retroactive/Retrospective Application

The landmark case on the PMLA is Vijay Madanlal Choudhary & Ors. v. Union of India & Ors. 2022 SCC OnLine SC 92. In this, the case for retrospective/retroactive application of the amendments made in 2019 made to Sections 3 and 2(1)(u) was fairly simple – what was inserted were merely explanations as a part of the statute. It was contended, inter alia, that these explanations were clarificatory in nature and did not increase the width of the definition itself.

What is important is that the constitutional validity of the provisions of Section 3 prior to the insertion of the explanation was not in doubt. What contended was that this amendment was merely clarificatory. It is trite law that the parliament is empowered to make laws that operate retroactively and retrospectively, and such action cannot be challenged especially if the changes are merely clarificatory and/or procedural in nature.

The Supreme Court’s Judgement with regard to Retroactive Application

In Vijay Madanlal Choudhary the SC held that the Explanation as inserted in 2019 in Section 3 of the PMLA (making the offence of money laundering a continuous one) did not entail expanding its purport as it stood prior to 2019. It held that the amendment is only clarificatory in nature in as much as Section 3 is widely worded with a view to not only investigate the offence of money laundering but also to prevent and regulate that offence. This provision (even de hors explanation) plainly indicates that any (every) process or activity connected with the proceeds of crime results in offence of money laundering. The Court held that projecting or claiming the proceeds of crime as untainted property is in itself an attempt to indulge in or being involved in money laundering, just as knowingly concealing, possessing, acquiring, or using of proceeds of crime, directly or indirectly. The Court held the inclusion of Clause (ii) in the Explanation inserted in 2019 was of no consequence as it does not alter or enlarge the scope of Section 3 at all as the existing provisions of Section 3 of the PMLA  as amended until 2013 which were in force till 31.7.2019, have been merely explained and clarified by it.

Similarly, for the changes in the definition of ‘proceeds of crime’ and ‘property’ it was held that the Explanation added in 2019, did not travel beyond that intent of tracking and reaching upto the property derived or obtained directly or indirectly as a result of criminal activity relating to a scheduled offence. Therefore, the Explanation was in the nature of a clarification and not to increase the width of the main definition of “proceeds of crime”. The Court held that the Explanation inserted in 2019 was merely clarificatory and restatement of the position emerging from the principal provision i.e., Section 2(1)(u) of the PMLA.

There is a stark difference in the approach of the SC in both cases. However, it cannot be challenged that the statutory matrix and the circumstances of the application of both laws were also very different. The PMLA was hardly in a state of stasis before the 2019 amendment. The constitutional validity of the sections sought to be amended was not in doubt, the challenge was limited to the amendment itself. However, it would be curious to see if the ‘continuing nature’ of the offence of PMLA will stand up to judicial scrutiny if dissected in a manner similar to the way it has been done in Ganpati Dealcom.

The Fundamental take-away from Vijay Madanlal Choudhary

The key take-away from the Vijay Madanlal Choudhary Judgment with regards to retrospective/retroactive application of criminal statutes is that the manner in which such amendments are brought about in the statute book does matter. Though the law as interpreted by the apex court now states that the explanations are merely clarificatory, the repercussion of making the offence of money laundering a continuing activity is far more sinister.

Though money laundering is an offence by itself, it is what can be termed as a predicate offence, it does not exist in the absence of a primary offence. That primary offence may be any of the offences that have been included in the schedule to the PMLA. By making the offence of money laundering a continuing one, however, the statute has empowered itself to virtually prosecute those accused of offences that may have been committed not only before their insertion into the schedule to the PMLA, but also before the PMLA ever came into force. It is possible that someone may be prosecuted for the offence of money laundering decades after the primary offence is committed, even though such an accused may not have been involved in the commission of the primary offence. This aspect of the retroactive application of the PMLA has been the subject of much litigation before various High Courts. The Vijay Madanlal Choudhary Judgment paves the way for such prosecutions at will, by upholding the explanation that states that the offence of money laundering never ends and also by upholding the explanation that makes proceeds of crime include any property ‘directly or indirectly’ obtained as a result of any criminal activity related to the scheduled offence.

It is not that the concept of manifest arbitrariness of various provisions of the PMLA has not been considered. Those claims however, have been dismissed.

C. CONCLUSION

The retrospective/retroactive application of criminal provisions of special laws cannot be countered by a broad sweeping observation that ‘Criminal legislation does not have retrospective application’. The approach of the Courts is always nuanced. Though certain amendments to the criminal provisions of the Benami Act were held to be prospective and certain amendments to the criminal provisions of the PMLA were considered retroactive/retrospective, this was done given due weightage to the type of amendment contemplated in the amending Act and the sort of lacunae that were sought to be filled by the amendments. The two judgments are harmonious in law, but a view can be taken that there is a difference in the approach and the jurisprudential philosophy between the both of them. It’s telling that just a few months after the Vijay Madanlal Choudhary judgment, in Ganpati Dealcom with regard to the principles regarding confiscation / forfeiture provisions the SC observed:

“In Vijay Madanlal Choudhary v. Union of India 2022 SCC OnLine SC 929, this Court dealt with confiscation proceedings under Section 8 of the Prevention of Money Laundering Act, 2002 (“PMLA”) and limited the application of Section 8(4) of PMLA concerning interim possession by the authority before conclusion of final trial to exceptional cases. The Court distinguished the earlier cases in view of the unique scheme under the impugned legislation therein. Having perused the said judgment, we are of the opinion that the aforesaid ratio requires further expounding in an appropriate case, without which, much scope is left for arbitrary application”.

Justice YK Sabharwal (the then Chief Justice of India) is said to have said in 2006 “We are final not necessarily because we are always right – no institution is infallible – but because we are final.”

The Supreme Court may be final – but that may not hold necessarily true for its judgments. Both these Judgments have come out in 2022. Review Petitions by aggrieved parties were filed against them and the Apex Court has already agreed (albeit separately) to consider the review of both of them, though such a review may take place well into the future.

 

Internal Financial Controls over Financial Reporting (ICFR) and Reporting Considerations

Assessment and reporting of internal financial controls over financial reporting is a vital responsibility of the auditor. The Companies Act, 2013 introduced Section 143(3)(i) which requires statutory auditors of companies (other than the exempted class of companies) to report on the internal financial controls over the financial reporting of companies. Globally, an auditor’s reporting on internal controls is together with the reporting on the financial statements and such internal controls reported upon relate to only internal controls over financial reporting. For example, in the USA, Section 404 of the Sarbanes Oxley Act of 2002, prescribes that the registered public accounting firm (auditor) of the specified class of issuers (companies) shall, in addition to the attestation of the financial statements, also attest the internal controls over financial reporting. The objective of Internal Financial Control (IFC) testing is to assist the management in evaluating and testing the effectiveness of financial controls that are in place to mitigate the risks faced by the Company and thereby achieve its business objectives.

The Institute of Chartered Accountants of India (ICAI) has issued Guidance Note on the Audit of Internal Financial Controls over Financial Reporting (‘Guidance Note’). The Guidance Note covers aspects such as the scope of reporting on the IFC, essential components of internal controls, technical and implementation guidance on the audit of the IFC, illustrative reports on the IFC, etc.

The auditor needs to obtain reasonable assurance to opine whether an adequate internal financial controls system was maintained and whether such internal financial controls system operated effectively in the company in all material respects with respect to financial reporting only, along with the audit of financial statements.

WHAT IS INTERNAL FINANCIAL CONTROL (IFC)?

Clause (e) of sub-section 5 of Section 134 explains the meaning of internal financial controls as “the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.”

RESPONSIBILITY OF STAKEHOLDERS

Company Management Auditors Audit committee/
Independent Director		 Board of Directors
• Create and test the framework of internal controls.

• IFC (including operational & compliance).

• Control documentation.

 • Focus on internal controls, to the extent these relate to
financial reporting.• Auditor’s responsibility is limited to the evaluation of
‘Financial reporting controls’ and to preparing IFC Audit documentation.		 • Would like to see a robust framework that is aligned with
acceptable standards.• Review & question the basis of controls, design &
ongoing assessments.		 • Would rely on the assessment & view of the audit
committee.• It may ask for additional information.

LEGAL REQUIREMENTS

Relevant clauses Requirements Applicability
Directors’ Responsibility Statement: Section 134(5)(e) Directors’ Responsibility Statement should state that the
directors have laid down internal financial controls to be followed by the
company and such controls are adequate and were operating effectively.		 Listed companies.
Section 143(3)(i) – Auditor’s Report The auditor’s report should state the adequacy and operating
effectiveness of the company’s internal financial controls.		 All companies except private companies with turnover of less
than Rs. 50 crores as per the latest audited
MCA vide its notification dated 13th June 2017 (G.S.R.
583(E)) amended the notification of the Government of India, In the Ministry
of Corporate of Affair, vide No G.S.R. 464(E) dated 05th June 2015 providing
an exemption from Internal Financial Controls to certain private companies.		 financial statement or which has aggregate borrowings from
banks or financial institutions or body corporate at any point of time during
the financial year less than Rs. 25 crores.
Section 177(4) – Audit Committee Audit Committee may call for the auditor’s comments on
internal control systems before their submission to the board and may also
discuss any related issues with the internal & statutory auditors and the
management of the company.		 All companies having an Audit Committee.
Schedule IV Independent Directors The independent directors should satisfy themselves on the
integrity of financial information and ensure that financial controls &
systems of risk management are robust and defensible.		 All companies.
Board Report: Rule 8(5)(viii) of the Companies (Accounts)
Rules, 2014		 Board of Directors to report on the adequacy of internal
financial controls with reference to financial statements.		 All companies

The Guidance Note states that though the Standards on Auditing (SA) do not address the auditing requirements for reporting on IFC, certain portions of the SAs may still be relevant. The procedures prescribed in the Guidance Note are supplementary in that the auditor would need to consider for planning, performing and reporting in an audit of IFC–FR under section 143(3)(i) of the Companies Act, 2013. The audit procedures would involve planning, design and implementation, operating effectiveness, and Reporting. The auditor should report if the company has adequate internal control systems in place and whether they were operating effectively at the balance sheet date.

REPORTING CONSIDERATIONS.

Circumstances when a Modification to the Auditor’s Opinion on Internal Financial Controls over Financial Reporting are required:

The auditor should modify the audit report on internal financial controls if –

a. The auditor has identified deficiencies in the design, implementation or operation of internal controls, which individually or in combination has been assessed as a material weakness.

b. There is a restriction on the scope of the engagement.

The auditor should determine the effect of his or her modified opinion on internal financial controls over financial reporting have, on his or her opinion on the financial statements.

Additionally, the auditor should disclose whether his or her opinion on the financial statements was affected by the modified opinion on internal financial controls over financial reporting. Based on the results of audit procedures, which may include testing the effectiveness of alternative controls established by the management, the auditor should evaluate the severity of identified control deficiencies.

A deficiency in internal control exists if a control is designed, implemented, or operated in such a way that it is unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis; or the control is missing.

EXAMPLES OF CONTROL DEFICIENCIES:

Deficiencies in the Design of Controls – Inadequate design of internal control over the preparation of the financial statements being audited.

Failures in the Operation of Internal Control – Failure in the operation of effectively designed controls over a significant account or process, for example, the failure of control such as dual authorization for significant disbursements within the purchasing process.

Significant Deficiencies – Controls over the selection and application of accounting principles that are in conformity with generally accepted accounting principles.

Material Weaknesses – Identification by the auditor of a material misstatement in the financial statements for the period under audit that was not initially identified by the entity’s internal control, identification of fraud, whether or not material, on the part of senior management; errors observed in previously issued financial statements in the current financial year;

The auditor should also consider additional considerations as mentioned below while reporting:

a) Evaluation of control not operating effectively on account of the hybrid mode of working and absence of the concerned person in the office.

b) Identify alternate controls.

c) Company’s ability to close the financial reporting process in time.

d) Perceived opportunity for fraudulent financial reporting or misappropriation of assets may exist when an individual believes internal control could be circumvented, for example, because the individual is in a position of trust or has knowledge of specific weaknesses in the internal control system.

Circumstances when a Modification to the Auditor’s Opinion on Internal Financial Controls Over Financial Reporting are required:

Effect of a modified report on internal financial controls over financial reporting on the audit of financial statements:

A modified report on internal financial controls over financial reporting does not imply that the audit report on financial statements should also be qualified. In an audit of financial statements, the assurance obtained by the auditor is through both internal controls and substantive procedures. Hence, substantive procedures are to be performed for all assertions, regardless of the assessed levels of material misstatement or control risk. Further, as a result of substantive procedures, if sufficient reliable audit evidence is obtained and if it addresses the risk identified or gains assurance on the account balance being tested, the auditor should not qualify the audit opinion on the financial statements.

For example, if a material weakness is identified with respect to customer acceptance, credit evaluation and establishing credit limits for customers resulting in a risk of revenue recognition where potential uncertainty exists for the ultimate realisation of the sale proceeds, the auditor may modify the opinion on internal financial controls in that respect. However, in an audit of financial statements, the auditor when performing substantive procedures obtains evidence of the confirmation of customer balances and also observes that all debtors as of the balance sheet date have been subsequently realised by the date of the audit, the audit opinion on the financial statements should not be qualified, though the internal control deficiency exists.

[e.g.- Refer to Mahanagar Telephone Nigam Limited1 -Consolidation Report for 31st March 2022, where ICFR Report is qualified as material weakness is being identified in Capitalisation, Provisions, Reconciliations but overall, it does not impact the auditor’s opinion on the ‘Consolidated Ind –As financial statement’ of the Holding Company.]

1. https://www.bseindia.com/bseplus/AnnualReport/500108/77259500108.pdf

The management relies on its internal financial controls for the preparation of financial statements, whereas the auditor tests controls as well as carries out substantive procedures to opine on financial statements. For companies that prepare and publish unaudited financial information (such as listed entities), internal controls related to the preparation of financial statements determine the company’s ability to accurately prepare such information. In such cases, even if an audit report on financial statements is unmodified, it does not give any indication of whether unaudited interim financial information prepared by the company is reliable or not. Therefore, if the report on internal financial controls over financial reporting is modified, the auditor needs to consider the effect of such modification in his review of interim financial information for the subsequent period.

An unmodified audit opinion is not a guarantee of error-free financials but is rather the conclusion by an auditor – using audit procedures and professional judgement that are reasonable to the circumstances – that the statements are fairly presented.

Inter-play between substantive procedures and operating effectiveness of internal controls:

Even if the operating effectiveness of internal controls is predominantly determined by testing controls, findings from substantive procedures carried out as part of an audit of financial statements also affect the auditor’s conclusion on the operating effectiveness of internal controls. The auditor needs to consider, inter alia, the risk assessment used to select substantive procedures, findings of illegal acts and related party transactions, management bias in making estimates and selecting accounting policies and the extent of misstatements detected by substantive procedures.

FINANCIAL STATEMENTS CLOSE PROCESS (FSCP)

Though internal controls over financial reporting are required for each type of transaction, FSCP is a significant process for which internal controls need to exist. Though there is no definition of FSCP, usually it refers to the process of how transactions are recorded in the books of account and the preparation, review, and approval of interim or annual financial statements including required disclosures therein.

Similar to carrying out the audit of internal controls related to all types of transactions, an auditor needs to perform a walkthrough of FSCP to understand the risks of material misstatements and related controls, including relevant IT controls.

Example of separate modified (qualified/adverse) audit report for an audit of internal financial controls over financial reporting

Nature
of Industry/Name of the Company		 Opinion
in Main Audit Report FY 21-22		 Opinion
in IFCR Reporting		 Material
Weakness
NEL Holdings South Limited2

– Standalone-

 Adverse Qualified • Granting of unsecured advances for acquiring various immovable
properties.• Compliance with the provision of the Companies Act• Obtaining year-end balance confirmation certificates in respect of
trade receivables, trade payables, vendor advances, advances from customers
and other advances.

• To ascertain the realizable value of Inventory and also does not have
a documented system of regular inventory verification.

• Ascertaining tax assets/liabilities and payments of statutory dues
including Income Tax and Goods and Service Tax and other relevant Taxes.

• Maintaining the details of pending litigations and ascertaining
corresponding financial impact to report on the contingent liability of the
Company.
• Ascertain and maintain employee-wise ageing
details of the salary payable and other employee
benefit expenses like gratuity payable.
Imagicaaworld Entertainment Limited – Standalone3 Adverse Adverse • Preparation of Financials on Going Concern.

• Impairment testing.
Reliance Infrastructure Limited –
Standalone4		 Disclaimer Disclaimer • Evaluating about the relationship, recoverability and possible
obligation towards the Corporate Guarantees given.
Hindustan Construction Company Ltd.

-Consolidation5

 

 Qualified Qualified • Compliance with the provisions of section 197 of the Companies Act,
2013 relating to obtaining prior approval from lenders for payment/ accrual
of remuneration exceeding the specified limits.• Internal financial system with respect to assessment of recoverability
of deferred tax assets were not operating effectively.		 
2 https://www.bseindia.com/bseplus/AnnualReport/533202/73138533202.pdf
3 https://www.bseindia.com/bseplus/AnnualReport/539056/74434539056.pdf
4 https://www.bseindia.com/bseplus/AnnualReport/500390/73190500390.pdf
5 https://www.bseindia.com/bseplus/AnnualReport/500185/76791500185.pdf

The Companies Act does not spell out or specify any particular framework to be followed while establishing an Internal Financial Control System, but the Guidance Note provides detailed guidance. Therefore, the first and foremost duty of auditors regarding Internal Financial Controls over Financial Reporting is to see and get satisfied with the framework set in place as specified in the Guidance Note and as declared in the Directors’ Responsibility Statement duly vetted by the Audit Committee and independent directors, are fool-proof, infallible and watertight. To achieve that, a checklist of internal controls is to be installed for each area so that the adequacy of controls is ensured in all respects. Further for companies to which ICFR is not applicable but have control deficiencies, the auditor will have to ascertain and apply professional judgment whether any modifications are required to be reported. Internal controls may change or fail to be performed, or the processes and procedures for which the controls were created may change, rendering them less effective or ineffective. Because internal controls are effective only when they are properly designed and operating as intended, it is of huge importance to determine the quality of internal control’s performance over a period of time. In scenarios, where ICFR is applicable for the first time or ICFR is applicable to the company and is not implemented by the company or there are no adequate controls, the auditor will have to assess and conclude whether modification or disclaimer of opinion in reporting is required.

Liberalised Remittance Scheme – How Liberal It Is? (An Overview And The Recent Amendments)

This article looks at recent amendments in the
Liberalised Remittance Scheme (LRS) under Foreign Exchange Management
Act (FEMA) and in the provisions of Tax Collection at Source (TCS) on
remittances under LRS under the Income-tax Act. The changes are
significant and people should be aware of these issues. Along with the
recent amendments, we have dealt with some important & practical
issues also.

A. FOREIGN EXCHANGE MANAGEMENT ACT:

1. Background:

1.1 In February 2004, RBI introduced the LRS with a small limit (vide A.P.
Circular No. 64 dated 4.2.2004). Any Indian individual resident could
remit up to US$ 25,000 or its equivalent abroad per year from his own
funds. It was introduced to provide exposure to individuals to foreign
exchange markets. Dr. Y. V. Reddy, ex-Governor of RBI in his book titled
“Advice & Dissent” on Page 352 mentions that the funds could be
used for almost any purpose. It was supposed to be a “No questions asked” window and was in addition to all existing facilities. Late Finance Minister Mr. Jaswant Singh in a gathering said “Go conquer the world, we will be your supporters”. That was the underlying theme of the LRS.

1.2 There was a small negative list of purposes for which remittance could
not be made. The negative list included payments prescribed under
Schedule I and restricted under Schedule II of Current Account
Transaction Rules such as lotteries and sweepstakes; and payments to
persons engaged in acts of terrorism. Remittances also could not be made
to some countries. Later in 2007 remittance under LRS for margin
trading was also prohibited.

1.3 Over the years, the scheme has been modified. The limits have been increased periodically
(except for a brief period from 2013 to 2015). Today the limit is US$
2,50,000 per year per person. Thus, every individual Indian resident can
remit US$ 2,50,000 per year for any permitted purpose. At the same
time, restrictions have been introduced on current account transactions
and investments under LRS and such restrictions have kept on increasing.
The spirit of the original theme has been diluted to a significant extent. Let us see the current provisions of LRS including its main issues.

2. The present LRS:

2.1 The present LRS is dealt with by the following rules, regulations and circulars. FAQs provide some more clarifications.

i) Foreign Exchange Management (Permissible Capital Account Transactions) Regulations, 2000 (FEMA Notification no. 1).

ii) Foreign Exchange Management (Permissible Current Account Transactions) Rules, 2000.

iii) Foreign Exchange Management (Overseas Investment) Rules, 2022 (hereinafter referred to as “OI Rules”).

iv) Foreign Exchange Management (Overseas Investment) Directions, 2022
vide AP circular no. 12 dated 22.8.2022 (hereinafter referred to as “OI
Directions”).

v) Master Direction No. 7 on LRS updated up to 24.8.2022.

vi) FAQs updated up to 21.10.2021 (these have not been updated with the
rules and regulations of August 2022. However, these contain some
important clarifications.)

The statutory documents are the first
three documents – Rules and Regulations. The fourth and fifth documents
are essentially directions to Authorised Persons – i.e. Banks for
implementation of the rules and regulations. The sixth document – FAQs –
doesn’t have a binding effect. These are clarifications and wherever
helpful, these can be used.

However, if one reads only the
statutory documents, one does not get the full picture. One has to read
all the documents together to understand the entire scheme with its
nuances. At times, A.P. Circulars and Master Directions contain
additional provisions which are nowhere covered in the statutory
documents. Hence it is necessary to consider all the documents.

Also,
as is the case with several rules and regulations under FEMA, one
cannot get the entire picture merely by reading the documents. Some
things go by practice. Many such issues and practical problems will be
dealt with subsequently. Needless to say, it will not be possible to
deal with all issues. The focus is on important issues and issues arising out of amendments to LRS in August 2022 and TCS provisions in Finance Act 2023.

2.2 The present LRS in brief:

2.2.1
Under the present scheme, an Indian resident individual (including a
minor) can remit up to US$ 2,50,000 or its equivalent per financial
year. This limit has been there since May 2015. The remittance can be
made for any “permitted” Current Account Transaction or a “permitted”
Capital Account Transaction. The word “permitted” is a later addition.
As per the 2004 circular, the LRS was overriding all restrictions
(except those stated in the circular itself).

For remittance
under LRS, the simple compliance is the submission of Form A2 with some
basic details. [No form is required for making a rupee gift or a loan.
However, the person must keep a track to see that aggregate of such
rupee payments (discussed later) and foreign exchange remitted during a
year are within the LRS limit.]

Remittances during one year have to be made through one bank only.

2.2.2 Remittance has to be made out of person’s own funds.
In a family, one member can gift (not loan) the funds to another family
member and all the relatives can remit the funds under LRS. This has
been an accepted position.

Source of funds:

Loans: A person cannot borrow funds in India and remit them abroad for capital account transactions.
The restriction on taking loans continues right from the beginning
(i.e., February 2004). One can refer to these provisions in Paragraphs 8
and 10 in Section B of the present Master Direction on LRS.

A person also cannot borrow funds from a non-resident to invest. Thus,
buying a home abroad with a foreign loan is not permitted even if the
loan repayment is within the LRS limit. Foreign builders offer schemes
where the person can get a completed house, but payment can be made over
the next few years after completion. This will clearly be a violation
as the payment option over a few years is a loan.

Primarily a loan also cannot be taken for current account transactions. However, in the FAQs dated 21st October 2021, FAQ 16 clarifies that banks can provide loans or guarantees for current account transactions
only. Here, FAQ is being relied upon. Strictly, FAQs have no legal
authority. In practice, it goes on. Thus, a loan can be taken from a
bank for education and funds can be remitted abroad. However, no loans
can be taken from anyone else even for a current account transaction.

Other prohibited sources:

Remittances out of “lottery winnings, racing, riding or any other
hobby” are prohibited. These are stated in Schedule I of the Current
Account Rules. Hence even if the person has his own funds but earned
from these sources, he cannot remit the same under LRS. This is an issue
that is missed by many people. Further, ‘hobby’ is a broad term. What
seems to be prohibited is income from hobbies which involve gambling and
chance income.

LRS covers both Current and Capital Account Transactions.

2.2.3 Current Account Transactions –

Under clause 1 of Schedule III of Foreign Exchange Management (Current
Account Transactions) Rules, 2000, the following purposes are specified
for which remittance can be made:

i) Private visits to any country (except Nepal and Bhutan).
ii) Gift or donation.
iii) Going abroad for employment.
iv) Emigration.
v) Maintenance of close relatives abroad.
vi) Travel for business or attending a conference or specialised
training or for meeting medical expenses, or check-up abroad, or for accompanying
as an attendant to a patient going abroad for medical treatment/check-up.
vii) Expenses in connection with medical treatment abroad.
viii) Studies abroad.
ix) Any other current account transaction.

Prior to May 2015, there was no limit on remittance for
Current Account transaction. Since May 2015, the limit has been brought
in. Item (ix) above seems to be a misplacement in the Current Account
Transaction rules. This raises some difficulties. Import of goods is a
Current Account transaction. An individual who is doing trading business
in his individual name could import goods worth crores of rupees. Now
can he import above the LRS limit? The view is that for Import, there is
a separate Master Direction laying down procedures and compliances.
Under that Master Direction, there is no limit for imports. Hence
whatever is covered under the Master Direction on Imports, can be
undertaken freely. All other expenses are restricted by the LRS limit.
Thus, expenses for services, travel, etc. will be restricted by the LRS
limit. It would be helpful if Central Government could come out with a
clarification.

We would like to state that India has accepted
Article VIII of the IMF agreement. Under the agreement, a country cannot
impose restrictions on Current Account transactions. However, some
reasonable restrictions can be placed. This is the stand adopted by
India also (refer Section 5 of FEMA). Under this section, a person is
allowed to draw foreign exchange for a Current Account Transaction.
However, the Government can impose some “reasonable restrictions”. This
can mean restrictions on some kinds of transactions or imposition of
some conditions. However, a blanket ban above US$ 2,50,000 on all
current account transactions may not come within the purview of
“reasonable restrictions”. A business entity owned by an individual can
remit any amount for a Current Account Transaction. But the same
individual cannot, if he is doing business in his individual name
(except import of goods and services). In our view, this is not logical.

Specified current account transactions allowed without any limit:

i) Expenses for emigration are permitted without limit. However,
remittances for making an investment or for earning points for the
purpose of an emigration visa are not permitted beyond the LRS limit.

ii)
For medical expenses and studies abroad also, one can incur expenses
more than the LRS limit subject to an estimate given by the hospital/
doctor or the educational institution.

2.2.4 Capital Account Transactions

– The permitted Capital Account transactions can be referred to in
Clause 6 – Part A of the Master Direction on LRS dated 24th August 2022.
Earlier the list was a little more elaborate. Now the list is truncated
after the Overseas Investment Rules have been enacted. The permitted
transactions are:

i) opening of foreign currency account abroad with a bank.
ii) acquisition of immovable property abroad, Overseas Direct
Investment (ODI) and Overseas Portfolio Investment (OPI), in accordance with
the provisions contained in OI Rules, 2022; OI Regulations, 2022 and OI
Directions, 2022.
iii) extending loans including loans in Indian Rupees to
Non-resident Indians (NRIs) who are relatives as defined in the Companies
Act, 2013.

The LRS is primarily used for opening bank accounts, portfolio
investment, acquiring immovable property and giving loans abroad. Prior
to 24th August 2022, the circular referred to specific kinds of
securities – listed and unlisted shares, debt instruments, etc. Now the
reference has been made to Overseas Portfolio Investment (OPI)
and Overseas Direct Investment (ODI) under the New Overseas Investment
regime. This is discussed more in detail in para 2.2.5 below.

It may be noted that a foreign currency account cannot be opened in a bank
in India or an Offshore Banking Unit. The bank account should be outside
India.

2.2.5 Overseas Portfolio Investment (OPI) – OPI has been defined in Rule 2(s) of OI Rules to mean “investment, other than ODI, in foreign securities, but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC”.
(It has been clarified that even after the delisting of securities, the
investment in such securities shall continue to be treated as OPI until
any further investment is made in the entity.)

Basically, OPI
means investment in foreign securities. Then, there are exclusions to
the same – ODI, unlisted debt instruments and securities issued by a
resident [except by a person in the International Financial Services
Centre (IFSC)].

ODI includes investment in the unlisted equity capital
of a foreign entity. Equity Capital includes equity shares and other
fully convertible instruments as explained under Rule 2(e) of OI Rules.
Thus, now it is clear that investment even in a single unlisted share of
a foreign entity falls under ODI and it requires separate compliance.

Listed foreign securities have not been defined. However, “listed foreign
entity” has been defined in Rule 2(m) of OI Rules to mean “a foreign
entity whose equity shares or any other fully and compulsorily convertible instrument is listed on a recognised stock exchange outside India.”

Para
1(ix)(a) of OI Directions provides further prohibitions under OPI which
are not covered under the OI Rules. It provides that OPI is not
permitted in derivatives and commodities.

This brings out the following:

OPI means Investment in foreign securities. However, investment in the following are not covered under OPI:

i) Investments considered as ODI:

a) Investment in unlisted equity capital;

b) Subscription to Memorandum of Association;

c) Investment in 10% or more of listed equity capital;

d) Investment of less than 10% of listed equity capital but with control in the foreign entity.

ii) Unlisted debt instruments.

iii) Security issued by a person resident in India (excluding a person in an IFSC).

iv) Derivatives unless specifically permitted by RBI.

v) Commodities including Bullion Depository Receipts.

Debt instruments are defined in clause (A) of Rule 5 of OI Rules. These mean:

i) Government bonds.

ii) Corporate bonds.

iii) All tranches of securitisation structure which are not equity tranches.

iv) Borrowings by firms through loans.

v) Depository receipts whose underlying securities are debt securities.

Other investments:
Apart
from listed securities, investment is permitted in units of mutual
funds, venture funds and other funds which can be considered as “foreign
securities”.

Investment in Gold (precious metal) bonds is not permitted as it amounts to a corporate bond.

Buying physical gold or other precious metals outside India is also not permitted under LRS.
Also, see para 2.2.12 for more prohibitions under LRS.

2.2.6 Bank fixed deposits

– Is investment in fixed deposits of banks permitted? Can these be
considered as loans? Extending loans is specifically permitted under
LRS. What is prohibited is borrowing by firms. Banks are not firms.
These are companies.

Bank FDs are also not corporate bonds.
Bonds have a specific meaning. It means a security or an instrument
which can be transferred. A bank FD cannot be transferred.

However,
OPI means investment in foreign securities. A Bank Fixed Deposit is not
a “security”. Hence in our view, keeping funds in Bank FDs is not
considered as OPI.

One view is that bank fixed deposit is like a bank balance. Hence funds remitted under LRS may be kept in bank fixed deposits.
However, funds remitted abroad have to be used within 180 days. (See
para 3 for more discussion). Hence such FDs cannot be held beyond 180
days and should be used for some permitted purpose within 180 days.

2.2.7 Unlisted shares of a foreign company – A background:

From 2004 till 22nd August 2022, the Master Directions were abundantly clear that investment under LRS could be made in unlisted and listed equity shares. However, vide A.P. Circular 57 dated 8th May 2007, the RBI introduced the sentence – “All other transactions which are otherwise not permissible under FEMA …… are not allowed under the Scheme.”
Under this clause, RBI took a view that investment in unlisted shares
was not permitted. According to RBI, investment in unlisted shares was
permitted only as per ODI rules applicable at that time (Old ODI Regime
under FEMA Notification 120 which was in effect before 22nd August
2022). Under those rules, individuals were not permitted to make
business investments outside India. Hence, investments made by resident
individuals in unlisted foreign companies to undertake business were
considered as a violation. With due respect, the stand taken by RBI does
not go in line with the language of the Master Directions – right till
22nd August 2022. All penalties imposed for investment in unlisted
shares by resident individuals – are not in keeping with the law – FEMA.

The phrase “which are otherwise not permissible” applies
to all investments. For example, investment in immovable property
abroad is otherwise not permissible. But under LRS it is permissible.
Loans abroad are otherwise not permissible. But under LRS they are
permissible. The LRS was supposed to apply in addition to all existing facilities.
In Master Circular on Miscellaneous Remittances from India – Facilities
for Residents dated 1st July 2008, the phrase was amended to “The facility under the Scheme is in addition to those already included in Schedule III of Foreign Exchange Management (Current Account Transactions) Rules, 2000”. From May 2015, the Current Account Rules were changed and from Master Circular dated 1st July 2015 onwards, the phrase “in addition to”
has been dropped. However, the fact remains that till 22nd August 2022
investment in unlisted shares was permitted as per Master Direction.
From 23rd August 2022, the phrase “unlisted shares” was dropped in the
Master Direction.

On representation, RBI formally introduced the
scheme of ODI for resident individuals from August 2013 (generally
called “LRS-ODI”). It permitted individuals to invest in unlisted shares
of a foreign company having bonafide business subject to compliances
pertaining to ODI. However, RBI considered investments made prior to
August 2013 as a violation which required compounding. This did leave a
bad taste for Indian investors.

Thus, now the investment in
unlisted securities is covered under the ODI route and has a separate
set of rules and compliances. This was the position since August 2013
under the Old ODI regime as well as under the New OI regime notified on
22nd August 2022. It is not dealt with more in this article as that is a
subject by itself.

2.2.8 Listed securities abroad of Indian companies – Up to Master Circular dated 1st July 2015, the language was that investment could be made under “assets” outside India.
It did not specifically state that investment could be only in
securities of foreign entities. Hence investment made in say GDRs or
securities of Indian companies listed abroad was possible. Later, Master
Circulars were replaced with Master Directions. From Master Direction
dated 1st January 2016, it was provided that investment could be in “shares of overseas company”. Hence, it should be noted that under LRS, an individual can invest in listed securities of a foreign entity.
One cannot invest in securities of an Indian company which are listed
abroad. Some people have invested in bonds of Indian companies listed
abroad. Such investments are not permitted under LRS. One should sell
such investments and apply for compounding of offence. Under the OI
Rules as well, investment in securities issued by a person resident in
India is not permitted under OPI. There is only one exclusion to the
prohibition – investment in securities issued by an entity in IFSC is
allowed.

2.2.9 Investment in permissible security of an entity in IFSC is permitted under LRS. Under the Notification No. 339 dated 2.3.2015, any entity in an IFSC is treated as a non-resident.

OPI as discussed in para 2.2.5 above means investment …. in foreign securities, but not in any unlisted debt instruments or any security issued by a person resident in India who is not in an IFSC”.
This language creates some confusion. Investment is not permitted in
any security issued by an Indian resident which is not in IFSC. Does it
mean that investment in any security such as “unlisted debt instrument”
issued by an entity in IFSC is permissible? We would not take such a
view. One has to equate an IFSC entity with a foreign entity. Whatever
security of a foreign entity one can invest in, similar security of an
IFSC entity can be invested in. Thus, investment should be in assets
discussed in paras 2.2.4 and 2.2.5.

2.2.10 Extending Loans:
Under LRS, extending loans to non-residents is allowed. However, this
is allowed in the case of outright loans to third parties. For instance,
Mr. A (an Indian resident) can give a loan to his friend Mr. B (a US
Resident) or to B Inc (a US company).

However, if Mr. A has made
ODI in the USA (whether in his individual capacity or through an Indian
Entity), then a loan by Mr. A to the investee entity in the USA is not
considered under LRS. Mr. A will have to comply with the ODI Rules in
such a case. Under ODI Rules, only equity investment can be made by
individuals. One cannot take a view that investment in equity of a
foreign entity will be under ODI and loan to that entity will be under
LRS. If there is any equity investment in a foreign entity as ODI, then
all conditions of the ODI route shall be fulfilled. Hence, no loan can
be given.

2.2.11 Transactions in Indian rupees – Indian
residents are allowed to give gifts and loans to NRI/ PIO relatives (as
defined under the Companies Act 2013) in rupees in their NRO account.

Para
6(iii) of the Master Direction initially refers to NRIs. Later, it has
been clarified that gifts and loans can be given to PIOs also (i.e.,
foreign citizens but Persons of Indian Origin).

It was represented to RBI that under LRS, foreign exchange can be remitted
outside India to anyone. However, if payment has to be made in rupees in
India, it is not permitted! RBI has since then permitted gifts and
loans in rupees in India but only to NRI/PIO relatives within the
overall LRS limit.

2.2.12 Prohibited transactions – Apart from restrictions discussed in para 2.2.5, the following transactions are prohibited:

i) Transactions specified in Schedule I and Schedule II of Current
Account Transactions Rules. This includes remittances for lottery
tickets, banned magazines, etc.

ii) Remittances to countries identified by FATF as non-co-operative countries.

iii) Remittance for margin trading. Thus, dealing in derivatives and options is not permitted.

iv) Trading in foreign exchange. (This is stated in FAQs updated up to 21.10.2021. No other document states this.)

3. Retaining funds abroad:

3.1 Background: This is the most important change in the LRS.

The individual who has remitted funds under LRS can primarily retain
the same abroad, reinvest the funds and retain the income earned from
such investments abroad. This has now undergone a change with effect
from 24th August 2022. The change has been carried out without any
specific announcement.

The Overseas Investment rules and
regulations were notified on 22nd August 2022. The Master Direction on
LRS was amended on 23rd August 2022 to factor in the changes in capital
account transactions as per the OI Rules as explained in paras 2.2.4 and
2.2.5 above. Paragraph 16 of the Master Direction amended on 23rd
August 2022 stated that – “Investor, who has remitted funds under LRS
can retain, reinvest the income earned on the investments. At present,
the resident individual is not required to repatriate the funds or
income generated out of investments made under the Scheme.” Till
23rd August 2022 funds remitted under LRS and income from the same could
be retained and used abroad without any restrictions.

The Master
Direction on LRS was amended again on 24th August 2022 (just one day
later). This amendment includes an important change in the scheme and
has been dealt with in the next para 3.2.

3.2 Main amendment: Under the LRS Master Direction amended on 24th August 2022, Paragraph 16 provides the following:

“Investor, who has remitted funds under LRS can retain, reinvest the income earned on the investments. The received/realised/unspent/unused foreign exchange, unless reinvested, shall be repatriated and surrendered to an authorised person within a period of 180 days
from the date of such receipt/ realisation/ purchase/ acquisition or
date of return to India, as the case may be, in accordance with
Regulation 7 of Foreign Exchange Management (Realisation, repatriation
and surrender of foreign exchange) Regulations, 2015 [Notification No.
FEMA 9(R)/2015-RB]”.

It is provided that the received or
realised or unspent or unused foreign exchange should be repatriated to
India, unless it is reinvested. The time limit of 180 days is provided.
This condition of repatriating the unused or uninvested funds back to
India within 180 days is a major change. No specific announcement was
made. It was simply brought in the Master Direction on 24th August 2022.

The language is broad. The terms “received” and “realised” can
refer to the amount received on sale of investment, or income on
investment. The terms “unspent” and “unused” can refer to amount
received on sale of investments, or income on investment, or amount remitted from India under the LRS. The amounts have to be reinvested within 180 days from the date of receipt, realisation, acquisition or purchase of foreign exchange.

While the word “reinvested” is used, it cannot be mandatory that the funds
should only be “reinvested”. The intention seems to be that funds should
not be parked idle. They should be “reinvested” or “used” within 180
days. Let us assume a person makes an investment under LRS, then sells
the same and receives the sale proceeds. These proceeds can be used for
any permitted Current Account Transaction (expenditure) or Capital
Account Transaction (investment) within 180 days. That is the purpose of
LRS. Here also it will be helpful if RBI could provide a clarification.

3.3 Retrospective amendment: The requirement to
repatriate the idle funds within 180 days applies not only to fresh
remittances but also to the existing funds lying abroad which were
remitted before 24th August 2022. It is effectively a retrospective amendment. Many people are not aware of this.

Let
us take a case where funds were remitted under LRS since 2018 and funds
were lying idle in the bank account since then. These are unspent funds
and the amendment made on 24th August 2022 applies to such funds as
well. Hence, the person will have 180 days to invest the funds from 24th
August 2022. If it is not done, the funds should be repatriated.

Thus, by 19th Feb 2023 the funds remitted prior to 24th Aug 2022 had to be
utilised, if they were lying unspent or unutilised. If the funds are not
used by then and are still lying abroad, it is a contravention of FEMA.

3.4 Issues: This will cause difficulties for several people. Let us consider some issues.

3.4.1 Small amounts to be tracked and invested: The
income earned on investments abroad should also be invested abroad
within 180 days, or these should be remitted back to India. The income
on LRS funds could be small. Let us take a case where funds are remitted
to a brokerage account in the USA and investment is made in listed
shares. A small amount of income is received and lying in the brokerage
account. Or some funds are kept in the brokerage account to pay an
annual fee. One will have to keep track of all these incomes and
reinvest them. Keeping such a track and investing small funds is
difficult. Further remittance of funds to India also costs money by way
of bank charges, etc.

3.4.2 Time-consuming investments: Let
us consider another case. Let us say the person has purchased a flat
and after few years, he sells the same. He would like to buy another
flat abroad. The sale proceeds of the first flat should be used within
180 days. Either he should buy the flat or invest the funds in permitted
investments. At times, to finalise the transaction for a flat takes lot
of time. Therefore, one will have to plan to invest within 180 days
from the sale of flat.

3.4.3 Consolidation of funds over multiple years for high-value investments:

Some people have sent funds over a few years to buy an immovable property
abroad as one year’s limit under LRS may not be sufficient. However,
with the 180 days’ time limit, the accumulation of funds is not
possible. In such cases, the funds remitted abroad should be invested in
portfolio investment. And when the funds are sufficient to buy the
property, the securities can be sold. This however means that the person
undertakes risks associated with the securities. A fall in prices of
the securities will jeopardise the purchase of property.

3.5 Can the person invest the funds in bank fixed deposits?

See
para 2.2.6 above where it is stated that Bank FDs do not fall within
the definition of OPI. Remitting funds under LRS and keeping them in
Bank FDs for up to 180 days is all right. However, bank fixed deposits
are not securities and can be considered equivalent to funds in a bank
account. Hence, in our view, placing funds in bank fixed deposits will
not be considered an “investment” of funds. It will be ideal if RBI
comes out with a clarification on the same.

3.6 Some cases where the 180-day limit will not apply:

As mentioned in para 2.2.4, Indian residents can give loans and gifts
to NRI relatives. Here, there is no question of utilising foreign
exchange. Hence there is no limit of 180 days or any other time period.
The limit of 180 days applies only for foreign exchange remitted abroad
or lying abroad.

Let us take another illustration. A student
remits funds under LRS for education purposes to his foreign bank
account. Before leaving India, he is an Indian resident. All funds may
not be utilised within 180 days. Some funds may be lying for ongoing and
future expenses. However, when the student leaves India for education
abroad, he becomes a non-resident. In such a case, the 180-day limit
will not apply. Once a person is a non-resident, the funds outside India
are not liable to FEMA restrictions. Hence, the condition of
repatriating the funds within 180 days will not apply.

3.7 Consequences of violation:

What are the consequences of a violation of not using the funds within
180 days? The person concerned has to apply for compounding. Compounding
is a process under which the person concerned admits to the violation.
RBI then levies a penalty for the violation. There is no option to pay
Late Submission Fee (LSF) and regularise the matter. LSF is for delays
in submitting the documents/forms.

There is however, a hitch. Before applying for compounding, the transactions have to be regularised. How does one regularise?

Regularising
means doing something now, which should have been done earlier. In our
view, the violation can be regularised in two manners – one is by
remitting the funds back to India. The other is to invest/use the funds
abroad as permitted – although with a delay. It is however doubtful
whether utilising the funds after the 180-days’ period will be
considered as regularisation. It will be better for the funds to be
repatriated to India. Once the funds are repatriated, a Compounding
Application should be filed with RBI.

3.8 Alternate views:

3.8.1
There is a view that the provision of use of funds within 180 days
applies to an “investor” only (see para 16 of Master Direction). Thus,
if funds are remitted by an investor for investment, one has to use the funds within 180 days. Whereas, if a person has remitted the funds for expenses
such as education, one can use the funds beyond 180 days also. However,
the language does not suggest such an intention. While the provision
starts with the term “investor”, the provision goes on further to add
that the funds have to be surrendered to the bank “in accordance with
Regulation 7 of Foreign Exchange Management (Realisation, repatriation
and surrender of foreign exchange) Regulations, 2015 [Notification No.
FEMA 9(R)/2015-RB]”. Regulation 7 of Notification 9(R) provides as under:

“A person being an individual resident in India shall surrender the
received/realised/unspent/unused foreign exchange whether in the form of
currency notes, coins and travellers cheques, etc. to an authorised
person within a period of 180 days from the date of such
receipt/realisation/purchase/acquisition or date of his return to India,
as the case may be.”

Regulation 7 applies to all individual
Indian residents and for all purposes. Hence even if the funds have been
remitted for expenses, they have to be utilised within 180 days.
Otherwise, the same should be remitted to India.

3.8.2 There is
another view as to when is the amount to be considered as unused/
unspent. The view is that once the amount is remitted abroad, it has to
be used on the first day. If it is not used on the first day, then it is
unused/unspent. If it unused/unspent, it has to be remitted back to
India. The time of 180 days is only to remit the funds back to India.

While
literal reading suggests this – in our view, this is neither the
correct interpretation, nor the intention. One cannot use the funds on
day one. It takes time for the funds to be used. If the funds are not
used within 180 days, then they have to be remitted back to India.

4. Some more issues:

4.1 Purpose Codes: At
the time of remittance, one has to state the purpose code in the form.
For example, one mentions the purpose code as S0023 (remittance for
opening a bank account abroad). After remittance, can the funds be used
for investment in shares? Or the purpose code stated is investment in
real estate (S0005) and one is not able to invest in real estate within
180 days, and hence invested in shares. Can it be done? Technically it
could be considered an incorrect purpose code. However, if one considers
the substance of LRS, remittance for any permitted purpose is allowed.
One may have the original intention for one purpose, but then the
purpose has changed, and it should be all right. After the remittance of
funds, change of use has always been permitted. Assume that a person
has remitted the funds to open a bank account abroad. Under the present
LRS scheme, funds have to be used within 180 days. To comply this
condition, funds are invested. This means the “use of funds” has changed
from keeping funds in bank account to investment. Or the funds are sent
for investment in shares, and then the shares are sold. Does it mean
the sale proceeds have to be reinvested only in shares? No. The funds
have to be used or reinvested for any permissible purpose.

It
will be better that after remitting the funds for the first time, if
there is a change in the use, one should write to the bank and inform
the change of use. This is however out of abundant caution. In substance
after sending the funds, the same can be used for any permitted
purpose. Also see para 3.2 of Part B on TCS provisions.

4.2 Joint holding:

There are people who open bank accounts and make investments in joint
names. Investment is made by one person (say the first holder). Funds
belong to the first holder. That is how it is declared in the income tax
returns. However, to take care of situations where the investor dies or
becomes incapacitated, the account or the investment is held in the
joint name. Otherwise, the funds may be blocked. The process of
producing a Will or succession document is a time-consuming process. So,
the second name is added for the sake of convenience. Hence in our
view, holding an investment or bank account in a joint name is all
right. It is a prudent step. There cannot be any objection to this.

5. Co-ownership and Consolidation of funds:

5.1 Co-ownership

– Assume that funds are sent by two or more relatives in one bank
account. From there investment has to be made. It is necessary that the
investment should be made in the proportion in which the funds are
remitted. Assume that Mr. A remits US$ 1,00,000 and Mrs. A remits US$
50,000, and together they invest US$ 1,50,000 in shares. The holding
ratio in the shares should be 2:1 between Mr. A and Mrs. A. If the
investment holding is 50:50, it means Mr. A has given a gift to Mrs. B.
Gift outside India from one resident to another resident is an
impermissible transaction. It will become a violation.

5.2 Consolidation of funds

– Master Direction prior to 23rd August 2022 permitted consolidation of
remittances by the family members. It further provided that clubbing is
not permitted by family members if they are not the co-owners of bank account/ investment/ immovable property. Here, the condition for co-ownership does not mean being just a co-owner. It means that ownership ratio in the asset should be commensurate with the ratio in which payment is made.
This is prima facie in line with the LRS that the owner should remit
the funds. If another person becomes the owner without remitting the
funds it is as good as a gift from the person who has remitted the
funds. This is different from being a joint holder (without remittance
or payment) for the sake of convenience discussed in para 4.2 above.

It may be noted that “family members” have not been explained. It should
be considered as a family comprising relatives under the Companies Act
2013.

5.3 Consolidation of funds for acquiring immovable property

– The amended Master Direction on LRS has retained the above-mentioned
condition of consolidation of funds and co-ownership. However, the
reference to the immovable property has been removed. The Master
Direction has stated that remittances for the immovable property should
be in accordance with OI rules.

Under the OI rules, an Indian
resident can acquire immovable property by remitting funds under LRS.
Further, an Indian resident can acquire property as a gift from another
resident also, subject to the condition that the donor should have
acquired such property in line with FEMA provisions applicable at the
time of acquisition.

Further, proviso to Rule 21(2)(ii)(c) of OI Rules states that “such
remittances under the Liberalised Remittance Scheme may be consolidated
in respect of relatives if such relatives, being persons resident in
India, comply with the terms and conditions of the Scheme”.

Does this mean that relatives can consolidate/ club the remittances, but
property can be owned by one person? As discussed above, an Indian
resident cannot gift funds to another Indian resident outside India.
When consolidated funds are remitted, purchase by one person actually
amounts to a gift of funds – which is not permitted. If the property is
acquired and then later the share in the property is gifted, it is
permissible.

However, if one considers the draft rules on Overseas investment published in 2021 for public consultation, it
provided that if funds were consolidated, the immovable property has to
be co-owned. In the final OI rules notified by Central Government and
the amended Master Direction, the language is different. The condition
of co-ownership is not present for the purchase of immovable property
abroad. While it seems like a specific amendment to relax the condition
for co-ownership, it does not come out clearly that funds can be
remitted by relatives but property can be purchased by one person.

At present, where remittances are consolidated amongst relatives, one
should avoid purchasing immovable property without complying with the
condition of co-ownership. It will be helpful if RBI can provide a
specific clarification.

5.4 In some cases, banks have permitted remittance under LRS from one account of an individual for say
4 different people by obtaining PAN of all 4 people. This is incorrect.
Remittance is not based on PAN. It is per person. One individual
can remit only up to the LRS limit and that too for himself/ herself.
If funds have to be remitted by other Indian resident family members,
then the account holder should first gift the funds to others and then
others may remit the funds from their account. Of course, if the bank
account is a joint account and funds in that account belong to all joint
holders, then each joint holder can remit up to the balance available
under his ownership. Consolidated funds can be remitted subject to what
has been discussed in para 5 above. In such cases, one should keep a
proper account of the funds, ownership and remittances.

Summary:

LRS was started in the year 2004 as the first step towards capital account
convertibility of the rupee. Subsequent amendments have imposed too many
conditions and restrictions. This clearly goes back from
liberalisation.

B. INCOME-TAX ACT – TAX COLLECTION AT SOURCE ON REMITTANCES UNDER LRS:

1. Provisions in force till 30th June 2023:

1.1 Basic provision:

Sub-section (1G) was introduced in Section 206C vide Finance Act, 2020
w.e.f. 1st October 2020. It provides for Tax Collection at Source (TCS)
at the rate of 5% on remittances out of India under LRS. There is
a threshold of INR 7,00,000 for the same, i.e., there is no TCS on
remittances up to INR 7,00,000. The rate of 5% is applicable for amount
in excess of Rs. 7,00,000. It should be noted that TCS is applicable per
person per financial year.

Thus, the bank which sells foreign exchange to the individual for remittance under LRS, will collect tax @
5% over and above the rupee amount required for sale of foreign
exchange. This TCS is like an advance tax. The individual can claim the
TCS as tax paid while filing his income-tax return. Many laymen are
under the impression that this is a straight loss. However, that is not
the case. The issue is that the funds of the person get blocked for some
time.

1.2 Non-applicability of TCS:

1.2.1 Remittance not covered under LRS: TCS applies only where remittance is made under the LRS. For instance – if
an NRI remits funds from his NRO/ NRE Account, TCS will not apply in
such case. It is because this is not a remittance under LRS. Similarly,
TCS is not applicable to remittances by persons other than individuals.

1.2.2 Remitter liable to TDS: It has been provided that if the remitter is liable to deduct tax at
source under any provisions of the Income-tax Act, and has deducted such
tax, then this TCS provision will not apply. The intention seems that
TCS is not applicable only if the remitter is liable to deduct tax at
source on the “concerned LRS remittance” and has deducted the same.

However, the language is not clear whether the remitter should be liable to
deduct tax at source on “the concerned remittance under LRS” or “any
transaction”. The literal reading suggests that it is not necessary that
TDS should be applicable on the concerned LRS remittance. The person
may be liable to deduct tax at source on any payment. Consider some
examples. Some individuals have to deduct tax at source where the
turnover or gross receipts from business/profession exceeds the
prescribed thresholds; or on purchase of immovable property u/s. 194-IA;
or on payment of rent u/s. 194-IB. These transactions on which TDS is
deductible are unrelated to the LRS remittance. The language suggests
that TCS is not applicable where the person has deducted tax at source
under any provisions. In our view, this is not the intention. It would
be better if the Government brings clarity in respect of the provision.

1.3. Concessional rate in case of loan taken for education:

A concessional rate of TCS @ 0.5% is applicable instead of 5% where:

the remittance is for the purpose of pursuing education; and
the amount being remitted is from loan funds obtained from a financial institution as defined u/s 80E.

In other words, if the remittance under LRS is made for the purpose of
education out of own funds then the concessional rate of TCS will not be
applicable and one needs to pay TCS @ 5 per cent.

1.4. Overseas Tour Program Package:

While the threshold of INR 7 Lakhs is prescribed for all purposes, such a
threshold is not applicable where the remittance is for the purpose of
an overseas tour program package. Hence, in such cases, TCS @ 5% is applicable without any threshold.

This is the position of TCS on remittances under LRS as of now. Let us take a look at the amendments proposed in Budget 2023.

2. Amendment vide Finance Act 2023 as passed by the Lok Sabha on 24.3.2023 – TCS rate to be increased to 20%:

2.1 Vide Finance Act 2023, the rate of TCS has been increased from the
existing 5% to 20% for remittances made under LRS w.e.f. 1st July 2023.

2.2 Further, the threshold of INR 7,00,000 has been restricted only to
cases where remittance is for the purpose of education or medical
treatment.

2.3 Consequently, the rate of TCS will now be 20% without any threshold for all purposes except education and medical treatment.

2.4 One more amendment is that the phrase “out of India” has been removed
for the purpose of TCS. Under the original provision, TCS was applicable
only where remittance was done “out of India” under LRS. As discussed
above in Para 2.2.11, LRS can be used for giving gift or loan in rupees
to NRI/ PIO relatives in their NRO account as well. In such case, TCS
was not applicable as per existing provision.

From 1st July 2023, TCS will be applicable on such rupee transfers as well. It is not
required that there is remittance out of India. It should be noted that
for rupee payments discussed in para 2.2.11 of Part A, there is no
mechanism to report to the bank. The remitter has to keep track of rupee
payments and see that all payments in rupees and foreign exchange
should be within the limits of LRS. For remittance abroad, formal
reporting must be made to the bank and thus bank will know that the
funds are being remitted under LRS. In the case of rupee payments, RBI
should work out a mechanism for reporting. Alternatively, the remitter
should himself provide the details to the bank and the bank should
collect TCS.

2.5 The concessional rate of 0.5% where remittance
is out of educational loan (discussed in Para 1.3 above) remains the
same after amendment.

The table below summarises the TCS rate for various transactions before and after the proposed amendment.

Particulars Vide
Finance Act 2020 1st
October 2020 to 30th June 2023		 Vide
Finance Act 20231st
July 2023 onwards
Remittance out of educational loan taken from
financial institution defined u/s 80E		 0.50% on amount exceeding INR
7,00,000
Education & medical treatment 5% on amount exceeding INR
7,00,000
Overseas tour program package 5% without any threshold 20% without any threshold
All other purposes 5% on amount exceeding INR 7,00,000 20% without any threshold

3. Other issues:

3.1 Payment through International Credit Cards:

It should also be noted that payments made by International Credit Card
(ICCs) for foreign tours or any other Current Account Transaction are
not captured within the purview of LRS. The limit of LRS, of course,
applies whether payment is made through bank transfer or through ICC.
There is however no mechanism to collect TCS when payment is made by
ICC.

Finance Minister – Smt. Nirmala Sitharaman, while passing
the Finance Bill in Lok Sabha on 24th March 2023 has made a statement on
this. The Central Government has requested the RBI to develop a
mechanism to capture payment for foreign tours and TCS by ICC.

3.2 Change in use of funds – As mentioned in para 4.1 of Part A, the purpose can be changed after remitting the funds. This can have some issues.

Normally the TCS rate is 20%. If the purpose of remittance is changed to
education, the TCS should have been lower at 5%. As excess tax is
collected, there is no difficulty. In any case, TCS is like advance tax.
It will be claimed as such in the income tax return.

However, let us assume that funds are remitted for education and TCS is 5%. Later
the use is changed to investment, then there is a shortfall in the TCS.
Banks would of course have collected the tax based on declaration and
documents provided by the remitter. The change in use would not cause
any liability on the bank. Will it cause any liability on the remitter?
There should be no implication for a bonafide case. For example, The
original remittance was for education purpose but some funds could not
be used within 180 days. In order to comply with the condition of
investing the funds within 180 days, the funds were invested.
Subsequently the investments were sold and funds were used for
education. This should not be an issue. Even otherwise there is no
specific provision for change of use. Please note that we are discussing
bonafide change in use and not false declarations. Out of abundant
caution, the remitter may inform the bank on change of use and if
necessary, ask the bank to collect additional tax from him and pay the
same to the Government. It may even collect interest. The remitter will
in any case claim the additional TCS in his tax return.

Summary:

20% is a very high rate for TCS. There are no thresholds. The threshold of
INR 7 Lakhs has also been removed. Sometimes, remittances are made for
pure expenses or gift to relatives which do not lead to any potential
incomes. However, with the steep hike in its rate, it appears that the
government does not wish to encourage remittances under LRS. Hence it is
making remittances costlier.

Conclusion:

There are significant changes in the LRS in terms of inserting some
restrictions and disincentives. Before making remittances under the LRS,
one should carefully understand the implications and then go ahead with
the remittance.

(Authors acknowledge contributions from CA Rutvik Sanghvi, Ms. Ishita Sharma and CA Nidhi Shah.)

Reassessment — Notice under section 148 — Service of notice without signature of AO digitally or manually — Notice invalid — Consequent proceedings without jurisdiction — Notices and order issued beyond period of three years after relevant assessment year — Show-cause notice and order for issue of notice and notice for reassessment quashed and set aside

85 Prakash Krishnavtar Bhardwaj vs. ITO
[2023] 451 ITR 27 (Bom)
A Y.: 2015-16
Date of order: 9th January, 2023
Sections 147, 148, 148A(b) and 148A(d) of ITA 1961:

Reassessment — Notice under section 148 — Service of notice without signature of AO digitally or manually — Notice invalid — Consequent proceedings without jurisdiction — Notices and order issued beyond period of three years after relevant assessment year — Show-cause notice and order for issue of notice and notice for reassessment quashed and set aside

The relevant year is the A.Y. 2015-16. The assessee filed a writ petition for quashing the impugned notice under clause (b) of section 148A dated 21st March, 2022, order under clause (d) of section 148A dated 2nd April, 2022 and notice under section 148 dated 2nd April, 2022 passed by the respondents under the Income-tax Act, 1961. The Bombay High Court allowed the writ petition and held as under:

“The notice issued under section 148 of the Income-tax Act, 1961 admittedly having no signature of the Assessing Officer affixed on it, digitally or manually, was invalid, and would not vest the Assessing Officer with any further jurisdiction to proceed with the reassessment under section 147. Consequently, the Assessing Officer could not assume jurisdiction to proceed with the reassessment proceedings. The notice having been sought to be issued after three years from the end of the relevant assessment year 2015-16 any steps taken by the Assessing Officer the notice issued u/s. 148A(b) and the order passed u/s. 148A(d) were without jurisdiction and therefore, arbitrary and contrary to article 14 of the Constitution of India and consequently set aside.”

Refund — Tax deposited by the assessee in compliance with order of Tribunal — Fresh assessment not made and becoming time-barred — Assessee entitled to refund of amount with statutory interest deducting admitted tax liability

84 BMW India Pvt Ltd vs. Dy. CIT

[2023] 450 ITR 695 (P&H)

A. Y.: 2009-10

Date of order: 5th July, 2022

Section 237 of ITA 1961

Refund — Tax deposited by the assessee in compliance with order of Tribunal — Fresh assessment not made and becoming time-barred — Assessee entitled to refund of amount with statutory interest deducting admitted tax liability

For the A.Y. 2009-10, the assessee filed an appeal before the Tribunal against the order under section 143(3) of the Income-tax Act, 1961. The Tribunal stayed the order subject to the condition that the assessee deposited an amount of Rs. 10 crores in two instalments and remanded the matter back for fresh assessment. The assessee complied with the order and deposited the amount. The issue with respect to the depreciation amount disallowed was not raised and was conceded by the assessee. According to the remand order dated 21st February, 2014 the authorities were required to pass fresh order before 31st March, 2017.

The assessee filed a writ petition claiming refund of Rs. 10 crores after deduction of tax liability on the admitted depreciation disallowance on the ground that the assessment proceedings had become time-barred. The Punjab and Haryana High Court allowed the writ petition and held as under:

“The assessee was entitled to refund of the excess amount deposited by it after deduction of the tax liability against the disallowance of depreciation which stood admitted by the assessee before the Tribunal with the statutory interest on the refund amount for the period starting from April 1, 2017 till the date of actual payment.”

Infrastructure facility — Special deduction under section 80-IA(4)(iii) of ITA 1961 — Construction of technology park — Finding recorded by the Tribunal in earlier assessment years that the assessee had not leased more than 50 per cent of area to single lessee — Notification to be issued by CBDT is only a formality once approval is granted by Government — Order of Tribunal deleting disallowance need not be interfered with

83 Principal CIT vs. Prasad Technology Park Pvt Ltd

[2023] 450 ITR 564 (Karn)

A. Y.: 2014-15

Date of order: 17th October, 2022:

Section 80-IA(4)(iii) of ITA 1961

Infrastructure facility — Special deduction under section 80-IA(4)(iii) of ITA 1961 — Construction of technology park — Finding recorded by the Tribunal in earlier assessment years that the assessee had not leased more than 50 per cent of area to single lessee — Notification to be issued by CBDT is only a formality once approval is granted by Government — Order of Tribunal deleting disallowance need not be interfered with

The assessee constructed and set up a technology park. For the A.Y. 2014-15, the AO disallowed its claim for deduction under section 80-IA(4)(iii) of the Income-tax Act, 1961 on the grounds that the assessee had leased out more than 50 per cent of the allocable industrial area to a single lessee which was in contravention of the Industrial Park Scheme, 2002.

The Commissioner (Appeals) allowed the assessee’s appeal following the order in the assessee’s own case for the A.Ys. 2007-08 and 2008-09 and his order was upheld by the Tribunal.

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

“i)    The Tribunal was correct in holding that the assessee was entitled to deduction under section 80-IA(4)(iii) and that the notification issued by the CBDT was only a formality once the approval was granted by the Government. For the A. Y. 2008-09 in the assessee’s own case the Tribunal had called for a remand report by the Commissioner (Appeals) and recorded a finding that the assessee had not leased out more than 50 per cent of the total area in favour of any one of the lessees. Based on that finding, the Tribunal had allowed the assessee’s appeal.

ii)    The questions of law are answered in favour of the assessee and against the Revenue.”

Income — Accrual of income — Time of accrual — Retention money — Payment contingent on satisfactory completion of contract — Accrued only after obligations under contract were fulfilled — Cannot be taxed in year of receipt

81 Principal CIT vs. EMC Ltd

[2023] 450 ITR 691 (Cal)

A. Y.: 2014-15

Date of order: 25th July, 2022

Section 4 of Income-tax Act, 1961

Income — Accrual of income — Time of accrual — Retention money — Payment contingent on satisfactory completion of contract — Accrued only after obligations under contract were fulfilled — Cannot be taxed in year of receipt

The assessee was a contractor. For the A.Y. 2014-15, since the contractee had deducted tax under section 194C of the Income-tax Act, 1961 and the assessee followed the mercantile system of accounting, the AO treated the retention money withheld by the contractee as income in accordance with the terms of contract.

The Commissioner (Appeals) held that the retention money was to be excluded from the income in the A.Y. 2014-15 but the tax deducted at source claimed by the assessee relatable to such retention money was to be allowed in the year in which the assessee declared the retention money as its income. The Tribunal held that the right to receive the retention money accrued only after the obligations under the contract were fulfilled and the assessee had no vested right to receive in the A.Y. 2014-15, and that therefore, it could not be taxed as income of the assessee in the year in which it was retained.

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

“i)    The Commissioner (Appeals) and the Tribunal on consideration of the undisputed facts had applied the correct legal position and had granted relief to the assessee holding that the retention money of  Rs. 142.53 crores did not arise in the relevant A.Y. 2014-15. The Department had not made out any ground to interfere with the order passed by the Tribunal.

ii)    Accordingly, the appeal filed by the Revenue is dismissed and the substantial questions of law are answered against the Revenue.”

Business deduction — Loss — Loss on forward contracts for foreign exchange — Transactions to hedge against risk of foreign exchange fluctuations falling within exceptions of proviso (a) to section 43(5) — Loss not speculative and to be allowed

80 Principal CIT vs. Simon India Ltd

[2023] 450 ITR 316 (Del)

A. Y.: 2009-10

Date of order: 2nd December, 2022

Sections 37(1) and 43(5) proviso (A) of ITA 1961

Business deduction — Loss — Loss on forward contracts for foreign exchange — Transactions to hedge against risk of foreign exchange fluctuations falling within exceptions of proviso (a) to section 43(5) — Loss not speculative and to be allowed

The assessee provided engineering consultancy and related services such as engineering designing, construction and commissioning of plants and installations. For the A.Y. 2009-10, the AO was of the view that the loss on forward contracts claimed by the assessee was a speculative loss under section 43(5) and was liable to be disallowed in terms of the CBDT Instruction No. 3 of 2010, dated 23rd March, 2010. He held that since the forward contracts had not matured, the losses were required to be considered as notional losses and accordingly made a disallowance.

The Commissioner (Appeals) set aside the disallowance. The Tribunal held that the loss on account of forward contracts was allowable under section 37(1) and was covered as a hedging transaction under proviso (a) to section 43(5).

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

“i)    In terms of the CBDT Instruction No. 3 of 2010, dated March 23, 2010 Assessing Officers were instructed to examine the “marked to market” losses. The instruction explained “marked to market” as a concept where financial instruments are valued at market rate to report their actual value on the date of reporting. Such “marked to market” losses represent notional losses and are required to be added back for the purposes of computing taxable income under the Income-tax Act, 1961. The CBDT also instructed Assessing Officers to examine whether such transactions were speculative transactions where losses on account of foreign exchange derivative transactions arise on actual transaction. However, it is well settled that the CBDT instructions and circulars which are contrary to law are not binding.

ii)    In CIT v. Woodward Governor India P. Ltd. [2009] 312 ITR 254 (SC) the Supreme Court referred to Accounting Standard-11 in terms of which exchange rate differences arising on foreign currency transactions are to be recognized as income or expenses in the period in which they arise, except in cases of exchange differences arising on repayment of liabilities for acquiring fixed assets.

iii)    The forward contracts were entered into by the assessee to hedge against foreign exchange fluctuations resulting from inflows and outflows in respect of the underlying contracts for provisions of consultancy and project management. Concededly, the assessee did not deal in foreign exchange. The transactions fell within the exceptions of proviso (a) to section 43(5). There was no allegation that the assessee had not been following the system of accounting consistently. The assessee had stated that it was reinstating its debtors and creditors in connection with execution of contracts entered into with foreign entities on the basis of the value of the foreign exchange. Therefore, the loss on account of forward contracts would require to be recognized as well. The assessee computed its income by taking into account the foreign exchange value as it stood on the due date.

iv)    The orders of the Commissioner (Appeals) and the Tribunal that the loss, on account of forward contracts could not be considered as speculative and that the Assessing Officer had erred in disallowing it were not erroneous. No question of law arose.”

Article 13(4A) of India – Singapore tax treaty – Tax authorities cannot go behind TRC issued by Singapore tax authorities. Gain on sale of shares acquired prior to 1st April, 2017 is not taxable in India.

18 Reverse Age Health Services Pte Ltd vs. DCIT
[TS-67-ITAT-2023(Del)]
 [ITA No: 1867/Del/2022]
A.Y.: 2018-19
Date of order: 19th February, 2023

Article 13(4A) of India – Singapore tax treaty – Tax authorities cannot go behind TRC issued by Singapore tax authorities. Gain on sale of shares acquired prior to 1st April, 2017 is not taxable in India.

FACTS

The assessee, a tax resident of Singapore, sold shares of an Indian Company (ICO). It claimed a refund of TDS on the grounds that capital gain income is not taxable in India as per Article 13 of India – Singapore DTAA3. AO denied benefit under Article 13(4A) of the India – Singapore DTAA on the grounds that the assessee had no economic or commercial substance and that it was a “shell” or a “conduit” company as per Article 3(1) of protocol to India-Singapore DTAA4. DRP upheld AO’s order.

Being aggrieved, the assessee filed an appeal to ITAT.

HELD

  •     ITAT placed reliance on Delhi High Court decision in the case of Black Stone Capital Partners5 which held that Indian tax authorities cannot go behind TRC issued by Singapore tax authorities.

ITAT took note of the following facts and documents and granted benefit of capital gains exemption under Article 13 of DTAA.

The assessee furnished TRC for relevant year issued by Singapore Tax authorities.

Two of the shareholders of assessee were also tax residents of Singapore.

Audited financial statements, return of income filed and tax assessment orders by Singapore Tax Authority.

GAAR provisions are not applicable as the tax on the gains was less than Rs 3 crores6 as also the fact that investment was made prior to 1st April, 2017 which is grandfathered7. 

 

3   Shares
were acquired by the assessee prior to 31st March, 2017. As per Article 13(4A)
gains from the alienation of shares acquired before 1st April, 2017 in a
company which is a resident of a Contracting State shall be taxable only in the
Contracting State in which the alienator is a resident.

4   Article
24A(1) of amended India- Singapore DTAA

5   W.P.(C)
2562/2022 decided on 30.01.2023

6   Rule
11U(1)(a)

7   Rule 11U(1)(d)

 

Article 12 of India – Singapore tax treaty – Uplinking and Playout Services are not royalty or FTS

17 Adore Technologies (P) Ltd vs. ACIT

[ITA No: 702/Del/2021]

A.Y.: 2017-18

Date of order: 19th December, 2022

Article 12 of India – Singapore tax treaty – Uplinking and Playout Services are not royalty or FTS

FACTS

The assessee, a tax resident of Singapore provides satellite-based telecommunication services. He earned income from disaster recovery uplinking and playout services1. The AO held that the disaster recovery uplinking service of the assessee is nothing but a part of a process wherein signals are taken from the playout equipment and sent to the satellite for broadcasting them to cable operators/direct to home operators. The AO relied on Explanation 6 to section 9(1)(vi) to assess the remittance as process royalty. Further, playout services were held to be inextricably linked with uplinking services and were taxable as FTS under Act and DTAA. DRP upheld order of AO. Being aggrieved, the assessee appealed to ITAT.

 

 

1   Uplinking service is a process wherein
signals are taken from the playout equipment and sent to the satellite for
broadcasting them to cable operators / direct to home operators. The disaster
recovery playout service involves provision of uninterrupted availability of
the playout service at a predetermined level.

 

 

HELD

Up-linking services

  •     The term ‘process’ in definition of royalty under the treaty has been used in the context of’ know-how’ and intellectual property.

 

  •     Royalty in relation to ‘use of a process’ envisages that the payer must use the ‘process’ on its own and bear the risk of its exploitation. If the ‘process’ is used by the service provider himself, and he bears the risk of exploitation or liabilities for the use, then service provider makes his own entrepreneurial use of the process.

 

  •     Considering the following facts, ITAT held that income cannot be considered as royalty.

 

  •     Satellite-based telecommunication services provided by the assessee are standard services. There is no ‘know how’ or ‘intellectual property’ involved.

 

  •     Services do not envisage granting the use of, or the right to use any technology or process to the customers.

 

  •     The assessee is responsible for maintaining the continuity of the service using its own equipment and facilities since the possession and control of equipment is with the assessee.

 

  •     Customers are merely availing a service from the assessee and are not bearing any risk with respect to exploitation of the assessee’s equipment involved in the provision of such service.

 

  •     Explanation 6 to section 9(1)(vi) of the Act is not applicable for interpretation of definition of royalty under DTAA. Reliance was placed on undernoted decisions2.

.

2 New Skies Satellite BV ((382 ITR 114) and NEO  Sports Broadcast Pvt Ltd. (264 Taxmann.com 323)

 

PLAYOUT SERVICES

 

  •     Playout service involves broadcasting and/ or transmission of channels by the assessee for its customers, without any involvement in decision-making with respect to the playlists and the content being broadcasted. The assessee does not have a right to edit, mix, modify, remove or delete any content or part thereof as provided by the customer.

 

  •     Services are not in nature of FTS as envisaged under Article 12(4)(a) of the DTAA as they are not ancillary or subsidiary to disaster recovery uplinking and allied services.

 

  •     Services also do not make available any technical knowledge, experience, skill, knowhow, or process or consist of the development and transfer of any technical plan or technical design.

 

  •     The taxpayer is accordingly not chargeable to tax in respect of entirety of its income towards uplinking and playout services.

 

Article 13 of India – UK DTAA – Where payment for use of the software is not taxable, services intricately and inextricably associated with use of software are also not taxable.

16 TSYS Card Tech Ltd vs. DCIT

[TS-36-ITAT-2023(Del)]

[ITA No: 2006/Del/2022]

A.Y.: 2019-20

Date of order: 24th January, 2023

Article 13 of India – UK DTAA – Where payment for use of the software is not taxable, services intricately and inextricably associated with use of software are also not taxable.

FACTS

The assessee, a tax resident of the UK, earned income from the sale of software licenses, provision of implementation services, enhancement services, annual maintenance services and consultancy services. The assessee relying upon provisions of the DTAA claimed income was not taxable in India.

AO taxed income as royalty and FTS under provisions of Act as also the DTAA. DRP, following decision of Supreme Court in Engineering Analysis Centre of Excellence (P) Ltd. vs. CIT [2021] 281 Taxman 19, ruled that payment for software license is not taxable in India. However, the implementation services, enhancement services, annual maintenance services and consultancy services, as per request of Indian customers, were held to be separate from software license, and were taxable under the Act and Article 13 of DTAA. It appears from the observations of the ITAT that AO and DRP merely relied upon the words “Make Available” found in the agreement with Indian customers to hold that make available clause stood satisfied under Article 13 of treaty. Being aggrieved, assessee filed an appeal to ITAT. Dispute before ITAT only related to services income earned by the assessee.

HELD

  •     Services like training and updates are in connection with utilization of the base software licenses. As software income is not taxable, training and related activities concerned with utilization and installation cannot be taxed as FTS.

 

  •     Mere use of ‘make available’ in agreement does not satisfy the requirement of Article 13(4)(c) in DTAA. Burden is on tax authorities to satisfy that requirement of make available clause are satisfied.

S.68 read with S.153A –When cash deposited post-demonetization by assessee was out of cash sales which had been accepted by Sales Tax/VAT Department and not doubted by the AO and when there was sufficient stock available with the assessee to make cash sales then the said fact was sufficient to explain the deposit of cash in the bank account and could not have been treated as undisclosed income of assessee and accordingly, impugned addition made by the AO was not justified.

63 Smt. Charu Aggarwal

[2022] 96 ITR(T) 66 (Chandigarh – Trib.)

ITA No.:310 & 311 (CHD.) OF 2021

A.Y.: 2017-18

Date of order: 25th March, 2022

S.68 read with S.153A –When cash deposited post-demonetization by assessee was out of cash sales which had been accepted by Sales Tax/VAT Department and not doubted by the AO and when there was sufficient stock available with the assessee to make cash sales then the said fact was sufficient to explain the deposit of cash in the bank account and could not have been treated as undisclosed income of assessee and accordingly, impugned addition made by the AO was not justified.

FACTS-I

The assessee was a limited liability partnership engaged in the business of resale of jewellery, diamond and other related items. A search operation was conducted in the K group of cases. Notice under section 153A was issued to the assessee and in response to the notice, the assessee filed its return of income declaring an income of Rs. 22.53 lakhs.

During the course of assessment proceedings the AO observed that the assessee had deposited Rs. 2.90 crores post-demonetization in its account and that during the course of search, books of account and sales bill books relating to the demonetization period and pre-demonetization period were verified which revealed that the assessee was maintaining its books of account in the computer of its accountant. The AO further observed that on examination of the digital data it was noticed that there were two sets of books of account, i.e., one in the computer of the accountant and another in the pen drive of the accountant. On comparison of the two accounts it was found that there was a difference in the sale figures for the month of October, 2016 as cash sales were increased in one set of books of account. The statement of the accountant was recorded during the course of search wherein he admitted that he had changed the sale figures of October, 2016 by increasing cash sales after demonetization to generate cash in hand in the books of account. The AO asked the assessee to furnish documentary evidence regarding the source of the cash deposits in its bank accounts, but did not find merit in the submission of the assessee and made an addition of Rs. 2.19 crores.

On appeal, the Commissioner (Appeals) after considering the submissions of the assessee allowed relief of Rs. 15 lakhs and sustained the addition of Rs. 2.05 crores by observing that the net profit of 1.57 per cent had been declared by the assessee in the books of account and that the profit had already been disclosed on the sales of Rs. 2.19 crores which was added by the AO.

Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

HELD-I

The Tribunal noticed that the assessee was maintaining the sales bills which were recorded in the regular books of account maintained in regular course of business by the assessee. No discrepancy was found in the quantitative details of the stock reflected in the stock register. In the instant case when there was a search at the premises of the assessee on 12th April, 2017, no discrepancy in respect of cash or stock was found which was evident from the assessment order dated 27th March, 2019 for the succeeding A.Y. 2018-19 wherein the addition of Rs. 1.02 lakhs only was made on account of difference in the stock in various items, which was negligible. The assessee was also filing regular returns with the VAT Department, copies of which were placed in the assessee’s compilation. In those VAT Returns also no difference/defect was pointed out which clearly showed that the stock available with the assessee in the form of opening stock and purchases had been accepted by the Department as well as the VAT Department. The Tribunal opined that the amount received by the assessee from the customer after selling the goods/jewellery out of the accepted stock (opening stock and purchases) cannot be considered as the income outside the books of account.

On the other hand, the Department had not brought any material on record to substantiate that the amount received by the assessee by selling the jewellery/goods out of the opening stock and the purchases was utilized elsewhere and not for depositing in the Bank account.

Furthermore, the opening stock, purchases & sales and closing stock declared by the assessee has not been doubted. The sales were made by the assessee out of the opening stock and purchases and the resultant closing stock has been accepted. The sales had not been disturbed either by the AO or by the sales tax/VAT Department and even there was no difference in the quantum figures of the stock at the time of search on 12th April, 2017. Therefore, the sales made by the assessee out of the existing stock were sufficient to explain the deposit of cash (obtained from realization of the sales) in the bank account and cannot be treated as undisclosed income of the assessee.

Accordingly, the impugned addition made by the AO and sustained by the Commissioner (Appeals) was not justified and therefore the same is liable to be deleted.

S.142A –When difference between valuation shown by the assessee and estimated by DVO was less than 10 per cent then the AO was not justified in substantiating the valuation determined by DVO in respect of cost shown by the assessee.

FACTS-II

During the course of assessment proceeding the AO confronted the assessee with the difference in the cost of construction of showroom as estimated by the departmental valuer and as shown by the assessee in the books of account. The AO came to conclusion that there was a difference in the valuation to the tune of Rs. 18.72 lakhs and accordingly made an addition of 7.97 lakhs in the hands of the assessee and the remaining addition of Rs. 10.75 lakhs in the hands of the other co-owner.

On appeal, the Commissioner (Appeals) sustained the addition made by the Assessing Officer.

Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

HELD-II

It was submitted by the assessee that he had asked for the benefit of 10 to 15 per cent on account of self-supervision but the valuation officer had given a benefit of only 3.75 per cent and even the valuation officer applied the Central Public Works Department (CPWD) rates instead of local Public Works Department (PWD) rates. The CPWD rates were higher than the PWD rates. The contention of the assessee was based on a well settled principle of law that in the place of the CPWD rates, the local PWD rates were to be applied and adopted to determine the cost of construction which was pronounced by the Apex Court in the case of CIT vs. Sunita Mansingha [2017] 393 ITR 121.

Accordingly, the Tribunal, keeping in view the ratio laid down by the Apex Court in the aforesaid case, observed that the Valuation Officer ought to have applied the local PWD rates instead of CPWD rates which were on the higher side.

Further, it was also observed that on the similar issue, various Benches of the Tribunal have taken a consistent view that when the difference in valuation shown by the assessee and estimated by the DVO is less than 10 per cent then the AO was not justified in substantiating the valuation determined by the DVO in respect of cost shown by the assessee.

Consequently, it was held that the impugned addition made by the AO and sustained by the Commissioner (Appeals) on account of difference in the valuation as determined by the DVO and shown by the assessee in its regular books of account was liable to be deleted.

S.10(38) –Where the assessee furnished all details to the AO with regards to long term capital gain arising from sale of shares on which securities transaction tax was paid, the the AO cannot deny exemption claimed under section 10(38) in respect of the said long term capital gain.

62 Mukesh Nanubhai Desai vs. ACIT
[2022] 96 ITR(T) 258 (Surat – Trib.)
ITA No.:781 (SRT) OF 2018
A.Y.: 2012-13
Date of order: 6th May, 2021

S.10(38) –Where the assessee furnished all details to the AO with regards to long term capital gain arising from sale of shares on which securities transaction tax was paid, the the AO cannot deny exemption claimed under section 10(38) in respect of the said long term capital gain.

FACTS-I

During the year under consideration, the assessee being an individual earned long term capital gain from sale of shares on which securities transaction tax was paid by him and claimed it as exempt under section 10(38). During the course of the assessment proceedings, the exemption was denied and the long-term capital gain was added to the total income of the assessee.

During the course of the first appellant proceedings, the AO furnished his remand report stating therein that contract notice/ledger accounts furnished by the assessee though matched with the data furnished by the stock exchange, it was however discovered that the directors of the broker companies, through whom the assessee undertook transaction of sale of shares, were banned by SEBI for market manipulation. Therefore, the AO derived a conclusion that the said companies did not have potential that the assessee could earn enormous capital gain.

On the basis of the same, the Commissioner (Appeals) held that although the basis for making the addition did not survive but there was a probability that allotment of shares and their eventual sale was a pre-planned scheme to convert unaccounted income into exempt income and accordingly the additions made by the AO were upheld. Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

HELD-I

The assessee contended that he had, during the course of the assessment proceedings as well as first appellate proceedings furnished all the documentary evidences in support of his claim of exemption such as books of accounts showing the credit of sale considerations of shares and details of various scrips of the shares with their date of purchase and its sales. It was also stated by the assessee that the purchase of the shares was accepted in the assessment completed for earlier years under section 143(3).

Despite production of documentary evidences by the assessee, the AO denied the exemption claimed under section 10(38) on the grounds that the Director of one of the broker companies was banned from trading by SEBI for market manipulation during the Initial Public Offer. The AO also stated that the director of the other broker company was also banned from trading by SEBI for market manipulation through artificially increasing the sale price and concluded that both the companies were not having potential so as to allow the assessee to earn enormous capital gain.

It was observed by the Tribunal that once it is accepted by the AO in his remand report that all the transactions of the assessee reflected in the contract notice/ledger accounts furnished by the assessee are matching with the data furnished by the stock exchange and the Commissioner (Appeals) had also taken a view that the basis for making addition did not survive, then addition cannot be sustained.

Further, in respect of the allegations of the AO with regard to ban from trading imposed upon the directors of the broker companies, the Tribunal had observed that the assessee had purchased shares much prior to the orders of SEBI. Accordingly, there was no live link between the order of the SEBI and the transactions by way of sale of shares undertaken by the assessee. Such an order of SEBI cannot be read against the assessee in the absence of anti-corroborative evidence.

Accordingly, the addition of long-term capital gain made to the total income of the assessee was deleted by the Tribunal.

S.10(2A) – Where assessee had furnished complete details of firm, details of partners with their PAN, copy of returns of firm with computation of income then assessee could not be denied exemption claimed under section 10(2A) in respect of income by way of share of profit received from firm.

FACTS-II

The assessee was a partner in a firm. He had received certain amount of income as remuneration, interest and share of profit from firm. The assessee had claimed exemption in respect of share of profit received from the firm under section 10(2A).The AO clubbed this exempt income with the LTCG and denied exemption in respect of the share of profit received from firm. On appeal, the Commissioner (Appeals) also upheld the same.
Aggrieved by the order of CIT(A), the assessee filed further appeal before the ITAT.

HELD-II

The assessee submitted that in the computation of income he had claimed exemption under section 10(2A) in respect of income by way of share of profit received from firm.

The Tribunal observed that the AO instead of examining the facts and the evidences furnished by the assessee, clubbed this income with the exempt long term capital gain claimed by the assessee. The Commissioner (Appeals) also upheld the action of the AO.

The Tribunal noted that the income by way of share of profit received from the firm is separate and independent income component earned by the assessee which is claimed as exempt under section 10(2A).

The Tribunal held that the AO ought to have examined the documentary evidences furnished by the assessee in support of his claim for exemption such as return of income of firm, details of partners, and their PAN. If the AO would have examined these evidences then the exemption under section 10(2A) would not have been denied.

Accordingly, the addition made to the total income of the assessee to the extent of income by way of share of profit received from firm stands deleted.

Income — Capital or revenue receipt — Race club — Membership fees received from members — Capital receipt

82 Principal CIT vs. Royal Western India Turf Club Ltd

[2023] 450 ITR 707 (Bom)

A. Y. 2009-10

Date of order: 22nd December, 2021

Section 4 of ITA 1961

Income — Capital or revenue receipt — Race club — Membership fees received from members — Capital receipt

 

The assessee ran a race course. It received membership fees from its members. For the A. Y. 2009-10, the AO disallowed the amount credited by the assessee as general reserve and claimed to be capital receipt, by treating it as revenue receipt.

The Commissioner (Appeals) held it to be capital receipt. The Tribunal held that from the date of incorporation of the assessee in the year 1925 onwards, the entrance fees received from the members of the assessee were treated as capital in nature and majority of these orders were passed under section 143(3) of the Income-tax Act, 1961 and relying on the judgment in CIT vs. Diners Business Services Pvt Ltd [2003] 263 ITR 1 (Bom) held that any sum paid by a member to acquire the rights of a club was a capital receipt.

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

“The Tribunal had not committed any perversity or applied incorrect principles to the given facts and when the facts and circumstances were properly analysed and correct test was applied to decide the issue at hand, no question of law arose.”

Conditional Gifts Vs. Senior Citizens Act

INTRODUCTION

A gift is a transfer of property, movable or immovable, made voluntarily and without any consideration from a donor to a donee. This feature, in the past, has examined whether a gift which has been made, can be taken back by the donor? In other words, can a gift be revoked? There have been several instances where parents have gifted their house to their children and then the children have either not taken care of their parents or ill-treated them. In such cases, the parents wonder whether they can take back the gift on grounds of ill-treatment? The position in this respect is not so simple and the law is clear on when a gift can be revoked. Recently, the Supreme Court faced an interesting issue of whether a gift made by a senior citizen can be revoked by having resort to the Maintenance and Welfare of Parents and Senior Citizens Act, 2007 (“Senior Citizens Act”)?

LAW ON GIFTS

The Transfer of Property Act, 1882 (‘the Act’) deals with gifts of property, both immovable and movable. Section122 of the Act defines a gift as the transfer of certain existing movable or immovable property made voluntarily and without consideration, by a donor, to a donee. The gift must be accepted by or on behalf of the donee during the lifetime of the donor and while he is still capable of giving. If the donee dies before acceptance, then the gift is void. In Asokan vs. Lakshmikutty, CA 5942/2007 (SC), the Supreme Court held that in order to constitute a valid gift, acceptance thereof is essential. The Act does not prescribe any particular mode of acceptance. It is the circumstances of the transaction which would be relevant for determining the question. There may be various means to prove acceptance of a gift. The gift may be handed over to a donee, which in a given situation may also amount to a valid acceptance. The fact that possession had been given to the donee also raises a presumption of acceptance.

This section is also clear that it applies to gifts of movable properties also. A gift is also a transfer of property and hence, all the provisions pertaining to transfer of property under the Act are applicable to it. Further, the absence of consideration is the hall mark of a gift. What is consideration has not been defined under this Act, and hence, one would have to refer to the Indian Contract Act, 1872. Section 2(d) of that Act defines ‘consideration’ as follows: ~ “when, at the desire of one person, the other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise.”

HOW ARE GIFTS TO BE MADE?

Section 123 of the Act answers this question in two parts. The first part deals with gifts of immovable property while the second part deals with gifts of movable property. Insofar as the gifts of immovable property are concerned, section 123 makes transfer by a registered instrument mandatory. This is evident from the use of word “transfer must be effected”. However, the second part of section 123 dealing with gifts of movable property, simply requires that gift of movable property may be effected either by a registered instrument signed as aforesaid or “by delivery”. The difference in the two provisions lies in the fact that in so far as the transfer of movable property by way of gift is concerned the same can be effected by a registered instrument or by delivery. Such transfer in the case of immovable property requires a registered instrument but the provision does not make delivery of possession of the immovable property gifted as an additional requirement for the gift to be valid and effective. This view has been upheld by the Supreme Court in Renikuntla Rajamma (D) By Lr vs. K.Sarwanamma (2014) 9 SCC 456.

CONDITIONAL GIFTS

In Narmadaben Maganlal Thakker vs. Pranjivandas Maganlal Thakker, (1997) 2 SCC 255 a conditional gift of an immovable property was made by the donor without delivering possession and there was no acceptance of the gift by the donee. There was no absolute transfer of ownership by the donor in favor of the donee. The gift deed conferred only limited right upon the donee and was to become operative after the death of the donor. The donor permanently reserved his rights to collect the mesne profit of the property throughout his lifetime. After the gift deed was executed, the donee violated certain conditions under the deed. Hence, the Supreme Court held that the donor had executed a conditional gift deed and retained the possession and enjoyment of the property during his lifetime. Since the donee did not satisfy the conditions of the gift deed, the gift was void.

In K. Balakrishnan vs. K Kamalam, (2004) 1 SCC 581 the donor gifted her share in land and a school building. However, the gift deed provided that the management of the school and income from the property remained with the donor during her lifetime and thereafter would be vested in the donee. The Supreme Court upheld the gift without possession and held that it was open to the donor to transfer by gift title and ownership in the property and at the same time reserve its possession and enjoyment to herself during her lifetime. There is no prohibition in law that ownership in a property cannot be gifted without its possession and right of enjoyment. It examined section 6(d) of the Transfer of Property Act, 1882 which states that an interest in property restricted in its enjoyment to the owner personally cannot be transferred by him. However, the Supreme Court held that Clause (d) of section 6 was not attracted to the terms of the gift deed being considered by the Court because it was not merely an interest in a property, the enjoyment of which was restricted to the owner personally. The donor, in this case, was the absolute owner of the property gifted and the subject matter of the gift was not an interest restricted in its enjoyment to herself. The Court held that the gift deed was valid even though the donor had reserved to herself the possession and enjoyment of the property gifted.

However, the Larger Bench of the Supreme Court settled the above issue by the decision in the case of Renikuntla Rajamma vs. K. Sarwanamma, (2014) 9 SCC 445. In this case, the donor made a gift of an immovable property by way of a registered gift deed, which was duly attested. However, the donor retained the possession of the gifted property for enjoyment during her life time, and also the right to receive the rents of the property. The question before the Court was that since the donor had retained the right to use the property and receive rents during her life time, whether such a reservation or retention or absence of possession rendered the gift invalid?

The Supreme Court upheld the validity of the gift. It held that a conjoint reading of sections 122 and 123 of the Transfer of Property, 1882 Act made it abundantly clear that “transfer of possession” of the property covered by the registered instrument of the gift duly signed by the donor and attested as required, was not a sine qua non for the making of a valid gift under the provisions of the Transfer of Property Act, 1882. Section 123 has overruled the erstwhile requirement under the Hindu Law/Buddhist Law of delivery of possession as a condition for making of a valid gift. Transfer by the way of gift of immovable property requires a registered instrument but the provision does not make delivery of possession of the immovable property gifted as an additional requirement for the gift to be valid and effective. Absence of any such requirement led the Court to conclude that the delivery of possession was not essential for a valid gift in the case of immovable property. The Court also distinguished on facts, its earlier decision in the case of Narmadaben Maganlal Thakker. It held that in that case, the issue was of a conditional gift whereas the current case dealt with an absolute gift. It accepted the ratio laid down in the latter case of K. Balakrishnan. Thus, the Supreme Court established an important principle of law that a donor can retain possession and enjoyment of a gifted property during his lifetime and provide that the donee would be in a position to enjoy the same after the donor’s lifetime.

REVOCATION OF GIFTS

Section 126 of the Act provides that a gift may be revoked in certain circumstances. The donor and the donee may agree that on the happening of certain specified event that does not depend on the will of the donor, the gift shall be revoked. Further, it is necessary that the condition should be expressed and specified at the time of making the gift. A condition cannot be imposed subsequent to giving the gift. In Asokan vs. Lakshmikutty, supra, the Supreme Court held that once a gift is complete, the same cannot be rescinded. For any reason whatsoever, the subsequent conduct of a donee cannot be a ground for rescission of a valid gift.

However, it is necessary that the event for revocation is not dependent upon the wishes of the donor. Thus, revocation cannot be on the mere whims and fancies of the donor. For instance, after gifting, the donor cannot say that he made a mistake, and now he has a change of mind and wants to revoke the gift. A gift is a completed contract and hence, unless there are specific conditions precedent which have been expressly specified there cannot be a revocation. It is quite interesting to note that while a gift is a completed contract, there cannot be a contract for making a gift since it would be void for absence of consideration. For instance, a donor cannot enter into an agreement with a donee under which he agrees to make a gift but he can execute a gift deed stating that he has made a gift. The distinction is indeed fine! It needs to be noted that a gift which has been obtained by fraud, misrepresentation, coercion, duress, etc., would not be a gift since it is not a contract at all. It is void ab initio.

DECISIONS ON THIS ISSUE

In Jagmeet Kaur Pannu, Jammu vs. Ranjit Kaur Pannu AIR 2016 P&H 210, the Punjab & Haryana High Court considered whether a mother could revoke a gift of her house in favor of her daughter on the grounds of misbehaviour and abusive language. The mother had filed a petition with the Tribunal under the Maintenance and Welfare of Parents and Senior Citizens Act, 2007 which had set aside the gift deed executed by the mother. It held that the deed was voidable at the mother’s instance. The daughter appealed to the High Court which set aside the Tribunal’s Order. The High Court considered the gift deed which stated that the gift was made voluntarily, without any pressure and out of natural love and affection which the mother bore towards the daughter. There were no preconditions attached to the gift. The High Court held that the provisions of s.126 of the Act would apply since this was an important provision which laid down a rule of public policy that a person who transferred a right to the property could not set down his own volition as a basis for his revocation. If there was any condition allowing for a document to be revoked or cancelled at the donor’s own will, then that condition would be treated as void. The Court held that there have been decisions of several courts which have held that if a gift deed was clear and operated to transfer the right of property to another but it also contained an expression of desire by the donor that the donee will maintain the donor, then such an expression in the gift deed must be treated as a pious wish of the donor and the sheer fact that the donee did not fulfil the condition could not vitiate the gift.

Again, in the case of Syamala Raja Kumari vs. Alla Seetharavamma 2017 AIR (Hyd) 86 a similar issue before the High Court was whether a gift which was made without any preconditions could be subsequently revoked? The donor executed a gift deed in favor of his daughters out of love and affection. He retained a life interest benefit and after him, his wife retained a life interest under the said document. However, there were no conditions imposed by the donor for gifting the property in favor of the donees. All it mentioned was that he and his wife would have a life-interest benefit. Subsequently, the donor executed a revocation deed stating that he wanted to cancel the gift since his daughters were not taking care of him and his wife, and were not even visiting them. The Court set aside the revocation of the gift. It held that once a valid unconditional gift was given by the donor and accepted by donees, the same could not be revoked for any reason. The Court held that the donees would get absolute rights in respect of the property. By executing the gift deed, the donor had divested his right in the property and now he could not unilaterally execute any revocation deed for revoking the gift deed executed by him in favor of the plaintiffs.

Similarly, in the case of Sheel Arora vs. Madan Mohan Bajaj, 2007 (6) BomCR 633, the donor executed a registered gift deed of a flat in favor of a donee. Subsequently, the donor unilaterally executed a revocation deed cancelling the gift. The Bombay High Court held that after lodging the duly executed gift deed for registration, there was an unilateral attempt on the part of the donor to revoke the said gift deed. Section 126 of the Act, provides that revocation of gift can be only in cases specified under the section and the same requires participation of the donee. In the case in hand, there was no participation of the donee in an effort on the part of the donor to revoke the said gift deed. On the contrary, an unilateral effort on the part of the donor by execution of a deed of revocation itself disclosed that the donor had clearly accepted the legal consequences which were to follow on account of execution of a valid gift deed, and presentation of the same for registration.

However, in the case of S. Sarojini Amma vs. Velayudhan Pillai Sreekumar 2018 (14) SCALE 339, the Supreme Court considered a gift, where in expectation that the donee would look after the donor and her husband, she executed a gift deed. The gift deed clearly stated that, gift would take effect after the death of the donor and her husband. Subsequently, the donor filed a Deed of Cancellation of the Gift Deed. The Supreme Court observed that a conditional gift became complete on the compliance of the conditions mentioned in the deed. Hence, it allowed the revocation.

CANCELLATION VS. SENIOR CITIZENS ACT

Recently, the Supreme Court in the case of Sudesh Chhikara vs. Ramti Devi, Civil Appeal No. 174 of 2021; Order dated 6th December, 2022 was faced with a very interesting issue as to whether a senior citizen can cancel a gift of lands made to her children on grounds that their relationship was strained. Accordingly, she filed a petition under section 23 of the Senior Citizens Act for the cancellation of the gift. The Maintenance Tribunal constituted under the Act (which adjudicates all matters for maintenance, including provision for food, clothing, residence and medical attendance and treatment) upheld the cancellation on the grounds that her children were not taking care of her.

Section 23 of this Act contains an interesting provision. If any senior citizen has transferred by way of gift or otherwise, his property, on the condition that the transferee shall provide the basic amenities and basic physical needs to the transferor and such transferee refuses or fails to provide such amenities and physical needs, then the transfer of property shall be deemed to have been made by fraud or coercion or under undue influence and shall at the option of the transferor be declared void by the Tribunal. This negates every conditional transfer if the conditions subsequent are not fulfilled by the transferee. Property has been defined under the Act to include any right or interest in any property, whether movable/immovable, ancestral/self-acquired, tangible/intangible.

The Supreme Court in Sudesh Chhikara (supra) held that the Senior Citizens Act was enacted for making effective provisions for the maintenance and welfare of parents and senior citizens guaranteed and recognized under the Constitution of India. The Maintenance Tribunal was established to exercise various powers under this Act. This Act provided that the Maintenance Tribunal, had to adopt such summary procedure while holding inquiry, as it deemed fit. The Court held that the Tribunal exercised important jurisdiction under Section 23 of the Senior Citizens Act and for attracting Section 23, the following two conditions must be fulfilled:

a)    The transfer must have been made subject to the condition that the donee / transferee shall provide the basic amenities and basic physical needs to the senior citizen transferor; and

b)    the transferee refuses or fails to provide such amenities and physical needs to the transferor.

The Apex Court concluded that if both the aforesaid conditions are satisfied, the transfer shall be deemed to have been made by fraud or coercion or undue influence. Such a transfer then became voidable at the instance of the transferor and the Maintenance Tribunal has the jurisdiction to declare the transfer as void.

The Court held that when a senior citizen parted with his property by executing a gift deed / release deed in favor of his relatives, the senior citizen does not make it conditional to taking care of him. On the contrary, very often, such transfers were made out of natural love and affection without any expectations in return. Therefore, the Court laid down an important proposition that when it was alleged that the conditions mentioned in section 23 were attached to a transfer, existence of a conditional gift deed must be clearly brought out before the Maintenance Tribunal. If a gift was to be set aside under section 23, it was essential that a conditional gift deed / release deed was executed, and in the absence of any such conditions, section 23 could not be attracted. A transfer subject to a condition of providing the basic amenities and basic physical needs of the senior citizen transferor was a sine qua non (essential condition) for applicability of section 23. Since in this case, there was no such conditional deed, the Apex Court did not set aside the release deed executed by the senior citizen.

CONCLUSION

Donor beware of how you gift, for gift once given cannot be easily revoked! If there are any doubts or concerns in the mind of the donor then he should refrain from making an absolute unconditional gift or consider whether to avoid the gift at all! This is all the more true in the case of old parents who gift away their family homes and then try to claim the same back since they are being ill-treated by their children. They should be forewarned that it would not be easy to revoke such a gift. Remember a non-conditional gift / release is like a bullet which once fired cannot be recalled!!

Assessment order passed in the name of non-existing entity is null and void ab initio. The decision of SC in Mahagun Realtors (P.) Ltd cannot be interpreted to mean that even in a case where factum of amalgamation was put to the notice of the AO, still the assessment made in the name of amalgamating company i.e. non-existing company is valid in law.

61 DCIT vs. Barclays Global Service Centre Pvt Ltd (formerly Barclays Shared Services Pvt Ltd)

[TS-29-ITAT-2023(PUN)]

A.Y.: 2014-15

Date of Order: 2nd January, 2023

Assessment order passed in the name of non-existing entity is null and void ab initio. The decision of SC in Mahagun Realtors (P.) Ltd cannot be interpreted to mean that even in a case where factum of amalgamation was put to the notice of the AO, still the assessment made in the name of amalgamating company i.e. non-existing company is valid in law.

FACTS

The assessee company, engaged in the business of providing Information Technology Enabled Services (ITES) to Barclays Bank PIc, United Kingdom (BBPLC) and its affiliates, filed its return of income for the A.Y. 2014-15 declaring a total income of Rs. 1,13,02,89,902 after claiming deduction under section 10AA of the Income-tax Act, 1961 (‘the Act’). The appellant company also reported international transactions entered with its AEs. On noticing the international transactions, the AO referred the matter to the Transfer Pricing Officer (‘TPO’) for the purpose of benchmarking the international transactions. The TPO vide order dated 30th October, 2017 suggested the TP adjustment of Rs. 95,88,72,618/-. On receipt of the draft assessment order, the appellant had not chosen to file objection before the DRP and the final assessment order dated 20th March, 2018 was passed by the AO after making disallowance of the excess deduction claimed under section 10AA amounting to Rs. 8,92,33,721.

Aggrieved, assessee preferred an appeal to CIT(A) where it interalia contended that the assessment is null and void as the assessment order is passed in the name of non-existing entity i.e. M/s Barclays Shared Services Pvt Ltd instead of Barclays Global Service Centre Pvt Ltd. The CIT(A) had dismissed the said ground i.e. challenging the very validity of the assessment on the grounds that when the notice under section 143(2) was issued, the amalgamating company was very much in existence. On merits, the issue was decided partly in favour of the assessee.

Aggrieved, by the relief granted on merits, the revenue preferred an appeal to the Tribunal and assessee filed cross objections being aggrieved by the validity of the assessment made in the name of amalgamating company i.e. M/s Barclays Shared Services Pvt Ltd which was a non-existing entity.

HELD

The Tribunal noted that the assessee company Barclays Shared Services Pvt Ltd was amalgamated with Barclays Technology Centre India Pvt Ltd vide order dated 2nd November, 2017 passed by NCLT. The appointed date for amalgamation was 1st April, 2017 but became effective only on filing of Form INC-28 along with prescribed fee before the Registrar of Companies. The return of income was filed in the name of amalgamating company as the process of amalgamation was not complete. During the course of assessment proceedings under consideration, the assessee company had brought to notice of the AO that the fact of amalgamation vide letter dated 15th December, 2017 along with copies of the amalgamation scheme dated 26th December, 2017. In-spite of this, the AO passed the assessment order in the name of amalgamating company.

The Tribunal observed that the issue that arises for its consideration is whether or not an assessment order passed in the name of amalgamating company i.e. non-existing company, is valid in the eyes of law. Despite knowing very well that the amalgamating company was not in existence at the time of passing the assessment order, still the AO had chosen to pass an assessment order in the name of the amalgamating company i.e. Barclays Shared Services Pvt Ltd.

The Tribunal held that the ratio that can be discerned from the decision of the Supreme Court in PCIT vs. Maruti Suzuki India Ltd. [416 ITR 613 (SC)] is that consequent upon the amalgamation, the amalgamating company ceases to exist, therefore, it cannot be regarded as a “person”. The assessment proceedings against an entity which had ceased to exist were void ab initio. The fact that the assessee had participated in the assessment proceedings cannot operate as an estoppel against law.

The Tribunal also noted the ratio of the decision of the Jurisdictional High Court in the case of Teleperformance Global Services Pvt. Ltd. vs. ACIT [435 ITR 725 (Bom.)]; Alok Knit Exports Ltd. vs. DCIT [446 ITR 748 (Bombay)] and Vahanvati Consultants (P.) Ltd. vs. ACIT [448 ITR 258 (Bom.)].

The Tribunal having noted that the decision of the Apex Court in PCIT vs. Mahagun Realtors (P.) Ltd. [443 ITR 194 (SC)] was rendered in the peculiar facts of that case held that this decision is not an authority of proposition, that an assessment can be made in the name of non-existing entity, even though the AO was put on notice of factum of amalgamation.

In the present case, since the fact of amalgamation was brought to the notice of the AO, the ratio of the decision of the Apex Court in Mahagun Realtors (P) Ltd. will not apply. Therefore, the Tribunal held the assessment order passed by the AO in the name of non-existing entity to be null and void ab initio and quashed the assessment order. Cross objections filed by the assessee were allowed.

Where the assessee mentioned residential status in original return as resident in India and in return filed under section 153A mentioned residential status as Non-resident which was uncontroverted fact, then merely mentioning the residential status as resident in original return of income, does not make the assessee a resident in India. Once the assessee is a non-resident then income or deposit in foreign bank account is not taxable in India

60 Ananya Ajay Mittal vs. DCIT

ITA Nos. 6949 & 6950/Mum/2019 and

576/Mum/2021

A.Ys: 2010-11 to 2012-13

Date of Order: 29th December, 2022

Where the assessee mentioned residential status in original return as resident in India and in return filed under section 153A mentioned residential status as Non-resident which was uncontroverted fact, then merely mentioning the residential status as resident in original return of income, does not make the assessee a resident in India.

Once the assessee is a non-resident then income or deposit in foreign bank account is not taxable in India

FACTS

The assessee in previous year relevant to A.Y. 2008-09 went to the US for studies. A search and seizure action was carried out in the case of the assessee’s father when during the course of search certain documents containing details of foreign bank account of Ananya Mittal. This foreign bank account was not declared by the assessee in the return of the income filed by him. In the course of post search assessment proceedings it was submitted by the assessee before the AO that the assessee was in the US for his post-graduation was to stay in there for four years. As a student pursuing studies in the US, it was mandatory for him to open a bank account in the country. All expenses of the assessee in USA were exclusively borne by a family friend of Mittal family, Dr. Prakash Sampath based in the USA. The assessee being a non-resident has not maintained records of his foreign bank account.

The AO held that the contention that assessee is a non-resident is an after thought since in the original return of income residential status has been stated as `resident’. It is only that this foreign bank account has been detected in the course of search that the assessee in the return of income filed in response to notice issued under section 153A has stated the residential status to be non-resident. However, the AO in the assessment order did mention the number of days the assessee was outside India. The AO taxed the entire credit of Rs.3,20,133 reflected in foreign bank account u/s 68 by holding that gift from family friend did not fall under section 56(2)(v) of the Act.

Aggrieved, the assessee preferred an appeal to CIT(A) confirmed the action of the AO on the grounds that the assessee had not explained the source of deposits in foreign bank account which was unearthed during the course of search and details of which were obtained by AO through Foreign Tax and Tax Research (FTTR).

Aggrieved, the assessee preferred an appeal to the Tribunal. The Tribunal decided the appeal of the assessee for A.Y. 2010-11 and 2011-12 vide order dated 23rd March, 2022 wherein additions made on certain credits in foreign bank account were confirmed. The assessee filed Miscellaneous Application (MA) and pointed out that an important fact that the assessee is a non-resident and therefore no addition could have been made has been omitted to be considered. The Tribunal recalled the earlier order.

HELD

The Tribunal noted that before CIT(A) the issue that assessee was a non-resident was specifically raised and CIT(A) has not refuted this submission of the assessee. The Tribunal also noted that the assessee was a non-resident which fact has not been refuted by either of the lower authorities. The Tribunal held that merely mentioning the status as resident in the original return of income does not make the assessee a resident in India. The present assessment was under section 153A of the Act and the assessee had in the return filed in response to notice issued under section 153A mentioned the residential status as non-resident. The AO in the assessment order has also stated the status to be non-resident. Therefore, this cannot be a ground for treating the assessee as a resident. Once the assessee is non-resident, then income or deposit in the foreign bank account of the assessee who is not resident in India cannot be taxed in India. Therefore, on this ground the entire additions cannot be sustained.

This ground of appeal filed by the assessee was allowed.

Qualification in A Limited Review Report Regarding Non-Compliance of Ind As 115 (Revenue From Contracts With Customers)

Emphasis of Matter/s for allegations made by a short seller on the company and
some other group entities and other matters

EKI ENERGY SERVICES LTD
(PERIOD ENDED 31ST DECEMBER, 2022)

From Limited Review Report

Qualified Opinion

As detailed in Note 3 to the accompanying Statement, we report that the Company has recognized revenue from contracts with few customers during the quarters ended 31st December, 2022, 30th September, 2022 and nine-month period ended 31st December, 2022. However, based on our review, we could not obtain sufficient and appropriate evidence regarding satisfaction of performance obligation for delivering the verified carbon units. Accordingly, in our view recognition of revenues together with the corresponding cost to fulfil the performance obligations is not consistent with the accounting principles as stated in Ind AS 115, Revenue from Contracts with Customers. Had the Company applied the principles as stated in Ind AS 115, revenues would have been lower by Rs. 1,818 lakhs, Rs. 10,162 lakhs and Rs. 19,011 lakhs, cost would have been lower by Rs. 1,140 lakhs, Rs. 3,950 lakhs and Rs. 7,971 lakhs and the profit before tax would have been lower by Rs. 679 lakhs, Rs. 6,212 lakhs and Rs. 11,040 lakhs for the periods stated above.

FROM NOTES TO RESULTS

The management entered into a few contracts with customers wherein the company agreed to deliver consultancy services and Verified Carbon Units. The management is of the opinion that it has duly satisfied the performance obligations under these arrangements and has accrued corresponding revenue and cost in accordance with the terms of the contract. However, in the opinion of the statutory auditors as referred in their review report, the following items of the standalone financial results would have been lower as summarized below. The management shall evaluate the statutory auditor qualification further and take necessary steps to resolve them.

Particulars Quarter ended
(in Rs.)		 Nine months ended (in Rs.)
31.12.2022 30.09.2022 31.12.2022
Revenue from operations 1,818.29 10,162.00 19,011.06
Purchase of stock in trade 1139.62 3950.22 7971.13
Profit after tax 498.78 4650.11 8251.44
Impact on EPS
Basic (Rs. In absolute) 1.81 16.91 30.01
Diluted (Rs. In absolute) 1.80 16.82 29.84

ADANI ENTERPRISES LTD (PERIOD ENDED 31ST DECEMBER, 2022) (CONSOLIDATED FINANCIAL RESULTS)

From Limited Review Report

Emphasis of Matter

We draw attention to Note 6 to the unaudited consolidated financial results, with respect to allegations made by a short seller on the Company and some other entities of the Adani Group companies which has been refuted by the management of the Adani Group. The Management of the company has internally assessed the impact of such allegations made and has represented to us that there is no material impact on the financial position and performance of the company for the quarter and nine months ended 31st December, 2022. Our conclusion on the statement is not modified in respect of the above matter.

We draw attention to the fact that certain of the subsidiary companies are incurring losses in continuous over past several years and have a negative net current asset position. However, the accounts of such subsidiary companies have been prepared on a going concern basis financial support provided by the Parent and other fellow subsidiaries within the Group. The above does not have material financial impact on the financial position of the Group as whole.

We further draw attention to Note 9 of the accompanied Unaudited Consolidated Financial Results. There are certain investigations and enquiries which are pending with regards to one of the subsidiaries of the Group. The Management of the said subsidiary has not received any chargesheet filed in this particular case. The financial implication if any, is not known pending investigation. The component auditors of this subsidiary have issued a modified view conclusion in this matter.
Auditors of other subsidiary included in the Statements have inserted an Emphasis of Matter paragraph in their Review Report stating that management of the particular company is of the opinion that the facility fees paid to Yes Bank Limited including Stamp Duty will be recovered.

From Notes to Results

Note 6

Subsequent to the quarter ended 31st December, 2022, a short seller has issued a report, alleging certain issues against some of the Adani Group entities which have been refuted by the company in its detailed resport submitted to the stock exchanges on 29th January, 2023. The management of the company has assessed that no material financial adjustment arises to the standalone financial results for the quarter and nine months ended 31st December, 2022 with respect to these allegations.

Note 9

Certain investigations and enquiries have been initiated by the Central Bureau of Investigation, the Enforcement Directorate and the Ministry of Corporate Affairs against one of its acquired stepdown subsidiary Mumbai International Airport Ltd (MIAL), its holding company GVK Airport Holdings Ltd and the erstwhile promoter director of MIAL for the period prior to 27th June, 2020. The CBI has filed a chargesheet during the hearing at Juridisctional Magistrate Court. However, MIAL or its officials have neither received summons nor the chargesheet filed, and the management of MIAL is in the process of obtaining the same. Considering the pendency of these proceedings, the resultant financial or other implications if any, would be known and considered upon receipt of the charge sheet on MIAL’s evaluation of the charges, facts, and circumstances.

ADANI PORTS AND SPECIAL ECONOMIC ZONE LTD (PERIOD ENDED 31ST DECEMBER, 2022)

From Limited Review Report

Emphasis of Matter

We draw your attention to Note 17 to the Statement where Management has provided its assessment of the impact of the allegations made in the report of short-seller issued post the reporting date in the standalone financial results for the quarter and nine months ended December 31, 2022.

We draw attention to Note 6 to the Statement, which describes the matter relating to delay in achievement of scheduled commercial operation date (COD i.e. December 03, 2019, as stipulated under the concession agreement) of the international deep-water multipurpose seaport being constructed by Adani Vizhinjin Port Pvt Ltd (AVPPL) at Vizhinjam, Kerala (the Project). The matter has been referred to arbitration proceedings by AVPPL to resolve disputes relating to force majeure events and failure of the Authority of the concession to fulfil its obligations under the concession agreement, which AVPPL contends, contributed to the delay in achieving COD. Based on an evaluation of the evidence supported by legal advice obtained by AVPPL, no provision has been made in this regard by the Group.

From Notes to Results

Note 17

Subsequent to the quarter ended 31st December, 2022, a short seller has issued a research report, alleging certain issues against some of the Adani promoted entities which have been refuted . The management has assessed that no financial adjustments arise to the financial results of the company for the quarter and nine months ended 31st December, 2022 with respect to these allegations, The management will further evaluate an independent assessment of the matter, if required.

Note 6

Adani Vizhinjam Port Pvt Ltd (AVPPL), a wholly owned subsidiary of the company was awarded the Concession Agreement (CA) dated 17th August, 2015 by the Government of Kerala for development of Vizhinjam International Deepwater Multipurpose Seaport (Project). In terms of the CA, the scheduled Commercial Operation Date (COD) of the project was 3rd December,2019, extendable to 30th August, 2020 with certain conditions. As at reporting date, the project development is still in progress although COD is past due in terms of CA. In respect of delay in COD, AVPPL has made several representations to Vizhinjam International Sea Port Ltd and the Department of Ports, Government of Kerala in respect to difficulties face by AVPPL including reasons attributable to the Government authorities and Force Majeure events such as Ockhi Cyclone, high waves, National Green Tribunal Order and COVID 19 pandemic etc. which led to delay in development of the project and AVPPL not achieving COD.

As on 31st December, 2022, resolution of the disputes with the VISL/ Government authorities and the arbitration proceedings is still in progress. The Government authorities continue to have the right to take certain adverse action including termination of the Concession Agreement and levying liquidated damages at a rate of 0.1 per cent of the amount of performance security for each day of delay in project completion in terms of the CA.

The management represents that the project development is in progress with revised timelines which has to be agreed with the authorities. AVPPL’s management represents that it is committed to develop the project and has tied up additional equity and debt funds and also received extension in validity of the environmental clearance from the Government for completion of the project. Based on the above developments and on the basis of favorable legal opinion from the external legal counsel in respect of likely outcome of the arbitration proceedings, the management believes it is not likely to have significant financial impact on account of the disputes which are required to be considered for the purpose of these financial results.

ADANI POWER LTD (PERIOD ENDED 31ST DECEMBER, 2022)

From Limited Review Report

Emphasis of Matter

We draw attention to Note 20 to the unaudited consolidated financial results, relating to allegations made by a short seller report on matters involving some of the Adani promoted entities, including the Company. The management of the Company is evaluating an independent assessment to look into the issues and compliance with applicable law and regulations, transaction specific issues, etc. The unaudited standalone financial results for the quarter ended December 31 2022, and year to date from April 1 2022 to December 31 2022, do not carry any adjustment.

From Notes to Results

Note 20

Subsequent to the quarter ended 31st December, 2022, a short seller has issued a report, alleging certain issues against some of the Adani promoted entities, including the Company. The Company has denied the allegations.

To uphold the principles of good corporate governance, the management of Adani promoters’ entities is evaluating an independent assessment to look into issues and compliance of applicable laws and regulations, transaction specific issues, etc. The management of the company is confident that no material adverse impact on the financial results is expected to arise upon such evaluation.

ADANI TRANSMISSION LTD (PERIOD ENDED 31ST DECEMBER, 2022)

From Limited Review Report

Emphasis of Matters

We draw attention to Note 8 to the Statement where Management has provided its assessment of the impact of the allegations made in the report of the short-seller issued post the reporting date, on the standalone financial results for the quarter and nine months ended December 31 2022.

From Notes to results

Note 8 – Subsequent to the quarter ended December 31, 2022, a short seller has issued a report which contains certain allegations relating to specific Adani promoted entities, which have been denied. Management has assessed that no adjustment arises to the financial results of the Company for the quarter and nine months ended December 31 2022 with respect to these allegations.

ADANI GREEN ENERGY LTD (PERIOD ENDED 31ST DECEMBER 2022)

From Limited Review Report

Emphasis of Matter

We draw attention to Note 20 to the unaudited consolidated financial results, relating to allegations made by a short seller report on matters involving some of the Adani Group entities, including the Company. The management of the Company is evaluating an independent assessment to look into the issues and compliance with applicable law and regulations, transaction specific issues, etc. The unaudited standalone financial results for the quarter ended December 31 2022, and year to date from April 1 2022 to December 31 2022, do not carry any adjustment.

From Notes to Results

Note 20 –

Subsequent to the quarter ended 31st December, 2022, a short seller has issued a report, alleging certain issues against some of the Adani promoted entities, including the Company. The Company has denied the allegations.

To uphold the principles of good corporate governance, the management of Adani Group entities is evaluating an independent assessment, on the basis of the requisite corporate approvals, to look into issues and compliance of applicable laws and regulations, transaction specific issues, etc. The management of the company is
confident that no material adverse impact on the financial results is expected to arise upon such evaluation, if any thereafter.

ADANI TOTAL GAS LTD (PERIOD ENDED 31ST DECEMBER, 2022)

From Limited Review Report

Emphasis of Matter

We draw attention to Note 8 to the unaudited consolidated financial results, with respect to allegations made by a short seller which contains certain allegations against some of Adani Group Companies which it has denied. Management of the Company has assessed that no adjustment arises to the financial results of the Company and its subsidiaries and for the corporate governance measure, the management of Adani Group is further evaluating an independent assessment of the matter. Our conclusion on the statement is not modified in respect of the above matter.

From Notes to results

Note 8

Subsequent to 31st December, 2022, a report was issued by a short seller which contains certain allegations relating to specific Adani-promoted entities, one of the ATGL Promoters, which have been duly denied. The management has assessed that no adjustments arises to the financial results of the Company and its subsidiaries for the quarter and nine months ended 31st December, 2022 with respect to these allegations. However, as an added corporate governance measure, the management of Adani Group is further evaluating an independent assessment of the matter.

AMBUJA CEMENTS LTD (PERIOD ENDED 31ST DECEMBER 2022)

From Limited Review Report

Emphasis of Matter

As explained in Note 10 to the consolidated financial results for the quarter ended 31st December, 2022 and year to date from 1st January, 2022 to 31st December 2022, the company is considering appointment of an independent firm to evaluate the allegations and compliance with applicable laws and regulations, related party transactions and internal controls of the Company and the financial results for the quarter ended 31st December, 2022 and year to date from 1st January, 2022 to 31st December, 2022 do not carry any adjustment.

We draw your attention to Note 3 of the Statement which describes the uncertainty related to the outcome of ongoing litigations with the Competition Commission of India.

From Notes to Results

NOTE 10

Subsequent to the quarter ended 31st December, 2022, a short seller has issued a research report, alleging certain issues against some of the Adani Group entities. The Adani Group entities have denied the allegations.

To uphold the principles of good governance, the management of Adani Group entities is considering the appointment of independent firm(s)/ agencies, basis the requisite corporate approvals, to assess/look into the issues and compliance of applicable laws and regulations, related party transactions, internal controls, etc. While the management is confident that no material adverse impact on the financial results is likely to arise on completion of such evaluation, the management will assess the necessary actions required, if any.

Note 3

The Competition Committee of India (CCI) vide, its order dated 31st August , 2016 had imposed a penalty of Rs. 1163.91 crores on the company. On the company’s appeal, the Competition Appellate Tribunal (COMPAT), subsequently merged with National Company Law Tribunal (NCLAT), vide its interim Order had granted stay against the CCI’s Order with the condition to deposit 10 per cent of the penalty amount, which was deposited and if the appeal is dismissed, interest at 12 per cent p.a., would be payable on the balance amount from date of the CCI order. NCLAT, vide its Order dated 25th July, 2018 dismissed the Company’s appeal and upheld the CCI’s order. Against this, the Company appealed to Hon’ble Supreme Court, which by its order dated 5th October, 2018, admitted the appeal and directed to continue the interim order passed by
the NCLAT.

In separate matter, pursuant to a reference filed by the Director, Supplies and Disposals, Government of Haryana, the CCI vide its Order dated 19th January, 2017, had imposed a penalty of R29.84 crores on the company. On the company’s appeal, COMPAT has stayed the operation of CCI’s order. The matter is pending for hearing before NCLAT.

Based on the advice of external legal counsel, the company believes it has good grounds on merit for a successful appeal in both the aforesaid matters. Accordingly, no provision is recognized in the financial results.

Provisions of section 115JC are applicable to projects approved before the introduction of the section 115JC.

59 DCIT vs. Vikram Developers and Promoters

TS-21-ITAT-2023(PUN)

ITA No. 608/Pune/2020

A.Y.: 2014-15

Date of Order: 10th, January, 2023

Provisions of section 115JC are applicable to projects approved before the introduction of the section 115JC.

FACTS

The assessee, a non-corporate entity, filed its return of income wherein it claimed deduction under section 80IB(10). In the return of income filed, the assessee did not give effect to the provisions of section 115JC. In the course of assessment proceedings, the AO held that the provisions of section 115JC which have been introduced w.e.f. 1st April, 2013 are applicable to the case of the assessee and accordingly the assessee is liable to pay taxes under 115JC for the year under consideration. Accordingly, the AO worked out the Adjusted Total Income and taxed it in accordance with the provisions of section 115JC of the Act.

Aggrieved, the assessee preferred an appeal to CIT(A) and contended that the Pune Bench of the Tribunal has in the assessee’s own case, for the assessment year 2013-14, decided the issue in favour of the assessee. The CIT(A), relying on the said order of the Tribunal, decided the issue in favor of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

HELD

The Tribunal noted that the recent decision of the co-ordinate bench in the case of Yash Associates [ITA.No.159/ PUN./2018 & C.O.No.1/PUN./2022 decided on 5th August, 2022 goes against the assessee. The Tribunal quoted the ratio of the decision in this case where considering the fact that section 115JC starts with a non-obstante clause and section 115JC(2)(i) stipulates adjustment(s) in an assessee’s total income “as increased by deductions claimed, if any, under any section (other than section 80P) included in Chapter VI-A under the heading C – Deduction in respect of certain incomes” and held that very clearly it is not the approval or completion of the residential project but the deduction claim only which has to be added under section 115JC(2)(i) of the Act. The Tribunal adopted stricter interpretation in light of the non-obstante provision and rejected the assessee’s contentions as per of decisions of the apex court in CIT vs. Calcutta Knitwears, Ludhiana [(2014) 6 SCC 444 (SC)], CCE vs. Dilip Kumar [(2018) 9 SCC 1 (SC) (FB)] and PCIT vs. Wipro Ltd [(2022) 140 taxmann.com 223 (SC)].

The Tribunal held that the co-ordinate bench deciding the case of the assessee in an earlier assessment year did not examine the ambit and scope of section 115JC of the Act so as to form a binding precedent in line with CIT vs. B. R. Constructions [(1993) 202 ITR 222 (AP)]. The Tribunal adopting the stricter interpretation held that the provisions of section 115JC would apply to the case of the assessee. The appeal filed by the Revenue was allowed.

Mere non-furnishing of the declaration by the deductee to the deductor in terms of proviso to Rule 37BA(2) cannot be reason to deny credit to the person in whose hands income is included.

58 Anil Ratanlal Bohra vs. ACIT
2023 (1) TMI 862 – ITAT PUNE
ITA No. 675/Pune/2022
A.Y.: 2021-22
Date of Order: 19th January, 2023

Mere non-furnishing of the declaration by the deductee to the deductor in terms of proviso to Rule 37BA(2) cannot be reason to deny credit to the person in whose hands income is included.

FACTS

Assessee, an individual, filed his return of income wherein he interalia claimed credit for TDS of Rs.2,80,456 being proportionate amount deducted at source by State Bank of India from the interest on fixed deposits placed by his wife with the State Bank of India. This amount of Rs.2,80,456 was in respect of interest attributable to fixed deposits which were placed by the wife of the assessee with State Bank of India out of the funds gifted by the assessee to her. Accordingly, in terms of section 64 of the Act, the income thereon was includible in total income of the assessee. The assessee included such income in the return of income and also claimed corresponding credit.

The CPC, in intimation denied credit of TDS claimed since the same was not reflected in Form No. 26AS of the assessee.

Aggrieved, the assessee filed an appeal to CIT(A) who held that the provisions of Rule 37BA(2) were not complied with and as a result, the assessee was not entitled to the credit for deduction of tax at source.

Aggrieved, the assessee preferred an appeal to the Tribunal.

HELD

The Tribunal noted the provisions of section 199 and observed that sub-Rule (2) of Rule 37BA is significant for deciding the appeal.

It noted that a careful perusal of sub-rule (2) indicates that where the income, on which tax has been deducted at source, is assessable in the hands of a person other than deductee, then credit for the proportionate tax deducted at source shall be given to such other person and not the deductee. The proviso to sub-rule (2) provides for deductee filing a declaration with the deductor giving particulars of the other person to whom credit is to be given. On receipt of such declaration, the deductor shall issue certificate for the deduction of tax at source in the name of such other person.

The crux of section 199 read with Rule 37BA(2) is that if the income, on which tax has been deducted at source, is chargeable to tax in the hands of the recipient, then credit for such tax will be allowed to such recipient. If, however, the income is fully or partly chargeable to tax in the hands of some other person because of the operation of any provision, like section 64 in the extant case, the proportionate credit for tax deducted at source should be allowed to such other person who is chargeable to tax in respect of such income, notwithstanding the fact that he is not the recipient of income.

It is with a view to regularise the allowing of credit for tax deducted at source to the person other than recipient of income, that the proviso to Rule 37BA(2) has been enshrined necessitating the furnishing of particulars of such other person by the recipient for enabling the deductor to issue TDS certificate in the name of the other person. The proviso to Rule 37BA(2) is just a procedural aspect of giving effect to the mandate of section 199 for allowing credit to the other person in whose hands the income is chargeable to tax.

One needs to draw a line of distinction between substantive provision [section 199 read with Rule 37BA(2) without proviso] and the procedural provision [proviso to Rule 37BA(2)]. Non compliance of a procedural provision, which is otherwise directory in nature, cannot disturb the writ of a substantive provision.

The Tribunal held that merely because the assessee’s wife did not furnish declaration to the bank in terms of proviso to Rule 37BA(2), the amount of tax deducted at source, which is otherwise with the Department, cannot be allowed to remain with it eternally without allowing any corresponding credit to the person who has been subjected to tax in respect of such income. As the substantive provision of section 199 talks of granting credit for tax deducted at source to the other person, who is lawfully taxable in respect of such income, we are satisfied that the matching credit for tax deducted at source must also be allowed to him.

The Tribunal held that the credit for Rs. 2,80,656 actually deducted on interest income of Rs. 37.42 lakh be allowed to the assessee who has been taxed on such income.

Equity Vs. Financial Liability

Classification, measurement and presentation of financial instruments as financial liabilities or equity will give information to users of financial statements about the nature, timing and amount of future cash flows of the entity. Reclassification of a financial instrument from equity to financial liability or vice-versa would not only affect its presentation in the balance sheet but also its measurement (equity is not remeasured whereas financial liabilities are) and, may result in a remeasurement gain or loss.

This article deals with the issue of whether reclassification between financial liabilities and equity instruments should be required or prohibited for changes in the substance of contractual terms without a modification to the contract.

FACT PATTERN

An entity issues a four-year convertible bond, where the holder has the option to convert it into the issuer’s equity shares after the first year, but where the conversion ratio is only fixed at the end of the first year at the lower of R6 and 120 per cent of the equity share price. Should an instrument be reclassified when the original classification might have changed but the contractual terms have not?

RESPONSE

Technical literature

Ind AS 32, Financial Instruments, Presentation

Paragraph 17 “……. a critical feature in differentiating a financial liability from an equity instrument is the existence of a contractual obligation of one party to the financial instrument (the issuer) either to deliver cash or another financial asset to the other party (the holder) ………”

Paragraph 15 “The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument.”

Ind AS 109, Financial Instruments

Paragraph 3.3.1 “An entity shall remove a financial liability (or a part of a financial liability) from its balance sheet when, and only when, it is extinguished – i.e., when the obligation specified in the contract is discharged or cancelled or expires.”

RESPONSE

In the described fact pattern, the instrument is a financial liability since there is a contractual obligation to pay cash, should the holder decide not to exercise his option to convert the instrument into equity. Additionally, the holder has a right to convert the instrument into equity which is an embedded derivative. Because the number of shares into which the bond could be converted is variable at inception, the conversion option is recognised on initial recognition, as a separate embedded derivative (financial liability). At the end of the first year, under the contract’s original terms, the conversion ratio is fixed, and so the embedded derivative no longer meets the definition of a financial liability. The question is, should the embedded derivative (financial liability) be reclassified from financial liability to equity, when the original classification as financial liability might have changed without the contractual terms having undergone any change?

Ind AS is not clear on whether an entity should reclassify an instrument if the contractual terms have not changed. Ind AS 32 and Ind AS 109 appears to have contradictory requirements. Ind AS 32 only prescribes that an entity should classify the instrument, or its component parts, on initial recognition. For example, paragraphs 15 and 17 are applied at inception. On the other hand, paragraph 3.3.1 of Ind AS 109 states that an entity should remove a financial liability from its balance sheet when it is extinguished; that is, the obligation specified in the contract is discharged or is cancelled or expires.

Consequently, there are two views that can be considered.

VIEW A

In considering the guidance in Ind AS 32, the change in the conversion ratio, from variable to fixed at the end of year 1, would not result in reclassification, because the assessment of whether the embedded derivative feature is a financial liability or equity would be based only on the terms at inception of the contract.

View B

In considering the guidance in Ind AS 109 (paragraph 3.3.1), the conversion option would be reclassified from a derivative liability to equity, because the obligation to deliver a variable number of shares on conversion expires, and the obligation to then deliver a fixed number of shares meets the definition of equity.

Both treatments can be supported; an entity should determine an appropriate accounting policy and apply it consistently.  If an entity does elect to reclassify an instrument from financial liability to equity, the below accounting policy choice exists in how to account for the change (which should be consistently applied and disclosed properly):

  • An entity can apply the same accounting treatment as when the convertible debt is converted into shares, where the existing debt’s carrying value is transferred to equity, and no gain or loss is recorded on conversion.
  • The exchange of an existing debt instrument of the issuer with new equity instruments could be viewed as an extinguishment of the existing financial liability. The original debt instrument is de-recognised, and the new equity instruments that are issued are recognised at fair value. The difference is recognised as a gain or loss in the profit or loss, in accordance with Appendix D of Ind AS 109 Extinguishing Financial Liabilities with Equity Instruments.

CONCLUSION

The International Finanical Reporting Intepretation Committee (IFRSIC) in earlier discussions has not provided any conclusive point of view on this matter. The International Accounting Standards Boards (IASB) will be resolving this issue in its current project Financial Instruments with Characteristics of Equity. The author believes that View B is more appropriate since it reflects the substance of the change and is in consonance with the broad principles of Ind AS 32 and Ind AS 109.

What is applicable for TDS should also be applicable for TCS and merely because there is no Rule identical to Rule 37BA(2)(i) of the Rules with reference to TCS provisions, it cannot be the basis for the Revenue to deny the legitimate claim for credit of TCS made by an assessee

57 Hotel Ashok Garden vs. ITO  

ITA Nos. 12 to 15 / Bang./2023

A.Ys.: 2016-17 to 2019-20

Date of Order: 6th February, 2023

What is applicable for TDS should also be applicable for TCS and merely because there is no Rule identical to Rule 37BA(2)(i) of the Rules with reference to TCS provisions, it cannot be the basis for the Revenue to deny the legitimate claim for credit of TCS made by an assessee.

FACTS

The assessee, a firm, engaged in the business of liquor bar and restaurant, claimed credit of TCS paid at the time of purchase of liquor in each of the four assessment years under consideration. The TCS certificate was in the name of Raju Shetty, a partner of the assesse firm, who held the license in the business of selling liquor. Since Raju Shetty held the license, the Karnataka State Beverages Corporation Ltd, (KSBCL) from whom liquor was purchased issued the certificate of TCS in the name of Raju Shetty but the credit wherefor was claimed by the assessee firm in the return of income filed by it.

In an intimation, the credit for TCS claimed by the assessee firm was denied. The assessee filed an application for rectification under section 154 of the Income tax Act, 1961 (Act) contending that the credit ought to be granted to the assessee firm. Along with the application, indemnity of the partner, Raju Shetty was also furnished. The AO rejected the application.

Aggrieved, the assessee preferred an appeal to CIT(A) who dismissed the appeal interalia on the grounds that this is a debatable issue which could not have been rectified under section 154 of the Act.

Aggrieved, the assessee preferred an appeal to the Tribunal where on behalf of the assessee, reliance was placed on the decision of the Jaipur Bench of the Tribunal in the case of Jai Ambey Wines vs. ACIT, order dated 11th January, 2017 where an identical issue came up for consideration with regard to the claim of TCS in the hands of the partnership firm when the licence stands in the name of the partners. The Tribunal after considering the statutory provisions held that the assessee firm should be given credit for TCS made in the hands of the partner.

The common issue in these four appeals was as to whether the lower authorities were justified in not granting credit for TCS as claimed by the assessee.

HELD

The Tribunal noted the ratio of the decision of the co-ordinate bench in the case of Jai Ambey Wines (supra). As regards the decision of the CIT(A) that the issue under consideration could not have been decided in an application under section 154 of the Act, the Tribunal held that if the ultimate conclusion on an application under section 154 of the Act can only be one particular conclusion, then even if in reaching that conclusion, analysis has to be done then it can (sic cannot) be said that the issue is debatable which cannot be done in proceedings under section 154 of the Act. The Tribunal held that the conclusion in the present case can only be one namely, that one person alone is entitled to claim credit for TCS and it is only the assessee who has claimed credit for TCS and not the licencee. In such circumstances, the application under section 154 of the Act ought to have been entertained by the Revenue. The Tribunal held that the assessee is entitled to claim credit for TCS when it is only the assessee who has claimed credit for TCS and not the licencee. In such circumstances, the application under section 154 of the Act ought to have been entertained by the Revenue.It also observed that the very basis of the decision of the Jaipur Bench of ITAT in the case of Jai Ambey Wines (supra) is based on the facts that what is applicable for TDS should also be applicable for TCS and merely because there is no Rule identical to Rule 37BA(2)(i) of the Rules with reference to TCS provisions, it cannot be the basis for the Revenue to deny the legitimate claim for credit of TCS made by an assessee.

The Tribunal allowed the appeal filed by the assessee and directed the AO to grant credit for TCS to the assessee.

Audit Trail under the Companies Act, 2013

The term ‘Audit trail’ has not been defined in the Companies Act, 2013 (Act) or the Companies (Accounts) Rules, 2014 (“Accounts Rules”), It implies a chronological record of the changes that have been made to the data. The Ministry of Corporate Affairs (“MCA”), in its continuing drive to improve transparency and reinforce the integrity of financial reporting, has amended the Accounts Rules requiring companies to ensure that the accounting software used to maintain books of accounts has the following features and attributes:

  • Records an audit trail of each and every transaction;
  • Creates an edit log of each change made in the books of account along with the date when such changes were made;
  • Ensuring that the audit trail is not disabled.

The Companies (Audit and Auditor) Rules, 2014 (“Audit Rules”) have been correspondingly amended wherein auditors are now required to report, as part of the auditor’s report (in the section ‘Report on Other Legal and Regulatory Requirements’, as to whether,

(a)    the accounting software used by the company being audited has the feature of recording audit trail (edit logs),

(b)    the audit trail feature was operational throughout the financial year and had not been “tampered” with and

(c)    such audit trails have been retained for the period as statutorily prescribed.

The MCA has notified that the aforesaid amendments will be effective from April 1, 2023, which implies that the accounting software employed by companies will need to be compliant with the Accounts Rules from FY 2023-24 onwards. The requirement was initially made applicable for the financial year commencing on or after the 1st day of April 2021, however the applicability was deferred to the financial year commencing on or after April 1, 2022 and thereafter to April 1, 2023.

The relaxations by way of deferment of the Accounts rules twice by the MCA ought to be leveraged by the companies to assess whether the accounting software has the requisite functional parameters and attributes which would be considered as being compliant with the Accounts Rules and where necessary, engage with their service providers to ensure compliance.

In today’s environment, accounting software used for maintaining books of accounts is hosted and maintained in India or outside India, on-premises or on the cloud, or through subscribed Software as a Service (SaaS) application. Also, there are multiple other software or infrastructure elements involved in processing end-to-end transactions like Enterprise Resource Planning (ERP), Web Portals, Applications, use of End User Applications like Excel, Email Systems, Mobile Applications, Ticketing Applications, Consolidation Solutions, and others.

Considering the requirements detailed above and the said complexities involved, it is important to understand the challenges and aspects which require careful consideration both by the companies as well as by the auditors. The amendments to the Accounts Rules and Audit Rules (collectively referred to as “Rules”) could be relevant as an absolute audit trail that would be critical to establishing accountability and may act as an impediment to the falsification and manipulation of accounting records. However, the Rules are in certain respects ambiguous, and this may lead to divergence in the interpretation and application of the Rules by auditees and auditors. The objective of this article is to outline the aforesaid aspects which require clarity, enhanced responsibilities of the management and the auditor, and to discuss key implementation challenges.

APPLICABILITY OF RULES

Section 128 read with Rule 3 of The Companies (Accounts) Rules, 2014 prescribes books of accounts etc. to be kept by the company. These are applicable to all the companies registered under the Companies Act, 2013. The reporting requirements for the auditors have been prescribed for the audit of financial statements prepared under the Act. Accordingly, auditors of all classes of companies including section 8 companies would be required to report on these matters. As per Companies (Registration of Foreign Companies) Rules, 2014 the provisions of Audit and Auditors (i.e., Chapter X of the 2013 Act) and Rules made there under apply, mutatis mutandis, to a foreign company as defined in Companies Act, 2013. Accordingly, one may take a view that reporting requirements would be applicable to the auditors of foreign companies as well.

WHAT IS AN ‘AUDIT TRAIL’?

The term ‘audit trail’ can be defined as a chronological sequence of the history of a particular transaction, tracking who created/changed a record, what record, what time etc. Audit trails amongst others may help in investigating frauds, system breaches etc. and can be considered an essential tool of monitoring for organisations. Many organisations use it today as well because it is critical for certain applications. However, all businesses or organisations may not be fully equipped or invested in best-class IT systems. Also, the cost of these IT systems does not involve only one-time costs. They also include expensive upgrades, security systems, etc.

So, what is the change for those companies which are already using audit trails? The change is that companies which earlier had a choice of deciding what type of IT systems to use depending on their needs and also a choice on deciding the type of data which they needed an audit trail for, now have limited choices.

AUDIT TRAIL – EXCLUSION AND INCLUSIONS?

The Rules do not specify the fields or data sets for which audit trails are required to be maintained. In relation to a transaction, data would comprise two types:

  • transactional data (e.g., amount, accounting date, ledger accounts, narration for the transaction)
  • data pertaining to the recording of the transaction (e.g., the identity of the user accounting for the transaction or the time on which the transaction was posted).

The companies would need to ensure that the audit trail captures changes to each and every transaction; changes that need to be captured may include the following

  • when changes were made,
  • who made those changes,
  • what data was changed,

For example, if a transaction is deleted or edited, apart from logging information about who effected the deletion/edit, the audit trail may include sufficient information to either view or trace the transaction which had been deleted. This aspect may be clarified by the MCA or the ICAI.

BOOKS OF ACCOUNT – FOR AUDIT TRAIL

Section 2(13) of the Companies Act 2013 defines Books of Account as below:

“Books of account” includes records maintained in respect of—

i.    all sums of money received and expended by a company and matters in relation to which the receipts and expenditure take place;

ii.    all sales and purchases of goods and services by the company;

iii.    the assets and liabilities of the company; and

iv.    the items of cost as may be prescribed under section 148 in the case of a company which belongs to any class of companies specified under that section

It is a very broad definition which encompasses every record maintained in respect of financial statements. So, inventory records, production records, expense records, asset records etc. would be part of books of account and would need to be covered and for which audit trail would need to be maintained.

ACCOUNTING SOFTWARE – COVERAGE

The term ‘software’ has not been defined in the Act or in the Rules. It may be noted that any software used to maintain books of account will be covered within the ambit of these rules. For e.g. if sales are recorded in a standalone system and only consolidated entries are recorded on a monthly basis into the General Ledger ERP, the sales system may also have an audit trail. The companies as well as auditors would need to evaluate whether such systems would also be covered within the meaning of the term accounting software. Accordingly, it appears that any software that maintains records or transactions that fall under the definition of Books of Account as per section 2(13) of the Act will be considered accounting software for this purpose. MCA or ICAI may clarify this matter.

MANAGEMENT RESPONSIBILITIES

In order to demonstrate that the audit trail feature was functional, operated and was otherwise preserved, a company may have to design and implement specific internal controls (predominantly IT controls) which in turn, would be evaluated by the auditors, as appropriate. A company may leverage its existent internal control systems and processes to design internal controls around the audit trail.

The management will be responsible for compliance with the requirement of the rules including to:

  • identify the records and transactions that constitute books of account under section 2(13) of the Act;
  • identify the software i.e., IT environment (including applications, web portals, databases; Interfaces, or any other IT component used for processing and or storing data for the creation and maintenance books of accounts
  • ensure such software have the audit trail feature;
  • ensure that the audit trail captures changes to each and every transaction recorded in the books of account;
  • ensure that the audit trail feature is always enabled (not disabled);
  • ensure that the audit trail is appropriately protected from any modification; and
  • ensure that the audit trail is retained as per statutory record retention requirements.
  • ensure that controls over maintenance and monitoring of the audit trail and its feature are designed and operating effectively throughout the period of reporting.

In the case of accounting software supported by service providers, the company management and the auditor may consider leveraging independent auditors’ report of a service organisation, if available (e.g., SOC 2/SAE 3402, Assurance reports on controls at a service organisation) for compliance with audit trail requirements.

It is important for the companies to discuss and evaluate the applicability of the rules pending issuance of guidance from the MCA or the ICAI.

AUDITOR’S REPORTING REQUIREMENTS 

Globally, no similar reporting obligation exists for the auditors and accordingly, it becomes imperative that MCA or ICAI prescribe specific guidance to enable the auditor to obtain assurance and report accordingly under these requirements.

Unlike reporting on internal financial controls, the provisions require the auditor to report that the feature of recording audit trail (edit log) facility has “operated throughout the year for all transactions recorded in the accounting software”.

The auditor would be expected to verify the following:

  • whether the trail feature configurable (i.e., if it can be modified)?
  • whether the feature enabled/operated available throughout the year and not tampered with?
  • whether all transactions1 recorded in the software covered in the audit trail feature?
  • whether the audit trail been preserved as per record retention requirements?
1. Proviso to Rule(1) of Companies (Accounts) Rules 2014 prescribes requirement of audit trail only in the context of books of account by stating that accounting software should be capable of creating an edit log of “each change made in books of account.” The auditors’ responsibilities have been prescribed for “all transactions recorded in the software”

Considering the amendment has been made to the Rules, the non-compliance with the mandatory provisions would imply contravention with the provisions of the Companies Act, 2013. Further, based on procedures performed the auditor may evaluate the reporting implications in case of non-compliance and consider the requirements specified in Standards on Auditing 250, Consideration of Laws, and Regulations in an Audit of Financial Statements. In respect of the audit trail following could be the expected scenarios:

Management may maintain an adequate audit trail as required by the law.

Management may not have identified all records/transactions for which an audit trail should be maintained.

The accounting software does not have the feature to maintain an audit trail, or it was not enabled throughout the audit period.

Scenarios mentioned against (ii) or (iii) may indicate non-compliance with the requirements prescribed in the rules resulting in the inclusion of a modified comment by the auditor against this clause. ICAI may issue guidance on this aspect.

REPORTING UNDER CLAUSE (G) OF RULE 11 VIS-À-VIS SECTION 143(3)(I)

Section 143(3)(i) of the Act, where applicable under the provisions of the Act, requires the auditor to state in his audit report whether the company has an adequate internal financial controls system in place and the operating effectiveness of such controls. Reporting on internal financial controls is not covered under the Standards on Auditing and no framework has been prescribed under the Act and the Rules thereunder for the evaluation of internal financial controls. Guidance in this regard was specified vide Guidance Note on Audit of Internal Financial Controls Over Financial Reporting.

Accordingly, where the feature of the audit trail has not operated throughout the year, the auditor would need to evaluate and perform further testing/examination as may be required to conclude the wider impact on the reporting implication.

However, the mere non-availability of an audit trail may not necessarily imply failure or material weakness in the operating effectiveness of internal financial control over financial reporting. ICAI may guidance on this aspect.

PRESERVATION OF THE AUDIT TRAILS

Section 128(5) of the Act requires books of accounts to be preserved by the companies for a minimum period of eight years. Since the requirement of an audit trail has been made effective from April 1, 2023, it seems that the provision of audit trail retention will apply from April 1, 2023, onwards.

The auditor is also required to report whether the audit trail has been preserved by the company as per the statutory requirements for record retention. Considering this reporting requirement, the auditor is expected to perform appropriate audit procedures to assess if the logs have been maintained for the period required and are retrievable in case of a need.

WRITTEN REPRESENTATIONS FROM THE MANAGEMENT

The auditor will be required to obtain written representations from management acknowledging management’s responsibility for establishing and maintaining adequate controls for identifying, maintaining, controlling, and monitoring of audit trails as per the requirements on a consistent basis.

AUDIT DOCUMENTATION

The auditor may also document the work performed on the audit trail such that it provides a sufficient and appropriate record of the basis for the auditor’s reporting requirement; and evidence that the audit was planned and performed in accordance with this implementation guide, applicable Standards on Auditing and applicable legal and regulatory requirements. In this regard, the auditor may comply with the requirements of SA 230 “Audit Documentation” to the extent applicable.

TIMELY PLANNING AND ABILITY OF COMPANIES TO INVEST IN SUCH SOFTWARE SYSTEMS

Since the rules are applicable with effect from April 1, 2023, onwards, it is important for companies to monitor the implementation of the amended rules. Long-term maintenance of audit logs can prove challenging for many organizations because it can occupy extensive storage space that may not be readily available in desktop applications. Also, with the amendment made in the Account Rules about the mode of keeping books of account and other books and papers in electronic mode, companies are required to keep back-up of books of account and other relevant books and papers maintained in electronic mode (including at a place outside India) in servers physically located in India on daily basis, instead of periodic basis. Existing software might not be able to support it. It may not be easy to reconstruct the database transaction order if the old software doesn’t have an audit trail.

WAY FORWARD

Considering that compliance with the amended rules will require significant efforts for the companies, it would be advisable for Companies to keep an eye out for any guidance from the MCA and/or the ICAI in this regard. At the same time, enabling audit trails may not be a simple task for companies that use simple accounting software, which typically doesn’t have an audit trail functionality. Companies may have to effect significant changes to their existing software or implement a different software altogether.

Apart from the compliance by the companies, the auditors of the company are required to report on the audit trail feature of the accounting software. Therefore, auditors will need to consider the extent of efforts required in testing an audit trail as part of their planning activities and the extent of audit procedures. The auditor may also discuss with those charged with governance/audit committee/ board of directors about the new reporting requirements and the possible reporting implications.

The Risks Posed to Chartered Accountants by the Prevention of Money Laundering Act, 2002

INTRODUCTION

The role of Chartered Accountants has increased exponentially in the modern-day business environment. Gone are the days when the question of whether a Chartered Accountant conducting an audit was expected to be a watchdog or a bloodhound. The enlarged scope of audit/ compliance and the multifaceted advisory services rendered in today’s complex business environment by Chartered Accountants have opened them up to numerous regulatory and compliance-related challenges. We can see that Chartered Accountants are being called in for questioning by investigating agencies when a client’s affairs are the subject matter of investigation. Much unlike a Lawyer, the communication between a client and a Chartered Accountant does not get covered within the ambit of ‘legal privilege/privileged communication’ even though modern-day Chartered Accountants render a raft of quasi-legal services. With mushrooming of various tribunals before which Chartered Accountants has the right to represent, the risks they are exposed to in dispensing quasi-legal services need to be looked into given the numerous statutory laws that can cause an individual or professional firm to land in hot waters.

The last decade has witnessed sea changes in the regulation of economic activities. A number of legislations have now granted mandates to specialized agencies to detect and prevent economic offences. Much water may have flown under the bridge since the judgment of the Supreme Court in the State of Gujarat v. Mohanlal Jitmalji Porwal (1987) 2 SCC 364 wherein economic offences were compared with even a crime as unforgivable as murder. However, the judiciary still considers economic offences very seriously. It has now been established without a doubt that economic offences are to be regarded as a class unto themselves. The Serious Fraud Investigations Office, the Directorate of Enforcement, and the Income Tax authorities as mandated by the Prohibition of Benami Transaction Law in addition to other investigating agencies including the local police all operate in the field of investigating economic offences. Economic offences do not exist in silos. There is always the possibility of an overlap or an interplay. Investigation of economic offences invariably involves, inter alia, following the trail of money. Consulting and accounting professionals thus suddenly may find themselves in the epicenter of these investigations. No matter what the final verdict is, the taint of being accused of an economic offence often leaves an indelible mark on a person.

While studying for Master’s degree in law, a curious question was posed by a professor: “What can be done about bad advice?” This question was raised over a decade ago, and much water has flown under the bridge since then. Advice no longer needs to be bad to land a professional in hot water. In the Indian context, we have seen auditors hauled onto the coals for mistakes and frauds perpetuated by clients. It may very well be that in some cases professionals are complicit in those crimes due to professional pressure, however, more often than not it is likely that an auditor or a consultant from this august profession has unwittingly and unfortunately been dragged into controversy for no fault of his. This begs the question, “What can be done if good advice has unintended consequences? What can be done if a client does not follow the advice? What is the extent of the advisor’s liability? Chartered Accountants being arrested under the provisions of the Prevention of Money Laundering Act, 2002 (PMLA) (“Act”) are no longer unheard of. Though much has already been discussed about this harsh law with a client-centric focus, today this article shifts the focus onto professionals.

THE RELEVANT PROVISIONS OF THE ACT

One of the most important sections in any Act is the section that contains definitions. More often than not these definitions are contained in section 2 of an Act. The PMLA is no exception and defines proceeds of crime in section 2(1)(u) of the Act while section 3 itself defines the offence of money laundering. Both are reproduced below for clarity.

Section 2(1)(u) – “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.]”

Section 3 reads as follows-

“Whoever 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 shall be guilty of offence of money-laundering.

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,

in any manner whatsoever,

(ii) the process or activity connected with the proceeds of crime is a continuing activity and continues till such time as 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.]”

ANALYSING THE RISK

A conjoint reading of both sections clearly shows that the Act casts an extremely wide net. This seems to be deliberate and by design. An immediate red flag for Chartered Accountants can be the term ‘knowingly assisted’ which can be easily imported to both, the act of commission as well as an omission by professionals. Some solace therefore can be sought from the inclusion of the word ‘knowingly’ before ‘assisted’, as it establishes the requirement of mens rea for an offence to be made out. The absence of mens rea will certainly be invoked as a defense if any accusations are made under the act, however, mens rea itself is not very easy to prove at the outset and often requires evidence to be lead which equates to one being subject to the rigors of an ignominious criminal trial. It is incredibly difficult to prove the absence of criminal intent before the trial commences unless it is apparent from the face of the record that the accused professional may indeed ex-facie have no criminal intent. A complication that one encounters is the fact that the Economic Case Information Report (ECIR) is not a public document and does not need to be handed over to the accused at the time of the arrest. It may be produced before the special court that shall conduct the trial if required as held in Vijay Madanlal Choudhary v. Union of India 2022 SCC Online SC 929; [2022] 140 Taxmann.com 610 (SC). The Court has held that the ECIR is an internal document of the Directorate and not equivalent to the First Information Report (FIR) which is provided for in the Criminal Procedure Code. This poses a significant increase in the challenge of drafting a bail application. Be that as it may, obtaining bail in PMLA prosecutions is whole together a different challenge by itself, even if the ECIR copy is supplied to the accused. The infamous twin conditions (of the court being satisfied that there are reasonable grounds for believing that the accused is not guilty of the offence and that he is not likely to commit any offence while on bail) fulfill the same role that the mythological Cerberus did when it comes to the grant of bail for those accused under the PMLA. The jurisprudence regarding bail under PMLA has been a roller coaster ride much akin to the plot of a gripping thriller novel, what with the Supreme Court in Nikesh Tarachand Shah v. Union of India (2018) 11 SCC 1 striking down the twin conditions, just for Vijay Madanlal Choudhary v. Union of India (supra) to uphold their revival post the 2018 amendment to the Act. Just like any other movie as of today, the story ends on a cliffhanger with the Supreme Court agreeing to review aspects of the Vijay Madanlal Choudhary judgment. That being said, as of today, the twin conditions are good law.

The red flag is not merely knowingly assisted. The explanation to section 3 lists out the processes or activities which shall constitute the offence of money laundering in wide terms such as ‘concealment, possession, acquisition, use, projecting as untainted property, or claiming as untainted property in any manner whatsoever’. This gamut of activities, despite the standard caveat of mens rea, is enough to cause considerable headaches to Chartered Accountants who are regularly called upon to assist in structuring transactions, helping out in complex business decisions, or auditing books of accounts. To precipitate matters, the definition includes the phrase “actually involved in any process or activity connected with the proceeds of crime.” It is incredibly easy for a Chartered Accountant to be accused of the crime of money laundering. The activity of money laundering, being a continuous activity, also leaves one susceptible to the wrath of the law long after one’s association with the clients concerned may have ceased. Yes, it is true that there are various defenses that may be available to a Chartered Accountant, but a defense is not the same as immunity. I’m sure many will agree that in this particular context, prevention is infinitely better than cure.

The definition of ‘proceeds of crime’ is also amorphous enough to cause sufficient headaches for a Chartered Accountant. Technically, a fee that is received from a client who is involved in the process of money laundering could easily fall within the four corners of the definition of proceeds of crime. This is due to the broad language employed by section 2(1)(u) where property derived even indirectly by a person as a result of criminal activity is to be considered as proceeds of crime, even though it may not by itself be derived or obtained from the scheduled offence. If a client is involved in the commission of a scheduled offence and he pays a fee to a Chartered Accountant, who is unaware of the occurrence of such a scheduled offence, arguably, the fee received could still be claimed to be proceeds of crime even though the offence of money laundering may not be made out. The Supreme Court in Vijay Madanlal Choudhary v. Union of India (supra) has held that the offence of money laundering is an independent offence and that the involvement of a person in any one of the processes or activities provided for in section 3 would constitute the offence of money laundering which would otherwise have nothing to do with the criminal activity relating to a scheduled offence except that the proceeds of crime may be derived or obtained as a result of that crime.

The Appellate Tribunal set up under the PMLA in the case of Vinod Kumar Gupta v. Joint Director, Directorate of Enforcement 2018 SCC On Line ATPMLA 27 has decided an appeal where the Appellant received consultation fees from a party accused of offences under the PMLA and the Appellant took up a defense that he had no way of knowing that he had received consultation fees which may be part of proceeds of crime. The Tribunal observed that all professionals such as Advocates, Solicitors, Consultants, Chartered Accountants, Doctors, and Surgeons receive their professional charges from their respective clients against the service provided. Neither can the presumption under section 5(1)(a) of the PMLA (section 5 deals with provisional attachment of proceeds of crime) be drawn ipso facto that they have the proceeds of crime received as professional charges in their possession nor on the basis of presumption can their movable and immovable properties be attached unless a link and nexus directly or indirectly towards the accused or the crime is established within the meaning of section 2(1)(u) of the Act. In the absence of such a link, the professionals are to be treated as innocent persons as unless a link and nexus of proceed of crime are established under section 2(1)(u), the proceeding under the Act cannot be initiated. A caveat here is advisable, the orders of the Adjudicating Authority and Appellate Tribunal are only with respect to Attachment – these orders are not binding upon the special court that actually tries the offence of money laundering. The Special Court is neither bound, governed nor influenced by any order passed by the Enforcement Authorities and has to act independently on the basis of evidence led before it. Various other High courts have held that the decisions of the Adjudicating Authorities are not binding upon the Special Court where the Special Court has independently applied its mind.

There are various ways in which a professional may be pulled into an investigation under the PMLA by the Directorate of Enforcement some examples that come to mind are:

(i)    Chartered Accountants are privy to sensitive information about their clients and therefore may find themselves receiving summons during an investigation.

Section 50 of the PMLA grants certain authorities of the Directorate the power to summon any person whose attendance they consider necessary to give evidence or to produce any records during the course of any investigation or proceeding under the PMLA. All the persons so summoned shall be bound to attend in person or through authorized agents, as such officer may direct, and shall be bound to state the truth upon any subject respecting which they are examined or make statements and produce such documents as may be required. This would not be a cause of concern for most Chartered Accountants as their role would be confined to assisting the Directorate with their investigation and as such, giving evidence. As mentioned earlier Chartered Accountants do not enjoy the protection of privilege as is enjoyed by lawyers under section 126 of the Indian Evidence Act, 1872. That being said, in Nalini Chidambaram v. Directorate of Enforcement 2018 SCC Online Mad 5924, the Madras High Court, where the concerned Senior Advocate had appeared through an authorized representative before the Directorate of Enforcement, permitted the Directorate to issue fresh summons to the Senior Advocate.

(ii)    Chartered Accountants may find themselves involved in strategizing/planning company structures etc. and may find themselves being entangled in the offence of money laundering.

It would considerably be riskier for a Chartered Accountant if a transaction that he has consulted upon attracts the offence of money laundering. A blanket stand that this was done unknowingly or without mens rea may not be sustainable at the outset, because both commissions and omissions of the Chartered Accountant would need to be considered and the Directorate can always take the stand that this would be a subject matter of evidence to be considered at trial. The directorate may also always take a stand that evidence would need to be led to establish the lack of mens rea or the innocence of the Chartered Accountant. Professionals may need to increase their due diligence with regard to the transactions that they consult upon with their client in order to avoid being unwittingly pulled into this web and ensure proper documentation.

(iii)    Chartered Accountants may find themselves certifying documents or statements and may find themselves being entangled in the offence of money laundering.

In Murali Krishna Chakrala v. The Deputy Director Criminal Revision Case No. 1354 of 2022 and Crl. M. P. No. 14972 of 2022, dated 23rd November 2022, the High Court of Madras held that when issuing certain certificates, a Chartered Accountant is not required to go into the genuineness or otherwise of the documents submitted by his clients and he cannot be prosecuted for granting the certificate based on the documents furnished by the clients.

However, the Madras High Court decision may not come to the aid of Chartered Accountants when they are required to exercise due care while issuing certificates without taking the same at face value. This judgment arguably may not aid auditors who are required to report whether the books of accounts reflect a true and fair view of the financial condition of the audited entity and to what extent an Auditor or a Chartered Accountant certifying a particular document is required to go into the accuracy of the data provided to them (which takes us back to the watchdog versus the bloodhound debate). The risk could always be higher for the internal auditors of an entity. There can be no clear-cut answers as to which commissions and the omissions of a certifying Chartered Accountant would entail scrutiny. It would be advisable to have an iron-fist adherence to the relevant auditing standards and checklists while also ensuring that the client similarly adheres to the relevant accounting standards. It may be tempting to make qualifications when undecided, if for no other reason than to cover one’s own risk. This may be an additional factor in the mind of an auditor or a Chartered Accountant issuing a certificate. It is always preferable to err on the side of caution when risk is involved. One may not need to be actually involved in any dubious activity to incur the wrath of this draconian law.

CONCLUSIONS

This article by itself cannot be considered to be exhaustive. It is meant to be indicative and to inform the Chartered Accountant fraternity that their roles are now under more scrutiny than ever before and so is the risk associated with it. As the business environment and transactions get increasingly complex while some of the scheduled offences remain by and large generic, it may prove impossible for a Chartered Accountant to mitigate all risks. The offences included in the schedule are wide-ranging, spanning from legislation regarding drug trade and human trafficking to offences under certain intellectual property legislations! The most dangerous are the generic offences under the India Penal Code for example -cheating – something that can be invoked easily and is generic enough to include a variety. This takes us back once again to the watchdog and bloodhound conundrum. In today’s modern world perhaps, the bloodhound side shall weigh heavily in the mind of a Chartered Accountant.

The diligence with regard to the documentation needs to start right at the start – from the engagement letter itself. A clearly defined scope of work can help mitigate risk as far as the question of the authorities as to why a specific issue has not been dealt with. Checklists can specify the depth of the scrutiny. An exhaustive and complete audit file for auditors is more important than ever. It may clearly need to be made out and disclaimers may be made out to the effect that the scope of the certification/audit or advice is limited to the commercials involved and that the client must ensure adherence to all relevant local and central laws. The scope of preventive documentation is not exhaustive. It is meant to ensure that the scope of engagement of Chartered Accountants as well as the actual work carried out by them are well defined in order to ensure that no aspersions can be cast upon the role of professionals in any manner. It is not possible for a Chartered Accountant to ensure that the client has not indulged in any of the scheduled offence, indeed, that is not their function unless they come across them while fulfilling the scope of their work. Increased diligence, erring on the side of caution, and extensive documentation are the key to mitigating risk. The margin of discretion in audit qualification has reduced drastically. Going through the schedule of the PMLA is highly recommended, you may be surprised at certain offences that are included therein!

Revisiting Non-Discrimination Clause of The India – Us Tax Treaty in Light of India’s Corporate Tax Rate Reduction

Tax complexity itself is a kind of tax – Max Baucus, US Senator

This Article seeks to juxtapose the principle of non-discrimination with Article 14(2) of the India – US tax treaty and analyse its fallout. The combined reading of the two provides for the applicability of different tax rates imposed on a permanent establishment of a US corporation vis-à-vis a domestic corporation in India. However, the treaty posits that the tax rate differential shall not exceed fifteen percentage points. In this Article, the author argues that with the reduction of the corporate tax rate in India (albeit through an election), the concession of fifteen percentage points provided by the United States stands breached. Sequitur, the full force of principles of non – discrimination may be applicable notwithstanding the carve-out of Article 14(2).

I. INTRODUCTION

On September 20, 2019 the Government of India enacted a significant reduction of the corporate income tax rate for domestic corporations. On the statute, it was introduced as an election where the domestic corporations could elect to be taxed at 22 per cent1 which was earlier either 25 per cent or 30 per cent2 effective taxable year beginning April 1, 2019. On making this election, the corporation would forgo majority of the tax exemptions and incentives. If the domestic corporation is engaged in manufacturing activity, subject to certain conditions like company formation and commencement of operations, then it could elect a tax rate of 15 percent3. On the other hand, tax rate for a foreign corporation or a Permanent Establishment (“PE”) of a foreign corporation was left unaltered at 40 per cent4.

Article 26 of the India-US Tax Treaty (“Treaty”) enlists the principle of non-discrimination which enjoins nationals of a Contracting State to not be subjected to any taxation that is ‘other or more burdensome’ or ‘less favourable’ than that taxation of nationals in ‘same circumstances’ in the other Contracting State. Article 26(5) of the Treaty creates a carve-out from the general principle in terms of Article 14(2) – Permanent Establishment Tax. To give some context, Article 14 concerns itself with the imposition of a permanent establishment or branch tax5. Article 14(2) while deviating from the general principle of non-discrimination provides for the taxation of United States resident at a tax rate higher than applicable to domestic companies in India. However, the Article posits that the difference in tax rate shall not exceed the ‘existing’ difference of 15 percentage points. The Article therefore, in a certain way, creates a positive obligation on the Contracting State, India, to adhere the domestic tax rates in line with the treaty obligations. Curiously, this is an obligation on the Contracting State and not the taxpayers who are usually stuck in fulfilling conditions for treaty benefits!

1    Effective tax rate of 25.17% including peak surcharge and cess.
2    Effective tax rate of 34.94% including peak surcharge and cess.
3    Effective tax rate of 17.16% including peak surcharge and cess.
4    Effective tax rate of 43.68% including peak surcharge and cess.
5    See, Tech. Ex. to the Convention between United States and India (1991).

This article concerns itself with the above treaty obligation and the gamut of questions that arise therefrom. However, in absence of any previous steep tax rate reduction, this obligation has not been extensively examined by the Judiciary. Nonetheless, an attempt is made to put India’s corporate tax rate reduction in context with the non-discrimination principles and try to shed some perspective on whether the obligation is breached, and if so, the effect of such breach.

II. CONTEXTUALIZING DOMESTIC TAX REGIME WITH TREATY OBLIGATIONS

A. Headline Rate v. Concessional Tax Rate as a base to measure the 15 per cent differential

The subject of how much tax corporations pay in India is a complicated one. Over the last decade, the statutory rate or the headline has fallen down from 35 per cent to 30 per cent and in cases where a certain turnover threshold is met to 25%. Sections 115BAA and 115BAB of the (Indian) Income-tax Act, 1961 (“Act”) accord an election to the taxpayer to elect the tax rate at 22 per cent or 15 per cent respectively for domestic corporations and domestic corporations engaged in manufacturing activities (collectively, “concessional tax regime”). This concessional rate is further increased by a surcharge of 10 per cent and a cess of 4 per cent and the concessional tax regime is applicable from the financial year 2019 – 2020. Once this election is made it cannot be revoked. Further, the corporations opting for the election are exempt from tax liability under Minimum Alternate Tax (“MAT”). The downside, as it were, to this election is forgoing majority of the tax incentives and exemptions. Some of these exemptions may be claimed by foreign corporations too (through their PE’s). The domestic corporations, therefore, undertake a cost-benefit analysis and either elect to be taxed at a concessional rate or maintain status-quo in light of their existing exemptions and incentives (which reduce their effective tax rate below the concessional rate).

The first question which arises in the calculation of the differential tax rate of 15 per cent is whether such rate would be inclusive of surcharge and cess. While generally for this purpose, the definition of ‘taxes covered’ under Article 2 of the Treaty would be inquired into – implying a rate inclusive of surcharge and cess should be considered. However, it is a well-established principle of law in regard to the interpretation of agreements that such interpretation adopted should effectuate the intention of the parties and not defeat it. The term used in Article 14(2) consciously puts an upper cap on percentage points caveating it to the ‘existing’ differential, making historical analysis of the tax rate at the time of signing of the Treaty imperative.

For the assessment year 1990-91 pertaining to the taxable year 1989-90 the rate of tax on the domestic companies was 50 percentage points and the surcharge was payable at the rate of 8 percentage points. The rate of tax in the case of companies other than domestic companies was 65 percentage points. The Treaty takes note of the difference in the tax rates of domestic companies and foreign companies at 15 percentage points. Therefore, the Treaty in measuring the tax rates disregards the surcharge and cess6.

6    The rate of tax referred to in the agreement is the rate of tax chargeable under Article 270 of the Constitution of India. The surcharge is the additional tax, which was not intended to be taken into account for the purpose of placing a limit in the levy of tax in the case of foreign companies, Bank of America v. Deputy Commissioner of Income-tax, [2001] 78 ITD 1 (Mumbai). This view in the context of India – US DTAA/ Treaty has been reiterated by the High Court of Uttarakhand in CIT v. Arthusa Offshore Company, ITA 46 of 2007 decision dated 31.03.2008.

Having analysed the above, the logical question that follows is whether a concessional regime may be taken as a base for measuring the differential? Because only if the concessional regime can be taken as a base would the argument of breach of treaty obligation survive. Otherwise, the headline rate in the Act still remains 30%/ 25% and in either case, 15% rate differential would not get breached in such a scenario.

To put it in perspective, under the terms of the Act, the Assessing Officer is mandated to carry out an assessment of the taxpayer in accordance with the provisions of the Act. The Treaty has statutory recognition under section 90 of the Act. Section 4 of the Act, which is a charging provision, provides that where a Central Act enacts that income-tax it shall be charged at that rate or those rates in accordance with and subject to the provisions of the Act. A concessional tax regime forms part of the Act and as such if elected the charging provision provides for levying tax at a specified (concessional) rate.

However, because the concessional tax regime is not available to foreign companies, they are unable to elect such a rate. This asymmetry merits consideration in light of the principle of ‘quando aliquid prohibetur ex directo, prohibetur et per obliquum’, which means ‘you cannot do indirectly what you cannot do directly’. Accordingly, such an approach, on the first principles, would be unsound in as much as it is well settled in law that the treaty partners ought to observe their treaties, including their tax treaties, in good faith.

B. Invoking Article 26 of the Treaty to provide parity to the rate of tax applicable to US companies

A non-discrimination clause in a tax treaty essentially prevents any discrimination afforded between two taxpayers on the basis of country of origin. There may be various types of protection against discrimination typically provided in tax treaties, that is, inter alia, nationality-based non-discrimination, situs-based non-discrimination, or ownership-based discrimination.

The Pune Bench of the Tribunal in the case of Automated Securities Clearance Inc. v. ITO7, has observed that principles of non-discrimination clause would be available in case of a non-resident in case the different treatment meted out by the other state is considered as unreasonable, arbitrary or irrelevant. However, the rigors laid down in Automated Securities (supra) were overruled by a Special Bench verdict in the case of Rajeev Sureshbhai v. ACIT8. The Tribunal relied upon the following principles to settle the controversy:

  • For the application of Article 26(2) of the Treaty, it is sufficient to show that the non-resident taxpayer is engaged in the same business and is treated less favourably, the different circumstances in which the business is being performed are irrelevant;
  • There is no scope for “reasonable” discrimination and the concept is alien to treaty law;
  • If certain exemptions and deductions are available only for Indian taxpayers and not available for non-resident taxpayers, the same is to be construed as a less favourable treatment.

Flowing from above, the principle of pacta sunt servanda9, disallowing a favourable taxation regime to companies situated in ‘same circumstance’10 may ipso facto be a ground for invocation of the non-discrimination principles11 justifying the need of a carve-out under Article 14(2) in the first place. While there is a carve-out in Article 26(5) of the Treaty, for the rate of tax, the general principles of non-discrimination in Article 26 of the Treaty are still in force. The application of general principles is not estopped but is only subject to the carve-out. Thus, principles under Article 26(1) and (2) still apply. This implies that the Contracting State, i.e., India is still obliged to provide taxation which is not ‘other or burdensome’ or ‘less favourable’ to the residents of the United States. Discrimination is to be seen not only from the viewpoint of Indian law but what the two sovereigns agreed on at the time of signing of the Treaty. This includes ‘indirect’ discrimination12, which appears to be precisely the fallout of adopting a concessional tax regime13 only for domestic taxpayers; putting the residents of the other Contracting State at a significant disadvantage. This prima facie seems to violate the non-discrimination provisions of the Treaty notwithstanding the carve-out.

7    118 TTJ 619

8    129 ITD 145 (Ahd. Trib. – SB)

9    Supreme Court of India recognized the customary status of the Vienna Convention despite India not having ratified the convention yet. The courts in India have been leaning towards the principles of pacta sunt servanda and general rules of interpretation of a treaty, as contained in the Vienna convention to embrace good faith compliance. See, Ram Jethmalani v. Union of India, (2011) 9 SCC 751

10    Non-Indian banks carry out the same activity as Indian banks, ABN Amro Bank N.V v. JCIT, ITA 692/Cal./2000

11    OECD MTC 2017 C-24, para 44, 45 – “As such measures are in furtherance of objectives directly related to the economic activity proper of the State concerned, it is right that the benefit of them should be extended to permanent establishments of enterprises of another State which has a double taxation convention with the first embodying the provisions of Article 24, once they have been accorded the right to engage in business activity in that State, either under its legislation or under an international agreement (treaties of commerce, establishment conventions, etc.) concluded between the two States….It should, however, be noted that although non-resident enterprises are entitled to claim these tax advantages in the State concerned, they must fulfil the same conditions and requirements as resident enterprises.”

12    Id., para 1, 56 “When the taxation of profits made by companies which are residents of a given State is calculated according to a progressive scale of rates, such a scale should, in principle, be applied to permanent establishments situated in that State”

13    Id., para 15 Subject to the foregoing observation, the words “...shall not be subjected...to any taxation or any requirement connected therewith which is other or more burdensome ...” mean that when a tax is imposed on nationals and foreigners in the same circumstances, it must be in the same form as regards both the basis of charge and the method of assessment, its rate must be the same and, finally, the formalities connected with the taxation (returns, payment, prescribed times, etc.) must not be more onerous for foreigners than for nationals.

C. Explanation 1 to section 90 of the Act – whether valid a defence?

Explanation 1 to section 90 of the Act inserted in 2001 with retrospective effect from April 1, 1962, envisages that rate of tax cannot by itself imply less favourable (term used by the Act, akin non-discrimination in the Treaty) treatment to a non-resident. Should this explanation be accepted it would amount to a treaty override. As originally inserted the Explanation acknowledged its existence owing to the difference in the tax treatment of a domestic corporation (in that the domestic corporations in addition to corporate tax pay dividend distribution tax) vis-à-vis a foreign corporation (which only pays corporate tax). Since then the position has changed and the Explanation has been amended. Now it does not mention any ‘reason’ for such treatment.

OECD in its 1989 report on treaty override specifically states that domestic legislation (whether inserted before or after the commencement of the Treaty) in no way affects the continuing international obligation of a State unless it has been specifically denounced14. In this context, the Hon’ble Supreme Court of India in the famous Azadi Bachao15 case held that that a Treaty overrides the provisions of the Act in the matter of ascertainment of income and its chargeability to tax, to the extent of inconsistency with the terms of the Treaty. This view has been reiterated by the judiciary multiple times16. The reasoning behind this principle is to curtail amendments to an international obligation through unilateral measures – something that we have been grappling with in the digital space!

14    See, OECD Report of 1989 on Tax treaty override, para 12

15    Azadi Bachao Andolan v. Union of India, (2003) 184 CTR (SC) 450

16    By virtue of Clause 24(2) of the said agreement and the statutory recognition thereof in section 90(2) of the Act, the permanent establishment of a Japanese entity in India could not have been charged tax at a rate higher than comparable Indian assessees carrying on the same activities. Bank of Tokyo Mitsubishi Ltd. v. Commissioner of Income-tax [2019] 108 taxmann.com 242 (Calcutta), para 5

Pertinently, the Andhra Pradesh High Court in the case of Sanofi Pasteur Holding SA v. Department of Revenue, Ministry of Finance: 354 ITR 316 (AP) gave due consideration to the question whether a retrospective amendment in the domestic law could be considered in interpretation of the tax treaty. The Court while holding tax treaty supremacy referred to the general rule of interpretation postulated in the Vienna Convention and observed as under:

“…Treaty-making power is integral to the exercise of sovereign legislative or executive will according to the relevant constitutional scheme, in all jurisdictions. Once the power is exercised by the authorized agency (the legislature or the executive, as the case may be) and a treaty entered into, provisions of such treaty must receive a good faith interpretation by every authorized interpreter, whether an executive agency, a quasi-judicial authority or the judicial branch. The supremacy of tax treaty provisions duly operationalised within a contracting State [which may (theoretically) be disempowered only by explicit and appropriately authorized legislative exertions], cannot be eclipsed by employment of an interpretive stratagem, on misconceived and ambiguous assumption of revenue interests of one of the contracting States. Where the operative treaty’s provisions are unambiguous and their legal meaning clearly discernible and lend to an uncontestable comprehension on good faith interpretation, no further interpretive exertion is authorized; for that would tantamount to usurpation (by an unauthorized body – the interpreting Agency/Tribunal), intrusion and unlawful encroachment into the domain of treaty-making under Article 253 (in the Indian context), an arena off-limits to the judicial branch; and when the organic Charter accommodates no participatory role, for either the judicial branch or the executors of the Act.”

On the other hand, it may be argued at the instance of the Revenue that Explanation 1 to section 90 is a specific provision aimed at providing different tax regimes for domestic companies vis-à-vis foreign companies. In Chohung Bank17, the Tribunal accepted that there is no conflict between Explanation 1 to section 90 and the India-Korea Tax Treaty. The Court inter-alia observed that the Explanation confirms the proposition that rates of taxes, which are provided under the Finance Act, as opposed to the Act, are out of the purview of the general rule under the Act – provisions to the extent they are more beneficial shall apply to a taxpayer.

17    12 SOT 301 (Mum – Trib.) relying on previous Tribunal order in ITA No. 4948/Mum/05

However, it may not be out of place to mention that the annual tax rates, which are decided as per section 4 of the Act, provide that where a Central Act enacts that income-tax it shall be charged at that rate or those rates in accordance with and subject to the provisions of the Act. Thus, the rates of taxes are subject to the provisions of the Act.

In an AAR Ruling Transworld Garnet Co. Ltd., In Re18 it was observed that terms “taxation” and “tax” are not interchangeable. The AAR went on to observe that the object clause of every agreement uses the expression “taxation” and “tax” where the purpose is stated to be “avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income or wealth”. Further, drawing contradistinction between the two expressions, the AAR held that where the rate of tax is the focus, the language used is “tax so charged shall not exceed”. The discrimination against taxation, therefore, means the procedures by which tax is imposed. While I may not entirely agree with the said proposition, it would still aid the taxpayer since Article 14(2) of the Treaty specifically uses the term “tax rate”.

In Sampath Iyengar’s Law of Income Tax19, the learned author has enunciated that giving effect to Explanation 1 contained in section 90 of the Act, would tantamount to a breach of the non-discrimination clause where the tax treaties themselves mention the differential tax rates. The author has observed:

“…This is a live issue, since a mere provision in domestic law will hardly help without such clarification in the anti-discrimination clause in the Agreement, where India has such an agreement. The solution lies in incorporating this understanding to be explicitly made as part of the Agreement to avoid such controversy. In other words, the Agreement, should itself indicate, whether discrimination is only with reference to nationality or otherwise and whether the differential rate of tax on residents would construe discrimination.”

18. 333 ITR 1
19. 12 Edn. at page 8562

It may further be apposite to state that in the context of discrimination on account of rate of tax, tax treaties signed by India with certain countries such as the UK, Germany, Canada, Russia etc. specifically permit taxation of PE at a rate higher than the rate applicable to domestic companies. In certain tax treaties, however, the tax treaties themselves provide an upper limit/ place a cap on the tax rate. Refer Annexure for the relevant Articles of the respective tax treaties.

Thus, where the Treaty itself acknowledges that the tax rate differential shall not exceed 15 percentage points, following the precedents as laid down by the Supreme Court, the taxpayer has a good case to defend that Explanation 1 shall not override the provisions of the Treaty20. Good faith interpretation as enunciated by VCLT necessitates the treaty provisions to be good law.

D. Prescribed Arrangement under section 2(22A) of the Act – an open question

The Mumbai Bench of the Tribunal in the case of ITO v. Decca Survey Overseas Ltd21 had observed that in absence of a notified “prescribed arrangement” as provided under section 2(22A) of the Act, Explanation 1 to section 90 would not come in the way for the non-resident companies to claim tax rates equal to the resident companies. Thereafter, Rule 27 of the (Indian) Income-tax Rules, 1962 (“the Rules”) was inserted.

20    The priority of two provisions of the same rank can be achieved by the interpretation rules of lex specialis derogate legi generali and lex generalis posterior non-derogat legi speciali priori. The tax treaty provision is seen as the more special provision.

21    ITA No. 3604/Bom/94 dated 27.02.2004

Rule 27 has been reproduced below for easy reference:

“Prescribed arrangements for declaration and payment of dividends within India.

27. The arrangements referred to in sections 194 and 236 to be made by a company for the declaration and payment of dividends (including dividends on preference shares) within India shall be as follows:

(1) The share register of the company for all shareholders shall be regularly maintained at its principal place of business within India, in respect of any assessment year from a date not later than the 1st day of April of such year.

(2) The general meeting for passing the accounts of the previous year relevant to the assessment year and for declaring any dividends in respect thereof shall be held only at a place within India.

(3) The dividends declared, if any, shall be payable only within India to all shareholders.”

The same has been relied upon by the Mumbai Bench of the Tribunal in the case of Shinhan Bank v. DCIT22 to hold that a foreign company could carry out the “prescribed arrangement” to be eligible to be classified as a domestic corporation and hence held that there was no discrimination per se in differential rates of tax.

The observation of the Tribunal are as under:

“As a matter of fact, the terminology used, so far as the tax rate for companies is concerned, in the finance Acts is “domestic company” and “a company other than a domestic company?. Under section 2(22A), a domestic company is defined as “an Indian company or any other company, which in respect of its income liable to tax in India makes prescribed arrangements for declaration and payment of dividends within India”, and Section 2(23A), a foreign company is defined as a company “which is not a domestic company” i.e. which has not made prescribed arrangements for declaration and payment of dividends in India. The basis of different tax rates being applied is thus not the situs of fiscal domicile or incorporation but simply the arrangement for making arrangements for the declaration of payment of dividends within India.”

“If a non-resident company can make arrangements for the declaration and payment of dividends, out of income earned in India, in India, that non-resident company will be subjected to the same rate of tax which is levied on the Indian companies. The taxation of the foreign companies at a higher rate therefore at a higher rate vis-à-vis the domestic companies is thus not considered to be discriminatory vis-à-vis the foreign companies. The sharp contrast in the definition of a foreign company under section 2(23A) vis-à-vis the definition of a non-resident company under section 6(3) makes it clear that so far as the charge of tax is concerned, the critical factor is the situs of the control and management of a company, but so far as the rate of tax is concerned, the critical factor is the arrangements for the declaration of dividends out of income earned in India. Clearly, thus, the mere fact that a company which has not made “arrangements for the declaration of dividends out of income earned in India” is charged at a higher rate of tax in India vis-à-vis domestic company, cannot be treated as discrimination on account of the fact that the enterprise belonged to the other Contracting State, i.e. Korea.”

At first glance, the prescribed arrangement does not seem “other or more burdensome” since even domestic companies are required to withhold tax on dividend payments. However, the above reasoning leaves many open questions:

  • The US Company would arguably consolidate its earnings at the US level, it would merit consideration whether the US or any other country of residence of such shareholder grants Foreign Tax Credit (“FTC”) on account of taxes withheld in India.

To elaborate, say a US Company has shareholders which are either US-based or based outside the US, Canada for instance. The US company enters into a prescribed arrangement to withhold taxes on account of dividend payments to its shareholders (qua income derived from India), however would the residence country of the shareholders (Canada in this case) grant FTC to these shareholders on account of taxes withheld in India? Or would the same be in accordance with the Convention between US and Canada (in our illustration). Without the grant of FTC, this arrangement may palpably result in double taxation, which is the first objective, the Tax Treaty is aimed to mitigate!

  • Where the US Company enters into the prescribed arrangement and is classified as a domestic company, Revenue in India may allege that as a domestic company, the US Company is not entitled to the benefits of the Treaty.
  • Since dividend payments are taxable at the level of the shareholder (as opposed to perhaps a dividend distribution tax) is the prescribed arrangement proportionate to the object sought to be achieved? Especially since payment of tax on dividends is a vicarious liability for the US Company.
  • Since Rule 27 would apply regardless of the tax treaty in question, there may be a situation where the corporate law, in the other Contracting State, may restrict moving the share register/ holding a general meeting for passing the accounts, outside that jurisdiction, which is the essence under Rule 27. In that situation, fulfillment of conditions specified in Rule 27 may become an impossibility. Would Rule 27, in that case, be read down?

A similar controversy is pending before the Hon’ble Delhi High Court in the case of Gokwik Commerce Solutions v. DCIT23 wherein the taxpayer has contended that it was a recently incorporated entity and hence could not fulfill the strict conditions, for obtaining lower withholding certificate, specified under Rule 28AA which require the filing of financial statements for four previous years.

E. Effect of breach of the treaty obligation

Tax Treaties do not usually provide for remedies in cases of breach24 since treaties are essentially agreements entered into by sovereign states25. In Sanchez-Llamas v. Oregon,26 the Supreme Court of the United States opined that “where a treaty does not provide a particular remedy, either expressly or implicitly, it is not for the federal courts to impose one on the States through law making of their own.”27. Closer home, in T Rajkumar v. Union of India28, the issue under consideration before the Hon’ble Madras High Court was the constitutional validity of section 94A of the Act and notification and circular issued thereunder, specifying Cyprus as a notified jurisdiction area for the purposes of section 94A of the Act. As per the provisions under section 94A, the executive is empowered to notify any country as a notified jurisdictional area having regard to the other country’s lack of effective exchange of information.

The petitioners in the case, inter alia, argued that basis the doctrine of pacta sunt servanda, the executive could not invoke municipal/ internal law to annul the provisions of a tax treaty. The Court did not entertain the said plea where there was a breach of an obligation from a treaty partner. The Court, inter alia, observed:

“88. But, even if we invoke the rule of Pacta Sunt Servanda contained in Article 26 of the Vienna Convention, on the basis that the same was part of the customary international law, the petitioners would not be better off. This is for the reason that Article 26 of the Vienna Convention obliges both the contracting parties to perform their obligations in good faith. As pointed out earlier, one of the four purposes for which, an agreement could be entered into by the Central Government under Section 90(1), is for the exchange of information. If one of the parties to the Treaty fails to provide necessary information, then such a party is in breach of the obligation under Article 26 of the Vienna Convention. The beneficiary of such a breach of obligation by one of the contracting parties (like the assessee herein) cannot invoke the Vienna Convention to prevent the other contracting party (India in this case) from taking recourse to internal law, to address the issue.”

22    ITA No. 2227 & 2229/Mum/2017 and 139 taxmann.com 563
23    WP (C) No. 199/202, order dated 09.01.2023
24    Lord Arnold McNair, The Law of Treaties 574 (1961)
25    Id.
26    Sanchez-Llamas v. Oregon, 126 S. Ct. 2669 (2006)
27    Id. at 2680
28    239 Taxman 283 (Mad.)

Therefore, while the Treaty does not enlist any repercussion/ fall out of breach of a tax treaty by a Contracting State, an inference may be drawn from the above precedent in T Rajkumar (supra), that the other Contracting State (in this case, United States) is free to utilize its domestic law to remedy the situation and the same would not fall foul of international commitments.

View 1: In light of the preceding, once the ostensible breach takes place and is continuing it may logically follow that the corporate tax rate afforded to a US corporation operating in India should be equal to the domestic (concessional) tax rate as adjusted by the differential as provided in Article 14(2) of the Treaty.

View 2: Article 14(2) is akin to a proviso to Article 26 of the Treaty. Essentially, a concession given by the United States to India on a good-faith basis. The words used, as described in preceding paragraphs, is ‘[the] existing tax rate’, implying thereby that the differential was needed to be maintained with reference to the time of the entry of the Treaty29.

29    Bank of America v. Deputy Commissioner of Income-tax, [2001] 78 ITD 1 (Mumbai)

To take an analogy, in cases of commercial contracts, the offending parts would be severed and the rest would stand up. More generally called the blue pencil doctrine. It owes its existence in the time when Courts were called in question to adjudge equities, where the Court would not re-write the contract but severe the unenforceable clauses. Though the blue pencil doctrine is not an absolute proposition it is generally applied in commercial contracts and finds its statutory basis in the Indian Contract Act, 1872.

The offending part is the proviso to Article 26 and therefore till the existence or continuance of the breach, a view may be taken that the proviso, since it is severed, has no legal effect. In other words, and to borrow constitutional law principles, the clause stands eclipsed till the time the breach is remedied. Once remedied the clause may spring back, however, till such time, the clause has no legal validity.

Assuming therefore, once the ostensible breach takes place and is continuing it would follow that the corporate tax rate afforded to a US corporation operating in India should be equal to the domestic tax rate. This rate should not automatically be adjusted by 15 percentage points since the existence of this particular clause stands severed till the time the breach continues. Sequitur, parity should subsist and the full breadth and scope of the non-discrimination clause should apply to US corporations in ‘same circumstances’ as their domestic counterparts.

The US may adopt the above route/ interpretation and may issue a notification for the same, and in accordance with the precedent in T Rajkumar (supra) till the time the treaty breach survives the said notification would be valid.

III. CONCLUSION

This commentary remains a work in progress and only scratches the surface. The heart of the matter is on first principles – ensuring non-discrimination. The non-discrimination clause of a tax treaty is one of the most important protections that is afforded to non-resident investors. As Rowlatt J. wrote ‘in taxing statute one has to merely look at what is clearly said’30. I hope we start to see more through the lens of the great judge. In the same measure, a global convergence is required in principles of tax treaty interpretation and following observations of the Tribunal in the case of Meera Bhatia v. ITO31 serve as a ready reckoner to that ideal:

“7. In legal matters like interpretation of international tax treaties and with a view to ensure consistency in judicial interpretation thereof under different tax regimes, it is desirable that the interpretation given by the foreign courts should also be given due respect and consideration unless, of course, there are any contrary decisions from the binding judicial forums or unless there are any other good reasons to ignore such judicial precedents of other tax regimes. The tax treaties are more often than not based on the models developed by the multilateral forums and judicial bodies in the regimes where such models are being used to get occasions to express their views on expressions employed in such models. It is only when the views so expressed by judicial bodies globally converge towards a common ground that an international tax language as was visualized by Hon’ble Andhra Pradesh High Court in the case of CIT v. Vishakhapatnam Port Trust [1983] 144 ITR 1461, can truly come into existence, because unless everyone, using a word, or a set of words, in a language, does not understand it in the same manner, that language will make little sense.”

30    Cape Brandy Syndicate v I.R.C. (1 KB 64, 71)
31    38 SOT 95 (Mum. – Trib.)

Annexure

  • India – UK Tax Treaty provides:

“ARTICLE 26

NON-DISCRIMINATION

1. The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.

2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favorably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities in the same circumstances or under the same conditions. This provision shall not be construed as preventing a Contracting State from charging the profits of a permanent establishment which an enterprise of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar enterprise of the first-mentioned Contracting State, nor as being in conflict with the provisions of paragraph 4 of Article 7 of this Convention.”

  • India – Germany Tax Treaty carries similar verbiage:

“ARTICLE 24

NON-DISCRIMINATION

1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances and under the same conditions are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States.

2. The taxation of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as preventing a Contracting State from charging the profits of a permanent establishment which a company of the other Contracting State has in the first-mentioned State at a rate of tax which is higher than that imposed on the profits of a similar company of the first-mentioned Contracting State, nor as being in conflict with the provisions of paragraph 3 of Article 7 of this Agreement. Further, this provision shall not be construed as obliging Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes which it grants only to its own residents.”

  • India – Canada Tax Treaty provides a cap on rate of tax:

“ARTICLE 24

NON-DISCRIMINATION

1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.

2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.

3. Nothing in this Article shall be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.

4. (a) Nothing in this Agreement shall be construed as preventing Canada from imposing on the earnings of a company, which is a resident of India, attributable to a permanent establishment in Canada, a tax in addition to the tax which would be chargeable on the earnings of a company which is a national of Canada, provided that any additional tax so imposed shall not exceed the rate specified in sub-paragraph 2(a) of Article 10 of the amount of such earnings which have not been subjected to such additional tax in previous taxation years. For the purpose of this provision, the term ‘earnings’ means the profits attributable to a permanent establishment in Canada in a year and previous years after deducting therefrom all taxes, other than the additional tax referred to herein, imposed on such profits by Canada.

The provisions of this sub-paragraph shall also apply with respect to earnings from the disposition of immovable property situated in Canada by a company carrying on a trade in immovable property without a permanent establishment in Canada but only insofar as these earnings may be taxed in Canada under the provisions of Article 6 or paragraph 2 of Article 13.

(b) A company which is a resident of Canada may be subject to tax in India at a rate higher than that applicable to Indian domestic companies. The difference in tax rate shall not, however, exceed 15 percentage points.”

  • India – Russia Tax Treaty provides a similar cap though more beneficial to the taxpayer:

“PROTOCOL

TO THE AGREEMENT BETWEEN THE GOVERNMENT OF THE REPUBLIC OF INDIA AND THE GOVERNMENT OF THE RUSSIA FEDERATION FOR THE AVOIDANCE OF DOUBLE TAXATION WITH RESPECT TO TAXES ON INCOME

The Government of the Republic of India and the Government of the Russian Federation, Having regard to the Agreement between the Government of the Republic of India and the Government of the Russian Federation for the avoidance of double taxation with respect to taxes on income signed today (in this Protocol called “the Agreement”),

Have agreed as follows :

1. …………….

3. Notwithstanding the provisions of paragraph 2 of Article 24 of this Agreement, either Contracting State may tax the profits of a permanent establishment of an enterprise of the other Contracting State at a rate which is higher than that applied to the profits of a similar enterprise of the first-mentioned Contracting State. It is also provided that in no case the differences in the two rates, referred to above will exceed 12 percentage points.”

High Hits and Hard Hits of the Finance Bill 2023

On 1st February 2023, the Finance Minister (FM) presented the last full-fledged Union Budget of the present Government as India will go to polls in early 2024. The current Budget was against the backdrop of major global disruptions in the supply chain due to the Ukraine War, economic sanctions imposed by the USA, the Pandemic, and other natural calamities. The good part is that despite all odds, the Indian economy is showing signs of resilience and faring better than other large economies. It was an opportune time for the Government to consolidate the measures taken so far and build on them to lay a solid foundation for a developed India. Cross sections of society were expecting some relief from the Budget. The January 2023 Editorial made an appeal to the Government to provide much-deserved relief to the Middle-class population of India which was hard hit during the Pandemic and is currently reeling under rising inflation. It is heartening to note the Government chose to provide some relief to the Middle-class and endeavored to enhance the Ease of Living in India.

However, it is observed over the years that all good intentions mentioned in the Budget speech may not be reflected in the fine print of the Finance Bill. In the words of Nani A. Palkhivala “India is the fabled land of contrasts, but there is no disparity so glaring and costly as that between the prized ends solemnly pronounced in the budget speech every year and the provisions of the annual Finance Bill which are so admirably calculated to frustrate those objectives.”

With this background let us discuss some of the “high hits and hard-hitting” provisions of the Finance Bill, 2023.

One of the high hits of the Finance Bill is an increase in the limit of the rebate of income tax under section 87A for individuals from Rs. 5 Lakhs to Rs. 7 Lakhs under the new regime of taxation for individuals, which is now the default regime (old regime is optional). It is accompanied by the withdrawal of various tax incentives/deductions from the Gross Total Income. The objective as stated by the Government is to let people decide where to invest their money, rather than to invest compulsorily to save taxes. Thus, withdrawal of tax rebates/deductions for premiums on life insurance policies, PF & PPF contributions, medical insurance premia, donations to charitable trusts, etc. to get the lower tax rates will have far-reaching and long-term consequences.

Let us look at the macro impact. The government started spending on infrastructure and capital projects in a big way since 2020, – during the Pandemic and continues to do so. Private spending/investments on capital projects have increased manifold in the recent past. This will result in a substantial increase in production. This would necessitate a corresponding increase in consumption as well. According to the reply by the Government in the Lok Sabha on 13th February 2023, the total number of individual taxpayers with annual income between Rs. 5 lakhs to Rs. 10 lakhs for AY 2021-2022 were about 1.4 crores. Assume that one crore assesses opt for the new tax regime with a tax-free income of up to Rs. 7 lakhs without any tax incentive-linked savings. This is likely to make available an additional amount of about Rs. 2 lakh crores in the hands of the middle-class taxpayers which they are most likely to spend on consumer durables, necessities of life and other semi-luxury products, etc. This will generate demand for goods, add to the exchequer by way of GST and boost the Indian economy with an increased GDP. However, this may reduce savings in the country with a consequent impact on private-sector capital investment. Along with the Middle-class, the role and contribution of the MSME sector have also been recognized and given some relief too.

Coming to the high hits of the Union Budget, one finds that the FM has laid down clear paths and priorities in seven important areas of the economy, termed as ‘Saptarishi,’ to guide the country through the Amrit Kaal with an eye on India @ 100 in 2047. The focus of the government would be on inclusive growth of all sections of society, promotion of green growth and environment-friendly lifestyle, investments and infrastructure, technology, empowering youth, and financial sector reforms. Thus, when we look at the Union Budget, we find a sincere attempt to address all sections of society with a grand vision for years to come.

However, there are also some serious hard-hitting provisions in the Finance Bill.

The proposed increase in the TCS rates from 5% to 20% under section 206C (1G) of the Income-tax Act, 1961 (“Act”) in respect of remittances under the Liberalised Remittance Scheme or for overseas tour packages of any amount and other cases, except for education and medical treatment exceeding Rs. 7 lakhs, will cause genuine hardship to people. TCS should be used only for tracking a transaction and not as a revenue generation mechanism. In the recent past, the burden of TCS and TDS has increased manifold, especially on individuals and the MSME sector. A holistic relook at various provisions of TDS/TCS is the need of the hour, with the objective of reducing compliances and encouraging ease of doing business.

Another hard-hitting proposal is with respect to the proposed amendment of section 115TD which seeks to tax the accreted income, of a charitable trust or an institution, being the difference between the fair market value of all the assets as reduced by the liabilities if the trust or institution fails to make an application under section 10(23C) or 12A within the specified time period. The proposed amendment does not provide any leeway even in a case where the delay may be due to any reasonable cause or for a very short period for justified reasons. The irony is that the provision mandates paying the tax on such accreted income within 14 days from the end of the concerned previous year in which such failure has occurred. This is against the principle of natural justice. An elaborate procedure for the opportunity to condone the delay in genuine cases and issuance of show cause notice before such an action should be provided. It is suggested that a one-time EXIT SCHEME should be introduced with a reasonable tax rate for all trusts/institutions which do not wish to claim exemption owing to onerous compliance burden or otherwise. The reason being that trusts/institutions holding properties for ages will not have the cash flow to pay taxes on the fair market values of their assets.

Another disturbing provision in the recent past was regarding the denial of exemption under sections 10(23C) or 11, 12 if the return of income is filed late even by a day. Small trusts/NGOs do not have qualified or paid staff to look after accounts and compliances. Therefore, denial of exemptions and taxing trusts on their accreted income at the maximum marginal rate will be a death blow to small and medium-sized trusts/NGOs.

In recent years, the regime for taxation of charitable trusts and other charitable institutions in India has witnessed unprecedented changes and an increase in compliance burden, virtually strangulating the sector. Therefore, the entire law relating to trusts/NGOs should be rewritten to make it simple. Small trusts should be subjected to bare minimum compliances. All in all, trusts/NGOs should be dealt with more dignity and respect, as they are contributing immensely by providing relief to the poor and downtrodden masses. (Read the Editorial in BCAJ, October 2022 issue, titled “Uncharitable Treatment to Charities?). I think the time has come for providing “Ease of Social Services in India”.

Section 10(10D) read with section 56 of the Act is sought to be amended to provide the taxability of maturity sum on life insurance policies with an annual premium exceeding Rs. 5 Lakhs as income from other sources. One fails to understand why such maturity sum is sought to be taxed under section 56 as income from other sources rather than as capital gains as in the case of ULIPs. It is stated that the amendment is to tax High Net worth Individuals (HNIs). Why deprive HNIs of securing their future in a country which is a welfare state for only selected classes of society? Alternatively, introduce a passbook system for the HNIs to pay them pensions in their old age in proportion to their contribution to the exchequer. To quote Nani A. Palkhivala, “in trying to achieve the objective of levelling of income, our annual budgets merely succeed in widening the gulf between the dishonest rich and the poor and narrowing the gap between the honest rich and the poor.”

What is heartening to see is the sincerity with which the government has planned to implement the Budget Proposals. Prime Minister, Mr. Narendra Modi, conducting 12 webinars on Budget implementation is unprecedented. Barring a few unreasonable proposals, the Budget is in the right direction and if implemented well, can lead India to greater heights. Let’s hope and trust that these provisions will be suitably modified before they are passed by Parliament. The need of the hour is to build trust between the bureaucracy and the people at large by enforcing provisions of laws in a just, fair and humane manner!

Best Regards,

Dr. CA Mayur B. Nayak, 

Editor

J. P. NAIK

In this series, I am trying to introduce to the readers the great personalities who deserve our Namaskaars. These personalities included freedom fighters, scientists, social reformers, entrepreneurs and so on. They laid the foundation for our country’s all-round development. Without a good education, the development of a country is difficult. In this article, I am going to write about one of the greatest educational thinkers of the world Mr. J. P. Naik.

UNESCO has made a list of 100 great educationists of last 25 centuries. Three Indian names are included in that list – Mahatma Gandhi, Ravindranath Tagore and J. P. Naik. Very few of us would have even heard Mr. J. P. Naik’s name!

His real name was Viththal Hari Ghotge. In the year 1930, during Gandhiji’s movement of non-co-operation, he went underground and changed his name to Jayant Pandurang Naik (J. P. Naik). Born on 5th September, 1907 in the village Bahire Wadi, Ajra Taluka of Kolhapur district in Maharashtra, he passed away on 30.08.1981. He was a great humanist, freedom fighter, polymath, encyclopedic thinker and socialist educationist. He was known as an institution maker. In the year 1948, he founded the Indian Institute of Education. He served as Member Secretary of the Indian Education Commission between 1964 to 1966 and worked as Educational Adviser to the Government of India.

He joined the Civil Disobedience Movement of Mahatma Gandhi in 1932, was arrested and put in Bellari Jail for about 18 months. He studied medicine in jail and practised it by nursing prisoners, patients etc. He was UNESCO consultant for the development plan for the provision of universal elementary education. He was the chief architect of the comprehensive report of the Indian Education Commission.

In 1974, he was awarded ‘Padma Bhushan’ and a commemorative postal stamp of Rs.5/- was issued in his name on 5th September, 2007. He had many other achievements and honours to his credit.

He made a fundamental contribution to the fields of primary and secondary education, rural education, educational administration, the economics of education, research in education, the Indian Council of Social Science Research (ICSSR), research in social studies, non-formal education, educational problems of underdeveloped and developing countries, health, town planning and so on. Influenced by the work of Mahatma Phule, Gandhiji and Marx; he wrote many books on these subjects.

During the emergency years of 1975 to 1977, under the leadership of Shri Jayprakash Narayan, he worked as a member of a study group of 40 educationists and prepared a 75-page report on the education of Indian people. Jayprakash Narayan wrote a foreword to this report. His last book; ‘Education Commission and thereafter’ is a philosophical guide on education for future generations. He says educational reforms are not effective without social and economic development. For bringing about changes in the educational system, society has to incur costs in terms of not only money but taking and implementing hard and unpleasant decisions, Education system cannot arise and function in a vacuum; it is a sub-system of a socio-eco-political system. It often differentiates between the elite and the poor; which is not good. He advocated strong value systems.

Our humble Namaskaar to this great educational thinker!

CORPORATE LAW CORNER PART B : INSOLVENCY AND BANKRUPTCY LAW

8 Shekhar Resorts Ltd (Unit Hotel Orient Taj) vs. Union of India & Ors  (CIVIL APPEAL NO.8957 OF 2022)

FACTS

The corporate debtor was engaged in the business of proving hospitality services and therefore was registered with Service Tax Department. On evasion of taxes by the Corporate Debtor, show cause notices were issued by the Service Iax Department. In interregnum, one Financial Creditor had filed an application under section 7 of the Code and vide order dated 11th September, 2018 and therefore moratorium kicked in which got over on 24th July, 2020 when plan of a resolution applicant was approved by the Adjudicating Authority. The Corporate Debtor had filed an application through Form 1 under the Sabka Vishwas (Legacy Dispute Resolution) Scheme, 2019 within the due date as prescribed and the application was accepted and necessary forms were issued for payment of the tax due by Designation Committee i.e. Rs. 1,24,28500. However, due to moratorium imposed under section 14 of the Code, the corporate debtor was unable to deposit the tax within the due date. When he approached the Joint Commissioner CGST, he was told that as the payment was not made within the due date, the benefit of scheme could not be availed. Aggrieved by the order, the corporate debtor approached the Allahabad High Court but the Court refused to entertain the writ as the Designation Committee was not in existence.

Question of law

a)    Whether it was impossible for the corporate debtor to deposit the settlement amount due to restrictions under the IB Code and whether the corporate debtor can be punished for no fault of his?

b)    Whether the High Court was right in quashing the petition on the basis of non-existence of the Designation Committee?

HELD

It was evident from the backdrop that the Corporate Debtor cannot e deposit the sum due to the operation of law in place. The Corporate Debtor was unable to make the payment due to the legal impediment and the bar to make the payment during the period of moratorium. Even if the Corporate Debtor wanted to deposit the sum before 30th June, 2020,, it would be against the provisions of the Insolvency and Bankruptcy Code because of the calm period in action. Once a moratorium is kicked in, any existing proceeding against the Corporate Debtor shall stand prohibited and it is a well-settled law that IBC shall have precedence over any inconsistent legislations. When the Form No.3 was issued under the Scheme 2019, the Corporate Debtor was subjected to the rigors of process of IBC by virtue of the moratorium. In such a scenario, the Corporate Debtor cannot be rendered remediless and should not be made to suffer due to a legal impediment which was the reason for it and/or not doing the act within the prescribed time. The Corporate Debtor could not make the payment due to legal disability and no one can be expected to do the impossible.

It was also held that the High Court shall grant relief to the Corporate Debtor when there are valid reasons or causes for his inability to make the payment. The High Court cannot extend the time period of the Scheme under section 226 of Constitution of India but it can consider extra ordinary circumstances where there is a legal disability on the part of the Corporate Debtor for the interest of justice. The Designated Committee under the Scheme had been constituted on a need basis to comply with the orders of the courts across the country and in many cases they have rejected the applications under the Scheme, 2019 erroneously.

The Apex Court is of the view that the corporate debtor cannot be remediless just because he is restrained by law. It is a pity if a person is accused wrongly when he is willing to not do that wrong thing. The orporate Debtor cannot make the payment due to legal disability and therefore, he is entitled to claim benefits under the Scheme.

Proposed Changes to Reporting Material Developments

INTRODUCTION AND BACKGROUND

SEBI has proposed changes to the provisions related to reporting of material events/developments by listed entities. These provisions are contained in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“the Regulations” or “the LODR Regulations”).

Timely reporting of material events and developments with regards to listed entities is important for several reasons. It puts an end to speculation and gossip due to leaks, guesswork (informed or otherwise) or even media reports. It informs the investors and public of important developments in a timely way to enable them to take their decisions factoring these into account. Hence, they do not have to wait for the financial statements released within about one and half months at the end of every quarter, which, while have much improved over previous annual reporting, are still considered late if major developments take place between two such reporting dates.

Further, reporting right from the proverbial horse’s mouth, is more reliable than market gossip. Indeed, as we will see, while there are already some provisions related to reporting by listed entities to reports/rumors in the market, the proposed provisions now require mandatory reporting by certain listed entities.

Reporting of material events also helps curb insider trading since  more delayed the reporting, more are the chances of insiders abusing knowledge of price sensitive information. However, what is considered ‘material’ for the purposes of LODR Regulations is different from the corresponding term – price-sensitive information – under the Regulations relating to insider trading, even if one may see overlap. Further, while there is a fairly elaborate definition of what is considered price-sensitive, there is no specific definition of ‘material’ under the LODR Regulations.

Instead, it is seen that the term material is defined as a mix of specific cases that are deemed to be material and for other cases, there is a blend of policy and discretion. The listed entity is required to lay down a policy related to not only determining the materiality of events, but also one that gives an element of discretion to the specified key managerial personnel in this regard.

Further, while the Regulations related to insider trading focus more on proper preservation of price sensitive information and prevention/prohibition of its abuse, the LODR Regulations are more concerned with prompt reporting.

The LODR Regulations have broadly divided material events into two categories. There are a set of items deemed to be material leaving no discretion to the company in this regard. Thus, these have to be reported, irrespective of the amounts involved or their nature. Then, there is a list of items in respect of which the top specified executives have to exercise discretion and report if found material.

To these provisions, SEBI has now proposed several changes vide its consultation paper on 12th November 2022. After taking feedback, SEBI will notify the final amendments. However, as has been often the practice, and a good one at that, the consultation paper gives the actual wording of the proposed amendments to the regulations. Hence, even the fine print as proposed is available making it easier to visualize the implications in more detail than otherwise when only the description of the proposed amendments is given.

Let us consider some of the important amendments as proposed.

QUANTIFIED PARAMETERS TO GIVE MINIMUM LIMITS TO DETERMINE MATERIALITY

At present, as discussed, there are two categories of criteria to determine whether a particular event or development is material or not. In the first category, are clearly specified events deemed to be material and where, thus, no discretion is available to management but to report. There is criticism, and in some cases rightly so there are areas in which these deemed material events are not really material at all in substance. Hence, there is a needless deluge of information which the public may actually misconceive as material on one hand and, on the other hand, substantially material events get lost in these.

The second category relates to matters where a principle-based guidance is given by SEBI to determine materiality but the company has the discretion to decide whether or not an event is material in context of this guidance. It is now proposed that one more principle, a quantified one, be laid down to provide a minimum lower limit which, if crossed, would make the event material. Three alternative parameters are provided and if the impact of the information in financial terms exceeds any of these three parameters, then the same would be deemed material. These three parameters, simplified for present purposes are 2 per cent of turnover, 2 per cent of net worth or 5 per cent of average net profits of last 3 years, whichever is lower.

Quantified limits are always welcome as they reduce ambiguity, and thus also avoid second guessing by the regulator, often based on hindsight wisdom. However, they may often be far from the substance, and may at times make non-material events material, material events non-material or, worse, may miss items not easy to quantify.

Secondly, the quantified limits are applied irrespective of whether the event may impact the turnover, net worth or profits. Thus, an event may have a significant impact on the turnover but not on profits (or vice versa). If, even one of the limits is crossed, the event is deemed to be material. Thus, not only more events would be reported because quantified parameters are provided but the number would also be more since the parameters provided are three, and not necessarily connected to the nature of the event and the impact it may have on a particular parameter.

It is also provided that while the company may continue to determine the policy of how it determines material events, this policy will not dilute the specified quantified parameters. Thus, these parameters would represent absolute lower limits which even the policy or discretion cannot exclude.

ESCALATION OF INFORMATION OF MATERIAL EVENTS UP THE LADDER OF MANAGEMENT

Typically, it is the man or woman in the field or on the ground level who becomes aware of a development that could have such material implications requiring reporting under the Regulations. For example, there may be a fire at a plant whose implications would have to be determined as material or not. It may take some time for the information to reach, with relevant data, to the KMPs. However, these requirements specify a short time limit (which is proposed to be shortened even further, as we will see herein) within which the information should be reported.

SEBI now proposes that a system be laid down in the policy whereby the information of material events would be escalated up to the KMPs for them to determine whether such an event is material or not. The details of how this would work would be up to the company to frame.

SHORTER TIMELINES FOR REPORTING OF MATERIAL EVENTS

The present provisions have a generic requirement of reporting of material developments within a maximum of 24 hours. It is now proposed to divide these requirements into three categories. In case of developments that emanate from outside the organization, the time limit would be maximum 24 hours. In case the information emanates from within the organization, a shorter period of 12 hours would be available. In case of events arising out of Board meetings, within 30 minutes of closure of such meeting.

Companies particularly have to plan well for this since this is the maximum time available for many things. Firstly, for the information to reach the management. Secondly, for deciding whether the event is material, whether deemed to be so under the Regulations or otherwise determined to be so taking into account the principles as well as the quantified parameters laid down. Thirdly, to compile the information in the format, if so prescribed. Finally, reporting the same. Too often, the compliance officer and even external legal advisors have to provide inputs in the process. The already short time limits are being proposed to be cut further. This may end up affecting the quality of information including its clarity and specificity.

REACTING TO MEDIA REPORTS

Under existing provisions, it is discretionary for management to react to media reports or rumors regarding developments related to the company. Exchanges, however, may ask in some cases a company to react to specific news.

It is now proposed to make companies proactively react to news in mainstream media. To begin with, top 250 companies (based on market capitalization) would be required to react to news reported in mainstream media that could, if true, have material implications. What is considered mainstream media (which may be print or digital), however, is not defined or described.

Companies thus will now have to keep track of reports in mainstream media and react to them. No time limit has been prescribed but, at least in spirit of the provisions, the 24 hour limit may be considered.

RATINGS, REVISIONS, RATING SHOPPING

Presently, companies need to report on ratings and revisions thereon. Now it is proposed that such reporting should be carried out even if the rating (or revision thereto) was not requested by the listed entity or, if requested, such request has been withdrawn by it. This may counter rating shopping that some entities may engage in.

WIDER COVERAGE OF DEVELOPMENTS RELATING TO PERSONNEL

At present, resignations by independent director or auditor, frauds or defaults by promoter/key management personnel, etc, are required to be reported. Now, it is proposed that certain developments by other specified persons should also be reported on by the listed entity.

Such information, in situations like fraud, defaults, etc, would have to be informed first by the person concerned to the entity, for the latter to report. However, curiously, such persons themselves are not required to report to the company. SEBI may, however, take a view that the requirements implicitly require them to do such reporting and if they do not report, SEBI could take action against them. However, it would have been better if the provisions had contained a specific obligation on such persons to report to the listed entity and a time limit therefor. Even better, the person could report simultaneously also to the exchanges.

CONCLUSION

There are several other changes proposed. Curiously, there seems to be a distinct change in approach from a principle-based reporting to rule-based reporting. In other words, instead of laying down broad principles that would have wider effect but at the same time give discretion to the entity to decide for each event based on its substance, increasingly the discretion is being taken away. Instead, detailed rules are being specified for reporting giving quantified parameters, specific categories of events/persons, etc. Partly this may arguably be considered as a failure of the principle-based approach. However, rule based reporting may also end up being tick-the-box attitude where form has precedence over substance. Worse, particularly considering the wider coverage and also lower quantified limits, there may be a deluge of reporting in which the real material developments may be missed by most except the discerning few who have time and experience to monitor and screen the reports.

CORPORATE LAW CORNER PART A : COMPANY LAW

15 Hydro Prokav Pumps India Pvt Ltd ROC/CBE/A.O./10A/9881/2022 – Office of the Registrar of Companies, Tamil Nadu-Coimbatore Adjudication order Date of Order: 10th October, 2022

Adjudication order: Penalty for violation of not attaching notes to the financial statements which is the mandatory requirement as per section 134 (7) (a) of the Companies Act, 2013.

FACTS

HPPIPL was having its registered office at Coimbatore in the state of Tamil Nadu.

HPPIPL realised that the financial statements along with the Director’s report filed with the Office of the Registrar of Companies, Tamil Nadu-Coimbatore (‘RoC’) for the financial years ended as on 31st March, 2017, 31st March, 2018, 31st March, 2019, 31st March, 2020 and 31st March, 2021 did not contain the notes to the financial statements which is a mandatory requirement as per section 134 (7) (a) of the Companies Act, 2013.

Thereafter, HPPIPL and its directors filed a suo-moto application before the office of the Registrar of Companies, (‘RoC’) for Adjudication of the penalty for violation of provisions of Section 134 of the Companies Act, 2013.

Provisions of Sub-section (7) of Section 134 of the Companies Act, 2013; A signed copy of every financial statement, including consolidated financial statement, if any, shall be issued, circulated or published along with a copy each of:-

(a) Any notes annexed to or forming part of such financial statement;

(b) The auditor’s report and

(c) The board’s report referred to in sub-section (3);

Further, penal provision for any default/violation of Section 134 of the Companies Act, 2013 are provided under Sub-section (8) of section 134;

that if a company is in default in complying with the provisions of this section, the company shall be liable for a penalty of ₹3 lakhs and every officer of the company who is in default shall be liable to a penalty of ₹50,000.

HELD

The Adjudication Officer was of the view that HPPIPL had defaulted in complying with provisions of Section 134 (7) (a) by not attaching/annexing the notes to the financial statements. Hence, he imposed penalty on HPPIPL and every officer of the company in default in a manner as provided under provisions of Section 134 (8) of the Companies Act, 2013 as mentioned below:

Sr. No. Penalty imposed on Maximum penalty imposed
1. HPPIPL Rs. 3,00,000
2. Officers in default (Total 3
Officers of Company i.e. 3 Directors)		 Rs. 1,50,000

(Rs. 50,000
each)
TOTAL Rs. 4,50,000

It was further directed that the company and its director(s) rectify the defect immediately on receipt of copy of the order.

16 Kosher Realhome Pvt Ltd ROC/D/Adj Order /defective/2022 Office of the Registrar of Companies, NCLT of Delhi & Haryana Adjudication order Date of Order: 16th November, 2022

Adjudication order: Penalty for violation of Rule 8(3) of (Registration Offices and Fees) Rules 2014 under Section 450 and 446 B of the Companies Act, 2013 for filing incorrect attachments along with e-form AOC-4 with the Registrar of Companies.

FACTS

KRPL was having its registered office at Delhi.

The Registrar of Companies, Delhi & Haryana (‘RoC’) had issued a show cause notice to the Company and its Directors stating that the financial statements attached by KRPL in E-form AOC-4 with RoC were the financial statements of “IGCPL” i.e., Transferee Company instead of financial statements of “KRPL”.

Further KRPL and its officer in default submitted their reply to the RoC admitting the fact that financial statement of “IGCPL” were attached to e-form AOC-4 instead of “KRPL.”

The following provisions were violated by the KRPL and its officer/s in default;

  • Rule 8 (3) of Companies (Registration Offices and Fees) Rules, 2014; The authorised signatory and the professional if any, who certify e-form shall be responsible for the correctness of its contents and the enclosures attached with the electronic form
  • Rule 8 (7) of Companies (Registration Offices and Fees) Rules, 2014; It shall be the sole responsibility of the person who is signing the form and professional who is certifying it to ensure that all the required attachments relevant to the form have been attached completely and legibly as per provisions of the Act and rules made thereunder to the forms or application or returns filed.

Section 450 of the Companies Act, 2013 for penal provision for any default / violation where no specific penalty is provided in the relevant section / rules;

If a company or any officer of a company or any other person contravenes any of the provisions of this Act or the rules made thereunder, or any condition, limitation or restriction subject to which any approval, sanction, consent, confirmation, recognition, direction or exemption in relation to any matter has been accorded, given or granted, any for which no penalty or punishment is provided elsewhere in this Act, the company and every officer of the company who is in default or such other person shall be liable to a penalty of Rs. 10,000 and in case of continuing contravention, with a further penalty of Rs. 1,000 for each day after the first during which the contravention continues, subject to a maximum of Rs. 2,00,000 in case of a company and Rs. 50,000 in case of an officer who is in default or any other person.

Further, KRPL being a Small Company, applicability of Section 446B of the Companies Act, 2013 provides for lesser penalties for certain companies and the relevant provision is as given below:

Section 446B – Notwithstanding anything contained in this Act, if a penalty is payable for non-compliance of any of the provisions of this Act by One Person Company, small company, start-up company or Producer Company, or by any of its officer in default, or any other person in respect of such company, then such company, its officer in default or any other person, as the case may be, shall be liable to a penalty which shall not be more than one half of the penalty specified in such provisions, subject to a maximum of Rs. 2,00,000.

HELD

The Adjudication Officer held that the concerned director i.e. Mr. VP was authorized by the board of directors for certifying the financial statements in e-form AOC 4 with complete and legible attachments and therefore he was liable under section 450 of the Companies Act 2013, for the in-correctness of the content of e-form AOC-4 and enclosures attached with the same pursuant to Rule 8 of the Companies (Registration Offices and Fees) Rules, 2014.

The Adjudication Officer also considered the provision of section 446 B of the Companies Act, 2013, r.w.s2(85) of the Companies Act, 2013, as the company fulfilled the requirements of the small company. Therefore, lesser penalty was levied as mentioned below:

Violation of section/rule Penalty imposed on Company / directors Penalty specified under section 450 of the
Companies Act 2013		 Penalty imposed by the Adjudicating Officer
under section 454 r.w.s 446B of the Companies Act 2013
Rule 8 (3) of the Companies (Registration
Offices and Fees) Rules 2014		 Mr. VP, Director Rs. 10,000 Rs. 5,000

Further it was held that Mr. VP, who was the authorized signatory shall have to make the payment of penalty individually out of his funds.

The AO order also directed Mr. VP to rectify the default immediately from the date of receipt of copy of this order.

Hindu Gains of Learning Act

INTRODUCTION

Hindu Undivided Families (HUFs) often have a scenario wherein the family sponsors the education of one of the members and he goes on to become a successful professional/businessman. In such a case, the question that one comes across is whether the joint family, which has funded his education, can stake a claim to his earnings? In other words, can the other family members state that whatever income / wealth the member has on account of the investment made by the family in his education and hence, they should also share in the same? Let us examine this quite interesting facet of family law.

HINDU LAW AND HUF

Hindu Law is a unique statute since part of it is codified by the Parliament whereas part of it is governed by customs, traditions, and usages. The answer to the above questions could be dissected into two scenarios ~ the position before 1930 and the position post-1930.

POSITION BEFORE 1930

Before 1930, the position in this respect was dictated by the ancient uncodified Hindu Law which was explained by a Division Bench ruling of the Supreme Court in the case of Chandrakant Manilal Shah vs. CIT (1992) 193 ITR 1 (SC). It held that before 1930, it was settled law that income earned by a member of a joint family by the practice of a profession or occupation requiring special training was joint family property if such training was imparted at the expense of the joint family property.

Accordingly, till 1930 if a joint family had spent on a coparcener’s education, then whatever he earned by virtue of this degree/skill became joint family property in which all coparceners also had a right.

POSITION AFTER 1930

On 25th July, 1930, the Parliament passed the Hindu Gains of Learning Act, 1930 (“the 1930 Act”). The 1930 Act was passed to remove doubts as to the rights of a member of a Hindu Undivided Family in the property acquired by him by means of his learning.

Section 3 of the 1930 Act provides that notwithstanding any custom, rule, or interpretation of the Hindu Law, gains of learning of a member shall be held to be the exclusive and separate property of the acquirer even if —

(a) his learning having been, in whole or in part, imparted to him by any member, of his family, or with the aid of the joint funds of his family/ any family member, or

(b) himself or his family having, while he was acquiring his learning, been maintained or supported, wholly or in part, by the joint funds of his family, any member.

The Act further describes “gains of learning” in an inclusive manner to mean `all acquisitions of property made substantially through learning, whether such acquisitions be made before or after the commencement of this Act and whether such acquisitions be the ordinary or the extraordinary result of such learning’.

The important term “learning” has been defined to mean education, whether elementary, technical, scientific, special or general, and training of every kind which is usually intended to enable a person to pursue any trade, industry, profession or a vocation in life.

Thus, the net impact of the 1930 Act is that on and from the date of its enactment:

(a) All gains of learning of a coparcener of an HUF shall be held to be his exclusive and separate property even if his learning was funded by the joint family funds /HUF. Thus, all income earned by him by virtue of his skill / knowledge / learning would solely belong to him.

(b) Even acquisitions of properties made by him out of such gains of learning are treated as his exclusive and separate property and not that of the HUF.

(c) Hence, the HUF cannot claim any right, title or interest in such gains of learning of the coparcener.

RATIONALE

The Supreme Court in Raj Kumar Singh Hukam Chandji vs. CIT, [1970] 78 ITR 33 (SC) has explained the rationale behind the enactment of the 1930 Act. It held that in Gokul Chand vs. Hukum Chand Nath Mal AIR 1921 PC 35, the Judicial Committee ruled “that there could be no valid distinction between the direct use of the joint family funds and the use which qualified the members to make the gains on his efforts”. In making this observation, the Judicial Committee appeared to have been guided by certain ancient Hindu law texts. According to the Supreme Court that view of the law became a serious impediment to the progress of the Hindu society. It was well-known that the decision in Gokul Chand’s case (supra), gave rise to a great deal of public dissatisfaction and the Central Legislature was constrained to step in and enact the Hindu Gains of Learning Act, 1930, which nullified the effect of that decision.

JURISPRUDENCE

The Gujarat High Court in CIT vs. Dineschandra Sumatilal, 1978 112 ITR 758 (Guj) has explained this Act. It held that the law now recognised the distinction between the earnings of a coparcener as a result of his learning, efforts, and advancement in life and the income which a coparcener received merely as a result of the investment of the family funds in the source which produced such income.

The Court held that with technological advancements in commerce and industry, a qualified coparcener might be employed in a business in which his family had contributed its funds, and by his skill, experience, and labor, all of which were his incorporeal property or intangible assets, might contribute to the growth of such a business. If any remuneration was received by him for the services so rendered, it could not, by any stretch of imagination, be related to the joint family investment in the business. The salary of such a coparcener was not an alias for the return of profits of the investment made by the family. It was a legitimate return for the human capital – sweat, skill, and toil, which were productive investments, which the coparcener made in such business. To treat his income as the income of the family was not only not in consonance with the true legal position, but would also lead to the denial to the family business of the human capital which the coparcener would contribute with greater sincerity than an outsider. Thus, the Gujarat High Court held that even in a case where the HUF funded the business, the remuneration earned by the coparcener would remain his personal property.

The decision of the Supreme Court in Chandrakant Manilal Shah vs. CIT (1992) 193 ITR 1 (SC) held that the definition of the term ‘learning’ was wide and encompassed every acquired capacity which enabled the acquirer of the capacity “to pursue any trade, industry, profession or avocation in life”. Skill and labor involved as well as generated mental and physical capacity. This capacity was in its very nature an individual achievement and normally varied from individual to individual. It was by utilisation of this capacity that an object or goal was achieved by the person possessing the capacity. Achievement of an object or goal was a benefit. This benefit accrued in favor of the individual possessing and utilising the capacity. Skill and labour were by themselves possessions. They were assets of that individual and there seemed to be no reason why they could not be contributed as a consideration for earning profit in the business of a partnership firm. They certainly were not the properties of the HUF but were the separate properties of the individual concerned.The Court held that where an undivided member of a family qualified in technical fields – may be at the expense of the family – he was free to employ his technical expertise elsewhere and the earnings were his absolute property; he will, therefore, not agree to utilise them in the family business, unless the latter is agreeable to remunerate him therefore immediately in the form of a salary or share of profits.

The Madras High Court in the case of Prof. G. S. Ramaswamy (2003) 259 ITR 442 (Mad) was dealing with the case of a Professor who was educated from funds belonging to his joint family. He published a book on a technical subject and threw the royalties from the book into the HUF hotchpot and claimed that the royalties would now belong to the HUF. The Tax department objected on the grounds that after the passage of the 1930 Act, all gains of learning of an individual cannot be treated as HUF property even if the education was funded by the HUF funds. The High Court said while the proposition of the Department was correct, the 1930 Act would not apply if the coparcener himself took steps to blend his self-acquired earnings / property with the joint family hotchpot.

In K Govindrajan vs. K Subramanian, 2013 AIR (Mad) 80, it was contended that if a member got educated from out of the joint family funds, and also acquired properties, the member should put all those properties into the common hotchpot, and also render accounts. The Madras High Court negated this claim and held, nothing had been demonstrated as on what basis the plaintiff should render accounts of his earnings and also put all the properties he earned out of such learning into the common hotchpot. Simply because, he admitted that he got his education, during the lifetime of his father that per se did not mean that it should be construed that what all he acquired out of his salary should be put into common hotchpot. The 1930 Act was relied upon by the Court to hold this conclusion.

CONCLUSION

Based on the above discussion, the following position emerges:

(a)    If a coparcerner’s education was funded out of HUF property, even in that scenario, his earnings and investments would remain his separate property.

(b)    The 1930 Act would clearly apply in this case and all gains of learning of such a coparcener would be his separate self-acquired property.

(c)    Even investments made by the coparcener would be treated as his gains of learning.

(d)    As long as the coparcener has not taken any action of blending his gains of learning with the common family hotchpot and hence not converted his personal property into joint family property, the gains of learning would not be a part of the HUF property.

This very old piece of pre-independence legislation could help quell several family disputes. It is interesting to note that even though this Act has been around for over 80 years it has not got the recognition which it deserves!

MANAGED

Once upon a time, there was a large kingdom that was overpopulated. The new King was good. He had honest intentions to have a clean and efficient administration. He had a few good ministers; but over the past many years, there had been complete lawlessness and indiscipline. Many ministers and bureaucrats were addicted to lavish living and resorted to rampant corruption.

Nothing moved without ‘speed money’. Corruption was firmly rooted in every walk of life. School admissions, exam results, health services, transport, business deals, jobs, defense, internal security services, and even judiciary. Nothing favorable could be achieved without ‘setting’. All conscientious persons and professionals were finding it very difficult to survive and perform without resorting to undesirable things.

Nobody listened to professionals and wise people. Justice was delayed inordinately. Wrongdoers were never punished. On the contrary, they enjoyed a high status in society. The common man was frustrated. Meritorious students could not join their desired course of study due to peculiar policies of the Government. They preferred to go, study and settle abroad.

This corruption had percolated down to the common people. Nobody was interested in hard work. Everybody wanted easy and quick money. Therefore, even the common man had become lazy and corrupt. The new king wanted to clean up all these things, but bureaucracy never allowed him to do so. They troubled the common man more and more so that people would hate the king. Nobody wanted discipline.

Since there were many complaints and grievances, the king announced that he would listen to 10 grievances every day and would sort them out immediately. People had to personally come to collect coupons to meet him in serial order. King used to himself issue the tokens early morning strictly on a ‘first come first served’ basis. There was no record as to whom the tokens were issued as it was not considered necessary. The King had an ambitious plan to eradicate corruption.

One day, just after 10 tokens were distributed, a man came. He was educated and wanted to share many grievances against the revenue authorities. The King asked him to come the next day. He urged that he was traveling the next day; but the King was uncompromising and refused to entertain him.

At 9 am sharp, the King would sit for meeting the ten persons. To his surprise, the man who was refused the token appeared before him! King got confused and puzzled.

“Oh! You gentleman, the one who came late in the morning?

“Yes, Your Majesty”.

“How come, you got the serial number one token?”

“ I paid money to the first person!’

‘ How did you do it?”

“Sir, I am a tax professional. I have to manage all such things. Otherwise, we will not survive!

The King realised that even the common citizen who sold the token was tempted by money! He also realised that his task was endless like an ocean!
 

Overview of the United Arab Emirates’s Corporate Tax Law

In a recent important development on the international tax front, United Arab Emirates (“UAE”) has issued its Decree-Law introducing taxation of Corporations and Businesses on their income.

In this article the authors endeavour to make the readers aware of the salient features and provide an overview of the UAE’s new Corporate Tax (“CT”) law. It is expected that further information and guidance on the technical details and other specifics of the UAE’s CT Regime will be made available in due course by the Federal Tax Authority (“FTA”) and Ministry of Finance (“MoF”) of the UAE. Accordingly, the authors have not touched upon the areas which are yet to be clarified.

INTRODUCTION

The UAE has been one of the few countries in the world with no taxes on income for most of the taxpayers, with the exception of a few industries. However, keeping the changing international tax landscape of global minimum tax in mind, the UAE has sought to introduce income tax on Corporations and Businesses. The MoF of UAE had issued a Public Consultation Document 28th April, 2022 seeking comments by 19th May, 2022.

Following the comments received, the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“CT Law” or “CT Decree-Law”) was issued by the UAE on 9th December, 2022. The CT Law is materially aligned with the Public Consultation Document and expands on many of the key provisions.

The CT Law provides the legislative basis for the introduction and implementation of a Federal Corporate Tax in the UAE. CT is a form of direct tax levied on the net income of corporations and other businesses. The CT Law was published in the Official Gazette on 10th October, 2022 and became effective on 25th October, 2022 and will apply to Taxable Persons for financial years commencing on or after 1st June, 2023.

The law has been supplemented with CT FAQs comprising of 158 questions and answers, also released on 9th December, 2022 to provide guidance on the UAE CT Decree-Law. The reader is advised to refer to the same for a detailed study and understanding.

The UAE CT regime appears to build from best practices globally and incorporates principles internationally known and accepted, with a minimal compliance burden placed on businesses as compared to other regimes internationally, to ensure efficiency, fairness, transparency and predictability in the design and execution of the proposed CT regime.

On 16th May, 2018, the UAE became the 116th jurisdiction to join the Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”). The CT Law lays the foundation for the UAE to align with the global minimum tax initiative as proposed under Pillar Two of the OECD BEPS project. The introduction of a CT regime helps provide the UAE with a framework to adopt the Pillar Two rules.

OVERVIEW OF THE UAE CT LAW

The CT Law has 20 chapters and 70 articles covering a wide range of areas and provisions. A brief outline of the same is given for a better understanding of the overall contents of the Law.

Chapter Articles
One –
General provisions		 Article 1 – Definitions
Two –
Imposition of Corporate Tax and Applicable Rates		 Article 2 – Imposition of Corporate Tax

Article 3 – Corporate Tax Rate
Three –
Exempt Person		 Article 4 – Exempt Person

Article 5 – Government Entity

Article 6 – Government Controlled Entity

Article 7 – Extractive Business

Article 8 – Non-Extractive Natural Resource Business

Article 9 – Qualifying Public Benefit Entity

Article 10 – Qualifying Investment Fund
Four –
Taxable Person and Corporate Tax Base		 Article 11 – Taxable Person

Article 12 – Corporate Tax Base

Article 13 – State Sourced Income

Article 14 – Permanent Establishment

Article 15 – Investment Manager Exemption

Article 16 – Partners in an Unincorporated Partnership

Article 17 – Family Foundation
Five –
Free Zone Person		 Article 18 – Qualifying Free Zone Person

Article 19 – Election to be Subject to Corporate Tax
Six –
Calculating Taxable Income		 Article 20 – General Rules for Determining Taxable Income

Article 21 – Small Business Relief
Seven –
Exempt Income		 Article 22 – Exempt Income

Article 23 – Participation Exemption

Article 24 – Foreign Permanent Establishment Exemption

Article 25 – Non-Resident Person Operating Aircraft or Ships in
International Transportation
Eight –
Reliefs		 Article 26 – Transfers Within a Qualifying Group

Article 27 – Business Restructuring Relief
Nine –
Deductions		 Article 28 – Deductible Expenditure

Article 29 – Interest Expenditure

Article 30 – General Interest Deduction Limitation Rule

Article 31 – Specific Interest Deduction Limitation Rule

Article 32 – Entertainment Expenditure

Article 33 – Non-deductible Expenditure
Ten –
Transactions with Related Parties and Connected Persons		 Article 34 – Arm’s Length Principle

Article 35 – Related Parties and Control

Article 36 – Payments to Connected Persons
Eleven –
Tax Loss Provisions		 Article 37 – Tax Loss Relief

Article 38 – Transfer of Tax Loss

Article 39 – Limitation on Tax Losses Carried Forward
Twelve –
Tax Group Provisions		 Article 40 – Tax Group

Article 41 – Date of Formation and Cessation of a Tax Group

Article 42 – Taxable Income of a Tax Group
Thirteen
– Calculation of Corporate Tax Payable		 Article 43 – Currency

Article 44 – Calculation and Settlement of Corporate Tax

Article 45 – Withholding Tax

Article 46 – Withholding Tax Credit

Article 47 – Foreign Tax Credit
Fourteen
– Payment and Refund of Corporate Tax		 Article 48 – Corporate Tax Payment

Article 49 – Corporate Tax Refund
Fifteen
– Anti-Abuse Rules		 Article 50 – General anti-abuse rule
Sixteen
– Tax Registration and Deregistration		 Article 51 – Tax Registration

Article 52 – Tax Deregistration
Seventeen
– Tax Returns and Clarifications		 Article 53 – Tax Returns

Article 54 – Financial Statements

Article 55 – Transfer Pricing Documentation

Article 56 – Record Keeping

Article 57 – Tax Period

Article 58 – Change of Tax Period

Article 59 – Clarifications
Eighteen
– Violations and Penalties		 Article 60 – Assessment of Corporate Tax and penalties
Nineteen
– Transitional Rules		 Article 61 – Transitional Rules
Twenty –
Closing provisions		 Article 62 – Delegation of Power

Article 63 – Administrative Policies and Procedures

Article 64 – Cooperating with the Authority

Article 65 – Revenue Sharing

Article 66 – International Agreements

Article 67 – Implementing Decisions

Article 68 – Cancellation of Conflicting Provisions

Article 69 – Application of this Decree-Law to Tax Periods

Article 70 – Publication and Application of this Decree-Law

SALIENT FEATURES AND IMPORTANT PROVISIONS OF THE CT LAW

Effective Date

The CT Law will become effective for financial years starting on or after 1st June, 2023. Accordingly, for F.Y. 1st July, 2023 – 30th June, 2024, the effective date would be 1st July, 2023. However, if the F.Y. is 1st January, 2023 – 31st December, 2023 then the effective date would be 1st January, 2024 and if the F.Y. is 1st April, 2023 – 31st March,2024, then the effective date would be 1st April, 2024 [FAQ 4].

CT is imposed on Taxable Income, at the rates determined under this Decree-Law, and payable to the Authority under CT Decree-Law and the Tax Procedures Law.

CT RATE [ARTICLE 3]

CT will be levied at a headline rate of 9 per cent on Taxable Income exceeding AED 375,000. Taxable Income below this threshold will be subject to a 0 per cent (zero per cent) rate of CT.

CT will be charged on Taxable Income as follows:

A. Resident
Taxable Persons		 Rate of Tax
1 Taxable Income not exceeding AED 375,000

(this amount is to be confirmed in a Cabinet Decision )

 0%
2 Taxable Income exceeding AED 375,000 9%
B. Qualifying
Free Zone Persons (“QFZP”)
1 Qualifying Income 0%
2 Taxable Income that does not meet the Qualifying Income
definition		 9%

TAXABLE PERSON AND CT BASE, ETC [ARTICLES 11 TO 17]

CT applies to the following “Taxable Person”:

  • UAE companies and other juridical persons that are incorporated or effectively managed and controlled in the UAE;
  • Natural persons (individuals) who conduct or undertake a business activity in the UAE as specified in a Cabinet Decision to be issued in due course; and
  • Non-resident juridical persons (foreign legal entities) that have a Permanent Establishment (“PE”) in the UAE, derive a UAE-sourced income and have a nexus in the UAE.

The main purpose of the PE concept in the UAE CT Law is to determine if and when a foreign person has established a sufficient physical presence in the UAE to warrant the business profits of that foreign person to be subject to CT.

The definition of PE in the CT Law has been designed on the basis of the definition provided in Article 5 of the OECD Model Tax Convention on Income and Capital and the position adopted by the UAE under the Multilateral Instrument to implement tax treaty related measures to prevent base erosion and profit shifting. This allows foreign persons to use the relevant Commentary of Article 5 of the OECD Model Tax Convention when assessing whether or not a PE has been constituted in the UAE. This assessment should consider the provisions of any bilateral tax agreement between the country of residence of the non-resident person and the UAE.

Juridical persons established in a UAE Free Zone are also within the scope of CT as “Taxable Person” and need to comply with the requirements set out in the CT Law. However, a Free Zone Person that meets the conditions to be considered a QFZP can benefit from a CT rate of 0 per cent on their Qualifying Income only.

In order to be considered a QFZP, the Free Zone Person must:

  • maintain adequate substance in the UAE;
  • derive ‘Qualifying Income’;
  • not have made an election to be subject to CT at the standard rates; and
  • comply with the transfer pricing requirements under the CT Law.

The Minister may prescribe additional conditions that a QFZP should meet. If a QFZP fails to meet any of these conditions, or makes an election to be subject to the regular CT regime, he will be subject to the standard rates of CT from the beginning of the Tax Period where he failed to meet the conditions.

Non-resident persons who do not have a PE in the UAE or who earn UAE-sourced income not related to their PE may be subject to Withholding Tax (at the rate of 0 per cent). Withholding tax is a form of CT collected at source by the payer on behalf of the recipient of the income. One of the reasons for the payment being subject to a Withholding Tax at 0 per cent is to bring such income within the scope of the income tax law while not taxing it. Therefore, one may be able to argue that such an income is subject to tax in the UAE even though no tax has actually been paid on the same.

For the purposes of the CT Law, a distinction is made between a Resident Person and a Non-Resident Person and the applicable tax base will depend on the nature of the taxable person.

In line with the tax regimes of most countries, the CT Law taxes income on both residence and source basis. The applicable basis of taxation depends on the classification of the Taxable Person.

  • A “Resident Person” is taxed on income derived from both domestic and foreign sources (i.e. a residence basis).
  • A “Non-Resident Person” will be taxed only on income derived from sources within the UAE (i.e. a source basis).

Residence for CT purposes is not determined by where a person resides or is domiciled but instead by specific factors set out in the CT Law. If a person does not satisfy the conditions for being either a resident or a non-resident person then he will not be a Taxable Person, and will not therefore be subject to CT.

Briefly, the following aspects should be considered when determining the nature of a Taxable Person as well as the applicable tax base:

Resident Person Tax base
An entity that is incorporated in the UAE (including a Free Zone
entity)		 Worldwide income
A foreign entity that is effectively managed and controlled in
the UAE		 Worldwide income
A natural person/individual who conducts a business or
undertakes business activity in the UAE		 Worldwide income
Non-resident Person Tax base
Has a PE in the UAE Taxable income attributable to the PE
Derives UAE-sourced income The UAE-sourced income not attributable to the PE
Has a nexus in the UAE Taxable income attributable to such a nexus

EXEMPT PERSON [ARTICLES 4 TO 10]

Certain types of businesses or organizations are exempt from CT given their importance and contribution to the social fabric and economy of the UAE. Exempt Persons include:

Exemption Category Entities covered
Automatically exempt a) Government Entities

Government Controlled Entities specified in a Cabinet Decision
Exempt if notified to the Ministry of Finance (and subject to
meeting certain conditions)		 a) Extractive Businesses

b) Non-Extractive Natural Resource Businesses
Exempt if listed in a Cabinet Decision a) Qualifying Public Benefit Entities
Has a PE in the UAE Taxable income attributable to the PE
Exempt if applied to and approved by the FTA (and subject to
meeting certain conditions)		 a) Public or private pension and social security funds

b) Qualifying Investment Funds

c) Wholly-owned and controlled UAE subsidiaries of a Government
Entity, a Government Controlled Entity, a Qualifying Investment Fund, or a
public or private pension or social security fund.
Has a nexus in the UAE Taxable income attributable to such a nexus

In addition to not being subject to CT, Government Entities, Government- Controlled Entities specified in a Cabinet Decision, Extractive Businesses and Non-Extractive Natural Resource Businesses may also be exempted from any registration, filing and other compliance obligations imposed by the CT Law, unless they engage in an activity which is within the charge of CT.

Resident and Non-resident Persons

Insofar as foreign incorporated entities effectively managed and controlled in the UAE are concerned, no additional guidance is provided in the CT Law. Therefore, taxpayers should rely on guidance from the OECD’s international tax commentaries, which provide detailed guidance on determination of ‘effective management and control’.

NON-RESIDENT PERSONS

Certain UAE sourced income of a Non-Resident Person that is not attributable to a PE in the UAE will be subject to withholding tax @ 0 per cent.

It will be subject to UAE CT on any Taxable Income attributable to the PE of the non-resident, or any UAE sourced income where the income is not attributable to the PE, or any Taxable Income attributable to the nexus of the non-resident in the UAE.

Both Resident Persons and Non-Resident Persons are regarded as Taxable Persons for purposes of the CT Law, meaning that the tax compliance obligations for these persons should be carefully considered.

DETERMINATION OF TAXABLE INCOME [ARTICLE 20]

CT is imposed on Taxable Income earned by a Taxable Person in a Tax Period. CT would generally be imposed annually, with the CT liability calculated by the Taxable Person on a self-assessment basis. This means that the calculation and payment of CT is done through the filing of a CT Return with the FTA by the Taxable Person.

The starting point for calculating the Taxable Income is the Taxable Person’s accounting income (i.e. net profit or loss before tax) as per their financial statements. The Taxable Person will then need to make certain adjustments to determine his Taxable Income for the relevant Tax Period. For example, adjustments to accounting income may need to be made for income that is exempt from CT and for expenditure that is wholly or partially non-deductible for CT purposes.

For this purpose, the financial statements should be prepared in accordance with accounting standards accepted in the UAE. The UAE does not have its own Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRS”) are commonly used by businesses in the UAE.

In order to arrive at Taxable Income, expenditure incurred wholly and exclusively for the purposes of the Taxable Person’s Business, not capital in nature, may be deductible in the Tax Period in which it is incurred. However, the CT Law disallows/restricts the deduction of certain expenses. This is to ensure that relief can only be obtained for expenses incurred for the purpose of generating Taxable Income, and to address possible situations of abuse or excessive deductions.

The CT Law prescribes a number of key adjustments to the accounting net profit (or loss) in order to compute the Taxable Income. These include; unrealised gains/losses (Taxable Persons now have an election to make on how to treat it), exempt income, certain tax reliefs, non-deductible expenditure, Transfer Pricing (“TP”) adjustments, tax loss reliefs, other incentives or special reliefs for a Qualifying Business Activity (as specified in a future Cabinet Decision), and any other income or expenditure as may be specified in a Cabinet Decision at a later stage.

The CT law makes reference to certain incentives and special relief for qualifying business on which further detail will be provided in a subsequent cabinet decision. The CT law is also silent on the tax treatment of depreciation, adjustments in respect of revenue and expense items accounted for in Equity or Other Comprehensive Income and Leases.

SMALL BUSINESS RELIEF [ARTICLE 21]

Article 21 provides that a tax resident person may elect to be treated as not having derived any Taxable Income where the revenue for the relevant and previous tax periods do not exceed a threshold and meet certain conditions, set or prescribed by the Minister.

If a tax resident person applies for “small business relief”, certain provisions of the CT Law will not apply such as exempt income, reliefs, deductions, tax loss relief, TP compliance requirements, as specified in the relevant chapters of the CT Law. The Authority may request any relevant records or supporting information to verify the compliance within a timeline, to be prescribed.

EXEMPT INCOME [ARTICLES 22 TO 25]

The CT Law also exempts certain types of income from CT. This means that a Taxable Person will not be subject to CT on such income and cannot claim a deduction for any related expenditure. Taxable Persons who earn exempt income will be subject to CT on their Taxable Income.

The main purpose of a certain income being exempt from CT is to prevent double taxation on certain types of income. Specifically, dividends and capital gains earned from domestic and foreign shareholdings will generally be exempt from CT. Furthermore, a Resident Person can elect, subject to certain conditions, to not take into account income from a foreign PE for UAE CT purposes.

The following income and related expenditure shall not be taken into account in determining the Taxable Income:

1. Dividends and other profit distributions received from a juridical person that is a Resident Person.

2. Dividends and other profit distributions received from a Participating Interest in a foreign juridical person as specified in Article 23.

3. Any other income from a Participating Interest as specified in Article 23.

4. Income of a Foreign PE that meets the condition of Article 24.

5. Income derived by a Non-Resident Person from operating aircraft or ships in international transportation that meets the conditions of Article 25.

RELIEFS [ARTICLES 26 & 27]

Article 26 contains provisions for relief in respect of Transfers within a Qualifying Group and provides that no gain or loss needs to be taken into account in determining the Taxable Income in relation to the transfer of one or more assets or liabilities between two Taxable Persons that are members of the same Qualifying Group.

Two Taxable Persons shall be treated as members of the same Qualifying Group where all of the following conditions are met:

a) The Taxable Persons are juridical persons that are Resident Persons, or Non- Resident Persons that have a PE in the UAE.

b) Either the Taxable Person has a direct or indirect ownership interest of at least 75 per cent (seventy-five per cent) in the other Taxable Person, or a third Person has a direct or indirect ownership interest of at least 75 per cent (seventy-five per cent) in each of the Taxable Persons.

c) None of the Persons qualify as an Exempt Person.

d) None of the Persons qualify as a QFZP.

e) The Financial Year of each of the Taxable Persons ends on the same date.

f) Both Taxable Persons prepare their financial statements using the same accounting standards.

Article 27 contains provisions for Business Restructuring Relief and provides tax relief on mergers, spin-offs and other corporate restructuring transactions where whole or independent part of business is being transferred in exchange of shares or other ownership interest provided the following conditions are met:

a) The transfer is undertaken in accordance with, and meets all the conditions imposed by, the applicable legislation of the UAE.

b) The Taxable Persons are Resident or Non-Resident Persons that have a PE in the UAE.

c) None of the Persons qualify as an Exempt Person.

d) None of the Persons qualify as a QFZP.

e) The Financial Year of each of the Taxable Persons ends on the same date.

f) The Taxable Persons prepare their financial statements using the same accounting standards.

g) The transfer is undertaken for valid commercial or other non-fiscal reasons which reflect economic reality.

DEDUCTIONS [ARTICLES 28 TO 33]

In principle, all legitimate business expenses incurred wholly and exclusively for the purposes of deriving a Taxable Income will be deductible, although the timing of the deduction may vary for different types of expenses and the accounting method applied. For capital assets, expenditure would generally be recognized by way of depreciation or amortization deductions over the economic life of the asset or benefit.

Expenditure that has a dual purpose, such as expenses incurred for both personal and business purposes, will need to be apportioned with the relevant portion of the expenditure treated as deductible if incurred wholly and exclusively for the purpose of the taxable person’s business.

Certain expenses deductible under general accounting rules may not be fully deductible for CT purposes. These will need to be added back to the Accounting Income for the purposes of determining the Taxable Income. Examples of expenditure that is or may not be deductible (partially or in full) include:

Types of Expenditure Limitation to deductibility
•  Bribes

•  Fines and penalties (other than amounts
awarded as compensation for damages or breach of contract).

•  Donations, grants or gifts made to an entity
that is not a Qualifying Public Benefit Entity

•  Dividends and other profits distributions

•  Corporate Tax imposed under the CT Law

•  Expenditure not incurred wholly and
exclusively for the purposes of the Taxable person’s Business

 No deduction
•  Expenditure incurred in deriving income that
is exempt from CT
•  Entertainment Expenditure Partial deduction of 50% of the amount of the expenditure
•  Interest Expenditure Deduction of net interest expenditure exceeding a certain de
minimis threshold up to 30 per cent of the amount of earnings before the
deduction of interest, tax, depreciation and amortization (except for certain
activities).

Further, there are certain exclusions, for example, expenses incurred in deriving an exempt income will not be tax deductible.

WITHHOLDING TAX [ARTICLE 45]

A 0 per cent withholding tax may apply to certain types of UAE-sourced income paid to non-residents insofar as it is not attributable to a PE of the non-resident. Because of the 0 per cent rate, in practice, no withholding tax would be due and there will be no withholding tax related registration and filing obligations for UAE businesses or foreign recipients of UAE sourced income.

Withholding tax does not apply to transactions between UAE resident persons.

TAX LOSSES [ARTICLES 37 TO 39]

Businesses will be able to carry forward tax losses indefinitely, subject to certain conditions. These losses can be used to offset up to 75 per cent of the taxable income of future tax periods. Losses incurred before the effective date of CT will not be eligible for relief.

TAX GROUP [ARTICLES 40 TO 42]

Two or more Taxable Persons who meet certain conditions can apply to form a “Tax Group” and be treated as a single Taxable Person for CT purposes.

To form a Tax Group, both the parent company and its subsidiaries must be resident juridical persons, have the same Financial Year and prepare their financial statements using the same accounting standards.

Additionally, to form a Tax Group, the parent company must:

  • own at least 95 per cent of the share capital of the subsidiary;
  • hold at least 95 per cent of the voting rights in the subsidiary; and
  • is entitled to at least 95 per cent of the subsidiary’s profits and net assets.

The ownership, rights and entitlement can be held either directly or indirectly through subsidiaries, but a Tax Group cannot include an Exempt Person or QFZP.

Forming a Tax Group may be more efficient from a tax standpoint when compared to each legal entity in a group filing on a standalone basis. This is mainly due to reduced administration costs, offsetting tax losses and profits within the group and the fact that inter-company balances and transactions between group entities should typically be eliminated on consolidation, thus reducing TP compliance obligations.

With regards to the offsetting tax losses and profits within the group, pre-grouping tax losses of any joining member will be the carried forward losses of the Tax Group; however, the offset of such pre-grouping loss is limited by the attributable income of the new joining member.

TAXABLE INCOME OF A TAX GROUP

To determine the Taxable Income of a Tax Group, the parent company must prepare consolidated financial accounts covering each subsidiary and member of the Tax Group for the relevant Tax Period. Transactions between the parent company and each of the group member and transactions between them would be eliminated for calculating the Taxable Income of the Tax Group.

TAX REGISTRATION AND DEREGISTRATION, RETURNS, CLARIFICATIONS, VIOLATIONS AND PENALTIES [ARTICLES 51 TO 60]

All Taxable Persons (including Free Zone Persons) will be required to register for CT and obtain a CT Registration Number. The FTA may also request certain Exempt Persons to register for CT.

Taxable Persons are required to file a CT return for each Tax Period within 9 months from the end of the relevant period. The same deadline would generally apply for the payment of any CT due in respect of the Tax Period for which a return is filed.

TRANSACTIONS WITH RELATED PARTIES AND CONNECTED PERSONS I.E. “TP” [ARTICLES 34 TO 36 AND 55]

The TP provisions will also take effect for financial years starting on or after 1st June, 2023.

The term ‘Related Parties’ has been defined in a very broad manner. When a legal entity or individual has more than 50 per cent of direct or indirect ownership or control over a taxable person, this falls within the related party definition. In addition to ‘related parties’ and ‘connected persons’, the law also defines ‘control’ as ‘the ability of a person, whether in their own right or by agreement or otherwise, to influence another person’.

TP rules seek to ensure that transactions between Related Parties are carried out on Arm’s Length Price (“ALP”), as if the transaction was carried out between independent parties and the consideration of transactions with Related Parties and Connected Persons needs to be determined by reference to their “Market Value”. The market value may represent an arm’s length range of financial results or indicators, subject to certain conditions.

Transactions between domestic related parties as well as between mainland and free zone entities are all covered within the scope of the Law.

A non-resident person, through a PE in the UAE, would also be subject to the UAE TP provisions, and therefore would be required to maintain and submit the relevant TP documentation.

Transactions carried out between different business lines of an Exempt Person (e.g. an exempt business and a non-exempt business of an Exempt Person) should also be carried out in accordance with the ALP.

Methods: For the purpose of the application of the ALP, the Law sets forth 5 TP methods (by applying one or a combination), broadly in line with the OECD TP Guidelines. The 5 methods are (a) Comparable Uncontrolled Price Method; (b) Resale Price Method; (c) Cost Plus method; (d) Transactional Net Margin Method; and (e) Transactional Profit Split Method.

In case neither of these methods can be reasonably applied, the Law allows for the application of any other TP method to the extent that it would lead to an arm’s length result.

Documentation: Certain businesses will be required to submit a disclosure containing information regarding their transactions with Related Parties and Connected Persons along with their tax return.

Certain businesses may be requested to maintain a master file and a local file.

The FTA may seek a taxpayer to provide a copy of their Master File or Local File or any information to support the arm’s length nature at any time by issuing a notice of not less than 30 days.

Threshold and format of the master file and a local file to be prescribed by the FTA.

The CT FAQs state that businesses which claim small business relief will not have to comply with the TP documentation rules.

Corresponding Adjustment: In the event of an adjustment imposed by a foreign tax authority which impacts a UAE entity, an application must be made to the FTA for a corresponding adjustment to provide the UAE Company with relief from double taxation. A corresponding adjustment related to a domestic transaction does not require this type of application.

TP Adjustment: While making any TP adjustments to the tax base of taxable persons, the FTA would need to rely on information that can or will be made available to the Taxable Person.

Advanced Pricing Agreements (APAs): An APA is an approach that attempts to prevent TP disputes from arising by determining criteria for applying the ALP to transactions in advance of those transactions taking place. The law provides that APAs will be exploitable, through the regular clarification process that is already in place.

The CT Law does not provide any materiality thresholds, but it is expected that the MoF will issue further guidance /clarification in this respect.

Penalties: Presently, no specific penalties for non-compliance of TP documentation requirements or non-submission of such information have been set out in the Law.

GENERAL ANTI-ABUSE RULE (‘GAAR’) [ARTICLE 50]

Article 50 applies to a transaction or an arrangement if, having regard to all relevant circumstances, it can be reasonably concluded that the entering into or carrying out of the transaction or arrangement, or any part of it, is not for a valid commercial or other non-fiscal reason which reflects economic reality; and the main purpose or one of the main purposes of the transaction or arrangement, or any part of it, is to obtain a CT advantage that is not consistent with the intention or purpose of CT Law.

Where the GAAR applies, the Authority may make a determination that one or more specified CT advantages are to be counteracted or adjusted. If such a determination is made, the Authority must issue an assessment giving effect to the determination and can make compensating adjustments to the UAE CT liability of any other person affected by the determination.

For the purpose of determining whether the GAAR applies to a transaction or arrangement, specific facts and circumstances should be analysed, such as form and substance, the manner in which entered into, the timing, whether the transaction or arrangement has created rights or obligations which would not normally be created between persons dealing with each other at arm’s length, changes in the financial position of the Taxable person or of another person etc.

In any proceeding concerning the application of the GAAR, the Authority must demonstrate that the determination made is just and reasonable.

Considering that GAAR aims to counteract any abusive tax arrangements, taxpayers should ensure that all their transactions have a bona fide business purpose and are properly documented.

CONCLUSION

With the CT law and FAQs in place, businesses should assess what impact the new CT law will have on their operations and legal structure. One should consider the law carefully and areas that are yet to be clarified by the MoF by way of separate Cabinet Resolutions / Ministerial decisions.

In this connection it would be advisable to (a) read the CT Law and the supporting information available on the websites of the MoF and the FTA; (b) use the available information to determine whether the business will be subject to CT and if so, from what date; (c) understand the requirements for business under the CT Law, including, for registration, determination of the accounting / tax Period, applicable due date for filing CT return, elections or applications may or should make and financial information and records needed to be kept for CT purposes. Further, regularly visiting the websites of the MoF (https://mof.gov.ae/) and the FTA (https://www.tax.gov.ae/en/) for further information and guidance on the CT regime will be useful.