Category: Article

Business reorganizations have always been of vital importance for any entity to meet certain needs, expand the business, etc. and have risen over time to explore various opportunities. The drivers that create interest in various forms of restructuring could be internal or external. Equally important is the tax aspect of such business reorganization.

The judiciaries have given importance to the law of succession while interpreting the tax implications in the hands of the successor. In the present article, we have dealt with the tax implications in the hands of the successor / resulting company and the benefits that can be passed on to the resulting company.

The Apex Court has laid down certain principles as a law of succession, which acts as a guide to assess the implications under various scenarios. In the case of succession through amalgamation, the SC¹ has held that although the outer shell of the entity is destroyed in case of amalgamation, the corporate venture continues to exist in the form of a new or the existing transferee entity. The SC in another decision² emphasized the point that the successor-in-interest becomes eligible to all the entitlements and deductions which were due to the predecessor firm subject to the specific provisions contained in the Act. Basis the said findings of the SC, what can be underlined is that the successor should be entitled to the benefits which would have been otherwise available to the predecessor had the restructuring not taken place.

In the present Article, we are discussing the tax implications in the hands of the successor under a few of the provisions of the Act.

1   PCIT vs Mahagun Realtors (P) Ltd. : [2022] 443 ITR 194 (SC)

2   CIT vs. T. Veerabhadra Rao : (1985) 155 ITR 152 (SC)

A) CARRY FORWARD AND SET-OFF OF MAT CREDIT

Section 115JAA deals with the carry forward and set-off of Minimum Alternate Tax (‘MAT’) credit in the subsequent years pursuant to any tax liability discharged under section 115JB of the Act. However, the provisions do not provide any specific clarifications for carrying forward MAT credit in case of business reorganizations, except a restriction to carry forward MAT credit in case of conversion of a Company to an LLP as per section 115JAA(7) of the Act. A few of the important points for consideration are discussed hereunder:

Whether MAT liability entity-specific or business-specific?

Before analyzing the impact under different forms of business reorganization, it is important to understand whether MAT liability is entity-specific or business-specific. And consequently, who should be eligible for the MAT credit; i.e., the entity who has discharged the MAT liability or if the MAT liability pertains to the business, then the entity who is in control of the business.

The provisions of section 115JAA state that the credit of the MAT liability discharged in the past should be allowed to the person who has paid such MAT liability. Relevant extracts of the provisions are reproduced as follows, for easy reference.

“…(1A) Where any amount of tax is paid under sub-section (1) of section 115JB by an assessee, being a company for the assessment year commencing on the 1st day of April 2006 and any subsequent assessment year, then, credit in respect of the tax so paid shall be allowed to him in accordance with the provisions of this section.”

Thus, the wording of the provision, basis literal interpretation, allows credit to the same person who has discharged the liability and the same is the contention of the Revenue.

Generally, tax liabilities are taxpayer-specific, wherein an entity is required to discharge the tax liability on the total book profit (in the case of MAT liability), which would be a consolidated profit from all the businesses carried on by the taxpayer. However, an equally important fact of the tax laws is that tax is on the income earned from the businesses carried on by the taxpayer. As held by the SC in the case of Mahagun Realtors (P) Ltd (supra), in case of amalgamation, the corporate venture continues and it just that the form of the entity changes. Thus, the importance is on the venture undertaken and the assets and liabilities are associated with the said venture and not the entity. Even the provisions for recovery of demand in case of succession permit the Revenue Authority to recover demand from the successor. Thus, these provisions also indicate that the tax is on the income earned from the relevant businesses.

Basis the above interpretation, identifying MAT credit particular to any undertaking could be a point of possibility in order to pass on the MAT credit, which would be available for set-off in the hands of the successor company that takes over the relevant part of the business from the transferor company. To put it in other words, it can be contended that the MAT liability discharged is specific to a particular business carried on by the company and can be passed on to the entity that is in control of such business.

Amalgamations and demergers are tax-neutral

Amalgamations and Demergers, if undertaken by complying with the conditions provided under the Act, are intended to be tax-neutral transactions. Accordingly, the successors should be entitled to all the available tax benefits as a part of succession which are associated with the businesses taken over. Thus, where in the past, any MAT liability was discharged on the book profits in relation to the business transferred, the credit of the same should be entitled to the successor company. To view it from another perspective, if the MAT credit relating to the business transferred is carried forward by the transferor company, it would lead to the set-off of the MAT credit in relation to the business which is transferred, against the tax liability on the income that would be retained by the transferor company. This could be an unjust position. Further, the said proposition would otherwise be impossible, at least in the case of amalgamation, where the amalgamating company ceases to exist. Thus, again, the contention that should prevail is that the MAT credit should be passed on to the successor company.

All the assets and liabilities to be transferred in case of amalgamation and demerger

One of the conditions under section 2(1B) dealing with amalgamation requires all the properties of the amalgamating company to become the properties of the amalgamated company. Similar provisions are for demergers wherein even section 2(19AA) requires all the properties of the demerged undertaking to be transferred to the resulting company.

Thus, all the properties could be contended to include the MAT credits of the entity (in case of amalgamation) and undertaking (in case of demerger). The important consideration would be to identify the MAT credit relating to the demerged undertaking in case of a demerger. Thus, the relevant computation needs to be in place to justify the MAT credit relating to the demerged undertaking and if it is possible to identify such MAT credit, a reasonable argument could be that even the MAT credits, as a part of the business, needs to be transferred.

However, a point that requires deliberation is whether MAT credit could be said to be “property” as the above provisions relating to amalgamation and demerger speaks about “properties” and not “assets”. Ideally, the intention in amalgamation and demergers is to include all the properties including trade receivables, cash and bank balance and other advances, etc. Thus, the word “property” would have a broader meaning and a justifiable proposition should be to also include MAT credits.

Approval of the Schemes by the Courts

If there are no statutory provisions on any specific issue, in that case, the scheme of arrangement as approved by the Courts (now NCLT) would have statutory recognition. The Mumbai Tribunal Bench³ had allowed the demerged entity to carry forward the MAT credit as the scheme was approved by the Court, holding that the tax payments until the appointed date would belong to the demerged entity. Thus, where any scheme of arrangement permits the carry forward of MAT credit to the successor, the scheme will prevail.

3   DCIT vs. TCS E-serve International Limited (ITA No. 2779/Mum/2108)

However, now the judicial authority to grant approvals for the various scheme of arrangements is the National Company Law Tribunal (‘NCLT’). Thus, it needs to be assessed as to whether the decisions, in respect of schemes where Courts were the approving authority, could also prevail and hold good where the approvals of the schemes are through NCLT.

As per the Companies Act, the scheme of arrangement would have statutory force, once the same is approved under the relevant provisions of the Companies Act. Accordingly, it may be argued that the scheme holds a position of sanctity once it receives the sanction of the NCLT and cannot be disturbed. A scheme is said to have statutory force under all the Acts for all the stakeholders unless any clause of the scheme is contrary to other provisions of the Act. Thus, once a scheme is sanctioned and is in force under one law, all the clauses for the said scheme should be said to have legal sanctity.

No case of dual credit

In the case of amalgamation, there are no chances of dual credit that could be claimed by two parties as the amalgamating company would cease to exist post-amalgamation. Hence, there is no question of claiming dual credits by both parties. The same would be a reasonable position to contend⁴

Even in the case of a demerger, if the MAT credit is transferred to the resulting company and the resulting company has paid for such takeover of credit, then naturally, the demerged entity should be debarred from claiming the MAT credit again.

To summarize, the position of carry forward of MAT credit in case of amalgamation is reasonable and there are judicial precedents providing assent for the same. However, the issue is slightly on a separate footing with distinct judicial precedents in the case of demergers. The Ahmedabad Tribunal⁵ has allowed the MAT credit to be carried forward by the resulting company in case of demerger, though certain aspects were not considered or argued by the Revenue. Thus, though a strong argument of the law of succession should equally apply in the case of demergers as in the case of amalgamation, the practical difficulties of apportioning the MAT credit to the demerged entity are equally challenging. Additionally, the contention that MAT credit associated with the business undertaking and not to be entity-specific also needs judicial sanction as the wording of the provisions do not support the same, basis the argument of tax being linked with income.

4   Ambuja Cements Ltd. vs. DCIT : [2019] 111 taxmann.com 10 (Mum Tri), Capgemini Technology Services India Ltd. in ITA Nos. 1857 & 1935/Pun/2017

5   Adani Gas Limited vs. ACIT in ITA Nos. 2241 & 2516/Ahd/2011

B) DEDUCTIONS UNDER SECTION 40(A) / 43B

At times, there are certain disallowances under section 40(a) for non-deduction of tax at source, or under section 43B for non-payment of statutory dues, or other payments prescribed under the said section. Generally, the deduction for the said expenses is allowed in the year when the tax is deducted or prescribed payments are made, unless the liabilities are discharged before the filing of the return of income under section 139(1) of the Act as prescribed.

The issue arises as to the allowability of deduction in the case of amalgamations or demergers where the disallowances happen in a particular financial year in the hands of the transferor companies, whereas the payments are made after the appointed date by the transferee companies.

In the absence of any explicit provisions in the above scenarios of business reorganizations, a question arises on the allowability of expense in the hands of the predecessor or successor due to the change of hands of the person incurring expenditure, and the person discharging the liability. There are multiple views adopted by the assessees due to a lack of clarity in the law and diverse judicial precedents.

i) As per the general principles of law, the deductibility of the expense is allowed to the assessee who has incurred the expenditure and expensed it out in the profit and loss account. However, the provisions of section 40(a) and section 43B come with an exception, where the allowability is deferred to the year in which the tax is deducted or expenses are paid, respectively.

ii) In the case of amalgamation as well as demerger, the definitions require all the liabilities to be taken over by the transferee company. Thus, the above statutory liabilities should also be taken over by the transferee company to meet the requirements under the Act. Thus, there is no option available to the predecessor companies in the case of a demerger to continue with such liabilities in the demerged entity. In the said scenarios, the question is whether the transferee company would be eligible for the deduction on making the respective payments or discharging the liabilities, or the same should be allowed to the transferor company.

iii) However, where such liabilities are taken over by the resulting company, the same is contended to be a capital expenditure by the Revenue on the ground that it arises on account of a capital account transaction of acquiring the business. Resultantly, the claim is denied to the transferee company and also to the transferor company.

It could be important to highlight the decision of the SC⁶ rendered in the context of taxability under section 41 wherein it was held that the amalgamated company should not be subjected to tax under section 41, as the corresponding expenses were claimed as a deduction by the predecessor entity, which ceased to exist. It was then that an amendment was made to section 41 whereby the provisions were specifically introduced to tax the successor company in the above scenario. The said precedence in the context of section 41 could be considered while assessing the deduction in the hands of the transferor company in case of demerger, or successor company in case of amalgamation and demerger.

6   Saraswati Industrial Syndicate Ltd vs. CIT : (1990) 186 ITR 278 (SC)

Implications under section 40(a)

iv) We may first analyze the provisions of section 40(a) of the Act which states that any expenditure on which tax is deductible will be allowed as a deduction only when tax is deducted and paid before filing the return of income under section 139(1) of the Act.

The provisions of the Act simply say that the deduction would be available when the tax is deducted and deposited to the credit of the Central Government. It does not talk about who should be allowed a deduction for the same. Thus, what can be construed is that the person who ultimately complies with the above conditions would be eligible for the deduction. When looking at the intent of the provisions, the focus is on the liability to deduct and deposit tax and naturally, the entity that complies with the condition should be eligible for the deduction.

v) Say for example, there is an expense which is debited to the profit and loss account in the books of the predecessor company. However, the tax is not deducted on the same and thus, there is a disallowance while computing the total income of the amalgamating company. Thereafter, amalgamation takes place, and the tax is deducted and paid by the amalgamated entity. A question arises as to whether the amalgamated company would be eligible for the deduction under section 40(a) of the Act. A similar situation may also arise in the case of a demerger. The only difference is that in the case of a demerger, the demerged entity would continue to be in existence, unlike in the case of amalgamation.

In the above scenario, as far as the amalgamation is concerned, a possible contention could be that the deduction should be allowed to the amalgamated company as the predecessor company ceases to exist. However, the scenario in the case of a demerger may differ as the entity that was subject to the disallowance, i.e., the demerged entity, continues to exist. Thus, taking an analogy from the decision of the SC in the case of Saraswat Industrial Syndicate Ltd. (supra), it can be contended that deduction should be allowed to the demerged entity in the year when the liability is discharged by the resulting company. While adopting such a position, there needs to be co-ordination between the entities to understand when such payments are made and that the resulting company is not claiming the deduction as well.

vi) As an alternate view, reference is made to the decision of the SC in the case of CIT v. T Veerabhadra Rao (cited supra), whereby the claim of bad debts was allowed in the hands of the transferee company even though the corresponding income was offered to tax by the predecessor company. Drawing an analogy from the same, deduction could be claimed by the successor company under section 40(a) on discharge of such liabilities even when the expense was incurred by the predecessor and disallowed in its hands.

Implications under section 43B

vii) Section 43B deals with deduction of any expense only while computing the income in the year in which such liability is paid by the assessee, irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him. Basis the literal reading of the law, the provisions of section 43B do not specifically mention that the deduction will only be allowed in the hands of the person who incurred and discharged the liability.

viii) Similar to the contention adopted for deduction under section 40(a) and adopting an analogy basis the decision of the SC in the case of Saraswat Industrial Syndicate Ltd. (supra), a similar plea could continue even in case of deductibility under section 43B, whereby, the demerged entity can claim deduction once the resulting company discharges the liability. However, due to the act of impossibility in case of amalgamation where the amalgamating company ceases to exist, the deduction could only be claimed in the hands of the successor company.

ix) Another way of looking at the provisions is that the income tax provisions treat certain specific dues mentioned under the section as expenses of the year in which the same are actually paid and no regard is given to the accounting principles followed by the assessee.

Consequently, it can be argued that the deduction should be allowed to the person discharging the liability. The provisions of section 43B are an exception to the general law in which the provision itself states that the expenses which are otherwise allowable under the Act, should be allowed as a deduction on a payment basis. Thus, in light of the same and obeying the provisions of the Act, the deduction of the expense could be allowed as a deduction basis for actual payment to the entity that has made the payment.

x) At the same time, while adopting the above view, there could be a practical difficulty in cases where the year of demerger is also the first year of the resulting company. The liabilities that would be discharged by the resulting company would pertain to the preceding previous years when the resulting company was not in existence and the expenses were booked by the demerged entity. Thus, the reporting under the relevant clause of the Tax Audit Report for section 43B stating liabilities pre-existing on the first day of the previous and being paid during the year, could be a practical challenge.

xi) The Mumbai Tribunal⁷ has relied on the principle held by the SC in the case of T Veerabhadra Rao, K Koteswara Rao & Co. (cited supra) and allowed the deduction of liabilities under section 43B to the transferee, on the reasoning that the transferee had taken over all the assets and liabilities of the transferor.

xii) The Mumbai Tribunal⁸ has analyzed the eligibility of deduction under section 43B in the hands of the transferor in the year in which slump sale took place. The Tribunal observed that the transferor cannot by contract, transfer or shift his statutory obligation to the transferee and thus, there was no basis to hold that impugned liability stands discharged by the transferor upon sale of its undertaking on slump sale basis.

Thus, in the absence of any explicit provisions, Revenue can contend a similar proposition even for demergers.

xiii) The implications in the case of demergers are litigious with divergent views. Thus, it is advisable to provide for a suitable clause in the scheme of arrangement for such statutory dues, which would give a legal sanction through approval of the scheme. Separately, it is also advised to have a suitable disclosure in the Tax Audit Report about the positions taken, to reflect the conscious and bonafide claim.

7   In KEC International (2011) 136 TTJ 60 (Mum Tri), Huntsman International (India) Private Limited (ITA No.3916 and 1539/Mum/2014)

8   Pembril Engineering (P) Ltd. v. DCIT (2015) 155 ITD 72 (Mum Tri)

C) IMPLICATIONS UNDER SECTION 79 IN LIGHT OF SECTION 72A

i) Section 79 of the Act restricts the carry forward and set off of business loss incurred in any preceding previous years by a company (other than a company in which the public is substantially interested and an eligible start-up company), if the shares of the company carrying more than 49 per cent of the voting power change hands and are beneficially held by different shareholders in the previous year when the losses are set off, as compared to the year when the losses were incurred. The provisions were introduced to prevent business reorganizations undertaken where the profits earned by a company are intended to be set off against the losses of the target company.

ii) Correspondingly, section 72A of the Act deals with specific provisions for carried forward and set-off of losses in case of amalgamations and demergers, subject to fulfilment of certain conditions.

iii) The provisions are mutually exclusive to each other. However, there could arise a situation in the cases of amalgamation and demergers between unrelated parties, which could lead to a change in the shareholding of the entities and where provisions of section 79 get triggered. At the same time, if the conditions of section 72A are fulfilled, the losses should be allowed to be carried forward in the hands of the successor company. Thus, it would be important to understand the interplay between the two provisions and we have tried to cover some issues in this regard.

Issue regarding carry forward of losses of the predecessor company to the successor company

iv) Before dealing with the interplay between the above provisions, it would be important to understand a scenario where the losses of the demerged entity are transferred to the resulting company, which is a profit-making entity. In the said scenario, the question is whether the provision of section 79 will be applicable in the said scenario. It may be noted that in the above scenario, the demerged entity is not going to claim the losses as the same are transferred to the resulting company. Thus, where the losses are not carried forward and set off by the demerged entity, the question of applying the provisions of section 79 will not be applicable.

Thereafter, another question is whether the provisions of section 79 will be applicable to the resulting company while setting off the losses of the demerged undertaking. It may be noted that the provisions of section 79 could come into play when losses of the same entity are proposed to be set off. In the above scenario, the losses proposed to be set off pertains to the demerged undertaking which comes due to demerger. Thus, ideally, a contention could be that the provisions of section 79 will not be applicable where the resulting company intends to set off the losses acquired by way of demerger.

Having said so, if there is contention to apply the provisions of section 79 even on set-off losses of the demerged undertaking by the resulting company, the following contentions could be considered.

v) One of the important legal interpretations of the above two provisions is that both Section 79 and Section 72A of the Act start with a non-obstante provision. While the former applies notwithstanding anything contained in Chapter VI of the Act, the latter applies notwithstanding anything contained in any other provisions of the Act. Thus, Section 79 of the Act has an overriding effect only over Chapter VI of the Act whereas Section 72A of the Act has an overriding effect over any other provisions of the Act. Thus, section 72A ideally should prevail over the provisions of section 79 of the Act.

vi) Another point to be noted is that the provisions of section 79 speak about losses incurred in the years preceding the previous year in which there is change in the shareholding of more than 49 per cent.

vii) Section 72A(1) states that in case of amalgamation, the losses incurred in the preceding previous years would be deemed to be the loss of the year in which the amalgamation took place and would be available for carry forward and set off for a period of 8 years thereafter. Accordingly, it can be contended that the provisions of section 79 will not be applicable in case of amalgamation and the amalgamated company can carry forward and set off the losses of the amalgamating company.

viii) However, unlike in the case of amalgamation, the provisions relating to a demerger are quite different. The provisions of sub-section (4) of section 72A do not cover the above deeming provisions. Accordingly, the losses of the preceding previous years would pertain to the said years only and would be available for carry forward and set off to the resulting company only for the balance years.

ix) However, a contention may be taken that the provisions of section 72A are more specific as it deal with an explicit scenario of amalgamation and demerger. Thus, as per the general rule of interpretation, the specific provisions will prevail over general provisions. Accordingly, the provisions of section 79 cannot be applied in case of amalgamations and demergers which meet the requirements of section 72A. This proposition is supported by a decision of the Mumbai Tribunal⁹.

9   Aegis Ltd. vs. Addl. CIT in ITA No. 1213 (Mum) of 2014

x) Thus, overall, considering the general rules of interpretation and intent of the introduction of provisions of section 72A, a liberal view is plausible that provisions of section 79 do not apply where requirements of section 72A are met.

xi) However, it may be noted that the present discussion is only limited towards the interplay of provisions of section 72A v/s section 79. There are other conditions also required to be fulfilled as per other provisions of the Act and requirements prescribed under section 72A need to be met to carry forward and set off the loss.

An issue where the successor company had losses and on account of amalgamation, the shareholding pattern changes by more than 49 per cent.

xii) In this scenario, say for example, the successor company had certain brought forward losses and pursuant to the business reorganization, the shareholding of the successor company changes by more than 49 per cent. Thus, as per the provisions of section 79 of the Act, the losses pertaining to the successor company would lapse. The provisions of section 72A would not apply to such losses, as section 72A deals with losses of the predecessor company getting transferred to the successor company.

xiii) Sub-section (2) of section 79 has provided certain exceptions where the provisions of section 79 will not apply. However, the said exceptions do not cover the above scenario. Thus, a position could be that the provisions of section 79 would get triggered, and the losses of the successor company may lapse.

xiv) Another way to look at the provisions is where the losses of the predecessor company are allowed to be set off in the hands of the successor company even if there is a change in the shareholding of the successor company by more than 49 per cent. However, at the same time, losses of the successor company itself are not allowed to carry forward and set off as the provisions of section 79 get triggered. Thus, this indicates an anomaly in allowing the set off of losses of the predecessor company and the successor company in the same restructuring of amalgamation and demerger.

xv) Additionally, it could also be a difficult proposition to digest the applicability of section 79 as the change in the shareholding is not on account of any transfer of shares by the existing shareholders of the successor company, but change is only in the percentage of shareholding i.e., dilution of the holding due to issue of shares to the new shareholders due to scheme of arrangement. However, it could be difficult to claim losses in the absence of any specific provisions and the basis of the literal reading of the provisions.

xvi) On the contrary, the applicability of section 79 in the above scenario could be genuine to avoid deliberate restructuring to set off the losses of the successor company against the profits of the predecessor company.

xvii) Thus, the contentions could change on the basis of the genuineness of the restructuring undertaken keeping aside the applicability of the provision basis the literal reading.

CONCLUDING THOUGHTS

There are following few other provisions which needs assessment for tax implications in the hands of the successor company:

— Implications under section 56(2)(viib) on the issue of shares pursuant to any business reorganization

— Treatment of depreciation on Goodwill / Intangible assets taken over

— Depreciation on other depreciable assets

— Tax implications under tax holiday provisions

Thus, there are plethora of issues which have implications in the hands of the successor entities apart from other transaction related issues, and it is important to take a position which has a reasonable view.

BCAJ Admin

1. GENERAL BACKGROUND AND SCOPE

1.1 Upon completion of the assessment of total income by the Assessing Officer (AO), the amount of tax payable by the assessee is determined. It is quite common to see huge additions being made, in many cases, which result in huge demands arising as a result of a tax on additions made to the returned income and interest thereon under section 234B (and in cases where the return of income was filed beyond due date than under section 234A as well). The amount determined to be payable by the assessee is stated in the notice of demand issued under section 156 and the amount so mentioned is generally payable within 30 days from the date of issue of the notice of demand. The notice of demand issued under section 156 of the Act accompanies the assessment order.

1.2 Non-payment of the amount specified in the notice of demand, which is validly served on the assessee, within the time mentioned in the notice will mean that the assessee becomes an `assessee in default’ and consequently is liable to not only interest and penalty being levied on the amount of demand which is unpaid but also coercive steps being taken for recovery of the unpaid amount. Refunds of other years may be adjusted against such demands which have arisen as a result of disputed additions.

1.3 As per CBDT Instruction No. 1914 dated 2^nd February, 1993 (hereinafter referred to as “the said Instruction”) —

i) the Board is of the view that, as a matter of principle, every demand should be recovered as soon as it becomes due;

ii) the responsibility of collection of the demand is upon the AO and the TRO;

iii) except for demands which are stayed every other demand is required to be collected;

iv) it is the responsibility of the supervisory authorities to ensure that the AOs and the TROs take all such measures as are necessary to collect the demand;

v) mere issuance of show cause notice with no follow-up is not to be regarded as an adequate effort to recover taxes.

1.4 While an assessee may choose to file an appeal against the assessment order, a question arises as to whether an assessee is bound to pay the demand which is disputed by the assessee. Many times, demands are of such a magnitude as would disrupt the smooth functioning of the business of the assessee. If recovery proceedings are to continue in spite of an appeal having been preferred, then the entire purpose of the appeal will be frustrated or rendered nugatory.

1.5 Does the filing of an appeal operate as a stay or suspension of the order appealed against? Is the assessee entitled to a stay of demand or instalments? Is the AO empowered to grant stay in a case where the assessee chooses to file a revision application under section 264? What is the position in case an assessee chooses not to contest the additions? Is granting of stay mandatory? Is AO bound by the Guidelines issued by CBDT? Is the AO bound by the restrictions imposed by the guidelines on exercise by the AO of the discretionary power conferred upon him by the statute under section 220(6) of the Act? These are some of the many questions which arise for consideration and are considered in this article.

1.6 Upon completion of the assessment, demand may arise as a result of —

i) additions made which are accepted by the assessee;

ii) additions which are disputed by the assessee and against which the assessee chooses to file a revision application under section 264 of the Act;

iii) additions which are disputed by the assessee and against which the assessee files an appeal under section 246 or section 246A to the JCIT(A) or CIT(A);

iv) additions which are disputed by the assessee and against which the assessee files an appeal to the Tribunal.

1.7 In a situation of the type referred to in (i) above it is quite unlikely (even unimaginable) that, in actual practice, a stay will ever be granted. Situations of the type mentioned in (ii) and (iv) above will be covered by the powers vested in the AO under section 220(3) of the Act. The situation of the type mentioned in (iii) above will be covered by the power vested in the AO under section 220(6) of the Act.

1.8 The power of the Tribunal to grant a stay of demand is not covered by this article.

2 ARE DECISIONS RENDERED IN THE CONTEXT OF PRE-DEPOSIT PRESCRIPTIONS PLACED BY A STATUTE OF RELEVANCE?

2.1 A plethora of judicial precedents are available in the context of pre-deposit prescriptions placed by a statute. The principles enunciated therein would clearly be relevant while examining the extent of power placed in the hands of the AO in terms of section 220(6) of the Act — National Association of Software and Services Companies (NASSCOM) vs. DCIT [(2024) 160 txmann.com 728 (Delhi HC); Order dated 1st March, 2024]. Courts have while deciding upon the allow ability or otherwise of the writ petitions filed by the assesses against refusal to grant stay by authorities, have based their decision on judicial precedents rendered in the context of pre-deposit prescription placed by a statute and have applied the ratio laid down by such decisions.

2.2 Consequently, this article contains references to decisions rendered in the context of Excise and Customs Laws to the extent it is considered that the said decisions are helpful in the context of the provisions of the Act.

3 NO COERCIVE RECOVERY CAN BE TAKEN DURING THE PENDENCY OF THE RECTIFICATION APPLICATION AND/OR STAY APPLICATION AND/OR TILL SUCH TIME AS STATUTORY TIME FOR FILING THE APPEAL EXPIRES.

3.1 Many times, assessment orders and/or tax computations have mistakes which are apparent on record and can be rectified by the AO under section 154 of the Act. An assessee is well advised to check if either the assessment order and/or the tax computation has any mistakes which are rectifiable under section 154 of the Act. In the event any such mistakes are found, an application should be made to the AO under section 154 of the Act requesting him to rectify these mistakes by passing an order under section 154 of the Act. Para D(iii) of the said Instruction requires the rectification application should be decided within 2 weeks of the receipt thereof. It goes on to say that instances where there is undue delay in deciding rectification applications, should be dealt with very strictly by the CCITs / CITs. In actual practice, this instruction is followed more in breach, and we find rectification applications undisposed for prolonged periods. Be that as it may, till the rectification application is not disposed of coercive steps cannot be taken for recovery of the demand because correct demand should be determined before an assessee can be treated as an assessee in default. For this proposition reliance may be placed on the decision in Sultan Leather Finishers P. Ltd. vs. ACIT [(1991) 191 ITR 179 (All. HC)].

3.2 Also, where an assessee has made an application to the AO for granting a stay of the demand which has arisen, then till the stay application is not disposed of by the AO, no coercive steps can be taken for recovery of the demand —Dr T K Shanmugasundaram vs. CIT & Others [(2008) 303 ITR 387 (Mad HC)] and UTI Mutual Fund vs. ITO [(2012) 345 ITR 71 (Bom.)].

Very recently, the Delhi High Court while deciding the writ petition filed by NASSCOM (supra) has termed the action of the AO in adjusting the refund against demand for AY 2018-19, while application for grant of stay under section 220(6) was pending to be wholly arbitrary and unfair. The court observed “Undisputedly, and on the date when the impugned adjustments came to be made, the application moved by the petitioner referable to section 220(6) of the Act had neither been considered nor disposed of. The respondents have thus, in our considered opinion, clearly acted arbitrarily in proceeding to adjust the demand for AY 2018-19 against the available refunds without attending to that application. This action of the respondents is wholly arbitrary and unfair.” The court allowed the writ petition and remitted the matter back to the AO for considering the application under section 220(6) in accordance with the observations made by the court in its order.

3.3 In a case where a stay application filed by the assessee before the AO is rejected or the AO has granted a stay but the assessee is not satisfied and has preferred an application to the PCIT / CIT for review of the order of AO then till such time as the application filed before the PCIT / CIT is not disposed of the AO cannot take any coercive steps to recover the demand. Para B(iii) of the said Instruction is also suggestive of this interpretation. However, the assessee should keep the AO informed of having preferred a review of his order.

3.4 No coercive action shall be taken till the expiry of the period within which an appeal can be preferred against the order which has resulted in the creation of the demand sought to be recovered — Mahindra and Mahindra Ltd. vs. UOI [(1992) 59 ELT 505 (Bom. HC)].

3.5 The Bombay High Court has in the case of UTI Mutual Fund vs. ITO [(2012) 345 ITR 71 (Bom.)] held that no recovery of tax should be made pending—

i) expiry of the time limit for filing an appeal; and

ii) disposal of a stay application, if any, moved by the Applicant and for a reasonable period thereafter to enable the Applicant to move to a higher forum.

3.6 Recovery of demand arising as a result of high-pitched assessment is dealt with in Para 5 herein.

4 POWER OF THE AO TO GRANT STAY IN A CASE WHERE AN APPEAL HAS BEEN PRESENTED TO JCIT(A) / CIT (A) — SECTION 220(6)

4.1Section 220(6) reads as under —

“(6) Where an assessee has presented an appeal under section 246 or section 246A the Assessing Officer may, in his discretion and subject to such conditions as he may think fit to impose in the circumstances of the case, treat the assessee as not being in default in respect of the amount in dispute in the appeal, even though the time for payment has expired, as long as such appeal remains undisposed of.”

4.2 The following points emerge from the above provision—

i) the AO has the discretion to treat the assessee as not being in default in respect of the amount in dispute (in general parlance it is referred to as a grant stay on recovery of the amount demanded);

ii) the stay may be granted without any conditions or with conditions which the AO may think fit to impose in the circumstances of the case;

iii) the discretion can be exercised only in cases where an appeal has been presented under section 246 or section 246A. In other words, the discretion under this sub-section cannot be exercised in cases where an appeal lies to the Tribunal and/or the assessee chooses to file an application under section 264 instead of filing an appeal under section 246A;

iv) the power may be exercised even after the time for making the payment, as per the notice of demand, has expired;

v) the power can be exercised and stay granted only till the appeal remains undisposed;

vi) the discretion can be exercised only in respect of an amount in dispute in an appeal. In a case where a particular addition can be a subject matter of rectification under section 154, it is advisable that the assessee takes up such addition in a rectification application as well as take the issue in appeal;

vii) while the section does not provide that the power will be exercised only upon an application to be made by the assessee, it is unimaginable that an AO may exercise the discretion vested in him by virtue of section 220(6) suo moto;

viii) while on a literal interpretation, it appears that an assessee can make an application / power can be exercised by the AO only where the assessee has `presented an appeal under section 246 or section 246A’.

In practice, it is advisable to make an application even before an appeal is filed. The application, in such a case, should mention that the assessee is in the process of filing an appeal under section 246A of the Act. The assessee should undertake to file an appeal before the expiry of the statutory time for filing of an appeal and also to provide to the AO a copy of the acknowledgement of having filed an appeal once it has been filed. The AO may grant a stay on the condition that an appeal be filed within the statutory time limit. Failure to do so would vacate the stay so granted.

4.3 Every power is coupled with a duty to act reasonably. While section 220(6) confers a discretion / authority upon the AO, going by the principles laid down bythe courts, such an authority has to be construed as a duty to exercise that power. This is evident from the following —

i) The Apex Court in L Hriday Narain vs. ITO [(1970) 78 ITR 26 (SC)] has observed as under —

“If a statute invests a public officer with authority to do an act in a specified set of circumstances, it is imperative upon him to exercise his authority in a manner appropriate to the case when a party interested and having a right to apply moved in that behalf and circumstances for the exercise of authority are shown to exist. Even if the words used in the statute are prima facie enabling, the courts will readily infer a duty to exercise power which is invested in aid of enforcement of a right-public or private — of a citizen.”

ii) The Allahabad High Court in ITC Ltd. vs. Commissioner (Appeals), Customs & Central Excise [2003 SCC Online All 2224] has held as under-.

“24. Thus, even where enabling or discretionary power is conferred on a public authority, the words which are permissive in character, require to be constituted, involving a duty to exercise that power, if some legal right or entitlement is conferred or enjoyed, and for the effectuating of such right or entitlement, the exercise of such power is essential. The aforesaid view stands fortified in view of the fact that every power is coupled with a duty to act reasonably and the Court / Tribunal / Authority has to proceed to have strict adherence to the provisions of law [vide Julius vs. Lord Bishop of Oxford, (1880) 5 Appeal Cases 214; Commissioner of Police, Bombay vs. Gordhandas Bhanji, 1951 SCC 1088; K S Srinivasan vs. Union of India, AIR 1958 SC 419; Yogeshwar Jaiswal vs. State Transport Appellate Tribunal (1985) 1 SCC 725; Ambica Quarry Works, etc. vs. State of Gujarat (1987) 1 SCC 213.”

4.4 CBDT has, from time to time, issued guidelines regarding the procedure to be followed for recovery of outstanding demand, including the procedure for granting of stay of demand. Presently, the said Instruction read with Office Memorandum (OM) dated 31^st July 2017 interalia provides for a grant of stay upon payment of 20 per cent of the disputed demand. Undoubtedly, under sub-section (6) of section 220 stay cannot be granted in respect of an amount which is admitted to be payable by the assessee.

4.5 A question often arises as to whether the discretion vested in the AO by section 220(6) is circumferenced by the said Instruction and the OM. Can the AO, in case circumstances so demand, exercise discretion and grant a stay of the entire amount of demand or on payment of an amount less than that mandated by the OM. Supreme Court in PCIT & Ors. vs. L G Electronics India Pvt. Ltd. [(2018) 18 SCC 477] has emphasized that the administrative circular would not operate as a fetter upon the power otherwise conferred upon a quasi-judicial authority and that it would be wholly incorrect to view the OM as mandating the deposit of 20 per cent, irrespective of the facts of the individual case.

The said Instruction states the following cases as illustrative situations where an assessee would be entitled to stay of the entire disputed demand where such disputed demand —

i) relates to the issues that have been decided in the assessee’s favour by an appellate authority or court earlier; or

ii) has arisen as a result of an interpretation of the law on which there is no decision of the jurisdictional high court and there are conflicting decisions of non-jurisdictional high courts;

iii) has arisen on an issue on which the jurisdictional high court has adopted a contrary interpretation, but the Department has not accepted that judgment.

The said Instruction read with OM suggests that where a stay is to be granted by accepting a payment of less than 20 per cent of the disputed demand then the AO should refer the matter to the administrative jurisdictional PCIT / CIT.

Undoubtedly, all such instructions and circulars are in the form of guidelines which the authority concerned is supposed to keep in mind. Such instructions/circulars are issued to ensure that there is no arbitrary exercise of power by the authority concerned or in a given case, the authority may not act prejudicial to the interest of the Revenue.

4.6 The courts have held that —

i) the discretion vested in the hands of the AO is one which cannot possibly be viewed as being cabined in terms of the OM [Nasscom (supra)];

ii) the requirement of payment of twenty per cent of the disputed tax demand is not a pre-requisite for putting in abeyance recovery of demand pending the first appeal in all cases — Dabur India Ltd. vs. CIT (TDS) & Another [2022 SCC OnLine Del 3905];

iii) it becomes pertinent to observe that the 20 per cent deposit which is spoken of in the OM dated 31^st July 2017 is not liable to be viewed as a condition etched in stone or one which is inviolable — Indian National Congress vs. DCIT [2024: DHC: 2016 — DB];

iv) CBDT’s Office Memorandum cannot be read as mandating a pre-deposit of 20 per cent of the outstanding demand – Sushem Mohan Gupta vs. PCIT [(2024) 161 taxmann.com 257 (Delhi HC)];

v) Instruction 1914 sets out guidelines to be taken into account while deciding stay applications. As is evident on examining such guidelines, the discretion of the appellate authority remains, and it is not mandated that in all cases 20 per cent of the disputed tax demand should be pre-deposited. This aspect was noticed by this Court in the Order in Kannammal [2019 (3) TMI 1 — MADRAS HIGH COURT] wherein, the appellate authority was directed to take into account the classical principles relating to the consideration of stay petitions – Telugupalayam Primary Agricultural Co-operative Bank vs. PCIT [2024 (2) TMI 549 — MADRAS HIGH COURT];

vi) The requirement of payment of 20 per cent of disputed tax is not a pre-requisite for putting in abeyance recovery of demand pending the first appeal in all cases. The said pre-condition of deposit of 20 per cent of the demand can be relaxed in appropriate cases – Dr B L Kapur Memorial Hospital vs. CIT [(2023) 146 taxmann.com 422 (Delhi HC)];

vii) .. we fail to understand what is so magical in the figure of 20 per cent. To balance the equities, the authority may even consider directing the assessee to make a deposit of 5 per cent or 10 per cent of the assessed amount as the circumstances may demand as a pre-deposit – Harsh Dipak Shah vs. Union of India [(2022) 135 taxmann.com 242 (Guj. HC)].

In spite of the clear position having been explained by various High Courts, an assessee desiring a stay of entire demand or stay of demand by paying an amount less than 20 per cent of the disputed demand has to knock on the doors of the writ courts merely because the AOs take a view that they are bound by the Instructions and OMs issued by CBDT.

4.7 The plain reading of the sub-section (6) of section 220 would indicate that if the assessee has presented an appeal against the final order of assessment under section 246A of the Act, it would be within the discretion of the AO subject to such conditions that he may deem fit to impose in the circumstances of the case, treat the assessee as not being in default in respect of the amount in dispute in the appeal so long as the appeal remains undisposed of. What is discernible from the provisions of section 220(4) is that once the final order of assessment has been passed, determining the liability of the assessee to pay a particular amount and such amount is not paid within the time limit as prescribed under sub-section (1) to section 220 or during the extended time period under sub-section (3) as the case may be, then the assessee, because of the deeming fiction, would be deemed to be in default. Therefore, even if the assessee prefers an appeal challenging the assessment order before the Commissioner of Appeals as the First Appellate Authority, he would still be treated as an assessee deemed to be in default because the mere filing of an appeal would not automatically lead to a stay of the demand as raised in the assessment order. It is in such circumstances that the assessee has to make a request before the authority concerned for appropriate relief for a grant of stay against such demand pending the final disposal of the appeal. This relief that the assessee seeks is within the discretion of the authority. In other words, the authority may grant such a stay conditionally or unconditionally or may even decline to grant any stay. However, the exercise of such discretion has to be in a judicious manner. Such exercise of discretion cannot be in an arbitrary or mechanical manner.

4.8 However, when it comes to granting a discretionary relief like a stay of demand, it is obvious that the four basic parameters need to be kept in mind (i) prima facie case (ii) balance of convenience (iii) irreparable injury that may be caused to the assessee which cannot be compensated in terms of money and (iv) whether the assessee has come before the authority with clean hands.

4.9 The power under section 220(6) is indeed a discretionary power. However, it is one coupled with a duty to be exercised judiciously and reasonably (as every power should be), based on relevant grounds. It should not be exercised arbitrarily or capriciously or based on matters extraneous or irrelevant. The AO should apply his mind to the facts and circumstances of the case relevant to the exercise of discretion, in all its aspects. He has also to remember that he is not the final arbiter of the disputes involved but only the first among the statutory authorities. Questions of fact and law are open for decision before the two appellate authorities, both of whom possess plenary powers. In exercising his power, the AO should not act as a mere tax-gatherer but as a quasi-judicial authority vested with the power of mitigating hardship to the assessee. The AO should divorce himself from his position as the authority who made the assessment and consider the matter in all its facets, from the point of view of the assessee without at the same time sacrificing the interests of the Revenue.

4.10 In the context of what is stated above, the following observations of Viswanatha Sastri J. in Vetcha Sreeramamurthy vs. ITO [(1956) 30 ITR 252 (AP)] (at pages 268 and 269) are relevant —

“The Legislature has, however, chosen to entrust the discretion to them. Being to some extent in the position of judges in their own cause and invested with a wide discretion under section 45 of the Act, the responsibility for taking an impartial and objective view is all the greater.If the circumstances exist under which it was contemplated that the power of granting a stay should be exercised, the Income-tax Officer cannot decline to exercise that power on the ground that it was left to his discretion. In such a case, the Legislature is presumed to have intended not to grant an absolute, uncontrolled or arbitrary discretion to the Officer but to impose upon him the duty of considering the facts and circumstances of the particular case and then coming to an honest judgment as to whether the case calls for the exercise of that power.”

4.11 Since the power under section 220(6) is discretionary it is not possible to lay down any set principles on which the discretion is to be exercised. The question as to what are the matters relevant and what should go into the making of the decision, in such circumstances, has been explained in Aluminium Corporation of India vs. C Balakrishnan [(1959) 37 ITR 267 (Cal.)] as follows—

“A judicial exercise of discretion involves a consideration of the facts and circumstances of the case in all its aspects. The difficulties involved in the issues raised in the case and the prospects of the appeal being successful is one such aspect. The position and economic circumstances of the assessee are another. If the Officer feels that the stay would put the realisation of the amount in jeopardy that would be a cogent factor to be taken into consideration. The amount involved is also a relevant factor. If it is a heavy amount, it should be presumed that immediate payment, pending an appeal in which there may be a reasonable chance of success, would constitute a hardship. The Wealth-tax Act has just come into operation. If any point is involved which requires an authoritative decision, that is to say, a precedent that is a point in favour of granting a stay. Quick realisation of tax may be an administrative expediency, but by itself, it constitutes no ground for refusing a stay. While determining such an application, the authority exercising discretion should not act in the role of a mere tax-gatherer.”

4.12 The Apex Court has in the case of Pennar Industries Ltd. vs. State of A.P. and Ors. [(2009) 3 SCC 177 (SC)] has held that —

“If on a cursory glance, it appears that the demand raised has no leg to stand, it would be undesirable to require the Applicant to pay full or substantive part of the demand. Petitions for stay should not be disposed of in a routine manner unmindful of the consequences flowing from the order requiring the Applicant to deposit full or part of the demand. There can be no rule of universal application in such matters and the order has to be passed keeping in view the factual scenario involved.”

4.13 It is a settled position that when a strong prima facie case, on merits, has been demonstrated, then no demand whatsoever can be enforced. This proposition can be substantiated by the ratio of the following decisions —

i) If the party has made out a strong prima facie case, that by itself would be a strong ground in the matter of exercise of discretion as calling on the party to deposit the amount which prima facie is not liable to deposit or which demand has no legs to stand upon, by itself, would result in undue hardship if the party is called upon to deposit the amount — CEAT Limited vs. Union of India [250 ELT 200];

ii) In the case of UTI Mutual Fund vs. ITO [(2012) 345 ITR 71 (Bom.)] the Bombay High Court, referring to the decision in the case of CEAT Limited (supra) observed that “where the assessee has raised a strong prima facie case which requires serious consideration, as in the present case, a requirement of pre-deposit would itself be a matter of hardship.”

iii) The Delhi Bench of the Tribunal in the case of Birlasoft (India) Ltd. vs. DCIT [(2011) 10 taxmann.com 220 (Delhi Trib.)], following the decision of the Apex Court in Pennar Industries Ltd. (supra) held that where the taxpayer demonstrates prima facie case, the Tribunal must weigh in favour of granting stay of disputed demand, particularly if recovery of such demand would cause financial hardship to the taxpayer.”

4.14 Demand needs to be stayed where the order giving rise to the demand has been passed in violation of principles of natural justice such as the opportunity of personal hearing not having been granted, request for short adjournment for filing reply to show cause notice having been neglected and assessee was devoid of opportunity to file reply on account of option of furnishing the response on the portal having been disabled, assessment order having been passed without considering the reply of the assessee. The assessee in Renew Power P. Ltd. vs. National E-Assessment Centre [(2021) 128 taxmann.com 263 (Delhi HC)] filed a writ against the assessment order as having beenpassed in violation of the principles of natural justice. The court on the basis of prima facie opinion of the order having been passed in violation of principles of natural justice granted a stay on the operation of the assessment order, notice of demand, and also notice for initiation of penalty proceedings under section 270A of the Act.

Similarly, even in the case of B L Gupta Construction P. Ltd. vs. National E-Assessment Centre [(2021) 127 taxmann.com 131 (Delhi HC)], where the assessment order was passed in violation of principles of natural justice, the court granted a stay on the operation of the assessment order and demand notice.

In the following cases also the courts have, in writ petitions filed by the assessee, granted a stay on the operation of the assessment order, demand notice and initiation of penalty proceedings on the ground that the assessment order was passed in violation of principles of natural justice —

i) Lemon Tree Hotels Ltd. vs. NFAC [(2021) 437 ITR 111 (Delhi HC)]

ii) GPL-PKTCPL JV vs. NFAC [(2022) 145 taxmann.com 156 (Delhi HC)]

iii) Dr. K R Shroff Foundation [(2022) 444 ITR 354 (Guj. HC)]

iv) Dangee Dums Ltd. vs. NFAC [(2023) 148 taxmann.com 22 (Guj. HC)]

5 POWER OF THE AO TO GRANT STAY — SECTION 220(3)

5.1 Section 220(3) reads as under —

“(3) Without prejudice to the provisions contained in sub-section (2), on an application made by the assessee before the expiry of the due date under sub-section (1), the Assessing Officer may extend the time for payment or allow payment by instalments, subject to such conditions as he may think fit to impose in the circumstances of the case.”

5.2 The following points emerge from the above provision—

i) the provisions of sub-section (3) of section 220 are without prejudice to the provisions of sub-section (2) of section 220 i.e., even if a stay is granted by the AO under section 220(3), the liability to pay interest leviable under sub-section (2) of the Act shall continue;

ii) the power conferred upon the AO under sub-section (3) can be exercised only upon satisfaction of twin conditions viz. an application being made by the assessee and such application being made before the expiry of the due date under sub-section (1);

iii) the AO has the power to either extend the time for payment or allow the payment by instalments;

iv) extension of time or payment by instalments may be permitted without imposing any conditions or it may be coupled with such conditions as the AO may think fit to impose in the circumstances of the case;

5.3 It is not necessary that the assessee making an application under sub-section (3) should have preferred an appeal under section 246A. This sub-section will therefore cover even cases where an appeal against an order lies to the
Tribunal or the assessee chooses to file a revision application under section 264 of the Act or the assessee accepts the additions made and chooses not to file an appeal.

5.4 On a comparison of the power vested under sub-section (3) with the power vested under sub-section (6), the following similarities and differences are evident —

SIMILARITIES

i) In both cases, the power is discretionary. In both cases, the power can be exercised and stay granted either with or without conditions as the AO may deem fit.

ii) In both cases, the assessee should make out a prima facie case; point of violation of principles of natural justice, if any; financial hardship and balance of convenience may be established.

DIFFERENCES

i) Power vested under section 220(3) can be exercised by the AO only on an application made by the assessee. Sub-section (6) does not have a reference to making an application by the assessee as a pre-condition for the exercise of the power vested under sub-section (6);

ii) Application under sub-section (3) needs to be made before the expiry of the time period mentioned in the notice of demand. However, an application under sub-section (6) may be made by the assessee even after the time period for making the payment, as mentioned in the notice of demand, has expired;

iii) For exercising the power vested under sub-section (3) it is not necessary that the assessee should have preferred an appeal to CIT(A). Even an assessee who has preferred a revision application under section 264 of the Act or an assessee who has preferred an appeal directly to the Tribunal can also apply for a stay. However, the power vested under sub-section (6) can be exercised only after the assessee has presented an appeal to the JCIT(A) / CIT(A).

iv) Sub-section (3) does not provide for an outer limit beyond which stay cannot be continued. However, under sub-section (6) can be granted only till such time as the appeal before CIT(A) is not disposed of.

v) The provisions of sub-section (3) are without prejudice to the provisions of sub-section (2) whereas sub-section (6) is not without prejudice to the provisions of sub-section (2).

vi) The stay granted pursuant to power under sub-section (6) can be only of disputed demand whereas that is not a pre-condition for grant of stay under sub-section (3).

vii) The said Instruction and the Office Memorandums are in connection with powers vested in the AO under sub-section (6).

6 INSTRUCTIONS ISSUED BY CBDT

6.1 With an intention to streamline recovery procedures, the Board has issued Instruction No. 1914 dated 2.2.1993 (herein referred to as “the said Instruction”). The said Instruction is stated to be comprehensive and is in supersession of all earlier instructions on the subjects and reiterates the then-existing Circulars on the subject.

6.2 Instruction No. 1914 is partially modified by Office Memorandum [F. No. 404/72/93-ITCC] dated 29th February, 2016 and also by Office Memorandum [F. No. 404/72/93-ITCC] dated 31^st July, 2017.

6.3 OM dated 29^th February, 2016 recognises that the field authorities often insist on payment of a remarkably high proportion of disputed demand before granting a stay of balance demand which results in hardship for taxpayers seeking a stay of demand. Therefore, to streamline the process of grant of stay and standardize the quantum of lumpsum payment, OM dated 29^th February, 2016 provides for a lump sum payment of 15 per cent of the disputed demand as a pre-condition for a stay of demand disputed before CIT(A). Exceptions to this general rule, as given in the said Instruction read with OMs, are discussed in 6.7 below.

6.4 OM dated 31^st July, 20217 only modifies the lump sum payment required to be made from 15 per cent as provided in OM dated 29^th February, 2016 to 20 per cent. All other guidelines provided by OM dated 29^th February, 2016 continue to be effective.

6.5 It is a settled position that such circulars and instructions are in the nature of guidelines and are issued to assist the Assessing Authority in the matter of grant of stay and cannot substitute or override the basic tenets to be followed in the consideration and disposal of the stay applications. However, the AOs feel that they are bound by the instructions issued by CBDT and therefore cannot act contrary thereto. Consequently, no matter how strong the facts of the case are, an AO never grants a stay of the entire demand but stays 80 per cent of the demand only if 20 per cent of the demand is paid.

6.6 The Bombay High Court in the case of Bhupendra Murji Shah vs. DCIT [(2020) 423 ITR 300 (Bom. HC)] held that the AO is not justified in insisting on payment of 20 per cent of the demand based on CBDT’s instruction dated 29^th February, 2016 during the pendency of the appeal before CIT(A). The court held that this approach may defeat and frustrate the right of the Applicant to seek protection against collection and recovery pending appeal. Such can never be the mandate of law. The operative paragraph of the order makes an interesting read and therefore is reproduced hereunder —

“We are not concerned here with the Circular of the Central Board of Direct Taxes. We are not concerned here also with the power conferred in the Assessing Officer of collection and recovery by coercive means. All that we are worried about is the understanding of this Deputy Commissioner of a demand, which is pending or an amount, which is due and payable as tax. If that demand is under dispute and is subject to appellate proceedings, then, the right of appeal vested in the Petitioner / Applicant by virtue of the Statute should not be rendered illusory or nugatory. That right can very well be defeated by such communication from the Revenue / Department as is impugned before us. That would mean that if the amount as directed by the impugned communication is not brought in, the Petitioner may not have an opportunity to even argue his appeal on merits or that appeal will become infructuous if the demand is enforced and executed during its pendency.

In that event, the right to seek protection against collection and recovery pending appeal by making an application for stay would also be defeated and frustrated. Such can never be the mandate of law. In the circumstances, we dispose of both these petitions with directions that the Appellate Authority shall conclude the hearing of the Appeals as expeditiously as possible and during the pendency of these appeals, the Petitioner / Applicant shall not be called upon to make payment of any sum.”

6.7 An AO may demand a lump sum payment which is greater than 20 per cent of the disputed demand in the following cases where the disputed demand is as a result of additions —

i) which are confirmed by the appellate authorities in earlier years;

ii) on which decision of the Apex Court or jurisdictional High Court is in favour of revenue;

iii) which are based on credible evidence collected in a search or survey operation.

However, in cases where the disputed demand arises because of addition which is decided by appellate authorities in favour of the assessee and / or the addition is on an issue which is covered in favour of the assessee by the decision of the Apex Court and / or the jurisdictional High Court and the AO is inclined togrant stay upon payment of an amount lower than 20 per cent of the disputed demand, the OM dated 29^th February, 2016 directs the AO to refer the matter to the administrative PCIT / CIT and states that the PCIT / CIT after considering all relevant facts shall decide the quantum / proportion of demand to be paid by the assessee as lump sum payment for granting a stay of the balance demand.

Therefore, while the AO can grant a stay upon directing payment of an amount greater than 20 per cent of the disputed demand, it appears on a literal interpretation of the said Instruction that the AO cannot reduce the magical figure of 20 per cent mentioned in the guidelines. This is contrary to what several courts have held upon interpreting the provisions of section 220(6) and even guidelines and circulars e.g., Madras High Court has in Mrs Kannammal vs. ITO [(2019) 103 taxmann.com 364 (Mad. HC)] has held as under —

“12. The Circulars and Instructions as extracted above are in the nature of guidelines issued to assist the assessing authorities in the matter of grant of stay and cannot substitute or override the basic tenets to be followed in the consideration and disposal of stay petitions. The existence of a prima facie case for which some illustrations have been provided in the Circulars themselves, the financial stringency faced by an assessee and the balance of convenience in the matter constitute the ‘trinity’, so to say, and are indispensable in consideration of a stay petition by the authority. The Board has, while stating generally that the assessee shall be called upon to remit 20 per cent of the disputed demand, granted ample discretion to the authority to either increase or decrease the quantum demanded based on the three vital factors to be taken into consideration.

6.8 In case the AO has granted a stay on payment of 20 per cent of the disputed demand and the assessee is still aggrieved, he may approach the jurisdictional administrative PCIT / CIT for a review of the decision of the AO.

6.9 The AO shall dispose of the stay application within 2 weeks of filing of the petition. Similarly, if reference has been made by the AO to PCIT / CIT or a review petition has been filed by the assessee the same needs to be disposed of within 2 weeks of the AO making such reference or assessee filing such review, as the case may be.

6.10 The other salient points arising out of the said Instruction No. 1914 read with the two OMs dated 29th February, 2016 and 31st July, 2017 are —

i) A demand will be stayed only if there are valid reasons for doing so;

ii) Mere filing of an appeal against the assessment order will not be sufficient reason to stay the recovery of demand;

iii) In the event that an appeal has been filed by an assessee to CIT(A), the AO shall grant stay upon payment of 20 per cent of the disputed demand;

iv) In the following cases, the AO can in his discretion, ask for payment of an amount greater than 20 per cent of the disputed demand —

a) where the disputed demand is on account of an addition which has been confirmed by the appellate authorities in earlier years;

b) where the disputed demand is on account of an issue on which the decision of the Apex Court or jurisdictional High Court is in favour of the revenue;

c) where the addition is based on credible evidence collected in a search or survey operation, etc.

However, this stands modified by a direction to refer the matter to the Administrative PCIT/CIT (see para 6.12).

6.11 The Bombay High Court in Bhupendera Murji Shah vs. DCIT [(2020) 423 ITR 300 (Bom.)] has held that – “The AO is not justified in insisting upon the payment of 20 per cent of the demand based on CBDTs instruction dated 29.2.2016 during the pendency of the appeal before the CIT(A). This approach may defeat and frustrate the right of the assessee to seek protection against collection and recovery pending appeal. Such can never be the mandate of law.”

6.12 However, where the disputed demand is on account of an addition which has been decided by appellate authorities in favour of the assessee in earlier years or where the decision of the Apex Court or jurisdictional High Court is in favor of the assessee, the said Instruction requires the AO to refer the matter to the administrative PCIT / CIT. The said Instruction states “The AO shall refer the matter to the administrative PCIT / CIT who after considering all relevant facts shall decide the quantum / proportion of demand to be paid by the assessee as lump sum payment for granting a stay on the balance demand.” The Instruction is shifting the discretion granted to the AO by the statute under section 220(6) to a superior authority. It is highly debatable as to whether CBDT has the power to divest the AO of his statutory powers and vest the same into a superior authority.

6.13 Section 220(6) empowers the AO to grant a stay subject to such conditions as he may think fit to impose in the circumstances of the case. While the section leaves it to the AO to decide the conditions to be imposed, the said Instruction No. 1914 lists 3 conditions, which may be imposed, as an illustration viz. —

i) requiring an undertaking from the assessee that he will cooperate in the early disposal of the appeal failing which the stay order will be cancelled;

ii) reserve the right to review the order passed after the expiry of a reasonable period (say 6 months) or if the assessee has not co-operated in the early disposal of the appeal, or where a subsequent pronouncement by a higher appellate authority or court alters the above situation;

iii) reserve the right to adjust refunds arising, if any, against the demand to the extent of the amount required for granting stay and subject to the provisions of section 245.

The conditions to be imposed are illustrative. The AO may consider imposing a condition/s which are other than the above-stated 3 conditions. However, such conditions to be imposed by the AO will need to be imposed considering the judicial exercise of his discretion. An AO imposing conditions will need to pass a speaking order listing reasons for his deciding to impose such conditions as he may decide to impose failing which his order may be subject to challenge as being arbitrary and having been passed without application of mind. Gujarat High Court has in the case of Harsh Dipak Shah (supra) observed that “Many times in the overzealousness to protect the interest of the Revenue, the authorities render their discretionary orders susceptible to the complaint that those have been passed without any application of mind.”

6.14 Where stay has been granted by the AO upon payment of 20 per cent as mentioned in the said Instruction and the assessee is aggrieved by such an order, the assessee may approach the jurisdictional administrative PCIT / CIT for a review of the decision of the AO.

6.15 The stay application as well as the review by the PCIT / CIT need to be decided within 2 weeks of filing of the application / making of a reference by the assessee / AO.

7 HIGH PITCHED ASSESSMENTS

7.1 High-pitched assessments are assessments where the assessed income is several times the returned income. Demand arising as a result of high-pitched assessment is generally required to stay.

7.2 The then Deputy Prime Minister, during the 8th Meeting of the Informal Consultative Committee held on 13^th May 1969, observed as under —

“Where the income determined on assessment was substantially higher than the returned income, say, twice the amount or more, the collection of tax in dispute should be held in abeyance till the decision on the appeals, provided there was no lapse on the part of the Applicant.”

The above observations were circulated to the field officers by the Board as Instruction No. 96 dated  21^st August, 1969 [F. No. 1/6/69-ITCC]. CBDT has on 1^st December, 2009 issued `Clarification on Instructions on Stay of Demand’ [F. No. 404/10/2009-ITCC] wherein it is clarified that there is no separate existence of Instruction no. 96 dated 21^st August, 1969 and presently it is Instruction No. 1914 which holds the field currently. Instruction No. 1914 does not mention a word about high-pitched assessment.

7.3 The courts have taken note of the tendency to make high-pitched assessments by the AO. Courts have observed that this tendency results in serious prejudice to the assessee and miscarriage of justice and sometimes may even result in insolvency or closure of the business if such power were to be exercised only in a pro-revenue manner — N Jegatheesan vs. DCIT [(2016) 388 ITR 410 (Mad. HC)] and Maheshwari Agro Industries vs. UOI [SB Civil Writ Petition No. 1264/2011 (Raj. HC)]. The Rajasthan High Court in Maheshwari Agro Industries (supra) has held that “it may be like the execution of death sentence, whereas the accused may get even acquittal from higher appellate forums or courts.”

7.4 Courts have consistently understood assessments where assessed income is twice the returned income to be a case of `high pitched assessment’ e.g., Gujarat High Court in Harsh Dipak Shah (infra) has held that the “high pitched assessment” means where the income determined and assessment was substantially higher than the returned income for example, twice the returned income or more”. The Madras High Court in N. Jegatheesan vs. DCIT [(2015) 64 taxmann.com 339 (Mad. HC)], in para 14, observed — “`High Pitched Assessment means where the income determined and assessment was substantially higher than returned income, say twice the later amount or more, the collection of tax in dispute should be kept in abeyance till the decision on the appeal provided there were no lapses on the part of the assessee.”. To a similar effect are the observations of the Delhi High Court in the case Valvoline Cummins Limited vs. DCIT [(2008) 307 ITR 103]; Soul vs. DCIT [(2010) 323 ITR 305] and Taneja Developers and Infrastructure Limited vs. ACIT [(2010) 324 ITR 247].

7.5 The view taken by the AO that in view of the CBDT Instructions and guidelines, he does not have the power to grant a stay unless 20 per cent of the disputed demand is paid is not legally correct.

Para 2B(iii) of the said Instruction No. 1914 states that “the decision in the matter of stay of demand should normally be taken by AO / TRO and his immediate superior. A higher superior authority should interfere with the decision of the AO / TRO only in exceptional circumstances e.g., where the assessment order appears to be unreasonably high pitched ….”

Para 2B(iii) of Circular No. 1914 CBDT which directs factors to be kept in mind both by the Assessing Officer and by the higher Superior Authority continues to exist and this part of Circular No. 1914 is left untouched by Circular dated 29^th February, 2016. Therefore, while dealing with an application filed by an Applicant, both the AO and PCIT are required to examine whether the assessment is “unreasonably high pitched” or whether the demand for depositing 20 per cent / 15 per cent of the disputed demand amount would lead to a “genuine hardship to the Applicant” or not? — Flipkart India Pvt. Ltd. vs. ACIT [396 ITR 551 (Kar. HC)].

7.6 The courts have in the following cases stayed the entire demand which was raised pursuant to high-pitched assessments e.g., see —

i) Delhi High Court in Valvoline Cummins Limited vs. DCIT [(2008) 307 ITR 103 (Del HC)]; Soul vs. DCIT [(2010) 323 ITR 305 (Del HC)]; Taneja Developers and Infrastructure Limited vs. ACIT [(2010) 324 ITR 247 (Delhi HC)]; Maruti Suzuki India Ltd. vs. ACIT [222 Taxman 211 (Delhi HC)]; Genpact India vs. ACIT [205 Taxman 51 (Delhi HC)];

ii) Bombay High Court in Humuza Consultants vs. ACIT [(2023) 451 ITR 77 (Bom. HC)]; BHIL Employees Welfare Fund vs. ITO [(2023) 147 taxmann.com 427 (Bom. HC)]; Mahindra and Mahindra vs. Union of India [59 ELT 505 (Bom. HC)]; Mahindra and Mahindra Ltd. vs. AO [295 ITR 42 (Bom. HC)]; ICICI Prudential Life Insurance Co. Ltd. vs. CIT [226 Taxman 74 (Bom. HC)]; Disha Construction vs. Ms. Devireddy Swapna [232 Taxman 98 (Bom. HC)]

iii) Gujarat High Court in Harsh Dipak Shah vs. Union of India [(2022) 135 taxmann.com 242 (Gujarat)];

iv) Andhra Pradesh High Court in IVR Constructions Ltd. vs. ACIT [231 ITR 519 (AP)]

v) Allahabad High Court in Mrs R Mani Goyal vs. CIT [217 ITR 641 (All. HC)]

vi) Rajasthan High Court in Maharana Shri Bhagwat Singhji of Mewar (Late His Highness) vs. ITAT, Jaipur Bench & Others [223 ITR 192 (Raj. HC)]

7.7 Gujarat High Court in Harsh Dipak Shah vs. Union of India [(2022) 135 taxmann.com 242 (Gujarat)] has held that in case of high pitched assessment, wheretax demanded was twice or more of declared taxliability, the application of stay under section 220(6) could not be rejected merely by describing it to be against interest of the revenue if recovery was not made, and; in such cases, revenue could even consider directing the assessee to make a pre-deposit of 5 per cent or 10 per cent of the assessed amount as circumstances may demand.

8 APPLICATION FOR STAY

8.1 It is seen in practice that generally an application made to the AO for a grant of stay is brief and merely mentions the fact that an appeal has been preferred against the order giving rise to the demand in respect of which stay is being sought. However, it needs to be noted that merely filing an appeal against the assessment order will not be sufficient reason to stay the recovery of the demand.

8.2 It is advisable that the stay application should contain arguments to support the contention that the assessee is entitled to a stay of recovery. The assessee must explain the facts of his case in brief, the assessment history, briefly describe the nature of additions made, the arguments in support of the contention that the addition is incorrect and is likely to be deleted in appellate proceedings, and particulars of the appeal filed. The three factors which an assessee must establish in his application are prima facie case, financial stringency, and balance of convenience. In addition, violation of principles of natural justice, if any, must be narrated.

Balance of convenience means comparative mischief or inconvenience that may be caused to either party. An assessee must demonstrate that the balance of convenience is in its favour.

In Avantha Realty Ltd. vs. PCIT [(2024) 161 taxmann.com 529 (Delhi)], the court remanded the matter back for fresh adjudication to the PCIT on the ground that the assessee failed to directly raise contentions such as prima facie case, the balance of convenience and irreparable loss that may be caused. Rajasthan High Court in Kunj Bihari Lal Agarwal vs. PCIT [2023] 152 taxmann.com 339 (Rajasthan)] quashed the order passed by PCIT granting stay upon payment of 20 per cent and remanded it for fresh adjudication since PCIT had failed to give any findings about financial hardships pointed out by assessee and had also not taken into consideration factors such as prima facie case, balance of convenience and irreparable loss while passing impugned order. Madras High Court in Aryan Share and Stock Brokers Ltd. vs. PCIT [(2023) 146 taxmann.com 508 (Madras)] set aside the stay order since it was passed without taking note of financial stringency and balance of convenience.

8.3 Undoubtedly, all instructions and circulars are in the form of guidelines which the authority concerned is supposed to keep in mind. Such instructions/circulars are issued to ensure that there is no arbitrary exercise of power by the authority concerned or in a given case, the authority may not act prejudicial to the interest of the Revenue. However, when it comes to granting a discretionary relief like a stay of demand, it is obvious that the four basic parameters need to be kept in mind (i) prima facie case (ii) balance of convenience (iii) irreparable injury that may be caused to the assessee which cannot be compensated in terms of money and (iv) whether the assessee has come before the authority with clean hands — Harsh Dipak Shah vs. Union of India [(2022) 135 taxmann.com 242 (Gujarat HC)]

9 PARAMETERS TO BE FOLLOWED BY THE AUTHORITIES WHILE DISPOSING OF STAY APPLICATIONS

9.1 Many times stay applications are disposed of in a routine manner. Applications are rejected without granting reasons. Courts have come down heavily on the disposal of stay applications in an arbitrary manner leading the orders to their challenge in writ courts. Casual disposal of stay applications leads to severe consequences e.g., if a garnishee is issued and recovery made from the bank account then the business may get crippled, salaries / wages which are due could remain unpaid, etc. More than two decades back, the Bombay High Court in the case of K E C International vs. B R Balakrishnan [(2001) 251 ITR 158 (Bombay)] laid down the following parameters which authorities should comply with while passing orders on stay applications —

i) while considering the stay application, the authority concerned will at least briefly set out the case of the assessee;

ii) the authority will consider whether the assessee has made out a case for unconditional stay; if not, whether a part of the amount should be ordered to be deposited for which purpose, some short prima facie reasons could be given by the authority in its order;

iii) in cases where the assessee relies upon financial difficulties, the authority concerned can briefly indicate whether the assessee is financially sound and viable to deposit the amount if the authority wants the assessee to so deposit;

iv) the authority concerned will also examine whether the time to prefer an appeal has expired. Generally, coercive measures may not be adopted during the period provided by the statute to go into appeal. However, if the authority concerned comes to the conclusion that the assessee is likely to defeat the demand, it may take recourse to coercive action for which brief reasons may be indicated in the order; and

The court added that “if the authority concerned complies with the above parameters while passing orders on the stay application, then the authorities on the administrative side of the department like Commissioner need not once again give reasoned order.”

9.2 In spite of clear parameters having been laiddown, the authorities are even today passing orders more in breach of the above parameters. It is in the interest of the revenue to pass orders which are reasoned and speaking so that they stand the tests laid down by the judiciary.

10 CAN A RECOVERY NOTICE BE ISSUED IF THE AO HAS NOT ISSUED A LETTER / PASSED AN ORDER GRANTING A STAY

10.1 A question which often arises in actual practice is that recovery notices are issued while the stay application has been made but no order has been passed rejecting the application / granting a stay. At the outset, such an inaction on the part of the Assessing Officer is contrary to the mandate of para 2B(i) of the said Instruction. Para 2B(i) requires the Assessing Officer to dispose of the stay petition filed with him within two weeks of the filing of the petition by the taxpayer. The said Instruction also states the obvious i.e., the assessee must be intimated of the decision without delay. The said Instruction also deals with a situation where a stay petition is filed with an authority higher than the AO then a responsibility is cast upon such higher authority to dispose of the petition without any delay and in any case within two weeks of the receipt of the petition. Such higher authority is required to communicate the decision thereon to the assessee and also to the Assessing Officer immediately. The obvious reason for communicating the decision to the Assessing Officer immediately is that the Assessing Officer can thereafter take further actions which are in consonance with the said decision.

10.2 As has been mentioned in para 3, no recovery can be made during the pendency of the stay application.

As long as the order rejecting the application is not passed and communicated to the assessee, the position in law would be that the stay application will be regarded as pending and undisposed with the authority to whom it is made. The proposition that no recovery can be made during the pendency of the stay application is supported by the ratio of the decisions of the Madras High Court in Dr T K Shanmugasundaram vs. CIT & Others [(2008) 303 ITR 387 (Mad. HC)] and Bombay High Court in Mahindra and Mahindra Ltd. vs. UOI [(1992) 59 ELT 505 (Bom. HC)] and UTI Mutual Fund vs. ITO [(2012) 345 ITR 71 (Bom.)].

10.3 To sum up, upon an application having been made by an assessee seeking a stay of demand, the AO ought to pass an order granting a stay or rejecting the application made by the assessee.

10.4 The remedy available to an assessee against whom recovery has been made or steps have been taken for recovery while the stay application remains undisposed of will be to approach the higher authorities against such an illegal recovery and/or in the alternative file a writ petition to the High Court. More often than not, in such matters, a writ is the only effective remedy if the assessee wants the recovery made to be restored. Needless to mention, filing a writ petition is both expensive and time-consuming apart from the fact that it results in scarce judicial time on avoidable issues.

11 WHERE DISPUTED DEMAND IS PENDING AND STAY THEREOF HAS BEEN GRANTED UPON PAYMENT OF 20 PER CENT, CAN REFUND BE ADJUSTED AGAINST THE BALANCE WHICH HAS BEEN STAYED

11.1 In a case where disputed demand is outstanding and AO has granted stay thereof upon payment of 20 per cent which has been paid, can the refund due for another year be adjusted against the outstanding demand which has been stayed. The categorical answer is in the negative. Once the demand is stayed then recovery thereof is not permissible. Adjustment of refund against the said demand which has been stayed also amounts to recovery thereof. This position is supported by the ratio of the decision of the Bombay High Court in Bharat Petroleum Corporation Ltd. vs. ADIT [(2021) 133 taxmann.com 320 (Bombay)].

11.2 In the event the assessee has not yet paid the lump sum amount of 20 per cent upon payment of which the stay of balance is to be granted, the refund, if any, can be adjusted only to the extent of 20 per cent. Bombay High Court has in Hindustan Unilever Ltd. vs. DCIT [(20150 377 ITR 281 (Bombay)] that it is not open to the revenue to adjust refund due to the assessee against recovery of demand which has been stayed by order of stay.

11.3 The situation of adjustment of refund against outstanding disputed demand qua which stay application is pending has been dealt with in para 3.2 above.

12 POWER OF CIT(A) TO GRANT STAY

12.1 The Supreme Court in ITO vs. Mohammed Kunhi [(1969) 71 ITR 815 (SC)] held that the Appellate Tribunal had powers to stay the collection of tax even though there was no specific provision conferring such power on the Tribunal. The Supreme Court had approved the principle that the power of the appellate authority to grant a stay was a necessary corollary to the very power to entertain and dispose of appeals. This lends credence to the general principle that wherever the appellate authority has been invested with power to render justice and prevent injustice, it impliedly empowers such authority also to stay the proceedings, in order to avoid causing further mischief or injustice, during the pendency of appeal. In fact, CIT(A) exercising power under section 251 has powerswhich are wider in content, and amplitude as compared to those of a Tribunal under section 254 of the Act. This is apart from the fact that the powers of CIT(A) are co-terminus with the powers of the AO. CIT(A) can do all that the AO can do. Therefore, relying upon the ratio of the decision of the Apex Court in Mohd. Kunhi (supra) it can safely be concluded that section 251 impliedly grants power to CIT(A) to do all such acts (including granting stay) as are necessary for the effective disposal of the appeal.

12.2 It is not correct to say that because a power to grant a stay, while the appeal is pending before CIT(A), has been specifically conferred upon an AO, the CIT(A) does not have power to grant a stay of demand during the pendency of the appeal before him because. Section 220(6) is no substitute for the power of stay, which was considered by the Supreme Court as a necessary adjunct to the very powers of the appellate authority. The powers conferred on the Assessing Officer and Tax Recovery Officer cannot be equated to the powers of the appellate authorities, either in their nature, quality, or extent or vis-à-vis the hierarchy — Paulsons Litho Works vs. ITO [(1994) 208 ITR 676 (Mad)].

12.3 In actual practice, CIT(A) generally does not grant a stay of demand. CIT(A) either keeps the stay application pending or in the alternative contends that under the Act it is the AO who has the discretion to grant a stay of demand or otherwise and that there is no express provision in the Act which grants power to CIT(A) to stay the demand raise.

12.4 The following decisions support the proposition that CIT(A) has the power to grant stay of demand —

i) Karmvir Builders vs. Pr. CIT [(2020) 269 Taxman 45 (SC)];

ii) Sporting Pastime India Ltd. vs. Asstt. Registrar [(2021) 277 Taxman 19 (Mad.)];

iii) Gorlas Infrastructure (P.) Ltd. vs. Pr. CIT [(2021) 435 ITR 243 (Telangana)];

iv) Prem Prakash Tripathi vs. CIT [(1994) 208 ITR 461 (All)];

v) Paulsons Litho Works vs. ITO [(1994) 208 ITR 676 (Mad)];

vi) Debashish Moulik vs. DCIT [(1998) 231 ITR 737 (Cal)];

vii) Punjab Kashmir Finance (P.) Ltd. vs. ITAT [(1999_ 104 Taxman 584 (P & H)];

viii) Bongaigaon Refinery & Petrochemicals Ltd. vs. CIT [ (1999) 239 ITR 871 (Gau)];

ix) Tin Mfg. Co. of India vs. CIT [(1995) 212 ITR 451 (All)]

12.5 Upon the filing of an appeal to CIT(A), where the assessee is of the view that it is entitled to stay of disputed demand without insisting upon the payment of 20 per cent of the disputed demand, it is desirable that a stay application is filed before CIT(A) as well. This will be useful in case the jurisdictional administrative PCIT / CIT does not pass the review order in favour of the assessee.

13 WRIT JURISDICTION

13.1 In cases where the assessee seeks a stay of demand by paying an amount less than 20 per cent of the disputed demand, more often than not, an assessee has to file a writ petition to seek a stay of demand. This is indeed a sorry state of affairs. As to what must be mentioned in the memorandum of the writ has been conveyed by the Apex court in ITO, Mangalore vs. M Damodar Bhat [1969 71 ITR 806 (SC)]. The Apex Court has conveyed that the writ applicant in the memorandum of his writ must furnish specific particulars in support of his case that the AO has exercised discretion in an arbitrary manner. It is just not sufficient to make an averment in the memorandum of writ application that “the order of the ITO made under section 220 is arbitrary and capricious.” In the absence of the specific particulars in the writ application, the High Court should not go into the question of whether the AO has arbitrarily exercised his discretion.

14 CONCLUSION

Section 220(6) confers discretion upon an AO to grant a stay of demand, whether conditionally or otherwise, in cases where the assessee has preferred an appeal to JCIT(A) / CIT(A). While granting a stay the AO has to exercise his discretion judiciously and grant a stay considering the facts and circumstances of the case. Prima facie case, balance of convenience, financial stringency and undue hardship need to be considered before deciding the stay application. The said Instruction, in the garb of standardising the procedure and percentage, curtails the power of the AO when it directs that the AO shall insist upon payment of at least 20 per cent of the demand. The said Instruction has been understood by the courts as only a guideline but not a curtailment of the power vested in the AO by the statute. The said Instruction is unfair as it states that if the circumstances so demand the AO can direct payment of a sum greater than 20 per cent of the disputed demand. However, if the circumstances demand that a sum lower than 20 per cent of the disputed demand be collected and the balance stayed then the said Instruction requires the AO to make a reference to the administrative PCIT / CIT. In case of high-pitched assessment, the assessee should be granted a total stay of demand. Stay application should state briefly the facts of the case and the merits, the application should demonstrate that the assessee has a prima facie case in its favour and bring out financial stringency and balance of convenience. Substantial litigation will be reduced if the authorities consider the stay application judiciously on merits. CBDT should issue a clarification to the effect that while 20 per cent payment is a general rule, the AO can without making a reference to the higher authorities grant a complete stay where circumstances so require.

BCAJ Admin

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:

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:

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.

shailesh.kwebmaker