BCAJ | Bombay Chartered Accountant Journal

Cross-border Secondments — Tax implications

Just as the ambiguity over tax implications on secondment of expats to India appeared to be settling down, the Authority for Advance Rulings (‘AAR’) has vide its ruling in the case of Verizon Data Services1, reopened the Pandora’s box by holding that salary reimbursement of seconded employees is taxable in India as Fees for Included Services (‘FIS’)/ Fees for Technical Services (‘FTS’).

This article discusses key tax implications arising on Secondment of employees of Foreign Company to Indian Company, in light of the existing regulations and various judicial precedents.

Introduction
Increasing number of MNCs establishing business in India has led to a huge surge in the number of ‘Expatriates’ working in India. The term ‘expatriate’ has not been defined in the Act. However, as per various legal dictionaries2, expatriate means someone who is removed from/voluntarily leaves one’s own country to reside in or become a citizen of another country.

Typically, Foreign Companies (‘FCo’) depute their employees to India either in connection with some project or for rendering services to the Indian company (‘ICo’) or to safeguard their interest in India (stewardship functions). For this purpose FCo may enter into a contract to depute their employees to ICo for a predetermined time period. FCos also depute their employees to India as a part of a Foreign Collaboration Agreement (‘FCA’) under which they are obliged to provide complete support to ICo in carrying out business ventures.

‘Deputation’, in common parlance means appointment, assignment to an office, function. The dictionary meaning of the term ‘Second’ is to transfer temporarily to another unit or employment for a special task3. However, as a common practice, both these terms are used interchangeably.

Dual employment

To retain employment with FCo and safeguard the social security/retirement benefits in their home country, expats desire to continue to be on the payroll of FCo and receive salary in their home country. Accordingly, the foreign entity will be regarded as the ‘Legal Employer’. On the other hand, the expats function under the control and supervision of the ICo which eventually bears their salary costs by reimbursing the same to FCo. Thus, ICo can be regarded as the ‘Real’ or ‘Economic employer’.

The concept of ‘Dual Employment’ is also recognised in section 192(2) of the Income-tax Act, 1961 (‘Act’). The Section provides for withholding tax compliances in case of ‘Simultaneous employment’ or ‘Successive employment’ with an option to the employee to choose one of the employers who can consolidate the withholding tax obligations in respect of his salary.

With this background, let us understand the tax implications arising out of the said arrangements. Key tax implications on secondments

Expats — Salary received by expatriate employees could be subject to tax in India as such
Foreign Companies — FCo deputing expats could be subject to tax in India.

For the purposes of this article, we have only discussed the taxability of FCos in India.

Tax implications in the hands of FCo
Taxation of payments made to FCos in India, pursuant to secondment contracts has been a subject-matter of litigation since quite some time now. The Indian Revenue authorities have been contending that by sending their employees to India, the foreign entities are actually rendering services to the ICo or carrying out business in India. Accordingly, they hold that;

the payments made by Indian entities are in the nature of Fees for Technical Services (‘FTS’); or
the foreign entities have a Permanent Establishment (‘PE’) in India by virtue of the employees’ presence in India.

Consequently, ICo is held liable to withhold taxes u/s.195 of the Act, before making payments to FCo.

On the other hand, FCos believe that merely by seconding their employees to work under the supervision and control of ICo, they are not rendering any services in India. The amount recharged to ICo is mere recovery of salary costs of secondee paid by FCo in the home country and no taxable income arises in India.

Explanation 2 to section 9(1)(vii) and Article 12/13 dealing with FTS in many DTAAs specifically excludes ‘salaries’ from the scope of FTS. Thus, if it can be established that the secondee is the employee of ICo, then the salary cost recharged by FCo cannot be regarded as FTS.

As regards PE, by virtue of its employees’ presence in India, FCos are exposed to two types of PEs; (i) Service PE and (ii) Fixed Place PE. One of the most important factors to mitigate the PE risk in case of secondment arrangements is establishing the fact that the ICo is the real employer of the expats and FCo does not have any presence in India through them.

Thus, the moot question is whether the secondee, who renders services to ICo can be regarded as its employee, even though he continues to remain on the payroll of FCo.

Contract of service and contract for service

A contract, by virtue of which an employer-employee relationship is established, is regarded as a Contract of Service, whereas contracts which entail services to be rendered by one entity to another could be regarded as Contracts for Services. The importance of this distinction is also recognised by the OECD4 in their ‘Model Tax Convention on Income and on Capital’ published in July 2010 (‘hereinafter referred to as the OECD commentary’).

In order to draw distinction between ‘contract of service’ and ‘contract for service’, one needs to understand what constitutes an employment relationship in case of such contracts. Thus, interpretation of the term ‘employer’ assumes paramount significance.

Employer
The term ‘employer’ is not defined in the OECD model convention or in the Indian domestic law. However, the Hon’ble Supreme Court of India, in various decisions5 has laid down the following key tests to determine the existence of employment relationship.

Control and supervision over the method of doing work;
Payment of wages or other remunerations;
Power of selection of the employee;
Right of suspension or dismissal of the employee

Further, the OECD Commentary6 has also laid down the following key factors for determining an employer-employee relationship:

Authority to instruct the individual regarding the manner in which the work is to be performed
Control and responsibility for the place of work
Remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided
Provision of tools and materials to employee
Determination of the number and qualifications of the individual seconded
Right to select the individual to perform work and to terminate contractual agreements with the employee for that purpose
Right to impose disciplinary sanctions related to the work of that individual
Determination of holidays and work schedule.

The OECD commentary7 also provides that the financial arrangement between the two enterprises would also be one of the relevant factors in determining the nature of the relationship.

Renowned author, Professor Klaus Vogel in his treatise on Double Taxation Conventions has provided his views on the term ‘employer’ as follows

“An employer is someone to whom an employee is committed to supply his capacity to work and under whose directions the latter engages in his activities and whose instructions he is bound to obey.”8

As per Prof. Vogel’s hypothesis9, the determination of employer rests with the degree of personal and economic dependence of the employee towards the enterprises involved. Thus, if the employee works exclusively for the ICo and was released for the period in question by the FCo, he may be regarded as an employee of the ICo.

Thus, the aforesaid criteria can be applied in determining the existence of an employer-employee relationship between the ICo and the Secondee.

Judicial precedents

Having discussed what constitutes an employer-employee relationship, let us now look at the stand adopted by Indian judicial authorities in case of such secondment contracts. The common issue before the judiciary is whether the reimbursement of salary cost by ICo to FCo could be regarded as income of the FCo (FTS or otherwise) and be subject to withholding tax u/s.195 of the Act?

Having regard to the terms of the secondment contracts and after applying the tests discussed above, the Indian judicial authorities, in various cases10 have held that reimbursement of salary costs of seconded employees cannot be regarded as income of the FCo. Consequently, there is no withholding tax requirement u/s.195 of the Act. Some of the key common observations in most of these decisions are discussed below:

Expats are deputed to work under the control and supervision of the ICo. FCo is not responsible for the actions of the expats. Thus, FCo does not render any technical service to the ICo.

Since payment by ICo is towards reimbursement of salary cost borne by FCo, no income can be said to accrue to FCo in India.

Referring to Klaus Vogel’s commentary and the relevant facts, ICo could be regarded as an ‘economic employer’ of the secondees. Agreement constituted an independent contract of service.

Since the deputed employees were not subject to the control and supervision of the FCo, there would be no Service PE.

However, in case of AT&S India Pvt. Ltd.11, it was held that compensation paid by ICo to FCo constituted FTS liable to withholding tax u/s.195 of the Act. While arriving at the said ruling, the AAR made the following key observations:

FCo was the real employer of the secondees as it retains right over the employees and has power to remove/replace them

Pursuant to foreign collaboration agreement, FCo had undertaken to render the services to ICo and hence, lent the services of its seconded employees on payment of compensation by ICo

The recipient of the compensation was FCo and not the seconded employees. Further, the payment was not merely reimbursement of salary, it also included other costs

Thus, compensation referred to in the secondment agreement was for rendering ‘services of technical or other personnel’ — hence taxable as FTS and liable to withholding of tax u/s.195.

Here the key fact noted by the AAR was that the secondment agreement was in connection with the foreign collaboration agreement, whereby FCO had undertaken to render services to ICo. Accordingly, payments made pursuant to the secondment agreement were held taxable in the nature of fees for services rendered by FCo.

Verizon ruling

This recent AAR ruling has reignited the somewhat settled position as regards secondment contracts.

Facts

The applicant, Verizon India (‘VI’) is engaged in providing software and allied services to its parent, Verizon US (‘VUS’). GTE Overseas Corporation (‘GTE’), another US-based affiliate is engaged in business activity similar to VI. VI entered into an agreement with GTE for secondment of its three employees to India. The structure of the arrangement is depicted below:

One of the secondees assumed the position of managing director of VI while the other two employees liaised between VI and VUS, and supervised its day-to-day operations.

The salient features of the agreement were:

Employees would function exclusively under the control and supervision of VI;

Employees would continue to remain on the payroll of GTE;

GTE would be absolved from the responsibility/ liability of the work, actions performed and the quality of results produced by its employees;

GTE had the authority to replace and terminate the employees;

GTE would disburse the salary of the secondees and get the same reimbursed from VI without any mark-up;

VI would be liable for the Indian withholding tax compliances and the payments to GTE would be made ‘Net of taxes’.

Key questions before the Authority

Whether the amounts reimbursed to GTE would constitute income accruing to GTE and therefore the same is liable to deduction of tax in accordance with the provisions of section 195 of the Act?

If yes, then whether the payment is taxable as Fees for Included Services (‘FIS’) under the Act read with the India-USA DTAA?

AAR Ruling12

The AAR held that the seconded employees are employees of GTE and not VI. The payments made for performing managerial services would be regarded as FIS under the India-USA DTAA. Also, managerial services are directly covered under FTS as defined under Explanation 2 to section 9(1)(vii) of the Act. Hence, the payment is taxable and VI would be liable to withhold tax u/s.195 of the Act. While arriving at the said conclusion, the AAR made the following key observations:

Since the control and supervision of the company vests with the managing director, GTE has rendered managerial services to the applicant.

The ‘net of tax’ payment clause in the agreement suggests that the services provided by GTE were liable to tax in India.

Since the employees continue to be on the payroll of GTE, get their salaries from it and can be terminated only by GTE, GTE is the employer of the seconded employees.

The nature of the two receipts, one in the hands of GTE and the other in the hands of employees by way of salaries spring from different sources and are of different character and represent different species of income.

As per MOU of the DTAA it is clear that ‘make available’ clause would be applicable only to technical services. ‘Make available’ clause does not apply to managerial services, the payments for which are otherwise covered within the ambit of FIS under Article 12(4) of the DTAA.

Since the amount reimbursed by the applicant is taxable as FIS, the question of PE is merely of an academic interest. Accordingly, the same was not delved into.

Analysis

AAR has not appreciated that managing director is subject to the superintendence and control of Board of Directors and MOA/AOA of the company. The fact that a managing director can be regarded as an employee of the company has been discussed in several judicial precedents14. The AAR also failed to consider the Tribunal rulings in the cases of IDS Software and Karlstorz Endoscopy India, which dealt with similar facts.

AAR failed to consider Circular No. 720 of the CBDT, dated 30th August 1995, which clarifies that each section relating to tax withholding under Chapter XVII of the Act deals with a particular kind of payment and excludes all other sections in that Chapter and that the payment of any sum shall be liable to deduction of tax only under one section. This Circular was duly relied upon in the case of HCL15. Withholding tax on reimbursements u/s.195 which have already suffered tax u/s.192 amounts to double taxation.

While analysing whether the ICo is the real employer, the AAR ignored the key tests laid down by the Supreme Court, OECD guidelines and Klaus Vogel’s commentary on International Hiring Agreements.

AAR has misinterpreted the FIS clause in the India-US treaty by holding that for services that are technical or consultancy in nature, the make-available clause would not apply. Various judicial precedents16 have held that services which are not technical in nature are not covered within the scope of FIS clause.

The AAR ruling is also not in line with other decisions pronounced on similar issue by various authorities in the cases of HCL Infosystems, Cholamandalam MS General Insurance, IDS Software Solutions, etc.

Key takeaways

Since the law is not yet settled and various judicial authorities have adopted different interpretations, drafting of the secondment agreement by clearly defining the nature of relationships between various parties assumes paramount significance.

While drafting the agreement, the principles promulgated by the OECD and the tests laid down by the Apex Court which determine the existence of an employer-employee relationship should be kept in mind.

The documentation and conduct of the seconded employees may also influence taxation of such transactions.

A periodic review of the documentation and compliance process in line with the latest judicial precedents could help in mitigating risk.

Conclusion

The conflicting rulings by various authorities and the uncertainty on taxability of payments made pursuant to secondment contracts continue to create a dilemma in minds of Indian as well as multinational corporations deputing their employees in India. However, to put at rest the stir created by such rulings, concrete clarification from the Legislature17 or the final word from the Apex Court in the near future is the need of the hour. Till then it’s a wait-and-watch situation for all18.

1       Verizon Data Services India Private Limited v. CIT (AAR No. 865 of 2010)

2       a. Law Lexicon (2nd Edition, reprint 1999 on page 681) — ‘Renunciation of allegiance, one voluntary renunciation of citizenship in order to become a citizen of another country’

b.     Black’s law dictionary (Sixth Edition, page 576) — The voluntary act of abandoning renouncing one’s country and becoming the citizen or subject of another

c.     Webster — Residing in a foreign country

d.    Oxford — Remove onself from homeland

3       As noted by the AAR Cholamandalam MS General Insurance Co. (2009 TIOL 02 ARA-IT)

4       Para 8.4 of the Commentary on Article 15

5       Lakshminarayan Ram Gopal (25 ITR 449); Piyare Lal Adishwar Lal (40 ITR 17); Ram Prashad (86 ITR 122)

6. Para 8.14 of the Commentary on Article 15

7       Para 8.15 of the Commentary on Article 15

8       Page 899

9       Page 885

10     IDS Software Solutions v. ITO, 2009 TII 22 ITAT-Bang-Intl; Cholamandalam MS General Insurance Co. Ltd. (‘CM’)(2009 TIOL 02 ARA-IT) (Advance Rulings); Tekmark Global Solutions LLC (‘TLLC’) (131 TTJ 173) (Mumbai-ITAT); ACIT v. Karlstorz Endoscopy India Pvt. Ltd. (‘KI’) (ITA No. 2929/ Del/2009)

11     AT&S India Pvt. Ltd. — 287 ITR 421 (‘AAR’) — Distinguished in case of Cholamandalam MS General Insurance Co. Ltd.

12     AAR ruling is binding only on the applicant and the Income-tax officer in respect of transaction in relation to which the ruling is sought. However, persuasive value may be drawn in other similar cases.

13     DIT v. Morgan Stanley and Co. Inc. 292 ITR 416 (SC)

14     K. R. Kothandaraman v. CIT (1966) 62 ITR 345 (Mad), Scottish Court of Sessions in Anderson v. James Sutherland(1941) S.C. 203, Ram Prashad v. CIT (1972) 86 ITR 122 (SC)

15     In HCL Infosystems Ltd. v. DCIT, (76 TTJ 505, later affirmed by Delhi High Court in 272 ITR 261), Delhi ITAT held that reimbursement of salary cost of personnel seconded by Indian company to foreign company was not subject to tax withholding u/s.195

16     Raymonds Ltd. 80 TTJ 120 (Mum.), Boston Consulting Group – 93 TTJ 293, McKinsey & Co. Inc (Philippines) & others 99 TTJ 857 (Mum.)

17     The Legislature has recognised the ambiguity and has endeavoured to provide some clarity on the subject by defining the term employer in the proposed Direct TaxesCode, 2010.

18 Verizon has filed an appeal before the High Court against the said ruling. The outcome is eagerly awaited.

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‘Income’ includes ‘loss’ – a revisit

‘Income includes loss’ is a phrase found in various judicial precedents in the context of Indian Incometax laws, although commercially ‘income’ and ‘loss’ have always been understood to be antonyms. The gap between the commercial and tax-understanding is intentional. In this context, it is important to know the meaning of the terms ‘income’ and ‘loss’ (along with difference between them).

Income is a term though commonly used; is seldom understood. It has always triggered more questions rather than answers. It cannot be understood with recourse to some accepted tenets, beliefs and established class of propositions. To limit income exclusively to one or any specific sphere would be an unjustified arrest of its reach. Possibly, this is the reason that Income-tax statute also has left the definition of income open-ended.

There are various principles concerning ambit of ‘income’. One among them is ‘income includes loss’. A number of decisions including the Apex Court ruling in the case of CIT vs. J.H. Gotla (1985) 156 ITR 323 (SC) and CIT vs. Harprasad & Co. Pvt. Limited (1975) 99 ITR 118 (SC) has flagged this canon. The attempt in this write-up is to revisit and discern the meaning of the phrase ‘income includes losses’. In this journey, the write-up touches upon various instances in the Act when this principle ‘appears’ to be inapplicable or unworkable. The write-up attempts to initiate a thought whether this principle is to be applied in every situation or this has a restricted application?

Definition of income in the Income-tax Act, 1961 (‘the Act’)

Section 2(24) of the Act provides an inclusive definition of the term ‘income’. It does not define ‘income’ per se. Section 2(24), if paraphrased, would read as under:

(24) “income” includes

• profits and gains
• dividend
• voluntary contributions received by a trust
• the value of any perquisite or profit in lieu of salary taxable
• any special allowance or benefit, other than perquisite included under sub-Clause (iii), specifically granted to the assessee
• any allowance granted to the assessee either to meet his personal expenses at the place where the duties of his office or employment of profit are ordinarily performed or to compensate him for the increased cost of living
• the value of any benefit or perquisite, whether convertible into money or not, obtained from a company or by a representative assessee
• any sum chargeable to Income-tax under Clauses (ii) and (iii) of section 28 or 41 or 59
• any sum chargeable to Income-tax under Clause (iiia) of section 28(iiia)/ (iiib)/ (iiic)
• the value of any benefit or perquisite taxable under clause (iv) of section 28
• any sum chargeable to Income-tax under clause (v) of section 28
• any capital gains chargeable u/s. 45
• the profits and gains of any business of insurance carried on by a mutual insurance company or by a co-operative society
• the profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members
• any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature whatsoever
• any sum received from employees towards ESIC contribution
• any sum received from Keyman Insurance policy
• Gifts or receipts for inadequate consideration.

Section 2(24) enlists various instances of income. First among them is ‘profits and gains’. The terms ‘profits’ and ‘gains’ have not been defined in the Act. It is trite to state that in the absence of statutory definition one could place reliance on the dictionary meaning or normal connotation of term(s). If dictionary meanings are referred, ‘profits’ means excess of revenue over expenditure and ‘gains’ as an increase in amount, degree or value. These twin concepts are indicative of a positive figure. There are judicial precedents to indicate that gains include ‘negative gains’ and we would keep these judicial precedents aside for the time being [and restrict ourselves to terminologies used in the Act].

Other terms used in the definition are ‘received’, ‘granted’, ‘winnings’, ‘obtained’. All these terms also have an element of ‘positivity’ inbuilt in them. Can these terms be used along with ‘losses’? A loss is something different. It is not something which is received or won or granted or obtained. It comes ‘ab-extra’ from outside. The term ‘loss’ generally accompanies verbs such as ‘incurred’, ‘sustained’, ‘computed’, ‘suffered’ etc. The use of these terms in section 2(24) appears to indicate that the law does not visualise any losses to be listed therein. This becomes more evident on a reading of the remaining instances in the definition which confine themselves to incomes which are chargeable to tax. These are obviously not concerned with losses. To conclude, although section 2(24) is an inclusive definition, the instances listed therein do not seem to accommodate ‘losses’ within its stride.

Although section 2(24) is an inclusive definition and its normal meaning should not be curtailed by various items listed therein in its inclusive sweep, it is interesting to observe that the legislature has consciously not included a ‘single’ instance to suggest that income may possibly include a negative face also.

Scope and charge of total income

Section 4 is the charging provision under the Act. The charge is in respect of the total income of a person for any year. The scope of total income is outlined by section 5 which has two sub-sections – one, dealing with residents and other with nonresidents. It enlists incomes which are includible in total income. It recognises those incomes which are to be included in total income on ‘receipt’ or ‘accrual’ or ‘deemed accrual’ basis. Cumulatively, these sections seek to include income within the scope of total income to levy a charge of tax. The question is whether losses can be charged to tax? Can losses be accrued or received or deemed so? The answer is negative in my view.

This is because, the term(s) ‘accrue or arise’ connotes ‘legal right to receive’. It is generally a stage prior to actual receipt (except for advances). The gap between accrual and actual receipt is only a matter of timing difference. It needs no explanation to state that losses cannot be ‘received’. When they cannot be received; how can there be a right to receive them? – Readers may deliberate.

Provisions of clubbing of income

Explanation 2 to section 64 reads – ‘For the purposes of this section, ‘income includes loss.’ This explanation was inserted by Finance Act 1979 whose objective is explained by Circular No. 258, dated 14-06-1979; relevant portion of which is as under:

“17.2 Under the provisions of section 64, the income of the specified persons is liable to be included in the total income of the individual in certain circumstances. The Finance Act, 1979 has inserted a new Explanation 2 below section 64(2) to provide that the term “income” for the purposes of section 64 would include a loss. Hence, for example, where the individual and his spouse are both partners in a firm carrying on a business and the firm makes a loss, the share of loss attributable to the spouse will be included in determining the total income of the individual.”(emphasis supplied)

The intention of the aforesaid amendment/insertion was to include losses in determining total income of the person in whose hands the income gets clubbed. The inclusion was, therefore, sought to be made in ‘total income’ determination. Losses of one person (whose income/loss get clubbed) were sought to be set-off against the income of another person (in whose hands the income is getting clubbed). The explanation seeks to enable set-off of losses of one person in another’s hand. To effectuate this principle the legislature inserted explanation 2 WHEReby income for the purposes of this section includes loss. The important aspect here is the limited scope of this explanation. The content of this explanation is limited to the context of section 64 only. It does not travel beyond this. The explicit mention of such an aspect goes on to substantiate that under general principles income does not include losses. This is a unique provision with a special purpose.

Some of the circulars on the aspect of considering losses for the purpose of set-off against income provide some insight into the purpose of such leg- islation. In addition to Circular 258 dated 14-06-1979 (referred above) one may refer the C. B. R. Circular No. 20 of 1944 – C. No. 4(13)-I.T/ 44 dated the 15TH July, 1944 which reads as under:
Subject : Section 16(3)(a) – Loss incurred by wife or minor child – Right of set off under section 24(1) and (2).

Attention is invited to the Boards Circular No. 35 of 1941, on the above subject. It was laid down therein that where the wife or minor child of an individual incurs a loss which if it were income would be includ- ible in the income of that individual u/s. 16(3), such loss should be set-off only against the income, if any, of the wife or minor child and if not wholly set-off should be carried forward, subject to the provisions of section 24(2). The Board has reconsidered the question and has decided that, although this view may be tenable in law, the other and more equitable view is at least equally tenable that such loss should be treated as if it were a loss sustained by that individual. Thus, if the wife or minor child has a personal income of Rs. 5,000 which is not includible in the individuals income and sustains a loss of Rs. 10,000 from a source the income of which would be includible in the income of the individual, the loss should be set-off against the income of the individual under section 24(1), and if not wholly set-off should be carried forward u/s. 24(2). The wife or the minor child, would, therefore, be assessable on the personal income of Rs. 5,000. If, in any case, the wife or minor child claims a set-off of the loss against the personal income, it should be brought to the notice of the Board. Boards Circular No. 35 of 1941 is hereby cancelled.” (emphasis supplied)

Thus, losses are included to enable set-off against income. The inclusion is in the total income computation and not in income as such. The inclusion is for the limited purpose of computation. The Direct Tax Law Committee 1978, in its final report, also made some observations on this provision:

“The provisions for aggregating income of the spouse under clause (i) of section 64(1) has led to a dispute in regard to the treatment of losses which may fall to the share of the spouse from the partnership. The Gujarat High Court in Dayalbhai Madhavji Vadera vs. CIT [1966] 60 ITR 551 has ruled that the section contemplates inclusion of income and, accordingly, the share of loss arising to the spouse cannot be set-off against the total income of the other spouse. The Karnataka High Court in Kapadia vs. CIT [1973] 87 ITR 511 has dissented from this view and has held that income in this section includes a loss. On general principles, income from membership in a firm would include a loss and the context of clause (i) of sub-section (1) does not warrant the contrary construction. The liability to assessment cannot alternate from year to year between the individual and the spouse depending on whether there is a profit or a loss…” (emphasis supplied)

The Committee has categorically said that income ‘in this section’ includes loss. To state negatively, otherwise (or under normal circumstances) income does not include loss. The reason for such inclusion is to ensure consistency in the process of aggre- gating the profit or loss with the spouse’s income. It does not indicate income to include loss in all circumstances.

The scope of clubbing section is limited. It provides for clubbing of one’s income in the total income of another. By defining income to include loss, it is suggesting that loss of one person (along with income) may also be included in the total income of another person. The inclusion of loss is expanding the scope of ‘clubbing’ and not ‘income’.

Set-off and carry forward of losses

Chapter VI of the Act deals with aggregation of income and set-off of loss. Section 70 provides for set off of ‘loss’ from one source of income against ‘income’ from another source under the same head. If the losses cannot be fully set-off against income under the same head, they may be set-off against incomes under other heads (section 71). The balance losses remaining after set off against the incomes computed under other heads is carried forward to the succeeding years as per the relevant provisions of the Act. Thus, the Act recognises loss to be different from income. Loss has an effect of reducing income in the process of set-off against income. An increase in loss would reduce the income. They are inversely proportional. The opening portion of section 70 and 71 is broadly similar language which is reproduced below:

Section 70

(1) Save
as otherwise provided in this Act,
where the net
result for any assessment year
in respect of any source
falling under any
head of income, other
than “Capital gains”, is a loss,
the assessee shall
be entitled to have
the amount of such loss
set-off against his
income from any other
source under the
same head.

Section 71

(1) Where
in respect of
any assessment year
the net result of the computation under any
head of income, other than “Capital gains”, is a loss and the assessee has no income
under the head “Capital gains”, he shall, subject to the provisions of this Chapter, be entitled to have
the amount of such loss
set-off against his
income, if any, assessable for that assessment year under any other head.

to absorb the costs/expenditures/ other outlays; an assessee ends up with a situation of unabsorbed costs/ expenditures. This event of income falling short of outflows is called ‘loss’. Can such a situation be termed as ‘in- come’? Loss and Income are names of opposite fiscal situation(s) and cannot be equated with one another. Both the sections deal with set off of loss against income. The legislature itself recognises income and loss to be different and distinct. They are different outcomes having opposite characters. They cannot co-exist. This being the case, can one say that income includes loss?

The term ‘include’ means – ‘to comprise or contain as part of a whole’. Say for instance, if A includes B, then, A either consists of B wholly or partially. On the contrary, if the presence of B negates or diminishes the existence of A, then can we say that A includes B? In the context of clubbing, the legislature required losses (of one person) to be clubbed along with income (of another). This clubbing is to facilitate total income computation. Thus, the inclusion is only ‘quantitative’ and not ‘qualitative’. This being the case, such limited quantitative inclusion of the legislature cannot be understood to be ‘qualitative’ to paint all the incomes with such understanding.

In the context of section 70 and 71, ‘loss’ is a mere outcome in the process of computing income. This is apparent from the language used in these twin sections which read – ‘where the net result….’. Loss is a net result or consequence. The other alternative outcome is ‘income’. To elucidate further, one may look at the structure of the Income-tax Act.

Section 4 creates a charge on total income. Section 5 (read with section 7 and 9) outline the scope for such total income. While computing total income certain incomes are excluded by section 10 (along with 11). Section 14 classifies income into 5 heads for the purpose of total income computation (and charge of Income-tax). Sections 15 to 59 compute incomes under various heads. Section 60 to 64 include (or club) certain incomes to assessee’s total income. The focus is thus on total income computa- tion since the charge u/s. 4 is on it. While making such computation, when the income is insufficient ‘Loss’ is conceptually different from income. It is not defined in the Act. Black’s law dictionary de- fines ‘loss’ as – ‘An undesirable outcome of a risk; disappearance or diminution in value; usually in an unexpected or relatively unpredictable way’. The definition appears to reflect attributes of involuntary happening. Although Companies Act of 1956 does not define ‘loss’ there is an indirect inference one could draw from section 210(2) therein which reads :

(2)IN the case of a company not carrying on business for profit, an income and expenditure account shall be laid before the company at its annual general meeting instead of a profit and loss account, and all references to “profit and loss account”, “profit” and “loss” in this section and elsewhere in this Act, shall be construed, in relation to such a company, as references respectively to the “income and expenditure account”, “the excess of income over expen- diture”, and “the excess of expenditure over income”. (emphasis supplied)

The meaning of loss has been explained to be ‘excess of expenditure over income’. It is a differential between expenditure and income. It is an outcome when income is unable to absorb all the expenditure/ costs. In other words, unabsorbed cost is loss. The interplay between income and expenditure results in loss. While computing income, loss could arise if the income falls short of expenditure. Loss is thus a status or situation wherein expenditure exceeds income. It is not a part of income. Something to be included in income, it should be a part of it. Income (net) or losses are two alternatives. They are outcomes. One denotes surplus and other is an epitome of deficit. From an Income-tax standpoint, marriage of these two extremes is impossible sans specific situations such as clubbing or set-off provi- sions (referred above).

Accounting standards also differentiate the two. Accounting Standard 22 [Disclosure and computation of deferred tax] defines taxable income (tax loss) as the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which Income-tax payable (recoverable) is determined. Income and loss have been recognised as alternatives. Loss is an antonym of income. The question is whether such parallel and unlike concepts overlap under the Income-tax regime?

As stated in the beginning of this write-up, various courts held that income includes ‘losses’. It appears to be a fairly settled proposition. Whether this proposition is applicable in every situation? Does ‘income’, which is inherently positive, include losses?

In my opinion, the term ‘income’ is not a polymor- phous term having an open texture. Income which indicates ‘coming in’ is an embodiment of positivity. It signifies pecuniary enrichment or accumulation. Loss is indicative of opposite emotions (to income). Loss may take various forms but would always result in deterioration. Indian tax provisions (keeping the judicial precedents aside) actually do not seek to hold these contradictory terms synonymous in every situation. At best, loss can be defined to be ‘loss of income’ and not ‘loss includes income’.

Having gone through the various instances and indications in the Act, the question still persists. The mystery around relationship between income and loss still lingers. Can these instances in the statute shake the law of land (Apex Court rulings)? Readers may deliberate whether INCOME REALLY INCLUDES LOSS?

If this proposition is accepted, can a daring attempt be made to claim that ‘losses emanating from sources of income which are exempt can be set-off against other income?’ Although this proposition is well settled by the Apex Court in the case of CIT vs. Harprasad & Co. Pvt. Limited (1975) 99 ITR 118 (SC), the attempt is to just explore an alternate school of thought:

Loss is not a part of total income

Section 2(45) defines total income to mean total amount of income referred to in section 5 and computed in the manner laid down in the Act. The definition thus contains two limbs which are
as follows:

(a) The income includible in total income must be ascertained as per section 5; and

(b) The income must be computed as per provisions of the Act.

‘Total income’ defined in section 2(45) presupposes an existence of ‘income’ referred to in section 5. For the reasons mentioned above, section 5 does not appear to cover losses. Therefore, section 2(45) can never include loss (since they cannot be ascertained as per section 5). Section 10 seeks to exclude certain incomes from total income. When a loss is never included in total income, how can section 10 exclude something which never existed?

Section 10 can never exempt a loss

Section 10 contains provisions for exemption of certain incomes. It never exempts a loss. Infact, courts have held that exemptions provided by the legislature itself may furnish an infallible clue to the income character of a particular receipt [Refer All India Defence Accounts Association, In re: Shailendra Kumar vs. UOI (1989) 175 ITR 494 (All)]; although not conclusive.

The apex court in the case of UOI vs. Azadi Bachao Andolan and Another 263 ITR 706 (SC) held that the ‘liability to tax’ is a legal situation; whereas ‘payment of tax’ is a fiscal fact. A taxing statute does not always proceed to charge and levy tax. Exemption provisions provide exemption from payment of tax. One among them is section 10. The incomes enumerated therein exclude income from the total income. However, it does not annul the charge of tax. An exemption cannot dispense with the very levy created under the Act [Refer B.K. Industries vs. UOI (1993) 91 STC 548]. Support for this proposi- tion can be drawn from the Apex Court decision in the case of Peekay Re-Rolling Mills vs. Assistant Commissioner – 2007 (219) ELT 3 (SC) – In this case, the court observed:

“In our opinion, exemption can only operate when there has been a valid levy, for if there is no levy at all, there would be nothing to exempt. Exemption does not negate a levy of tax altogether.” “Despite an exemption, the liability to tax remains unaffected, only the subsequent requirement of payment of tax to fulfill the liability is done away with.” (emphasis supplied)

Taking cue from the aforesaid decision (although rendered in the context of central excise), one could argue that exemption section could operate on only those income which can come within the ambit of Income-tax levy. Loss can never be subject to Income-tax levy; so there is no occasion to take relief of exemption provisions. Moreover, it is a settled principle that exemption provisions have to be construed liberally. The tax relief granted by a statute should not be whittled down by importing limitations not inserted by the legislature [Refer CIT vs. K E Sundara Mudaliar (1950) 18 ITR 259 (Mad) and others].

With utmost respect for the Apex Court decision in the case of Harprasad & Co. Pvt. Limited case and many other cases which have concurred or followed this proposition, the aforesaid write-up is an attempt to take a deeper insight into these landmark judgments and may be challenge the obvious.

shailesh.kwebmaker

Deductibility of Discount on Employee Stock Options — An analysis, Part 2

PART C(4) — Deductibility of ESOP
discountu/s.28 of the Act

If for any reason ESOP discount cannot be claimed u/s.37, it would alternatively be allowable u/s.28 of the Act.

Business loss is different from expenditure

Disbursement or expenses of a trader is something ‘which goes out of his pocket’. A loss is something different. That is not a thing which he expends or disburses. That is a thing which comes upon him ‘ab-extra’ from outside.

There is a distinction between the business expenditure and business loss. Finlay J said
in the case of Allen v. Farquharson Bros., 17 TC 59, 64 observed

“…expenditure or disbursement means something or other which the trader pays out; I think some sort of volition is indicated. He chooses to pay out some disbursement; it is an expense; it is something which comes out of his pocket. A loss is something different. That is not a thing which he expends or disburses. That is a thing which so to speak, comes upon him ab-extra”

Certain judicial principles have held that section 37 does not envisage losses. The Supreme Court in the case of CIT v. Piara Singh, (1980) 124 ITR 40 (SC) held —

“The confiscation of the currency notes is a loss occasioned in pursuing the business; it is a loss in much the same was as if the currency notes had been stolen or dropped on the way while carrying on the business.”

In the case of Dr. T. A. Quereshi v. CIT, (2006) 287 ITR 547 (SC), the Supreme Court relied on the aforesaid judgment and held —

“The Explanation to section 37 has really noth-ing to do with the present case as it is not a case of a business expenditure, but of business loss. Business losses are allowable on ordinary commercial principles in computing profits. Once it is found that the heroin seized formed part of the stock-in-trade of the assessee, it follows that the seizure and confiscation of such stock-in-trade has to be allowed as a business loss.”

If ESOP discount is not held to be expenditure, its deductibility will have to be examined u/s.28 of the Act.

Business loss allowable u/s.28

Sections 30 to 37 are not exhaustive of the type of permissible deductions. Non deductibility u/s.30 to 37 does
not mar the claim for business loss as a deduction. These are to be allowed in section 28 itself.

“The list of allowances enumerated in sections 30 to 43D is not exhaustive. An item of loss incidental to the carrying on of a business may be deducted while computing the profits and gains of that business, even if it does not fall within any of the specified sections”.

The above observations have been quoted with approval in CIT v. Chitnivas, AIR 1932 PC 178; Ram-chander Shivnarayan v. CIT, (1978) 111 ITR 263, 267 (SC); Motipur Sugar Factory Ltd. v. CIT, (1955) 28 ITR 128 (Pat.); Tata Iron & Steel Co. Ltd. v. ITO, (1975) 101 ITR 292, 303 (Bom.).

As mentioned earlier, the charge u/s.28 is on ‘profits’. This term has to be understood in a commercial sense. Expenditure incurred or loss suffered in the course of business or which is incidental to the carrying of business would be allowed as a deduction even in the absence of any statutory provision granting such deduction.

The concept of ‘profit’ in section 28 and the provisions of sections 30 to 43D correspond to section 10(1) and section 10(2) respectively of the Indian Income Tax Act, 1922. The interrelation of these sections was explained by the Supreme Court in Badridas Daga v. CIT, (1958) 34 ITR 10 (SC), in the following words:

“It is to be noted that while section 10(1) imposes a charge on the profits and gains of a trade, it does not provide how those how profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions, but it is settled that they are not exhaustive of all allowances which could be made in ascertaining profits taxable u/s.10(1). The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2) whether it is admissible or not will depend on whether having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed provided of course there is no prohibition against it, express or implied in the Act.”

Accordingly, a loss suffered in the course of business and incidental to the carrying of business is allowable as a deduction even in the absence of any specific provision conferring the said deduction.

Conditions for claim of loss u/s.28

In order to claim a loss u/s.28, such loss should fulfill the following conditions:

It should be a real loss, not notional or fictitious

It should have actually arisen and been incurred, not contingent upon a future event

It must be incidental to business and arise out of an operation therefrom and not on capital account

A. ESOP discount is real loss and not notional or fictitious

Under the general principles of tax laws, artificial and/ or fictitious transactions are disregarded. In order to be deductible, the loss must be a real loss and not merely notional or anticipatory.

In an ESOP, the loss is the sum that the company could have derived, if it had issued the shares at the premium prevailing in the market. It is the quantum of money forgone, as a result of the employer choosing not to issue shares at market value.

A fair measure of assessing trading profits in such circumstances is to take the potential market value at one end and the actual proceeds at the other. The difference between the two would be the loss since loss is not notional or fictional.

Section 145(1) is enacted for the purpose of determining profits under the head ‘Profits and gains of business or profession’. In the present case, section 28 is relevant and hence, section 145(1) is attracted. Under the principles of mercantile system of accounting on which section 145 is founded, ‘prudence’ is an extricable part. Under this principle, the expenditure is debited when a legal liability has been incurred. Any ‘delay in actual disbursement’ or ‘non occurrence of disbursement’ does not mar the liability so created. In other words, expenses ought to be recognised in the year of incurrence of liability irrespective of the time of actual disbursement.

The recognition of the said loss is supported by the corresponding benefit enjoyed by an employee.
The enjoyment of a benefit by an employee and the corresponding suffering of a pecuniary detriment by the employer are two sides of the same coin. Being inter-related, the nature of benefit should influence the characterisation of the sufferance by the other.

ESOP is nothing but a bonus or an incentive paid in the form of company stocks. From an employee perspective, it is an election made by him by opting to have the bonus/incentive received in the form of shares. Alternatively, the employee may opt for actual payment of salary and subsequently, pay it back to the company as subscription to share capital. If such a mode is adopted the salary payment would be deductible. The receipt of subscription monies thereafter would be on capital account. The character of the subsequent transaction would not impact the allowability of the earlier payment. This conclusion should not alter merely because the two-stage transaction is accomplished through a unified act. One may rely on the principles underlined in Circular No. 731 [(1996) 217 ITR (St.) 5], dated December 20, 1995, in relation to claim u/s.80-O of the Act.

Circular No. 731, dated 20-12-1995 reads as follows:

“1. Under the provisions of section 80-O of the Income-tax Act, 1961, an Indian company or a non-corporate assessee, who is resident in India, is entitled to a deduction of fifty per cent. of the income received by way of royalty, commission, fees, etc., from a foreign Government or foreign enterprise for the use outside India of any patent, invention, model, design, secret formula or process, etc., or in consideration of technical or professional services rendered by the resident. The deduction is available if such income is received in India in convertible foreign exchange or having been converted into convertible foreign exchange outside India, is brought in by or on behalf of the Indian company or aforementioned assessee in accordance with the relevant provisions of the Foreign Exchange Regulation Act, 1973, for the time being in force.

2. Reinsurance brokers, operating in India on behalf of principals abroad, are required to collect the re-insurance premia from ceding insurance companies in India and remit the same to their principals. In such cases, brokerage can be paid either by allowing the brokers to deduct their brokerage out of the gross premia collected from Indian insurance companies and remit the net premia overseas or they could simply remit the gross premia and get back their brokerage in the form of remittance through banking channels.

3. The Reserve Bank of India have expressed the view that since the principle underlying both the transactions is the same, there is no difference between the two modes of brokerage payment. In fact, the former method is administratively more convenient and the reinsurance brokers had been following this method till 1987 when they switched over to the second method to avail of deduction u/s.80-O of the Act.

4. The matter has been examined. The condition for deduction u/s.80-O is that the receipt should be in convertible foreign exchange. When the commission is remitted abroad, it should be in a currency that is regarded as convertible foreign exchange according to FERA. The Board are of the view that in such cases the receipt of brokerage by a reinsurance agent in India from the gross premia before remittance to his foreign principals will also be entitled to the deduction u/s.80-O of the Act.”
(Emphasis supplied by us)

The Apex Court relied on the aforesaid circular, in the case of J. B. Boda and Company Private Limited v. CBDT, (1996) 223 ITR 271 (SC); and held —

“It seems to us that a ‘two-way traffic’ is unneces-sary. To insist on a formal remittance to the foreign reinsurers first and thereafter to receive the commission from the foreign reinsurer will be an empty formality and a meaningless ritual, on the facts of this case.”

Applying this principle in the present case, insisting for actual payment of salary to employees and taking it back as subscription to capital is unnecessary. The purpose is short circuited by issue of ESOP shares instead of initial salary payment and deployment of salary by the employees to buy stocks.

Hypothetically, it could be assumed that employees are paid remuneration with an attached compulsion/ condition to appropriate such payments mandatorily towards Company’s shares. In such cases, whether the deductibility of salary payments could be questioned? — The answer obviously is no. Disallowing ESOP discount on the ground that there is no actual payment of salary, but only profit forgone may not be a correct proposition of law.

B. Whether ESOP expenses have actually arisen/ incurred, not contingent upon future events?

A loss is allowable in the year in which it is incurred. In a commercial sense, trading loss is said not to have resulted so long as reasonable chances of obtaining restitution is possible. Losses can be claimed in the year in which they occur if there are no chances of recovery/restitution.

If one follows the mercantile system, the loss becomes deductible at the point when it occurs. Lord Russell in the case of CIT v. Chitnavis, 6 ITC 453, 457 (PC) stated

“You may not, when setting out to ascertain the profits and gains of one year, deduct a loss which had, in fact, been incurred before the commencement of that year. If you did you would not arrive at the true profits and gains for the year. For the purposes of computing yearly profits and gains, each year is a self contained period of time in regard to which profits earned or losses sustained before its commencement are irrelevant.”

The accounting treatment of a contingent loss is determined by the expected outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements.

The term ‘contingent’ has not been defined in the Act. Section 31 of the Indian Contract Act, 1872 defines ‘contingent contract’ as

A ‘contingent contract’ is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen.

A contract which is dependent on ‘happening’ or ‘not happening’ of an event is a contingent contract. In an ESOP, the loss contemplated is the discount on issue of shares. The quantum of loss would depend on the number of employees accepting the offer. This however does not render the loss ‘contingent’. In other words, the aggregate obligation to discharge discount to all the employ-ees in a year cannot be regarded as contingent merely because some employees may forfeit their rights. Accordingly, ESOP discount is not a contingent loss.

Support can be drawn from Owen v. Southern Railway of Peru Ltd., (1956) 36 TC 602 (HL) which dealt with a liability arising on account of gratuity benefit. It was held —

“where you are dealing with a number of obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision.”

ESOP discount is thus an ascertained loss. ESOP discount is actuarially calculated. The Black-Scholes model or the Binomial model is generally used in quantifying the discount. The method of ascertaining the loss is scientific. It is not adhoc or arbitrary.

C. Whether ESOP discount is incidental to business and not on capital account

It is only a trading loss that is allowable and not capital loss. The loss should be one that springs directly from carrying on of the business or is incidental to it. From section 28 it is discernible that the words ‘income’ or ‘profits and gains’ should be understood as including losses also. In other words, loss is negative profit. Thus, trading loss of a business is deductible in computing the profits earned by the business. The loss for being deductible must be incurred in carrying out business or must be incidental to the operation of business. The determination of whether it is incidental to business is a question of fact.

For the reasons already detailed, ESOP discount should be treated as a revenue account. Business income is to be computed based on the general commercial principles. In the application of these commercial principles, reckoning a loss is an integral part.

In summary, ESOP discount is a loss incidental to business which is incurred by the company. This loss is incurred on account of forgoing the right to issue shares at a higher value. The company abdicates such right in favour of employees as a part of employee recognition and compensation strategy. It is an act which is consistent and justified by the business interest of the employer. Accordingly, a claim of ESOP discount should be allowable u/s.28 of the Act, if it is, for any reason, not allowable u/s.37.

PART C(5) — Year of deductibility

After ascertaining that the ESOP discount is a deductible expense, the year of deductibility needs to be determined. As per section 145, provision should be made for all known liabilities and losses, even though the amount cannot be determined with certainty. Section 145(1) regulates the method of accounting for computing incomes under the ‘Business income’ and ‘Income from other sources’ head. It provides:

“(1) Income chargeable under the head ‘Profits and gains of business or profession’ or ‘Income from other sources’ shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.”

Assessees therefore have a choice in selecting the system of accounting to be followed in maintenance of the books of account. However, u/s.209 of the Companies Act, 1956, companies are bound to maintain their accounts on the accrual or mercantile basis only. If companies fail to follow the accrual system of accounting, it will be deemed that no proper books have been maintained by them.

Under the mercantile or accrual system of accounting, income and expenditure are recorded at the time of their accrual or incurrence. For instance, income accrued during the year is recorded whether it is received during the year or during a year preceding or following the relevant year. Similarly, expenditure is recorded if it becomes due during the previous year, irrespective of the fact whether it is paid during the previous year or not. The profit calculated under the mercantile system is profit actually earned during the previous year, though not necessarily realised in cash.

There can be no computation of profits and gains until the expenditure necessary for earning the receipts is deducted therefrom. Profits or gains have to be understood in a commercial sense. Whether the liability was discharged at some future date, would not be an impediment in the claim as a deduction. The difficulty in the estimation of expenditure would not convert the accrued liability into a conditional one. This was upheld by the Apex Court in the case of Calcutta Co. Limited v. CIT, (1959) 37 ITR 1 (SC).

The use of the words ‘laid out or expended’ in section 37 along with the word ‘expenditure’ indicates that the expenditure may either be an actual outgo of money irretrievably (expended as per the cash system of accounting) or a putting aside of money towards an existing liability (laid out as per the mercantile system of accounting) . The decisions in 3 CIT v. Nathmal Tolaram, (1973) 88 ITR 234 (Gauhati) and Saurashtra Cement and Chemical Industries Ltd. v. CIT, (1995) 213 ITR 523 (Guj.) support this proposition.

The ESOP discount is an expenditure incurred for the purpose of business. In accordance with section 145, business income has to be computed in accordance with the method of accounting regularly followed by the assessee. As discussed earlier, the choice of ‘method’ of accounting is with the assessee. The computation of income and expenses should be in accordance with the ‘method of accounting’ so followed by the assessee. The term ‘method’ is defined in the Oxford Dictionary as ‘procedure for attaining an object’.

The operative portion of section 145 uses the phrase ‘system of accounting regularly employed’. The term ‘regularly’, as defined in Concise Oxford Dictionary means ‘following or exhibiting a principle, harmonious, constituent, systematic’. Such system/method of accounting for ESOP discount is prescribed by SEBI. The SEBI guidelines mandates the ESOP discount to be spread over the period of vesting. The company is therefore obliged to follow the guidelines and that forms its ‘regular system of accounting’ (for the purposes of section 145). Income-tax statute follows the system so mandated. A method/system of accounting may be disregarded only when the assessing officer is not satisfied about the correctness or completeness of accounts or where the method of accounting has not been regularly followed. Such system which is based on guidelines prescribed by the regulatory bodies cannot be negated on the grounds that there are alternative methods/systems possible. An aliquot portion of the ESOP discount may be allowed in each of the years and this is the position recommended by SEBI as well.

Part D — Judicial pronouncements
Certain favourable judicial pronouncements

The honorable Chennai Tribunal in the case of S.S.I. Limited v. DCIT, (2004) 85 TTJ 1049 (Chennai) held that the ESOP discount is an allowable expenditure. In the aforesaid case, the assessee amortised the ESOP discount over a period of three years and claimed it as staff welfare expense. The Assessing Officer (AO) allowed this claim of expenditure. The Commissioner of Income-tax initiated proceedings u/s.263 of the Act holding the AO’s order to be prejudicial to the interests of the Revenue. It enlisted various grounds in support of this. Specifically, ground number 5 reads as below:

“…..The Assessing Officer has allowed this claim without any application of mind inasmuch as no details have been called for. What was the basis of arriving at the difference has also not been ex-amined. The difference between the market value of the shares and the discounted value at which these were allotted to the employees cannot be a revenue expenditure.”

The CIT directed the AO to disallow the ESOP discount. The assessee appealed against such order before the Chennai Tribunal. The Tribunal’s decision is therefore with reference to appeal against the revision order passed by the CIT u/s.263 and not the basis of regular appeal.

The basis of the assumption of the jurisdiction u/s.263 by the CIT is that the AO had not applied his mind in deciding on the issues in his order. Typically, the Tribunal would examine this aspect and decide whether the exercise of such jurisdiction is justified or not. In the SSI’s case, the Tribunal gave its decision by discussing merits of each of the issues in detail. An extract of discussion on the ESOP discount is as follows :

“…..It was a benefit conferred on the employee and a benefit, which could not be taken back by the company. So far as the company is concerned, once the option is given and exercised by the employee, the liability in this behalf is ascertained. This fact is recognised even by SEBI and the entire ESOP scheme is governed by the guidelines issued by SEBI. It is not the case of contingent liability depending upon various factors on which the assessee had no control…. There can be no denial of the fact that in respect of ESOP, SEBI had issued guidelines and assessee-company had followed these guidelines to the core and the claim of expenditure was in accordance with the guidelines of SEBI…. ”
(Emphasis supplied by us)

The ESOP discount was held as an employee benefit. It was an ascertained liability which was recognised in the books of account. Reliance was placed on the SEBI regulations. The regulations mandated charge of such expense to profit and loss account.

In the case of Consolidated African Selection Trust v. Inland Revenue Commissioners, (1939) 7 ITR 442 (CA), the Court dealt with the issue of shares be-ing an alternate mode of liability discharge. It was observed:

“If an employer having two receptacles, one containing cash and the other containing goods, chooses to remunerate his employee by giving him goods out of the goods receptacle instead of cash out of the cash receptacle, the expenditure that he makes is the value of those goods, not their purchase price or anything else but their value, and that is the amount which he is entitled to deduct for income-tax purposes.”

Distinguishing certain judicial precedents

In this part, we discuss why the decisions of the Delhi Tribunal in Ranbaxy’s case (2009) 124 TTJ 771 (Del.) and Lowry’s case 8 ITR 88 (Supp) are distinguishable where the ESOP discount was held as not an allowable expenditure.

It is a trite law that a judgment has to be read in the context of a particular case. A judgment cannot be applied in a mechanical manner. A decision is a precedent on its own facts. In State of Orissa v. Md. Illiyas, AIR 2006 SC 258, the Supreme Court explained this principle in the following words:

“…..Reliance on the decision without looking into the factual background of the case before it is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

The following words of Lord Denning in the mat-ter of applying precedents have become locus classicus:

“Each case depends on its own facts and a close similarity between one case and another is not enough because even a single significant detail may alter the entire aspect, in deciding such cases, one should avoid the temptation to decide cases (as said by Cardozo) by matching the colour of one case against the colour of another. To decide therefore, on which side of the line a case falls, the broad resemblance to another case is not at all decisive…..”

Precedent should be followed only so far as it marks the path of justice, but you must cut the dead wood and trim off the side branches, else you will find yourself lost in thickets and branches. My plea is to keep the path to justice clear of obstructions which could impede it.”

Ranbaxy case has largely relied on this decision of the House of Lords and accordingly, we have not provided any specific comments on this case. Here-inbelow are our comments/rebuttal on contentions raised in the Lowry’s case. These would apply for the Ranbaxy case also apart from what has been outlined hereinbefore.

Lowry’s case based on foreign law

The decision of the Court in Lowry’s case was based on the then prevailing English law. Before dwelling on the specific arguments/contentions in this case, it may be relevant to discuss the principle of interpretation in case of foreign judicial precedents.

Aid from foreign decisions in interpretation

The words and expressions in one statute as judicially interpreted do not afford a guide to the construction of the same words or expressions in another statute unless both the statutes are pari materia legislations. English Acts are not pari materia with the Indian Income-tax Act. In some cases, English decisions may be misleading since the Act there may contain provisions that are not found in the Indian statute or vice versa. As a result, foreign decisions are to be used with great circumspection. They are not to be applied unless the legal and factual backgrounds are similar.

The Supreme Court in the case of Bangalore Water Supply and Sewerage Board v. A. Rajappa, AIR 1978 SC 548 held — “Statutory construction must be home-spun even if hospitable to alien thinking.”

The Supreme Court in the case of General Electric Company v. Renusagar Power Co., (1987) 4 SCC 213 held — “When guidance is available from binding Indian decisions, reference to foreign decisions may become unnecessary.”

The rationale of the ESOP discount being capital expenditure is largely based on the Lowry’s case. This was a landmark judgment by the House of Lords in the year 1940. However, the applicability of this judgment in the present age, case and context is debatable.

The Lowry’s case was adjudged on the principles prevailing then before the House of Lords. Lord Viscount Maugham (one of the judges who held the ESOP discount to be capital in nature) observed:

“The problem which arises under Schedule D seems to me to be a very different one, since it concerns profits of a trade and is subject to a large number of prohibitions as to the deductions which alone are permissible and no other statutory rules of some complexity.”
(Emphasis supplied by us)

From the above observation, one can infer that deductibility of any business expenditure was subject to strict prohibitions. An expense would not be a deductible unless specifically allowed. This is in total contrast to the provisions of deductibility under the Income-tax Act (as discussed earlier) which allows any business expenditure unless specifically prohibited. The provisions of law applied in the case of Lowry are not pari materia with the Act. Accordingly, the judgment cannot and should not be relied upon.

Updation of construction

It is presumed that Parliament intends the Court to apply to an ongoing Act a construction that continuously updates its wording to allow for changes. The interpretation must keep pace with changing concepts and values and should undergo adjustments to meet the requirements of the developments in the economy, law, technology and the fast changing social conditions. The Supreme Court decisions in the cases of Bhagwati J. Gupta v. President of India, AIR 1982 SC 149 and CIT v. Poddar Cements, 226 ITR 625 (SC) can be referred in this regard.

In the treatise ‘The Principles of Statutory Interpre-tation’ by Justice G. P. Singh, (9th edition — page 228) the learned author observes:

“It is possible that in some special cases a statute may have to be historically interpreted “as if one were interpreting it the day after it was passed.” But generally statutes are of the “always speaking variety” and the court is free to apply the current meaning of the statute to present-day conditions. There are at least two strands covered by this principle. The first is that the court must apply a statute to the world as it exists today. The second strand is that the statute must be interpreted in the light of the legal system as it exists today.”
(Emphasis supplied by us)

The Apex Court in the case of CIT v. Poddar Cements, 226 ITR 625 (SC) relied on the treatise ‘Statutory Interpretation’ by Francis Bennion, (2nd edition — section 288) with the heading ‘Presumption that updating construction to be given’ (page 617, 618, 619) and observed as follows:

“It is presumed that Parliament intends the Court to apply to an ongoing Act a construction that continuously updates its wording to allow for changes since the Act was initially framed (an updating construction). While it remains law, it is to be treated as always speaking. This means that in its application on any date, the language of the Act, though necessarily embedded in its own time, is nevertheless to be construed in accordance with the need to treat it as current law.

In construing an ongoing Act, the interpreter is to presume that Parliament intended the Act to be applied at any future time in such a way as to give effect to the true original intention. Accordingly the interpreter is to make allowances for any relevant changes that have occurred, since the Act’s passing, in law, social conditions, technology, the meaning of words, and other matters…. That today’s construction involves the supposition that Parliament was catering long ago for a state of affairs that did not then exist is no argument against that construction. Parliament, in the wording of an enactment, is expected to anticipate temporal developments. The drafter will try to foresee the future, and allow for it in the wording.

An enactment of former days is thus to be read today, in the light of dynamic processing received over the years, with such modification of the current meaning of its language as will now give effect to the original legislative intention. The reality and effect of dynamic processing provides the gradual adjustment. It is constituted by judicial interpretation, year in and year out. It also comprises process-ing by executive officials.”

The Supreme Court in the case of Bhagwati J. Gupta v. President of India, AIR 1982 SC 149 held:

“The interpretation of every statutory provision must keep pace with changing concepts and values and it must, to the extent to which its language permits or rather does not prohibit, suffer adjustments through judicial interpretation so as to accord with the requirements of the fast changing society which is undergoing rapid special and economic transformation. The language of a statutory provision is not a static vehicle of ideas and concepts and as ideas and concepts change, as they are bound to do in a country like ours with the establishment of a democratic structure based on egalitarian values and aggressive developmental strategies, so must the meaning and content of the statutory provision undergo a change. It is elementary that law does not operate in a vacuum. It is not an antique to be taken down, dusted admired and put back on the shelf, but rather it is a powerful instrument fashioned by society for the purpose of adjusting conflicts and tensions which arise by reason of clash between conflicting interests. It is therefore intended to serve a social purpose and it cannot be interpreted without taking into account the social, economic and political setting in which it is intended to operate. It is here that the Judge is called upon to perform, a creative function. He has to inject flesh and blood in the dry skeleton provided by the Legislature and by a process of dynamic interpretation, invest it with a meaning which will harmonise, the law with the prevailing concepts and values and make it an effective, instrument for delivery of justice….”

In case of ESOP, the primary issue revolves around the character of discount — whether capital or revenue? In this context, it may be relevant to quote one of the observations of the Apex Court in the case of Alembic Chemical Works Co. Ltd. v. CIT, (1989) 177 ITR 377 (SC). The Court observed:

“The idea of ‘once for all’ payment and ‘enduring benefit’ are not to be treated as something akin to statutory conditions; nor are the notions of ‘capital’ or ‘revenue’ a judicial fetish. What is capital expenditure and what is revenue are not eternal verities, but must be flexible so as to respond to the changing economic realities of business. The expression ‘asset or advantage of an enduring nature’ was evolved to emphasise the element of a sufficient degree of durability appropriate to the context.”

Interpretation must be with reference to the law and circumstances as it exists when tax has to be paid. This helps in keeping the meaning updated with changing times. In the present eco-nomically advancing modern world, the purpose of ESOP should not be defeated by the narrow interpretation of colouring the transaction as a mere transaction of ‘issue of shares’. The approach of the present-day taxes is to recognise ESOP as a tool of employee compensation.

In Lowry’s case, as per the then prevailing law, a claim of deduction was subject to a large number of prohibitions which alone were permissible. This contradicts the rules of deductibility under the Act. This law is not pari materia with the Act. Accordingly, the binding nature of the Court is diluted. Even otherwise, the Court’s decision could be rebutted on the following points:

Intention implied from erroneous documents

Intention of the parties to the transaction and objective were discerned by placing a huge reliance on the terms and conditions in the employee letters. However, Lord Russell (judge of the majority view) has himself acknowledged:

“The transactions as evidenced by the documents does not, I think, warrant the terminology.”

Any conclusion drawn by placing reliance on badly drafted document is not valid. Reliance was placed on employee letters which were tainted by erroneous drafting/wrong language and nomenclatures. The majority view that ESOP is primarily to issue shares and not employee remuneration (by deriving support from the impugned letters), is thus not a correct statement of fact. The Court seems to have given weightage to form over substance of the transaction.

Impact on financial statements

The Court held that the ESOP discount is not an item of profit/trading transaction and there was no impact on the financial position.

This write -up has examined the treatment of the ESOP discount from various angles, namely, commercial accounting, international practices, statutory guidelines and from an income-tax perspective. All lead to the same conclusion that ESOP is a revenue item which needs to be treated as a charge against profits. It is a part of the financial statements.

Reliance on some judicial precedents

All the judges deliberated on some of the judicial precedents (primarily, Usher’s case and Dexter case).

These cases are not applicable in the present case — they are factually distinguishable. Even otherwise, these judgments relate to foreign law which is not pari materia with the Act and hence are inconsequential.

No monies worth given up by either the Company or the employees

Company’s perspective: The Court held that no money’s worth had been given up by the Company.

The ESOP discount is the difference between the strike price paid and the value of the share at the date the option is exercised. This difference is certainly a charge against the profits — as an expense, profit forgone or a loss. There is a loss of opportunity of issue of shares at the prevailing market price. It is certainly a money’s worth given up. In fact Lord Viscount (judge from majority view) said:

“If this House had regarded the transaction as one in which the company was giving “money’s worth” in the sense of an equivalent for cash in consider-ation of the promise to subscribe for shares the decision would have been the other way.”

In case of the ESOP discount, the Company has for-gone share premium receivable. The Company has given up a portion of money receivable on issue of its shares. Accordingly, the aforesaid contention is rebutted.

Employee’s perspective: ESOP was held to be gift to the employees and that employees had not given up anything for procuring these shares.

ESOP is a form of employee remuneration. It is a remuneration paid either for his past services or with intent to retain his services for the future. Thus it is an award in lieu of his services to the organisation rendered/expected to be rendered. This truth has been acknowledged by the regulatory bodies — OECD, SEBI and ICAI. The Karnataka High Court has acknowledged ESOP as an employee remuneration tool.

Hypothetical proposition of ESOP being an application of salary

The Court held that ESOP being an application of salary to employees for share subscription — is only a hypothetical proposition.

The ESOP discount is amount notionally received on capital account and utilised on revenue account. Instead of salary being paid and inturn application of employees to ESOP, this two-way transaction has been short-circuited. Support can be drawn from Circular 731, dated 20-12-1995 and Apex Court decision in the case of J. B. Boda and Company Private Limited v. CBDT, (1996) 223 ITR 271 (SC).

Share premium forgone is a capital item and hence ESOP discount is capital in nature

The Court held that share premium is a capital receipt. Forbearance of such capital receipt is not deductible.

It has been sufficiently put forth that the ESOP discount is a revenue item. The ESOP discount is not a capital receipt. The determination of capital v. revenue should be done based on the utilisation of expense. The ESOP discount is incurred for employee benefit and hence revenue in nature.

Employee paying tax is inconsequential

The Court held that the fact that the employee paid tax on ESOP (on benefit of discount on share premium) was inconsequential in determining the allowability of the ESOP discount.

It is an accepted principle that ‘Income charge-ability’ is not the basis for ‘expenditure allowability’. The fact that amount receivable has the character of income in the hands of recipient, is not relevant for determining the expense allowability. The fact that it does not get taxed or is taxed at a later point of time or is taxed under a different head in the hands of the employee would not be relevant.

Additionally, comments of Lord Wright (judge from minority view) are worth men-tioning which held that ESOP was held taxable in employee’s hands, but was not correspondingly entitled to deduction in the hands of employer:

“….he was receiving by way of remuneration money’s worth at the expense of the company, and yet that the company which was incurring the expense for purposes of its trade to remunerate the directors was not entitled to deduct that expense in ascertaining the balance of its profits….”

Discount on shares is a ‘choice’ and not an ‘obligation’

The Court held that the Company was entitled to issue shares at a lesser/discounted value and it did so. It was a matter of election or choice and not a discharge of any liability/debt.

It may be relevant to note that ESOP is a form of employee remuneration/salary. Salary is a consideration for services rendered by the employees. It is an obligation/liability incurred for the business. Accordingly, the ESOP discount is allowable expenditure. In fact Lord Viscount (judge of majority view) held as follows:

“….If in this case the employees were paying the par value of the shares and also releasing to the company some amounts of salary due to them, the case would be very different from what it is….”

This observation supports the view that the ESOP dis-count in discharge of salary due to employees could have been held deductible by the Court itself.

To summarise, there are judicial precedents supporting the ESOP discount to be an allowable revenue expenditure and judgments with contrary view can be distinguished on law and facts.

Closing comments

Typically, a payment to an employee is called as ‘Salary’. This payment may be ‘paid in meal or malt’. ESOP is just another form of such salary given to employees. Etymologically, the term ‘Salary’ owes it origin to the Latin term ‘salarium’ which means ‘money allowed to Roman soldiers for purchase of salt’. One could therefore trace back the concept of payment in kind to the Roman age. This payment of salary in kind has taken various forms over a period of time. Employees have been rewarded with assets such as gold, accommodation, motor vehicles; facilities such as personal expense reimbursement, insurance and medical facilities, etc.; sometimes not only for employees but for their family members as well. Employee rewards in kind have taken various shapes. ESOP is one among them. It is an employee welfare measure. Such measures need a boost from the income-tax authorities. Such support would only escalate into a supportive social measure.

The Karnataka High Court in the case of CIT and Anr. v. Infosys Technologies Ltd., (2007) 293 ITR 146 (Kar.) had an occasion to comment on the same issue of ESOP discount. It held:

“India is a growing country. The technological development of this country has resulted in economical prosperity of this country. Several giant undertakings have shown interest in this great country after taking note of the manpower and the intelligence available in this country. Stock option is nothing new and it is being continued in the larger interest of industrial harmony, industrial relations, better growth, better understanding with employees, etc. It is a laudable scheme evolved and accepted by the Government. Good old days of only master and only servant is no longer the mantra of today’s economy. Today sharing of wealth of an employer with his employees by way of stock option is recognised, respected and acted upon. Such stock option is way of participation and it has to be encouraged…. The Department, in our view, must approve such welfare participatory pro-labour activities of an employer. Of course, we do not mean that if law provides for taxation, no concession is to be shown. But wherever there are gray areas, it is preferable for the Department to wait and not hurriedly proceed and arrest the well-intended scheme of welfare of the employer. We would be failing in our duty if we do not note the Directive Principles of the Constitution in the matter of labour participation. Article 43A provides that the State shall take steps by suitable legislation or by any other way to secure participation of workers in the management of undertakings, establishment or other organisation engaged in other industries…. We would ultimately conclude by saying that any welfare measure has to be encouraged, but of course within the four corners of law. We do hope that other employers would follow this so that the economic and social justice is made available to the weaker sections of society also.”

Human resource management has evolved as a separate field of study. Today this study is not restricted populating a concern with right people. The challenge is not mere correct staffing. This human resource need to be nurtured, trained and developed. They should be transformed from ‘people in the organisation’ to ‘people for and of the organisation’. This transformation is not automatic. It is a result of the committed effort from the concern/company. It is a commitment to reward for the past services of its employees as well as their future endeavours. This reward kindles motivation in employees; seemingly the only antidote to attrition. ESOP is just another employee motivation tool. No statute or fiscal law should discourage an employee motivation/welfare measure. Our attempt in this write-up has been to uphold this very thought.

shailesh.kwebmaker

DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS— Part II

In the first part of this article we had discussed why fees paid to a syndicating agency for assisting capital expansion for the purpose of working capital needs would be allowed as a revenue expenditure in the hands of a companyassessee. In this part, we are discussing why the decisions of the Supreme Court in Punjab Industrial Development Corporation’s case 225 ITR 792 and Brooke Bond India’s case 225 ITR 798 are distinguishable where expenditure has been incurred for the purpose of working capital needs in connection with capital expansion.

Decisions in Punjab Industrial Development Corporation Ltd. and Brooke Bond India are distinguishable:

“. . . . . Reliance on the decision without looking into the factual background of the case before it, is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

In Goodyear India Ltd v. State of Haryana, 188 ITR 402, the Supreme Court held that a precedent is an authority only for what it actually decides and not what may remotely or even logically follow from it. The Supreme Court further held that a decision on a question which has not been argued cannot be treated as a precedent.

In CIT v. Sun Engineering Works P. Ltd., 198 ITR 297, the Supreme Court held as under:

“It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasonings. In H.H. Maharajadhiraja Madhav Rao Jiwaji Rao Scindia Bahadur v. Union of India, (1971) 3 SCR 9, this Court cautioned:

“It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment.”

In Bharat Petroleum Corporation Ltd. v. N. R. Vairamani, 8 SCC 579, the Supreme Court held that “Courts should not place reliance on decisions, without discussing as to how the factual situation fits in with the fact situation of the decision on which reliance is placed. Observations of Courts are neither to be read as Elucid’s theorems nor as provisions of a statute and that too taken out of their context. These observations must be read in the context in which they appear to have been stated. Judgments of Courts are not be construed as statutes.” The Supreme Court quoted the following observations of Lord Morris in Herrington v. British Railways Board, 2 WLR 537 with approval:

“There is always peril in treating the words of a speech or a judgment as though they were words in a legislative enactment, and it is to be remembered that judicial utterances made in the setting of the facts a particular case.

11. Circumstantial flexibility, one additional or different fact may make a world of difference between conclusions of two cases. Disposal of cases by blindly placing reliance on a decision is not proper.

12. The following words of Lord Denning in the matter of applying precedents have become locus classicus:

The Full Bench of the Delhi Court recently in L.D. Bhatia Hingwala (P.) Ltd v. ACIT, 330 ITR 243 after quoting the above decisions of the Supreme Court held as under:

“From the aforesaid authorities, it is luculent that a judgment has to be read in the context, and discerning of factual background is necessary to understand the statement of principles laid down therein. It is obligatory to ascertain the true principle laid down in the decision and it is inappropriate to expand the principle to include what has not been stated therein.”

In Punjab Industrial Development Corporation Ltd. case and Brooke Bond India’s case, the question before the Supreme Court was whether filling fees paid to the Registrar of Companies for enhancement of capital constituted revenue expenditure? The Supreme Court was not concerned with a case where the object of capital expansion was to have working funds for carrying on business activities. In the former case, after quoting various contrary decisions of the High Courts, the Supreme Court held as under:

“We do not consider it necessary to examine all the decisions in extenso because we are of the opinion that the fee paid to the Registrar for expansion of the capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. We are, therefore, of the opinion that the view taken by the different High Courts in favour of the Revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram (India) (P.) Ltd.’s case (supra). We, therefore, answer the question raised for our determination in the affirmative, i.e., in favour of the Revenue and against the assessee.”

In the latter case, viz., Brooke Bond India’s case, the Supreme Court placed reliance on its decision in Punjab Industrial Development Corporation Ltd. case to reiterate that fees paid to the Registrar of Companies for enhancement of capital constitutes capital expenditure. In this case the counsel raised an argument that the case of the assessee is not covered by the decision in Punjab Industrial Development Corporation Ltd. case as the object of capital expansion was to have more working funds for the assessee to carry on its business and to earn more profits. The Supreme Court while dealing with the said argument held that it is unable to accept the said argument for the reason that the statement of case sent by the Tribunal does not indicate a factual finding in that connection. The relevant portion of the decision is as under:

“Dr. Pal has, however, submitted that this decision does not cover a case, like the present case, where the object of enhancement of the capital was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. In this connection, Dr. Pal has invited our attention to the submissions that were urged by learned counsel for the assessee before the Appellate Assistant Commissioner as well as before the Tribunal. It is no doubt true that before the Appellate Assistant Commissioner as well as before the Tribunal it was submitted on behalf of the assessee that the increase in the capital was to meet the need for working funds for the assessee-company.

But the statement of case sent by the Tribunal does not indicate, that a finding was recorded to the effect that the expansion of the capital was undertaken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. In any event, the above-quoted observations of this Court in Punjab State Industrial Development Corpn. Ltd.’s case (supra) clearly indicate that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.” (emphasis supplied)

The decision of the Supreme Court in Brooke Bond India’s case (wherein principle laid down in Punjab Industrial Development Corporation Ltd. case has been reiterated), has to be seen in the light of the context and questions involved. It is a settled proposition that a decision takes colour from the questions involved in the case in which it is rendered. [Refer among others Prakash Amichand Shah v. State of Gujarat, AIR 1986 SC 468 (SC), Union of India v. Dhanwanti Devi, (1996) 6 SCC 44] The question before the Supreme Court was whether fees paid to the Registrar of Companies in relation to expansion of capital base is in the nature of revenue expenditure? The Supreme Court was called upon to render its verdict without an occasion to consider the aim or object for which the expenditure had to be incurred. In fact, the Supreme Court was concerned with the fees paid to the Registrar of Companies for increasing the authorised capital as a prelude to infusion of funds. There was no actual receipt of funds during the year. The expenditure towards the increased ability to raise capital was in these circumstances held to be capital. The Supreme Court had no occasion to examine the ‘two stages’ of deployment of funds. In fact the Supreme Court was concerned with a stage anterior to both the stages as funds had not yet been raised/received; such a potential only had been created. The decision of the Supreme Court therefore has to be seen in that context and cannot be extended beyond.

One may note that the Supreme Court in these decisions had not referred to its earlier decisions wherein principles with respect to characterisation of an expenditure into revenue or capital have been outlined. Some of the decisions are of larger Bench viz., Assam Bengal Cement’s case 27 ITR 34 etc. In such circumstances, it is the principles laid down by the larger Bench of Supreme Court which have to be kept in mind while characterising the nature of any expenditure into revenue or capital. The ratio of the decisions of the Supreme Court in Punjab Industrial Corporation Ltd.’s case and Brooke Bond India’s case should therefore be limited to facts similar as in these two cases.

In Lakshmi Auto Ltd. v. DCIT, 101 ITD 209, the Chennai Tribunal had an occasion to explain the scope of the decision in Brooke Bond India’s case; especially the observations made by the Supreme Court in the context of the argument made by Dr. Pal. In the case before the Chennai Tribunal, the assessee claimed deduction u/s. 37(1) towards expenditure on issuance of right shares. The Assessing Officer processed the return u/s. 143(1)(a). The assessee’s claim was disallowed on the grounds that the said expenditure was capital in nature. On appeal to the Commissioner (Appeals), the assessee raised a specific plea that expenses incurred on rights issue was for raising working capital. The Commissioner (Appeals) held that the decision of the Supreme Court in Brooke Bond (India) Ltd. v. CIT (supra) squarely applied to the case of the assessee and, therefore, the prima facie adjustment was held to be valid.

On further appeal to the Tribunal, the Judicial Member held that the Supreme Court in Brooke Bond India Ltd.’s case (supra) had not decided the issue as regards the expenditure incurred on increase of capital to meet the need for more working funds. The Judicial Member further held that the Assessing Officer was not correct in making prima facie adjustment on the grounds that the expenditure was capital in nature as no facts were available on record as to whether the assessee required the funds to increase capital to meet the need of work-ing capital or not. Not agreeing with the conclusions and findings of the Judicial Member, the Accountant Member held that the Assessing Officer was within his jurisdiction to make adjustment as no debate was involved after pronouncement of the decision in case of Brooke Bond (India) Ltd. (supra). The third Member on reference concurred with the views of the Judicial Member. The relevant observations of the third Member are as under:

“9. Having heard both the parties on the point and after perusing the various precedents relied upon, I find that the issue in question is a debatable issue. It is not directly covered by the decision of the Apex Court rendered in the case of Brooke Bond (India) Ltd. v. CIT, (1997) 225 ITR 798. In this case the Supreme Court has held that expenditure incurred by a company in connection with issue of shares, with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making. It was contended before the Supreme Court that where the enhancement was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. On this the Supreme Court has held that the statement of case sent by the Tribunal did not record the finding to the effect that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for more working funds for the assessee to carry on its business.

From this it can be concluded that if the expansion of capital is in order to meet the need for more working funds, in that eventuality the expenditure could partake the nature of revenue expenditure. De hors examination in this regard, it is not possible to apply the ratio.

Each case depends on its own facts, and a close similarity between one case and another is not enough, because even a single significant detail may alter the entire aspect. In deciding such cases, one should avoid the temptation as said by Cordozo by matching the colour of one case against the colour of another. I am reminded of Heraclitus who said “you never go down the same river twice”. What the great philosopher said about time and flux can relate to law as well. It is trite that a ruling of superior Court is binding law. It is not of scriptural sanctity, but is of ratiowise luminosity within the edifice of facts where the judicial lamp plays the legal flame. Beyond those walls and de hors the milieu we cannot impart eternal vernal value to the decision, exalting the doctrine of precedents into a prison house of bigotry, regardless of varying circumstances and myriad developments. Realism dictates that a judgment has to be read subject to the facts directly presented for consideration.

I have considered the entire conspectus of the case. In my opinion, the decision of the Apex Court in the case of Brooke Bond (India) Ltd. (supra) can be applied only after examining the object of the capital enhancement. This decision is not applicable if enhancement of the capital was made for gearing up funds for working capital. The object of gearing up of the capital was not looked into. Total amount was disallowed without examining the details. Even applicability of section 35D was not considered. In my opinion, this is not correct. I have gone through the reasoning adduced by the ld. Judicial Member. In my opinion he took a correct view in the matter. I concur with his decision on this issue.” (emphasis supplied)

In view of all the above, one may argue that the expenditure incurred in connection with issuance of shares for augmenting working capital needs should be allowed as deduction u/s. 37(1) of the Act. The decisions of the Supreme Court in Punjab Industrial Corporation case and Brooke Bond India case (supra) would not be applicable to cases where the object of enhancement of the capital expansion is to have more working funds. As a result, fees paid to XY bank by ABCL in the present case should be allowed as revenue expenditure u/s. 37(1) of the Act.

Partner’s interest — On capital:

Interest paid on partner’s capital by a partnership firm is allowed as a business deduction subject to the limit specified u/s. 40(b) of the Act. Under the Act, a partnership firm is regarded as a taxable entity distinct and separate from partners constituting it. Interest paid is deducted while computing the total income of the firm. Such deduction is admissible, irrespective of whether the capital is used for acquiring an asset or for working capital purposes. The admissibility of interest on partner’s capital account is in one sense a measure of avoiding double taxation on the same income. It is also an acknowledgement of separate existence of the firm and the partners.

A company is also regarded as a separate and distinct person from its shareholders. A company and a partnership firm thus stand on the same pedestal on this count. If in the eyes of Legislature expenditure connected with capital of a firm (viz., interest on capital introduced by a partner into a partnership firm) is allowable as a business deduction, it would be unreasonable to disallow expenditure incurred by a company in connection with share capital of a company. This is especially in view of the fact that there are no specific provisions in the Act restricting the admissibility of such an expenditure; the disallowance only being sustained on the premise of it being a capital expenditure u/s. 37.

What could be/is ‘working capital/funds’:

In Advance Law Lexicon 3rd edition 2005, the term ‘working capital’ is defined as ‘the funds available for conducting day-to-day operations of an enterprise; the money in circulation, acquired through cash balances, daily cash sales or short-term borrowings and used to run day-to-day affairs of a business organisation; capital available for day-to-day running of a company, used to pay expenses such as salaries, purchases, etc.’. The word web defines it as assets available for use in the production of further assets. In CIT v. IBM World Trade Corporation, 161 ITR 673, the Bombay High Court held that working capital is that which is utilised in a business and is another expression for circulating capital. In CIT v. Modern Theatres Ltd., 50 ITR 548, the Madras High Court held that circulating capital is a capital which is turned over and in the process of being turned over yields profit or loss. The Kerala High Court in Kerala Small Industries Development Corporation Ltd. v. CIT, 270 ITR 452 held that ‘Circulating capital’ means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursement. The term ‘working capital’ thus implies funds which an organisation must have to finance its day-to-day business operations. It is that part of the total capital which is employed in the trading/current assets.

What could be a trading/current asset for a particular business may be a fixed/capital asset for another business. There are no fixed rules with regard to characterisation of assets into current asset and fixed asset. One has to determine under what circumstances the asset has been acquired? What is the purpose for which the assets are acquired? If the asset is related to day-to-day business operations, then it would be regarded as current asset. It would be part of the circulating capital. Expenses incurred in connection with such acquisitions are to be allowed as business deduction. In this connection one may refer to the decision of the Supreme Court in Bombay Steam Navigation Co. v. CIT (supra). In the said decision, the Supreme Court held that if transaction of acquisition of the asset is closely related to carrying on of the assessee’s business, the expenditure incurred in connection therewith is to be regarded as revenue expenditure. The Supreme Court in CIT v. Bombay Dyeing and Mfg. Co. Ltd., 219 ITR 521 applying the ratio of Bombay Steam Navigation Co. v. CIT (supra) held that ex-penses incurred in connection with amalgamation of companies could be characterised as revenue expenditure if amalgamation is essential for smooth and efficient conduct of business.

The expense under discussion (viz., fees paid to XY bank) is incurred in connection with raising of funds for working capital purposes and for securing distribution rights, licences and brands in European, African and Asia-pacific countries. Securing distribution rights, licences and brands are essential for running business in such countries. ABCL acquires these intangibles for smooth and efficient conduct of business in such countries. It is on such rationale [and following rationale of the Supreme Court’s decision in Bombay Dyeing and Mfg Co.’s case (supra)] that associated expenses may be argued to be revenue in nature. Otherwise, it would be argued that licences, brands, etc. are intangible assets (see the definition of ‘block of assets’) necessitating the branding of associated expense as capital in nature.

shailesh.kwebmaker

Legitimacy of Reference to OECD Commentary for Interpretation of Income Tax Act and DTAs

Recently, in the case of Gracemac Corporation and Others v. ADIT, (47 DTR 65) (Del.) (Tri.), the appellant had relied on the Commentary of OECD Model Tax Convention (‘the OECD Commentary’) in order to differentiate between ‘copyright’ and ‘copyrighted article’ for interpretation of the term ‘royalty’ in respect of computer software. The Tribunal rejected the reliance on the OECD Commentary after referring to the decision of the Apex Court in the case of CIT v. P.V.A.L. Kulandagan Chettiar, (137 Taxman 460) for the following reasons:

The phrase ‘copyrighted article’ is not used under the Income-tax Act, 1961 (‘the Act’) or in the Double Taxation Avoidance Agreements (‘DTAA’) or even under the Copyright Act, 1957; and

As held by the Apex Court in the aforesaid decision, OECD Commentary is not a safe or acceptable guide or aid for interpretation of provisions of the Act or DTAAs between India and other countries.

The Tribunal concluded that royalty in respect of computer software has to be decided on the basis of provisions of the Act or relevant DTAA under consideration.

On the other hand, the Delhi High Court recently in the case of Asia Satellite Telecommunications Co. Ltd. v. DIT and vice versa, (332 ITR 340) upheld the reliance on OECD Commentary while interpreting the definition of ‘royalty’ in respect of leasing out transponder capacity on a satellite. The Court held that the technical terms used in DTAA are the same which appear in section 9(1)(vi) and for better understanding of the terms, OECD Commentary can always be relied upon. The Court relied on the decision of the Apex Court in the case of UOI and Anr v. Azadi Bachao Andolan & Anr., (263 ITR 706) and other catena of decisions1 to emphasise that the international accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed by the Courts in India when it comes to construing similar terms occurring in the Act.

On a combined reading of the findings of the aforesaid decisions, one may reconcile that for better understanding of the terms used in the Act or DTAAs, one may refer to the OECD Commentary provided and subject to:

The technical terms as sought for interpretation are ambiguous; and

Technical terms as used in the Act or DTAAs are identical or similar to terms employed in OECD Commentary.

The true significance however, lies in the practical implementation of the aforesaid principle while interpreting the provisions of the Act and DTAAs, which may be subject to criticisms or limitations similar to reliance on English decisions and other international decisions and/or statutes. In addition, India not as a ‘Member’ of OECD but as ‘Observer’ has expressed its position/views on the Articles of OECD Model Convention and its commentary thereon, which has been published in the OECD Model Tax Convention on Income and on Capital 2010 (version dated 22 July 2010). The position is presented qua the Articles under the Tax Convention as regard to its disagreement with the Text of the Article or disagreement with an interpretation given in the commentary in relation to the Article. It would be further necessary to highlight that while nations like Indonesia and China, (non-OECD economies like India) have expressly clarified that in the course of negotiations with other countries, they will not be bound by their stated positions in the OECD Commentary; India has not expressly clarified as such. Therefore, one may suggest that India may be bound by its stated positions in respect of the OECD Commentary in its course of negotiation and interpretations of DTAAs with other countries.

In the backdrop of the aforesaid discussion, it may then be necessary to consider the legitimacy in relying on OECD Commentary for interpretation of provisions of the Act and DTAAs entered into by India with other countries.

Reliance on OECD Commentary in interpreting provisions of the Act

Reference to English and other International decisions for interpretation and construction of the provisions of the Act have been subject of concern and criticism, time and again by the Courts2 since the provisions of the Act are not in pari materia with the provisions of the other statues, as well as the fundamental concepts and the principles on which the provisions are incorporated under the Act are different vis-à-vis the other statues. The provisions of the Act though may at times appear to be similar to the provisions of OECD Tax Convention, on deeper scrutiny may reveal differences not only in the wording but also in the meaning of a particular expression which has been acquired in the context of the development of law in those countries. Reliance on OECD Commentary in interpreting the provisions of the Act may therefore be subject to similar criticisms and concerns.

OECD is a 31 Member country organisation where the respective governments work together to address the economic, social and environmental challenges of globalisation. The OECD Model Tax Convention on Income and on Capital was designed and developed by the member countries as a means to settle on a uniform basis the most common problems that arise in the field of International juridical double taxation. India while negotiating its tax treaties maintains a balance and follows either OECD Model or UN Model on Tax Convention or a mix of the two. So, the provisions and terms as used in the Act may not confirm to the same language, interpretation and meanings as used in the DTAAs by India with other countries. Observations have been made by various Courts in catena of decisions3 with respect to various provisions of the Act as being wider/narrower in scope to the analogous provisions of DTAAs.

One may therefore say that the provisions of the Act should be construed on their own terms without drawing any analogy of the OECD Commentary, subject to principles as drawn above.

Reliance on OECD Commentary in interpreting provisions of DTAAs

Though, India is not a signatory to Vienna Convention on the Law of Treaties (‘VCLT’), but the judicial forums4 in India have acknowledged its importance in interpreting the provisions of DTAAs and have observed as under:

“The DTAAs are international agreements entered into between States. The conclusion and interpretation of such convention is governed by public international law, and particularly, by the Vienna Convention on the Law of Treaties of 23 May 1969. The rules of interpretation contained in the Vienna Convention, being customary international law also apply to the interpretation of tax treaties. . . . .”

The principles governing the interpretation of tax treaties can be broadly summed up as follows:

(i) A tax treaty is an agreement and not a taxing statute, even though it is an agreement about how taxes are to be imposed.

(ii) The principles adopted in the interpretation of statutory legislation are not applicable in interpretation of treaties.

(iii) A tax treaty is to be interpreted in good faith in accordance with the ordinary meaning given to the treaty in the context and in the light of its objects and purpose.

(iv) A tax treaty is required to be interpreted as a whole, which essentially implies that the provisions of the treaty are required to be construed in harmony with each other.

(v) The words employed in the tax treaties not being those of a regular Parliamentary draughtsman, the words need not examined in precise grammatical sense or in literal sense. Even departure from plain meaning of the language is permissible whenever context so requires, to avoid the absurdities and to interpret the treaty ut res magis valeat quam pereat i.e., in such a manner as to make it workable rather than redundant.

(vi) A literal or legalistic meaning must be avoided when the basic object of the treaty might be defeated or frustrated insofar as particular items under consideration are concerned.

(vii) Words are to be understood with reference to the subject-matter, i.e., verba accopoenda sunt secundum subjectum materiam.

(viii) When a tax treaty does not define a term employed in it, and if the context of the treaty so requires, the terms can be given a meaning different from its meaning in the domestic law. The meaning of the undefined terms in a tax treaty should be determined by reference to all of the relevant information and the context.

The rules of interpretation in VCLT can be found in Article 31 to 33 of the Convention. Article 32 of the Convention provides recourse to supplementary means of interpretation, which in turn should confirm to the broad principles of Article 31 as summarised above. According to Article 32 of VCLT, the ‘supplementary means of interpretation’ include the preparatory work of the treaty and the circumstances of its conclusion. The word ‘include’ indicates that the rule is not exhaustive and there may be other supplementary means of interpretation. One such means is provided by the commentaries appended to the OECD Model Tax Convention. To the extent, the provisions of DTAAs are similar to OECD Model Convention, the OECD commentaries may become relevant to interpretation of DTAAs.

The Kolkata Tribunal in the case of Graphite India Ltd. v. DCIT, (86 ITD 384) while deciding whether the services rendered by an American Consultant to an Indian Company are covered under the Article 15, being in the nature of professional services or under Article 12, being in the nature of Fees for Technical services, observed as under as regard to interpretation of OECD and UN Model Commentaries:

“17. The aforesaid interpretation is clearly in harmony with the OECD and UN Model Conventions’ official commentaries, ………….. Andhra Pradesh High Court has, in the case CIT v. Visakhapatnam Port Trust, (1984) 38 CTR (AP) 1: (1983) 144 ITR 146 (AP), referred to OECD commentaries on the technical expressions and the clauses in the model conventions, and referred to, with approval, Lord Radcliffe’s observations in Ostime v. Australian Mutual Provident Society, (1960) AC 459, 480: (1960) 39 ITR 210, 219 (HL), which have described the language employed in these documents as the ‘international tax language’. In view of the observations of Andhra Pradesh High Court, in Visakhapatnam Port Trust’s case (supra), these model conventions and commentaries thereon constitute international tax language and the meanings assigned by such literature to various technical terms should be given due weightage. In our considered view, the views expressed by these bodies, which have made immense contribution towards development of standardisation of tax treaties between various countries, constitute ‘contemporanea expositio’ inasmuch as the meanings indicated by various expressions in tax treaties can be inferred as the meanings normally understood in, to use the words employed by Lord Radcliffe, ‘international tax language’ developed by bodies like OECD and UN.”

As discussed earlier, India by giving its stance on the text of the Article of OECD Model Tax Convention and commentaries thereon has helped in confirming an interpretation, in resolving ambiguities and obscurities and in displacing interpretation which appears absurd or unreasonable from India’s point of view. India’s position qua the text of the Articles and commentaries thereon as stated in the OECD Model Tax Convention — July 2010 version under the chapter ‘Non -OECD Economies’ positions on the OECD Model Tax Convention’ is tabulated below:

Relevant
Article

OECD
— India’s position

Text
of the Article

Commentary
of the Article

Article 1 – Persons
covered

No disagreement5

Disagreement6

Article 2 – Taxes
Covered

No disagreement

Article 3 – General
Definitions

Reservations7

No disagreement

Article 4 – Resident

Reservations

Disagreement

Article 5 – Permanent
Establishment

Reservations

Disagreement

Article 6 – Income
from Immovable Property

Reservations

No disagreement

Article 7 – Business
Profits (position after 22-7-2010)

Reservation and

Disagreement

disagreement

Article 7 – Business
Profits (position before 22-7-2010)

Reservations

Disagreement

Article 8 – Shipping,
Inland Waterways Transport and

Air Transport

Reservations

Article 9 –
Associated Enterprises

No disagreement

Article 10 –
Dividends

Reservations

Disagreement

Article 11 – Interest

Reservations

Disagreement and
Reservations

Article 12 – Royalties

Reservations

Disagreement and Reservations

Article 13 – Capital
Gains

Reservations

No disagreement

Article 14 –
Independent Personal Services

Article and
commentary thereon has been deleted by OECD

Article 15 – Income
from Employment

Reservations

Disagreement

Article 16 – Director’s
Fees

No disagreement

Article 17 – Artists
and Sportsmen

Reservations

No disagreement

Article 18 – Pensions

No disagreement

Article 19 –
Government Service

No disagreement

Disagreement

Article 20 – Students

Reservations

No disagreement

Article 21 – Other
Income

Reservations

No disagreement

Article 22 – Taxation
of Capital

Reservations

No disagreement

Article 23A –
Exemption Method

Reservations

No disagreement

Article 23B – Credit
Method

Article 24 – Non
Discrimination

Reservations

Article 25 – Mutual
Agreement Procedure

No disagreement

Disagreement

Article 26 – Exchange
of Information

Reservations

No disagreement

Article 27 –
Assistance in the Collection of Taxes

Article 28 – Members
of Diplomatic Missions and

There are no disagreements which India has
raised as regard to Text

Consular Posts

Article 29 – Territorial Extension

of the Article and
Commentary thereon.

Article 30 – Entry
into Force

Article 31 –
Termination

However, a question that arises is whether the position by India with respect to provisions of OECD Model Tax Convention is binding on taxpayers, tax authorities and more so, on the judicial forums of India.

To begin with, it is necessary to find the statutory force or lack of it, under which India has provided its position to the OECD Model Tax Convention, since its nature will determine the legitimacy of reference to OECD Commentary for interpreting the provisions of DTAAs.

After considering the OECD Commentary — ‘Non-OECD Economies’ Positions on the OECD Model Tax Convention’ Chapter, one understands that these are official statements made by Government of India as regard its interpretation of the Tax Convention. The clarifications or comments provided to OECD are not issued as a rule u/s.295, Circular or order u/s.119 of the provisions of the Income-tax Act, 1961. A pos-sible conclusion which can then be drawn is that even though such clarification may not be binding on taxpayers, they shall have high persuasive value considering contemporary official statements made by the Government of India on the subject of interpretation.

One also needs to consider whether these official statements can be considered as an aid for construction of the DTAAs entered into by India and which are based on OECD Model Tax Convention.

The aforesaid explanations received from the Indian Government could be considered as an aid for construction, which is in accordance with the Latin Maxim Contemporanea expositio. The Indian Courts8 have time and again held that Contemporaneous Exposition by the administrators entrusted with the task of executing the statute is extremely significant in interpretation of the statutory instruments. The rule of contemporanea expositio provides that “administrative construction (i.e., contemporaneous construction placed by administrative or executive officers) generally should be clearly wrong before it is over-turned; such a construction commonly referred to as practical construction, although non-controlling, is nevertheless entitled to considerable weight, it is highly persuasive.” [Crawford on Statutory Construction, 1940 Ed, as in K. P. Varghese (supra)]. However, generally, such expositions from the administrators are subject to the following limitations:

The plain and unambiguous language of the statutory instruments shall hold

good against such expositions; and

Such expositions even though binding on the Income-tax Department, are not binding on the Tribunal and Courts.

Therefore, based on the aforesaid discussion and doctrine of Contemporanea exposition, one may hold that provisions of DTAAs could be construed based on the explanation as received from the Indian Government on the OECD Model Tax Convention, provided the said exposition adheres to the broad principles of Article 31 of the VCLT, even though the applicability of VCLT to India may be a question in itself.

So, besides, decisions delivered by the various Indian judicial forums interpreting the provisions of DTAAs, one can now rely on India’s position on the Articles of the OECD Model Tax Convention and commentary thereon.

Lastly, the relevant extracts of the decision of the Apex Court in the case of UOI v. Azadi Bachao Andolan and Anr. (supra) as regard to interpretation of DTAAs are reproduced below:

“………… Interpretation of Treaties

96. The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. While commenting on the interpretation of a treaty imported into a municipal law, Francis Bennion observes:

“With indirect enactment, instead of the substantive legislation taking the well-known form of an Act of Parliament, it has the form of a treaty. In other words the form and language found suitable for embodying an international Agreement become, at the stroke of a pen, also the form and language of a municipal legislative instrument. It is rather like saying that by Act of Parliament, a woman shall be a man. Inconveniences may ensue. One inconvenience is that the interpreter is likely to be required to cope with disorganised composition instead of precision drafting. The drafting of treaties is notoriously sloppy, usually for very good reason. To get Agreement, politic uncertainty is called for.

…… This echoes the optimistic dictum of Lord Widgery CJ that the words “are to be given their general meaning, general to lawyer and layman alike… the meaning of the diplomat rather than the lawyer.” [Francis Bennion, Statutory Interpretation, p. 461 (Butterworths) 1992 (2nd Ed.)]

An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. Commenting on this aspect of the matter, David R. Davis in Principles of International Double Taxation Relief, p. 4 (London Sweet & Maxwell, 1985), points out that the main function of a Double Taxation Avoidance Treaty should be seen in the context of aiding commercial relations between treaty partners and as being essentially a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions”

On a more practical front, one finds that since the publication of India’s position on OECD Model Tax Convention, the Courts have not acknowledged much, the said publication as an aid for construction in interpreting the provisions of DTAAs. The taxpayers could however look forward to taking re-course to the India’s position on OECD Commentary as an aid for construction, for the favourable interpretations with respect to provisions of DTAA.

shailesh.kwebmaker

Why income from sale of computer soft ware not taxable as royalty?

While best efforts were made from world over to persuade the then Finance Minister of India to have second thoughts on the retrospective proposals introduced in the Finance Bill, 2012, nothing seems to have appealed. The retrospective amendments as were proposed in the Finance Bill, 2012 have received the President’s assent. In this backdrop, an effort is made to consider whether the Income-tax Department under the so retrospectively amended section 9(1)(vi) of the Act would be able to tax, income from sale of computer software as royalty under the Income-tax Act, 1961 (‘the Act’) and/or Double Taxation Avoidance Agreements (‘DTAAs’) entered in by India with other countries?

From the following three Circulars issued by the Central Board of Direct Taxes at different points in time, one understands that the intention of the Legislature was very clear to tax any income from ‘right for use’ or ‘right to use’ any copyright (viz., computer program) as royalty under the Act:

Circular No. 152, dated 27th November 1974;
Circular No. 588, dated 2nd January 1991; and
Circular No. 621, dated 19th December 1991.

However, the controversy whether income from sale of computer software is taxable as royalty under the Act or not, developed only from the year 2005, with the judgment of the Special Bench of Delhi Tribunal in the case of Motorola Inc. v. DCIT, (95 ITD 269). The decision pertained to A.Ys. 1997-98 and 1998-99, though the first Circular justifying the taxability of income as royalty under the Act was issued in 1974.

Such an unusual scenario could be the result of imperfect drafting of section 9(1)(vi) to support the taxability of sale of computer software as royalty. This article examines whether the retrospective introduction of Explanation 4 to section 9(1)(vi), achieves the object of the Legislature to tax the income from sale of computer software as royalty under the Act. The said retrospective amendment in section 9(1)(vi) reads as under:

“Explanation 4 — For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of licence) irrespective of the medium through which such right is transferred.”

Section 9(1)(vi) provides that any income payable by way of royalty in respect of any right, property or information is deemed to accrue or arise in India. So, to determine the taxability of income u/s.9(1)(vi), an income needs to satisfy the following twin conditions, apart from the principle of ‘source rule of taxation’ in section 9(1)(vi): The income should be covered under the definition of ‘royalty’ i.e., under Explanation 2 to section 9(1) (vi); and
l It has to be in respect of any right, property or information.

The expression ‘any right, property or information’ is explained in the definition of ‘royalty’ viz., intellectual properties, equipments, know-how, experience or skills, etc. In other words, the definition of ‘royalty’ gives colour to or limits the scope of, the expression, which is otherwise very wide in scope.

Explanation 4 retrospectively includes, ‘right for use or right to use computer software’ under the expression ‘any right, property or information’. The text of Explanation 4, however, does not include the said rights of a computer software under the definition of ‘royalty’, which is specifically required as discussed, for applicability of section 9(1)(vi). Even though, the Memorandum explaining the amendments relating to Direct Taxes in the Finance Bill, 2012 mentions that ‘transfer of all or any right in respect of any right, property or information’ used in Explanation 4 defines the rights, property or information referred to in Explanation 2 to section 9(1)(vi), the text of Explanation 4 does not refer to Explanation 2. Therefore, one may argue that until the language of Explanation 4 is amended to include the aforesaid rights of computer software under Explanation 2, section 9(1)(vi) may not apply to the said rights of computer software.

The said argument also draws support from the Karnataka High Court judgment in the case of Jindal Thermal Power Company Ltd. v. DCIT, (321 ITR 31). The High Court while considering the retrospective amendment in context of Explanation to section 9(2) r.w.s. 9(1)(vii) held that since the purport of Explanation 2 is plain in its meaning, it is unnecessary and impermissible to refer to the Memorandum Explaining the provisions. Apart from the above or assuming that the Legislature amends Explanation 4 on the lines as suggested above or the Courts hold otherwise, the question that arises is, what is the meaning of the expression ‘right for use’ or ‘right to use’ a computer software? The provisions of the Act do not define ‘right for use’ or ‘right to use’.

Broadly, there are two schools of thought emerging for interpretation of the aforesaid rights of computer software. One school of thought suggests that the said expression should be construed in its general sense. Whereas, the other school of thought suggests the said expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital.

First school of thought

The Memorandum justifies the retrospective insertion, so as to restate the intention of the Legislature to tax the income from use or right to use computer software as royalty under the Act, which was interpreted otherwise by some judicial authorities. The judicial authorities1 in India have given conflicting findings on different questions relating to taxability of income from sale of computer software as royalty. Out of these questions, the Legislature has by Finance Act, 2012 sought to address only the question whether the expression ‘transfer of all or any rights’ includes ‘right for use’ or ‘right to use’?

The Memorandum does not refer to the conflicting judgements. The findings of these conflicting judgements were summarised in a Table in the feature Direct Tax Controversy in the BCAS Journal for the month of December 2011, (page no. 54).

In such a scenario, it would be relevant to understand the meaning of the expression ‘right for use’ or ‘right to use’ a computer software in the light of the findings of Heydon’s case (1584) (3 Co Rep 7a, 7b), better known as Mischief Rule. The Heydon’s case requires that to construe a provision of a statute, it would be just and proper to see what was the position before an amendment and find out what was ‘the mischief’ sought to be remedied and then discover the true rationale for such remedy. The aforesaid rule which is more than four hundred years old requires the following four questions to be answered in order to construe the provisions of section 9(1)(vi):

1. What was the common law before making the amendment in section 9(1)(vi)?

Judicial authorities were divided as regard the taxability of the subject. Some of the findings of the said decisions are:

— Passing on the right to use and facilitating the use of a product for which the owner has a copyright is not the same thing as transferring or assigning rights in relation to copyright and therefore, consideration to authorise the end-user to have an access to and make use of the licensed computer software, does not amount to royalty under the Act.

— On the other hand, some judicial authorities, held that payments made by end-users or distributors for granting of licence to use copyright i.e., computer program in respect of sale of computer software is royalty under the Act. Right of user of computer software involves right to use the computer program. When the right for user is given, right to use copyright is also given and therefore, consideration amounts to royalty under the Act.

2. What was the mischief and defect for which the Act did not provide?

The mischief and the defect for which the Act did not provide and which seems to be the intent of the Legislature was to tax ‘right for use’ or ‘right to use’ computer program [involved in a sale of/ licence to use computer software] as royalty under the Act.

3. What remedy the Legislature/Parliament has resolved and appointed to cure the defect?

The remedy effected by the Legislature to cure the aforesaid defect is retrospective insertion of Explanation 4.

4. What is the true reason for the remedy?

The true reason for the remedy seems that the Legislature wanted to subject ‘right for use’ or ‘right to use’ computer program involved in sale of computer software as royalty under the Act. The Legislature instead of using the expression to achieve its remedy to tax “right for use or right to use computer program embedded in a computer software” has chosen to use the expression “right for use or right to use computer software”, in a way suggesting that words ‘computer software’ and ‘computer program’ are used interchangeably.

In other words, the true expression ‘right for use or right to use a computer software’ is referred to as having a general meaning of act of using the property i.e., computer program embedded in a computer software and right to transfer such usage, respectively. Therefore, if one agrees with the conclusion of first school of thought, then purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software, would be taxable as ‘royalty’ under the Act.

Second school of thought

The second school of thought suggests that the impugned expression should be construed in the light of the meaning as given in 2010 OECD Commentary on Model Tax Convention on Income and on Capital. The Para 2 of Article 12 of 2010 OECD Model defines ‘royalty’ as under:

The term ‘royalties’ as used in this Article means payments of any kind received as a consideration for the use of, or the right to use any copyright of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

The expressions ‘right for use’ or ‘right to use’ as referred in Explanation 4 to section 9(1)(vi) is also found in Article 12(2). Paras 12 to 17 of the OECD Model Commentary on Article 12 cover the various facets of taxability of computer software as royalty. Para 13.1 of the Commentary explains the meaning of the expression ‘right for use’ or ‘right to use’ any copyright in the context of a computer software. This is similar to rights referred to in section 14 of the Copyright Act, 1957 (‘the Copyright Act’) and India has not raised any reservations or disagreements to such construction. The rights referred in section 14 of the Copyright Act for computer program are reproduced below:

to reproduce the work in any material form including the storing of it in any medium by electronic means;

to issue copies of the work to the public not being copies already in circulation;

to perform the work in public, or communicate it to the public;

to make any cinematograph film or sound recording in respect of the work;

to make any translation of the work;

to make any adaptation of the work;

to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in any of the points mentioned above; and

to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program.

So, it is the transfer or granting of licence of rights in section 14 of the Copyright Act which refers to use or right to use the copyright in context of computer software.

Further, there is a case to presume that the expression ‘right for use’ and ‘right to use’ in the context of taxability of computer software as royalty, has acquired a particular meaning, when India has accepted the meaning of that expression as explained in the 2010 OECD Model Commentary. Therefore, it is worth arguing that when India has accepted the meaning of the expression in a particular sense, then the use of the said expression subsequently should also be given similar meaning. The Courts also have in a catena of decisions2 held that internationally accepted meaning and interpretation placed on identical or similar terms employed in various DTAAs should be followed when construing similar terms occurring in the Act. However, the said reference/is subject to certain limitations, and for better understanding of the subject, one may refer to the Article ‘Legitimacy of References to OECD Commentary for interpretation of provisions under the Act and DTAAs’ published in BCAJ, February 2012, (page no. 9).

Therefore, if one agrees with the conclusion of the second school of thought, then it is only the income from the transfer or granting of licence of rights in section 14 of the Copyright Act which means use or right to use copyright in the context of computer soft-ware and accordingly will be taxable as royalty under the Act. In other words, purchase of any computer software viz., either shrinkwrap, bundled, canned or customised software would still continue to remain non-taxable as ‘royalty’ under the Act.

Analysis

Based on the above discussion, if the text of the Explanation 4 to section 9(1)(vi) is brought to test then one feels that the Legislature may still fail to pass the muster to tax the income from sale of computer software as royalty under the Act for want of the following broad reasons:

In Explanation 4, the Legislature has used the words ‘all or any’ which are prefixed to expression ‘right for use’ or ‘rights to use’ computer software. The expression ‘transfer of all or any right for use or right to use a computer software (including granting of licence)’ gives an impression of there being many ‘rights for use’ or ‘rights to use’ a computer software, which can either be transferred or licensed. However, as concluded under the first school of thought, ‘right for use’ or ‘right to use’ computer software in its general sense refers to only a simple case of ‘usage’ of property. One fails to determine the various rights ‘for use’ or rights ‘to use’ involved in context of a computer software and is forced to doubt whether the Explanation 4 supports the construction of the expression as sought under the first school of thought. On the contrary, considering the multiple rights referred in section 14 of the Copyright Act, one may agree that the expression ‘all or any’ could be construed as referring to those multiple rights u/s.14 of the Copyright Act, thereby supporting the meaning as drawn under the second school of thought.

Further, Explanation 3 to section 9(1)(vi) of the Act defines ‘computer software’ to mean computer program recorded on any medium. In a sense, suggesting that even though the Copyright Act distinguishes between ‘original copyrighted computer program’ and ‘copy of said computer program embedded in computer software’, the Income-tax Act, 1961 does not recognise such a distinction for the purpose of taxation and the words ‘computer software’ and ‘computer program’ may be used interchangeably. The same conclusion is also drawn under question no. 4 – What is the true reason for remedy, while discussing the findings of Heydon’s case in the context of computer software, under the first school of thought? So, the expression ‘right for use or right to use a computer software’ may be read as ‘right for use or right to use a computer program’ in respect of computer software.

Conclusion

Considering the above, one may conclude that Explanation 4 to section 9(1)(vi) of the Act, in its present form, may fail to achieve its object for want of the following broad reasons:

Expressions viz., ‘transfer of all or any rights in respect of any right, property or information’, ‘all or any’, ‘rights for use’ or ‘right to use’ are neither defined nor properly referenced in section 9(1)(vi) of the Act;

Expression ‘right for use’ or ‘right to use’ referred to in Explanation 4 to section 9(1)(vi) may suggest a meaning different than meaning in general sense of usage of property and transfer thereof; and

Explanation 4 to section 9(1)(vi) supports the construction of the expressions ‘right for use’ or ‘right to use’ to cover the rights referred to in section 14 of the Copyright Act.

Apart from the above, it would be possible for non-resident taxpayers to take recourse to the beneficial provisions of DTAAs entered in by India with other countries. The Article on taxability of ‘royalty income’ generally defines “royalty as payment of any kind from ‘use or right to use’ any copyright”. It thus restricts the scope of royalty income and one may rely on the 2010 OECD Model Commentary and India’s position thereof for non-taxability of computer software as royalty.

Further, the Central Government has recently issued a Notification giving relief from multiple level of tax deduction at source (‘TDS’) u/s.194J in the context of computer software. The said Notification No. 21 of 2012, dated 13rd June 2012 is issued u/s.197A(1F) effective from 1st July 2012 and provides as under:

The transferee has been defined to be a person who acquires the software. He may be a resident or a non-resident of India and the transferor is defined to be a person from whom the software is acquired, but he has to be a resident of India (as a precursor for applicability of section 194J of the Act).

Acquisition of the software has to be in the course of transfer of software (referred to as ‘subsequent transfers’) and tax should have been deducted at source either u/s.194J or section 195 of the Act, as the case may be, in any of the previous transfers;

The software so acquired under subsequent transfer should not have been modified; and

The transferee should obtain a declaration from the transferor that the tax has been deducted in any of the previous transfers along with PAN of the transferor.

This Notification has a narrow scope and has several limitations, which are as under:

The exemption from multiple level of deduction of tax has only been provided to payments subject to tax deduction as royalty u/s.194J of the Act and not u/s.195 of the Act; and

The acquisition of software under subsequent transfers should be without modification. One generally finds that in a direct arrangement between a copyright owner and end-user, the standard End-User Licence Agreement (‘EULA’) specifically prevents the end-user for resale of acquired software and therefore, the question of multiple level of deduction of tax will not arise in such a scenario. However, in case of copyright owner-distributor- end -user chain, it may be possible to undertake the benefit of the said Notification.

A fact pattern which is generally involved in the case of copyright owner-distributor-end user chain of transfer of software and its TDS implications thereof are explained in the Diagram for ease of understanding and ready reference:

Generally, the copyright owner of a computer program assigns/licenses rights to commercially exploit the copyright to the distributor. The rights to commercially exploit copyright provide for making multiple copies of software along with rights to sell and/or rent computer software qua a geographical location i.e., in the given example could be India. Pursuant to aforesaid rights, the end-user in India acquires the software copy from the distributor, subject to terms and conditions as provided in a EULA.

(Note: It is assumed that under the Scenario 1 and 2, the income from sale of computer software is taxable as ‘royalty’ under the Act and respective DTAAs between India and other countries. The analysis has been limited with respect to TDS implications, which arise in the light of aforesaid notification.)

The important question which is relevant to determine the TDS implications in context of non-residents transferors that is discussed here is ‘Can a non-resident transferor take recourse to Article on ‘Non-discrimination’ under the DTAAs as regard the discriminatory treatment sought by the Notification by limiting the benefit to only resident transferors u/s.194J of the Act?’

Section 40a(ia) r.w.s. 194J and Notification No. 21 of 2012 provides for deduction of royalty expenses for payment to resident transferor for acquisition of software without any deduction of tax. On the other hand, for similar payment to non-resident transferor, if the transferee has not deducted tax u/s.195, then the said expense will not be allowed as deduction u/s.40a(i). Such discrimination is addressed in an indirect manner by Article 24(3) of the respective DTAAs entered in between India and other countries. Article 24(3), generally reads as under:

“Except where the provisions of para 1 of Article 19, para 7 of Article 11, or para 8 of Article 12 apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State, shall for the purposes of determining the taxable profits of the first mentioned person, be deductible under the same conditions as if they had been paid to a resident of the first mentioned State.”

Article 24(3) deals with the treatment of the enterprises of Contracting State under the tax laws of that State. The said Article provides that interest, royalties and other disbursements paid to a resident of the other contracting State should be deductible to the same extent as would be deductible if paid to a resident of the same State. The said para of the Article is designed to end a particular form of discrimination resulting from a fact that in certain countries the deduction of interest, royalties and other disbursements is allowed without restriction when the recipient is a resident, but is restricted or prohibited when the recipient is non-resident4.

A similar discriminatory treatment is sought by Notification No. 21 of 2012. Therefore, by taking recourse to Article 24(3) of DTAAs read with Notification No. 21 of 2012, similar exemption from multiple level of TDS may be claimed on payment to non-resident transferors.

Given the aforesaid situation, one is reminded of the proverb, ‘Once burnt is twice shy.’ But the hard lesson of consequences from imperfect drafting do not seem to have learnt and therefore, the Income-tax Department may still fail to tax income from sale of computer software as ‘royalty’ under the Act and may also fail to simultaneously impose onerous and discriminatory treatment of multiple level of TDS u/s.195 of the Act.

shailesh.kwebmaker

Controversy on taxability of cross-border software payments

Introduction:

Section 4 and section 5 r.w.s. 9(1)(vi) of the Incometax Act, 1961 (the Act) provide for taxability of income from royalty in India. Section 9(1)(vi) of the Act by a deeming fiction provides for the taxation of income from royalty in India. Explanation 2 to section 9(1)(vi) of the Act defines the word ‘royalty’, which is wide enough to cover both industrial royalties as well as copyright royalties, both being forms of intellectual property. Computer software is regarded as an ‘industrial royalty’ and/or a ‘copyright royalty’. Industrial properties include patents, inventions, process, trademarks, industrial designs, geographic indicators of source, etc. and are generally granted for an article or for the process of making such article, on the other hand, copyright property includes literary and artistic works, plays, films, musical works, knowledge, experience, skill, etc. and are generally granted for ideas, principles, skills, etc.

Just as tangible goods are sold, leased or rented in order to earn monetary gain, on similar lines, the Intellectual Property laws enable authors of the intellectual properties to exploit their work for monetary gain. The modes of exploitation of intellectual property for monetary gains are different for each type of intellectual property covered in various sub-clauses of the definition of ‘royalty’ under Explanation 2 to section 9(1)(vi) and subjected to tax as per the scheme of the Act.

The controversy on taxability of cross-border software payments basically relates to characterisation of the income in the hands of the non-resident payee. The controversy, sought to be discussed here, revolves around the issue “whether the payment received by non-resident for giving licence of the computer software, popularly known as ‘sale of software’, is chargeable to tax as ‘royalty’, or it is a ‘sale’. The Revenue holds such sales to be royalty on the ground that during the course of sale of computer software, computer program embedded in it is also licensed and/or parted with the end-user of the software, and as against the claim of the taxpayers who treat the transaction as one of transfer of ‘copyrighted article’ and not transfer of the right in the copyright or licence of the software. Typically the tax authorities seek to tax these payments in the hands of non-residents as royalty and subject the same to withholding taxes. The non-resident payees seek to label such receipts as business income not chargeable to tax, in the absence of a Permanent Establishment in India. Taxability of software-related transaction depends upon the nature and extent of rights granted or transferred under the particular arrangement regarding use and exploitation of the program.

Determining the taxability of any cross-border software transaction involves an understanding and analysis of the following aspects:

I. Definition and classification of Computer Software;
II. Definitions of Royalty under the Act and Double Tax Avoidance Agreement (DTAA);
III. Relevant provisions of the Copyright Act, 1957;
IV. OECD Commentary on Software Payments; and
V. Key judicial and advance rulings.

I. Definition and classification of Computer Software

Definition: Income-tax Act: Explanation 3 to Section 9(i)(vi) of the Act defines ‘Computer Software’ to mean any computer program recorded on any disc, tape, perforated media or other information storage device and includes any such program or any customised electronic data.

Copyright Act: Under the Indian Copyright law (Copyright Act, 1957), computer program and computer databases are considered literary works.

Section 2(ffc) defines ‘Computer Programme’ as a set of instructions expressed in words, codes, schemes or any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result.

Commentary on Article 12 of the OECD Model Convention describes software as a program, or series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).

The New Oxford Dictionary for the Business World defines ‘software’ as programs used with a computer (together with their documentation), including program listings, program libraries, and user and programming manuals.

Typical Business Model relating to computer software:

Single End-user model — Foreign Company supplies a single copy of the software to the end-user.

Distributor Model — Foreign Company either supplies soft copies to an independent distributor in India for onward distribution to Indian customers either directly or through distribution channels or supplies a single copy of the software to a distributor in India who is given the licence to make copies and distribute soft copies to the customers.

Multiple-user licence model — Foreign Company supplies a single disk containing the software program to an Indian Company with a right to make copies of the software and distribute to in-house end users.

Customised model — Foreign Company customises the software as per Indian buyer’s requirements/ specifications — Enterprise Resource Planning software.

Software embedded in hardware — Foreign Company supplies integrated equipment (software bundled with hardware).

Cost contribution model — Foreign Company incurs expenditure for installation and maintenance of software system for the benefit of the group companies. It provides access to such Indian group company to use the system and recharges the cost on the basis of use of the system.

Electronic model — Payment to Foreign Company for purchase of software through electronic media.

Payment to Foreign Company for provision of services for development or modification of the computer program (incl. for upgradation, training, installation, maintenance, etc.).

Payment to Foreign Company for know-how related to computer programming techniques.

Definition of Royalty

Under the Act:Explanation 2 to Section 9(i)(vi) of the Act defines the term ‘Royalty’ to mean consideration for:(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trademark or similar property;

(ii) …………….
(iii) …………….
(iv) …………….
(v) …………….
(vi) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or

(vii) the rendering of any services in connection with the activities referred to above in subclauses (i) to (iv), (iva) and (v).

Under the DTAA:
Most DTAAs define the term ‘royalty’ to mean:

(i) payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on films, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience; and

(ii) payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise of a Contracting State from the operation of ships or aircraft in international traffic.

III. Relevant provisions of the Copyright Act, 1957

Section 2(o): Literary Work

includes computer programs, tables and compilations including computer databases.

Section 14: Meaning of Copyright:

Copyright means the exclusive right, subject to the provisions of this Act, to do or authorise the doing of any of the following acts in respect of a work or any substantial part thereof, namely;

(i) in the case of a literary, dramatic or musical work, not being a computer program —

(a)    to reproduce the work in any material form including the storing of it in any medium by electronic means;
(b)    to issue copies of the work to the public and not being copies already in circulation;
(c)    to perform the work in public, or communicate it to the public
(d)    to make any cinematograph film or sound recoding in respect of the work
(e)    to make any translation of the work
(f)    to make any adaptation of the work
(g)    to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses

(i) to (vi).

(ii) in the case of computer program —

(a)    to do any of the acts specified in clause (a) above;
(b)    to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer program
(c)    No copyright except as provided in this Act, i.e., Copyright does not extend to any right beyond the scope of section 14.

Section 52: Certain acts not to be infringement of copyright.

(1) The following act shall not constitute an infringement of copyright, namely:

(a) …………

(aa) The making of copies or adaptation of a computer program by a lawful possessor of a copy of such computer program, from such copy —

a) In order to utilise the computer program for the purpose for which it was supplied; or
b) To make back-up copies purely as a tem-porary protection against loss, destruction or damage in order only to utilise the computer program for the purpose for which it was supplied.

IV. OECD on Software Payments

The 1992 OECD Model Convention (MC):

(1)    Following a survey in the OECD member states, the question of classification of computer software was first considered in 1992 and accordingly revision made in the Commentary to the OECD Model Convention on Article 12.
(2)    Software was generally defined as a program, or a series of program, containing instructions for a computer either for the computer itself or accomplishing other tasks. Modes of media transfer were also discussed.
(3)    Acknowledged that OECD member countries typically protect software rights under copyright laws.
(4)    Different ways of transfer of software rights e.g., Alienation of entire rights, alienation of partial rights (sale of a product subject to restrictions on the use).

The taxability was analysed under 3 situations:

First situation: Payments made where less than full rights in the software are transferred:

In a partial transfer of rights the consideration is likely to represent a royalty only in very limited circumstances.

One such case is where the transferor is the author of the software and alienates part of his right in favour of a third party to enable the latter to develop or exploit the software itself commercially — for example by development and distribution of it.

In other cases, acquisition of the software will generally be for personal or business use of the purchaser and will be business income or independent personal services. The fact that software is protected by copyright or there are end use restrictions is of no relevance.

Second situation: Payments made for alienation of Complete Rights attached to the software:

Payments made for transfer of a full ownership cannot result in royalty.

Difficulties can arise where there are extensive transfer of rights, but partial alienation of rights involving:

exclusive right of use during a specific period
or in a limited geographical area.
additional consideration related to usage.
consideration in the form of substantial lump-sum payment.

Subject to facts, generally such payments are likely to be commercial income or capital gains rather than royalties.

Third situation: Software payments under mixed contracts:

Examples include sale of computer hardware with built-in software with concessions of the right to use software with provision for services.

In such a scenario, it was felt that the consideration be split on the basis of information contained in the contract or by a reasonable apportionment with the appropriate tax treatment being applicable to each part.

Thus for the first time these three situations were envisaged by the OECD in its 1992 MC.

2000 OECD MC brought in further refinements to the earlier positions.

It acknowledged that software can be transferred as an integral part of computer hardware or in independent form available for use with various hardware. For the first time, the 2000 MC suggested a distinction between a copyright in the program and software which incorporates a copy of the copyrighted program. The transferee’s rights will in most cases consist of partial rights or complete rights in the underlying copyright or they may be rights partial or complete in a copy of the program. — It does not matter, if such copy is provided in a material medium, or electronically. Payments made for acquisition of partial rights in the copyright will represent ‘royalty’ only if consideration is for granting of rights to use the program that would, without such licence, constitute an infringement of copyright.

The 2000 MC also throws light on rights to make multiple copies for operation within its own business and these are commonly referred to as ‘site licences’, ‘enterprise licences’, or ‘network licences’. If these are for the purposes of enabling the operation of the program on the licensee’s computers/network and reproduction for any other purpose is not permitted, payments for such arrangements would not be reckoned as royalty, but may be business profits.

2008 MC to the OECD Model expanded the scope of software payments by including transactions concerning digital products such as images, sounds or text. The downloading of images, sounds or text for the customers own use or enjoyment is not royalty as the payment is essentially for acquisition of data transmitted digitally. However, if the essential consideration for the payment for a digital product is the right to use that digital product, such as to acquire other types of contractual rights, data or services, then the same would be characterised as royalty.

Example a book publisher, who would download a picture and also acquire the right to reproduce that picture on the cover of a book that it is producing.

India’s position on OECD: India reserves its position on the interpretations provided in the OECD MC and is of the view that some of the payments referred therein may constitute royalties.

Issues in the controversy:
(1) Whether payment for purchase of computer software is payment for ‘goods’ or payment for ‘royalty’?

(2) Whether payment for computer software can be said to be payment for ‘use of process’ as referred to in clauses (i), (ii) and (iii) of the royalty definition in the Act?

(3) Whether payment for computer software is for ‘right to use the copyright in a program’ or ‘right to use the program only’? [Copyright v. Copyrighted Article]

(4) Whether mere grant of non-exclusive licence would fall within the ambit of ‘royalty’ definition under the Act? [Ref. clause (v) of the royalty definition in the Act which also includes the phrase ‘granting of a licences’]

(5) Whether payment for computer software can be said to ‘impart information concerning technical, industrial, commercial or scientific knowledge’ and hence falling under clause (iv) of the royalty definition under the Act?

(6) Section 115A prescribes the rate of tax applicable to a foreign company on income by way of ‘royalty’ or ‘fees to technical services’. Whether as per section 115A(1A) of the Act, it is not necessary that copyright therein should be specifically transferred as consideration in respect of any computer software is stated to be taxable u/s.115A?

V. Key judicial and advance rulings

CIT v. Samsung Electronics Co. Ltd., 64 DTR (Kar.) 178

Facts:

The assessee was engaged in the development and export of computer program. The assessee imported ‘shrinkwrapped’/‘off-the-shelf’ software from suppliers in foreign countries for use in its business and made payment for the same without deducting tax at source u/s.195.

Ruling of the High Court:

U/s.9(1)(vi) of the Act and Article 12 of the DTAA, “payments of any kind in consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work” is deemed to be ‘royalty’.

It is well settled that in the absence of any definition of ‘copyright’ in the Act or DTAA with the respective countries, reference is to be made to the respective law regarding definition of Copyright, namely, the Copyright Act, 1957, in India, wherein it is clearly stated that ‘literary work’ includes computer programs, tables and compilations including computer (databases).

On reading the contents of the respective agreement entered with the non-resident, it is clear that under the agreement, what is transferred is a right to use the copyright for internal business by making copies and back-up copies of the program.

The amount paid to the supplier for supply of the ‘shrinkwrapped’ software is not the price of the CD alone nor software alone nor the price of licence granted. It is a combination of all. In substance unless a licence was granted permitting the end-user to copy and download the software, the CD would not be helpful to the end-user.

There is a difference between a purchase of a book or a music CD, because while these can be used once they are purchased, software stored in a dumb CD requires a licence to enable the user to download it upon his hard disk, in the absence of which there would be an infringement of the owner’s copyright. Therefore, there is no similarity between the transaction of a computer program and books.

The decision of the Supreme Court in case of TCS v. State of AP, (271 ITR 404) distinguished as being in the context of sales tax.

Thus, held that the payments made in respect of computer program would constitute ‘royalty’ under the applicable DTAA and would also fall within the ambit of ‘royalty’ under the broader definition in the Act. Thus, the assessee would be required to deduct tax on the payment made in respect of computer programs.

Further, the Karnataka High Court in case of CIT v. M/s. Wipro Ltd., (ITA No. 2804 of 2005) has also held that payment for subscription/access to database is payment for licence to use the copyright hence taxable as ‘royalty’.

Director of Income-tax v. Ericsson Radio System AB, (ITA No. 504 of 2007) (Delhi High Court)

Facts:

The assessee, a Swedish company, entered into con-tracts with ten cellular operators for the supply of hardware equipment and software. The installation and testing were done in India by the assessee’s group entities.

The contracts were signed in India. The supply of the equipment was on CIF basis and the assessee took responsibility thereof till the goods reached India. The assessee claimed that the income arising from the said activity was not chargeable to tax in India.

The Assessing Officer and the Commissioner of Income-tax (Appeals) held that the assessee had a ‘business connection’ in India u/s.9(1)(i) and a ‘permanent establishment’ under Article 5 of the DTAA. It was also held that the income from supply of software was assessable as ‘royalty’ u/s.9(1)(vi) and Article 13. On appeal, the matter was referred to Special Bench of the Tribunal. The Tribunal held that as the equipment had been transferred by the assessee offshore, the profits therefrom were not chargeable to tax. It also held that the profits from the supply of software were not assessable to tax as ‘royalty’ either under the Act or DTAA with Sweden.

Aggrieved by the common order of the Special Bench in case of Motorola Inc. 95 ITD 269 (Del.) (SB), which also covered the case of Ericsson, the Tax Authority filed an appeal before the High Court.

Ruling of the High Court:

The profits from the supply of equipment were not chargeable to tax in India because the property and risk in goods passed to the buyer outside India. The assessee had not performed installation service in India.

The argument that the software component of the supply should be assessed as ‘royalty’ is not acceptable because the software was an integral part of the GSM mobile telephone system and was used by the cellular operator for providing cellular services to its customers.

Software was embedded in the equipment and could not be independently used. It merely facilitated the functioning of the equipment and was an integral part thereof. The Tax Authority accepts that it could not be used independently. The fact that in the supply contract, the lump -sum price was bifurcated is not material. The same was only because differential customs duty was payable.

To qualify as royalty, it is necessary to establish that there is transfer of all or any right (including the granting of any licence) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer program is to be regarded as a ‘literary work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the present case, this has not been established. It is not even the case of the Revenue that any right contem-plated u/s.14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the supply contract.

A distinction has to be made between the acquisition of a ‘copyright right’ and a ‘copyrighted article’. The submissions made by the assessee on the basis of the OECD commentary are correct.

Even assuming the payment made by the cellular operator is regarded as a payment by way of royalty as defined in Explanation 2 below section 9(1)(vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in Article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower than the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what are contemplated are a payment that is dependent upon user of the copyright and not a lump-sum payment as is the position in the present case.

The payment received by the assessee was towards the title of the equipment of which software was an inseparable part incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment could be classified as payment towards royalty.

Solid Works Corporation, ITA No. 3219/Mum./2010 (Mum. Tribunal), dated 8-2-2012

Recently the Mumbai ITAT on the issue of characterisation of shrinkwrapped computer software in the case of Solid Works Corporation (Taxpayer) has held that the consideration received by the taxpayer for the shrinkwrapped software is not ‘royalty’ under the provisions of the India-USA DTAA, but business receipts.

While arriving at its decision, the ITAT relied on the favourable view taken by the Delhi High Court in the case of Ericsson, after considering the decision of the Karnataka High Court in the case of Samsung (supra).

It may be noted that the ITAT has also accepted the argument of the taxpayer that when two views are available, the one favourable to the taxpayer should be followed. This principle should apply even to a non-resident in view of the non-discrimination article in the DTAA.

This ruling should be helpful, especially to taxpayers coming within the jurisdiction of the Mumbai ITAT, and is likely to have persuasive value in case of other neutral jurisdictions (i.e., other than the jurisdiction of the Karnataka High Court), in defending the tax position that is taken based on whether a transaction is a ‘copyright right’ or a ‘copyrighted article’.

Further, the Mumbai Tribunal in the following cases had ruled the issue in favour of the taxpayer by following the Special Bench decision in case of Motorola Inc.:

Kansai Nerolac Paints Ltd. v. Addl. DIT, 134 TTJ 342 (Mum.)

DDIT v. M/s. Reliance Industries Ltd., 43 SOT 506 (Mum.)

Addl. DIT v. Tata Communications Limited, 2010 TII 157 ITAT-Mum.

Controversy before the AAR:

The Authority for Advance Rulings (‘AAR’) recently in its ruling in the case of Citrix Systems Asia Pacific Pty. Limited (AAR No. 882 of 2009) and Millennium IT Software Ltd., 338 ITR 391 had an occasion to deal with the aforesaid issue under consideration, wherein the AAR while deciding against the taxpayer’s contention, held that the income from the transaction be regarded as a royalty, liable to tax in India. In deciding the issue in this case the AAR gave findings that were contrary to its own findings on the subject given in the earlier decisions in the cases of Dassault Systems K. K., 322 ITR 125 and FactSet Research Systems Inc., 317 ITR 169.

Citrix Systems Asia Pacific Pty. Limited (AAR):

In this case, the AAR held that the payment received from Indian distributor under software distribution agreement is taxable as royalty u/s.9(1)(vi) of the Act as well as Article 12 of the India-Australia DTAA. It also observed that sale/licence to use software entails transfer of rights in copyrights embedded in software. The AAR took a contrary view to its earlier ruling in the case of Dassault Systems and refused to rely on the Delhi HC ruling in the case of Ericsson (supra), thereby following the ruling in the case of Millennium IT Software and the Karnataka HC in the case of Samsung (supra).

It is interesting to note that the Chairman of the AAR has mentioned in the ruling of Citrix that the differing views on the issue can get resolved and the matter can be set at rest only by a decision of the Supreme Court, laying down the law finally, to be followed by all the Courts and Tribunals including the AAR. Only an authoritative pronouncement by the Apex Court can settle this controversy.

Millennium IT Software’s case:

In this ruling, the AAR held that the licence fees paid for use of ‘Licenced Program’ is taxable as ‘royalty’ under clause (v) of Explanation 2 to section 9(1)(vi) of the Act and Article 12 of the India-Sri Lanka DTAA. Thus the provisions of withholding tax u/s.195 are applicable to the applicant. The AAR’s ruling was based on the ruling of the Delhi ITAT in the case of Gracemac Corporation v. DIT, (42 SOT 550).

The said Delhi ITAT ruling has been distinguished by the Mumbai ITAT in the case of TII Team Telecom Inter-national Pvt. Ltd., 60 DTR 177. Also, the Mumbai ITAT has distinguished the AAR ruling of Millennium in the case of Novel Inc. (ITA No. 4368/Mum./2010) where income of non-resident from re-selling of software via Indian distributor was held as not taxable.

Conclusion:

The issue under consideration is otherwise a multi-faceted issue and has several dimensions which are sought to be addressed through a few questions and answers thereon. An analysis of the above-discussed important decisions rendered in the context of software/ use of technology-related payments give rise to the following open-ended questions before the taxpayers:

What is meant by the expression ‘transfer of all or any rights (including granting of licence) and which rights are sought to be covered?

Whether the rights referred in section 14 of the Copyrights Act, 1957 are transferred in sale of computer software to end-users?

Whether ‘computer program’ is copyright and/or industrial intellectual property?

Whether the payment made in relation to shrink-wrapped/off-the-shelf software would constitute payment for a copyright, would need to be determined as per section 14 of the Copyright Act, 1957?

Where there is any distinction between a copyright v. copyrighted article in light of the decision of the Karnataka High Court in the case of Samsung Electronics?

Whether in case of bundled contract i.e., software supplied along with hardware, any bifurcation can be made between the payments made for software and hardware?

Whether every payment made by the taxpayer for use of computer program would constitute ‘royalty’ under the Act and relevant DTAA?

Is the position under the DTAA stronger than un-der the Act as the definition of royalty under the DTAA is restrictive than under the Act?

What would be the position, where the DTAA between two Contracting States specifically cover the payments for computer software program within the ambit of taxation as royalty, vis-à-vis the DTAA where such inclusion is not there.

Key takeaways:

The ruling of the Karnataka High Court in the case of Samsung would have significant tax implications on the industries operating under jurisdiction of the Karnataka High Court dealing in computer software/ other technology. The Delhi High Court in the case of Ericsson Radio System A.B., New Delhi having upheld the decision of the Special Bench on this issue, could help the taxpayers to reinforce its position on this contentious issue before various Tribunals (except Bangalore Tribunal). Although, the AAR rulings in the case of Dassault, Geo quest, Citrix’s and Millennium are applicable only to the applicant and Tax Department, they have persuasive value.

Analysis of Finance Bill, 2012 — Proposals:

Controversy revolving around the tax-ability of software payments, is sought to be resolved by amendment to section 9(1)(vi) of the Act. The Finance Bill, 2012 has proposed to insert Explanation 4 and Explanation 5 to the section 9(1)(vi) with retrospective effect from 1st June 1976. The definition of the royalty in Explanation 2 is sought to be expanded by these two explanations.

Explanation 4 clarifies that the transfer of all or any rights in respect of any right, property or information includes transfer of all or any right for use or right to use a computer software (including granting of a licence), irrespective of the medium through which such right is transferred.

Implications of Explanation 4:

By insertion of proposed Explanation 4 to section 9(1) (vi) the controversy surrounding taxability of software payment by characterising it as royalty is sought to be put at rest. The main issue would be whether by inserting Explaination and expanding the scope of the definition ‘royality’ by way of clarificatory retro-spective amendment, can a payment for software be brought to tax?

The dispute was whether by making a payment for software, the licensee gets rights in the ‘copyright’ of the software. It appears that it is felt by the law-makers that by specifically inserting payment for software itself in the definition of royalty, this purpose will be achieved. The moot question however is, whether it can be done retrospectively from 1 June 1976?

Further, Explanation 5 clarifies that royalty includes consideration in respect of any right, property or information whether or not the payer has the possession or control of it, the payer is using it directly or such right, etc. are located outside India.

Implications of Explanation 5:

Explanation 5 seeks to clarify that once a right, property or information is deemed to be covered under Explanation 2 read with Explanation 4 to the section 9(1)(vi), the interpretation would continue to remain so, irrespective of possession or control of the right, property or information, direct or indirect use of the right, property or information or location of the right, property or information.

While it remains to be seen how Explanation 5 will be interpreted by the Courts. It would not be correct to say that on fulfilment of the situations laid down in Explanation 5, the taxability of sale of software is, per se, attracted.

Existence of beneficial treaty provisions:

As mentioned above, the payment for the sale or licence of software, would now get covered u/s. 9(1) (vi), if provisions of the Act are to be applied. However, if the provisions of the treaty are beneficial than the provisions of section 9(1)(vi), still it will be possible to contend that payment for software as per the provisions of the treaty is not liable to tax in India. Further, out of several treaties signed by India, only in 4 to 5 treaties, namely, Morocco, Rus-sia, Turkmenistan, Malaysia and Tobago specifically payment for software is covered as part of royalty. Therefore, it will still be a good case to argue that in case of, off-the-shelf or standardised software are not chargeable to tax in India except where as per treaty it is specifically covered.

It is, therefore, important to note here that the taxpayers who are entitled to claim benefit of tax treaty will still be able to take shelter under the beneficial treaty provisions as the scope of provisions (generally Article 12) under the treaty is restricted than under the Act.

Way forward:

It is learnt that the taxpayer has filed an SLP against the Karnataka High Court ruling in the case of Samsung Electronics Company Ltd. in December 2011 which is yet to be admitted. The SC has reacted that adjudication on this issue is going to be the next big thing after Vodafone judgment.

The proposed amendment, as mentioned above, may resolve the controversy in respect of future transactions, however, whether the amendment will apply retrospectively or not will be a matter of debate and litigation. So in cases where applicable the treaty does not specifically cover the software, the non-taxability could be claimed.

Hence, till the time, the issue gets settled at the highest level, litigation over taxability of software payments is likely to continue. So let’s WAIT & WATCH.

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2004	Tata Consultancy Services	Supreme	—	3
		Court

2004	Wipro Ltd.	ITAT	Bangalore	3

2005	Motorola Inc.	Special	Delhi	3
		Bench ITAT

2005	Lucent Technologies Hindustan Ltd.	ITAT	Bangalore	3

2005	Samsung Electronics Company Ltd.	ITAT	Bangalore		3

2005	Sonata Software Ltd.	ITAT	Bangalore	3

2006	Hewlett-Packard (India) (P) Ltd.	ITAT	Bangalore	3

2006	Sonata Information Technology Ltd.	ITAT	Bangalore	3

2006	IMT Labs (India) Pvt. Ltd.	AAR	—		3

2006	Metapath Software International Ltd.	ITAT	Delhi	3

2008	Airports Authority of India	AAR	—		3

2009	FactSet Research Systems Inc.	AAR	—	3

2009	Samsung Electronics	High Court	Karnataka		3

2010	Lotus Development (Asia Pacific) Ltd. Corp.	ITAT	Delhi	3

2010	Microsoft Corporation and
	Gracemac Corporation	ITAT	Delhi		3

2010	Reliance Industries Ltd.	ITAT	Mumbai	3



2010	M/s. Tata Communications Ltd.	ITAT	Mumbai	3

2010	M/s. Daimler Chrysler AG	ITAT	Mumbai	3

2010	Dassault Systems K.K.	AAR	—	3

Year of	Decision in the case of	Authority	Jurisdiction	Favourable	Against
judgment

2010	GeoQuest Systems BV	AAR	—	3

2010	Velankani Mauritius Ltd.	ITAT	Bangalore	3

2010	Kansai Nerolac Paints Ltd.	ITAT	Mumbai	3

2010	Bharati AXA General Insurance Co. Ltd.	AAR		3

2011	Asia Satellite Co. Ltd.	High Court	Delhi	3

2011	Dynamic Vertical Software India Pvt. Ltd.	High Court	Delhi	3

2011	Standard Chartered Bank Ltd.	ITAT	Mumbai	3

2011	ING Vysya Bank Ltd.	ITAT	Bangalore		3

2011	TII Telecom International Pvt. Ltd.	ITAT	Mumbai	3

2011	M/s. Abaqus Engineering Pvt. Ltd.	ITAT	Chennai	3

2011	Millennium IT Software	AAR	—		3

2011	Samsung Engineering Company Limited	High Court	Karnataka		3

2011	Novel Inc. (Mum.)	ITAT	Mumbai	3

2011	Lucent Technologies	High Court	Karnataka		3

2011	Ericsson Radio System AB	High Court	Delhi	3

2012	Solid Works Corporation	ITAT	Mumbai	3

2012	Citrix Systems Asia Pacific Pty. Limited	AAR			3

2012	Acclerys K. K.	AAR	—		3

2012	People Interactive (I) P. Ltd.	ITAT	Mumbai	3

shailesh.kwebmaker

AMENDMENTS IN DIRECT TAX PROVISIONS BY THE FINANCE ACT, 2012

1. Background:

The Finance Minister presented the Budget
for the year 2012-13 on 16th March, 2012, and introduced the Finance
Bill, 2012, containing 154 clauses. Out of these, 113 clauses relate to
‘Direct Taxes’ and other 41 clauses relate to ‘Indirect Taxes’. There
was heated discussion on the various provisions of the Bill which
included over 30 amendments in various sections of the Income-tax Act
with retrospective effect. There was lot of protest in India and abroad
as most of these amendments would affect non-residents and will have
adverse effect on global trade. Inspite of this protest, the Government
could manage to get through the legislation with some changes. The
Finance Act, 2012, containing 119 sections relating to Direct Taxes is
now passed by both Houses of the Parliament and received the assent of
the President on 28-5-2012. Originally, the existing Income-tax Act was
to be replaced by the Direct Taxes Code (DTC) w.e.f. 1-4-2012. Since the
implementation of DTC is delayed, we will have to live with the
existing Income-tax Act for one more year. Some of the amendments made
by the Finance Act, 2012, will give some relief in the computation of
Income and Tax. However, some of the amendments, which have
retrospective and retroactive effect, will make the life of taxpayers
miserable.

In particular, the retrospective amendments of some
of the sections of the Income-tax Act will increase the tax burden of
non-resident assessees and also increase their compliance cost. In this
respect, the tax litigation will also increase in the coming year. In
this article, the amendments made in the Incometax Act, Wealth-tax Act
and Securities Transaction Tax are discussed.

2. Rates of income tax, surcharge and education cess:

2.1
Relief in income tax: The tax slabs for individuals, HUF, AOP, BOI,
etc. have been made more beneficial. The exemption limit for these
assessees have been raised from Rs.1.80 lac to Rs.2 lac. As a result of
the revision of the exemption limit and realignment of some of the
slabs, tax liability of this category of assessees for A.Y. 2013-14 will
be less by Rs.2,000 in respect of income up to Rs.8 lac. In respect of
income above Rs.8 lac the reduction of the tax will be of Rs.22,000. For
senior citizens and very senior citizens there is no change in tax
payable on income up to Rs.8 lac. If the income is more than Rs.8 lac
the reduction in the tax liability in their cases will be of Rs.20,000.

2.2 Rates of income tax:

(i)
For individuals, HUF, AOP, BOI and Artificial Juridical person, as
stated above, the threshold limit of basic exemption has been increased
for A.Y. 2013-14. Individuals above the age of 60 years are treated as
‘Senior Citizens’ and those above the age of 80 years are treated as
‘Very Senior Citizens’. The rates of tax for A.Y. 2012-13 and A.Y.
2013-14 are as under:

(a) Rates in A.Y. 2012-13 (Accounting Year ending 31-3-2012)

(b) Rates in A.Y. 2013-14 (Accounting Year ending 31-3-2013)

No
surcharge is payable for A.Y. 2012-13 and 2013-14. However, education
cess of 3% (2+1) of the tax is payable for both the years.

(ii)
The following table gives comparative figures of tax payable by
individuals, HUF, AOP, BOI, etc. in A.Y. 2012-13 and A.Y. 2013-14.

The above tax is to be increased by 3% of tax for education cess.

(a) Tax payable in A.Y. 2012-13 (Accounting Year ending 31-3-2012)

(b) Tax payable in A.Y. 2013-14 (Accounting Year ending 31-3-2013)

The
concessional rate of 15% plus applicable surcharge and education cess
which was provided for A.Y. 2012-13 has been continued for A.Y. 2013-14
also.

(vii) Rate of Alternate Minimum Tax (AMT)

The
rate of tax 18.5% plus education cess of 3% of tax which was payable as
AMT on income of LLP for A.Y. 2012-13 is now payable by all assessee,
other than a company, i.e., LLP, firm, individual, HUF, AOB, BOI, etc.
in A.Y. 2013-14. No surcharge is payable on AMT.

2.3 Surcharge on income tax:

(i)
As in A.Y. 2012-13, no surcharge is payable by non-corporate assessees
i.e., individuals, HUF, AOP, BOI, Firm LLP, co-operative societies, etc.
in A.Y. 2013-14. In the case of a company the rate of surcharge, if
income exceeds Rs.1 Cr, is 5% of income tax. As regards MAT u/s.115JB,
if the book profit exceeds Rs.1 Cr., rate of surcharge is 5%.

(ii) As regards TDS and TCS, no surcharge is required to be added to the rates of TDS or TCS.

(iii) In the case of dividend distribution tax u/s.115O and 115R the rate of surcharge on tax (i.e., 15%) is 5% of the tax.

(iv)
In the case of foreign companies, the rate of surcharge on income tax
is 2% of tax if the taxable income of the company exceeds Rs.1 Cr.
Similarly, the rate of surcharge on tax to be deducted u/s.195 in case
of foreign company is 2% of the tax if the income from which tax is
deductible at source exceeds Rs.1 Cr. 2.4 Education cess: As in earlier
years, education cess of 3% (including 1% higher education cess) of
income tax and surcharge (if applicable) is payable by all assesses
(Residents or non-residents). No education cess is applicable on TDS or
TCS from payments to all residents (including companies). However, if
tax is deducted from payments made to

(a) foreign companies,

(b) non-residents or

(c)
on salary payments to residents or non-residents, education cess at 3%
of the tax and surcharge (if applicable) is to be deducted.

3. Tax Deduction and Collection at Source (TDS and TCS):

3.1 Section 193: At
present, no tax is required to be deducted at source if interest
payable to a resident individual on debentures issued by a listed
company does not exceed Rs.2,500 in a year. This limit is increased to
Rs.5,000 w.e.f. 1-7-2012. This concession will now apply to debentures
issued by unlisted public companies as well as to interest payable to
resident HUF. The existing exemption in respect of interest paid on
debentures issued by listed companies which are held in Demat Account
will continue without any limit. The amendment in this section comes
into force on 1-7-2012.

3.2 Section 194J — TDS from fees
from professional or technical services: This section is now amended
w.e.f. 1-7-2012. It will now be necessary for a company to deduct tax at
source from any remuneration, fees or commission paid or payable to a
director, if no tax is deductible u/s.192 under the head salary. The
rate for TDS is 10%. It may be noted that the manner in which the
section is amended indicates that this deduction is to be made
irrespective of the quantum of such payment in the year. As regards
professional fees, technical service fees, royalty, etc. to which this
section applies it is provided that tax is to be deducted only if
payment under each head exceeds Rs.30,000 in the financial year.
Therefore, in case of payment of fees to non-executive directors and
independent directors as ‘Director’s Fees’, the tax at 10% will be
deductible even if the total payment in the F.Y. is less than Rs.30,000
to each of them.

3.3 Section 194LA:

At present TDS from compensation on compulsory acquisition of immovable property at 10% is required to be made if compensation amount exceeds Rs.1 lac. This will now be required to be made if the compensation amount exceeds Rs.2 lac w.e.f. 1-7-2012.

3.4 Section 194LC:

This is a new section inserted in the Income-tax Act w.e.f. 1-7-2012. It provides for deduction of tax at the concessional rate of 5% plus applicable surcharge and education cess, in respect of interest paid to a non-resident, other than a foreign company. This interest should relate to monies borrowed by an Indian company from the non-resident at any time on or after 1-7-2012 and before 1-7-2015 in foreign currency from a source outside India. This borrowing should be (i) under a loan agreement or (ii) by way of issue of long- term infrastructure bonds approved by the Central Government. Further, the rate of such interest should not exceed the rate approved by the Government for this purpose.

3.5 Section 201 — Failure to deduct tax at source:

U/s.201, a person can be deemed to be an assessee in default in respect of non/short deduction of tax at source. The AO can pass order for this purpose within a period of four years from the end of the financial year in a case where no returns for tax deducted at source have been filed. Section 201 is amended with retrospective effect from 1st April, 2010, to extend the time limit for passing the order u/s.201(1) for non/short deduction of tax from 4 years to 6 years from the end of the F.Y. in which payment is made or credit is given.

3.6 Section 206C — Tax Collection at Source (TCS):

This section provides for collection of tax at source from sale of alcoholic liquor, tendu leaves, timber, forest products, scrap, etc. at the rates ranging from 1% to 5% of the sale price. The scope of this provision for TCS is extended w.e.f. 1-7-2012 as under.

i) In respect of sale of minerals, being coal or lignite or iron ore, tax is to be collected by the seller at the rate of 1% of the sale price.

ii) However, such tax is not to be collected if the purchase of such goods listed in section 206C(i) is made by the buyer for the purpose of manufacturing, processing or producing articles or things or for the purposes of generation of power. For this purpose the buyer of such goods has to give a declaration in Form No. 37C.

iii) In order to reduce the quantum of cash trans-actions in bullion or jewellery sector and for curbing the flow of unaccounted money in the trading system, it is now provided that the seller of bullion or jewellery shall collect from the buyer tax at the rate of 1% of the sale consideration. For this purpose it is provided that the collection of the above tax of 1% shall be made if the sale price in cash exceeds the following amounts:

a. For bullion, if the sale price exceeds Rs.2 lac. It may be noted that for this purpose definition of ‘Bullion’ does not include coin or any other article weighing ten grams or less.

b. For jewellery, if the sale price exceeds Rs.5 lac.

iii) It may be noted that this tax will be collected from the buyer even if the buyer has purchased bullion or jewellery for personal use or for manufacture or processing the same for his business. Further, it appears that persons who purchase bullion or jewellery for personal use will not be able to get credit for the tax collected at source because there will be no corresponding income from sale of bul-lion or jewellery in respect of which such credit for tax can be claimed. Further, the person making such payment for purchase of bullion or jewellery in cash will have to prove the source from which such cash is paid.

iv) There are certain consequential amendments made in section 206C on the same lines as in section 201 . According to these amendments, if the seller, who is required to collect tax under this section fails to do so, he will not be deemed to be in default if he can establish that the buyer has filed his return u/s.139 and paid tax on his income after considering the goods purchased by him. Consequential provision for reduction in the period for which interest is payable u/s.206C is also made.

3.7 No Advance tax payable by senior citizens u/s.207:

This section provides for payment of Advance Tax in instalments. It is now provided, w.e.f. 1-4- 2012, that a senior citizen who has no income from business or profession will not be required to pay any Advance Tax.

4. Exemptions and deductions:

4.1 Charitable trust:

Section 2(15) provides that if the object of advancement of general public utility involves carrying on of any activity in the nature of trade, commerce or business, etc. and the aggregate value of the receipts from such activity exceeds Rs.25 lac, the trust will not be considered as charitable trust. New s.s (8) has been inserted in section 13 and a proviso has been added in section 10(23C), with retrospective effect from A.Y. 2009- 10, to provide that the trust or institution will not be granted exemption only for the year in which such receipts exceed Rs.25 lac. Such loss of exemption in that year will not affect the registration of the trust or institution u/s.12AA. The exemption can be claimed in subsequent years when such receipts do not exceed Rs.25 lac.

4.2 Section 10(10D) — Deduction of life insurance premium:

At present, any sum received under a life insurance policy, including bonus, but excluding amount re-ceived under Keyman Insurance policy, is exempt, provided the premium amount does not exceed 20% of the actual capital sum assured in any year during the policy period. Now, this limit is reduced to 10% in the case of an insurance policy issued on or after 1st April, 2012. Similar amendment is made u/s.80C, whereby it is provided that deduction in respect of life insurance premium, etc. in the case of insurance policies issued on or after 1st April, 2012 shall be avail-able only in respect of premium not exceeding 10% of the actual capital sum assured. It may be noted that in respect of life insurance premium paid on policies issued before 31-3-2012, the old limit of 20% of actual capital sum assured will apply.

‘Actual capital sum assured’ is also defined to mean the minimum amount assured under the policy on happening of the specified event at any time during the term of the policy, and excluding the value of any premiums agreed to be returned and benefit of bonus or otherwise over and above the sum actually assured. This is done to ensure that life insurance products are not designed to circumvent the prescribed limit by varying the capital sum as-sured from year to year. This amendment comes into force from A.Y. 2013-14 (Accounting Year end-ing on 31-3-2013).

4.3 Section 10(23FB) — Venture Capital Company (VCC) and Venture Capital Funds (VCF):

i) This section has been amended w.e.f. A.Y. 2013-14. Simultaneously, section 115U has also been amended. Section 10(23FB) provides that a VCC or VCF registered with SEBI and deriving income from investment in a Venture Capital Undertaking (VCU) is exempt from tax. VCU is presently defined to mean such domestic company whose shares are not listed in a recognised stock exchange in India and which is engaged in any one of the nine specified businesses. VCC and VCF registered with SEBI are granted a pass-through status and the income in the hands of the investor is taxed in the like manner and to the same extent as if the investment was directly made by the investor in the VCU.

ii) The sectoral restriction that the VCU should be engaged in only the nine specified businesses is now removed. The definition of VCU is now amended to cover any undertaking referred to in SEBI (Venture Capital Funds) Regulations, 1996. As such VCC and VCF will be exempt from tax, irrespective of the nature of business carried out by the VCU, as long as it satisfies the conditions imposed by SEBI.

iii) At present, the income received by any VCC/ VCF from VCU, is taxed on receipt basis in the hands of the investor and hence could result in deferral of taxation till the income is distributed to the investor. It is now provided that the income accruing to VCC/ VCF will be taxable in the hands of the investor on accrual basis.

4.4 Section 10(23BBH):

This new section is inserted w.e.f. 1-4-2013 to pro-vide for exemption from tax in the case of income of the Prasar Bharati (Broadcasting Corporation of India) from A.Y. 2013-14.

4.5 Section 10(48):

This is a new provision made w.e.f. A.Y. 2012-13 (1-4-2011 to 31-3-2012). This section provides for exemption in respect of any income of a foreign company received in India, in Indian currency, on account of sale of crude oil to any person in India. This is subject to the conditions that (i) the receipt of money is under an agreement which is entered into by the Central Government or approved by it the foreign company, and the arrangement or agreement has been notified by the Central Govern-ment and (iii) the receipt of the money is the only activity carried out by the foreign company in India. This provision is introduced in view of the mecha-nism devised by the Government to make payment to certain foreign companies in Indian currency for import of crude oil (e.g., from Iran).

4.6 Section 40(a)(ia):

This section provides for disallowance of payment to a resident if tax required to be deducted there from has not been deducted by the assessee. By amendment of this section it is provided that if the assessee establishes that the resident payee (de-ductee) has paid tax on this income before furnish-ing his return of income, the expenditure shall not be disallowed under this section. This amendment is made from A.Y. 2013-14 (Accounting Year 2012-13). Consequential amendment is made in section 201 to provide, w.e.f. 1-7-2012, that the payer shall not be deemed to be in default if he can prove that the payee has furnished his return u/s.139 and paid tax on such amount. However, the payer will have to pay interest from the due date till the date of filing return by the payee. This being a beneficial provision, it should be made applicable to earlier years also. This will reduce litigation on this issue. It will be pos-sible to argue that the above beneficial amendment will have retrospective effect in view of decision of CIT v. Virgin Creations, ITA No. 302 of 2011 (Calcutta High Court) in respect of similar amendment in the section by the Finance Act, 2010.

4.7 Section 80C:

As discussed in Para 4.2 above, section 80C is amended to provide that the deduction of LIP in respect of life policy taken out on or after 1-4-2012 shall be restricted to 10% of the capital value assured.

4.8 Section 80CCG:

This is a new section inserted w.e.f. A.Y. 2013-14 (Accounting Year 1-4-2012 to 31-3-2013) and provides as under:

i) The deduction under this section can be claimed by an Individual who is a resident, if he acquires listed equity shares in accordance with the scheme to be notified by the Government. The assessee will be allowed deduction of 50% of the amount invested subject to the limit of deduction of Rs.25,000 in the computation of income for the year of investment. It may be noted that this deduction is not allowable to an HUF.

ii) The above deduction is subject to the following conditions:

a) The gross total income of the assessee for the relevant assessment year should not exceed Rs.10 lac.
b) The assessee should make the above investment in retail category specified in the scheme.

c) The above investment should be in listed equity shares as specified under the scheme.

d) There will be locking period of 3 years for such investment.

iii) If the assessee fails to comply with any of the above conditions in any year, the amount of deduction allowed in earlier years will be taxable in that year.

4.9 Section 80D:

Under this section deduction up to Rs.15,000 is allowed to an assessee (individual or HUF) for premium paid on mediclaim insurance policy. For senior citizens the limit for deduction is Rs.20,000. Now it is provided that, effective from Accounting Year 2012-13, if the assessee makes payment up to Rs.5,000 in a year for preventive health check-up, deduction will be allowed within the above ceiling limit. Further, age limit for senior citizens is reduced from 65 years to 60 years. It is suggested that this deduction upto Rs.5,000 should have been allowed over and above the existing ceiling limit of Rs.15,000 or Rs.20,000. The limits of Rs.15,000/20,000 were fixed in the year 2000 and deserve to be enhanced due to increase in medical cost and consequential increase in insurance premium.

4.10 Sections 80G and 80GGA:

Deduction for donation of Rs.10000 or more under these sections will not be allowed if the same is paid in cash. This provision will apply to donations made in the Accounting Year 2012-13 onwards.

4.11 Section 80IA(4)(iv):

Under this section an industrial undertaking engaged in the business of generation and distribution of power and allied activities is entitled to tax holiday for 10 years if such undertaking begins its activities on or before 31-3-2012. This date is now extended to 31-3-2013.

4.12 Interest from bank exempt u/s.80TTA:

This is a new section which has been introduced effective from A.Y. 2013-14 (accounting year ending 31-3-2013). Under this section, in the case an individual or HUF, interest from savings bank account with a bank, co- operative bank or post office bank up to Rs.10000 will not be taxable. This provision will not apply to interest on fixed deposit with banks.

4.13 Section 115-O:

At present, dividend distributed by a company out of the dividend received from its subsidiary company, which has paid Dividend Distribution Tax, is not liable to Dividend Distribution Tax once again. For this purpose, the dividend receiving company should not be a subsidiary of any other company. By amendment of this section, effective from 1-7-2012, the condition that “the company is not a subsidiary of any other company” has now been removed. Therefore, any domestic company (whether it is a holding company or a subsidiary company) receiving dividend from its subsidiary or step down subsidiary company and declaring dividend in the same year out of such dividend amount will be allowed to reduce the amount of such dividend for determining the liability to Dividend Distribution Tax if the subsidiary or step down subsidiary company has paid Dividend Distribution Tax that is payable.

5. Income from business or profession:

5.1 Section 32(1)(iia):

At present, an assessee engaged in the business of manufacture or production of any article or thing is entitled to additional depreciation of 20% of the cost of the new plant and machinery in the year of acquisition. From A.Y. 2013-14, this benefit is now extended to an assessee engaged in the business of generation or generation and distribution of power.

5.2 Section 35(2AB):

According to the existing provisions of section 35 (2AB) weighted deduction at 200% of expenditure on approved in-house research and development by a company engaged in the business of biotechnology or in the manufacture of specified articles is allow-able up to 31-3-2012. This benefit is now extended up to 31-3-2017.

5.3 Section 35AD:

i) Investment-linked deduction of 100% of capital expenditure (excluding expenditure incurred for land, goodwill or financial instrument) is allowed for certain specified businesses. In the list of specified businesses, there are at present 8 types of businesses. With effect from 1-4-2012, 3 new businesses have been added to this list. These 3 businesses re-late to setting up and operating (a) inland container depot, or container freight station, (b) warehousing facility for storage of sugar and (c) bee-keeping and production of honey beeswax which commence operations on or after 1-4-2012.

ii) Further, the above investment-linked deduction is now enhanced to 150% of the capital expenditure incurred on or after 1st April, 2012 in respect of certain specified businesses which commence operations on or after 1-4-2012. These specified businesses are setting up and operating (a) cold-chain facility warehousing facility for agricultural produce, (c) building and operating a hospital with at least 100 beds, (d) developing and building affordable housing project and (e) production of fertiliser in India.

iii) Further, it is provided that an assessee who builds a hotel of two-star or above category as classified by the Central Government and subsequently, continuing to own the hotel, transfers the operation thereof, the assessee shall be deemed to be engaged in specified business and will be eligible to claim deduction u/s.35AD. This amendment has been made with effect from A.Y. 2011-12.

5.4 New sections 35CCC and 35CCD:

These two new sections are inserted effective from A.Y. 2013-14. They provide as under:

i. Section 35CCC provides that when an assessee incurs any capital or revenue expenditure for agricultural extension project notified by the CBDT, he will be allowed deduction of 150% of such expenditure.

ii. Section 35CCD provides that where a company incurs expenditure (other than expenditure on any land or building) on any skill development project notified by the CBDT, it will be allowed deduction of 150% of such expenditure.

5.5 Presumptive taxation:

Section 44AD provides for presumptive taxation in respect of non-corporate assessees carrying on specified businesses and having a total turnover of less than Rs.60 lac. Under this section 8% of the total turnover is deemed to be the income from business subject to certain conditions. It is now provided that this section will not apply to a person having income from (i) a profession, (ii) commission or brokerage or (iii) any agency business. This amendment is made effective A.Y. 2011-12. Further, the limit of Rs.60 lac for total turnover is increased to Rs.1 crore w.e.f. A.Y. 2013-14 (Accounting Year 2012-13).

5.6 Section 44AB:

The limit of turnover/gross receipts for tax audit u/s.44AB has also been increased for business to Rs.1 Cr. And for profession to Rs.25 lac w.e.f. A.Y. 2013-14 as discussed in Para 17.2 below:

6. Capital gains:

6.1 Section 47(vii):

This section is amended w.e.f. A.Y. 2013-14. It is now provided that when a subsidiary company amalgamates with a holding company, the requirement of the issue of shares of the amalgamated company on amalgamation will not apply.

6.2 Section 49:

At present, there is no provision to treat the cost of assets of a proprietary concern, converted into a company, or a firm converted into a company as the cost of the assets in the case of the company. It is now provided, w.e.f. A.Y. 1999 -2000, that the cost of assets on conversion of a proprietary concern or a firm into a company u/s.47(xiii), or 47 (xiv), in the hands of the company shall be the same as in the hands of the converting enterprise. Similarly, when an unlisted company is converted into LLP u/s.47(xiiib), the cost assets in the case of the company shall be treated as cost in the case of the LLP.

6.3 Section 50D:

This is a new section inserted w.e.f. A.Y. 2013-14. It provides that where the consideration received or accrued for transfer of a capital asset is not ascertainable or cannot be determined, then the fair market value of the said asset shall be deemed to be the full value of the consideration on the date of transfer for computing the capital gain. This situation may arise in a case where the capital asset is transferred in exchange of another capital asset.

6.4 Section 54B:

At present, the benefit of exemption from capital gain on sale of agricultural land is available to the assessee on reinvestment of such capital gain for purchase of another new agricultural land within two years. One of the conditions is that the land should have been used by the assessee or his parent for agricultural purposes. This provision is amended, w.e.f. A.Y. 2013-14, to provide that even if such land was used by the HUF, in which the as-sessee or his parent was a member, this exemption can be claimed.

6.5 Section 54GB:

This is a new section which is inserted w.e.f. A.Y. 2013-14 to provide that if an Individual or HUF makes capital gains on sale of a residential house or plot, he can claim exemption from Capital Gains Tax if he invests the net consideration in equity shares of a new SME company. Such SME company is required to invest this amount in purchase of new plant and machinery. This exemption can be claimed subject to the following conditions.

i) The investee company should qualify as a small or medium enterprise under the Micro, Small and Medium Enterprises Act, 2006. (SME).

ii) The company should be engaged in the business of manufacture of an article or a thing.

iii) SME company should be incorporated within the period from 1st of April of the year in which capital gain arises to the assessee and before the due date for filing the return by the assessee u/s.139(1).

iv) The assessee should hold more than 50% of the share capital or the voting right after the subscription in the shares of a SME company.

v) The assessee will not be able to transfer the above shares for a period of 5 years.

vi) The company will have to utilise the amount invested by the assessee in the purchase of new plant and machinery. If the entire amount is not so invested before the due date of filing the return of income by the assessee u/s.139, then the company will have to deposit the amount in the scheme to be notified by the Central Government.

vii) The above new plant and machinery acquired by the company cannot be sold for a period of 5 years.

viii) The above scheme of exemption granted in respect of capital gains on sale of residential property will remain in force up to 31-3-2017.

The above conditions prescribed in the new section are very harsh. This section should have allowed the investment in existing SME company for the purpose of exemption. Further, investment in LLP, which satisfies the condition of SME enterprises, should also be permitted. The restricted time limit for acquiring new plant and machinery will create difficulties and, therefore, it should have been provided that the SME company should be allowed to make such investment in new plant and machinery within a period of 18 months from the date on which the assessee makes the investment in its equity shares. The period of 5 years for retaining the equity shares is too long and should have been reduced to 3 years. Similarly, lock-in-period for plant and machinery acquired by the SME company should be reduced from 5 years to 3 years.

6.6 Section 55A — Reference to Valuation Officer:

This section is amended w.e.f. 1-7-2012. Under this section, the AO can make a reference to the Valuation Officer with a view to ascertain the fair market value of the capital asset. At present, such reference can be made when the AO is of the view that the value disclosed by the assessee is less than the fair market value. In some cases it is held that when the assessee exercises his option to substitute fair market value of the capital asset as on 1-4-1981, for the cost of the asset, and if the AO is of the view that such market value as declared by the assessee was more, he cannot make a reference to the Valuation Officer. To overcome this position, this amendment provides that w.e.f. 1-7-2012 the AO can make such reference to the Valuation Officer. This amended provision will apply w.e.f. 1 -7-2012 but will have retroactive effect, inasmuch as, the AO can make such a reference to the Valuation Officer in respect of all pending assessments of earlier years.

6.7 Securities Transaction Tax (STT):

i) Section 98 of the Finance (No. 2) Act, 2004, providing for rates of STT has been amended w.e.f. 1-7-2012. The revised rates of STT in Cash Delivery Segment are reduced from 0.125% to 0.1%. Therefore, in the case of delivery-based transaction relating to equity shares of a company or units of equity ori-ented fund of a mutual fund entered into through a recognised Stock Exchange, the STT payable by a purchaser is reduced from 0.125% to 0.1% and a seller is reduced from 0.125% to 0.1% w.e.f. 1-7-2012.

ii) In order to encourage unlisted companies to get them listed in recognised Stock Exchange, it is now provided that sale of unlisted equity shares by any holder of such shares, under an offer for sale to the public included in an Initial Public Offer (IPO), if subsequently such shares are listed on the recognised Stock Exchange, will be liable for pay-ment of STT at 0.2%. If such STT is paid, long-term capital gain on such sales will be exempt from tax and tax on short-term capital gain will be payable at concessional rate of 15% u/s.111A.

7. Income from other sources:

7.1 Section 56(2)(vii):

Under this section any gift exceeding Rs.50,000 in any year received by an Individual or HUF on or after 1-10-2009 is taxable as income from other sources, subject to certain exceptions. One of the exceptions is about gift received from relatives of the individual as defined. Similar exemption is not given in respect of gifts from members of HUF. It is now provided, w.e.f. 1-10-2009, that gifts received by HUF from its members will be exempt. However, if such a gift is given by a member to such HUF, income from the property gifted will be clubbed with the income of the member u/s.64(2). In order to mitigate hardship experienced in practical life it is suggested that the following relationship should have been covered in the definition of relatives.

i. Gifts by HUF to its members

ii. Gifts to an Individual by any lineal descendant of a brother or sister of the Individual or his/ her spouse (i.e., gift by a nephew or niece to an uncle or aunt). Similar provision is made in section 314(214)(h) of DTC Bill, 2010.

7.2 Section 56(2)(viib):

This is a new provision inserted from the A.Y. 2013-14. It is now provided that where a closely held company issues shares to a resident, for amount received in excess of the fair market value of the shares, it will be deemed to be the income of the company under the head ‘Income from other Sources’. The fair market value for this purpose is the higher of the value arrived at on the basis of the method to be prescribed or the value as substantiated by the company to the satisfaction of the Assessing Officer. The company can substantiate the value based on the value of the tangible and intangible assets and various types of commercial rights as stated in the section.

This provision will not apply to amounts received by a venture capital undertaking from a venture capital fund or a venture capital company. Further, this provision will not apply to amount received from non-resident, a foreign company or from a class of persons as may be notified by the Government. The provision appears to have been made with a view to ensure that excessive amount, representing revenue payment, is not received in the form of share premium and does not escape taxation.

7.3 Section 68:

This section deals with taxation of cash credits. The section is amended w.e.f. A.Y. 2013-14. This section now provides that in the case of a closely held company, if the amount credited in the name of a resident is by way of share application money, share capital, share premium or any such amount, by whatever name called, and the explanation offered for the credit is not considered to be satis-factory, such amount will be considered as income of the company. However, if the person (being a resident) in whose name the amount is credited offers explanation about the source and nature of the amount credited and such explanation is found to be satisfactory by the Assessing Officer this Section shall not apply. In the event of failure to do so, the entire amount credited will be taxed at the rate of 30% plus applicable surcharge and Education cess in the hands of the company.

This provision does not apply to amount received from a venture capital fund or a venture capital company. It will also not apply to the amount received from a non-resident or a foreign company.

7.4 Section 115BBD:

At present, this section provides that rate of tax, for dividend received by an Indian company from a foreign company in which it has share holding of 26% or more, is 15% for A.Y. 2012-13. This concession has been extended for one more year i.e., A.Y. 2013-14.

7.5 Section 115BBE:

This is a new section inserted from A.Y. 2013-14. The section provides that unexplained amounts treated as income (i) u/s.68 cash credits, (ii) u/s.69 unexplained investment, (iii) u/s.69A unexplained money, bullion, jewellery or other valuable articles, u/s.69B amount of investments, expenditure on jewellery, bullion or other valuable articles not fully disclosed in books, (v) u/s.69C — Unexplained expenditure, and (vi) u/s.69D — Amount borrowed or repaid on a Hundi in cash, will now be taxed at a flat rate of 30% plus applicable surcharge and education cess. No deduction for any expenditure or allowance will be allowed against such income.

8. Minimum Alternate Tax (MAT) (section 115JB):

8.1 Section 115JB is amended w.e.f. 1-4-2001 (A.Y. 2001-02) to provide that in the case of the income arising from life insurance business the tax under this section will not be payable. In other words, MAT provisions will not apply from A.Y. 2001-02 onwards in respect of income from life insurance business.

8.2 (i) The section is amended w.e.f. A.Y. 2013 -14 to provide that in the case of a company, such as insurance, banking, electricity company, etc., for which the Form of Profit & Loss A/c. and Balance Sheet is prescribed in the Act governing such com-panies, the book profit shall be determined on the basis of the Form of Profit & Loss A/c. prescribed under that Act. Further, it is provided that in respect of companies to which the Companies Act applies, the book profit will be computed on the basis of the revised format of Schedule VI.

ii) By another amendment of this section effective from A.Y. 2013-14, it is now provided that the book profit will be increased by the amount standing to the credit of revaluation reserve relating to reval-ued asset which has been discarded or disposed of, if the same is not credited to the Profit & Los A/c. This amendment is in order to cover cases in which revaluation reserve is directly transferred to general reserve on disposal of asset resulting in the gain that is not being included in the computation of book profits up to now.

9. Alternate Minimum Tax (AMT)

9.1 Sections 115JC to 115JE for levy of AMT on ad-justed total income of LLP have now been extended to other non-corporate assessees such as individual, HUF, AOP, BOI, Firm, etc. w.e.f. A.Y. 2013-14. New section 115JEE has also been added from A.Y. 2013-14.

9.2 Provision for AMT was made last year for income of LLP w.e.f. A.Y. 2012- 13 in sections 115JC to 115JE. Now section 115JC is replaced by a new section and other sections 115JD to 115JE have been amended w.e.f. A.Y. 2013-14. A new section 115JEE is also inserted. The effect of these amendments is as under.

i) The provisions of section 115JC will now apply to LLP and all other non-corporate assessees i.e., individual, HUF, AOP, BOI, Firm, etc. As provided in section 115JC the assessees will have to obtain audit report in the prescribed form before the due date.

ii) In the case of an individual, HUF, AOP, BOI or Artificial Juridical person, AMT will not be payable if the adjusted total income does not exceed Rs.20 lac. (section 115JEE)

iii) AMT is payable at 18.5% plus applicable surcharge and education cess of the adjusted total income if the amount of such tax is more than the tax payable on the total income computed under other provisions of the Income-tax Act.

iv) Adjusted total income is defined to mean the total income computed under the Income-tax Act increased by (a) deductions claimed under Chapter VIA (section C) i.e., 80HH to 80 RRB (other than section 80P) and (b) deduction claimed u/s.10AA (SEZ income).

v) Other provisions of sections (a) section 115JD for tax credit for AMT paid for 10 years, (b) Section 115JE applicability of other sections of the Income-tax Act and (c) Section 115JF— Definitions will continue to apply to LLP and also to other non-corporate assessees to whom sections 115JC and 115JEE for payment of AMT apply.

10. Specified domestic transactions:

Section 40A(2) of the Income-tax Act empowers the AO to disallow payment to a related person for expenditure, if he considers that such expenditure is excessive or unreasonable, having regard to the fair market value of the goods, services or facilities for which such payment is made and claimed as a deduction in the computation of income. Similarly, sections 10AA, 80A, 80IA, 80IB, etc. provide that if there are any transactions of purchases, sales, etc. between two related persons, the AO can ap-ply the test of fair market value and make adjust-ments in the computation of income. In all these sections, the concept of ‘fair market value’ has not been specifically explained. Therefore, the Supreme Court in the case of CIT v. Glaxo Smithkline Asia (P) Ltd., 195 Taxman 35 (SC) observed that in order to reduce litigation, sections 40A(2) and 80IA(10) need to be amended to empower the AO to make adjustments to the income declared by the assessee, having regard to the market value of the transac-tions between related parties, by applying any of the generally accepted methods for determination of Arm’s- Length Price (ALP), including methods provided under Transfer Pricing Regulations. In view of the above, amendments are made in sec-tions 40A(2), 10AA, 80A and 80IA to provide that the ‘Specified domestic transactions’ will now be subject to Transfer Pricing Regulations contained in sections 92, 92BA to 92F — from A.Y. 2013-14 (Accounting Year 1-4-2012 to 31-3-2013). In brief, the effect of these provisions, from A.Y. 2013-14 (1-4-2012 to 31-3-2013) onwards will be as under.

10.1 The term ‘specified domestic transaction’ is defined in new section 92BA to mean the following transactions, other than the international transactions:

a) Any expenditure in respect of which payment has been made or to be made to a person referred to in section 40A(2)(b). This will include remuneration, commission, rent, interest, etc. paid to a related person as well as purchases made from such person.

b) Any transaction referred to in section 80A.

c) Any transfer of goods or services referred to in section 80IA(8).

d) Any business transacted between the assessee and other person as referred to in section 80IA(10).

e) Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sections 80IA(8) or 80IA (10) are applicable.

f) Any other transaction as may be prescribed by Rules by the CBDT.

10.2 It is also provided that the Transfer Pricing provisions will not apply if the aggregate amount relating to the above transactions entered into by the assessee, in the relevant accounting year, does not exceed Rs.5 crore. It is not clear from the word-ing of the above section whether such aggregate amount is to be worked out by considering the amount of expenditure, purchases, sales, etc. under all the above sections taken together or whether the aggregate amount under each section i.e., 40A(2), 80A, 80IA, 10AA, etc. is to be separately worked out in order to determine the limit of Rs.5 crore provided in the section.

10.3 Section 40A(2):

This section provides for disallowance of revenue expenditure incurred by the assessee. The section does not apply to any revenue or capital receipt or to capital expenditure. Further, the section does not apply to any revenue expenditure which is capita-lised. Under this section, if any payment is made or to be made for any revenue expenditure to any ‘Related Person’, the AO can disallow that part of the expenditure which he considers to be excessive or unreasonable, having regard to the fair market value of the goods, services or facilities for which such payment is made and claimed as a deduction in computing the income. This section applies to the computation of ‘Income from Business or Profession’ and ‘Income from other Sources’. This section is now amended to provide that the fair market value for any payment to which the concept of specified domestic transaction applies shall be determined on the basis of arm’s-length price concept as provided in sections 92C and 92F(ii).

10.4 Section 80A:

Section 80A(6) refers to transfer of any goods or services held for the purposes of the undertaking, unit, enterprise, or eligible business to any other business carried on by the assessee. It also refers to transfer of goods or services held for the pur-poses of any other business of the assessee to the undertaking, unit, enterprise or eligible business. If the consideration for such transfer is not at the market value, then the AO can substitute the market value of the goods or services for such transfer. The expression ‘Market Value’ is defined in the Explanation to mean the price that such goods or services would fetch, if they were sold in the open market, subject to statutory or regulatory restrictions. This Explanation is now amended w.e.f. A.Y. 2013-14 to provide that the expression ‘Market Value’ in relation to specified domestic transactions shall now mean, in relation to any goods or services sold, supplied or acquired, the ‘Arm’s-length price’ as defined in section 92F(ii). It may be noted that this section applies to transfer of goods or services from one undertaking, unit or business owned by the assessee to another undertaking, unit or business owned by the same assessee.

10.5 Section 80IA:

S.s (8) and s.s (10) of this section are amended w.e.f. A.Y. 2013-14 as under.

i) Section 80IA(8):

This provision refers to transfer of goods or services held for the purposes of the eligible business to any other business of the assessee. The section also refers to transfer of goods or services from any other business of the assessee to any eligible business. For this purpose, the expression ‘eligible business’ means business carried on by any indus-trial undertaking owned by the assessee carrying on business of infrastructure development, generation of power, telecommunication services, etc. as listed in section 80IA(4), for which 100% deduction is given u/s.80IA. Section 80IA(8) provides that transfer of goods or services between eligible business under-taking and other undertakings of the assessee shall be at market value. Now, it is provided that such transfers should be made at arm’s-length price as defined by the provisions of section 92F(ii).

ii) Section 80IA(10):

This section provides that where it appears to the AO that, owing to the close connection between the assessee carrying on the eligible business and any other person, the course of business between them is so arranged that the profits of the eligible business for which 100% deduction is allowed u/s.80IA is shown at a figure higher than the ordinary profits in such business, the AO can recompute the profits of the eligible business for deduction u/s.80IA. The section is now amended to provide that, if the above arrangement between closely related parties involves specified domestic transactions, the AO shall compute the profit of the eligible business having regard to the arm’s-length price concept as defined in section 92F(ii).

iii) Other sections:

It may be noted that the provisions of section 80IA(8) and 80IA(10) apply to certain other sections of the Income-tax Act also. These sections provide for deduction of income derived from various specified activities. In respect of transactions with related parties for claiming deduction from income, the above concept of arm’s-length price as applicable to specified domestic transactions will apply.

10.6 Since the concept of arm’s-length price is now extended to section 80IA(8) and 80IA(10), this concept will apply to transactions between related parties in computing income under the following sections:

Section 10AA: Income from newly established units in SEZ.

Section 80IAB: Income of an undertaking or enterprise engaged in the development of SEZ.

Section 80IB: Income from certain industrial undertakings and housing projects, etc. (other than infrastructure development undertakings).

Section 80IC: Income from certain undertakings set up in certain States such as Sikkim, Himachal Pradesh, Uttarakhand, North-Eastern States, etc.

Section 80ID: Income from hotels and convention centres set up in National Capital Territory of Delhi, and Districts of Faridabad, Gurgaon, Gautam Buddhha Nagar and Ghaziabad and other specified districts having ‘World Heritage
Site’.

Section 80IE: Income from eligible business undertakings in North-Eastern States.

10.7 Other transactions:

The CBDT has been given power to prescribe, by Rules, other domestic transactions to which the above provisions will apply.

10.8 Effect of application of arm’s-length price concept:

As stated above, the concept of arm’s-length price (ALP) is now to be applied to certain domestic trans-actions. In view of this, the assessee who enters into specified domestic transactions will have to comply with the following sections w.e.f. A.Y. 2013-14.

i) Section 92: This section deals with computation of income from international transactions. It is now extended, w.e.f. A.Y. 2013-14, to specified domestic transactions. Therefore, the concept of ALP which was applicable to international transactions up to now will now apply to specified domestic transactions also. S.s (2A) inserted in this section now provides that any allowance for an expenditure or interest or allocation of any cost, expense or income in relation to specified domestic transactions shall be computed having regard to the ALP.

ii) Section 92C: This section deals with computa-tion of ALP in relation to international transactions. As stated above, this concept is now extended to specified domestic transactions. The section pro-vides for six alternate methods for determination of ALP.

iii) Section 92CA: This section provides for reference by AO to the Transfer Pricing Officer (TPO). Such reference is to be made if the aggregate value of international transactions exceed Rs.5 cr. The TPO is given wide powers. The order passed by the TPO is binding on the AO and the AO has to complete the assessment in conformity with the order of the TPO. This section has now been amended and it is now provided that such reference is to be made by the AO to the TPO even in cases where the assessee has entered into specified domestic transactions. Since section 92BA states that transactions with related parties aggregating Rs.5 Cr. or more will be considered as specified domestic transactions, all cases in which these transactions are involved will have to be referred to the TPO.

iv) Section 92D: This section provides for maintenance and keeping of information and documents by persons entering into international transactions. This section is made applicable to specified domestic transactions. Therefore, all assessees who enter into specified domestic transactions, as stated above, will have to maintain the information and documents specified in this section. It may be noted that these records and documents will have to be maintained w.e.f. 1-4-2012, in the manner prescribed in Rule 10D.

v) Section 92E: This section requires that an as-sessee entering into international transactions has to obtain report from a Chartered Accountant in the prescribed form No. 3CEB before the due date for filing the return of income. This requirement is now extended to specified domestic transactions from the A.Y. 2013-14 (Accounting Year 1-4-2012 to 31-3-2013).

vi) Section 92F: This section gives definition of certain terms. The following definitions are relevant in the context of specified domestic transactions.

a. ‘Arm’s-length price’: This term means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.

b. ‘Transaction’: This term includes an arrangement, understanding or action in concert, whether or not it is formal or in writing or whether or not it is intended to be enforceable by legal proceedings.

vii) Penalty u/s.271 and 271AA: By amendment of Explanation 7 of section 271, it is now provided that penalty under that section will be leviable in respect of amount disallowed out of the above specified domestic transactions u/s.92C(4). Similarly, penalt 2% of the amount can also be levied u/s.271AA for not maintaining records u/s.92D or not reporting such transactions u/s.92E or furnishing incorrect information.

11. Taxation of non-residents:

Some of the sections dealing with taxation of non-residents have been amended with retrospective effect. These amendments will have far reaching effect. While presenting the Budget the Finance Minister has not made any mention about these far -reaching changes affecting non-residents in his Budget Speech. However, in the Explanatory Memorandum attached to the Finance Bill, 2012, the reasons for these retrospective amendments have been explained.

The effect of these amendments with retrospective effect will be that cases of many assesses may be reopened and they may be required to pay tax, interest or penalty for last 16 years. It appears that these amendments provide for taxing gain on sale of shares in foreign countries and therefore, the time limit of 16 years for reopening the assessments will apply to such transactions. It is, therefore, necessary that a specific provision should have been made that no interest or penalty will be payable if tax levied as a result this retrospective amendment is paid by the assessee. It may be noted that when sections 28 and 80HHC were amended by the Taxation Laws (amendment) Act, 2005, with retrospective effect, CBDT issued a Circular No. 2/2005 on 17-1-2006. In this Circular the tax authorities were directed not to levy any interest or penalty if tax levied due to these retrospective amendments was paid. The Circular also provided that the tax due as a result of the retrospective amendment can be paid in five equal yearly instalments. No interest was payable on such instalments. Let us hope that the CBDT issues similar Circular in respect of the tax payable as a result of these retrospective amendments made by the Finance Act, 2012.

11.3 Section 2(14):

This section defines that term ‘Capital asset’ to mean ‘Property’ of any kind held by an assessee, whether or not connected with his business or profession. However, assets in the nature of stock-in-trade, personal effects, agricultural land, etc. are excluded from this definition. Now, Explanation has been added w.e.f. 1-4-1962 to clarify that ‘property’ shall include and shall be deemed to have always included any rights in or in relation to an Indian company, including right of management or control or any other rights. This will mean that the term, ‘Capital asset’ shall now include a tangible as well as intangible property.

11.4 Section 2(47):

This section defines the word ‘Transfer’ in relation to a capital asset. This is an inclusive definition and includes transfer of a capital asset by way of sale, exchange, relinquishment, or extinguishment of rights in the asset, compulsory acquisition of the asset, etc. Now a new Explanation is added w.e.f. 1-4-1962 to clarify that the word ‘Transfer’ shall include, and shall be deemed to have always included, disposing of, parting with an asset or any interest therein, or creating any interest in any asset, directly, indirectly, absolutely, conditionally, voluntarily or involuntarily. Such transfer may be by agreement made in India or outside India. This is irrespective of the fact that such transfer has been characterised as being effected, dependent upon or following from the transfer of shares of an Indian or foreign company. This will show that if any interest is created in the shares of an Indian or foreign company by agreement or even an action, it will be considered as a ‘transfer’ of capital asset u/s.2(47).

11.5 Section 9:

This section explains when income is deemed to ac-crue or arise in India in the case of a non-resident. The scope of this section is widened by addition of Explanation 4 and 5 below section 9(1)(i) w.e.f. 1-4-1962 as under:

i) In section 9(1)(i) it is stated that any income shall be deemed to accrue or arise if it accrues or arises, directly or indirectly ‘Through’ or ‘From’ (a) any business connection in India, (b) any property in India (c) any asset or source of Income in India or (d) the transfer of a capital asset situated in India. Now, it is clarified in Explanation 4 that the word ‘Through’ in the above section shall mean and include (w.e.f. 1-4 -1962) — ‘by means of’, ‘in consequence of’ or ‘by reason of’. This explanation appears to have been introduced with retrospective effect to counter the decision of the Supreme Court in ‘Vodafone’ case which was against the Income-tax Department.

ii) Similarly, Explanation 5 clarifies with retrospective effect from 1-4-1962 that an asset or capital asset being any share or interest in a foreign company shall be deemed to be situated in India if such share or interest derives, directly or indirectly, its value substantially from the assets located in India. It may be noted that the concept of holding interest in substantial value of assets located in India has not been explained or defined in this Explanation. This concept is explained in various other sections in the Income tax in different manner. This will be evident from reference to substantial interest in the following sections.

a. Section 2(32): While defining ‘person having substantial interest in the company’ it is stated that if a person holds 20% or more of voting power it is considered as substantial interest.

b. Section 40A(2): Under this section the provisions of transfer pricing are now made applicable in respect of domestic transactions. In the definition of related party, the concept of substantial interest in a company is to be determined by applying the test of 20% or more voting power.

c. Section 79: For carry forward and set-off of losses of a closely held company, the concept of holding at least 50% holding of shares by shareholders who were shareholders on the last day of the year in which loss was incurred has been provided.

In view of the above, for determination of the tax liability on transfer of shares in a foreign company the concept of holding substantial interest in the value of assets located in India should have been clearly defined. Further, the section refers to share on interest in a foreign company which derives (directly or indirectly) its value substantially from the assets located in India. The word ‘value’ is also required to be defined otherwise there will be confusion as to whether the word ‘value’ refers to ‘book value’ or ‘market value’.

11.6 Section 9(1)(vi) — Royalty:

This Section provides that income by way of royalty earned by a non-resident is deemed to be income accruing or arising in India under the circumstances explained in this section. The concept of royalty for this purpose is now expanded, with retrospective effect from 1-6-1976 as under:

i) New Explanation 4 is now added to provide that the transfer of any rights in respect of any right, property or information includes all or any right for use or right to use computer software (including granting of a licence) irrespective of the medium through which such right is transferred.

ii) New Explanation 5 now provides that ‘Royalty’ includes consideration in respect of any right, prop-erty or information, whether or not (a) the posses-sion or control of such right, etc. is with the payer such right, etc. is used directly by the payer, or the location of such right, etc. is in India.

iii) New Explanation 6 now provides that the expression ‘Process’ used in section 9(1)(vi), in-cludes transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic-fiber or by any other similar technology. This is irrespective of the fact whether such process is a secret process or otherwise. It ap-pears that this provision has been made to over rule the decision of the Delhi High Court in the case of Aasia Satellite Telecommunication Co. Ltd. v. DIT, 332 ITR 340 (Del.).

The above amendments with retrospective effect from 1-6-1976 will create lot of practical difficulties. It is possible that the Tax Department may consider part of purchase consideration for software paid to a non-resident as royalty payment. This amendment, read with amendment of section 195, with retrospective effect from 1-4-1962, will create greater hardship to tax payers, as it will be impossible to comply with TDS provisions in respect of such payments made to non-residents in earlier years. It is also possible that the AO may invoke provisions of section 40(a)(i) and disallow such payment made to non-residential and claimed as revenue expenditure by the assessee in the earlier years.

It may, however, be noted that if any such payment is made to a non- resident in a country with which there is DTAA, the provisions in DTAA, if favourable, will apply in preference to the above provision.

11.7 Sections 90 and 90A:

Section 90 empowers the Central Government to enter into agreements with any foreign country or a specified territory for Double Taxation Relief (DTAA). Section 90A empowers the Government to enter into similar agreements with certain specified/ notified association in specified territories. Both these sections are amended as under:

i) New s.s (2A) is inserted w.e.f. 1-4-2013 (A.Y. 2013-14) in section 90 to provide that the provisions of new sections 95 to 102 dealing with General Anti-Avoidance Rule (GAAR) will be applicable even if the provisions of DTAA are more favourable to the assessee. In other words, where GAAR is invoked, the assessee cannot seek protection of beneficial provisions of DTAA. Similar amendment is made in section 90A also.

ii) New s.s (4) is inserted in section 90 w.e.f. 1-4-2013 (A.Y. 2013-2014) to provide that a non-resident cannot claim benefit of DTAA unless a certificate in the Form prescribed by the CBDT is obtained from the foreign country with which the Indian Govern-ment has entered into the DTAA. In this certificate such foreign country will have to certify the place of residence of the non-resident and such other particulars which the Indian Tax Department may require to decide whether the benefit claimed under a particular DTAA is available to the non-resident assessee. Similar amendment is made in section 90A.

iii) New Explanation 3 is inserted in section 90 w.e.f. 1-10-2009 to provide that any meaning as-signed through Notification u/s.90(3) to a term used in DTAA shall be effective from the date of coming into force of the applicable DTAA. Similar amend-ment is made in section 90A w.e.f. 1-6-2006.

11.8 Section 195:

This section provides for deduction of tax at source (TDS) in the case of payments made to non-residents. This section is now amended with retro-spective effect from 1-4-1962. By this amendment it is provided in the new Explanation-2 that the obligation to comply with TDS provisions will apply, with retrospective effect, to all persons whether resident or non-resident. So far section 195 was understood to put the obligation for TDS on residents and non-residents who have a permanent establishment in India and who make payments to non-residents of Income taxable under the Income-tax Act. Now, w.e.f. 1-4-1962, the obligation is extended to a non-resident person who has (a) residence or place of business or business connection in India, or (b) any other presence in any manner whatsoever in India. It may be noted that the obligation for deducting tax at source (TDS) is never made under Chapter XVII of the Income-tax Act (sections 192 to 194, 194A to 194CC and 195) with retrospective effect. All these provisions for TDS, whenever introduced or amended, are from prospective dates to enable the payer to comply with the same. Even in the Finance Act, 2012, such provisions for TDS or amendments are made in sections 193, 194E, 194J, 194LA, 194LC and 195(7) only w.e.f. 1-7-2012. However, only Explanation 2 has been inserted in section 195(1) with retrospective effect from 1-4-1962. By putting such obligation to deduct tax on certain non-residents who were not covered by the section earlier will create practical difficulties for them. It may not be possible to deduct tax from payments covered by section 195 for earlier years and they may be saddled with huge Interest liabilities and other penal conse-quences under the Income-tax Act. TDS provisions in Chapter XVII puts an obligation on the payer of any amount to collect tax due by the payee and pay to the Government. This obligation is in the nature of vicarious liability. It is a well-settled principle of law that such vicarious liability cannot be saddled on a person with retrospective effect.

ii) New s.s (7) has been inserted in section 195 w.e.f. 1-7-2012. By this amendment it is provided that the CBDT may, by Notification specify a class of persons or cases where the person responsible for paying to a non-resident, any sum, whether, chargeable to tax or not, can make an application to the AO to determine the appropriate proportion of sum chargeable to tax. On such determination tax will be deductible u/s.195(1) on that portion of the amount. Such determination by the AO may be by a general order applicable to all similar payments or may be specific order applicable to one specific transaction.

11.9 Section 163:

This section provides for liability of an ‘Agent’ of a non-resident to pay the tax or meet with obligations of a non-resident for whom he is recognised as an agent under this section. For this purpose an employee of the non-resident, (b) a person who has any business connection with the non-resident, (c) a person from or through whom the non-resident receives any income, (d) a person who is the trustee of the non-resident or (e) a person (resident or non-resident) who has acquired by way of transfer a capital asset in India. The section provides for certain limitations on the vicarious li-ability of the agent. Section 149 provides that AO has to give notice to the person whom he wants to treat as agent of a non-resident. The time limit for giving such notice was 2 years from the end of the assessment year for which he wants to treat that person as agent u/s.163. This time limit is now extended to 4 years w.e.f. 1-7-2012. It is also pro-vided, by this amendment, that such notice can be given for any assessment year prior to A.Y. 2012-13. In other words, the AO can give such notice to any person to treat him as agent of a non-resident in respect of income assessable in the case of a non-resident for A.Y. 2008-09, after 1-7-2012 but before 31-3-2013. This amendment appears to have been made to recover tax from Vodafone by treating it as agent of the non-resident company in respect of capital gain alleged to have been made on transfer of shares of a non-resident company to another non-resident company. This tax is now proposed to be levied in respect of such transactions as a result of retrospective amendments of sections 2(14), 2(47), 9 and 195 as discussed above.

11.10 Section 119 of the Finance Act, 2012:

This section provides for validation of demands raised under the Income-tax Act in certain cases in respect of income accruing or arising, through or from a transfer of capital asset situated in India, in consequence of the transfer of shares of a foreign company or in consequence of an agreement or otherwise in a foreign country. This section also states that any notice sent or taxes levied, demanded, assessed, imposed, collected or recovered during any period prior to 1-4 -2012 shall be deemed to have been validly made. Such notice or levy of tax, etc. shall not be called in question on the ground that the tax was not chargeable. This cannot be challenged even on the ground that it is a tax on capital gains arising out of transactions which have taken place in a foreign country. This section will operate notwithstanding anything contained in any judgment, decree or order of any Court, Tribunal or any Authority. It appears that this section is inserted in the Finance Act to ensure that taxes collected in the Vodafone case or other similar cases are not required to be refunded. A question may arise about validity of such a provision for retention of taxes collected from certain assesses by the Govern-ment when any Court judgment or decree directs that such tax should be refunded to the assessee. Another question will arise whether the Government will be liable to pay interest on such amount retained under the validation provision if ultimately the Government has to refund the amount after some years of litigation.

11.11 Section 115A:

This section is amended with effect from 1-7-2012. It is provided that the rate at which Income tax shall be payable in the case of a non-resident, other than a foreign company, in respect of interest received from an Indian company engaged in specified in-frastructure activities, in respect of loan given in foreign currency under an agreement approved by the Government between 1-7-2012 to 30-6-2015, shall be taxable @ 5%. This tax shall be subject to deduction at source u/s.194LC w.e.f. 1-7-2012.

11.12 Section 115BBA:

This section is amended effective from A.Y. 2013-14 to provide that a non-resident, entertainer, such as a theatre, radio, television artist and musician, from performance in India will be taxable at 20% of gross receipts. It is also provided that in the case of a non-resident sports association, tax will be payable at 20% of gross receipts instead of 10% which is the existing rate. Consequential amendments have also been made for the purpose of TDS on these payments u/s.194E w.e.f. 1-7-2012.

11.13 Tax on long-term capital gain:

Section 112 has been amended from A.Y. 2013 -14 to provide that, in the case of a non -resident or a foreign company, capital gains tax payable on transfer of a long-term capital asset, being shares or securities which are not listed on the Stock Ex-change shall be 10%. For this purpose the long-term capital gain is to be computed without indexation or without taking advantage of foreign currency rate differences provided in section 48.

12. Transfer pricing provisions:

In order to widen the scope of transfer pricing pro-visions and to clarify certain issues, the following sections are amended. Some of these amendments have retrospective effect.

12.1 Section 92B:

This section gives the meaning of ‘International Transaction’. This section is now amended with retrospective effect from 1-4-2002. By this amendment, it is provided that the expression ‘International Transaction’ shall include —

i) the purchase, sale, transfer, lease or use of tangible property, including building, transportation vehicle, machinery, equipment, tools, plant, furniture, commodity and any other article or thing.

ii) the purchase, sale, transfer, lease or use of intangible property, including transfer of owner-ship or the provision for use of rights regarding land, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any business or commercial rights of similar nature.

iii) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment receivable or any other debt arising during the course of business.

iv) provision of services, including provision of mar-ket research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service.

v) a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has a bearing on the profit, income, losses, or assets of such enterprise at the time of the transaction or at future date.

Further, the expression ‘Intangible Property’ has also been defined w.e.f. 1-4-2002 to include 12 items listed in the amended section. This refers to various types of intangible properties related to marketing, technology, artistic, data processing, engineering, customer, control, human capital, location, goodwill and similar items which derive their value from intellectual content rather than physical attributes.

12.2 Section 92C:

i) This section deals with computation of arm’s-length price. In section 92C(1) six methods are provided for determination of ALP. Section 92C(2) states that the most appropriate method for this purpose shall be determined as provided in the Rules 10B and 10C framed by the CBDT. The second proviso to this section is now amended w.e.f. A.Y. 2013-14 to provide that if the variation between the ALP determined under the section and the price at which the international transaction has actually been undertaken does not exceed such percentage not exceeding 3% of the latter, as may be notified by the Government. Earlier this margin was ±5% which has now been restricted to ±3%.

ii) Further, section 92C is amended by insertion of s.s (2A) with retrospective effect from 1-4-2002. The amendment is stated to be of a clarificatory nature. The effect of this amendment is that, in respect of first proviso to section 92C(2), as it stood before its substitution by the Finance (No. 2) Act, 2009, the tolerance band of 5% is not to be taken as a standard deduction while computing ALP. However, it is also clarified that already concluded assessment proceedings should not be a reopened or rectified on the ground of retrospective amendment.

iii) Section 92C(2) is also amended with retrospective effect from 1-10-2009. This amendment clarifies that the second proviso to section 92C(2) shall also be applicable to all proceedings which were pending as on 1-10-2009 i.e., the date on which the second proviso, as inserted by the Finance (No. 2) Act, 2009, came into force.

iv) It may be noted that, as stated above, section 92C now applies to specified domestic transactions also from A.Y. 2013-14.

12.3 Section 92CA:

i) This section deals with reference by the AO to the Transfer Pricing Officer (TPO) in specified cases involving Transfer Pricing issues. S.s (2B) has now been inserted with retrospective effect from 1-6- 2002. It is provided by this amendment that if the assessee has not furnished the audit report u/s.92E in respect of an international transaction and such transaction comes to the notice of the TPO, during the course of proceedings before him, it will be possible for the TPO to consider this transaction as if it has been referred to him by the AO It is also provided in new sub-section (2C) that the AO shall not have power to reopen or rectify any assessment proceedings which have been completed before 1-7-2012.

ii) As stated above, this section is now applicable to specified domestic transactions from A.Y. 2013-14. This will mean that assesses who have entered into specified domestic transaction exceeding Rs.5 Cr. in the accounting year 2012-13 onwards will have to appear before the AO as well as the TPO.

13. Advance Pricing Agreement:

Advance Pricing Agreement (APA) mechanism is introduced by new sections 92CC and 92CD inserted in the Income-tax Act, w.e.f. 1-7-2012. This provision is similar to Clause 118 of the DTC Bill, 2010. This provision is introduced to provide certainty to the international transactions and will reduce litigation relating to transfer pricing issues. Section 92CC gives power to the CBDT to enter into an APA, with any person, determining arm’s-length price.

13.1 In brief, the provisions of section 92CC are as under:

i) The CBDT, with the approval of the Central Government, can enter into an APA with any person (assessee) determining the arm’s-length price or specifying the manner in which such ALP is to be determined. This APA will relate to an international transaction to be entered into by that person.

ii) The manner in which ALP is to be determined in the above APA may include any of the methods referred to in section 92C(1) or any other method, with such adjustments or variations, as the assessee and the CBDT agree upon.

iii) Once APA is entered into by the CBDT with the assessee, the ALP for the international transaction, stated in APA, will be determined on that basis and the AO cannot invoke the provisions of sections 92C and 92CA.

iv) APA referred to above shall be valid for such period not exceeding 5 years as specified in the APA.

v) The above APA shall be binding on (a) the person in whose case and in respect of the transaction stated in the APA and (b) the Income tax Authorities in respect of the party to the APA for the transaction specified therein.

vi) The above APA shall not be binding if there is change in the law or facts relating to the APA.

vii) The CBDT, with the approval of the Govern-ment, can declare the APA as void abinitio, if it finds that the APA has been obtained by the assessee by fraud or misrepresentation of facts.

viii) If the APA is declared as void by the CBDT, all the provisions of the Act shall apply as if such agreement was not entered into. For the purpose of taking any action against the assessee, in view of the cancellation of APA, the period from the date of the APA to the date of its cancellation will not be counted for determining the limitation period.

ix) The CBDT will prescribe a scheme for the pro-cedure to be followed for entering into the APA.

13.2 The effect of the APA entered into by an as-sessee is explained in the new section 92CD as under:

i) Where APA has been entered into by an assessee, the Income-tax return which pertains to a previous year covered under the above agreement and is already filed, the assessee has to file a modified return of income u/s.139 in accordance with and limited to the APA. This modified return has to be filed within 3 months from the end of the month in which APA is entered into.

ii) Once the modified return of income is filed, the AO will have to assess, reassess or recompute the income, irrespective of the fact whether the assessment/reassessment proceedings are over or not, in accordance with the APA.

iii) Where the assessment proceedings are completed, the reassessment proceedings are to be completed within one year from the end of the financial year in which modified return of income is filed. If the assessment proceedings are pending, the period of limitation for completion of these proceedings will be extended by 12 months.

13.3 Considering the wording of sections 92CC and 92CD and the intention of the legislation, it will be possible for any assessee, who has already entered into international transactions in the earlier years, to approach the CBDT after 1-7-2012 to enter into APA in respect of such transactions already entered into in the past. This will enable the assessee to apply to the AO that the pending assessments may be completed on the basis of APA. It appears that even if any appeals are pending for any of the earlier years, the assessee will be entitled to withdraw the appeals and approach the AO to make reassessment or recomputation of income for those years in ac-cordance with APA. For this purpose, the assessee should ensure that the APA covers all the earlier years for which disputes are pending.

13.4 Since the transfer pricing provisions have now been extended to ‘Specified Domestic Transactions’ also, it will be in the interest of the assessee and the Tax Department that the above provisions for Advance Pricing Agreement are extended to ‘Specified Domestic Transactions’ also. This will reduce litigation on the question of determination of arm’s-length pricing issues which will arise in relation to such domestic transactions.

14. General Anti-Avoidance Rule (GAAR):

14.1 This is a new concept introduced in the Income-tax Act by the Finance Act, 2012. Very wide powers are given to the Tax Authorities by these provisions. In new Chapter X-A, sections 95 to 102 have been inserted. In para 154 of the Budget Speech, while introducing the Finance Bill, 2012, the Finance Minister has stated that “I propose to introduce a General Anti-Avoidance Rule (GAAR) in order to counter aggressive tax avoidance schemes, while ensuring that it is used only in appropriate cases, enabling review by a GAAR panel.

14.2 The reasons for introducing GAAR provisions in the Income-tax Act are explained in the Explanatory Notes attached to the Finance Bill, 2012.

14.3 There was large-scale opposition to the introduction of this provision in the form suggested in the Finance Bill, 2012, and the DTC Bill, 2010, pending consideration of the Parliament. This opposition was voiced by various trade and industry bodies in India and abroad. The Finance Minister responded to the various suggestions made by members of the Parliament and various trade and industry bodies while replying to the debate in the Parliament on 7th May 2012.

14.4 GAAR provisions:

For the reasons stated by the Finance Minister, special provisions relating to GAAR have been made in sections 95 to 102 in the Income-tax Act from A.Y. 2014-15 (Accounting Year ending 31-3-2014) and onwards. These provisions apply to all assesses (residents or non-resident) in respect of their transactions in India as well as abroad. Very wide powers are given to the tax authorities to disregard any agreement, arrangement or any claim for expenditure, deduction or relief. These provisions, broadly stated are discussed below.

14.5 Section 95:

This section provides that an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement. The tax arising from such declaration by the tax authorities, will be determined subject to provisions of sections 96 to 102. It is also stated in this section that the provisions of sections 96 to 102 may be applied to any step, or a part of the arrangement as they are applicable to the entire arrangement.

14.6 Impermissible Avoidance Arrangement (section 96):

i) Section 96 explains the meaning of Impermissible Avoidance Arrangement to mean an arrangement, the main purpose or one of the main purposes of which is to obtain a tax benefit and it —

a. Creates rights or obligations which would not ordinarily be created between persons dealing at arm’s length.

b. Results, directly or indirectly, in misuse or abuse of the provisions of the Income-tax Act.

c. Lacks commercial substance, or is deemed to lack commercial substance u/s.97, or

d. is entered into or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

ii) The Finance Bill, 2012, provided in the section that an arrangement whereby there is any tax benefit to the assessee shall be presumed to have been entered into or carried out for the main purpose of obtaining tax benefits, unless the assessee proved otherwise. It will be noticed that this was a very heavy burden cast on the assessee. However, this requirement has now been deleted and, as declared by the Finance Minister, the onus of proof is now on the Department who has to establish that the arrangement is to avoid tax before initiating the proceedings under these provisions.

14.7 Lack of commercial substance (section 97):

i) Section 97 explains the concept of lack of com-mercial substance in an arrangement entered into by the assessee. It states that an arrangement shall be deemed to lack commercial substance if —

a) The substance or effect of the arrangement, as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part of such steps.

b) It involves or includes

— Round-trip financing
— An accommodation party,
— Elements that have the effect of offsetting or canceling each other, or
— A transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction, or

c) It involves the location of an asset or a transaction or the place of residence of any party which is without any substantial commercial purpose. In other words, the particular location is disclosed only to obtain tax benefit for a party.

ii) For the above purpose, it is provided that round-trip financing includes any arrangement in which through a series of transactions —

a) Funds are transferred among the parties to the arrangement, and
b) Such transactions do not have any substantial commercial purpose other than obtaining tax benefit.

iii) It is further stated that the above view will be taken by the Tax Authorities without having regard to the following.

a) Whether or not the funds involved in the round-trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement,

b) The time or sequence in which the funds involved in the round trip financing are transferred or received, or

c) The means by, manner in, or mode through which funds involved in the round-trip financing are transferred or received.

iv) The party to such an arrangement shall be treated as ‘Accommodating Party’ whether or not such party is connected with the other parties to the arrangement, if the main purpose of, direct or indirect, participation of such party with the arrangement is to obtain, direct or indirect, tax benefit under the Income-tax Act.

v) It is clarified in the section that the following factor shall not be taken into consideration for determining whether there is commercial substance in the arrangement:

   a. The period or time for which the arrangement exists.
   b. The fact of payment of taxes, directly or indirectly, under the arrangement.
   c. The fact that an exist route, including transfer of any activity, business or operations, is provided by the arrangement.

14.8    Consequence of impermissible avoidance arrangement (section 98):

Under the newly inserted section 144BA, the Commissioner has been empowered to declare any arrangement as an impermissible avoidance arrangement. Section 98 states that if any arrangement is declared as impermissible, then the consequences, in relation to tax or the arrangement shall be determined in such manner as is deemed appropriate in the circumstances of the case. This will include denial of tax benefit or any benefit under applicable DTAA. The following is the illustrative list of conse-quences and it is provided that the same will not be limited to the list:

i) Disregarding, combining or re-characterising any step in, or part or whole of the impermissible avoidance arrangement;

ii) Treating, the impermissible avoidance arrangement as if it had not been entered into or carried out;

iii) Disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;

iv) Deeming persons who are connected persons in relation to each other to be one and the same person;

v) Re-allocating between the parties to the ar-rangement, (a) any accrual or receipt of a capital or revenue nature or (b) any expenditure, deduction, relief or rebate;

vi) Treating (a) the place of residence of any party to the arrangement or (b) situs of an asset or of a transaction at a place other than the place or location of the transaction stated under the arrangement.

vii) Considering or looking thorough any arrangement by disregarding any corporate structure.

viii ) It is also clarified that for the above purpose that Tax Authorities may re-characterise (a) any equity into debt or any debt into equity, (b) any accrual or receipt of capital nature may be treated as of revenue nature or vice versa or (c) any expenditure, deduction, relief or rebate may be re-characterised.

14.9 Section 99:

This section provides for treatment of connected person and accommodating party. The section provides that for the purposes of sections 95 to 102, for determining whether a tax benefit exists —

i)The parties who are connected person, in relation to each other, may be treated as one and the same person.

ii) Any accommodating party may be disregarded.

iii) Such accommodating party and any other party may be treated as one and the same person.

iv) The arrangement may be considered or looked through by disregarding any corporate structure.

14.10 It is further provided in section 100 that the provisions of sections 95 to 102 shall apply in addition to, or in lieu of, any other basis for determination of tax liability. Section 101 gives power to the CBDT to prescribe the guidelines and lay down conditions for application of sections 95 to 102 relating to the General Anti-Avoidance Rules (GAAR). Let us hope that these guidelines will specify the type of arrangements and transactions in relation to which alone the Tax Authorities have to invoke the provision of GAAR. Further, it is necessary to specify that if the tax benefit sought to be obtained by any arrangement is say Rs.5 crore or more in a year, then only the Tax Authorities will invoke these powers.

14.11 Section 102:

This section defines words or expressions used in sections 95 to 102 as stated above.

14.12 Section 144BA:

Procedure for declaring an arrangement as impress-ible u/s.95 to u/s.102 is given in this section. This section will come into force from A.Y. 2014-15.

i) The Assessing Officer can make a reference to the Commissioner for invoking GAAR and on re-ceipt of reference the Commissioner shall hear the taxpayer. If he is not satisfied by the submissions of taxpayer and is of the opinion that GAAR provi-sions are to be invoked, he has to refer the matter to an ‘Approving Panel’. In case the assessee does not object or reply, the Commissioner shall make determination as to whether the arrangement is an impermissible avoidance arrangement or not.

ii) The Approving Panel has to dispose of the ref-erence within a period of six months from the end of the month in which the reference was received from the Commissioner.

iii) The Approving Panel shall either declare an arrangement to be impermissible or declare it not to be so after examining material and getting further inquiry to be made. It can issue such directions as it thinks fit. It can also decide the year or years for which such an arrangement will be considered as impermissible. It has to give hearing to the assessee before taking any decision in the matter.

iv) The Assessing Officer will determine conse-quences of such a positive declaration of arrangement as impermissible avoidance arrangement.

v) The final order, in case any consequences of GAAR is determined, shall be passed by the AO only after approval by the Commissioner and, thereafter, first appeal against such order shall lie to the Ap-pellate Tribunal.

vi) The period taken by the proceedings before the Commissioner and the Approving Panel shall be excluded from time limitation for completion of assessment.

vii) The CBDT has to constitute an ‘Approving Panel’ consisting of not less than three members. Out of these three members, two members shall be of the rank of Commissioners of Income-tax and one member shall be an officer of the Indian Legal Service of the rank of Joint Secretary or above to the Central Government. It is not clear from these provisions whether the CBDT will appoint only one Approving Panel for the whole of the country or there will be separate Panels in each State. Considering the work load and considering the convenience of the assessees it is necessary to have one such Panel in each State.

viii) In addition to the above, it is provided that the CBDT has to prescribe a scheme for efficient functioning of the Approving Panel and expeditious disposal of the references made to it.

ix) Appeal against order of assessment passed under the GAAR provisions after approval by the appropriate authority is to be filed directly with the ITA Tribunal and not before the CIT(A). Section 144C relating to reference before DRT does not apply to this assessment order and, therefore, no reference can be made to DRT when GAAR provisions are invoked.

14.13 The above GAAR provisions will have far-reaching consequences for assessees engaged in the business with Indian or foreign parties. GAAR is not restricted to only business transactions. Therefore, all other assessees who are engaged in business or profession or who have no income from business or profession will be affected by these provisions. It appears that any assessee having any arrangement, agreement, or transaction with an associated person will have to take care that the same is at arm’s-length consideration. In particular, an assessee will have to consider the implications of GAAR while (a) executing a will or trust, (b) entering into partner-ship or forming LLP, (c) taking controlling interest in a company, (d) carrying out amalgamation of two or more companies, (e) effecting demerger of a company, (f) entering into a consortium or joint venture, (g) entering into foreign collaboration, or acquiring an Indian or foreign company. It may be noted that this is only an illustrative list and there may be other transactions which may attract GAAR provisions.

14.14 From the wording of the above provisions of sections 95 to 102 and 144BA it appears that the provisions of GAAR can be invoked in respect of an arrangement made prior to 1-4-2013. The CIT or the Approving Panel can hold any such arrangement entered into prior to 1-4-2013 as impermissible and direct the AO to make adjustments in the computation of income or tax in the A.Y. 2014-15 or any year thereafter. As stated in para 15.15 of the report of the Standing Committee on Finance on the DTC Bill, 2010, it would be fair to apply GAAR provisions prospectively, so that it is not made applicable to existing arrangements/transactions. It may be noted that no such provision is made in sections 95 to 102 and 144BA and, therefore, it can be presumed that the above GAAR provisions will have retroactive effect.

14.15 In section 101 it is stated that the CBDT will issue guidelines to provide for the circumstances under which GAAR should be invoked. Let us hope that these guidelines will specify that GAAR provisions will apply to all arrangements or transactions entered into after 1-4-2013 and also the type of arrangements or transactions to which GAAR will apply. It is also necessary to specify that GAAR provisions will be invoked if the tax sought to be avoided is more than Rs.5 crore, in any one year. This is also suggested by the Standing Committee on Finance in their report on the DTC Bill, 2010. As regards the procedure for invoking GAAR, section 144BA(4) provides that if the CIT agrees with the view of the AO to invoke GAAR, he should refer the matter to an Approving Panel. U/s.144BA(14) it is provided that the CBDT will appoint an Approving Panel consisting of two members of the level of Commissioners and one Law Officer. As suggested by the above Standing Committee in their report on the DTC Bill, 2010, such Panel should consist of a Chief Commissioner and two independent technical persons.

15. Assessment, reassessment and appeals:

15.1 Section 139 — Return of income:

i) This section is amended from A.Y. 2012-13 (Ac-counting Year ending 31-3-2012). The amendment now requires that a resident and ordinarily resident, who is otherwise not required to furnish a return of income, will be required to furnish his return of income before the due date for filing the return in the following cases:

a) If the person has any asset located outside India. This will mean that if the person owns any immovable property outside India, any shares in a foreign company, any bank account or other assets outside India, he will have to file return even if the total income is below the taxable limit.

b) If the person has any financial interest in any entity in a foreign country. This will mean that if the person is a beneficiary in any specific or any discretionary foreign trust, he will have to file his return of income whether he has received any benefit from the trust or not.

c)If the person has signing authority in any account located outside India.

ii) The above provision applies to a company, firm, individual, HUF or any non-corporate entity who is a resident and ordinarily resident. Such person will have to file return of income for the accounting year 1-4-2011 to 31-3-2012 (A.Y. 2012-13) and onwards. It may be noted that in a case where the person (whether resident or non-resident) has taxable income in India, he will have to give information about the above items in the form of return of income prescribed for A.Y. 2012-13.
iii) At present, the due date for furnishing the return of income in the case of an assessee, being a company is required to file Transfer Pricing Re-port u/s.92E, is 30th November. It is now provided that the extended time limit up to 30th November will apply to all assessees who are required to fileTransfer Pricing Report u/s.92E. This amendment will come into force from A.Y. 2012-13.

15.2 Section 143 — Procedure for assessment:

At present, the return is required to be processed u/s.143(1) even if the case is selected for scrutiny. The section is now amended, effective from 1-7-2012, to provide that if the case is selected for scrutiny, the AO is not required to process the return of income u/s.143(1). This will mean that if the person has claimed refund in the return of income and his case is taken up for scrutiny, the refund if due, will be issued only after completion of assessment u/s.143(3).

15.3 Section 144C — Reference to DRP:

i) This section is amended with retrospective effect from 1-10-2009. Under this section when the AO wants to make a variation in the income or loss, as a result of order passed by a Transfer Pricing Officer u/s.92CA(3), he has to pass a draft assessment order. If the assessee objects to the variation, he has to refer the matter to the Dispute Resolution Panel (DRP) u/s.144C. The DRP has power to confirm, reduce or enhance the assessment. There was a controversy as to whether this power of enhancement includes power to consider any other matter arising out of the assessment proceedings relating to the draft assessment order. To clarify this doubt, this section is now amended w.e.f. 1-10-2009 to provide that the DRP can consider any other mater relating to the draft assessment order while enhancing the variation. It may be noted that this amendment does not clarify whether the DRP can consider any other matter brought to its notice by the assessee which has the effect of reducing the income or increasing the loss.

ii) Further, it is also clarified that the enhance-ment in time limit for computation of assessment, provided in this section 144C(13), will apply to time limit provided u/s.153 as well as u/s.153B w.e.f. 1-10-2009.

iii) It may be noted that from A.Y. 2013-14, cases in which specified domestic transactions are there will now be referred to TPO. Therefore, the above procedure of making draft order and reference to
DRP will apply in such cases also.

15.4 Sections 147 and 149 — Reassessment of income:

These two sections dealing with income-escaping assessment and time limit for reopening assessment have been amended w.e.f. 1-7-2012. These amendments will apply to any assessment year beginning on or before 1-4-2012. The effect of these amendments is as shown in Table on the next page.

i) At present, the time limit for reopening assessments is 6 years. In a case where assessment is made u/s.143(3) and the income-escaping assessment is not due to failure of the assessee to disclose fully and truly all material facts necessary for assessment for that year, the time limit for reopening is 4 years. This time limit is now enhanced in specified cases.

ii) It is now provided that if the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment for any year, the time limit for reopening the assessment shall be 16 years. For this purpose, where a person is found to have any asset or any financial interest in any entity located outside India, shall be deemed to be a case where income chargeable to tax has escaped assessment. This provision will apply to a resident or a non-resident. In the coming years, this provision will have far-reaching implications.

iii) It is now provided that if a person has failed to furnish the Transfer Pricing Report u/s.92E in respect of any international transaction, income shall be deemed to have escaped assessment. In such a case the AO can send notice for reopening assessment within the prescribed period.

iv) Similar amendments are made in the Wealth Tax Act also.

v) Reading the above provisions, it appears that in a transaction similar to the case of the famous VODAFONE the assessments of a foreign company which has made taxable capital gains or other income can be reopened for 16 years instead of 6 years as in such cases some assets will be located outside India.

15.5 Sections 153 and 153B — Time limit for completion of assessments:

These sections are amended w.e.f. 1-7-2012. At present, the time limit for completion of assessment or reassessment proceedings is 21 months. In a case where reference is made to the Transfer Pricing Officer, the time limit for completion of assessment is 33 months. This time limit is extended as under:

15.6 Sections 153A and 153C — Assessment in case of search or requisition:

These sections are amended w.e.f. 1-7-2012. Sections 153A and 153C of the Act lay down the procedure for assessment/reassessment in case of search or requisition. Presently, the notice for filing of returns of income and assessment thereof has to be given for six assessment years preceding the previous year in which the search was conducted or requisi-tion made.

It is now provided that the Central Government can notify cases or class of cases where the Assessing Officer shall not be required to issue notice for initia-tion of assessment/reassessment proceedings for six preceding assessment years and proceedings may only be taken up for the assessment year relevant to the year of search or requisition.

15.7 Sections 154 and 156:

i) These sections have been amended w.e.f. 1-7-2012. A statement of tax deduction at source is processed u/s.200A and an intimation is sent to the deductor as provided u/s.200A(1). At present, there is no provision for rectification or appeal against the said intimation.

ii) It is now provided that any mistake apparent from the record in the intimation issued u/s.200A shall be rectifiable u/s.154. It is also provided that the intimation issued u/s.200A shall also be deemed to be a notice of demand u/s.156 and an appeal can be filed with the Commissioner of Income-tax (Appeals) u/s.246A.

iii) In actual practice there is considerable delay in passing order u/s.154 for rectification of mistake in any order passed by the AO It is, therefore, sug-gested that section 246A should be amended to provide that if rectification order is not passed by the AO within 6 months of filing such application the assessee will have a right to file appeal to the CIT(A). It may be noted that similar provision is made in clause 178 of the DTC Bill, 2010.

15.8 Section 245C — Settlement Commission:

Sections 245C dealing with application for settlement of cases has been amended w.e.f. 1-7-2012. At present, an application can be filed before the Settlement Commission u/s.245C by a related person who has substantial interest of more than 20% of the profits of the business at any time during the previous year. Now, it is provided that the substan-tial interest should exist on the date of search and not at any time during the previous year.

15.9 Section 245N: Authority for Advance Ruling (AAR)

This Section is amended w.e.f. 1-4-2013 (A.Y. 2013-14). By this amendment it is provided that an assessee can approach the AAR for determination or decision whether an arrangement which is proposed to be undertaken by any person (resident or non-resident) is an impermissible arrangement as provided in sections 95 to 102. This will enable the person enter-ing into an arrangement to get an Advance Ruling from AAR if he apprehends that the AO may invoke GAAR provisions during assessment proceedings. As suggested earlier, this provision should be made available to persons entering into specified domestic transactions u/s.92BA.

15.10 Section 245Q — Fees for filing application for Advance Ruling:

Fees for filing an application before the Authority for Advance Ruling is increased from Rs.2500 to Rs.10000 w.e.f. 1-7-2012. The CBDT is now given power to increase or reduce the amount of fees from time to time by prescribing the necessary rule for this purpose.

15.11 Section 246A — Appealable orders before CIT(A):

The list of orders against which appeals can be filed before the CIT(A) has now been expanded. Now appeals can be filed before the CIT(A) against the following orders:

i) The tax deductor can file appeal on after 1-7-2012 against the intimation issued u/s.200A relat-ing to short deduction of tax at source.

ii) The assessee can file appeal against the order passed by the AO u/s.153A in search cases if such order is not passed in pursuance of the directions of the DRP. This will be effective from 1-10-2009.

iii) The assessee can file appeal against the order of assessment or reassessment passed under new section 92CD(2) after furnishing the modified return based on the Advance Pricing Agreement as provided in the new section 92CC. This is effective from 1-7-2012.

iv) Penalty order passed under new section 271 AAB where search has been initiated. This is effec-tive from 1-7-2012.

15.12 Section 253 — Appeals before ITA Tribunal:

i) The following amendment is made w.e.f. 1-4-2013:

Any order passed by the AO u/s.143(3), 147, 153A or 153C in pursuance of the order passed by the CIT u/s.144BA(12) in accordance with the directions by the Approving Panel or the CIT, declaring any ar-rangement as impermissible avoidance arrangement, is appealable directly to the ITA Tribunal.

ii) The following amendments are made with reference to DRP cases:

a) The directions given by the DRP in the case of a foreign company or any person in whose case variation in the income arises due to order of the Transfer Pricing Officer are binding on the Assessing Officer. It is now provided that the Assessing Officer can also file an appeal before the ITA Tribunal against an order passed in pursuance of directions of the DRP in respect of objections filed on or after 1st July, 2012.

b) The Assessing Officer or the assessee is entitled to file memorandum of cross objections on receipt of notice that an appeal has been filed by the other party.

c) Any order passed u/s.153A or 153C in pursuance of directions of the DRP shall be directly appeal-able to the ITA Tribunal w.e.f. 1st October, 2009. Presently, such appeals are being filed with the Commissioner (Appeals).

15.13 Section 292CC — Authorisation and assessment in case of search or requisition:

This is a new section inserted w.e.f. 1-4-1976 to clarify the procedure for authorisation and assessment in certain cases of search or requisition. In the case of CIT v. Smt. Vandana Verma, 330 ITR 533 (All.) it was held that if search warrant is in the name of more than one person, then assessment cannot be made individually in the absence of any search warrant in the individual name. To overcome this judgment, it is now provided in this new section, with retrospective effect from 1-4-1976, that where a search warrant has been issued mentioning names of more than one persons, the assessment/reassessment can be made separately in the name of each of the persons mentioned in such search warrant.

16. Penalties and prosecution:

16.1 Section 234E — Fees for delay in furnishing TDS/TCS statement:

This is a new section which has been inserted w.e.f. 1-7-2012. At present, section 272A provides for penalty of Rs.100 per day for delay in furnishing TDS/TCS statement within the time prescribed in section 200(3) or 206C(3). Newly inserted section 234E now provides for levy of fees of Rs.200 for every day of the delay in furnishing TDS/TCS state-ments. However, the total fee shall not be more than the amount of tax deductible/collectable for the quarter for which the TDS/TCS statement is delayed. The fee is to be paid before the delivery of the TDS/TCS statements. Consequently levy or penalty provided in section 272A(2)(k) is deleted. However, new section 271H has been added to levy of penalty under certain circumstances as discussed in Para 16.5 below. It may be noted that no appeal against levy of fees payable u/s.234E is provided in section 246A.

16.2 Section 271 — Penalty for concealment — Amendment w.e.f. 1-4-2013:

The transfer pricing regulations are extended to specified domestic transactions entered into by domestic related parties. If any amount is added or disallowed, based on the arm’s- length price determined by the Assessing Officer, it is now provided that such addition/disallowance shall be deemed to represent the income in respect of which particulars have been concealed or inaccurate particulars have been furnished as provided in Explanation 7 to section 271(1) and it is liable to penalty accordingly.

16.3 Section 271AA — Penalty for failure to report, etc. of International and specified domestic transactions:

i) Amendment w.e.f. 1-7-2012

At present, there is no penalty for non-reporting of an international transaction in the report filed u/s.92E or maintaining or furnishing or incorrect information of documents.

Therefore, a levy of penalty at the rate of 2% of the value of the international transaction is provided, if the taxpayer

   a) fails to keep and maintain prescribed information and documents u/s.92D(1) or (2)
   b) fails to report any international transaction u/s.92E, or
   c) maintains or furnishes any incorrect information or documents.
   ii) Amendment w.e.f. 1-4-2013

The above provision for levy of penalty u/s.271AA will apply if there is failure to comply with the above requirements in the case of domestic transactions also from A.Y. 2013-14.

16.4 Section 271G — Penalty for failure to furnish information or documents u/s.92D — w.e.f. 1-4-2013:

At present, section 271G provides for levy of penalty at 2% of the value of transaction for failure to furnish information or documents u/s.92D which requires maintenance of certain information and documents in the prescribed proforma by the persons entering into an international transaction. This penal provision will now apply to persons entering into specified domestic transactions for such failure effective from A.Y. 2013-14.

16.5 Section 271H: Penalty for failure to furnish TDS/TCS statements:

This is a new section which has been inserted w.e.f. 1-7-2012. In addition to fees payable under the newly inserted section 234E, section 271H also provides for penalty for not furnishing quarterly TDS statements within the prescribed time limit or penalty for furnishing incorrect information such as PAN of the deductee or amount of TDS deducted, etc. in the statements to be filed u/s.200 (3) or 206C(3). A penalty ranging from Rs.10,000 to Rs.1,00,000 is leviable for these failures. No appeal against the levy of this penalty is provided u/s.246A.

It is also provided that no such penalty will be levied if the deductor delivers the statement within a year from the due date and the person has paid the tax along with fees and interest before delivering the statement.

16.6 Sections 271AAA and 271AAB — Penalty on undisclosed income found in the course of search:

i) At present, penalty in the case of search initiated on or after 1st June, 2007 is not liviable u/s.271AAA subject to certain conditions, such as:

   a) the assessee admits the undisclosed income in a statement u/s.132(4) recorded during the search,
   b) he specifies the manner in which such income has been derived, and
   c) he pays the tax together with interest, if any, in respect of such income.

Now, section 271AAA will not apply to search initi-ated on or after 1st July, 2012.

ii) Newly inserted section 271 AAB now provides for levy of penalty on undisclosed income of specified previous years where search has been initiated on or after 1st July, 2012 as under:

   a) If the assessee admits undisclosed income during the course of search in a statement u/s.132(4), specifies the manner in which such income has been derived, pays the tax with interest on such income and furnishes return of income declaring such income, penalty shall be 10% of undisclosed income.
   b) If undisclosed income is not so admitted during the course of search, but disclosed in the return of income filed after the search and he pays the tax with interest, penalty shall be 20% of undisclosed income.
   c) In other cases, the minimum penalty shall be 30% subject to maximum of 90% of the undisclosed income.

16.7 Prosecution provisions — Sections 276C, 276CC, 277, 277A, 278 and 280A to 280D:

The effect of these amendments w.e.f. 1-7-2012 shall be as under:

i) Section 276C — Wilful attempt to evade tax:

At present, if the amount of tax sought to be evaded exceeds Rs.1 lac, the punishment is rigorous imprisonment for minimum of 6 months and maximum of 7 years. The limit of Rs.1 lac is now raised to Rs.25 lac.

In other cases, the rigorous imprisonment period is 3 months minimum and 3 years maximum. The period of 3 years is now reduced to 2 years.

ii) Section 276CC — Failure to furnish Returns of Income:

In this section also amendments similar to amendments in section 276C as stated in para (i) above are made.

iii) Section 277 — False Statement in Verification:

In this section also amendments similar to amendments in section 276C as stated in para (i) above are made.

iv) Section 277A — Falsification of Books of Accounts or Documents:

In this section the maximum term of imprisonment has been reduced from 3 years to 2 years.

v) Section 278 — Abetment of False Return of Income and Statements:

In this section also amendments similar to amendments in section 276C as stated in (i) above are made.

(vi) Sections 280A to 280D:

These new sections have been inserted w.e.f. 1-7-2012 with a view to appoint Special Courts to try specified offences under the Income-tax Act. It appears that these new provisions are made to strengthen the prosecution mechanism and expe-dite the disposal of prosecution cases under the Income-tax Act. In brief these provisions deal with the following matters:

a. Providing for constitution of Special Courts for trial of offences under the Act.

b. Application of summons trial for offences under the Act to expedite prosecution proceedings as the procedures in summons trial are simpler and less time consuming. The provision for summons trials will apply to offences where the maximum term of Imprisonment does not exceed 2 years.

c. Providing for appointment of public prosecutors.

17. Other amendments:
17.1 Senior citizens:
In various sections of the Income-tax Act the age limit for senior citizens was fixed at 65 years. This has now been reduced to 60 years w.e.f. A.Y. 2013-14 (Accounting Year 2012-13).

17.2 Tax audit:
Section 40AB provides that an assessee carrying on business or profession has to get the accounts audited by a Chartered Accountant if the turnover or gross receipts exceed Rs.60 lac in the case of business or exceeds Rs.15 lac in the case of profession. The limit of turnover or gross receipts for this purpose has now been increased to Rs.1 crore in the case of business or Rs.25 lac in the case of profession. Further, date for obtaining tax audit report which is 30th September has been changed to the due date of filing return of income u/s.139(1) as applicable to the assessee. The amendment increasing the limit for turnover/gross receipts will come into force from A.Y. 2013-14 (Accounting Year 2012-13).

17.3 Section 115VG — Computation of daily tonnage income for shipping companies:

This section is amended w.e.f. A.Y. 2013-14. The Tonnage Tax Scheme for shipping companies was introduced by the Finance Act, 2005. This section provides for taxation of income of a shipping company on presumptive basis. Under this scheme, the operating profit of a shipping company is determined on the basis of tonnage capacity of its ships. The rates of daily tonnage income specified in the section have not been changed since 2005. By this amendment these rates are enhanced as under:

17.4 Section 209 — Advance tax calculation:

At present, for the purpose of calculation of advance tax liability, tax deductible or collectable at source was required to be reduced even though the tax was actually not deducted. Therefore, in such cases, there was no interest liability. Now it is provided that unless such tax is actually deducted, the advance tax liability. This amendment is made w.e.f. 1-4-2012.

17.5 Section 234D — Interest on excess refund:

This section is amended w.e.f. 1-6-2003. This section was inserted by the Finance Act, 2003, w.e.f. 1-6-2003 to enable the Government to recover amount of excessive refund granted u/s.143(1). The section provides for levy of simple interest at the rate of ½% for every month or part thereof on the excess amount of refund granted u/s.143(1) if, on regular assessment, it is found to be excessive. Interest is payable for the period starting from the date of refund to the date of regular assessment.

The Delhi High Court in DIT v. Jacabs Civil Incorporated, (2011) 330 ITR 578 held that this provision will apply from the A.Y. 2004-05 and no interest is payable for the earlier assessment years. To overcome this decision, it is now provided that interest shall be payable u/s.234D on excess refund for any earlier assessment years if the proceedings in respect of such assessment are completed after 1-6-2003.

Wealth Tax Act :

Section 2(ea) — Definition of ‘Assets’:

At present, any residential unit allotted to officers, employees or whole-time directors is exempt from wealth tax if the gross annual salary of such person is less than Rs.5 lac. This limit of gross annul salary is increased to Rs.10 lac. This amendment is effec-tive from A.Y. 2013-14.

Section 17 — Wealth-escaping assessment:

This section is amended w.e.f. 1-7-2012 — It is now provided in this section that if any person is found to have any asset or financial interest in any entity located outside India, it will be deemed to be a case where net wealth chargeable to tax has escaped as-sessment. In such cases the wealth tax assessment can be reopened by the AO within 16 years.

Section 17A — Time limit for completion of assessment and reassessment:

This section is amended w.e.f. 1-7-2012. As discussed earlier, while considering the amendments in sections 153 and 153B of the Income tax, this amendment has the effect of increasing the time limit by 3 months for completion of assessment/reassessment proceedings.

Section 45:

This section provides for exemption from wealth tax to section 25 companies, co-operative societies, social clubs, recognised political parties, mutual funds, etc. This list is now expanded to provide that the ‘Reserve Bank of India’ will not be liable to pay wealth tax w.e.f. 1-4-1957.

To sum up:

19.1 From the above discussion, it will be evident that the amendments made in the Income-tax Act by this Budget are the most controversial. In par-ticular, the amendments affecting non -residents which have retrospective and retroactive effect will affect our relationship with many foreign countries and will affect our global trade. The Finance Minister has quoted in his Budget Speech Shakespear’s immortal words “I must be cruel only to be kind”. Reading the provisions relating to amendments in the Income-tax Act, one can say that this year he has been ‘Cruel’ with the non-resident taxpayers. Hopefully he may become ‘kind’ next year.

19.2 In his Budget speech, the Finance Minister has stated that his proposals relating the Direct Taxes will result in a net revenue loss of Rs.4,500 Cr. in the year and the proposals relating to Indirect Taxes will yield net revenue gain of Rs.45940 Cr. However, from his post-budget speeches before various trade bodies indicate that retrospective amendments in the Income-tax Act itself will yield revenue of about Rs.40000 Cr. Considering the stakes involved, it is evident that in the coming years we will witness a long-drawn tax litigation relating to interpretation of the retrospective amendments in the Income-tax Act.

19.3 Another provision which is likely to create lot of hardship to resident as well as non-resident tax-payer is about GAAR. It is true that the implementation of GAAR has been postponed to next year, there is apprehension that the Tax Department may hold arrangements made prior to 1-4-2013 as impermissible and make adjustments in the income for the year 1-4-2013 to 31-3-2014 and subsequent years. In other words, GAAR provisions may have retroactive effect. From the wording of GAAR provisions it is evident that it will now be difficult for resident as well as non-resident tax-payers to take any major decisions about the structure of any business transaction. Even the tax consultants will find it difficult to advise their clients about structuring or restructuring any business transaction. If the Government does not come out with a taxpayer-friendly Guidance Note, taking into consideration the business realities, the fear above invocation of GAAR will continue in the minds of all taxpayers and their tax consultants.

19.4 Another controversial provision which has been made this year relates to specified domestic transactions. By extending the scope of Transfer pricing provisions to these transactions, the compliance cost of the assessee will increase. At present no adequate data about domestic comparable prices is available in our country, and therefore, it will be difficult for assesses to maintain transfer pricing records and documents for this purpose. Since the provisions have been made effective from 1 -4-2012, many assesses may not be well equipped to maintain these records in this year. Since every case in which specified domestic transactions are entered into will be referred to the TPO, the entire assessment proceedings will become lengthy and time consuming. This will also increase compliance cost.

19.5 It is true that the tax burden of individuals, HUF, etc. has been reduced and some beneficial provisions have been introduced to remove some practical difficulties. But, it can be stated that these efforts are only half-hearted and there are many areas in which the taxpayers will have to face many practical difficulties.

19.6 The DTC Bill, 2010, is pending before the Par-liament. The report of the Standing Committee on Finance is also laid before the Parliament. This Bill was to be implemented from 1-4-2012. However, due to the delay in the legislative process it is stated that DTC will now be passed in the next session of the Parliament and will be made effective from 1-4-2013. In view of this, it is not clear why such controversial amendments are made this year in the last year of the life of the present Income-tax Act. By the time the taxpayers grasp the implications of these amend-ments, the new provisions of DTC will come into force from next year. When it became evident in the beginning of this year that DTC may be postponed by one year, it was felt that in this Budget some minimal amendments will be made in the Income-tax Act as and by way of parting gift to the taxpayer. But, after reading the controversial amendments in the Income-tax Act in this Budget, the taxpayers have felt that this Act has given a parting kick to the taxpayers in the last year of its existence.

Acknowledgement:

S. M. Jhaveri, Chartered Accountant has assisted the author in the preparation of this article.

shailesh.kwebmaker

War Against Offshore Tax Evasion — Will Tax Information Exchange Agreements Work?

In the recent crackdown against errant taxpayers, the Income-tax Department has initiated action against many Indians who had stashed their wealth in the HSBC bank in Geneva. This is similar to the action it had taken earlier against the Indian account holders in LGT Bank in Lichtenstein. Similarly, proceedings are also expected to be initiated against many tax evaders on the basis of more than 10,000 pieces of information reportedly received from the different countries. This news may be comforting to the majority of taxpayers who honestly pay their taxes and believe that the Government ought to severely punish tax evaders.

This development gives hope that such trickle would turn into a flow of information to bring back Indian black money stashed abroad after the Indian Government has entered into Tax Information Exchange Agreements (TIEAs) with the tax havens. India has so far signed TIEAs with Bermuda, Bahamas, Isle of Man, British Virgin Island, Cayman Island, Liberia, and Jersey and more TIEAs are under negotiation. India is also seeking to amend its 75 existing Double Taxation Agreements with the countries to provide for effective exchange of tax information.

However, sceptics feel that Tax Information Exchange Agreements are unlikely to make any meaningful contribution in fight against tax evasion, more particularly against offshore tax evasion. Their scepticism is because of several reasons. However, before discussing their views it may be necessary to go through a bit of background to understand the issues involved in TIEAs.

Background
The global financial crisis triggered TIEA drive. One of the fallout of the global financial crisis was that of growing realisation among the governments on the menace of tax evasion, particularly offshore tax evasion, which has resulted in massive revenue loss hitting developing countries harder, which need more funds for their development and poverty eradication. Various agencies and organisations have estimated the magnitude of the problem. For example, a non-profit organisation, ‘Global Financial Integrity’ in its report published in January 2009, has estimated that the developing countries lost between $ 858 billion to $ 1.06 trillion in illicit financial outflows in 2006. ‘Oxfam’, another non-profit organisation in a study carried out in March 2009 found that at least $ 6.2 trillion wealth of the developing countries is held offshore, depriving them annual tax receipts between $ 64-124 billion. Therefore, considering the sheer size of the revenue loss, the governments are looking to collect tax from the funds deposited in the offshore accounts, on which tax was not paid.

Role of a tax haven

Critical role played by tax havens in offshore tax evasion is well known, which often ignore and many a time aid tax evasion taking place in their jurisdiction. Tax evaders find tax havens attractive because many tax havens have developed ‘liberal’ systems, such as simple registration of a company with bearer shares, minimum capitalisation, nominal reporting requirements, provide ease of funds transfer and offer possibility of keeping ownership anonymous. Such rules make tax evasion easier. More importantly, tax havens are attractive to tax evaders because of lack of transparency and little exchange of information apart from the fact that it levies nominal tax or no tax on them. On the other hand, for a tax haven, on-going financial activity in its jurisdiction is beneficial for its survival and prosperity. It is win-win situation for both: the tax haven and the tax evaders.

OECD response
Tax administrations cannot function beyond their country’s jurisdiction, although globalisation of economy and growing international business require tax administrations to operate internationally. Tax administrations find it difficult to detect tax evasion involving tax haven because of the lack of adequate information on such transactions. Therefore, ‘Organisation of Economic Cooperation and Development’ (OECD) decided to tackle two critical elements — which make a jurisdiction a tax haven — lack of transparency and lack of or little exchange of information. The OECD, strongly supported by the G20 Nations, has aggressively promoted international co-operation in tax matters through exchange of information by promoting TIEAs with tax havens.

The OECD started its campaign in 1998 with the publication of the report ‘Harmful Tax Competition: Emerging Global Issue’ emphasising the need for effective exchange of information. Subsequently, the OECD developed a model ‘Tax Information Exchange Agreement’ which is largely followed by all nations. The OECD also devised a compliance standard for the tax havens to ensure that each of them sign and effectively implement TIEAs. This compliance standard required each tax haven to sign TIEAs with minimum 12 nations other than tax havens. As standards for monitoring their compliance, the OECD also calls for willingness on part of the tax haven to continue to sign agreements even after reaching threshold and insists on effective implementation of the TIEAs.

The ‘Global Forum’ created by the OECD member countries has devised a system to monitor jurisdiction’s standards on transparency and exchange of tax information by carrying out phase-wise peer reviews by other jurisdictions. Peer review assesses jurisdiction’s legal and regulatory framework on criteria of 10 key elements in 1st Phase of review and in Phase 2 review, examines effective implementation of exchange of tax information after a jurisdiction removes deficiencies identified in its legal and regulatory framework. The peer reviews assess the availability of ownership, accounting and bank information and authorities’ power to access as well as capacity to deliver information along with rights and safeguards and provisions of confidentiality.

So far various countries world over have signed more than 700 TIEAs. The tax havens have signed these agreements to come out of the OECD’s ‘grey list’ to avoid possible sanctions imposed on them if they fail to comply with the stipulated standard of signing minimum 12 TIEAs with the countries other than tax havens.

TIEA
TIEAs provide for exchange of requested information even in the cases in which the conduct of the taxpayer does not constitute crime in the jurisdiction of the requested country (Tax haven). The country is also required to provide requested information which is not in its possession by gathering it. Most importantly, the TIEAs provide for obtaining information from the banks and the financial institutions regarding ownership of companies, partnerships, trusts including ownership information of the persons in the ownership chain and also information on the settlers, trustees, and beneficiaries. This is one of the most important provisions of the agreement, which make it possible, at least theoretically, to unravel ultimate beneficiaries of the tax haven bank accounts. It is too well known that beneficiaries of the tax haven bank accounts are often shielded by a deliberately created complex ownership structure consisting of a maze of entities. It is also important to note that TIEA does not place any restrictions on information exchange caused by the bank secrecy or domestic tax interest requirements.

Why TIEAs cannot be effective

Despite having the well-designed provisions in the TIEA and seriousness of the OECD and governments in dealing with tax evasion, many professionals believe that the TIEAs will not work. There are various reasons for this negative sentiment.

Firstly, there is a conflict of interests among tax haven and non-tax haven countries. Secrecy jurisdictions are hardly interested in sharing information about their customers.

In many jurisdictions, ownership and beneficial ownership information is protected by domestic law.

From the OECD’s Progress Report Tax Transparency of 2011, it becomes clear that making legal and structural changes in secrecy jurisdictions is going to be a time-consuming affair. So far, out of total 81 peer reviews launched, Global Forum has adopted 59 reports. Out of the 59 reviews completed, 42 are Phase 1 reviews and 17 are combined reviews (reviews of both the Phases conducted simultaneously). Nine Jurisdictions will move to Phase 2 after they fix the deficiencies pointed out in the peer reviews. Thus, jurisdictions have to do considerable work to enable them to exchange tax information effectively. Moreover, one of the conclusions of the Report is that the information exchange is too slow.

Secondly, there is no automatic exchange of information. The TIEA requires that for getting information on a taxpayer, the applicant country has to provide specific information of the taxpayer such as (a) the identity of the taxpayer under examination or investigation; (b) the period for which information is requested; (c) the nature of the information requested and the tax purpose for which the information is sought; (d) grounds for believing that the requested information is present in the requested country or is in the possession of a person within the jurisdiction of the requested country; (e) to the extent known, the name and address of any person believed to be in possession of the requested information; (f) a statement that the request is in conformity with the law and administrative practices of the applicant country, that if the requested information was within the jurisdiction of the applicant country, then the applicant country would be able to obtain the information under the laws of the applicant country or in the normal course of administrative practice and that it is in conformity with this agreement; (g) a statement that the applicant country has pursued all means available in its own territory to obtain the information, except which would give rise to dispro-portionate difficulties. Thus, very high amount of information is required to be furnished for making a request meaning that the tax administration should already have substantial evidence against the taxpayer rather than gathering evidence against a taxpayer to make a case of tax evasion. Very often, furnishing such information before the completion of investigation is like putting a cart before the horse.

Thirdly, a taxpayer can move his deposits from the bank account of one tax haven to another before developing of an enquiry making tax administration’s efforts futile. Lastly, experiences of some of the countries indicate little usefulness of TIEAs as they have sparingly used it for the information exchange.

It may be recalled here that the information on the basis of which the Income-tax Department has recently initiated action was not received under the TIEA. The information on Indian account holders in LGT bank Lichtenstein was provided by Germany, which in turn had bought it from the disgruntled employee of the Bank, whereas France reportedly passed on the information on the account holders of the HSBC Bank, Geneva.

Responses by other countries

Probably considering the limitations of the TIEA, some of the countries have adopted multi-pronged strategy to counter offshore tax evasion. On the one hand, US, Germany and Australia had offered Voluntary Income Disclosure Scheme and on the other, some of them have enacted specific legislations to deal with it.

The US has strengthened domestic legislation by enacting specific laws to counter offshore tax evasion by creating additional sources of information gathering.

The US introduced ‘Hiring Incentives to Restore Employment Act’ (HIRE) providing tax incentives for hiring and retaining unemployed workers also imposes 30% withholding on payment made to foreign financial institution, unless such institution agrees to adhere to certain reporting requirements with respect to US account holders. It has also enacted legislation — FATCA (the Foreign Account Tax Compliance Act) which is to be implemented from 2013 requiring non-US banks to report the accounts of US clients to the US Internal Revenue Service. There is also a proposal in the US for enacting additional law, ‘Stop Tax Haven Abuse Act’ strengthening FATCA and plugging specific offshore tax evasion schemes. Similarly, UK’s new law introduced in 2010 provides for higher penalty at 200% on offshore tax evasion.

In addition, many countries have stepped up their counter offensive by allocating more work force to investigate the cases of offshore tax evasion. It is reported that the IRS of the US had placed more than 1400 agents on a project to investigate the merchants who were directly depositing credit card sales in their offshore accounts.

Conclusion

The real challenge to willingness to exchange of information comes from the difference in the tax laws and law on confidentiality along with conflicting interests among countries. Therefore, there is a need to take additional measures along with the TIEAs. However, the measures for information gathering which may work for the countries such as the US, Germany or the UK because of their political and economic clout may not work for India. India will have to supplement its measures — legislative as well as administrative — for information gathering in its battle against tax evasion leveraging at the international level its position of a giant emerging market.

On a positive note, the biggest contribution of the TIEAs is providing legal instrument in an environment against tax evasion. With the result, tax evaders are now increasingly realising that there will be no safer havens in near future for their tax evaded funds, which is the fundamental requirement in a fight against tax evasion.

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DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS, Part I

Background :
The Supreme Court in Punjab Industrial Development Corporation Ltd v. CIT, (1997) 225 ITR 792 held that the amount paid to the Registrar of Companies as filing fee for enhancement of capital constitutes capital expenditure. Relying on this decision, the Supreme Court in Brooke Bond India Ltd. v. CIT, (1997) 225 ITR 798 held that expenditure incurred in connection with issuing shares for increasing capital by a company is capital expenditure. Since then one is a witness to these two decisions being mechanically applied by tax authorities as a ground for disallowing any and every expenditure associated with share capital. These include expenses not only directly related but also incidentally connected to capital expansion. The question for consideration is whether any and every expenditure relatable to capital expansion is capital expenditure? Whether the above-mentioned decisions of the Supreme Court are all-pervasive? To put it differently, could there be occasions when these Supreme Court decisions become distinguishable? This write-up discusses one such occasion — in two parts. The first part outlines the law applicable for allowing any expenditure as business expenditure under the head income from business or profession. The second part would cover why the ratio of above-mentioned decisions of the Supreme Court cannot be regarded as all-pervasive as also other connected matters.

Assumed facts:
ABC Limited is a public company (hereinafter referred to as ‘ABCL’ for brevity) engaged in the business of manufacture and sale of pharmaceuticals products. ABCL has presence in various countries across the globe. The success of the business of ABCL is dependent upon marketing of its products. During financial year 2010-11, ABCL undertook certain strategic initiatives (including organisational restructuring) to re-align its business activities for entering into European, African and Asia-pacific countries. The objective was to capture trading opportunities available in such countries. ABCL was thus in need of funds for various business purposes viz., working capital for carrying out business, funds for securing distribution rights, licences, brands.

In view of the above, ABCL engaged the services of a commercial bank (say, XY bank) which assisted it in raising funds through foreign investors. With assistance from XY bank, ABCL managed to raise funds by issuing preference shares to three foreign investors. The funds raised by ABCL were utilised for the above purposes. In consideration of all the services provided, ABCL paid a consolidated fee to XY bank. The question for consideration is whether fees or any portion thereof paid to XY bank would be deductible as business expenditure under the provisions of the Income-tax Act, 1961 (‘Act’ for short hereinafter).

Applicable law — Introduction:
Chapter IV-D contains provisions relating to computation of ‘Profits and gains from business or profession’. Section 28 is the charging section. Section 29 enjoins that profits and gains referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D. Sections 30 to 36 and 38 outline the law relating to specific deductions. Section 37 deals with expenditure which is general in nature and not covered within sections 30 to 36.

The payment by XY bank would not qualify for deduction under sections 30 to 36. Even section 35D would not have relevance. This is for the reason that the section would apply when expenses are incurred under specified heads prior to incorporation or after incorporation in connection with the extension of the industrial undertaking. The expenses under consideration are not pre-incorporation expenses. No extension of any existing undertaking is involved. Section 35D therefore would not be relevant. The deductibility of the said expenditure under section 37(1) of the Act remains for consideration.

Deductibility under section 37(1):
Section 37(1) of the Act enables a general or residual deduction while computing profits and gains of business or profession. Section 37(1) reads as under: “(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ‘Profits and gains of business or profession’.

(Explanation — For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.)

In order to be eligible for an allowance under section 37, the following conditions should be cumulatively satisfied:
(i) The impugned payment must constitute an expenditure;
(ii) The expenditure must not be governed by the provisions of sections 30 to 36;
(iii) The expenditure must not be personal in nature;
(iv) The expenditure must have been laid out or expended wholly and exclusively for the purposes of the business of the assessee; and
(v) The expenditure must not be capital in nature.

(i) The payment must constitute an expenditure:
The first and foremost requirement of section 37 is that there should be an expenditure. The term expenditure is not defined in the Act. The Supreme Court in Indian Molasses Company (P) Ltd. v. CIT, (1959) 37 ITR 66 (SC) defined it in the following manner:
“ ‘Expenditure’ is equal to ‘expense’ and ‘expense’ is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another’s expense. But the idea of ‘spending’ in the sense of ‘paying out or away’ money is the primary meaning and it is with that meaning that we are concerned. ‘Expenditure’ is thus what is ‘paid out or away’ and is something which is gone irretrievably.”

A definition to a similar effect is found in section 2(h) of the Expenditure Act, 1957. This definition reads as : “Expenditure : Any sum of money or money’s worth spent or disbursed or for the spending or disbursing of which a liability has been incurred by an assessee. The term includes any amount which, under the provision of the Expenditure Act is required to be included in the taxable expenditure.”

In CIT v. Nainital Bank Ltd., (1966) 62 ITR 638, the Supreme Court held : “In its normal meaning, the expression ‘expenditure’ denotes ‘spending’ or ‘paying out or away’, i.e., something that goes out of the coffers of the assessee. A mere liability to satisfy an obligation by an assessee is undoubtedly not ‘expenditure’ : it is only when he satisfies the obligation by delivery of cash or property or by settlement of accounts, there is expenditure.”

Expenditure for the purposes of section 37 includes amounts which the assessee has actually expended or which the assessee has provided for or laid out in respect of an accrued liability. In the case under discussion, ABCL has paid fees to XY bank as consideration for services. The amount paid to XY bank constitutes ‘expenditure’ for the purpose of section 37(1) of the Act.

(ii) The expenditure must not be governed by the provisions of sections 30 to 36:
As already stated, the payment under discussion viz., fees paid to XY bank is not covered by any of the provisions of sections 30 to 36 of the Act. The payment would also not qualify for deduction under section 35D as the same has not been incurred prior to incorporation of business of ABCL or in connection with extension of the undertaking or setting up a new u

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FINANCE ACT, 2011

1. Background:

1.1 The Finance Minister, Shri Pranab Mukherjee, presented the third Budget of UPA-II Government in the Parliament on 28-2-2011. The Finance Act, 2011, has now been passed by both Houses of the Parliament on 24-3-2011, without any discussion. It has received the assent of the President on 8-4- 2011. There are only 35 sections in the Finance Act amending some of the provisions of the Income tax and Wealth tax Act. This year’s amendments in our Direct Tax Laws are very few, probably because the Direct Taxes Code Bill, 2010 (DTC), introduced in the Parliament is under discussion and will replace the existing Income tax Act and Wealth tax Act hopefully from 1-4-2012.

1.2 Part ‘B’ of the Budget Speech deals with proposals relating the Direct Taxes, Excise Duty, Customs Duty and Service tax. In para 139 and 140 of his Budget Speech the Finance Minister has stated as under:

“139. In the formulation of these (tax) proposals, my priorities are directed towards making taxes moderate, payments simple for taxpayers and collection of taxes easy for the tax collector.”

“140. As Government’s policy on direct taxes has been outlined in the DTC which is before the Parliament, I have limited my proposals to initiatives that require urgent attention.”

After presenting his budget proposals, he has concluded his speech as under:

“197. As an emerging economy, with a voice on the global stage, India stands at the threshold of a decade which presents immense possibilities. We must not let the recent strains and tensions hold us back from converting these possibilities into realities. With oneness of heart, let us all build an India, which in not too distant a future, will enter the comity of developed nations.”

1.3 The various important amendments made in the Income tax Act and Wealth tax Act can be briefly stated as under:

(i) Slabs for tax payable by Individuals/HUF/ AoP/ BoI have been revised and the tax burden on these assessees have been reduced to some extent.

(ii) MAT on Corporate Bodies has been marginally raised and surcharge on income of companies is reduced.

(iii) Alternate Minimum Tax (AMT) will be levied on Limited Liability Partnership (LLP).

(iv) Certain exemption and deduction provisions have been relaxed.

(v) Provisions relating to taxation of international transactions have been made more strict.

(vi) Scope of cases which can be referred to the Settlement Commission has been widened.

(vii) Some procedural changes have been made.

1.4 In this article some of the important amendments made in rates of taxes and in some of the provisions of the Income tax and Wealth tax Acts have been discussed.

2. Rates of taxes, surcharge and education cess:

2.1 Rates of Income tax:

(i) For Individuals, HUF, AoP, BoI and Artificial Juridical Persons the threshold limit of basic exemption has been revised upwards for A.Y. 2012-13. Age limit for resident senior citizens has been lowered to 60 years from the present limit of 65 years. Further, a new category of ‘VERY SENIOR CITIZEN’ who is a resident and 80 years and above has been created. The revised tax rates for A.Y. 2012-13 as compared to A.Y. 2011-12 are as under:

(a) Rates in A.Y. 2011-12
(Accounting Year ending 31-3-2011):

Note: There is no surcharge but Education cess at 3% (2 + 1) of tax is payable.
(b) Rates in A.Y. 2012-13 (Accounting Year ending 31-3-2012):

Note: No surcharge is payable but Education cess @ 3% (2 +1) of tax is payable.
(ii) The impact of these changes can be noticed from the following charts.

(a) Tax payable in A.Y. 2011-12 (Accounting Year ending 31-3-2011):

The above tax is to be increased by 3% of tax for Education cess.

(b) Tax payable in A.Y. 2012-13 (Accounting Year ending 31-3-2012):

The above tax is to be increased by 3% of tax for Education cess.

(iii) Other assessees: There are no changes in the rates of taxes so far as other assessees are concerned. Therefore, they will have to pay taxes in A.Y. 2012-13 at the same rates as applicable in A.Y. 2011-12.

(iv) Rate of tax u/s.115JB (MAT): The rate of tax on book profits u/s.115JB i.e., MAT has been increased from 18% in A.Y. 2011-12 to 18.5% in A.Y. 2012-13. This is to be increased by surcharge of 5% of tax if the Book Profit is more than Rs.1 cr. Education cess at 3% of tax is also payable.

(v) Rate of tax on dividends from foreign companies:
A new section 115BBD is inserted for A.Y. 2012- 13. This section provides for concessional rate of tax payable by an Indian company on dividend received by it from any Foreign company in which the Indian company holds 26% or more of the equity capital. The rate of tax on such dividend income will be 15% plus applicable surcharge and education cess. This concessional rate of tax on foreign dividend income is applicable only for one year i.e., dividend received during the year ending 31-3-2012 (A.Y. 2012-13). It is also provided in this section that no expenditure shall be allowed against this dividend income. Therefore, an Indian company which controls a Foreign company by holding 26% or more of equity capital in such a company can consider repatriation of profits accumulated in the foreign company to avail of this concessional rate of tax during the current year before 31-3-2012.

(vi) Rate of Alternate Minimum Tax on LLP (AMT):
Limited Liability Partnership (LLP) will now have to pay Alternative Minimum Tax (AMT) at the rate of 18.5% on its gross total income as computed under new section 115JC. No surcharge is payable, but education cess is payable @ 3% of tax. This is discussed in para 8 below.

2.2 Surcharge on Income tax:
(i) No surcharge is payable by non-corporate assessees i.e., Individuals, HUF, Juridical person, AoP, BoI, Firm, LLP, Co-operative Society and Local Authority. In the case of a company, if the total income is more than Rs.1 cr. the surcharge on tax payable in A.Y. 2011-12 is 7.5%. This is now reduced to 5% for A.Y. 2012-13. Similarly, rate of surcharge on tax payable by a company u/s.115JB (MAT) is also reduced to 5% for A.Y. 2012-13 if the Book Profits amount is more than Rs.1 cr. So far as Dividend Distribution and Income Distribution Tax payable u/s.115O and u/s.115R by companies and Mutual Funds is concerned the rate of surcharge on tax is reduced from 7.5% to 5% w.e.f. 1-4-2011.

(ii) In the case of a Foreign company the rate of surcharge on tax is also reduced from 2.5% to 2% w.e.f. A.Y. 2012-13 if the taxable income of such a company is more than Rs.1 cr. Similarly, for deduction of tax at source u/s.195 from the income of a foreign company the Income tax has to be increased by surcharge at the rate of 2% (instead of 2.5%) w.e.f. 1-4-2011 if the income from which tax is deducted at source is more than Rs.1 cr.

(iii) It may be noted that no surcharge on tax is required to be charged on tax deducted at source from payments to resident assessees.

2.3 Education cess:
As in earlier years, Education cess of 3% (including 1% for higher education cess) of Income tax and Surcharge (if applicable) is payable by all assessees (Residents and Non-residents). No Education cess is to be deducted or collected from TDS or TCS from payments to all resident assessees, including companies. However, if the tax is deducted from payments made to (a) Foreign companies, (b) Non- Residents or (c) on Salary payments, Education cess at 3% of tax and surcharge (if applicable) is to be applied.

2.4 TDS on interest:
New s

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Foreign Satellite Operators – finally relieved?

Modern technology has been posing challenges before the tax administrators time and again. May it be e-commerce, use of telecom circuits or Internet bandwith or transponder capacity for relaying over a footprint area; the emerging issues have left tax experts all over the world scratching their heads and compelled the judiciary across the globe to probe into the complicated technical facts to arrive at a fair conclusion.

One such issue, being leasing of transponder capacity in a satellite has been a matter of vexed litigation in India in the past decade. After having conflicting tribunal decisions, some resolution seems to have been now reached in this context with the recent decision of the Hon’ble Delhi High Court in the case of Asia Satellite Telecommunications (AsiaSat). In the said decision, the Delhi High Court held that payments for use of transponder capacity to satellite operators by Television (TV) channels cannot be taxed as ‘royalty’ in India. This has rendered a sigh of relief to the satellite operators, given that the quantum of tax involved in these disputes is very large.

Here is a quick backdrop of the litigation history in this context and the key findings of the Delhi High Court also keeping in mind the OECD commentary and the Direct Taxes Code Bill, 2010.

Common Facts From a reading of the various tribunal decisions on this issue, it appears that the facts are almost the same in all cases where TV channels make payments for use of transponder capacity in a satellite. The facts in the case of AsiaSat were as follows:

AsiaSat, a Hong Kong based company, is engaged in the business of providing data and video transmission services to TV channels through its satellites (owned and leased) placed in the geostationary orbital slots at a distance of 36000km from the earth. These satellites neither use Indian orbital slots, nor are they positioned over Indian airspace.

In the transmission chain, the TV channels uplink their signals to the transponder in the satellite through ground stations which are located outside India. The signals are then amplified by the transponder and downlinked with a different frequency (without any change in the content of the programmes) over the footprint area covered by the satellite, which also included India amongst the four continents covered.

Under the arrangement, AsiaSat has complete control over the satellite (including the transponder) and the tracking, telemetering, and other control operations of the satellite are done by AsiaSat from its control centre located outside India.

The typical flow of activities in a transaction of leasing of transponder capacity is as in the diagram:

Issue The main issue in all the cases that came up before the Tribunal Benches was, whether the payments being made by the TV Channels to the satellite operator for the use of transponder capacity could be characterised and taxed as ‘royalty’ within its meaning u/s. 9(1)(vi) of the Income-tax Act, 1961 (‘the Act’) or under the relevant article of the relevant tax treaty (if applicable).

In order to conclude on the above issue, the important aspects that need to be decided upon are:

1. Whether the payments can be said to be for ‘use of’ or ‘right to use of’ the process involved in the transponder?

2. If the answer to the above is yes, whether to be characterised as ‘royalty’ u/s. 9(1)(i), the process needs to be ‘secret’ in nature?

3. If a tax treaty is applicable, whether the payments could be said to be covered within the definition of the term ‘royalty’, under the relevant article in such tax treaty?

Indian litigation history prior to Delhi High Court’s decision

(a) Raj Television Networks – Chennai Tribunal (unreported) (2001)

The Chennai Tribunal’s decision in the case of Raj Television Networks (unreported) was one of the initial decisions dealing with this issue. It was held that since the payments are not for use of any specified intellectual property rights or imparting any industrial, commercial or scientific information, the same cannot be said to be ‘royalties’ under the Act.

(b) Asia Satellite Telecommunications Co. Ltd. v. DCIT (2003)1

The Delhi Bench of the Tribunal, in the matter of AsiaSat held that the satellite company’s revenues fell within the purview of royalty u/s. 9(1)(vi) of the Act. In arriving at this conclusion, the Tribunal held that the TV channels were not merely using the facility, but were using the process as a result of which the signals after being received in the satellite were converted to a different frequency and after amplification were relayed to the footprint area. Further, it held that ‘process’ need not necessarily be a secret process, as the expression ‘secret’, as appearing in Explanation 2(iii) to section 9(1)(vi) of the Act, qualifies the expression ‘formula’ only and not ‘process’. The decision in the case of Raj Television Networks was considered and it was held that transponder was not ‘equipment’ and the payments cannot be regarded as for use of equipment.

Since AsiaSat was a Hong Kong based entity, the Tribunal did not deal with the arguments in connection with the treaty.

In PanAmSat’s case, while the Delhi Tribunal, followed the conclusion in case of AsiaSat with respect to the definition of ‘royalty’ under the Act, it further carved out the distinction between the language in India-US Tax Treaty (‘tax treaty’) and the Act. It held that, in the definition under the tax treaty, the term ’secret‘ also qualifies ‘process’, unlike the Act. Since the process being used in the satellite was not ‘secret’, it was held that they are not taxable as ‘royalty’ under the tax treaty.

(d) ACIT v. Sanskar Info. T.V. P. Ltd. (2008)3

In this case, the Mumbai Tribunal placed heavy reliance on the AsiaSat decision and held that the payments are taxable as ‘royalty’ under the Act. The Tribunal does not seem to have considered the India Thailand Treaty as well as the decision in the case of PanAmSat in arriving at its conclusion.

(e) ISRO Satellite Centre [ISAC], In re4

In this case, ISRO had entered into a contract with a UK based satellite operator for leasing of a navigation transponder capacity for uplinking of augmented data and transmission by the transponder for better navigational accuracies. The Authority for Advance Ruling (‘AAR’) has made detailed observations regarding functioning and use of the transponder. It ruled that the payment by ISRO could not be regarded as one for the “use of” or “right to use” any equipment. It was held that the transponder and the process therein were utilised by the satellite operator to render a service to ISRO and ISRO neither uses nor is it conferred with the right to use the transponder. Hence, the receipts cannot be taxable as ‘royalty’ under the Tax Treaty or under the Act.

(f) New Skies Satellites N.V. v. ADIT (2009)5

The Delhi Special Bench constituted in light of inconsistent decisions in the cases of AsiaSat and PanAmSat, held in October 2009 that revenues earned by the satellite operators are taxable as ‘royalty’ both under the Act and various tax treaties, thereby reversing the PanAmSat decision. It held that the payments are for the ‘use’ or ‘right to use’ the process involved in the transponder and that for the purpose of determining the payments as ‘royalty’ it is not necessary for the ‘process’ to be ‘secret’ under the Act as well as the tax treaty.

Key findings of Delhi High Court in case of AsiaSat

1. The High Court stated that merely because the footprint area includes India and the programmes are watched by the ultimate consumers/viewers in India, it would not mean that satellite operator is carrying out its business operations in India attracting the provision of section 9(1)(i) of the Act.

2. The transponder is an inseparable part of a satellite and is incapable of functioning on its own and so is the case with the transponder’s process.

3. The substance of the agreement between AsiaSat and the TV channels is not to grant any ‘right to use’ qua the process embedded in the transponder or satellite, since the entire control of the satellite and transponder remains with AsiaSat. It is observed that the process in the transponder is used by the satellite operator for rendering services to the TV channels, thus holding that the satellite operator itself was the user of the satellite and not the TV channels who were given mere access to the broadband available.

4. The High Court has distinguished between transfer of ‘rights in respect of a property’ and transfer of ‘right in the property’. In case of royalty, the ownership of property or right remains with the owner and the transferee is permitted to use the right is respect of such property. A payment for the absolute assignment of and ownership of rights transferred is not a payment for the use of something belonging to another party and therefore not royalty.

5. It has supported the illustration that there is distinction between hiring of a truck for a specified time period and use of transportation services of a carrier who uses a truck for rendering such services.

6. Thus, relying upon the detailed observations in the AAR’s ruling in case of ISRO (mentioned above), the High Court held that the payments for the use of transponder capacity cannot be said to be for the use of a process or equipment by its customers.

7. Though there was no treaty involved in this case, to support its view, the High Court has also referred to the OECD model commentary in this context. It observed that the OECD model commentary may be relied upon to understand the meaning of similar terms used in the Act.

8. While, it did not get into a detailed comparison of the language of the definition of ‘royalty’ in the Act and treaty, it observed that the definition in the OECD model is virtually the same as the Act in all material respects. The High Court has made a mention of the OECD Commentary (para 9.1 of the commentary on Article 12) which suggests that payments made by customers under typical ‘transponder leasing’ arrangements (which is not a leasing of industrial, commercial or scientific equipment due to the fact that the customers do not acquire the physical possession of the transponder, but simply its transmission capacity) would be in the nature of business profits and not royalty.

Overall Comments
1. The issue, whether the ‘process’ needs to be ‘secret’ remains unanswered, as the High Court did not comment on the same given that it concluded that the payments were not for use of process.

2. There is no mention of the Special Bench’s ruling in the case of New Skies Satellite in the High Court decision.

3. While the High Court has referred to the inter-pretation in paragraph 9.1 of Article 12 of the OECD Commentary which states that payment for transponder leasing will not constitute royalty, there is no mention of the specific reservation that India has made against the same. India, in its position on OECD commentary has mentioned that India intends to tax such payments as equipment royalty under its domestic law and many treaties. It has also expressly been mentioned that as per India’s position, the payment for use of transponder is a payment for use of a ‘process’ resulting in ‘royalty’ under Article 12.

DTC Scenario
Under the proposed Direct Tax Code (‘DTC’), the definition of royalty includes payments made for ‘the use of or right to use of transmission by satellite, cable, optic fibre or similar technology’. Hence the definition is wide enough to encompass payments for transponder capacity and hence, would be taxable under the DTC.

Notwithstanding the above, the taxpayer could always claim the benefit of the tax treaty.

Conclusion
The decision of the Delhi High Court would have a significant favourable impact on taxability of revenues earned by foreign satellite operators and other connectivity service providers. Of course, the High Court decision would serve as a strong precedent for such companies at lower Appellate levels for the past years. However the decision would be helpful only in the pre-DTC scenario and the impacting companies would need to make fresh representation for relief in the post-DTC scenario given the High Court ruling.

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Income Computation & Disclosure Standards – Some Issues

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The 10 Income Computation and Disclosure Standards (ICDS) which have been notified on 31st March 2015 u/s. 145(2) of the Income-tax Act, 1961 have significant implications on the computation of income for assessment years beginning from assessment year 2016-17.

Under the notification, these standards come into force from 1st April 2016, i.e. assessment year 2016-17, apply to all assessees following mercantile system of accounting, and are to be followed for the purposes of computation of income chargeable to income tax under the head “Profits and gains of business or profession” or “Income from other sources”. The notification also supercedes notification dated 25th January 1996 [which notified 2 Accounting Standards u/s 145(2) – Disclosure of Accounting Policies, and Disclosure of Prior Period and Extraordinary Items and Changes in Accounting Policies], except as regards such things done or omitted to be done before such supersession.

Background
Section 145, which deals with method of accounting, was substituted by the Finance Act, 1995, with effect from assessment year 1997-98. Sub-section (2) to this section, after this amendment, provided that the Central Government may notify in the Official Gazette from time to time accounting standards (“AS”) to be followed by any class of assessees or in respect of any class of income.

The provisions of sub-section (1) were made subject to the provisions of sub-section (2), whereby the income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” was to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee, subject to the provisions of subsection (2).

Sub-section (3) provided that where the assessing officer was not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or AS notified under sub-section (2) had not been regularly followed by the assessee, the assessing officer could make an assessment in the manner provided in section 144 (i.e. a best judgement assessment).

In 1996, AS notified by ICAI were not mandatory for companies, but were mandatory for auditors auditing general purpose financial statements. On 29th January 1996, two AS (“IT-AS”) were notified by the CBDT, Disclosure of Accounting Policies, and Disclosure of Prior Period and Extraordinary Items and Changes in Accounting Policies.

In July 2002, the Government constituted a Committee for formulation of AS for notification u/s 145(2). In November 2003, this Committee recommended the notification of the AS issued by ICAI without any modification, since it would be impractical for a taxpayer to maintain two sets of books of account. It also recommended appropriate legislative amendments to the Act for preventing any revenue leakage due to the AS being notified by ICAI. These recommendations were not implemented.

With the imminent introduction of International Financial Reporting Standards (IFRS) in India in the form of Ind- AS, in December 2010, the Government constituted a Committee of Departmental Officers and professionals to suggest AS for notification u/s. 145(2). The terms of the Committee were as under:

i) to study the harmonisation of AS issued by the ICAI with the direct tax laws in India, and suggest AS which need to be adopted u/s. 145(2) of the Act along with the relevant modifications;

ii) to suggest method for determination of tax base (book profit) for the purpose of Minimum Alternate Tax (MAT) in case of companies migrating to IFRS (IND AS) in the initial year of adoption and thereafter; and

iii) to suggest appropriate amendments to the Act in view of transition to IFRS (IND AS) regime. This Committee submitted an interim report in August 2011. The recommendations of the Committee in such interim report were as under:

1. Separate AS should be notified u/s. 145(2), since the AS to be notified would have to be in harmony with the Act. The notified AS should provide specific rules, which would enable computation of income with certainty and clarity, and would also need elimination of alternatives, to the extent possible.

2. Since it would be burdensome for taxpayers to maintain 2 sets of books of account, the AS to be notified should apply only to computation of income, and books of account should not have to be maintained on the basis of such AS.

3. T o distinguish such AS from other AS, these AS should be called Tax Accounting Standards (“TAS ”).

4. S ince TAS were based on mercantile system of accounting, they should not apply to taxpayers following cash system of accounting.

5. S ince TAS are meant to be in harmony with the Act, in case of conflict, the provisions of the Act should prevail over TAS .

6. S ince the starting point for computation of taxable income was the profit as per the financial accounts, which are prepared on the basis of AS whose provisions may be different from TAS , a reconciliation between the income as per the financial statements and the income computed as per TAS should be presented.

In October 2011, drafts of 2 TAS – Construction Contracts and Government Grants – were released for public comment. In May 2012, drafts of another 6 TAS were released for public comment.

The Committee gave its final report in August 2012. It focused only on formulation of TAS harmonised with the provisions of the Act, since the position regarding the transition to Ind-AS was fluid and uncertain, and therefore even the impact of Ind-AS on book profits relevant for the purposes of MAT could not be ascertained.

It recommended that of the 31 AS issued by ICAI, 7 AS did not need to be examined, since they did not relate to computation of income. Of the remaining 24 AS, 10 related to disclosure requirements, were not yet mandatory or were not required for computation of income. The Committee therefore provided drafts of 14 TAS . The Committee also recommended that TAS in respect of certain other areas be considered for notification – Share based payment, Revenue recognition by real estate developers, Service concession arrangements (example, Build Operate Transfer agreements), and Exploration for and evaluation of mineral resources.

In January 2015, the CBDT released the draft of 12 TAS (renamed as ICDS) for public comment. These did not include 2 TAS recommended by the Committee – Contingencies and Events Occurring After the Balance Sheet Date and Net Profit or Loss for the Period, Prior Period Items and changes in Accounting Policies.

Section 145 was amended by the Finance (No. 2) Act, 2014 with effect from 1st April 2015 (assessment year 2015-16), by substituting the term “income computation and disclosure standards” for the term “accounting standards” in sub-section (2). Similarly, sub-section (3) was amended to substitute the “not regular following of accounting standards” with “non-computation of income in accordance with the notified ICDS”.

Finally, in March 2015, the CBDT notified 10 ICDS as under:

ICDS I – Accounting Policies
ICDS II – Valuation of Inventories
ICDS III – Construction Contracts
ICDS IV – Revenue Recognition
ICDS V – Tangible Fixed Assets
ICDS VI – Effects of Changes in Foreign Exchange Rates
ICDS VII – Government Grants
ICDS VIII – Securities
ICDS IX – Borrowing Costs
ICDS X – Provisions, Contingent Liabilities and Contingent Assets

The draft ICDS prepared by the Committee but not notified were those relating to Leases and Intangible Fixed Assets.

Applicability & Issues
The notified ICDS apply with effect from assessment year 2016-17, while section 145(2) was amended with effect from assessment year 2015-16. Therefore, for assessment year 2015-16, IT-AS would not apply, since the section provides for ICDS to be followed. Further, since ICDS were not notified till March 2015, ICDS were also not required to be followed for that year. Effectively, for assessment year 2015-16, neither IT-AS nor ICDS would apply. ICDS would apply only with effect from assessment year 2016-17.

ICDS would apply to all taxpayers following mercantile system of accounting, irrespective of the level of income. It would not apply to taxpayers following cash system of accounting. It would not apply only to taxpayers carrying on business, but even to other taxpayers, who may have income under the head “Income from Other Sources”. Effectively, since almost every taxpayer would have at least bank interest, which is taxable under the head “Income from Other Sources”, it would apply to most taxpayers. Further, most taxpayers choose to offer income for tax on an accrual basis, to facilitate matching of tax deducted at source (TDS) from their income with their claim for TDS credit as per their return of income.

Would it apply to taxpayers who do not maintain books of accounts? The provisions would certainly apply to all taxpayers who offer their income to tax under these 2 heads of income on a mercantile basis. Can a taxpayer choose to offer his income to tax on a cash basis, where books of account are not maintained, or is it to be presumed that his income has to be taxed on a mercantile or accrual basis in the absence of books of accounts?

In N. R. Sirker vs. CIT 111 ITR 281, the Gauhati High Court considered the issue and held as under:

“It can safely be assumed that ordinarily people keep accounts in cash system, that is to say, when certain sum is received, it is entered in his account and in the case of firms, etc., where regular method of accounting is adopted, sometimes accounts are kept in mercantile system. In the instant case it was not the case of the department that the assessee’s accounts were kept in mercantile system. On the other hand, the assessment orders showed that no proper accounts were kept. That being so it would not be justified to presume that the assessee kept his accounts in the mercantile system. Income-tax is normally paid on money actually received as income after deducting the allowable deductions. In the case of an assessee maintaining accounts in mercantile system, there was some variation, inasmuch as moneys receivable and payable were also shown as received and paid in the books. In order to apply this method, the proved or admitted position must be that the assessee keeps his accounts in mercantile system.”

Similarly, in Dr. N. K. Brahmachari vs. CIT 186 ITR 507, the Calcutta High Court held that unless and until it was found that the assessee maintained his accounts on accrual basis, income accrued but not received could not be taxed.

In CIT vs. Vimla D. Sonwane 212 ITR 489, the Bombay High Court considered a case where the assesse did not maintain regular books of accounts and did not follow mercantile system of accounting. The Bombay High Court held in that case:

“Option regarding adoption of system of accounting is with the assessee and not with the Income-tax Department. The assessee is indeed free even to follow different methods of accounting for income from different sources in an appropriate case. The department cannot compel the assessee to adopt the mercantile system of accounting. As a matter of fact, it was not adopted.”

In Whitworth Park Coal Co. Ltd. vs. IRC [1960] 40 ITR 517, the House of Lords laid down that where no method of accounting had been regularly employed, a non-trader cannot be assessed, (in the Indian context, u/s. 56 under the head ‘Income from other sources’) in respect of money which he has not received. The House of Lords observed:

“…The word ‘income’ appears to me to be the crucial word, and it is not easy to say what it means. The word is not defined in the Act and I do not think that it can be defined. There are two different currents of authority. It appears to me to be quite settled that in computing a trader’s income account must be taken of trading debts which have not yet been received by the trader. The price of goods sold or services rendered is included in the year’s profit and loss account although that price has not yet been paid. One reason may be that the price has already been earned and that it would give a false picture to put the cost of producing the goods or rendering the services into his accounts as an outgoing but to put nothing against that until the price has been paid. Good accounting practice may require some exceptions, I do not know, but the general principle has long been recognised. And if in the end the price is not paid it can be written off in a subsequent year as a bad debt.

But the position of an ordinary individual who has no trade or profession is quite different. He does not make up a profit and loss account. Sums paid to him are his income, perhaps subject to some deductions, and it would be a great hardship to require him to pay tax on sums owing to him but of which he cannot yet obtain payment. Moreover, for him there is nothing corresponding to a trader writing off bad debts in a subsequent year, except perhaps the right to get back tax which he has paid in error.” (p. 533)

“The case has often arisen of a trader being required to pay tax on something which he has not yet received and may never receive, but we were informed that there is no reported case where a non-trader has had to do this whereas there are at least three cases to the opposite effect—Lambe v. IRC [1934] 2 ITR 494, Dewar v. IRC 1935 5 Tax LR 536 and Grey v. Tiley [1932] 16 Tax Cas. 414, and I would also refer to what was said by Lord Wrenbury in St. Lucia Usines & Estates Co. Ltd. v. St. Lucia ( Colonial Treasurer) [1924] AC 508 (PC). I certainly think that it would be wrong to hold now for the first time that a non-trader to whom money is owing but who has not yet received it must bring it into his income-tax return and pay tax on it. And for this purpose I think that the company must be treated as a non-trader, because the Butterley’s case [1957] AC 32 makes it clear that these payments are not trading receipts.” (p. 533)

Therefore, for income falling under the head “Income from other sources”, it is clear that in the absence of books of accounts, and where the assessee has not exercised any option, the income would be taxable on a cash basis.

It is well settled that the method of accounting is vis-a-vis each source of income, since computation of income is first to be done for each source of income, and then aggregated under each head of income. An assessee can choose to follow one method of accounting for some sources of income, and another method of accounting for other sources of income. In J. K. Bankers vs. CIT 94 ITR

107 (All), the assessee was following mercantile system of accounting in respect of interest on loans in respect of its moneylending business, and offered lease rent earned by it to tax on a cash basis under the head “Income from Other Sources”. The Allahabad High Court held that an assessee could choose to follow a different method of accounting in respect of its moneylending business and in respect of lease rent. Similarly, in CIT vs. Smt. Vimla D. Sonwane 212 ITR 489, the Bombay High Court held that “The assessee is indeed free even to follow different methods of accounting for income from different sources in an appropriate case”.

Where an assessee follows cash method of accounting for certain sources of income and mercantile system of accounting for others, ICDS would apply only to those sources of income, where mercantile system of accounting is followed and would not apply to those sources of income, where cash method of accounting is followed. For instance, an assessee may have a manufacturing business, and a separate commission agency business. He may be following mercantile system of accounting for his manufacturing business, and a cash method of accounting for his commission agency business. ICDS would then apply only to the manufacturing business, and not to the commission agency business.

Can a taxpayer opt to change his method of accounting from mercantile to cash basis, in order to prevent the applicability of ICDS? Under paragraph 5 of ICDS I, an accounting policy shall not be changed without reasonable cause. Under AS 5, such a change was permissible only if the adoption of a different accounting policy was required by statute or for compliance with an accounting standard or if it was considered that the change would result in a more appropriate presentation of the financial statements of the enterprise. Would a change in law amount to reasonable cause? If such a change is made from assessment year 2016-17, the year from which ICDS comes into effect, an assessee would need to demonstrate that such change was actuated by other commercial considerations, and not merely to bypass the provisions of ICDS.

Do ICDS apply to a taxpayer who is offering his income to tax under a presumptive tax scheme, such as section 44AD? Under the presumptive tax scheme, books of account are not relevant, since the income is computed on the basis of the presumptive tax rate laid down under the Act. It therefore does not involve computation of income on the basis of the method of accounting, or on the basis of adjustments to the accounts. Therefore, though there is no specific exclusion under the notification for taxpayers following under presumptive tax schemes from the purview of ICDS, logically, ICDS should not apply to such taxpayers. However, where the presumptive tax scheme involves computation of tax on the basis of gross receipts, turnover, etc., it is possible that the tax authorities may take a view that the ICDS on revenue recognition would apply to compute the gross receipts or turnover in such cases.

Would ICDS apply to non-residents? The provisions of ICDS apply to all taxpayers, irrespective of the concept of residence. However, where a non-resident taxpayer falls under a presumptive tax scheme, such as section 115A, on the same logic as that of presumptive tax schemes applicable to residents, the provisions of ICDS should not apply. Further, where a non-resident claims the benefit of a double taxation avoidance agreement (DTAA), by virtue of section 90(2), the provisions of the DTAA would prevail over the provisions of the Income-tax Act, including section 145(2) and ICDS notified thereunder. In other cases of incomes of non-residents, which do not fall under presumptive tax schemes or DTAA, the provisions of ICDS would apply.

It has been stated in each ICDS that the ICDS would not apply for the purpose of maintenance of books of accounts. While theoretically this may be the position, the question arises as to whether it is practicable or even possible to compute the income under ICDS without maintaining a parallel set of books of account, given the substantial differences between AS being followed in the books of accounts and ICDS. Most taxpayers would end up at least preparing a parallel profit and loss account and balance sheet, to ensure that ICDS and its consequences have been properly taken care of while making the adjustments.

Further, the Committee had recommended that a tax auditor is required to certify that the computation of taxable income is made in accordance with the provisions of ICDS. Before certification, a tax auditor would invariably require such parallel profit and loss account and balance sheet to be prepared, to ensure that all adjustments required on account of ICDS have been considered. This will result in substantial work for most businesses, and may even result in the requirement of parallel MIS, one for the purposes of regular accounts, and the other for the purposes of ICDS. One wonders whether the Committee really wanted to avoid the requirement of maintenance of 2 sets of books of account, as stated by it, or has taken into account the practical difficulties, given the complex and myriad adjustments it has suggested through ICDS.

An interesting issue arises in this context. Can an assessee maintain 2 separate books of accounts – one under the Companies Act or other applicable law on a mercantile system, and a parallel set of books of accounts for income tax purposes on a cash basis? If one looks at the provisions of section 145(1), it provides that income chargeable under these 2 heads of income shall be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. What is the meaning of the term “regularly employed”? Normally, the system of accounting adopted by the assesse in his books for his dealings with the outside world would be adopted for the purposes of computing the profit or loss for tax purposes also. The accounts are those maintained in the regular course of business. It may therefore be difficult for an assessee to maintain separate books of account with different system of accounting only for income tax purposes.

It may be noted that even after the introduction of ICDS, the computation still has to be in accordance with the method of accounting regularly employed by the assessee. Compliance with ICDS is an additional requirement. Therefore, the computation in accordance with the method of accounting is merely modified by the requirements of ICDS, and not substituted entirely.

Since ICDS is not applicable for the purposes of maintenance of books of account, one wonders as to what is the purpose and ambit of ICDS I on Accounting Policies. Since the purpose of ICDS is not to lay down accounting policies which are to be followed in the maintenance of the books of account, ICDS I should be regarded as merely a disclosure standard and not a computation standard. There are however certain provisions in ICDS I which relate to computation.

For example, the provision that accounting policies adopted shall be such was to represent a true and fair view of the state of affairs and income of the business, profession or vocation, and that for this purpose, the treatment and presentation of transaction and events shall be governed by their substance and not merely by their legal form, and marked to market loss or an expected loss shall not be recognised, unless the recognition of such loss is in accordance with the provisions of any other ICDS, really relates to what accounting policies an assessee should follow in its books of account. This is inconsistent with the preamble to this ICDS, that it is not applicable for the purpose of maintenance of books of account. This is also ultra vires the powers available under the provisions of section 145(2), which provide for computation in accordance with notified ICDS, and no longer contain the power to notify accounting standards.

This anomaly possibly arose on account of the fact that the provisions of section 145(2) were modified only after the Committee provided the draft of the relevant ICDS. Possibly, such provisions of ICDS I may not be valid.

Each ICDS states that in the case of conflicts between the provisions of the Income-tax Act and the ICDS, the provisions of the Act would prevail to that extent. Such a provision is ostensibly to harmonise the provisions of the ICDS with the provisions of the Act. One wonders as to why the Committee did not take into account the various provisions of the Act while framing ICDS. While such a provision is helpful, it would lead to substantial litigation in cases where there is no express provision in the Act, but where courts have interpreted the provisions of the Act in a manner which is inconsistent with the provisions of the ICDS.

There have been 3 specific amendments made to the Income-tax Act by the Finance Act 2015, to ensure that the provisions of the Act are in line with the provisions of ICDS. These 3 provisions are as under:

1. The definition of “income” u/s. 2(24) has been amended by insertion of clause (xviii) to include assistance in the form of a subsidy or grant or cash incentive or duty drawback or favour or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee, other than the subsidy or grant or reimbursement, which is taken into account for determination of the actual cost of the asset in accordance with the provisions of explanation 10 to clause (1) of section 43. This is to align it with the provisions of ICDS VII on Government Grants.

2. The provisions of the proviso to section 36(1)(iii) have been modified to delete the words “for extension of existing business or profession”, after the words “in respect of capital borrowed for acquisition of an asset”, to bring the section in line with ICDS IX on Borrowing Costs, whereby interest in respect of borrowings for all assets acquired, from the date of borrowing till the date of first put to use of the asset, is to be capitalised.

3. A second proviso has been inserted to section 36(1) (vii), to provide that where a debt has been taken into account in computing the income of an assessee for any year on the basis of ICDS without recording such debt in the books of accounts, then such debt would be deemed to have been written off in the year in which it becomes irrecoverable. This is to facilitate the claim for deduction of bad debts, where the debt has been recognised as income in accordance with ICDS, but has not been recognised in the books of accounts in accordance with AS.

Obviously, with the amendment of the Income-tax Act as well, the provisions of the ICDS in this regard read along with the amended Act, which may be contrary to earlier judicial rulings, would now apply.

There could be earlier judicial rulings which are based on the relevant provisions of the accounting standards, and where the court therefore interpreted the law on the basis of such accounting standards. These judicial rulings would now have to be considered as being subject to the requirements of ICDS, as the method of accounting is now subject to modification by the provisions of ICDS.

The third and last category of judicial rulings would be those where the courts have laid down certain basic principles while interpreting the tax law, in particular, the relevant provisions of the tax law. In such cases, such judicial rulings would override the provisions of ICDS, since such rulings have interpreted the provisions of the Act, which would prevail over ICDS.

For instance, various judicial rulings have propounded the real income theory. The Delhi High Court, in the case of CIT vs. Vashisht Chay Vyapar 330 ITR 440 has held, based on the real income theory, that interest accrued on non-performing assets of non-banking financial companies cannot be taxed until such time as such interest is actually received. Would the contrary provisions of ICDS IV on revenue recognition change the position? It would appear that the ruling will still continue to hold good even after the introduction of ICDS.

In case any of the provisions of ICDS is contrary to the Income Tax Rules, which one would prevail? The provisions of ICDS are silent in this regard. Given the fact that rules are a form of delegated legislation, while ICDS is in the form of a notification, which then becomes a part of the legislation, it would appear that the provisions of ICDS should prevail in such cases.

Since ICDS is not applicable for the purpose of maintenance of books of account, it is clear that the provisions of ICDS would not apply to the computation of “book profits” for the purposes of minimum alternate tax under section 115JB.

In fact, most of the ICDS provisions would increase the gap between the taxable income and the book profits, instead of narrowing down the gap. In this context, one wonders whether a recent Telangana & Andhra Pradesh High Court decision would be of assistance. In the case of Nagarjuna Fertilizers & Chemicals Limited 373 ITR 252, the High Court held that where an item of income was taxed in an earlier year but was recorded in the books of account of the current year, on the principle that the same income could not be taxed twice, such income had to be excluded from the book profits of the current year.

Can one use the provisions of AS for interpreting ICDS, where the provisions of both are identical? If one compares the ICDS with the corresponding AS, one notices that the bold portion of the AS has been picked up and modified, and issued as ICDS. Where the provisions of the AS and ICDS are identical, one should therefore be able to take resort to the explanatory paragraphs forming part of the AS, though they do not form part of the ICDS, in order to interpret the ICDS.

Impact & Conclusion

One thing is certain – the provisions of ICDS will create far greater litigation, then what one is now witnessing. That would defeat the very purpose of ICDS of bringing in tax certainty and reduction of litigation. Does reduction of litigation mean introduction of complicated provisions which are unfair to taxpayers? Is there at least one provision in the ICDS which decides a disputed issue in favour of taxpayers?

Does the CBDT believe that what is accepted worldwide as income (profit determined in accordance with IFRS), is not the real income when it comes to taxation? Are the Indian tax authorities an exception to the rest of the world? ICDS does not increase taxes – it merely results in advancement of taxability of income to an earlier year, and postponement of allowability of expenditure to a later year. Is the need for advancement of tax revenues so pressing, that taxpayer convenience and compliance costs are brushed aside?

Looking at the requirements of ICDS, one cannot but help wonder as to whether ICDS has been merely brought in to overcome the impact of adverse judicial rulings, and not really with a view to facilitate transition to IndAS. What ought to have been done by amendments to the law is being sought to be implemented through ICDS.

Assessees would now have to cope with not only frequent changes to the law, but also with frequent changes to ICDS, given the unfinished agenda of 4 draft ICDS yet to be notified, and the further 4 recommended for notification by the Committee. One understands that the Committee is in the process of drafting further ICDS for notification.

One also understands that the CBDT is likely to issue FAQs to clarify various aspects of ICDS. One only hopes that such FAQs will not create further confusion, but would help clear the confusion created by the ICDS.

One wonders as to how such ICDS fits in with the Prime Minister’s promise to improve the ease of doing business. The additional compliance costs in order to comply with ICDS would far outweigh the advantages gained by the tax department by recovering taxes at an earlier stage. Would business be keen to expand or would persons be willing to set up new businesses, given the significant compliance costs? The country would certainly take a significant hit in the “Ease of Doing Business Survey” once ICDS is implemented.

Tax auditors will now be in an extremely difficult situation, if the recommendation relating to requirement of certification of computation of income in accordance with ICDS is implemented. So far, they merely had to certify the true and fair view of the accounts, and the correctness of the information provided in Form 3CD. They did not have to certify the correctness of the claims for various deductions. If an auditor would now have to certify the correctness of the computation of income, this would give rise to various issues as to how such certification could be carried out, particularly in cases where the issue was debatable.

Instead of taxpayers, tax auditors may bear the brunt of the income tax department’s actions in respect of claims for deduction or exemption made which, in the view of the income tax department, is not allowable. Would assessees be willing to remunerate tax auditors for such additional high risks which they would bear in certifying the computation of income? If such a requirement of certification of the computation of income were introduced, it is possible that many chartered accountants may no longer be willing to carry out tax audits.

The biggest beneficiaries of ICDS may be tax lawyers and chartered accountants, who will have to handle the resultant additional litigation. The biggest losers will be the taxpayers, due to additional compliance and litigation costs, and the country, due to loss of productive manhours, and the loss of potential growth in business.

Nirav Shah

THE FINANCE ACT, 2013

1 Introduction

1.1 Shri P. Chidambaram, the Union Finance Minister, presented the last effective Budget of the present term of the UPA II Government for the year 2013-14 on 28th February, 2013. The Finance Bill, 2013, introduced by him with his budget, contained 125 clauses, out of which only 53 clauses relate to ‘Direct Taxes’ and 72 clauses relate to ‘Indirect Taxes’. This year, there was no serious debate in the Parliament on the Finance Bill. The Finance Minister introduced 11 new clauses, which were more or less of clarificatory nature on 30th April, 2013, and the Bill was passed by the Lok Sabha on the same day without any debate. Similarly, the Rajya Sabha passed the Finance Bill without any debate on 2nd May, 2013. The Bill has received the assent of the President on 10th May, 2013.

1.2 While concluding his Budget Speech, the Finance Minister has, in Para 188, made some predictions as under:

“Any economist will tell us what India can become. We are the tenth-largest economy in the World. We can become the eighth, or perhaps the seventh largest by 2017. By 2015, we could become a $5 trillion economy, and among the [top] five in the world. What we will become depends on us and on the choices that we make. Swami Vivekananda, whose 150th birth anniversary we celebrate this year, told the people: “All the strength and succour you want is within yourself. Therefore, make your own future.”

1.3 In Para 185 of the Budget Speech, it is stated that the effect of changes in Direct Tax Laws this year will bring additional revenue of Rs. 13,300 crore. So far as Indirect Taxes are concerned, the additional revenue will be Rs 4,700 crore.

1.4 In this Article, the amendments made in the Income-tax Act, the Wealth Tax Act and Securities Transaction Tax (STT) are discussed. A new tax viz. “Commodities Transaction Tax” (CTT) is now levied u/s. 105 to 124 of the Finance Act, 2013. This is on the same lines as the STT. The important features of this new tax are also discussed in this Article.

2 Rates of income tax, surcharge and education cess:
2.1 Surcharge on Super-Rich:

There are no changes in the tax slabs, rates of income tax, or rates of Education Cess. In Para 126 of the Budget Speech, the Finance Minister has stated that “Fiscal consolidation cannot be effected only by cutting expenditure. Wherever possible, revenues must also be augmented. When I need to raise resources, who can I go to except those who are relatively well placed in society? There are 42,800 persons — let me repeat, only 42,800 persons — who admitted to a taxable income exceeding Rs. 1 crore per year. I propose to impose a surcharge of 10 percent on persons whose taxable income exceeds Rs. 1 crore per year. This will apply to individuals, HUFs, firms and entities with similar tax status.” In Para 127, he has stated that in the cases of domestic companies, the existing surcharge is 5% if the taxable income exceeds Rs. 1 crore. This will now be 10% if the taxable income exceeds Rs. 10 crore. Similarly, in the case of a foreign company the existing surcharge of 2% will increase to 5% — if the income exceeds Rs. 10 crore. In Para 128, the Finance Minister has stated that the existing surcharge of 5% will increase to 10% in case of tax on dividend distribution. Further, in Para 129 of his speech, he has stated that this additional surcharge will be in force only for one year i.e. financial year 2013-14 (A.Y. 2014-15).

2.2 Rebate from Tax:

In order to give a small relief to Resident Individual Tax Payers, a new Section 87A is inserted in the Income-tax Act (IT Act) w.e.f. A.Y. 2014-15. Under this section, a resident individual whose total income does not exceed Rs. 5 lakh, will be entitled to receive a rebate of Rs. 2,000/- or the income tax payable (whichever is less) from the income tax payable by him. It may be noted that this rebate cannot be claimed by an HUF.

2.3 Rates of Income-tax and Surcharge:

(i) For Resident Individuals, HUF, AOP, BOI and Artificial Juridical Person, as stated above, there are no changes in the tax slabs, rates of Income tax or rates of Education Cess. The only change is about levy of 10% surcharge on tax if the income exceeds Rs. 1 crore. The rates of tax for A.Y. 2013-14 and A.Y. 2014-15 (Accounting years ending on 31-03-2013 and 31-03-2014) are the same as stated below):

Notes:

•    In A.Y. 2014-15 Surcharge @ 10% of the tax will be payable if income of the assessee exceeds Rs. 1 crore.
•    An Individual having gross total income below Rs 5 lakh will get rebate upto Rs. 2,000/- from tax in A.Y. 2014-15 u/s. 87A.
•    Education Cess of 3% (2%+1%) of the tax is payable for both the years.

(ii) The following table gives figures of tax payable by Resident Individual, HUF, AOP, BOI etc. in A.Y. 2013-14 and A.Y. 2014-15.

(a) Tax payable in A.Y. 2013-14 (Accounting year ending on 31-03-2013)

Note: The above tax is to be increased by 3% of tax for Education Cess.

(b) Tax payable in A.Y. 2014-15(Accounting year ending on 31-03-2014)

Notes:

•    In the first two items (Rs. 3 lakh and Rs. 5 lakh) in the case of an Individual having income below Rs. 5 lakh, the tax payable will be reduced by Rebate of Rs. 2,000/- u/s. 87A.
•    The last item (Rs. 125 lakh) includes surcharge of 10%.
•    The above tax is to be increased by 3% of tax for Education Cess.

(iii) Other Assessees (excluding companies)

The rates of taxes (including rate of Education Cess) for the other assesses (excluding companies) for A.Y. 2013-14 and A.Y. 2014-15 are the same. No surcharge on tax was payable by Co-operative Societies, Firms, LLP or Local Authority in A.Y. 2013-14. However, in A.Y. 2014-15, if the income of the above entities exceed Rs. 1 crore, Surcharge @ 10% of tax will be payable.

(iv) For Companies:

The rates of Income tax for Companies for A.Y. 2013-14 and A.Y. 2014-15 are the same. For domestic companies, surcharge of 5% of tax is payable in A.Y. 2013-14 if the total income exceeds Rs. 1 crore. In A.Y. 2014-15, the rate of surcharge will be 5% if the total income exceeds Rs. 1 crore but does not exceed Rs. 10 crore. If the total income exceeds Rs. 10 crore, the rate of surcharge will be 10% of the tax payable on the entire income.

In the case of a foreign company there is no change in the rates of income tax in A.Y. 2013- 14 and A.Y. 2014-15. As regards surcharge, the rate is 2% of the tax if the total income exceeds Rs. 1 crore in A.Y. 2013-14. In A.Y. 2014-15, the rate of surcharge will be 2% if the total income exceeds Rs. 1 crore but does not exceed Rs. 10 crore. If the total income exceed Rs 10 crore the rate of surcharge will be 5% of the tax payable on the entire income.

In both the above cases, Education Cess @ 3% of tax is payable in A.Y. 2013-14 and A.Y. 2014-15.

(v) Rate of Tax u/s. 115JB (MAT)

The rate of tax (i.e. 18.5%) will be payable on the book profits of a company computed u/s. 115JB (MAT) in A.Y. 2013-14 and A.Y. 2014-15. The surcharge will be payable on this tax as stated in (iv) above. Education Cess @ 3% of the tax plus applicable surcharge will be payable as at present.

(vi) Rate of Tax u/s. 115JC (AMT)

The rate of tax (i.e. 18.5%) will be payable on the adjusted total income of non-corporate assesses u/s. 115JC (AMT) in A.Y. 2013 -14 and A.Y. 2014-15. The surcharge and Education Cess will be payable on this tax as stated in (iii) above.

(vii) Dividend Distribution Tax:

Dividend Distribution Tax or Income Distribution Tax payable u/s. 115O, 115QA, 115R or 115TA shall be pay-able as provided in these section. The surcharge at 10% of tax will be payable in respect of the above tax for A.Y. 2014-15. The Education Cess @ 3% of the tax shall also be payable on the above tax. It may be noted that surcharge @ 10% of tax will be payable irrespective of the amount distributed under these sections.

(viii) Rate of Tax on Dividends from Specified Foreign Companies:

The concessional rate of 15% plus applicable surcharge and Education Cess which was applicable for A.Y. 2013-14 u/s. 115BBD has been extended for one more year i.e. for A.Y. 2014-15.

2.4 Education Cess:

As in the earlier years, Education Cess of 3% (including 1% Higher Education Cess) of the income tax and applicable surcharge is payable by all resident assessees and non-resident assessees. No Education Cess or surcharge is applicable on TDS and TCS from payments to all resident corporate and non-corporate assesses. However, if tax is deducted from

(a) payments to foreign companies, (b) payments to non-residents or (c) salary to residents or non-residents, Education Cess at 3% of the tax and applicable surcharge is to be deducted.

3. Tax deduction and collection at source (TDS and TCS)

3.1 In the case of a resident assessee or a domestic company, where tax is required to be deducted or collected at source, no surcharge or Education Cess of the applicable rate of tax is to be considered. However, in the case of a non -resident or a foreign company while deducting or collecting tax at source, under the provisions of the Income-tax Act during the period commencing from 01-04-2013, the applicable rate of tax is to be increased by the applicable rate of surcharge and Education Cess. As stated earlier, in the case of non-residents (other than foreign companies), if the total income exceeds Rs. 1 crore, the rate of surcharge is 10% of the tax. In the case of a foreign company, if the total income is more than Rs. 1 crore but less than Rs. 10 crore, the rate of surcharge is 2% of the tax. If the income is more than Rs. 10 crore, this rate is 5% of the tax on total income. In all cases, the rate of Education Cess is 3% of the tax (including applicable surcharge).

3.2 TDS on transfer of immovable property:

(i) Section 194-1A – This new section is inserted in the Income-tax Act w.e.f. 01-06-2013. It provides that any person (transferee) who purchases any immovable property (whether residential or commercial) for a consideration, shall now deduct tax at source at the rate of 1% of the amount paid to a resident seller (transferor) if the said consideration exceeds Rs. 50 lakh. For this purpose, the term “Immovable Property”, is defined to mean any land (other than Agricultural Land) or any building or part of a building. It may be noted that the section will apply in both cases i.e. when the purchaser is purchasing the property as a capital asset or as stock-in-trade.

(ii) This section will apply to all assessees, whether resident or non-resident, who purchase any immovable property in India from a resident. In other words, the obligation for deduction of tax is on every purchaser of immovable property, whether he is required to get his books of accounts audited u/s. 44AB or not. It will not be necessary for the purchaser to obtain Tax Deduction Account Number (TAN) u/s. 203A.

However, the purchaser will have to file TDS Return and deposit TDS amount with the Government as provided in Section 200. The seller of the property must provide his PAN to the purchaser. If this is not done, tax on the sale consideration will have to be deducted at 20% as provided in section 206AA. It may be noted that the option of obtaining certificate from the A.O. u/s. 197 prescribing NIL rate or lower rate of TDS is not available in the above case.

(iii) If the purchase of the immovable property is from a non-resident, the tax will be deductible by the purchaser at the applicable rate u/s. 195 as at present. This new section will not apply to such a purchase. Similarly, this new section will not apply to payment of compensation on acquisition of immovable property to which the provisions of TDS u/s. 194LA are applicable.

(iv) It may be noted that a similar provision for TDS was proposed to be introduced by the insertion of section 194LAA in the Income-tax Act by the Finance Bill, 2012. Under this provision, it was proposed that the purchaser of an immovable property for a consideration exceeding Rs. 50 lakh in the specified area and Rs. 20 lakh in other areas shall deduct tax at source @ 1% of the consideration. For this purpose, the consideration was to be considered as specified in the Sale Deed or stamp duty valuation u/s. 50C whichever was higher. The registering authority was directed not to register the document unless the evidence for payment of TDS amount was produced before him. There was a lot of protest against the introduction of such a provision last year. Therefore, this provision was dropped before passing the Finance Act, 2012. A similar provision is again introduced this year and in the absence of any serious debate the same has been now brought into force from 01-06-2013.

(v) This new provision is likely to raise some issues as under:

(a) The definition of immovable property only covers land (other than agricultural land) or building or part of the building. This will mean that any right in a building such as tenancy right, leasehold right etc. will not be subject to this TDS provision. [Refer: Atul G Puranik vs. ITO 132 ITD 499 (Mum)]

(b) If a person has booked a flat in a building under construction, either the flat is booked before 01-06-
2013 or after that date, and makes payment for the same, a question will arise whether he is required to deduct tax at source under this section. It is possible to take the view that by the agreement with the builder the purchaser gets a right to get the flat when constructed. Therefore, when the instalment payments are made to the builder there is no transfer of immovable property. [Refer: ITO vs. Yasin Moosa Godil 147 TTJ 94 (Ahd)] The transfer of flat will take place only when possession is given.

Therefore, the obligation to deduct tax will arise under this section only when the last instalment is paid against possession of the flat. However, TDS @ 1% will have to be deducted on the entire consideration for the flat at that time.

(c) Since there is no specific mention in this section that if the amount of stamp duty valuation u/s. 50C is more than the actual consideration, the stamp duty valuation will be considered as consideration for TDS purposes, it can be concluded that tax is to be deducted from the actual consideration payable as per the sale deed. As stated earlier, in the Finance Bill, 2012 the proposed section 194LAA specifically provided for considering stamp duty valuation if that was more than the consideration stated in the Sale Deed. There is no such provision in this new section 194-1A.

(d) Section 199 of the Income-tax Act provides that credit for TDS amount will be given against the income in respect of which such tax is deducted. In a transaction of sale of immovable property, the seller will be showing income from such sale under the head “Capital Gains” or “Income from Business or Profession”. It may so happen that an individual selling his immovable property may claim exemption u/s. 54 or 54F due to reinvestment in another property or u/s. 54EC by reinvestment in Bonds. In all such cases, credit for TDS under this new section will be available even if the income computed under the head “Capital Gains” is NIL.

(e) If the property is purchased by two or more persons as co-owners, the tax will be deductible by each co-owner in respect of his/her share of the consideration paid if the total consideration for the property exceeds Rs. 50 lakh. This section also applies in respect of purchase of property from a relative.

(f) It may be noted that there is no provision for disallowance of purchase price of the property u/s. 40(a)(ia) in the case of a purchaser who has purchased the property as stock-in-trade.

3.3 tds from interest income of FII or qfi:

Section 194LD: This is a new Section inserted in the Income-tax Act w.e.f. 01-06-2013. This Section provides that any person paying interest to a Foreign Institutional Investor (FII) or a Qualified Foreign Investor (QFI) in respect of the following investment shall deduct tax at source at the rate of 5% plus applicable surcharge and Education Cess.

(a) Interest on a Government Security

(b) Interest on a rupee denominated bond of an Indian Company, provided that the rate of interest does not exceed the rate notified by the Central Government.

It may be noted that consequential amendments have been made in Sections 115A, 115AD, 195 and 196D. However, no consequential amendment is made in Section 206AA and, therefore, in the case of any FII or QFI, if PAN is not furnished tax will be deductible @ 20% plus applicable surcharge and Education Cess.

3.4 Section 206AA: This section is amended w.e.f. 01-06-2013. By this amendment, it is now clarified that in respect of interest paid to a non-resident or a foreign company on long term infrastructure bonds issued by an Indian Company in foreign currency as provided in section 194LC, the provisions of section 206AA will not apply from 01-06 -2013. Therefore, if such foreigner lender does not furnish PAN, the tax will be deducted at 5% plus applicable surcharge and Education Cess u/s. 194LC and not at the rate of 20% as provided in section 206AA.

It is surprising that similar concession is not given u/s. 206AA to tax deductible u/s. 194LD as discussed in Para 3.3 above.

3.5 Section 206C – Tax collection at source (TCS)

This section was amended last year w.e.f. 01-07-2012 by inserting s/s. (1D) in section 206C providing for TCS @ 1% of the sale consideration for bullion purchased by a buyer if the consideration exceeded Rs. 2 lakh and was paid in cash by the buyer. It was provided that for this purpose, the term “Bullion” shall not include any coin or any other article weighing 10 grams or less. This provision is now amended by the Finance Act, 2013, and it is provided that w.e.f. 01-06-2013, the exemption given from TCS provision to a coin or other article of bullion weighing 10 grams or less shall not be available. Therefore, tax will have to be collected @ 1% if the buyer of bullion (including any coin or other article) pays amount exceeding Rs. 2 lakh in cash.

4. Exemptions and Deductions:

4.1 Agricultural Land Section 2(1A) and 2(14):

These two sections of the Income tax Act have been amended w.e.f. A.Y. 2014-15.

(i) Section 2(14) defines the term “Capital Asset”.
As per the provisions of the section before the amendment, agricultural land situated within the jurisdiction of a Municipality, Cantonment Board etc. having population of more than 10,000 was considered as a Capital Asset. Similarly, agricultural land situated within the distance (not exceeding 8 kms) from the local limits of a Municipality, Cantonment Board etc. as notified was also considered as Capital Asset.

(ii) Section 2(14) has now been amended to provide that the agricultural land situated in any area within the following distance, measured aerially, from the local limits of any Municipality, Cantonment etc. shall be considered as a Capital Asset.

(a)    Within 2 kms having population of more than 10,000 but less than 1 lakh;
(b)    Within 6 kms having population of more than 1 lac but less than 10 lakh;
(c)    Within 8 kms having population of more than 10    lakh.

In other words, agricultural land situated outside the above territory will not be considered as Capital Asset u/s. 2(14).

(iii) The population for the above purpose is defined to mean population according to the last preceding census of which the relevant figures have been published before the first day of the Financial Year. The distance for the above purpose is to be measured “aerially”. This provision appears to have been made to settle the controversy about the method of measurement. In the case of CIT vs. Satinder Pal Singh 188 Taxman 54 (P&H) it was held that the distance should be measured by approach road and not by a straight line distance on a horizontal plane.

(iv) Section 2(1A) has similarly been amended w.e.f. A.Y. 2014-15.

Income derived from any building and situated in the immediate vicinity of the agricultural land is presently exempt as agricultural income, subject to certain conditions u/s. 2(1A). By amendment of this section, it is now provided that income from such building falling within the area specified in (ii) above will not qualify for exemption as agricultural income.

4.2 Keyman Insurance Policy – Section 10(10D)

(i) Section 10(10D) grants exemption to any sum received under a life insurance policy, subject to certain conditions. Amount received on maturity of Keyman Insurance Policy is not exempt u/s. 10(10D). There was a controversy whether the Keyman Insurance Policy assigned to the beneficiary continues to be a Keyman Insurance Policy. Delhi High Court held in the case of CIT vs. Rajan Nanda 349 ITR 8 that the Keyman Insurance Policy becomes an ordinary policy on the life of the beneficiary on assignment and therefore the amount received under this policy will be exempt if other conditions of section 10(10D) are complied with. To overcome this decision, Explanation 1 to the section is now amended w.e.f. A.Y. 2014-15 to provide that the Keyman Insurance Policy which has been assigned to the beneficiary during its term, with or without consideration, will be considered to be a Keyman Insurance Policy u/s. 10(10D) and exemption under that section will not be available in respect of the amount received on maturity. It may be noted that for A.Y. 2013-14 and earlier years the exemption can be claimed on the basis of Delhi High Court decision in the case of CIT vs. Rajan Nanda 349 ITR 8.

(ii) One of the conditions for granting exemption provided in section 10(10D)(d) is that the annual premium payable in respect to a life insurance policy should not exceed 10% of capital sum insured. This percentage of the premium is increased to 15% in the case of insurance policy issued on or after 01-04-2013 on the life of (a) a person with disability stated in section 80U or (b) a person who is suffering from a disease or ailment specified u/s. 80DDB. Consequential amendment is made in section 80C also.

4.3 Securitisation Trusts: New Sections 10(23DA), 10(35A), 115TA to 115TC

(i) New Scheme for taxation of Income of Securitisation Trust (Trust) has been introduced from A.Y. 2014-15. For this purpose, new sections 10(23D), 10(35A), 115TA, 115TB and 115TC have been added. The terms “Securitisation Trust”, “Securities”, “Securitised Debt Instrument”, “Instruments” “Investor” and “Special Purpose Vehicle” are defined in section 115TC. These terms have the same meaning as given to them in SEBI (Public Offer and

Listing of Securitised Debt Instruments) Regulations, 2008 or the Guidelines on the securitisation of standard assets issued by RBI.

(ii) Under the new scheme the provisions can be summarised as under:

(a) Any income of the Trust from the activity of securitisation will be exempt from tax u/s. 10(23DA);

(b) Income received by the Investor holding any securitised debt instrument or securities issued by the Trust will be exempt in the hands of the Investor u/s. 10(35A);

• In the case of Individual or HUF – 25% Income tax plus applicable surcharge and Education Cess;

• In the case of others – 30% Income tax plus applicable surcharge and Education Cess;

• In the case of a person who is not liable to pay tax on such income – No tax is payable by the Trust.

The provisions for payment of the above tax on income distributed to Investors are contained in section 115TA to 115TC. These provisions are similar to tax payable on distribution of dividend by a company and tax payable on distribution of income by a Mutual Fund.

(iii) Section 115TA also provides for filing of Statement of income distributed and tax paid thereon, charging of interest for the delayed payment of tax and treating a person responsible for compliance with these provisions as an assessee in default for the non-compliance with provisions of sections 115TA to 115TC.

(iv) If one compares the existing provisions with the above new scheme, it will noticed that under the above scheme the total tax liability of the trust and Investors, put together, will be more.

4.4 Investor Protection Fund: New Section 10(23ED)

This is a new section inserted w.e.f. A.Y. 2014-15. This section grants exemption to any income, by way of contribution received from a Depository by an Investor Protection Fund (Fund) set up in accordance with the regulations notified by the Central Government. It may be noted that Depositories (NSDL or CDSL) are required to set up Investor Protection Fund as provided in SEBI (Depositories and Participants) Regulations, 1996. The above exemption is now provided to the Fund in respect of contribution by the Depository. It is also provides that if the Fund shares any amount with the Depository in any year, out of such exempt income, the amount so shared will be taxable in its hands. This section is on the same lines as section 10(23EA) which grants exemption to amount contributed by a recognised Stock Exchange to its approved Investor Protection Fund.

4.5 Venture Capital Fund: Section 10(23FB):

This section provides for exemption to any income of Venture Capital Company (VCC) and Venture Capital Fund (VCF) from investment in Venture Capital Undertaking (VCU). Essentially, this section treats VCC and VCF as pass-through entities. U/s. 10(23FB), the income of VCC and VCF is exempt but is taxable directly in the hands of investors in these entities u/s. 115U. The SEBI (VCF) Regulations, 1996, have been replaced by the SEBI (Alternative Investment Funds) Regulations, 2012 w.e.f. 12-05-2012. By amendment of Section 10(23FB), w.e.f. A.Y. 2013-14, the existing explanation has been substituted to provide as under:

(i) The pass-through status can be enjoyed by VCC and VCF that has been granted registration as category I Alternative Investment Fund;

(ii) VCC and VCF registered and governed by old VCF Regulations will continue to enjoy the pass through status;

(iii) VCC/VCF will have to comply with the conditions stated in the Explanation. Shares of the VCC and Units of the VCF should not be listed on any recognised stock exchange. 2/3rd of the investible funds should be invested in unlisted equity shares or equity linked instruments of a VCU. Further, the VCC should not invest any funds in a VCU in which its directors and substantial shareholders (10% or more holding) hold more than 15% of paid-up equity share capital of the VCU. Similar conditions are provided for VCF also.

4.6 Section 10(48):

Under this section, any income received in India in Indian currency by a foreign company on account of sale of crude oil to any person in India is exempt from tax, subject to certain conditions. The scope of this exemption is now expanded w.e.f. A.Y. 2014-15 and it is now provided that this exemption can be claimed by a foreign company in respect of income from sale to any person in India of crude oil, any other goods or rendering of services as may be notified by the Central Government.

4.7 New Section 10(49):

This new Section is inserted in the Income -tax Act to provide for exemption from tax to any income of the National Financial Holding Company Ltd., a company set up by the Central Government on 07-06-2012. This exemption is granted for A.Y. 2013-14 and for subsequent years.

4.8 Recognised Provident Fund:

One of the conditions in Schedule IV – Proviso to Rule 3 of Part A is that a Provident Fund will be considered as recognised under the Income tax Act only if the establishment for which the Provident Fund is set up is also exempted u/s. 17 of the P.F. Act. The date for obtaining such exemption under the P.F. Act which expired on 31-03-2013 under Rule 3 has now been extended by amendment of Rule 3 to 31-03-2014.

4.9 Rajiv Gandhi Equity Savings Scheme (RGESS): Section 80CCG:

At present, a resident individual, who is a first time retail investor, investing in listed equity shares under RGESS Scheme, is allowed a one time deduction of 50% of the eligible investment upto Rs. 50,000/- in the A.Y. 2013-14. Thus, the maximum deduction allowable under this section is Rs. 25,000/- if the gross total income of such individual does not exceed Rs. 10 lakh.

Now this section is amended w.e.f. A.Y. 2014-15 to provide as under:

(i) Limit of gross total income of the individual is increased from Rs. 10 lakh to Rs 12 lakh.

(ii) The scope of investment in eligible investment is extended to include listed units of an equity fund specified in RGESS. This includes investment in eligible shares, ETFs and Mutual Fund Units which has such eligible shares as the underlying assets.

(iii) The deduction upto Rs. 25,000/- (50% of investment upto Rs. 50,000/-) will now be available for each of the 3 consecutive assessment years beginning with the year in which such investment was first made.

(iv) There is a lock-in period of 3 years for such investment.

(v) If the prescribed conditions of RGESS are violated, the deduction originally granted will be deemed to be the income of the year in which such violation takes place.

4.10 Contribution to Health Scheme: Section 80D:

At present deduction u/s. 80D can be claimed in respect of premium on Mediclaim Policy upto Rs. 15,000/- (Rs. 20,000/- for Senior Citizens) by an individual or an HUF. Such deduction is also allowable for any contribution made to the Central Government Health Scheme or for preventive health check-up subject to the above limit. By amendment of this section the above benefit is now extended w.e.f. A.Y. 2014 -15 to contribution to such other Health Schemes as may be notified by the Central Government.

4.11 Additional Deduction for Interest on Housing Loans: Section 80EE:

This is a new section inserted in the Income tax Act w.e.f. A.Y. 2014-15. Under this section, one time deduction upto Rs. 1,00,000/- will be allowed to an individual for interest paid on Housing Loan taken for acquiring a residential house. This deduction will be over and above the deduction allowed for interest paid for the housing loan u/s. 24(b) of the Income-tax Act. This deduction can be claimed subject to following conditions.

(i) Housing Loan should be taken from a Bank, Financial Institution or a Housing Finance Company as defined in Section 80EE (5);

(ii) Housing Loan should have been sanctioned between 01-04-2013 to 31-03-2014;

(iii) Housing Loan sanctioned should not exceed Rs. 25 lakh;

(iv) The value of the residential house should not exceed Rs. 40 lakh;

(v) The individual claiming this deduction should not own any residential house on the date of sanction of the housing loan;

(vi) If the interest payable on the above loan, in A.Y. 2014-15, is less than Rs. 1,00,000/-, the assessee can claim deduction for the balance amount paid in A.Y. 2015-16. In other words, deduction allowable for interest on the housing loan in the A.Y. 2014-15 and 2015-16 cannot exceed Rs. 1,00,000/-.

It may be noted that this deduction cannot be claimed by an HUF. Further, there is no condition that the residential house should be self occupied. The assessee can let out the residential house. It also appears that if a residential house is purchased by two or more co-owners, each co-owner can claim the deduction for interest under this section against his share of income from the joint property.

4.12 Donation u/s. 80G:

This section is amended w.e.f. A.Y. 2014-15. At present, donation to National Children’s Fund is eligible for deduction u/s. 80G at the rate of 50% of the amount of the donation. This section is now amended to provide that 100% of the donation to National Children’s Fund made on or after 01-04-2013 will be eligible for deduction u/s. 80G.

4.13 Donation to Political Parties: Sections 80GGB and 80GGC.

These two sections provide for deduction from gross total income of 100% of the amount donated by any company, individual, HUF, firm, LLP or other specified persons to recognised Political Parties or Electoral Trusts. Now, it is provided, by amendment of these sections, that no such deduction will be allowed if such donation is made in cash on or after 01-04-2013. It may be noted that in sections 80G and 80GGA donation to approved trusts can be made in cash upto Rs. 10,000/-. So far as Political Donations are concerned, it is now provided that no cash donations will be eligible for deduction under the above sections.

4.14 Power Sector undertakings: Deduction u/s. 80IA.

This section provides for deduction of income of certain undertakings. This includes undertaking which commences its business of generation and/or distribution, transmission or distribution of power, or substantial renovation and modernisation of the existing transmission or distribution lines on or before 31-03-2013. By amendment of this section, the above time limit for commencement of business by such an undertaking is extended upto 31-03-2014.

4.15 Additional deduction for wages paid to New Workmen: Section 80JJAA:

Under the existing section, deduction is allowed to an Indian Company of an additional amount equal to 30% of the wages paid to new regular workmen employed by the Company in an industrial undertaking engaged in the manufacture or production of an article or thing, subject to certain conditions specified in this section.

This section is amended w.e.f. A.Y. 2014-15 to provide as under:

(i) Now the above deduction can be claimed by an Indian company only if it is deriving income from the manufacture of goods in a factory. For this purpose, the word “Factory” shall have the same meaning as in section 2(m) of the Factories Act, 1948;

(ii) The new regular workmen should be employed by the company in such factory;

(iii) This deduction can be claimed by the company in the year in which appointment is made and for two subsequent assessment years;

(iv) Such deduction is not allowable to the company in case the factory is hived off, transferred from another existing entity or acquired as a result of an amalgamation.

5. Income from Business or Profession:

5.1 Investment Allowance: New Section 32AC: This is a new section inserted in the Income tax Act w.e.f. A.Y. 2014- 15. The section provides for a one time deduction (Investment Allowance) to a company. This deduction can be claimed if the following conditions are complied with:

(i) This deduction can be claimed by a company engaged in the business of manufacture or production of any article or thing.

(ii) Such a company should acquire and install specified new asset between 1-4-2013 to 31-3-2015 for an aggregate cost exceeding Rs. 100 crore. If the specified new asset is acquired before 1-4-2013, this deduction cannot be claimed.

(iii) The above deduction is allowable at the rate of 15% of the actual cost of the specified new asset acquired and installed during the accounting year 2013-14 (A.Y. 2014-15) if the actual cost of such asset exceeds Rs. 100 crore. If such actual cost is less than Rs. 100 crore no deduction will be allowed in A.Y. 2014-15.

(iv)The company can claim deduction of 15% of the actual cost of such new asset acquired and installed during accounting year 2014-15 (A.Y. 2015-16) if the aggregate cost of the new asset during the period 1-4-2013 to 31-3-2015 exceeds Rs. 100 crore.

In other words, deduction of 15% can be claimed as under:

v) The deduction allowed under this section will be over and above the normal depreciation and additional depreciation (20%) allowable u/s. 32(1)(ii) and (iia) on the above specified new assets.

(vi) This being a special incentive for encouraging industrial companies which invest more than Rs. 100 crore in specified new assets, the amount of deduction allowed is not to be deducted from W.D.V. of the block of assets.

(vii) Further, this deduction is not for depreciation and, therefore, for the purpose of carry forward of losses, it will form part of business loss and not “unabsorbed depreciation”.

(viii) Since no provision for this deduction of 15% (investment allowance) is required to be made in the books of the company, deduction for this amount cannot be claimed for computation of Book Profits u/s. 115 JB.

(ix) For the purpose of this section, specified new asset means new plant and machinery. This will not include (a) ship or aircraft, (b) second hand plant and machinery (whether imported or not), (c) plant and machinery installed in office premises or residential premises (including guest house), (d) office appliances, (including computers or computer software), (e) vehicles, and (f) plant and machinery in respect of which 100% deduction by way of depreciation or otherwise is allowed in any previous year. It may be noted that intangible assets are not excluded from the definition of specified new asset. Therefore, any intangible asset attached to a plant and machinery can be considered as a specified new asset.

(x) It may be noted that this deduction will not be allowable to companies engaged in the business of hotel, hospital, road, bridge and other construction businesses.

(xi) There is a lock-in period of 5 years for the above specified new assets. If such asset is sold or transferred within 5 years of the date of installation, then the amount allowed as deduction in the earlier years will be taxable as profit or gain from business in the year of such sale or transfer. This will be in addition to the taxability of capital gains (if any) arising on such sale or transfer of such assets.

(xii) The above provision of lock-in period as stated in (xi) above, will not apply if the transfer of such asset is as a result of an amalgamation or a demerger. However, the Amalgamated Company or the Resulting Company will have to ensure that such new asset is not sold or transferred by it within 5 years from the date of installation by the Amalgamating Company or the Demerged Company.

5.2 Deduction of Bad/Doubtful Debts to Indian Banks: Section 36(1)(vii) and 36(1)(viia) – (i) Under the existing provisions of section 36(1)(viia), banks and financial institutions, depending upon their categories, are entitled to claim deduction for provision for bad and doubtful debts made for Urban and Rural Branches at specified rates. Similarly, a bank/financial institution is also entitled to claim deduction for bad debts actually written off u/s. 36(1)(vii) to the extent it is in excess of the credit balance in Provision for Bad and Doubtful Debts A/c made u/s. 36(1)(viia). Some doubts had arisen about the interpretation of the provisions of these two sections. In the case of Catholic Syrian Bank Ltd v/s CIT 343 ITR 270 the Supreme Court held that banks are entitled to full benefit of write off bad debts, written off u/s. 36(1)(vii) in addition to the deduction for the provision for bad and doubtful debts made u/s. 36(1)(viia). It is also held that, in the case of rural advances, there will be no double deduction for provision made u/s. 36(1)(viia). The proviso to section 36(1)(vii) limits its application to the bank which has made such provision u/s.6(1)(viia). The provision of section 36(1)(vii) and 36(1)(viia) and 36(2)(V) should be construed together. Thus, they form a complete scheme for deduction and prescribe the extent to which deduction is available to banks.

(II) For removal of doubts, section 36(1)(vii) has been amended from A.Y. 2014-15 by adding an Explanation that for the purpose of proviso to this section, the account referred to therein shall be only one account in respect of provision for doubtful debts u/s. 36(1)(viia). In other words, no distinction will be made for provision for urban and rural advances made u/s. 36(1)(viia). Therefore, in such cases, the amount of deduction in respect of bad debts u/s. 36(1)(vii) shall be limited to the amount by which the same exceeds the credit balance of the provision made u/s. 36(1)(viia).

5.3 Commodities Transaction Tax (CTT): Section 36(1) has been amended from A.Y. 2014-15 and it is now provided in section 36(1)(xvi) that the amount equal to CTT paid by the assessee in respect of the taxable commodities transactions entered by it in the course of its business will be allowed as its business expenditure.

5.4 Disallowance of certain payments by State Government Undertakings: Section 40(a)(iib) -This new clause has been added in section 40(a) from A.Y. 2014-15. Disputes had arisen in income tax assessments of some State Government Undertakings (SGU) as to whether any amount paid by SGU to the State Government by way of Royalty, Licence Fees, Service Fee, Privilege Fee, Service charges or any similar Fee/charge is deductible as business expenditure. It is now provided by this amendment that any such fee or charge which is levied exclusively on the SGU or is directly or indirectly appropriated from the SGU by the State Government will not be allowed as business expenditure to SGU. For this purpose, Explanation to the section defines SGU. (It includes a company in which the State Government has more than 50% of equity).

5.5 Commodity Derivative Transactions:
Section 43(5) – This section defines a “Speculative Transaction”. At present, it excludes from this definition certain transactions, including eligible transactions in respect of derivative transactions carried out in a recognised Stock Exchange. In view of introduction of MCX as a recognised association for commodities transactions, this section is now amended from A.Y. 2014-15 to provide that eligible transactions in Commodity Derivatives entered into through a recognised association will not be considered as speculative transactions.

5.6 Full value of consideration of Immovable Property held as Stock-in-Trade: New section 43CA

– (i) This new section is inserted from A.Y. 2014-15. Therefore, it will apply to real estate transactions entered into on or after 1st April, 2013. U/s. 50C, in the case of transfer of an immovable property (land, building or both) which is held by the seller as a capital asset, if the consideration is less than the market value adopted (assessed or assessable) for the purpose of payment of stamp duty, such stamp duty valuation is considered as the full value of the consideration u/s. 50C. Thus, the capital gain in the hands of the seller is computed on that basis as provided u/s. 50C. This provision was not applicable to immovable property held by the seller as stock-in-trade.

(ii) By introduction of this new section 43CA, it is now provided that the above concept of section 50C of adopting stamp duty valuation as full value of consideration will apply for computation of business income in the hands of seller who holds such property as stock-in-trade. The provisions of section 50C are made applicable w.e.f. 01-04-2013, to the extent applicable, to such transactions. This new provision will apply to Builders, Developers and Dealers engaged in real estate transactions. The provision will apply according to the method of accounting followed by the assessee. It may be noted that this new provision will not apply when the assessee makes a slump sale of the business as a going concern.

(iii) It is also provided in this Section that if there is a time gap between the date of the agreement of sale and the date of registration. The full value of the consideration will be determined with reference to the stamp duty valuation assessable on the date of the agreement of sale provided that full or part of the consideration stated in the agreement was paid, otherwise than in cash.

(iv) It may be noted that the definition of immovable property for the purpose of this section or section 50C does not include any right in the immovable property such as leasehold or tenancy right etc. If the assessee has booked a flat in a property under construction, the right to get possession of the flat is not covered under the section. However, when the property is constructed and the possession of the flat is taken, the section will apply with reference to the Agreement for sale when executed.

(v) It may be noted that section 56(2)(vii)(b) has been amended as discussed in Para 6 below. Effect of this amendment is that w.e.f. 01-04-2013, in the case of a purchaser of an immovable property, if the difference between the stamp duty valuation and the actual consideration paid as per the agreement of sale is more than Rs. 50,000/-, such difference will be considered as “income from other sources” in the hands of such purchaser. However, this provision will not apply if the purchase is from a relative as defined in Explanation to section 56(2)(vii). From this provision, it will be noticed the difference between the stamp duty valuation and actual consideration will be taxable in the hands of the seller as well as the purchaser if such difference exceeds Rs. 50,000/-.

6. Income from other sources: Section 56(2)(vii)(b) – (i) This section is amended from A.Y. 2014-15. This section provides for levy of tax on certain gifts received from non-relatives. This amendment comes into force in respect of transactions relating to purchase of immovable property i.e. land, building or both made on or after 01-04-2013. Prior to 31-03-2013, if an immovable property was received by an Individual or HUF from a non-relative, without consideration, the market value (based on the stamp duty valuation) on the date of the gift, if it exceeds Rs. 50,000/-, was treated as income from other sources in the hands of the assessee. There is no change in this provision. However, it is now provided, w.e.f. 01-04-2013, that if the purchase of an immovable property by an Individual or HUF is made for consideration which is less than the stamp duty valuation assessed or assessable by the stamp duty authorities, the difference will be taxable as income in the hands of the purchaser. This provision will apply only if such difference is more than Rs. 50,000/-.

(ii) It is now also provided by this amendment that if there is a time gap between the date of the agreement for purchase of the property and date of registration of the agreement, the stamp duty valuation assessable on the date of the agreement will be considered for this purpose. This concession will apply only if the full or part of the consideration stated in the agreement is paid by the purchaser by any mode other than cash before the date of registration.

(iii) For this purpose, the term “Immovable Property” is defined to mean “Land, Building or Both”. This will mean that any right in the immovable property will not be covered by this provision. Therefore, any tenancy right, leasehold right or similar right will not be considered as Immovable Property. If a flat in a building under construction is booked by the individual or HUF, the right to get possession of the flat will not be considered as purchase of immovable property under this section. Therefore, the consideration paid for this right as per the agreement will not be covered by this section.

(iv) If the stamp duty valuation is disputed, the provisions of section 50C for reference to Valuation
Officer will apply.

(v) It may be noted that if the difference between the stamp duty valuation and actual consideration exceeds Rs. 50,000/- tax will be payable on such notional amount by the seller as well as the purchaser under the following sections:

(a) In the case of the seller who is holding the immovable property as stock-in-trade as business income under new section 43CA – w.e.f. 01-04-2013.

(b) In the case of the seller who is holding the property as a capital asset, as capital gain u/s. 50C.

(c) In the case of Individual or HUF purchaser, under amended section 56(2)(vii)(b) – w.e.f. 01-04-2013 as income from other sources.

(vi) It may be noted that in the hands of the individual or HUF, if such property is held as “Capital Asset”, then such an assessee will be entitled to claim that the stamp duty valuation of the property adopted for taxation u/s. 56(2)(vii)(b) should be deemed to be the cost of acquisition of such property. To this extent there will be some deferred benefit to such individual or HUF. This benefit is provided u/s. 49(4). This benefit will not be available to a person who purchases an immovable property and treats it as stock-in-trade of his business.

(vii) It may be noted that amendment similar to what has been made, as stated above, in section 56(2)(vii)(b) was made in section 50(2)(vii)(b) by the Finance (no.2) Act, 2009, w.e.f. 01-10-2009. When it was pointed out to the Government that such a provision is unjust as both the seller and the purchaser of the immovable property will have to pay tax on this same notional addition, it was realised by the Government and in the Finance Act, 2010, this provision for levying tax on the purchaser was deleted with retrospective effect from 01-10-2009. This year the same amendment is made to tax the purchaser w.e.f. 01-04-2013, which has the effect of levying tax on the seller as well as the purchaser on the same notional addition. No reasons are given in the Explanatory Statement issued with the Finance Bill, 2013, for reintroducing this provision.

7. Buy-back of shares and Dividend Distribution Tax: Sections 10 (34A), 115-O, 115 QA to 115QC and 115R:

7.1 (i) At present, when a company buys back its shares from shareholders u/s. 77A of the Companies Act the shareholder is liable to pay tax u/s. 46A on the difference between the amount received from the company and the cost of acquisition of shares as provided u/s. 48 under the head “Capital Gains”. This provision will continue to apply in the case of shares which are listed if such buy back is not through a Recognised Stock Exchange.

(ii) A new section 115QA is inserted w.e.f. 01-06-2013 which provides as under.

(a) This section applies to buy back of shares which are not listed by a domestic company (whether public or private) u/s. 77A of the Companies Act on or after 01-06-2013.

(b) The consideration paid by the company to its shareholders for such buy-back of shares will now be liable to additional tax in the hands of the company at the rate of 20% plus 10% surcharge on tax (i.e. 2%) and 3% Education Cess on the tax (i.e. 0.66%) (Aggregate 22.66%). This tax is to be paid on the amount of such consideration after deduction of the amount received on the issue of such shares.

(c) The shareholder receiving this consideration on buy back of shares will not be liable to pay capital gains tax u/s. 46A as provided in the new section 10(34A) introduced w.e.f. A.Y. 2014-15.

(d) The above tax is to be deposited with the Government within 14 days of the payment of the consideration by the company to the shareholders.

(e) No credit for such tax can be claimed by the shareholder or the company against any tax liability.

(f) The above provision is on the same lines as Dividend Distribution Tax payable u/s. 115-0.

(iii) New section 115QB is also inserted to provide that interest at the rate of 1% p.m. for each month or part of the month shall be payable for the delay in payment of tax as required u/s. 115QA. Further, under new section 115QC provision is made for considering the company as assessee in default if it does not comply with the provisions of section 115QA. These provisions are similar to existing sections 115P and 115Q.

(iv) In section 115QA, it is stated that from the consideration paid by the company for buy-back of shares, the amount received on issue of shares should be deducted and the tax @ 20% is to be paid on this net amount. The question for consideration is as to how the amount received on issue of shares will be worked out in the following cases:

(a) When shares are issued at a Premium.

(b) When shares are issued as Bonus shares.

(d) When shares are issued to employees at concessional rate under ESOP scheme.

(e) When shares are issued at a discount or there is reduction in face value of shares to write off losses under a High Court Order.

(f) When shares are issued on amalgamation or on demerger.

In all the above cases, it will not be possible to determine the exact amount received on the issue of a particular share which the shareholder has offered for buy-back. This practical difficulty will have to be resolved by the tax authorities by a issuing a clarification.

(v) In the above scheme of taxation of the net consideration paid on buy-back of shares, it will be noticed that the tax is payable by the company. However, at present, the shareholder holding shares as a Capital Asset, is pays tax on such buy-back on the surplus, after the following deductions, under the head capital gains, at applicable rate.

(a) Actual cost of shares or Indexed cost (if long term asset) is deductible from the consideration.

(b) Set off of other capital loss or brought forward loss can be claimed against such capital gain.

(c) Benefit of deduction u/s. 54EC or 54F is available if the consideration is invested in Bonds or purchase of a residential house.

Taking into consideration the above, it will be noticed that incidence of tax under the new section 115QA will be higher as compared to the present provisions. In the case of a person holding such shares as stock-in-trade he will not get benefit of deduction of actual cost or set off of business losses or set off of carried forward losses.

7.2 Section 115-0: This section deals with Dividend Distribution Tax (DDT) payable by a Domestic company on dividend distributed by it. Section 115-0 (1A) has now been amended w.e.f. 01- 06-2013 to provide that no DDT will be payable on the amount relatable to dividend received from a foreign subsidiary company on which tax is paid by the domestic company at 15% u/s 115 BBD.

7.3 Section 115R: (i) This section deals with the payment of additional tax by a Mutual Fund (other than an equity oriented mutual fund) on the income distributed to the unit holders. This section is amended w.e.f. 01-06-2013. Hitherto such additional tax payable in respect of income distribution to Individual or HUF unit holders (excluding Money Market Fund or liquid fund) was 12.5%. Now from 1-6-2013 such tax will be payable by Mutual Fund at the rate of 25%. This will mean that the amount to be distributed to such unit holders will be reduced.

(ii) There is also an amendment in the section from 1-6-2013 to the effect that the rate of tax payable in the case of income distribution by an Infrastructure Debt Fund Scheme to a Non-Resident (including foreign company) unit holder shall be 5% only.

(iii) Surcharge at the rate of 10% of tax and Education Cess at the rate of 3% of tax will also be payable on the above tax.

8. Tax Residency Certificate for Non-Residents(TRC): Sections 90 and 90A

(i)These two sections empower the Central Government to enter into Agreements with any foreign country, Specified Territory or certain specified/Notified Associations in Specified Territories for avoidance of double taxation (DTAA). The Finance Act, 2012, had amended section 90 by insertion of sub- section (2A) w.e.f. 01-04-2013 to provide that the provisions of new sections 95 to 102 dealing with General Anti Avoidance Rule (GAAR) will be applicable even if the provisions of DTAA are more favourable to the assessee. In other words, where GAAR is invoked the assessee cannot seek protection of beneficial provision of DTAA. Similar amendment was also made in section 90A.

(ii) These two sections have now been amended to provide that section 90(2A) as well as 90A(2A) will now apply w.e.f. A.Y. 2016-17 because applicability of the provisions of sections 95 to 102 dealing with GAAR has now been postponed to A.Y. 2016-17.

(iii) (a) In section 90(4) as well as 90A(4), last year an amendment was made to provide that a Non Resident cannot claim benefit of DTAA unless Tax Residency Certificate in the form prescribed is obtained from the foreign country/specified territory with which India has entered into DTAA. In this certificate, such Foreign Country/Territory was required to certify the place of residence and such other particulars which the Indian Tax Department may require to decide where the benefit claimed under a particular DTAA is available to the Non Resident assessee.

(b) Some doubts were expressed about the effect of the amendment on the evidential value of TRC. Subsequently, the CBDT issued a press release clarifying the issue as under. “The Tax Residency Certificate produced by resident of contracting state will be accepted as evidence that he is a resident of that contracting state and the Income tax Authorities in India will not go behind the TRC and question his residential status.”

(c) To give effect to the above assurance section 90(4) as well as 90A(4) have been amended and the requirements about the Tax Residency Certificate containing the prescribed particulars about the assessee being resident of the contracting foreign country/specified territory has now been removed with retrospective effect i.e. A.Y. 2013-14. After removal of the above requirements s/s. (5) has been added in section 90 as well as 90A to provide that the Non-Resident which has obtained TRC from the foreign country/specified territory shall provide such other documents and information as may be prescribed. This amendment is made w.e.f. A.Y. 2013-14.

9. Taxation of Non-Residents: Sections 115A and 115AD

9.1 Section 115A: This section deals with tax on Dividends, Royalty and Technical Service Fees in the case of a Non-Resident. This section is amended w.e.f. A.Y. 2014-15 as under :

(i) It is now provided that the tax on interest referred to in section 194LD from Rupee Denominated Bonds of Indian Company as discussed in para 3.3 above will be payable @ 5% plus applicable surcharge and the Education Cess.

(ii) Under the existing section 115A(i)(b), the rate of tax on Royalty and Fees for Technical services is 10%. With effect from 1-4-2013 (A.Y. 2014-15) that rate is increased to 25% plus applicable surcharge and the Education Cess.

9.2 Section 115AD : This section deals with taxation of Foreign Institutional Investors. By an amendment of this section, w.e.f. A.Y. 2014-15, it is now provided that the tax on interest referred to in section 194LD from Rupee Denominated Bonds of an Indian company, as discussed in para 3.3 above, will be payable @ 5% plus applicable surcharge and the Education Cess.

10. General Anti-Avoidance Rule (GAAR)

10.1 This was a new concept introduced in the Income tax Act by the Finance Act, 2012. Very wide powers were given to the tax authorities by these provisions. In new Chapter X–A, sections 95 to 102 were inserted. In para 154 of the Budget Speech, while introducing the Finance Bill, 2012, the Finance Minister had stated that “I propose to introduce a General Anti-Avoidance Rule (GAAR) in order to counter aggressive tax avoidance schemes, while ensuring that it is used only in appropriate cases, enabling review by a GAAR panel.”

10.2 The reasons for introducing GAAR provisions in the Income tax Act were explained in the Explanatory Notes attached to the Finance Bill, 2012 as under:

“The question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of the transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. The existence of anti-avoidance principles are based on various judicial pronouncements. There are some specific anti-avoidance provisions but general anti-avoidance has been dealt only through judicial decisions in specific cases.

In an environment of moderate rate of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning and use of opaque law tax jurisdictions for residence as well as for sourcing capital. Most countries have codified the “substance over form” doctrine in the form of General Anti Avoidance Rule (GAAR).

In the above background and keeping in view of the aggressive tax planning with the use of sophisticated structures, there is a need for statutory provisions so as to codify the doctrine of “substance over form” where the real intention of the parties and effect of transaction and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure that has been superimposed to camouflage the real intent and purpose. Internationally several countries have introduced, and are administering statutory General Anti Avoidance Provisions. It is, therefore, important that Indian taxation law also incorporates a statutory General Anti Avoidance Provisions to deal with aggressive tax planning. The basic criticism of statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.”

10.3 There was large scale opposition to the introduction of this provision in the form suggested in the Finance Bill, 2012, and the DTC Bill, 2010, pending consideration of the Parliament. This opposition was voiced by various Trade and Industry bodies in India and abroad. The Finance Minister responded to the various suggestions made by members of the Parliament and various Trade and Industry bodies while replying to the debate in the Parliament on 7th May 2012, in the following words.

“Certain provisions relating to a General Anti-Avoidance Rules (GAAR) have also been proposed in the Finance Bill, 2012. After examining the recommendations of the Standing Committee on GAAR provisions in the DTC Bill, 2010, I propose to amend the GAAR provisions as follows:

(i) Remove the onus of proof entirely from the tax payer to the Revenue Department before any action can be initiated under GAAR.

(ii) Introduce an independent member in the GAAR approving panel to ensure objectivity and transparency. One member of the panel now would be an officer of the level of Joint Secretary or above from the Ministry of Law.

(iii) Provide that any tax payer (resident or non-resident) can approach the Authority for Advances Ruling (AAR) for a ruling as to whether an arrangement to be undertaken by the assessee is permissible or not under the GAAR provisions.

To provide greater clarity and certainty in the matters relating to GAAR, a Committee has been constituted under the Chairmanship of the Director General of Income Tax (International Taxation) to give recommendations for formulating the rules and guidelines for implementation of the GAAR provisions and to suggest safeguards so that these provisions are not applied indiscriminately. The Committee has already held several rounds of discussion with various stakeholders including the Foreign Institutional Investors. The Committee will submit its recommendations by 31st May, 2012.

To provide more time to both tax payers and the tax administration to address all related issues. I propose to defer the applicability of the GAAR provisions by one year. The GAAR provisions will now apply to Income of Financial Year 2013-14 and subsequent years.”

10.4 For the reasons stated above, special provisions relating to GAAR were made in sections 95 to 102 in the Income tax Act from A.Y. 2014-15 (Accounting Year ending 31-3- 2014) and onwards. These provisions applied to all assesses (Residents or Non-Residents) in respect of their transactions in India as well as abroad. Wide powers were given to the tax authorities to disregard any agreement, arrangement or any claim for expenditure, deduction or relief.

10.5 The GAAR provisions contained in sections 95 to 102 (chapter X-A) and in section 144-BA which were introduced by the Finance Act, 2012, w.e.f. A.Y. 2014-15 have now been withdrawn and replaced by another set of provisions in new chapter X-A (sections 95 to 102) and new section 144-BA by the Finance Act, 2013, w.e.f. A.Y. 2016-17 (Accounting year 01-04-2015 to 31-03-2016).

10.6 In para 150 of the Budget Speech while introducing the Finance Bill, 2013, the Finance Minister has stated as under:

“150. Hon’ble Members are aware that the Finance Act, 2012 introduced the General Anti Avoidance Rules, for short, GAAR. A number of representations were received against the new provisions. An expert committee was constituted to consult stakeholders and finalise the GAAR guidelines. After careful consideration of the report, Government announced certain decisions on 14-01-2013 which were widely welcomed. I propose to incorporate those decisions in the Income tax Act. The modified provisions preserve the basic thrust and purpose of GAAR. Impermissible tax avoidance arrangements will be subjected to tax after a determination is made through a well laid out procedure involving an assessing officer and an Approving Panel headed by the Judge. I propose to bring the modified provisions into effect from 01-04-2016.”

10.7 In the Explanatory Statement presented with the Finance Bill, 2013, the reasons for introducing the new provisions are explained as under:

“The General Anti Avoidance Rule (GAAR) was introduced in the Income tax Act by the Finance Act, 2012. The substantive provisions relating to GAAR are contained in Chapter X-A (consisting of section 95 to 102) of the Income tax Act. The procedural provisions relating to mechanism for invocation of GAAR and passing of the assessment order in consequence thereof are contained to section 144 BA. The provisions of Chapter X-A as well as section 144 BA would have come into force with effect from 1st April, 2014.

A number of representations were received against the provisions relating to GAAR. An Expert Committee was constituted by the Government with broad terms of reference including consultation with stakeholders and finalizing the GAAR guidelines and a road map for implementation. The Expert Committee’s recommendations included suggestions for legislative amendments, formulation of rules and prescribing guidelines for implementations of GAAR. The major recommendations of the Expert Committee have been accepted by the Government, with some modifications. Some of the recommendations accepted by the Government require amendment in the provisions of Chapter X-A and section 144 BA.”

GaarProvisions

10.8 In view of the above discussion, the existing sections 95 to 102 and 144BA have been now deleted. New set of Sections 95 to 102 and 144BA have been inserted in the Income tax Act w.e.f. F.Y.: 2015-16 (A.Y. 2016-17). These new provisions are discussed below broadly.

10.9 Section 95 : This section provides that an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement. The tax arising from such declaration by the tax authorities, will be determined subject to provisions of sections 96 to 102. It is also stated in this section that the provisions of sections 96 to 102 may be applied to any step or a part of the arrangement as they are applicable to the entire arrangement.

10.10 Impermissible Avoidance Arrangement (Section 96) :

(i) Section 96 explains the meaning of Impermissible Avoidance Arrangement to mean an arrangement, the main purpose of which is to obtain a tax benefit and it –

(a) Creates rights or obligations which would not ordinarily be created between persons dealing at arm’s length.

(b) Results, directly or indirectly, in misuse or abuse of the provisions of the Income-tax Act.

(d) is entered into or carried out, by means, or in a manner, which are not ordinarily employed for bonafide purposes.

(ii) An arrangement whereby there is any tax benefit to the assessee shall be presumed to have been entered into or carried out for the main purpose of obtaining tax benefits, unless the assessee proved otherwise. It will be noticed that this was a very heavy burden cast on the assessee. The Finance Minister has, however, declared on 07-05-2012 that the onus of proof will be on the department who has to establish that the arrangement is to avoid tax before initiating the proceedings under these provisions.

10.11 Lack of Commercial Substance (Section 97) :

(i) Section 97 explains the concept of Lack of Commercial Substance in an arrangement entered into by the assessee. It states that an arrangement shall be deemed to lack commercial substance if:

(a) The substance or effect of the arrangement, as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part of such steps; or

(b) It involves or includes:

–    Round Trip Financing
–    An accommodating party.
–    Elements that have the effect of offsetting Or cancelling each other; or
–    A transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction.

(ii) It involves the location of an asset or a transaction or the place of residence of any party which is without any substantial commercial purpose. In other words, the particular location is disclosed only to obtain tax benefit for a party, or

(iii) It does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained.

(iv) For the above purpose, it is provided that round trip financing includes any arrangement in which through a series of transactions –

(a) Funds are transferred among the parties to the arrangement, and,

(b) Such transactions do not have any substantial commercial purpose other than obtaining tax benefit.

(iii) It is further stated that the above view will be taken by the tax authorities without having regard to the following:

(a) Whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement.

(b) The time or sequence in which the funds involved in the round trip financing are transferred or received, or

(c) The means by, manner in, or mode through which funds involved in the round trip financing are transferred or received.

(iv) The party to such an arrangement shall be treated as “Accommodating Party” whether or not such party is connected with the other parties to the arrangement, if the main purpose of, direct or indirect tax benefit under the Income tax Act.

(v) It is clarified in the section that the following factors may be relevant but shall not be sufficient for determining whether the arrangement lacks commercial substance.

(a) The period or the time for which the arrangement exists

(b)The fact of payment of taxes, directly or indirectly, under the arrangement.

(c) The fact that an exit route, including transfer of any activity, business or operations, is provided by the arrangement.

10.12 Consequence of Impermissible Avoidance Arrangement (Section 98) :

Under the newly inserted section 144BA, the Commissioner has been empowered to declare any arrangement as an impermissible avoidance arrangement. Section 98 states that if an arrangement is declared as impermissible, then the consequences, in relation to tax or the arrangement shall be determined in such manner as is deemed appropriate in the circumstances of the case. This will include denial of tax benefit or any benefit under applicable DTAA. The following is the illustrative list of consequences and it is provided that the same will not be limited to the list.

(i) Disregarding, combining or re-characterising any step in, or part or whole of the impermissible avoidance arrangement;

(ii) Treating, the impermissible avoidance arrangement as if it had not been entered into or carried out;

(iii) Disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;

(iv) Deeming persons who are connected persons in relation to each other to be one and the same person;

(v) Re-allocating between the parties to the arrangement, (a) any accrual or receipt of a capital or revenue nature or (b) any expenditure, deduction, relief or rebate;

(vi) Treating (a) the place of residence of any party to the arrangement or (b) situs of an asset or of a transaction at a place other than the place or location of the transaction stated under the arrangement.

(vii) Considering or looking through any arrangement by disregarding any corporate structure.

(viii) It is also clarified that for the above purpose that tax authorities may re-characterise (a) any equity into debt or any debt into equity, (b) any accrual or receipt of Capital nature may be treated as of revenue nature or vice versa or (c) any expenditure, deduction, relief or rebate may be recharacterised.

10.13 Section 99 : This section provides for treatment of connected persons and accommodating party.

The section provides that for the purposes of sections 95 to 102, for determining whether a tax benefit exists –

(i) The parties who are connected persons, in relation to each other, may be treated as one and same person.

(ii) Any accommodating party may be disregarded.

(iii) Such accommodating party and any other party may be treated as one and same person.

(iv) The arrangement may be considered or looked through by disregarding any corporate structure.

10.14 It is further provided in section 100 that the provisions of sections 95 to 102 shall apply in addition to, or in lieu of, any other basis for determination of tax liability. Section 101 gives power to CBDT to prescribe the guidelines and lay down conditions for application of sections 95 to 102 relating to General Anti-Avoidance Rules (GAAR). Let us hope that these guidelines will specify the type of arrangements and transactions in relation to which alone the tax authorities have to invoke the provision of GAAR. Further, it is necessary to specify that if the tax benefit sought to be obtained by any arrangement is, say Rs. 5 crore or more in a year, then only the tax authorities will invoke these powers.

10.15 Section 102 : This section defines words or expressions used in sections 95 to 102 as stated above. Some of these definitions are as under:

(i) “Arrangement” means any step in, a part or whole of any transaction, operations, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding.

(ii) “Connected Person”, in relation to a person who is an Individual, Company, HUF, Firm, LLP, AOP or BOI is defined in more or less the same manner as the term “Related Person” is defined in section 40A(2). It may be noted that, for this purpose, the definition of the word “Relative” is wider in as much as the definition of “Relative” given in Explanation to section 56(2)(vi) is adopted, whereas in section 40A(2) the narrower definition of “Relative” given in section 2(41) is adopted.

(iii) “Fund” includes (a) any cash, (b) cash equivalents and (c) any right or obligation to receive or pay in cash or cash equivalent.

(iv) “Party” means any person, including Permanent Establishment which participates or takes part in an arrangement.

(v) “Relative” has the same meaning as given in section 56(2)(vi) – Explanation. It may be noted that this definition is very wide as compared to the definition given in section 2 (41) which is adopted for the purpose of explaining related person in section 40 A (2).

(vi) The definition of a person having substantial interest in the company and other non-corporate bodies is the same as given in section 40A (2).

(vii) “Tax Benefit” includes (a) a reduction, avoidance or deferral of tax or other amount payable under the Income tax Act, (b) an increase in a refund of tax or other amount under the Act, (c) a reduction, avoidance or deferral of tax or other amount that would be payable under the Act, as a result of tax treaty, (d) an increase in a refund of tax or other amounts under the Act as a result of tax treaty, (e) a reduction in total income or (f) increase in loss in the relevant accounting year or any other accounting year.

(viii) “Tax Treaty” means Agreements entered into by the Government with any foreign country, territory or Association u/s. 90 or 90A.

10.16 Section 144 BA : Procedure for declaring an arrangement as impressible u/s. 95 to 102 is given in this section. This section will come into force from A.Y. 2016-17.

(i) The Assessing Officer can, at any stage of assessment or reassessment, make a reference to the Commissioner for invoking GAAR. On receipt of reference the Commissioner has to hear the tax payer. If he is not satisfied by the submissions of the taxpayer and is of the opinion that GAAR provisions are to be invoked, he has to refer the matter to an “Approving Panel”. In case the assessee does not object or reply, the Commissioner can issue such directions as he deems fit in respect of declaration as to whether the arrangement is an impermissible avoidance arrangement or not.

(ii) The Approving Panel has to dispose of the reference within a period of six months from the end of the month in which the reference was received from the Commissioner.

(iii) The Approving Panel can either declare an arrangement to be impermissible or declare it not to be so after examining material and getting further inquiry to be made. It can issue such directions as it thinks fit. It can also decide the year or years for which such an arrangement will considered as impermissible. It has to give hearing to the assessee before taking any decision in the matter.

(iv) The Assessing Officer (AO) can determine consequences of such a positive declaration of arrangement as impermissible avoidance arrangement.

(v) The final order, in case any consequences of GAAR are determined, shall be passed by the AO only after approval by Commissioner and, thereafter, first appeal against such order shall lie to the Appellate Tribunal.

(vi) The period taken by the proceedings before Commissioner and the Approving Panel shall be excluded from time limitation for completion of assessment.

(vii) The Central Government has to constitute one or more Approving Panels. Each Panel shall consist of 3 members, including a chairperson. The constitution of the Panel shall be as under.

(a) Chairperson – He shall be a sitting or retired judge of a High Court.

(b) Members – One member shall be IRS of the rank of CCIT or above.

– One member shall be an academic or scholar having special knowledge of matters such as direct taxes, business accounts and international trade practices.

The term of the Panel shall ordinarily be for one year and may be extended from time to time upto 3 years. The Panel shall have power similar to those vested in AAR u/s. 245U. CBDT has to provide office infrastructure, manpower and other facilities to the Approving Panel’s members. The remuneration payable to Panel members shall be decided by the Central Government.

(viii) In addition to the above, it is provided that the CBDT has to prescribe a scheme for efficient functioning of the Approving Panel and expeditious disposal of the references made to it.

(ix) Appeal against order of assessment passed under the GAAR provisions, after approval by the appropriate authority, is to be filed directly with the ITA Tribunal and not before CIT(A). Section 144C relating to reference before DRT does not apply to such assessment order and, therefore, no reference can be made to DRT when GAAR provisions are invoked.

10.17 The above GAAR provisions will have far reaching consequences for assessees engaged in the business with Indian or Foreign parties. GAAR is not restricted to only business transactions. Therefore, all assessees who are engaged in business or profession or who have no income from business or profession will be affected by these provisions. It appears that any assessee having any arrangement, agreement, or transaction with a connected person will have to take care that the same is at Arm’s Length Consideration. In particular, an assessee will have to consider the implications of GAAR while (a) executing a WILL or Trust, (b) entering into a partnership or forming an LLP, (c) taking controlling interest in a company, (f) entering into amalgamation of two or more companies, (c) effecting demerger of a company, (f) entering into a consortium or joint venture, (g) entering into foreign collaboration, or (h) acquiring an Indian or Foreign company. It may be noted that this is only an illustrative list and there may be other transactions which may attract GAAR provisions.

10.18 From the wording of the above provisions of sections 95 to 102 and 144BA it appears that the provisions of GAAR can be invoked even in respect of an arrangement made prior to 01-04-2015. The CIT or the Approving Panel can hold any such arrangement entered into prior to 01-04-2015 as impermissible and direct the AO to make adjustments in the computation of income or tax in the assessment year 2016-17 or any year thereafter. As stated in para 15.15 of the report of the Standing Committee on Finance on the DTC Bill, 2010 it would be fair to apply GAAR provisions prospectively so that it is not made applicable to existing arrangements/transactions. Even in the Press Note issued by the Central Government on 14-01-2013 it was stated that transactions entered into prior to 30-08-2010 will not made subject to GAAR provisions. This has not been provided in the above sections and, therefore, the above GAAR provisions will have a retrospective effect.

10.19 In section 101, it is stated that CBDT will issue guidelines to provide for the circumstances under which GAAR should be invoked. Let us hope that these guidelines will specify that GAAR provisions will apply to all arrangements or transactions entered into after 01-04-2015 and also the type of arrangements or transactions to which GAAR will apply. It is also necessary to specify that GAAR provisions will be invoked only if the tax sought to be avoided is more than Rs. 5 crore, in any one year. This is also suggested by the Standing Committee on Finance in their report on the DTC Bill, 2010. Even in the Press Note dated 14-01-2013, the Government had stated that there will be monetary threshold of Rs. 3 crore of tax benefit in a year for invocation of GAAR.

10.20 It may be noted that the above revised set of provisions for invoking of GAAR which will come into force on 01-04-2015 do not contain provisions relating to following decisions of the Government announced in the Government Press Note dated 14-1-2013.

(i) GAAR will not apply to an FII which does not avail treaty benefit.

(ii) GAAR will not apply to Non-Resident Investors in FII.

(iii) Where GAAR and SAAR are both in force, only one of them will apply subject to prescribed guidelines.

(iv) GAAR will be restricted to only “PART” of the arrangement which is impermissible and not to the whole arrangement.

Let us hope that these issues will be considered when CBDT issues the Guidelines for invocation of GAAR.

11. Assessments, Reassessments and Appeals:

11.1 Section 132B : This section, which deals with application of seized or requisioned assets, is amended w.e.f. 01 -06-2013. This section provides that the “existing liability” under the Income tax Act, Wealth tax Act, etc. and the amount of liability determined on completion of assessment under 153A and the assessment of the year relevant to the previous year in which search is initiated or requisition is made, or the amount of liability determined on completion of assessment for the block period (including any penalty levied or interest payable in connection with such assessment) may be recovered out of assets seized u/s. 132 or requisitioned u/s. 132A if such person is in default or is deemed to be in default. It was debatable as to whether the assets seized or requisitioned could be adjusted against advance tax payable. With effect from 01-06-2013, an Explanation 2 is inserted to this section to provide that the “existing liability” does not include advance tax payable in accordance with the provisions of the Income-tax Act.

11.2 Section 139(9) : This section explains when the return of income filed by the assessee u/s. 139 will be considered as defective. If these defects are not removed within the prescribed time, the A.O. will consider that the assessee has not filed the return. This section is now amended w.e.f. 01- 06- 2013. As per section 140A of the Act tax payable on the basis of return of income i.e. self assessment tax, along with interest payable, if any, is required to be paid by the assessee before furnishing the return of income. With effect from 1st June, 2013, non-payment of self assessment tax together with interest, if any, payable in accordance with the provisions of section 140A, before furnishing the return of income, shall make the return of income a defective return. This defect will have to be rectified on receipt of defect notice u/s. 139(9) within the prescribed time.

11.3 Section 142(2A) : This section empowers the CIT to order a Special Tax Audit of Accounts of the assessee in specified circumstances. At present, order for such audit can be passed having regard to the nature and complexity of the accounts of the assessee and taking into consideration the interest of the revenue. The scope of this section is now expanded w.e.f. 01-06-2013. By amendment of this section such order for Special Audit can be passed by the CIT having regard to –

(i) Volume of the accounts,

(ii) Doubts about the correctness of the accounts,

(iii) Multiplicity of transactions in the accounts and

(iv) Specialised nature of business activity of the assessee.

This new provision will cover a large number of assessees and although the accounts of large companies are audited by Statutory Auditors as well as Tax Auditors, they can be subjected to this Special Audit.

It may be noted that the CIT has to fix fees of the Chartered Accountant for such special audit on the basis of guidelines contained in Rule 14B and the same is payable by the Central Government.

11.4 Section 153 : This section deals with the time limit for the completion of Assessments and Reassessments. Some issues were arising in computation of this time limit. To resolve these issues the following amendments are made in this section with effect from different dates as stated below.

(i) If income of the assessee was first assessable in A.Y. 2009-10 or any subsequent year, and the matter is referred to the Transfer Pricing Officer (TPO) u/s. 92 CA, the time limit for completion of assessment will be 3 years from the end of the assessment year instead of 2 years. This amendment is effective from 01-07-2012.

(ii) In the case of reassessment where notice u/s. 148 is issued on or after 1-4-2010 and the case is referred to TPO u/s. 92CA, the time limit for completion of reassessment will be two years instead of 1 year. This is effective from 01-07-2012.

(iii) Where order of ITA Tribunal is received by CIT or where CIT has passed order u/s. 263 or 264 on or after 01-04-2010, and while passing the fresh assessment order, a reference is made to TPO u/s. 92CA, the time limit for completion of the fresh assessment will be two years instead of 1 year. This is effective from 01-07-2012.

(iv) Explanation 1(iii) to this section is amended from 01-06-2013. At present, in computing time limit for completion of assessment in a case in which AO has issued direction for special Audit u/s. 142(2A), the period from the date on which such direction is issued to the date on which the assessee is required to furnish report of the special Audit is to be excluded. It is now provided that, if the above direction is challenged in any court, the period upto the date on which such order is set aside by the court will also be excluded.

(v) Explanation 1(viii) to this section is amended w.e.f. 01-06-2013. It is now provided that while computing the time limit for completion of assessment the time taken for obtaining information from a foreign country/territory of foreign specified Association u/s. 90 or 90A will be excluded. This will be subject to a maximum of one year.

(vi) A new clause (ix) is added to Explanation 1 to the above section, effective from 01-04-2016. This relates to GAAR provisions as discussed in para 10 above. It is provided in this clause that the period from the date on which reference for declaration of an arrangement to be an impermissible avoidance arrangement is received by CIT u/s. 144BA and the date when direction from the CIT or the Approving Panel is received by the A.O. will be excluded for computing the period for completion of the assessment.

11.5 Section 153B : This section provides for time limit for completion of assessment in cases of Search and Seizure u/s. 153A. The section is amended from 01-07-2012, 01-04-2013 and from 01-04-2016 as stated in para 11.4 above. These amendments for computation of time limit for completion of the assessment or the reassessment are on the same lines as amendments in section 153 discussed in para 11.4 above.

11.6 Section 153D : This section provides for prior approval for assessment in cases of search or Requisition. This section is amended w.e.f. 01-04-2016. It is now provided that in cases of assessments or reassessments in respect of any of the years mentioned in section 153(1)(b) or the assessment year referred to in section 153B(1)(b), where the Assessing Officer has made a reference to the Commissioner to declare an arrangement as an impermissible avoidance arrangement and to determine the consequence of such an arrangement within the meaning of Chapter X- A, dealing with GAAR, the Assessing Officer shall pass the order of assessment or reassessment with the prior approval of the Commissioner. In such cases, the prior approval of the Joint Commissioner shall not be required.

11.7 Sections 167C and 179 : These sections deal with recovery of taxes due from partners of an LLP in liquidation and directors of a private limited company in liquidation respectively. These sections are amended w.e.f. 01-06-2013. Section 167C allows recovery from the partners of any tax due from an LLP in certain cases. Similarly, section 179 allows recovery from the directors of any tax due from a private company in certain cases. In certain decisions [e.g. Dinesh T. Tailor vs. TRO 326 ITR 85 (Bom.)] it has been held that the “Tax due” will not comprehend within its ambit a penalty or interest. Now, an Explanation is added to both these sections to provide that the expression “Tax due” shall include penalty, interest or any other sum payable under the Act. It would, therefore, be possible for tax authorities to recover not only the tax but also the penalty and the interest dues of an LLP or private company from its partners or directors respectively.

11.8 Sections 245N and 245R :(i) Section 245N(a) defines “Advance Ruling”. In view of the amendments relating to GAAR as discussed in para 10 above, section 245N(a)(iv) has been amended w.e.f. 01-04-2015 (A.Y.: 2016-17). It provides that a Non-Resident can obtain Advance Ruling under XIX-B in respect of determination or decision by Authority for Advance Ruling (AAR) whether an arrangement, which is proposed to be undertaken by a Resident or Non-Resident, is an impermissible avoidance arrangement as referred to in GAAR provisions. Consequential amendment is made in section 245N(b) also.

(ii) Section 245R is also amended effective 01-04-2015 to provide that AAR will not allow an application where it finds that the transaction is designed prime facie as arrangement which is impermissible avoidance arrangement.

11.9 Section 246A: This section provides for appeal to CIT(A). Clauses (1)(a)(b)(ba) and (c) of section 246A have been amended w.e.f. 01-04-2016 to provide that an assessment or reassessment order passed u/s. 143(3), 147 or 153A with the approval of CIT u/s. 144BA(12) or any order passed u/s. 154 or 155 in relation to such an order shall not be appealable before CIT(A). In all such cases, direct appeal before ITA Tribunal can be filed.

11.10 Section 252: This section deals with the constitution and appointment of the ITA Tribunal Members. This section is amended w.e.f. 01-06-2013. After this amendment, it is provided that the Central Government shall appoint a President of ITA Tribunal out of the following persons.

(i) A sitting or retired High Court Judge who has completed 7 years or more of service as such High
Court Judge.

(ii) Senior Vice President or one of the Vice Presidents of ITA Tribunal.

11.11 Section 253: This section provides for the list of orders against which appeal can be filed before the ITA Tribunal. Effective from A.Y. 2016 -17, it is now provided that such appeal can be filed directly before the ITA Tribunal against an assessment order passed u/s. 143(3) in regular case, in reassessment proceedings u/s. 147 or in search proceedings u/s. 153A with the approval of CIT u/s. 144BA. Even orders passed u/s. 154 or 155 to rectify mistakes in such proceedings u/s. 144BA will be subject to such appeals before ITA Tribunal u/s. 253.

11.12 Section 271FA: This section provides for levy of penalty for failure to furnish “Annual Information Return” (AIR). This section is amended effective from 01-04-2013 (A.Y. 2014-15). As per the existing provisions, in case of failure in furnishing AIR a penalty of Rs. 100 is leviable for each of day of default after the prescribed date. i.e. 31st August. If the Income tax authority issues notice requiring any person, who has failed to furnish an AIR to submit such return and such person does not furnish such return within the time provided in the notice then the enhanced penalty of Rs. 500 per day is now leviable for the period of such default after the expiry of time provided to furnish the return in the notice issued by AO.

12. Wealth tax act :

12.1 Section 2(ea): Explanation 1(b) defines “Urban land”. The existing definition is modified w.e.f. A.Y. 2014-15 in such a manner that Urban Land within the area as stated in the amended section 2(1A) of the Income tax Act (as discussed in para 4.1 above) will be included in the definition of Urban Land.

The Finance Minister has stated in his speech while replying to Budget discussion that no wealth tax will be levied on Agricultural Land as at present.

12.2 Sections 14A, 14B and 46 : These sections are amended w.e.f. 01-06-2013. So far provision for electronic filing of returns are applicable to returns filed under the Income tax Act.p Now, sections 14A, 14B & 46 of WT Act are inserted to facilitate electronic filing of annexure – less return of net wealth. Under these provisions, rules will be made for the following:

(i) The class of person who shall be required to furnish the return electronically.

(ii) The form and manner in which returns can be filed electronically.

(iii) The computer resource or the electronic record to which the return may be transmitted electronically.

(iv) The exemption from furnishing the documents, statements, reports, etc. along with the return filed in an electronic form.

13. Commodities transaction tax (ctt)

(i) The Finance Act, 2013 has introduced a new tax called Commodities Transaction Tax (CTT) to be levied on Taxable Commodities Transactions entered into in a recognised association. A transaction of sale of commodity derivatives in respect of commodities, other than agricultural commodities, traded in recognised associations is considered as Taxable Commodities Transaction.

(ii) CTT is leviable on sale of Commodities Derivatives at the rate of 0.01 per cent and the same is payable by the seller.

(iii) Section 36 of the Income-tax Act is amended to provide that CTT paid in the course of business shall be allowable as deduction if the income arising from such taxable commodities transactions is included in the income computed under the head “Profits and gains of business of profession”.

(iv) This tax is to be levied from the date on which Chapter VII of the Finance Act, 2013 relating to CTT comes in to force by way of notification by the Central Government.

(v) Sections 105 to 124 (Chapter VII) of the Finance Act, 2013, make detailed provisions for the levy of CTT, collection, filing of returns, assessments, appeals, rectifications, penalties etc. on the same lines as chapter VII of the Finance (No.2) Act, 2004 relating to STT.

14. Securities Transactions Tax (stt)

With effect from 1st June, 2013, the rates of STT have been revised as under:

15. General Observations:

15.1 This year’s budget being the last effective budget of the present Government can be considered as a soft budget. The provisions relating to GAAR which were to come into force from the current year have been postponed by two years. The provisions relating to the constitution of the Approving Panel and resolution of GAAR disputes have been strengthened. However, unless the mindset of the persons administering these provisions is changed, the tax payers will have to face hardships and they will face unending litigation. For implementing such complex provisions, the tax authorities have to implement these provisions by taking into consideration the ground realities of business and industry in our country. In implementing such provisions the tax authorities should not only consider the letter of the law but should consider the spirit behind this legislation. For this purpose, the CBDT will have to consider the business realities while framing the tax payer friendly guidelines for implementing these provisions.

15.2 As stated above, the Finance Minister has addressed the issue relating to GAAR to some extent. However, the provisions relating to taxation of Non-Residents introduced last year with retrospective effect have not been addressed. These provisions have affected our relationship with many foreign countries. This will affect our global trade in the long term. Disputes have arisen in some cases of large Multinationals and the Government is trying to resolve these disputes by enactment of separate legislation. When the Government has recognised that these disputes have arisen due to these retrospective amendments, it should have amended these provisions and given them only prospective effect.

15.3 One disturbing feature relates to the amendments made this year relating to TDS from consideration paid or payable on purchase of an Immovable Property under new section 194-IA. This will put tax payers and those who are not liable to pay tax into many practical difficulties of collecting 1% tax at source, depositing the same with the Government and filing return of TDS. There will be some issues relating to the date on which such tax is to be deducted when a flat is booked prior to 01-06-2013 or after that date in a building under construction and payments are made in instalments.

15.4 Amendment made in section 56(2)(vii)(b) levying tax on the notional amount of difference between stamp duty valuation of an immovable property sold and the actual consideration paid by an Individual or HUF (Purchaser). This will mean levying tax on the same notional amount in the hands of the seller as well as purchaser. It may be noted that such tax is not payable if the purchaser is a firm, LLP, company or persons other than individual or HUF. Similar tax was levied in 2009 but was withdrawn in 2010 with retrospective effect. It is unfortunate that the Government has again levied this type of tax which is payable by individual/HUF purchaser and seller of the property on the same notional amount. This is a very harsh and unjust provision in the Income-tax Act.

15.5 Provision made last year, effective from 01-04-2012 relating to “Specified Domestic Transactions” has increased the compliance cost of assessees. Transfer Pricing provisions have been made applicable to some domestic transactions. Although one year has passed since these provisions have come into force, there is no clarity about the type of transactions to which these provision will apply. No adequate data about comparable prices is available. In particular, there is no clarity as to how the assessing officers will compare the managerial remuneration paid to connected persons while making disallowance u/s. 40A(2). CBDT has not framed any separate Rule prescribing the information or documents required to be maintained by the assessee to whom this provision is applicable. No separate Form of Audit Report to be obtained u/s. 92E by the assessee to whom these provisions apply has been prescribed. We are informed that the provisions of Rule 10D and 10E and Form 3CEB of Audit Report prescribed for International Transactions can be used. If we refer to these Rules and the Form it will be noticed that there is no mention about Specified Domestic Transactions in these Rules or Form. It is not clear as to how specific requirements of these Domestic Transactions are to be reported in the Audit Report.

15.6 It may be noted that the present Finance Minister mooted the idea of replacing the present Income-tax Act and the Wealth Tax Act by Direct Taxes Code (DTC) in 2006-07. The DTC Bill, 2009 was circulated on 12.08.2009 for public debate. After considering the suggestions from various quarters, the DTC Bill, 2010, was introduced in the Lok Sabha and was to come into force w.e.f. 01.04.2012. The Bill was referred to the Standing Committee of the Finance. Since its report was delayed, DTC could not be passed in 2011 and hence its implementation was delayed. In Para 154 of the Budget Speech the Finance Minister has stated that DTC is work-in-progress. He has also stated that the report of the Standing Committee is received. The same is being examined and the revised Bill will be introduced in the budget session of the Parliament. This has not happened and it appears that this important legislation may not be passed during the present term of the UPA II Government.

15.7 Another legislation viz. Goods and Service Tax (GST) in the field of Indirect Taxes, was announced by the Finance Minister in 2007-08. He has referred to this in Para 186 of the Budget Speech this year. Due to differences in the views of various States, the required legislation has not been introduced in the Parliament. The Prime Minister has admitted that GST, which is to replace Excise Duty, Customs Duty, Service Tax and VAT laws in our Country may be enacted in 2014 after the elections by the new Government which may come to power.

15.8 Another major reform measure in the field of Corporate legislation relates to replacement of the Companies Act, 1956 by the Companies Bill, 2011. This Bill has been passed by the Lok Sabha in December, 2012. It is pending in the Rajya Sabha. The impression given to us was that this Bill will be passed in this year’s Budget Session and will come into force soon. This Bill is pending before the Rajya Sabha and this important legislation is also delayed.

15.9 The above three legislations are being discussed for the last more than five years but our Parliament is not able to legislate the same. We are assured that these new legislations will simplify our tax and Corporate Legislation and make the life of all stakeholders hassle free. Let us hope the Parliament in its wisdom legislates these provisions before the end of the current Financial Year.

(Acknowledgement: S.M. Jhaveri, Chartered Accountant and Dalpat H Shah, Chartered Accountant have assisted the Author in the preparation of this Article)

Nirav Shah

WRIT PETITION MAINTAINABILITY

SYNOPSIS

When an alternative remedy is
available under the Act, writ petition is not maintainable. However, in
various decisions the Hon’ble Supreme Court and High Courts have held
that if a issued is patently illegal or without jurisdiction,
notwithstanding the alternative remedy, writ is maintainable. In this
article, the author analyses of the recent SC ruling in the case of
Vijaybhai N. Chandrani which in his view is inconsistent with this
position and therefore requires reconsideration.

Brief Factual Background of the case before the Hon’ble Supreme Court:

Recently,
the Hon’ble Supreme Court in the case of CIT vs. Vijaybhai N. Chandrani
[Civil Appeal No. 5888 to 5903 of 2013 dated 18.7.2013] has held that
writ petition before the Hon’ble High Court is not maintainable when
alternate remedy is available under the Income-tax Act, 1961 (‘the
Act’). The brief background of the case is given hereunder:

In
the case of Vijaybhai (supra), the assessee purchased a plot of land
from Samutkarsh Co-operative Housing Society being developed by Savvy
Infrastructure Ltd. In 2008, a search was conducted u/s. 132 of the Act
in the premises of the Society and Savvy Infrastructure Ltd. During the
search, Assessing Officer (‘AO’) seized certain documents u/s. 132A of
the Act. One of the documents was loose sheet of paper containing list
of members under the heading “Samutkarsh Members Details”. One of the
names was that of the assessee and certain details were mentioned
against each name in different columns. On the basis of these documents
the AO issued notices u/s. 153C to the assessee to furnish his returns
of income for assessment years 2001-2002 to 2006-2007. Upon receipt of
the said notice, the assessee requested the AO to provide copies of the
seized material. The AO supplied copies of three loose sheets of paper
which, according to the assessee, did not belong to him. Under these
circumstances, the assessee moved a writ petition before the Hon’ble
Gujarat High Court challenging the aforesaid notices.

The
Hon’ble Gujarat High Court quashed the notices by holding that as the
said documents undoubtedly did not belong to the assessee the condition
precedent for issuance of notice was not fulfilled and therefore the
action taken u/s. 153C of the Act stood vitiated. Though the Hon’ble
Supreme Court did not express any opinion on the correctness or
otherwise of the construction that was placed by the High Court on
Section 153C of the Act, it held that as alternate remedy was available
to the assessee, the High Court ought not to have entertained the writ
petition and instead should have directed the assessee to file reply to
the said notices. Upon receipt of a decision from the AO, if for any
reason assessee was aggrieved by the said decision, the same could be
questioned before the forum provided under the Act. Accordingly, the
order of the Hon’ble Gujarat High Court was reversed.

Supreme
Court decisions on maintainability of writ petition – against
action/notice without jurisdiction – when alternative remedy is
available

It is a settled position that, generally, when
alternative remedy is available under the Act, writ petition is not
maintainable. However, in various decisions the Hon’ble Supreme Court
and High Courts have held that if the notice issued is patently illegal
or without jurisdiction, notwithstanding the alternative remedy, writ is
maintainable. Some key decisions laying down the said ratio are quoted
hereunder:

• Calcutta Discount Co. Ltd. v. ITO [1961] 41 ITR 191 (SC)

“Mr.
Sastri mentioned more than once the fact that the company would have
sufficient opportunity to raise this question, viz., whether the
Income-tax Officer had reason to believe that under-assessment had
resulted from non-disclosure of material facts, before the Income-tax
Officer himself in the assessment proceedings and, if unsuccessful
there, before the Appellate Officer or the Appellate Tribunal or in the
High Court under section 66(2) of the Indian Income-tax Act. The
existence of such alternative remedy is not however always a sufficient
reason for refusing a party quick relief by a writ or order prohibiting
an authority acting without jurisdiction from continuing such action.” (Emphasis supplied).

• Foramer vs. CIT [2001] 247 ITR 436 (All) affirmed by Supreme Court in [2003] 264 ITR 566 (SC)

“As
regards alternative remedy, we are of the opinion since the notice
under section 148 is without jurisdiction, the petitioner should not be
relegated to his alternative remedy vide Calcutta Discount Co. Ltd. v.
ITO [1961] 41 ITR 191 (SC)…. .”

• UOI & Anr vs. Kunisetty Satyanarayana [2007] 001 CLR 0067 (SC)

“No
doubt, in some very rare and exceptional cases the High Court can quash
a charge-sheet or show-cause notice if it is found to be wholly without
jurisdiction or for some other reason if it is wholly illegal.”

From
the above decisions, it is very clear that as a matter of practice writ
petition is not maintainable if alternative remedy is available under
the Act. However, in exceptional cases when the notices issued are
patently illegal or without jurisdiction, the Hon’ble Supreme Court has
held that writ petition is maintainable.

Notice u/s. 153C in the case of Vijaybhai (supra) – without jurisdiction – liable to be quashed

In
the case of Vijaybhai (supra), the Hon’ble Gujarat High Court drew
distinction between the provisions of section 153C and section 158BD.
Whereas section 158BD seeks to tax any “undisclosed income” which “belongs”
to a person other than the person in whose case search has been carried
out, section 153C seeks to tax such other person only where “money, bullion, jewellery or other valuable article or thing or books of account or documents seized” “belongs” to him. The Hon’ble High Court held “….it is an admitted position as emerging from the record of the case, that the documents
in question, namely the three loose papers recovered during the search
proceedings do not belong to the petitioner. ….it is nobody’s case that
the said documents belong to the petitioner. It is not even the case of
Revenue that the said three documents are in the handwriting of the
petitioner. In the circumstances, when the condition precedent for
issuance of notice is not fulfilled any action taken under s. 153C of
the Act stands vitiated.” In the instant case, since it was an
admitted fact that the documents seized did not belong to the assessee,
the High Court held the notices issued u/s. 153C to be without
jurisdiction. In light of the above, having regard to the judgments
noted earlier, it is respectfully submitted that the Hon’ble Supreme
Court should have upheld the judgment of the Gujarat High Court.

An
alternate remedy against an order passed pursuant to a notice cannot be
considered as an alternate remedy available against the notice which is
patently without jurisdiction

The Hon’ble Supreme Court did
not affirm the decision of Hon’ble Gujarat High Court supposedly on the
ground that the assessee had alternate remedies under the Act against
the notices issued. The Hon’ble Supreme Court held:

“…… at the
said stage of issuance of the notices under Section 153C, the assessee
could have addressed his grievances and explained his stand to the
Assessing Authority by filing an appropriate reply to the said notices
instead of filing the Writ Petition impugning the said notices. ….

In the present case, the assessee has invoked the Writ jurisdiction of the High Court at the first instance without first exhausting the alternate remedies provided under the Act. In our considered opinion, at the said stage of proceedings, the High Court ought not have entertained the Writ Petition and instead should have directed the assessee to file reply to the said notices and upon receipt of a decision from the

Assessing Authority, if for any reason it is aggrieved by the said decision, to question the same before the forum provided under the Act. ….

Further, we grant time to the assessee, if it so desires, to file reply/objections, if any, as contemplated in the said notices within 15 days’ time from today. If such reply/objections is/are filed within time granted by this Court, the Assessing Authority shall first consider the said reply/objections and thereafter direct the assessee to file the return for the assessment years in question. We make it clear that while framing the assessment order, the Assessing Authority will not be influenced by any observations made by the High Court while disposing of the Writ Petition. If, for any reason, the assessment order goes against the assessee, he/it shall avail and exhaust the remedies available to him/it under the Act, 1961. ….”

It is respectfully submitted that if the underlined portion of the judgment was not forming part of it, the said judgment of the Hon’ble Supreme Court would have been on the lines of its earlier judgment in the case of GKN Driveshafts (India) Ltd vs. ITO [2003] 259 ITR 19 (SC) wherein the Hon’ble Supreme Court in a writ challenging notice u/s. 148 had directed the assessee/AO as under:

Thus, in the absence of the underlined part in the aforesaid judgment, as has happened in several writs challenging notices u/s. 148, the assessee would be able to approach the High Court after the AO’s order dealing with or rejecting the objections of the assessee against issue of notices u/s. 153C. As evident from the underlined part of the judgment quoted above, it is respectfully submitted that it appears that the Hon’ble Supreme Court:

a) was either under an impression that there is a remedy under the Act against issue of notice u/s. 153C; or

b) has failed to appreciate the difference between an alternate remedy available against an order passed pursuant to a notice in contradistinction with an alternate remedy available against the issuance of the notice itself.

Conclusion:
In the light of the above, it is most humbly and respectfully submitted that the aforesaid judgment of Hon’ble Supreme Court requires reconsideration as:

(i) the notice issued u/s. 153C was clearly without jurisdiction.

(ii) there is no alternate remedy available under the Act against the issuance of notice u/s. 153C.

(iii) in any case, as held by the Hon’ble Supreme Court in number of cases notwithstanding the availability of an alternate remedy, a writ is clearly maintainable against an action/notice which is issued patently without jurisdiction.

Nirav Shah

Recovery of tax pending stay application – A draconian directive

New Year Shock

The Central Board of Excise and Customs (CBEC) has, in supersession of seven previous circulars on the same subject, issued Circular No. 967/01/2013 CX dated 1-1-2013 (the new Circular), directing the departmental officers to initiate recovery action in cases where 30 days have expired after the filing of appeal by an assessee before an appellate authority. This action by CBEC is highly unprecedented and totally unjust and unfair inasmuch as it would not only result in penal consequences for reasons beyond the control of an assessee, but also render the statutory right of appeal nugatory.

While the taxpayer fraternity fully recognises that the Government is empowered under the relevant statutory provisions to collect and recover legitimate taxes due from assessees, at the same time, the taxpayer fraternity does feel that as a good tax administration practice, it is essential that, in regard to tax demands which are pending in appeal before various appellate authorities, the legitimate rights of assessees under the relevant statutory provisions are also recognised, before initiation of coercive action for recovery of tax dues.

Impact

The new Circular which seeks to instruct departmental officers to initiate recovery action, if no stay is granted by the concerned appellate authorities within 30 days of filing of an appeal, is likely to result in severe hardships to taxpayers. Coercive actions for recovery of tax like attachment of bank accounts, assets and properties, etc. of assessees pending disposal of stay applications would adversely impact businesses in a significant way and also cause unprecedented hardships. It is also likely to result in filing of writ petitions before the High Courts across the country in large numbers. In fact, the Honourable Andhra Pradesh High Court has granted interim stay against the operation of the new Circular in a writ petition.

Reasons for High Level of Tax Litigation

Before issuing such a drastic and draconian circular, the Government needs to appreciate and take cognizance of the fact that, the principal reason for extensive tax litigation is high pitched adjudications which do not fully appreciate the correct legal position in a matter. A perusal of records available with the Government would clearly reveal that, in a high number of tax litigations, the matters are finally decided against the revenue and in favour of tax payers. Statistics (Refer Table) given by the Union Minister of State for Finance, Mr. S.S. Palanimanickam in a written reply to a question in the Lok Sabha on 5-9-2012, regarding the outcome of revenue cases supports the above view.

Table – Revenue Department’s Success Rate (%)

Year	Supreme Court	High Court	CESTAT
2008-09	9.81	29.6	10
2009-10	7.85	35.1	18.2
2010-11	5.5	27.1	17.2
2011-12	10.64	29.85	19.7

The Minister also mentioned that, even though approx. Rs. 86,000 crore were held up in court cases, it should not create an impression that the Government would get much monies upon finalisation of litigation. It may get only about 10% to 15% of the said amount. In the light of the above stated position, in a scenario where tax demands are unrealistic and sustained in a very small number of cases by the appellate authorities, it is totally unfair, unjust and unwarranted on the part of the Government to pressurise tax payers for no fault on their part.

Unjust and Unfair Circular

The new Circular is unjust and unfair to the taxpayer due to the following reasons, in particular:
a) Initiation of coercive actions to recover the tax dues in regard to which appeal and stay application are pending disposal before the concerned appellate authorities, is not in consonance with the settled principles of natural justice, laid down by the Supreme Court of India from time to time.

b) It also needs to be appreciated that, in a large number of cases, stay applications are not disposed off due to inactions at the end of the concerned appellate authority and for no fault of the assessee.

c) The new Circular refers to a very old Supreme Court ruling in Krishna Sales (P) Ltd (1994) 73 ELT 519 (SC) wherein it was observed as under: “As is well known, mere filing of an Appeal does not operate as a stay or suspension of order appealed against”.

However, the significant observations made by the the Honourable Supreme Court of India in a subsequent ruling in Commissioner of Cus & CE vs. Kumar Cotton Mills Pvt. Ltd. (2005) 180 ELT 434 (SC), have been totally ignored. The relevant observations are reproduced below for ready reference :

Para 6

“The s/s. which was introduced in terrorem cannot be construed as punishing the assessees for matters which may be completely beyond their control. For example, many of the Tribunals are not constituted and it is not possible for such Tribunals to dispose of matters. Occasionally by reason of other admin-istrative exigencies for which the assessee cannot be held liable, the stay applications are not disposed within the time specified. ….

The aforesaid observations need to be appropriately recognised and appreciated by the Government.

d) There are a large number of judicial decisions including those of various High Courts, to the effect that, no recovery actions should be taken until the disposal of the stay application by the appellate authorities. In this regard, useful reference can be made to the following rulings:

i) In Legrand (India) vs. UOI (2007) 216 ELT 678 (BOM HC DB), the Asst. Commissioner enforced the bank guarantee even before the expiry of the statutory period of filing appeal, despite a directive of High Court (in another case) not to take coercive action for recovery in such cases. It was held that this was a civil contempt of Court.

ii) Quoting CBEC Circular, in Shree Cement Ltd vs. UOI (2002) 126 STC 324 (Raj HC DB), it was held that no coercive action for recovery should be taken when stay application is pending.

iii) A view similar to the view expressed in the above case was expressed in Delhi Acrylic Mfg C6 vs. CC (2002) 144 ELT 24 (DEL HC DB).

It is most inappropriate for the CBEC to issue a circular in disregard to the binding court judgments and showing no respect for judicial precedence on the subject.

Suggestions

The following is suggested so as to ensure that undue hardship is not caused to tax payers:

a) CBEC Circular No. 967/01/2013 – CX dated 1-1-2013 needs to be immediately withdrawn/appropriately modified to provide that no recovery actions are initiated until the disposal of the stay applications by the appellate authorities.

b) Suitable instructions need to be issued that recovery action be restricted to cases where stay applications are disposed off and stipulated conditions are not complied with.

c) Vacancies existing in Tribunals/Courts should be filled up at the earliest.

d) All stay applications pending before appellate authorities be disposed off, in terms of existing provisions under the relevant law, on a war footing by appointing fast track Tribunals/Courts.

e) Alternatively, in all cases where appeals are filed, stay be granted and appeal itself be taken up for disposal.

Reforming Tax Administration – Some Recommendations

In order to promote and encourage good tax administration practices, from a long term perspective, the following measures are recommended:

a)    Establish accountability in tax administration whereby statutory provisions are enacted in tax laws specifically providing for actions against departmental officers passing inappropriate orders.
b)    Install quality reviews/audits of tax administration processes including adjudication process in particular.
c)    Expand the scope of Advance Ruling Mechanism to minimise litigation.
d)    Evolve new speedy dispute redressal mechanisms.
e)    Award costs to the assessees so as to cover litigation expenses.
f)    Increase the existing rate of interest on refunds of pre-deposit pending appeals as well as other refunds so as to be on par with prevailing commercial rate of interest.
g)    Introduce incentive schemes for team of departmental officers, in cases where, demands are sustained at higher judicial levels.

Conclusion

It is projected that by 2030, India is likely to become a World Economic Power. Hence, the entire world is looking at us. As per the taxation policy announced by the Government, it is expected that substantive tax reforms (viz. DTC & GST) are likely to be introduced in the near future. However, the Government needs to expressly recognise and take cognizance of the fact that, from a taxpayer perspective, the need of the hour is reforming tax administration. Employing unfair, unjust and coercive tax administration methods, would only encourage dishonest practices and non-compliances, rather than boosting tax revenues. Government needs to recognise that employing coercive tax administration methods is not the right policy to boost tax revenues. Instead, in order to boost tax revenues, priority focus of the government should be on evolving good tax administration practices.

Nirav Shah

GAAR — are safeguards adequate?

It was not surprising that the Government did not wait for introducing the General Anti Avoidance Rules (GAAR) as a part of the Direct Taxes Code (DTC). Its introduction in the Finance Bill, 2012 was natural corollary to the Supreme Court decision in the Vodafone’s case. The Government has now deferred the implementation of GAAR for a year and has introduced few more safeguards after negative reaction of the stock market and industry in general to GAAR.

Now, the discussion on the issue as to whether or not India should have GAAR has become irrelevant after its introduction in the Finance Bill. At this moment arguably, pertinent discussion could be about whether or not GAAR has enough safeguards that address the concerns of the taxpayers. Common concerns of the most taxpayers are that GAAR gives too much power to the tax authorities; it will also hit genuine tax planning schemes and it creates uncertainty as it cannot be predicted as to which arrangements will be hit by GAAR.

Many countries such as Australia, Canada, China, New Zealand, South Africa, and Spain among others have safeguards in varying degrees in their GAAR responding to the similar concerns expressed in their jurisdictions. This article discusses the safeguards in the Indian provisions and particularly, the safeguard provided by Australia, Canada, and UK on Panel akin to the Approving Panel in Indian GAAR.

Safeguards in the Indian GAAR GAAR has now the following safeguards after the amendments to the Finance Bill, 2012: The burden of application of GAAR rests with the tax authority.
Assessing Officer (AO) can invoke GAAR only after obtaining the approval of the Approving Panel.
The Approving Panel will have an ‘Independent Member’.
AO can pass Order only after the approval of the Commissioner.
Taxpayer can avail the facility of the Advance Ruling on GAAR.

The Government has also formed a committee for drafting and recommending the Rules and the Guidelines for the implementation of GAAR. The Guidelines are almost certain to specify a monetary threshold for invoking GAAR and may incorporate the Parliamentary Committee’s recommendation that the AO should record the reasons before applying GAAR.

Burden of proof is on the Department

The earlier version of GAAR had one of the most criticised provision under which the taxpayer was responsible for proving that the GAAR is not applicable to it. In the amended Bill, this particular provision is deleted to bring it in line with other tax charging provisions. Now, the burden of proving the applicability of the GAAR in a particular case rests with the tax authority.

Approving Panel

GAAR has provided one more safeguard in the form of the Approving Panel. The provision on the Approving Panel in the clause 144BA of the Finance Bill is as under:

The AO has to make a reference to the Commissioner for invoking GAAR.
The Commissioner shall provide an opportunity of being heard to the taxpayer on receipt of the reference. He shall refer the matter to the Approving Panel if he is not satisfied by the reply of the taxpayer and is of the opinion that GAAR provisions are required to be invoked. The Commissioner shall also decide as to whether the arrangement is an impermissible avoidance arrangement or not when the taxpayer does not object or reply.
The Approving Panel after providing an opportunity to be heard to the taxpayer has to dispose of the reference within six months after examining material and if necessary, after getting further inquiry conducted. The disposal could be either by declaring an arrangement to be impermissible or by declaring it to be not impermissible.

The AO will determine the consequences of such declaration of an arrangement as ‘impermissible avoidance arrangement’.

Every direction of the Approving Panel shall be binding on the AO and the AO shall complete the proceedings in accordance with the directions only after the approval of the Commissioner.
The period taken by the proceedings before the Commissioner and the Approving Panel shall be excluded from the time limitation for the completion of assessment. l The Approving Panel shall comprise of minimum three members. Out of which, two members would be of the Income-tax Department of the rank of Commissioner or above and third ‘independent’ member would be from the Indian Legal Service not below the rank of Joint Secretary.
The Board may make rules for the procedure, for efficient working of the Panel and for expeditious disposal of references.

This proposed Section is largely based on the provision under UK’s draft law on GAAR2. For appreciating the issues involved in Approving Panel, it might be worthwhile to peruse the information on similar panels formed by Australia and Canada as well as proposed Panel of UK for the application of GAAR.

Role of the Approving Panel

Australia3 (GAAR Panel) and Canada4 (GAAR Committee) have non-statutory, advisory or consultative body to assist tax officers in administration of GAAR and to ensure consistency in approach in application of GAAR. In both the countries, although the Tax Officer finally decides as to whether or not to apply GAAR, he considers the advice given by the Panel before taking the decision. Similarly, UK’s proposed statutory Advisory Panel also shall give only its opinion as to whether there is reasonable ground for the application of GAAR5. The Indian Approving Panel neither is an advisory in nature, nor is mandated to assist the AO on the application of GAAR. Neither the clause 144BA elaborate, nor the ‘explanatory notes to the Finance Bill’ explain the role of the Approving Panel. This ambiguity can create different expectations among taxpayers as it has happened in the case of the ‘Dispute Resolution Panel’ (DRP).

Many taxpayers see the DRP as an adjudicating body on a dispute between the taxpayer and the Department. This expectation is because of the words ‘dispute resolution’ used for the Panel along with the lack of clarity on its role. On the other hand, many Departmental officers perceive DRP as an administrative safety mechanism to prevent inappropriate application of law against a taxpayer. Their justification is based on the argument that, the Law does not intend to have an appellate level between the AO and the Tribunal even before the order is passed. Moreover, DRP cannot be an adjudicating body, as it does not have necessary powers to function as an Appellate Court.

The role of the Approving Panel appears to be of an administrative in nature for ‘approving’ or ‘disapproving’ applicability of GAAR, a function similar to that of the Range head (Additional Commissioner) who approves some of the AO’s orders6. However, in absence of clarity, officers on the Panel may consider that it is their job to ensure successful invoking of GAAR in deserving cases. Therefore, they also may give directions to strengthen the case of the Department. On the other hand, the taxpayer would like to have a neutral body in which the panel should decide against the Department in weak cases rather than the Panel issuing directions to strengthen the Department’s case. Therefore, elaboration of the Panel’s role will help all in its functioning.

Aspect of consistency in the Panel’s approach is also of worth consideration. Australia and Canada ensure consistency in the Panel’s decisions by having a system under which reference is made only from a single point (head office) and by having centralised Panel in the country. In India also, initially only one Panel may be constituted to ensure consistency. Number of Panels can be gradually added with the increase in work. The need for consistency also requires that the Panel members should be appointed for a longer duration and should not be frequently changed. It might be a good idea to have the members dedicated only for the work of the Approving Panel or the DRP for ensuring consistency in its approach.

Composition of the Panel
The Parliamentary Standing Committee has recommended that the Departmental body should not review application of GAAR but an independent body should review it. The Committee has suggested that the Chief Commissioner should head the reviewing body and it should have two independent technical members. However, the Government has decided to form a Panel consisting of the senior Tax Officers and an Officer of Indian Legal Service as against the arguments for having non-Governmental independent members. Now the composition of the Panel appears to be more balanced than what was previously proposed, although taxpayers would have preferred to have non-Governmental independent member on the Approving Panel.

The Australian GAAR Panel consists of senior tax officers, businessmen and professional experts. The Panel is headed by a senior Tax Officer7. UK’s Advisory Panel is proposed to be to be chaired by an independent person and will have a tax officer and an independent member having experience in area relevant to the activity involved in the arrangement8. Whereas, the Canadian GAAR Committee consists of the representatives from the different departments of the Government such as Department of Legislative Policy, Tax Avoidance and Income-tax Rulings. The Committee also has lawyers and representatives from the Department of Finance of the Government.9

Presence of the non-governmental independent members on the Approving Panel gives more confidence to taxpayers in its decisions. Tax-payers perceive such a panel to be fair and unbiased. It also results in external review of the Departments’ work on GAAR and makes the Department some-what accountable to external systems.

However, having independent non-governmental member in the Committee raises different issues, such as such member’s eligibility criteria, transparency in selection process, tenure, etc. Having non-Governmental independent members on the Panel also raises the issue of protection of taxpayers’ confidentiality. Not many taxpayers would prefer their affairs becoming known to other professionals or businesspersons. Again, non-Governmental independent members have conflict of perception and occasionally may have conflict interest. Unlike in many developed taxation systems, it is doubtful as to how many independent members in India would take an adverse view of the arrangement devised by a fellow professional or a businessperson. Further, a non-Governmental independent member on a Panel also may lead to the issue of his accountability, especially when the Panel’s decision is not advisory but is binding on the tax authority under the present law. Moreover, eminent independent persons may not be easily available for the Approving Panel work due to pressure on their time. Constituting a Panel with eminent independent persons is easier said than done and therefore, a Panel consisting of independent members also may not solve the problem.

Powers and procedure of the Panel

Both, the Australian GAAR Panel and the Canadian GAAR Committee do not investigate or find facts or arbitrate disputed contentions. They advise on the basis of the facts referred by the tax officer and by the taxpayer. The Panel may suggest tax officer to make additional enquiries if the facts are disputed. As against this, Indian Panel is armed with more powers and it can direct the Commissioner to get necessary enquiries conducted as the Panel’s role is not advisory in its nature.

The Australian GAAR Panel may extend invitation to the taxpayer to make oral as well as concise written submission before it. The Canadian GAAR Committee does not afford taxpayer right to represent before it, but they may file written submissions before it. The taxpayers are not entitled to have copies of the reports and other submissions made by the authorities or experts in their case before the Committee. However, they will receive the copy of the Committee’s decision along with the reasons of the decision. The Australian Tax office releases the decision of the Panel in the form of either taxation ruling or in the form of the summarised decision on issue to be followed by the tax officers as the official tax office position on that issue.

Working of the Panel

The statistics of Australia and Canada show that these bodies have recommended application of GAAR in majority of the cases referred to it. In a period from 1st July 2007 to 30th June 2011, the Australian Panel advised application of GAAR in 64% of cases, called for further information in 17% of cases, whereas it decided not to apply GAAR only in 19% of the cases referred to it10. Whereas, as on 31st March 2011, the Canadian Committee approved application of GAAR in 73% cases referred from the date since GAAR was first introduced in Canada in 1988¹¹. Based on this statistics, one can expect similar trend in India on approval of GAAR references.

The statistics of the decisions of these Panels are available in public domain in Australia and in Canada. Australia also releases the decisions of the Panel in form of taxation rulings or in form of decisions to be followed as a precedent. UK’s draft law also proposes publication of a synopsis of each opinion (without revealing the identity of
taxpayer to protect confidentiality) and publication of regular digests of such opinions.¹² It might be good to release statistics of the decisions of the Approving Panel for transparency.¹³

Purposive interpretation of GAAR

One relevant issue, which is not a safeguard but requires consideration for ensuring effectiveness of GAAR is of having a legal provision on interpretation of GAAR.

The Indian Courts have largely applied the rule of literal construction to the interpretation of taxing statutes. This approach is based on the following two principles:

Legislation should be strictly interpreted on the basis of the words used and legislative purpose should not be presumed and

If the words of a provision are found to be ambiguous, the ambiguity should be resolved in favour of the taxpayer.

This approach creates problem when taxpayer pay lesser taxes by using a legal construction or transaction based on a gap or a loophole in law which will place him outside reach of the law.14 Therefore, the Courts of Australia, UK and Canada more often use purposive interpretation on provisions of tax avoidance as narrow interpretation of the legal provisions could result in injustice. Purposive interpretation of taxing statute seeks to interpret the provision according to the object, spirit, and purpose of the tax provision. This approach is sum marised in the case of the Pepper v. Hart, (1993) 1 All ER 42, HL(E) as under:

“The object of the Court in interpreting legislation is to give effect so far as the language permits to the intention of the Legislature….. Courts now adopt a purposive approach which seeks to give effect to the true purpose of legislation and are prepared to look at much extraneous material that bears upon the background against which the legislation was enacted.”

Purposive interpretation is also justified on the ground of fundamental principle of taxation statute, which seeks to treat similarly placed taxpayers similarly. In absence of purposive interpretation, arrangement of one taxpayer may be treated as tax avoidance, but similar arrangement of other taxpayer may not be treated as tax avoidance due to some minor insignificant difference. Therefore, Australia15 and New Zealand16 have enacted a specific legal provision to ensure that the provision is interpreted according to purpose and object of the statute. Other provision permits them to use extrinsic aids to overcome the problem of gathering the purpose and object of the law17.

Tax laws deal with the transactions taking place in changing economic circumstances. Tax avoidance schemes are carefully devised so that legal provision may not catch them. Purposive interpretation could be helpful on such occasions. Therefore, clarification in the proposed Guidelines may help in ensuring uniformity in the judicial approach on interpretation of the GAAR.

Conclusion

The Indian Approving Panel is statutory and non-advisory body and its directions are binding on the AO. It is sufficiently empowered to carry out its function effectively by getting further enquires conducted. The Indian Panel is the most powerful when compared to similar Panels in other jurisdictions. Therefore, legally, the Indian GAAR has the strongest safeguard on this ground among all.

However, industry’s apprehensions on GAAR may be arising out on implementation of such tax laws in India. It is a fact that many of these concerns are because of the huge trust deficit between the Department and taxpayers. Improving their relationships is an uphill task in a country which has massive tax evasion leading to various estimates of the size of parallel economy. For the Government, raising more revenue by plugging revenue loss taking place due to tax evasion schemes is a matter of high priority when less than 3% of its population bears the burden of paying taxes. Therefore, there is no going back from GAAR. Now, one can only hope that, GAAR and its procedure will gradually evolve for better with the feedback of the stakeholders.

1    The author is Commissioner of Income-tax. Views expressed in the article are entirely personal.

2    Section 14, ‘Illustrative draft GAAR’, ‘GAAR Study’, Report by Graham Aaronson, QC, at p-52

3    PS LA 2005/24, 13th December 2005, Australian Taxation Office.

4    William Innes, Patrick Boyle and Joel Nitikman, ‘The essential GAAR manual: Policies, principles and procedures’, CCH Canadian Ltd. (Toronto: 2006) pp- 1-296, at p-90.

5    Para 61, See note-2, at p-72

6    Search Assessment Orders, some of the penalty orders under Chapter-XXI.

7    Para 23, see note-3.

8    Para 66, see note-2, at p 73

9    See note-4, at p 90

10    Out of total 55 cases, GAAR application was advised in 35, declined in 10 and decision deferred for various reasons in 9. Source- GAAR Panel Report, NTLG Minutes, March 2008, September 2008, September 2009, March 2010, October 2010, March 2011 and September 2011, Australian Taxation Office, Australia website.

11    Lynch Paul, ‘GAAR Committee Update-March 31 2011’ Canadian Tax Adviser, May 24,2011, http://www.kpmg. com/Ca/en/IssuesAndInsights/ArticlesPublications/ CanadianTaxAdviser/CTA_Uploads/

12    Para 5.25, see note 2, at p 34.

13    “We are working on an easy and transparent mechanism to implement GAAR, but more specifics will be notified once the Finance Bill is passed,” Shri R. Gopalan, Secretary, Economic Affairs, 16th April 2010, moneycontrol.com

14    Vanistendael Frans, ‘Legal framework for taxation’, Tax Law Design and Drafting, Vol-1, (ed, Victor Thuronyi), International Monetary Fund (1996), Washington DC, at p 45.

15    Acts Interpretation Act, 1901, Australia. section 15AA — Regard to be had to purpose or object of the Act.
“(1) In the interpretation of a provision of an Act, a construction that would promote the purpose or object underlying the Act (whether that purpose or object is expressly stated in the Act or not) shall be preferred to a construction that would not promote that purpose or object.”

16    Interpretation Act, 1999, Section 5(1) “The meaning of an enactment must be ascertained from its text and in the light of its purpose.”

17 Australia section 15AB of Acts Interpretation Act, 1991 and New Zealand section 5(1) and 5(2) of the Interpretation Act, 1999.

Nirav Shah

Taxability of Fees from offshore services — post Finance Act, 2010

Article

By the time you read this Article, the Finance Bill, 2011
will be presented by the Hon’ble Finance Minister in the Parliament and probably
with minimum changes expected in the direct tax provisions in this year’s budget
on account of onset of the Direct Tax Code in the financial year 2012-2013, it
is then time to introspect on one of the most discussed and publicised amendment
of Finance Act, 2010 in section 9 of the Income-tax Act, 1961 (‘the Act’).

By the Finance Act, 2010; the Legislature retrospectively
amended the Explanation to section 9 of the Act (which was inserted retrospectively only vide the
Finance Act, 2007) to reiterate the taxability of income by way of interest,
royalty and Fees for Technical Services (‘FTS’), under the principle of ‘source
rule of taxation’. This was done with a view to reverse the findings of the Apex
Court in the cases of Ishikawajima-Harima Heavy Industries Ltd. v. DIT,
(288 ITR 408) and the Karnataka High Court in the case of Jindal Thermal
Power Company Ltd. v. DCIT (TDS), (321 ITR 31) on the issue of taxability of
FTS in India u/s.9 of the Act. The Legislature amended the language of the
Explanation to provide that situs of rendering of services was not relevant in
determining the taxability of the aforesaid income u/s.9 of the Act. The
Memorandum explaining the Finance Bill, 2010 specifically stated the intention
of the Legislature to tax the fees from technical services which are provided
from outside India as long as they are utilised in India (services
rendered from outside India are for brevity referred to as ‘offshore services’).
The aforesaid intention further got judicial recognition in the decisions of the
Income-tax Appellate Tribunal (‘the Tribunal’) of Ashapura Minechem Limited
v. ADIT, (2010) (40 DTR 42) (Tri.) and Linklaters LLP v. ITO, (42 DTR
233) (Tri).

However, on a careful reading of section 9(1)(vii) along with
the aforesaid Explanation, a question that arises for consideration is whether
the plain words of the statute in their present form support the intention of
the Legislature of ‘situs of utilisation of services’ as being condition of
paramount importance to determine the tax jurisdiction of income from offshore
services u/s.9 of the Act.

The issue has been dealt only from the perspective of
provisions of the Act and not from the perspective of Double Taxation Avoidance
Agreements entered by India with other countries.

Section 4, section 5, r.w.s. 9(1)(vii) of the Act provide for
taxability of FTS in India.

Section 9(1)(vii) of the Act by deeming fiction prescribes three rules qua the
category of the payer for determination of the tax jurisdiction of FTS in India
in the form of sub-clauses (a), (b) and (c). The concept of ‘source rule’ of
taxation was introduced in section 9 of the Act to address the difficulties
faced in taxing income in the nature of interest, royalty and FTS by the Finance
Act, 1976. Section 9(1)(vii)(b) which deals with taxation of FTS along with an
Explanation to Section 9, in its present form, is reproduced below for ready
reference:

“(vii) income by way of fees for technical services payable by:

(a)

(b) a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India; or

(c)

Explanation — For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section(1) and shall be included in the total income of the non-resident, whether or not, :

(i) the non-resident has a residence or place of business or business connection in India; or

(ii) the non-resident has rendered services in India.”

From the aforesaid provision, one would appreciate that in
its present form, the condition of ‘utilisation of services in India’ as
determining the tax jurisdiction of fees from offshore services

cannot be found in the plain words of the statute. The condition of ‘utilisation
of services’ may be of relevance in order to test the exception as provided in
section 9(1)(vii)(b) of the Act, but cannot be read to determine the taxability
of offshore services. In other words, the ‘situs of service utilised’ can be
relevant only to fall under the exception of section 9(1)(vii)(b) and not the
main part of section 9(1)(vii)(b). Further, if the said condition was to be read even in the
main part of section 9(1)(vii)(b), then there was no requirement to separately classify the
provision in clauses (a), (b) and (c) and the language of the provision would
have been different. The condition on the touchstone of ‘source rule of
taxation’ which then determines the tax jurisdiction of fees from offshore services is discussed below.

The concept as well as the expression ‘source of income’ is
not new to the Income-tax Act, 1961. In fact, this concept even existed under
the Income-tax Act, 1922 (‘the 1922 Act’). The provisions of section 42(1) of
the 1922 Act analogous to the present provisions of section 9(1)(i) considered
‘source of income in India’ as one of the basis for determining whether income
was deemed to accrue or arise in India.

The word ‘source of income’ is not defined under the
provisions of the Act. However, the CBDT in Circular No. 3 of 2008 on
Explanatory Notes on provisions relating to Direct Taxes of the Finance Act,
2007 explained the principle of ‘source rule of taxation’ for determining tax
jurisdiction of FTS in S. 9 as to be the country where the income is earned.
The word ‘earned’, though not defined under the provisions of the Act, has
received judicial interpretation in various decisions.

The Gujarat High Court, in the case of CIT v. S. G. Pgnatale, (124 ITR 391) explained the concept of ‘income earned’ for the purpose of section 9(1)(ii) of the Act. The Court, after con-sidering the ratio of the relevant legal precedents at that point of time, explained the meaning of the word ‘earned’ in the narrower sense and in the wider sense. In the narrower sense, the word ‘earned’ refers to a place of rendering or performance of services as an ingredient to determine the ‘source of income’ and in the wider sense equated it with ‘accrued’, meaning that not only the assessee under consideration should have rendered services or otherwise, but also should have created a debt in his favour i.e., a right to receive. Thus, the wider meaning of the word ‘earned’ indicates something which is due and entitlement to a sum of money consideration for which services have been rendered or otherwise by the assessee.

Further, the principle of ‘source of income’ juxta-posed with the words ‘income earned’ has been aptly explained in the following decisions, which hold the field of taxation on ‘source of income’, even today:

E. D. Sassoon & Co. Ltd. v. CIT, (26 ITR 27) (SC);

CIT v. Ahmedbhai Umarbhai & Co., (18 ITR 472) (SC);

CIT v. K.R.M.T.T. Thiagaraja Chetty & Co., (24 ITR (SC);

CIT of Taxation v. Kirk, (1900) AC 588 (PC);

W. S. Try Ltd. v. Johnson (Inspector of Taxes),(1946) 1 ALL ER 532 (CA); and

Webb v. Stenton, (1883) (11 QBD 518) (CA).

A question may then arise as to where then the condition of ‘income earned’ as intended by the Legislature can be found in the plain words of section 9(1)(vii) of the Act. The words ‘payable by’ in section 9(1)(vii) express the condition of ‘income earned’.

In the general sense, the word ‘payable’ means that which should be paid. However, the following decisions have held that the word ‘payable’ is somewhat indefinite in import and its meaning must be gathered from the context in which it occurs:

New Delhi Municipal Committee v. Kalu Ram,(1976) (3 SCC 407); and

Garden Silk Weaving Factory v. CIT, (213 ITR 10) (Guj.)

Further, the decision of Madhya Pradesh High Court in the case of CIT v. The Central India Electricity Supply Co. Ltd., (114 CTR 160) has explained the words ‘due’ and ‘payable’ in context of section 41(2) of the Act. The Court observed that the word ‘due’ has two meanings, and one of the meaning is equivalent to ‘payable’, thereby indicating that the word ‘payable’ can be read to include ‘due’ and expressing that debt or obligation to which applied has by contract or operation of law becomes immediately enforceable, thereby in other words, satisfying the twin condition of ‘income earned’ in the wider sense u/s.9(1)(vii) of the Act. This argument gets support from the fact that Explanation to section 9 of the Act has been specifically amended to provide that situs of rendering of services shall not be relevant in determining the tax jurisdiction of the income from offshore services and thereby conveying the meaning of ‘income earned’ in a wider sense. The findings of the Apex Court in E. D. Sassoon & Co. Ltd. (supra) were relied upon by the Gujarat High Court in the case of CIT v. S. G. Pgnatale, (Guj.) in order to differentiate the meaning of the word ‘earned’ in wider sense from the narrower sense.

The relevant observations of the decision of CIT v. S. G. Pgnatale, (supra) with respect to the word ‘earned’ are reproduced below, duly explaining it in the narrow sense as well as in the wider sense:

“…..17. The word ‘earned’ even though it does not appear in section 4 of the Act has been very often used in the course of the judgments…. The concept, however, cannot be divorced from that of the income accruing to the assessee.

If the income has accrued to the assessee, it is certainly earned by him, in the sense that he has contributed to its production or the parenthood of the income can be traced to him….The mere expression ‘earned’ in the sense of rendering the services, etc., by itself is of no avail.”

Thus, it is clear that according to the Supreme Court in E. D. Sassoon’s case (supra) the word ‘earned’ has two meanings. One meaning is the narrower meaning in the sense of rendering of services, etc., and the wider meaning in the sense of equating it with ‘accrued’ and treating only that income as earned by the assessee to which the assessee has contributed to its accruing or arising by rendering services or otherwise, but he must have created a debt in his favour…..?It may be pointed out that these two meanings indicated by the Supreme Court in E. D. Sassoon’s case (supra) have also been indicated in Corpus Juris Secundum, Vol. 28, p. 069 where it has been pointed out that the word ‘earned’ has been construed as meaning entitled to a sum of money under the terms of a contract, implies that wages earned are owing, and may carry the meaning of unpaid, but does not necessarily imply that they are due and payable. The term has been distinguished from ‘due’ and ‘payable’. Thus, the wider meaning of the word ‘earned’ indicates something which is due, owing and entitlement to the sum of money consideration for which services have been rendered by an assessee, is a clear concept indicated by Corpus Juris Secundum….”

So, based on the aforesaid consideration, it is possible to conclude that the word ‘payable’ in section 9(1)(vii) symbolises the condition of income ‘earned’ in the wider sense and reiterating the principle of ‘source rule of taxation’ u/s.9(1)(vii) of the Act.

In all fairness, before concluding on the condition which determines the tax jurisdiction of fees from offshore services, it would be relevant to consider the finding of the decisions of the Mumbai Tribunal as referred above of Ashapura Minechem Ltd. (supra) and Linklaters LLP v. ITO (supra).

The Tribunal in the case of Ashapura Minechem Limited ( supra) relying on the provisions of section 9 of the Act (as amended vide the Finance Act, 2010) held that the technical services of bauxite testing and preparation of reports rendered from outside India by a non- resident company shall be deemed to accrue or arise in India u/s.9(1)(vii) of the Act (and also under Article of India-China tax treaty) on the ground that the impugned services were utilised in India. On a similar analogy, fees from professional services rendered by Linklaters LLP (‘the Appellant’) to residents of India in the case of Linklaters LLP v. ITO (supra) was also held to be taxable in India as FTS under the provisions of section 5(2) r.w.s. 9(1)(vii)(b) of the Act. The Tribunal further opined that ‘situs of utilisation of service’ and ‘situs of payer’ determine the tax jurisdiction of FTS under the source rule of taxation in section 9(1)(vii) of the Act, which also finds support in the respective Memorandum explaining the provisions of the Finance Bill, 2007 and Finance Bill, 2010.

In this regard, it may be relevant to consider the decision of the Gujarat High Court in the case of CIT v. Saurashtra Cement and Chemical Industries Ltd., (101 ITR 502), wherein the Court held that a debt due to a foreigner cannot be treated as an asset or source of income in India and the interest thereon cannot be deemed to accrue or arise in India, merely because the debtor is in India, thereby upholding that situs of the payer itself cannot solely determine the tax jurisdiction of income.

Thus, ‘situs of payer’ and ‘situs of utilisation of service’ may be of relevance for the purpose of determining the applicability of exception u/s. 9(1)(vii)(b) of the Act or satisfaction of additional condition u/s.9(1)(vii)(c).

In addition, the following decisions by various judicial authorities have also upheld the principle of ‘the country where income is earned’ as the basis for determining the tax jurisdiction of income under source rule of taxation:

Rajiv Malhotra, in re (284 ITR 564) (AAR);

Rupajee Ratanchand and Anr. v. CIT, (28 ITR 282) (AP);

Mansinghka Brothers Private Ltd. v. CIT, (147 ITR (Raj.);

C. G. Krishnaswami Naidu v. CIT, (62 ITR 686) (Mad.); and

SAT Behwaric & Co. v. CIT, (30 ITR 151) (Raj.)

In light of the above, one may conclude that it is the principle condition of ‘income earned’ under the source rule of taxation, which determines tax jurisdiction of FTS u/s.9(1)(vii).

Further, the next important concept which requires simultaneous discussion is of whether India has a ‘territorial tax system’, ‘worldwide tax system’ or ‘mixed tax system’. The reference towards the concept of ‘territorial nexus’ was recently found in the judgments of the Mumbai Tribunal in the case of Ashapura Minechem case (supra), Linklaters LLP v. ITO (supra) and also under Memorandum explaining the provisions to Finance Bill, 2007.

There are essentially three types of tax strategies applied worldwide, which are as under?:

Territorial tax system;

Worldwide tax system; and

Mixed tax system

Under ‘territorial tax system’ as rightly explained by the Tribunal in the aforesaid decisions, a tax-payer is responsible for paying taxes only on that part of business which he does within his home country or state. In other words, it relies only on the ‘territorial’ principle for taxing income earned inside the national borders. On the other hand, in ‘worldwide tax system’, a taxpayer is taxed by the home government on all the business that the taxpayer does worldwide. Whereas in the case of mixed tax systems, elements of both territorial and worldwide tax systems are in place.

India follows ‘mixed tax system’. Elements of worldwide tax system are found while taxing residents of India and elements of territorial tax systems are found while taxing non-residents of India. ‘Doctrine of nexus’ is considered in India for the purpose of determining tax jurisdiction of income in case of non-residents.

The ‘doctrine of nexus’ for determination of tax jurisdiction of income of non- residents in India was approved by the Supreme Court in the case of Electronics Corporation of India Ltd. (183 ITR (three-Member Bench decision) as early as in the year 1989 while rejecting the submission of extra-territorial application of the provisions of section 9(1)(vii) of the Act, which are presently being considered. The principle of ‘doctrine of nexus’ was well read down in the provisions of section 9(1)(vii) of the Act by the said judgment. However, the ingredient which shall determine such nexus was referred to the Constitution Bench of the Supreme Court in the Electronics Corporation’s case (supra), since the question was of substantial importance. It would be important to mention here that the decision of the Constitution Bench is still awaited. However, there are reports that before the matter could be placed before the Constitution Bench, the appeal was withdrawn.

Further, the law of nations generally recognises that the ‘doctrine of nexus’ involves consideration of two elements:

The connection must be real and not illusory; and

The liability sought to be imposed must be pertinent to the connection.

Thus, based on the aforesaid principles, the customary international law that comprehends levy of taxes by a state where there is connection between the state and the taxpayer on either of the following basis:

Territorial nexus, based on domicile or residence of the taxpayer in the taxing state; or

Economic nexus, based on the economic activity within, or connected with, the taxing state.

If one were to define economic nexus, in common parlance, it is regarded as part of ‘territorial nexus’. A nexus between the person or income sought to be taxed on the one side and the taxing country on the other.

Similarly, one may refer to the following Indian judicial precedents wherein time and again, the judicial authorities have upheld the ‘doctrine of nexus’ between the person or income which is subject to tax and the country imposing the tax as a pre-requisite for the purposes of taxation:

CIT v. Eli Lilly and Co. (India) P. Ltd. and Ors., (312 ITR 225) (SC);

Hoechst Pharmaceuticals Ltd. v. State of Bihar, (154 ITR 64) (SC);

Mahaveer Kumar Jain v. CIT, (277 ITR 166) (Raj.) [decision following the judgment of Electronics Corporation of India Ltd. case (supra)]; and

Worley Parsons Services Pty Ltd., In re (312 ITR 273) (AAR);

Based on the aforesaid discussion, one may conclude that the ‘doctrine of nexus’ is well recognised and is an accepted principle for the purpose of determining tax jurisdiction of in-come, more specifically in cases of taxation of non-residents in India and ‘source of income in India’ is recognised as one of the ‘doctrine of nexus’ to establish territorial nexus in India.

India, therefore, neither follows pure ‘territorial tax system’ nor pure ‘worldwide tax system’, but follows ‘mixed tax system’. So, even after looking at the issue to determine tax jurisdiction of FTS from the point of view of the ‘doctrine of nexus’, the result under this alternative also remains the same that ‘source of income’, being the necessary nexus or connection, must have a relationship with India i.e., of ‘income earned’ in India and therefore, the observations of the Mumbai Tribunal may require reconsideration.

Conclusions:

In the backdrop of the aforesaid discussions, one may conclude as under:

Plain words of the statute in section 9(1)(vii) of the Act cannot be read to state that ‘situs of service utilised’ shall be of paramount importance to determine the tax jurisdiction of fees from offshore services;

The principle of ‘source rule of taxation’ recognises the country where the income is earned as the basis for determining the tax jurisdiction of fees from offshore services;

‘Situs of payer’ and ‘Situs of services utilised’ are of relevance for the purpose of falling under the exception of section 9(1)(vii)(b) and satisfying the additional condition of section 9(1)(vii)(c) of the Act;

Non-relevance of ‘situs of service rendered’, supports the argument that the concept of ‘income earned’ is interpreted in wider sense to determine tax jurisdiction of income from FTS u/s.9(1)(vii) of the Act;

India, neither follows pure ‘territorial tax system’ nor pure ‘worldwide tax system’, but follows ‘mixed tax system’; and

‘Source of income’ is recognised under the Act as one of the basis of territorial nexus in determination of tax jurisdiction of income.

Therefore, in light of the aforesaid considerations, the general understanding of fees from offshore services being income deemed to accrue or arise in India and taxable under the domestic provisions of the Act, may require reconsideration.

Editor’s Note: Attention of the readers is invited to the recent decision of the Supreme Court of India (five member Bench) in the case of GVK Industries Ltd vs. ITO (2011-TII-03-SC-CB-INTL) in which the Court has opined on the issue of `territorial nexus’ for taxation in India.

Nirav Shah

Is Syncome Formulations (I) Ltd. [292 ITR (AT) 144 (SB)(Mum.)] Still a good law ?

Article 1

I. Introduction :

1.
The calculation of deduction u/s.80HHC of the Income-tax Act itself is a complex
issue. The complexity is further increased when one attempts to calculate the
deduction u/s.80HHC of the Act for the purpose of making adjustments u/s.115JA/JB
of the Act in order to arrive at the ‘book profit’. The Special Bench in the
case of Syncome Formulations (I) Ltd. [292 ITR (AT) 144 (Mum.)] held that for
the purpose of S. 115JB, the deduction u/s.80HHC of the Act has to be calculated
with reference to the adjusted book profits and not the normal gross total
income.

2.
Recently, the Bombay High Court has rendered a decision in the case of CIT v.
Ajanta Pharma Ltd. reported at (318 ITR 252). In the said decision, the
Bombay High Court has observed at para 36, page 269 as under :

“We
have had the benefit of going through the reasoning and the orders in
Deputy CIT v. Syncome Formulations (I) Ltd.,
(2007) 292 ITR (AT) 144; (2007) 106 ITD 193 (Mum.)(SB) as also in the case of
Deputy CIT v. Govind Rubber P. Ltd., (2004) 89 ITD 457; (2004) 82 TJT 615.
It is not possible to agree with the view taken by the Benches. Those decisions
in view of these judgments stand overruled.”

3.
An attempt has been made in this article to find out as to whether; subsequent
to the decision of Bombay High Court, the ratio laid down by the Special Bench
in the case of Syncome Formulations (I) Ltd. is still valid or not, and if yes,
to what extent.

4.
Before we really go into the judgment of the Bombay High Court in the case of
Ajanta Pharma Ltd., it is imperative to closely look into the decision of the
Special Bench in the case of Syncome Formulations (I) Ltd. and also the decision
of the Division Bench of the Mumbai Tribunal in the case of Ajanta Pharma Ltd.
(21 SOT 101) which has been ultimately reversed by the Bombay High Court in the
above-referred decision. This is for the reason that according to the humble
opinion of the author, the issue involved in Syncome Formulations (I) Ltd. is
totally different than the issue involved in the case of Ajanta Pharma Ltd.

II. Issue involved in the decision
of Special Bench — Syncome Formulations (I) Ltd. :

5.
According to the provisions of S. 80HHC of the Act, the deduction provided under
that Section is to be calculated as per the formula prescribed in Ss.(3).
According to the said formula, one has to start with the ‘profit of the
business’ and make some multiplication, division, etc. in case of manufacturing
exporter to arrive at eligible amount of deduction. The Section also provides
for the formula in case of trader exporter wherein also one has to calculate the
profit of the business. The question which arose before the Special Bench is as
to what is to be taken as the ‘profit of the business’ which would further
undergo the mathematical exercise. According to the assessee, while calculating
the deduction u/s. 80HHC for the purpose of 115JA/JB, the profit of the business
should be the profit as shown in Profit and Loss Account; whereas as per the
revenue, the profit would mean profit assessable under the head ‘business
income’. Thus, the whole controversy is — What is the starting point for
calculating deduction u/s.80HHC for the purpose of S. 115JA/JB of the Act. This
issue has been resolved by the Special Bench in favour of the assessee for the
detailed reasons given in the said decision.

III. Issue involved in the decision
of Ajanta Pharma Ltd. (80 HHC) :

6.
The Bombay High Court in the case of Ajanta Pharma Ltd. was required to address
an issue as to whether the export profits to be excluded from the ‘book profits’
u/s.115JB of the Act is to be calculated after applying the restriction of S.
80HHC(1B) of the Act. In other words, whether the amount to be reduced from the
book profits should be the entire eligible amount of deduction or only the
percentage of the eligible deduction actually allowable under the Act as per S.
80HHC(1B) of the Act ? The questions of law raised before the High Court are as
under :

“1. Whether on the facts and in the circumstances of the case and in law the
ITAT was justified in approving the Order of the CIT(A) in allowing respondent
to exclude export profits for the purpose of S. 115JB at the figure other than
that allowed u/s.80HHC(1B) ?

2. Whether in law for the purpose of calculating book profit u/s.115JB of the Income-tax Act, 1961 under Explanation 1 sub-clause (iv) the export profits to be excluded from the book profits would be the export profits allowed as a deduction u/s.80HHC after restricting the deduction as per the provisions of Ss.(1B) of S. 80HHC of the Act or the export profits calculated as per Ss.(3) and Ss.(3A) of S. 80HHC before applying the restriction contained in Ss.(1B) of S. 80HHC??”

Answering the said question, the High Court held that while computing the ‘book profits’, the quantum of deduction allowable under clause (iv) to Explanation 1 u/s.115JB of the Act will have to be restricted to actual permissible deduction as calcu-lated u/s.80HHC(1B) of the Act.

IV. To what extent is Syncome Formulations Ltd. still a good law??

7. As seen above, the question referred to the High Court was restricted to S. 80HHC(1B). The issue dealt with by the Tribunal in the case of Ajanta Pharma Ltd. was only in respect of S. 80HHC(1B) and, therefore, the High Court could not have dealt with the controversy which was there in Syncome Formulations (I) Ltd. This is further fortified by the question of law referred to before the High Court.

8. Further, no arguments were also raised by the either parties before the Bombay High Court in respect of the controversy involved in Syncome Formulations (I) Ltd. In my opinion, something which has not been considered could never have been disapproved.

9. The reason as to why the Bombay High Court observed that Syncome Formulations (I) Ltd. is overruled is because the Tribunal decision in the case of Ajanta Pharma Ltd. (21 SOT 101) at para 10, page 109 heavily relied upon para 59 of the decision of Syncome Formulations (I) Ltd. The reliance was limited to the controversy which was involved in Ajanta Pharma Ltd. and not the one which was involved in Syncome Formulations (I) Ltd. It is only because the Tribunal in the case of Ajanta Pharma Ltd. in one of the paragraphs, has heavily relied upon the decision of Syncome Formulations (I) Ltd., the High Court has observed that Syncome Formulations (I) Ltd. is overruled.

10. Further, controversy involved in Syncome Formulations (I) Ltd. is resolved in favour of the assessee after strongly relying upon the Circular of CBDT [Circular No. 680, dated 21-2-1994 (206 ITR 297)]. The said Circular has neither been cited nor discussed by the Bombay High Court.
This also establishes that the controversy was totally different before the Bombay High Court. This view is made abundantly clear by the immediately following paragraphs (para 37 on page 269, 270), wherein the Bombay High Court has observed in respect of the decision of the Kerala High Court in the case of CIT v. GTN Textiles Ltd., (248 ITR 372) as under?:

“The issue before the Kerala High Court was, what is the profit that should be taken into consideration considering the accounting system that has to be followed while working out the book profits. Therefore, the judgment would be no assistance in considering the question framed for consideration. (Emphasis supplied).

11. From this, it is clear that the decision of the Kerala High Court which is directly on the issue dealt with Syncome Formulations (I) Ltd. has been held to be not applicable. Moreover, the Bombay High Court has not dissented from the view of the Kerala High Court.

12. The view taken by the Special Bench is correct also in view of the fact that there are direct decisions of the High Court in the following cases supporting the stand taken by the Special Bench?:

CIT v. GTN Textiles Ltd., [248 ITR 372 (Ker.)]

CIT v. K. G. Denim, [180 Taxman 590 (Mad.)]

Rajnikant Schenelder & Associates (P) Ltd., [302 ITR 22 (Mad.)]

13. It is also relevant to refer the decision in the case of Sun Engineering Works Ltd. (198 ITR 297) (SC), wherein the Supreme Court has observed that a decision of the Court takes its colour from the question involved in the case in which it is rendered and while applying the decision, one must carefully try to ascertain the principles laid down by the Court and not to pick out words or a sentence from the judgments delivered from the context of the question under consideration. It was categorically held that “It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgments have to be considered in the light of the question which were before this Court.” Applying the said ratio, the observations in the case of decision of the Bombay High Court in the case of Ajanta Pharma Ltd. cannot be construed to mean that the decision of Special Bench is completely overruled.

14. (ITA No. 4155/Mum./2007) dated 9-11-2009 has accepted that the issue decided by the Bombay High Court does not entirely overrule the issue decided by the Special Bench in the case of Syncome Formulations (I) Ltd. However, the Delhi Tribunal recently in the case of ACIT v. Cosmo Ferrites Ltd., [126 TTJ 666 (Del.)] has rendered a contrary view and held that the decision in the case of Ajanta Pharma Ltd. overrules the decision of the Special Bench in Syncome Formulations (I) Ltd. However, with due respect, the author disagrees with the said views of the Delhi Tribunal for the detailed discussion made above.

15. Construed from the discussion made above, it can be assumed that the decision of Syncome Formulations (I) Ltd. cannot be said to be entirely overruled except only to the extent of quantum of deduction. In other words, the necessary conclusion of the said discussion could be that while computing the amount of deduction as per clause (iv) to Explanation I to S. 115JB(2) of the Act, the book profits should be considered as the gross total income for the purpose of determining the eligible amount of deduction u/s.80HHC of the Act as per S. 80HHC(3)/(3A) of the Act. The provision of S. 80HHC(1B) would then be applied, as held by the Bombay High Court, to determine the quantum of deduction which will be allowed to be reduced while computing the book profits for the purpose of S. 115JB of the Act.

Nirav Shah

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