BCAJ | Bombay Chartered Accountant Journal

Do Provisions Of S.68 Of Income-Tax Act, 1961 Apply To Donations Received By A Charitable Trust?

ISSUE FOR CONSIDERATION

Charitable or religious trusts are generally funded by donations (voluntary contributions) received from donors. Such donations are taxable as income (subject to exemption in respect of application and accumulation), as they fall within the definition of income under s.2(24)(iia) of the Income Tax Act, 1961 (“the Act”), which reads as under:

“voluntary contributions received by a trust created wholly or partly for charitable or religious purposes or by an institution established wholly or partly for such purposes or by an association or institution referred to in clause (21) or clause (23), or by a fund or trust or institution referred to in sub-clause (iv) or sub-clause (v) or by any university or other educational institution referred to in sub-clause (iiiad) or sub-clause (vi) or by any hospital or other institution referred to in sub-clause (iiiae) or sub-clause (via) of clause (23C) of section 10 or by an electoral trust.”

Such donations are also regarded as income from property held for charitable or religious purposes by virtue of the provisions of section 12(1). Section 12(1) reads as under:

“Any voluntary contributions received by a trust created wholly for charitable or religious purposes or by an institution established wholly for such purposes (not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution) shall for the purposes of section 11 be deemed to be income derived from property held under trust wholly for charitable or religious purposes and the provisions of that section and section 13 shall apply accordingly.”

A charitable or religious trust registered under section 12A of the Act is entitled to exemption under section 11 in respect of its income from property held for charitable or religious purposes, which would include such donations, to the extent of such income applied, accumulated, etc. as provided in section 11. Therefore, such donations are income in the first place, and are thereafter entitled to exemption to the extent permitted by section 11.

Section 68 of the Act provides for taxation of unexplained cash credits. Section 68 provides as under:

“Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.”

Such unexplained cash credits are taxable at the rate of 60%, plus surcharge at the rate of 25% of such tax, plus education cess of 4% on the tax plus surcharge, i.e. at an effective tax rate of 78%.

An issue has arisen before the High Courts as to whether the provisions of section 68 apply to donations received by charitable trusts; in other words, whether donations received by a charitable trust, which may otherwise qualify for exemption, can be taxed as unexplained cash credits. While the Delhi, Allahabad and Karnataka High Courts have held that such donations received by a charitable trust cannot be brought to tax under section 68, the Punjab & Haryana High Court has held that such donations can be taxed under section 68.

KESHAV SOCIAL & CHARITABLE FOUNDATION’S CASE

The issue first came before the Delhi High Court in the case of DIT(E) vs. Keshav Social & Charitable Foundation 278 ITR 152.

In this case, during the relevant year, the assessee was a charitable trust registered under section 12A. It received donations amounting to ₹18,24,200. The assessee had spent more than 75% of the donations for charitable purposes.

During the course of assessment proceedings, the assessee was asked to furnish details of the donations, i.e. the names and addresses of the donors and the mode of receipt of donations. The assessee was unable to satisfactorily explain the donations. The assessing officer (AO) was of the view that the donations were perhaps fictitious donations, and that the assessee had tried to introduce unaccounted money into its books by way of donations. Therefore, the amount of ₹18,24,200 was treated as cash credit under section 68, and the benefit of exemption under section 11 was denied in respect of such donations.

In first appeal, the Commissioner (Appeals) was of the view that the AO was not justified in treating the donations received as income under section 68. He noted that the assessee had disclosed the donations as its income, and had spent 75% of the amount for charitable purposes. Therefore, in his view, the assessee had not committed any default. The Commissioner (Appeals) therefore directed the AO to allow exemption to the assessee under section 11, holding that the treatment of the donations of ₹18,24,200 as income under section 68 was incorrect.

In second appeal, the Tribunal was of the view that since more than 75% of the donations received by the assessee was spent on charitable purposes, the addition of ₹18,24,200 was not correct. The Tribunal accepted the argument of counsel for the assessee that once a donation was received, it was deemed to be received for a charitable purpose unless the donation was received towards the corpus of the trust.

Before the Delhi High Court, on behalf of the revenue, it was submitted that essentially what the assessee was trying to do was to launder its black money or unaccounted income by converting it into donations, and it should not be permitted to do so.

Referring to the decision of the Supreme Court in the case of S Rm M Ct M Tiruppani Trust 230 ITR 636, the High Court observed that every charitable or religious trust was entitled to exemption for income applied to its charitable or religious purposes in India. It noted that on the facts of the case before it, more than 75% of the donations for charitable purposes had been applied for its objects.

The Delhi High Court observed that to obtain the benefit of the exemption under section 11, the assessee was required to show that the donations were voluntary. The High Court further observed that the assessee had not only disclosed its donations, but had submitted a list of donors. According to the High Court, the fact that the complete list of donors was not filed or that the donors are not produced, did not necessarily lead to the inference that the assessee was trying to introduce unaccounted money by way of donation receipts. This was more particularly so in the facts of the case, where admittedly more than 75% of the donations were applied for charitable purposes.

The High Court held that section 68 had no application to the facts of the case, because the assessee had in fact disclosed the donations of ₹18,24,200 as its income. The High Court observed that it could not be disputed that all receipts, other than corpus donations, would be income in the hands of the assessee. Accordingly, there was full disclosure of income by the assessee, and also application of the donations for charitable purposes.

The High Court therefore upheld the decision of the Tribunal, holding that the provisions of section 68 would not apply to the donations received by the assessee trust.

This decision of the Delhi High Court was followed by the Delhi High Court in DIT v Hans Raja Samarak Society217 Taxman 114 (Del)(Mag), by the Allahabad High Court in the case of CIT v Uttaranchal Welfare Society 364 ITR 398, and by the Karnataka High Court in the cases of DIT(E) v. Sri BelimathaMahasamsthana Socio Cultural & Education Trust 336 ITR 694 and CIT v MBA Nahata Charitable Trust 364 ITR 693.

MAYOR FOUNDATION’S CASE

The issue came up again recently before the Punjab & Haryana High Court in the case of Mayor Foundation v CIT 170 taxmann.com 749.

In this case, the assessee was a company registered under section 25 of the Companies Act, 1956. It was also registered under section 12A and section 80G of the Act. It was running one educational institution, Mayor World School, at Jalandhar. The assessee had filed its income tax return, disclosing Nil income. During the year, it received corpus donations of ₹1,43,40,039.

During the course of assessment proceedings, the AO sought to verify the names and addresses of the donors. Notices were issued u/s 133(6) to some donors. 14 donors could be verified, and 7 were found not genuine as the donors’ identity was doubtful. A show cause notice was issued as to why such doubtful donations amounting to `53 lakh should not be taxed as anonymous donations under section 115BBC.

The assessee responded seeking more time to establish contact with such donors and obtain their due replies. None of the donors were produced before the AO. It was pointed out that such donations were received through bank accounts, and certain confirmations were received from 3 company donors.

The AO noticed the following in respect of these 3 companies:

In the case of all 3, first notices were first returned unserved. Responses were received to the second notices.
2 of the companies were located in West Bengal, and the replies were sent by post from Mumbai General Post Office.
2 of the companies were shown as struck-off in the ROC records, and 1 was reflected as dormant.
There seemed to be no working directors in all 3 companies.
The assessee had failed to produce any director or shareholder of all the 3 companies.

The AO therefore concluded that the assessee had received huge donations, the sources of income were not genuine, the companies were not working, and the genuineness, identity, sources and credit worthiness of these companies had not been proved. Besides addition of donations of ₹8,00,000,other donations of ₹40 lakh and ₹8 lakh were added as undisclosed cash credit under section 68, and tax was levied under section 115BBC and 115BBE.

In first appeal, the assessee submitted copies of income tax returns and proved the credit worthiness of 2 donees, who were NRIs, and who had given the rupee donations of ₹48 lakh. These additions of ₹48 lakh were deleted. The addition of donations of ₹8 lakh from the 3 corporate entities under section 68 was sustained in first and second appeals, on account of inability to prove any relationship between the donors and the donee, their whereabouts not being produced in the form of documents, and the companies having been struck off or being defunct.

The reasoning which prevailed with the Tribunal was that these companies had been struck-off the record of the Registrar of Companies, and therefore had to be treated as shell companies. Therefore, their identity was in question, the existence of the corporate body having been duly rejected by the Registrar of Companies. The existence of the donors itself was questioned, and the assessee was unable to produce any document in support of their action to restore the company before a judicial authority.

The questions of law raised before the High Court were:

“a. Whether the Income Tax Appellate Tribunal is justified in concurring with the findings of CIT(A) and in confirming the impugned income of ₹8,00,000 under the provisions of section 115BBC, section 68 read with section 115BBE of the Income Tax Act, 1961 being perverse and against the statutory provisions and as upheld in catena of judgments?

b. Whether the orders of the authorities below are illegal, erroneous, without jurisdiction and thus perverse?”

Before the Punjab & Haryana High Court, on behalf of the assessee, it was argued that there was sufficient material produced on record to show that the three companies existed and had been filing returns at the time of the corpus donations. Reliance was placed upon the documents in support of the publication that the amounts had been received by way of cheque. It was submitted that the companies were incorporated in 1992, and even if they were no longer registered at the time when the matter was inquired, there was no such reason why addition could have been made. It was submitted that the requisite communication had been made by the companies with the tax authorities, Ledger copy of the accounts and the income tax returns for the year and bank statements had been sent to the assessing officer. The three companies had acknowledged the donations that they had given.

The High Court observed that the companies at West Bengal had sought to give the details of the donations from Mumbai, and it was in such circumstances, that the AO came to the conclusion that the expression given was not bona fide. Opportunity was given to produce the directors, which was not done. It was due to this that the tax authorities had taken the view that the companies were no longer functional and not functioning and struck off by the Registrar of Companies. The High Court observed that nothing had been brought on record that these companies were actually functioning at the time of donations, and when they were struck off.

Under such circumstances, the High Court was of the opinion that the genuineness, identity and credit worthiness of these companies was rightly doubted by the AO, and under such circumstances, the additions had been made.

The High Court was therefore of the view that the question of law raised before it did not arise, keeping in view the facts and circumstances, as the appellant could not produce sufficient material before the authorities to dispel the suspicion which had been raised about the donations received from the companies which were not even based geographically close to the educational institution, and the reason to grant the donations were never properly explained.

OBSERVATIONS

It may be noted that in Mayor Foundation’s case (supra), neither before the Tribunal nor before the High Court were the decisions of other High Courts on the issue cited. Therefore, the Tribunal and the High Court merely decided the matter in that case on the basis of the facts before them, without really examining the legal issues involved in respect of the very applicability of section 68. Further, it seems that in that case, both section 115BBC as well as section 68 were invoked, which was patently incorrect, as the same income cannot be subjected to tax twice.

Section 68 seeks to bring to tax receipts which are not offered to tax as income, such as capital or loans received by a taxpayer. When the charitable trust has already included donations received as income in the first place, the question of applicability of section 68 should not arise.

Section 115BBC is a special provision introduced by the Finance Act 2006 with effect from AY 2007-08, to tax anonymous donations received by charitable trusts at the flat rate of 30%. The CBDT, vide Circular No. 14 of 2006 dated 28th December, 2006,has clarified that section 115BBC has been introduced” to prevent channelisation of unaccounted money to these institutions by way of anonymous donations”. An anonymous donation has been defined as a voluntary contribution where the recipient does not maintain details of the identity, indicating name and address of the donor. This is therefore a specific provision to tax donations received by charitable trusts where the donors are bogus entities. As opposed to this, the provisions of section 68 are general provisions to tax all types of cash credits which are unexplained, and apply to all types of assessees.

Section 115BBC is therefore a specific provision, while section 68 is a general provision. It is well-settled law that the specific provision of law would prevail over a general provision. Therefore, section 115BBC would prevail over the provisions of section 68 in the case of donations received by a charitable trust.

The Bombay High Court, in the recent case of Everest Education Society v ACIT 164 taxmann.com 744, while deciding a review petition against its order upholding treatment of donations as anonymous donations under section 115BBC, observed in paragraph 7 of the judgment that:

“Section 68 of the Act was not applicable since the applicant had disclosed the income from donation.”

Further, the Delhi High Court decision in Keshav Social and Charitable Foundation’s case (supra) has been upheld by the Supreme Court in a short decision disposing of the appeal, in the case reported as DIT(E) v Keshav Social and Charitable Foundation 394 ITR 496.

One aspect of the matter which also needs to be considered is that in Keshav Social & Charitable Foundation’s case, the donations were general donations, while in Mayor Foundation’s case, the donations were corpus donations. Would this make any difference to the aspect of applicability of the provisions of section 68?

This should really not make any difference on account of the following:

a. The provisions of section 115BBC apply equally to corpus donations as they do to general donations.

b. In the view of tax authorities, corpus donations are also income as defined in section 2(24)(iia) in the first place, and are thereafter exempt under section 11(1)(d) if the conditions specified therein are fulfilled.

c. In Uttaranchal Welfare Society’s case before the Allahabad High Court, the question before the High Court was in relation to taxability of corpus donations received under section 68. There also, the Allahabad High Court held that section 68 could not be applied to such corpus donations.

Therefore, the provisions of section 68 should not apply to donations received by registered charitable trusts (whether corpus or otherwise), and if at all, the provisions of section 115BBC may apply in such cases where details of the donor are lacking.

BCAJ Admin

Merger of Intimation under Section 143(1) With Subsequent Assessment Order under Section 143(3)

ISSUE FOR CONSIDERATION

The return of income filed by the assessee first gets processed by the CPC under section 143(1) of the Income-tax Act, 1961 (‘the Act’), and an intimation is issued to the assessee. While processing the return of income, adjustments may be made to the total income as provided in section 143(1) for the reasons as specifically provided in clause (a) of section 143(1) such as arithmetical error, incorrect claim, etc.

Thereafter, a few of the returns are also selected for regular assessment, popularly referred to as scrutiny assessment, by issue of notice under section 143(2) of the Act. The consequential order of regular assessment is then passed under section 143(3) or 144, as the case may be.

In such cases, where the intimation is issued first and then the regular assessment order is passed, the issue often arises as to whether the intimation issued u/s. 143(1) merges with the subsequent assessment order passed. This issue is relevant mainly from the point of view of maintainability of the appeal filed against the intimation issued u/s. 143(1).

In few of the cases, the tribunals have taken a view that the appeal against the intimation issued u/s. 143(1) becomes infructuous in cases where the assessment order has been passed subsequently u/s. 143(3); and that the additions made in the intimation under section 143(1) can be challenged in the appeal against the order under section 143(3). As against this, in few cases, the tribunals have taken a view that the enhancement to the income arising from the adjustments made in an intimation issued u/s. 143(1) cannot be challenged in the appeal filed against the assessment order passed u/s. 143(3), and ought to have been challenged in an appeal against the intimation under section 143(1).

ARECA TRUST’S CASE

The issue had earlier come up for consideration before the Bangalore bench of the tribunal in the case of Areca Trust vs. CIT (A) – ITA No. 433/Bang/2023 dated 26th July, 2023.

In this case, the assessee trust filed its return of income for assessment year 2018-19 on 28th August, 2018 declaring total income at Nil. The return of income was processed by the AO/CPC under section 143(1) of the Act on 28.02.2020. In the said intimation, an amount of ₹23,29,62,417 was considered as income chargeable to tax @ 10 per cent at special rate under section 115BBDA of the Act. Thereafter, the assessment was selected for scrutiny and notice under section 143(2) of the Act was issued on 23^rd September, 2019. The assessment under section 143(3) was completed by assessing the total income at the same amount i.e. ₹23,29,62,420/- as per the intimation issued under section 143(1) of the Act.

Being aggrieved by the order passed under section 143(3) of the Act, the assessee filed an appeal to the CIT (A). Before the CIT (A), it was contended that the assessee earned dividend income of ₹23,29,62,417 on mutual funds registered with SEBI and hence the exemption claimed under section 10(35) r.w.s. 10(23) of the Act was to be granted. Further, it was contended that the income was assessed at 10 per cent as per the intimation under section 143(1) of the Act, whereas in the assessment completed under section 143(3) of the Act, it was treated as business profit and taxed at 30 per cent as against the special rate of 10% under section 115BBDA of the Act.

The CIT(A) held that the assessee had filed an appeal against the assessment completed under section 143(3) of the Act, wherein no separate addition was made, but which only incorporated the adjustment made under section 143(1) of the Act. Therefore, it was concluded by the CIT(A) that appeal against the order passed under section 143(3) of the Act was not maintainable, and he did not adjudicate the appeal on merits. However, the CIT(A) directed the AO to dispose of the assessee’s rectification application dated 16.06.2020 against the order passed under section 143(1) of the Act. As regards the rate of tax, the CIT(A) directed the AO to tax the income of ₹23,29,62,420 at 10 per cent as per section 115BBDA of the Act, as was done in the intimation under section 143(1) of the Act. Accordingly, the appeal of the assessee was partly allowed.

The assessee filed a further appeal to the tribunal and reiterated the submissions which were made before the CIT (A).

The tribunal held that section 246A specifically provided for an appeal against intimation issued under section 143(1) of the Act. In the case before it, total income had been assessed at ₹23,29,62,420 as per the intimation issued under section 143(1) of the Act. Therefore, according to the tribunal, the cause of action of the assessee arose from the intimation issued under section 143(1) of the Act and appeal ought to have been filed against the same. The assessment completed under section 143(3) of the Act merely adopted the assessed figures in the intimation order passed under section 143(3) of the Act. Therefore, no cause of action arose from the order passed under section 143(3) of the Act. Section 143(4) of the Act only mentioned that on completion of regular assessment under section 143(3) or 144 of the Act, the tax paid by assessee under section 143(1) of the Act shall be deemed to have been paid toward such regular assessment. That by itself did not mean there was a merger of the intimation under section 143(1) with that of regular assessment under section 143(3) / 144 (unless the issue had been discussed and adjudicated in regular assessment under section 143(3) / 144 of the Act).

Accordingly, the tribunal dismissed the appeal of the assessee, with the direction that a liberal approach may be taken for condonation of delay in filing the appeal against the intimation under section 143(1) if the same was filed by the assessee, since the assessee’s application for rectification of the intimation under section 143(1) of the Act had been filed within time and was pending for disposal.

A similar view has also been taken by the tribunal in the following cases –

Epiroc Mining India Pvt. Ltd. vs. ACIT (ITA No. 50/Pun/2024) dated 14.5.2024
Global Entropolis (Vizag) Private Limited vs. AO, NFAC 2023 (8) TMI 81 – ITAT Chennai
Orient Craft Ltd. vs. DCIT (2024) 158 taxmann.com 1124 (Delhi – Trib.)

SOUTH INDIA CLUB’S CASE

Recently, the issue had come up for consideration of the Delhi bench of the tribunalin the case of South India Club vs. Income-tax Officer [2024] 163 taxmann.com 479 (Delhi – Trib)[22-05-2024].

In this case, the assessee society had filed its return of income for assessment year 2018-19 on 30^th March, 2019, wherein it had claimed application of income for charitable purposes of ₹6,01,35,500. The return was processed u/s 143(1)(a) of the Act, wherein the exemption claimed u/s. 11 was disallowed on the ground that the total income of the trust, without giving effect to the provisions of section 11 and 12, exceeded the maximum amount which was not chargeable to tax and, therefore, the audit report in Form 10B was required to be submitted along with the return of income. Since, the assessee had not filed its audit report in Form 10B electronically along with or before filing the return of income, exemption u/s 11 was not allowed. Aggrieved with the above order, the assessee preferred an appeal before the CIT (A).

Before the CIT (A), the assessee submitted as under –

The application for registration under Section 12A was submitted on 27^th March, 2019. While this application was pending, the assessee filed its return of income for the Assessment Year 2018-19 on 30^th March, 2019 claiming the exemption u/s. 11.
The intimation u/s.143(1) dated 10^th November, .2019 was issued by the DCIT, CPC, wherein the exemption claimed u/s. 11 was denied as Form No. 10B was not e-filed in time.
The application for registration under Section 12A was rejected by CIT(E) vide his order dated 30^th September, 2019. The order of the CIT(E) was appealed and the assessee received a favourable decision of Hon’ble ITAT dated 13^th August, 2020 allowing its appeal and directing the CIT (Exemption) to grant registration u/s 12AA.
Consequent to the ITAT’s order, the CIT (Exemptions) granted registration by order dated 5^th January, 2021.
It was due to the reason that the registration was not granted on the date when the return of income was filed for the year under consideration, that the assessee could not submit the audit report in Form No. 10B.
When the CIT (Exemptions) granted registration on 05.01.2021 the income tax scrutiny assessment for the assessment year 2018-19 was pending which was completed on 8^th February, 2021 denying the exemption claimed u/s. 11. The appeal was filed before the CIT (A), NFAC and the same was yet pending.
On the basis of the above, the assessee pleaded that when the CIT (Exemptions) granted registration to it w.e.f. Assessment year 2019-20 in accordance with sub-section 2 of Section 12A, on the basis of the application filed in March 2019, automatically the second proviso to that sub section had become applicable, granting the benefit of exemption under section 11 and 12 for pending assessments of earlier assessment years, subject only to the condition that there has been no change in objects and activities in the intervening period.
Since there was no change in the objects and activities of the appellant during the financial year concerned, the assessee claimed that the benefit of exemption u/s. 11 and 12 was required to be granted, and the second proviso did not prescribe any other pre-condition to become eligible for the exemption.
The assessee also took an alternative plea of non-taxability of the amount received during the year on the basis of the principle of mutuality.

The CIT (A) took the view that the intimation issued u/s. 143(1) merged with the subsequent order passed u/s. 143(3) and, therefore, the appeal on this issue had become infructuous. In addition to this, the CIT (A) also held that the filing of Form 10B before the filing of return was compulsory to grant exemption u/s 11 even in a case where the assessment order passed u/s. 143(3) was considered. On that basis, the CIT (A) held that the exemption could not be granted even in an appeal against the order passed u/s. 143(3) without there being any application for condonation of delay by the assessee in respect of filing of Form 10B.Against this order of the CIT (A), the assessee filed an appeal before the tribunal.
Before the tribunal, apart from contending that the exemption u/s. 11 ought to have been granted to it in view of the Second Proviso to Section 12A, the assessee also submitted that once an assessment was selected for scrutiny; notice u/s 143(2) had been issued and an order had been passed u/s 143(3), the intimation u/s 143(1) merged into the assessment order and lost its standalone existence. On this basis, it was contended that intimation u/s. 143(1) and consequential demand should be quashed. The assessee relied upon the following decisions in support of this contention —

ACIT vs. GPT-Bhartia JV (I.T.A No. 13/Gty/ 2022 dated 9^th June, 2023)
Dura Roof Pvt. Ltd. vs. ACIT (I.T.A No. 49/Gty/ 2022 dated 14^th June, 2023)
M P Madhyam vs. DCIT (I.T.A No. 424 & 426/Ind/2022 dated 30^th August, 2023)

On behalf of the revenue, it was argued that there was no decision of the jurisdictional High Court available with respect to the point that upon issuing of notice u/s 143(2) of the Act, passing of the order u/s 143(1) of the Act was impermissible. Further, regarding the issue of pending assessment at the time of granting of registration, it was agreed that the assessment was pending at the time of grant of registration. However, it was submitted that whether other conditions for claiming deductions u/s 11 were fulfilled or not, had to be verified.

The Delhi bench of the tribunal held that the validity of the intimation issued u/s 143(1) was limited to mere intimation of correctness and accuracy of the income declared in ROI and its accuracy based on the information submitted along with the ROI. It did not carry the legitimacy of an assessment. When the return of income was assessed under the regular assessment, then it lost its individuality and merged with the regular assessment. The tribunal concurred with the view of the CIT (A) that the intimation u/s 143(1) merged with the order passed u/s 143(3) of the Act and the appeal against the said intimation became infructuous. However, it was further held that the CIT (A) should have stopped with the above findings and should not have proceeded to decide the issue on merits, because it was brought to his knowledge that the assessee had filed an appeal against the regular assessment order. Therefore, he had travelled beyond his mandate. The issue of allowability of section 11 was already considered in the regular assessment and that issue was already in appeal before another appellate authority. Therefore, reviewing the same by the CIT(A) in an appeal against the intimation u/s. 143(1), which had become infructuous, was uncalled for. With respect to the applicability of the Second Proviso to Section 12A, the tribunal held that this issue has to be raised before the FAA in the appeal against regular assessment passed u/s 143(3).

Accordingly, it was held that the intimation passed u/s 143(1) had merged with the regular assessment passed u/s 143(3), and it did not have legs to stand on its own, once the regular assessment proceedings were initiated.
A similar view has also been taken by the tribunal in the following cases –

National Stock Exchange of India Ltd. vs. DCIT (ITA No. 732/Mum/2023)
Lokhandwala Foundation vs. ITO (ITA No. 1702/Mum/2020)

OBSERVATIONS

The issue under consideration is whether, in a case where the regular assessment has been made, the intimation issued under section 143(1) still survives, or it loses its existence and merges with the assessment order passed after the issue of intimation.

There is no express provision under the Act providing for such merger of the intimation issued under section 143(1) with the assessment order passed subsequently either under section 143(3) or under section 144. However, there are several provisions under the Act which need to be considered for the purpose of deciding the issue under consideration, which are discussed below:

Firstly, the processing of the return and issuing intimation under section 143(1) is not expressly prohibited in a case where the notice has already been issued under section 143(2) selecting the return for the purpose of scrutiny assessment. In fact, in sub-section (1D), as it stood prior to its amendment by the Finance Act, 2017, it was provided that the processing of a return shall not be necessary, where a notice has been issued to the assessee under sub-section (2). However, by virtue of the amendment made by the Finance Act, 2017, the provisions of sub-section (1D) have been made inapplicable to the returns pertaining to AY 2017-18 and thereafter. Therefore, the Act provides for both i.e. processing of the return of income as well as making the assessment, if that is required in a particular case. Had it been intended that the intimation issued under section 143(1) should get merged with the assessment order passed subsequently, then the law would not have provided for processing of the return of income at all in a case where the case had already been selected for the scrutiny assessment and that too on a mandatory basis.
Section 246 and section 246A provide for the list of orders against which the appeal can be filed by the assessee. Here, both the orders i.e. the intimation issued u/s. 143(1) and the assessment order passed u/s. 143(3) or 144 have been listed separately. Therefore, it is clear that an appeal can be filed before the Joint Commissioner (Appeals) or Commissioner (Appeals) against both; intimation as well as the assessment order. For filing the appeal against the intimation issued u/s. 143(1), section 246A does not differentiate between cases where the assessment order has been passed subsequently or not. Therefore, technically, the provisions permit filing of the appeal against the intimation issued under section 143(1), even in a case where the appeal has already been filed against the assessment order, if the delay in filing that appeal is condonable.
An intimation under section 143(1) may not have been appealable at a time when no adjustments were permitted under section 143(1)(a). Now that such adjustments are permitted, the right of appeal has been restored, which indicates that such adjustments have to be agitated separately in appeal.
There is no provision in the law for merger of the two appeals, if two appeals are filed separately against the intimation under section 143(1) and against the assessment order under section 143(3). Both appeals have to be adjudicated separately. Withdrawal of any one of the appeals is possible only with the permission of the Commissioner (Appeals).
In civil law, the doctrine of merger is a common law doctrine that is rooted in the idea of maintenance of the decorum of the hierarchy of courts and tribunals. The doctrine is based on the simple reasoning that there cannot be, at the same time, more than one operative order governing the same subject matter. As stated by the Supreme Court in Kunhayammed vs. State of Kerala, (2000) 6 SCC 359, “Where an appeal or revision is provided against an order passed by a court, tribunal or any other authority before superior forum and such superior forum modifies, reverses or affirms the decision put in issue before it, the decision by the subordinate forum merges in the decision by the superior forum and it is the latter which subsists, remains operative and is capable of enforcement in the eye of the law”. However, as clarified by the Supreme Court in Supreme Court in State of Madras vs. Madurai Mills Co. Ltd.(1967) 1 SCR 732, “… doctrine of merger is not a doctrine of rigid and universal application and it cannot be said that wherever there are two orders, one by the inferior tribunal and the other by a superior tribunal, passed in an appeal on revision, there is a fusion of merger of two orders irrespective of the subject-matter of the appellate or revisional order and the scope of the appeal or revision contemplated by the particular statute. In our opinion, the application of the doctrine depends on the nature of the appellate or revisional order in each case and the scope of the statutory provisions conferring the appellate or revisionaljurisdiction.”In this case, both the appeals are before the same level of appellate authority, and in the absence of any specific provision, the doctrine of merger of appeals should not apply.
Further, the adjustments made to the returned income while processing the return under section 143(1) and the additions or disallowances made while passing the assessment order are treated differently in so far as the levy of penalty under section 270A is concerned. The former is not considered to be under-reporting of income by the assessee, whereas the latter is considered to be under-reporting of income. Therefore, the enhancement made to the total income of the assessee by way of adjustments as permissible under section 143(1) does not lead to levy of penalty under section 270A. However, the enhancement made to the total income of the assessee by virtue of the assessment order might result in levy of a penalty under section 270A, if other relevant conditions are satisfied. Section 270A(2)(a) provides that a case where the income assessed is greater than the income determined in the return processed under section 143(1)(a) is to be regarded as under-reporting. If a view is to be taken that the intimation issued under section 143(1) gets merged with the assessment order and it loses its existence, then the provisions of section 270A(2)(a)may become redundant.
Also, the intimation issued under section 143(1) is deemed to be a notice of demand under section 156 in a case where any sum is determined to be payable by the assessee under that intimation. Therefore, the assessee is required to make the payment of the said demand within a period of thirty days as provided in section 220. In case if such demand has not been paid within a period of thirty days, then the consequences as provided under the Act like levy of interest under section 220(2) or levy of penalty under section 221 etc. would follow. If a view is to be taken that the intimation issued under section 143(1) gets merged with the assessment order and loses its existence, then it might be possible to also argue that the assessee will not be liable for any consequences that would have otherwise arisen for non-payment of the demand raised in the intimation within a period of thirty days.

Considering the above, it appears that the better view is that the intimation issued under section 143(1) will not lose its existence, even in a case where the assessment order has been passed subsequently. It is only the demand raised vide that intimation, if it has remained outstanding, which will get merged with the demand raised consequent to the passing of the assessment order, wherein the tax liability will be recomputed based on the income assessed finally. Therefore, appeals filed against intimations under section 143(1)(a) would have to be decided independent of the appeals against assessment orders under section 143(1)(a).

It is therefore advisable to file an appeal against adjustments under section 143(1)(a), which according to the assessee are not tenable, and such appeal should be filed independent of whether assessment proceedings under section 143(2) are initiated or not. Such adjustments need not again be the subject matter of the appeal against the assessment order under section 143(3) though retained in that assessment. Of course, as a matter of abundant precaution, till such time as the CBDT does not clarify its views on this matter, the assessee may still choose to take up such matters in the appeal, particularly if the issue has been discussed and has been examined during the assessment proceedings

BCAJ Admin

Validity Of Reassessment Notice Issued U/S 148 By Jurisdictional Assessing Officer

ISSUE FOR CONSIDERATION

The revised procedure for reassessment introduced with effect from 1^st April, 2021 is a two-stage process – a procedure u/s 148A for deciding whether it is a fit case for issue of notice for reassessment, and the procedure for reassessment u/s 148. While the reassessment has to be done in a faceless manner as required by section 151A by the National Faceless Assessment Centre / Faceless Assessing Officer (NFAC / FAO), the procedure u/s 148A to determine whether the case is fit for reassessment is not required to be conducted in a faceless manner and has therefore to be conducted by the Jurisdictional Assessing Officer (JAO).

Under section 148A(3) [s.148A(d) till 31^st August, 2024], the Assessing Officer (AO) is required to pass an order, after taking approval of the specified authority u/s 151, determining whether or not the case is fit for reassessment. This has to be done by the AO after issuing show cause notice to the assessee and considering the reply of the assessee. If the case is found fit for reassessment, u/s 148(1), the AO is required to issue a notice u/s 148, along with a copy of the order passed u/s 148A(3)/148A(d), requiring the assessee to furnish a return of income for the relevant
assessment year.

In most cases of reassessment, the JAO has been issuing the notice u/s 148 and serving it on the assessee, along with the order u/s 148A(3)/148A(d). The issue has arisen before the High Courts as to whether such a notice u/s 148 should have been issued by the FAO, and therefore whether the notice u/s 148 and the consequent reassessment proceedings are valid in law. While the Karnataka, Telangana, Bombay and Gauhati High Courts have recently taken the view that such notice issued by the JAO is invalid since it ought to have been issued by the FAO, the Delhi High Court has upheld the validity of such a notice issued by the FAO.

While this controversy has been covered in the June 2024 issue of the BCA Journal, at that point of time there were only two High Court decisions on the subject, that of the Calcutta High Court and one of the Bombay High Court. The subsequent High Court decisions have dealt with the subject at great length, in particular, the Delhi High Court, and therefore it was thought fit to cover
the greater detail of this controversy that has come to the fore.

HEXAWARE TECHNOLOGIES’ CASE

The issue had come up for consideration before the Bombay High Court in the case of Hexaware Technologies Ltd vs. ACIT 464 ITR 430.

In this case, the assessee company was engaged in information technology consulting, software development and business process services. For assessment Year 2015-16, the assessee had filed its return of income on 28^th November, 2015. Its assessment was completed u/s 143(3) vide assessment order dated 30^th November, 2017.

The JAO issued a notice dated 8^th April, 2021 under section 148 (pre-amendment) stating that he had reason to believe that income chargeable to tax for Assessment Year 2015-2016 had escaped assessment within the meaning of Section 147. The assessee filed a writ petition before the Bombay High Court challenging the notice u/s 148 on the ground that the notice had been issued on the basis of provisions which had ceased to exist and were no longer in the statute. The writ
petition was allowed by the Bombay High Court on 29^th March, 2022, holding that the notice dated 8^th April, 2021 was invalid.

On a Special leave Petition filed by the Revenue in the case of Union of India vs. Ashish Agarwal 444 ITR 1 (SC), the Supreme Court, in exercise of jurisdiction under Article 142 of the Constitution of India, passed orders with respect to the notices and inter alia held that the notices issued under section 148 after 1^st April, 2021 be treated as notices issued under section 148A(b); and provided for timelines to be followed by the AOs for providing assessees the information and material relied upon by the Revenue for initiating reassessment proceedings. The Supreme Court also clarified that all the defenses available to assessees under the provisions of the Act would be available to the assessee.

Thereafter, the JAO issued notice dated 25^th May, 2022, stating that the notice was issued in view of the decision of the Supreme Court in Ashish Agarwal (supra). The assessee filed its objections to the validity of the notice and proposed reassessment vide its letter dated 10th June, 2022. The JAO passed an order u/s 148A(d) on 26th August, 2022, holding that it was fit case for reassessment on some of the grounds. Notice u/s 148 was issued manually by the JAO on 27^th August, 2022, stating that the JAO had information which suggested that income chargeable to tax had escaped assessment for AY 2015-16.

The assessee again approached the Bombay High Court with a writ petition, challenging the validity of notice dated 25^th May, 2022, order u/s 148A(d) dated 26^th August, 2022 and notice u/s 148 dated 27^th August, 2022 on various grounds, including that the notice u/s 148 was invalid as it had been issued by the JAO and not by the FAO.

Before the Bombay High Court, on behalf of the assessee, besides other arguments relating to the validity of the notices, it was argued that the notice u/s 148 dated 27^th August, 2022 was invalid and bad in law, being issued by the JAO, which was not in accordance with Section 151A, which gave power to the CBDT to notify the Scheme for the purpose of assessment, reassessment or recomputation under section 147, for issuance of notice under section 148 or for conducting of inquiry or issuance of show cause notice or passing of order under section 148A or sanction for issuance of notice under section 151.

In exercise of the powers conferred under section 151A, the CBDT issued a notification dated 29^th March, 2022 after laying the same before each House of Parliament, and formulated a Scheme called “the e-Assessment of Income Escaping Assessment Scheme, 2022” (the Scheme). The Scheme provides that (a) the assessment, reassessment or recomputation under section 147 and (b) the issuance of notice under section 148 shall be through automated allocation, in accordance with Risk Management Strategy (RMS) formulated by the Board as referred to in Section 148 for issuance of notice and in a faceless manner, to the extent provided in Section 144B with reference to making assessment or reassessment of total income or loss of assessee. The notice dated
27^th August, 2022 had been issued by the JAO and not by the NFAC, which was not in accordance with the Scheme.

On behalf of the Revenue, in relation to the jurisdiction of the JAO to issue notice u/s 148, relying on the notification dated 29^th March 2022 [Notification No. 18/2022/F. No.370142/16/2022-TPL], it was submitted that:

(i) The guideline dated 1^st August, 2022 issued by the CBDT includes a suggested format for issuing notice under section 148, as an Annexure to the said guideline and it requires the designation of the AO along with the office address to be mentioned and, therefore, it is clear that the JAO is required to issue the said notice and not the FAO.

(ii) ITBA step-by-step Document No. 2 dated 24^th June, 2022, an internal document, regarding issuing notice under section 148 for the cases impacted by Hon’ble Supreme Court’s decision in the case of Ashish Agarwal (supra), requires the notice issued under section 148 to be physically signed by the AOs and, therefore, the JAO has jurisdiction to issue notice under section 148 and it need not be issued by FAO.

(iii) FAO and JAO have concurrent jurisdiction and merely because the Scheme has been framed under section 151A, does not mean that the jurisdiction of the JAO is ousted or that the JAO cannot issue the notice under section 148.

(iv) The notification dated 29^th March, 2022 provides that the Scheme so framed, is applicable only ‘to the extent’ provided in Section 144B and Section 144B does not refer to issuance of notice under section 148. Hence, the notice cannot be issued by the FAO as per the said Scheme.

(v) No prejudice is caused to the assessee when the notice is issued by the JAO and, therefore, it is not open to the assessee to contend that the said notice is invalid merely because the same is not issued by the FAO.

(vi) Office Memorandum dated 20^th February, 2023 issued by CBDT (TPL division) with the subject – “seeking inputs/comments on the issue of challenge of jurisdiction of JAO – reg.” the Office Memorandum contains the arguments of the Revenue in the context of the Scheme to submit that the notice under section 148 is required to be issued by the JAO and not FAO.
It was argued on behalf of the Revenue that no prejudice had been caused to assessee by the JAO issuing the notice, because the reassessment would be done by the FAO. As held by the Calcutta High Court in Triton Overseas (P.) Ltd. vs. Union of India 156 taxmann.com 318 (Cal.), this objection of the assessee had to be rejected.

The Bombay High Court analysed the provisions of section 151A and the notification dated 29^th March, 2022 issued u/s 151A. It noted that as per the notified scheme, the issuance of notice under section 148 shall be through automated allocation, in accordance with RMS formulated by the Board as referred to in Section 148 for issuance of notice and in a faceless manner, to the extent provided in Section 144B with reference to making assessment or reassessment of total income or loss of assessee. It observed that the notice u/s 148 dated 27^th August, 2022 had been issued by the JAO and not by the NFAC, which was not in accordance with the Scheme.

The Bombay High Court observed that the guidelines dated 1^st August, 2022 relied upon by the Revenue were not applicable because these guidelines were internal guidelines as was clear from the endorsement on the first page of the guideline “Confidential For Departmental Circulation Only”. These guidelines were not issued under section 119 and were not binding on the assessee. According to the High Court, these guidelines were also not binding on the JAO as they were contrary to the provisions of the Act and the Scheme framed u/s 151A. The High Court referred to its decision in the case of Sofitel Realty LLP vs. ITO (TDS) 457 ITR 18 (Bom.), where the Court had held that guidelines were subordinate to the principal Act or Rules, and could not restrict or override the application of specific provisions enacted by the legislature. The Court further observed that the guidelines did not deal with or even refer to the Scheme dated 29^th March, 2022 framed by the Government under section 151A. As per the Court, the Scheme dated 29^th March, 2022 u/s 151A, which had also been laid before Parliament, would be binding on the Revenue, and the guideline dated 1^st August, 2022 could not supersede the Scheme. If it provided anything to the contrary to the said Scheme, then that was required to be treated as invalid and bad in law.

As regards ITBA step-by-step Document No. 2 regarding issuance of notice u/s 148 relied upon by the Revenue, as per the High Court, an internal document could not depart from the explicit statutory provisions of, or supersede the Scheme framed by the Government under section 151A, which Scheme was also placed before both the Houses of Parliament. This was more so when the document did not even consider or refer to the Scheme. Further, the High Court was of the view that the document was clearly intended to be a manual/guide as to how to use the Income-tax Department’s (ITD) portal, and did not even claim to be a statement of the Revenue’s position/stand on the issue in question.

The Bombay High Court was further of the view that there was no question of concurrent jurisdiction of the JAO and the FAO for issuance of notice u/s 148 or even for passing assessment or reassessment order. When specific jurisdiction had been assigned to either the JAO or the FAO in the Scheme dated 29^th March, 2022, then it was to the exclusion of the other. According to the High Court, to take any other view in the matter would not only result in chaos but also render the whole faceless proceedings redundant. If the argument of Revenue was to be accepted, then even when notices were issued by the FAO, it would be open to an assessee to make submission before the JAO and vice versa, which was clearly not contemplated in the Act.

The High Court further noted that the Scheme in paragraph 3 clearly provided that the issuance of notice “shall be through automated allocation” which meant that the same was mandatory, and was required to be followed by the Department, without any discretion to the ITD to choose whether to follow it or not. “Automated allocation” was defined in paragraph 2(b) of the Scheme to mean an algorithm for randomized allocation of cases by using suitable technological tools, including artificial intelligence and machine learning, with a view to optimise the use of resources. Therefore, it meant that the case could be allocated randomly to any officer who would then have jurisdiction to issue the notice under section 148. The Court noted that it was not the ITD’s case that the JAO was the random officer who was allocated jurisdiction.

Addressing the Revenue’s argument that the Scheme so framed was applicable only ‘to the extent’ provided in Section 144B, that Section 144B did not refer to issuance of notice u/s 148 and hence the notice could not be issued by the FAO as per the said Scheme, the High Court noted that section 151A itself contemplated formulation of Scheme for both assessment, reassessment or recomputation u/s 147 as well as for issuance of notice u/s 148. Therefore, the Scheme, which covered both the aforesaid aspects of the provisions of section 151A, could not be said to be applicable only for one aspect, i.e., proceedings post the issue of notice u/s 148, being assessment, reassessment or recomputation u/s 147 and inapplicable to the issuance of notice u/s 148. According to the High Court, such an argument advanced by the Revenue would render clause 3(b) of the Scheme otiose and to be ignored or contravened, as according to the JAO, even though the Scheme specifically provided for issuance of notice u/s 148 in a faceless manner, no notice was required to be issued u/s 148 in a faceless manner. In such a situation, not only clause 3(b) but also the first two lines below clause 3(b) would be otiose, as it dealt with the aspect of issuance of notice u/s 148.

If clause 3(b) of the Scheme was not applicable, then only clause 3(a) of the Scheme remained. What was covered in clause 3(a) of the Scheme was already provided in Section 144B(1), which Section provided for faceless assessment, and covered assessment, reassessment or recomputation u/s 147. Therefore, if Revenue’s arguments were to be accepted, there was no purpose of framing a Scheme only for clause 3(a), which was in any event already covered under faceless assessment regime in Section 144B. Therefore, as per the High Court, the Revenue’s argument rendered the whole Scheme redundant. An argument which rendered the whole Scheme otiose could not be accepted as correct interpretation of the Scheme.

The High Court observed that the phrase “to the extent provided in Section 144B of the Act” in the Scheme was with reference to only making assessment or reassessment or total income or loss of assessee, and was not relevant for issuing notice. The phrase “to the extent provided in Section 144B of the Act” would mean that the restriction provided in Section 144B, such as keeping the International Tax Jurisdiction or Central Circle Jurisdiction out of the ambit of Section 144B, would also apply under the Scheme. Further the exceptions provided in sub-section (7) and (8) of Section 144B would also be applicable to the Scheme.

As per the Bombay High Court, when an authority acted contrary to law, the said act of the Authority was required to be quashed and set aside as invalid and bad in law, and the person seeking to quash such an action was not required to establish prejudice from the said act. An act which was done by an authority contrary to the provisions of the statute itself caused prejudice to an assessee. All assessees are entitled to be assessed as per law and by following the procedure prescribed by law. Therefore, when the Income-tax Authority proposed to act against an assessee without following the due process of law, the said action itself resulted in a prejudice to the assessee.

With respect to the Office Memorandum (OM) dated 20^th February, 2023, the Bombay High Court observed that that OM merely contained the comments of the Revenue issued with the approval of Member (L&S), CBDT, and was not in the nature of a guideline or instruction issued u/s 119 so as to have any binding effect on the Revenue. Further, some of the contents of the OM were clearly contrary to the provisions of the Act and the Scheme. These were highlighted by the Court as under:

1. Paragraph 3 of the OM stated that issue of the notice u/s 148 had to be through automation in accordance with the RMS referred to in section148. The issuance of notice is not through automation but through “automated allocation”. The term “automated allocation” is defined in clause 2(1)(b) of the Scheme to mean random allocation of cases to AOs. Therefore, it is clear that the AOs are randomly selected to handle a case and it is not merely notice sought to be issued through automation.

2. Paragraph 3 of the OM stated that “To this end, as provided in section 148 of the Act, the Directorate of Systems randomly selects a number of cases based on the criteria of RMS.” The reference to “random” in the Scheme is reference to selection of AO at random and not selection of Section 148 cases at random. If the cases for issuance of notice u/s 148 are selected based on criteria of the RMS, then, obviously, the same are not randomly selected, as random means something which is chosen by chance rather than according to a plan. If the ITD’s argument is that the applicability of section 148 is on random basis, then the provisions of section 148 itself would become contrary to Article 14 of the Constitution of India as being arbitrary and unreasonable. The term ‘random’, in the Court’s view, had been used in the context of assigning the case to a random AO, i.e., an AO would be randomly chosen by the system to handle a particular case. The term ‘random’ was not used for selection of case for issuance of notice u/s 148 as had been alleged by the Revenue in the OM. Further, in paragraph 3.2 of the OM, with respect to the reassessment proceedings, the reference to ‘random allocation’ had correctly been made as random allocation of cases to the Assessment Units by the NFAC. The Court observed that when random allocation was with reference to officer for reassessment, then the same would equally apply for issuance of notice u/s 148.

3. The conclusion in paragraph 3 of the OM that “Therefore, as provided in the scheme the notice u/s 148 of the Act is issued on automated allocation of cases to the AO based on the risk management criteria” was also held to be factually incorrect and on the basis of incorrect interpretation of the Scheme by the High Court. Clause 2(1)(b) of the Scheme, which defined ‘automated allocation’, did not provide that the automated allocation of case to the AO was based on the risk management criteria. The reference to risk management criteria in clause 3 of the Scheme was to the effect that the notice u/s 148 should be in accordance with the RMS formulated by the board, which was in accordance with Explanation 1 to Section 148.

4. In paragraph 3.1 of the OM, it was stated that the cases selected prior to issuance of notice are decided on the basis of an algorithm as per RMS and are, therefore, randomly selected. It was further stated that these cases are ‘flagged’ to the JAO by the Directorate of Systems, the JAO does not have any control over the process and has no way of predicting or determining beforehand whether the case will be ‘flagged’ by the system. The contention of the Revenue is that only cases which are ‘flagged’ by the system as per the RMS formulated by CBDT can be considered by the AO for reopening. In clause (i) in Explanation 1 to Section 148, the term “flagged” has been deleted by the Finance Act, 2022, with effect from 1^st April, 2022. In any case, whether only cases which are flagged can be reopened or not is not relevant to decide the scope of the Scheme framed under section 151A.

5. As regards the statement in paragraph 3.1 of the OM that “Therefore, whether JAO or NFAC should issue such notice is decided by administration keeping in mind the end result of natural justice to the assessees as well as completion of required procedure in a reasonable time”, the High Court was of the opinion that there was no such power given to the administration under either Section 151A or under the Scheme. The Scheme was clear and categorical that notice u/s 148 shall be issued through automated allocation and in a faceless manner.

6. The statement in paragraph 3.3 of the OM that “Here it is pertinent to note that the said notification does not state whether the notices to be issued by the NFAC or the Jurisdictional Assessing Officer (“JAO”)……It states that issuance of notice under section 148 of the Act shall be through automated allocation in accordance with the RMS and that the assessment shall be in faceless manner to the extent provided in section 144B of the Act” was also held to be erroneous by the High Court. The Scheme was categoric that the notice u/s 148 was to be issued through automated allocation and in a faceless manner. The Scheme clearly provided that the notice u/s 148 of the Act was required to be issued by NFAC and not the JAO. Further, unlike as canvassed by Revenue that only the assessment shall be in faceless manner, the Scheme was very clear that both the issuance of notice and assessment shall be in faceless manner.

7. In paragraph 5 of the OM, a completely unsustainable and illogical submission had been made that Section 151A considers that procedures may be modified under the Act or laid out, considering the technological feasibility at the time. Reading the Scheme along with Section 151A made it clear that neither the Section or the Scheme spoke about the detailed specifics of the procedure to be followed therein. The argument of the Revenue that Section 151A considered that the procedure may be modified under the Act was without appreciating that if the procedure was required to be modified, then that would require modification of the notified Scheme. It was not open to the Revenue to refuse to follow the Scheme as the Scheme was clearly mandatory and was required to be followed by all AOs.

8. The argument of the Revenue in paragraph 5.1 of the OM that the Section and Scheme had left it to the administration to devise and modify procedures with time while remaining confined to the principles laid down in the said Section and Scheme, was without appreciating that one of the main principles laid down in the Scheme was that the notice u/s 148 was required to be issued through automated allocation and in a faceless manner.

The Bombay High Court refused to treat the Calcutta High Court decision in Triton Overseas (supra) as a precedent, since the Calcutta High Court had passed the order without considering the Scheme dated 29^th March, 2022. The Calcutta High Court had only referred to the OM dated 20^th February, 2023, which had been considered by the Bombay High Court. The Bombay High Court expressed its agreement with the decision of the Telangana High Court in the case of Kankanala Ravindra Reddy vs. ITO 295 Taxman 652, which had held that in view of the provisions of Section 151A read with the Scheme dated 29^th March, 2022, the notices issued by the JAOs were invalid and bad in law.

The Bombay High Court therefore held that the notice u/s 148 was invalid and bad in law, being issued by the JAO, as the same was not in accordance with Section 151A.

The view taken in this decision of the Bombay High Court was followed in many more subsequent decisions of the Bombay High Court, and by other High Courts in the cases of Govind Singh vs. ITO 300 Taxman 216 (HP), Jatinder Singh Bhangu vs. Union of India 466 ITR 474 (P&H), and Jasjit Singh vs. Union of India 467 ITR 52 (P&H).

T K S BUILDERS’ CASE

The issue came up again for consideration before the Delhi High Court in the case of TKS Builders (P) Ltd v ITO 167 taxmann.com 759. A bunch of other appeals were also decided along with this.

In this case, a notice u/s 148 (pre-amendment) was issued on 31^st March 2021. This was challenged by way of a writ petition. The writ petition was decided along with Suman Jeet Agarwal vs. ITO 2022 SCC OnLine Del 3141, and interim orders were passed on 24^th March, 2022 restraining the tax authorities from taking any coercive action against the assessee in pursuance of the notice u/s 148. Subsequently, on 4^th May, 2022, the Supreme Court pronounced its judgment in Ashish Agarwal (supra), treating all such notices issued under the pre-amended section 148 as notices issued u/s 148A(b) as inserted with effect from 1.4.2021.

Pursuant to the decision in Ashish Agarwal (supra), a notice u/s 148A(b) was issued to the assessee on 2nd June, 2022. The assessee furnished a response to that notice on 15^th June, 2022. As per the procedure prescribed in Section 148A, the JAO passed an order u/s 148A(d) dated 22^nd July 2022 rejecting the objections against reassessment. This was followed by issue of a notice u/s 148 of the same date.

Pursuant to Asish Agarwal’s decision, the Delhi High Court passed orders in Suman Jeet Agarwal and bunched cases on 27^th September, 2022, reported as Suman Jeet Agarwal vs. ITO 449 ITR 517. Pursuant to this decision of the Delhi High Court, another notice u/s 148A(b) dated 28^th October 2022 was issued to the assessee. This was followed by an order u/s 148A(d) dated 13^th December, 2022 along with a notice u/s 148 of the same date. Although a final reassessment order dated 24^th May, 2023 was passed, this order refers to the notice u/s 148 dated 22^nd July, 2022. The assessee filed a writ petition against this order of reassessment.

The challenge to the notice u/s 148 was primarily based on the argument that, after the introduction of sections 144B and 151A read together with the E- Assessment of Income Escaping Assessment Scheme, 2022, the JAO would stand denuded of jurisdiction to commence proceedings u/s 148.

On behalf of the assessee, it was argued that once the Revenue had chosen to adopt the faceless procedure for assessment even in respect of reassessment, the JAO would have no authority to invoke Section 148. Reliance was placed on the decisions in the cases of Kankanala Ravindra Reddy (supra), Hexaware Technologies (supra), Venkatramana Reddy Patloola vs. Dy CIT 2024 SCC Online TS 1792, Rama Narayan Sah vs. Union of India 299 Taxman 276 (Gau), Jatinder Singh Bhangu vs. Union of India (supra) for this proposition.

The Delhi High Court observed that in the decision in Hexaware Technologies (supra), a detailed reference was made to an Office Memorandum dated 20^th February, 2023. However, that document was actually the instructions provided to counsels for the Revenue in connection with the batch of writ petitions pending before that High Court. They were thus rightly construed as not being statutory instructions which the CBDT is otherwise empowered to issue under the Act.

The Delhi High Court, keeping in mind that its decision was likely to have an impact on a large number of matters, passed a direction on 29th August 2024 for an appropriate affidavit being filed by the Revenue, bearing in mind the larger ramifications of an action annulling innumerable notices which had come to be issued in the meanwhile. Accordingly, a detailed affidavit was filed by the Revenue. The points made in this affidavit included:

1. As envisioned in s.148, the Directorate of Systems randomly selects a number of cases based on the criteria of the RMS. The AO has no role to play in such selection. Consequent to such selection, the information is made available to the AO who, with the prior approval of specified authority, determines which of these cases are fit for proceedings u/s 147 as per the procedure provided in s.148A.

2. The scheme provides for randomized allocation of cases, to ensure fair and reasonableness in the selection of cases. In the procedure for issuance of notice u/s 148, this is ensured, as cases selected prior to issuance of the notice are decided on the basis of an algorithm as per the RMS and are, therefore, randomly selected.

3. Such cases are flagged to the JAO by the Directorate of Systems and the JAO does not have any control over the process.

4. The cases are selected on the basis of RMS in a random manner, and the JAO has no way of predicting or determining beforehand whether a case will be flagged by the Systems.

5. Consequent to the issuance of notice u/s 148 as per the procedure discussed above, cases are again randomly allocated to the Assessment Units by the National Faceless Assessment Centre as per Section 144B(1)(i).

6. Under the provisions of the Act, both the JAO as well as units under NFAC have concurrent jurisdiction. The Act does not distinguish between JAO or NFAC with respect to jurisdiction over a case. This is further corroborated by the fact that u/s 144B, the records in a case are transferred back to the JAO as soon as the assessment proceedings are completed.

7. Since s.144B does not provide for issuance of notice u/s 148, there is no ambiguity in the fact that the JAO still has jurisdiction to issue notice u/s 148.

8. The parent section 151A considers that procedures may be modified under the Act or laid down considering their technological feasibility at the time.

9. The Scheme lays down that the issuance of notice u/s 148 shall be through automated allocation in accordance with the RMS, and that the assessment shall be in a faceless manner to the extent provided in s. 144B.

10. The specifics of the various parts of the procedure will evolve with time as the technology evolves and the structures in the ITD change. The Section and the scheme have left it to the administration to devise and modify procedures with time, while remaining confined to the principles laid down in the Section and scheme. By conducting the procedures at two levels, one with the JAO and other with NFAC, an attempt has been made to introduce checks and balances within the system that the assessee can submit evidences and can avail opportunity of hearing prior to commencement of any proceedings under the Act.

11. Re-assessment proceedings consequent to the issuance of notice conducted as per the faceless assessment ensures convenience of the assessee, equitable distribution of workload among the officers and is also compatible with the technological abilities in the ITD as on date, to ensure a procedure which is seamless, reasonable and fair for the assessee.

On behalf of the Revenue, attention of the Court was drawn to the evolution of the Faceless Assessment Scheme. The various Faceless Schemes, as envisaged in the Act, were placed on record. Statutory provisions relevant to Faceless Scheme of Assessment were also considered, including sections 135A, 144B, 148 and 151A, and the Faceless Re-Assessment Scheme, 2022.

The Delhi High Court observed that with the advent of technology, the Revenue appeared to have over a course of time adopted new tools for assembling, accumulation and analysis of data embedded in the millions of returns which came to be filed every financial year, adopting measures such as Computer Aided Scrutiny Selection, Annual Information Return data and Central Information Branch data. These measures appeared to have been formulated in order to aid and assist the Revenue with respect to scrutiny assessment, investigation and evaluation.

The Instructions issued by the ITD from time to time, which assisted in appreciating how these new technological capabilities had been deployed by the ITD to aid it in the discharge of its functions, were also placed before the High Court. The order u/s 119 dated 6^th September, 2021 and amending order dated 22^nd September, 2021, which chronicled various categories of cases which would stand excluded from faceless assessment, were placed before the High Court, as well as the Instructions issued by the Directorate of Systems dated 16^th November 2023, relating to the utilization of the Insight Portal and selection of cases in accordance with the RMS as formulated. The Notification issued u/s 120 dated 13^th August 2020, which designated the authorities charged with the conduct of faceless assessment in respect of various territorial areas, was also brought to the notice of the High Court.

The Delhi High Court analysed the evolution of the Faceless Assessment Scheme. It noted that the common thread underlying the various facets of the evolving faceless assessment regime from its inception till the present, had been the felt need to enhance efficiency, transparency and accountability in the process of assessment and reducing the human interface between the AO and the assessee. It further noticed that despite the expressed intent to altogether eliminate the interface between the AO and the assessee, both the Notifications of 12^th September, 2019 as well as of 13^th August, 2020 had not excluded the involvement of the JAO completely and in the course of the faceless assessment process. As per the High Court, the ITD appeared to have been at all times, cautious of not precluding the involvement of JAO within the faceless assessment process. The retention of the JAO in certain phases of the assessment process reflected a balanced approach, aiming to preserve transparency and efficiency while ensuring that complex issues received appropriate attention from a qualified and experienced AO.

The High Court illustrated this by reference to:

1. the Notification of 12^th September, 2019 which mandated that NFAC, after the completion of assessment, would transfer all electronic records of the case to the JAO under certain circumstances;

2. the Notification dated 13^th August, 2020, which had introduced amendments to the previous Notification of 12^th September, 2019, and had contemplated the role of the JAO in the faceless assessment scheme for transfer of case records, for transfer of case to the AO, and for transfer of case records of penalty proceedings.

The High Court observed that the principal question which arose for its consideration was whether s.144B precluded the JAO from initiating proceedings for reassessment in terms as contemplated u/s 148 and in accordance with the procedure prescribed in s. 148A. Analysing the provisions of s.151A, the High Court noted that as was manifest from the plain language of that provision, the underlying objective of such a scheme was to meet the legislative objective of eliminating the interface between an income tax authority and the assessee, optimal utilization of resources through economies of scale and functional specializations, the introduction of team based assessment, reassessment, recomputation as well as issuance or sanction of notices. Such team-based assessment was intended to be in accordance with the randomized allocation of cases and thus the usage of the expression “dynamic jurisdiction”.

As per the High Court, both section 144B as well as section 151A sought to introduce a system in terms of which assessment or reassessment proceedings could be entrusted to Assessment Units which would be randomly identified. Section 144B and the Explanation appended thereto defined an “automated allocation system” to mean an algorithm for randomised allocation of cases with the aid of suitable technological tools and which were envisaged to extend to the employment of artificial intelligence and machine learning. From a reading of Clause 3 of the Faceless Reassessment Scheme, 2022, assessment, reassessment or recomputation u/s 147 as well as issuance of notice u/s 148 was to be by way of an automated allocation and in a faceless manner to the extent provided in Section 144B. Clause 3 also used the expression “…..in accordance with risk management strategy formulated by the Board as referred to in Section 148 of the Act……”. The reference to RMS in the scheme was clearly intended to align with the concept of information which was spoken of in Explanations 1 and 2 of Section 148. According to the High Court, both Explanations 1 and 2 of Section 148 were of critical importance.

The Delhi High Court then went on to elaborate upon the underlying scheme and objective of the RMS which came to be formulated by the Board as well as other data analytical measures which came to be adopted for the purposes of assessment under the Act. The RMS was preceded by the adoption of various technological tools by the ITD for the purposes of analysing returns, extracting data and information pertaining to the constituents of the tax base of the country and the selection of appropriate cases for scrutiny and other measures contemplated under the Act. It noted the response made by the Minister of State for Finance in the Rajya Sabha on 7^th December, 2021, where he stated that for the purposes of scrutiny, cases are selected randomly through the CASS process and “in an identity blind manner”. The High Court observed that it would thus appear that by this time, the ITD clearly had in place selection criteria which took into consideration various risk parameters, and which would operate as red flags enabling and assisting the ITD to assess or reassess as well as to scrutinize in a more effective and efficient manner. This process used data analytics and algorithms to identify cases that may need closer inspection based on specific risk parameters, such as unusual financial activity, discrepancies in tax returns, or high-value transactions. The CASS process minimised human intervention in the selection phase, aiming to make the scrutiny process more objective, efficient, and unbiased by focusing on risk-based criteria rather than manual selection.

On the concept of RMS, the High Court took note of the Insight Instruction No. 71 issued by the Directorate of Income Tax (Systems) specifically addressing this approach. As per the Instruction, RMS and the creation of an Insight Portal were digital tools created internally by the ITD in order to enable an AO to holistically evaluate individual returns, map returns that may be found to be connected and a data set thus becoming available to be used for exploratory, statistical and perhaps even inferential analysis. The Insight Portal thus assimilated data pertaining to each individual assessee across broad parameters, stretching from comparative income tax return information, financial profiles and asset details amongst various other factors. The Insight Portal thus integrated a comprehensive dataset for each individual assessee, encompassing a wide range of parameters. These included comparative analyses of income tax return histories, detailed financial profiles, asset holdings, and additional relevant financial and transactional information. This data assimilation allowed for a nuanced view of each taxpayer’s financial standing and reporting consistency across multiple dimensions. The Insight Instruction dated 16^th November 2023 disclosed that the data so collected was made visible to the JAOs on the verification module of the Insight Portal. This enabled the JAO to test the completeness of disclosures made by an individual assessee against material aggregated by the system.

In addition, the Insight Portal enabled the JAO to access a Transaction Number Sequence hyperlink which would disclose the following information pertaining to that particular assessee: (a) bank account (b) aggregate gross amount related to the account (c) cash deposits in that account and (d) information with respect to immovable property transactions and other relevant details. This feature allowed JAOs to verify if a taxpayer‘s information was complete and consistent with the data gathered by the system, making it easier to catch any missing links or inaccurate information.

The Delhi High Court emphasised that the extensive framework of information which was collected, structured and made available on the Insight Portal represented data which was made visible solely to the JAO. This entire spectrum of data, information and comprehensive insight was not digitally pushed to the NFAC in the first instance. The High Court noted that the Directorate of Income Tax (Systems) was accorded the ability to randomly select cases which may have been cross referenced on the basis of the criteria and factors on which the RMS was founded. Upon such cases coming to be randomly selected and flagged, the cases so identified were then forwarded to the concerned JAO. What the ITD sought to emphasize was that the cases which were selected by the Directorate of Income Tax (Systems) based on the RMS was an exercise independently undertaken, with the JAO having no control over the selection process. It was in that light that the ITD asserted that the JAO could neither predict nor determine beforehand whether a case would be flagged by the Directorate of Income Tax (Systems).

The High Court observed that besides the technological aspects and analytical tools, the Act itself enabled the JAO itself to select cases which may merit further inquiry or investigation on the basis of information as defined. Explanation 1 to s.148 enabled an AO to form an opinion that income chargeable to tax had escaped assessment on the basis of (a) information which came to light through the RMS (b) an audit objection (c) information received under agreements with nations (d) information made available to the JAO in terms of a scheme notified u/s 135A or (e) information on which further action was warranted in consequence to an order of a Tribunal or a Court. The Act therefore permitted reassessment not only on RMS data, but also on a variety of other specified inputs, ensuring a broader foundation for initiating reassessment. Under Explanation 2 to Section 148, the material that may be gathered in the course of a search or survey also thus constituted information which came to be placed in the hands of the JAO and which may form the basis for formation of opinion of whether reassessment was merited.

The High Court then took note of the provisions of the Act which broadly identified sources from which information may be gathered by an AO for the purposes of assessment, including sections 133, 133A, 133B and 133C. It took note of the scheme for the purposes of calling for information notified u/s 135A, the powers to make reference to a Valuation officer u/s 142A and the scheme notified u/s 142B for the purposes of faceless inquiry or valuation.

The Delhi High Court then went on to consider provisions of the Act incorporated for the purposes of delineating jurisdictional boundaries and conferment of powers amongst income tax authorities, including sections 120 and 127. It noted that power to transfer a case for the purpose of centralised assessment could be exercised so as to place a particular batch of cases before any AO, irrespective of whether it had been empowered to exercise concurrent jurisdiction. The Court noted that the CBDT notifications issued for the purposes of facilitating conduct of faceless assessment and which in ambiguous terms provided that the authorities so designated in those notifications would exercise powers and discharge functions of an AO ”concurrently”, were of equal significance.

Under section 127, cases originally assigned to one officer or jurisdiction could be reassigned, grouping similar cases together for efficient handling. This power to transfer cases allowed a group of cases to be examined by a particular AO, regardless of whether that officer had authority over the cases initially. The CBDT had also issued notifications to facilitate faceless assessments, where assessments were handled without in-person interaction between the tax official and the taxpayer. These notifications allowed designated tax authorities to share the powers and duties of an AO in a concurrent manner, meaning multiple officers or authorities could simultaneously exercise the functions of an AO, especially in a faceless system. Besides, Section 144B itself conferred a power upon the Principal Chief Commissioner or the Principal Director General to transfer cases to the JAO.

The Delhi High Court took note of the deletion of sub-section (9) of section 144B by the Finance Act 2022, and the explanation given in the Explanatory Memorandum. This provided that assessment proceedings shall be void if the procedure mentioned in the section was not followed. A large number of disputes had been raised under that sub-section involving technical issues arising due to use of information technology, leading to unnecessary litigation, and hence this provision was deleted. According to the High Court, this captured the legislative intent to create an effective, fair, and flexible tax assessment process that balanced structured jurisdictional roles with the adaptability needed for centralized, faceless assessments. Notably, among the various factors that influenced this decision, what is not lost was the delicate balance sought to be struck by the Legislature between procedural adherence and practical efficiency. The Legislature recognised that while strict procedural compliance was fundamental to maintaining fairness and transparency in the assessment process, an inflexible adherence to procedure—especially in a digital and faceless assessment environment—could inadvertently lead to administrative bottlenecks and a surge in litigation. The legislature sought to ensure that the intent of the law was not overshadowed by technicalities.

The High Court observed that it became apparent that the procedure formulated and introduced by virtue of Section 144B, while undeniably transformative and disruptive and transformational, was also in many ways transitional and representative of a phased and evolving process. Various categories of cases were from inception excluded specifically from the ambit of faceless assessment. Section 144B, when it originally came to be inserted in the statute, stood confined to assessments under Sections 143(3) and 144. The words “reassessment”, ”recomputation” came to be added subsequently by virtue of Finance Act, 2022. It was this Amending Act which also added the words “Section 147” specifically in Section 144B. As the court read the section, the focal point and the nucleus of faceless assessment primarily appeared to be the assessment and analysis of returns which had been filed electronically and were to go through the rigors of regular assessment. This position emerged from a reading of the elaborate provisions contained therein and which in minute detail provided how returns were, generally under the faceless scheme, liable to be scrutinised and assessed, the random allocation of those cases to different Assessment Units, the conferment of dynamic jurisdiction upon Assessment Units, the internal review procedure pertaining to draft orders, issuance of notices and a host of other facets pertaining to assessment in general.

The High Court noted that of critical significance was the absence of any provision of Section 144B seeking to regulate the commencement of reassessment action as contemplated under Sections 147, 148 and 148A. The provision was conspicuously silent with respect to commencement of action u/s 147. Of equal importance was the fact that although Section 144B described the various steps to be taken in the course of assessment and assigned roles to different constituents of the NFAC, it did not, at least explicitly, incorporate any machinery provisions which may be read as intended to regulate the pre-issuance stages of a notice u/s 148. While it was true that Section 144B did specifically refer to reassessment, the Court was of the view that the significance of that insertion would perhaps have to adjudged bearing in mind the interpretation of the scheme for reassessment which had been advocated for the Court’s consideration by the ITD. The Court was of the view that this not only appealed to reason but may also be the more sustainable view to adopt if one were to harmoniously interpret the provisions of the Act alongside the schemes for faceless assessment coupled with the underlying objectives of reducing human interface. This approach sought to ensure that the reassessment scheme functioned in concert with the faceless assessment framework.

The Delhi High Court observed that a reassessment need not in all conceivable contingencies be triggered by a return that an assessee may choose to lodge electronically. It is a complex process driven by multiple factors that extend far beyond the initial filing of a return. As per explanations 1 and 2 of Section 148, reassessment may be commenced on the basis of information that may otherwise come to be placed in the hands of the JAO. It may be initiated if an audit objection were flagged and placed for the consideration of the JAO. Material unearthed in the course of a search or material, books of accounts or documents requisitioned under Section 132A could also constitute the basis for initiation of reassessment. Material gathered in the course of survey may also be the basis of formation of opinion as to whether income had escaped assessment. These are not founded on the material or data which may be available with NFAC.

The statute thus clearly conceived of various scenarios where the case of an assessee may be selected for examination and scrutiny on the basis of information and material that fell into the hands of the JAO directly or was otherwise made available with or without the aid of the RMS. The High Court was of the opinion that it would therefore be erroneous to view Section 144B as constituting the solitary basis for initiation of reassessment. Section 144B was primarily procedural and was principally concerned with prescribing the manner in which a faceless assessment may be conducted as opposed to constituting a source of power to assess or reassess in itself. The Dehi High Court observed that Section 144B was not intended to establish a substantive basis for the exercise of reassessment powers; rather, it was inherently procedural. Its function was confined to outlining the processes through which faceless assessments were to be conducted, ensuring efficiency and consistency in the manner of assessment rather than determining the substantive grounds upon which reassessment was founded. Therefore, Section 144B was procedural, forming part of the broader legislative framework aimed at structuring the assessment process without encroaching upon the substantive grounds for reassessment itself. That provision was not the singular and exclusive repository of the power to assess as contemplated under the Act.

The randomized allocation of cases based on the adopted algorithm and the use of technological tools, including artificial intelligence and machine learning, appeared to be primarily aimed at subserving the primary objective of faceless assessment, namely, of reducing a direct interface, for reasons of probity and to obviate allegations of individual arbitrariness. However, as per the High Court, it was wholly incorrect to view the faceless assessment scheme as introduced by virtue of Section 144B as being the solitary route which the Act contemplated being tread for the purposes of assessment and reassessment.

The core attributes of the faceless assessment system revolved around the principle of randomised allocation, where ‘random’ in its literal sense meant that case assignments were made without any predetermined or controlling factor. This principle was a deliberate feature of the faceless assessment framework, aimed at reducing direct human interaction — a facet historically susceptible to biases and potential misconduct. By substituting the human element with a carefully designed algorithm, the system restricted human involvement to only those essential stages, thereby enhancing fairness and accountability.

The High Court observed that Section 144B therefore played a crucial role by establishing the procedural mechanisms for faceless assessments, specifically through the random allocation of cases to different Assessment Units. However, to read into Section 144B a substantive basis for assessments and reassessments would extend its role beyond its intended design. The section‘s true function lay in facilitating an unbiased, algorithm-driven distribution of cases, supporting the overarching objective of minimizing direct human interaction in the assessment process. As per the High Court, it would be incorrect to interpret Section 144B as the sole pathway envisioned by the Act for conducting assessments or initiating reassessments. Instead, it should be recognised as one component within a broader statutory framework that provides multiple avenues for the lawful assessment and reassessment of returns.

The Delhi High Court further observed that the conferred jurisdiction upon authorities for the purposes of faceless assessment itself used the expression “concurrently”. That word would mean contemporaneous or in conjunction with, as opposed to a complete ouster of the authority otherwise conferred upon an authority under the Act. This too was clearly demonstrative of the Act not intending to deprive the JAO completely of the power to reassess. In understanding the concept of concurrent jurisdiction, it was essential to recognise that the retention of a human element within the broader framework of the National Faceless Assessment Centre (NeAC) does not conflict with the powers held by the JAO. Rather, as per the High Court, this setup must be viewed as complementary, reinforcing both accountability and adaptability within the assessment process.

The Delhi High Court referred to its decision in the case of Sanjay Gandhi Memorial Trust vs CIT(E) 455 ITR 164,where it had been concluded that, while the faceless system centralised case handling through the NFAC, this framework did not completely replace or nullify the JAO‘s role. It held that the CBDT notifications further affirmed this shared responsibility, specifying that the NFAC and the JAO hold concurrent jurisdiction, thereby allowing the faceless system to conduct assessments without stripping the JAO of its foundational authority. In this way, the High Court had held in that case that the JAO‘s retention of original jurisdiction provided a critical balance, ensuring that human oversight remained available within the faceless assessment structure when needed, and that the JAO‘s authority was not merely residual but an active, complementary role that reinforced the flexibility of the assessment system.

The Delhi High Court stated that in that case, the Court came to the firm conclusion that irrespective of the system of faceless assessment that had come to be introduced and adopted, it would be wholly incorrect to hold or construe the provisions of the Act as denuding the JAO of the authority to undertake an assessment or of the said authority being completely deprived of authority and jurisdiction. According to the High Court, the judgment in Sanjay Gandhi Memorial Trust (supra) was a resounding answer to the challenge as raised by the writ petitions before it, and reinforced its conclusion of the two permissible modes of assessment being complementary, and the Act envisaging a coexistence of the two modes.

Besides, according to the Delhi High Court, if the position canvassed on behalf of the assessee were to be accepted, the provisions relating to the various sources of information which the JAO stood independently enabled to access and which could constitute material justifying initiation of reassessment, would be rendered a complete dead letter and the information so gathered becoming worthless and incapable of being acted upon. This is because such information is firstly provided to the JAO and it is that authority which is statutorily obliged to assess and evaluate the same in the first instance.

The Delhi High Court held that within the framework of the faceless assessment system, the JAO retained powers that do not conflict with, but rather complement, the objectives of neutrality and efficiency. The faceless assessment scheme centralised processes under the Faceless Assessing Officer (FAO) to reduce direct interaction. However, this structure did not diminish the JAO‘s authority. Instead, the JAO‘s retained jurisdiction was vital for ensuring continuity and accountability, acting as a complementary element to the faceless assessment framework. the JAO‘s powers should be understood as integral and not in conflict with faceless assessment. Rather, it represented a foundational jurisdictional safeguard, enabling the JAO to initiate reassessment based on independent, credible sources of information. This concurrent authority of the JAO reinforced the integrity and adaptability of the faceless system, ensuring that both centralised and jurisdictional assessments operated cohesively within the larger statutory framework.

The High Court also noted that an Assessing Unit of the NFAC derived no authority or jurisdiction till such time as a case was randomly allocated to it, which triggered the assessment process in accordance with the procedure prescribed by Section 144B. The evaluation of data and information would precede the actual process of assessment. As per the Delhi High Court, if the interpretation which was advocated by the assessee were to be countenanced, the appraisal and analysis of information and data functions which the Act entrusted upon the JAO would be rendered wholly unworkable and clearly be contrary to the purpose and intent of the assessment power as constructed under the Act. Eliminating the JAO’s role altogether would not only fail to further these goals but could actually compromise the system‘s functionality and flexibility. The JAO‘s retained powers, particularly in accessing and evaluating specific information sources for reassessment, played a critical role in supplementing the centralized, algorithm-driven processes of faceless assessment. By allowing the JAO to operate in conjunction with the FAO, the Act ensured that both roles work complementarily to deliver comprehensive and balanced assessments. Far from conflicting with the faceless system, the JAO‘s role enhanced it, ensuring that assessments remained grounded in thorough investigation.

The Delhi High Court observed that the decisions of various High Courts which had taken a contrary view, had proceeded on the basis that consequent to faceless assessment coming into force by virtue of Section 144B, the JAO stood completely deprived of jurisdiction. In Hexaware Technologies (supra), a specific issue with respect to the validity of the notice came to be raised, with it being argued that once the scheme of faceless reassessment had come to be promulgated, the JAO would stand denuded of jurisdiction. The Delhi High Court noted that apart from the Faceless E-Assessment Scheme 2022 itself and the instructions which were provided to counsel appearing for the Revenue, most of the High Courts did not appear to have had the benefit of reviewing the copious material which the counsel for the Revenue had so painstakingly assimilated and placed for the Delhi High Court’s consideration. They also did not appear to have had the advantage of a principled stand of the Revenue having been placed on the record of those proceedings.

In Hexaware Technologies (supra), the Bombay High Court ultimately came to conclude that there could be no question of a concurrent jurisdiction of the JAO and the FAO for issuance of notice u/s 148. From a reading of the record, the Delhi High Court observed that it was unclear whether the notifications conferring jurisdiction on authorities of the NFAC for the purposes of conducting faceless assessment was placed before the Bombay High Court. At least the decision made no reference to the notification of 13^th August, 2020, which had been produced in the proceedings before the Delhi High Court, and which in clear and unambiguous terms declared that the officers empowered to conduct faceless assessment were being conferred concurrent powers and functions of the AO. The Delhi High Court therefore expressed its inability to concur with Hexaware Technologies decision, bearing in mind the various sources of information and material which may assist a JAO in forming an opinion as to whether income had escaped assessment and which had been commented upon earlier.

The Delhi High Court observed that the other High Courts too as well as subsequent decisions of the Bombay High Court did not appear to have had the advantage of reviewing and analysing the material that had been placed by the Revenue in the proceedings before the Delhi High Court. In Ram Narayan Sah’s case (supra), though the Delhi High Court decision in the case of Sanjay Gandhi Memorial Trust (supra) was cited before it, the judgment of the Gauhati High Court neither entered any reservation nor did it record any reasons which may have assisted the Delhi High Court in discerning what weighed with the Gauhati High Court to brush aside the aspect of concurrent jurisdiction. The Delhi High Court stated that unlike prior cases where certain High Courts, including in Hexaware Technologies (supra), were not provided with the full spectrum of relevant notifications and contextual information, the extensive documentation in the matter before it had helped clarify ambiguities in both law and fact. This record had allowed for a deeper analysis, addressing key points left unexamined in previous judgments, and had illuminated the legislative and procedural intentions behind the faceless assessment scheme, particularly the concurrent jurisdiction between the JAO and FAO.

The Delhi High Court further observed that in a recent decision rendered by the Gujarat High Court, in the case of Talati and Talati LLP vs. Office of ACIT 167 taxmann.com 371, a view had been expressed which appeared to be in tune with the conclusions which the Delhi High Court had reached.

Referring to clause 3 of the Faceless Reassessment Scheme 2022, which provided that assessment, reassessment or recomputation u/s 147 as well as issuance of notice u/s 148 would be through automated allocation in accordance with the risk management strategy and in a faceless manner, the Delhi High Court observed that from the punctuation, by the placement of commas, it appeared to have been the clear intent of the author to separate and segregate the phases of initiation of action in accordance with RMS, the formation of opinion whether circumstances warrant action u/s 148 being undertaken by issuance of notice, and the actual undertaking of assessment itself. As per the Delhi High Court, beyond the specific use of punctuation within Clause 3, a comprehensive reading of the Faceless Reassessment Scheme 2022, supported by the extensive material presented by the Revenue, bolstered the clear intent underlying each phase of the faceless assessment process.

The Delhi High Court stated that the Revenue would appear to be correct in its submission that when material comes to be placed in the hands of the JAO by the RMS, he would consequently be entitled to initiate the process of reassessment by following the procedure prescribed u/s 148A. If after consideration of the objections that are preferred, he stood firm in his opinion that income was likely to have escaped assessment, he would transmit the relevant record to the NFAC. It is at that stage and on receipt of the said material by NFAC that the concepts of automated allocation and faceless distribution would come into play. The actual assessment would thus be conducted in a faceless manner and in accordance with an allocation that the NFAC would make. In the opinion of the Delhi High Court, this would be the only legally sustainable construction liable to be accorded to the scheme. This conclusion would thus strike a harmonious balance between the evaluation of information made available to an AO, the preliminary consideration of information for the purposes of formation of opinion and its ultimate assessment in a faceless manner.

The Delhi High Court stated that it was guided by the principles of beneficial construction, to the effect that avoiding an interpretation that would render portions of the Act or the Faceless Assessment Scheme superfluous or ineffective should be avoided. To assert that the JAO‘s powers become redundant under the faceless assessment framework would conflict with beneficial construction, as it would undermine provisions specifically established to support comprehensive data analysis and informed decision-making, such as the JAO‘s access to RMS and Insight Portal information.

The Delhi High Court therefore dismissed the writ petitions filed before it.

OBSERVATIONS

From the text of the decisions in Hexaware Technologies (supra) and those of other High Courts which decided the matter, besides the Delhi High Court, none of the other High Courts had the occasion to examine the Faceless Assessment Scheme, 2022 and the notifications issued for that purpose, in such minute detail as was done by the Delhi High Court. The Delhi High Court went into the object of the Scheme, the manner in which it was to be implemented and the difficulties faced in implementing it and how these were resolved.

In particular, the notification NO. S.O. 2757 [NO. 65/2020/F.NO. 187/3/2020-ITA-I] dated 13^th August, 2020, was not considered by those High Courts. This specified as under:

“In pursuance of the powers conferred by sub-sections (1), (2) and (5) of section 120 of the Income-tax Act, 1961 (43 of 1961) (hereinafter referred to as the said Act, the Central Board of Direct Taxes hereby directs that the Income-tax Authorities of Regional e-Assessment Centres(hereinafter referred to as the ReACs) specified in Column (2) of the Schedule below, having their headquarters at the places mentioned in column (3) of the said Schedule, shall exercise the powers and functions of Assessing Officers concurrently, to facilitate the conduct of Faceless Assessment proceedings in respect of territorial areas mentioned in the column (4), persons or classes of persons mentioned in the column (5) and cases or classes of cases mentioned in the column (6) of the Schedule-1 of the notification No. 50 of 2014 in S.O. 2752 (E), dated the 22^nd October, 2014 published in the Gazette of India, Extraordinary Part II, section 3, sub-section (ii):”

Had this notification been brought to the attention of the other High Courts, they may perhaps have taken a different view of the matter.

Further, the Revenue filed a detailed affidavit, explaining the logic of various provisions of and governing the Scheme. The Delhi High Court therefore had the opportunity to examine in detail the role of the JAO, the role of the FAO, and the logic behind the bifurcation of the activities of reassessment. Such details were not before the other High Courts. Again, had all such material been before the other High Courts as well, perhaps those decisions may have been otherwise.

One aspect does not seem to have been considered by the Delhi High Court — the purpose of introduction of section 151A. The Delhi High Court has expressed a view that the JAO would be entitled to initiate the process of reassessment by following the procedure u/s. 148A, and thereafter he would transmit the relevant records to the NFAC. The role of NFAC would come into play only after receiving the said materials from the JAO. If the view is taken that section 151A was inserted with effect from 1^st November, 2022 by the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 only to permit conduct of faceless reassessment proceedings by the NFAC, it may be seen that such a practice was prevalent even before the insertion of Section 151A. The Faceless Assessment Scheme, 2019 as amended by Notification No. 61/2020 dated 13-8-2020 specifically provided for reassessment in pursuance of notices issued under Section 148 also in a faceless manner. Therefore, effectively, there was no change in the position, post insertion of Section 151A, with respect to when the role of NFAC would come into play, If the view is taken that section 151A was inserted only to facilitate faceless reassessment proceedings and not for issue of notice u/s 148, it will render the provisions of Section 151A redundant in so far as it provides specifically for issuance of notice under Section 148, besides conduct of enquiries or issue of show-cause notice or passing of order under Section 148A. This aspect may require greater consideration.

While the Delhi High Court’s view seems to be the better view of the matter, being a more detailed analysis, the matter will be set to rest only after the decision of the Supreme Court on the issue. The Supreme Court had fixed the matters initially for hearing in October and thereafter November 2024, which have since been adjourned to 28^th January, 2025. Hopefully, this controversy will soon be resolved in a few months by the Supreme Court.

BCAJ Admin

Transfer of Capital Asset to Subsidiary / Holding Company

ISSUE FOR CONSIDERATION

Any transfer of a capital asset by a company to its subsidiary company, subject to compliance of the specified conditions, is not regarded as a “transfer” under section 47(iv) of the Income Tax Act (“ACT”). Likewise, a transfer of a capital asset by a subsidiary company to the holding company is not regarded as a transfer under section 47(v). A company is defined by section 2(17) and includes an Indian company and a company in which, the public are substantially interested is defined by section 2(18) of the Act and includes the subsidiary company of a company in specified cases. An Indian company is defined by section 2(26) of the Act. The terms or expressions ‘subsidiary company’ or ‘holding company’ are not defined under the Income Tax Act. These terms, however, are defined under sections 2(46) and 2(87) of the Companies Act, 2013. (Section 4 of the Companies Act, 1956). The definition of a subsidiary company under the Companies Act includes a step-down subsidiary or sub-subsidiary, ie. a subsidiary of a subsidiary company.

An issue has arisen under the income tax law as to whether a step-down subsidiary is a subsidiary for the purposes of sections 47(iv) and (v) of the Act, and therefore, whether the transfer to or from such a subsidiary is regarded as a case of ‘no transfer’ for the purposes of section 2(47) of the Act; in other words, whether the capital gains on such a transfer is exempt from taxation.

The Gujarat High Court has held that a transfer of capital asset by a holding company, to its step-down subsidiary, is not covered by the provisions of section 47(iv) of the Act while the Bombay High Court, in the context of erstwhile section 108 r.w.s. 104 of the Act has held that a subsidiary included the subsidiary of a subsidiary. Recently, the Kolkata bench of the Income Tax Appellate Tribunal, following the decision of the Bombay High Court, has held that a transfer by a holding company to its step-down subsidiary is a case of transfer that is not regarded as a transfer. The Gujarat High Court in deciding the issue has specifically dissented from the decision of the Bombay High Court.

PETROSIL OIL CO. LTD.’S CASE

The issue under consideration first arose in the case of Petrosil Oil Co. Ltd. vs. CIT, 236 ITR 220 before the Bombay High Court in the context of the erstwhile section 108 r.w.s 104 of the Act.

In the said case, the assessee-company incorporated under the Companies Act, 1956 in India was a wholly owned subsidiary of a company incorporated in United Kingdom (UK company), which itself was also a subsidiary of another company based and registered in the United States of America holding its 100 per cent shares (US Company was one in which the public were substantially interested). Section 104 of the Act provided for the levy of additional tax on undistributed income of a closely held company under certain circumstances. Section 108 provided for the relief from such tax (a) to any company in which the public are substantially interested; or (b) to a subsidiary company of such company if the whole of the share capital of such subsidiary company has been held by the parent company or by its nominees throughout the previous year.”

In the course of assessment, a controversy arose in regard to the appropriate tax rate of income-tax applicable to the assessee-company. The question arose whether the company could be considered a domestic company in which the public are substantially interested. The AO did not accept the contention of the assessee that the assessee-company, being a wholly owned subsidiary of another company which in turn was a subsidiary of another company in which the public were substantially interested, then by virtue of section 108, having been incorporated by reference in definition of ‘a company in which public were substantially interested’ in then s.2(18), it should be deemed to be a company in which public were substantially interested.

The Appellate Commissioner decided in favour of the assessee holding that a subsidiary of a subsidiary also fell within the ambit of clause (b) of section 108 if it satisfied the requirements prescribed therein. The Tribunal was however, of the view that section 108, did not cover a case of sub-subsidiary and decided the appeal before it against the assessee.

On reference, there being a point of difference between the two judges of the Division Bench – one judge holding that to qualify as a ‘company in which the public are substantially interested’ not only the assessee-company but also its parent company / companies must also be domestic company, while the other judge held that the assessee in question was a company in which public was substantially interested in as much as the holding company was the subsidiary of a company which was a company in which public was substantially interested, the case was referred to the Third Judge.

In response, the company, in the context of the relevant issue, submitted that;

The U.S. company fell within section 2(18)(b)(B)(i)(d); as 100 per cent of the shares of the U.K. company were held by the U.S. company, the U.S. company and U.K. company were one and the same; then the assessee would fall within section 2(18)(b)(B)(i)(c); a 100 per cent owned subsidiary of a 100 per cent owned subsidiary should be considered as a subsidiary.
Under section 4(1)(c) of the Companies Act, a company was deemed to be a subsidiary of another if it was a subsidiary of any company which was the subsidiary of the other; a sub-subsidiary which fulfilled the requirement of section 108(b) would be a subsidiary under section 108(b); in that case 100 per cent of the shares of the assessee were held by the U.K. company whose shares were held by the US holding company, and the assessee, thus, fulfilled the requirement of section 108(b).
Reliance was placed upon the case of Howrah Trading Co. Ltd. vs. CIT 36 ITR 215 (SC), wherein the question was whether a person, who had purchased shares in a company under blank transfer forms and in whose name the shares had not been registered in the books of the company, was or was not a shareholder within the meaning of section 18(5). The Supreme Court, whilst deciding this question, held that under the Indian Companies Act, the expression ‘shareholder’ denoted no other person except a member. The Supreme Court held that no valid reason existed why the word ‘shareholder’ as used in section 18(5) should mean a person other than the one denoted by the same expression in the Indian Companies Act. The Supreme Court was, thus, importing the definition of the term ‘shareholder’ as used in the Companies Act into the Income-tax Act.
The definition under section 4(1)(c) of the Companies Act must be imported into section 108; even on the doctrine of lifting of corporate veil, it would be found that 100 per cent of the shares of the assessee-company were held by the U.K. company and 100 per cent of the shares of the U.K. company were held by a U.S. company; it must, therefore, be held that the sub-subsidiary was also a subsidiary of the U.S. company and fell within section 108(b).

On behalf of the revenue department, in the context of the relevant issue, it was submitted that section 108(b) applied only to such companies whose entire share capital was held by a company falling under section 108(a); the definition of the expression ‘subsidiary company’ under the Companies Act could not be incorporated into section 108; neither of the two conditions prescribed under section 108(b) were satisfied by the assessee-company; the assessee was not a subsidiary of the U.S. company and, therefore, was not a subsidiary of a company falling within section 108(a); a sub-subsidiary could not be treated as a subsidiary for the purposes of section 108(b); the assessee was, thus, not a company in which the public were substantially interested.

On due consideration of the rival submissions, the court held that;

The Income-tax Act nowhere defined what was a ‘subsidiary company’. The Finance (No. 2) 1971 Act also did not define what was a ‘subsidiary company’
There would be a dichotomy if the assessee-company were to be a subsidiary company of the U.S. company for the purposes of the Companies Act but were deemed not to be a subsidiary of the U.S. company for the purposes of the Act.
The meaning given to the term ‘subsidiary company’ under section 4(1)(c) of the Companies Act must be imported into section 108. Of course, the further condition laid down under section 108(b) must also be fulfilled. Thus, a sub-subsidiary would be a subsidiary under section 108(b) if the whole of its share capital had been held by the parent company or its nominees throughout the previous year.
If that meaning was incorporated, then it was very clear that the assessee was a subsidiary within the meaning of section 108(b). This was so because, admittedly, the U.S. company was a company in which the public are substantially interested and fell within section 108(a). A 100 per cent owned sub-subsidiary of a 100 per cent owned subsidiary would be a subsidiary within the meaning of section 4(1)(c) of the Companies Act and also within the meaning of section 108(b) of the Companies Act. The assessee fulfilled the condition of section 108(b) in as much as, throughout the previous year, 100 per cent of its share capital was held by the U.K. company. Throughout the previous year, 100 per cent of the share capital of the U.K. company was held by the U.S. company. The U.K. company was, thus, a nominee of the U.S. company. The assessee would, thus, be a subsidiary within the meaning of section 108(b).
Once the definition of the expression ‘subsidiary company’ appearing in section 4(1) of the Companies Act was imported to find out the true meaning of the word ‘subsidiary company’ in clause (b) of section 108, it would have to be read in the context of the requirements of clause (b) of section 108. In other words, ‘subsidiary company’ in section 108 could be understood to mean a subsidiary company as defined in section 4(1) of the Companies Act, which met the further requirements of clause (b) of section 108, viz., if the whole of the share capital of such subsidiary company had been held by the parent company or by its nominees throughout the previous year. If company ‘A’ held 100 per cent of the shares of a subsidiary company ‘B’ which held 100 per cent of the shares of another company ‘C’, under the Companies Act, Company ‘A’ could be said to be holding 100 per cent of the shares of company ‘C’ also. In conclusion section 2(6)(a) of the Finance Act, read with section 108(b), covered the case of a subsidiary company which was a subsidiary of a subsidiary company falling therein, if it also met the requirements mentioned in that clause.

KALINDI INVESTMENT (P.) LTD.’S CASE

The issue again came up for consideration before the Gujarat High Court in the case of Kalindi Investment (P.) Ltd. vs. CIT, 256 ITR 713 in the context of section 47(iv) of the Act.

In the said case, the facts were that one Kaveri Investments (P.) Ltd. was a wholly-owned subsidiary of the assessee company. Ambernath Investments (P.) Ltd. was a wholly-owned subsidiary of Kaveri Investments (P.) Ltd. As such, Ambernath Investments (P.) Ltd. was a step-down subsidiary of the assessee company.

The assessee, a private limited holding company, was earning dividend and interest income from its activities of making or holding investments and financing industrial enterprises. It maintained its books of account on mercantile system of accounting. For the assessment year under consideration, i.e., 1975-76, for which the accounting period ended on 31^st March, 1975, the assessee-company filed its return of income declaring total loss of ₹3,02,858. The total loss included an amount of ₹1,26,201 claimed by the assessee to have been incurred on account of short-term capital loss.

At the assessment proceedings, the ITO noted that during the accounting period the assessee had sold its 2,300 shares of Sarabhai Management Corpn. Ltd., a private limited company, on 20^th January, 1975, to its subsidiary company, viz., Ambernath Investments (P.) Ltd. Co. for ₹13,600 only at the rate of ₹6 per share. The said shares had been purchased by the assessee-company on 30^th July,1973, for ₹1,38,345 at the rate of ₹60.15 per share. The difference of ₹1,24,545 was claimed by the company as short-term capital loss occasioned as a result of transfer of the said shares by it to Ambernath Investments (P.) Ltd. The ITO rejected the assessee’s claim on the ground that the transferee-company, i.e., Ambernath Investments (P.) Ltd. was a subsidiary company of the assessee-company and, therefore, the case was clearly covered by the provisions of section 47(iv) of the Income-tax Act, 1961 (‘the Act’).

The CIT(A) and the tribunal confirmed the finding of both the lower authorities that the provisions of section 47(iv) were attracted. For this purpose, the Tribunal relied on the definitions of ‘holding company’ and ‘subsidiary company’ as given in section 4 of the Companies Act, 1956.

At the instance of the assessee company the following question was referred by the Tribunal for opinion of the Gujarat Hogh Court:

“1…………….

2. Whether the Tribunal was justified in interpreting various relevant provisions of various Acts such as sections 45, 47(iv)(a), 2(17), 2(26) of the Act as well as section 4, etc., of the Companies Act, 1956, while arriving at the conclusion that the loss in question was incurred on account of transaction between the parent company and the subsidiary company and, hence, the same was disallowable under section 47(iv)(a) of the Act in spite of the fact that the assessee-company did not hold all the share capital of Ambernath Investments (P.) Ltd. ?”

The company contended before the court that:

Section 47(iv) contemplated transfer of a capital asset by a holding company to its subsidiary company and that since Ambernath Investments (P.) Ltd. was not a subsidiary company of the assessee-company, there was no question of applying section 47(iv). The assessee-company did not hold the whole of the share capital of Ambernath Investments (P.) Ltd. and, therefore, clause (a) of section 47(iv) was also not attracted. Of course, there was no dispute about the fact that Ambernath Investments (P.) Ltd. was an Indian company.
The Tribunal erred in invoking the provisions of the Companies Act, for applying section 47(iv) to the facts of the instant case. Section 4(1) of the Companies Act, commenced with the words ‘For the purposes of this Act’, and therefore the definition of ‘holding company’ contained in the aforesaid provision could not be applied for the purposes of section 47(iv) which is a different enactment altogether.
Because the transaction in question resulted into capital loss, the revenue had held that it was not a transfer, but if the transaction had resulted into capital gain, the revenue would have canvassed the other way around to rope in the income as taxable, by treating it as a transfer of capital asset outside the purview of section 47(iv). For that purpose, the revenue would have contended that Ambernath Investments (P.) Ltd. was not the immediate subsidiary of the assessee-company.

On the other hand, the Revenue, submitted that:

When the Act itself did not contain any definitions of ‘holding company’ and ‘subsidiary company’, and the Companies Act was a special enactment for companies, there was nothing wrong on the part of the Tribunal in relying on the definition of ‘holding company’ contained in section 4 of the Companies Act, more particularly, when the assessee held the entire share capital of Kaveri Investments (P.) Ltd. and Kaveri Investments (P.) Ltd., in turn, held the entire share capital of Ambernath Investments (P.) Ltd. The provisions of section 4(1)(c), read with illustration thereof were clearly applicable in the facts of the instant case.
In any event of the matter, the Commissioner (Appeals) had also given another ground for holding that there was no capital loss and, therefore, also the finding given by the Tribunal is not required to be disturbed.

Having heard the learned counsels for the parties, the court observed that;

although revenue’s first submission appeared to be prima facie attractive, there was no justification for transplanting the definition of ‘holding company’ under the Companies Act into the provisions of section 47 automatically. The Companies Act had been enacted to consolidate and amend the law relating to companies and certain other associations.
Various regulatory provisions contained in the Companies Act were meant to make the companies accountable for their activities to the authorities as well as to the shareholders and creditors.
In order to ensure that a company having controlling interest in another company did not escape the liabilities of the other company, section 4(1) gave an expanded definition of a ‘holding company’.
On the other hand, the Income-tax Act was a taxing statute for taxing the Income under various heads and subject them to levy of tax. Capital gains was one such head. Section 45 provided that any profits or gains arising from the transfer of a capital asset effected in the previous year shall be chargeable to income-tax under the head ‘Capital gains’ and shall be deemed to be the income of the previous year in which the transfer took place. Since there could be borderline transactions, the Legislature has taken care to provide in section 47 that certain transfers shall not be considered as transfers for the purpose of levy of capital gains. For instance, any distribution of capital assets on the total or partial partition of an HUF was not to be treated as a transfer for the purpose of capital gains. So also, any distribution of capital assets on the dissolution of a firm, or an AOP was not to be treated as a transfer for the purpose of capital gains. Similarly, any transfer, in a scheme of amalgamation of a capital asset by the amalgamating company to the amalgamated company was also not be treated as a transfer for the purpose of capital gains, subject to compliance with certain conditions.
• The same section provided that, transfer of a capital asset by a holding company to its Indian subsidiary company or by a subsidiary company to its Indian holding company was not to be treated as a transfer for the purposes of capital gains.
The words ‘any transfer of a capital asset by a company to its subsidiary company’ would, as per the ordinary grammatical construction, contemplate only the immediate subsidiary company of the holding company as the holding company held the share capital only of its immediate subsidiary company.
If the Legislature, while enacting the Act, intended that the provisions of section 4 of the Companies Act should apply to a holding or a subsidiary company under section 47, there was nothing to prevent the Legislature from making such an express provision. The question was when that was not done, whether the provisions of section 4(1)(c) of the Companies Act were required to be read into section 47(iv) and (v) by necessary implication.
Section 4 of the Companies Act made it clear that the expanded definition of ‘holding company’ was applicable for the purposes of the Act. The Legislature gave an expanded definition of ‘holding company’ for the purposes of the Companies Act with the object to make the companies more accountable to the authorities, shareholders and creditors, With emphasis on ‘control’ of one company over another, the definition of ‘holding company’ under the Companies Act clearly indicated control over the composition of the Board of Directors or holding more than half in nominal value of equity share capital of the other company, which was sufficient to treat the two companies in question as a holding company and a subsidiary company.
On the other hand, the Legislature has provided different criteria for dealing with a holding company and a subsidiary company in the matter of tax in capital gains on transfer of assets between such companies. The Act has carved out a smaller number of holding and subsidiary companies for the purposes of section 47(iv) and (v). The wider definition of a ‘holding company’ with emphasis on ‘control’ as the guiding factor was not adopted in clauses (iv) and (v) of section 47. It was specifically provided that the parent company or its nominees must hold the whole of the share capital of the company.
The Legislature while enacting the Act, therefore, made a clear departure from the definition of ‘holding company’ as contained in the Act. In this view of the matter, there was no justification for invoking clause (c) of sub-section (1) of section 4 while interpreting the provisions of clauses (iv) and (v) of section 47, which laid down two specific conditions for applicability of the said clauses, and which were quite different from the criteria laid down in sub-section (1) of section 4 of the Companies Act, 1956, for giving a more expanded definition of a ‘holding company’ to subject more companies to regulatory control under the Companies Act. On the other hand, the object underlying section 47 was to lay down exceptions to the legal provision (section 45) for taxing gains on transfer of capital assets. The general rule was to construe the exceptions strictly and not to give them a wider meaning.

In this view of the findings, the Gujarat High Court had no hesitation in expressing the view that the Tribunal was not justified in law in treating Ambernath Investments (P.) Ltd. as a subsidiary company of the assessee-company for the purposes of clause (iv) of section 47 of the Income-tax Act.

OBSERVATIONS

The relevant provisions of the Income-tax Act are sections 2(17), 2(18), 2(26), 2(47), 45 and 47. Sections 47(iv) and (v) read as: “47. Transactions not regarded as transfer. –Nothing contained in section 45 shall apply to the following transfers:-

(i) …

(ii) …

(iii) …

(iv) any transfer of a capital asset by a company to its subsidiary company, if-

a. the parent company or its nominees hold the whole of the share capital of the subsidiary company, and

b. the subsidiary company is an Indian company;

(v) any transfer of a capital asset by a subsidiary company to the holding company, if-

a. the whole of the share capital of the subsidiary capital is held by the holding company, and

b. the holding company is an Indian company:”

The relevant provision of the Companies Act, 1956 is section 4(1) which reads as;

“Meaning of ‘holding company’ and ‘subsidiary’:

“4(1). For the purposes of this Act, a company shall, subject to the provisions of sub-section (3), be deemed to be subsidiary of another if, but only if,-

a. that the other controls the composition of its Board of Directors; or

b. that other-

(i) ******

(ii) . . . holds more than half in nominal value of its equity share capital; or

c. the first-mentioned company is a subsidiary of any company which is that other’s subsidiary.”

The Illustration below sub-section (1) of section 4 reads as under:

“Company B is a subsidiary of company A, and company C is a subsidiary of company B. Company C is a subsidiary of company A, by virtue of clause (c) above. If company D is a subsidiary of company C, company D will be a subsidiary of company B and consequently also of company A, by virtue of clause (c) above, and so on.”

The terms “subsidiary company” and “holding company”, as noted earlier, are not defined in the Income Tax Act. These terms are, however, defined under section 4(1)(c) of the Companies Act 1956, now sections 2(46) and 2(87) of the Companies Act, 2013. On a bare reading of the definitions provided by the Companies Act, it is clear that 100 per cent subsidiary company of a 100 per cent subsidiary company of a holding company is also regarded as a subsidiary of the holding company. In other words, a step-down subsidiary is treated as a subsidiary of the holding company for the purposes of the Companies Act.

The Gujarat High Court, while examining the issue in the context of section 47 has held that the meaning of the term “subsidiary” for the purposes of section 47 of the Income Tax Act should be gathered from the ordinary understanding of the term and the provisions of the Companies Act should not be imported for assigning the meaning to a subsidiary under the Income Tax Act. In view of the Gujarat High Court, the meaning provided by the Companies Act should not be relied upon in interpreting the provisions of Income Tax Act.

A subsidiary company and a holding company are companies incorporated and registered under the Companies Act and derive their existence from the Companies Act. In the circumstances, it is natural and logical to rely on the meaning supplied by the Companies Act, especially where the term subsidiary company is not defined under the Income Tax Act. It is a settled position in law, to gather the meaning of an undefined term used in the Income Tax Act from any other enactment where such term is defined, more so where the definition is under an enactment under which the entity is born, and is the principal enactment that governs and regulates such an entity. In modern days, it is usual for the legislature, while enacting a new law, to specifically clarify the situation, by providing for a clear right to refer to another enactment for gathering the meaning of an undefined term. The rule of harmonious construction also supports an interpretation that avoids absurdity of limiting the understanding of the term subsidiary company to the Income Tax Act alone. It would create an absurdity where a step-down subsidiary is treated as a subsidiary under the parent enactment governing the companies but is not treated so under the Income Tax Act. The provisions of the General Clauses Act also support such a view. In fact, the legislature was aware that the terms under consideration are not defined under the Income Tax Act and therefore intended that the meaning of such terms would be gathered from the Companies Act that regulates the functioning of such companies.

The Supreme Court in the case of Paresh Chandra Chatterjee vs. State of Assam, AIR 1962, SC 167 confirmed this Rule of Interpretation in the following words;

“Sections 23, 24 and 25 [of the Land Acquisition Act, 1894], lay down the principles for ascertaining the amount of compensation payable to a person whose land has been acquired. We do not see any difficulty in applying those principles for paying compensation in the matter of requisition of land. While in the case of land acquired, the market value of the land is ascertained, in the case of requisition of land, the compensation to the owner for depriving him of his possession for a stated period will be ascertained. It may be that appropriate changes in the phraseology used in the said provisions may have to be made to apply the principles underlying those provisions.” (p. 171).”

It was further observed: “If instead of the word ‘acquisition’ the word ‘requisition’ is read and instead of the words ‘the market value of the land’ the words ‘the market value of the interest in the land’ of which the owner has been deprived are read, the two sub-sections of the section can, without any difficulty, be applied to the determination of compensation for requisition of a land. So too, the other sections can be applied”. (p. 171)

In the case of Howrah Trading Co. Limited vs. CIT 36 ITR 215, the Supreme Court held that in gathering the meaning of the word ‘shareholder’ not defined u/s 18(5) of the Indian Income Tax Act 1992, a complete reliance should be placed on the definition of the term ‘shareholder’ under the Indian Companies Act 1913. It held that “no valid reason existed why “shareholder” as used in section 18(5) of the Act should mean a person other than the one denoted by the same expression in the Indian Companies Act 1913.

Again, the same court in the case of CIT vs. Shantilal (P.) Ltd., 144 ITR 57 (SC) held that “there is no reason why the sense conveyed by the law relating to contract should not be imported into the definition “speculative transaction” under Income Tax Act.”

No particular benefit is sought to be provided by adopting this Rule of Interpretation, which, in any event, cuts either way, as has happened in some of the cases where the loss arising on transfer of capital asset to the subsidiary company was not allowed for set-off, in as much as the income, if any, on such a transfer would have been exempt from tax.

Recently, in the case of Emami Infrastructure Ltd vs. ITO, 91 taxmann.com 62 (Kolkata), the ITAT held that a transfer to a step-down subsidiary by a holding company was a case of a transfer not regarded as a transfer u/s 2(47) of the Act.

The better view, therefore, is that the meaning of the terms ‘subsidiary’ and ‘holding’ companies should be gathered from the Companies Act, as long as they are not defined under the Income Tax Act, more so where the meaning supplied is contextual.

BCAJ Admin

Taxability of Compensation for Reduction in Value of ESOPs

ISSUE FOR CONSIDERATION

Employee stock options (ESOPs) are granted to employees by the employer company or its parent company as an incentive. These ESOPs so granted can be exercised only after they vest in the employee over the vesting period, after which the employee can choose to exercise the vested ESOPs by applying for shares of the issuer company (employer or its parent) and making payment of the exercise price to the company. The shares are then allotted to the employee by the company.

Such ESOPs are taxable at the time of exercise of the ESOPs by virtue of clause (vi) of section 17(2) as a perquisite under the head ‘Salaries’. This provides that:

“(2) ‘perquisite’ includes the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee.

Explanation: For the purposes of this sub-clause –

(a) ‘specified security’ means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees stock option has been granted under any plan or scheme therefore, includes the securities offered under such plan or scheme;

(b) …..

(c) Shall be the fair market value of the specified security or sweat equity shares, as the case may be, on the date on which the option is exercised by the assessee as reduced by the amount actually paid by or recovered from, the assessee in respect of such security or shares;

(d) ………….

(e) ‘Option’ means a right but not an obligation granted to an employee to apply for the specified security or sweat equity shares at a predetermined price;”

At times, it may so happen that the value of the shares for which ESOPs are granted is diminished before the vesting period and the employer may compensate an employee for the diminution in the value of his options, pending the exercise of the options. In such a case, even after the receipt of such compensation, the options continue to exist and can be exercised by the employee.

In one such case, a company compensated employees of its subsidiary for the diminution in the value of their vested but unexercised stock options. On rejection of an application by the employee to the AO, for lower deduction of tax at source, the Delhi High Court held that such compensation was not taxable as a perquisite under the head ‘Salaries’; the Madras High Court in the case of another employee of the same company held that such compensation was taxable as a perquisite and was therefore taxable under the head ‘Salaries’ and tax was deductible by the employer at source at the time of payment of such compensation. It is this controversy, fuelled by the conflicting decisions of the courts, that is sought to be addressed here on the question whether the receipt for compensating the diminution in value is a perquisite and is taxable under the head ‘Salaries’ and is therefore liable to tax deduction at source under s. 192 of the Act by the employer.

The Assessing Officer (AO) in the case before the Madras High Court had in fact conceded that the compensation received was not a perquisite that was taxable under the head ‘Salaries’, but had nonetheless proceeded to hold that the receipt was an income taxable under the head ’Capital Gains’. This issue was not before the Delhi High Court at all, and, therefore, obviously not examined by the court, and as such there is no conflict between the courts on the issue of taxation under the head ‘Capital Gains’. The issue, however, was extensively examined by the Madras High Court to hold that the receipt could not have been taxed as capital gains, though finally it held that receipt was a perquisite taxable under the head ‘Salaries’ and was liable to deduction of tax at source under s. 192 of the Act. For the sake of being comprehensive in reproducing the facts, the contentions and the counter contentions on the issue of capital gains and the findings in law of the Madras High Court are also reproduced for the benefit of the readers.

SANJAY BAWEJA’S CASE

The issue first came up before the Delhi High Court in the case of Sanjay Baweja vs. DCIT 299 Taxman 313.

In this case, the assessee was an ex-employee of Flipkart Internet Pvt Ltd (FIPL), an Indian company, which was a step-down subsidiary of Flipkart Pvt Ltd, Singapore (FPS), a Singapore company. FPS gave stock options (ESOPs) to its employees and the employees of its subsidiaries. The assessee had been granted ESOPs from November 2014 to November 2016 during the period of his employment with FIPL. Some of the ESOPs had vested in the assessee before he left the employment of FIPL, and the unvested ESOPs had been cancelled on account of termination of his employment with FIPL. Out of the vested ESOPs, some had been repurchased by Walmart when it acquired FPS, subsequent to the cessation of employment of the assessee with FIPL.

FPS divested another wholly owned subsidiary, PhonePe. Due to such divestment and subsequent distribution to the shareholders of FPS on account of dividend, buy-back, etc., the value of the ESOPs of FPS fell. The Board of Directors of FPS decided that while there was no legal or contractual right under the ESOP plan to provide compensation for loss in current value or any potential losses on account of future accretion to the ESOP holders, at its own discretion, it decided to pay USD 43.67 as compensation for each ESOP, subject to applicable withholding taxes and other tax rules in respective countries of various ESOP holders.

The assessee was, therefore, entitled to certain compensation from FPS for the diminution in the value of his remaining vested ESOPs. The assessee filed an application under section 197, seeking a nil declaration certificate on the deduction of TDS by FPS from such compensation.

The AO rejected the application of the assessee for nil deduction certificate on the following grounds:

While the assessee had contended that the amount receivable by him did not constitute income under section 2(24), this section provided an inclusive definition of “income”, which was not exhaustive. Therefore, even a receipt not specifically mentioned therein could still be includible in the taxable income of the assessee.
While the general rule was that every amount received by an assessee was taxable unless specifically exempt under any provision, the assessee had failed to quote any express provision under which this receipt was exempt from tax.
The assessee had stated that FPS intended to withhold full tax on the payment. If the amount receivable by the assessee was not an income and not taxable, then the question arose as to why the payer intended to withhold tax on it. This implied that the payer was satisfied that the payment was subject to withholding tax.
Since the assessee stated that he would be reporting this income as exempt in his tax return, and the quantum was quite substantial, there was a high probability that the tax return would be selected for scrutiny assessment, and the assessee’s claim will not be accepted by the AO, which would result in creation of tax demand. Issue of a nil TDS certificate would hence be detrimental to the interest of revenue and recovery of taxes.
The use of the phrase “directly or indirectly” in section 17(2)(vi) implies that the amount receivable by the assessee in this case would be covered under the purview of “perquisite”.
The compensation was linked to the vested ESOPs. ESOPs resulted in a taxable perquisite on the allotment of shares, equivalent to the fair market value less the exercise price of the shares so allotted, which was taxable under the head “Salaries” in the hands of the employee or ex-employee, as the case may be. Consequently, the compensation receivable on these ESOPs, even though from a former employer, on account of diminution in value of the underlying shares, should also have the same characterisation and tax treatment, and was hence taxable under the head “Salaries”.

The Delhi High Court noted that ,undisputedly, the assessee had not exercised his vested right with respect to the ESOPs till date, which showed that the right of holding the shares had not been exercised. It analysed the provisions of section 17(2)(vi). The Delhi High Court observed that the determination of whether a particular receipt tantamounted to a capital receipt or a revenue receipt was dependent upon the factual scenario of the case. It noted the decisions of the Supreme Court in the case of CIT vs. Saurashtra Cement Ltd 325 ITR 422 and Shrimant Padmaraje R Kadambande vs. CIT 195 ITR 877 in this regard. The Delhi High Court also took note of the decision of the Supreme Court in the case of Godrej & Co vs. CIT 37 ITR 381, where a one-time payment was given to the assessee in view of the change in contractual terms between the assessee and the management company. In that case, the Supreme Court held that the amount was received as compensation for the deterioration or injury to the managing agency by reason of the release of its rights to get higher termination, and was, therefore, a capital receipt.

As regards the AO’s argument that the amount was liable to be taxed since FPS intended to deduct TDS, the Delhi High Court observed that the manner or nature of payment, as comprehended by the deductor, would not determine the taxability of such transaction. It was the quality of payment that would determine its character and not the mode of payment. According to the Delhi High Court, unless the charging section of the Act elucidated any monetary receipt as chargeable to tax, the revenue could not proceed to charge such receipt as revenue receipt. The Delhi High Court referred to the Supreme Court decision in the case of Empire Jute Co Ltd vs. CIT 124 ITR 1 for the proposition that the perception of the payer would not determine the character of the payment in the hands of the recipient.

Referring to the provisions of section 17(2)(vi), the Delhi High Court noted that the most crucial ingredient of this provision was – determinable value of any specified security received by the employee by way of transfer / allotment, directly or indirectly, by the employer. As per explanation (c) to this provision, the value of the specified security could only be calculated once the option was exercised. In a literal reading of the provision, the value of specified securities or sweat equity shares was dependent upon the exercise of option. Therefore, for an income to be included as perquisite, it was essential that it was generated from the exercise of options by the employee.

On the facts of the case before it, the High Court noted that the assessee had not exercised options under the ESOP scheme till date but the options were merely held by the assessee. The Delhi High Court was, therefore, of the view that the options did not, therefore, constitute income chargeable to tax in the hands of the assessee, as none of the contingencies specified in section 17(2)(vi) had occurred.

Besides, the Delhi High Court noted that the compensation was a voluntary payment and not a transfer by way of any obligation. It was important that the management proceeded by noting that there was no legal or contractual right under the ESOP scheme to provide compensation for loss in current value or any potential losses on account of future accretion to the ESOP holders. FPS, on its own discretion, had estimated and decided to pay USD 43.67 as compensation for each stock option held on the record date.

According to the Delhi High Court, it was elementary to highlight that the payment in question was not linked to the employment or business of the assessee but was a one-time voluntary payment to all the option holders of ESOP, pursuant to the divestment of PhonePe business from FPS. In the case before it, even though the right to exercise the option was available to the assessee, the amount received by him did not arise out of any transfer of stock options. It was a one-time voluntary payment not arising out of any statutory or contractual obligation.

Therefore, the Delhi High Court held that treatment of the amount of compensation as a perquisite under section 17(2)(vi) could not be countenanced in law, as the stock options were not exercised by the assessee, and the amount in question was a one-time voluntary payment made by FPS to all the option holders in lieu of disinvestment of PhonePe business.

NISHITHKUMAR MUKESHKUMAR MEHTA’S CASE

The issue again came up before a single judge of the Madras High Court in the case of Nishithkumar Mukeshkumar Mehta vs. Dy CIT 165 taxmann.com 386.

In this case, the assessee was an employee of FIPL to whom stock options had been granted by FPS. Compensation was announced by FPS at USD 43.67 per ESOP on divestment of PhonePe business as described above, with former employees to receive the compensation only on vested ESOPs which were not exercised, while existing employees would receive the compensation on all unexercised outstanding ESOPs, whether vested or unvested. Such compensation was proposed to be treated as a perquisite taxable under the head ‘salaries’ by FIPL, with deduction of tax at source under section 192 on that basis. The assessee applied for a nil tax deduction certificate under section 197.

The assessee’s application was rejected by the AO on the basis of the following:

While the compensation to be received was not chargeable under the head ‘Salaries’, the contention that it was not taxable as capital gains was found to be an illogical contention;
The value of compensation to be received represented the surrender value of PhonePe shares held by the assessee while holding the FPS ESOPs. Therefore, the claim that no asset was transferred was found to lack credence;
The surrender or relinquishment of right to sue and litigate was the asset transferred so as to earn this compensation and therefore, the transaction squarely fell under the provisions of section 45.

Therefore, the AO was of the view that there was a capital gain arising out of the transfer of a capital asset, which was taxable under section 45,and therefore, rejected the application u/s 197. Against this rejection of application under section 197, the assessee filed a writ petition to the Madras High Court.

On behalf of the assessee (incidentally represented by the same counsel who had appeared before the Delhi High Court in Sanjay Baweja’s case), before the Madras High Court, it was pointed out that the ESOPs were rights in relation to shares of FPS which had issued such ESOPs. They were, therefore, capital assets. Since the assessee continued to hold the same number of ESOPs before and after receipt of the compensation, there was no transfer of capital assets, and in the absence of transfer of capital assets, capital gains tax could not be levied. Compensation paid to the assessee was a capital receipt, and such capital receipt was taxable as capital gains only if gains accrued from the transfer of capital assets. Since capital assets were not transferred by the assessee, capital gains tax could not be imposed.

It was further argued on behalf of the assessee that it was never held that the asset transferred by the assessee was the relinquishment of the right to sue or litigate. The assessee had no right to receive compensation for the divestment of the PhonePe business by FPS. In the absence of a right to receive compensation, the payment was a discretionary one-time payment by FPS. Even if such compensation had not been paid, the terms of the ESOP scheme did not confer any rights on the assessee, including the right to sue. Further, a right to sue was not transferable as per section 7 of the Transfer of Property Act, 1882. Therefore, the conclusion that the transaction fell within the scope of section 45 was untenable.

It was argued that since the receipt by the assessee was a capital receipt, the Income Tax Act did not provide for TDS thereon. While the Income Tax Act provides for machinery for the computation of capital gains, being the difference between the acquisition price and resale price, there was no machinery provision with regards to taxation of receipts such as compensation in relation to ESOPs. It was submitted that the order of rejection called for interference not only because the conclusion that there was a relinquishment of the right to sue was erroneous, but also because the order did not identify the provision of the Income Tax Act under which the assessee was liable to pay tax or under which tax was liable to be deducted at source.

Reliance was placed upon various judgments of the Supreme Court and High Courts to support the propositions that the compensation was in the nature of a capital receipt, that capital receipts which are not chargeable under section 45 cannot be taxed under any other head, that capital gains tax cannot be imposed in the absence of a computation mechanism, that a mere right to sue cannot be transferred and that tax cannot be deducted at source if the payment does not constitute income.

On behalf of the revenue, it was submitted that ESOPs are capital assets, and that the ESOPs had a higher value while FPS held an interest in PhonePe. Since the value of ESOPs held by the assessee declined on divestment of the PhonePe business by FPS, the assessee had a right to sue for diminution of value. Since the compensation was paid as consideration for relinquishment of the right to sue, such relinquishment qualified as the transfer of a capital asset.

Reliance was placed upon the decision of the Madras High Court in K R Srinath vs. ACIT,268 ITR 436, where the court held that the compensation received for relinquishment of a right to sue for specific performance of a contract relating to the purchase of immovable property was a capital receipt, which was liable to capital gains tax. It was, therefore, argued that the amount of compensation received by the assessee was a capital gain which was taxable, because it accrued from the transfer / relinquishment of the right to sue for compensation for diminution in the value of the ESOPs.

On behalf of the assessee, in rejoinder, it was pointed out that in contrast to the facts of the case in K R Srinath (supra), the ESOP scheme did not confer a contractual right on the assessee to sue for specific performance.

The Madras High Court analysed the provisions of the ESOP scheme and the facts pertaining to the compensation. It then went on to analyse whether the ESOPs were capital assets. It noted that while shares were indisputably capital assets because they qualified as movable goods under the Sale of Goods Act, 1930, and the Companies Act, 2013, ESOPs were rights in relation to capital assets, i.e., right to receive capital assets subject to the terms and conditions of the ESOP scheme. Analysing the definition of capital assets, it noted that explanation 1 to section 2(14), which clarifies that property includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever, was not attracted, since the assessee had no rights in the Indian company of which he was an employee.

It, thereafter, went on to analyse the judgments relied upon by the assessee for the proposition that compensation was a capital receipt which was not taxable because it did not accrue from the transfer of a capital asset.

In Kettlewell Bullen & Co Ltd vs. CIT 53 ITR 261 (SC) and Karam Chand Thapar & Bros Pvt Ltd vs. CIT 4 SCC 124, the compensation received for relinquishment of the managing agency was construed as a capital receipt because it was intended to compensate for the impairment of the source of revenue or profit-making apparatus.
In Vodafone India Services (P) Ltd vs. UOI 368 ITR 1 (Bom), receipt arising out of a capital account transaction was held to be not taxable as income in the absence of an express legislative mandate.
In Oberoi Hotel (P) Ltd vs. CIT 236 ITR 903 (SC), compensation received for relinquishment of rights of management of a hotel for a management fee calculated on the gross operating profits and right of first offer in the event of transfer / lease, was held to be for injury inflicted on the capital asset of the assessee, resulting in the loss of the source of the assessee’s income, and was, therefore, construed as a capital receipt.
On a similar basis, compensation for variation of the terms of the managing agency was held to be a capital receipt by the Supreme Court in Godrej & Co’s case (supra).
In Senairam Doongarmall vs. CIT 42 ITR 392 (SC), compensation received for acquisition of factory buildings adjoining a tea garden with consequential cessation of the production was held to be a capital receipt, while in CIT vs. Saurashtra Cement Ltd 325 ITR 422 (SC), liquidated damages received for failure to supply an additional cement plant was construed as a capital receipt.

According to the Madras High Court, the common thread running through all these cases was that the compensation was paid either for the loss of the profit-making apparatus or, at a minimum, for the sterilisation thereof. Hence, such compensation was held to be a capital receipt.

The Madras High Court observed that, at first blush, the ratio of these cases seems to apply to the case at hand because compensation was paid for the diminution in value of ESOPs and potential losses on account of future accretion to ESOP holders due to the divestment of the PhonePe business. It, however, noted the following significant differences on a closer examination. It noted that the ESOPs were contractual rights, and that the scheme included conditions regarding vesting, cancellation and transfer. In case of breach of the obligation by the insurer to allot shares upon exercise of the option in terms of the ESOP scheme, the assessee would have the right to claim compensation or sue for specific performance. Therefore, the ESOPs were contractual rights that may qualify as actionable claims (though not as defined in The Transfer of Property Act) or choses in action in certain circumstances.

Unlike in the case of managing agency or tea factory in the cited cases, ESOPs were not a source of revenue or profit-making apparatus for the holder because these actionable claims were intrinsically not capable of generating revenue (notional or actual) and could not be monetised, whether by transfer or otherwise, until shares were allotted. Even at the time of allotment,
there was a notional but not an actual benefit. Actual benefit accrued only upon transfer, provided there was a capital gain.

According to the Madras High Court, in all the cited cases, the compensation was received in relation to relinquishment of rights in revenue generating and subsisting capital assets, while in the case of ESOPs, the capital assets came into existence only upon allotment of shares, and revenue generation from the capital assets was possible only thereafter. Therefore, the compensation was not for the loss of or even sterilisation of a profit-making apparatus but by way of a discretionary payment towards potential (as regards unvested options) or actual (as regards vested options) diminution in value of contractual rights. This was supported by the FPS communication that referred to the compensation as being paid without legal or contractual obligation towards loss in value of ESOPs (and not shares).

The Madras High Court noted that the ESOP scheme did not contain any representation or warranty to ESOP holders that no action would be taken that could impair the value of the ESOPs, and therefore, there was no contractual right to compensation. It could, therefore, not be said that a non-existent right was relinquished.

The Madras High Court, therefore, concluded that ESOPs did not fall within the ambit of the expression “property of any kind held by an assessee” in section 2(14) and were consequently not capital assets. Therefore, the receipt was not a capital receipt.

Since the order of rejection by the AO concluded that a capital asset was transferred, the Court then went on to analyse the tenability of that conclusion. Since the ESOPs were not exercised, shares of FPS were not issued or allotted to the assessee, and therefore the assessee neither received nor transferred a capital asset. Since the ESOP scheme did not confer a right to receive compensation for impairment in the value of ESOPs, both the conclusion in the order of rejection the contention on behalf of the revenue, that compensation was paid towards relinquishment of the right to sue, by placing reliance on the decision in the case of K R Srinath, was untenable.

Given this conclusion, the matter could have been remanded by the Court to the AO. However, the counsel for the assessee confirmed to the Court that the relief claimed included a direction for issuance of a nil certificate, and therefore, it was not sufficient to remand the matter for reconsideration. The Madras High Court, therefore, went on to consider the manner in which the Income Tax Act dealt with receipts in relation to the holding of ESOPs. It noted that the definition of “salary” was inclusive and included perquisites, while the definition of “perquisite” was also inclusive and covered the value of a specified security. It analysed that the ESOPs granted to the assessee as an employee of a step-down subsidiary qualified as ESOPs under the Companies Act, 2013, and therefore, fell within the scope of explanation (a) to clause (vi) of section 17(2). It is in this light that the specific issue of whether the compensation paid to the assessee qualified as a perquisite had to be considered.

The Madras High Court noted the decision of the Delhi High Court in Sanjay Baweja’s case (supra), where the Delhi High Court had concluded that the one-time voluntary payment was a capital receipt, which was not liable to tax as a perquisite.

Analysing clause (vi) of section 17(2), the Madras High Court observed that since clause (vi) was illustrative of perquisite, it was not intended to tax the capital gains that may accrue if such specified security were to be sold by the allottee after capital appreciation. Instead, as the plain language indicated, clause (vi) took within its fold and treated as a perquisite the benefit extended to the employee or any other person from out of the grant of specified securities at concessional rates or free of cost. In the specific context of ESOPs, explanation (a) to clause (vi) explains the scope of “specified security” by using expression “includes the securities offered under such plan or scheme”, and not the phrase “includes the securities allotted under such plan or scheme”. Given that the assessee had not exercised the option in respect of the ESOPs held by him, shares of FPS were not issued or allotted to him. According to the court, the inference that followed was that “specified security” in the context of ESOPs was not confined to allotted shares but included securities offered to the holder of ESOPs. The use of “includes” instead of “means” also indicated that the phrase “securities offered under such plan or scheme” was not intended to be exhaustive.

The Madras High Court was of the view that the expression “value of any specified security… transferred directly or indirectly by the employer… free of cost or at concessional rate to the assessee” in clause (vi) was wide enough to encompass the discretionary compensation paid to ESOP holders to compensate for the potential or actual diminution in value thereof. Consequently, especially in view of the inclusive definition of perquisite, merely because the method of valuing the perquisite did not fit neatly into explanation (c) to clause (vi) of section 17(2), did not mean that it could not be taxed as a perquisite, provided the value of the perquisite could be determined. According to the High Court, to determine the value of the perquisite, the benefit that the employee or other person received from the specified security, though not by way of capital gains, should be determinable.

Addressing the issue of ascertainment of the benefit, the Madras High Court observed that ordinarily, the benefit would be the difference between the fair market value of the share and the price at which such share is offered to the ESOP holder. Since such monetary benefit would typically be realised, though notionally, only at the time of exercise of the option and remains a non-monetisable contractual right until then, the fair market price of the shares on the date of exercise of the option is reckoned and the price paid by the option holder is deducted therefrom to determine the value of the perquisite in the form of ESOP. Therefore, explanation (c) to clause (vi) prescribes that the value of the specified security is the difference between the fair market value of the shares on the date of exercise of the option and the price paid by the option holder. In the case before the court, the assessee received a substantial monetary benefit at the pre-exercise stage by way of discretionary compensation for diminution in the value of the stock options.

The Madras High Court referred to the decision of the Supreme Court in the case of CIT vs. Infosys Technologies Ltd 297 ITR 167, where the Supreme Court considered the question whether the issuer company was liable to deduct TDS under section 192 in respect of shares allotted under an ESOP scheme and subject to a lock-in for a period of five years. The relevant assessment year was 1999–2000, when clause (vi) was not applicable. After holding that the insertion of clause (vi) with effect from assessment year 2000–01 did not apply retrospectively, the Supreme Court held that the notional benefit that accrued from shares that were subject to a lock-in could not be treated as a perquisite because there was no cash inflow to the employees till the end of the lock-in period. The Madras High Court observed that while the principle that notional benefit cannot be taxed as a perquisite was formulated in a specific statutory context which no longer existed, the broader principle laid down therein to the effect that the benefit from the ESOP was to be determined for purposes of and as a prerequisite for taxation as a perquisite continued to apply.

The Madras High Court noted that in the case before it, actual monetary benefit was received at the pre-exercise stage by the assessee and other stakeholders. Such monetary benefit was paid to the assessee on account of being an ESOP holder, and ESOPs were granted to the assessee as an employee under the ESOP scheme. If payments had been made by the assessee in relation to the ESOPs, it would have been necessary to deduct the amount of such payment to arrive at the value of the perquisite. Since the assessee did not make any payments towards the ESOPs and continued to retain all the ESOPs even after the receipt of compensation, the Madras High Court was of the view that the entire receipt qualified as a perquisite liable to be taxed under the head “Salaries”.

Therefore, according to the Madras High Court, it was not necessary to consider whether it fell under any other head of income. Due to the conclusion that the compensation qualified as a perquisite and not as a capital receipt, as per the Madras High Court, the judgments cited in respect of capital gains, including those relating to the absence of the rate or computation mechanism or provision for TDS, lost relevance. For these reasons, the Madras High Court expressed its inability to endorse the view taken by the Delhi High Court in the case of Sanjay Baweja (supra).

OBSERVATIONS

The crucial aspect in this controversy is whether the compensation received for diminution in value of ESOPs is a perquisite under the head ‘Salaries’ and if yes, whether the payer was liable to deduct tax at source. The incidental issue is whether the receipt is a capital receipt and the right granted of ESOPs is a capital asset or not. The Madras High Court addressed the issue of capital gains to hold that the employee in question was not holding a capital asset that was transferred resulting into capital gains but proceeded further to hold that the receipt in question was a perquisite liable to taxation under the head ‘Salaries’ and the employer was required to deduct tax at source.

An important point that is required to be noted, at the outset, is that in the case before the Madras High court, the AO had conceded and held that the compensation was not a perquisite under the head ‘Salaries’. In view of the definitive conclusion of the AO on the issue of perquisite, there was no dispute before the High Court on this aspect of taxation under the head ‘Salaries’. It is, therefore, intriguing that the Madras High court proceeded to hold, though it was not asked to do so, that the receipt of compensation was a perquisite that was taxable under the head ‘Salaries’ and was liable to deduction of tax at source under s. 192 of the Act. Could it have done so in the writ jurisdiction, where the issue before the court was perhaps whether the AO was right in holding that the compensation received was a capital gain and was subjected to the deduction of tax at source, when there is no provision for such deduction in respect of the payment of capital gains?

The logic of the Madras High Court was that ESOPs were merely rights to receive capital assets (shares) and not capital assets themselves. In doing so, the definition of “specified security”, which referred to securities as defined in section 2(h) of the securities Contracts (Regulation) Act, 1956, was not considered in depth by the High Court.

Section 2(h) of the Securities Contracts (Regulation) Act, 1956 (SCRA) reads as under:

“securities” include—

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature
in or of any incorporated company or other body
corporate;

(ia) derivative;

(ib) units or any other instrument issued by any collective investment scheme to the investors in such schemes;

(ic) security receipt ………….;

(ii) Government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities.

Therefore, derivative or rights or interest in securities are also securities. Further, “derivative” is defined in section 2(ac) of SCRA as under:

“derivative” includes —

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

Further, section 2(d) of SCRA defines “option” as under:

“option in securities” means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities.

An option is definitely a derivative, if not a right or interest in a security, and is, therefore, a security by itself. That being so, it would certainly be a capital asset. Therefore, the very basis of the distinction drawn by the Madras High Court in rejecting the decisions cited on behalf of the assessee, and in holding that such a right is merely a chose in action or only a right to receive a capital asset, does not seem to be justified. The fact that an ESOP is a capital asset is also supported by the well-settled view taken by the Bombay High Court in the case of CIT vs. Tata Services Ltd 122 ITR 594 and the Madras High Court in the case of K R Srinath (supra), where the High Courts had held that the right to acquire an immovable property or the right to specific performance under an agreement to purchase an immovable property was also a capital asset, the transfer or extinguishment of which was subject to capital gains tax. Besides, the Karnataka High Court in the case of Chittranjan A. Dassanacharya, 429 ITR 570 and the Bangalore bench of the Tribunal in the case of N.R. Ravikrishnan, 155 ITD 355 have held that the right to acquire shares under ESOP was a capital asset and the holding period commenced with the date of grant.

The other angle in the logic of the Madras High Court was that the ESOP scheme did not contain any representation or warranty to ESOP holders that no action would be taken that could impair the value of the ESOPs, and therefore, there was no contractual right to compensation, and therefore, it could not be regarded as a transfer of any rights. On the facts of the case, it was clear that the payment was a voluntary one, and that the assessee was not entitled to any such compensation. The assessee also did not have any right to make such a claim for any compensation under the ESOP scheme. In fact, the assessee’s claim was that since there was no transfer, the amount received could not be taxed as capital gains.

The third basis of the Madras High Court decision was that section 17(2)(vi) was an inclusive definition and, therefore, applied to the compensation received. In this connection, the Madras High Court failed to take note of certain findings of the Supreme Court in the case considered by it of Infosys Technologies (supra):

Unless a benefit /receipt is made taxable, it cannot be regarded as ‘income’. This is an important principle of taxation under the Act.
…..
Be that as it may, proceeding on the basis that there was ‘benefit’, the question is whether every benefit received by the person is taxable as income? It is not so. Unless the benefit is made taxable, it cannot be regarded as income. During the relevant assessment years, there was no provision in law which made such benefit taxable as income. Further, as stated, the benefit was prospective. Unless a benefit is in the nature of income or specifically included by the Legislature as part of income, the same is not taxable.

As per the Supreme Court, unless an item is specifically included in the definition of “perquisite”, it would not be taxable as a perquisite. This is directly contrary to the view taken by the Madras High Court that even if the compensation did not fall strictly within the definition of perquisite, it would still be taxable as a perquisite since the definition was an inclusive one. Clause (vi) clearly provides for both the date of taxation as well as the computation mechanism — if neither applies, the compensation received would not be taxable as a perquisite.

On the other hand, the various decisions cited on behalf of the assessee before the Madras High Court clearly point out that if a receipt is relatable to a capital asset, it is a capital receipt. Such capital receipt is chargeable to tax as capital gains only if there is transfer of a capital asset. If there is no transfer of a capital asset in connection with which the amount is received, in the absence of a specific charging provision, it is not subject to tax at all. In this case, there was no transfer of a capital asset at all by the assessee.

Therefore, the view taken by the Delhi High Court in Sanjay Baweja’s case that such compensation was not a perquisite, not liable to be taxed under the head ‘Salaries’, and not subject to tax deduction at source, seems to be the better view of the matter.

BCAJ Admin

Whether the Order Passed Under Section 139(9) Invalidating the Return Is Appealable?

ISSUE FOR CONSIDERATION

Quite often the income tax returns filed by the taxpayers are considered to be defective and the defect notices are being sent by the Centralised Processing Centre. If the defects pointed out have not been resolved, then such a defective return filed is considered to be an invalid return, by virtue of the provisions of section 139(9). Under such circumstances, it is considered that the assessee has not filed his return of income at all for the relevant year. As a result, the assessee does not get the benefits like getting the refund of excess tax paid or carry forward of unabsorbed losses etc. which he was entitled to get otherwise had the return been considered to be a valid return.

Section 246A provides for the dispute resolution mechanism whereby, if the assessee is aggrieved by the order passed by the income-tax authorities, then he can challenge that order by filing an appeal against it before the Commissioner (Appeals). However, the list of orders against which the appeal can be so filed are listed in sub- section (1) of section 246A. Therefore, the appeal can be filed before the Commissioner (Appeals) against a particular order, only if that order is included in the list of orders which are appealable under section 246A.

The order passed under section 139(9), considering the return of income as invalid return due to non-removal of the defects, is not specifically included in the list of orders which are appealable under section 246A. Therefore, the issue arises as to whether the assessee can file the appeal before the Commissioner (Appeals) against such an order considering the return as a defective return or not. The Pune bench of the tribunal had earlier taken a view that such an order is appealable and the assessee can file the appeal challenging it before the CIT (A). However, in a later case, the Pune bench took a contrary view disagreeing with its earlier decision and held that no appeal can be filed before the CIT (A) against such an order.

DEERE & COMPANY’S CASE

The issue had come up for consideration of the Pune bench of the tribunal in the case of Deere & Company vs. DCIT [2022] 138 taxmann.com 46.

In this case, the assessee was a foreign company and it had filed its return of income for assessment year 2016- 17 declaring the income of ₹474.37 crore and claiming a refund of ₹1.34 crore. The return was processed by the Centralized Processing Centre (CPC), Bengaluru, and a notice dated 15-11-2017 was issued under Explanation (a) to section 139(9) highlighting the difference between the income shown in the return at ₹474.37 crore and as shown in Form No. 26AS at ₹478.62 crore. The assessee responded to the same on 4th December, 2017 through e-portal elaborating the reasons for the difference in the two amounts by maintaining that correct income was reported in the return of income. It was explained that the difference was arising mainly due to two reasons as mentioned below –

1. The assessee had computed its income accruing in India as per Rule 115 whereby invoices raised in foreign currency were converted into Indian Rupees on the basis of SBI TT Buying Rate of such currency prevailing on the date of credit to the account of the payee or payment, whichever is earlier. As against this, the parties on the other hand have deducted tax at source by converting the foreign currency amount into Indian Rupees adopting some other exchange rates.

2. There were certain reimbursements and reversals on which tax had been deducted but they were not in the nature of income of the assessee company.

The DCIT (CPC), Bengaluru rejected the assessee’s contention and declared the return to be invalid by means of the order u/s 139(9) of the Act. The assessee filed an appeal against that order before the CIT(A) which came to be dismissed at the threshold on the ground that the order u/s 139(9) was not appealable under section 246A.

The assessee filed the further appeal before the tribunal against the said order of the CIT (A).

Firstly, the tribunal held that the DCIT (CPC), Bengaluru could not have acted u/s 139(9) in an attempt to correct the mismatch and in the process declared the return as invalid, thereby depriving the assessee from refund claimed in the return of income. The tribunal observed that the AO had activated clause (a) of an Explanation to section 139(9), which stated that: “the annexures, statements and columns in the return of income relating to computation of income chargeable under each head of income, computation of gross total income and total income have been duly filled in”. On this basis, it was held that if all the annexures, statements and columns etc. of the return have been duly filled in, there could be no defect as per clause (a). The defect referred to in clause
(a) was of only non-filling of the requisite columns of the return of income. If the relevant columns in the return of income were duly filled in but were not tallying with the figures reported in Form 26AS due to a valid difference of opinion then it was not covered by clause (a). Further, the tribunal also observed that the Finance Act, 2016 inserted sub-clause (vi) in section 143(1) providing that that if certain amount of income appearing in Form 26AS etc. is not fully or partly included in the total income returned by the assessee, then the AO will process the return u/s 143(1) and make adjustment by way of addition to the total income so computed by the assessee. Therefore, if the intention of the Legislature had been to treat the mismatch of income between Form 26AS and as shown in the return of income rendering the return defective, then there was no need to incorporate clause (vi) of section 143(1)(a) of the Act requiring the AO to carry out the adjustment during the processing of return of income on this score.

With respect to the effect of the return being considered as invalid under section 139(9), the tribunal observed that there were two possibilities. The first possibility was that the assessee could have again filed a fresh return. However, the AO, sticking to his earlier stand, would have held such return also as invalid on the same premise, throwing the proceedings in a vicious circle resulting in an impasse. The second possibility was that the AO, having knowledge of the assessee having taxable income, could have issued a notice u/s 142(1)(i) requiring the assessee to file a return of income. This would have resulted in the assessee filing its return and then the AO determining correct total income of the assessee as per law after making assessment u/s 143(3) of the Act. However, in the instant case, the AO did not issue any notice u/s 142(1) (i) and pushed the proceedings to a dead end, leaving the assessee without any apparent legal recourse. It was under such circumstances, left with no option, the assessee preferred an appeal before the ld. CIT(A) against the order u/s 139(9) of the Act, which has been dismissed as not maintainable on the ground that an order u/s 139(9) is not covered by the list of appealable orders given in section 246A.

In view of these facts, the tribunal held that the assessee could not have been left remediless. Every piece of legislation is ultimately aimed at the well-being of the society at large. No technicality could be allowed to operate as a speed breaker in the course of dispensation of justice. In the context of taxes, if a particular relief was legitimately due to an assessee, the authorities would not circumscribe it by creating such circumstances leading to its denial.

The tribunal held that the first look at different clauses of section 246A(1) transpired that an order u/s 139(9) was ex-facie not covered therein. However, there were two clauses of section 246A(1), namely, (a) and (i), which in the opinion of the tribunal could provide succor to the assessee. The clause (a) of section 246A provided for filing an appeal before CIT(A), inter alia, against “an order against the assessee where the assessee denies his liability to be assessed under this Act”. The word ‘order’ in the expression ‘an order against the assessee where the assessee denies his liability’ was not preceded or succeeded by the word ‘assessment’. Thus any order passed under the Act against the assessee, impliedly including an order u/s 139(9) as in the present case, having the effect of creating liability under the Act which he denies or jeopardizing refund, got covered within the ambit of clause (a) of section 246A(1).

Further, Clause (i) of section 246A(1) dealt with the filing of an appeal before the CIT(A) against an order u/s 237. Section 237 provided that ‘If any person satisfies the Assessing Officer that the amount of tax paid by him or on his behalf or treated as paid by him or on his behalf for any assessment year exceeds the amount with which he is properly chargeable under this Act for that year, he shall be entitled to a refund of the excess.’ Technically speaking, the AO has not passed an order u/s 237 but only u/s 139(9) of the Act. Firstly, the AO could not have treated the return as invalid u/s 139(9) because of mismatch between the figure of income shown in the return and that in Form 26AS and secondly, if at all he did so on a wrong footing, he ought to have issued notice u/s 142(1)(i) of the Act for enabling the assessee to file its return so that a regular assessment could take place determining the correct amount of income and the consequential tax/refund. Here was a case in which the assessee has been deprived by the DCIT (CPC), Bengaluru of any legal recourse to claim the refund. Considering the intent of section 237 in mind and the unusual circumstances of the case, the tribunal held that the order passed by the AO was also akin to an order refusing refund u/s 237 making it appealable u/s 246A(1)(i).

On this basis, the tribunal held that the appeal against the order passed under section 139(9) was maintainable before the CIT (A).

The Mumbai bench of the tribunal has followed this decision of the Pune bench in the case of V.K. Patel Securities Pvt. Ltd. v. ADIT (ITA No. 1009/Mum/2023).

AMRUT RAJENDRAKUMAR BORA’S CASE

The issue, thereafter, came up for consideration before the Pune bench of the tribunal again in the case of Amrut Rajendrakumar Bora [ITA No. 563/Pun/2023 – Order dated 4-8-2023].

In this case, the return of income filed by the assessee for assessment year 2018-19 was treated as invalid under section 139(9) on account non-removal of the defects which were pointed out to the assessee. The appeal filed by the assessee before the CIT (A) against the said order was dismissed on the same ground that it was not an appealable order as per the provisions of section 246A. Before the tribunal, the assessee primarily relied upon the decision in the case of Deere & Co. (supra). As against that, the revenue placed strong reliance on section 246A and contended that it did not contain any specific clause regarding the maintainability of appeal against an order passed under section 139(9) of the Act.

The tribunal held that section 246A was a self-exhaustive provision providing remedy of an appeal against the orders passed by lower authorities in various clauses from (a) to (r) followed by Explanation(s) and statutory proviso(s); as the case may be. The order passed under section 139(9) is not covered specifically under any of the clauses. The tribunal held that a stricter interpretation in such an instance has to be adopted in light of Hon’ble Apex Court’s landmark decision in Commissioner of Customs (Imports), Mumbai vs. M/s. Dilip Kumar And Co. & Ors. [2018] 9 SCC 1 (SC) (FB).

As far as clause (i) was concerned, the tribunal held that it could come into play only when the concerned taxpayer was denying his liability to be assessed under the Act which was not the case as the point involved was limited to the validity of the return of income filed by the assessee. The tribunal further held that section 246A envisaged an appellate remedy before the CIT(A) not based on various consequences faced by an assessee or by way of necessary implications but as per various orders passed by the field authorities under the specified statutory provisions only.

The decision of the co-ordinate bench in the case of Deere & Co. (supra) was held to be per inquirium for not adopting the stricter interpretation as was required. Accordingly, the tribunal upheld the order of the CIT (A) dismissing the appeal of the assessee as not maintainable.

OBSERVATIONS

It is a well-settled principle that the right to make an appeal is not an inherent right, but a statutory right. Therefore, an appeal can be filed against a particular order only if such order is made appealable under the Act. Hence, an appeal cannot be filed before CIT(A) against any order which is not included in the above list. The Supreme Court in the case of Gujarat Agro Industries Co Ltd. vs. Municipal Corporation of City of Ahmedabad (1999) 45 CC 468 (SC) has held that the right of appeal is the creature of a statute. Without a statutory provision creating such a right, the person aggrieved is not entitled to file an appeal. Similarly, in the case of National Insurance Co. Ltd. v. Nicolletta Rohtagi (2002) 7 SCC 456, the Supreme Court has held that the right of appeal is not an inherent right or common law right, but it is a statutory right. The appeal can be filed only if the law so provides.

In light of these principles, one needs to examine the provisions of section 246A for the purpose of determining whether the appeal can be filed against the order passed under section 139(9) considering the return as a defective return. The relevant provision of section 139(9) read as under –

“Where the Assessing Officer considers that the return of income furnished by the assessee is defective, he may intimate the defect to the assessee and give him an opportunity to rectify the defect within a period of fifteen days from the date of such intimation or within such further period which, on an application made in this behalf, the Assessing Officer may, in his discretion, allow; and if the defect is not rectified within the said period of fifteen days or, as the case may be, the further period so allowed, then, notwithstanding anything contained in any other provision of this Act, the return shall be treated as an invalid return and the provisions of this Act shall apply as if the assessee had failed to furnish the return”

As rightly noted by the tribunal in both the cases as discussed above, the order passed under section 139(9) is not included specifically in the list of orders which are made appealable under sub-section (1) of section 246A. On perusal of sub-section (1) of section 246A, it can be observed that it lists down several orders which have been passed under the specific provisions of the Act which does not include the order passed under section 139(9) of the Act. The only sub-clause which refers to the order in general without referring to any specific provision of the Act is sub-clause (a). It refers to the ‘order against the assessee where the assessee denies his liability to be assessed under this Act’. Therefore, one needs to examine as to whether the order passed under section 139(9) can be considered to be in the nature of an order against the assessee where the assessee denies his liability to be assessed under the Act.

When a person files his return of income taking a particular position, it results into a self-assessment of his liability under the Act. When such a return of income filed by the assessee is considered to be an invalid return of income for non-removal of defects as per the provisions of section 139(9), return of income becomes non-est in law i.e. as if it had never been filed. Consequentially, the self-assessment of the liability which had been declared through the return of income also becomes invalid. Thus, there is no assessment of the liability of the assessee under the Act till that point in time unless it is followed by the specific assessment being made in accordance with the relevant provisions of the Act, which may be either a regular assessment under section 144 or reassessment under section 147. Further, by passing an order under section 139(9), the Assessing Officer is not assessing the liability of the assessee under the Act. Therefore, strictly speaking, the order passed under section 139(9) does not result into assessment of the assessee’s liability in any manner which could have been denied by the assessee.

Alternatively, a view can be taken that the order passed invalidating the return also results in rejecting the self- assessment of the liability of the assessee as declared in the return of income. It might be possible that the assessee claims certain benefits while assessing his liability under the Act in the return of income which has been submitted. Such benefits can be in the nature of claim of loss, or claim of refund on account of excess tax paid in the form of advance tax or TDS. On account of the fact that the return is being considered as invalid return, the benefits so claimed also get rejected indirectly. Therefore, under such circumstance, it is possible to take a view that the liability of the assessee gets increased indirectly as a result of denial of the benefits, which had been claimed by the assessee through the return of income. Although such an increase in the liability of the assessee is not due to any order of assessment, there is an order passed under section 139(9) which is affecting the quantum of the liability of the assessee under the Act. If the claim of refund as made by the assessee in the return becomes invalid, then it results into overcharging of tax upon the assessee to that extent. Therefore, it may be considered as an order affecting the liability of the assessee as originally declared in the return of income and, hence, appealable under section 246A.

The question of applying strict interpretation as laid down by the Supreme Court in the case of Dilip Kumar & Co. (supra) does not arise here as we are not dealing with the exemption provision. The principles of strict interpretation were laid down by the Supreme Court in the context of the exemption provision as the exemption granted affects the exchequer which will then results in increase in tax liability of the other taxpayers. The provision of section like 246A providing for the remedy of filing an appeal against the order passed by the Assessing Officer is no way be compared with the case which was before the Supreme Court in which such a strict interpretation was required.

If a view is taken that the order passed under section 139(9) is not appealable under the provisions of section 139(9), then the only remedies available to the assessee would be to file the petition of revision under section 264 or to knock the doors of the high court by filing certiorari or mandamus writ against such orders. Therefore, a better view seems to be the one which was taken by the Pune bench of the tribunal in its earlier case of Deere & Co. However, the readers may explore the other alternatives as they would be left with no remedy if the appeal filed is not being entertained by following the contrary view.

The CBDT has been given the powers under sub- clause (r) of section 246A(1) to issue direction making any particular order passed by the Assessing Officer as appealable in the case of any person or class of persons having regard to the nature of the cases, the complexities involved and other relevant considerations.

This is a fit case where the CBDT should issue the necessary direction providing for the appeal against the order passed under section 139(9) treating the defective return of income as invalid return.

BCAJ Admin

Applicability of Section 50c to Rights in Land

ISSUE FOR CONSIDERATION

Section 50C of the Income Tax Act, 1961 provides for substitution of the actual consideration by the stamp duty valuation on the transfer of a capital asset, being land or building, if the consideration is less than the stamp duty valuation, for purposes of computing capital gain under section 48. In other words, the full value of consideration, in such cases, shall be deemed to be the value adopted for the purpose of levy of stamp duty. Section 50C reads as follows:

“Where the consideration accruing as a result of transfer of the capital asset, being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government (hereinafter in this section referred to as the “stamp valuation authority”) for the purpose of payment of stamp duty in respect of such transfer, the value so adopted or assessed or assessable shall, for the purposes of section 48, be deemed to be the full value of consideration received or accruing as a result of such transfer.”

The issue has arisen before the Courts as to whether this deeming fiction of s. 50C applies to a case of transfer of leasehold or other rights in land or building, which are not ownership rights and are not land and building simpliciter. While the Rajasthan High Court has held that the provisions of section 50C do apply to such leasehold and other rights, the Karnataka and Bombay High Courts have held that the provisions of section 50C do not apply in such cases.

RAM JI LAL MEENA’S CASE

The issue had come up before the Rajasthan High Court in the case of Sh. Ram Ji Lal Meena s/o Sh. Bachu Ram Meena vs. ITO 423 ITR 439 (Raj).

In this case, the land was sold by the assessee under a registered sale deed for a consideration of ₹11,70,000. The Registering Authority adopted the value of the property at ₹53,11,367 for stamp duty purposes. The assessee or the transferee did not file any appeal against such valuation by the stamp authorities before the appellate authorities appointed under the stamp duty law. The land in question had been allotted by a cooperative society to the assessee’s predecessor, from whom the assessee had purchased the land. The land was acquired by the Government for the public purpose for RIICO after its purchase / allotment by / to the co-operative society. A writ petition for validating the purchase / allotment of land was filed by the co-operative society, which was allowed by the Rajasthan High Court. At the time of validation of the sale to the society, an appeal by RIICO against the Rajasthan High Court’s order was pending before the Supreme Court. Subsequent to the sale by the assessee, the Supreme Court reversed the High Court’s order on an appeal by RIICO, and upheld the acquisition by the Government for RIICO.

The assessee did not file any tax return either u/s 139(1) or in response to a notice received for reassessment u/s 148. During reassessment proceedings, he merely filed a computation of total income, disclosing a capital loss of ₹1,22,303. In reassessment proceedings, the assessee objected to the stamp duty valuation. The Assessing Officer referred the matter to the Departmental Valuation Officer, who returned the reference stating that statutory references normally required 120 days, and it was not possible to take up the case, as it was getting time barred by 31^st March 2016.

The assessee contended that section 50C was not applicable as the land was under dispute, and the assessee had only sold out / transferred the rights to the land under dispute. The Assessing Officer did not accept the assessee’s contention and made an addition of ₹41,80,805 to the capital gains by applying the provisions of section 50C.

The Commissioner (Appeals) dismissed the appeal of the assessee.

The Tribunal, on appeal by the assessee, held that there was a transfer of a plot of land, by the assessee, and not just rights in land as claimed by the assessee, because the Rajasthan High Court’s order, which had held that the co-operative society was entitled to the land, was in force at the point of sale of the land by the assessee and as such the assessee sold the land in his capacity as the owner of the land. The Tribunal however restored the matter to the file of the Assessing Officer to decide the matter afresh after obtaining a valuation report from the Departmental Valuation Officer.

The assessee filed an appeal to the High Court against the order of the Tribunal. Before the Rajasthan High Court, it was argued on behalf of the assessee that this was not a case of transfer of land, but the transfer of rights therein, since the land was under acquisition by the Government for RIICO. Due to upholding the order of acquisition by the Supreme Court, it was claimed that the land vested in the State Government, and the possession remained with RIICO and not with the assessee. It was therefore urged that it was wrongly taken as a transfer of land when what was transferred by the assessee was only rights in land. Therefore, it was submitted that section 50C was not applicable.

It was also submitted that as per the revenue records the rights in land were khatedari rights, the ownership of the land vested with the Government and not the assessee, and the assessee had leasehold and not freehold rights over land, and as such section 50C could not have been invoked. Reliance was placed on various decisions of the Tribunal and the decision of the Bombay High Court in the case of Greenfield Hotels & Estates Pvt Ltd 389 ITR 68, to support the contention that section 50C would not be applicable when there was a transfer of leasehold land. It was contended that the assessee had rights similar to that possessed by a leaseholder, and therefore section 50C would not apply.

The High Court observed that a sale deed was executed for the sale of land, and the assessee had received consideration. The sale deed was registered by the Sub-Registrar. A transfer of a capital asset existed and for a valuable consideration received by the assessee. There was a dispute regarding possession of the property, which possession according to the assessee was with RIICO, but according to the revenue, the possession was with the assessee. The High Court noted that the material on record did not show any possession with RIICO, as only a notification for the acquisition of land had been issued, and there was no award passed for the acquisition by the Government for RIICO. It was the notification, the court noted, that was in dispute before the Supreme Court and not the possession of the land.

The High Court held that no question of law was involved in the case, as the dispute had been raised on facts, and the Commissioner (Appeals) and the Tribunal had held that section 50C would apply in the circumstances. According to the High Court, the appeal preferred by the assessee against the order passed by the Tribunal could not be admitted.

The Rajasthan High Court rejected reliance placed on behalf of the assessee on the decision of the Ahmedabad Tribunal in the case of Smt Devindraben I Barot vs. ITO 159 ITD 162 (Ahd), on the ground that in that case there was a relinquishment without there being a relinquishment deed and that the tribunal had decided the case without examining what was the difference between sale of the land and relinquishment of right therein. The Rajasthan High Court also rejected the reliance placed by the assessee on the Jaipur Tribunal decision in the case of ITO vs. Tara Chand Jain 155 ITD 956 (Jp), on the ground that the finding in that case that the assessee had transferred only the right in the land for valuable consideration and thereby did not transfer the capital asset, was recorded without proper scrutiny of facts and without elaborate finding on the issue. The tribunal in that case had not examined how the land and building or both were disclosed by the assessee in the balance sheet had not been taken note of, nor had it been shown how it was not a transfer of capital asset.

Referring to the decision of the Bombay High Court in the case of Greenfield Hotels & Estates Pvt Ltd (supra), the Rajasthan High Court observed that a bare perusal of section 50C did not show that transfer of a capital asset for consideration should be other than that of leasehold property or khatedari land, and that the Court could not rewrite the provision. According to the Rajasthan High Court, if the analogy taken by the Bombay High Court was applied in general, then section 50C would not be applicable in the majority of the cases as it was not allowed for leasehold property. The Rajasthan High Court further observed that the Bombay High Court had not referred to how the land was reflected in the balance sheet, whether as a capital asset or not. It therefore expressed its inability to apply the ratio of the judgment of the Bombay High Court to the case before it.

The Rajasthan High Court dismissed the appeal, holding that it did not find any question of law involved in the case before it.

V S CHANDRASHEKHAR’S CASE

The issue had also come up before the Karnataka High Court in the case of V S Chandrashekhar vs. ACIT 432 ITR 330.

In this case, the assessee had entered into an unregistered agreement for the purchase of land from Namaste Exports Ltd for a consideration of ₹4.25 crore. Under the agreement, the assessee was neither handed over the possession of the land nor was power of attorney executed in his favour. Namaste Exports Ltd. subsequently sold the land to another person, to which agreement the assessee was a consenting party.

The assessing officer of the assessee made an addition under section 50C, in his hands, in respect of the capital gains offered by the assessee for the transaction of consenting to the transfer by Namaste Exports Ltd. of the land. The appeals by the assessee to the Commissioner (Appeals) and the Tribunal confirmed the order of the assessing officer.

Before the Karnataka High Court, on appeal by the assessee, it was claimed that the provisions of section 50C were not applicable to the case of the assessee, since he was merely a consenting party in the transaction of transfer of land by a third party. It was urged that section 50C, being a deeming provision, required strict interpretation, and applied to the transfer of the land, by Namaste Exports Ltd. In its hands, and not to the assessee, who was a consenting party and not the transferor / co-owner of the property. It was further argued that since the assessee was only a consenting party, he had no locus standi in the transaction of transfer of land. It was further pointed out that section 50C used the expression ‘capital asset’ as being ‘land, building or both’, and the expression ‘being’ was more like ‘namely’, and therefore section 50C did not deal with interest in land but only dealt with land.

It was also urged on behalf of the assessee that where the language of the statute was clear and unambiguous, there was no room for the application of either the doctrine of ‘causes omissus’ and external aids for interpretation of the provision of s.50C could also not be taken recourse to. It was submitted that the assessee could not be taxed without clear words for the purpose and that every Act of Parliament must be read according to the natural construction of words.

Various alternative arguments were made on behalf of the assessee, including that the land was stock-in-trade and that section 50C did not therefore apply.

On behalf of the Revenue, besides rebutting the arguments that the land was stock-in-trade, it was contended that section 50C mandated the adoption of consideration on the basis of guidance value prescribed by the State Government for the purposes of stamp duty, as the consideration reflected by the assessee was much less than the guidance value provided by the Government of Karnataka. Therefore, the assessing officer had rightly adopted the stamp duty valuation in terms of section 50C.

It was also argued on behalf of the revenue that since the assessee had entered into a purchase agreement and had paid substantial consideration to the extent of 80%, rights had accrued in his favour, which had been extinguished by the sale deed, which would amount to transfer under section 2(47). Reliance was placed on the decision of the Supreme Court in the case of Sanjeev Lal vs. CIT 365 ITR 389 for this proposition that consideration had rightly been subjected to capital gains.

The Karnataka High Court examined the provisions of section 2(47) and section 50C. It noted that explanation 1 to section 2(47) used the term “immovable property”, whereas section 50C used the term “land or building or both” instead of “immovable property”. The Karnataka High Court was of the view that it was pertinent that wherever the legislature intended to expand the meaning of land to include rights or interest in land, it had said so specifically; viz., sections 35(1)(a), 54G(1), 54GA(1), 269UA(d) and Explanation to section 155(5A). According to the Court, section 50C therefore applied only in the case of a transferor of land, which in the case before the court, was Namaste Exports Ltd., and not the assessee, who was only a consenting party and not the transferor or co-owner of land.

According to the Karnataka High Court, the assessee had certain rights under the agreement, but from the clear, plain and unambiguous language used in section 50C, it was evident that it did not apply to a case of rights in land. According to the Karnataka High Court, it was a well-settled rule that in interpreting the taxing statutes no charge should be applied where the words used in the law by the legislature are clear and not ambiguous and the words used in the statute should be given natural meaning when they were clear and unambiguous, and the extended meaning should not be read into such words in the name of legislative intent and for any other reason.

For these reasons, the Karnataka High Court was of the view that the provisions of section 50C were not applicable to the case of the assessee.

OBSERVATIONS

The issue under consideration though moves in a narrow compass has a wider application. Other provisions of the Act namely, s.2(42A), s. 43CA and 56(2)(x) apply in the same context of bringing to tax the difference between the agreement value and the stamp duty value in respect of the transfer of land or building or both or for determination of the period of holding a capital asset. Besides these direct provisions, the Act is replete with provisions that use the term ‘immovable property’ in preference to the term ‘land or building or both’. They are found in s.27, 35(1)(a), 54G(1), 54GA(1), 269UA(d) and Explanation to section 155(5A) of the Act. The Transfer of Property Act and the General Clauses Act also deal with immovable property instead of land or building. All of these make one thing clear that the term immovable property is wider in its scope and embraces in its sweep the terms land and building, though the converse of the same is not true.

Various benches of the tribunal and some high courts have held that the profits and gains on transfer of rights in the land or building are not exigible to the deeming provisions being discussed herein. This is based on the application of the understanding that the terms ‘land or building’ have narrower meaning than the term ‘immovable property’ which is wider to include in its scope the rights and interest in the land or building, besides the land or building. These decisions hold that tenancy rights, leasehold rights, and rights in buildings under construction and development rights are not the same as the ‘land’ or ‘building’.

It’s useful to refer to the meaning of the term ‘immovable property’ provided under s.269UA of the Income Tax Act s.3 of the Transfer of Property Act (“TOPA”) and s.3 of the General Clauses Act (“GCA”). Immovable property, under TOPA and GCA, is defined to mean “Immovable property does not include standing timber, growing crops and grass”,. and “Immovable property shall include land benefits to arise out of the land, and things attached to the earth ”, respectively. S. 269UA of the Income-tax Act defined the term as under;

“immovable property” means-

(i) any land or any building or part of a building, and includes, where any land or any building or part of a building is to be transferred together with any machinery, plant, furniture, fittings or other things, such machinery, plant, furniture, fittings or other things also.

Explanation. – For the purposes of this sub-clause, “land, building, part of a building, machinery, plant, furniture, fittings and other things” include any rights therein;

(ii) any rights in or with respect to any land or any building or a part of a building (whether or not including any machinery, plant, furniture, fittings or other things, therein) which has been constructed or which is to be constructed, accruing or arising from any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement of whatever nature), not being a transaction by way of sale, exchange or lease of such land, building or part of a building;

A bare reading of the definitions leaves no doubt that the term ‘immovable property’ as defined, is wider in its scope and includes the terms land or building while the latter terms are not defined and would be assigned their natural meaning, and not the wider meaning to include the rights in the land and building.

Importantly, the legislature in framing the different provisions of the Income Tax Act has a clear perception and understanding of the difference between these terms which is made clear by the use of different terms at different places with different objectives. Had the intention been to cover the cases of the rights in land too in the ambit of the provisions being examined namely, s.43CA, 50 C and 56(2), the legislature would have used the term’ immovable property’ in place and stead of the terms ‘land’ or ‘building’. S.27, 35(1)(a), 54G(1), 54GA(1), 269UA(d) and Explanation to section 155(5A) of the Act use the term ‘immovable property’ whose meaning would be supplied reference to the enactments which define this term while the meaning of the terms ‘land’ or ’building’ used in the Act should be gathered by the natural meaning of these terms.

This issue had first come up before the Bombay High Court in the case of CIT vs. Greenfield Hotels & Estates (P) Ltd 389 ITR 68. In that case, the Bombay High Court noted that the tribunal had followed its decision in Atul G Puranik vs. ITO 132 ITD 499, which had held that section 50C is not applicable while computing capital gains on the transfer of leasehold rights in land and buildings. In that case, the counsel for the revenue stated that the revenue had not preferred any appeal against the decision of the tribunal in the case of Atul G Puranik (supra). The Bombay High Court therefore stated that it could be inferred that the tribunal decision in Atul Puranik’s case had been accepted by the Government. The High Court referred to its own decision in the case of DIT vs. Credit Agricole Indosuez 377 ITR 102 and the decision of the Supreme Court in the case of UOI vs. Satish P Shah 249 ITR 221, for the salutary principle that where the revenue had accepted the decision of the court / tribunal on an issue of law and not challenged it in appeal, then a subsequent decision following the earlier decision cannot be challenged. Therefore, the Bombay High Court had taken the view that no substantial question of law arose in that case.

An identical view had been taken by the Bombay High Court on the same reasoning earlier in CIT vs. Heatex Products Pvt Ltd 2016 (7) TMI 1393 – Bombay High Court. However, in a subsequent matter in the case of Pr CIT vs. Kancast Pvt Ltd 2018 (5) TMI 713 – Bombay High Court, the Bombay High Court took note of its decisions in Greenfield Hotels & Estates (P) Ltd (supra) and Heatex Products Pvt Ltd (supra) and observed that these were decided on the basis that no appeal had been filed against the Tribunal’s decision in the case of Atul G Puranik (supra). The High Court observed that in the case before it, reliance had been placed on the Tribunal decisions in the case of Atul G Puranik (supra) and ITO vs. Pradeep Steel Re-Rolling Mills Pvt Ltd 2011(7) TMI 1101 – ITAT Mumbai (supra). The counsel for the Revenue pointed out that the Revenue had preferred an appeal against the Tribunal’s order in Pradeep Steel Re-Rolling Mills Pvt Ltd (supra), which was admitted. It was however later withdrawn in view of the low tax effect.

The Bombay High Court noted that when both appeals in Greenfield Hotels & Estates Pvt Ltd (supra) and Heatex Products Pvt Ltd (supra) were not entertained by it, the decision of the Court in Pradeep Steel Re-Rolling Mills Pvt Ltd (supra) admitting the appeal on the same question had not been brought to its notice. It therefore admitted the appeal on the substantial question of law in Kancast Pvt Ltd’s (supra) case. Therefore, the issue is still pending for decision before the Bombay High Court.

However, in a decision of the Bombay High Court in the case of Pr CIT vs. MIG Co-op. Hsg. Soc. Group II Ltd 298 Taxman 284 (Bom), in the context of a redevelopment agreement entered into by a co-operative housing society, the Bombay High Court noted with approval the following observations of the Tribunal in the case before it:

“We also hold that Society was only the lessee and what was transferred to the developer is development rights, not land or building. Section 50C of the Act stipulates as under:

“Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being land or building or both.….…”

No authority is required to hold that terms’ land or building’ ‘or both’ do not include development rights and that in the case before (them) there was the transfer of such rights only.”

Looking at the number of judicial decisions, including various decisions of the Tribunal, it appears that the majority of the Courts and the Tribunals seem to favour the proposition that given the express language of section 50C, referring to “capital asset, being land or building or both” and not using the broader term “immovable property”, the intention clearly seems to be that only land building per se was intended to be covered, and not all types of immovable property.

The facts in both cases are highly peculiar. In the case before the Rajasthan High Court, the subsequent order of the Supreme Court has made the entire transaction of the transfer by the assessee non-est and not enforceable in law, and the assessee would have been better off by contending that no capital gains could be said to have arisen out of a non-est transaction by relying on the settled position in law including by the decisions of the Supreme Court in the case of Balbir Singh Maini,86 taxmann.com 94 and Ranjit Kaur, 89 taxmann.com 9. In the facts of the assessee before the Karnataka High court the assessee had never acquired any land or building, nor had he acquired even the rights in the land, nor had he possessed the land, neither had he transferred the land, nor was he capable of doing so; he was just a consenting or confirming party and was included for the reason of he having made the part payment to the extent of 80% of the consideration agreed. In such facts, it was not possible for the court to have come to any other conclusion other than the one delivered by it.

Therefore, the better view is that rights in immovable property which are inferior to ownership rights, such as leasehold rights or the right to acquire immovable property, would not be covered by section 50C.

BCAJ Admin

Taxation of Interest on Compensation

ISSUE FOR CONSIDERATION

The Constitution of India has vested the Government of India with the power to acquire properties for public purposes, provided an adequate compensation is paid to the owner for deprivation of the property. Such a power was largely exercised by the government under the Land Acquisition Act, 1894 (“LAA”), which Act has been substituted by the Right to Fair Compensation and Transparency in Land Acquisition and Rehabilitation and Resettlement Act, 2013 (“RFCTLARRA”) w.e.f 1^st January, 2014. In addition, various specifically legislated enactments permit the government to acquire properties, e.g., The National Highways Act and The Metro Railways Act.

On acquisition of properties, the government is required to adequately compensate the owner with payment of the assured amount under the award. This amount is determined as per certain guidelines provided in the respective acts and in the rules. At times, the awards are challenged on several grounds, including on the ground of inadequacy of the compensation. The government usually pays compensation as per the award within a reasonable period and the enhanced compensation is paid on settlement of the dispute.

The government pays interest for delay in payment of the awarded compensation under s. 34 of the LAA (s.72 of RFCTLARRA), and pays interest under s. 23 and 28 of the LAA (section 80 of RFCTLARRA) in cases of enhanced compensation for the period commencing from the date of award to the date of the payment of the enhanced compensation after settlement of the dispute.

Section 45 (5) of Income Tax Act, 1961 provides a deeming fiction to tax the compensation, including enhanced compensation, in the year of receipt of the compensation under the head “Capital Gains”. Section 10(37) of the Act provides for exemption from tax on capital gains arising in the hands of an individual or HUF on transfer of an agricultural land. A separate exemption is provided under s. 10(37A) for acquisition of properties under the Land Pooling Scheme of Andhra Pradesh on or after 2nd June, 2014 in the hands of an individual or HUF for development of the proposed city of Amravati. In addition, section 96 of the RFCTLARRA provides an independent exemption from payment of income tax on a compensation received under an award or an agreement under the said Act. No capital gains tax is payable at all on application of the provisions of the section 10 (37) and 10(37A) of the IT Act and section 96 of the RFCTLARRA. In respect of the other cases, the taxation is governed by section 45(5) of the Act.

Section 56(2)(viii) was inserted by the Finance Act, 2009 w.e.f A.Y 2010-11 to provide for taxation of interest on compensation in the year of receipt of the interest. Simultaneously section 145A/145B have been amended /inserted to provide that such interest would be taxed in the year of receipt, irrespective of the method of accounting followed by the assessee.

An interesting issue has arisen recently in relation to taxation of interest on the enhanced compensation. The Punjab and Haryana High Court, in a series of cases, held that such interest was taxable under the head Income From Other Sources, while the Gujarat High Court has held that such interest on enhanced compensation was a part of the compensation, and was governed by the provisions of section 45(5) and / or the tax exemption provisions. In fact, the Punjab & Haryana High Court has not followed its own decisions in later decisions, and the Pune bench of the Income tax Appellate tribunal has given conflicting decisions.

MANJET SINGH (HUF) KARTA MANJEET SINGH’S CASE

The issue first arose in the case of Manjet Singh (HUF) Karta Manjet Singh vs. UOI, 237 Taxman 161(P&H). During the period relevant to the assessment year 2010-11, the assessee, a landowner, received interest under section 28 of the Land Acquisition Act, 1894 and claimed that the said interest did not fall for taxation under section 56 as income from other sources, in view of the judgment of the Apex Court in the case of Ghanshyam (HUF) 315 ITR 1.

In this case, Notifications under sections 4 and 6 of the Land Acquisition Act, 1894 were issued on 2^nd January, 2002 and 24^th December, 2002 respectively for acquisition of land in District Karnal. After considering all the relevant factors, the Land Acquisition Collector assessed the compensation vide award No.22, which award was contested by way of a reference under Section 18 of the 1894 Act, which was accepted vide order dated 11^th August, 2009. Higher Compensation was awarded on reference, along with other statutory benefits, including the interest in accordance with sections 23(1-A), 23(2) and 28 of the 1894 Act. Form ‘D’ had been drawn on 11^th May, 2010 and 27^th May, 2010 by the Land Acquisition Officer containing the complete details regarding the names of the petitioners, principal, interest, cost, total amount, TDS and net payable in accordance with the decision dated 11^th August, 2009.

Proceedings for reassessment were initiated under Section 148 of the Income Tax Act,1961 on 9^th April, 2012, by issue of notice under Section 148 of the Act to the assessee.

In the reply submitted to the Assessing Officer, the benefit of exemption under Section 10(37) of the Act was claimed. It was also pointed out that interest under section 28 of the 1894 Act did not fall for taxation under Section 56 of the Act as income from other sources in view of the judgment of the Apex Court in the case of Ghanshyam (HUF), and in case it was still treated as income from other sources by the AO, then the assessee was entitled to mandatory deduction as enumerated under Section 57(iv) of the Act on a protective basis.

A Writ Petition was filed before the Punjab & Haryana High Court by the assessee challenging the notice under s. 148, and requesting for appropriate orders by the court, including on the prayer of the assessee to refund the tax deduced at source from the compensation for the land acquisition which was claimed to be exempt from deduction under Section 194LA of the Act.

The High Court also noted that the assessee, on the basis of the judgment of the Supreme Court rendered in the case of Ghanshyam (HUF) (supra), had sought reconsideration of judgment of the Punjab and Haryana High Court in CIT vs.Bir Singh [IT Appeal No. 209 of 2004, dated 27^th October, 2010], where the Division Bench had held that element of interest awarded by the Court on enhanced amount of compensation under section 28 of the 1894 Act fell for taxation under section 56 as income from other sources in the year of receipt.

The High Court noted that the primary question for consideration related to the nature of interest received by the assessee under section 28 of the 1894 Act. In other words, whether the interest which was received by the assessee partook the character of income or not, and in such a situation, was it taxable under the provisions of the Income-tax Act.

In accordance with the decision of the Apex Court in Ghanshyam (HUF), 315 ITR 1, it was claimed by the assessee that the amount of interest component under section 28 of the 1894 Act should form part of enhanced compensation, and secondly, that concluded matters should not be reopened. Reliance was placed by the assessee upon following observations in Ghanshyam (HUF)’s case (supra):—

“To sum up, interest is different from compensation. However, interest paid on the excess amount under Section 28 of the 1894 Act depends upon a claim by the person whose land is acquired whereas interest under Section 34 is for delay in making payment. This vital difference needs to be kept in mind in deciding this matter. Interest under Section 28 is part of the amount of compensation whereas interest under Section 34 is only for delay in making payment after the compensation amount is determined. Interest under Section 28 is a part of the enhanced value of the land which is not the case in the matter of payment of interest under Section 34.”

The claim of the assessee was controverted by the revenue by filing a written statement. In the reply, the initiation of proceedings under Section 148 of the Act was sought to be justified by relying upon judgment of this Court in Bir Singh (HUF’s case (supra). It had also been stated that legislature had introduced Section 56(2) (viii) and also Section 145A(b) of the Act by Finance (No.2) Act, 2009 with effect from 1^st April, 2010, according to which the interest received by the assessee on compensation or enhanced compensation should be deemed to be his income in the year of receipt, irrespective of the method of accountancy followed by the assessee subject however to the deduction of 50 per cent under Section 57(iv) of the Act. It had further been pleaded that the amendment was applicable with effect from assessment year 2010-11, and the assessee had received the interest amount during the period relevant to assessment year 2010-11 and therefore, the assessee was liable to pay tax.

The assessee submitted that the judgment of this Court in Bir Singh (HUF)’s case (supra) required reconsideration being contrary to the decision of the Hon’ble Supreme Court in Ghanshyam’s case (supra). In response, the revenue contended that the judgment in Bir Singh (HUF)’s case (supra) neither required any reconsideration nor any clarification, as the same was in consonance with the Scheme of the 1894 Act and law enunciated by the Constitution Bench of the Apex Court in Sunder vs. Union of India JT 2001 (8) SC 130.

The court reiterated that the main grievance was regarding the treatment given qua the amount of interest received under section 28 of the 1894 Act while arriving at the chargeable income under the Act. It observed that the grant of interest under Section 28 of the 1894 Act applied when the amount originally awarded had been paid or deposited and subsequently the Court awarded excess amount and in such cases interest on that excess alone was payable; section 28 empowered the Court to award interest on the excess amount of compensation awarded by it over the amount awarded by the Collector; the compensation awarded by the Court included the additional compensation awarded under Section 23(1A) and the solatium under Section 23(2) of the said Act. It further observed that Section 28 was applicable only in respect of the excess amount, which was determined by the Court after a reference under Section 18 of the 1894 Act.

The High Court observed that a plain reading of sections 23(1A) and 23(2) as also section 28, clearly spelt out that additional benefits were available on the market value of the acquired lands under sections 23(1A) and 23(2), whereas benefit of interest under section 28 was available in respect of the entire compensation. The High Court observed that the Constitution Bench of the Supreme Court in the case of Sunder vs. Union of India JT 2001 (8) SC 130 had approved the observations of the Division Bench of the Punjab and Haryana High Court made in the case of State of Haryana vs. Smt. Kailashwati AIR 1980 Punj. & Har. 117, that the interest awardable under section 28 would include within its ambit both the market value and the statutory solatium, and as such the provisions of section 28 warranted and authorised the grant of interest on solatium as well.

The High Court then noted that the Three Judge Bench of the Supreme Court in the case of Dr. Shamlal Narula, 53 ITR 151 had considered the issue regarding award of interest under the 1894 Act, wherein the interest under section 28 was considered akin to interest under section 34, as both were held to be on account of keeping back the amount payable to the owner, and did not form part of compensation or damages for the loss of the right to retain possession. The principle of Dr. Shamlal Narula’s case had subsequently been applied by a Three Judge Bench of the Apex Court in a later decision in T.N.K. Govindaraju Chetty, 66 ITR 465.

The High Court also took note of another Three Judge Bench of the apex Court in the case of Bikram Singh vs. Land Acquisition Collector, 224 ITR 551, wherein the court following Dr. Shamlal Narula’s case (supra), and taking into consideration definition of interest in section 2(28A) of the Income-tax Act, had held that interest under section 28 of the 1894 Act was a revenue receipt and was taxable.

The High Court cited with approval the decision of the Supreme Court in the case of Dr. Shamlal Narula vs. CIT, 53 ITR 151, which had considered the issue regarding award of interest under the 1894 Act and held that the interest under Section 28 of the 1894 Act was considered akin to interest under Section 34 thereof, as both were held to be on account of keeping back the amount payable to the owner and did not form part of compensation or damages for the loss of the right to retain possession. It was noticed as under:—

“As we have pointed out earlier, as soon as the Collector has taken possession of the land either before or after the award the title absolutely vests in the Government and thereafter owner of the land so acquired ceases to have any title or right of possession to the land acquired. Under the award he gets compensation or both the rights. Therefore, the interest awarded under s. 28 of the Act, just like under s. 34 thereof, cannot be a compensation or damages for the loss of the right to retain possession but only compensation payable by the State for keeping back the amount payable to the owner.”

The Punjab & Haryana High Court held that in view of the authoritative pronouncements of the apex court in cases of Dr. Sham Lal Narula, T.N.K. Govindaraja Chetty, Bikram Singh (supra), State of Punjab vs. Amarjit Singh, 2011 (2) SC 393, Sunder vs. Union of India [2001] (8) SC 130, Rama Bai, 181 ITR 400 and K.S. Krishna Rao, 181 ITR 408, the assessee could not derive any benefit from the observations made by the Supreme Court in the case of Ghashyam (HUF) (supra).

While deciding the issue of the taxation of interest, the court kept open the issue of tax deduction at source, which was not being agitated in this case, and stated that it would be taken up in an appropriate case and thus the issue was left open, observing “We make it clear that since no arguments have been addressed with regard to the tax deduction at source, the said issue is being left open which may be taken up in accordance with law.”

It also noticed the claim of the assessee based on provisions of Section 10(37) and 57(iv) of the Act, and held that the issue required examination based on factual matrix, and therefore directed that the assessee might plead and claim the benefit thereof before the Assessing Officer in accordance with law.

Accordingly, finding no merit in the petitions, the court dismissed the same.

MOVALIYA BHIKHUBHAI BALABHAI’S CASE

The issue arose before the Gujarat High Court, this time under s.194 LA of the Income tax Act relating to the tax deduction at source in the case of Movaliya Bhikhubhai Balabhai vs. ITO TDS-1, Surat, 388 ITR 343.

In this case, the assessee’s agricultural lands were acquired under the provisions of the Land Acquisition Act, 1894 for the public purpose of developing irrigation canals. The compensation awarded by the Collector was challenged by the assessee before the Principal Senior Civil Judge, who awarded additional compensation with other statutory benefits. Pursuant to such award, the Executive Engineer of the irrigation scheme calculated the amount payable to the petitioner, that included an amount of interest of ₹20,74,157 computed as per s. 28 of the said Act. An amount of tax of ₹2,07,416 was proposed to be deducted at source as per section 194A of the Income tax Act by the Executive Engineer.

The assessee made an application to the Income-tax Department under section 197(1) for ascertaining the tax liability on interest, claiming that such interest was not taxable and requested the AO to issue a certificate for Nil tax liability. The application was rejected on the ground that the interest for the delayed payment of compensation and for enhanced value of compensation was taxable as per the provisions of sections 56(2)(viii) and 145A(b) r.w.s 57(iv). Being aggrieved, the assessee filed a writ petition before the Gujarat High Court.

The assesseee submitted to the court that, when the interest under section 28 of the Act of 1894 was to be treated as part of compensation and was liable to capital gains under section 45(5) of the I.T. Act, such amount could not be treated as Income from Other Sources and hence no tax could be deducted at source. It was submitted that subsequent to the refusal to grant the certificate under section 197 of the I.T. Act, the Executive Engineer deducted tax at source to the extent of ₹2,07,416, which was not in consonance with the statutory provisions, and directions should be issued for refund of tax deducted.

On behalf of the revenue, it was submitted that the interest in question was taxable under the head Income from Other Sources on insertion of s. 56(2) (viii) and s. 145A of the Act. Reliance was placed upon several decisions of the High Courts, including the decision of the Punjab and Haryana High Court in the case of Manjet Singh (HUF) Karta Manjeet Singh vs. Union of India (supra) in support of the view of the revenue.

Opposing the petition, the revenue submitted that the Income Tax Officer, TDS-1, Surat, while rejecting the application made by the petitioner under section 197 of the I.T. Act, had taken into consideration the provisions of section 57(iv) read with section 56(2)(viii) and section 145A(b) of that Act, and the action of the AO in rejecting the application was just, legal and valid in terms of the provisions of section 57(iv) read with section 56(2)(viii) and section 145A(b) of the I.T. Act. It was submitted that tax was required to be deducted at source under section 194A of the I.T. Act at the rate of 10% from the interest payable under section 28 of the Act of 1894.

Referring to the provisions of section 56 of the I.T. Act, it was pointed out that sub-clause (viii) of sub-section (2) thereof provided that income by way of interest received on compensation or on enhanced compensation referred to in clause (b) of section 145A was chargeable to income tax under the head “Income from other sources”. It was pointed out that under sub-clause (iv) of section 57, in case of the nature of income referred to in clause (viii) of sub-section (2) of section 56, a deduction of a sum equal to fifty per cent of such income was permissible. It was pointed out that under section 145A of the Act, interest received by the assessee on compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the year in which it was received. It was submitted that the interest on enhanced compensation under section 28 of the Act of 1894, being in the nature of enhanced compensation, was deemed to be the income of the assessee in the year under consideration and had to be taxed as per the provisions of section 56(2)(viii) of the Act, as income from other sources.

As regards the decision of the Supreme Court in the case of Ghanshyam (HUF) (supra), it was submitted on behalf of the revenue that such decision was rendered prior to the amendment in the I.T. Act, whereby clause (b), which provides that interest received by an assessee on compensation or on enhanced compensation, as the case may be, should be deemed to be the income in the year in which it was received, came to be inserted in section 145A of the Act and hence, the said decision would not have any applicability in the facts of the case before the court.

In support of the submissions, the revenue placed reliance upon the decision of the Punjab & Haryana High Court in the case of Hari Kishan vs. Union of India [CWP No. 2290 of 2001 dated 30^th January, 2014] wherein the court had placed reliance upon its earlier decision in the case of CIT vs. Bir Singh (HUF) ITA No. 209 of 2004 dt. 27^th October, 2010, wherein the court, after considering the decision of the Supreme Court in Ghanshyam (HUF)’s case (supra), had held that the interest received by the assessee was on account of delay in making the payment of enhanced compensation, which would not partake the character of compensation for acquisition of agricultural land and thus, was not exempt under the Income Tax Act. Once that was so, the tax at source had rightly been deducted by the payer.

The Gujarat High Court held that it was not in agreement with the view adopted by the other high courts, which were not consistent with the law laid down in the case of Ghanshyam (HUF) 182 Taxman 368 (SC). The Gujarat High Court took notice of the decision in Manjet Singh (HUF) Karta Manjeet Singh’s case, 237 Taxman 116 by the Punjab and Haryana High Court, wherein the court had chosen to place reliance upon various decisions of the Supreme Court rendered during the period 1964 to 1997, and had chosen to brush aside the subsequent decision of the Supreme Court in Ghanshyam (HUF)’s case (supra), which was directly on the issue, by observing that the assessee could not derive any benefit from the observations made by the Supreme Court in that case.

The court held that the view of the Punjab and Haryana High Court was contrary to what had been held in the decision of the Supreme Court in Ghanshyam (HUF)‘s case (supra), that interest under section 28, unlike interest under section 34, was an accretion to the value, hence it was a part of enhanced compensation or consideration, which was not the case with interest under section 34 of the 1894 Act. The Gujarat High Court stated that it was rather in agreement with the view adopted by the Punjab and Haryana High Court in Jagmal Singh vs. State of Haryana [Civil Revision No. 7740 of 2012, dated 18^th July, 2013], which had been extensively referred to in paragraph 4.1 of the later decision of the said court.

It was clear to the Gujarat High Court that the Supreme Court, after considering the scheme of section 45(5) of the I.T. Act, had categorically held that payment made under section 28 of the Act of 1894 was enhanced compensation. As a necessary corollary, therefore, the contention that payment made under section 28 of the Act of 1894 was interest as envisaged under section 145A of the I.T. Act and had to be treated as income from other sources, deserved to be rejected.

The court also held that the substitution of section 145A by the Finance (No. 2) Act, 2009 was not in connection with the decision of the Supreme Court in Ghanshyam (HUF)’s case (supra) but was brought in to mitigate the hardship caused to the assessee on account of the decision of the Supreme Court in Rama Bai’s case, 181 ITR 400, wherein it was held that arrears of interest computed on delayed or enhanced compensation should be taxable on accrual basis. Therefore, in reading the words “interest received on compensation or enhanced compensation” in section 145A of the I.T. Act, the same have to be construed in the manner interpreted by the Supreme Court in Ghanshyam (HUF)’s case (supra).

The upshot of the above discussion, the court stated, was that since interest under section 28 of 1894 Act partook the character of compensation, it did not fall within the ambit of the expression ‘interest’ as contemplated in section 145A of the Income-tax Act. The Income Tax Officer was, therefore, not justified in refusing to grant a certificate under section 197 of the Income-tax Act to the assessee for non- deduction of tax at source, inasmuch as, the taxpayer was not liable to pay any tax under the head ‘income from other sources’ on the interest paid to him under section 28 of the Act of 1894.

The court noted that the assessee had earlier challenged the communication dated 9^th February, 2015, whereby its application for a certificate under section 197 had been rejected, and subsequently, tax on the interest payable under section 28 of the Act of 1894 had already been deducted at source. Consequently, the challenge to the above communication had become infructuous and hence, the prayer clause came to be modified. However, since the amount paid under section 28 of the Act of 1894 formed part of the compensation and not interest, the Executive Engineer was not justified in deducting tax at source under section 194A of the Income-tax Act in respect of such amount. The assessee was, therefore, entitled to refund of the amount wrongly deducted under section 194A.

For the foregoing reasons, the court allowed the petition. The Executive Engineer, having wrongly deducted an amount of ₹2,07,416 by way of tax deducted at source out of the amount of ₹20,74,157 payable to the assessee under section 28 of the Act of 1894 and having deposited the same with the income-tax authorities, taking a cue from the decision of the Punjab and Haryana High Court in Jagmal Singh’s case (supra), the High Court directed the AO to forthwith deposit such amount with the Reference Court, which would thereafter disburse such amount to the assessee.

OBSERVATIONS

Under the land acquisition laws, two types of payments are generally made, besides the payment of compensation for acquisition of property. These payments are referred to in the respective amendments as “interest”. One such ‘interest’ is payable under section 34 of LAA (s.80 of RFCTLARRA) for delay in payment of the amount of compensation award, in the first place, on passing of an award of acquisition. This interest is payable on the amount of award for the period commencing from the date of award and ending with the date of payment of the compensation awarded. Another such ‘interest’ is payable on the increased/enhanced compensation under section 23 and/or s. 28 of the LAA of section 72 of the RFCTLARRA for the period commencing from the date of the award to the date of award for enhanced compensation, on the amount of enhanced compensation.

Section 28 of the LAA reads as “28. Collector may be directed to pay interest on excess compensation. – If the sum which, in the opinion of the court, the Collector ought to have awarded as compensation is in excess of the sum which the Collector did award as compensation, the award of the Court may direct that the Collector shall pay interest on such excess at the rate of nine per centum per annum from the date on which he took possession of the land to the date of payment of such excess into Court.”

Section 34 of the LAA reads as; “34. Payment of interest- When the amount of such compensation is not paid or deposited on or before taking possession of the land, the Collector shall pay the amount awarded with interest thereon at the rate of nine per centum per annum from the time of so taking possession until it shall have been so paid or deposited.

Provided that if such compensation or any part thereof is not paid or deposited within a period of one year from the date on which possession is taken, interest at the rate of fifteen per centum per annum shall be payable from the date of expiry of the said period of one year on the amount of compensation or part thereof which has not been paid or deposited before the date of such expiry.”

Section 2(28A) defines “interest” for the purposes of the Income -tax Act effective from 1-6-1976. The expression “interest” occurring in section 2(28A) widens the scope of the term “interest” for the purposes of the Income-tax Act.

The interest of the first kind, payable under section 34 of LAA, is paid for the delay in payment of the awarded compensation and therefore represents an interest as is so understood in common parlance. In contrast, the ‘interest’ on the enhanced compensation is not for the delay in payment of compensation, but is in effect a compensation for deprivation of the amount of the compensation otherwise due to be payable to the owner of the property. The nature of the two payments referred to as ‘interest’ under the LAA is materially different; while one represents the interest the other represents the compensation for deprivation of the lawful due which was otherwise withheld and not paid on account of an unjust order. LAA awards ‘interest’ both as an accretion in the value of the lands acquired and interest for undue delay. Interest under section 28 is an accretion to the value and is a part of enhanced compensation or consideration which is not the case with interest under section 34 of LAA. Additional amount paid under section 23(1A) and the solatium under section 23(2) form part of enhanced compensation under section 45(5)(b) of the 1961 Act , a view that is confirmed by clause (c) of section 45(5). Equating the two payments, with distinct and different characters, as interest under the Income tax Act is best avoidable. The Supreme Court in the case of Ghanshyam (HUF), 315 ITR1, vide it’s order dated 16^th July, 2009 passed for assessment year 1999-2000, held that the interest on enhanced compensation paid under LAA was compensation itself and its taxability or otherwise was governed by the provision of section 45(5) of the Income Tax Act in the following words;

“The award of interest under section 28 of the 1894 Act is discretionary. Section 28 applies when the amount originally awarded has been paid or deposited and when the Court awards excess amount. In such cases interest on that excess alone is payable. Section 28 empowers the Court to award interest on the excess amount of compensation awarded by it over the amount awarded by the Collector. The compensation awarded by the Court includes the additional compensation awarded under section 23(1A) and the solatium under section 23(2) of the said Act. This award of interest is not mandatory but is left to the discretion of the Court. Section 28 is applicable only in respect of the excess amount, which is determined by the Court after a reference under section 18 of the 1894 Act. Section 28 does not apply to cases of undue delay in making award for compensation” [Para 23].

“To sum up, interest is different from compensation. However, interest paid on the excess amount under section 28 of the 1894 Act depends upon a claim by the person whose land is acquired whereas interest under section 34 is for delay in making payment. This vital difference needs to be kept in mind in deciding this matter. Interest under section 28 is part of the amount of compensation whereas interest under section 34 is only for delay in making payment after the compensation amount is determined. Interest under section 28 is a part of enhanced value of the land which is not the case in the matter of payment of interest under section 34.” [Para 24].

It is true that ‘interest’ is not compensation. It is equally true that section 45(5) refers to compensation. But the provision of the 1894 Act awards ‘interest’ both as an accretion in the value of the lands acquired and interest for undue delay. Interest under section 28 unlike interest under section 34 is an accretion to the value. Hence, it is a part of enhanced compensation or consideration which is not the case with interest under section 34 of the 1894 Act. So also, additional amount under section 23(1A) and solatium under section 23(2) of the 1894 Act form part of enhanced compensation under section 45(5)(b) of the 1961 Act. The said view is reinforced by the newly inserted clause (c) in section 45(5) by the Finance Act, 2003 with effect from 1-4-2004.” [Para 33]

“When the Court/Tribunal directs payment of enhanced compensation under section 23(1A), or section 23(2) or under section 28 of the 1894 Act, it is on the basis that award of the Collector or the Court under reference has not compensated the owner for the full value of the property as on date of notification.” [Para 35]

The ratio of this decision of the Supreme Court was followed by the apex court in the later decisions in the cases of Govindbhai Mamaiya, 367 ITR 498, Chet Ram (HUF), 400 ITR 23 and Hari Singh and Other, 302 CTR 0458.

In the background of this overwhelming positioned in law, it is relevant to examine the true implications of the insertion of section 56(2)(viii) and section 145A/B of the Income tax Act which provide for taxation of interest on compensation under the head Income from other sources. The Punjab and Haryana High Court, guided by the amendments in the Income Tax Act, has held in a series of cases, distinguishing the decision in the case of Ghanshyaam (HUF)(supra), that interest on enhanced compensation was taxable under the head Income From Other Sources, in the year of receipt of interest on enhanced compensation. The Gujarat high court has chosen to dissent from the decisions of the Punjab and Haryana high court to hold that such interest was in the nature of compensation even after insertion/amendment of the Income Tax Act. The Supreme Court has dismissed the Special Leave Petition of the assessee, 462 ITR 498, against the order of the high court in one of the decisions of the high court in the case of Mahender Pal Narang, 423 ITR 13(P&H), a decision where the court has dissented form the decision of the Gujarat high court. Like the high courts, there are conflicting decisions of the different benches of the Income tax Appellate Tribunal; the Pune bench has delivered conflicting decisions on the same subject. All of these conflicting decisions highlight the raging controversy about taxation of interest under consideration.

The issue according to us moves in a narrow compass; whether the law laid down by the Supreme Court in the series of cases, that interest on enhanced compensation is taxable as compensation and not as an interest has undergone any change on account of insertion of section 56(2)(viii) and 145A/B of Income Tax Act. In our considered opinion – No.

The insertion / amendment of the Income tax Act has the limited object of providing for the year of taxation of such interest in the year of receipt. The objective of the amendment is limited to settle the then prevailing controversy about the year of taxation of interest in cases where such interest was otherwise taxable. This can be gathered and confirmed by a reference to the Notes to Clauses and the Explanatory Memorandum accompanying the Finance (No.2) Bill, 2009. Circular No. 5 of 2010 in a way confirms that the amendments by the Finance Act, 2010 Act are not in connection with the decision of the Supreme Court in Ghanshyam’s case (supra); they are made to mitigate the hardship caused by the decision of Supreme Court in Rama Bai’s case about the year or years of taxation of interest, where taxable. Under no circumstances, the amendments should be viewed to have changed the law settled by the Supreme Court, where the apex court held that the interest on enhanced compensation was nothing but compensation and the payment being labelled as interest under the LAA did not change the character of the receipt of compensation for the purposes of the Income tax Act.

The better and the correct view is to treat the interest on enhanced compensation as a payment for unjust deprivation of the lawful dues payable under the statute and treat such payment as a compensation and not as an interest taxable under the head Income from Other Sources.

BCAJ Admin

Validity of Notice under Section 148 Issued By the JAO

ISSUE FOR CONSIDERATION

Over the last few years, the Government has adopted a policy of making several processes under the Act fully faceless, which otherwise required interface with the taxpayers. In line with this objective, Section 151A was inserted with effect from 1^st November, 2020, which provides for notification of a faceless scheme for the following purposes, namely —

assessment, reassessment or re-computation under section 147;
issuance of notice under section 148;
conducting of enquiries or issuance of show-cause notice or passing of order under section 148A;
sanction for issue of such notice under section 151.

Notification No. 18/2022 was issued notifying the ‘e-Assessment of Income Escaping Assessment Scheme, 2022’ (Scheme) under Section 151A with effect from 29^th March, 2022. The scope of this scheme as provided in Clause 3 of the Scheme is reproduced below for reference —

Scope of the Scheme

3. For the purpose of this Scheme, —

(a) assessment, reassessment or recomputation under section 147 of the Act,

(b) issuance of notice under section 148 of the Act,

shall be through automated allocation, in accordance with the risk management strategy formulated by the Board as referred to in section 148 of the Act for issuance of notice, and in a faceless manner, to the extent provided in section 144B of the Act with reference to making assessment or reassessment of total income or loss of assessee.

Even after this Scheme has come into effect, in several cases, the notices under Section 148 have been issued by the concerned Jurisdictional Assessing Officer (JAO) and not by the Faceless Assessing Officer (FAO) or National Faceless Assessment Centre (NFAC).

Therefore, an issue has arisen before the High Courts as to whether such notice issued by the JAO under Section 148 post this Scheme coming into effect is valid, and consequently, whether the reassessment proceeding conducted in pursuance of such notice would be valid. The Calcutta High Court has affirmed the validity of such notices issued by the JAO. However, the Telangana and Bombay High Courts have taken a view that the JAO did not have the power to issue a notice under Section 148 and, therefore, the notice issued by him in contravention of the provisions of Section 151A read with the Scheme was invalid and bad in law.

TRITON OVERSEAS (P.) LTD.’S CASE

The issue had first come up for consideration before the Calcutta High Court in the case of Triton Overseas (P.) Ltd. vs. UOI [2023] 156 taxmann.com 318 (Calcutta).

In this case, the assessee had challenged the notice dated 28^th April, 2023, issued under Section 148 relating to the assessment year 2019–20 on the ground that the same had been issued by the JAO and not by NFAC as required under Section 151A. The revenue contended that the issue raised by the assessee was hyper-technical, since the mode of service did not affect the contents and merit of the notice. Further, it was also argued that the issuance of the notice under Section 148 of the Act was justifiable and sustainable in law in view of the office memorandum dated 20^th February, 2023, being F No. 370153/7/2023-TPL, issued by the CBDT.

The High Court referred to Paragraph 4 of the said office memorandum which is reproduced below —

“4. It is also pertinent to note here that under the provisions of the Act, both the JAO as well as units under NFAC have concurrent jurisdiction. The Act does not distinguish between JAO or NFAC with respect to jurisdiction over a case. This is further corroborated by the fact that under section 144B of the Act, the records in a case are transferred back to the JAO as soon as the assessment proceedings are completed. So, section 144B of the Act lays down the role of NFAC and the units under it for the specific purpose of conducting assessment proceedings in a specific case in a particular Assessment Year. This cannot be construed to be meaning that the JAO is bereft of jurisdiction over a particular assessee or with respect to procedures not falling under the ambit of section 144B of the Act. Since, section 144B of the Act does not provide for issuance of notice under section 148 of the Act,there can be no ambiguity in the fact that the JAO still has the jurisdiction to issue notice under section 148 of the Act.”

On this basis, the High Court held that there was no merit in the writ petition, and accordingly dismissed it.

HEXAWARE TECHNOLOGIES LTD.’S CASE

The issue recently came up for consideration before the Bombay High Court in the case of Hexaware Technologies Ltd. vs. ACIT [2024] 162 taxmann.com 225 (Bombay).

In this case, the assessee was issued a notice dated 8^th April, 2021 under Section 148 for assessment year 2015–16. The assessee filed a writ petition challenging this notice issued under section 148, on the ground that the said notice has been issued under the unamended provisions, which have ceased to exist and are no longer in the statute. The petition was allowed on 29^th March 2022 and the Court held that the notice dated 8^th April 2021 was invalid.

Thereafter, the JAO issued another notice dated 25^th May 2022 stating that the said notice was issued in view of the decision of the Hon’ble Apex Court in Ashish Agarwal, whereby the notice issued under Section 148 during the period from 1^st April, 2021 to 30^th June, 2021 under the unamended provisions of Section 148 was to be treated as notice issued under Section 148A(b). The JAO also provided a copy of the reasons recorded and claimed that the information relied upon by him was embedded in the said reasons.

The assessee filed a detailed reply vide its letter dated 10^th June, 2022 raising objections challenging the validity of the notice on several grounds. The JAO issued another notice dated 29^th June, 2022 requiring the assessee to submit any further explanation / documentary evidence in support of its case before 4^th July, 2022, and it was also stated that a fresh notice was issued due to a change in incumbency as per the provisions of Section 129. The assessee informed the JAO that its earlier submission dated 10^th June, 2022 should be considered as a response to the fresh notice dated 29^th June, 2022.

The JAO passed an order under Section 148A(d) dated 26^th August, 2022 rejecting the objections raised by the appellant. Thereafter, the JAO also issued the notice under Section 148 dated 27^th August, 2022, which was issued manually, stating that he had information in the case of the assessee, which required action in consequence of the judgment of the Hon’ble Apex Court, which suggested that income chargeable to tax for Assessment Year 2015-2016 had escaped assessment. Separately, a communication dated 27^th August 2022 was issued where the JAO stated that DIN had been generated for the issuance of notice under Section 148 of the Act dated 26^th August, 2022.

The assessee approached the Court under Article 226 of the Constitution of India and challenged the validity of (i) notice dated 25^th May 2022 purporting to treat notice dated 8^th April 2021 as notice issued under Section 148A(b) for Assessment Year 2015-2016; (ii) the order dated 26^th August 2022 under Section 148A(d); and (iii) the notice dated 27^th August 2022 issued by the JAO under Section 148.

On the basis of the arguments advanced by both parties, the Court identified the issues as follows which were required to be adjudicated —

(1) Whether TOLA was applicable for Assessment Year 2015-2016 and whether any notice issued under Section 148 of the Act after 31^st March 2021 will travel back to the original date?

(2) Whether the notice dated 27^th August 2022 issued under Section 148 of the Act was barred by limitation as per the first proviso to Section 149 of the Act?

(3) Whether the impugned notice dated 27^th August 2022 was invalid and bad in law as the same had been issued without a DIN?

(4) Whether the impugned notice dated 27^th August 2022 was invalid and bad in law being issued by the JAO as the same was not in accordance with Section 151A of the Act?

(5) Whether the issues raised in the impugned order showed an alleged escapement of income represented in the form of an asset or expenditure in respect of a transaction in relation to an event or an entry in the books of account as required in Section 149(1)(b) of the Act?

(6) Whether the Assessing Officer had proposed to reopen on the basis of change of opinion and if it was permissible?

(7) When the claim of deduction under Section 80JJAA of the Act had been consistently allowed in favour of petitioner by the Assessing Officers/ Appellate Authorities in the earlier years, can the Assessing Officer have a belief that there was escapement of income?

(8) Whether the approval granted by the Sanctioning Authority was valid?

Since the subject matter of this article is limited to the issue of jurisdiction of the JAO to issue a notice under Section 148 post notification of ‘e-Assessment of Income Escaping Assessment Scheme, 2022’ under Section 151A, the other issues decided by the Court in this decision are not dealt with here.

With respect to Issue No. (4) as listed above, the assessee argued that the impugned notice dated 27^th August, 2022 was invalid and bad in law, being issued by the JAO, which was not in accordance with Section 151A, which gave power to the CBDT to notify the Scheme for the purpose of assessment, reassessment or recomputation under Section 147, for issuance of notice under Section 148 or for conducting of inquiry or issuance of show cause notice or passing of order under Section 148A or sanction for issuance of notice under Section 151. In exercise of the powers conferred under Section 151A, CBDT issued a notification dated 29^th March, 2022 after laying the same before each House of Parliament and formulated a Scheme called “the e-Assessment of Income Escaping Assessment Scheme, 2022” (the Scheme). The Scheme provided that (a) the assessment, reassessment or recomputation under Section 147 and (b) the issuance of notice under Section 148 shall be through automated allocation, in accordance with risk management strategy formulated by the Board as referred to in Section 148 for issuance of notice and in a faceless manner, to the extent provided in Section 144B with reference to making assessment or reassessment of total income or loss of assessee. The impugned notice under Section 148 dated 27^th August, 2022 had been issued by the JAO and not by the NFAC, which was not in accordance with the aforesaid Scheme and, therefore, bad in law.

The following contentions were raised by the revenue with respect to this issue —

The guideline dated 1^st August 2022 issued by the CBDT for issuance of notice u/s. 148 included a suggested format for issuing notice under Section 148, as an Annexure to the said guideline and it required the designation of the Assessing Officer along with the office address to be mentioned, therefore, it was clear that the JAO was required to issue the said notice and not the FAO.
ITBA step-by-step Document No.2 dated 24^th June 2022, an internal document, regarding issuing notice under Section 148 for the cases impacted by Hon’ble Supreme Court’s decision dated 4^th May 2022 in the case of Ashish Agarwal (Supra), required the notice issued under Section 148 to be physically signed by the Assessing Officers and, therefore, the JAO had jurisdiction to issue notice under Section 148 and it need not be issued by FAO.
FAO and JAO had concurrent jurisdiction and merely because the Scheme had been framed under Section 151A, it did not mean that the jurisdiction of the JAO was ousted or that the JAO could not issue the notice under Section 148.
The notification dated 29^th March 2022 issued under Section 151A provided that the Scheme so framed was applicable only ‘to the extent’ provided in Section 144B and Section 144B did not refer to the issuance of notice under Section 148. Hence, the notice could not be issued by the FAO as per the said Scheme.
No prejudice was caused to the assessee when the notice was issued by the JAO and, therefore, it was not open to the assessee to contend that the said notice was invalid merely because the same was not issued by the FAO.
Office Memorandum dated 20^th February, 2023 issued by CBDT (TPL Division) with the subject – ‘seeking inputs / comments on the issue of the challenge of the jurisdiction of JAO – reg.’ was also relied upon by the revenue in support of its stand that the notice under Section 148 was required to be issued by the JAO and not FAO.
The revenue also relied upon the decision of the Calcutta High Court in the case of Triton Overseas Pvt. Ltd. (supra).

On this issue under consideration, the Bombay High Court held as under –

There was no question of concurrent jurisdiction of the JAO and the FAO for issuance of notice under Section 148 or even for passing assessment or reassessment order. When specific jurisdiction has been assigned to either the JAO or the FAO in the Scheme dated 29^th March, 2022, then it was to the exclusion of the other. To take any other view on the matter would not only result in chaos but also render the whole faceless proceedings redundant. If the argument of Revenue was to be accepted, then even when notices were issued by the FAO, it would be open to an assessee to make submission before the JAO and vice versa, which was clearly not contemplated in the Act. Therefore, there was no question of concurrent jurisdiction of both FAO or the JAO with respect to the issuance of notice under Section 148 of the Act.
The Scheme dated 29^th March 2022 in paragraph 3 clearly provided that the issuance of notice “shall be through automated allocation” which meant that the same was mandatory and was required to be followed by the Department and did not give any discretion to the Department to choose whether to follow it or not.
The argument of the revenue that the Scheme so framed was applicable only ‘to the extent’ provided in Section 144B, the fact that Section 144B did not refer to issuance of notice under Section 148 would render the whole scheme redundant. The Scheme framed by the CBDT, which covered both the aspects of the provisions of Section 151A could not be said to be applicable only for one aspect, i.e., proceedings post the issue of notice under Section 148 of the Act being assessment, reassessment or recomputation under Section 147 and inapplicable to the issuance of notice under Section 148. The Scheme was clearly applicable for issuance of notice under Section 148 and accordingly, it was only the FAO which could issue the notice under Section 148 of the Act and not the JAO. The argument advanced by the revenue would render clause 3(b) of the scheme otiose. If clause 3(b) of the Scheme was not applicable, then only clause 3(a) of the Scheme remained. What was covered in clause 3(a) of the Scheme was already provided in Section 144B(1) of the Act, which Section provided for faceless assessment, and covered assessment, reassessment or recomputation under Section 147 of the Act. Therefore, if Revenue’s arguments were to be accepted, there was no purpose of framing a Scheme only for clause 3(a) which was in any event already covered under the faceless assessment regime in Section 144B of the Act. The phrase “to the extent provided in Section 144B of the Act” in the Scheme was with reference to only making assessment or reassessment of total income or loss of assessee. For issuing notice, the term “to the extent provided in Section 144B of the Act” was not relevant. The phrase “to the extent provided in Section 144B of the Act” would mean that the restriction provided in Section 144B of the Act, such as keeping the International Tax Jurisdiction or Central Circle Jurisdiction out of the ambit of Section 144B of the Act, would also apply under the Scheme.
When an authority acted contrary to law, thesaid act of the Authority was required to be quashed and set aside as invalid and bad in law, and the person seeking to quash such an action was not required to establish prejudice from the said act. An act which was done by an authority contrary to the provisions of the statute, itself caused prejudice to the assessee. Therefore, there was no question of the petitioner having to prove further prejudice before arguing the invalidity of the notice.
The guideline dated 1^st August 2022 relied upon by the Revenue was not applicable because these guidelines were internal guidelines as was clear from the endorsement on the first page of the guideline — “Confidential For Departmental Circulation Only”. These guidelines were not issued under Section 119 of the Act. Further, these guidelines were also not binding on the Assessing Officer, as they were contrary to the provisions of the Act and the Scheme framed under Section 151A of the Act. The scheme dated 29^th March, 2022 issued under Section 151A, which had also been laid before the Parliament, would be binding on the Revenue and the guidelines dated 1^st August, 2022 could not supersede the Scheme.
As regards ITBA step-by-step Document No.2 regarding issuance of notice under Section 148 of the Act, relied upon by Revenue, an internal document cannot depart from the explicit statutory provisions of, or supersede the Scheme framed by the Government under Section 151A of the Act, which Scheme was also placed before both the Houses of Parliament as per Section 151A(3) of the Act.
Office Memorandum dated 20^th February, 2023 as referred merely contained the comments of the Revenue issued with the approval of Member (L&S) CBDT and the said Office Memorandum was not in the nature of a guideline or instruction issued under Section 119 of the Act so as to have any binding effect on the Revenue. The High Court also dealt with several errors in the position which had been taken in the said Office Memorandum in detail in its order.
With respect to the decision in the case of Triton Overseas Private Limited (supra), it was noted that the Calcutta High Court did not consider the Scheme dated 29th March, 2022 but had referred to an Office Memorandum dated 20^th February, 2023, which could not have been relied upon, in the opinion of the Bombay High Court.

The Bombay High Court relied upon the decision of the Telangana High Court in the case of Kankanala Ravindra Reddy vs. ITO [2023] 156 taxmann.com 178 (Tel) wherein it was held that, in view of the provisions of Section 151A read with the Scheme dated 29^th March, 2022, the notice issued by the JAOs were invalid and bad in law.

Accordingly, on the basis of the above, the Bombay High Court decided the issue in favour of the assessee and declared the notice issued under Section 148 dated 27^th August, 2022 to be invalid and bad in law, having been issued by the JAO and, hence not being in accordance with Section 151A.

OBSERVATIONS

The power of the Assessing Officer to make the assessment or reassessment of income escaping assessment under Section 147 is subject to the provisions of sections 148 to 153. This is evident from the main operating provision of Section 147 which is reproduced below —

If any income chargeable to tax, in the case of an assessee, has escaped assessment for any assessment year, the Assessing Officer may, subject to the provisions of sections 148 to 153, assess or reassess such income or recompute the loss or the depreciation allowance or any other allowance or deduction for such assessment year (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year.

Therefore, it is mandatory for the Assessing Officer to comply with the requirements of sections 148 to 153 in order to make the assessment or reassessment of the income escaping assessment. The Assessing Officer will lose his jurisdiction to make the assessment under section 147 if he has contravened the provisions of sections 148 to 153.

Issuance of notice under section 148 is a sine qua non for the purpose of making the assessment or reassessment of income escaping assessment under section 147. There are several conditions which have been imposed under several sections for the purpose of issuing notice under section 148, viz. time limit within which the notice can be issued, obtaining of sanction of the higher authority before issuance of the notice, etc. Time and again, the Courts have held the notice issued under section 148 to be bad in law if it has been issued without fulfilling the relevant conditions which were required to be satisfied before issuing the said notice.

Section 151A is also one of the provisions of the entire scheme of reassessment, as provided in sections 147 to 153. It authorises the Central Government to make a scheme by notification in the Official Gazette. The objective of the said scheme to be notified should be to impart greater efficiency, transparency and accountability by—

(a) eliminating the interface between the income-tax authority and the assessee or any other person to the extent technologically feasible;

(b) optimising utilisation of the resources through economies of scale and functional specialisation;

(c) introducing a team-based assessment, reassessment, re-computation or issuance or sanction of notice with dynamic jurisdiction.

In line with this objective, the Central Government notified e-Assessment of Income Escaping Assessment Scheme, 2022 vide Notification No. 18/2022 dated 29-3-2022. This Scheme provided not only for making of the assessment or reassessment under section 147, but also for issuing notice under section 148 in a faceless manner through automated allocation.

The requirement of issuing notice under section 148 in a faceless manner by the FAO is mandatorily applicable without any exceptions. When the jurisdiction to issue any particular notice under the Act lies with a particular officer, another officer cannot assume that jurisdiction and issue that notice. It is a settled proposition that when a law requires a thing to be done in a particular manner, it has to be done in the prescribed manner and proceeding in any other manner is necessarily forbidden. The Madras High Court in the case of Danish Aarthi vs. M. Abdul Kapoor [C.R.P.(NPD)(MD)No.475 of 2004 and C.R.P.(NPD)(MD)No.476 of 2004] has dealt with this principle extensively and the relevant observations of the High Court in this regard are reproduced below –

20. It is well settled in law that when a statute prescribes to do a particular thing in a particular manner, the same shall not be done in any other manner than prescribed under the law. The said proposition is well recognised as held by the Honourable Supreme Court in the following decisions:

(a) In the decision reported in AIR 1964 SC 358 (State of Uttar Pradesh vs. Singhara Singh) in paragraphs 7 and 8 of the Judgment, it is held thus, “7. In Nazir Ahmed’s case, 63 Ind App 372: (AIR 1936 PC 253 (2)) the Judicial Committee observed that the principle applied in Taylor vs. Taylor, (1876) 1 Ch.D 426 to a Court, namely, that where a power is given to do a certain thing in a certain way, the thing must be done in that way or not at all and that other methods of performance are necessarily forbidden, applied to judicial officers making a record under S.164 and, therefore, held that the magistrate could not give oral evidence of the confession made to him which he had purported to record under S.164 of the Code. It was said that otherwise all the precautions and safeguards laid down in Ss.164 and 364, both of which had to be read together, would become of such trifling value as to be almost idle and that “it would be an unnatural construction to hold that any other procedure was permitted than that which is laid down with such minute particularity in the sections themselves.”

8. The rule adopted in Taylor vs. Taylor (1876) 1 Ch D 426 is well recognized and is founded on sound principles. Its result is that if a statute has conferred a power to do an act and has laid down the method in which that power has to be exercised, it necessarily prohibits the doing of the act in any other manner than that which has been prescribed. The principle behind the rule is that if this were not so, the statutory provision might as well not have been enacted. A magistrate, therefore, cannot in the course of investigation record a confession except in the manner laid down in S.164. The power to record the confession had obviously been given so that the confession might be proved by the record of it made in the manner laid down. If proof of the confession by other means was permissible, the whole provision of S.164 including the safeguards contained in it for the protection of accused persons would be rendered nugatory. The section, therefore, by conferring on magistrates the power to record statements or confessions, by necessary implication, prohibited a magistrate from giving oral evidence of the statements or confessions made to him.”

(b) The said proposition is also reiterated in the decision reported in (1999) 3 SCC 422 (BabuVerghese vs. Bar Council of Kerala). In paragraphs 31 and 32 of the Judgment, the Honourable Supreme Court held thus, “31. It is the basic principle of law long settled that if the manner of doing a particular act is prescribed under any statute, the act must be done in that manner or not at all. The origin of this rule is traceable to the decision in Taylor vs. Taylor ((1875)1 Ch D 426) which was followed by Lord Roche in Nazir Ahmad vs. King Emperor (AIR 1936 PC 253) who stated as under: “(W)here a power is given to do a certain thing in a certain way, the thing must be done in that way or not at all.”

32. This rule has since been approved by this Court in Rao Shiv Bahadur Singh vs. State of V.P. (AIR 1954 SC 322) and again in Deep Chand vs. State of Rajasthan (AIR 1961 SC 1527). These cases were considered by a three-Judge Bench of this Court in State of U.P. vs. Singhara Singh (AIR 1964 SC 358) and the rule laid down in Nazir Ahmed case (AIR 1936 PC 253) was again upheld. This rule has since been applied to the exercise of jurisdiction by courts and has also been recognised as a salutary principle of administrative law.”

(c) In Captain Sube Singh vs. Lt.Governor of Delhi, AIR 2004 SC 3821 : (2004) 6 SCC 440, the Supreme Court, at paragraph 29, held as follows: “29. In Anjum M.H. Ghaswala a Constitution Bench of this Court reaffirmed the general rule that when a statute vests certain power in an authority to be exercised in a particular manner then the said authority has to exercise it only in the manner provided in the statute itself. (See also in this connection Dhanajaya Reddy vs. State of Karnataka.) The statute in question requires the authority to act in accordance withthe rules for variation of the conditions attached to the permit. In our view, it is not permissible to the State Government to purport to alter these conditions by issuing a notification under Section 67(1)(d) read with sub-clause (i) thereof.”

(d) In State of Jharkhand vs. Ambay Cements, (2005) 1 SCC 368: 2005 (1) CTC 223, at paragraph 26 (in SCC), the Supreme Court held as follows: “26. Whenever the statute prescribes that a particular act is to be done in a particular manner and also lays down that failure to comply with the said requirement leads to severe consequences, such requirement would be mandatory. It is the cardinal rule of interpretation that where a statute provides that a particular thing should be done, it should be done in the manner prescribed and not in any other way. It is also a settled rule of interpretation that where a statute is penal in character, it must be strictly construed and followed. Since the requirement, in the instant case, of obtaining prior permission is mandatory, therefore, non-compliance with the same must result in cancelling the concession made in favour of the grantee, the respondent herein.”

(e) The Division Bench of this Court in 2009 (1) CTC 32 (Indian Network for People living with HIV/AIDS vs. Union of India) and in 2002 (1) LW 672 (Rev. Dr. V. Devasahayam, Bishop in Madras CSI and another vs. D. Sahayadoss and two others) also held to the same effect.

Therefore, the JAO cannot be permitted to issue the notice under section 148 which under the law is required to be issued by the FAO. Further, there is no express provision under the Act providing for concurrent jurisdiction of both; JAO and FAO. To take a view that the JAO also has a concurrent jurisdiction for issuing notice under section 148 would be against the very objective of making the processes under the Act faceless.

The Bombay High Court has dealt with the provisions of section 151A as well as the scheme notified thereunder extensively and took the view that the notice would be invalid if it is issued by the JAO post the effective date of the scheme. The Calcutta High Court merely relied upon the office memorandum dated 20^th February, 2023 being F No. 370153/7/2023-TPL issued by the CBDT, which was not having any authority under the Act. In view of this, the view taken by the Bombay High Court and Telangana High Court appears to be the better view of the matter.

BCAJ Admin

Loss on Reduction of Capital without Consideration

ISSUE FOR CONSIDERATION

Under section 66 of the Companies Act, 2013, a company can reduce its share capital by inter alia cancelling any paid-up share capital which is lost or is not represented by available assets, or for payment of any paid-up share capital which is in excess of the wants of the company, after obtaining the approval of the National Company Law Tribunal (NCLT). The reduction of share capital may be effectuated either by cancelling some shares, or by reducing the paid-up value of all shares. When paid-up share capital which is lost or unrepresented by available assets is reduced, either by cancelling some shares or by reducing the paid-up value of all shares, no consideration is paid to the shareholders, as the share capital is set off against the accumulated losses (debit balance in the Profit & Loss Account).

While the Supreme Court has held that reduction of share capital is a transfer in the hands of the shareholder, in the cases of Kartikeya V. Sarabhai vs. CIT 228 ITR 163 and CIT vs. G Narasimhan 236 ITR 327, and there arose a liability to pay capital gains tax where a consideration was received on reduction of capital the issue has arisen before various benches of the Tribunal as to whether in cases of capital reduction where no amount is paid to the shareholder, whether a capital loss is allowable to the shareholder, since there is no consideration received by him on such reduction.

Special Bench of the Mumbai Tribunal has taken a view that a capital loss is not allowable on reduction of capital without any payment, a recent decision of the Mumbai bench of the Tribunal however has taken the view that in such a case, the shareholder is entitled to claim a loss under the head ‘capital gains’.

BENNETT COLEMAN & CO’S CASE

The issue had come up before the Special Bench of the Mumbai Tribunal in the case of Bennett Coleman & Co Ltd vs. Addl CIT 133 ITD 1(Mum)(SB).

In this case, the assessee had made an investment of ₹2,484.02 lakh in equity shares of a group company, TGL. TGL applied to the Bombay High Court for reduction of its equity share capital by 50 per cent, by reducing the face value of each share from ₹10 to ₹5, which was approved by the High Court. The assessee claimed a capital loss of half its investment, claiming the indexed cost of ₹1,242.01 lakh (₹2,221.85 lakh) as a capital loss.

Before the Assessing Officer (AO), it was claimed that such loss was allowable in view of the decisions of the Supreme Court in the cases of Kartikeya V Sarabhai (supra) and G Narasimhan (supra), where it was held that reduction of face value of shares was a transfer. According to the AO, the decision of the Supreme Court in the case of Kartikeya Sarabhai(supra) could not be applied, because in that case the voting rights were also reduced proportionately on the reduction in face value of preference shares, whereas in the case before him, there was no reduction in the rights of the equity shareholders. According to the AO, since there was no change in the rights of the assessee vis-à-vis other shareholders, no transfer had taken place and thus the assessee was not entitled to the claim of long-term capital loss.

The Commissioner (Appeals) upheld the action of the AO in disallowing the claim for capital loss.

Before the Tribunal, on behalf of the assessee, it was argued that the claim of long-term capital loss had been rejected mainly on the ground that no transfer had taken place. It was pointed out that the accumulated losses of ₹42.97 crore of TGL were written off by the reduction of capital and by utilising the share premium account. Equity shares of ₹10 each were reduced to equity shares of ₹5 each by cancelling capital to the extent of ₹5 per equity share, and thereafter every two such equity shares of ₹5 each were consolidated into one equity share of ₹10 each, under the scheme of reduction of capital. The assessee’s shareholding of 1,34,74,799 shares of ₹10 each was therefore reduced to 67,37,399 shares of ₹10 each. It was argued on behalf of the assessee that the shares received after reduction of capital were credited to the demat account under a different ISIN, which clearly indicated that the new shares were different shares. This was therefore an exchange of shares which was covered by the definition of “transfer”.

On behalf of the assessee it was argued that the Supreme Court had observed in the case of Kartikeya Sarabhai (supra) that the definition of transfer in section 2(47) was an inclusive one, which inter alia provided that relinquishment of an asset or extinguishment of any right therein would also amount to transfer of a capital asset. It was further argued that even if it was assumed that the principle laid down by the Supreme Court in the case of preference shares was not applicable, the principle laid down in the case of G Narasimhan(supra) squarely applied, since the issue in that case was regarding reduction of equity share capital. Reliance was also placed on the decision of the Supreme Court in the case of CIT vs. Grace Collis 248 ITR 323, wherein the Supreme Court observed that the expression ‘extinguishment of any right therein’ could be extended to extinguishment of rights independent of or otherwise than on account of transfer. It was argued that therefore, even extinguishment of rights in a capital asset would amount to transfer, and in the case before the Tribunal, since the assessee’s right got extinguished proportionately due to the reduction of capital, it would amount to transfer.

Attention of the Tribunal was drawn to the following decisions of the Tribunal, where it had been held that reduction of capital would amount to transfer and capital loss was therefore held to be allowable:

Zyma Laboratories Ltd vs. Addl CIT 7 SOT 164 (Mum)

DCIT vs. Polychem Ltd ITA No 4212/Mum/07

Ginners & Pressers Ltd vs. ITO 2010(1) TMI 1307 – ITAT Mumbai

The Bench raised the question that the capital loss had not been disallowed only on the ground that it would not amount to transfer but mainly on the point that the assessee had not received any consideration, by applying the principle laid down by the Supreme Court in the case of CIT vs. B C SrinivasaSetty 128 ITR 294, wherein it was held that if the computation provisions fail, capital gains cannot be assessed under section 45.

Responding to the question, on behalf of the assessee, it was pointed out that in the case of B C Srinivasa Setty (supra), the Supreme Court held that it was not possible to ascertain the cost of goodwill and therefore it was not possible to apply the computation provisions. The proposition was not that if no consideration was received then no gain could be computed, but the proposition was that if any of the elements of the computation provisions could not be ascertained, then the computation provisions would fail, and such gain could not be assessed to capital gains tax. In the case of the assessee, the consideration was ascertainable, and should be taken as zero.

On behalf of the revenue, it was argued that the value of assets of the company remained the same before and immediately after such reduction, and therefore no loss was caused to the assessee. It was argued that a share meant proportionate share of assets of the company, and since share of the assessee in the company’s assets had not gone down, therefore no loss could be said to have been incurred by the assessee. It was argued that reduction of share capital could at best lead to a notional loss.

Attention of the bench was drawn to section 55(2)(v), which defines cost of acquisition in case of shares in the event of consolidation, division or conversion of original shares, as per which clause, original cost had to be taken as cost of acquisition. It was argued that therefore the cost of acquisition would remain the same to the assessee as per this provision.If the loss on reduction of share capital was allowed at this stage, in future if such shares were sold, the assessee could then claim the cost as cost of acquisition, which would be a double benefit to the assessee, which was not permissible under law as laid down by the Supreme Court in the case of Escorts Ltd. vs. Union of India 199 ITR 43.

It was further submitted on behalf of the revenue that whenever a company issued bonus shares, no capital gains was chargeable on the mere receipt of such bonus shares, and capital gains would be charged only when such bonus shares were sold by the assessee. A similar principle needed to be applied in a case when the assessee’s shareholding was reduced on reduction of such capital. It was argued that at best, just as held by the Supreme Court in CIT vs. Dalmia Investment Co Ltd 52 ITR 567that average cost of shares would have to be taken when bonus shares are sold, meaning that the cost of the shares was adjusted and cost of acquisition was taken at average value, the same principle should be applied on reduction of share capital, average cost of holding after reduction of capital would increase, and the loss could be considered only when such shares were transferred for a consideration.

It was argued that this principle has been affirmed by the Supreme Court in the case of Dhun Dadabhoy Kapadia v CIT 63 ITR 651, where the court held that gain was to be understood in a similar way as understood by the commercial world, and receipt on sale of right to subscribe to rights shares was required to be reduced by fall in the value of existing shareholding. Following the same principle, it was argued that at best in the assessee’s case, the value of reduced shareholding could be increased (cost of acquisition could be increased) but the loss could not be allowed, since at the stage of capital it was only a notional loss.

In rejoinder on behalf of the assessee, it was pointed out that no double benefit had been obtained by the assessee, since the cost claimed had been reduced from the value of investment.

The Tribunal referred to the decision of the Supreme Court in the case of CIT vs. Rasiklal Maneklal HUF 177 ITR 198, where shares were received by the assessee in the amalgamated company in lieu of shares held in the amalgamating company. In that case, the Supreme Court had observed that in case of exchange, where one person transfers a property to another person in exchange of another property, the property continues to be in existence. Therefore, the Supreme Court had held that since the shares of the amalgamating company had ceased to be in existence, the transaction did not involve any transfer. Applying those principles to the case before it, the Tribunal observed that if the argument of the assessee was accepted, older shares with different ISIN ceased to exist and new shares with different ISIN were issued, which would not be called a case of extinguishment or relinquishment, but was a mere case of substitution of one kind of share with another. According to the Tribunal, the assessee got its new shares on the strength of its rights with the old shares, and therefore this would not amount to a transfer.

Analysing the decision of the Supreme Court in the case of G Narasimhan(supra), which involved reduction of share capital in respect of equity shares, the Tribunal observed that a careful analysis of this decision indicated that whenever there was reduction of shares and upon payment by the company to compensate the value equivalent to reduction, apart from the effect on shareholders rights to vote, etc, a transfer could be said to have taken place. The question was whether this would still attract section 45.

According to the Tribunal, the answer was given by the Gujarat High Court in the case of CIT vs. MohanbhaiPamabhai 91 ITR 393, where the High Court held that section 48 showed that the transfer that was contemplated by section 45 was a transfer as a result of which consideration was received by the assessee or accrued to the assessee. If there was no consideration received or accruing to the assessee as a result of the transfer, the machinery section enacted in section 48 would be wholly inapplicable, and it would not be possible to compute profits or gains arising from the transfer of the capital asset. According to the High Court, the transaction in order to attract the charge of tax as capital gains must therefore clearly be such that consideration is received by the assessee or accrues to the assesse as a result of the transfer of the capital asset. Where transfer consisted in extinguishment of rights in a capital asset, there must be an element of consideration for such extinguishment, for only then would it be a transfer exigible to capital gains tax. The Tribunal noted that the Supreme Court had dismissed the appeal of the revenue against this decision, which is reported as Addl CIT vs. MohanbhaiPamabhai 165 ITR 166.

Analysing the decision of the Supreme Court in the case of Sunil Siddharthbhai(supra), the Tribunal observed that the court relied upon the principle laid down in the case of CIT vs. B C Srinivasa Setty (supra), and held that unless and until consideration was present, the computation provisions of section 48 would not be workable, and therefore such transfer could not be subjected to tax. The court further held that unless and until the profits or losses were real, the same could not be subjected to tax. Referring to the Supreme Court decision of B C Srinivasa Setty(supra), the Tribunal noted that it was clear that unless and until a particular transaction led to computation of capital gain or loss as contemplated by section 45 and 48, it would not attract capital gains tax.

The Tribunal observed that in the case before it, the assessee had not received any consideration for a reduction of share capital. Ultimately the number of shares held by the assessee had been reduced to 50 per cent, and that nothing had moved from the side of the company to the assessee. Addressing the argument of the assessee that the decision of Mohanbhai Pamabhai (supra) was not applicable, because in this case it was possible to ascertain the consideration by envisaging the same as zero, the Tribunal held that in the case of reduction of capital, nothing moved from the coffers of the company, and therefore it was a simple case of no consideration which could not be substituted to zero. The Tribunal also noted that wherever the legislature intended to substitute the cost of acquisition at zero, specific amendment had been made. In the absence of such amendment, it had to be inferred that in the case of reduction of shares, without any apparent consideration, and that too in a situation where the reduction had no effect on the right of the shareholder with reference to the intrinsic rights on the company, section 45 was not applicable.

The Tribunal rejected the reliance by the assessee on the decision of the Karnataka High Court in the case of Dy CIT vs. BPL Sanyo Finance Ltd 312 ITR 63, a case of claim of loss on forfeiture of partly paid up shares, on the ground that in the case before it, shares had not been cancelled but only the number of shares had been reduced, which was only a notional loss. Further according to the Tribunal, in that case, the decision of the Supreme Court in the case of B C Srinivasa Setty (supra) had not been considered, but it had decided this issue on the basis of the Supreme Court decision in the case of Grace Collis (supra)

Noting the decision of Grace Collis (supra), the Tribunal observed that it was clear that even extinguishment of rights in a particular asset would amount to transfer. It however observed that in the case before it, the assessee’s rights had not been extinguished, since the effective share of the assessee in the assets of the company would remain the same immediately before and after reduction of such capital.

The Tribunal went on to analyse in great detail with illustrations as to how issue of bonus shares by a profit-making company or reduction of capital by a loss-making company did not affect the shareholders rights, because such profit or loss belonged to the company. According to the Tribunal, since the share of the shareholder in the net worth of the company remained the same before and after reduction of capital, there was no change in the intrinsic value of his shares and even his rights vis-à-vis other shareholders as well as vis-à-vis the company would remain the same. Therefore, the Tribunal was of the view that there was no loss that could be said to have actually accrued to the shareholder as a result of reduction in the share capital.

The Tribunal also relied on the decision of the Bombay High Court in the case of Bombay Burmah Trading Corpn Ltd vs. CIT 147 Taxation Reports 570 (Bom), a very short judgment where the facts were not discussed, but the question was answered by the Bombay High Court as being covered by the ratio of the decision of the Supreme Court in the case of B C Srinivasa Setty (supra), and held to be not a referable question of law, as the answer to the question was self-evident. According to the Tribunal, in that case it was held that if no compensation was received, then capital loss cannot be allowed, and that the decision of the jurisdictional High Court could not be ignored by the Tribunal simply because it was assumed that certain aspects of the issue might not have been considered by the jurisdictional High Court.

The Tribunal also relied upon the decision of the Authority for Advance Rulings in the case of Goodyear Tire & Rubber Co, in re, 199 Taxman 121, where the assessee, a US company, propose to contribute voluntarily its entire holding in an Indian company to a Singapore-based group company voluntarily without consideration. The AAR held that no income would arise, as the competition provision under section 48 could not be given effect to, and therefore the charge under section 45 failed, in view of the decisions of the Supreme Court in the case of B C Srinivasa Setty (supra) and Sunil Siddharth bhai (supra).

The Tribunal also agreed with the submissions of the revenue that the provisions of section 55(2)(v) would apply in such a case and that after reduction of share capital, the cost of acquisition of the remaining shares would be reckoned with reference to the original cost.

The Tribunal therefore held that the loss arising on account of reduction in share capital could not be subjected to provisions of section 45 with section 48, and accordingly, such loss was not allowable as capital loss. At best, such loss was a notional loss, and it was a settled principle that no notional loss or income could be subjected to the provisions of the Income Tax Act.

This decision of the Special bench was also followed by another bench of the Mumbai Tribunal in the case of Shapoorji Pallonji Infrastructure Capital Company Pvt Ltd vs. Dy CIT, ITA No 3906/Mum/2019.

TATA SONS’ CASE

The issue again recently came up before the Mumbai bench of the Tribunal in the case of Tata Sons Ltd v CIT 158 taxmann.com 601.

In this case, the assessee held 288,13,17,286 equity shares in TTSL, an Indian telecom company which had incurred substantial losses in the course of its business. A Scheme of Arrangement and Restructuring was entered into by TTSL and its shareholders whereby the paid up equity share capital was to be reduced by reducing the number of equity shares of the company by half, and given effect to by reducing the amount from the accumulated debit balance in the Profit and Loss Account and by a reduction from Share Premium Account. No consideration was payable to the shareholders in respect of the shares which were to be cancelled. The reduction of capital was effected under section 100 of the Companies Act, 1956. As a result of such reduction of capital, the assessee’sshare holding of 288,13,17,286 equity shares in TTSL was reduced to half, i.e. 144,06,58,643 equity shares.

In its return of income, the assessee claimed a long-term capital loss on reduction of the shares of TTSL of ₹2046,97,54,090. During the course of assessment proceedings, in response to a query from the AO, the assessee provided details, the working of the capital gains, and explained how the claim of the assessee for long term capital losses was allowable in view of the decisions of the Supreme Court in the cases of Kartikeya Sarabhai (supra), G Narasimhan (supra) and D P Sandhu Brothers ChemburPvt Ltd 273 ITR 1. It was specifically pointed out that reduction of capital, i.e. loss of shares, was tantamount to a transfer under section 2(47), and that computation provision can fail only if it was not possible to conceive of any element of cost.

A show cause notice was issued by the AO asking as to why corresponding cost of shares on reduction in share capital of TTSL should not be treated as cost of the balance shares of TTSL. The AO asked for further details of capital gains, which was duly provided. After examining the factual and legal submissions, the AO accepted the assessee’s claim for long term capital loss in his assessment order under section 143(3).

The Principal Commissioner of Income Tax (PCIT) initiated revision proceedings under section 263, on various grounds, and held that the assessment order was erroneous and prejudicial to the interests of revenue on the following grounds:

since no consideration had accrued or received as a result of transfer of the capital asset, the provisions of section 48 could not be applied;
the Supreme Court decision in the case of Kartikeya Sarabhai was distinguishable as that was not a case of reduction in the face value of shares but an effacement of the entire shares;
the scheme was claimed as a scheme of arrangement and restructuring but was not a scheme of reduction of capital;
the consideration received is ₹ nil and not ₹ zero;
in another company, Tata Power Ltd, the AO had disallowed the capital loss in respect of reduction of share capital/cancellation of shares of TTSL.

The PCIT therefore directed the AO to determine the total income by disallowing the long-term capital loss after giving the assessee an opportunity of being heard.

Before the Tribunal, on behalf of the assessee it was argued that:

the issue had been examined by the AO during assessment proceedings and, if the AO had taken one possible view of the matter, then the CIT could not revise or cancel the assessment order within the scope of section 263;
the PCIT failed to consider that it is possible in law for schemes of reduction of capital to provide for payment of consideration to the holders of the shares; in such cases the Tribunal has held that it is an allowable capital loss, whether or not consideration was payable in terms of the scheme;
the PCIT had based his decision on an entirely incorrect legal principle that the provisions of section 48 failed and therefore no capital loss can be determined in the case where no consideration is received/accrues to the transferor of the capital asset. This was contrary to the well-settled law laid down by the Supreme Court in B C Srinivasa Setty (supra) and D P Sandhu Brothers ChemburPvt Ltd (supra), wherein the correct principle laid down was that the capital gains computation provisions may be held not to apply, if and only if, any part thereof cannot conceivably be attracted. The correct principle is that if it is impossible to conceive of consideration as a result of the transfer, then perhaps it could be argued that the provisions of section 48 do not apply.
There is a vast difference between a case where no consideration is conceivable in a transaction, as opposed to a case where nil consideration is received; if it is conceivable that consideration can result, that consideration may be zero or nil or any figure. This is vastly different from no consideration being conceivable.
There could be no dispute that the shares held by the assessee had been reduced, which had led to a huge loss to the assessee, which was clearly a capital loss.
It was undisputed that the reduction of capital effected under the scheme resulted in cancellation of 144,06,58,653 equity shares of TTSL held by the assessee; such cancellation in extinguishment of the shares clearly amounted to a transfer as defined in section 2(47); the provisions of section 45 were clearly attracted as the shares had been transferred; the provisions of section 48 were also clearly attracted; on a plain reading of the provisions, it was indisputable that a capital loss had arisen as a result of transfer of the shares and consequently allow ability of the capital loss was certainly a possible view, and accordingly the provisions of section 263 could not have been invoked by the PCIT;
The view of the PCIT that since no consideration was received by the assessee on reduction of capital, the provisions of section 45 to 48 could not be applied, cannot be termed to be a correct, irrefutable, or definitive view and was not supported by any statutory provision or principle of law or binding judicial precedent.
The decision of the Gujarat High Court in the case of CIT vs. Jaykrishna Harivallabhdas 231 ITR 108 holds in favour of the assessee’s contention that the capital loss was to be computed in cases even where no consideration had been received on the transfer of a capital asset.
The order of the Delhi High Court approving the scheme specifically provided that the scheme was one of reduction of capital.

Addressing the conclusion of the PCIT that the computation mechanism under section 48 fails, it was argued on behalf of the assessee that the correct principle was that the capital gains provisions may be held not to apply if and only if any part thereof cannot conceivably be attracted. Although no consideration had been received by or had accrued to the assessee, it was certainly possible to conceive of consideration being received or receivable in such cases, and that the consideration here was zero. Reliance was placed on the decisions of the Tribunal in the cases of Jupiter Capital Pvt Ltd vs. ACIT (ITA No 445/Bang/2018) and Ginners and Pressers Ltd v ITO 2010 (1) TMI 1307 – ITAT MUMBAI for the proposition that when there was a reduction by way of cancellation of shares, it constituted a transfer under section 2(47) and the consequential capital loss was allowable whether or not any consideration was received/receivable by the shareholder.

It was argued on behalf of the assessee that the ITAT Special Bench decision in the case of Bennett Coleman and Co Ltd(supra) was not applicable due to the following reasons:

this was a case where section 263 had been invoked where the AO had taken a possible view of the matter, while in Bennett Coleman’s case, there was a dissenting order;
in Bennett Coleman’s case, there was a substitution of shares, which was not the fact in Tata Sons case. This distinction had been noted by the Tribunal in the case of Carestream Health Inc. vs. DCIT 2020 (2) TMI 325 – ITAT Mumbai, where the Tribunal had allowed capital loss on cancellation of shares.

It was pointed out that section 55(2)(v)(b) does not include the situation of cancellation of shares held consequent to reduction of capital, and hence if the cost of the cancelled shares is not allowed in the year of cancellation, it will never be allowed.

On behalf of the revenue, it was submitted that the AO had not examined the correct principle of law on the facts of the case. The judgements relied upon by the assesse in the facts of the case, because none of the cases pertains to loss on reduction of capital. Even if there is a transfer under section 2(47), the computation mechanism fails because there is no cost. On this very issue there was an ITAT Mumbai Special Bench Decision in the case of Bennett Coleman(supra), which had considered all the judgements of the Supreme Court cited by the assessee, and had categorically held that in the case of reduction of capital, if no consideration can be determined, then the computation mechanism fails. In view of this decision of the Special Bench, it was submitted that the claim of the assessee cannot be upheld, because capital gain / loss cannot be determined.

Looking at the facts, the Tribunal observed that there could be no dispute that there was a loss on the capital account by way of reduction of capital invested, and therefore any loss on capital account was a capital loss. The issue therefore was whether it was a notional loss, and even if it was a capital loss whether the same could be allowed because no consideration had been received by or accrued to the assessee.

The Tribunal analysed the provisions of section 100(1) of the Companies Act, 1956, which provided for the manner in which reduction of capital could be effected. This also envisaged payment of any paid up capital which was in excess of the wants of the company. Thus, the Tribunal noted that there could be a case where the consideration was paid on the reduction of capital, or there could be a case where consideration was not paid at all. The Tribunal questioned as to whether, in such circumstances, two views could be taken in the reduction of capital, one where certain consideration was paid, and another where no consideration was paid. For instance, if the assessee had received a nominal consideration, then it would be entitled to claim the capital loss. Not allowing such loss just because the assessee had not received any consideration, was a reasoning which the Tribunal expressed its inability to accept.

The Tribunal noted that the issue of whether the reduction of face value of shares amounted to transfer or not had been settled by the Supreme Court in the case of Kartikeya Sarabhai(supra), where the court held that it was not possible to accept the contention that there had been no extinguishment of any part of the right as a shareholder qua the company, on reduction of capital by reduction of face value of shares of the company. It noted the observations of the Supreme Court to the effect that when, as a result of reducing the face value of the shares, the share capital is reduced, the right of the preference shareholder to the dividend or his share capital and the right to share in the distribution of the net assets upon liquidation is extinguished proportionately to the extent of reduction in the capital. According to the Supreme Court, such reduction of right of the capital asset amounted to a transfer within the meaning of that expression in section 2(47).

Further referring to the decision of the Karnataka High Court in the case of BPL Sanyo Finance Ltd(supra) and the decision of the Supreme Court in the case of Grace Collis(supra), the Tribunal concluded that if the right of the assessee in the capital assets stood extinguished either upon amalgamation or by reduction of shares, it amounted to transfer of shares within the meaning of section 2, and therefore computation of capital gains had to be made. As per the Tribunal, there could be no quarrel that reduction of equity shares under a Scheme of Arrangement and Restructuring in terms of section 100 of the Companies Act amounted to extinguishment of rights in the shares, and hence was a transfer within the ambit and scope of section 2 (47).

As regards cost of acquisition, the Tribunal referred to the Supreme Court decision in the case of D P Sandhu Brothers ChemburPvt Ltd (supra), where the court analysed its decision in B C Srinivasa Setty(supra), and concluded that an asset which was capable of acquisition act at a cost would be included within the provisions pertaining to the head “capital gains”, as opposed to assets in the acquisition of which no cost at all can be conceived. According to the Tribunal, from a plain reading of this judgement, the sequitur was, where the cost of acquisition is inherently capable of being determined or not, i.e. whether it was possible to envisage the cost of an asset which was capable of acquisition at a cost. The distinction had been made by the Supreme Court where the asset which was capable of acquisition at a cost would be included for the purpose of computing capital gains, as opposed to assets in the acquisition of which no cost at all could be conceived. If cost could be conceived, then it was chargeable under the head capital gains.

Applying this ratio to the facts before it, the Tribunal noted that the assessee had incurred the cost for acquiring the shares, and therefore there was no dispute regarding cost of acquisition. The assessee did not receive any consideration due to reduction of capital, which had resulted into a loss to the assessee. The issue examined by the Tribunal was, whether the price could be conceived or not? It noted that the price on paper for which the assessee had acquired the asset had been reduced to half the cost, as half the cost was waived off / extinguished.

The Tribunal raise the question that if Re 1 per share had been received on reduction of capital, could it be said that there was no consideration received or consideration was inconceivable, and if zero was received, could it be said that there was no conceivable consideration at all or that zero was not a consideration?

The Tribunal noted that this issue has been addressed by the Gujarat High Court in the case of Jaykrishna Harivallabhdas (supra), where the Gujarat High Court pointed out the incongruity, anamoly and absurdity of taking a view that in a case where a negligible or insignificant sum was disbursed on liquidation, capital gains was to be computed, but where nothing was disbursed on liquidation of the company, the extinguishment of rights would result in total loss with no consequence. The Gujarat High Court had accordingly held that even when there was a nil receipt of capital, the entire extinguishment of rights had to be written off as a loss resulting from computation of capital gains. According to the Tribunal, this ratio of the Gujarat High Court was clearly applicable on the facts of the case before it, because they could be no distinction where an assessee received negligible point insignificant consideration, and where the assessee received nil consideration. The Tribunal was of the view that this judgement and the ratio clearly clinched the issue in favour of the assessee.

The Tribunal therefore held that:

the reduction of capital was extinguishment of right on the shares amounting to a transfer within the meaning and scope of section 2(47);
the loss on reduction of shares was a capital loss and not a notional loss;
even when the assessee had not received any consideration on reduction of capital but its investment was reduced to a loss, resulting into a capital loss, while computing the capital gain, capital loss had to be allowed or set-off against any other capital gain.

The Tribunal distinguished the decision of the Special Bench in the case of Bennett Coleman & Co(supra) by observing that that was a case of substitution of shares, which was not the case before it. The distinction on the facts had been noted by the Tribunal in the case of Care stream Health Inc.(supra). It noted the minority judgment in the Special Bench decision, where the accountant member had held that a shareholder who is capital has been reduced is deprived of his right to receive that part of the share capital which has been reduced and therefore it is an actual loss. In that minority judgement, the distinction between cases where cost of acquisition is incapable of ascertainment and cases in which it is ascertained as zero was clearly brought out.

The Tribunal observed that it was not relying upon the minority judgment in the Special Bench case, but that the case before it was of the revision under section 263. According to the Tribunal, the dissenting judgement when to show that it was a possible view, if a view had been taken by the AO in favour of the assessee, then the order of the AO could not be said to be erroneous and could not therefore have been set aside or cancelled. It noted that it was following the Gujarat High Court decision in the case of Jaykrishna Harivallabhdas(supra) as against the majority judgment given by the Tribunal Special Bench in Bennett Coleman & Co(supra).

The Tribunal therefore held that the AO had rightly allowed the computation of long-term capital loss, to be set-off against the capital gain shown by the assessee, and therefore set aside the revision order of the PCITu/s 263.

OBSERVATIONS

The heart of the controversy in this case revolved around the understanding of the Supreme Court decision in the case of B C Srinivasa Setty (supra) – whether the ratio decided applied to all situations where there was no cost of acquisition or whether it applied only to situations where the cost of acquisition was not conceivable. The language of the Court was “What is contemplated is an asset in the acquisition of which it is possible to envisage a cost. The intent goes to the nature and character of the asset, that it is an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. It is immaterial that although the asset belongs to such a class it may, on the facts of a certain case, be acquired without the payment of money….”

This aspect has been analysed by the Supreme Court in the case of D P Sandhu Brothers ChemburPvt Ltd(supra) where the Supreme Court observed:

“In other words, an asset which is capable of acquisition at a cost would be included within the provisions pertaining to the head ‘capital gains’ as opposed to assets in the acquisition of which no cost at all can be conceived. The principle propounded in B.C. SrinivasaSetty’s case (supra) has been followed by several High Courts with reference to the consideration received on surrender of tenancy rights. [See Among others Bawa Shiv Charan Singh v. CIT [1984] 149 ITR 29 (Delhi); CIT v. MangtuRam Jaipuria [1991] 192 ITR 533 (Cal.); CIT v. Joy Ice Cream (Bang.) (P.) Ltd. [1993] 201 ITR 894 (Kar.); CIT v. MarkapakulaAgamma [1987] 165 ITR 386 (A.P.); CIT v. Merchandisers (P.) Ltd. [1990] 182 ITR 107 (Ker.)]. In all these decisions the several High Courts held that if the cost of acquisition of tenancy rights cannot be determined, the consideration received by reason of surrender of such tenancy rights could not be subjected to capital gain tax.”

It is therefore clear that as per the Supreme Court, capital gains is not capable of being computed only in a case where the cost of acquisition (or consideration as in this case) is not conceivable at all, and not in a case where it is conceivable, but is nil.

Though the decision of the Gujarat High Court in the case of Jaykrishna Harivallabhdas(supra) had been cited before the Special bench in Bennett Coleman’s case, it was not taken into consideration. This decision rightly brings out the absurdity of taking a view that one has to compute capital gains when there is a nominal consideration, and that one cannot compute capital gains when nothing is received. As observed by the Gujarat High Court:

“The contention that this provision should apply to actual receipts only also cannot be accepted for yet another reason, because acceptance of that would lead to an incongruous and anomalous result as will be seen presently. The acceptance of this view would mean whereas even in a case where a sum is received, howsoever negligible or insignificant it may be, it would result in the computation of capital gains or loss, as the case may be, but in a case where nothing is disbursed on liquidation of a company the extinction of rights, would result in total loss with no consequence. That is to say on receipt of some cost, however insignificant it may be, the entire gamut of computing capital gains for the purpose of computing under the head “Capital gains” is to be gone into, computing income under the head “Capital gains”, and loss will be treated under the provisions of Act, but where there is nil receipt of the capital, the entire extinguishment of rights has to be written off, without treating under the Act as a loss resulting from computation of capital gains. The suggested interpretation leads to such incongruous result and ought to be avoided, if it does not militate in any manner against object of the provision and unless it is not reasonably possible to reach that conclusion. As discussed above, once a conclusion is reached that extinguishment of rights in shares on liquidation of a company is deemed to be transfer for operation of section 46(2) read with section 48, it is reasonable to carry that legal fiction to its logical conclusion to make it applicable in all cases of extinguishment of such rights, whether as a result of some receipt or nil receipt, so as to treat the subjects without discrimination. Where there does not appear to be ground for such different treatment the Legislature cannot be presumed to have made deeming provision to bring about such anomalous result.”

Had this reasoning of the Gujarat High Court pointing out the absurdity been considered by the Special Bench in the case of Bennett Coleman(supra), perhaps the conclusion reached might have been different.

Therefore, the view taken by the Tribunal in the case of Tata Sons, that even in a case where nil consideration is received on reduction of capital, the capital loss is to be allowed, seems to be the better view of the matter.

BCAJ Admin

Revision under Section 264 of Intimation Issued Under Section 143(1)

ISSUE FOR CONSIDERATION

Section 264 is one of the important provisions under the Act beneficial to the assessee, whereunder the higher authority has been given the power to revise any order passed by the lower authority and pass a revisionary order in favour of the assessee. The CIT or PCIT or CCIT or PCCIT (referred to as CIT hereafter) may, either of his own motion or on an application made by the assessee in this regard, revise any order passed by any authority which is subordinate to him. The CIT has to pass an order as he thinks fit, which cannot be prejudicial to the assessee.

Section 264 reads as under:

“Revision of other orders.

264. (1) In the case of any order other than an order to which section 263 applies passed by an authority subordinate to him, the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner may, either of his own motion or on an application by the assessee for revision, call for the record of any proceeding under this Act in which any such order has been passed and may make such inquiry or cause such inquiry to be made and, subject to the provisions of this Act, may pass such order thereon, not being an order prejudicial to the assessee, as he thinks fit.

(2) The Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner shall not of his own motion revise any order under this section if the order has been made more than one year previously.

(3) In the case of an application for revision under this section by the assessee, the application must be made within one year from the date on which the order in question was communicated to him or the date on which he otherwise came to know of it, whichever is earlier:

Provided that the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner may, if he is satisfied that the assessee was prevented by sufficient cause from making the application within that period, admit an application made after the expiry of that period.

(4) The Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner shall not revise any order under this section in the following cases—

(a) where an appeal against the order lies to the Deputy Commissioner (Appeals) or to the Joint Commissioner (Appeals) or the Commissioner (Appeals) or to the Appellate Tribunal but has not been made and the time within which such appeal may be made has not expired, or, in the case of an appeal to the Joint Commissioner (Appeals) or the Commissioner (Appeals) or to the Appellate Tribunal, the assessee has not waived his right of appeal; or

(b) where the order is pending on an appeal before the Deputy Commissioner (Appeals); or

(c) where the order has been made the subject of an appeal to the Joint Commissioner (Appeals) or the Commissioner (Appeals) or to the Appellate Tribunal.

(5) Every application by an assessee for revision under this section shall be accompanied by a fee of five hundred rupees.

(6) On every application by an assessee for revision under this sub-section, made on or after the 1st day of October, 1998, an order shall be passed within one year from the end of the financial year in which such application is made by the assessee for revision.

Explanation.—In computing the period of limitation for the purposes of this sub-section, the time taken in giving an opportunity to the assessee to be re-heard under the proviso to section 129 and any period during which any proceeding under this section is stayed by an order or injunction of any court shall be excluded.

(7) Notwithstanding anything contained in sub-section (6), an order in revision under sub-section (6) may be passed at any time in consequence of or to give effect to any finding or direction contained in an order of the Appellate Tribunal, the High Court or the Supreme Court.

Explanation 1.—An order by the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner declining to interfere shall, for the purposes of this section, be deemed not to be an order prejudicial to the assessee.

Explanation 2.—For the purposes of this section, the Deputy Commissioner (Appeals) shall be deemed to be an authority subordinate to the Principal Chief Commissioner or Chief Commissioner or Principal Commissioner or Commissioner.”

Thus, the assessee has been provided the benefit of seeking revision of the order passed by the AO under Section 264, but with the condition that such order should not be appealable, or if appealable, then no appeal should have been filed against such order.

Quite often, the issue has arisen as to whether an ‘intimation’ issued under Section 143(1) can be regarded as an ‘order’ for the purposes of Section 264 and can, therefore, be the subject matter of revision under Section 264. The Delhi and Bombay High Courts have taken a view that the order referred to in Section 264 would include an intimation issued under Section 143(1) and, therefore, can be revised. However, the Gujarat, Kerala and Karnataka High Courts have taken a contrary view.

EPCOS Electronic Components SA’s Case

The issue had come up for consideration by the Delhi High Court in the case of EPCOS Electronics Components SA vs. UOI [WP (C) 10417/2018, 10th July, 2019].

In this case, the assessee filed its return of income for the Assessment Year 2014–15 by offering tax @20 per cent on its earnings for the provision of management services to its associated enterprise, EPCOS India Pvt. Ltd. in terms of Article 13 of the Double Taxation Avoidance Agreement entered into between India and Spain. The AO by an intimation dated 10th March, 2016, under Section 143(1) processed the said return of income. Later, the assessee realised that it had failed to claim the lower rate of tax it was eligible for, by virtue of Clause 7 of the Protocol appended to the India-Spain DTAA. Another mistake committed by the assessee was that it paid a surcharge and cess on the tax, which was not required to be paid, as the tax rate under the DTAA was a final rate inclusive of surcharge and cess. This led the assessee to file a revision petition under Section 264 on 16th January, 2017, before the CIT, seeking to revise the order under Section 143(1), claiming it to be prejudicial to the assessee’s interest.

The CIT rejected the application filed by the assessee under Section 264 on the grounds that no amount was payable by the assessee in terms of an intimation under Section 143(1), and therefore, no prejudice was caused to the assessee in terms thereof. Alternatively, the CIT held that the assessee should have filed a revised return claiming the relief so claimed by it in the revision application. Further, it was held by the CIT that Section 264 could not be invoked to rectify the assessee’s own mistakes, if any. Against the said order, the assessee filed a writ petition before the High Court.

The question before the High Court was whether a revision petition under Section 264 was maintainable to rectify the mistake committed by the assessee while filing its return, which had been accepted by the Department by issuing an intimation under Section 143(1). Before the High Court, the assessee relied upon the decision in the case of Vijay Gupta vs. CIT 386 ITR 643 (Delhi) and the revenue relied upon the decision in the case of ACIT vs. Rajesh Jhaveri Stock Brokers Pvt. Ltd. 291 ITR 500 (SC) to urge that an intimation under Section 143(1) could not be treated as an ‘order’ and, therefore, no petition under Section 264 could be maintained against such intimation.

The High Court observed that the decision in Rajesh Jhaveri Stock Brokers Pvt. Ltd. (supra) was in the context of Sections 147 and 148. If the original assessment was under Section 143(3), then the proviso to Section 147 would be attracted, and the procedure prescribed thereunder for re-opening an assessment would have to be followed. On the other hand, if the return had been accepted by the Department by a mere intimation under Section 143(1), then a different set of consequences would ensue, and there would be no requirement for the department if it were to re-open the assessment to follow the procedure it would have had to had the assessment order been passed under Section 143(3). The context of the case before the High Court was totally different. It was not an attempt by the Revenue to re-open the assessment by invoking Sections 147 and 148 but was of the assessee realising the mistake made by it while filing the return of paying a higher rate of tax.

In such a context, the intimation received by the assessee from the AO accepting the return under Section 143(1) would partake the character of an order for the purpose of Section 264, though in the context of Sections 147 and 148, it might have had a different connotation. However, the consistent view of the High Court, as expressed in Vijay Gupta (supra) and the other decisions which have been cited therein, has been that for the purposes of Section 264, a revision petition seeking rectification of the return accepted by the Department in respect of which intimation is sent under Section 143(1) was indeed maintainable.

On this basis, the High Court disagreed with the view expressed by the CIT and held that a revision petition under Section 264 would be maintainable vis-à-vis an intimation under Section 143(1).

A similar view has also been expressed by the Bombay High Court in the cases of Diwaker Tripathi vs. Pr CIT 154 taxmann.com 634 (Bom),Smita Rohit Gupta vs. Pr CIT 459 ITR 369 (Bom) and Aafreen Fatima Fazal Abbas Sayed vs. ACIT, W.P. (L) NO. 6096 OF 2021 dated 8th April, 2021.

Gujarat Gas Trading Co. Ltd.’s Case

The issue again came up for consideration before the Gujarat High Court in the case of Gujarat Gas Trading Co. Ltd. vs. CIT (Special Civil Application No. 2514 of 2011, order dated 7th September, 2016).

In this case, for the Assessment Year 2003–04, the assessee company filed its return of income declaring income of ₹3.31 crores, which included a sum of ₹1.87 crores pertaining to expenses on account of commission which had been disallowed wrongly. These expenses were disallowed under the mistaken belief that the assessee was allowed to claim a deduction of these expenses only upon payment. The return of income of the assessee company was accepted by the AO under Section 143(1) without scrutiny, and the refund claimed was issued.

Having realised the error in not claiming the deduction of expenditure on accrual basis while filing the return, the assessee filed a petition before the CIT under Section 264 on 29th December, 2008, seeking revision of the intimation / order under Section 143(1). In response, the assessee was called upon to produce necessary evidence in support of the date of receipt of the intimation under Section 143(1). Instead of replying, the assessee filed a fresh petition for revision on 13th April, 2009, which was rejected by an order dated 3rd December, 2009, inter-alia, on the grounds that the revision petition was filed after a lapse of about six years. The assessee approached the High Court against the order of dismissal mainly on the ground that it was not provided any opportunity to explain the delay. The High Court directed the CIT to decide the matter afresh after giving an opportunity of hearing to the assessee.

In the revision proceeding which was initiated afresh, the CIT rejected the revision petition on the grounds of delay as well as maintainability. The CIT held that the intimation was not a revisable order. He relied upon the decision of Karnataka High Court in the case of Avasaraja Automation Ltd. vs. DCIT 269 ITR 163 in which it was held that the petition under Section 264
against intimation was not maintainable in view of the deletion of Explanation to Section 143 with effect from 1st June, 1999. The assessee challenged the order of the CIT on both counts by filing a petition before the High Court.

Before the High Court, with respect to the issue of maintainability, the assessee argued that, under Section 264, any order is subject to revision and not only an order of assessment. Even acceptance of assessment without scrutiny and intimation thereof in terms of Section 143(1) was an order of assessment, may be without scrutiny. The assessee also placed reliance upon the following decisions:

i. C. Parikh & Co. vs. CIT 122 ITR 610 (Guj)

ii. Assam Roofing Ltd. vs. CIT 43 taxmann.com 316 (Gauhati)

iii. Ramdev Exports vs. CIT 251 ITR 873

iv. Vijay Gupta vs. CIT (supra)

The revenue contended that the intimation under Section 143(1) was neither an order of assessment nor an order which was capable of revision under Section 264. It was merely an administrative action of intimating the assessee that his return was accepted. The revenue relied upon the amendment made in Section 143(1) with effect from 1st June, 1999, when the explanation was dropped and submitted that, prior to 1st June, 1999, the AO had the power to make prima facie adjustments. Due to this, the intimation under Section 143(1) was deemed to be an order of assessment for the purpose of Section 264. The revenue also relied upon the following decisions where it had been held that an intimation was not capable of being subject to revision under Section 264:

i. CIT vs. K. V. Mankaram and Co. 245 ITR 353 (Ker)

ii. Avasaraja Automation Ltd. vs. DCIT 269 ITR 163 (Kar)

The High Court held that the assessee had failed to explain the delay and, therefore, the order of the CIT not condoning the delay was upheld. The High Court also accepted the view of the CIT that against the intimation under Section 143(1), the revision petition was not maintainable for the following reasons:

• ‘Any order’ referred to in Section 264 was not meant to cover even mere administrative orders without there being any element of deciding any rights of the parties.

• In the case of Rajesh Jhaveri Stock Brokers Pvt. Ltd. (supra), the Supreme Court observed that acknowledgement under Section 143(1) is not done by an AO, but mostly by ministerial staff. It could not be stated that by such intimation, the assessment was done.

• An Explanation was added below Section 143 by the Finance Act, 1991, with effect from 1st October, 1991, which provided that an intimation sent to the assessee shall be deemed to be an order for the purpose of Section 264. This explanation came to be deleted with effect from 1st June, 1999, when Section 143 itself underwent major changes. It could, thus, be seen that during the period when, under subsection (1) of Section 143, the AO had the power of making prima facie adjustments, the legislature provided for an explanation that an intimation sent to the assessee under subsection (1) would be deemed to be an order for the purposes of Section 264. Once, with the amendment of Section 143, such powers were rescinded, a corresponding change was, therefore, made by deleting the explanation and withdrawing the deeming fiction.

The High Court also dealt with each of the decisions which was relied upon by the assessee and distinguished it. The decision in the case of C. Parikh & Co. (supra) was held to be focusing on the question of whose mistake can be corrected by the CIT in revisional powers, whether of the assessee or the AO and did not concern the question whether an intimation was open to revision or not. Similarly, in the case of Ramdev Exports (supra), the question of maintainability of a revision petition against a mere intimation under Section 143(1) did not arise. In the case of Vijay Gupta (supra), before the Commissioner, the assessee had not only challenged the intimation under Section 143(1) but also the rejection of application under Section 154. Thus, these decisions relied upon by the assessee were held to be distinguishable.

OBSERVATIONS

Section 264 is a beneficial provision whereunder the higher authorities have been empowered to pass a revisionary order, not being prejudicial to the assessee, revising the order passed by the lower authorities. The objective of this provision is also to provide a remedy to an assessee when he is aggrieved by any order passed against him, whereby he can approach the higher authority within the given time limit requiring it to pass the revisionary order not prejudicial to him.

The whole controversy under consideration revolves around only one issue, i.e., whether the intimation issued under Section 143(1) upon processing of the return of income filed by the assessee can be considered to be an order. The issue is whether the word ‘order’ used in Section 264 should be interpreted so strictly so as to exclude any other intimation which has not been termed as ‘order’ under the relevant provision of the Act, although it has been generated and issued by the AO, and more particularly when it otherwise determines the total income and tax liability of the assessee.

Firstly, it needs to be appreciated that the term ‘order’ is not defined expressly in the Act. The simple dictionary meaning of the term ‘order’ is an authoritative command or instruction. When the intimation is issued under Section 143(1) upon processing of the return of income filed by the assessee, it is nothing but an official instruction which is issued under the authority of the AO determining the amount of total income and tax liability of the assessee after incorporating necessary adjustments, if any, to the return of income filed. Merely because it has been referred to as ‘intimation’ and not ‘order’ under Section 143(1), it cannot be considered as not falling within the purview of Section 264.

By relying upon the decision of the Supreme Court in the case of Rajesh Jhaveri Stock Brokers Pvt. Ltd. (supra), the revenue has attempted to argue that the intimation is not an assessment order and, therefore, there is no application of mind by the Assessing Officer when such intimation is issued. However, it needs to be appreciated that the provision of Section 264 does not only bring the ‘assessment order’ within its purview but it brings all types of orders within its purview. Therefore, to examine the applicability of Section 264, it is irrelevant to consider the fact that the intimation issued under Section 143(1) is not an assessment order. What is relevant is that it bears all the characteristics of an order, although it is not an assessment order.

The Gujarat High Court has heavily relied upon the omission of Explanation to Section 143 with effect from 1st June, 1999, which had provided that the intimation shall be deemed to be an order for the purpose of Section 264. It has been observed that since the power to make the prima facie adjustment while processing the return of income had been removed, the intimation was no longer regarded to be an order for the purpose of Section 264. However, it needs to be appreciated that in various cases, the Courts have also allowed the assessees to raise fresh claims under Section 264 which were never raised by them in the return of income. Therefore, it was not only prima facie adjustments in respect of which relief could have been sought under Section 264.

Besides, Section 143(1), as amended by the Finance Act 2008 with effect from 1st April, 2008, now permits certain adjustments to be made under six circumstances referred to in clause (a) thereof. The Gujarat High Court decision was rendered for AY 2003–04, at a point of time when no adjustments were permissible under Section 143(1). Therefore, by the logic of the Gujarat High Court itself, an intimation should now be regarded as an order.

An intimation under Section 143(1) is also now an appealable order under Section 246(1)(a) as well as Section 246A(1)(a) with effect from 1st July, 2012. Though it is appealable only if an assessee objects to the adjustments made, the very fact that it is placed at par with other orders clearly brings out the fact that an intimation is now an order.

The heading of Section 263 also refers to “Revision of Other Orders”, and the section itself refers to any order other than an order to which Section 263 applies. This is broad enough to cover an intimation under Section 143(1).

In CIT vs. Anderson Marine & Sons (P) Ltd 266 ITR 694 (Bom), a case relating to AY 2009–10, a year in which adjustments under Section 143(1) were not permissible, the Bombay High Court held that sending of an intimation, being a decision of acceptance of self-assessment, is in the nature of an order passed by the AO for the purposes of Section 263. If so, the same logic should apply to Section 264 as well.

The Delhi High Court in Vijay Gupta’s case rightly pointed out that Circular No.14(XL-35) of 1955, dated 11th April, 1955, which required officers of the Department to assist a taxpayer in every reasonable way, particularly in the matter of claiming and securing reliefs, and Article 265 of the Constitution of India, which prohibited the arbitrary collection of taxes stating that ‘no tax shall be levied or collected except by authority of law’, had not been considered by the CIT while rejecting the revision petition. If this is taken into account, the assessee should not be denied a deduction rightfully allowable in law, merely because it is not claimed in the return of income, on the grounds that the assessee has no remedy under Section 264 against an intimation.

Further, an intimation issued under Section 143(1) is amenable to rectification under Section 154. Therefore, consider a case where the order of rectification has been passed under Section 154, rectifying the intimation issued under Section 143(1), either suo moto or upon an application made by the assessee in this regard. In such a case, the rectification order would fall within the purview of Section 264, it being an ‘order’, upon taking such a strict interpretation, whereas the intimation itself which has been rectified by the said order would not fall within its purview. Thus, such an interpretation leads to an absurd result, which needs to be avoided.

Therefore, at least as the law now stands, thebetter view is that taken by the Delhi and Bombay High Courts considering the intimation issued under Section 143(1) to be in the nature of ‘order’ for the purpose of Section 264.

BCAJ Admin

Claim of Loss in Revised Return of Income

ISSUE FOR CONSIDERATION

The provisions relating to filing of return of income are contained in section 139 of the Income Tax Act, 1961. A return of income filed within the due date is governed by sub-section (1) of section 139 Sub-section (3) deals with a return of loss. A return not filed in time can be furnished within the time prescribed under sub-section(4). The return furnished under sub-section (1) or (4) can be revised as per sub-section (5) of section 139.

Section 139(5) reads as under:

“If any person, having furnished a return under sub-section (1) or sub-section (4), discovers any omission or any wrong statement therein, he may furnish a revised return at any time before three months prior to the end of the relevant assessment year or before the completion of the assessment, whichever is earlier.”

Section 80 provides that no loss shall be carried forward and set off unless such loss has been determined in pursuance of a return filed in accordance with sub-section (3) of section 139. Section 80 reads as under:

“Notwithstanding anything contained in this Chapter, no loss which has not been determined in pursuance of a return filed in accordance with the provisions of sub-section (3) of section 139, shall be carried forward and set off under sub-section (1) of section 72 or sub-section (2) of section 73 or sub-section (2) of section 73A or sub-section (1) or sub-section (3) of section 74 or sub-section (3) of section 74A.”

Sub-section (3) of section 139 reads as under:

“If any person who has sustained a loss in any previous year under the head “Profits and gains of business or profession” or under the head “Capital gains” and claims that the loss or any part thereof should be carried forward under sub-section (1) of section 72, or sub-section (2) of section 73, or sub-section (2) of section 73A or sub-section (1) or sub-section (3) of section 74, or sub-section (3) of section 74A, he may furnish, within the time allowed under sub-section (1), a return of loss in the prescribed form and verified in the prescribed manner and containing such other particulars as may be prescribed, and all the provisions of this Act shall apply as if it were a return under sub-section (1).”

A question had earlier arisen before the courts as to whether a return of income filed under section 139(1) declaring a positive income, could be revised under section 139(5) to declare a loss, which could be carried forward for set-off as per s.80 by treating such a return as the one filed under s. 139(3) of the Act. The Gujarat High Court in the case of Pr CIT vs. Babubhai Ramanbhai Patel 249 Taxman 470, the Madras High Court in the case of CIT vs. Periyar District Co-op. Milk Producers Union Ltd 266 ITR 705, and various benches of the Tribunal, in the cases of Sujani Textiles (P) Ltd 88 ITD 317 (Mad), Sarvajit Bhatia vs. ITO ITA No 6695/Del/2018, and The Dhrangadhra Peoples Co-op. Bank Ltd vs. DCIT 2019 (12) TMI 976 – ITAT Rajkot had all taken a view that it was permissible to file a return of loss for revising the return of income, and such a loss so declared in the revised return could be carried forward for set off. The Kerala High Court in the case of CIT vs. Kerala State Construction Corporation Ltd 267 Taxman 256, however, held to the contrary disallowing the right of set-off in the case where the original return of income was for a positive income,

The position believed to be settled was disturbed by a decision of the Supreme Court. The Supreme Court, in the case of Pr CIT vs. Wipro Ltd 446 ITR 1, in the context of withdrawal of a claim for exemption (of a loss) under section 10B through a revised return under section 139(5) claiming to carry forward of such loss (not claimed in view of s.10B exemption), has observed that the Revenue was right in claiming that the revised return filed by the assessee under section 139(5) can only substitute its original return under section 139(1) and cannot transform it into a return under section 139(3), in order to avail the benefit of carry forward or set off of any loss under section 80. The review petition against this order was dismissed by the Supreme Court vide its order reported at 289 Taxman 621.

Subsequent to this Supreme Court decision, the controversy has arisen before the Tribunal as to whether the Supreme Court’s decision has impacted the allowance of a claim for carry forward or set off of a loss not made in the original return by filing a revised return filed under section 139(5), after the due date of filing of the return under section 139(1). While the Pune Bench of the Tribunal has held that a claim of enhanced loss under a revised return is permissible, the Delhi Bench has taken a view that a claim of loss under a revised return would not enable the assessee to carry forward or set off a loss claimed for the first time in the revised return of income.

BILCARE’S DECISION

The issue first came up for discussion before the Pune bench of the Tribunal in the case of Dy CIT vs. Bilcare Ltd 106 ITR(T) 411, the relevant assessment year being the assessment year 2016-17.

In this case, the assessee had a wholly-owned subsidiary in Singapore, which went into liquidation. While the company was ordered to be liquidated within 30 days in February 2014, the assessee made an application to the High Court of Singapore in October 2015 seeking permission to transfer the shares held by it in the Singapore subsidiary to another foreign subsidiary incorporated in Mauritius for a consideration of SGD 1. The permission was granted by the Singapore High Court in October 2015, and the transfer of shares was completed on 22nd October, 2015.

The assessee had not reflected this sale of shares of the Singapore subsidiary in its audited financial statements. The assessee had filed its original return before the due date on 28th November, 2016, declaring a loss of ₹45.98 crore, not taking into consideration such loss on the sale of shares of the Singapore subsidiary. The return was revised after the due date on 29th March, 2018, increasing the loss to ₹968.31 crore. The increase in loss was on account of the claim for long-term capital loss of ₹922.33 crore arising on transfer of shares of the Singapore subsidiary of the company, which claim was not made in the original return of income.

In the draft assessment order, the assessing officer refused to take cognizance of the revised return of income, in which the claim for such long-term capital loss was made. The assessee filed an application before the Joint Commissioner of Income Tax under section 144A for issuance of a direction on the issue of disallowance of the long-term capital loss arising on the sale of shares of the subsidiary of ₹922.33 crore. The Joint Commissioner directed that the loss on sale of shares claimed in the revised return should not be entertained, but that the claim of capital loss of ₹922.33 crore made during the course of assessment proceedings may be examined on merits.

The assessing officer disallowed the claim of long-term capital loss on the sale of shares of the foreign subsidiary on the following grounds:

(i) the claim for deduction of loss on the sale of shares in the revised return of income was not valid in law as the necessity for filing the revised return of income was not on account of any omission or wrong statement in the original return of income;

(ii) the Singapore High Court simply permitted the assessee to sell the shares of the Singapore subsidiary without mentioning the consideration for the sale of shares, and therefore the transaction of sale of shares was not by operation of law;

(iii) the assessee only sold the shares of the Singapore subsidiary to another wholly-owned subsidiary in Mauritius, and there being complete unity of control between the seller and purchaser, the transaction was not undertaken at arm’s length;

(iv) the assessee failed to furnish the information sought by the AO in order to determine the fair market value of the shares in terms of the provisions of rule 11UA of the Income Tax Rules, 1962.

The assessing officer was of the view that it was a dubious method adopted by the assessee in order to avail the benefit of set-off of the long-term capital loss arising on the sale of the shares of the subsidiary. Invoking the doctrine laid down by the Supreme Court in the case of McDowell and Co Ltd vs. CTO 154 ITR 148, the AO denied the claim for deduction of long-term capital loss of ₹922.33 crore arising on sale of shares of the Singapore subsidiary.

The Commissioner (Appeals) considered the chronology of events and facts of the case and upheld the finding of the AO that the long-term capital loss could not have been claimed through a revised return of income. He however held that since the assessee had suffered a loss, the claim made during the course of assessment proceedings could also be considered, placing reliance on the decision of the Bombay High Court in the case of CIT vs. Pruthvi Brokers & Shareholders 349 ITR 336. He therefore directed the AO to allow the loss as the claim was genuine and bona fide.

Before the tribunal, on behalf of the revenue, it was contended that the revised return of income was not valid in law and that the Commissioner (Appeals) ought not to have applied the ratio of the Bombay High Court decision in the case of Pruthvi Brokers & Shareholder (supra), as the decision related to a claim made for the first time before the Commissioner (Appeals) and that the ratio of the decision of the Supreme Court in the case of Goetze (India) Ltd 284 ITR 323 was squarely applicable to the facts of the case. It was further claimed that the Commissioner (Appeals) had failed to examine the colourful device adopted by the assessee and that the transactions of sale of shares of the Singapore subsidiary to another wholly-owned foreign subsidiary were not at arm’s length price.

On behalf of the revenue, it was further claimed that the revised return of income was not valid in law, as the assessee had chosen not to challenge this finding before the tribunal. It was claimed that the Commissioner (Appeals) had failed to take cognizance of the provisions of section 139(3) read with section 80. Reliance was placed on the decision of the Supreme Court in the case of Wipro Ltd (supra).

On behalf of the assessee, it was submitted that the ratio of the decision of the Supreme Court in the case of Wipro Ltd (supra) had no application to the facts of the case, as the issue before the Supreme Court was regarding the interpretation of the provisions of section 10B(8). It was further submitted that the claim of the assessee in the case before the tribunal was totally different from the facts in the case of Wipro Ltd (supra), and therefore the ratio of the decision of the Supreme Court in the case of Wipro Ltd (supra) could not be applied to the facts of the case before the tribunal. It was submitted that the material on record clearly showed that after meeting the liabilities of creditors of the Singapore subsidiary, nothing remained to be distributed amongst the shareholders. Therefore the intrinsic value of the shares was nil, and that there could not be any dispute with regard to consideration received on the sale of the shares.

It was further pointed out on behalf of the assessee that rule 11UA did not apply to the year under consideration, since it came into effect from 1st April, 2018. It was further submitted that the transaction was not a dubious transaction but was a real transaction, as evidenced by the documents showing the completeness of the transaction of the sale of shares. It was argued that the ratio of the decision in the case of McDowell & Co Ltd (supra) had no application to the facts of the case as it was a real transaction, and citizens were free to arrange affairs in order to minimise the tax liability.

Analysing the provisions of section 139, the tribunal observed that there was no dispute that the original return was filed within the due date for filing of the return of income under section 139(1). Even the revised return of income was filed within the prescribed period as required by section 139(5). The revised return could be filed in a situation where an assessee discovered any omission or any wrong statement made in the original return of income. The circumstances that led the assessee not to claim the long-term capital loss in the original return of income were explained before the AO, and which explanation remained uncontroverted. Therefore, according to the tribunal, it could not be said that it was not a bona fide omission made in the original return of income, or that the assessee had failed to satisfy the conditions prescribed under section 139(5) for filing the revised return of income. The Tribunal therefore held that the AO was not justified in not accepting the revised return of income filed by the assessee.

The tribunal observed that it was a settled position of law that an assessee was entitled to revise the return of income within the time allowed under section 139(5). Once the revised return of income was filed, the natural consequence was that the original return of income was effaced or obliterated for all purposes, and it was not open to the AO to revert to the original return of income. This position of law was approved by the Supreme Court in the case of CIT vs. Mahendra Mills/Arun Textile C/Humphreys Glasgow Consultants 243 ITR 56.

As regards the applicability of the Supreme Court decision in the case of Wipro Ltd (supra), the tribunal observed that, in that case, the Supreme Court was concerned with the interpretation of the provisions of section 10B(8), and had made a passing remark that the revised return of income filed by the assessee under section 139(5) only substituted original return of income under section 139(1), and such a return could not be transformed as return of loss filed under section 139(3) in order to avail the benefit of carry forward and set off of any loss under the provisions of section 80. The issue of interpretation of the provisions of section 139(3) and section 80 was not before the Supreme Court in the case of Wipro Ltd (supra). According to the tribunal, it was a settled legal position that every interpretation made by the Honourable Judges did not constitute the ratio decidendi. The tribunal further observed that the observations made by the Supreme Court had no application to the facts of the case before it, as the assessee had filed the original return of income showing loss within the time prescribed under section 139(1), and therefore the decision of the Supreme Court was distinguishable on facts.

According to the tribunal, it was clear that the assessee had discovered and omitted to claim a genuine loss arising on sale of shares, and therefore filed a revised return of income under section 139(5) within the prescribed time limit claiming the determination and carry forward of loss. It was a valid revised return of income filed under section 139(5). Therefore, the findings of the AO as well as the Commissioner (Appeals) to the extent that the revised return of income was not a valid one, was reversed by the tribunal.

The tribunal further rejected the arguments made on behalf of the revenue, that the finding that the revised return of income was not valid was accepted by the assessee as the issue was neither raised in cross-appeal nor in cross-objection, observing that respondent to an appeal could always support the order of the Commissioner (Appeals) on the ground decided against him under the provisions of rule 27 of the Income Tax (Appellate Tribunal) Rules, 1963. The tribunal observed that it was a settled position of law that in a case where the assessee filed the return of loss within the time prescribed under section 139(1), there was no bar under the provisions of the Income Tax Act to claim a higher loss during the course of assessment proceedings, nor were there any fetters on the AO to allow such higher loss.

Placing reliance on the decisions of the Delhi High Court in the case of CIT vs. Nalwa Investment Ltd 427 ITR 229 and Karnataka High Court in the case of CIT vs. Srinivasa Builders 369 ITR 69, the tribunal observed that when the assessee had claimed a lower amount of loss erroneously, which was sought to be corrected during the course of assessment proceedings, the AO was not justified in not determining and allowing the carry forward and set off of the loss, as the conditions for triggering the provisions of section 80 would not apply.

The Tribunal therefore held that the reasoning of the AO, that the loss not claimed in the original return of income but claimed in the revised return of income could not be allowed, was not sustainable in the eyes of the law.

RRPR HOLDING’S DECISION

The issue again came up before the Delhi bench of the tribunal in the case of RRPR Holding (P) Ltd vs. DyCIT 201 ITD 781.

The assessee was an investment holding company set up to acquire and hold shares of NDTV Ltd and its group companies. It filed its original return of income under section 139(1) on 15th October, 2010, declaring total income at ₹4,17,005. The original return was subjected to scrutiny assessment by the issuance of notice under section 143(2) dated 29th August, 2011. Pending completion of assessment under section 143(3), the assessee filed a revised return under section 139(5) on 2nd February, 2012 within the prescribed time. As per the revised return, the assessee claimed a long-term capital loss of ₹206.25 crore arising on the sale of shares, along with the income from other sources of ₹4,17,005 declared in the original return and claimed to carry forward of such loss.

The AO noted that no such loss arising on the sale of shares was claimed in the original return filed by the assessee. Subsequently, according to the AO, enquiries in respect of certain transactions entered into by the assessee were carried out by the Investigation Wing. Following the same, the assessee revised its return of income after a lapse of 17 months and filed a revised return claiming the long-term capital loss. The AO observed that such a revised return was not a valid return, and therefore non-est in the eyes of law. The AO noted that there was not even an iota of reference to any transaction involving any capital gains or capital loss in the original return. As per the AO, for entitlement of carry forward of losses, as per section 139(3), the loss return had to be necessarily filed within the time allowed for filing return under section 139(1), whereas the capital loss had been claimed for the first time in the revised return filed beyond the time limit stipulated under section 139(1). Thus, the AO refused to admit the claim of long-term capital loss and denied carrying forward and setting off of such loss.

The Commissioner (Appeals) upheld the denial of the long-term capital loss, on the ground that the return had to be necessarily filed within the time limit prescribed under section 139(1), but that the loss had been claimed by filing a revised return under section 139(5) beyond the time limit prescribed under section 139(1).

Before the tribunal, on behalf of the assessee, it was contended that where the original return had been filed on or before the due date under section 139(1), the assessee was entitled in law to revise the return under section 139(5) within the due date prescribed therein. The assessee had filed the original return as well as the revised return within the due dates prescribed under the respective sub-sections (1) and (5) of section 139. Thus the loss arising on the sale of the shares claimed as long-term capital loss was not hit by the embargo placed by section 80. Reliance was placed on the decisions of the High Courts in the case of Babubhai Ramanbhai Patel (supra), Dharampur Sugar Mills Ltd (supra), and the decision of the Mumbai bench of the tribunal in the case of Ramesh R Shah vs. ACIT 143 TTJ 166 (Mum) in support of this proposition. It was submitted that the denial of carry forward of losses claimed in the revised return was opposed to the scheme of the Act as interpreted by the judicial dicta and hence was required to be reversed by admitting the claim made towards long-term capital losses by way of revised return, and allowing carry forward and set off of such losses.

On behalf of the revenue, it was submitted that the loss return under section 139(3) must be necessarily filed within the due date prescribed under section 139(1) to avoid the rigours of section 80. The losses claimed had come into consideration by virtue of a revised return which was filed subsequent to the due date prescribed under section 139 (1), and thus the revised return to make a new claim giving rise to losses, could not be allowed in defiance of the provisions of the Act, regardless of the fact that the revised return had been filed within the due date prescribed under section 139(5). It was further submitted that the claim of capital loss had been made for the first time in the revised return, and it was not a case where the claim of loss made in the original return had been modified in the revised return. It was further pointed out that such a huge loss was claimed for the first time by way of a revised return, and that there was no reference to the loss in the original return or in the profit and loss account. It was contended that such an omission to claim the loss in the original return was prima facie willful to hide the transactions from the knowledge of the Department, and therefore the claim of loss made by filing the revised return should not be granted.

The tribunal observed that the moot question in the case was whether the assessee was entitled in law to make an altogether new claim of capital loss in the revised return which was filed within the due date prescribed under section 139(5) but subsequent to the due date prescribed under section 139(1), and consequently, whether the assessee was entitled to carry forward such capital losses claimed in the revised return. The other integral issue was whether the loss claimed in the revised return met the requirement of section 139(5).

The tribunal analysed the provisions of sections 139(1), 139(3), 139(5) and 80. It noted that section 80 began with a non-obstante clause, unequivocally laying down that to get the benefit of carry forward of loss pertaining to capital gains, the return of loss had to be filed within the time allowed under section 139(1). Section 80 therefore prohibited the claim of carry forward of such losses unless determined under section 139(3). Section 139(3) in turn made the mandate of the law clear that the loss return must be filed within the time limit permitted under section 139(1). The revision of the return under section 139(5) was also circumscribed by the expression “discovers any omission or any wrong statement in the original return”.

Analysing the facts of the case before it, the tribunal noted that the original return filed under section 139(1) did not make reference to the existence of any capital loss at all. The loss had been claimed for the first time in the revised return of income filed beyond the time limit prescribed under section 139(1). According to the tribunal, the provisions of section 80 thus came into play. The tribunal observed that the law codified was plain and clear and did not have any ambiguity. Therefore, the tribunal was of the view that the capital loss claimed under a return filed beyond the time limit under section 139(1) could not be carried forward under section 74.

The tribunal was of the view that the decision of the Allahabad High Court in the case of Dhampur Sugar Mills Ltd (supra) did not apply as the facts of the case before it were quite different. The tribunal refused to follow the decision of the Gujarat High Court in Babubhai Ramanbhai Patel (supra) on the ground that section 80 had not been pressed for the consideration of the High Court at all, and reliance upon such judgment rendered without reference to section 80, which was pivotal to the controversy, was of no relevance, and the observations made therein could not be applied to the facts of the case before it.

The tribunal further observed that no explanation was given as to how the omission to account for such a large loss had resulted, and therefore the propriety of such capital loss itself was under a cloud. It was therefore difficult for the tribunal to affirm that the omission or wrongful statement in the original return was sheer inadvertence and not deliberate or willful. The revised return could be filed only if there was an omission or wrong statement. A reference was made by the tribunal to the decision of the Supreme Court in the case of Kumar Jagdish Chandra Sinha vs. CIT 220 ITR 67, where it was held that a revised return could not be filed to cover up deliberate omission etc. in the original return.

The Tribunal therefore upheld the order of the AO.

OBSERVATIONS

There are various facets to the issue of claim of loss vis-à-vis a revised return;

A claim of increased loss where the original return declared loss that was increased in the revised return,
A claim of loss vide a revised return of income filed within the due date prescribed under s. 139(1),
Where the claim for loss was made during the course of assessment before the AO,
Where the claim for loss was made before the appellate authorities.
A claim of loss where the original return disclosed positive income,
Where the omission or wrong statement was conscious.

In Wipro’s case, the Supreme Court has rejected the claim for set-off and carry forward of the loss on two grounds;

the reason for filing the revised return could not be attributed to a mistake or a wrong statement, and
the return so filed could not transform itself into a return of loss under s. 139(3).

The Supreme Court in Wipro’s case considered the facts where the assessee filed a return under section 139(1), claiming exemption under section 10B, and therefore did not claim carry forward of the loss otherwise incurred. After the due date, it filed the declaration under section 10B(8) claiming that the provisions of section 10B should not apply, and claimed loss and the right to carry forward of losses under section 72, withdrawing its claim under section 10B. It may be noted that section 10B(8) requires the filing of the declaration to opt out before the due date prescribed under section 139(1). The Supreme Court held that the requirement to file the declaration under section 10B(8) was a mandatory requirement and not a directory one, and therefore filing the revised return under section 139(5) could not help the assessee to withdraw the claim under s. 10B of the Act and in its place stake a claim for the loss.

The Supreme Court also held that the assessee could file a revised return in a case only where there was an omission or a wrong statement. As per the Supreme Court, the revised return of income could not be filed to withdraw the claim of exemption and stake a claim for set-off of loss and to carry forward such loss. The Court held that the filing of a revised return to take a contrary stand regarding the claim of exemption was not permissible. In deciding so, the Supreme Court observed that the revised return filed by the assessee under section 139(5) only substituted the original return under section 139(1) and could not transform the original return into a return under section 139(3) in order to avail the benefit of carry forward or set-off of any loss under section 80. The issue in Wipro’s case was more about the right to withdraw the claim for an exemption by filing a revised return, and less about the right to claim a loss for the first time in a revised return of income.

In a situation where an original return of income is filed claiming a loss, either under the head “Business or Profession” or “Capital Gains” or both, which is filed within the time limit specified in section 139(1), what has undoubtedly been filed is a return of loss as envisaged by section 139(3), which is regarded as a return under section 139(1) by reason of operation of section 139(3). As held by the Supreme Court in Mahendra Mills case (supra), the revised return effaces or obliterates or replaces the original return, which original return cannot be acted upon by the AO. Any mistake or wrong statement made in a return furnished under section 139(1) can be corrected by filing a revised return under section 139(5) within the time specified in that sub-section. Therefore, logically, a return under section 139(3) declaring a loss under any one of the two heads of income can be revised to disclose a further loss under any of those heads (either the head with a positive income or the head with a loss in the original return) not disclosed in the original return. In Bilcare’s case, this was the position. The Delhi High Court supports this proposition in Nalwa Investments (supra) case, where a higher loss than that filed in the original return was claimed during assessment proceedings and allowed by the High Court. The Madras High Court also supports this proposition in the case of Periyar District Co-op. Milk Producers Union Ltd (supra), where it held that in view of the expression “all the provisions of this Act shall apply as if it were a return under sub-section (1)” contained in section 139(3), there was no reason to exclude the applicability of sub-section (5) to a return filed under sub-section (3). A similar view was taken by the Pune Tribunal in the case of Anagha Vijay Deshmukh vs. DyCIT 199 ITD 409, where a revised return was filed to claim a higher capital loss than that claimed in the original return.

In Bilcare’s case, the tribunal was concerned with a case where the original return of loss was revised and the claim of loss was substituted with the higher loss. This made it easier for the tribunal to hold the case in favour of the assessee as the original return was a return under s. 139(3). The facts presented by the assessee substantiated that there was an omission while filing the original return which was circumstantial and not deliberate. On a co-joint reading of the provisions of s. 139(3) and (5) along with sub-section (1), it is correct to hold that a return of loss filed under s. 139(3) can be revised under s.139(5) of the Act. In our considered view, there is no room for doubt about this position in law. The ratio of the decision in the case of Wipro was not applicable in this case, even where its decision in the context was not held to be obiter dicta.

Likewise, a case where the assessee has filed the revised return filed before the expiry of time prescribed under s.139(1), for claiming the loss for the first time should not pose a problem as such a return is nonetheless within the time permissible under s. 139(3) of the Act. The case of the assessee will be better served where there was a mistake in omitting to claim the loss originally.

A claim for deduction or expenditure is permissible to be made during the course of assessment or appellate proceedings, and such a claim resulting in assessed loss should not be disallowed and should be eligible for carry forward as long as the return of income was filed within the due date of s.139(1).

The challenge remains in a case where the original return of income filed u/s 139(1) was for a positive income which was changed to loss while filing the revised return under s. 139(5), outside the time prescribed under s.139(1) of the Act. It is in such a case that the Supreme Court in Wipro’s case held that it was not possible to grant the claim of loss staked under the revised return. The facts in RRPR’s case were similar to the facts in Wipro’s case, and therefore the tribunal in that case had no option but to apply the ratio of the decision of the Supreme Court.

In all cases of the revised return under s.139(5), the assessee has to establish that the revision was on account of the omission or a wrong statement and was not a deliberate and conscious act. Kumar Jagdish Chandra Sinha (supra),

Assuming that a given case does not suffer from the handicap of the deliberate or intentional act on the part of the assessee, one can perhaps analyse the issue in the absence of Wipro’s decision, notwithstanding the fact that even the application for the review of Wipro’s decision is rejected.

A situation where the income declared in the original return is a positive income under both heads of income, “Business or Profession” as well as “Capital Gains”, but a loss under either head is sought to be claimed in a revised return, as was the situation in RRPR Holding’s case. These were the facts before the Gujarat High Court in Babubhai Ramanbhai Patel’s case, where a positive return of income that was filed was sought to be revised disclosing such income, but also disclosing a speculation loss. While the Gujarat High Court did not expressly refer to section 80, they did hold that accepting the contention of the revenue would amount to limiting the scope of revision of the return, which did not flow from the language of section 139(5).
Similarly, the Karnataka High Court, in the case of Srinivas Builders (supra) allowed the claim for loss made during assessment proceedings, where the return of income originally filed was of a positive income.
A contrary view was taken by the Kerala High Court in the case of CIT vs. Kerala State Construction Corporation Ltd 267 Taxman 256, where the High Court held that when a return is originally filed under section 139(1), the enabling provision under section 139(5) to file a revised return only enables the substitution or revision of the original return filed. On a revised return filed, it can only be a return under section 139(1) and not one under section 139(3). The Kerala High Court relied (perhaps unjustifiably) on the decision of the Punjab & Haryana High Court in the case of CIT vs. Haryana Hotels Ltd 276 ITR 521, which was a case where a loss of an earlier year was claimed for set off without a return of income being filed at all and without any assessment having been done for that earlier year.
In Ramesh R Shah’s case (supra), a return of positive income was sought to be revised by claiming a long-term capital loss which was to be carried forward, in addition to the income declared in the original return. In that case, the Tribunal observed as under:

“In our humble opinion correct interpretation of section 80, as per the language used by the Legislature, condition for filing revised return of loss under section 139(3) is confined to the cases where there is only a loss in the original return filed by the assessee and no positive income and assessee desires to take benefit of carry forward of said loss. Once, assessee declares positive income in original return filed under section 139(1) but subsequently finds some mistake or wrong statement and files revised return declaring loss then can he be deprived of the benefit of carry forward of such loss? In our humble opinion, if we accept interpretation given by the authorities below, it would frustrate the object of section 80. Section 80 is a cap on the right of the assessee, when the assessee claims that he has no taxable income but only a loss but does not file the return of income declaring the said loss as provided in sub-section (3) of section 139. It is pertinent to note here that Legislature has dealt with two specific situations (i) under section 139(1), if the assessee has a taxable income chargeable to tax then it is a statutory obligation to file the return of income within the time allowed under section 139(1). So far as section 139(3) is concerned, it only provides for filing the return of loss if the assessee desires that the same should be carried forward and set off in future. As per the language used in sub-section (3) to section 139, it is contemplated that when the assessee files the original return, at that time, there should be loss and the assessee desires to claim said loss to be carried forward and set off in future assessment years. Sub-section (1) of section 139 cast statutory obligation on the assessee when there is positive income. In the present case, admittedly, the assessee filed the return of income declaring the positive income and even in the revised return, the assessee has declared the positive income as the loss in respect of the sale of shares, which could not be set off, inter-source or inter-head under section 70 or 71 of the Act.

11. We have to interpret the provisions of any statute to make the same workable to the logical ends. As per the provisions of sub-section (5) to section 139, in both the situations where the assessee has filed the return of positive income as well as return of loss at the first instance as per the time limit prescribed and subsequently, files the revised return then the revised return is treated as valid return. In the present case, as the assessee filed its original return declaring the positive income and hence, in our opinion, subsequent revised return is valid return also and the assessee is entitled to carry forward of ‘long-term capital loss’. Sub-sections (1) and (3) of section 139 provides for the different situations and in our opinion, there is no conflict in applicability of both the provisions as both the provisions are applicable in the different situations. We are, therefore, of the opinion that there is no justification to deny the assessee to carry forward the loss.”

Unfortunately, the decision in Ramesh R Shah’s case, though cited before the Tribunal in RRPR Holding’s case, was not considered by it in deciding the matter. It appears that the decision in RRPR Holding’s case was swayed by the assessee’s failure to furnish an explanation of the nature and character of transactions resulting in the capital loss, and therefore the genuineness of the transactions.
This view taken in Ramesh R Shah’s case has also been followed by the Tribunal in the case of Mukund N Shah vs. ACIT, ITA No 4311/Mum/2009 dated 17th August, 2011, where a revised return was filed during the course of assessment proceedings, claiming a capital loss which had not been claimed in the original return filed under section 139(1). The Tribunal held that once the return is revised the original return filed gets substituted by a revised return, and therefore, loss determined as per the revised return was to be treated as loss declared under section 139(3), because the original return was filed within the time allowed under section 139(1). Therefore, the loss determined has to be taken as a loss computed in accordance with the provisions of section 139(3) and such loss has to be allowed to be carried forward under the provisions of section 80. The Tribunal also looked at it from a different angle. If the assessee had not revised the return at all and no loss was shown in the original return due to some mistake, the AO in the assessment under section 143(3) was required to compute income or loss correctly. Once the loss had been determined by the AO under section 143(3), it cannot be said that the loss cannot be allowed to be carried forward when the return has been filed within the time allowed under section 139(1).

A harmonious reading of the provisions of sub-sections (1),(3),(5) of s. 139 with s.80 of the Act reveals that the return of income is to be filed under s.139(1) and of loss under s. 139(3) and both the returns are to be filed within the time prescribed under s.139(1). The reading also confirms that both of these returns can be revised under sub-section (5). There is no express or implicit condition in s.139 that stipulates that a return of income cannot be revised to declare loss for the first time.

Importantly s.139(3) clearly states that all the provisions of the Act shall apply to such a return as if the return of loss is the return of income furnished under s.139(1) of the Act. In our respectful opinion, it is clear that no further transformation is called for where the legislature itself had bestowed the return of loss with the status of a return under s.139(1), and no further aid is required from the provisions of sub-section (5) to further transform the return filed thereunder as one under sub-section (3).

The purpose of section 80 is that, while there is no obligation to file a return of income under section 139(1), the assessee should file a return of income and have the loss determined in order to be able to claim carry forward and set off of the loss. This purpose is achieved even in a situation where the original return declaring a positive income is filed in time but is revised on account of a mistake to reflect a loss. Further, if a return of loss can be revised to claim a higher loss or can be assessed at a higher loss on account of a claim made in assessment proceedings, there is no justification in denying a claim of a loss merely because it was made through a revised return and not through the original return. This view also results in a harmonious interpretation of sections 80, 139(3) and 139(5).

There is no doubt that the ratio of the Supreme Court‘s decision in Wipro Ltd.’s case will be applicable to cases with identical facts, till such time the relevant part of the decision is read as obiter dicta by the courts or the same is reconsidered by the Supreme Court itself. Better still is for the legislature to come forward and correct an aberration that is harmful, and the harm is unintended.

BCAJ Admin

‘Only Source of Income’ For S. 80-IA/80IB and Other Provisions

ISSUE UNDER CONSIDERATION

A deduction in respect of profits and gains from industrial undertakings or enterprises engaged in infrastructure development is conferred vide s. 80-IA for varied periods at the specified percentage of profit, subject to compliance with several conditions specified in s. 80-IA of the Income Tax Act, 1961. One of the important conditions is provided by sub-section (5) of s. 80-IA, which overrides the other provisions of the Act, requiring an assessee to determine the quantum of deduction to be computed as if the qualifying business is the only source of income.The said provision of s. 80-IA (5) reads as under;

‘Notwithstanding anything contained in any other provision of this Act, the profits and gains of an eligible business to which the provisions of sub-section (1) apply shall, for the purposes of determining the quantum of deduction under that sub-section for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year, be computed as if such eligible business were the only source of incomeof the assessee during the previous year relevant to the initial assessment year and to every subsequent assessment year up to and including the assessment year for which the determination is to be made.’

A similar condition is prescribed in a few other provisions of Chapter VIA of the Act, and was also found in some of the provisions now omitted from the Act. Like any other deduction, the benefit of deduction here is subject to compliance with the conditions and the ceilings of s. 80A to 80B of the Act. The computation of the quantum of the ‘only source of income’ has become a major issue that has been before the courts for quite some time. The Delhi, Rajasthan and Madras High Courts have taken a view that, in computing the only source of income, the losses of the preceding previous years relating to the same source should not be set off and adjusted or reduced from the income of the year, where such losses are otherwise absorbed in the preceding previous years. In contrast, the Karnataka High Court has taken a contrary view, holding that such losses, even though absorbed, should be notionally brought forward for computing the quantum of deduction for the year under consideration.

MICROLAB’S CASE

The issue had come up for consideration of the Karnataka High Court in the case of Microlabs Limited vs. ACIT, 230 Taxman 647. In that case, the assessee was engaged in the business of running an industrial undertaking and had derived profit from such business for the year under consideration. The losses remaining to be absorbed of the preceding previous years of such business were absorbed against the other income of the immediately preceding previous year. Accordingly, in computing the quantum of deduction under s. 80-IA for the year under consideration, the assessee company had claimed a deduction in respect of the entire profit of the year of such business. The AO however had reduced the quantum of deduction by the amount of losses of the preceding previous years that were absorbed and adjusted in computing the deduction for the immediately preceding previous year. The action of the AO was upheld by the tribunal.Aggrieved by the action of the AO and the tribunal, the assessee company had raised the following substantial question of law for consideration of the High Court;

“Whether in law, the Tribunal is justified in holding that in view of provision of Section 80-IA(5) of the Income Tax Act, the profit from the eligible business for the purpose of deduction under Section 80-IB of the Act has to be computed after deduction of notional brought forward losses of eligible business even though they have been allowed to set off against other income in the earlier years?”

On behalf of the assessee company, relying on the decision of the Madras High Court in the case of Velayudhaswamy Spinning Mills (P) Ltd. vs. ACIT, 340 ITR 477, it was contended that, once the set-off of losses had taken place in an earlier year against the other income of the assessee, such losses could not be notionally brought forward and set-off against the income of the eligible business for the year in computing deduction under s. 80-IA of the Act.

In contrast, the Revenue, relying on the decision of the Special Bench of the tribunal in the case of ACIT vs.Goldmine Shares and Finance (P) Ltd., 113 ITD 209 (Ahd.), contended that the non-obstante clause in sub-section (5) had the effect of overriding all the provisions of the Act, and therefore the other provisions of the act were to be ignored in computing the deduction for the year. As a consequence, the losses already set off against the other income of the immediately preceding previous year were to be brought forward notionally, and again set off against the profit of the year.

The Karnataka High Court, in deciding the substantial question of law in favour of the Revenue and against the assessee, followed the view taken by the special bench of the tribunal to hold that the losses absorbed in the past should be notionally brought forward to reduce the profit for the year while computing the deduction u/s. 80-IA of the Act.

STERLING AGRO INDUSTRIES’ CASE

Recently the issue again arose before the Delhi High Court in the case of Pr CITvs.Sterling Agro Industries Ltd. 455 ITR 65. In this case, the assessee company had returned an income of Rs.22.12 crore after claiming deduction u/s. 80-IA. On assessment, the AO disallowed the claim of Rs.12.63 crore, by applying the provisions of s. 80-IA(5) of the Act. On appeal to the tribunal, the claim of the assessee was allowed in full by the tribunal, by relying on the decision of the Madras High Court in the case of Velayudhaswamy Spinning Mills (P.) Ltd (supra). In an appeal by the Revenue, the following question of law was placed for consideration by the High Court;

‘Given the facts and circumstances of the case, has the Income Tax Appellate Tribunal erred in deleting the addition made by the Assessing Officer on account of disallowance of deduction under section 80IA of the Income-tax Act, 1961, amounting to Rs.12,63,07,697, ignoring the mandate of provisions of Section 80IA(5) of the Act?’The Revenue contended that the losses of the preceding previous years, though absorbed against the profits of such years, had to be notionally brought forward and reduced from the profit of the year in computing the deduction for the year, in view of the non-obstante clause of sub-section (5) of s. 80-IA, whose contention was upheld by the Karnataka High Court in the case of Microlabs Ltd. (supra).In contrast, the assessee contended that once the losses were absorbed and adjusted in the preceding previous years, such losses could not be brought forward and set off in computing the deduction for the year. The Delhi High Court upholding the decision of the tribunal and the contentions of the assessee company held that;

‘….., there is nothing to suggest in Sub-clause (5) of Section 80IA of the Act that the profits derived by an assessee from the eligible business can be adjusted against “notional losses which stand absorbed against profits of other business.” The deeming fiction created by sub-section (5) of Section 80IA does not envisage such an adjustment. The fiction which has been created is simply this: the eligible business will be the only source of income. There is no fiction created, that losses which have already been absorbed, will be notionally carried forward and adjusted against the profits derived from the eligible business to quantify the deduction that the assessee could claim under section 80IA of the Act.

A perusal of the judgment rendered in the Microlabs Ltd. case (supra) would show that the Karnataka High Court gave weight to the fact that sub-section (5) of Section 80IA commenced with a non-obstante clause. It was based on this singular fact that the Karnataka High Court chose to veer away from the view expressed by the Madras High Court in the Velayudhaswamy Spinning Mills (P.) Ltd. case (supra). This aspect emerges on an appraisal of paragraph 6 of the judgement of the Karnataka High Court rendered in Microlabs Ltd. case (supra).’

The Court observed that similar contentions were advanced by the Revenue in the case of Velayudhaswamy Spinning Mills (P.) Ltd. Case (Supra), and such contentions were disapproved by the Madras High Court. The Court also noted that the decision in the said case was followed by the Madras High Court in the case of Pr CIT vs.Prabhu Spinning Mills (P.) Ltd. 243 taxman 462 (Madras).In deciding the issue in favour of the assessee, the Delhi High Court disagreed with the ratio of the decision in the case of Microlabs Ltd. (supra)and chose to follow the ratio of the two decisions of the Madras High Court, to allow the claim of deduction without adjusting the losses set-off in the preceding previous years.

OBSERVATIONS

This interesting issue has far-reaching economic impact in cases of assessees otherwise qualifying for the deduction. The non-obstante clause of sub-section (5) has the effect of overriding the other provisions of the Act. The said clause requires that while determining the quantum of deduction under s. 80-IA, it should be assumed that the eligible business is the only source of income. The provision throws open a few questions;

What is the true meaning of the term ‘only source of income’,
Whether the other provisions of the Act applied in the preceding previous years should be presumed to have been ignored and the effect thereof be nullified for the purpose of computing deduction for the year on a stand-alone basis,
Whether the concept of stand-alone computation be applied for all the eligible years of deduction or should it be limited to the first year of claim of deduction,
Whether the past losses already absorbed against the past profits of the eligible business be notionally brought forward to the year of claim,
Whether the past losses already absorbed against the past profits of the other business or other income be notionally brought forward to the year of claim,
Whether the losses of the year from other ineligible business be set off and adjusted against the profit for the year of the eligible business in computing the claim of deduction.

The incentive was first conferred by the introduction of S. 80-I by the Finance Act, 1980 with effect from 1st April, 1981, which was substituted by s. 80-IA by the Finance (2) Act, 1991 with effect from 1.4.1991. The said provision was further substituted by the Finance (No 2) Act, 1998 with effect from 1st April, 1998, by splitting the provision into two parts, s. 80-IA and s. 80-IB. The new section 80-IA materially contains the identical provision for granting deduction in respect of profits of an infrastructure development enterprise, and s. 80-IB contains similar provisions for the profits of an industrial undertaking.

The provision of s. 80-IA (5) contains a non-obstante clause for computing only source of income on a stand-alone basis. This provision is made equally applicable to the computation of the deduction u/s. 80-IB as well. Some other incentive provisions of Chapter VIA of the Act also contain similar provisions. The deductions are, as noted earlier, subject to the overall conditions of s. 80A to 80B of the Act, which has the effect of limiting the overall deduction for the year to the gross total income of the year.

The case for higher deduction for the assessee, by holding out that the losses that are absorbed in the preceding previous years stand absorbed and cannot be rekindled by invoking the fiction of s. 80-IA(5), is better in as much as the Madras High Court and the Delhi High Court in three important decisions have held that such absorbed losses should not be notionally revived for set-off against the profits of the year of the eligible business. These High Courts have taken into consideration the ratio of the Special Bench decision in the case of Goldmine Shares & Finance (supra)and, only after considering the counter contentions, have decided the issue in favour of the assessee. The Courts also considered the decisions of the High Courts in the cases of CIT vs. Mewar Oil & General Mills Ltd. 271 ITR 311 (Raj.),Indian Transformers Ltd. vs. CIT, 86 ITR 192 (Ker.),CIT vs. L.M.Van Moppes Diamond Tools (India) Ltd., 107 ITR 386 (Mad.)andCIT vs. Balmer Lawrie & Company Ltd. 215 ITR 249 (Cal), to arrive at a conclusion rejecting the case for notional carry forward of the losses that were absorbed in the preceding previous years.

This view also gets support from CBDT Circular No. 1 dated 15th February, 2016. Importantly, these courts have held that there was nothing in sub-section (5) of s. 80-IA that suggested that profits derived by an assessee from the eligible business should be adjusted against notional losses which have been absorbed against profits of other businesses in the past years. They held that the deeming fiction created by sub-section (5) did not envisage any such adjustment. In the courts’ view, the fiction created was that the eligible business profit should be the only source of income; and that such a fiction did not extend to provide that the losses that have already been absorbed would be notionally carried forward and adjusted against the profits derived from the eligible business, while quantifying the deduction that the assessee could claim under s. 80-IA for the year. The Delhi High Court also held that the Karnataka High Court in Microlabs Ltd. case perhaps gave greater weightage to the non-obstante clause to expand its meaning to notionally carry forward such losses that had already been adjusted and absorbed.

It however is relevant for the record to state that the issue is presently before the Supreme Court, as in some of the cases, including in Microlabs Ltd. case, the apex Court has admitted the special leave petition. Incidentally, in the Prabhu Spinning Mills case, the Supreme Court has rejected the Special Leave Petition filed by the Department.

One of the considerations for the decisions in favour of the assessee was that the profits were allowed full deduction in the preceding previous years without set-off of absorbed losses, and with that, the Revenue had accepted the position in law. The circular of 2016, relied upon by the courts, was rendered in the context of defining the initial assessment year and permitting the deduction for the block period commencing from the initial year assessment year and not from the year of manufacturing or production.

It is also relevant to note that the profits that would finally be eligible for deduction would be limited to such profits that are included in the gross total income. Only such profits remain after the set off of the losses of the year pertaining to ineligible business, in view of a specific provision of s. 80A and s. 80B of the Act, would finally be allowed deduction.

S. 80-I brought in by the Finance Act, 1980 with effect from 1st April, 1981 provided for a similar incentive deduction and the implication and the scope of the deduction were explained by the Explanatory Notes and by the Board vide Circular No. 281 dated 22nd September, 1980. The said section also contained a non-obstante clause namely s. 80-I(6), which is more or less similar to s. 80-IA(7) and now 80-IA(5), presently under consideration. The scope of this section 80-I(6) was examined in the cases of Dewan Kraft System (P.) Ltd., 160 taxman 343 (Del), Ashok Alco Chem Ltd., 96 ITD 160 (Mum.), Prasad Production (P.) Ltd.,98 ITD 212 (Chennai), Sri. Ramkrishna Mills (CBE) Ltd., 7 SOT 356andKanchan Oil Industries Ltd., 92 ITD 557 (Kol.). These decisions largely favoured a view that the losses were required to be notionally carried forward, even though they were set off in the actual computation of earlier years.

The Calcutta High Court in Balmer Lawrie’s case was concerned with the deduction u/s. 80HH of the Act, which provision had no specific overriding clause like s. 80-I(6) or its successors. The decision of the Rajasthan High Court in the case of Mewar Oil & General Mills Ltd., (supra)was a case where the implication of the non-obstante clause was not examined and considered at all at any stage, and the issue involved therein was about the losses that were absorbed before the non-obstante clause was brought in force, or the incentive deduction was provided for. The decision largely concerned itself with an order that was passed u/s. 154 of the Act to withdraw the incentive granted in rectification proceedings.

There is no dispute that the non-obstante clause incorporates a deeming fiction which has to be given meaning, and importantly, has to be carried to its logical conclusion. The view that fiction has to be carried to its logical conclusion and should be given full force without cutting it midway, in the absence of any specific provision to cut it midway, is a settled position in law. Instead of appreciating the need for logically concluding the scope of a legal fiction, the courts have rather abruptly sought to cut its application midway; to hold, in the absence of a specific positive provision, permitting the notional carry forward of absorbed losses, that no fiction can be introduced. The alternative view perhaps was to allow the fiction to run its full course, by permitting the notional carry forward of absorbed losses in the interest of logically concluding such a fiction for the computation of quantum of deduction, and not for the purposes of any other provisions of the Act;

The deeming fiction by use of words ‘only source of income’ might take into consideration the income from that source alone from the initial assessment year and subsequent years, and might lead to computing the profit of the year after setting off the losses not absorbed by such profits, only by applying the rule that the fiction should be extended to the consequence that would inevitably follow by assuming an imaginary state of affairs as real unless prohibited, even where inconsistent corollaries are drawn.

Section 80-IA(5) bids one to imagine and treat the eligible business as the only source of income of an undertaking as real, as if there was no other source of income for the assessee. Having said so, the statute does not provide for limiting one’s imagination when it comes to the inevitable corollaries of the imagined state of affairs. It does not provide that the depreciation or losses of eligible business of past years if set off as per s.70 to 74 or s.32, should remain to be so set off, and should not be brought forward for computing the only source of income.

A legal ?ction of substance is created by sub-section (5) by which the eligible business has been treated as the only source of income. In applying the same, it may not be improper, but necessary, to assume all those facts on which alone the ?ction can operate, so, necessarily, all the provisions in the Act in respect of a source of income will apply. As a consequence, the other sources of income of an assessee / undertaking would have to be assumed as not existing. Consequently, any depreciation or loss of the eligible business cannot be set off against any income from another source which is assumed to have not been in existence, and therefore, the depreciation or the loss of the eligible business has to be carried forward for set off against the pro?ts of the eligible business in the subsequent year, even where such past losses were set off against the profits of the ineligible business as per the other provisions of the Act in the preceding previous year. Because of the ?ction, even if any set off of eligible business loss was made against other sources of income, it has to be assumed to not have been so set off.

“As if that were the only source of income” may require an assessee to ignore all other sources of income and that there was no other source of income. If that be so, the depreciation and loss of the eligible business cannot be absorbed and be set off against any other source or head of income. Consequently, they be carried forward and set off against the income of this very source only, for which the deduction is being computed.

It is not impossible to hold that neither the income nor loss of a business other than the eligible business of any year can be taken into consideration; nor the earlier years’ losses of the eligible business can be ignored, in computing the pro?t and gains to determine the quantum of the deduction under this section. Losses of the eligible business are to be set off only against the subsequent years’ income of the eligible business, even though these were set off against other income of the assessee in that earlier year.

Notes on clauses explaining the scope of sub-section (6) of s.80 I, 123 ITR 126 (Statute) reads as under:

“Sub-section (6) provides that for the purpose of computing the deduction at the speci?ed percentage for the assessment year immediately succeeding the initial assessment year and any subsequent assessment year, the pro?ts and gains will be computed as if such business were the only source of income of the assessee in all the assessment years for which the deduction at the speci?ed percentage under this section is available.”

The relevant part of the Memorandum Explaining the provisions of the Finance Bill, 1980, in the context of s. 80I reads as under;

‘”The new “tax holiday” scheme differs from the existing scheme in the following respects, namely

(i) The basis of computing the “tax holiday” pro?ts is being changed from capital employed to a percentage of the taxable income derived from the new industrial unit, ship or approved hotel. In the case of companies, 25 per cent of the pro?ts derived from new industrial undertaking etc., will be exempted from tax for a period of seven years and in the case of other taxable entities 20 per cent of such pro?ts will be exempted for a like period. In the case of co-operative societies, however, the exemption will be allowed for a period of ten years instead of seven years.

(ii) The bene?t of “tax holiday” under the new scheme would be admissible to all small-scale industrial undertakings even if they are engaged in the production of articles listed in the Eleventh Schedule to the Income-tax Act. In the case of other industrial undertakings, however, the deduction will be available, as at present, where the undertakings are engaged the production of articles other than articles listed in the said Schedule.

(iii) In computing the quantum of “tax holiday” pro?ts in all cases, taxable income derived from the new industrial units, etc., will be determined as if such unit were an independent unit owned by a taxpayer who does not have any other source of income. In the result, the losses, depreciation and investment allowance of earlier years in respect of the new industrial undertaking, ship or approved hotel will be taken into account in determining the quantum of deduction admissible under the new section 80-I even though they may have been set off against the pro?ts of the taxpayer from other sources.”

S. 80-IA(5), by use of the words ‘for initial assessment year and every subsequent year up to and including the assessment year for which the determination is to be made’, has clarified that the provisions of the non-obstante clause shall apply to all the relevant assessment years for which a deduction was claimed and its scope should not be restricted to the initial assessment year alone.

It is also clear that the overriding effect of sub-section (5) is limited to the computation of the quantum of deduction u/s. 80-IA or 80-IB, and has no role to play in computing the total income otherwise as per the provisions of the Act. Therefore, the provisions of s. 80A and s. 80B have their own place in the scheme of the Act. It appearsthat the language of the text of sub-section (5) is clearand unambiguous, and therefore the meaning that has to be supplied for understanding its scope, will have to be from the literal reading of the provision,without bringing in the case for liberal or restricted interpretation.

In our considered opinion, it is appropriate for the Supreme Court or the Legislature to put the issue beyond doubt, in view of the larger effect on the taxpayers.

BCAJ Admin

The Requirement To Provide Materials And Evidences Along With Show Cause Notice U/S 148A(B)

ISSUE FOR CONSIDERATION

The new provision of section 148 as substituted by the Finance Act, 2021, authorizes the Assessing Officer to issue a notice of reassessment where there is information with him which suggests that the income chargeable to tax has escaped assessment in the case of the assessee, subject to fulfillment of other conditions. Section 148A lays down the procedure which needs to be followed by the Assessing Officer before a notice under section 148 is issued by him, except where the search is conducted in the assessee’s case, or where assets or materials seized during the search in someone else’s case belong or pertain to the assessee.

One of the requirements of section 148A contained in clause (b), is to serve a notice upon the assessee providing him with an opportunity of being heard and asking him to show cause within a specified time as to why a notice under section 148 should not be issued on the basis of information which suggests that income chargeable to tax has escaped assessment in his case.

Recently, an issue has arisen as to whether it is sufficient if the relevant information suggesting escapement of income has been mentioned in the show cause notice issued under section 148A(b), or whether the Assessing Officer is also required to provide copies of the materials available with him containing such information and on the basis of which he wants to ascertain whether an income has escaped assessment or not. The Bombay, Delhi, Chhattisgarh and Calcutta High Courts have taken a view that the Assessing Officer is duty bound to provide not only the information but also the copies of the materials to the assessee. However, recently, the Madhya Pradesh High Court has taken a contrary view holding that the copies need not be provided with the notice u/s. 148A of the Act.

ANURAG GUPTA’S CASE

The issue had come up for consideration by the Bombay High Court in the case of Anurag Gupta vs. ITO [2023] 150 taxmann.com 99 (Bombay).

In this case, for the assessment year 2018–19, the Assessing Officer had issued a notice under section 148A(b) on 8th March, 2022, on the ground that the information was received consequent to search / survey action carried out in the case of Antariksh Group, that assessee had purchased a warehouse from BGR Construction LLP for which on-money of ₹70,00,000 was paid, which was not accounted in the books of account of the assessee.

The said show cause notice was replied by the assessee on 14th March, 2022, wherein he totally denied the existence of any transaction with BGR Construction LLP, booking of a warehouse or payment made to the said entity. The assessee also denied any ‘on-money cash transaction’ with the said entity and therefore, demanded that the proceedings initiated under section 147 of the Act be dropped.

Thereafter, on 21st March, 2022, the Assessing Officer issued a clarification in regard to the notice under section 148A(b), this time stating therein that the assessee had also executed a conveyance deed with Meet Spaces LLP and, therefore, the Assessing Officer required the assessee to furnish payment details regarding this deed also.

The assessee did not file any response to the second notice and, therefore, the Assessing Officer proceeded to pass an order under section 148A(d), wherein it was mentioned, firstly, that cash payments had been made by the assessee to BGR Construction LLP as had been confirmed in the statement recorded during the survey action and, secondly, that the assessee had entered into a conveyance deed as a purchaser with Meet Spaces LLP for a consideration of ₹10,00,000, which remained unexplained.

Before the High Court, it was argued on behalf of the assessee that the procedure as prescribed under section 148A(b) as well as the principles of natural justice had been violated. While the assessee was given the information in terms of section 148A(b), the material which ought to have been provided to the assessee was not so furnished. In the absence of the same, the assessee was precluded from filing an effective reply to the show cause notice. On the other hand, the revenue contended that there was no such obligation cast upon the revenue in terms of Section 148A(b) of the Act to provide to the assessee anything beyond providing him with the information.

The assessee also relied upon the decision of the Supreme Court in the case of UOI vs. Ashish Agarwal [2022] 138 taxmann.com 64 wherein on a related matter, the Assessing Officers were directed to provide to the respective assessee the information and material relied upon by the Revenue within thirty days of the decision so that the assessees can reply to the show cause notices within two weeks thereafter. It was urged that the requirement of section 148A(b) has clearly been spelt out in the direction of the Supreme Court in the case of Ashish Agarwal (supra), which envisaged that not only information be provided to the assessee, but also the copies of the material relied upon by the revenue for purposes of making it possible for the assessee to file a reply to the show cause notice in terms of the said section.

The High Court observed that no material had been supplied to the assesse even though there was material available with the Assessing Officer, as could be seen from the order passed under section 148A(d) which was in the shape of a statement recorded, during survey action of the partner of BGR Construction LLP. There also appeared to be a sale list, which was allegedly found during the search operations containing the names of 72 investors, including the assessee, which although referred to in the order under section 148A(d) as also in the subsequent clarification, was also not provided to the assessee. Interestingly, while the said subsequent communication dated 21st March, 2022, did say that the list of total sales “was being attached for the ready reference of the assessee for purposes of submitting a reply to the show cause notice”, no such list was admittedly furnished.

The High Court held that providing information to the assessee, without furnishing the material based upon which the information was provided, would render an assessee handicapped in submitting an effective reply to the show cause notice, thereby rendering the purpose and spirit of section 148A(b) totally illusive and ephemeral. The fact that the material also was required to be supplied could very well be gauged from the clear directions issued by the Supreme Court in the case of Ashish Agarwal (supra). Accordingly, the High Court held that the reassessment proceedings initiated were unsustainable on the ground of violation of the procedure prescribed under section 148A(b), on account of the failure of the Assessing Officer to provide the requisite material, which ought to have been supplied along with the information in terms of the said section. The order passed under section 148A(d) and consequential notice issued under section 148 were quashed, and the matter was left open for the revenue from the stage of the notice under section 148A(b) for supplying the relevant material, if it was otherwise permissible, keeping in view the issue of limitation.

Although the assessee raised the other two contentions with respect to the sanction to be obtained under section 151 and also with respect to the inquiry being not conducted under section 148A(b), the High Court did not deal with those issues, as the order passed under section 148A(d) was found to be bad in law on the ground of not providing the requisite materials to the assessee.

AMRIT HOMES (P) LTD’S CASE

The issue, thereafter, came up for consideration before the Madhya Pradesh High Court in the case of Amrit Homes (P) Ltd vs. DCIT [2023] 154 taxmann.com 289.

In this case, the order was passed under section 148A(d) for the assessment year 2016–17 on 28th April, 2023, which was followed by the issue of notice under section 148 on the same date. The assessee challenged the validity of this order and notice by filing a writ petition under Article 226 of the Constitution. Primarily, the grievance of the assessee was that information/evidence categorized as foundational material was not sufficient to suggest that any income chargeable to tax has escaped assessment.

The High Court held that section 148A was inserted in the Act by the Finance Act, 2021 primarily to give effect to the ratio laid down by Apex Court in GKN Driveshafts (India) Ltd vs. ITO [2003] 259 ITR 19 (SC). In the said decision it was held that the assessee, if it so desired, could seek for the reasons for issuing notice under section 148, could also file the objections to issuance of notice upon receipt of the reasons and the Assessing Officer was bound to dispose of the objections so raised by passing a speaking order. Section 148A has provided a similar opportunity of being heard before reopening the case and issuing notice under section 148.

It was held by the Court that the nature of inquiry contemplated by Section 148A was not a detailed one. The purpose of the inquiry was to communicate to the assessee that the Assessing Officer was in possession of information suggesting that certain income of the assessee which was chargeable to tax had escaped assessment. The communication made by issuance of show cause notice, should contain enough information and reasons to reveal the intention of the Assessing Officer.

The Court further held that the statute however did not oblige the Assessing Officer to supply the relevant material/evidence, which was the foundation for the Assessing Officer to come to the prima facie view that income chargeable to tax had escaped assessment. This was because neither in the judgment of the Apex Court in the case of GKN Driveshafts (India) Ltd. (supra) nor in section 148A any such indication could be gathered. The only duty cast upon the Assessing Officer was to supply information by mentioning the same in the show cause notice issued under section 148A(b). If the inquiry contemplated in Section 148A was interpreted to mean a detailed inquiry, where both sides could seek and adduce evidence / material (documentary / ocular), then the entire object behind Section 148A would stand defeated.

The High Court further held that section 148A did not expressly provide for the supply of any material/evidence in support of the show cause notice under section 148A(b). It did not obligate the Assessing Officer to supply any material / evidence, provided the show cause notice contained reasons disclosing the mind of the Assessing Officer nursing the prima facie view suggestive of a case where income chargeable to tax had escaped assessment.

The High Court also considered the concept of reasonable opportunity, and whether the said concept could be stretched to the extent of supplying material / evidence in support of the opinion of the Assessing Officer that certain income had escaped assessment. On this, the High Court held that the concept of reasonable opportunity in non-taxing statutes was required to be applied to its fullest (including supply of adverse material), irrespective of the presence of any express provision or not, in cases where the authority concerned passed an order entailing civil consequences of adverse nature. However, the law of interpretation of taxing statutes was at variance with the law of interpretation of non-taxing statutes. The difference was that the taxing statute was to be understood by the plain words used in it, without taking aid of other tools of interpretation of statutes e.g. intendment, implication or reading into. The words employed by section 148A(b) provided for affording of opportunity of being heard by way of show cause notice. This requirement of the law was satisfied if the show cause notice contained information which had persuaded the Assessing Officer to form an opinion that certain income had escaped assessment of a particular assessment year. The statute did not compel the Assessing Officer to supply material/evidence (documentary / oral) on the basis of which the aforesaid opinion had been formed by the Assessing Officer.

On the basis of these reasonings, the High Court concluded that the assessee was not entitled to the material/evidence (oral/documentary), which was the foundation of the opinion formed by the Assessing Officer, so long as a show cause notice mentioned about such foundational information and the supportive reasons to form the said opinion.

The Madhya Pradesh High Court disagreed with the view taken by the Delhi High Court in Mahashian Di Hatti (P) Ltd vs. Dy CIT (W.P. (C) 12505/2022), Divya Capital One (P) Ltd vs. Asstt CIT 445 ITR 436 (Delhi), SABH Infrastructure Ltd. vs. Asstt CIT 398 ITR 198 (Delhi), Chhattisgarh High Court in Vinod Lalwani vs. Union of India 455 ITR 738 (Chhattisgarh) and Bombay High Court in Anurag Gupta vs. ITO (W.P. No. 10184/2022) / 454 ITR 326 on the ground that the foundational principle of interpretation of taxing statutes was not considered. It was held that those High Courts were persuaded by the principle of reasonable opportunity, which was ordinarily applied while interpreting non-taxing statutes, and in taxing statutes, nothing could be read into or implied and the plain meaning of the words used in the taxing statute were to be given their due meaning.

The High Court dismissed the petition of the assessee and did not deal with the veracity and genuineness of material/evidence forming the opinion of the Assessing Officer suggesting that the income of the assessee had escaped assessment, as it was considered to be outside the scope of the writ jurisdiction under Article 226 or supervisory jurisdiction under Article 227 of the Constitution.

OBSERVATIONS

The relevant clause of section 148A under which this issue is arising is being reproduced below for reference –

The Assessing Officer shall, before issuing any notice under section 148,—

(a)……………..

(b) provide an opportunity of being heard to the assessee, by serving upon him a notice to show cause within such time, as may be specified in the notice, being not less than seven days and but not exceeding thirty days from the date on which such notice is issued, or such time, as may be extended by him on the basis of an application in this behalf, as to why a notice under section 148 should not be issued on the basis of information which suggests that income chargeable to tax has escaped assessment in his case for the relevant assessment year and results of enquiry conducted, if any, as per clause (a);

It can be seen the law expressly provides for issuing a notice on the basis of information available and affording an opportunity of being heard to the assessee, before a view is formed that an income has escaped assessment and the assessee is put to hardship by issuing a notice under section 148. Obviously, in availing the opportunity afforded, the assessee should be allowed to examine the veracity of the information relied upon and refute the derivation of the AO. Though prima facie this would be possible only where copies of the material or information are provided to the assessee. It is a settled principle of law that the opportunity to be heard should be real, reasonable and effective. It should not be an empty formality. The observations of the Hon’ble Supreme Court with respect to the principle of natural justice from the case of Mohinder Singh Gill vs. Chief Election Commissioner AIR 1978 (SC) 851, are noteworthy and they are being reproduced below:

“Natural justice is a pervasive facet of secular law where a spiritual touch enlivens legislation, administration and adjudication, to make fairness a creed of life. It has many colours and shades, many forms and shapes and, save where valid law excludes, it applies when people are affected by acts of authority. It is the bone of healthy government, recognised from earliest times and not a mystic testament of judge-made law. Indeed from the legendary days of Adam — and of Kautilya’s Arthashastra — the rule of law has had this stamp of natural justice, which makes it social justice. We need not go into these deep for the present except to indicate that the roots of natural justice and its foliage are noble and not new-fangled. Today its application must be sustained by current legislation, case law or another extant principle, not the hoary chords of legend and history. Our jurisprudence has sanctioned its prevalence even like the Anglo-American system.”

In order to provide the effective opportunity of being heard, as required in terms of clause (b) of section 148A, it is imperative that the relevant materials containing the information about the escapement of income in the case of the assessee have been provided to the assessee. Without having seen the relevant materials in the possession of the Assessing Officer, the assessee would not be able to effectively defend his case, and prove that there had been no basis to form an opinion that income had escaped assessment in his case. For instance, if the Assessing Officer was relying upon the statement of a third-party and, on the basis of the information provided in that statement with respect to the assessee, an opinion had been formed that income had escaped assessment, then it was obvious that the assessee needed to understand as to what had been deposed by the witness in his statement so recorded, and whether it was true and sufficient to come to a conclusion that income had escaped assessment as alleged by the Assessing Officer.

The Madhya Pradesh High Court has held that the assessee is not entitled to have the materials or evidence which were the foundation of the opinion formed by the Assessing Officer, so long as the show cause notice mentioned about such foundational evidence or materials, and the supportive reasons to form the said opinion. However, the question which arises is how the assessee would be able to show cause that based on the information specified it was not possible to conclude by the AO that the income could have escaped assessment, and defend himself effectively if he is not provided with the relevant materials or evidence which are proposed to be used against him. Such an interpretation would render the provisions of clause (b) to a mere formality, which is against the basic principle of natural justice, that opportunity should not be provided in a manner whereby it becomes a mere formality.

The Supreme Court in the case of Ashish Agarwal (supra) had directed the Assessing Officer to not only provide the information suggesting the escapement of income, but also the relevant materials while validating the notices issued under the erstwhile provisions of section 148, during the time period extended by TOLA. It appears that the relevant observations of the Supreme Court from the case of Ashish Agarwal (supra) were not brought to the notice of the Madhya Pradesh High Court.

Further, with due respect, the distinction drawn between the interpretation of a taxing statute and a non-taxing statute by the Madhya Pradesh High Court is illusive and in any case not very relevant in so far as the issue is with respect to the manner in which the opportunity of being heard should be given. The extent to which the opportunity of being heard is required to be given under a taxing statute can be no less than the extent to which it is required to be given under a non-taxing statute.

While taking a view that the Assessing Officer is not duty bound to provide the relevant materials or evidence, while issuing a show cause notice under section 148A(b), the Madhya Pradesh High Court has relied upon the literal interpretation of the law and noticed that there is no such requirement in the relevant provision of section 148A(b). However, what should have been considered as relevant is the interpretation of the words “provide an opportunity of being heard” as used in section 148A(d). The requirement to provide the relevant materials used against the assessee for forming an opinion about the escapement of income is in-built within the requirement of providing an opportunity to be heard.

Justice must not only be done but should also be seen to have been done. There is a difference between delivering justice and a judgment. A judgment could be delivered by reading the language of the law while justice is delivered on appreciation of the spirit of the law besides of course, the language of the law. We are fortunate to be in a country where both have been given equal weightage by the judiciary in dispensing justice.

The judiciary governed by a rule of law has tacitly and expressly accepted the application of natural justice unless otherwise expressly prohibited by the statute. Following the canons of natural justice is an accepted jurisprudence in dispensing justice. In interpreting the provisions relating to the scheme of reopening and reassessment, even without there being a specific provision, the courts have consistently emphasised the need for an authority to provide to the assessee, the copies of the reasons recorded, material relied upon, information available, sanction obtained, and the inquiry conducted. Please see GKN Driveshafts (India) Ltd., 259 ITR 19 (SC), SABH Infrastructure, (supra), Micro Marbles, 457 ITR 567(Raj.), Tata Capital Financial Services Ltd., 443 ITR 127(Bom.) and Ashish Agarwal (supra).

It is worthwhile to note the suo moto directions of the Delhi High Court on the subject in the case of SABH Infrastructure (supra);

Before parting with the case, the court would like to observe that on a routine basis, a large number of writ petitions are filed challenging the reopening of assessments by the Revenue under sections 147 and 148 of the Act and despite numerous judgments on this issue, the same errors are repeated by the concerned Revenue authorities. In this background, the court would like the Revenue to adhere to the following guidelines in matters of reopening of assessments:

(i)	while communicating the reasons for reopening the assessment, a copy of the standard form used by the Assessing Officer for obtaining the approval of the Superior Officer should itself be provided to the assessee. This would contain the comment or endorsement of the Superior Officer with his name, designation and date. In other words, merely stating the reasons in a letter addressed by the Assessing Officer to the assessee is to be avoided;
(ii)	the reasons to believe ought to spell out all the reasons and grounds available with the Assessing Officer for reopening the assessment—especially in those cases where the first proviso to section 147 is attracted. The reasons to believe ought to also paraphrase any investigation report which may form the basis of the reasons and any enquiry conducted by the Assessing Officer on the same and if so, the conclusions thereof;
(iii)	*where the reasons make a reference to another document, whether as a letter or report, such document and/or relevant portions of such report should be enclosed along with the reasons;*
(iv)	the exercise of considering the assessee’s objections to the reopening of the assessment is not a mechanical ritual. It is a quasi-judicial function. The order disposing of the objections should deal with each objection and give proper reasons for the conclusion. No attempt should be made to add to the reasons for reopening of the assessment beyond what has already been disclosed.

The application of principles of natural justice is confirmed by the courts by regularly applying various provisions of the natural justice to the practice of the Income-tax Act, to ensure that no order is passed without sharing of information, statements recorded, and the material relied upon and affording of an opportunity of hearing before an adverse order is passed. This is evident, especially in respect of the provisions of s. 131, 132, 133A, 142(3), 147, 151, 153, 250, 254, 260 and chapters dealing with penalties and punishment under the Income tax Act. Most of these provisions do not expressly provide for sharing the copies of the material and information but the courts have read such requirements in implementing the law by applying the simple rule that a person cannot be hanged without a trial and that the trial should be fair and equitable. Even in cases of criminal justice, the application of the provisions of natural justice is desired and is applied by the courts to the extent possible under the facts of the case.

The new scheme of reopening and reassessment has clearly recorded the legislative intent in accepting the law laid down by the courts on the lines of what has been discussed here. In fact, the memorandum explaining the provisions of the new scheme, has expressly stated the need for respecting natural justice and following the mandate of the Supreme Court in the case of GKN Driveshafts (India) Ltd (supra). The new scheme has gone a step further by including a statutory provision in the form of section 148A in the body of the Act containing 4 very important provisions, under clauses (a) to (b), each of which is nothing but affirmation of the tenets of natural justice spelt out by the apex court in the cases of GKN Driveshafts (India) Ltd. (supra) and Ashish Agarwal (supra).

All the High Courts with the exception of the Madhya Pradesh High Court, in interpreting the new scheme of reopening and reassessment have reiterated that there was no change in judicial understanding of the old law, which continues even under the new scheme, that required the authorities to provide copies of the information and the material available with them.

In our respectful opinion, the significant change between the old scheme and the new scheme is that, under the new scheme, the authorities, before issuing the notice under section 148, now have to make up their minds that an income has escaped assessment. For making up their minds, they have to first follow the due procedure of section 148A and thereafter decide that there was an escapement of income and then only issue a notice. Once a decision is taken, the only course open for the AO is to examine the case of the assessee on merits. Having once issued a notice under section 148, it may be difficult for an AO to drop the proceedings by holding that there was no escapement of income, other than doing so on merits of the facts produced before him.

The better view, in our considered opinion, is that the relevant materials and evidences on the basis of which an inquiry is initiated (and subsequently an opinion about the escapement of income would be formed), have to be provided to the assessee along with the show cause notice issued under section 148A(b). If that is not done, the notice would be invalid.

BCAJ Admin

Charitable Trusts Exemption – Application in India or Purposes in India

ISSUE FOR CONSIDERATION

Under the provisions of section 11(1)(a), a charitable or religious trust is entitled to exemption of income derived from property held under trust wholly for charitable or religious purposes, to the extent to which such income is applied to such purposes in India.

An issue has arisen before the courts as to whether exemption is available for such trusts in cases where income is spent outside India for the benefit of charitable purposes in India. In other words, whether for a valid exemption, the application of income is required to be made in India or it is sufficient that the purpose for which the income is applied is in India in order to be eligible for the benefit of exemption.

While the Delhi High Court has taken the view that the spending or application has to be in India, a contrary view has been taken by the Karnataka High Court, holding that the application has to be for purposes in India.

NATIONAL ASSOCIATION OF SOFTWARE AND SERVICES COMPANIES’ CASE

The issue first came up before the Delhi High Court in the case of DIT(E) vs. National Association of Software and Services Companies 345 ITR 362.

In this case, the assessee, an association of Indian software companies, had spent Rs. 38,29,535 on
events / activities in connection with an exhibition in Germany. The assessee had claimed such amount as an application of income for charitable purposes, as it was in pursuance of its objects of promotion of the Indian software industry. The Assessing Officer (AO) did not allow such amount as an application of income, on the grounds that expenditure on activities outside India was not eligible to be treated as an application of income for charitable purposes under section 11(1)(a). The Commissioner (Appeals) upheld the order of the AO.

Before the Tribunal, on behalf of the assessee, it was argued that while the AO and the CIT(A) were of the view that the expenditure should have been incurred in India in order to be eligible for exemption, it was not the case of the Revenue that the expenditure incurred was not for the purpose of the charitable activities of the assessee. The fact that the expenditure was incurred for attaining the objects of the assessee’s trust was not in dispute and the dispute centred only on the issue that the expenditure had been incurred outside India and not in India. The provisions of section 11(1)(a) envisaged the grant of exemption with respect to income applied for attaining the charitable purpose. Even though section 11(1)(a) used the word “in India”, what was intended was that the income was to be applied to such purpose in India, i.e., the purpose of the expenditure should be to attain the charitable objects in India. The expenditure need not be incurred in India and the benefit of the expenditure incurred should give the charitable benefit in India. If any expenditure was incurred even outside India to achieve the charitable objects in India, it should be allowed as application, as it had been expended for advancing charitable objects in India and for fulfilling the charitable purpose in India. The assessee was primarily looking after the interests of software development and software growth in India. The expenditure had been incurred outside India for attaining the primary objects of the assessee’s trust for the promotion and export of software for India which, needless to say, was advancement of charitable object in India and the fulfilment of charitable purpose in India.

Before the Tribunal, it was further argued on behalf of the assessee that it was the software industry in India which benefited from the expenditure incurred by the assessee on the event in Hanover, Germany. In fact, by incurring the expenditure which had compulsorily to be incurred at the event in Hanover, Germany, no other person had got any benefit whatsoever, other than the Indian software industry on whose behalf and for whom the charitable activities were carried out. Further, it was pointed out that in section 11(1)(a), the words “in India” followed the words “to such purpose” and the words used were not “applied in India”. The legislature intended that the application should be in India, it would have specifically stated so, which was conspicuous by the absence of the words “in India” after “applied”. On behalf of the assessee, reliance was placed on the decision of the Tribunal in the case of Gem & Jewellery Export Promotion Council vs. ITO 68 ITD 95 (Mum), wherein it was held that even if the expenditure was incurred outside India, but it was for the benefit of charitable purposes in India, it was an application of income for the purposes of section 11(1)(a).

The Tribunal observed that the fact the legislature had put the words “to such purposes” between “is applied” and “in India” showed that the application of income need not be in India, but that the application should result in and be for the charitable and religious purpose in India. It noted that the Revenue did not dispute that the benefit of the expenditure was derived in India. It, therefore, held that expenditure outside India was an application of income for the purposes of section 11(1)(a).

Before the Delhi High Court, on behalf of the Revenue, it was argued that the expenditure, even if it was considered as an application of income, was outside India, and the mandate of the section was that the income should be applied in India to charitable purposes. The said condition not having been satisfied, it was urged that the Tribunal was wrong in holding that expenditure incurred outside India should be considered as an application of income of the trust in India.

The Delhi High Court referred to section 4(3)(i) of the Indian Income Tax Act, 1922, and its amendment with effect from 1st April,1952. It noted the observations of the Supreme Court in the case of H E H Nizam’s Religious Endowment Trust vs. CIT 59 ITR 582, where the Court noted and contrasted the differences pre- and post-amendment. The Supreme Court observed:

“Under the said clause, trust income, irrespective of the fact whether the said purposes were within or without the taxable territories, was exempt from tax in so far as the said income was applied or finally set apart for the said purposes. Presumably, as the state did not like to forgo the revenue in favour of a charity outside the country, the amended clause described with precision the class or kind of income that is exempt thereunder so as to exclude therefrom income applied or accumulated for religious or charitable purposes without the taxable territories.”

The Delhi High Court noted that prior to 1st April, 1952, there was no difference between an application of income of the trust within and outside the taxable territories. The amendment after 1952 made a reference to application or accumulation for application of income to such religious or charitable purposes as relate to anything done within the taxable territories. Dealing with the argument on behalf of the assessee that these words clearly showed that the charitable purposes must be executed within the taxable territories, and that it was immaterial where the income was actually applied, the Delhi High Court observed that it was difficult to conceive of a situation under which the charitable purposes were executed within the taxable territories but the income of the trust was applied elsewhere in the implementation of such purposes.

According to the Delhi High Court, the position was put beyond doubt by the proviso to section 4(3)(i) of the 1922 Act, which stated that the income of the trust would stand included in its total income if it was applied to religious or charitable purposes without the taxable territories. This was indicative of the object of the main provision — in the main part it was provided that the income should be applied for religious or charitable purposes within the taxable territories and in the proviso, an exception was carved out to provide that if the income was applied outside the taxable territories, even though for religious or charitable purposes, the trust would not secure exemption from tax for such income. The Delhi High Court also noted that the provisions of section 11(1)(c) of the 1961 Act were similar to the provisions of the proviso to section 4(3)(i) of the 1922 Act, and therefore, the Supreme Court’s observations applied to section 11(1)(c) of the 1961 Act as well.

The Delhi High Court was also of the view that the interpretation canvassed on behalf of the assessee was opposed to the natural and grammatical meaning that could be ascribed to the language of the section. The Court noted that the term “income applied to such purposes in India” answers three questions which arise in the mind of the reader: apply what? applied to what? and where? According to the Court, the answer to the first question would be: apply the income of the trust, the answer to the second question would be: applied to charitable purposes, and the answer to the third question would be: applied in India. Therefore, according to the Delhi High Court, grammatically also it would be proper to understand the requirement of the provision that the income of the trust should be applied not only to charitable purposes but also applied in India to such purposes. The Delhi High Court rejected the submissions on behalf of the assessee that the words “in India” qualified only the words “such purposes” so that only the purposes were geographically confined to India, stating that that did not appear to be the natural and grammatical way of construing the provision.

The Delhi High Court also observed that if the assessee’s interpretation was correct, then section 11(1)(c) would become redundant and otiose. If the income of the trust could be applied even outside India, so long as the charitable purposes were in India, then there was no need for a trust which tended to promote international welfare in which India to apply to the CBDT for a general or special order directing that the income, to the extent to which it was applied to the promotion of international welfare outside India, should not be denied the exemption. The Delhi High Court was, therefore, of the view that the words “in India” appearing in section 11(1)(a) and the words “outside India” appearing in section 11(1)(c) qualified the word “applied” appearing in those provisions and not the words “such purposes”.

Dealing with the assessee’s argument that the Court would be changing the group of words appearing in section 11(1)(a) by displacing the words “in India” and transposing them between the words “applied” and the words “to such purposes”, redrafting the clause as “to the extent such income is applied in India to such purposes”, the Delhi High Court observed that it would make no difference to the meaning to be ascribed to the group of words. In that case, perhaps the meaning would have been brought out in still more precise or clear terms, but there were different ways of expressing the requirement that the income of the trust should be applied in India in order to get an exemption. Even assuming that the language was not sufficiently expressive of the idea, the Court should be able to set right and construe the provision in the manner in which it made sense, unless by such construction, there resulted an absurdity which could not be countenanced at all. Looking at the history of the provision, according to the Delhi High Court, it could not be said that by construing section 11(1)(a) in the manner that the requirement was that the income of the trust should be applied in India for charitable or religious purposes, it was doing any violence to the provisions nor could it be said that the Court was condoning an absurd result.

The Delhi High Court referred to various decisions of the Supreme Court and the House of Lords for the proposition that the statute should be read literally, by giving the words used by the Legislature their ordinary, natural and grammatical meaning and the construction of section 11(1)(a) by the Court was in accordance with the rules laid down in the judgments cited by it.

The Court then dealt with the assessee’s arguments that the time had now come to take a fresh look at the section. Having regard to the globalisation of commerce and the vast strides made in cross-border trade and flight of capital, it was the need of the hour to shed conservative thinking on the subject and adopt a bold and innovative approach, by dispensing with the requirement that the application of the income of the trust should be in India in order to secure exemption for the trust. On behalf of the assessee, it had been claimed that this could be achieved by construing or interpreting the section in the manner suggested on behalf of the assessee. The Delhi High Court stated that what was contended by the assessee was not without force or merit, but that the Court was required to interpret the statute as it was, and not in the manner in which it thought the law ought to be. Further, according to the Court, in the matter of exemption from tax in an all-India statute, judicial restraint, and not innovativeness or novelty, might be the proper approach to follow.

The Delhi High Court, therefore, held that since the application of income was outside India, such expenditure was not eligible to be considered for exemption of the income as an application of income for charitable purposes in India.

A similar view was taken by the Madras Bench of the Tribunal, but in a reverse situation, in the case of Bharat Kalanjali vs. ITO 30 ITD 161 (Mad). In that case, the assessee had paid travel expenses in India to an Indian travel agency to send a troupe for dance performances abroad. The tour was organised by the Government of India at the request of the foreign government. In the said case, the Tribunal held that the expression “applied to such purposes in India” referred only to the situs of the expenditure and not to the place where the purposes were carried out, and the fact that the troupe gave the performance abroad was not a disqualification for treating the amount actually spent in India as application for charitable purposes in India.

OHIO UNIVERSITY CHRIST COLLEGE’S CASE

The issue again came up before the Karnataka High Court in the case of CIT(E) vs. Ohio University Christ College 408 ITR 352.

In this case, the assessee was a charitable trust registered under section 12A. It conducted MBA programs in India in collaboration with Ohio University, USA. The assessee trust had entered into an agreement with Ohio University, USA, whereby Ohio University sent its faculty to the assessee’s premises in India for teaching purposes, for which the assessee made payment to Ohio University for providing the faculty and other support services. In terms of the agreement, the assessee was required to pay a sum of USD 9,000 per student for the 18 months duration of the course (i.e., USD 3,000 per student for a 6-month period). At the end of the year, as the payments had not yet been made, the assessee had provided for / accrued the amount in its books of account, and the actual remittance was made in the subsequent year, from India to the overseas university. The assessee had claimed application of income in respect of expenditure incurred / provided by it, which included faculty teaching charges payable to Ohio University, USA.

The AO disallowed the claim of such faculty teaching charges payable to Ohio University on the grounds that mere making of an entry could not be considered as an application of income. The income had to be applied for charitable purposes only in India, and that the assessee had not proven that the payments made to Ohio University resulted in charitable purposes in India.

The CIT(A) allowed the assessee’s claim, observing that the application should be for charitable purposes in India, and if the payment was made outside the country in furtherance of charitable purposes in India, it could be counted as an application for charitable purposes in India.

Before the Tribunal, on behalf of the Revenue, it was submitted that the assessee had only made entries in the books of accounts in the relevant periods and had not utilised or spent the amount during the year. The actual payment of the same had happened in the subsequent year only, and as such, there was no application of income during the relevant year under consideration. It was submitted that the phrase “such income is applied to such purposes in India” appearing in section 11(1)(a) of the Act connoted “actual payment”, and since it had not happened, the assessee was not entitled to treat the provision as application of income.

On behalf of the assessee, it was urged that the assessee had actually incurred the said expenditure towards faculty teaching charges payable to Ohio University, USA, and therefore, it should be considered as having been applied under section 11(1)(a). It was submitted that the AO had misdirected himself in holding that the amounts had to be actually spent in the year under consideration for it to be considered as application of income. It was submitted that even if the payment was earmarked and allocated for charitable purposes, it should be taken to be applied for charitable purposes.

It was further submitted on behalf of the assessee, in response to the inquiry / contention that merely because the payment was made outside India, it did not mean that the charitable purpose was outside India. It was submitted that the charitable activities were rendered in India and just because the payment was made to parties outside India, it did not change the fact that the charitable activities were carried out in India. Reliance was placed on the decisions of the Income Tax Appellate Tribunal in the cases of Gem & Jewellery Export Promotion Council vs. Sixth ITO 69 ITD 95 (Mum) and National Association of Software & Services Companies vs. Dy. DIT (E), 130 TTJ 377 (Delhi).

The Tribunal noted that the services had been rendered by faculty members from Ohio University as the classes were taken in Bangalore. The services had been utilised for the trust’s objectives in India, viz., of imparting higher education in India. Ohio University had also offered the income earned by it from the assessee trust to tax in India. It was therefore clear that the activities of the assessee trust were conducted in India in accordance with its objects.

As regards the payments being made out of India, the Tribunal concurred with the view of the CIT(A) that merely because the payments were made outside India, it could not be said that the charitable activities were also conducted outside the country. The Tribunal further held that the decisions of the Mumbai and Delhi Tribunals (overruled on a different point) cited before it on behalf of the assessee squarely applied to the case before it.

The Tribunal further rejected the AO’s view that a specific exemption was required from CBDT for making a claim of application of income. The Tribunal noted that the said requirement had been specified only for those trusts that had as its objects, the promotion of international welfare. In the case of the assessee, the objects of charitable activities for imparting higher education in India had already been approved by the Department while granting the registration to the assessee trust.

Further holding that the amounts debited to the income and expenditure account, which were not actually disbursed during the year but in a subsequent year, amounted to application of income during the year, the Tribunal, therefore, held that the faculty charges payable to Ohio University amounted to an application of income for charitable purposes in India.

In further appeal, the Karnataka High Court took the view that the Tribunal had rightly held that section 11(1)(a) did not employ the term “spent” but used the term “applied” and the latter term had a wider connotation. The Karnataka High Court also held that the findings of the Tribunal, relying upon the decision of the Supreme Court in the case of CIT vs. Thanthi Trust 239 ITR 502 and High Court judgments in the case of CIT vs. Trustees of H E H the Nizam’s Charitable Trust 131 ITR 479 (AP) and CIT vs. Radhaswami Satsang Sabha 25 ITR 472 (All), were correct and justified. The Karnataka High Court, therefore, upheld the view taken by the Tribunal, holding that the amount of faculty charges payable to Ohio University amounted to application of income for charitable purposes in India.

OBSERVATIONS

The Delhi High Court, in holding that for an expenditure to be qualified as an application, the expenditure should be incurred in India, has decided the matter based on a strict grammatical interpretation of the language of the section and based on the history of the section. The Karnataka High Court, though not faced with a case where the activity for which expenditure was incurred was performed outside India, has adopted a more purposive interpretation in the matter by holding that the objective of the exemption was to encourage charitable organisations to do charity in India — i.e., to benefit beneficiaries in India, and therefore, the mere fact that the amount was actually disbursed outside India should not make any difference, so long as the purpose of doing charity in India was achieved.

As regards the history of the section referred to by the Delhi High Court, by referring to the Supreme Court decision, it is to be noted that the language of section 4(3)(i) was “in so far as such income is applied or accumulated for application to such religious or charitable purposes as relate to anything done within the taxable territories”. This language indicates that the action of the charitable activities for which expenditure is incurred has to be within India, and not the actual payment. As regards the distinction noted by the Supreme Court before the 1952 amendment and post the 1952 amendment, the words used are “to exclude therefrom income applied or accumulated for religious or charitable purposes without the taxable territories”. The present provisions of section 11 are not as explicit to exclude an overseas payment for an expenditure incurred for the benefit made available in India.

It is important to note that one of the observations made by the Delhi High Court while analysing these observations, which seems to have partially led it to take the view that it did, was that it was difficult to conceive of a situation under which the charitable purposes were executed within the taxable territories but the income of the trust was applied elsewhere in the implementation of such purposes. The classic illustration of this is the situation which was before the Karnataka High Court — where the teaching was actually in India to Indian students but only the expenditure was remitted outside India.

An angle, though not relevant to the issue under consideration, is a confirmation by the Karnataka High Court that application could arise on accrual itself, and actual payment may take place at a later point in time. What is relevant for the issue under consideration is where the accrual of the expenditure took place — if the obligation in respect of the expenditure arose in India, due to approval of the expenditure in India and agreement to incur the expenditure in India, the mere fact that the payee is outside India should not impact the fact that application of the income was in India.

In the context of the issue of accrual and payment, the decisions noted with approval by the Karnataka High Court in the cases of Thanthi Trust (supra), H E H the Nizam’s Charitable Trust (supra), and Radhaswami Satsang Sabha (supra) all support the view that application does not necessarily mean the same thing as actually paid — the mere fact of payment outside India in the context should, therefore, not impact the fact that application is in India, particularly where the decision to incur the expenditure is taken in India, is approved and agreed upon in India and the services or goods are actually utilised for activities carried out in India for the benefit of beneficiaries in India.

In conclusion, we notice that there are two distinct situations: one where the amount is paid outside India for an overseas activity, and a second where the amount is paid outside India for an activity performed in India. In our respectful opinion, once the benefit for the payment, wherever made, is located / received / found in India, the application should be treated as eligible for exemption from tax, and the place of receipt of payment and the performance of the activity should not be an obstacle in the claim.

BCAJ Admin

Indexation of Cost Where Cost Paid In Instalments

ISSUE FOR CONSIDERATION

In computing the long term capital gains on transfer of a capital asset, an assessee is entitled to certain deductions specified under section 48 of the Income Tax Act 1961, which provides for the mode of computation of the capital gains. This section, besides other deductions, allows deduction of indexed cost of acquisition of the asset in computing the long term capital gains. The term “indexed cost of acquisition” is defined in clause (iii) of the explanation to section 48 as:“indexed cost of acquisition” means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 2001, whichever is later.

Generally, in the case of immovable properties which are agreed to be purchased before or during the construction period, payment for the asset is made in instalments spread over several years. Therefore, the cost of the asset is paid over several years.

The issue has arisen before the ITAT in such cases as to how the indexation of cost is to be computed – whether the entire cost is to be indexed from the year in which the asset has been agreed to be acquired, or whether the cost is to be indexed instalment wise from each year in which the part payment of the cost is made. Different benches of the Tribunal have taken conflicting views on the subject, with some holding that the indexation of the entire cost is available from the year of agreement for the acquisition of the asset, while some holding that the indexation is to be computed vis-à-vis payment of each instalment.

CHARANBIR SINGH JOLLY’S CASE

The issue first came up before the Mumbai bench of the Tribunal in the case of Charanbir Singh Jolly vs. 8th ITO 5 SOT 89.

In this case, relating to assessment year 1998-99, involving two brothers who had sold their respective houses at Powai, Mumbai during the year, the assessees had purchased their respective houses under agreements dated 31st March, 1993 but had made payments for purchase of the houses over a period of four years from July 1992 to June 1996. The assessees claimed indexation of the entire cost from the financial year 1992-93, being the year of payment of the first instalment under the agreement to purchase, in computing their long-term capital gains on sale of the houses.The AO treated the first instalment paid by the assessees as the cost of acquisition of the houses, and subsequent instalments paid as cost of improvement of the houses from time to time, allowing indexation for subsequent instalments from the respective years of payment. The result was that the total cost incurred by the assessees for acquiring the houses was not taken as the cost of acquisition for the purpose of indexation, but, on the other hand, cost was taken at static points corresponding to the instalments paid by the assessees. This resulted in a partial loss of indexation benefit to the assessees. The CIT(A) upheld the stand taken by the assessing officer.

Before the Tribunal, on behalf of the assessee, reliance was placed on the decision of the Ahmedabad bench of the Tribunal in the case of ITO vs. Smt Kashmiraben M Parikh 44 TTJ 68, for the proposition that the date of acquisition of the property was the date of booking of the property. In that case, the issue was as to whether the property was a long-term capital asset or short term capital asset, and on the basis of the date of booking, the property had been held to be a long-term capital asset. It was argued before the Mumbai bench of the Tribunal that even though that decision, technically speaking, covered the question of period of holding of property by an assessee, the date of acquisition had been accepted in that judgment, which was relevant to the question of cost of acquisition involved in the case before the Mumbai bench. Reliance was also placed on the decision of the Bombay High Court in the case of CIT vs. Hilla J B Wadia 216 ITR 376.

The Tribunal noted that the real question was what the cost of acquisition was for the purposes of section 48 – the amount of first instalment paid by the assessees, or the total amounts paid by the assessees for acquiring the properties. According to the Tribunal, every property has its own intrinsic/market value or price, irrespective of the mode of payment negotiated between the respective parties. The cost or the value of the property remained the same subject to minor variations of interest or discount factor, irrespective of the mode of payments. The cost or value of the property did not get diluted on account of the fact that the cost of acquisition was paid by instalments.

According to the Tribunal, the basic idea of bringing the principle of indexation was to give some sort of protection to the assessees from the onslaught of inflation. The effect of inflation could be measured only with reference to the total cost of acquisition of a property. The Tribunal observed that if the effect of inflation was measured with the payment of the first instalment, the whole scheme became ridiculous. The factor of inflation was not with reference to the payments made by the assessee but with reference to the value of the asset vis-à-vis the cost of acquisition of the sale consideration of the property.

The Tribunal therefore held that the cost of acquisition of the houses for the purpose of long-term capital gains computation was the total cost incurred by the assessees and not the first instalment value, and that the assessees were entitled to indexation of the entire payment made for acquisition of the properties from the date of payment of the first instalment.

A similar view was taken by the Tribunal in the cases of Lata G Rohra vs. DCIT 21 SOT 541 (Mum), Divine Holdings Pvt Ltd ITA No 6423/Mum/2008, Pooja Exports vs. ACIT ITA No 2222/Mum/2010, ACIT vs. Ramprakash Bubna ITA No 6578/Mum/2010, Renu Khurana vs. ACIT 200 ITD 130 (Del) and Nitin Parkash vs. DCIT TS-734-Tribunal-2022(Mum), holding that the assessee was entitled to indexation of the entire cost from the date of booking, which was the date of acquisition of the property.

ANURADHA MATHUR’S CASE

The issue had also come up before the Delhi bench of the Tribunal in the case of Anuradha Mathur vs. ACIT ITA No 2297/Del/2011 dated 14th March, 2014.In this case, pertaining to assessment year 2006-07, the assessee sold a residential flat during the year. Payments of the cost of this house had been made from 1989 to 1996. The assessee became a member of the society and was allotted shares in 1989. The draw for allotment of flat took place in March 1996 and possession of the flat was given in August 1997. Assessee claimed indexation of the entire cost from 1989, i.e. the year of payment of the first instalment.

The AO took the view that the assessee was entitled to indexation of cost from the year of possession, and therefore allowed indexation of the entire cost from the financial year 1997-98 only, not even w.r.t the dates of payments.

Before the CIT(A), it was submitted that indexation was to be allowed from the year in which the asset was first held by the assessee. The assessee became a member of the society in 1989, acquired shares and held an interest in allotment of the flat, being a shareholder, by way of right for making payment for the flat as determined by the society. The word ‘held’ in ordinary parlance would include a right for acquisition of the flat, which was the case of the assessee.

The CIT(A) rejected the assessee’s appeal, holding that the assessing officer was right in treating the date of possession as the date on which the house came to be vested in the control of the assessee. It was held that mere ownership of the shares did not confer the benefit to enjoy the flat, unless the flat had been physically handed over to the assessee.

Before the Tribunal, on behalf of the assessee, the meaning of the term “held” was reiterated, and it was prayed that the indexation as was claimed by the assessee be allowed. It was argued that the assessee’s interest in acquisition of the flat itself amounted to an inchoate right of holding the right of acquiring the ownership of the flat. An alternative plea was raised that if the entire cost of acquisition was regarded as not related to the date of first instalment, then, since there was no doubt that the assessee had made the payments of these amounts for the acquisition of the flat by becoming the member and shareholder of the housing development cooperative society, and the payments made by the assessee over a period of time were towards the right of holding of the flat i.e. towards the acquisition of the asset, therefore these instalments needed to be considered for suitable indexation. It was argued that appropriate indexation of such part payment towards cost of asset would be in the interest of justice.

On behalf of the Department, it was submitted before the Tribunal that the assessee had not disputed the date of allotment and the date of possession. It was amply clear that the assessee became the owner of the flat on possession, and therefore indexation had been correctly computed by the AO.

Considering the submissions, the Tribunal observed that it was inclined to uphold the order of the lower authorities to the effect that the cost of the entire flat could not be indexed from the date of the first instalment. According to the Tribunal, the meaning of the word “held” could not be extended to the part of the payment which was not even made by the assessee till that date. The Tribunal was therefore of the view that there was no case for allowing indexation of the entire cost from the date of payment of the first instalment.

However, the Tribunal found merit in the alternative plea of the assessee. It observed that there was no dispute that assessee had made part payment by way of instalments towards acquisition of the flat by becoming shareholder and member of the society through a recognised and approved method of acquiring membership of a housing cooperative society. The payment of individual instalments made by the assessee amounted to payment towards holding of an asset, which deserved to be indexed from the date of actual payment of each instalment.

The Tribunal therefore held that the long-term capital gain was to be computed by taking the indexed cost of acquisition qua the actual payment of each instalment.

A similar view has been taken by the Tribunal in the cases of Praveen Gupta vs. ACIT 137 TTJ (Del) 307, Vikas P Bajaj vs. ACIT ITA No 6120/Mum/2010, Lakshman M Charanjiva vs. ITO ITA No 28/Mum/2017, and ITO vs. Monish Kaan Tahilramani 109 taxmann.com 156 (Mum).

OBSERVATIONS

In many of the Tribunal decisions (Anuradha Mathur, Praveen Gupta and Vikas Bajaj) in which it has been held that indexation should be allowed vis-à-vis each instalment of payment made, it may be noticed that these were either cases where the assessee himself had claimed indexation of cost on the basis of payments made, or taken that as an alternative plea, since the tax authorities had been claiming that the subsequent date of possession was the date of acquisition, and not the date of booking, and therefore had been allowing indexation of the entire cost only from the date of possession, though payments were made much earlier. In these cases, the Tribunal in a sense decided the issue in favour of the claim made by the assessee.The Tribunal in the cases of Lakshman Charanjiva and Monish Tahilramani (supra) has followed the decision of the Allahabad High Court in the case of Nirmal Kumar Seth vs. CIT 17 taxmann.com 127. In that case, the assessee had been allotted a plot of land in 1982-83 by paying a nominal advance, and had paid the remaining amount in instalments over a period of years. The allotment letter was issued in 1985. While the assessee had claimed a long-term capital loss, the AO had computed a short-term capital gain. The Tribunal had held that the gain was long-term, and that indexation of cost was to be computed with reference to the date of each payment made. The claim of the assessee before the Allahabad High Court was that the full benefit of indexation of cost was not given by the Tribunal.

The Allahabad High Court upheld the view of the Tribunal that the gain was long-term in nature since the letter of allotment was issued more than three years before. The High court also confirmed the order of the Tribunal on the issue of the base year of indexation by observing that the actual amount was paid from time to time after the date of issuance of the allotment letter, which had to be considered for the purpose of indexation with reference to the date of payments. The High Court noted that the Tribunal had rightly directed to compute the indexation of the cost as per the payment schedule, and that there was nothing wrong in the Tribunal’s order, which was based on the well-established legal position as well as the CBDT Circular, which had been mentioned in the order passed by the Tribunal.

The High Court noted that tax on the long-term capital gains had already been deposited as per the computation made by the AO, in the manner claimed by the assessee and that being so, nothing survived in the appeal. On that reasoning, it declined to interfere with the Tribunal’s order. In a sense perhaps, the Allahabad High Court did not really decide the matter, as the issue was no longer found to be relevant in the case before it.

The CBDT Circular referred to in this High Court decision is Circular No 471 dated 15th October, 1986. In this Circular, in the context of acquisition of a flat under the self-financing scheme of Delhi Development Authority, the CBDT has stated:

“2. The Board had occasion to examine as to whether the acquisition of a flat by an allottee under the Self-Financing Scheme (SFS) of the D.D.A. amounts to purchase or is construction by the D.D.A. on behalf of the allottee. Under the SFS of the D.D.A., the allotment letter is issued on payment of the first instalment of the cost of construction. The allotment is final unless it is cancelled or the allottee withdraws from the scheme. The allotment is cancelled only under exceptional circumstances. The allottee gets title to the property on the issuance of the allotment letter and the payment of instalments is only a follow-up action and taking the delivery of possession is only a formality. If there is a failure on the part of the D.D.A. to deliver the possession of the flat after completing the construction, the remedy for the allottee is to file a suit for recovery of possession.

3. The Board have been advised that under the above circumstances, the inference that can be drawn is that the, D.D.A. takes up the construction work on behalf of the allottee and that the transaction involved is not a sale. Under the scheme the tentative cost of construction is already determined and the D.D.A. facilitates the payment of the cost of construction in instalments subject to the condition that the allottee has to bear the increase, if any, in the cost of construction. Therefore, for the purpose of capital gains tax the cost of the new asset is the tentative cost of construction and the fact that the amount was allowed to be paid in instalments does not affect the legal position stated above. In view of these facts, it has been decided that cases of allotment of flats under the Self-Financing Scheme of the D.D.A. shall be treated as cases of construction for the purpose of capital gains.”

In fact, this CBDT Circular supports the case of the assessee, that all the instalments being paid are part of the cost of acquisition. In CIT vs. Mrs Hilla J B Wadia 216 ITR 376, the Bombay High Court, referring to the Circular, held that the CBDT confirmed that when an allotment letter was issued to an allottee under a scheme on payment of the first instalment of the cost of construction, the allotment was final unless it was cancelled. The allottee, thereupon, gets title to the property on the issuance of the allotment letter and the payment of instalments is only a follow-up action and taking delivery of possession is only a formality. The Board has directed that such an allotment of flat under such scheme should be treated as construction for the purpose of capital gains.

Explanation at the end of Section 48 defines the ‘indexed cost of acquisition’ vide clause(iii) as under “ ‘indexed cost of acquisition’ means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 2001 whichever is later”. The definition of indexed cost of acquisition in the Explanation to section 48 is fairly clear – indexation would be available from the first year in which the asset is held by the assessee. The definition does not refer to payments, and in many such cases, the dates of payment are quite different from the dates of acquisition. Therefore, the date of payment should not really matter for the purposes of indexation of cost of acquisition, based on the clear language of the provision. What would be relevant would be the date from which the asset can be said to be held. The issue in many cases has really been as to what is the date of first holding of the asset – the date of booking/first payment when the right to acquire the asset has been acquired, or the date of possession of the asset.

This issue in a sense has been settled by various High Courts, holding that the date of allotment would be the date of acquisition for computation of the period of holding of the immovable property. This view has been taken by the Bombay High Court in PCIT vs. Vembu Vaidyanathan 413 ITR 248, with SLP against this decision being dismissed by the Supreme Court, reported as Pr.CIT vs. Vembu Vaidyanathan 265 Taxman 535 (SC). A similar view has also been taken by the Punjab & Haryana High Court in the cases of CIT vs. Ved Prakash & Sons (HUF) 207 ITR 148, Madhu Kaul vs. CIT 363 ITR 54, and Vinod Kumar Jain vs. CIT 344 ITR 501, Delhi High Court in the case of CIT vs. K Ramakrishnan 363 ITR 59, and Madras High Court in CIT vs. S R Jeyashankar 373 ITR 120 (Mad).

Once the asset is taken to be held from the date of allotment, indexation of the entire cost would be available from that date, i.e. when the asset is first held. Besides, all instalments paid constitute part of the cost of acquisition, irrespective of when they are paid. This is also clear from the fact that when the asset is agreed to be acquired, the amount of consideration is agreed upon, with only the payment being deferred.

The scheme of taxation of capital gains is also such that what is relevant is the date of acquisition and the date of transfer of the asset – the date of payment of cost of acquisition or the date of realization of consideration are irrelevant for that purpose.

Therefore, the view taken by the Tribunal in the cases of Charanbir Singh Jolly, Lata Rohra and other similar cases, that indexation of the entire cost would be available from the date of allotment, seems to be the better view of the matter.

shailesh.kwebmaker

Loan – Whether A Capital Asset?

ISSUE FOR CONSIDERATION

Lending of money on interest or otherwise to other persons, on request or otherwise, in the course of business or as an investment, is normal. Some of the money so lent at times becomes bad and irrecoverable, besides inability of recovery of interest.

In such circumstances, the issue that arises for consideration is whether the loan is a capital asset within the meaning of section 2(14) of the Income tax Act. The definition includes property of any kind including the right, title and interest in property. Is loan not a property and a capital asset? Is it not an asset even under popular parlance? The case of the lender to hold it as a capital asset seems better.

The additional issue that arises is whether on recovery of loan becoming bad, whether there arises a transfer within the meaning of the term under section 2(47) of the Act. Can it be said that on write-off of the loan, there is a relinquishment or extinguishment of the asset or the right therein? Is it possible to hold that there is a transfer even where legal steps are not taken or where taken but not concluded against the lender? Will the claim of the tax payer for loss and its set-off be better in cases where a loan or a deposit or advance is exchanged for another asset or similar product or where it is assigned or transferred in the course of an amalgamation?

Is the amount invested in financial small savings instruments such as Kisan Vikas Patra a capital asset and whether on its redemption or maturity a transfer happens, entitling the investor to claim the benefit of indexation of the cost of investment?

The issues definitely are interesting and of importance, and have been presented before the courts for adjudication, resulting in conflicting views. A decade ago, the Bombay High Court held that the loss arising on the loans turning irrecoverable was not allowable under the head capital gains. A later decision of the same Court however has held that such a loss arising on assignment was allowable under the head capital gains.

CROMPTON GREAVES LTD.’S CASE

The issue had first come up for consideration of the Bombay High Court in the case of Crompton Greaves Ltd. vs. DCIT [2019] [2014] 50 taxmann.com 88.

In this case, the assessee was a company carrying on the business of manufacturing transformers, switch gears, electrical products, home appliances, etc. It was to receive amounts of Rs.17,87,31,508 and Rs. 17,25,46,484 from M/s Bharat Starch Industries Ltd and M/s JCT Ltd, respectively. Against the said dues, it had received shares worth of Rs. 60,00,000 only from M/s Bharat Starch Industries Ltd. Therefore, during the previous year relevant to the assessment year 2002-03, it had written off balance of Rs. 34,52,77,992, and claimed it as a capital loss, carried forward for set-off in subsequent years. The said write-off was in the course of schemes of arrangement, which were subsequently sanctioned by the Gujarat and Punjab and Haryana High Courts, respectively.

The AO rejected the claim of the assessee, by holding that in order to be eligible to carry forward of the capital loss, there should be a capital asset as defined in section 2(14) and the same should have been transferred in the manner as defined in section 2(47). Since, in his view, the deposits or advances given to M/s JCT Ltd. and M/s Bharat Starch Industries Ltd. written off were not capital assets nor was there any transfer, no capital loss was allowed to be carried forward to the subsequent year.

The CIT (Appeals) also held that the loss incurred by the appellant-assessee was not a capital loss in relation to the transfer of an asset. He agreed with the AO and held that the loss has been rightly determined as a capital loss.

Upon further appeal, the Tribunal concluded that it was clear that the loans were not given in the ordinary course of business. The assessee’s claim that the loan was in the form of an inter-corporate deposit, which was a case of capital asset and had been transferred, was also rejected by the Tribunal. The Tribunal found that there was no evidence to show that it was a case of an inter-corporate deposit, because before the AO, it was claimed that the loss was on account of writing off of the advances given to M/s Bharat Starch Industries Ltd and M/s JCT Ltd. There was no material to show that a case of intercorporate deposit had been made out. The loans, therefore, could not be termed or construed as capital assets.

Agreeing with the finding of the Tribunal, the High Court held that the said findings of fact rendered in the peculiar factual backdrop did not give rise to any substantial question of law. Thus, the High Court did not entertain the appeal filed by the assessee.

However, in fairness, the High Court dealt with the judgment cited before it in support of the argument that the definition of “capital asset” in section 2(14) of the Income-tax Act, 1961, was wide enough to include even an advance of money. The Bombay High Court held that the judgment of the Supreme Court in the case of Ahmed G.H. Ariff vs. CWT [1970] 76 ITR 471 (SC), was in the context of the provisions in the Wealth-tax Act, 1957. The question raised before the Supreme Court was that the right of the assessee to receive a specified share of the net income from the estate in respect of which wakf-alal-aulad has been created, was an asset assessable to wealth-tax. It was in that context that the definition of the term “asset” as defined in section 2(e) of the Wealth-tax Act, 1957, and section 6(dd) of the Transfer of Property Act were referred to. All conclusions which had been rendered by the Supreme Court, must be, therefore, read in the peculiar factual situation and circumstances. In dealing with the argument that the right claimed of the nature could not be termed as property, the Supreme Court had held that “property” was a term of the widest import and subject to any limitation which in the context was required. It signified every possible interest which a person could clearly hold and enjoy. On this basis, the High Court held that this decision of the Supreme Court was not relevant for the assessee’s case.

With respect to the decision of the Gujarat High Court in the case of CIT vs. Minor Bababhai [1981] 128 ITR 1 (Guj) which was cited before the Bombay High Court, it was held that it could not assist the assessee, because in the said case, there was no controversy that what was before the authorities was a claim in relation to capital asset. Further, it was also observed by the Court that what was argued before the lower authorities was that the loss of advance was a capital loss in relation to transfer of capital asset, and now what had been argued was that the advances were not as such but intercorporate deposits (ICDs). It was in relation to this alternative argument that the judgment of the Gujarat High Court was cited before the Court. In view of this, it was held that the said judgment was of no assistance as the issue advanced did not arise for determination and consideration of the lower authorities.

On this basis, the High Court dismissed the appeal of the assessee, by holding that it did not give rise to any substantial question of law.

SIEMENS NIXDORF INFORMATION SYSTEMSE GMBH’S CASE

The issue, thereafter, came up for consideration once again before the Bombay High Court in the case of CIT vs. Siemens Nixdorf Information Systemse GmbH [2020] 114 taxmann.com 531.

In this case, under an agreement dated 21st September, 2000, the assessee company had lent an amount of €90 lakhs to its subsidiary, Siemens Nixdorf Information Systems Ltd (SNISL). SNISL ran into serious financial troubles and it was likely to be wound up. Therefore, the assessee sold its debt of €90 lakhs receivable from SNISL to one Siemens AG. The difference between the amount which was lent to SNISL and the consideration received upon its assignment to Siemens AG was claimed as a short-term capital loss in assessment year 2002-03.

The AO disallowed the said short-term capital loss on the grounds that the amount of €90 lakhs lent by the assessee to its subsidiary SNISL was not a capital asset under section 2(14) and also that no transfer in terms of Section 2(47) had taken place on its assignment. Upon further appeal, the CIT (A) held that, although the assignment of a debt was a transfer under section 2(47) of the Act, but it was of no avail, as the loan being assigned/transferred, was not a capital asset. Thus, he confirmed the disallowance made by the AO.

On further appeal, the Tribunal held that in the absence of loan being specifically excluded from the definition of capital assets under the Act, the loan of €90 lakhs would stand covered by the meaning of the word ‘capital asset’ as defined under section 2(14) of the Act. The term ‘capital asset’ was defined under section 2(14) to mean ‘property of any kind held by an assessee, whether or not connected with his business or profession’, except those which were specifically excluded in the said section. The word ‘property’ had a wide connotation to include interest of any kind. The Tribunal placed reliance upon the decision of the Bombay High Court in the case of CWT vs. Vidur V. Patel [1995] 79 Taxman 288/215 ITR 301 rendered in the context of Wealth Tax Act, 1957 which, while considering the definition of ‘asset’, had occasion to construe the meaning of the word ‘property’. It held the word ‘property’ to include interest of every kind. In view of this, the Tribunal held that the assessee was entitled to claim short-term capital loss on assignment/transfer of the SNISL loan to Siemens AG.

1   In this case, it was held that the amount standing to the credit of the assessee in the compulsory deposit account was an 'asset' within the meaning of section 2(e) of the Wealth-tax Act.

Before the High Court, the revenue contended that the loan of €90 lakhs was not a capital asset in terms of Section 2(14) of the Act. Further, it was submitted that reliance placed upon the decision in the case of Vidur V. Patel (supra) was not proper for the reason it was rendered in the context of a different Act i.e. the Wealth Tax Act, 1957. Thus, it could not have application while dealing with the Income-tax Act.

The High Court held that section 2(14) of the Act has defined the word ‘capital asset’ very widely to mean property of any kind. Though it specifically excluded certain properties from the definition of ‘capital asset’, the revenue had not been able to point out any of the exclusion clauses being applicable to advancement of a loan. It was also not the case of the revenue that the said amount of €90 lakhs was a loan/advance in the nature of trading activity.

In so far as the reliance placed by the tribunal on the decision of Vidur V. Patel (supra) was concerned, the High Court noted that the revenue had not been able to point out any reason to understand meaning of the word ‘property’ as given in section 2(14) of the Act differently from the meaning given to it under section 2(e) of the Wealth Tax Act, 1957. The High Court disagreed with the contention of the revenue that the said decision should not be considered as relevant, merely because it was under a different Act, when both the Acts were cognate.

Further, the High Court referred to the decision in the case of Bafna Charitable Trust vs. CIT [1998] 101 Taxman 244/230 ITR 864 (Bom.)2 which was rendered in the context of capital assets as defined in section 2(14) of the Act and it was held that property was a word of widest import and signifies every possible interest which a person can hold or enjoy except those specifically excluded. On this basis, the High Court held that loan given to SNISL would be covered by the meaning of ‘capital asset’ as given under section 2(14) of the Act. The High Court declined to entertain the question of law framed in the appeal before it, on the grounds that it did not give rise to any substantial question of law.

2.  In this case, it was held that advancing of money on English mortgage could be regarded as utilisation for acquisition of another capital asset within the meaning of section 11(1A).

OBSERVATIONS

A loan or a deposit or an advance or an investment is a case of an asset for finance personnel and so it is for an accountant. It was also an asset for the purpose of the levy of wealth tax till such time it was leviable. The dictionary meaning of an asset includes any one or all of them, and so it is in popular parlance.

Capital Asset under the Income-tax Act, 1961 is defined under section 2(14) of the Act. While expressly excluding many items, it is inclusively defined to include property of any kind. Section 2(14) surely does not exclude a loan or a deposit or such other assets from its domain. In the above understanding, is it possible to contend that a loan is an asset but is not a capital asset? We think not. The term “capital” is perhaps used to isolate a trading asset from the other assets. It would not be possible to exclude an asset from section 2(14) once it is a property of any kind, unless it is one of the assets that are specifically excluded.

A loan, like many other assets or properties, is transferable or assignable; it is an actionable claim under the Transfer of Property Act; a lender can relinquish or release his rights to recover the same. All in all, it has all the characters of a capital asset.

A gain or loss arises under the Act only where a capital asset is transferred. The term “transfer” is inclusively defined in section 2(47) of the Act. An act of assignment of a loan is a transfer. In some cases, the loan becoming irrecoverable may be regarded as extinguishment or relinquishment. For this, support can be drawn from the decision of the Supreme Court in the case of CIT vs Grace Collis 248 ITR 323 (SC), where the Supreme Court, in the context of extinguishment of shares, held:

“The definition of ‘transfer’ in section 2(47) clearly contemplates the extinguishment of rights in a capital asset distinct and independent of such extinguishment consequent upon the transfer thereof. One should not approve the limitation of the expression ‘extinguishment of any rights therein’ to such extinguishment on account of transfers, nor can one approve the view that the expression ‘extinguishment of any rights therein’ cannot be extended to mean extinguishment of rights independent of or otherwise than on account of transfer. To so read, the expression is to render it ineffective and its use meaningless. Therefore, the expression does include the extinguishment of rights in a capital asset independent of and otherwise than on account of transfer.”

A loan can be exchanged for any other asset, including the shares of company or a promissory note and even a new loan. A contract to exchange is governed by the Indian Contract Act or the Transfer of Property Act or other relevant statutes.

In the above understanding and settled position in law, it is appropriate to hold that a gain or loss arising on transfer of a loan, is taxable under the head capital gains and likewise, a loss arising on its transfer will be eligible for the prescribed treatment under sections 70 to 79 of the Act.

In fact, the Mumbai Tribunal, in the dissenting case of Crompton Greaves Ltd. (supra), agreed that the company could not establish that the asset in question was not an inter-corporate deposit; had the company done so, the decision may have been different. The Tribunal also observed that the treatment could have been different for a loan advanced in the course of business. Importantly, the case of the company for a claim under sections 70 to 79 was better, in as much as the assets in question (loans) were extinguished and in lieu thereof, shares of the amalgamated company were issued in the course of amalgamation of the companies under the Court’s order.

In our considered opinion, there at least was a substantial question of law that required the High Court’s consideration. It seems that the later decision of the same Court has settled the controversy in favour of the allowance of the loss on transfer of the loan or such investments.

shailesh.kwebmaker

Claim of Additional Depreciation – Additional Issue

ISSUE FOR CONSIDERATION

An assessee is entitled to the claim of ‘additional depreciation’, in computing the total income, under the Income Tax Act. This benefit was first conferred by the insertion of clause (iia) in Section 32(1) by the Finance (No. 2), 1980 w.e.f. 1st April, 1981 which benefit was withdrawn w.e.f. 1st April, 1988. The benefit was again introduced w.e.f. 1st April, 2003 and was substituted w.e.f. 1st April, 2006 by the Finance Act, 2005.The present provision contained in clause (iia) of Section 32(1), in sum and substance, provides for the grant of a ‘further sum’ (referred to as an ‘additional depreciation’) equal to 20 per cent of the actual cost of new machinery or plant acquired and installed, on or after 1st April, 2005, by an assessee engaged in the business of manufacturing or production of any article or thing or in the business of generation, transmission or distribution of power subject to various conditions prescribed in the two provisos to the said clause.

The interpretation of the clause (iia) and the grant of additional depreciation, at any point of time, has been the subject matter of numerous controversies. One such interesting controversy is about the claim and allowance of additional depreciation under the present clause (iia) in a year subsequent to the year in which such a claim was already allowed. In other words, the claim for additional depreciation is made in a year even after such a claim was once allowed in the past.

The Kolkata bench of the Tribunal allowed such a claim while the Chennai and Mumbai benches rejected such a claim. Interestingly, the Mumbai bench first disallowed the claim but in the later decisions entertained it following the decision of the Kolkata Bench.

GLOSTER JUTE MILLS LTD.’S CASE

The issue first arose in the case of Gloster Jute Mills Ltd., before the Kolkata Bench of ITAT reported in 88 taxmann.com 738. In this case, the assessee company purchased and installed new machinery during the financial year 2005-06, i.e. on or after 1st April, 2005 and claimed additional depreciation under section 32(1)(viia) of the Act, which was allowed to the assessee for A.Y. 2006-07. The assessee company again claimed the additional depreciation for A.Y. 2007-08, which was rejected by the AO on the grounds that such an allowance was limited to the ‘new’ machineries and in the second year the machinery was no more new. The AO referred to the provision of the substituted section 32(1)(iia) which allowed the additional depreciation only to a new machinery. Referring to the dictionary, the AO observed that ‘ new’ meant something which did not exist before; now made or brought into existence for the first time. The AO held that, the assets in question were already used and depreciated, and therefore were old, and no additional depreciation was allowable for such assets as the basic qualification for such a claim was not satisfied.

The assessee company invited the attention of the Tribunal to the history of the allowance of additional depreciation by highlighting that the benefit was first conferred by insertion of clause (iia) of Section 32(1) by the Finance No. 2, 1980 w.e.f. 1st April, 1981. It was explained by the assessee company that the benefit then was explicitly allowed for the previous year in which the machinery or plant were installed or were first put to use. It was further explained to the Tribunal that the said benefit was withdrawn w.e.f. 1st April, 1988; the newly introduced provision presently did not contain any such limitation that restricted the benefit only in the year of installation or the use.

The assessee company invited attention to the now substituted provision that was introduced w.e.f 01.04.2003 by the Finance (No.2) Act, 2002 which conferred the benefit for the previous year in which the assessee began manufacturing or production or in the year of achieving the substantial expansion. It was highlighted that the newly introduced provision presently did not contain any such limitation that restricted the benefit to the year of manufacturing or production or substantial expansion.

The revenue supported its case for disallowance by reiterating the AO’s findings that the claim was allowable only in the year of acquisition of the new machinery.

The assessee company further contended that since the specific condition for the claim of additional depreciation, in one year only, has been done away with, it should be construed as the intention of the legislature, post substitution, to allow additional depreciation in subsequent years, as well. Relying on the settled position in law it was contended that a fiscal statute should be interpreted on the basis of the language used and not de hors the same. It was contended even if there was a slip, the same could be rectified only by the legislature and by an amendment only. A reference was also made to the DTC Bill, 2013 which had then proposed that the claim of additional depreciation would be allowed in the previous year in which the asset was used for the first time.

The Kolkata bench, on careful consideration of the provisions of the law and its history, confirmed that the present law before them, did not limit the allowance to the year of installation or manufacture or substantial expansion; the present law did not carry any stipulation for limiting the benefit of additional depreciation to one year only. It further noted that the case of the revenue for limiting the deduction to the year of acquisition of new machinery was not supported by the language of the provision; the condition for allowance was limited to ensuring that the machinery was new in the year of installation failing which no allowance was possible at all; however once this condition was satisfied, the claim for additional depreciation was allowable even for the year next to the year in which such an allowance was granted. It was therefore held, that the requirement of the machine being new should be a condition that should be fulfilled in the year of installation and once that was satisfied, no further compliance was called for in the year or years next to the year of installation.

This decision has been followed in the case of Graphite India Ltd., ITA No. 472 / Kol / 2012 and the latter decision is followed in the case of ACC Ltd., ITA No. 6082 / MUM / 2014. In addition, the claim was allowed in the case of Ambuja Cements Ltd., ITA No. 6375 / MUM / 2013 following these decisions.

EVEREST INDUSTRIES LTD.’S CASE

The issue also arose subsequently in the case of Everest Industries Ltd., before the Mumbai Bench of the ITAT, reported in 90 taxmann.com 330. The assessee company in this case, had acquired and installed plant and machineries in financial year 2005-06, and onwards and had claimed additional depreciation under section 32(1)(iia) @ 20 per cent of the original cost of the plant and machinery and such claims were allowed by the AO. For assessment year 2009-10, the company again claimed the benefit of additional depreciation for the said plant and machineries. The AO disallowed the claim on the ground that the allowance under section 32(1)(iia) was a one-time allowance that was allowed on the cost of the new plant and machineries, acquired and installed during the year of acquisition and installation. The AO held that the machineries acquired and put to use in the earlier years were no longer new and therefore no benefit was again allowed where the benefit of additional depreciation was already granted once in an earlier assessment year. The order of the AO was confirmed by the CIT(A).The assessee, in the appeal before the Tribunal, contended that the provisions of s.32(1)(iia), applicable to A.Y.2006-07 and onwards, were different from its predecessor provisions in as much as the new provisions did not require the installation or the use or the manufacturing or the substantial expansion in the year of the claim. It further contended that there was no bar on claiming the additional depreciation, more than once. It also contended that the machinery in question need not have been acquired in A.Y. 2009-10 and for this proposition it heavily relied on the decision of the Kolkata Bench in the case of Gloster Jute Mills Ltd. (supra).

In reply, the revenue submitted that the legislative intent was to allow additional depreciation under section 32(1)(iia) of the Act only in the year in which the new plant and machinery was acquired and installed. The revenue invited the attention to the Second Proviso of s.32(1)(iia) to highlight that the claim for depreciation was to be restricted to one half of the allowable amount in cases where the new plant and machinery was installed and used for less than 180 days. In such a case, the remaining depreciation was allowed in the next year; as was claimed by the assessees, the balance depreciation was allowed in the next following year by the courts; the amendment by the Finance Act, 2015 had made that aspect amply clear. The revenue also contended that in the past it was necessary for the legislature to have used the words ‘during the previous year’ so as to qualify numerous conditions. However, with removal of many such conditions, the use of such words became redundant as long as the condition requiring the machinery to be ‘new’ was retained; therefore there was no change in the law and the legislative intent continued to be that the allowance was a one-time benefit not intended to be enjoyed year after year.

The Mumbai bench of the Tribunal took note of the decision of the Kolkata Bench, in the case of Gloster Jute Mills Ltd. (supra) and found that the views of the said bench were, on the plain reading of the new provision in comparison to the predecessor provisions, contrary to the views canvassed by the revenue. The Mumbai bench proceeded to analyse the provisions of section 32(1) for allowance of the regular depreciation, and the concepts of the ‘user of assets’ and the ‘block of assets’.

Relying on certain decisions, it observed that the concept of user in the scheme of depreciation was required to be examined and tested only in the first year of the claim of depreciation and not thereafter, once an asset entered into the block of assets. Applying this proposition to the issue of additional depreciation, the Mumbai bench held that the additional depreciation in respect of a machinery was allowed when its identity was known; on merger of the identity, the question of allowing additional depreciation did not arise; any allowance of additional depreciation as was claimed by the assessee would necessitate maintaining a separate record for each of the asset, contrary to the concept of block of asset and the legislative intent; no provision was found for maintenance of separate records. It also held that, the retention of the term “new” confirmed that the claim was allowable only once in the year of acquisition of the asset.

The Mumbai bench approved of the contention of the revenue that the provision for restriction of the claim to 50 per cent of the allowable amount and the allowance of the balance amount in the subsequent year confirmed that the allowance was a one-time affair, not to be repeated year after year, and, to support its decision, it relied upon the Memorandum explaining the provisions of the Finance Bill, 2015 while inserting the Third Proviso to s.32(1)(iia) w.e.f 1st April, 2016; the bench noted that the said amendment was not considered by the Kolkata bench and therefore the Mumbai bench found itself unable to agree with the Kolkata bench. Accordingly, the Mumbai bench held that the claim for additional depreciation under section 32(1)(iia) was not allowable for more than one year.

OBSERVATIONS

The interesting issue, with substantial revenue implications, moves in a narrow compass. The dividing lines are sharply drawn with conflicting decisions of three benches of the Tribunal and further extenuated by three conflicting decisions of the Mumbai bench. There is no doubt that the overall quantum of depreciation cannot exceed the cost of an asset and the claim of additional depreciation is an act of advancing the relief in taxation and not enhancing it. It is also clear that the asset, on entering the block of assets, loses its identity. It is also not disputed that there is a difference between the meaning of the words ‘new’ and ‘old’; a new cannot be old and old cannot be new, both the words are mutually exclusive. It is also essential to provide a lawful meaning to the word “new” used in s.32(1)(iia); it surely cannot be held to be redundant and excessive.The law of additional depreciation has a turbulent history and has undergone important changes and therefore the legislative intent of the law can neither be gathered by its past or the subsequent amendments introduced with prospective effect, unless an amendment is made with an express intent of amending the course. It is also fair to accept that the decisions of the Courts or the Tribunal delivered in respect of unrelated issues, though under section 32(1)(iia), should not colour the understanding of the issue relating to the subject on hand.

Having noted all of this, it seems that there is no disagreement as regards the meaning of the word ‘new’; an asset to be new, has to be something which did not exist before, which is now made, which is brought into existence for the first time; it is clear that an asset that does not satisfy the test of being new can never be eligible for the claim of additional depreciation, in the first place. There is no conflict on this or there can be no conflict on this aspect of newness of the asset; the conflict is about the year in which the test of newness is to be applied. Is the test to be applied every year or is to be applied once is a question that is to be resolved. No claim would be permissible to be made more than once where it is held that the test is to be applied every year. As against that, once the test is satisfied in the year in which the claim was first made, the claims would be allowed in the following year, where it is held that a one-time satisfaction of the test is sufficient. The language of the present section, in its comparison to the language of the predecessors, does not expressly prohibit the claim in more than one year, as noted by the Kolkata bench. The decision therefore has to be gathered by the words used in law and the word ‘new’ is the only word, the meaning supplied to which would make or mar the case.

It is usual and not abnormal to apply the test in the year in which the claim is made and the test of newness may not be possible to be satisfied for the subsequent years and in that view of the matter it may not be possible for an assessee to claim the allowance year after year. However, such a claim year after year, would be possible where a view is taken that the test of newness is to be satisfied once or that even in the subsequent year the test of newness where examined should be limited to verify whether the asset in the first year of acquisition or installation and claim was new or not. The later view is difficult, but not impossible to hold, as there is no explicit restriction in the provision.

The concept of block of assets and its application to the facts of the case of repetitive claims may also cause a concern. Accepting the claim of the assessee would mean regular and substantial erosion of the written down value of the asset, year after year, which in our respectful opinion cannot be a clinching factor.

The Mumbai bench of the Tribunal in the later decision dated 7th November, 2022 has chosen to follow the decision of the Kolkata bench, maybe due to the fact that it’s own decision in case of Everest Industries Ltd. was not cited before the bench.

The latest decision of the Mumbai Tribunal dated 28th February, 2023 however has taken note of 2018 decision of the bench in Everest Industries Ltd’s case but has chosen to follow the 2022 decision of the bench, on the ground of it being the later decision of the bench.

The Chennai bench of the Tribunal was the first to address the issue in its decision dated. 4th April, 2013 in the case of CRI Pumps (P.) Ltd., 34 taxmann.com 123. In that case, the assessee company had claimed additional depreciation on certain machineries that were not acquired during the year. The Tribunal held that the machinery in question were acquired before the commencement of the year and were not new and therefore the claim for the year was not maintainable in as much as it would not be a claim for a new machinery. In this case, a reference was made by the revenue to the decision of the co-ordinate bench dated 6th January, 2012 in ITA No. 1069/ Mds / 2010 in the case of Brakes India Ltd.

It appears that we should wait for the decision of the High Court to conclude the interesting issue.

shailesh.kwebmaker

Validity of Reassessment Proceedings

ISSUE FOR CONSIDERATION

The scope and time limits for initiation of reassessment and the procedure of reassessment underwent a significant change with effect from 1st April, 2021, due to the amendments effected through the Finance Act, 2021. Through these amendments, sections 147, 148, 149 and 151 were replaced, and a new section 148A, laying down a new procedure to be followed before issue of notice under section 148, was inserted.

Till 31st March 2021, section 149 laid down the time limit for issue of notice for reassessment as under:

“149. (1) No notice under section 148 shall be issued for the relevant assessment year,—

(a) if four years have elapsed from the end of the relevant assessment year, unless the case falls under clause (b) or clause (c);

(b) if four years, but not more than six years, have elapsed from the end of the relevant assessment year unless the income chargeable to tax which has escaped assessment amounts to or is likely to amount to one lakh rupees or more for that year;

(c) if four years, but not more than sixteen years, have elapsed from the end of the relevant assessment year unless the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.

Explanation.—In determining income chargeable to tax which has escaped assessment for the purposes of this sub-section, the provisions of Explanation 2 of section 147 shall apply as they apply for the purposes of that section.”

The new section 149, effective 1st April, 2021, reads as under:

“149. (1) No notice under section 148 shall be issued for the relevant assessment year,—

(a) if three years have elapsed from the end of the relevant assessment year, unless the case falls under clause (b);

(b) if three years, but not more than ten years, have elapsed from the end of the relevant assessment year unless the Assessing Officer has in his possession books of account or other documents or evidence which reveal that the income chargeable to tax, represented in the form of asset, which has escaped assessment amounts to or is likely to amount to fifty lakh rupees or more for that year:

Provided that no notice under section 148 shall be issued at any time in a case for the relevant assessment year beginning on or before 1st day of April, 2021, if such notice could not have been issued at that time on account of being beyond the time limit specified under the provisions of clause (b) of sub-section (1) of this section, as they stood immediately before the commencement of the Finance Act, 2021:

Provided further that the provisions of this sub-section shall not apply in a case, where a notice under section 153A, or section 153C read with section 153A, is required to be issued in relation to a search initiated under section 132 or books of account, other documents or any assets requisitioned under section 132A, on or before the 31st day of March, 2021:

Provided also that for the purposes of computing the period of limitation as per this section, the time or extended time allowed to the assessee, as per show-cause notice issued under clause (b) of section 148A or the period during which the proceeding under section 148A is stayed by an order or injunction of any court, shall be excluded:

Provided also that where immediately after the exclusion of the period referred to in the immediately preceding proviso, the period of limitation available to the Assessing Officer for passing an order under clause (d) of section 148A is less than seven days, such remaining period shall be extended to seven days and the period of limitation under this sub-section shall be deemed to be extended accordingly.

Explanation: For the purposes of clause (b) of this sub-section, “asset” shall include immovable property, being land or building or both, shares and securities, loans and advances, deposits in bank account.”

The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (TOLA) was enacted to relax certain timelines and requirements, in the light of the COVID-19 pandemic and related lockdowns. Section 3(1) of that Act provided that where, any time-limit had been prescribed under a specified Act which falls during the period from 20th March, 2020 to 31st December, 2020, or such other date after 31st December, 2020, as the Central Government may notify, for the completion or compliance of such action as completion of any proceeding or passing of any order or issuance of any notice, intimation, notification, sanction or approval by any authority under the provisions of the specified Act; , and where completion or compliance of such action had not been made within such time, then the time-limit for completion or compliance of such action shall stand extended to 31st March, 2021, or such other date after 31st March, 2021, as the Central Government may notify. Pursuant to this, notifications were issued from time to time, whereby the time limits up to 31st March 2021 for issue of various notices (including notices under section 148) were extended till 30th June 2021.

Pursuant to such notifications under TOLA, a large number of notices for reassessment were issued from April to June 2021 under the old section 148 r.w.s 149. Many of these notices were challenged in writ petitions before the High Courts. Some High Courts had held that such notices issued after 31st March, 2021 under the old law were invalid, as they could only have been issued under the new law which became effective from April 2021 by following the procedure prescribed under section148A, within the timelines prescribed by section 149.

All cases were then consolidated and heard by the Supreme Court. The Supreme Court, in the case reported as Union of India vs. Ashish Agarwal 444 ITR 1, held that the notices issued under old section 148 to the respective assessees were invalid but should nonetheless be deemed to have been issued under newly inserted section 148A as substituted by the Finance Act, 2021 and treated to be show-cause notices in terms of section 148A (b). With this the Supreme court regularised the defaults of the AOs under the special powers of Article 142 of the Constitution of India. The AOs were directed to provide to the assessees the information and material relied upon by the revenue within 30 days, so that the assessees could reply to the notices within two weeks thereafter. The requirement of conducting any enquiry with the prior approval of the specified authority under section 148A(a) was dispensed with as a one-time measure vis-à-vis those notices which had been issued under the old provisions of section 148 prior to its substitution with effect from 1st April, 2021. The Supreme Court, at the same time directed that such regularised reassessment proceedings should in all cases be subjected to compliance of all the procedural requirements and the defences which might be available to the assessee under the substituted provisions of sections 147 to 151 and which may be available under the Finance Act, 2021 and in law.

Given the fact that these notices issued under old Section148 were deemed to be notices under section 148A(b), and orders under section 148A(d) were to be passed after completion of enquiry along with issue of notice under new Section 148, the issue has arisen about the applicable time limit in such cases – whether the time limits under the pre-amended section 149 apply or whether the time limits under the amended section 149 apply for issue of notice under new Section148. Accordingly, the question that has arisen for the courts is whether notices under the old Section 148 issued after 31st March. 2021, particularly for A.Ys. 2013-14 and 2014-15 and for A.Y. 2015-16 under the new section 148 pursuant to notices issued under the old section 148 are validly issued within the time prescribed in new section 149. While the Delhi High Court has taken the view that such notices were validly issued within the time extended by TOLA, the Allahabad and Gujarat High Courts have held that such notices were invalid as they were not issued within the permissible time limit prescribed under new law.

TOUCHSTONE HOLDINGS CASE

The issue first came up before the Delhi High Court in the case of Touchstone Holdings (P) Ltd vs. ITO 289 Taxman 462.

In this case, a notice under the pre-amended section 148 was issued on 29th June, 2021 for the A.Y. 2013-14 in respect of an item of purchase of shares of Rs 69.93 lakhs. Pursuant to the decision of the Supreme Court in the case of Ashish Agarwal (supra), proceedings continued under section 148A, and an order was finally passed under section 148A(d) on 20th July, 2022, with notice under the amended section 148 being issued on the same date. The assessee challenged this order and notice in a writ petition before the Delhi High Court.

Besides arguing that the assessee had no connection with the concerned transaction, on behalf of the assessee, it was argued that as per the first proviso to Section 149 of the Act (as amended by Finance Act, 2021), no notice for re-assessment could be issued for A.Y. 2013-14 as the time limit for initiating the proceedings expired on 30th March, 2020 as per the provisions of Section 149 (as it stood prior to its amendment by Finance Act, 2021). It was therefore contended that the proceedings pursuant to the notice dated 29th June, 2021 and the judgement of the Supreme Court in the case of Ashish Agarwal (supra), were time barred.

On behalf of the Revenue, it was submitted that Section 3 of TOLA applied to the pre-amended Section 149 and therefore the initial notice dated 29th June, 2021, and the proceedings taken in continuation as per the judgment of Ashish Agarwal (supra) were not time barred. Further submissions were made regarding the merits of the reassessment proceedings.

Examining the submissions on merits of the reassessment proceedings, the Delhi High Court held that these being disputed questions of fact, could not be adjudicated by it in writ proceedings. The Delhi High Court further held that the contention of the assessee that the present proceedings were time barred was not correct in the facts of the case, which pertained to A.Y. 2013-2014 and where reassessment proceedings were initiated during the time limit extended by TOLA. Examining the pre-amended provisions of Section 149, the Delhi High Court noted that the time limit for issuing notice under unamended Section 149, which was falling from 20th March, 2020 till 31st March 2021, was extended by Section 3 of TOLA read with Notification No. 20/2021 dated 31st March, 2021, and Notification No. 38/2021 dated 27th April, 2021, until 30th June, 2021.

The Delhi High Court noted that the initial notice in the proceedings before it was issued on 29th June, 2021 i.e. within extended time limit. The notice was quashed by the Delhi High Court following its judgment in Mon Mohan Kohli vs. ACIT 441 ITR 207, as the mandatory procedure of Section 148A was not followed before issuing the notice. In the judgment, the Delhi High Court had struck down Explanations A(a)(ii) and A(b) to the said notifications. However, the relevant portion of the notification, which extended the time limit for issuance of time barring reassessment notices until 30th June, 2021 was not struck down by the Court and in fact the Court categorically held at paragraph 98 that power of re-assessment that existed prior to 31st March 2021 stood extended till 30th June, 2021. The notice stood revived as a notice under section 148A(b) due to the decision of the Supreme Court in the case of Ashish Agarwal (supra).

In the view of the Delhi High Court, consequently, since the time period for issuance of reassessment notice for the A.Y. 2013-14 stood extended until 30th June, 2021, the first proviso of the amended Section 149 was not attracted in the facts of the case. Since the time limit for initiating assessment proceedings for A.Y. 2013-14 stood extended till 30th June, 2021, consequently, the reassessment notice dated 29th June, 2021, which had been issued within the extended period of limitation was not time barred.

The Delhi High Court also held that the challenge to paragraph 6.2.(i) of the CBDT Instruction No. 1/2022 dated 11th May, 2022 was not maintainable. The contention of the assessee that assessment for A.Y. 2013-14 became time barred on 31st March, 2020 was incorrect. The time period for assessment stood extended till 30th June, 2021.The initial reassessment notice for A.Y. 2013-14 had been issued to the petitioner within the said extended period of limitation. The Supreme Court had declared that the reassessment notice be deemed as a notice issued under section 148A of the Act and permitted Revenue to complete the said proceedings. The income alleged to have escaped assessment was more than Rs 50 lakhs and therefore, the rigour of Section 149 (1)(b) of the Act (as amended by the Finance Act, 2021) had been satisfied.

The Delhi High Court therefore dismissed the writ petition. This decision was subsequently followed by the Delhi High Court in the case of Kusum Gupta vs ITO 451 ITR 142.

RAJEEV BANSAL’S CASE

The issue came up again before the Allahabad High Court in the case of Rajeev Bansal vs. Union of India 147 taxmann.com 549.

A large number of writ petitions involving A.Ys. 2013-14 to 2017-18 were heard by the Allahabad High Court together. In all these cases, notice had been issued under the pre-amended section 148 between 1st April, 2021 to 30th June, 2021. Two legal issues were framed by the court, which would cover the issues involved in all the cases. These were:

(i) Whether the reassessment proceedings initiated with the notice under section 148 (deemed to be notice under section 148A), issued between 1st April, 2021 and 30th June, 2021, can be conducted by giving benefit of relaxation/extension under TOLA upto 30th March, 2021, and then the time limit prescribed in Section 149(1)(b) (as substituted w.e.f. 01st April, 2021) is to be counted by giving such relaxation benefit of TOLA from 30th March, 2020 onwards to the revenue.

(ii) Whether in respect of the proceedings where the first proviso to Section 149(1)(b) is attracted, benefit of TOLA will be available to the revenue, or in other words, the relaxation law under TOLA would govern the time frame prescribed under the first proviso to Section 149 as inserted by the Finance Act, 2021, in such cases?

For the A.Ys. 2013-14 and 2014-15, it was argued by the counsels for the assessees that the assessment for these years cannot be reopened, in as much as, maximum period of six years prescribed in pre-amendment provision of Section 149(1)(b) had expired on 31st March, 2021. No notice under section 148 could be issued in a case for the A.Y. 2013-14 and 2014-15 on or after 01st April, 2021, being time barred, on account of being beyond the time limit specified under the provisions of Section 149(1)(b) as they stood immediately before the commencement of the Finance Act 2021. For the A.Ys. 2015-16, 2016-17, 2017-18, it was contended that the monetary threshold and other requirements of the Income Tax Act in the post-amendment regime, i.e. after the commencement of the Finance Act, 2021 have to be followed. The validity of the jurisdictional notice under section 148 was thus to be tested on the touchstone of compliances or fulfilment of requirements by the revenue as per Section 149(1)(b) and the first proviso to Section 149(1) inserted by the amendment under the Finance Act 2021, w.e.f. 1st April, 2021.

The Allahabad High Court noted that it was undisputed that the notices issued under the pre-amendment section 148 were to be regarded as notices issued under section 148A(b). The High Court analysed the provisions of the pre-amended section 148, the provisions of TOLA and the notifications issued under TOLA. It also analysed the history of the litigation in this regard, commencing from its decision in the case of Ashok Kumar Agarwal vs. Union of India 131 taxmann.com 22 and ending with the Supreme Court decision in the case of Ashish Agarwal (supra). The Allahabad High Court thereafter took note of the CBDT instruction No. 1 of 2022, dated 11th May, 2022, for implementation of the judgement of the Supreme Court in Ashish Agarwal (supra).

The Allahabad High Court thereafter noted the arguments on behalf of the assessees as under:

(i) After the amendment brought by the Finance Act, 2021, new/amended provisions will apply to reassessment proceedings.

(ii) TOLA will not extend the time limit provided for initiation of reassessment proceedings under the amended Sections 147 to 151 from 1st April, 2021 onwards.

(iii) The result is that the revenue has to comply with all the requirements of the substituted/amended provisions of Sections 147 to 151A in the reassessment proceedings, initiated on or after 1st April, 2021. All compliances under the amended provisions will have to be made by the revenue.

(iv) Simultaneously, all defences under the substituted/amended provisions will be available to the assessee.

(v) About the impact of TOLA on the amendment by the Finance Act, 2021, no time extension under section 3(1) of TOLA can be granted in the time limit provided under the substituted provisions. Section 3(1) of TOLA saved only the reassessment proceeding as they existed under the unamended law.

(vi) The scheme of assessment underwent a substantial change with the enforcement of the Finance Act, 2021. The general provisions of TOLA cannot vary the requirements of the Finance Act, 2021, which is a special provision, as the special overrides general.

(vii) Reassessment notice under section 148 can be issued only upon the jurisdiction being validly assumed by the assessing authority, for which the compliances of substituted provisions of Sections 149 to 151A have to be made by the revenue.

(viii) New/amended provisions are beneficial in nature for the assessee and provide certain pre-requisite conditions/monetary threshold, etc. to be adhered to by the revenue to issue jurisdictional notice under section 148. The revenue has to meet a higher threshold to discharge a positive burden because of the substantive changes made in the new regime.

(ix) The pre-requisite conditions to issue notice under section 148 in the pre and post amendment regime demonstrate that for the reassessment notice after elapse of the period of 3 years but before 10 years from the end of the relevant assessment year, notice under section 148 cannot be issued unless the AO has in his possession books of accounts or other documents or evidence which reveal that the income chargeable to tax, represented in the form of assets, which has escaped assessment, amount to or is likely to amount to Rs.50 lakhs or more for that year.

(x) The monetary threshold for opening of assessment after elapse of three years for the period upto ten years has, thus, been put in place.

(xi) Further, first proviso to sub-section (1) of Section 149 has been placed to assert that the cases wherein notices could not have been issued within the period of six years as per clause (b) of sub-section (1) of Section 149 under the pre-amendment provision, reassessment notices cannot be issued on or after 1st April, 2021 after the commencement of the Finance Act, 2021, as such cases have become time barred.

(xii) Such cases cannot be reopened by giving an extension in the time limit by applying the provisions of TOLA.

(xiii) The Finance Act, 2021 had limited the applicability of TOLA and after amendment, the compliances/conditions under the amended provisions have to be fulfilled.

(xiv) The Apex Court in Ashish Agarwal (supra) has categorically provided that all defences available to the assessee including those under section 149 and all rights and contentions available to the concerned assessee and revenue under the Finance Act, 2021 and in law, shall continue to be available. The effect of the said observation is that the Revenue though may be able to maintain the notices issued under the unamended Section 148, as preliminary notices under section 148-A as inserted by the Finance Act, 2020, but for issuance of jurisdictional notice under section 148, the requirements of the amended Section 149 under the Finance Act, 2021 have to be fulfilled.

(xv) TOLA was enacted by the Parliament to deal with the contingency and the extension of time limit under section 3(1) of TOLA and was contemplated not to remain in perpetuity. TOLA had only substituted the limitation that was expiring. The extension under TOLA for the A.Y. 2015-16, 2016-17, 2017-18 was not permissible as the time limit for reopening of assessment proceedings for the said assessment years even under the unamended Section 149 was not expiring at the time of enforcement of the Enabling Act (TOLA 2020).

(xvi) The findings returned by the Division Bench and the Apex Court as noted above were reiterated that the relaxation granted by the Apex Court to consider Section 148 notices under the unamended Act as preliminary notices issued under Section 148A as inserted by the Finance Act, 2021, was a one time measure treating them as a bona fide mistake of the Revenue. However, it is evident from the said finding that the provisions of the Finance Act, 2021 have to be given their full effect.

(xvii) TOLA cannot infuse life into the pre-existing law to provide an extension of time to the Revenue in the time limit therein, to reopen cases for the assessment years which have become time barred under the first proviso to Section 149.

(xviii) As regards Instruction No 1 of 2022, executive instructions cannot limit or extend the scope of the Act or cannot alter the provisions of the Act. Instructions or Circular cannot impose burden on a tax payer higher than what the Act itself as a true interpretation envisages.

(xix) The direction issued in (clause 6.1, in third bullet point) that the decision of the Apex Court read with the time extension provided by TOLA, will allow extended reassessment notices to travel back in time to their original date when such notices were to be issued and then new Section 149 is to be applied at that point, is based on the wrong interpretation of the judgement of the Apex Court and the High Court. In clause 6.2 (i) of the Circular, it is provided that reassessment notices for A.Ys. 2013-14 and 2014-15 can be issued with the approval of the specified authority, if the case falls under clauses (b) of sub section (1) of Section 149 amended by the Finance Act, 2021. By issuing such instructions contained in clauses 6.1 and 6.2 of the Circular dated 11th May, 2022, the CBDT has devised a novel method to revive the reassessment proceedings which otherwise became time barred under the amended Section 149, specifically for the A.Ys. 2013-14 and 2014-15 being beyond the time limit specified under the provisions of unamended clause (b) of sub section (1) of section 149.

(xx) Reference was made to the Bombay High Court decision in Tata Communications Transformation Services Ltd vs ACIT 443 ITR 49 for the proposition that section 3(1) of TOLA does not provide that any notice issued under section 148 after 31st March, 2021 will relate back to the original date when it ought to have been issued or that the clock is stopped on 31st March, 2021 such that the provisions as existing on the said date will be applicable to notices issued thereafter, relying on the provisions of TOLA. It was observed therein that the purpose of Section 3(1) of TOLA is not to postpone or extend the applicability of the unamended provisions of the IT Act. Observations were made by the Bombay High Court therein that TOLA is not applicable for A.Y. 2015-16 or any subsequent year as the time limit to issue notice under section 148 for these assessment years was not expiring within the period for which Section 3(1) of TOLA was applicable and hence TOLA could not apply for these assessment years. As a consequence, there can be no question of extending the period of limitation for such assessment years, where the revenue could have issued notice of reassessment by complying with the requirements of the unamended provisions. In a case where the revenue did not initiate proceedings within the time limit under the unamended IT Act extended by TOLA, further extensions for inaction of the revenue cannot be granted by the notifications issued under TOLA on 31st March, 2021 or thereafter, once the amendments have been brought into place on 1st April, 2021, to extend the time limit under the unamended provisions.

On behalf of the Revenue, it was pointed out that TOLA was enacted to provide relaxation of the time limit provided in the Specified Acts, including the IT Act. Issuance of notice under section 148 as per the prescribed time limit in Section 149 was permissible until 30th June, 2021. It was argued that the notices issued on or after 1st April, 2021 under section 148, for reassessment were issued in accordance with the substituted laws and not as per the pre-existing laws and TOLA was only applied for extension in the timeline. TOLA has overriding effect over the IT Act, and will extend the time limit for issue of notice/action under the IT Act. The extension of time granted by TOLA would save all notices issued on or after 1st April, 2021.

It was claimed on behalf of the Revenue that only the time limit for various action/compliances/issuance of notices had been changed in the Finance Act, 2021. In any case, timelines remained under both the enactments, pre and post amendment. The reassessment notices would have been barred by time had there been no extension of the time limit under the IT Act by TOLA. The applicability of Explanation to Clause A(a) of the notification dated 31st March, 2021 and Explanation to clause A(b) of the notification dated 27.4.2021, may have been restricted to reassessment proceedings as in existence on 31.3.2021 and have been read down as applicable to the pre-existing Section 147 to 151-A, but the substantive provisions of extension of time for action/compliances/issuance of notice of the notifications dated 31st March, 2021 and 27th April, 2021, still survive.

It was argued that in Ashok Kumar Agarwal’s case, the explanations which provided that for the notices issued after 1st April, 2021, the time line under the pre-existing provisions would apply, had been held to be offending provisions, but the Allahabad High Court had left it open to the respective assessing authorities to initiate reassessment proceedings in accordance with the amended provisions by the Finance Act, 2021. The extension in time until 30th June, 2021 as granted by the notifications dated 31st March, 2021 and 27th April, 2021 would, thus, apply to the timeline provided under the amended provisions brought by the Finance Act, 2021.

It was submitted that when two Parliamentary Acts were on the statute book, one providing substantive provisions and procedure for initiating reassessment proceeding and the other granting extension of time for action/compliances/issuance of notices under the substantive and procedural provisions of the IT Act, a harmonious construction of both the provisions had to be made. Thus, whatever time limit was provided under the IT Act as on 1st April, 2021, the same had to be extended until 30th June, 2021 to enable the revenue to initiate and process the reassessment proceedings under section 148 as amended by the Finance Act, 2021.

It was argued that in view of the decision of the Apex Court in saving all notices issued by the revenue pan-India by treating them as notices under section 148-A of the amended provisions, all actions of the revenue subsequent to the issuance of notices under section 148-A in compliance of the directions of the Apex Court would have to be saved. The reference to the date of issuance of Section 148 notices, which were quashed by different High Courts, thus, has to be the date of notices under section 148-A of the amended provisions and extension of time, for compliances prescribed under the amended provisions, has to be granted to the revenue, accordingly. As observed by the Apex Court, when all defences remain available to the assessee, all rights of the revenue will have to be preserved/made available.

It was urged that even the Division Bench in Ashok Kumar Agarwal’s case (supra) had recognised that TOLA plainly was an enactment to extend timelines. Consequently, from 1st April, 2021 onwards, all references to issuance of notices contained in TOLA must be read as references to the substituted provisions only. The Allahabad High Court had observed that there was no difficulty in applying the pre-existing provisions to pending proceedings and then proceeded to harmonize the two laws. It was argued that giving this plain and simple meaning to TOLA, the extensions in time limit which were available to the revenue until 31st March, 2021 under TOLA, became available to the revenue after 1st April, 2021 by the Notification No.20 of 2021 dated 31st April, 2021 and the Notification No.38 dated 2th April, 2021, which had not been quashed or held invalid by the High Court or the Apex Court. Thus, extension of three months until 30th June, 2021 in the time limit provided under the IT Act, whether pre or post amendment, had to be granted. The time limit provided in the amended Section 149 of three years and 10 years had to be extended until 30th June, 2021, by virtue of the notifications issued under section 3(1) of TOLA. It was argued that the CBDT Instruction only clarifies the above position of the two provisions – that the time extension provided by TOLA will allow “extended reassessment notices” to travel back in time to their original date when such notices were to be issued, and then the new Section 149 is to be applied at that point of time.

It was submitted that based on the said logic, the “extended reassessment notices” for the A.Ys. 2013-14, 2014-15 and 2015-16 were to be dealt with by issuance of fresh notice under amended Section 148, with the approval of the specified authority, in the cases which fall under clause (b) of Section 149(1) as amended by the Finance Act, 2021. It is further clarified in the CBDT instruction that the specified authority under section 151 of the amended provisions shall be the authority prescribed under clause (ii) of that section. Similarly, for A.Y. 2016-17 and A.Y. 2017-18, fresh notice under Section 148 can be issued with the approval of the specified authority under clause (a) of amended Section 149(1), as they are within the period of three years from the end of the relevant assessment years, because of the extension of time by TOLA.

On behalf of the Revenue, reliance was placed on the decision of the Delhi High Court in the case of Touchstone Holdings (supra), which had relied on the earlier decision of the Delhi High Court in the case of Mon Mohan Kohli vs. ACIT (supra), and had held that with the declaration by the Apex Court that the reassessment notice issued on or after 1st April, 2021 shall be deemed to be the notice under section 148-A, the Revenue was permitted to complete the reassessment proceedings in accordance with the amended provisions of Section 149.

A specific query was raised by the Bench to the revenue to answer the effect of the first proviso to Section 149(1) of the amended provisions inserted by the Finance Act, 2021 which prohibits issuance of notice under section 148, in a case where it has become time barred under the unamended (pre-existing) clause (b) of Section 149(1). The answer on behalf of the revenue was that time limit of 6 years provided in clause (b) of Section 149(1) stood extended by virtue of TOLA until 31st March, 2021, and further extensions in the time limit (of six years) are to be granted under the notifications issued under section 3(1) of TOLA until 30th June, 2021. The result would be that the cases for the A.Ys. 2013-14 and 2014-15, where the period of six years had expired on 31st March, 2020 and 31st March, 2021 respectively, would not be hit by the first proviso to Section 149(1) brought by the Finance Act, 2021. The cases for these assessment years had to be evaluated and the reassessment proceedings had to be conducted for them in accordance with clause (b) of Section 149(1) as amended by the Finance Act, 2021, being beyond the period of three years but within the limitation of ten years. Similarly, for the A.Y. 2015-16, on the expiry of three years on 31st March, 2019, the extension until 30th June, 2021 is to be granted to bring the reassessment proceedings under amended clause (b) of Section 149(1). For the A.Ys. 2016-17 and 2017-18, where the period of three years had expired on 31st March, 2020 and 31st March, 2021 respectively, the extension in the time limit of three years was to be granted under TOLA and these cases would fall under the amended clause (a) of Section 149(1), being within the prescribed limit of three years until 30th June, 2021.

The Allahabad High Court noted the summary of its observations in the case of Ashok Kumar Agarwal (supra) as under:

(i) By its very nature, once a new provision has been put in place of the pre-existing provision, the earlier provision cannot survive, except for the things done or already undertaken to be done or things expressly saved to be done.

(ii) In absence of any saving clause to save pre-existing provisions, the revenue authorities could only initiate proceeding on or after 1st April, 2021, in accordance with the substituted laws and not the pre-existing laws. TOLA, that was pre-existing, confronted the IT Act as amended by the Finance Act, 2021, as it came into existence on 1st April, 2021. In both the provisions, i.e. TOLA and the Finance Act, 2021, there is absence, both of any express provision in its effort to delegate the function, to save the applicability of provisions of pre-existing Sections 147 to 151, as they existed up to 31st March, 2021.

(iii) Plainly, TOLA is an enactment to extend timelines only from 1st April, 2021 onwards. Consequently, from 1st April, 2021 onwards all references to issuance of notice contained in TOLA must be read as reference to the substituted provisions only.

(iv) There is no difficulty in applying pre-existing provisions to pending proceedings and, this is how, the laws were harmonized.

(v) For all reassessment notices which had been issued after 1st April, 2021, after the enforcement of amendment by the Finance Act, 2021, no jurisdiction has been assumed by the assessing authority against the assesses under the unamended law. No time extension could, thus, be made under section 3(1) of TOLA read with the notifications issued thereunder.

(vi) Section 3 of TOLA only speaks of saving or protecting certain proceedings from being hit by the rule of limitation. That provision also does not speak of saving any proceeding from any law that may be enacted by the Parliament, in future. The non-obstante clause of Section 3(1) of TOLA does not govern the entire scope of the said provision. It is confined to and may be employed only with reference to the second part of Section 3(1) of TOLA, i.e. to protect the proceedings already underway. The Act, thus, only protected certain proceedings that may have become time barred on 30th March, 2021 up to the date 30th June, 2021. Correspondingly, by delegated limitation incorporated by notifications, the Government may extend that time limit. That timeline alone stood extended up to 30th June, 2021.

(vii) Section 3(1) of TOLA does not itself speak of the reassessment proceeding or Section 147 or Section 148 as it existed prior to 1st April, 2021. It only provides a general relaxation of limitation granted on account of the general hardship existing upon the spread of pandemic COVID-19. After the enforcement of the Finance Act, 2021, it applies to the substituted provisions and not the pre-existing provisions.

The reference to reassessment proceedings with respect to pre-existing and new substituted provisions of Sections 147 and 148 has been introduced only by the later notifications issued under TOLA. It was concluded that in absence of any proceedings of reassessment having been initiated prior to the date 1st April, 2021, it is the amended law alone that would apply. The notifications issued by the Central Government or the CBDT Instructions could not have been issued plainly to over reach the principal legislation. Unless harmonised as such, those notifications would remain invalid.

(viii) On the submission of the revenue that practical difficulties faced by the revenue in initiation of reassessment proceedings due to onset of pandemic COVID-19 dictates that the reassessment proceedings be protected, it was noted that practicality, if any, may lead to litigation. Once the matter reaches the Court, it is the legislation and its language and the interpretation offered to that language as may primarily be decisive to govern the outcome of the proceedings. To read practicality into enacted law is dangerous.

(ix) It would be oversimplistic to ignore the provisions of, either TOLA or the Finance Act, 2021 and to read and interpret the provisions of Finance Act, 2021 as inoperative in view of the facts and circumstances arising from the spread of the pandemic Covid-19.

(x) In absence of any specific clause in the Finance Act, 2021 either to save the provisions of TOLA or the notifications issued thereunder, by no interpretative process can those notifications be given an extended run of life, beyond 31st March, 2021.

(xi) The notifications issued under TOLA may also not infuse any life into a provision that stood obliterated from the statute book w.e.f. 31st March, 2021, in as much as, the Finance Act, 2021 does not enable the Central Government to issue any notification to reactivate the pre-existing law, which has been substituted by the principal legislature. Any such exercise made by the delegate/Central government would be dehors any statutory basis.

(xii) In absence of any express saving of the pre-existing laws, the presumption drawn in favor of that saving, is plainly impermissible.

(xiii) No presumption exists by the notifications issued under TOLA that the operation of the pre-existing provisions of the Act had been extended and thereby provisions of Section 148A (introduced by the Finance Act, 2021) and other provisions had been deferred.

On these grounds, in Ashok Kumar Agarwal’s case, the Allahabad High Court had quashed the reassessment notices, leaving it open to the respective assessing authorities to initiate reassessment proceedings in accordance with the provisions of the IT Act as amended by the Finance Act, 2021 after making all compliances, as required by law.

The Allahabad High Court then summarized the Supreme Court findings in Ashish Agarwal’s case (supra) as under:

(I) By substitution of Sections 147 to 151 by the Finance Act, 2021, radical and reformative changes are made governing the procedure for reassessment proceedings. Under pre-Finance Act, 2021, the reopening was permissible for a maximum period up to 6 years and in some cases beyond even 6 years leading to uncertainty for considerable time. Therefore, the Parliament thought it fit to amend the Income Tax Act to simplify the Tax Administration, ease compliances and reduce litigation. To achieve the said object, by the Finance Act, 2021, Sections 147 to 149 and Section 151 have been substituted.

(II) Section 148(A) is a new provision, which is in the nature of a condition precedent. Introduction of Section 148A can, thus, be said to be a game changer with an aim to achieve ultimate object of simplifying the tax administration. By way of Section 148A, the procedure has now been streamlined and simplified. All safeguards are, thus, provided before issuing notice under section 148. At every stage, the prior approval of the specified authority is required, even for conducting the inquiry as per Section 148(A)(a).

(III) Substituted Section 149 is the provision governing the time limit for issuance of notice under section 148. The substituted Section 149 has reduced the permissible time limit for issuance of such a notice to three years and, only in exceptional cases, in ten years. It also provides further additional safeguards which were absent under the earlier regime pre-Finance Act, 2021.

(IV) The new provisions substituted by the Finance Act, 2021, being remedial and benevolent in nature and substituted with a specific aim and object to protect the rights and interest of the assesses as well as and the same being in public interest, the respective High Courts have rightly held that the benefit of new provisions shall be made applicable even in respect of the proceedings related to past assessment years, provided Section 148 notice has been issued after 1st April, 2021.

The Supreme Court had therefore confirmed the view taken by the High Courts, including by the Allahabad High Court in the case of Ashok Kumar Agarwal (supra). However, the Supreme Court had further observed that:

I) The judgments of several High Courts would result in no assessment proceedings at all, even if the same are permissible under the Finance Act, 2021 as per substituted Sections 147 to 151. To remedy the situation where revenue became remediless, in order to achieve the object and purpose of reassessment proceedings, it was observed that the notices under section 148 after the amendment was enforced w.e.f 1st April, 2021, were issued under the unamended Section 148, due to bonafide mistake in view of the subsequent extension of time by various notifications under TOLA.

II) The notices ought not to have been issued under the unamended Act and ought to have been issued under the substituted provisions of Sections 147 to 151 as per the Finance Act, 2021.

III) There appears to be a genuine non application of the amendments as the officers of the revenue may have been under a bona fide belief that the amendments may not yet have been enforced.

The Supreme Court therefore held that:

“Instead of quashing and setting aside the reassessment notices issued under the unamended provisions of IT Act, the High Courts ought to have passed order construing the notices issued under the unamended Act/unamended provision of the IT Act as those deemed to have been issued under Section 148(A) of the Income Tax Act, as per the new provision of Section 148(A). In that case, the revenue ought to have been permitted to proceed with the reassessment proceedings as per the substituted provisions of Sections 147 to 151 of the Income Tax Act as per the Finance Act, 2021, subject to compliance of all the procedural requirements and the defences which may be available to the assessee under the substituted provisions of Section 147 to 151 of the Income Tax Act, and which may be available under the Finance Act, 2021 and in law.”

The Allahabad High Court observed that while passing the order, it was noted by the Apex Court that there was a broad consensus on the proposed modification on behalf of the revenue and the counsels appearing on behalf of respective assessees.

The Allahabad High Court noted that in Ashok Kumar Agarwal’s case, it had held that if the Finance Act, 2021 had not made the substitution of the reassessment procedure, revenue authorities would have been within their rights to claim extension of time, under TOLA. The sweeping amendments made by the Parliament by necessary implication or implied force limited applicability of TOLA. The power to grant time extension thereunder was limited to only such reassessment proceedings as had been initiated till 31st March, 2021. It was also held that in absence of any specific clause in the Finance Act, 2021 either to save the provisions of TOLA or the Notifications issued thereunder, by no interpretative process, the notifications could be said to infuse life into a provision that stood obliterated from the Statute book w.e.f 31st March, 2021. It was held that the Finance Act, 2021 did not enable the Central Government to issue any notification to reactivate the pre-existing law, the exercises made by the delegate/Central Government would be dehors any statutory basis. It was, thus, categorically held by the Division Bench that the notifications did not insulate or save the pre-existing provisions pertaining to reassessment under the Act and that the operation of the pre-existing provisions of the Act could not be extended.

The Allahabad High Court noted that the contention of the revenue, if accepted, would create conflict of laws. The limitation under the pre-existing provisions would have to be kept alive till 30th June, 2021 with the aid of the extensions granted by the notifications issued by the Central Government, which had been read down by the Co-ordinate Division Bench in Asok Kumar Agarwal’s case. As per the Division Bench judgment, the time limit provided in unamended Section 149, could not be extended beyond 31st March, 2021, so as to render the amended provisions of Section 149 ineffective. The stand of the revenue that TOLA simply extended the period of limitation until 30th June, 2021, due to the disturbances from the spread of pandemic COVID-19, had been categorically turned down by the Division Bench in Ashok Kumar Agarwal’s case (supra) with the above observations.

The Allahabad High Court observed that there was a substantial change in the threshold/requirements which had to be met by the revenue before issuance of reassessment notice after elapse of three years under clause (b) of Section 149(1). Not only monetary threshold had been substituted but the requirement of evidence to arrive at the opinion that the income escaped assessment has also been changed substantially. A heavy burden was cast upon the revenue to meet the requirements of clause (b) of Section 149(1) for initiation of reassessment proceedings after lapse of three years.

Analysing the first proviso to Section 149(1), the Allahabad High Court observed that the time limit in clause (b) of unamended Section 149(1) of six years, thus, cannot be extended up to ten years under clause (b) of amended Section 149(1), to initiate reassessment proceeding in view of the first proviso to Section 149(1). In other words, the case for the relevant assessment year where six years period has elapsed as per unamended clause (b) of Section 149(1) cannot be reopened after commencement of the Finance Act, 2021 w.e.f. 1st April, 2021.

The view in Ashok Kumar Agarwal’s case (supra) that after 1st April, 2021, if the rule of limitation permitted, the revenue could initiate reassessment proceedings in accordance with the new law, after making adequate compliances, had been upheld by the Apex Court in Ashish Agarwal’s case (supra). According to the Allahabad High Court, in case the arguments of the revenue were accepted, the benefits provided to the assessee in the substantive provisions of clause (b) of Section 149(1) and the first proviso to Section 149 had to be ignored or deferred. The defences which may be available to the assessee under section 149 and/or which may be available under Finance Act, 2021 had to be denied.

At the first blush, the argument of the revenue seemed convincing by simplistic application of TOLA, treating it as a statute for extension in the limitation provided under the IT Act, but on a deeper scrutiny, if the argument of the revenue were accepted, it would render the first proviso to Section 149(1) ineffective until 30th June, 2021 and otiose. This view, if accepted, would result in granting extension of time limit under the unamended clause (b) of Section 149, in cases where reassessment proceedings had not been initiated during the lifetime of the unamended provisions, i.e. on or before 31st March, 2021. It would infuse life in the obliterated unamended provisions of clause (b) of Section 149(1), which was dead and removed from the Statute book w.e.f. 1st April, 2021, by extending the timeline for actions therein.

According to the Allahabad High Court, in absence of any express saving clause, in a case where reassessment proceedings had not been initiated prior to the legislative substitution by the Finance Act, 2021, the extended time limit of unamended provisions by virtue of TOLA cannot apply. In other words, the obligations upon the revenue under clause (b) of amended Section 149(1) cannot be relaxed. The defences available to the assessee in view of the first proviso to Section 149(1) could not be taken away. The notifications issued by the delegates/Central Government in exercise of powers under Section 3(1) of TOLA could not infuse life in the unamended provisions of Section 149 by this way.

The Allahabad High Court addressed the argument of the revenue that this interpretation would render TOLA otiose, though it had not been declared invalid by any court, by stating that this argument was misconceived, as the extensions in the time limit under the unamended Sections of the IT Act prior to the amendment by the Finance Act, 2021, would still be applicable to the reassessment proceedings as may have been in existence on 31st March, 2021.

Referring to the CBDT Instruction No 1 of 2022, the Allahabad High Court found that that the third bullet to clause (6.1) which stated that the Apex Court had allowed time extension provided by TOLA and the “extended reassessment notices” will travel back in time to their original date when such notices were to be issued and then Section 149 is to be applied at that point, was a surreptitious attempt to circumvent the decision of the Apex Court. The Supreme Court observations had been given in piecemeal in that bullet to give it a distorted picture. As per the Allahabad High Court, terming reassessment notices issued on or after 1st April, 2021 and ending with 30th June, 2021 as “extended reassessment notices”, within the time extended by TOLA and various notifications issued thereunder, in Para 6.1 was an effort of the revenue to overreach the judgment of that Court in Ashok Kumar Agarwal (supra) as affirmed by the Apex court in Ashish Agarwal (supra).

In any case, the Allahabad High Court observed that this instruction, as per the Revenue itself, was only a guiding instruction – the instructions in the third bullet to clause 6.1 and clauses 6.2(i) and (ii), being contrary to the decision of the Supreme Court, had no binding force.

Referring to the Delhi High Court decision in Touchstone Holdings (supra), the Allahabad High Court observed that the view taken therein was in direct conflict with the view taken by the Allahabad High Court in Ashok Kumar Agarwal (supra) affirmed by the Apex Court in Ashish Agarwal (supra). In fact, the observation in Mon Mohan Kohli (supra) by the Delhi High Court in paragraph ‘98’ that the power of reassessment that existed prior to 31st March, 2021 continued to exist till the extended period, i.e. till 3th June, 2021, and the Finance Act, 2021 had merely changed the procedure to be followed prior to issuance of notice w.e.f. 1st April, 2021, had been misread and misapplied in Touchstone (supra) by the Division Bench of the Delhi High Court. Even in Mon Mohan Kohli’s case (supra), the Delhi High Court had quashed the reassessment notices issued on or after 1st April, 2021 on the grounds that TOLA did not give power to the Central Government to extend the erstwhile Sections 147 to 151 beyond 31st March, 2021 and/or defer the operation of substituted provisions enacted by the Finance Act, 2021. In fact, in Mon Mohan Kohli’s case (supra), the Delhi High Court had concurred with the Allahabad High Court view in Ashok Kumar Agarwal’s case (supra).

The Allahabad High Court observed that it was a settled law that a taxing statute must be interpreted in the light of what was clearly expressed. It was not permissible to import provisions in a taxing statute so as to supply any assumed deficiency. In interpreting a taxing statute, equitable considerations are out of place. Nor can taxing statutes be interpreted on any presumptions or assumptions. The court must look squarely at the words of the statute and interpret them. Taxing statute would need to be interpreted in the light of what is clearly expressed. It cannot imply anything which is not expressed. Before taxing any person it must be shown that he falls within the ambit of the charging section by clear words used in the section, and if the words are ambiguous and open to two interpretations, the benefit of interpretation is given to the subject. There is nothing unjust in the taxpayer escaping if the letter of the law fails to catch him on account of the legislature’s failure to express itself clearly.

The Allahabad High Court therefore held that:

(i) The reassessment proceedings initiated with the notice under section 148 (deemed to be notice under section 148-A), issued between 1st April, 2021 and 30th June, 2021, could not be conducted by giving benefit of relaxation/extension under TOLA up to 30th March, 2021, and the time limit prescribed in Section 149(1)(b) (as substituted w.e.f. 01st April, 2021) cannot be counted by giving such relaxation from 30th March, 2020 onwards to the Revenue.

(ii) In respect of the proceedings where the first proviso to Section 149(1)(b) is attracted, benefit of TOLA will not be available to the revenue, or in other words, the relaxation law under TOLA would not govern the time frame prescribed under the first proviso to Section 149 as inserted by the Finance Act, 2021, in such cases.

A similar view was taken by the Gujarat High Court in the case of Keenara Industries (P) Ltd vs. ITO 147 taxmann.com 585, where the Gujarat High Court held that the reassessment notices for A.Ys. 2013-14 and 2014-15, which had become time-barred prior to 1st April, 2021 under the old regime on expiry of 6 years limitation period, could not be revived by TOLA/extension of time notification issued under TOLA. Therefore, reassessment notices for A.Ys. 2013-14 and 2014-15 could not be issued on or after 1st April, 2021 under the new regime effective from 1st April, 2021 even within the extended time-limit of 1st April, 2021 to 30th June, 2021 applicable under the TOLA Notifications.

OBSERVATIONS

In Ashish Agarwal’s case, the Supreme Court had held:

“ 8.However, at the same time, the judgments of the several High Courts would result in no reassessment proceedings at all, even if the same are permissible under the Finance Act, 2021 and as per substituted sections 147 to 151 of the IT Act. The Revenue cannot be made remediless and the object and purpose of reassessment proceedings cannot be frustrated. It is true that due to a bonafide mistake and in view of subsequent extension of time vide various notifications, the Revenue issued the impugned notices under section 148 after the amendment was enforced w.e.f. 01.04.2021, under the unamended section 148. In our view the same ought not to have been issued under the unamended Act and ought to have been issued under the substituted provisions of sections 147 to 151 of the IT Act as per the Finance Act, 2021. There appears to be genuine non-application of the amendments as the officers of the Revenue may have been under a bonafide belief that the amendments may not yet have been enforced. Therefore, we are of the opinion that some leeway must be shown in that regard which the High Courts could have done so. Therefore, instead of quashing and setting aside the reassessment notices issued under the unamended provision of IT Act, the High Courts ought to have passed an order construing the notices issued under unamended Act/unamended provision of the IT Act as those deemed to have been issued under section 148A of the IT Act as per the new provision section 148A and the Revenue ought to have been permitted to proceed further with the reassessment proceedings as per the substituted provisions of sections 147 to 151 of the IT Act as per the Finance Act, 2021, subject to compliance of all the procedural requirements and the defences, which may be available to the assessee under the substituted provisions of sections 147 to 151 of the IT Act and which may be available under the Finance Act, 2021 and in law. Therefore, we propose to modify the judgments and orders passed by the respective High Courts as under:

(i) The respective impugned section 148 notices issued to the respective assessees shall be deemed to have been issued under section 148A of the IT Act as substituted by the Finance Act, 2021 and treated to be show-cause notices in terms of section 148A(b). The respective assessing officers shall within thirty days from today provide to the assessees the information and material relied upon by the Revenue so that the assessees can reply to the notices within two weeks thereafter;

(ii) The requirement of conducting any enquiry with the prior approval of the specified authority under section 148A(a) be dispensed with as a one-time measure vis-à-vis those notices which have been issued under Section 148 of the unamended Act from 01.04.2021 till date, including those which have been quashed by the High Courts;

(iii) The assessing officers shall thereafter pass an order in terms of section 148A(d) after following the due procedure as required under section 148A(b) in respect of each of the concerned assessees;

(iv) All the defences which may be available to the assessee under section 149 and/or which may be available under the Finance Act, 2021 and in law and whatever rights are available to the Assessing Officer under the Finance Act, 2021 are kept open and/or shall continue to be available and;

(iv) The present order shall substitute/modify respective judgments and orders passed by the respective High Courts quashing the similar notices issued under unamended section 148 of the IT Act irrespective of whether they have been assailed before this Court or not.”

The Supreme Court therefore held that the new law would apply, even where notices issued under old law were deemed to be valid and the AO was permitted to proceed thereunder, and while so holding, did not exclude the operation of the first proviso to new Section 149(1). On the contrary, it held that all other provisions of the new law would apply and that the defences otherwise available thereunder would be available to the assessee. Further, the Supreme Court was seized with the view taken by the different High Courts, and had agreed with their views particularly that the notices issued under the old law of s. 148, on or after, 31st March, 2021, were invalid. It only modified those decisions to the extent stated above that the notices were deemed to be issued within the time. Therefore, the Allahabad High Court rightly held that the assessee was entitled to the defence that the notices were barred by limitation due to the applicability of the first proviso to the amended section 149(1), and that its order in the case of Ashok Kumar Agarwal (supra) was modified only to the extent of the above.

As observed by the Gujarat High Court, no notification could extend the limitation of a repealed law. The Apex Court in case of Ashish Agarwal (supra) had not disturbed the findings of various High Courts to the effect that the notifications in question were ultra vires the law. The Gujarat High Court also rightly pointed out that in Touchstone Holdings’ case, the Delhi High Court proceeded on the basis that earlier notice was legal, valid and within the time frame. The Delhi High Court had gone on a premise that by virtue of observation in case of Mon Mohan Kohli (supra), the extension to time limit would survive.

Therefore, the view taken by the Allahabad and Gujarat High Courts seems to be the better view of the matter, and that in cases where the notice is barred by limitation on account of the first proviso to new section 149(1), the reassessment notices would be invalid.

shailesh.kwebmaker

Letter of Allotment and Receipt of Immovable Property

ISSUE FOR CONSIDERATION

Section 56(2) provides for the taxability of certain receipts, which inter alia include the receipt of any immovable property, either without consideration or for a consideration which is less than its stamp duty value. When taxability of such receipts was introduced for the first time vide clause (vii) of section 56(2), it was applicable only if the immovable property was received without consideration by the assessee on or after 1st October, 2009. The Finance Act, 2013 amended the provision of clause (vii) with effect from AY 2014-15, expanding its scope to cover the receipt of an immovable property for a consideration, if the consideration was lesser than the stamp duty value of the said immovable property.

The said clause (vii) of section 56(2) was applicable only to individuals and HUFs. However, thereafter, the Finance Act, 2017 made clause (vii) inapplicable to receipts after 31st March, 2017. Receipts subsequent to that date were brought to tax under clause (x) in the hands of all types of assessees. The taxability under both these clauses is subject to further conditions and several exclusions.

In the real estate market, when the immovable property is bought from a builder in a project which is underconstruction, it is a common practice that the builder will first issue a letter of allotment upon finalization of the deal and receipt of the booking amount. Thereafter, it will be followed by execution of a detailed agreement for sale and its registration. Even as per the provisions of the Real Estate (Regulation and Development) Act, 2016, it is obligatory for the promoter to enter into an agreement and to get it registered only when a sum of more than 10 per cent of the total consideration is received from the buyer. Thus, generally, the agreement for sale is not executed and registered immediately when the assessee books any property with the builder in an under-construction project and pays booking amount not exceeding 10 per cent of the total consideration.

If, in such cases, the year in which the assessee booked the property and received the letter of allotment is different from the year in which the agreement for sale has been executed and registered, then the issue arises as to in which year the assessee should be considered to have ‘received’ the immovable property. The Mumbai bench of the tribunal has considered the year in which the agreement for sale was executed as the year in which the property was effectively received by the assessee, and the Jaipur bench of the tribunal has considered the year in which the letter of allotment was issued as the year in which the property was effectively received by the assessee.

SUJAUDDIAN KASIMSAB SAYYED’S CASE

The issue first came up for consideration of the Mumbai bench of the tribunal in the case of Sujauddian Kasimsab Sayyed vs. ITO (ITA No. 5498/Mum/2018). The assessment year involved in this case was 2015-16.

In this case, the assessee had agreed to purchase flat No. 2901 on 29th Floor, C-Wing, in the building named as Metropolis, Andheri (West), Mumbai admeasuring area of 123.36 sq. m (carpet area) for a consideration of Rs. 88,30,008, whereas its stamp duty value was determined at Rs. 1,88,44,959. The assessee had originally booked this flat with M/s Housing Development & Infrastructure Ltd on 27th April, 2012 and an advance payment of Rs. 3,00,000 was also made on 27th April, 2012. The purchase deed was executed and registered on 10th September, 2014 i.e. during the year under consideration, apart from the payment of Rs. 3,00,000 at the time of booking of the flat, the assessee had made the payment of Rs. 14,66,001 till the time of execution of the agreement. The balance amount of Rs. 70,64,007 was still payable, and it was to be paid in instalments as specified in the agreement.

During the course of assessment proceedings, the AO asked the assessee to explain why the difference of Rs.1,00,14,951 (being the stamp duty value) should not be treated as income from other sources under section 56(2)(vii)(b). Not being satisfied with the reply of the assessee, the AO made the addition of such difference while passing the assessment order.

Aggrieved by the order of the AO, the assessee filed an appeal before the CIT(A). Before the CIT(A), it was contended that the assessee had booked the said flat on 27th April, 2012 on which date the letter of allotment was issued as well as the amount of Rs.3,00,000 was also paid. The copies of the allotment letter and receipt were also placed on record. On this basis, it was contended that these dates were falling in the previous year relevant to AY 2013-14, in which year the amended provisions of section 56(2)(vii)(b) were not applicable. The amendment made by the Finance Act, 2013 bringing to tax the receipt of immovable property for a consideration lesser than the stamp duty value was applicable only w.e.f. 01st April, 2014

The CIT (A) dismissed the appeal of the assessee, mainly on the ground that 27th April, 2012 could not be considered to be the date of purchase of the flat, as it was merely an allotment on that date, and the real transaction of purchase of flat had been entered on 10th September, 2014 by a registered deed. It was held that for any purchase or sale deed of immovable property to be covered under section 53A of the Transfer of Property Act, it was required to be a registered instrument enforcing civil law rights. In the absence of registration, the transaction would not fall under section 2(47)(v) of the Act. The CIT (A) placed reliance on the decisions of the tribunal in the case of Saamag Developers Pvt Ltd [TS-26-ITAT-2018(DEL) order dated 12th January, 2018] wherein it was held that registration under section 17(1A) of the Registration Act, 1908 was a pre-condition to give effect to section 53A of the Transfer of Property Act. He also relied upon the decision in Anil D. Lohana [TS-466-ITAT-2017(MUM) order dated 25th September, 2017], wherein it was held that the holding period of the property is to be reckoned from the date on which the assessee got right over the property by virtue of sale agreement.

Before the tribunal, the assessee submitted that the letter of allotment was executed with the builder on 27th April, 2012, which conferred the right to obtain conveyance of the said flat. It therefore became an asset under section 2(14) and therefore, the date of letter of allotment should be considered as the date of receipt of immovable property. Since the allottee would get title to the property on issuance of an allotment letter, and the payment of instalments would be only a consequential action upon which the delivery of possession would follow, it was claimed that the assessee was having a right in the property since 27th April, 2012 i.e. the date of allotment. Therefore, the effective date of agreement was 27th April, 2012, which pertained to A.Y. 2013-14. On this basis, it was argued that no addition should have been made in the assessment year under consideration.

The assessee relied upon the following decisions in support of his contentions –
Babulal Shambhubhai Rakholia vs. ACIT (ITA No. 338/Rjt/2017 for A.Y. 2014-15),
Sanjay Kumar Gupta vs. ACIT (ITA No. 227/JP/2018 for A.Y. 2014-15),
Anita D. Kanjani vs. ACIT (2017) 79 taxmann.com 67 (Mumbai-Trib),
DCIT vs. Deepak Shashi Bhusan Roy (2018) 96 taxmann.com 648 (Mumbai-Trib),
Pr. CIT vs. Vembu Vaidyanathan (2019) 101 taxmann.com 436 (Bombay HC) and
ACIT vs. Shri Keyur Hemant Shah (ITA No. 6710/Mum/2017 for AY 2013-14 dated 2nd April, 2019)(Mumbai ITAT).

The tribunal held that the decisions of Anita D. Kanjani, Deepak Shashi Bhusan Roy and Keyur Hemant Shah were not applicable to the case under dispute, since the issue under consideration in those cases was the period of holding of the property – whether to be reckoned from the date of issue of the letter of allotment or from the date when the agreement was executed. With respect to the decision in the case of Vembu Vaidyanathan, the tribunal held that the High Court in that case had considered the date of allotment would be the date on which the purchaser of a residential unit could be stated to have acquired the property for the purposes of section 54. In that case, the High Court had relied upon the CBDT Circular No. 471 dated 15th October, 1986 and Circular No. 672 dated 16th December, 1993 and had observed that there was nothing on record to suggest that the allotment in the construction scheme promised by the builder in that case was materially different from the terms of allotment and construction by DDA as referred to in those circulars. By observing that the issue in the case under consideration was not the allotment in construction scheme promised by the builder which is materially the same as the terms of the allotment and construction by DDA, the tribunal held that the decision in Vembu Vaidynathan was distinguishable.

The decision in Babulal Shambhubhai Rakholia was also distinguished on the grounds that, in that case, the stamp papers were purchased on or before 30th March, 2013 and the transferor as well as the transferee had put their signature on the sale deed on 30th March, 2013. It was on this basis, it was held that section 56(2)(vii)(b) would not be applicable. Similarly, the decision in Sanjay Kumar Gupta was also distinguished as in that case the assessee had claimed to have purchased the property in question vide unregistered agreement dated 28th March, 2013 and the AO considered the date of transaction as of the sale deed which was dated 26th April, 2013. Though the agreement dated 28th March, 2013 was not registered, it was attested by the notary and the payment of part of the consideration on 28th March, 2013 was duly mentioned in the sale deed dated 26th April, 2013. Under these facts, it was held in that case, that the transaction would be treated to have been completed on 28th March, 2013 as the agreement to sell dated 28th March, 2013 had not been held to be bogus.

The tribunal further held that there was no dispute that the “Agreement for Sale” was dated 10th September, 2014. The “Letter of Allotment” dated 27th April, 2012 could not be considered as the date of execution of agreement by any stretch of imagination. The immovable property was not conveyed by delivery of possession, but by a duly registered deed. Further, it was the date of execution of registered document, not the date of delivery of possession or the date of registration of document which was relevant. The tribunal relied upon the decisions in the cases of Alapati Venkataramiah vs. CIT (1965) 57 ITR 185 (SC), CIT vs. Podar Cements Pvt Ltd (1997) 226 ITR 625 (SC).

On the basis of the above, the tribunal upheld the order of the CIT (A) and dismissed the appeal of the assessee.

NAINA SARAF’S CASE

The issue, thereafter, came up for consideration of the Jaipur bench of the tribunal in Naina Saraf vs. PCIT (ITA No. 271/Jp/2020).

In this case, in the previous year relevant ot the AY 2015-16, the assessee had purchased an immovable property i.e. Flat No. 201 at Somdatt’s Landmark, Jaipur for a consideration of Rs.70,26,233 as co-owner with 50 per cent share in the said property. The stamp duty value was determined at Rs.1,03,12,220 as against the declared purchase consideration of Rs.70,26,233.

The case of the assessee was selected under CASS for the reason of “Purchase of property”. During the course of the assessment proceeding, the assessee filed registered purchase deed and other details as required by the AO. Finally, the AO after examining all the details and documents filed, accepted the return of income vide his order dated 21st December, 2017 passed under section 143(3).

Later on, the PCIT observed that the AO had failed to invoke the provisions of section 56(2)(vii)(b) with respect to the difference between the stamp duty value and the purchase consideration amounting to Rs.32,85,987, and, therefore, considered the order of the AO as erroneous and prejudicial to the interest of the revenue by passing an order under section 263 of the Act.

The assessee filed an appeal before the tribunal against the said order of the PCIT passed under section 263. Before the tribunal, the assessee not only challenged the jurisdiction of the PCIT to invoke the provisions of section 263, but also disputed the applicability of section 56(2)(vii)(b) to her case on merits. It was submitted that the assessee applied for purchase of Flat No.201 on 23.09.2006 (as mentioned in allotment letter) and paid Rs.7,26,500 on 3rd October, 2006. The seller company M/s SDB Infrastructure Pvt Ltd issued allotment letter on 06th March, 2009 to the assessee. On 11th November, 2009, by signing the allotment letter as token of acceptance, the assessee agreed to purchase the property measuring 2,150 sq ft at the rate of Rs. 3,050 per sq. ft. for a sum of Rs. 65,57,500 as per terms and conditions mentioned in the allotment letter dated 6th March, 2009. The formal agreement was exceuted and registered on 09th December, 2014. It was also submitted that the consideration of Rs.45,26,233 was already paid before 5th April, 2008 i.e. even prior to the date on which the allotment letter was issued.

On the basis of the above, the assessee contended that the purchase transaction effectively took place in AY 2010-11 itself, and not in AY 2014-15 when the actual registration took place. Therefore, the case of the assessee would be governed by the pre-amended provision of section 56(2)(vii)(b), which applied only where there was a total lack of consideration and not when there was inadequacy of purchase consideration.

Further, the assessee also challenged the denial of benefit of the first proviso to section 56(2)(vii)(b) by the PCIT, on the grounds that the date of the sale deed and the date of its registration were the same. It was contended that a bare perusal of the allotment letter showed that all the substantive terms and conditions which bound the parties, creating their respective rights and obligations were contained therein. The said allotment letter also provided for giving possession of the property within a period of 30 months from the date of allotment (except if due to some unavoidable reasons). Hence, there was an offer and acceptance by the competent parties for a lawful purpose. Thus, such allotment letter was having all the attributes of an agreement as per the provisions of the Indian Contract Act, 1872.

In so far as the PCIT’s observation that the allotment letter was provisional was concerned, it was submitted that the provisional nature of allotment was only to take care of unexpected happenings, such as changes by the sanctioning Authority or by the Architect or by the Builder, which might result in increase or decrease in the area, or absolute deletion of the apartment from the sanctioned plan. But for all intents and practical purposes, it was a complete agreement between the parties, which was even duly acted upon by both of them.

Further, the assessee contended that the relevant provision used the word ‘receives’ but did not use the word ‘purchases’ or ‘transfers’. Therefore, the legislature never contemplated the receipt of the subjected property as a complete formal transfer by way of registration of the property purchased in order to invoke section 56(2)(vii)(b)(ii). This would have had the effect of deferring the taxability, and resulted in late receipt of revenue from the taxpayer. On the contrary, by using the word ‘receives’, the legislature had advanced the taxability (provided the assesse clearly falls within the four walls of the provision as existed on the date of such receipt of the subjected property). The receipt of the property simplicitor happened in AY 2010-11, and not in the subject year i.e. AY 2014-15, where mere registration and other legal formalities were completed. The assesse’s right stood created and got vested at the time of the signing of the allotment letter itself by both the parties, on certain terms and conditions, and on specific purchase consideration. What happened later on was a mere affirmation / ratification by way of registration of the sale transaction in that year.

The tribunal perused the allotment letter and observed that it contained all the substantive terms and conditions which create the respective rights and obligations of the parties i.e. the buyer (assessee) and the seller (the builder) and bind the respective parties. The allotment letter provided detailed specification of the property, its identification and terms of the payment, providing possession of the subjected property in the stipulated period and many more. Evidently the seller (builder) had agreed to sell and the allottee buyer (assessee) had agreed to purchase the flat for an agreed price mentioned in the allotment letter. What was important was to gather the intention of the parties and not go by the nomenclature. Thus, there being the offer and acceptance by the competent parties for a lawful purpose with their free consent, the tribunal found that all the attributes of a lawful agreement were available as per provisions of the Indian Contract Act, 1872. It was also noted by the tribunal that such agreement was acted upon by the parties, and pursuant to the allotment letter, the assessee paid a substantial amount of consideration of Rs.45,26,233, as early as in the year 2008 itself. With respect to the PCIT’s observation that it was a mere provisional allotment, the tribunal held that it was a standard practice to incorporate the provision for increase or decrease in area due to unexpected happening so as to save the builder from unintended consequences. On this basis, it was concluded that the assessee had already entered into an agreement by way of allotment letter on 11th November, 2009, falling in AY 2010-11. Having said so, it was held that the law contained in section 56(2)(vii)(b) as it stood at that point of time, did not contemplate a situation of a receipt of property by the buyer for inadequate construction.

Accordingly, the tribual quashed the order of the PCIT, on the grounds that the assessment order, which was subjected to revision under section 263, was not erroneous and prejudicial to the interest of the revenue.

An identical view has been taken by the Mumbai bench of the tribunal in the case of Indu Kamlesh Jain vs. PCIT (ITA No. 843/Mum/2021) and Siraj Ahmed Jamalbhai Bora vs. ITO (ITA No. 1886/Mum/2019).

With respect to the applicability of section 43CA which has come in force with effect from A.Y. 2014-15, in cases where the allotment letters were issued prior to 1st April, 2013, diagonally opposite views have been taken by the Mumbai and Jaipur benches of the tribunal. In the case of Spenta Enterprises vs. ACIT [TS-63-ITAT-2022(Mum.)], it has been held that the provisions of section 43CA would not apply in such cases. As against this, in the case of Spytech Buildcon vs. ACIT [2021] 129 taxmann.com 175 (Jaipur – Trib.), it has been held that merely because an agreement had taken place prior to 1st April, 2013, it would not take away the transaction from the ambit of provisions of section 43CA. However, in the case of Indexone Tradecone (P) Ltd. vs. DCIT [2018] 97 taxmann.com 174 (Jaipur – Trib.), it was held that the provisions of section 43CA would not apply to a case where the agreement to sell was entered into much prior to 1st April, 2013, though the sale deed was registered after it came in force.

OBSERVATIONS

There are different stages through which a transaction of buying an immovable property passes, particularly when it has been bought from the builder in an ongoing project which is under construction and yet to be completed. These different stages can be broadly identified as under –

Allotment – When the person decides to buy a particular property and finalizes the relevant terms and conditions, the builder allots that particular property to that person by issuing a letter of allotment or a booking letter against the receipt of the booking amount. It contains the broad terms and conditions, which are the bare minimum required, such as identification of the property by its unique no., area of the property, total consideration to be paid, the time period within which the possession would be given etc. Normally, it is signed by both the parties i.e. the buyer as well as the seller.
Such an allotment letter is normally issued because it may not be feasible to execute the agreement for sale immediately. The execution of the agreement may take time due to its drafting and settlement, payment of stamp duty etc.
Agreement – After the necessary formalities are completed, the parties may thereafter proceed to execute an agreement which is popularly called as ‘agreement for sale’ and get it registered also. In order to safeguard the interest of the buyer, the relevant applicable local law may provide for restrictions on receipt of consideration in excess of certain limit, unless the necessary agreement has been executed and registered. For instance, as per the Real Estate (Regulation and Development) Act, 2016, it is obligatory for the promoter to enter into an agreement and to get it registered when a sum of more than 10 per cent of the total consideration is received from the buyer.

Possession – Upon completion of the construction, the builder hands over the possession of the property to the buyer in accordance with the terms and conditions as agreed.

The buyer is required to make the payment of the consideration as per the agreed terms throughout these stages. Normally, if the entire consideration as agreed has been paid, then the receipt of possession of the property is regarded as its deemed conveyance.

The first stage i.e. issuance of the allotment letter, may not be there in every case. But, the other two stages will normally be there in all cases, unless the property has been conveyed at the time of agreement itself and possession has also been handed over simultaneously.

Due to such multiple stages, several issues arise while applying the provisions of the Income-tax Act, some of which are listed below –

From what date should the assessee be considered as holding the property for determining whether it is short-term or long-term in accordance with the provisions of section 2(42A)?
When should the assessee be considered to have purchased or constructed the residential house for the purpose of allowing exemption under section 54 or 54F?
When should the assessee be considered to have received the property under consideration for the purpose of section 56(2)(x)? Whether the first proviso to section 56(2)(x) applies in such case and whether the stamp duty value as on the date of the allotment letter can be taken into consideration?
If the assessee is the seller, when should he be considered to have transferred the property for the purpose of attracting the charge of capital gains or business income in his hands? Whether the first proviso to section 50C is applicable in such case and whether the stamp duty value as on the date of the allotment letter can be taken into consideration?

Though the controversies exist on each of the above issues, the scope of this article is to deal with the controversy with respect to the applicability of section 56(2)(x) only. The limited issue under consideration is whether can it be said that the assessee ‘receives’ an immovable property when a letter of allotment is issued to him by the seller or he ‘receives’ it only upon the execution of the agreement for sale. Though one may contend that the assessee does not receive the property on either, and he receives it only upon receipt of the possession of the property, such issue has not been dealt by the tribunals in the cases discussed above.

The primary reason as to why the allotment letter was not considered to be receipt of the immovable property by the Mumbai bench of the tribunal in the case of Sujauddian Kasimsab Sayyed (supra) was that the allotment letter was not considered to be in the nature of an agreement equivalent to an agreement for sale, resuling into receipt of the property in the hands of the assessee. Therefore, first and foremost, it is required to be examined whether the letter of allotment or the booking letter can be considered to be an agreement and is there any material difference between the allotment letter and the agreement for sale, because of which the assessee is considered to have received the property on execution of the agreement for sale but not on issue of the allotment letter.

At the outset, it is clarified that the contents of the allotment letter and other related facts would be very relevant to decide this aspect of the matter. In this article, the attempt has been made to discuss the issues, assuming that the allotment letter contains all the important terms and conditions necessary to be agreed upon in any transaction of purchase and sale of property as per the standard practice of the industry i.e. identification of specific unit no. of the property, its area, total consideration, schedule of payment and possession, etc.

The Indian Contract Act, 1872 simply defines an agreement that is enforceable by law as a contract. It further provides that all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not expressly declared to be void. Further, it also provides that the agreement need not be in writing, unless it is required so to be in writing by any other law in force. All the essential ingredients of a contract are present in the allotment letter, and, therefore, the same needs to be considered as a contract enforceable in the eyes of law.

In the case of Manjit Singh Dhaliwal vs. JVPD Properties Pvt Ltd (No. AT006000000000017 – decision dated 12th April, 2018), the issue before the Maharashtra Real Estate Appellate Tribunal was whether the allottees who had been issued only the letter of allotment and no agreement for sale had been executed could seek relief under the RERA Act or not. While holding that the complaint of the allottees would not fall for want of agreement for sale, the tribunal observed that the letter of allotment in that case stipulated the description of the property to be purchased, description of the payment schedule, the total cost, the necessary requisite permission, obligation to complete the projects and getting clarity to the title and, therefore, the cumulative effect of it would not be short of branding it to be the terms agreed upon between the parties. It was held that the agreement is a form of contract relating to offer, acceptance, consideration, time schedule, clarity of title and as to essence of time. The allotment letter incidentally was couched in such a fashion as to incorporate all the requisite terms. Hence, the absence of an agreement for sale would not scuttle the rights of allottees.

In the case of Shikha Birla vs. Ambience Developers Pvt Ltd (IA No. 418/2008 dated 20th December, 2008), the Delhi High Court was dealing with a suit against the developer for specific performance of the contract contained in the letter of allotment, and for direction to handover possession of the concerned property. In this case, the High Court held that an understanding to enter into a legally binding agreement does not result in a legally enforceable contract, but an understanding or a bargain is legally enforceable, if execution of a further document is to effectuate the manner in which the transaction already agreed upon by the parties is to be implemented. In the former case, execution of the agreement is a condition precedent. An agreement to enter into an agreement is not executable, but in the latter case, execution of a formal document is not a condition precedent and rights and obligations of the parties come into existence. A mere reference to a future formal contract will not in law prevent a binding bargain between the parties. On the facts of that case, the High Court held that, vide the allotment letter, the terms and conditions were ascertained and certain. Nothing was left to be negotiated and settled for future. Terms were agreed and the agreement for sale on a standard format was read and understood. It was a certain and concluded bargain. It was not a case where the parties were entering into a temporary understanding, which may or may not fructify into a binding bargain, and where execution of agreement for sale was a condition precedent for creating permanent obligations. A concluded contract therefore had come into existence. Therefore, the letters of allotment, in that case, were not regarded as in the nature of an understanding which did not create an enforceable agreement in law but only an understanding between the parties to enter into an enforceable agreement in future.

The Delhi High Court in the said case also referred to the decision of the Supreme Court in the case of Poddar Cement Pvt Ltd (supra) and held that the Supreme Court had also referred to with approval the need and requirement to continuously update and construe law in accordance with changes, ground realities to make it a living enactment, in tune with the present state of affairs.

Further, the clause in the allotment letter that the allottee shall not be entitled to enforce the same in a Court of Law was regarded as void by the Delhi High Court in view of section 28 of the Contract Act, 1872, by relying upon the decision of the Supreme Court in the case of Food Corporation of India vs. New India Assurance Company Ltd reported in AIR 1994 SC 1889, wherein it was held that every agreement, by which any party thereto is restricted absolutely from enforcing his rights under or in respect of any contract by the usual legal proceedings in the ordinary tribunals, or which limits the time within which he may thus enforce his rights, is void to that extent.

In the context of the Income-tax Act, 1961, the Mumbai bench of the tribunal in the case of Indogem vs. ITO (2016) 160 ITD 405 (Mum) has already examined the issue as to whether the letter of allotment could be regarded as agreement giving equivalent benefits to the assessee under the Act and the relevant portion from this decision is reproduced below:

“First point for consideration is whether there is an agreement for acquisition of property between the builder and the assessee. Agreement means set of promises forming consideration for each other. Law does not require that an agreement shall always be in writing or if reduced into writing, it shall be in a particular/specific format. As could be seen from the record, the allotment letter runs into so many clauses and, in our view, it answers the description of an agreement. When all the terms agreed upon by the parties are reduced into writing in detail, nothing more is required than formal compliance with the stamp and registration requirements. On a careful perusal of this allotment letter, we find that it contains all the details that were agreed upon by the parties, as such, by no stretch of imagination could it be said that there is no valid agreement for acquisition of the property.”

In view of the above, it appears that the view taken by the Mumbai bench of the tribunal in the subsequent decision in the case of Sujauddian Kasimsab Sayyed was contrary to what was held in the decision as referred above of the co-ordinate bench.

There can be an equally strong argument to claim that, upon issuance of the allotment letter, what is received is not the immovable property itself, but only the right to receive it in future by executing a registered agreement at a later stage or by receiving its possession. This view can be further justified on the grounds that if the allotment letter is considered to be a receipt of the immovable property, then it would result in taxing the difference in that year itself (in a case where the allotment letter has been issued subsequent to 1st April, 2013 i.e. subsequent to the amendment), irrespective of whether it has then culminated into a registered agreement or has been cancelled due to any reason. In the case of Hansa V. Gandhi vs. Deep Shankar Roy (Civil Appeal No. 4509 of 2007), the Supreme Court has held that mere letter of intent, which was subject to several conditions, would not give any right to the allottee for purchase of the flats in question, till all the conditions incorporated in the letter of intent were fulfilled by the the proposed purchasers. Further, it was also held that if the same flat has been sold to the other buyer upon non-fulfillment of the conditions of the letter of intent, then it cannot be presumed that such subsequent buyer had knowledge about the previous transaction for want of registration of the said letter of intent.

However, even if the provisions of section 56(2)(x) are invoked for taxing the difference between the stamp duty value and the actual consideration in the year in which the agreement has been executed and registered, then the benefit of the first proviso to section 56(2)(x) needs to be extended. The first proviso states that where the date of agreement fixing the amount of consideration for the transfer of immovable property and the date of registration are not the same, the stamp duty value on the date of agreement may be taken for this purpose. In such a case, the letter of allotment is to be considered as the agreement fixing the amount of consideration, subject to fulfillment of the other conditions. Difference of opinion may exist only with respect to the nature of rights which the buyer derives on the basis of the letter of allotment, but certainly not with respect to the fact that the letter of allotment needs to be regarded as the agreement fixing the amount of consideration.

The view that the stamp duty value as on the date of allotment letter should be preferred over the stamp duty value as on the date of registration of the agreement for sale is supported by the following decisions:-

ITO vs. Rajni D. Saini (ITA No. 7120/Mum/2018)
Sajjanraj Mehta vs. ITO (ITA No. 56/Mum/2021)
Radha Kishan Kungwani vs, ITO [2020] 120 taxmann.com 216 (Jaipur – Trib.)

That being the position, where the inadequacy of the consideration has to be judged on the basis of the difference in valuation on a date before the amended law came into force, the better view seems to be that such transactions entered into at that point of time are not intended to be covered by the subsequent amendments.

Section 56(2)(x) and its predecessor clause(vii) provides for bringing to tax the cases of inadequate consideration on receipt of an immovable property. The term ‘property’ is defined in vide clause (d) of Explanation to s.56(2)(vii) which in turn includes an immovable property and sub-clause(i) thereof defines an ‘imovable property’ to be ‘land and building or both’. There is a reasonable consistency of the judiciary in restricting the scope of the term immovable property to the cases of land and building simpliciter and not to the cases of the rights in land and building. Please see Atul G.Puranik, 132 ITD 499 (Mum) which holds that even leasehold rights in land are not the ‘land’ simpliciter. Equating the ‘land and building’ to the case of a rights under a letter of allotment, issued at the time where the premises are yet under construction, perhaps is far -fetched and avoidable. Secondly, what is required for a charge of tax, under s.56(2). to be complete is the ‘receipt’ of a property ; such a property that can be regarded as land or building. Obviously, the receipt of a right under letter of allotment would not satisfy the requirement for a valid charge of tax. Under the circumstances, it is better to hold that the provisions of s.56(2)(x) are inapplicable in the year in which an allotment letter is issued in respect of the premises under construction. The charge of tax may be attracted in the year of receipt of the premises, Yasin Moosa Godil, 52 SOT 344(Ahd.), and in that year the benefit of the Provisos(s.43CA,50C and 56(2)(x)), while determining the inadequacy shall be ascertained w.r.t the allotment letter.

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Payment of Taxes Pending Appeal before Tribunal

ISSUE FOR CONSIDERATION

The tax demanded vide a notice under section 156, issued in pursuance of an order of assessment, is required to be paid within 30 days of the demand. A provision is made under section 220 for a stay of the recovery proceeding in deserving cases on an application to the AO in cases where an appeal is filed before CIT(A) against the assessment order. A similar provision is made under section 253(7) in cases where an appeal is filed before the Appellate Tribunal. No specific criteria have been laid down by section 220(6) or section 253(7) for the grant of stay, and the decision to stay the demand or otherwise is left to the discretion of the AO or the Tribunal. The Courts have held from time to time that a demand for tax should be stayed on satisfaction of troika of conditions which are financial stringency, prima facie case or high-pitched assessment and the possibility of success in appeal, and lastly the balance of convenience.

The CBDT, under the Ministry of Finance, has issued guidelines, addressed to the AO, for stay of the recovery proceeding in the circumstances specified in the guidelines issued from time to time. The Board has advised the AO to stay the recovery proceeding in cases of financial difficulties and also in cases of high pitched assessment, and in cases where the issue in appeal is covered in favor of assessee by the order of Courts, where an appeal has been filed by the assessee, and is pending for hearing and/or disposal by the CIT(A), provided, as per the latest guidelines of 2017, the assessee has paid 20 per cent of the taxes due, till the disposal of the first appeal.

The taxes due become payable in full on disposal of the first appeal against the assessee even where a second appeal is preferred before the Appellate Tribunal. The assessee, however, has an option to apply under section 254(7) to the Tribunal for a stay of the demand and recovery proceedings, and the Tribunal is empowered to stay the proceedings at its discretion, on being satisfied of the presence of the troika of the conditions. The Finance Act, 2020 has amended the First Proviso to sub-section (2A) of section 254 under which the Tribunal is empowered to stay the recovery proceedings on application under section 253(7) of the Act. The amendment provides that the Tribunal may pass an order of stay subject to the condition that the assessee deposits not less than 20 per cent of the amount of tax, interest, fee, penalty, or any other sum or, in the alternative, the assessee furnishes security of an equal amount. No such statutory restriction is provided in the Act on the powers of the CIT(A) or AO while entertaining an application for stay of the demand.

The tax demand arising out of the high-pitched assessment poses a serious challenge for the assessee, more so, where there is a financial difficulty or no liquidity of funds. The High Courts and even the Tribunal in such cases, on the touchstone of the troika of conditions, has ordered for complete stay of the proceedings without payment of 20 per cent of the taxes demanded.

Post the amendment of 2020, a difficulty is faced by the assessee and also by the Tribunal in granting a stay of demand where the assessee is unable to pay 20 per cent of the outstanding taxes demanded or to make an arrangement for security of the payment. The issue was first examined in the year 2020, immediately post amendment, by the Mumbai Bench of the Tribunal, which had found merit in the case of the assessee for grant of interim stay without payment of taxes and had referred the matter to the special bench of the Tribunal, keeping in mind the express provisions of the amendment of 2020.

Recently, the Mumbai Tribunal held that no application for stay under section 253(7) could be entertained without a payment of 20 per cent of the taxes demanded in view of the amendment of 2020 in the Act. The decision has raised serious concerns for the assessees and also in respect of the powers of the AO, CIT, CIT(A) and of the Courts, besides the Tribunal, to stay the recovery proceedings, even in the cases of serious hardship or where the issue is otherwise decided by the courts in favour of the assessee in other years, without payment of 20 per cent of the taxes demanded. With the latest decision of the Mumbai Bench of the Tribunal, delivered in the context of the first Proviso to section 254(2A), taking a view against the stay of the demand, the issue requires consideration in light of the independent powers of the AO and the other authorities, and also inherent powers of the Tribunal and those of the Courts.

HINDUSTAN LEVER’S CASE

The power of the Tribunal and its limitation, post amendment of 2020, was directly examined in the case of Hindustan Lever Ltd v/s. DCIT, 197 ITD 802 (Mum). In this case, an application for the stay of recovery proceedings, for A.Y. 2018-19, of the demand aggregating to Rs. 172.48 crore was made. The demand was raised under an assessment order passed under section 143(3) of the Act, against which an appeal was filed before the Tribunal and was pending for hearing. No payment or partial payment was made towards the tax demanded by the assessee.

The applicant company stated that its case on merits was covered by the decisions in its own case for the preceding previous year, on most of the grounds in appeal, and therefore it was not required to make any payment. It also stated that it was not in a position to make any payment. In applying for the blanket stay of the demand, it expressed that it was not required to make a payment and did not intend to make it.

In the context of the amendment in the first proviso to section 245(2A), requiring payment of 20 per cent of the taxes demanded, the applicant drew the attention of the Tribunal to the provisions of section 254(1) which empowered the Tribunal to pass such orders as it thought fit. The applicant also heavily relied on the decision of the Supreme Court in the case of M. K. Mohd.Kunhi,71 ITR 815, where the court held that the Tribunal had inherent powers of granting a stay on the recovery of disputed tax demand in fit and deserving cases, and the said powers were ancillary and incidental to the powers of disposing of an appeal. It further argued that the powers under section 254(1) could not be curtailed or diluted or narrowed down by the proviso to section 254(2A), which had no bearing on the powers of the Tribunal under section 254(1).

It was next highlighted that several co-ordinate benches of the Tribunal had granted a blanket stay of the recovery proceedings, post amendment, in fit and deserving cases. A reference was made to the guidelines of the CBDT which permitted the stay of demand in cases where an appeal was pending before the first appellate authority, and also to the cases where the issues in appeal were decided in favor of the assessee in other years by the courts. The applicant also highlighted that the High Courts in many cases have stayed the recovery proceedings, even in the cases where appeals were pending before the Tribunal.

In contrast, the Revenue brought to the attention of the Tribunal the inherent limitation imposed on the Tribunal by the first proviso to section 254(2A), which required the Tribunal to insist on payment of 20 per cent of the outstanding disputed tax. The attention of the Tribunal was invited to the amendment of 2020 to contend that the Tribunal had no power to grant a blanket stay.

The Tribunal, on due consideration of the rival contentions, observed and held as under;

The Tribunal had the power to grant a stay of demand under the powers of section 254(1) itself, which powers were incidental or ancillary to its appellate jurisdiction.
It noted with the approval the decision of the Supreme Court in Mohd.Kunhi‘s case (Supra), which had held that even in the absence of power to stay available to an AO under section 220(6), in cases of first appeal, the Tribunal had an inherent power to stay the demand once it assumed the appellate jurisdiction, provided the power was not used in a routine manner.
The position stated by the Supreme Court was changed by the amendment of 2020 and post amendment, no stay could be granted by the Tribunal without insisting on payment of 20 per cent of tax outstanding.
There was a difference between reading the power to stay the proceeding, when there was no express power to do so, and the case where there was an express statutory prohibition to grant a stay, unless a payment of 20 per cent of tax was made.
Reading and retaining the power to stay, post amendment of 2020, would render the amendment and its condition for payment otiose.
The Tribunal has no power to construct a provision that would make an express provision redundant.
The powers of the Tribunal should be gathered by harmonious reading of sections 254(1) and 2A) of the Act in a manner that did not destroy one of the provisions.
Granting a stay, post amendment, without payment would be a clear disharmony with the statutory condition of payment.
The law laid down in Mohd. Kunhi’s case stood modified in view of the amendment of 2020.
No courts have held that the Tribunal has the powers to stay the recovery proceedings, post the insertion of the amendment in sections 254(2A) of the Act, to permit the Tribunal to grant a stay without payment of taxes.

Having so held that it does not have the power to stay the demand, without payment of 20 per cent of the taxes, the Tribunal allowed the application for stay on assurance of the applicant that it would provide a security for the payment of outstanding tax demanded of an equal amount and directed the AO to stay the recovery proceeding on being satisfied that a security of an equal amount was furnished by the applicant which was an alternative permitted under the amendment of 2020.

TATA EDUCATION AND DEVELOPMENT TRUST

The issue first arose in the case of Tata Education and Development Trust vs. ACIT, 183 ITD 883 (Mum), for A.Ys.: 2011-12 and 2012-13.

In this case, involving stay applications, the assessee applicant was a public charitable trust registered under the Bombay Public Trust Act, 1950 as also as a charitable institution under section 12A of the Act. The assessee had returned NIL income, after claiming the amounts remitted to educational universities outside India as application of income under section 11(1)(c). This claim was disallowed by the AO on the grounds that the requisite approval of the CBDT for such remittance was not taken. The assessee challenged the orders of the assessment in appeal before the CIT(A) and, pending the disposal of the appeals, the assessee obtained the orders of approval for remittance by the CBDT. Based on the same, while the AO rectified the assessment orders, the same were ignored by the CIT(A) in adjudicating the appeal resulting in the disallowance and demand for taxes being upheld. The assesseee Trust challenged the order of the CIT(A) before the Tribunal and sought a stay on collection / recovery of the amount of tax and interest, etc., aggregating to Rs. 88.84 crore for the A.Y. 2011-12 and aggregating to Rs. 10.91 crore for the A.Y. 2012-13, in respect of the assessment orders under section 143(3) r.w.s. 250 of the Income-Tax Act, 1961, which were contested in appeal before the Tribunal.

The assesee submitted that its case was very strong on merits. It submitted that it was not open to the CIT(A), in any case, to question the wisdom of the CBDT, and that on passing the order of rectification by the AO himself, the appeals had become infructuous, and that there was a very strong prima facie case, and very good chances to succeed in appeals before the Tribunal. It was thus urged that the assessee had a reasonably good case in appeal, that there was no apprehension to the interests of the revenue by waiting till outcome of the appeal, and that therefore, the balance of convenience was in favour of the demands being stayed till the outcome of the appeals.

It was explained that the amendment in the first Proviso to Section 254(2A) vide Finance Act, 2020, was only directory, not mandatory, in nature, and it did not curtail the powers of the Tribunal; it was submitted that any other interpretation would result in unsurmountable practical difficulties. With examples, it was explained to the Tribunal that taking a different view would require the payment of the mandated tax even in cases where the issue has been squarely decided in favor of the assessee in its own case for a different year by the High Court or the Supreme Court or a case where the Tribunal or the High Court had decided the issue in the assessee’s favor and the Department had preferred an appeal before the higher court just to keep the matter alive. It was also explained that the view that the provision was mandatory in nature and would result in a situation which was completely arbitrary, unconstitutional and contrary to the well settled scheme of law.

On the other hand, the Revenue submitted that so far as the merits of the case was concerned, there was a good chance for the Revenue to support the appellate order, in as much as the AO could not have subjected the contentious issue to rectification proceedings, and, in any case, presently the appeals were not being argued on merits, and, therefore, it was not really material whether the assessee had a good case or not. It was pointed out that no case had been made out for the paucity of funds, and that, in any case, in view of the amendment to the first proviso to Section 254 (2A), the assessee was required to pay at least 20 per cent of the disputed demand raised on the assessee. The Memorandum explaining the provisions of the Finance Bill, 2020 specifically stated that the condition was inserted for payment of 20 per cent of tax and was mandatory. It was submitted that the intention of the legislature was very clear and unambiguous, that the assessee had to pay at least 20per cent of demand for a stay of the balance amount of tax demanded.

On due consideration of the contentions of the rival parties, the Tribunal granted an interim stay of the demand to remain in operation till the time the stay applications were finally adjudicated by the Special bench of the Tribunal, to which the applications were referred to for the final adjudication by the division bench of the Tribunal, by observing that there were two very significant aspects of the whole controversy- first, with respect to the legal impact, if any, of the amendment in first proviso to Section 254(2A) on the powers of the Tribunal, under section 254(1) to grant stay; and, second, if this amendment was held to have any impact on the powers of the Tribunal under section 254(1),- (a) whether the amendment was directory in nature, or was mandatory in nature; (b) whether the said amendment affected the cases in which appeals were filed prior to the date on which the amendment came into force; (c) whether, with respect to the manner in which, and nature of which, security was to be offered by the assessee under first proviso to Section 254(2A), what were the broad considerations and in what reasonable manner such a discretion must essentially be exercised, while granting the stay by the Tribunal.

While recommending the stay applications for consideration of the special bench, the Tribunal observed as under; “We are of the considered view that these issues are of vital importance to all the stakeholders all over the country, and in our considered understanding, on such important pan India issues of far reaching consequence, it is desirable to have the benefit of arguments from stakeholders in different part of the country. We are also mindful of the fact, as learned Departmental Representative so thoughtfully suggests, the issues coming up for consideration in these stay applications involve larger questions on which well-considered call is required to be taken by the bench. Considering all these factors, we deem it fit and proper to refer the instant Stay Applications to the Hon’ble President of Income Tax Appellate Tribunal for consideration of constitution of a larger bench and to frame the questions for the consideration by such a larger bench, under section 255(3) of the Income Tax Act, 1961.”

The Tribunal granted an interim stay on collection/ recovery of the aggregate amounts of tax and interest, etc, amounting to Rs. 88.84 crores and Rs. 10.91crores for the A.Ys. 2011-12 and 2012-13 respectively, on the condition of giving an undertaking to not to dispose of the investments of a value equivalent to the amount of tax demanded.

DR. B. L. KAPUR MEMORIAL HOSPITAL’S CASE

The issue of stay recently came up for consideration of the Delhi High Court in the case of Dr. B L Kapur Memorial Hospital vs. CIT, (2022) 11 DEL CK 0160, Civil Writ Petition No. 16287, 16288 Of 2022. In this case, the writ petitions were filed before the High Court, challenging the orders dated 6th September, 2022 and 7th November, 2022, rejecting the applications filed by the petitioner assessee and directing the assessee to make a payment to the extent of 20 per cent of the total tax demand arising under section 201(1) of the Income Tax Act, 1961, for the A.Ys. 2013-14 and 2014-15.

The AO had passed orders dated 30th March, 2021 under Section 201(1) / 201(1A) of the Act holding the assessee to be an ‘assessee-in-default’ for short deduction of tax at source of Rs. 16.47 crores and Rs. 20.09 crores for A.Ys. 2013-14 and 2014-15, respectively. Aggrieved by the orders, the assessee had filed appeals, along with an application seeking a stay on the recovery of demand.

The stay applications filed by the assessee were dismissed in a non-speaking manner and the assessee was directed to pay 20 per cent of the disputed demand. The review petitions filed by the assessee were also rejected without dealing with the contentions raised by the petitioner assessee. It was explained to the authorities and the Court that the assessee hospital had executed contracts for service, and not contract of service with its consultant doctors, and the consultant doctors had paid their tax dues, and as such no tax was payable by the assessee hospital as per the first proviso to Section 201 of the Act, which however was summarily ignored by the authorities.

It was contended that the AO or the CIT, while disposing of the stay applications, had failed to appreciate that the condition under Office Memorandum dated 31st July, 2017, read with the Office Memorandum dated 29th February, 2016, stating that, “the assessing officer shall grant stay of demand till disposal of the first appeal on payment of twenty per cent of the disputed demand”, were merely directory in nature and not mandatory. In support of the submission, the assessee had relied on the decision of the Supreme Court in Pr. CIT vs. LG Electronics India (P) Ltd., 303 CTR 649 (SC) wherein it had been held that it was open to the tax authorities, on the facts of individual cases, to grant stay against recovery of demand on deposit of a lesser amount than 20 per cent of the disputed demand, pending disposal of appeal.

In reply, the Revenue contended that the consultant doctors of the assessee hospital were not allowed to work in any other hospital; consequently, the consultant doctors had executed a contract of service and not a contract for service and that the first proviso to Section 201 was not attracted to the cases of the assessee.

Having heard the parties and having perused the two Office Memoranda in question, the Court held that the requirement of payment of 20 per cent of the disputed tax demand was not a pre-requisite for putting in abeyance the recovery of demand pending first appeal in all cases; the said pre- condition of deposit of 20 per cent of the demand could be relaxed in appropriate cases; even the Office Memorandum dated 29th February, 2016, gave instances like where addition on the same issue had been deleted by the appellate authorities in the previous years or where the decision of the Supreme Court or jurisdictional High Court was in favour of the assessee where a demand could be stayed; the Supreme Court in the case of PCIT vs. M/s LG Electronics India Pvt. Ltd. (Supra) had held that the tax authorities were eligible to grant a stay on the deposit of amounts lesser than 20 per cent of the disputed demand in the facts and circumstances of a case.

Having held so, the court noted that the impugned orders were non-reasoned orders and neither the AO nor the Commissioner of Income Tax had dealt with the contentions and submissions advanced by the assessee nor had they considered the three basic principles i.e. the prima facie case, balance of convenience and irreparable injury, while deciding the stay application.

Consequently, the orders and notices were set aside, and the matters were remanded back to the Commissioner of Income Tax for fresh adjudication of the application for stay, with a direction to grant a personal hearing to the assessee.

BHUPENDRA MURJI SHAH’S CASE

The issue of the stay of demand had arisen before the Bombay High Court in the case of Bhupendra Murji Shah vs. DCIT 423 ITR 300, before the amendment of 2020. In this case, the assessee petitioner had filed an appeal against the assessment orders demanding the sum of Rs. 11,15,99,897 for A.Y. 2015-2016 and a similar amount for A.Y. 2016-17, which were not paid. He had, in the meanwhile, filed appeals before the CIT (A), and had approached the AO, pending the appeals, with an application termed as a request for stay of the demand for taxes.

The applications for stay were dismissed and the petitioner assessee was ordered to pay 20 per cent of the outstanding amount as prescribed in Office Memorandum dated 29th February, 2016, and produce the challan and seek stay of demand again, failing which collection and recovery would continue, and the appeal would be heard on payment of taxes.

The Court observed that the right of appeal vested in the petitioner assessee by virtue of the statute should not be rendered illusory and nugatory by such communication from the Revenue. The Court was concerned with the mistaken understanding of the authorities that on failure of the assesseee to pay the 20 per cent of the tax demanded, the petitioner might not have an opportunity to even argue his appeals on merits, or that the appeals would become infructuous, if the demand was enforced and executed during the pendency. The court observed that the right to seek protection against collection and recovery, pending appeals, by making an application for stay could not be defeated and frustrated, as doing so would be against the mandate of law.

In the circumstances, the Court directed the appellate authority to conclude the hearing of the appeals as expeditiously as possible and, during pendency of the appeals, the petitioner should not be called upon to make payment of any sum, much less to the extent of 20 per cent of the demand or claim outstanding. The Court noted that, in ordinary circumstances, it would have relegated the petitioner to the remedy of making an application for stay before the Commissioner (Appeals), and thereafter left it to the Commissioner (Appeals) to take an appropriate decision thereon. However, since the appeals were being held back, the order for stay was passed by the Court, which order could not be treated as a precedent for all cases of this nature. The Court directed that during the pendency of the appeals, the petitioner should not dispose of or create any third party right in respect of his movable assets and properties, subject however, with the permission to use assets and properties in the ordinary and normal course of business.

OBSERVATIONS

No revenue law could be held to be equitous, fair and judicious without the provision for the right to challenge the order of the authorities appointed under the law before the same authorities or the higher or the superior authorities. This understanding of law equally applies to the tax demands arising out of the orders passed by these authorities. A statute for levy of tax, duty, cess, fee or any other revenue by the government should ideally provide for the right to challenge any order, and the demands arising out of such orders. In cases where the remedies are not expressly provided for in these statutes, they may be read into the statute. This power to challenge, however could be subjected to specific condition incorporated in the statute itself, provided compliance of such condition is possible under the circumstances of each case, Secondly the power to read the right to challenge, and even to insist for relaxation of condition, should be entertained in cases wherein the order in question is prima facie not tenable in law; where it is passed in violation of the tenets of law touching the existence of a judicious system of law. It is on this sound understanding that the courts have regularly and liberally stayed the recovery proceedings, and, in doing so, the courts have, over the period, laid down certain conditions known as troika of conditions, which conditions have so far acted as a lighthouse in the matters of staying the recovery proceedings.

The condition for payment of a certain percentage of the tax demand has been prescribed by the Board in Office Memoranda of 2016 and 2017, without in any manner withdrawing the power of the AO, Additional CIT, CIT, PCIT and CCIT to stay the recovery of taxes in fit and deserving cases on satisfaction of the conditions otherwise prescribed in the past from 1969 onwards.

It is significant to note that this power to grant a stay has not been subjected to any express statutory condition for any of the authorities, other than in respect of the Tribunal. An express condition is provided by the legislature only in respect of the Tribunal’s power to stay the proceedings, by amending section 254(2A) providing for the payment of 20 per cent of the tax due before a stay is granted by it. This has created a highly anomalous situation wherein the authorities lower than the Tribunal have the discretion to grant a blanket stay, while the Tribunal’s power is limited to grant of stay for 80 per cent of tax demand only.

It should be just and fair for the Tribunal to examine the condition of the assessee, and use its inherent power to grant a stay of demand in full, on being satisfied that the assessee otherwise has complied with the conditions for the grant of stay, and its case is fit and deserving. Taking any other view might mean that the Tribunal has necessarily to grant the stay once the stipulated condition is satisfied by payment of 20 per cent of tax demanded, even where the case of the assessee otherwise does not deserve a stay.

An assessee will be advised to move the Court for a grant of a complete stay of demand, in cases where the Tribunal has rejected the stay application only on the grounds that the assessee has failed to pay 20 per cent of the demand. The High Court is not shackled by any provision of the law, express or otherwise, in granting the complete stay of the recovery proceeding for 100 per cent of the tax demanded.

The issue was first examined by the Tribunal in the case of Tata Education & Development Trust, (supra) and the Tribunal by an order dated 17th June, 2020 granted an interim stay of the demand of taxes and referred the issue to the Special Bench on the grounds that the issue was of greater importance with wider application on the national level and it was appropriate to refer the matter to the special bench. The said reference since than was withdrawn by the Tribunal on adjudication of the appeals in favour of the Trust, leading to cancellation of the tax demands. The time has come for the Tribunal to make or approve of another reference to the Special Bench to set the issue at rest.

It is a settled position that any Court, including the Tribunal, while interpreting a statutory provision, cannot interpret it so as to render the provision unworkable and contrary to the settled law. In the context of the Third Proviso of the same section 254 (2A), providing for a limitation on the period of stay granted prohibiting the extension of the stay and /or vacation of the stay, even where the assessee was not in default, the Bombay High Court in the case of Narang Overseas Pvt Ltd vs. ITAT, 295 ITR 22 held that the third proviso to Section 254 (2A) was directory in nature; that the proviso could not be read to mean or that a construction be given for holding that the power to grant interim relief was denuded, even where acts attributable for delay were not of assessee but of revenue or of Tribunal itself. It was held that the power of the Tribunal to grant stay or interim relief, being inherent or incidental, was not overridden by the language of the proviso to section 254 (2A).

The Supreme Court, in the case of DCIT vs. Pepsi Foods Ltd 433 ITR 295, has approved the decision of the Bombay High Court in Narang Overseas (supra), holding as under:

“The object sought to be achieved by the third proviso to section 254(2A) is without doubt the speedy disposal of appeals before the Appellate Tribunal in cases in which a stay has been granted in favour of the assessee. But such object cannot itself be discriminatory or arbitrary. Since the object of the third proviso to section 254(2A) is the automatic vacation of a stay that has been granted on the completion of 365 days, whether or not the assessee is responsible for the delay caused in hearing the appeal, such object being itself discriminatory, in the sense pointed out above, is liable to be struck down as violating article 14 of the Constitution of India. Also, the said proviso would result in the automatic vacation of a stay upon the expiry of 365 days even if the Tribunal could not take up the appeal in time for no fault of the assessee. Further, vacation of stay in favour of the revenue would ensue even if the revenue is itself responsible for the delay in hearing the appeal. In this sense, the said proviso is also manifestly arbitrary being a provision which is capricious, irrational and disproportionate so far as the assessee is concerned.”

The Punjab & Haryana High Court in the case of PML Industries Ltd vs,Vs CCE (2013) SCC OnLine P&H 4440, in the context of a similar condition under the Central Excise Act, held that such a condition was directory and not mandatory, and that the Tribunal, in appropriate circumstances, could extend the period of stay beyond 180 days. Likewise, the amendment to Section 254(2A) by the Finance Act, 2020, in the first Proviso should be read as directory and not mandatory in nature.

Reading the condition for payment of 20 per cent as mandatory for admission of appeal, would cause serious harm to the right of the appeal vested in the assessee. The right of appeal is a creation of a statute, and such right of appeal cannot be circumscribed by the conditions imposed by the Legislature as well. In Hoosein Kasam Dada (India) Ltd. vs. State of Madhya Pradesh AIR 1953 SC 221, the Supreme Court held that a provision which is calculated to deprive the appellant of the unfettered right of appeal cannot be regarded as a mere alteration in procedure. It was held that in truth such provisions whittle down the right itself and cannot be regarded as a mere rule of procedure.

The Tribunal has the power to grant a stay and even to award costs; a direct appeal lies to the High Court against its order and the Tribunal is entitled to try a person for contempt under the Contempt of Courts Act, 1979. It has all the trappings of a Court, and its powers are similar to the power of an appellate Court under the Code of Civil Procedure. As such the powers of the Tribunal are widest possible, and should authorize it to interpret the provisions of law and supply meaning to the amendments including the implication of the amendment to first Proviso to section 254 (2A) of the Act. It has the powers to pass such orders as it thinks fit under section 254(1), which powers should include the power to stay the demand for taxes payable out of the assessment order in appeal before it. This power is an inherent power, independent of the power under section 254(2A) of the Act, and such inherent power under section 254(1) is not scuttled or curtailed or limited by the provisions of section 254(2A) or its Provisos. There is nothing in section 254(2A) to overwrite or even limit the powers of the Tribunal conferred under section 254(1) of the Act. Chitra Devi Soni, 313 ITR 174 (Raj.). The powers of the Tribunal include all the powers which are conferred upon the CIT(A) by section 251 which should include the power to grant stay in fit and deserving cases. Hukumchand, 63 ITR 233 (SC).

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Tax Audit and Penalty under Section 271B

ISSUE FOR CONSIDERATION

A failure to get accounts audited or to obtain and furnish the audit report as required under section 44AB is made liable to a penalty under section 271B of a sum equal to 0.5 per cent of the total sales, turnover or gross receipts of business or profession subject to a ceiling of Rs. 1,50,000.

The provision of section 271B, introduced by the Finance Act, 1984, has undergone various changes from time to time, including the omission of the words “without reasonable cause” with effect from 10th September, 1986. Presently, the failure to get the accounts audited or to obtain and furnish an audit report, as required under section 44AB, are made liable to penalty subject to the discretion of the AO. Section 273B provides that no penalty shall be imposable where the person proves that he had a reasonable cause for the failure specified under section 271B. Section 274 provides that no order imposing a penalty shall be made unless the Assessee has been heard or is given a reasonable opportunity of being heard.

Section 44AA read with Rule 6F requires maintenance of books of account and other documents to enable the AO to compute the total income in accordance with the provisions of the Act. Failure to keep and maintain the books of account and other documents as required by section 44AA is made liable to penalty under section 271A of a sum of Rs. 25,000 with effect from 1st April, 1976 at the discretion of the AO where there is no reasonable cause.

An issue has arisen about the possibility of levy of penalty under section 271B for failure to get accounts audited in cases where no books of account are maintained. Conflicting views are available on the subject supported by the decisions of different benches of the ITAT. The Ranchi Bench of the tribunal has held that it is possible to levy penalty under section 271B even where books of account are not maintained, while the Delhi Bench has held that no such penalty is leviable where no books of account are maintained.

RAKESH KUMAR JHA’S CASE

The issue arose in the case of Rakesh Kumar Jha vs. ITO, 224 TTJ (Ranchi) 11 before the Ranchi Bench of the tribunal. In that case, the Assessee was running the business of tuition classes and was required to maintain books of account and get such books of account audited. The Assessee had maintained the books of account that were rejected by the AO. However, the Assessee had failed to get the books of account audited. The income of the Assessee was estimated by the AO by applying provisions of section 145(3) of the Act which act of estimation was confirmed by the tribunal under a separate order. A penalty under section 271B was levied by the AO for the failure to get the books of account audited and the levy of penalty was confirmed in appeal by the CIT(A). In the further appeal before the tribunal, the Assessee contended that his books of account were rejected, and therefore, he was held to have not maintained the proper books of account as prescribed. It was, therefore, not possible for him to get the accounts audited under section 44AB of the Act, and in that view of the matter, it was not possible to levy penalty under section 271B for not getting the accounts audited.

The Assessee relied on the decision of the Allahabad High Court in the case of CIT vs. Bisauli Tractors, 217 CTR 558 to plead that no penalty under section 271B was leviable. The tribunal noted that the Assessee had maintained the books of account that were rejected by the AO and his income was estimated and which act of estimation had become final by the order of the tribunal. It found that the decision of the Allahabad High Court was not applicable to the facts of the case of the Assessee, in as much as the Assessee in the case before the tribunal had maintained the books of account, but had failed to get the same audited, and therefore, the levy of penalty by the AO was in order. Importantly, the tribunal held that even otherwise, the penalty could have been levied under section 271B for the failure to get the books of account audited where no books of account were maintained, after analysing the provisions of sections 44AA and 44AB and the provisions of levy of penalty under sections 271A and 271B.

The tribunal noted that those provisions were independent of each other and so operated by prescribing specific requirements on the assessee and by providing separate penalties for the respective non-compliances. In para 6 of the order, it gave an example to highlight that reading the provisions collectively might confer unjust benefit to the person who had not maintained books of account and had claimed that no penalty under section 271B should be levied and the penalty, if levied, should be the one under section 271A, only. The said paragraph reads as under: “Suppose there are two persons namely, Ram and Shyam. Both are required to maintain their books of account and also get those audited as required under ss. 44AA and 44AB. Ram maintains his books of account but did not get those audited, whereas Shyam did not maintain his book of accounts at all and there was no question of audit of the same as the books did not exist at all. Under these circumstances, if the contention of the learned counsel is to be accepted, Ram will be subjected to higher penalty under s. 271B of the Act, whereas Shyam who has committed double default would escape with lesser penalty. This proposition, in our humble view, is neither legally justified nor it can pass the test of application of principles of justice, equity and good conscience.”

The tribunal held that to exclude the case of a person from levy of penalty under section 271B on the ground that he has not maintained books of account was not justified legally, and was in violation of the principals of justice, equity and good conscience.

The tribunal extensively referred to the decision of the Madhya Pradesh High Court in the case of Bharat Construction Co vs. ITO, 153 CTR 414 wherein the order of the AO levying penalty under section 271B for not getting the accounts audited, preceded by the proceedings for levy of penalty under section 271A for non-maintenance of books, was upheld by the High Court on the ground that the defaults contemplated under the two provisions were separate and distinct.

The tribunal accordingly upheld the order of AO, levying penalty under section 271B and dismissed the appeal of the Assessee.

TARANJEET SINGH ALAGH’S CASE

The issue again arose in the case of Taranjeet Singh Alagh vs. ITO, in ITA No. 787/Del/2020 for A.Y. 2015–16. In this case for A.Y. 2015–16, the Assessee was found to have not maintained the books of account and had not obtained the audit report. The AO had initiated the penalty proceedings under section 271A for not maintaining the books of account and under section 271B for not obtaining and furnishing the Tax Audit Report. The AO later dropped the proceedings under section 271A but levied the penalty under section 271B of the Act. The order of the AO was confirmed by the CIT(A).

On further appeal, it was contended in writing by the Assessee before the tribunal that the AO was convinced that no books of account were maintained, and of the reason for not maintaining the books; he had, therefore, dropped the penalty proceedings under section 271A of the Act.

It was further contended that no penalty under section 271B was maintainable where no books of account were maintained, as no audit was possible. Reliance was placed on the decision of the bench in the case of Chander Prakash Batra, ITA No. 4305/Del./2011 to support the proposition that no penalty could have been levied.

The tribunal noted the facts, particularly, the fact that the Assessee was held to be not in default under section 271A. It proceeded to hold that no penalty under section 271B was leviable where books of account were not maintained, and the reason for not maintaining the books was found to be justified by the AO. Paragraph 4.1 of the order reads as under: “We have given our thoughtful consideration to the present appeal, admittedly, the penalty was initiated U/s 271A of the Act for non-maintenance of books of account as well as under s. 271B for not complying with the provisions of section 44AB of the Act regarding the auditing of the account. The penalty for non-maintenance on books of account was dropped but the penalty for not getting the accounts audited is sustained. We find merits into the contentions of the Assessee that if he was not guilty of non maintaining of books of account, the presumption would be that he shall not required to maintain the books of account. Under these undisputed facts, imposing penalty for non auditing of books of account is not justified. Therefore, we hereby direct the Assessing authority to delete the penalty.”

The appeal of the Assessee was allowed by the Tribunal, and the penalty was deleted.

OBSERVATIONS

There are two distinct provisions, one requires the maintenance of books of account by specified persons in certain prescribed cases, and another provision requires the audit of accounts that were required to be maintained by the first provision. Section 44A provides for maintenance of accounts, while section 44AB requires the audit of accounts that are required to be maintained by section 44A of the Act.

There are distinct provisions for levy of penalty for two different defaults. One for penalising an Assessee under section 271A for the offence of not maintaining books of account, and the second for penalising him under section 271B for not getting the accounts audited, and obtaining the audit report and filing it in time. These two provisions are separate and are provided for by two distinct provisions introduced at different points of time for penalising two different offences.

In the circumstances, where two separate defaults are committed, for which two separate penalties are provided for, on first blush, it is possible to levy two separate penalties. While this may be true in cases where two offences are not interrelated and are independent and distinct, in the case under consideration, however, the second offence is related to the first, and the second offence can happen only where the person has committed the first offence. This peculiar situation requires us to address the possibility of considering whether the second offence can at all be penalised when the person has already been penalised for the first offence. In other words, can the second offence be ever committed where the books of account are not maintained at all? Can a law require the audit of accounts which are not maintained at all? It seems not. To require a person to get the accounts audited, obtain an audit report and file the same in a case where he has not maintained the books at all; in his case, an audit is an impossibility, and therefore, he cannot be penalised for not doing something which was impossible.

The Allahabad High Court precisely held that no penalty was leviable for not obtaining the audit report in cases where the Assessee had otherwise not maintained the books of account — Bisauli Tractors (supra). The court appreciated that the Assessee could not have got the accounts audited when he had not maintained the books at all. The court rightly held that in such situations, it was appropriate for the authorities to have initiated and levied penalty under section 271A.

The Madhya Pradesh High Court noticed that the offences were separate, and for which separate penalties were provided for in the law and, therefore, did not see any reason why two penalties for separate defaults could not be levied. In confirming the penalty under section 271B, had the court realised that the two offences were interrelated and the first offence, once committed, had rendered impossible the commitment of the second offence, it might not have confirmed the penalty for the second offence.

Importantly, the main and only issue before the court was whether the notice issued under section 271B, and the pursuant order of penalty passed suffered from the law of limitation under section 275(b) or not. The court, while upholding the actions of the AO observed, though it was not called upon to do so, stated that it was possible to pass separate orders due to different provisions of law that provided for penalty at the varying rates. With due respect to the Ranchi bench, the tribunal should have ignored or treated the observations of the court at the best as obiter dicta, not having the force of precedent. Had the case before the bench been decided independent of the observations, maybe the outcome would have been more forceful.

The Allahabad High Court, for its decision, drew analogy from the cases decided under the sales tax laws applicable to the State of Uttar Pradesh. Those were the cases where the court found that the levy of two penalties was not called for, though the defaults were not parallel. Under the Income-tax Act, 1961, not deducting tax at sourceis an offense and not depositing tax is another offense,but a person is not penalised twice; the reason being the two are interrelated, the second cannot be penalised where the person is penalised for the first, i.e., for not deducting.

Section 273B saves cases from levy of penalty in cases where the failure was for a reasonable cause and what better cause can be conceived for the defence under section 271B, where the books of account are not maintained at all.

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Adjustment u/s 143(1) in Respect of Employees’ Contribution to Welfare Funds

ISSUE FOR CONSIDERATION

Under section 2(24)(x) of the Income-tax Act, 1961, any sum received by an employer from his employees as contributions to any provident fund, superannuation fund, ESIC fund or any other employees’ welfare fund is in the first place taxable as income of the employer. The employer can thereafter claim a deduction of such amount from his income under section 36(1)(va) or section 57(ia), if the amount is credited by him to the employee’s account on or before the due date. For this purpose, “due date” has been defined as the date by which the employer is required to credit an employee’s contribution to the employee’s account in the relevant fund under any Act, rule, order, notification, or any standing order, award, contract of service, or otherwise.

Various High Courts, including the Bombay High Court in the case of CIT vs. Ghatge Patil Transports 368 ITR 749, had interpreted this provision to be on par with section 43B, which applies with respect to employer’s contribution to these welfare funds, and held that so long as such employees’ contributions were paid before the due date of filing the income tax return under section 139(1), as required by section 43B, such employees’ contributions were also allowable as a deduction even where the deposits were made outside the time limits provided by the respective welfare statutes.

On 12th October, 2022, this controversy as applicable to assessments up to AY 2020-21, is resolved by the Supreme Court in the case of Checkmate Services (P) Ltd vs. CIT 448 ITR 518, where the Supreme Court held that there was a marked difference between employer’s contribution and employee’s contribution held in trust by the employer and that for the purposes of section 36(1)(va), the payment had to be made before the due date applicable under the relevant Act applies to the contribution for an effective claim under the Income-tax Act.

An Explanation 2 to section 36(1)(va) has also been inserted by the Finance Act, 2021 with effect from A.Y. 2021-22, clarifying for removal of doubts, that the provisions of section 43B shall not apply and shall be deemed to never have applied for the purposes of determining the “due date” under section 36(1)(va). In spite of the amendment, interpreting the language of the amendment, the benches of the Tribunal have taken a view, prior to 12th October, 2022, that such amendment applied prospectively from A.Y. 2021-22, and not to earlier years and with that the disallowance where made was deleted.

In the meanwhile, prior to the Supreme Court judgment in Checkmate Services’ case (supra), even for assessment years prior to A.Y. 2021-22, adjustments were being made, by the AO(CPC), under section 143(1)(a) in respect of the payments made after the due date under the respective Act but before the due date of filing of the return of income, based on disclosures of payments made in the tax audit report furnished under section 44AB. In fact, in some of the cases, it has been held that no disallowance was possible while issuing an intimation u/s 143(1) simply on the basis of the tax audit report.

While processing the return of income, section 143(1)(a) permits adjustments of, amongst others:

(i) …………………………….;

(ii) an incorrect claim, if such incorrect claim is apparent from any information in the return;

(iii) ………;

(iv) Disallowance of expenditure indicated in the audit report but not taken into account in computing the total income in the return;

(v) ……………..

Till Checkmate Services decision (supra), the benches of the Tribunal had generally been taking a view that such an adjustment leading to the disallowance of the claim was not permissible u/s 143(1)(a), since the question of allowance or otherwise was a debatable one, in view of the various High Courts and Tribunal decisions.

The issues have arisen recently before the Tribunal, as to whether, (a) taking into account the subsequent Supreme Court decision in Checkmate Services (supra), such adjustments made u/s 143(1)(a) prior to the Supreme Court decision in Checkmate Services case, for disallowing the employees’ contribution u/s 36(1)(va) where payments were made by the employer after the due date under the respective Acts but before the due date of filing of the return of income, could have been validly made (b) will the ratio of the decision would apply only where the order is passed u/s143(3) and will not apply to the cases of the adjustment being made in issuing intimation u/s143(1) which will continue to be not permissible and (c) the adjustment will be possible based on the reporting by the tax auditor. While the Pune, Panaji, Chennai and Bangalore benches of the Tribunal have held that such adjustment u/s 143(1) by AO(CPC) for disallowing the claim was valid, the Mumbai bench of the Tribunal has held that such an adjustment could have been made u/s 143(3) only prior to the Supreme Court decision in Checkmate Services case. Further, the Pune bench of the Tribunal held that the adjustment in issuing the intimation by disallowing the claim based on the tax audit report was permissible for the AO, many other benches including the Mumbai and Hyderabad held that such an adjustment simply based on such a report was not permissible. Once again the Mumbai bench has observed that the ratio of the decision in Checkmate’s case was applicable only for disallowance of the claim where an assessment was completed u/s143(3), the Pune bench has not made any such distinction in upholding the disallowance made while issuing the intimation u/s143(1).

CEMETILE INDUSTRIES’ CASE

The issue came up before the Pune bench of the Tribunal in the case of Cemetile Industries vs. ITO 220 TTJ (Pune) 801, and many assessees. The assessment years involved in these cases were from A.Y. 2017-18 to AY 2020-21.

In this lead case, relating to A.Y. 2018-19, the tax audit report filed by the assessee highlighted the due dates of payment to the relevant funds under the respective Acts relating to employees’ share, and the dates by which the amounts were deposited by the assessee after such due dates but before the filing of the return u/s 139(1). The assessee was of the view that such payments before the due date as per section 139(1) amounted to sufficient compliance in terms of section 43B and were not disallowable in issuing the intimation u/s143(1).

The return of the assessee was processed u/s 143(1), making disallowance u/s 36(1)(va) of Rs 3,40,347, on the ground that the amount received by the assessee from its employees as a contribution to Employees Provident Fund, ESIC, etc was not credited to the employees’ accounts on or before the due date prescribed under the respective Acts. The assessee applied for rectification under section 154, which was rejected. The Commissioner (Appeals) also rejected the assessee’s appeal.

Before the Tribunal, the Department contended that the disallowance was called for because of the per se late deposit of the employees’ share beyond the due date under the respective Act, and that section 43B was of no assistance in view of the decision of the Supreme Court.

The Tribunal analysed the provisions of sections 2(24)(x) and 36(1)(va). It observed that it was axiomatic that the deposit of the employees’ share of the relevant funds before the due dates under the respective Acts was sine qua non for claiming the deduction and if the contribution of the employees to the relevant funds was not deposited by the employer before the due date under the respective Acts, then the deduction u/s 36(1)(va) was lost notwithstanding the fact that the share of the employees had been deposited by the due date of filing the return of income as per section 43B.

The Tribunal referring to the assessee’s reliance on section 43B for claiming deduction noted that the main provision of section 43B, providing for the deduction of employer’s contribution to such funds only on an actual payment basis, had been relaxed by the proviso so as to enable the deduction even if the payment was made before the due date of furnishing the return of income u/s 139(1) for that year. The assessee’s claim was that the deduction became available in the light of section 36(1)(va) r.w.s. 43B on depositing the employees’ share in the relevant funds before the due date under section 139(1). The tribunal observed that the said position was earlier accepted by some of the High Courts, holding that the deduction was to be allowed once the assessee deposited the employees’ share in the relevant funds before the date of filing of return under section 139(1) even though the payments were made outside of the time provided under the respective Acts. The courts had allowed the deduction on the analogy of treating the employee’s share as having the same character as that of the employer’s share, becoming deductible under section 36(1)(va) read in the light of section 43B(b).

The tribunal thereafter took note of the Supreme Court’s decision, in Checkmate Services P Ltd & Ors vs. CIT & Ors, 448 ITR 518, and observed that the apex court had threadbare considered the issue and had drawn a distinction between the parameters for allowing deduction of employer’s share and employee’s share for contribution in the relevant funds. It had been held by the court that the contribution by the employees to the relevant funds was the employer’s income u/s 2(24)(x), but the deduction for the same could be allowed only if such amount was deposited in the employee’s account in the relevant funds before the date stipulated under the respective Acts. Thereby, the tribunal noted that the earlier view taken by some of the High Courts in allowing deduction even where the amount was deposited in the employee’s account before the time allowed under section 139(1), got overturned by the apex court. The tribunal observed that the net effect of this Supreme Court judgment was that the deduction under section 36(1)(va) could be allowed only if the employee’s share in the relevant funds was deposited by the employer before the due date stipulated in the respective Acts and further that the due date under section 139(1) was alien for the purpose of deduction of such contribution.

The tribunal noted that the enunciation of law by the Supreme Court was always declaratory having effect and application ab initio, being from the date of insertion of the provision unless a judgment was categorically made prospectively applicable; the judgment would apply equally to the disallowance under section 36(1)(va) in all earlier years as well as for the assessments completed under section 143(3). It was however pointed out by the assessee that the appeals before the tribunal involved disallowance made under section 143(1) and as such no prima facie adjustment could be made in the intimation issued under section 143(1), unless the case was covered within the specific four corners of the provision, and it was stressed that the action of the AO in making the disallowance did not fall in any of the clauses of section 143(1).

The Tribunal then noted that the assessees as well as the Department were in agreement that the case of payment and its disallowance could be considered only as falling under either clause (ii) or under clause (iv) of section 143(1).

The Tribunal then noted that none of the first three clauses of explanation (a), was attracted to the facts of the case before it.

The Tribunal then proceeded to examine the provisions of clause (iv) of section 143(1)(a), which provided for disallowance of expenditure or increase in income indicated in the audit report but not taken into account in computing the total income in the return. The words “or increase in income” in the above provision were inserted with effect from the assessment year 2021-22 by the Finance Act 2021 and therefore did not apply to the assessment years in the cases before the tribunal.

The Tribunal, therefore, went on to ascertain if the disallowance made under section 36(1)(va) in the intimation under section 143(1)(a) could be construed as a disallowance of expenditure indicated in the audit report not taken into account in computing the total income in the return. The tribunal thereafter went on to examine the reporting of such payments in clause 20(b) of the tax audit report. It noted that the due date for payment had been reported (in one case as 15th July, 2017), and the actual date for payment had been reported as a later date (in that case as 20th July, 2017). Therefore, according to the tribunal, it was manifest that the audit report clearly pointed out that as against the due date of payment of the employee’s share in the relevant funds of 15th July, 2017 for deduction under section 36(1)(va), the actual payment was delayed and deposited on 20th July, 2017.

The tribunal noted that for disallowance under sub-clause (iv) of section 143(1)(a), the legislature had used the expression ‘indicated in the audit report’. According to the tribunal, the word ‘indicated’ was wider in amplitude than the word ‘reported’, which enveloped both direct and indirect reporting. Even if there was some indication of disallowance in the audit report, which was short of direct reporting of the disallowance, according to the tribunal, the case got covered within the purview of the provision warranting the disallowance. However, the tribunal expressed the view that the indication must be clear and not vague. As per the tribunal, if the indication gave a clear picture of the violation of a provision, there could be no escape from disallowance.

Examining the facts of the case, the tribunal observed that it was clear from the mandate of section 36(1)(va) that the employee’s share in the relevant funds must be deposited before the due date under the respective Acts. If the audit report mentioned the due date of payment and also the actual date of payment with specific reference in clause 20(b) – Details of contributions received from employees for various funds as referred to in section 36(1)(va), it was an apparent indication of the disallowance of expenditure under section 36(1)(va) in the audit report in a case where the actual date of payment was beyond the due date. The tribunal observed that though the audit report clearly indicated that there was a delay in the deposit of the employees’ share in the relevant funds, which was in contravention of the prescription of section 36(1)(va), the assessee chose not to offer the disallowance in computing the total income in the return, which rightly called for the disallowance in terms of section 143(1)(a).

The tribunal rejected the assessee’s argument that this was a case of increase in income, which was applicable only from the A.Y. 2021-22 and not for the relevant assessment year, on the ground that the two limbs, “disallowance of expenditure” and “increase in income” were independent of each other, and that the indication in the audit report for “increase in income” should be qua some item of income, and not increase of income because of the disallowance of expenditure. If this argument were to be accepted that even a disallowance of expenditure amounted to an increase in income, then the amendment with effect from the A.Y. 2021-22 would be redundant. According to the tribunal, interpretation had to be given to the statutory provisions in such a manner that no part of the Act was rendered nugatory.

Looking at the provisions of the tax audit report, the tribunal observed that the column giving details of the amounts received from employees indicates an increase in income if the assessee does not take the sum in computing total income, while the columns giving details of due date for payment and the actual date of payment indicate disallowance of expenditure suo moto disallowance in computing total income. In the case, before it the AO did not make adjustments for non-offering of the sums received from employees but made the adjustment for disallowance of expenditure with the remarks that “amount debited to the profit and loss account to the extent of disallowance under section 36 due to non-fulfillment of conditions specified in relevant clauses”. Therefore, according to the tribunal, it was evident that it was a case of disallowance of expenditure and not an increase in income. Further, the entire challenge by the assessee throughout had been to the disallowance of expenditure made by the AO. The assessee’s argument all along before the appellate authorities had been that the shelter of section 43B was available and disallowance could not be made because such payment was made before the due date under section 139(1).

The tribunal also rejected the assessee’s argument that the assessee did not claim any deduction in the profit and loss account of the amount under consideration and hence no deduction could have been made, holding that the deduction made from the salary had been claimed as a deduction by way of gross salary, which had been debited to the profit and loss account.

The Tribunal, therefore, upheld the adjustment made under section 143(1)(a) by disallowance of late deposit of employees’ share to the relevant funds prescribed under the respective Acts.

A similar view has also been taken by the Chennai, Bangalore and Panaji benches of the tribunal, in the cases of Electrical India vs. Addl DIT 220 TTJ (Chennai) 813, Legacy Global Projects (P) Ltd vs. ADIT 144 taxmann.com 4 (Bang), and Gurunath Yashwant Amathe vs. ADIT TS-7318-ITAT-2022(PANAJI)-O [ITA No 64/PAN/2022 dated 5th December, 2022].

P R PACKAGING SERVICE’S CASE

The issue came up again recently before the Mumbai bench of the tribunal in the case of P R Packaging Service vs. ACIT, TS-961-ITAT-2022(Mum) [ITA No 2376/Mum/2022 dated 7th December, 2022].

The assessee for the assessment year 2019-20 had remitted the employees’ contribution to the provident fund beyond the due date prescribed under the Provident Fund Act but had remitted the same before the due date of filing the return of income under section 139(1). The fact of remittance made by the assessee with delay had been reported by the tax auditor in the tax audit report. Such amount was disallowed under section 143(1), while processing the return of income.

The Tribunal, on perusal of the tax audit report, noted the tax auditor had merely mentioned the due date for remittance of provident fund as per the provident fund Act and the actual date of payment made by the assessee. According to the tribunal, the tax auditor had not even contemplated disallowance of the employees’ contribution to the provident fund wherever it was paid beyond the due date prescribed under the provident fund Act. It was merely a recording of facts and a mere statement made by the tax auditor in his audit report.

The CPC Bangalore had taken up this data from the tax audit report and sought to disallow the amount of delayed payment while processing the return under section 143(1), apparently by applying the provisions of section 143(1)(a)(iv).

Analysing the provisions of section 143(1)(a)(iv), the tribunal observed that it was very clear that this clause would come into operation when the tax auditor had suggested a disallowance of expense, but such disallowance had not been carried out by the assessee while filing the return of income. As per the tribunal, the tax auditor had not stated that the employees’ contribution to the provident fund was disallowable wherever it was remitted beyond the due date under that Act. Hence, according to the tribunal, CPC Bangalore was not correct in disallowing the employees’ contribution to the provident fund while processing the return under section 143(1), as it did not fall within the ambit of prima facie adjustments.

The tribunal further relied to a great extent upon the observations of the Mumbai bench of the tribunal in the case of Kalpesh Synthetics Pvt Ltd vs. DCIT 195 ITD 142, where the tribunal had examined in detail the scope of the adjustments permissible under section 143(1)(a), and in particular, the disallowance under section 36(1)(va) in such situations where the payments were made before the due date under section 139(1), and whether the reporting in the tax audit report could be the basis of such disallowance.

The tribunal observed that it was conscious of the recent Supreme Court decision in Checkmate Services (supra), where the issue had been decided on merits. It however observed that such a decision was rendered in the context where the assessment was framed under section 143(3), and not under section 143(1)(a).

Therefore, the tribunal deleted the addition made with respect to employees’ contribution to the provident fund made under section 143(1)(a).

OBSERVATIONS

Adjustment should be possible u/s143(1)(a) while issuing any intimation under s.143(1) after 12th October 2022 in respect of the amounts remaining to be paid by the due dates prescribed under the respective Acts for payment of the welfare dues contributed by the employees even though paid by the due dates of the filing of the return of income .under s. 139(1) of the Income-tax Act. After the Supreme Court decision in the case of Checkmate Services (supra), there should be no debate that the delayed payment of employee contributions to such funds after due dates under the respective Acts is disallowable under section 36(1)(va), even if such payment is made before the due date under section 139(1). In that view of the matter, the observation of the Mumbai bench of the Tribunal that the ratio of the decision of the apex court was applicable only to the assessments made under s. 143(3), in our respectful opinion, requires reconsideration.

The issue however continues to be relevant where such adjustment is made under section 143(1)(a), before the decision of the Supreme Court, at which point of time the matter was debatable, given the decisions of various High Courts.

Can an adjustment by way of a disallowance which was debatable at the relevant point of time that it was made, be held to be permissible under s.143(1), because of a subsequent Supreme Court decision which settles the debate on the disallowance? In other words, has the disallowability of the expenditure to be seen as per the legal position taken by the Courts as prevailing at the time of making the adjustment, or at the point of time when the appeal against the adjustment is being decided? Can it be held that the issue was never debatable in as much as the law declared subsequently by the decision of the apex court was always the law and, therefore, any adjustment if made before the decision should be considered in consonance with the law.

The Supreme Court, in the case of DCIT vs. Raghuvir Synthetics Ltd 394 ITR 1, has held that the decision of the jurisdictional High Court is binding, the issue is therefore not debatable in relation to assessees within that jurisdiction and therefore held that the adjustment could be made u/s 143(1)(a) (as it stood for AY 1994-95, when the law permitted adjustment of prima facie disallowances) in respect of such assessees. This would therefore indicate that at the time of making the adjustment, the law prevalent in the relevant High Court jurisdiction on the date of making the adjustment has to be considered.

However, the fact remains that on a ruling given by the Supreme Court on the issue, overruling the relevant High Court decision, the legal position is as if the relevant High Court ruling had never been in existence. In Southern Industrial Corporation vs. CIT 258 ITR 481, the Madras High Court held that when a statutory provision is interpreted by the Apex Court in a manner different from the interpretation made in the earlier decisions by a smaller Bench, ( or by the lower court) the order which does not conform to the law laid down by the larger Bench in the later decision, the later decision would constitute the law of the land and is to be regarded as the law as it always was, unless declared by the Court itself to be prospective in operation. Besides, it is also well settled law that a decision of the Supreme Court on an issue can form the basis for rectification of a mistake apparent from the record under section 154. This being the position, can an adjustment be held to be invalid based on a then prevalent decision of the jurisdictional High Court, which has ceased to exist after the Supreme Court ruling?

The enunciation of law by the Supreme Court is always declaratory having effect and application ab initio, being from the date of insertion of the provision, unless a judgement is categorically made prospectively applicable; the judgement as observed by the Pune bench would apply equally to the disallowance under section 36(1)(va) in all earlier years as well as for the assessments completed under section 143(3).

The better view of the matter, though unfair to the assessee who did not have the benefit of the Supreme Court ruling when he filed his return, seems to be that of the Pune, Chennai, Panaji and Bangalore benches of the Tribunal, that such subsequent Supreme Court decision validates the prior adjustment made, as the Supreme Court enunciates the law as it always stood. The appellate authorities should not be precluded from extending its powers to give effect to the subsequent decision of the apex court in adjudicating the appeal before them.

It is possible to hold that the appeals before the tribunal involved disallowance made under section 143(1) and as such no prima facie adjustment could be made in the intimation issued under section 143(1), unless the case was covered within the specific four corners of the provision and that the action of the AO in making the disallowance did not fall in any of the clauses of section 143(1). To meet such a contention, an alternative way of confirming the abovementioned better view and putting the said view beyond doubt is by rectifying or revising or reassessing the income wherever otherwise permissible in law and is within the prescribed time or by the appellate authorities exercising its enhancement powers while adjudicating the appeal.

The other issue is whether any disallowance of expenditure under sub-clause (iv) of clause (a) of sub-section (1) of s.143 on the basis of the words “indicated in the audit report” would include a conclusion drawn from facts given in the audit report, or would cover only express disallowance identified by the auditor in the tax audit report and whether the tax audit report observations can at all be the basis for adjustment u/s 143(1). The observations of the Mumbai bench of the Tribunal, in Kalpesh Synthetics case (supra) in this regard are summarized as under:

The precise and proximate reason for disallowance is the inputs based on the tax audit report.
Can the observations in a tax audit report, by themselves, be justification enough for any disallowance of expenditure under the Act?
Section 143(1)(a)(iv) specifically calls for an adjustment in respect of “disallowance of expenditure indicated in the audit report but not taken into account in computing the total income in the return”.
It does suggest that when a tax auditor indicates a disallowance in the tax audit report, for this indication alone, the expense must be disallowed while processing under section 143(1) by the CPC.
The tax auditor is an independent person though appointed by the assessee.
The fact remains that the tax auditor is a third party, and his opinions cannot bind the auditee in any manner.
The audit observations are seldom taken as an accepted position by the auditee.
They are mere opinions and at best these opinions flag the issues which are required to be considered by the stakeholders.
On such a fine point of law, considering the conflicting views of the courts, these audit reports are inherently even less relevant.
Audit report requires reporting of a factual position rather than expressing an opinion about the legal implication of that position.
Assuming the finality of the observations by an auditee with, the audit observations, is too unrealistic and incompatible with the very conceptual foundation of independence of an auditor.
Elevating the status of the observations of a tax auditor to a level above that of the Hon’ble Courts seems incongruous and is clearly unsustainable in law.
It is for the Hon’ble Constitutional Courts to take a call on the vires of this provision, and the tribunal is nevertheless required to interpret the provision in a manner to give it a sensible and workable interpretation.
When the opinion expressed by the tax auditor is contrary to the correct legal position, the tax audit report has to make way for the correct legal position.
Under Article 141 of the Constitution of India, the law laid down by the Hon’ble Supreme Court unquestionably binds all. East India Commercial Co. Ltd. vs. Collector of Customs 1962 taxmann.com 5
On a combined reading of articles 215, 226, and 227 It would be anomalous to suggest that a Tribunal over which the High Court has superintendence can ignore the law declared by that Court and start proceedings in direct violation of it.
It is implicit that all the Tribunals subject to courts’ supervision should conform to the law laid down by it.
The views expressed by the tax auditor, cannot be reason enough to disregard the binding views of the jurisdictional High Court. To that extent, the provisions of section 143(1)(a)(iv) must be read down.
What essentially follows is that the adjustments under section 143(1)(a) in respect of “disallowance of expenditure indicated in the audit report but not taken into account in computing the total income in the return” is to be read as, for example, subject to the rider “except in a situation in which the audit report has taken a stand contrary to the law laid down by Hon’ble Courts above”.
It is also important to bear in mind the fact that what constitutes jurisdictional High Court will essentially depend upon the location of the jurisdictional Assessing Officer.
What a tax auditor states in his report are his opinion and his opinion cannot bind the auditee at all. It is not even an expression of opinion about the allowability of deduction or otherwise; it is just a factual report about the fact of payments and the fact of the due date as per the Explanation to section 36(1)(va).
It cannot, therefore, be said that the reporting of payment beyond this due date in the tax audit report constituted “disallowance of expenditure indicated in the audit report but not taking into account in the computation of total income in the return” as is sine qua non for disallowance of section 143(1)(a)(iv).
When the due date under Explanation to section 36(1)(va) is judicially held to be not decisive for determining the disallowance in the computation of total income, there is no good reason to proceed on the basis that the payments having been made after this due date is “indicative” of the disallowance of expenditure in question.
While preparing the tax audit report, the auditor is expected to report the information as per the provisions of the Act, and the tax auditor has done that, but that information ceases to be relevant because, in terms of the law laid down by Hon’ble Courts, the said disallowance does not come into play when the payment is made well before the due date of filing the income tax return under section 139(1).

In contrast, it is important to reiterate in a summarized manner the observations of the Pune bench of the Tribunal in the context of the reporting of such payments in clause 20(b) of the tax audit report.

Where an auditor reported that the due date for payment was 15th July, 2017 and the actual date for payment had been reported as a later date (in that case as 20th July, 2017, it was manifest that the audit report clearly pointed out that as against the due date of payment of the employee’s share in the relevant funds of 15th July, 2017 for deduction under section 36(1)(va), the actual payment was delayed and deposited on 20th July, 2017.
That for disallowance under sub-clause (iv) of section 143(1)(a), the legislature had used the expression ‘indicated in the audit report’ and the word ‘indicated’ was wider in amplitude than the word ‘reported’, which enveloped both direct and indirect reporting.
Even if there was some indication of disallowance in the audit report, which was short of direct reporting of the disallowance, the case got covered within the purview of the provision warranting the disallowance.
However, the indication must be clear and not vague. If the indication gave a clear picture of the violation of a provision, there could be no escape from disallowance.
If the audit report mentioned the due date of payment and also the actual date of payment with specific reference in clause 20(b) – Details of contributions received from employees for various funds as referred to in section 36(1)(va), it was an apparent indication of the disallowance of expenditure under section 36(1)(va) in the audit report in a case where the actual date of payment was beyond the due date.
Though the audit report clearly indicated that there was a delay in the deposit of the employees’ share in the relevant funds, which was in contravention of the prescription of section 36(1)(va), the assessee chose not to offer the disallowance in computing the total income in the return, which rightly called for the disallowance in terms of section 143(1)(a).

Sub-clause(iv) in express words requires an AO(CPC) to disallow the amount of expenditure that is indicated in the tax audit report and is not taken into account in computing the total income in the return. Without questioning the wisdom of the law passed by the legislature, we wish to limit our views to understanding what is truly stated by the legislature by understanding the legal import of the words ‘indicated in the tax audit report’. Does the term require that for the disallowance to happen an auditor should expressly state that the amount referred to in his report is disallowable by expressing his opinion or the requirement of the tax audit report is to report by identifying the amount and thereafter it is for the AO to disallow the same? A comprehensive reading of the sub-clause(iv), in our opinion, indicates an action on the part of the AO to act by first ascertaining whether the assessee has taken into account the tax audit report in computing the total income in the return and if not only thereafter to apply the sub-clause and proceed to adjust the returned income. In our opinion, the auditor is not required to give his opinion on whether the amount reported is disallowable or not and which is rightful for the reason that the power of the AO to assess the final income is not taken away by entrusting the same to the auditor. There is no automatic disallowance possible. The role of the auditor is therefore limited to indicating the subject matter of the audit under the respective clause of the tax audit report. The dictionary meaning of the term ‘indicate’ is to point out; show, be a sign of, give a reading or state briefly. In the context of the placement, it is very difficult to hold that the term is recommendatory, more so, where the authority to disallow is strictly resting with the AO. The sum and substance of the views are that the term ‘indicated’ is limited to reporting of the quantum and is not even recommendatory of the disallowance. In other words, the reporting by the tax auditor is not a compulsion for the assessee or the AO to disallow the amount and it is only when the assessee had not suo moto disallowed the amount, the AO will use his power to act on such information.

shailesh.kwebmaker

Location of Source of Income in Case of Exports

ISSUE FOR CONSIDERATION

Section 9 deems certain incomes to have accrued or arisen in India, thereby making a non-resident liable to tax in India on such income. Clauses (vi) and (vii) of section 9(1) deal with the taxability of income by way of royalty and fees for technical services respectively. As per these clauses, royalty and fees for technical services are deemed to have accrued or arisen in India under the following cases:

a) If they are payable by the Government.

b) If they are payable by a person who is a resident. However, if the properties for which the royalty is payable or the services for which fees are payable are utilized by the resident payer for the purposes of his business or profession carried on by him outside India or for the purposes of making or earning any income from any source outside India then this deeming fiction is not applicable.

c) If they are payable by a person who is a non-resident but only when the properties for which the royalty is payable or the services for which fees are payable are utilized by the non-resident payer for the purposes of his business or profession carried on by him in India or for the purposes of making or earning any income from any source in India.

In the case of export sales, residents need to avail various types of services from non-residents, and the corresponding consideration payable for such services may be characterized as royalty or fees for technical services, as defined in sub-sections (vi) and (vii) respectively of section 9(1). Often, the issue arises in such a case as to whether it can be said that the source of income with respect to export sales is situated outside India and, therefore, such royalty or fees for technical cannot be deemed to have accrued or arisen in India due to the exception provided in sub-clause (b) of clauses (vi) or (vii) of section 9(1). The Madras High Court has taken a view in favour of the assessee by holding that royalty payable on export sales falls under this exception. As against this, the Delhi High Court has taken a view against the assessee by holding that testing fee payable for products to be exported does not fall under this exception as the source of income of the resident payer was situated in India.

AKTIENGESELLSCHAFT KUHNLE KOPP’S CASE

The issue first came up for consideration before the Madras High Court in the case of CIT vs. Aktiengesellschaft Kuhnle Kopp and Kausch W. Germany by BHEL [2003] 262 ITR 513 (Mad). The assessment years involved in this case were 1978-79 to 1982-83. In this case, the assessee was a German company, which had entered into a collaboration agreement with BHEL, an Indian company. By the virtue of this agreement, the assessee had received a a royalty on the export sales made by BHEL. The asseessee claimed that the amount received as royalty was not liable to tax in India. The AO did not accept the claim and completed the assessment taxing the royalty in the hands of the assessee.

The assessee challenged the assessment order before the Commissioner (Appeals), who confirmed the assessment order. Upon further appeal, the Tribunal set aside the assessment and restored the same to the AO to consider the question whether the amount of royalty received was exempt under the Double Taxation Avoidance Agreement (“DTAA”). The AO, once again, completed the assessment bringing the royalty received by the assessee to tax and the same was upheld by the Commissioner (Appeals). In the second round of appeal, the Tribunal held that the royalty payable on export sales could not have been regarded as income deemed to have accrued in India within the meaning of section 9(1)(vi) of the Act. The Tribunal, therefore, held that the royalty on export sales is not taxable. It was this order of the Tribunal which was the subject-matter of the reference before the High Court.

With regard to the taxability of royalty, which was payable on export sales, the High Court held that it was paid out of the export sales and hence, the source of royalty was the sales outside India. Therefore, it could not be deemed to have accrued or arisen in India, though it was paid by a resident in India. Since the source for royalty was from the source situated outside India, the royalty payable on export sales was not taxable in India. On this basis, the High Court upheld the order of the tribunal.

HAVELLS INDIA LTD.’S CASE

The issue, thereafter, came up for consideration of the Delhi High Court in CIT vs. Havells India Ltd. [2013] 352 ITR 376 (Del).

In this case, for A.Y. 2005-06, the assessee paid testing fees of Rs. 14,71,095 to M/s. CSA International, Chicago, Illinois, USA for the purpose of obtaining witness testing of AC contractor as a part of the CB report and KEMA certification. During the course of the assessment proceedings, the AO observed that the assessee had not deducted tax at source u/s 195 of the Act from the amount paid to the US Company and, accordingly, he proposed to disallow the payment by invoking section 40(a)(i). The assessee claimed that the testing was carried out by the US Company outside India, that no income arose or accrued to the US Company in India and, therefore the assessee did not deduct any tax from the amount paid. The AO did not agree with the assesse’s contentions. He held that the amount paid represented fees for technical services rendered by the US Company to the assessee within the meaning of Explanation 2 to Section 9(1)(vii)(b) of the Act, since the testing of the equipment was a highly specialised job of technical nature. The AO also referred to Article 12(4)(b) of the DTAA entered into between India and USA and observed that the payment was also covered under the said article as “fees for included services” as defined therein. According to the AO, the testing report and certification represented technical services which made available technical knowledge, experience and skill to the assessee, because they were utilized in the manufacture and sale of the products in the business of the assessee.

On this basis, the AO disallowed it u/s 40(a)(i) of the Act. Upon further appeal, the CIT (A) agreed with the view of the AO and he further supported it by relying on the decision of the Kerala High Court in Cochin Refineries Ltd. vs. CIT, (1996) 222 ITR 354.

Before the tribunal, the assessee raised the following contentions –

Since the assessee was engaged in the export of goods outside India, the fees for technical services under consideration were paid for the purpose of making or earning income from a source outside India. Thus, it was excluded from the purview of taxability in India due to an exception provided in sub-clause (b) of clause (vii) of section 9(1).

The authorities have erred in holding that the technical report and certification were utilized in the manufacture and sale of the assessee’s products in the assessee’s business in India.

The concerned certification was not required for selling the products in India and it only enabled selling of products in the European Union. Thus, the authorities were wrong in saying that the technical services were utilised by the assessee for its business in India.

In any case, in order to tax the fees for included services in India under Article 12(4)(b) of the DTAA, mere rendering of technical services was not sufficient, and it was necessary that such services should have resulted in ‘making available’ the technical knowledge, experience and skill to the assessee, which was not the case.

On the basis of the aforesaid arguments, the tribunal recorded the following findings –

The certification obtained by the assessee from the US Company was for enabling the export of its products.

The authorities below had not been able to bring anything on record to support their stand that the service of testing and certification had been applied by the assessee for its manufacturing activity within India.

The assessee had been able to show that the testing and certification were necessary for the export of its products, and that these were actually utilised for such export, and were not utilised for the business activities of production in India. The assessee has thus discharged its burden, whereas the Revenue has not been able to show to the contrary, and they had not denied that the utilisation of the testing and certification was in respect of the exports.

In view of these findings, the Tribunal accepted the contention of the assessee that the technical services were utilised for the purpose of making or earning income from a source outside India and was therefore covered by the second exception made in Section 9(1)(vii)(b).

Before the High Court, the assessee reiterated its contentions and also relied upon the decision of the Madras High Court in the case of Aktiengesellschaft Kuhnle Kopp (supra). The High Court observed that this judgement of the Madras High Court certainly was supporting the contentions of the assessee. However, the High Court referred to the earlier decision of the Madras High Court in the case of CIT vs. Anglo French Textiles Ltd. (1993) 199 ITR 785 and observed that it appeared that this earlier decision had not been brought to the notice of the division bench which decided the later case.

In the case of Anglo French Textiles Ltd. (supra), the assessee was a company incorporated under the French laws which were applicable to possessions in Pondicherry in India. It had a textile mill in Pondicherry and its activity consisted in the manufacture of yarn and textiles as well as export of textiles from Pondicherry. The entire business operations were confined to the territory of Pondicherry. After the merger of Pondicherry with India in August, 1962, the Income-tax Act was extended to Pondicherry w. e. f. 1st April, 1963 Till then, the French law relating to income tax was in force in Pondicherry. During the period when the French tax law was in force, the assessee surrendered certain raw cotton import and machinery import entitlements and received payments from the Textile Commissioner (Bombay). The question arose as to the taxability of the income referable to the import entitlements.

While the Income-tax department took the stand that the income accrued to the assessee in India and was therefore taxable under the Act, the assessee claimed that the receipts were in Pondicherry, and since the exports were made from Pondicherry, the income accrued or arose to the assessee in the territory of Pondicherry, which was outside the purview of the Act.

The Madras High Court observed that the import entitlements arose out of the export activity which was carried on by the assessee only in Pondicherry, that no part of the manufacturing or selling activity of the assessee was carried on outside Pondicherry, that the import entitlements were relatable only to the export performance which took place in Pondicherry, and that on the fulfillment of the export activity, a right to receive the export incentive accrued in favour of the assessee in the territory of Pondicherry.

The argument of the department was that the incentive was quantified and sent from Bombay from the office of the Textile Commissioner and, therefore, the income arose within the taxable territories. This argument was rejected by the Madras High Court by holding that “the right to receive the import entitlements arose when the export commitment was fulfilled by the assessee in Pondicherry, though such amount was subsequently ascertained or quantified”.

It was also argued on behalf of the Revenue before the High Court that the import entitlement should be regarded as a source of income in the taxable territories, and u/s 9(1) of the Act, the income arising out of the encashment of the import entitlements should be deemed to accrue or arise in the taxable territories. This argument was also rejected by the High Court on the ground that source of income should be looked at from a practical viewpoint, and not merely as an abstract legal concept.

Applying this earlier judgement of the Madras High Court in the case of Anglo French Textiles Ltd. (supra), the Delhi High Court held that the export activity having taken place or having been fulfilled in India, the source of income was located in India and not outside. The mere fact that the export proceeds emanated from persons situated outside India did not constitute them as the source of income. The export contracts obviously were concluded in India and the assessee’s products were sent outside India under such contracts. The manufacturing activity was located in India. The source of income was created at the moment when the export contracts were concluded in India. Thereafter the goods were exported in pursuance of the contract, and the export proceeds were sent by the importer and were received in India.

The importer of the assessee’s products was no doubt situated outside India, but he could not be regarded as a source of income. The receipt of the sale proceeds emanated from him from outside India. He was, therefore, only the source of the monies received. The income component of the monies or the export receipts was located or situated only in India. Thus, on this basis, the High Court drew a distinction between the source of the income and the source of the receipt of the income. In order to fall within the second exception provided in Section 9(1)(vii)(b) of the Act, the source of the income, and not the receipt, should be situated outside India.

On this basis, the Delhi High Court held that since the source of income from the export sales could not be said to be located or situated outside India, the case of the assessee could not be brought under the second exception provided in section 9(1)(vii)(b).

Further, the Delhi High Court also rejected the contention raised by assessee that the income arose not only from the manufacturing activity but also arose because of the sales of the products, and if necessary, a bifurcation of the income should be made on this basis, and that portion of the income which was attributable to the export sales should qualify for the second exception. The High Court relied upon the observations of the Supreme Court in the case of CIT vs. Ahmedbhai Umarbhai, (1950) 18 ITR 472 (SC) that the place where the source of income was located might not necessarily be the place where the income also accrues and held that this question was not material in the present case, because they were concerned only with the question as to where the source was located.

As far as the issue of taxability under the DTAA was concerned, the High Court restored it to the tribunal to decide, as it had not considered this issue on account of the view it took regarding the taxability of the fees for technical services under the Act.

The Madras High Court in a later decision in the case of Regen Powertech (P) Ltd. vs. DCIT [2019] 110 taxmann.com 55 (Madras) has agreed with the view of the Delhi High Court in Havells India Ltd. (supra).

OBSERVATIONS

The primary issue for consideration is the place where the source of income can be said to be located when a resident exports goods outside India. Whether the source of income in such case can be considered to have been located outside India because it arises from the export of goods outside India and it is received from a person situated outside India?

In order to address this issue, it is first imperative to understand the meaning of the term ‘source of income’. The Judicial Committee in Rhodesia Metals Ltd. vs. Commissioner of Income Tax, (1941) 9 ITR (Suppl.) 45, observed that a “source” means not a legal concept but one which a practical man would regard as a real source of income. The observations of the Judicial Committee (supra) as to what is a source of income have been approved by the Supreme Court in CIT vs. Lady Kanchanbai [1970] 77 ITR 123.

The Allahabad High Court has explained the meaning of source of income in the case of Seth Shiv Prasad vs. CIT, (1972) 84 ITR 15 (All.), in the following words –

“A source of income, therefore, may be described as the spring or fount from which a clearly defined channel of income flows. It is that which by its nature and incidents constitutes a distinct and separate origin of income, capable of consideration as such in isolation from other sources of income, and which by the manner of dealing adopted by the assessee can be treated so.”

Thus, the source of income needs to be understood from the perspective of the person who is earning that income. It is something from which the income flows to him. In view of these guidelines, what needs to be considered is whether it is the activity that generates the income which needs to be considered as the source of that income or whether it is the person from whom the income flows that needs to be considered as the source of that income. If the activity generating the income is regarded as the source of income, then the place at which that activity has been carried on would be regarded as the place where the source of that income is situated. However, if the person from whom the income has been received is regarded as the source of income, then the place where that person is located would be regarded as the place where the source of that income is situated.

Normally, it should be the activity generating the income which should be considered as the source of income. The income is earned by the person through the activitiy which he carries on and in which he employs his resources. The receipt of the income and the person from whom it is received are merely the offshoots of the activity carried on by the person. The receipt of the income is merely a final step within the activity, and that by itself should not be considered to be the source of income disregarding the whole of the activity. Similarly, in case of export sales, the customer situated in a foreigh country to whom the goods have been sold and from whom the sale consideration is received should not be regarded as the source of income, disregarding the fact that the origin of the export sales is the business which has been carried on from India.

Further, if the other person with whom the activity has been carried on and from whom the income has been received is considered to be the source of income, then the same activity will result into multiple sources of income, merely because it has been carried on with multiple persons. For example, consider a case of a person who is engaged in a business involving domestic sales as well as export sales, and that too to different countries. In such a case, it will be illogical to consider every person to whom or every geographical segment to which the sales have been made as a separate and distinct source of income.

It is true that every part of the activity contributes to the income which is being earned from that activity. So, as a result, it can be said that income accrues partly from the sales and partly from the other business functions which are involved. As a corollary, if the sales are made outside India, then the part of that income which is attributable to sales is also accruing outside India. But, here, we are concerned with the source of income and not the accrual of income.

A distinction has been drawn between the source of income and the accrual of income by the Supreme Court in the case of CIT vs. Ahmedbhai Umarbhai & Co. [1950] 18 ITR 472. It has been held that the income may accrue or arise at the place of the source or may accrue or arise elsewhere. Thus, merely because the income needs to be considered as partly accruing outside India to the extent it is attributable to the export sales, the source of income per se cannot be considered to be located outside India. This aspect has also been considered by the Delhi High Court in its decision.

Consider a case where the income is earned from the exploitation of an asset, e.g., income earned from renting of an immovable property. In such a case, merely because the person to whom the property has been leased out is situated outside India and the rent is also received from him outside India, it will be illogical to conclude that the source of income is situated outside India. As the location of the asset in case of asset-based income is the material factor to decide where the source of income is located, the location of the actitiy in case of activity-based income is the material factor to decide where the source of income is located.

In the following cases, a view similar to the view of the Delhi High Court in the case of Havells India Ltd. (supra) has been taken by holding that the source does not refer to the person who makes the payment, but it refers to the activity which gives rise to the income-

Asia Satellite Telecommunications Co. Ltd. vs. DCIT (2003) 85 ITD 478

International Hotel Licesnsing Co. In re (2007) 288 ITR 534 (AAR)

South West Mining Ltd. In re (2005) 278 ITR 233 (AAR)

Dorf Ketal Chemicals LLC vs. DCIT (2018) 92 taxmann.com 222 (Mumbai – Trib.)

Infosys Ltd. vs. DCIT (2022) 140 taxmann.com 600 (Bangalore – Trib.)

International Management Group (UK) Ltd. vs. ACIT (2016) 162 ITD 219 (Del)

In PrCIT vs. Motif India Infotech (P) Ltd 409 ITR 178, the Gujarat High Court held that in a case where technical services were provided by a supplier to overseas customers of a software company directly outside India, the fees for technical services was paid by the assessee for the purpose of making or earning any income from any source outside India, and clearly, the source of income, namely the assessee’s customers, were the foreign based companies. In this case, the assessee had certain contracts for rendering outsourcing services in Philippines. For rendering such services, it had availed services of a Philippines company. Therefore, the services had been rendered outside India. The Gujarat High Court distinguished the Delhi High Court decision in Havell’s case, stating that the facts were different. Perhaps, in the case before the Gujarat High Court, the fact that the services were performed outside India for the overseas customers, which services also had to be physically performed outside India, had a direct bearing on the matter.

In view of the above, the better view seems to be the one adopted by the Delhi High Court that the source of income cannot be considered to be located outside India solely on the basis that the income is derived from export of goods outside India.

shailesh.kwebmaker

Retention in Escrow Account – Liability to Capital Gains

ISSUE FOR CONSIDERATION

In most merger and acquisition transactions involving sale of a business or controlling interest in a company, a certain part of the sale consideration is not directly paid to the seller but is kept aside to meet certain contingencies which may arise in the next few years, such as contingent liabilities. This amount is retained in an escrow account with an escrow agent, with instructions as to how the amount is to be utilized and paid out to the seller, depending upon the happening of certain events. Similar contingent payments may prevail in ordinary non-merger cases, too.

An Escrow Arrangement is a monetary instrument whereby a third-party, i.e. an Escrow Agent, holds liquid assets for the benefit of two parties who have entered into an exchange/transaction, and disburses the liquid assets upon the fulfilment of a specific set of obligations on the part of both the parties under a contract i.e. on happening or non-happening of the contingent event.

The issue has arisen before the courts whether, in a situation where the monies kept in escrow are not released to the seller, pending the contingency, at all or released in a year subsequent to the year of transfer of the capital asset, the amount until certain obligations or conditions are fulfilled, would form a part of the consideration accruing or arising to the seller on transfer of the capital asset in the year of transfer of the asset for the purposes of computing the capital gains on transfer of the asset. While the Madras High Court has held that such an amount, so held in escrow, forms a part of the sale consideration for computing the capital gains; the Bombay High Court has held that such an amount cannot be included in the full value of consideration for computing the capital gains in the year of transfer of the capital asset.

CARBORUNDUM UNIVERSAL’S CASE

The issue first came up for the Madras High Court in the case of Carborundum Universal Ltd vs. ACIT 283 Taxmann 312.

In this case, the assessee sold an Electrocast Refractories Plant on a slump sale basis to another company for a total consideration of Rs. 31.14 crore. Out of the total consideration, an amount of Rs. 3.25 crore was deposited in an escrow account by the purchaser to meet any contingent liabilities. The assessee disclosed a long-term capital gain of Rs. 23.58 crore, taking the sale consideration at Rs. 27.89 crore instead of Rs. 31.14 crore.

The Assessing Officer noted that while it had sold the plant for a total sale consideration of Rs. 31.14 crore, it had considered only Rs. 27.89 crore as the consideration for computation of long-term capital gain and asked the assessee to show cause as to why Rs. 31.14 crore should not be considered for computation of long-term capital gains. The assessee explained that the difference between the consideration taken for computation of capital gains and that for which the plant was sold was an account of the fact that an amount of Rs. 3.25 crore was kept in an escrow account to meet any contingent liabilities.

The Assessing Officer recomputed the capital gains taking the consideration as Rs. 31.14 crore, on the grounds that the amount of Rs. 3.25 crore kept in escrow account would only constitute an application of income, and that the full consideration of Rs. 31.14 crore had accrued to the assessee immediately on the execution of the agreement for sale.

In first appeal, the Commissioner (Appeals) noted that the amount in the escrow account had been kept by the purchaser to indemnify against breach of warranty or other losses or on account of further litigation as a result of non-compliance to the conditions of the agreement by the assessee. The Commissioner (Appeals) therefore was of the view that the sum retained in the escrow account had not accrued to the assessee in the year under consideration. He therefore held that amount of Rs. 3.25 crore kept in escrow account had neither been received or accrued by/to the assessee during the year, and since the said amount had been subsequently received by the assessee after the stipulated period of agreement, it had been offered to tax by the assessee under the head capital gains in the year of its receipt. Therefore, holding that the Assessing Officer was not justified in taxing the amount in the year under consideration, the Commissioner (Appeals) deleted the addition of Rs. 3.25 crore.

Before the Tribunal, on behalf of the Revenue, it was contended that the amount kept in escrow account represented application of income and keeping the amount in escrow account was only a formality, as the entire amount of Rs. 3.25 crore had been received without any deduction towards claims/warranties, and had been offered to tax in a subsequent year.

The Tribunal, after examining the Business Sale Agreement, held that, the agreement had given legally enforceable rights to the parties with respect to the transfer of undertaking, the assessee had a right to receive the lump-sum consideration upon effecting the sale in the previous year, and there was effective conveyance of the capital asset to the transferee. The Tribunal further noted that the monies kept in the escrow account were for meeting claims that may arise on a future date, and that the interest which accrued on the sums retained in the escrow account had been agreed to be belonging to the seller, i.e., the assessee, and had to be paid to the assessee as per the instructions in the escrow account. Therefore, the Tribunal held that the assessee always had a right to receive the sums kept in the escrow account. Though they were to be quantified after a specified period, they did not change the agreed lump-sum sale consideration finalized based on the agreement between the parties. Therefore, the quantification of deductions to be made from the sums lying in the escrow account would not postpone the charge of such income which was deemed to be taxed in the year of transfer.

The Tribunal rejected the argument of the assessee that the entire sale consideration was not received during the relevant year and could not be deemed as income of that year, holding that it was sufficient if, in the relevant year, profits had risen out of sale of capital assets, i.e. when the assessee had a right to receive the profits in the year under consideration, it would attract liability to capital gains tax. According to the Tribunal, it was not necessary that the whole amount of lump-sum consideration should have been received by the assessee in the previous year, and whatever the parties did subsequent to that year would have no bearing on the liability to tax as deemed income of the year under consideration. Reliance was placed by the Tribunal on the Madras High Court decision in the case of TV Sundaram Iyengar and Sons Ltd vs. CIT 37 ITR 26, while upholding the order of the Assessing Officer.

Before the Madras High Court, on behalf of the assessee, attention was drawn to the Business Sale Agreement, and in particular, covenant No. 14 dealing with indemnities for other losses and covenant No. 15 dealing with retention sum for indemnities. The attention of the Court was also drawn to a second supplementary agrement where there was a reference to a charge of theft of electricity and demand raised by the State Electricity Board from the purchaser of the asset. These facts demonstrated that the intention behind retention of a certain sum in escrow account was to meet liabilities which may be fastened on to the purchaser on conclusion of the sale transaction.

On behalf of the assessee, reliance was placed on the following decisions:

• The Bombay High Court decision in the case of CIT vs. Hemal Raju Shete 239 Taxman 176, which was a case where certain amounts were set apart to meet contingent liabilities, and it was held that this amount was neither received nor accrued in favour of the assessee.

• The Supreme Court decision in the case of CIT vs. Hindustan Housing & Land Development Trust Ltd 161 ITR 524, where a similar view was taken.

• The Madras High Court decision in the case of PPN Power Generating Co (P) Ltd vs. CIT 275 Taxman 143 in support of the alternative submission that in the subsequent year the amount had been offered for taxation.

• The Gujarat High Court decision in the case of Anup Engineering Ltd vs. CIT 247 ITR 457.

• Cases of CIT vs. Ignifluid Boilers (I) Ltd 283 ITR 295 (Mad), CIT vs. Associated Cables (P) Ltd 286 ITR 596 (Bom), DIT(IT) vs. Ballast Nedam International 215 Taxman 254 (Guj), and Amarshiv Construction (P) Ltd vs. Dy CIT 367 ITR 659 (Guj), in the context of treatment of retention money withheld by the contractee.

On behalf of the Revenue, before the Madras High Court, it was argued that the Tribunal order was well considered and the factual aspects thoroughly analyzed. It was clearly brought out by the Tribunal on the facts that the retention money kept in the escrow account had accrued in favour of the assessee in the year under consideration. It was pointed out that the entire amount of Rs. 3.25 crore retained in the escrow account had been received by the assessee and offered for taxation in a subsequent year, with no deduction towards claims/warranties from the amount kept in escrow account. Attention was also drawn to the provisions of section 48, with the submission that if either the full value of the consideration had been received by the assessee during the year or it had accrued, that alone would be sufficient, and the subsequent act of the assessee and the purchaser by creating an escrow account would not change the character of receipt of the consideration.

Referring to the various clauses of the Business Sale Agreement, it was submitted that the facts clearly demonstrated that the amount retained in the escrow account, which was a subsequent arrangement between the parties, would have no impact for the purpose of computation of capital gains on the total sale consideration fixed under the agreement. On behalf of the Revenue, reliance was placed on the following decisions:

• The Supreme Court decision in the case of CIT vs. Attilli N Rao 252 ITR 880 in the context of full price realised for the purpose of computation of capital gains.

• CIT vs. N M A Mohammed Haniffa 247 ITR 66 (Mad).

• CIT vs. George Henderson and Co Ltd 66 ITR 622 (SC).

• CIT vs. Smt Nilofer I Singh 309 ITR 233 (Del).

• Smt D Zeenath vs. ITO 413 ITR 258 (Mad).

The decisions relied upon by the Revenue were rebutted by the assessee’s counsel, that all those were cases relating to mortgage, and that the agreement between the assessee and the purchaser clearly showed that the retention money was neither received nor accrued in favour of the assessee during the relevant year.

The Madras High Court examined the provisions of the Business Sale Agreement and noted that the retention amount had been retained for the purpose of ensuring that sufficient funds would be available to indemnify the purchaser against any damages or losses arising from indemnification for breach of warranty, indemnification for other losses, unpaid accounts receivables, and other obligations to pay or reimburse the purchaser as provided under the agreement. It noted that admittedly, no indemnification had to be given under either of the four heads, and the entire amount was received by the assessee without any deduction and was offered for taxation by the assessee in the subsequent year. The High Court noted that the Commissioner (Appeals) had not specifically examined as to whether the entire amount of Rs. 3.25 crore had been received by the assessee without any deduction and offered for taxation, but had solely proceeded on the basis that the escrow account had been opened and amount retained as retention money to be utilized by the purchaser for indemnification or breach of warranty for any other losses. On this basis, the Commissioner (Appeals) had concluded that the retention sum retained in the escrow account had not accrued to the assessee during the relevant year.

According to the Madras High Court, the Terms and Conditions of the Business Sale Agreement were vivid and clear, the total sale consideration having been clearly mentioned. After fixing the full and final sale consideration, the parties mutually agreed to retain a specified quantum of money in an escrow account to meet any one of the exigencies as mentioned in the agreement. Therefore, according to the High Court, for all purposes, the entire sale consideration had accrued in favour of the assessee during the year under consideration. Possession of the asset was also handed over by the assessee. Besides, no deductions were made from the escrow account and the entire amount was received by the assessee and offered to tax.

According to the Madras High Court, the purchaser, retaining a particular amount of money in the escrow account could not take away the amount from the purview of full consideration received or accruing in favour of the assessee for the purpose of computation of capital gains u/s 48. Besides the assessee had received the entire amount of Rs. 3.25 crore without any deduction. The right of the assessee over the amount retained in the escrow account had not been disputed. The Madras High Court observed that assuming certain payoffs were to be made from the retention money, that would not in any manner alter the full and total consideration received by the assessee pursuant to the business sale agreement. Given the factual position, according to the Madras High Court, undoubtedly the entire sale consideration had accrued in favour of the assessee during the relevant assessment year and, assuming that certain payment had been made from the amount retained in the escrow account, it would not change or in any manner reduce the sale consideration.

The Madras High Court therefore upheld the order of the Tribunal, holding the assessee liable to capital gains tax during the relevant year on the entire sale consideration as per the agreement.

DINESH VAZIRANI’S CASE

The issue again recently came up before the Bombay High Court in the case of Dinesh Vazirani vs. Pr CIT 445 ITR 110.

In this case, the assessee, who was a promoter of a company, agreed to sell shares of the company held by him along with other promoters for a total consideration of Rs. 155 crore. The Share Purchase Agreement (SPA) provided for specific promoter indemnification obligations. To meet such promoter indemnification obligations, the SPA provided that out of the sale consideration of Rs. 155 crore, Rs. 30 crore would be kept in escrow. If there was no liability as contemplated under the specific promoter indemnification obligations within a particular period, the amount of Rs. 30 crore would be released by the escrow agent to the seller promoters. A separate escrow agreement was entered into between the sellers, the buyers and the escrow agent.

The assessee filed his return of income in July, 2011 by computing capital gains on his proportion of the total sale consideration of Rs. 155 crore, including the amount kept in escrow, which had not been paid out but was still parked in the escrow account till the time the return was filed. The assessment was selected for scrutiny, and an assessment order was passed u/s 143(3) on 15th January, 2014 accepting the returned income.

Subsequent to the passing of such assessment order, certain statutory and other liabilities arose in the company amounting to Rs. 9.17 crore relatable to the period prior to the sale of the shares. This amount of Rs. 9.17 crore was withdrawn by the company from the escrow account, and therefore the assessee received a lesser amount from the escrow account.

The assessee thereafter filed a revision petition u/s 264 with the Commissioner, stating that the assessment had already been completed taxing the capital gains at higher amount on the basis of sale consideration of Rs. 155 crore without reducing the consideration by Rs. 9.17 crore. It was claimed that since the amount of Rs. 9.17 crore had been withdrawn by the company from the escrow account, what the assessee received was lesser than that mentioned in the return of income, and therefore the capital gain needed to be recomputed by reducing the proportionate amount deducted from the escrow account. It was pointed out that since the withdrawal from the escrow account happened after the completion of assessment proceedings, it was not possible for the assessee to make such a claim before the Assessing Officer or file a revised return. The assessee therefore requested the Commissioner to reduce the long-term capital gains by the proportionate amount withdrawn by the company from the escrow account of Rs. 9.17 crore.

The Commissioner rejected the revision petition on the ground that, from the sale price as specified in the agreement, only cost of acquisition, cost of improvement or expenditure incurred exclusively in connection with the transfer could be reduced in computing the capital gains, and that the agreement between the seller and buyer for meeting certain contingent liability which may arise subsequent to the transfer could not be considered for reduction from the consideration. The Commissioner further held that in the absence of a specific provision by which an assessee could reduce the returned income filed by him voluntarily, the same could not be permitted indirectly by resorting to provisions of section 264. The Commissioner relied on the proviso to section 240, which stated that if an assessment was annulled, the refund would not be granted to the extent of tax paid on the returned income. According to the Commissioner, this showed that the income returned by an assessee was sacrosanct and could not be disturbed, and even an annulment of the assessment would not impact the suo moto tax paid on the returned income. The Commissioner further was of the view that the contingent liability paid out of escrow account did not have the effect of reducing the amount receivable by the promoters as per the agreement.

The assessee filed a writ petition before the Bombay High Court against such order of the Commissioner rejecting the revision petition.

The Bombay High Court held that the order passed by the Commissioner was not correct and quashed the order. It observed that the Commissioner had failed to understand that the amount of Rs. 9.17 crore was neither received by the promoters nor accrued to the promoters, as this amount was transferred directly to the escrow account and was withdrawn from the escrow account. In the view of the High Court, when the amount had not been received by or accrued to the promoters, it could not be taken as the full value of consideration in computing capital gains from the transfer of shares of the company.

The Bombay High Court observed that the Commissioner had not understood the true intent and content of the SPA, and not appreciated that the purchase price as defined in the agreement was not an absolute amount, as it was subject to certain liabilities which might arise to the promoters on account of certain subsequent events. According to the Bombay High Court, the full value of consideration for computing capital gains would be the amount ultimately received by the promoters after the adjustments on account of the liabilities from the escrow account as mentioned in the agreement.

The Bombay High Court referred to the observations of the Supreme Court in CIT vs. Shoorji Vallabhdas & Co 46 ITR 144, where the Supreme Court had held that income or gain is chargeable to tax on the basis of the real income earned by an assessee, unless specific provisions provide to the contrary. The Bombay High Court noted that in the case before it, the real income (capital gain) would be computed only by taking into account the real sale consideration, i.e., sale consideration after reducing the amount withdrawn from the escrow account.

The Bombay High Court observed that the Commissioner had proceeded on an erroneous understanding that the arrangement between the seller and buyer which resulted in some contingent liability that arose subsequent to the transfer could not be reduced from the sale consideration as per section 48. As per the High Court, the liability was contemplated in the SPA itself, and had to be taken into account to determine the full value of consideration. If the sale consideration specified in the agreement was along with certain liability, then the value of consideration for the purpose of computing capital gains u/s 48 was the consideration specified in the agreement as reduced by the liability. In the view of the High Court, it was incorrect to say that the subsequent contingent liability did not come within any of the items of reduction, because the full value of the consideration u/s 48 would be the amount arrived at after reducing the liabilities from the purchase price mentioned in the agreement. Even if the contingent liability was to be regarded as a subsequent event, then also, it ought to be taken into consideration in determining the capital gain chargeable u/s 45.

The Bombay High Court expressed its disagreement with the Commissioner on his statement that the contingent liability paid out of escrow account did not affect the amount receivable as per the agreement for the purposes of computing capital gains u/s 48. As per the High Court, the Commissioner failed to understand or appreciate that the promoters had received only the net amount of Rs. 145.83 crore, i.e., Rs. 155 crore less Rs. 9.17 crore, and that such reduced amount should be taken as full value of consideration for computing capital gains u/s 48.

The Bombay High Court also rejected the Commissioner’s argument that the assessee’s returned income could not be reduced by filing a revision petition u/s 264. According to the High Court, section 264 had been introduced to factor in such situation as the assessee’s case, because if income did not result at all, there could not be a tax, even though in bookkeeping, an entry was made for hypothetical income which did not materialise. Section 264 did not restrict the scope of power of the Commissioner to restrict a relief to assessee only up to the returned income. Where the income can be said not to have resulted at all, there was obviously neither accrual nor receipt of income, even though an entry may have been made in the books and account. Therefore, the Commissioner ought to have directed the Assessing Officer to recompute the income as per the provisions of the Act, irrespective of whether the computation resulted in income being less than the returned income. The Bombay High Court stated that it was the obligation of the Revenue to tax an assessee on the income chargeable to tax under the Act, and if higher income was offered to tax, then it was the duty of the Revenue to compute the correct income and grant the refund of taxes erroneously paid by an assessee.

The Bombay High Court therefore held that the capital gain was to be computed only on the net amount actually received by the assessee, and that he was entitled to refund of the excess taxes paid by him on the returned capital gains.

OBSERVATIONS

Section 45(1) provides that any capital gains arising from the transfer of a capital asset effected in the previous year shall be chargeable to tax under the head “Capital Gains” and shall be deemed to be the income of the previous year in which the transfer took place. Undoubtedly, in both these cases, discussed herein, there was no dispute about the year of transfer or the amount of consideration. The consideration had been agreed upon, and the payment was made by the purchaser. The issue was really whether the amount retained with the escrow agent was retained on behalf of the seller, or was consideration withheld on behalf of the purchaser, and whether the amount so kept in escrow could be reduced from the full value of consideration and the taxable capital gains.

While the Madras High Court has taken the view that the amount retained in the escrow account was received by and accrued to the assessee, the Bombay High Court has taken the view that such amount in escrow cannot be said to have been received by or accrued to the assessee. To understand the tax effect of an escrow arrangement, it is necessary to understand the legal implications of such an arrangement.

The Bombay High Court, in the case of Hira Mistan vs. Rustom Jamshedji Noble & Others 2000 (1) BomCR 716, has observed:

“An escrow has been held to be a document deposited with the third person to be delivered to the person purporting to be benefited by it upon the performance of some condition, the fulfillment of which is only to bring the contract into existence… Escrow has also been explained as an intended Deed after sealing and any signature required for execution as a deed, be delivered as an escrow, that is as a simple writing which is not to become the deed of the party expressed to be bound by it until some condition has been performed. Escrow has also been defined to mean that where an instrument is delivered to take effect on the happening of a specified event or upon condition that it is not to be operative until some condition is performed then pending the happening of that event or the performance of the condition the instrument is called an escrow.”

The Bombay High Court, in Jeweltouch (India) Pvt. Ltd. vs. Naheed Hafeez Quraishi And Ors 2008 (3) BomCR 217, has observed:

“When parties to an agreement or the executants of a document place the agreement or, as the case may be, the document in escrow, parties intend that pending the fulfillment of certain conditions which they stipulate, the document will be held in custody by the person with whom it is placed. Notwithstanding the execution of the agreement or the execution of the document, the act of placing the instrument in escrow evinces an intent that the document would continue to lie in escrow until a condition which is precedent to the enforceability of the document comes to exist. The instrument becomes valid and enforceable in law only upon the due fulfillment of a prerequisite and often the parties may stipulate the due satisfaction of a named person on the fulfillment of the condition. An Escrow agent may be appointed by the parties as the person who will determine whether a promise or condition has been fulfilled so as to warrant the release of the document from escrow. In Wharton’s Law Lexicon, the effect of an escrow is stated thus: Escrow, a writing under seal delivered to a third person, to be delivered by him to the person whom it purports to benefit upon some condition. Upon the performance of the condition it becomes an absolute deed; but if the condition be not performed, it never becomes a deed. It is not delivered as a deed, but as an escrow, i.e. a scrowl, or writing which is not to take effect as a deed till the condition be performed.”

In Halsbury the effect of the delivery of a document as escrow is explained thus:

“1334. Effect of delivery as escrow. When a sealed writing is delivered as an escrow it cannot take effect as a deed pending the performance of the condition subject to which it was so delivered, and if that condition is not performed the writing remains entirely inoperative. If, therefore, a sealed writing delivered as an escrow comes, pending the performance of the condition and without the consent, fault, or negligence of the party who so delivered it, into the possession of the party intended to benefit, it has no effect either in his hands or in the hands of any purchaser from him; for until fulfillment of the condition it is not, and never has been, the deed of the party who so delivered it. When a sealed writing has been delivered as an escrow to await the performance of some condition, it takes effect as a deed (without any further delivery) immediately the condition is fulfilled, and the rule is that its delivery as a deed will, if necessary, relate back to the time of its delivery as an escrow; but the relation back does not have the effect of validating a notice to quit given at a time when the fee simple was not vested in the person giving it.”

While these views are in the context of a document placed in escrow, the views might help to understand the impact of money placed in escrow also and may impact the final computation of capital gains until such time consideration payable attains finality based on the fulfillment of the conditions of the escrow . However, once the conditions are fulfilled, the payment would relate back to the date when the payment was deposited with the escrow agent. In substance therefore, the escrow agent is holding the amount on behalf of the seller, but the funds are released only after fulfilment of the conditions of escrow.

If one examines the facts of the two cases discussed, in the case before the Madras High Court, there was no deduction or reduction from the amount placed in escrow, and therefore the question of amendment of the consideration did not arise at all. Since capital gains is chargeable in the year of transfer, the Madras High Court held that the entire capital gain, including amount placed in escrow was taxable in that year itself.

The facts before the Bombay High Court were that there was actually a deduction from the amount placed in escrow, and the amount of consideration therefore underwent a change. The amount withdrawn from the escrow account was ultimately never received as income by the seller as the amount was returned to the buyer. The issue before the Bombay High Court was whether a revision of the assessment order was possible in view of the facts, which arose due to subsequent events impacting the taxable capital gains. It was in that context that the High Court took the view that the real income had to be considered, and not a notional income.

Viewed in this light, there is no conflict between the decisions of the two Courts. Both have rightly decided the cases before them on the merits of the cases before them. In one case, the fact was that the amount eventually was paid in full to the seller as was agreed while in the other case, a part of the agreed consideration, though paid, was returned to the buyer. Therefore, deferment of the liability to capital gains tax was not intended nor was it suggested by the Bombay High Court, and what was suggested was the downward revision of the consideration that was offered for taxation.

Therefore, to take the view that the amount placed in escrow should be taxable if and only when released from escrow on fulfillment of the conditions does not appear to be the attractive position in law.

The moot question that arises in such circumstances is as to what should be the manner of correction of the capital gains offered for taxation when the consideration so offered subsequently undergoes a change, as per the conditions provided in the sale agreement itself. The assessment of the capital gains legally cannot be held back, as that would take away the time bound finality of an assessment. There is presently no provision in law that permits the deferment of taxation to the later year on receipt of the amount released from the escrow account. No transfer in law can be said to have taken place in such later year, and the charge of capital gains would fail in that later year for want of transfer required for application of s. 45.

The only possibility therefore is that while the income be offered in the year of transfer based on the agreed consideration, without factoring in the events subsequent to the filing of the return, which have modified the actual consideration, the assessee can, as per the law applicable today, only take recourse to the existing provisions for filing a revised return (which time is generally inadequate after the reduced time limits),or for filing a revision petition with the Commissioner u/s 264, which time is also inadequate in many cases to revise the claim.

It is therefore essential that the law take cognizance of the difficulty arising on account of the subsequent revision of the consideration being redefined due to subsequent events by permitting rectification, revision or fresh claim without affecting the primary liability of offering the full value of consideration. This may be made possible by amending section 155 to permit rectification, by adding to the many existing situations therein, requiring the assessee to demonstrate the contingency actually happened, resulting in amendment of the consideration.

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Disallowance u/s 14A Where No Exempt Income and Effect of Explanation

ISSUE FOR CONSIDERATION

S.14A, introduced by the Finance Act, 2001, provides for disallowance with retrospective effect from 1st April, 1962 of an expenditure incurred in relation to income which does not form part of the total income under the Income-Tax Act. The expenditure to be disallowed is required to be determined in accordance with Rule 8D of the Income-Tax Rules provided the AO, having regard to the accounts, is not satisfied with the correctness of the claim of the assessee, including the claim that no expenditure has been incurred in relation to an exempt income.

The provision of s.14A r.w. Rule 8D has been the subject matter of unabated litigation since its introduction, which continues despite various amendments made thereafter. The subjects of litigation involve a variety of reasons and many of them have reached the Apex Court. One such subject is about the possibility of disallowance in a case where the assessee has not earned any exempt income during the year for which expenditure is incurred.

Applying the law prior to the recent insertion of the Explanation and the non-obstante clause in s. 14A, the Delhi High Court in the case of Cheminvest Ltd., 61 taxmann.com 118, ruled that no disallowance could be made u/s 14A if no exempt income had been earned during the year. The Supreme Court has dismissed the SLP against the Madras High Court ruling that s.14A could not be invoked where no exempt income was earned by the assessee in the relevant assessment year. Chettinad Logistics (P) Ltd., 95 taxmann.com 250 (SC).

The legislature, for undoing the impact of the law laid down by the Supreme Court, has introduced an Explanation to s.14A by the Finance Act, 2022, w.e.f 1st April, 2022. The said Explanation reads as under: “Explanation-For the removal of doubts, it is hereby clarified that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where the income, not forming part of the total income under this Act, has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such income not forming part of the total income.”

The Explanatory Memorandum to the Finance Bill, 2022, relevant parts, reads as:

“4. In order to make the intention of the legislation clear and to make it free from any misinterpretation, it is proposed to insert an Explanation to section 14A of the Act to clarify that notwithstanding anything to the contrary contained in this Act, the provisions of this section shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the previous year relevant to an assessment year and the expenditure has been incurred during the said previous year in relation to such exempt income.

5. This amendment will take effect from 1st April, 2022.”

Simultaneously a non-obstante clause is introduced in s. 14A(1) which reads as: Notwithstanding anything contained to the contrary in the Act, for the purposes of ………………” The Explanatory Memorandum, relevant parts, read as:

“6. It is also proposed to amend sub-section (1) of the said section, so as to include a non-obstante clause in respect of other provisions of the Income-tax Act and provide that no deduction shall be allowed in relation to exempt income, notwithstanding anything to the contrary contained in this Act.

7. This amendment will take effect from 1st April, 2022 and will accordingly apply in relation to the assessment year 2022-23 and subsequent assessment years”.

Ironically, an amendment made to settle a raging controversy has itself become the cause of another fresh controversy. An issue has arisen whether the Explanation now inserted, is prospective in its nature and therefore would apply to A.Y. 2022-23 onwards or would apply retrospectively to cover at least the pending assessments and appeals. While the Mumbai Bench of the Tribunal, has held the Explanation to be prospective in its application, the Guwahati Bench of the Tribunal has held the same to be retrospective in nature and has applied the same in adjudicating an appeal before it for A.Y. 2009-10 and onwards. The Delhi High Court, however, has in a cryptic order recently held the Explanation to be prospective. The Guwahati Bench has passed a detailed order for holding the Explanation to be retrospective for a variety of reasons which are required to be noted and may require examination by the Courts to arrive at a final conclusion on the subject.

BAJAJ CAPITAL VENTURES (P) LTD.’S CASE

The issue first came up for consideration of the Mumbai bench of the ITAT in the case of ACIT vs. Bajaj Capital Ventures (P.) Ltd. 140 taxmann.com 1. In the cross appeals filed, one of the grounds raised by the assessee company was “On the facts and in the circumstances of the case and in law, the respondent prays that no disallowance ought to be made in absence of earning of any exempt income.”

During the course of the scrutiny assessment proceedings, it was noticed that the assessee was holding investments in shares, which were for the purpose of earning dividend income, but no disallowance was made u/s 14A for expenses incurred to earn this tax exempt income. The AO disallowed an amount of Rs. 11,87,85,293 under rule 8D r.w. Section 14A. Aggrieved, the assessee carried the matter in appeal before the CIT(A), who restricted the disallowance to Rs. 9,87,978, as was claimed by the assessee, with observations, inter alia, as follows:

6.2 I have considered the assessment order and the submission of the appellant. The issue regarding applicability of section 14A read with rules 8D of the Income Tax Rules,1962 has been the subject matter of incessant litigation on almost every issue, involved, i.e. whether a disallowance can be made when no exempt income has been earned during the year, whether the satisfaction has been correctly recorded by the AO regarding the correctness of the claim and in respect of such expenditure incurred in relation to exempt income, whether share application money is to be considered as investment, whether investment in subsidiary company or joint ventures can be said to be made with a view of earn exempt income etc. In the present case the admitted fact is that no dividend income or any other exempt income has been earned during the year under consideration. The present legal position established by the Delhi High Court in the case of Cheminvest Ltd. (61 taxmann.com 118), which has also been relied upon by the appellant, is that no disallowance can be made if no exempt income has been earned during the year. Recently, in the case of Commissioner of Income Tax, (Central) 1 v. Chettined Logistics (P) Ltd. [(2018) 95 taxmann 250 (SC)1, the Hon’ble Supreme Court have dismissed the SLP against High Court ruling that section 14A cannot be invoked where no exempt income was earned by assessee in relevant assessment year. The ITAT Mumbai [jurisdictional ITAT] has recently in the case of ACIT v. Essel Utilities Distribution re affirmed the same.”

On further appeals by the assessee and the revenue, to the Tribunal, the bench on due consideration of the rival contentions and facts, passed the following order in light of the applicable legal position;

“7. We find that there is no dispute about the fact that the assessee did not have any tax exempt income during the relevant previous year and that the period before us pertains to the period prior to insertion of Explanation to section 14A. In this view of the matter, and in the light of consistent stand by co-ordinate benches, following Hon’ble Delhi High Court’s judgment in the case of Cheminvest Ltd v. CIT [(2015) 61 taxmann.com 118 (Del)], we uphold the plea of the assessee that no disallowance under section 14A was and in the circumstances of the case. The plea of the Assessing Officer is thus rejected. As regards the disallowance of Rs. 9,87,978/- it is sustained on the basis of computation given in the alternative plea of the assessee, but given the fact that the basic plea of non-disallowance itself was to be upheld, there was no occasion to consider the computation given in the alternative plea. This disallowance of Rs. 9,87,978/- must also be deleted.

8. In view of the above discussions, we hold that no disallowance under section 14A was justified on the facts, and the remaining disallowance of Rs. 9,87,978/- must be deleted. Ordered, accordingly.

9. In the result, appeal of the Assessing Officer is dismissed and appeal of the assessee is allowed. Pronounced in the open court today on the 29th day of June, 2022.”

It is clear from the reading of the order that the bench did notice that the period involved in appeal pertained to a period for which the Explanation inserted by the Finance Act, 2022 was not applicable and in view of the same had thought it fit to not to invoke application of the Explanation on the understanding that the said Explanation had no retrospective application, though this part has not been expressly noted in the body of the order.

The catch words by Taxmann read as: “The assessee did not have any tax exempt income during the relevant previous year (P.Y. 2016-17/A.Y. 2017-18) which pertains to the period prior to insertion of Explanation to section 14A (by Finance Act, 2022 w.e.f. 1st April,). As the new Explanation applies with effect from A.Y. 2022-23 and does not even have limited retrospective effect even to proceedings for past assessment years pending on 1st April, 2022, no disallowance u/s 14A shall apply in the absence of any tax-free income in the relevant assessment year prior to A.Y. 2022-23.”

WILLIAMSON FINANCIAL SERVICES LTD.’S CASE

Back to back, the issue came up again in the case of ACIT vs. Williamson Financial Services Ltd. 140 taxmann.com 164 (Guwahati – Trib.) relating to the A.Ys. 2009-10 and 2012-13 to 2014-15. In assessing the income for A.Y 2013-14, the AO noted that the assessee during the year had earned an exempt dividend income of Rs. 3,70,80,750 on the investments made by the company. He also noticed that the own funds of the company were not sufficient to meet the investments in question and therefore, applied the provisions of s.14A read with Rule 8D and computed the expenditure relatable to the exempt dividend income at Rs. 10,62,10,110. Since the assessee in its computation of income had suo moto disallowed an amount of Rs. 2,25,48,285 on account of expenditure relatable to the tax exempt dividend income earned by it, the AO disallowed the balance amount of Rs. 8,36,61,625 and added back the same to the income and computed the taxable income accordingly.

Being aggrieved by the same, the company filed an appeal before the CIT(A) who, relying upon the decision in the case of Moderate Leasing and Capital Services Private Limited ITA 102/(2018) dated 31/01/2018, held that the disallowance u/s 14A could not exceed the total tax exempt income earned during the year. He accordingly restricted the disallowance to the extent of exempt income earned by the company.

Being aggrieved by the above action of the CIT(A), the revenue has appealed to the ITAT. The Revenue contested the decision of the CIT (Appeals) on the ground that he was not justified in facts as well as in law in restricting the disallowance u/s 14A to the extent of income claimed exempt for the assessment year under consideration.

The Revenue invited the attention to the newly inserted Explanation to s. 14A to submit that it had now been clarified that notwithstanding anything to the contrary contained in the Act, the provisions of s.14A should apply and be deemed to have always applied in a case where the income, not forming part of the total income had not accrued or arisen or had not been received during the year and the expenditure had been incurred during the year in relation to such income. It was contended that the Explanation was declaratory and clarificatory in nature, therefore, the same would apply with retrospective effect, and that the action of the CIT(A) in restricting the disallowance to the extent of exempt income earned by the assessee was not as per the mandate of the amended law.

The Revenue supported its contentions with the following submissions:

The CBDT Circular No. 5/2014 dated 11th February, 2014, had clarified that disallowance of the expenditure would take place even where the taxpayer in a particular year had not earned any exempt income.

Ignoring the circular, the Courts had held that where there was no exempt income during the year, no disallowance u/s 14A of the Act could be made. Such an interpretation by the Courts, ignoring the expressed intent stated in the circular, in the opinion of the legislature was not in line with its intent and defeated the legislative intent of s.14A of the Act.

In order to make the intention of the legislation clear and to make it free from misinterpretation and to give effect to the CBDT’s Circular No. S/2014 dated 11th February, 2014, the Legislature had made two changes to s. 14A through the Finance Act, 2022, which are (a). Insertion of non-obstante clause by way of substitution and, (b). Insertion of an Explanation to reinforce, by way of clarification, the intents of the CBDT’s Circular No.05/2014 dated 11th February, 2014.

The main objective to insert a non-obstante clause in sub-section (1) of s.14A which read as “Notwithstanding anything to the contrary contained in this Act, for the purpose of…” was to overcome the observations made in the case of Redington (India) Ltd vs. Addl.CIT, 392 ITR 633, 640 (Mad), wherein it was observed that an assessment in terms of the Act was specific to an assessment year and related previous year as per s.4 r.w.s. 5 of the Act. The Madras High Court in that case had further held that any contrary intention, if there was, would have been expressly stated in s.14A and in its absence, the language of s. 14A should be read in the context such that it advanced the scheme of the Act rather than distort it. Such interpretation of the Court had made the Circular No.05/2014 dated 11th February, 2014 infructuous. To address the misunderstanding, the legislature had inserted the Explanation to clarify its intentions.

The Explanation inserted contained another non-obstante clause, to overcome the past judicial observations and it was clarified the intention of the legislature that the Explanation should always be deemed to have been in s.14A for disallowance of any claim for deduction against expenditure incurred to earn an exempt income, irrespective of the fact whether or not any income was earned in the same financial year.

Further, in general parlance, whenever a clarificatory amendment with the use of words such as “for the removal of doubts”, and “shall be deemed always to have meant” etc. was made, the amendment was to have a retrospective effect, even if it was made effective prospectively.

Circular No 5/2014 dated 11th February, 2014 was still in force, and for invoking disallowance u/s 14A of the Act, it was not material that the assessee should have earned such exempt income during the financial year under consideration.

The decision of the CIT(A) holding that the disallowance u/s 14A read with Rule 8D could not exceed the income claimed exempt appeared to be perverse.

In reply, on behalf of the assesse, it was submitted that the Explanation to s. 14A introduced vide the Finance Act 2022, was prospective in nature and could not be applied to the pending appeals, and that the law settled prior to the insertion of the Explanation, holding that the disallowance of expenditure u/s 14A could not exceed the exempt income earned by the assessee during the year, alone should apply. It was further contended that:

Even after the issue of the CBDT Circular No. 5/2014 dated 11th February, 2014, the Courts held that when there was no exempt income, then disallowance u/s 14A was unwarranted, following a simple rule that when there was no exempt income, there was no necessity to disallow the expenditure. CIT vs. Corrtech Energy Pvt. Ltd., 223 Taxman 130 (Guj); CIT vs. Holcim India Pvt. Ltd., 57 taxmann.com 28 (Del); Marg Ltd vs. CIT,120 taxmann.com 84 (Madras).

The Delhi High Court, in the case of CIT vs. Moderate Leasing and Capital Services Pvt. Ltd in ITA 102/2018 order dated 31/01/2018 had held that disallowance u/s 14A should not exceed the exempt income itself. The SLP filed by the Revenue was dismissed by the Supreme Court of India Special Leave Petition (Civil) Diary No(s). 38584/2018 dated 19/11/2018.

The Guwahati bench of the ITAT, in deciding the issues in favour of the Revenue on due consideration of the contentions of the opposite parties, observed as under:

In determining the effective date of the application of an amendment, prospective or retrospective, the date from which the amendment was made operative did not conclusively decide the question of its effective date of application.

The Court had to examine the scheme of the statute prior to the amendment and subsequent to the amendment to determine whether an amendment was clarificatory or substantive.

An amendment which was clarificatory was regarded by the Courts as being retrospective in nature and its application would date back to the date of introduction of the original statutory provision which it sought to amend. Clarificatory amendment was an expression of intent which the Legislature had always intended to hold the field with retrospective effect.

A clarificatory amendment might be introduced in certain cases to set at rest divergent views expressed in decided cases on the true effect of a statutory provision.

Where the Legislature expressed its intent, by declaring the law as clarificatory, it was regarded as being declaratory of the law as it always stood and was therefore, construed to be retrospective.

A perusal of the Explanation revealed that it started with the words “For the removal of doubts, it is hereby clarified ……”. Then the wording in the body of the provision expressly stated: “…..the provisions of this section shall apply and shall be deemed to have always applied……”

The opening words of the Explanation revealed in an unambiguous manner that the said provision was clarificatory and had been inserted for removal of doubts. Further, as provided in the Memorandum explaining the provision, the Explanation had been inserted to make the intention clear and to make it free from any misinterpretation.

The said Explanation being clarificatory in nature was inserted for the purpose of removal of doubts and to make the intention of the legislature clear and free from misinterpretation and thus the same, obviously, would operate retrospectively.

Any contrary interpretation holding that the said Explanation shall operate prospectively would render the words “shall apply and shall be deemed to have always applied” as redundant and meaningless, which was not the intention of the legislature.

The Explanation did not propose to levy any new taxes upon the assessee but it only purported to clarify the intention of the legislature that actual earning or not earning of the exempt income was not the condition precedent for making the disallowance of the expenditure incurred to earn an exempt income.

The legal position was declared by the Supreme Court in the case of Walfort Share & Stock Brokers Pvt. Ltd., 326 ITR 1 (SC), that the expenses allowed could only be those incurred for earning the taxable income; that the basic principle of the taxation was to tax the net income and on the same analogy, the exemption was also in respect of net income.

The Supreme Court in the case of CIT vs. Rajendra Prasad Moody 115 ITR 519 had held that even if there was no income, the expenditure was allowable. Income included loss, as was held by the Supreme Court in the case of CIT vs. Harprasad & Co. P Ltd. 99 ITR 118, and as such only the net income was taxable, i.e. gross income minus expenditure, and as such the net income might be a loss also.

Since the earning of positive net income was not a condition precedent for claiming deduction of expenditure, on the same analogy, the earning of exempt income was also not a condition precedent for attracting a disallowance of expenditure incurred to earn exempt income. This position had only been reiterated and clarified by the Explanation to s.14A, so as to remove the doubts and to make clear the intention of the legislature and to make the provision of s. 14A free from any other interpretation. Therefore, it could not be said that the Explanation proposed or saddled any fresh liability on the assessee.

The contention of the assessee that the Explanation applied only to those cases where no exempt income had been earned at all and that the said Explanation was not applicable to cases where the assessee had earned some exempt income was not acceptable; such a proposition might place different assessees in inequitable position. In such a scenario, in a case where an assessee did not earn any exempt income, he might suffer disallowance as per the formula prescribed under Rule 8D, whereas, in a case where an assessee earned some meagre exempt income, the disallowance in his case would be restricted to such meagre exempt income and the assessee having no exempt income, would have to suffer more disallowance than the assessee having meagre exempt income. Even otherwise, the Explanation sought to clarify the position that the disallowance of expenditure relatable to exempt income was not dependent upon actual earning of any exempt income.

The legal position that the AO must first record satisfaction as to the correctness of the claim of the assessee in respect of expenditure incurred in relation to exempt income before invoking rule 8D for disallowance of expenditure u/s 14A continued to apply and should still be adhered to and the aforesaid Explanation introduced vide Finance Act 2022 did not in any manner change that position. There was no change of the legal position even after introduction of the Explanation.

The Guwahati bench of the tribunal in conclusion held that the:

Explanation to s. 14A, inserted by Finance Act, 2022 w.e.f. 1st April, 2022, shall apply retrospectively even for periods prior to 1st April, 2022.

Disallowance of expenditure incurred in relation to exempt income shall apply in terms of the Explanation even in those cases where assessee has earned no exempt income during the relevant assessment year.

Application of the amendment shall not be restricted to those cases where assessee had earned some exempt income which was less than expenditure incurred in relation to exempt income.

The disallowance could not be limited to the amount of exempt income of an year.

The decision of the Mumbai bench of the Tribunal in the case of ACIT vs. Bajaj Capital Ventures (P.) Ltd. (supra), holding a contrary view that the Explanation to s.14A inserted w.e.f. 1st April, 2022 has no retrospective applicability, was not expressly considered by the bench as the same might not have been cited by the assessee.

OBSERVATIONS

Section 14A of the Act was introduced in 2001, with retrospective effect from the year 1962, to state that no deduction shall be granted towards an expenditure incurred in relation to an income which does not form part of the Total Income. The method for identifying the expenditure incurred is prescribed under Rule 8D of the Income-tax Rules,1962. Further, by the Finance Act, 2006, sub-sections (2) and (3) have been inserted w.e.f. 1st April, 2007.

A Proviso was inserted earlier by the Finance Act of 2002 with retrospective effect from 11th May, 2001. It reads: “Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001”.

The CBDT has issued a Circular No. 5 dated 11th February, 2014, clarifying that Rule 8D r.w.s. 14A provides for disallowance of the expenditure even where taxpayer in a particular year has not earned any exempt income. The circular noted that still some Courts had taken a view that if there was no exempt income during a year, no disallowance u/s 14A could be made for that year. The Circular had stated that such an interpretation by the Courts was not in line with the intention of the legislature.

Over the years, disputes have arisen in respect of the issue whether disallowance u/s 14A can be made in cases where no exempt income has accrued, arisen or received by the assessee during an assessment year. From its inception, the applicability of this provision has always been a subject matter of litigation and one such point that has been oft-debated is regarding the disallowance of expenditure in the absence of exempt income. In 2009, a Delhi Special Bench of the Tribunal in Cheminvest Ltd. vs. CIT, 121 ITD 318, took a view that when an expenditure is incurred in relation to an exempt income, irrespective of the fact whether any exempt income was earned by the assessee or not, disallowance should be made, a position that has not been found acceptable to the Courts, including the Apex Court.

An interesting part is noticed on reading of the Explanatory Memorandum to the Finance Bill, 2022 which clarifies that the Explanation has been inserted in s. 14A w.e.f. 1st April, 2022, while the non-obstante clause in sub- section (1) of s. 14A has been inserted w.e.f A.Y. 2022-23. This inconsistent approach has led one to wonder whether the insertion of the Explanation is prospective and is applicable to A.Y. 2022-23 and onwards, while the amendment in s.14A(1) made applicable w.e.f. 1st April, 2022 has a retrospective applicability to pending proceedings on 1st April, 2022.

The amendment, by insertion of non-obstante clause in sub-section (1), is expressly made effective from 1st April, 2022; whereas in respect of the Explanation, as noted vide paragraph 5 of the Memorandum, it is written that the amendment will take effect on 1st April, 2022 and will accordingly apply in relation to A.Y. 2022-23 and subsequent assessment years.

The Explanation inserted in the section is worded as: ‘Section 14A shall apply and shall be deemed to have always applied in a case where exempt income has not accrued or arisen or has not been received during the financial year and the expenditure has been incurred in relation to such exempt income.’ The provision seems to apply to past transactions as well, but the Memorandum makes it effective from A.Y. 2022-23 only.

Whether the provisions of s. 14A will have a retroactive application? Will the Explanation apply retrospectively even where the same has been expressly made affective from A.Y. 2022-23? Can the Explanatory Memorandum override the language of the law amended? Can there be a mistake in the Memorandum and if yes, can it be overlooked? Can it be said that the amendment in s. 14A by the Finance Act, 2022 by inserting an Explanation to s. 14A alters the position of law adversely for the assessee and hence, such an amendment cannot be held to be retrospective in nature? These are the questions that have arisen in a short span that have a serious impact on the adjudication of the assessments and appeals, and may lead to rectification, revision and reopening of the completed assessments.

The Delhi High Court, in the case of Moderate Leasing and Capital Services Pvt. Ltd in ITA 102/2018 dated 31/01/2018 held that disallowance u/s 14A should not exceed the exempt income itself; the SLP filed by the Revenue against this judgment was dismissed by the Supreme Court of India Special Leave Petition (Civil) Diary No(s). 38584/2018 dated 19/11/2018. Can such a finality be disturbed and reversed by the Explanation now inserted, even where the Explanation is not introduced with retrospective effect?

A proviso to s.14A inserted by the Finance Act, 2002, with retrospective effect from 11th May, 2001, prohibits an AO from reassessing an income u/s 147 or passing an order enhancing the assessment or reducing the refund u/s 154 for any assessment year up to 2001-02. No such express prohibition is provided for in respect of the application of the Explanation in question.

The CBDT vide Circular No. No. 5/2014, dated 11th February, 2014, had clarified the stand of the Government of India that the expenditure, where claimed, would be liable for disallowance even where the assessee has not earned any taxable income for the year. The Courts, in deciding the issue, have not followed the mandate of the Circular.

The incidental issue that has come up is about the application of Explanation to cases where some exempt income is earned during the year. It is argued that the Explanation would have no application in such cases in as much as the Explanation can apply only to cases where no exempt income has accrued or arisen or been received during the year.

It is important to appreciate the true nature of the Explanation; does it supply an obvious omission or does it clear up the doubts as to the meaning of the previous law. If yes, it could be considered as declaratory or curative and its retrospective operation is generally intended. Venkateshwara Hatcheries Ltd., 237 ITR 174 (SC). The other aspect that has to be considered in deciding the effective date of application is to determine whether the amendment levies a tax with retrospective effect; if yes, it’s retrospective application should be given only if the amendment is made expressly retrospective and not otherwise. Retrospectivity, in such a case, cannot be presumed. Thirdly, an amendment which divests an assessee of a vested right should be applied retrospectively with great discretion even where such an amendment is made expressly retrospective.

An explanatory, declaratory, curative or clarificatory amendment is considered by Courts to be retrospective. Allied Motors, 224 ITR 677 (SC). This is true so far as there prevailed a doubt or ambiguity and the amendment is made to remove the ambiguity and provide clarity. However, an amendment could not be retrospective even where it is labeled as clarificatory and for removal of doubts where there is otherwise no ambiguity or doubt. Vatika Township P. Ltd., 367 ITR 490 (SC). In provisions that are procedural in nature, it is not difficult to presume retrospective application. Even in such case the retrospectivity would be limited to the express intention. National Agricultural, 260 ITR 548 (SC).

Article 20 of the Constitution imposes two limitations on the retrospective applicability. Firstly, an act cannot be declared to be an offence for the first time with retrospective effect, and secondly, a higher penalty cannot be inflicted with retrospective effect.

A declaratory act is intended to remove doubts regarding the law; the purpose usually is to remove a doubt as to the meaning of an existing law or to correct a construction by Courts considered erroneous by the legislature. Insertion of an Explanation where intended to supply an obvious omission or clear up doubts as to the true meaning of the Act is usually retrospective. However, in the absence of the clear words indicating that the amendment is declaratory it would not be so construed when the pre-amended provision was clear and unambiguous. A curative amendment is generally considered to be retrospective in its operation. Lastly, the substance of the amendment is more important than its form. Agriculture Market Committee, 337 ITR 299 (AP) and Brij Mohan, 120 ITR 1 (SC).

The sum and substance emerging from the above discussion is that an amendment in law is retrospective when it is so provided and it is prospective when it is not so provided in express terms. Even a declaratory or a clarificatory amendment requires an express intention to make it retrospective. In other words, there is no presumption for an amendment to be considered as retrospective in nature, unless the amendment is procedural in nature.

The power of the legislature to make a retrospective amendment is not in question here. It is a settled position that an amendment can be made by the legislature with retrospective effect and when so made, it would always be presumed to have been made w.e.f. the date specified in the amendment, and would be enforced by the authorities in applying the law as amended. In many cases of amendments, it may be necessary to examine the scheme of the Income-Tax Act prevailing prior to the amendment and also subsequent to the amendments. Vijayawada Bottling Co. Ltd., 356 ITR 625 (AP).

The issue under consideration as noted is more complex or different; the Explanation inserted in s.14A is expressly made to be effective from 1st April, 2022 and is intended to apply to A.Y. 2022-23, onwards. Under the circumstances, on a first blush it would be correct to concur with the decisions of the Mumbai Bench and of the Delhi High Court, but for the fact that these decisions have not considered the intention of the legislature behind the amendment in detail, which is expressed in so many words in the Explanatory Memorandum. Importantly, they have not considered the express language of the Explanation, which reads as ‘the provisions of this section shall apply and shall be deemed to have always applied’.

The challenge here is to resolve the conflict that is posed on account of two contrasting expressions and terms used in the Explanation and in the Explanatory Memorandum. The Explanation in clear words provides for a retrospective application, while the Explanatory Memorandum applies the amendment prospectively. In such circumstances, the issue for consideration is whether the effect should be given to the express language of the Explanation or to the Explanatory Memorandum for determining the date of its application. The Guwahati Bench, is of the view that in such circumstances the Court should examine the true legislative intent instead of simply being swayed by the express mention of the effective date and assessment year in the Explanatory Memorandum. For this, the Bench has relied upon the decision in the case of Godrej & Boyce, Mfg. Co. Ltd., 328 ITR 81 (Bom.). The view that is canvased is that the mention of the date or the year in the Explanatory Memorandum is not sacrosanct or conclusive of the retrospective nature or otherwise of the amendment.

The Bombay High Court, in the case of Godrej & Boyce, Mfg. Co. Ltd., (supra.), relying on several decisions of the Supreme Court, had held that in determining the effective date of applying an amendment, the date from which the amendment was made operative did not conclusively decide the question and the Court has to examine the scheme of the statute prevailing prior to and subsequent to the amendment to determine whether an amendment was clarificatory or substantive and further, if it was clarificatory, it could be given a retrospective effect, and if it was substantive, it should be prospectively applied.

It further held that a clarificatory amendment was an expression of intent which the legislature had always intended to hold the field; such an amendment might be introduced in certain cases to set at rest divergent views expressed in decided cases on the true effect of a statutory provision. The Court accordingly held a legislative intent when clarified was to be regarded as declaratory of the law as it always stood and therefore be construed as retrospective provided the amendment did not bring about a substantive change in legal rights and obligations of the parties.

The Guwahati Bench of the Tribunal, taking a leaf from the above referred decision in the case of Godrej & Boyce, Mfg. Co. Ltd., 328 ITR 81 (Bom.), held that simply because the Explanatory Memorandum provided that the Explanation would apply from A.Y. 2022-23, the Explanation did not become prospective in nature and the adjudicating authorities were required to examine the true legislative intent for deciding the effective date of application of an amendment.

The Delhi High Court however, in the case of Pr CIT vs. ERA Infrastructure (India). Ltd. 327 CTR (Del) 489, has, in a cryptic order, recently held the Explanation to be prospective, holding that the amendment cannot be held to be retrospective if it changes the law as it earlier stood.

In our considered opinion, the effective date of application specified by the Explanatory Memorandum may not be taken as sacrosanct and final in all cases, unless the amendment has the effect of adversely disturbing the rights and obligations of the parties with retrospective effect. In other words, an attempt should be made by the Courts to determine independently the effective date of application where the law has been amended for removal of doubts or is expressly provided to be declaratory or clarificatory. In the case of the Explanation, on a bare reading of the language thereof, it is gathered that in express language it is provided that the amendment should always be read as if the same was always there by use of words ”the provisions of this section shall apply and shall be deemed to have always applied”. It is therefore, very respectfully noted that the Courts were required to examine whether the Explanation in question was retrospective or not without being summarily swayed by the effective date specified in the Explanatory Memorandum for holding that the amendment was prospective in nature and would not apply to assessment years up to A.Y. 2021-22. Having said that, it is fair to await the final view of the highest Court that is obtained on due consideration of the views expressed here. The situation is unique and demands discretion for conclusive views of the Apex Court.

shailesh.kwebmaker

ALLOWABILITY OF PROVISION FOR SALES RETURNS

ISSUE FOR CONSIDERATION

When goods are sold by a business, in most cases, the business also has a policy permitting customers to return the goods under certain circumstances. Though the actual sales returns may take place after the end of the year, many companies following the mercantile system of accounting, choose to follow a conservative policy for recognition of income arising from sales during the year, by making a provision for sales returns in respect of sales made during the year in the year of sale itself. The provision may be based either on the actual sales returns made in respect of such sales subsequent to the year-end till the date of finalisation of accounts, or may be based on an estimate of the likely sales returns based on past trends. Such provisions are authorized by accounting principles and at times are mandated in accounting for sales revenue.

The issue of allowability of deduction for such provision in the year in which such provision is made has arisen before the different benches of the Tribunal. While the Mumbai bench of the Tribunal has taken a view that such provision for sales returns is an allowable deduction, in the year of sales itself, recently the Bangalore bench of the Tribunal has taken a contrary view, holding that deduction of such provision is not allowable in the year in which it is made i.e, the year of sales.

BAYER BIOSCIENCE’S CASE
The issue first came up before the Mumbai bench of the Tribunal in the case of Bayer Bio Science Pvt Ltd vs. Addl CIT in an unreported decision in ITA 7123/Mum/2011 dated 8th February, 2012, relating to A.Y. 2006-07.

In this case, the assessee made a provision for sales return of Rs. 2,00,53,988 in respect of sales made during F.Y. 2005-06, which had been returned by customers in the subsequent F.Y. 2006-07 before finalization of the accounts and claimed such provision as a deduction in computing the income for A.Y. 2006-07.

The Assessing Officer (AO) took the view that since the sales returns had actually been made in the subsequent year, they should have been accounted for in the subsequent year. Accordingly, he disallowed the provision made by the assessee for sales return. The assessee did not succeed before the Dispute Resolution Panel in respect of such disallowance, and therefore preferred an appeal to the Tribunal on this issue, along with other issues.

The Tribunal examined the provisions of section 145 as it then stood. It noted that while that section laid down that business income had to be computed in accordance with the cash or mercantile system of accounting as regularly employed by the assessee, there was a rider to this section that the Central Government may notify accounting standards and the applicable accounting standards would have to be followed by the assessee in applying the method of accounting followed by it.

The Tribunal noted that two accounting standards had been notified in this regard vide notification no. 9949 dated 25th January, 1996. One of these accounting standards (AS-I, Disclosure of Accounting Policies) provided that:

“the major considerations governing the selection and application of accounting policies are the following, namely:–

(i) Prudence – Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.”

This approach required all anticipated losses to be taken into account in computation of income taxable under the head “Profits and Gains of Business or Profession”. The Tribunal noted that unlike under the pre-amended section 145 (prior to A.Y. 1997-1998), there was no enabling provision which permitted the AO to tinker with the profits computed in accordance with the method of accounting so employed u/s 145. The Tribunal took note of the fact that it was not even the AO’s case that the mandatory accounting standards had not been followed.

The Tribunal observed that besides this analysis of section 145, even on first principles, deduction in respect of anticipated losses as a measure of prudent accounting principles, could not be declined. According to the Tribunal, it was only elementary that the accountancy principle of conservatism, which had been duly recognized by the courts, mandated that anticipated losses were to be provided for in the computation of income, and anticipated profits were not to be taken into account till the profits actually arose.

As per the Tribunal, an anticipated loss, even if it might not have crystallised in the relevant previous year, was to be allowed as a deduction in the computation of business profits. The Tribunal noted that there was no dispute that goods sold had been returned in the subsequent year, and that fact was known before the date of finalization of accounts. Therefore, in the view of the Tribunal, there was no point in first taking into account income on sales, which never reached finality, and then accounting for loss on sales return in the subsequent year, in which the actual sales return took place.

The Tribunal therefore allowed the assessee’s appeal, holding that the approach of the assessee was in consonance with well settled accountancy principles, and accordingly deleted the disallowance.

This decision was followed by the Tribunal in subsequent years in DCIT vs. Bayer Bioscience P Ltd ITA Nos 5388/Mum/2009 and 2685/Del/2009 dated 21st April, 2016, and in the case of DCIT vs. Cengage Learning India Pvt Ltd ITA No 830/Del/2013 dated 10th April, 2017. A similar view was also taken by the Delhi Bench of the Tribunal favouring allowability of deduction of such provision for sales returns in the year of sales, in the case of Inditex Trent Retail India (P) Ltd vs. Addl CIT 95 ITR (T) 102, a case relating to A.Y. 2014-15. In this case, the Tribunal held that the provision was governed by AS 29 issued by ICAI, and it required recognition as there existed an obligation resulting from past event and a probability of outflow of resources required to settle the obligation.

HERBALIFE INTERNATIONAL INDIA’S CASE

The issue came up recently before the Bangalore bench of the Tribunal in the case of Herbalife International India Pvt Ltd vs. ACIT TS-126-ITAT-2022.

In this case, the assessee had made a provision for sales returns for the 3 financial years 2012-13 to 2014-15 corresponding to assessment years A.Ys. 2013-14, 2014-15 and 2015-16, and claimed such provision as a deduction. The AO disallowed such deduction, and such disallowance was confirmed by the CIT (Appeals), in the first appeal.

Before the tribunal, on behalf of the assessee, it was submitted that sales returns were a regular feature in its line of business, and had been consistently accepted by the assessee over a period of time. The accounting policy followed by the assessee for revenue recognition in this regard had been disclosed in the notes to the accounts, and had been consistently followed by the assessee over the years.

It was clarified that the provision for sales return had been made in accordance with the Accounting Standard (AS) 9 – Revenue Recognition, issued by ICAI which mandated that when the uncertainty relating to collectability arises subsequent to the time of sale or rendering of service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded. Attention was also drawn to paragraph 14 of AS 9, which provided in relation to disclosure of revenue that, in addition to the disclosures required by AS 1 – Disclosure of Accounting Policies, an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.

Attention was also drawn to the opinion of ICAI Expert Advisory Committee dated 10th October, 2011 which had noted that “The company should recognise a provision in respect of sales returns at the best estimate of the loss expected to be incurred by the company in respect of such returns including any estimated incremental costs that would be necessary to resell the goods expected to be returned, on the basis of past experience and other relevant factors.”

It was submitted on behalf of the assessee that the estimate of sales return could be made adopting different approaches namely, sales return after the balance sheet date can be tracked to the date of closing accounts finally, or estimated by simple tracking the returns year wise for past years and adopting the percentage on current sales for the provision, or estimated in the manner made by the company; the company had followed the method of estimating sales in the pipeline by assigning weights to each month sales, based on the proximity of that month to the end of the financial year, and applying the percentage of sales returns experience of the past years to such sales in the pipeline, to arrive at the provision for sales return required at the end of the year. Adjustment was made in respect of the opening provision and the actual returns during the year, and the differential amount required for the provision for sales return was debited to the P&L Account.

It was emphasised that the estimate made and provisions made had proved accurate up to 90% in the company’s case i.e., utilisation by way of actual refunds for sales returns out of the provisions made during the period, which was therefore more than a fair estimate, and was a scientific estimate.

It was explained that conceptually, in the company’s case, the closing balance in provision for sales returns account could be described as the estimated amount (based on immediate past experience) of refund towards sales return in near future (next year) period that company was expecting out of current year’s sales revenue. The company made the necessary provision from P&L Account to ensure this closing balance for meeting its obligations from sales revenue recognised during each year. The data provided proved clearly the consistent basis adopted for recognising estimated sales return with more than reasonable accuracy. As the utilisation numbers indicated in the provision movement indicated that the provision was at actuals, no separate adjustment for excess provision, if any, would be necessitated.

It was argued that all parameters indicated by the Supreme Court while dealing with accounting for similar aspects, like warranty provisions, were fully satisfied. Hence, it was submitted that the company’s claim for deduction of provision made in each year deserved to be accepted on the basis of the above facts.

Reliance was placed on behalf of the assessee on the decisions of the tribunal in the cases of Bayer Bioscience (supra) and Cengage Learning (supra), which had held that provision for sales return in consonance of well-settled accountancy principles needed to be allowed and no disallowance was called, for provision for sales return. It was submitted that the decision of the tribunal in the case of Nike India Pvt Ltd vs. ACIT IT(TP)A No 739/Bang/2017 dated 14th October, 2020 was incorrect, as there was no reference to relevant aspects such as AS 9, issued by ICAI, on accounting of provision for sales return, with reference only being made to AS 29 – Provisions, Contingent Liabilities and Contingent Assets, and earlier decisions of the tribunal in the cases of Bayer Bioscience (supra) and Cengage Learning (supra) not having been considered in this decision.

It was further submitted that the provision for sales returns was made on a scientific basis, and was consistently followed by the company from A.Y. 2010-11 onwards, with no additions being made by the AO till A.Y. 2012-13. A reference was also invited to the CIT (Appeals) order for A.Y. 2015-16, where the alternate claim made by the company to allow the excess utilization of such provision was also rejected. It was argued that on the one hand, the Department did not want to allow the provision for sales returns in the year of creation, and on the other hand, where the utilisation of provision was higher, it wanted to deny the benefit on hyper technicalities, without appreciating the settled principle of law, that the principle of consistency needed to be followed.

An alternative prayer was made on behalf of the assessee that in case the provision was held to be not allowable, the utilisation of the provision by actual refunds made towards sales return in respective years should be allowed since the amounts were refunded to third parties at actuals during the relevant year.

On behalf of the Department, it was submitted that the assessee’s method for arriving at the amounts to be added to the provision for sales return had been found to be not scientific or reasonable. Various alleged defects in the method followed by the assessee were pointed out on behalf of the Department. Reliance was placed on the decision of the Bangalore bench of the tribunal in the case of Nike India Pvt Ltd (supra). It was therefore submitted that the action of the AO in disallowing the provision of sales return was to be upheld.

The tribunal noted that the assessee had taken support of AS 29, which explained that a provision should be recognised when:

an enterprise had a present obligation as a result of past event;

it was probable that an outflow of resources embodying economic benefit would be required to settle the obligation, and

a reliable estimate could be made of the amount of the obligation.

The tribunal noted that there should exist a “present obligation” as a result of “past event”. It questioned whether provision for sales returns could fall under the category of present obligation as a result of past event. According to the tribunal, the present obligation as a result of past event contemplated that there had occurred some event in the past, and the same would give rise to some obligation of the assessee, and further the said obligation should exist as on the balance sheet date. Further, the prudence principle in accounting concepts mandates that an assessee should provide for all known losses and expenses, even though the exact quantum of loss/expense was not known.

According to the tribunal, the facts in the case before it were different. The assessee had effected sale of products, and accordingly recognised revenue arising on such sales. On effecting the sales, the contract had already been concluded. Sales returns was another separate event, even though it had connection with the sales, i.e., the very same product already sold by the assessee was being returned. By making provision for sales returns, what the assessee sought to do was to derecognise the revenue recognised by it earlier. Therefore, sales returns were reduced from the sales in the P&L Account.

As per the tribunal, there should not be any dispute that the past event in the case before it was sales, and not sales returns. When there was no past event, the question of present obligation out of such past event did not arise. Therefore, the tribunal was of the view that the provision for sales return did not represent the present obligation arising as a result of past event, but was an expected obligation that might arise as a result of a future event.

The tribunal observed that the sales return expected after the balance sheet date was an event occurring after the balance sheet date. As per the tribunal, AS 4 – Contingencies and Events Occurring after the Balance Sheet Date, actually governed this situation. It observed that a careful perusal of AS 4 showed that the adjustment on account of contingencies and events occurring after the balance sheet date should relate to the contingencies and conditions existing as on the balance sheet date. As per the tribunal, the contract of sale was concluded when the goods were supplied to the customers, and the sales return was a separate event, which was not a contingency or any condition existing at the balance sheet date.

Further, the tribunal noted that sales and sales returns actually represented receipt and issue of goods, and therefore had an impact on the physical stock of goods. Hence, when there was sales return, there would be increase in physical stock of goods, and the physical stock should accordingly be increased when an entry is made for sales return. According to the tribunal, making provision for expected sales return would not result in cost on receipt of goods and increase of closing stock, which was against accounting principles.

The Tribunal further examined the deductibility of the provision for sales returns u/s 37(1). It noted that what was deductible under that section was an expenditure laid out or expended wholly and exclusively for the purposes of business. Since the sales returns actually represented derecognition of revenue already recognised earlier, and there was corresponding receipt of goods on such sales return, as per the Tribunal, it did not qualify as an expenditure. According to the tribunal, provision for sales returns was therefore not allowable u/s 37(1).

Referring to the Mumbai and Delhi tribunal decisions of Bayer Bioscience (supra) and Cengage Learning (supra), relied upon by the assessee, the Tribunal observed that in those cases, the bench did not refer to the provisions of AS 4 and AS 29, and did not consider another important point that sales return should result in corresponding receipt of goods, which would result in increase of closing stock. The Bangalore bench of the Tribunal therefore chose to follow the logic and detailed reasoning that it had undertaken, rather than those earlier decisions of the tribunal referred to by the assessee.

The Tribunal, therefore, held that the provision for sales returns was not allowable as a deduction under the provisions of the Income-tax Act. As regards the alternate ground of the assessee to allow the provision in the subsequent year in which the returns took place, the Tribunal observed that while computing disallowance on account of provision for sales return, the AO considered only the net closing provision or closing provision less opening provision, and allowed the utilisation amount in each assessment year under consideration. It meant that the AO allowed the actual sales returns made in each assessment year under consideration, and therefore the question of any further deduction did not arise.

OBSERVATIONS

The Bangalore Tribunal has relied on its own interpretation of the Accounting Standards, ignoring the views of the Expert Advisory Committee of ICAI in this regard. The ICAI Expert Advisory Committee in its Query No 14 dated 10th October, 2011, on Accounting for Sales Returns (Compendium of Opinion, Vol XXXI, page 101) has opined as under:

“10. However, the Committee notes from the Facts of the Case that in the extant case, there is a right of return by the franchisees (refer paragraph 6 above). The existence of such right would create a present obligation on the company. In this context, the Committee notes the definition of the term ‘provision’ as defined in paragraph 10 of Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets notified under Companies (Accounting Standards) Rules, which provides as follows:

‘A provision is a liability which can be measured only by using a substantial degree of estimation.

A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.’

The Committee is of the view that since obligation in respect of sales return can be estimated reliably on the basis of past experience and other relevant factors such as fashion trends, etc. in the extant case, a provision in respect of sales returns should be recognised. The provision should be measured as the best estimate of the loss expected to be incurred by the company in respect of such returns including any estimated incremental cost that would be necessary to resell the goods expected to be returned.”

“11. The company should recognise a provision in respect of sales returns at the best estimate of the loss expected to be incurred by the company in respect of such returns including any estimated incremental cost that would be necessary to resell the goods expected to be returned, on the basis of past experience and other relevant factors as discussed in paragraph 10 above. Necessary adjustments to the provision should be made for actual sales return after the balance sheet date up to the date of approval of financial statements. Such provision should also be reviewed at each balance sheet date and if necessary, should be adjusted to reflect the current best estimate.”

From the above EAC opinion, it is clear that the past event is the sale, which gives rise to the obligation to take back the goods, with a resultant loss of profit in relation to the goods returned. The sales return is, therefore, clearly linked with the initial sale. Also, a reliable estimate can be made of the goods likely to be returned. Accounting for sales returns, in the year of sales, is therefore a ‘provision’ as contemplated by AS 29. The interpretation by the Bangalore Tribunal that the sale and the sales returns are two separate transactions, and that therefore there is no past event in relation to the sales return, does not seem to be the correct understanding of AS 29.

Further, the Bangalore Tribunal seems to have assumed that a provision is being made for the gross value of the sales returns, and not for the loss of profit or additional cost to be incurred on account of the sales returns, when it observed that the sales returns increases the closing stock. From the EAC’s opinion, again, it is clear that only the loss expected to be incurred is to be provided for. In the Bayer Bioscience’s case also, it was clear that only the loss on account of sales returns was the issue under consideration, and not the entire value of sales returns. The factual position if not clear in Herbalife’s case, could have been inquired in to ensure that, the total value of expected sales returns was provided, in accordance with AS 29, only to the extent of the expected loss on account of such anticipated returns.

While the decisions of the Mumbai and Delhi benches of the Tribunal seem to have focused mainly on the provisions of the Income- tax Act and the Accounting Standards notified under that law to arrive at their conclusions, the Bangalore bench seems to have relied mainly on Accounting Standards issued by ICAI. For all the years under consideration in all these appeals, the provisions of law were identical, in that till A.Y. 2015-16, the 2 accounting standards notified u/s 145 were applicable. These two IT Accounting Standards modify the method of accounting followed u/s 145, and therefore, to that extent supersede normal accounting standards, to the extent that they are in conflict with those standards, for the purposes of taxation of business income. The other normal accounting standards would also continue to apply, to the extent that no accounting standards have been issued u/s 145, which cover those issues or are in conflict with those. This aspect does not seem to have been considered by the Bangalore bench in Herbalife’s case, which relied primarily on the ICAI Accounting Standards.

The new Income Computation and Disclosure Standards (ICDS) notified u/s 145(2), which became effective only from A.Y. 2017-18, also effectively modify the normal accounting standards in so far as taxation of income is concerned, to the extent that they are in conflict with normal accounting standards.

For certain large companies, the provisions of Ind AS 37 notified by the Ministry of Corporate Affairs, now apply in place of AS 29. The provisions of Ind AS 37 are similar to those of AS 29, and in fact contain greater clarity. Appendix F to Ind AS 37 gives examples of applicability of the Ind AS, by recognition of a provision. Example 4 therein reads as under:

Example 4 Refunds policy

A retail store has a policy of refunding purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.

Present obligation as a result of a past obligating event – The obligating event is the sale of the product, which gives rise to a constructive obligation because the conduct of the store has created a valid expectation on the part of its customers that the store will refund purchases.

An outflow of resources embodying economic benefits in settlement – Probable, a proportion of goods are returned for refund (see paragraph 24).

Conclusion – A provision is recognised for the best estimate of the costs of refunds (see paragraph 10 (the definition of a constructive obligation), 14, 17 and 24).

From Ind AS 37, it is absolutely clear that a provision for loss due to future sales returns is required to be made under Ind AS. In fact, Ind AS simply amplifies the view which always was under the AS and which was explained by the EAC.

With effect from A.Y. 2017-18, the provisions of ICDS apply, and modify the accounting under normal accounting method. ICDS X relating to provisions, contingent liabilities and contingent assets would apply in such a situation. This ICDS is similar to AS 29 read with Ind AS 37, and requires a provision to be recognized when:

(a) a person has a present obligation as a result of a past event;

(b) it is reasonably certain that an outflow of resources embodying economic benefits will be required to settle the obligation; and

Therefore, even under ICDS, a provision for loss due to sales returns is required to be made, and would therefore be an allowable deduction.

In so far as the allowability of deduction of such a provision u/s 37(1) is concerned, the question does not arise at all, as the computation of business income, including all business losses, is u/s 28 itself. The loss on account of sales returns is therefore to be considered u/s 28 itself.

It is a settled position in law that a deduction otherwise admissible in law should not be tweaked by the assessing authorities simply because in their view the claim was allowable in a later year or that the revenue was to be recognized in an earlier year, or simply because in their opinion it fell for allowance or recognition in a different year as long as the treatment of the assessee was in accordance with generally accepted accounting principles and the rate of taxation was uniform. Nagri Mills Ltd. 33 ITR 681 (Bom.), Millenium Estates, 93 taxmann.com 41 (Bom.), Vishnu Industrial Gas Ltd. ITR 228 of 1988(Delhi) and Excel Industries Ltd. 358 ITR 295 (SC).

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HRA EXEMPTION FOR RENT PAID TO WIFE OR MOTHER

ISSUE FOR CONSIDERATION

An employee who is in receipt of House Rent Allowance (HRA) from his employer, and who incurs expenditure by way of rent on residential accommodation occupied by him, is entitled to claim an exemption of the HRA to the extent prescribed by rule 2A. By virtue of the explanation to Section 10(13A), the assessee is not entitled to such exemption if:

(a) the residential accommodation so occupied is owned by the assessee himself, or

(b) the assessee has not actually incurred any expenditure by way of rent on such accommodation occupied by him.

At times, it may so happen that the accommodation in which the employee is residing is owned by a close relative, either wife or a parent, who also resides in the same accommodation along with the assessee. The issue has arisen before the Tribunals as to whether the assessee is entitled to exemption for HRA under section 10(13A) in such circumstances, more so when the expenditure on rent is not adequately evidenced.

While the Ahmedabad and Delhi benches of the Tribunal has taken the view that an assessee cannot be denied the exemption under such circumstances, the Mumbai bench of the Tribunal has taken a contrary view, holding that the assessee was not entitled to the benefit of the exemption in such a case.

BAJRANG PRASAD RAMDHARANI’S CASE
The issue first came up before the Ahmedabad bench of the Tribunal in the case of Bajrang Prasad Ramdharani vs. ACIT 60 SOT 66 (Ahd)(URO).

In this case, the assessee had paid rent to his wife during the year, and claimed exemption under section 10(13A) of Rs 1,11,168 for House Rent Allowance. The Assessing Officer disallowed the assessee’s claim for exemption on the ground that the assessee had not given details of payment and evidences, and also on the basis that the assessee and his wife were living together. According to the Assessing Officer, the claim of payment of rent was just to avoid taxes, and to reduce the tax liability.

In first appeal, the assessee filed the requisite details and evidence before the Commissioner (Appeals). In the remand report sought by the Commissioner (Appeals) from the Assessing Officer, the Assessing Officer had commented that it was not ascertainable whether the assessee stayed at his wife’s house or at his own house, owned by him, which he had claimed exempt as self-occupied under Section 24. The Commissioner (Appeals) noted that the rent was paid by the assessee as a tenant to his wife, who was the landlord, and that the landlord and tenant were living together in the same house property. According to the Commissioner (Appeals), the very fact that they were staying together indicated that the whole arrangement was in the nature of a colourable device. The Commissioner (Appeals) therefore confirmed the disallowance of the HRA exemption.

Before the Tribunal, on behalf of the assessee, it was argued that a bare reading of the provision would make it amply clear that the assessee was entitled to exemption under Section 10(13A). It was pointed out that requisite details and evidences had been filed before the Commissioner (Appeals), who had called for a remand report from the Assessing Officer. It was submitted that the reasoning given by the Assessing Officer and the Commissioner (Appeals) in disallowing the exemption were different. Therefore, it was claimed that the authorities below grossly erred in not allowing the exemption.

On behalf of the revenue, reliance was placed on the orders of the lower authorities. It was pointed out that the Assessing Officer, in the remand report, had submitted that the assessee had claimed the house owned by him as self-occupied, and therefore disallowance of the assessee’s claim was justified.

The Tribunal noted that the Assessing Officer and the Commissioner (Appeals) had disallowed the claim of the assessee on the ground that the assessee and his wife were living together, and not on the ground that in the return of income, the house owned by the assessee was declared as self-occupied. There was only a mention of it in the remand report, where the Assessing Officer had commented that it was not ascertainable whether the assessee stayed at his wife’s house or at his own house which he claimed as self-occupied. Under these circumstances, according to the Tribunal, it only had to examine whether the assessee was entitled to the exemption under section 10(13A) or not.

The Tribunal analysed the provisions of section 10(13A). It pointed out that the exemption was not allowable in case the residential accommodation was owned by the assessee, or the assessee had not actually incurred expenditure on payment of rent in respect of the residential accommodation occupied by him.

It noted that the Assessing Officer had given a finding of fact that the assessee and his wife were living together as a family. Therefore, it could be inferred that the house owned by the assessee’s wife was occupied by the assessee also. The assessee had submitted rent receipts showing payments made by way of bank transfer.

Therefore, according to the Tribunal, the assessee had fulfilled the twin requirements of the provision; i.e. occupation of the house and payment of rent. The Tribunal therefore held that the assessee was entitled to the exemption under section 10(13A).

A similar case had come up recently before the Delhi bench of the Tribunal in the case of Abhay Kumar Mittal vs. DCIT 136 taxmann.com 78, where the Assessing officer had clubbed the rent paid by the assessee to his wife with the income of the assessee, on the ground that the property was purchased by the wife mainly out of funds borrowed from the assessee. The Commissioner (Appeals), besides confirming the addition, also disallowed exemption on HRA on such rent paid by the assessee to his wife. The facts were that the wife was a qualified medical practitioner, who had repaid the loan later by liquidating her investments.

The Tribunal noted in that case, that the assessee had paid house rent, and the wife had declared such income under the head “Income from House Property” in her returns of income. There was no bar on the assessee extending a loan to his wife from his known sources of income. The Tribunal expressly held that that the Commissioner (Appeals)’s contention that the husband cannot pay rent to his wife was devoid of any legal implication supporting any such contention, and therefore allowed HRA exemption to the assessee.

MEENA VASWANI’S CASE
The issue came up again before the Mumbai bench of the Tribunal in the case of Meena Vaswani vs. ACIT 164 ITD 120.

In this case, the assessee was a Chartered Accountant, working as a Senior Finance and Accounts Executive with a listed company. She had claimed exemption for HRA received from her employer under section 10(13A) of Rs 2,52,040 for A.Y. 2010-11 towards rent paid to her mother for a flat in Neha Apartments, owned by her mother. She also had a self-occupied property, a flat in Tropicana, in respect of which she claimed a loss on account of interest on housing loan of Rs 13,888, and deduction under section 80C for repayment of housing loan.

During the course of assessment proceedings under section 143(3), in October 2012, the Assessing Officer asked the assessee to show cause as to why HRA claimed as exempt should not be added to her income, and brought to tax.

The assessee submitted that she had paid a rent of Rs 31,500 per month to her mother in cash for her house in Neha Apartments, and was therefore entitled to the exemption.

The Assessing Officer observed that in her return of income, the assessee had shown her residential address as Tropicana. The same address appeared on her ration card as well as her bank account. The Assessing Officer noted that the assessee was claiming loss from self-occupied property, as well as claiming exemption under section 10(13A). The assessee was asked to furnish leave and licence agreement with respect to the Neha Apartments property taken on rent, and to explain the need for hiring a house property when another house property owned by the assessee was claimed as self-occupied.

The assessee submitted that while she had a self-occupied property at Tropicana jointly held with her husband, she had to live in her mother’s house at Neha Apartments, and pay her rent for her day-to-day living cost. She had no option but to live with her mother at Neha Apartments as her mother was a sick and single old lady. She paid rent so that none of the other siblings would raise any objection on her staying in Neha Apartments. It was claimed that her living in a rented premises was a purely family matter. Since the transaction was between daughter and mother, no formal agreement was executed. Rent receipts were however collected as evidence of payment of rent for income tax purposes. The assessee therefore claimed that she was entitled to the exemption under section 10(13A) for the HRA.

An inspector was deputed to make an enquiry to verify the assessee’s claim that she was living with her mother at Neha Apartments, and paying rent to her. The Inspector visited the Neha Apartments premises, and issued a summons to the mother, who was present there.

In his report, the Inspector noted that:

1. The mother was staying in the 1 Bedroom-Hall-Kitchen premises at Neha Apartments.

2. She had 3 daughters, of whom one daughter Vimla, who was unmarried, was staying in the flat with her mother.

3. Another daughter, the assessee, was staying with her husband and daughter at Tropicana.

4. The third daughter, Kamla, was staying at Thane.

The Inspector also visited the Tropicana premises, which was a walk of just five minutes away from Neha Apartments, and confirmed that the assessee was living there for the last many years with her husband and daughter. These facts were also confirmed with the watchmen and secretaries of the two societies.

The Assessing Officer observed that:

1. The assessee had herself submitted that she was living with her husband, who was also a Chartered Accountant, and a daughter, and that most of her household expenses were taken care of by her husband. There were not many withdrawals for household expenses, except payment of mobile bills.

2. The mother lived with her unmarried daughter in Neha Apartments, and not with the assessee.

3. The assessee could not produce the mother for examination before him, nor did the mother file any further details subsequent to the summons.

4. The mother had not filed any returns of income for the last six assessment years. In March 2013, subsequent to the enquiries made, a return of income of the mother was filed for the relevant year under assessment.

5. The mother was in receipt of pension income, and rental income ought to have been offered to tax by her, which was not done till enquiries were made.

6. There was no leave and licence agreement, or any other proof of stay by the assessee with her mother, and hence genuineness of payment of rent was not established.

The Assessing Officer therefore concluded that the assessee was neither staying in her mother’s flat, nor paying any rent to her, and therefore disallowed the assessee’s claim of exemption of HRA under section 10(13A).

Before the Commissioner (Appeals), the assessee submitted that:

1. Her unmarried sister, Vimla, did not stay with her mother, since she had her own ownership flat in another suburb.

2. The assessee had shifted to Tropicana during the previous year relevant to A.Y. 2013-14, from which year no HRA exemption was claimed.

3. The payment of rent pertained to A.Y. 2010-11, whereas the Inspector visited the premises in March 2013.

4. The statement of the watchman could not be relied upon, since the watchman changed every month.

5. The statement of the Secretaries of the two societies could not be treated as evidence, since the secretaries were neither authorized to keep constant watch on the movements of any members residing in or moving out, nor could their statements for past events be considered as evidence.

6. Even the Inspector did not record the statement of the mother during his visit.

It was therefore argued that the conclusions drawn by the Inspector were based on conjectures and surmise, and that no adverse inference could be drawn against the assessee without any supporting documentary evidence. It was claimed that the rent receipts were valid documentary evidence in support of the assessee’s claim for exemption of HRA under section 10(13A).

The Commissioner (Appeals) rejected the assessee’s claim that her unmarried sister was not staying with her mother as she had her own flat in another suburb, and that the assessee shifted to Tropicana in A.Y. 2013-14, on the ground that these were self-serving statements not supported by any evidence on record. The Commissioner (Appeals) placed reliance on the Inspector’s Report and the statements of Secretaries and Watchmen on the two societies, since they could not be rebutted by the assessee. Noting that no pressing need was shown by the assessee for living in a small flat with her mother while leaving her bigger flat (which was just five minutes walk away) with her family, the Commissioner (Appeals) held that the assessee failed to establish that she was staying with her mother and paying rent to her, and dismissed the assesee’s appeal.

Before the Tribunal, on behalf of the assessee, affidavits of the assessee and her mother were filed, stating the whole facts. Reiterating the facts as stated at the lower levels, and that the assessee’s mother was an old and sick lady, it was claimed that the assessee stayed with her mother, and had genuinely paid her rent.

On behalf of the Department, it was argued that the rent of Rs 31,500 per month being paid to mother was shown only to take exemption of HRA under section 10(13A). Rents were stated to have been paid in cash, and drawings from the bank account were minimal, as it was admitted that the household expenses were met by the husband. No leave and licence agreement was produced. There was no independent evidence of the assessee’s staying with her mother, and no intimation was given to the society about such stay. The mother had not filed her returns of income, and filed one return only after enquiries were made. The ration cards, bank statements and return of income showed Tropicana as the assessee’s place of residence, and not Neha Apartments. The Tropicana premises was shown as self-occupied property in the return of income. There was no evidence to support the fact that the unmarried sister Vimla was residing in her flat in another suburb. The mother did not respond to summons served on her, but had now filed an affidavit before the Tribunal. It was urged that such affidavit filed after four years should be rejected as it was filed before the Tribunal for the first time.

In the assessee’s rejoinder to the Tribunal, it was pointed out that there was no bar to payment of rent in cash. There was no requirement in law to inform the society about the assessee’s staying with her mother. Further, it was argued that even with the meagre pension and rent, the mother’s income was below the taxable limit, and she had no obligation to file her return of income. Further, no evidence had been asked for by the lower authorities to prove that the unmarried sister lived in her own property in another suburb.

The Tribunal analysed the facts of the case before it, including the Inspector’s Report. It noted that the assessee could not produce proof of cash withdrawals from her bank account to substantiate payments of rent made to her mother in cash. It observed that the affidavits filed by the assessee and her mother before it constituted additional evidences, for which no application was made for admission under rule 29 of the Income Tax (Appellate Tribunal) Rules, 1963. The facts stated in the affidavits had already been stated before the lower authorities.

The Tribunal observed that the rent receipts prepared by the assessee’s mother did not inspire confidence, as the assessee was not able to substantiate the source of the cash payments. According to the Tribunal, there were no other evidences available which related to the period when the transaction of hiring of the premises in the normal course was progressing. The Tribunal observed that the evidences at the time of transactions which are normal are relevant and cogent evidence to substantiate the assessee’s contentions. These facts are especially in the knowledge of the assessee, and the burden was on the assessee to bring out these evidences to substantiate her contentions that the rent paid was genuine.

The Tribunal noted that the assessee did not come forward with any evidence to substantiate her contentions, except rent receipts, which were not backed by any known sources of cash, as cash was not withdrawn from the bank. The Tribunal referred to Section 106 of The Indian Evidence Act, 1872, which provides that when any fact is especially within the knowledge of any person, the burden of proving that fact is upon him. Further, Section 6 of that Act provides that facts which, though not in issue, are so connected with a fact in issue so as to form part of the same transaction, are relevant, whether they occurred at the same time and place or at different times and places.

According to the Tribunal, the doctrine of res gestae would set in. The assessee could not produce any evidence arising in the normal course of happening of transaction of hiring of premises to prove that transaction of hiring of premises was genuine and was happening during the period. According to the Tribunal, no cogent evidence was brought on record which could substantiate that the assessee had taken the Neha Apartments premises on rent from her mother, as no evidence of her actually staying at the premises were brought on record. According to the Tribunal, the assessee was actually staying in her own flat in Tropicana, as per various evidences, which was also in consonance with normal human conduct of married Indian woman living with her husband and daughter in their own house.

The Tribunal noted that, even on the touchstone of preponderance of human probabilities, it was quite improbable that the assessee, a married lady, would leave her husband and daughter and start living with her mother at another flat just five minutes walk away, and pay a huge rent per month. According to the Tribunal, it was a different matter that the assessee may look after her sick and old mother by frequent visits, but this theory of rent as set out by the assessee did not inspire confidence, keeping in view the evidence produced before the Tribunal. The Tribunal observed that it was also probable that the assessee may have contributed towards looking after her old and ailing mother out of her salary, but that was not sufficient to claim exemption under section 10(13A).

Looking at the factual matrix, the Tribunal was of the considered view that the whole arrangement of rent payment by the assessee to her mother was a sham transaction, which was undertaken by the assessee with sole intention to claim exemption of HRA under section 10(13A) in order to reduce her tax liability. The Tribunal therefore held that exemption under section 10(13A) could not be allowed to the assessee.

OBSERVATIONS
If one examines the language of the explanation to Section 10(13A), it is clear that so long as the assessee has actually paid rent in respect of the premises occupied by him, and so long as the premises does not belong to the assessee himself, the benefit of exemption for HRA under section 10(13A) cannot be denied to him. There is no express prohibition on the premises being owned by a close relative, so long as rent is genuinely paid to that relative. As rightly pointed out by the Delhi bench of the Tribunal, there was no prohibition in law prohibiting payment of rent to the wife (or a close relative).

There is also no express prohibition on such landlord also occupying the premises along with the assessee, as his close relative. It is only that the assessee necessarily has to occupy the premises for his residence.

If one looks at the facts of Meena Vaswani’s case, the decision of the Tribunal was based on two important facts which the assessee was unable to prove with the help of contemporaneous evidence – the fact that she actually occupied the premises, and the fact that she had actually paid rent. Therefore, clause (b) of the explanation to Section 10(13A) was clearly attracted in that case, leading to the loss of exemption.

Therefore, the view taken by the Ahmedabad and Delhi benches of the Tribunal seems to be the better view, and that exemption for HRA would be available under section 10(13A) even if rent is paid to the wife or a close relative, who stays along with the assessee.

In any case, in case the property belongs to the wife or other close relative, who continues to reside therein along with the assessee who pays the rent, one needs to keep in mind that the matter may certainly invite closer inspection by the tax authorities as to whether such letting on rent is genuine, or just a sham, as in the case before the Mumbai bench of the Tribunal.

shailesh.kwebmaker

POINT OF TAXABILITY – SECTION 56(2)(viib)

ISSUE FOR CONSIDERATION

Section 56(2)(viib) provides for taxability of the consideration received by a closely held company for issue of shares to the extent it exceeds the fair market value of the shares. It is applicable when such a company is issuing shares at a premium.

In cases where the share application money is received in one year, but the shares have been allotted in another year, the issue has arisen as to whether this provision is applicable in the year of receipt of the share application money or in the year of allotment of the shares. While the Delhi, Bengaluru and Mumbai benches of the Tribunal have taken a view that it is applicable in the year in which the shares have been finally allotted, the Kolkata bench of the Tribunal has taken a view that it is applicable in the year in which the consideration for issue of shares is received.

CIMEX LAND AND HOUSING (P.) LTD.’S CASE

The issue had first come up for consideration of the Delhi bench of the Tribunal in the case of Cimex Land and Housing (P.) Ltd. vs. ITO [2019] 104 taxmann.com 240.

In this case, the assessee company had received the share application money from V. L. Estate Pvt. Ltd. as follows –

A.Y.	No. of shares	Face value	Premium per share	Total share application money
2012-13	50,375	R10	R790	R4,03,00,000
2013-14	5,000	R10	R790	R40,00,000
2015-16	24,625	R10	R790	R1,97,00,000
TOTAL		R6,40,00,000

A.Y.

No. of shares

Face value

Premium per
share

Total share
application money

2012-13

50,375

R10

R790

R4,03,00,000

2013-14

5,000

R10

R790

R40,00,000

2015-16

24,625

R10

R790

R1,97,00,000

TOTAL

R6,40,00,000

As against the share application money received as aforesaid, the shares were allotted only in F.Y. 2014-15 relevant to A.Y. 2015-16. The assessee’s case for A.Y. 2015-16 was selected for the assessment for verification of large share premium received during the year. During the course of the assessment proceedings, the Assessing Officer took a stand that he had a right to examine the basis on which share premium was received with respect to all the shares which were allotted during the year. The Assessing Officer took a view that the share application money could be returned back without allotting shares, and examination of basis of share premium could be verified only in the year when shares were allotted. The Assessing Officer also disregarded the valuation report of the registered valuer dated 5th April, 2011, on the ground that it was not in accordance with the valuation method as prescribed in Rule 11UA.

Since the assessee company did not provide any justification for the allotment of shares at a premium during the year under consideration along with the valuation in accordance with the prescribed method, the Assessing Officer added the amount of Rs. 6.32 crore u/s 56(2)(viib) as income from other sources. The CIT(A) also confirmed this addition.

Before the tribunal, the assessee reiterated that only Rs. 1.97 crores was received during the year under consideration as share application money for 24,625 shares, and the balance amounts were received in earlier assessment years, which could not be brought to tax u/s 56(2)(viib) for the year under consideration. On the other hand, the revenue contended that since, in the A.Ys. 2012-2013 and 2013-14, only share application money was received and no shares were allotted, the question of examining the case from the perspective of applicability of section 56(2)(viib) did not arise in those assessment years.

The tribunal held that though the provisions of Section 56(2)(viib) referred to the consideration for issue of shares received in any previous year and the amount of Rs. 4.43 crore was not received during the year under consideration, it could not be said that the assessee was not liable to justify the share premium supported by the valuation report as mentioned in Rule 11UA. Since the shares were not allotted in the years in which the share application money was received, the applicability of section 56(2)(viib) could not have been examined by the Assessing Officer in those years.

Since the entire transaction had crystallised during the year under consideration, which also included determination of the share premium of Rs. 790 per share, it was required to be examined during the year under consideration only. Accordingly, the Tribunal restored the matter back to the Assessing Officer, with a direction to examine the justification of share premium as per the procedure prescribed under Rules 11U and 11UA of the IT Rules, and to decide the issue afresh, after giving a reasonable opportunity of being heard to the assessee.

A similar view has been adopted by the different benches of the tribunal in the following cases:

• Taaq Music Pvt. Ltd. vs. ITO – ITA No. 161/Bang/2020 dated 28th September, 2020

• Medicon Leather (P) Ltd. vs. ACIT – [2022] 135 taxmann.com 165 (Bangalore – Trib.)

• Impact RetailTech Fund Pvt. Ltd. vs. ITO – ITA No. 2050/Mum/2018 dated 5th March, 2021

DIACH CHEMICALS & PIGMENTS PVT. LTD.’S CASE

The issue, thereafter, came up for consideration before the Kolkata bench of the tribunal in the case of ACIT vs. Diach Chemicals & Pigments Pvt. Ltd. [TS-355-ITAT-2019(Kol)].

In this case, the assessee issued and allotted 10,60,000 equity shares of Rs. 10 face value at a premium of Rs. 90 per share during the previous year 2012-13 relevant to A.Y. 2013-14. However, the consideration for issue of these shares was received in the preceding year i.e. previous year 2011-12 relevant to A.Y. 2012-13. During the course of the assessment for A.Y. 2013-14, the assessing officer found that the fair market value of the shares was Rs. 41.38 only and, accordingly, asked the assessee as to why the provisions of section 56(2)(viib) should not be invoked.

In reply, the assessee submitted that the applicability of provisions of section 56(2)(viib) did not arise, as the relevant provision came into force only with effect from A.Y. 2013-14, and the consideration for issue of shares was received in A.Y. 2012-13, and not in the assessment year under consideration.

The assessing officer did not accept the submissions of the assessee and held the consideration for shares was to be treated as received in the year of allotment of the shares i.e. the year under consideration, and added an amount of Rs. 61,69,200 [(100-41.38) X 10,60,000] to the total income of the assessee.

The CIT (A) deleted this addition made by the Assessing Officer by holding that the connotation of the meaning ‘received in any previous year’ used in section 56(viib) would be in respect of the year of receipt and not the year of allotment. The shares were allotted in F.Y. 2013-14 but the share application monies were received in the F.Y. 2012-13. According to the CIT(A), the provisions of section 56(2)(viib) were to be construed with respect to the year in which consideration was received and not the year in which the allotment of shares was made.

Before the tribunal, the revenue contended that the valuation of shares could be made only when the transaction had been fully completed and apportionment between share capital and share premium had fully crystallised. As the transaction of issue of shares got completed in the year under consideration when the shares were allotted, the taxability with respect to the actual value at which the shares had been allotted and the value of shares as per the valuation norms was required to be examined. It was also pointed out that if the transaction was taxed in the year of receipt of share application money, then it would result in absurdity if the share application money is refunded in the subsequent year without any allotment of shares.

As against that, the assessee contended that the provisions of section 56(2)(viib) were not applicable as there was no receipt of consideration in the year under consideration.

The Tribunal held that the provisions of section 56(2)(viib) could not be applied in A.Y. 2013-14 on the basis that the shares were allotted in that year. It was for the reason that the shares were applied in A.Y. 2012-13 as per the terms and conditions settled in that year. On that basis, the Tribunal confirmed the order of the CIT (A) deleting the addition.

OBSERVATIONS
The relevant provision of section 56(2) is reproduced below for better understanding of the issue under consideration –

56. (2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely:

(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares.

The taxability under the aforesaid provision arises if the following conditions are satisfied:

• The assessee is a closely held company i.e. a company in which the public are not substantially interested.

• Such company has received the consideration for issue of shares exceeding the face value of such shares i.e. the shares have been issued at a premium.

• The consideration so received exceeds the fair market value of the shares issued.

If the above mentioned conditions are satisfied, then the excess of consideration over the fair market value of the shares becomes chargeable to tax under the head income from other sources. The Explanation to clause (viib) provides the manner in which the fair market value of shares needs to be determined for this purpose.

The issue under consideration lies in a narrow compass i.e. whether the taxability under this provision gets triggered at the moment when the share application money is received irrespective of the fact that the shares have been allotted at a later date. This issue becomes more relevant in a case where the receipt of share application money and the allotment of shares fall in different assessment years.

When the company receives the share application money, technically speaking, what it receives is the advance against the issue of shares and not the consideration for issue of shares. This advance is then appropriated towards the consideration for issue of shares at the time when the shares are actually allotted to the applicant. This aspect has been well explained in the case of Impact RetailTech Fund Pvt. Ltd. vs. ITO (supra) as under –

The receipt of consideration for issue of shares to mean the proceeds for exchange of ownership for the value. The term consideration means “something in return” i.e. “Quid Pro Quo”. The receipt is exchanged with the ownership in the company.

The consideration means the promise of the assessee to issue shares against the advances received. In our view, the receipt of advances are a liability and will never take the character of the ownership until it is converted into share capital. The assessee can never enjoy the receipt of money from the investor until the ownership for the money received is not passed on i.e. by allotment of shares. The receipt of consideration during the previous year means the year in which the ownership or allotment of shares are passed on to the allottee in exchange for the investment of money.

The tax authorities interpretation that when the receipt of money and mere agreement for allotment of shares without actual allotment of shares will make the consideration complete as per the contractual laws. In our view, unless and until the event of allotment of shares takes place, the assessee cannot become the owner of the funds invested in the company. The event of allotment will change the colour of funds received by the assessee from liability to the ownership.

The provision of clause (viib) which is under consideration has been inserted by the Finance Act, 2012 as a measure to prevent generation and circulation of unaccounted money. The objective of introducing such a provision as it appears is to tax the share premium received against issue of shares at a value which exceeds the fair market value of the shares. The share application money gets converted into share premium only when the shares are issued. Also, the quantum of share premium gets crystallised finally only when the shares are issued. Even if the amount of share application money is received on the basis of the proposal to issue shares at premium, it is only tentative at that point in time, and becomes final only when it is converted into share premium by issuing shares. Therefore, even considering the objective of the provision, the right stage at which the taxability should be determined is at the time when the shares are issued and not at the time when the share application money is received.

If the income is taxed at the time of receipt of the share application money disregarding the allotment of shares, correspondingly then, the excess amount received from every applicant of shares would become taxable irrespective of whether the shares have been actually issued or not. The only way to overcome such an absurdity is to apply the provision only in respect of the share application money which has been converted into share capital by issuing the shares to the applicant, and this can happen only at the time when the shares have been issued to the applicant.

Further, clause (a) of the Explanation which provides for the determination of fair market value also supports this view. This clause reads as under –

Explanation—For the purposes of this clause,—

(a) the fair market value of the shares shall be the value—

(i) as may be determined in accordance with such method as may be prescribed; or

(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,

whichever is higher;

The sub-clause (ii) refers to the value of the shares as on the date of issue of shares. Therefore, the computation of the fair market value would also fail in a case where only the share application money is received and the shares have not been issued.

The better view, in our considered opinion, is that the provisions of section 56(2)(viib) can be invoked only when the shares are issued and not prior to that, as held by Delhi, Bengaluru and Mumbai benches of the Tribunal.

shailesh.kwebmaker

EXTENDING THE SCOPE OF REASSESSMENT

ISSUES FOR CONSIDERATION

Section 147, applicable up to 31^st March, 2021, empowers an Assessing Officer (AO) to assess or reassesses the income in respect of any issue which has escaped assessment and which has come to his notice subsequent to the recording of reasons and the issue of a notice u/s 148, in the course of reassessment proceedings. The relevant part of the said section reads as under:

‘If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or re-compute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned.’

Section 147, effective from 1^st April, 2021, has dispensed with the condition of ‘reason to believe’. Instead, a new provision in the form of section 148A has been introduced to provide for compliance of a set of four conditions by an AO before issuing any notice u/s 148. The Explanation thereto empowers the AO to reassess an income in respect of an issue for which the four conditions of s. 148A has not been complied with.

This Explanation is materially the same as Explanation 3 of s. 147 applicable w.e.f. 1^stApril, 2021, with a change that reference to ‘reasons recorded’ is substituted by ‘compliance of s.148A of the Act’.

Explanation 3 to s. 147 was added w.r.e.f. 1st April, 1989 by Finance (No. 2) Act, 2009 for providing that the reassessment would be valid even where the reasons recorded did not include an issue that has escaped assessment. The said Explanation reads as under:

‘For the purpose of assessment or reassessment under this section, the Assessing Officer may assess or reassess the income in respect of any issue, which has escaped assessment, and such issue comes to his notice subsequently in the course of the proceedings under this section, notwithstanding that the reasons for such issue have not been included in the reasons recorded under sub-section (2) of section 148.’

On the insertion of Explanation 3 to s. 147 by the Finance (No.2) Act, 2009, the then-existing conflict between various decisions of the Courts regarding the expansion of the subject matter of reassessment beyond the reasons recorded, had been rested in cases where some addition or disallowance or variation was made in respect of the subject matter for which the reasons were recorded. Apparently, the provisions, old or new, permit an AO to expand or extend the proceedings to a subject not covered either by notice u/s 148A or the reasons recorded for reopening an assessment.

An interesting issue, however arisen in cases where no addition or disallowance or variation is made in the order of reassessment in respect of the subject matter of the notice u/s 148A or the reasons recorded but all the same the addition or disallowance or variation is made in respect of a subject matter not covered by such notice or the reasons. At the same time, even after insertion of Explanation 3, the issue that remained open was about the power of the AO to travel beyond the reasons recorded, where no addition or disallowance or variation was made in respect of the subject matter recorded in the reasons for reopening.

Conflicting decisions of the courts are available on the subject. The Bombay and the Delhi High Courts have held that where no addition or disallowance or variation was made in respect of the subject matter of the reasons recorded, then, in such a case, the AO could not have extended the scope of reassessment beyond the reasons recorded. The Punjab & Haryana and Karnataka High Courts have, as against the above, held that it was possible for the AO to travel beyond the subject matter of the reasons recorded while reassessing the income.

It is felt that the conflict would apply to the old as well as the new provisions, requiring us to take notice of the conflict.

JET AIRWAYS (I) LTD.’S CASE
The issue arose in the case of CIT vs. Jet Airways (I) Ltd., 195 Taxman 117 (Bom.). In the said case, pertaining to A.Ys. 1994-1995 and 1995-1996, the revenue had raised the following substantial question of law in appeal u/s. 260A for consideration of the Bombay High Court.

“Where upon the issuance of a notice under section 148 of the Income-tax Act, 1961 read with section 147, the Assessing Officer does not assess or, as the case may be reassess the income which he has reason to believe had escaped assessment and which formed the basis of a notice under section 148, is it open to the Assessing Officer to assess or reassess independently any other income, which does not form the subject-matter of the notice?”

The revenue in appeal urged that even if, during the course of assessment or, as the case might be a reassessment, the AO did not assess or reassess the income which he had reason to believe had escaped assessment and which formed the subject matter of a notice u/s 148(2), it was nonetheless open to him to assess any other income which, during the course of the proceedings was brought to his notice as having escaped assessment. It contended that the use of the words ‘and also’ clearly permitted an AO to make addition on an issue, even where no addition was made in respect of the issues for which the reasons were recorded and on the basis of which the assessment was reopened. It submitted that the language of the section was clear to reach such a conclusion. The words were non-conjunctive, and the two parts could operate independently of each other.

The assessee in response contended that the words “and also” in s. 147 postulated that the AO might assess or reassess the income for which he had reason to believe had escaped assessment together with any other income chargeable to tax which had escaped assessment and which came to his notice during the course of the proceedings; unless the AO assessed the income with reference to which he had formed a reason to believe, it was not open to him to assess or reassess any other income chargeable to tax which had escaped assessment and which came to his notice subsequently in the course of the proceedings.

It was clear to the Court, applying the first principle of interpretation for interpreting the section as it stood, and on the basis of precedents on the subject, without adding or deducting from the words used by Parliament, that upon the formation of a reason to believe u/s 147 and following the issuance of a notice u/s 148, the AO had the power to assess or reassess the income, that he had reason to believe had escaped assessment and also any other income chargeable to tax; that the words “and also” could not be ignored; the interpretation which the Court placed on the provision should not result in diluting the effect of those words or rendering any part of the language used by Parliament otiose; Parliament having used the words “assess or reassess such income and also any other income chargeable to tax which has escaped assessment”, the words “and also” could not be read as being in the alternative. On the contrary, the correct interpretation would be to regard those words as being conjunctive and cumulative; that Parliament had not used the word “or” and that it did not rest content by merely using the word “and” it followed it with the word “also” clearly suggesting that the words had been used together and in conjunction.

The Court, after hearing the rival contentions, upheld the decision of the Tribunal in favour of assessee for the reasons recorded in Para 16 and 17 of its order as under:

‘This interpretation will no longer hold the field after the insertion of Explanation 3 by the Finance Act (No. 2) of 2009. However, Explanation 3 does not and cannot override the necessity of fulfilling the conditions set out in the substantive part of section 147. An Explanation to a statutory provision is intended to explain its contents and cannot be construed to override it or render the substance and core nugatory. Section 147 has this effect that the Assessing Officer has to assess or reassess the income (“such income”) which escaped assessment and which was the basis of the formation of belief and if he does so, he can also assess or reassess any other income which has escaped assessment and which, comes to his notice during the course of the proceedings. However, if after issuing a notice under section 148, he accepted the contention of the assessee and holds that the income which he has initially formed a reason to believe had escaped assessment, has as a matter of fact not escaped assessment, it is not open to him independently to assess some other income. If he intends to do so, a fresh notice under section 148 would be necessary, the legality of which would be tested in the event of a challenge by the assessee.

We have………. The words “and also” are used in a cumulative and conjunctive sense. To read these words as being in the alternative would be to rewrite the language used by Parliament. Our view has been supported by the background which led to the insertion of Explanation 3 to section 147. Parliament must be regarded as being aware of the interpretation that was placed on the words “and also” by the Rajasthan High Court in Shri Ram Singh’s case (supra). Parliament has not taken away the basis of that decision. While it is open to Parliament, having regard to the plenitude of its legislative powers to do so, the provisions of section 147(1) as they stood after the amendment of 1-4-1989 continue to hold the field.’

The AO, the Court noted, upon the formation of a reason to believe u/s 147 and the issuance of a notice u/s 148(2), must assess or reassess: (i) ‘such income’; and also (ii) any other income chargeable to tax which had escaped assessment and which came to his notice subsequently in the course of the proceedings under the section. The words ‘such income’ refers to the income chargeable to tax which had escaped assessment, and in respect of which the AO had formed a reason to believe that it had escaped assessment. The language used by the Parliament was indicative of the position that the assessment or reassessment must be in respect of the income in respect of which he had formed a reason to believe that it had escaped assessment and also in respect of any other income which came to his notice subsequently during the course of the proceedings as having escaped assessment. If the income, the escapement of which was the basis of the formation of the reason to believe, was not assessed or reassessed, it would not be open to the AO to independently assess only that income which came to his notice subsequently in the course of the proceedings under the section as having escaped assessment.

The Court observed that the Parliament when it enacted the provisions of s. 147 w.e.f. 1st April, 1989, clearly stipulated that the AO had to assess or reassess the income that he had reason to believe had escaped assessment and any other income chargeable to tax that came to his notice during the proceedings. In the absence of the assessment or reassessment of the former, he could not independently assess the latter.

The Court in deciding the issue, in favour of the contentions of the assessee that it was not possible to make an addition in respect of an issue that was not recorded in the reasons for reopening, in cases where no addition was made in respect of the subject matter of reasons recorded, referred to the decisions in the cases of Vipan Khanna vs. CIT, 255 ITR 220 (Punj. & Har.); Travancore Cements Ltd. vs. Asstt. CIT 305 ITR 170 (Ker.); CIT vs. Sun Engg. Works (P.) Ltd., 198 ITR 297 (SC); V. Jaganmohan Rao vs. CIT, 75 ITR 373 (SC); CIT vs. Shri Ram Singh, 306 ITR 343 (Raj.); and CIT vs. Atlas Cycle Industries, 180 ITR 319 (Punj. & Har.).

N. GOVINDARAJU’S CASE
The issue again arose before the Karnataka High Court in the case of N. Govindaraju vs. ITO, 60 taxmann.com 333 (Karn.). In the said case for A.Y. 2004-05, the assessee, in its appeal against the order of Tribunal, approached the Court with the following substantial questions of law:

• Whether the Tribunal was correct in upholding reassessment proceedings, when the reason recorded for re-opening of assessment under S. 147 of Act itself does not survive.

• Whether the Tribunal was correct in upholding levy of tax on a different issue, which was not a subject matter for re-opening the assessment and moreover the reason recorded for the re-opening of the assessment itself does not survive.

• Whether the Tribunal was justified in law in passing an order without application of mind as to the determination of the fair market value as on 1.4.1981 by not taking into consideration the material on record and the valuation report filed by the appellant and consequently passed a perverse order on the facts and circumstance of the case.

• Whether the Tribunal was justified in law in not allowing a sum of Rs. 3,75,000/- being expenditure incurred wholly and exclusively in connection with the transfer more so when the payments are through banking channels, and consequently passed a perverse order on the facts and circumstance of the case.

On behalf of the assessee, in the appeal, it was contended before the Court that an order u/s 147 of the Act had to be in consonance with the reasons given for which notice u/s 148 had been issued, and once it was found that no tax could be levied for the reasons given in the notice for reopening the assessment, independent assessment or reassessment on other issues would not be permissible, even if subsequently, in the course of such proceedings, some other income chargeable to tax had been found to have escaped assessment. It was further submitted that the reason for which notice was given had to survive. It was only thereafter that ‘any other income’ which was found to have escaped assessment could be assessed or reassessed in such proceeding. Hence, the reopening of assessment should first be valid (which could be only when reason for reopening survived) and once the reopening was valid, then the entire case could be reassessed on all grounds or issues. That was to say, if reopening was valid and reassessment could be made for such reason, then only the AO could proceed further; if the AO could proceed further even without the reason for reopening surviving, it could lead to fishing and roving enquiry and would give unfettered powers to him.

On behalf of the revenue, it was contended that under the old s. 147 (as it stood prior to 1989), grounds or items for which no reasons had been recorded could not be opened, and because of conflicting decisions of the High Courts, the provisions of the said section had been clarified to include or cover any other income chargeable to tax which might have escaped assessment, and for which reasons might not have been recorded before giving the notice. That the said s. 147 was in two parts, which had to be read independently, and the phrase “such income” in the first part was with regard to which reasons had been recorded, and the phrase “any other income” in the second part was with regard to where no reasons were recorded in the notice and had come to notice of the AO during the course of the proceedings. Accordingly, both being independent, once the satisfaction in the notice was found sufficient, the addition could be made on all grounds, i.e., for which reason had been recorded and also for which no reason had been recorded, and all that was necessary was that during the course of the proceedings u/s 147, income chargeable to tax must be found to have escaped assessment relying on Explanation 3 to s. 147 which was inserted by Finance Act, 2009 w.e.f. 1st April, 1989.

The Karnataka High Court on hearing rival contentions observed and held as under:

• From a plain reading of s. 147 of the Act, it was clear that its latter part provides that ‘any other income’ chargeable to tax which has escaped assessment and which had come to the notice of the AO subsequently in the course of the proceedings, could also be taxed.

• The two parts of the section have been joined by the words ‘and also’ and the Court has to consider whether ‘and also’ would be conjunctive, or the second part has to be treated as independent of the first part. If the words were held to be conjunctive, then certainly the assessment or reassessment of ‘any other income’ which was chargeable to tax and had escaped assessment, could not be made where the original issue did not survive.

• The purpose of the provisions of Chapter XV was to bring to tax the entire taxable income of the assessee, and in doing so, where the AO had reason to believe that some income chargeable to tax had escaped assessment, he might assess or reassess such income. Since the purpose was to tax all such income which had escaped assessment, besides ‘such income’ for which he had reason to believe to have escaped assessment, it would be open to him to also independently assess or reassess any other income which did not form the subject matter of notice.

• While interpreting the provisions of s. 147, different High Courts have held differently, i.e., some have held that the second part of s. 147 was to be read in conjunction with the first part, and some have held that the second part was to be read independently. To clarify the same, in 1989, the legislature brought in suitable amendments in sections 147 and 148 of the Act, which was with the object to enhance the power of the AO, and not to help the assessee.

• Explanation 3 was inserted in s. 147 by Finance (No. 2) Act, 2009 w.e.f 1st April, 1989. By the said Explanation, which was merely clarificatory in nature, it had been clearly provided that the AO might assess or reassess the income in respect of any issue, which had escaped assessment, and where such issue came to his notice subsequently in the course of the proceedings, notwithstanding that the reasons for such issue had not been included in the reasons recorded under sub-section (2) of s. 148. Insertion of this Explanation could not be but for the benefit of the Revenue, and not the assessee.

• It was clear that in the phrase ‘and also’ which joined the first and second parts of the section, ‘and’ was conjunctive which was to join the first part with the second part, but ‘also’ was for the second part and was disjunctive; it segregated the first part from the second. Thus, on a comprehensive reading of the entire section, the phrase ‘and also’ could not be said to be conjunctive.

• It was thus clear that once the satisfaction of reasons for the notice was found sufficient, i.e., if the notice u/s 148(2) was found to be valid, then addition could be made on all grounds or issues (with regard to ‘any other income’ also) which might come to the notice of the AO subsequently during the course of proceedings u/s 147, even though the reason for notice for ‘such income’ which might have escaped assessment, did not survive.

• If there was ambiguity in the main provision of the enactment, it could be clarified by inserting an Explanation to the section of the Act which had been done in the case. Section 147 of the Act was interpreted differently by different High Courts, i.e., whether the second part of the section was independent of the first part, or not. To clarify the same, Explanation 3 was inserted by which it had been clarified that the AO could assess the income in respect of any issue which had escaped assessment and also ‘any other income’ (of the second part of s. 147) which came to his notice subsequently during the course of the proceedings under the section.

• After the insertion of Explanation 3 to s. 147, it was clear that the use of the phrase “and also” between the first and the second parts of the section was not conjunctive and assessment of ‘any other income’ (of the second part) could be made independent of the first part (relating to ‘such income’ for which reasons were given in notice u/s 148), notwithstanding that the reasons for such issue (‘any other income’) had not been given in the reasons recorded u/s 148(2).

• The view of the Court was in agreement with the view taken by the Punjab & Haryana High Court in the cases of Majinder Singh Kang 344 ITR 348 and Mehak Finvest 52 taxmann.com 51.

• Considering the provision of s. 147 as well as its Explanation 3, and also keeping in view that s. 147 was for the benefit of the Revenue and not the assessee and was aimed at garnering the escaped income of the assessee (namely Sun Engineering) and also keeping in view that it was the constitutional obligation of every assessee to disclose his total income on which it was to pay tax, the two parts of s. 147 (one relating to ‘such income’ and the other to ‘any other income’) were to be read independently. The phrase ‘such income’ used in the first part of s. 147 was with regard to which reasons have been recorded u/s 148(2) of the Act, and the phrase ‘any other income’ used in the second part of the section was with regard to income where no reasons have been recorded before issuing notice and which has come to the notice of the AO subsequently during the course of the proceedings, which could be assessed independent of the first part, even when no addition could be made with regard to ‘such income’, but the notice on the basis of which proceedings had commenced was found to be valid.

• It was true that where the foundation did not survive, then the structure could not remain. Meaning thereby, if notice had no sufficient reason or was invalid, no proceedings could be initiated. But the same could be checked at the initial stage by challenging the notice. If the notice was challenged and found to be valid, or where the notice was not at all challenged, then, in either case, it could not be said that the notice was invalid. As such, if the notice was valid, then the foundation remains and, the proceedings on the basis of such notice could go on. We might only reiterate here that once the proceedings had been initiated on a valid notice, it became the duty of the AO to levy tax on the entire income (including ‘any other income’) which might have escaped assessment and came to his notice during the course of the proceedings initiated u/s 147 of the Act.

The Karnataka High Court found it unable to persuade itself, with due respect, to follow the decisions in the cases of Ranbaxy Laboratories Ltd. vs. CIT, 336 ITR 136 (Bom.), CIT vs. Adhunik Niryat Ispat Ltd., 63 DTR 212 (Del.) and CIT vs. Mohmed Juned Dadani, 355 ITR 172 (Guj.), and proceeded to hold that it was permissible for an AO to make addition in respect of an issue noticed during the course of assessment even where no addition was made in respect of the issues for which the assessment was reopened by recording the reasons at the time of issue of notice u/s 148 of the Act.

OBSERVATIONS
One of the controversies about expanding the scope of reopened assessment, about the permission to travel beyond the subject matter of reasons recorded for reopening or otherwise, has been sought to be set to rest by insertion of Explanation 3 w.r.e.f 1st April, 1989. The other controversy, relating to AO’s power to make addition or disallowance or variation in cases where no addition or disallowance or variation is made on the subjects recorded in the reasons, continues to be relevant and live. This unresolved issue involves an appreciation of different schools of interpretation of the language used in the section and also of the legislative intent behind it. Very forceful, intense and valid contentions are made by both the schools of interpretation, which are backed by the decisions of the different High Courts. Even an amendment, that too with retrospective effect, has not been able to resolve the conflict. The best solution is to await the final word of wisdom from the Supreme Court.

The issue, in our considered opinion, would continue to be relevant even under the new scheme of reopening and reassessment made effective from 1st April, 2021. The new scheme retains an Explanation that empowers an AO to travel beyond the subject matter of ‘information’ received by an AO, and also the need for compliance of the four conditions of s. 148A of the Act. The Explanation to s. 147 might permit an AO to cover an issue even where ‘no information’ is received by him as per s. 148 of the Act.

The ‘reason to believe’ that any income chargeable to tax has escaped assessment, was one aspect of the matter. If such reason existed, the AO could undoubtedly assess or reassess such income, for which there was such ‘reason to believe’ that income chargeable to tax has escaped assessment. This is the first part of the section, and up to this extent, there is no dispute. The issues as noted however were in respect of two aspects; one was whether the AO was permitted to rope in an issue for which reasons were not recorded. There were conflicting decisions of the Courts on this aspect which conflict was set at rest by the insertion of Explanation 3. The other issue was and is about the power of the AO to make an addition in respect of an additional issue, not recorded in the reasons, even where no addition is made in respect of the main issue recorded in the reasons. It is this second issue that has remained open and unresolved, even after insertion of Explanation in s. 147 and on which conflicting decisions of the Courts are noted.

It is the latter part of the s. 147 and not the Explanation 3 that is to be interpreted, which is as to whether the second part relating to ‘any other income’ is to be read in conjunction with the first part (relating to ‘such income’) or not. If it is to be read in conjunction, then without there being any addition made with regard to ‘such income’ (for which reason had been given in the notice for reopening the assessment), the second part cannot be invoked. But if it is not to be read in conjunction, the second part can be invoked independently, even without reason for the first part surviving, permitting an AO to make addition even where no addition is made in respect of the main issue for which reasons are recorded.

The effect of Explanation 3, inserted by the Finance (No. 2) Act, 2009 as is understood by one school of interpretation is that even though the notice issued u/s 148 containing the reasons for reopening the assessment does not contain a reference to a particular issue with reference to which income has escaped assessment, yet the AO may assess or reassess the income in respect of any issue which has escaped assessment, when such issue comes to his notice subsequently in the course of the proceedings. The reasons for the insertion of Explanation 3 are to be found in the memorandum explaining the provisions of the Finance (No. 2) Bill, 2009.

The memorandum states that some of the Courts have held that the AO has to restrict the reassessment proceedings only to issues in respect of which reasons have been recorded for reopening the assessment, and that it is not open to him to touch upon any other issue for which no reasons have been recorded. This interpretation was regarded by the Parliament as being contrary to the legislative intent. Hence, Explanation 3 came to be inserted to provide that the AO may assess or reassess income in respect of any issue which comes to his notice subsequently in the course of proceedings u/s 147, though the reasons for such issue have not been included in the reasons recorded in the notice u/s 148(2).

The effect of s. 147, as it now stands, after the amendment of 2009, can, therefore, be summarised as follows : (i) the Assessing Officer must have reason to believe that any income chargeable to tax has escaped assessment for any assessment year; (ii) upon the formation of that belief and before he proceeds to make an assessment, reassessment or recomputation, the AO has to serve a notice on the assessee under sub-section (1) of s. 148; (iii) the AO may assess or reassess such income, which he has reason to believe, has escaped assessment and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under the section; and (iv) though the notice u/s 148(2) does not include a particular issue with respect to which income has escaped assessment, yet he may nonetheless, assess or reassess the income in respect of any issue which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under the section.

Insertion of ‘Explanation’ in a section of an Act is for a different purpose than the insertion of a ‘Proviso’. ‘Explanation’ gives a reason or justification and explains the contents of the main section, whereas ‘Proviso’ puts a condition on the contents of the main section or qualifies the same. ‘Proviso’ is generally intended to restrain the enacting clause, whereas ‘Explanation’ explains or clarifies the main section. Meaning thereby, ‘Proviso’ limits the scope of the enactment as it puts a condition, whereas ‘Explanation’ clarifies the enactment as it explains and is useful for settling a matter of controversy.

Having noted that the issue on hand needs to be resolved by a decision of the Supreme Court at the earliest, in our opinion, the decisions of the High Courts in favour of the assessee represent a better view and the decisions of the High Courts holding a contrary view are based on considerations, the following of which require rethinking, for the reasons noted in italics:

• One of the grounds on which the Courts rested their decisions was that the assessee was given an opportunity to challenge the notice along with the reasons for reopening, both of which were held to be valid and the reopening proceedings were therefore validly initiated and with such initiation there would be no question of assessment of either ‘such income’ of the first part of s. 147 or ‘any other income’ of its second part. The courts, with respect, did not appreciate the fact that on the lapse of the reasons recorded, once no addition was made on such reasons, the notice and the proceedings were rendered invalid. The courts also ignored that the assessee had no opportunity to contest the validity of the notice on the reason subsequently added by the AO, and importantly, the proceedings might lead to fishing and roving inquiry.

• The Courts further held that as long as the proceedings had been initiated on the basis of a valid notice, it became the duty of the AO to levy tax on the entire income, which may have escaped assessment during the assessment year. With great respect, if this were to be true, there was no need for having amended the law to expressly provide the AO with the power to expand the scope of reassessment to add an issue or issues beyond the issues covered by the recorded reasons. The scope of the reassessment is limited to the issues recorded in reasons, and a special power was needed to rope in an additional issue without which the AO is not empowered to travel beyond the recorded reasons.

• The Courts admitted that where the words ‘and also’ was to be treated as conjunctive, then certainly, if the reason to believe was there for a particular ground or issue with regard to escaped income which had to be assessed or reassessed, and such ground was not found or did not survive, then the assessment or reassessment of ‘any other income’ which was chargeable to tax and has escaped assessment, could not be made. However, after having done so, for some not very comprehensive reasons, they proceeded to hold that the words were not to be read in conjunction and therefore, the second part could be invoked independently even without reason for the first part surviving.

• The Courts held that the purpose of the scheme was to tax all such income which had escaped assessment, besides ‘such income’ for which he had reason to believe to have escaped assessment and, based on such findings, the Courts held that it would be open to the AO to also independently assess or reassess any other income which did not form the subject matter of notice. With respect, this understanding of the courts might hold true in the case of regular assessment, but are surely not so in cases of reassessment, where the power of the AO to reassess an income for which he had valid reasons and which reasons were duly recorded. In the absence of such compliance, it was not possible to hold that his power was all-encompassing.

• The Courts further held that the insertion of the Explanation could not be but for the benefit of the revenue and not the assessee. This understanding based on the judgement of the Supreme Court in Sun Engineering’s case, might be true in the context of the scope of the reopening but cannot be applied to understand the implication of the written law and the Explanation thereto. In any case, taking a legal view on the language of the provision cannot be termed to be beneficial to the assesssee; rather the courts are bound to take a view that is correct in law, irrespective of the party on which the benefit is conferred; such benefit, even where conferred, is intended by the express language used by the parliament. In any case, the decision of the Supreme Court is capable of a different interpretation, as has been recently found by the Karnataka High Court in a decision in the case of The Karnataka State Co-Operative Apex Bank Limited vs. DCIT 130 taxmann.com 114. (Refer Controversy Feature of BCAJ, March, 2022)

• The Courts further held that the word ‘and’ used in the phrase ‘and also’ was conjunctive, which was used to join the first part with the second part, but the word ‘also’ was only for the second part and would be disjunctive; it segregated the first part from the second and thus, upon reading the full section, the phrase ‘and also’ could not be said to be conjunctive. With utmost respect, we find such a circuitous interpretation not tenable and strange and not found to have any precedent.

• The Courts held that the insertion of Explanation 3 to s. 147 did not in any manner override the main section and had been added with no other purpose than to explain or clarify the main section so as to also bring in ‘any other income’ (of the second part of s. 147) within the ambit of tax, which might have escaped assessment, and came to the notice of the AO subsequently during the course of the proceedings. Circular 5 of 2010 issued by the CBDT also made this position clear. There was no conflict between the main s. 147 and its Explanation 3. This Explanation had been inserted only to clarify the main section and not curtail its scope. Insertion of Explanation 3 was thus clarificatory and was for the benefit of the revenue and not the assessee. We do not think that there is any dispute about the purpose of Explanation and its clarificatory nature. What is disagreeable is the use of the Explanation to prove a point that is not borne out of the Explanation or the Memorandum explaining the object behind its insertion. The language and the memorandum explain that the objective of the Explanation was to clarify that an issue, the subject matter of which was not recorded in the reasons, could be taken up by the AO in reassessment if noticed by him. Nowhere it is clarified that an additional issue could be taken up even where the main issue did not survive. Secondly, the reliance on the circular to prove a complex legal point was avoidable. Thirdly, to hold that the clarification was for the benefit of the revenue is unacceptable.

• Lastly, the Court held that If there was ambiguity in the main provision of the enactment, it could be clarified by insertion of an Explanation to the main section of the Act. The same had been done in the instant case. Section 147 was interpreted differently by different High Courts, i.e., whether the second part of the section was independent of the first part or not. To clarify the same, Explanation 3 was inserted by which it had been clarified that the AO could assess the income in respect of any issue which had escaped assessment and also ‘any other income’ (of the second part of s. 147) which came to his notice subsequently during the course of the proceedings under the section. Again there is no dispute in this understanding of the purpose of insertion of Explanation and its meaning. The difficulty is where one reads it in a manner to hold that the Explanation also permitted to make addition in respect of an additional issue even where the main issues do not survive, and thereby rendering the proceedings otiose. With respect, the language of the Explanation and its objective, as explained, nowhere bears this understanding of the courts. As explained earlier, there were two controversies, and the Explanation clarified the legislative stand only in respect of one of them, namely, to cover an additional issue even where the reason for such issue was not recorded. The other controversy being considered here had and has remained unaddressed.

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FRESH CLAIM IN A RETURN FILED IN RESPONSE TO A NOTICE ISSUED UNDER SECTION 148

ISSUE FOR CONSIDERATION

In Volume 53 of BCAJ (January, 2022), we covered the issue of the validity of a fresh claim, made otherwise than by way of revising the return of income. Such fresh claim can be in respect of any deduction, exemption etc., which has not been claimed in the return of income already filed. Yet another facet of this controversy is sought to be addressed here. When it is found that an income chargeable to tax has escaped the assessment, the Assessing Officer is empowered to reopen the case and reassess the income under Section 147. In such cases, the assessee has to be served with a notice u/s 148 requiring him to furnish his return of income. The question that frequently arises, for consideration of the courts, is as to whether the assessee can furnish a return of income in response to the notice issued u/s 148, declaring an income lesser than what has already been declared/assessed prior to issuance of the notice by making a fresh claim for an allowance or deduction therein.

In the case of CIT vs. Sun Engineering Works (P) Ltd. 198 ITR 297, the Supreme Court held that it was not open to the assessee to seek a review of the concluded item, unconnected with the escapement of income, in the reassessment proceeding. Following this decision, several High Courts, including the Madras, Bombay and Calcutta High Courts, have taken the view that the income returned in response to the notice issued u/s 148 cannot be lesser than the amount of income originally declared/assessed. However, recently, the Karnataka High Court has taken a contrary view on the issue after considering the Supreme Court’s decision in the case of Sun Engineering Works (P) Ltd. (supra).

SATYAMANGALAM AGRICULTURAL PRODUCER’S CO-OPERATIVE MARKETING SOCIETY LTD.’S CASE

The issue had earlier come up for consideration of the Madras high court in the case of Satyamangalam Agricultural Producer’s Co-operative Marketing Society Ltd. vs. ITO 40 taxmann.com 45.

The assessment years involved in this case were 1997-98, 1998-99 and 1999-2000. The assessee was dealing with the marketing of agricultural produce of members, sale of liquor and consumer goods. It had filed its returns of income for the assessment years under consideration and the returns filed were also processed u/s 143(1)(a). Later, the Assessing Officer issued notices u/s 148 on noticing that deduction u/s 80P was wrongly claimed regarding income derived from the sale of liquor. In response to the notices issued u/s 148, the assessee society filed returns of income wherein it also claimed deduction u/s 80P(2)(d) in respect of its interest income on investments with co-operative banks, which was not claimed in filing the first return of income. This being a fresh claim made by the assessee in the returns filed in response to the notice issued u/s 148, it was rejected by the Assessing Officer by relying on the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra).

The Commissioner (Appeals), as well as the ITAT, confirmed the Assessing Officer’s order. Before the High Court, the assessee contended that the claim made in response to the notice u/s 148 could not have been rejected at the threshold itself since it was never assessed earlier and their returns only processed u/s 143(1); since the proceedings were completed u/s 143(1), the claims made were never considered initially; the assessments to be made u/s 147 were required to be considered as the regular assessments under which such claims could have been made. The assessee relied upon the decision of the Supreme Court in the case ITO vs. K.L. Srihari (HUF) 250 ITR 193.

The High Court held that when there was no dispute that the claim made by the assessee about the interest income on investment was not made in the original return, and only a fresh claim was made for the first time in the return filed in pursuance of notice u/s 148, such fresh claims could not be allowed as the proceedings u/s 147 were for the benefit of the Revenue. The High Court relied upon the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra) and decided the issue against the assessee.

A similar view has been taken by the High Courts in the following cases –

• CIT vs. Caixa Economica De Goa 210 ITR 719 (Bom)

• K. Sudhakar S. Shanbhag vs. ITO 241 ITR 865 (Bom)

• CIT vs. Keshoram Industries Ltd. 144 Taxman 1 (Calcutta)

THE KARNATAKA STATE CO-OPERATIVE APEX BANK LTD.’S CASE

The issue, recently, came up for consideration before the Karnataka High Court in the case of The Karnataka State Co-Operative Apex Bank Limited vs. DCIT 130 taxmann.com 114.

In this case, for A.Y. 2007-08, the assessee had filed its return of income on 31st October,2007, declaring a total income of Rs. 40,77,27,150. No assessment u/s 143(3) was made for that year. The Assessing Officer issued a notice u/s 148 on 31st March, 2012. The assessee filed the return of income in response to the aforesaid notice on 13th September, 2012 and declared a lower income of Rs. 32,56,61,835 claiming a loss on sale of securities to the extent of Rs. 8,28,65,052, not claimed in the first return of income. Thereafter, the Assessing Officer passed an order u/s 143(3) r.w.s 147 determining the assessee’s income at Rs. 51,71,70,670 and made the following additions:

a) disallowance of contributions made to funds – Rs. 10,86,43,782; and

b) denial of set-off of loss claimed on sale of securities – Rs. 8,28,65,052.

The CIT (A) as well as tribunal did not grant relief regarding the additional claim of loss made by the assessee on account of the sale of securities on the ground that the aforesaid additional claim was not made in the original assessment proceeding. The assessee preferred the further appeal before the High Court raising the following substantial questions of law –

1) Whether the Tribunal is right in applying the ratio of the decision of the Hon’ble Supreme Court in CIT vs. Sun Engineering (P.) Ltd. 198 ITR 297 (SC) and holding that concluded issue in the original proceeding cannot be reagitated in reassessment proceedings even though the case of the appellant is distinguishable inasmuch as there was no original assessment proceedings on the facts and circumstances of the case?

2) Whether the Tribunal was justified in law in not appreciating that the notice u/s 148 of the Act was issued to “assess” the income and thus all contentions in law remained open for the appellant to agitate by filling a return in response to the notice u/s 148 of the Act on the facts and circumstances of the case?

3) Whether the Tribunal is justified in law in holding that the appellant is not entitled to make additional claim of loss incurred of Rs. 8,28,65,052/- in the reassessment proceedings under section 147 of the Act on the facts and circumstances of the case?

4) Whether the Tribunal is right in not holding that the appellant is entitled to the additional claim of actual loss incurred of Rs. 8,28,65,052/- on account of sale of government securities on the facts and circumstances of the case?

Before the High Court, the assessee submitted that there was no original assessment for the same assessment year, and only an intimation u/s 143(1) was issued to the assessee. The said intimation u/s 143(1) was not an order of assessment as held by the Supreme Court in the case of ACIT vs. Rajesh Jhaveri Stock Brokers (P.) Ltd. 291 ITR 500. Therefore, the issue of loss on sale of securities was not considered by the Assessing Officer and has not reached finality. The assessee also urged that the decision of the Supreme Court in the case of Sun Engineering Works (P) Ltd. (supra) should not be applied in its case on the ground that in that case the original order of assessment had attained finality and, therefore, it was held that the assessee could not agitate the issues in reassessment proceedings. Further, reliance was placed on the decision of the Supreme Court in the case of V. Jagan Mohan Rao vs. CIT & Excess Profit Tax 75 ITR 373 in which it was held that the original assessment got effaced upon issuance of notice of reassessment and the subsequent assessment proceedings has to be done afresh. The assessee also relied upon the decisions of the Supreme Court in ITO vs. Mewalal Dwarka Prasad 176 ITR 529 (SC) and ITO vs. K.L. Sri Hari (HUF) 250 ITR 193 (SC) as well as on the decisions of the Karnataka High Court in CIT vs. Mysore Iron & Steel Ltd. 157 ITR 531, Nitesh Bera (HUF) vs. Dy. CIT [IT Appeal No. 585 of 2016, dated 17th February, 2021] and CIT vs. Avasarala Automation Ltd. [Writ Appeal Nos. 1411-1413 of 2004, dated 5th April, 2005].

On the other hand, the revenue relied upon the decision of the Supreme Court in the case of Sun Engineering Works (P.) Ltd. (supra) and argued that it still held the field. It was submitted that Section 148 of the Act provided a remedy to the revenue and not to the assessee. If the assessee discovered any omission or any wrong statement in the original return filed after the time limit to revise u/s 139(5) expired, the only remedy which was available to the assessee was to file a return and to seek condonation of delay in filing the return u/s 119 where the time for completion of assessment was not over.

The High Court referred to the decision of a three-judge bench of the Supreme Court in the case of V Jagan Mohan Rao (supra) wherein it was held that when there was a reassessment or assessment u/s 147, the original assessment proceeding, if any, got effaced and the reassessment or assessment has to be done afresh. The High Court also referred to the decision of the Supreme Court in the case of Mewalal Dwarka Prasad (supra) in which it was held that once proceeding u/s 148 of the Act was initiated, the original order of assessment got effaced. The court noted that in Sun Engineering Works (P.) Ltd. (supra), it was held that in a proceeding for reassessment, the issues forming part of the original assessment could not be agitated, whereas, in Mewalal Dwarka Prasad (supra), it was held that once proceeding u/s 148 was initiated, original order of assessment got effaced.

The High Court further referred to the decision of the Supreme Court in the case of K.L. Srihari (HUF) (supra), in which the matter was referred to a three judges bench considering divergence of view so taken in the earlier cases. The relevant portion from the decision of the Supreme Court as reproduced in its order by the Karnataka High Court is as follows –

1. By order dated 19th November, 1996, these special leave petitions have been directed to be placed before the three-judge Bench because it was felt that dissonant views have been expressed by different Benches of this court on the scope and effect of reopening of an assessment under section 147 of the Income-tax Act, 1961. It has been pointed out before us that the matter has earlier been considered by a Bench of three judges in V. Jagan Mohan Rao vs. CIT and EPT and the observations in the said case came up for consideration before two judges’ Benches of this court in ITO vs. Mewalal Dwarka Prasad [1989] 176 ITR 529 and in CIT vs. Sun Engineering Works (P.) Ltd. [1992] 198 ITR 297 and that there is a difference in the views expressed in said later judgments.

2. We have heard Shri Ranbir Chandra, learned counsel appearing for the petitioners, and Shri Harish N. Salve, learned senior counsel appearing for the respondents. We have also perused the original assessment order dated 19th March, 1983, as well as the subsequent assessment order that was passed on 16th July, 1987, after the reopening of the assessment under section 147. On a consideration of the order dated 16th, July, 1987, we are satisfied that the said assessment order makes a fresh assessment of the entire income of the respondent-assessee and the High Court was, in our opinion, right in proceeding on the basis that the earlier assessment order had been effaced by the subsequent order. In these circumstances, we do not consider it necessary to go into the question that is raised and the same is left open. The special leave petitions are accordingly dismissed.

In view of the above, the High Court held that, in the case of the assessee, there was no original assessment order and it was only an intimation u/s 143(1), which could not be treated to be an order in view of the decision of the Supreme Court in the case of Rajesh Jhaveri (supra). Therefore, the proceeding u/s 148 was the first assessment and the same could have been done after taking into consideration all the claims of the assessee including the one made in filing the return in response to the notice u/s 148. It was held that the decision rendered by the Supreme Court in Sun Engineering Works (P.) Ltd. had no application to the fact of the case. It was also held that even if an intimation u/s 143(1) was considered to be an order of assessment, in the subsequent reassessment proceedings, the original assessment proceeding got effaced and the Assessing Officer was required to conduct the proceedings de novo and to consider the fresh claim of the assessee.

Accordingly, the High Court decided the issue in favour of the assessee and remitted the matter to the Assessing Officer for adjudication of the fresh claim made by the assessee in its return filed in response to the notice issued u/s 148.

OBSERVATIONS
The scope of assessment in a case where a notice is issued u/s 148 is governed by section 147 which provides as under (as it existed prior to its substitution by the Finance Act, 2021) –

If the Assessing Officer has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year).

In Sun Engineering Works (P.) Ltd.’s case (supra), the Supreme Court held that the reference to ‘such income’ here would mean the income chargeable to tax which has escaped assessment as referred in the initial part of the section and, therefore, the scope of assessment u/s 147 is limited only to the income which has escaped the assessment for which the proceeding has been initiated by issuing notice u/s 148. The only other income other than such escaped income which also can be included is any other escaped income which comes to the notice of the Assessing Officer subsequently in the course of the proceeding and which is not forming part of the reasons recorded for the issuance of notice u/s 148.

In the case of V. Jaganmohan Rao (supra), the Supreme Court was dealing with the case wherein the assessment was reopened with regard to the escaped income which accrued to the assessee as a result of the decision of the Privy Council in a dispute related to title of the property. While finally assessing the income, the Assessing Officer not only taxed such escaped income accruing as a result of the decision of the Privy Council but also assessed the other portion of the income which accrued to the assessee in accordance with the judgement of the High Court. The assessee contested it on the ground that at the time when the original order of assessment was passed, the ITO could have legitimately assessed the other income which was due to be assessed as per the judgment of the High Court and that there was, therefore, an escapement only to the extent of the income accruing as a result of the decision of the Privy Council. It is in this context, the Supreme Court held as under –

Section 34 in terms states that once the Income-tax Officer decides to reopen the assessment he could do so within the period prescribed by serving on the person liable to pay tax a notice containing all or any of the requirements which may be included in a notice under section 22(2) and may proceed to assess or reassess such income, profits or gains. It is, therefore, manifest that once assessment is reopened by issuing a notice under sub-section (2) of section 22 the previous under-assessment is set aside and the whole assessment proceedings start afresh. When once valid proceedings are started under section 34(1)(b) the Income-tax Officer had not only the jurisdiction but it was his duty to levy tax on the entire income that had escaped assessment during that year (emphasis supplied).

Subsequent to this decision of the Supreme Court in the case of V. Jaganmohan Rao, several High Courts took the view that the assessee can seek relief even during the course of the reassessment proceeding by relying on the Supreme Court’s observation that the whole assessment proceeding would start afresh in case of reassessment. Later, this issue of whether the assessee can claim reliefs to his benefit during the course of the reassessment proceeding reached the Supreme Court in the case of Sun Engineering Works (P.) Ltd. (supra) in which it was held as under –

37. The principle laid down by this Court in V. Jaganmohan Rao’s case (supra) therefore, is only to the extent that once an assessment is validly reopened by issuance of notice under section 32(2) of the 1922 Act (corresponding to section 148 of the 1961 Act), the previous under-assessment is set aside and the ITO has the jurisdiction and duty to levy tax on the entire income that had escaped assessment during the previous year. What is set aside is, thus, only the previous under-assessment and not the original assessment proceedings. ………..The judgment in V. Jaganmohan Roa’s case (supra), therefore, cannot be read to imply as laying down that in the reassessment proceedings validly initiated the assessee can seek reopening of the whole assessment and claim credit in respect of items finally concluded in the original assessment. The assessee cannot claim recomputation of the income or redoing of an assessment and be allowed a claim which he either failed to make or which was otherwise rejected at the time of original assessment which has since acquired finality. Of course, in the reassessment proceedings it is open to an assessee to show that the income alleged to have escaped assessment has in truth and in fact not escaped assessment but that the same had been shown under some inappropriate head in the original return, but to read the judgment in V. Jaganmohan Roa’s case (supra) as if laying down that reassessment wipes out the original assessment and that reassessment is not only confined to ‘escaped assessment’ or ‘under-assessment’ but to the entire assessment for the year and start the assessment proceedings de novo giving right to an assessee to reagitate matters which he had lost during the original assessment proceeding, which had acquired finality, is not only erroneous but also against the phraseology of section 147 and the object of reassessment proceedings. Such an interpretation would be reading that judgment totally out of context in which the questions arose for decision in that case. 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.

38. …..

39. As a result of the aforesaid discussion we find that in proceedings under section 147 the ITO may bring to charge items of income which had escaped assessment other than or in addition to that item or items which have led to the issuance of notice under section 148 and where reassessment is made under section 147 in respect of income which has escaped tax, the ITO’s jurisdiction is confined to only such income which has escaped tax or has been under-assessed and does not extend to revising, reopening or reconsidering the whole assessment or permitting the assessee to reagitate questions which had been decided in the original assessment proceedings. It is only the under-assessment which is set aside and not the entire assessment when reassessment proceedings are initiated (emphasis supplied). The ITO cannot make an order of reassessment inconsistent with the original order of assessment in respect of matters which are not the subject matter of proceedings under section 147. An assessee cannot resist validly initiated reassessment proceedings under this section merely by showing that other income which had been assessed originally was at too high a figure except in cases under section 152(2). The words ‘such income’ in section 147 clearly refer to the income which is chargeable to tax but has ‘escaped assessment’ and the ITO’s jurisdiction under the section is confined only to such income which has escaped assessment.

Keeping in view the object and purpose of the proceedings under section 147 which are for the benefit of the revenue and not an assessee, an assessee cannot be permitted to convert the reassessment proceedings as his appeal or revision, in disguise, and seek relief in respect of items earlier rejected or claim relief in respect of items not claimed in the original assessment proceedings, unless relatable to ‘escaped income’, and reagitate the concluded matters. Even in cases where the claims of the assessee during the course of reassessment proceedings related to the escaped assessment are accepted, still the allowance of such claims has to be limited to the extent to which they reduce the income to that originally assessed. The income for purposes of ‘reassessment’ cannot be reduced beyond the income originally assessed.

The Karnataka High Court, in the case of The Karnataka State Co-operative Apex Bank Ltd. (supra), observed that divergent views had been taken by the Supreme Court in these two cases i.e. Sun Engineering Works (P.) Ltd. (supra) and Mewalal Dwarka Prasad (supra). The High Court also by referring to the decisions of the Supreme Court in the case of V. Jagmohan Rao, Mewalal Dwarka Prasad and K.L. Srihari (HUF) (supra) observed that once proceeding u/s 148 was initiated, the original order of assessment got effaced.

In the case of Mewalal Dwarka Prasad (supra), the notice u/s 148 was issued for income escaping the assessment w.r.t three different cash credit entries in the assessee’s books during the year. When the assessee challenged the validity of the notice before the High Court, the High Court upheld its validity but only with respect to one of the cash credit entries, and for the balance two entries, the notice was held to be invalid. The revenue disputed these findings and argued that the High Court should not have examined the tenability of the assessee’s contention with regard to the other two transactions and that aspect should have been left to be considered by the ITO while making the reassessment as it was open to the ITO to examine not only the three items referred to in the notice but also whatever came within the legitimate ambit of an assessment proceeding. In this context, the Supreme Court held that it was not for the High Court to examine the validity of the notice u/s 148 regarding the two items if the High Court concluded that the notice was valid at least in respect of the remaining item. Whether the ITO, while making his reassessment, would take into account the other two items should have been left to be considered by the ITO in the fresh assessment proceeding.

In our respectful submission, in the case of Mewalal Dwarka Prasad (supra), the Supreme Court had dealt with the limited issue about whether the High Court should have considered the validity of notice on the basis of the other items of income when it was held to be valid at least for one of the items of escaped income. In this context, the Supreme Court referred to the decisions of several High Courts and also to its own decision in the case of V. Jaganmohan Rao wherein it was held that when a notice is issued u/s 148 based on a certain item of income that had escaped assessment, it is permissible for the income-tax authorities to include other items in the assessment, in addition to the item which had initiated and resulted in issuance notice u/s 148. As far as the decision of the Supreme Court in the case of K.L. Srihari (HUF) (supra) is concerned, in its final order dated 25th March, 1998, a reference has been made to its earlier order dated 19th November, 1996 (in the same case) whereby the SLPs have been directed to be placed before the three-judges bench on the ground that dissonant views have been expressed in the cases of Sun Engineering Works (P.) Ltd. and Mewalal Dwarka Prasad.

The Calcutta High Court in the case of Keshoram Industries Ltd. (supra) has considered the impact of the Supreme Court’s decision in the case of K.L. Srihari (HUF) (supra) and held as under:

8. True as contended by Mr. Khaitan in ITO vs. K.L. Srihari (HUF) [2001] 250 ITR 193 (SC), a three-judges Bench considered the following judgments:

(1) CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 (SC);
(2) ITO vs. Mewalal Dwarka Prasad [1989] 176 ITR 529 (SC); and
(3) V. Jaganmohan Rao vs. CIT and CEPT [1970] 75 ITR 373 (SC).

but observed that:

“In these circumstances we do not consider it necessary to go into the question that is raised and the same is left open…”. (p. 194)…………..

12. Having heard learned counsel for the respective parties, we are respectfully of the view that in ITO vs. K.L. Srihari (HUF) 250 ITR 193, the Supreme Court did not consider it necessary to go into the views expressed by different Benches of the Supreme Court on the scope and effect of reopening of an assessment under section 147 of the Income-tax Act. We, respectfully, are, therefore, of the view that the judgment of the Supreme Court in CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 has neither been dissented from nor overruled.

13. No doubt as contended by Mr. Khaitan, the judgment in CIT vs. Sun Engg. Works (P.) Ltd.[1992] 198 ITR 297 1 (SC), is a two-judges Bench judgment. By the said judgment, the three-judges Bench judgment in V. Jaganmohan Rao vs. CIT/CEPT [1970] 75 ITR 373 (SC), has not been and could not have been overruled. As noticed supra, the Supreme Court in CIT vs. Sun Engg. Works (P.) Ltd. [1992] 198 ITR 2971 has explained the principle laid down in V. Jaganmohan Rao vs. CIT/CEPT[1970] 75 ITR 373 (SC).

The decision of the Karnataka High Court has thrown open some very pertinent and interesting issues, some of which are listed hereunder:

• Whether an assessment made u/s 143(3) r.w.s 147 is a fresh assessment or re-assessment where it is made in pursuance of an intimation u/s 143(1) or where no assessment was made.

• Whether there was any conflict of views between the four decisions of the Supreme Court referred to and analyzed by the Karnataka High Court.

• Whether the three decisions of the Supreme Court, other than the decision in the case of Sun Engineering Works (supra), held that the original assessments which were made got effaced and therefore an altogether fresh assessment is to be made as per the provisions of law.

• Whether the decision in Supreme Court, being the latest in line, and delivered by the larger bench of three judges, could be said to have laid down the law permitting an assessee to make a fresh claim, when the court confirmed the decision of the Karnataka High Court, 197 ITR 694, which had held that the interest levied u/s 139(8) and 217 in original assessment was required to be deleted.

• Whether the proceedings for re-assessment are necessary for the benefit of revenue.

• Whether the purpose and objective of the Income Tax Act are to levy tax on real income whenever assessed under the Act.

The decision of the Karnataka High Court, by opening a new possibility for the taxpayers, has thrown a serious challenge for the revenue. It would be better for the Supreme Court to examine the issue afresh and reconcile its views in the four decisions rendered by it, over a period of time, preferably by constituting a larger bench.

shailesh.kwebmaker

CONTROVERSIES

ISSUE FOR CONSIDERATION

Charitable institutions generally receive donations (voluntary contributions) from various donors for carrying out their charitable activities. Earlier, till A.Y. 1972-73, section 12(1) provided that voluntary contributions would not be included in income, while section 12(2) provided that voluntary contributions from another trust referred to in section 11, would be deemed to be income from property held in trust for charitable purposes. These voluntary contributions now fall within the definition of ‘income’ by virtue of insertion of section 2(24)(iia) of the Income Tax Act, 1961, with effect from A.Y. 1973-74. Such contributions (other than corpus donations) are also deemed to be income from property held under trust for charitable purposes, by virtue of section 12(1) of the Act, since A.Y. 1973-74. The exemption under section 11 of a charitable trust, registered under section 12A/12AA (now section 12AB), is therefore now computed by considering such voluntary contributions and adjusting the same by the application and accumulation of income, for charitable purposes, by applying the various sub-sections of section 11.

At times, charitable institutions receive grants from other institutions or persons, Indian or foreign, Government or non-government, with the condition that such grants are to be utilised only for specific purposes (“tied-up grants”). In most such cases, there is also a stipulation that in case the tied-up grants are not used for the specified purposes within a specific period of time, the unutilised amounts are to be refunded to the grantor of the aid.

The issues in the context of taxation have arisen before the courts as to whether such tied-up grants could be termed as voluntary contributions and whether, where not utilized during the year, are income of the recipient institution, as the same are to be refunded and represent a liability to be discharged in the future. While the Bombay High Court has taken the view that such grants are voluntary contributions, the Delhi High Court has taken the view that such receipts are not voluntary contributions and are liabilities and not in the nature of income of the recipient institution. A similar view has been taken by the Gujarat High court following the Delhi High court decision.

GEM & JEWELLERY EXPORT PROMOTION COUNCIL’S CASE
The issue had first come up before the Bombay High Court in the case of CIT vs. Gem & Jewellery Export Promotion Council 143 ITR 579.

In this case relating to A.Y. 1967-68, the assessee was a company set up for the advancement of an object of general public utility, i.e., to support, protect, maintain, increase and promote exports of gems and jewellery, including pearls, precious and semi-precious stones, diamonds, synthetic stones, imitation jewellery, gold and non-gold jewellery and articles thereof, whose income was applied only for charitable purposes as defined in section 2(15).

The assessee received grants-in-aid from the Government of India for meeting the expenditure on specified projects. Some of the conditions on which those grants-in-aid were given were the following:
1. The funds should be kept with the State Bank of India, the total expenditure should not be more than the expenditure approved by the Central Government for each project; separate accounts should be kept for Code and non-Code projects and the accounts were to be audited by chartered accountants approved by the Government.
2. Any amount unspent was to be surrendered to the Government by the end of the financial year unless allowed to be adjusted against next year’s grant.
3. The grant should be spent upon the object for which it had been sanctioned. The assets acquired wholly or substantially out of grant-in-aid would not, without prior sanction of the Central Government, be disposed of, encumbered or utilised for purposes other than those for which the grant was sanctioned.

At that point of time, relying on section 12(1), which provided that any income derived from voluntary contributions applicable solely to charitable or religious purposes would not be includible in the total income, the assessee claimed that the grants-in-aid were in the nature of voluntary contributions, and were therefore not taxable, whether spent or not. The assessing officer taxed such unspent grants-in-aid, allowing accumulation of 25% of such amount.

In first appeal, the assessee’s claim was allowed, holding that such grants-in-aid were not taxable, being voluntary contributions. Before the Tribunal, the Department argued that the grants-in-aid could not be considered as voluntary contribution for the purpose of section 12(1), having regard to the fact that the grants were made subject to conditions mentioned above. The Tribunal confirmed the first appellate order, holding that the amounts given by the Government were voluntary contributions and were not in the nature of any price paid for any benefit or privilege, nor were they for any consideration. According to the Tribunal, the conditions imposed by the Government did not change the nature of the payment, which was initially a voluntary contribution.

Before the Bombay High Court, on behalf of the revenue, it was argued that while making contributions, the Government imposed certain conditions and having regard to the fact that the conditions governed the grants, the grants could not be considered to be a donation or a voluntary contribution or, in other words, it was not a pure and simple gift by the Government.

The Bombay High Court observed that it was well known that grants-in-aid were made by the Government to provide certain institutions with sufficient funds to carry on their charitable activities. The institutions or associations to which the grant was made had no right to ask for the grant. It was solely within the discretion of the Government to make grants to institutions of a charitable nature. The Government did not expect any return for the grants given by it to such institutions. There was nothing which was required to be done by these institutions for the Government, which can be considered as a consideration for the grant.

The Bombay High Court noted the meaning of the words ‘voluntarily contributed’ as held in Society of Writers to the Signet vs. CIR 2 TC 257, as “the meaning of the word ‘voluntary’ is ‘money gifted voluntarily contributed in the sense of being gratuitously given’.” The Bombay High Court held that the conditions attached to the grant did not affect the voluntary nature of the contribution. The conditions were merely intended to see that the amounts were properly utilised, and therefore did not detract from the voluntary nature of the grant.

The Bombay High Court accordingly held that the grants-in-aid were voluntary contributions, and were exempt under section 12(1), as it then stood.

SOCIETY FOR DEVELOPMENT ALTERNATIVES’ CASE
The issue again came up before the Delhi High Court in the case of DIT vs. Society for Development Alternatives 205 Taxman 373 (Del).

In this case, relating to A.Y. 2006-07 and 2007-08, the assessee was a society, which was registered under Section 12A and Section 80G. It was undertaking activities relating to research, development and dissemination of (i) Technologies for fulfillment of basic needs of rural households (ii) Solutions for regeneration of natural resources and the environment and (iii) Community based institution strengthening methods to improve access to for the poor.

It had received grants for specific purposes/projects from the government, non-government, foreign institutions etc. These grants were to be spent as per the terms and conditions of the project grant. The amount, which remained unspent at the end of the year, got spilled over to the next year and was treated as unspent grant. The Assessing Officer treated such unspent grants as income of the assessee, invoking the provisions of section 12(1). This section then provided that any voluntary contributions received by a trust created wholly for charitable or religious purposes (other than corpus donations) were, for purposes of section 11, deemed to be income from property held under trust wholly for charitable or religious purposes.

The Commissioner (Appeals) deleted the addition, noting that:
1. The amounts were received/sanctioned for a specific purpose/project to be utilized over a particular period.
2. The utilisation of the said grants was monitored by the funding agencies who sent persons for inspection and also appointed independent auditors to verify the utilisation of funds as settled terms.
3. The assessee had to submit inter/final progress/work completion reports along with evidences to the funding agencies from time to time.
4. The agreements also included a term that separate audited accounts for the project would be maintained.
5. The unutilised amount had to be refunded back to the funding agencies in most of the cases.
6. All the terms and conditions had to be simultaneously complied with, otherwise the grants would be withdrawn.
7. The assessee had to utilise the funds as per the terms and conditions of the grant. If it failed to utilise the grants for the purpose for which grant was sanctioned, the amount was recovered by the funding agency.

The Commissioner (Appeals) was therefore of the view that the assessee was not free to use the funds voluntarily as per its sweet will and, thus, these were not voluntary contributions as per Section 12. He concluded that these were tied-up grants, where the appellant acted as a custodian of the funds given by the funding agency to channelise the same in a particular direction. The Tribunal upheld the order passed by the Commissioner (Appeals).

The Delhi High Court agreed with the findings of the Tribunal, holding that these were not voluntary contributions, and were therefore not income under section 12(1).

A similar view has been taken by the Gujarat High Court in the case of DIT(E) vs. Gujarat State Council for Blood Transfusion, 221 Taxman 126, for AY 2009-10, holding that the grant received from the State Government was not income of the trust for the purposes of section 11.

OBSERVATIONS
Though both the Bombay and Delhi High Court decisions were decided in favour of the assessee and held that the tied-up grants were not taxable, since the law in both the years was different, the ratio of these decisions is opposite to that of each other – while the Bombay High Court has held that tied-up grants are ‘voluntary contributions’, the Delhi High Court has taken the view that these tied-up grants are not ‘voluntary contributions’.

The Bombay High Court, in examining whether the tied-up grants were voluntary contributions or not, looked at the receipt from the perspective of the grantor – was the grant voluntary, or was it for some consideration, and held that since it was voluntary from the viewpoint of the donor, the receipt was a voluntary contribution; and applying the then applicable law, it held that voluntary contributions were not income, as the definition of ‘income’ at the relevant time did not include voluntary contributions. The Bombay High Court did not have to consider the subsequent amendment, under which such amounts were independently in the nature of income.

The law presently applicable provides that a ‘voluntary contribution’ is an income, and hence it has become necessary to examine whether a tied-up grant, not spent by the year end or not accumulated, is a voluntary contribution, more so where it is attached with the condition of refunding the unspent amount. Following the Bombay High Court, the receipt is a voluntary contribution, and once so accepted, the same has to be subjected to the rules of application and accumulation. In contrast, where the Delhi High court is followed, the receipt in the first place shall not be construed as a voluntary contribution and would not be subjected to the rules of application and accumulation.

In order for a receipt to be regarded as a voluntary contribution and for it to bear the character of income, the recipient has to have some element of domain over the receipt – the freedom to apply such income as it desires. If the recipient has to necessarily spend the receipt as per the directions of the grantor, and under the supervision of the donor, it has no control over such spending and over such amounts. Such receipts should be considered as held in trust for the grantor and when spent, the expenditure be held to be the expenditure of the grantor, and not that of the recipient trust, which disburses the amounts. Besides, where the unspent amount is refundable, it is a liability and cannot be regarded as income at all.

The Hyderabad bench of the Tribunal has therefore held, in the case of Nirmal Agricultural Society vs. ITO 71 ITD 152, that ‘The grants which are for specific purposes do not belong to the assessee-society. Such grants do not form corpus of the assessee or its income. Those grants are not donations to the assessee so as to bring them under the purview of section 12 of the Act. Voluntary contributions covered by section 12 are those contributions freely available to the assessee without any stipulation which the assessee could utilise towards its objectives according to its own discretion and judgment. Tied-up grants for a specified purpose would only mean that the assessee, which is a voluntary organisation, has agreed to act as a trustee of a special fund granted by Bread for the World with the result that it need not be pooled or integrated with the assessee’s normal income or corpus. In this case, the assessee is acting as an independent trustee for that grant, just as same trustee can act as a trustee of more than one trust. Tied-up amounts need not, therefore, be treated as amounts which are required to be considered for assessment, for ascertaining the amount expended or the amount to be accumulated.’

According to the Tribunal, such unspent grants should be shown as a liability, and the expenditure incurred for the specified purposes adjusted against such liability, and not be treated as the expenses of the assessee. Only any non-refundable credit balance in the liability account of the grantor would be treated as income in the year in which such non-refundable balance was ascertained.

A similar view has been taken by the Mumbai bench of the Tribunal in the case of NEIA Trust v ADIT ITA No 5818-5819/Mum/2015 dated 24th December 2019 (A.Y. 2011-12 and 2012-13), where the Tribunal has held:
‘upon perusal of stated terms & conditions, it could not be said that the funds received by the assessee were not in the nature of voluntary contributions rather they were more in the nature of specific grants on certain terms and conditions and liable to be refunded, in case the same were not utilized for specific purposes. It is trite law that entries in the books of accounts would not be determinative of the true nature / character of the transactions and the same could not be held to be conclusive. Therefore, the mere fact that the assessee credited the receipts as corpus contribution, in our considered opinion, would not make much difference and would not alter the true nature of the stated receipts. The said funds / receipts, as stated earlier, were more in the nature of specific grants and represent liability for the assessee and liable to be refunded in case of non-utilization.’

The Hyderabad Bench decision in Nirmal Agricultural Society’s case has also been followed by the Tribunal in the cases of Handloom Export Promotion Council vs. ADIT 62 taxmann.com 288 (Chennai) and JB Education Society vs. ACIT 55 taxmann.com 322 (Hyd).

Besides, in the cases of various Government Corporations set up to implement Government policies, grants received from the Government by such corporations have been held not to constitute income of the Corporation, since the Corporation acts as an agency of the Government in spending for the Government schemes. The funds therefore really belong to the Government, until such time as the funds are spent. This view has been taken by the High Courts in the following cases:
• CIT vs. Karnataka Urban Infrastructure Development and Finance Corpn. 284 ITR 582 (Kar.)
• Karnataka Municipal Data Society vs. ITO 76 taxmann.com 167 (Kar)

The position may be slightly different in case of grants from the Government and a few specified bodies, with effect from A.Y. 2016-17. Clause (xviii) of section 2(24) has been inserted in the definition of ‘income’, which provides for taxation of grants from the Central Government, State Government, any authority, body or agency as income. Such grants would therefore be taxable as income of the recipient trust, and the fact anymore may or may not be material that the receipt is not a voluntary contribution. This inserted provision in any case would not apply to grants received from other non-governmental organisations.

In case the Government tied-up grant is refundable if not spent, can it be regarded as income at all post insertion of clause (xviii)? One way to minimize the harm on the possible application of clause (xviii) of section 2(24) could be to tax such unspent receipts in the year in which the fact of the non-utilisation is final; even in such a case, a possibility of claiming deduction for the refund of unspent amount should be explored. Alternatively, in that year, the expenditure, where incurred, should be treated as an application of income. The other possible view is that clause (xviii) applies only to recipient persons, other than charitable organisations, to whom the specific provisions of clause (iia) of section 2(24) applies, rather than generally applying the provisions of clause (xviii) to all and sundry.

The better view therefore seems to be that of the Delhi and Gujarat High Courts, that tied-up grants are not voluntary contributions and/or income of the recipient institution.

shailesh.kwebmaker

CLAIM FOR RELIEF OF REBATE OUTSIDE REVISED RETURN OF INCOME

ISSUE FOR CONSIDERATION
It is usual to come across cases where an assessee, in filing the return of income, fails to make a claim for relief on account of a rebate or deduction or exemption and also overlooks the filing of the revised return within the time prescribed u/s 139(5). His attempt to remedy the mistake by staking a claim for relief before the A.O. or the CIT(A) afresh is usually dismissed by the authority. At times, even the appellate Tribunal or the courts have not appreciated the bypassing of the statutory remedy entrusted u/s 139(5), more so after the decision of the Supreme Court in the case of Goetze (India) Ltd., 284 ITR 323 was delivered, a decision interpreted by the authorities and at times by the Courts to have laid down the law that requires an assessee to stake a fresh claim, not made while filing the return of income, only by revising the return within the prescribed time.

Several Benches of the Tribunal and the Courts, after due consideration of the said decision of the Apex Court, have permitted the assessee to stake a fresh claim, which claim was not made while filing the return of income or by revising the same in time, either by filing an application during the course of the assessment or, at the least, while adjudicating the appeal. At a time when it appeared that the law was reasonably settled on the subject, the recent decision of the Kerala High Court has warned the assessee that the last word on the subject has not yet been said. It held that the claim for relief, not made vide a return, revised or otherwise, could not be made before the A.O. or even before the appellate authorities.

RAGHAVAN NAIR’S CASE
The issue recently came up for the consideration of the Kerala High Court in the case of Raghavan Nair, 402 ITR 400. The assessee had received a certain sum of money during F.Y. 2014-15 pertaining to A.Y. 2015-16 by way of compensation for land acquired from him for a Government project. The assessee offered the receipt for taxation in filing the return of income under the head capital gains. During the course of the scrutiny assessment, the assessee claimed that the compensation received was not taxable in the light of section 96 of the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013. The assessee requested for the relief vide a letter which was denied by the A.O., against which the assessee filed a writ petition before the Court.

The Court noted that the assessee, when he was made to understand that he had no liability to pay tax on capital gains, could not file a revised return since the time for filing the revised return had expired by the time he came to know that there was no such liability to pay tax.

At the hearing, the Court held that it was the duty of the A.O. to refrain from assessing an income even if the same had been included by mistake by the assessee in his return of income filed. The Court held that the decision of the Supreme Court was not applicable to the facts of the case by explaining the implication of the decision of the Apex Court as: ‘The question that arose in Goetze (India) Ltd.’s case (Supra) was whether an assessee could make a claim for deduction other than by filing a revised return. As noted above, the question in the case on hand is whether the A.O. is precluded from considering an objection as to his authority to make an assessment u/s 143 merely for the reason that the petitioner has included in his return an amount which is exempted from payment of tax and that he could not file a revised return to rectify the said mistake in the return. The decision of the Apex Court in the Goetze case has, therefore, no application to the facts of the present case.’

The High Court held that this was a clear case where the A.O. had penalised the assessee for having paid tax on an income which was not exigible to tax. It noted that in the light of the mandate under article 265 of the Constitution, no tax should be levied or collected except by authority of law. The Court relied on the observations of the Apex Court in the case of Shelly Products 129 Taxman 271:

‘We cannot lose sight of the fact that the failure or inability of the Revenue to frame a fresh assessment should not place the assessee in a more disadvantageous position than in what he would have been if a fresh assessment was made. In a case where an assessee chooses to deposit by way of abundant caution advance tax or self-assessment tax which is in excess of his liability on the basis of the return furnished, or there is any arithmetical error or inaccuracy, it is open to him to claim refund of the excess tax paid in the course of the assessment proceeding. He can certainly make such a claim also before the authority concerned calculating the refund. Similarly, if he has by mistake or inadvertence or on account of ignorance, included in his income any amount which is exempted from payment of Income-Tax, or is not income within the contemplation of law, he may likewise bring this to the notice of the assessing authority, which if satisfied, may grant him relief and refund the tax paid in excess, if any. Such matters can be brought to the notice of the authority concerned in a case when refund is due and payable, and the authority, on being satisfied, shall grant appropriate relief. In cases governed by section 240 of the Act, an obligation is cast upon the Revenue to refund the amount to the assessee without his having to make any claim in that behalf. In appropriate cases, therefore, it is open to the assessee to bring facts to the notice of the authority concerned on the basis of the return furnished, which may have a bearing on the quantum of the refund, such as those the assessee could have urged u/s 237 of the Act. The authority, for the limited purpose of calculating the amount to be refunded u/s 240 of the Act, may take all such facts into consideration and calculate the amount to be refunded. So viewed, an assessee will not be placed in a more disadvantageous position than what he would have been, had an assessment been made in accordance with law.’

Accordingly, the Court held that the A.O. should not have taxed the income that was not liable to tax even where the assessee had offered such an income for taxation and had not filed the revised return of income.

PARAGON BIOMEDICAL INDIA (P) LTD.’S CASE
The issue recently again came before the Kerala High Court in the case of Paragon Biomedical India (P) Ltd. 438 ITR 227 (Ker). In this case, the assessee had claimed a deduction u/s 10B which was disallowed by the A.O. In the appeal to the CIT(A), the assessee modified the claim for deduction from section 10B to section 10A, which was allowed by the CIT(A). On appeal by the Revenue, the Tribunal held that the CIT(A) was justified in allowing the alternative claim of deduction u/s 10A and confirmed the order of the Commissioner (Appeals) that permitted the assessee to claim the deduction under a different provision of law than the one that was applied for while filing the return of income.

On further appeal, the High Court, however, reversed the order of the Tribunal and held the order to be contrary to the principles laid down by the Apex Court in the cases of Goetze (India) Ltd. (Supra) and Ramakrishna Deo 35 ITR 312. In the light of the said decisions, the High Court termed the orders of the CIT(A) and the Tribunal as both illegal and untenable. The Court, in deciding the case, found that the decisions in the cases of National Thermal Power Co. Ltd. 229 ITR 383 (SC) and Goetze did not conflict with each other, as NTPC’s decision did not in any way relate to the power of the A.O. to entertain a claim for deduction otherwise than by filing a revised return.

OBSERVATIONS
Article 265 of the Constitution of India provides that any retention of tax collected, which is not otherwise payable, would be illegal and unconstitutional. Retaining the mandate of the Constitution, the Board vide Circular 14(XL-35) dated 11th July, 1955 reiterated that the taxing authority cannot collect or retain tax that is not authorised by law and further that it was the duty of the assessing authority to ensure that a relief allowable to an assessee in law shall be allowed to him even where such a claim is not made by him in filing the return of income.

An A.O. has been vested with the power to assess the total income and in doing so he has wide powers to bring to tax any income, whether or not disclosed in the return of income. He also has the powers to rectify any mistakes. The Board has invested in him the power to grant the reliefs and rebates that an assessee is entitled to but has failed to claim while filing the return of income. [CBDT Circular No. 14 dated 11th July, 1955]. This Circular is relied upon by the Courts to hold that an A.O. is duty-bound to grant such reliefs and rebates that an assessee is entitled to, based on the records available, even where not claimed by the assessee in filing the return of income or otherwise.

Section 139(5) provides for filing of a revised return of income in cases where the return furnished contains any omission or any wrong statement within the prescribed time independent of the powers and the duties of the A.O. It was a largely settled understanding that an assessee could make a claim for a relief or rebate, during the course of assessment, by filing a petition without filing a revised return of income even after the time of filing such return has expired. The Apex Court, however, in one of the decisions (Goetze), held that a rebate or a relief can be claimed by an assessee only by filing of a revised return of income. This decision has posed various challenges, some of which are:

• Whether an A.O. can entertain a petition outside of the revised return and allow a relief claimed by the assessee.
• Whether an A.O. is duty-bound to allow a relief even where not claimed in the return filed by the assessee where no petition or revised return is filed.
• Whether an A.O. is bound to allow such a relief where the material for such relief is available on his records though no petition or revised return is filed.
• Whether an A.O. is required to allow a petition for a modified claim for relief, which was otherwise claimed differently in the return of income filed, without insisting on the revised return of income.
• Whether an appellate authority, being CIT(A) or the Tribunal, can entertain a petition for a relief not claimed or allowed in any of the above situations.

Section 143, as noted above, has invested the A.O. with wide powers in assessing the total income and bringing to tax the true or real income of the assessee, whether or not disclosed in the return of income, even where no return has been filed by an assessee. Sections 250(5) and 251(1) have invested a CIT(A) with powers that are consistently held by the Courts to be coterminus with the powers of an A.O.; he can do everything that an A.O. could have done and has all those powers which an A.O. has, besides the power of enhancement of an income that has not been brought to tax by the A.O. in the course of adjudicating an appeal, subject to a limitation in respect of the new source of income. The appellate Tribunal is vested with powers u/s 254(1) that are held to be wide enough to include entertaining a claim for the first time, subject to certain limitations.

By now it is the settled position in law that the appellate authorities have the power to entertain a new or a fresh claim for relief made by the assessee for the first time before them subject to providing an opportunity to the A.O. to put up his case. This is clear from the reference to the following important decisions:

The Supreme Court in the case of Jute Corporation of India Ltd., 187 ITR 688 dealt with a case where the assessee, during the pendency of its appeal before the AAC, raised an additional ground claiming deduction of certain amount on account of liability of disputed purchase tax, not claimed while filing the return of income. The AAC permitted the assessee to raise the additional ground and after hearing the ITO, accepted the assessee’s claim and allowed the deduction. However, the Tribunal held that the AAC had no jurisdiction to entertain the additional ground or to grant relief to the assessee on a ground which had not been raised before the ITO. On appeal to the Supreme Court, the Court, following its decision in the case of Kanpur Coal Syndicate, 53 ITR 225, delivered by a Bench of three judges and dissenting from its later decision in the case of Gurjaragraveurs (P) Ltd., 111 ITR 1 delivered by a Bench of two judges, held as under:

‘The Act does not contain any express provision debarring an assessee from raising an additional ground in appeal and there is no provision in the Act placing restriction on the power of the appellate authority in entertaining an additional ground in appeal. In the absence of any statutory provision, the general principle relating to the amplitude of the appellate authority’s power being coterminous with that of the initial authority should normally be applicable. If the tax liability of the assessee is admitted and if the ITO is afforded an opportunity of hearing by the appellate authority in allowing the assessee’s claim for deduction on the settled view of law, there appears to be no good reason to curtail the powers of the appellate authority u/s 251(1)(a). Even otherwise an appellate authority while hearing an appeal against the order of a subordinate authority has all the powers which the original authority may have in deciding the question before it, subject to the restrictions or limitations, if any, prescribed by the statutory provisions. In the absence of any statutory provision, the appellate authority is vested with all the plenary powers which the subordinate authority may have in the matter. There appeared to be no good reason to justify curtailment of the power of the AAC in entertaining an additional ground raised by the assessee in seeking modification of the order of assessment passed by the ITO.’

The Supreme Court in the case of Nirbheram Deluram, 91 Taxman 181 (SC) held that the first appellant authority could modify an assessment on a ground not raised before an A.O. following Jute Corporation of India Ltd.’s case (Supra) which had held that the first appellate authority could permit an additional ground not raised before the A.O.

The Kerala High Court, in the case of V. Subhramoniya Iyer, 113 ITR 685, held that the first appellate authority had the power to substitute the order of an A.O. with his own order and the Gujarat High Court in the case of Ahmedabad Crucible Co., 206 ITR 574 held that the powers of the first appellate authority extended beyond the subject matter of assessment, which powers were held to include the power to make an addition on a ground not considered by the A.O.

The Supreme Court in the National Thermal Power Corporation case (Supra) confirmed the judicial view that in cases where a non-taxable receipt was taxed or a permissible deduction was denied, there was no reason why the assessee should be prevented from raising the claim before the second appellate authority for the first time, so long as the relevant facts were on record pertaining to the claim. This condition of the availability of the evidence on records is also waived where the fresh issue relates to the moot question of law or goes to the root of the appeal. Even otherwise, the courts are liberal in upholding the powers of the second appellate authorities generally to entertain a lawful claim.

This understanding and the contours of law are not sought to be disturbed even by the decision of the Apex Court delivered in the Goetze case, which rather confirmed that the said decision was independent of the powers of the appellate authorities. In fact, the appellate authorities regularly entertained a fresh claim by relying on the said decision. It is this settled position of law, even post-Goetze, that is sought to be disturbed by the recent Kerala High Court decision in the case of Paragon Biomedical (Supra) when holding that the claim made before the A.O., outside the revised return of income, was not entertainable. Even when the CIT(A) entertained and allowed such a claim, the said claim was found to be not permissible in law by the Court.

And even prior to the decision of the Kerala High Court, the Madras High Court in the case of Shriram Investments Ltd. (TCA No. 344 of 2005) and the Chennai Bench of the Tribunal in the case of Litostroj, 54 SOT 37 (URO) following the said Madras High Court decision, had held that relief could have been claimed only by filing a revised return of income.

We are of the considered opinion that the position in law settled by the series of Supreme Court decisions permitting the assessee to raise a new or a fresh claim before the appellate authorities is nowhere unsettled by the decision in Paragon Biomedical and a few other cases. In fact, had these decisions of the Supreme Court been cited before the High Court, the decision of the Court would surely have been otherwise. The case before the Kerala High Court was not represented by the assessee before the Court and the representative of the Revenue seems to have failed to bring these cases to the notice of the Court. [Please see Pruthvi Stock Brokers Ltd., 23 taxmann.com 23 (Bom); Kotak Mahindra Bank Ltd., 130 taxmann.com 352 (Kar); Ajay G. Piramal Foundation, 228 Taxman 332 (Del).]

The real issue of the assessee’s power to claim a relief or a rebate outside of a revised return of income, under a petition to the A.O. during the course of assessment, appears to have been soft-pedalled by the Courts either by holding that the A.O. was duty-bound, under the Circular No. 14 of 1955, to allow the relief on his own based on records available, as was done in the cases of Sesa Goa Ltd., 117 taxmann.com 548 (Bom) or CMS Securitas, 82 taxmann.com 319 (Mum) or Perlos, ITA No. 1037/Madras/2013, to name a few, and alternatively by holding that the claim for relief, made outside the revised return before the A.O. was not a new or a fresh claim but was a modified claim based on a mistaken provision of law or the quantum or the failure to claim a relief for which the reports and other material were available on record, as was held in the cases of Malayala Manorama, 409 ITR 358 (Ker), Ramco Engineering, 332 ITR 306 (P&H), Influence, 55 taxmann.com 192 (Del), Shri Balaji Sago Agro, 53 SOT 15 (Mad), Perlos, ITA No. 1037/Madras/2013 and also in Raghavan Nair (Supra), 402 ITR 400 by the same Kerala High Court. [Please also see Sam Global, 360 ITR 682 (Del), Jai Parabolic, 306 ITR 42 (Del), Natraj Stationery, 312 ITR 22 (Del) and Rose Services, 326 ITR 100 (Del).]

A fresh claim for relief is different from a revised claim for relief. In cases where a claim has been made while filing the return of income and is modified or is enhanced or is made under a different provision of the law, the case can be classified as a case of a revised claim, and not a fresh claim. The outcome can be different in cases where the evidence in support of the fresh claim is available on record, from cases where such evidence is not available on record.

The issue of an assessee’s right to claim a relief or a rebate, outside the revised return of income post Goetze, has been addressed directly in the case of CMS Securitas Ltd., 82 taxmann.com 319 by the Mumbai Bench of the Tribunal in favour of the assessee, while the Chennai Bench of the Tribunal in the case of Litostroj, 54 SOT 37 (URO), following an unreported decision of the Madras High Court in the case of Shriram Investments Ltd. [T.C. (A) No. 344 of 2005, dated 16th June, 2011] restored the matter to the file of the A.O. to verify the facts, instead of upholding the power of the CIT(A) to entertain a fresh claim.

In Goetze the question raised in the appeal by the assessee related to whether the assessee could make a claim for deduction other than by filing a revised return by way of a letter before the A.O. The deduction was disallowed by the A.O. on the ground that there was no provision under the Act to make an amendment in the return of income by an application at the assessment stage without revising the return. In the appeal, the assessee had relied upon the decision in the case of National Thermal Power Co. Ltd. (Supra) to contend that it was open to the assessee to raise the points of law even before the appellate Tribunal. The Court noted that the said decision dealt with the power of the Tribunal to entertain a claim where the facts relating to the law were available on record, and that it did not in any way relate to the power of the A.O. to entertain a claim for deduction otherwise than by filing a revised return; and that the NTPC decision could not be relied upon to allow the claim before the A.O. outside the revised return of income. The appeal of the assessee was dismissed by clarifying that the issue in the case was limited to the power of the assessing authority and did not impinge on the power of the appellate Tribunal u/s 254.

The better view therefore is that the appellate authority certainly has the right to consider a fresh or revised claim made by the assessee in appeal, and certainly so in respect of a claim made for which the relevant facts are already on record.

Besides the issue under consideration w.r.t. section 139(5), the issues regularly arise where a fresh claim is sought to be made while filing the return in response to a notice u/s 153A / 153C, abated or not, or section 148, or where such a claim is sought to be made in a revision application u/s 264 or by filing rectification u/s 154 or on application u/s 119(2)(b).

A fresh claim was held to be permissible in the return filed in response to notice u/s 153A / 153C in case of abated assessment [JSW Steel Ltd., 422 ITR 71 (Bom), B.G. Shirke Construction Technology (P) Ltd., 79 taxmann.com 306 (Bom)] and where assessment was unabated and incriminating documents were found for that year [Sheth Developers (P) Ltd., 210 Taxman 208 (Mag)(Bom), Neeraj Jindal, 393 ITR 1 (Del), Kirit Dahyabhai Patel, 80 taxmann.com 162 (Guj), Shrikant Mohta, 414 ITR 270 (Cal)]. In contrast, the courts in a few other cases have held that the assessee is not permitted to stake such a fresh claim that was not made in the return filed u/s 139.

In the context of the return of income filed in response to a notice u/s 148, it was held that a fresh claim was not permissible in the cases of Caixa Economica De Goa, 210 ITR 719 (Bom), Satyamangalam Agricultural Producer’s Co-operative Marketing Society Ltd.,357 ITR 347 (Mad) and K. Sudhakar S. Shanbhag, 241 ITR 865 (Bom).

In contrast, a fresh claim was held to be permissible in filing a revision application u/s 264. [Vijay Gupta, 386 ITR 643 (Del), Assam Roofing Ltd., 43 taxmann.com 316 (Gau), S.R. Koshti, 276 ITR 165 (Guj), Sharp Tools, 421 ITR 90 (Mad), Shri Hingulambika Co-operative Housing Society Ltd. 81 taxmann.com 157 (Kar), Agarwal Yuva Mandal, 395 ITR 502 (Ker), EBR Enterprises, 415 ITR 139 (Bom), Kewal Krishan Jain, 42 taxmann.com 84 (P&H).]

In the cases of Curewel (India) Ltd., 269 Taxman 397 (Del) it was held permissible to place a fresh claim while an assessment is being made afresh in pursuance of an order setting aside the original order of assessment. But see also Saheli Synthetics (P) Ltd., 302 ITR 126 (Guj).

In filing an application for rectification u/s 154, it was held permissible to file a fresh claim [Nagaraj & Co. (P) Ltd., 425 ITR 412 (Mad), Anchor Pressings (P) Ltd., 161 ITR 159 (SC), Gujarat State Seeds Corpn. Ltd., 370 ITR 666 (Guj) and NHPC Ltd., 399 ITR 275 (P&H).]

An assessee who has missed making a claim in the return of income, may explore the possibility of filing an application to the CBDT u/s 119(2)(b) for permitting the filing of a revised return of income after the expiry of the time u/s 139(5). [Mrs. Leena R. Phadnis,387 ITR 721 (Bom), Mahalakshmi Co-operative Bank Ltd., 358 ITR 23 (Kar) and Labh Singh, 111 taxmann.com 53 (HP).]

shailesh.kwebmaker

PREMIUM RECEIVED BY LANDLORD ON TRANSFER OF TENANCY RIGHTS – CAPITAL OR REVENUE?

ISSUE FOR DISCUSSION

A person acquiring the right to use an immovable property on a month-to-month basis without acquiring the ownership right is known as the tenant and the person continuing to be the owner of the property is known as the landlord. The monthly compensation paid for the use of the property is known as the rent. Various States in India have tenancy laws, whereby tenants are protected from eviction by the landlord from premises in which they are tenants. The rights so acquired by the person to use the property are known as tenancy rights. These rights may be acquired for a consideration known as salami or premium, though many States prohibit payment of such consideration.

On the other hand, many States permit the transfer of tenancy rights by the tenant for a consideration with the consent of the landlord, who may consent to the transfer on receipt of a payment or even without it. These tenancy rights are recognised by the tax laws as capital assets of the tenant and accordingly the gains if any on their transfer are taxed under the head capital gains. Section 55 provides that the cost of acquisition of the tenancy is to be taken as Nil unless paid for, in which case the cost would be the one that is paid for acquiring the tenancy. Tenancy rights when acquired for a fixed period under a written instrument are known as leasehold rights. Acquisition of a license to use the property, although similar to lease or tenancy, is not the same.

An interesting issue has arisen as to the manner of taxation of the receipt by the landlord for consenting to such transfer of tenancy – whether it is capital in nature and therefore not taxable or taxable as capital gains, or whether it is revenue in nature and taxable as income. There have been conflicting decisions of the Mumbai Bench of the Tribunal on this issue. The taxation of such receipt under the provisions of section 56(2)(x) is another aspect that requires consideration.

THE VINOD V. CHHAPIA CASE
The issue came up before the Mumbai Bench of the Tribunal in the case of Vinod V. Chhapia vs. ITO (2013) 31 taxmann.com 415.

In this case, the assessee was a HUF which owned an immovable property. Part of the property was let out to a tenant since 1962 and part of the property was occupied by the members of the HUF. The tenant expired in 1986 and the tenancy rights were inherited by her daughter.

A tripartite agreement was entered into between the daughter, new tenants and the landlord for surrender of tenancy by the daughter and grant of tenancy by the landlord in favour of the new tenants. The daughter surrendered her tenancy rights in favour of the landlord to facilitate renting of the property to the new tenants. The incoming tenants paid an amount of Rs. 14.74 lakhs to the daughter and an amount of Rs. 7.26 lakhs to the assessee-landlord simultaneously. The assessee accepted the surrender of tenancy rights and possession of the property and received the amount from the new tenants as consideration for granting the new tenants monthly tenancy of the flat.

The assessee invested the amount of Rs. 7.26 lakhs in bonds issued by NABARD, treated the amount received from the new tenants as capital gains and claimed exemption u/s 54EC.

During assessment proceedings, the assessee claimed that the amount was received towards surrender of a right, which was part of the bundle of rights owned by the assessee in respect of the property. The assessee claimed that the receipt of the consideration of Rs. 7.26 lakhs was for the extinguishment of the rights and therefore was capital gains eligible for exemption u/s 54EC. Various decisions were cited by the assessee in support of the proposition that the amount received on surrender of tenancy rights was a capital receipt, which was taxable under the head ‘capital gains’.

But the A.O. brought out the distinction between transfer of tenancy rights vis-à-vis surrender of tenancy rights. According to him, the receipt by the landlord was for consenting to a transfer of the right of residence by the existing tenant to the new tenants. He sought to support this view by the fact of payment of consideration by the new tenants to both the original tenant and the landlord. The A.O. distinguished the judgments cited before him, since all of those related to surrender of tenancy rights.

According to the A.O., the outgoing tenant (the daughter) surrendered (transferred) the tenancy rights in favour of the new tenants and not to the assessee-landlord. He held that the amount of Rs. 7.26 lakhs was received by him from the new tenants for consenting to the transfer of tenancy to the new tenants, and not for surrender of tenancy, and was therefore not a capital receipt. The A.O. therefore taxed the amount of Rs. 7.26 lakhs as income of the assessee under the head ‘income from other sources’, rejecting the claim of exemption u/s 54EC.

Before the Commissioner (Appeals), the assessee submitted that consent of the landlord was mandatory for the new tenants to enjoy the right of residence. Thus, by consenting, the assessee gave up (transferred) some of the rights out of the bundle of rights attached to the said property, a capital asset. Reliance was placed on the Supreme Court decision in the case of CIT vs. D.P. Sandu Bros. Chembur (P) Ltd. 273 ITR 1 and on the Bombay High Court decision in the case of Cadell Weaving Mill Co. (P) Limited vs. CIT 249 ITR 265, for the proposition that the amount received on surrender of tenancy rights is a capital receipt taxable under the head ‘capital gains’, and not ‘income from other sources’.

The Commissioner (Appeals) rejected the appeal, confirming the order of the A.O. and held that the assessee continued to hold the ownership rights even after the new tenants entered the house and that the outgoing tenant transferred the tenancy rights to the new tenants. The assessee merely gave its consent for such transfer, for which it received the sum of Rs. 7.26 lakhs which could not be termed as a receipt for surrender of tenancy rights. Had it amounted to a surrender of tenancy rights in favour of the landlord, the consideration would have been paid by the landlord to the outgoing tenant. Therefore, it was a case of encashment of the power of consent for transfer of the tenancy rights to the new tenants. The Commissioner (Appeals) next observed that if the new tenants further transferred the property to some other tenant, the assessee would be entitled to receive a similar amount and the ownership rights of the property would continue to vest with the assessee.

Before the Tribunal, on behalf of the assessee it was submitted that the rights attached to an immovable property constituted a bundle of rights. Exploitation of these rights gives rise to capital gains. Without the surrender of tenancy rights by the original tenant to the assessee, the assessee could not have consented to the transfer of residence in favour of the new tenant. Therefore the consideration received by the assessee was for surrender of tenancy rights, which was a capital receipt, taxable as capital gains.

Attention was drawn by the assessee to the tripartite agreement between the assessee, the original tenant and the new tenants, which mentioned that the original tenant was the sole owner of the tenancy rights and she surrendered the flat to the landlord including the tenancy rights.

On behalf of the Revenue it was argued that normally in the case of surrender of tenancy rights the tenant would receive the consideration from the landlord for surrender of the same. In the case before the Tribunal, the landlord did not pay the consideration to the original tenant, but it was the new tenants who paid the consideration to the original tenant. Further, the assessee continued to hold the right of ownership of the property and tenancy rights were transferred from the old tenant to the new tenants. It was therefore submitted that the amount was rightly taxed as ‘income from other sources.’

The Tribunal noted that all the decisions cited before it, whether by the assessee or by the Revenue, were in the context of undisputed surrender of tenancy rights and were therefore distinguishable on facts. Analysing the facts of the case, the Tribunal was of the view that the consideration paid by the new tenants was for consent of the landlord for the transfer of tenancy rights between the new and old tenants and the amount of Rs. 7.26 lakhs was the consideration for consent. According to the Tribunal, generally in matters of tenancy rights disputes it is the tenant who gets the financial benefit, which flows from the pockets of the landlord in lieu of surrender of the tenancy rights by the tenant, and the landlord does not receive any amount. Therefore, according to the Tribunal, the settled law relating to taxation of a receipt on surrender of tenancy rights would not apply in the case before it.

The Tribunal also examined whether the assessee actually received all the rights over the property, including the tenancy rights. It noted the clause in the agreement which indicated that the existing tenant surrendered the tenancy rights along with the property to the assessee. It questioned the need for the existing tenant to be a signatory to the agreement giving the property on monthly rent to the new tenants and the need for a tripartite agreement. According to the Tribunal, letting of the property to the new tenant was a matter of agreement between the landlord and the new tenant.

Noting that the monthly rental and rental advance were nominal, the Tribunal was of the view that the sum of Rs. 7.26 lakhs paid to the landlord by the new tenant was consideration for the consent. As per the Tribunal, the receipt was for the consent for transfer by the old tenant to the new tenants, for a consideration of Rs. 14.48 lakhs and there was a need for the consent of the landlord. The Tribunal accordingly held that there was no transfer of any capital asset by the landlord to the new tenants and that the sum of Rs. 7.26 lakhs was neither a capital receipt nor a rental receipt.

The Tribunal also noted that there was no time gap between the vacation of the property by the old tenant and grant of rental rights to the new tenants. There was continuity of renting of the property and there was no evidence to infer that the house was in the vacant possession of the assessee even after the alleged end of the tenancy of the old tenant. Therefore, the assessee never got the property in vacant condition. Hence the Tribunal held that the amount received was consideration for consent, it did not involve any transfer of capital rights attached to the property, and it constituted a windfall gain to the assessee, which was taxable under the head ‘income from other sources’.

NEW PIECE GOODS BAZAR CO. LTD. CASE
The issue again came up before the Mumbai Bench of the Tribunal in the case of Jt. CIT vs. New Piece Goods Bazar Co. Ltd., ITA No. 6983/Mum/2012 dated 25th May, 2016.

In this case, the assessee was the owner of several shops in the cloth market which were given on rent to different tenants. Every year, some tenants transferred the possession of shops to new tenants, with the consent of the assessee, who was the owner of the shops. In consideration of giving its consent to the transfer of possession of the shops from old tenants to the new tenants, the assessee was receiving a certain premium from the old tenants.

Earlier, the receipt of premium by the assessee was shown as income under the head ‘capital gains’. During the relevant year also, certain old tenants transferred their possessory rights of the rental shops to the new tenants with the consent of the assessee. In consideration of giving consent for such transfer of possessory rights, the assessee received a premium of Rs. 1,15,50,000 from the old tenants. The assessee treated such amount as income from ‘capital gains’ and claimed exemption from taxation of a part thereof u/s 54EC.

The A.O. held that the assessee was the owner of the shops, the old tenants had transferred the tenancy rights in favour of the new tenants along with rights of possession and the assessee remained the owner of the shops as before. Consequently, there was no transfer of the capital assets, being shops, as even after the transfer of tenancy rights the assessee continued to remain the owner of the shops. According to the A.O., while the transfer of tenancy rights indisputably resulted in capital gains, such capital gains would be taxable in the hands of the outgoing tenants and could not be taxed as the capital gains of the assessee. The A.O. therefore held that the amount received by the assessee as premium was taxable in the hands of the assessee as ‘income from other sources’ and not as ‘capital gains’, and that the assessee was therefore not entitled to exemption u/s 54EC.

In an appeal before the Commissioner (Appeals), the assessee submitted that in earlier and subsequent years also, a similar amount was offered to tax as capital gains and was accepted by the Income-tax Department. It was further argued that tenancy rights was undoubtedly a capital asset under the law and therefore any gains arising from the transfer of such rights had to be assessed under the head ‘capital gains’.

The Commissioner (Appeals) noted that a right was a bundle of benefits embedded in some asset or independent thereof. Capital asset meant property of any kind held by an assessee. Therefore, a right, whether or not attached to any asset, was also a property. The old tenant could transfer the possessory rights of the shops only with the consent of the landlord. According to the Commissioner (Appeals), such right of consent was a property in the hands of the assessee. Since that right or property was connected to the capital asset, i.e., shops, therefore such a right of consent was also a capital asset in the hands of the assessee which was more or less similar to a tenancy right, which was also a capital asset.

The Commissioner (Appeals) therefore held that on giving consent to change in the possession of rented premises from an old tenant to a new tenant, there was a transfer of capital asset. He, therefore, held that such receipt was liable to tax as capital gains and the assessee was entitled to exemption u/s 54EC.

On appeal by the Revenue, the Tribunal expressed its agreement with the observations of the Commissioner (Appeals) that the assessee acquired a bundle of rights (ownership) with respect to the shops. These rights included, inter alia, the right of grant of tenancy. The term ‘capital asset’ was defined in the widest possible manner in section 2(14) and had been curtailed only to the extent of exclusions given in the said section, including stock-in-trade and personal effects. The asset under consideration clearly did not fall within the above exclusions. The bundle of rights acquired by the assessee was undoubtedly valuable in terms of money.

On the above reasoning, the Tribunal held that the tenancy rights formed part of a capital asset in the hands of the assessee and therefore any gains arising therefrom would be assessable under the head ‘capital gains’, eligible for deduction u/s 54EC.

In Sujaysingh P. Bobade (HUF) vs. ITO (2016) 158 ITD 125 (Mum) a similar view was taken that the amount received by the landlord was a capital receipt, subject to tax as capital gains. However, in that case the appeal was against an order of revision passed u/s 263 and the landlord had received the amount from the new tenants for allotment of tenancy rights under tenancy agreements.

A similar view has also been taken by the Tribunal in the case of ITO vs. Dr. Vasant J. Rath Trust, ITA No. 844/Mum/2014 dated 29th February, 2016 wherein the old tenants had surrendered their tenancy rights to the landlord without receiving any consideration and the landlord directly entered into tenancy agreements with the six new tenants on receipt of consideration for grant of tenancy rights.

OBSERVATIONS
Any property, especially immovable property, comprises of a bundle of rights where each such right is a capital asset capable of being transferred by the owner for an independent consideration to different persons. Ownership of the land and / or building is the classic case of owning such a bundle of rights. The right to grant tenancy flows from such a bundle. The Supreme Court in the case of A.R. Krishnamurthy, 176 ITR 417, in the context of the ownership of a mine, held that the mining rights were a part of the mine and were capable of being held as an independent asset and therefore of being transferred independent of the ownership of the mine. It held that the grant of the lease to mine the asset or the mining rights resulted in the transfer of a capital asset, negating the case of the assessee that there was no transfer of capital asset on grant of the mining rights where the ownership of the mine continued with the assessee. The court also rejected the contention that there was no cost of acquisition of such rights or the cost could not be attributed to such rights.

Receipt of a salami or premium by a landlord from a tenant for grant of tenancy rights in an immovable property owned by him is a capital receipt and not a revenue receipt [Durga Das Khanna vs. CIT 72 ITR 796 followed by the Bombay and the Calcutta High Courts in CIT vs. Ratilal Tarachand Mehta 110 ITR 71 and CIT vs. Anderson Wright & Co. 200 ITR 596, respectively]. The Courts held that unless such a receipt is proved to be in the nature of rent or advance rent, it could not be taxed under the Act as revenue income.

The Supreme Court, in the case of CIT vs. Panbari Tea Co. Ltd. 57 ITR 422 held that a premium received on parting with the lessor’s interest was a capital receipt and the rent receipt was revenue in nature:

‘When the interest of the lessor is parted with for a price, the price paid is premium or salami. But the periodical payments made for the continuous enjoyment of the benefits under the lease are in the nature of rent. The former is a capital income and the latter a revenue receipt. There may be circumstances where the parties may camouflage the real nature of the transaction by using clever phraseology. In some cases, the so-called premium is in fact advance rent and in others rent is deferred price. It is not the form but the substance of the transaction that matters. The nomenclature used may not be decisive or conclusive but it helps the court, having regard to the other circumstances, to ascertain the intention of the parties.’

The amount received for giving consent is certainly not an advance rent. Can the giving of a consent in relation to user of a capital asset amount to a revenue receipt, even where it is assumed, though not right, that there is no transfer of the capital asset itself (in this case, tenancy rights) by the landlord? The character of a receipt depends upon its relation with the capital asset. For a receipt to be considered as income, it should be a receipt that is of revenue in nature. Normally, the amount received for use of an asset, such as rent, is revenue in nature and is income. However, that logic may not apply to all receipts in relation to a capital asset. Again, for a receipt to be a capital receipt it is not necessary that there should be a transfer of a capital asset or a diminution in value of a capital asset. Transfer of a capital asset is only necessary in order to subject a capital receipt to tax as capital gains.

When a landlord gives his consent for transfer of a tenancy, in substance, he is consenting to grant of the possessory rights to a new tenant. Therefore, he is giving up his possessory rights over the premises in favour of a new tenant. This can be viewed as a right in respect of the premises being agreed to be foregone for the future as well.

Another way of examining the matter is whether the receipt is in relation to a capital asset. The right to consent to a new tenant is also a right associated with the ownership of the immovable property. It is therefore part of the bundle of rights which constitute the immovable property. The exercise of such right in favour of the incoming tenant amounts to exercise of a capital right, the compensation for which would necessarily be capital in nature.

Therefore, the better view of the matter is that the premium received by the landlord for according his consent to transfer of tenancy rights is a capital receipt, subject at best to capital gains tax, and is not a revenue income.

The connected important issue is whether there is any cost of acquiring / holding such a right in the hands of the landlord. Can a part of the cost of acquiring the immovable property be attributed to the cost of the tenancy rights and be claimed and allowed as deduction in computing the capital gains? In our considered opinion, yes, such cost though difficult to ascertain is not an impossible task and should be determined on commercial consideration and be allowed in computing the capital gains arising on grant of the consent to transfer the tenancy rights or for creation of such rights.

Once it is held that the receipt is in the nature of a capital receipt that is liable to tax in the hands of the landlord under the head capital gains, the question of applicability of section 56(2)(x) should not arise. In any case, the receipt, in our opinion, is for a lawful consideration and cannot be subjected to the provisions of this provision that should not have had any place in the Income-tax Act.

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TAXABILITY OF MESNE PROFITS

ISSUE FOR CONSIDERATION

The term ‘mesne profits’ relates to the damages or compensation recoverable from a person who has been in wrongful possession of immovable property. It has been defined in section 2(12) of the Code of Civil Procedure, 1908 as under:

‘(12) “mesne profits” of property means those profits which the person in wrongful possession of such property actually received or might with ordinary diligence have received therefrom, together with interest on such profits, but shall not include profits due to improvements made by the person in wrongful possession.’

At times, the tenant or lessee continues to use and occupy the premises even after the termination of the lease agreement either due to efflux of time or for some other reasons. In such cases, the courts may direct the occupant of the premises to pay the mesne profits to the owner for the period for which the premises were wrongfully occupied. The taxability of the amounts received as mesne profits in the hands of the owner of the premises has become a subject matter of controversy. While the Calcutta High Court has taken the view that mesne profit is in the nature of damages for deprivation of use and occupation of the property and, therefore, it is a capital receipt not chargeable to tax, the High Courts of Madras and Delhi have taken the view that it is a recompense for deprivation of income which the owner would have enjoyed but for the interference of the persons in wrongful possession of the property and, consequently, it is a revenue receipt chargeable to tax.

LILA GHOSH’S CASE

The issue had earlier come up for consideration of the Calcutta High Court in the case of CIT vs. Smt. Lila Ghosh (1993) 205 ITR 9.

In that case, the assessee was the owner of the premises in question which were given on lease. The lease expired in 1970. However, the lessee did not give possession to the assessee. The assessee filed a suit for eviction and mesne profits. The decree was passed in favour of the assessee by the trial court and it was affirmed by the High Court as well as by the Supreme Court. The assessee then applied for the execution of the decree. The Court appointed a Commissioner to determine the claim of quantum of mesne profits. While the execution of the said decree and the determination of the quantum of the mesne profits were pending, the Government of West Bengal requisitioned the demised property on 24th December, 1979. The said requisition order was challenged by the assessee before the High Court through a writ application filed under Article 226 of the Constitution of India.

During its pendency, a settlement was arrived at between the assessee and the State of West Bengal which was recorded by the Court in its order dated 28th February, 1980. Under the terms of the settlement, the property in question was to be acquired by the State under the Land Acquisition Act, 1894 and compensation of Rs. 11 lakhs for the acquisition was to be paid to the assessee. There was no dispute relating to this compensation received. Apart from the compensation, the assessee also received a sum of Rs. 2 lakhs from the State of West Bengal against the assignment of the decree for mesne profits obtained and to be passed as a final decree against the tenant.

While making the assessment for the assessment year 1980-81, the A.O. assessed the said sum of Rs. 2 lakhs representing mesne profits as revenue receipt in the hands of the assessee under the head ‘Income from Other Sources’. It was taxed as income of the assessment year 1980-81 since it had arisen to the assessee in terms of an order of the Court dated 28th February, 1980. On appeal by the assessee before the CIT(A), it was submitted that the mesne profits were nothing but damages and, therefore, capital receipt not chargeable to tax. It was also contended that in case the assessee’s contention in this respect was to be rejected and the mesne profits of Rs. 2 lakhs be held to be revenue receipts, the same could not be taxed in one year since it related to the period from 19th May, 1970 to 24th December, 1979. However, the CIT(A) rejected all the contentions of the assessee and held that the mesne profits of Rs. 2 lakhs were revenue receipts and assessable under the head ‘Income from Other Sources’ in the A.Y. 1980-81.

On further appeal by the assessee, the Tribunal held that the mesne profits of Rs. 2 lakhs had arisen as a result of the transfer of the capital asset and the same was assessable under the head ‘capital gains’. According to the Tribunal, the assessee had received the sum of Rs. 2 lakhs for transferring her right to receive the mesne profits which was her capital asset. The contention of the assessee that no capital gain was chargeable inasmuch as no cost of acquisition was incurred for the so-called capital asset was rejected by the Tribunal. The Tribunal held that it was possible to determine the cost of acquisition of the asset in question which, according to the Tribunal, consisted of the amount spent by the assessee towards stamp duty and other legal expenses incurred for obtaining the decree. From the decision of the Tribunal, both the assessee as well as the Revenue had sought reference to the High Court.

After referring to the definition of ‘mesne profits’ as per the Code of Civil Procedure, 1908, the High Court referred to the observations of the Judicial Committee of the Privy Council in Girish Chunder Lahiri vs. Shashi Shikhareswar Roy [1900] 27 IA 110 in which it was stated that the mesne profits were in the nature of damages which the court may mould according to the justice of the case. Further, the Supreme Court’s observations in the case of Lucy Kochuvareed vs. P. Mariappa Gounder AIR [1979] SC 1214 were also referred to, which were as under:

‘Mesne profits being in the nature of damages, no invariable rule governing their award and assessment in every case can be laid down and “the Court may mould it according to the Justice of the case”.’

Accordingly, the High Court held that the mesne profits were nothing but damages for loss of property or goods. The Court further held that such damages were not in the nature of revenue receipts but in the nature of capital receipt. While holding so, the High Court relied upon the decisions in the case of CIT vs. Rani Prayag Kumari Debi [1940] 8 ITR 25 (Pat.); CIT vs. Periyar & Pareekanni Rubbers Ltd. [1973] 87 ITR 666 (Ker.); CIT vs. J.D. Italia [1983] 141 ITR 948 (AP); and CIT vs. Ashoka Marketing Ltd. [1987] 164 ITR 664 (Cal.).

The Court disagreed with the views expressed by the Madras High Court in CIT vs. P. Mariappa Gounder [1984] 147 ITR 676 wherein it was held that mesne profits awarded by the Court for wrongful possession were revenue receipts and, therefore, liable to be assessed as income. The Calcutta High Court observed that neither the decision of the Privy Council in Girish Chunder Lahiri (Supra) nor the decision of the Supreme Court in Lucy Kochuvareed (Supra) was either cited or noticed by the learned Judges of the Madras High Court. It was also observed that even the decisions of the Patna High Court in Rani Prayag Kumari Debi (Supra) and that of the Kerala High Court in Periyar & Pareekanni Rubbers Ltd. (Supra), wherein it was held that damages or compensation awarded for wrongful detention of the properties of the assessee was not a revenue receipt, were neither noticed nor considered by the Madras High Court.

As far as the Tribunal’s direction to tax the amount received as capital gains was concerned, the High Court held that there was no assignment of the decree for mesne profits. No final decree in respect of mesne profits was passed in favour of the assessee and the State Government had reserved the right to itself for getting an assignment from the assessee in respect of the final decree for mesne profits, if any, passed against the tenant for its use and occupation of the said property. Therefore, the High Court held that the assessee had not earned any capital gains on the transfer of a capital asset.

The High Court held that the mesne profits received was a capital receipt and, hence, not liable to tax.

THE SKYLAND BUILDERS (P) LTD. CASE
The issue thereafter came up for consideration before the Delhi High Court in the case of Skyland Builders (P) Ltd. vs. ITO (2020) 121 taxmann.com 251.

In this case, the assessee company had let out the property in the year 1980 for five years to Indian Overseas Bank. The parties had agreed to increase the rent by 20% after the expiry of the first three years. The lessee bank did not comply with the terms and increased the rent by 10% only. Therefore, the assessee terminated the lease agreement w.e.f. 31st January, 1990 by serving notice upon the lessee. Since the lessee failed to vacate the premises, the assessee filed a suit for damages / mesne profit and restoration of the premises to the owner. The suit of the assessee was decreed vide judgment / decree issued dated 27th July, 1998 for mesne profit and damages, including interest. In compliance with the Court’s order, the lessee Indian Overseas Bank paid Rs. 77,87,303 to the assessee company. In the original return for the A.Y. 1999-2000, mesne profits of Rs. 77,87,303 was declared as taxable income, whereas in the revised return the assessee claimed it as a capital receipt and excluded it from its taxable income.

The A.O. did not accept the contention of the assessee that it was a capital receipt and relied upon the decision of the Madras High Court in P. Mariappa Gounder (Supra) in which it was held that mesne profits were also a species of taxable income. The A.O. taxed it as ‘Income from other sources’ and allowed a deduction of legal expenses incurred in securing the mesne profits.

Before the CIT(A), apart from claiming that the mesne profits were not taxable, the assessee raised an alternative plea that even if it was treated as income in the nature of arrears of rent, even then it could not have been taxed in the year under consideration merely based on its realisation during the year and, rather, should have been taxed in the respective years to which it pertained. It was claimed that the enabling provision to tax the arrears of rent in the year of its receipt was inserted in section 25B with effect from the A.Y. 2001-02 and it was not applicable for the year under consideration. However, the CIT(A) did not accept the contentions of the assessee and held it to be a revenue receipt liable to be taxed as income. Insofar as section 25B was concerned, the CIT(A) observed that it did not bring about any change in law and it only set at rest doubts regarding taxability of income relating to earlier years in the previous year concerned in which the arrears of rent were received.

The Tribunal also rejected the assessee’s claim with regard to the non-taxability of mesne profits as income under the Act on the ground that it was a capital receipt. It followed the decisions of the Madras High Court in the cases of P. Mariappa Gounder (Supra) and S. Kempadevamma vs. CIT [2001] 251 ITR 87. It did not follow the decision of the Calcutta High Court in the case of Smt. Lila Ghosh (Supra) on the ground that the decision of the Madras High Court in the case of S. Kempadevamma (Supra) was rendered after that and it was binding in nature, being a later decision. The Tribunal also held that the sum which was granted by the Civil Court as mesne profit in respect of the tenanted property could be presumed to be a reasonably expected sum for which property could be let from year to year, and the same value could have been taken as annual letting value of the property in dispute as per section 23(1). With regard to the alternate plea of the assessee concerning the provisions of section 25B introduced subsequently, the Tribunal relied upon the decision in the case of P. Mariappa Gounder in which it was held that the mesne profit is to be taxed in the assessment year in which it was finally determined. The Tribunal’s decision has been reported at 91 ITD 392.

In further appeal before the High Court, the following arguments were made on behalf of the assessee:
•   The income falling under the specific heads enumerated in the Act as being taxable income alone was liable to tax and the income which did not fall within the specific heads was not liable to be taxed under the Act.
•   By its definition, ‘mesne profits’ were a kind of damages which the owner of the property, which was a capital asset, was entitled to receive on account of deprivation of the opportunity to use that capital asset on account of the wrongful possession thereof by another. Therefore, such damages which were awarded for deprivation of the right to use the capital asset constituted a capital receipt.
•   Section 25B introduced w.e.f. 1st April, 2001 could not be applied to bring the mesne profits and interest thereon to tax in the A.Y. 1999-2000 even though they pertained to the earlier financial years. Further, the amount received from the erstwhile tenant could not be regarded as rent under the rent agreement which ceased to exist. The assessee had received damages and not rent since there was no subsisting relationship of landlord and tenant between the assessee and the bank post the termination of their tenancy.
•   Reliance was placed on the decision of the Supreme Court in the case of CIT vs. Saurashtra Cement Ltd. 325 ITR 422 wherein it was held that the amount received towards compensation for sterilisation of the profit-earning source, not in the ordinary course of business, was a capital receipt in the hands of the assessee. In this case, the liquidated damages received from the supplier on account of the delay caused in delivery of the machinery was held to be a capital receipt not liable to tax.
•   The facts before the Madras High Court in the case of P. Mariappa Gounder were different from the facts of the present case. In that case, the assessee had entered into an agreement to purchase a property which was not conveyed by the vendor to the assessee as it was sold to another person who was put in possession. The Court decreed specific performance of the assessee’s agreement with the original owner and the assessee’s claim for mesne profits against the other purchaser who was in possession was also accepted. Thus, it was not a case of grant of mesne profits against the erstwhile tenant who continued to occupy the premises despite termination of the tenancy. But it was a case where another purchaser of the same property held on to the possession of the property and the mesne profits were awarded against him.
•   The decision of the Madras High Court in the case of P. Mariappa Gounder was not followed by the Calcutta High Court in a subsequent decision in the case of Smt. Lila Ghosh (Supra). It was the view of the Calcutta High Court which was the correct view and should be followed.
•   Reliance was also placed on the Special Bench decision of the Mumbai Bench of the Tribunal in the case of Narang Overseas (P) Ltd. vs. ACIT (2008) 111 ITD 1 wherein the view favourable to the assessee was adopted, in view of conflicting decisions of the High Courts, and mesne profits were held to be capital receipts.

The Revenue pleaded that the decision of the Madras High Court in P. Mariappa Gounder had been affirmed by the Supreme Court (232 ITR 2). It was submitted that the decision of the Calcutta High Court in Smt. Lila Ghosh was a decision rendered before the Supreme Court decided the appeal in the case of P. Mariappa Gounder. Further, the view taken by the Madras High Court in P. Mariappa Gounder was reiterated by it in the case of S. Kempadevamma (Supra). The Revenue also placed reliance on the decision of the Delhi High Court in the case of CIT vs. Uberoi Sons (Machines) Ltd. 211 Taxman 123, wherein it was held that the arrears of rent received as mesne profits are taxable in the year of receipt, and that section 25B of the Act which was introduced vide amendment in 2000 with effect from A.Y. 2001-02 was only clarificatory in nature.

In reply, the assessee submitted that the real issue in the case before the Delhi High Court in Uberoi Sons (Machines) Ltd. (Supra), was in which previous year the arrears of rent received by the assesse (as mesne profits) could be brought to tax and the issue was not whether mesne profits received by the landlord / assesse from the erstwhile tenant constituted revenue receipt or capital receipt.

The Delhi High Court held that if the test laid down by the Supreme Court in the case of Saurashtra Cement Ltd. (Supra) had been applied to the facts of the case, then the only conclusion that could be drawn was that the receipt of mesne profits and interest thereon was a revenue receipt. This was because the capital asset of the assessee had remained intact, and even the title of the assessee in respect of the capital asset had remained intact. The damages were not received for harm and injury to the capital asset, or on account of its diminution, but were received in lieu of the rent which the appellant would have otherwise derived from the tenant. Had it been a case where the capital asset would have been subjected to physical damage, or of diminution of the title to the capital asset, and damages would have been awarded for that, there would have been merit in the appellant’s claim that damages were capital receipt.

The High Court held that the issue was no longer res integra as it stood concluded not only by the decision of the Supreme Court in P. Mariappa Gounder but also by the co-ordinate Bench of the Delhi High Court itself in Uberoi Sons (Machines) Ltd. In that case, the Court not only held that section 25B was clarificatory and applied to the assessment year in question, but also held that the receipt of mesne profits constituted revenue receipt. The Court also held that the issue of invocation of section 25B was intimately linked to the issue of whether the said receipts were revenue receipts, or capital receipts, and had it not been so there would be no question of the Court upholding the applicability of section 25B. Therefore, the submission of the assessee that the ratio of the decision in Uberoi Sons (Machines) Ltd. was not that income by way of mesne profits constituted revenue receipts, was found to be misplaced by the Court.

The Delhi High Court in this case did not follow the decision of the Calcutta High Court in the case of Smt. Lila Ghosh for two reasons: due to the subsequent decision of the Supreme Court in P. Mariappa Gounder approving the Madras High Court’s view, and due to the decision of the co-ordinate Bench of the Delhi High Court in the case of Uberoi Sons (Machines) Ltd. following the Madras High Court’s view and taking note of its approval by the Supreme Court. The ratio of the decision of the Special Bench in the Narang Overseas case (Supra) of the Tribunal was also not approved by the High Court for the same reason that the jurisdictional High Court’s decision prevailed over it.

Accordingly, the High Court held that mesne profits and interest on mesne profits received under the direction of the Civil Court for unauthorised occupation of the immovable property of the assessee by Indian Overseas Bank, the erstwhile tenant of the appellant, constituted revenue receipts and were liable to tax u/s 23(1) of the Act.

OBSERVATIONS

In order to determine the tax treatment of mesne profits, it is necessary to first understand the meaning of the term ‘mesne profits’ and the reason for which the owner of the property becomes entitled to receive it. Though the term ‘mesne profits’ is not defined under the Income-tax Act, it is defined under section 2(12) of the Civil Procedure Code. (Please see the first paragraph.)

The definition makes it very clear that mesne profits represent the damages that emanate from the property, the true owner of which has been deprived of its possession by a trespasser. It is not rent for use of the property. The Supreme Court in the case of Lucy Kochuvareed vs. P. Mariappa Gounder AIR 1979 SC 1214 has considered mesne profits to be damages. The relevant observations of the Supreme Court are reproduced below:

‘Mesne profits being in the nature of damages, no invariable rule governing their award and assessment in every case can be laid down and “the Court may mould it according to the justice of the case”. Even so, one broad basic principle governing the liability for mesne profits is discernible from section 2(12) of the CPC which defines “mesne profits” to mean “those profits which the person in wrongful possession of property actually received or might with ordinary diligence have received therefrom together with interest on such profits, but shall not include profits due to improvements made by the person in wrongful possession”. From a plain reading of this definition, it is clear that wrongful possession of the defendant is the very essence of a claim for mesne profits and the very foundation of the defendant’s liability therefor. As a rule, therefore, liability to pay mesne profits goes with actual possession of the land. That is to say, generally, the person in wrongful possession and enjoyment of the immovable property is liable for mesne profits.’

The basis for quantification of mesne profits is the gain that the person in wrongful possession of the property made or might have made from his wrongful occupation and not what the owner of the property has lost on account of deprivation from the possession of the property. This aspect of the nature of the receipt has been explained by the Delhi High Court in the case of Phiraya Lal alias Piara Lal vs. Jia Rani AIR 1973 Del 18 as follows:

‘When damages are claimed in respect of wrongful occupation of immovable property on the basis of the loss caused by the wrongful possession of the trespasser to the person entitled to the possession of the immovable property, these damages are called “mesne profits”. The measure of mesne profits according to the definition in section 2(12) of the Code of Civil Procedure is “those profits which the person in wrongful possession of such property actually received or might with ordinary diligence have received there from, together with interest on such profits”. It is to be noted that though mesne profits are awarded because the rightful claimant is excluded from possession of immovable property by a trespasser, it is not what the original claimant loses by such exclusion but what the person in wrongful possession gets or ought to have got out of the property which is the measure of calculation of the mesne profits. (Rattan Lal vs. Girdhari Lal, AIR 1972 Delhi ll). This basis of damages for use and occupation of immovable property which are equivalent to mesne profits is different from that of damages for tort or breach of contract unconnected with possession of immovable property. Section 2(12) and order Xx rule 12 of the Code of Civil Procedure apply only to the claims in respect of mesne profits but not to claims for damages not connected with wrongful occupation of immovable property. The measure for the determination of the damages for use and occupation payable by the appellants to the respondent Jia Rani is, therefore, the profits which the appellants actually received or might with ordinary diligence have received from the property together with interest on such profits.’

The mesne profit cannot be viewed as compensation for the loss of income which the owner of the property would have earned but for deprivation of its possession, or as compensation for the loss of the source of income. It will be more appropriate to consider the mesne profit as compensation or damages for the loss of enjoyment of the property instead of the loss of income arising from the property. Mesne profits is for the injury or damages caused to the owner of the property due to deprivation of the possession of the property. Mesne profits become payable due to wrongful possession of the property with the trespasser, irrespective of whether or not that property before deprivation was earning any income for its owner. It might be possible that the property concerned might not be a let-out property and, therefore, yielding no income for its owner. Even in a case where the property was self-occupied by the owner which is not resulting in any income, the mesne profits become payable if that property has come in wrongful possession of the trespasser. Therefore, it is inappropriate to consider the mesne profits as compensation for loss of income which the owner would have earned otherwise. Any such compensation received due to the injury or damages caused to the assessee is required to be considered as a capital receipt not chargeable to tax, unless it is received in the ordinary course of business as held by the Supreme Court in the case of Saurashtra Cement Ltd. (Supra).

Mesne profits cannot be brought to tax as income under the head ‘Income from House Property’ as it cannot be said to be representing the annual value and that it will not come within the purview of taxation at all. Section 22 creates a charge of tax over the ‘annual value’ of the property. The ‘annual value’ is required to be determined in accordance with the provisions of section 23. As per section 23, the annual value is the sum which the property might reasonably be expected to get from year to year or the actual rent received or receivable in case of let-out property, if it is higher than that sum. The sum of mesne profits per se, which may pertain to a period of more than one year, cannot be considered as an ‘annual value’ of the property concerned for the year in which it accrued to the assessee by virtue of court order or received by the assessee. Therefore, the mesne profits cannot be held to be an annual value of the property u/s 23(1). For this reason and for the reasons stated in the next paragraph, it is respectfully submitted that part of the Delhi High Court’s decision in Skyland Builders (Supra) requires reconsideration where it held that the mesne profits were taxable u/s 23(1).

The erstwhile provisions of section 25B dealing with the taxability of arrears of rent or the corresponding provisions of section 25A, as substituted with effect from 1st April, 2017, can be pressed into play only if the receipt is in the nature of ‘rent’ in the first place. The Supreme Court in the case of UOI vs. M/s Banwari Lal & Sons (P) Ltd. AIR 2004 SC 198 has referred to the Law of Damages & Compensation by Kameshwara Rao (5th Ed., Vol. I, Page 528) and approved the learned author’s statement that right to mesne profits presupposes a wrong, whereas a right to rent proceeds on the basis that there is a contract. Therefore, the rent is the consideration for letting out of the property under a contract and there is no question of any wrongful possession of the property by the tenant. In a manner, the mesne profits and the rent are mutually exclusive.

Furthermore, the erstwhile sections 25AA and 25B and the present section 25A provide for taxation of an arrear of rent received from a tenant or unrealised rent realised subsequently, in the year of receipt under the head ‘Income from House Property’, irrespective of the ownership of the property in the year of taxation. The objective behind these provisions is to overcome the difficulties that used to arise in the past on account of the year of taxation and also in relation to the recipient not being the owner in the year of receipt. All of these provisions, for the purposes of activating the charge, require that the amount received represented (a) rent and (b) such rent was in arrears or unrealised and which rent was (c) subsequently realised. These three conditions are cumulative in nature for applying the deeming fiction of these provisions. Applying these cumulative conditions to the receipt of ‘mesne profits’, it is apparent that none of the conditions could be said to have been satisfied when a person receives damages for deprivation of the use of the property. The receipt in his case is neither for letting out the property nor does it represent the rent, whether in arrears or unrealised. It is possible that for measuring the quantum of damages and the amount of mesne profits the amount of prevailing rent is taken as a benchmark but such benchmarking cannot be a factor that has the effect of converting the damages into rent for the purposes of taxation of the receipt under the head ‘Income from House Property’. In fact, the right to receive mesne profits starts from the time where the relationship of the owner and tenant terminates and the right to receive rent ends.

The next question is whether the receipt of mesne profits could be considered as income under the head ‘Income from Other Sources’, importantly, u/s 56(2)(x). Apparently, the case of the receipt is to be tested vis-à-vis sub-clause (a) of clause (x) which brings to tax the receipt of any sum of money in excess of Rs. 50,000. Obviously, the receipt of mesne profits is on account of damages and cannot be considered to be without consideration and for this reason alone section 56(2)(x) cannot be invoked to tax such a receipt under the head ‘Income from Other Sources’. It is possible that the head is activated for charging the part of the receipt where such part represents the interest on the amount of damages for delay in payment thereof. But then that is an issue by itself.

It is, therefore, correct to hold that the Income-tax Act does not contain a specific provision to tax mesne profits under a specific head of income listed u/s 14. It is a settled position in law that for a receipt to be taxed as an income it should be fitted into a pigeon-hole of a particular head of income or the residual head and in the absence of a possibility thereof, a receipt cannot be taxed.

The next thing to assess is whether the receipt of mesne profits is an income at all or is in the nature of an income. Maybe not. For a receipt to qualify as income it perhaps is necessary that it represents the fruits of the efforts or labour made, or the risks and rewards assumed, or the funds employed. None of the above could be said to be present in the case of mesne profits where the receipt is for deprivation of the use of property. Such a receipt is not even for transfer of any property or right therein and cannot fit into the head capital gains. The receipt is for the unlawful action of the erstwhile tenant and is certainly not payment for the use of the property by him. No efforts are made by the recipient nor have any services been rendered by him. He has not employed any funds nor has he assumed any risks and the question of him being rewarded for the risks does not arise at all.

Lastly, as regards the decision of the Supreme Court in P. Mariappa Gounder confirming the ratio of the decision of the Madras High Court in the same case and the following of the said decision by the Delhi High Court in Skyland Builders (P) Ltd., it is respectfully stated that the Delhi High Court in the latter case did not concur with the view of the Calcutta High Court in the case of Smt. Lila Ghosh only for the reason that the Court noted that the Madras High Court’s view in the case of P. Mariappa Gounder that the mesne profits were revenue receipts was approved by the Supreme Court. With respect, in that case there was a complete failure on the part of the assessee to highlight the fact that the Supreme Court in deciding the case before it had considered only a limited issue concerning the year in which the mesne profits were taxable which arose from the Madras High Court’s decision. The Apex Court in that case had not considered whether the mesne profits was a capital receipt or revenue receipt and this fact of the non-consideration of the main issue by the Court was not pointed out to the Delhi High Court. Had that been highlighted, we are sure that the decision of the Delhi High Court would have been otherwise. This limited aspect of the Supreme Court’s decision becomes very clear on a perusal of the decisions of the High Court and the Supreme Court in P. Mariappa Gounder. The relevant part of both the decisions is reproduced as under:

Madras High Court – Two controversies arise in these references under the Income-tax Act, 1961 (‘the Act’). One is whether mesne profits decreed by a court of law can be held to be taxable income in the hands of the decree holder? The other question is about the relevant year in which mesne profits are to be charged to income-tax.

Supreme Court – The question which arises for consideration in this appeal is as to in which assessment year the appellant is liable to be assessed in respect of mesne profits which were awarded in his favour.

Further, the Mumbai Special Bench in the case of Narang Overseas (P) Ltd. (Supra) has extensively dealt with this aspect of the limited application of the Supreme Court’s decision at paragraphs 6 to 23 and concluded as follows:

‘The above discussion clearly reveals that the judgment of the Hon’ble Supreme Court in the case of P. Mariappa Gounder (Supra) only decides the issue regarding the year of taxability of the mesne profits. That judgment, therefore, cannot be said to be an authority for the proposition that the nature of mesne profits is revenue receipts chargeable to tax. Accordingly, the contention of Revenue that the issue regarding the nature of mesne profits is covered by the aforesaid decision of the Hon’ble Supreme Court cannot be accepted.’

This decision of the Special Bench has remained unchallenged by the Income-tax Department in an appeal before the High Court as is noted by the Bombay High Court in the case of Goodwill Theatres Pvt. Ltd. [2016] 241 Taxman 352. The appeal filed by the Income-tax Department against the decision of the Special Bench was dismissed for non-removal of the office objections.

Insofar as the reliance placed by the Delhi High Court on its earlier decision in the case of Uberoi Sons (Machines) Ltd. (Supra) is concerned, it is worth noting that the following questions of law were framed for consideration of the High Court in that case:
(i) Whether the ITAT was, in the facts and circumstances of the case, correct in law in quashing the re-assessment order passed by the Assessing Officer under section 147(1) of the Income Tax Act, 1961?
(ii) Whether the ITAT was correct in law in holding that the excess amount payable to the assessee towards mesne profits / compensation for unauthorised use and occupation of the premises accrued to the assessee only upon the passing of the decree by the Civil Court on 14th October, 1998?

It can be noticed that the question about the nature of mesne profits, whether revenue or capital, was not raised before the Delhi High Court even in the Uberoi case. Therefore, in our considered opinion the decision of the Supreme Court cannot be a precedent on the subject of the taxability or otherwise of mesne profits. The Court in that simply confirmed that the year of taxation would be the year of the order of the civil court as was decided by the Madras High Court. Any High Court decision not touching the issue of taxability of the receipt cannot be pressed into service for deciding the issue of taxability or otherwise of the receipt.

It may be noted that the question whether mesne profits were capital receipts or revenue receipts had also arisen before the Bombay High Court in the case of CIT vs. Goodwill Theatres Pvt. Ltd. [2016] 241 Taxman 352. The High Court had dismissed the appeal of the Revenue on the ground that the decision of the Special Bench in the case of Narang Overseas (P) Ltd. (Supra) had remained unchallenged, as the appeal filed against that decision before the High Court was dismissed for non-removal of office objections. The Supreme Court, however, on an appeal by the Income-tax Department challenging the order of the High Court has remanded the issue back to the High Court for its adjudication on merits which is reported at [2018] 400 ITR 566.

It is very difficult to persuade ourselves to believe that the decision of the Supreme Court in the case of Saurashtra Cement Ltd. (Supra) could be applied to the facts of the case to hold that the mesne profits was revenue receipts taxable under the Act. The Supreme Court in the said case was concerned with the facts unrelated to mesne profits. In that case, the capital asset was subjected to physical damage leading to the diminution of the title to the capital asset, and damages had been awarded for that, which damages were found to be capital receipt. It was the assessee who had relied upon the decision to contend that the mesne profits was not taxable. Instead, the Court applied the decision in holding against the assessee that applying the ratio therein the receipt could be exempted from taxation only where there was a damage or destruction to the property and diminution to title. Nothing can be stranger than this. The said decision nowhere stated that any receipt unrelated to damage to the capital asset would never be a capital receipt not liable to tax. The Supreme Court in that case of Saurashtra Cement Ltd. held that the amount received towards compensation for sterilization of the profit-earning source, not in the ordinary course of business, was a capital receipt in the hands of the assessee. In that case, the liquidated damages received from the supplier on account of delay caused in delivery of the machinery were held to be a capital receipt not liable to tax.

The facts in Skyland Builders were better than the facts in P. Mariappa Gounder where the receipt of mesne profits was from a person who was never a tenant of the assessee while in the first case the receipt was from an erstwhile tenant who deprived the owner of the possession, meaning there was a prior letting of the premises to the payer of the mesne profits and the receipt from such a person could have been better classified as mesne profits not taxable under the head ‘Income from House Property’.

The better view, in our considered opinion, therefore, is the view expressed by the Calcutta High Court that mesne profits are in the nature of capital receipts not chargeable to tax.

shailesh.kwebmaker

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

ISSUE FOR CONSIDERATION

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

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

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

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

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

THE INDIA ADVANTAGE FUND CASE

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

TVS INVESTMENTS IFUND CASE

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

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

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

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

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

OBSERVATIONS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

shailesh.kwebmaker

RATE OF TAX ON DEEMED SHORT-TERM CAPITAL GAINS U/S 50

ISSUE FOR CONSIDERATION

Section 50 of the Income-Tax Act, 1961 provides for the manner of computation of capital gains arising on sale of depreciable assets forming part of a block of assets and for deeming such gains as the one on transfer of the short-term capital assets. The section reads as under:

‘Special provision for computation of capital gains in case of depreciable assets

50. Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922 (11 of 1922), the provisions of sections 48 and 49 shall be subject to the following modifications: –

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely: –
(i) expenditure incurred wholly and exclusively in connection with such transfer or transfers;
(ii) the written down value of the block of assets at the beginning of the previous year; and
(iii) the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.’

In a situation where an asset which is otherwise held for more than three years but is deemed short-term capital asset, on application of section 50, for the reason such an asset forming part of the block of assets and depreciated is transferred, the issue has arisen as to the rate of tax applicable to the gains on transfer of such assets – whether such gains would be taxable in the manner prescribed u/s 112 at a concessional rate of 20%, or at the regular rates prescribed for the total income. While a few benches of the Tribunal have held that the rate applicable would be the regular rate applicable to total income including the short-term capital gains, in a number of decisions various benches of the Tribunal have taken the view that the rate applicable on such deemed short-term capital gains would be the rate applicable to long-term capital gains, i.e., the rate of 20% prescribed u/s 112. This controversy has been discussed in the BCAJ Vol. 48-B, November, 2016, Page 51, but the latest decision in Voltas Ltd. has added a new dimension to the conflict and some fresh thoughts on the subject are shared herein.

THE RATHI BROTHERS’ CASE

The issue had come up before the Pune bench of the Tribunal in the case of Rathi Brothers (Madras) Ltd. vs. ACIT, ITA No. 707/PN/2013 dated 30th October, 2014.

During the previous year relevant to A.Y. 2008-09, the assessee sold its office premises for Rs. 98,37,000. Since depreciation had been claimed on such asset in the past, the assessee computed its capital gains u/s 50 at Rs. 93,40,796, disclosed such capital gains as short-term capital gains but computed tax thereon at the rate of 20%.

It was contended before the A.O. that the tax rate u/s 112 was being applied on the gains treating the gains as long-term capital gains, though the resultant capital gains were in the nature of short-term capital gains as per the provisions of section 50 based on the decision of the Bombay High Court in CIT vs. Ace Builders (P) Ltd. 281 ITR 210. The assessee also placed reliance on the decision of the Mumbai Tribunal in the case of P.D. Kunte & Co. vs. ACIT (ITA No. 4437/Mum/05 dated 10th April, 2008).

However, the A.O. observed that the said ITAT decision was in the context of eligibility of exemption u/s 54EC in respect of capital gains computed u/s 50 on transfer of an asset held for more than three years. It was pointed out to the A.O. that in response to a miscellaneous application filed in that case the order was modified to hold that on the reasoning of the Bombay High Court in the case of Ace Builders (Supra), it naturally followed that even the tax rate applicable while bringing capital gain to tax would be as per the provisions of section 112.

However, attempting to distinguish this interpretation, the A.O. stated that section 50 was a special provision inserted to compute capital gains in respect of depreciable assets with an intention to prevent dual concession to the assessee in the form of depreciation as well as concessional rate of tax. It was also emphasised by the A.O. that even in the case decided by the Bombay High Court, the larger issue involved was the eligibility to claim deduction u/s 54E against capital gains arising on transfer of an asset on which depreciation was being claimed, even if such gains were to be computed in accordance with the provisions of section 50.

The A.O. accordingly taxed the capital gain as short-term capital gain and declined to apply the tax rate prescribed u/s 112.

The Commissioner (Appeals) dismissed the assessee’s appeal, holding that section 50 was enacted with the objective of denying multiple benefits to the owners of assets. According to him, the rationale behind enacting such a deeming provision u/s 50 was that the assessee had already availed benefits in the form of depreciation in case of depreciable assets, and it was not equitable to extend dual benefit of depreciation as well as concessional tax rate of 20% to capital gains arising on transfer of depreciable assets.

On behalf of the assessee it was argued before the Tribunal that since the asset was held for more than three years, it was a long-term capital asset as defined in section 2(14), and capital gain computed even u/s 50 is to be treated as long-term capital gain. The Bombay High Court in Ace Builders (Supra) had held that section 50 is a deeming provision, hence the same is to be interpreted to the extent to achieve the object of the said provision. Reliance was also placed by the assessee on the Mumbai Tribunal decision in the case of P.D. Kunte & Co. (Supra).

The Tribunal refused to accept the argument that in case of Ace Builders the Bombay High Court had held that even capital gain computed u/s 50 is to be treated as long-term capital gain. According to the Tribunal, the High Court had explained that if the capital gain was computed as provided u/s 50, then the capital gains tax would be charged as if such capital gain had arisen out of a short-term capital asset. The Tribunal also did not follow the Mumbai Tribunal decision in the case of P.D. Kunte & Co. on the ground that this ground had remained to be adjudicated in that case.

The Tribunal therefore held that such capital gains was not eligible for the 20% rate of tax applicable to long-term capital gains u/s 112.

A similar view has been taken by the Mumbai bench of the Tribunal in the cases of ACIT vs. SKF Bearings India Ltd. (ITA No. 616/Mum/2006 dated 29th December, 2011), SKF India Ltd. vs. Addl. CIT (ITA No. 6461/Mum/2009 dated 24th February, 2012) and Reckitt Benckiser (India) Ltd. vs. ACIT, 181 TTJ 384 (Kol.).

THE VOLTAS CASE

The issue came up again recently before the Mumbai bench of the Tribunal in the case of DCIT vs. Voltas Ltd. TS-566-ITAT-2020(Mum).

In this case, the assessee had sold buildings which were held for more than three years. The assessee claimed that the capital gains on the sale of the buildings should be taxed at 20% u/s 112 instead of at 30%, the rate applicable to short-term capital gains.

It was argued on behalf of the assessee before the Tribunal that the issue was covered in favour of the assessee by the Mumbai Tribunal decision in the case of Smita Conductors Ltd. vs. DCIT 152 ITD 417. Reliance was also placed on the decision of the Bombay High Court (actually of the Supreme Court, affirming the decision of the Bombay High Court) in the case of CIT vs. V.S. Dempo Company Ltd. 387 ITR 354 and the decision of the Supreme Court (actually of the Bombay High Court) in the case of CIT vs. Manali Investment [219 Taxman 113 (Bombay)(Mag.)] and it was argued that both Courts had held that the deeming provision of the section could not be extended beyond the method of computation of the cost of acquisition involved.

It was argued on behalf of the Revenue that section 50, being a special provision for computation of capital gains in case of depreciable assets, specifically provides in the concluding paragraph that the income accrued or arising as a result of such transfer shall be deemed to be income from transfer of a short-term capital asset. It was submitted that the language of the Act was very clear and unambiguous. It was argued that there would have been scope for ambiguity only if the term ‘short term’ was not used. It was submitted that when the Act provides that such gain would be gain arising from short term capital asset, there was no reason why the term ‘short term’ appearing in that provision should be regarded as superfluous. It was argued that when the Act was so clear there could not be any dispute about the rate of tax applicable for short-term capital gain.

The Tribunal analysed the provisions of section 50 and the decisions in the cases of V.S. Dempo (Supra) and Manali Investment (Supra). It noted the observations of the Bombay High Court (actually the Supreme Court) that section 50 is only restricted for the purpose of sections 48 and 49 as specifically stated therein, and the fictions created in sub-sections (1) and (2) have limited application only in the context of the mode of computation of capital gains contained in sections 48 and 49. The fictions have nothing to do with exemption that is provided in a totally different provision, viz., section 54EC. The Tribunal cited with approval the observations of the Bombay High Court in the case of Ace Builders (Supra) and noted that the Gujarat and Gauhati High Courts had taken a similar view in the cases of CIT vs. Polestar Industries 221 Taxman 423 and CIT vs. Assam Petroleum Industries (P) Ltd. 262 ITR 587, respectively. It also noted the Supreme Court (Bombay High Court) decision in the case of Manali Investment where the Supreme Court (Bombay High Court) permitted set-off of brought forward long-term capital loss against gains computed u/s 50 on sale of an asset which had been held for more than three years.

The Tribunal observed that the higher Courts had held that the deeming fiction of section 50 was limited and could not be extended beyond the method of computation of capital gain and that the distinction between long-term and short-term capital gains was not obliterated by this section. The Tribunal, therefore, allowed the appeal of the assessee on this ground.

A similar view has been taken by the Tribunal in the cases of Smita Conductors vs. DCIT 152 ITD 417 (Mum.), Poddar Brothers Investments Pvt. Ltd. vs. DCIT [ITA 1114/Mum/2013 dated 25th March, 2015), Castrol India Ltd. vs. DCIT [ITA 195/Mum/2012 dated 18th October, 2016], Yeshwant Engineering Pvt. Ltd. vs. ITO [ITA 782/Pun/2015 dated 9th October, 2017], DCIT vs. Eveready Industries Ltd. [ITA 159/Kol/2016 dated 18th October, 2017], BMC Software India Pvt. Ltd. vs. DCIT (ITA 1722/Pun/2017 dated 12th March, 2020), Mahindra Freight Carriers vs. DCIT, 139 TTJ 422 and Prabodh Investment & Trading Company vs. ITO (ITA No. 6557/Mum/2008). In most of these cases, the view taken by the Tribunal in the case of Smita Conductors (Supra) has been followed.

OBSERVATIONS

Section 50 provides for modification to provisions of sections 48 and 49, while giving the mode of computation as well as stating that such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets. Both sections 48 and 49 are computation provisions and therefore section 50 really only modifies the manner of computation of capital gains.

This aspect has been clarified by various Courts as under:

In Ace Builders (Supra), the Bombay High Court has observed:
‘21. On perusal of the aforesaid provisions, it is seen that section 45 is a charging section, and sections 48 and 49 are the machinery sections for computation of capital gains. However, section 50 carves out an exception in respect of depreciable assets and provides that where depreciation has been claimed and allowed on the asset, then, the computation of capital gain on transfer of such asset under sections 48 and 49 shall be as modified under section 50. In other words, section 50 provides a different method for computation of capital gain in the case of capital assets on which depreciation has been allowed.

22. Under the machinery sections the capital gains are computed by deducting from the consideration received on transfer of a capital asset, the cost of acquisition, the cost of improvement and the expenditure incurred in connection with the transfer. The meanings of the expressions “cost of improvement” and “cost of acquisition” used in sections 48 and 49 are given in section 55. As the depreciable capital assets have also availed depreciation allowance under section 32, section 50 provides for a special procedure for computation of capital gains in the case of depreciable assets. Section 50(1) deals with the cases where any block of depreciable assets do not cease to exist on account of transfer and section 50(2) deals with cases where the block of depreciable assets cease to exist in that block on account of transfer during the previous year. In the present case, on transfer of depreciable capital asset the entire block of assets has ceased to exist and, therefore, section 50(2) is attracted. The effect of section 50(2) is that where the consideration received on transfer of all the depreciable assets in the block exceeds the written down value of the block, then the excess is taxable as a deemed short-term capital gain. In other words, even though the entire block of assets transferred are long-term capital assets and the consideration received on such transfer exceeds the written down value, the said excess is liable to be treated as capital gain arising out of a short-term capital asset and taxed accordingly.
…………………………

25. In our opinion, the assessee cannot be denied exemption under section 54E because, firstly, there is nothing in section 50 to suggest that the fiction created in section 50 is not only restricted to sections 48 and 49 but also applies to other provisions. On the contrary, section 50 makes it explicitly clear that the deemed fiction created in sub-section (1) and (2) of section 50 is restricted only to the mode of computation of capital gains contained in sections 48 and 49. Secondly, it is well established in law that a fiction created by the Legislature has to be confined to the purpose for which it is created. In this connection, we may refer to the decision of the Apex Court in the case of State Bank of India vs. D. Hanumantha Rao 1998 (6) SCC 183. In that case, the Service Rules framed by the bank provided for granting extension of service to those appointed prior to 19th July, 1969. The respondent therein who had joined the bank on 1st July, 1972 claimed extension of service because he was deemed to be appointed in the bank with effect from 26th October, 1965 for the purpose of seniority, pay and pension on account of his past service in the army as Short Service Commissioned Officer. In that context, the Apex Court has held that the legal fiction created for the limited purpose of seniority, pay and pension cannot be extended for other purposes. Applying the ratio of the said judgment, we are of the opinion that the fiction created under section 50 is confined to the computation of capital gains only and cannot be extended beyond that.’

These observations of the Bombay High Court in paragraph 25 of the Ace Builder’s decision have been reproduced and approved of by the Supreme Court in the V.S. Dempo case, thereby confirming that the fiction of section 50 is confined to the computation of capital gains only and cannot be extended beyond that.

However, in paragraph 26, the Bombay High Court has observed:
‘26. It is true that section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. In other words, where the long-term capital asset has availed depreciation, then the capital gain has to be computed in the manner prescribed under section 50 and the capital gains tax will be charged as if such capital gain has arisen out of a short-term capital asset, but if such capital gain is invested in the manner prescribed in section 54E, then the capital gain shall not be charged under section 45 of the Income-tax Act.’

The Mumbai bench of the Tribunal in the SKF cases as well as the Pune bench of the Tribunal in the Rathi Brothers case has relied on these observations for holding against the assessee. However, since the issue before the Bombay High Court was regarding the availability of the exemption u/s 54E, the observations regarding charge of capital gains tax should be regarded as the obiter dicta. Further, the Tribunal in these cases did not have the benefit of the Supreme Court’s decision in the V.S. Dempo case, where it had approved of the fact that the applicability of section 50 is confined to the computation of capital gains only.

The observations of the Gauhati High Court, which had also been approved by the Supreme Court in the V.S. Dempo case, can also be referred to:

‘7. Section 2(42A) defines “short-term capital asset” which means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer. Thus the assets, which have been already held for more than 36 months before it is transferred, would not be short-term capital assets. Section 2(29A) defines “long-term capital asset” means a capital asset which is not short-term capital asset. Therefore, the asset, which has been held for more than 36 months before the transfer, would be long-term capital asset. Section 2(29B) provides for “long- term capital gain”, which means capital gain arising from the transfer of a long-term capital asset.

8. All capital gains on the transfer of the capital asset whether short-term capital asset or long-term capital asset except otherwise provided in mentioned sections in section 45 of the Income-tax Act are chargeable to income-tax. How the capital gains shall be computed is laid under sections 48 and 49 of the Income-tax Act, 1961. The capital gain arising from the transfer of short-term assets under section 48 (as it stands at the relevant time) are wholly assessable to be as ordinary income after deduction as provided under section 48(1)(e) whereas the capital gain arising from the transfer of long-term capital assets are partially assessable as provided under section 48(b), which reads:

“(b) where the capital gain arises from the transfer of a long-term capital asset (hereinafter in this section referred to, respectively, as long-term capital gain and long-term capital asset) by making the further deductions specified in sub-section (2).”

9. Thus by virtue of this section, long-term capital assets would be entitled for further deduction as provided in sub-section (2) of section 48. Section 49 is a provision whereunder the general principle is laid down for computing capital gains and certain exceptions are engrafted in the section. Thus, sections 48 and 49 provide for the principles on which the capital gains shall be computed and the benefit which can be given for transfer of long-term capital assets while calculating the capital gain by virtue of sub-section (2) of section 48 wherein the assessee transferring long-term capital assets can claim further deduction as specified under sub-section (2). Section 50…….

10. By virtue of this section, notwithstanding anything contained in clause (42A) of section 2, where the short-term capital asset has been defined, if the depreciation is allowed, the procedure for computing the capital gain as provided under sections 48 and 49 would be modified and shall be substituted as mentioned in section 50. Section 50 only provides that if the depreciation has been allowed under the Act on the capital asset then the assessee’s computation of capital gain would not be under sections 48 and 49 of the Income-tax Act and it would be with modification as provided under section 50. Section 54E is the section which has nothing to do with sections 48 and 49 or with section 50 of the Income-tax Act, 1961 wherein the mode of computation of capital gain is provided.
…………………..

12. Section 50 is a special provision where the mode of computation of capital gains is substituted if the assessee has claimed the depreciation on capital assets. Section 50 nowhere says that depreciated asset shall be treated as short-term assets, whereas section 54E has an application where long-term capital asset is transferred and the amount received is invested or deposited in the specified assets as required under section 54E.’

The observations of the Madras High Court in the case of M. Raghavan vs. Asst. CIT 266 ITR 145, in the context of the purpose of section 50, are also relevant:

‘22. It would appear that the object of introducing section 50 in order to provide different method of computation of capital gain for depreciable assets was to disentitle the owners of such depreciable assets from claiming the benefit of indexing, as if indexing were to be applied, there would be no capital gain available in most cases for being brought to taxation. The value of depreciable asset in most cases comes down over a period of time, although there are cases where the sale value of a depreciated asset exceeds the cost of acquisition. The result of allowing indexing, if it were to be allowed, is to regard the cost of acquisition as being very much higher than what it actually is, to the assessee. If such boosted cost of acquisition is required to be deducted from the amount realised on sale, in most cases it would result in a negative figure, resulting in the assessee being enabled to claim a capital loss. Clearly, it could not have been the legislative intent to confer such multiple benefits to the assessees selling depreciable assets.’

Therefore, from the above it is clear that the deeming fiction of section 50 is for the limited purpose of computation in case of sale of depreciable assets where the computation has to be in the same manner as that applicable to short-term capital assets, i.e., without indexation of cost and with substituted cost of acquisition, being the written down value of the block of assets. The deeming of short-term capital gains can therefore be viewed in the context of the manner of computation of the capital gains, i.e., without the indexation of cost available u/s 48.

It may also be noted that one of the factors that weighed with the Pune bench of the Tribunal in Rathi Brothers for not following the Mumbai Tribunal decision in the P.D. Kunte & Co. case (which was the first case on the issue) was that this issue had not been decided in the P.D. Kunte & Co. case. However, the Tribunal failed to take note of the order in the Miscellaneous Application in the P.D. Kunte & Co. case (MA 394/Mum/2008 dated 6th August, 2008), where the Tribunal had allowed this ground by observing as under:

‘On the reasoning of the Hon’ble Bombay High Court in the case of Ace Builders (P) Ltd. (Supra), it naturally follows that even the tax rate applicable while bringing capital gain to tax will be as per the provisions of section 112 of the Act. The Assessing Officer is directed to apply the same’.

The decision of the Pune bench of the Tribunal in the said case would have been different had the amended decision delivered in the Miscellaneous Application been brought to its notice.

The better view of the matter therefore is the view taken by the Tribunal in the cases of P.D. Kunte & Co., Smita Conductors, etc., that the provisions of section 50 do not take away the benefit of the concessional rate of tax, where available, for the capital gains based on its period of holding.

shailesh.kwebmaker

DEDUCTION FOR PENALTIES AND FINES UNDER THE MOTOR VEHICLES ACT, 1988

ISSUE FOR CONSIDERATION

Section 37 allows a deduction for any revenue expenditure, laid out or expended wholly and exclusively for the purposes of business or profession, in computing the income under the head Profit and Gains from Business and Profession, provided the expenditure is not of a nature covered by sections 30 to 36.

Explanation 1 to section 37(1) provides that no deduction or allowance shall be made in respect of an expenditure incurred for any purpose which is an offence or which is prohibited by law; such an expenditure shall not be deemed to have been incurred for the purposes of business and profession.

Explanation 1, inserted for removal of doubts with retrospective effect from 1st April, 1962, has been the subject matter of fierce litigation even before it was inserted by the Finance No. 2 Act, 1998. Disputes regularly arise about the true meaning of the terms ‘for any purpose which is an offence’ or ‘which is prohibited by law’ in deciding the allowance of an expenditure incurred. The courts have been disallowing expenditure incurred against the public policy or payments that were made for serious violation of law even before the insertion of Explanation 1. Issues also arise about the legislative intent of Explanation 1 and about the scope of Explanation 1; whether the Explanation has limited the law as it always was or whether it has expanded its scope, or has reiterated what was always there.

In the last few years, the legislatures, Central and State, have increased the fines and penalties many-fold for violation of traffic laws and with this enormous increase the issue of allowance or deduction of such payments has also attracted the attention of the taxpayers who hitherto never viewed these seriously. The issue has been considered on several occasions by the courts and is otherwise not new, but it requires consideration in view of the sizeable increase in the quantum of expenditure and the dexterous implementation of the new fines by the traffic authorities with vigour hitherto unknown in this vast country. The recent decision of the Kolkata Bench of the Tribunal holding that such an expenditure is not allowable as a deduction in contrast to many decisions regularly delivered for allowance of such payments, requires us to examine this conflict once more, mainly with the intention to recap the law on the subject and share some of our views on the same.

THE APARNA AGENCY LTD. CASE

The issue recently came up for consideration in Aparna Agency Ltd. 79 taxmann.com 240 (Kolkata-Trib). In that case the assessee was engaged in the business of clearing and distribution of FMCG products and of forwarding agents and had claimed deduction for expenses in respect of payments made to State Governments for violating the provisions of the Motor Vehicles Act, 1988 (M.V. Act) for offences committed by its employees. The A.O. disallowed the payments by holding that such payments were made for infraction of law and could not be allowed as a deduction. The Commissioner (Appeals) confirmed the action of the A.O. but reduced the quantum of disallowance.

In an appeal to the Tribunal, the assesse challenged the orders of the A.O. and the Commissioner (Appeals). It submitted that the payments were made to the traffic department for minor traffic violations committed by its delivery vans, and the payments were not against any proved violation or infraction of law but were made in settlement of contemplated governmental actions that could have led to charging the assessee with an offence. It submitted that the payment did not prove any guilt and was made with a view to avoid prolonged litigation, save time and litigation cost.

The assessee relied on the decision of the Madras High Court in CIT vs. Parthasarathy, 212 ITR 105 to contend that the payment that was compensatory in nature should be allowed as a deduction so long as the said payment was not found to be penal in nature.

The Tribunal examined the provision of the M.V. Act, 1988, and in particular the relevant sections concerning the offence and the levy of the fine, namely, sections 119, 122, 129 and 177. It noted that the term ‘offence’ though not defined under the Income-tax Act, 1961, was, however, defined exhaustively by section 3(38) of the General Clauses Act, 1887 to mean ‘any act or omission made punishable by any law for the time being in force’. It was also noted that even the expression ‘prohibited by law’ has not been defined in the I.T. Act. Under the circumstances, the Tribunal held that the expression should be viewed either as an act arising from a contract which was prohibited by statute or which was entered into with the object of committing an illegal act. The Tribunal quoted with approval the following paragraph of the decision of the Supreme Court in the case of Haji Aziz and Abdul Shakoor Bros. vs. CIT 41 ITR 350:

‘In our opinion, no expense which is paid by way of penalty for a breach of the law can be said to be an amount wholly and exclusively laid for the purpose of the business. The distinction sought to be drawn between a personal liability and a liability of the kind now before us is not sustainable because anything done which is an infraction of the law and is visited with a penalty cannot on grounds of public policy be said to be a commercial expense for the purpose of a business or a disbursement made for the purposes of earning the profits of such business’.

The Tribunal, on perusal of various statutory provisions of the M.V. Act under which the payments in question were made, for offences committed by the employees for which the assessee was vicariously liable, held that such payments were not compensatory in nature and could not be allowed as a deduction by upholding the order of the Commissioner (Appeals) to that extent.

BHARAT C. GANDHI’S CASE

A similar issue had arisen in the case of DCIT vs. Bharat C. Gandhi, 10 taxmann.com 256 (Mum). The assessee in the case was an individual and the proprietor of Darshan Roadlines which specialised in transporting cargo consignments of huge or massive dimensions where the weight and the size of the same exceeded the limits laid down under the M.V. Act and the rules thereunder. The assessee paid compounding fees aggregating to Rs. 73,45,953 to the RTO on various trips during the year for transportation of the massive consignments on its trailers by way of fines at the check-post at Bhachau, Gujarat on various trips during the year for Suzlon Energy Ltd. The A.O. disallowed the assessee’s claim in respect of the said payments, holding that it was in the nature of penalty and, thus, not allowable u/s 37(1). The Commissioner (Appeals), however, held that the expenditure was not in violation of the M.V. Act and the payments could not be termed as penalty. He further relied on the clarifications given by the Central Government vide letter dated 3rd August, 2008 and allowed the expenditure.

On Revenue’s appeal, the Departmental Representative submitted that the issue was not of nomenclature but the intention of the Legislature in not allowing the amounts paid for violation of law. It was further submitted that it was nowhere stated that the assessee satisfied the conditions of the Circular referred to by it before the Commissioner (Appeals). It was submitted that the payment was a penalty for violating the law and could not be allowed.

In reply, the assessee contended that the massive (or over-dimensioned) consignment was indivisible and could not be divided into parts and pieces and hence there was no other way to transport it except by exceeding the permitted limits. It was submitted that transportation in such a manner was a business necessity and commercial exigency and did not involve any deliberate intention of violating any law or rules. It was further submitted that even though it was a compounding fees paid u/s 86(5) of the M.V. Act to the RTO, it was an option given to the assessee and hence payment could not be referred to as a penalty. It was further submitted that such over-dimension charges were also paid to Western Railways for crossing the railway tracks and an amount of Rs. 2,71,380 was allowed by the A.O. It was highlighted that the Central Government vide letter dated 3rd August, 2008 had clarified that transport could take place on payment of the fines.

The assessee further referred to section 86(5) of the M.V. Act and relied on the precedents on the issue in the following cases:
(i) Chadha & Chadha Co. in IT Appeal No. 3524/Mum/2007
(ii) CIT vs. Ahmedabad Cotton Mfg. Co. Ltd. 205 ITR 163(SC)
(iii) CIT vs. N.M. Parthasarathy 212 ITR 105 (Mad)
(iv) ACIT vs. Vikas Chemicals 122 Taxman 59 (Delhi)
(v) CIT vs. Hero Cycles Ltd. 17 Taxman 484 (Punj. & Har.)
(vi) Kaira Can Co. Ltd. vs. Dy. CIT 32 DTR 485 (Mum-Trib)
(vii) Western Coalfields Ltd. vs. ACIT, 27 DTR 226 (Nag-Trib)

The Tribunal noted that the issue was elaborately discussed by the ITAT in the case of Chadha & Chadha Co., IT Appeal No. 6140/Mum/2009, dated 17th September, 2010 relied upon by the assessee wherein the ITAT in its order has considered as under:

‘9. The liability for additional freight charges was considered in the case of ITO vs. Ramesh Stone Wares by the ITAT Amritsar Bench in 62 TTJ (Asr.) 93 wherein the additional freight charges paid to Railway Department for overloading was considered and held that the expense was not penal in nature because it is not the infringement of law but same is violation of contract that too not by the assessee but by his agent, i.e., Coal Authority of India. In terms of an agreement, if coal is finally found by the authorities to be overloaded then the assessee has to pay additional freight charges which according to the terminology of the contract is called penalty freight. This liability was not considered as penal nature and allowed. In the assessee’s case also the overloading charges are to be incurred regularly in view of the nature of goods transported for the said steel company and since the nature of the goods is indivisible and generally more than the minimum limit prescribed under the Motor Vehicles Act, the assessee has to necessarily pay compounding charges for transporting goods as part of the business expenses. These are not in contravention of law and the RTO authorities neither seized the vehicle nor booked any offence but are generally collecting as a routine amount at the check-post itself while allowing the goods to be transported. In view of the nature of collection and payment which are necessary for transporting the goods in the business of the assessee, we are of the opinion that it does not contravene the M.V. Act as stated by the A.O. and the CIT(A).

10. Similar issue also arose with reference to fine and penalty paid on account of violation of National Stock Exchange Regulations in the case of Master Capital Services Ltd. vs. DCIT and the Hon’ble ITAT Chandigarh “A” Bench in ITA No. 346/Chd/2006, dated 26th February, 2007 108 TTJ (Chd) 389 has considered that fines and penalties paid by the assessee to NSE for trading beyond exposure limit, late submission of margin certificate due to software problem and delay in making deliveries of shares due to deficiencies are payments made in regular course of business and not infraction of law, hence allowable. In the assessee’s case also these fines are paid regularly in the course of the assessee’s business for transportation of goods beyond the permissible limit and these payments are being made in the regular course of business to the same RTO authorities at the check-post every year, in earlier years and in later years also. Accordingly, it has to be held that these payments are not for any infraction of law but paid in the course of assessee’s business of transportation and these are allowable expenses under section 37(1).’

In view of the legal principles established by the decisions referred to and noticing that the assessee had made about 230 trips by paying compounding fees, as per the rules in the M.V. Act, the Tribunal held that it could not be stated that the assessee’s payments of compounding fees was in violation of law. Since the assessee was engaged in transporting of over-dimensioned goods, in excess of specified capacities in its transport business, it was a necessary business expenditure, wholly and exclusively incurred for the purpose of business, and the same was allowable u/s 37(1). The order of the Commissioner (Appeals) on the issue was confirmed and in the result, the appeal of the Revenue was dismissed.

OBSERVATIONS
Section 37 is a residual provision that allows a business deduction for an expenditure not specified in sections 30 to 36, provided that the expenditure in question is incurred wholly and exclusively for the purposes of business, an essential precondition for any allowance under this section. Any expenditure that cannot be classified as such a business expenditure gets automatically disallowed under this provision unless it is specifically allowed under other provisions of the Act. Likewise, under the scheme of the Act, an expenditure of capital nature or a personal nature is also not allowable in computing the total income. The sum and substance of this is that a payment which cannot be construed as made for the purposes of business gets disallowed.

In the context of the discussion here, it is a settled position in law that the purpose of any ordinary business can never be to offend any law or to commit an act that violates the law and therefore any payments made for such an offence or as a consequence of violating any law is not allowable; such an allowance is the antithesis of the business deduction. Allowance for such payments has no place for the deduction in the general scheme of taxation. Such payments would be disallowed irrespective of any express provision, like Explanation 1, for its disallowance. It is for this reason that the payments of the nature discussed have been disallowed even before the insertion of Explanation 1 by the Finance (No. 2) Act, 1998 w.r.e.f. 1st April, 1962. It is for this reason that the insertion of this Explanation has been rightly labelled as ‘for removal of doubts’ to reiterate a provision of law which was always there.

Under the circumstances, the better view of the law is that the insertion of the Explanation is not to limit the scope of disallowance; any expenditure otherwise disallowable would remain disallowable even where it is not necessarily provided for by the express words of the Explanation. It is with this understanding of the law that the courts have been regularly disallowing the expenditure against public policy, for committing illegal acts, for making payments which are crimes by themselves and even, in some cases, expenditure incurred for defending the criminal proceedings. The disallowance here of an expenditure is without an exception and the principle would apply even in respect of an illegal business unless when it comes to the allowance of a loss of such business, in which case a different law laid down by the courts may apply.

The decisions chosen and discussed here are taken with the limited objective of highlighting the principles of the law of disallowance, even though they may not be necessarily conflicting with each other and maybe both may be correct in their own facts. The settled understanding of the law provided by the decisions of the Supreme Court in a case like Haji Aziz and Abdul Shakoor Bros. 41 ITR 350 has been given a new dimension by the subsequent decisions of the said court in the cases of Prakash Cotton Mills, 201 ITR 684 and Ahmedabad Cotton Manufacturing Co. Ltd., 205 ITR 163 for making a distinction in cases of payment of redemption fine or compounding fees. The court in these case held that it was required to examine the scheme of the provisions of the relevant statute providing for payment of an impost, ignoring its nomenclature as a penalty or fine, to find whether the payment in question was penal or compensatory in nature and allow an expenditure where an impost was found to be purely compensatory in nature. It was further held that when an impost was found to be of a composite nature, the payment was to be bifurcated and the part attributable to penalty was to be disallowed.

Following this distinction, many courts and tribunals have sought to allow those payments that could be classified as compensatory in nature. Needless to say, the whole exercise of distinguishing and separating the two is discretionary and at times results in decisions that do not reconcile with each other. For example, some courts hold that the penalty under the Sales Tax Act is not disallowable while a few others hold that it is disallowable. At times the courts are led to decide even the payment admittedly made for an offence or violation of law was allowable if it was incurred under a bona fide belief out of commercial expediency.

The other extreme is disallowance of payments that are otherwise bordering on immorality as perceived by society. The Supreme Court in the case of Piara Singh 124 ITR 40 and later in the case of Dr. T.A. Qureshi 287 ITR 647 held that there was a clear distinction between morality and law and the decision of disallowance should be purely based on the considerations rooted in law and not judged by morality thereof. These decisions also explain the clear distinction in principle relating to a loss and an expenditure to hold that in cases of an illegal business, the loss pertaining to such a business may qualify for set-off against income of such business.

As noted earlier, the Income-tax Act has not defined the terms like ‘offence’ or ‘prohibited by law’ and it is for this reason, in deciding the issue, that the taxpayer and the authorities have to necessarily examine the relevant statute under which the payment is made, to determine whether such a payment can be classified to be made for any purpose which is an offence or which is prohibited by law under the respective statutes.

Needless to reiterate, the scope of disallowance is not restricted by the Explanation and the expenditure otherwise held to be disallowed by the courts should continue to be disallowed and those covered by the Explanation would surely be disallowed. In applying the law, one needs to appreciate the thin line of distinction between an infraction of law, an offence, a violation and a prohibition, each of which may carry a different connotation while deciding the allowance or otherwise of a payment. In deciding the issue of allowance or otherwise, it perhaps would be appropriate to examine the ratio of the latest and all-important decision of the Supreme Court in the case of Maddi Venkataraman & Co. (P) Ltd., 229 ITR 534 where the Court held that a penalty for an infraction of law is not deductible on grounds of public policy, even if it is paid for an act under an inadvertence. The Full Bench of the Punjab and Haryana High Court in the case of Jamna Auto Industries, 299 ITR 92 held that a penalty imposed for violation of any law even in the course of business cannot be held to be a commercial loss allowable in law. One may also see the latest decision in the case of Confederation of Indian Pharmaceutical Industry vs. CBDT, 353 ITR 388 (HP) wherein the Court examined the issue of payment by the pharmaceutical company to the medical practitioners in violation of the rules of the Indian Medical Council.

It appears that the plea that the payment was made during the course of business and the businessman was compelled to offend or violate the law out of commercial expediency is no more tenable and, in our considered opinion, not an attractive contention to support a claim for a business deduction. A payment to discharge a statutory obligation, for correcting the default when permitted under the relevant statute, can be viewed differently and favourably in deciding the allowance of such payment, but such a payment may not be allowed when it is otherwise for an offence or for violating the law inasmuch as it cannot be considered as an expenditure laid out for the purpose of the business. An infraction of law cannot be treated as a normal occurrence in business.

Having noted the law and the developments in law, it is advisable to carefully examine the relevant law under which the payment is made for ascertaining whether the payment can at all be classified as a compensatory payment, for example interest, including those which are labelled as fines and penalties but are otherwise compensatory in nature and have the effect of regularising a default. Surely a payment made for compounding an offence to avoid imprisonment is not one that can be allowed as a deduction, even where such a compounding is otherwise permitted under the relevant statute?

The tribunal and courts in the following decisions, too, have taken a stand that payments made for traffic violations were not allowable as deductions:

Vicky Roadways ITA No. 38/Agra/2013,

Sutlej Cotton Mills ITA 1775/1991 (Del) HC, dated 31st October, 1997,

Kranti Road Transport (P) Ltd. 50 SOT 15 (Visakhapatnam).

However, the tribunal and courts in the following cases have allowed the deduction for expenditure made for violation of the M.V. Act, 1988 in cases where the payment was made for overloading the cargo beyond the permissible limit, on the ground that the cargo in question was indivisible and there was a permission from the Central Government to allow the overloading on payment of fines:

Ramesh Stone Wares, 101 Taxman 176 (Mag) (Asr),

Vishwanath V. Kale ITA/20181/Mum/2010,

Chetak Carriers ITA 2934/Delhi/1996,

Amar Goods Carrier ITA 50 and 51/Delhi/199.

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TAXABILITY OF CORPUS DONATIONS RECEIVED BY AN UNREGISTERED TRUST

ISSUE FOR CONSIDERATION
Section 2(24)(iia) of the Income-tax Act, 1961 defines income to include voluntary contributions received by a trust created wholly or partly for charitable or religious purposes. Till Assessment Year 1988-89, this included the phrase ‘not being contributions made with a specific direction that they shall form part of the corpus of the trust’, which was omitted with effect from the A.Y. 1989-90. Section 11(1)(d) of the Act, which was inserted with effect from A.Y. 1989-90, provides for exemption in respect of voluntary contributions made with a specific direction that they shall form part of the corpus of the trust or institution. However, this exemption applies only when the recipient trust or institution is registered with the income-tax authorities under section 12A or 12AA, as applicable up to 31st March, 2021, or section 12AB as applicable thereafter.

The issue has arisen as to whether such voluntary contributions (referred to as ‘corpus donations’) received by an unregistered trust, not registered u/s 12A or 12AA or 12AB, can be regarded as income taxable in its hands on the ground that it does not qualify for the exemption u/s 11, or in the alternative whether such donations can be regarded as the capital receipt not falling within the scope of income at all.

Several Benches of the Tribunal have taken a view, post-amendment, that a voluntary contribution received by an unregistered trust with a specific direction that it shall form part of its corpus, is a capital receipt and therefore not chargeable to tax at all. As against this, recently, the Chennai Bench of the Tribunal took a view that such a corpus donation would fall within the ambit of income of the trust and hence is includible in its total income.

SHRI SHANKAR BHAGWAN ESTATE’S CASE
The issue had first come up for consideration before the Kolkata Bench of the Tribunal in the case of Shri Shankar Bhagwan Estate vs. ITO (1997) 61 ITD 196.

In this case, two religious endowments were effectuated vide two deeds of endowment dated 30th October, 1989 and 19th June, 1990, respectively, in favour of Shree Ganeshji Maharaj and Shri Shankar Bhagwan by Smt. Krishna Kejriwal. The debutter properties, i.e., estates were christened as ‘Shree Ganeshji Maharaj Estate’ and ‘Shree Shankar Bhagwan Estate’. She constituted herself as the Shebait in respect of the deity. The estates were not registered u/s 12AA as charitable / religious institutions. The returns of income of the two estates for the A.Y. 1991-92 were filed declaring paltry income excluding the donations / gifts received towards the corpus of the estates.

During the course of the assessment proceedings, it was observed from the balance sheet that gifts were received by the estates from various persons. The assessees claimed that the said amounts were received towards the corpus of the endowments and, therefore, could not be taxed. Though the A.O. accepted the fact that the declarations filed by the donors indicated that they have sent moneys through cheques as their contributions to the corpus of the endowments, he held that the receipts were taxable u/s 2(24)(iia). Accordingly, the assessment was made taking the status of the assessees as a private religious trust, as against the status of an individual as claimed by the assessees, and taxing the income of the estates u/s 164, including the amounts received as corpus donations. He also held that the deities should have been consecrated before the endowments for them to be valid in law.

Before the CIT(A), the assessee contended that the provisions of section 2(24)(iia) did not authorise the assessment of the corpus gifts. However, the CIT(A) endorsed the view taken by the A.O. and upheld the assessment of the corpus gifts as income.

Upon further appeal, the Tribunal decided the issue in favour of the assessee by holding as under –

‘So far as section 2(24)(iia) is concerned, this section has to be read in the context of the introduction of the present section 12. It is significant that section 2(24)(iia) was inserted with effect from 1st April, 1973 simultaneously with the present section 12, both of which were introduced from the said date by the Finance Act, 1972. Section 12 makes it clear by the words appearing in parenthesis that contributions made with a specific direction that they shall form part of the corpus of the trust or institution shall not be considered as income of the trust. The Board’s Circular No. 108 dated 20th March, 1973 is extracted at page 1277 of Vol. I of Sampat Iyengar’s Law of Income-tax, 9th Edn. in which the interrelation between section 12 and section 2(24)(iia) has been brought out. Gifts made with clear directions that they shall form part of the corpus of the religious endowment can never be considered as income. In the case of R.B. Shreeram Religious & Charitable Trust vs. CIT [1988] 172 ITR 373 it was held by the Bombay High Court that even ignoring the amendment to section 12, which means that even before the words appearing in parenthesis in the present section 12, it cannot be held that voluntary contributions specifically received towards the corpus of the trust may be brought to tax. The aforesaid decision was followed by the Bombay High Court in the case CIT vs. Trustees of Kasturbai Scindia Commission Trust [1991] 189 ITR 5. The position after the amendment is a fortiori. In the present cases, the A.O. on evidence has accepted the fact that all the donations have been received towards the corpus of the endowments. In view of this clear finding, it is not possible to hold that they are to be assessed as income of the assessees. We, therefore, hold that the assessment of the corpus donations cannot be supported.’

The Tribunal upheld the claim of the assessee that the voluntary contributions received towards the corpus could not be brought to tax. In deciding the appeal, the Bench also held that the status of the endowments should be ‘individual’ and it was not necessary that the deities should have been consecrated before the endowments, or that the temple should have been constructed prior to the endowments.

Apart from this case, in the following cases a similar view has been taken by the Tribunal that the corpus donation received by an unregistered trust is a capital receipt and not chargeable to tax –

• ITO vs. Smt. Basanti Devi & Shri Chakhan Lal Garg Education Trust

For A.Y. 2003-04 – ITA No. 3866/Del/2007, dated 30th January, 2009

For A.Y. 2004-05 – ITA No. 5082/Del/2010, dated 19th January, 2011

• ITO vs. Chime Gatsal Ling Monastery [ITA No. 216 to 219 (Chd) of 2012, dated 28th October, 2014]
• ITO vs. Gaudiya Granth Anuved Trust [2014] 48 taxmann.com 348 (Agra-Trib)
• Pentafour Software Employees Welfare Foundation vs. Asstt. CIT [IT Appeal Nos. 751 & 752 (Mds) of 2007]
• ITO vs. Hosanna Ministries [2020] 119 taxmann.com 379 (Visakh-Trib)
• Indian Society of Anaesthesiologists vs. ITO (2014) 47 taxmann.com 183 (Chen-Trib)
• J.B. Education Society vs. ACIT [2015] 55 taxmann.com 322 (Hyd-Trib)
• ITO vs. Vokkaligara Sangha (2015) 44 CCH 509 (Bang–Trib)
• Bank of India Retired Employees Medical Assistance Trust vs. ITO [2018] 96 taxmann.com 277 (Mum-Trib)
• Chandraprabhu Jain Swetamber Mandir vs. ACIT [2017] 82 taxmann.com 245 (Mum-Trib)
• ITO vs. Serum Institute of India Research Foundation [2018] 90 taxmann.com 229 (Pune-Trib)

VEERAVEL TRUST’S CASE
Recently, the issue again came up for consideration before the Chennai Bench of the Tribunal in the case of Veeravel Trust vs. ITO [2021] 129 taxmann.com 358.

In this case, the assessee was a public charitable and religious trust registered under the Indian Trusts Act, 1882. It was not registered under the Income-tax Act. It had filed its return of income for A.Y. 2014-15, declaring Nil total income. The return of income filed by the assessee had been processed by the CPC, Bengaluru u/s 143(1) and the total income was determined at Rs. 55,82,600 by making additions of donations received amounting to Rs. 55,82,600.

The assessee trust filed an appeal against the intimation issued u/s 143(1) before the CIT(A) and contended that while processing the return u/s 143(1), only prima facie adjustments could be made and no addition could be made for corpus donations. The assessee further contended that corpus donations received by any trust or institution were excluded from the income derived from property held under the trust u/s 11(1)(d) and hence, even though the trust was not registered u/s 12AA, corpus donations could not be included in the income of the trust.

The CIT(A) rejected the contentions of the assessee and held that the condition precedent for claiming exemption u/s 11 was registration of the trust u/s 12AA and hence, in the absence of such registration, exemption claimed towards corpus donations could not be allowed. The CIT(A) relied upon the decision of the Supreme Court in the case of U.P. Forest Corpn. vs. Dy. CIT [2008] 297 ITR 1.

Being aggrieved by the order of the CIT(A), the assessee trust filed a further appeal before the Tribunal and contended that the donations under consideration were received for the specific purpose of construction of building and the said donations have been used for construction of building. Therefore, when donations have been received for specific purpose and such donations have been utilised for the purpose for which they were received, they were capital receipts by nature and did not fall within the scope of income.

The assessee relied upon the following decisions in support of its contentions –

(i) Shree Jain Swetamber Deharshar Upshraya Trust vs. ACIT [IT Appeal No. 264 (Mum) of 2016, dated 15th March, 2017]
(ii) ITO vs. Serum Institute of India Research Foundation [2018] 90 taxmann.com 229 (Pune)
(iii) Bank of India Retired Employees Medical Assistance Trust vs. ITO (Exemption) [2018] 96 taxmann.com 277 (Mum)
(iv) Chandraprabhu Jain Swetamber Mandir vs. Asstt. CIT [2017] 82 taxmann.com 245 (Mum)

The Revenue reiterated its stand that in the absence of registration of the trust u/s 12AA, no exemption could be given to it for the corpus donations.

The Tribunal referred to the relevant provisions of the Act and observed that the definition of income u/s 2(24) included voluntary contributions received by any trust created wholly or partly for charitable or religious purpose; that the provisions of sections 11, 12A and 12AA dealt with taxation of trust or institution and the income of any trust or institution was exempt from tax on compliance with certain conditions; the provisions of section 11(1)(d) excluded voluntary contributions received by a trust, with a specific direction that they shall form part of the corpus of the trust or institution which was subject to the provisions of section 12A, which stated that the provisions of sections 11 and 12 shall not apply in relation to income of any trust or institution, unless such trust or institution fulfilled certain conditions.

The Tribunal held that as per the said section 12A, one of the conditions for claiming benefit of exemption under sections 11 and 12 was registration of the trust as per sub-section (aa) of section 12A; that on a conjoint reading of the provisions, it was very clear that the income of any trust, including voluntary contributions received with a specific direction, was not includible in the total income of the trust, only if such trust was registered u/s 12A / 12AA and the registration was a condition precedent for claiming exemption u/s 11, including for voluntary contributions.

The Tribunal also took support from the decision of the Supreme Court in the case of U.P. Forest Corporation (Supra) wherein it was held that registration u/s 12A was a condition precedent for availing benefit under sections 11 and 12. Insofar as various case laws relied upon by the assessee were concerned, the Tribunal found that none of the Benches of the Tribunal had considered the ratio laid down by the Supreme Court in the case of U.P. Forest Corporation (Supra) while deciding the issue before them. In this view of the matter, it was held that corpus donations with a specific direction that they form part of the corpus received by the trust which was not registered under sections 12A / 12AA was its income and includible in its total income.

OBSERVATIONS
The issue under consideration is whether the voluntary contribution received by a trust with a specific direction that it shall form part of its corpus can be considered as the ‘income’ of the trust, is a capital receipt, not chargeable to tax, and whether the answer to this question would differ depending upon whether or not the trust was registered with the income-tax authorities under the relevant provisions of the Act.

Sub-clause (iia) was inserted in section 2(24) defining the term ‘income’ by the Finance Act, 1972 with effect from 1st April, 1973. It included the voluntary contribution received by a trust created wholly or partly for charitable or religious purposes within the scope of the term ‘income’ with effect from 1st April, 1973. Therefore, firstly, what was the position about taxability of such voluntary contribution prior to that needs to be examined.

The Supreme Court had dealt with this issue of taxability of an ordinary voluntary contribution for the period prior to 1st April, 1973 in the case of R.B. Shreeram Religious & Charitable Trust [1998] 233 ITR 53 (SC) and it was held that –

Undoubtedly by a subsequent amendment in 1972 to the definition of income under section 2(24), voluntary contributions, not being contributions towards the corpus of such a trust, are included in the definition of ‘income’ of such a religious or charitable trust. Section 12 as amended in 1972 also expressly provides that any voluntary contribution received by a trust for religious or charitable purposes, not being contribution towards the corpus of the trust, shall, for the purpose of section 11, be deemed to be income derived from property held by the trust wholly for charitable or religious purposes. This, however, does not necessarily imply that prior to the amendment of 1972, a voluntary contribution which was not towards the corpus of the receiving trust, was not income of the receiving trust. Even prior to the amendment of 1972, any income received by a religious or charitable trust in the form of a voluntary contribution would be income of the trust, unless such contribution was expressly made towards the corpus of the trust’s fund.

Thus, even prior to the insertion of sub-clause (iia) in the definition of income in section 2(24), the ordinary voluntary contribution received by a religious or charitable trust was regarded as income chargeable to tax and, therefore, no substantial change had occurred due to its specific inclusion in the definition of the term income. At the same time, the position was different as far as a voluntary contribution received towards the corpus was concerned. The settled view was that it was a capital receipt not chargeable to tax. The following are some of the cases in which such a view was taken by different High Courts as referred to by the Supreme Court in the case of R.B. Shreeram Religious & Charitable Trust (Supra) –
• Sri Dwarkadheesh Charitable Trust vs. ITO [1975] 98 ITR 557 (All)
• CIT vs. Vanchi Trust [1981] 127 ITR 227 (Ker)
• CIT vs. Eternal Science of Man’s Society [1981] 128 ITR 456 (Del)
• Sukhdeo Charity Estate vs. CIT [1984] 149 ITR 470 (Raj)
• CIT vs. Shri Billeswara Charitable Trust [1984] 145 ITR 29 (Mad)

The objective of inserting sub-clause (iia) treating voluntary contributions received by a religious or charitable trust specifically as its income in section 2(24) was not to unsettle this position of law as held by the Courts as explained above. Only ordinary voluntary contributions other than those which were received with a specific direction that they shall form part of the corpus of the trust were brought within the definition of ‘income’, perhaps by way of clarification and removal of doubts. The sub-clause (iia) as it was inserted with effect from 1st April, 1973 is reproduced below –

‘(iia) voluntary contributions received by a trust created wholly or partly for charitable or religious purposes or by an institution established wholly or partly for such purposes not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution’

Thus, the voluntary contributions made with a specific direction that they shall form part of the corpus of the trust were expressly kept outside the ambit of the term ‘income’ and they continued to be treated as capital receipts not chargeable to tax. This position in law has been expressly confirmed by the Supreme Court in the above quoted paragraph, duly underlined for emphasis, when the Court clearly stated that the said section 2(24)(iia) covered donations not being the contributions towards corpus.

In such a scenario, a question may arise as to what was the purpose of making such an amendment in the Act to include the voluntary contributions (other than corpus donations) within the definition of ‘income’? The answer to this question is available in Circular No. 108 dated 20th March, 1973 explaining the provisions of the Finance Act, 1973 (as referred in the case of Shri Shankar Bhagwan Estate Supra). The relevant extract from this Circular is reproduced below –

The effect of the modifications at (1) and (2) above would be as follows:
(i) Income by way of voluntary contributions received by private religious trusts will no longer be exempt from income-tax.
(ii) Income by way of voluntary contributions received by a trust for charitable purposes or a charitable institution created or established after 31st March, 1962 (i.e., after the commencement of the Income-tax Act, 1961) will not qualify for exemption from tax if the trust or institution is created or established for the benefit of any particular religious community or caste.
(iii) Income by way of voluntary contributions received by a trust created partly for charitable or religious purposes or by an institution established partly for such purposes will no longer be exempt from income-tax.
(iv) Where the voluntary contributions are received by a trust created wholly for charitable or religious purposes or by an institution established wholly for such purposes, such contributions will qualify for exemption from income-tax only if the conditions specified in section 11 regarding application of income or accumulation thereof are satisfied and no part of the income enures and no part of the income or property of the trust or institution is applied for the benefit of persons specified in section 13(3), e.g., author of the trust, founder of the institution, a person who has made substantial contribution to the trust or institution, the relatives of such author, founder, person, etc. In other words, income by way of voluntary contributions will ordinarily qualify for exemption from income-tax only to the extent it is applied to the purposes of the trust during the relevant accounting year or within next three months following. Such charitable or religious trusts will, however, be able to accumulate income from voluntary contributions for future application to charitable or religious purposes for a maximum period up to ten years, without forfeiting exemption from tax, if they comply with certain procedural requirements laid down in section 11 in this behalf. These requirements are that (1) the trust or institution should give notice to the Income-tax Officer, specifying the purpose for which the income is to be accumulated and the period for which the accumulation is proposed to be made, and (2) the income so accumulated should be invested in Government or other approved securities or deposited in post office savings banks, scheduled banks, co-operative banks or approved financial institutions.

Thus, it can be seen from the Circular that the objective of the amendment made with effect from 1st April, 1973 was to make the trust or institution liable to tax on the voluntary contributions received in certain cases like where it has not been applied for the objects of the trust, it has been received by a private religious trust, or it has been received by a trust created for the benefit of any particular religious community or caste and to make the charitable and religious trusts to apply the contributions only on the objects of the trust and to apply for the accumulation thereof where it has not been so utilised before the year-end. In other words, the intention is expressed to regulate voluntary contributions of an ordinary nature.

This position under the law continued till 1st April, 1989 and the issue deliberated in this article could never have arisen till then as the Act itself had provided expressly that the voluntary contributions received with a specific direction that they shall form part of the corpus would not be regarded as ‘income’ and, hence, not chargeable to tax. The issue under consideration arose when the law was amended with effect from 1st April, 1989. The Direct Tax Laws (Amendment) Act, 1987 deleted the words ‘not being contributions made with a specific direction that they shall form part of the corpus of the trust or institution’ from sub-clause (iia) of section 2(24) with effect from 1st April, 1989.

The Revenue authorities read sub-clause (iia) as amended with effect from 1st April, 1989, in contrast to the erstwhile sub-clause (iia), to hold that even the voluntary contributions received with a specific direction that they shall form part of the corpus of the trust would be considered as income chargeable to tax subject to the provisions dealing with exemptions upon satisfaction of several conditions, including that of registration of the trust with the income-tax authority.

The aforesaid interpretation of the Revenue is on the basis of the Circular No. 516 dated 15th June, 1988, Circular No. 545 dated 24th September, 1989, Circular No. 549 dated 31st October, 1989 and Circular No. 551 dated 23rd January, 1990 explaining the provisions of the Direct Tax (Amendment) Act, 1987 [as amended by the Direct Tax Laws (Amendment) Act, 1989]. The relevant extract dealing with the amendment to section 2(24)(iia) is reproduced below –

4.3 Under the old provisions of sub-clause (iia) of clause (24) of section 2 any voluntary contribution received by a charitable or religious trust or institution with a specific direction that it shall form part of the corpus of the trust or institution was not included in the income of such trust or institution. Since this provision was being widely used for tax avoidance by giving donations to a trust in the form of corpus donations so as to keep this amount out of the regulatory provisions of sections 11 to 13, the Amending Act, 1987 amended the said sub-clause (iia) of clause (24) of section 2 to secure that all donations received by a charitable or religious trust or institution, including corpus donations, were treated as income of such trust or institution.

Analysing the impact of the amendment, the eminent jurist Mr. Nani Palkhivala, in his commentary Law and Practice of Income Tax page 156 of the 11th edition, has commented:

‘This, however, does not mean that such capital contributions are now taxable as income. Sometimes express exclusion is by way of abundant caution, due to the over-anxiety of the draftsman to make the position clear beyond doubt. But in such a case, the later omission of such express exclusion does not necessarily involve a change in the legal position. Section 12 still provides that voluntary contributions specifically made to the corpus of a charitable trust are not deemed to be income, and the same exclusion must be read as implicit in section 2(24)(ii-a). It would be truly absurd to expect a charitable trust to disburse as income any amount in breach of the donor’s specific direction to hold it as corpus; such breach in many cases would involve depriving charity of the benefit of acquiring a lasting asset intended by the donor. Under this sub-clause, only voluntary contributions received by such institutions as are specified therein are taxable as income. A voluntary contribution received by an institution not covered in this sub-clause is not taxable as income.’

Further, in the commentary on section 12(1), page 688 of the same edition, it is stated:

‘The correct legal position is as under:
(i) All contributions made with a specific direction that they shall form part of the corpus of the trust are capital receipts in the hands of the trust. They are not income either under the general law or under section 2(24)(ii-a).
(ii) Section 2(24)(ii-a) deems revenue contributions to be income of the trust. It thereby prevents the trust from claiming exemption under general law on the ground that such contributions stand on the same footing as gifts and are therefore not taxable.
(iii) Section 12 goes one step further and deems such revenue contributions to be income derived from property held under trust. It thereby makes applicable to such contributions all the conditions and restrictions under sections 11 and 13 for claiming exemption.
(iv) Section 11(1)(d) specifically grants exemption to capital contributions to make the fact of non-taxability clear beyond doubt. But it proceeds on the erroneous assumption that such contributions are of income nature – income in the form of voluntary contributions. This assumption should be disregarded.’

This supports the argument that corpus donations are capital receipts, which are not in the nature of income at all.

Taking a view as is canvassed by the Revenue would tantamount to interpreting a law in a manner that holds that where an exemption has been expressly provided for any income, then it needs to be presumed that in the absence of the specific provision the income is taxable otherwise; such a view also means that any receipt that is not expressly and specifically exempted is always taxable; that a deletion of an express admission of the exemption, as is the case under consideration, would automatically lead to its taxation irrespective of the position in law that such receipt even before introduction of the express provision for exempting it was never taxable. In this regard, a reference may be made to the decision in the case of CIT vs. Shaw Wallace 6 ITC 178 (PC) wherein it was held as under –

‘15. Some reliance has been placed in argument upon section 4(3)(v) which appears to suggest that the word “income” in this Act may have a wider significance than would ordinarily be attributed to it. The sub-section says that the Act “shall not apply to the following classes of income,” and in the category that follows, Clause (v) runs:
Any capital sum received in commutation of the whole or a portion of a pension, or in the nature of consolidated compensation for death or injuries, or in payment of any insurance policy, or as the accumulated balance at the credit of a subscriber to any such Provident Fund.
16. Their Lordships do not think that any of these sums, apart from their exemption, could be regarded in any scheme of taxation of income, and they think that the clause must be due to the over-anxiety of the draftsman to make this clear beyond possibility of doubt. They cannot construe it as enlarging the word “income” so as to include receipts of any kind, which are not specially exempted. They do not think that the clause is of any assistance to the appellant.’

Similarly, the Karnataka High Court in the case of International Instruments (P) Ltd. vs. CIT [1982] 133 ITR 283 held that a receipt which is not an income does not become income, for the years before its inclusion, just because it is later on included as one of the items exempted from income-tax. Thus, it was held that merely because the exemption has been provided it cannot be presumed that it would necessarily be taxable otherwise. Similarly, merely because the voluntary contributions which were capital in nature otherwise were specifically excluded from the definition of income, it cannot be presumed that they were otherwise falling within the definition of income. The Courts in several cases had already held that such voluntary contributions received with a specific direction that they should be forming part of the corpus are receipt of capital nature and not income chargeable to tax. In view of this, the omission of a specific exclusion, w.e.f. 1st April, 1989, provided to it from the definition of income till the date, should not be considered as sufficient to bring it within the scope of the term ‘income’ so as to make it chargeable to tax from the date of the amendment.

All the decisions cited above, wherein a favourable view has been taken, have been rendered for the A.Ys. beginning from 1st April, 1989 onwards post amendment in sub-clause (iia) of section 2(24). Reliance was placed by the Revenue, in these cases, on the amended definition of income provided in section 2(24)(iia) and yet the Tribunals took a view that the corpus donations did not fall within the scope of term ‘income’ as they were capital receipts and, hence, the fact that the exemption otherwise provided in section 11(1)(d) was not available due to non-registration, though argued, was not considered to be relevant at all.

In the case of Smt. Basanti Devi & Shri Chakhan Lal Garg Education Trust, the matter pertaining to A.Y. 2003-04 had travelled to the Delhi High Court and the Revenue’s appeal was dismissed by the High Court (ITA 927/2009, order dated 23rd September, 2009), by taking a view that the donations received towards the corpus of the trust would be capital receipt and not revenue receipt chargeable to tax. The further appeal of the Revenue before the Supreme Court has also been dismissed by an order dated 17th September, 2018, though on account of low tax effect. Therefore, the view as adopted in these cases should be preferred, irrespective of the amendment made with effect from 1st April, 1989.

The Chennai Bench of the Tribunal has disagreed with the decisions of the other Benches taking a favourable view which were cited before it, on the ground that the ratio of the Supreme Court’s decision in the case of U.P. Forest Corporation (Supra) had not been considered therein. Nothing could have turned otherwise even if the Tribunal, in favourably deciding those cases, had examined the relevance of the Supreme Court decision. On a bare reading of the decision, it is clear that the facts in the said case related to an issue whether the corporation in question was a local authority or not and, of course, also whether an assessee claiming exemption u/s 11 should have been registered under the Income-tax Act or not. The Court was pleased to hold that an assessee should be registered for it being eligible to claim the exemption of income u/s 11. The issue in that case was not related to exemption for the corpus donation at all and the Court was never asked whether such a donation was exempted or not because of non-registration of the corporation under the Act in that regard.

With utmost respect, one fails to understand how this important fact was not comprehended by the Chennai Bench. The Bench was seriously mistaken in applying the ratio of the Supreme Court decision which has no application to the facts of the case before it. The issue in the case before the Bench was whether receipt of a corpus donation was a capital receipt or not which was not liable to tax in respect of such a receipt, not due to application of section 11, but on application of the general law of taxation which cannot tax a receipt that is not in the nature of income. Veeravel Trust may explore the possibility of filing a Miscellaneous Application seeking rectification of the order.

The issue under consideration here and the issue that was before the Supreme Court in the case of U.P. Forest Corporation were distinguished by the Bengaluru Bench of the Tribunal in the case of Vokkaligara Sangha (Supra) as follows –

‘5.3.6 Before looking into the facts of the case, we notice that Revenue has relied upon a judgment of the Hon’ble Apex Court in the case of U.P. Forest Corporation & Another vs. DCIT reported in 297 ITR 1 (SC). According to the aforesaid decision, registration under section 12AA of the Act is mandatory for availing the benefits under sections 11 and 12 of the Act. However, the question that arises for our consideration in the case on hand is not the benefit under sections 11 and 12 of the Act, but rather whether voluntary contributions are income at all. Thus, with due respects, the aforesaid decision, in our view, would not be of any help to Revenue in the case on hand.’

The Chennai Bench, with due respect, has looked at the issue from the perspective of exemption u/s 11(1)(d). Had it been called upon to specifically adjudicate the issue as to whether the corpus donation was an income at all in the first place, and not an exemption u/s 11, the view could have been different.

Further, if a view is taken that the corpus donations received by a religious or charitable trust would be regarded as income under sub-clause (iia), then it will result in a scenario whereunder treatment of corpus donations would differ depending upon the type of entity which is receiving such corpus donations. If they are received by a religious or charitable trust or institution then it would be regarded as income, but if they are received by any other entity then it would not fall under sub-clause (iia) so as to treat it as income, subject, of course, to the other provisions of the Act.

In the case of CIT vs. S.R.M.T. Staff Association [1996] 221 ITR 234 (AP), the High Court held that only when the voluntary contributions were received by the entities referred to in sub-clause (iia), such receipts would fall within the definition of income and the receipts by entities other than the specified trusts and associations would not be liable to tax on application of sub-clause (iia). In the case of Pentafour Software Employees Welfare Foundation (Supra), a case where the assessee was a company incorporated u/s 25 of the Companies Act, the Madras High Court in the context of the taxability or otherwise of the corpus donations, held that the receipt was not taxable, more so where it was received by a company. An interpretation which results in an illogical conclusion should be avoided.

Reference can also be made to the Memorandum explaining the provisions of the Finance Bill, 2017 wherein, while explaining the rationale of inserting Explanation 2 to section 11(1), it was mentioned that a corpus donation is not considered as income of the recipient trust. The relevant extract from the Memorandum is reproduced below –

‘However, donation given by these exempt entities to another exempt entity, with specific direction that it shall form part of corpus, is though considered application of income in the hands of donor trust but is not considered as income of the recipient trust. Trusts, thus, engage in giving corpus donations without actual applications.’

The issue may arise as to why a specific exemption is provided to such corpus donations under section 11(1)(d) which applies only when the trust or institution receiving such donations satisfies all the applicable conditions, including that of registration with the income-tax authorities. In this regard, as explained by Mr. Palkhivala in the commentary referred to above, this specific exemption should be regarded as having been provided out of abundant caution though not warranted, as such corpus donations could not have been regarded as income in the first place.

The Finance Act, 2021 with effect from 1st April, 2022 requires that such voluntary contributions are invested or deposited in one or more of the forms or modes specified in sub-section (5) maintained specifically for such corpuses. In our view, the amendment stipulates a condition for those who are seeking an exemption u/s 11 of the Act but for those who hold that the receipt of the corpus donation at the threshold itself is not taxable in view of the receipt being of a capital nature, need not be impressed by the amendment; a non-taxable receipt cannot be taxed for non-compliance of a condition not intended to apply to a capital receipt.

In any case, if there exist divergent views on the issue as to whether or not a particular receipt can be regarded as income, then a view in favour of the assessee needs to be preferred.

It may be noted that in one of the above-referred decisions (Serum Institute of India Research Foundation), the Department had made an argument that such corpus donations received by an unregistered trust be brought to tax u/s 56(2). The Tribunal, however, decided the matter in favour of the assessee, on the ground of judicial discipline, following the earlier Tribunal and High Court decisions.

The better view is therefore that corpus donations received by a charitable or religious trust, registered or unregistered, are a capital receipt, not chargeable to income-tax at all.

shailesh.kwebmaker

ALLOWABILITY OF PORTFOLIO MANAGEMENT FEES IN COMPUTING CAPITAL GAINS

ISSUE FOR CONSIDERATION

Many investors in the stock market, especially high net-worth individuals or investors who have no investing experience, use the services of portfolio managers to manage their share and / or debt portfolios. Such services of expert portfolio managers are used to maximise the returns on investments. The portfolio managers charge the investors an annual fee for their services. Such fee is normally charged as a percentage of the value of the portfolio and may also include a fee linked to the performance of the portfolio. For instance, if the likely returns at the end of the year exceed a particular threshold percentage, the portfolio manager may get a percentage of the excess return over the threshold rate of return by way of a fee. Often, particularly for high net-worth individuals, such fees may constitute a substantial amount. Such fees include STT, stamp duty and other charges and are apart from the brokerage on purchase and sale of shares.

Investors have sought to claim deduction of such portfolio management fees in the computation of capital gains. There have been several conflicting decisions of the Tribunal on the deductibility of portfolio management fees while computing the capital gains. While the Mumbai Bench has held in several cases that such portfolio management fees are not deductible, the Pune, Delhi and Kolkata Benches, and even some Mumbai Benches of the Tribunal, have held that such fees are an allowable deduction in the computation of capital gains.

DEVENDRA MOTILAL KOTHARI’S CASE
The issue first came up before the Mumbai Bench of the Tribunal in the case of Devendra Motilal Kothari vs. DCIT 132 ITD 173, a case relating to A.Y. 2004-05.

In this case, the assessee declared certain long-term capital gains (LTCG) and short-term capital gains (STCG) after setting off the long-term capital losses and short-term capital losses. In the course of assessment, the A.O. noticed that the assessee had added portfolio management fees of Rs. 85,63,233 to the purchase cost of the shares while computing the capital gains. According to the A.O., the fees paid by the assessee for portfolio management services were not a part of the purchase cost of the shares. He, therefore, asked the assessee to explain why these fees should not be disallowed while computing the capital gains. The assessee submitted that the fees and other charges formed part of the cost of purchase and / or expenditure incurred by him and therefore must be taken into account whilst determining the chargeable capital gain. The assessee claimed that such fees and other expenses incurred by him as an investor, including fees for managing the investments, constituted the cost of purchase and were allowable for the purpose of computing the STCG or LTCG.

The A.O. disallowed the claim of the assessee while computing the STCG and LTCG, holding that these did not form part of the cost of acquisition of the shares.

In the appeal before the Commissioner (Appeals), it was contended by the assessee that the portfolio management fees constituted the cost of purchase of shares and securities and therefore was allowable as deduction while computing the capital gains. It was also submitted that without payment of these fees, no investments could have been made by the assessee and the question of realisation of capital gains would not have arisen. Alternatively, it was also contended that the portfolio management fees paid could be allocated between the purchase and sale of shares for the purpose of computing capital gains.

The Commissioner (Appeals) requested the assessee to submit a working, allocating the portfolio management fees paid in connection with the purchase and sale of shares, and also in relation to the opening and closing stock of shares during the year under consideration. The assessee submitted that the management fees paid was an allowable expenditure for the purpose of computing capital gains. Alternatively, it was also submitted that these fees could be allocated on the basis of the values of opening stock, long-term purchases, short-term purchases, long-term capital sale, short-term capital sale and closing stock, and based on such allocation, deduction may be allowed while computing LTCG and STCG.

The Commissioner (Appeals) found, on the basis of two portfolio management agreements filed with him, that the quantification of the fees was based on either the market value of the assets or the net value of the assets of the assessee as held by him either at the beginning or at the end of each quarter. He held that the assessee could not explain as to how the fees paid to the portfolio managers on such explicit basis could be considered differently so as to constitute either the cost of acquisition of the assets or expenditure incurred for selling such assets. He noted in this context that nothing was furnished by the assessee to establish any such nexus.

He held that the quarterly payment of fees by the assessee to the portfolio manager had no nexus either with the acquisition of the assets or the transfer of specific assets. He also held that it was just not possible to break up the fees paid by the assessee to the portfolio manager so as to hold that the same was relatable to the expenditure incurred solely for the purchase or transfer of assets. The assessee was paying these fees to the portfolio managers even on the interest accrued to him and the dividend received and it was therefore not acceptable that these fees were exclusively paid for acquiring or selling of shares as claimed by the assessee. The disallowance made by the A.O. of the assessee’s claim for deduction of portfolio management fees while computing the capital gains was therefore confirmed by the Commissioner (Appeals).

Before the Tribunal, it was submitted on behalf of the assessee that he had entered into an Investment Management Agreement with four concerns for managing his investments and fees was paid to them for these services. These fees were paid for the advice given by the Investment Management Consultants for purchase and sale of particular shares and securities as well as for the advice given by them not to sell particular shares and securities. Thus, it was contended that the expenditure incurred on the payment of these fees was in connection with the acquisition / improvement of assets as well as in connection with the sale of assets. Therefore, the fees were deductible in computing the capital gains arising to the assessee from the sale of assets, i.e., shares and securities, as per the provisions of section 48.

Without prejudice to the contention that the portfolio management fees was deductible u/s 48 in computing capital gains and as an alternative, it was contended on behalf of the assessee that this expenditure was deductible even on the basis of Real Income Theory and the Rule of Diversion of Income by Overriding Title. It was contended that these fees were in the nature of a charge against the consideration received by the assessee on the sale of shares and securities, and therefore were deductible from the sale consideration, being Diversion of Income by Overriding Title.

It was argued on behalf of the Revenue that the relevant provisions in respect of computation of income from capital gains were very specific and the Real Income Theory could not be applied while computing the income from capital gains. It was submitted that portfolio management services were generally not required in the case of investment in shares and that was the reason why there was no provision for allowing deduction for portfolio management fees in the computation of capital gains. It was contended that the income can be taxed in generic terms applying the Real Income Theory, but this theory was not relevant for allowance of any deduction.

The Revenue further argued that the basis on which the portfolio management fees was paid by the assessee was such that there was no relationship with the purchase or sale of shares. Even without making any purchase or sale of shares and securities, the assessee was liable to pay a substantial sum as portfolio management fees.

The Tribunal noted that u/s 48 expenditure incurred wholly and exclusively in connection with transfer and the cost of acquisition of the asset and cost of any improvement thereto, were deductible from the full value of the consideration received or accruing to the assessee as a result of transfer of the capital assets. While the assessee had claimed a deduction in computing the capital gains, he had, however, failed to explain as to how the fees could be considered as cost of acquisition of the shares and securities or the cost of any improvement thereto. According to the Tribunal, the assessee had also failed to explain as to how the fees could be treated as expenditure incurred wholly and exclusively in connection with the sale of shares and securities.

On the other hand, the basis on which the fees were paid by the assessee showed that the fees had no direct nexus with the purchase and sale of shares, and the fees was payable by the assessee, going by the basis thereof, even without there being any purchase or sale of shares in a particular period. Also, when the Commissioner (Appeals) required the assessee to allocate the fees in relation to purchase and sale of shares as well as in relation to the shares held as investment on the last date of the previous year, the assessee could not furnish such details nor could he give any definite basis on which such allocation was possible.

The Tribunal concluded, therefore, that the fees paid by the assessee for portfolio management was not inextricably linked with the particular instance of purchase and sale of shares and securities so as to treat the same as expenditure incurred wholly and exclusively in connection with such sale, or the cost of acquisition / improvement of the shares and securities, so as to be eligible for deduction in computing capital gains u/s 48.

Even though the assessee was under an obligation to pay the fees for portfolio management, the mere existence of such an obligation to pay was not enough for the application of the Rule of Diversion of Income by an Overriding Title. The true test for applicability of the said rule was whether such obligation was in the nature of a charge on source, i.e., the profit-earning apparatus itself, and only in such cases where the source of earning income was charged by an overriding title it could be considered as Diversion of Income by an Overriding Title. The Tribunal noted that the profit arising from the sale of shares was received by the assessee directly, which constituted its income at the point when it reached or accrued to the assessee. The fee for portfolio management, on the other hand, was paid separately by the assessee to discharge his contractual liability. In the Tribunal’s view, it was thus a case of an obligation to apply income which had accrued or arisen to the assessee and it amounted to a mere application of income.

The Tribunal further held, following the Supreme Court decision in the case of CIT vs. Udayan Chinubhai 222 ITR 456, that the Theory of Real Income could not be applied to allow deduction to the assessee which was otherwise not permissible under the Income-tax Act. What was not permissible in law as deduction under any of the heads could not be allowed as a deduction on the principle of the Real Income Theory.

The Tribunal therefore dismissed the assessee’s appeal, holding that the portfolio management fees was not deductible in computing the capital gains.

This view of the Tribunal was followed in subsequent decisions of the Mumbai Bench of the Tribunal in the cases of Pradeep Kumar Harlalka vs. ACIT 143 TTJ 446 (Mum), Homi K. Bhabha vs. ITO 48 SOT 102 (Mum), Capt. Avinash Chander Batra vs. DCIT 158 ITD 604 (Mum), ACIT vs. Apurva Mahesh Shah 172 ITD 127 (Mum) and Mateen Pyarali Dholkia vs. DCIT (2018) 171 ITD 294 (Mum).

KRA HOLDING & TRADING (P) LTD.’S CASE
The issue again came up before the Pune Bench of the Tribunal in the case of KRA Holding & Trading (P) Ltd. vs. DCIT 46 SOT 19, in cases pertaining to A.Ys. 2002-03 and 2004-05 to 2006-07.

For A.Y. 2004-05, the assessee paid fees of Rs. 69,22,396 to a portfolio manager, consisting of termination fee of Rs. 59,15,574 and annual maintenance fee of Rs. 10,06,823. The capital gains on the sale of shares were disclosed net of such fees.

The A.O. disallowed such fees on the ground that the payment constituted ‘profit sharing fee’ paid to the portfolio manager and that the same was not authorised by or borne out of any agreement between the assessee and the portfolio manager or the SEBI (Portfolio Managers) Rules & Regulations, 1993.

Before the Commissioner (Appeals), the assessee submitted that the expenditure was incurred in connection with the acquisition of shares. Therefore, the expenditure was required to be capitalised as done by the assessee in the books of accounts. As per the assessee, this expenditure was part of the cost of acquisition of shares as there was a direct and proximate nexus between the fees paid to the portfolio manager and the process of acquisition of the securities and the sale of securities.

Without prejudice, the assessee argued that part of the fee was attributable to the act of selling of securities and, therefore, part of the fees could be said to be expenditure incurred wholly and exclusively in connection with the transfer. Further, it was argued that the fee was paid wholly and exclusively for acquiring and selling securities during the year under review. Therefore, the fees so paid should be loaded on the shares / securities purchased and sold during the year in the value proportion. In respect of the shares purchased during the year, the fees loaded would be the cost of acquisition and in respect of shares sold during the year the fees loaded would represent expenditure incurred wholly and exclusively in connection with the transfer.

The Commissioner (Appeals) dismissed the assessee’s appeal.

It was argued on behalf of the assessee before the Tribunal, that section 48 allowed deduction of any expenditure incurred wholly and exclusively in connection with transfer and this expenditure being an outflow to the assessee, should be loaded to the cost of the investments. It was claimed that what was taxable in the hands of the assessee was the actual income that reached the assessee and, therefore, the fees paid to the portfolio manager had to be deducted from the capital gains earned by the assessee.

Reliance was placed on behalf of the assessee on the jurisdictional High Court decision in the case of CIT vs. Smt. Shakuntala Kantilal 190 ITR 56 (Bom) for the proposition that when the genuineness and certainty and necessity of the payments was beyond doubt, and if it was only a case of absence of the enabling provisions in section 48, ‘such type of payments were deductible in two ways, one, by taking full value of consideration, i.e., net of such payments, or deducting the same as expenditure incurred wholly and exclusively in connection with the transfer.’ As per the High Court, the Legislature, while using the expression ‘full value of consideration’, has contemplated both additions as well as deductions from the apparent value. What it means is the real and effective consideration. The effective consideration is that after allowing the deductible expenditure. The expression ‘in connection with such transfer’ was certainly wider than the expression ‘for the transfer’. As per the High Court, any amount, the payment of which is absolutely necessary to effect the transfer, will be an expenditure covered by this clause.

On behalf of the Revenue it was contended that (i) the expenditure in question was directly unconnected with the securities in question and the same cannot be loaded to the cost of the acquisition; (ii) securities is a plural word, whereas the capital gains is calculated considering each capital asset on standalone basis, and for this there is need for identification of the asset-specific expenditure, be it for arriving at the cost of acquisition or for transfer-specific expenditure. Reliance was placed on the Mumbai Tribunal decision in Devendra Motilal Kothari (Supra).

In counter arguments, it was stated on behalf of the assessee that the Tribunal decision was distinguishable on facts. In that case, the assessee claimed the deduction which was calculated based on the global turnover reported by the portfolio manager, and where such turnover also included the dividend income, the basis was unscientific and unspecific, etc. Further, it was pointed out that the assessee in that case failed to discharge the onus of establishing the nexus that the fee paid to the portfolio manager was incurred wholly and exclusively in connection with the transfer of the assets; whereas, in the case being considered by the Pune Tribunal, the assessee not only demonstrated the direct nexus of the expenditure to the acquisition and sale / transfer of the securities successfully but also the fee in question was strictly on the NAV of the securities and not on the dividends or other miscellaneous income. It was claimed that the basis was totally and exclusively capital-value-oriented, consistently followed by the assessee and it constituted an acceptable basis. It was argued that when the expenditure of fee paid to the portfolio manager was genuine and an allowable claim, the claim must be allowed under the provisions of section 48.

The Tribunal observed that the scope of section 48 as per the binding judgment of the High Court in Shakuntala Kantilal (Supra) was that the claim of bona fide or genuine expenditure should be allowable in favour of the assessee so long as the incurring of the expenditure was a matter of fact and the necessity of making such a payment was the imminent requirement for the transfer of the asset. According to the Tribunal, it was now binding on its part to take the view that the expression ‘in connection with’ had wider meaning than the expression ‘for the transfer’.

The Tribunal observed that for allowing the claim of deduction in the computation of the capital gains, the expenditure had to be distinctly and intricately linked to the asset and its transfer. The onus was on the assessee to demonstrate the said linkage between the expenditure and the asset’s transfer. It was evident and binding that if the expenditure was undisputedly, necessarily and genuinely spent for the asset’s transfer within the scope of the provisions of section 48, the claim could not be disallowed for want of an express provision in section 48.

The Tribunal noted the following facts:
(i) the assessee made the payment of fee to the portfolio manager and the genuineness of the said payment was undisputed;
(ii) the Revenue authorities had also not disputed the requirement or necessity of the said payments;
(iii) quantitatively speaking, in view of the adverbial expression ‘wholly’ used in section 48(i), the payment of fee @ 5% was only restricted to the NAV of the securities and not the global turnover, including the other income;
(iv) regarding the purpose of payment in view of the adverbial expression, ‘exclusively’ used in section 48(i), the same was intended only for the twin purposes of the acquisition of the securities and for the sale of the same;
(v) the NAV was defined as the ‘net asset value of the securities of the client’ and the assessee calculated the fee linked to the securities’ value only and not including other income, such as interest or dividend, etc.

The Tribunal was of the opinion that:
(i) the expenditure was directly connected to the asset and its transfer;
(ii) it was genuinely incurred as accepted by the Revenue;
(iii) it was a bona fide payment made as per the norms of the ‘arm’s length principle’ since the portfolio manager and the assessee were unrelated;
(iv) the necessity of incurring of expenditure was imminent and it was in the normal course of the investment activity;
(v) the provisions of section 48 had to be read down in view of the ratio in the case of Shakuntala Kantilal (Supra) to accommodate the claim of such expenditure legally.

According to the Tribunal, the expression ‘in connection with such transfer’ enjoyed much wider meaning and, therefore, the fee paid to the portfolio manager had to be construed to have been expended for the purposes of acquisition and transfer of the investment of the securities. The Tribunal was of the view that the expression ‘transfer’ involved various sub-components and the first sub-component must be of purchase and possession of the securities. Unless the assessee was in possession of the asset, he could not transfer the same. Therefore, the expression ‘expenditure’ incurred wholly and exclusively in connection with ‘such transfer’ read with ‘as a result of the transfer of the capital asset’ mentioned in section 48 and 48(i) must necessarily encompass the transfer involved at the stage of acquisition of the securities till the stage of transfer involved in the step of sale of the impugned securities. Such an interpretation of section 48 of the Act was a necessity to avoid the likely absurdity.

The Tribunal therefore held that the expenditure was allowable u/s 48.

The view taken by the Pune Bench of the Tribunal in this case has been followed by the Pune and other Benches of the Tribunal in the cases of DCIT vs. KRA Holding & Trading (P) Ltd. 54 SOT 493 (Pune), Serum International Ltd. vs. Addl. CIT [IT Appeal No. 1576/PN/2012 and 1617/PN/2012, dated 18th February, 2015], RDA Holding & Trading (P) Ltd. vs. Addl. CIT [IT Appeal No. 2166/PN/2013 dated 29th October, 2014], Hero Motocorp Ltd. vs. DCIT [ITA No. 6282/Del/2015 dated 13th January, 2021], Amrit Diamond Trade Centre Pvt. Ltd. vs. ACIT [ITA No. 2642/Mum/2013 dated 15th January, 2016], Shyam Sunder Duggal HUF vs. ACIT [ITA No. 2998/Mum/2011 dated 22nd February, 2019] and Joy Beauty Care (P) Ltd. vs. DCIT [ITA No. 856/Kol/2017 dated 5th September, 2018].

OBSERVATIONS
A portfolio manager’s services, his fees and many related aspects are governed by the SEBI (Portfolio Managers) Regulations, 2000. Services include taking investment decisions on behalf of the client that can largely be classified into three parts:
a. identifying the scrip and the time and value of purchase,
b. decision as to retention of an investment, and
c. identifying the scrip and the time and price for exit.

The services do not include brokerage. Fees, though composite, are payable for performing the above-listed functions. The Regulations require the portfolio manager to share the manner of charging the fees and, importantly, for each service rendered to the client in the agreement. These fees are annually charged on the basis of the value of the portfolio or any other agreeable basis. In addition, though not always, fees are charged by sharing a part of the profit that accrues to the client.

In the context of section 48 of the Income-tax Act, the part of the fees attributable to the advisory services leading to the purchase should qualify to be included in the cost of acquisition and the other part of the fees attributable to the advisory services leading to the sale of the scrip should qualify to be included in the expenses incurred for the transfer. Unless otherwise stated in section 48, deduction of these parts of the fees should not be resisted. At the most, there could be a need to scientifically identify the parts of the fees attributable to these activities and allocate the parts rationally. Paying a lump sum or a composite fee should not be a ground for its blanket disallowance, nor should the manner of such payment take away the fact that the major part of the fees is paid for advising or deciding on various components of the purchase and sale of the scrip. No one pays the fees to a portfolio manager only for advice to retain the investment, though that part is relevant, but it is not a deciding factor for seeking the services of the portfolio manager. Besides, the advice to continue to retain a scrip is intended to fetch a better price realisation for the scrip and such advice should therefore also be construed as advice in relation to the sale of the investment.

Even otherwise, this should not discourage the claim for its allowance once it is accepted that the fees are paid mainly for advice on purchase and sales of investment; in the absence of a provision similar to section 14A, no part of an indivisible expenditure can be disallowed.

The issue in case of composite charges should not be whether it is allowable or not, at the most it could be how much out of the total is allowable. Even the answer here should be that no part of it could be disallowable where no provision for its segregation exists in the Act. [Maharashtra Sugars Ltd. 82 ITR 452(SC) and Rajasthan State Warehousing Corporation Ltd. 242 ITR 450(SC).]

As regards the fees representing the sharing of profit, we are of the considered opinion that such part is diverted at source under a contract which is not an agreement for partnership and surely is for payment for services offered.

The lead dissenting decision in the case of Devendra Motilal Kothari (Supra) was delivered against the claim for allowance, largely on account of the inability of the assessee to provide the basis for allocation of expenses on rational basis. This part is made clear by the Tribunal in its decision, making it clear that the expenditure could have been allowed in cases where the allocation was made available.

The other reason for dissenting with the decision of the Pune Bench in the KRA Investment case (Supra) was that the Bench had followed the Bombay High Court decision in Shakuntala Kantilal (Supra ) which, as noted in Pradeep Harlalka’s case (Supra), was overruled by the same Court in its later decision in Roshanbanu’s case (Supra). With great respect, without appreciating the facts in both the cases and, importantly, the part that had been overruled, it was incorrect on the part of the Mumbai Bench to proceed to disallow a legitimate claim simply because the decision referred to or even relied on was overruled. The reasons and rationale provided by the Court and borrowed by the Pune Bench for allowance of the expenditure could not have been ignored simply by stating that the decision relied upon by the Bench was overruled.

The Pune Bench of the Tribunal in KRA Holding & Trading’s case (Supra), placed substantial reliance on the Bombay High Court decision in the case of Shakuntala Kantilal (Supra) while deciding the matter. In Pradeep Kumar Harlalka’s case (Supra), the Tribunal noted that in the case of CIT vs. Roshanbanu Mohammed Hussein Merchant 275 ITR 231 (Bom), the Bombay High Court had observed that the decision in the case of Shakuntala Kantilal (Supra) was no longer good law in the light of subsequent Supreme Court decisions in the cases of R.M. Arunachalam vs. CIT 227 ITR 222, VSMT Jagdishchandran vs. CIT 227 ITR 240 and CIT vs. Attili N. Rao 252 ITR 880. All these decisions were rendered in the context of deductibility of mortgage debt and estate duty u/s 48 as expenditure incurred for transfer of the property.

Had the Bench looked into the facts of both the court cases and the conclusions arrived at therein, it could have appreciated that it was only a part of the decision, unrelated to the allowance of the expenditure of the PMS kind that was overruled.

It’s important to note that the following relevant part of the Shakuntala Kantilal decision continues to be valid:
‘The Legislature while using the expression “full value of consideration”, in our view, has contemplated both additions to as well as deductions from the apparent value. What it means is the real and effective consideration. That apart, so far as (i) of section 48 is concerned, we find that the expression used by the Legislature in its wisdom is wider than the expression “for the transfer”. The expression used is “the expenditure incurred wholly and exclusively in connection with such transfer”. The expression “in connection with such transfer” is, in our view, certainly wider than the expression “for the transfer”. Here again, we are of the view that any amount the payment of which is absolutely necessary to effect the transfer will be an expenditure covered by this clause. In other words, if without removing any encumbrance including the encumbrance of the type involved in this case, sale or transfer could not be effected, the amount paid for removing that encumbrance will fall under clause (i). Accordingly, we agree with the Tribunal that the sale consideration requires to be reduced by the amount of compensation.’

These parts of the decision are not overruled by the decision of the Supreme Court. With due respect to the Bench of the Tribunal that held that the expenditure on fees was not allowable simply because the decision of one court was found, in the context of the facts, to be not laying down the good law, requires reconsideration. The fact that the many parts of the decision continued to be relevant could not have been ignored. It is these parts that should have been examined by the Tribunal to decide the case for allowance or, in the alternative, it should have independently adjudicated the issue without being influenced by the observation of the Apex Court made in the context of the facts in the case before it.

In Shakuntala Kantilal, the Bombay High Court examined the meaning of the terms ‘full value of consideration’ (to mean the real and effective consideration, including both additions to and deductions from the apparent value), and ‘expenditure incurred wholly and exclusively in connection with such transfer’ (to mean any amount the payment of which is absolutely necessary to effect the transfer), in deciding the matter regarding deductibility of compensation paid to previous intending buyer of the property.

In R.M. Arunachalam’s case (Supra), the Supreme Court examined the deductibility of estate duty paid as cost of improvement of the inherited asset. In this decision, the Supreme Court did not examine any issue relating to full value of consideration, cost of acquisition or expenses in connection with transfer at all. The Court specifically refused to answer the question regarding diversion of income by overriding title, which involved the question whether apart from the deductions permissible under the express provision contained in section 48, deduction on account of diversion was permissible, since the issue had not been raised before the Tribunal or the High Court.

In V.S.M.R. Jagdishchandran’s case (Supra), the Supreme Court considered whether the discharge of a mortgage debt created by the owner himself amounted to cost of acquisition of the property deductible u/s 48. The Court in this case did not examine the issue regarding full value of consideration or expenditure in connection with transfer. In Attili N. Rao’s case (Supra), the assessee’s property had been mortgaged with the Excise Department for payment of kist dues, the property was auctioned by the Government and the proceeds, net of the kist dues, was paid to the assessee. In this case, two of the questions before the Supreme Court were whether the charge was to be deducted in computing the full value of consideration, or could it be regarded as an expenditure incurred towards the cost of acquisition of the capital asset. The Supreme Court did not answer these questions while holding that the gross realisation was to be considered for computation of capital gains.

The Supreme Court, therefore, does not seem to have specifically overruled the Bombay High Court decision in the case of Shakuntala Kantilal (Supra), specifically those aspects dealing with the expenses in connection with the transfer.

On the other hand, in a subsequent decision in Kaushalya Devi vs. CIT 404 ITR 536, the Delhi High Court had an occasion to examine a situation identical to that prevailing in the Shakuntala Kantilal case. While holding that the payment of liquidated damages to the previous intending purchaser was an expenditure incurred wholly and exclusively in connection with the transfer, the Delhi High Court observed that,

…the words ‘wholly and exclusively’ used in section 48 are also to be found in section 37 of the Act and relate to the nature and character of the expenditure, which in the case of section 48 must have connection, i.e., proximate and perceptible nexus and link with the transfer resulting in income by way of capital gain. The word ‘wholly’ refers to the quantum of expenditure and the word ‘exclusively’ refers to the motive, objective and purpose of the expenditure. These two words give jurisdiction to the taxing authority to decide whether the expenditure was incurred in connection with the transfer. The expression ‘wholly and exclusively’, however, does not mean and indicate that there must exist a necessity or compulsion to incur an expense before an expenditure is to be allowed. The word ‘connection’ in section 48(i) reflects that there should be a causal connect and the expenditure incurred to be allowed as a deduction must be united, or in the state of being united with the transfer, resulting in income by way of capital gains on which tax has to be paid. The expenditure, therefore, should have direct concern and should not be remote or have an indirect result or connect with the transfer. A practical and pragmatic view in the circumstances should be taken to tax the real income, i.e., the gain.

The Delhi High Court further observed that: ‘the words “wholly and exclusively” require and mandate that the expenditure should be genuine and the expression “in connection with the transfer” require and mandate that the expenditure should be connected and for the purpose of transfer. Expenditure, which is not genuine or sham, is not to be allowed as a deduction. This, however, does not mean that the authorities, Tribunal or the Court can go into the question of subjective commercial expediency or apply subjective standard of reasonableness to disallow the expenditure on the ground that it should not have been incurred or was unreasonably large. In the absence of any statutory provision on these aspects, discretion exercised by the assessee who has incurred the said expenditure must be respected, for interference on subjective basis will lead to unpalatable and absurd results. As in the case of section 37 of the Act, jurisdiction of the authorities, Tribunal or Court is confined to investigate and decide as to whether the expenditure was actually incurred, i.e., the expenditure was genuine and was factually expended and paid to the third party’.

If one applies this ratio to the deductibility of portfolio management charges in computing capital gains, the portfolio manager is paid for the services of advising on what shares to buy and when to buy and sell the shares, and of carrying out the transactions. To the extent that the services are rendered in connection with the purchase of the shares, the fees constitute part of the cost of acquisition of the shares, and to the extent that the fees relate to the sale of shares, the fees are expenses incurred wholly and exclusively for the transfer of the shares. In either situation, the fees should clearly be deductible in computing the capital gains, as held by the Pune Bench of the Tribunal.

If one analyses the facts of the cases as well, it can be clearly observed that the decision in Devendra Motilal Kothari’s case was to a great extent influenced by the fact that the assessee was unable to apportion the fee between the purchases, sales and the closing stock on a rational basis, whereas in KRA Holding & Trading’s case, the assessee was able to demonstrate such bifurcation on a reasonable basis. Therefore, if a rational allocation of the fees is carried out, there is no reason as to why such fees should not be allowed as a deduction, either as cost of acquisition or as expenses in connection with the transfer.

It may also be noted that as observed by the Tribunal in Joy Beauty Centre’s case (Supra), the Department had filed an appeal in the Bombay High Court against the Pune Tribunal’s decision in the case of KRA Holding & Trading (Supra). The appeal has been admitted by the Bombay High Court only on the question of whether the income was in the nature of business income or capital gains. Therefore, the Pune Tribunal’s decision in respect of allowability of portfolio management fees has attained finality.

There is no dispute that the objective behind the hiring of the portfolio manager’s services is to seek advice on purchase and sale of scrips, which expenses, without much suspicion, are allowable in computing the capital gains.

It would be inequitable to disallow a genuine expenditure incurred for earning a taxable income on the pretext that no express and specific provision for its allowance exists in the Act. In our opinion, the existing provisions of section 48 are wide enough to support the deduction of the fees.

Any attempt to isolate a part of the expenditure for disallowance should be avoided on the grounds of the composite expenditure and the expense in any case representing either the cost of acquisition or an expense in connection with the transfer.

As clarified by the Tribunal in the KRA Holding’s case, where the assessee demonstrated the direct nexus of the expenditure to the acquisition and sale / transfer of the securities successfully, and also the fee in question was strictly on the NAV of the securities and not on the dividends or other miscellaneous income, such fee should be allowable in computing the capital gains.

The better view of the matter, therefore, seems to be that portfolio management fees are deductible in computing the capital gains, as held by the Pune, Delhi, Kolkata and some Mumbai Benches of the Tribunal.

shailesh.kwebmaker

DEDUCTION FOR CONTRIBUTION BY EMPLOYER TO SPECIFIED FUNDS – SECTION 40A(9)

ISSUE FOR CONSIDERATION

For an employer, staff welfare expense is normally an allowable business deduction under section 36 or 37 in computing his income under the head ‘Profits and Gains of Business or Profession’. However, the allowability of business deductions is restricted by the provisions of section 40A. Section 40A(9), inserted by the Finance Act, 1984 with retrospective effect from 1st April, 1980, provides that no deduction shall be allowed in respect of any sum paid by the assessee as an employer towards the setting up or formation of, or as contribution to, any fund, trust, company, AOP, BOI, society or other institution for any purpose. Exceptions are provided, for permitting deductions, for payment of contributions to specified funds being recognised provident fund, approved superannuation fund, approved gratuity fund and towards a pension scheme referred to in section 80CCD [i.e., sums paid for the purposes and to the extent provided by or under clauses (iv), (iva) or (v) of section 36(1)], or for payments required by or under any other law.

The issue has come up before the High Courts as to whether all contributions to funds, other than those specified, are hit by the embargo of section 40A(9) leading to disallowance of expenditure, or whether the provisions for disallowance apply only to funds which merely accumulate and do not spend such contributions on staff welfare. While the Kerala High Court has taken the view that in terms of section 40A(9) the payment of contributions would be disallowed where the contribution is to a fund other than the specified funds, the Bombay and Karnataka High Courts have taken a more liberal view, holding that the prohibition does not apply to contributions to genuine funds and the deduction would be allowed irrespective of section 40A.

ASPINWALL & CO.’S CASE

The issue had come up before the Kerala High Court in the case of Aspinwall and Co. Ltd. vs. DCIT 295 ITR 533.

In this case, pertaining to assessment years 1990-91, 1991-92 and another year post assessment year 1980-81, the assessee had made a contribution to the Executive Staff Provident Fund, which was not a recognised provident fund, and claimed a deduction for such contribution. Such contribution had been allowed to it as a deduction u/s 37 for A.Y. 1979-80 by the Kerala High Court vide its decision reported in 194 ITR 739, and also for A.Y. 1977-78 by the Kerala High Court in a decision reported in 204 ITR 225 u/s 36(1)(iv), following its own earlier decision. The A.O. had disallowed such contribution.

The assessee contended before the Kerala High Court that in view of the decisions of the High Court in the earlier years in its own cases, it was entitled to get deduction for the amount paid to the unrecognised provident fund u/s 36(1)(iv) or (v), or in the alternative u/s 37. On behalf of the Revenue, it was contended that the earlier decisions of the Kerala High Court would not apply to the assessment years in question in view of the insertion of sub-section (9) to section 40A with retrospective effect from 1st April, 1980.

The Kerala High Court analysed the provisions of section 40A(9) to hold that after the insertion of sub-section (9), no deduction be allowed in respect of any sum paid by the assessee as an employer towards contribution to a provident fund, except where such amount was paid for the contribution to a recognised provident fund and for the purposes of and to the extent provided by or u/s 36(1)(iv). The High Court noted that section 37(1) was a general provision which stated that any expenditure, other than 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, was to be allowed in computing the income chargeable under the head ‘profits and gains of business or profession’. According to the High Court, in view of the provisions of section 40A(9), no deduction could be allowed in respect of any sum paid towards contribution to a provident fund by taking recourse to the residuary section 37(1).

The Kerala High Court analysed the Explanatory Notes to the Finance Act, 1984 in relation to section 40A(9) to hold that the intention of the Legislature was to deny the deduction in respect of sums paid by the assessee as employer towards contribution to any fund, trust, company, etc., for any purposes, except to a recognised fund and that, too, within the limits laid down under the relevant provisions. Placing reliance on the decision of the Supreme Court in Shri Sajjan Mills Ltd. vs. CIT 156 ITR 585, where the Supreme Court had held that unless the conditions laid down in section 40A(7) were fulfilled, a deduction could not be allowed on general principles under any other provisions of the Act relating to computation of income under the head ‘profits and gains of business or profession’, the Kerala High Court held that section 40A had to be given effect to, notwithstanding anything contained in sections 30 to 39 of the Act, and
in view of that no deduction could be allowed in respect of any contribution towards an unrecognised provident fund.

The Kerala High Court noted that the deduction u/s 36(1)(iv) was subject to the prescribed limits, which limits had been laid down in Rules 75, 87 and 88 of the Income Tax Rules, 1962. Section 40A(9) referred to the purposes and the extent provided by or u/s 36(1)(iv), and therefore only such amounts, within the prescribed limits, could be allowed as a deduction.

The Kerala High Court, therefore, held that no deduction could be allowed u/s 37(1) in respect of contribution to the unrecognised provident fund, having regard to the provisions of section 40A(9).

This decision of the Kerala High Court was followed again by the Kerala High Court in the case of TCM Ltd. vs. CIT 196 Taxman 129 (Ker), where the issue related to the deduction for a contribution to an Employees’ Welfare Fund.

STATE BANK OF INDIA’S CASE

The issue came up again recently before the Bombay High Court in the case of Pr. CIT vs. State Bank of India 420 ITR 376.

In this case, the assessee claimed expenditure of Rs. 50 lakhs incurred towards contribution to a fund created for the welfare of its retired employees. The A.O. disallowed such expenditure, invoking the provisions of section 40A(9).

The Tribunal allowed the assessee’s claim, observing that the assessee had made such contribution to a fund for the medical benefits specially envisaged for the retired employees of the bank. In the opinion of the Tribunal, section 40A(9) was inserted to discourage the practice of creation of bogus funds and not to disallow the general expenditure incurred for welfare of the employees. The Tribunal also noted that the A.O. had not doubted the bona fides of the assessee in creation of the fund, and that such fund was not controlled by the assessee. Proceeding on the basis that the A.O. and the Commissioner (Appeals) had not doubted the bona fides in creation of the trust and that the expenditure was incurred wholly and exclusively for the employees, the Tribunal allowed the assessee’s appeal and deleted the disallowance.

The Bombay High Court, on appeal by the Revenue, analysed the provisions of section 40A(9) to hold that the case of the assessee did not fall in any of the clauses of section 36(1) mentioned in section 40A(9), i.e., clauses (iv), (iva) or (v). It referred to the provisions of the Explanatory Memorandum and the Notes to the Finance Act, 1984 when section 40A(9) was introduced to hold that the purpose of inserting sub-section (9) in section 40A was not to discourage the general expenditure by an employer for the welfare activities of the employees. The Bombay High Court was of the view that the purpose of insertion of section 40A(9) was to restrict the claim of expenditure by the employers towards contribution to funds, trust, association of persons, etc., which were wholly discretionary and which did not impose any restriction or condition for expending such funds, which had possibility of misdirecting or misuse of such funds after the employer claimed benefit of deduction thereof. Basically, according to the Bombay High Court, the inserted provision was not meant to hit the allowance of the general expenditure by an employer for the welfare and the benefit of the employees.

The Court placed reliance on its earlier decisions in the cases of CIT vs. Bharat Petroleum Corporation Ltd. 252 ITR 43 where a donation to a club created for social, cultural and recreational activities of its members was allowed, by holding the expenditure to be on staff welfare activity; CIT vs. Indian Petrochemicals Corporation Ltd. 261 Taxman 251, where contributions to various clubs and facilities meant for use by staff and their family members were held allowable; and Pr. CIT vs. Indian Oil Corporation, ITA No. 1765 of 2016, where expenditure on setting up or providing grant-in-aid to Kendriya Vidyalaya Schools where children of staff of the assessee would receive education, was held to be allowable as a deduction.

The Bombay High Court in the case was not asked to examine or consider the ratio of the decision of the Kerala High Court in the case of Aspinwall Ltd. (Supra) and the said decision remains to be dissented with. In fact, the Court relied on another decision of the Kerala High Court in the case of PCIT vs. Travancore Cochin Chemicals Ltd. 243 ITR 284 to support its action to allow the deduction. It held that the contribution to a fund for the healthcare of retired employees was an allowable deduction and was not disallowable u/s 40A(9).

A similar view was also taken by the Karnataka High Court in the case of CIT vs. Motor Industries Co. Ltd. 226 Taxman 41, where the Court held that the contribution made by the assessee towards a benevolent fund created for the benefit of its employees was entitled to deduction, notwithstanding section 40A(9), though there was no compulsion under any other law for making such contribution. The Karnataka High Court relied on its earlier decision in the case of the same assessee, in ITA 3 of 2002 dated 2nd November, 2007. Such contribution was made pursuant to a Memorandum of Understanding embodying the terms of a settlement arrived at between the management and employees of the company.

OBSERVATIONS

It is interesting to note that both the Kerala as well as the Bombay High Courts relied on the same Explanatory Memorandum to the Finance Act, 1984 explaining the rationale behind introduction of sub-section (9) in section 40A, for arriving at diametrically opposite conclusions. The Explanatory Notes read as under:

‘(ix) Imposition of restrictions on contributions by employers to non-statutory funds.
16.1 Sums contributed by an employer to a recognised provident fund, an approved superannuation fund and an approved gratuity fund are deducted in computing his taxable profits. Expenditure actually incurred on the welfare of employees is also allowed as deduction. Instances have come to notice where certain employers have created irrevocable trusts, ostensibly for the welfare of employees, and transferred to such trusts substantial amounts by way of contribution. Some of these trusts have been set up as discretionary trusts with absolute discretion to the trustees to utilise the trust property in such manner as they may think fit for the benefit of the employees without any scheme or safeguards for the proper disbursement of these funds. Investment of trust funds has also been left to the complete discretion of the trustees. Such trusts are, therefore, intended to be used as a vehicle for tax avoidance by claiming deduction in respect of such contributions, which may even flow back to the employer in the form of deposits or investment in shares, etc.
16.2 With a view to discouraging creation of such trusts, funds, companies, association of persons, societies, etc., the Finance Act has provided that no deduction shall be allowed in the computation of taxable profits in respect of any sums paid by the assessee as an employer towards the setting up or formation of or as contribution to any fund, trust, company, association of persons, body of individuals, or society or any other institution for any purpose, except where such sum is paid or contributed (within the limits laid down under the relevant provisions) to a recognised provident fund or an approved gratuity fund or an approved superannuation fund or for the purposes of and to the extent required by or under any other law.
16.3 With a view to avoiding litigation regarding the allowability of claims for deduction in respect of contributions made in recent years to such trusts, etc., the amendment has been made retrospectively from 1st April, 1980. However, in order to avoid hardship in cases where such trusts, funds, etc., had, before 1st March, 1984, bona fide incurred expenditure (not being in the nature of capital expenditure) wholly and exclusively for the welfare of the employees of the assessee out of the sums contributed by him, such expenditure will be allowed as deduction in computing the taxable profits of the assessee in respect of the relevant accounting year in which such expenditure has been so incurred, as if such expenditure had been incurred by the assessee. The effect of the underlined words will be that the deduction under this provision would be subject to the other provisions of the Act, as for instance, section 40A(5), which would operate to the same extent as they would have operated had such expenditure been incurred by the assessee directly. Deduction under this provision will be allowed only if no deduction has been allowed to the assessee in an earlier year in respect of the sum contributed by him to such trust, fund, etc.’

The Kerala High Court interpreted the Memorandum to mean that the intention of the Legislature was to deny the deduction in respect of the sums paid by the assessee to all funds, trusts, AOPs, etc., other than those specified in section 36(1)(iv), (iva) and (v), while the Bombay High Court understood it to mean that the inserted provision applied only to trusts which were discretionary, with possibility of misdirection or misuse of such contributions, and not applicable to any genuine expenditure.

The intention of the Legislature behind the amendment may be gathered from paragraph 16.1 of the Explanatory Notes, where the types of cases of misuse sought to be plugged have been set out. The amendment is intended to apply in cases where the employer had discretion in utilisation of funds and in investment of funds without any safeguards, and which could be used as tools of tax avoidance by claiming deduction in respect of such contributions, which could flow back to the employer in the form of deposits or investment in shares, etc. It was certainly not intended to apply to genuine staff welfare trusts, where the amount of contributions was expended on staff welfare, where the contribution was really in the nature of staff welfare expenses. Clearly, the amendment was not targeted to curtail the allowance of staff welfare expenditure but only to curb misuse of claim for deduction of a payment disguised as staff welfare expenditure, of amounts not intended to be spent on staff welfare expenditure.

The Kerala High Court itself, in CIT vs. Travancore Cochin Chemicals Ltd. 243 ITR 284, while considering a payment towards proportionate share of expenses of assessee for running of a school wherein children of the assessee’s employees were studying, had held that such expenditure was expenditure for the smooth functioning of the business of the assessee and also expenditure wholly and exclusively for the welfare of the employees of the assessee and, thus, allowable.

In Sandur Manganese & Iron Ores Ltd. vs. CIT 349 ITR 386, the Supreme Court had occasion to examine the provisions of section 40A(9) and their applicability to payments made to schools claimed as welfare expenses towards providing education to its employees’ children. The Tribunal and High Court had concluded that those payments made by the assessee constituted ‘reimbursement’ to schools promoted by the assessee, and accordingly had upheld the disallowance. The Supreme Court on appeal observed that section 40A(9) of the Act was inserted as a measure for combating tax avoidance. Noting that the A.O. had observed that certain payments had been made to educational institutions other than those promoted by the assessee, in view of these facts, the Supreme Court further directed the ITAT to record a separate finding as to whether the claim for deduction was being made for payments to the school promoted by the assessee or to some other educational institutions / schools and thereafter apply section 40A(9). The action of the Court indicates that the expenditure where incurred for payments to funds, etc., not promoted by the assessee, were to be separately considered.

In Kennametal India Ltd. vs. CIT 350 ITR 209 (SC), the Tribunal had held that the amount paid by a company towards employees’ welfare trust had been reimbursed. The Supreme Court on appeal held that there was a difference between the reimbursement and contribution; the assessee could make a claim for deduction in case of the reimbursement, if the quantified amount was certified by the Chartered Accountant of the assessee. This decision supports the case for allowance of the expenditure on payment by way of reimbursement.

Having noted the above, it is possible for the Government to contend that the language of section 40A(9) is fairly clear and not ambiguous and may not permit the luxury of interpreting the provision by examining the intent behind the insertion of the provision. In simple words, it prohibits the allowance of all those payments specified therein, unless the same are covered by the provisions of section 36(1), clauses (iv), (iva) and (v). At the same time, it has to be appreciated that there is nothing in the language that provides for the disallowance of expenditure, including the reimbursement thereof, which is wholly and exclusively incurred for the purposes of the business. In cases where the contribution can be shown to be expenditure of such a nature, in our considered opinion, there can be no disallowance.

Again, the allowance of expenditure or payment would, to a large extent, depend upon the factual position relating to the contribution, its size, its objective and the composition of the recipient fund / trust. A distinction can be drawn between cases where:
1. the trusts are controlled by the employer, provisions of section 40A(9) may apply;
2. the contributions by the employer are of large amounts intended to remain invested by the trust and where the trustees have the discretion to invest the funds with the employer, the provisions of section 40A(9) may apply;
3. the contributions by the employer are to meet the annual staff welfare expenditure incurred by the trust, provisions of section 40A(9) may not apply;
4. the expenditure is in the nature of staff welfare or reimbursement thereof, the provisions of section 40A(9) should not apply.

The better view of the matter seems to be that the provisions relating to disallowance would not apply to genuine staff welfare expenditure or reimbursement thereof, even though routed through funds, trusts, AOPs, etc.

shailesh.kwebmaker

BUSINESS INCOME OF A CHARITABLE INSTITUTION

ISSUE FOR CONSIDERATION

Section 11 of the Income-tax Act confers exemption from tax in respect of an income derived from ‘property held under trust’, in the circumstances specified in clauses (a) to (c) of section 11(1), to a charitable institution or a trust or such other person registered u/s12A of the Act.

Section 11(4) provides that a ‘property held under trust’ includes a business undertaking held in trust and the income from such business, subject to the power of the A.O., shall not be included in the total income of the institution.

Sub-section (4A) provides for the denial of the benefit of tax exemption u/s 11(1) and prohibits the application of sub-sections (2), (3) and (3A) in relation to any income being profits and gains of business, unless the business is incidental to the attainment of the main objectives of the trust and separate books of accounts are maintained for the business.

The ‘property held under trust’ is required to be held for the charitable or religious purposes for its income to qualify for exemption from taxation. The term ‘charitable purpose’ is defined by section 2(15) and includes relief of the poor, education, yoga, medical relief, preservation of environment and of monuments or places or objects of artistic or historic interest, and the advancement of any other object of general public utility. A proviso to section 2(15) stipulates some stringent conditions in respect of an institution whose object is the advancement of general public utility, where it is carrying on any business to advance its objects. The said proviso does not apply to institutions whose objects are other than those of advancing general public utility, provided their objects otherwise qualify to be treated as charitable purposes.

The sum and substance of the aforesaid provisions, in relation to business carried out by an institution, is that a business run by it would be construed as a ‘property held under trust’ and its income, subject to the proviso to section 2(15), would be exempt from tax u/s 11. The conditions prescribed u/s (4A), where applicable, would require the business to be incidental to the attainment of the objectives of the trust and separate books of accounts would have to be maintained in respect of the business by the institution.

Some interesting controversies have arisen around the true meaning and understanding of the terms ‘property held under trust’ and ‘incidental to the attainment of the objectives of the trust’ and in relation to the applicability of sub-section (4A) to cases where provisions of sub-section (4) are applicable. The Delhi High Court has held that a business carried on with borrowed funds and unrelated to the objects of the trust could not be held to be a ‘property held under trust’. It has also held that for a business to be incidental to the attainment of the objects of the trust, its activities should be intricately related to its objects. It also held that the provisions of sub-section (4A) and sub-section (4) cannot apply simultaneously. As against the above decision, the Madras High Court has held that a business carried on by the trust is a ‘property held under trust’ and such business would be construed to be incidental to the attainment of the objectives of the trust where the profits of such business are utilised for meeting the objects of the trust and, of course, separate books of accounts are maintained by the trust.

Some of these issues have a chequered history and were the subject matter of many Supreme Court decisions, including in the cases of J.K. Trust, 32 ITR 535; Surat Art Silk Cloth Manufacturers Association, 121 ITR 1; and Thanthi Trust, 247 ITR 785. Besides the above, the Supreme Court had occasion to examine the meaning of the term ‘not involving the carrying out of any activity of profit’ and the concept of business held in trust in the cases of CIT vs. Dharmodayam Co., 109 ITR 527 (SC); Dharmaposhanam Co. vs. CIT, 114 ITR 463 (SC); and Dharmadeepti vs. CIT, 114 ITR 454 (SC).

MEHTA CHARITABLE PRAJNALAY TRUST’S CASE

The issue came up for consideration in the case of CIT vs. Mehta Charitable Prajnalay Trust, 357 ITR 560 before the Delhi High Court. The assessment years involved therein were 1992-93 to 1994-95; 2001-02; and 2005-06 to 2007-08. The trust was constituted in the year 1971 for promotion of education, patriotism, Indian culture and running of dispensaries and hospitals and many other related charitable objects with a donation of Rs. 2,100. Besides pursuing the above objects, the trust commenced Katha manufacturing business in the year 1972 with the aid and assistance of borrowings from banks and sister concerns in which the settlors, trustees or their relatives had substantial interest. At some point of time, the Katha manufacturing unit was leased to a related concern on receipt of lease rent. The trust made purchases and sales from its head office through the two related concerns.

The exemption u/s 11 claimed by the trust was denied by the A.O. for some of the years and such denial was confirmed by the CIT(A) on the ground that the Katha business was carried on by the trustees and not by the beneficiaries of the trust, as was required by the then applicable section 11(4A), and the exemption was not available to the trust in respect of the profits of the Katha business. In respect of some other years, the CIT(A) held that the business was held under trust and was covered by section 11(4) of the Act and on application of the said section, the provisions of sections 11(4A) were not applicable and therefore the trust was entitled for the exemption. For the years under consideration, the A.O. denied the exemption for the same reasons, besides holding that carrying on of the Katha business was not incidental to the attainment of the objects of the trust. The orders of the A.O. for those years were sustained by the CIT(A) for reasons different from those of the A.O.

On appeal, the Tribunal, following its decision for the A.Y. 1989-90, held that the Katha business carried on by the assessee was incidental to the attainment of the objects of the trust, which were for charitable purposes. Relying on the judgment of the Supreme Court in Thanthi Trust (Supra), in which the effect of the amendment was considered, the Tribunal held that the said decision squarely covered the controversy in the present case about the business being incidental to the attainment of the objects of the trust.

The High Court noted that the Tribunal did not specifically address itself to the question which arose out of the order of the CIT(A), whether the business itself can be said to be property held under trust within the meaning of section 11(4). There was no discussion in the order of the Tribunal as to the impact of the various clauses of the trust deed which were referred to by the CIT(A) while making a distinction between the objects of the trust and the powers of the trustees. In respect of all the other assessment years, namely, 1993-94, 1994-95, 2001-02 and 2005-06 to 2007-08, the Tribunal followed the order passed by it for the A.Y. 1992-93.

On an appeal by Revenue, the Delhi High Court in appreciation of the contentions of the parties, held as under:
• There was no exhaustive definition of the words ‘property held under trust’ in the Act; however, sub-section (4) provided that for the purposes of section 11 the words ‘property held under trust’ include a business undertaking so held.

• The question whether sub-section (4A) would apply even to a case where a business was held under trust was answered in the negative in several authoritative pronouncements. Thus, if a property was held under trust, and such property was a business, the case would fall u/s 11(4) and not u/s 11(4A). Section 11(4A) would apply only to a case where the business was not held under trust. In view of the settled legal position, the contention of the Revenue, that the provisions of section 11(4A) were sweeping and would also take in a case of business held under trust, was not acceptable.

• In the facts of the present case, and having regard to the terms of the trust deed and the conduct of the trustees, it could not be said that the Katha business was itself held under trust. There was a difference between a property or business held under trust and a business carried on by or on behalf of the trust, a distinction that was recognised in Surat Art Silk Cloth Manufacturers Association (Supra), a decision of five Judges of the Supreme Court. It was observed that if a business undertaking was held under trust for a charitable purpose, the income therefrom would be entitled to the exemption u/s 11(1).

• In the case before the Court, the finding of the CIT(A), in his order for the A.Y. 1992-93, was that the Katha business was not held under trust but it was a business commenced by the trustees with the aid and assistance of borrowings from the sister concerns in which the settlors and the trustees or their close relatives had substantial interest, as well as from banks. It was thus with the help of borrowed funds, or in other words, the funds not belonging to the assessee trust, that the Katha business was commenced and profits started to be earned.

• There was a distinction between the objects of a trust and the powers given to the trustees to effectuate the purposes of the trust. The Katha business was not even in the contemplation of the settlors and, therefore, could not have been settled upon trust, even where they were empowered to start any business.

• There was thus no nexus or integration between the amount originally settled upon the trust and the later setting up and conduct of the Katha business. Moreover, the distinction between the original trust fund and the later commencement of the business with the help of borrowed funds should be kept in mind in the context of ascertaining whether the particular Katha business was even in the contemplation of the settlors of the trust.

• There was no connection between the carrying on of the Katha business and the attainment of the objects of the trust, which were basically for the advancement of education, inculcation of patriotism, Indian culture, running of dispensaries, hospitals, etc. The mere fact that the whole or some part of the income from the Katha business was earmarked for application to the charitable objects would not render the business itself being considered as incidental to the attainment of the objects. The Delhi High Court was in agreement with the view taken by the CIT(A) in his order for A.Y. 1992-93 that the application of the income generated by the business was not the relevant consideration and what was relevant was whether the activity was so inextricably connected to or linked with the objects of the trust that it could be considered as incidental to those objectives.

• Prima facie, the observations in the case of Thanthi Trust (Supra) would appear to support the assessee’s case in the sense that even if the Katha business was held not to constitute a business held under trust, but only as a business carried on by or on behalf of the trust, so long as the profits generated by it were applied for the charitable objects of the trust, the condition imposed u/s 11(4A) should be held to be satisfied, entitling the trust to the tax exemption.

• The observations of the Apex Court, however, have to be understood in the light of the facts before it. The assessee in that case carried on the business of a newspaper and that business itself was held under trust. The charitable object of the trust was the imparting of education which fell u/s 2(15). The newspaper business was certainly incidental to the attainment of the object of the trust, namely, that of imparting education. The observations were thus made having regard to the fact that the profits of the newspaper business were utilised by the trust for achieving the object, namely, education. The type of nexus or connection which existed between the imparting of education and the carrying on of the business of a newspaper did not exist in the present case. There was no such nexus between the Katha business and the objects of the assessee trust that can constitute the carrying on of the Katha business, an activity incidental to the attainment of the objects, namely, advancing of education, patriotism, Indian culture, running of hospitals and dispensaries, etc.

• It would be disastrous to extend the sweep of the observations made by the Supreme Court in the case of the Thanthi Trust (Supra), on the facts of that case, to all cases where the trust carried on business which was not held under trust and whose income was utilised to feed the charitable objects of the trust. The observations of the Supreme Court must be understood and appreciated in the background of the facts in that case and should not be extended indiscriminately to all cases.

The Delhi High Court held that a business carried on with borrowed funds and unrelated to the objects of the trust could not be held to be a ‘property held under trust’. It has also held that for a business to be incidental to the attainment of the objects of the trust, its activity should be intricately related to its objects. It also held that where a property was held under trust and such property was a business, the case would fall u/s 11(4) and not u/s 11(4A). Section 11(4A) would apply only to a case where the business was not held under trust. It therefore held that the Katha business was not a property held under trust, the provisions of section 11(4) did not apply, and the provisions of section 11(4A) would have to be applied. Since the business was not incidental to the attainment of the objects of the trust as required by section 11(4A), the trust was not entitled to exemption in respect of the business income.

The Special Leave Petition filed by the assessee against this decision has been admitted by the Supreme Court as reported in Mehta Charitable Prajnalay Trust vs. CIT, 248 Taxman 145 (SC).

BHARATHAKSHEMAM’S CASE

The issue recently arose in the case of Bharathakshemam vs. PCIT, 320 CTR (Ker) 198, a case that required the Court to adjudicate whether the assessee trust was eligible for exemption from tax u/s 11, in respect of the business of Chitty / Kuri which was utilised for medical relief, an object of the trust, and could such business be considered as a business incidental or ancillary to the attainment of the objects of the trust. In that case, the Revenue had relied on the decision of the Delhi High Court in the case of Mehta Charitable Prajnalay Trust (Supra) to support the contention that the business carried on by the trust had no connection or nexus with the charitable objects of the trust. It was the Revenue’s contention that the business, being run by the trust, should itself be connected or should have a nexus with the object of medical relief, for example, running a dispensary or a hospital or a drugstore or even a medical college; surely, running a Chitty / Kuri business was none of them and therefore could not be said to be incidental or ancillary to the objects of the trust, and the fact that the profit of such business was utilised entirely for medical relief was not sufficient for excluding the income of the business from taxation.

In this case, the facts gathered from the order of the High Court reveal that the claim for exemption of the trust in respect of its profit from its Chitty / Kuri business was denied by the A.O. on the grounds that such a business was not incidental or ancillary to the attainment of the objects of the trust. The A.O. had also evoked the proviso to section 2(15) which was held by the Court to be irrelevant in view of the finding that the said proviso had a restricted application to the cases where a business was being carried on for pursuing its object of carrying on an activity of general public utility. In the case before the Court, the main object was providing medical relief and the profits of the business were utilised for medical relief which was the main object of the trust.

The first appellant authority held that the business was carried out by the trust for the mutual benefit of the subscribers to the Chitty / Kuri and the substantial profit of the business was passed on to such subscribers and therefore such business, which retained minor profits, could not have been treated as incidental to the objects of the trust. It also held that the profit, even where applied fully to the objects of the trust, could not have deemed the business to be incidental to the main objects of the trust. On appeal by the assessee to the Tribunal, it agreed with the findings of the first appellate authority and also referred to the first proviso to section 2(15) to hold that the business of the trust was not incidental to the attainment of the objects of the trust.

On further appeal to the High Court, relying on a few decisions of the courts, the Kerala High Court held that the proviso to section 2(15) had no relation to the case of the trust which had as its object providing medical relief. This part is not relevant to the issues under consideration here and is mentioned only for completeness.

The Court also observed, though not relevant to the issue before it, that in the aftermath of the deletion of section 13(1)(bb) and insertion of sub-section (4), the distinction between a business held in trust and one run by the trust was not very relevant and the observations in the minority judgment in the case of Thanthi Trust (Supra) should not be applied in preference to the observations of the majority, more so when the court later on delivered a unanimous judgment of the five judges.

On the issue of satisfaction of the condition of sub-section (4A), relating to the business being incidental to the attainment of the objects of the trust, the Kerala High Court exclusively relied on paragraph 25 of the decision of the Supreme Court in the case of the Thanthi Trust (Supra) for holding that the business of Chitty / Kuri was incidental to the attainment of the objects of the trust. The said paragraph 25 is reproduced hereunder:

‘The substituted sub-section (4A) states that the income derived from a business held under trust wholly for charitable or religious purposes shall not be included in the total income of the previous year of the trust or institution if “the business is incidental to the attainment of the objective of the trust or, as the case may be, institution” and separate books of accounts are maintained in respect of such business. Clearly, the scope of sub-section (4A) is more beneficial to a trust or institution than was the scope of sub-section (4A) as originally enacted. In fact, it seems to us that the substituted sub-section (4A) gives a trust or institution a greater benefit than was given by section 13(1)(bb). If the object of Parliament was to give trusts and institutions no more benefit than that given by section 13(1)(bb), the language of section 13(1)(bb) would have been employed in the substituted sub-section (4A). As it stands, all that it requires for the business income of a trust or institution to be exempt is that the business should be incidental to the attainment of the objectives of the trust or institution. A business whose income is utilised by the trust or the institution for the purposes of achieving the objectives of the trust or the institution is, surely, a business which is incidental to the attainment of the objectives of the trust. In any event, if there be any ambiguity in the language employed, the provision must be construed in a manner that benefits the assessee. The trust, therefore, is entitled to the benefit of section 11 for A.Y. 1992-93 and thereafter. It is, we should add, not in dispute that the income of its newspaper business has been employed to achieve its objectives of education and relief to the poor and that it has maintained separate books of accounts in respect thereof.’

The Kerala High Court, in paragraph 13, examined the facts and the decision of the Delhi High Court in the case of Mehta Charitable Prajnalay Trust (Supra) relied upon by the Revenue. In paragraph 14 it reiterated the above-referred paragraph 25 of the decision in the case of the Thanthi Trust (Supra) to disagree, in paragraph 15, with the ratio of the decision of the Delhi High Court in the case of Mehta Charitable Prajnalay Trust (Supra). The Court also held that the Chitty / Kuri business did not require any initial investment and therefore the facts in the case before it were found to be different from the facts in the case before the Delhi High Court. The Kerala High Court also noted that the example cited by the Delhi High Court was relevant only in the context of section 13(1)(bb), which became irrelevant on its deletion; on simultaneous insertion of sub-section (4A), the case was to be adjudicated by reading the substituted provision that did not stipulate any condition that business carried on by the trust should be connected or should have nexus with the charitable purpose for such business to be treated as being carried on as incidental to the attainment of the objects of the trust. It held that the Chitty / Kuri business was incidental to the main object as long as its profits were applied for medical relief, which was the object of the trust. The trust was accordingly granted the exemption in respect of its profits of the Chitty / Kuri business.

OBSERVATIONS
The issue that moves in a narrow compass, is about the eligibility of a trust for exemption u/s 11 where it carries on a business, the corpus whereof is supplied by the borrowings from the sister concerns of the settlor / trustees and the profit thereof is used for the purpose of meeting the objects of the trust; should such business be treated as one ‘held in trust’ and if yes, whether the business can be said to be incidental to the attainment of the objects of the trust.

A business run by a charitable institution, whether out of borrowed funds or from the funds settled on it, is surely a ‘property held under trust’ as is confirmed by the express provisions of sub-section (4) of section 11 and this understanding is confirmed by the decision of the Supreme Court in the case of Thanthi Trust (Supra). In this case, the Supreme Court observed ‘A public charitable trust may hold a business as part of its corpus. It may carry on a business which it does not hold as a part of its corpus. But it seems that the distinction has no consequence insofar as section 13(1)(bb) is concerned.’ The doubt, if any, was eliminated by the deletion of section 13(1)(bb) w.e.f. 1st April, 1983. Section 13(1)(bb) provided that nothing contained in section 11 or section 12 shall operate so as to exclude from the total income of the previous year of the person in receipt thereof, in the case of a charitable trust or institution for the relief of the poor, education or medical relief, which carries on any business, any income derived from such business, unless the business is carried on in the course of the actual carrying out of a primary purpose of the trust or institution.

The Supreme Court also stated in the Thanthi case:
‘Sub-section (4) of section 11 remains on the statute book and it defines property held under trust for the purposes of that section to include a business so held. It then states how such income is to be determined. In other words, if such income is not to be included in the income of the trust, its quantum is to be determined in the manner set out in sub-section (4).
Sub-section (1)(a) of section 11 says that income derived from property held under trust only for charitable or religious purposes, to the extent it is used in the manner indicated therein, shall not be included in the total income of the previous year of the trust. Sub-section (4) defines the words “property held under trust” for the purposes of section 11 to include a business held under trust. Sub-section (4A) restricts the benefit under section 11 so that it is not available for income derived from business unless ……’

The Supreme Court therefore clearly indicated that both sub-sections (4) and (4A) of section 11 have to be read together.

The position now should be accepted as settled unless the A.O. finds that the business is not owned and run by the institution. It is difficult to concur with a view that a business owned and run by a trust or on its behalf may still not be held to be ‘a property held under trust’. Sub-section (4) should help in concluding the debate. Yes, where the business itself is not owned or run by the trust, there can be a possibility to hold that it is not ‘a property held in trust’, but only in such cases based on conclusive findings that the business belongs to a person other than the trust.

The fact that the business is a ‘property held in trust’ by itself shall not be sufficient to exempt its income u/s 11 unless the business is found to be incidental to attainment of the objects of the trust and further the institution maintains separate books of accounts for such business. These conditions are mandated by the Legislature on insertion of sub-section (4A) into section 11 w.e.f. 1st April, 1992. In our considered opinion, the compliance of the conditions of sub-section (4A) is essential even for a business held as a ‘property held under a trust’. A co-joint reading of sub-sections (4) and (4A) is advised in the interest of the harmonious construction of the provisions that enables an institution to claim the exemption from tax.

The term ‘property held under trust’ is not defined in the Act; however, vide sub-section (4), for the purposes of section 11, the words ‘property held under trust’ include a business undertaking held by the trust. This by itself shall not qualify the trust to claim an exemption from tax. In our opinion, it is not correct to hold that once the case falls under section 11(4), the conditions of section 11(4A) will not have to be satisfied. For a valid claim of exemption, it is necessary to satisfy the twin conditions: that the business is a property held in the trust and the same is incidental to the attainment of the objects of the trust and that separate books of accounts are maintained of such business. It is also incorrect to hold that the provisions of sub-section (4A) would apply only to a business which is not a property held in trust; taking such a view would disentitle a trust altogether from claiming exemption for non-compliance of conditions of sections 11(1)(a) to (c) of the Act; the whole objective of insertion of sub-section(4A) would be lost inasmuch as it cannot be read in isolation of section 11(1)(a) to (c).

As regards the meaning of the term ‘incidental to the objects of the trust’, the better view is to treat the conditions as satisfied once the profits of the business are spent on the objects of the trust. There is nothing in section 11(4A) to indicate that there is a business nexus to the objects of the trust, for example, a business of running a laboratory or a school or a hospital w.r.t. the object of medical relief. The profit of the business of running a newspaper or printing press shall satisfy the conditions of section 11(4A) once it is utilised for the charitable purposes, i.e., the objects of the trust, even where there is no business nexus with the objects of the trust.

Attention is invited to the decision of the Madras High Court in the case of Wellington Charitable Trust, 330 ITR 24. In that case, the Court held that when a business income was used towards the achievement of the objects of the trust, it would amount of carrying on of a business ‘incidental to the attainment of the objects of the trust’. Importance is given to the application of the business income and not its source, its use and not its origin. Nothing would be gained by exempting an income which has a nexus with the objects of the trust but is not utilised for meeting the objects of the trust. The provisions of section 11(4) and section 11(4A) will have to be read together for a harmonious construction; it would not be correct to hold that section 11(4A) would override section 11(4) as doing so would make the very provision of section 11(4) otiose and redundant. The Court should avoid an interpretation that would defeat the provision of the law where there is no express bar in section 11(4A) that prohibits the application of section 11(4). The provisions should be construed to be complementary to each other.

Having said that, it would help the case of the trust, for an exemption, where the settlor of the trust has settled the business in the trust and the objects of the trust include the carrying on of such business for the attainment of the charitable objects of the trust.

shailesh.kwebmaker

DEDUCTION OF MAINTENANCE CHARGES IN COMPUTING INCOME FROM HOUSE PROPERTY

ISSUE FOR CONSIDERATION
Section 22 of the Income-tax Act creates a charge over the annual value of the house property being a building or lands appurtenant to the building of which the assessee is the owner and which has not been used for the purpose of any business or profession carried on by the assessee. The annual value of the house property is required to be computed in the manner laid down in section 23. It deems the sum for which the property might reasonably be expected to be let from year to year as its annual value subject to the exception where the property is let, in which case the amount of rent received or receivable is considered to be its annual value if it is higher. Section 24 provides for the deductions which can be claimed in computing the Income from House Property, namely, (i) a sum equal to 30% of the annual value (referred to as ‘standard deduction’), and (ii) interest payable on capital borrowed for acquisition, construction, repairs, etc., of the property subject to further conditions as provided in clause (b).

Quite often, an issue arises as to whether the assessee can claim a deduction of expenses like maintenance charges, etc., which it had to incur in relation to the property which is let out while computing its annual value for the purposes of section 23. The fact that the annual value is required to be computed on the basis of rent received or receivable in case of let-out property and no specific deduction has been provided for any expenses other than interest u/s 24, makes the issue more complex. Numerous decisions are available dealing with this issue in the context of different kind of expenses, such as maintenance charges, brokerage, non-occupancy charges, etc. For the purpose of this article, we have analysed two decisions of the Mumbai bench of the Tribunal taking contrary views in relation to deductibility of maintenance charges while computing annual value u/s 23.

SHARMILA TAGORE’S CASE
The issue had earlier come up for consideration of the Mumbai bench of the Tribunal in the case of Sharmila Tagore vs. JCIT (2005) 93 TTJ 483.

In this case, for the assessment year 1997-98, the assessee had claimed deduction for the maintenance charges of Rs. 48,785 and non-occupancy charges of Rs. 1,17,832 levied by the society from the total rent received of Rs. 3,95,000 while computing her income under the head Income from House Property. The A.O. disallowed the claim for deduction of both the payments on the ground that the expenses were not listed for allowance in section 24. On appeal, the disallowance made by the A.O. was confirmed by the Commissioner (Appeals).

The Tribunal, on appeal by the assessee, held that the maintenance charges have to be deducted while determining the annual letting value of the property u/s 23 following the ratio of the decisions in the cases of –
• Bombay Oil Industries Ltd. vs. Dy. CIT [2002] 82 ITD 626 (Mum),
• Neelam Cables Mfg. Co. vs. Asstt. CIT [1997] 63 ITD 1 (Del),
• Lekh Raj Channa vs. ITO [1990] 37 TTJ (Del) 297,
• Blue Mellow Investment & Finance (P) Ltd. [IT Appeal No. 1757 (Bom), dated 6th May, 1993].

The claim of the assessee for the deduction of maintenance charges while computing the annual value on the basis of rent received was upheld by the Tribunal. As regards the non-occupancy charges, the Tribunal noted that the expenditure had to be incurred for letting out the property. Therefore, while estimating the annual letting value of the property, which was the sum for which the property might reasonably be expected to be let from year to year, the non-occupancy charges could not be ignored and should be deducted from the annual value. Thus, the Tribunal directed the A.O. to re-compute the annual value after reducing the maintenance charges as well as non-occupancy charges from the rent received.

In the case of Neelam Cables Mfg. Co. (Supra), the assessee had claimed deduction for building repairs and security service charges. Insofar as building repair charges were concerned, the Tribunal held that no separate deduction could be allowed in respect of repairs as the assessee was already allowed the deduction of 1/6th for repairs as provided in section 24 (as it was prevailing at that time). However, in respect of security service charges, the Tribunal held that the charges would be deductible while computing the annual value u/s 23, though no such deduction was specifically provided for in section 24. Since the gross rent received by the assessee should be considered as inclusive of security service charges, the Tribunal held that such charges which were paid in respect of letting out of the property should be deducted while determining the annual value.

In the case of Lekh Raj Channa (Supra), the Tribunal allowed the deduction of salaries paid to persons for the maintenance of the building, security of the building and attending to the requirements of the tenants while computing the annual letting value.

The Tribunal in the case of Bombay Oil Industries Ltd. (Supra), following the above referred decisions of the Delhi bench and in the case of Blue Mellow Investment & Finance (P) Ltd. (Supra), had held that the expenditure by way of municipal taxes, maintenance of the building, security, common electricity charges, upkeep of lifts, water pump, fire-fighting equipment, staff salary and wages, etc., should be taken into account while arriving at the annual letting value u/s 23.

A similar view has been taken in the following cases about deductibility of expenses, mainly maintenance charges, while arriving at the annual letting value of the let-out property –
• Realty Finance & Leasing (P) Ltd. vs. ITO [2006] 5 SOT 348 (Mum),
• J.B. Patel & Co. vs. DCIT [2009] 118 ITD 556 (Ahm),
• ITO vs. Farouque D. Vevania [2008] 26 SOT 556 (Mum),
• ACIT vs. Sunil Kumar Agarwal (2011) 139 TTJ 49 (UO),
• Asha Ashar vs. ITO [2017] 81 taxmann.com 441 (Mum-Trib),
• Neela Exports Pvt. Ltd. vs. ITO (ITA No. 2829/Mum/2011 dated 27th February, 2013),
• Krishna N. Bhojwani vs. ACIT (ITA No. 1463/Mum/2012 dated 3rd July, 2017),
• Saif Ali Khan vs. CIT (ITA No. 1653/Mum/2009 dated 23rd June, 2011).

ROCKCASTLE PROPERTY (P) LTD.’S CASE
The issue again came up for consideration recently before the Mumbai bench of the Tribunal in the case of Rockcastle Property (P) Ltd. vs. ITO [2021] 127 taxmann.com 381.

In this case, for the assessment year 2012-13, the assessee had earned rental income from a commercial property which was situated in a condominium. The assessee credited an amount of Rs. 91.42 lakhs as rental income in its Profit & Loss account as against gross receipts of Rs. 93.65 lakhs after deducting Rs. 2.23 lakhs paid towards the ‘society maintenance charges’. The A.O. held that the charges were not allowable as a deduction since the assessee was already allowed deduction of 30% u/s 24(a). The CIT(A) confirmed the disallowance by relying upon several decisions, including the decisions of the Delhi High Court in the case of H.G. Gupta & Sons, 149 ITR 253 and of the Punjab & Haryana High Court in Aravali Engineers P. Ltd. 200 Taxman 81.

On appeal to the Tribunal, it was contended on behalf of the assessee that under the terms of letting out, the assessee was required to bear the expenses on society maintenance and the gross rent received by the assessee included the society maintenance charges that were paid by the assessee. Therefore, in computing the annual value, the amount of rent which actually came to the hands of the owner should alone be taken into consideration in view of the provisions of section 23(1)(b) that provide for adoption of the ‘actual rent received or receivable by the owner’. Reliance was also placed on various decisions of the Tribunal taking a view that such maintenance charges should be deducted while computing the annual letting value of the let-out property. As against this, the Revenue submitted that the assessee’s claim was not admissible as per the statutory provisions.

The Tribunal perused the Leave & License agreement and noted that the payment of municipal taxes and other outgoings was the liability of the assessee. Any increase was also to be borne by the assessee. The licensee was required to pay a fixed monthly lump sum to the assessee as license fees irrespective of the assessee’s outgoings. On the above findings, the Tribunal noted that it was incorrect for the assessee to plead that the actual rent received by the assessee was net of ‘society maintenance charges’ as per the terms of the agreement.

The Tribunal further noted that section 23 provided for deduction of only specified items, i.e., taxes paid to the local authority and the amount of rent which could not be realised by the assessee, from the ‘actual rent received or receivable’. No other deductions were permissible. Allowing any other deduction would amount to distortion of the statutory provisions and such a view could not be countenanced. It observed that accepting the plea that the rent which actually went into the hands of the assessee was only to be considered, would enable the assessee to claim any expenditure from rent actually received or receivable which was not the intention of the Legislature.

As far as the decision of the co-ordinate bench in the case of Sharmila Tagore (Supra) was concerned, the Tribunal relied upon its earlier decision in the case of Township Real Estate Developers (India) (P) Ltd. vs. ACIT [2012] 21 taxmann.com 63 (Mum) wherein it was held that –
• the decision of the Delhi High Court in the case of H.G. Gupta & Sons (Supra) had not been considered in the Sharmila Tagore case;
• the decision of the Punjab & Haryana High Court in the case of Aravali Engineers (P) Ltd. (Supra) was the latest decision on the subject that held that the deduction was not allowable.

Apart from the cases of Rockcastle Property (P) Ltd. (Supra) and Township Real Estate Developers (India) (P) Ltd. (Supra), a similar view has been taken in the following cases whereby the expenses in the nature of maintenance of the property have not been allowed to be reduced from the gross amount of the rent for the purpose of determining the annual value of the property –
• Sterling & Wilson Property Developers Pvt. Ltd. vs. ITO (ITA No. 1085/Mum/2015 dated 11th November, 2016),
• Ranjeet D. Vaswani vs. ACIT [2017] 81 taxmann.com 259 (Mum-Trib), and
• ITO vs. Barodawala Properties Ltd. (2002) 83 ITD 467 (Mum).

OBSERVATIONS
What is chargeable to tax in the case of house property is its ‘annual value’ after reducing the same by the deductions allowed u/s 24. The annual value is required to be determined in accordance with the provisions of section 23. Sub-section (1) of section 23 which is relevant for the purpose of the subject matter of controversy reads as under –

For the purposes of section 22, the annual value of any property shall be deemed to be –
(a) the sum for which the property might reasonably be expected to let from year to year; or
(b) where the property or any part of the property is let and the actual rent received or receivable by the owner in respect thereof is in excess of the sum referred to in clause (a), the amount so received or receivable; or
(c) where the property or any part of the property is let and was vacant during the whole or any part of the previous year and owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the sum referred to in clause (a), the amount so received or receivable:
Provided that the taxes levied by any local authority in respect of the property shall be deducted (irrespective of the previous year in which the liability to pay such taxes was incurred by the owner according to the method of accounting regularly employed by him) in determining the annual value of the property of that previous year in which such taxes are actually paid by him.
Explanation. – For the purposes of clause (b) or clause (c) of this sub-section, the amount of actual rent received or receivable by the owner shall not include, subject to such rules as may be made in this behalf, the amount of rent which the owner cannot realise.

The limited issue for consideration, where the property is let, is whether ‘the actual rent received or receivable’ referred to in clause (b) in respect of letting of the property or part thereof can be said to have included the cost of maintaining that property and, if so, whether the actual rent received or receivable can be reduced, by the amount of the cost of maintaining the property, for the purposes of clause (b) of section 23(1).

One possible view of the matter is that the ‘actual rent received or receivable’ should be the amount of consideration which the tenant has agreed to pay for usage of the property and merely because the owner of the property has to incur some expenses in relation to that property, the amount of ‘actual rent received or receivable’ cannot be altered on that basis; the proviso to section 23(1) permits the deduction for taxes levied by the local authority, which is also the obligation of the owner of the property, is indicative of the intent of the Legislature that no other obligations of the owner of the property can be reduced from the amount of actual rent received or receivable; any payment or other than the taxes so specified shall not be deductible from the annual value; section 24 limits the deduction to those payments that have been expressly listed in the said section and any deduction outside the list is not allowable, as has been explained in the Circular No. 14/2001 dated 9th November, 2001 explaining the objective of the amendment of 2001 in section 24 to substitute some eight deductions like cost of repairs, collection charges, insurance premium, annual charge, ground rent, interest, land revenue, etc., with only two, namely, standard deduction and interest; any deduction other than the ones specified by the proviso to section 23(1) and section 24, i.e., municipal taxes, interest and standard deduction, is not permissible.

The other equally possible view is that the amount of ‘actual rent received or receivable’ is dependent on the fact that the let-out property in question necessarily requires the owner to bear the expenses in relation to the property as a condition for letting, expressly or otherwise, and considering this correlation, the amount of ‘actual rent received or receivable’ should be adjusted taking into consideration the cost of maintaining the property or any other such expenses in relation to the property which the owner is required to incur; the express permission to deduct the municipal taxes under the proviso should not be a bar from claiming such other payments and expenses which have the effect of reducing the net annual rent in the hands of the owner and should be allowed to be reduced form the annual value as long as there is no express prohibition in the law to do so; section 24 lists the permissible deductions in computing the income under the head ‘income from house property’ and is unrelated to the determination of annual value and should not have any role in determination thereof; the expenses that go to reduce the annual value should nonetheless be allowed as they remain unaffected by the provisions of section 24.

The obligation of the owner to incur the expenses in question is directly linked to the earning of the income and has the effect of determining the fair rental value. The value shall stand reduced where such obligations are not assumed by the owner. Needless to say, an express agreement by the parties for passing on the obligation to pay such expenses to the tenant and reducing the rent payable would achieve the desired objective without any litigation; this in itself should indicate that the fair rental value is directly linked to the assuming of the obligations by the owner to pay the expenses in question and that such expenses should be reduced from the annual value. The case for deduction is well supported on the principle of diversion of obligation by overriding covenant. The concept has been well explained by the Supreme Court in the case of CIT vs. Sitaldas Tirathdas [(1961) 41 ITR 367] the relevant extract from which is reproduced below –

In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assesse as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation, cannot be said to be a part of the income of the assesse. Where by the obligation income is diverted before it reaches the assesse, it is deductible; but where the income is required to be applied to discharge an obligation after the income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one’s own income, which has been received and is since applied. The first is a case where income never reaches the assessee, who even if he were to collect it does so, not as part of his income, but for and on behalf of the person to whom it is payable.

Further reference can also be made to the case of CIT vs. Sunil J. Kinariwala [2003] 259 ITR 10 wherein the Supreme Court has, after referring to various precedents on the subject, explained the concept of diversion of income by overriding title in the following manner:

When a third person becomes entitled to receive the amount under an obligation of an assessee even before he could lay a claim to receive it as his income, there would be diversion of income by overriding title; but when after receipt of the income by the assessee, the same is passed on to a third person in discharge of the obligation of the assessee, it will be a case of application of income by the assessee and not of diversion of income by overriding title.

It is possible to canvass two views when the issue under consideration is examined in light of this principle; it can be said that there is no diversion of income by the owner of the property when he incurs the expenses for maintenance of the property, or it can be held that there is a diversion. The better view is to favour an interpretation that permits the reduction than the one that defeats the claim. It is also possible to support the claim for reduction from annual value on the basis of real income theory.

In the cases of Sharmila Tagore and others, the Tribunal has taken a view that allowed the reduction of maintenance charges from the annual value on the basis that to that extent the amount of rent never reached the owner or the owner was not benefited to that extent.

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IMPACT OF WAIVER OF LOAN ON DEPRECIATION CLAIM

ISSUE FOR CONSIDERATION

When a loan taken for acquiring a depreciable capital asset or a part of the purchase price of such capital asset is waived in a year subsequent to the year of acquisition, an issue that arises with respect to waiver of loan or part of the purchase price is whether the depreciation claimed in the past on that portion of the cost of the asset which represents the waiver of the purchase price, or which had been met from the loan waived, can be added / disallowed u/s 41(1) / 43(6) in the year in which that amount of the loan / purchase price has been waived, and whether the written down value (WDV) of the block of the assets concerned needs to be reworked so as to reduce it by the amount of loan / purchase price waived. The Hyderabad Bench of the Tribunal has held that while section 41(1) would not apply, the depreciation claimed in the past needs to be added as income and the WDV is also required to be reworked in such a case. As against this, the Bengaluru Bench of the Tribunal has held that waiver of loan taken to acquire a depreciable asset does not have any consequences in the year in which the loan has been waived off, insofar as claim of depreciation is concerned.

BINJRAJKA STEEL TUBES LTD.’s CASE

The issue had earlier come up for consideration of the Hyderabad Bench of the Tribunal in the case of Binjrajka Steel Tubes Ltd. vs. ACIT 130 ITD 46.

In this case, the assessee had purchased certain machinery from M/s Tata SSL Ltd. for a total consideration of Rs. 6 crores. Since the machinery supplied was found to be defective, the matter was taken up with the supplier for replacement and after protracted correspondence and a legal battle, the supplier agreed to an out-of-court settlement. As per this settlement, the liability of the assessee which was payable to the supplier to the extent of Rs. 2 crores was waived.

During the previous year relevant to assessment year 2005-06, the assessee gave effect to this settlement in its books of accounts by reducing the cost of machinery by Rs. 2 crores. Consequently, the depreciation for the year had also been adjusted, including withdrawal of excess charged depreciation of earlier years amounting to Rs. 1,19,01,058. While making the assessment, the A.O. added back the amount of Rs. 2 crores as income of the assessee u/s 41(1), and this was confirmed by the CIT(A).

Before the Tribunal, the assessee submitted that the remission of liability of Rs. 2 crores which was written back was not taxable u/s 41(1) because cessation of liability was towards a capital cost of asset and, hence, it was a capital receipt. On the other hand, the Department argued that the assessee had claimed the depreciation on Rs. 6 crores from the year of acquisition of the asset. From the date of inception of the asset, depreciation was allowed by the Department on the block of assets, and when the assessee received any amount as benefit by way of reduction of cost of acquisition, the amount of benefit had to be offered for taxation as per the provisions of section 41(1).

The Tribunal referred to the provisions of section 41(1) and held that it could be invoked only where any allowance or deduction had been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee, and subsequently, during any previous year, the assessee had obtained any amount or some benefit with respect to such loss, expenditure or trading liability. The benefit of depreciation obtained by the assessee in the earlier years could not be termed as an allowance or expenditure claimed by the assessee in the earlier years. Hence, any recoupment received by the assessee on this count could not be taxed u/s 41(1). Accordingly, the Tribunal rejected the Revenue’s contention that the assessee had obtained the benefit of depreciation in the earlier years as allowance in respect of expenditure incurred by it when it bought the plant and machinery and the Rs. 2 crores liability waived by the supplier of the machinery in the year under consideration was liable to be taxed as deemed income within the purview of section 41(1).

Though the issue raised before the Tribunal was only with regard to the taxability of the amount waived u/s 41(1), it further dealt with the issue of adding back of depreciation which was already claimed on the said amount. For the purpose of dealing with the said issue of disallowance of depreciation which was not raised before it, the Tribunal placed reliance on the decision of the Calcutta High Court in the case of Steel Containers Ltd. vs. CIT [1978] 112 ITR 995, wherein it was held that when the Tribunal finds that disallowance of a particular expenditure by the authorities below is not proper, it is competent to sustain the whole or part of the disputed disallowance under a different section under which it is properly so disallowable.

On the merits of the issue of disallowance of depreciation, the Tribunal held that depreciation already allowed in past years on the amount which was waived by the supplier under the settlement with the assessee had to be withdrawn and added back in the year under consideration, as otherwise, the assessee would get double benefit which was not justified. Accordingly, the A.O. was directed to add the amount of depreciation claimed in past years on the amount of Rs. 2 crores as income u/s 28(iv) as the value of benefit arising from the business. After reducing the said amount of depreciation granted earlier from the amount of Rs. 2 crores, the Tribunal further directed that the balance amount was to be reduced from the closing WDV of the block of assets, without giving any reasoning or relying on any relevant provision of the Act.

AKZO NOBEL COATINGS INDIA (P) LTD.’s CASE
The issue, thereafter, came up for consideration before the Bengaluru Bench of the Tribunal in the case of Akzo Nobel Coatings India (P) Ltd. vs. DCIT (2017) 139 ITD 612.

In this case, the assessee acquired plant and machinery for its Hoskote plant in April, 1996. Since the assessee could not obtain approval from the RBI for making payment to the supplier, ultimately CEL, UK, one of the group companies, made the payment for the machinery to the suppliers. Thus, the funds for supply of machinery which were originally payable by the assessee to the suppliers became payable by the assessee to CEL, UK. Later, CEL, UK was taken over by Akzo International BV. As a part of the business restructuring and because of the absence of RBI approval for making remittances of monies due for supply of machinery, and taking note of the business exigency, Akzo International BV decided to waive the money payable in respect of supply of machineries to the assessee. Thus, the assessee was the beneficiary of the waiver of loan to the extent of Rs. 13,48,09,000.

This waiver of the loan took place in April, 2000. The benefit as a result of the waiver was shown in the books of accounts of the assessee in the balance sheet as a capital receipt not chargeable to tax. The assessee had claimed depreciation on those machineries from the A.Y. 1997-98 onwards. The fact of waiver of the amount payable by the assessee came to the knowledge of the A.O. in the course of assessment proceedings for the A.Y. 2004-05. Thereafter, action was initiated u/s 148 to reduce the WDV of the relevant block of assets and withdraw the depreciation already granted to the assessee in the past.

According to the A.O., on the waiver of loan by the parent company, the WDV of the plant and machinery had to be reworked by reducing from the opening WDV, the amount of loan which had been waived by the parent company, viz., a sum of Rs. 13,48,09,000. The A.O., accordingly, worked out the depreciation allowable on plant and machinery by reducing the WDV on which depreciation had to be allowed for A.Y. 2001-02. A similar exercise of reworking the amount of the WDV and resultant depreciation thereon was made for the subsequent years as well.

On appeal by the assessee, the CIT(A) took the view that the entire waiver of the loan cannot be reduced from the WDV of the block of assets. He held that the whole of the original cost cannot be reduced from the opening WDV as on 1st April, 2001. This was on the basis that the provisions of section 43(6) did not envisage reduction of cost of assets in the guise of disallowance of depreciation. He, accordingly, directed the A.O. to reduce only the WDV of the assets concerned, i.e., Rs. 4,73,32,812, and not the whole of the original cost. The assessee as well as the Revenue filed appeals before the Tribunal against the order of the CIT(A) giving partial relief.

Before the Tribunal, the assessee contended that only those adjustments which have been provided u/s 43(6)(c) could be made to the WDV of the block of assets. Since no assets were sold, discarded, demolished or destroyed, the amount of loan waived by the supplier of machinery could not be reduced. The assessee relied upon the decision of the Supreme Court in the case of CIT vs. Tata Iron & Steel Co. Ltd. [1998] 231 ITR 285, wherein the Supreme Court held that the manner of repayment of loan availed by an assessee for the purchase of an asset on which depreciation is claimed cannot have any impact on allowing depreciation on such assets. It was also submitted that Explanation 10 to section 43(1) would not apply to the present case, because the amount waived by the parent company cannot be said to be the cost of the asset met directly or indirectly by any authority in the form of ‘subsidy or grant or reimbursement’. On the other hand, Revenue pleaded to restore the order of the A.O.

The Tribunal held that the only way by which the WDV on which depreciation is to be allowed as per the provisions of section 32(1)(ii) can be altered is as per the situation referred to in section 43(6)(c)(i), A and B, i.e., increased by the actual cost of any asset falling within that block, acquired during the previous year and reduced by the monies payable in respect of any asset falling within that block, which is sold or discarded or demolished or destroyed during that previous year together with the amount of the scrap value, if any. In the present case, neither was there purchase of the relevant assets during the previous year, nor was there sale, discarding or demolition or destruction of those assets during the previous year. The relevant assets continued to be owned and used by the assessee. Therefore, these provisions could not have been resorted to for the purpose of making adjustments to the WDV of the block as made by the A.O.

Examining the applicability of the provisions of Explanation 10 to section 43(1), which provide for reduction of cost under certain circumstances, the Tribunal held that they would apply only when there was a subsidy or grant or reimbursement. In the present case, there was no subsidy or grant or reimbursement. There was only a waiver of the amounts due for purchase of machinery, which did not fall within the scope of any of the aforesaid expressions used in Explanation 10. Even otherwise, section 43(1) was applicable only in the year of purchase of machinery and in the case before the Tribunal, the purchase of the machinery in question was not in A.Y. 2001-02. Therefore, the actual cost which had already been recognised in the books in the A.Y. prior to A.Y. 2001-02 could not be disturbed in A.Y. 2001-02.

The Tribunal pointed out that there was a lacuna in the law as the assessee on the one hand got the waiver of monies payable on purchase of machinery and claimed such receipt as not taxable because it was a capital receipt. On the other hand, the assessee claimed depreciation on the value of the machinery for which it did not incur any cost. Thus, the assessee was benefited both ways.

As per the law as it prevailed as on date, the Revenue was without any remedy. The only way that the Revenue could remedy the situation was that it had to reopen the assessment for the year in which the asset was acquired and fall back on the provisions of section 43(1), which provided that actual cost means the actual cost of the assets to the assessee. Even this could be done only after the waiver of the loan which was used to acquire machinery. By that time if the assessments for that A.Y. got barred by time, the Revenue was without any remedy. Even the provisions of section 155 did not provide for any remedy to the Revenue in this regard.

The Tribunal also relied on the decision of the Supreme Court in the case of Tata Iron & Steel Co. Ltd. (Supra) wherein a view had been taken that repayment of loan borrowed by an assessee for the purpose of acquiring an asset had no relevance to the cost of assets on which depreciation has to be allowed.

OBSERVATIONS

There is a distinction in the facts between the two decisions – in Binjrajka Steel Tubes case (Supra), the waiver was a part of the purchase price itself by the seller of the machinery, while in the Akzo Nobel Coatings case, it was a waiver of the loan extended by a group company. The issue really is whether the cost of the asset can undergo a change in a subsequent year, due to waiver of a part of the purchase price, or a loan taken to acquire the asset, whether such waiver is to be ignored or given effect to, and when and how the effect is to be given for such change in the cost of the asset.

The claim of depreciation is governed by the provisions of section 32. It allows a deduction of an amount to be calculated at prescribed percentage on the WDV of the block of assets. Section 43(6)(c) defines the expression ‘written down value’ with respect to a block of assets and it reads as under:

(6) ‘written down value’ means –
(c) in the case of any block of assets, –
(i) in respect of any previous year relevant to the assessment year commencing on the 1st day of April, 1988, the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year and adjusted, –
(A) by the increase by the actual cost of any asset falling within that block, acquired during the previous year;
(B) by the reduction of the moneys payable in respect of any asset falling within that block, which is sold or discarded or demolished or destroyed during that previous year together with the amount of the scrap value, if any, so, however, that the amount of such reduction does not exceed the written down value as so increased; and…………………..

The WDV of the block of assets is required to be determined only in the manner as provided in section 43(6)(c). Nothing can be added to it and nothing can be reduced from it which has not been provided for in the aforesaid provision. The aforesaid provision leaves no scope for any reduction in the WDV of any block of assets for any reasons other than the sale, discarding, demolition or destruction of the assets falling within that block.

Thus, once the actual cost of any asset has been added to the WDV of the block of assets, no further adjustments have been provided for in the Act to reduce the amount of that actual cost in any later year on the ground that the loan taken to pay that cost or a part of the purchase price has been waived off. In the absence of any such provision under the Act allowing reduction of the WDV of the block of assets on account of waiver of loan taken or part of purchase price for acquiring the assets forming part of that block of assets, no adjustment could have been made for giving effect to the benefits derived by the assessee on account of such a waiver by revising the amount of WDV.

This leads us to the issue whether on account of waiver of the loan from which that asset was acquired it can be said that the ‘actual cost’ of the asset which was added to the WDV of the block of assets has now undergone a change and, therefore, the adjustment is required to be made to give effect to the revised amount of the ‘actual cost’. In this regard, attention is drawn to the decision of the Supreme Court in the case of Tata Iron & Steel Co. Ltd. (Supra); the relevant extract from it is reproduced below:

Coming to the question raised, we find it difficult to follow how the manner of repayment of loan can affect the cost of the assets acquired by the assessee. What is the actual cost must depend on the amount paid by the assessee to acquire the asset. The amount may have been borrowed by the assessee, but even if the assessee did not repay the loan, it will not alter the cost of the asset. If the borrower defaults in repayment of a part of the loan, the cost of the asset will not change. What has to be borne in mind is that the cost of an asset and the cost of raising money for purchase of the asset are two different and independent transactions. Even if an asset is purchased with non-repayable subsidy received from the Government, the cost of the asset will be the price paid by the assessee for acquiring the asset. In the instant case, the allegation is that at the time of repayment of loan, there was a fluctuation in the rate of foreign exchange as a result of which the assessee had to repay a much lesser amount than he would have otherwise paid. In our judgment, this is not a factor which can alter the cost incurred by the assessee for purchase of the asset. The assessee may have raised the funds to purchase the asset by borrowing but what the assessee has paid for it is the price of the asset. That price cannot change by any event subsequent to the acquisition of the asset. In our judgment, the manner or mode of repayment of the loan has nothing to do with the cost of an asset acquired by the assessee for the purpose of his business.

Relying on the aforesaid decision of the Supreme Court, the Kerala High Court in the case of Cochin Co. (P) Ltd. 184 ITR 230 (Supra) while dealing with the same issue of adjustment to the actual cost consequent to waiver of loan, held as under:

The Tribunal has categorically found that Atlanta Corpn. is only a financier and when Atlanta Corpn. wrote off the liability of the assessee, it cannot be said in retrospect that the cost of the assessee to any part of the machinery purchased in 1968 was met by Atlanta Corpn. The Tribunal held that the remission of liability by Atlanta Corpn. long after the liability was incurred, cannot be relied on to hold that Atlanta Corpn. met directly or indirectly part of the cost of the machinery of the assessee purchased as early as 1968. As per section 43(7), if the cost of the asset is met directly or indirectly, at the time of purchase of the machinery, by any other person or authority, to that extent the actual cost of the asset to the assessee will stand reduced. But it is a far cry to state that though at the time of purchase of the machinery, no person met the cost either directly or indirectly, if, long thereafter a debt incurred in that connection is written off, it could be equated to a position that the financier met part of the cost of the asset to the assessee. We are unable to accept the plea that the remission of liability by Atlanta Corpn. can, in any way, be said to be one where the Corpn. met directly or indirectly the cost of the asset to the assessee.

Thus, the ‘actual cost’ of the asset does not undergo any change due to waiver of the loan obtained to acquire that asset. Explanation 10 to section 43(1) has limited applicability when the subsidy, grant or reimbursement is involved. The waiver of loan in no way can be equated with the subsidy, grant or reimbursement.

The next issue then is whether change in cost on account of price difference has any effect. The Supreme Court, in the case of CIT vs. Arvind Mills Ltd. 193 ITR 255, held as under:

‘On strict accountancy principles, the increase or decrease in liability towards the actual cost of an asset arising from exchange fluctuation can be adjusted in the accounts of the earlier year in which the asset was acquired (if necessary, by reopening the said accounts). In that event, the accounts of that earlier year as well as subsequent years will have to be modified to give effect to variations in depreciation allowances consequent on the re-determination of the actual cost. However, though this is a course which is theoretically advisable or precise, its adoption may create a lot of practical difficulties. That is why the Institute of Chartered Accountants gave an option to business people to make a mention of the effect of devaluation by way of a note on the accounts for the earlier year in case the balance sheet in respect thereof has not yet been finalised but actually to give effect to the necessary adjustments in the subsequent years instead of reopening the closed accounts of the earlier year.

So far as depreciation allowance is concerned, under section 32, read with section 43(1) and (6) of the Act, the depreciation is to be allowed on the actual cost of the asset less all depreciation actually allowed in respect thereof in earlier year. Thus, where the cost of the asset subsequently goes up because of devaluation, whatever might have been the position in the earlier year, it is always open to the assessee to insist and for the ITO to agree that the written down value in the year in which the increased liability has arisen should be taken on the basis of the increased cost minus depreciation earlier allowed on the basis of the old cost. The written down value and allowances for subsequent years will be calculated on this footing. In other words, though the depreciation granted earlier will not be disturbed, the assessee will be able to get a higher amount of depreciation in subsequent years on the basis of the revised cost and there will be no problem.
,,,,,,,,,,,,,
To obviate all these doubts and difficulties, section 43A was enacted.
…………………….
We also find it difficult to find substance in the second argument of Shri Salve that sub-section (1) was inserted only to define the year in which the increase or decrease in liability has to be adjusted. It is no doubt true that but for the new section, various kinds of arguments could have been raised regarding the year in which such liability should be adjusted. But, we think, arguments could also have been raised as to whether the actual cost calls for any adjustment at all in such a situation. It could have been contended that the actual cost can only be the original purchase price in the year of acquisition of the asset and that, even if there is any subsequent increase in the liability, it cannot be added to the actual cost at any stage and that, for the purposes of all the statutory allowances, the amount of actual cost once determined would be final and conclusive. Also, section 43A provides for a case in which, as in the present case, the assessee has completely paid for the plant or machinery in foreign currency prior to the date of devaluation but the variation of exchange rate affects the liability of the assessee (as expressed in Indian currency) for repayment of the whole or part of the monies borrowed by him from any person directly or indirectly in any foreign currency specifically for the purposes of acquiring the asset. It is a moot question as to whether in such a case, on general principles, the actual cost of the assessee’s plant or machinery will be the revised liability or the original liability. This is also a situation which is specifically provided for in the section. It may not, therefore, be correct to base arguments on an assumption that the figure of actual cost has necessarily to be modified for purposes of development rebate or depreciation or other allowances and that the only controversy that can arise will be as to the year in which such adjustment has to be made. In our opinion, we need not discuss or express any concluded opinion on either of these issues.’

The Supreme Court has therefore pointed out the situation in the absence of section 43A, which provision applies only to foreign exchange fluctuations. The identical logic would apply to other changes in cost, if such difference in cost is on account of difference in purchase price. In the absence of any specific provision similar to section 43A, any adjustment in cost would not be possible.

Further, the logic applied by the Tribunal in Binjrajka’s case to the effect that write-back of depreciation is a benefit derived by the assessee on waiver of the purchase price, and is therefore taxable u/s 28(iv), does not seem to be justified. A depreciation is only an allowance, and not an expenditure. It is merely an internal book entry to reflect diminution in value of the asset. By writing back depreciation, the assessee cannot be said to have derived any benefit. Further, as held by the Supreme Court in CIT vs. Mahindra & Mahindra Ltd. 404 ITR 1, the benefit taxable u/s 28(iv) has to be a non-monetary benefit and a monetary benefit is not covered by section 28(iv). Therefore, the waiver of cost to the extent of excess depreciation allowed cannot be said to result in a perquisite chargeable to tax u/s 28(iv).

It is very clear that the provisions of section 41(1) would not apply in such a situation of waiver of loan or part of purchase price, as has also been accepted by the Tribunal in both the decisions. The provisions of section 28(iv) would also not apply. There is no other provision by which such waiver of a sum of a capital nature can be subjected to tax. The depreciation allowed in the past on the cost is not an expenditure or trading liability, which has been remitted or has ceased. It is the loan amount or the purchase price of the asset which has been remitted or which has ceased. Depreciation cannot be regarded to be a deduction claimed of such purchase price, being a statutory allowance. Therefore, as rightly pointed out by the Bangalore Bench of the Tribunal, there is a lacuna in law, whereby such waiver is not required to be reduced from the cost of acquisition of the asset or from the written down value, nor is there a requirement for addition by way of reversal of depreciation claimed on such waived amount. The only recourse is to the provisions of section 155, within the specified time limit.

The better view of the matter, therefore, seems to be the view taken by the Bengaluru Bench of the Tribunal in the case of Akzo Nobel Coatings India (P) Ltd. (Supra) that neither the depreciation claimed in the past year can be disallowed nor the written down value for the current year can be adjusted in a case where the loan taken to acquire or a part of the purchase price of the depreciable asset has been waived.

shailesh.kwebmaker

TAX EXEMPTION FOR A REWARD

ISSUE FOR CONSIDERATION

A reward by the Central
Government or a State Government for purposes approved by the Central Government
in the public interest, is exempted from taxation under clause (ii) of section
10(17A) of the Income-tax Act, 1961. Likewise, a receipt of an award instituted
in the public interest by the Central Government or any State Government or by
any other body and approved by the Central Government, is exempt from taxation
as per clause (i) of section 10(17A) of the Act.

Section 10(17A) reads as under;

‘Any payment made, whether in cash or in kind –

(i) in pursuance of any award instituted in the public interest by
the Central Government or any State Government or instituted by any other body
and approved by the Central Government in this behalf; or

(ii) as a reward by the Central Government or any State Government
for such purposes as may be approved by the Central Government in this behalf in
the public interest’.

A controversy has arisen in the context of the eligibility of a
reward by the Central Government or a State Government for the purposes of
exemption from tax under clause (ii) of section 10(17A) where the reward so
conferred is not expressly approved by the Central Government. The issue is
whether such approval can be construed to be implied in a reward so
conferred.

The Patna and Delhi High Courts in the past had held that the awards
instituted by the Government required approval by the Central Government, while
recently the Madras High Court, following an earlier decision, has held that
express approval is not required for the awards so instituted by such Government
and the approval can be implied also and can be gathered from the facts in the
public domain or can be read into a reward.

S.N. SINGH’S CASE

The issue before the Patna High Court first arose in the case of
S.N. Singh, 192 ITR 306 followed by a case before the Delhi High Court in the case of
J.C. Malhotra, 230 ITR
361.

In this case, the assessee, an individual,
was working as an ITO at the material time.. In
appreciation of the meritorious work done by the Income-tax personnel for the
success of the Voluntary Disclosure Scheme, 1975 the Government of India decided
to grant a reward of an amount equal to one month’s basic pay (vide Notification dated 16^th January, 1976). In pursuance of
the Notification, the assessee received a sum by way
of a reward during the assessment year 1976-77. The assessee claimed exemption from income-tax of this amount
under the then section 10(17B). The ITO rejected that claim.

On appeal, the AAC upheld the contention advanced on behalf of the
assessee that the amount of reward could not be
included in computing his total income in view of the provisions of then section
10(17B). On further appeal, the Tribunal agreed with the finding of the AAC and
dismissed the appeal. Aggrieved by the order passed by the Tribunal, the Revenue
sought reference and it was at the instance of the Revenue that the following
question of law had been referred to the Patna High Court for its
opinion:

‘Whether, on the facts and in the circumstances of the case, the
Tribunal has rightly held that the award of Rs. 1,150
received by the assessee is exempt from income-tax u/s
10(17B) of the Income-tax Act, 1961?’

At the time of hearing, no one appeared on behalf of the assessee. From a perusal of the provision it was clear to
the Court that a payment made as reward by the State or Central Government was
not includible in computing the total income only when the reward was for such
purposes as might be approved by the Central Government in that behalf in the
public interest. The Court found that there was no material on record for
holding that the purpose for which the reward in question had been given had
been approved by the Central Government in public interest for the applicability
of clause (17B) of section 10. The Court noted that it was no doubt true that
the payment had been made by the Central Government to the assessee as a reward and that the said payment was also in
the public interest. However, unless and until it was shown by the assessee that such reward had been approved by the Central
Government for purposes of exemption u/s 10(17B), the Court held that such
reward would not qualify for exemption under that section and that the Tribunal, therefore, was
not right in holding that the reward received by the assessee was exempt from income-tax u/s 10(17B).

In the case of CIT vs. J.C. Malhotra, 230 ITR 361
(Delhi) the assessee, who was an ITO at the
relevant time, had been given a reward by the Central Government directly in
connection with the Voluntary Disclosure Scheme. The Tribunal had upheld the
claim of exemption holding that the cash award was exempt from taxation u/s
10(17B). On further appeal by the Revenue, the Delhi High Court observed that a
separate approval of the Central Government for the purpose of exemption u/s
10(17B) was not given and that that being the position, the reward was not
eligible for exemption from Income-tax by relying upon the decision in the case
of CIT vs. S.N. Singh, ITO (Supra).

THE K. VIJAYA KUMAR CASE

Recently, the issue again arose in the case of K. Vijaya Kumar, 422 ITR
304.

In this case, the petitioner in the Indian Police Service had been
appointed as Chief of the Special Task Force (STF) leading ‘Operation Cocoon’
against forest brigand Veerapan, leading to the
latter’s fatal encounter on 18^th October, 2004. In recognition of the
special and commendable services of the STF, the Government of Tamil Nadu had
issued G.O.Ms. No. 364, Housing and Urban Development Department dated
28^th October, 2004 instituting an award in national interest to
personnel of the STF for the valuable services rendered by them as part of the
team. In consequence thereof, G.O.Ms. No. 16, Housing
and Urban Development Department dated 12^th January, 2006 was issued
sanctioning a sum of Rs. 54,29,88,200 towards the cost of 773 plots to be allotted to
STF personnel, including the petitioner. A specific
G.O.Ms. 368, Housing and Urban Development dated 29^th October,
2004 read with G.O.Ms. No. 763 was issued for first allotting an HIG Plot
bearing No. 1A-642 at Thiruvanmiyur Scheme to the
petitioner, subsequently modified to Plot No. 1 adjacent to Andaman Guest House
at Anna Nagar West Extension. A registered deed of sale had been executed on
27^th November, 2009 in consideration of Rs.
1,08,43,000 paid by the Government of Tamil Nadu on his
behalf to the Tamil Nadu Housing Board.

It appears that the assessee had sold the
plot of land and had offered the capital gains for taxation, computed after
deducting the cost of the land that was paid by the Government. The assessment
was completed u/s 143(3) r.w.s. 147 and the capital
gain as computed by the assessee was accepted by the
A.O.

The order of the A.O. was sought to be revised by the Commissioner
u/s 263. In the said order u/s 263, the exemption granted u/s 10(17A) in respect
of the reward of land was questioned by the Commissioner.

At paragraph 8 of the order, the Assessing Authority was directed to
allow the claim of exemption u/s 10(17A) only if the assessee was able to produce an order granting approval of
exemption by the Government of India u/s 10(17A)(ii).

Admitting the writ petition challenging the order, the single judge
of the Madras High Court noted that the question that arose related to whether
the reference to ‘approval’ in section 10(17A) included an implied approval or
whether such approval had to be express.

The Court, referring to the legislative history of the provision,
observed that the erstwhile clause (17A) contained a proviso that required that the ‘effective date’ from which the approval was
granted was to be specified in the order of the Central Government granting such
approval. Noting that the proviso had been omitted in the substituted provision, effective
1^st April, 1989 onwards, it appeared to the Court that while
enlarging the clauses generally, by obviating specific reference to the purposes
for which the awards could be given, the Legislature had also done away with the
specification of a written approval from the Central Government with effect from
1^st April, 1989.

The Madras High Court, approving the decision of the Division Bench
of the Court in the case of CIT vs. J.G. Gopinath, 231 ITR
229 held that the amount of reward received by the assessee was not taxable and was exempt from tax. The single
judge of the Court noted with approval the following part of the decision in the
case of CIT vs. J.G. Gopinath
(Supra):

‘To quote the Ministry of Finance letter F. No. 1-11015/1/76 Ad. IX,
dated January 16, 1976, the first paragraph itself explains the circumstances
under which it is granted, “I am directed to state that in appreciation of the
meritorious work done by the Income-tax personnel for the success of the
voluntary disclosure schemes, the Government have decided to grant them reward
of an amount equal to one month’s basic pay.”

The above extract makes it clear that such reward was granted in
public interest. It would be surprising if the Government were to grant rewards
for reasons other than public interest. It is, therefore, evident that the terms
of section 10(17B) are completely satisfied in the present case as the circular
gives the circumstances under which the rewards are granted. The voluntary
disclosure scheme could only have been conceived in public interest as we do not
see any other reason for this scheme coming into existence. If any person
rendered sincere work to make this scheme a success, and if he is rewarded for
it, such grant of reward cannot but be in public interest. There is no specific
mode of approval indicated in the statute. No further approval is necessary or
called for. The section is clear in its language and does not raise any problem
of construction. Therefore, we do not find that any question of law arises out
of the Tribunal’s order. Even assuming that a question of law arises, the answer
is self-evident and, therefore, the reference shall be wholly academic and
unnecessary. The petition is accordingly dismissed.’

The Court also took note of the contrary view expressed by the Patna
High Court in CIT vs. S.N. Singh (Supra) and the Delhi High Court in CIT vs. J.C. Malhotra (Supra).
The Court observed that the Division Bench of the Patna High Court
took a view directly opposed to the view expressed by the Madras High Court in
the J.G. Gopinath case and the said order delivered prior to the decision of this
Court in the J.G. Gopinath case had not been taken into consideration by the Madras High Court.
It was noted that the Patna High Court had proceeded on a strict interpretation
of the provision rejecting the claim of exemption on the ground that though the
reward by the Central Government to the assessee was
indisputably in public interest, approval by the Central Government was
mandatory for the purpose of exemption u/s 10(17B).

The single judge of the Court observed that sitting in Madras, he was
bound by the view taken by the jurisdictional High Court to the effect that
‘approval’ of the Centre might either be express or implied, and in the latter
case, gleaned from surrounding circumstances and events. Thus, that was the
perspective from which the eligibility of the petitioner u/s 10(17A) to
exemption or otherwise should be tested and decided.

On a reading of section 321 of the Criminal Procedure Code and the
judgment of a three-Judge Bench in the case of Abdul Karim vs. State of Karnataka [2000] 8
SCC 710, the issue faced by the country because of the operations carried on
by Veerapan and his associates was found to be grave
and enormous by the single judge of the Madras High Court. The categorical
assertion of the Apex Court that Veerapan was acting
in consultation with secessionist organisations with the object of splitting
India, in the Court’s view, was a vital consideration to decide the present
lis.

The object of section 10(17A), the Court noted, was to reward an
individual who had been recognised by the Centre or the State for rendition of
services in public interest. The Court noted that no specification or
prescription had been set out in terms of how the approval was to be styled or
even as to whether a formal written approval was required and nowhere in the
Rules / Forms was there reference to a format of approval to be issued in this
regard.

One should, in the Court’s view, interpret the provision and its
application in a purposive manner bearing in mind the spirit and object for
which it had been enacted. It was clear that the object of such a reward was by
way of recognition by the State of an individual’s efforts in protecting public
interest and serving society in a significant manner. Thus, in the Court’s
considered view, the reference to ‘approval’ in section 10(17A) did not only
connote a paper conveying approval and bearing the stamp and seal of the Central
Government, but any material available in public domain indicating recognition
for such services, rendered in public interest.

Allowing the petition of the assessee, the
Court in the concluding paragraph held as under: ‘The petitioner has been recognised by the Central Government on
several occasions for meritorious and distinguished services and from the
information available in public domain, it is seen that he was awarded the Jammu
& Kashmir Medal, Counter Insurgency Medal, Police Medal for Meritorious
Service (1993) and the President’s Police Medal for Distinguished Service
(1999). Specifically for his role in nabbing Veerapan,
he was awarded the President’s Police Medal for Gallantry on the eve of
Independence Day, 2005. What more! If this does not constitute recognition by
the Centre of service in public interest, for the same purposes for which the
State Government has rewarded him, I fail to understand what is. The reward
under section 10(17A)(ii) is specific to certain “purposes” as may be approved
by the Central Government in public interest and the “purpose” of the reward by
the State Government has been echoed and reiterated by the Centre with the
presentation of the Gallantry Award to the petitioner in 2005. This aspect of
the matter is also validated by the Supreme Court in Abdul Karim (Supra) as can be seen from the judgment extracted earlier, where the Bench
makes observations on the notoriety of Veerapan and
the threat that he posed to the country as a whole.

Seen in the context of the recognition by the Centre of the
petitioners’ gallantry as well as the observations of the Supreme Court in
Abdul Karim (Supra) and the ratio of the decision in J.G. Gopinath (Supra), the approval of the Centre in this case, is rendered a
fait accompli.’

OBSERVATIONS

At the outset, for the record it is noted that in the original scheme
of the Act of 1961, section 10(17A) [inserted by the Direct Taxes (Amendment)
Act, 1974] provided for tax exemption for an award w.r.e.f. 1^st April, 1973 and a separate provision
in the form of section 10(17B) [inserted by the Direct Taxes (Amendment) Act,
1974] provided for tax exemption for a reward w.r.e.f.
1^stApril, 1973. The two reliefs are now conferred under a new
provision of section 10(17A) made effective from 1^st April, 1989.
Clause (i) of the said new section provides for exemption for an award, while
clause (ii) provides for exemption for a reward. While both the clauses provide
for some approval by the Central Government, the issue for the present
discussion is limited to whether such approval should be specifically obtained
or such approval should be presumed to have been granted when a reward is
conferred, especially by the Central Government.

The issue under consideration moves in a very narrow compass. There
is no dispute that a reward, to qualify for exemption from tax, should be one
that is approved by the Central Government. The debate is about whether such an
approval should necessarily be in writing and express under a written order or
whether such an order of approval can be gathered by implication, and whether
implied approval can be gathered by referring to the facts of the services of
the recipient available in public domain. In other words, by the very fact that
a person has been rewarded for his services to the public, it should be
construed that it was in public interest to do so and the availability of
information of his services in public domain should be a fact good enough to
imply a tacit approval by the Central Government of such a reward, and no
insistence should be pressed for a written approval.

It is possible to hold that the requirement of a written order has
been done away with by the deletion of the proviso w.e.f. 1^st April, 1989 in the then prevailing 10(17A), which
removed the requirement of referring to the purpose and the assessment year in
the order, implying that the Legislature has done away with the specification of
written approval from that date.

The legislative intent behind the exemption, no doubt, is not to tax
a person in receipt of a reward from the Central or State Government. The
approval for the purpose is incidental to the main intention of exempting such
receipts. The need for such approval in writing is at the most a procedural or
technical requirement, the non-compliance of which should not result in total
denial of the exemption, defeating the legislative intent.

The very fact that the reward is conferred by the Government along
with the fact that the facts of the rewards are in the public domain, should be
sufficient to determine the grant of exemption from tax in public
interest.

A purposive and liberal interpretation here advances the cause
of justice and public good.

Writing is
the process by which you realize that you do not
understand what you are
talking about

— Shane Parrish

There is no
austerity equal to a balanced mind, and there is no happiness equal
to
contentment; there is no disease like covetousness, and no virtue like
mercy

— Chanakya

shailesh.kwebmaker

TAXABILITY OF INTEREST ON ENHANCED COMPENSATION OR CONSIDERATION

ISSUE FOR CONSIDERATION

Section 45(5) of
the Income-tax Act provides for taxability of the capital gains arising from
(i) the transfer of a capital asset by way of compulsory acquisition under any
law, or (ii) on a transfer the consideration for which was determined or
approved by the Central Government or the Reserve Bank of India, or (iii)
compensation or consideration which is enhanced or further enhanced by any
court, tribunal or other authority. Inter alia, clause (b) of section
45(5) provides for the taxability of the enhanced compensation or consideration
as awarded by a court, tribunal or other authority as deemed capital gains in
the previous year in which such enhanced compensation or consideration is
received by the assessee.

Section 10(37)
exempts the capital gains arising to an individual or an HUF from the transfer
of agricultural land by way of compulsory acquisition where the compensation or
consideration or the enhanced compensation or consideration is received on or
after 1^st April, 2004 subject to fulfilment of other conditions as
specified therein. Further, section 96 of the Right to Fair Compensation and
Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013
exempts the compensation received for compulsory acquisition of land under
defined circumstances (except those made u/s 46 of that Act) from the levy of
income tax. This exemption provided under the RFCTLARR Act is available
irrespective of whether the land acquired compulsorily is agricultural or
non-agricultural land.

In the case of land
acquired under the Land Acquisition Act, 1894 the person whose land has been acquired,
if aggrieved by the amount of compensation originally granted to him, may
require the matter to be referred to the Court u/s 18 of the 1894 Act for the
re-determination of the amount of the compensation. The Court may enhance the
amount of compensation payable to the claimant and also direct the authority
concerned to pay interest on the enhanced amount of compensation and also
interest for the delay caused in payment of the compensation otherwise ordered.
Section 28 of the 1894 Act empowers the Court to award interest at its
discretion on the excess amount of compensation awarded by it over the amount
originally awarded. Section 34 of that Act also provides for the liability of
the land acquisition authority concerned to pay interest, which is, however,
totally different from the interest referred to in section 28. The interest
payable u/s 34 is for the delay in paying the awarded compensation and it is
mandatorily payable.

A controversy had
arisen with respect to the nature of the interest received by the assessee on
the amount of enhanced compensation as per the directions of the Court in
accordance with the provisions of section 28 of the 1894 Act and the year of
taxation thereof which was settled by the Supreme Court in the case of CIT
vs. Ghanshyam (HUF) [2009 315 ITR 1] by holding that the interest
granted u/s 28 of the 1894 Act was an accretion to the value and, hence, it was
a part of the enhanced compensation which was taxable as capital gains u/s
45(5). Subsequent to the decision, the Finance (No. 2) Act, 2009 inserted
clause (viii) in section 56(2) and clause (iv) in section 57 and section 145A/B
to specifically provide for taxability of interest received on compensation or
enhanced compensation as income from other sources and for deduction of 50% of
the interest amount.

This set of
amendments in sections 56(2), 57, 145A and later in 154B has given a rise to a
fresh controversy about the head of taxation under which the interest in
question awarded u/s 28 of the 1894 Act is taxable: whether such interest was
taxable under the head ‘capital gains’ or ‘income from other sources’ and
whether what is termed as interest under the said Act be treated differently
under the Income-tax Act.

The Gujarat High
Court has taken a view that the interest granted u/s 28 of the 1894 Act
continues to be taxable as capital gains in accordance with the decision of the
Supreme Court in the case of Ghanshyam (HUF) (Supra) even after
the set of amendments to tax ‘interest’ as income from other sources. As a
corollary, tax ought not to have been deducted on that amount of interest u/s
194A. As against this, the Punjab & Haryana High Court has held that
interest granted u/s 28 of the 1894 Act needs to be taxed as income from other
sources in view of the specific provision contained in section 56(2)(viii) in
this regard and, therefore, the assessee was not entitled to the exemption from
tax under provisions of section 10(37) of the Act.

THE MOVALIYA BHIKHUBHAI BALABHAI CASE

The issue first
came up for consideration of the Gujarat High Court in the case of Movaliya
Bhikhubhai Balabhai vs. ITO (2016) 388 ITR 343.

In this case, the
assessee was awarded additional compensation in respect of his land along with
the other benefits under the 1894 Act. Pursuant to this award passed by the
Reference Court, the authorities concerned inter alia determined the
amount of Rs. 20,74,157 as interest payable u/s 28 of that Act. Against this
interest, the amount of TDS to be deducted as per section 194A was also shown
in the relevant statement issued to the assessee. The assessee made an
application in Form No. 13 u/s 197(1) for issuing a certificate for Nil tax
liability. But the application was rejected on the ground that the interest
amount on the delayed payment of compensation and enhanced value of
compensation was taxable as per the provisions of section 56(2)(viii) read with
sections 57(iv) and 145A(b). The assessee approached the High Court by filing a
petition against the rejection of his application.

Before the High
Court, the assessee relied upon the decision of the Supreme Court in the case
of Ghanshyam (HUF) (Supra) and claimed that interest u/s 28 was,
unlike interest u/s 34 of the 1894 Act, an accretion in value and regarded as a
part of the compensation itself which was not the case with interest u/s 34.
Therefore, when the interest u/s 28 of the 1894 Act was to be treated as part
of compensation and was liable to capital gains u/s 45(5), such amount could
not be treated as income from other sources and, hence, no tax could be
deducted at source by considering the same to be interest. Reliance was also
placed on the decisions of the Punjab & Haryana High Court in the cases of Jagmal
Singh vs. State of Haryana rendered in Civil Revision No. 7740 of
2012 on 18^th July, 2013 and Haryana State Industrial
Development Corpn. Ltd. vs. Savitri rendered in Civil Revision
No. 2509 of 2012 on 29^th November, 2013, wherein it was held
that there was no requirement of deducting tax at source from the amount of
interest determined to be payable u/s 28 of the Land Acquisition Act.

It was argued on
behalf of the Revenue that the A.O. was justified in rejecting the application
of the assessee in view of the specific provision contained in sub-clause
(viii) of section 56(2) providing that income by way of interest received on
compensation or on enhanced compensation referred to in clause (b) of section
145A was chargeable to income tax under the head ‘income from other sources’.
It was submitted that the interest on enhanced compensation u/s 28 of the 1894
Act being in the nature of enhanced compensation, was deemed to be the income
of the assessee in the year in which it was received as provided in section
145A and had to be taxed as per the provisions of section 56(2)(viii) as income
from other sources. As regards the decision of the Supreme Court in the case of
Ghanshyam (HUF), it was submitted that it was rendered prior to
the amendment in the I.T. Act whereby clause (b), which provided that interest
received by an assessee on compensation or on enhanced compensation, as the
case may be, shall be deemed to be income in the year in which it is received,
came to be inserted in section 145A of the Act and, hence, would not have any
applicability in the facts of the present case.

The Revenue relied
upon the decisions of the Punjab & Haryana High Court in the case of CIT
vs. Bir Singh (HUF) ITA No. 209 of 2004 dated 27^th October, 2010
which was later followed in the case of Hari Kishan vs. Union of India
[CWP No. 2290 of 2001 dated 30^th January, 2014]; Manjet Singh (HUF)
Karta Manjeet Singh vs. Union of India [2016] 65 taxmann.com 160; and
of the Delhi High Court in the case of CIT vs. Sharda Kochhar [2014] 49
taxmann.com 120.

The High Court
extensively referred to the decision of the Supreme Court in the case of Ghanshyam
(HUF) wherein various provisions of the 1894 Act were analysed vis-à-vis
the provisions of the Income-tax Act. On the basis of this decision, the High
Court reiterated that there was a vital difference between the interest payable
u/s 28 and the interest payable u/s 34 of the 1894 Act. Section 28 applies when
the amount originally awarded has been paid or deposited and when the court
awards excess amount. In such cases, interest on that excess alone is payable.
Section 28 empowers the court to award interest on the excess amount of
compensation awarded by it over the amount awarded by the Collector. This award
of interest is not mandatory but is left to the discretion of the court. It was
further held that section 28 is applicable only in respect of the excess amount
which is determined by the court and it does not apply to cases of undue delay
in making award for compensation. The interest u/s 34 is only for delay in
making payment after the compensation amount is determined. Accordingly, the
Supreme Court had held that interest u/s 28 of the 1894 Act was an accretion to
compensation and formed part of the compensation and was, therefore, exigible
to tax u/s 45(5). The decision in the case of Ghanshyam (HUF) was
followed by the Supreme Court in a later case, that of CIT vs. Govindbhai
Mamaiya [2014] 367 ITR 498.

Insofar as the provisions of section 57(iv) read with section
56(2)(viii) and section 145A(b) were concerned, the High Court held that the
interest received u/s 28 of the 1894 Act would not fall within the ambit of the
expression ‘interest’ as envisaged u/s 145A(b) inasmuch as the Supreme Court in
the case of Ghanshyam (HUF) had held that interest u/s 28 of the
1894 Act was not in the nature of interest but was an accretion to the
compensation and, therefore, formed part of the compensation. Further, a
reference was made to CBDT Circular No. 5/2010 dated 3^rd June, 2010
wherein the scope and effect of the amendment made to section 56(2) and also to
section 145A were explained. It was clarified in the said circular that undue
hardship had been caused to the taxpayers as a result of the Supreme Court’s
decision in the case of Smt. Rama Bai vs. CIT (1990) 181 ITR 400
wherein it was held that arrears of interest computed on delayed or enhanced
compensation shall be taxable on accrual basis. It was to mitigate this
hardship that section 145A was amended to provide that the interest received by
an assessee on compensation or enhanced compensation shall be deemed to be his
income for the year in which it was received, irrespective of the method of
accounting followed by the assessee. By relying upon this clarification, the
High Court held that the amendment by the Finance (No. 2) Act, 2009 was not in
connection with the decision of the Supreme Court in the Ghanshyam (HUF)
case but was brought in to mitigate the hardship caused to the assessee on
account of the decision of the Supreme Court in the case of Rama Bai
(Supra).

The High Court did
not agree with the view adopted by the other High Courts in the cases which
were relied upon by the Revenue as it was contrary to what had been held in the
decision of the Supreme Court in Ghanshyam (HUF). The High Court
held that the deduction of tax at source u/s 194A from the amount of interest
granted u/s 28 of the 1894 Act was not justified.

MAHENDER PAL NARANG’S CASE

The issue recently
came up for consideration before the Punjab & Haryana High Court in the
case of Mahender Pal Narang vs. CBDT (2020) 423 ITR 13.

In this case, land
of the assessee was acquired during the previous years relevant to the
assessment years 2007-08 and 2008-09 for the compensation determined by the
acquisition authorities which was challenged by the assessee and the
corresponding enhanced compensation was received on 21^st March,
2016. The assessee filed his income-tax return for the assessment year 2016-17
treating the interest received u/s 28 of the 1894 Act as income from other
sources and claimed deduction of 50% as per section 57(iv). Thereafter, the
assessee filed an application u/s 264 claiming that the interest was wrongly
offered as income from other sources, whereas the same was required to be
treated as part of the enhanced compensation under the head capital gains and
the gains were to be exempted from taxation u/s 10(37). However, the revisional
authority rejected the application. The assessee then filed a writ petition
before the High Court against the said rejection order passed u/s 264.

The assessee
contended before the High Court that the interest received as part of the
additional compensation was in the nature of compensation that was not taxable
u/s 10(37) and further argued that the provisions of section 10(37) have
remained unchanged, though sections 56(2)(viii) and 57(iv) had been inserted by
the Finance (No. 2) Act, 2009 with effect from 1^stApril, 2010. The
amendments were brought in to remove the hardships created by the decision of
the Supreme Court in the case of Rama Bai (Supra) as explained by
Circular No. 5 of 2010. It was contended that the nature of interest u/s 28 of
the 1894 Act would remain that of compensation even after the amendments. The
assessee also relied upon the decision of the Supreme Court in CIT vs.
Ghanshyam (HUF) as well as of the Gujarat High Court in Movaliya
Bhikhubhai Balabhai vs. ITO (Supra).

The High Court
referred to the provisions of sections 45(5), 56(2)(viii) and 57(iv) as well as
the decision of the Supreme Court in CIT vs. Ghanshyam (HUF).
After dealing with them, it was held that the scheme with regard to
chargeability of interest received on compensation and enhanced compensation
had undergone a sea change with the insertion of sections 56(2)(viii) and
57(iv) in the Act. In view of the amendments, according to the Punjab &
Haryana High Court, the decision of the Apex Court in the Ghanshyam
case did not come to the rescue of the assessee to claim that interest received
u/s 28 of the 1894 Act was to be treated as compensation and to be dealt with
under ‘capital gains’. The argument raised that there was no amendment in
section 10(37) was considered to be ill-founded, on the ground that it dealt
with capital gains arising from transfer of agricultural land and it nowhere
provided as to what was to be included under the head ‘capital gains’.

The High Court did
not agree with the view taken by the Gujarat High Court in the Movaliya
Bhikhubhai Balabhai case that amendment by the Finance (No. 2) Act,
2009 was not in connection with the decision of the Supreme Court in the Ghanshyam
case but to mitigate the hardship caused by the decision of the Supreme Court
in the Rama Bai case. The interpretation based on Circular No. 5
of 2010 did not influence the Punjab & Haryana High Court and it was held
that there was no scope of taking outside aid for giving such an interpretation
to newly-inserted provisions when their language was plain, simple and
unambiguous. Accordingly, it was held that the interest received on compensation
or enhanced compensation was to be treated as ‘income from other sources’ and
not under the head ‘capital gains’.

In deciding the
issue in favour of the Revenue, the High Court chose to follow its own
decisions in the cases of CIT vs. Bir Singh (HUF) in ITA No. 209 of 2004
dated 27^th October, 2010 which was later on followed in the
case of Hari Kishan vs. Union of India [CWP No. 2290 of 2001 dated 30^th
January, 2014]; Manjet Singh (HUF) Karta Manjeet Singh vs. Union of India
[2016] 65 taxmann.com 160; and the decision of the Delhi High Court in the case of CIT
vs. Sharda Kochhar [2014] 49 taxmann.com 120. The Court overlooked its
own decisions, delivered in the context of TDS, in the cases of Jagmal
Singh vs. State of Haryana rendered in Civil Revision No. 7740 of
2012 on 18^th July, 2013 and Haryana State Industrial
Development Corpn. Ltd. vs. Savitri rendered in Civil Revision
No. 2509 of 2012 on 29^thNovember, 2013, wherein it was held
that there was no requirement of deducting tax at source from the amount of
interest determined to be payable u/s 28 of the Land Acquisition Act, 1894.

OBSERVATIONS

There can be three
different components of amount received or to be received by a person whose
land has been compulsorily acquired under any law for the time being in force:
the initial compensation which is awarded by the competent authority, the
enhanced compensation which is awarded by the court, and interest, on
compensation or the enhanced compensation which becomes payable due to the
direction of the court or due to the statutory provision of the relevant law.

Sub-section (5) of
section 45 is a charging provision and it creates a charge on the capital gains
on transfer of a capital asset, being a transfer by way of compulsory
acquisition under any law, or a transfer where the consideration for which is
determined or approved by the Central Government or the Reserve Bank of India.
The relevant portion of the sub-section (5) of section 45 is reproduced below:

Notwithstanding
anything contained in sub-section (1), where the capital gain arises from the
transfer of a capital asset, being a transfer by way of compulsory acquisition
under any law, or a transfer the consideration for which was determined or
approved by the Central Government or the Reserve Bank of India, and the
compensation or the consideration for such transfer is enhanced or further
enhanced by any court, Tribunal or other authority, the capital gain shall be
dealt with in the following manner, namely…

It can be noticed
that an accrual or a receipt which can be considered as ‘the compensation or
the consideration’ in the circumstances specified in section 45(5) gets covered
within the ambit of this provision and needs to be taxed as ‘capital gains’ in
the manner provided therein. In particular, sub-clause (b) of section 45(5)
deals with the taxability of the enhanced amount of compensation or
consideration and it provides as under:

(b) the amount
by which the compensation or consideration is enhanced or further enhanced by
the court, Tribunal or other authority shall be deemed to be income chargeable
under the head ‘Capital gains’ of the previous year in which such amount is
received by the assessee.

Therefore, the
whole of the amount by which the compensation or consideration is enhanced by
the court is deemed to be the income chargeable under the head capital gains
irrespective of the manner in which such enhanced amount of the compensation or
consideration has been determined or how that amount has been referred to in
the relevant governing law under which it has been determined. What is relevant
is that the compensation or the enhanced amount needs to be brought to tax
under the head ‘capital gains’ by virtue of the deeming fiction created under
the aforesaid provisions.

There are no
separate or specific provisions dealing with the taxability of the interest
received on compensation or enhanced compensation which is being taxed as per
the general provisions of the Act, particularly sections 56 to 59. The
confusion about the year of taxation was addressed by the Apex Court in the
case of Smt. Ramabai. A set of the specific provisions was
inserted in the Act by the Finance (No. 2) Act, 2009 with effect from 1^st
April, 2010 to provide that such interest shall be taxable in the year of
receipt nullifying the ratio of the Supreme Court decision. The issue of
taxation of such interest was dealt with extensively by the Supreme Court in
the case of Ghanshyam (HUF) while dealing with the taxation of
capital gains u/s 45(5). The issue before the Supreme Court was about the year
in which the enhanced compensation and interest thereon, received by the
assessee, were taxable. The assessee contended that those amounts could not be
held to have accrued to him during the year of receipt, as the entire amount
received was in dispute in appeal before the High Court, which appeal stood
filed by the State against the order of the reference Court granting enhanced
compensation; and that the amount of enhanced compensation and the interest
thereon were received by him in terms of the interim order of the High Court
against his furnishing of security to the satisfaction of the executing Court.
As against this, the Revenue pleaded that those amounts in question were
taxable in the concerned year of receipt in which they were received by relying
upon section 45(5).

For deciding this
issue, of the year in which the enhanced compensation as well as interest
thereon were taxable, the Supreme Court in that case, of Ghanshyam (HUF),
had to first decide as to what fell within the meaning of the term
‘compensation’ as used in section 45(5). It was for the obvious reason that if
any of the components of the receipt could not be regarded as ‘compensation’,
then such component would not be governed by the provisions of section 45(5) so
as to deem it to be income chargeable under the head ‘capital gains’. Apart
from dealing with the nature of different amounts which were awarded under
different sub-sections of section 23 of the Land Acquisition Act, 1894 as part
of the enhanced compensation, the Supreme Court also determined the true nature
of receipt of ‘interest’ granted under two different provisions of that Act,
i.e., sections 28 and 34. These two provisions dealing with the interest to be
paid to the person whose land has been acquired are as follows:

28. Collector
may be directed to pay interest on excess compensation

If the sum
which, in the opinion of the Court, the Collector ought to have awarded as
compensation is in excess of the sum which the Collector did award as
compensation, the award of the Court may direct that the Collector shall pay
interest on such excess at the rate of nine per centum per annum from the date
on which he took possession of the land to the date of payment of such excess
into Court

34. Payment of
interest

When the amount
of such compensation is not paid or deposited on or before taking possession of
the land, the Collector shall pay the amount awarded with interest thereon at
the rate of nine per centum per annum from the time of so taking possession
until it shall have been so paid or deposited.

The Supreme Court,
explaining the distinction between the interest that became payable under both
the above provisions of the 1894 Act held that the interest u/s 28 only was
needed to be considered as part of the compensation itself. The relevant
extracts from the Supreme Court’s decision in this regard are reproduced below:

Section 28
applies when the amount originally awarded has been paid or deposited and when
the Court awards excess amount. In such cases interest on that excess alone is
payable. Section 28 empowers the Court to award interest on the excess amount
of compensation awarded by it over the amount awarded by the Collector…

This award of
interest is not mandatory but is left to the discretion of the Court. Section
28 is applicable only in respect of the excess amount, which is determined by
the Court after a reference under section 18 of the 1894 Act. Section 28 does
not apply to cases of undue delay in making award for compensation [See: Ram
Chand vs. Union of India (1994) 1 SCC 44]. In the case of Shree Vijay
Cotton & Oil Mills Ltd. vs. State of Gujarat [1991] 1 SCC 262, this
Court has held that interest is different from compensation.

To sum up,
interest is different from compensation. However, interest paid on the excess
amount under section 28 of the 1894 Act depends upon a claim by the person
whose land is acquired whereas interest under section 34 is for delay in making
payment. This vital difference needs to be kept in mind in deciding this
matter. Interest under section 28 is part of the amount of compensation whereas
interest under section 34 is only for delay in making payment after the
compensation amount is determined. Interest under section 28 is a part of
enhanced value of the land which is not the case in the matter of payment of
interest under section 34.

The issue to be
decided before us – what is the meaning of the words ‘enhanced compensation /
consideration’ in section 45(5)(b) of the 1961 Act? Will it cover ‘interest’?
These questions also bring in the concept of the year of taxability.

Section 28 of
the 1894 Act applies only in respect of the excess amount determined by the
Court after reference under section 18 of the 1894 Act. It depends upon the
claim, unlike interest under section 34 which depends on undue delay in making
the award. It is true that ‘interest’ is not compensation. It is equally true
that section 45(5) of the 1961 Act refers to compensation. But as discussed
hereinabove, we have to go by the provisions of the 1894 Act, which awards
‘interest’ both as an accretion in the value of the lands acquired and interest
for undue delay. Interest under section 28 unlike interest under section 34 is
an accretion to the value, hence it is a part of enhanced compensation or
consideration which is not the case with interest under section 34 of the 1894
Act.

Thus, though a
component of the amount received was referred to as the ‘interest’ in section
28 of the 1894 Act, such part was to be considered to be part of the
‘compensation’ insofar as section 45(5) of the Income-tax Act was concerned.
When it came to the ‘interest’ referred to in section 34 of the 1894 Act, it
was to be treated as interest simpliciter and not as the ‘compensation’
for tax purposes and such interest was to be brought to tax as per the general
provisions of the law. This was because of the Court’s understanding that
interest u/s 28 was in the nature of damages awarded for granting insufficient
compensation in the first instance. The Court held that the interest under the
latter section 34 was to make up the loss due to delay in making the payment of
the compensation, the former section 28 interest being at the discretion of the
court and the latter section 34 interest being mandatory.

Later, this
decision in the case of Ghanshyam (HUF) was followed by the
Supreme Court in the cases of CIT vs. Govindbhai Mamaiya (2014) 367 ITR
498 and CIT vs. Chet Ram (HUF) (2018) 400 ITR 23.

Now the question
arises as to whether the amendments made by the Finance (No. 2) Act, 2009 with
effect from 1^st April, 2010 have altered the position. The relevant
amendments are narrated below:

Section 145A as existing then was substituted
whereby a sub-clause (b) was added to it to provide as under:

(b) interest
received by an assessee on compensation or on enhanced compensation, as the
case may be, shall be deemed to be the income of the year in which it is
received.

Sub-clause (viii) was inserted in sub-section
(2) of section 56 to provide as under:

(viii) income by
way of interest received on compensation or on enhanced compensation referred
to in clause (b) of section 145A.

Sub-clause (iv) was inserted in section 57 to
provide as under:

(iv) in the case
of income of the nature referred to in clause (viii) of sub-section (2) of
section 56, a deduction of a sum equal to fifty per cent of such income and no
deduction shall be allowed under any other clause of this section.

These amendments,
in our considered opinion, will apply only if the receipt concerned, like in
section 34 of the 1894 Act, can be regarded as ‘interest’ in the first place
and not otherwise. If the amount concerned has already been considered to be a
part of the compensation and, hence, governed by section 45(5), it cannot be
recharacterised as ‘interest’ merely by relying on the aforesaid amended
provisions. The characterisation of a particular receipt either as
‘compensation’ or ‘interest’ needs to be done independent of these provisions
and one needs to apply these amended provisions only if it has been
characterised as ‘interest’. Therefore, the basis on which the interest payable
u/s 28 of the 1894 Act has been regarded as part of the compensation by the
Supreme Court still prevails and does not get overruled by the aforesaid
amendments.

Recently, in the
context of a motor accident claim made under the Motor Vehicles Act, the Bombay
High Court in the case of Rupesh Rashmikant Shah vs. UOI (2019) 417 ITR
169, after considering the amended provisions of the Income-tax Act,
has held that interest awarded under the said Act as a part of the claim did
not become chargeable to tax merely because of the provision contained in
clause (viii) of section 56(2) of the Income-tax Act. Please see BCAJ Volume
51-A Part 3, page 51 for a detailed analysis of the nature of interest
awarded under the Motor Vehicles Act and the implications of section 56(2)
r/w/s 145A/B thereon. The relevant portion from this decision is reproduced
below:

We, therefore, hold that the interest awarded in
the motor accident claim cases from the date of the Claim Petition till the
passing of the award or in case of Appeal, till the judgment of the High Court
in such Appeal, would not be exigible to tax, not being an income. This
position would not change on account of clause (b) of section 145A of the Act
as it stood at the relevant time amended by Finance Act, 2009 which provision
now finds place in sub-section (1) of section 145B of the Act. Neither clause
(b) of section 145A, as it stood at the relevant time, nor clause (viii) of
sub-section (2) of section 56 of the Act, make the interest chargeable to tax
whether such interest is income of the recipient or not.

Further, section
2(28A) defines the term ‘interest’ in a manner that includes the interest
payable in any manner in respect of any moneys borrowed or debt incurred. In a
case of compulsory acquisition of land, there is obviously no borrowing of
monies. Is there any debt incurred? The ‘incurring’ of the debt, if at all,
arises only on grant of the award for enhanced compensation. Before the award
for the enhanced compensation, there is really no debt that can be said to have
been incurred in favour of the person receiving compensation. In fact, till
such time as the enhanced compensation is awarded there is no certainty about
the eligibility to it, leave alone the quantum of the compensation. This is
also one of the reasons in support of the argument that the amount so awarded
u/s 28 of the 1894 Act cannot be construed as ‘interest’ even when it is
referred to as ‘interest’ therein.

It is important to
appreciate the objective for the introduction of the amendments in sections
56(2), 57(iv) and 145A/B which was to provide for the year in which interest
otherwise taxable is to be taxed. This objective is explained in clear terms by
Circular No. 5/2010 dated 3^rd June, 2010 issued by the CBDT for
explaining the objective behind the introduction. The relevant paragraph of the
Circular reads as under:

‘The existing provisions
of Income Tax Act, 1961, provide that income chargeable under the head
“Profits and gains of business or profession” or “Income from
other sources”, shall be computed in accordance with either cash or
mercantile system of accounting regularly employed by the assessee. Further the
Hon’ble Supreme Court in the case of Smt. Rama
Bai vs. CIT (1990) 84 CTR (SC) 164 : (1990) 181 ITR 400 (SC) has held that arrears of interest computed on delayed or enhanced
compensation shall be taxable on accrual basis. This has caused undue hardship
to the taxpayers. With a view to mitigate the hardship, section 145A is amended
to provide that the interest received by an assessee on compensation or
enhanced compensation shall be deemed to be his income for the year in which it
was received, irrespective of the method of accounting followed by the
assessee.

Further, clause
(viii) is inserted in sub-section (2) of the section 56 so as to provide that
income by way of interest received on compensation or enhanced compensation
referred to in clause (b) of section 145A shall be assessed as “income
from other sources” in the year in which it is received.’

In the
circumstances, it is clear that the provisions of clause (viii) of section 56
and clause (iv) of section 57 and section 145A/B are not the charging sections
in respect of interest under consideration and their scope is limited to
defining the year of taxation of a receipt which is otherwise characterised as
interest.

The amendment as noted by the Gujarat High Court was brought about by the
Legislature to alleviate the difficulty that arose due to the decision of the
Apex Court in the case of Smt. Rama Bai vs. CIT, 181 ITR 400
wherein it was held that arrears of interest computed on delayed or enhanced
compensation should be taxable on accrual basis in the respective years of
accrual. It was to mitigate this hardship that section 145A was amended to
provide that the interest received by an assessee on compensation or enhanced
compensation shall be deemed to be his income for the year in which it was
received, irrespective of the method of accounting followed by the assessee. By
relying upon this clarification, the Gujarat High Court held that the concerned
amendments by the Finance (No. 2) Act, 2009 were not in connection with the
decision of the Supreme Court in the Ghanshyam (HUF) case but was
brought in to mitigate the hardship caused to the assessee on account of the
decision of the Supreme Court in the Rama Bai case.

Summing up, it is appropriate to not decide
the taxability or otherwise and also the head of taxation simply on the basis
of the nomenclature used in the relevant law under which the payment is made,
of compensation or enhanced compensation or interest, whatever the case may be.
The receipt for it to be classified as ‘interest’ or ‘compensation’ should be
tested on the touchstone of the provisions of the Income-tax Act. The better
view, in our considered opinion, is the view expressed by the Gujarat High
Court that the interest received u/s 28 of the Land Acquisition Act, 1894
should be taxed as capital gains in accordance with the provisions of section
45(5), subject to the exemption provided in section 10(37), and not as
interest, and no tax at source should be deducted therefrom u/s 194A.

shailesh.kwebmaker

DEEMED GRANT OF REGISTRATION U/S 12A

ISSUE FOR CONSIDERATION

In order
for the income of a charitable or religious institution to be eligible for
exemption u/s 11 of the Income-tax Act, the institution has to be registered
with the Commissioner of Income Tax u/s 12A read with section 12AA. For this
purpose, the institution has to file an application for registration u/s
12A(1)(aa) and the Commissioner on receipt of the application is required to
then follow the procedure laid down in section 12AA by passing an appropriate
order. Section 12AA(2) provides that every such order of the Commissioner
granting or refusing registration has to be passed before the expiry of six months
from the end of the month in which the application was received by him.

But often
it is seen that the Commissioner fails to act on the application within the
prescribed time, leaving the institution without registration. An issue arises
in such cases before the Courts about the status of the institution where the
Commissioner does not pass any order u/s 12AA within the time limit. Is the
institution to be treated as unregistered, which it is, or is it to be deemed
to be registered on failure of the Commissioner to act within the prescribed
time? While the Kerala and the Rajasthan High Courts, following an earlier
decision of the Allahabad High Court upheld on an appeal decided by the Supreme
Court, have held that in such a situation the registration u/s 12AA is deemed
to have been granted on the expiry of the period of six months, the Gujarat
High Court, following a subsequent Full Bench decision of the Allahabad High
Court, has held that the expiry of the period of six months does not result in
a deemed registration of the institution. In deciding the issue, the Gujarat
High Court held that the Supreme Court in the above referred appeal had left
the issue of deemed registration open while the other High Courts followed the
decision of the Apex Court on the understanding that it had held that the
institution was deemed to be registered once the time for rejecting the
application and refusing the registration was over. The added controversy,
therefore, moves in a narrow compass whereunder it is to be examined whether
the Supreme Court really adjudicated the issue as understood by the Kerala and
Rajasthan High Courts or whether the Court had kept the same open as held by
the Gujarat High Court.

TWO INTRICATELY LINKED CASES

The issue
had first come up before the Allahabad High Court in the case of Society for the Promotion of Education, Adventure Sport &
Conservation of Environment vs. CIT 372 ITR 222 and a
little later before the Full Bench of the same High Court in the case of CIT vs. Muzafar Nagar Development Authority 372 ITR 209.
Both these cases are intricately linked and therefore it is thought fit to
consider them at one place.

In the
Society’s case, the assessee was running a school. Till A.Y. 1998-99 it was
claiming exemption u/s 10(22). It had, therefore, not registered itself u/s 12A
to claim exemption u/s 11. Since section 10(22) was omitted by the Finance Act,
1998, the Society applied for registration u/s 12A with retrospective effect,
since the inception of the Society. But because the application was not made
within one year from the date of its establishment as required by the law at
that point of time, the Society sought for condonation of delay in making an
application.

No
decision was taken by the Commissioner on the Society’s application within the
time of six months prescribed u/s 12AA(2) and, in fact, the decision was
pending even after almost five years. Therefore, the Society was treated by the
A.O. as unregistered and was not allowed exemption from tax and was assessed on
its income that resulted in large tax demands. The Society filed a writ
petition before the Allahabad High Court seeking relief, including on the
ground that it was deemed to be registered u/s 12AA and was eligible for
exemption u/s 11.

The
Allahabad High Court observed that what was to be examined in the petition was
the consequence of such a long delay on the part of the Commissioner in not
deciding the Society’s application for registration. It noted that admittedly,
after the statutory limitation, the Commissioner would become functus officio, and could not thereafter pass
any order either allowing or rejecting the registration; it was obvious that
the application could not be allowed to be treated as perpetually undecided,
and under the circumstances, the key question was whether, upon lapse of the
six-month period without any decision, the application for registration should
be treated as rejected or to be treated as allowed.

It was
vehemently argued on behalf of the Society before the High Court that
registration shall be deemed to have been granted after the expiry of the
period prescribed u/s 12AA(2) if no decision had been taken on the application
for registration. Reliance was placed on the decision of the Bangalore bench of
the Tribunal in the case of Karnataka Golf
Association vs. DIT 91 ITD 1, where such a view had
been taken. Reliance was also placed on the decisions of the Allahabad High
Court in the cases of Jan Daood & Co. vs. ITO
113 ITR 772 and CIT
vs. Rohit Organics (P) Ltd. 281 ITR 194, both of
which laid down that when an application for extension of time was moved and
was not decided, it would be deemed to have been allowed. Further reliance was
placed on the decisions of the Allahabad High Court in the case of K.N. Agarwal vs. CIT 189 ITR 769 and of
the Bombay High Court in the case of Bank
of Baroda vs. H.C. Shrivastava 256 ITR 385 for the
proposition that the discipline of quasi-judicial functioning
demanded that the decision of the Tribunal or the High Court must be followed
by all Departmental authorities because not following the same could lead to a
chaotic situation.

The
Society further argued that the absence of any order of the Commissioner should
be taken to mean that he has not found any reason for refusing registration,
notice of which could have been given to the Society by way of an opportunity
of hearing. It was also argued that latches and lapses on the part of the
Department could not be to its own advantage by treating the application for
registration as rejected.

On behalf
of the Revenue reliance was placed on a decision of the Supreme Court in the
case of Chet Ram Vashisht vs. Municipal Corporation of Delhi, 1981 SC 653.
In that case, the Supreme Court, while examining the effect of the failure on
the part of the Delhi Municipal Corporation to decide an application u/s 313(3)
of the Delhi Municipal Corporation Act, 1957 for sanctioning a layout plan
within the specified period, had held that non-consideration of the application
would not amount to a deemed sanction.

The
Allahabad High Court, in the context of the Chet
Ram decision (Supra),
observed that the Supreme Court decision dealt with a different statute. It
further noted that one of the important aspects pointed out by the Supreme
Court for taking the view was the purpose of the provision requiring sanction
to layout plans. There was an element of public interest involved, namely, to
prevent unplanned and haphazard development of construction to the detriment of
the public. Besides, sanction or deemed sanction to a layout plan would entail
constructions being carried out, thereby creating an irreversible situation.
According to the Allahabad High Court, in the case before it there was no such
public element or public interest. Taking a view that non-consideration of the
registration application within the stipulated time would result in a deemed
registration might, at the worst, cause loss of some revenue or income tax
payable by that particular assessee, similar to a situation where an assessment
or reassessment was not completed within the prescribed limitation and the
inaction of the authorities resulted in deemed acceptance of the returned
income.

On the
other hand, according to the Allahabad High Court, taking the contrary view and
holding that not taking a decision within the time fixed by the law was of no
consequence, would leave the assessee totally at the mercy of the income tax
authorities, inasmuch as the assessee had not been provided any remedy under
the Act against such non-decision. Besides, according to the Court, their view
did not create any irreversible situation because the Commissioner had the
power to cancel registration u/s 12AA(3) if he was satisfied that the objects
of such trust were not genuine or the activities were not being carried out in
accordance with its objects. The only adverse consequence likely to flow from
the Court’s view would be that the cancellation would operate only
prospectively, resulting in some loss of revenue from the date of expiry of the
limitation u/s 12AA(3) till the date of cancellation of the registration. In
the view of the Allahabad High Court, the purposive construction adopted by the
Court furthered the object and purpose of the statutory provisions.

By far the
better interpretation according to the Court was to hold that the effect of
non-consideration of the registration application within the stipulated time
was a deemed grant of registration. It accordingly held that the institution
was a registered one and was eligible for the benefit of exemption u/s 11.

The
Income-tax Department challenged the decision of the Allahabad High Court
before the Supreme Court and in a decision reported as CIT vs. Society for the Promotion of Education, Adventure Sports
& Conservation of Environment, 382 ITR 6, the
Supreme Court, confirming the deemed registration, inter
alia addressed the apprehension raised on behalf of the Revenue by
holding that the deemed registration would, however, operate only after six
months from the date of the application, stating that this was the only logical
sense in which the judgment could be understood. In other words, the deemed
registration would not operate from the date of application or before the date
of application, but would operate on and from the date of expiry of six months
from the date of application. The Supreme Court disposed of the appeal by
noting that all other questions of law were kept open. It is not possible to
gather what those other questions of law were before the Court in the appeal as
the order did not record such questions. It is best to believe that the
observations of the Court were for the limited purpose of restricting the
decision to the issue expressly decided by it, which was to confirm the deemed
registration as was held by the Allahabad High Court and, inter alia, clarify that what the Allahabad
High Court meant was that the registration was to be effective from the date of
expiry of six months from the date of application.

The above ratio of the Allahabad High Court’s
decision in the case of the Society for the
Promotion of Education, Adventure Sport & Conservation of Environment vs.
CIT 372 ITR 222 was doubted by another Division
Bench in the case of CIT vs. Muzafar Nagar
Development Authority and the Bench referred the case
before it to a Full Bench of the Allahabad High Court reported in CIT vs. Muzafar Nagar Development Authority 372 ITR 209.
The doubts expressed by the Division Bench were as follows:

1. There was nothing in section 12AA(2) which
provided for a deemed grant of registration if the application was not decided
within six months;

2. In the absence of a statutory provision
stipulating that the consequence of non-consideration would be a deemed grant
of permission, the Court could not hold that the application would be deemed to
be granted after the expiry of the period; and

3. The Legislature had not contemplated that the
authority would not be entitled to pass an order beyond the period of six
months.

4. The decision of the Court in the case of the Society for the Promotion of Education, Adventure Sport &
Conservation of Environment (Supra) did not
lay down a good law.

On behalf
of the assessee, it was argued before the Full Bench of the Allahabad High
Court that the intention of the Legislature was that the decision of the
Commissioner within the period of six months was mandatory and must be strictly
observed. The Legislature had used both expressions ‘may’ and ‘shall’ in
section 12AA(1), which was indicative of the fact that the expression ‘shall’
was regarded as mandatory wherever it had been used. Therefore, the period
prescribed in section 12AA(2) must be regarded as mandatory. If it was not
treated as mandatory, the assessee would be subjected to great prejudice by an
inordinate delay on the part of the Commissioner in disposing of his
application and the period, which had been prescribed otherwise, would be
rendered redundant.

It was
submitted on behalf of the Revenue that the period of six months was clearly
directory and the Legislature had not provided any consequence, such as a
deeming fiction that the application would be treated as being granted if it
was not disposed of within six months. Even if this was regarded as a casus omissis,
it was a well-settled principle of law that the Court had no jurisdiction to supplant
it and it must adopt a plain and literal meaning of the statute.

The Full
Bench of the Allahabad High Court examined the provisions of sections 12A and
12AA. It noted that the Legislature had not imposed a stipulation to the effect
that after the expiry of the period of six months the Commissioner would be
rendered functus officio or that he would be disabled
from exercising his powers. It had also not made any provision to the effect
that the application for registration should be deemed to have been granted if
it was not disposed of within a period of six months with an order either
allowing registration or refusing to grant it. According to the Full Bench,
providing that the application should be disposed of within a period of six
months was distinct from stipulating the consequence of a failure to do so.

The Court
observed that laying down the consequence that the application would be deemed
to be granted upon the expiry of six months could only be by way of reading a
legislative fiction or a deeming definition into the law which the Court, in
its interpretive capacity, could not create. That would amount to rewriting the
law and introduction of a provision which, advisedly, the Legislature had not
adopted. The Full Bench also held that a legislative provision could not be
rewritten by referring to the notes on clauses which, at the highest, would
constitute background material to amplify the meaning and purport of a
legislative provision.

The Full
Bench of the Allahabad High Court placed reliance on two decisions of the
Madras High Court in the cases of CIT
vs. Sheela Christian Charitable Trust 354 ITR 478
and CIT vs. Karimangalam Omriya Pangal Semipur Amaipur Ltd. 354 ITR
483 where it had held that failure to pass an order on an application
u/s 12AA within the stipulated period of six months would not automatically
result in granting registration to the trust.

According
to the Full Bench of the Allahabad High Court, the assessee was not without a
remedy on expiry of the period of six months, as this could be remedied by
recourse to the jurisdiction under Article 226 of the Constitution. Therefore,
the Court held that the judgment of the Division Bench in Society for the Promotion of Education (Supra)
did not lay down the correct position of law and that non-disposal of an
application for registration within the period of six months would not result
in a deemed grant of registration.

THE TBI EDUCATION TRUST CASE

The issue
came up again before the Kerala High Court in the case of CIT vs. TBI Education Trust 257 Taxman 355.

In this
case the assessee trust was constituted on 27^thMay, 2002 and filed
an application for registration u/s 12A on 10^th October, 2006. The
Commissioner called for a report from the Income-tax Officer (ITO) on 12^th
January, 2007 and this report was submitted only on 24^th July, 2007.
Vide this report, the ITO recommended
registration u/s 12AA(2). However, the Joint Commissioner of Income-tax sent an
adverse report dated 31^st July, 2007 to the Commissioner. There were
some adjournments later, and finally the Commissioner passed an order dated 29^thNovember, 2007 rejecting the application for registration.

The
Tribunal allowed the assessee’s appeal, relying on the decision of the Special
Bench of the Tribunal in the case of Bhagwad
Swarup Shri Shri Devraha Baba Memorial Shri Hari Parmarth Dham Trust vs. CIT
111 ITD 175 (Del.)(SB), holding that since the
application was not disposed of within the period of six months, registration
would be deemed to have been granted.

In the appeal filed by the Commissioner against the Tribunal order
before the Kerala High Court, on behalf of the Revenue, attention of the Court
was drawn to the detailed consideration by the Commissioner of the assessee not
being a charitable trust, especially with reference to the clause in the trust
deed which enabled collection of free deposits, contributions, etc., from
students and their parents. It was argued that there was a specific finding
that though the trust was essentially for setting up of an educational institution,
there was no charity involved. There was also considerable delay in filing the
application for registration by the assessee, and sufficient reasons were not
stated for condoning such delay.

It was
further argued that though a period of six months was provided under the
statute, there was no deeming provision as such and under such circumstances
there could not be a deemed registration u/s 12AA. Reliance was also placed by
the Revenue on the decision of the Full Bench of the Allahabad High Court in
the Muzafar Nagar Development Authority case (Supra), for the proposition that there
could be no deemed registration. It was argued that there was no declaration of
law in the decision of the Supreme Court in the case of Society for the Promotion of Education (Supra),
as it was only a concession made by the counsel appearing for the Department.
It was urged that the High Court should be concerned with the interpretation of
the provision to advance the course of law and not a concession by a counsel before
the Supreme Court in a solitary instance.

On behalf
of the assessee, it was submitted that the same Commissioner who had filed the
appeal before the Court had given effect to the order of the Tribunal, and
therefore the appeal was infructuous. Reliance was also placed on the decision
of the special bench of the Tribunal in the case of Bhagwad Swarup Shri Shri Devraha Baba Memorial Shri Hari Parmarth
Dham Trust (Supra) which held the limitation to be
a mandatory provision, failure to comply with which would result in deemed
registration. Attention of the Court was drawn to the CBDT Instruction No.
16/2015 (F No 197/38/2015-ITA-1) dated 6^th November, 2015 which
mandated that the application should be considered and either allowed or
rejected within the period of six months as provided under the section.
Reliance was also placed on the decision of the Supreme Court in the case of Society for the Promotion of Education (Supra).

The Kerala
High Court initially observed that the Full Bench decision of the Allahabad
High Court had a persuasive power and they were inclined to follow the
decision, holding that without a specific deeming provision there could be no
grant of deemed registration u/s 12AA. According to the Kerala High Court,
there could be no fiction created by mere inference in the absence of a specific
exclusion deeming something to be other than what it actually was. The Kerala
High Court therefore observed that the fact assumed significance as to the view
of the Department insofar as the mandatory provision of consideration of
application and an order being issued within a period of six months.

Further,
the Kerala High Court noticed that there was unreasonable delay in complying
with the mandatory provision u/s 12AA(2). It also took note of the CBDT
Instruction Number 16/2015 (F No 197/38/2015-ITA-1) dated 6^th
November, 2015 where the CBDT had noted that the time limit of six months was
not being observed in some cases by the Commissioner. Instructions were
therefore issued that the time limit of six months was to be strictly followed
by the Commissioner of Income-tax (Exemptions) while passing orders u/s 12AA
and the Chief Commissioner (Exemptions) was instructed to monitor adherence to
the prescribed time limit and initiate suitable administrative action in case
any laxity in such adherence was noticed.

The Kerala
High Court observed that the CBDT had thought it fit, obviously from experience
of dealing with delayed applications, that the mandatory provision had to be
complied with in letter and spirit. These directions were binding on the officers
of the Department and were a reiteration of the statutorily prescribed mandate.
According to the Kerala High Court, the CBDT instruction gave a clear picture
of how the CBDT expected the officers to treat the mandatory provision as being
scrupulously relevant and significant.

The Kerala
High Court then considered the decision of the Supreme Court in the case of Society for the Promotion of Education (Supra).
It stated that it was not convinced with the contention of the Revenue that
there was any concession made by the Additional Solicitor-General who appeared
in the matter for the Income-tax Department. It noted that the appeal before
the Supreme Court arose from the judgment of the Allahabad High Court. When the
matter was considered by the Supreme Court, the Full Bench decision of the
Allahabad High Court had already been passed and the said decision had not been
placed before the Supreme Court. According to the Kerala High Court, rather
than a concession, the Additional Solicitor-General specifically informed the
Supreme Court that the only apprehension of the Department was regarding the
date on which the deemed registration would be effected; whether it was on the
date of application or on the expiry of six months.

The Civil
Appeal before the Supreme Court was disposed of expressing the apprehension to
be unfounded, but all the same, clarifying that the registration of the
application u/s 12AA would only take effect from the date of expiry of six
months from the date of application. Considering the effect of disposal of a
Civil Appeal as laid down by the Supreme Court in the case of Kunhayammed vs. State of Kerala 245 ITR 360,
the Kerala High Court was of the view that the judgment of the High Court
merged in the judgment of the Supreme Court, since the Supreme Court approved
the judgment of the Allahabad High Court allowing deemed registration u/s 12AA,
though applicable only from the date of expiry of the six-month period as
mandated in section 12AA(2). According to the Kerala High Court, since the
verdict delivered by the Allahabad High Court regarding deemed registration u/s
12AA for reason of non-consideration of the application within a period of six
months from the date of filing was not differed from by the Supreme Court in
the Civil Appeal, the declaration by the High Court assumed the authority of a
precedent by the Supreme Court on the principles of the doctrine of merger.

Therefore,
the Kerala High Court rejected the appeal of the Department, following the
decision of the Supreme Court in the case of Society
for the Promotion of Education (Supra) holding
that the failure of the Commissioner to deal with the application within the
prescribed time led to the deemed registration.

A similar
view was also taken by the Rajasthan High Court in the case of CIT vs. Sahitya Sadawart Samiti Jaipur 396 ITR 46.

ADDOR FOUNDATION CASE

The issue
again came up before the Gujarat High Court in the case of CIT vs. Addor Foundation 425 ITR 516.

In this
case, the assessee trust made an online application for registration u/s 12AA
on 23^rd January, 2017. The Commissioner called for details of the
various activities actually carried out by the trust vide his letter dated 5^th February,
2018. After considering the details submitted by the trust, the Commissioner rejected
the application for registration.

In the
appeal, the Tribunal noted the fact that while passing the order rejecting the
registration application, the Commissioner wrongly mentioned the date of
receipt of the application for registration as 23^rd January, 2018,
instead of 23^rd January, 2017. Placing reliance on the decision of
the Supreme Court in the case of Society
for the Promotion of Education (Supra), the
Tribunal held the registration as deemed to have been granted and allowed the
appeal of the assessee.

On behalf
of the Revenue it was submitted before the Gujarat High Court that the dictum of law as laid down by the
Supreme Court in the case of Society for the
Promotion of Education (Supra) was of no avail to the
assessee in the facts and circumstances of the case before the Gujarat High
Court. Though the issues were quite similar, the Supreme Court had decided the
issue in favour of the assessee and against the Revenue only on the basis of the
statement made by the Additional Solicitor-General, keeping all the questions
of law open. It was submitted that on a plain reading of the section it could
not be said that merely by the Commissioner not deciding the application within
the stipulated period of six months, deemed registration was to be granted.

On behalf
of the assessee, reliance was placed on the decisions of the Kerala High Court
in the case of TBI Education Trust (Supra)
and of the Rajasthan High Court in the case of Sahitya
Sadawart Samiti Jaipur (Supra). It was argued that
although the Legislature had thought fit not to incorporate the word ‘deemed’
in section 12AA(2), yet, having regard to the language and the intention, it
could be said that a legal fiction had been created.

The Gujarat
High Court observed that the decision of the Division Bench of the Allahabad
High Court in the case of Society for the Promotion of
Education (Supra) was of no avail as the
correctness of that decision had been questioned before the Full Bench of the
Allahabad High Court in the case of Muzafar
Nagar Development Authority (Supra) to hold
that there was no automatic deemed registration on failure of the Commissioner
to deal with the application within the stipulated six months. The Gujarat High
Court was not inclined to accept the line of reasoning which had found favour
with the Division Bench of the Allahabad High Court in the case of Society for the Promotion of Education (Supra).

The
Gujarat High Court reproduced with approval extracts from the Full Bench
decision of the Allahabad High Court in the case of Muzafar Nagar Development Authority (Supra).
The Court analysed various decisions of the Supreme Court, which had examined
the issue whether a legal fiction had been created by use of the word ‘deemed’,
and observed that the principle discernible was that it was the bounden duty of
the Court to ascertain for what purpose the legal fiction had been created. It
was also the duty of the Court to imagine the fiction with all real
consequences and instances unless prohibited from doing so.

The
Gujarat High Court did not agree with the views expressed by the Kerala High
Court in the case of TBI Education Trust (Supra),
stating that the Supreme Court decision in the case of Society for the Promotion of Education (Supra)
did not lay down any principle of law and, on the contrary, kept the questions
of law open to be considered. The Gujarat High Court therefore expressed its
complete agreement with the view taken by the Full Bench of the Allahabad High
Court in the Muzafar Nagar Development Authority
case and held that deemed registration could not be granted on the ground that
the application filed for registration u/s 12AA was not decided within a period
of six months from the date of filing.

OBSERVATIONS

The issue
of deemed registration u/s 12AA in the event of failure to dispose of the
application within the specified time limit of six months has continued to
remain a highly debatable issue, even after the matter had reached the Supreme
Court. The additional and avoidable debate on the issue could have been avoided
had the attention of the Supreme Court been drawn by the Revenue to the fact
that the Full Bench of the Allahabad High Court in a later decision had
disapproved of the Division Bench judgment of the Allahabad High Court, which
was being considered in appeal by the Supreme Court. It could have also been
avoided had the Apex Court not stated in the order that the other issues were
kept open, where perhaps there were none that were involved in the appeal.

The issue
which arises now is whether the issue has been concluded by the Supreme Court
or whether it has been left open! While the Kerala High Court has taken the
view that the issue has been concluded, the Gujarat High Court is of the view
that the issue has not been decided by the Supreme Court.

If one
examines the decision of the Supreme Court, it clearly states that the short
issue was with regard to the deemed registration of an application u/s 12AA and
that the High Court had taken the view that once an application was made under
the said provision and in case the same was not responded to within six months,
it would be taken that the application was registered under the provision. This
was the only issue before the Supreme Court. Thereafter, the Supreme Court
clarified the apprehension raised by the Additional Solicitor-General, which
was addressed by the Supreme Court by holding that the deemed registration
would take effect from the expiry of the six-month period. Then, the Supreme
Court stated that subject to the clarification and leaving all other questions
of law open, the appeal was disposed of.

From this
it is evident that the appeal has been disposed of and not returned unanswered
or sent back to the lower court or appellate authorities. The appeal was on
only one ground – whether registration would be deemed to have taken place when
there was no disposal of the application within six months. The very fact that
the Supreme Court held that deemed registration would take effect on the expiry
of the six-month period clearly showed that it approved the concept of deemed
registration under such circumstances. Had the Supreme Court not approved the
concept of deemed registration, there was no question of clarifying that deemed
registration would take effect on the expiry of the six-month period.
Therefore, in our view, the Supreme Court approved of the decision of the
Division Bench of the Allahabad High Court.

The Kerala
High Court rightly appreciated this aspect of disposal of a Civil Appeal, which
implies approval of the judgment against which the appeal was preferred. In Kunhayammed vs. State of Kerala 245 ITR 360,
the Supreme Court considered the effect of disposal of a Civil Appeal as under:

‘If
leave to appeal is granted, the appellate jurisdiction of the Court stands
invoked; the gate for entry in appellate arena is opened. The petitioner is in
and the respondent may also be called upon to face him, though in an
appropriate case, in spite of having granted leave to appeal, the Court may
dismiss the appeal without noticing the respondent.

……..

The
doctrine of merger and the right of review are concepts which are closely
inter-linked. If the judgment of the High Court has come up to the Supreme
Court by way of a special leave, and special leave is granted and the appeal is
disposed of with or without reasons, by affirmance or otherwise, the judgment
of the High Court merges with that of the Supreme Court. In that event, it is
not permissible to move the High Court for review because the judgment of the
High Court has merged with the judgment of the Supreme Court.

……………………

Once a
special leave petition has been granted, the doors for the exercise of
appellate jurisdiction of the Supreme Court have been let open. The order
impugned before the Supreme Court becomes an order appealed against. Any order
passed thereafter would be an appellate order and would attract the
applicability of the doctrine of merger. It would not make a difference whether
the order is one of reversal or of modification or of dismissal affirming the
order appealed against. It would also not make any difference if the order is a
speaking or non-speaking one. Whenever the Supreme Court has felt inclined to
apply its mind to the merits of the order put in issue before it, though it may
be inclined to affirm the same, it is customary with the Supreme Court to grant
leave to appeal and thereafter dismiss the appeal itself (and not merely the
petition for special leave) though at times the orders granting leave to appeal
and dismissing the appeal are contained in the same order and at times the
orders are quite brief. Nevertheless, the order shows the exercise of appellate
jurisdiction and therein the merits of the order impugned having been subjected
to judicial scrutiny of the Supreme Court.

……..

Once
leave to appeal has been granted and appellate jurisdiction of the Supreme
Court has been invoked, the order passed in appeal would attract the doctrine
of merger; the order may be of reversal, modification or merely affirmation’.

In case
one accepts that the Supreme Court in the case of Society for the Promotion of Education (Supra)
had comprehensively decided the main issue of deemed registration, then in that
case no debate survives on that issue at least. It is only where one holds that
the Court had left the issue open and had delivered the decision on the basis
of a concession by the Revenue that an issue arises. In our considered opinion,
the Court had clearly concluded, though it had not expressed it in so many written
words, that the non-decision by the Commissioner within the stipulated time led
to the deemed registration of the society. It seems that this fact of law and
the finding of the Court were rather accepted by the Revenue which had raised
an apprehension for the first time about the effective date of deemed
registration inasmuch as the order of the High Court was silent on the aspect
of the effective date. In meeting this apprehension of the Revenue, the Court
clarified that there was no case for such an apprehension as in the Court’s
view the effective date was the date of expiry of six months, and again in the
Court’s view such a view was in concurrence with the High Court’s view on such
date. The Kerala and Rajasthan High Courts are right in holding that the Court
had concluded the issue of registration in favour of the deemed registration
and had not left the said issue open and were right in interpreting the
decision of the Apex Court in a manner that confirmed the view expressed.

There was
no concession by the Revenue in the said case before the Apex Court as made out
by the Revenue. The fact is that an apprehension was independently raised for
the first time by the Revenue about the effective date of registration, which
was dismissed by the Court by holding that there was every reason to hold that
the High Court in the decision had held that the registration was effective
only from the date of expiry of six months from the date of the application and
not before the said date. It is this part which has been expressly recorded in
the judgment. What requires to be appreciated is that the clarification was
sought because once the main issue of deemed registration was settled by the
Court, there could not have been a clarification on an effective date of the deemed
registration had the issue of deemed registration been decided against the
assessee or was undecided and, as claimed, kept open.

The issue
in appeal before the Supreme Court was never about the effective date of
registration but was about the registration itself; it could not have been for
the date of registration for the simple reason that the Allahabad High Court
had nowhere in its decision dealt with the issue of the effective date of
registration.

In the
case of the Society for the Promotion of Education
(Supra), the Supreme Court had therefore modified the
order of the Division Bench of the Allahabad High Court, which order had merged
in the order of the Supreme Court. Therefore, the subsequent order of the Full
Bench of the Allahabad High Court would no longer hold good since the Supreme
Court had taken a view contrary to that taken by the Full Bench of the
Allahabad High Court. This aspect does not seem to have been appreciated by the
Gujarat High Court.

The better
view, therefore, is the view taken by the Kerala and Rajasthan High Courts –
that failure to dispose of an application u/s 12A within the period of six
months results in a deemed registration u/s 12AA.

At the
same time note should be taken of the decisions of the Madras High Court in the
cases of CIT vs. Sheela Christian Charitable Trust 354 ITR 478
and CIT vs. Karimangalam Omriya Pangal Semipur Amaipur Ltd. 354 ITR
483. In the said cases the Court held that the non-decision by the
Commissioner within the prescribed time did not result in deemed registration
of the institution. These decisions should be held to be no longer good law in
view of the subsequent decision of the Apex Court.

The law is now amended with effect from 1^st
April, 2021, with registration now required u/s 12AB. Section 12AB(3) also
requires disposal of the application within a period of three months, six
months or one month, depending upon the type of application, from the end of
the month in which the application is filed. The issue would therefore continue
to be relevant even under the amended law.

shailesh.kwebmaker

UNEXPLAINED DEPOSITS IN FOREIGN BANK ACCOUNTS

ISSUE FOR CONSIDERATION

A few years back, around 2011, the Government of France shared certain
information with the Government of India concerning deposits in several bank
accounts with HSBC Bank, Geneva, Switzerland held in the names of Indian
nationals, or where such nationals had a beneficial interest. The information
was received in the form of a document known as ‘Base Note’ wherein various
personal details of account holders such as name, date of birth, place of
birth, sex / gender, residential address, profession, nationality, date of
opening of bank account in HSBC Bank, Geneva and balances in certain years, etc.,
were mentioned.

A number of cases
have since then been reopened on the basis of the ‘Base Note’, leading to
reassessments involving substantial additions and sizable consequential
additions which are being contested in numerous appeals across the country
mainly on the following grounds:

(i) the assessee is a resident of a foreign
country and his income is not taxable in India,

(ii) the source of income of the assessee in India
has no connection with the bank deposits concerned,

(iii) the bank account was not opened or operated by
the assessee,

(iv) the bank account was not in the name of the
assessee,

(v) the bank account was in the name of a private
trust which was a discretionary trust and the assessee had not received any
payment or income from the trust,

(vi) the reopening was bad in law.

In addition to the
above defences, the assessees have also contended that the additions were made
on the basis of unauthentic material (the ‘Base Note’), that copies of the
material relied upon were not provided, or that adequate opportunity of hearing
was not provided, or that the principles of natural justice were violated on
various grounds, and also that the A.O. had failed in establishing his case for
addition and in linking the deposits to an Indian source.

More than 20 cases
have been adjudicated by the Tribunal or the courts on the issue of the
additions, some in favour of the Revenue, some against the Revenue and in
favour of the assessee, either on application of the provisions of the
Income-tax Act, 1961 or on the grounds of natural justice. Most of these
decisions have been rendered on the facts of the case. In a few cases, the
issue involved was about the possibility of taxing an income in India for a
year during which the assessee was a non-resident and was the beneficiary of a
discretionary trust under the Income-tax Act, 1961. In one of the cases, one of
the Mumbai benches of the Tribunal held that no addition could be made on
account of such deposits in the assessment year in the hands of the assessee who
was a non-resident and had not received any money on distribution from the
trust in that year. As against this, recently in another case, another Mumbai
bench of the Tribunal held that the addition was sustainable even when the
assessee in question was not a resident for the purposes of the Act and claimed
to be a beneficiary of a discretionary trust.

THE DEEPAK B. SHAH CASE

The issue came up
for consideration in the case of Deepak B. Shah 174 ITD 237 (Mum).
The assessees in this case had filed income-tax returns which were processed
u/s 143(1). Subsequently, the Government of India received information from the
French Government under DTAA that some Indian nationals and residents had
foreign bank accounts in HSBC Bank, Geneva, Switzerland which were not
disclosed to the Indian Tax Department. This information was received in the
form of a document known as ‘Base Note’ wherein various personal details of
account holders, such as name, date of birth, place of birth, sex / gender,
residential address, profession, nationality, date of opening of bank account
in HSBC Bank, Geneva and balances in certain years, etc., were mentioned. After
receiving the ‘Base Note’ as a part of the Swiss leaks, the Investigation Wing
of the Income Tax Department conducted a survey u/s 133A at the premises of one
Kanu B. Shah & Co. During the course of the survey proceedings, the ‘Base
Note’ was shown to the assessees Deepak B. Shah and Kunal N. Shah and it was
indicated that the Revenue was of the view that both the assessees had a
foreign bank account. The said foreign bank account was opened in 1997 by an
overseas discretionary trust known as ‘B’ Trust, set up by a Settlor, an NRI
since 1979 and a non-resident u/s 6. Both the assessees with Indian residency
were named as discretionary beneficiaries of the said trust.

The A.O. added peak
balance in the hands of both the assessees at Rs. 6,13,09,845 and Rs.
5,99,75,370 for assessment years 2006-07 and 2007-08, respectively. The same
additions were also made in the case of Dipendu Bapalal Shah who created the
private discretionary trust known as Balsun Trust.

On appeal, the
CIT(A) affirmed the addition to the tune of half of the peak balance in the
hands of both the assessees to avoid double taxation. The CIT(A) confirmed the
addition to the tune of Rs. 3,06,54,922 and Rs. 2,74,007 (sic) in
A.Ys. 2006-07 and 2007-08 u/s 69A of the Act in both the cases.

In the appellate
proceedings of Dipendu Bapalal Shah, the CIT(A) set aside the addition on the
basis that as an NRI none of his business monies earned outside India could be
brought to tax in India, unless they were shown to have arisen or accrued in
India. He also held that there was no linkage of the amounts to India and the
Revenue had not discharged its duty on this issue. The said order of the CIT(A)
in the case of Dy. CIT vs. Dipendu Bapalal Shah 171 ITD 602 (Mum.-Trib.)
was upheld by the Tribunal on the ground that the contents of the affidavit
dated 13^th October, 2011 were not denied or proved to be not true by
the A.O. Further, it was held that the bank account with HSBC Bank, Geneva was
outside the purview of the IT Act as Dipendu Bapalal Shah was a non-resident
Indian.

In the second
appeal, the assessees reiterated the undisputed facts about the ‘Base Note’ of
2011, denied knowledge of any such bank account and highlighted that no
incriminating material was found during the course of the survey; the Settlor
had created and constituted an overseas discretionary trust known as ‘Balsun
Trust’ by making a contribution to the said trust from his own funds / sources
with Deepak and Kunal as discretionary beneficiaries of the said trust; during
the years under consideration, they did not receive any distribution of income
from the said trust as no such distribution was done by the trust during those
years; the Settlor was a foreign resident since 1979 and was a non-resident u/s
6 of the Act; the Settlor and both the assessees in their respective assessment
proceedings had filed their sworn-in affidavits; the affidavit of the Settlor was
sworn before the UAE authority, stating on oath that he had settled an offshore
discretionary trust with his initial contribution, none of the discretionary
beneficiaries had contributed any funds to the trust, and none of the
beneficiaries had received any distribution from the trust.

The sworn
affidavits of the assessees stated that they were not aware of the existence of
any of the accounts in HSBC Bank, Geneva, that they never carried out any
transactions in relation to the said account, nor received any benefit from the
said account, and that they had not signed any documents nor operated the said
bank account. A clarificatory letter from HSBC Bank, Geneva was also filed
stating that they had neither visited nor opened or operated the bank accounts
and that no payments had been received from them or made to them in relation to
the said account; the addition was made in three hands but the Commissioner
(Appeals) deleted the addition in the hands of the Settlor, which order of
deletion was also upheld by the coordinate bench of the Tribunal, holding that
the contents of the affidavit of the Settlor were not declined or held to be
not true by the A.O.

It was explained
further that the bank account of HSBC Bank, Geneva was out of the purview of
the IT Act, as the Settlor was a non-resident Indian since 1979; looking to the
decision of the coordinate bench holding that the money belonged to the
Settlor, who was a non-resident, and the income of the non-resident held abroad
was not assessable in India unless it was shown to have arisen or accrued in
India; since it was held by the Tribunal that the amount in the HSBC account in
Geneva was owned by the Settlor who was a non-resident, there was no
justification or reason to sustain the order of the Commissioner (Appeals); the
Revenue had completely failed to show any linkage of the foreign bank account
with Indian money; addition had been made u/s 69A and it was a sine qua non
for invoking section 69A that the assessee must be found to be the owner of
money, bullion, jewellery or other valuable articles. The money was held in the
name of the Settlor, who claimed to be the owner of the said deposits from his
own funds / sources, and the Revenue had failed to bring any cogent and
convincing materials on record which proved that the assessees were owners of
the money in the HSBC account.

It was further
contended that the Settlor was the owner of the HSBC Bank account, Geneva and
the assessees were discretionary beneficiaries which led to the positive
inference that they were not the owners of the said account and hence the
additions u/s 69A could not be sustained; the assessees had not made any
contribution to, nor done any transaction with, the said trust at all; the
income of the trust could not be added in the hands of the beneficiaries and
the trustees, as the representative assessees, were liable to be taxed on the
income of the trust; if the discretionary trust had made some distribution of
income during the year in favour of the discretionary beneficiaries, only then
was the distributed income taxable in the hands of the beneficiaries; but
nothing of the sort had happened nor had the assessees received any money as
distribution of income by the discretionary trust; so long as the money was not
distributed by the discretionary trust, the same could not be taxed in the
hands of the beneficiaries.

It was explained
that as per the provisions of sections 5 and 9 read with sections 160-166 of
the IT Act, qua a trust, the statute clearly prescribed a liability to
tax in the hands of the trustee, and stipulated that a discretionary
beneficiary having received no distribution would not be liable to tax. As
such, the provisions required to be read strictly and no tax liability could be
imputed to the assessees as discretionary beneficiaries when the statute
specifically provided otherwise.

The Revenue
contended that the affidavits filed were self-serving documents without any
corroborative or evidentiary value; in the affidavit of Dipendu Bapalal Shah,
there was no detail of his family members, and, therefore, the said document
was self-serving without any evidentiary value; the confirmation submitted by
HSBC Bank had confirmed the names of Deepak B. Shah and Kunal N. Shah (the
assessees); the names of the assessees had been mentioned in the information
received by the Government of India as a part of Swiss Leaks in relation to
HSBC Bank, Geneva by way of the ‘Base Note’; the assessee had refused to sign
any consent paper, which clearly showed that the said transactions were proved
beyond doubt that these two assessees had a connection with the said bank
account; the assessees did not co-operate at any stage of the proceedings; in
such clandestine operations and transactions, it was impossible to have direct
evidence or demonstrative proof of every move of the assessee and that the
income tax liability was to be assessed on the basis of parameters gathered
from the inquiries, and that the A.O. had no choice but to take recourse to the
material available on record.

The Tribunal, on
due consideration of the contentions of both the parties, vide
paragraphs 14, 15, 17 and 18 of the order held as under:

‘14. Further, the bank account of HSBC Bank, Geneva is out of the
purview of the IT Act, as Mr. Dipendu Bapalal Shah is a non-resident Indian
since 1979. In the case of the two appellants before us, the same amount was
added in AYs 2006-07 and 2007-08 which was reduced by Ld. CIT(A) to one half of
the total additions to avoid any double taxation affirming the additions to
that extent. Looking to the decision of the coordinate bench holding that the
money belonged to Mr. Dipendu B. Shah who is non-resident and the income of the
non-resident held abroad is not assessable in India unless it is shown to have
arisen or accrued in India. Since it is held by the ITAT that the amount in
HSBC Account in Geneva is owned by Mr. Dipendu Bapalal Shah who is non-resident
we do not find any justification or reasons to sustain the order of Ld. CIT(A)
when the Revenue has completely failed to show any linkage with foreign bank
account with Indian money. We find that addition has been made by the A.O. u/s
69A of the Act to justify the addition on account of peak balance. We agree
with the contentions of the Ld. AR that it is sine
qua non for invoking section 69A of the IT Act, the assessee must be found
to be the owner of money, bullion, jewellery or other valuable articles and
whereas in the present case the money is owned and held by Mr. Dipendu Bapalal
Shah a foreign resident in an account (with) HSBC, Geneva and also admitted
that he is the owner of the money in the HSBC Account Geneva.’

‘15. In the present case the money is held in the name of Mr. Dipendu
Bapalal Shah who vehemently claimed to be owner of the said deposits from his
own fund / sources and the Revenue has failed to bring any cogent and
convincing materials on record which proved that the two appellants are owners
of the money in HSBC Account.’

‘17. In the present case, undisputedly Mr. Dipendu Bapalal Shah is owner
of HSBC Bank account, Geneva and the appellants are discretionary beneficiaries
which leads to positive inference that the appellants are not the owners of the
said bank account and hence the additions under section 69A cannot be
sustained. In the present case before us, admittedly both the appellants,
namely Deepak B. Shah and Kunal N. Shah are discretionary beneficiaries of the
“Balsun Trust” created by Mr. Dipendu Bapalal Shah and the two
appellants have not made any contribution nor done any transaction with the
said trust at all. In our opinion in the case of discretionary trust, the
income of the trust could not only be added in the hand of beneficiary but the
trustees are the representative assessees who are liable to be taxed for the
income of the trust. If the discretionary trust has made some distribution of
income during the year in favour of the discretionary beneficiaries only then
the distributed income is taxable in the hands of the beneficiaries but nothing
of the sort has happened nor two appellants have received any money as
distribution of income by the discretionary trust. So long as the money is not
distributed by the discretionary trust, the same cannot be taxed in the hands
of the beneficiaries. Similarly, in the present case before us, the deposits held
in HSBC, Geneva account cannot be taxed in the hand of beneficiaries /
appellants at all.’

‘18. So applying the ratio laid down by the Hon’ble Apex Court in the
abovesaid two decisions, we are of the considered view that the additions
cannot be made and sustained in the hands of the appellants as the Balsun Trust
is a discretionary trust created by Mr. Dipendu Bapalal Shah and said trust has
neither made any distribution of income nor did the two beneficiaries /
appellants receive any money by way of distribution. While the Department has
failed to bring any conclusive evidence to establish nexus between these two
appellants and the bank account in HSBC, Geneva and more so when Mr. Dipendu
Bapalal Shah has owned the balance in the HSBC, Geneva bank account, we are not
in agreement with the conclusions of the CIT(A) in sustaining the additions
equal to fifty percent of the peak balance in the hands of both the appellants.
Considering the facts of the two appellants, in view of various decisions as
discussed hereinabove, we hold that the order of CIT(A) is wrong in assuming
that the said money may belong to these two appellants and such conclusion is
against the facts on record and based on surmises and presumptions.
Accordingly, we set aside the order of Ld. CIT(A) and direct the A.O. to delete
the additions made u/s 69A in respect of HSBC Bank account for assessment years
2006-07 and 2007-08 in the case of both the appellants before us.’

In the result, the
appeals of the assessees were allowed and the additions made in their hands
were deleted.

THE RENU T. THARANI CASE

Recently, the issue
arose in the case of Renu T. Tharani 107 taxmann.com 804 (Mum).
The assessee in the case was an elderly woman in her late eighties. On 29^th
July, 2006 she had filed her income tax return for A.Y. 2006-07 disclosing a
returned income of Rs. 1,70,800 in Ward 9(1), Bangalore. Her case was
transferred to Mumbai under an order dated 20^th December, 2013
passed u/s 127 of the Act. The return was not subjected to any scrutiny and the
assessment thus reached finality as such. The investigation wing of the Income
Tax Department received information that the assessee had a bank account with
HSBC Private Bank (Suisse) SA Geneva. Based on the information, this case was
reopened for fresh assessment on 30^th October, 2014 by issuance of a
notice u/s 148.

She responded by
stating that she had neither been an account holder of HSBC nor a beneficial
owner of any assets deposited in the account with HSBC Private Bank (Suisse)
SA, Switzerland, during the last ten years. It was further stated that HSBC
Private Bank (Suisse) SA had also confirmed that GWU Investments Ltd. was the
holder of account number 1414771 and, according to their records, GWU
Investments Limited used to be an underlying company of Tharani Family Trust,
of which Mrs. Renu Tharani was a discretionary beneficiary, and that the
Tharani Family Trust was terminated and none of the assets deposited with them
were distributed to her. It was further stated that the ‘Base Note’ issued was
inaccurate, as she did not have any account with HSBC Bank Geneva bearing
number BUP_SIFIC_PER_ID_5090178411 or any other number.

It was explained
that the income of a discretionary trust could not be taxed in her hands as per
the decision in the case of Estate of HMM Vikramsinhji of Gondal, 45
taxmann.com 552(SC), wherein it was held that in the hands of the
beneficiary of a discretionary trust income could only be taxed when the income
was actually received, but in her case she had not received any money in the
capacity of beneficiary. It was submitted that in the light of the abovesaid
facts, there was no reason why the A.O. should insist on asking the assessee to
provide the details of the account standing in the name of GWU Investments
Ltd., as she was in no position to provide the details for the reasons
mentioned to the A.O.

However, none of
the submissions impressed the A.O. He rejected the submissions made by the
assessee and proceeded to make an addition of Rs. 196,46,79,146, being an
amount equivalent to US $3,97,38,122 at the relevant point of time, by
observing as follows:

‘12. The
assessee has not provided the bank account statement in which she is the
discretionary beneficiary nor has explained the sources of deposits made in the
said account… not acceptable because of the following reasons:

(a) It is surprising that she does not know about
the Settlor of the Trust as well as the sources of deposits made in the HSBC
account. No bank account statement has been provided nor the source of deposits
made in the account explained by the assessee even after specific queries were
raised on this.

(b) It is also surprising that as a beneficiary
she did not receive any assets when the Tharani Family Trust was terminated and
if that be so, then where all the money went after termination of the Tharani
Family Trust is open to question and the same remains unexplained.

Considering the
facts of this case, the decision of the Hon’ble ITAT, Mumbai in the case of Mohan Manoj Dhupelia in ITA No. 3544/Mum/2011 etc. is
directly applicable to this case.

In absence of
anything contrary, the only logical conclusion that can be inferred is that the
amounts deposited are unaccounted deposits sourced from India and therefore
taxable in India. This presumption is as per the provisions of section 114 of
The Indian Evidence Act, 1872.

Thus, as per the
provisions of section 114 of The Indian Evidence Act, 1872 also, it needs to be
held at this stage that the information / details not furnished were
unfavourable to the assessee and that the source of the money deposited in the
HSBC account is undisclosed and sourced from India.’

Aggrieved, the
assessee carried the matter in appeal but without any success. The CIT(A)
confirmed the conclusions so arrived at by the A.O. He noted as under:

‘21. The focus
of the submission is shifting responsibility on Assessing Officer without
furnishing any supplementary and relevant details. Vital facts (at cost of
repetition) regarding the entities involved / persons are as under:

A. Smt. Renu Tharani is the beneficiary of
Tharani Family Trust.

B. Smt. Renu Tharani is the sole beneficiary.

C. Tharani Family Trust is the sole beneficiary
of GWU Investments Ltd.

D. Smt. Renu Tharani holds interest in GWU
Investments Ltd. through Tharani Family Trust.

E. Income attributable directly or indirectly to
GWU Investments Ltd. or Tharani Family Trust pertains to Smt. Renu Tharani.

F. GWU Investments Ltd. having address in Cayman
Islands has investment manager as Shri Haresh Tharani, son of the appellant.

The holding
pattern of entities concerned and the contents of the base note cement the
issue. The fact that the appellant is sole beneficiary implies that there is
never a case of distribution and all income concerning the asset only belongs
to her, i.e., will accrue or arise only to her from the moment beneficial
rights came to the appellant.’

Coming to the
quantum of additions, however, the CIT(A) upheld the stand of the assessee and
gave certain directions to the A.O.

On second appeal,
the assessee stated that she was admittedly a non-resident assessee, inasmuch
as the impugned assessment was framed on the assessee in her residential status
as ‘non-resident’, and it was thus not at all required of her to disclose her
foreign bank accounts, even if any. It was explained that unlike in the United
States, where global taxation of income of the assessee was on the basis of
citizenship, the basis of taxability of income outside India, in India, was on
the basis of the residential status of the assessee. The fundamental principles
of taxation of global income in India were explained in detail to highlight
that unless someone was resident in India, taxability of such a person was
confined to income accruing or arising in India, income deemed to accrue or
arise in India, income received in India and income deemed to have been
received in India. None of those categories covered the income, even if any, on
account of an unexplained credit outside India.

The assessee
pointed out that since 23^rd March, 2004 she was regularly residing
in the United States of America, and that, post the financial year ended 31^st
March, 2006 onwards, the assessee was a non-resident assessee. In this
backdrop, she was not required to disclose any bank account outside India or
report any income outside India unless it was covered by the specific deeming
fiction which was admittedly not the case for her. It was, therefore, contended
that any sums credited in the bank account in question could not be taxed in
her hands.

Attention was
invited to a coordinate bench decision in the case of Hemant Mansukhlal
Pandya 100 taxmann.com 280, 174 ITD 101 (Mum), wherein it was inter
alia held that where additions were made to the income of an assessee who
was a non-resident since 25 years, since no material was brought on record to
show that funds were diverted by the assessee from India to source deposits
found in a foreign bank account, the impugned additions were unjustified. It
was thus contended that she, too, being a non-resident, such an income in
foreign bank deposits, even if that were so, could not be taxed in the hands of
the assessee.

It was further
contended that when the account did not belong to the assessee, there was no
question of the assessee being in a position to furnish any evidence in respect
of the same; that she did not have information whatsoever about the source of
deposits in this account, and the assets held therein; that the account was
held with GWU Investments Limited with which the assessee had no relationship
whatsoever; she at best was a beneficiary of the discretionary trust, settled
by GWU Investments Limited, but then in such an eventuality the question of
taxability would arise only at the point of time when the assessee actually
received any money from the trust by relying on the judgment in the case of Estate
of HMM Vikramsinhji of Gondal (Supra), in support of the proposition;
that the entire case of the A.O. was based on gross misconception of facts and
ignorance of the well-settled legal position.

It was reiterated
that the assessee did not have any account with the HSBC Private Bank (Suisse)
SA, and yet she was treated as the owner of the account. The account was of the
investments, but was treated as a bank account. The assessee was a
non-resident, taxable in India in respect of her income earned in India, and yet
the assessee was being taxed in respect of an account which undisputedly had no
connection with India. Denying the tax liability in respect of such an account
at all, it was submitted that if at all it had tax implications anywhere in the
world, the liability was in the jurisdiction of which the assessee was a
resident. The assessee was taxable only on disbursement of the benefits to the
beneficiary, but then the beneficiary was being taxed in respect of the corpus
of the trust. The impugned additions were, even on merits, wholly devoid of any
substance.

The Revenue in
response vehemently relied upon, and elaborately justified, the orders of the
authorities below by highlighting that it was a case in which a specific
information had come to the possession of the Government of India, through
official channels, and this information, amongst other things, categorically
indicated that the assessee was a beneficiary and beneficial owner of a
particular account which had peak assets worth US $3,97,38,122 and that the
genuineness of the account was not in doubt and had not even been challenged by
the assessee, which reality could not be wished away. It was contended that the
IT Department had discharged its burden of proof by bringing on record
authentic information received through government channels about the bank
relationships which were unaccounted in India and unaccounted abroad, and
whatever documents the assessee had given were self-serving documents and
hyper-technical explanations, which did not contradict the official information
received by the Government of India through official channels, and it did in
fact corroborate and evidence the existence of the account with the assessee as
beneficiary and, in any case, the documents submitted could not be considered
enough to discharge the burden of the assessee that the evidences produced by
the Department were not genuine or the inescapable conclusions flowing from the
same were not tenable in law.

It was highlighted
by the Revenue that all that the assessee said was that she had no idea as to
who did it, and passed on the blame to a Cayman Island-based company which was
operating the said account, but then the Cayman Island company could not be a
person unconnected with the assessee. It was inconceivable that a rank outsider
would be generous enough to put that kind of huge money at her disposal or for
her benefit but, as a beneficiary, she was expected to know the related facts
which she alone knew. The fact of the Swiss Bank accounts being operated
through conduit companies based in tax havens was common knowledge and, seen in
that light, if the assessee had an account for her benefit in a Swiss Bank,
whether she operated it directly or through a web of proxies, the natural
presumption was that the money was her money which she must account for.

It was also pointed
out that within months of her changing the residential status, the account was
opened and the credits were afforded. Where did this money come from?
Obviously, in such a short span of time that kind of huge wealth of several
millions of dollars could not be earned by her abroad, but then if she had
shown that kind of earning anywhere to any tax authorities, to that extent, the
balance in Swiss account could be treated as explained. The technicalities
sought to be raised were of no use and the judicial precedents, rendered in an
altogether different context, could not be used to defend the unaccounted
wealth stashed away in the assessee’s account with HSBC Private Bank, Geneva.

In a brief
rejoinder, the assessee submitted that the sweeping generalisations by the
Revenue had no relevance to the facts before the Tribunal. The hard reality was
that the account did not belong to the assessee and that there was no direct or
indirect evidence to support that inference. The assessee was only a
beneficiary of a trust but the taxability in her hands must, at best, be
confined to the monies actually received from the trust; that admittedly GWU
Investments Ltd. was owner of the account in which the assessee was neither a
director nor a shareholder; and that, in any case, nothing remained in the
account as the same stood closed now. It was then reiterated that the assessee
was a non-resident and she could not be taxed in respect of monies credited,
even if that be so, in her accounts outside India; that there was no evidence
whatsoever of the assessee having an account abroad, that whatever evidence had
been given to the assessee was successfully controverted by her, that she was a
non-resident and her taxability was confined to the incomes sourced in India,
and that, for the detailed reasons advanced by her, the impugned addition of
Rs. 196,46,79,146 in respect of her alleged and non-existent bank account in
HSBC Private Bank (Suisse) SA Geneva must be deleted.

The Tribunal deemed
it important to recall the backdrop in which the information about the
assessee’s account with the HSBC Private Bank (Suisse) SA was received by the
Government of India to also refresh memories, and certain undisputed facts,
about the ‘HSBC Private Bank Geneva scandal’ as it was often referred to. In
paragraph 23 of the judgment, it detailed the backdrop. In paragraph 24, it
also referred to one more BBC report, which could throw some light on the
backdrop of this case, and found the report worth a look at by reproducing
extensively from it. The Tribunal further noted that those actions of the HSBC
Private Bank (Suisse) SA had not gone unnoticed so far as law enforcement
agencies were concerned, and the bank had to face criminal investigations in
several parts of the globe, and had to pay millions of dollars in settlement
for its lapses. In paragraph 26, it explained that the above press reports were
referred to just to set the backdrop in which the case before them was set out,
and, as they explain the rationale of their decision, the relevance of the
backdrop would be appreciated.

The Tribunal took it upon itself to examine the trust structures
employed by HSBC Private Bank since a lot had been said about the assessee
being a discretionary beneficiary of a trust which was said to have the account
with HSBC Private Bank (Suisse) SA Geneva. The Tribunal found that it would be
of some use to understand the nature of trust services offered by HSBC Private
Bank, as stated on their website even on the date of the decision.

It noted that the
assessee had shifted to the USA just seven days before the beginning of the
relevant previous year, and it would be too unrealistic an assumption that
within those seven days plus the relevant financial year, the assessee could
have earned that huge an amount of around Rs. 200 crores which, at the rate at
which she did earn in India in the last year, would have taken her more than
11,500 years to earn. Even if one went by the basis, though the material on
record at the time of recording reasons did not at all indicate so, that the
assessee was a non-resident for the assessment year, which was, going by the
specific submissions of the assessee, admittedly the first year of her
‘non-resident’ status, it was wholly unrealistic to assume that the money at
her disposal in the Swiss Bank account reflected income earned outside India in
such a short period of one year.

The Tribunal took a
very critical note of the fact that the assessee had, in response to a specific
request from the A.O., declined to sign ‘consent waiver’ so as to enable the IT
Department to obtain all the necessary details from the HSBC Private Bank
(Suisse) SA, Geneva which aspect of the matter was clear from the extracts from
the assessee’s submissions dated 25^th February, 2015 filed by the
A.O. as follows:

‘……..we would
like to submit that the letter from HSBC Private Bank dated 5^th
January, 2015 categorically states that the assessee does not have any account
in HSBC Private Bank (Suisse) SA in Switzerland, hence question of providing
you with CD of HSBC Bank account statement does not arise. Also, the question
of signing the consent waiver does not arise as the assessee does not have any
account in HSBC Private Bank (Suisse) SA.’

The Tribunal
observed that the net effect of not signing the consent waiver form was that
the A.O. was deprived of the opportunity to seek relevant information from the
bank in respect of the assessee’s bank account; if she had nothing to hide,
there was no reason for not signing the consent waiver form; all that the
consent waiver form did was to waive any objection to the furnishing of
information relating to the assessee’s bank account, i.e. HSBC Private Bank
(Suisse) SA Geneva in her case. The Tribunal found it necessary to take note of
the above position so as to understand that the assessee had not come with
clean hands and, quite to the contrary, had made conscious efforts to scuttle
the Department’s endeavours to get at the truth.

Proceeding with the
consent letter aspect, the Tribunal further observed that clearly, therefore,
the consent waiver being furnished by the assessee did not put the assessee to
any disadvantage so far as getting at the actual truth was concerned. Of
course, when the monies so kept in such banks abroad were legal or the
allegations incorrect, the assessee could always, and in many a case assessees
did, co-operate with the investigations by giving the consent waivers. The case
before the Tribunal, however, was in the category of cases in which consent
waiver had been emphatically declined by the assessee, and thus a deeper probe
by the Department had been successfully scuttled.

On the aspect of
the consent, the Tribunal found it useful to refer to a judgment of the
jurisdictional Bombay High Court on materially similar facts, wherein the Court
had disapproved and deprecated the conduct of the assessee in not signing the
consent waiver form, in the judgment reported as Soignee R. Kothari’s
case in 80 taxmann.com 240. The Tribunal noted that it
was also a case in which the assessee, originally a resident in India, had
migrated to the USA and in whose case the information by way of a ‘Base Note’
was received from the French Government under the DTAA mechanism (as in the
assessee’s case), about the existence of her bank account with the same bank,
i.e. HSBC Private Bank (Suisse) SA Geneva; it was a case in which the assessee
had declined to sign the consent waiver form outright, and taken a stand that
the question of signing the consent waiver form did not arise. Neither such a
conduct could be appreciated, nor anyone with such a conduct merited any
leniency, the Court had held in that case.

The Tribunal
observed that on the one hand the assessee had not co-operated with the IT
authorities in obtaining the relevant information from HSBC Private Bank (Suisse)
SA Geneva, or rather obstructed the flow of full, complete and correct
information from the said bank by not waiving her rights to protect privacy for
transactions with the bank, and, on the other hand, the assessee had complained
that the IT authorities had not been able to find relevant information.
Obviously, those two things could not go together.

The Tribunal found
that while the claim of the assessee was that she was a discretionary
beneficiary of the Tharani Family Trust, that fact did not find mention in the
‘Base Note’ which showed that the assessee was the beneficial owner or
beneficiary of GWU Investments Ltd.; that in the remand report filed by the
A.O., there was a reference to some unsigned draft copy of the trust deed
having been filed before him but neither the deed was authentic nor was it
placed before the Tribunal in the paper-book. The assessee had not submitted
the trust deed or any related papers but merely referred to a somewhat
tentative claim made in a letter between one Mahesh Tharani, apparently a
relative of the assessee, and the HSBC Private Bank (Suisse) SA, an
organisation with a globally established track record of hoodwinking tax
authorities worldwide. Nothing was clear, nor did the assessee throw any light
on the same. The letter did not deny, nor show any material to controvert, what
was stated in the ‘Base Note’ i.e. GWU Investments Ltd. and the assessee were
linked as beneficial owners. There was no dispute that the account was in the
nominal name of GSW Investments Ltd., but the question was who was the natural
person / beneficial owner thereof. As for the trust, there was no corroborative
evidence about the statement, but nothing turned thereon as well. The assessee
being the discretionary beneficiary owner of the trust, and beneficial owner of
the underlying company, was not mutually exclusive anyway; but the claim of the
assessee being a discretionary beneficiary of the trust was without even
minimal evidence.

As regards the
reference to the judgment in the case of the estate of HMM Vikramsinhji
of Gondal (Supra), the Tribunal noted that it was important to
understand that it was a case in which a discretionary trust was settled by the
assessee and the limited question for adjudication was taxability of the income
of the trust, after the death of the Settlor and in the hands of the
beneficiary. The observations had no relevance in the context of the case of
the assessee; firstly, neither was there any trust deed before the Tribunal,
nor the question before it pertained to the taxability of the income of the
trust; secondly, beyond a mention in the ‘Base Note’ as a personnes légales
liées (i.e. related legal persons), there was no evidence even about the
existence, leave aside the nature, of the trust; thirdly, the point of
taxability here was beneficial ownership of GWU Investments Ltd., a Cayman
Island-based company, by the assessee; finally, even if there was a dispute
about the alleged trust, the dispute was with respect to taxability of funds
found with the trust and the source thereof. Clearly, therefore, the issue
adjudicated upon in the said decision had no relevance in the present context.
The very reliance on the said decision presupposed that the assessee was
discretionary beneficiary simplicitor of a discretionary family trust,
and nothing more – an assumption which was far from established on the facts of
the case.

As regards the
question of income which could be brought to tax in the hands of the assessee,
being a non-resident, and certain errors in computation on account of duplicity
of entries, etc., the Tribunal had noted that the CIT(A) had given certain
directions which it had reproduced in paragraph 18 of the Order, and those
directions were neither challenged nor any infirmities were shown therein. Obviously,
therefore, there was no occasion, or even prayer, for interference in the same.

In the end, the
Tribunal while confirming the order of the A.O. read with the order of the
CIT(A), nonetheless recorded that their decision could not be an authority for
the proposition that wherever the name of the assessee figured in a ‘Base Note’
from HSBC Private Bank (Suisse) SA Geneva an addition would be justified in
each case. The mere fact of an account in HSBC Private Bank (Suisse) SA Geneva
by itself could not mean that the monies in the account were unaccounted,
illegitimate or illegal. The conduct of the assessee, the actual facts of each
case, and the surrounding circumstances were to be examined on merits, and then
a call was to be taken about whether or not the explanation of the assessee
merited acceptance. There could not be a short-cut and a one-size-fits-all
approach to the exercise.

OBSERVATIONS

The provisions of
the Income-tax Act, 1961 extend to the whole of India vide section 1 of
the Act. Section 4 of the Act provides for the charge of income tax in respect
of the total income of the previous year of a person. The total income so
liable to tax includes, vide section 5 of the Act, the income of a
person who is a non-resident, derived from whatever source which is received or
is deemed to be received in India or has accrued or arisen or is deemed to
accrue or arise to him in India. A receipt by any person on behalf of the
assessee is also subject to tax in India. The scope of the total income subject
to tax in case of a resident is a little wider inasmuch as, besides the income
referred to above, he is also liable to tax in respect of the income that
accrues or arises to him outside India, too, unless the person happens to be
Not Ordinarily Resident in India.

Section 9 expands
the scope of the income that is deemed to have accrued or arisen in India even
where not actually accrued or arisen in India and the income listed therein, in
the circumstances listed in section 9, such income would be ordinarily taxable
in India even where belonging to a non-resident, subject of course to the
provisions of sections 90, 90A and 91 of the Act.

The sum and
substance of the provisions is that the global income of a resident is taxable
in India, irrespective of its place of accrual. In contrast, income in the case
of a non-resident or Not Ordinarily Resident person is taxed in India only
where such an income is received in India or has accrued or arisen in India or
where it is deemed to be so received or accrued or arisen.

In both the cases
under consideration the assessees were non-residents and applying the
principles of taxation explained above, the income could be taxed in their
hands only where such income for the respective assessment years under
consideration was received in India or had accrued or arisen in India or where
it was deemed to be so. In both cases, the deposits were made during the
relevant financial year in the bank account with HSBC Geneva, Switzerland held
in the name of the discretionary trust or its nominee during the period when
the assessees in question were non-residents for the purposes of the Act. In
both the cases, the provisions of section 5 were highlighted before the
authorities to explain that the deposits in question did not represent any
income of the assessee that was received in India or had accrued or arisen in
India or where it was deemed to be so. In both cases, the assessees were the
beneficiaries of discretionary trusts and had not received any money or income
on distribution by the trust and it was explained to the authorities that the
additions could not have been made in the hands of the beneficiaries of such
trusts. In both the cases, the authorities had sought the consent of the
assessees for facilitating the investigation with the Swiss bank and collecting
information and documents from the bank – and in both the cases the consent was
refused.

In the first case
of Deepak B. Shah, the Tribunal found that the assessee was a non-resident for
many years, and the A.O. had failed to establish any connection between the
deposits in the impugned bank account and his Indian income. No addition was
held to be sustainable by the Tribunal in the hands of the non-resident
assessee on account of such deposits which could not be considered to be
received in India or had accrued or arisen in India or was deemed to be so. In
this case, the bank account was in the name of a discretionary trust of which
the assessee was a beneficiary and the Settlor of the trust had admitted the
ownership of the funds in the bank account and these facts weighed heavily with
the Tribunal in deleting the additions. It held that a beneficiary of the
discretionary trust could be taxed only when there was a receipt by him during
the year, on distribution by the trust.

And in the second
case, of Renu T. Tharani, the assessee, aged 83 years, a resident of the USA
for a few years, was a sole beneficiary of a discretionary trust who operated
the HSBC Geneva bank account. The addition was made in the hands of the
beneficiary assessee on account of deposits in a foreign bank account held in
the name of a company, whose shares were held by a discretionary trust, the
Tharani Beneficiary Trust; in the course of reopening and reassessment, and on
appeal to the Tribunal, the addition was sustained in spite of the fact that
not much material was available for linking the deposits to the Indian income
of the assessee for the year under consideration, and the fact that the
assessee was a beneficiary of the discretionary trust from which she had not
received any income on distribution during that year.

In the latter
decision, the assessee had brought to the attention of the Tribunal the
decision in the case of Hemant Mansukhlal Pandya, 100 taxmann.com 280
(Mum) but that did not help her case. The fact that the assessee had
refused to grant the consent, as required under the treaties and agreements,
for facilitating the inquiry and investigation by permitting the authorities to
obtain documents from the foreign bank, had substantially influenced the
adjudication by the Tribunal. That the bank account was closed and the trust
was dissolved with no trail was also a factor that was not very helpful. The
fact that the trust was in a tax haven, Cayman Islands, and was managed by
‘professional trustees’ did not help the case of the assessee. The Tribunal
gave due importance to the international reports on the clandestine movement of
funds to go to the root of the source. It was also not very happy with the
genuineness of the evidences produced or their authenticity and also with the
withholding of information by the assessee, as also with the limited
co-operation extended by her.

The fact that the
assessee in the latter case had ceased to be a resident only a few years in the
past and had left India just a year before the year of deposit, and that the
quantum of deposits was very huge, might have influenced the outcome in the
case, though in our opinion these factors were not determinative of the
outcome. It is true that the deposits were made during the year under
consideration, but it is equally true that during the year under consideration
the assessee was a non-resident and therefore the addition to the income could
have been sustained only if it was found to have been received in India or was
linked to Indian operations. The fact that the assessee was a beneficiary of a
discretionary trust and the bank account was not in her name but in the name of
the company that belonged to the trust, coupled with the fact that the assessee
had not received any money on distribution from the trust during the year, are
the factors which weighed in favour of not taxing the assessee, but although
considered, these did not inspire the Tribunal to delete the addition.

The decisions of
the Apex Court relating to the taxation of a discretionary trust were held by
the Tribunal to be delivered in the context of the facts of the cases before
the Court and not applicable to the facts and the issue before it. In case of a
discretionary trust, the beneficiaries could be taxed only on receipt from the
trust on distribution of income by the trust. Please see Estate of HMM
Vikramsinhji of Gondal 45 taxamnn.com 552 (SC); and Smt. Kamalini
Khatau 209 ITR 101 (SC).

The Tribunal in the
first case of Deepak B. Shah approved the contention of the assessee that the
addition in his hands was not sustainable in a case where the bank account was
in the name of the discretionary trust and the assessee was only the
beneficiary. It also upheld that the addition could not have been sustained
when no income of the trust was distributed amongst the beneficiaries. Its
decision was also influenced by the fact that the Settlor of the trust had
admitted the ownership of the account and the addition made in the Settlor’s
hands was deleted vide an order of the ITAT, reported in 171 ITD
602 (Mum) in the name of Dipendu B. Shah on the ground that the
Settlor was a non-resident during the year under consideration.

As against that, in
the latter case of Renu T. Tharani, all the three facts that influenced the
Tribunal in the Deepak B. Shah case were claimed to be present. But those facts
did not deter the Tribunal from sustaining the addition, perhaps for the lack
of evidence acceptable to it to satisfy itself and delete the addition on the
basis of the evidence available on record. Had proper evidence in support of
the existence of a discretionary trust or in support of the non-resident source
of the funds been available, it could have strengthened the case of the
assessee.

There was no
finding of the A.O. to the effect that there was, nor had the A.O. established,
any Indian connection to the deposits. If the deposits were considered to be
made out of her income while she was in India, then such income should have
been taxed in that year alone, and not in the year of deposit.

A receipt in the
hands of a non-resident in a foreign country is not taxable under the Indian
tax laws unless such a receipt is found to be connected to an Indian activity
giving rise to accrual or arising of income in India. Please see Finlay
Corporation Ltd. 86 ITD 626 (Delhi); Suresh Nanda 352 ITR 611 (Delhi);
and Smt. Sushila Ramaswamy 37 SOT 146; Saraswati Holding Corporation 111
TTJ Delhi 334; and Vodafone International Holding B.V. 17
taxmann.com 202 (SC).

Besides various
unreported case laws, the issue of addition based on the said ‘Base Note’
concerning the deposits in HSBC Bank account Geneva, Switzerland arose in the
following reported cases:

1. Mohan M. Dhupelia, 67 SOT 12 (URO) (Mum)

2. Ambrish Manoj Dhupelia, 87 taxmann.com 195
(Mum)

3. Hemant Mansukhlal Pandya, 100 Taxmann.com 280
(Mum)

4. Shravan Gupta, 81 taxmann.com 123 (Delhi)

5. Shyam Sunder Jindal, 164 ITD 470 (Delhi)

6. Soignee R. Kothari, 80 taxmann.com 240 (Bom).

The first two cases
were decided by the Tribunal against the assessees, while the later cases were
decided in favour of the assessee mainly on account of the failure of the A.O.
to establish the nexus of the bank deposits to an Indian source of income or to
adhere to the rules of natural justice or to obtain authentic documents.

A deposit in the
foreign bank account of a trust wherein the assessee was a beneficiary of a
trust was held to be taxable in the hands of the assessee for A.Y. 2002-03 for
the inability of the assessee to render satisfactory explanation in the course
of reopening and reassessment which were also held to be valid. Please see Mohan
M. Dhupelia, 67 SOT 12 (URO) (Mum). Also see Ambrish Manoj
Dhupelia, 87 taxmann.com 195 (Mum).

The assessee, a
non-resident since 25 years, was found to have a foreign bank account in HSBC
Bank Geneva in his name for which no explanation was provided by the assessee,
staying in Japan for A.Y. 2006-07 and 2007-08. The addition made by the A.O.
was deleted on the ground that the A.O. had not brought on record any material
to show that the income had accrued or arisen in India and the money was
diverted by the assessee from India. As against that, the assessee had proved
that he was a non-resident for 25 years. Please see Hemant Mansukhlal
Pandya, 100 Taxmann.com 280 (Mum).

In the absence of a
nexus between the deposits found in a foreign bank account and the source of
income derived from India, the addition made for A.Y. 2006-07 and 2007-08 on
account of deposits in HSBC Account Geneva on the basis of a ‘Base Note’ in the
hands of the assessee who was a non-resident since 1990, was deleted. The
assessee was a Belgian resident. Please see Dipendu Bapalal Shah 171 ITD
602 (Mum).

For A.Y. 2006-07,
the A.O. had made additions to the total income on account of deposits in a
foreign bank account with HSBC Geneva. The assessee claimed complete ignorance
of the fact of the bank account. The addition was deleted on the ground that it
was made on the basis of unsubstantiated documents which were not signed by any
bank official and were without any adequate and reliable information. Please
see Shravan Gupta, 81 taxmann.com 123 (Delhi).

The addition was
made by the A.O. to the assessee’s income in respect of undisclosed amount kept
in a foreign bank account HSBC, Geneva, Switzerland. However, the same was set
aside due to non-availability of authentic documents and requisite information
to be relied upon by the A.O. to make the addition. Please see Shyam
Sunder Jindal, 164 ITD 470 (Delhi).

shailesh.kwebmaker

TAXATION OF RECEIPT BY RETIRING PARTNER

ISSUE FOR CONSIDERATION

On retirement of a
partner from a partnership firm, at times the outgoing partner may be paid an amount
which is in excess of his capital, current account and loan balances with the
firm. Such amount paid to the outgoing partner is often determined on the basis
of an informal valuation of the net assets of the firm, or of the business of
the firm.

Taxation of such
receipts by a partner on retirement from a partnership firm has been an issue
which has been the subject matter of disputes for several decades. As far back
as in September, 1979, the Supreme Court in the case of Malabar Fisheries
Co. vs. CIT 120 ITR 49, held that dissolution of a firm did not amount
to extinguishment of rights in partnership assets and was thus not a ‘transfer’
within the meaning of section 2(47). In 1987, the Supreme Court, in a short
decision in Addl. CIT vs. Mohanbhai Pamabhai 165 ITR 166,
affirmed the view taken by the Gujarat High Court in 1973 in the case of CIT
vs. Mohanbhai Pamabhai 91 ITR 393. In that case, the Gujarat High Court
had held that when a partner retires from a partnership and the amount of his
share in the net partnership assets after deduction of liabilities and prior
charges is determined on taking accounts on footing of notional sale of
partnership assets and given to him, what he receives is his share in the
partnership and not any consideration for transfer of his interest in
partnership to the continuing partners. Therefore, charge of capital gains tax
would not apply on such retirement.

The law is amended
by the Finance Act, 1987 with effect from Assessment Year 1988-89 by insertion
of section 45(4) and simultaneous deletion of section 47(ii). Section 47(ii)
earlier provided that distribution of assets on dissolution of a firm would not
be regarded as a transfer. Section 45(4) now provides as under:

‘The profits or
gains arising from the transfer of a capital asset by way of distribution of
capital assets on the dissolution of a firm or other association of persons or
body of individuals (not being a company or a co-operative society) or
otherwise, shall be chargeable to tax as the income of the firm, association or
body, of the previous year in which the said transfer takes place and, for the
purposes of section 48, the fair market value of the asset on the date of such
transfer shall be deemed to be the full value of the consideration received or
accruing as a result of the transfer.’

Section 45(4), with
its introduction, so far as the firm is concerned, provides for taxing the firm
on distribution of its assets on dissolution or otherwise. However, even
subsequent to these amendments, the taxability of the excess amounts received
by the partner on retirement from the firm, in his hands, has continued to be a
matter of dispute before the Tribunals and the High Courts. While the Pune,
Hyderabad, Mumbai and Bangalore benches have taken the view that such excess
amounts are chargeable to tax as capital gains in the hands of the partner, the
Mumbai, Chennai, Bangalore and Hyderabad benches have taken the view that such
amounts are not taxable in the hands of the retiring partner. Further, while
the Bombay, Andhra Pradesh and Madras High Courts have taken the view that such
amount is not taxable in the hands of the partner, the Delhi High Court has
taken the view that it is taxable in the hands of the partner as capital gains.

THE HEMLATA S. SHETTY CASE

The issue came up
before the Mumbai bench of the Tribunal in the case of Hemlata S. Shetty
vs. ACIT [ITA Nos. 1514/Mum/2010 and 6513/Mum/2011 dated 1st December, 2015].

In this case,
relating to A.Y. 2006-07, the assessee was a partner in a partnership firm of
D.S. Corporation where she had a 20% profit share. The partnership firm had
acquired a plot of land in September, 2005 for Rs. 6.50 crores. At that time,
the original capital contributions of the partners was Rs. 3.20 crores, the
partners being the assessee’s husband (Sudhakar M. Shetty) and another person.
The assessee became a partner in the partnership firm on 16^th
September, 2005, contributing a capital of Rs. 52.50 lakhs. On 26^th
September, 2005 three more partners were admitted to the partnership firm. Most
of the tenants occupying the land were vacated by paying them compensation, and
the Ministry of Tourism’s approval was received for setting up a five-star
hotel on the plot of land.

On 27^th
March, 2006 the assessee and her husband retired from the partnership firm, at
which point of time the land was revalued at Rs. 193.91 crores and the surplus
on revaluation was credited to the partners’ capital accounts. The assessee and
her husband each received an amount of Rs. 30.88 crores on their retirement
from the partnership firm, over and above their capital account balances.

The A.O. noted that
the revaluation of land resulted in a notional profit of Rs. 154.40 crores for
the firm and 20% share therein of the assessee and her husband at Rs. 30.88
crores each was credited to their accounts. No tax was paid on such revalued
profits on the plea that those amounts were exempt u/s 10(2A). The A.O. held
that the excess amount received on retirement from the partnership firm was
liable to tax as short-term capital gains as there was a transfer within the
meaning of section 2(47) on retirement of the partner.

The Commissioner
(Appeals), on appeal, confirmed the order of the A.O.

Before the
Tribunal, on behalf of the assessee, reliance was placed on a decision of the
Bombay High Court in the case of Prashant S. Joshi vs. ITO 324 ITR 154,
where the Bombay High Court had quashed the reassessment proceedings initiated
to tax such excess amount received on retirement of a partner from the
partnership firm, on the ground that the amount was a capital receipt not
chargeable to tax and the reopening of the case was not maintainable.

It was argued on
behalf of the Department that the Tribunal had decided the issue against the
assessee in the case of the assessee’s husband, Sudhakar M. Shetty vs.
ACIT 130 ITD 197, on 9^th September, 2010. In that case, the
Tribunal had referred to the observations of the Bombay High Court in the case
of CIT vs. Tribhuvandas G. Patel 115 ITR 95, where the Court had
held that there were two modes of retirement of a partner from a partnership
firm; in one case, a retiring partner, while going out, might assign his
interest by a deed; and in the other case, he might, instead of assigning his
interest, take the amount due to him from the firm and give a receipt for the
money and acknowledge that he had no more claim on his co-partners. In that
case, the Bombay High Court held that where, instead of quantifying his share
by taking accounts on the footing of a notional sale, the parties agreed to pay
a lump sum in consideration of the retiring partner assigning or relinquishing
his share or right in the partnership and its assets in favour of the
continuing partners, the transaction would amount to transfer within the
meaning of section 2(47). This view was followed by the Bombay High Court in
subsequent decisions in the cases of CIT vs. H.R. Aslot 115 ITR 255
and N.A.Mody vs. CIT 162 ITR 420, and the Delhi High Court in the
case of Bishan Lal Kanodia vs. CIT 257 ITR 449.

In the case of Sudhakar
Shetty (Supra), the Tribunal observed that in deciding the case of Prashant
S. Joshi (Supra), the Bombay High Court had not considered its earlier
decisions in the cases of N.A. Mody (Supra) and H.R. Aslot
(Supra) and the said decision was rendered by the Court in the context
of the validity of the notice u/s 148, and therefore the ratio of the
decision in that case did not apply to the facts of the case before it in the Sudhakar
Shetty case.

On behalf of the
assessee, Hemlata Shetty, it was pointed out to the Tribunal that, after the
Tribunal’s decision in Sudhakar Shetty’s case, the Department had
reopened the assessment of the firm where the assessee and her husband were
partners and assessed the notional profits as income in the hands of the firm
u/s 45(4). It was argued that the Department had realised the mistake that it
could not have assessed the partners on account of receipt on retirement u/s
45(4). It was therefore pointed out that due to subsequent developments, the
facts and circumstances had changed from those prevalent when the Tribunal had
decided the case of Sudhakar Shetty.

It was further
argued on behalf of the assessee that after the judgment in the Sudhakar
Shetty case on 9^thSeptember, 2010, a similar matter had
been decided by the Mumbai bench of the Tribunal in the case of R.F.
Nangrani HUF vs. DCIT [ITA No. 6124/Mum/2012] on 10^th
December, 2014, where the decision in Sudhakar Shetty’s case was
also referred to. The issue in that case was similar to the issue in the case
of Hemlata Shetty. In R.F. Nangrani HUF’s case, the
Tribunal had followed the decision of the Supreme Court in the case of CIT
vs. R. Lingamallu Rajkumar 247 ITR 801, where it had held that the
amount received on retirement by a partner was not liable to capital gains tax,
and the Tribunal in that case had also considered the decision of the Hyderabad
bench in ACIT vs. N. Prasad 153 ITD 257, which had taken a
similar view. It was argued on behalf of the assessee that when there were
conflicting decisions delivered by a bench of equal strength, the later
judgment should be followed, especially when the earlier judgment was referred
to while deciding the matter in the later judgment.

The Tribunal noted
that in the case of CIT vs. Riyaz A. Shaikh 221 Taxman 118, the
Bombay High Court referred to the fact that the Tribunal in that case had
followed the Bombay High Court decision in Prashant S. Joshi’s
case, while noting that Tribuvandas G. Patel’s case, which had
been followed in N.A. Mody’s case, had been reversed by the
Supreme Court. The Bombay High Court further noted in Riyaz Shaikh’s
case that Prashant Joshi’s case had also noted this fact of
reversal, and that it had followed the decision of the Supreme Court in R.
Lingamallu Rajkumar’s case 247 ITR 801.

The Tribunal
therefore followed the decision of the jurisdictional High Court in Riyaz
Shaikh’s case and held that the amount received by the assessee on
retirement from the partnership firm was not taxable under the head ‘Capital
Gains’.

This decision of
the Tribunal in Hemlata Shetty’s case has been approved by the
Bombay High Court in Principal CIT vs. Hemlata S. Shetty 262 Taxman 324.
R.F. Nangrani HUF’s Tribunal decision has also been approved by the
Bombay High Court in Principal CIT vs. R.F. Nangrani HUF 93 taxmann.com
302. A similar view has also been taken by the Andhra Pradesh High
Court in the case of CIT vs. P.H. Patel 171 ITR 128, though this
related to A.Y. 1973-74, a period prior to the deletion of clause (ii) of
section 47. Further, in the case of CIT vs. Legal Representative of N.
Paliniappa Goundar (Decd.) 143 ITR 343, the Madras High Court also
accepted the Gujarat High Court’s view in the case of Mohanbhai Pamabhai
(Supra) and disagreed with the view of the Bombay High Court in the
case of Tribhuvandas G. Patel (Supra), holding that excess amount
received by a partner on retirement was not taxable.

A similar view has
also been taken by the Mumbai bench of the Tribunal in the case of James
P. D’Silva vs. DCIT 175 ITD 533, following the Bombay High Court
decisions in Prashant S. Joshi and Riyaz A. Shaikh’s
cases and by the Bangalore bench in the case of Prabhuraj B. Appa, 6 SOT
419 and by the Chennai bench in the case of P. Sivakumar (HUF),
63 SOT 91.

SAVITRI KADUR’S CASE

The issue again
came up before the Bangalore bench of the Tribunal recently in the case of Savitri
Kadur vs. DCIT 177 ITD 259.

In this case, the
assessee and another person had formed a partnership with effect from 1^st
April, 2004. Yet another person was admitted as a partner with effect from 1^st
April, 2007, and simultaneously the assessee retired from the firm with effect
from that date. The assessee had a capital balance of Rs. 1.64 crores as on 1^st
April, 2006 and her share in the profit for the year of Rs. 46 lakhs was
credited to her account. The land and building held by the firm was revalued
and her share of Rs. 62.51 lakhs in the surplus on revaluation was credited to
her account. Interest on capital of Rs. 18.12 lakhs was also credited to her
account which, after deducting drawings, showed a balance of Rs. 2.78 crores as
on the date of her retirement. The assessee was paid a sum of Rs. 3.40 crores
on her retirement. The assessee had invested an amount of Rs. 50 lakhs in
capital gains bonds.

The difference of
Rs. 62 lakhs between Rs. 3.40 crores and Rs. 2.78 crores was taxed as capital
gains by the A.O. in her hands. According to the A.O., such amount was nothing
but a payment for her giving up her right in the existing goodwill of the firm,
that there was a transfer u/s 2(47) on her retirement, which was therefore
liable to capital gains tax.

The Commissioner
(Appeals) upheld the order of the A.O., placing reliance on the decision of the
Bombay High Court in the case of CIT vs. A.N. Naik Associates 265 ITR 346,
where the High Court had held that there was a charge to capital gains tax u/s
45(4) when the assets of the partnership were distributed even on retirement of
a partner, and the scope of section 45(4) was not restricted to the case of
dissolution of the firm alone.

On appeal, the
Tribunal observed that it was necessary to appreciate how the act of the
formation, introduction, retirement and dissolution of partnership was used by
assessees as a device to evade tax on capital gains; first by converting an
asset held individually into an asset of the firm and later on retiring from
the firm; and likewise by conversion of capital assets of the firm into assets
of the partners by effecting dissolution or retirement. In that direction, the
Tribunal analysed the background and tax implications behind conversion of
individual assets into assets of partnership, distribution of assets on
dissolution, reconstitution of the firm with the firm continuing whereby a
partner retired and the retiring partner was allotted a capital asset of the
firm for relinquishing all his rights and interests in the partnership firm as
partner, and continuation of the firm after reconstitution whereby a partner
retired and the retiring partner was paid a consideration for relinquishing all
his rights and interests in the partnership firm as partner in any of the
following manner:

(a) on the basis of
amount lying in his / her capital account, or

(b) on the basis of
amount lying in his / her capital account plus amount over and above the sum
lying in his / her capital account, or

The Tribunal
thereafter held that the case of the appellant, on the basis of the facts
before it, was a situation falling under (b) above, meaning that the assessee
on her retirement from the firm was paid on the basis of the amount lying in
her capital account plus an amount over and above the sum lying in her capital
account.

The Tribunal
observed that:

(i) there was no
dispute that there could not be any incidence of tax in situation (a) above on
account of the Supreme Court decision in the case of Additional CIT vs.
Mohanbhai Pamabhai (Supra);

(ii) so far as
situations (b) and (c) were concerned, they had been the subject matter of
consideration in several cases, and there had been conflict of opinion between
courts on whether there would be incidence of tax or not;

(iii) the fact that
there was revaluation of assets of the firm with a resultant enhancement of the
capital accounts of the partners was not relevant.

The Tribunal
further observed that:

(1) the share or
interest of a partner in the partnership and its assets would be property and,
therefore, a capital asset within the meaning of the aforesaid definition. To
this extent, there could be no doubt;

(2) the question
was whether it could be said that there was a transfer of capital asset by the
retiring partner in favour of the firm and its continuing partners so as to
attract a charge u/s 45;

(3) the share or
interest of a partner in the partnership and its assets would be property and,
therefore, a capital asset within the meaning of the aforesaid definition. The
next question was whether it could be said that there was a transfer of capital
asset by the retiring partner in favour of the firm and its continuing partners
so as to attract a charge u/s 45;

(4) the question
whether there would be incidence of tax on capital gains on retirement of a
partner from the partnership firm would depend upon the mode in which
retirement was effected. Therefore, taxability in such a situation would depend
on several factors like the intention, as was evidenced by the various clauses
of the instrument evincing retirement or dissolution, the manner in which the
accounts had been settled and whether the same included any amount in excess of
the share of the partner on the revaluation of assets and other relevant
factors which would throw light on the entire scheme of retirement /
reconstitution;

(5) for the
purposes of computation, what was to be seen was the credit in the capital
account of the partner alone.

The Tribunal,
referring to the observations of the Bombay High Court in the case of Tribhuvandas
G. Patel (Supra), held that the terms of the deed of retirement had to
be seen as to whether they constituted a release of any assets of the firm in
favour of the continuing partners; where on retirement an account was taken and
the partner was paid the amount standing to the credit of his capital account,
there would be no transfer and no tax was exigible; however, where the partner
was paid a lump sum consideration for transferring or releasing his interest in
the partnership’s assets to the continuing partners, there would be a transfer,
liable to tax. The Tribunal noted that the Supreme Court, in appeal in that
case, had held that there was no incidence of tax on capital gains on the
transaction only because of the provisions of section 47(ii), which exempted
the distribution of capital assets on dissolution, even though the facts in the
case in appeal before the Supreme Court were concerning the case of a retiring
partner giving up his rights over the properties of the firm.

The Tribunal
referred to the cases of the Pune bench in the case of Shevantibhai C.
Mehta 4 SOT 94 and the Mumbai bench of the Tribunal in the case of Sudhakar
M. Shetty (Supra) and held that the facts in the case before it were
almost identical to the facts in the case of Sudhakar M. Shetty.

It distinguished
the other cases cited before it on behalf of the assessee on the grounds that
some of those cases related to a period prior to the amendment of the law made
effective from A.Y. 1988-89, or were cases where the issue involved was whether
the reassessment proceedings were valid, or were cases involving the
partnership firm and not the partner, or were cases where the retiring partner
was paid a share in the goodwill of the firm. In short, the Tribunal held that
those cases were not applicable to the facts of the assessee’s case.

The Tribunal
finally upheld the action of the A.O. in taxing the excess paid to the retiring
partner over and above the sum standing to the credit of her capital account as
capital gains. However, it modified the computation of the capital gains by
treating the amount lying to the credit of the partner’s account, including the
amount credited towards goodwill in the partner’s capital account, as a cost
and allowing the deduction thereof. It also held the gains to be long-term
capital gains and allowed exemption u/s 54EC to the extent of investment in
capital gains bonds.

A similar view has
been taken by the other benches of the Tribunal in the cases of Shevantibhai
C. Mehta (Supra), Sudhakar M. Shetty (Supra) and Smt. Girija
Reddy vs. ITO 52 SOT 113 (Hyd)(URO). The Delhi High Court also, in a
case relating to A.Y. 1975-76 (before the amendment), Bishan Lal Kanodia
vs. CIT 257 ITR 449, followed the decision of the Bombay High Court in Tribhuvandas
G. Patel (Supra) to hold that the receipt on retirement was liable to
capital gains tax.

OBSERVATIONS

To understand the
root of the controversy, one would have to go back to the decision of the
Gujarat High Court in the case of CIT vs. Mohanbhai Pamabhai 91 ITR 393,
which was affirmed by the Supreme Court, 165 ITR 166, holding
that there was no transfer of capital assets by a partner on his retirement. In
that case, on retirement, the assessee received a certain amount in respect of
his share in the partnership which was worked out by taking the proportionate
value of a share in the partnership assets, after deduction of liabilities and
prior charges, including an amount representing his proportionate share in the
value of the goodwill. It was this proportionate share in the goodwill which
was sought to be taxed as capital gains by the authorities.

In that case, the
Gujarat High Court held that:

(i) what the
retiring partner was entitled to get was not merely a share in the partnership
assets, he has also to bear his share of the debts and liabilities, and it was
only his share in the net partnership assets, after satisfying the debts and
liabilities, that he was entitled to get on retirement;

(ii) Since it was only in the surplus that the
retiring partner was entitled to claim a share, it was not possible to predicate
that a particular amount was received by the retiring partner in respect of his
share in a particular partnership asset, or that a particular amount
represented a consideration received by the retiring partner for extinguishment
of his interest in a particular partnership asset;

(iii) when the
assessee retired from the firm, there was no transfer of interest of the
assessee in the goodwill or any other asset of the firm;

(iv) no
consideration received or accrued as a result of such transfer of such interest
even if there was a transfer; and

(v) no part of the amount received by the assessee
was assessable to capital gains tax u/s 45.

The Gujarat High
Court relied on its earlier decision in the case of CIT vs. R.M. Amin 82
ITR 194, for the proposition that where transfer consisted in
extinguishment of a right in a capital asset, unless there was an element of
consideration for such extinguishment, the transfer would not be liable to
capital gains tax.

It may be noted
that in Mohanbhai Pamabhai, the document pursuant to which
retirement was effected stated that the amount had been decided as payable to
the retiring partners in lieu of all their rights, interest and share in
the partnership firm, and each of them voluntarily gave up their right, title
and interest in the partnership firm. The goodwill had not been recorded or
credited to the capital accounts of the partners, and therefore it was a (b)
type of situation classified by the Bangalore Tribunal. The Bangalore bench of
the Tribunal therefore does not seem to have been justified in stating that
only cases where only balance standing to credit of the capital account is paid
to the retiring partner [situation (a) cases] are not transfers as was held by
the Supreme Court in Mohanbhai Pamabhai. In other words, the
facts of the Mohanbhai Pamabhai case classified with situation
(b) and the Tribunal overlooked this fact; had it done so by appreciating that
the facts in the case before the Supreme Court were akin to situation (b), the
decision could have been different.

The Supreme Court
approved the Gujarat High Court decision on the footing that there was no
transfer within the meaning of section 2(47) on retirement of a partner from a
partnership firm. By implication, the Supreme Court held that such cases of
retirement, where a partner was paid a sum over and above the balance due as
per the books of accounts, was not chargeable to capital gains tax.
Interestingly, in deciding the case the Supreme Court, while holding that the
receipts in question were not taxable, did not distinguish between different
modes of retirement, as some of the Tribunals and High Courts have sought to
do, for taxing some and exempting others.

The Tribhuvandas
G. Patel case (Supra) was one where the retiring partner was paid his
share in the goodwill of the firm and was also paid his share of appreciation
in the assets of the firm. Here, relying on the Commentary of Lindley on
Partnership, the Bombay High Court observed as under:

‘Further, under
section 32, which occurs in Chapter V, retirement of a partner may take any
form as may be agreed upon between the partners and can occur in three
situations contemplated by clauses (a), (b) and (c) of sub-section (1) of
section 32. It may be that upon retirement of a partner his share in the net
partnership assets after deduction of liabilities and prior charges may be
determined on taking accounts on the footing of notional sale of partnership
assets and be paid to him, but the determination and payment of his share may
not invariably be done in that manner and it is quite conceivable that, without
taking accounts on the footing of notional sale, by mutual agreement, a
retiring partner may receive an agreed lump sum for going out as and by way of
consideration for transferring or releasing or assigning or relinquishing his
interest in the partnership assets to the continuing partners and if the
retirement takes this form and the deed in that behalf is executed, it will be
difficult to say that there would be no element of “transfer”
involved in the transaction. In our view, it will depend upon the manner in
which the retirement takes place. What usually happens when a partner retires
from a firm has been clearly stated in the following statement of law, which
occurs in Lindley on Partnership, 13^thedition, at page 474:

“24.
Assignment of share, etc., by retiring partner.—When a partner retires or dies,
and he or his executors are paid what is due in respect of his share, it is
customary for him or them formally to assign and release his interest in the
partnership, and for the continuing or surviving partners to take upon
themselves the payment of the outstanding debts of the firm, and to indemnify
their late partner or his estate from all such debts, and it is useful for the
partnership agreement specifically so to provide.”

At page 475,
under the sub-heading “stamp on assignment by outgoing partner”, the
following statement of law occurs:

“An
assignment by a partner of his share and interest in the firm to his
co-partners, in consideration of the payment by them of what is due to him from
the firm, is regarded as a sale of property within the meaning of the Stamp
Acts; and consequently the deed of assignment, or the agreement for the
assignment, requires an ad valorem stamp. But if
the retiring partner, instead of assigning his interest, takes the amount due
to him from the firm, gives a receipt for the money, and acknowledges that he
has no more claims on his co-partners, they will practically obtain all they
want; but such a transaction, even if carried out by deed, could hardly be held
to amount to a sale; and no ad valorem stamp, it is apprehended, would
be payable.”

A couple of
things emerge clearly from the aforesaid passages. In the first place, a
retiring partner while going out and while receiving what is due to him in
respect of his share, may assign his interest by a deed or he may, instead of
assigning his interest, take the amount due to him from the firm and give a
receipt for the money and acknowledge that he has no more claim on his
co-partners. The former type of transactions will be regarded as sale or
release or assignment of his interest by a deed attracting stamp duty, while
the latter type of transaction would not. In other words, it is clear, the
retirement of a partner can take either of two forms, and apart from the
question of stamp duty, with which we are not concerned, the question whether
the transaction would amount to an assignment or release of his interest in
favour of the continuing partners or not would depend upon what particular mode
of retirement is employed and as indicated earlier, if instead of quantifying
his share by taking accounts on the footing of notional sale, parties agree to
pay a lump sum in consideration of the retiring partner assigning or
relinquishing his share or right in the partnership and its assets in favour of
the continuing partners, the transaction would amount to a transfer within the
meaning of section 2(47) of the Income-tax Act.’

Based on the
language of the Deed of Retirement, the Bombay High Court took the view that
since there was an assignment by the outgoing partner of his share in the
assets of the firm in favour of the continuing partners, there was a transfer
and the gains made on such transfer were exigible to tax.

In the context of
taxation, the Bombay High Court observed:

‘It may be
stated that the Gujarat decision in Mohanbhai
Pamabhai’s case [1973] 91 ITR 393 is the only
decision directly on the point at issue before us but the question is whether
the position of a retiring partner could be equated with that of a partner upon
the general dissolution for capital gains tax purposes? The equating of the two
done by the Supreme Court in Addanki
Narayanappa’s case, AIR 1966 SC 1300, was not
for capital gains tax purposes but for considering the question whether the
instrument executed on such occasion between the partners inter se required registration and could be admitted in evidence
for want of registration. For capital gains tax purposes the question assumes
significance in view of the fact that under section 47(ii) any distribution of
assets upon dissolution of a firm has been expressly excepted from the purview
of section 45 while the case of a retirement of a partner from a firm is not so
excepted and hence the question arises whether the retirement of a partner
stands on the same footing as that upon a dissolution of the firm. In our view,
a clear distinction exists between the two concepts, inasmuch as the
consequences flowing from each are entirely different. In the case of
retirement of a partner from the firm it is only that partner who goes out of
the firm and the remaining partners continue to carry on the business of the
partnership as a firm, while in the latter case the firm as such no more exists
and the dissolution is between all the partners of the firm. In the Indian
Partnership Act the two concepts are separately dealt with.’

This distinction between the dissolution and the retirement, made by
the High Court for taxing the receipt was overruled by the Supreme Court by
holding that the two are the same for the purposes of section 47(ii) of the
Act.

It was therefore
that the Bombay High Court first held that there was a transfer and later that
the receipt of consideration on transfer was not exempt from tax u/s 47(ii) of
the Act. The Supreme Court, however, overruled the Bombay High Court decision,
holding that retirement was also covered by dissolution referred to in section
47(ii), and that such retirement would therefore not be chargeable to capital
gains. It may also be noted that the Bombay High Court’s decision was rendered
prior to the Supreme Court decision in the case of Mohanbhai Pamabhai
(Supra).

Surprisingly, the
Delhi High Court, while deciding the case of Bishanlal Kanodia (Supra),
relied upon the decision of the Bombay High Court in Tribuhuvandas G.
Patel (Supra), overlooking the implications of the decisions of the
Supreme Court in the cases of Mohanbhai Pamabhai and Tribhuvandas
G. Patel wherein the ratio of the decision of the Bombay High
Court was rendered inapplicable. The Delhi High Court sought to distinguish
between dissolution and retirement, even though the Supreme Court had held that
the term ‘dissolution’ for the purpose of section 47(ii) included retirement up
to A.Y. 1987-88; the case before the Delhi High Court concerned itself with
A.Y. 1975-76.

Further, though the
decision of the Madras High Court in the case of the Legal Representatives of
N. Paliniappa Goundar (Supra) was relied upon by the assessee in the
case of Savitri Kadur (Supra), it was not considered by the
Bangalore bench of the Tribunal. The Madras High Court in that case, for A.Y.
1962-63, considering the provisions of section 12B of the 1922 Act, had dealt
with the decisions of the Gujarat High Court in the case of Mohanbhai
Pamabhai and of the Bombay High Court in the case of Tribhuvandas
G. Patel, which had not yet been decided by the Supreme Court. While
disagreeing with the view of the Bombay High Court, the Madras High Court
observed as under:

With respect, we
cannot see why a retirement of a partner from a firm should be treated as
having different kinds of attributes according to the mode of settlement of the
retiring partner’s accounts in the partnership. In our view, whether the
retiring partner receives a lump sum consideration or whether the amount is
paid to him after a general taking of accounts and after ascertainment of his
share in the net assets of the partnership as on the date of retirement, the
result, in terms of the legal character of the payment as well as the
consequences thereof, is precisely the same. For, as observed by the Gujarat
High Court in Mohanbhai‘s case when a partner retires from the firm and receives an amount
in respect of his share in the partnership, what he receives is his own share
in the partnership, and it is that which is worked out and realised. Whatever
he receives cannot be regarded as representing some kind of consideration
received by him as a result of transfer of assignment or extinguishment or
relinquishment of his share in favour of the other partners.

We hold that
even in a case where some kind of a lump sum is received by the retiring
partner, it must be regarded as referable only to the share of the retiring
partner. This being so, no relinquishment at all is involved. What he receives
is what he has already put in by way of his share capital or by way of his
exertions as a partner. In a true sense, therefore, whether it is a dissolution
or a retirement, and whether in the latter case the retirement is on the basis
of a general taking of accounts or on the basis of an ad hoc payment to the retiring partner, what the partner obtains
is nothing more and nothing less than his own share in the partnership. A
transaction of this kind is more fittingly described as a mutual release or a
mutual relinquishment. In the very case dealt by the Bombay High Court, the
particular amount paid by the remaining partners in favour of the retiring
partner was only a payment in consideration of which there was a mutual
release, a release by the retiring partner in favour of the remaining partners
and a release by the remaining partners in favour of the retiring partner. The
idea of mutual release is appropriate to a partnership, because a retired
partner will have no hold over the future profits of the firm and the partners
who remain in the partnership release the retired partner from all future
obligations towards the liabilities of the firm.

We, therefore,
unqualifiedly accept the decision of the Gujarat High Court as based on a
correct view of the law and the legal relations which result on the retirement
of a partner from the partnership. With respect, we do not subscribe to the distinction
sought to be drawn by the learned Judges of the Bombay High Court between an ad hoc payment to a retiring partner and a payment to him after
ascertaining his net share in the partnership.

The Andhra Pradesh High Court in the case of CIT vs. L. Raghu
Kumar 141 ITR 674, also had an occasion to consider this issue for the
A.Y. 1971-72. In this case, the retiring partner received an amount in excess
of the balance lying to the credit of his capital account and his share of
profits. The Andhra Pradesh High Court considered the decisions of the Bombay
High Court in the case of Tribhuvandas G. Patel (Supra) and CIT
vs. H.R. Aslot 115 ITR 255, where the Bombay High Court had held that
whether there was a transfer or not would depend upon the terms of the retirement
deed – whether there is an assignment by the outgoing partner in favour of the
continuing partners, or whether the retiring partner merely receives an amount
for which he acknowledges receipt.

The Andhra Pradesh
High Court observed as under:

‘It is no doubt
true as submitted by the learned counsel for the revenue that the Bombay High
Court did not accept the principle in the Mohanbhai case, that there is no distinction between a case of a retirement
of the partner and dissolution of the partnership firm and that there can never
be a transfer of a capital asset in the case of a retirement of a partner as
there is no relinquishment of a capital asset or extinguishment of rights
therein. With great respect, we are unable to agree with the view of the Bombay
High Court. The rights of a partner are governed by the provisions of the
Partnership Act. Otherwise by a mere description, the nature of the transaction
can be altered. Further, the Gujarat High Court in Mohanbhai’s case (Supra) followed the
decision of the Supreme Court in Narayanappa
(Supra) which laid down the proposition of law
unequivocally.’

This decision of
the Andhra Pradesh High Court has been affirmed by the Supreme Court in CIT
vs. R. Lingmallu Raghukumar 247 ITR 801. Therefore, effectively, the
Supreme Court has approved of the approach taken by the Andhra Pradesh High
Court, to the effect that there can never be a transfer of a capital asset in
the case of retirement of a partner as there is no relinquishment of a capital
asset or extinguishment of rights therein, and that the nature of the
transaction cannot be altered by a mere description, but is governed by the
provisions of the Partnership Act. It is only logical that a transfer cannot
arise merely because a retiring partner is paid an amount in excess of his
capital, or because the retirement deed wording is different.

This fact of law
laid down by the Supreme Court and the overruling of the law laid down by the
Bombay High Court, has been recognised by the Bombay High Court in its later
decision in the case of Prashant S. Joshi (Supra), clearly and
succinctly, where the Bombay High Court observed:

‘The Gujarat
High Court held that there is, in such a situation, no transfer of interest in
the assets of the partnership within the meaning of section 2(47). When a
partner retires from a partnership, what the partner receives is his share in
the partnership which is worked out by taking accounts and this does not amount
to a consideration for the transfer of his interest to the continuing partners.
The rationale for this is explained as follows in the judgment of the Gujarat
High Court (in the Mohanbhai Pamabhai case):

“…What
the retiring partner is entitled to get is not merely a share in the
partnership assets; he has also to bear his share of the debts and liabilities
and it is only his share in the net partnership assets after satisfying the
debts and liabilities that he is entitled to get on retirement. The debts and
liabilities have to be deducted from the value of the partnership assets and it
is only in the surplus that the retiring partner is entitled to claim a share.
It is, therefore, not possible to predicate that a particular amount is
received by the retiring partner in respect of his share in a particular
partnership asset or that a particular amount represents consideration received
by the retiring partner for extinguishment of his interest in a particular
asset.”

14. The appeal
against the judgment of the Gujarat High Court was dismissed by a Bench of
three learned Judges of the Supreme Court in Addl.
CIT vs. Mohanbhai Pamabhai [1987] 165 ITR 166.
The Supreme Court relied upon its judgment in Sunil
Siddharthbhai vs. CIT [1985] 156 ITR 509. The
Supreme Court reiterated the same principle by relying upon the judgment in Addanki Narayanappa vs. Bhaskara Krishnappa AIR 1966 SC 1300. The Supreme Court held that what is envisaged on the retirement of
a partner is merely his right to realise his interest and to receive its value.
What is realised is the interest which the partner enjoys in the assets during
the subsistence of the partnership by virtue of his status as a partner and in
terms of the partnership agreement. Consequently, what the partner gets upon
dissolution or upon retirement is the realisation of a pre-existing right or
interest.

The Supreme
Court held that there was nothing strange in the law that a right or interest
should exist in praesenti but its realisation or
exercise should be postponed. The Supreme Court inter alia cited with
approval the judgment of the Gujarat High Court in Mohanbhai Pamabhai’s
case (Supra) and held that there is no transfer upon the retirement of a
partner upon the distribution of his share in the net assets of the firm. In CIT
vs. R. Lingmallu Raghukumar [2001] 247 ITR 801, the Supreme Court held,
while affirming the principle laid down in Mohanbhai Pamabhai
that when a partner retires from a partnership and the amount of his share in
the net partnership assets after deduction of liabilities and prior charges is
determined on taking accounts, there is no element of transfer of interest in
the partnership assets by the retired partner to the continuing partners.

15. At this
stage, it may be noted that in CIT vs.
Tribhuvandas G. Patel [1978] 115 ITR 95 (Bom.),
which was decided by a Division Bench of this Court, under a deed of
partnership, the assessee retired from the partnership firm and was inter alia paid an amount of Rs. 4,77,941 as his share in the
remaining assets of the firm. The Division Bench of this Court had held that
the transaction would have to be regarded as amounting to a transfer within the
meaning of section 2(47) inasmuch as the assessee had assigned, released and
relinquished his share in the partnership and its assets in favour of the
continuing partners. This part of the judgment was reversed in appeal by the
Supreme Court in Tribhuvandas G. Patel vs. CIT [1999] 236 ITR 515.

Following the
judgment of the Supreme Court in Sunil
Siddharthbhai’s case (Supra), the Supreme Court
held that even when a partner retires and some amount is paid to him towards
his share in the assets, it should be treated as falling under clause (ii) of
section 47. Therefore, the question was answered in favour of the assessee and
against the revenue. Section 47(ii) which held the field at the material time
provided that nothing contained in section 45 was applicable to certain
transactions specified therein and one of the transactions specified in clause
(ii) was distribution of the capital assets on a dissolution of a firm. Section
47(ii) was subsequently omitted by the Finance Act of 1987 with effect from 1^st
April, 1988. Simultaneously, sub-section (4) of section 45 came to be inserted
by the same Finance Act. Sub-section (4) of section 45 provides that profits or
gains arising from the transfer of a capital asset by way of distribution of
capital assets on the dissolution of a firm or other association of persons or
body of individuals (not being a company or a co-operative society) or
otherwise, shall be chargeable to tax as the income of the firm, association or
body, of the previous year in which the said transfer takes place.

The fair market
value of the assets on the date of such transfer shall be deemed to be the full
value of the consideration received or accruing as a result of the transfer for
the purpose of section 48. Ex facie sub-section
(4) of section 45 deals with a situation where there is a transfer of a capital
asset by way of a distribution of capital assets on the dissolution of a firm
or otherwise. Evidently, on the admitted position before the Court, there is no
transfer of a capital asset by way of a distribution of the capital assets on a
dissolution of the firm or otherwise in the facts of this case. What is to be
noted is that even in a situation where sub-section (4) of section 45 applies,
profits or gains arising from the transfer are chargeable to tax as income of
the firm.’

The Bombay High
Court in Prashant Joshi’s case (Supra) also considered the fact
that section 45(4) was brought in simultaneously with the deletion of section
47(ii), providing for taxation in the hands of the firm, in a situation of
transfer of a capital asset on distribution of capital assets on the
dissolution of a firm or otherwise. Clearly, therefore, the intention was to
tax only the firm and that too only in a situation where there was a
distribution of capital assets of a firm on dissolution or otherwise, which
situation would include retirement of a partner as held by the Bombay High
Court in the case of CIT vs. A.N. Naik Associates 265 ITR 346.
This understanding of the law has clearly been brought out by the Bombay High
Court in Hemlata Shetty’s case (Supra), where the Bombay High
Court has observed that amount received by a partner on his retirement from the
partnership firm is not subject to tax in the retiring partners’ hands in view
of section 45(4), and the liability, if any, for tax is on the partnership
firm.

Had the intention
been to also tax a partner on his retirement on the excess amount received over
and above his capital balance in the books of the firm, an amendment would have
been made to cover such a situation involving the receipt of capital asset by a
partner on distribution by the firm simultaneously with the deletion of section
47(ii).

The Bombay High
Court’s decision in the case of Riyaz A. Shaikh (Supra) is a
decision rendered in the context of A.Y. 2002-03, i.e., post-amendment. It was
not a case of a writ petition filed against any reassessment but was an appeal
from the decision of the Tribunal. The Court in that case has considered all
the relevant decisions – the Bombay High Court’s decisions in the cases of Prashant
S. Joshi, N.A. Mody and Tribhuvandas G. Patel, besides
the Supreme Court decisions in the cases of Tribhuvandas G. Patel
and R. Lingamallu Rajkumar – while arriving at the view that the
amounts received on retirement by a partner are not liable to capital gains
tax.

Similarly, Hemlata
Shetty’s case pertained to the post-amendment period and the Court
therein has considered the earlier decisions of the Bombay High Court in the Prashant
S. Joshi and Riyaz A. Sheikh cases and has also
considered the impact of section 45(4). It is indeed baffling that the Bombay
High Court decision delivered on 5^th March, 2019 and the earlier
decision of the Tribunal in the same case have not been considered by the
Bangalore bench of the Tribunal in Savitri Kadur’s case, decided
on 3^rd May, 2019, which chose to follow the decision of Sudhakar
M. Shetty (Supra), where the matter was still pending before the Bombay
High Court, rather than a decision of the Bombay High Court in his wife’s case
on identical facts (retirement from the same partnership firm) for the
immediately preceding assessment year, where the matter had already been
decided on 5^th March, 2019. We are sure that the decision of the
Tribunal could have been different if the development had been in its
knowledge.

One may note that
the Legislature, realising that the receipt in question was not taxable under
the present regime of the Income-tax Act, 1961, had introduced a specific
provision for taxing such receipt in the hands of the partner under the
proposed Direct Tax Code which has yet to see the light of the day.

The better view of
the matter therefore is that retirement of a partner from a partnership firm is
not subject to capital gains tax, irrespective of the mode of retirement of the
partner, as rightly held by the Bombay High Court in various decisions, and the
Mumbai bench of the Tribunal in the cases of Hemlata Shetty and James
P. D’Silva (Supra). It is rather unfortunate that this issue has been
continuing to torture assessees for the last so many decades, even after
several Supreme Court judgments. One hopes that this matter will finally be
laid to rest either through a clarification by the CBDT or by a decision of the
Supreme Court.

The beauty of doing nothing is that you can do it
perfectly. Only when you do something is it almost impossible to do it without
mistakes. Therefore people who are contributing nothing to society, except
their constant criticisms, can feel both intellectually and morally superior.

—
Thomas Sowell

shailesh.kwebmaker

SET OFF OF UNABSORBED DEPRECIATION WHILE DETERMINING BOOK PROFIT u/s 40(B)

ISSUE FOR CONSIDERATION

Section 40(b)
limits the deduction, in the hands of a partnership firm, in respect of an
expenditure on specified kinds of payments to partners. Amongst several
limitations provided in respect of deduction to be claimed by the partnership
firm, clause (5) of section 40(b) limits the deduction for remuneration to the
working partners to the specified percentage of the ‘book profit’ of the firm.

The term ‘book
profit’ is defined exhaustively by Explanation 3 to section 40(b) which reads
as under:

‘Explanation 3 –
For the purpose of this clause, “book profit” means the net profit, as shown in
the profit and loss account for the relevant previous year, computed in the
manner laid down in Chapter IV-D as increased by the aggregate amount of the
remuneration paid or payable to all the partners of the firm if such amount has
been deduced while computing the net profit.’

‘Book profit’, as per Explanation 3, means the net profit as per the
profit and loss account of the relevant year, computed in the manner laid down
in Chapter IV-D. The net profit in question is the one that is shown in the
profit and loss account which is computed in the manner laid down in Chapter
IV-D. This requirement to compute the net profit in the manner laid down in
Chapter IV-D has been the subject matter of debate. Section 32, which is part
of Chapter IV-D, provides for the depreciation allowance in computing the
income of the year and, inter alia, sub-section (2) provides for the
manner in which the unabsorbed depreciation of the earlier years is to be
adjusted against the income of the year. The interesting issue which has arisen
with respect to the computation of ‘book profit’ for the purpose of section
40(b) is whether the net profit for the year should also be reduced by the
unabsorbed depreciation of earlier years and whether the amount of remuneration
to the partners eligible for deduction should be computed with respect to such
reduced amount.

The Jaipur bench of
the Tribunal has held that in computing the ‘book profit’ and the amount
eligible for deduction on account of the remuneration to partners, unabsorbed
depreciation of the earlier years should be deducted from the net profit for
the year as provided in section 32(2). As against this, the Pune bench of the
Tribunal has taken a contrary view and has allowed the assessee firm’s claim of
the remuneration paid to its partners which was computed on the basis of ‘book
profit’ without reducing it by the unabsorbed depreciation of the earlier
years.

THE VIKAS OIL MILLS CASE

The issue first
came up for consideration of the Jaipur bench of the Tribunal in the case of Vikas
Oil Mills vs. ITO (2005) 95 TTJ 1126.

In that case, for
the assessment year 2001-02 the A.O. disallowed the remuneration amounting to
Rs. 1,79,005 paid to the working partners on the ground that the assessee firm
had not reduced the unabsorbed brought-forward depreciation of earlier years
from the profit of the year under consideration while claiming deduction for
the remuneration payable to the partners. Since the resultant figure after
reducing the unabsorbed depreciation of earlier years from the profit of the
assessee firm was a negative figure, the A.O. disallowed the remuneration paid
to the partners. The CIT(A) confirmed this order.

The assessee argued
before the Tribunal that the unabsorbed depreciation was allowed to be deducted
only because of a fiction contained in section 32(2) and that otherwise the
deduction was subject to the provisions of section 72(2). Hence, unabsorbed
depreciation should not be considered for computation of net profit in Chapter
IV-D. On the other hand, the Departmental representative supported the orders
of the lower authorities by submitting that unabsorbed depreciation of earlier
years was part of the current year’s depreciation as per section 32(2) which
fell in Chapter IV-D and, therefore, for computation of book profit unabsorbed
depreciation was to be necessarily taken into account.

The Tribunal
concurred with the view of the lower authorities and held that the remuneration
paid to the working partners was to be reduced from the book profit as per the
provisions of section 40(b)(v). The definition of book profit was provided in
Explanation 3 as per which it was required to be computed in the manner laid
down in Chapter IV-D. Therefore, the Tribunal held that the unabsorbed
depreciation of earlier years had to be reduced as provided in section 32(2)
while determining the book profit for the purpose of determining the amount of
deductible remuneration. However, the Tribunal agreed with the alternative plea
of the assessee for allowing the minimum amount of remuneration which was
allowable even in case of a loss.

RAJMAL LAKHICHAND CASE

The issue
thereafter came up for consideration before the Pune bench of the Tribunal in
the case of Rajmal Lakhichand vs. JCIT (2018) 92 taxmann.com 94.

In this case, for
the assessment year 2010-11 the A.O. disallowed the remuneration to working
partners amounting to Rs. 17,50,000 on the ground that the unabsorbed
depreciation of earlier years was not reduced in computing the book profit
which was contrary to the provisions of section 40(b). Upon further appeal, the
CIT(A) deleted this disallowance by holding that the remuneration to partners
was to be worked out on the basis of the current year’s book profit and
therefore the remuneration was to be deducted first before allowing the set-off
of brought-forward losses. He held that the computation of book profit was as
per section 40(b) while the set-off of brought-forward losses was to be granted
in terms of section 72. Therefore, while arriving at the business income, the
deduction of section 40(b) was to be given first and then, if at all there
remained positive income, the brought-forward losses were to be set off.

Before the
Tribunal, the Income-tax Department assailed the findings of the CIT(A) on the
ground that the unabsorbed brought-forward depreciation became a part of the
current year’s depreciation as per the provisions of section 32(2) and that as
per Chapter IV-D, the book profit was determined only after deduction of
depreciation including unabsorbed depreciation. Since, in the assessee’s case,
there was a loss after deduction of unabsorbed brought-forward depreciation to
the tune of Rs. 10,84,75,430 remuneration to the extent of only Rs. 1,50,000
should have been allowed. Reliance was placed on the decision in Vikas
Oil Mills (Supra).

As against that,
the assessee submitted that the remuneration paid to the partners was to be
based on the current year’s book profit derived before deducting the unabsorbed
depreciation and that the set-off of unabsorbed losses and depreciation was
governed by section 72. The unabsorbed business losses were to be set off first
and then the unabsorbed depreciation was to be considered.

The Tribunal upheld
the order of the CIT(A) deleting the disallowance of remuneration paid to the
working partner by the assessee-firm. In addition to accepting the contention
of the assessee, the Tribunal also relied upon the decision of the Ahmedabad
bench of the Tribunal in the case of Yogeshwar Developers vs. ITO [IT
Appeal No. 1173/AHD/2014 for assessment year 2005-06 decided on 13^th
April, 2017]. The decision of the Jaipur bench in the case of
Vikas Oil Mills (Supra) cited before the Tribunal by the Income-tax
Department was not followed by the bench.

OBSERVATIONS

Sub-section (2) of
section 32 provides that where full effect cannot be given to the depreciation
allowance for any previous year, then the depreciation remaining to be absorbed
shall be added to the amount of the depreciation allowance for the following
previous year and deemed to be part of the depreciation allowance for that
year. It further provides that if there is no such depreciation allowance for
the succeeding previous year, then that unabsorbed depreciation of the
preceding previous year itself shall be deemed to be the depreciation allowance
for that year. However, such a treatment of unabsorbed depreciation u/s 32(2)
is subject to the provisions of sub-section (2) of section 72 and sub-section
(3) of section 73 under which first brought-forward business loss needs to be set
off and then unabsorbed depreciation. Therefore, in a situation where the
assessee has brought-forward business loss as well as unabsorbed depreciation,
the combined reading of sections 32 and 72 or 73 required that the
brought-forward business loss shall be set off first against the income of the
previous year and then against the unabsorbed depreciation.

As per
Explanation-3 to section 40(b), all the deductions as provided in Chapter IV-D
including depreciation allowance provided in section 32 have to be taken into
consideration while determining the book profit. Since the provision of section
32(2) treats the unabsorbed depreciation of earlier years at par with the
depreciation allowance of the current year, except where there is a
brought-forward business loss, the issue as to whether the unabsorbed
depreciation should also be deducted from the book profit requires deeper
analysis.

Though the literal
interpretation of all the provisions concerned may appear to support the view
that the amount of depreciation allowance, whether of the current year or the
one which is of the earlier years and has remained unabsorbed, should be
reduced from the net profit for the purpose of arriving at the book profit, one
needs to also consider the legislative history as well as the intent of the
provisions of section 32(2) before accepting the literal interpretation. The
present provision of section 32(2) as it stands today was brought in force by
the Finance Act, 2001 by substituting the old provision with effect from assessment
year 2002-03. The old provision of section 32(2), prior to its substitution by
the Finance Act, 2001, was effective for the assessment years 1997-98 to
2001-02 and it read as under:

(2) Where in the
assessment of the assessee full effect cannot be given to any allowance under
clause (ii) of sub-section (1) in any previous year owing to there being no
profits or gains chargeable for that previous year or owing to the profits or
gains being less than the allowance, then, the allowance or the part of
allowance to which effect has not been given (hereinafter referred to as
unabsorbed depreciation allowance), as the case may be,

(i) shall be set off against the profits and gains,
if any, of any business or profession carried on by him and assessable for that
assessment year;

(ii) if the unabsorbed depreciation allowance cannot
be wholly set off under clause (i), the amount not so set off shall be set off
from the income under any other head, if any, assessable for that assessment
year;

if the unabsorbed
depreciation allowance cannot be wholly set off under clause (i) and clause
(ii), the amount of allowance not so set off shall be carried forward to the
following assessment year and,

(a) it shall be
set off against the profits and gains, if any, of any business or profession
carried on by him and assessable for that assessment year;

(b) if the
unabsorbed depreciation allowance cannot be wholly so set off, the amount of
unabsorbed depreciation allowance not so set off shall be carried forward to
the following assessment year not being more than eight assessment years
immediately succeeding the assessment year for which the aforesaid allowance
was first computed.

It is significant
to note that for the assessment years up to 2001-02, the unabsorbed depreciation
did not become part of the current year’s depreciation and was not to be
reduced from the net profit for the purposes of section 40(b) of the Act; in
short, it was not to be reduced from the book profit. It can be noticed that
the manner in which the unabsorbed depreciation is treated under the old
provision differed greatly from the manner in which it is treated under the
present provision. One of the glaring differences is that before the amendment
it was not being treated as part of the depreciation allowance for the current
year. Instead, it was required to be set off against the profits and gains of
business or profession separately. Sub-clause (a) of clause (iii) of the old
provision made this expressly clear by providing that unabsorbed depreciation
allowance was to be set off against the profits and gains of any business or
profession assessable for the subsequent assessment year as such and not as a
part of the depreciation allowance of that year. Further, the amount against
which the unabsorbed depreciation allowance was required to be set off was the
profits and gains of any business or profession carried on by the assessee and
assessable for that assessment year. The assessable profits and gains of any
business or profession for the purpose was necessarily the profits determined
after claiming all the permissible deductions, including remuneration to the
partners, subject to the limitations provided in section 40(b). Any other
interpretation or connotation was not possible; a contrary interpretation would
have needed an express provision to that effect which was not the case.

As a result, the
requirement under the then Explanation-3 to section 40(b) to compute the book
profit in the manner laid down in Chapter IV-D was to exclude the set-off of
unabsorbed depreciation. Any interpretation otherwise would have led to an
unworkable situation whereunder the amount of unabsorbed depreciation which
could have been set off would then be dependent upon the amount of the
deductible remuneration, and the amount of the deductible remuneration would in
turn be dependent upon the amount of unabsorbed depreciation that could be set
off.

Having analysed the
position under the old provision of section 32(2), let us consider the
objective of its substitution by the Finance Act, 2001 with effect from 1^stApril, 2002. The Memorandum explaining the provisions of the Finance
Bill, 2001, which is reproduced below, explains the legislative intent behind
the amendment.

Modification of
provisions relating to allowance of depreciation

Under the
existing provision of sub-section (2) of section 32 of the Income-tax Act,
carry forward and set off of unabsorbed depreciation is allowed for 8
assessment years.

With a view to
enable the assessee to conserve sufficient funds to replace capital assets,
specially in an era where obsolescence takes place so often, the Bill proposes
to dispense with the restriction of 8 years for carry forward and set off of
unabsorbed depreciation.

It can be observed
that the limited purpose of substituting the provision of sub-section (2) of
section 32 was to relax the limitation of eight years over the carry forward of
unabsorbed depreciation. It is worth noting that in order to achieve this
objective, the old provision as it existed prior to its amendment by the
Finance (No. 2) Act, 1996, was being restored. Therefore, effectively, the
present provision of sub-section (2) of section 32 is the same as the provision
as it existed prior to its amendment by the Finance (No. 2) Act, 1996. It was
only for the period starting from the assessment year 1997-98 to 2002-03 that
the provision was different.

In the context of
the old provision prevailing up to assessment year 1996-97, the Supreme Court
in the case of CIT vs. Mother India Refrigeration Industries (P) Ltd.
(1985) 155 ITR 711 has held as follows:

‘It is true that
proviso (b) to section 10(2)(vi) creates a legal fiction and under that fiction
unabsorbed depreciation either with or without current year’s depreciation is deemed to be
the current year’s depreciation but it is well settled that legal fictions are
created only for some definite purposes and these must be limited to that
purpose and should not be extended beyond that legitimate field. Clearly, the
avowed purpose of the legal fiction created by the deeming provision contained
in proviso (b) to section 10(2)(vi) is to make the unabsorbed carried forward
depreciation partake of the same character as the current depreciation in the
following year, so that it is available, unlike unabsorbed carried forward
business loss, for being set off against other heads of income of that year.
Such being the purpose for which the legal fiction is created, it is difficult
to extend the same beyond its legitimate field and will have to be confined to
that purpose.’

In view of these
observations of the Supreme Court and the legislative intent behind section
32(2), it can be inferred that the only purpose of deeming the unabsorbed
depreciation as the depreciation allowance of the current year, post amendment,
is limited to ensuring the benefit of its set off, irrespective of the number
of years, against any income, irrespective of the head of income under which it
falls. In other words the intention has never been to treat it as part of the depreciation of the year.

Further, in a
situation where the assessee has both, i.e., unabsorbed depreciation and
business loss brought forward from earlier years, the set off of business loss
in terms of sections 72 or 73 needs to be given a preference over set-off of
unabsorbed depreciation as per section 72(2). This again confirms that the
unabsorbed depreciation is given a separate treatment than the business loss
and both are intended to be distinct and separate from each other. The Supreme
Court, in the case of CIT vs. Jaipuria China Clay Mines (P) Ltd. 59 ITR
555, had held that the reason for such order of allowance is as under:

‘The unabsorbed depreciation allowance is carried
forward under proviso (b) to section 10(2)(vi) of the 1922 Act and the method
of carrying it forward is to add it to the amount of the allowance of
depreciation in the following year and deeming it to be part of that allowance;
the effect of deeming it to be part of that allowance is that it falls in the
following year within clause (vi) and has to be deducted as allowance. If the
legislature had not enacted proviso (b) to section 24(2) of the 1922 Act, the
result would have been that depreciation allowance would have been deducted
first out of the profits and gains in preference to any losses which might have
been carried forward under section 24 of the 1922 Act, but as the losses can be
carried forward only for six years under section 24(2) of the 1922 Act, the
assessee would in certain circumstances have in his books losses which he would
not be able to set off. It seems that the legislature, in view of this gave a
preference to the deduction of losses first.’

The set off of
business loss is governed by section 72 which is part of Chapter VI and not
Chapter IV-D and, therefore, is not required to be considered while computing
the book profit for the purpose of section 40(b). Hence, it would be absurd and
contrary to the provisions to set off the unabsorbed depreciation first only
for the purpose of arriving at the book profit for the purpose of section
40(b), though unabsorbed depreciation is to be set off only after brought-forward
business losses are exhausted in accordance with section 72(2).

Further, if one
analyses the definition of book profits as contained in Explanation 3 to
section 40(b), it refers to ‘net profit, as shown in the profit and loss
account for the relevant previous year…’
Therefore, clearly, the intention is only to consider the profit of the
relevant year and not factor in adjustments permissible against such profits
relating to earlier years, such as unabsorbed depreciation.

The better view, in our considered opinion,
therefore is that the brought-forward depreciation should not be deducted while
computing the book profit for the purpose of
section 40(b).

shailesh.kwebmaker

DEDUCTIBILITY OF FOREIGN TAXES

ISSUE FOR CONSIDERATION

Section 40 of the Income Tax Act, 1961 deals with amounts
that are not deductible in computing income under the head ‘Profits and Gains
of Business or Profession’. This section, in particular clause (a)(ii)
thereof, reads as under:

‘Notwithstanding
anything to the contrary in sections 30 to 38, the following amounts shall not
be deducted in computing the income chargeable under the head “Profits and
gains of business or profession”, –

(a) in the case of any assessee—

(i) ………..

(ia) …………….

(ib) ……………

(ic) …………….

(ii) any sum paid on account of any rate or tax
levied on the profits or gains of any business or profession or assessed at a
proportion of, or otherwise on the basis of, any such profits or gains.

Explanation 1. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes and
shall be deemed always to have included any sum eligible for relief of tax
under section 90 or, as the case may be, deduction from the Indian income-tax
payable under section 91.

Explanation 2. —
For the removal of doubts, it is hereby declared that for the purposes of this
sub-clause, any sum paid on account of any rate or tax levied includes any sum
eligible for relief of tax under section 90A.’

Explanations 1 and
2 were inserted with effect from Assessment Year 2006-07. Prior to that there
was much litigation on whether income taxes paid in a foreign country were an
allowable deduction or not. These explanations were added to prevent a double
relief or benefit , since in most cases such foreign taxes for which deduction
was being claimed were also entitled to tax relief under sections 90, 90A or
91. After the amendment, the issue still remains alive insofar as taxes which
are not entitled to the relief or even a partial relief under sections 90, 90A
or 91, and under the rules only a part of the foreign taxes paid may be
entitled to the relief u/s 90 or u/s 90A in some cases.

An issue has arisen
involving the deductibility of the foreign tax paid on account of the profits
or gains of a foreign business or profession in computing the income under the
head ‘profits and gains of business and profession’ under the Income-tax Act,
1961. While there have been conflicting decisions on the subject, of the Ahmedabad
bench of the Tribunal post amendment, to really understand the controversy one
would need to understand the two conflicting decisions of the Bombay High Court
on the issue, one of which was rendered after the amendment but dealt with a
period prior to the amendment.

THE S. INDER SINGH GILL CASE

The issue came up before the Bombay High Court in the case
of S. Inder Singh Gill vs. CIT 47 ITR 284.

In this case,
pertaining to assessment years 1946-47 to 1951-52, under the Income-tax Act,
1922 the assessee was a non-resident. A resident was treated as the assessee’s
statutory agent u/s 43 of the 1922 Act (corresponding to representative
assessee u/s 163 of the 1961 Act).

In the original
assessments, income from certain Bombay properties was assessed to tax in
computing the total income. The Income Tax Officer later found that the
assessee owned certain other properties also in the taxable territories whose
income had escaped assessment, and therefore initiated re-assessment
proceedings. In response to the notice, the assessee filed his return of
income.

In the return,
among other deductions the assessee claimed that in computing his world income,
the tax paid by him to the Uganda government on his Ugandan income should be
deducted. This claim of the assessee was disallowed by the tax authorities. The
assessee’s first appeal was dismissed by the Appellate Assistant Commissioner.
The Tribunal also rejected the contention that tax paid to the Uganda
government on his foreign income should be deducted in determining his foreign
income and in including it in his total world income.

The Bombay High
Court in deciding the issue, noted that the Tribunal had observed as under:

‘We are not
aware of any commercial practice or principle which lays down that tax paid by
one on one’s income is a proper deduction in determining one’s income for the
purposes of taxation’.

The Bombay High
Court held that no reason had been shown to it by the assessee to differ from
the conclusion that the Tribunal had reached. The Court therefore rejected the
reference made to it by the assessee.

A similar view was
taken by the Calcutta High Court in the case of Jeewanlal (1929) Ltd. vs.
CIT 48 ITR 270, also a case under the 1922 Act, where the issue was
whether business profits tax paid in Burma was an allowable deduction.

Again, a similar
view was taken by the Karnataka High Court in Kirloskar Electric Co. Ltd.
vs. CIT 228 ITR 676, prior to the amendment, by applying section
40(a)(ii). Besides, the Madras High Court, in CIT vs. Kerala Lines Ltd.
201 ITR 106, has also held that foreign taxes are not allowable as a
deduction.

THE RELIANCE INFRASTRUCTURE CASE

Recently, the issue
again came up before the Bombay High Court in the case of Reliance
Infrastructure Ltd. vs. CIT 390 ITR 271.

This was a case
pertaining to A.Y. 1983-84. During the year, the assessee executed projects in
Saudi Arabia. The income earned in Saudi Arabia had been subjected to tax in
Saudi Arabia. While determining the tax payable under Indian tax laws, the
assessee sought the benefit of section 91, claiming relief from double taxation
of the same income, i.e., the Saudi income which was included in the total
income of the assessee.

The assessee
claimed the benefit of double taxation relief on the amounts of Rs. 47.3 lakhs,
otherwise claimed as deduction u/s 80HHB, and Rs. 5.59 lakhs on which a
weighted deduction was otherwise claimed u/s 35B. The A.O. dismissed the
assessee’s claim for relief u/s 91 on the ground that the relief u/s 91 would
be possible only when the amount of foreign income on which the foreign tax was
paid was again included in the taxable income liable to tax in India, i.e., the
relief was possible only where the same income was taxed in both the countries.

The Commissioner
(Appeals) rejected the assessee’s appeal, holding that the assessee had, in
respect of his Saudi income,
claimed deductions u/s 80HHB and
section 35B and such income did not suffer any tax in India and was therefore
not eligible for the benefit of relief u/s 91.

Before the
Tribunal, the assessee urged that the Commissioner (Appeals) ought to have held
that in respect of such percentage of income which was deemed to accrue in
India, and on which the benefit of section 91 was not available, the tax paid
in Saudi Arabia should be treated as an expenditure incurred in earning income,
which was deemed to have accrued or arisen in India, and reduced therefrom.

The Tribunal
dismissed the assessee’s appeal, holding that the issue stood concluded against
the assessee by the decision of the Andhra Pradesh High Court in the case of CIT
vs. C.S. Murthy 169 ITR 686. The Tribunal also held that the tax paid
in Saudi Arabia on which even where no double tax relief could be claimed, was
not allowable as a deduction in computing the income under the provisions of
the Income-tax Act. As regards tax in respect of income which had accrued or
arisen in India, the Tribunal rejected the assessee’s contention on two grounds
– that such a claim had not been raised before the Commissioner (Appeals), and
that the disallowance was as per the
decision of the Bombay High Court in S. Inder Singh Gill’s case
(Supra).

It was claimed on
behalf of the assessee before the Bombay High Court inter alia that the
assessee should be allowed a deduction
of the foreign tax paid in Saudi Arabia, once it was held that the benefit of
section 91 was not available for such tax. It was emphasised that the deduction
was claimed only to the extent that tax had been paid in Saudi Arabia on the
income which had been deemed to have accrued or arisen in India.

It was pointed out
to the Bombay High Court that such a
deduction had been allowed by the Tribunal in the assessee’s own case for A.Y.
1979-80 and therefore the principle of consistency required the Tribunal to adopt the same view
as it did in A.Y. 1979-80. It was pointed out that Explanation 1 added to
section 40(a)(ii) with effect from A.Y. 2006-07 was clarificatory in nature, as
was evident from the fact that it began with the words ‘for removal of doubts’.
It should therefore be deemed to have always been there and would apply to the
case before the High Court. It was argued that if it was held that section 91
was not applicable, then the bar of claiming deduction to the extent of the tax
paid abroad would not apply.

Reference was made
on behalf of the assessee to the commentary on ‘Law and Practice of Income
Tax’ by Kanga & Palkhivala (8^th Edition), wherein a
reference was made to the decisions of the Bombay High Court in CIT vs.
Southeast Asian Shipping Co. (IT Appeal No. 123 of 1976) and CIT
vs. Tata Sons Ltd. (IT Appeal No. 209 of 2001) holding that foreign tax did not fall within
the mischief of section 40(a)(ii) and that the assessee’s net income after
deduction of foreign taxes was his real income for the purposes of the
Income-tax Act.

It was therefore
argued on behalf of the assessee that the decision of the Bombay High Court in S.
Inder Singh Gill (Supra) would not apply and the tax paid in Saudi
Arabia on the income accrued or arising in India was to be allowed as a
deduction to arrive at the real profits which were chargeable to tax in India.

On behalf of the
Revenue, it was submitted that the issue stood concluded against the assessee
by the decision of the Bombay High Court in S. Inder Singh Gill (Supra).
It was submitted that the real income theory was inapplicable in view of the
specific provision of section 40(a)(ii) which prohibited deduction of any tax
paid. It was submitted that in terms of the main provisions of section
40(a)(ii), any sum paid on account of any tax on the profits and gains of
business or profession would not be allowed as a deduction.

It was argued on
behalf of the Revenue that the Explanation 2, inserted with effect from A.Y.
2006-07, only reiterated that any sum entitled to tax relief u/s 91 would be
covered by the main part of section 40(a)(ii). It did not take away the taxes
not covered by it out of the ambit of the main part of section 40(a)(ii).

The Bombay High
Court held that the Tribunal was justified in not following its order in the
case of the assessee itself for A.Y. 1979-80, as it noted the decision of the
Bombay High Court in S. Inder Singh Gill (Supra) on an identical
issue. The Court observed that the decisions in South Asian Shipping Co.
(Supra) and Tata Sons Ltd. (Supra) were rendered not at
the final hearing but while rejecting the applications for reference u/s 256(2)
and at the stage of admission u/s 260A, unlike the judgment rendered in a
reference by the Court in S. Inder Singh Gill, and therefore
could not be relied upon in preference to the decision in S. Inder Singh
Gill.

Further, the Court
observed that it was axiomatic that income tax was a charge on the profits or
income. The payment of income tax was not a payment made or incurred to earn
profits and gains of business. It could therefore not be allowed as an
expenditure to determine the profits of the business. Taxes such as excise
duty, customs duty, octroi, etc., were incurred for the purpose of doing
business and earning profits or gains from business or profession and
therefore, they were allowable as
deduction to determine the profits of the business. It is the profits and gains
of business, determined after deducting all expenses incurred for the purpose
of business from the total receipts, which were subjected to income tax as per
the Act. The main part of section 40(a)(ii) did not allow deduction of tax to
the extent the tax was levied on the
profits or gains of the business. According to the Court, it was on this
general principle, universally accepted, that the Bombay High Court had
answered the question posed to it in S. Inder Singh Gill in
favour of the Revenue.

The Bombay High
Court went on to observe that it would have followed the decision in the case
of S. Inder Singh Gill. However, it noticed that that decision
was rendered under the 1922 Act and not under the 1961 Act. The difference
between the two Acts was that the 1922 Act did not contain a definition of
‘tax’, unlike the 1961 Act where such term was defined in section 2(43) as
‘income tax chargeable under the provisions of this Act’. In the absence of any
definition of ‘tax’ under the 1922 Act, the tax paid on income or profits and
gains of business or profession anywhere in the world would not be allowable as
a deduction for determining the profits or gains of the business u/s 10(4) of
the 1922 Act, and therefore the decision in S. Inder Singh Gill
was correctly rendered on the basis of the law then prevalent.

Proceeding on the
said lines, the Bombay High Court held
that by insertion of section 2(43) for defining the term ‘tax’, tax which was
payable under the 1961 Act on the profits and gains of business that alone was
not allowed to be deducted u/s 40(a)(ii), notwithstanding sections 30 to 38.
According to the Court, the tax, which had been paid abroad would not be
covered within the mischief of section 40(a)(ii), in view of the definition of
the word ‘tax’ in section 2(43). The Court said that it was conscious of the
fact that section 2, while defining the various terms used in the Act,
qualified it by preceding the definition with the words ‘in this Act, unless
the context otherwise requires’. It noted that it was not even urged by the
Revenue that the context of section 40(a)(ii) would require it to mean tax paid
anywhere in the world and not only tax payable under the Act.

The Court analysed
the rationale for introduction of the Explanations to section 40(a)(ii), as set
out in the Explanatory Memorandum to the Finance Act, 2006, recorded in CBDT
Circular No. 14 of 2006 dated 28^th December, 2006. It recorded the fact that some assessees, who
were eligible for credit against the tax payable in India on the global income
to the extent that the tax had been paid outside India u/s 90/91, were also
claiming deduction of the tax paid abroad as it was not tax under the Act. In
view of the above, the explanation would require in the context thereof that
the definition of the word ‘tax’ would also mean tax which was eligible to the
benefit of section 90/91. However, as per the High Court, this departure from
the meaning of the word ‘tax’ as defined in the Act was restricted to the above-referred section 90/91
only and gave no license to widen the meaning of the word ‘tax’ to include all
taxes on income or profits paid abroad for the purposes of section 40(a)(ii).

The Court further
noted that it was undisputed that some part on which tax had been paid abroad
was on income that had been deemed to have accrued or arisen in India. To that
extent, the benefit of section 91 was not available for such tax so paid
abroad. Therefore, such tax was not hit by the Explanation to section 40(a)(ii)
and was to be considered in the nature of an expenditure incurred to earn
income. The Court then held that the Explanation to section 40(a)(ii) was
declaratory in nature and would have retrospective effect.

The Bombay High
Court therefore held that the assessee was entitled to deduction for foreign
taxes paid on income accrued or arisen in India in computing its income, to the
extent that such tax was not entitled to the benefit of section 91.

OBSERVATIONS

Before looking at
the applicability of section 40(a)(ii), one first needs to examine whether
income tax is at all an expenditure, and if so, whether it is a business
expenditure. Accounting Standard 22, issued by the Ministry of Corporate
Affairs under the Companies Act, provides that ‘Taxes on income are
considered to be an expense incurred by the enterprise in earning income and are accrued
in the same period as the revenue and expenses to which they relate.’ It
therefore seems that income tax is an expenditure under accounting principles.

Since only certain
types of business expenditure are allowable as deductions while computing
income under the head ‘Profits and Gains of Business or Profession’, the
question that arises is whether tax is a business expenditure. Accounting
Standard 22 states that ‘Accounting income (loss) is the net profit or loss
for a period, as reported in the statement of profit and loss, before deducting
income tax expense or adding income tax saving.’ Ind AS 12 issued by the
Ministry of Corporate Affairs states ‘The tax expense (income) related to
profit or loss from ordinary activities shall be presented as part of profit or
loss in the statement of profit and loss.’

However, if one
looks at the manner of presentation in the final accounts, it is clear that
income tax is treated quite differently from business expenditure, being shown
separately as a deduction after computing the pre-tax profit. Therefore, it
appears that while tax is an expense, it may not be a business expenditure.
This is supported by the language of AS 22, which states that ‘Accounting
income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income tax expense or adding
income tax saving.’

Further, the
fundamental issue still remains as to whether such foreign income taxes can
ever be a deductible expenditure under sections 30 to 38. Even on basic
commercial principles, income tax is not an expenditure for earning income; it
is a consequence of earning income. Whether such income tax is a foreign tax or
tax under the 1961 Act is irrelevant – it is still an application of income
after having earned the income. This view is supported by the decision of the
Madras High Court in the Kerala Lines case (Supra),
where the High Court observed that the payment of foreign taxes could not be
regarded as an expenditure for earning profits; they could at best be
considered as an application of profits earned by the assessee.

In the Reliance
Infrastructure case, the decision of the Bombay High Court was primarily
focused and based on the language of section 40(a)(ii), the Explanation thereto
read with the definition of ‘tax’ u/s 2(43). However, it needs to be kept in
mind that section 40 is a section listing out expenses, which are otherwise
allowable under sections 30 to 38, but which are specifically not allowable.
The provisions of section 40(a)(ii) will therefore come into play where an item
of expenditure is otherwise allowable as a business expenditure under sections
30 to 38. If such expenditure is in any case not allowable under sections 30 to
38, the question of applicability of section 40(a)(ii) does not arise.

The Bombay High
Court, in the case of CIT vs. Plasmac Machine Mfg. Co. Ltd. 201 ITR 650,
considered a situation of payment of tax liability of a transferor firm by the
transferee company, where the company had taken over the business of the
transferor firm. It held that the expenditure representing the liability of the
transferor, which was discharged by the transferee, was a capital expenditure
forming part of the consideration for the acquisition of the business and was
therefore not deductible in the computation of income. Hence, the question of
applicability of section 40(a)(ii) did not arise.

Under what clause
would foreign income taxes be allowable under sections 30 to 38? The only
possible provision under which such income taxes may fall for consideration as
a deduction would be section 37(1). Section 37(1) allows a deduction for
expenditure (not being in the nature of capital expenditure or personal
expenses) incurred wholly and exclusively for the purpose of business or
profession. Is a foreign income tax an expenditure incurred wholly and
exclusively for the purpose of business or profession, or is it an application
of the income after it has been earned?

The House of Lords,
in the case of Commissioners of Inland Revenue vs. Dowdall O’Mahoney
& Co. Ltd. 33 Tax Cases 259, had occasion to consider this issue in
the case of an Irish company which had branches in England; it claimed that in
computing the English profits, it was entitled to deduct that proportion of the
Irish taxes attributable to those profits. The House of Lords held that payment
of such taxes by a trader was not a disbursement wholly and exclusively laid
out for the purposes of the trade and this was so whether such taxes were
United Kingdom taxes or foreign or Dominion taxes. The House of Lords further
observed that taxes like these were not paid for the purpose of earning the
profits of the trade; they were the application of those profits when made and
not the less so that they were exacted by a Dominion or foreign government. It
further observed that there was not and never was any right under the
principles applicable to deduct income tax or excess profits tax, British or
foreign, in computing trading profits. According to the House of Lords, once it
was accepted that the criterion is the purpose for which the expenditure is
made in relation to the trade of which the profits are being computed, no
material distinction remained between the payment to make such taxes abroad and
a payment to meet a similar tax at home. A similar view was taken by the Madras
High Court in Kerala Lines (Supra).

In the Reliance
Infrastructure case, the Bombay High Court, while referring to this
basic principle, also accepted by it in the S. Inder Singh Gill
case, did not lay down any rationale for departing from this principle while
deciding the matter. It perhaps was swayed by the Explanation to section 90/91
and section 2(43), both of which had no application on the subject of allowance
of deduction of the foreign tax in computing the business income in the first
place.

The issue of
deductibility of foreign taxes had also come up recently before the Ahmedabad
Bench of the Tribunal, in which the Tribunal took differing views. In both
these cases the assessee had claimed foreign tax credit under section 90/91 on
the basis of the gross foreign income, but was allowed tax credit on the basis
of net foreign income taxable in India. It alternatively claimed deduction for
such foreign taxes not allowed as credit. In the first case, DCIT vs.
Elitecore Technologies (P) Ltd., 165 ITD 153, the Tribunal held, after
a detailed examination of the entire gamut of case laws on the subject, that
foreign taxes were not a deductible expenditure. It pointed out aspects which
had not been considered by the Bombay High Court in the Reliance
Infrastructure case. In the subsequent decision in Virmati
Software & Telecommunication Ltd. vs. DCIT, ITA No 1135/Ahd/2017 dated 5^th
March, 2020, the Tribunal took a contrary view, following the Bombay
High Court decision in the Reliance Infrastructure case, that
such foreign taxes not allowed credit u/s 91 were deductible in computing the
income. The Mumbai Bench of the Tribunal, in the case of Tata Motors Ltd.
vs. CIT ITA No. 3802/Mum/2018 dated 15^th April, 2019, has
also followed the Bombay High Court decision in Reliance Infrastructure
and held that the deduction for foreign taxes not entitled to relief under
section 90/91 could not be the subject matter of revision u/s 263.

The Mumbai Bench of
the Tribunal, on the other hand, in the case of DCIT vs. Tata Sons Ltd.
43 SOT 27, has, while disallowing the claim for deduction of foreign
taxes u/s 37(1), observed that if it was to be held that the assessee was
entitled to deduction of tax paid abroad, in addition to admissibility of tax
relief u/s 90 or section 91, it would result in a situation that on the one
hand double taxation of income would be eliminated by ensuring that the
assessee’s total income-tax liability did not exceed the income-tax liability
in India or the income-tax liability abroad, whichever was greater, and, on the
other hand, the assessee’s domestic tax liability would also be reduced by tax
liability in respect of income decreased due to deduction of taxes. Such a
double benefit to the assessee was contrary to the scheme of the Act as well as
the fundamental principles of international taxation.

Interestingly, the
Mumbai Bench of the Tribunal, in Tata Consultancy Services Ltd. vs. ACIT
203 TTJ 146, considered a disallowance of US and Canadian state taxes
and held that such taxes were not covered by section 40(a)(ii) and were
therefore allowable.

A question arose in
Jaipuria Samla Amalgamated Collieries Ltd. 82 ITR 580 (SC) where
the assessee, a lessee of mines, incurred statutory liability for the payment
of road and public works cess and education cess, and claimed deduction of such
cess in its computation of income. The A.O. disallowed such claim relying on
section 10(4) of the 1922 Act, corresponding to section 40(a)(ii) of the 1961
Act. In that decision, the Supreme Court held that the words ‘profits and gains
of any business, profession or vocation’ which were employed in section 10(4),
could, in the context, have reference only to profits or gains as determined
u/s 10 and could not cover the net profits or gains arrived at or determined in
a manner other than that provided by section 10. Can one apply the ratio
of this decision to foreign income taxes, which are levied on income computed
in a manner different from that envisaged under the 1961 Act?

Subsequently, the
Supreme Court itself in the case of Smithkline & French India Ltd.
vs. CIT 219 ITR 581 has taken a different view in the context of surtax.
The Supreme Court observed in this case:

‘Firstly, it may
be mentioned, s.10(4) of the 1922 Act or s.40(a)(ii) of the present Act do not
contain any words indicating that the profits and gains spoken of by them
should be determined in accordance with the provisions of the IT Act. All they
say is that it must be a rate or tax levied on the profits and gains of
business or profession. The observations relied upon must be read in the said
context and not literally or as the provisions in a statute…’

This argument
therefore seems to no longer be valid. In this case, the Supreme Court has also
approved the Bombay High Court decision in Lubrizol India Ltd. vs. CIT
187 ITR 25, where the Bombay High Court noted that section 40(a)(ii)
uses the term ‘any’ before ‘rate or tax’. The High Court had observed:

‘If the word “tax” is to be given the meaning
assigned to it by s.2(43) of the Act, the word “any” used before it will be
otiose and the further qualification as to the nature of levy will also become
meaningless. Furthermore, the word “tax” as defined in s.2(43) of the Act is
subject to “unless the context otherwise requires”. In view of the discussion
above, we hold that the words “any tax” herein refers to any kind of tax levied
or leviable on the profits or gains of any business or profession or assessed
at a proportion of, or otherwise on the basis of, any such profits or gains’.

This view is in
direct contrast to the view expressed in the Reliance Infrastructure
case, and having been approved by the Supreme Court in the case of Smithkline
& French (Supra), this view should prevail. Perhaps, the ratio
of the Reliance Infrastructure case was largely governed by the
fact that the non-applicability of section 2(43) to section 40(a)(ii) was never
urged by the Department before it.

Therefore, the better view is that foreign
income taxes are not a deductible expenditure in computing income under the
1961 Act, irrespective of whether they are eligible for credit under sections
90, 90A or 91.

shailesh.kwebmaker

INTERPLAY BETWEEN DEEMING FICTIONS OF SECTIONS 45(3) AND 50C

ISSUE FOR
CONSIDERATION

Section
45(3) of the Act provides for taxation of the capital gains on transfer of a capital
asset by a person to a firm in which he is or becomes a partner, by way of
capital contribution or otherwise, in the year of transfer and further provides
that the amount recorded in the books of accounts of the firm shall be deemed
to be the full value of the consideration received or accruing as a result of
such transfer of the capital asset for the purposes of section 48. Section 50C
of the Act provides that the value adopted or assessed or assessable by the
stamp valuation authority for the purpose of payment of stamp duty in respect
of transfer of a capital asset, being land or building or both, shall for the
purposes of section 48 be deemed to be the full value of the consideration
received or accruing as a result of such transfer if it is higher than its
actual consideration.

Whether both
the aforesaid provisions of the Act can be made applicable in a case where the
capital asset transferred by a partner to his firm by way of his capital
contribution is land or building or both is the issue that is sought to be
examined here. Whether for the purposes of section 48 the full value of
consideration should be the amount as recorded in the books of the firm in
accordance with the provisions of section 45(3), or whether it should be the
value as adopted or assessed or assessable by the stamp valuation authority in
accordance with the provisions of section 50C? Whether in computing the capital
gains, the higher of the two is to be adopted or not?

The Lucknow
bench of the Tribunal has held that the provisions of section 50C shall prevail
over the provisions of section 45(3) in a case where the stamp duty value was
higher than the value recorded in the books of the firm. As against this, the
Mumbai, Kolkata, Hyderabad and Chennai benches of the Tribunal have held that
the provisions of section 45(3), ignoring the provisions of section 50C, alone
can apply in a case where land or building has been introduced by a partner by
way of his capital contribution.

THE CARLTON HOTEL
(P) LTD. CASE

The issue
first came up for consideration of the Lucknow bench of the Tribunal in the
case of Carlton Hotel (P) Ltd. vs. ACIT 35 SOT 26 (Lucknow) (URO).
In this case, during the previous year relevant to A.Y. 2004-05 the assessee
company entered into a partnership with two other persons. The assessee company
contributed 2,40,000 sq. ft. of land as its capital contribution which was
valued at Rs. 7,81,96,735 and was so recorded in the books of the partnership
firm. The assessee was given 5% share in the partnership firm, whereas the
other two partners were given 95% share.

For the
purposes of computing capital gains in the hands of the partner assessee on
transfer of the land to the partnership firm, the A.O. invoked the provisions
of section 50C and applied circle rates for the purpose of calculating the
consideration for transfer. He valued the consideration at Rs. 29,75,46,468
instead of Rs. 7,81,96,735 and on that basis he calculated the long-term
capital gains. The A.O. inter alia doubted the genuineness of the
introduction of land and noted that the assessee has contributed 88% of capital
in lieu of only 5% share in profits which was beyond the normal business
prudence and the transfer of the land to the firm was as good as a sale. For
the purpose of holding so, he referred to the clauses of the partnership deed
and observed that the assessee had little role to play in the partnership
business, the assessee was not a managing partner in the firm, construction on
the plot was to be carried out by another partner of the firm, the assessee was
not having any civil, criminal or financial liability, the business of the
partnership was to be exclusively carried out by other partners of the firm,
the bank account could be independently operated only by the other two
partners, whereas the assessee could operate only with joint signatures of the
other two partners; it was only the other partners who had been empowered to
introduce new partners, the assessee did not have any right over the goodwill
of the firm, was not authorised to make any change in the composition of the
board which had controlling interest in its share capital, etc.

Thus, the A.O. alleged that the
assessee had adopted a device to evade capital gains tax by showing lower value
of sale consideration in the books of the firm, whereas the actual market value
of the land was much higher as reflected from the circle rate. He relied on the
decisions of the Supreme Court in the case of McDowell & Co. Ltd. vs.
CTO 154 ITR 148 for the proposition that if an assessee adopts a tax
avoidance scheme, then the form can be ignored. Thus, by taking the substance
of the transaction into consideration, the market value of the land transferred
to the firm as capital contribution was adopted by invoking section 50C,
contending that mere reliance on section 45(3) in isolation would defeat the
intent and purpose of the taxing statute.

Importantly, the A.O. also took a
view that section 50C was applicable even in a situation covered by section
45(3). The A.O., ignoring the facts that the transfer of land as capital
contribution was not through a registered document and that the provisions of
section 50C were amended only thereafter to rope in even the transfer of
immovable property otherwise than through a registered document, applied the provisions
of section 50C.

Upon further appeal, the CIT(A)
confirmed the order of the A.O. confirming that the value adopted by the
assessee for transferring the land to the firm was a collusive one and that the
provision of section 50C being a specific provision was applicable even where
provisions of section 45(3) had been invoked.

Upon further appeal to the
Tribunal, it was contended on behalf of the assessee that the provisions of
section 45(3) and section 50C were mutually exclusive; where section 45(3) was
applicable, section 50C would not be applicable and vice versa. It was
further submitted that section 45(3) created a deeming fiction whereby the
consideration recorded by the firm in its books was deemed to be the full value
of consideration for the purpose of computing capital gains. Section 50C was
another deeming section which empowered the A.O. to substitute the valuation
done by the stamp valuation authority as sale consideration in place of
consideration shown by the parties to the transaction. Once one deeming section
was invoked, another deeming section could not be made to nullify the effect of
the earlier deeming section. The application of section 50C in such a situation
would render section 45(3) otiose. Regarding the allegation that the assessee
had entered into a collusive transaction and accordingly had shown lower value
of consideration in the books of the firm, it was submitted that the firm would
be paying tax upon its further sale by adopting the value of land as recorded
in the books and, hence, there would not be any revenue loss.

On the other hand, the Revenue
supported the order of the A.O. and the CIT(A) and claimed that the form of the
transaction had to be ignored and its substance had to be considered, since the
assessee had entered into a collusive transaction.

The Tribunal
for the reasons recorded in the order rejected one of the contentions of the
Revenue that since section 50C required adoption of the circle rates for the
purpose of levy of the stamp duty which rates, once declared, could be
‘adopted’ for the purpose of substituting the full value of consideration for
section 48 and it was not necessary that the document for transfer of asset was
actually registered before invoking section 50C.

On the issue under consideration,
however, the Tribunal held that the provisions of section 50C could be invoked
even though the case was otherwise covered under section 45(3); section 50C
would override section 45(3). Section 45(3) was a general provision, while
section 50C was a special provision which would override section 45(3). In the
final analysis, however, the Tribunal rejected the action of the A.O. in
applying the provisions of section 50C on the ground of non-registration and
non-payment of the stamp duty.

It may be noted for the record
that the Revenue had filed a further appeal before the Allahabad High Court
against the decision of the Tribunal mainly for pleading that the transaction
was a colourable transaction executed with the intention to evade the tax
liability. And the High Court upholding the contention held that there existed all
the facts and circumstances to show prima facie that the entire
transaction of contribution to partnership was a sham and fictitious
transaction and an attempt to devise a method to avoid tax and remanded the
matter back to the Tribunal to look into this aspect of the matter, which was
an issue directly raised by the Revenue right from the stage of assessment. No
findings have been given by the High Court with respect to the issue of
applicability of section 50C to the transaction of introduction of capital
asset by the partner in the firm which is otherwise covered by section 45(3).

AMARTARA PVT. LTD.
CASE

Thereafter,
the issue came up for consideration of the Mumbai bench of the Tribunal in DCIT
vs. Amartara Pvt. Ltd. 78 ITR (Trib.)(S.N.) 46 (Mum).

In this
case, during the previous year relevant to A.Y. 2012-13 the assessee entered
into a limited liability partnership with the object of developing,
constructing and operating resorts, hotels and apartment hotels and / or for
carrying out such other hospitality businesses. The assessee transferred an
immovable property, being a plot of land admeasuring 6,869.959 metres situated
at Powai, Mumbai, as its capital contribution to the newly-created LLP vide
a supplementary agreement dated 29^th December, 2011.

The said
plot of land was valued at Rs. 5.60 crores on the basis of the valuation report
obtained and it was recorded at that value in the books of the LLP. The
assessee, while computing capital gains on transfer of land into the
partnership firm in accordance with the provisions of section 45(3), had taken
the value as recorded in the books of the firm, i.e., Rs. 5.60 crores, as the
full value of the consideration deemed to have been received or accrued as a
result of transfer of capital asset to the partnership firm. The supplementary
agreement through which the said plot of land was introduced by the assessee
into the LLP was registered on 24^th April, 2012 and the stamp duty
authority had determined the market value of the property for the purpose of
payment of stamp duty at Rs. 9,41,78,500.

The A.O.
invoked the provisions of section 50C and adopted the amount of Rs.
9,41,78,500, being the value determined by the stamp valuation authority at the
time of registration of the supplementary partnership deed, as the full value
of consideration for the purpose of computing capital gains. He observed that
the provisions of section 45(3) did not begin with a non-obstante clause
and, therefore, there was no specific mention of non-applicability of section
50C in the cases covered by section 45(3). He also relied upon the Lucknow
Tribunal decision in the case of Carlton Hotel (P) Ltd. (Supra)
for the proposition that section 50C, being a specific provision, would
override the provisions of section 45(3). The CIT(A) confirmed the order of the
A.O. by following the said decision in the case of Carlton Hotel (P) Ltd.
(Supra).

On further
appeal before the Tribunal, the assessee contended that sections 45(3) and
45(4) were special provisions for computation of capital gains on transfer of
capital assets between the partnership firm and the partners and that both the
provisions were deeming fictions created for the purpose of taxation of
transfers of capital assets in such special cases; importing another deeming
fiction to determine the full value of consideration in such special cases was
incorrect in view of the decision of the Hon’ble Supreme Court in the case of CIT
vs. Moon Mills Ltd. 59 ITR 574. It was submitted that the decision
rendered by the Lucknow bench of the Tribunal was per incuriam, in the
light of the decision of the Hon’ble Supreme Court in the case of CIT vs.
Moon Mills Ltd. (Supra), as per which a deeming fiction could not be
extended by importing another deeming fiction for the purpose of determination of
the full value of consideration.

It was also
contended on behalf of the assessee that section 50C of the Act had no
application where no consideration was received or accrued, and hence,
computing full value of consideration by applying the provisions of section 50C
in a case where there was a transfer between partners and the partnership firm
without there being any actual consideration received or accrued, was
incorrect.

In reply,
the Revenue heavily relied upon the said decision of the Lucknow bench of the
Tribunal in the case of Carlton Hotel (P) Ltd. (Supra) and
contended that section 50C overrode the provisions of section 45(3) once the
document of transfer was registered as per the provisions of the Registration
Act, 1908 and the stamp duty was paid for the registration of such document.

The Tribunal held that the
purpose of insertion of section 45(3) was to deal with cases of transfer
between a partnership firm and partners and in such cases the Act provided for
the computation mechanism of capital gains and also provides for consideration
to be adopted for the purpose of determination of full value of consideration.
Since the Act itself provided for deeming consideration to be adopted for the
purpose of section 48 of the Act, another deeming fiction provided by way of
section 50C could not be extended to compute the deemed full value of
consideration as a result of transfer of capital asset. It held that the
Lucknow bench had simply observed that the provisions of section 50C overrode
the provisions of section 45(3) but had not given a categorical finding.
Accordingly, the addition made towards the long-term capital gain by invoking
the provisions of section 50C
was deleted.

This decision of the Mumbai bench
of the Tribunal has been subsequently followed by the Tribunal in the cases of ACIT
vs. Moti Ramanand Sagar (ITA No. 2049/Mum/2017); ACIT vs. Kethireddy Venkata
Mohan Reddy (ITA No. 259/Hyd/2019); and ITO vs. Sheila Sen (ITA No.
554/Kol/2016).

OBSERVATIONS

The issue
under consideration arises due to two conflicting provisions of the Act which
can be invoked for a given transaction wherein the capital asset transferred by
a partner to his firm, as a capital contribution or otherwise, is land or
building. Section 45(3) provides for the amount recorded in the books of
accounts of the firm as deemed consideration. Section 50C provides for the
value adopted, assessed or assessable by stamp valuation authorities as deemed
consideration, if it exceeds the consideration received or accruing. Thus, both
the provisions deal with the determination of the full value of consideration
for the purpose of computation of capital gains by creating a deeming fiction.
Apart from considering the legislative intent behind both the provisions in
order to resolve the conflict between these two provisions, there are various
other aspects which are also required to be considered, like whether two
deeming fictions can operate simultaneously with respect to the same component
of the computation; whether one of these two provisions can be considered as a
general provision and the other one as a special provision whereby it can
override the general one; and which one will prevail if both the provisions are
required to be considered as special provisions.

Sub-section (3) was inserted in
section 45 by the Finance Act, 1987 with effect from A.Y. 1988-89. Prior to the
insertion of sub-section (3), the issue of taxability of the transfer of
capital asset by a partner to his firm was decided by the Supreme Court in the
case of Sunil Siddharthbhai vs. CIT 156 ITR 509. In this case,
the Supreme Court held that when the assessee brought his personal assets into
the partnership firm as his contribution to the capital, there was a transfer
of a capital asset within the meaning of the terms of section 45. This was
because the asset which was, till the date of such bringing in as firm’s
capital, an individual asset, after bringing it in became a shared asset. The
Supreme Court further held that the transfer of asset by the partner to the
firm as capital contribution would not necessarily result in receipt of any
consideration by the assessee so as to attract section 45 and the credit entry
made in the partner’s capital account in the books of the partnership firm did
not represent the true value of consideration. It was a notional value only,
intended to be taken into account at the time of determining the value of the
partner’s share in the net partnership assets on the date of dissolution or on
his retirement.

Therefore,
according to the Supreme Court, it was not correct to hold that the
consideration which a partner acquires on making over his personal asset to the
partnership firm as his contribution to its capital can fall within the
provisions of section 48. Since section 48 was fundamental to the computation
machinery incorporated in the scheme relating to determination of charge
provided in section 45, the Supreme Court held that such a case must be
regarded as falling outside the scope of capital gains taxation altogether.

It was in
this background that the legislature had introduced a specific provision so as
to bring the transfer of the capital asset by a partner to his firm to tax, as
is evident from Circular No. 495 dated 22^nd September, 1987, the
extract from which is reproduced below:

Capital
gains on transfer of firms’ assets to partners and vice versa and by way of compulsory acquisition

24.1 One of
the devices used by assessees to evade tax on capital gains is to convert an
asset held individually into an asset of the firm in which the individual is a
partner. The decision of the Supreme Court in Kartikeya V. Sarabhai vs. CIT [1985] 156 ITR 509 has set at rest the controversy as to whether such a conversion amounts
to transfer. The Court held that such conversion fell outside the scope of
capital gains taxation. The rationale advanced by the Court is that the
consideration for the transfer of the personal asset is indeterminate, being
the right which arises or accrues to the partner during the subsistence of the
partnership to get his share of the profits from time to time and on
dissolution of the partnership to get the value of his share from the net
partnership assets.

24.2 With a
view to blocking this escape route for avoiding capital gains tax, the Finance
Act, 1987 has inserted new sub-section (3) in section 45. The effect of this
amendment is that profits and gains arising from the transfer of a capital
asset by a partner to a firm shall be chargeable as the partner’s income of the
previous year in which the transfer took place. For purposes of computing the
capital gains, the value of the asset recorded in the books of the firm on the
date of the transfer shall be deemed to be the full value of the consideration
received or accrued as a result of the transfer of the capital asset.

In view of
the above, it is clear that but for the specific provision of section 45(3),
the transfer of any capital asset by a partner to his firm could not have been
charged to tax under the head capital gains. In addition to providing for the
chargeability, section 45(3) also addresses the lacuna of the inability of
section 48 to cover such transfer within its ambit which was noticed by the Supreme
Court in the case of Sunil Siddharthbhai (Supra), by deeming the
amount recorded in the books of accounts of the firm as the full value of
consideration received or accruing as a result of such transfer.

Therefore,
it is obvious that section 45(3) needs to be invoked in order to charge the
capital gains tax in respect of transfer of a capital asset by a partner to his
firm. Having invoked the provisions of section 45(3) for the purpose of
chargeability, it needs to be applied in full and the alteration in the
computation mechanism as provided in that section also needs to be considered.
It would not be possible to invoke the provisions of section 45(3) only for the
purpose of creating a charge and, then, compute the capital gain in accordance
with the other provision, i.e., section 50C, by ignoring the computational
aspect of section 45(3) altogether.

The Mumbai
bench of the Tribunal in the case of ACIT vs. Prem Sagar (ITA No.
7442/Mum/2016) has held that both the limbs of section 45(3), i.e.,
charging provision and deeming fiction providing for the full value of
consideration, go hand in hand for facilitating quantification of the capital
gains tax. In case the quantification of the capital gains tax as envisaged in
section 45(3) is substituted by section 50C, then the charging to tax of the
transaction under consideration would in itself stand jeopardised and the
section would be rendered inoperative.

Having said
that the computation of capital gains needs to be made in accordance with the
provisions of section 45(3), the question may arise as to whether the amount of
consideration as decided in accordance with it can then be amended by invoking
the provisions of section 50C, in a case where the valuation adopted, assessed
or assessable by the stamp valuation authority is found to be higher than the
amount recorded in the books of the firm. For the purpose of section 50C the
comparison is required to be made between the consideration received or
accruing as a result of the transfer of the capital asset and the value
adopted, assessed or assessable by the stamp valuation authority for the
purpose of payment of stamp duty in respect of such transfer. Here, the
consideration received or accruing should be the real consideration received or
accruing, and not the consideration which is deemed to have been received or
accrued. This is because the expression ‘the consideration received or accruing
as a result of the transfer’ cannot be construed to include the consideration
deemed to have been received or accrued.

Wherever
required, the legislature has included a specific reference to something which
has been deemed to be so, in addition to the reference of the same thing in
simple terms. For example, section 9 provides for incomes which shall be deemed
to accrue or arise in India under certain circumstances. For the purpose of
including such income which is deemed to accrue or arise in India within the
scope of total income, clause (b) of section 5(1) makes specific reference to
it in addition to referring to the income which accrues or arises (in real and
not on deemed basis). The relevant clause is reproduced below:

(b) accrues
or arises or is deemed to accrue or arise to him in India during such year

There was no
need to make such a specific reference to the income which is deemed to accrue
or arise in India, if a view is taken that the income which accrues or arises
in India will in any case include the income which is deemed to accrue or arise
in India. As a corollary, the expression ‘the consideration received or
accruing as a result of the transfer’ as used in section 50C cannot include the
consideration deemed to be received or accrued in terms of the provisions of
section 45(3).

Further,
section 45(3) deems the amount recorded in the books of accounts of the firm as
a consideration only for the purpose of section 48. Therefore, the deeming
fiction created in section 45(3) has limited applicability and it cannot be
extended to section 50C, to deem the amount so recorded in the books of
accounts of the firm as consideration received or accruing for the purpose of
making its comparison with the valuation adopted, assessed or assessable by the
stamp valuation authorities. As a result, the provisions of section 50C cannot
be made applicable to the transfer of a capital asset by a partner to his firm
for which the true value of consideration received or accruing cannot be
determined, as held by the Supreme Court in the case of Sunil
Siddharthbhai (Supra).

The Supreme
Court in the case of CIT vs. Moon Mills Ltd. 59 ITR 574 has held
that one fiction cannot be imported within another fiction. Two different
provisions of the Act are providing for a fiction by deeming certain amounts as
the full value of consideration for the purpose of computation of capital gains
as per section 48. Section 45(3) deems the amount recorded in the books of the
firm as the full value of consideration and section 50C deems the value
adopted, assessed or assessable by the stamp valuation authority as the full
value of consideration. If section 50C has been made applicable over the amount
deemed to be the full value of consideration in terms of section 45(3), then it
will amount to superimposing a fiction upon a fiction – which would be contrary
to the decision of the Supreme Court.

In the case
of ITO vs. United Marine Academy 130 ITD 113 (Mum)(SB), a special
bench of the Tribunal has dealt with the interplay of deeming fictions as
provided in sections 50 and 50C and has observed as under:

For the
reasons given above and on interpretation of the relevant provisions of
sections 48, 50 and 50C, we are of the view that there are two deeming fictions
created in section 50 and section 50C. The first deeming fiction modifies the
term ‘cost of acquisition’ used in section 48 for the purpose of computing the
capital gains arising from transfer of depreciable assets, whereas the deeming
fiction created in section 50C modifies the term ‘full value of the
consideration received or accruing as a result of transfer of the capital
asset’ used in section 48 for the purpose of computing the capital gains
arising from the transfer of capital asset being land or building or both. The
deeming fiction created in section 50C thus operates in a specific field which
is different from the field in which section 50 is applicable. It is thus not a
case where any supposition has been sought to be imposed on any other
supposition of law. On the other hand, there are two different fictions created
into two different provisions, and going by the legislative intentions to create
the said fictions, the same operate in different fields. The harmonious
interpretation of the relevant provisions makes it clear that there is no
exclusion of applicability of one fiction in a case where another fiction is
applicable. As a matter of fact, there is no conflict between these two legal
fictions which operate in different fields and their application in a given
case simultaneously does not result in imposition of one supposition on another
supposition of law.

Thus,
insofar as transfer of an asset forming part of a block is concerned, the
Tribunal has held that both the provisions of the Act, i.e. sections 50 and
50C, can operate simultaneously. This is primarily for the reason that they
operate in different fields of the computation of capital gains. It was
categorically observed by the Tribunal that it was not a case where any
supposition has been sought to be imposed on another supposition of law.
Therefore, the inference which can be drawn indirectly on the basis of these
observations of the special bench is that two deeming fictions cannot operate
simultaneously if they operate in the same field like in the issue under
consideration.

It is also a
settled principle of interpretation that if a special provision is made on a
certain matter, the matter is excluded from the general provisions. This
principle is expressed in the maxims Generalia specialibus non derogant
(general things do not derogate from special things) and Generalibus
specialia derogant (special things derogate from general things).

However, it won’t be correct to
claim here that either of the two sections is a special one and, hence, it
overrides the other. Section 45(3) is a special provision insofar as
computation of capital gains resulting from capital contribution made by a
partner to the firm is concerned, and section 50C is a special provision
insofar as transfer of immovable property is concerned. Therefore, the issue
can better be resolved having regard to the other considerations as discussed
instead of merely relying upon these principles of interpretation.

In Canora
Resources Ltd., In Re 180 Taxman 220, the AAR was dealing with a case
where the transfer pricing provisions contained in sections 92 to 92F were also
becoming applicable to the transaction of the type which was covered by section
45(3). In this case, the AAR rejected the contention of the assessee that
section 45(3) being a special provision shall prevail over the general
provisions of sections 92 to 92F with regard to the transfer pricing.
Considering the purpose for which the transfer pricing provisions have been
made, the AAR held that section 45(3) would not apply to international
transactions and they should be dealt with in accordance with the transfer
pricing provisions. Insofar as such purposive interpretation is concerned with
respect to the issue under consideration, recently, the Chennai bench of the
Tribunal in the case of Shri Sarrangan Ashok vs. ITO (ITA No.
544/Chny/2019) has held that had it been the intention of the
legislature to make section 50C applicable even to the transaction of the
contribution of immovable property by a partner into the firm, the Parliament
could have repealed section 45(3) while introducing the provisions of section
50C. However, the fact that Parliament in its wisdom had retained section 45(3)
shows that Parliament intended to apply only the provisions of section 45(3) to
such transfer of capital assets by the partner to his firm.

The better view in our considered opinion, therefore,
is that the provisions of section 50C cannot be made applicable to a
transaction which falls within the scope of the provisions of section 45(3).

shailesh.kwebmaker

ACCUMULATION OF INCOME U/S 11(2) – STATEMENT OF PURPOSES

ISSUE FOR CONSIDERATION

A
charitable institution registered u/s 12A or 12AA of the Income-tax Act, 1961
can claim exemption of its income from property held for charitable or
religious purposes u/s 11(1) to the extent of such income applied or deemed to
be applied for charitable or religious purposes. In addition, exemption is also
available in respect of income not so applied but accumulated or set apart u/s
11(2), for such purposes for a period not exceeding five years, by filing a
statement of such accumulation in form No. 10. Section 11(2) requires the
institution to state the purpose for which the income is being accumulated or
set apart and the period for which the income is to be accumulated or set apart
in form No 10.

One of the longest running
controversies for the last 29 years has been about whether the purpose required
to be stated in form No. 10 can be general in nature, such as mere reference to
or reproduction of the objects of the trust, or that the statement has to be
specific in nature. In other words, should it be held to be a sufficient
compliance where the accumulation is stated to be for any medical and / or
educational purpose, or the statement should specify that the accumulation is
for the building of a hospital or a school, or anything else. While the
Calcutta and Madras High Courts have taken a view that a mention of a specific
purpose, and not just the general objects, is necessary, a majority of other
Courts, including the Delhi, Karnataka, Punjab and Haryana, Gujarat and Andhra
Pradesh and Telangana High Courts, have taken a contrary view holding that a
mere specification of the broad objects in the statement would suffice for this
purpose.

THE SINGHANIA CHARITABLE
TRUST CASE

The issue first came up for
discussion before the Calcutta High Court in the case of DIT(E) vs.
Trustees of Singhania Charitable Trust 199 ITR 819.

In this case, the assessee, a public
charitable trust, had claimed exemption u/s 11 for A.Y. 1984-85, including for
accumulation u/s 11(2), for which purpose it had filed form No. 10. In the said
form, as purposes of accumulation of income, the assessee had listed all the charitable
objects for which it was created.

These were:

(i) To
assist, finance, support, found, establish and maintain any institution meant
for the relief of the poor, advancement of education and medical relief;

(ii) To open, found, establish or finance, assist and contribute to the
maintenance of hospitals, charitable dispensaries, maternity homes, children’s
clinics, family planning centres, welfare centres, schools, colleges and / or
institutions for promotion of research and education in medical science,
including surgery;

(iii) To maintain beds in hospitals and make research grants for the
promotion and advancement of medical science in India;

(iv) To help needy people in marriage, funeral and cremation of the
dead;

(v) To
found, establish, maintain and assist leper asylums or other institutions for
the treatment of leprosy;

(vi) To open, found, establish, assist and maintain schools, colleges
and boarding houses;

(vii) To open, found, establish contribute to the maintenance of
orphanages, widows’ homes, lunatic asylums, poor houses;

(viii) To open, found, establish and assist schools, colleges and
hospitals, for the physically or mentally handicapped, spastics, the blind, the
deaf and the dumb;

(ix) To distribute dhotis, blankets, rugs, woollen clothing,
quilts or cotton, woollen, silken or other varieties of clothes to the poor;

(x) To
grant fees, stipends, scholarships, prizes, books, interest-free loans and
other aid for pursuing studies, training or research;

(xi) To establish, found and maintain libraries, reading rooms for the
convenience of the public;

(xii) To establish scholarships, teaching and research chairs in Indian
universities and contribute towards installation of capital equipment in
educational and research institutes;

(xiii) To print, publish, distribute journals, periodicals, books and
leaflets for the promotion of the objects of the society;

(xiv) To establish or support or aid in the establishment or support
of any other associations having similar objects;

(xv) To assist, support and to give monetary help to any individual in
distress, poor or poor(s) for his or their medical treatment, advancement of
education;

(xvi) To start, maintain and assist in relief measures in those parts
of India which are subjected to natural calamities such as famine, epidemics,
fire, flood, dearth of water, earthquake.

The resolution passed by the Board
of Trustees of the trust was to the effect that the balance of unapplied income
of the year was to be accumulated and / or set apart for application to any one
or more of the objects of the trust as set out in item numbers (i) to (xvi)
under paragraph 1 of the deed of the trust.

Its
assessment was completed, allowing the exemption u/s 11, including accumulation
u/s 11(2). Subsequently, a notice was issued by the Commissioner for revision
u/s 263. According to the Commissioner, section 11(2) contemplated only
specific or concrete purposes and since those were not specified by the
assessee, the assessment order was erroneous and prejudicial to the interests
of the Revenue. The Commissioner called for the revision of the order of
assessment u/s 263, setting aside the assessment order and directing the A.O.
to redo the assessment taking into account the correct position of facts and
law. The Commissioner observed that it would be a mockery of the section if, in
the application for accumulation, all the objects of the trust were listed out
and the period was mentioned as ten years, which was the maximum then
permissible under law.

On appeal, the Tribunal held that on
an examination of the scheme of the Act since a plurality of charitable
purposes was not ruled out under it, no objection could possibly be taken to
the assessee’s listing out all the objects of the trust in form No. 10. The Tribunal
held the act of the assessee to be in compliance with the provisions of the Act
and disagreed with the findings of the Commissioner.

Before the Calcutta High Court, it
was contended on behalf of the assessee that one purpose of accumulation was
interlinked with the other and, therefore, the mention of all the purposes did
not make any difference and satisfied the requirements of section 11(2).

The Calcutta High Court observed
that the Tribunal’s decision overlooked the scheme relating to the accumulation
of income for a particular future use. It noted that section 11(1) itself
provided for marginal setting apart and accumulation of up to 25% (now 15%) of
the income of the trust. According to the High Court, section 11(1)
accumulation could be taken for the broad purposes of the trust as a whole and
that is why the statute in section 11(1) did not require an assessee to state
or specify the purpose. Such setting apart u/s 11(1) for any of the purposes of
the trust was, however, a short-term accumulation, in view of the Court, not to
exceed beyond the subsequent year. The High Court noted that it was sub-section
(2) which provided for the long-term accumulation of the income where it was
obvious that the long-term accumulation thereunder should be for a definite and
concrete purpose or purposes.

The High Court noted that the
assessee had sought permission to accumulate not for any determinate purpose or
purposes, but for the objects as enshrined in the trust deed in a blanket or
global manner which, in its view, was definitely not in the contemplation of
section 11(2) when it was construed in its setting. The High Court held that
accepting the assessee’s contention that saving and accumulation of income for
future application of the income was for the purposes of the trust in the
widest terms so as to embrace the entirety of the objects clause of the trust
deed, would render the requirement of specification of the purpose for
acquisition in that sub-section redundant.

The High Court observed that the
purpose of accumulation could not tread beyond the objects clause of the trust,
the legislature could not have provided for the period of accumulation if it
did not have in mind the particularity of the purpose or purposes falling
within the ambit of the objects clause of the trust deed. The High Court was of
the view that when section 11(2) required the specification of the purpose, it
did so with the objective of calling an assessee to state some specific purpose
out of the multiple purposes for which the trust stood; had it not been so,
there would have been no mandate for such specification since, in any case, a
charitable trust could, in no circumstances, apply its income, whether current
or accumulated, for any purposes other than the objects for which it stood; the
very fact that the statute required the purpose for accumulation to be stated
implied that such a purpose be a concrete one, an itemised purpose or a purpose
instrumental or ancillary to the implementation of its object or objects; the
very requirement of specification of purpose predicated that the purpose must
have an individuality.

According to the High Court, the
provision of section 11(2) was a concession provision to enable a charitable
trust to meet the contingency where the fulfilment of any project within its
object or objects needed heavy outlay calling for accumulation to amass
sufficient money to implement it and, therefore, specification of purpose as
required by section 11(2) admitted of no amount of vagueness about such
purpose.

The
High Court observed that it was not necessary that the assessee had to mention
only one specific object; there could be a setting apart and accumulation of
income for more objects than one, but whatever the objects or purposes might
be, the assessee must specify in the notice the concrete nature of the purposes
for which the application was being made; plurality of the purposes of
accumulation might not be precluded, but it must depend on the exact and
precise purposes for which the accumulation was intended; the generality of the
objects of the trust could not take the place of the specificity of the need
for accumulation.

The Calcutta High Court, therefore,
remanded the matter to the Tribunal to allow the assessee to adduce fresh
evidence, whether in the form of any resolution or otherwise, showing that the
specific purpose for which the trust required the accumulation of the income
existed and, if such resolution or evidence was placed before the Tribunal, the
Tribunal was directed to consider whether the obligation cast on the assessee
u/s 11(2) had been discharged and the exemption might accordingly be granted to
the assessee.

This decision of the Calcutta High
Court was referred to with approval by the Madras High Court in the case of CIT
vs. M. CT. Muthiah Chettiar Family Trust 245 ITR 400, though the Court
did not decide on the issue under consideration, since the issue before it
pertained to the taxation of the unutilised accumulation u/s 11(3), and it was
conceded by the Department that it was not in a position at a later date to
challenge that the form No. 10 filed in the year of accumulation was invalid
for not having stated a specified purpose for accumulation.

THE HOTEL AND RESTAURANT
ASSOCIATION’S CASE

The issue subsequently came up
before the Delhi High Court in the case of CIT vs. Hotel and Restaurant
Association 261 ITR 190.

In this case, pertaining to A.Y.
1992-93, the assessee, a company registered u/s 25 of the Companies Act, 1956
was also registered u/s 12A of the Income-tax Act. For the relevant year the
assessee accumulated its income for a period of ten years for fulfilment of the
objects for which it had been created. Notice to that effect was given by
filing form No. 10, giving particulars of the income sought to be accumulated.

During the assessment proceedings,
the A.O. declined to take into consideration the amount so accumulated on the
ground that in form No. 10 the specific object for which the income was sought
to be accumulated was not indicated. Accordingly, exemption in respect of such
accumulation was not allowed.

The Commissioner (Appeals) held that
the assessee was entitled to the exemption for the accumulation since the
assessee had passed a resolution to accumulate income so as to apply the same
in India in the next ten years to achieve the objects for which it had been
incorporated, and notice of this fact had been given to the A.O. in the
prescribed format. The Tribunal confirmed the view taken by the Commissioner
(Appeals).

Before the High Court, it was
submitted on behalf of the Revenue that the appellate authorities had failed to
appreciate that in the prescribed form the assessee had failed to indicate the
specific purpose for which the income was sought to be accumulated and,
therefore, the statutory requirement had not been strictly complied with,
disentitling the assessee from relief u/s 11(2).

The Delhi High Court, disagreeing
with the Revenue’s contentions, observed that while it was true that
specification of a certain purpose or purposes was needed for accumulation of
the trust’s income u/s 11(2), the purpose or purposes to be specified could not
have been beyond the objects of the trust; plurality of purposes of
accumulation was not precluded but depended on the precise purpose for which the
accumulation was intended.

The Delhi High Court noted that the
appellate authorities below had recorded a concurrent finding that the income
was sought to be accumulated by the assessee to achieve the objects for which
the assessee was incorporated. It further noted that it was not the case of the
Revenue that any of the objects of the assessee company were not for charitable
purposes. The findings of fact by the Tribunal gave rise to no question of law.
The Delhi High Court therefore declined to entertain the appeal.

This decision of the Delhi High
Court was followed in subsequent decisions of the same High Court and other
High Courts in the following cases:

(1) DIT(E)
vs. Daulat Ram Education Society 278 ITR 260 (Del.) – in this case, out
of 29 objects stipulated in the Memorandum of Association, the assessee had
specified eight objects;

(2) DIT(E)
vs. Mamta Health Institute for Mother and Children 293 ITR 380 (Del.) –
in form No. 10, the purpose of accumulation was stated to be as per the resolution passed by the assessee; and in the
resolution the purpose specified was that of financing of the ongoing
programmes and of furtherance of the objects of the society;

(3) Bharat
Kalyan Pratishthan vs. DIT(E) 299 ITR 406 (Del.) – in this case the
resolution was to the effect that the amount accumulated be utilised for the
purposes of the trust, where the trust had only three objects, viz., medical
relief, help to the poor and educational purposes;

(4) DIT
vs. Mitsui & Co. Environmental Trust 303 ITR 111 (Del.) – in form
No. 10 it was mentioned that the amount accumulated would be utilised for the
objects of the trust;

(5) Bharat
Krishak Samaj vs. DDIT(E) 306 ITR 153 (Del.) – here, the accumulation
was for the objects of the trust;

(6) CIT
vs. National Institute and Financial Management 322 ITR 694 (P & H)
– the purpose of the accumulation stated was for expenditure on the building
fund and equipment fund;

(7) DIT(E)
vs. NBIE Welfare Society 370 ITR 490 (Del.) – in form No. 10, the
purpose stated for accumulation was for ‘further utilisation’;

(8) Samaj
Seva Nidhi vs. ACIT 376 ITR 507 (AP & T) – form No. 10 stated that
the accumulation was for general objects, but by a subsequent letter it was
stated that the amount was for the welfare of Scheduled Castes, Scheduled
Tribes, Vanvasis and socially and economically weaker sections of the society
as mentioned in a specific clause of the trust deed;

(9) DIT(E)
vs. Envisions 378 ITR 483 (Kar.) – in this case, three out of the 14
objects were reproduced in form No. 10, viz., conduct of various activities in
the field of academics, architecture, music and literature for preservation of
heritage; to run and maintain educational or other institutions for providing
and promoting education for the poor and weaker sections of society; and to
run, maintain or assist any medical institution to grant assistance to indigent
needy people for meeting the cost of medical treatment;

(10) CIT(E) vs. Gokula Education Foundation 394 ITR 236 (Kar.)
– in form No. 10, the purpose of accumulation stated was to improve / develop
the buildings of the trust and to conduct educational / charitable activities;
a special leave petition against the order of the High Court has been granted
to the Income Tax Department by the Supreme Court [248 Taxman 13(SC)];

(11) CIT(E) vs. Ohio University Christ College 408 ITR 352 (Kar.) –
three purposes were stated in form No. 10, which were all charitable, but
details of such purposes were not given;

(12) CIT(E) vs. Bochasanwasi Shri Akshar Purshottam Public Charitable
Trust 409 ITR 591 (Guj.) – in form No. 10, the purpose stated was for
providing medical facilities at various centres; the resolution had specified
purposes such as for future hospital of the trust, for purchase of necessary
equipment, ambulance van, furniture and fixtures and further expenditure for
modernisation of the hospitals.

OBSERVATIONS

Section 11(2) of the Income -tax Act
permits accumulation or setting apart of an income of a charitable institution
which is otherwise not applied or is not deemed to have been applied for the
charitable or religious purposes during the year. The income so accumulated or
set apart for application to such purposes is not included in the total income
for the year, provided the conditions specified in section 11(2) are complied
with. These conditions are:

(a) a
statement is furnished, in the prescribed form and manner, to the A.O. (form
No. 10 under Rule 17), stating therein the purpose for which the income is so
accumulated or set apart and the period for which the income is to be
accumulated or set apart and which period shall not exceed five years;

(b) the
money so accumulated or set apart is invested or deposited in the specified
form or mode;

(d) form
No. 10 is furnished electronically under the digital signature or an electronic
verification code.

On
an apparent reading of the provision, it is gathered that an assessee, in cases
where the income is accumulated or set apart, is required to state the purpose
of accumulation and also state the period of accumulation in form No. 10. Once
this is dutifully complied with, no other prescription is provided for in the
Act. In other words, the assessee is to state the purpose of accumulation and
the period thereafter. The law apparently does not limit the purpose of
accumulation to a single purpose and further does not require such accumulation
for a dedicated project or a task within the objects of the institution. It
also does not call for passing of a resolution or enclosing of a copy of such
resolution with form No. 10.

There is no disagreement amongst the
High Courts about the need for a trust to spend its income, including the
accumulated income, only for those charitable or religious purposes specified
in its objects as per the Trust Deed. While granting registration u/s 12A/12AA,
the Commissioner would already have examined whether such objects qualify as
public charitable and religious purposes. It is also not in dispute that the
accumulation can be for more than one purpose; plurality of purposes is not
prohibited; there is no prohibition on a trust accumulating its income for all
of its activities. The obvious corollary to this undisputed position is that
while stating the purpose of accumulation in form No. 10, the assessee instead
of reproducing the list of all such activities, specifies that it is for its
objects, which have already been found to be charitable or religious in nature,
that should suffice for the purposes of section 11(2).

The 25% (now 15%) accumulation u/s
11(1) is not a short-term accumulation only for one year but is in fact for the
life-time of the trust and this factor should not have influenced the Calcutta High
Court to hold that for the purposes of section 11(2) accumulation there was a
need to state a specific purpose and not the general one by simply referring to
the objects clause.

If one examines the various types of
exemption u/s 11, one can see that all of these are for any of the objects of
the trust – the spending during the year u/s 11(1), the 15% accumulation u/s
11(1), the option to spend in the subsequent year under the explanation to
section 11(1). If that be the position, the legislature cannot be said to have
intended to restrict only the accumulation u/s 11(2) to a limited part of the
objects.

The requirement to specify the
purposes of accumulation can perhaps have been intended to ensure that the
accumulation is spent within the specified time and to tax it u/s 11(3) if it
is not spent within that time. But that purpose would be met even if all the
objects are specified for accumulation or setting apart.

In any case, almost all the High
Courts, except the Calcutta and the Madras High Courts, have held that so long
as the purpose of accumulation is clear from either the resolution or
subsequent correspondence or surrounding circumstances, that should suffice as
specification of the objects. This also seems clear from the fact that while
the Supreme Court has admitted the special leave petition against the Karnataka
High Court decision in Gokula Education Foundation (Supra), it
has rejected the special leave petition against the decision of the Gujarat
High Court in the case of Bochasanwasi Shri Akshar Purshottam Public
Charitable Trust (Supra).

The Tribunal in the case of Associated
Electronics Research Foundation 100 TTJ 480 (Del.) has held that it
would be a sufficient compliance of section 11(2) where the purpose of
accumulation can be gathered from the minutes of the meeting wherein a decision
to accumulate is taken and such decision is recorded in the minutes.

In the end, the assessee, in the
cases of deficiency or failure, may consider the possibility of making up for
such deficiency or failure by prescribing the purpose of accumulation or
setting apart during the course of assessment or before or thereafter. The
Gujarat High Court in the case of Bochasanwasi Shri Akshar Purshottam
Public Charitable Trust (Supra) has permitted the institution to
specify and to state the purpose of accumulation, subsequent to the filing of
the return of income. The special leave petition filed by the Income-tax
Department has been rejected by the Supreme Court in 263 Taxman 247 (SC).

The Calcutta High Court view seems to require
reconsideration, or should be read in the context of the matter, and the view
taken by the other High Courts seems to be the better view. One can only hope that the Supreme Court speedily decides this long-standing controversy which
has resulted in litigation for so many trusts.

shailesh.kwebmaker

FAILURE TO CLAIM DEDUCTION IN RETURN OF INCOME AND SECTION 80A(5)

ISSUE FOR CONSIDERATION

Section 80A(5)
provides for denial of deduction under sections 10A, 10AA, 10B, 10BA, or under
any of the provisions of part C of Chapter VIA (‘specified deductions’) of the
Income-tax Act in cases where the assessee fails to make a claim in the return
of income. It is usual to come across cases where assessees have failed to make
a specific claim for deduction in computing the total income and, as a
consequence, in claiming the same in the return of income, or where the
assessees try to cover up the failure by filing a revised return.

This disabling
provision has been introduced by the Finance (No. 2) Act, 2009 with
retrospective effect from 1^st April, 2003. On introduction of the
new provision, an issue has arisen about the eligibility of an assessee to qualify
for the specified deductions in cases where the assessee has staked the claim
for the specified deduction for the first time in the revised return of income
and such return is filed beyond the time permissible in law but before the
completion of assessment. Conflicting decisions of the Tribunal are available
in the context of the new provision of section 80A(5) on the subject. The ratio
of such decisions is discussed here to highlight the difficulty and the
possible steps that may be taken to mitigate the hardship.

THE
OLAVANNA SERVICE CO-OP. BANK CASE

The issue arose in the case of M/s Olavanna Service Co-op. Bank ITA
No. 398/Coch/2014 dated 21^stNovember, 2017 (unreported-Cochin).
The only issue in the appeal for assessment year 2010-11 was with regard to the
denial of deduction u/s 80P by invoking the provisions of section 80A(5). The
assessee, a co-operative bank registered under the Kerala Co-operative
Societies Act, 1969, had failed to file return of income for the A.Y. 2010-11.
The AO had issued notice u/s 142(1) requiring the assessee to file the return
of income but the assessee neither complied with the notice nor filed a return
of income. The AO initiated best judgment proceedings u/s 144 and called for
the details, at which point in time the assessee filed the return of income on
20^th March, 2013 which was beyond the time limit prescribed u/s 139
and the time limit prescribed in notice u/s 142(1) and, therefore, the AO treated
the same as invalid. On the basis of the material gathered during the course of
assessment, the AO worked out the total income of the assesse from business and
in completing the assessment he disallowed the claim of deduction u/s 80P by
invoking the provisions of section 80A(5).

On appeal, the CIT(A) relied on the decision of the ITAT, Cochin Bench in
the case of Kadachira Service Co-op. Bank Ltd. & Ors., 153 TTJ
(Cochin) 129 wherein it was held that
the assessee was not entitled for deduction u/s 80P for the A.Y. 2009-10
if the return of income had not been filed within the prescribed time. The
CIT(A) dismissed the appeal as, in his opinion, the factual matrix was the same
in both the cases. Against this order of the CIT(A), the assessee filed an appeal
before the Tribunal.

It was contended
before the Tribunal on behalf of the assessee that the assessee had filed the
return of income before the assessment proceedings were completed and,
therefore, the return filed should have been considered for the purpose of
making the assessment. It was further submitted that the AO should have
regularised the return of income u/s 148 of the Act, considering the fact that
the proceedings had been initiated on the basis of the reason to believe that
the income had escaped assessment. Further, it was submitted that since the
income had been assessed u/s 144 relying on all the materials, deeds and
documents submitted by the assessee in the course of the assessment proceedings
in response to the directions of the AO, he should have granted the deduction
as provided u/s 80P of the I.T. Act.

It was explained
that the assessee was a co-operative society coming under the classification of
Primary Agricultural Credit Society or Primary Co-operative Agricultural and
Rural Development Bank carrying on the business of banking, providing credit
facility to its members for agricultural purposes and, therefore, the claim of
exemption u/s 80P should have been allowed and that, even if it was held that
the assessee was doing banking business, proportionate exemption should have
been granted in respect of the agricultural credit facilities given to its
members, instead of disallowing the entire claim of deduction u/s 80P of the
Act.

The Tribunal, on
hearing both the sides, noted that a similar issue had come up for
consideration in the case of Kadachira Service Co-op. Bank Ltd. &
Ors., 153 TTJ (Cochin) 129. The relevant portion of the observations in
the said case were referred to by the Tribunal to hold that unless the Central
Government, by a notification in the official gazette, exempted the
co-operative societies from filing the returns, they had to file the return of
income and the co-operative societies could not have been under the impression
that they need not file their returns of income since their income was
exempted; a statutory liability of filing the return under the Income-tax Act
could not be disowned on the ground of a bona fide impression that no
return of income was required to be filed. It was observed that when the language
of the provision was plain and unambiguous, the language employed in the
statute was determinative of the legislative intent.

On examination of
section 80A(5), the Tribunal noted that the intention of the legislature in
introducing the provision was to avoid multiple deductions in respect of the
same profit and for that the legislature had imposed three conditions for
claiming deduction under sections 10A, 10AA, 10B, 10BA, or under any provisions
of part C, Chapter VIA. One of the conditions required that there should be a
claim made in the return of income. The legislature, in its wisdom, thought it
fit that implementation of these three conditions would prevent misuse and
avoid multiple claims of deduction under sections 10A, 10AA, 10B, 10BA, or under
any provisions of part C, Chapter VIA. A plain reading of the language of
sections 80A(4) and 80A(5) made clear the purpose and intent of the legislature
in a manner that did not require any further interpretation.

The Tribunal
examined the other provisions of the Act that provided for a deduction, to
appreciate the provisions of section 80A(5) of the Act, noting that while other
provisions required filing of return u/s 139(1), section 80A(5) did not carry
any such limitation. That being so, even if a return was filed u/s 139(4) it
would not dilute the infraction in not furnishing the return in due time as
prescribed in section 139(1). In section 80A(5) the legislature obviously
omitted to mention the words ‘in due time’. What it says is that where the taxpayer
fails to make a claim in the return of income, no deduction shall be allowed.
It does not say that the return of income shall be furnished in due time. The
return might be filed either u/s 139(1), or 139(4), or in pursuance of a notice
issued u/s 142(1) or 148 of the Act.

On the question of
when there was a failure on the part of the taxpayer to file return of income
within the time limit provided u/s 139(1) or 139(4), or within the time
specified in the notice u/s 142(1) or 148, the Tribunal held that the return of
income filed belatedly could not be treated as return of income.

While dealing with
the contention that when the return was filed before completion of the
assessment proceedings, the AO ought to have issued notice u/s 148 for regularising
the returns, the Tribunal held that the AO had no jurisdiction to issue notice
u/s 148 for assessing the income of the taxpayer. In other words, no income
could be said to have escaped assessment at that point of time. Therefore, the
contention of the assessee that notice ought to have been issued u/s 148 had no
merit at all. It referred to the decision in the case of Sun Engineering
Works (P) Ltd., 198 ITR 297, 320 (SC) to hold that proceedings u/s 147
were for the benefit of the Revenue.

The Tribunal held
that accepting the plea of the assessee that the deduction be allowed even
where no return was filed, would mean that a person who had not filed a return
would get benefit but a person who filed the return but failed to make a claim
either by ignorance or otherwise may not get the benefit at all. The Tribunal
was of the considered opinion that such could certainly not be the legislative
intent.

In conclusion, the
Tribunal held that it was a settled principle of law that in order to avail benefits
under the beneficial provision, the conditions provided by the legislature had
to be complied with, and therefore, the Tribunal was of the considered opinion
that in view of the mandatory provisions contained in section 139(1) r/w/s
80A(5) of the Act, it was mandatory for every co-operative society for claiming
deduction u/s 80P to file the return of income and to make a claim of deduction
u/s 80P in the return itself. If the return was not filed either u/s 139(1) or
139(4), or in pursuance of notice issued u/s 142(1) or 148, the taxpayer was
not entitled for any deduction u/s 80P.

CASE OF KAMDHENU BUILDERS AND DEVELOPERS

A similar issue was
examined in yet another case, of Kamdhenu Builders and Developers vs.
DCIT, ITA No. 7010/Mum/2010 (unreported-Mumbai) for A.Y. 2007-08 dated
27^th January, 2016. The assessee in that case, a partnership firm,
was engaged in the business of building housing projects and doing real estate
development. The original return of income for A.Y. 2007-08 was filed on 18^th
October, 2007 declaring total income from the housing project at Rs.
1,94,12,489. During pendency of assessment proceedings, the assessee had filed
a revised return of income on 31^st August, 2009 declaring Nil
income, as the entire profit of Rs. 1,94,12,489 was claimed to be allowable as
deduction u/s 80IB(10) of the Income-tax Act. The AO had not allowed the claim
of deduction on the ground that revised return of income was furnished on 31^stAugust, 2009, which was beyond the date by which the revised return of
income should have been furnished as per the provisions of law u/s 139(5) of
the Income-tax Act. According to the AO, the claim of deduction u/s 80IB was
also inadmissible on account of the provision of law u/s 80A(5) of the
Income-tax Act.

On appeal, the
CIT(A) allowed the assessee’s claim. The Tribunal, on further appeal by the
Revenue, has largely relied upon the order of the CIT(A) and has reproduced
extensively his observations and findings in its order, some of which were as
under:

‘I have circumspected
the entire spectrum and circumstances of the case and considered finding of the
AO, remand report, written submission of the appellant and counter
representation vis-à-vis provision of
law and various decisions of the Hon’ble
ITAT, High Court and Supreme Court relevant to the issue. It transpires from the
assessment order and remand report of AO dated 7^th June, 2010 that
Ld. AO had denied or is not willing to give deduction u/s 80IB(10) merely on
the ground of provision of law u/s 80A(5) irrespective of fulfilment of all the
conditions prescribed by the appellant to be entitled for legal claim of
deduction u/s 80IB(10) of the Act. This approach and contention of the Ld. AO
is not tenable because of obvious facts of fulfilment of all the conditions by
the appellant. There is no bar of furnishing of revised return of income u/s
80A(5) and the decision of the Hon’ble ITAT, High Courts and Supreme Court over
such issues support the appellant. Under section 80A(5), there is an insertion
of new provision of law with effect from 1^st April, 2003 providing
that where the assessee failed to make claim in his return of income for any deduction u/s 10(A),
or section 10(AA), or section 10(B), or section 10(BA), or under any provision
of Chapter VIA under the head in C – deduction in respect of certain income, no
deduction shall be allowed to him thereunder, means there is no restriction
about the revised return of income but
there is a provision of law for claiming such deduction through return of
income only. This provision of law does not limit the date of filing of return
of income to be either as provided u/s 139(1) or 139(4) or 139(5) of the
Income-tax Act. As such, there is no ambiguity regarding interpretation or
understanding of this provision of law. The provision of section 80A(5) does
not provide that return of income through which the deduction has to be claimed
should be filed on or before the due date specified under these sections, it is
worthwhile to mention that whenever legislature intends to provide a law with
reference to the prescribed date of return of income before any specified date, it has
clearly identified and mentioned in expressed word.’

The CIT(A) cited
the examples of section 80AC where a return of income had to be filed prior to
due date as per section 139(1) and of section 54(2) which referred to the date
of furnishing return as per section 139 and also of section 139(3) where carry
forward of loss was permitted only if such return of loss was filed within the
time limit provided by section 139(1). He noted that for claiming any such
deduction under these sections, return of income had to be filed within the
specified date u/s 139(1), whereas u/s
80A(5) there was no such specific limitation of date; therefore, in absence of
any specific limitation of date, the words ‘return of income’ provided u/s
80A(5) had to be construed to mean any such return of income filed prior to the
completion of assessment or a return of income filed during the assessment
proceedings, provided the original return of income was filed within the time limit prescribed u/s 139(1).

He further held: ‘Obviously,
appellant complies with the provision of section 80AC of the Income-tax Act.
When the original return of income has been filed well within the due date, the
revised return filed thereafter before the completion of assessment proceedings
or assessment order is passed, it is a valid return of income to be considered
by the Assessing Officer, otherwise every purpose of giving such right to such
appellant would be frustrated. The revised return of income is essential for
removal of defects of original return. It obviously corrects shortcomings from
which it suffered. The revised return must therefore be considered as it was
originally filed vide Thakur Dharmapur Sugar Mills Ltd. vs. CIT (1973) 90
ITR 236, 239 & 240 (All.) and Gopaldas Parshottamdas vs. CIT
(1941) 9 ITR 130 (All.). It is important to point out that when a revised return cures the
defects in the original return and does not obliterate the latter, the
assessment means on the basis of original return of income ignoring the revised
return is liable to be set aside vide CIT vs. Chitranjali (1986) 159 ITR 801
(Cal.). Similar view has also been taken in the case of CIT vs.
Bansidhar Dalal and Sons, 207 ITR 494 (Cal.).’

The CIT(A) observed
that an AO’s functions encompassed power as well as duty to be exercised within
the ambit of law. Relying on various court pronouncements, he observed that it
was only the true and correct total income of every person which was assessable
u/s 4 of the Act and, consequently, the tax collector was rather duty-bound to
collect the legitimate tax due on such total income – neither a penny less nor
a penny more, and the determination / assessment of total income would depend
on the relevant provisions of the Act irrespective of the nature of return
filed by any person; and that an income which was not taxable could not be
taxed merely because the assessee forgot to claim the exemption / deduction
under some mistaken belief. Rather, it was the duty of the Assessing Officer to
allow such deduction or exemption to which the assessee was entitled on the
basis of material placed on record. Therefore, the assessee was entitled to
claim deduction if such claim was made by the assessee before the completion of
assessment proceedings. He relied on the findings in the case of Anchor
Pressings (P) Ltd., 161 ITR 159 (SC) in which case the claim for
deduction u/s 80-O was made by the assessee before completion of assessment
proceedings by way of a revised return filed after expiry of period specified
u/s 139(5), it was held that the assessee was entitled to the said deduction in
computing his total income.

The CIT(A) relying
on the cases of Lucknow Public Educational Society, 318 ITR 223 (All.);
Gujarat Oil & Allied Industries, 109 CTR (Guj.) 272, 201 ITR 325 (Guj.); and
Berger Paints (India) Ltd., 174 CTR (Cal.)269: 254 ITR 503 (Cal.)
held that the mistake was procedural in nature. The mistake was a technical
breach and the AO was duty-bound to ask for details before denying the claim.
In the instant case, the AO had not asked any information before denying the
exemption for which the assessee was legally entitled. On the other hand, he
had rejected the second return which enclosed the necessary documents for
claiming the exemption.

The CIT(A) noted
with approval the decision in the case of Emerson Network Power India (P)
Ltd., 122 TTJ/27 SOT/19 DTR where it had been held that any claim made
at the time of assessment but not made in the original return, nor made by way
of valid revised return, could not be denied and the AO was obliged to give due
relief to the assessee or entertain its claim if admissible as per law, even
though the assessee had not filed the revised return, and that the legitimate
claim of the assessee should not be rejected on technical grounds. In the
background of all the decisions and facts of the case, the denial of claim of
deduction of the appellant made through revised return of income during the
course of assessment proceedings and well before the passing of assessment
order, according to the CIT(A), was not tenable in the eye of law.

Against the above
order of the CIT(A), the Revenue filed an appeal to the Tribunal on the
following grounds:

‘(i) On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in holding that the assessee is entitled to deduction
u/s 80IB(10) of Rs. 1,94,12,489 in spite of the fact that the claim for
deduction was not made in the original return and was only made in the return
filed for A.Y. 2007-08 on 31^stAugust, 2009, which is not a valid
return in the eye of law and also cannot be treated as revised return u/s
139(5).

(ii) On the
facts and circumstances of the case and law, the Ld. CIT(A) erred in allowing
the deduction u/s 80IB(10) of Rs. 1,94,12,489 as the same is contrary to the
provisions of section 80A(5), effective from 1^stApril, 2003, which
does not permit allowance of deduction unless the claim for deduction is made
in the return of income.

(iii) On the facts and circumstances of case and in
law, the Ld. CIT(A) erred in allowing the deduction u/s 80IB(10) as the same
only means that deduction can be claimed just by filling revised return u/s
139(5)… has already elapsed, in the course of assessment proceedings, which is
not at all acceptable in the light of amended provisions of section 80A(5),
vide Finance (No. 2) Bill, 2009.’

It was contended by
Revenue that as per the provisions of section 80A(5), effective from A.Y.
2003-04, the assessee was not entitled for deduction unless the claim of
deduction was made in the original return filed by him. On the other hand, the
assessee contended that original return was filed well within the time, and the
revised return was filed to correct the omission in the original return.
Nowhere had the AO alleged that the assessee had not complied with any of the
conditions prescribed for claim of deduction u/s 80IB(10). A legal claim, even
if not made in the original return or even in the revised return, but made by
the assessee before the AO completing the assessment, should be allowed.

The Tribunal in its
considered view noted that section 80A(5) only required filing of return.
Nowhere is it suggested that claim should be made in the original return and
not by way of revised return. It further noted that when the original return of
income had been filed well within the due date, the revised return filed
thereafter, before the completion of assessment proceedings, was a valid return
of income to be considered by the AO; that the assessee had been given
opportunity to file revised return u/s 139(4) for removal of any defect in the
original return; the CIT(A), considering the remand report and the written
submission of the assessee, and after applying various judicial pronouncements,
recorded a finding to the effect that the assessee had filed a revised return
claiming deduction u/s 80IB(10) before completion of assessment, and following
the judicial pronouncements laid down by the Allahabad High Court in the case
of Thakur Dharmapur Sugar Mills Ltd. 90 ITR 236, held that
revised return must be considered as it was originally filed; it was the duty
of the AO to allow legal claim if made before him and provided it fulfilled all
the conditions of the claim; nowhere had the AO alleged that the assessee has
failed to comply with any of the conditions of section 80IB(10); the only
grievance of the AO was that the claim was not made in the return filed u/s
139(1); the CIT(A) recorded a finding to the effect that both the original
return was filed well within the time limit prescribed under the law and the
revised return was filed before the AO completed the assessment, that the
assessee had fulfilled all the conditions u/s 80IB(10) and, therefore was
entitled for deduction in respect of the housing project.

The Tribunal noted
that the findings recorded by the CIT(A) had not been controverted by the
Department by bringing any positive material on record and the Tribunal did not
find any reason to interfere in the order of the CIT(A) in allowing the
assessee’s claim for deduction u/s 80IB(10) of the Act.

OBSERVATIONS

Section 80A(1)
stipulates that in computing the total income of an assessee, there shall be
allowed the deductions specified in sections 80C to 80U of the Act. Section
80A(5) reads as follows: ‘Where the assessee fails to make a claim in his
return of income for any deduction under section 10A or section 10AA or section
10B or section 10BA or under any provision of this Chapter under the heading
“C Deductions in respect of certain
incomes”, no deduction shall be allowed to him thereunder’.

On a plain reading
of the provision it is clear that the disabling provision is activated only in
the case of an ultimate failure to make a claim in the return of income. The claims
though not made in the return of income u/s 139(1), would continue to be valid
as long as the claim for specified deduction is made in any of the returns
filed u/s 139(3), 139(4) and 139(5), or even in response to notices u/s 142(1)
or 148 of the Act, subject to compliance of the independent conditions of the
respective provisions under which a specified deduction is being claimed.

In cases where it
is necessary for the taxpayer to file the return of income within a specified
date, the legislature has inserted the words ‘before the due date specified’ or ‘in due
time’ or ‘within the time limit’. In
section 80A(5), the legislature expressly omitted to include the words ‘within
the time limit’ or ‘before the due date specified’ or ‘in due time’. Therefore,
for the purpose of Chapter VIA the legislature intended not to make compulsory
the filing of return of income within the specified time or in due time as
provided in section 139(1) of the Act. In fact, section 80 r/w/s 139(3) of the
Income-tax Act, which provides for carry forward of losses, requires the
taxpayer to file the return of income within the time allowed u/s 139(1).

While introducing
section 80A(5), the legislature was well aware that not only for carry forward
of losses but also for deductions u/s 10A and 10B, the taxpayer has to file the
return of income within the time limit prescribed u/s 139(1) of the Act. In
spite of that, the legislature omitted to mention the words ‘within due time’
in section 80A(5). Therefore, the return of income filed within the time limit
provided in section 139(1) or 139(4), or the time specified in the notice u/s
142(1) or 148 can be considered as return of income. The issue, therefore, is
limited to the belated return filed beyond the time limit provided u/s 139(1)
or 139(4), or the time specified in notice u/s 142(1) or 148 of the Act.

The challenge
therefore is in respect of a case where no claim at all is made in the return
of income, or a case where such a claim is made in the return of income that is
filed, not under any of the above referred provisions, but before the
assessment. Nonetheless, such a challenge may also be faced in a case where the
assessee for the first time seeks to claim one of the specified deductions
before the appellate authorities. For brevity’s sake, however, the discussion
here is mainly restricted to a case where a deduction has been claimed in the
revised return of income filed beyond the permissible time but before the
assessment is completed; it is this aspect of section 80A(5) that has been
examined under the conflicting decisions discussed above.

The Notes to Clauses and the Explanatory Memorandum issued at the time of
introduction of the provision by the Finance (No. 2) Bill, 2009 are reported in
315 ITR (Stat) 81 and 82. The intention of the legislature in enacting sections
80A(4) and 80A(5) is to avoid multiple deduction in respect of the same profit.
The legislature prescribed three conditions in sections 80A(4) and 80A(5) which
are: (i) If a deduction in respect of any amount was allowed u/s 10A, 10AA
or 10B or 10BA or under provisions of Chapter VIA under the head ‘C – Deductions in respect of certain
incomes’ in any assessment year, then the same deduction in respect of the same
profit & gains shall not be allowed under any other provisions of the Act
for such assessment year; (ii) The aggregate deduction under various provisions
shall not exceed the profit and gains of the undertaking or unit or enterprise
or the business profit, as the case may be; and (iii) There shall be a claim
made in the return of income. The legislature in its wisdom thought that
the above three conditions would avoid multiple deductions in respect of the
same profit. One of the conditions prescribed by the legislature in section
80A(5) is to make a claim in the return of income. The Delhi High Court in the
case of Nath Brothers Exim International Limited, 394 ITR 577
examined and upheld the constitutionality of the provision of section 80A(5).

A reference may also
be made to the Circular No. 37 of 2016 dated 2^nd November, 2016
clarifying that an increased claim for deduction would not be denied in cases
where such increase is on account of the additions or disallowances made in
assessment of the total income. In this context, a useful reference may be made
to the decision in the case of Oracle (OFSS) BPO Services Limited, 307
CTR (Delhi) 97, which, independent of circulars, supports such a claim.
[Also see Influence, 55 taxmann.com 192 (Delhi) and E-Funds
International India (P) Limited, 379 ITR 292 (Delhi).]

In a case where the
assessee cannot claim the deduction for want of positive profits, or where the
electronic return does not permit to record the eligibility to the claim for
deduction, or where a return carries a note, as was in the case of DIC
Fine Chemicals Limited, 202 TTJ (Mum.) 378, highlighting its inability
to claim deduction for want of profits, or the inability to disclose, the
deduction should not be denied; the deduction, in such cases, on assessment,
would be well within the provision of section 80A(5) and would in any case be
saved by the said circular and the said decisions. Such cases cannot be
attributed to the failure of the assessee to claim a deduction in the return of
income.

The issue of the failure to claim a deduction in the return of income has
in fact been examined by the Delhi and the Bombay High Courts in the cases of Nath
Brothers, 394 ITR 577 and EBR Enterprises, 107 taxmann.com 220,
respectively. The Courts, in these cases, have held that not only the provision
of section 80A(5) is constitutional, as it is based on a reasonable
classification, but it also denies the right to claim the specified deduction
in a case where an assessee fails to claim such deduction in the return of income.
The Bombay High Court in the EBR Enterprises case specifically
disapproved the decision of the Mumbai Bench of the Tribunal in the case of Madhav
Constructions (Supra) where the Tribunal had held that the deduction
was not limited by the provisions of section 80A(5). The High Court, however,
in the very same Madhav Constructions case had refused to admit
the appeal of the Revenue against the order of the Tribunal

The case of the
assessee for the claim of deduction is likely to be on a better footing where a
claim is staked before the AO, before completion of assessment, by filing a
return of income, revised or otherwise. Please see Chirakkal Service
Co-op. Bank Ltd., 384 ITR 490 and The Pazhavangadikara Service
Co-op. Bank (Cochin-unreported) ITA No. 200/Coch/2018 dated 9^th
July, 2018. In these cases, a claim made vide a belated return of
income, filed in response to notice u/s 148, was allowed as a deduction.

Outside of section
80A(5), it is a settled position in law that an AO is duty-bound to allow all
those deductions, reliefs and rebates otherwise allowable irrespective of the
claim by the assessee. This position of law articulated by the CBDT in Circular
No. 14(XL-35) of 1955 dated 11^thApril, 1955 has been approved by
several decisions of the courts rendered from time to time.

It is also a settled position in law that an assessee is entitled to
place a fresh claim for deduction or relief or rebate before the appellate
authorities, for the first time. Similarly, there is no bar on the AO to
entertain a claim made outside the return of income during the course of
assessment proceedings. Likewise, no special emphasis is required in stating
that a mere failure to stake a claim at a specific point of time or in a
specified format should not result in the frustration of a valid claim.

In view of the overwhelming position in law
in favour of allowance of a lawful claim, we are of the considered view that
the courts should favour an allowance of a lawful claim, even in the cases
where there is an express stipulation for denial of the benefits on the grounds
of non-compliance of a technical requirement, as long as the assessee has
finally corrected himself by compliance before the authorities. The court, in
such cases, should not only entertain the claim but is also obliged to allow
the reliefs to avoid unjust enrichment of the State.

shailesh.kwebmaker

DEPRECIATION ON GOODWILL ARISING DUE TO AMALGAMATION

ISSUE FOR CONSIDERATION
Depreciation is allowable u/s 32(1) on buildings, machinery, plant or furniture, being tangible assets, and also on knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets, acquired on or after 1st April, 1998. The Supreme Court in the case of CIT vs. Smifs Securities Ltd. 348 ITR 302 has held for assessment year 2003-04 that the goodwill acquired on amalgamation (being excess of consideration paid over the value of net assets acquired) by the amalgamated company would fall under the expression ‘any other business or commercial right of a similar nature’ and qualify to be treated as an intangible asset eligible for depreciation while computing business income. This was decided by the Supreme Court on the basis of the undisputed factual finding as recorded by the lower authorities that such a difference constituted goodwill and that the assessee in the process of amalgamation had acquired a capital right in the form of goodwill because of which the market worth of the assessee had increased.

The sixth proviso to section 32(1)(ii) provides that the aggregate depreciation allowable to the transferor and transferee, in any previous year, in the case of succession or amalgamation or demerger shall not exceed the deduction allowable at prescribed rates, as if such succession or amalgamation or demerger has not taken place and the deduction on account of depreciation shall be apportioned between the transferor and the transferee in the ratio of number of days for which the assets were used by them.

While the Supreme Court has held that the goodwill arising on account of amalgamation falls within the scope of the ‘intangible assets’ and it is entitled for depreciation u/s 32(1), an issue has arisen subsequently as to whether the depreciation on such goodwill can be denied to the amalgamated company by applying the sixth proviso to section 32(1)(ii) on the ground that no such goodwill was held by the amalgamating company. While the Bangalore bench of the Tribunal has held that the amalgamated company was not eligible for depreciation on goodwill due to the restriction placed in the said sixth proviso, the Hyderabad bench of the Tribunal has taken a contrary view, holding that the depreciation was available on such goodwill to an amalgamated company in spite of the restriction of the sixth proviso.

THE UNITED BREWERIES LTD. CASE
The issue first came up for consideration before the Bangalore bench of the Tribunal in the case of United Breweries Ltd. vs. Addl. CIT, TS-553-ITAT-2016 (Bang.). In this case, during the previous year relevant to A.Y. 2007-08, the assessee’s wholly-owned subsidiary, Karnataka Breweries & Distillery Ltd. (KBDL), got amalgamated with the assessee as per the order of the High Court. The shares of the said company were acquired by the assessee in the preceding year for a consideration of Rs. 180.52 crores. The goodwill amounting to Rs. 62.30 crores was shown as arising on account of the amalgamation, being the excess of purchase consideration over fair value of tangible assets and other net current assets received from the amalgamating company. Accordingly, depreciation of Rs. 15.57 crores was claimed by the assessee.

The AO, in the first place, disputed the method of valuing the assets and disallowed the depreciation on the goodwill on the ground that there was no goodwill if proper valuation was assigned to the tangible asset and land. Apart from that, the AO relied upon the sixth proviso (then fifth proviso) to section 32(1) (ii). He noted that the goodwill on which depreciation was being claimed by the assessee arose only on amalgamation and the amalgamating company had no goodwill on which depreciation was allowed to it. Under such circumstances, there would not be any deduction of depreciation on goodwill in the hands of the amalgamated company. Prior to the amalgamation, KBDL could not have claimed any depreciation on such goodwill that came into existence only on amalgamation as it did not own any such goodwill nor was it eligible for depreciation on such goodwill.

The CIT(A), while concurring with the decision of the AO, observed that the value of the goodwill recorded in the books of KBDL was only Rs. 7.45 crores while it had been shown by the assessee at Rs. 62.30 crores. The CIT(A) also questioned the valuation of goodwill in view of the fact that KBDL had not earned sufficient profits in the past to justify the goodwill on the basis of average of profits. The CIT(A) also concurred with the view of the AO that the assessee was not entitled to depreciation in view of the sixth (then fifth) proviso to section 32(1)(ii).

Before the Tribunal, the assessee submitted that the issue of depreciation on goodwill was covered by the judgment of the Supreme Court in the case of Smifs Securities Ltd. (Supra). Insofar as the valuation was concerned, it was contended that when the assessee had produced the valuation report valuing the tangible asset, then without giving the correct value by the AO, the rejection of the valuation report was not justified. Without giving any counter valuation, the claim of depreciation could not have been rejected only by doubting the valuation of the assessee. Insofar as the sixth proviso to section 32(1)(ii) was concerned, it was submitted that it did not apply when the assets were introduced in the books of the assessee at the balancing figure, being the excess consideration over the value of the tangible assets. It was further contended that in none of the cases decided by the Supreme Court as well as the High Courts the Revenue had ever raised the objection of rejecting the claim of depreciation by applying the fifth (now sixth) proviso to section 32(1) of the Act. Therefore, the Revenue could not have raised the objection in the assessee’s case only when it was not raised in the other cases before the courts in the past.

The Revenue, apart from resting its case on the valuation as well as the said proviso to section 32(1)(ii), also relied upon Explanation 3 to section 43(1) and submitted that the AO had the power to examine the valuation of the assets acquired by the assessee if these assets were already in use for business purpose. If the AO was satisfied that the main purpose of transfer of such assets was the reduction of the liability to income tax, then the actual cost of the asset to the assessee was to be such an amount as the AO determined. Therefore, it was claimed that the AO had rightly determined the valuation of the goodwill at NIL. The Tribunal rejected the contention of the assessee that the AO could not have disturbed the valuation of the goodwill in cases where it represented a differential amount between the consideration paid for acquisition of shares and the FMV of the tangible assets. It held that if such claim of goodwill and depreciation was allowed, then it would render the provisions of Explanation 3 to section 43(1) redundant; in every case of transfer, succession or amalgamation, the party would claim excessive depreciation by assigning arbitrary value to the goodwill. However, the Tribunal held that the AO was at fault in choosing to examine the valuation of goodwill alone; the AO ought to have examined the valuation of all the assets taken over by the assessee under the amalgamation and thereby should have determined the actual cost of all the assets to the assessee for the purpose of claim of depreciation.

The Tribunal further held that by virtue of the said proviso to section 32(1)(ii), the depreciation in the hands of the assessee was allowable only to the extent that was otherwise allowable if such succession or amalgamation had not taken place. Therefore, the assessee, being amalgamated company, could not claim or be allowed depreciation on the assets acquired in the scheme of amalgamation of an amount more than the depreciation which was allowable to the amalgamating company. Insofar as the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) was concerned, the Tribunal observed that the said ruling of the Supreme Court was only on the point whether the goodwill fell in the category of intangible assets and the said judgment would not override the provisions of the said proviso to section 32(1)(ii), which restricted the claim of depreciation in the cases specified thereunder. Accordingly, the issue of allowability of depreciation on goodwill was decided against the assessee.

THE MYLAN LABORATORIES LTD. CASE
The issue again arose recently, in the case of Mylan Laboratories Ltd. vs. DCIT TS-691-ITAT-2019 (Hyd.). In this case, during the previous year relevant to A.Y. 2014-15, the assessee had acquired Agila Specialities Ltd. (ASPL) along with its wholly-owned subsidiary, Onco Therapies Ltd. (OTL), vide a share purchase agreement on 5th December, 2013 immediately followed by the merger of both the companies with the assessee under the scheme effective from 6th December, 2013. The assessee, by applying the principles of ‘purchase method of accounting’, considered the difference between the amount of investment (Rs. 4,386 crores) and the fair value / tax WDV value of net assets which was negative (being Rs. -106 crores) as goodwill arising on amalgamation. This goodwill of Rs. 4,492 crores was grouped under the Intangible Assets block as goodwill, and depreciation at half of the eligible rate of 25% was claimed by the assessee, since the assets were put to use for less than 180 days.

The AO disallowed the depreciation on goodwill by relying upon the decision of the Bangalore bench of the Tribunal in the case of United Breweries Ltd. (Supra). The CIT(A) confirmed the order of the AO.

Before the Tribunal, apart from relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) and several other decisions of the High Court holding the goodwill as eligible for depreciation, the assessee also submitted that the sixth proviso to section 32(1)(ii) was only a mechanism of allocation of depreciation otherwise allowable on the WDV of assets owned by the amalgamating company, whereby such depreciation got allocated between the amalgamating and the amalgamated company in the year of amalgamation, and had no applicability for any new asset arising on account of the amalgamation in the hands of the amalgamated company. It was contended on behalf of the assessee that the sixth proviso was introduced to curb the practice of claiming depreciation on the same assets by both the predecessor company and the successor company in the case of a merger or succession, as was evident from the Memorandum explaining the provisions of the Finance Bill, 1996. Therefore, the said proviso should not be made applicable to the goodwill arising by virtue of the amalgamation.

The assessee also submitted that a similar issue was raised before the Hon’ble Kolkata High Court in the appeal by the Revenue in the case of Smifs Securities Ltd. ITA No. 116 of 2010 for the year, i.e., A.Y. 2001-02, and the said question was not pressed by the Department, by conceding that it was covered by the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra). It was submitted that the Revenue had not filed any appeal before the Supreme Court against the decision in the said case and once the Revenue had chosen not to challenge a particular decision, it was bound by the said decision. In this regard, reliance was placed on the decision of the Supreme Court in the case of Narendra Doshi, 254 ITR 606 [SC].

The Revenue, on the other hand, supported the orders of the lower authorities and submitted that the net assets acquired were valued at Rs. -106.8 crores after reducing the liabilities. Thus, when the net asset value was negative, there could not have been any goodwill. It was also pleaded that the amalgamation of whollyowned subsidiary would not lead to transfer of assets u/s 2(47) and therefore, claiming of goodwill as arising out of a transaction not regarded as transfer would be a case of making profit out of oneself. Additionally, it was also claimed that the valuation of the enterprise for purchase of shares could not be equated to the valuation for amalgamation.

On the basis of the arguments raised by both the sides, the Hyderabad bench of the Tribunal ruled in favour of the assessee, holding that the deduction of depreciation on goodwill could not be denied. The reliance placed by the Revenue on the sixth proviso to section 32(1)(ii) did not find favour with the Tribunal. The Tribunal referred to the accounting principles as laid down in AS-14 and observed that, in case of amalgamation in the nature of purchase, the consideration paid in excess of the net value of assets and liabilities of the amalgamating company was to be treated as goodwill. Such goodwill was held to be eligible for depreciation u/s 32(1) by relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra).

OBSERVATIONS

The issue under consideration moves in a narrow compass. Depreciation is allowable in computing the total income by virtue of section 32 on compliance with the conditions of the said provision. One of the conditions is that the asset in question should be acquired and owned by the assessee claiming the depreciation. On satisfaction of the conditions prescribed, the depreciation can be denied only with an express provision for denial of the claim. The provisos to section 32 have the effect of restricting the amount of depreciation, or of sharing it, or denying it in the stated circumstances. We do not find that any of the provisos, including the sixth proviso, denies the claim of depreciation in cases of an amalgamation. In the circumstances for a valid claim of depreciation, the amalgamated company should satisfy the compliance of the main conditions, namely, acquisition and ownership, besides use. Once they are satisfied, the claim could be denied only by an express provision and not by a roundabout or convoluted reading of the sixth proviso that has been inserted much later in the day to ensure that in the year of transfer both the transferor and the transferee do not claim the ‘full’ depreciation; it is introduced to ensure the sharing of the amount of depreciation in the year of transfer, nothing less, nothing more.

In the absence of the sixth proviso, it was not possible to deny the claim of depreciation in full by both the transferor and the transferee, a position that had been confirmed by the courts. Reference can be made to CIT vs. Fluid Controls Mfg. Co. 286 ITR 86 (Guj.), Sita Ram Saluja vs. ITO 1 ITD 754 (Chd.).

The sixth proviso does not deal with the case of an asset that comes into existence and / or is acquired for the first time in the course of amalgamation. It also does not deal with an asset on which one of the parties could not have claimed the deduction for depreciation. Goodwill of the kind being discussed here is one such asset on which it was never possible for the amalgamating company to have claimed depreciation, and therefore it is fruitless to apply the sixth proviso to such a situation or claim.

The enabling provision therefore is the main provision of section 32(1), and once the terms therein stand satisfied, the claim cannot be denied or even be reduced without an express provision to do so. In our considered opinion, there is nothing in the sixth proviso to facilitate the denial of the claim altogether. In the absence of the disabling provision, it is not fair on the part of the Revenue to frustrate the claim otherwise held to be lawful by the Apex Court.

The sixth proviso can have an application, in cases of amalgamation, only where some asset which was owned by the amalgamating company is acquired by the amalgamated company in the course of the amalgamation and the acquiring company is seeking to claim depreciation thereon.

There is no dispute as to whether the goodwill arising on the amalgamation falls within the ambit of business or commercial rights, being intangible assets eligible for depreciation. The only dispute is about the applicability of the sixth proviso to section 32(1)(iia) and invocation thereof by the Revenue so as to deny the benefit of depreciation on such goodwill to the amalgamated company. The sixth proviso to section 32(1)(ii) reads as under:

‘Provided also that the aggregate deduction, in respect of depreciation of buildings, machinery, plant or furniture, being tangible assets or knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets allowable to the predecessor and the successor in the case of succession referred to in clause (xiii), clause (xiiib) and clause (xiv) of section 47 or section 170, or to the amalgamating company and the amalgamated company in the case of amalgamation, or to the demerged company and the resulting company in the case of demerger, as the case may be, shall not exceed in any previous year the deduction calculated at the prescribed rates as if the succession or the amalgamation or the demerger, as the case may be, had not taken place and such deduction shall be apportioned between the predecessor and the successor, or the amalgamating company and the amalgamated company, or the demerged company and the resulting company, as the case may be, in the ratio of the number of days for which the assets were used by them.’

The aforesaid proviso was originally inserted as the fourth proviso by the Finance (No. 2) Act, 1996. The rationale behind insertion of this proviso can be gathered from the Circular No. 762 dated 18th February, 1998, the relevant extract from which is reproduced below:

‘The third proviso to sub-section (1) of section 32 provides that the depreciation allowance will be restricted to fifty per cent of the amount calculated at the prescribed rates in cases where assets acquired by an assessee during the previous year are put to use for the purpose of business or profession for a period of less than one hundred and eighty days in that previous year. Thus, in cases of succession in business and amalgamation of companies, the predecessor in business and the successor or amalgamating company and amalgamated company, as the case may be, are entitled to depreciation allowance on the same assets, which in the aggregate may exceed the depreciation allowance admissible for a previous year at the rates prescribed in Appendix-I of the Income-tax Rules, 1962. An amendment has, therefore, been made to restrict the aggregate deduction for this allowance in a year in such cases to the amount computed at the prescribed rates. It has also been provided that the allowance shall be apportioned in the ratio of the number of days for which the asset is put to use in such cases.’

From the Circular as well as the language of the proviso it becomes clear that the restriction placed is applicable only when it is otherwise possible to claim depreciation on the same asset by both the companies, i.e., the amalgamating company as well as the amalgamated company. In order to trigger the sixth proviso, there has to be an asset, tangible or intangible, on which both the companies could have claimed the depreciation u/s 32(1) in the year of amalgamation. This proviso should not be made applicable to any such asset on which only one of the two companies could have claimed the depreciation otherwise. The goodwill being an offshoot of the amalgamation, the question of claiming depreciation thereon by the amalgamating company does not arise at all.

There can be a case where the amalgamated company is disentitled to claim depreciation on the assets acquired through the amalgamation, even without applying the sixth proviso to section 32(1)(ii). For instance, where the assets acquired through the amalgamation are recognised as inventories of the amalgamated company, though they were depreciable assets of the amalgamating company or where the corresponding income generated from such assets falls outside the scope of business income of the amalgamated company and, therefore, depreciation on such assets cannot be allowed to it on such assets u/s 32(1). In such cases, the question is whether the aggregate depreciation can be determined ignoring the amalgamation and the portion of it can be claimed in the hands of the amalgamated company on the basis of number of days for which the assets were used by it merely by relying upon the sixth proviso to section 32(1)(ii)? The answer obviously is no. This leads us to the conclusion that the sixth proviso to section 32(1)(ii) applies only in a situation where both the companies are eligible to claim the depreciation on the same assets for the year of amalgamation and not otherwise.

Further, this proviso has a limited applicability only to the year in which the succession or amalgamation takes place and it does not apply to the subsequent years. There is no probability of claiming depreciation by two entities in the subsequent years on the same assets exceeding the depreciation otherwise allowable, for the obvious reason that the predecessor or the amalgamating company will cease to own the asset or exist by virtue of the succession or the amalgamation as the case may be. Therefore, if a view is taken that the depreciation on goodwill arising on account of the amalgamation cannot be allowed only because of the sixth proviso to section 32(1)(ii), then it will result into denial of depreciation only for the year of amalgamation and not for subsequent years. It would be quite illogical to consider the amalgamated company as ineligible for depreciation on such goodwill only for the first year and, then, allow it to claim the depreciation from the second year onward.

The better view therefore is the one propounded by the Hyderabad bench of the Tribunal in the case of Mylan Laboratories Ltd. (Supra) that the depreciation should be granted to the amalgamated company on the goodwill recognised by it, being the excess of consideration over the appropriate values of net assets acquired, starting from the year of amalgamation itself.

shailesh.kwebmaker

DOUBLE DEDUCTION FOR INTEREST UNDER SECTIONS 24 AND 48

ISSUE FOR CONSIDERATION

Section 24
of the Income-tax Act grants a deduction for interest payable on the borrowed capital
for acquisition, etc. of a house property in computing the income under the
head ‘Income from House Property’. This
deduction is allowed for interest for the pre-acquisition period in five equal
annual instalments from the year of acquisition, and for the period
post-acquisition, annually in full, subject, however, to the limits specified
in section 24.

Section 48
of the Act grants a deduction for the cost of acquisition and improvement of a
capital asset in computing the income under the head ‘Capital Gains’. That for
the purposes of section 48 interest paid or payable on borrowings made for the
acquisition of a capital asset is includible in such a cost and is allowable as
a deduction in computing the capital gains, is a settled position in law.

The above
understandings, otherwise settled, encounter difficulty in cases where an
assessee, after having claimed a deduction over a period of years, for the same
interest u/s 24 in computing the income from house property, claims a deduction
for such interest, in aggregate, paid or payable over a period of the
borrowings again u/s 48, in computing the capital gains. It is here that the
Revenue authorities reject the claim for deduction u/s 48 on the ground that
such an interest has already been allowed u/s 24 and interest once allowed
cannot be allowed again in computing the total income.

The issue of
double deduction for interest, discussed above, has been the subject matter
of conflicting decisions of different benches of the Income Tax Appellate
Tribunal some of which are examined here and their implications analysed for a
better understanding of the subject.

THE C. RAMABRAHMAM CASE

The issue was first examined by the Chennai Bench of the Appellate
Tribunal in the case of ACIT vs. C. Ramabrahmam, 57 SOT 130 (Mds).
In that case the assessee, an individual, had purchased a house property with
interest-bearing borrowed funds at T. Nagar, Chennai on 20^th
January, 2003 for an aggregate cost of Rs. 37,03,926. An amount of Rs. 4,82,042
in aggregate was paid as interest on the housing loan taken in 2003 for
purchasing the property which was claimed as deduction u/s 24(b) in the A.Ys.
2004-05 to 2006-07. He sold the property on 20^th April, 2006 for Rs.
26.00 lakhs and in computing the capital gains, he claimed the deduction for
the said interest u/s 48 of the Act. The A.O. disallowed the claim for
deduction of interest u/s 48 since interest in question on the housing loan had
already been claimed as deduction u/s 24(b) in the A.Ys. 2004-05 to 2006-07,
and the same could not be taken into consideration for computation u/s 48
inasmuch as the legislative provision of section 48 did not permit inclusion of
the amount of deduction allowed u/s 24(b) of the Act. The A.O. added back the
interest amount to the income of the assessee from short-term capital gains vide
the assessment order dated 24^th November, 2009.

The assessee
preferred an appeal against the assessment order, wherein the addition made by
the A.O. was deleted by the CIT(A) on the ground that the assessee was entitled
to include the interest amount for computation u/s 48, despite the fact that
the same had been claimed u/s 24(b) while computing income from house property.
The Revenue challenged the CIT(A)’s order in an appeal before the Tribunal.

Before the
Tribunal, the Revenue prayed for restoring the additions made by the A.O. on
the ground that once the assessee had availed deduction u/s 24(b), he could not
include the very same amount for the purpose of computing capital gains u/s 48.
On the other hand, the assessee sought to place reliance on the CIT(A)’s order
as well as the findings contained therein, and in the light thereof, prayed for
upholding his order and sought dismissal of the Revenue’s appeal.

On due
consideration of the rival submissions of both the parties at length and the
orders of the authorities on the issue of capital gains, the Tribunal noted
that there was hardly any dispute that the assessee had availed the loan for
purchasing the property in question and had declared the income under the head
‘house property’ after claiming deduction u/s 24(b) and that there was no
quarrel that the assessee’s claim of deduction was under the statutory
provisions of the Act and, therefore, he succeeded in getting the deduction.
The Tribunal also noted that after the property was sold, the assessee also
chose to include the said interest amount in the cost while computing capital
gains u/s 48.

The Tribunal
observed that deductions u/s 24(b) and u/s 48 were covered by different heads
of income, i.e., ‘income from house property’ and ‘capital gains’, respectively; that a perusal
of both the provisions made it unambiguous that none of them excluded the
operation of the other; in other words, a deduction u/s 24(b) was claimed when
the assessee concerned declared income from house property, whereas the cost of
the same asset was taken into consideration when it was sold and capital gains
was computed u/s 48; that there was not even the slightest doubt that the
interest in question was indeed an expenditure in acquiring the asset.

The Tribunal
proceeded to hold that since both provisions were altogether different, the
assessee in the instant case was certainly entitled to include the interest
amount at the time of computing capital gains u/s 48 and, therefore, the CIT(A)
had rightly accepted the assessee’s contention and deleted the addition made by
the A.O. The Tribunal, qua the ground, upheld the order of the CIT(A).

The decision
of the Chennai Bench has since been referred to with approval in the following
decisions to either allow the double deduction of interest on the borrowed
capital, and in some cases to allow the deduction u/s 48 where no deduction was
claimed u/s 24: Ashok Kumar Shahi, ITA No. 5155/Del/2018 (SMC)(Delhi);
Gayatri Maheshwari, 187 TTJ 33 (UO)(Jodhpur); Subhash Bana, ITA 147/Del/2015
(Delhi); and R. Aishwarya, ITA 1120/Mds/2016 (Chennai).

CAPT. B.L. LINGARAJU’S CASE

The issue
came up for consideration before the Bangalore Bench of the Tribunal in the
case of Capt. B.L. Lingaraju vs. ACIT, ITA No. 906/Bang/2014. The
facts as gathered from the notings of the Tribunal are that in this case the
total income computed by the assessee, an individual, included income from
house property of Rs. 1,09,924, which meant that the interest expenditure on
the housing loan was already allowed. A revised computation submitted during
the assessment by the assessee before the A.O. along with the return of income,
recomputed the income at Rs. 2,59,924. The assessee had claimed deduction for
housing loan interest restricted to Rs. 1.50 lakhs because the house property
in question was self-occupied and the deduction on account of interest was
restricted to Rs. 1.50 lakhs as per the provisions of section 24(b) of the I.T.
Act. The assessee appears to have sold the house property during the year and
the capital gains thereon, computed after claiming the aggregate interest of
Rs. 13,24,841 u/s 48, was included in the total income returned for the A.Y.
2009-10. The A.O. seems to have disallowed the claim of interest in assessing
the capital gains u/s 48 of the Act and the CIT(Appeals), vide his order
dated 1^st April, 2014
confirmed the action of the A.O.

The
assessee, aggrieved by the orders, had filed an appeal before the Tribunal
raising the following grounds:

‘1. The order of the Learned Assessing Officer is
not justified in disallowing capitalisation of interest for computing short
term capital gains.

2. The Learned CIT(A) II has wrongly interpreted
the term cost of acquisition under sections 48, 49 and section 55(2). The
Learned CIT(A) II is of the opinion that the cost of acquisition cannot be
fluctuating, but it should be fixed, except in circumstances when the law permits
substitution. Learned CIT(A) II has disallowed the interest paid on loan
amounting to Rs. l3,24,841 in his order without considering the facts of the
case and the CIT and ITO has ignored the decision in the case of CIT
vs. Hariram Hotels (P) Ltd. (2010) 229 CTR 455 (Kar) which
is in favour of appellant.

3.
……………………………………….

On the basis
of above grounds and other grounds which may be urged at the time of hearing,
it is prayed that relief sought be granted.’

The Tribunal
has noted that the appeal was earlier fixed for hearing on 14^th
January, 2016 and on that date the hearing was adjourned at the request of the
AR of the assessee and the next date of hearing was fixed on 21^stApril,
2016; the new date of hearing was intimated to the AR of the assessee at the
time of hearing on 14^th January, 2016. None appeared on behalf of
the assessee on 21^st April, 2016 and there was no request for
adjournment. Under the facts, the Tribunal proceeded to decide the appeal of
the assessee ex parte qua the assessee after considering the written
submissions of the AR of the assessee which were available on pages 1 to 8 of
the Paper Book. The Revenue supported the orders of the authorities below.

The
Tribunal, on due consideration of the written submissions filed by the AR of
the assessee and the submissions of the Revenue and the orders of the
authorities below, found that the
assessee had placed reliance on the judgments of the jurisdictional High Court
rendered in the case of CIT & Anr. vs. Sri Hariram Hotels (P) Ltd.,
229 ITR 455 (Kar) and CIT vs. Maithreyi Pai, 152 ITR 247 (Kar). It
noted the fact that the judgment rendered in the case of Sri Hariram
Hotels (P) Ltd. (Supra) had followed the earlier judgment of the
jurisdictional High Court rendered in the case of Maithreyi Pai (Supra).
The assessee had also placed reliance on the judgments of the Delhi High Court
and the Madras High Court and several Tribunal orders which were not found to
be relevant as the Tribunal had decided to follow the orders of the
jurisdictional High Court.

While examining the applicability of the judgments of the jurisdictional
High Court, it was found that the Court in the case of Maithreyi Pai
(Supra), had held that the interest paid on borrowing for the
acquisition of capital asset must fall for deduction u/s 48, but if the same
was already the subject matter of deduction under other heads like those u/s
57, it was not understandable as to how it could find a place again for the
purpose of computation u/s 48 because no assessee under the scheme of the Act
could be allowed a deduction of the same amount twice over; in the present
case, as per the facts noted by the A.O. on page 2 of the assessment order,
interest in question was paid on home loan and it was not in dispute that
deduction on account of interest on housing loan / home loan was allowable
while computing income under the head ?income from house property’; as per the
judgment of the jurisdictional High Court, if interest expenditure was
allowable under different sections including section 57, then the same could
not be again considered for cost of acquisition u/s 48.

In the
Tribunal’s considered opinion, in the present case interest on housing loan was
definitely allowable while computing income under the head ?house property’
and, therefore, even if the same was not actually claimed or allowed, it could
not result into allowing addition in the cost of acquisition.

The Tribunal
further noted that it was not the case of the assessee that the housing loan
interest in dispute was for any property used for letting out or used for
business purposes, and even if that be a claim, the interest could be claimed
u/s 24 or 36(1)(iii) but not as cost of acquisition u/s 48; it was seen that
interest expenditure was allowed as deduction u/s 24 to the extent claimed and,
therefore, interest on housing loan could not be considered again for the
purpose of addition in the cost of acquisition as per the judgment of the High
Court of Karnataka cited by the assessee in the grounds of appeal and by the AR
of the assessee in his written submissions. The Tribunal, in the facts of the
case, respectfully following the judgment of the High Court of Karnataka, held
that the claim of the assessee for deduction of interest u/s 48 in computing
the capital gains was not allowable.

OBSERVATIONS

The relevant
part of section 24 which grants deduction for interest payable on the borrowed
capital reads as: ‘(b) where the property has been acquired, constructed,
repaired, renewed or reconstructed with borrowed capital, the amount of any
interest payable on such capital…’

Likewise,
the part relevant for deduction of cost u/s 48 reads as: ‘the income
chargeable under the head “capital gains” shall be computed, by
deducting from the full value of the consideration received or accruing as a
result of the transfer of the capital asset the following amounts, namely: (i)
expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement
thereto:’

Apparently,
section 24 grants a specific deduction for interest in express terms subject to
certain conditions and ceilings. While section 48 does not explicitly grant a
deduction for interest, the position that such interest is a part of the cost
for section 48 and is deductible is settled by the decisions of various Courts
in favour of the allowance of the claim for deduction. There is nothing
explicit or implicit in the respective provisions of sections 24 and 48 that
prohibits the deduction under one of the two where a deduction is allowable or
allowed under the other. One routinely comes across situations where it is
possible to claim a deduction under more than one provision but dual claims are
not attempted or entertained due to the express pre-emption by the several
statutory provisions which provide for denial of double deductions. These
provisions in express terms lay down that no deduction under the provision
concerned would be allowable where a deduction is already claimed under any
other provisions of the Act. The Act is full of such provisions, for example,
in section 35 in its various alphabets and chapter VIA.

In the
circumstances, it is tempting to conclude that in the absence of an express
prohibition, the deductions allowable under different provisions of the statute
should be given full effect to, more so in computing the income under different
heads of income. It is this logic and understanding of the law that has
persuaded the different benches of the Tribunal to permit the double deduction
in respect of the same expenditure, first u/s 24 and later u/s 48. For the
record it may be noted that most of the decisions have followed the decision in
the case of C. Ramabhramam (Supra). In fact, some of them have
followed this decision to support the claim of deduction u/s 48 even in cases
where they were not asked to deal with the issue of double deduction.

Having noted
this wisdom behind the allowance for double deduction, it is perhaps
appropriate to examine whether such deduction, under the overall scheme of the
Act, is ever permissible. One view of the matter is that under the scheme of
taxation of income, net of the expenditure, there cannot be any license to
claim a double deduction of the same expenditure unless such a dual deduction
is permissible by express language of the provisions. Under this view, a double
deduction is not a rule of law but can be an exception in exceptional
circumstances. A prohibition in the rule underlying the overall scheme of the
taxation of income and all the provisions of the Act is not required to
expressly contain a provision that prohibits a double deduction.

This view
finds direct favour from the ruling of the Supreme Court in the case of Escorts
Ltd. 199 ITR 43. The relevant parts in paragraphs 18 and 19 read as
follows: ‘In our view, it is impossible to conceive of the Legislature
having envisaged a double deduction in respect of the same expenditure, even
though it is true that the two heads of deduction do not completely overlap and
there is some difference in the rationale of the two deductions under
consideration. On behalf of the assessees, reliance is placed on the following
circumstances to support the contention that the statute did not intend one
deduction to preclude the other: …We think that all misconceptions will vanish
and all the provisions will fall into place if we bear in mind a fundamental,
though unwritten, axiom that no Legislature could have at all intended a double
deduction in regard to the same business outgoing; and, if it is intended, it
will be clearly expressed. In other words, in the absence of clear statutory
indication to the contrary, the statute should not be read so as to permit an
assessee two deductions, both under section 10(2)(vi) and section 10(2)(xiv) of
the 1922 Act, or under section 32(1)(ii) and section 35(2)(iv) of the 1961 Act qua
the same expenditure. Is then the use of the words “in respect of the same
previous year” in cl. (d) of the proviso to section 10(2)(xiv) of
the 1922 Act and section 35(2)(iv) of the 1961 Act a contra-indication which
permits a disallowance of depreciation only in the previous years in which the
other allowance is actually allowed? We think the answer is an emphatic
“no” and that the purpose of the words above referred to is totally
different.’

The position
laid down by the Apex Court continues with force till date. It is also
important to take note of the fact that none of the decisions of the Tribunal
have examined the ratio and the implication of this decision and,
therefore, in our respectful opinion, cannot be said to be laying down the
final law on the subject and have to be read with caution.

It is most
appropriate to support a claim for deduction u/s 48 for treating the interest
as a part of the cost with the two famous decisions of the Karnataka High Court
in the cases of Maithreyi Pai and Sri Hariram Hotels
(Supra). At the same time it is important to note that the same
Karnataka High Court in the very decisions has observed that the double
deduction was not permissible in law and in cases where deduction was already
allowed under one provision of the Act, no deduction again of the same
expenditure under another provision of the Act was possible, even where there
was no provision to prohibit such a deduction. The relevant part of the
decision of the High Court in the Maithreyi Pai case reads as
under:

‘8.
Mr. Bhat, however, submitted that section 48 should be examined independently
without reference to section 57. Section 48 provides for deducting from the
full value of consideration received, the cost of acquisition of the capital
asset and the cost of improvement, if any. The interest paid on the borrowings
for the acquisition of capital asset must fall for deduction under section 48.
But, if the same sum is already the subject-matter of deduction under other
heads like under section 57, we cannot understand how it could find a place
again for the purpose of computation under section 48. No assessee under the
scheme of Income-tax Act could be allowed deduction of the same amount twice
over. We are firmly of the opinion that if an amount is already allowed under
section 57, while computing the income of the assessee, the same cannot be
allowed as deduction for the purpose of computing the “capital gains” under
section 48.

9.
The statement of law thus being made clear, it is not possible to answer the
question one way or the other, since there is no finding recorded by the
Tribunal in regard to the contention raised by the Department that it would
amount to double deduction. We, therefore, decline to answer the question for
want of a required finding and remit the matter to the Tribunal for fresh
disposal in the light of observations made.’

This being
the decision of the High Court directly on the subject of double deduction, judicial
discipline demands that due respect is given to the findings therein in
deciding any claim for double deduction. In that case, the Karnataka High Court
was pleased to allow the deduction u/s 48 of the interest on capital borrowed
for acquisition of the capital asset being shares of a company, that was
transferred and the gain thereon was being brought to tax under the head
capital gains. The Court, however, pointed out, as highlighted here before,
that such a deduction would not have been possible if such an interest was
allowed as a deduction u/s 57 in computing the dividend income.

The view
that the deduction u/s 48 is not possible at all once a deduction was allowable
under any other provision of law, for example, u/s 24, even where no such deduction
was claimed thereunder, is incorrect and requires to be avoided. We do not
concur with such an extreme view and do not find any support from any of the
Court decisions to confirm such a view.

A note is
required to be taken of the decision of the Ahmedabad bench in the case of Pushpaben
Wadhwani, 16 ITD 704, wherein the Tribunal held that it
was not possible to allow a deduction u/s 48 for interest in cases where a
deduction u/s 24 for such an interest was allowed. The Tribunal, in the final
analysis, allowed the deduction u/s 48 after confirming that the assessee was
not allowed any deduction in the past of the same interest. In that case the
Tribunal in paragraph 6 while allowing the claim u/s 48, in principle, held:

‘In the case of Maithreyi
Pai (Supra), the Hon’ble High Court has held that the interest paid on
the borrowed capital for the purposes of purchase of shares should form part of
“the cost of acquisition” provided the assessee has not got deduction in
respect of such interest payment in earlier years. In the instant case, from
the order of the ITO it is not clear as to when the assessee acquired the flat
in question and whether she was allowed deduction of interest payments in
computing the income from the said flat under the head “Income from house
property” in earlier years. If that be so, then the interest paid on the loan
cannot be treated as part of “the cost of acquisition”. However, if the
assessee has not been allowed such deduction in earlier years, then in view of
the decision in the case of Maithreyi Pai (Supra), the interest
should form part of “the cost of acquisition” of the asset sold by her. Since
this aspect of the matter requires investigation, I set aside the orders of the
income-tax authorities on this point and restore the case once more to the file
of the ITO with a direction to give his decision afresh keeping in mind the
observations made in this order and after giving an opportunity of being heard
to the assessee in this regard.’

However, two views on the subject
are not ruled out as is made apparently clear by the conflicting decisions of
the different benches of the Tribunal; it is possible to contend that a view
favourable to the taxpayer be adopted till the time the issue is settled. The
case for double deduction is surely on better footing in a case where the
deduction is being claimed in computing the income under different heads of
income and in different assessment years

shailesh.kwebmaker

INTEREST U/S 201(1A) WHERE PAYEE IS INCURRING LOSSES

ISSUE FOR CONSIDERATION

Section 201(1) of the Income-tax Act, 1961
provides that where any person, who is required to deduct any sum in accordance
with the provisions of the Act, does not deduct, or does not pay, or after so
deducting fails to pay the whole or any part of the tax as required under the
Act, then he is deemed to be an assessee in default in respect of such tax. The
proviso to this section, inserted with effect from 1^st July, 2012,
provides that such a person shall not be regarded as an assessee in default if
the payee has furnished his return of income u/s 139, has taken into account
the relevant sum (on which tax was deductible or was deducted) for computing
his income in such return of income, and has paid the tax due on the income
declared by him in such return of income and has furnished a certificate to
this effect from an accountant in form 26A prescribed under rule 31ACB. An
amendment by the Finance Act (No. 2) 2019, not relevant for our discussion, has
been made to apply the proviso to the case of a payee, irrespective of his
residential status.

Sub-section (1A) of section 201, without
prejudice to section 201(1), provides for payment of interest at the prescribed
rate for the prescribed period by the person who has been deemed to be in
default; however, in case of a person who has been saved under the proviso as
aforesaid with effect from 1^st July, 2012 such interest shall be
paid from the date on which such tax was deductible by him to the date of
furnishing of the return of income by the payee.

A question has arisen before the High Courts
as to whether any interest u/s 201(1A) is payable by the payer on failure to
deduct tax at source, in a case where the payee has filed a return of income
declaring a loss. While the Madras, Gujarat and Punjab and Haryana High Courts
have taken the view that interest is payable even in such cases, the Allahabad
High Court has taken a contrary view, that no interest is payable in such a
case.

DECISION IN SAHARA INDIA COMMERCIAL CORPN.
LTD. CASE

The issue came up before the Allahabad High
Court in the cases of CIT (TDS) vs. Sahara India Commercial Corporation
Ltd. (ITA Nos. 58, 60, 63, 68 and 69 of 2015 dated 18^th January,
2017).

In those cases pertaining to the period
prior to the amendment of 2012, the assessee had made payments to a sister
concern, Sahara Airlines Ltd., without deducting the tax at source, which had
suffered loss in all the relevant years. While interest u/s 201(1A) had been
levied by the AO, the Tribunal had held that if the recipient payee had filed
all its returns for those years declaring loss in all the relevant assessment
years, interest u/s 201(1A) could not be charged on the payer assessee.
According to the Tribunal, the fact that the loss declared by the recipient in
its return on assessment turned into a positive income, would not make a
difference inasmuch as the tax demand was on account of difference between the
returned income and assessed income and not because of non-deduction of tax by
the assessee payer, and hence it would not alter the situation and no interest
was payable by the payer.

Since no evidence was placed before the
Tribunal regarding the claim of incurring of losses by the recipient, it
restored the matter to the AO for verification that the recipient had filed all
its returns for those years declaring loss in all the relevant assessment years
and there was no tax liability on the receipts at any point of time. The
Tribunal had held that if it was established that the recipient had filed all
its returns for those years declaring loss in all the relevant assessment
years, interest u/s 201(1A) could not be charged on the assessee payer.

On an appeal by the Revenue, the Allahabad
High Court noted that the question about liability of interest u/s 201(1A) had
also been considered by the same court in Writ Tax No. 870 of 2006 in
Ghaziabad Development Authority vs. Union of India and others, wherein
it had been held that the nature of interest charged u/s 201(1) was
compensatory and if the recipient had already paid tax or was not liable to pay
any tax whatsoever, no interest u/s 201(1A) could have been recovered from the
assessee for the reason that interest could have been charged for the period
from when tax was due to be deducted till the date the actual amount of tax was
paid by the recipient; if there was no liability for payment of tax by the
recipient, the question of deduction of tax by the assessee payer would not
arise and the interest also could not have been charged.

The Allahabad High Court following its own
decision approved and confirmed the view taken by the Tribunal, that no
interest u/s 201(1A) was chargeable in a case where the payee had filed a
return of loss.

A similar view, that no interest was
chargeable u/s 201(1A) in cases where the recipient had returned losses, has
been taken by the Income Tax Appellate Tribunal in the cases of Allahabad
Bank vs. ITO 152 ITD 383 (Agra), National Highway Authority of India vs. ACIT
152 ITD 348 (Jab.), Haldia Petrochemicals Ltd. vs. DCIT 72 taxmann.com 338
(Kol.), and Reliance Communications Ltd. vs. ACIT 69 taxmann.com
307 (Mum.).

THE PUNJAB INFRASTRUCTURE DEVELOPMENT BOARD
DECISION

The issue had also come up before the Punjab
and Haryana High Court in CIT vs. Punjab Infrastructure Development Board 394
ITR 195.

In that case, the assessee entered into
contracts with concessionaires for achieving its objects under various models
such as the ‘Build Operate and Transfer’, ‘Design Build Operate and Transfer’
and ‘Operation and Management’ models. Under those contracts, payments were made
to various concessionaires without deduction of tax at source. The AO had held
that the assessee was liable to deduct tax at source on such payments u/s 194C
and, having failed to do so, levied interest u/s 201(1A).

The Commissioner (Appeals) allowed the
assessee’s appeals, holding that no tax was deductible u/s 194C. Since the
assessee was not liable to deduct tax at source at all, the Commissioner
(Appeals) deleted the interest charged u/s 201(1A).

The Income Tax Appellate Tribunal dismissed
the appeals of the Revenue, accepting the assessee’s alternative argument that
the assessee was not liable to interest u/s 201(1A) on account of the fact that
the payees had filed their returns, which were nil returns or returns showing a
loss, and the sums paid were included in such return of income. The Punjab and
Haryana High Court, on appeals by the Revenue, analysed the provisions of
section 201. Though these appeals pertained to assessment year 2007-08, the
High Court thought fit to analyse the amendment of 2012 by way of insertion of
the provisos to sub-section (1) and sub-section (1A), since it was contended
that these amendments were clarificatory in nature and therefore had
retrospective effect. The High Court observed that even if the proviso to
sub-section (1) was held to be not retrospective, it would make no difference
to the assessee’s case in view of the judgement of the Supreme Court in the
case of Hindustan Coca-Cola Beverage (P) Ltd. vs. CIT 293 ITR 226,
where the Supreme Court held as follows:

‘10. Be that as it may, circular No.
275/201/95-IT (B) dated 29.1.1997 issued by the Central Board of Direct Taxes,
in our considered opinion, should put an end to the controversy. The circular
declares “no demand visualised under section 201(1) of the Income Tax Act
should be enforced after the tax deductor has satisfied the officer in charge
of TDS, that taxes have been paid by the deductee assessee.” However, this
will not alter the liability to charge interest under section 201(1A) of the
Act till the date of payment of taxes by the deductee assessee or the liability
for penalty under section 271C of the Income Tax Act.’

According to the Punjab and Haryana High
Court, the last sentence made it clear that even if the deductee had paid the
tax dues, it would not alter the liability of the payer of the sum to pay
interest u/s 201(1A) till the date of payment of taxes by the deductee. Thus,
according to the High Court, even prior to the amendment on 1^st
July, 2012, the liability to pay interest u/s 201(1A) was there even in cases
where the deductee had paid the tax dues.

The Court observed that the language of
section 201 was clear and unqualified; it did not permit an assessee to decide
for itself what the liability of the deductee was or was likely to be; that it
was a matter for the AO who assessed the returns of the deductee; and it was in
fact not even possible for him to do so inasmuch as he could not have
ascertained with any degree of certainty about the financial position of the
deductee. According to the High Court, a view to the contrary would enable an
assessee to prolong the matter indefinitely and, if accepted, it might even
entitle the assessee to contend that the adjudication of the issue be deferred
till the finalisation of the assessment of the deductee; that such could never
have been contemplated by the legislature; and that the language of section 201
did not even suggest such an intention.

The Punjab and Haryana High Court also
referred with approval to the decisions of the Madras High Court in the cases
of CIT vs. Ramesh Enterprises 250 ITR 464 and CIT vs.
Chennai Metropolitan Water Supply and Sewerage Board 348 ITR 530. The
Court agreed with the view that the terminal point for computation of interest
had to be taken as a date on which the deductee had paid taxes and filed
returns, even before the amendment. The Court also observed that section 197
militated against the deductor unilaterally not paying or paying an amount less
than the specified amount of TDS, by itself deciding the deductee’s liability
to pay tax or otherwise.

In conclusion the Court held that interest
u/s 201(1A) was chargeable even if the deductee had incurred a loss, though it
remanded the matter back to the Tribunal for deciding on the applicability of
section 194C.

The Gujarat High Court, in the case of CIT
vs. Labh Construction & Ind. Ltd. 235 Taxman 102, has taken a
similar view that interest was payable in such a case, though holding that the
liability to pay interest would end on the date on which the assessment of the
deductee was made.

OBSERVATIONS

The purpose of charging the interest in
question is to ensure that the Revenue is compensated for late payment of the
tax from the period when it was due till the time it was recovered. Where no
tax is due, the question of payment of any compensatory interest should not
arise at all unless it is penal in nature. In ascertaining the fact of payment
of taxes, due credit should be given for the taxes paid by the payee and also
to the fact that the payee was otherwise not liable to tax. The Gujarat High
Court, in the case of CIT vs. Rishikesh Apartments Co-op. Housing Society
Ltd. 253 ITR 310, has observed:

‘From the legal provisions discussed
hereinabove, it is crystal clear that in the instant case, Ravi Builder, on
whose behalf the tax was to be paid by the assessee, had duly paid its tax and
was not required to pay any tax to the Revenue in respect of the income earned
by it from the assessee. If the tax was duly paid and that too at the time when
it had become due, it would not be proper on the part of the Revenue to levy
any interest under section 201(1A) of the Act, especially when the builder had
paid more amount of tax by way of advance tax than what was payable by it. As
the amount of tax payable by the contractor had already been paid by it and
that too in excess of the amount which was payable by way of advance tax, in
our opinion, the Tribunal was absolutely right in holding that the tax paid by
the contractor in its own case, by way of advance tax and self-assessment tax,
should be deducted from the gross tax that the assessee should have deducted
under section 194C while computing interest chargeable under section 201(1A) of
the Act. If the Revenue is permitted to levy interest under the provisions of
section 201(1A) of the Act, even in the case where the person liable to be
taxed has paid the tax on the due date for the payment of the tax, the Revenue
would derive undue benefit or advantage by getting interest on the amount of
tax which had already been paid on the due date. Such a position, in our
opinion, cannot be permitted.’

A similar view has been taken by the Bombay
High Court in the case of Bennett Coleman & Co. Ltd. vs. ITO 157 ITR
812, that interest is compensatory interest in nature and it seeks to
compensate the Revenue for delay in realisation of taxes. Interest should be
charged only where tax is due and if
found to be due, for the period ending with the payment of such tax. In a case
where the payee has a loss, there is no question of payment of any tax by the
payee, and therefore the question of payment of interest by the payer also
should not arise.

The deductor
cannot be held to be an assessee in default if tax has been paid by the
deductee. Once this non-payment of taxes by the recipient is held as a
condition precedent to invoking section 201(1), the onus is then on the AO to
demonstrate that the condition is satisfied. It is for the AO to ascertain
whether or not the taxes have been paid by the recipient of income – Hindustan
Coca-Cola Beverages (Supra).The question of making good the loss
of Revenue by way of charging of interest arises only when there is indeed a
loss of revenue, and loss of revenue can be there only when the recipient has a
liability to tax and has yet not paid the tax. It is also necessary for the AO
to find that the deductee has also failed to pay such tax directly before
treating the payer as an assessee in default. In Jagran Prakashan Ltd.
vs. Dy. CIT, 345 ITR 288:

‘…The issue on hand, of charge of
interest u/s 201(1A), cannot be adjudicated in cases where the payee has filed
a return of loss, by relying on the non-contextual observation or an obiter dicta of the decision in the case of Hindustan
Coca-Cola Beverage (P) Ltd. vs. CIT 293 ITR 226. In that case, the issue
was about the treatment of the assessee in default or not where the payee had
otherwise paid taxes and the apex court held that the payer was not to be
deemed to be an assessee in default. The issue of interest u/s 201(1A) was not
before the Court. The Court, applying the circular of 1997, held that the payer
was not an assessee in default and stated, though not being called to do so,
that the decision had no implication on the liability to pay interest u/s
201(1A) for the period up to the date of payment by the payee. It is
respectfully stated that a part of the observations of the decision should not
be used to apply to the facts that are materially different and not in the
context…’

The better view therefore seems to be that
of the Allahabad High Court that no interest is chargeable u/s 201(1A) in a
case where the deductee has incurred losses during the relevant assessment year
and has no income chargeable to tax and no tax was payable by the payee and
that there was no loss to the Revenue.

It is relevant
to note that the decisions referred to and analysed here are in respect of the
period before 1^st July, 2012
with effect from which date provisos have been inserted in section
201(1) and (1A). The first amendment in section 201(1) provides that an
assessee shall not be deemed to be in default in cases where the conditions
prescribed are satisfied, the main condition being the payment of taxes by the
payee. It can therefore be safely stated that the amendment in sub-section (1)
is providing the legislative consent to the law laid down by the courts and
discussed here, and to that extent there is no disagreement between the
taxpayers and the tax gatherers.

Whether the same can be said of the second
amendment in section 201(1A) by way of insertion of the proviso therein which
has the effect of providing for payment of interest by the payer, for the
period up to the date of filing the return of income? Can it be said that
interest under sub-section (1A) shall be payable in cases governed by the
proviso to section 201(1A) for the period up to the date of filing of return by
the payee now that an express charge has been created for such payment? In our
considered opinion, no interest shall be payable by the payer in a case where
the payee has filed a return of loss or where he has paid taxes on its income
before the year-end, for the following reasons:

(i) Sub-section (1A) creates a charge for
payment of interest without prejudice to the fact that the payer is not treated
as an assessee in default. In other words, the charge is expected to
stick even where the payer is not treated as an assessee in default. It is
possible to seriously contend that an independent charge for levy of interest
is not sustainable where the assessee is not held to be in default and there
otherwise is no loss of revenue. In the circumstances, for the Revenue to
demand compensation may not hold water;

(ii) The courts, as noted above, without the
benefit of the amendments, have held that no interest u/s 201(1) was chargeable
in the facts and circumstances discussed here. The ratio of these decisions
should help the assessee to successfully plead that no interest is payable by
the payer where no tax is found to be payable by the payee even after the
amendment of section 201(1A);

(iii) With insertion of the proviso to
sub-section (1), it is clear that the legislature intends to exempt the payers
who ensure the compliance of the prescribed conditions. This intention should
be extended to interest under sub-section (1A) as well;

(iv) A proviso to the main section should be
applied only in cases where the main section is otherwise found to be
applicable; in cases where there is no ‘failure’ on the part of the payer, the
question of applying the proviso should not arise. The proviso here has the
effect of limiting the liability and not expanding it. In that view of the
matter, the insertion of the proviso should not be read to have created an
independent charge for levy of interest. In other words, the understanding
prevailing before the insertion w.e.f. 1^stJuly, 2012 has not
changed at all qua the levy of interest;

(v) For the charge of interest under
sub-section (1A) to succeed, it is essential to establish the failure to deduct
tax or pay tax; such failure has to be determined w.r.t. the liability to
deduct and / or pay which in turn is linked to the liability of the payee to
taxation. In cases where the payee is not otherwise liable to pay any taxes, it
may be very difficult to establish failure on the part of the payer;

(vi) Cases where the payee has filed the
return of loss or where it has paid taxes before the year-end, have a much
better case for exemption from interest.

shailesh.kwebmaker

RETROSPECTIVE IMPACT OF BENEFICIAL PROVISO – SECTION 40(a)(ia) & (i)

ISSUE FOR CONSIDERATION

In computing the income under the head ‘Profit and
Gains from Business and Profession’, several expenditures specified under
sections 30 to 37 are allowed as deductions. The deductions, however, are
subject to the provisions of sections 38 to 43B of the Act. These provisions of
law stipulate that an expenditure, otherwise allowable, would not be allowed to
be deducted or fully deducted in computing the business income. One such
provision is contained in sub clause (ia) of clause (a) of section 40 of the
Act. The said provision at present provides that 30% of an expenditure shall
not be deducted in computing the business income, involving payments to the
residents on which tax was deductible at source under Chapter XVII-B and, such
tax has not been deducted or, after deduction, has not been paid by the due
date for filing the return of income specified u/s 139(1) of the Act. This
provision introduced by the Finance Act, 2004 w.e.f. 1^st April, 2005
has been amended from time to time. A similar provision, in the form of section
40(a)(i), exists for disallowance of expenditure on payments made to
non-residents.

A proviso was introduced by the Finance Act, 2008 with
retrospective effect from 1^st April, 2005 to relax the rigors of
disallowance in cases where the assessee has otherwise paid the tax deducted,
after the end of the year, at any time before the due date of filing return of
income. Since then, the benefit of this proviso is now conferred under the main
provision itself. The said proviso is substituted by the Finance Act, 2010
w.e.f. 1^st April, 2010 to provide for deduction in any other year,
other than the year of expenditure, in which the tax has been paid.

The Finance Act, 2012 has introduced the second
proviso w.e.f. 1^st April, 2013 to deactivate the disallowance
provision in the case of an assessee who is not deemed to be an assessee in
default under the first proviso to section 201(1); in such a case it shall be
deemed that the assessee has deducted and paid the tax on the date of
furnishing the return of income by the payee in question.

Section 201 provides for the consequences of failure
to deduct tax at source or to pay as per the provisions of Chapter XVII-B by
treating the person as an assessee in default. The proviso to section 201(1),
introduced by the Finance Act, 2012 w.e.f. 1^stJuly, 2012, relaxes
the rigors of the consequences of failure in cases where the payee of the
expenditure has paid the tax due on his income, including the sum of
expenditure, has furnished the return of income u/s 139 and has issued a
certificate to this effect in the prescribed form.

It is seen that the provisions of disallowance are
being relaxed by amendments from time to time to alleviate the harsh consequences
of disallowance. All of these amendments are introduced with prospective effect
and apparently do not help cases of assessees with defaults prior to the date
of introduction of the relief. Naturally, attempts are regularly made by the
assessees to seek retrospective application of the amendments for obtaining
relief otherwise made available prospectively, which attempts are resisted by
the Revenue authorities. The conflict about the date of application of the
second proviso to section 40(a)(ia), introduced by the Finance Act, 2012 w.e.f.
1^stApril, 2013 has reached the courts and conflicting decisions are
available on the subject. The Kerala High Court has consistently held that the
amendment is prospective in its application, while the Delhi, Allahabad,
Bombay, Karnataka, Punjab and Haryana High Courts have held that the benefit of
the second proviso is available retrospectively.

THE CASE OF THOMAS GEORGE MUTHOOT & ORS.

The issue came up for consideration before the Kerala
High Court in the case of Thomas George Muthoot & Ors. vs. CIT, 287
CTR 101. During the relevant assessment years, the assessees had paid
interest on amounts drawn by them from partnership firms of which they were
partners, without deduction of tax at source as was provided under Chapter
XVII-B of the IT Act, 1961. For that reason, the interest paid was disallowed
by the AO in terms of section 40(a)(ia) of the Act. The order passed by the AO
was confirmed by the CIT(A) and further appeals filed before the Tribunal were
dismissed by a common order dated 28^th August, 2014. Aggrieved by
the orders passed by the Tribunal, the assessees filed appeals before the High
Court, formulating the following questions of law (the relevant ones):

‘(i) Whether on the facts and in the circumstances of
the case, did not the Tribunal err in law in sustaining the addition of Rs.
6,28,28,000 by invoking section 40(a)(ia) for the A.Y. 2006-07?

(ii) Did not the statutory authorities and the
Tribunal err in law in making addition under s. 40(a)(ia) when the payee has
included the entire interest paid by the appellant in its total income and
filed return of income accordingly?

(iii) Should not the statutory authorities and the
Tribunal have accepted the contention that the second proviso inserted w.e.f. 1^stApril, 2013 was intended to remove the unintended consequences and was a
beneficial provision for removal of hardship and therefore, retrospective in
operation and applicable to the appellant’s case?

On hearing the parties, the Court noted that section
194A(1) of the Act provided that any person, not being an individual or an HUF,
who is responsible for paying to a resident any income by way of interest,
other than income by way of interest on securities, shall at the time of credit
of such income to the account of the payee, or at the time of payment thereof
in cash or by issue of a cheque or draft or by any other mode, whichever was
earlier, deduct income tax thereon at the rate in force. As per the proviso to
the said section, an individual or HUF, whose total sales, gross receipts or
turnover from business or profession carried on by him exceeded the monetary
limits specified u/s 44AB(a) or (b) during the financial year immediately
preceding the financial year in which such interest was credited or paid, was
liable to deduct income tax u/s 194A.

One of the consequences of the non-compliance of
section 194A, as noted by the Court, was contained in section 40 of the Act,
whereunder, notwithstanding anything to the contrary contained in sections 30 to 38, the amounts specified in the
section was not to be deducted in computing the income chargeable under the
head ‘profits and gains of business or profession’. It further observed that
among the various amounts that were specified for deduction of tax, clause
(a)(ia) of section 40, insofar as it was relevant, provided for disallowance of
interest payable to a resident, where tax had not been deducted at source.

The Court also observed that the assessees were
partners of the firms and during the assessment years in question they had paid
interest to the firms without deducting tax as required u/s 194A. It was in
such circumstances that the interest paid by them to the firms was disallowed
u/s 40(a)(ia), which order of the AO had been concurrently upheld by the CIT(A)
and the Tribunal.

The Court took note of the contention raised by the
assessees that the second proviso to section 40(a)(ia) of the Act, introduced
by the Finance Act, 2012, was retrospective in operation and as such, disallowance
could not have been ordered invoking section 40(a)(ia) of the Act, relying on
the judgements in Allied Motors (P) Ltd. vs. CIT-2 24 ITR 677 (SC) and
Alom Extrusions Ltd. 319 ITR 06 (SC).

It was noticed by the Court that the proviso was
inserted by the Finance Act, 2012 and came into force w.e.f. 1^stApril,
2013. The fact that the second proviso was introduced w.e.f. 1^st
April, 2013 was expressly made clear by the provisions of the Finance Act, 2012
itself and the said legal position was clarified by the Court in Prudential
Logistics & Transports, 364 ITR 89 (Ker.).

The Court observed that the judgement in Allied
Motors (P) Ltd. (Supra) was a case where the Apex Court was considering
the scope and applicability of the first proviso to section 43B inserted by the
Finance Act, 1987 w.e.f. 1^st April, 1988. On examination of the
legislative history, the Apex Court found that the language of section 43B was
causing undue hardship to the taxpayers and the first proviso was designed to
eliminate the unintended consequences which caused undue hardship to the
assessees and which made the provision unworkable or unjust in a specific
situation. Accordingly, the Apex Court held that the proviso was remedial and
curative in nature and on that basis held the proviso to be retrospective in
operation. Similarly, the Court noted that the Apex Court in Alom
Extrusions Ltd. (Supra) following the judgement in the Allied
Motors (Supra) case, held that the provisions of the Finance Act, 2003
by which the second proviso to section 43B was deleted and the first proviso
was amended, were curative in nature and therefore retrospective.

In conclusion, the Court held that a statutory
provision, unless otherwise expressly stated to be retrospective or by
intention shown to be retrospective, was always prospective in operation. The
Finance Act, 2012 clearly stated that the second proviso to section 40(a)(ia)
had been introduced w.e.f. 1^st April, 2013. A reading of the second
proviso did not show that it was meant or intended to be curative or remedial
in nature and even the assessees did not have such a case. Instead, by the
proviso, an additional benefit was conferred on the assessees. Such a provision
could only be prospective as was held by the Court in Prudential
Logistics & Transports (Supra). Therefore, the contention raised
could not be accepted.

As a result, the Court did not find any merit in the
contention that the second proviso to section 40(a)(ia) inserted by the Finance
Act, 2012 w.e.f. 1^stApril, 2013 was prospective in nature. The
relevant questions of law were answered against the assessees and the appeals
were dismissed by the Court.

In a subsequent decision in the case of Academy
of Medical Sciences, 403 ITR 74 (Ker.), the Court reiterated the
proposition propounded in the cases of Prudential Logistics &
Transports, 364 ITR 689 (Ker.) and Thomas George Muthoot 287 CTR
(Ker.).

SHIVPAL SINGH CHAUDHARY’S CASE

The issue again arose recently in the case of CIT
vs. Shivpal Singh Chaudhary, 409 ITR 87 (P&H). The assessee in this
case had filed his return of income for the assessment year 2012-13 on 30^th
September, 2012 declaring the total income of Rs. 1,25,96,920. The assessment
was completed u/s 143(3) of the Act on 27^th February, 2015 on an
income of Rs. 2,45,41,840 by making the following additions / disallowances:
(i) Rs. 1,90,626 u/s 43B; (ii) Rs. 95,31,276 u/s 40(a)(ia) for non-deduction of
TDS on payment made for job work; (iii) Rs. 54,045 u/s 40(a)(ia) for non-deduction
of TDS on professional charges; (iv) Rs. 3,47,743 and Rs. 21,313 u/s 40(a)(ia)
for non-deduction of TDS on interest paid; (v) Rs. 17,98,420 out of interest on
the ground that the assessee had paid interest-free loans; and (vi) Rs. 1,500
being charity and donation expenses.

In the context of the issue under consideration, the
focused facts are that the assessee during the year in question had debited Rs.
98,99,141 on account of job work, out of which Rs. 95,31,276 was paid to M/s
Jhandu Construction Company without deduction of tax. The AO took the view that
the said payment should have been made only after deduction of tax at source
and, in view of the assessee’s failure to deduct tax at source, the AO
disallowed the payment in question u/s
40(a)(ia) of the Act. The assessee filed an appeal before the CIT(A)
pleading that, in view of the second proviso to section 40(a)(ia) of the Act,
payment should not have been disallowed. The CIT(A), after considering the
submissions of the assessee and going through the evidence on record, found
that the assessee had filed confirmation from the party that the payment made
by him to Jhandu Construction Co. had been reflected in its return of income.
Thus, the CIT(A) vide order dated 10^th November, 2016 decided the
issue in favour of the assessee, which was upheld by the Tribunal vide order
dated 26^th May, 2017.

The Revenue, aggrieved by the order of the Tribunal
for the assessment year 2012-13, had filed an appeal before the Punjab and
Haryana High Court u/s 260A of the Act raising the following substantial
question of law:

‘Whether on the facts and in the circumstances of the
case and in law, the Hon’ble Tribunal has erred in deleting the addition of Rs.
95,31,276 made under s. 40(1)(ia) for non-deduction of TDS on payment made for
job works by holding that the second proviso to s. 40(a)(ia) has a
retrospective effect and is applicable to the applicant for the relevant
assessment year whereas the said provisions of s. 40(a)(ia) are prospective in
operation w.e.f. 1^st April,2013 as was held by the Hon’ble Kerala
High Court in the case of Thomas George Muthoot vs. CIT (IT Appeal No. 278
of 2014), [reported as (2016) 287 CTR (Ker.) 101: (2016) 137 DTR (Ker.)
76—Ed.]?’

On hearing the parties, the Court noted that:

(a) the issue
raised by the Revenue before the Tribunal pertained to the retrospectivity of
the second proviso to section 40(a)(ia) of the Act. Sub-clauses (i), (ia) and
(ib) in section 40(a) were substituted for clause (i) by the Finance (No. 2)
Act, 2004 w.e.f. 1^st April, 2005;

(b) the second
proviso to section 40(a)(ia) of the Act was inserted by the Finance Act, 2012
w.e.f. 1^stApril, 2013;

(c) according to
the aforesaid proviso, a fiction has been introduced where an assessee, who had
failed to deduct tax in accordance with the provisions of Chapter XVII-B of the
Act, is not deemed to be an assessee in default in terms of the first proviso
to sub-section (1) of section 201 of the Act, then in such event it shall be
deemed that the assessee has deducted and paid the tax on such sum on the date
of furnishing of return of income by the resident / payee referred to in the
said proviso;

(d) the
purpose of insertion of the first proviso to section 201(1) of the Act was to
benefit the assessee. It stipulated that a person who had failed to deduct tax
at source on the sum paid to a resident or on the sum credited to the account
of the resident, should not be deemed to be an assessee in default in respect
of such tax, provided the resident had furnished the return of income u/s 139
of the Act, had taken into account such sum for computing income in the return
of income, and paid tax due on the income declared by him in such return of
income;

(e) a mandatory
requirement existed under Chapter XVII-B of the Act to deduct tax at source
under certain eventualities;

(f) the
consequences for failure to deduct or pay tax deducted at source within the
time permissible under the statute were spelt out in section 201 of the Act.
However, under the first proviso to section 201(1) of the Act, inserted w.e.f.
1^st July, 2012, an exception had been carved out which showed the
intention of the legislature to not treat the assessee as a person in default,
subject to fulfilment of the conditions as stipulated thereunder;

(g) no different
view could be taken regarding introduction of the second proviso to section
40(a)(ia) of the Act w.e.f. 1^st April, 2013 which proviso was also
intended to benefit the assessee by creating a legal fiction in his favour, not
to treat him in default of deducting tax at source under certain contingencies
and that it should be presumed that the assessee had deducted and paid tax on
such sum on the date of furnishing of the return of income by the resident /
payee.

From the legal analysis of the first proviso to
section 201(1) and of the second proviso to section 40(a)(ia) of the Act, it
was discernible to the Court that according to both the provisos, where the
payee / resident had filed its return of income disclosing the payment received
by it or receivable by it, and had also paid tax on such income, the assessee
would not be treated to be a person in default and presumption would arise in
his favour as noted above.

The question that would require an answer from the
Court was whether the insertion of the second proviso to section 40(a)(ia) of
the Act w.e.f. 1^st April, 2013 would apply to assessment year
2012-13, being retrospective. In that context, the Court observed that a
similar issue of whether the second proviso to section 40(a)(ia) of the Act was
prospective or retrospective in nature came up for consideration before the
Delhi High Court in Ansal Land Mark Township (P) Ltd. 377 ITR 635 (Del.).
The High Court in that case approved the ratio of the decision of the Agra
Bench of the Tribunal in ITA No. 337/Agra/2013 (Rajiv Kumar Aggarwal vs.
Asstt. CIT) wherein it was held that the second proviso to section
40(a)(ia) of the Act was declaratory and curative in nature and should be given
retrospective effect from 1^st April, 2005.

The Court expressed its agreement with the view of the
Delhi High Court in Ansal Land Mark Township (P) Ltd. (Supra),
approving the reasoning of the Agra Bench of the Tribunal upholding the
rationale behind the insertion of the second proviso to section 40(a)(ia) of
the Act, and held that it was merely declaratory and curative and thus was
applicable retrospectively w.e.f. 1^st April, 2005.

The Court noticed that the Revenue had relied upon two
decisions of the Kerala High Court in the cases of Prudential Logistics
& Transports (Supra) and Thomas George Muthoot (Supra),
wherein it had been held that the second proviso to section 40(a)(ia) of the
Act w.e.f. 1^st April, 2013 was prospective and not retrospective.
The Court noted with respect that it was unable to subscribe to the aforesaid
contrary view of the Kerala High Court in the aforesaid two decisions.

The substantial question of law was answered against
the Revenue and in favour of the assessee and the appeal was dismissed by the
Punjab & Haryana High Court.

The Allahabad High Court in the case of Pr. CIT
vs. Manoj Singh, 402 ITR 238, concurring with Ansal Land Mark
Township (P) Ltd. (Supra) and dissenting with Thomas George
Muthoot & Ors. (Supra) also has held that the second
proviso to section 40(a)(ia) was retrospective in nature. The recent decisions
of the High Courts in CIT vs. S.M. Anand, 3 NYPCTR 383; Principal CIT vs.
Mobisoft Telesolutions (P) Ltd., 411 ITR 607 (P&H); Soma Trg. Joint Venture
vs. CIT, 398 ITR 425 (J&K); Principal CIT vs. Perfect Circle India (P) Ltd.
IT Appeal No. 707 of 2016 (Bom.) and Smt. Deeva Devi vs.
Principal CIT & Anr. WP No. 3928 of 2018 (Karn.), are on similar
lines.

OBSERVATIONS

The issue under consideration moves in a narrow range.
There is no dispute about the prospective application of the second proviso to
section 40(a)(ia), for allowance of deduction in cases where the assessee is
not deemed to be in default on payment by the payee of an expenditure, subject
to satisfaction of the prescribed conditions. There is also no dispute that the
said proviso, in express language, is made applicable w.e.f. 1^stApril,
2013. The dispute is limited to reading the said proviso in a manner that
permits the retrospective application of the said proviso to assessment year
2012-13 and the earlier years.

The second proviso to section
40(a)(ia) of the Act reads thus:

‘Provided further that where an assessee fails to
deduct the whole or any part of the tax in accordance with the provisions of
Chapter XVI-IB on any such sum but is not deemed to be an assessee in default
under the first proviso to sub-s. (1) of s. 201, then, for the purpose of this
sub-clause, it shall be deemed that the assessee has deducted and paid the tax
on such sum on the date of furnishing of return of income by the resident payee
referred to in the said proviso.’

Admittedly, this proviso was inserted by the Finance
Act, 2012 and came into force w.e.f. 1^st April, 2013. The fact that
the second proviso was introduced w.e.f. 1^st April, 2013 is
expressly made clear by the provisions of the Finance Act, 2012 itself. A
statutory provision, unless otherwise expressly stated to be retrospective or
by intendment shown to be retrospective, is always prospective in operation.
The Finance Act, 2012 shows that the second proviso to section 40(a)(ia) has
been introduced w.e.f. 1^st April, 2013. A reading of the second
proviso does not show that it was meant or intended to be curative or remedial
in nature. Instead, by this proviso an additional benefit was conferred on the
assessees. Such a provision can only be prospective.

Ordinarily, a law, unless otherwise provided for, is
applicable from the date when it is introduced. This principle holds good even
in a case where the legislature has not expressly provided for the date of its
application. In cases where the date of the application of the law has been
expressly provided for, not much difficulty should arise in holding its
application to be prospective. Further, in cases where the law seeks to cast an
obligation on the subject, it will be fair to hold that such law is applied
prospectively, unless it has been in express terms retrospectively applied by
the legislature.

These understandings, so derived, may be materially
altered in cases where the law seeks to grant a relief or where it seeks to
undo an injustice or unfair practice or a prevailing hardship or remedy a wrong.
This is even in respect of the procedural amendments. Looking at the general
principles governing the date of application of the law or an amendment, it was
not very difficult for the five high courts to hold that the second proviso had
a retrospective application, the reason being that it, in essence, sought to
remove a hardship which was unintended and its application in this manner would
not harm the interest of the other party, namely, Revenue, in any manner in
this case.

Where a law is enacted to benefit a large section of
the public, the benefit may be applied retrospectively, even where it has not
been expressly so provided. The effect of the second proviso is to simply
remedy a wrong. In the circumstances, it was fair for the courts to have applied
the amendment retrospectively, though it was expressly made applicable
prospectively, by reading the retrospectivity into the law. Such a reading, in
our opinion, cannot be viewed to be doing violence to the law.

It is worth noting that most of the high courts have
quoted with approval and appreciation the ratio of the decision of the Agra
Bench of the Tribunal in the case of Rajeev Kumar Agarwal vs. Addl. CIT
165 TTJ (Agra) 228. The relevant part reads thus:

‘On a conceptual note, primary justification for such
a disallowance is that such a denial of deduction is to compensate for the loss
of revenue by corresponding income not being taken into account in computation
of taxable income in the hands of the recipients of the payments. Such a policy
motivated deduction; restrictions should, therefore, not come into play when an
assessee is able to establish that there is no actual loss of revenue. This
disallowance does de-incentivise not deducting tax at source when such tax deductions
are due, but so far as the legal framework is concerned, this provision is not
for the purpose of penalising for the tax deduction at source lapses. There are
separate penal provisions to that effect. Deincentivising a lapse and punishing
a lapse are two different things and have distinctly different, and sometimes
mutually exclusive, connotations. When one appreciates the object of the scheme
of section 40(a)(ia), as on the statute, and to examine whether or not, on a
“fair, just and equitable” interpretation of law as is the guidance
from the Delhi High Court on interpretation of this legal provision, it could
not be an “intended consequence” to disallow the expenditure, due to
non-deduction of tax at source, even in a situation in which corresponding
income is brought to tax in the hands of the recipient.

The scheme of section 40(a)(ia) is aimed at ensuring
that an expenditure should not be allowed as deduction in the hands of an
assessee in a situation in which income embedded in such expenditure has
remained untaxed due to tax withholding lapses by the assessee. It is not a
penalty for tax withholding lapse but it is a sort of compensatory deduction
restriction for an income going untaxed due to tax withholding lapse. The
penalty for tax withholding lapse per se is separately provided for
in section 271C and section 40(a)(ia) does not add to the same. The provisions
of section 40(a)(ia), as they existed prior to insertion of second proviso
thereto, went much beyond the obvious intentions of the law-makers and created
undue hardships even in cases in which the assessee’s tax withholding lapses
did not result in any loss to the exchequer. Now that the legislature has been
compassionate enough to cure these shortcomings of the provision and, thus, obviate
the unintended hardships, such an amendment in law, in view of the well-settled
legal position to the effect that a curative amendment to avoid unintended
consequences is to be treated as retrospective in nature even though it may not
state so specifically… the insertion of second proviso must be given
retrospective effect from the point of time when the related legal provision
was introduced.

In view of these discussions, as also for the detailed
reasons set out earlier, the view cannot be subscribed that it could have been
an “intended consequence” to punish the assessees for non-deduction
of tax at source by declining the deduction in respect of related payments,
even when the corresponding income is duly brought to tax. That will be going
much beyond the obvious intention of the section. Accordingly, the insertion of
second proviso to section 40(a)(ia) is declaratory and curative in nature and
it has retrospective effect from 1^stApril, 2005, being the date
from which sub-clause (ia) of section 40(a) was inserted by the Finance (No. 2)
Act, 2004.’

The retrospective operation is substantiated by
relying on the judgement in Allied Motors (P) Ltd. 224 ITR 677 (SC).
That was a case where the Apex Court was considering the scope and
applicability of the first proviso to section 43B inserted by the Finance Act,
1987 w.e.f. 1^st April, 1988. On examination of the legislative
history, the Court found that the language of section 43B was causing undue
hardship to the taxpayers and the first proviso was designed to eliminate
unintended consequences which caused undue hardship to the assessees and which
made the provision unworkable or unjust in a specific situation. Accordingly,
the Court held that the proviso was remedial and curative in nature, and on that
basis held the proviso to be retrospective in operation.

In Alom Extrusions Ltd. 319 ITR 306 (SC) also
following the judgement in Allied Motors (Supra), the Apex Court
held that provisions of the Finance Act, 2003 by which the second proviso to
section 43B was deleted and the first proviso was amended, were curative in
nature and therefore retrospective.

The issue has been considered by five High Courts to
hold that the second proviso to section 40(a)(ia) of the Act is declaratory and
curative in nature and should be given retrospective effect from 1^st
April, 2005. The finding of the judgement in the case of Ansal Land Mark
Township (P) Ltd. (Supra) was considered by the Apex Court in the case
of CIT vs. Calcutta Export Co. 404 ITR 654 (SC), in the context
of the first proviso to section 40(a)(ia) of the Act, which proviso was held to
be retrospective in nature. It is, however, noted that a Special Leave Petition
is granted by the Apex Court against the judgement of the Delhi High Court in CIT
vs. Ansal Land Mark Township (P) Ltd. (Supra) 242 Taxman 5(SC) (St.).

The Apex Court in the case of Hindustan
Coca-Cola Beverage (P) Ltd. vs. CIT, 293 ITR 226 (SC) held that even in
the absence of second proviso to section 40(a)(ia), once the payee has been
found to have already paid the tax, the payer / deductor can at best be asked
to pay the interest on delay in depositing tax.

The Kerala High Court, while deciding the cases of Thomas
George Muthoot (Supra) and Prudential Logistics & Transports
(Supra), did not have the benefit of authority of the Constitution
Bench in Vatika Township (P) Ltd. (Supra). In both these
judgements, as observed by the Allahabad High Court in Manoj Kumar Singh’s
case, the judgement of the Apex Court in the case of Vatika Township (P)
Ltd. (Supra) was not considered.

The Apex Court in CIT vs. Vatika Township (P)
Ltd., 367 ITR 466 (SC) while holding that, unless otherwise provided,
an amendment should be held to be prospective and should apply from the date
expressly specified for its application, nonetheless held as under:

‘31. Of the various rules guiding how a legislation
has to be interpreted, one established rule is that unless a contrary intention
appears, a legislation is presumed not to be intended to have a retrospective
operation. The idea behind the rule is that a current law should govern current
activities. Law passed today cannot apply to the events of the past. If
we do something today, we do it keeping in view the law of today and in force
and not tomorrow’s backward adjustment of it. Our belief in the nature of the
law is founded on the bedrock that every human being is entitled to arrange his
affairs by relying on the existing law and should not find that his plans have
been retrospectively upset. This principle of law is known as lex prospicit non respicit: law looks forward not backward. As
was observed in Phillips vs. Eyre (1870) LR 6 QB 1, a
retrospective legislation is contrary to the general principle that legislation
by which the conduct of mankind is to be regulated when introduced for the
first time to deal with future acts ought not to change the character of past
transactions carried on upon the faith of the then existing law.

32. The obvious basis of the principle against
retrospectivity is the principle of “fairness” which must be the basis of every
legal rule as was observed in the decision reported in L’Office Cherifien
des Phosphates vs. Yamashita-Shinnihon Steamship Co. Ltd. (1994) 1 AC 486 (HL).
Thus, legislations which modified accrued rights or which impose
obligations or impose new duties or attach a new disability have to be treated
as prospective unless the legislative intent is clearly to give the enactment a
retrospective effect, unless the legislation is for the purpose of
supplying an obvious omission in a former legislation or to explain a former
legislation. We need not note the cornucopia of case law available on the
subject because aforesaid legal position clearly emerges from the various
decisions and this legal position was conceded by the counsel for the parties.
In any case, we shall refer to few judgements containing this dicta a little later.

33. We would also like to point out, for the sake of
completeness, that where a benefit is conferred by a legislation, the rule
against a retrospective construction is different. If a legislation confers
a benefit on some persons but without inflicting a corresponding detriment on
some other person or on the public generally, and where to confer such benefit
appears to have been the legislators’ object, then the presumption would be
that such a legislation, giving it a purposive construction, would warrant it
to be given a retrospective effect. This exactly is the justification to treat
procedural provisions as retrospective. In Government
of India & Ors. vs. Indian Tobacco Association [(2005) 7 SCC 396], the
doctrine of fairness was held to be relevant factor to construe a statute
conferring a benefit, in the context of it to be given a retrospective
operation. The same doctrine of fairness, to hold that a statute
was retrospective in nature, was applied in the case of Vijay vs. State of Maharashtra & Ors. (2006) 6 SCC 289. It was held that where a law is enacted for the benefit of community as
a whole, even in the absence of a provision the statute may be held to be
retrospective in nature. However, we are (not) confronted with any such
situation here.

34. In such cases, retrospectively(ity) is attached to
benefit the persons in contradistinction to the provision imposing some burden
or liability where the presumption attaches towards prospectivity. In the
instant case, the proviso added to s. 113 of the Act (surcharge on special tax
in search cases) is not beneficial to the assessee. On the contrary, it is a
provision which is onerous to the assessee. Therefore, in a case like this, we
have to proceed with the normal rule of presumption against retrospective
operation. Thus, the rule against retrospective operation is a fundamental rule
of law that no statute shall be construed to have a retrospective operation
unless such a construction appears very clearly in the terms of the Act, or
arises by necessary and distinct implication. Dogmatically framed, the rule is
no more than a presumption and thus could be displaced by outweighing factors.’

It is not always necessary that an express provision
is made to make a statute retrospective. In fact, where a prohibition has been
deleted by a subsequent amendment, it is possible to presume that the same was
never in existence. It may be true, as noted by the Kerala High Court, that law
in general has to be applied prospectively, but such a presumption against the
retrospective operation may be rebutted by necessary implication, especially in
a case where the new law is made to cure an acknowledged evil for the benefit
of the community as a whole (Zile Singh vs. State of Haryana, 8 SCC 1,
page 9). The material to show that the Legislature intended to cure the
acknowledged evil or to remove any such hardship is available in the form of
the Explanatory memorandum explaining the need to introduce the second proviso.
The language used, the object intended, the nature of rights affected and the
circumstances under which the amendment is passed, support that the same is
retrospective in nature.

The test to be applied for deciding as to whether a
later amendment should be given a retrospective effect, despite a legislative
declaration specifying a prospective date as the date from which the amendment
is to come into force, is as to whether without the aid of the subsequent
amendment, the unamended provision is capable of being so construed as to take
within its ambit the subsequent amendment [CWT vs. B.R. Theatres and
Industrial Concerns (P) Ltd., 272 ITR 177 (Mad.)]. The Kerala High
Court did not, in our respectful opinion, provide adequate reasons as to how
this test was not met in the case of the second proviso under consideration
here, inasmuch as the amendment made provided an important guideline in interpretation
of the law prevailing before the amendment. This is all the more so where the
Apex Court (in the Hindustan Coca-Cola case) had taken a view
that even before the insertion of the proviso to section 201(1), the payer
could not be treated to be an assessee in default if the payee had paid tax on
such income, implying that the failure to deduct tax had been made good on
payment of tax by the payee. The Explanatory Memorandum to the Finance Act,
2012 in the context of this amendment reads as under:

‘In order to rationalise the provisions of
disallowance on account of non-deduction of tax from the payments made to a
resident payee, it is proposed to amend section 40(a)(ia) to provide that where
an assessee makes payment of the nature specified in the said section to a
resident payee without deduction of tax and is not deemed to be an assessee in
default under section 201(1) on account of payment of taxes by the payee, then,
for the purpose of allowing deduction of such sum, it shall be deemed that the assessee
has deducted and paid the tax on such sum on the date of furnishing of return
of income by the resident payee.

These beneficial provisions are proposed to be
applicable only in the case of resident payee.

These amendments will take effect from 1^stApril,
2013 and will, accordingly, apply in relation to the assessment year 2013-14
and subsequent assessment years.’

The Explanatory Memorandum therefore does indicate
that this was a measure of rationalisation – in other words, to correct
something which was irrational. This amounts to correction of a wrong.

An amendment is best considered to be curative in
nature if it is introduced to remove the hardship, more so where the amendment
takes care of ensuring that there is no leakage of revenue.

In the context of section 43B itself, the Supreme
Court in Allied Motors (P) Ltd. (Supra), held that the amendment
made in section 43B by the Finance Act, 1987 by way of insertion of the first
proviso is of curative nature and thereby retrospective in application. The
said first proviso was introduced to provide that the payment of taxes, duties,
fees, cess, etc., made by the due date of filing return of income was eligible
for deduction. No express provision was made to provide that the said proviso
had a retrospective effect. In spite of the absence of the express provision,
the Court held that the same was retrospective in nature and should be so
applied in conferring the relief to the assessees.

The better view on the subject is to apply the benefit
of the second proviso retrospectively to assessment year 2012-13 and earlier
years by holding that retrospectivity is called for by necessary and distinct
implication and its express application w.e.f. 1^stApril, 2013
should be displaced by outweighing factors.

shailesh.kwebmaker

A ‘RESIDENTIAL HOUSE’ FOR SECTIONS 54 AND 54F

ISSUE FOR CONSIDERATION

An assessee, whether an individual or an
HUF, is exempted u/s 54 of the Income-tax Act from capital gains arising from
the transfer of a long-term capital asset, being a residential house, on the
purchase or construction of a residential house within the specified period.
Similar exemption is granted u/s 54F of the Act for capital gains arising from
the transfer of any long-term capital asset, not being a residential house, on
the purchase or construction of a residential house, within the specified
period and subject to other conditions as provided therein. One of the
essential conditions for availing the exemption under both these provisions is
that the house purchased or constructed should be a ‘residential house’.

Quite often, an issue arises as to whether
the exemption can be availed when the new property purchased or constructed,
though approved and referred to as a residential house, has been used for
non-residential or commercial purposes. Such issues arise in implementation of
sections 54 and 54F, including for compliance with conditions that apply
post-exemption. The issue may arise even where one is required to determine the
nature of premises under transfer, for ascertaining the application of sections
54 or 54F, which are believed to be mutually exclusive, that call for
compliance with
different conditions.

The Hyderabad bench of the Tribunal has held
for the purposes of section 54F that the new house constructed for residential
use, consisting of all the required amenities, accordingly would not lose its
character of a residential house even if it was used for some commercial
purposes. As against this, the Delhi bench of the Tribunal has held that the
existing residential house which was used by the assessee as his office would
not be taken into consideration while determining whether the assessee owned
more than one residential house as on the date of transfer of the original
asset while applying the provisions of section 54F.

THE N. REVATHI CASE

The issue
first came up for consideration of the Hyderabad Bench of the Tribunal in the
case of N. Revathi vs. ITO 45 taxmann.com 30 (Hyderabad – Trib.).
In this case, the assessee claimed the exemption u/s 54F on transfer of a
long-term capital asset, not being a residential house, on utilisation of the
net consideration in constructing a residential building over the plot of land
owned by her jointly with her sister for assessment year 2007-08. The building
consisted of ten flats, five each belonging to the assessee and her sister.
Since the AO was of the view that the exemption could be claimed only for one
flat, he deputed the Inspector to make a spot inquiry for verifying the
assessee’s claim. Upon verification, it was also found that the said building
was used for running a school by the assessee and her friend and it had
classrooms, a big hall and a play area for children in the cellar of the
premises. The exemption u/s 54F was denied by the AO on the ground that the
building constructed was not a residential house. While passing an ex parte
order on account of non-appearance on the part of the assessee, the CIT (A)
concurred with the view of the AO by holding that the term ‘residential’
clearly implied usage as a ‘home’.

Before the Tribunal, it was argued on behalf
of the assessee that the Inspector, while submitting his report on 23^rd
December, 2009, had categorically stated that the school had started
functioning six months earlier. Therefore, it implied that no school was
functioning in the said residential building during the relevant assessment
year.

The Tribunal held that only because the
building was used as a school could not change the nature and character of the
building from residential to commercial; even a residential building could be
used as a school or for any other commercial purpose; the relevant factor to
judge was whether the construction made was for residential purpose or for
commercial purpose; if the building had been constructed for residential use
with all amenities like kitchen, bathroom, etc., which were necessary for
residential accommodation, then even if it was used as a school or for any
other commercial purpose, it could not lose its character as a residential
building. However, it further held that if the construction was made in such a
way that it was not normally for residential use but for purely commercial use,
then it could not be considered to be a residential house; the primary fact
which was required to be examined was whether the building had been constructed
for residential use or not, a fact that could be verified from the approved
plan and architectural design of the building.

As the approved plan of the building
constructed by the assessee was not brought on record, the Tribunal remitted
the matter back to the file of the AO to conduct an inquiry to find out the
exact nature of construction, i.e., whether the said building was constructed
for residential use or for commercial use. The AO was directed to allow the
exemption if it was found that the building had been constructed for
residential use with all amenities which were necessary for a residential
accommodation. Insofar as the allowability of the exemption with respect to
more than one flat was concerned, the Tribunal decided the issue in favour of
the assessee.

THE SANJEEV PURI CASE

The issue, thereafter, came up for
consideration of the Delhi Bench of the Tribunal in the case of Sanjeev
Puri vs. DCIT 72 taxmann.com 147 (Delhi – Trib.).

In this case (assessment year 2010-11) the
assessee, who was a senior advocate, owned three different properties as
follows:

(i) E-549A, which was used for residential
purposes;

(ii) E-575A, used
as office for conducting the legal profession; and

(iii) Gurgaon flat which was still under
construction.

The assessee sold the rights in the
under-construction Gurgaon flat which resulted in long-term capital gains of
Rs. 1,48,23,645. Proceeds from the aforesaid sale were invested in purchase of
a new residential house for which the assessee claimed an exemption u/s 54F of
the Act. The exemption claimed u/s 54F was denied by the AO on the ground that
the assessee on the date of transfer of the rights held more than one
residential house, namely, E-549A and another at E-575A, holding that the
latter was also a residential property and, therefore, the assessee owned more
than one residential house at the time of transfer. He held that a residential
property could not be used as an office and that there was no distinction
between the ‘type’ of the property and its ‘actual use’. In other words, the
actual use of E-575A for commercial purposes did not make the premises
non-residential. The CIT (A) upheld the view of the AO and confirmed the
disallowance.

Before the Tribunal, it was argued by the
assessee that the house at E-575A was not used for residential purposes and was
put to use for the purposes of his profession being carried on by the assessee
from the said premises; holding the said property to be residential house
merely on the basis that the same was classified as residential property as per
municipal laws and in the registered sale deed executed at the time of purchase
of such property and disregarding the actual use thereof for professional
purposes, was not justified.

The Revenue argued before the Tribunal that
the manner of the construction would decide the nature of the house, as to
whether it was residential or commercial. The usage of the property was
immaterial if the property was shown as residential on the records of the
corporation. The capability of the premises for use as a residential house was
enough and it was not necessary to reside there. Therefore, it was claimed that
the exemption was rightly denied on the basis of the fact that the property was
classified as residential property as per municipal laws and in the registered
sale deed executed at the time of purchase of such property, disregarding the
actual use thereof for professional purposes.

The Tribunal
held that for availing deduction u/s 54F, the test to be applied would be that
of the actual use of the premises by the assessee during the relevant period.
In other words, it did not make a difference whether the property had been
shown as residential house on the records of the government authority but it
was actually used for non-residential purpose. The actual usage of the house by
the assessee would be considered while adjudicating upon the eligibility of exemption
u/s 54F. Accordingly, the AO was directed to allow the exemption u/s 54F as
claimed by the assessee for the reason that E-575A was used for commercial
purposes, i.e., non-residential purposes, and therefore the assessee could not
be held to have held more than one residential premises.

OBSERVATIONS

The primary issue under consideration is the
basis on which a particular house should be recognised as a residential house,
i.e., whether the premises by its plans and approval and its design should be a
residential house, or whether it should have been used as a residential house,
or whether both these conditions should have been satisfied. While the
Hyderabad Bench of the Tribunal has considered the nature of the house, i.e.,
how it has been built and how it has been classified in the records of the
local authorities as the basis, the Delhi Bench of the Tribunal has considered
the actual usage of the premises as the basis for determination.

The provisions of sections 54 and 54F use
the term ‘residential house’, but without defining it. One possibility is to
apply a common parlance test to understand the meaning of such term, which has
not been defined expressly under the Act. It should be attributed a meaning
supplied to it by a common man, i.e., a meaning accorded to the term in the
popular sense. In that sense, a house is considered to be a residential house
when it has all the facilities which makes that house capable of residing in,
i.e., facilities for living, cooking and sanitary requirements, when its
location is in a residential area, when it has been recognised as a residential
house by the local authorities for the purpose of levying different types of
taxes. The house satisfying these conditions, not necessarily all of them, can
be regarded as a residential house irrespective of the purpose for which that
house has been put to use, unless it is found that it was always intended to be
used for non-residential purposes and it was shown to be a residential house
only for the purpose of availing the benefit of exemption.

A useful reference can be made to the
observations of the Delhi High Court in the case of CIT vs. Purshottam
Dass 112 Taxman 122 (Delhi) for understanding the meaning of the term
‘residential house’. In this case, the High Court was dealing with the issue of
eligibility of exemption granted under erstwhile provisions of section
23(1)(b)(ii), which was available only in respect of ‘residential unit’. The
relevant observations of the High Court in this regard are reproduced below:

Question whether a particular unit is
residential or not is to be determined by taking into account various factors,
like, the intention of the constructor at the time of construction, intended
user, actual user, potentiality for a different user and several other related
factual aspects. The provision only stresses on erection of a building
comprising of residence(s) during a particular period.

In a given case, the constructor may have
constructed a particular unit as the residential unit, but to avoid deterioration
on account of non-user, may have temporarily let out for office purposes. There
may be a case where for some period of a particular assessment year, the
building has been used for residential purposes and for the residual period for
office purposes. There may be another case when during the period of five years
referred to in the provision for three years building is used for residential
purposes and for balance period for office purposes. Can it be said in the
above three contingencies, the unit ceases to be a residential unit for some
periods? These factual aspects have great relevance while adjudicating the
question whether the exemption is to be allowed. We may state that user is one
of several relevant factors and not the conclusive or determinative one. The
intention of constructor at the time of erection is one of the relevant
factors, as stated above. If intention at the time of erection was use for
residential purposes, it is of great relevance and significance.

In view of these observations, the High
Court allowed the exemption as claimed u/s 23(1)(b)(ii), on the ground that the
construction of the house was made for residential purpose and in a residential
area though there was temporary non-use as residence and, consequently,
temporary use for office purposes. Thus, one of the important criteria which is
required to be considered is the intention of the assessee while purchasing or
constructing a house. If the intention was to use the house as a residential
house at that point in time, then the subsequent usage of that house for a
non-residential purpose for a temporary period should not disqualify that
assessee from claiming the exemption.

Reference can also be made to the definition
of a ‘residential unit’ as provided in section 80-IBA, though it has restricted
applicability only for that section. This definition is reproduced below:

‘residential unit’ means an independent
housing unit with separate facilities for living, cooking and sanitary
requirements, distinctly separated from other residential units within the
building, which is directly accessible from an outer door or through an
interior door in a shared hallway and not by walking through the living space
of another household.

In this definition also, importance has been
given to the structure of the unit, rather than the usage of the unit.

Further, a usage test may not help in
several cases, like in a case where the house has not been put to any use at
all, or a case where the house has been used for both residential as well as commercial
purposes, or a case where the house has been used for different purposes over
different periods. In such cases, it will be difficult to determine the nature
of the house for the purpose of allowing the exemption u/s 54 or 54F. However,
again, the intention may play an important role; commercial premises purchased
with the intention to use them for residential purposes may qualify to satisfy
the test of the provisions.

Importantly, the erstwhile provision of
section 54 as applicable prior to A.Y. 1983-84 was materially different from
its present provision. Under the erstwhile provision, the exemption was
available only when the house property was purchased or constructed by the
assessee for the purpose of his own residence or of the parents. This condition
was omitted by the Finance Act, 1982 with effect from A.Y. 1983-84. The
expression ‘the assessee has within a period of one year before or after
that date purchased, or has within a period of two years after that date
constructed, a house property for the purposes of his own residence’ was
substituted by the expression ‘the assessee has within a period of one year
before or after the date on which the transfer took place purchased or has
within a period of three years after that date constructed, a residential
house’. Circular No. 346 dated 30^thJune, 1982 explained the
reason for this change as follows:

The conditions of self-occupation of the
property by the assessee or his parents before its transfer and the purchase or
construction of the new property to be used for the residence of the assessee
for the purposes of exemption of capital gains created hardships for assessees.
This was usually due to the fact of employment or business of the assessee at a
place different from the place where such property was situated.

Thus, the fact that the assessee cannot
always occupy the house for his own residential purpose has been recognised
while relaxing the condition for claiming the exemption. In such a case, the
exemption cannot be denied merely because the residential house has been let
out and the tenant has used it for non-residential purpose.

In the case of Dilip Kumar and Co.
(TS-421-SC-2018), it has been held that the notification conferring an
exemption should be interpreted strictly and the assessee should not be given
the benefit of ambiguity. However, the Delhi High Court, in the case of Purshottam
Dass (Supra), has considered this aspect. In this case, the Revenue had
also argued that the exemption provisions or exception provisions have to be
construed strictly and it should be construed against the subject in case of
ambiguity. Reliance was placed upon the decisions of the Supreme Court in the
case of Novopan India Ltd. vs. CCE JT 1994 (6) SC 80; CCE vs. Parle
Exports (P) Ltd. 1989 (1) SCC 345; and Union of India vs. Wood
Papers Ltd. 1990 (4) SCC 246. With regard to this contention, the High
Court held that the language with which the case at hand was concerned was
clear and unambiguous and, therefore, there was no need for seeking the intention
and going into the question whether a strict or liberal interpretation was
called for.

The better view is that a house, which is
otherwise a residential house by its nature, cannot cease to be a residential
house merely on the ground that it has been used for non-residential purpose,
unless it is found that the intention of the assessee was never to put that
house for residential use. This principle should equally apply while
determining the number of houses owned by the assessee as on the date of transfer
of the original asset while applying the proviso to sub-section (1) of section
54F without any exception. Two diagonally opposite views may not be taken while
interpreting the same expression ‘residential house’ used at two different
places in the same section, unless warranted by the rule of beneficial
interpretation, where two views are possible.

It is
interesting to see that the assessee in both the cases, in either of the
situations, has been allowed the exemption by the Tribunal, perhaps indicating
that the benefit of the exemption should not be denied by laying undue emphasis
on the approval by the authorities and the use thereof. As long as the assessee
is seen to have complied with the other conditions, the benefit under the
beneficial provisions should be granted and not denied. Accepting this would
even be the best view.

shailesh.kwebmaker

REOPENING CASES OF INTIMATION u/s. 143(1)

ISSUE FOR CONSIDERATION

Section 147 of the Income Tax Act, 1961
provides for reassessment of income which has escaped assessment for any
assessment year. The section reads as under:

“Income Escaping Assessment

If the Assessing Officer has reason to
believe that any income chargeable to tax has escaped assessment for any
assessment year, he may, subject to the provisions of sections 148 to 153,
assess or reassess such income and also any other income chargeable to tax
which has escaped assessment and which comes to his notice subsequently in the
course of the proceedings under this section, or recompute the loss or the
depreciation allowance or any other allowance, as the case may be, for the
assessment year concerned (hereafter in this section and in sections 148 to 153
referred to as the relevant assessment year) :

Provided that where an assessment under
sub-section (3) of section 143 or this section has been made for the relevant
assessment year, no action shall be taken under this section after the expiry
of four years from the end of the relevant assessment year, unless any income
chargeable to tax has escaped assessment for such assessment year by reason of
the failure on the part of the assessee to make a return under section 139 or
in response to a notice issued under sub-section (1) of section 142 or section
148 or to disclose fully and truly all material facts necessary for his
assessment, for that assessment year:”

The issue of applicability of the above
referred proviso to section 147 has come
up before the courts in cases where no assessment has been made u/s. 143(3),
but merely an intimation has been issued u/s. 143(1). In other words, in cases
where more than 4 years have expired from the end of the relevant assessment
year, is the A.O. required to satisfy and establish that there was a failure on
the part of the assessee to disclose
fully and truly all material facts necessary for the assessment for a valid
reopening of the case? While the Madras High Court has taken the view that
the proviso applies even in cases of
intimation u/s. 143(1) and the A.O is
required to establish that there was a failure to disclose material facts
before reopening a case, the Gujarat High Court has taken a contrary view that
the proviso applies only in the case of
assessments u/s. 143(3).

EL FORGE’S CASE

The issue came up before the Madras High
Court in the case of EL Forge Ltd vs. Dy CIT 45 taxmann.com 402.

In this case, an intimation was issued u/s.
143(1) on 31^st December, 1991 for assessment year 1989-90. The
assessing officer thereafter noticed that the assessee had claimed deduction
u/s. 80HH and 80-I on the total income before set off of unabsorbed losses of
earlier years. Therefore, as the assessing officer was of the view that the
assessee was not entitled to deduction under chapter VI-A, reassessment proceedings
were initiated u/s. 147 and a notice was issued u/s. 148 on 15^th
December, 1997.

The assessee objected to the reopening of
the assessment, contending that as the reopening was made after a lapse of 4
years from the end of the assessment year, and as there was no failure on the
part of the assessee to disclose all material facts necessary for making the
assessment, the reopening was not valid.

The Commissioner (Appeals) rejected the
assessee’s claim and dismissed the appeal, holding that the reopening of the
assessment by the assessing officer was perfectly in order. The Tribunal held
that the assessee did not disclose fully and truly all material facts, and
therefore agreed with the finding of the assessing officer as well as the
Commissioner (Appeals). It held that the reopening of the assessment was
justified, as it was well within the period provided for under the proviso to
section 147.

Before the Madras High Court, besides pointing
out on behalf of the assessee that the notice u/s. 147 did not give any
independent reasons for reopening of assessment u/s. 147, it was argued that the details of the income
computation were very much before the assessing officer. The assessee therefore
claimed that the assessing officer had not shown that there was a failure to
disclose material facts necessary for assessment.

The Madras High Court observed that the
facts of the case showed that there was no denial of the fact that the assessee
had disclosed details of carry forward of the losses as well as the computation
of income, and that these details were very much before the assessing officer.
It observed that there was no denial of the fact that there was no failure on
the part of the assessee in disclosing the facts necessary for assessment, and
there was no allegation that the escapement of income was on account of failure
of the assessee to disclose fully and truly all material facts for assessment.

Applying the decision of the Supreme Court
in Kelvinator’s case, the Madras High Court accepted the argument of the
assessee that the assumption of jurisdiction beyond four years was hit by the
limitation provided under the proviso to section 147. The Madras High Court
therefore allowed the appeal of the assessee.

LAXMIRAJ DISTRIBUTORS’ CASE

The issue again came up before the Gujarat
High Court in the case of Pr CIT vs. Laxmiraj Distributors (P) Ltd 250
Taxman 455.

In this case, the assessee, a company, had
filed its return of income for assessment year 2009-10 on 13^th
September, 2009. The return was accepted and an intimation was issued u/s.
143(1). Subsequently, a survey was carried out on the premises of the company.
During the course of such survey, several documents were seized and a statement
of a director of the company was recorded on 30^th August, 2012.

The assessee also wrote a letter on 4^th
September, 2012 to the assessing officer, in which it stated that the company
had verified its records for various years, that it might not be possible to substantiate certain
issues and transactions recorded in the regular books of account as required by
law, as it would take a lot of time and effort, and that it would like to avoid
protracted litigation. To avoid litigation and penalty and to buy peace, the
company stated that it would voluntarily disclose an amount of Rs. 9 crore as
it’s undisclosed income, comprising of Rs. 7.52 crore for assessment year
2009-10 towards share capital reserves and Rs. 1.48 crore for assessment year
2013-14 towards estimated profit for the year of survey. In such letter,
details of the companies to which 7.52 lakh shares were allotted with premium
of Rs. 6.77 crore were given.

In spite of such letter, the company did not
offer such income to tax. The assessing officer therefore issued notice on 13^th
February, 2013 u/s. 148, to reopen the assessment for assessment year 2009-10.
The reason recorded for such reassessment was that the income disclosed as a
result of survey at Rs. 7.52 crore was over and above the income of Rs. 78.47
lakh returned in the original return of income.

In reassessment proceedings, an addition of
Rs. 7.52 crore as bogus share capital was made. The Commissioner (Appeals)
rejected the assessee’s appeal.

The ground of
validity of the notice of reopening was raised before the Tribunal for the
first time. The Tribunal permitted raising of such ground, since it touched
upon the very jurisdiction of the assessing officer to reassess the income.

The Tribunal held that reopening of
assessment was bad in law, and therefore it did not enter into the question of
correctness of the additions. The Tribunal referred to the Supreme Court
decisions in the case of ITO vs. Lakhmani Mewal Das 103 ITR 437, and Asst
CIT vs. Rajesh Jhaveri Stock Brokers (P) Ltd 291 ITR 500, and the decision
of the Gujarat High Court in the case of Inductotherm (India) (P) Ltd vs. M
Gopalan, Dy CIT 356 ITR 481, and proceeded to annul the reassessment on the
ground that the formation of belief by the assessing officer that income
chargeable to tax had escaped assessment was erroneous on account of the fact that there was no
corroborative evidence casting doubts on the assessee’s share capital received
up to the date of issue of the notice of reopening. According to the Tribunal, the
basic tenet of cause effect relationship between the reasons for reopening and
the taxable income having escaped assessment was not made out by the assessing
officer.

The Gujarat High Court observed that, in the
case of Rajesh Jhaveri Stock Brokers (P) Ltd (supra), the Supreme Court
highlighted a clear distinction between assessment under section 143(1) and
assessment made by the assessing officer after scrutiny u/s. 143(3). Such distinction was noticed in the background of the
notice of reassessment where the return of the assessee was accepted u/s.
143(1). The Supreme Court had observed that, in the scheme of things, the
intimation u/s. 143 (1) could not be treated to be an order of assessment, and
that being the position, the question of change of opinion did not arise. The
Gujarat High Court further observed that the ratio of the decision was
reiterated in a later judgement of the Supreme Court in the case of Dy CIT
vs. Zuari Estate Development & Investment Co Ltd 373 ITR 661.

The Gujarat High Court also referred to its
decision in the case of Inductotherm (supra), where the court observed
that even in case of reopening of an assessment where the return was accepted
without scrutiny, the requirement that the assessing officer had reason to
believe that income chargeable to tax had escaped assessment, would apply.

The Gujarat High Court further referred to
the Supreme Court decision in the case of Lakhmani Mewal Das (supra),
where it had been held that the reasons for the formation of the belief contemplated
by section 147 for the reopening of an assessment must have a rational
connection or relevant bearing on the formation of the belief. Rational
connection postulated that there must be a direct nexus or live link between
the material coming to the notice of the assessing officer and the formation of
his belief that there had been escapement of the income of the assessee from
assessment.

Culling out the ratio of those decisions,
the Gujarat High Court stated that what broadly emerged was that there was a
vital distinction between the reopening of an assessment where the return of an
assessee had been accepted u/s. 143 (1) without scrutiny, and where the
scrutiny assessment had been framed.
According to the Gujarat High Court, in the former case, the assessing officer
could not be stated to have formed any opinion, and therefore, unlike in the
latter case, the concept of change of opinion would have no applicability. The
common thread that would run through both sets of exercises of reopening of assessment
was that the assessing officer must have reason to believe that income
chargeable to tax had escaped assessment.

Looking at the facts of the case and the
observations of the Tribunal, the Gujarat High Court observed that the Tribunal
had evaluated the evidence on record in minutest detail, as if each limb of the
assessing officer’s reasons recorded for issuing notice of reassessment was in
the nature of an addition made in assessment order, which had either to be
upheld or reversed, which, according to the High Court, was simply
impermissible.

The Gujarat High Court referred to the
decision of the Delhi High Court in the case of Indu Lata Rangwala vs. Dy
CIT 384 ITR 337, where the Delhi High Court had taken the view that where
the return initially filed was processed u/s. 143(1), there was no occasion for
the assessing officer to form an opinion after examining the documents enclosed
with the return. In other words, the requirement in the first proviso to
section 147 of there having to be a failure on the part of the assessee “to
disclose fully and truly all material facts” did not at all apply whether the
initial return had been processed u/s. 143(1). In that case, the Delhi High
Court had taken the view that it was not necessary in such a case for the
assessing officer to come across some fresh tangible material to form reasons
to believe that income had escaped assessment.

The Gujarat
High Court thereafter considered the decision of the Madras High Court in the
case of EL Forge (supra) and expressed its inability to concur with the
view of the Madras High Court in the said case where it held that the condition
that there was a failure to disclose the material facts for the purposes of
assessment was required to be satisfied even in cases of intimation issued u/s.
143(1). According to the Gujarat High Court, the proviso to section 147 would
apply only in a case where an assessment
had been framed after scrutiny. In a case where the return was accepted u/s.
143(1), the additional requirement that income chargeable to tax had escaped
assessment on account of the failure on the part of the assessee to disclose
truly and fully all material facts, would simply not apply. According to the
Gujarat High Court, the decision of the Supreme Court in Kelvinator’s
case did not apply, to the facts of the
case before the court, as that was a case in which the original assessment was
framed after scrutiny.

The Gujarat High Court therefore allowed the
appeal of the revenue, quashing the conclusion of the Tribunal that the notice
of reopening of assessment was invalid.

OBSERVATIONS

Reading the proviso in the manner, as is read by the Gujarat High Court, would mean that in all
cases of the intimation u/s. 143(1) where other things are equal, the time
limit for reopening gets automatically extended to six years from the end of
the assessment year and that the requirement to satisfy the disclosure test has
to be met with only in cases of assessment u/s. 143(3) and is otherwise dispensed with in cases of intimation u/s. 143(1). On a reading
of the Proviso this does not appear to be the case and even on the touchstone
of common sense there appears to be a
case that the requirement to satisfy the disclosure test should not be
restricted to section 143(3) cases only. A failure by the AO to initiate the
proceedings u/s. 143(2) and again under the main provisions of section 147,
within the time prescribed under the respective provisions can not be remedied
by resorting to the reading of the proviso in a convenient manner that
gives a license to the AO to reopen a
case even after a lapse of a long time
and deny the finality to the proceedings in cases where there otherwise is not
a failure to disclose the material on the part of the assessee. Such an
understanding is strongly supported by the overall scheme of the Income tax
Act.

In cases where the assesssee has disclosed
the material facts and the AO has failed to have a prima facie look into
the facts, in time, and fails to pursue the matter appropriately, within the
prescribed time, it is reasonable to hold that his power to reopen a case comes
to an end irrespective of the fact that the assessment was not made u/s.
143(3).

Even otherwise, it is not unreasonable to
hold that in cases where the assessee has made an adequate disclosure of facts,
then the same are deemed to have been considered by the AO and therefore his
inaction, within the prescribed time, should be construed to be a case of a
change of opinion.

It is difficult to appreciate that the
standards that are applicable to the cases covered by section 143(3) are not
applied to cases covered by section 143(1) for no fault of the assessee more so when the assessee has no control over
the action or inaction of the AO. It is not the assessee who prevented the AO
from scrutinising the return of income. In fact, permitting the AO to have a
longer time than it is prescribed is giving him a premium for his inefficiency
of not having acted within the time when he should have.

The decision of the Gujarat High Court in Laxmiraj’s
case, is the one delivered on very peculiar facts involving an admission by the
assessee firm at the time of survey and not following it us with the offer for
tax in spite of admitted facts that were not denied by the assessee later on at
the time of even reassessment. The SLP file by the assessee against the
decision has been rejected by the Supreme Court 95 taxxmann.com
109(SC).

The Madras High Court in case of TANMAC India vs. Dy.CIT 78 taxmann.com 155 (Mad.) held
that if after issuing intimation u/s. 143(1) of the Act, the Assessing
Officer did not issue notice of scrutiny assessment u/s. 143(2) of the Act, it
would not be open for the Assessing Officer thereafter to resort to reopening
of the assessment. The High Court in deciding the case placed heavy reliance on
the decision of Delhi High Court in case of CIT vs. Orient Craft Ltd. 354
ITR 536 in which the distinction between scrutiny assessment and a
situation where return has been accepted u/s. 143(1) was narrowed down. The
Court had applied the concept of true and full disclosure even in case of
reopening assessment where return was accepted u/s. 143(1) of the Act.

It seems that the excessive reliance on the
ratio of the Supreme Court cases in Rajesh Jhaveri Stock Brokers’ case
(supra) and Zuari Estate & Investment Co.‘s case (supra) requires a fresh
consideration and perhaps was uncalled for. The issue in those cases has been about whether there could be a
change of opinion in a case where an intimation u/s. 143(1) was issued and
whether there was a need to have the
reason to believe that income has escaped income in such cases of intimation
and whether an intimation was different form an order. The issue under consideration, namely, the
application of the first proviso to section 147 was not an issue before
the court in both the cases. It is
respectfully submitted that in the below quoted part of the decision, the
Supreme Court inter alia held that the condition of the First Proviso to
section 147 were required to be satisfied for a valid reopening of a case
involving even an intimation issued u/s. 143(1) of the Act.

“The scope and effect of section
147 as substituted with effect from 1-4-1989, as also sections 148 to 152 are
substantially different from the provisions as they stood prior to such
substitution. Under the old provisions of section 147, separate clauses (a) and
(b) laid down the circumstances under which income escaping assessment for the
past assessment years could be assessed or reassessed. To confer jurisdiction
under section 147(a) two conditions were required to be satisfied firstly the
Assessing Officer must have reason to believe that income profits or gains
chargeable to income tax have escaped assessment, and secondly he must also
have reason to believe that such escapement has occurred by reason of
either omission or failure on the part
of the assessee to disclose fully or truly all material facts necessary for his
assessment of that year. Both these conditions were conditions precedent to be
satisfied before the Assessing Officer could have jurisdiction to issue notice
under section 148 read with section 147(a). But under the substituted section
147 existence of only the first condition suffices. In other words if the
Assessing Officer for whatever reason has reason to believe that income has
escaped assessment it confers jurisdiction to reopen the assessment. It is
however to be noted that both the conditions must be fulfilled if the case
falls within the ambit of the proviso to section 147.” The disclosure of
the material facts is a factor that can not be ignored even in the case of
intimation simply because the first proviso expressly refers only to the order
of assessment u/s. 143(3). It appears that the last word on the subject has yet
to be said and sooner the same is said by the Supreme Court, is better.

shailesh.kwebmaker

SPORTS ASSOCIATIONS AND PROVISO TO SECTION 2(15)

ISSUE FOR
CONSIDERATION

A charitable
organisation is entitled to exemption from tax under sections 11 and 12 of the
Income-tax Act, 1961 in respect of income derived from property held under
trust for charitable purposes. The term ‘charitable purpose’ is defined in
section 2(15) as under:

‘“charitable purpose”
includes relief of the poor, education, yoga, medical relief, preservation of
environment (including watersheds, forests and wildlife) and preservation of
monuments or places or objects of artistic or historic interest, and the
advancement of any other object of general public utility:

Provided that
the advancement of any other object of general public utility shall not be a
charitable purpose, if it involves the carrying on of any activity in the
nature of trade, commerce or business, or any activity of rendering any service
in relation to any trade, commerce or business, for a cess or fee or any other
consideration, irrespective of the nature of use or application, or retention,
of the income from such activity, unless –

(a) such activity is undertaken in the course of
actual carrying out of such advancement of any other object of general public
utility; and

(b) the aggregate receipts from such activity or
activities during the previous year do not exceed twenty per cent of the total
receipts, of the trust or institution undertaking such activity or activities,
of that previous year;’

For the purposes of
income tax exemption, promotion of sports and games is regarded as a charitable
activity, as clarified by the CBDT vide its Circular No. 395 dated 14^th
September, 1984. Many sports associations conduct tournaments where sizeable
revenues are generated from sale of tickets, sale of broadcasting and
telecasting rights, sponsorship, advertising rights, etc. resulting in earning
of a large surplus by such associations.

The issue has
arisen before the appellate authorities as to whether such sports associations
can be regarded as carrying on an activity in the nature of trade, commerce or
business and whether their activities of conducting tournaments cease to be
charitable activities by virtue of the proviso to section 2(15), leading to
consequent loss of exemption under sections 11 and 12. While the Jaipur,
Chennai, Ahmedabad and Ranchi Benches of the Tribunal have held that such
activity does not result in a loss of exemption, the Chandigarh Bench has
recently taken a contrary view, holding that the association loses its
exemption for the year due to such activity.

THE RAJASTHAN
CRICKET ASSOCIATION CASE

The issue came up
before the Jaipur Bench of the Tribunal in Rajasthan Cricket Association
vs. Addl. CIT, 164 ITD 212.

In this case, the
assessee was an association registered under the Rajasthan Sports
(Registration, Recognition and Regulation of Association) Act, 2005. It was
formed with the objective of promotion of the sport of cricket within the state
of Rajasthan. The main object of the association was to control, supervise,
regulate, or encourage the game of cricket in the areas under the jurisdiction
of the association on a ‘no profit-no loss’ basis. It was granted registration
u/s 12A. The assessee had filed its return claiming exemption u/s 11 for the
assessment year 2009-10.

During the course
of assessment proceedings, the AO observed that the assessee had earned
substantial income in the shape of subsidy from the Board of Control for
Cricket in India (BCCI), advertisement income, membership fees, etc. and
concluded that since the assessee was earning huge surplus, the same was not in
the nature of charitable purpose and was rather in the nature of business. The
AO, therefore, denied exemption u/s 11, computing the total income of the
association at Rs. 4,07,58,510, considering the same as an AOP. The
Commissioner (Appeals) upheld the order of the AO confirming the denial of exemption
u/s 11.

It was argued
before the Tribunal on behalf of the assessee that:

(i) the term ‘any activity in the nature of
trade, commerce or business’ was not defined and thus the same had to be
understood in common parlance and, accordingly, the expression ‘trade, commerce
or business’ has to be understood as a regular and systematic activity carried
on with the primary motive to earn profit, whereas the assessee never acted as
a professional advertiser, TV producer, etc.;

(ii) no matches of any game other than cricket or
no other events were organised to attract an audience, only cricket matches
were being organised, whether the same resulted in profit or loss. Further, not
all the cricket matches attracted an audience – the surplus had been earned
only from one cricket match;

(iii) the Hon’ble Madras High Court in the case of Tamil
Nadu Cricket Association, 360 ITR 633 had held that volume should not
be the sole consideration to decide the activity of the society – rather, the
nature of activity vis-a-vis the predominant object was to be seen;

(iv) being registered under the Rajasthan Sports
(Registration, Recognition and Regulation of Association) Act, 2005, the
assessee was authorised as well as well-equipped for organising all the cricket
matches taking place in the state of Rajasthan.

(v) all the payments in the shape of sponsorship,
advertisements, TV rights, etc. were received directly by BCCI which had later
shared such receipts with the assessee. Further, BCCI had delegated the task of
the organisation of matches to state associations and, in turn, state
associations were paid some funds for promotion and expansion of their
charitable activities;

(vi) a major benefit of organising the matches was
that the local teams, being trained by RCA, got an opportunity to learn from
the experience of coaches of international calibre assisting them during
practice matches and by witnessing the matches played by international players,
by spending time with them, etc. Ultimately, organising such matches resulted
in promotion of the sport of cricket and the surplus generated, if any, was purely
incidental in nature;

(vii) the assessee had been organising matches even
in the remote areas of Rajasthan where there few spectators and the assessee
association had to essentially incur losses in organising such matches;

(viii) the surplus was the result of subsidies only
and not from the conducting of tournaments on a commercial basis. The subsidies
were a form of financial aid granted for promoting a specific cause, which was
ultimately for the overall benefit of a section of the public, but never for
the benefit of an individual organisation. The subsidy received was utilised in
the promotion and development of the sport of cricket in the state at each
level, i.e., from mofussil areas to big cities like Jaipur;

(ix) the renting of premises was done wholly and
exclusively for the purpose of cricket and no other activity of whatsoever
nature had been carried out, and neither was it engaged in the systematic
activity as a hotelier;

(x) RCA was run by a committee which consisted of
members from different walks of life – such members were not professional
managers or businessmen. The agreement with the players was only to control and
monitor their activities, to ensure that the same was in accordance with the
objects;

(xi) The RCA was providing technical and financial
support to all the DCAs (District Cricket Associations), i.e., providing
equipments, nets, balls, etc. without any consideration. RCA was getting only
nominal affiliation fee from them and had provided grants of a substantial
amount to the DCAs;

(xii) RCA was organising various matches of national
level tournaments like Ranji Trophy, Irani Trophy, Duleep Trophy, Maharana
Bhagwat Singh Trophy, Salim Durrani Trophy, Laxman Singh Dungarpur Trophy,
Suryaveer Singh Trophy, matches for under-14s, u-15s, u-19s, u-22s, etc.,
without having any surplus. Rather, they were organised for the development of
the game of cricket at the national level and to identify the players who could
represent the country at the international level;

(xiii) RCA was spending a large amount on the
training and coaching camps for which no fee was charged from the participants;

(xiv) the assessee had organised several
championships in various interior towns and smaller cities of Rajasthan in
order to provide an opportunity and to create a competitive environment for the
talented youth, without any profit motive and with the sole intention to
promote the game of cricket;

(xv) the surplus, if any, generated by the
assessee was merely incidental to the main object, i.e., promotion of the sport
of cricket and in no way by running the ‘business of cricket’.

Reliance was placed
on behalf of the assessee on the following decisions:

(a) the Delhi High Court in the case of Institute
of Chartered Accountants of India vs. Director-General of Income Tax
(Exemptions) 358 ITR 91;

(b) the Madras High Court in the case of Tamil
Nadu Cricket Association vs. DIT(E) 360 ITR 633;

(d) the Delhi bench of the ITAT in the case of DDIT
vs. All India Football Federation 43 ITR(T) 656.

On behalf of the
Revenue, it was argued that:

(1) the entire argument of the assessee revolved
around the theory that grant of registration u/s 12A automatically entitled it
for exemption u/s 11. The case laws cited by the assessee in the case of the T.N.
Cricket Association and DDCA, etc., were in the context
of section 12A and were inapplicable;

(2) the domain of registration u/s 12AA and
eligibility for exemption u/s 11 were totally independent and different. At the
time of registration, CIT was not empowered to look into the provisions of
section 2(15); these were required to be examined only by the AO at the time of
assessment;

(3) once the first proviso to section 2(15) got
attracted, the assessee lost the benefit of exemption as per the provisions of
section 13(8) – therefore, the only question to be decided was whether the
assessee was engaged in commercial activity for a fee or other consideration;

(4) the nature of receipt in the hands of the
assessee was by way of sharing of sponsorship and media rights with BCCI, as
well as match revenue for conducting various cricket matches. The assessee had earned
surplus of 75% out of the receipts in the shape of advertisement, canteen and
tickets, which amounted to super-normal profit. Therefore, the income of the
assessee from ‘subsidy’ was nothing but a percentage of the fee gathered from
the public for matches and a percentage of advertisement receipts while
conducting matches;

(5) the nature of receipts in the hands of the
assessee certainly fell under ‘Trade & Commerce’ as understood in common
parlance. Once the receipts were commercial in nature and such receipts
exceeded the threshold of
Rs. 10 lakhs as the proviso then provided (both conditions satisfied in the
assessee’s case), the assessee would be hit by the proviso to section 2(15);

(6) and once the proviso to 2(15) was attracted,
the assessee ceased to be a charitable organisation irrespective of whether it
was registered u/s 12A. Grant of registration u/s 12A did not preclude the AO
from examining the case of the assessee in the light of the said proviso and if
he found that the assessee was hit by the proviso, then the assessee ceased to
be a charitable organisation;

(7) the receipts of ICAI were basically from
members (and not the public as in the case of the assessee) and did not exploit
any commercial / advertisement / TV rights as in the case of the assessee. One
test of the commercialism of receipt was whether receipts were at market rates
and were open to subscription by the general public as opposed to a select few
members;

(8) and once the provisos to 2(15) were attracted,
the assessee lost the benefit of exemption u/s 11 as per section 13(8) and the
entire income became taxable.

The Tribunal noted
that the Revenue had not doubted that the assessee had conducted cricket
matches; the only suspicion with regard to the activity was that during the
One-Day International match played between India and Pakistan there was huge
surplus and the assessee had rented out rooms belonging to the association at a
very high rate. Therefore, according to the Tribunal, it could be inferred that
the AO was swayed by the volume of receipts. It noted that these identical
facts were also before the Hon’ble Madras High Court in the case of Tamil
Nadu Cricket Association vs. DIT (Exemptions) 360 ITR 633, wherein the
Court opined that from the volume of receipts an inference could not be drawn
that an activity was commercial and that those considerations were not germane
in considering the question whether the activities were genuine or carried on
in accordance with the objects of the association.

Further, it was not
in dispute that the TV subsidy, sale on advertisements, surplus from the ODI
between India and Pakistan, income from the RCA Cricket Academy were all
related to the conduct of cricket matches by the association. Without the
conduct of matches, such income could not have been derived. Therefore, the
incomes were related to the incidental activity of the association which
incomes could not accrue without the game of cricket.

The Tribunal, while
examining the facts from the perspective of volume of receipts and constant
increase in surplus, referred to the Supreme Court decision in the case of Commissioner
of Sales Tax vs. Sai Publication Fund [2002] 258 ITR 70, for holding
that where the activity was not independent of the main activity of the assessee,
in that event, such ancillary activity would not fall within the term
‘business’.

It added that the
objection of the AO was that the other activities overshadowed the main
activity, based upon the receipts of the assessee from the other activity. It,
however, noted that all those activities were dependent upon the conduct of the
match. Referring to various High Court decisions, the Tribunal was of the view
that the AO was swayed by the figures and the volume of receipts. It noted that
such receipts were intermittent and not regular and also were dependent on the
conduct of cricket matches. It was not the other way round, that the cricket
matches were dependent upon such activities. According to the Tribunal, the
facts demonstrated that the assessee had been predominantly engaged in the
activity of promoting cricket matches. The Tribunal, therefore, held that the
AO was not justified in declining the exemption.

A similar view has
also been taken by the Tribunal in the cases of Tamil Nadu Cricket
Association vs. DDIT(E) 42 ITR(T) 546 (Chen.); DCIT(E) vs. Tamil Nadu Cricket
Association 58 ITR(T) 431 (Chen.); Gujarat Cricket Association vs. JCIT(E) 101
taxmann.com 453 (Ahd.); Jharkhand State Cricket Association vs. DCIT(E) (Ran.);
Chhattisgarh State Cricket Sangh vs. DDIT(E) 177 ITD 393 (Rai.); and DDIT(E)
vs. All India Football Federation 43 ITR(T) 656 (Del).

THE PUNJAB CRICKET ASSOCIATION CASE

The issue again
came up before the Chandigarh Tribunal in the case of the Punjab Cricket
Association vs. ACIT 109 taxmann.com 219.

In this case, the
assessee cricket association was a society registered under the Societies
Registration Act, 1860. It was also registered u/s 12A of the Income Tax Act.
It filed its return of income claiming exemption u/s 11 for the assessment year
2010-11.

The AO observed
that the income of the assessee was inclusive of an amount of Rs. 8,10,43,200
from IPLsubvention from BCCI and Rs. 6,41,100 as service charges for IPL
(Net). The AO observed that the IPL event was a highly commercial event and the
assessee had generated income from the same by hosting matches of Punjab
franchisee ‘Kings XI, Punjab’ during the Indian Premier League through TV
rights subsidy, service charges from IPL and IPL-subvention, etc. Similarly,
the assessee had earned income from the facilities of swimming pool, banquet
hall, PCA chamber, etc., by hosting these facilities for the purpose of
recreation or one-time booking for parties, functions, etc., which activities
were commercial in nature, as the assessee was charging fees for providing the
facilities to its members. The assessee had also received income from M/s
Silver Services who provided catering services to Punjab Cricket Club and its
restaurant, which again was a commercial activity, as the assessee was earning
income from running of the restaurant which was not related to the aims and
objectives of the society. According to the AO, the activities of the assessee
were not for charitable purposes, and therefore, in view of the proviso to
section 2(15), he disallowed the claim of exemption u/s 11.

The Commissioner
(Appeals) dismissed the appeal of the assessee observing that:

(a) it could not be disputed that the Indian
Premier League was a highly commercialised event in which huge revenue was
generated through TV rights, gate-money collection, merchandising and other
promotions;

(b) the franchises had been sold to corporates
and individuals and in this process, the appellant had received a huge income
of Rs. 8,10,43,200 for IPL-subvention from BCCI, service charges (Net) of Rs.
6,41,100 and reimbursement of Rs. 1,86,64,990 from BCCI;

(c) the argument of the appellant that all the
tickets of the IPL matches were sold by the BCCI or the franchisee team, and
the IPL players were sold in public auction for a huge amount, was all done by
the BCCI and the appellant had no role in conducting these matches, could not
be accepted, as huge revenue was generated in this commercial activity and
whether it was done by BCCI or by the appellant, the share of the income so generated
had been passed on to the appellant;

(d) the Chennai Tribunal’s decision in the case
of Tamil Nadu Cricket Association (Supra) did not apply to the
appellant’s case as in that case the assessee had received funds from BCCI for
meeting the expenditure as the host, while in the case of the appellant it was
not only the reimbursement of expenses but over and above that a huge amount
had been passed on to the appellant;

(e) the activity generating the income, whether
undertaken by BCCI or by the appellant, was purely a business activity of which
the appellant was a beneficiary.

It was argued before the Tribunal on behalf of the assessee that:

the assessee was not involved in any manner
in organising or commercially exploiting the IPL matches. The commercial
exploitation, if any, was done by the BCCI;

the only activity on the part of the
assessee was the renting out of its stadium to BCCI for holding of IPL matches;

‘T-20’ or IPL was also a
form of popular cricket. Since the main object of the assessee was the
promotion of the game of cricket, considering the popularity of the IPL
matches, the renting out of the stadium for the purpose of holding of IPL
matches by the BCCI for a short period of 30 days in a year was an activity
towards advancement of the objects of the assessee, of promotion of the game;

in lieu of providing the
stadium, the assessee got rental income for a short period and renting out the
stadium was not a regular business of the assessee;

the grant received from the
BCCI during the year under consideration in the form of share of TV subsidy of
Rs. 18,00,76,452 and IPL subvention of Rs. 8,10,43,200 was part of the largesse
distributed by BCCI to its member associations at its discretion for promotion
of the sport of cricket;

BCCI was not obliged to
distribute the earnings generated by it to state cricket associations and no
such association could claim, as an integral right, any share in the earnings
of BCCI;

even if a member state
association did not provide any assistance in holding of the IPL matches, or
when the IPL match was not hosted or organised at the stadium of an
association, yet the member cricket association got a grant out of the TV
subsidy. However, if a match was staged or hosted at the ground of an
association, the amount of subsidy was increased;

whatever had been received
from the BCCI on account of IPL subvention was a voluntary, unilateral donation
given by BCCI to various cricket associations, including the assessee, to be
expended for the charitable objects of promotion of the game of cricket and not
in lieu of carrying out any activity for conducting of IPL;

the assessee had no locus
with respect to the promotion and conduct of IPL, except for the limited extent
of providing its stadium and other allied services for holding of the matches.
The question whether the conduct of IPL was a commercial activity or not might
be relevant from BCCI’s standpoint, but not to the case of the assessee;

the assessee’s income,
including grants received from BCCI, was applied for attainment of the objects
of the assessee society, i.e., mainly for promotion of the game of cricket;

the assessee was running a
regional coaching centre wherein gaming equipment / material was also provided
such as cricket balls, cricket nets, etc. The assessee also distributed grants
to the district cricket associations attached to it for the purpose of laying
and maintenance of grounds, purchase of equipment, etc., as well as for holding
of matches and for the purpose of promoting the game of cricket;

the assessee conducted
various tournaments for the member district cricket associations. On the basis
of the inter-district tournaments, players were selected for the Punjab team
who underwent training at various coaching camps and thereafter the teams were
selected to participle in the national tournaments for different age groups. In
addition, financial assistance had also been provided to the ex-Punjab players
in the shape of monthly grants;

the assessee was also
maintaining an international cricket stadium, which gave needed practice and
exposure to the cricketers. Even other sports facilities like swimming pool,
billiards, lawn tennis, etc., were provided to the members as well as to the
cricketers, which activities were also towards the achievement of the objects
of the assessee society;

the assessee had been
spending substantial amounts towards development of the game at the grassroots
level and also for the development and promotion of the game by holding
international matches;

the assessee was only
conducting activities in pursuance of the objects, i.e., the promotion of the
game of cricket in India and that merely because some revenue had been
generated in pursuance of such activities, the same was not hit by the proviso
to section 2(15);

the Supreme Court had held
in CIT vs. Distributors (Baroda) (P) Ltd. 83 ITR 377 that
‘business’ refers to real, substantial, organised course of activity for
earning profits, as ‘profit motive’ is an essential requisite for conducting
business;

Delhi High Court in India
Trade Promotion Organization vs. DIT(E) 371 ITR 333, reading down the
scope of the proviso to section 2(15), had held that an assessee could be said
to be engaged in business, trade or commerce only where earning of profit was
the predominant motive, purpose and object of the assessee and that mere
surplus from incidental or ancillary activities did not disentitle claim of
exemption u/s 11;

Punjab & Haryana High
Court in the cases of The Tribune Trust vs. CIT & CIT (Exemptions)
vs. Improvement Trust, Moga 390 ITR 547 had approved the predominant
object theory, i.e. if the predominant motive or act of the trust was to
achieve its charitable objects, then merely because some incidental income was
being generated that would not disentitle the trust to claim exemption u/s 11
r.w.s. 2(15);

all the incidental income /
surplus so earned by the assessee in the course of advancement of its object of
promotion of the game of cricket had been ploughed back for charitable
purposes;

profit-making was not the
motive of the assessee and the only object was to promote the game of cricket.

It was argued on
behalf of the Revenue that:

(1) in the annual report of BCCI, the concept of
IPL was described as merger of sport and business – the various IPL-related
activities described in the report indicated that the entire IPL show was a
huge money-spinner and had been rightly termed as ‘cricketainment’ by the BCCI;

(2) the 38^th Report of the Standing
Committee on Finance, dealing with Tax Assessment / Exemptions and related
matters concerning IPL / BCCI, mentioned that the income derived from media
rights and sponsorships was shared with the franchisees as envisaged in the
franchise agreement. The franchisees had to pay the BCCI an annual fee which
BCCI distributed to the associations as subvention. The report highlighted the
commercial character of IPL, which established that no charitable activity was
being promoted in organising the commercial venture called BCCI-IPL;

(3) the Justice Lodha Committee, set up by the
Supreme Court, highlighted the unhealthy practices of match-fixing and betting.
Its report highlighted the indisputable fact that there was absolutely no
charitable work which was undertaken by the BCCI or its constituents while
organising the cricket, especially IPL, where the entire spectacle of
‘cricketainment’ was a glamorous money-spinner;

(4) the Justice Mudgal IPL Probe Committee, set up
by the Supreme Court, highlighted the allegation of match / spot-fixing against
players. It further found that the measures undertaken by the BCCI in combating
sporting fraud were ineffective and insufficient. The facts demonstrated that
no charitable activity was undertaken in various matches conducted by BCCI-IPL.
The report highlighted the commercial character of the venture sans any
trace of charitable activity;

(5) the Bombay High Court, in the case of Lalit
Kumar Modi vs. Special Director in WP No. 2803 of 2015, observed that
if the IPL had resulted in all being acquainted and familiar with phrases such
as ‘betting’, ‘fixing of matches’, then the RBI and the Central Government
should at least consider whether holding such tournaments served the interest
of a budding cricketer, the sport and the game itself;

(6) the tripartite agreement / stadium agreement
proved that the assessee was intrinsically and intimately involved in
organising the commercial extravaganza of the IPL. It required the PCA to
provide all the necessary co-operation and support to the BCCI-IPL and the
franchisee. It mandated the PCA to provide adequate, sufficiently skilled and
trained personnel to BCCI-IPL at its own cost. The PCA was duty-bound to ensure
that TV production took place at the stadium according to the requirements of
TV producers. It required PCA to erect and install all the desired facilities,
structures and equipment required in connection with the exploitation of media
rights at its own cost. It was to use its best endeavour to make areas
surrounding the stadium available for exploitation of the commercial rights.
The PCA agreed to assist the BCCI-IPL with local trading standard department,
police, private security arrangements, with a view to minimising or eliminating
certain exigencies pertaining to matches, advertising / promotions,
unauthorised sale of tickets, etc. All costs of such services were to be borne
by the PCA;

(7) the above clauses amply demonstrated that the
PCA, being the federal constituent and full member of BCCI, had taken various
steps / initiatives at its own cost to ensure that the BCCI-mandated IPL
matches were organised smoothly and were a huge commercial success;

(8) no claim was made on behalf of the assessee
that the BCCI-IPL matches were charitable activities;

(9) a perusal of the case laws cited on behalf of
the assessee revealed that the Hon’ble Courts therein were not presented with
public documents / Standing Committee Reports / facts wherefrom judicial notice
could be taken as per the Evidence Act.

Summons was issued
to the BCCI by the Tribunal for determination of the character of the amounts
paid by it to the assessee. BCCI clarified that there were two types of
payments made by it – reimbursements of expenditure which the state
associations had to incur for conduct of matches, and a share in the media
rights income earned by the BCCI. The claim of the BCCI was that these payments
were application of income for the purpose of computation of income u/s 11.
Since the tax authorities were denying BCCI the exemption u/s 11, strictly in
the alternative and without prejudice to its contention that the entire sum was
allowable as an application, BCCI had contended that the payments were
allowable as a deduction u/s 37(1).

The Tribunal observed that a perusal of the accounts of the BCCI revealed
that it had booked the above payments to the state associations as expenditure
out of the gross receipts. The BCCI had taken a clear and strong stand before
the tax authorities, including appellate authorities, that the payment to the
state associations was not at all an appropriation of profits. The Tribunal
noted certain appellate submissions made by the BCCI in its own case, which
seemed to indicate that it was organising the matches jointly with the state
associations.

In response to the
above observations, it was contended on behalf of the assessee that:

(a) the primary plea / stand of the BCCI is that
the payments / grants made by it to the state associations is application of
income, hence it is only a voluntary grant given by the BCCI to the state
associations, including the assessee, for the purpose of the promotion of the
game of cricket, hence it cannot be treated as income of the assessee from IPL
matches;

(b) the alternate stand of the BCCI that the
payments to the state associations be treated as expenditure in the hands of
the BCCI was opposite and mutually destructive to the primary stand of the BCCI
and thus could not be made the basis to decide the nature of receipts from BCCI
in the hands of the assessee;

(c) the Revenue authorities, even otherwise, have
consistently rejected the aforesaid alternate contention of the BCCI and the
entire receipts from the IPL had been taxed in the hands of the BCCI;

(d) if the BCCI was treated as an Association of
Persons (AOP) as per the plea of the Revenue, still, once the entire income
from IPL had been taxed in the hands of an AOP, further payment by BCCI to its
member associations could not be taxed as it would amount to double taxation of
the same amount.

The corresponding
submissions of the Revenue were:

(A) the Punjab Cricket Association was absolutely
involved in the commercial venture of IPL;

(B) BCCI had stated that it did not have the
infrastructure and the resources to conduct the matches by itself and was
dependent on the state associations to conduct them;

(C) according to BCCI, the income from media
rights was dependent on the efforts of the state associations in conducting the
matches from which the media rights accrued;

(D) as per the BCCI, the state
associations were entitled by virtue of established practice to 70% of the
media rights fee. It was in expectation of the revenue that the various state
associations took an active part and co-operated in the conduct of the matches.
The payment was therefore made only with a view to earn income from the media
rights;

(E) it was clear that the transaction between the
BCCI and the PCA was purely commercial in nature and the income / receipts
received by the PCA were in lieu of its services rendered to BCCI;

(F) the share of revenue from BCCI out of sale of
media rights was not a grant – the various payments made by the BCCI ensured
that the state associations were ever ready with their stadia and other
infrastructure to ensure smooth execution of IPL matches.

On the basis of the
arguments, the Tribunal observed that the status of the BCCI was of an
Association of Persons (AOP) of which the state associations, including the
assessee, were members. It noted that the BCCI, in its consistent plea before
the tax authorities had claimed that the payments made to the state
associations were under an arrangement of sharing of revenues with them. BCCI
had pleaded that it had just acted as a facilitator for the sale of media
rights collectively on behalf of the state associations for the purpose of
maximising the profits, for which it retained 30% of the profits and the
remaining 70% belonged to the state associations. According to the Tribunal,
when the payer, i.e., BCCI, had not recognised the payments made by it to the
state associations as voluntary grant or donation, rather, the BCCI had
stressed that the payments had been made to the state associations under an
arrangement arrived at with them for sharing of the revenues from international
matches and the IPL, then the payee (the recipient associations) could not
claim the receipts as voluntary grants or donations at discretion from the
BCCI.

The Tribunal,
however, noted that the legal status as of that date was that BCCI was being
treated by the tax authorities as an AOP and the payments made to the state
associations as distribution of profits. The BCCI payments to the state
associations, including the appellant, having already been taxed in the hands
of BCCI, could not be taxed again in the hands of the member of the AOP, i.e.,
the state association, as it would amount to double taxation of the same
amount.

Further, it
observed that the state associations in their individual capacity were pleading
that the IPL might be the commercial venture of their constituent and apex
body, the BCCI, but that they were not involved in the conduct of the IPL.
However, these associations had collectively formed the apex association named
BCCI, got it registered under the Tamil Nadu Societies Registration Act and
thereby collectively engaged in the operation and conduct of the IPL through
their representatives in the name of BCCI. As per the Tribunal, PCA was
individually taking a totally opposite stand to the stand it had taken
collectively with other associations under the umbrella named as BCCI.

The Tribunal
observed that it was settled law that what could not be done directly, that
could not be done indirectly, too. If an institution claiming charitable status
being constituted for the advancement of other objects of public utility as per
the provisions of law was barred from involving in any commerce or business, it
could not do so indirectly also by forming a partnership firm or an AOP or a
society with some other persons and indulge in commercial activity. Any
contrary construction of such provisions of law in this respect would defeat
the very purpose of its enactment.

According to the
Tribunal, the assessee was a full member of BCCI, which was an AOP, which had
been held to be actively involved in a large-scale commercial venture by way of
organising IPL matches, and therefore the assessee could be said to have been
involved in a commercial venture as a member of the BCCI, irrespective of the
fact whether it received any payment from the BCCI or not, or whether such
receipts were applied for the objects of the assessee or not. However, once the
income was taxed in the hands of the AOP, the receipt of share of the income of
the AOP could not be taxed in the hands of the member of the AOP. For the sake
of ease of taxation, the AOP had been recognised as a separate entity; however,
actually, its status could not be held to be entirely distinct and separate
from its members and that was why the receipt of a share by a member from the
income of its AOP would not constitute taxable income in the hands of the
member.

The Tribunal
observed that even otherwise, PCA was involved in commercial activity in a
systemic and regular manner not only by offering its stadium and other services
for conduct of IPL matches, but by active involvement in the conduct of matches
and exploiting their rights commercially in an arrangement arrived at with the
BCCI. According to the Tribunal, there was no denial or rebuttal by the
appellant to the contention that the IPL was purely a large-scale commercial
venture involving huge stakes, hefty investments by the franchisees, auction of
players for huge amounts, exploiting to the maximum the popularity of the game
and the love and craze of the people of India for cricket matches. From a
reading of the tripartite agreement, the Tribunal was of the view that it
showed that the assessee was systematically involved in the conduct of IPL
matches and not just offering its stadium on rent to BCCI for the conduct of
the matches.

The Tribunal
further accepted the Department’s argument that the BCCI, which was constituted
of the assessee and other state associations, had acted in monopolising its
control over cricket and had also adopted a restrictive trade practice by not
allowing the other associations, who may pose competition to the BCCI, to hold
and conduct cricket matches for the sole purpose of controlling and exclusively
earning huge revenue by way of exploiting the popularity of cricket. PCA, being
a constituent member of the BCCI, had also adopted the same method and rules of
the BCCI for maintaining its monopoly and complete domain over the cricket in
the ‘area under its control’. Such an act of exclusion of others could not be
said to be purely towards the promotion of the game, rather, it was an act
towards the depression and regression of the game. Hence the claim of the
assessee that its activity was entirely and purely for the promotion of the
game was not accepted by the Tribunal. The Tribunal also did not accept the
assessee’s argument that the payment to it by the BCCI was a grant, holding
that it was a payment in an arrangement of sharing of revenue from commercial
exploitation of cricket and infrastructure thereof.

The Tribunal took
the view that the commercial exploitation of the popularity of cricket and its
infrastructure by the assessee was not incidental but was, inter alia,
one of the main activities of the assessee. It relied upon certain observations
of the Supreme Court in the case of Addl. CIT vs. Surat Art Silk Cloth
Manufacturers’ Association 121 ITR 1, to point out that there was a
differentiation between ‘if some surplus has been left out of incidental
commercial activity’ and ‘the activity is done for the generation of
surplus’ – the former would be charitable, the latter would not be
charitable. The Tribunal was of the view that despite having the object of
promotion of sports, the fact that the activity of the assessee was also
directed for generation of profits on commercial lines would exclude it from
the scope of charitable activity.

Even if it was
assumed that the commercial exploitation of cricket and infrastructure was
incidental to the main purpose of promotion of cricket, even then, in view of
the decision of the Chandigarh Bench of the Tribunal in the case of Chandigarh
Lawn Tennis Association vs. ITO 95 taxmann.com 308, as the income from
the incidental business activity was more than Rs. 10 lakhs [as the proviso to
section 2(15) then provided], the proviso to section 2(15) would apply,
resulting in loss of exemption.

Therefore, the
Tribunal held that the case of the assessee would not fall within the scope of
‘charitable purpose’ as defined in section 2(15), as the commercial
exploitation of the popularity of the game and the property / infrastructure held
by the assessee was not incidental to the main object but was apparently and inter
alia one of the primary motives of the assessee. Hence the assessee was not
entitled to exemption u/s 11.

The Tribunal
further noted that PCA had amended its objects to add the following object: ‘To
carry out any other activity which may seem to the PCA capable of being
conveniently carried on in connection with the above, or calculated directly or
indirectly to enhance the value or render profitable or generate better income
/ revenue, from any of the properties, assets and rights of the PCA;’

According to the
Tribunal, the amendment revealed that the assessee’s activities inter alia
were also directed for generation and augmentation of revenue by way of
exploitation of its rights and properties, and with the amended objects it
could exploit the infrastructure so created for commercial purposes which
supported the view taken by the Tribunal.

OBSERVATIONS

The Chandigarh
Tribunal seems to have gone into the various facts in far greater detail than
the Jaipur, Chennai, Ahmedabad and Ranchi Benches, having examined the stand
taken by the BCCI, in its accounts and before the tax authorities, as well as
examined the reports of various committees set up by the Supreme Court to look
into match-fixing and the management of the affairs of BCCI. It rightly
highlighted the observations of the Supreme Court in Surat Art Silk Cloth
Manufacturers Association (Supra), where it observed:

‘Take, for
example, a case where a trust or institution is established for promotion of
sports without setting out any specific mode by which this purpose is intended
to be achieved. Now obviously promotion of sports can be achieved by organising
cricket matches on free admission or no-profit-no-loss basis and equally it can
be achieved by organising cricket matches with the predominant object of
earning profit. Can it be said in such a case that the purpose of the trust or
institution does not involve the carrying on of an activity for profit, because
promotion of sports can be done without engaging in an activity for profit. If
this interpretation were correct, it would be the easiest thing for a trust or
institution not to mention in its constitution as to how the purpose for which
it is established shall be carried out and
then engage itself in an activity for profit in the course of actually carrying
out of such purpose and thereby avoid liability to tax. That would be too
narrow an interpretation which would defeat the object of introducing the words
“not involving the carrying on of any activity for profit”. We cannot
accept such a construction which emasculates these last concluding words and
renders them meaningless and ineffectual.’

The Tribunal
incorrectly interpreted this to apply to the facts of the assessee’s case,
since the Tribunal was of the view that the assessee was organising cricket
matches with a view to earn profit.

Besides holding
that PCA was carrying on a business activity of assisting BCCI in the conduct
of matches, one of the basis of the Chandigarh Tribunal decision was that since
BCCI was carrying on a commercial activity every member of BCCI (an AOP) should
also be regarded as carrying on a commercial activity through BCCI, which would
attract the proviso to section 2(15). In so doing, it seems to have ignored the
fact that under tax laws an AOP and its members are regarded as separate
entities and the activities carried on by each need to be evaluated independently.
For instance, if a charitable organisation invests in a mutual fund and its
share of income from the mutual fund is considered for taxation in the hands of
the charitable organisation, does it necessarily follow that the charitable
organisation is carrying on the business of purchase and sale of shares and
securities just because the mutual fund is doing so?

Secondly, the
Chandigarh Tribunal relied on the BCCI’s alternative contention that the
payments to the state associations should be treated as expenditure incurred by
it, ignoring BCCI’s main contention that it was a division of surplus amongst
the member associations. A division of surplus cannot be regarded as an income
from exploitation of assets, nor can it be regarded as a compensation for services
rendered.

Thirdly, the Tribunal relied on the then prevalent income tax appeal
status of BCCI, ignoring the fact that the appeals had not yet attained
finality; the conclusions in the appeals were therefore only a view of the
interim appellate authorities which may undergo a change on attaining finality.
Placing absolute reliance on such ratios of appeals of BCCI not yet finally
concluded, for deciding the case of PCA, was therefore not necessarily the
right approach.

The Chandigarh
Tribunal also seems to have taken the view that generating better returns from
use of properties, assets or rights amounts to commercialisation, vitiating the
charitable nature. That does not seem to be justified, as every person or
organisation, even though they may not carry on business, may seek to maximise
their income from assets. Can a charitable organisation be regarded as carrying
on business just because it invests in a bank which offers higher interest than
its existing bank? Would it amount to business if it lets out premises owned by
it to a person who offers to pay higher rent, rather than to an existing tenant
paying lower rent? Seeking maximisation of return from assets cannot be the
basis for determination of whether business is being carried on or not.

Can it be said that
merely because PCA was assisting BCCI in conducting the IPL matches at its
stadium it was engaged in a business activity? Such assistance may not
necessarily be from a profit-earning motive. It could be actuated by the motive
of popularising the game of cricket amongst the public, or by the desire to
ensure better utilisation of its stadium and to earn rent from its use. This
would not amount to carrying on of a business activity.

The question which
would really determine the matter is as to the nature of the amounts paid by
BCCI out of the telecast rights. Were such payments for the support provided by
the associations, for marketing of telecast rights by BCCI on behalf of the
state associations, a distribution of surplus by BCCI, or a grant by BCCI to
support the state associations?

If one examines the
submissions made by BCCI to the Tribunal in response to the summons issued to
it, it had clarified that payments towards participation subsidy, match and
staging subsidies were in the nature of reimbursements of expenditure which the
state associations have to incur for conduct of matches. This indicates that
the state associations incur the expenditure for the matches on behalf of BCCI,
which expenditure is reimbursed by BCCI. This indicates that the activity of
conduct of the tournament was that of BCCI.

In respect of the
second category of payments in regard to a share in the media rights income
earned by the BCCI, BCCI had clarified that these payments were application of
income for the purpose of computation of income u/s 11. Either donations /
grants or expenses incurred, both could qualify as application of income. In
the submissions to the Commissioner (Appeals) in its own case, BCCI had
clarified that such TV subvention represents payment of 70% of revenue from the
sale of media rights to state associations. These payments were made out of the
gross revenue from the media rights and not out of the surplus and were
therefore not a distribution of profit. Even if there were to be losses in any
year, TV subvention and subsidy would be payable to the state associations.

In its appeal
submissions, BCCI has stated that the state association is entitled to the
ticket revenue and ground sponsorship revenue. Expenses on account of security
for players and spectators, temporary stands, operation of floodlights, score
boards, management of crowds, insurance for the match, electricity charges,
catering, etc. are met by the state associations. On the other hand,
expenditure on transportation of players and other match officials, boarding
and lodging, expenses on food for players and officials, tour fee, match fee,
etc., are met by BCCI and the revenues from sponsorship belong to BCCI.

The submissions by
BCCI, in its appeal, further clarified that for a Test series or ODI series
conducted in multiple centres and organised by BCCI and multiple state
associations, it was found that if each state association were to negotiate the
sale of rights to events in its centre, its negotiating strength would be low.
It was, therefore, agreed that BCCI would negotiate the sale of media rights
for the entire country to optimise the income under this head. It was further
decided that out of the receipts from the sale of media rights, 70% of the
gross revenue, less production cost, would belong to the state associations.
Every year, BCCI has paid out 70% of its receipts from media rights (less
production cost) to the state associations. This amount has been utilised by
the respective associations to build infrastructure and promote cricket, making
the game more popular, nurturing and encouraging cricket talent and leading to
higher revenues from media rights.

From the above, it
is clear that while the conduct of matches may be physically done by the state
associations, it was BCCI which was responsible for the commercial aspects of
the IPL, such as sale of sponsorship rights, media rights, etc. BCCI pays 70%
of such revenues to the state associations for having permitted it to market
such rights. The state associations are conducting the matches as a part of
their object of promoting and popularising cricket. The conduct of matches was
quite distinct from marketing the rights to sponsor or telecast those matches.
Can the state associations be regarded as having carried on a commercial
activity, if they have granted the right to market such sponsorship and media
rights to the BCCI, with the consideration being a percentage of the revenues
earned by BCCI from such marketing?

A mere passive
receipt of income (though recurring and linked to gross revenues) for giving up
a valuable right may perhaps not constitute a business activity. An analogy can
be drawn from a situation where a business is given on lease to another entity
for running (or conducting). If such a lease is for a long period, various
Courts have taken the view that since the intention is not to carry on business
by the lessor, such lease rentals are not taxable as business profits of the
lessor. The mere fact that the lease rentals may be linked to the gross revenues
of the business carried on by the lessee would not change the character of the
income. It is only the lessee who is carrying on business and not the lessor.
On a similar basis, the carrying on of the business of marketing of rights by
BCCI would not change the character of matches conducted by the state
associations from a charitable activity carried on in furtherance of their
objects to a business activity, even if the state associations are entitled to
a certain part of the revenues for having given up the right to market such
rights.

In today’s times,
when watching of sport is a popular pastime resulting in large revenues for the
organisers, a mere seeking of maximising the revenue-earning potential of the
matches, in order to raise funds for furtherance of the cause of the sport,
cannot be said primarily to be the conduct of a business. The mere fact of the
quantum being large cannot change the character of an activity from a
charitable activity to a business activity, unless a clear profit-earning
motive to the exclusion of charity is established. This is particularly so when
all these state associations have been actively involved in encouraging sport
at the grassroots level in cities as well as smaller towns.

In a series of
decisions, the Supreme Court, the Madras, Gujarat and Bombay High Courts and
various benches of the Tribunal have held that the section 12A registration of
the state associations could not be cancelled merely on account of the fact
that they have conducted IPL matches. These decisions are:

DIT(E) vs.
Tamil Nadu Cricket Association 231 Taxman 225 (SC);

DIT(E) vs.
Gujarat Cricket Association R/Tax Appeal 268 of 2012 dated 27^th
September, 2019 (Guj.);

Pr. CIT(E)
vs. Maharashtra Cricket Association 407 ITR 9 (Bom.);

Tamil Nadu
Cricket Association vs. DIT(E) 360 ITR 633 (Mad.);

Saurashtra
Cricket Association vs. CIT 148 ITD 58 (Rajkot ITAT);

Delhi &
District Cricket Association vs. DIT(E) 38 ITR(T) 326 (Del. ITAT);

Punjab
Cricket Association vs. CIT 157 ITD 227 (Chd. ITAT).

While most of these
decisions have been decided on the technical ground that applicability of the
proviso to section 2(15) cannot result in cancellation of registration u/s
12AA(3), in some of these decisions there has been a finding that the activity
of the conduct of the matches by the state associations is a charitable
activity in accordance with its objects.

Recently, in an
elaborate judgment of over 200 pages, the Gujarat High Court, hearing appeals
filed against the Tribunal orders in the case of Gujarat Cricket
Association (Supra), Baroda Cricket Association and Saurashtra
Cricket Association, in a series of appeals heard together (R/Tax
268 of 2012, 152 of 2019, 317 to 321 of 2019, 374 and 375 of 2019, 358 to 360
of 2019, 333 to 340 of 2019, 675 of 2019, and 123 of 2014, by its order dated
27^th September, 2019), has decided the matter in favour of
the state associations. It noted from the resolution passed by BCCI that the
grants given by it were in the nature of corpus donations to the state
associations. After analysing the concept of ‘charitable purpose’, the
insertion of the proviso to section 2(15) and various case laws on the subject
of charity, the High Court held:

(i) In carrying on the charitable activities,
certain surplus may ensue. However, earning of surplus, itself, should not be
construed as if the assessee existed for profit. The word ‘profit’ means that
the owners of the entity have a right to withdraw the surplus for any purpose,
including a personal purpose.

(ii) It is not in dispute that the three
associations have not distributed any profits outside the organisation. The profits,
if any, are ploughed back into the very activities of promotion and development
of the sport of cricket and, therefore, the assessees cannot be termed to be
carrying out commercial activities in the nature of trade, commerce or
business.

(iii) It is not correct to say
that as the assessees received a share of income from the BCCI, their
activities could be said to be the activities of the BCCI. Undoubtedly, the
activities of the BCCI are commercial in nature. The activities of the BCCI are
in the form of exhibition of sports and earning profit out of it. However, if
the associations host any international match once in a year or two at the
behest of the BCCI, then the income of the associations from the sale of tickets, etc., in such
circumstances would not portray their character as being of a commercial
nature.

(iv) The state cricket associations
and the BCCI are distinct taxable units and must be treated as such. It would
not be correct to say that a member body can be held liable for taxation on
account of the activities of the apex body.

(v) Irrespective of the nature of
the activities of the BCCI (commercial or charitable), what is pertinent for
the purpose of determining the nature of the activities of the assessees is the
object and the activities of the assessees and not that of the BCCI. The nature
of the activities of the assessee cannot take its colour from the nature of the
activities of the donor.

The Gujarat High
Court has, therefore, squarely addressed all the points made by the Chandigarh
Tribunal while deciding the issue. It has emphatically held that the conduct of
the matches did not amount to carrying on of a business, particularly if the
surplus was merely on account of one or two matches. Further, the nature of
activity of BCCI cannot determine the nature of activity of the state
associations.

Therefore, as discussed in detail by
the Gujarat High Court, the better view seems to be that of the Jaipur,
Chennai, Ahmedabad, Delhi and Ranchi Benches of the Tribunal. But, given the
high stakes involved for the Revenue, it is highly likely that the matter will
continue to be agitated in the courts, until the issue is finally settled by
the Supreme Court.

shailesh.kwebmaker

PERIOD OF INTEREST ON REFUND IN CASES OF DELAYED CLAIMS OF DEDUCTIONS

ISSUE FOR CONSIDERATION

Section 244A(1) provides for the grant of
simple interest in cases where refund is due to the assessee – simple interest
at the rates prescribed for different circumstances and for the periods
specified in the section. No interest is payable if the amount of refund is
less than 10% of the tax as determined u/s 143(1) or on regular assessment. In
a case where the return of income is not filed by the due date specified u/s
139(1), the interest is payable for the period commencing with the date of
filing the return. Ordinarily, interest is calculated at the rate of 0.5% for
every month or part of a month. Additional interest at the rate of 3% per annum
is granted in cases where the refund due as the result of appellate or
revisional orders is delayed beyond the period of the time allowed u/s 153(5)
of the Act. The amount of interest granted gets adjusted on account of
subsequent orders which have the effect of varying the amount of refund.

Where the proceedings resulting in the
refund are delayed for reasons attributable to the assessee, wholly or in part,
the period of the delay attributable to him is excluded from the period for
which interest is payable as per the provisions of sub-section (2) of section
244A. In deciding the question as to the period to be excluded, the decision of
the Commissioner shall be final.

Often, the refund arises or its amount
increases where a claim for deduction is made after filing the return of income
by filing a revised return, or placing the claim in the assessment or appellate
proceedings. In such cases, an interesting issue arises about deciding whether
the period for which the claim is deferred can be excluded for calculation of
the interest due to the assessee. Conflicting views of the courts are available
on the subject of excluding the period or otherwise. Gauhati and a few other
high courts have taken a view that the refund can be said to have been delayed
due to the failure of the assessee in claiming the deduction in time and the
period in question should be excluded while granting the interest on refund.
The Bombay, Gujarat and the other high courts have held that such situations of
deferred claims cannot be held to reduce the period for which the interest is
otherwise allowable to the assessee under
sub-section (1).

THE ASSAM ROOFING LTD. CASE

The issue came up for consideration in the
case of Assam Roofing Ltd. vs. CIT, 11 taxmann.com 279
(Gauhati). In that case the assessee filed its return of income on 31^st
December, 1992 for the assessment year 1991-92, including the receipt of the
transport subsidy in the total income. In the note it was claimed to be a
capital receipt, though during the assessment proceedings completed on 16^th
May, 1994 u/s 143(3) no separate representation was made by the assessee
claiming that subsidy was not taxable. An appeal was filed against the
assessment order for contesting the addition on account of the said subsidy
which was decided in its favour by the Commissioner (Appeals) by an order dated
27^th October, 1994 directing that the transport subsidy amounting to
Rs. 98,79,266 be deleted from the total income. The AO passed an order dated 13^th
December, 1994 to give effect to the appellate order, deleting transport
subsidy amounting to Rs. 98,79,266. He also allowed interest u/s 244A on the
amount of refund that was found due to the assessee as a result of the
appellate order for a period of 33 months, i.e., from 1^st April,
1992 to 13^th December, 1994.

Subsequently, in the rectification
proceedings, the AO held that the grant of refund was delayed for reasons
attributable to the assessee and, as a consequence, interest on refund was held
to be payable only for a period of eight months, that is, from 16^th
May, 1994 (date of completion of assessment) to 13^th December, 1994,
that is, the date of order giving effect to the appellate order. The appeal by
the assessee against the order reducing the interest was allowed by the
Commissioner (Appeals) and his order was confirmed by the Tribunal. The
following substantial question of law was raised: ‘Whether on the facts and
in the circumstances of the case, the Tribunal was justified and correct in
allowing interest u/s 244A of the Income-tax Act, 1961 to the assessee for the
period of delay in granting refund of tax where such delay is due to reasons
attributable to the assessee?’

The Revenue contended that the assessee had
voluntarily included the amount received on account of transport subsidy as
taxable income and on the said basis the assessment was made; at no point of
time in the course of the assessment proceedings had the assessee taken the
stand that the amount received on account of transport subsidy was not taxable;
the issue was raised by the assessee only in the appeal filed before the
Commissioner (Appeals) which was disposed of by the order dated 27^thOctober,
1994; thereafter, on 13^th December, 1994 the amount of transport
subsidy earlier included in the taxable income of the assessee was deleted and
orders were passed for the refund.

Relying on the provisions of section 244A(2)
of the Act, it was contended that the payment of refund was made at the
particular point of time only because of the conduct of the assessee in not
raising the said issue at any earlier point of time and the payment of refund, therefore,
got delayed for reasons attributable to the assessee; consequently, the
assessee was not entitled for interest for the period for which he was at
fault.

In reply the assessee contended that the
provisions of Chapter XIX of the Act made it abundantly clear that the grant of
refund was not contingent on any application of the assessee and such refund
u/s 240 of the Act was consequential to any order passed in an appeal or other
proceedings under the Act; no claim for refund was required to be lodged; the
provisions of section 244A(2) of the Act had no application to the case
inasmuch as the refund was consequential to the appellate order, no proceeding
for refund could be visualised so as to hold the assessee responsible for any
delay in finalisation of such a proceeding.

Relying on the decision in Sandvik
Asia Ltd. vs. CIT, 280 ITR 643, it was contended by the assessee that
there was a compensatory element in the interest that was awardable u/s 244A of
the Act and that such interest mitigates the hardship caused to the assessee on
account of wrongful levy and collection of tax. Reliance was also placed on the
decision of the Punjab and Haryana High Court in the case of National
Horticulture Board vs. Union of India, 253 ITR 12 to contend that interest
on refund was automatic and consequential and did not depend on initiation of a
proceeding for refund or on raising a claim for refund, as the case may be.

Section 244A of the Act, the Court observed,
contemplated grant of interest at the specified rate from the first day of
April of the assessment year to the date on which refund was granted in case of
payments of tax as contemplated by sub-clauses (a) and (b) of sub-section (1).
It further noted that under sub-section (2) of section 244A if the ‘proceedings
resulting in the refund’ were delayed for reasons attributable to the assessee,
no interest was to be awarded for the period of such delay for which the
assessee was responsible. Significantly, the Court took note of the expression ‘proceedings
resulting in revision (to be read as “refund”)’ appearing in sub-section
(2) of Section 244A to hold that the scope of section 244A(2) was not limited
to the cases of sections 238 and 239 but covered the cases of the refunds
arising on account of any order under the scheme of the Act; the expression
‘proceeding’ referred to in sub-section (2), more reasonably, would mean any
proceeding as a result of which refund had become due; viewed thus, the
expression ‘proceeding’ might take within its ambit an appeal proceeding
consequential to which refund had become due. The Court supported its decision
by relying on the decision of the Punjab and Haryana High Court in the
National Horticulture Board case (supra).

The Court in
deciding the issue noted the fact that the assessee itself declared the amount
of transport subsidy received by it to be taxable and voluntarily paid the tax
and no claim to the contrary was raised in the course of the assessment
proceeding; it was only in the appeal filed that the issue was raised and was
allowed by the Commissioner (Appeals) and a consequential refund was granted.

The Court ruled that in the above
circumstances, it could not but be held that the assessee was responsible for
the delay in grant of refund and it would be correct to hold that the interest
was payable only with effect
from 16th May, 1994 till the date of payment of the refundable amount.

The Gauhati High Court allowed the appeal of
the Revenue and reversed the order of the Tribunal by holding that the delay in
grant of refund was attributable to the assessee and as a consequence the
period for which interest on refund was to be granted required to be reduced.

MELSTAR INFORMATION TECHNOLOGIES LTD. CASE

The issue recently arose in the case of the CIT
vs. Melstar Information Technologies Ltd., 106 taxmann.com 142 (Bom.).
In this case, the assessee had not claimed certain expenditure before the AO
but raised such a claim before the Tribunal which remanded the proceedings to
the Commissioner (Appeals) who allowed the claim of expenditure. The deduction
so allowed resulted in a refund of taxes paid and it is at that juncture that
there arose the question u/s 244A of payment of interest on such refund.

It appears that there was a dispute about
the period for which the interest was to be granted to the assessee, or about
the eligibility of the assessee to interest. The AO seemed to be of the view
that no interest was payable to the assessee for the reason that the delay in
granting the refund was entirely attributable to the assessee inasmuch as he
had delayed the claim for deduction. The AO, while granting refund, seemed to
have denied the interest by relying on the provisions of section 244A(2) after
taking the approval of the Commissioner. The Tribunal, on an appeal by the
assessee, held that an appeal was maintainable against the order refusing the
interest on refund and further held that the delay could not be held to be
attributable to the assessee and, therefore, the Tribunal directed the payment
of interest.

The Revenue, aggrieved by the order of the
Tribunal had raised the following question for the Court’s consideration: ‘Whether
on the facts and circumstances of the case and in law, the ITAT has erred in
law in assuming jurisdiction to hear the appeal when no such appeal lies before
the ITAT or before CIT(A) because as per the provisions of Section 244A(2) of
the Income Tax Act, decision of CIT is final as held by Kerala High Court in
the case of Kerala Civil Supplies 185 taxman 1?’

The Court noted that the issue pertained to
interest payable to the assessee u/s 244A of the Act where the Revenue did not
dispute the assessee’s claim of refund and its eligibility to interest thereon
in ordinary circumstances. However, since the delay in the proceedings
resulting in the refund was attributable to the assessee, by virtue of
sub-section (2) of section 244A of the Act the assessee was not entitled to
such interest.

The Court observed that there was no
allegation or material on record to suggest that any of the proceedings were
delayed in any manner on account of reasons attributable to the assessee and
therefore the Tribunal was correct in allowing the interest to the assessee.

The Court, in deciding that there was no substantial
question of law involved in the appeal of the Revenue, relied on the decision
in the case of Ajanta Manufacturing Ltd. vs. Deputy CIT, 391 ITR 33
(Guj.) wherein a similar issue was considered. In that case, the
assessee had made a belated claim for deduction during assessment on filing a
revised return of income, and the Revenue had denied the interest by
attributing the delay in grant of refund to the assessee on applying the
provisions of sub-section (2) of section 244A of the Act. The Court noted with
approval the following observations of the said decision:

“16. We would also examine the order
of the Commissioner on merits. As noted, according to the Commissioner the
assessee had raised a belated claim during the course of the assessment proceedings
which resulted into delay in granting of refund and therefore, the assessee was
not entitled to interest for the entire period from the first date of
assessment year till the order giving effect to the appellate order was passed.
We cannot uphold the view of the Commissioner. First and foremost requirement
of sub-section (2) of Section 244A is that the proceedings resulting into
refund should have been delayed for the reasons attributable to the assessee,
whether wholly or in part. If such requirement is satisfied, to the extent of
the period of delay so attributable to the assessee, he would be disentitled to
claim interest on refund. The act of revising a return or raising a claim
during the course of the assessment proceedings cannot be said to be the
reasons for delaying the proceedings which can be attributable to the assessee.
(The) mere fact that the claim came to be granted by the Appellate Commissioner
would not change this position. In essence, what the Commissioner (Appeals) did
was to allow a claim which in law, in his opinion, was allowable by the
Assessing Officer. In other words, by passing order in appeal, he merely
recognised a legal position whereby the assessee was entitled to claim certain
benefits of reduced tax. Surely, the fact that the assessee had filed the
appeal which ultimately came to be allowed by the Commissioner, cannot be a
reason for delaying the proceedings which can be attributed to the assessee.

17. The Department does not contend that
the assessee had needlessly or frivolously delayed the assessment proceedings
at the original or appellate stage. In absence of any such foundation, (the)
mere fact that the assessee made a claim during the course of the assessment
proceedings which was allowed at the appellate stage would not ipso facto imply
that the assessee was responsible for causing the delay in the proceedings
resulting into refund. We may refer the decision of the Kerala High Court in
case of CIT vs. South Indian Bank Ltd., reported in (2012) 340 ITR 574 (Ker)
in which the assessee had raised a belated claim for deduction which was
allowed by the Commissioner (Appeals). The Revenue, therefore, contended that
for such delay, interest should be declined under Section 244A of the Act. In
the said case also, the assessee had not made any claim for deduction of
provision of bad debts in the original return. But before completion of the
assessment, the assessee had made such a claim which was rejected by the
Assessing Officer. The Commissioner allowed the claim and remanded the matter
to the Assessing Officer. Pursuant to which, the assessee became entitled to
refund. Revenue argued that the assessee would not be entitled to interest in
view of Section 244A(2). In this context, the Court held in Para. 6 as under
(page 578 of 340 ITR):

‘6.
Sub-section (2) of section 244A provides that the assessee shall not be
entitled to interest for the period of delay in issuing the proceedings leading
to the refund that is attributable to the assessee. In other words, if the
issue of the refund order is delayed for any period attributable to the
assessee, then the assessee shall not be entitled to interest for such period.
This is of course an exception to clauses (a) and (b) of section 244A(1) of the
Act. In other words, if the issue of the proceedings, that is, refund order, is
delayed for any period attributable to the assessee, then the assessee is not
entitled to interest for such period. Further, what is clear from sub-section
(2) is that, if the officer feels that delay in refund for any period is
attributable to the assessee, the matter should be referred to the Commissioner
or Chief Commissioner or any other notified person for deciding the issue and
ordering exclusion of such periods for the purpose of granting interest to the
assessee under section 244A(1) of the Act. In this case, there was no decision
by the Commissioner or Chief Commissioner on this issue and so much so, we do
not think the Assessing Officer made out the case of delay in refund for any
period attributable to the assessee disentitling for interest. So much so, in
our view, the officer has no escape from granting interest to the assessee in
terms of section 244A(1) (a) of the Act’.”

OBSERVATIONS

The issue under consideration revolves in a
narrow compass; whether the claim for deduction, made subsequent to the filing
of return of income, can be held to be attracting the provisions of sub-section
(2) of section 244A for excluding the period of delay in claiming the deduction
from the period for which interest is granted u/s 244A on the amount of refund
that has resulted or has increased due to the grant of deduction pursuant to
the delayed claim.

The relevant sub-section reads as under: (2)
If the proceedings resulting in the refund are delayed for reasons
attributable to the assessee, whether wholly or in part, the period of the
delay so attributable to him shall be excluded from the period for which
interest is payable under sub-sections (1) or (1A), and where any question
arises as to the period to be excluded, it shall be decided by the Principal
Chief Commissioner or Chief Commissioner or Principal Commissioner or
Commissioner whose decision thereon shall be final.

The requirement of sub-section (2) is that
the proceedings resulting into refund should have been delayed and the delay
should be for the reasons attributable to the assessee. Only where such
requirement is satisfied, the interest relating to the period of delay so
attributable to the assessee would be denied.

On a careful reading of the provision of
sub-section (2) it is gathered that the said provisions are attracted only in
cases where the twin conditions are cumulatively satisfied: the proceedings
resulting into refund have been delayed, and further that the delay is for
reasons that are attributable to the assessee. Non-satisfaction of any one of
the conditions would not disentitle the assessee from the claim of interest on
refund; for this purpose it may be essential to appreciate the contextual
meaning of the term ‘proceedings’. Can the acts of filing the revised return or
claiming the reliefs in assessment or appellant proceedings be construed to be
‘proceedings’ for attracting the provisions of sub-section (2)? May be not. The
proceedings referred to in sub-section (2) should, in our opinion, mean and
co-rate the proceedings in respect of assessment or adjudication of appeals and
it is here that the assessee should be found to have delayed such proceedings
in any manner for disentitling him from the claim of interest.

Revising the return or placing the claim
during such proceedings cannot be considered to be part of proceedings
resulting in refund. It is essential that the proceedings in question should
further result in refund. Only assessment, rectification, revision or appellate
proceedings can be considered to be proceedings that result in refund. It is
such proceedings that should have been delayed and not the claim of deduction
or refund, and further the delay in such proceedings should be attributable to
the assessee. It is for these reasons some of the Courts have given emphasis to
ascertain whether the assessee had contributed to delay the assessment
proceedings on frivolous grounds without placing their analysis of provisions
in so many words in the orders.

Our understanding is further strengthened by
the amendments of 2016 for insertion of clause “a” in sub-section (1) of
section 244A with effect from 1^stJune, 2016 to provide that the
interest would be paid for the period commencing from the date of filing of
return of income where such return is filed outside the due date prescribed u/s
139(1). In the absence of such an amendment, interest could not have been
denied to the assessee for the delay in filing the return of income as was held
by some of
the Courts.

The Court in the Assam Roofing Limited
case rightly held that the meaning of the term ‘proceedings resulting in
refund’ was not limited to cases of sections 238 and 239 of the Act but also
cover the other cases of refund and would include any proceedings resulting in
refund and such proceedings also included the appellate proceedings. Having
held that, the Court failed in appreciating that the assessee was not
responsible for delaying any of the proceedings that resulted in refund or said
to have been delayed. Instead, the Court held that the act of filing the claim
in the appellate proceedings was to be construed as an act of delaying the
proceedings that resulted in refund. It therefore held that putting a claim at
the appellate stage was responsible for delay in grant of refund and therefore
the interest for the period up to the date of putting the claim was not
allowable. It is respectfully submitted that this was a classic case of missing
the wood for the trees; the case where the Court was preoccupied with the delay
in placing the claim for deduction, overlooking the important fact that what
was relevant for the application of sub-section (2) was delay in the proceeding
and not the delay in grant of refund as a consequence of the delayed claim. It
might be that the assessee was responsible for making belated claim but
certainly not delaying
the proceedings.

It is required to be appreciated that the
interest is the consequence of payment of excess tax. Accordingly, once excess
tax is found to have been paid at whatever stage, the tax was required to be
refunded. And as a consequence interest was bound to be paid unless the
assessee is shown to be responsible for delaying the proceedings and not the
refund. Putting a delayed claim for the deduction, otherwise allowable under
the Act, under no circumstances could be construed as an act of delaying the
‘proceedings’, when it was otherwise the duty of the authorities to compute the
correct total income by allowing all deductions that were allowed under the Act
and simultaneously excluding all such receipts that were required to be
excluded. (Please see circular No. 26 dated 7^th July, 1955.)

The act of revising a return or raising a
claim during the course of the assessment proceedings cannot be said to be part
of the proceedings for refund and cannot also be said to be the reasons for
delaying the proceedings which can be held to be attributable to the assessee.
This understanding will not change on account of the claim for deduction
outside the return of income. What happens on allowing the claim is something
which is otherwise required to be allowed as per the law by the AO. In other
words, by passing an order he merely recognises a legal position whereby the
assessee is entitled to claim certain benefits of reduced tax. Surely, the
claim in the proceedings ultimately resulting in refund cannot be construed as
an act of delaying the proceedings that can be attributed to the assessee. In
the absence of any finding that the assessee was responsible for delaying the
proceedings, the mere fact that the assessee made a claim during the course of
the assessment proceedings which was allowed at the appellate stage would not ipso
facto imply that the assessee was responsible for causing the delay in the
proceedings that resulted into refund.

In the case of Ajanta Manufacturing
Limited, 72 taxmann.com, 148 (Guj.), the assessee company had included
the receipt of subsidy in total income and paid tax thereon while filing the
return of income. During the course of assessment, a claim was made under a
letter for excluding the subsidy for receipt from income. The claim of the
assessee was allowed in appeal by the Commissioner (Appeals) and the reduction
in income resulted in refund. In deciding the period for which the interest
should be allowed for such refund, the High Court held that the disabling
provisions of sub-section 2 and section 244A were not attracted in the facts of
the case and the interest should be granted for the full period as per the
provisions of section 244(1) of the Act.

In the case of Sahara India Savings
& Investments Corporation Limited, 38 taxmann.com 192 (All.) the
refund was not granted for not filing TDS certificates with the return of
income. Subsequently, the refund became due on filing of the certificates;
while the refund was granted, the interest thereon was denied on the ground
that the refund was delayed due to non-filing of TDS certificates with the
return of income. The Allahabad High Court held that a delay in application for
refund could not be construed as a delay attributable to the assessee and the
provisions of sub-section (2) were not attracted in the facts of the case.

In the case of Larsen & Toubro,
330 ITR 340 (Bom.), again in the circumstances where the TDS
certificates were not filed with return of income, the Court upheld the order
of the Tribunal holding that interest u/s 244A could not be denied only on the
ground that certificates were not filed with the return of income.

The Supreme Court in the case of H.E.G.
Limited, 334 ITR 331 (SC), held that interest was payable to the
assessee u/s 244A for withholding of the refund by the AO on account of denial
of credit for TDS.

The Punjab and
Haryana High Court in the case of National Horticulture Board, 253 ITR 12
(P&H), held that the interest u/s 244A could not be denied on the
ground of the delayed application for refund of the taxes paid.

In the case of South Indian Bank
Limited, 340 ITR 574 (Ker.), the Commissioner (Appeals) had allowed the
related claim for deduction. The interest on resulting refund was denied by the
income tax authorities on the ground of the delayed claim for deduction which
was made, outside the return of income, in the assessment proceedings. The
Kerala High Court held that the AO had no escape from granting interest to the
assessee.

The Kerala High Court, in the case of Pala
Marketing Co-Op. Society Limited, 79 taxmann.com 438 (Ker.), however,
held that the assessee was not entitled to interest on refund where he had
delayed the filing of return of income even where such delay was condoned
following its own decision in the case of M. Ahammadkutty Haji, 288 ITR
304. However, the Rajasthan High Court in the case of Dariyavie
Singh Karnavat, 18 taxmann.com 180, held that the interest was payable
in similar circumstances ignoring the decision of the Kerala High Court in the M.
Ahammadkutty case cited before
the Court.

Interestingly, the Karnataka High Court in
the case of Dinakar Ullal, 323 ITR 452 (Kar.), ruled out the
application of circular No. 12 dated 30^th October, 2003 and circular
No. 13 dated 22^nd December, 2006 issued by CBDT. In granting the
interest on refund due on an application for condonation of delay in claiming
the refund of taxes paid, the said circulars provided that no interest on
refund should be granted in cases where the delay in application of refund was
favourably condoned.

Recently, the Bombay High Court in the case
of State Bank of India in ITA No. 1218 of 2016 held that interest
on refund could not be denied in a case where the refund arose on account of
the claim for deduction made during the assessment proceedings… following its
own decision in the case of Chetan M. Shah, 53 taxmann.com 18.

The better view appears to be the
one in favour of granting interest for the full period commencing from the
first day of the assessment year to the date of the grant of refund.

shailesh.kwebmaker

TDS UNDER SECTION 194A ON PAYMENT OF ‘INTEREST’ UNDER MOTOR ACCIDENT CLAIM

ISSUE FOR CONSIDERATION

Under the Motor Vehicles
Act, 1988 (MVA), a liability has been cast on the owner of the motor vehicle or
the insurer to pay compensation in the case of death or permanent disablement
due to a motor vehicle accident. This compensation is payable to the legal
heirs in case of death and to the victim in case of permanent disablement. For
the purposes of adjudicating upon claims for compensation in respect of motor
accidents, the Motor Accident Claims Tribunals (MACTs) have been established.
The MVA further provides that in case of death the claim may be preferred by
all or any of the legal representatives of the deceased. The quantum of
compensation is decided by taking into consideration the nature of injury in
case of an injured person and the age, monthly income and dependency in death
cases. The MVA contains the 2nd Schedule for compensation in fatal accidents
and injury cases claims. While awarding general damages in case of death, the
funeral expenses, loss of consortium, loss of estate and medical expenses are
also the factors that are considered.

The claims under the MVA may involve delay which may be due
to late filing of the compensation claim, investigation, adjudication of claim
and various other factors. A provision is made u/s. 171 of the MVA to
compensate the injured or his legal heir for the delay, which reads as under:

“Section 171. Award of interest where any claim is
allowed.

Where any Claims Tribunal allows a claim for compensation
made under this Act, such Tribunal may direct that in addition to the amount of
compensation, simple interest shall also be paid at such rate and from such
date not earlier than the date of making the claim as it may specify in this
behalf.”

CBDT circular No. 8 of 2011 requires deduction of income tax
at source on payment of the award amount and interest on deposit made under
orders of the court in motor accident claims cases. The issue has arisen before
courts as to whether tax is deductible at source u/s. 194A on such interest
awarded by the MACTs u/s. 171 of the MVA for delay.

While the Allahabad, Himachal Pradesh and Punjab and Haryana
High Courts have held that such payment is not income by way of interest as
defined in section 2(28A) and no tax is deductible at source u/s. 194A, the
Patna and Madras High Courts have taken a contrary view, holding that such
payment is interest on which tax is deductible at source u/s. 194A.

THE ORIENTAL INSURANCE CO. LTD. CASE

The issue first arose before the Allahabad High Court in the
case of CIT vs. Oriental Insurance Co. Ltd. 27 taxmann.com 28.

In this case, the
assessee, an insurance company, paid compensation and interest thereon under
the MVA to claimants without complying with the provisions of section 194A. The
assessing authority took a view that the assessee had failed to deduct income
tax on the amount of interest u/s. 194A and held that it was accordingly liable
to deposit the amount of short deduction of tax u/s. 201(1) along with interest
u/s. 201(1A) for a period of five assessment years. According to the assessing
officer, debt incurred included claims and interest on such claims was clearly
covered u/s. 2(28A). His reasoning was as below:

1. Interest paid under the MVA was a revenue receipt like
interest received on delayed payment of compensation under the Land Acquisition
Act. Since section 194A applied to interest on compensation under the Land
Acquisition Act, it also applied in respect of interest on compensation under
the MVA.

2. The interest element in a total award was different from
compensation. However, interest on such compensation was on account of delayed
payment of such compensation, and therefore it was clearly an income in the
hands of the recipient, taxable under the Income-tax Act.

3. The interest element
was different from compensation as provided in section 171 of the MVA as that section provided that the tribunal
might direct that in addition to the amount of compensation, simple interest
should also be paid.

4. There was no exemption u/s. 194A for TDS on interest
payment by insurance companies on MACT awards.

5. The actual payer of interest was the insurance company and
the responsibility to deduct tax lay squarely on it. The provisions of section
204(iii) were very clear that the person responsible for payment meant “in the
case of credit or as the case may be, payment of any other sum chargeable under
the provisions of this Act, the payer himself, or, if the payer is a company,
the company itself including the principal officer thereof.”

6. Payment awarded under the MVA was identical to the award
under the Land Acquisition Act. Tax was deducted u/s. 194A on interest paid or
credited for late payment of compensation under the Land Acquisition Act.
Therefore, section 194A was also applicable in respect of interest paid or
credited on delayed payment of compensation under the MVA.

7. Interest under the MVA was similar to interest paid under
the Income-tax Act, as both arose by operation of law. The nature of payment
mentioned in both the Acts was “interest”. TDS on interest payment under the
Income-tax Act was not deductible in view of the specific exemption u/s. 194A(3)(viii).
Since there was no similar exemption for interest payment under the MVA, the
provisions of section 194A applied to these payments.

The Commissioner (Appeals) dismissed the appeal of the
assessee, confirming the action of the assessing authority and holding that the
interest payment awarded u/s. 171 of the MVA was nothing but interest, subject
to the provisions of section 194A.

In the second appeal before the tribunal, the Agra Tribunal
decided the issue in favour of the assessee, following its own earlier
decisions in the cases of Divisional Manager, New India Insurance Co.
Ltd., Agra vs. ITO [ITA Nos. 317 to 321/Agra/2003], which, in turn, had
followed the decision of the Delhi Tribunal in the case of Oriental
Insurance Co. Ltd. vs. ITO dated 27.9.2004, and in Oriental
Insurance Company Ltd. vs. ITO [ITA Nos. 276 & 280/Agra/2003 dated
31.1.2005].

It was argued before the Allahabad High Court on behalf of
the Revenue that it was the responsibility of the payer of interest to deduct
tax on such payment of interest, because section 2(28A) clearly envisaged that
interest meant interest payable in any manner in respect of moneys borrowed or
debt incurred (including a deposit, claim or other similar right / obligation)
and includes any service fee or other charges in respect of the money borrowed
or debt incurred, or in respect of any credit facility which had not been
utilised. It was argued that the Tribunal had not referred to the decision of
the Supreme Court in the case of Bikram Singh vs. Land Acquisition
Collector 224 ITR 551, in which it had been held that interest paid on
the delayed payment of compensation was a revenue receipt eligible to tax u/s.
4 of the Income-tax Act, 1961.

On behalf of the Revenue, reliance was placed upon the following
decisions:

a) The Karnataka High Court in the case of CIT vs.
United Insurance Co. Ltd. 325 ITR 231, where the court held that
interest paid above Rs. 50,000 was to be split and spread over the period from
the date interest was directed to be paid till its payment.

b) The Karnataka High Court in the case of Registrar
University of Agricultural Science vs. Fakiragowda 324 ITR 239 where
interest received on belated payment of compensation for acquisition of land
was held to be a revenue receipt chargeable to income tax on which tax was
deductible at source.

c) The Supreme Court, in the case of T.N.K. Govindaraju
Chetty vs. CIT 66 ITR 465, in the context of interest on compensation
awarded for acquisition of land, held that if the source of the obligation
imposed by the statute to pay interest arose because the claimant was kept out
of his money, the interest received was chargeable to tax as income.

d) The Supreme Court, in the case of K.S. Krishna Rao
vs. CIT 181 ITR 408, where interest paid on compensation awarded for
compulsory acquisition of land u/s. 28 of the Land Acquisition Act, 1894 was
held to be in the nature of income and not capital.

On behalf of the assessee, it was argued before the Allahabad
High Court that:

1. The interest paid on the award of compensation was not
interest as understood in general parlance and it was not an income of the
claimant.

2. The compensation
awarded by the MACT to the claimants was a capital receipt in the hands of the
recipients, not taxable under any provision of the Income-tax Act. Since the
award was not taxable in the hands of the recipient, it was not an income but
was a capital receipt.

3. Interest paid by the insurance company u/s. 171 of the MVA
was not interest as contemplated u/s. 194A, because interest that was contented
under that section was an income taxable in the hands of the recipient, whereas
interest received by the recipient u/s. 171 of the MVA was a capital receipt in
the hands of the recipient, being nothing but an enhanced compensation on account
of delay in the payment of compensation.

The Allahabad High Court referred to the definition of
interest u/s. 2(28A), which reads as under:

“ ‘interest’ means interest payable in any manner in
respect of any moneys borrowed or debt incurred (including a deposit, claim or
other similar right or obligation) and includes any service fee or other charge
in respect of the moneys borrowed or debt incurred or in respect of any credit
facility which has not been utilised.”

After referring to the language of section 194A, the
Allahabad High Court referred to the CBDT circular 24 of 1976 (105 ITR
24), where the concept of interest had been explained. It also referred
to clause (ix) of section 194A(3), which had been inserted by the Finance Act,
2003 with effect from 1^st June, 2003, which read as under:

“to such income credited or paid by way of interest on the
compensation amount awarded by the Motor Accidents Claims Tribunal where the
amount of such income or, as the case may be, the aggregate of the amount of
such income credited or paid during the financial year does not exceed Rs.
50,000.”

The Allahabad High Court referred to the following decisions:

1. The Punjab and Haryana High Court in the case of CIT
vs. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd. 179 ITR 157, where it
had been held that interest awarded by the court for loss suffered on account
of deprivation of property amounted to compensation and was not taxable.

2. The National Consumer Disputes Redressal Commission in Ghaziabad
Development Authority vs. Dr. N.K. Gupta 258 ITR 337, where it had been
held that if proper infrastructure facilities had not been provided to a person
who was provided with a flat and was therefore entitled to refund of the amount
paid by him along with interest at 18%, the paying authority was not entitled
to deduct income tax on the amount of interest, as it was not interest as
defined in section 2(28A), but was compensation or damages for delay in
construction or handing over possession of the property, consequential loss to
the complainant by way of escalation in the price of property, and also on
account of distress and disappointment faced by him.

3. The Himachal Pradesh High Court in the case of CIT
vs. H.P. Housing Board 340 ITR 388, where the High Court had held that
payment for delayed construction of house was not payment of interest but was
payment of damages to compensate the claimant for the delay in the construction
of the house and the harassment caused to him.

4. The Supreme Court, in the case of CIT vs. Govind
Choudhury & Sons 203 ITR 881, had held that when there were
disputes with the state government with regard to payments under the contracts,
receipt of certain amount under the arbitration award and the interest for
delay in payment of amounts due to it, such interest was attributable to and
incidental to the business carried on by it. It was also held that interest
awarded could not be separated from the other amounts granted under the awards
and could not be taxed under the head “income from other sources”.

5. The Bombay High Court decision in the case of Islamic
Investment Co. vs. Union of India 265 ITR 254, where it had been held
that there was no provision under the Income-tax Act or under the Code of Civil
Procedure to show that from the amount of interest payable under a decree, tax
was deductible from the decretal amount on the ground that it was an interest
component on which tax was liable to be deducted at source.

The Allahabad High Court also referred to the decisions of
the Delhi High Court in the case of CIT vs. Cargill Global Trading (P)
Ltd. 335 ITR 94 and CIT vs. Sahib Chits (Delhi) (P) Ltd. 328 ITR
342, which had analysed the meaning of the term “interest”.

The Allahabad High Court observed that most of the rulings
relied upon by the Revenue related to interest paid on delayed payment of
compensation awarded under the Land Acquisition Act. According to the Allahabad
High Court, an award under the Land Acquisition Act and an award under the MVA
could not be equated for the simple reason that in land acquisition cases the
payment was made regarding the price of the land and on such price the
provisions of capital gains tax were attracted. On the other hand, in motor
accident claims, the payment was made to the legal representatives of the
deceased for loss of life of their bread-earner, the recipients of awards being
poor and illiterate persons who did not even come within the ambit of the
Income-tax Act, and the amount of compensation under the MVA also did not come
within the definition of “income”.

According to the Allahabad High Court, the term “interest” as
defined in section 2(28A) had to be strictly construed. The necessary
ingredient was that it should be in respect of any money borrowed or debt
incurred. The award under the MVA was neither money borrowed by the insurance
company nor debt incurred by the insurance company. The word “claim” in section
2(28A) should also be regarding a deposit or other similar right or obligation.

The Allahabad High Court observed that the intention of the
legislature was that if the assessee had received any interest in respect of
moneys borrowed or debt incurred, including a deposit, claim or other similar
right or obligation, or any service fee or other charge in respect of moneys
borrowed or debt incurred had been received, then certainly it would come
within the definition of interest. The word “claim” used in the definition may
relate to claims under contractual liability, but certainly did not cover
claims under a statutory liability, the claim under the MVA regarding
compensation for death or injury being a statutory liability.

Further, the Allahabad High Court referred to the insertion
of clause (ix) to section 194A(3), stating that it showed that prior to 1^st
June, 2003 the legislature had no intention to charge any tax on interest
received as compensation under the MVA. According to the High Court, there was
therefore no justification to cast a liability to deduct TDS on interest paid
on compensation under the MVA prior to 1^st June, 2003.

The Allahabad High Court also noted that u/s. 194A(1), tax
was deductible at source if a person was responsible for paying to a resident
any income by way of interest other than interest on securities. In the opinion
of the Allahabad High Court, the award of compensation under motor accident
claims could not be regarded as income, being compensation to the legal heirs
for the loss of life of their bread-earner. Therefore, interest on such award
also could not be termed as income to the legal heirs of the deceased or the
victim himself.

It was noted by the Allahabad High Court that an award under
the MVA was like a decree of the court, which would not come within the
definition of income referred to in section 194A(1) read with section 2(28A) of
the Income-tax Act. According to the court, proceedings regarding claims under
the MVA were in the nature of garnishee proceedings, where the MACT had a right
to attach the judgement debt payable by the insurance company. Even in the
award, there was no direction of any court that before paying the award the
insurance company was required to deduct tax at source. As held by the Supreme
Court in the case of All India Reporter Ltd. vs. Ramachandra D. Datar 41
ITR 446, if no provision had been made in the decree for deduction of
tax before paying the debt, the insurance company could not deduct the tax at
source from the amount payable to the legal heirs of the deceased.

The Allahabad High Court
observed that the different High Courts in the cases of Chiranji Lal
Multani Mal Rai Bahadur (P) Ltd. (supra), Dr. N.K. Gupta (supra), H.P. Housing
Board (supra) and Sahib Chits (Delhi) (P) Ltd. (supra),
held that if interest was awarded by the court for loss suffered on account of
deprivation of property or paid for breach of contract by means of damages or
was not paid in respect of any debt incurred or money borrowed, it would not
attract the provisions of section 2(28A) read with section 194A(1). The
Allahabad High Court, therefore, held that interest paid on compensation under motor
accident claims awards was not liable to income tax.

A similar view has been taken by the Himachal Pradesh High
Court in the case of Court on Its Own Motion vs. H.P. State Co-operative
Bank Ltd. 228 Taxmann 151, where the High Court quashed the CBDT circular
No. 8 of 2011 which required deduction of income tax on award amount and
interest accrued on deposit made under orders of the court in motor accident
claims cases, and in the case of National Insurance Co. Ltd. vs. Indra
Devi 100 taxmann.com 160, and by the Punjab and Haryana High Court in
the case of New India Assurance Co. Ltd. vs. Sudesh Chawla 80 taxmann.com
331.

THE NATIONAL INSURANCE CO. LTD. CASE

The issue again came up before the Patna High Court in the
case of National Insurance Co. Ltd. vs. ACIT 59 taxmann.com 269.

In this case, the District Judge gave an award to the
claimant under the MVA of Rs. 3,70,000 plus interest at 6% per annum from the
date of filing of the claim. The amount was to be paid within two months of the
passing of the order, failing which the further direction was to pay interest
at 9% per annum from the date of the order till the date of final payment. The
insurance company deducted and deposited TDS of Rs. 24,715 u/s. 194A while
making the payment of the amount of the award. The claimant objected to the
deduction of TDS by filing a petition before the District Judge. The District
Judge held that the deduction of Rs. 24,175 by way of TDS was not sustainable
and directed the insurance company to disburse the amount to the claimant
without TDS. The insurance company filed a writ petition in the High Court
against this order of the District Judge for seeking permission to deduct tax
at source on payment of the interest on compensation.

Before the Patna High Court, on behalf of the insurance
company, reliance was placed upon the relevant provisions of the Income-tax Act
in support of the stand that the insurance company was under a statutory
liability u/s. 194A of the Act to have made deduction of the amount of TDS
while making payment by way of interest on the compensation amount awarded by
the MACT. The total interest component under the award came to a little over
Rs. 1,20,000, and therefore, the insurance company was bound under the Act to
make deduction of TDS while making payment; accordingly, an amount of Rs.
24,175 was to be deducted as TDS.

Reliance was also placed upon a decision of the Patna High
Court in C.W.J.C. No. 5352 of 2013, National Insurance Co. Ltd. vs. CIT,
where the court had held as under:

“It appears that the Tribunal below has ignored the
statutory duty conferred upon the insurer under section 194 (1) (sic) of the
Income-tax Act. Under the said provision, the insurer is obliged to deduct tax
at source from the amount of interest paid by the insurer to the claimant. The
said amount has to be deposited with the Government of India as the income tax
deducted at source. The Tribunal below has grossly erred in directing the
insurer to pay the said sum to the claimant.”

Reliance was further placed upon a decision of the Madras
High Court in the case of New India Assurance Co. Ltd. vs. Mani 270 ITR
394, in which it had been held as follows:

“A plain reading of section 194A of the IT Act would
indicate that the insurance company is bound to deduct the income tax amount on
interest, treating it as a revenue, if the amount paid during the financial
year exceeds Rs. 50,000. In this case, admittedly, when the compensation amount
has been deposited during the financial year, including interest, the interest amount
alone exceeded Rs. 50,000 and therefore the insurance company has no other
option except to deduct the income tax at source for the interest amount
exceeding Rs. 50,000, failing which they may have to face the consequences,
such as prosecution, even. In this view alone, when the execution petition was
filed for the realisation of the award amount, deducting the income tax at
source for the interest, since it exceeded Rs. 50,000, on the basis of the
above said provision, the balance alone had been deposited, for which the court
cannot find fault.”

It was highlighted that the Madras High Court in the said
case had relied upon the decision of the Supreme Court in the case of Bikram
Singh vs. Land Acquisition Collector 224 ITR 551, where the Supreme
Court had held that interest received on delayed payment of compensation under
the Land Acquisition Act was a revenue receipt eligible to income tax. It was
explained that the Madras High Court in the said case had further held that the
trial court had not considered the actual effect of the amendment to section
194A, which came into effect from 1^st June, 2003. The Madras High
Court observed that if the claimant was not liable to pay tax, his remedy was
to approach the department concerned for refund of the amount. According to the
Madras High Court, the executing court did not have the power to direct the
insurance company not to deduct the amount and pay the entire amount, thereby
compelling the insurance company to commit an illegal act, violating the statutory
provisions.

The Patna High Court examined the provisions of sections
194A(1) and (3)(ix) of the Income-tax Act. According to the Patna High Court,
it was evident from the above provisions that any person responsible for paying
any income by way of interest (other than the interest on securities) was
obliged to deduct income tax thereon. The only exception was in case of income
paid by way of interest on compensation amount awarded by MACT, where the
amount of such income or the aggregate of the amounts of such income credited
or paid during the financial year did not exceed Rs. 50,000. The court was
therefore of the view that if the interest component of the payment to be made
during the financial year on the basis of award of the MACT exceeded Rs. 50,000,
then the person making the payment was obliged to deduct TDS while making
payment.

The Patna High Court further held that while exercising his
jurisdiction with regard to execution of the award, the District Judge had to
be conscious of the fact that any such payment would be subjected to statutory
provisions. Since there was a clear provision under the Income-tax Act with
regard to TDS, the District Judge could not have held to the contrary. The only
remedy for the claimant under such circumstances was to approach the assessing
officer u/s. 197 for a certificate for a lower rate of TDS or non-deduction of
TDS, or alternatively to approach the tax authorities for refund of the amount
in case no tax was due or payable by the claimant.

The Patna High Court therefore allowed the writ petition of
the company and set aside the order of the District Judge.

OBSERVATIONS

Section194A requires a person responsible for payment of
interest to deduct tax at source in the circumstances specified therein. Clause
(ix), inserted with effect from 1^st
June, 2003 in section 194A(3) exempted income credited or paid by way of
interest on the compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income credited or paid
during the financial year did not exceed Rs. 50,000. This clause (ix) has been
substituted by clauses (ix) and (ixa) with effect from 1^st June, 2015. The new clause
(ix) altogether exempts income credited by way of interest on the compensation
amount awarded by the MACT from the liability to deduct tax at source u/s.
194A, while clause (ixa) continues to provide for exemption to income paid by
way of interest on compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income paid during the
financial year does not exceed Rs. 50,000. In effect, therefore, no TDS is
deductible on interest on such compensation which is merely credited but not
paid, or on payment of interest where the amount of interest paid during the
financial year does not exceed Rs. 50,000. The issue of applicability of TDS
therefore is really relevant only to cases where there is payment of such
interest exceeding Rs. 50,000 during the year and that, too, when it was not
preceded by the credit thereof.

Section 2(28A) defines the term “interest” in a manner that
includes the interest payable in any manner in respect of any moneys borrowed
or debt incurred. In a motor claim award, there is obviously no borrowing of
monies. Is there any debt incurred? The “incurring” of the debt, if at
all, may arise only on grant of the
award. Before the award of the claim, there is really no debt that can be said
to have been incurred in favour of the person receiving compensation. In fact,
till such time as a claim is awarded there is no certainty about the
eligibility to the claim, leave alone the quantum of the claim. In our
considered view, no part of the amount awarded as compensation under the MVA
till the date of award could be considered as in the nature of interest. The
amount so awarded till the time it is awarded cannot be construed as interest
even where it includes the payment of “interest” u/s. 171 of the MVA for the
reason that such “interest” cannot be construed as “‘interest” within the meaning
of section 2(28A) of the Act and as a consequence cannot be subjected to TDS
u/s. 194A of the Act.

If one looks at the award of “interest” u/s. 171 of the MVA,
typically in most cases, such interest is a part of the amount of compensation
awarded and is not attributable to the late payment of the compensation, but is
for the reasons mentioned in section 171 and at the best relates to the period
ending with the date of award. This “interest” u/s. 171 for the period up to
the date of award, would not fit in within the definition of interest u/s.
2(28A). Interest for the period after the date of award, if related to the
delayed payment of the awarded compensation, would fall within the definition
of interest, being interest payable in respect of debt incurred. It would only
be the interest for the period after the date of award which would be liable to
TDS u/s. 194A of the Income-tax Act provided, of course, that the amount being
paid is exceeding Rs. 50, 000 and was not otherwise credited to the payee’s
account before the payment.

Looked at differently, the interest up to the date of award
would also partake of the same character as the compensation awarded, being
damages for a personal loss, and would therefore not be regarded as an income
at all, opening a new possibility of contending that the provisions of section
194A may not apply to a case where the payment otherwise is not taxable in the
hands of the recipient.

In cases where the payment of the awarded compensation is
delayed, the ultimate amount of payment to be made may include interest for the
post-award period. In such a case, the ultimate amount will have to be
bifurcated into two parts, one towards compensation including interest for the
pre-award period, and the other being interest which may be subjected to TDS.
This need for bifurcation of interest into pre-award interest and post-award
interest, and the character of each, is supported by the decision of the
Supreme Court in the case of CIT vs. Ghanshyam (HUF) 315 ITR 1,
where the Supreme Court held as under in the context of interest on
compensation under the Land Acquisition Act:

“To sum up, interest is different from compensation.
However, interest paid on the excess amount under section 28 of the 1894 Act
depends upon a claim by the person whose land is acquired whereas interest
under section 34 is for delay in making payment. This vital difference needs to
be kept in mind in deciding this matter. Interest under section 28 is part of
the amount of compensation whereas interest under section 34 is only for delay
in making payment after the compensation amount is determined. Interest under
section 28 is a part of enhanced value of the land which is not the case in the
matter of payment of interest under section 34.”

One of the side questions is whether such interest included
in MACT compensation awarded under the MVA is chargeable to tax at all? There
is no doubt that the amount of compensation awarded is for the loss of a
personal nature and is therefore a capital receipt of a personal nature, which
is not chargeable to tax at all. The payment, though labelled “interest” u/s.
171 of the MVA, bears the same character of such compensation inasmuch as it
has no relation to the dent or the period and is nothing but a compensation to
an injured person determined on due consideration of the relevant factors,
including for the period during the date of injury to the date of award.

The mere fact that such income credited by way of interest on
MACT compensation awards is subjected to the provisions of section 194A and the
payer is required to deduct tax at source does not necessarily mean that such
amounts are otherwise chargeable to tax. It is important to note that section
194A, in any case, refers to a person responsible for paying to a resident “any
income” by way of interest and demands compliance only where the payment is in
the nature of income. As interpreted by the Allahabad High Court and the other
courts, such income would mean income which is chargeable to tax. If the
interest is not chargeable to tax, then the question of deduction of TDS u/s.
194A does not arise.

The question of chargeability to tax of such income has also
been recently considered by the Rajasthan High Court in case of Sarda
Pareek vs. ACIT 104 taxmann.com 76, where the High Court took the view
that on a plain reading of section 2(28A), though the original amount of MACT
compensation is not income but capital, the interest on the capital
(compensation) is liable to tax. The Supreme Court has admitted the special
leave petition against this order of the Rajasthan High Court in 104
taxmann.com 77. In the case of New India Assurance Company Ltd.
vs. Mani (supra) the Madras High Court held that the interest awarded
as a part of the compensation was income chargeable to tax; however, in a later
decision in the case of Managing Director, Tamil Nadu State Transport
Corpn. (Salem) Ltd. vs. Chinnadurai, 385 ITR 656, the High Court took a
contrary view and held that such interest awarded did not fall under the term
“income” as defined under the Income-tax Act. An SLP is admitted by the Supreme
Court against this decision, too. Therefore, clearly the issue of chargeability
of even the post-award interest to income tax is still a matter of dispute.

As observed by the Allahabad High Court, the one significant
difference between the compensation under the Land Acquisition Act and under
the MVA is that the compensation under the Land Acquisition Act may be
chargeable to tax under the head capital gains, whereas the compensation under the
MVA is not chargeable to tax at all.

One has to also keep in mind the provisions of section
145A(b), as applicable from assessment year 2010-11 to assessment year 2016-17,
which provided that notwithstanding anything to the contrary contained in
section 145, interest received by an assessee on compensation or on enhanced
compensation, as the case may be, shall be deemed to be the income of the year
in which it is received. With effect from assessment year 2017-18, an identical
provision is found u/s. 145B(1). However, the provisions of section 145A and
section 145B merely deal with how the income is to be computed and in which
year it is to be taxed, and do not deal with the issue of whether a particular
item of interest is chargeable to income tax or not. Therefore, these
provisions would apply only to interest on compensation which is otherwise
chargeable to income tax, and would not be applicable to interest which is not
so chargeable.

One also needs to refer to the provisions of section
56(2)(viii), which provides for chargeability under the head “income from other
sources” of interest received on compensation or on enhanced compensation
referred to in section 145A(b). Again, this provision merely prescribes the
head of income under which such interest would fall, provided such interest
income is chargeable to tax. It does not necessarily mean that the interest in
question is in the nature of income in the first place.

This is further clear from the fact that section 2(24), which
contains the definition of income, specifically includes receipts under various
clauses of section 56(2), such as clauses (v), (vi), (vii), (viia) and (x) –
gifts and deemed gifts, (viib) – excess premium received by a company for
shares, (ix) – forfeited advance for transfer of capital asset, and (xi) –
compensation in connection with termination or modification of terms of
employment for ensuring that such receipts so specified are treated as an
“income” for the purposes of the Act. In contrast, receipt of the nature
specified under clause (viii) of section 56(2) is not included in section 2(24)
indicating that such interest on compensation is not deemed always to be an
income.

One Mr. Amit Sahni has recently knocked the doors of the
Delhi High Court by filing a writ petition seeking quashing of the provision
which mandates deduction of tax on the interest on compensation awarded under
the MVA. The court, vide order dated 16^th April, 2019, has directed
the CBDT to pass a reasoned order latest by 30^th June, 2019 in
response to the representation made by the petitioner in this regard.

The better view, therefore, seems to be that of the
Allahabad, Himachal Pradesh and Punjab and Haryana High Courts, that no tax is
deductible in respect of interest awarded u/s. 171 of the Motor Vehicles Act,
even if such interest exceeds Rs. 50,000, unless such interest is (i)
attributable to the delay in payment of the awarded compensation and (ii)
pertains to the period after the date of the award and is (iii) calculated
w.r.t. the amount of the compensation awarded. This view is unaffected by the
fact of the insertion of clause (x) in section 194A(3), w.e.f. 1^st
June, 2003 and the substitution thereof w.e.f.
1^st June, 2015.

Given this position, and since the issue involves TDS, which
is merely a procedural requirement, one hopes that the CBDT will come out with
a clarification explaining that the provisions of section 194A have a
restricted application to the cases involving payment of interest for the delay
in payment of awarded compensation, so that neither the insurance companies nor
the poor claimants have to unnecessarily suffer through unwarranted tax
deduction or litigation in this regard.

shailesh.kwebmaker

TDS – YEAR OF TAXABILITY AND CREDIT UNDER CASH SYSTEM OF ACCOUNTING

ISSUE FOR
CONSIDERATION

Section 145
requires the assessee to compute his income chargeable under the head “Profits
and gains of business or profession” or “Income from other sources” in
accordance with either cash or mercantile system of accounting, which is
regularly followed by the assessee. The assessee following cash system of
accounting would be offering to tax only those incomes which have been received
by him during the previous year. On the other hand, most of the provisions of
Chapter XVII-B provide for deduction of tax at source at the time of credit of
the relevant income or at the time of its payment, whichever is earlier.
Therefore, often tax gets deducted at source on the basis of the mercantile
system of accounting followed by the payer, which requires crediting of the
amount to the account of the assessee in his books of account. However, the
underlying amount on which the tax has been deducted at source is not
includible in the income of the assessee till such time as it has been received
by him.

Section 198
provides that all sums deducted in accordance with the provisions of Chapter
XVII shall be deemed to be income received, for the purposes of computing the
income of an assessee.

Till Assessment Year 2007-08, section 199 provided for grant of credit
for tax deducted at source to the assessee from income in the assessment made
for the assessment year for which such income is assessable. From Assessment
Year 2008-09, section 199 provides that the CBDT may make rules for the
purposes of giving credit in respect of tax deducted or tax paid in terms of
the provisions of Chapter XVII, including rules for the purposes of giving
credit to a person other than the payee, and also the assessment year for which
such credit may be given.

The corresponding
Rule 37BA, issued for the purposes of section 199(3), was inserted with effect
from 01.04 2009. The relevant part of this Rule, dealing with the assessment
year in which credit of TDS can be allowed, is as follows:

(3) (i) Credit
for tax deducted at source and paid to the Central Government, shall be given for
the assessment year for which such income is assessable.

(ii) Where tax
has been deducted at source and paid to the Central Government and the income
is assessable over a number of years, credit for tax deducted at source shall
be allowed across those years in the same proportion in which the income is
assessable to tax.

After the amendment, though the section does not expressly provide for
the year of credit as it did prior to the amendment, Rule 37BA effectively
provides for credit similar to the erstwhile
section. In fact, under Rule 37BA, more clarity has now been provided in
respect of a case where the income is assessable over a number of years.

In view of these
provisions, an issue has arisen in cases where the assessee’s income is
computed as per the cash system of accounting regarding the year in which the
TDS amount is taxable as an income, and the year of credit of such TDS to the
assessee, when the underlying income from which tax has been deducted is not
received in the year of deduction. The Delhi bench of the Tribunal took a view
that the income to the extent of TDS has to be offered to tax as an income as
provided in section 198 in the year of deduction, and the credit of TDS is
available in such cases in the year of deduction, irrespective of Rule 37BA. As
against this, the Mumbai bench of the Tribunal did not concur with this view,
and denied credit of TDS in the year of deduction.

CHANDER SHEKHAR
AGGARWAL’S CASE

The issue had come
up before the Delhi bench of the Tribunal in the case of Chander Shekhar
Aggarwal vs. ACIT [2016] 157 ITD 626.

In this case, the
assessee was following cash system of accounting. He filed his return of income
for A.Y. 2011-12, including the entire amount of TDS deducted during the year
as his income, claiming TDS credit of Rs. 80,16,290.

While processing
the return u/s. 143(1), the Assessing Officer allowed credit of only Rs.
71,20,267, on the ground that the income with respect to the balance amount was
not included in the return filed by the assessee. The assessee appealed to the
CIT (A), disputing the denial of credit of the differential amount of TDS.
Placing reliance on Rule 37BA, the CIT (A) concluded that the assessee was not
entitled to credit for the amount though mentioned in the certificate for the
assessment year, if income relatable to the amount was not shown and was not
assessable in that assessment year.

The assessee
contended before the Tribunal that the amount equivalent to the TDS had been
offered as income by him in his return of income. This was in accordance with
the provisions of section 198, which mandates that all sums deducted under
Chapter XVII would be deemed to be income received for the purposes of computing
the income of an assessee. It was argued that the provisions of Rule 37BA are
not applicable to assessees following cash system of accounting. Since, as per
provisions of section 199, any deduction of tax under Chapter XVII and paid to
the Central Government shall be treated as payment of tax on behalf of the
person from whose income deduction of tax was made, it was pleaded that the
credit of the disputed amount should be allowed to the assessee.

The Tribunal duly
considered the amended provisions of section 199 as well as Rule 37BA. It
concurred with the view that once TDS was deducted by the deductor on behalf of
the assessee and the assessee had offered it as his income as per section 198,
the credit of that TDS should be allowed fully in the year of deduction itself.
Once an income was assessable to tax, the assessee was eligible for credit,
despite the fact that the remaining amount would be taxable in the succeeding
year.

With regard to Rule
37BA(3)(ii) providing for proportionate credit across the years when income was
assessable over a number of years, the Tribunal held that it would apply where
the entire compensation was received in advance but was not assessable to tax
in that year, but was assessable over a number of years. It did not apply where
the assessee followed cash system of accounting.

This was supported by an illustration – suppose an assessee who was
following cash system of accounting raised an invoice of Rs. 100 in respect of
which deductor deducted and deposited TDS of Rs. 10. Accordingly, the assessee
would offer an income of Rs. 10 and claim TDS of Rs. 10. However, in the
opinion of the Revenue, the assessee would not be entitled to credit of the
entire TDS of Rs. 10, but would be entitled to proportionate credit of Re. 1
only. Now let us assume that Rs. 90 was never paid to the assessee by the
deductor. In such circumstances, Rs. 9 which was deducted as TDS by the
deductor would never be available for credit to the assessee though the said
sum stood duly deposited to the account of the Central Government. Therefore,
as per the Tribunal, Rule 37BA(3) could not be interpreted so as to say that
TDS deducted at source and deposited to the account of the Central Government,
though it was income of the assessee, but was not eligible for credit of tax in
the year when such TDS was offered as income.

The Tribunal also
placed reliance upon the decisions of the Visakhapatnam bench in the case of ACIT
vs. Peddu Srinivasa Rao Vijayawada [ITA No. 234 (Vizag.) of 2009, dated
03.03.2011] and of the Ahmedabad bench in the case of Sadbhav
Engineering Ltd. vs. Dy. CIT [2015] 153 ITD 234. In these cases, it was
held that the credit of tax deducted at source from the mobilisation advance
adjustable against the bills subsequently was available in the year of
deduction, though it was not considered while computing the income of the
assessee.

Accordingly, the
Tribunal held that the assessee would be entitled to credit of the entire TDS
offered as income in the return of income.

SURENDRA S. GUPTA’S
CASE

A similar issue
recently came up for consideration before the Mumbai bench of the Tribunal in
the case of Surendra S. Gupta vs. Addl. CIT [2018] 170 ITD 732 .

In this case, the assessee, following cash system of accounting, did
not offer consultancy income of Rs. 83,70,287 to tax, since the same was not
received during the relevant A.Y. 2010-11. However, he offered corresponding
TDS to tax in respect of the same, amounting to Rs. 8,41,240, and claimed the
equivalent credit thereof in the computation of income. The Assessing Officer, applying Rule 37BA(3)(i),
restricted the credit to proportionate TDS of Rs. 84,547, against income of Rs.
8,41,240 offered to tax by the assessee, and disallowed the balance credit of
Rs. 7,56,693.

The assessee contested the denial of TDS credit before the CIT (A),
who upheld the order of the Assessing Officer, and directed that credit for the
balance amount should be given in the subsequent years in which income
corresponding to such TDS is received.

On the basis of
several decisions of the co-ordinate bench on the issue, the Tribunal noted
that there were two lines of thought on the issue; one which favours grant of
full TDS credit in the year of deduction itself, and the other which, following
strict interpretation, allows TDS credit in the A.Y. in which the income has
actually been assessed / offered to tax. Reference was made to the following
decisions wherein the former view was taken –

(i). Chander
Shekhar Aggarwal vs. ACIT (supra)

(ii). Praveen Kumar Gupta vs. ITO [IT Appeal No.
1252 (Delhi) of 2012]

(iii). Anil Kumar Goel vs. ITO [IT Appeal No. 5849
(Delhi) of 2011]

The Tribunal found
that in none of the above cases was the decision of the Kerala High Court in
the case of CIT vs. Smt. Pushpa Vijoy [2012] 206 Taxman 22 considered by
the co-ordinate bench. In this case, the Kerala High Court had held that the
assessee was entitled to credit of tax only in the assessment year in which the
net income, from which tax had been deducted, was assessed to tax. Following
this decision, the Tribunal rejected the claim of the assessee to allow the
full credit of TDS.

OBSERVATIONS

There are two
aspects to the issue – the year in which the amount of TDS should be regarded
as income of the assessee chargeable to tax (the year of deduction, or the year
in which the net income is received by the assessee), and accordingly accounted
for under the cash system of accounting; and secondly, to what extent credit of
the TDS is available against such income.

Therefore, it
becomes imperative to analyse the impact of the provisions of section 198 with
respect to the assessment of the income of an assessee who is following cash
system of accounting. Section 198 provides as under:

All sums
deducted in accordance with the foregoing provisions of this Chapter shall, for
the purpose of computing the income of an assessee, be deemed to be income
received.

It can be seen that
section 198 creates a deeming fiction by considering the amount of TDS as
deemed receipt in the hands of the deductee, though it has not been received by
him. This deeming fiction operates in a very limited field to consider the
unrealised income as realised. It appears that the legislative intent behind
this provision is to negate the probability of exclusion of the amount of TDS
from the scope of total income by the assessee, on the ground that it amounted
to a diversion of income by overriding title. It also precluded the deductee
from making a claim on the payer for recovery of the amount which had been deducted
at source in accordance with the provisions of Chapter XVII-B. But, this
section, by itself, does not create a charge over the amount of tax deduction
at source.

A careful reading
of this provision would reveal that it does not provide for the year in which
the said income shall be deemed to have been received. In contrast, reference
can be made to section 7, which also provides for certain incomes deemed to be
received. It has been expressly provided in section 7 that “the following
incomes shall be deemed to be received in the previous year….” unlike section
198. Therefore, it would not be correct to say that, once the sum is deducted
at source, it is deemed to be the income received in the year in which it has
been deducted and assessable in that year, de hors the other provisions
determining the year in which the said income can be assessed.

For instance, the
buyer of an immovable property may deduct tax at source u/s. 194-IA on the
advance amount paid to the assessee transferring that property. In such a case,
the capital gain in the hands of the transferor is taxable in the year in which
that immovable property has been transferred as provided in section 45.
Obviously, tax deducted at source u/s. 194-IA cannot be assessed as capital
gain in the year of deduction merely by virtue of section 198, if the capital
asset has not been transferred in the same year.

Similarly, in case
of an assessee who is following cash system of accounting, it cannot be said
that the amount of tax deducted at source is deemed to have been received in
the very same year in which it was deducted. Section 145 governs the
computation of income, which is in accordance with the method of accounting
followed by the assessee. The income equivalent to the amount of tax deducted
at source cannot be charged to tax de hors the method of accounting
followed by the assessee. In case of cash system of accounting, unless the
balance amount is received by the assessee, the amount of tax deducted at
source cannot be included in the income on the ground that it is deemed to be
received as per section 198. The reference to ‘sums deducted’ used in section
198 should be seen from the point of view of the recipient assessee and not the
payer. The ‘deduction’, from the point of view of the recipient, would happen
only when he receives the balance amount, as prior to that, the concerned
transaction would not be recognised at all in the books of account maintained
under the cash system of accounting.

In the context of
section 198 and the pre-amended provisions of section 199, in a Third Member
decision in the case of Varsha G. Salunkhe vs. Dy CIT 98 ITD 147, the
Mumbai Bench of the Tribunal has held as under:

“Both the sections, viz., 198 and 199, fall within
Chapter XVII which is titled as ‘Collection and recovery – deduction at
source’. In other words, these are machinery provisions for effectuating
collection and recovery of the taxes that are determined under the other
provisions of the Act. In other words, these are only machinery provisions
dealing with the matters of procedure and do not deal with either the
computation of income or chargeability of income….

Sections 198 and
199 nowhere provide for an exemption either to the determination of the income
under the aforesaid provisions of sections 28, 29 or as to the method of
accounting employed under section 145 which alone could be the basis for
computation of income under the provisions of sections 28 to 43A. Section 198
has a limited intention. The purpose of section 198 is not to carve out an
exception to section 145. Section 199 has two objectives – one to declare the
tax deducted at source as payment of tax on behalf of the person on whose
behalf the deduction was made and to give credit for the amount so deducted on
the production of the certificate in the assessment made for the assessment
year for which such income is assessable. The second objective mentioned in
section 199 is only to answer the question as to the year in which the credit
for tax deducted at source shall be given. It links up the credit with
assessment year in which such income is assessable. In other words, the
Assessing Officer is bound to give credit in the year in which the income is
offered to tax.

Section 199 does
not empower the Assessing Officer to determine the year of assessability of the
income itself but it only mandates the year in which the credit is to be given
on the basis of the certificate furnished. In other words, when the assessee produces
the certificates of TDS, the Assessing Officer is required to verify whether
the assessee has offered the income pertained to the certificate before giving
credit. If he finds that the income of the certificate is not shown, the
Assessing Officer has only not to give the credit for TDS in that assessment
year and has to defer the credit being given to the year in which the income is
to be assessed. Sections 198 and 199 do not in any way change the year of
assessability of income, which depends upon the method of accounting regularly
employed by the assessee. They only deal with the year in which the credit has
to be given by the Assessing Officer.

It could not be
disputed that according to the method of accounting employed by the assessee,
the income in respect of the three TDS certificates did not pertain to the
assessment year in question but pertained to the next assessment year and, in
fact, in that year, the assessee had offered the same to tax. Therefore, the
credit in respect of those three TDS certificates would not be given in the
assessment year under consideration, but in the next assessment year in which
the income was shown to have been assessed.”

Following this
decision, the Bilaspur bench of the Tribunal, in the case of ACIT vs. Reeta
Loiya 146 TTJ 52 (Bil)(URO), has held as under:

“It is a settled
proposition that the provisions of s. 198 are merely machinery provisions and
are not related to computation of income and chargeability of income as held by
the Bombay Tribunal in the case of Smt. Varsha G. Salunke (supra). In
the absence of the charging provisions to tax such deemed income as the income
of the assessee, the provisions of s. 198 of the Act cannot by themselves
create a charge on certain receipts.”

The Mumbai bench of
the Tribunal, in the case of Dy CIT vs. Rajeev G. Kalathil 67 SOT 52
(Mum)(URO), observed:

“It is a fact
that deduction of tax for the payment is one of the deciding facts for
recognising the revenue of a particular year. But TDS in itself does not mean
that the whole amount mentioned in it should be taxed in a particular year,
deduction of tax and completion of assessment are two different things while
finalising the tax liability of the assessee and Assessing Officer is required
to take all the facts and circumstances of the case not only the TDS
certificate.”

In the case of ITO
vs. Anupallavi Finance & Investments 131 ITD 205, the Chennai bench of
the Tribunal, while dealing with the controversy under discussion, has dealt
with the impact of section 198 as follows:

We are unable to
understand as to how the said provision assists the assessee’s case. All the
section says, to state illustratively, is that if there is deduction of tax at
source out of income of Rs. 100 [say at the rate of 10 per cent], crediting or
paying assessee Rs. 90, the same, i.e., Rs. 10 is also his income. It nowhere
speaks of the year for which the said amount of TDS is to be deemed as income
received. The same would, understandably, only correspond to the balance 90 per
cent. As such, if 30 per cent of the total receipt/credit is assessable for a
particular year, it shall, by virtue of section 198 of the Act be reckoned at
Rs. 30 [Rs. 100 × 30 per cent] and not Rs. 27 [Rs. 90 × 30 per cent]. Thus,
though again a natural consequence of the fact that tax deducted is only out of
the amount paid or due to be paid as income, and in satisfaction of the tax
liability on the gross amount to that extent, yet clarifies the matter, as it
may be open to somebody to say that TDS of Rs. 10 has neither been credited nor
received, so that it does not form part of income received or arising and,
thus, outside the scope of section 5 of the Act. That, to our mind, is sum and
substance of section 198.

Similar
observations have been made by the Mumbai bench of the Tribunal in the case of ITO
vs. PHE Consultants 64 taxmann.com 419 which are reproduced hereunder:

It is pertinent
to note that the provisions of sec. 198, though states that the tax deducted at
source shall be deemed to be income received, yet it does not specify the year
in which the said deeming provision applies. However, section 198 states that
the same is deemed to be income received “for the purpose of computing the
income of an assessee.” The provisions of section 145 of the Act state
that the income of an assessee chargeable under the head “Profits and
gains of business or profession” or “Income from other sources”
shall be computed in accordance with either cash or mercantile system of
accounting regularly employed by the assessee. Hence a combined reading of
provisions of section 198 and section 145 of the Act, in our view, makes it
clear that the income deemed to have been received u/s. 198 has to be computed
in accordance with the provisions of section 145 of the Act, meaning, thereby,
the TDS amount, per se, cannot be considered as income of the assessee by
disregarding the method of accounting followed by the assessee.

The Kerala High
Court has also expressed a similar view as extracted below in the case of Smt.
Pushpa Vijoy (supra), although without referring expressly to section 198.

We also do not
find any merit in the contention of the respondents-assessees that the amount
covered by TDS certificates itself should be treated as income of the previous
year relevant for the assessment year concerned and the tax amount should be
assessed as income by simultaneously giving credit for the full amount of tax
remitted by the payer.

Further, deeming
the amount of tax deducted at source as a receipt in the year of deduction and
assessing it as income of that year would pose several difficulties. Firstly,
the assessee might not even be aware about the deduction of tax at source on
his account while submitting his return of income. This may happen due to delay
on the part of the deductor in submitting the TDS statement and consequential
reflection of the information in Form 26AS of the assessee. Secondly, the tax
might be deducted at source while making the provision for the expenses by the
payer following mercantile system of accounting. For instance, tax is deducted
at source u/s. 194J while providing for the auditor’s remuneration. In such a
case, treating the amount of tax deducted at source as income of the auditor in
that year, would result into taxing the amount, even before the corresponding
services have been provided by the assessee.

Moreover, for an
amount to constitute a receipt under the cash method of accounting, it should
either be actually received or made available unconditionally to the assessee.
As held by the Supreme Court in the case of Keshav Mills Ltd. vs. CIT 23 ITR
230, “The ‘receipt’ of income refers to the first occasion when the
recipient gets the money under his own control.” In case of TDS, one can
take a view that such TDS is not within the control of the payee until such
time as he is eligible to claim credit of such TDS. That point of time is only
when he receives the net income after deduction of TDS, when he is eligible to
claim credit of such TDS.

Since the amount of
tax deducted at source cannot be charged to tax in the year of deduction merely
by virtue of section 198, no part of that income is assessable in that year, in
the absence of any receipt, in view of the cash system of accounting followed
by the assessee. The Delhi bench of the Tribunal in the case of Chander Shekhar
Aggarwal (supra) has decided the whole issue on the basis of the fact
that the amount equivalent to TDS was being offered to tax by the assessee in
accordance with the provision of section 198. Since the income was assessed to
that extent, the Tribunal opined that the assessee was eligible for full credit
of TDS, notwithstanding Rule 37BA(3)(ii), which provided for allowance of
proportionate TDS credit when the income was not fully assessable in the same
year. Thus, the very foundation on the basis of which the Delhi bench of the
Tribunal has allowed the full credit of TDS to the assessee in the case of
Chander Shekhar Aggarwal (supra) appears to be incorrect.

Having analysed the provisions of section 198, let us now consider the
issue about the year in which the credit for tax deducted at source is
allowable. As per section 4, the tax is chargeable on the ‘total income’ of the
assessee for a particular previous year. When the assessee pays the income-tax
under the Act, he does not pay it on any specific income but he pays it on the
‘total income’. Thus, it cannot be said that a particular amount of tax has
been paid or payable on a particular amount of income. However, when it comes
to TDS, the erstwhile provision of section 199 expressly provided that its
credit shall be given for the assessment year in which the relevant income is
assessable. After its substitution with effect from 01.04.2008, new section 199
has authorised CBDT to prescribe the rules which can specifically provide for
the assessment for which the credit may be given. As per the mandate given in
section 199, Rule 37BA provides that the credit shall be given for the
assessment year for which the concerned income is assessable. In view of such
express provisions, the credit cannot be availed in any year other than the
assessment year in which the income subject to deduction of tax at source is
assessable.

The Delhi bench of the Tribunal took a view that Rule 37BA does not
apply where the assessee follows cash system of accounting insofar as it
provides for the year in which the credit is available. In order to support its
view, it has been pointed out that the credit would not be available otherwise
in a case where the assessee does not receive the underlying income at all.
Certainly, the law does not provide about how the credit would be given for
that amount of TDS which was deferred for the reason that the relevant income
is assessable in future but, then, found to be not assessable at all for some
reason. However, this lacuna under the law can affect both types of assessees,
i.e., assessees following cash system of accounting, as well as assessees
following mercantile system of accounting.

Circular No. 5
dated 02.03.2001 has addressed one such situation wherein the tax has been
deducted at source on the rent paid in advance u/s. 194-I and subsequently the
rent agreement gets terminated or the rented property is transferred due to
which the balance of rent received in advance is refunded to the tenant or to
the transferee. It has been clarified that in such a case, credit for the
entire balance amount of tax deducted at source, which has not been given
credit so far, shall be allowed in the assessment year relevant to the
financial year during which the rent agreement gets terminated / cancelled or
rented property is transferred and balance of advance rent is refunded to the
transferee or the tenant, as the case may be. Similarly, in a few cases, the
Courts and Tribunal have held that where income has been offered to tax in an
earlier year, but tax has been deducted at source subsequently, credit for the
TDS should be allowed in such subsequent year [CIT vs. Abbott Agency,
Ludhiana 224 Taxman 350 (P&H), Societe D’ Engineering Pour L’ Industrie Et.
Les Travaux Publics, (SEITP) vs. ACIT 65 SOT 45 (Amr)(URO)].

Therefore, in our
view, the mere probability of income not getting assessed in future cannot by
itself be the reason for not applying the express provision of the law, unless
suitable amendment has been carried out to overcome such difficulty. Taking a
clue from the CBDT’s clarification vide aforesaid Circular, it is possible to
take a view that the credit of TDS should be made available in the year in
which the assessee finds that the relevant income would not be assessable at
all due to its irrecoverablity or any other reasons.

The view taken by the Mumbai bench of the
Tribunal in the case of Surendra S. Gupta (supra) by following the
decision of Kerala High Court in the case of Pushpa Vijoy (supra)
therefore seems to be the more appropriate view. The amount of tax deducted at
source is neither assessable as income nor available as credit in the year of
deduction, if the assessee is following the cash system of accounting, and has
not received the balance amount in that year. The taxation of the entire
amount, as well as credit for the TDS, would be in the year in which the net
amount, after deduction of TDS, is received. In case the net amount is received
over multiple years, the TDS amount would be taxed proportionately in the
multiple years, and proportionate TDS credit would also be given in those
respective years.

shailesh.kwebmaker

CO-OWNERSHIP AND EXEMPTION UNDER SECTION 54F

ISSUE FOR CONSIDERATION

An assessee,
whether an individual or an HUF, is exempted from payment of income tax on
capital gains arising from the transfer of any long-term capital asset, not
being a residential house, u/s. 54F of the Income-tax Act on the purchase or
construction of a residential house within the specified period. This exemption
from tax is subject to fulfilment of the other conditions specified in section
54F. One of the important conditions required to be satisfied in order to be
eligible for claiming exemption u/s. 54F is about the ownership of another
residential house, other than the one in respect of which the assessee intends
to claim the exemption, as on the date of transfer of the asset.

This limitation on ownership of another
house is placed in the Proviso to section 54F(1). Till the assessment year
2000-01, the condition was that the assessee should not own any other
residential house on the date of transfer other than the new house in respect
of which the assessee intends to claim the exemption. Thereafter, the rigours
of the Proviso to section 54F(1) were relaxed by amending the same by the
Finance Act, 2000 w.e.f. 1^st April, 2001 so as to provide that the
assessee owning one residential house as on the date of transfer of the
original asset, other than the new house, is also eligible to claim the
exemption u/s. 54F. This condition prescribed by item (i) of clause (a) of the
Proviso to section 54F(1) reads as under: “Provided that nothing contained
in this sub-section shall apply where – (a) the assessee – (i) owns more than
one residential house, other than the new asset, on the date of transfer of the
original asset; or…”

Therefore, ownership of more than one
residential house, on the date of transfer, is fatal to the claim of exemption
u/s. 54F.

In respect of this condition, the
controversy has arisen in cases where the assessee is a co-owner of a house
besides owning one house on the date of the transfer. The question that has
arisen is whether the residential house which is not owned by the assessee
exclusively but is co-owned jointly with some other person should also be
considered while ascertaining the number of houses owned by the assessee as on
the date of transfer of the original asset. The issue involves the
interpretation of the terms ‘owns’ and ‘more than one residential house’ as
used in the provision concerned.

The Madras High Court has allowed the
exemption by holding that the co-ownership of a house as on the date of
transfer of the original capital asset was not an impediment in the claim of
exemption, while the Karnataka High Court has denied the benefit of exemption
by considering the house jointly owned by the assessee with others as the house
owned by the assessee which disqualified the assessee from claiming the
exemption.

The conflict was first examined by BCAJ
in March, 2014 when the controversy was fuelled by the two conflicting decisions
of the appellate Tribunal. In the case of Rasiklal N. Satra, 98 ITD 335,
the Mumbai bench of the Tribunal had taken a stand that the co-ownership of a
house at the time of transfer does not amount to ownership of a house and is
not an impediment for the claim of exemption u/s. 54F; on the other hand, the
Hyderabad bench of the Tribunal had denied the benefit of section 54F in the Apsara
Bhavana Sai case, 40 taxmann.com 528 where the assesses have been found
to be holding a share in the ownership of the house as on the date of transfer
of the asset. This difference of view continues at the high court level and
therefore requires a fresh look.

THE DR. P. K. VASANTHI RANGARAJAN CASE

The issue first came up for consideration of
the Madras High Court in the case of Dr. P.K. Vasanthi Rangarajan vs. CIT
[2012] 209 Taxman 628 (Madras). In this case, the long-term capital
gains arising from the execution of a joint development agreement was offered
to tax in the return of income for the assessment year (AY) 2001-02 and the
corresponding exemption was claimed u/s. 54F on reinvestment of such gains in
purchasing the residential premises. However, considering the fact that
possession of the property was handed over in the previous year relevant to AY
2000-01, the assessee finally conceded the view of the assessing officer that the gains were taxable
in AY 2000-01. So, the exemption provisions contained in section 54F, as it
then stood prior to the amendment by the Finance Act, 2000, effective from 1^st
April, 2001, were applicable to the case.

So far as the exemption u/s. 54F was
concerned, the AO observed that the assessee owned 50% share in the property
situated at 828 and 828A, Poonamallee High Road which consisted of a clinic on
the ground floor and a residential portion on the first floor. The balance 50%
share was owned by the husband of the assessee. In view of the fact that the
assessee owned a residential house as on the date of transfer of the rights by
virtue of the development agreement, the exemption u/s. 54F was denied by the
AO as the conditions prescribed therein in his opinion were not satisfied. The
CIT (A) confirmed the rejection of the claim by the AO.

On appeal by the assessee, the Tribunal
rejected the assessee’s claim u/s. 54F on the ground that the assessee was the
owner of 50% share in the residential property on the date of transfer and as a
result was disentitled to the benefit of section 54F inasmuch as she was found
to be the owner of the premises other than the new house on the date of
transfer. It was held that even though the property was not owned fully, yet, as
the assessee was having 50% share in the residential property, the conditions
envisaged u/s. 54F were not fully satisfied, hence the assessee was not
entitled to exemption u/s. 54F.

It was innovatively claimed before the High
Court on behalf of the assessee that the assessee’s share in the property was
to be taken as representing the clinic portion alone and that the residential
portion being in the name of her husband, the proviso denying the exemption
u/s. 54F had no application to the assessee’s case. However, this contention
was found to be contrary to the facts of the case by the High Court. The
assessee as well as her husband had offered 50% share each in the income of the
clinic in the income-tax assessment and had claimed depreciation thereon. Besides,
50% share in the said property in the wealth tax proceedings was offered by the
assessee and her husband.

It was further argued that for grant of
exemption u/s. 54F, the limitation applied only where the premises in question
were a residential house, was owned in the status as an individual or an HUF as
on the date of the transfer; that holding the house jointly could not be held
to be owned in the status of individual or HUF. As against this, the Revenue
contended that the co-ownership of another house as on the date of transfer,
even in part, would disentitle the assessee of the benefit of section 54F and
the proviso would be applicable to her case.

Given the fact that the assessee had not
exclusively owned the house, but owned it jointly with her husband, the High
Court held that unless and until the assessee was the exclusive owner of the
residential property, the harshness of the proviso to section 54F could not be
applied to deny the exemption. A reading of section 54F, the court noted, clearly
pointed out that the holding of the residential house as on the date of
transfer had relevance to the status of the assessee as an individual or HUF
and when the assessee, as an individual, did not own any property in the status
of an individual as on the date of transfer, joint ownership of the house would
not stand in the way of claiming an exemption u/s. 54F. Accordingly, the High
Court allowed the exemption to the assessee.

THE M.J. SIWANI CASE

The issue, thereafter, came up for
consideration of the Karnataka High Court in CIT vs. M.J. Siwani [2014]
366 ITR 356 (Karnataka).

In this case,
the assessee and his brother, H.J. Siwani, jointly owned a property at 28,
Davis Road, Bangalore which consisted of land and an old building. During the
year relevant to the assessment year 1997-98, they transferred this property by
executing an agreement to sell. The resultant long-term capital gains arising
on the transfer of the said property was claimed to be exempt u/s. 54 or, in
the alternative, u/s. 54F. The claim of exemption was denied on various grounds
including for owning few more houses as a co-owner on the date of the transfer.

The claim of exemption u/s. 54F was denied
since as on the date of transfer, both the assessees owned two residential
houses having one-half share each therein. As the assessee was in possession of
a residential house on the date on which the transaction resulting in long-term
capital gains took place, the AO as well as the first appellate authority
refused to grant any benefit either u/s. 54 (for reasons not relevant for our
discussion) or u/s. 54F in respect of capital gains income derived by the
assessees.

The Tribunal, on appeal, however, reversed
the findings of the authorities below holding that ‘a residential house’ meant
a complete (exclusively owned) residential house and would not include a shared
interest in a residential house; in other words, where a property was owned by
more than one person it could not be said that any one of them was the owner. A
shared property, as observed by the Tribunal, continued to be of the co-owners
and such joint ownership was different from absolute ownership. The Tribunal
relied upon the decision of the Supreme Court in Seth Banarasi Dass Gupta
vs. CIT [1987] 166 ITR 783 wherein it was held that a fractional
ownership was not sufficient for claiming even fractional depreciation u/s. 32
as it stood prior to the amendment with effect from 1st April, 1997 whereby the
expression ‘owned wholly or partly’ was inserted.

On appeal by the Revenue, the High Court,
allowing the appeal held that even where the residential house was shared by
the assessee, his right and ownership in the house, to whatever extent, was
exclusive and nobody could take away his right in the house without due process
of law. In other words, a co-owner was the owner of a house in which he had a
share and that his right, title and interest was exclusive to the extent of his
share and that he was the owner of the entire undivided house till it was
partitioned. The Court observed that the right of a person, might be one half,
in the residential house could not be taken away without due process of law and
such right continued till there was a partition of such residential house.
Disagreeing with the view of the Tribunal, the High Court decided the issue in
favour of the Revenue denying the exemption u/s. 54F to both the assessees by
holding that the ownership of a house, though jointly, violated the condition
of section 54F and the benefit could not be granted to the assessees.

OBSERVATIONS

The issue as to whether the expression “owns
more than one residential house” covers the case of co-ownership of the house
or not can be examined by comparing it with the expressions used in other
provisions of the Act. In this regard, a useful reference may be made to the
provisions of section 32 which expressly covers the cases of whole or part
ownership of an asset for grant of depreciation. The term ‘wholly or partly’
used after the term ‘owned’ in section 32(1) clearly conveys the legislative
intent of covering an asset that is partly owned for grant of depreciation. In
its absence, it was not possible for a co-owner of an asset to claim the
depreciation as was held in the case of Seth Banarasi Dass Gupta (Supra).
In that case, a fractional share in an asset was not considered as coming
within the ambit of single ownership. It was held that the test to determine a
single owner was that “the ownership should be vested fully in one single
name and not as joint owner or a fractional owner”. The provisions of
section 32 were specifically amended thereafter to insert the words ‘wholly or
partly’ in order to extend the benefit of depreciation to the assessee owning
the relevant assets in part.

Since the words ‘wholly or partly’ have not
been used in the Proviso to section 54F(1), its scope cannot be extended to
even include the residential house which is owned partly by the assessee or is
co-owned by him and to deny the benefit of exemption thereby. The Tribunal did
decide the issue in the case of M.J. Siwani (supra) by relying
upon the aforesaid decision of the Supreme Court in the case of Seth
Banarasi Dass Gupta (Supra).Following the very same decision of the
Supreme Court, very recently, the Mumbai bench of the Tribunal has also decided
this issue in favour of the assessee in the case of Ashok G. Chauhan
[2019] 105 taxmann.com 204.

Further, section 54F uses different terms,
‘a residential house’, ‘any residential house’ and ‘one residential house’ at
different places. It is also worth noting that one expression has been replaced
by another expression through the amendments carried out in the past as
summarised below:

AMENDMENTS
AND THEIR EFFECT

Prior to the Finance Act, 2000

Main provision of section 54F(1) used the term ‘a
residential house’, the purchase or construction of which entitled the
assessee to claim the exemption;

Proviso to section 54F(1) used the term ‘any
residential house’, the ownership of which disentitled the assessee to claim
the exemption

Amendment by the Finance Act, 2000

A new Proviso was inserted replacing the old Proviso
whereunder the expression ‘more than one residential house’ was used.
After the amendment, the assessee owning more than one residential house was
disentitled to claim the exemption; The main provision remained unchanged

Amendment by the Finance (No. 2) Act, 2014

The main provision was also amended replacing the expression
‘a residential house’ by ‘one residential house’

The expression ‘one
residential house’ used in the Proviso in contrast to the other expressions
would mean one, full and complete residential house, exclusively owned, as
distinguished from the partial interest in the house though undivided. Holding
such a view may cut either way and might lead to the denial of exemption in the
case where the assessee has acquired a partial interest in the residential
house and seeks to claim the benefit of exemption from gains on the strength of
such reinvestment. The main operative part of section 54F itself now refers to
‘one residential house’.

In our opinion, for
the benefit of reinvestment of gains the case of the assessee requires to be
tested under the main provision and not the Proviso thereto. One should be able
to distinguish its implication on the basis of the fact that the subsequent amendment
replacing ‘a residential house’ by ‘one residential house’ in the main
provision is intended to deny the exemption where more than one house is acquired and not for
denying the exemption in cases where a share or a partial interest in one house
is acquired. In any case, the provisions being beneficial provisions, the
interpretation should be in favour of conferring the benefit against the denial
thereof, more so where two views are possible.

Further, since the
provisions of section 54F apply only to an individual or an HUF, owning of the
house by the assessee in his status as individual or HUF is relevant for the
purpose of Proviso to section 54F(1) as held by the Madras High Court. If the
residential house is owned by a group of individuals and not by the individual
alone, then that should not be considered as impediment in the claim of
exemption.

The ratio of the
Supreme Court decision in the case of Dilip Kumar
and Co. (TS-421-SC-2018) holding that the
notification conferring an exemption should be interpreted strictly and the
assessee should not be given the benefit of ambiguity, would not be applicable
where two views are legitimately possible and the benefit is being sought under
the provisions of the statute and not under a notification. The inference that
ownership of the house should not include part ownership of the house flows
from the Supreme Court decision in the case of Seth Banarasi Dass Gupta
(Supra) and it can be said that there is no ambiguity in its
interpretation.

It may be noted that the assessee had filed
a Special Leave Petition before the Hon’ble Supreme Court against the decision
of the Karnataka High Court in the case of M.J. Siwani (supra) which
has been dismissed. However, as held by the Supreme Court in the case of Kunhayammed
vs. State of Kerala [2000] 113 Taxman 470 (SC), dismissal of SLP would
neither attract the doctrine of merger so as to stand substituted in place of
the order put in issue before it, nor would it be a declaration of law by the
Supreme Court under Article 141 of the Constitution for there is no law which
has been declared. Therefore, it cannot be said that the view of the Karnataka
High Court has been affirmed by the Supreme Court.

The better view, in our considered opinion,
is that the premises held on co-ownership should not be considered to be
‘owned’ for the purposes of the application of restrictions contained in
Proviso to section 54F(1) of the Income-tax Act so as to enable the claim of
exemption.

shailesh.kwebmaker

PERIOD OF LIMITATION PROVIDED IN SECTION 154(7) VIS-À-VIS DOCTRINE OF MERGER

ISSUE FOR CONSIDERATION

Section 154 empowers the income-tax
authority to amend any order passed by it under the provisions of Act with a
view to rectifying any mistake apparent from the record. Sub-section (7) of
section 154 provides for the time limit within which the order can be amended
for this purpose. It provides that no amendment u/s. 154 shall be made after
the expiry of four years from the end of the financial year in which the order
sought to be amended was passed.

Under the Act, many times, more than one
order is framed in the case of the assessee for the same assessment year, . For
instance, the reassessment order is passed u/s. 147 after the assessment order
u/s. 143(3) has already been passed, or the order is passed for giving effect
to the order passed by the appellate authorities while adjudicating the appeal
filed against the order passed by the lower authorities. Quite often, the issue
arises in such cases about the limitation period; whether it should be counted
from the date of the original order or from the date of the subsequent order.

In the case of Hind Wire Industries Ltd.
vs. CIT 212 ITR 639, the Supreme Court has dealt with an issue where an order was sought to be rectified for the
second time, on an issue which was not the subject matter of the first order.
The Supreme Court in the facts of the case held that the word ‘order’ in the
expression ‘from the date of the order sought to be amended’ in section 154(7)
as it stood at the relevant assessment year had not been qualified in any way,
and it did not necessarily mean the original order. It could be any order,
including the amended or rectified order. Accordingly in the facts of the case,
it was held that the time limit as provided in section 154(7) should be
reckoned from the date of rectified order, and not from the date of original
order. This finding of the Supreme Court has been relied upon by the different
high courts to support the conflicting decisions delivered by them.

Section 263 authorising Pr. CIT or CIT to
pass the order of revision also contains an express provision whereby an order
of revision is not allowed to be passed after the expiry of two years from the
end of the financial year in which the order sought to be revised was passed.
In the case of CIT vs. Alagendran Finance Ltd. 293 ITR 1, in the context
of section 263 , the Supreme Court held that the period of limitation provided
for under sub-section (2) of section 263 would begin to run from the date of
the order of original assessment and not from the order of reassessment, if the
issue on which the order was sought to be revised was not the subject matter of
the reassessment. It was held that the doctrine of merger will have no
application in such a case. In deciding the case, the Supreme Court had
referred to its earlier decision in the case of Hind Wire Industries Ltd.
(supra).

In a situation where the order giving effect
to an appellate order has been passed subsequent to the assessment order, and
the Assessing Officer wishes to rectify the mistakes arising from his original
order, the High Courts have given conflicting decisions in so far as the period
of limitation provided in section 154(7) is concerned. The Delhi High Court has
held that the period of limitation would begin from the date of order giving
effect to that appellate order. As against this, the Allahabad High Court has
held that it would begin from the date of original order which contained the
mistake apparent from the record.

Tony Electronics’ case:The issue first came up before the Delhi High Court in the case of CIT
vs. Tony Electronics Ltd. 320 ITR 378 (Delhi).

In this case, the assessment order passed
u/s. 143(3) had been challenged by filing an appeal before the Commissioner
(Appeals). The order was also passed by
the Assessing Officer giving effect to the Commissioner (Appeals)’ directions.
Thereafter, the notice u/s.154 was issued for rectifying the mistake apparent
from record in the latest order. The relevant dates on which different types of
orders and notices issued were as follows:

24-11-1998

Assessment order
u/s. 143(3) was passe.

20-5-1999

Appeal against
assessment order dated 24-11-1998 was disposed of by the
Commissioner(Appeals).

8-5-2003

The appeal effect
order u/s. 143(3)/250 was passed.

28-6-2004

Appeal against the
appeal effect order dated 8-5-2003 was disposed of by the
Commissioner(Appeals).

23-7-2004

Second Order u/s.
143(3)/250 giving effect to the second order of Commissioner(Appeals) dated
28-6-2004 was passed.

30-1-2006

Notice u/s. 154 of
the Act, alleging that there was mistake in the second order dated 23-7-2004
.

26-4-2006

Order u/s. 154 of
the Act was passed.

In this case, while making the assessment
originally, the AO had discussed in the order that the depreciation amounting
to Rs. 6,28,842 claimed by the assessee was to be disallowed however, in the
final computation of assessed income, had under an error failed to reduce the
said amount of disallowed depreciation. The assessee not having any grievance,
had not filed any appeal against the said order proposing for the withdrawal of
depreciation. Therefore, the same was required to be reduced from the total
amount of depreciation of Rs. 54,86,162 and only the balance depreciation of
Rs. 48,57,200 was allowable to the assessee. The lapse of the AO had resulted
into under assessment by Rs. 12,57,688. In short, the mistake was that
disallowed depreciation, instead of being added to the income, was reduced from
the income, resulting in double deduction. The notice issued u/s.154 stated
that the amount of assessed income taken as the basis while passing the latest
order dated 23-7-2004 giving effect to the Commissioner (Appeals)’s order was
mistakenly taken lower by Rs. 12,57,688.

The assessee questioned the jurisdiction of
the Assessing Officer to pass the rectification order u/s. 154 on the ground
that in view of sub-section (7) of section 154, such a rectification order
could be passed within four years “from the end of the financial year in
which the order sought to be amended was passed”. According to the
assessee, since the assessment was framed on 24-11-1998, the period of four
years had lapsed long ago and, therefore, the proposed action on the part of
the Assessing Officer was time-barred. The Assessing Officer did not accept the
plea while passing the order dated 26-4-2006. According to him, the period of four years was to be counted from
23-7-2004 when the Assessing Officer had passed an order for giving appeal
effect.

The Commissioner(Appeals) confirmed the
action of the Assessing Officer and dismissed the appeal filed by the assessee.
However, the Tribunal quashed the Assessing Officer’s order on the ground that
the action of rectification u/s. 154 was barred by limitation. The Revenue
challenged the findings of the Tribunal before the High Court.

Before the High Court, the contentions of
the Revenue were two fold namely:

1. The Assessing Officer had inherent power to
rectify a totalling mistake which crept in computation. For correcting a
totalling mistake, limitation prescribed under sub-section (7) of section 154
was not even applicable. Otherwise, it would frustrate the object and purpose
of determining the taxable income and to collect the tax thereon.

2. Even if it was held that
limitation under sub-section (7) of section 154 was applicable, then also it
would start to run from the last order, i.e. order dated 23-7-2004, and not
from the original order. The revenue sought to invoke the doctrine of Merger
and submitted that since the mistake had occurred at the time of passing order
dated 28-6-2004, while giving effect to the decision of the
Commissioner(Appeals), limitation should start from that date.

The assessee submitted that the appellate
orders dealt with altogether different issues while the impugned mistake sought
to be rectified had crept in the original order dated 24-11-1998 and was not
the subject-matter of appeals. It was not a mistake in the amount of income
taken to be the basis, which had occurred in the order dated 23-7-2004, as
stated in his notice by the Assessing Officer u/s. 154, but it was a mistake
that had taken place in the original order by not reducing the amount of
depreciation disallowed in computing the assesse income. The doctrine of merger
would be applicable
only in respect of those issues that were before the appellate authorities.

The High Court duly noted that both
Commissioner (Appeals) and the Tribunal had recorded a finding that the mistake
was in the original order dated 24-11-1998 and not in the order dated 23-7-2004
but hereafter went on to hold that the doctrine of merger applied to the said
order and the order merged with the latest order.

The High Court relied upon the decision of
the Supreme Court in the case of Hind Wire Industries Ltd. (supra) and
observed that, the Supreme Court, in that case, was of the view that the word
‘order’ used in the expression “from the date of the order sought to be
amended” occurring in sub-section (7) of section 154 had not been
qualified in any way and it did not necessarily mean the original order. The
Court was further of the view that once a reassessment order or rectification
order was passed giving effect to the order of the appellate forum, the
original order ceased to operate.

By relying upon
the understandings of the Courts with regard
to the Doctrine of Merger[1],
the High Court also held that once an appeal against the order passed by an
authority is preferred and is decided by the appellate authority, the original
order merged into the order passes subsequently.With this merger, order of the
original authority ceased to exist and the subsequent order prevailed, in which
the original order merged. For all intent and purposes, it was the subsequent
order that was to be seen.

The High Court noted that the counsel for
the assessee agreed that the order of re-assessment substituted the initial
order that did not survive in any manner or to any extent. The High Court
extended the principle to a case where the assessment order wass challenged in
appeal and the appellate authority passed an order at variance with the order
passed by the Assessing Officer, on the basis of which a fresh order u/s.143(3)
r.w.s 250 was required to be passed by the Assessing Officer giving effect to
the order of the appellate authority.

Accordingly, the High Court upheld invoking
of the provisions of section 154 by the Assessing Officer in this case, on the
ground that the assessment order had merged with the order of
Commissioner(Appeals) passed on 28-6-2004, the limitation for the purpose of
sub-section (7) of section 154 was to be counted from the said date.

SHREE NAV DURGA COLD STORAGE & ICE FACTORY’S CASE

A similar issue recently came up for
consideration before the Allahabad High Court in the case of Shree Nav Durga
Cold Storage & Ice Factory vs. CIT 397 ITR 626 (Allahabad).

In this case,
for Assessment Year 2003-04, various orders were passed as explained below in
the chronological order:

31-3-2006

Assessment order u/s. 143(3) was passed.

27-12-2006

Appeal against assessment order dated 31-3-2006 was disposed
of by the Commissioner(Appeals).

13-6-2008

ITAT passed the order remanding the matter back to the
Assessing Officer for the limited purpose of arriving at the fair market
value on the date of transfer by referring to the Valuation Authority and,
accordingly, recalculate the long-term capital gain.

31-12-2009

The fresh assessment order was passed by the Assessing
Officer but without the benefit of report of Valuation Officer.

25-1-2011

Upon receipt of the report of the Valuation Officer, the
order was passed in exercise of power u/s. 154, 254, 143(3) re-determining
the amount of long-term capital gain.

9-5-2011

The assessee filed the application u/s. 154 for rectification
of mistake stating that long-term capital loss which was brought forward from
earlier years had to be set off against capital gain for the year but the
same had been missed by Assessing Officer

This application made u/s. 154 was rejected
by the Assessing Officer. Both, the Commissioner(Appeals) and ITAT, confirmed
the order of the Assessing Officer rejecting the application of the assessee by
observing that the purpose of section 154, the limitation would commence from
assessment order dated 31.03.2006 and not subsequent orders.

On behalf of the assessee, it was contended
before the High Court that the Assessing Officer was under a statutory
obligation to allow set off of brought forward capital loss and since the last
order was passed by him on 25.01.2011, for the purpose of section 154 (7),
limitation would count from the date of the said order, and in any case, from
the date of the order dated 31.12.2009 which was passed after remand by the Tribunal.
It was argued that the order dated 31.03.2006 merged in the judgment of the
Tribunal dated 13.06.2008 whereby the matter was remanded to the Assessing
Officer. Reliance was placed on the judgment of the Supreme Court in Hind
Wire Industries Ltd. (supra) and Delhi High Court in Tony Electronics
Ltd. (supra).

On the facts, the High Court observed that
the issue of set off of brought forward capital loss had already attained
finality when assessment order dated 31.03.2006 was passed by the Assessing Officer
since in the appeal before Commissioner (Appeals) and the Tribunal, the
Assessee did not raise that plea at all. The order of remand passed by the
Tribunal was only confined to determination of long-term capital gain for the
year and not for any other purpose. It was a limited and partial remand,
confined to a particular purpose.

In the light of these facts, the High Court
observed that the legislature had not thought it fit to apply the general
doctrine of merger, but the doctrine of ‘Partial Merger’ had been adopted. The
High Court drew support from the relevant provision of section 263 which
permitted the Commissioner to exercise revisional power over such matters as
had not been considered and decided in the appeal.

Once the issue of merger was governed by
statutory provisions, then, obviously, it was the statute which shall prevail
over the general doctrine of merger. Accordingly, the High Court rejected the
appellant’s contentions and held that the order in which the amendment was
sought was the original order dated 31-3-2006 and, hence, limitation would
count from the date of that order.

With regard to the Delhi High Court’s
decision in the case of Tony Electronics Ltd.(supra), the Allahabad High
Court held that the inference drawn therein from reading of the judgement in Hind
Wire Industries Ltd. was much more then what had actually been said by the
Supreme Court. The Supreme Court had held as follows in Hind Wire Industries
Ltd.:

“word “order” has not been
qualified in any way and it does not necessarily mean the original order. It
can be any order, including the amended or rectified order.”

The aforesaid word “including”
made it very clear that an amended or rectified order would not result in
nullifying the original order and to say that the original order would cease to
exist. To read it as if, once the rectified order was passed, the original
order would disappear, would result in nullifying the effect of the word
“including” in the observations made by the Supreme Court, while
reading the meaning of the word “order” in section 154(7).
Accordingly, the Allahabad High Court disagreed with the view taken by the
Delhi High Court in the case of Tony Electronics Ltd,(supra) and held that the
rectification was barred by limitation.

OBSERVATIONS

Under the Income tax Act, an assessment
order or an order giving appeal effect
is usually passed by an Assessing officer. This order can be later on;

? rectified by him

? revised by the Commissioner,

? modified by the
Commissioner(Appeals) or other appellate authorities,

? set aside by the
Commissioner or the appellate authorities,

? reopened and reassessed or
specially assessed by him (only assessment order)

? substituted by him by giving
effect to the order of the higher authorities,

? substituted by passing fresh
order when set-aside by the higher authorities.

Unless any of the above happens, the order
passed by the AO attains finality. Once, any one of the above orders are
passed, the original order, till then final, becomes disturbed or vitiated, and
the question arises whether the order originally passed is substituted or
survives or it partially survives. The Act by itself does not provide for an
answer to this question and with that throws open challenging situations in
applying the provisions that stipulate time limits for actions w.r.t the date
of an order.

Ordinarily, where an appeal is provided
against an order passed by an authority, the decision of the appellate
authority, when passed, becomes the operative decision in law. If the appellate
authority modifies or reverses the decision of the authority, it is the
appellate decision that is effective and can be enforced. In law the position
would be just the same even if the appellate decision merely confirms the
decision of the authority. As a result of the confirmation or affirmance of the
decision by the appellate authority the original decision merges in the
appellate decision and it is the appellate decision alone which subsists and is
operative and capable of enforcement. The act of fusion of the one order in to
another is enshrined in ‘doctrine of merger’ which again is neither a doctrine
of constitutional law nor a doctrine statutorily recognised. It is a common law
doctrine founded on principles of propriety in the hierarchy of justice
delivery system. Please see Kunhayammed vs. State of Kerala, 245 ITR 360
(SC) which reiterates the position affirmed by various courts over a period
of time.

The merger doctrine in civil procedure
stands for the proposition that when the court order replaces an order of the authority with that of the
court , it is the order of the court that prevails. The logic underlying the
doctrine of merger is that there cannot be more than one decree or operative
orders governing the same subject-matter at a given point of time. When a
decree or order passed by inferior court, tribunal or authority was subjected
to a remedy available under the law before a superior forum then, its finality
is put in jeopardy. Once the superior court has disposed of the lis before it
either way – whether the decree or order under appeal is set aside or modified
or simply confirmed, it is the decree or order of the superior court, tribunal
or authority which is the final, binding and operative decree or order wherein
merges the decree or order passed by the court, tribunal or the authority
below.

This doctrine
however is not of universal or unlimited application and is not rigid in its
application. The nature of jurisdiction exercised by the superior forum and the
content or subject-matter of challenge laid or which could have been laid shall
have to be kept in view. If the subject matter of the two proceedings is not
identical, there can be no merger. The doctrine of merger does not by default
mean that wherever there are two orders, one by the inferior authority and the
other by a superior authority, passed in an appeal or revision there is a
fusion or merger of two orders irrespective of the subject-matter of the
appellate or revisional order and the scope of the appeal or revision
contemplated by the particular statute. The application of the doctrine depends
on the nature of the appellate or revisional order in each case and the scope
of the statutory provisions conferring the appellate or revisional
jurisdiction.

The Courts are clear that the doctrine of
merger cannot be applied rigidly in all cases. Its application varies from case
to case keeping in mind the subject matter and the nature of jurisdiction
exercised by the authority. It is this flexibility of the doctrine that has
been beautifully explained by the Supreme court in the case of Hind Wires
Industries Ltd. when it stated that “word “order” has not
been qualified in any way and it does not necessarily mean the original order.
It can be any order, including the amended or rectified order.” Both
the courts, Allahabad and Delhi, have heavily relied on these findings of
flexibility to deliver conflicting decisions in some what similar
situations.

The doctrine
may apply differently in each of the situations referred to earlier in this
part; in some cases the original order will survive and the limitation may
apply from its date; in other cases, the limitation may begin from the
substituted order while for some items in some cases, the limitation may apply
from the date of the order and for the rest of the items it may apply form the
date of the later order.

The real issue therefore before both the
courts was whether the original order survived or not. Application of period of
limitation would begin with the date of the order that subsisted. There could
be cases where both the orders survive which happens in cases of a partial
application of doctrine whereunder a part of the order passed in respect of
some items has remained intact and undisturbed by the later events and the
other part has been unsettled by later events. In such cases, the limitation
will apply from the date of the first order in respect of settled or
undisturbed items and would apply w.r.t the date of later order in respect of
the disturbed or unsettled items of the first order. Applying this
understanding , the Allahabad high court in the case of Shree Nav Durga Cold
Storage & Ice Factory (supra) correctly held that the claim for set off
of brought forward losses could not be claimed on application u/s. 154 in as
much as the same was time barred for the reason that the issue of set –off of
losses was not the subject matter of the appeal and had become final on passing
of the first order and in that view of the matter could not have been affected
by the appellate order or the order giving effect to the appellate order.

The Allahabad High Court in the context has
observed that what has been adopted in the Income-tax Act is the doctrine of
partial merger and not the full merger on the basis of the following provisions
of the Act:

? Even in a case where the
order of the lower authority had been the subject matter of the appeal, section
263 permits the Pr. CIT or CIT to pass the order of revision but only in
respect of such matters as had not been considered and decided in such appeal.

? Where the earlier
assessment made has become the subject matter of any appeal, reference or
revision, the Assessing Officer is still permitted to reopen the assessment
u/s. 147 for reassessing the other incomes which are not subject matter of any
such appeal, reference or revision.

? Sub-section (1A) of section
154 inserted w.e.f. 6^th Oct., 1964 by the Direct Taxes (Amendment)
Act, 1964 also embodies the doctrine of partial merger. It lays down that where
any matter had been considered and decided in any proceeding by way of appeal
or revision relating to an order referred to in s/s. (1), the authority passing
such order may, notwithstanding anything contained in any law for the time
being in force, amend the order under that sub-section in relation to any
matter other than the matter which had been so considered and decided.

The decision of the Supreme Court in the
case of Hind Wire Industries Ltd. which has been relied upon by the
Delhi High Court dealt with a case, wherein the original as well as amended
order were passed by the same authority i.e. the Assessing Officer. Further,
the Delhi High Court proceeded on the basis of the principle that when the
reassessment order is passed, the initial order of assessment does not survive
in any manner or to any extent and extended this principle to decide the issue
before it. Had the ratio of the decision of the Supreme Court in the case of
Hind Wire Industries Ltd. been properly explained the Delhi High Court, we are
sure that the decision could have been different in the case of Tony Electronics
wherein it ordered for rectification of a mistake contained in the original
order overlooking the fact that the mistake was not the subject matter of the
appeal and therefore that part of the order containing the mistake had become
final and did not get substituted by the order giving effect to the appellate
order.

In view of the above, the period of
limitation provided in section 154(7) should be reckoned from the date of such
order under which the issue sought to be rectified had become final which could
either be the original assessment order
or the subsequent order. What is important is to figure out the order in which
the mistake has occurred and to find out whether the mistake has been the
subject matter of the orders passed by the higher authorities or even by the AO
himself in some cases. Having said this,
the limitation will have a fresh lease of life from the date of the later order
in all cases where a fresh order is passed under the provisions of the Act or
in pursuance of the set-aside of the entire order by the higher authorities or
where the direction for passing a fresh order is issued. In such a case, if the
mistake sustains in the fresh order, it will be rectified within the time limit
determined w.r.t the date of passing the fresh order.

[1] Gojer Bros. (P.)
Ltd. vs. Ratan Lal Singh [1974] 2 SCC 453 and CIT vs. Amritlal Bhogilal &
Co. [1958] 34 ITR 130 (SC).

shailesh.kwebmaker

AMOUNTS NOT DEDUCTIBLE U/S. 40(a)(ii) AND TAX

ISSUE FOR CONSIDERATION

Section 40(a) provides for a list of expenses that are not
deductible in computing the income chargeable under the head “Profits and gains
of business or profession”, notwithstanding the provisions of sections 30 to 38
of the Act in case of any assesse. Vide clause (ii), any sum paid on account of
any rate or tax levied on the profits or gains of any business or profession
of, or otherwise on the basis of any such profits or gains is disallowable.
Explanations 1 & 2 of the said clause,
provide that any tax eligible for relief u/s. 90, 90A and 91 shall be deemed
to be the rate or tax. Likewise, any sum paid on account of wealth-tax is also
disallowable vide clause (iia) of section 40 (a).

The term ‘tax’ is defined by section 2(43) of the Act to mean income-tax
chargeable under the provisions of the Act. The courts often have been asked to
examine the true meaning of the term “tax” and to determine whether any of the
following are includible in the meaning of the term tax.

Education cess including secondary and higher
education cess.

Interest on late payment of tax deducted at
source.

Foreign taxes i.e. taxes on foreign
income.

The Tribunals and the Courts at
times have delivered conflicting
decisions on each of the above issues. The short issue which however is sought
to be examined here is about the deductibility of the payment of the education
cess, in computing the profits and gains of business or profession.

SESA GOA LTD’S CASE

The issue arose in the case of Sesa Goa Ltd vs. JCIT, 38 taxmann.com
(Panaji), 60 SOT 121, for assessment
year 2009-10. In that case, the assessee company had claimed a deduction of an
amount of Rs.19.72 crore towards payment of education cess, which amount was
disallowed by the AO and the disallowance was confirmed by the CIT (Appeals) by
applying provisions of section 40(a)(ii) of
the Act.

On appeal to the Tribunal, it was contended that the education cess was
paid for providing finance for quality education and therefore should be
considered to have been paid and incurred for the purposes of business. It was
further explained that cess was not listed for disallowance under the
provisions of clause (ii) of section 40 of the Act. In reply, it was contended
by the Revenue that the education cess formed an integral part of the direct
tax collection and the payment thereof was clearly covered for the disallowance
under the aforesaid clause of section 40(a) of the Act.

On hearing the rival submissions and on due consideration of the
parties, the Tribunal held that the education cess was collected as a part of
the income tax and the provisions of the respective clauses of section 40(a)
were applicable and the assessee was not entitled for the deduction of the
amount paid towards education cess.

According to the Tribunal, the payment of the education cess could not
be treated as a “fee” but should be treated as a “tax” for the reason that the
payment of fees was meant for getting certain benefits or services, while tax
was imposed by the Government and was levied without promising in return any
benefit or service to the assessee.

The Tribunal held that such payment could not be said to be an
expenditure incurred wholly and
exclusively for the purpose of the business. An appeal filed by the
assessee against the order of the Tribunal in this case has been admitted by
the High Court and is pending for hearing.

CHAMBAL FERTILIZERS AND CHEMICALS’ CASE

The issue again came up for
consideration of the Jaipur bench of the Tribunal in the case of ACIT vs.
Chambal Fertilizers & Chemicals Ltd., for assessment year 2009-10, in
ITA No.412/JP/2013. In that case, the assessee had challenged the action of
the CIT (Appeals) in confirming the
action of disallowance of education cess of Rs.3.05 crore, by the AO, u/s. 40
(a) (ii). The AO had also held that such cess was not an allowable expenditure
u/s. 37. The Tribunal noted that the same issue, in the assessee’s own case,
was adjudicated by a co-ordinate bench of the Tribunal vide an order dated
28.10.2016 passed in ITA No.s 459 and 558/JP/2012.

In the said appeals, it was contended by the assessee that the
legislature, where desired had provided
that the payment of cess was not deductible, by specifically including the same
in the language of the provisions; it was explained that there was no intention
to disallow the payment of education cess in computing the income. The Tribunal
observed that the basic character of the education cess was that of a tax which
was levied on the profits or gains of the business and given that such a tax
was liable for disallowance u/s. 40(a) (ii), the payment of education cess was
not eligible for deduction. The Tribunal, in the later case under
consideration, following the above mentioned orders, decided the appeal against
the assessee by confirming the disallowance made by the AO.

On further appeal by the assessee to the high court in the case of Chambal Fertilizers & Chemicals Ltd. vs. JCIT in
D.B ITA No. 52 of 2018 decided by an order dt. 31.07.2018, the assessee,
relying on the decision in the case of Jaipuria Samla Amalgamated Collieries Limited vs. CIT , 82 ITR 580 (SC)
contended that the term tax did not
include cess. Attention of the court was invited to circular No. 91 of 1967, bearing number
91/58/64–ITJ(19) dated 18.05.1967 to contend that the CBDT vide that circular
had clarified that the cess was not specifically included in section 40(a)(ii)
for disallowance and that no disallowance of education cess was possible.

The following submissions made before the lower authorities by the
assessee were taken note of by the court;

On a plain reading of the above provision of
section 40(a) (ii), it was evident that
a sum paid of any rate or tax was expressly disallowed only where : (i) the
rate was levied on the profits or gains of any business or profession, and
(ii) the rate or tax was assessed at a
proportion of or otherwise on the basis of any such profits or gains. It was
evident that nowhere in the said section, it had been mentioned that education
cess was not allowable. Education cess was neither levied on the profits or
gains of any business or profession nor assessed at a proportion of, or
otherwise on the basis of, any such profits or gains.

In CBDT Circular No. 91/58/66 ITJ (19), dated
May 18, 1967 it has been clarified that the effect of the omission of the word
“cess” from section 40(a)(ii) was that only taxes paid were to be disallowed in
the assessment for the years 1962-63 onwards. Thus, as per the said circular,
Education cess could not be disallowed; there could not be a contradiction, as
the circulars bind the tax authorities.

That education cess could not be treated at
par with any “rate” or “tax” within the meaning of section 40(a)(ii) especially
when the same was only a “cess” as seen from the speech of the Finance Minister .

The Revenue placed reliance on
the decision in the case of Smithkline & French (India) Ltd. vs. CIT, 219 ITR 581 (SC) wherein it
was held that ‘surtax’ was levied on business profits of the company and was
therefore, disallowable u/s. 40(a)(ii) of the Act. It was also contended
relying on the decision in the case of SRD Nutrients Private Limited vs. CCE AIR 2017 SC 5299 that ‘education
cess’ was in the nature of surcharge, which the assessee was required to pay
along with the basic excise duty.

The following submissions made before the lower authorities by the
Revenue were taken note of by the court;

The purpose of introducing the cess was
to levy and collect, in accordance with
the provisions of the relevant chapter,
as surcharge for purposes of Union, a cess to be called the Education
Cess, to fulfill the commitment of the Government to provide and finance
universalised quality basic education. It was clear that the said cess was
introduced as a surcharge, which was admittedly not deductible.

The
provision was wide enough to
cover any sum paid on account of any rate or tax on the profits or assessed at
a proportion of such profits. Education cess being calculated at a proportion
(2% or 1%) to Income Tax, which in turn, was in proportion to profits of
business, would certainly qualify as a sum assessed at a proportion to such
profits.

If education cess was considered deductible,
then by the same logic Income-Tax or any surcharge would also became
deductible, which would be an absurd proportion.

If Education cess were to be deductible, then
it would not be possible to compute it, e.g. If profit is Rs. 100, Income Tax
was Rs. 30 and Education Cess was Rs. 0.90 and if education cess were to be
deductible from profit, such profit (after such deduction) would become Rs.
99.1 (100-0.9) which would again necessitate re-computation of Income-Tax. The
vicious circle of such re-computation would continue, which was why the
legislature, in its wisdom, had not allowed deductibility of amounts calculated
at a proportion of profits.

The mechanism of recovery of unpaid Education
cess and the penal provision for non payment being the same as that for income tax, indicated that unpaid cess was
treated as unpaid tax and was visited with all consequences of non-payment of
demand. There was no separate machinery in the Act for recovery of unpaid cess
and imposition of interest and penalty in case of default in payment of unpaid
cess. This indicated that cess is a part of tax and all recovery mechanisms and
consequences pertaining to recovery of tax apply to recovery of cess also
without explicit mention of the word “cess” in the foregoing
provisions. Hence, drawing a parallel, no explicit mention of “cess”
was required in section 40a(ii) for making disallowance thereof.

On due consideration of the submissions by the parties, the Rajasthan
high court allowed the appeal of the assesse and ordered the deletion of the
disallowance of the education cess by holding in paragraph 5 that ;

“On the third issue in appeal no.52/2018, in view
of the circular of CBDT where word “Cess” is deleted, in our
considered opinion, the tribunal has committed an error in not accepting the
contention of the assessee. Apart from the Supreme Court decision referred that
assessment year is independent and word Cess has been rightly interpreted by
the Supreme Court that the Cess is not tax in that view of the matter, we are
of the considered opinion that the view taken by the tribunal on issue no.3 is
required to be reversed and the said issue is answered in favour of the
assessee.”

The High Court directed the AO to allow the claim of the assesse for
deduction of the cess in computing the profits and gains of business.

OBSERVATIONS

The issue, under the controversy,
is all about deciding whether the education cess levied under the
Finance Act with effect from financial year 2004-05 is disallowable under
clause (ii) of section 40(a) of the Income tax Act.

The Education Cess, secondary and higher, has been levied since financial year 2004-05
by the respective Finance Acts. The Finance Minister, while presenting the
Finance (No.2) Bill, 2004, 268 ITR (st.) 1, had explained the objective and the
purpose behind the levy of cess in the following words. “Education 22.
In my scheme of things, no issue enjoys a higher priority than providing basic
education to all children. I propose to levy a cess of 2 per cent. The new cess
will yield about Rs. 4000- 5000 crores in a full year. The whole of the amount
collected as cess will be earmarked for education, which will naturally include
providing a nutritious cooked midday meal. If primary education and the
nutritious cooked meals scheme can work hand-in-hand, I believe there will be a
new dawn for the poor children of India.”

The cess is levied and collected
at a specified percentage of the Income tax i.e. otherwise payable on the total
income, including the profits or gains of any business or any profession. It is
deposited in a separate account to be known as ‘Prarambhik Shiksha Kosh’ which
deposits are used for this specific purpose of meeting the educational needs of
the citizens of India. The power to levy income tax as also cess is derived by
the parliament under Article 270 of the Constitution of India. The term ‘tax’
is defined by section 2 (43) of the Income tax Act and in the context, means,
the income tax chargeable under the provision of the Act. With effect from
financial year, 2018-19, this cess includes collection for health also and is
now know as the Health & Education Cess.

A provision similar to section 40(a)(ii), is not contained in section 58
for disallowance of tax payable on the income computed under the head Income from
Other Sources. Explanation 1 of section 115JB(2) provides that the
amount of income tax paid or payable and the provision therefore should be
added to the profit, as shown in the Statement of Profit and Loss, in computing
the book profit that is liable for the MAT.
Explanation 2 specifically provide, vide clauses (iv) and (v), that the
income tax shall include education cess levied by the Central Acts. No such
extension of the meaning of the term ‘tax’, used in section 40(a)(ii), has been
provided for or clarified for including the education cess, in its scope for
disallowance u/s. 40(a)(ii) of the Act.

Section 10(4) of the Income tax Act, 1922 provided for a similar
disallowance in computing the income from the specified sources. The said
section in clear words provided that the income tax and “cess” were to be
disallowed in computing the income. Section 40(a)(ii) which is the successor of
section 10(4) of 1922 Act, has chosen to not include the term “cess” in its
fold specifically, there by indicating that the cess would not be subjected to
disallowance, unless the term “tax”, used therein, by itself includes a cess.

Importantly a circular issued by the CBDT, in the year 1967,
specifically clarified for the purpose of section 40(a)(ii), that the term
“tax” did not include in its scope any cess and the exclusion of ‘cess’ in
section 40(a)(ii) of the Act of 1961, in contrast to section10(4) of the Act of
1922, was for a significant reason. In
short, the said circular bearing number 91/58/64–ITJ(19) dated 18.05.1967
clarified that a cess was not disallowable u/s. 40(a)(ii) of the Income tax Act
of 1961. The relevant part of the circular reads as;

CIRCULAR F. NO. 91/58/66-ITJ(19) DT. 18^TH
MAY, 1967 Interpretation of provision of s.40(a)(ii) of IT Act,
1961-Clarification regarding 18/05/1967 . BUSINESS EXPENDITURE SECTION
40(a)(ii),

1. Recently a case has come to the notice of the
Board where the ITO has disallowed the ‘cess’ paid by the assessee on the ground
that there has been no material change in the provisions of s.10(4) of the old
Act and s.40(a)(ii) of the new Act.

2. The view of the ITO is not correct. Clause
40(a)(ii) of the IT Bill, 1961 as introduced in the Parliament stood as under:
“(ii) any sum paid on account of any cess, rate or tax levied on the profits or
gains of any business or profession or assessed at a proportion of, or
otherwise on the basis of, any such profits or gains”. When the matter came up
before the Select Committee, it was decided to omit the word ‘cess’ from the
clause. The effect of the omission of the word ‘cess’ is that only taxes paid
are to be disallowed in the assessments for the year 1962-63 and onwards.

3. The Board desire that the changed position may
please be brought to the notice of all the ITOs so that further litigation on
this account may be avoided.

Under the Constitution of India, the collected tax is to be used for the
general purpose of running and administration of the country, while the cess is
collected for a specified purpose. In
that sense, the cess is usually held to be in the nature of a fee and not a
tax. The education cess as noted
earlier, is levied for a specific purpose of promoting education in India; importantly the cess is not calculated as a
tax, at the specified rate on the income of an assessee, it is rather calculated as a percentage
of such tax, so determined on income, by
applying the specified rate to the tax, so computed.

The Supreme court in the case of Dewan Chand Builders &
Contractors vs. UOI [CA Nos. 1830 to 1832 of 2008, dated 18-11-2011], held
that a cess levied under the BOCW Welfare Cess Act was a fee, not a tax,
collected for a specified purpose. It
was not a part of the consolidated fund and was to be used for the specified
purpose of promoting the security of the workers. Similarly, the Apex court in
the cases of Kesoram Industries Ltd. 262 ITR 721(SC)– held that a cess
when levied for the specific purpose was a fee and not a tax.

The Mumbai bench of the Tribunal, in an unreported decision in the case
of Kalimata Investment Co. Ltd., ITA No. 4508/N/2010 dated 19.05.2012, held that the term ”tax” used in section
40(a)(ii) included education cess, levied w.e.f. financial year 2004-05, and that a cess was an additional sur-charge
and was therefore disallowable in computing the income of an assessee. An
appeal filed against the decision is admitted by the High Court and is pending
for hearing.

The related issue, of education
cess being an expenditure incurred wholly or
exclusively for the purpose of business or profession, was also
addressed by the Rajasthan high court in
the case of Chambal Fertilizers & Chemicals Ltd. (supra) by holding
that the payment of education cess was for the purpose of business, by
referring to the objective behind its levy and the purpose for which it is
collected by the Government, and was allowable as a deduction u/s. 37 of the
Act.

In a different context, a cess may also be a tax and not only a
fee. Entry 49, List 2 of the Government
of India Act which uses the expression “cesses” was examined by the Supreme Court in the case of Kunwar Ram
Nath vs. Municipal Board AIR 1983 SC 1930 to hold that such a cess levied
under Entry 53 of List 2 of the Constitution of India was a “tax”. In the case
of Shinde Brothers vs. Deputy Commissioner, Raichur, AIR 1967 SC 1512, it was held that a ‘cess’ meant a ‘tax’ and
was generally imposed for meeting some special administrative expenses, like
health cess, education cess, road cess, etc.

For the
reason noted above and in particular on accounts of the circular No. 91 of
1967 (supra) and the provisions of section 2(43) and section115JB, the
expenditure on education cess is not disallowable u/s. 40(a)(ii) of the Act,
unless the Government is able to establish that the education cess is also a
tax chargeable under the provisions of the Income Tax Act, 1961. Presently the
education cess is levied under sub-sections (12) & (13) of section 2 of the Finance Act, 2018. The
decisions of the tribunal had not taken in to
consideration circular 91 of 1967 in deciding the issue against the
assessee; had the same been brought to the attention of the Tribunal, the
decision could have been different.

shailesh.kwebmaker

Gift From ‘HUF’ and Section 56(2)

Issue for
Consideration

Under the provisions of section 56(2)(x) of
the Income-tax Act, 1961, receipt of any sum of money or any property without consideration or for inadequate
consideration (in excess of the specified limit of Rs. 50,000) by the assessee
is chargeable to income-tax under the head “Income from other
sources”. The term ‘property’ is defined for this purpose as immovable
property, shares, securities, jewellery, bullion and artistic works like
drawings, paintings etc. The Finance Act, 2017 while inserting this new provision
has widened the scope of the old
provision by making the new
provision applicable to all types of assessees, as against the erstwhile
provision of section 56(2)(vii), which was applicable only to an individual or
an HUF.

The taxability as provided in section
56(2)(x) is subjected to several
exceptions. One of the important exceptions from taxability is when any such
sum of money or property is received by the assessee from his relative. The
Explanation to clause (x) of section 56(2) provides that the expression
‘relative’ shall have the same meaning as is assigned to it in the Explanation
to clause (vii). The said Explanation to clause (vii) defines ‘relative’
separately for individual and HUF in an exhaustive manner. In case of an
individual, ‘relative’ means –

(a). spouse of the individual;

(b). brother or sister of the individual;

(c). brother or sister of the spouse of the
individual;

(d). brother or sister of either of the parents of
the individual;

(e). any lineal ascendant or descendant of the
individual;

(f). any lineal ascendant or descendant of the
spouse of the individual;

(g). spouse of the person referred to in items (B)
to (F).

In case of an HUF, ‘relative’ means any
member of such HUF. Till 1^st October 2009, there was no definition
of relative qua an HUF. The definition of “relative” qua an HUF
was inserted by the Finance Act 2012, with retrospective effect from 1.10.2009.

The definition of ‘relative’ for an individual does not include his HUF. In
other words, the definition of the term ‘relative’, qua an individual,
does not specifically exclude the receipt of a gift by an individual from an
HUF from the scope of taxation u/s. 56(2) (x). Therefore, the issue has arisen,
in the context of a receipt by an individual from his HUF, as to whether an HUF can be regarded as the
relative of the individual, if all the members of that HUF are otherwise his
relatives as per the above definition. While the Rajkot bench of the Tribunal
has taken the view that gift received from an HUF, whose members comprised of
the relatives of the recipient, is not
taxable, the Ahmedabad bench of the Tribunal has taken the view that HUF does
not fall in the definition of relative, so as to qualify for the exemption from
taxability. The view of the Rajkot bench has been confirmed by the decisions of
the Mumbai and Hyderabad benches.

Vineetkumar Raghavjibhai Bhalodia’s case:

The issue first came up before the Rajkot
bench of the Tribunal in the case of Vineetkumar Raghavjibhai Bhalodia vs.
ITO 46 SOT 97.

In this case, relating to assessment year
2005-06, the assessee i.e. Vineetkumar Raghavjibhai Bhalodia received a gift of
Rs. 60 lakh from Shri Raghavjibhai Bhanjibhai Patel (Bhalodia) HUF in which he
was a member. The assessing officer held that the HUF was not a ‘relative’ of the recipient and the gift of Rs. 60 lakh received from the HUF
was taxable.

The CIT(A) confirmed the view of the
assessing officer. He observed that if the legislature wanted that money received by a member of the HUF from the HUF
should also not be chargeable to tax, it would have specifically mentioned so
in the definition of ‘relative’. The CIT(A) also rejected the alternative
submissions of the assessee that the said gift was exempt u/s. 10(2), on the
ground that the sum was not received on total or partial partition of the HUF.
He held that the exemption u/s. 10(2) was available only in respect of that
amount which could be apportioned to the member’s share in the income of his
HUF. Since the assessee failed to establish whether the amount received was
equal to or less than the income which could be apportioned to his share, the
exemption was denied.

Before the Tribunal, on behalf of the
assessee, it was argued that HUF was a ‘relative’, in as much as the HUF was a
collective name given to a group consisting of individuals, all of whom were
relatives as per the definition. The HUF was a conglomeration of relatives as
defined under section 56(2)(v)[1].
Section 56(2)(v) should be interpreted in such a way that avoided absurdity. Alternatively, it was also
contended that the receipt was exempt u/s. 10(2). Section 10(2) used the
language “paid out of the income of the family” and not “paid
out of the income of the previous year of the family” as was interpreted
by the assessing officer. Finally, it was submitted that if two views were
possible, the one beneficial to the assessee had to be adopted.

On behalf of the revenue, it was pointed out
that ‘person’ had been defined u/s. 2(31) of the Act and HUF was a separate
person thereunder. The revenue also relied upon the definition of ‘relative’
given in section 2(41), wherein also HUF was not included. Regarding
applicability of section 10(2), it was submitted that its object was to provide
exemption only in respect of partition, and not in case of gift.

The Tribunal held that the expression
“Hindu Undivided Family” must be construed in the sense in which it
was understood under Hindu Law. HUF constituted all persons lineally descended
from a common ancestor and included their mothers, wives or widows and
daughters. All those persons fell in the definition of “relative” as
provided in Explanation to clause (v) of section 56(2). The gift received from
“relative”, irrespective of whether it was from an individual
relative or from a group of relatives, was exempt from tax. Though it was not
expressly defined in the Explanation that the word “relative”
represented a single person. It was not always necessary that singular remained
a singular. Sometimes a singular could
mean more than one, as was in the present case of the gift from an HUF.

Regarding exemption u/s. 10(2), the Tribunal
disagreed with the view of the CIT (A) that only the amount received on partial
partition or on partition was exempt, as well as only up to the extent of share
of assessed income of HUF for the year. According to the Tribunal, for getting
exemption u/s. 10(2), two conditions were to be satisfied. Firstly, he must be
a member of the HUF, and secondly he received the sum out of the income of such
HUF, may be of an earlier year. Since there was no material on record to hold
that the gift amount was part of any assets of the HUF, it was out of the
income of the family to a member of the HUF. According to the Tribunal,
therefore, the same was exempt u/s. 10(2).

A similar view has
been taken by the Hyderabad and Mumbai benches of the Tribunal in the following
cases –

(i). Hemal D. Shah vs. DCIT [IT Appeal No.
2627 (Mum.) of 2015, dated 8-3-2017]

(ii). Dy. CIT vs. Ateev V. Gala [IT Appeal
No. 1906 (Mum.) of 2014, dated 19-4-2017]

(iii). ITO vs. Dr. M. Shobha Raghuveera [IT
Appeal No. 47 (Hyd.) of 2013, dated 3-3-2014]

(iv). Biravelli Bhaskar vs. ITO [IT Appeal No.
398 (Hyd.) of 2015, dated 17-6-2015]

Gyanchand M. Bardia’s case

The issue again came up before the Ahmedabad
bench of the Tribunal in the case of Gyanchand M. Bardia vs. ITO 93
taxmann.com 144.

In this case, relating to assessment year
2012-13, the assessee received a gift of Rs.1,02,00,000 from an HUF, which
consisted of the assessee, being Karta, his wife and son. This gift was claimed
to be exempt by the recipient. The assessing officer rejected the claim of the
assessee on the ground that the definition of ‘relative’ of an individual
recipient did not include HUF as a donor. He made the addition of the impugned
amount u/s. 68.

The CIT (A) confirmed the addition made by
the assessing officer. In doing so, he
observed that the relevant provision had been amended to exempt the gift
received by the HUF from its members. Though the Hon’ble Parliament brought
amendment to the statute declaring gift from member to HUF as tax free, it did
not consider it proper to make a gift from the HUF to a member as tax free. The
reason might be that if such provision
was made, the Karta of an HUF might
misuse the provisions and gift the corpus of the HUF to himself, as
other members of the HUF had no control over managing affairs of the HUF.
Further, the CIT (A) also noticed that the assessee could not produce the gift
deed in respect of the said gift received by him.

Before the Tribunal, on behalf of the
assessee, it was emphasised that besides him, the other two members of the HUF
i.e. assessee’s wife and son were also
covered in definition of “relative”. Accordingly, it was
claimed that the said gift received was not taxable, by placing reliance on the
decision in the case of Vineetkumar Raghavjibhai Bhalodia (supra). Apart
from this contention, the assessee also claimed exemption u/s. 10(2), which had
not been decided by the lower authorities, though it was claimed before them on
an alternative basis.

The Tribunal held that the ratio of the
decision in the case of Vineetkumar Raghavjibhai Bhalodia (supra) was no
more applicable in view of the subsequent legislative developments vide Finance
Act, 2012 w.r.e.f. 01.10.2009. The legislature substituted clause (e) to
Explanation in section 56(2)(vii) defining the term “relative” to be applicable in case
of an individual assessee as well as HUF; with retrospective effect from
01.10.2009. The legislature had incorporated clause (ii) therein to deal only
with an instance of an HUF donee receiving gifts from its members. Therefore,
by implication, the legislative intent was very clear that a receipt from an
HUF was not to be taken as one from a relative
in the hands of an individual
recipient. Accordingly, the assessee’s plea of receipt of valid gift from his
HUF being exempt, was declined.

Regarding the claim of exemption u/s. 10(2),
it was held that a sum which was not eligible for exemption under the relevant
specific clause could not be considered to be an exempt income u/s. 10(2).

Observations

An HUF is a separate assessable unit for the
purpose of the Income-tax Act. Under the general law, it is the members who constitute and represent it.
It being so, the gift received from the HUF may also be viewed as a gift
received from all the members of the said HUF and if that be so, such receipt
should be treated as the one from a relative of the donee and not liable
to tax.

The Ahmedabad bench of the Tribunal in the
case of Gyanchand M. Bardia (supra) did not follow the decision of the
Rajkot bench for the reason that the amendment made by the Finance Act, 2012 altered
the definition of the term ‘relative’
to specifically provide for relationship
vis-à-vis an HUF recipient and the amendment did not do so for an
individual in receipt of a gift from an HUF. The bench observed that a gift from an HUF, post amendment, will not be
exempt from tax for the reason that the
legislative intent was clear from the amendment that post amendment only a
receipt of gift by an HUF from its members is exempt from tax. Since this amendment is effective from
1-10-2009, receipts during the pre-amendment
period was not taxable as per the Rajkot bench. No other reason was
provided by the bench for upholding the taxability in the hands of the
individual. One fails to appreciate how
an amendment providing for an exemption for a particular situation changes the understanding derived for taxation or
otherwise in an altogether different and
converse situation. The kind of deductive interpretation applied by the bench
is not comprehensible. In our considered
view, the bench was bound to follow the
decision of the Rajkot bench and was required to refer the matter to a special
bench, if it disagreed with the said decision.

A useful reference may be made to the
memorandum explaining the insertion of the new definition of the term
‘relative’. A bare reading of the same
clarifies that there is nothing therein that conveys that the legislature
intended that it wanted to disturb the understanding supplied by the Rajkot
bench. The better way of appreciating the amendment is to accept that the
legislative intent was contrary to what was held by the Ahmedabad bench. The
legislature clearly intended not to provide that a gift from an HUF will not be
treated as from a
relative and will be taxable, in
view of its awareness of the
five decisions in favour of the interpretation exempting the gift
received by an individual from an
HUF. Not having so provided, the intention should be held to
be favouring the exemption, and not otherwise.

The issue can be looked at from another angle
also. A coparcener can make a gift of his undivided interest in the coparcenary
property to another coparcener[2]
or to a stranger with the prior consent of all other coparceners. Such a gift
would be quite legal and valid. Therefore, when the karta of the HUF gifts
coparcenary property after obtaining the consent of all the coparceners, it may
be regarded as the gift of undivided interests in that property by all the
coparceners individually. Accordingly, the gift of property received from the
HUF may also be viewed as the gift of undivided interests in that property by
all the coparceners of that HUF. In such a case, if all the coparceners are
relatives of the recipient assessee, then the said gift cannot be taxed under
the provisions of section 56(2)(x). Alternatively, the receipt can be considered as the one for the body of
individuals where all the individuals are related to the recipient and the
receipt therefore is made eligible to exemption from tax.

Another important aspect is the intention behind
the provisions under consideration. In Circular No. 1/2011 dated 6-4-2011, it
has been mentioned that the provisions of section 56(2)(vii) were introduced as
a counter evasion mechanism to prevent laundering of unaccounted income. The
gifts received from relatives have been kept out of the purview of this
provision obviously because the possibility of such laundering of unaccounted
income does not exist or is very less. Therefore, taxing such gifts received
from the HUF, consisting of members who all are relatives, would not be in
consonance with the object of the provision.

Looking at the intention of the relevant
provision and the legal understanding of the concept of HUF, the view taken by
the Rajkot, Mumbai and Hyderabad benches
of the Tribunal seems to be the more appropriate view.

There is even otherwise a flaw in the view
that views the relationship in one direction only. This view holds that A is
the relative of B but B is not a relative of A. Such an absurdity in
interpreting the law should be avoided in preference to the harmonious reading
of the provisions under which the relationship is a two way affair whereby A is
a relative of B and B is therefore a relative of A and A and B are relative of
each other. Needless to say that the view beneficial to the tax payer should be
adopted in a case where two views are possible.

In the end, it may be useful to examine the
competence of the Karta or an HUF to deal with and dispose of the property of
the HUF by way of gifts. A gift may be rendered invalid where it is held to be
not permissible under the general law as
the one made beyond the competence of the person making it. One also needs to
examine whether such gifts when made, though not permissible in law, are void ab
initio or are voidable at the option of the parties to the gift. The issue
regarding validity of such gift given by the HUF needs to be examined. The
Supreme Court, in the case of R. Kuppayee & Anr. vs. Raja Gounder (2004)
265 ITR 551, has dealt with this issue and held as under:

“Combined reading of these paragraphs shows
that the position in Hindu law is that whereas the father has the power to gift
ancestral movables within reasonable limits, he has no such power with regard
to the ancestral immovable property or coparcenary property. He can, however,
make a gift within reasonable limits of ancestral immovable property for
“pious purposes”. However, the alienation must be by an act inter
vivos, and not by will. This Court has extended the rule in para. 226 and
held that the father was competent to make a gift of immovable property to a
daughter, if the gift is of reasonable extent having regard to the properties
held by the family.”

Thus, HUF’s property can be gifted by its
manager or karta only to a reasonable extent, and of immovable property only
for pious purposes. The Courts have given extended meaning to the ‘pious
purposes’ and validated the gift of ancestral property made by the father to
the daughter within reasonable limits. However, such extended meaning given to the
words ‘pious purposes’ enabling the father to make a gift of ancestral
immovable property within reasonable limits to a daughter has not been extended
to the gifts made in favour of other female members of the family. Rather it
has been held that husband could not make any such gift of ancestral property
to his wife out of affection on the principle of ‘pious purposes’.

However, gift of HUF’s property in excess of
reasonable limit or not for pious purposes is not void but voidable and that too at the instance of other members
of the family and not strangers. In Pollock on Contracts, page 6 (twelfth
edition), this distinction between the terms ‘void’ and ‘voidable’ has been
explained as follows:

“The distinction between void and
voidable transactions is a fundamental one, though it is often obscured by
carelessness of language. An agreement or other act which is void has from the
beginning no legal effect at all, save in so far as any party to it incurs
penal consequences, as may happen where a special prohibitive law both makes
the act void and imposes a penalty. Otherwise no person’s rights, whether he be
a party or a stranger, are affected. A voidable act, on the contrary, takes its
full and proper legal effect unless and until it is disputed and set aside by
some person entitled so to do.”

In the case of R.C. Malpani vs.
CIT 215 ITR 241, the Gauhati High
Court held that the income derived from the property which is alienated by the
Karta without any legal necessity is not assessable in the hands of the HUF, as
it is only voidable and not void. Similarly, any gift received from the HUF may
be required to be considered (whether income or not) under the provisions of
section 56(2)(x), even if it is impermissible and voidable, unless the Court
has declared it to be void.

[1] In this case, the
Tribunal was dealing with the assessment year 2005-06 and the relevant clause
applicable in that assessment year was clause (v) of Section 56(2) which had
similar provisions

[2] Thamma Venkata
Subbamma (By Legal Representative) vs. Thamma Rattamma [1987] 168 ITR 760 (SC).

shailesh.kwebmaker

REVENUE EXPENDITURE ON TECHNICAL KNOW-HOW AND SECTION 35 AB

Issue for Consideration

Section 35 AB introduced by the Finance Act, 1985, w.e.f 1^st April 1986, provides for
deduction of an amount paid towards any lump sum consideration for acquiring
know-how for the purposes of business in six equal annual instalments
commencing from the previous year in which the deductions is first allowed. The
relevant part contained in s/s. (1) reads as ; “S. 35AB. Expenditure on
know-how. (1) Subject to the provisions of sub-section (2), where the assessee
has paid in any previous year relevant to the assessment year commencing on or
before the 1^st day of April, 1998 any lump sum consideration for
acquiring any know-how for use for the purposes of his business, one-sixth of
the amount so paid shall be deducted in computing the profits and gains of the
business for that previous year, and the balance amount shall be deducted in
equal instalments for each of the five immediately succeeding previous years.”

The term ‘know-how’ is exhaustively defined vide an
Explanation to the section to mean any industrial information or technique
likely to assist in the manufacture or processing of goods or in the working of
mine, oil, etc.

Prior to the insertion of section 35AB, an expenditure of
revenue nature, incurred on know-how, was allowed as deduction u/s. 37 of the
Income tax Act. A capital expenditure on know-how was not allowable as a
deduction and its treatment was governed by the other provisions of the Income
tax Act. With insertion of section 35AB, a capital expenditure became eligible
for deduction, subject to compliance of the prescribed conditions, in the
manner specified in the section.

Section 37 provides for a deduction of any expenditure laid
out or expended wholly and exclusively for the purposes of business or
profession, in full, provided it is not in the nature of a capital expenditure
or personal expenses of the assessee and further that the expenditure is not in
the nature of the one described in section 30 to section 36 of the Act.

Section 35 AB while opening a door for deduction of a capital
expenditure fuelled a new controversy, perhaps unintentionally, involving the
denial of 100% deduction to a revenue expenditure on know-how which was
hitherto allowable. It is the stand of the Revenue authorities that with the
introduction of section 35AB, the deduction for an expenditure on know-how, of
any nature, would be governed strictly by the new provision and be allowed in
six instalments and would not be allowed u/s. 37 as was the case before
insertion of the specific provision. Like any provision, a new one in
particular, section 35AB became a highly debatable provision not on one count
but on various counts. The related issues that arose, besides the issue of
identification of the relevant provision of the Act under which the deduction
for the revenue expenditure is allowable, are whether it was necessary that the
assessee acquired ownership rights over the know-how and whether the condition
for ‘lump sum’ payment meant payment in one go or even in instalments.

Various High Courts had occasion to examine these issues or
some of them, leading to a fierce controversy surrounding the eligibility of a
deduction, in full u/s. 37, of an expenditure on a know-how, otherwise of a
revenue nature. The Madras, MP and the Bombay High Courts decided the issue in
favour of the Revenue by denying the deduction u/s. 37 and the Gujarat,
Karnataka and Punjab & Haryana High Courts favoured the deduction u/s. 37
for such an expenditure, incurred on know-how, in favour of the assessee. On
the issue of ‘lump sum’ payment , the Bombay High Court in two cases held that
the payment in instalments would not cease to be lump sum. The High Court also
decided that for application of section 35AB , it is not necessary to be an
owner of the know-how.

Anil Starch Products Ltd.’s case

The issue arose in the case of DCIT vs. Anil Starch
Products Ltd., 57 taxmann.com 173 (Guj.) for A.Y 1990-91, 1992-93 and
1993-94. While admitting one of the appeals, the following substantial
questions of law arose for the determination of the court; “Whether,
the Appellate Tribunal was justified in law and on facts in confirming the
order of the Commissioner of Income-tax (A) who held that the expenditure under
consideration was revenue in nature and allowable u/s 37 of the Act
disregarding the special provisions of sec.35AB?”

The Gujarat High Court at the outset noted that an identical
question had arisen before them in another appeal of the assessee for A.Y.
1989-90 numbered 326 of 2000 decided on 03.07.2012 , not otherwise reported,
and chose to reproduce the facts, pleadings, law and even the decision therein
to finally conclude, in the cases before them, that the provisions of section
35 AB were not applicable to the case of a revenue expenditure which was
allowable u/s. 37 of the Act. The facts and the sequence of events of the case
is therefore not available in the judgement and therefore the facts, pleadings
and the outcome of the case heavily relied upon by the court are placed and
considered here as had been done by the court.

The assessee in that case, a company engaged in manufacturing
of starch and other similar products, during the year under consideration
relevant to assessment year 1989-90, paid
the technical know-how and service fees, totalling to a sum of
Rs.23,23,880 and claimed deduction thereof in full as the revenue expenditure.
The assessee had contended that the provisions of section 35AB of the Act were
applicable only in respect of the capital expenditure and not in respect of the
revenue expenditure. The assessee further contended that the company while
acquiring such know-how, obtained no ownership right on such information and
know-how was furnished by the foreign company to the assessee under an
agreement. The assessee also contended that such technical know-how was for the
purpose of production of its existing items which are being manufactured by the
assessee company since many years.

The AO held that such expenditure fell within section 35AB of
the Act. The AO, did not accept the contentions of the assessee, though agreed
that such expenditure was revenue in nature and was covered within section 35AB of the Act and were to be amortised, as provided under the said
section, by spreading the benefit over a period of six years. Dissatisfied with
such a decision of the AO, the assessee carried the matter in appeal. Before
the CIT (Appeals), the assessee in addition to contending that a revenue
expenditure could not be brought under the ambit of section 35AB of the Act,
further contended that the provision of section 35AB of the Act was an enabling
provision, introduced to facilitate the deduction for a capital expenditure.

The CIT (A) rejected the assessee’s appeal as he was of the
opinion that section 37(1) of the Act, which covered expenditure not being in
the nature of the expenditure described in sections 30 to 36, would not apply
in the case by virtue of the provisions contained in section 35AB of the Act.
He held that since section 35AB of the Act made a specific provision to treat
the expenditure incurred for acquisition of technical know-how by way of lump
sum payment and that even if such a payment was revenue in nature, it would not
fall within sub-section (1) of section 37 of the Act.

On a further appeal by the assessee, the Tribunal reversed
the decisions of the revenue authorities. The Tribunal noted that as per the
agreement, all information and know-how furnished by the foreign company
remained the property of that company; the payment was made as a lump sum
consideration for use of the know-how, only, for the purpose of its running
business, for a limited period. The Tribunal noted that undisputedly, there was
no purchase of the know-how from the foreign company. The Tribunal held that
the case of the assessee was not covered u/s.35AB of the Act and that section
35AB had no application in the case and the assessee was entitled to deduction
u/s. 37(1) of the Act.

In the appeal to the High Court, by the Revenue, it was
contended that the Tribunal committed grave error in allowing the assessee’s
appeal; that section 35AB of the Act was widely worded and included any
expenditure incurred for acquisition of technical know-how and that the concept of ownership was not material for
section 35AB; that once an expenditure, whether revenue or capital, was covered
u/s. 35AB of the Act then by virtue of the language of sub-section
(1) of section 37 of the Act, the assessee could not claim any benefit thereof
u/s. 37 of the Act. Reliance was placed on the decision of the Madras High
Court in the case of Commissioner of Income Tax vs. Tamil Nadu Chemical
Products Ltd., reported in 259 ITR 582, wherein a division bench of the
Madras High Court had held that during the period when section 35AB of the Act
remained effective, any expenditure towards acquisition of know-how,
irrespective of whether it was a capital or a revenue expenditure, was to be
treated only in accordance with section 35AB and the deduction allowable in
respect of such know-how was 1/6th of the amount paid as lump sum consideration
for acquiring know-how. The Revenue relying on the decision of the MP High
Court in the case of Commissioner of Income Tax vs. Bright Automotives and
Plastics Ltd., reported in 273 ITR 59 further contended that in
order to attract the rigour of section 35AB of the Act, it was not necessary
for the assessee to actually become an absolute owner of the know-how and also
that the nature of expenditure whether revenue or capital, was of no
consequence.

The assessee in response contended that the expenditure in
question was purely revenue in nature and the same was, therefore, not covered
u/s. 35AB of the Act; that the said provision was made to encourage acquisition
of know-how to improve the quality and efficiency of Indian manufacturing; that
the assessee had acquired the know-how for a limited period and had never
enjoyed any ownership or domain right over the know-how; that the know-how was
utilised for manufacturing of its existing items and that neither any new
manufacturing unit was established nor new item of manufacturing was
introduced. It was pointed out that even the AO agreed that the expenditure in
question was a revenue expenditure; that section 35AB of the Act had no
application to such an expenditure since the provision of section 35AB was an
enabling provision that was not introduced to limit the benefits which were
already existing. Attention was also drawn to the C.B.D.T. Circular No.421
dated 12.6.1985 wherein with respect to deduction in respect of an
expenditure on know-how, it was clarified that, the provision was inserted with
a view to providing encouragement for indigenous scientific research. Heavy
reliance was placed on the decision of the Apex Court in the case of Commissioner
of Income Tax vs. Swaraj Engines Ltd., 309 ITR 443 in which the Apex Court
had an occasion to examine the decision of the Punjab & Haryana High Court
on the question of applicability of section 35AB of the Act.

The Gujarat High Court noted that the AO himself had accepted
that the expenditure in question was of revenue nature and that the circular
No. 421 confirmed that the provisions of section 35AB were enabling provision
and if that be so, the deduction of such expenditure could not be limited by
applying section 35AB of the Act. The Court took note of the facts in Swaraj
Engines Ltd.’s case and also of the decision therein and observed as under;
“The Apex Court decision would suggest that for determining whether certain expenditure
would fall within section 35AB or not, it would be important to examine the
nature of the expenditure. If it is found that the same is revenue in nature,
the question of applicability of section 35AB of the Act would not arise. On
the other hand, if it is found to be capital in nature, then the question of
amortisation and spreading over, as contemplated under section 35AB of the Act
would come into play.”

The Court held that such provision, as was clarified by the
C.B.D.T, was made with a view to providing encouragement for indigenous
scientific research; that such statutory provision was made for making
available the benefits which were hitherto not available to the manufacturers
while incurring expenditure for acquisition of technical know-how; that to the
extent such expenditure was covered u/s. 35AB, amortised deduction spread over
six years was made available; that where such expenditure was capital in
nature, prior to introduction of section 35AB of the Act, no such deduction
could be claimed; that with introduction of section 35AB, to encourage
indigenous scientific research, such deduction was made available; that such a
provision could not be seen as a limiting provision restricting the existing
benefits of the assessee. In other words the revenue expenditure in the form of
acquisition of technical know-how, which was available as deduction u/s. 37(1)
of the Act, was never meant to be disallowed or taken away or limited by
introduction of section 35AB of the Act.

The Gujarat High Court also cited with approval the paragraph
from the Ninth Edition, Volume-I of Kanga & Palkhivala, while
explaining the provisions of section 35AB of the Act, : “This section
allows deduction, spread over six years, of a lump sum consideration paid for
acquiring know-how for the purposes of business even if later the assessee’s
project is abandoned or if such know-how subsequently becomes useless or if the
same is returned. The section, which is an enabling section and not a disabling
one, should be confined to that consideration which would otherwise be
disallowable as being on capital account. A payment for acquiring know-how or
the use of know-how which is on revenue account is allowable under section 37,
and does not attract the application of this section at all.”

The High Court concluded that the provisions of section 35AB
of the Act could apply only in case of a capital expenditure and would not
apply to a revenue expenditure even if the same was incurred for acquisition of
technical know-how and the deduction thereof could not be curtailed or limited
by applying section 35AB.A revenue expenditure remained within the ambit of
section 37(1) of the Act. The Court observed that it was unable to concur with
the view of the Madras High Court in case of Commissioner of Income Tax vs.
Tamil Nadu Chemical Products Ltd. (supra), which was in any case rendered
prior to the decision of the Apex Court in the case of Commissioner of
Income Tax vs. Swaraj Engines Ltd. (supra).

Accordingly, the Gujarat High Court, in the case before it,
in appeal, in Anil Starch Ltd.’s case, dismissed the Revenue’s appeal
holding that the provisions of section 35AB did not apply to an expenditure
which otherwise was of a revenue nature. In deciding the case, the High Court
followed the ratio of the decisions in the cases of DCIT vs. Sayaji
Industries Ltd. 82 CCH 412 and the Karnataka High Court in the case of Diffusion
Engineers Ltd. vs. DCIT, 376 ITR 487.

Standard Batteries Ltd.’s case

Recently the issue came up for consideration, before the
Bombay High Court, in the case of Standard Batteries Ltd. vs. CIT, 255
Taxman 380 (Bom.). The assessee, in that case, had entered into an
agreement with ‘O’, UK, in terms of which, the assessee was to receive outside
India a license to transfer and import information, know-how, advice,
materials, documents and drawings as required for the manufacture of miners’
cap lamp batteries and stationery batteries for a lump sum consideration paid
in three equal instalments, where the permission was only to use the know-how
and information without transfer of ownership. The assessee claimed deduction
in respect of the said payment u/s. 37(1). The AO however, rejected the claim
of the assessee but allowed deduction to the extent of 1/6th of the amount
spent and claimed, and the balance amount was to be deducted in equal
instalments for each of the five immediately succeeding previous years in terms
of section 35AB.

The Tribunal held that the assessee had acquired the
ownership rights in the technical know-how and accordingly the assessee was
entitled to deduction u/s. 35AB, and not u/s. 37(1) as was claimed by the
assessee.

On appeal by the assessee to the High Court, the three
aspects before the Court were about the application of section 35 AB to the
case where; (i) a revenue expenditure was incurred (ii) payment was made in
instalments and (iii) the assessee was not an owner of the rights or asset for
an effective application of section 35AB.

On behalf of the assessee, it was contended that the expenditure
for receipt of technical know-how would
not fall u/s. 35AB of the Act but would appropriately fall u/s. 37 of
the Act for the following reasons;

(a) Section 35AB of the Act
required a lump sum consideration to be paid for acquiring any technical
know-how, while in the case before the Court admittedly payment was made in 3
instalments, therefore could not be regarded as a lump sum payment and as such
was therefore, outside the scope of section 35AB of the Act;

(b) There was no acquisition of a technical
know-how in the facts of the case, as the applicant merely obtained a lease /
license of the rights to use such technical know-how; not having any ownership
rights over the technical know-how, the requirement of acquiring the know-how
u/s. 35AB of the Act was not satisfied and was thus, outside the mischief of
section 35AB of the Act;

(c) The technical know-how
obtained by the applicant under the agreement dated 19^th June, 1984
was to be used in the regular course of its business of manufacturing batteries
and therefore, would be revenue in nature; section 35AB would apply only where
the expenditure was in the nature of a capital expenditure; the expenditure for
obtaining technical know-how being of revenue nature, would fall in the
residuary section 37 of the Act.

In response, it was contended on behalf of the Revenue, that
:—

(a) The payment made in three equal instalments
continued to be a lump sum payment;

(b) Section 35AB of the Act, did not require
obtaining ownership of the technical know-how; the license to use the know-how
by itself would be covered by the words “consideration paid for acquiring
any know-how”; there was no basis for restricting the plain meaning of the
word “acquiring” in section 35AB of the Act;

(c) The applicant had used the technical know-how
so obtained in its business and on plain interpretation of section 35AB of the
Act, it would apply; it did not exclude revenue expenditure from its purview,
as there was no requirement in section 35AB that the same would be available
only if the expenditure was of a capital nature and not if it was revenue in
nature: that wherever the legislature wanted to restrict the benefit in respect
of the deduction claimed of expenditure dependent upon its nature, described in
sections 30 to 36 of the Act, it specifically provided so therein as was in
sections 35A and 35ABB of the Act;

(d) In any event, section 37 of the Act excluded
expenditure of a nature described in sections 30 to 36 from the purview of s.
37 of the Act; section 35AB fell within sections 30 to 36 and therefore, no
occasion to apply section 37 of the Act would arise;

Relying on the decision of the Court in the case of CIT
vs. Raymond Ltd., 209 Taxman 154 (Bom.), the Court held that merely because
the payments were made in instalments for using the technical know-how, it
would not cease to be a lump sum payment where the amount payable was fixed and
not variable more so when the words used in section 35AB were ‘lump sum’
payment and not a one time payment. Therefore, making of lump sum payment in 3
instalments would not make the payment any less a lump sum payment.

On the issue of the need to be an owner of know-how, the
assessee reiterated that the word ‘acquiring’ as used in section 35AB would
necessarily mean, acquisition of ownership rights of the technical know-how;
that a mere lease / license, would not amount to acquisition of technical
know-how as per the dictionary meaning of the word “acquisition”. The
Court however held that the dictionary meaning relied upon did not exclude the
cases of obtaining any knowledge or a skill, as was in the case before them or
technical know-how for a limited use. It held that the gaining of knowledge was
complete / acquired by transfer of know-how and the limited use of it would not
detract the same from being included in the scope and meaning of the word
acquisition; that the word “acquisition” as defined in the larger
sense even in the Oxford Dictionary referred to above, would cover the use of
technical knowledge know-how by the applicant assessee which was made available
to it; thus, the restricted meaning of the word ‘acquisition’ to mean ‘only
obtaining rights on ownership’ was not the plain meaning in English language
and obtaining of technical know-how under a license would also amount to
acquiring know-how as the words ‘on ownership basis’ were completely absent in
section 35AB(1) of the Act. The Court held that accepting the contention of the
applicant, would necessarily lead to adding the words ‘by ownership’ after the
word ‘acquiring’ in section 35AB(1) of the Act, which addition was not
permitted while interpreting a fiscal statute.

On the main issue of allowability u/s. 37, it was reiterated
that the technical know-how which had been obtained was used in the regular
course of its business of manufacturing batteries and it would necessarily be
in the nature of revenue expenditure, allowable u/s. 37 of the Act. Reliance
was placed upon the decisions of Gujarat High Court in DCIT vs. Anil Starch
Products Ltd. 232 Taxman 129 and DCIT vs. Sayaji Industries Ltd. 82
CCH 412 and the decision of the Karnataka High Court in Diffusion Engineers
Ltd. vs. DCIT 376 ITR 487, to contend that the issue stood concluded in
favour of the company for the reason that while dealing with an identical
situation, the courts in the above referred three cases, have held that section
35AB of the Act would not be applicable where the expenses were of revenue
nature, and the expenditure was deductible u/s. 37(1) of the Act.

In contrast, the Revenue reiterated that section 37 of the
Act itself excluded expenditure of the nature described in sections 30 to 36
without any qualification as was held by the Madhya Pradesh High Court in CIT
vs. Bright Automotives & Plastics Ltd. 273 ITR 59 and the Madras High
Court in CIT vs. Tamil Nadu Chemical Products Ltd. 259 ITR 582. That the
courts in those cases had held that the expenditure incurred for acquiring technical
know-how would fall u/s. 35AB of the Act irrespective of the fact that the
expenditure was revenue in nature.

On due consideration of the submission of the parties , the
Bombay High Court held as under;

The submission that the expenditure in
question be allowed u/s. 37 could not be accepted for the reason that section
35AB of the Act itself specifically provided that any expenditure incurred for
acquiring know-how for the purposes of the assessee’s business be allowed under
that section; that as detailed in the Explanation thereto the know-how to
assist in the manufacturing or processing of goods would necessarily mean that
any expenditure on know-how which was used for the purposes of carrying on
business would stand covered by section 35AB of the Act.

Section 37 of the Act itself excluded
expenditure of the nature described in sections 30 to 36 of the Act without any
qualification.

On examination of sections 30 to 36 to find
whether any of them restricted the benefit to
only capital expenditure, it was found that section 35AB of the Act made no
such exclusion / inclusion on the basis of the nature of expenditure i.e.
capital or revenue. In fact, wherever the parliament sought to restrict the benefit
on the basis of nature of expenditure falling u/s. 30 to 36 of the Act, it
specifically so provided viz. section
35A which was introduced along with
section 35AB of the Act w.e.f. assessment year 1986-87. In fact, later sections
35ABA and 35ABB have also provided for deduction thereunder only for a capital
expenditure .

Wherever the Parliament sought to restrict
the expenditure falling within sections 30 to 36 only to a capital expenditure,
the same was expressly provided for in the section concerned. To illustrate,
section 35A and 35ABB of the Act have specifically restricted the benefits
thereunder only to a capital expenditure.

In the above view, submission on behalf of
the assessee that section 35AB of the Act would apply only to the case of a
capital expenditure and exclude the revenue expenditure, required adding words
to s. 35AB which the legislature had specifically not put in; the court could
not insert words while interpreting the fiscal legislation in the absence of
any ambiguity in reading of section as it stood; thus, even if technical
know-how was revenue in nature, yet it would be excluded from the provisions of
section 37 of the Act.

The Court took note of the fact that Gujarat High Court in Anil
Starch Products Ltd.’s case (supra) and Sayaji Industries Ltd.’s
case (supra) did not agree with the view of the M.P. High Court in Bright
Automotives & Plastics Ltd.’s case (supra) and of the Madras
High Court in Tamil Nadu Chemical Products Ltd.’s case (supra). It also
noted that the Karnataka High Court in Diffusion Engineers Ltd.’s case
(supra) did not agree with the view of the Madras High Court in Tamil
Nadu Chemical Products Ltd.’s case (supra). Having taken note, it
observed that the basis of all the above referred three decisions was the
subsequent decision of the Apex Court in CIT vs. Swaraj Engines Ltd. 301 ITR 284. It further noted that the
above case before the Apex Court arose from the decision of the Punjab &
Haryana High Court in Swaraj Engines Ltd.’s case, wherein it was held
that payments made on account of the royalty would be deductible u/s. 37 and
not u/s 35AB of the Act; that the Apex Court had restored the issue to the
Punjab & Haryana High Court, by way of remand; that the Apex Court directed
that the High Court should first decide whether the expenditure incurred on
royalty would be capital or revenue in nature at the very threshold before
deciding the applicability of section 35AB or 37 of the Act.

The Court also observed that the Apex Court, while restoring
the issue, had clearly recorded that it had not expressed any opinion on the
matter and on the question whether the expenditure was revenue or capital in
nature and had instead, depending on the answer to that question, directed the
High Court to decide the applicability of section 35AB, and had kept all
contentions on both sides expressly open.

The entire issue, in the opinion of the Bombay High Court,
about whether section 35AB applied only in case of capital expenditure and not
in case of revenue expenditure had not been decided by the Apex Court in Swaraj
Engines Ltd.’s case (supra) and was left to be decided by the Punjab
& Haryana High Court on the basis of the fresh submissions to be made by
the respective parties. It was clear to the High Court that the Apex Court in Swaraj
Engines Ltd.’s case (supra) had not concluded the issue by holding
that section 35AB would apply only in cases where the expenditure was capital in
nature. Instead the Apex Court had expressed only a tentative view and the
issue itself was left open to be decided by the Punjab & Haryana High Court
on remand.

The Bombay High Court importantly held that the reliance by
the Gujarat High Court in Anil Starch Products Ltd.’s case (supra)
and Sayaji Industries Ltd.’s case (supra) and by the Karnataka
High Court in Diffusion Engineers Ltd.’s case (supra), on the
Apex Court decision in Swaraj Industries Ltd.’s case (supra), to
hold that an expenditure which was revenue in nature would not fall u/s. 35AB
and would have necessarily to fall u/s. 37 of the Act, was not warranted by the
decision of the Apex Court in Swaraj Engines Ltd.’s case (supra).
Hence, the Bombay High Court was unable to agree with the decisions of the
Gujarat High Court and the Karnataka High Court, in as much as the Apex Court
had not conclusively decided the issue and left it open for the Punjab &
Haryana High Court to adjudicate upon the said issue.

Observations

That the expenditure of revenue nature on acquiring know-how
is eligible for deduction u/s. 37 in full, prior to insertion of section 35AB,
was a position in law that was well settled by several decisions of the courts,
and in particular, the decisions in the cases of Ciba of India Ltd.69 ITR
692(SC), IAEC(Pumps) Ltd. 232 ITR 316(SC), Indian Oxygen Ltd. 218 ITR 337(SC)
and Alembic Works Co Ltd. 177 ITR 377(SC).In contrast, the expenditure of
capital nature on know-how was not eligible for deduction u/s. 37, prior to
insertion of section 35AB, in as much as the section itself prohibited
deduction of an expenditure of a capital nature, though in the above referred
cases, the deduction was held to be allowable even where the expenditure
resulted in some enduring benefits.

This settled position in law was disturbed by the
introduction of section 35AB. With its introduction, the deduction for all
expenses on know-how, capital or revenue, was governed by the provisions of
section 35AB, was the understanding of the Revenue, a stand that was not
supported by the comments of the leading jurists published in the 9^th
edition of the book titled Kanga & Palkhivala’s Law and Practice of
Income tax. In contrast, tax payers hold that the insertion of section 35
AB had not changed the settled position for deduction in full u/s. 37 of the
Act for an expenditure of revenue nature.

Both the views, as noted, are supported by the conflicting
decisions of about six High Courts where some of the decisions are delivered in
favour of the taxpayers on the ground that the issue has already been settled
by the Apex Court in the case of Swaraj Engines Ltd.(supra) while
recently the Bombay High Court held to the contrary, leading to one more
controversy involving whether the Apex Court really adjudicated the issue for
good or it has left the issue open.

It is perhaps not difficult to decide whether the Supreme
court in the case of Swaraj Engines Ltd. (supra), at all concluded the
issue under consideration and if yes, was the conclusion arrived at in favour of
the proposition that the provisions of section 35AB applied only where the
expenditure in question was of capital nature. The Apex Court in Swaraj’s
case had noted, in paragraphs 4 and 5 of the decision, that there was a
considerable amount of confusion whether the AO in the case before him applied
section 35AB at all and whether the said contention regarding applicability of
section 35AB was at all raised. The court had further observed that the order
of the AO was not clear, principally, because the order was focussed only one
point namely, on the nature of expenditure. It further observed that depending
on the answer to the said question, the applicability of section 35AB needed to
be considered; the said question needed to be decided authoritatively by the
High Court as it was an important question of law, particularly, after
insertion of section 35AB. The Court therefore remitted the matter to the High
Court for a fresh consideration in accordance with law. It also clarified, in
para 7, on the second question, that “we do not wish to express any opinion.
It is for the High Court to decide, after construing the agreement between the
parties, whether the expenditure is revenue or capital in nature and, depending
on the answer to that question, the High Court will have to decide the
applicability of section 35AB of the Income-tax Act. On this aspect we keep all
contentions on both sides expressly open”. Accordingly, the impugned
judgment of the High Court was set aside and the matter was remitted for fresh
consideration in accordance with law.

It seems that the
confusion has arisen out of the following observations of the Apex Court in Swaraj’s
case, wherein it stated that “At the same time, it is important to note
that even for the applicability of section 35AB, the nature of expenditure is
required to be decided at the threshold because if the expenditure is found to
be revenue in nature, then section 35AB may not apply. However, if it is found
to be capital in nature, then the question of amortisation and spread over, as
contemplated by section 35AB, would certainly come into play. Therefore, in our
view, it would not be correct to say that in this case, interpretation of section
35AB was not in issue.” These observations, made mainly to emphasise that
the decision of the High Court required to be set aside for further
examination, has been construed differently by the High Courts, some to support
the proposition that section 35AB had no application to an expenditure that was
held to be of revenue nature. In fact, in the said case, when the matter had
reached the High Court, it was dismissed by the Punjab & Haryana High Court
on an altogether different aspect of section 35AB which is not under
consideration, presently. The High Court in that case had held and observed
that effort of the revenue to bring the expenditure within the domain of
section 35AB was totally misplaced, since the pre-condition for application of
section 35AB was that the payment had to be a lump sum consideration for
acquiring any know-how and such pre-condition was not satisfied. On that basis,
the High Court had dismissed the appeal. It was this decision of the High Court
which had come up for consideration of the Apex Court . We respectfully submit
that the decision of the Apex Court in Swaraj Engines Ltd.’s case, has
not concluded that a revenue expenditure was outside the scope of section 35AB
. It has instead left this aspect of the issue open for a fresh consideration,
as has been explained by the Bombay High Court in Standard Batteries Ltd.’s
case.

Having noted the facts, the issue requires to be analysed on
the basis of;

implication of the decisions favouring the
claim for deduction u/s. 37

an understanding of the position prevailing
prior to insertion of section 35 AB,

legislative intent behind introduction of
section 35AB,

whether section 35AB is an enabler or
disabler,

language of section 35AB and its scope , and

restriction in section 37 .

We very respectfully submit that the decisions favouring the
claim u/s. 37, based simply on the perceived findings of the Apex Court in Swaraj
Machines Ltd.‘s case, may not hold any force, in view of our considered
opinion that the Apex Court had, in that case, not adjudicated the issue but
had instead set aside the matter and restored the same to the Punjab &
Haryana High Court. If that is so, the decisions of the courts holding that the
deduction for expenses is governed by section 35AB alone become the only
available decisions of the High Courts leaving no controversy on the subject.
The best hope for the taxpayer is to await the decision of the Apex Court on
the subject. The issue till such time remains not concluded but the one on which
no other High Court has decided in favour of the tax payer after examining the
merits of the case.

The legal position, prevailing prior to insertion of section
35AB by the Finance Act, 1985, is cleared by the decisions of the Supreme Court
holding that an expenditure, on acquisition of know-how, of revenue nature is
eligible for deduction u/s. 37 of the Act, once it was incurred wholly and
exclusively for the purposes of the business and the expenditure in question
was not of a capital nature or for personal purposes. Ciba of India Ltd.69
ITR 692(SC), IAEC(Pumps ) Ltd. 232 ITR 316(SC), Indian Oxygen Ltd. 218 ITR
337(SC) and Alembic Works Co Ltd. 177 ITR 377(SC) to name a few
wherein the deduction u/s 37 was held to be allowable for an expenditure incurred
on technical know-how acquisition even where the expenditure resulted in some
enduring benefit to the payer.

The CBDT circular No. 421 dated 12.6.1985, vide paragraphs
15.1 to 15.3 explains the intention behind the insertion of the new
provision in the form of section 35AB which is for providing further
encouragement for indigenous scientific research. The memorandum explaining the
provisions of the Finance Bill, 1985 and the Notes thereon have been reiterated
by the circular. They together do not throw any light about the scope of the
new provision, nor about the intention to override the existing understanding,
nor the available decisions on the subject. If that had been the intent, the
same is not expressed by the supporting documents.

Ideally from the tax payers angle, the provision of section
35AB should be construed to be an enabling provision that facilitates the
deduction for a capital expenditure hitherto not available before its
introduction and its scope should be restricted to that. Its insertion should
not be taken as a disabling provision leading to a disentitlement not expressly
provided for nor intended.

Section 35AB in its language does not limit the deduction to
the case of an expenditure that is capital in its nature. It also does not
expressly provide that a revenue expenditure on acquisition of know-how will
fall for deduction only u/s. 35AB. Neither does it provide that such an
expenditure will not qualify for deduction u/s. 35AB and thereby strengthening
the claim for deduction u/s. 37. Useful reference may be made to the provisions
of section 35A and section 35ABA and section 35ABB which specifically apply
only to the cases of capital expenditures.

Section 37 grants deduction for any and all types of
expenditures wholly and exclusively for business purposes, other than those
described under sections 30 to 36 of the Act. The true intent and meaning of
the words ‘not being the expenditure described in s.30 to 36’ placed in
s/s. (1) was examined in various cases by the courts over a period of time. It
has been held by the High Courts, including by the full benches of courts, that
section 37 is a residuary provision and can be activated only where it is found
not to be covered by any of the provisions of section 30 to section 36. If it
is covered by any of those provisions, then the deduction cannot be granted
under the residual section 37. It will be so even where the conditions
prescribed under sections 30 to 36 remain to be satisfied. The use of the term ‘described’
as against the terms ‘covered’ or ‘of the nature covered by or
prescribed in’ is equally intriguing.

If the expenditure on know-how does not satisfy the
conditions of the lump sum payment and of the acquisition, then, in that case,
provisions of section 35AB would have no application. The deduction in such
cases would possibly be governed by the provisions of section 37, subject to
the satisfaction of the conditions satisfied therein. This view however is not
free from debate in view of the discussion in the preceding paragraph.

Obviously, section 35 AB will have no application in cases
where the payment is not lump sum and is periodical or annual or is turnover
based, and the tax payer would be able to stake its claim u/s. 37, provided of
course that the payment is not of the capital nature. Tata Yodogawa Ltd. vs.
CIT, 335ITR 53 (Jhar.).

The Apex Court in the case of Drilcos (India) Pvt. Ltd.vs.
CIT, 348 ITR 382 has held that once section 35AB had come into play,
section 37 had no role to play. This decision of the court, delivered
subsequently to Swaraj Machines’ case, may play an important role in
addressing the outcome of the issue on hand. The Apex Court, in Drilcos’
case, confirmed the decision of the Madras High Court reported in 266
ITR 12, on an appeal by the company challenging the order of the High
Court. The High Court had held that the provisions of section 35AB encompassed
in its scope the case of a revenue expenditure, following the decision in the
case of Tamil Nadu Chemicals Products Ltd.(supra).

While the controversy continues for the past,
the position is now clear with effect from 1.10.1998. A ‘know-how’ is expressly
included in the definition of an intangible asset with effect from 1.10.1998
and is accordingly made eligible for depreciation. Obviously, no depreciation
would be claimed or allowed in respect of a revenue expenditure on know-how,
and with that, such an expenditure, on discontinuation of section 35AB w.e.f
1.04.1998, would be eligible for deduction u/s. 37 of the Act.

shailesh.kwebmaker

TDS On Provision For Expenses Made At Year-End

Issue for Consideration

Many
of the provisions casting obligation to deduct tax at source (‘TDS’) under
Chapter XVII-B require tax deduction at
the time of credit of the specified income or sum to the account of the payee
or at the time of payment, whichever is earlier.

Each
of the relevant provisions of TDS, by way of a deeming fiction, under an
Explanation, provide that when the
income or sum is credited to any account by any name in the books of account of
the person liable to pay it, such crediting shall be deemed to be credit of
such income or sum to the account of the payee and the provisions of the
relevant section shall apply accordingly[1].

A
question often arises as to whether tax is required to be deducted at the time
of making provision, in the books of account,
for several expenses at the end of the accounting year under the
mercantile system of accounting. While
a view has been taken in some cases that
tax is not required to be deducted at source where the payee is not
identifiable, there has arisen one more controversy even in respect of ad-hoc or
interim provisions made, in respect of liability payable to identified payees
in future. The issue that has arisen is, whether crediting the amount to the
provision account, in such cases, be
deemed to be credit to the account of the concerned payee attracting the
liability to TDS. The incidental issue also arises as to whether the reversal
of such provision in the subsequent period has any bearing in determining
applicability of TDS. Conflicting decisions have been rendered by the Bangalore
bench of Tribunal on this subject.

[1]
Refer to Explanations to Section 193,
Section 194A, Section 194C,
Section 194H, Section 194-I, Section 194J.

IBM
INDIA (P) LTD.’S CASE

The
issue first came up before the Bangalore bench of the Tribunal in the case of IBM
India (P) Ltd vs. ITO 154 ITD 497.

In this case, pertaining to assessment years 2005-06 to
2009-10, the assessee, a wholly owned
subsidiary of a U.S. based company, was following the mercantile system of
accounting. As a part of the global group accounting policy, the assessee had
to quantify its expenses every quarter, within 3 days of the end of each
quarter. The assessee made a provision in the books of account for expenses, on
such quantification, in respect of which
service/work had been provided/performed by the vendors in the relevant quarter but for which the invoices had not been
furnished or in respect of which the payments had not fallen due, recognising
the liability incurred. On the basis of scientific methodology, the assessee
estimated such expenses and created a provision for such expenses every quarter
within 3 days of the end of the quarter. At the time of creation of provision,
in this manner, it was not possible for the assessee to identify parties, or if
parties were identified, to arrive at the exact sum on which TDS was to be
deducted.

The
expenses were debited to the profit and loss account and the provisions were
credited to a provision account, and not to the vendor accounts, as those had
not fallen due for payment. In the subsequent financial year, the provision
entries were reversed and on receipt of invoices in respect of the respective
expenses, the same were recorded as liabilities due to the respective parties,
at which point of time taxes were deducted
at source. The provision so made was disallowed by the assessee itself
in terms of section 40(a)(i) and 40(a)(ia) while filing its return of income.

According
to the Assessing Officer, in respect of the provision so created by the
assessee in the books of account, tax was deductible at source and the assessee
by not deducting the tax has been in default and was liable to deposit the tax
and also for interest and penalty. In response to the show cause notice issued
u/s. 201(1) & 201(1A), the assessee submitted that invoices were not
received in respect of the underlying expenses, and therefore there was neither
accrual of expenditure nor was the payee identified, as the amount was not
credited to the account of the payee, but to a suspense account. There was no
accrual of expenditure in accordance with the mercantile system of accounting,
and therefore there was no obligation on its part to deduct tax at source. The
assessee took a stand that, though the
relevant provisions of law in Chapter XVII-B, did provide for the situation
where an amount was credited to a
“Suspense Account”, there should be a legal liability to pay, and the
payee should be known, and only then the obligation to deduct tax at source
arose. The Assessee also submitted that the provision entries were reversed in
the subsequent financial year(s) and necessary taxes were withheld at source at
the time of actual payment (when legal liability to pay arose and the identity
of the party was known).

The
Assessing Officer rejected the assessee’s arguments on the grounds that:

1. The
assessee did not explain as to how the expenses had been quantified;

2. When
no invoices were received, the booking of such expenses in the accounts and
claiming them as expenditure of the previous year was erroneous; and

3. The
procedure followed by the assessee, of reversing the entries and recording the liability
in its books of account when invoices were received, was contrary to the
accounting policy, because once expenditure was booked in the profit and loss
account, it could not be reversed;

4. There
was no clarification as to whether tax
was deducted on the whole of the provisional entries, so as to allow the
amount that was disallowed u/s.
40(a)(ia), in the year in which tax was
deducted and paid ;

5. The
procedure followed by the assessee might
have led to the allowing of the expenditure one year prior to the
incurring of the actual expenses;

6. The
details of the TDS made on such provisions made at the end of the year was also
provided by the assessee on sample basis, contending that the number of entries
were huge and hence could not be provided in full within a limited period;
giving rise to non-verification of deductions claimed.

The Assessing Officer treated the assessee
as an assessee in default for the taxes
not deducted at source, in respect of provision for expenses made in the books
of account, and also levied consequential interest.

The orders passed u/s. 201(1) and 201(1A)
were upheld by the CIT (A) for the following reasons:

1. Under
mercantile system of accounting, accrual of liability for any expenditure was
not dependent on receipt of invoice from the person to whom payment for
expenditure had to be made. The accounting practice followed by the assessee
was contrary to the mercantile system of accounting.

2. The
claim of the assessee that it created provision in the books of account on an
estimated basis in some cases, on a historical basis in one set of cases and by using some sort of arithmetical or
geometric progression in other cases, was not acceptable. The assessee had not
established its plea with concrete evidence. The assessee had full knowledge of
what was due to its vendors, sub-contractors, commission agents etc. Therefore,
there was no necessity to create provisions.

3. The
argument regarding chargeability to tax in the hands of the payee or the time
at which the payee recognised income in respect of the payment received from
the assessee was irrelevant.

Before the Tribunal, the assessee
contended that:

1. When
payee was not identified there could be
no charge u/s. 4(1) and therefore there could
be no obligation to deduct tax at source;

2. The
returns of TDS to be filed under the Income Tax Rules, 1962 contemplated
furnishing of names of payees.

3. Judicial
decisions recognise that there could be no TDS obligation in the absence of
payee.

4. If there was no income chargeable to tax in
the hands of the payee, there could be
no TDS obligation. TDS obligations arose only when there was
“Income”. TDS obligations did not arise on the basis of mere payment,
without there being income and corresponding liability of the person receiving
payment from the assessee to pay tax.

5. The
Assessee relied on CBDT Circular No. 3/2010 dated 2.3.2010, issued in the
context of the provisions of section 194A of the Act dealing with TDS
obligation of banks at the time of provision of monthly interest liability
under the Core Banking Solution software, where the CBDT had clarified that TDS
was not applicable at the time of such monthly provisioning.

6. Reliance
was also placed by the assessee on the Delhi High Court decision in the case of
UCO Bank vs. Union of India [2014] 369 ITR 335, where the Delhi High
Court had held that no tax was deductible on deposits kept by the Registrar
General of the High Court, since the ultimate payee was not known.

The Revenue argued that:

1. The
assessee on its own had disallowed the expenditure in question u/s. 40(a)(i)
& 40(a)(ia). Such disallowance arose only when there existed a liability to
deduct tax at source in terms of Chapter-XVII-B of the Act. The assessee having
on its own disallowed expenditure u/s. 40(a)(i) & 40(a)(ia), could not
later on turn around and say that there
was no obligation to deduct tax at source.

2. The
assessee did not account for expenditure on accrual basis but on receipt of
invoice which could not be the point of time at which accrual of
expenditure could be said to have
happened. The system of accounting followed by the assessee was not in tune
with the mercantile system of accounting.

3. When
the assessee credited suspense account for payments due to various persons,
such credit itself was treated as credit to the account of the payee by a
deeming fiction in the various provisions of Income tax Act. The assessee could
not therefore say that the payee was not identified. Even in such a situation,
the assessee had to comply with the TDS provisions.

4. The
method of accounting followed by the Assessee resulted in postponement of time
at which tax had to be remitted to the credit of the Government. It could be seen from the fact that the
assessee, in some cases, was liable to charge of interest u/s. 201(1A) for
about 84 months. The question whether the Assessee was indulging in a
deliberate exercise in this regard was irrelevant. The fact that the revenue
was put to loss by reason of the system of accounting followed by the assessee
and the fact that otherwise the money should have reached the coffers of the
revenue much earlier, was sufficient to uphold the levy of interest u/s.
201(1A) of the Act.

5. When
the Assessee argued that the payees were not identified, it was not open to the
assessee to also contend that there was no accrual of income in the hands of
the payee or that the payment was not chargeable to tax in the hands of the
payee in India.

6. The
CBDT circular No. 3/2010 was in the context of banks crediting interest on
fixed deposits of customers. The decisions rendered by the judicial forums
based on those circulars were not
relevant, as they were relevant only in the case of Banks and could not be
pressed into service in other cases, such as the case of the Assessee.

The Tribunal deleted the demand for
payment of taxes raised u/s. 201(1) as the tax that was deducted subsequently when the actual liability was
booked, was paid. However, it upheld the applicability of the provisions of TDS
at the time of making provision and the obligation to deduct tax thereon and
accordingly, levy of interest u/s.
201(1A) on account of delay on the part
of the assessee in complying with the TDS provisions. On the facts of the case,
the Tribunal noted that the assessee was fully aware of the payee, but
postponed credit to its account for want of receipt of invoice. Proceeding on
the basis that payees were known to the assessee, regarding applicability of
TDS on provision, the Tribunal held as under:

1. Once
the assessee had offered disallowance in respect of provision u/s. 40(a)(i) and
40(a)(ia), it was not possible to argue that there was no liability to deduct
tax at source on the same provision. The disability u/s. 40(a)(i) &
40(a)(ia), and the liability u/s. 201(1) could not be different and they arose
out of the same default;

2. The
liability to deduct tax at source existed when the amount in question was
credited to a “Suspense Account” or any other account by whatever
name called, which would also include a “Provision” created in the
books of account;

3. Since
the assessee had not established with concrete evidence that provision was made
on an estimated basis, it had full knowledge of amounts payable to vendors,
sub-contractors, commission agents, etc., and there was no necessity to
create a provision;

4. The
statutory provisions clearly envisaged collection at source de hors the
charge u/s. 4(1).

5. The
argument that TDS provisions operated on income and not on payment, in the
facts and circumstances of the case, was
erroneous. Section 194C & 194J used the expression “sum” and not
“income”. Further, section 194H & 194-I did not use the expression
“chargeable to tax”.

6. The
Tribunal further held the decision of the Bangalore bench in the case of DCIT
vs. Telco Construction Equipment Co. Ltd. ITA No. 478/Bang/2012 to be sub
silentio, and, therefore, not binding. The Delhi High Court decision in the
case of UCO Bank (supra) was also
distinguished on the ground that the assessee was fully aware of the payee in
the case before the Tribunal.

The Tribunal therefore confirmed the levy
of interest u/s. 201(1A).

BOSCH
LTD.’S CASE

The issue again came up before the
Bangalore bench of the Tribunal in the case of Bosch Ltd vs. ITO
TS-116-ITAT-2016.

This was a case relating to assessment
year 2012-13. The facts of this case were almost identical to the facts of
IBM’s case. The assessee was a company engaged in the business of manufacture
and sale of injection equipments, auto electric items, portable electric power tools, etc.

In respect of expenses amounting to Rs.1,96,84,115, a provision was created by
the company in its books and the same was disallowed under the provisions of section
40(a)(i)(ia) in computation of total income filed for the assessment year
2012-13. Out of Rs.1,96,84,115, no invoices were received for an amount of
Rs.1,79,36,713 and the said amount was
reversed in the beginning of the next accounting year. The assessee contended
that no tax was required to be deducted in respect of such amount for which no
invoices were received.

The contention of the assessee was not
accepted by the Assessing Officer by holding that the system of accounting
followed by the assessee was faulty and did not enable any verification. He
held that since the assessee company was following mercantile system of
accounting, tax should have been deducted on the provisions made. Accordingly,
the Assessing Officer held that the
assessee to be an ‘assessee in default’ u/s. 201(1) of the IT Act and demanded
tax and interest thereon.

The CIT (A) confirmed the action of the
Assessing Officer by holding that suo-moto disallowance under the
provisions of section 40(a)(ia) did not absolve the assessee from its
responsibility of deducting tax at source. However, the CIT (A) directed the
Assessing Officer to exclude those
amounts in respect of which TDS had been made on the dates on which invoices
had been raised.

Before the Tribunal, the assessee
submitted that, as regards the expenses for which the service provider or
vendor had not raised any invoices nor were they acknowledged by the assessee
company, it made a provision for such expenses on a scientific basis and such
provision was debited to its P&L account, in conformity with the provisions
of Accounting Standard 29- Provisions, Contingent Liabilities and Contingent
Assets (AS 29) issued by the Institute of Chartered Accountants of India
(ICAI). Such provision, which was mandatory as per AS 29, was reversed in the
beginning of the next accounting year.

It was argued that:

a. No
income had accrued to the payees and a mere provision was made in the books of
account at the year end. The very fact that the provision was reversed in the
beginning of the next accounting year showed that no income had accrued to the
payee and therefore, there was no liability to deduct TDS on the basis of mere
provision.

b. The
payees as well as the exact amount payable to them were not identifiable and
therefore, there was no liability to deduct tax at source.

c. The
existence/accrual of income in the hands of payee was a pre-condition to fasten
the liability of TDS in the hands of the payer;

d. The
provisions of section 195 stipulated that the payer had to deduct tax at source
at an earlier point of time, either at the time of crediting to the payee’s
account or at the time of payment of income to the payee. The phrase “whichever
is earlier” would mean that both the events i.e crediting the amount to the
account of payee and payment to the assessee must necessarily occur. Therefore,
when there was no payment made the question of deducting TDS at the time of
crediting did not arise.

Reliance was also placed on the CBDT’s
Instruction No.1215 (F.No.385/61/78 IT(B) dated 08-11-1978.

On behalf of the revenue, it was argued
that on a plain reading of section 195, the liability to deduct tax at source
had arisen the moment the amount was credited in the books of account,
irrespective of fact whether the amount was paid or not. It was further submitted that the provision of
taxing statutes should be construed strictly so that there was no place for any
inference.

The Tribunal took a view that the liability
to deduct tax at source arose only when there was accrual of income in the
hands of the payee. It relied upon the decision of Supreme Court in the case of
GE India Technology Centre P. Ltd. vs. CIT 327 ITR 456. According to the
Tribunal, the fact that the provisions made at the year-end were reversed in
the beginning of the next accounting year showed that there was no income
accrued. The Tribunal observed that mere entries in the books of account did
not establish the accrual of income in the hands of the payee, as held by the
Hon’ble Supreme Court in the case of CIT vs. Shoorji Vallabhdas & Co. 46
ITR 144.

The Tribunal
accordingly concluded that there was no liability in the hands of the assessee
company to deduct tax at source, merely on the provisions made at the year end.

This order of the
Tribunal has been followed by the Bangalore bench of the Tribunal in the case
of TE Connectivity India Pvt Ltd vs. ITO (ITA 3/Bang/2015 dated 25.5.2016).

OBSERVATIONS

The objective of inserting the Explanation has been stated
in Circular No. 3/2010 dated 2-3-2010. The relevant portion of this circular is
reproduced below:

Explanation to section 194A was introduced
with effect from 1-4-1987 by the Finance Act, 1987 to plug the loophole of
avoiding deduction of tax at source by crediting interest in the books of
account under accounting heads ‘interest payable account’ or ‘suspense account’
instead of to the depositor’s/payee’s account. (emphasis added)

It is gathered from the above that, the Explanation applies
where the interest (or any other amount
to which other provisions of TDS applies) is otherwise required to be credited
to the payee’s account and in order to avoid deduction of tax at source, it has
been credited to some other account, and not to the payee’s account.

A provision for an expense, by its very
nature, can not, in accountancy, be credited to any particular payee’s account;
it is rather to be credited to the Provision Account. The sum which cannot be
credited to the payee’s account as per the accounting principles cannot be
brought within the purview of Explanation so as to deem to have been credited to the payee’s
account. The possibility to have credited a sum to the payee’s account should
first exist in order to invoke the Explanation. There is a stronger case for
non application of the Explanation in cases where the payee is not known in
comparision to the cases where the payee
is known. Mere non-receipt of an invoice by the assessee cannot result in
claiming that the amount has not accrued to the service provider, particularly
when the contractual terms are also known to the assessee. The TDS provisions
in the later circumstances may be construed to have been avoided or defeated by crediting an expenditure to a provision account, instead of to the
payee’s account.

One view that the Explanation is intended
to apply only when the liability to pay that amount has become due is on
account of the language of the Explanation itself. The relevant provision of
section 194C [earlier it was present in the form of an Explanation II to s/s.
(2) but re-enacted as s/s. (2) with effect from 1-10-2009] is reproduced below:

Where any sum referred to in sub-section
(1) is credited to any account, whether called “Suspense account” or
by any other name, in the books of account of the person liable to
pay such income,
such crediting shall be deemed to be credit of such income to the account of
the payee and the provisions of this section shall apply accordingly. (emphasis
added)

The words used in the Explanation are
“person liable to pay such income” in contrast to the “person responsible for
paying” as used in the main provision. Therefore, as per this view, the person
should have become liable to pay the income on which tax is required to be withheld
in order to get covered by the Explanation.
This view perhaps has a better appeal in cases of section 195 which
bases the obligation on ‘chargeability’ in the hands of the payee.
However, this view may not hold water, when one appreciates that the term
“liable to pay such income” merely qualifies the person who is required to
deduct tax, and not the point of time of deduction of tax.

As far as disallowance u/s. 40(a)(ia) is
concerned, offering disallowance u/s. 40(a)(ia) cannot absolve the assessee
from his liability u/s. 201(1). Both the provisions, one for disallowance u/s.
40(a)(i) or 40(a)(ia) and the other for treatment of the assessee as an assessee in default can
co-exist. The Second Proviso to section 40(a)(ia) envisages such a possibility whereby
the assessee can be proceeded against under the provisions of section 201,
apart from disallowing the relevant expenditure on account of his default in
complying with the TDS provisions.

But then, the incidental issue would be as
to whether the provision created in the books of account, for which a view is
taken that tax is not deductible on it, can be subjected to the disallowance provisions of section
40(a)(i) or 40(a)(ia) or not. These provisions of section 40(a) apply to any sum payable
and on which tax is deductible at source under Chapter XVII-B. It is not the
case that the tax is not deductible at all from the provisions for expenses. It
is only the point of time at which tax is required to be deducted that is in
dispute. Therefore, it would be difficult to take a view that the claim based on such provisions cannot be
disallowed u/s. 40(a)(i) or 40(a)(ia) merely because tax is not deductible at
present but in future. Otherwise, it would result into granting of deduction in
the year of making provision and making disallowance provision otiose in the
subsequent year in the absence of any claim for its deduction. However,
difficulties would certainly arise in a case where the provision is made for
liability towards unidentified payees. In such case, neither payee is known nor
his residential status is known.

One may however take notice of the
decision of the Mumbai Tribunal in the case of Pranik Shipping &
Services Ltd. vs. ACIT [2012] 135 ITD 233 wherein a view was taken that the
provision of section 40(a) would not apply in cases where the expenditure in
question was claimed in the return of income but was neither credited to the
account of payee nor provided for in the books.

If one looks at the plain reading of the
tax deduction sections, they require tax deduction at source on payment of any
income of specified nature (except in case of section 194C, which requires
payment of any sum). The chargeability to tax of such income is not a
prerequisite, except in case of section 195, which specifically requires such
sum to be chargeable to tax. Therefore, one can distinguish the provisions of
section 195 from the other tax deduction provisions, which do not specify that
such amounts have to be chargeable to tax. The reliance by the Tribunal on GE
Technology Centre’s decision (supra) in Bosch’s case, in relation to
section 195, may be a good law and may be debatable for provisions other
than section 195.

The assessees are advised, in the interest of
mitigating litigation to deduct tax at source
in cases where the services are rendered and the payee is known, even
while making the provisions for expenses on an estimated basis or otherwise.

shailesh.kwebmaker

BOOK-PROFIT FOR PAYMENTS TO PARTNERS – SECTION 40(B)

The column “Controversies” was started
in January, 1980, with Vilas K. Shah and Rajan R. Vora as the initial
contributors. Harish N Motiwalla took over from 1985-86 to 1993-94. Pradip
Kapasi contributed from May, 1992, and has not stopped rolling out controversy
after controversy till today. That is 27 years of monthly contributions. Gautam
S Nayak joined as co-author in April, 1996 and is now an experienced
‘controversialist’ for 23 years. Their unbeaten partnership is perhaps the
longest under BCAJ! The authors have been bringing out a new controversy every
month, month after month. So far, they would have brought out a record 275
controversies. Bhadresh Doshi joined them in June, 2018.

This is not a digesting feature, but an
ANALYTICAL FEATURE. The process starts with identifying a suitable controversy
where there are two conflicting views on a legal issue which are not settled by
the Supreme Court. Currently forum based or subject based issues are covered.
Pradip Kapasi says: “The authors, in the initial years used to ‘conclude’ the
issue, under consideration, in the end which practice for long has been
substituted with the authors offering their comments in the form of
‘observations’ leaving the debate open for readers.”

In the era of law driven by judgements,
the authors bring observations, record decisions, and also alternative
contentions that help resolve or reconcile controversies. In answer to the
question – what keeps them going – Pradipbhai said: “At an early age, the
feature taught that no view, even of the high court, is final and that there is
always another view which at times can be a better view.” Gautambhai answered
thus: “Writing this column is time consuming, but exhilarating, as one has to
consider all aspects of the issue thoroughly, while giving the observations.
After writing on an issue, one becomes completely aware of all the nuances of
the issue, as well as case laws on the subject, which definitely helps in one’s
practice, when one comes across similar issues.”

Book-Profit for payments to
partners –
Section 40(b)

ISSUE FOR CONSIDERATION

Section 40(b)
limits the deduction, in the hands of a firm, in respect of expenditure on
specified kinds of payments to partners. Clause(1) of section 40(b) prohibits
the deduction for payment of remuneration to a partner who is not a working
partner. Clause(2) provides that a deduction for payment of remuneration to a
working partner is allowed in accordance with the terms of the partnership
deed. Clause (5) has the effect of limiting the deduction for remuneration to
working partners, to the specified percentage of the “book-profit” of the firm.

“Remuneration”
includes any payment of salary, bonus, commission or remuneration by whatever
name called. The term “book-profit” is defined exhaustively by
Explanation 3 to section 40(b) which reads as under “Explanation 3-For the
purpose of this clause, ”book-profit” means the net profit, as shown in the
profit and loss account for the relevant previous year, computed in the manner
laid down in Chapter IV-D as increased by the aggregate amount of the
remuneration paid or payable to all the partners of the firm if such amount has
been deduced while computing the net profit”

‘Book-Profit’, as
per Explanation 3, means the net profit as per the profit and loss account of
the relevant year, computed in the manner laid down in Chapter IV-D. The
requirement to take net profit as shown in profit and loss account is quite
simple, but the requirement to compute the same in the manner laid down in
Chapter IV-D has been the subject matter of debate.

It is usual to
come across cases wherein the profit and loss account is credited with receipts
such as interest, rent, dividend, capital gains and such other income, which
may or may not have any relationship to the business of the firm. It is in such
cases that an issue arises while computing the Book-Profit of the firm, wherein
the firm is required to ascertain as to whether the interest and such other receipts
credited to profit and loss account are required to be excluded from the net
profit or not to arrive at the figure of the book-profit.

Conflicting
decisions of the high court are available on the subject of determination of
the book-profit for the purpose of section 40(b) of the Act. While the Calcutta
high court has favoured the acceptance of the net profit as per the profit and
loss account as representing the book-profit, the Rajasthan high court has
recently ordered for exclusion of such receipts from the net profit.

MD SERAJUDDIN
& Bros.’ CASE

The issue arose
before the Calcutta High Court in the case of
Md. Serajuddin & Bros. vs. CIT, 24 taxmann.com 46 (Cal.). In
that case, the assessee, a partnership firm, filed its return of income for the
relevant assessment years 1995-96 to 1998-99 by claiming deduction for
remuneration paid to partners which was calculated on the basis of the net
profit of the firm as per the profit & loss account of the year, which inter
alia included the credits for consultancy fees, interest on bank deposits,
profit on disposal of assets and interest on advance tax, which had been shown
as income under the head ‘other sources’. The returned income was accepted by
the Assessing Officer on issue of the intimation u/s. 143(1)(a). Subsequently,
the AO held that the income by way of consultancy fees, interest on bank
deposit, profit on disposal of assets and interest on advance tax, which had
been shown as income under the head ‘other sources’, could not be considered as
part of the book profit for the purpose of computation of allowable partners’
remuneration. He recomputed the deduction for remuneration by reworking the
book profit and disallowed the excess remuneration by applying the provisions
of section 40(b) of the Act. The Commissioner (Appeals) rejected the appeal of
the assessee. On further appeal, the Tribunal, without giving any reasonable
opportunity to the assessee, dismissed the appeal.

The High Court
admitted the appeals of the assessee firm on the following substantial question
of law on the issue under consideration, besides a few other aspects of the
issue not germane for the discussion :-

“Whether and
in any event, on a proper construction of the provisions of Section 40(b)(v)
and explanation 3 thereto, book profit comprises the entire net profit as shown
in the profit and loss account or only profit and gains of business assessed
under Chapter IV-D?”

On behalf of
the assessee firm, it was highlighted that for the purpose of Explanation 3 to
section 40(b)(v), the appellant had taken into consideration its net profit as
shown in the profit and loss account, which included consultancy fees, interest
on bank and company deposits, profit on disposal of cars used in the business
and interest on refund of advance tax paid and other items of incomes, which
were shown in the return under heading ‘income from other sources’. In support
of its action, it was submitted that;

the said Explanation 3 of section 40(b)(v)
provides for taking the net profit as shown in the profit and loss account and
not the profit computed under the head ‘profit and gains of business or
profession’;

unlike Explanation (baa) to section 80HHC
and section 33AB, both of which mentioned profit as computed under the head
‘profit and gains of business or profession’, Explanation 3 to Section 40(b)(v)
did not refer to any head of income and instead mentioned ‘net profit as shown
in the profit and loss account’;

had the intention been to restrict the
deduction only to the profit computed under the head ‘profits and gains of
business or profession’, the expression used in Explanation (baa) to section
80HHC and section 33AB would have also found place in Explanation 3 to section
40(b).

that none of the sections 30 to 43D, of part
IV –D, provided for exclusion of any item of income because it did not fall
under the head of ‘profits and gains of business or profession’.

the reasons for making the computation
provisions of Chapter IV-D applicable for computing the book profit was only to
ensure that all deductions had been allowed, as otherwise an assessee might
compute the book profit at a higher figure and thereby claim a higher amount by
way of remuneration for the purpose of deduction.

the quantum of deduction in computing income
under the head ‘profits and gains of business or profession’ ought be computed
with reference to the income falling under all the heads of income, including
the head ‘income from other sources’.

the decision of the Supreme Court in case of
Apollo Tyres Ltd. vs. CIT, 255 ITR 273 confirmed that the decision as to
which item of income should be taken into account for computing the quantum of
deduction, depended upon the language of the statutory provision allowing the
deduction.

The Revenue, in
response, contended that the assessee himself had offered the receipts in
question under the head ‘income from other sources’; that from a plain reading
of section 40(b)(v) r.w. Explanation 3 thereto, it was manifestly clear that
the term ‘book profit’ meant only that net profit which was computed in the
manner laid down in Chapter IV-D of the Act, which chapter dealt only with the
profit and gains of business or profession, and did not include profits
chargeable under Chapter IV-F under the head ‘income from other sources’; that
in a taxing statue, the words of the statue were to be interpreted strictly;
that section 40(b)(v), Explanation 3 made it abundantly clear that the net
profit had to be computed in the manner laid down in Chapter IV-D and such
profit did not include profit referred to in Chapter IV-F of the Act.

The Calcutta
High Court, on due consideration of the rival contentions, held that chapter
IV-D nowhere provided that the method of accounting for the purpose of
ascertaining net profit should consider the income from business alone and not
from other sources; section 29 provided for the manner of computing the income
from profits and gains of business or profession which had to be done as
provided u/s. 30 to 43D; by virtue of section 5 of the said Act, the total
income of any previous year, included all income from whatever source derived;
for the purpose of section 40(b)(v) read with Explanation there could not be
separate method of accounting for ascertaining net profit and/or book-profit;
the said section nowhere provided that the net profit as shown in the profit
and loss account should be the profit computed under the head profits and gains
of business or profession, only.

The Calcutta
High Court, citing the following paragraphs from the decision of the Supreme
court in the case of Apollo Tyres Ltd.(supra) , observed that the said
decision provided for an appropriate guidance on the point as to what should be
done in order to ascertain the net profit in case of the nature before the
court.

“Sub-section
(1A) of section 115J does not empower the Assessing Officer to embark upon a
fresh inquiry in regard to the entries made in the books of account of the
company. The said sub-section, as a matter of fact, mandates the company to
maintain its account in accordance with the requirements of the Companies Act
which mandate, according to us, is bodily lifted from the Companies Act into
the Income-tax Act for the limited purpose of making the said account so
maintained as a basis for computing the company’s income for levy of
income-tax. Beyond that, we do not think that the said sub-section empowers the
authority under the Income-tax Act to probe into the accounts accepted by the
authorities under the Companies Act. If the statute mandates that income
prepared in accordance with the Companies Act shall be deemed income for the
purpose of section 115J of the Act, then it should be that income which is
acceptable to the authorities under the Companies Act. There cannot be two
incomes one for the purpose of the Companies Act and another for the purpose of
income-tax both maintained under the same Act. If the Legislature intended the
Assessing Officer to reassess the company’s income, then it would have stated
in section 115J that “income of the company as accepted by the Assessing
Officer”. In the absence of the same and on the language of section 115J,
it will have to held that view taken by the Tribunal is correct and the High
Court has erred in reversing the said view of the Tribunal.”

“The fact that it is shown under a
different head of income would not deprive the company of its benefit under
section 32AB so long as it is held that the investment in the units of the UTI
by the assessee-company is in the course of its “eligible business”.
Therefore, in our opinion, the dividend income earned by the assessee-company
from its investment in the UTI should be included in computing the profits of
eligible business under section 32AB of
the Act.”

Relying heavily
on the findings of the apex court, the Calcutta High Court held that once the
income from other sources was included in the profit and loss account, to
ascertain the net profit qua book-profit for computation of the
remuneration of the partners, the same could not be discarded for the purposes
of computing the deductible amount of remuneration to partners. The appeal of
the assessee firm was thus allowed and the orders of the lower authorities were
set aside.

ALLEN CAREER INSTITUTE’S CASE

Recently, the
issue again arose before the Rajasthan High Court in the case of CIT vs.
Allen Career Institute. 94 taxmann.com 157. In this case, the Rajasthan
High Court, admitting the Revenue’s appeals, framed the following substantial
questions of law:

“Whether
in the facts and circumstances of the case the ITAT is justified in considering
the interest as part of the book profit in contravention of Section 40(b) i.e
as per Section 40(b) the book profit has to be computed in the manner laid down
in Chapter-IV D?”

“Whether
the Tribunal was legally justified in deleting the disallowance of
Rs.2,30,00,796/- made on account of remuneration to partners by taking the
interest earned on FDRs as part of book profit and business income under
Section 28 specifically when it was “Income from other sources” and
contrary to Section 40(b), Explanation 3 and Section 40(b) (v) (2)?”

On behalf of
the Revenue it was contended that Chapter IV-D, consisting of section 28 to 44,
provided for computation of the income under the head profits and gains of
business or profession; that the investment in the FDRs was not made as a
business necessity, without which the business of the assessee could not be
run, and, in fact, the FDRs were made out of the surplus funds available with
the assessee, and the income from bank FDRs could not be said to be business
income and was to be treated as income from other sources.

On behalf of
the assessee, it was contended that the interest income from the FDRs, credited
to the profit & loss account, should not be excluded from the net profit
for the purposes of determining the quantum of deduction in respect of the
payment of remuneration to the partners while applying the provisions of
section 40(b). Reliance was placed on the decisions in the case of CIT vs.
J.J. Industries, 358 ITR 531 (Guj.) and Md. Serajuddin & Bros. vs.
CIT, (supra) and Apollo Tyres Ltd. vs. CIT(supra). In addition, the
decision in the case of CIT vs. Hycron India Ltd. 308 ITR 251 (Raj.),
was relied upon to contend that the expression “profits and gains” as
used in section 2(24), had a wider expression, and was not confined to
“profits and gains of business or profession”. Further, the language
of section 10B, again, provides for exemption, with respect to any
“profits and gains” derived by the assessee, and was not confined to
“profits and gains of business and profession” as provided u/s. IV-D.
That ‘profit’ was an elastic and ambiguous word, often properly used in more
than one sense; its meaning in a written instrument was governed by the
intention of the parties appearing therein, but any accurate definition thereof
must always include, the element of gain. The meaning of word “gain”
has been given as acquisition, and has no other meaning. Gain was something
obtained or acquired, and was not limited to pecuniary gain. The word
“profit”, as ordinarily used, means the gain made upon any business
or investment. “Profits” is capable of numerous constructions, and
for any given use, its meaning must be derived from the context. In addition,
it was contended that had the intention been to limit the scope of the term
‘profit’ to the income determined under the head profits and gains of business
or profession, then it would have been so done as was done in the case of
section 115J of the Act.

The Rajasthan
High Court rejected the contentions of the assesse made in support of inclusion
of the income from interest and other sources for the purposes of computing the
quantum of the deduction in respect of the remuneration paid to partners,
holding that the interest and other income taxable under the head ‘income from
other sources’ was not to form part of the book profits for the purposes of section
40(b) of the Act, and was therefore required to be excluded from the net profit
as per the profit & loss account.

OBSERVATIONS

Section 14
requires the total income to be classified into five different heads of income
for the purpose of charge of income tax. Subject to such classification, the
total income of an assessee remains unchanged. The charge of the tax is on the
total income of the firm, and is not changed on account of its classification
into different heads of income.

There are
several provisions in the Income Tax Act, for grant of relief or otherwise,
where the legislature has used such language that expressly refers to the
income computed under the head ‘profits and gains from business and
profession’. For example, the benefit of deduction u/s. 10B is not restricted
to the income computed under the head ‘profits and gains from business and
profession’ but is allowed in respect of the ‘profits and gains’. Again,
section 115JB deals with the profit and loss account of an assessee in its entirety,
and covers the profit of the company as shown by the profit and loss account,
without restricting the same to the income of business. Explanation 3 also
employs a similar terminology while defining the term “book-profit” to mean the
net profit as shown in the profit and loss account for the relevant previous
year. In contrast, the provisions of section 33AB and section 80 HHC restrict
the relief to profits computed under the head ‘profits and gains of business or
profession’.

The use of the
words “computed in the manner laid down in Chapter IV-D” in Explanation
3 that follows the words ‘net profit, as per profit & loss account for
the relevant previous year’ may not presently change the amount of net
profit for the following reasons;

Unlike adjustments to book-profit required
to be made u/s. 115JB for MAT, no specific guidelines are provided in section
40(b) for adjusting the net profit. Reference may also be made to provisions of
section 33AB and section 80HHC, which expressly provide for restricting the
relief to profits computed under the head ‘profits and gains of business or
profession’ .

Chapter IV-D by itself cannot be considered
to provide any help in the matter of computation of book profit. Any attempt to
compute the book profit by applying all and sundry provisions of Chapter IV-D
would lead to a “book-profit” that would be devoid of any reality and may
result in allowing remuneration in excess of even the net profit of the firm.

Explanation 3 requires the net profit to be
increased by the amount of remuneration paid to partners of the firm. This
specific requirement is an example of an adjustment expressly provided by the
legislature to the net profit for quantification of the remuneration payable.

Needless to say that any attempt to exclude
certain receipts from net profit will have to be followed by the exclusion of
the expenditure incurred for earning such income. Such an exercise may be
extremely difficult and if attempted, may reflect inaccurate results.

None of the provisions for allowing deduction u/s.
30 to 43D of Chapter IV-D contains a provision that restricts the deduction
thereunder to the profits computed under the head ‘profits and gains of
business or profession’. There cannot be a separate method of accounting for
ascertaining net profit/book-profit and therefore, any income, if credited to
profit and loss account, should be eligible to be classified as book profit.

Ordinarily
unless otherwise provided, an income, even though computed under the different
heads of income, would not cease to be the income of the business more so where
the objective of the assessee such as a firm or company is to carry on business
for the entity.

The issue under
consideration has also been addressed by the Gujarat High Court in the case of CIT
vs. J.J.Industries, (supra), wherein the court allowed the deduction of
remuneration to partners calculated on net profit that included receipts of
interest and a few other items taxed under the head ‘ income from other
sources’.

The term
“profits and gains” used in section 2(24), clause(i) is wide enough to include
all the receipts of an assessee firm, and its scope need not be restricted to
the ‘profits and gains of business or profession’. Profit is an ambivalent and
multi-faceted term which connotes different meanings at different times and in
different contexts. The Supreme Court, in the case of Apollo Tyres Ltd.
(supra), clarified that the true meaning of the ‘profit’ should be gathered
with reference to the intention of the legislature in enacting the particular
provision. Any attempt to ascribe a general and all purpose meaning to the term
“profit” should be avoided and only such a meaning that fits into the context
should be supplied. The Rajasthan high court in fact, in the case of Hycron
India Ltd (supra), in a different context, has held that the term ‘profits
and gains’ need not necessarily be confined to ‘profits and gains of business
or profession’.

Attention is
invited to the decisions of the Jaipur bench of the tribunal in the case of S.P.
Equipment & Services 36 SOT 325, and Allen Career Institution 37 DTR 379
and the Madras High Court in the case of Sri Venkateshwara Photo Studio,
33 taxmann.com 360 and the Rajkot Bench in the case of Sheth
Brothers, 99 TTJ189 and the Mumbai Bench in the case of Suresh A. Shroff &
Co., 27 taxmann.com 291, all of which have held that, for the purpose of
computing the deduction for payment of remuneration to partners in the hands of
the firm, the items of income credited to the profit & loss account should
not be excluded, even where such items have otherwise been taxed under the head
‘income from other sources’.

The better view
therefore is the one propounded by the Calcutta & the Gujarat High Courts
that takes into consideration the larger meaning of the ‘profits & gains’
which fits into the context of section 40(b) and takes into consideration the
method of accounting employed by the firm for determining the net profit of the
firm.

The case for
inclusion of interest and such other receipts in the book profit is stronger in
cases where such receipts have been taxed under the head ‘profits and gains of
business or profession’. In such cases, there should not be any opposition from
the AO, who has otherwise accepted the character of such receipts as a business
income and assessed and brought to tax such receipts under the head ‘profits
and gains from business and profession’.

There is no
leakage or very little leakage of revenue in the whole exercise, in as much as
what is allowed in the hands of the firm is taxed in the hands of the partners.
Further what is disallowed in the hands of the firm is to be excluded from the
income of the partners. All of this is made clear by the express provisions of section28(v) of the Act.

shailesh.kwebmaker

BOOK PROFIT – WHETHER ADJUSTMENT REQUIRED FOR SHARE OF LOSS FROM PARTNERSHIP FIRM?

Issue for consideration

U/s. 115JB
of the Income Tax Act, 1961, a company is required to computateits book profits
and pay the Minimum Alternate Tax at 18.5% of such book profits. Explanation 1
to section 115JB provides that the term “book profit” means the ‘profit’ as
shown in the statement of profit and loss for the relevant previous year
prepared under s/s. (2), as increased or reduced by certain items specified
therein. One of the items of reduction contained in clause (ii) is –

(ii) – the
amount of income to which any of the provisions of section 10 (other than the
provisions contained in clause (38) thereof) or section 11 or section 12 apply,
if any such amount is credited to the statement of profit and loss.

There is
also a corresponding item of addition contained in clause (f) of the
explanation, which reads as under –

(f) the
amount or amounts of expenditure relatable to any income to which section 10
(other than the provisions contained in clause (38) thereof) or section 11 or
section 12 apply;

Section
10(2A) provides for an exemption in the case of a partner of a firm which is
separately assessed as such. The exemption is as under:

“in the
case of a person being a partner of firm which is separately assessed as such,
his share in the total income of the firm.

Explanation:
For the purposes of this clause, the share of a partner in the total income of
a firm separately assessed as such shall, notwithstanding anything contained in
any other law, be an amount which bears to the total income of the firm the
same proportion as the amount of share in the profits of the firm in accordance
with the partnership deed bears to such profits;

Therefore,
where a company is a partner in a partnership firm, which is taxed separately
as a partnership firm, and the company is entitled to a share of profits of the
partnership firm, such share of profit that the company is entitled to, is not
only exempt u/s. 10(2A) from income tax, but is also to be excluded from the
book profit, by reducing such share of profit credited to the statement of
profit and loss under Explanation 1(ii) of section 115JB and in so computing
any expenditure, incurred for earning such share of profit, is required to be
added back while computing the book profit.

The issue
has arisen before the Income tax Appellate Tribunal as to whether, in a case
where the share of the company in the income of the firm is a ‘loss’ which has
been debited to the statement of profit and loss of the company, whether such
loss is required to be added to the book profit of the company , in the same
manner as the share of profit is reduced from the profit as per the statement
of profit and loss. While the Chennai bench of the Tribunal has taken a view
that such share of loss from the partnership firm is to be added back while computing
the book profit, the Mumbai and Kolkata benches have taken the view that such
share of loss is not required to be added back while computing the book profit.

Metro Exporters Ltd’s case

The issue
first came up before the Mumbai bench of the tribunal in the case of DCIT
vs. Metro Exporters Ltd 10
SOT 647.

In this
case, relating to assessment year 1997-98, the provision then applicable was
section 115JA, which was almost identical to section 115JB in respect of the
issue under consideration. It provided for a reduction from the net profit as
shown in the profit and loss account for the relevant previous year of the
amount of income to which any of the provisions of Chapter III applied, if any
such amount was credited to the profit and loss account.

The assessee had debited its share of loss of Rs. 46.94 lakh from a
partnership firm to its profit and loss account. In the initial assessment, the
assessee’s computation of book profits, wherein it had not added back such
share of loss to the book profits, was accepted by the AO. However,
subsequently, reassessment proceedings were initiated u/s. 148 on the ground
that the income chargeable to tax was under assessed by way of omission to
increase the book profit by the share of loss in the partnership firm amounting
to Rs. 46.94 lakh debited to profit and loss account while computing the book
profit as per provisions of section
115 JA. Such share of loss was added to book profits by the AO in the
reassessment proceedings.

In first
appeal, the Commissioner(Appeals) deleted the addition made in the reassessment
proceedings, holding the reassessment proceedings as not being in accordance
with law, besides holding that the addition of Rs. 46.94 lakh of share of loss
from partnership firm could not be made to the book profits.

Before the
Tribunal, the Department contested both aspects – the decision against validity
of the reassessment proceedings, as well as the merits of the addition made to
book profits. Before the Tribunal, it was argued on behalf of the Department
that sub-clause (f) of the Explanation to section 115 JA, provided that for the
purposes of the section, the profit meant the net profit as shown in the profit
and loss account for the relevant previous year prepared under s/s. (2) as
increased by the amount or amounts of expenditure relatable to any income to
which any of the provisions of Chapter III applied and that the sub-clause
applied in the case of the assessee. It was further argued that the word
‘income’ included ‘loss’ also, and therefore sub-clause (ii) to Explanation to
section 115JA applied to the assessee.

On behalf
of the assessee, it was submitted that the addition was wrongly made as Chapter
XII-B was a special provision relating to certain companies, and therefore had
to be strictly construed. It was submitted that the proposition that the word
‘income’ included ‘loss’ was not applicable to assessment framed under Chapter
XII-B of the Act. Further, it was argued that the ‘loss’ was not an
‘expenditure’, and therefore did not fall within the purview of sub-clause (f)
to Explanation to section 115 JA. It was further submitted that sub-clause (ii)
to the Explanation to section 115 JA applied only “if any such amount is
credited to the profit and loss account”. In the case of the assessee, the
share of loss from the partnership firm was not credited to the profit and loss
account, but was debited to the profit and loss account, and therefore
sub-clause (ii) also did not apply to the case of the assessee.

The
Tribunal noted that the assessee had debited its share of loss from the
partnership firm to its profit and loss account. It observed that the
provisions of Chapter XII-B were special provisions relating to assessment of
certain companies, whereby the income of certain companies chargeable to tax
for the relevant previous year was deemed to be an amount equal to 30% of such
book profit. Being special provisions applicable to certain companies,
according to the Tribunal, they had to be strictly applied. The income of the
assessee had to be computed in accordance with book profit of the assessee, and
the working of the book profit had to be made as per the provisions of Chapter
XII-B.

The
Tribunal held that the proposition that the word “income” included “loss” was
not applicable while computing the profit in accordance with the provisions of
Chapter XII-B. The Tribunal further found that the provisions of sub-clause (f)
of the Explanation to section 115 JA applied to the amounts of “expenditure”
relatable to any income to which any of the provisions of Chapter III applied.
According to the Tribunal, the share of loss from a partnership firm was not
synonymous with the word “expenditure” used in that sub-clause.

The
Tribunal further noted that sub-clause (ii) of the Explanation to section 115
JA applied to income to which chapter III applied, if such amount was credited
to the profit and loss account of the assessee. In the case before it, the
tribunal noted that the share of the assessee from the partnership firm was
loss, and was therefore debited to the profit and loss account of the assessee,
and could not have been credited to the profit and loss account of the
assessee. Since it was not a case of share of profit from a firm credited to
the profit and loss account of the assessee, the tribunal held that no addition
for the purpose of computation of the book profit under section 115 JA could be
made with regard to share of loss of the assessee from a partnership firm.

The ratio
of this decision of the Mumbai bench of the Tribunal has been appllied by the
Kolkata bench of the Tribunal in the case of CD Equifinance Pvt Ltd vs.
DCIT, ITA No 577/Kol/2016 dated 9.2.2018 in the context of section 115JB
for Assessment Year 2012-13.

Fixit (P) Ltd’s case

The issue
again came up before the Chennai bench of the Tribunal in the case of DCIT
vs. Fixit (P) Ltd 95 taxmann.com 188.

In this
case,the assessee was a partner in two partnership firms, and its share of loss
from the two firms was Rs. 2,11,346 and Rs. 68,564, respectively. Such share of
loss was debited to the profit &loss account of the assessee, but was not
added back by the assessee to the net profit while computing book profit u/s.
115JB.

The
Assessing Officer was of the opinion that share income from a firm being exempt
under Chapter III, even if such share was a loss, it had to be added back for
computing the profit u/s. 115 JB. He therefore added the share of loss of the
two firms to the profits as per the profit & loss account and computed the
book profit for the purpose of levying tax u/s. 115 JB accordingly.

The
Commissioner (Appeals) decided the first appeal in favour of the assessee, on
the ground that the Explanation to section 115 JB spelt out the additions that
could be made to the profits shown in the audited profit & loss account.
Share of loss from a partnership firm could not be considered as an expenditure
relatable to exempt income, and therefore though such share of loss was debited
to the profit &loss account, such share of loss could not be added back
while computing the book profit u/s. 115 JB.

Before the
Tribunal, on behalf of the Department, it was argued that clause (ii) of the
Explanation to section
115JB clearly mandated deduction of any income to which any of the provisions
of section 10 applied, if such amount was credited to the profit & loss
account. It was argued that loss incurred by a firm was carried forward in the
hands of such firm. When share of profits from firms were to be reduced, loss,
being a negative income, had to be added back to profits shown in the profit
&loss account. That would be equivalent to an addition.

The
Tribunal analysed the provisions of section115 JB, in particular the
Explanation to that section. It also analysed the provisions of section 10
(2A). According to the Tribunal, what was excluded from the total income by
section 10 (2A) was the share of the partner in the total income of the firm.
Since share of loss in the firm was not an expenditure relatable to any exempt
income, in the opinion of the Tribunal, clause (f) of the explanation did not
apply.

However,
according to the Tribunal, it was clause (ii) of the Explanation which was
applicable. That was on account of the fact that in the opinion of the
Tribunal, share of loss was nothing but share of negative income. Clause (ii)
of the Explanation mandated reduction of income to which section 10 applied, if
such income was credited in the profit & loss account. According to the
Tribunal, when share of income from a firm was exempt and required to be
excluded u/s. 10 (2A), necessarily the share of loss was also to be excluded.
In the view of the Tribunal, what the assessing officer had done was that by
adding the loss from the two firms to the profits, he was effectively reducing
the negative profit, since loss was nothing but negative profit.

The
Tribunal therefore upheld the addition made by the assessing officer of share
of loss from the partnership firms to the book profit of the assessee.

Observations

The
controversy surrounds adjudicating upon two important facets; whether a ‘loss’
could be termed as an ‘expenditure’ and be added back to the book profit and
whether the right to reduce an ‘income’ from the book profit would oblige a
company to add back its losses. In effect, both the Mumbai and the Chennai
benches of the Tribunal have accepted the position that the provisions of
clause (f) to section 115 JB, providing for add back of the expenditure, do not
apply to the share of loss from a partnership firm, since such loss is not an expenditure
in relation to exempt income. Therefore, there is no dispute on the first
aspect of the controversy.

The
dispute is only as to whether clause (ii) of the Explanation to section 115JB
applies so as to require the company to exclude the loss in computing the book
profit or add back the loss, otherwise debited to the profit & loss
account, to the book profit. That Explanation applies to “amount of income
to which any of the provisions of section 10 apply”. The issue therefore
revolves around whether the proposition that “income” includes loss would apply
in this case i.

The
provisions of Chapter XII-B are special provisions that carry a fiction for
taxing an artificially computed income termed as book profit which is far
detached from the income or the real income on which tax is payable under the
original scheme of taxation of the Act. Computing the book profit is a
convoluted exercise that is removed from the concept of income and seeks to tax
an income that can in no sense be termed as an income. In the circumstances, it
is a futile exercise to apply the understanding otherwise derived in
interpreting the main provisions of the Act that deal with the income or the
real income.In the context of the income taxation, which seeks to tax the real
income of a person, It is true that the term ‘income’ includes ‘loss’ but it is
equally true to restrict the application of such an understanding to such an
income and not extend it to artificial income or fictional income. The Supreme
Court in J.H. Gotla’s case, 156 ITR 323 laid down the law while
explaining the ordinary concept of income to hold that it includes loss, as
well. Application of this analogy to an artificially conceived income should be
avoided at all costs.

There are
however two more arguments in favour of the proposition that such share of loss
is not to be added back in computing the book profits. The first is that the
share of loss is not credited to the profit and loss account, as required by
clause (ii), but is debited to the profit and loss account. Besides clause (ii)
falls under the items to be deducted while computing book profits, and not
under the additions to be made while computing book profits.

Secondly,
one may draw support from the decision of the Mumbai bench of the Tribunal in
the case of Raptakos Brett & Co Ltd 69 SOT 383 in the context
of exemption of capital losses on sale of listed shares u/s. 10(38). In that
case, while holding that only gains arising from the transfer of a long term
listed equity share was exempt, and not loss, the Tribunal interpreted the term
“income arising from the transfer of a long term capital asset”. It drew a
distinction between a situation where an entire source of income was exempt,
and a situation where only certain types of income from a source were exempt.
According to the Tribunal, if the entire source is exempt or is considered as
not to be included while computing the total income, then, in such a case, the
profit or loss resulting from such a source does not enter into the computation
at all. However, if a part of the source is exempt by virtue of particular
provision of the Act for providing benefit to the assessee, it cannot be held
that the entire source will not enter into the computation of total income.
According to the Tribunal, the concept of income including loss applies only
when the entire source is exempt, and not in the cases, where only one
particular stream of income falling within a source is falling within the
exemption provisions.

In the
case of a partner of a partnership firm, the partnership firm is the source of
income. Remuneration and interest from the partnership firm are taxable, with
only share of profit from the partnership firm being exempt from tax.
Therefore, only one stream of income from the source is exempt. That being the
case, following the rationale of Raptakos Brett’s decision, “income”
would not include loss, and share of profit would not include share of loss.
Therefore, the share of loss from a partnership firm, though may be covered by
section 10(2A), is not an income for the purposes of clause(ii) of section
115JB , and is further not credited to the profit and loss account. That being
the case, it is not required to be added back while computing book profits.

The better
view seems to be that no adjustment to the net profit is required to be made in
respect of the amount of share in loss debited to the statement of profit &
loss of the company while computing book
profit u/s. 115JB.

shailesh.kwebmaker

Scope of The Definition of The Term ‘Interest’ – Section 2(28a)

Issue for Consideration

The term ‘interest’ has been defined in section 2(28A) of the Income
tax Act as under:

“interest” means interest payable in
any manner in respect of any moneys borrowed or debt incurred (including a
deposit, claim or other similar right or obligation) and includes any service
fee or other charge in respect of the moneys borrowed or debt incurred or in
respect of any credit facility which has not been utilised.

The term has been exhaustively defined and in its scope it includes the
service fee or other charges in respect of the borrowings, debts and even
unutilized credit facilities. It not only includes interest, as understood
generally, which is payable on any kind of borrowing or debt, but also includes
payment on a deposit, claim or other similar right or obligation. This
extensive definition of ‘interest’ has been a subject matter of controversy,
more particularly from the point of view of the applicability of section 194A
to various types of payments for deduction of tax at source.

By applying the extensive definition, the Madras High Court considered
the payment of guaranteed return at a particular percentage to the investors,
under an investment scheme, to be an ‘interest’, though not captioned as
interest otherwise by the parties. On the other hand, the Calcutta High Court
took a view that the payment of an amount due to delay in delivering the plots,
though termed as interest in the letter of allotment, did not fall within the
ambit of the definition of ‘interest’. Though the facts of the cases before the
Madras High Court and the Calcutta High Court were materially different, the
issue arising therefrom was similar i.e. when does a payment made in respect of
a particular ‘obligation’ constitute interest.

Viswapriya Financial Services & Securities Ltd.’s case:

The issue regarding the interpretation of the definition of the term
‘interest’ first came up, before the Madras High Court, in the case of Viswapriya
Financial Services & Securities Ltd. vs. CIT 258 ITR 496.

In this case, the assessee had floated an innovative scheme of
investment which enabled individual investors to entrust their funds for
management to the assessee, with a guarantee from the assessee that it would so
manage the funds as to ensure a minimum return of 1.5 percent per month to the
investor. The salient features of the scheme operated by the assessee were as
follows:

– The offer memorandum was issued inviting the
investors to contribute and to entrust their money to the assessee for what had
been referred to as fund management. The offer memorandum formed the contract
between the investors and the assessee for the management on the investors’
behalf of the funds provided by the investors under the memorandum for
deployment in any investment.

– The investor, under that memorandum, was to
pay the amount to the assessee by cheques or drafts drawn in the name of
“Viswapriya Funds Management Account-Bank Guaranteed Investments”.
The investors’ money were not made part of the funds of the assessee-company’s
accounts but were kept in a separate account.

– A firm of chartered accountants had
been appointed to function as fiduciary and custodian of the scheme and the
accounts of that fund were also separately audited.

– The investments made in the course of the
management were fully secured and were backed by bank guarantees. However, the
money entrusted under the scheme was to be managed by the assessee, and the
investor was not required to be informed as to the specific investments made
from the fund and the particular investment in which the investor’s amount was
utilised.

– The investors were assured a guaranteed
return of 1.5 percent per month of the amount invested.

– The assessee was entitled to a management
fee of 6 percent per annum from all the funds invested on behalf of the
investors, but with a condition to forgo a part of that management fee if the
returns on the investment were insufficient to ensure the stipulated distribution
at the rate of 1.5 percent per month to the investors.

– If the return from the investments was in
excess of the amount of management fee and the minimum guaranteed return for
the investor, the assessee would become entitled to a performance incentive of
10 percent of such excess.

– The investor had been promised the return of
his investment at the end of the agreed period of three years.

– The investment made by the investor was
transferable. It was possible to be assigned or pledged with prior intimation
to the assessee. In the event of the death of the investor, the amount was to
be transferred to his nominee, if any, and in the absence of nomination, to his
legal heirs.

In the backdrop of these facts, for the assessment years 1993-94 and
1994-95, the assessing officer had passed an order u/s. 201(1) holding that the
assessee was liable to deduct tax at source u/s. 194A on the payments made to
the investors. The Tribunal upheld the order of the assessing officer and held
that the money received by the assessee from the investors created an
‘obligation’ and that the return on that investment at the guaranteed minimum
payment of 1.5 percent per month was covered by the definition of ‘interest’ as
provided in section 2(28A).

Before the High Court, on behalf of the assessee, it was submitted that
the income received by the assessee from the investments made by it did not
attract the liability for deduction of tax at source. Therefore, when the
amounts were distributed among the investors, no tax was deducted at source, as
the returns of the investments made from the fund were received by the
fiduciary and the custodian. It was also submitted that the scheme did not
bring about a relationship of debtor and creditor or borrower and lender and,
therefore, the definition of ‘interest’ in section 2(28A) did not apply to the
facts of the scheme.

The High Court held that the definition of interest, after referring to
the interest payable in any manner in respect of any money borrowed or debt
incurred, included the deposits, claims
and ‘other similar right or obligation’ and observed that the statutory
definition included amounts which might not otherwise be regarded as interest
for the purpose of the statute. Even amounts payable in transactions where
money had not been borrowed and debt had not been incurred were brought within
the scope of the definition, as in the case of a service fee paid in respect of
a credit facility which had not been utilised. Even in cases where there was no
relationship of debtor and creditor or borrower and lender, if payment was made
in any manner in respect of any money received as deposits or on money claims
or rights or obligations incurred in relation to money, such payment was, by
the statutory definition, regarded as interest.

The scheme operated by the assessee imposed an obligation on the
assessee to repay the investor at the end of the period of 36 months, and also
to ensure a monthly payment of 1.5 percent to the investor during that period.
This obligation to repay, in the opinion of the High Court, was an obligation
akin to a claim or a deposit, to which reference was made in the definition of
interest. The payment made by the assessee being a payment made in respect of
an obligation incurred under the terms of the offer memorandum, was regarded as
interest falling within the scope of section 2(28A). The fact that the assessee
did not choose to characterise such payment as interest was not considered as
relevant by the High Court.

West
Bengal Housing Infrastructure Development Corpn. Ltd.’s case

The issue of the interpretation of the definition of the term
‘interest’, in the contest of section 194A, again came up before the Calcutta
High Court in the case of Pr. CIT vs. West Bengal Housing Infrastructure
Development Corpn. Ltd. 96 taxmann.com 610.

The assessee was a
company engaged in the business of development of land, housing and
infrastructural facilities in New Town Projects, Kolkata. For assessment year
2005-06, it claimed a deduction of expenditure amounting to ` 9,71,17,977 which was in the nature of compensation for delay in
delivery of plots. As per the offer for allotment of plot of land developed by
the assessee, the assessee was under an obligation to hand over physical
possession of the plot to the allottees on payment of the entire cost of the
land and registration of sale deed.

If possession of
the plot was delayed for more than six months from the scheduled date of
possession, the assessee had to pay interest on installments already paid by
the allottee during such extended period, at the prevailing fixed term deposit
rates, for similar period offered by the State Bank of India. According to the
assessee, although the relevant clause of the allotment letter used the
expression “interest”, the actual nature of payment was in the nature
of damages for delayed allotment of a plot and not in the nature of interest.

Rejecting the explanation of the assessee, the assessing officer viewed
the payment to be in the nature of interest, and disallowed the expenditure
claimed by the assessee u/s. 40(a)(ia), on account of the failure of the
assessee to deduct tax at source u/s.194A. The CIT (A) confirmed the order of
the assessing officer. Upon further appeal, the Tribunal held that the amount
in question could not be characterised as interest within the meaning of
section 194A, and hence there was no obligation on the part of the assessee to
deduct tax at source. Accordingly, it deleted the disallowance made by the
assessing officer and confirmed by the CIT(A).

Before the High Court, on behalf of the revenue, it was argued that the
amount in question was covered by the definition of interest as provided in
section 2(28A). Reliance was placed on the decision of the Madras High Court in
the case of Viswapriya Financial Services & Securities Ltd. (supra). Reliance
was also placed on the decision in the case of CIT vs. Dr. Sham Lal Narula
50 ITR 513 (Punj), for the proposition that the amount paid in lieu of
delayed payment of compensation to which a person was entitled on the
acquisition of his land was in the nature of interest¹.

On behalf of the
assessee, it was argued that the amount payable by the assessee on account of
delay in delivering the plots was not interest within the meaning of section
2(28A), since the contract, in the instant case, was for sale of land by the
assessee to the allottee; the assessee did not borrow any money or incur any
debt; and no money was due by the assessee to the allottee. There was no
debtor-creditor relationship between the parties. The ‘right’ must be to a sum
of money and the ‘obligation’ must also be in respect of a sum of money. The
right of an allottee to obtain possession of land and the obligation of the
assessee to deliver possession therefore did not fall within the purview of the
definition. Reliance was also placed on the decision of the Himachal Pradesh
High Court in the case of CIT vs. H.P. Housing Board 340 ITR 388
wherein, on an almost identical set of facts, it was held that the amount paid
by the assessee (H.P. Housing Board, in that case) was not payment of interest,
but payment of damages to compensate the allottee for the delay in the
construction of his house and the harassment caused to him.

Additionally, the assessee also contended that taxing statutes must be
strictly construed and any doubt must be construed against the taxing
authorities and in favour of the taxpayer.

As far as the definition of ‘interest’ was concerned, the High Court
held that the term ‘interest’ had been made entirely relatable to money
borrowed or debt incurred, and various gradations of rights and obligations
arising from either of the two. The parenthesis in the section was in the
nature of a qualification of the borrowing of money/incurring of debt and what
it included.

On the facts of the case, the High Court held that the payment made by
the assessee to the allottee was in terms of the agreement entered between
them, where the liability of the assessee would arise only if it failed to make
the plots available within the stipulated time. Hence, the payment made under
the relevant clause of the letter of allotment was purely contractual and in
the nature of compensation or damages for the loss caused to the allottee in
the interregnum for being unable to utilise or possess the flat. It had the
flavour of compensation and the expression ‘interest’ used in the concerned
clause might be seen merely as a quantification of the liability of the
assessee in terms of the percentage of interest payable by the State Bank of
India. Since there was neither any borrowing of money nor incurring of debt on
the part of the assessee, it was held that the interest as defined u/s. 2(28A)
had no application to such payments.

__________________________________________________

1 Though the
revenue relied upon this decision and claimed that such amount paid in lieu of
delayed payment of compensation was regarded as interest, the High Court in
that case refrained itself from dealing with the question as to whether the
said amount was “interest” or “compensation”. The High Court in that case had
considered the essence of the transaction more than the nomenclature and dealt
with the issue as to whether the said amount was a “capital receipt” or
“revenue receipt”.

While holding so, the High Court preferred to rely upon the decision of
the Himachal Pradesh High Court in the case of H.P. Housing Board (supra) over
the decision of the Madras High Court in the case of Viswapriya Financial
Services & Securities Ltd (supra).

Observations

From the features of the scheme operated in Viswapriya’s case as
presented before the High Court, it appears that the scheme was similar to the
portfolio management scheme. In the case of portfolio management scheme, the
fund manager invests the funds of the investors and the gains generated by it
accrue to the investors. The fund manager receives the management fees for
managing the portfolio.

In Viswapriya’s case, the assessee had guaranteed a minimum
return with the condition that its management fees would get reduced to the extent
it failed to provide the guaranteed return. Therefore, as per the facts as
presented before the High Court, the only consequence of inability to provide
the guaranteed return was forgoing of the management fee to the extent of
shortfall and nothing more. Had it been the obligation of the assessee to
compensate the shortfall out of its own capital, then perhaps the view taken by
the High Court would have been justified.

In a similar case of chit funds, where the funds belong to the
contributors, various High Courts have taken a view that the bid discount and
dividend to contributors does not amount to interest. The logic is that bid
amount which is distributed among all the subscribers/members is not in respect
of any money borrowed by the chit fund company or any debt incurred by it.

Reference may be made to the following decisions in this regard:

CIT vs. Sahib Chits (Delhi) Pvt Ltd 328 ITR 342
(Del)

CIT vs. Avenue Super Chits (P) Ltd 375 ITR 76
(Kar)

CIT vs. Panchajanya Chits (P) Ltd 232 Taxman 592
(Kar)

The similar logic should have applied equally in Viswapriya’s
case. It appears that these cases have not been cited before the Madras High
Court nor the distinction between the interest, a definite liability, and the
return of gain to the one on whose behalf it was earned has been appropriately
highlighted.

A careful analysis of the definition of ‘interest’ as provided in
section 2(28A) reveals that, in order that a particular payment is regarded as
‘interest’ the following conditions should be satisfied –

1. The payment should be
interest, service fee or other charge.

2. It should be in respect of any
money borrowed or debt incurred including a deposit, claim or other similar
right or obligation and credit facility which has not been utilised.

3. It is payable in any manner.

Not all payments can be considered as ‘interest’, unless the payment
can be termed as the interest, service fee or other charge. The legislature in
its wisdom has used the words “interest” and not just “any amount”.
Therefore, an amount paid, which is not an interest in form and in substance,
cannot be brought into the definition of the term to deem it as interest. The
very fact that the definition, in its second limb, has specifically included
‘any service fee or other charge’ within its scope suggests that the ‘interest’
in its extended meaning includes service fee and other charge and nothing else.
If the first limb was capable of including any type of payment within its
scope, which is in respect of money borrowed or debt incurred, then the second
limb would become otiose. Such an interpretation is against the basic rule of
harmonious construction, whereby an interpretation which reduces one of the
provisions to a dead letter should be avoided. In short, unless the payment can
be classified as an ‘interest’ in its ordinary meaning of the term, it would
not be termed as ‘interest’ u/s. 2(28A) unless of course, the payment
represents the service fee or charge of the specified kind.

In the case of Viswapriya Financial Services & Securities Ltd.,
the amount paid by the assessee under the investment scheme floated by it can
also not be characteriSed as interest as per its general meaning. Interest is
something which is paid from one’s own income or capital. In the kind of
investment scheme operated by the assessee, the money was received from the
investors and retained by it in its fiduciary capacity. The assessee did not
become the owner of that money. The accumulated money was invested by the assessee
on behalf of the investors and the return earned by investing such money had
been distributed back to the investors who were entitled to it.

The Madras High Court was also swayed by the fact that the assessee had
guaranteed a certain percentage of return on investment made by the investors.
However, there may be several such arrangements under which the minimum return
has been guaranteed. For instance, a builder may assure a guaranteed repurchase
price to the investors. A life insurance policy may also have a minimum sum
assured on maturity to the policyholder. The differential amount in such cases
cannot be considered as an ‘interest’ merely because there is an obligation to
pay the amount with a pre-determined rate of return.

In the context of the certificates of deposit and the commercial paper
which are issued at a discount, the CBDT vide its Circular No. 647 dated
22-3-1993 has clarified that the difference between the issue price and the
face value is to be treated as ‘discount allowed’ and not as ‘interest paid’
and, therefore, the provisions of section 194A are not applicable to it. Thus,
the payment, even though in respect of the borrowing, has not been treated as
interest, as it is understood to be the discount and not the interest.

Guidance can be obtained from the decision of the High Court of Punjab
in the case of CIT vs. Sham Lal Nerula 50 ITR 513² for
understanding the general meaning of interest as quoted below:

“Interest” in general terms is the return or compensation
for the use or retention by one person of a sum of money belonging to or owed
to another. In its narrow sense, “interest” is understood to mean the
amount which one has contracted to pay for use of borrowed money.
“Interest” in this sense may be placed broadly in three categories.
The first kind is interest fixed by the parties to the bargain or contract,
that is, “interest'” ex pacto or ex contractu. The second kind of
“interest” is conventional interest, determined by the accepted
usage, prevalent in a trade or a mercantile community. This is also called ex
mora. In the third category may be placed the legal interest allowed by law or
where the court is empowered by the statute to grant interest generally or at a
fixed rate, that is, ex lege.

_______________________________________________

2 This decision is pertaining to the assessment
years prior to 1-6-1976 the date from which the definition of the term
‘interest’ was inserted in the Act.

The High Court of Punjab relied upon the decision of the House of Lords
in Westminster Bank Ltd. vs. Riches [1947] A.C. 390 / 28 Tax Cas. 159.
It was a case where a decree was passed against the Westminster Bank for £
36,255 as representing a debt due to Riches. In the exercise of its statutory
powers, the court also awarded a further sum of £ 10,028 as representing
interest due on the debt from the date when the cause of action arose. The
issue before the House of Lords was whether the additional sum of £ 10,028 was
taxable, being in the nature of income. The appellant contended that the
additional sum of £ 10,028, though awarded under a power to add interest to the
amount of the debt, and though called interest in the judgment, was not really
interest attracting income tax, but was damages.

In this context, Lord Wright observed:

“The appellant’s contention is in any case
artificial and is, in my opinion, erroneous, because the essence of interest is
that it is a payment which becomes due because the creditor has not had his
money at the due date. It may be regarded either as representing the profit he
might have made if he had had the use of the money, or conversely the loss he
suffered because he had not that use. The general idea is that he is entitled to
compensation for the deprivation. From that point of view it would seem
immaterial whether the money was due to him under a contract express or
implied, or a statute, or whether the money was due for any other reason in
law. In either case the money was due to him and was not paid or, in other
words, was with-held from him by the debtor after the time when payment should
have been made, in breach of his legal rights, and interest was a compensation,
whether the compensation was liquidated under an agreement or statute, as for
instance under section 57 of the Bills of Exchange Act, 1882, or was
unliquidated and claimable under the Act as in the present case. The essential
quality of the claim for compensation is the same, and the compensation is
properly described as interest.”

Though interest has been interpreted as including the damages or
compensation for deprivation in the aforesaid decision, it may not be true in
every case, in view of the subsequent insertion of the specific definition in
the Act. As per the definition, the interest should be one which is payable in
respect of –

– any moneys borrowed

– debt incurred

– deposit

– claim

– other similar right or obligation

– Credit facility, utilised or not.

Something which is not payable in respect of any of the above, cannot
be regarded as interest for the purpose of the Act, though can be regarded or
called as interest otherwise as per the principles laid down in the aforesaid
decisions.

The first item in the above list is borrowing of money, which is simple
to understand, and there cannot be any debate with regard to it. The second
item refers to the ‘debt incurred’ and the term ‘debt’, though not defined
further in this section, has been defined in section 94B as follows:

“debt” means any loan, financial instrument,
finance lease, financial derivative, or any arrangement that gives rise to
interest, discounts or other finance charges that are deductible in the
computation of income chargeable under the head “Profits and gains of
business or profession”.

The term ‘deposit’ is defined in section 269T as follows:

“loan or deposit” means any loan or
deposit of money which is repayable after notice or repayable after a period
and, in the case of a person other than a company, includes loan or deposit of
any nature.

Though both the above definitions have limited applicability to the
relevant Sections, it will have a persuasive value in order to understand their
meaning in the context of the definition of the term ‘interest’.

It can be seen that the common feature of all of the above items is
that there should be an involvement of money. As far as the borrowing is
concerned, the reference to ‘any moneys’ makes it clear that it cannot include
borrowing of non-monetary assets, for instance, borrowing of securities under
Securities Lending and Borrowing Scheme. As far as incurring of debt is
concerned, it can be a monetary debt or even a non-monetary debt. However, in
the context of this definition and considering the other preceding and
succeeding terms, it should be read in the narrow sense by applying the
principles laid down by the Supreme Court in the case of CIT vs. Bharti
Cellular Ltd. 330 ITR 239. In this case, the words “technical
services” have been interpreted in the narrower sense by applying the rule
of Noscitur a sociis, because the words “technical services”
in section 9(1)(vii) read with Explanation 2 comes in between the words
“managerial and consultancy services”. Therefore, incurring of a debt
not having monetary involvement should not be considered for the purpose of
interpreting the definition of the term ‘interest’.

Apart from borrowing of money and incurring of debt, the definition
also includes “deposit, claim or other similar right or obligation” in
parenthesis. As involvement of money is regarded as essential criteria, the
right must be to a sum of money and the obligation must also be in respect of a
sum of money. The Madras High Court has interpreted the term ‘obligation’ as
including the obligation to repay the money received. However, the definition
refers to a ‘similar’ right or obligation. Therefore, any and every obligation
in respect of money does not get covered unless it is similar to the borrowing
of money or incurring of debt. For instance, preference share capital cannot be
considered as a ‘similar obligation’.

Reference can also be made to CBDT’s Instruction O.P. No.
275/9/80-IT(B) dt. 25-1-1981 which dealt with the issue of applicability of
s/s. 94A to the hire purchase instalment paid by a hirer to the owner under a
hire purchase contract. The relevant portion of the circular is reproduced
below:

4. It has to be considered whether the payment of any instalment or
instalments under a hire purchase agreement can be said to be by way of
interest in respect of any moneys borrowed or debt incurred. In this context,
it has to be borne in mind that a hire purchase agreement is a composite
transaction made up of two elements bailment and sale. In such an agreement,
the hirer may not be bound to purchase the thing hired. It is a contract
whereby the owner delivers goods to another person upon terms on which the
hirer is to hire them at a fixed periodical rental. The hirer has also the
option purchasing the goods by paying the total amount of the agreed hire at
any time or of returning before the total amount is paid. What is involved in
the present reference is the real nature of the fixed periodical rental payable
under a hire purchase agreement.

5. It may be pointed out that part of the amount
of the hire purchase price is towards the hire and part towards the payment of
price. The agreed amount payable by the hirer in periodical instalments cannot
be characterised as interest payable in any manner within the meaning of
section 2(28A) of the Income-tax Act. It is in the nature of a fixed periodical
rental under which the hire purchase takes place.

6. It is true that the definition of the hire
purchase price in section 2(d) of the Hire Purchase Act, 1972, also refers to
any sum payable by the hirer under the hire purchase agreement by way of
deposit or other initial payment or credit or amounts to be credited to him
under such agreement on account of any such deposit or payment. But such
deposit or payment is not in respect of any money borrowed or debt incurred
within the meaning of section 2(28A) of the Income-tax Act.

7. In view of the above, it would appear that the
provisions of section 194A will not be attracted in the case of payment of
periodical instalments under a hire purchase agreement.

Thus, deposit not in the nature of
money borrowed or debt incurred has been considered to be not relevant for the
purpose of interpreting the definition of the term ‘interest’. It strengthens
the view that “deposit, claim or other similar right or obligation” in
parenthesis should also have the element of borrowing of money or incurring of
debt. Similarly, in the case of bill discounting and factoring, where the bill
or debt is assigned to the bank/financial entity, various High Courts have
taken the view that the discount or factoring charges in such cases does not
amount to interest, given that such transactions amount to assignment of the
bill or debt, and discounting or factoring charges paid were not in respect of
any debt incurred or money borrowed. Reference may be made to the following
cases:

CIT vs. MKJ Enterprises Ltd 228 Taxman 61
(Cal)(Mag)

Principal CIT vs. M Sons Gems N Jewellery (P.)
Ltd 69 taxmann.com 373 (Del)

CIT vs. Cargill Global Trading (P) Ltd 335 ITR 94
(Del) – affirmed by the Supreme Court in 21 taxmann.com 496

Attention is also invited to the decision of the Allahabad High Court
in the case of CIT vs. Oriental Insurance Co. Ltd. 211 Taxman 369. The
High Court was dealing with the applicability of section 194A on delayed
payment of compensation for accident under the Motor Vehicle Act. The relevant observations of the Court are
reproduced here:

37. The necessary ingredients of such interest are
that it should be in respect of any money borrowed or debt incurred. The award
under the Motor Vehicle Act is neither the money borrowed by the insurance
company nor the debt incurred upon the insurance company. As far as the word
“claim” is concerned, it should also be regarding a deposit or other
similar right or obligation. The definition of Section 2(28A) of the Income Tax
Act again repeats the words “monies borrowed or debt incurred” which
clearly shows the intention of the legislature is that if the assessee has
received any interest in respect of monies borrowed or debt incurred including
a deposit, claim or other similar right or obligation, or any service fee or
other charge in respect of monies borrowed or debt incurred has been received
then certainly it shall come within the definition of interest.

38. The word “claim” used in the
definition may relate to claims under contractual liability but certainly do
not cover the claims under the statutory liability. The claim under the Motor
Vehicle Act regarding compensation for death or injury is a statutory
liability.

In the case of West Bengal Housing Infrastructure Development Corpn.
Ltd. 96 taxmann.com 610, the Calcutta High Court was dealing with
altogether different facts as compared to Viswapriya’s case. The High
Court rightly held that the rights and obligation referred in the definition
should be arising either from borrowing of money or incurring of debt.
Therefore, the interest payable on account of failure to deliver a particular
asset on the scheduled date as per the agreed terms does not fall within the
definition of the term ‘interest’ under the Act. Though such compensatory
payment could have been regarded as interest as per the principles laid down in
the case of CIT vs. Sham Lal Nerula and Westminster Bank Ltd. vs. Riches,
the statutory definition does not recognise it as interest in the absence of
any borrowing of money, incurring of (monetary) debt or other such similar
arrangements having monetary involvement in respect of which the payment has
been made. Perhaps for similar reasons, the interest payable under the Real
Estate (Regulation and Development) Act, 2016 on account of the failure of the
promoter as envisaged in Section 18 of that Act may also not be regarded as
interest for the purpose of the Act.

This
analysis is restricted to the interpretation of the term ‘interest’ mainly from
the point of view of applicability of section 194A.

shailesh.kwebmaker

Failure To Dispose Of Objections – Whether Renders Reassessment Void Or Defective And Curable?

Issue for
Consideration

Section 147 of the Income Tax Act, 1961
provides that if an Assessing Officer has reason to believe that any income
chargeable to tax has escaped assessment, he may assess or reassess such
income, subject to the provisions of sections 148 to 153 of the Act. Section
148 provides for issue of notice to an assessee, requiring him to furnish his
return of income in response to the notice, for the purposes of reassessment.
Section 148(2) requires an Assessing Officer to record his reasons for issue of
notice, before issuing any notice under this section. Courts have held that
recording of such reasons is mandatory, and issue of notice without recording
of such reasons is invalid.

The Supreme Court, in the case of GKN
Driveshafts (India) Ltd. vs. ITO 259 ITR 19, held that:

“when a notice under section 148 is
issued, the proper course of action for the noticee is to file return and if he
so desires, to seek reasons for issuing notice. The Assessing Officer is bound
to furnish reasons within a reasonable time. On receipt of reasons, the noticee
is entitled to file objections to issuance of notice and the Assessing Officer
is bound to dispose of the same by passing a speaking order. In the instant
case, as the reasons had been disclosed in the proceedings, the Assessing
Officer had to dispose of the objections, if filed, by passing a speaking
order, before proceeding with the assessment.”

Following this decision of the Supreme
Court, various cases have come up before different High Courts, requiring the
courts to consider the consequences in cases where the Assessing Officer passed
the reassessment order without disposing of the objections raised by the
assessee against the issue of notice for reassessment. The courts are of the
unanimous view that the reassessment order is not sustainable on account of
such lapse. The issue however has arisen in such cases as to whether the
reassessment proceedings are null and void, or whether the defect is curable by
providing a fresh innings to the AO for curing the defect by disposal of the
objections and pass a fresh order of reassessment after following the correct
procedure. While in some cases, the Gujarat, Bombay and Delhi High Courts have
quashed or set aside the reassessment order on the ground that the necessary
procedure had not been followed, effectively nullifying the order of
reassessment, in other cases, the Gujarat, Bombay, Delhi and Madras High
Courts, while setting aside the reassessment order, have restored the matter to
the Assessing Officer for disposing of the reasons and thereafter proceeding
with the reassessment.

MGM Exports’ case:

The issue came up before the Gujarat High
Court in the case of MGM Exports vs. DCIT 323 ITR 331.

In this case, for assessment year 2001-02,
the assessment was completed in September 2006 u/s. 143(3) read with section
254, after the original assessment order u/s. 143(3) was remanded back to the
Assessing Officer by the Tribunal. On 3^rdMarch 2008, the Assessing
Officer issued notice u/s. 148 proposing to reopen the completed assessment.
Vide communication dated 8^th March 2008, the assessee requested the
Assessing Officer to treat the original return of income as return of income
filed in response to notice u/s. 148 of the Act and also asked for a copy of
the reasons recorded by the Assessing Officer. The Assessing Officer supplied
the copy of the reasons recorded for reopening on 21^stOctober 2008.
On receipt of the reasons recorded, the assessee filed its objections, both on
jurisdiction and on the merits, vide communication dated 11^th
December, 2008. The Assessing Officer passed the reassessment order on 16^th
December, 2008.

The assessee filed a writ petition before
the Gujarat High Court. Before the High Court, it was argued on behalf of the
assessee that the Assessing Officer was under an obligation to first dispose of
the preliminary objections raised by the assessee, and could not have framed
the reassessment order. It was also submitted that until such speaking order
was passed, the Assessing Officer could not have undertaken reassessment.
Reliance was placed on the decisions of the Gujarat High Court in the cases of Arvind
Mills Ltd. vs. Asst. CWT (No. 1) 270 ITR 467, and Arvind Mills Ltd. vs. Asst.
CWT (No. 2) 270 ITR 469 for supporting the proposition.

On behalf of the Revenue, it was submitted
that the Assessing Officer had dealt with the objections in the reassessment
order itself, and hence, the same should be treated as sufficient compliance
with the directions and the procedure laid down by the Supreme Court in the
case of GKN Driveshafts (supra).

The Gujarat High Court considered the
decisions cited before it, and observed that the position in law was well
settled, and the Assessing Officer was accordingly required to decide the
preliminary objections and pass a speaking order disposing of the objections
raised by the assessee. Until such a speaking order was passed, the Assessing
Officer could not undertake reassessment.

Applying the settled legal position to the
facts of the case, the Court noted that it was apparent that the action of the
Assessing Officer in framing the reassessment order, without first disposing of
the preliminary objections raised by the assessee, could not be sustained.
Accordingly, it quashed and set aside the reassessment order. It however
directed the Assessing Officer to dispose of the preliminary objections by
passing a speaking order, and only thereafter proceed with the reassessment
proceedings in accordance with law.

A similar view was taken by the High Courts
in the following cases, where the reassessment order was quashed but the
Assessing Officer was directed to dispose of the objections and then proceed
with the reassessment:

Garden Finance Ltd. vs. Asstt. CIT 268
ITR 48 (Guj.)(FB)

IOT Infrastructure & Energy Services
Ltd. vs. ACIT 233 CTR 175 (Bom)

Rabo India Finance Ltd. vs. DCIT 346 ITR
81 (Bom)

SAK Industries (P) Ltd. vs. DCIT 19
taxmann.com 237 (Del)

Torrent Power SEC Ltd. vs. ACIT 231
Taxman 881 (Guj)

V. M. Salgaoncar Sales International vs.
ACIT 234 Taxman 325 (Bom)

Banaskantha District Oilseeds Growers
Co-op. Union Ltd. vs. ACIT 59 taxmann.com 328 (Guj)

Pr. CIT vs. Sagar Developers 72
taxmann.com 321 (Guj)

Simaben Vinodrai Ravani vs. ITO 394 ITR
778 (Guj)

In Home Founders Housing Ltd. vs. ITO 93
taxmann.com 371, the Madras High Court went a step further, and held that
non-compliance of the procedure indicated in the GKN Driveshafts (India)
case (supra) would not make the order void or non est, while
remitting the matter to the Assessing Officer for passing a fresh order, after
disposing of the objections. A Special Leave Petition against the said decision
has been rejected by the Supreme court.

Bayer Material Science’s case

The issue again came up before the Bombay
High Court in the case of Bayer Material Science (P) Ltd v DCIT 382 ITR 333.

In this case, relating to assessment year
2007-08, the assessee filed its return declaring certain taxable income. The
return was accepted by issuing intimation u/s. 143(1). On 6^th
February 2013, a notice u/s. 148 was issued seeking to reopen the assessment.
On 15^thMarch, 2013, the assessee filed its return of income, in response to the notice,
and sought a copy of the reasons recorded in support of the notice. The
Assessing Officer did not furnish the reasons recorded, in spite of the
assessee’s letters dated 15^thMarch, 2013 and 12^th
September, 2013 seeking the reasons recorded for issuing the notice. The
Assessing Officer finally furnished the copy of the reasons recorded for
issuing the notice to the assessee only on 19^th March, 2015.

On 25^th March, 2015, the assessee
filed its objections to the reasons recorded. The Assessing Officer, without
disposing of the assessee’s objections, issued a draft Assessment order,
required for a Transfer Pricing assessment, dated 30^thMarch, 2015.

The Bombay High Court noted that, as the
case involved transfer pricing issues, the period of limitation to dispose of
an Assessment consequent to reopening notice as per the 4th proviso to section
153(2) was two years from the end of the financial year in which the reopening
notice was served. The reopening notice was issued on 6^th February,
2013, and the reasons in support were supplied only on 19^th March,
2015 in spite of the fact that the
Revenue was aware at all times that the period to pass an order of reassessment
on the impugned reopening notice dated 6^th February 2013 would
expire on 31^st March, 2015.

The Bombay High Court observed that there
was no reason forthcoming on the part of the Revenue to satisfactorily explain
the delay. The only reason made out in the affidavit filed by the Assessing
Officer was that the issue was pending before the Transfer Pricing Officer
(TPO) and it was only after the TPO had passed his order on transfer pricing,
that the reasons for reopening were provided to the assessee. The Bombay High
Court expressed its surprise as to how the TPO could at all exercise
jurisdiction and enter upon enquiry on the reopening notice, before the notice
was upheld by an order of the Assessing Officer passed on objections. Besides,
the recording of reasons for issuing the reopening notice was to be on the
basis of the Assessing Officer’s reasons. The High Court observed that the
TPO’s reasons on merits, much after the issue of the reopening notice, did not
have any bearing on serving the reasons recorded upon the party whose
assessment was being sought to be reopened.

The Bombay High Court further noted that, in
the affidavit filed before it by the Department, it was stated that the
Assessing Officer was under a bonafide impression that the TPO would pass an
order in favour of the assessee. The Bombay High Court expressed its surprise
as to how the assessing officer could
then have any reason to believe that income chargeable to tax had escaped
assessment.

On 23^rd December 2015, when the
Department again sought more time from the High Court, the High Court indicated
that in view of the gross facts of the case, the Principal Commissioner of
Income Tax would take serious note of the above, and after examining the facts,
if necessary, take appropriate remedial action to ensure that an assessee was
not made to suffer for no fault on its part particularly so as almost the
entire period of two years from the end of the financial year in which the
notice was issued was consumed by the Assessing Officer in failing to give
reasons recorded in support of the notice.

When the matter again came up for hearing on
27^thJanuary 2016, the High Court was informed that, on 22^ndJanuary,
2016 the Principal Commissioner of Income Tax had passed an order u/s. 264, by
which he set aside the draft Assessment order dated 30^thMarch 2015,
and thereafter restored the matter to the Assessing Officer for passing order
after deciding the objections filed by the assessee. However, during the course
of hearing, the learned Additional Solicitor General, on instructions, stated
that the order dated 22^nd January, 2016 passed by the Principal
Commissioner of Income Tax was being withdrawn.

The Bombay High Court noted that the draft
Assessment order was passed on 30^thMarch, 2015 without having
disposed of the assessee’s objections to the reasons recorded in support of the
notice. The reasons were supplied to the assessee only on 19^th
March, 2015 and the assessee had filed the objections to the same on 25^thMarch,
2015. According to the Bombay High Court, thes passing of the draft Assessment
order without having disposed of the objections was in defiance of the Supreme
Court’s decision in GKN Driveshafts (India) (supra). Thus, the Bombay
High Court held that the draft Assessment order dated 30^th March,
2015 was not sustainable, being without jurisdiction, and set it asideas it had
been passed without disposing of the objections filed by the assessee to the
reasons recorded in support of the notice.

A similar view has been taken by the Gujarat
High Court in the case of Vishwanath Engineers vs. ACIT 352 ITR 549,
where, in spite of repeated reminders by the assessee even by pointing out the
law laid down by the Supreme Court, the Assessing Officer failed to dispose of
the said objections and instead of that, straightaway passed the order of
reassessment. In that case also, the Gujarat High Court, in the context of the
issue under consideration, held that AO was bound to disclose the reasons
within a reasonable time and on receipt of the reasons, the assesseee was
entitled to raise objections and if any such objections were filed, the
objections must be disposed of by a speaking order before proceeding to
reassess in terms of the notice earlier given.. The order of reassessment was
held to be not valid.

Similarly, in Ferrous Infrastructure (P)
Ltd. vs. DCIT 63 taxmann.com 201, the Delhi High Court considered a case
where the objections furnished by the petitioners to the section 148 notice had
not been disposed of by a separate speaking order prior to the reassessment
order. The Delhi High Court quashed the notice under section 148, the
proceedings pursuant to the notice and the reassessment order, on two grounds –
that the reasons had been recorded by the Assessing Officer after issue of the
notice u/s. 148, and that a separate speaking order had not been passed in
response to the objections, with the objections having been dealt with, if at
all, in the reassessment order itself.

Observations

The rationale for remanding the matter back
to the Assessing Officer, while quashing the reassessment order, has been
explained in detail by the Gujarat High Court, in the case of Sagar
Developers (supra):

“the question that arises is, whether if
the Assessing Officer defaults in disposing of the objections but proceeds to
frame the assessment without so doing, should the reassessment be terminated
permanently. In other words, the question is, should the assessment be placed
back at a stage where such defect is detected or should the Assessing Officer
for all times to come be prevented from carrying out his statutory duty and
functions.

It is by now well settled principle of
administrative law that whenever administrative action is found to be suffering
from breach of principles of natural justice, the decision making process
should be placed at a stage where the defect is detected rather than to
permanently annul the action of the authority.

Further it is also well settled that
whenever an administrative action is found to be tainted with defect in the
nature of breach of natural justice or the like, the Court would set aside the
order, place back the proceedings at the stage where the defect is detected and
leave the liberty to the competent authority to proceed further from such stage
after having the defect rectified. In other words, the breach of principle of
natural justice would ordinarily not result in terminating the proceedings
permanently.

The requirement of supplying the reasons
recorded by the Assessing Officer issuing notice for reopening and permitting
the assessee to raise objections and to decide the same by a speaking order are
not part of the statutory provisions contained in the Act. Such requirements
have been created under a judgment of the Supreme Court in the case of GKN
Driveshafts (India) Ltd. (supra). It is true that when the Assessing Officer
proceeds to pass the final order of assessment without disposing of the
objections raised by the assessee, he effectively deprives the assessee of an
opportunity to question the notice for reopening itself. However, the assessee
is not left without the remedy when the Assessing Officer proceeds further with
the assessment without disposing of the objections. Even before the final order
of assessment is passed, it would always be open for the assessee to make a
grievance before the High Court and to prevent the Assessing Officer from
finalizing the assessment without disposing of the objections.

The issue can be looked from slightly
different angle. Validity of the notice for reopening would depend on the
reasons recorded by the Assessing Officer for doing so. Similarly the order of
reassessment would stand failed on the merits of the order that the Assessing
Officer has passed. Neither the action of the Assessing Officer of supplying
reasons to the assessee nor his order disposing of the objections if raised by
the assessee would per se have a direct relation to the legality of the notice
of reopening or of the order of assessment. To declare the order of assessment
illegal and to permanently prevent the Assessing Officer from passing any fresh
order of assessment, merely on the ground that the Assessing Officer did not
dispose of the objections before passing the order of assessment, would be not
the correct reading of the judgment of Supreme Court in the case of GKN
Driveshafts (India) Ltd. (supra). In such judgment, it is neither so provided
nor one think the Supreme Court envisaged such an eventuality.”

Similarly, in Home Finders Housing’s case
(supra), the Madras High Court explained the rationale as under:

“It is not in dispute that there is no
statutory requirement to pass an order taking into account the statement of
objections filed by the assessee after receiving the reasons for invoking
section 147. The Supreme Court in GKN Driveshafts (India) Ltd. (supra) has
given a procedural safeguard to the assessee to avoid unnecessary harassment by
directing the Assessing Officer to pass a speaking order taking into account
the objections for reopening the assessment under section 147.

The forming of opinion to proceed further
by disposal of the objections need not be a detailed consideration of all the
facts and law applicable. It must show application of mind to the objections
raised by the noticee. In case the objections are such that it would require a
detailed examination of facts and application of legal provisions, taking into
account the assessment order sought to be reopened, the string of violations,
suppression of material particulars and transactions which would require considerable
time and would be in the nature of a detailed adjudicatory process, the
Assessing Officer can dispose of the objections, by giving his tentative
reasons for overruling the objections.

The disposal of objections is in the
value of a procedural requirement to appraise the assessee of the actual
grounds which made the Assessing Officer to arrive at a prima facie
satisfaction that there was escape of assessment warranting reopening the
assessment proceedings. The disposal of such objection must be before the date
of hearing and passing a fresh order of assessment. In case, on a consideration
of the objections submitted by the assessee, the Assessing Officer is of the
view that there is no ground made out to proceed, he can pass an order to wind
up the proceedings. It is only when a decision was taken to overrule the
objections, and to proceed further with the reassessment process, the Assessing
Officer is obliged to give disposal to the statement of objections submitted by
the assessee.

The core question is as to whether
non-compliance of a procedural provision would ipso facto make the assessment
order bad in law and non est. The further question is whether it would be
permissible to comply with the procedural requirement later and pass a fresh
order on merits.

In case an order is passed without
following a prescribed procedure, the entire proceedings would not be vitiated.
It would still be possible for the authority to proceed further after complying
with the particular procedure.

The enactments like the Land Acquisition
Act, 1894, contain mandatory provisions like section 5A, the non compliance of
which would vitiate the declaration under section 6 of the Act. Even after
quashing the declaration for non compliance of section 5A, the Court would permit
the conduct of enquiry and pass a fresh declaration within the period of
limitation.

Therefore, that non compliance of the
procedure indicated in the GKN Driveshafts (India) Ltd. case (supra) would not
make the order void or non est and such a violation in the matter of procedure
is only an irregularity which could be cured by remitting the matter to the
authority.”

Therefore, the High Courts which have held
in favour of remand, have relied on three aspects – one is that the
non-consideration of objections is a breach of principles of natural justice,
which can be remedied by restoring the matter to the earlier stage, secondly,
that the requirement is merely a procedural requirement, and thirdly, that this
is not a statutory requirement, but one laid down by the Supreme Court.

In Garden Finance’s case (supra), the
Full Bench of the Gujarat High Court analysed the logic of the Supreme Court
decision in GKN Driveshaft’s case (supra), as under:

“it appears that prior to the GKN’s case
(supra), the Courts would entertain the petition challenging a notice under
section 148 and permit the assessee to satisfy the Court that there was no
failure on the part of the assessee to disclose fully and truly all material
facts for assessment. Upon reaching such satisfaction, the Court would quash
the notice for reassessment. The question is why did the Court not require the
assessee to appear before the Assessing Officer.

Earlier when the Court required the
assessee to appear before the Assessing Officer, the Assessing Officer would
not pass any separate order dealing with the preliminary objections and much
less any speaking order, and the Assessing Officer would deal with all the
objections at the time of re-assessment. Hence, if the assessee was not
permitted to challenge the re-assessment notice under section 148 at the
initial stage, the assessee would thereafter have to challenge the
re-assessment itself entailing the cumbersome liability of paying taxes during
pendency of the appeal before the Commissioner (Appeals), second appeal before
the Income-tax Appellate Tribunal and then reference/tax appeal before the High
Court. It was in this context that the Constitution Bench had observed in
Calcutta Discount Co. Ltd.’s case (supra) that where an action of an executive
authority, acting without jurisdiction subjected, or was likely to subject, a
person to lengthy proceedings and unnecessary harassment, the High Courts would
issue appropriate orders or directions to prevent such consequences and,
therefore, the existence of such alternative remedies as appeals and reference
to the High Court was not 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 and that is why in a fit case it would become the
duty of the Courts to give such relief and the Courts would be failing to
perform their duty if reliefs were refused without adequate reasons.

What the Supreme Court has now done in
the GKN’s case (supra) is not to whittle down the principle laid down by the
Constitution Bench of the Apex Court in Calcutta Discount Co. Ltd.’s case
(supra) but to require the assessee first to lodge preliminary objection before
the Assessing Officer who is bound to decide the preliminary objections to
issuance of the re-assessment notice by passing a speaking order and,
therefore, if such order on the preliminary objections is still against the
assessee, the assessee will get an opportunity to challenge the same by filing
a writ petition so that he does not have to wait till completion of the
re-assessment proceed- ings which would have entailed the liability to pay tax
and interest on re- assessment and also to go through the gamut of appeal,
second appeal before Income-tax Appellate Tribunal and then reference/tax
appeal to the High Court. Viewed in this light, it appears that the rigour of
availing of the alternative remedy before the Assessing Officer for objecting
to the re-assessment notice under section 148 has been considerably softened by
the Apex Court in the GKN’s case (supra) in the year 2003. Therefore, the GKN’s
case (supra) does not run counter to the Calcutta Discount Co. Ltd.’s case
(supra) but it merely provides for challenge to the re-assessment notice in two
stages, that is: (i) raising preliminary objections before the Assessing
Officer and in case of failure before the Assessing Officer, and (ii )
challenging the speaking order of the Assessing Officer under section 148 of
the Act.”

From the above observations of the Courts,
it is clear that the requirement of disposal of objections by a speaking order
is not just a mere procedural formality, but a procedural safeguard introduced
by the Supreme Court, just as the recording of reasons by the Assessing Officer
is a procedural safeguard built in into the statute.

This safeguard, as analysed by the Gujarat
High Court Full Bench in Garden Finance’s case (supra), was to prevent
unnecessary harassment – to ensure that in cases where the issue of notice was
not justified, the assessee does not have to wait till completion of the
reassessment proceedings, which would entail the liability to pay tax and
interest on reassessment and also to go through the gamut of appeal, second
appeal before Income-tax Appellate Tribunal and then reference/tax appeal to
the High Court. The Supreme Court decision in GKN Driveshaft’s case (supra)
now provides for challenge to the reassessment notice in two stages, that is:
(i) raising preliminary objections before the Assessing Officer and (ii) in
case of failure before the Assessing Officer, challenging the speaking order of
the Assessing Officer u/s. 148. The requirement of disposal of objections is
therefore an additional level of protection granted to an assessee, and not
just a mere procedural requirement. This decision is delivered by the Full
Bench of the high court and shall, in any case, have a binding force over the
decisions of the division bench.

While disposing of the reasons, the
Assessing Officer has to pass a speaking order dealing with the objections, as
held by the Courts, and not just dispose of it mechanically without application
of mind, or in a standard format. The requirement of disposal of objections
cannot therefore be taken lightly.

It is at the same time important to appreciate
that in the matters of revenue laws, an order is to be conferred with a
finality at some point of time; an assessment cannot be kept open on one count
or another and certainly not for the lapses and latches of those in governance
and vested with power. Income tax Act, like many tax laws, is enshrined with
not one but various provisions that require the authorities and the tax payers
to carry out a task within the prescribed time limit; respecting these
statutory deadlines is not only essential for administration but also for the
dispensation of timely justice. ‘Satvar Nyay’, within the prescribed
time, is one of the promised objective of the tax laws.

An order of reassessment is required to be
necessarily passed within the time provided by section 153 of the Act and any
license even by the court to act beyond the prescribed time limit, will amount
to doing violence to the statutory law. In our considered view, a breach or a
lapse, in administration of a civil law or a procedure, should not be equated
with a breach in revenue laws and a breach here, should as a rule, be viewed as
fatal to the dispensation of justice. Significantly, one would find, not a few,
but hundreds of cases wherein the reassessment orders are routinely passed
without paying any heed to the need to dispose of objections by a speaking
order as mandated, under the law of the land, by the Supreme court; these
orders are passed with the knowledge of the law and, in most of the cases, are
passed in spite of being informed of the law. We are unable to side with a view
that seeks to provide a fresh innings to
an officer who consciously, knowingly has chosen to disrespect the law, even
where it is held to be administrative.

The fact that this safeguard has been
introduced by the Supreme Court and not incorporated in the statute itself,
should not make any difference – after all, what the Courts are doing is
interpreting the law as enacted. In the course of such interpretation, if a
view is taken by the Courts that a particular procedural safeguard is necessary
to avoid misuse of the provisions, such procedural safeguard should be regarded
as inherently built into the provisions itself.

Reassessment itself is a tool of harassment
of the assessee, as noted by the Gujarat High Court, in cases where it is not
justified. It is therefore a serious imposition on the taxpayer, for which
safeguards have been built in. If these safeguards are flouted by the Assessing
Officer, should the assessing Officer be given a second chance, is the moot question
that needs to be addressed.

Recording of reasons is the other safeguard
that has been built in. This is also a procedural safeguard. Almost all the
courts have been unanimous in their view that in a case where reasons have not
been recorded in writing before issue of notice u/s. 148, the reassessment
proceedings are invalid, and deserve to be quashed. Why should the same logic
not apply to the procedural safeguard of disposal of reasons before completion
of assessment?

Emphasising the need for such an order, the
Bombay High Court, in the case of Asian Paints Ltd. vs. DCIT 296 ITR 90,
recognised the importance of the safeguard of disposal of reasons, by holding
that if the Assessing Officer does not accept the objections filed to the
notice u/s. 148, he cannot proceed further in the matter for a period of four
weeks from the date of receipt of service of the order on the assessee,
disposing of objections with a view to enable the assessee to challenge the
order disposing of the objections, before the appropriate forum to prevent the
AO to proceed further with reassessment, if desired to do so.

Given the importance of this safeguard, and
the harassment that a reassessment causes to an assessee, the better view
therefore seems to be that in case these safeguards are not observed, the
Assessing Officer cannot be given a second chance to rectify his blatant
disregard of the safeguards put in place by the Supreme Court.

shailesh.kwebmaker

TAXABILITY OF PROPORTIONATE DEEMED DIVIDEND IN CASE OF LOANS TO CONCERNS

Issue
for Consideration

“Dividend” is inclusively defined
u/s. 2(22) of the Income Tax Act, 1961. Clause (e) of that section provides for
taxation of of any payment by a company, not being a company in which public
are substantially interested, of any sum by way of advance or loan to a
shareholder, who is the beneficial owner of shares holding not less than 10% of
the voting power, or to any concern in which such shareholder is a member or a
partner and in which he has a substantial interest, to the extent to which the
company possesses accumulated profits. As per Explanation 3(b) of section
2(22), a person shall be deemed to have a substantial interest in a concern,
other than a company, if he is at any time during the previous year
beneficially entitled to not less than twenty per cent of the income of such
concern while in the case of a company, a person carrying not less than twenty
per cent of the voting power shall, by virtue of section 2(32) be considered to
be the person holding a substantial interest in the company.

In the case of loan or advance to a
concern in which a shareholder has a substantial interest, the Supreme Court in
the case of CIT vs. Madhur Housing & Development Co Ltd Ltd. 401 ITR 152,
has recently held that the taxation of deemed dividend would be
in the hands of the shareholder, and not in the hands of the recipient concern.
The ratio of this decision though has been doubted by the apex court in a later
decision in the case of National Travel Services vs. CIT, 401 ITR 154
and the issue therein has been referred to the larger bench of the court.

Whether in bringing to tax the
deemed dividend, in the hands of the shareholders, the amount of the loan
advanced to a concern, is to be apportioned in their hands or not is an issue
that requires consideration. If yes, what shall be the basis on which the
amount is to be apportioned is another issue that is open; in cases where more
than one shareholder holds more than 10% of the voting power in the lending
company, and also has a substantial interest in the recipient concern, in what
proportion would the amount of loan be taxed as deemed dividend amongst such
shareholders – in the proportion of their shareholding in the lending company
or in the proportion of their interest in the recipient concern.

While the Delhi bench of the
Tribunal has held that the taxation of deemed dividend would be in the
proportion of the interest in the recipient concern, the Hyderabad bench of the
Tribunal has taken a contrary view, that such taxation would be in the
proportion of the voting power in the lending company.

Puneet Bhagat’s case

The issue came up for consideration
before the Delhi SMC bench of the Tribunal in the case of Puneet Bhagat vs.
ITO 157 ITD 353.

The facts in this case were that
the assessee held 50% of shares in a company, in which his wife held the
remaining 50%. This company advanced a loan of Rs 10 lakh to another company,
in which the assessee held 53.85% shares, and his wife held 46.11%. At the
relevant point of time, the accumulated profits of the lending company were Rs
14.51 crore.

The assessing officer, following
the decision of the Delhi High Court in the case of CIT vs. Ankitech (P) Ltd
340 ITR 14, held that the deemed dividend had to be taxed in the hands of
the shareholders of the loan recipient company. Since both the assessee and his
wife were equal shareholders in the lending company, he taxed an equal amount
of Rs 5 lakh in the hands of each of the two shareholders.

The Commissioner (Appeals) rejected
the assessee’s appeal, confirming the addition made by the assessing officer.

Before the Tribunal, on behalf of
the assessee, it was argued that though, on the facts of the case, the amount
of loan liable for addition u/s. 2(22)(e) could not be apportioned amongst the
shareholders, both of whom had substantial interest in the concerns, in as much
as no mechanism had been provided in the Act for apportioning the amount of the
deemed dividend in the respective shareholders hands. The fact that there was a
different shareholding pattern of shareholdings in the two companies made the
thing all the more unworkable. Therefore, the computation provisions failed,
and, following the Supreme Court decision in the case of CIT v s. B C
Srinivasa Setty 128 ITR 294, the charging provisions would also fail.
Hence, it was argued that deemed dividend could not be taxed in the hands of
any or both the shareholders.

The Tribunal noted that there was
no dispute that the total amount of loan was taxable as deemed dividend in the
hands of the 2 shareholders, as the 2 shareholders held more than 20%
shareholding in both the lending company as well as the recipient company.
Referring to the argument that the charging sections would fail on account of
failure of the computation provisions, the Tribunal noted that for application
of section 2(22)(e), a loan to a ‘concern’ was also contemplated in the section
itself and therefore the charge could not have failed It also observed that it
would be too technical to hold that the legislature visualised only one
shareholder in the concern and therefore the better view would be to pin the
charge on all the qualified shareholders.

The Tribunal, having held so,
observed that the section clearly stated that the shareholder might be a member
of the concern or a partner thereof, which implied that the interest of the
shareholder in the concern was to be determined with reference to the
percentage of share in income or of the shareholding with the voting power in
the concern, of the qualified shareholder, that received the loan or advance.
According to the Tribunal, it was not necessary that in every case, the
detailed mechanism should be provided by the Act for computing the income. If by
reasonable construction of the section, the income could be deduced, then,
merely on the ground that a specific provision had not been provided, it could
not be held that the computation provisions failed. The Tribunal also observed
that it was well settled law that a construction which advanced the object of
legislation should be preferred to the one which defeated the same.

According to the Tribunal, the
percentage of shareholding in the concern to which the loan was given, was a
determining factor of the quantum of the deemed dividend to be taxed in case of
the shareholder. In the case before it, it noted that the assessee had 53.85%
shareholding with the voting power in the loan receiving company. Therefore,
according to the Tribunal, Rs. 5,38,500 should have been assessed as dividend
in his hands, and the balance Rs.4,61,100 should have been taxed as dividends
in the case of his wife. However, since in the assessee’s case, the AO had made
an addition of Rs. 5 lakh only, the Tribunal upheld the addition of Rs. 5 lakh.

G Indira Krishna Reddy’s case

Recently, the issue again came up
for consideration before the Hyderabad bench of the Tribunal in the cases of G
Indira Krishna Reddy vs. DyCIT (ITA Nos 1495-1497/Hyd/2014) and G V Krishna
Reddy vs. DyCIT (ITA Nos 1498-1500/Hyd/2014) dated 24^th May
2017.

In this case, the assessee and her
husband were both shareholders of a company, Caspian Capital & Finance P.
Ltd.holding more than 10% of the share capital of the company. This company
advanced amounts of Rs. 36.10 lakh and Rs. 15 lakh ostensibly by way of share
application money to 2 companies namely, Metro Architectures & Contractors
Pvt.Ltd. and Orbit Travels & Tours Pvt. Ltd. in which the assessee had shareholding of 20%
and 40% respectively, her husband also was holding more than 20% shareholding
in both the companies. The lending company Caspian Capital & Finance P.
Ltd. had accumulated profits exceeding the amounts of share application money
advanced at the relevant point of time.

The assessing officer, based on the
facts, held that such amounts advanced by Caspian Capital & Finance P. Ltd.
were unsecured loans, though termed as share application money. He therefore
added the entire share application money
of Rs. 51.10 lakh as income of the assessee by way of deemed dividend.

Before the Commissioner (Appeals),
on behalf of the assessee it was argued that the entire share application money
had been taxed as deemed dividend in the hands of the assessee as well has her
husband, which had led to double taxation. It was argued that the amount of the
deemed dividend, to be taxed in the asessee’s hands, should be restricted to
the percentage of the assessee’s shareholding in the recipient companies.

The Commissioner (Appeals), while
upholding the taxation of deemed dividend, directed the assessing officer to
apportion the entire advanced amounts between the assessee and her spouse as
per their shareholding pattern in the lending company and not in the recipient
company as was claimed by the assessee subject to the fact that it was taxed in
both hands of the assesseee and her husband. In case there was no taxation in
both hands, the Commissioner (Appeals) held that the question of apportionment
did not arise.

Before the Tribunal, it was argued inter
alia, that the share application money advanced to the recipient companies
should be taxed in proportion to the shareholding of the assessee and her
husband in the recipient company.

The Tribunal rejected the
assessee’s main contention that since the computation mechanism failed, no
addition of deemed dividend could be made. It observed that the entire advances
or loans, given to the concerns of the shareholders having substantial interest
were required to be taxed to the extent of accumulated profits. It observed
that dividend was always distributed to the shareholders of the company, and
the entire advances or loans given to such concerns of shareholders with
substantial interest should be brought to tax to prevent unauthorised
distribution of dividend to the controlling shareholders in the guise of loans
and advances.

On the issue under consideration
the Tribunal observed that there was no other shareholder who had substantial
interest in both the payer company and the recipient company, other than the
assessee and her husband. Therefore, the Tribunal held that the advances given
to the recipient companies were required to be taxed in the hands of both the
assessee and her husband. It however expressed its inability to follow the
decision of the Delhi tribunal in the case of Puneet Bhagat (supra),
wherein the Delhi Tribunal had held that the dividend would be assessable in
the hands of the shareholders in the proportion of the shareholding of the
shareholders in the recipient entity. The Hyderabad Tribunal observed that
dividend was always payable to the shareholders of the payer company, and
non-shareholders had no right in the dividend. Hence, according to the
Tribunal, the question of taxing the deemed dividend as per the proportion of
shareholding in the borrowing company did not arise.

The Hyderabad Tribunal, in holding
as above that the proportion should be in the ratio of the holding in the payer
company, relied upon the observations in the decision of the Mumbai bench of
the Tribunal in the case of ITO vs. Sahir Sami Khatib 57 taxmann.com 13,.
The Hyderabad Tribunal therefore expressed its inability to accept the
contention that the deemed dividend should be assessed in the hands of the
assessee in proportionto the assessee’s shareholding in the recipient company.

Observations

If one analyses the objective
behind section 2(22)(e), as noted by the Hyderabad Tribunal, it is to tax a
shareholder who is circumventing the taxation of dividend by taking the benefit
in a disguised form as a loan to another concern. That being the purpose, it is
no doubt true that the person who has got the benefit should be taxed to the
extent of the benefit that he has derived. However, when a loan is given to a
company or other concerns, one can perhaps say that the shareholders of the
borrowing company or the members of such concerns have received an indirect
benefit in the ratio of their shareholding in the borrowing company or in the
income sharing ratio of such concerns.

The argument on the other hand is
that normally, if the intention of shareholders of a company is to give a loan
to another entity instead of distributing dividend, they would have factored in
the shareholding of that other entity, to ensure that the shareholders of the
lending company get the benefit of the accumulated profits indirectly in the
ratio of their entitlements to such profits in the receiving company.

Given the fact that this is a
taxation of dividend, unless it can be demonstrated that the benefit has
actually flowed to the shareholders in a different ratio, the more appropriate
ratio to be adopted in such cases is the ratio of the shareholding of the
assessee in the lending company. The difference of opinion between
the Delhi and the Hyderabad benches of the Tribunal is limited to the adoption
of the proportion in which such loan is to be taxed; should the proportion be
determined w.r.t the shareholding pattern of the shareholders in a lending
company or should it be w.r.t such pattern in the receiving company or concern.

The decision of the Mumbai bench of
the Tribunal in the case of Sahir Sami Khatib vs. ITO(supra) relied upon
by the Hyderabad Tribunal has been upheld by the Bombay High Court, on the
facts of the case, in [ITA No 722 of 2015] vide its order dated 3^rd
October 2018 for reasons not relevant in deciding the issue under
consideration. The Bombay High Court observed in this case:

“Equally, we find that the
reasoning given by the ITAT that there cannot be any proportionate addition of
deemed dividend taking into consideration the percentage of the shareholding in
the borrowing company, does not give rise to any substantial question of law.
In the factual matrix before the ITAT, it held that Section 2(22)(e) of the I.
T. Act, 1961 does not postulate any such situation. This is especially the case
before us as there is only one shareholder that has a shareholding in the
lending company as well as in the borrowing company. This being the case and
purely factual in nature, we do not think that the ITAT was in any event
incorrect in rejecting this argument of the assessee. We may hasten to add that
different considerations may arise if two or more shareholders are shareholders
of the same lending company and the same borrowing company. In such a factual
position it could possibly be argued that the addition ought to be made on a
proportionate basis. However, we are not examining this issue in the present
case as the facts before us are completely different.

The last decision relied upon by Ms
Jagtiani was a decision of the Delhi ITAT wherein it appears that the Delhi
ITAT has allowed the proportionate allocation of deemed dividend on the basis
of the shareholding of the borrowing company. We find this Judgment to be
wholly inapplicable to the facts of the present case as in the facts of this
decision, both the shareholders were holding more than 10% in the lending
company and more than 46% in borrowing company. In fact, there were only two
shareholders of the lending company as well as of the borrowing company. It was
in these peculiar facts that the Delhi ITAT came to a conclusion that the
deemed dividend ought to be proportionately divided. In the facts before us,
and as mentioned earlier, the appellant – assessee is the only shareholder who
is the shareholder of the lending company as well as that of the borrowing
company. This being the case, the ratio of the Delhi ITAT is squarely not
applicable to the facts and circumstances of the present case.”

From these observations of the
Bombay High Court, it is clear that the decision of the Mumbai bench of the
Tribunal in Sahir Sami Khatib’s case was based on entirely
different facts, where there was only one shareholder who fulfilled the
conditions of being the beneficial owner of more than 10% of voting power in
the lending company, and more than 20% of the shareholding in the recipient
company. It was on these facts that both the Mumbai Tribunal and the Bombay
High Court held that there was no question of proportional taxation of deemed
dividend. Therefore, to that extent, the reliance of the Hyderabad bench of the
Tribunal on the decision of the Mumbai bench of the Tribunal was not justified.

Useful reference may be made to the
decision of the Pune bench of the Tribunal in the case of Kewalkumar Jain
vs. ACIT 144 ITD 672, though the issues in that case were slightly
different. In that case, loans were given directly to the four shareholders
holding more than 10% of the shares of the company (the total holding of such
shareholders being 100% of the company), and the aggregate value of such loans
amounting to Rs 3.81 crore exceeded the total accumulated profits of the
company, which amounted to Rs. 2 .61 crore. The assessee had a shareholding of
14%, and received a loan of 0.76 crore.

The assessing
officer had computed the assessee’s share of accumulated profits at 14% of 2.61
crore, amounting to Rs. 0.36 crore, added the assessee’s proportionate share of
the general reserve, and since such amount of Rs.0.42 crore was less than the
loan received by the assessee, had taxed such amount of Rs 0.42 crore as deemed
dividend in the hands of the assessee. In this case, the Commissioner exercised
his revisional powers u/s. 263, setting aside the assessment with a direction
to the assessing officer to arrive at the correct available accumulated profits
for considering the amount of deemed dividend assessable in the hands of the
assessee. According to the Commissioner, there was nothing in section 2(22)(e)
permitting or prescribing the restriction to the proportionate amount of
accumulated profits.

The Tribunal set aside the order of
the Commissioner u/s. 263, noting that the balance of the accumulated profits
had been taxed in the hands of the other shareholders, and hence there was no
error in taxing only the proportionate accumulated profits in the hands of the
assessee. This decision of the Pune Tribunal therefore does indicate that the
relevant ratio for the purpose of taxation of deemed dividend is the proportionate
shareholding in the lending company, where more than one shareholder is
chargeable to tax on the deemed dividend.

Fortunately or otherwise, with
effect from 1^st April 2018, this issue would no longer be relevant,
except perhaps for the disclosure by the shareholders of exempt income in their
returns of income, since such deemed dividend would also now be subject to
payment of dividend distribution tax at the rate of 30% u/s. 115-O by the
lending company, and would be exempt in the hands of the shareholders.

shailesh.kwebmaker

Business of Derivatives Trading & Explanation to Section 73

Issue for Consideration
Section 73 of
the Income Tax Act, 1961 provides that any loss, computed in respect of a
speculation business carried on by the assessee, cannot be set off
except against profits of another speculation business. Explanation 2 to
section 28 provides that where speculative transactions carried on by
an assessee are of such a nature as to constitute a business, the
business is deemed to be distinct and separate from any other business,
and is referred to as ‘speculation business’ for the purposes of the
Act.

Section 43(5) defines the term “speculative transaction”,
as a transaction in which a contract for the purchase or sale of any
commodity, including stocks and shares, is periodically or ultimately
settled otherwise than by the actual delivery or transfer of the
commodity or scrips. Proviso to section 43(5) lists certain exceptions
to the ‘speculative transactions’, vide clasues (a) to (e). Clause (d)
of the proviso provides that an ‘eligible transaction’ in respect of
trading in derivatives referred to in section 2(ac) of the Securities
Contracts (Regulation) Act, 1956 carried out on a recognised stock
exchange shall be deemed not to be a speculative transaction.

Therefore,
derivatives transactions satisfying the needs of being treated as
‘eligible transactions’ are not regarded as speculative transactions for
the purposes of computing business profits u/s. 28.

The
explanation to section 73 provides for a deeming fiction where under
certain business carried on by a company is deemed to be a speculation
business. This fiction of explanation to section 73 applies only to a
company. If any part of the business of the company consists in the
purchase and sale of shares of other companies, such company is deemed
to be carrying on a speculation business to the extent to which the
business consists of the purchase and sale of such shares. Certain
exceptions to this fiction are provided in this regard.

An
interesting issue which has come up for consideration before the courts
is as to whether the business of derivatives transactions, which are not
regarded as speculative transactions by virtue of the proviso to
section 43(5), can be deemed to be a speculation business by virtue of
the explanation to section 73. While the Delhi High Court has taken the
view that the provisions of the explanation to section 73 do apply to
such derivatives trading business, and it is therefore deemed to be a
speculation business, the Calcutta High Court has taken a contrary view
and held that the explanation to section 73 applies only to transactions
in shares, and not to transactions in derivatives, and that therefore
derivatives trading business cannot be deemed to be a speculation
business.

DLF Commercial Developers’ Case
The issue first came up before the Delhi High Court in the case of CIT vs. DLF Commercial Developers Ltd 218 Taxmann 45.

In
this case, the assessee claimed a loss of Rs 492.71 lakh on account of
purchase and sale of derivatives. It claimed that the loss in trading of
derivatives was not a speculation loss in terms of section 43(5), and
could not be disallowed as a speculation loss under any provisions of
the Income Tax Act. The assessing officer rejected that submission, and
held that the explanation to section 73 applied, since it was
independent of section 43(5). He therefore treated the loss as a
speculation loss, and did not permit the adjustment of the loss against
business income.

The Commissioner(Appeals) rejected the
assessee’s contention. In further appeal to the tribunal, the tribunal
held that the explanation to section 73 was not applicable, and granted
relief to the assessee.

Before the Delhi High Court, on behalf
of the revenue, it was argued that the explanation to section 73
categorically provided that where any part of the business of the
company included purchase and sale of shares of another company, it
should l be deemed that the company was carrying on speculation business
to the extent to which the business consisted of that activity. It was
further argued that the intention of section 43 was to define certain
terms for the purposes of sections 28 to 41. It was argued that clause
(d) of the proviso to section 43(5) had restricted application, in that
it excluded transactions in derivatives only for a limited purpose. It
was claimed that section 73 had wider application and related to all
manner of losses concerning shares.

Reliance was placed on
behalf of the revenue on the decisions in the cases of CIT vs.
Intermetal Trade Ltd 285 ITR 536 (MP), CIT vs. Arvind Investments Ltd
192 ITR 365 (Cal) and Eastern Aviation and Industries Ltd vs. CIT 208
ITR 1023 (Cal). It was argued that the specific inclusion of the
activity of sale and purchase of shares of other companies from the
otherwise general application of principles underlying section 73 meant
that those transactions could not claim the benefit of the provision of
s.43(5). It was pointed out that derivatives of the kind and nature
traded by the assessee in the case before the court related to stocks
and shares, and were the subject matter of transactions on a stock
exchange. It was therefore claimed that the tribunal ought not to have
permitted the assessee the benefit of set of such loss.

On
behalf of the assessee, it was argued that the transactions in
derivatives were specifically excluded from the definition of
speculative transactions. Even though that definition was in section
43(5), it could not be ignored, since there was no other definition of
derivatives in the Income Tax Act. It was highlighted that derivatives
need not be only in respect of stocks and shares, but could also be in
respect of commodities. Reliance was placed on the decision of the
Madras High Court in Rajshree Sugars and Chemicals Ltd vs. Axis Bank Ltd
AIR 2011 Mad 144, for this proposition. The attention of the court was
also drawn to the decision of the Bombay High Court in the case of CIT
vs. Bharat R Ruia (HUF) 337 ITR 452, where the court had considered the
pre-amended section 43(5) before insertion of clause (d) in the proviso,
and held that derivatives in the light of the then existing law were
speculative transactions, but that the position had changed after
1.4.2006, when clause (d) was inserted in the proviso to section 43(5).
It was therefore argued that the tribunal had correctly held that the
assessee was entitled to the benefit of set off of the losses.

The
Delhi High Court analysing the provisions of section 73 and section
43(5) held that ; the term “speculative transaction” was defined only in
section 43(5) and the scope of the definition was restricted in its
application to working out the mandate of sections 28 to 41 in as much
as those provisions dealt with the computation of business income and
that it was not possible for the court to ignore or overlook that the
definition was confined in its application, to the extent it excluded
such transactions from the mischief of the expression “speculative
transactions”.

The Delhi High Court observed that while it was
tempting to hold that since the expression “derivatives” was defined
only in section 43(5), and since it excluded such transaction from the
odium of speculative transactions, and further, since it had not been
excluded from section 73, the explanation to section 73 did not apply,
however by doing so, the court would be doing violence to the
parliamentary intendment. This was because a definition enacted for only
a restricted purpose or objective should not be applied to achieve
other ends or purposes. Doing so would be contrary to the statute.

The
High Court stressed the contextual application of a definition or term.
The High Court observed that the stated objective of section 73, as was
apparent from the tenor of its language, was to deny speculative
businesses the benefit of set off of losses against other business
income.

The explanation to section 73 had been enacted to
clarify beyond any shadow of doubt that share business of of companies,
subject to certin exceptions, was deemed to be speculative. The fact
that in another part of the statute, which dealt with the competition of
business income, derivatives were excluded from the definition of
speculative transaction only underlined that such exclusion was limited
for the purposes of those provisions or sections. In the case before it,
the High Court noted that the derivatives were based on stocks and
shares, which fell squarely within the explanation to section 73.

According
to the Delhi High Court, it was therefore ideal to contend that
derivatives did not fall within the provision, when the underlying asset
itself did not qualify for the benefit, as derivatives were entirely
dependent on stocks and shares for the determination of their value. The
Delhi High Court therefore held that the explanation to section 73
applied to the case before it, and that the loss on trading in
derivatives could not be set off against other income.

Asian Financial Services’ Case
The
issue again came up recently before the Calcutta High Court In the case
of Asian Financial Services Ltd vs. CIT 70 taxmann.com 9.

In
this case, the assessee, a company, incurred a loss of Rs. 3,24,76,185
in futures and options transactions in shares being loss in derivatives
transactions. It claimed that this loss should be set off against other
business income, including profit from transactions in shares. The
assessing officer, for the purposes of s. 73, treated such loss as a
deemed speculation loss and did not allow set off of the loss against
the business income, by applying the explanation to section 73. While
the Commissioner (Appeals) allowed the assessee’s appeal, the tribunal
held against the assessee, holding that the explanation to section 73
applied, and the loss was a speculation loss, which could not be set off
against any other income.

Before the Calcutta High Court, on
behalf of the assessee, it was argued that the loss was on account of
derivatives being the futures and options which was excepted from the
definition of the speculative transaction and as a consequence the loss
was to be treated as a business loss under the proviso to section 43(5).
It was argued that once it was deemed to be a business loss under the
proviso to section 43(5), the question of applying section 73 or the
explanation to that section for the purpose of refusing the loss to be
set off against business income was palpably wrong. It was claimed that
the decision of the Delhi High Court relied upon by the tribunal did not
lay down good law, and that the Delhi High Court erred in holding that
dealing in derivatives was also a speculation loss within the meaning of
section 73.

On behalf of the revenue, it was argued that
section 43(5) was a general provision, while section 73 was a specific
provision. Attention was drawn to the explanation to section 73 to
submit that a company dealing in purchase and sale of shares amongst
others, which did not come within the exceptions carved out in the
explanation itself, was hit by the mischief of the explanation. A
question was raised that whether it could be said that when a business
consisting of purchase and sale of shares of other companies amounted to
a speculation business, business in derivatives, which depended on the
value of the underlying shares, was anything other than a speculation
business. It was argued that the view taken by the Delhi High Court in
DLF Commercial Developers’ case ( supra) was the correct view.

The
Calcutta High Court rejected the arguments of the revenue, observing
that, it could not be said that section 43(5) was a general provision
and section 73 was a specific provision. The Calcutta High Court in
fact, expressed the contrary view that the object of section 43(5) was
to define “speculative business”. The High Court observed that chapter
IV-D of the Income Tax Act, consisting of sections 28 to 44DB, dealt
with profits and losses of business or profession. It observed that when
the statute talked of profit, it also referred to losses, because loss
had been construed as a negative profit.

The Calcutta High Court
noted the language of the explanation to section 28 and observed that
from a plain reading of the explanation, the following deductions could
be made:

1. speculative transactions carried on by an assessee might be of such a nature as to constitute a business;

2. such speculation business carried on by an assessee should be deemed to be distinct and separate from any other business.

The
Calcutta High Court therefore concluded that speculation transactions
might partake the character of deemed business where the statute so
provided. The court then noted the definition of speculative transaction
contained in section 43(5), and the five exceptions contained in the
proviso thereto, and observed that such excepted transactions came
within the category of deemed business, which was distinct and separate
from any other business.

Addressing the question as to whether
loss arising out of such deemed business could be set off against the
profit arising out of other business or businesses, the High Court noted
that the provisions of section 70 permitted an assessee to set off loss
against his income from any other source under the same head, unless
otherwise provided. Therefore, the losses from the deemed business could
be set off against other business profits, unless otherwise provided.
The question was whether the explanation to section 73 provided
otherwise. According to the Calcutta High Court, a plain reading of the
explanation showed that it did not provide otherwise. Therefore,
according to the Calcutta High Court, the irresistible conclusion was
that the assessee was entitled to set of such loss arising out of deemed
business against other business income.

While the Calcutta High
Court agreed with the view of the Delhi High Court that shares fell
squarely within the explanation to section 73, it expressed its
disagreement with the treatment of derivatives at par with shares by the
Delhi High Court, since the Legislature had treated them differently.

The
Calcutta High Court therefore allowed the appeal of the assessee,
holding that the loss in derivatives transactions was not covered by the
explanation to section 73, and could be set off against other business
profits.

Observations
The definition of “securities”
u/s. 2(h) of the Securities Contracts (Regulation Act), 1956 makes it
clear that shares and derivatives are distinct from each other, though
both are securities, and even though derivatives derive their value from
the underlying shares or commodities.

The Companies Act, 2013
eliminates any possibility of treating the derivatives and shares to be
one. Section 2(84) defines ‘shares’ while section 2(33) defines the term
’derivatives’ and section 2(81) defines ‘securities’ and a combined
reading of all of them clearly confirm that the shares are not
derivatives for the purposes of the Companies Act, 2013 and if they are
not so there is no reason to treat as one and the same unless they are
defined to mean so for the purposes of the Income tax Act. In fact,
clause(d) of section 43(5) in turn refers to clause (ac) of section 2 of
the SCRA for providing the meaning to the term ‘derivatives’ for the
purposes of the Income tax Act.

It is well settled that a
deeming fiction is to be strictly construed. The explanation to section
73 deems certain business to be a speculation business, and is therefore
a deeming fiction. This deeming fiction merely refers to purchase and
sale of shares, and does not refer to purchase and sale of any other
securities. Therefore, given the fact that derivatives are not referred
to in the explanation, the deeming fiction of the explanation cannot be
extended to cover derivatives.

This view is supported by the
decision of the Supreme Court in the case of CIT vs. Apollo Tyres Ltd
255 ITR 273, where the Supreme Court held that units of mutual funds
were not shares, and therefore that the business loss in dealing in such
units was not covered by the explanation to section 73. In the case of
units of mutual fund also, as in the case of derivatives, the value of
the mutual fund units is derived from the underlying assets, which are
shares. If transactions of trading in mutual fund units do not fall
within the ambit of the explanation to section 73, logically,
transactions of trading in derivatives should also not fall within the
ambit of the explanation.

We have no doubt that the decision of
the Delhi high court could have been different had the court’s attention
been drawn to the decision of the apex court delivered in the context
of explanation to section 73 i.e on the same subject as is the subject
of discussion here.

Further, the provisions of section 43(5),
explanation 2 to section 28, and section 73 should be regarded as one
integrated scheme, for the limited purpose of set off of business loss
against any other income.

The term “speculation” is not used in
any other section of the Income Tax Act, and therefore this is a logical
interpretation. In the absence of section 73, there was no necessity of
the definition of speculative transaction in section 43(5), nor of
explanation 2 to section 28. When an item is specifically excluded from
the provisions of section 43(5), the intention clearly is to exclude it
also from the provisions of section 73, unless section 73 expressly
provides to the contrary. In any case, the explanation to section 73
while referring only to shares, clearly indicates that loss of trading
in derivatives does not fall within the deeming fiction of the
explanation.

The better view, therefore, seems to be that of the
Calcutta High Court, that loss on trading in derivatives is not
governed by the explanation to section 73, and that such loss incurred
by companies can be set off against other income.

shailesh.kwebmaker

Interest paid on borrowings for purchase of house- SECTION 24 & SECTION 48

ISSUE FOR CONSIDERATION
An assessee acquiring a house property with borrowed funds, pays interest on such borrowed funds, till such time as the borrowed funds are repaid by him. In most of the cases, the funds are repaid over a period of years, for which the interest is paid on the borrowings made.

In computing the income from such house property, a deduction is allowed u/s. 24(b) of the Income Tax Act of interest on such borrowings subject to certain conditions contained in the said provisions.

The interest so paid, over the period of years, is paid for the purposes of acquiring a capital asset, namely, the house property, and accordingly, the interest paid constitutes the cost of acquisition or the cost of improvement for the purposes of section 48 and generally qualifies for deduction in computing the capital gains arising on transfer of such house property.

Cases have come up wherein the assesses, who are allowed a deduction u/s. 24(b) of interest paid in computing the income from house property, have, on transfer of the house property, claimed deduction for the said interest in computing the capital gains on the ground that such an interest was a part of the cost of acquisition /improvement of the said asset. Obviously the Income Tax department, in such cases, has refused to allow deduction for interest paid in computing the capital gains on the ground that a deduction was already allowed, in the past assessment years, in computing the income from house property.

Conflicting decisions by different benches of the Income Tax Appellate Tribunal have warranted attention to this interesting issue. The Chennai bench of the tribunal has held that the deduction in computing the capital gains for interest is allowable while the Bangalore bench has held that such a deduction is not permissible in computing the capital gains.

C. Ramabrahmam’s case
The issue arose in the case of ACIT v. C. Ramabrahmam, 57 SOT 130 (Chennai), for the A.Y 2007-08 during which year the assessee had transferred a house property for a valuable consideration. In computing the capital gains, on transfer of the said house property, a deduction was claimed for an amount of Rs. 4,82,042, which amount represented the interest paid on a housing loan, taken in the year 2003, for purchasing the property, a deduction for which was allowed u/s. 24(b), in computing total income for A.Y. 2004-05 to 2006-07. The Assessing Officer disallowed the claim for deduction of the said interest in computing the capital gains for A.Y. 2007-08. On appeal, the CIT(A) allowed the claim of the assessee, by holding that the assessee was entitled to claim the deduction for interest u/s. 48, despite the fact that the same had been claimed u/s. 24(b) while computing income from house property.

In appeal to the tribunal, the Revenue contended that once the assessee had availed a deduction u/s. 24(b) for interest, he could not claim again a deduction for the same amount for the purposes of computation of Capital Gains. In reply, the assessee relied upon the findings and the order of the CIT(A).

The tribunal noted that there was no dispute about the fact that the interest in question was claimed and allowed as a deduction in the past in computing the income from house property under the statutory provisions of section 24(b). It further noted that the assessee had chosen to claim the said interest again as a deduction in computing the Capital Gains.

The Chennai tribunal, on consideration of the facts and the law, held in Para 8 of the order that; “We are of the opinion that deduction u/s. 24(b) and computation of capital gains u/s. 48 of the “Act” are altogether covered by different heads of income i.e., ‘income from house property’ and ‘capital gains’. Further, a perusal of both the provisions makes it unambiguous that none of them excludes operation of the other. In other words, a deduction u/s. 24(b) is claimed when concerned assessee declares income from ‘house property’, whereas, the cost of the same asset is taken into consideration when it is sold and capital gains are computed u/s 48. We do not have even a slightest doubt that the interest in question is indeed an expenditure in acquiring the asset. Since both provisions are altogether different, the assessee in the instant case is certainly entitled to include the interest amount at the time of computing capital gains u/s 48 of the “Act”. Therefore, the CIT(A) has rightly accepted the assessee’s contention and deleted the addition made by the Assessing officer. Hence, qua this ground, we uphold the order of the CIT(A).”

Captain B. L. Lingaraju’s case
The issue once again arose in the case of Captain B L Lingaraju vs. ACIT, before the Bangalore bench of the tribunal in ITA No. 906/Bang/2014 for A.Y 2009-10. In that case, the claim of the assessee for deduction u/s.48, of interest paid on a loan amounting to Rs.13,24,841, was disallowed by the A.O. on the ground that the said interest was allowed as the deduction u/s.24(b), in computing the income from house property. The action of the A.O. was upheld by the CIT(A).

In appeal to the tribunal, the assessee filed a paperbook containing written submissions and supported his claim by relying on the decisions of the Karnataka high court in the cases of CIT vs. Sri Hariram Hotels (P) Ltd., 229 TR 455 and CIT vs. Maithreyi Pai, 152 ITR 247 and also on the decisions of the Delhi and Madras high courts. He however did not appear for hearing and the appeal was decided ex-parte, qua the assessee.

The tribunal, on consideration of the written submissions and the decisions relied upon by the assessee therein, noted that the Court in the case of Sri Hariram Hotels (supra) had followed its earlier decision in the case of Maithreyi Pai (supra) to hold in Hariram Hotels case, that an interest paid on borrowings for the acquisition of capital asset must fall for deduction u/s.48 only if the same was not allowable as deduction u/s.57 of the Act and that no assessee under the scheme of the Act could be allowed a deduction of the same amount twice over. On the facts in B L Lingaraju’s case, the tribunal noted that the assessee had claimed a deduction of interest of Rs.1,50,000 in computing the income from self-occupied house property as per section 24(b) of the Act. Relying on the decision of the jurisdictional Karnataka high court in the case of Maithreyi Pai (supra), the tribunal held that no deduction u/s.48 could be allowed for the same interest in computing the Capital Gains, where it was allowed as deduction or was allowable as a deduction. The appeal of the assessee was thus dismissed by the tribunal.

Observations
Section 24(b) reads as under:

“Income chargeable under the head “Income from house property” shall be computed after making the following deductions, namely:—
(a) …………………………………..

(b) where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital:

Provided ………………………………”

The relevant part of Section 48 reads as under:

“The income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely :—

(i) expenditure incurred wholly and exclusively in connection with such transfer;

(ii) the cost of acquisition of the asset and the cost of any improvement thereto:

Provided ……………………………”

The principle that the cost of acquisition is a dynamic and a fluctuating number is by now widely accepted; it may increase in a subsequent year as a result of a liability or expenditure incurred after the date of acquisition. The cost of acquisition can increase on account of the interest paid, post acquisition of asset, on borrowings made for the acquisition of the asset. CIT vs. Mithlesh Kumar 92 ITR 9(Delhi), CIT vs. K.S Gupta 119 ITR 372 (AP), CIT vs. A.R Damodara Mudaliar & Co. 119 ITR 583 (Madras), CIT vs. K Raja Gopala Rao 252 ITR 459 (Madras) and CIT vs. Maithreyi Pai 152 ITR 247 (supra).

While the above stated principle permits increase in the cost of acquisition by the amount of interest, such an increase has been made conditional by the Karnataka high court in Maithreyi Pai’s case(supra), by observing that an interest which had already been allowed as revenue expenditure could not be virtually deducted again u/s 48 MLG Enterprise vs. CIT 167 ITR 11.

Usually unless otherwise prohibited, a deduction under a specific provision cannot be denied under a different provision for the same expenditure. The Act has a few parallels wherein such deductions or allowances are found by the courts to be allowable; for example the investments in depreciable assets are treated as an application for charitable purposes, and depreciation on such assets has been held to be eligible for deduction again from income u/s 11, in computing the income of a charitable institution.

The Income Tax Act is replete with examples of the provisions which specifically provide that no deduction under any other provision of the Act would be allowable in the cases where a deduction is allowed under a particular provision; e.g. section 35AD(3). The present day’s trend therefore appears to be that the legislature, wherever intended, makes a specific provision for denying double deductions. No such express provision is found either in section 24(b) or in section 48, as has been confirmed by the Chennai bench of the tribunal. These provisions operate in different fields and that too for computation of income under two different heads of income. Further the deduction in one case is a statutory deduction, whereas in the other, it is on capital account. One may at the same time have to look into the reasons behind the observations of the Karnataka high court in the case of Maithreyi Pai (supra) wherein the court observed that an interest for which a deduction had already been allowed could not be allowed twice over while computing the capital gains u/s. 48. Apparently, one does not find any express provisions in any of the provisions of the Act, at least not in section 48 and section 24(b), which could have formed the basis for the court to have observed as it did.

One may also ascertain whether there is anything in the law of taxation that has prompted the court to hold that a deduction u/s. 48 was not allowable once it was allowed in the past. The Supreme court held in Escorts Ltd vs. UOI, 191 ITR 43 a double deduction could not be a matter of inference; it must be provided for in clear and expressive language, regard being had to its unusual nature and its serious impact on the revenues of the State. Having noted the findings of the apex court, one is required to appreciate that the case of the assessee, in the issue under consideration, is not a case of having claimed a deduction for revenue expenditure at all. In the facts of the case, under the issue, a specific deduction is allowed u/s. 24(b) in computing the income from house property and, in another case, the interest constitutes the cost of acquisition and is therefore claimed as a deduction representing the capital expenditure. Considering the distinction, it may be possible to contend that the case under consideration, is not squarely covered by the decision of the Supreme court in Escort’s case. Whether it is a case of double deduction, at all, is the question that remains to be concluded.

In B. L. Lingaraju’s case, the deduction for interest was restricted to Rs.1,50,000/-, though actual interest paid was much higher than the said amount, leaving open a possibility for claiming a deduction u/s. 48, at least for the balance unclaimed amount of interest, that was not allowed and was not even allowable.

shailesh.kwebmaker

NEED FOR DEPOSITS UNDER CAPITAL GAIN ACCOUNTS SCHEME

Issues for Consideration

Section
54(2) and a set of other similar provisions, provide for the deposit of Capital
Gains or the net consideration in a bank account in accordance with the Capital
Gains Account Schemes, 1988, in a case where such amount is not appropriated or
utilized by the assessee towards the purchase or construction of the new asset
before the date of furnishing return of income u/s. 139 of the Income Tax Act.

The amount so
deposited under this Scheme, is required to be utilized for investment in the
specified new asset, within the specified period by withdrawal from the same account
in accordance with the Scheme. The amount in the bank account remaining
unutilized, shall be charged as the Capital Gains for the year in which the
period of reinvestment expires and the assessee shall be entitled to withdraw
the same unutilized balance.

Instances happen
whereunder, an assessee utilizes the amount of the Capital Gains or the net
consideration in reinvesting the same in the specified new asset, within the
permissible time of 2 or 3 years, after filing the return of income u/s. 139,
without first depositing such amount in the designated account and routing the
investment through such account.

Issues arise in such
cases about the eligibility of the assessee, for claim of exemption from the
liability to tax on Capital Gains. The courts, in considering the issue, have
delivered conflicting decisions. The Karnataka High Court had held, that the assessee
should be eligible for the relief once the amount in question was utilized
within the permissible time. However, the Bombay High Court recently held, that
it was essential for an assessee to first deposit the unutilized amount in the
designated account and any failure to do so would result in denial of the
relief, even where he had utilized the amount of gains or consideration in
purchase or construction of a new asset with the overall permissible time
frame.

K Ramachandra Rao’s case

The issue arose before the Karnataka High Court in the case of the CIT
v. K. Ramachandra Rao, 230 Taxman 334. In that case, the assessee sold
certain converted lands for a consideration of Rs.2.87 crore. The assessee
constructed the residential premises on another plot of land owned by him,
for which certain payments towards construction were made within a period of one
year of the transfer of the said lands, some payments were made within one
year before the transfer of the said lands and balance payments were made after
the transfer and after the due date of filing return of income u/s 139(1)
directly, without depositing the same in the designated bank account under
the Capital Gains Scheme. The construction of the premises was completed
within a period of three years of the transfer. The assessee claimed
exemption u/s 54F from taxation in respect of the capital gains arising on
the transfer of the said lands. The AO denied the claim for exemption on the
ground that a part was invested before the transfer of the said lands in
construction, and that the balance was invested directly without depositing
the same in the designated bank account.

On appeal, the Commissioner(Appeals) held that the payments made within
one year before the date of transfer and also the payments made after
transfer were eligible for exemption in spite of the fact that the proceeds
were not deposited in the designated bank account. The tribunal, on appeal by
the revenue, confirmed the findings of the Commissioner(Appeals).

In appeal to the High Court, the Revenue, besides another question, raised
the following substantial question of law:

“When the assessee invests the entire sale consideration construction of
a residential house within three years from the date of transfer can he be
denied exemption under Section 54F on the ground that he did not deposit the
said amount in capital gains account scheme before the due date prescribed
under Section 139(1) of the IT Act?”

The decision,
as reported, does not record the conflicting stands presented by the parties to
the appeal nor does it record the observations of the court that led to the
decision of the High Court rejecting the
appeal of the Revenue, which held as
under;

“As is clear from
Sub-section (4) in the event of the assessee not investing the capital gains
either in purchasing the residential house or in constructing a residential house
within the period stipulated in Section 54F(1), if the assessee wants the
benefit of Section 54F, then he should deposit the said capital gains in an
account which is duly notified by the Central Government. In other words if he
want of (sic) claim exemption from payment of income tax by retaining the cash,
then the said amount is to be invested in the said account. If the intention is
not to retain cash but to invest in construction or any purchase of the
property and if such investment is made within the period stipulated therein,
then Section 54F(4) is not at all attracted and therefore the contention that
the assessee has not deposited the amount in the Bank account as stipulated and
therefore, he is not entitled to the benefit even though he has invested the
money in construction is also not correct.”

Humayun Suleman Merchant’s case

The issue again
came up recently before the Bombay High Court in the case of Humayun Suleman
Merchant v CCIT, ITA No 545 of 2002 dated 18^th August 2016.

In this case,
the assessee sold a plot of land for a consideration of Rs. 85.33 lakh on 29^th
April 1995. The due date of filing of his return of income was 31^st
October 1996. He entered into an agreement to purchase a flat for a
consideration of Rs. 69.60 lakh on 16^th July 1996. Under this
agreement, 2 instalments of Rs. 10 lakh each were paid on 17^th July
1996 and 23^rd October 1996 to the developer/builder. A further
payment of Rs. 15 lakh was made on 1^st November 1996 under the
agreement to purchase the flat. The possession of the new flat was obtained on
27^th January 1997. No amount was deposited in the capital gains
account scheme.

The assessee
filed his return of income on 4^th November 1996, after the due date
of filing of his return of income. In the return, exemption under section 54F
was claimed in respect of the entire cost of the new flat of Rs. 69.60 lakh.

The assessing
officer allowed exemption from capital gains under section 54F in respect of
the amount of Rs. 35 lakh paid till the date of the filing of the return, and
did not consider the balance amount of Rs 34.60 lakh paid subsequently for the
flat, on account of the assessee’s failure to deposit the unutilised consideration
for purchase on the flat in the specified bank account in accordance with the
capital gains account scheme. The Commissioner(Appeals) upheld the order of the
assessing officer. The tribunal also dismissed the appeal of the assessee.

Before the Bombay
High Court, on behalf of the assessee, it was argued that:

1. The issue was covered by the decision of the Bombay High Court in the case
of CIT v Hilla J B Wadia 261 ITR 376, read with CBDT circulars dated 15 October
1986 and 16 December 1993. Further, the decision of the Madhya Pradesh High
Court in the case of Smt Shashi Varma v CIT 224 ITR 106 also applied. Besides,
the decision of the Karnataka High Court in the case of K Ramachandra Rao
(supra) covered the issue.

2. Section 54F had been brought into the Act with the object of encouraging
the housing sector. Therefore, a liberal/beneficial interpretation/construction
should be given to section 54F(4). Reliance was placed upon the decision of the
Delhi High Court in the case of CIT v Ravinder Kumar Arora 342 ITR 38.

3. Section 54F(4) deliberately use the word “appropriation” while extending
the benefit, since it intended to expand the scope of the benefit. Since the
word “appropriation” meant setting apart, once an agreement to purchase the
flat was executed in July 1996, and the consideration was set aside, though not
paid, it should be considered to be appropriated towards the purchase of a
flat, and hence the benefit of section 54F was available.

4. Alternatively, the requirements of section 54F(4) had been satisfied, as
the entire amount had been paid to the developer before the last date
prescribed to file the return of income [the date prescribed under section 139
(4)], as held by the Gauhati High Court in the case of CIT v Rajesh Kumar Jalan
286 ITR 274.

On behalf of
the revenue, it was argued that:

1. on a plain reading of section 54F(4), the assessee had not utilised the
entire net consideration taxable under the head capital gains for purchase of
the flat, nor had he deposited the balance unutilised consideration in a
specified bank account as notified in terms of section 54F(4), and was
therefore not entitled to the benefit of exemption from capital gains under
section 54F to the extent the requirements of the section were not met.

2. The decision of the Bombay High Court in Hilla J B Wadia (supra), as well
as the circulars cited on behalf of the assessee had no application to the
facts of the case, as these were not in the context of section 54F(4), which
was not existing in the statute books at that point of time.

3. The word “appropriation” only covered cases where the flat had already been
purchased within one year before the date on which the capital gains arose on
the transfer of the asset. In the present case, there was no purchase of a flat
prior to the sale of the capital asset, but the purchase was post sale of the
capital asset, which required utilisation and deposit in the specified account
to the extent not utilised.

4. The decision of the Gauhati High Court in Rajesh Kumar Jalan had no
application to this case, as the amounts had not been utilised or deposited in
the specified bank account before the assessee filed his return of income on 4^th
November 1996.

The Bombay High
Court analysed the provisions of section 54F. It noted that, while implementing
section 54F, it was noticed that at times assessments were completed prior to
the expiry of the period of 2 or 3 years from the date of sale of the capital
asset, and the assessee had not utilised the amount within the prescribed
period. This led to assessment orders being rectified by appropriate orders, to
withdraw the excess exemption allowed under section 54F. It was for this reason
that section 54F(4) was introduced. Further, the provisions of section 54F(1)
were made subject to the provisions of section 54F(4). Therefore, where the
consideration received on sale of the capital asset was not appropriated (where
purchase was earlier than sale) or utilised (where purchase was after the
sale), then the gains were subject to the charge of capital gains tax, unless
the unutilised amounts were deposited in the specified bank account as notified
under the capital gains account scheme. The exemption was available to the
unutilised amounts only if the mandate of section 54F(4) was complied with. A
further safeguard was provided to the revenue, where the assessee had not
invested the amounts in purchase/construction of a house property within the
specified time under section 54F(1), by providing that in such cases, capital
gains would be charged on the unutilised amount as income of the previous year
in which the period of 3 years from the date of the transfer of the capital
asset expired.

Applying this
analysis of the provisions to the facts before it, the Bombay High Court noted
that the entire net consideration which was to be utilised in purchase of the
new flat and which had not been utilised, had not been deposited in the
specified bank account before the due date of filing of the return under
section 139(1). The High Court noted that except Rs. 35 lakh, the balance of
the net consideration to be utilised, had not been utilised before the date of
furnishing of the return, 4^th November 1996. Therefore, according to
the High Court, the order of the tribunal was correct.

The Bombay High
Court noted that the ratio of the cases of Hilla J B Wadia (supra) and Smt.
Shashi Varma did not apply, as in those cases, at the relevant point of time,
there was no requirement of depositing any unutilised amount in a specified
bank account under the capital gains account scheme. Further, the Bombay High
Court noted that the 2 CBDT circulars relied upon on behalf of the assessee did
not do away with and/or relax the statutory mandate of depositing the
unutilised amount in the specified bank account as required by section 54F(4).

Referring to
the decision of the Karnataka High Court in K Ramachandra Rao (supra), the
Bombay High Court expressed its inability to accept the reasoning adopted by
the Karnataka High Court. According to the Bombay High Court, the mandate of
section 54F(4) was clear, that an amount which had not been utilised in
construction and/or purchase of property before filing the return of income
must necessarily be deposited in an account under the capital gains account
scheme, so as to claim exemption. According to the Bombay High Court, this
aspect had not been noticed by the Karnataka High Court, and the entire basis
of the decision of the Karnataka High Court was the intent of the parties.
According to the Bombay High Court, in interpreting a fiscal statute, one must
have regard to the strict letter of law, and intent can never override the
plain and unambiguous letter of the law. The Bombay High Court observed that
while it should not easily depart from a view taken by another High Court on
considerations of certainty and consistency in law, the view of other High
Courts were not binding upon it unlike a decision of the Supreme Court or of a
larger or coordinate bench of the same court. If, on an examination of the
decision of the other High Court, it was unable to accept the same, it was not
bound to follow/accept the interpretation of the other High Court, leading to a
particular conclusion.

In the case
before it, the Bombay High Court found that the decision of the Karnataka High
Court was rendered sub-silentio; i.e. no argument was made with regard to the
requirement of deposit in notified bank account under the capital gains account
scheme before the due date as required by section 54F(4). The Bombay High Court
relied on Salmond’s Jurisprudence for the proposition that a precedent
sub-silentio is not authoritative. The Bombay High Court therefore held that it
could not place any reliance upon the decision to conclude the issue on the
basis of that decision.

The
Bombay High Court further rejected the reliance on the decision of the Delhi
High Court in the case of Ravindra Kumar Arora (supra), where the court had
held that the provisions of section 54F should be liberally construed, on the
grounds that in that case, all the requirements of section 54F stood satisfied,
and the only issue was the addition of the name of his wife in the purchase, on
the ground that that case had no application to the facts before it.

According
to the Bombay High Court, no occasion to give a beneficial constructions to a
statute could arise when there was no ambiguity in the provision of law, which
was subject to interpretation. In the face of the clear words of the statute,
the intent of parties and/or beneficial construction was irrelevant. It relied
on the decisions of the Supreme Court in the cases of Sales Tax Commissioner,
vs Modi Sugar Mills 12 STC 182, Mathuram Agarwal vs State of Madhya Pradesh 8
SCC 67 and CIT vs. Thana Electricity Supply Ltd 206 ITR 727 for this
proposition.

The
Bombay High Court also rejected the argument that since the funds had been
earmarked to be invested in construction of a house, the funds could be
regarded as appropriated for the purpose of purchase of new residential house,
and therefore the requirements of section 54F(4) were satisfied. According to
the Bombay High Court, the word “appropriated” had been used with reference to
the cases where property had already been purchased prior to the sale of the
capital asset, and the amount received on sale of the capital asset was
appropriated towards consideration which had been paid for purchase of the
property. According to it, the plain language of the section made a clear
distinction between cases of appropriation (purchase prior to sale of capital
asset) and utilisation (purchase/construction after the sale of capital assets).
Therefore, the word “appropriated” would have no application in cases of
purchase/construction of a house after the sale of capital asset, as was the
fact in the case before it.

Referring
to the argument on behalf of the assessee, that since the entire amount had
been paid before the last due date to file the return specified in section
139(4), the exemption was available, based on the decision of the Gauhati High
Court in the case of Rajesh Kumar Jalan, the Bombay High Court noted that the
factual situation before it was different. In the case before the Gauhati High
Court, the amounts were utilised before the date of filing of the return of
income, whereas in the case before the Bombay High Court, only a part of the
amounts were utilised before the date of filing of the return of income.
Therefore, the Bombay High Court was of the view that the decision of the
Gauhati High Court in that case was not applicable to the case before it.

The
Bombay High Court therefore held that the assessee was entitled to an exemption
under section 54F only in respect of the amount of Rs. 35 lakh actually paid
before the date of filing of the return of income, and not in respect of the
entire amount of Rs. 69.60 lakh agreed to be paid for purchase of the new
house.

Observations

Section 54 (2) reads
as under:

The amount of the capital gain which is not
appropriated by the assessee towards the purchase of the new asset made within
one year before the date on which the transfer of the original asset took
place, or which is not utilised by him for the purchase or construction of the
new asset before the date of furnishing the return of income under section 139, shall be deposited by him before furnishing such return [such deposit
being made in any case not later than the due date applicable in the case of
the assessee for furnishing the return of income under sub-section (1) of section 139] in an account in any such bank or institution as may be
specified in, and utilised in accordance with, any Scheme which the Central
Government may, by notification in the Official Gazette, frame in this behalf
and such return shall be accompanied by proof of such deposit; and, for the
purposes of sub-section (1), the amount, if any, already utilised by the
assessee for the purchase or construction of the new asset together with the
amount so deposited shall be deemed to be the cost of the new asset :

Provided that if the amount deposited under this
sub-section is not utilised wholly or partly for the purchase or construction
of the new asset within the period specified in sub-section (1), then,—

(i) The amount not so
utilized shall be charged under section 45 as the income of the previous year in which
the period of three years from the date of the transfer of the original asset
expires; and

(ii) The assessee shall be
entitled to withdraw such amount in accordance with the Scheme aforesaid.

The said sub-section
was introduced in the Finance Act, 1987 w.e.f. 01.04.1988. The intention behind
the introduction is explained vide memorandum explaining the provisions, as
under:

“The existing provisions under sec. 54, ….. the original assessments
need rectification whenever the taxpayer fails to acquire the corresponding new
asset. With a view to dispensing with such rectification of assessment, the
bill seeks to provide for new Scheme for deposit of amounts meant for
reinvestment in the new asset. Under the proposed amendment, … also.”

Circular No. 495 dt.
22.9.1987 has explained the amendment vide para 26.2 & 26.3 to avoid the
need for rectification of the assessment order of the year of transfer on
account of the assessee’s failure to acquire corresponding new asset within the
permissible time.

On a combined reading,
it is gathered that sub-section 2 has been introduced to provide for the
deposit of that part of the gain which has remained unutilized upto the date of
filing of return. The provision simultaneously ensures that the amount so
deposited in the designated account shall be deemed to be the cost of the new
asset, so as to enable an assessee to claim relief for the assessment year
corresponding to the year of transfer of the original asset without any further
compliance needed. As it is seen, the provision is primarily introduced to
avoid any rectification of the original assessment that maybe required, to meet
the consequences of the failure of the assessee to acquire the new asset within
the overall time permitted by law. Apparently, the law of sec. 54 and other
similar sections permitted and continue to permit an assessee to reinvest the
gains or the consideration within the prescribed time. This relief has neither
been taken away by the amendment nor is it intended to be taken away. In that view
of the matter, the core requirement for a relief continues to be the reinvestment
of the gains or consideration within the overall framework of the law.

The only purpose of
the amendment, therefore is to provide for a procedural mechanism in the form
of introduction of the Scheme so as to avoid the consequential rectification in
limited cases of failure of an assessee to reinvest. It may therefore not be
appropriate, to altogether deny the benefit to an assessee in a case where he
has reinvested the gains or the consideration in new asset within the
permissible time, though without depositing the gain or the consideration under
the Scheme. This more so, as in the case before the Bombay High Court, the
entire payment has been made before the date of the assessment.

In reality, one
routinely comes across cases where the payment of consideration is deferred for
several reasons, leading to non-compliance of conditions for deposit under the Scheme.
However, the transferor, on receipt of the consideration after the filing of
return of income, acquires or is in a position to acquire the new asset within
the specified period. Many intended transactions are seen to be not implemented
simply for inability to realize the funds by the due date of filing the return
of income. A provision introduced to facilitate the smooth assessment cannot be
so construed as to defeat the provisions of law.

The Courts seem to be favoring
the view that the deposits made within the extended time of s.139(4) would be
in compliance with the provisions of law. The Courts also seem to be of the
view that the benefit of the sections should not be denied in cases where the
new asset is purchased or constructed within the time extended u/s.139(4), even
where the deposits are made under the Scheme. Under the circumstances, no
serious controversy should arise in cases where reinvestment is made within
such extended time, with or without routing the investment through the
designated account.

One may also consider
the possibility of always routing the reinvestment through the designated
account, irrespective of the delay in depositing the gains or consideration
under the Scheme. This may help the assessee in contending that he has complied
with the provisions of law, but for the delay in depositing under the Scheme,
which delay may be condoned.

There is no doubt that
the entire Scheme of exempting the Capital Gains from taxation on reinvestment is
for the benefit of the assessee and for directing the investments in the
desired channels. It is a settled position in law that such provisions being beneficial
provisions for the assessee, should be construed liberally, so as to facilitate
the deduction and not to deny it.

In view of the above
discussion, it appears that the view of the Karnataka High Court is a better
view, in as much as the court has taken a view that promotes the legislative
intent behind the main provisions of law. It is respectfully submitted that an
important factor that should have been appreciated in Humayun’s case was that
there had been no loss of revenue nor was there any delay in reinvestment, and
that the entire payment for the new house had been made by the time the
assessment was completed.

shailesh.kwebmaker

Rate of Taxation and Deemed Short-term Capital Gains

Issue for consideration

Any
profits or gains arising from the transfer of a property, held as a capital
asset, is liable to be taxed under the head “capital gains”. Such gains are
classified into short term capital gains and long term capital gains, where the
former is subjected to tax at the ordinary rates, while the later qualifies for
concessional rate of taxation, besides being eligible for the benefit of
reinvestment related exemptions from tax.

Ordinarily,
a short term capital gains arises on transfer of a short term capital asset and
long term capital gain arises on transfer of a long term capital asset. An
asset held for a period exceeding 36 months is usually treated as a long term
capital asset. Under a fiction of section 50 however, the act provides for a
separate treatment for an asset on which depreciation has been claimed, even
where such an asset is otherwise held for a period exceeding 36 months.

Section
50 has been the subject matter of two important controversies; one relating to
the eligibility of the deemed short term capital gains to the benefit of
sections 54E, 54f, 54EC, etc. and the other relating to the eligibility of such
gains for the concessional rate of taxation. While the former has now been
settled with the recent decision of the Supreme Court in the case of CIT vs.
V.S. Dempo Co. Ltd. 387 ITR 354, the later continues to be debatable as is
confirmed by conflicting decisions of the courts on the subject. While the Pune
and the Kolkata Tribunal are against conferring the benefit of concessional
rate on the deemed short term capital gains, a series of decisions of the
Mumbai Tribunal favour the grant of the benefit of concessional rate of
taxation for such gains.

Reckitt Benckiser (India)
Ltd.’s case

The issue recently arose in the case of Reckitt
Benckiser (India) Ltd. vs. ACIT, 181 TTJ 384(Kol.) before the Kolkata Tribunal
involving the determination of rate of tax payable by the assessee on capital
gains arising from the sale of flats on which depreciation was claimed. In the
year under consideration, flats owned by the assessee were sold and since the
sold flats were held by the assessee for more than 36 months, the capital gains
arising from the sale thereof was offered to tax by the assessee at the
concessional rate applicable to long-term capital gains. Since the flats sold
by assessee were depreciable assets, the AO invoked the provisions of section
50 and brought to tax the capital gains arising from the sale thereof at normal
rate applicable to short-term capital gains.

On
appeal, the CIT(A) upheld the action of the AO on the issue, by observing that
the provisions of section 50 were clearly applicable to the capital gains
arising on account of sale of depreciable assets not only for computation but
also for the rate of tax.

The
Tribunal, on hearing the arguments from both the sides on the issue and perusal
of the relevant material available on record, held that the relevant provisions
of section 50 as applicable in the context were very clear and specific, as
rightly held by the learned CIT (A). As per the said provisions, which were
overriding in nature, the capital gains arising from the sale of depreciable
assets was chargeable to tax at the rate applicable to short-term capital
gains, irrespective of the holding period. Certain judicial pronouncements,
relied upon by the appellant, were found to be not applicable in the context,
involving the issue relating to rate of tax applicable to the capital gains
arising from sale of depreciable assets. The Tribunal did not find merit in
ground raised by the assessee and dismissed the same.

Smita Conductors Ltd.’s case, 152 ITD 417 (Mum.)

The issue arose before the Tribunal in the case
of Smita Conductors Ltd. vs. DCIT, 152 ITD 417(Mum.) wherein the assessee had
filed an additional ground for contesting the tax rate applied in case of
capital gains computed u/s 50 r.w.s 50C of the income-tax act. In that case,
the assessee had sold a flat after holding the same for more than 36 months. It
had claimed depreciation on the flat and had claimed that the gains arising
thereon be taxed at the concessional rate u/s. 112.

In
the appeal to the Tribunal, it was
submitted that the flat sold by the assessee had been held for a long time
exceeding more than three years and, therefore, the capital gains, though
required to be computed u/s. 50 of the it act, had to be treated as long term
capital gain in view of the judgment of the high Court of Bombay in case of Ace
Builders Ltd.,281 ITR 410, in which it had been held that the factum of deemed
short term capital gains u/s. 50 of the it act was applicable only to
computation of capital gains, and for the purpose of other provisions of the
act, such as section 54EC, the capital gains had to be treated as long term
capital gains, if the asset was held for more than three years. it was
contended that section 50(1) made it quite clear that the capital gains in
respect of depreciable asset was deemed as short term capital gains for the
purposes of sections 48 and 49 of the it act, which related to computation of capital gains. Therefore, the deeming
provision was only limited to the provisions for computation of capital gains.

Reference
was made to the decision of the mumbai bench of the Tribunal in case of
Mahindra Freight Carriers vs. DCIT, 139 TTJ 422, in which it had been held that
prescriptions of section 50 were to be extended only to stage of computation of
capital gains and, therefore, capital gain resulting from transfer of depreciable
asset which was held for more than period of three years would retain the
character of long term capital gains for all other provisions of the act and
consequently qualify for set off against brought forward loss of long term
capital gains. reference was also made to another decision of mumbai bench of
the Tribunal in case of Prabodh Investment & Trading Company Vs. ITO in
(ITA No. 6557/Mum/2008), in which following the judgment of the high Court of
Bombay in case of Ace Builders P. Ltd. (Supra), the Tribunal held that section
50 created a legal fiction only for a limited purpose i.e. for the purpose of
sections 48 and 49 and for the purposes of section 54E, the gains had to be
treated as long term capital gains. the Tribunal in that case also accepted the
arguments of the assessee that in case capital gains was assessed as long term
capital gain the rate of tax as provided in section 112 of the it act would
apply.

It
was explained that provisions of section 50, deeming the capital gains as short
term capital gains was only for the purposes of section 48 and 49, which
related to computation of capital gains. The deeming provisions therefore was
to be restricted only to computation of capital gain and for the purpose of
other provisions of the act, the capital gain has to be treated as long term
capital gain. it was, therefore, argued that in the case of the assessee, rate
of tax applicable to long term capital gain had to be applied as per the
provisions of section 112 of the IT act.

The
same view had been taken by the mumbai bench of Tribunal in case of Manali
Investments vs. Assistant CIT, 139 TTJ 411, in which it had been held that the
prescriptions of section 50 were to be extended only to the stage of
computation of capital gain and, therefore, capital gain resulting from
transfer of depreciable asset, which was held for more than three years would
retain the character of long term capital gain for the purpose of all other
provisions of the act.

It
was highlighted that the flat had been held for 15 to 20 years, which was
supported by the fact that cost of the flat as shown in the balance sheet was
only Rs.1, 30,000/-, and if the flat was held for more than three years, the
tax rate as provided in section 112 of the it act applicable in respect of capital
gains arising from transfer of long term capital asset, had to be applied.

The Tribunal held that, for the purpose of
computation of capital gains, the flat had to be treated as short term capital
gains u/s. 50 of the it act, but for the purpose of applicability of tax rate,
it had to be treated as long term capital gains if held for more than three
years. It accordingly directed the AO to compute the capital gains from the
sale of flat and apply the appropriate tax rate, after necessary verification
in the light of observations made in the order.

Observations

The
basis of the claim for the benefit of concessional rate of taxation for the
deemed gains, besides being founded in law, has largely been founded on the
decisions of the high Courts delivered in the context of the eligibility of
such deemed gains for the benefit of exemption u/s. 54E, 54EC, etc. the high Courts have consistently held that such
gains are eligible for the benefit of exemption u/s. 54E, 54EC, etc. CIT vs.
Assam Petroleum 263 ITR 587 (Gau), CIT vs. Ace Builders 281 ITR 240 (Bom), CIT
vs. Pole Star Industries, 41taxmann.com 237 (Guj), Aditya Media Sales Ltd.,
38taxmann 244 (Guj), Rajiv Shukla 334 ITR 0138 (Del) and CIT vs. Delite Tin
Industries in ITA no. 118 of 2008 dated 26/09/2008. The Bombay high Court is
deciding the case of delite tin industries (supra), had followed its own
decision in the case of ace Builders (supra). The Special leave Petition of the
income tax department against the said decision has been rejected by the Supreme
Court vide order dated 20/10/2009 in SlP. (c) no. 21450 of 2009, 322 itr (st)
8. The delhi high Court in the case of rajiv Shukla (supra) has taken note of
the said dismissal of SLP by the apex court. The issue has recently been
settled in favour of allowability of the benefit in the case of CIT vs. V.
S.Dempo Co. Ltd. (supra).

The issue under consideration had also arisen
before the Pune bench of the Tribunal in the case of Rathi Bros. Madras Ltd.
vs. ACIT in ITA No. 787/PN/2813. In a decision dated 30/10/2014, the Tribunal
decided the issue against the assesssee, interestingly, by holding that the
issue on hand has been decided by the decision of the Bombay high Court in the
case of ace Builders (supra). the Tribunal noted that the Bombay high Court in
para 23 of the order while confirming the grant of benefit of exemption u/s.54,
had observed that the deemed short term capital gains, though taxable at the
ordinary rates would nonetheless be eligible for the tax exemption. It is
respectfully submitted that such observations, not made in the context of the
case, should not have been the guiding force in adjudicating an issue that was
otherwise decided by the co-ordinate bench in favour of the assessee. The issue
before the high Court was about the eligibility of an assessee for the benefit
of section 54E and not for the concessional rate of taxation u/s. 112 of the
Act. In any case, the final findings of the Court on the issue before it are
clearly placed in para 25 of the order, which has no observations on the
subject of rate of taxation.

In
Rathi Bros.’ case (supra), the Tribunal, under an error, did not follow the
decision of the co-ordinate bench in the case of P.D. Kunte and Co., by observing that in the
said case the issue though raised, had remained to be adjudicated by the Tribunal.
The fact of the matter, as was noted by the AO, is that the said assessee had
filed an MA on the ground that the issue had remained to be adjudicated by the Tribunal
and the Tribunal had rectified the error by adjudicating the issue and deciding
the issue in favour of the assessee. The Tribunal had followed the decision of
the Bombay high Court in the case of Ace Builders (supra). Accordingly, it was
the decision in the case of Rathi Bros. that requires rectification. It seems
that the order in the MA was lost sight of while adjudicating the issue.

On
a comprehensive reading of the various provisions of the income-tax act,
namely, sections 2(14), 2(29A), 2(42A), 45, 48, 49, 50 and section 112, all of
which are relevant to the issue under consideration, the following things
emerge:

A distinction is made in the scheme of taxation of
capital gains by classifying such gains into short term capital gains and
long term capital gains. Such a classification is primarily based on the
nature of capital asset, namely short-term capital asset and long-term
capital asset which distinction is founded on the period of holding of a
capital asset.
An exception has been made, where under the deeming
fiction of section 50 treats even a long-term capital asset as a
short-term capital asset.
The deeming fiction of section 50 however has a limited
application in as much as the fiction created there under has the effect
of qualifying the application of only sections 48 and 49 and no other provisions
of the act.
The said deeming
fiction of section
50 has been introduced as
a special provision with
effect from 01/04/1988 by
the taxation laws (A&MP) act,1986 with the objective of providing
a working solution to the problems of identifying the cost of acquisition
and indexing such cost in cases of depreciable assets whose cost kept on
varying year after year.
No parallel amendments have been carried out in any of
the other provisions of the act, clearly conveying the legislative intent
that the other provisions continued to operate with full force.
Even otherwise there is nothing in section 50 which has
the effect of overriding the other provisions of the act, including
section112, but for the provisions of section 2(42A), which override has a
very limited application. The said override cannot convert a long-term
capital asset into a short-term capital asset, as has been now recently
confirmed by the Supreme Court. In our considered opinion, section 50 will
apply and operate even without the said override.
Section 50 is a special provision for computation of
capital gains in case of depreciable assets and it is incorrect to apply
the same fiction in deciding the rate of tax at which the income so
computed is to be taxed.
There is no provision, implied or express, in
section112, to indicate that the benefit of the concessional rate of tax
thereunder would be denied to the gains computed under the deeming fiction
of section 50 of the Act.
The logic and the rationale applied by the Supreme
Court for granting the benefit of sections 54E, 54EC, etc. shall equally
apply in conferring the benefit u/s.112 of the concessional rate of
taxation.

shailesh.kwebmaker

Taxability of Foreign Salary Credited to NRE Bank Account

ISSUE FOR CONSIDERATION

Section 5 of the Income Tax Act, 1961 (“the Act”) lays down the scope of total income. Sub-section (2) of that section lays down the scope of the total income of a nonresident. It provides as under:

“(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived, which:
(a) is received or is deemed to be received in India in such year by or on behalf of such person; or
(b) which accrues or arises or is deemed to accrue or arise to him in India during such year.”

Explanation 2 to this section clarifies that income, which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him, shall not again be so included on the basis that it is received or deemed to be received by him in India.

It is usual to come across cases where a person, not resident under the Act, receives some money in India, the income whereof has accrued outside India; for example, Indian citizens employed abroad, regarded as non-residents for the purposes of the Act, depositing their salary in India for the services rendered out of India . Similarly, crew of a foreign ship or an Indian ship who leave India on account of their employment on the ship, non-residents under the Act, depositing the salary In India, is another example.

Many such persons, may request their foreign employers to credit their salaries to their Non-Resident (External) bank accounts (“NRE accounts”) maintained with banks in India. An issue has arisen before different benches of the Income Tax Appellate Tribunal regarding the taxability in India of such foreign salaries credited to NRE accounts. While the Agra bench of the tribunal has taken the view that such salaries are not taxable in India, the Kolkata bench of the tribunal has recently taken a contrary view, holding that such salaries are taxable in India.

Arvind Singh Chauhan’s case
The issue first came up before the Agra bench of the tribunal in the case of Arvind Singh Chauhan vs. ITO 147 ITD 509.

In this case, the assessee was a crew member of a ship, who was employed with a Singapore company. His employment letter was issued by the foreign employer’s agent in India. He worked on merchant vessels and tankers plying on international routes. His salary was directly credited by his employer to his NRE account with HSBC Bank in Mumbai.

His stay in India during the relevant previous year was less than 182 days, and hence his residential status was nonresident. In the income tax return filed by the assessee, the salary received from the Singapore company was not offered to tax. However, his income from pension received from Government of India and interest were offered for taxation.

During the course of assessment proceedings, when the assessee was asked to show cause as to why the salaries received from the Singapore company for services rendered as a crew member of a ship should not be taxed in India, the assessee argued that since such salary was accruing and arising outside India, it was outside the scope of section 5(2).

As regards the fact that the salary was directly credited to a bank account in India, the assessee argued that salary income deposited in a bank account in India directly from the bank account of his employer outside India and as such was not taxable in India. Reliance was placed on the decisions in the cases of DIT vs. Prahlad Vijendra Rao 198 Taxmann 551 (Kar), DIT vs. Diglan George Smith 40(1) ITCL 419 and ITO vs. Lohitakshan Nambiar (ITA No 1045/Bang/09 dated 12.4.2010).

The AO did not accept the assessee’s explanation, on the ground that since the assessee’s status for income from pension and interest was that of resident, as a result his status for all sources of income was to be taken as a resident. In addition the AO held that the salary income accrued in India by relying on the Supreme Court decision in the case of CIT vs. Shri Govardhan Ltd 69 ITR 675, for the proposition that if an assessee acquires a right to receive income, the income is said to have accrued to him, even though it may be received later on its being ascertained. According to the AO by receiving the appointment letter in India from the agent of the foreign employer and details of salary to be paid, the assessee got the right to receive the salary. Importantly, the AO relied on the fact that the salary cheques were credited to the assessee’s account with HSBC bank in India and hence the income was received in India.

The Commissioner (Appeals) upheld the order of the AO, holding that the salary income accrued in India as well as was received in India, and was therefore taxable in India.

The Tribunal noted the fact that the AO had himself noted the number of days of the assessee’s stay outside India as per his passport, and categorically found that his status u/s. 6 was that of a non-resident. The tribunal held that the AO was wrong in holding that the assessee was a resident in India on account of the fact that he had offered interest and pension income in his taxable income, given the fact that both the pension and interest accrued and were received in India, the pension being payable by a former employer in India. The mere taxability of such pension and interest in India would not result in the inference that the assessee was a resident of India, since such incomes were taxable in India even in the case of a non-resident.

Examining the scope of total income in the case of a nonresident, the tribunal noted that it was only when one of the 2 conditions – i.e. income was received or was deemed to be received in India by or on behalf of the nonresident or income accrued or arose or was deemed to accrue or arise to the non-resident in India – was fulfilled, that the income of a non-resident could be brought to tax in India. The tribunal held that salary was compensation for services rendered by an employee, and therefore situs of its accrual was the situs of services being rendered, for which salary was paid. It noted that in the case of CIT vs. Avtar Singh Wadhwan 247 ITR 260, the Bombay High Court had held that income from salary, even in the case of crew of an Indian vessel operating in international waters, was to be treated as having accrued outside India. According to the tribunal, it was incorrect to assume that an employee got a right to receive the salary just by getting an appointment letter, because unless services were rendered, no right to receive salary accrued to an employee. Therefore, according to the tribunal, the assessee got the right to receive salary income when he rendered the services, and not when he received the appointment letter.

The tribunal next considered the aspect of whether the income was received in India, since the salary cheques were credited to the assessee’s account with HSBC, Mumbai. According to the tribunal, the law was clear that receipt of income for this purpose referred to the first occasion when the assessee got the money in his own control, real or constructive. What was material was the receipt of income in its character as income, and not what happened subsequently, once the income, in its character as such, was received by the assessee or his agent. An income could not be received twice or on multiple occasions. The bank statement of the assessee clearly revealed that these were US dollar denominated receipts from the foreign employer credited to the NRE account of the assessee with HSBC, Mumbai.

The tribunal noted that the assessee was in lawful right to receive those monies as an employee at the place of employment, i.e. at the location of his foreign employer. It was a matter of convenience that the monies were thereafter transferred to India. According to the tribunal, these monies were at the disposal of the assessee outside India, and it was in exercise of his rights to so dispose of the money, that monies were transferred to India. The tribunal referred to the decision of the Madras High Court in the case of CIT vs. A P Kalyanakrishnan 195 ITR 534, where the assessee’s pension from the Malaysian government was remitted by the Accountant General of Malaysia to the Accountant General, Madras, for onward payment to the assessee. While rejecting the contention of the revenue that the pension was to be regarded as having been received in India, the court in that case had observed that the pension payable to the assessee had accrued in Malaya, and only thereafter by an arrangement embodied in the letter…………, the pension had been remitted to the assessee in India and been made available to him. The Madras High Court had therefore held that the assessee had to be regarded as having received the income outside India and that the pension had been remitted or transmitted to the place where the assessee was living, as a matter of convenience, which would not constitute receipt of pension in India by the assessee.

According to the tribunal, once an income was received outside India, whether in reality or on constructive basis, the mere fact that it had been remitted to India would not be decisive on the question as to whether the income was to be treated as having been received in India. The tribunal observed that the connotation of an income, having been received and an amount having been received were qualitatively different. The salary amount was received in India in this case, but the salary income was received outside India. The tribunal further noted that it was elementary that an income could not be taxed more than once, but, if at each point of receipt, the income was to be taxed, it may have to be taxed on multiple occasions. The tribunal therefore held that in a situation in which the salary had accrued outside India, and thereafter, by an arrangement, salary was remitted to India and made available to the employee, it would not constitute receipt of salary in India by the assessee, so as to trigger taxability under section 5(2)(a). The tribunal therefore deleted the addition of the salary amount credited to the NRE bank account in India.

Tapas Kr Bandopadhyay’s case
The issue again came up recently before the Kolkata bench of the tribunal in the case of Tapas Kr Bandopadhyay vs. DyDIT 70 taxmann.com 50.

In this case, the assessee was a marine engineer, who was a non-resident. During the year, he was engaged with an Indian company and a Singapore company as a marine engineer, working in international waters, and received remuneration from both the companies. His contract of service with the Indian/foreign shipping company was executed in India with an agent, before joining the ship. His residential status was non-resident, on account of the fact that he was outside India for more than 182 days, sailing in international waters. The salary incomes were received by credit to the assessee’s NRE accounts with banks in India.

The assessee claimed that the salary incomes were exempt from tax, being received from outside India in foreign currency. The assessing officer accepted the residential status of the assessee as a non-resident, after verification of the passport and other details. He, however, asked the assessee to show cause as to why the incomes received in India by way of credit to the NRE accounts maintained in India should not be taxable, since the income received in India was taxable in case of nonresidents. The assessee responded by stating that the entire amount was received in foreign currency outside India and were credited to his NRE accounts in India, and that the amounts received in foreign currency could not be deemed to be received in India. It was also pointed out that only foreign currency could be deposited in NRE account, and hence the amounts credited to the NRE account were received outside India. The assessing officer rejected the assessee’s contention that amounts received in foreign currency were not taxable in India, and observed that any income received or deemed to be received in India was taxable in India, irrespective of the currency in which such amounts were received.

The assessing officer observed that income received in India was taxable in all cases (whether accrued in India or elsewhere), irrespective of residential status of the assessee. According to the assessing officer, the meaning of the term “income received in India” was significant. If the place where the recipient got the money on the first occasion under his control was in India, it would be income received in India. In the case before him, since the income was remitted by the employer to the bank accounts of the assessee maintained in India, the assessee got the money under his control for the first time in India. The assessing officer, therefore, taxed the salaries for the services rendered overseas, received by the assessee by credit to his bank accounts from his employers.

Before the Commissioner (Appeals), on behalf of the assessee, it was argued that:

(a) The assessee was a non-resident rendering services outside India.

(b) The payments were being made by a foreign company outside India and the foreign company did not have any permanent establishment in India.

(c) The point of payment was to be taken into consideration for determining the provisions of section 5(2)(a) of the Income Tax Act and the point of payment should be considered as the point of receipt.

(d) It was immaterial that the payment was being transferred by the foreign company or remitted by the foreign company to the NRE accounts in foreign exchange in India, because payments had been made by the foreign company outside India and the point of payment was to be taken as the point of receipt.

(e) The amount which was received by the assessee from the foreign company was in foreign exchange and therefore income could not be said to have been received in India, where payment had been received in foreign currency.

(f) The provisions of section 5(2)(a) had to be interpreted in a manner that it did not render the section meaningless. If interpretation as made out by the Department was adopted, then definitely the section would be otiose and meaningless, because no benefit would be given to non-residents, even if all the conditions had been satisfied.

(g) The true interpretation of the provisions of section 5(2)(a) to be adopted for income received or deemed to be received in India, was that the payments had been made in India in Indian currency and the recipient of the payments had received payments in Indian currency.

The Commissioner (Appeals) rejected the assessee’s arguments, and upheld the order of the assessing officer.

Before the tribunal, on behalf of the assessee, reliance was placed on the decisions of the Karnataka High Court in the case of Prahlad Vijendra Rao (supra) and of the Bombay High Court in the case of Avtar Singh Wadhwan (supra). Reliance was also placed on the decision of the Agra bench of the tribunal in the case of Arvind Singh Chauhan (supra).

On behalf of the revenue, it was argued that income will get included in the total income of a non-resident through any of the four modes prescribed in section 5(2). All the four modes stood on their own legs, or else the enactment would be rendered redundant. There was no specific section in the Act, which dealt with income accruing or arising to any person only in India, though section 5(2) (b) used the term “accrues or arises to him in India”. The context of this term was provided by section 5(1)(c), which mentioned that total income of a person resident in India included all income from whatever source, which accrued or arose to him outside India. This was the reason that the main charging section, section 4, did not make any reference to the words “in India”, as it had to provide a basis of charge for both – income accruing or arising to a person in India as well as income accruing and arising to a person outside India. The charging section did not have a territorial bias. Similarly, section 15(a) also did not reflect any locational preference, as salary could become due to an assessee anywhere in the world. Salary due from an employer was taxable, whether paid or not.

Reliance was placed on the observations of the Supreme Court in the case of CIT vs. L W Russell 53 ITR 91, where the Supreme Court had held as under:

“the expression ‘due’ followed by the qualifying clause ‘whether paid or not’ shows that there shall be an obligation on the part of the employer to pay that amount, and a right on the employee to claim the same.”

Therefore, it was argued that taxation of salary was on the basis of the contractual right of the employee to receive his salary, and nothing else, and it had no relation with location or place of services rendered or to where the amount had become due. The place where it had become due and the place where service was rendered did not form a basis of charge u/s. 15.

It was further argued on behalf of the revenue that though the assessee had rendered services outside India, he had received salary in India by way of fund transfer from the foreign company directly to the NRE account of the assessee in India. It was argued that the receipt contemplated u/s. 5(2)(a) was actual receipt. Hence, such income was actually received in India and was taxable in India. Reliance was placed on the Third Member decision of the Mumbai bench of the tribunal in the case of Capt A L Fernandez vs. ITO 81 ITD 203, which was claimed to be directly on the point. The Bombay and Karnataka High Court decisions relied upon by the assessee were sought to be distinguished by the revenue, on the ground that they were rendered in the context of taxability u/s. 5(2)(b), and not section 5(2)(a), and that they did not frame any question of law.

The tribunal noted that the scheme of the Act was such that the charge of tax was made independent of territoriality, residency and currency. According to the tribunal, the assessee was only trying to introduce one more layer to the entire transaction, that the assessee had the control over his money in the form of salary income in international waters, and for the sake of convenience, he had instructed the foreign employer to send the monies to his NRE account in India. The assessee’s argument was that what was brought into India was not the salary income, but only the salary amount. The tribunal, however, held that there was no evidence brought on record to prove that the assessee had control over his salary income in international waters.

The tribunal further observed that if this argument of the assessee were to be accepted, then the assessee went scot-free, not paying tax anywhere in the world on this salary income. According to the tribunal, the provisions of section 5(2)(a) were probably enacted keeping in mind that income has to suffer tax in some tax jurisdiction. The tribunal observed that it believed that such provisions would exist in tax legislation of all countries.

The tribunal held that if the argument of the assessee were to be accepted, it would make the provisions of section 5(2)(a) redundant. A statutory provision was to be interpreted to make it workable rather than redundant. In case of non-residents, the scope of total income had four modes, one of which was receipt in India from whatever source derived. If this was construed to mean that income from whatever source should first accrue or arise in India, and then it should be received in India to be included u/s. 5(2)(a), then section 5(2)(a) would lose its independence and would become a subset of section 5(2)(b). There would then not be any need for having section 5(2)(a) on the statute.

The tribunal noted that the issue before the Bombay High Court in the case of Avtar Singh Wadhwan (supra) was about the place of accrual of income, and the court held that income accrued in the place where the services were rendered, which in that case, was admittedly outside India. According to the tribunal, the Bombay High Court did not deliberate upon the fact whether the receipt of the income was in India, as the issue was only about the place of accrual of income in the context of section 5(2) (b). This decision was followed by the Karnataka High Court in case of Prahlad Vijendra Rao (supra).

Addressing the argument of the assessee that salary was received on the high seas, and by way of convenient arrangement, was directed to be deposited in the NRE account of the assessee in India, the tribunal raised the question whether a person could receive salary on high seas. According to the tribunal, the only possibility of receiving salary on board a ship on high seas was to receive it in physical currency. The tribunal observed that it was not the assessee’s case that the physical currency got deposited in the NRE account. The money was transferred from the employers account outside India to the assessee’s NRE account in India.

Referring to the decision of the Agra bench of the tribunal in the case of Arvind Singh Chauhan (supra), the Kolkata tribunal observed that this decision was based on the decision of the Madras High Court in the case of Kalyanakrishnan (supra). In that case, the facts were distinguishable from the facts of the case before it, as the income in that case was taxable in Malaysia. In the case before the Kolkata tribunal, the income did not suffer tax in any other jurisdiction nor was it received in any other tax jurisdiction. The receipt in the NRE account in India was the first point of receipt by the assessee, and according to the tribunal, prior to that, it could not be said that the assessee had control over the funds that had been deposited in the NRE account by the employer. Based on the Madras High Court decision, the Agra bench had held that the assessee had a lawful right to receive the salary as an employee at the place of employment, i.e. at the location of his foreign employer, and it was a matter of convenience that the monies were thereafter transfer to India. The Kolkata tribunal observed that in section 5(2) (a), right to receive salary was not the relevant criterion, but the relevant criterion was the receipt of payment, which was admittedly in India. The Kolkata tribunal therefore expressed its doubts as to the applicability of the Madras High Court decision in Kalyanakrishnan’s case to the facts before it.

Finally, the Kolkata tribunal placed reliance on the Third Member decision of the Mumbai tribunal in the case of Capt A L Fernandes (supra), where the Mumbai tribunal held that there was a clear finding and there was no dispute that the salary was received in India. Since the ships were not regarded as part of India, the services were rendered outside India. However, since the salary was received in India, it was held to be taxable in India u/s. 5(2)(a). According to the Kolkatta tribunal, this decision clearly laid down that receipt in India of salary for services rendered on board a ship outside the territorial waters of any country would be sufficient to give the country where it was received, the right to tax the income on a receipt basis. The Kolkatta tribunal also noted that the Third Member decision was not brought to the notice of the Agra tribunal, when it decided the issue.

Since a Third Member decision was equivalent to a Special Bench decision, the Kolkata tribunal followed the Third Member decision, holding that salary was received in India by credit to the NRE account of the employee was taxable in India by virtue of the provisions of section 5(2)(a).

Observations
The issue really is whether the assessee can be said to have obtained control over his salary at the place where his employer is located, and therefore whether the receipt of the salary is outside India. While the Agra bench of the tribunal was of the view that the assessee obtained control over his salary at the place where his employer was located, as he had a right to receive the salary at that location, the Kolkatta bench was of the view that the assessee had not obtained control over his salary at the location of the foreign employer merely on account of the contract of employment.

Interestingly, the Supreme Court in the cases of Raghava Reddi vs. CIT 44 ITR 720 and Standard Triumph Motor Co Ltd v CIT 201 ITR 391, has held that crediting the account of the assessee in the books of the payer Indian company amounted to a receipt by the foreign company in India.

In Raghava Reddi’s case, the Supreme Court observed:
“This leaves over the question which was earnestly argued, namely, whether the amounts in the two account years can be said to be received by the Japanese company in the taxable territories. The argument is that the money was not actually received, but the assessee firm was a debtor in respect of that amount and unless the entry can be deemed to be a payment or receipt, clause (a) cannot apply. We need not consider the fiction, for it is not necessary to go to the fiction at all. The agreement, from which we have quoted the relevant term, provided that the Japanese company desired that the assessee firm should open an account in the name of the Japanese company in their books of account, credit the amounts in that account, and deal with those amounts according to the instructions of the Japanese company. Till the money was so credited, there might be a relation of debtor and creditor; but after the amounts were credited, the money was held by the assessee firm as a depositee. The money then belonged to the Japanese company and was held for and on behalf of the company and was at its disposal. The character of the money changed from a debt to a deposit in much the same way as if it was credited in bank to the account of the company. Thus, the amount must be held, on the terms of the agreement, to have been received by the Japanese company, and this attracts the application of section 4(1)(a). Indeed, the Japanese company did dispose of a part of those amounts by instructing the assessee firm that they be applied in a particular way. In our opinion, the High Court was right in answering the question against the assessee.”

In Standard Triumph Motor Co Ltd’s case, royalty income payable to the assessee was credited by the Indian company to the account of the assessee in its books of account at the end of each year. The Supreme Court observed:

“the credit entry to the account of the assessee in the books of the Indian company does amount to its receipt by the assessee and is accordingly taxable and it is immaterial when did it actually receive it in the UK.”

Therefore, where the foreign employer were to credit the account of the employee in its books of account in respect of the liability to pay salary, and were then to remit the money to India, it would amount to receipt of the salary income outside India in the first place on credit of the salary to the employee’s account.

One of the aspects, which needs to be borne in mind, is the issue of non-taxability of such income in any country, if it is not taxed on a receipt basis in India. Today, one of the major issues which countries are seeking to tackle is the issue of double non-taxation, through amendment of tax treaties. The Kolkata tribunal, in a way, seeks to address this aspect through its decision, though no tax treaties were involved in this case.

In the case of Capt A. L. Fernandes, the other issue which was decided by the Mumbai tribunal was that the salary income actually accrued or arose in India, on account of the contract of employment being signed in India, and all rights flowing from that also being enforceable in India, and therefore the concept of deemed accrual u/s 9(1) was irrelevant for the purpose. Therefore, the corollary of sections 9(1)(ii) and 9(1)(iii) could not be applied for the purpose. Interestingly, the Kolkata tribunal did not refer to or follow this aspect of the decision, when deciding the case before it, though in the facts of the case before it, the contracts of employment were signed in India.

Possibly, this is on account of the fact that the Bombay High Court had clearly held in the case of Avtar Singh Wadhwan (supra) that the relevant test to be applied to decide if income accrued to a non- resident in India or outside India, is where services are rendered, and not where the contract is signed. The Karnataka High Court also, in the case of Prahlad Vijendra Rao (supra), held that u/s. 15 of the Act, even on accrual basis, salary income is taxable i.e., it becomes taxable irrespective of the fact whether it is actually received or not; only when services are rendered in India it becomes taxable by implication. However, if services are rendered outside India, such income would not be taxable in India.

Lastly, while perhaps the view of the Kolkata Tribunal does seem to be the better position based on a strict reading of the provisions, one also needs to consider the fact that in both the cases, the salaries were credited to an NRE account with a bank in India. For all practical purposes, under the Foreign Exchange Management Act, such an account is treated as the equivalent of a foreign bank account of the depositor outside India – transfers from Non-Resident Ordinary accounts (which are nonrepatriable) to such NRE accounts are governed by the procedures applicable to repatriation of funds overseas, transfer of funds from such accounts overseas is freely permissible, interest on such accounts is not taxable, etc. Given this situation, should amounts received in such NRE bank accounts not be regarded as having been received outside India? What purpose would be served by having Indian citizens open overseas bank accounts to receive their foreign salaries in the first instance, just to save on tax on such salaries?

The CDBT has come out with clarifications in the past, regarding the residential status of seafarers operating on ships in international waters, and taxability of their salary. In order to avoid further litigation, and unnecessary reduction of inflows into NRE accounts, it would be better for the CBDT to clarify that such foreign salaries credited to NRE accounts of seafarers or other NRIs would not be regarded as having been received in India.

shailesh.kwebmaker

Derived or not Derived From …….. ……

ISSUE FOR CONSIDERATION
In the annals of the Income-tax Act, no controversy is buried for ever. Like a hydra, it raises its head at the first available opportunity. One such controversy is about the eligibility for an incentive deduction of interest, received on deposits made in the course of an activity of an under taking or a business, the income of which is otherwise eligible for deduction. Whether such an interest is derived from the eligible activity or business and therefore, qualifies for a deduction or not is an issue which refuses to die down and comes up with regularity before the courts, in varied circumstances, with interesting facets.

At a time when the import of the issue has been fairly understood and addressed by the law makers and the practitioners and was believed to have been settled, it has resurfaced with beautiful facts. The recent decision of the Bombay High Court on the subject has revived the controversy with an immortal life span.

CYBER PEARL’S CASE
The issue recently came up for consideration in the case of Cyber Pearl IT Park Pvt. Ltd. vs. ITO, 399 ITR 310 before the Madras High Court in the context of section 80IAB for A.Y. 2009-10. The assessee in that case was engaged in the business of developing and leasing of Information Technology parks. For the assessment year 2009-10, the assessee claimed deduction u/s. 80-IAB of the Act to the extent of Rs. 4,20,59,087 which included a sum of Rs. 2,52,04,544 representing interest which the assessee had earned from security deposits from persons who had taken on lease the facilities set up in the parks. In form 10CCB filed by the assessee, the claim for deduction u/s. 80-IAB was restricted to a sum of Rs. 1,68,54,543. Based on this, the Assessing Officer passed an order u/s. 143(3) of the Act, restricting the deduction to a sum of Rs. 1,68,54,543 and treating the sum of Rs. 2,52,04,544, which was interest received by the assessee from security deposits given by the lessees as income from other sources. The CIT(A) confirmed the order of the AO and the Tribunal rejected the assessee’s claim for deduction qua the balance sum, i.e. Rs. 2,52,04,544 on two grounds: (a) that via auditor’s certificate issued in form 10CCB, the claim u/s. 80-IAB had been restricted to Rs. 1,68,54,543, (b) that the interest received from security deposit in the sum of Rs. 2,52,04,544 had “no direct nexus” with the industrial undertaking.

On further appeal to the High Court, the assessee contended the following:

–    the Tribunal did not appreciate the fact that in the income tax return filed by the assessee, the entire amount, of Rs. 4,20,59,087 was claimed as a deduction. The learned counsel submitted that because the mere fact that Form 10CCB restricted the claim to a sum of Rs. 1,68,54,543 could not be a ground for denying the deduction, which the assessee could otherwise claim as a matter of right u/s. 80-IAB.
–   the interest derived from the security deposit upon its investment in fixed deposits with the bank, was income, which was derived from business of developing a Special Economic Zone and therefore, was amenable to deduction u/s. 80-IAB.
–   the issue was settled in favour of deduction by the Bombay High Court in CIT vs. Jagdishprasad M. Joshi, 318 ITR 420 (Bom).

In response on the other hand, the Revenue made the following submissions.
–    for the interest earned from security deposits, to be amenable to deduction u/s. 80-IAB, it should have a “direct nexus” with the subject activity, which was, the business of developing a special economic zone.
–    only those profits and/or gains, which were derived by an undertaking or an enterprise from “any” business of developing a Special Economic Zone, would come within the purview of section 80-IAB.
–   in the following cases, the courts have held that the deduction was not eligible:

(i)   CIT vs. A.S. Nizar Ahmed and Co., 259 ITR 244 (Mad)
(ii)   CIT vs. Menon Impex P. Ltd., 259 ITR 403 (Mad)
(iii)   Pandian Chemicals Ltd. vs. CIT, 262 ITR 278 (SC)
(iv)   CIT vs. Shri Ram Honda Power Equip, 289 ITR 475 (Delhi)
(v)   Dollar Apparels vs. ITO, 294 ITR 484 (Mad)
(vi)   Sakthi Footwear vs. Asst. CIT(No.1), 317 ITR 194 (Mad)
(vii)   CIT vs. Mereena Creations, 330 ITR 199 (Delhi) and
(viii)   CIT vs. Tamil Nadu Dairy Development Corpo.Ltd., 216 ITR 535 (Mad).

The High Court, on an analysis of provisions of section 80-IAB, observed that an assessee was entitled to a deduction of the profits and gains derived by an undertaking or an enterprise from the business of developing a special economic zone. On examination of the decision of the Supreme Court in Pandian Chemicals Ltd.’s case (supra), and applying it to the case before it, the court observed as under;
– Pandian Chemicals Ltd. was a case for deduction u/s. 80-HH in respect of interest on deposits with Electricity Board for supply of electricity to industrial undertaking and the issue therein was whether such interest could be construed to be profits and gains ‘derived’ from an industrial undertaking and were eligible for deduction.
– the Supreme Court rejected the claim of the assessee by observing that the term ‘derived’ concerned itself with effective source of income only and did not embrace the income by way of interest on deposits made, which was a
secondary source.

–    only such income was eligible for deduction which had a direct or immediate nexus with the industrial undertaking.
–   the term ‘derived from’ had a narrower meaning than the term ‘attributable to’ and excluded from its scope the income with secondary or indirect source as was explained by various decisions of the apex court including in the cases of Cambay Electric Supply Industrial Co. Ltd., 113 ITR 84 (SC) and Raja Bahadur Kamakhaya Narain Singh, 16 ITR 325 (PC) and Sterling Foods, 237 ITR 579(SC).
–    the Madras High Court in the case of Menon Impex P. Ltd. 259 ITR 403 denied the deduction us. 10A by holding that interest on deposits made for obtaining letter of credit was not ‘derived from’ the undertaking carrying on the business of export.
–    the contention of the assessee that the decisions cited by the Revenue did not deal with the provisions of
section 80-IBA of the Act was to be rejected as the provisions of section 80-IBA were found to be para materia with the provisions dealt with in those cases, as all of them were concerned with the true meaning of the term ‘derived from’ whose width and amplitude was narrower in scope than the term “attributable to”.
–    once it was found that income was from a secondary source, it fell outside the purview of desired activity, which in the case before them was the business of developing a Special Economic Zone.

In deciding the case, in favour of the Revenue, the court was unable to persuade itself to agree with the decision of the Bombay High Court in the case of CIT vs. Jagdishprasad M. Joshi, 318 ITR 421 which had taken a contrary view on the subject of deduction of interest.

JAGDISHPRASAD JOSHI’S CASE
The issue had come up for consideration before the Bombay High Court in the case of CIT vs. Jagdishprasad M. Joshi, 318 ITR 421 in the context of section 80-IA for A.Y. 1997-98.

In that case, the court was asked to address the following substantial question of law; “Whether, on the facts and in the circumstances of the case and in law, the Tribunal was right in allowing the appeal of the assessee holding that the interest income earned by the assessee on fixed deposits with the bank and other interest income are eligible for deduction u/s. 80-IA of the Income-tax Act, 1961 ?”

On behalf of the Revenue, a strong reliance was placed upon the judgement of the Supreme Court in the case of Pandian Chemicals Ltd.(supra) and also the judgement of the Madras High Court in the same case reported in 233 ITR 497.

On behalf of the assessee, equally strong reliance was placed on the judgement of the Delhi High Court in the case of CIT vs. Eltek SGS P. Ltd.,300 ITR 6, wherein the Delhi High Court had considered the very same issue, and in the process examined the applicability of the judgement relied upon by the Revenue, and the court in Eltek’s case. The Delhi High Court had distinguished the language employed under sections 80-IB and 80-HH and had observed as under :
“ That apart s. 80-IB of the Act does not use the expression ‘profits and gains derived from an industrial undertaking’ as used in s. 80-HH of the Act but uses the expression ‘profits and gains derived from any business referred to in sub-section’..

A perusal of the above would show that there is a material difference between the language used in s. 80-HH of the Act and s. 80-IB of the Act. While s. 80-HH requires that the profits and gains should be derived from the industrial undertaking, s. 80-IB of the Act requires that the profits and gains should be derived from any business of the industrial undertaking. In other words, there need not necessarily be a direct nexus between the activity of an industrial undertaking and the profits and gains.

Learned counsel for the Revenue also drew our attention to Pandian Chemicals Ltd. vs. CIT, 262 ITR 278 (SC). However, on a reading of the judgement we find that also deals with s. 80-HH of the Act and does not lay down any principle different from Sterling Foods, 237 ITR 579 (SC). Reliance has been placed on Cambay Electric Supply Industrial Co. Ltd., 113 ITR 84 (SC) and the decision seems to suggest, as we have held above, that the expression ‘derived from an industrial undertaking’ is a step removed from the business of the industrial undertaking.”

The Bombay High Court dismissed the appeals, approving the decision of the Tribunal, holding that no substantial question of law arose in the appeal of the Revenue. The deduction allowed u/s. 80-IA to the assessee was upheld.

OBSERVATIONS
A few largely undisputed understandings, in the context of the issue under consideration, of the eligibility of an income from interest or any other receipt, are listed as under:
–   the term ‘attributable to’ is wider in its scope than the term ‘derived from’,
– the
term ‘attributable to’ is wider in its scope than the term ‘derived from’,
which has a limited scope of inclusion.
–    the term ‘attributable to’ usually includes in its scope, a secondary and indirect source of income, besides the primary and the derived source of income.
–    as against the above, the term ‘derived from’ means a direct source and may include a source which is intricately linked to the main activity which is eligible for deduction.
–    the difference between the two terms is fairly addressed to, explained and understood, not leaving much scope for assigning a new meaning.

It is also understood that the term ‘derived from’, is capable of encompassing within its scope, such income or receipts which can also be construed to be the primary source of the eligible activity or is found to be intricately and inseparably linked thereto.

Under the circumstances, whether a particular receipt or an income is derived from or not and is eligible for the deduction or not are always the questions of fact and no strait-jacket formula can be supplied for the same.

The legislature has from time to time enacted provisions for conferring incentives for promoting the preferred or the desired activities or businesses, over a period of almost a century. Obviously, the language employed in the multitude of sections and provisions varies and thereby, it has become extremely difficult to apply the ratio of one decision to the facts of another case, as a precedent. A little difference in the language employed by the legislature invites disputes, leading to a cleavage of judicial views as is seen by the present controversy under discussion. At times, it becomes very difficult to resolve an issue simply on the basis of the language alone, even where the provisions are otherwise required to be construed liberally, in favour of the tax payers.

An attempt has been made to list down a few of the examples of the language used in the different provisions of chapter VI-A and sections 10 A to 10 C of the Act.
–    Profits and gains derived from an industrial undertaking.
–    Profits and gains derived from the business of a hotel or a ship.
–    Profits and gains derived from a small scale industry.
–    Profits and gains derived from a business of …..
–   Profits and gains derived from execution of a Housing Project.
–    Profits and gains derived from exports.
–    Profits and gains derived from services.
–    Profits and gains derived from such business.
–    Profits and gains derived from an undertaking or an enterprise from any business of …..
–    100% of the profits.
–   Profits and gains derived by an undertaking from exports.

The list, though not exhaustive, highlights the possibility of supplying different meanings based on the difference in the language employed by the legislature. The major difference that has emerged in the recent years is between the following three terminologies:
–    Profits and gains derived from an undertaking .
–    Profits and gains derived from an undertaking or an enterprise from any business of …..
–   Profits and gains derived from a business of …..

The rules of interpretation provide that each word, or the omission thereof, should be assigned a specific meaning and should be believed to be inserted or omitted by the legislature with a purpose. Nothing should be believed to be meaningless. Applying this canon of interpretation, the Delhi High Court in the case of Eltek SGS P. Ltd. 300 ITR 006, in the context of section 80 IB, refused to follow the decisions in the cases of Cambay Electric Supply Industrial Co. Ltd. (supra), Sterling Foods (supra) and Pandian Chemicals Ltd. (supra) and Ritesh Industries, 274 ITR 324 (Delhi), by distinguishing the language used in sections 80 HH and 80 I from that used in section 80- IB of the Act. The High Court chose to strengthen its case by referring to the decision of the Gujarat High Court in the case of Indian Gelatin and Chemical Ltd. 275 ITR 284 (Guj). As noted earlier, in respect of income from interest, the Bombay High Court in Jagdishprasad’s case has followed the decision of the Delhi High Court in Eltek’s case in respect of duty drawback.

It is crucial to appreciate the difference in the language in section 80HH, section 80-I and section 80-IB of the Act. The language used in section 80-IB of the Act is a clear departure from the language used in section 80-HH and section 80-I of the Act. It is this choice of words that makes all the difference to the controversy that we are concerned with.

The court in Eltek’s case found it to be not necessary to go as far as the Gujarat High Court had done in coming to the conclusion that duty drawback was profit or gain derived from the business of an industrial undertaking. It was sufficient for the Court to stick to the language used in section 80-IB of the Act and come to the conclusion that duty drawback was profit or gain derived from the business of an industrial undertaking. The language used in section 80-IB of the Act, though not as broad as the expression ‘attributable to’ referred to by the Supreme Court in Sterling Foods and Cambay Electric’s cases is also not as narrow as the expression ‘derived from’. The expression “derived from the business of an industrial undertaking” is somewhere in between.

The distinction between the language employed in two different provisions has been noticed favourably by the courts in the judgements in the cases of Dharampal Premchand Ltd., 317 ITR 353 (Delhi) and Kashmir Tubes, 85 Taxmann.com 299 (J &K). In contrast, the Punjab & Haryana High Court following Liberty India, 317 ITR 258 (SC), has denied the deduction in spite of being informed about the difference in the language employed in the two provisions. [Raj Overseas, 317 ITR 215 and Jai Bharat Gums, 321 ITR 36].

A serious note needs to be taken of the decision of the Jammu & Kashmir High Court in the case of Asian Cement Industries, 261 CTR 561 wherein the court on a combined reading of section 80-IB(1) with section 80-IB(4), in the context of interest, held that nothing turned on the difference in language between the sections 80HH and 80IB and that the law laid down by the Supreme court in the cases of Sterling Foods (supra) and Pandian Chemicals Ltd. (supra) applied to section 80-IB as well. Similarly, the Uttarakhand High Court in the case of Conventional Fasteners, 88 Taxmann.com 163 held that the difference noted by the High Court in Eltek and Jagdishprasad’s cases was not of relevance and the ratio of the Supreme Court’s decisions continued to apply, in spite of the difference in language of the provisions.

Lastly, a careful reference may be made to the Supreme Court decision in the case of Meghalaya Steels, Ltd., 383 ITR 217 for a better understanding of the subject on hand. A duty drawback or refund of excise duty or receipt of an insurance claim or sale proceeds of scrap and such other receipts has obviously a better case for qualifying for deductions.

The better view appears to be that the use of different languages and terminologies in some of the provisions has the effect of expanding the scope of such provisions for including such incomes that may otherwise be derived from secondary source of the activity; more so, on account of the accepted position in law that an incentive provision should be construed in a manner that allows the benefit, than that denies the benefit. _

shailesh.kwebmaker

Annual Value of a Vacant Property

Issue for Consideration

The annual value of any building or land
appurtenant thereto is chargeable to income tax in the hands of the owner,
under the head ‘Income from House Property’, as per section 22 of the
Income-tax Act. The amount received or receivable is deemed to be the annual
value, as per section 23(1)(c), in a case where the property is let and was
vacant during the whole or any part of the previous year and as a result
thereof, the amount received or receivable is less than the sum for which the
property is reasonably expected to be let from year to year.

The relevant part of section 23(1),
substituted with effect from 1.4.2002, reads as under:

23.
(1) For the purposes of section 22, the annual value of any property shall be
deemed to be—

(a) the sum for which the
property might reasonably be expected to let from year to year; or

(b) where the property or any
part of the property is let and the actual rent received or receivable by the
owner in respect thereof is in excess of the sum referred to in clause (a), the
amount so received or receivable; or

(c) where the property or any
part of the property is let and was vacant during the whole or any part of the
previous year and owing to such vacancy the actual rent received or receivable
by the owner in respect thereof is less than the sum referred to in clause (a),
the amount so received or receivable :

Issues arise in interpretation and application
of clause (c) of section 23(1), particularly about the possibility of claiming
the benefit of section 23(1)(c) by limiting the deemed annual value determined
under clause (a), in cases where the property was not let out during the year
and had remained vacant throughout the year. An additional dimension is
provided to the issue in a case where attempts are made to let out the property
without success, or where the property was let out during the preceding
previous year, but had remained vacant during the previous year.

A controversy has arisen around the true
import of clause (c) on account of certain decisions, whereunder the Pune and
other benches of the Income Tax Appellate Tribunal have taken a view that the
benefit of clause (c) shall be available even in cases where a property had
remained vacant throughout the year. Against that the Mumbai bench had recently
held that the property should have been let, at least for some part of the
year, for availing the benefit under the said clause.

Vikas Keshav Garud’s Case

The issue in
the recent past had arisen in the case of Vikas Keshav Garud vs. ITO, 71
taxmann.com 214,
before the Pune Bench of the Tribunal for assessment year 2009-10.

In that case, the commercial premises
situated at Dande Towers, Pune, owned by the assessee, had remained vacant
throughout the financial year 2008-09. The assessee had not offered any deemed
income for the purposes of taxation for assessment year 2009-10. The A.O.
however assessed the notional income of the premises at Rs. 1,51,200 under the
head ‘Income From House Property’ by adopting annual letting value of Rs.
12,600 p.m., which was the monthly rent received by the assessee during the
financial year 2006-07 from a tenant.

The assessee challenged the assessment under
the head ‘Income from House Property’ before the CIT(A) in appeal, which was
dismissed by the CIT(A), by confirming the action of the A.O., relying on the
decision of the Andhra Pradesh High Court in the case of Vivek Jain vs.
ACIT, 337 ITR 74 (AP).

The Tribunal, in a further appeal by the
assessee, noticed that the A.O. had denied the benefit of clause (c) on the
ground that the property was not let at all during the year under consideration
and had also held that the intention to let out the property had no bearing on
application of the provisions of clause (c) of section 23(1); that the assessee
had ardently contested the action of the A.O. by relying on the decisions,
before the CIT(A) in the cases of Premsudha Exports (P.) Ltd. vs. ACIT, 110
ITD 158 (Mum) and Shakuntala Devi vs. DDIT, ITA No. 1520/Ban/2010 dt.
20.12.2011; that both the authorities had relied upon the decision in the
case of Vivek Jain (supra) for denying the benefit of clause (c) and
rejecting the claim of the assessee.

The Tribunal noted that the property was let
out in financial year 2006-07 to IDBI Home Finance Ltd. at a monthly rent of
Rs. 12,600 and that the assessee could not let out the property during the
year, which led to the property remaining vacant throughout the year, though it
was available for being let and the intention to let, though clear, could not
fructify into actual letting. The Tribunal, in allowing the claim of the
assessee, held that the underlying principle of the provision was to be viewed
with regard to the intention of the assessee in letting out of the property,
together with the efforts put in by assessee for such letting out; that the
actual rent received from the property would have to be considered as ‘zero’ in
case of an assessee who made appropriate efforts for letting the property, but
failed to let.

Importantly, the Tribunal held that the
language of section 23(1)(c) clearly included a situation, where a property was
vacant for the whole year; that a situation could not co-exist wherein the
property was let during the year, with it being simultaneously vacant for the ‘whole’
year; that the words ‘let’ and ‘vacant’ were mutually exclusive;
that the interpretation placed by the authorities was inconsistent with the
phraseology of the provision.

The Tribunal gathered the legislative intent
of allowing the benefit of clause (c) in the given situation, by contrasting
the provisions of sub-section (3) of section 23 of the Act, whereunder the
legislature in its wisdom used the phraseology ‘house is actually let’.
The Tribunal observed that the legislature, wherever required, had insisted on
actual letting of the property in express terms. Applying the purposive
interpretation, the Tribunal held that the expression “property is let”
had to be read in contrast to “property is self-occupied” to arrive at
the true import of clause (c).

Importantly, the Tribunal observed that the
decision of the high court in Vivek Jain’s case (supra) could not
be read by the revenue in a manner that if the property remained vacant
throughout the year, section 23(1)(c) did not apply at all. The Tribunal also
relied on the fact that the property was actually let out during the financial
year 2006-07. In the totality of the circumstances and having regard to the
provisions of the Act, the Tribunal held that the annual value for the property
had to be assessed at Nil. The appeal of the assessee on this ground was
accordingly allowed by the tribunal.

A similar view was taken by the Mumbai bench
of the Tribunal in the case of Informed Technologies India Ltd. vs. Dy CIT
162 ITD 153.

Sharan Hospitality (P.) Ltd.’s case

The issue again arose before the Mumbai
bench of the ITAT in the case of Sharan Hospitality (P.) Ltd. vs. DCIT in
ITA No. 6717/Mum/2012 dt. 12.09.2016 for assessment year 2009-10.

The assessee company, in the facts of the
case during the previous year under consideration, had acquired two properties.
One of the properties was acquired on December 18, 2008 and possession was
received on the same date. The property was acquired with the intent of
letting, so as to earn rental income. The assessee had entered into
negotiations with a company, which was in the process of setting up a state of
the art laboratory, at the relevant time. The basic terms and conditions agreed
upon between the parties for taking the property on rent, w.e.f 1.4.2009
onwards, were recorded in a letter of Intent dated February 9, 2009. The
property was accordingly let with effect from 1.4.2009 at the agreed rent of
Rs.38.95 lakh per month vide Leave and License Agreement dated 06.08.2009. The
Assessing Officer computed the annual value of the said property for assessment
year 2009-10 at Rs.116.85 lakh, i.e., taking notional rent for three months,
being January to March, 2009, ignoring the fact that the property was vacant
during that period. The action of the AO was confirmed by the CIT(A).

In appeal to the Tribunal, the assessee,
while not disputing the quantum of the gross annual rental value, claimed that,
inasmuch as the property, though lettable, was ‘vacant’ during the entire
period of the year since its acquisition in December, 2008; that its annual
value ought to be restricted to the actual rent received or receivable, i.e.,
Nil; that the condition of the property being let was met by the intent to let
out the same; that when the legislature had required the house property to be
actually let, it had stated so, as in section 23(1)(a); that not accepting the
claim of assessee would lead to absurd results, as in a case where the property
was not let for a single day of the year, and was vacant for the whole year,
its AV would stand to be computed taking the lettable value for the entire
year, while if it was let even for a single day during the year, the same would
stand restricted to the actual rent received/receivable, i.e., for one day.

It was further argued that the property
could not be ‘let’ and be ‘vacant‘ for the whole year at the same
time in-as-much as the two conditions could not co-exist, as was pointed out by
the Tribunal in Premsudha Exports (P.) Ltd. vs. ACIT, 295 ITR (AT) 341
(Mum). The words “where the property was let” were to be
construed to include property held with the intent of letting it. Reliance was
also placed on decisions in cases of, Kamal Mishra vs. ITO 19 SOT 251 (Del);
Smt. Poonam Sawhney vs. AO, 20 SOT 69 (Del.); ACIT vs. Dr. Prabha Sanghi, 139
ITD 504 (Del); DLF Office Developers vs. ACIT, 23 SOT 19 (Del); Indu Chandra
vs. DCIT in ITA No. 96/2011 (Luck.); Shakuntala Devi vs. Dy. DIT (in ITA No.
1524/Bang/2010 dated 20.12.2011); Aryabhata Properties Ltd. vs. ACIT (in ITA
No. 6928/Mum/2011 dated 31.7.2013); and ACIT vs. Suryashankar Properties
Ltd. in ITA No. 5258/Mum/2013 dated 10.6.2015).

The Revenue, in reply, contended that the
notion of ‘proposed to be let’ or ‘held for letting‘, etc.,
could not be imported into the provision, which sought to bring to tax a
notional sum, being the income potential – termed annual value, of a house
property, subject of course to the provisions of the Act, the measure of which
was the fair rental value, defined as the rent at which the house property
might reasonably be let from year to year; that it had nothing to do with the
actual letting of the house property, or the actual receipt of rent, and was in
the nature of an artificial or statutory income; the law in the matter was
well-settled, by the decision in case of CIT vs. Dalhousie Properties Ltd.,
149 ITR 708 (SC); New Piece Goods Bazar Co. Ltd. vs. CIT, 18 ITR 516 (SC); CIT
vs. H. G. Gupta & Sons, 149 ITR 253 (Del); and Sakarlal Balabhai vs.
ITO, 100 ITR 97 (Guj). It was further contended that the annual value,
irrespective of whether the property was actually let or not, was thus to be
subjected to tax, unless covered u/s. 23(1)(b), as was reiterated in Sultan
Brothers (P.) Ltd. vs. CIT, 51 ITR 353 (SC) and In Liquidator of
Mahamudabad Properties (P.) Ltd. vs. CIT, 124 ITR 31 (SC), wherein it was
held that even where the property was found to be in a state of utter
disrepair, it would yet have some annual value. The decisions relied upon by
the assessee, viz. Premsudha Exports (P.) Ltd. (supra); Shankuntala
Devi (supra); and Indu Chandra (supra) were claimed to be
distinguishable on facts. Reliance was placed on the case of Vivek Jain vs.
ACIT 337 ITR 74 (AP), wherein the Andhra Pradesh high court, had rejected
similar contentions as were made in the instant case.

The Tribunal noted that a deduction for
vacancy allowance up to assessment year 2001-02, was allowable under clause
(ix) of section 24(1) which clause was omitted w.e.f. assessment year 2002-03.
Instead, section 23(1), substituted w.e.f. A.Y. 2002-03, contained clause (c)
that provided for appropriate reduction of annual value in cases where a let
property was vacant. The Tribunal simultaneously took note of various decisions
of the courts, wherein it was held that the vacancy allowance of the kind
provided u/s. 24(1)(ix) could not be claimed if the property was not let out at
all during the previous year concerned, and that a proportionate amount out of
the annual value was permissible to be deducted, only where the property was
let out for a part of the year.

The Tribunal further noted that the issue,
u/s. 24(1)(ix), was well settled in favour of the view that a vacancy allowance
was possible only where the property was let out for a part of the year and not
where the property remained vacant throughout the year. Importantly, the
Tribunal in paragraph 5.3 of its order observed, that the position of the law qua
vacancy remission, post amendment, remained the same. The law laid down by
the courts in interpreting section 24(1)(ix) materially remained the same u/s.
23(1)(c), and therefore, no adjustment was possible under clause (c) of section
23(1) for a property which was vacant throughout the year. It also referred to
Circular no. 14 of 2001 issued by the CBDT for explaining the provisions of the
Finance Act, 2001 and to the Notes to clauses and the Explanatory Memorandum
accompanying the said Finance Act.

The Tribunal, in paragraph 5.2, took a
detailed note of the decision of the Andhra Pradesh high court in the case of Vivek
Jain (supra) and the reasons supplied by the court in arriving at the
conclusion that no adjustment was possible u/s. 23(1)(c) on account of vacancy
in a case where the property was not let out at all during the year of
assessment.

The Tribunal also took note of the decisions
in cases of Ramesh Chand vs. ITO 29 SOT 570 (Agra) and Indra S. Jain
vs. ITO, 52 SOT 270 (Mum.), wherein a view similar to the one being
advocated by the revenue was taken. The plethora of cases cited by the assessee
in favour of its claim including the case of Premsudha Exports (P.) Ltd. vs.
ACIT, 295 ITR (AT) 341 (Mum.), could not persuade the Tribunal to allow a
relief under clause (c) of section 23(1). On the contrary, the Tribunal
expressed its anguish that the different benches in the past failed to take
notice of the decision in the case of Vivek Jain (supra) and also did
not notice the developed law on the subject while deciding the issue u/s.
24(1)(ix), now omitted. It also observed that the Tribunal, in any case, was
not competent to read down the provision of law in a manner desired by the
assessee.

The Tribunal further observed that vacancy
as a concept had a symbiotic relationship with the notion of letting out and both
of them were intrinsically linked. There could not be a vacancy without actual
letting and there was no scope for the application of the ‘principle of causus
omissus’, inasmuch as the law on the subject was abundantly plain and
clear. A vacancy could not exist or be considered independent of and de hors
the letting. The assessee’s appeal was accordingly dismissed.

Observations

The issue under consideration has become
extremely contentious in as much as some of the decisions, delivered by
different benches of the Tribunal, uphold the claim for relief u/s. 23(1)(c) on
account of vacancy, even after the sole decision of the high court on the
subject in the case of Vivek Jain (supra), a decision which was cited
specifically in Vikas Keshav Garud’s case (supra).

In Vivek Jain’s case (supra), the
assessee, a practicing advocate, had adopted an annual value of Rs. Nil in
respect of a property that was vacant during the year as the same was not let
out. The benefit of section 23(1)(c) claimed by him was rejected by the AO, the
CIT(A) and the ITAT. In the further appeal u/s. 260A, the Andhra Pradesh High
Court upheld the action of the assessing officer with the following findings
and observations;

– the
contention that, as clause (c) provided for an eventuality where a property
could be vacant during the whole of the relevant previous year, both
situations, i.e., “property is let” and “property is vacant for
the whole of the relevant previous year”, could not co-exist, did not
merit acceptance.

– a
property let out for two or more years could also be vacant for the whole of a
previous year bringing it within the ambit of clause (c) of section 23(1) of
the Act.

– clause
(c) encompassed only such cases where a property was let out for more than a
year in which event alone would the question of it being vacant during the
whole of the previous year arose.

– the
contention that, if the owner had let out the property even for a day, it would
acquire the status of “let out property” for the purpose of clause
(c) for the entire life of the property even without any intention to let it
out in the relevant year was also not tenable.

– the circumstances in which the annual let out value of a house
property should be taken as nil was as specified in section 23(2) of the
Act.

– u/s.
23(l)(c), the period for which a let out property might remain vacant could not
exceed the period for which the property had been let out.

– if
the property had been let out for a part of the previous year, it can be vacant
only for the part of the previous year for which the property was let out and
not beyond.

– for that part of the previous year during which the property was not
let out, but was vacant, clause (c) would not apply and it was only clause (a)
which would be applicable, subject of course to sub-sections (2) and (3) of
section 23 of the Act.

– such
a construction did not lead to any hardship, inconvenience, injustice,
absurdity or anomaly and, therefore, the rule of ordinary and natural meaning
being followed could be departed from.

– the
benefit u/s. 23(1)(c) could not be extended to a case where the property was
not let out at all.

– there
was no merit in the submission that the words “property is let” were
used in clause (c) to take out those properties which were held by the
owner for self-occupation from the ambit of the said clause.

– section
23(2)(a) took out a self-occupied residential house, or a part thereof,
from the ambit of section 23(1) of the Act. Likewise, u/s. 23(2)(b),
where a house could actually not be occupied by the owner, on account of his
carrying on employment, business or profession at any other place requiring him
to reside at such other place in a building not belonging to him, the annual
value of the property was also required to be treated as nil, thereby taking it
out of the ambit of section 23(1) of the Act. Section 23(3)(a) makes it
clear that section 23(2) would not apply if the house, or a part thereof, was
actually let during the whole or any part of the previous year. Thus, only such
of the properties which were occupied by the owner for his residence, or which
were kept vacant on account of the circumstances mentioned in clause (b)
of section 23(2), fell outside the ambit of section 23(1) provided they were,
as stipulated in section 23(3)(a), not actually let during the whole or part of
the previous year.

– clause
(c) was not inserted to take out from its ambit properties held by the
owner for self-occupation inasmuch as section 23(2)(a) provided for such
an eventuality.

– it
was only to mitigate the hardship faced by an assessee, and as clause (b)
did not deal with the contingency where the property was let and, because of
vacancy, the actual rent received or receivable by the owner was less than the
sum referred to in clause (a), that clause (c) was inserted.

– in
cases where the property had not been let out at all, during the previous year
under consideration, there was no question of any vacancy allowance being
provided thereto u/s. 23(l)(c) of the Act.

– the
order of the Tribunal, denying the benefit of vacancy u/s. 23(1)(c), was
upheld.

The unfairness of the law is manifest in
cases where the property is ready for being let out and cannot be let out in
spite of the best of the efforts of the owner. This unfairness is further
aggravated in a case where the property was let out in the past but could not
be let out during the year. It is in such circumstances that the decision of the
Andhra Pradesh high court hits hard and perhaps requires reconsideration. It is
true that the court had comprehensively examined the provisions, on hand, of
section 23(1)(c). There, however, is an urgent need to appreciate the
following:

– the
provisions of section 23(1)(c) are materially different than the erstwhile
provisions of section 24(1)(ix), and therefore the case law developed on the
subject of a provision, now omitted, i.e. based on past law, should not color
the outcome on a new provision of law. An independent appraisal of section
23(1)(c) on the basis of the language of the law is required.

– the
express words of the phraseology ‘was vacant during the whole or any part of
the previous year’ in section 23(1)(c) requires to be given due weightage.
While the Andhra Pradesh High Court has sought to give meaning to the term ‘whole’
in the provision by explaining that it dealt with a situation involving letting
out of the premises for longer period, it remains to be interpreted in the
context of real life situations involving shorter periods of letting out. There
is no reason to not apply the provision in cases of letting out for shorter
periods and, if done so, there is a good possibility of a relief in such cases.

– again,
the use of the phraseology ‘actually let’ in section 23(3)(a), during the whole
or any part of the previous year, clearly indicates that the legislature
whenever intended has in express terms provided for actual letting out of the
premises during the year itself. This aspect, though examined by the court, in
our respectful opinion, requires to be reviewed in as much as the fact
continues to be that the term ‘actually let’ has been used in contradiction to
only ‘let’ in the same section 23(3).

– it
is impossible to envisage a situation wherein a property is vacant for the
‘whole of the year’ and is still let out during the same year. The property is
either vacant or let out.

We are of the considered view that the
provisions of section 23(1)(c), when read in the manner in which it has been
read by the Andhra Pradesh High Court, results in unjust deprivation of a
deserving benefit in cases where the property had remained vacant throughout
the year and was not put to any use. The legislative intent therefore requires
to be clarified, or the law requires to be amended to restore the equity and
fairness.

shailesh.kwebmaker

Set-Off of Losses from an Exempt Source Of Income

Issue for consideration

It is usual to come across cases of losses
on transfer of shares of listed companies held as long term capital assets.
These losses arise for several reasons including on account of erosion in
value, borrowing cost and indexation. Such losses, where on capital account,
are computed under the head ‘capital gains’. Any long-term capital gains on
transfer of listed shares, on which STT is paid, is exempt from liability to
taxation u/s. 10(38) provided the conditions prescribed therein are satisfied.

Sections 70 and 71 permit the set-off of the
losses under the head ‘capital gains’ against any other income within the same
head of income and also against the income under any other sources subject to
certain specified conditions.

An issue often discussed is about the
eligibility of the losses, of the nature discussed above, for set-off in
accordance with the provisions of section 70 and 71 of the Act. In the recent
past, the Mumbai bench of the Tribunal held that such losses are eligible for
set-off against income from other sources, while the Kolkata bench held that it
is not permissible to do so.

LGW Ltd.’s case

The issue arose in the case of LGW Ltd.
vs. ITO, 174 TTJ 553 (Kol.). In that case, the assessee incurred a loss of
Rs.5,00,160 on sale of listed shares for assessment year 2009-10. The loss was
claimed as a deduction in the computation of the total income by setting off
against the other income. The AO disallowed the set-off of loss in view of the
fact that section 10(38) exempted any income arising from the long-term capital
asset being equity share and as such the loss if any should be kept outside the
computation of the total income; thus, loss in view of section10(38), would not
enter the computation of total income of an assessee. The appeal of the
assessee against the said order was dismissed by the CIT(A). The assessee not
being satisfied raised the following ground before the Tribunal; “That the
learned Commissioner of Income Tax (Appeals) erred in confirming the
disallowance of loss of Rs.5,00,160 incurred by the assessee company on sale of
Long Term investment in shares.”

On behalf of the assessee, it was submitted
that section 10(38) of the Act used the expression “any income” and
therefore loss on sale of long term capital asset being equity shares should be
allowed as deduction. In reply, the Revenue relied on the order of CIT (A).

The Tribunal observed that the stand taken
by the assessee was not acceptable in view of the decision in the case of CIT
vs. Harprasad & Co. (P.) Ltd. 99 ITR 118 (SC)., and cited with approval
the following part of the decision : ‘From the charging provisions of the
Act, it is discernible that the words ” income ” or ” profits
and gains ” should be understood as including losses also, so that, in one
sense ” profits and gains ” represent ” plus income ”
whereas losses represent ” minus income ” (1). In other words, loss
is negative profit. Both positive and negative profits are of a revenue
character. Both must enter into computation, wherever it becomes material, in
the same mode of the taxable income of the assessee. Although section 6
classifies income under six heads, the main charging provision is section 3
which levies income-tax, as only one tax, on the ” total income ” of
the assessee as defined in section 2(15). An income in order to come within the
purview of that definition must satisfy two conditions. Firstly, it must
comprise the ” total amount of income, profits and gains referred to in
section 4(1) “. Secondly, it must be ” computed in the manner laid
down in the Act “. If either of these conditions fails, the income will
not be a part of the total income that can be brought to charge.’

The Tribunal noted that Supreme Court in
that case, took note of the fact that any capital gains arising between April 1, 1948, and April 1,
1957 was not chargeable to tax and therefore had held that the condition, namely,
“the manner of computation laid down in the Act” which “forms
an integral part of the definition of ‘ total income’ ” was not
satisfied and in the assessment year,
capital gains or capital losses did not form part of the “total
income” of the assessee which could be brought to charge, and therefore,
were not required to be computed under the Act.

The Tribunal held that the law laid down by
the Supreme Court clearly supported the stand taken by the Revenue and as a
consequence, the claim for deduction by way of set-off of loss was without any
merit and the same was dismissed.

Raptakos Brett & Co. Ltd.’s case

The issue arose in the case of Raptakos
Brett & Co. Ltd. vs. DCIT, 58 taxmann.com 115 (Mumbai). In that case,
the assessee, a pharmaceutical company, in the computation of income had shown
long term capital loss on sale of shares amounting to Rs.57,32,835 and loss on
sale of mutual funds units amounting to Rs.2,61,655. The said long term capital
loss had been set off against the long term capital gains of Rs.94,12,00,000
arising from sale of land at Chennai. The AO held that the losses claimed could
not be allowed since the income from long term capital gain on sale of shares
and mutual funds was exempt u/s. 10(38) of the Act of 1961. He held that the
long term capital loss in respect of shares, where securities transaction tax
had been paid, would have been exempt from long term capital gain had there
been profits, and therefore, long term capital loss from sale of shares could
not be set off against the long term capital gain arising out of the sale of
land. The CIT(A) confirmed the action of the AO on the ground that exempt
profit or loss construed separate species of income or loss and such exempt
species of income or loss could not be set off against the taxable species of
income or loss. He held that the tax exempt losses could not be deducted from
taxable income and, therefore, the AO had rightly disallowed the claim of
losses from shares to be set off against the long term capital gain from sale
of land. The assesseee company in appeal to the Tribunal raised the following
grounds; ‘1.1 On the facts and circumstances of the case and in law, the
learned Commissioner of Income-tax (Appeals) – Central II, Mumbai [“the
CIT(A)”] erred in confirming the action of Deputy Commissioner of Income
Tax (the A.O) by not allowing the claim of set off of Long term Capital Loss on
sale of shares where Security Transaction Tax (“STT”) was deducted
against the Long Term Capital Gain arising on sale of land at Chennai; 1.2 the
appellant prays that such set off of the said Long Term Capital Loss be
allowed;

It was submitted that what was contemplated
in section 10(38) was exemption of positive income and losses would not come
within the purview of the said section; the set off of long term capital loss
had been clearly provided in sections 70 and 71; the legislation had not put
any embargo to exclude long term capital loss from sale of shares to be set off
against long term capital gain arising on account of sale of other capital
asset; even in the definition of capital asset u/s. 2(14), no exception or exclusion
had been provided to equity shares the profit/gain of which were treated as
exempt u/s. 10(38); capital gain was chargeable on transfer of a capital asset
u/s. 45 and mode of computation had been elaborated in section 48; certain
exceptions had been provided in section 47 to those transactions which were not
regarded as transfer; nothing had been mentioned in sections 45 to 48 that
capital gain or loss on sale of shares were to be excluded as section 10(38)
exempted the income arising from the transfer of long term capital asset being
an equity share or unit; legislature had given exemption to income arising from
transfer of long term capital asset being an equity share in company or unit of
equity oriented fund, which was chargeable to STT; section 10(38) could not be
read into section 70 or 71 or sections 45 to 48.

The assessee supported the contention by
relying upon the decision of the Calcutta High Court in the case of Royal
Calcutta Turf Club vs. CIT, 144 ITR 709 to submit that similar issue with regard
to the losses on account of breeding horses and pigs which were exempt u/s.
10(27), whether it could be set off against its income from a business source
was considered and the High Court after considering the relevant provisions of
section 10(27) and section 70, had held that section 10(27) excluded in
expressed terms only any income derived from business of livestock breeding,
poultry or dairy farming and did not exclude the business of livestock
breeding, poultry or dairy farming from the operation of the Act. The losses
suffered by the assessee in respect of livestock, breeding were held to be
admissible for deduction by the court and were allowed to be set off against
other business income. It was pointed out that the court in turn had relied on various
decisions, especially in the case of CIT vs. Karamchand Premchand Ltd.40 ITR
106(SC). It was pointed out that there was a decision of the Gujarat High
Court in the case of Kishorebhai Bhikhabhai Virani vs. Asstt. CIT, 367
ITR 261, which had decided the issue against the assessee and the said decision
had not referred to the decisionof the Calcutta High Court at all and
therefore, did not have precedence value as compared to the Calcutta High Court
decision, which was based on Supreme Court decision on the point. Also pointed
out was the fact that the ITAT Mumbai bench also in the case of Schrader
Duncan Ltd. vs. Addl. CIT 50 SOT 68 had decided a somewhat similar issue
against the assessee but was distinguished.

On the other hand, the Revenue strongly
relied upon the order of the AO and CIT(A) and submitted that, firstly, if the
income from the long term capital gain on sale of shares was exempt, then the
loss from such sale of shares would also not form part of the total income and
therefore, there was no question of set off against other income or long term
capital gain on different capital asset. Secondly, the decisions of the Gujarat
High Court and ITAT Mumbai bench were required to be followed. It was further submitted
that it was quite a settled law that income included loss also and, therefore,
if the income from sale of shares did not form part of the total income, then
the losses from such shares also would not form part of the total income.

The Mumbai Tribunal on the conjoint reading
and plain understanding of all the sections observed that;

– firstly,
shares in the company were treated as capital asset and no exception had been
carved out in section 2(14), for excluding the equity shares and unit of equity
oriented funds that they were not treated as capital asset;

– secondly,
any gains arising from transfer of Long term capital asset was treated as
capital gain which was chargeable u/s. 45;

– thirdly,
section 47 did not enlist any such exception that transfer of long term equity
shares/funds were not treated as transfer for the purpose of section 45, and
section 48 provides for computation of capital gain, which was arrived at after
deducting cost of acquisition i.e., cost of any improvement and expenditure
incurred in connection with transfer of capital asset, even for arriving of
gain in transfer of equity shares;

– sections
70 & 71 elaborated the mechanism for set off of capital gain. Nowhere, any
exception had been made/carved out with regard to Long term capital gain
arising on sale of equity shares. The whole genre of income under the head
‘capital gain’ on transfer of shares was a source, which was taxable under the
Act. If the entire source was exempt or was considered as not to be included
while computing the total income then in such a case, the profit or loss
resulting from such a source did not enter into the computation at all.
However, if a part of the source was exempt by virtue of particular
“provision” of the Act for providing benefit to the assessee, then it
could not be held that the entire source would not enter into computation of
total income.

– the
concept of income including loss would apply only when the entire source was
exempt and not in the cases where only one particular stream of income falling
within a source was falling within exempt provisions. Section 10(38) provided
exemption of income only from transfer of long term equity shares and equity
oriented fund and not only that, there are certain conditions stipulated for exempting
such income and as such exempted only a part of the source of capital gain on
shares.

– it
needed to be seen whether section 10(38) exempted the source of income which
did not enter into computation at all or only a part of the source, the income
in respect of which was excluded in the computation of total income.

– the
precise issue had come up for consideration before the Calcutta High Court in Royal
Calcutta Turf Club’s case (supra), wherein the court observed that “under
the Income tax Act, 1961 there are certain incomes which do not enter into the
computation of the total income at all. In computing the total income of a
resident assessee, certain incomes are not included under s.10 of the Act. It
depends on the particular case; where the Act is made inapplicable to income
from a certain source under the scheme of the Act, the profit and loss
resulting from such a source will not enter into the computation at all. But
there are other sources which, for certain economic reasons, are not included or
excluded by the will of the Legislature. In such a case, one must look to the
specific exclusion that has been made.” The court relying specifically
on the decision of in the case of Karamchand Premchand Ltd. (supra),
came to the conclusion that “cl.(27) of s.10 excludes in express terms
only “any income derived from a business of live-stock breeding or poultry
or dairy farming. It does not exclude the business of livestock breeding or
poultry or dairy farming from the operation of the Act. Therefore, the losses
suffered by the assessee in the broodmares account and in the pig account were
admissible deductions in computing its total income”

– the
decision in the case of Schrader Duncan Ltd. (supra), the issue
involved was slightly distinguishable and secondly, the ratio of Calcutta High
Court was applicable in the case before them. Lastly, the decision of the
Gujarat High Court in the case of Kishorebhai Bhikhabhai Virani (supra),
though the issue involved was almost the same, and was decided against the assessee,
the ratio of the decision of the Calcutta High Court was to be followed more so
where the said decision had not been referred or distinguished by the Gujarat
High Court.

The Mumbai bench of the Tribunal finally
held that the ratio laid down by the Calcutta High Court was clearly applicable
and accordingly was to be followed in the case before them to conclude that
section 10(38) excluded in expressed terms only the income arising from
transfer of long term capital asset being equity share or equity fund which was
chargeable to STT and not entire source of income from capital gains arising
from transfer of shares and that the provision of section 10(38) did not lead
to exclusion of the entire source and not even income from capital gains on
transfer of shares. Accordingly, long term capital loss on sale of shares was
allowed to be set off against long term capital gain on sale of land in
accordance with section 70(3) of the Act.

Observations

The issue being considered here has a long
history. Time and again, it has been subjected to judicial inspection including
by the Supreme Court and in spite of the decisions of the Apex court,
conflicting decisions are being delivered by the courts on the subject as was
highlighted by this feature published in BCAJ, some 25 years ago.

The Supreme court in the case of Harprasad
& Co. (P) Ltd. 99 ITR 118 (SC) (supra) held that losses from a
source, the income whereof did not enter into computation of total income, was
not eligible for set-off against income from other sources. The Supreme court
in yet another case, Karamchand Premchand & Co. (supra),
narrated the circumstances where the losses of the given nature were eligible for set-off.

One would have thought the issue of set-off
was settled with the Supreme court decisions on the subject, but as is pointed
out by the conflicting decisions of the Tribunal that the issue is alive and
kicking. Subsequent to the Apex court decisions, the Madras High Court in the
case S.S. Thiagarajan 129 ITR 115(Mad) examined the issue to decide
against the eligibility for set-off of such losses from an exempt source of
income. In that case, the assessee had incurred losses on his activity of
racing and betting on horses, the income whereof was otherwise exempt u/s.
10(3) of the Income-tax Act. Subsequently, the Calcutta High Court in the case
of Royal Calcutta Turf Club 144 ITR 709 held that the losses from a
source, the income whereof was otherwise exempt, was eligible for set-off
against income from other sources. In that case, the assessee club had incurred
losses on its activities of livestock breeding, dairy farming and poultry
farming, the income whereof was exempt from taxation under the then section
10(27) of the Act and had sought its set off against the income from dividend
which was then taxable. In deciding the issue, the High Court took notice of
the decision of the Madras High Court in the case of S.S. Thiagarajan (supra)
and dissented from the ratio of the said decision.

A finer distinction is to be kept in mind,
for supporting the claim, between a case where an income does not enter into
computation of total income per se, as per the scheme of taxation, for
e.g., an agricultural income or a capital receipt as against the case of an
income, otherwise taxable, but has been exempted expressly from taxation for
economic reasons or where a part thereof only is exempted and not the entire
source thereof or a case where the exemption is conditional. It is believed
that in the later cases, where the exemption is conferred for economic reasons
and few other reasons cited, the law otherwise settled by the Supreme Court in
the case of Harprasad & Co. should not apply. Needless to say that
the exemption, u/s. 10(38) for long term capital gains on sale of shares was
given for economic reasons of developing the securities market and was also
otherwise a case quid pro quo inasmuch as exemption was only on payment
of another direct tax namely STT and in any case is conditional and further, is
not for all types of capital gains.

There also is a merit in the contention that
section 10(38) deals with the case of an ‘income’ alone and should not be
stretched to include the case of a ‘loss’ and principle that an ‘income
includes loss ‘should not be applicable to the provision of section 10(38) of
the Act.

Section 10(38) is a beneficial provision
introduced to help the tax payers to minimise their tax burden, once an STT is
paid. In the circumstances, it is in the fitness of the things that the
provisions are construed liberally in favour of the exemption. Bajaj Tempo
Ltd., 196 ITR 188(SC). The fact that the issue of eligibility of setoff is
controversial and is capable of two conflicting views is highlighted by the two
opposing decisions discussed here and therefore, a view favourable to the tax
payer, in such cases, should be taken. Vegetable Products, 88 ITR 192 (SC).

In Harprasad & Co.‘s case (supra)
, the assessee claimed capital loss on sale of shares of Rs.28,662 during the
previous year relevant to assessment year 1955-56. The AO disallowed the loss
on the ground that it was a loss of a capital nature and the CIT (A) confirmed
his order. Before the Tribunal, the assessee modified its claim and sought that
the loss which had been held to be a ” capital loss ” by the authorities
below, should be allowed to be carried forward and set off against profits and
gains, if any, under the head ” capital gains ” earned in future, as
laid down in sub-sections (2A) and (2B) of section 24 of the Act of 1922. The
Tribunal accepted the contention of the assessee and directed that the ”
capital loss ” of Rs. 28,662
should be carried
forward and set off
against ” capital gains “, if any, in
future. On appeal, the Delhi High Court confirmed the order of the tribunal.

On further appeal by the Revenue, the
Supreme Court considered: “Whether, on the facts and in the
circumstances of the case, the capital loss of Rs. 28,662 could be determined
and carried forward in accordance with the provisions of section 24 of the
Indian Income-tax Act, 1922, when the provisions of section 12B of the
Income-tax Act, 1922, itself were not applicable in the assessment year 1955-
56. “The Court, on due consideration of facts and the law, held: ‘Under
the Income Tax Act, 1922, capital gain was not included as a head of income and
therefore capital gain did not form part of the total income. Certain important
amendments were effected in the Income-tax Act by Act XXII of 1947. A new
definition of ” capital asset ” was inserted as Section 2(4A) and
” capital asset ” was defined as ” property of any kind held by
an assessee, whether or not connected with his business, profession or vocation
“, and the definition then excluded certain properties mentioned in that
clause. The definition of ” income ” was also expanded, and ” income
” was defined so as to include ” any capital gain chargeable
according to the provisions of Section 12B “. Section 6 of the Income-tax
Act was also amended by including therein an additional head of income, and
that additional head was ” capital gains, ” Section 12B, provided
that the tax shall be payable by an assessee under the head ” capital
gains ” in respect of any profits or gains arising from the sale, exchange
or transfer of a capital asset effected after 31st March, 1946, and that such
profits and gains shall be deemed to be income of the previous year in which
the sale, exchange or transfer took place. The Indian Finance Act, 1949,
virtually abolished the levy and restricted the operation of section 12B to
” capital gains ” arising before the 1st April, 1948. But section
12B, in its restricted form, and the VIth head, ” capital gains ” in
section 6, and sub-sections (2A) and (2B) of section 24 were not deleted and
continued to form part of the Act. The Finance (No. 3) Act, 1956, reintroduced the
” capital gains ” tax with effect from the 31st March, 1956. It
substantially altered the old section 12B and brought it into its present form.
As a result of the Finance (No. 3) Act of 1956, “capital gains ”
again became taxable in the assessment year 1957-58. The position that emerges
is that ” capital gains ” arising between April 1, 1948, and March
31, 1956, were not taxable. The capital loss in question related to this
period.’

In Karamchand Premchand & Co. Ltd.
(supra) the court held ; “What it says in express terms is that the Act
shall not apply to any incosme, profits or gains of business accruing or
arising in an Indian State etc. It does not say that the business itself is
excluded from the purview of the Act. We have to read and construe the third
proviso in the context of the substantive part of section 5 which takes in the
Baroda business and the phraseology of the first and second provisos thereto,
which clearly uses the language of excluding the business referred to therein.
The third proviso does not use that language and what learned counsel for the
appellant(Revenue) is seeking to do is to alter the language of the proviso so
as to make it read as though it excluded business the income, profits or gains
of which accrue or arise in an Indian State. The difficulty is that the third
proviso does not say so; on the contrary, it uses language which merely exempts
from tax the income, profits or gains unless such income, profits or gains are
received in or brought into India”. It went on to hold “ Next, we have to
consider what the expression “income, profits or gains” means. In the
context of the third proviso, it cannot include losses ……….. and the expression
“income, profits or gains” in the context cannot include losses. ………
The appellant(Revenue) cannot therefore say that the third proviso excludes the
business altogether, because it takes away from the ambit of the Act not only
income, profits or gains but also losses of the business referred to therein.”
Lastly, “The argument merely takes us back to the question—does the third
proviso to section 5 of the Act merely exempt the income, profits or gains or
does it exclude the business ? If it excludes the business, the appellant
(Revenue) is right in saying that the position under the proviso is not the
same as under section 14(2)(c) of the Indian Income-tax Act. If on the contrary
the proviso merely exempts the income, profits or gains of the business to
which the Act otherwise applies, then the position is the same as under section
14(2)(c). It is perhaps repetition, but we may emphasize again that exclusion,
if any, must be done with reference to business, which is the unit of taxation.
The first and second provisos to section 5 do that, but the third proviso does
not.”

The Mumbai bench of the Tribunal, in
deciding the issue in favour of the assessee, has taken due note of the direct
decision of Gujarat High Court in the case of Kishore Bhikhabhai Virani,
(supra) which in turn had followed the decision of Madras High Court in S.S.
Thiagarajan’s case(supra) and chose to chart a different course of
action for itself only after due consideration of the law on the subject. The
Kolkata bench of the Tribunal has however followed the said decision of the
Gujarat High Court to arrive at the opposite conclusion.

In deciding the issues before them, both the
High Courts have based their decisions on the different decisions of the
Supreme court, one in the case of Harprasad & Co.(supra) and
the other in the case of Karamchand Premchand Ltd.(supra). The
Mumbai bench has dutifully examined the ratio of these decisions of the Supreme
court while applying one of the ratios of the decisions of the high courts. It
has also examined the application or otherwise of the direct decision of the
Gujarat High Court. In that view of the matter, the decision of the Mumbai
bench is the only decision which has examined the issue with its various facets
and has brought on record a very detailed analysis of a vexatious and complex
issue on due application of judicial process. The better view, in our humble
opinion, is in favour of allowance of the set-off of losses against income from
other sources, for the reasons discussed here. _

shailesh.kwebmaker

Can Box Collection By Charitable/Religious Trusts Be In The Nature Of Corpus?

Issue for
Consideration

Voluntary contributions received by a
charitable or religious trust are taxable as its income, by virtue of the
specific provisions of section 2(24)(iia) of the Income-tax Act, 1961, subject
to exemption under sections 11 and 12. Section 12(1) provides that any
voluntary contribution received by a trust created wholly for charitable or religious
purposes (not being contributions made with a specific direction that they
shall form part of the corpus of the trust), shall be deemed to be income
derived from property held under trust wholly for charitable or religious
purposes for the purposes of section 11. Section 11(1)(d) provides for a
specific exemption for income in the form of voluntary contributions made with
a specific direction that they shall form part of the corpus of the trust.
Therefore, on a comprehensive reading of sections 2(24), 11 and 12, it can be inferred that corpus donations are
entitled to the benefit of exemption, irrespective of whether the trust has
applied 85% of the corpus donations for charitable or religious purposes, or not.

Many charitable or religious trusts keep
donation boxes on their premises for donors to donate funds to such trusts.
Such donation boxes can be seen in various temples, hospitals, etc. At
times, some of the donation boxes have an inscription or a sign nearby stating
that the donation made in that particular box would be for a particular capital
purpose, or that it is for the corpus of the trust. The question has arisen
before the various benches of the Tribunal as to whether such amounts received
through the donation boxes having such inscription or sign would either not be
regarded as income, being receipts in the nature of contributions to corpus, or
even otherwise be eligible for exemption as corpus donations u/s. 11(1)(d), or
whether such amounts of box collection would be voluntary contributions in the
nature of regular income of the trust.

While the Chandigarh bench of the Tribunal
has taken the view that such box collections are corpus donations, and
therefore not income of the trust, the Mumbai and Calcutta benches of the
Tribunal have taken the view that such box collections could not be regarded as
corpus donations.

Prabodhan Prakashan’s case

The issue first came up before the Bombay
bench of the Tribunal in the case of Prabodhan Prakashan vs. ADIT 50 ITD
135.

In that case, the main object of the
assessee was promotion and propagation of ideologies, opinions and ideas for
furtherance of national interest, and for this purpose, publishing of books,
magazines, weeklies, dailies and other periodicals, as also establishing and
running printing presses for this purpose. Contributions were invited by the
assessee from the public towards the corpus fund of the trust through an appeal
as under:

“Establishing a firm financial foundation
for Dainik Saamana and Prabodhan Prakashan is in your hands. For this strong
foundation, we are establishing a Corpus Fund. Offeratory boxes for the corpus
will be placed in today’s meeting and meetings to be held in future. In order
to assist our activities, which will always have a nationalistic fervour and social
relevance, it is our earnest request that you contribute to the Corpus Fund
Offeratory boxes to the best of your ability”.

The words “donations towards corpus” were
written on the offeratory boxes. The boxes were opened in the presence of
Trustees, and the amount of Rs. 13,77,465 found in these boxes was credited to
the account “Donations Towards Corpus”.

Before the assessing officer, it was claimed
that the donations were made to the corpus of the trust, and were therefore
exempt u/s. 11(1)(d). The assessee was asked to furnish specific letters from
the donors confirming that they had given directions that the donations were to
be utilised towards the corpus of the trust. Such letters could be furnished
only for donations of Rs. 3,90,277, but not for the balance of Rs. 9,86,188.
For such balance amount, it was submitted that the Income-tax Act did not
specify that the directions of the donors should be in writing. It was claimed
that in view of the appeal issued for donations, and the words “donations
towards corpus” on the offeratory boxes, it should be held that specific
directions were indeed given by the donors. The assessing officer did not
accept this contention, and treated donations of Rs. 9,86,188 as ordinary
contributions, which were taxable.

The Commissioner(Appeals) referred to the
provisions of section 11(1)(d), according to which, income in the form of
voluntary contributions made with the specific direction that they shall form
part of the corpus of the trust, would not be included in the total income of
the person in receipt of the income. According to him, a specific direction of
the donor was necessary, and the circumstances relevant to prove such direction
included the need to establish the identity of the donor, which was not established
in this case. According to the Commissioner(Appeals), merely writing “donations
towards corpus” on the offeratory boxes was not sufficient, since many of the
donors might not even know as to what was the corpus of the trust. The
Commissioner(Appeals) was of the view that the burden lay upon the assessee to
prove that the donations were received towards the corpus of the trust, and
that burden had not been discharged. He therefore, upheld the action of the
assessing officer in treating the donations of Rs. 9,86,188 as voluntary
contributions in the nature of income.

Before the Tribunal, on behalf of the
assessee, it was argued that the appeal had been issued for donations towards
the corpus, and the offeratory boxes had the inscription that the donations
were towards the corpus. The trust records of collection showed that the
donations were credited to the corpus account. It was argued that there was no
provision in the Act that the specific directions from the donor should be in
writing, and that the directions were to be inferred from the facts and
circumstances.

Considering the provisions of section
11(1)(d), the Tribunal noted that it was true that there was no stipulation in
that section that the specific directions should be in writing. It agreed that
it should be possible to come to a conclusion from the facts and circumstances
of the case, whether a specific direction was there or not, even where there
were no written directions accompanying the donation. However, according to the
Tribunal, at the same time, it needed to be kept in mind that the specific
direction was to be that of the donor, and not that of the donee. It was not
sufficient for the donee alone to declare that the voluntary contributions were
being allocated to the corpus, and there should be evidence to show that the
direction came from the donor.

In the opinion of the Tribunal, when there
was no accompanying letter to the effect that the donation was towards corpus,
at least such subsequent confirmation from the donor was a necessity. In the
case before it, such subsequent confirmation was also absent, and all that was
there, according to the Tribunal, was the intention of the donee and the actual
carrying out of that intention.

The Tribunal therefore held that the facts
did not fulfil the requirement of section 11(1)(d), and that it could not be
said that there was a specific direction from the donor to use the contribution
towards the corpus of the trust. It accordingly held that the amount was not
exempt u/s. 11(1)(d).

A similar view was taken by the Calcutta
bench of the Tribunal in the case of Shri Digambar Jain Naya Mandir vs. ADIT
70 ITD 121, which was the case of a religious trust running a temple, which
had kept two boxes in the premises of the temple, one marked “Corpus Donations”
and the other marked as “Donations”. In that case, the Tribunal held that the
assessee had not made out that the donors were able to give the direction
before/at the time of donation, and that for an ordinary devotee, it was not
possible to distinguish the corpus and non-corpus funds.

Shree Mahadevi Tirath Sharda Ma Seva Sangh’s
case

The issue again came up before the
Chandigarh bench of the tribunal in the case of Shree Mahadevi Tirath Sharda
Ma Seva Sangh vs. ADIT 133 TTJ 57(Chd.) (UO).

In the case, the assessee was a society
registered under the Societies Registration Act, 1860 and u/s. 12AA of the
Income-tax Act, 1961, running a temple, Vaishno Mata Temple, at Kullu. A
resolution had been passed whereby the different boxes were decided to be kept
in the temple premises for enabling the devotees to make donations according to
their discretion. It included keeping of a box for collection of donations,
which were to be used for undertaking construction of building. Any
devotee/donor desirous of making a donation towards construction of buildings
would put the money in this box. In the temple premises, donation boxes were
kept with different objectives. One donation box was kept for “Construction of
Building”, and other boxes for donations meant for langar and general purposes.
At specified intervals, the boxes were opened and the amounts collected were
put into respective accounts. The donations were duly entered in either the
building fund donation register or the normal donation account, and thereafter
entered in the books of account accordingly.

The return of income was filed, claiming
exemption for donations received in the box kept for donations for construction
of building. The donations were reflected in the balance sheet under the head
“Donation for Building Construction with Specific Directions from Individuals”.

The assessing officer however, treated such
donations of Rs. 40,55,480 as donations, and not as receipts towards corpus,
and included the donations in the total income liable to tax. It was done on
the reason that the assessee did not possess any evidence to show that the
donation credited under the Building Fund had been donated by donors with the
specific direction to utilise the same for building construction only.

The Commissioner(Appeals) rejected the
appeal of the assessee, on the ground that the assessee failed to provide the
requisite details or any documentary evidence to prove that the donations were
made with specific directions for construction of building.

Before the Tribunal, it was pointed out that
the assessee had collected donations earmarked for being spent on construction
of building in the same manner as in the past years. It was pointed out that
the amount was credited to the Building Fund in the balance sheet, which also
included the opening balance, and, on the assets side, the assessee had shown
the expenditure on construction of the building. The amount had been spent
exclusively towards construction of the building, on which there was no
dispute. The fact that the donation boxes were kept with different objectives
in the temple premises was demonstrated with the help of photographs and
certificates from the local gram panchayat, Councillor, etc. It was
claimed that the certificates testified the system evolved by the assessee
since earlier years for collection of donations towards construction of
building.

It was further argued that in view of the
nature of collection undertaken by the assessee, which was supported by past
history, the assessing officer was not justified in insisting on production of
specific names of donors.

On behalf of the revenue, it was pointed out
that the assessee could not furnish the complete names and addresses of the
donors who had made the donations with specific directions for building
construction, though such details were asked for during the course of
assessment proceedings. It was only because such information was not available
that the amounts had been treated as voluntary/general donations, and not as
corpus donations.

The Tribunal considered the various facts
placed before it, supported by photographs, testimony of the local gram
panchayat, resolution, the fact that different boxes were kept for separate
purposes, the utilisation of the Building Fund, etc. It noted the fact that the
assessee had received general donations of Rs. 19,53,094 and other incomes,
which were credited to the income and expenditure account.

Analysing the provisions of section 12(1),
the Tribunal noted that any voluntary contributions made with a specific
direction that they shall form part of the corpus of the trust were not to be
treated as income for the purposes of section 11. It observed that the moot
question was whether or not the manner in which the assessee had collected the
donations could be said to signify a direction from the donor that the funds
were to be utilised for the construction of building. It noted that the manner
in which the specific direction was to be made had not been laid down in the
Act or the Rules; there was no method or mode prescribed by law of giving such
directions. Therefore, according to the Tribunal, it was in the fitness of
things to deduce that the same was to be gathered from the facts and
circumstances of each case.

The Tribunal noted that the resolution of
the Society clearly showed that a donation box had been kept in the temple
premises with the appeal that the amount collected would be spent for building
construction. The devotees visiting the temple or other donors were depositing
money in the donation box, which was to be utilised for construction of
building only. The assessing officer had not disputed the manner in which such
donations had been collected by the assessee. The only dispute was that the
assessee could not provide the names and addresses of individual donors who had
contributed towards Building Fund. According to the Tribunal, since the
donations were being collected from the devotees at large, the insistence of
the assessing officer of production of individual names and addresses was not
justified. Further, the bona fides of such practice being carried out by the
assessee, either in the past or during the year under consideration, was not doubted.

Therefore, in the opinion of the Tribunal,
having regard to the facts and circumstances of the case, the donations of Rs.
40,55,480 collected by the assessee were to be considered as carrying specific
directions for being used for construction of the building. Ostensibly, the
devotees putting money in the donation box did so in response to the appeal by
the society that the amounts collected would be used for construction of
building. Under such circumstances, the Tribunal was of the view that the assessee’s
plea, that these amount should be taken as donations towards corpus, was
reasonable.

The Tribunal accordingly held that such
amounts received in the box for construction of building would form part of the
corpus of the Society, and would not constitute income for the purposes of
section 11.

Observations

When one analyses both these decisions
(Prabodhan Prakashan & Shree Mahadevi Tirath Sharda Ma Seva Sangh), one
realises that the common thread running through both these decisions is that
both confirm that the direction of the donors, that the amount of donation is
towards corpus need not be in writing, and that it is sufficient if the
surrounding circumstances indicate that the donors intended to give the funds
put in the boxes for corpus/capital purposes, for such amounts to be treated as
corpus donations. In Prabodhan Prakashan’s case, the Tribunal went further and
held that there should be evidence to show that the direction came from the
donor, while in Shri Digambar Jain Naya Mandir’s case, the Tribunal observed
that the assessee had not made out that the donors were able to give the
direction before or at the time of donation to the corpus funds. Both the
Bombay and Calcutta decisions, therefore, placed the onus on the assessee to
show the existence of the directions from the donors.

A view similar to the Chandigarh bench’s
view has been taken by the Karnataka High Court in the case of DIT vs. Sri
Ramakrishna Seva Ashrama 357 ITR 731, where the High Court held that it was
not necessary that a voluntary contribution should be made with a specific
direction to treat it as corpus. If the intention of the donor was to give that
money to a trust, which would be kept in a deposit, and the income from the
same was to be utilised for carrying on a particular activity, it satisfied the
definition part of the corpus. It further held that whether a donation was in
the nature of corpus or not was to be gauged from the intention of the donor
and how the recipient treated the receipt. In that case, the assessee had
received various donations for Rural Health Project, which were kept in fixed
deposits. The income derived from those deposits was utilised for carrying on
its various rural activities.

Similarly, in
the case of Shri Vasu Pujiya Jain Derasar Pedhi vs. ITO 39 TTJ (Jp) 337,
the receipts by the trust were issued under the head “Mandir Nirman”, and the
dispute was whether the donations could be said to be received with specific
directions that they shall form part of the corpus of the trust. It was held by
the Jaipur bench of the Tribunal that the donations were to be treated as
corpus donations.

In the case of Agnel Charities (Agnel
Sewa Sang) vs. ITO 31 TTJ (Del) 160, the assessee had staged a drama for
raising funds for construction of a school building. The circular issued
relating to the drama mentioned that the assessee was inviting subscriptions
and donations for school building. The Delhi bench of the Tribunal held that
such donations received were corpus donations, entitled to exemption.

In the case of N. A. Ramachandra Raja
Charity Trust vs. ITO 14 ITD 230 (Mad), the receipts given to the donors
had a rubber stamp “towards corpus only” on each of the receipts. In addition,
certificates were obtained from some of the donors confirming the fact that the
donations were towards corpus. In that case, the Madras bench of the tribunal
held that it was clear from the inception that the amounts received by the
assessee and held by it were under an obligation to appropriate the same
towards the corpus of the trust alone. While so holding, the tribunal relied
upon the decision of the Supreme Court in the case of CIT v. Bijli Cotton
Mills 116 ITR 60, whereof the Supreme Court confirmed that certain amounts
received by the assessee and shown in the bills issued to the customers in a
separate column headed “Dharmada” was not income of the assessee, since right
from inception, these amounts were received and held by the assessee under an
obligation to spend the same for charitable purposes only, being earmarked by
the customers for Dharmada.

In Prabodhan Prakashan’s case, the
Tribunal, perhaps, was not justified in inferring that the specific direction in that case was
that of the donee, and not that of the donor. Perhaps, in that case, the
tribunal was not convinced by the evidence placed before it that the donor was
aware of the fact that the donation was being given for a capital purpose.

The observation of the Tribunal in Shri
Digambar Naya Mandir’s case that, for an ordinary devotee, it was not
possible to distinguish the corpus and non-corpus funds did not seem to be
justified. While a devotee may not know what is the meaning of corpus, a
devotee would certainly be aware of the purpose for which his donation into a
particular box would be used, particularly when there are clear indications in
the form of inscription or signs on the box or near the box stating the
purpose. This would be all the more relevant when there are boxes for more than
one purpose placed in the same premises, some for corpus purposes and others
for non-corpus purposes. By putting his donation in a particular box, the
devotee should be regarded as having exercised his option as to how his
donation is to be used.

Therefore, where a trust receives certain
box collections for capital purposes, the surrounding circumstances clearly
indicate that the donor intended the amounts deposited in the box to be
utilised for such capital purposes, and such receipts are bona fide for
such capital purposes (as perhaps indicated by fairly large collection for
non-corpus purposes as well), such collections should certainly be
regarded as corpus
donations eligible for
exemption u/s. 11(1)(d).

All the above decisions were rendered in the
context of the law prior to the insertion of section 56(2)(x), and therefore
the Tribunals did not have the opportunity to consider taxation of such box
collections under that section. Section 56(2)(x) provides that where any person
receives any sum of money aggregating more than Rs. 50,000 in a year from any
persons, such amount is chargeable to income-tax as Income from Other Sources.
There is no exemption for amounts received by a charitable or religious trust.
After the insertion of section 56(2)(x), would such box collection be taxable
under that section?

If one looks at section 2(24)(iia) and
section 12(1), these operate specifically to tax voluntary contributions
received by a charitable or religious trust as its income. Being specific
sections, these would prevail over the general provisions of section 56(2)(x),
which apply to all assessees. Therefore, in our view, section 56(2)(x) would
not apply to a charitable or religious trust, the specific exclusions u/s.12(1)
cannot be taxed by roping in the general provisions of section 56(2)(x).

One more section which needs to be kept in
mind, in the context of box collections, is section 115BBC. This section, which
does not apply to wholly religious trusts, provides that, where the total
income of an assessee referred to in section 11, includes any anonymous
donations, such anonymous donations in excess of the specified limit, shall be
chargeable to tax at the rate of 30%. Box collection of wholly religious trusts
would not be taxable under this section, whereas only donations made for the
purposes of a medical institution or educational institution would be taxable
in case of partly charitable and partly religious trusts. While this section
would apply to normal box collections of charitable trusts, the issue is
whether it would apply to box collections for a capital purpose of such
charitable trusts, which would otherwise be regarded as corpus donations?

Given the specific exclusion in section
12(1) for corpus donations, a view is possible that such corpus donations (box
collections) are capital receipts, which do not fall within the domain of
income of a charitable trust at all, and that therefore, the provisions of
section 115BBC do not apply to such box collections for capital purposes. In
fact, in DCIT vs. All India Pingalwara Charitable Society 67 taxmann.com
338, the Amritsar bench of the Tribunal took a view that section 115BBC
does not apply at all to box collections of genuine charitable trusts.
According to the Tribunal, the object of the section was to catch the
‘unaccounted money’ which was brought in as tax free income in the hands of
charitable trusts, and this section was never meant for taxing the petty
charities. The Legislature intended to tax the unaccounted money or black money
which was brought in the books of charitable trusts in bulk, and not to tax the
small and general charities collected by genuine charitable trusts.

In Gurudev Siddha Peeth vs. ITO 59
taxmann.com 400, the Mumbai bench of the Tribunal also held that amount of
offerings put by various devotees in donation boxes of the assessee-trust, a
sidh peeth/deity, could not be treated as anonymous donations taxable u/s.
115BBC merely on ground that assessee had not maintained any records of such
offerings. According to the Tribunal, it is clear that the provisions of
section 115BBC(1) will not apply to donations received by the assessee in
donation boxes from numerous devotees who have offered the offerings on account
of respect, esteem, regard, reference and their prayer for the deity/siddha
peeth. Such type of offerings are made/put into the donation box by numerous
visitors and it is generally not possible for any such type of institutions to
make and keep record of each of the donors, with his name, address etc.
This section is meant to curb the flow of unaccounted money into the system,
with a modus operandi to introduce such black money into accounts of
institutions such as university, medical institutions, where there is a problem
relating to the receipt of capitation fees, etc.

Therefore, a view is possible that section
115BBC does not apply at all to box collections of genuine charitable trusts.

shailesh.kwebmaker

Allowability Of Interest On Delayed Payment Of Tax Deducted At Source

Issue for Consideration

Chapter XVII of the
Income-tax Act, 1961 contains several provisions for collection and recovery of
tax, by way of Tax Deduction at Source (‘TDS’) and Tax Collection at Source
(‘TCS’), by the payer and the receiver respectively. The payer and receiver are
also tasked with remitting the TDS and TCS to the government, filing periodic
statements and issuing certificates in respect of the same. Interest is levied
u/s. 201(1A), on the payer/receiver, for the period of delay in case of
non-deduction or collection of tax, or for failure to pay the same as required
by the Act.

Section 37(1) of the Act
provides for allowance of a deduction in respect of any expenditure, which is
not dealt with in sections 30 to 36 and is not in the nature of capital
expenditure or personal expenses of the assessee, but is laid out or expended
wholly and exclusively for the purposes of the business or profession.

Further, Explanation 1 to
section 37(1) declares that, for the removal of doubts, 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.

Four attributes emerge from
the provisions of section 37 as being essential for claiming deduction in respect
of any expenditure in computing the income under the head “Profits and gains of
business or profession” –

1) It
must not be capital in nature;

2) It
must not be personal in nature;

3) It
must be laid out or expended wholly and exclusively for the purposes of
business or profession; and

4) It
must not be incurred for a purpose which is an offence or which is prohibited
by law.

In
claiming the deduction u/s. 37(1) for interest u/s. 201(1A), an issue arises as
to whether such interest can be considered to be incurred wholly and exclusively for the
purpose of business or profession.

Conflicting decisions of
the different benches of the Tribunal, delivered in recent times, have
reignited the controversy. The Ahmedabad bench has, in two separate decisions,
taken a view that no deduction can be allowed in respect of such interest and
the Kolkata bench, on the other hand, has upheld the allowability of deduction
of interest in a recent decision.

Shree Saras Spices & Food P.
Limited’s case

The issue came up before
the Ahmedabad bench of the Tribunal in the case of Shree Saras Spices &
Food P. Limited vs. DCIT ITA Nos. 2527/Ahd/2010 and 1220/Ahd/2012 for
assessment years 2007-08 and 2009-10.

In the said case, the
assessee had claimed deduction in respect of interest on TDS. The A.O.
disallowed the same. The assessee challenged the addition before the CIT(A),
who dismissed the appeal and confirmed the action of the A.O., relying on the
Supreme Court decisions in the case of East India Pharmaceutical Works Ltd.
vs. CIT (1997) 224 ITR 627 (SC) and Bharat Commerce & Industries
Ltd. vs. CIT (198) 230 ITR 733 (SC). The CIT(A) observed that interest was
paid on TDS only upon late payment to the Government treasury, which implied that
the assessee had utilised Government funds and paid interest as a compensation
for enjoyment of the amount due to the Government.

On second appeal by the
assessee, the Tribunal also noted that the assessee had used the Government
money for its own purposes and interest on late payment of TDS was not
allowable as was held in East India Pharmaceutical Works Ltd. vs. CIT
(supra) and accordingly, dismissed the appeal.

The issue of allowability
of interest on late payment of TDS was also examined by the Ahmedabad bench in
an earlier decision in the case of ITO vs. Royal Packaging ITA No.
1363/Ahd/2010 for assessment year 2005-06.

In that case, interest on
TDS was disallowed by the A.O. on the ground that since TDS was not allowable,
interest on same was also not allowable. On appeal before the CIT(A), it was
argued by the assessee that since interest received on tax refund was taxable,
in the same manner, interest on late payment of TDS was an allowable expense.
The CIT(A) accepted the contention of the assessee and deleted the addition
made by the A.O.

On further appeal, the
Tribunal relying on the Supreme Court decision in the case of Bharat
Commerce & Industries Ltd. vs. CIT (supra), held that interest on late
payment of TDS is also not allowable and restored the disallowance made by the
A.O.

Narayani Ispat Pvt. Ltd.’s case

Recently, the issue had
once again arisen before the Kolkata bench in the case of DCIT vs. Narayani
Ispat Pvt. Ltd. ITA No. 2127/Kol/2014 for assessment year 2010-11.

In that case, interest on
late payment of service tax and TDS was claimed by the assessee as a part of
its interest and finance expenses. However, the A.O., relying on the Supreme
Court decision in the case of Bharat Commerce & Industries Ltd. vs. CIT
(supra), disallowed the claim of interest.

The assessee preferred an
appeal against the addition before the CIT(A), wherein it was pointed out that
in the case of Bharat Commerce & Industries Ltd. vs. CIT (supra),
the disallowance was made in respect of interest u/s. 215 of the Act due to
delay in the payment of income tax on the income disclosed under Voluntary
Disclosure of Income and Wealth Act, 1976, which was different from the
interest u/s. 201(1A) on late deposit of service tax and TDS. The assessee
relied on the decision of the Karnataka High Court in the case of CIT vs.
Mysore Electrical Industries Ltd. 196 ITR 884 (Kar), where interest for
failure to pay PF contribution was held deductible, and also on the Supreme
Court decision in the case of Lachmandas Mathura Das vs. CIT 254 ITR 799 (SC),
where interest on sales tax arrears was held deductible. Accepting the
arguments of the assessee, the CIT(A) held that the impugned interest expense
was incurred wholly and exclusively for the purpose of business and was thus,
allowable.

The Tribunal, in further
appeal by the Revenue discussed the judgement in the case of Bharat Commerce
& Industries Ltd. vs. CIT (supra) in detail and distinguished its facts
since it dealt with interest on delayed payment of income tax, whereas in the
appeal before the tribunal, interest was paid for delayed payment of service
tax and TDS. The Tribunal observed that interest for delay in making payment of
service tax and TDS was compensatory in nature and not in the nature of
penalty. It also delved upon the decision of the Supreme Court in the case of Lachmandas
Mathura Das vs. CIT (supra), and held that its principles can be applied to
interest on delayed payment of TDS, noting that interest on late payment of TDS
related to expenses claimed by the assessee which were subjected to the TDS
provisions and that TDS did not represent tax of the assessee, but rather the
tax of the payee. The deduction allowed by the CIT(A) in respect of interest on
TDS was thus upheld by the Tribunal.

Observations

The issue under
consideration is relevant for a large number of assessees.

Section 40(a)(ii) of the
Act expressly provides for disallowance of any sum paid on account of any rate
or tax levied on the profits or gains of any business or profession under the
head ‘Profits and Gains of Business Profession’. The case for disallowance of
income tax levied on the profits and gains of the business or profession is
thus specifically settled by the express provisions of the Act. Similarly
settled by the decisions of the Supreme Court, is the proposition of the law
that any interest paid for delay in payment of income tax on profits and gains
of business or profession is also not deductible in computing the profits and
gains of business. It is also settled that any interest paid on borrowings made
for payment of such income tax is also not deductible in computing such profits
and gains of business.

In the case of Bharat
Commerce & Industries Ltd. vs. CIT (supra), the assessee, a
manufacturing company, had claimed deduction in respect of interest on delay in
payment of advance tax u/s. 37(1) of the Act on the ground that delayed payment
of taxes resulted in increase in the assessee’s financial resources, which
became available for its business. The assessee also contended that the
interest paid to the Government represented in effect, the interest on capital
that would have been borrowed by it otherwise and thus, it was an expense
incurred wholly and exclusively for the purpose of its business.

The Apex Court observed as under –

“When interest is paid
for committing a default in respect of a statutory liability to pay advance
tax, the amount paid and the expenditure incurred in that connection is in no
way connected with preserving or promoting the business of the assessee. This is
not expenditure which is incurred and which has to be taken into account before
the profits of the business are calculated. The liability in the case of
payment of income- tax and interest for delayed payment of income-tax of
advance tax arises on the computation of the profits and gains of business. The
tax which is payable is on the assessee’s income after the income is
determined. This cannot, therefore, be considered as an expenditure for the
purpose of earning any income or profits.”

The Supreme Court, in the
said case, in conclusion, held that the interest levied u/s. 139 and section
215 of the Income-tax Act was not deductible as a business expenditure u/s.
37(1) of the Act. The court in that case held that the income tax was a tax on
profit of the business and was therefore not allowable as a deduction.
Similarly, interest also was not deductible as the same was inextricably
connected with the assessee’s tax liability; if the income tax was not a
permissible deduction u/s. 37, any interest payable for default in payment of
such income tax could not be allowed as a deduction. In arriving at the
conclusion, the court followed its own decision in the cases of East India
Pharmaceutical Works Ltd, 224 ITR 627 and Smt. Padmavati Jaikrishna, 166
ITR 176, where decisions dealt with the issue of deductibility of interest
paid on moneys borrowed for payment of income tax.

The principles that emerge
from the observations of the Apex Court in the above decision as well as in the
various decisions cited therein, are that interest on delayed payment of income
tax would take its colour from the principal amount of income tax and thus, it
could not be considered to be incurred wholly and exclusively for the purpose
of business and consequently, such interest cannot be claimed as a deduction.
Where, however, the principal amount is an expenditure for the purpose of
earning any income or profits and is incidental to the business, whether
interest on delayed payment thereof would be allowed as a deduction u/s. 37(1)
is a question that was not addressed by the court.

The Bombay High Court had
the occasion to examine the issue of deductibility u/s. 37(1) of the interest
u/s 201(1A) of the Act. The court, in a brief order, upheld the disallowance of
the deduction u/s. 37 by simply following the decisions in the cases of Aruna
Mills Ltd, 31 ITR 153 (Bom.), Ghatkopar Estate and Finance Corporation Pvt.
Ltd, 177 ITR 222 (Bom.), Bharat Commerce Industries Ltd, 153 ITR 275 (Del.) and
Federal Bank Ltd, 180 ITR 37 (Kerela) after noting that the high courts in
the above referred decisions had taken a similar view.

Subsequently, the Madras
High Court in the case of Chennai Properties and Investments (P) Ltd., 239
ITR 435 (Mad) examined the deductibility u/s. 37(1) of the interest u/s.
201(1A) of the Act. The court noted that the interest paid took it’s colour
from the nature of the principal amount remaining unpaid.The principal amount
being income tax, interest thereon was in the nature of a direct tax, and could
not be regarded as a compensatory payment, and was therefore not allowable as
business expenditure. In deciding against the assessee, the court followed the
decision of the Supreme Court in the case of Bharat Commerce and Industries
Ltd, 230 ITR 733 (SC).

In spite of the issue of
the deductibility and allowance of interest paid for delay in payment of the
tax deducted at source levied u/s 201(1A) being decided against the assessee by
the high courts, in our considered opinion, it remains open and debatable.
While the Bombay and the Madras High Courts have examined the issue and have
held against the allowability of such interest, the said decisions, in our very
respectful opinion, cannot be taken to have been delivered on due examination
of the law, in as much as the courts, in those cases, have simply relied on the
precedents to arrive at a conclusion without appreciating that the decisions,
referred to as precedents, were concerned with the payment of interest under
sections 139, 215 and 270, levied for delay in payment of income tax on gains
of business. None of them were concerned with the payment of interest on
delayed payment of the tax deducted at source. Neither was this distinction
highlighted before the courts nor did the courts on their own examine the vital
difference between the tax on income and the tax deducted at source. It is
possible that the decisions in question may be reviewed or reconsidered or
dissented or distinguished. The law shall remain debatable till such time as
the same is examined by the highest court of the land.

It is significant to note
that usually a tax is deducted at source on payments made by a businessman in
his character as a trader and, in most of the cases, such payments are
expressly or otherwise deductible under the Act, in computing the Profits and
Gains of Business or Profession. In the absence of any specific provisions such
as section 40(a), for expressly disallowing the payments, the tax deducted and
withheld is a part of the expenditure of the payer and in no manner can be construed
as a tax on his profits or gains of business or profession. Therefore,
provisions of section 40(a)(ii) have no application to such payments or
interest thereon. In fact, the entire expenditure representing the payment,
including tax deducted and withheld, is deductible in law without reservation.

The
term “tax” is defined u/s. 2(43) to mean income tax chargeable under the
provisions of Income-tax Act and includes the fringe benefit tax. On a bare
reading of this provision, it is clear that the term “tax” in no manner
includes the tax deducted at source which is tax on somebody else’s income and
not on the income of the assessee payer; in any case, the tax deducted at
source is not an income tax ‘chargeable’ under the provisions of the Act.

The view of the Kolkata
Tribunal in the case of Narayani Ispat Pvt. Ltd. (supra), thus,
appears reasonable that TDS, by itself, does not represent income tax of the
assessee, but is a deduction from the payment made to a party in respect of
expenses claimed by the assessee, at a certain percentage prescribed in the
Act. So long as the expenses from which tax is deducted, relate to the business
of the assessee, the TDS thereon would also be considered to be relating to the
business of the assessee and therefore, interest on delayed payment of such TDS
would be considered to be incurred wholly and exclusively for the purpose of
business.

It may be true that the
interest for delay in payment of the tax deducted at source would not be
considered to be interest on capital borrowed for the purposes of business and
therefore, may not be eligible for deduction u/s. 36(1)(iii) of the Act. The same however, would be eligible for deduction
u/s.37(1) of the Act, being an expenditure wholly and exclusively incurred for
the purposes of business.

The better view therefore, is that
interest on delayed payment of the tax deducted at source, payable u/s. 201(1A)
or any other similar provision, is deductible in law in computing the Profits
and Gains of Business or Profession of the payer. _

shailesh.kwebmaker

Applicability of Section 14A – Interest To Partners

Issue for Consideration

Section 14A(1) of the Income-tax Act, 1961 provides that for
the purposes of computing the total income, under the chapter (Chapter IV –
Computation of Total Income), no deduction shall be allowed in respect of an
expenditure incurred by the assessee in relation to the income which does not
form part of the total income under the Act.

Under the scheme of taxation of partnership firms, a
partnership firm is entitled to deduction of interest paid to partners, and
such interest paid is taxable in the hands of the partners, under the head
‘profits and gains of business and profession, vide section 28(v) of the Act. The
deduction of such interest to partners, in the hands of the firm, is governed
by the restrictions contained in section 40(b)(iv), which section provides that
payment of interest to any partner, which is authorised by, and is in
accordance with, the terms of the partnership deed and relates to any period
falling after the date of such partnership deed in so far as such amount
exceeds the amount calculated at the rate of 12% simple interest per annum,
shall not be allowed as deduction.

A question has arisen before the Tribunal in various cases as
to whether interest paid to partners, which is allowable as a deduction to the
partnership firm, can be regarded as an ‘expenditure incurred’ by the assessee
firm, and can therefore form part of the disallowance u/s.14A, to the extent
that it has been incurred in relation to the income arising on investment made
out of the funds received from the partners and on which interest is paid by
the firm, which income does not form part of the total income of the partnership
firm.

While the Ahmedabad and Mumbai benches of the Income Tax
Appellate Tribunal have held that such interest, in the hands of the firm,
would be regarded as an expenditure subject to disallowance u/s. 14A, the Pune
bench of the Tribunal has taken a contrary view holding that interest paid by a
partnership firm on its partners’ capital cannot be regarded as an expenditure amenable to section 14A.

Shankar Chemical Works’ case

The issue first came up before the Ahmedabad bench of the
Tribunal in the case of Shankar Chemical Works vs. Dy CIT 47 SOT 121.

In this case, relating to assessment year 2004-05, the
assessee was a partnership firm carrying on the business of manufacturing of
chemicals. It had invested in various financial assets, such as debentures,
bonds, mutual funds and shares to the extent of Rs. 1.93 crore, the income from
some of which investments was exempt from tax to the extent of Rs. 43.48 lakh.
The assessing officer noted that the assessee had borrowings to the extent of
Rs. 15.57 lakh, on which an interest of Rs. 1.54 lakh had been paid. Besides,
the firm had paid interest on partners’ capital. The assessing officer
concluded that investments in all these mutual funds, shares and securities had
been made out of the funds of the firm, which were either out of the partners’
capital or from borrowings from others. The interest payment on these funds
were made either to partners or to the persons from whom borrowings were made.
He therefore disallowed an amount of Rs. 17.04 lakh out of the total interest expenses of Rs. 23.23 lakh u/s. 14A.

On appeal before the Commissioner(Appeals), the disallowance
of interest u/s. 14A was upheld. The Commissioner(Appeals) held that the
capital was employed for the purpose of investment in mutual funds, shares and
debentures and bonds, and not for the business of the assessee firm for which
the partnership was formed. He also held that the provisions of section 40(b)
were not applicable, and the funds were utilised for the purpose of investment
rather than the business. He upheld the working of the disallowance of interest
made by the assessing officer in proportion to the amount of investment and
total funds employed, and held that the partners of the firm were entitled to
relief under the explanation to section 10(2A) in respect of the that part of
interest of the firm which was not allowed as a deduction to the firm.

Before the Income Tax Appellate Tribunal, on behalf of the
assessee, it was argued that no nexus had been established between the interest
payment and the earning of the exempt income. It was further argued that as per
section 28(v), interest paid to a partner of a firm was chargeable to tax in
the hands of the firm. Therefore, disallowance of such interest u/s. 14A, in
the hands of the firm, would amount to a double taxation. It was further argued that the
firm and the partners were not different entities.

Reliance was placed on paragraph 48 of the CBDT Circular No.
636 dated 31^st August 1992, where the provisions of the Finance act,
1992, regarding assessment of the firm were explained. In the circular, it was
stated that share of a partner in the profits of the firm would not be included
in computing, his total income u/s. 10(2A). However, interest, salary, bonus,
commission or any other remuneration paid by the firm to the partner would be
liable to tax as business income in the partner’s hands. An explanation has
been added to section 10(2A) to make it clear that the remuneration or
interest, which was disallowed in the hands of the firm, would not suffer
taxation in the hands of the partner. It was further pointed out that in the
case of the assessee, the partners to whom interest was paid were taxable at
the maximum rate.

It was further argued on behalf of the assessee that the
amendment to the scheme of assessment of a firm had been made to avoid double
taxation of the income. Interest paid to partners was distribution of profit
allocated to the partners in the form of interest and as such it could be taxed
once either in the hands of the firm or in the partners’ hands, but could not
be taxed in both places. Since the partners had paid tax on interest received
from the firm, and all the conditions laid down in section 40(b) had been
fulfilled, no portion of interest paid to partners could be disallowed, and if
it was disallowed it would amount to double taxation.

On behalf of the revenue, it was contended that no interest
free funds were available to the assessee, and therefore disallowance had
rightly been made. The investments were made from capital of the partners, on
which interest at the rate of 10.5% per annum was paid.

The Tribunal rejected the contention of the assessee that
there was no nexus between the exempt income and partners’ capital, since no
interest-free funds were available with the firm. Importantly, in respect of
the assessee’s argument that any disallowance of interest u/s. 14A would amount
to double disallowance, the Tribunal noted that as per the provisions contained
in section 14A(1), an expenditure incurred for earning exempt income was not to
be considered for computing total income under chapter IV. This implied that
such expenditure was to be allowed as deduction while working out the exempt
income under chapter III. In case of expenditure which was incurred for earning
exempt income, a specific treatment was to be given, that such expenses should
be disregarded for computing total income under chapter IV and should be
reduced from exempt income under chapter III. Hence, according to the Tribunal,
there was no double addition or double disallowance.

The Tribunal observed that partners had a share in all the
incomes of the firm. As per the above treatment in the hands of the firm,
regarding expenses incurred for earning exempt income, taxable income of the firm
would increase and exempt income of the firm would go down by the same amount,
total of both remaining the same. The total share of profit of the partner in
the income of the firm would also remain the same, but his share in income
which was exempt in the hands of the firm would be less, and his share in
income which Is taxable in the hands of the firm would be more. However, the
entire share of profit receivable by a partner from a firm was exempt, and
hence there was no impact in the hands of a partner. According to the Tribunal,
since there was no disallowance as such in the hands of the firm, but the
expenditure incurred for earning exempt income was not allowed to be reduced
from taxable income, and instead was to be reduced from exempt income, there
was no effective disallowance in the hands of the firm of the expenses incurred
for earning exempt income, and hence there was no question of any double
allowance or double disallowance.

It also noted that under the proviso to section 28(v), where
there was a disallowance of interest in the hands of the firm due to the
provisions of section 40(b), then and only then the income in the hands of the
partner had to be adjusted to the extent of the amount not so allowed to be
deducted in the hands of the firm. Hence, the proviso to section 28(v) would
come into play only if there was some disallowance in the hands of the firm
u/s. 40(b). According to the Tribunal, in the case before it, the disallowance
was u/s. 14A, and not u/s. 40(b), and therefore, the proviso to section 28(v)
was not applicable and therefore, the partner of the firm was not entitled to
any relief under the said proviso. In any case, since the appellant before the
Tribunal was the firm, and not the partners, the Tribunal did not give any direction
on this aspect of taxability of the partners.

Examining section 10(2A) and the explanation thereto, the
Tribunal rejected the assessee’s argument that if any interest was disallowed
in the hands of the firm, the same could not form part of the total income in
the hands of the partner. According to the Tribunal, the explanation to section
10(2A) did not support such a contention, as the total income of the firm, as
assessed, should alone be considered, and the share of the concerned partner in
such assessed income should be worked out as per the profit sharing ratio as
specified in the partnership deed, and it was such share of the relevant
partner, which only would be considered as exempt u/s. 10(2A).

The Tribunal next addressed the assessee’s argument that
interest paid to partners was distribution of profits allocated to the partners
in the form of interest and hence interest to partners could be taxed once,
either in the hands of the firm or in the hands of the partner, and could not
be taxed in both hands. It also considered the argument of the assessee that
since the partners had paid tax on interest received by them from the firm, no
portion of interest paid to partners could be disallowed, and if disallowed, it
would amount to double taxation. According to the tribunal, such arguments were
devoid of any merit, because interest paid to partners by the firm was not
distribution of profit by the firm, since interest was payable to the partners
as was prescribed in the partnership deed, even if there was no profits in the
hands of the firm. If a firm had a loss and paid interest to the partners, the
loss of the firm would increase to that extent, which would be allowed to be
carried forward in the hands of the firm. Therefore, according to the Tribunal,
interest, to partners was not a distribution of profits by the firm to the
partners and there was no double taxation.

Addressing the assessee’s argument that interest paid to
partners was not an expenditure at all, but was a special deduction allowed to
the firm u/s. 40(b), the tribunal observed that there was no deduction allowed
under section 40(b). According to the Tribunal, section 40(b) was a restricting
section for various deductions allowable under sections 30 to 38. Analysing the
provisions of section 40(b), the Tribunal was of the view that this section was
really restricting and regulating deduction allowable to the firm on account of
payment of interest to partners, and was not an allowing section. According to
the Tribunal, the section allowing the deduction of interest remained section
36(1)(iii), and therefore payment of the interest to partners was also an
expenditure, which was hit by the provisions of section 14A, if it was incurred
for earning exempt income.

The Tribunal accordingly rejected the assessee’s appeal, and
thereby upheld the disallowance of interest to partners u/s. 14A.

This decision of the Tribunal was followed by the Mumbai
bench of the Tribunal in the case of ACIT vs. Pahilajrai Jaikishin 157 ITD
1187, where the Tribunal held that such interest paid to partners on their
capital was an expenditure subject to disallowance u/s. 14A, if it was incurred
in relation to exempt income.

Quality Industries’ case

The issue again came up for consideration before the Pune
bench of the Tribunal in the case of Quality Industries vs. Jt CIT 161 ITD
217.

In this case, relating to assessment year 2010-11, the
assessee firm was engaged in the business of manufacture of chemicals, and had
earned tax-free income of Rs. 24.64 lakh from investment in mutual funds of Rs.
4.42 crore. The assessee had claimed deduction for interest of Rs. 75.64 lakh,
consisting of interest to partners of Rs. 74.88 lakh and interest on bank loans
of Rs. 0.76 lakh.

The assessing Officer, observing that investment in mutual
funds was made out of interest-bearing funds, which included interest-bearing
partners capital, was of the view that the assessee had incurred expenditure,
including interest expenses, which was attributable to earning income from
investment in mutual funds, which was exempt. He, therefore, disallowed
estimated expenditure incurred in relation to such income from mutual funds in
terms of the formula under rule 8D amounting to Rs. 29.25 lakh, including
interest of Rs. 27.85 lakh.

The Commissioner(Appeals) observed that the main source of
investment in mutual funds was partners’ capital, which bore interest at 12%
per annum. According to the Commissioner(Appeals), such interest was relatable
to income from mutual funds, which did not form part of the total income.
Therefore, the Commissioner(Appeals) upheld the disallowance made by the
assessing officer observing that the provisions of section 14A were attracted
to such expenditure.

Before the Tribunal, it was argued on behalf of the assesse,
that the assessee had fixed capital of Rs. 6.24 crore, received from the
partners, on which interest at the rate of 12% per annum had been charged to
the partnership firm. The firm also had current capital from partners that was
received from time to time, which amounted to Rs. 1.14 crore at the end of the
year, on which no interest was paid. It was argued that interest payable on
fixed capital from partners did not bear the characteristic of expenditure per
se as contemplated u/s. 14A. It was pointed out that as per the scheme of
taxation of firms, the payment to the credit of partners in the form of
interest and salary was chargeable to tax in the respective hands as business
income by operation of law.

Reliance was placed on behalf of the assessee on the decision
of the Supreme Court in the case of CIT vs. R M Chidambaram Pillai 106 ITR
292 for the proposition that payment of salary represented special share of
profits, and was therefore taxable as business income. On the same footing, it
was argued that interest on partners’ capital was a return of share of profit
by the firm to the partners. Both interest and salary to partners were not
subjected to TDS, and both fell for allowance under section 40. It was argued
that section 40(b) was not just a limiting section, notwithstanding the fact
that some fetters on the rate of interest had been put thereunder. Salary to
partners and interest paid on partners’ capital was made allowable in the hands
of the firm only from assessment year 1993-94, subject to limits and
restrictions placed u/s. 40(b), and was not allowable prior thereto and
supported the view that section 40(b) was not merely meant for limiting the
deduction, as had that been the case, interest would have been allowable in the
hands of the partnership firm since the birth of the income tax law.

It was further submitted that section 14A was applicable only
where an expenditure was incurred, and not in respect of any and every
deduction or allowance. It was argued that an expenditure was needed to be
incurred by the party, which was absent in view of the mutuality present in a
partnership firm between the firm and its partners. The firm had no separate
existence from its partners, and it was a separate assessable entity only for
the purposes of the Income-tax Act. The Partnership Act, 1932 did not recognise
the firm as a separate entity.

It was further argued on behalf of the assessee that any
disallowance of interest of capital would lead to double disallowance of the
same expenditure, as the partners were already subjected to tax on interest on
capital in their respective personal returns.

The Tribunal analysed the nuances of the scheme of taxation
of partnership firms. It noted that prior to assessment year 1993-94, the
interest charged on partners’ capital was not allowed in the hands of the partnership
firm, while it was simultaneously taxable in the hands of the respective
partners. The amendment by the Finance Act, 1992 by insertion of section 40(b)
was to enable the firm to claim deduction of interest outgo payable to partners
on the respective capital subject to some upper limits. Therefore, according to
the tribunal, as per the present scheme of taxation, the interest payment on
partners’ capital in a sense was not treated as an allowable business
expenditure, except for the deduction available u/s. 40(b).

The Tribunal noted that partnership firms, on complying with
the statutory requirements, were allowed deduction in respect of interest to
partners, subject to the limits and conditions specified in section 40(b), and
in turn those items would be taxed in the hands of the partners as business
income u/s. 28(v). Share of partners in the income of the firm was exempt from
tax u/s. 10(2A). Therefore, the share of income from a firm was on a different
footing from the interest income, which was taxable as business income.

The Tribunal also noted that interest and salary received by
the partners were treated on a different footing by the Act, from the ordinary
sense of the terms. Section 28(v) treated interest as also salary received by a
partner of the firm as a business receipt, unlike different treatment given to
similar receipts in the hands of entities other than partners. It also noted
that under the proviso to section 28(v), the disallowance of such interest was
only with reference to section 40(b), and not with reference to section 36 or
section 37. According to the tribunal, it gave a clue that deduction towards
interest to partners was regulated only u/s. 40(b), and that the deduction of
such interest was out of the purview of sections 36 or 37.

The Tribunal observed that there was no amendment to the
general law provided under the Partnership Act, 1932. The amendment to section
40(b) had only altered the mode of taxation. The partnership firm continued not
to be a separate legal entity under the Partnership Act, and it was not within
the purview of the Income-tax Act to change or alter the basic law governing
partnership. Therefore, interest or salary paid to partners remained the
distribution of business income. The tribunal referred to the decision of the
Supreme Court in the case of R. M. Chidambaram Pillai (supra) for this
proposition. The tribunal also referred to the decision of the Supreme Court in
the case of CIT vs. Ramniklal Kothari 74 ITR 57, for the proposition
that the business of the firm was business of the partners of the firm. Hence,
salary, interest and profits received by the partner from the firm was business
income, and therefore expenses incurred by the partner for the purpose of
earning this income from the firm was admissible as deduction from such share
of income from the form in which he was a partner. Thus, even for taxation
purposes, the partnership firm and partners have been seen collectively, and
the distinction between the two was blurred in the judicial precedents.

Since the firm and partners of the firm were not separate
persons under the Partnership Act, though they were a separate unit of
assessment for tax purposes, according to the Tribunal, there could not be a
relationship inferred between the partner and firm as that of lender of funds
(capital) and borrowal of capital from the partners. Therefore, section
36(1)(iii) was not applicable at all. According to the Tribunal, section 40(b)
was the only section governing deduction towards interest to partners. In view
of section 40(b), according to the Tribunal, the assessing officer had no
jurisdiction to apply the test laid down under section 36, to find out whether
the capital was borrowed for the purposes of business or not. Thus, the
question of allowability or otherwise of the deduction did not arise, except
for section 40(b).

According to the Tribunal, the interest paid to partners
simultaneously getting subjected to tax in the hands of the partners was merely
in the nature of contra items in the hands of the firm and partners.
Consequently, interest paid to partners could not be treated at par with the
other interest payable to outside parties. Thus, in substance, the revenue was
not adversely affected at all by the claim of interest on capital employed with
the firm by the partnership firm and partners put together. Capital diverted to
mutual funds to generate alleged tax-free income did not lead to any loss in
revenue due to the action of the assessee. In view of the inherent mutuality,
as per the Tribunal, when the partnership firm and its partners were seen
holistically and in a combined manner, with interests paid to partners
eliminated in contra, the investment in mutual funds, generating tax-free
income bore the characteristic of an expenditure that was attributable to its own capital, where no disallowance
u/s. 14A read with rule 8D was warranted.

The Tribunal therefore held that the provisions of section
14A read with rule 8D were not applicable to interest paid to partners, but
applied only to interest payable to parties other than partners.

Observations

The logic of the Pune bench of the Tribunal, that the amount
introduced by the partners into the partnership firm is not a borrowing of
capital by the partnership firm but is an introduction of capital by the
partners for constituting the partnership firm and carrying on its business,
does seem fairly attractive at first sight.

The scheme of taxation of the partnership firm and its
partners under tax laws is also relevant. It is only by an artificial provision
that the entire income of the partnership firm is divided into two components
for convenience of taxation – one component taxable in the hands of the firm,
and the second component taxable in the hands of the partners. Section 40(b) read
with the proviso to section 28(v) clearly brings out this intent that what is
taxable in the hands of the firm, is not taxable in the hands of the partners,
while what is taxable in the hands of the partners is not taxable in the hands
of the firm. Therefore, viewed from that perspective, the view of the Pune
Tribunal that the interest to partners was not an expenditure, but was a mere apportionment of the income of the firm, also seems attractive.

This view is also supported by the fact that though salaries
and interest are subjected to tax deduction at source, remuneration and
interest to partners are not so subject to the provisions of tax deduction at
source. In a sense, the tax laws now recognise the fact that such remuneration
and interest to partners stands on a different footing from the normal
expenditure of salaries and interest.

However, to a great extent, the answer to this question is to
be found in the decision of the Supreme Court in the case of Munjal Sales
Corpn vs. CIT 298 ITR 298. In this case, relating to assessment years
1993-94 to 1997-98, the Supreme Court was considering a situation where
interest free loans had been granted to sister concerns in August/September
1991, and interest paid had been disallowed u/s. 36(1)(iii) by the Assessing
Officer. The Tribunal had deleted the disallowance for assessment years 1992-93
and 1993-94, holding that interest free loans had been given out of the
assessee’s own funds. The disallowances for assessment years 1994-95 to 1996-97
were however upheld by the Tribunal.

Before the Supreme Court, the assessee contended that section
40(b) was a standalone section having no connection with the provisions of
section 36(1)(iii), and that section 36(1)(iii) did not apply, as it was a case
of payment of interest to a partner on his capital contribution, which could
not be equated to monies borrowed by the firm from third parties.

In this case, while holding that since the loans were
advanced for business purposes, the interest on such loans would not be subject
to any disallowance under section 36(1)(iii) read with section 40(b)(iv), the
Supreme Court observed as under:

“Prior to the Finance Act,
1992, payment of interest to the partner was an item of business disallowance.
However, after the Finance Act, 1992, the said section 40(b) puts limitations
on the deductions under sections 30 to 38 from which it follows that section 40
is not a stand-alone section. Section 40, before and after the Finance Act,
1992, has remained the same in the sense that it begins with a non obstante clause.
It starts with the words ‘Notwithstanding anything to the contrary in sections
30 to 38’ which shows that even if an expenditure or allowance comes within the
purview of sections 30 to 38, the assessee could lose the benefit of deduction
if the case falls under section 40. In other words, every assessee, including a
firm, has to establish, in the first instance, its right to claim deduction
under one of the sections between sections 30 to 38 and in the case of the
firm, if it claims special deduction, it has also to prove that it is not
disentitled to claim deduction by reason of applicability of section 40(b)(iv).
Therefore, in the instant case, the assessee was required to establish in the
first instance that it was entitled to claim deduction under section 36(1)(iii
), and that it was not disentitled to claim such deduction on account of
applicability of section 40(b)(iv). It is important to note that section 36(1)
refers to other deductions, whereas section 40 comes under the heading ‘Amounts
not deductible’. Therefore, sections 30 to 38 are other deductions, whereas
section 40 is a limitation on those deductions. Therefore, even if an assessee
is entitled to deduction under section 36(1)(iii), the assessee-firm will not
be entitled to claim deduction for interest payment exceeding 18/12 per cent
per se. This is because section 40(b)(iv) puts a limitation on the amount of
deduction under section 36(1)(iii).

It was vehemently urged on
behalf of the assessee that the partner’s capital is not a loan or borrowing in
the hands of a firm. According to the assessee, section 40(b)(iv) applies to
partner’s capital, whereas section 36(1)(iii) applies to loan/borrowing.
Conceptually, the position may be correct, but in the instant case, the scheme
of Chapter IV-D was in question. After the enactment of the Finance Act, 1992,
section 40(b)(iv) was brought to the statute book not only to avoid double
taxation, but also to bring on par different assessees in the matter of
assessment. Therefore, the assessee-firm, in the instant case, was required to
prove that it was entitled to claim deduction for payment of interest on
capital borrowed under section 36(1)(iii), and that it was not disentitled
under section 40(b)(iv). There was one more way of answering the above contention.
Section 36(1)(iii) and section 40(b)(iv) both deal with payment of interest by
the firm for which deduction can be claimed. Therefore, keeping in mind the
scheme of Chapter IV-D, every assessee, who claims deduction under sections 30
to 38, is also required to establish that it is not disentitled under section
40. The object of section 40 is to put limitation on the amount of deduction which the assessee is entitled to under sections 30 to 38. Section 40
is a corollary to sections 30 to 38 and, therefore, section 40 is not a
stand-alone section.”

The Supreme Court has therefore held that
interest on partner’s capitals is primarily to be considered for allowance u/s.
36(1)(iii), and that section 40(b) puts a restriction on the quantum of interest
so allowable. That being the view taken by the Supreme Court, the view taken by
the Ahmedabad and Mumbai benches of the Tribunal seems to be the better view,
that interest on capitals to partners would be an expenditure, which would also
need to be considered for the purposes of disallowance u/s. 14A.

shailesh.kwebmaker

Applicability of Section 68 to Cash Credits in Absence of Books of Account

Issue for Consideration

Section 68 of the Income-tax Act, 1961 deems
unexplained cash credits to be the income of the assessee under certain
circumstances. Section 68 reads as under:

“Where any sum
is found credited in the books of assessee maintained for any previous year,
and the assessee offers no explanation about the nature and source thereof or
the explanation offered by him is not, in the opinion of the Assessing Officer,
satisfactory, the sum so credited may be charged to income tax as the income of
the assessee of that previous year.”

The section, for its application, apparently
requires that a sum is found credited in the books of account of the assessee. An
issue has arisen before the courts as to whether unexplained receipts or
credits can be deemed to be the income of the assessee u/s. 68, even in a
situation where books of account are not maintained or the sum is not credited
in the books of account of the assessee. In an earlier decision, the Bombay
High Court (followed by the Gauhati High Court and the Madras High Court) has
taken the view that such amounts, not found credited in the books of account,
cannot be treated as cash credits taxable u/s. 68. Recently, the Bombay High
Court has however, taken a contrary view that such amounts can be taxed under
section 68.

Bhaichand N. Gandhi’s case

The issue first arose before the Bombay High
Court in the case of CIT vs. Bhaichand N. Gandhi 141 ITR 67.

In this case, pertaining to assessment year
1962-63, where the previous year was Samvat year 2017, the assessing officer was
not satisfied with the explanations offered by the assessee regarding the
genuineness of certain cash credits totalling to Rs. 30,000 found recorded in
certain books, which, according to the assessing officer, were the books of
account of the assessee. He, therefore, treated the amount of such credits as
income from undisclosed sources. The Appellate Assistant Commissioner confirmed
the addition of such credits as income of the assessee.

Before the Tribunal, an argument was put
forward on behalf of the assessee that in respect of one of the deposits of Rs.
10,000 included in the amount of Rs. 30,000, that it was not an amount credited
in the books of the assessee maintained by the assessee for the previous year,
but was only a deposit in the bank account of the assessee. It was contended
that the bank passbook was not a book maintained by the assessee, and that
therefore, even if such amount was treated as undisclosed income of the
assessee, it could only be assessed in
the financial year of the deposit (as applicable to unexplained
investments/money u/s. 69/69A), and not in the previous year.

The Tribunal accepted the assessee’s
argument holding that the bank passbook could not be treated as a book of the
assessee, and that it was not a book maintained by the assessee for any
previous year as referred to in section 68.

On an appeal by the Revenue, the Bombay High
Court analysed the provisions of section 68. It took note of the decision of
the Supreme Court in the case of Baladin Ram vs. CIT 71 ITR 427, where
the court had held that it was only when an amount was found credited in the
books of an assessee that the new section would be attracted. It further
observed that it was well settled that the only possible way in which income
from an undisclosed source could be assessed or reassessed, was to make an
assessment during the ordinary financial year. The Supreme Court had noted that
even under the provisions embodied in section 68, it was only when any amount
was found credited in the books of the assessee for any previous year that the
section would apply, and the amount so credited might be charged to tax as the
income of that previous year, if the assessee offered no explanation or the
explanation offered by him was not satisfactory.

The Bombay High Court noted with approval
the observations of the Tribunal that it was fairly well settled that when
monies were deposited in a bank, the relationship that was constituted between
the bank and the customer was one of debtor and creditor and not of trustee and
beneficiary. Applying this principle, the passbook supplied by the bank to its
constituent was only a copy of the constituent’s account in the books
maintained by the bank. The passbook was not maintained by the bank as the
agent of the constituent, nor could it be said that the passbook was maintained
by the bank under the instructions of the constituent. The Bombay High
Court, therefore, held that the Tribunal was justified in holding that the
passbook supplied with the bank to the assessee could not be regarded as a book
of the assessee, i.e. a book maintained by the assessee or under his
instructions.

The Bombay High Court, therefore,
confirmed the conclusions of the Tribunal, holding that the provisions of
section 68 did not apply to the credit in the passbook, which was not recorded
in the books of account of the assessee.

In the case of Anand Ram Raitani vs. CIT
223 ITR 544, the Gauhati High Court took a view that existence of books of
account was a condition precedent for the invocation of power by the assessing
officer u/s. 68. Since a partnership firm was a separate entity, books of
account of a partnership could not be treated as those of individual partners.
Therefore, addition to an assessee’s income on account of unexplained cash
credit u/s. 68, on the basis of cash credit found in books of accounts of a
firm in which the assessee was a partner was not justified. The court in
deciding the case followed the decision in the case of Smt. Shanta Devi vs.
CIT, 171 ITR 532(P& H).

Similarly, in the case of CIT vs. Taj
Borewells 291 ITR 232, the Madras High Court, considered a case of the
first year of assessment of a partnership firm, where no books of account were
maintained, but accounts were presented in the form of profit and loss account
and balance sheet. The Madras High Court held that the profit and loss
account and balance sheet were not books of account as contemplated u/s. 68. It
held that since there were no books of account, there could be no credits in
such books, and therefore the provisions of section 68 could not be invoked to
tax capital contributions of partners in the hands of the firm.

Arunkumar J. Muchhala’s case

Recently, the issue again came up before the
Bombay High Court in the case of Arunkumar J. Muchhala vs CIT 85 taxmann.com
306.

In this case,
the assessee had income from rent, share of profit from a partnership firm,
salary income and income from other sources. The assessee had taken loans from
various parties totalling to Rs. 79.06 lakh. Since no loan confirmations were
provided in respect of these amounts, the assessing officer treated them as
unexplained cash credits and added them to the total income of the assessee.

In appeal before the Commissioner (Appeals),
explanations were given in respect of some of the loan amounts, for which
additions were deleted. However, no relief was given in respect of the other
amounts for which no further explanations or details were filed. The further
appeal of the assessee was dismissed by the tribunal.

Before the Bombay High Court, on behalf of
the assessee, it was argued that books of account had not been maintained by
the assessee, and therefore the provisions of section 68 would not apply. It
was claimed that though it was a fact that certain amounts had been taken by
the assessee from those persons, yet, when entries of these amounts were not
taken in the books of account, they could not be added to the income of the
assessee. These entries were only found by the assessing officer in the bank
statement, and no other document was considered by him while passing the
assessment order.

Reliance was placed on behalf of the
assessee on the decisions of the Supreme Court in the case of Baladin Ram
(supra), of the Bombay High Court in the case of Bhaichand H Gandhi
(supra), of the Gauhati High Court in the case of Anand Ram Raitani(supra)
and of the Delhi High Court in the case of CIT vs. Usha Jain 182 ITR 487. It
was argued that section 68 was a charging section and was also a deeming
provision. Further reliance was placed on the decision of the Madras High Court
in the case of Taj Borewells (supra). It was further argued that the
amounts were received by cheques, and that some of them were in respect of flat
bookings, which did not materialise, and therefore, cheques were returned and
there was no credit at the end of the year.

On behalf of the Revenue, it was argued that
many opportunities were given to the assessee to produce relevant documents in
order to substantiate and prove his version, but that the assessee had failed
to give the further details of the persons from whom the loans were allegedly
taken. It was argued that it was the bounden duty of the assessee to explain
the nature and source of cash deposits, and that it had therefore rightly been
held that the assessee could not take advantage of the fact that he had not
kept any books of account.

Reliance was placed on behalf of the Revenue
on the decision of the Punjab & Haryana High Court in the case of Sudhir
Kumar Sharma (HUF) vs. CIT 224 Taxman 178, the special leave petition
against which decision had been rejected by the Supreme Court.239 Taxman
264(SC).

The Bombay High Court observed that the
assessee had not denied that he had received the loan amounts/cash deposits
from those persons whose names had been given in the assessment order and that
those names had been taken from the bank account of the assessee. The High Court
observed that the assessee’s case was that since he had not maintained books of
account, those amounts could not be considered. The Bombay High Court observed
that when the assessee was doing business, it was incumbent on him to maintain
proper books of account. Such books could be in any form. According to the
Bombay High Court, if he had not maintained the books which he was required to,
then he could not be allowed to take advantage of his own wrong. The Bombay
High Court observed that the burden lay on the assessee to show from where he
had received the amounts, and what was their nature and the onus was on the
assessee to explain those facts.

The Bombay High Court noted that huge
amounts had been credited in the account of the assessee, and he had not
explained the nature of those credits. The fact of those amounts was discovered
by the assessing officer from the bank passbook. When the source and nature had
been held to have been explained, certain amounts had been deleted by the
appellate forums. In respect of the balance amounts of Rs. 58 lakh, no document
was produced in respect of those transactions, nor amounts had been confirmed
from those persons who were shown to have lent them. Therefore, according to
the Bombay High Court, the authorities below had rightly held that the nature
of the transaction had not been properly shown by the assessee.

According to the Bombay High Court, the
ratio of the decisions relied upon on behalf of the assessee were not
applicable to the case before it. In those cases, either the entries were
confirmed by the parties in whose name they were standing, or books of account
were showing the cash credits.

The court observed that in the case before
it, at no earlier point of time had a firm stand been taken by the assessee
that he had not maintained the books of account. Whenever a direction had been
given to produce the same in any form, the assessee had replied that he wanted
time to prepare. Many opportunities were given by the assessing officer for the
production of relevant documents, including books of account. However, such
documents were never produced. The assessee had raised the point of books of
accounts not being maintained for the first time before the Bombay High Court.
The Bombay High Court observed that non-production of documents was different
from non-maintenance of books of account. The Bombay High Court observed that
the facts in Sudhir Kumar Sharma’s case (supra) were almost similar, and
that case was, therefore, binding. It also noted that the special leave
petition of the assessee in that case to the Supreme court was dismissed by the
court.

The Bombay High Court, therefore, upheld the
addition made by the assessing officer of such amounts as unexplained cash
credits u/s. 68.

Observations

Section 68 while referring to the books
of account requires that (i) such books of account are ‘maintained’ (ii) by the
‘assessee’ and (iii) the assessee is ‘found’ (iv) to have ‘credited’ any sum
therein and (v) such finding, needless to say, is by the assessing officer.
Each of these requirements, are to be fulfilled for a valid charge u/s. 68. The terms referred to have their own meanings and their import
cannot be wished away in applying the provisions. The onus is heavy on the
assessing officer to establish strict compliance of each of the conditions
stated herein, before invoking and applying section 68 for an addition of the
deemed income. In a few cases, the courts have concurred that a pass book of a
bank cannot be construed to be maintained by the assessee and the bank cannot
be held to be an agent of the assessee.

There has been a special significance
attached to the books of account in the Act and the requirement for recording a
transaction or a write off with reference to the books of account has been
subjected to the examination by the courts, which have held that a deduction
based on the condition of an entry in the books of account would be conferred
only where the assessee has recorded the entry in the books and not otherwise;
a debit in the profit and loss account without supporting books would
disentitle an assessee from claiming the deduction. Please see National
Syndicate, 41 ITr 225(SC), S. Rajagopala Vandayar, 184 ITR 450(Mad.) and P.
Appuvath Pillai,58 ITR 622(Mad.), as a few examples.

Section 2(12) of the Income-tax Act defines
the term ‘books or books of account’ as including ledgers, day-books, cash
books, account-books and other books, whether kept in the written form or as
print-outs of data stored in a floppy, disc, tape or any other form of
electro-magnetic data storage device. Accordingly, a reference in section 68 to
books of account has to be given a meaning that is due to it keeping in mind
the definition of the term contained in the provisions of section 2(12)of the
Act. There is nothing in section 2(12) that indicates that a recording outside
the books would be construed to be the books of account.

The Bombay High Court in Bhaichand H.
Gandhi’s case, has said and confirmed what has been said above in so many words
and we do not think that there is any reason to differ from the ratio of the
said decision. Importantly, the court in Arunkumar J. Muchala’s case has
not expressly dissented from its earlier decision; it has rather chosen to
highlight the following distinguishing facts in the latter case;

u The
assessee was a businessman and was required to maintain the books of account,

u The
assessee had not maintained the books of account which he was required to
maintain,

u The
assesee was claiming the benefit of his own action which was not permissible in
law,

u The
assessee had at times pleaded that he was in the course of preparing the books
of account and would produce the same when ready, indicating that he was
otherwise required to maintain the books of account,

u The
assessee had for the first time taken a fresh plea before the high court that
the provisions of section 68 were not applicable, as he was not maintaining the
books of account and as a result, the lower authorities were deprive of
examining the facts and the merits of a fresh plea.

In Arunkumar J. Muchhala’s case, the
Bombay High Court has not entertained or has ignored the contention raised by
the assessee that he had not maintained the books of account. The Bombay High
Court’s decision seems to have been based on its disbelief of the assessee’s
arguments as on this aspect, and there was no fact-finding by the lower
authorities.

The main basis of the decision of the Bombay
High Court in Arunkumar J. Muchhala’s case, was that an assessee had
committed a wrong by not maintaining the books when he was required by law and
hence, cannot take advantage of his own wrong. The Bombay High Court has
observed that it was incumbent on the assessee to maintain proper books of
account when he was doing business. From the facts as stated earlier, it
appears that the assessee was not carrying on business himself, but was a
partner of a partnership firm. In that event, there was no statutory obligation
for the assessee to maintain his books of account. That being the position, it
cannot be said that the assessee was wrong in not maintaining books of account.
This aspect could have been explained to the court by the assessee with a
little more precision.

The Bombay High Court, while rejecting the
cases cited in support of inapplicability of section 68 including its own
decision before it in Arunkumar J. Muchhala’s case, has observed that in
those cases, either the entries were confirmed by the parties in whose name
they were standing, or books of account were showing the cash credits. It is
very respectfully pointed out that in all those cases, when one reads the
facts, no books of account were maintained by the assessee, nor were
confirmations available, and therefore, those decisions were delivered purely
on the principle that, where, admittedly books of account were not maintained
by the assessee, the provisions of section 68 would not apply.

The Bombay High Court in Arunkumar J.
Muchhala’s case, has decided the issue largely based on the decision of the
Punjab & Haryana High Court in the case of Sudhir Kumar Sharma (HUF)
(supra). If one examines the facts of that case, it is gathered that it was
not the case where books of accounts were not maintained. In response to
various questions by the assessing officer, the assessee’s representative had
replied that records were as per books of account, that details would be
checked with the books of accounts and provided, etc. The assessing
officer had observed that books of account were not produced. According to the
Commissioner (Appeals), the answer by the assessee to these questions of
assessing officer clearly showed that the assessee had maintained books of
accounts. Though the assessing officer made the additions on the basis of
deposits in the bank account, the Commissioner (Appeals) had held that this
would be tantamount to additions made on the basis of entries in the books of
account, since such deposits/credits would also appear in the books of account
of the assessee, which were not produced before the assessing officer. Accordingly,
the provisions of section 68 were held to be applicable in that case, on a
clear cut finding by the authorities that the assessee had maintained the books
of account. In the circumstances, the exclusive reliance on a decision with
contrary facts by the court in Arun Muchala’s case seems to be a case of
misunderstanding of the facts which understanding of facts could have been
provided by the assessee with a little
application in his own interest.

It is therefore appropriate to hold that
the decision of the court in Arunkumar J. Muchala’s case, should be
considered as one of its kind, delivered on the facts of the case, and not
laying down the rule of law.

In Baladin Ram vs. CIT (supra), a case decided under the Income-tax Act, 1922, but delivered after
the Income-tax Act, 1961, was enacted, the Supreme Court in the context of
section 68 observed:

“Even under the
provisions embodied under the new Act, it is only when any amount is found
credited in the books of an assessee that the section will apply. On the other
hand, if the undisclosed income was found to be from some unknown source or the
amount represents some concealed income which is not credited in his books, the
position would probably not be different from what was laid down in the various
cases decided when the Act was in force.”

In Taj Borewell’s case (supra), the
Madras High Court held as under:

“Unless the following circumstances
exist, the revenue cannot rely on section 68 of the Act:

(a) credit in the books of an
assessee maintained for the year;

(b) the assessee offers no
explanation or if the assessee offers explanation and if the assessing officer
is of the opinion that the same is not satisfactory, the sum so credited is
chargeable to tax as “Income from Other Sources”.

From these decisions as well as the language
of the section, it is clear that in the absence of books of account, section 68
would not apply.

The applicability of section 68 vis-à-vis
books of account was examined in the cases of Smt. Shanta Devi Jain, 171 ITR
532(P&H), Smt.Usha Jain, 182 ITR
487(Delhi) and Sundar Lal Jain, 117 ITR 316(All), in favour of
assessee besides the above referred and discussed cases. The Third Member of
the Tribunal in the case of Smt. Madhu Raitani, 45 SOT 23(Gau.) also
held that the provisions of section 68 were applicable in cases where the
assessee had maintained the books of account.

Therefore, the view appearing from the two
apparently conflicting decisions of the Bombay High Court is that in a case
where, admittedly, books of account are not maintained or the entry is not
appearing in the books of account, the provisions of section 68 would not
apply; however, in a case where the facts indicate that books of accounts are
maintained, but are not produced before the authorities, the provisions of
section 68 can be invoked on the assumption that entries in the bank statements
must have been recorded in the books of account.

Therefore, the principle laid down by the
Bombay High Court in Bhaichand H. Gandhi’s case would still continue to
be applicable. _

shailesh.kwebmaker

Depreciation on Non-Compete Fees

Issue for Consideration

Depreciation is allowable u/s. 32(1) on buildings, machinery,
plant or furniture, being tangible assets, and on know-how, patents,
copyrights, trade marks, licences, franchises or any other business or
commercial rights of similar nature, being intangible assets acquired on or
after 1^stApril 1998. At times, under an agreement for acquisition
of shares or acquisition of a business or on cessation of employment of an
employee, the seller, its promoters or the employee may be paid a non-compete
consideration, in addition to the sale consideration. The agreement for such
non-compete would generally provide that the payee shall refrain from carrying
on a competing business for a certain number of years.

The issue has arisen before the High Courts as to whether such
non-compete fee constitutes an intangible asset of the payer, which is eligible
for depreciation u/s. 32(1). While the Delhi High Court has held that such
non-compete fee is not an intangible asset eligible for depreciation, the
Karnataka and the Madras High Courts have held that the rights acquired on
payment of a non-compete fee are intangible assets eligible for depreciation.

Sharp Business System’s case

The issue had come up before the Delhi High Court in the case
of Sharp Business System vs. CIT 211 Taxman 576.

In this case, the assessee was a joint-venture between Sharp
Corporation and L & T. It used to import, market and sell electronic office
products and equipments in India. During the relevant year, it paid Rs. 3 crore
to L & T as consideration for the latter not setting up or undertaking or
assisting in setting up or undertaking any business in India of selling,
marketing and trade of electronic office products for a period of 7 years. In
the accounts of the assessee, this amount was treated as a deferred revenue
expenditure and written off over the period of 7 years. In the return of
income, the entire sum paid was claimed as a revenue expenditure, on the ground
that the payment facilitated its business and did not enhance or alter the fixed
capital.

The assessing officer disallowed the deduction on account of
non-compete fee, on the ground that it conferred a capital advantage of
enduring value. The Commissioner(Appeals) rejected the assessee’s appeal, and
also rejected the alternative contention of the assessee for allowance of the
depreciation on such payment.

On further appeal, the Tribunal also rejected the contention
that the non-compete fee constituted revenue expenditure, holding that the
payment made by the assessee was not to increase the profitability, but to
establish itself in the market and acquire market share, as the period of 7
years was quite long, during which any new company could establish its
reputation and acquire a reasonable market share. It held that by keeping L &
T away from the same business, the assessee hoped to acquire a good market
share. The Tribunal also rejected the assessee’s claim for depreciation on
intangible asset.

Before the High Court, on
behalf of the assessee, besides arguing that the expenditure was of a revenue
nature, it was argued that the Tribunal was wrong in concluding that the right
to trade freely in the market was not an asset, and did not qualify for
depreciation u/s. 32. Reliance was placed on section 32(1)(ii) for the
proposition that intangible assets used for the business were eligible for
depreciation. It was argued that once it was held that the assessee had
acquired an advantage in the capital field, denial of depreciation amounted to
an inconsistent approach.

Reliance was also placed on behalf of the assessee on the
decision of the Supreme Court in the case of Techno Shares and Stocks Ltd
vs. CIT 327 ITR 323, where the Supreme Court had held that holding of a
membership card of the stock exchange amounted to acquisition of an intangible
asset, which qualified for depreciation u/s. 32(1)(ii). On a similar reasoning,
it was argued that the right acquired by the assessee for itself after payment
of the non-compete fee was akin to a license or other similar rights, on which
depreciation had to be given. Reliance was also placed on the decision of the
Delhi High Court in the case of CIT vs. Hindustan Coca-Cola Beverages (P)
Ltd 331 ITR 192, where it was held that intangible advantages all assets in
the form of know-how, trade style, goodwill, etc. were depreciable
assets.

On behalf of the revenue, it was argued that the question of
allowability of depreciation did not arise at all, because the business or
commercial rights of similar nature could not be said to arise overnight on
account of payment of non-compete fee. Besides, the payment did not result in
any intangible asset akin to a patent or intellectual property right.
Therefore, it was claimed that the non-compete agreement did not create an
asset of intangible nature or kind which qualified for depreciation.

While holding that the payment amounted to a capital
expenditure, given the fact that the arrangement was to endure for a
substantial period of 7 years, the Delhi High Court considered whether an
expenditure conferring a capital advantage was necessarily depreciable. It
observed that as was evident from section 32(1)(ii), depreciation could be
allowed in respect of intangible assets. Parliament had spelt out the nature of
such assets by explicit reference to know-how, patents, copyrights, trademarks,
licences and franchises. It noted that so far as patents, copyrights,
trademarks, licences and franchises are concerned, though they were intangible
assets, the law recognised through various enactments that specific
intellectual property rights flowed from them.

According to the Delhi High Court, licences were derivatives
and often were the means of conferring such intellectual property rights. The
enjoyment of such intellectual property right implied exclusion of others, who
did not own or have license to such rights, from using them in any manner
whatsoever. Similarly, in the matter of franchises and know-how, the primary
brand or intellectual process owner owns the exclusive right to produce, retail
and distribute the products and the advantages flowing from such brand or
intellectual process owner, but for the grant of such know-how rights or
franchises. In other words, the species of intellectual property like rights or
advantages led to the definitive assertion of a right in rem.

Referring to the Supreme Court decision in the case of Techno
Shares and Stocks(supra), the Delhi High Court was of the view that the
Supreme Court had clearly limited its scope while holding that the right to
membership of the stock exchange was in the nature of any other business or
commercial right, which was an intangible asset, by clarifying that the
judgement of the court was strictly confined to the right to membership
conferred upon the member under the BSE membership card during the relevant
assessment years. According to the Delhi High Court, that ruling was therefore
concerned with an extremely limited controversy, i.e. depreciability of stock
exchange membership. In the view of the Delhi High Court, the membership rights
of a stock exchange was held to be akin to a license, because it enabled the
member to access the stock exchange for the duration of the membership, and
therefore it conferred a business advantage, which was an asset and clearly an intangible asset.

While analysing the question of whether the non-compete right
of the kind acquired by the assessee against L&T for 7 years amounted to a
depreciable intangible asset, the Delhi High Court observed that each of the
species of rights spelt out in section 32(1)(ii), i.e. know-how, patent,
copyright, trademark, license of franchise or any other right of a similar kind
conferred a business or commercial right, which amounted to an intangible
asset. The nature of these rights clearly spelt out an element of exclusivity,
which enured to the assessee as a sequel to the ownership. In other words, if
it was not for the ownership of the intellectual property or know-how or
license or franchise, it would be unable to either access the advantage or
assert the right and the nature of the right mentioned spelt out in the
provision as against the world at large, in legal parlance, in rem.

According to the Delhi High Court, in the case of a
non-compete agreement or covenant, the advantage was a restricted one in point
of time. It did not necessarily, and in the facts of the case before the Delhi
High Court, according to the court, did not confer any exclusive right to carry
on the primary business activity. The right could be asserted in the present
case only against L&T, and was therefore a right in personam.

The Delhi High Court further observed that another way of
looking at the issue was whether such rights could be treated or transferred, a
proposition fully supported by the controlling object clause, i.e. intangible
asset. Every species of rights spelt out expressly by the statute, i.e. of the
intellectual property right and other advantages such as know-how, franchise,
license, et cetera and even those considered by the courts, such as
goodwill, could be said to be transferable. Such was not the case with an
agreement not to compete, which was purely personal.

The Delhi High Court therefore held that the words “similar
business or commercial rights” had to necessarily result in an intangible asset
against the entire world, which could be asserted as such, to qualify for
depreciation u/s. 32(1)(ii). Accordingly, it was held that the non-compete
payment made by the assessee did not result in an intangible asset eligible for
depreciation.

Ingersoll Rand International Ind Ltd.’s case

The issue came up again before the Karnataka High Court in
the case of CIT vs. Ingersoll Rand International Ind. Ltd. 227 Taxman 176
(Mag).

In this case, the assessee was engaged in the business of
security and access control systems integration. During the relevant year, it
entered into a business purchase agreement with another company, Dolphin,
whereby it purchased the business of Dolphin for a consideration of Rs. 11.71
crore. The purchase consideration included a sum of Rs. 54.43 lakh paid to the
promoter as non-compete fees, and a sum of Rs. 43.55 lakh paid to him for
purchase of patents. The promoter was also appointed as the Vice President and
Company Head of the assessee through a contract of employment.

Out of the total consideration of Rs. 11.71 crore,
non-compete fees and patents were shown as assets in the books of account of
the assessee, and the balance amount was shown as goodwill. The payment of
non-compete fee was treated as a revenue expenditure in the computation of
total income, though capitalised in the books of account. The assessee also
claimed depreciation on the patents in the computation of its income, though it
did not claim depreciation on goodwill.

The assessing officer held that the non-compete fee was
capital in nature and disallowed it. The Commissioner(Appeals), while holding
that the non-compete fee was in the nature of capital expenditure, also held
that it was not eligible for depreciation. The Tribunal, while upholding the
view that the non-compete fee was in the nature of capital expenditure, held
that it was in the nature of a business or commercial right, and that depreciation
was allowable on such an asset.

Before the Karnataka High Court, on behalf of the revenue, it
was argued that non-compete fee did not constitute a commercial or a business
right for allowing depreciation u/s. 32(1)(ii). It was argued that in order to
claim depreciation, the assessee should own and use the asset in the business,
and that this user test was not satisfied in this case. It was therefore argued
that non-compete fee could not be classified as an asset, and now depreciation
could be allowed thereon.

On behalf of the assessee, it was argued that by virtue of
payment of the non-compete fee, the assessee could carry on business without
any competition for the limited period, which in turn resulted in an advantage
to the business, and as that advantage conferred on it a commercial and
business right, once it was held to be of the nature of capital expenditure,
the assessee was entitled to depreciation u/s. 32(1)(ii).

The Karnataka High Court referred to the decisions of the
Delhi High Court in the case of Hindustan Coca-Cola Beverages (P) Ltd.
(supra) and Areva T & D India Ltd.vs. Dy CIT 345 ITR 421 to
understand the meaning of the term “any other business or commercial rights of
a similar nature”. It further referred to the decision of the Madras High Court
in the case of Pentasoft Technologies Ltd vs. Dy CIT 222 Taxman 209,
where the Madras High Court had held that a non-compete fee amounted to an
intangible asset eligible for depreciation, and the decision of the Delhi High
Court in the case of Sharp Business System (supra).

The Karnataka High Court, while analysing the provisions of
section 32(1)(ii), noted that in the definition of intangible assets, any other business or commercial rights of
similar nature were included. Therefore, such rights need not answer the
description of know-how, patents, copyrights, trademarks, licenses, or
franchises, but must be of similar nature as those assets, namely know-how, etc.
According to the Karnataka High Court, the fact that after the specified intangible
assets, the words “business or commercial rights of similar nature” had been
additionally used, clearly demonstrated that the legislature did not intend to
provide for depreciation only in respect of specified intangible assets, but
also to other categories of intangible assets, which were neither feasible nor
possible to exhaustively enumerate.

The Karnataka High Court noted that the words “similar
nature” carried a significant expression. The Supreme Court, in the case of Nat
Steel Equipment (P) Ltd vs. Collector of Central Excise AIR 1988 SC 631,
had held that the word similar did not mean identical, but meant corresponding
to resembling to in many respects, somewhat like or having a general likeness.
According to the Karnataka High Court, therefore, what was to be seen was what
the nature of intangible assets was, which would constitute business or
commercial rights to be eligible for depreciation.

The Karnataka High Court noted that the intangible assets
enumerated in section 32(1)(ii) effectively conferred a right upon an assessee
for carrying on of business more efficiently, by utilising an available
knowledge or by carrying on a business to the exclusion of another assessee. A
non-compete right represented a right, under which one person was prohibited
from competing in business with another for a stipulated period. It would be
the right of the person to carry on the business in competition, but for such
agreement of non-compete. The right acquired under a non-compete agreement was
a right for which a valuable consideration was paid. The right was acquired to
ensure that the recipient of the non-compete fee did not compete in any manner
with the business with which he was earlier associated.

According to the Karnataka High Court, the object of
acquiring a know-how, patent, copyright, trademark, license, or franchise was
to carry on business against rivals in the same business in a more efficient manner,
or in the best possible manner. The object of entering into a non-compete
agreement was also the same, i.e., to carry on business in a more efficient
manner by avoiding competition, at least for a limited period of time. On
payment of non-compete, the payer acquired a bundle of rights, such as
restricting the receiver directly or indirectly from participating in the
business, which was similar to the business being acquired, from directly or
indirectly suggesting or influencing clients or customers of the existing
business or any other person either not to do business with the person to whom
he has paid the non-compete fee, or the person receiving the non-compete fee is
prohibited from doing business with the person who was directly or indirectly in competition with the business, which was
being acquired. The right was acquired for carrying on the business, and
therefore it was a business right.

The right by way of non-compete was acquired essentially for
trade and commerce, and therefore qualified as a commercial right. Such a right
could be transferred to any other person, in the sense that the acquirer got
the right to enforce the performance of the terms of agreement under which a
person was restrained from competing. When a businessman paid money to another
businessman for restraining the other businessman from competing with the
assessee, he got a vested right, which would be enforced under law, and without
that, other businessmen could compete with the first businessman. By payment of
non-compete fee, the businessman got a right which was a kind of monopoly to
run his business without bothering about the competition.

The Karnataka High Court noted that the non-compete fee was
paid for a definite period. The idea behind this was that, by that time, the
business would stand firmly on its own footing, and could sustain later on.
This clearly showed that a commercial right came into existence, whenever the
assessee made a payment of non-compete fee. Therefore, according to the
Karnataka High Court, the right which the assessee acquired on payment of
non-compete fee conferred in him a commercial or business right, which was
similar in nature to know-how, patents, copyrights, trademarks, licenses and
franchises, which unambiguously fell within the category of an intangible
asset. The right to carry on business without competition had an economic
interest and a money value.

In the view of the Karnataka High Court, the doctrine of ejusdem
generis would come into operation. The non-compete fee vested right in the
assessee to carry on business without competition, which in turn conferred a
commercial right to carry on a business smoothly. Once such expenditure was
held to be capital in nature, consequently, the assessee was entitled to the
depreciation provided u/s. 32(1)(ii). The Karnataka High Court therefore held
that the assessee was entitled to depreciation on the non-compete fee.

A similar view was taken earlier by the Madras High Court in Pentasoft
Technologies’ case (supra), though in that case the non-compete payment was
for restraint on use of trade mark, copyright, etc.

Observations

One makes a payment, in the course of business either for
meeting an expenditure or for acquiring an asset or a right. An expenditure can
be either in the revenue field or in the field of capital. Where a revenue
expenditure is incurred, no asset can be said to have been acquired and hence
no depreciation is allowable. When a capital expenditure results in acquisition
of an asset that is eligible for depreciation, the payer will be entitled to
depreciation. Besides, being an owner of the asset, it is essential that the
owner uses the asset and such user is for the purposes of business. On
satisfaction of these tests, a valid claim for depreciation is made that cannot
be frustrated for ambiguous reasons.

Any payment made, in the course of business, not resulting in
acquisition of a tangible asset generally should be for acquiring some right or
removing some disability and when seen to be resulting in to a business or commercial
right should, without hesitation, be classified as an intangible asset, in view
of the two landmark decisions of the apex court in the case of Techno Shares
and Smifs Securites. It is inconceivable that a businessman would make a
payment that does not endow him with business rights or, in the alternative,
saves him from some disability that facilitates the conduct of his business
efficiently. Looked at from this angle,
any non revenue payment results in acquiring a business right, provided it does
not result in acquisition of a tangible asset.

The principle of user of an asset, in the context of an
intangible asset, will have to be viewed differently. In the context, it will
also include a case of preventing another person from using it against the
assessee and therefore a non-user by the others, on payment, should be viewed
as the user by the assessee. The authorities or the courts should appreciate
this aspect or the character of the intangible asset while dealing with the
concept of user.

A business or commercial right of a similar nature is vast
enough to cover a good number of cases, where the payer, on payment, is seen to
be facilitating the efficient conduct of business, by use or by non-user by the
payee. A know-how, license, franchise, etc. are cases where the payer is
enabled to carry on business with the protection of law or of the payee.
Similarly, on payment of non-compete consideration, the payer acquires a
protection from the payee for carrying on his business without competition.

Both the Delhi and Karnataka High Courts seem to have adopted
the principle of ejusdem generis, to arrive at diametrically opposite views.
While the Delhi High Court was of the view that a right obtained under a
non-compete agreement was not akin to trademarks, copyrights, licences, etc.,
the Karnataka High Court was of the view that such right is similar in nature,
as both facilitate carrying on of business more smoothly.

The distinction between the right in rem and in personam
perhaps is not relevant or conclusive in deciding the issue whether an
asset is depreciable or not. Neither the law nor the courts require that a
right in an asset should be against the world before a valid depreciation is
allowed. In the case of Techno Shares & Stocks (supra), while the
Bombay High Court had earlier held that the membership rights of the Bombay
Stock Exchange was not an intangible asset eligible for depreciation, not being
similar to other rights specified in section 32(1)(ii), the Supreme Court took
a contrary view on the same principle of ejusdem generis, holding that such
membership right was similar to a licence, since it permitted a member to carry
on trading on the exchange. This was notwithstanding the fact that such right
was a personal permission granted to the member under the bye-laws of the
exchange, and therefore not transferable. In a similar manner, a right of
non-compete, though not strictly transferable, can still be an intangible
asset.

Therefore, though the Supreme Court may have observed that the
ratio of its decision applied only to a case of membership rights of the Bombay
Stock Exchange, the principles on the basis of which the case was decided,
would apply equally for other payments under which a right to carry on a
business is acquired, though non transferable. Interestingly, the Karnataka
High Court has found such rights to be transferable by the payer for a
consideration and has noted that the transferee should be in a position to
enforce such rights against the payee.

Similarly, in the case of CIT vs. Smifs Securities Ltd 348
ITR 302 (SC), the Supreme Court held that goodwill arising on amalgamation
of companies was an intangible asset eligible for depreciation. This was
notwithstanding the fact that such a goodwill arose only to the amalgamated
company, and was not on account of any transferable asset which can be put to
any specific use.

From the two decisions of the Supreme Court on the subject of
depreciable intangible assets, it is therefore clear that the Supreme Court has
taken a broader view of the term, by permitting depreciation on business and
commercial rights, in cases where the payment
permitted smoother functioning of the business, holding that such rights
were similar to the specified rights, such as trademarks, copyrights, licences,
etc.

Therefore, the better view seems to be that
rights acquired under a non-compete agreement are intangible assets, eligible
for depreciation u/s. 32(1(ii).

shailesh.kwebmaker

Taxability of Contingent Consideration on Transfer of Capital Asset

Issue for Consideration

Section 45 provides for the charge of tax in respect of
capital gains. It provides that any profits or gains arising from the transfer
of a capital asset shall be chargeable to income-tax under the head “Capital
Gains”, and shall be deemed to be the income of the previous year in which the
transfer took place.Entire capital gains is chargeable to tax in the year of
transfer of the capital asset, irrespective of the year in which the
consideration for the transfer is received.

Section 48 provides for the mode of computation of the
capital gains. It provides that the income chargeable under the head “Capital
gains” shall be computed by deducting from the full value of the consideration
received or accruing as a result of the transfer of the capital asset, the
expenditure incurred wholly and exclusively in connection with such transfer,
and the cost of acquisition and the cost of improvement of the asset.

In many transactions, particularly transactions of
acquisition of a company through acquisition of its shares, it is common that a
certain consideration is paid at the time of transfer of the shares, while an
additional amount is agreed to be
payable, the payment of which is deferred to a subsequent year or years, and is
dependant upon the happening of certain events, such as achievement of certain
turnover or profitability targets or obtaining of certain business or approvals
in the years subsequent to sale. Such receipt is contingent, in the sense that
it would not be payable if the targets are not achieved or the contemplated
event does not occur. Such payments are commonly referred to as “earn-outs”,
when they are linked to achievement of certain targets.

Given the fact that such payment may or may not be
receivable, the issue has arisen before the courts as to whether such
contingent consideration is chargeable to tax as capital gains in the year of
transfer of the capital asset. While the Delhi High Court has taken the view
that such contingent consideration is chargeable to income tax in the year of
transfer of the shares, the Bombay High Court has taken the view that such
contingent consideration does not accrue in the year of transfer of the shares,
and is therefore not taxable in that year.

Ajay Guliya’s case

The issue first came up before the Delhi High Court in the
case of Ajay Guliya vs. ACIT, 209 Taxman 295.

In this case, the assessee sold 1500 shares held by him
through a share purchase agreement dated 15 February 2006. The total
consideration agreed upon was Rs. 5,750 per share, out of which Rs. 4,000 was
payable on the execution of the share purchase agreement and the balance was
payable over a period of 2 years. The balance amount of Rs. 1750 per share
depended upon the performance of the company, and fulfilment of the specified
parameters. The assessee considered the sale consideration at Rs. 4,000 per share, while computing the capital gains in
his return of income for assessment year 2006-07.

The assessing officer held that the entire income accruing to
the assessee was chargeable as capital gains, and accordingly considered the
entire consideration of Rs. 5,750 per share for computation of capital gains.
The Commissioner (Appeals) allowed the appeal of the assessee, holding that
such part of the consideration which was payable in future did not constitute
income for the relevant assessment year and that the assessee would become
entitled to it only on the fulfilment of certain conditions, which could not be
predicated.

The Tribunal on being asked to examine the applicability of
the decision of the Authority for Advance Ruling held that the ratio of the
advance ruling in the case of Anurag Jain, in re, 277 ITR 1, was not
applicable, as in that case, the payment for consideration of shares was
interlinked with the performance of the assessee employee, and not the company
whose shares were transferred, and the question before the authority was
regarding the taxation of the capital gains and contingent payments under the
head “Salaries”. According to the tribunal, in the case before it, the issue
was one of transfer of shares simpliciter, and the payment of additional
consideration did not depend upon the performance of the assessee. The Tribunal
further noted that there was no provision for cancellation of the agreement in
case of failure to achieve targets. Considering the deeming fiction of section
45(1), the tribunal held that the whole of the consideration accruing or
arising or received in different years was chargeable under the head capital
gains in the year in which the transfer of shares had taken place. The tribunal
therefore held that the entire consideration of Rs. 5,750 per share was
chargeable to capital gains in the relevant year of transfer.

Before the Delhi High Court, on behalf of the assessee,
reliance was placed on the decision of the Supreme Court in the case of CIT
vs. B. C. Srinivasa Setty 128 ITR 294, for the proposition that the
provisions of the charging section, section 45 were not to be read in
isolation, but had to be read along with the computation provision, section 48.
It was argued that the entire consideration of Rs. 5,750 per share was not
payable at one go, and that the parties had specified conditions which would
have to be fulfilled before the balance of Rs. 1,750 per share became payable.
Even though the valuation had been agreed upon, much depended on the
performance of the company whose shares were the subject matter of the sale.
The balance amount of Rs. 1,750 per share could never be said to have arisen or
accrued during the relevant assessment year, as the assessee became entitled to
it only upon fulfilment of these conditions. The assessee could not claim the
balance amount unless the essential prerequisites had been fulfilled. It was
argued that the Supreme Court in Srinivasa Setty’s case, had held that though
section 45 was the charging section and ordinarily acquired primacy, while
section 48 was merely the computation mechanism, at the same time, in order to
arrive at chargeability of taxation, both the sections had to be looked into
and read together.

The Delhi High Court observed that the reasoning of the
tribunal was based upon the fact that capital assets were transferred on a
particular date, i.e., on the execution of the agreement. It noted that there
was no material on record or in the agreement, suggesting that even if the
entire consideration or part thereof was not paid, the title to the shares
would revert to the seller. According to the High Court, the controlling
expression of “transfer” was conclusive as to the true nature of the
transaction. In the opinion of the Court, the fact that the assessee adopted a
mechanism in the agreement that the transferee would defer the payments, would
not in any manner detract from the chargeability when the shares were sold.

Dealing with the argument that the tribunal’s had not dealt
with the deeming fiction about the accrual required by section 48, the High
Court was of the view that the tenor of the tribunal’s order was that the
entire income by way of capital gains was chargeable to tax in the year in
which the transfer took place, as stated in section 45(1). According to the
High Court, merely because the agreement provided for payment of the balance
consideration upon the happening of certain events, it could not be said that
the income had not accrued in the year of transfer.

The Delhi High Court therefore held that the entire
consideration of Rs. 5,750 per share was to be considered in the computation of
capital gains in the year of transfer.

Mrs. Hemal Raju Shete’s case

The issue again recently came up before the Bombay High Court
in the case of CIT vs. Mrs. Hemal Raju Shete 239 Taxman 176.

In this case, the assessee sold shares of a company under an
agreement, along with other shareholders of the company. Under the terms of the
agreement, the initial consideration was Rs. 2.70 crore. There was also a
deferred consideration which was payable over a period of 4 years following the
year of sale, which was linked to the future profits of the company whose
shares were being sold, and which was subject to a cap of Rs. 17.30 crore.

The assessee filed her return of income, computing the
capital gains by taking her share of only the initial consideration of Rs. 2.70
crore. The assessing officer was of the view that under the agreement, the
shareholders were to receive in aggregate, a sum of Rs. 20 crore, and therefore
proceeded to tax the entire amount of Rs. 20 crore in the year of transfer of
the shares in the hands of all the shareholders.

The Commissioner (Appeals) deleted the addition made by the
assessing officer on the ground that it was notional. He observed that the
working of the formula agreed upon by the parties for payment of the additional
consideration could lead, and in fact had led to a situation, where no amount
on account of deferred consideration for the sale of shares was receivable by
the assessee in the immediately succeeding assessment year. There was no
guarantee that this amount of Rs. 20 crore, or for that matter, any amount,
would be received. The amount to be received as deferred consideration was
contingent upon the performance of the company in the succeeding year.
Therefore, according to the Commissioner (Appeals), no part of the deferred
consideration could be brought to tax during the relevant assessment year,
either on receipt basis or on accrual basis.

The Tribunal upheld the findings of the Commissioner
(Appeals), holding that, as there was no certainty of receiving any amount as
deferred consideration, the bringing to tax of the maximum amount of Rs. 20
crore provided as a cap on the consideration, was not tenable. The Tribunal
further held that what had to be brought to tax was the amount which had been
received and/or accrued to the assessee, and not any notional or hypothetical
income.

Before the Bombay High Court, on behalf of the revenue, it
was argued that transfer of capital asset would attract capital gains tax in
terms of section 45(1), and that the amount to be taxed u/s. 45(1) was not
dependent upon the receipt of the consideration. Attention of the court was
drawn to sections 45(1A) and 45(5), which in contrast, brought to tax capital
gains on amounts received. It was therefore submitted that the assessing
officer was justified in bringing to tax the assessee’s share in the entire
amount of Rs. 20 crore, which was referred to in the agreement as the maximum
amount that could be received on the sale of shares of the company by the
shareholders from the purchaser.

The Bombay High Court noted the various clauses in the
agreement in relation to the deferred consideration, and observed that the
formula prescribed in the agreement itself made it clear that the defer
consideration to be received by the assessee in the 4 years was dependent upon
the profits made by the company in each of the years. Thus, if the company did
not make a net profit in terms of the formula for the year under consideration
for payment of deferred consideration, then no amount would be payable to the
assessee as deferred consideration. The court noted that the consideration of
Rs. 20 crore was not an assured consideration to be received by the selling
shareholders. It was only the maximum that could be received. According to the
High Court, this was therefore not a case where any consideration out of Rs. 20
crore or part thereof (other than Rs. 2.70 crore), had been received or had
accrued to the assessee.

The Bombay High Court noted the observations of the Supreme
Court in the case of Morvi Industries Ltd vs. CIT 82 ITR 835, as under:

“The income can be said to
accrue when it becomes due………. The moment the income accrues, the assessee gets
vested right to claim that amount, even though not immediately”

According to the Bombay High Court, in the relevant
assessment year, no right to claim any particular amount of the deferred
consideration got vested in the hands of the assessee. Therefore, the deferred
consideration of Rs. 17.30 crore, which was sought to be taxed by the assessing
officer, was not an amount which had accrued to the assessee. The test of
accrual was whether there was a right to receive the amount, though later, and
whether such right was legally enforceable. The Bombay High Court noted the
observations of the Supreme Court in the case of E. D. Sassoon & Co.
Ltd. 26 ITR 27:

“it is clear therefore that
income may accrue to an assessee without the actual receipt of the same. If the
assessee acquires a right to receive the income, the income can be said to have
accrued to him, though it may be received later on its being ascertained. The
basic conception is that he must have acquired a right to receive the income.
There must be a debt owed to him by somebody. There must be as is otherwise expressed
debitum in presnti, solvendum in futuro…”

The Bombay High Court noted that the amount which could have
been received as deferred consideration was dependent/contingent upon certain
uncertain events, and therefore it could not be said to have accrued to the
assessee. The Bombay High Court also noted the observations of the Supreme
Court in the case of CIT vs. Shoorji Vallabhdas & Co. 46 ITR 144:

“Income tax is a levy on
income. No doubt, the income tax Act takes into account two points of time at
which liability to tax is attracted, viz., the accrual of its income or its
receipt; but the substance of the matter is income. If income does not result,
there cannot be a tax, even though in bookkeeping, an entry is made about a
hypothetical income, which does not materialise.”

The Bombay High Court also noted the observations of the
Supreme Court in the case of K. P. Varghese vs. ITO 131 ITR 597, to the
effect that one has to read capital gains provision along with computation
provision, and the starting point of the computation was the full value of the
consideration received or accruing. In the case before it, the Bombay High
Court noted that the amount of Rs. 17.30 crore was neither received, nor had it
accrued to the assessee during the relevant assessment year. The Bombay High
Court also stated that it had been informed that for subsequent assessment
years, other than the year in which there was no deferred consideration on
account of the formula, the assessee had offered to tax the amounts which had
been received pertaining to the transfer of shares.

The Bombay High Court also rejected the argument of the
revenue that by not bringing it to tax in the year of transfer on the ground
that it had not accrued during the year, the assessee was seeking to pay tax on
the amount on receipt basis. The High Court observed that accrual would be a
right to receive the amount, and the assessee had not obtained a right to
receive the amount in the relevant year under the agreement.

The Bombay High Court accordingly held that the deferred
consideration of Rs. 17.30 crore could not be brought to tax in the relevant
assessment year, as it had not accrued to the assessee.

Observations

There is not much of a debate possible in cases where the
consideration for transfer is agreed but the payment thereof is deferred. The
facts of Ajay Gulati’s case seemed to suggest that. In that case, a lump sum
consideration was defined and was agreed upon but the payment thereof was
deferred based on happening of the event. The case perhaps could have been
better in cases where the lump sum is not agreed upon at all, but a minimum is
agreed upon, and the additional payment, if any, is made contingent as to
quantum and the time, on the basis of certain deliverables.

Besides ‘transfer’, the most important thing, for the charge
of capital gains tax, is that there should arise profits and gains on transfer
and it is that profits that has arisen as a result of the transfer that can be
brought to tax. A profit that has not arisen or the one that has yet to arise
may not be termed as having arisen so as to bring it to tax. Another equally
important requirement is that the consideration must have been ‘received or
accrued’ for it to be treated as the ‘full value of consideration’ in terms of
section 48 of the Act. It is only such consideration that can enter in to the
computation of the capital gains. In the case of the additional payments, that
can accrue only on happening of the event and can be received only thereafter.
No right to receive accrues till such time the events happen.

A clause for cancellation may help in minimising the damage
for the assesseee as had been observed by the Delhi high court in Ajay Gulati’s
case. A transfer expressly providing for cancellation, not of the transfer, but
of the right to receive additional compensation, may help the case of the
assessee.

“Full Value of Consideration” is a term that has not been
defined in section 48 of the Act. Its meaning therefore has to be gathered from
a composite reading of the provisions of section 48 of the Act. The term is
accompanied with the words ‘received or accruing’, which words indicate that it
is such a consideration that has been received or has accrued in the least,
failing which it may not enter in to the computation for the time being for the
year of the transfer.

There is a possibility that the additional consideration
would be taxed as income for the independent performance by the transferor in
the subsequent year and be taxed independently in a case where the transferor
is required to perform and deliver certain milestones, subsequent to the
transfer of shares. In such a case, the additional payment accrues to him for
delivering the milestones based on his performance and in such a case the
payment would be construed to be the one for the performance, and not for
transfer of the shares; it would accrue only on performance, and cannot be
taxed in the year of transfer. Please see Anurag Jain’s case (supra).

An alternative to the issue is to read the law in a manner
that permits the taxation of capital gains in different years; ascertained
gains in the year of transfer and the contingent ones only on accrual in the
year thereof and yet better in the year of receipt. It is not impossible to do
so. The charge of section 45 should be so read that it fructifies in two years
instead of one year. There does not seem to be anything that prohibits such a
reading of the law. In taxing the business income, it is usual to come across
cases wherein the additional payments contingent on happenings in future years
are taxed in that year on the ground that they accrue on happening of an event.
It is for this reason that the Bombay high court in Shete’s case has relied
upon the decisions delivered in the context of the real income.

The logic of the Bombay High Court decision does seem
appealing, as a notional income or income, which has not accrued, can never be
taxed under the Income Tax Act. Taxation of such a potential income under the
head “Capital gains” in the year of transfer of the capital asset, merely on
the ground that the charge is linked to the date of transfer, does not seem
justified, where such consideration has not really accrued and there is a
possibility that it may not be recieved.

The peculiar nature of this controversy is on account of the
fact that the charge to capital gains is in the year of transfer, while the
computation is on the basis of accrual or receipt. In the case of earn outs,
there is no accrual in the year of transfer, but in the year of accrual, there
is no transfer of a capital asset.

Therefore, if one follows the Delhi High Court decision, one
may end up paying tax on a notional income which one may never receive. On the
other hand, if one follows the Bombay High Court decision, it may result in a
situation where the deferred consideration is never taxed, as it does not
accrue in the year of transfer, and in the subsequent year when it accrues, the
charge to tax fails on account of the fact there is no transfer of the capital asset.

From the facts of the Bombay High Court decision, it is not
clear as to under which head of income the deferred consideration was offered
to tax in subsequent years when it accrued. However, to a great extent, the
decision of the Bombay High Court may have been influenced by the fact that
such deferred consideration was taxed in subsequent years. Again, the
substantial amount of deferred consideration as against the initial
consideration, and the direct linkage of the formula for determination of
deferred consideration with the profits of the company, may have impacted the
decision of the Bombay High Court.

Therefore, while on principles, the Bombay High Court
decision seems to be the better view of the matter, it is essential that the
law should be amended to bring clarity to the taxation of such deferred
consideration which does not accrue on the transfer of the asset. There are
already specific provisions in the law in the form of section 45(5) in relation
to enhanced compensation received on compulsory acquisition of a capital asset
by the Government, where such enhanced compensation is taxable in the year of
receipt, and is not taxable in the year of transfer of the capital asset.

Pending such amendment to the law, the only option available
to an assessee is to initially offer the capital gains to tax on the basis of
the initial consideration, and subsequently revise the return of income to
reflect the enhanced consideration on account of the deferred consideration as
and when it accrues. Even here, this is not a happy situation, as the time
limit for revision of a return of income under the provisions of section
139(5), is now only one year from the end of the relevant assessment year. If
this time limit has expired, by the time the deferred consideration accrues,
even such a revision would not be possible. Rectification u/s. 154 is yet
another possibility whereunder the additional payment on happening of an event
and on receipt be tagged to the original consideration and be taxed in the year
of transfer.

One therefore hopes that a specific provision is
made to cover such situations of deferred consideration, which are commercially
insisted upon by the purchaser in many transactions. This alone, will put an
end to the litigation on the matter.

shailesh.kwebmaker

Expenditure by Pharmaceutical Companies On Doctors

Issue for Consideration

Explanation 1 to section 37(1) declares, for the removal of
doubts, that any expenditure incurred for a 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 shall be allowed for such an
expenditure.

It is the usual industry practice for companies, engaged in
the business of manufacturing pharmaceutical products, to distribute their
products amongst the medical practitioners by way of free samples and gift
articles; to conduct and sponsor seminars and lectures in and outside India; to
hold dinner and parties; to sponsor holidays and pay for travel and
accommodation of doctors and their spouses and incur such other expenses.

The expenditures so incurred is usually classified as the
advertisement and sales promotion expenses and is claimed as a business
expenditure. The validity of such claim is examined by the Supreme Court in the
case of Eskayef Pharmaceuticals Ltd, 245 ITR 116 (SC), in the context of section
37(3A), now omitted. A controversy has arisen, on account of the
conflicting decisions of the Tribunal, in the recent years, on the subject of
allowance or otherwise of the deduction of such expenditure, post issue of a
circular No.5 dt. 1.08.2012 by the CBDT in pursuance of the amendments of 2009
in the Indian Medical Council (Professional Conduct, Etiquette & Ethics)
Regulations, 2002 ( ‘Regulations’).

Liva Healthcare Ltd’s case.

The issue had first arisen in the case of Liva Healthcare
Ltd. vs. DCIT, 161 ITD 63. In the said case, the company for assessment
year 2009-10 had incurred expenditure on travel and accommodation of doctors
and their spouses to Istanbul and Hongkong and towards distribution of free
samples to the physicians. The tours were conducted to promote the products and
samples were distributed free of cost as a necessity of business requirement of
the assessee. The company had submitted before the AO that the expenditures
were incurred, including on samples given free of cost to doctors, to obtain
information regarding efficacy of the medicine and for the purposes of
advertisement, publicity and sales promotion; that samples were given free of
cost to the doctors so that they could try the same on patients and inform the
medical representative of the assessee about their results and their
experiences; that the nature of the product sought to be sold was such that it
could be done through the doctors alone and as such promoted sales also; that
when such expenditure was incurred on doctors and samples were given to
doctors, certain amount of good relationship was created with them who might
then buy or prescribe those medicines in preference to other similar products.
In a nutshell, it was explained that the twin purpose of such expenditures was
to test the efficacy of the products as well as for advertisement, publicity or
sales promotion. It was also submitted that the samples were manufactured as
“physician samples not for sale” and the suppliers invoices were
marked as “physician samples” only. The assessee relied upon a few
decisions including the decision in the case of Eskayef Pharmaceuticals
(India) Ltd., (supra) :

In assessing the total income, the A.O. disallowed the
expenditure incurred on travel and accommodation in full and also disallowed
25% of the expenditure claimed on distribution of free samples by applying
Explanation 1 to section 37(1) of the Act. The CIT(A) upheld the
disallowance of the travel and accommodation expenditure but deleted the
addition on account of disallowance of the expenditure in part of distribution
of the free samples by allowing the appeal of the assessee company, in part.

In cross appeals to the Tribunal, the revenue relied upon the
order of the A.O. while the assessee company reiterated its stand taken before
the A.O. Significantly, it brought to the notice of the Tribunal the order
passed by the Tribunal in its own case for assessment year 2008-09. The
Tribunal examined the provisions of the said Regulations of 2002 and in
particular clauses 6.4 and 6.8 as also the then newly amended clause
6.8. It also took into consideration the decision of the Himachal Pradesh
High Court in the case of the Confederation of Pharmaceutical Industry vs.
CBDT, 355 ITR 388 wherein validity of the said CBDT circular No. 5 of
2012 and the said Regulations of 2002 governing professional ethics
of doctors was challenged and was found by the court to be as per the law and
salutary and issued in the interest of public and patients. The Tribunal also
took note of the decision of the Punjab and Haryana High Court in the case of CIT
vs. Kap Scan and Diagnostic Centre (P.) Ltd., 344 ITR 478, wherein the
court had confirmed the disallowance of commission paid to the doctors, as not
allowable u/s. 37(1) of the Act, being against public policy and
prohibited by law.

The Tribunal at the outset expressed their agreement, in
principle, with its decision in assessee’s own case for assessment year
2008-09, so far as the expenditure incurred on distributing free samples to
test the efficacy of the pharmaceutical products, in accordance with the ratio
of the case of Eskayef Pharmaceuticals (India) Ltd. (supra), at the
initial stage of introduction of the products to get the feedback of the users
and held that such expenses could be said to be incurred wholly and exclusively
for the purposes of business satisfying the mandate of section 37 of the Act.
The Tribunal held that the physicians’ samples were necessary to ascertain the
efficacy of the medicine and for introduction of a new product in the market,
it was only by distributing the free samples that the purpose was achieved.

The Tribunal however proceeded to hold that where a
particular medicine had already been introduced into the market, in the past,
and its uses were established, giving of free samples could only be as a
measure of sales promotion and advertisement and that the ratio of the said
decision in the case of Eskayef Pharmaceuticals (India) Ltd.(supra),
delivered in the context of section 37(3A) of the Act, did not apply due to the
fact that the Finance Act, 1998 had thereafter, introduced an Explanation to
section 37(1) of the Act which required that an expenditure, the purposes
which was an offence or prohibited under the law, was disallowed.

The Tribunal noted that the purpose for incorporation of the
said Explanation to section 37(1) had been explained by the CBDT in Circular
No. 772, dated December 23, 1998. It further noted that the said Regulations
of 2002 prohibited, vide regulation 6.4.1, a physician from receiving any
gifts, gratuity, commission or bonus in consideration or return for referring
the patients for medical, surgical or other treatment.

It held that once the pharmaceutical products were
distributed after the products were introduced in the market and its uses were
established, giving of free samples to doctors and physicians would be a measure
of sales promotion which would be hit by regulation 6.4.1 of the said Regulations
of 2002. It further held that the said regulation had a force of law and
the receipt of free samples amounted to receipt in consideration of or return
for referring patients and that such receipts were prohibited under regulation
6.4.1 of the said Regulations of 2002 inasmuch as the stated
objective of giving free samples to the doctors and physicians was to induce
them to write prescriptions of the said pharmaceutical products. It held that
the expenses could not be allowed as deduction while computing income from
business or profession.

The Tribunal drew support from the decision in the case of Eskayef
Pharmaceuticals (India) Ltd. (supra) to hold that the test laid down by the
court, read in conjunction with Explanation to section 37 of the Act and
regulation 6.4.1. of the said Regulations of 2002, made it clear
that the expenditure on such free samples was hit by the Explanation to
section 37 of the Act and was not allowable as deduction.

In conclusion, the Tribunal held that the expenditure on
foreign travel and accommodation of doctors and their spouses was incurred with
the intent and the objective of profiting from the distribution and
entertainment and had a direct nexus with promoting the sales and
profitability, all of which made such expenditure violate the provisions of the
said Regulations of 2002. It held that the expenditure was incurred to
seek favours from the doctors by way of recommendation of the company’s
products which was an illegal gratification, was against public policy, was
unethical and was prohibited by law. Accordingly, the expenditure in question
was liable for disallowance in full as was held by the A.O. and the CIT(A).

PHL Pharma (P) Ltd.

The issue had again arisen in the case of PHL Pharma (P)
Ltd. vs. ACIT, 163 ITD 10(Mum. ). In this case, the assessee company had
debited an amount aggregating to Rs. 83.93 crore to the Profit & Loss
Account towards advertisement and sales promotional expenses, for the year
ending on 31.03.2010. The said expenditure included expenses on distribution of
free samples and gift articles to medical practitioners and doctors, besides
the expenditures on conducting seminar and lecture meetings, journals and
books, travel and accommodation and such other items and things. The A.O.
disallowed an amount of Rs. 23 crore being that part of the expenditure that
was incurred on or after 10.12.2009, i.e. the date of notification of the said
amendments in the said Regulations of 2002. On appeal, the CIT(A) agreed
with the case of the assessee company and allowed the appeal.

On appeal by the Income tax Department to the Tribunal, it
was held as under:

– The said Regulations of 2002 dealt
with the professional conduct, etiquette and ethics for the registered medical
practitioners, only; it requires that they shall not aid or abet or commit any
of the prescribed unethical acts; it laid down the code of conduct for doctors
in their relationship with pharmaceutical and allied health sector industry.

– The CBDT Circular No. 5 of 2012 had
heavily relied upon the said Regulations of 2002.

– The code of conduct has meant to be followed
and adhered to by the medical practitioners and doctors alone and did not apply
any manner to pharmaceutical companies and the Delhi High Court in the case of Max
Hospitals vs. MCI had confirmed this position in WPC 1334 of 2013 dt.
10.01.2014.

– The Indian Medical Council did not have any
jurisdiction nor had any authority upon the pharmaceutical companies and could
not have prohibited such companies in conduct of their business.

– As far as the company was concerned, there
was no violation of any law or regulation. The provisions of section 37(1)
applied to a company claiming the expenditure and the violation of section
37(1) was to be examined w.r.t the company incurring the expenditure and not
the doctors who were the beneficiary of the expenditure. Even the additional
prohibition prescribed on 01.12.2016 applied only to the medical practitioners
and not to the pharmaceutical companies .

– The punishments or penalties prescribed in
the said Regulations applied only to the medical practitioners and not to the
companies.

– The CBDT in issuing the said circular No.
5 had enlarged the scope of the said Regulations by applying it to
the pharmaceutical companies without any enabling provisions to do so. It had
no power to create a new impairment adverse to an assesee or a class of
assessees, without any sanction of law. The circular issued should have
confirmed with the tax laws and should not have created a new burden by
enlarging the scope of a different regulation.

– The circular in any case could not be
reckoned retrospectively i.e., it could not be applied before the date of its
issue on 01.08.2012.

– The expenditure incurred by the assessee
company was in the nature of sales and business promotion and was to be
allowed; the gift articles bore the logo of the assessee and could not be held
to the freebies; the free samples proved the efficacy of the products of the
company and again were not in violation of the said Regulations framed
by the Medical Council of India.

– The decision in the case of Confederation
of Indian Pharmaceutical Industry (supra) upheld the validity of the said
circular with a rider that no disallowance should take place where the assessee
satisfied the authority that the expenditure was not in violation of the Regulations
framed by the Medical Council of India.

– The assesseee company, in the opinion of the
CIT(A), in the case had proved that the
expenditure were not in violation of the said Regulations.

– The action of the CIT (A) was upheld and the
expenditure claimed was allowed by the Tribunal.

Observations

The conflicting decisions have brought out a very interesting
issue wherein all the sections of the society are required to address a few
pertinent questions; whether one can participate in an offence, even trigger
it, and still not be accused of the offence? For example, can one give a bribe
to a government official and still plead that he cannot be punished or can one
pay a ransom and plead that he cannot be punished? Can one be a party to illcit
activities and plead that not him but the other person be punished for the
crime? Can one be an abettor or instigator of a crime or an offence and plead
innocence?

It may be possible to legally resolve the controversy by
holding, that in the absence of a provision of law that expressly provides for
the conviction, in explicit words, of both the parties to an offence, one of
the parties to an offence, though found to be abetting the offence, will go
scot free. The apparently simple answer may not remain so when the facts are
tested on the touchstone of public policy and ethics and importantly the
questions raised. In our view, these are the questions and the factors that
were relevant for deciding an issue of allowance of an expenditure even before
the Explanation to section 37 was issued in the year 1998. The courts, in scores
of the decisions, had occasion to address this issue even before the issuance
of the said Explanation and had largely held that an expenditure that was
against the public policy was not deductible. It is this aspect of the issue
that was partly touched in Liva Healthcare’s case and with
respect could have been explored in depth in the PHL Pharma’s case.

Medical Council of India is constituted under the Medical
Council Act, 1956 with the object of governing and regulating the practice of
medicines in India. It has been empowered to formulate rules and regulations
for effectively carrying out its objectives. The said council, empowered under
the said Act, has formulated The Indian Medical Council (Professional
Conduct, Etiquette and Ethics) Regulations, 2002 which was amended in 2009
and the amendment was notified on 10-12-2009 by the council. The said Regulations
vide amended clauses 6.4 and 6.8 provide for rules that prohibit receipt of the
freebies and many related acts and items and things by the medical
practitioners. Vide regulation 6.4.1, a physician is prohibited to
receive any gifts, gratuity, commission or bonus in consideration or return for
referring the patients for medical, surgical or other treatment. It reads as:
“6.4 Rebates and Commission: 6.4.1 A physician shall not give, solicit, or
receive nor shall he offer to give solicit or receive, any gift, gratuity,
commission or bonus in consideration of or return for the referring,
recommending or procuring of any patient for medical, surgical or other
treatment. A physician shall not directly or indirectly, participate in or be a
party to act of division, transference, assignment, subordination, rebating,
splitting or refunding of any fee for medical, surgical or other
treatment.”

Subsequent to the
notification of the said regulations, the CBDT has issued the Circular No. 5
dated 1-8-2012 directing the Income-tax authorities to disallow the expenditure
incurred on distribution of freebies on application of Explanation 1 to section
37(1) of the Income-tax Act. The relevant part reads as under; “It has been
brought to the notice of the Board that some pharmaceutical and allied health
sector Industries are providing freebees (freebies) to medical practitioners
and their professional associations in violation of the regulations issued by
Medical Council of India (the ‘Council’) which is a regulatory body constituted
under the Medical Council Act, 1956. 2. The council in exercise of its
statutory powers amended the Indian Medical Council (Professional Conduct,
Etiquette and Ethics) Regulations, 2002 (the regulations) on 10-12-2009
imposing a prohibition on the medical practitioner and their professional
associations from taking any Gift, Travel facility, Hospitality, Cash or
monetary grant from the pharmaceutical and allied health sector Industries. 3.
Section 37(1) of Income Tax Act provides for deduction of any revenue
expenditure (other than those failing under sections 30 to 36) from the
business Income if such expense is laid out/expended wholly or exclusively for
the purpose of business or profession. However, the explanation appended to
this sub-section denies claim of any such expense, if the same has been
incurred for a purpose which is either an offence or prohibited by law. Thus,
the claim of any expense incurred in providing above mentioned or similar
freebees in violation of the provisions of Indian Medical Council (Professional
Conduct, Etiquette and Ethics) Regulations, 2002 shall be inadmissible under
section 37(1) of the Income Tax Act being an expense prohibited by the law.
This disallowance shall be made in the hands of such pharmaceutical or allied
health sector Industries or other assessee which has provided aforesaid
freebees and claimed it as a deductable expense in its accounts against
income.”

The validity of the said circular has been examined by the
Himachal Pradesh High Court in the case of Confederation of Indian
Pharmaceutical Industries, 353 ITR 388. The Punjab and Haryana High Court
in the case of KAP Scan and Diagnostics, 343 ITR 476 has examined the
issue of allowance of expenditure incurred on payment of commission to the doctors
by the diagnostic company. Recently, the Chennai Tribunal examined the issue of
allowance of deduction of an expenditure incurred by the pharmaceutical
manufacturers on distribution of freebies to the medical practitioners in the
case of Apex Laboratories (P) Ltd, 164 ITD 81 to hold that such an
expenditure was not allowable as deduction in view of the said Regulations of
2002 issued by the MCI.

The same CBDT circular
had come up for consideration in the case of Syncom Formulations (I) Ltd. IT
Appeal Nos. 6429 & 6428 (Mum.) of 2012, dated 23-12-2015, wherein the
Tribunal held that CBDT circular was not be applicable in the A.Ys. 2010-11 and
2011-12 as it was introduced w.e.f. 1.8.2012. Similar issue of allowance of
such expenditure in the case of pharmaceutical companies had been decided in
favour of the assessee, in the case of UCB India (P.) Ltd. v. ITO, IT Appeal
No. 6681 (Mum.) of 2013, dated 13-05-2016, wherein it was held that the
CBDT circular could not have a retrospective effect.

The question is, can a person participating in an act, which
is considered as an offence in the hands of other party, be held to have not
offended the law? Can he not be said to have abetted an offence? Can he be
treated as a conspirator? Can he be said to have triggered the offence? Can he
not be punished for exploiting the weakness of the week? The answers in our
opinion may or may not be available in the express provisions of a statute but
will have to be found from the understanding of the public policy which is one
of the important pillars of the jurisprudence, civil or criminal. It may be
simple to hold that once an act is an offence for one party it shall equally be
an offence for anothers party whether expressly provided for in a statute or
not and the other party shall not be allowed to reap the benefits of such an
act, however, this apparently simple solution in our opinion, may not really
hold water in all cases and may not even be judicious. For example, in cases
involving ransom or protection money. The issue requires an in-depth debate
involving conscience of the society and perhaps cannot be adjudicated by only
interpreting one of the provisions of a statute in isolation.

Interestingly, the said circular vide paragraph
4 encourages the AO to tax the sum equivalent to value of freebees enjoyed by
the medical practitioner as business income or income from other sources as the
case may be depending on the facts of each case. The AO of such medical
practitioner or professional associations are directed to examine the facts and
take an appropriate action.

shailesh.kwebmaker

Interest Income of a Credit Society and Deductibility U/S. 80p

Issue for Consideration

Section 80P of the Income-tax Act grants a deduction to an
assessee, being a co-operative society, in respect of such sums that,
inter-alia, includes the whole of the amount of profits and gains of business
attributable to any one or more of such activities which are listed in clauses
(i) to (vii) of clause (a) of sub-section (2). One of the sub-clauses grants a
deduction for a co-operative society engaged in carrying on the business of
banking or providing credit facilities to its members.

The Courts, in the past, have time and again examined the
true meaning of the term ‘attributable’, and have found the same to be of wider
import in contrast to the term ‘derived from’. Based on such interpretation,
the courts have been inclined to include income from activities incidental to
the main business or activity of the assessee, and have held that such incidental
income too was eligible for deduction, inasmuch as such income was profits and
gains attributable to the business.

In the recent past, the Supreme Court, in the case of Totgars
Co-operative Sale Society Ltd., 322 ITR 283 held that income from interest
on deposits with the bank, earned by a credit society, was to be taxed u/s.56
of the Income-tax Act.

The above mentioned decision in Totgars Co-operative Sale
Society’s case has become a subject matter of controversy leading to
conflicting decisions of the High Courts, whereunder, the Gujarat High Court
followed the said decision, but the Karnataka High Court chose to distinguish
the same on facts, and the Andhra Pradesh High Court held the said decision to
be applicable only to Totgars Co-operative Sale Society Limited. In fact, the
ratio of the said decision and its applicability has also become debatable.

Tumkur Merchants Souharda Credit Cooperative Ltd.’s case

The issue arose in the case of Tumkur Merchants Souharda
Credit Cooperative Ltd. vs. Income-tax officer, 55 taxmann.com 447 (Karnataka).
The assessee, a Cooperative Society registered under the provisions of section
7 of the Karnataka Co-operative Societies Act, 1959, was engaged in the
activity of carrying on the business of providing credit facilities to its
members. It filed the return of income for the assessment year 2009-10,
declaring a total income of Rs. NIL, after claiming a deduction of
Rs.42,02,079/- under the provisions of section 80P of the Act in respect of its
business income, which, inter alia, included interest from short term
deposits and savings bank accounts aggregating to Rs. 1,77,305.

The assessing authority denied the deduction claimed u/s. 80P
and passed an order of assessment, determining a total income of
Rs.42,02,079/-, as against the declared income of Rs.NIL. Aggrieved by the said
order, the assessee preferred an appeal to the Commissioner of Income Tax
(Appeals) who held that assessee’s interest income earned from short-term
deposits with Allahabad Bank of Rs. 1,55,300/- and savings bank account with
Axis Bank of Rs.22,005/-, totalling to Rs. 1,77,305/- was liable to income tax,
in view of the judgment of the Apex Court in the case of Totgars Cooperative
Sale Society Ltd. vs. ITO, 322 ITR 283(SC).

Aggrieved by that part of the order, the assessee preferred
an appeal to the Tribunal, which dismissed the appeal, following the judgment
of the Apex Court in the aforesaid case. Aggrieved by the said order, the
assessee filed the appeal challenging the order passed by the Tribunal
raising the following substantial question of law: ‘”Whether the Tribunal
failed in law to appreciate that the interest earned on short-term deposits
were only investments in the course of activity of providing credit facilities
to members and that the same cannot be considered as investment made for the
purpose of earning interest income and consequently passed a perverse
order?”

The assessee, assailing the impugned order, contended before
the Karnataka High Court, that the interest accrued in a sum of Rs. 1,77,305/-
was from the deposits made by the assessee in a nationalised bank out of the
amounts which was used by the assessee for providing credit facilities to its
members, and therefore the said interest amount was attributable to the credit
facilities provided by the assessee, and formed part of profits and gains of
business. It therefore submitted that the appellate authorities were not
justified in denying the said benefit in terms of sub-section (2) of section
80P of the Act. In support of the contention that the interest income was
eligible for deduction u/s. 80P, it relied on several judgments, and pointed
out that the Apex Court in the aforesaid judgment had not laid down any law. In
reply, the Revenue strongly relied on the said judgment of the Supreme Court in
Totgars Co-operative Sale Society Ltd. (supra), and submitted that the
case before the court was covered by the judgment of the Apex Court and no case
for interference was called for.

The Karnataka High Court, on hearing the facts and the rival
contentions, noted the undisputed facts emerging that the assessee was a
co-operative society providing credit facilities to its members, was not
carrying on any other business and that the interest income earned by the
assessee by providing credit facilities to its members was deposited in the
banks for a short duration, which had earned interest in the sum of Rs.
1,77,305/- .

Analysing the provisions of section 80P, the court found that
the word ‘attributable’ used in the said section was of great importance. It
took note of the fact that the Apex Court had considered the meaning of the
word ‘attributable’ as opposed to ‘derived from’ in the case of Cambay
Electric Supply Industrial Co. Ltd. vs. CIT ,113 ITR 84. The court found
from the above decision that the word “attributable to” was certainly
wider in import than the expression “derived from”, and whenever the
legislature wanted to give a restricted meaning, they had used the expression
“derived from”. The expression, “attributable to”, being of
wider import, was used by the legislature whenever they intended to gather
receipts from sources other than the actual conduct of the business.

The court observed that a cooperative society, which was
carrying on the business of providing credit facilities to its members, earned
profits and gains of business by providing credit facilities to its members;
the interest income so derived and the capital, if not immediately required to
be lent to the members, could not be kept idle, and the interest income earned
on depositing such balance in hand was to be treated as attributable to the
profits and gains of the business of providing credit facilities to its members
only; the society was not carrying on any separate business for earning such
interest income; the income so derived was the amount of profits and gains of
business attributable to the activity of carrying on the business of banking or
providing credit facilities to its members by a co-operative society and was
liable to be deducted from the gross total income u/s. 80P of the Act.

The court further observed that the Apex Court in the case of
Totgars Co-operative Sale Society Ltd.(supra), on which reliance was
placed, was dealing with a case where the assessee – cooperative society, apart
from providing credit facilities to the members, was also in the business of
marketing of agricultural produce grown by its members and the sale
consideration received from marketing agricultural produce of its members was retained
in many cases, and the said retained amount which was payable to its members
from whom produce was bought, was invested in a short-term deposit/security;
such an amount which was retained by the assessee – society was a liability and
it was shown in the balance sheet on the liability side; therefore, to that
extent, such interest income could not be said to be attributable either to the
activity mentioned in section 80P(2)(a)(i) of the Act or u/s. 80P(2)(a)(iii) of
the Act; in the facts of the said case, the Apex Court held that the assessing
officer was right in taxing the interest income u/s. 56 of the Act after making
it clear that they were confining the said judgment to the facts of that case.
It was clear to the Karnataka high court that the Supreme Court in Totgars
Co-operative Sale Society Ltd.(supra) was not laying down any law.

In the instant case, the court noted that the amount which
was invested in banks to earn interest was not an amount due to any members; it
was not the liability; it was not shown as liability in the accounts and that
the amount which was in the nature of profits and gains, was not immediately
required by the assessee for lending money to the members, as there were no
takers. Therefore, they had deposited the money in a bank so as to earn
interest. The court accordingly held that the said interest income was
attributable to carrying on the business of banking and was liable to be
deducted in terms of section 80P(1) of the Act. The court cited with approval
the decision of the Andhra Pradesh High Court in the case of CIT vs. Andhra
Pradesh State co-operative Bank Ltd.,200 Taxman 220.

State Bank Of India (SBI)’s case

The issue again arose in the case of State Bank of India
vs. CIT , 74 taxmann.com 64 before the Gujarat high court. The assessee, a
co-operative society, namely State Bank of India Employees Co-op Credit and
Supply Society Ltd. was registered under the Gujarat Co-operative Societies
Act, 1961 with the object of accepting deposits from salaried persons of the
State Bank of India, Gujarat region, with a view to encourage thrift and
providing credit facility to them. It had launched various deposit schemes such
as Term Deposit, Recurring Deposit, Aid to Your Family Scheme, Members Retiring
Benefit Fund etc., and at the same time, was advancing loans to the
members, such as consumer goods loan, car-vehicle loan, food grain loan and
general purposes loan, etc. It had filed its return of income for
assessment year 2009-10 and 2010-11, declaring total income at Rs. Nil, after
claiming deduction u/s. 80P of the Income-tax Act, 1961 of Rs.29,69,444/- and
Rs.43,64,828/-.respectively.

The matter was taken up in
scrutiny by the Assessing Officer who called for various details, including
justification regarding claim of deduction u/s. 80P of the Act vide notice
u/s. 142(1). The society submitted its replies, narrating the nature of
activities carried out by it, and details of claim of deduction u/s. 80P with
copy of bye-laws, and the Assessing Officer framed assessment u/s. 143(3) of
the Act accepting the claim.

Subsequently, the Commissioner of Income Tax invoked powers
u/s. 263 of the Act, proposing to revise the above order on the ground that
interest income of Rs.16,14,579/- for assessment year 2009-10 and of
Rs.32,83,410/- from the State Bank of India for assessment year 2010-11 was not
exempt u/s. 80P(2)(d) of the Act. In response, the assessee contended that the
interest income was business income, and was exempt u/s. 80P(2)(a)(i) of the
Act. The Commissioner of Income Tax did not find the explanation satisfactory,
on the ground that interest income was not business income, so as to be exempt
u/s. 80P(2)(a)(i) of the Act. Hence, the assessment order was held to be
erroneous and prejudicial to the revenue.

Being aggrieved, the appellant carried the matter in appeal
before the Income Tax Appellate Tribunal, which held that interest income
earned from members on grant of credit did not have nexus with the interest
earned on deposits made with SBI, and could not be said to be the one arising
from business of providing credit facility to its members, by drawing support
from the decision of the Supreme Court in Totgars Co-operative Sales Society
Ltd. vs. ITO 322 ITR 283(SC) .

The assessee being aggrieved, raised substantial questions of
law in appeal for consideration of the Gujarat High Court, which included ;

‘(1) Whether on the facts and in the
circumstances of the case, ………… ?

(2) Whether on the facts and in the
circumstances of the case, the Income Tax Appellate Tribunal was justified in
holding that interest income of Rs……………. on deposits placed with State Bank of
India was not exempt under section 80P(2)(a)(i) of the Income Tax Act, 1961?

On behalf of the society, it was submitted that the assessee
was a co-operative society formed by the employees of the State Bank of India,
Gujarat Circle, under the Gujarat Co-operative Societies Act, 1961 in the
category of Employees’ Co-operative Credit Society for the purpose of
encouragement of savings and providing credit facilities to the members of the
Society; it was not engaged in any other activity except giving credit
facilities to its members, who were employees of State Bank of India, and that
the income generated by the assessee was mainly on account of differential rate
of amount of deposits received from the members and the amount of loans given
to the members; the income generated was only from the contributions received
from the members and it did not deal in any way with any person other than the
members; the employer deducted the contribution from the salary of the
employees and the collective contribution received was remitted to the assessee
society, generally on the first of every month, while the loans were given to
the employees on a fixed day of the month (around 15^th of the month)
and not every day, and during the intervening period, the idle money collected
by the assessee was deposited with the State Bank of India for the purpose of
earning interest; as and when the amount was required, the deposits with the
State Bank of India are liquidated and utilised for the purposes of the
assessee.

In the above stated facts, it was pleaded that the deposit of
amount with State Bank of India was during the course of business and was part
of the activities of the assessee society and could not be seen in isolation.
It was submitted that the decision of the Supreme Court in the case of Totgars
Co-operative Sales Society Limited (supra) would not be applicable to the
facts of the present case, inasmuch as to apply the said decision, the
necessary facts had to be on record, and that there was no strait-jacket
formula that the above decision would be applicable. Reliance was placed upon
the decision of the Karnataka High Court in Tumkur Merchants Souharda Credit
Cooperative Ltd. vs. ITO, 55 taxmann.com 447, wherein the court had held
that the word “attributable to” was certainly wider in import than
the expression “derived from” and whenever the legislature used the
expression ‘attributable ‘ they intended to gather receipts from sources other
than the actual conduct of business. Reliance was also placed upon the decision
of the Karnataka High Court in the case of Guttigedarara Credit Co-operative
Society Ltd. vs. ITO, 377 ITR 464 wherein the above view has been
reiterated. Reliance was also placed upon the decision of the Patna High Court
in the case of Bihar State Housing Co operative Federation Ltd. vs. CIT, 315
ITR 286 wherein the court was dealing with the question as to whether on
the facts and in the circumstances of that case, the Tribunal was correct in
holding that the sum of Rs.15,98,590/- received by way of interest on bank
deposit was not ancillary and incidental to carrying on the business of
providing credit facilities to its members and as such, exempt u/s.
80P(2)(a)(i) of the Income-tax Act, 1961. It was submitted that the above
decisions would be squarely applicable to the facts of the present case, as the
factual background in which the said decisions were rendered were similar to
the present case.

It was contended that insofar as the interest earned from
deposits was concerned, section 80P(2)(a)(i) did not make any difference nor
was it possible to read any limitation having regard to the language of the
said provision and every income “attributable to any one or more of such
activities” should be deducted from the gross total income. It was
highlighted that one had to bear in mind the object with which the provision
was introduced, viz. to encourage and promote growth of co-operative sector in
the economic life of the country and in pursuance of the declared policy of the
Government. Reference was made to bye-law 7 of the Bye-laws of the appellant
society to point out that the interest income was a part of the corpus of the
society, and when the corpus was invested, the decision of the Supreme Court in
the case of Totgars Co-operative Sales Society Ltd. (supra) would not be
applicable. It was submitted that the interest income was incidental to the
main activity of the appellant of providing credit facility and that in the
above decision of the Supreme Court, the word ‘incidental’ had not come up for
consideration. In conclusion, it was submitted that the appeals deserved to be
allowed by answering the questions in favour of the assessee and against the
revenue.

Opposing the appeals, it was contended by the Revenue that it
was only the interest received from members towards credit facilities extended
to them that would fall within the ambit of the expression profits and gains of
business attributable to the activities of the appellant; interest from bank on
surplus did not have any direct or proximate connection with the activities of
the society , and hence, it would not be entitled to the benefit of section
80P(2) of the Act in respect of such income.

It was submitted that in case of a credit co-operative
society, it was the income derived from such activity that was exempt.
Adverting to the facts of the present case, it was submitted that the decision
of the Supreme Court in the case of Totgars Co-operative Sales Society Ltd. (supra)
was squarely applicable. It was submitted that section 80P of the Act was based
upon the concept of mutuality, and accordingly exempted any income derived by
the society from its members. As the interest earned from the funds deposited
with the banks lacked the degree of proximity between the appellant and its
members, it could not be categorised as an activity in the pursuit of its
objectives, so as to fall within the ambit of section 80P(2)(a)(i) of the Act.

Reference was made to the decision of the Karnataka High
Court in the case of Totgars Co-operative Sale Society Ltd. (supra), to
point out the nature of the dispute involved in that case. It was submitted
that, in that case, the court was concerned with two activities of the assessee
society: (i) to provide credit facility to its members, and (ii) to market the
agricultural produce of its members. It was submitted that the findings
recorded by the Supreme Court were also in connection with the two activities
and, therefore, to say that the Supreme Court was only concerned with the
surplus of marketing produce was not correct. It was submitted that the
observation regarding the judgment being confined to the facts of that case was
because the assessee was not in the banking business, and all the earlier
decisions in this regard were relating to banking business. It was submitted
that the decision of the Karnataka High Court in the case of Tumkur
Merchants Souharda Credit Cooperative Ltd. (supra) was based upon an
incorrect reading of the above decision of the Supreme Court.

The Gujarat High Court, on hearing the parties to the appeal,
noted that the short question that arose for consideration in these appeals was
as to whether the appellant was entitled to claim deduction u/s. 80P(2)(a)(i)
of the Act in respect of the interest earned on the deposits placed with the
State Bank of India. For the purpose of appreciating the controversy in issue,
it extensively referred to the records of the case and appreciated the
contesting views of the parties before the lower authorities. The court also
examined the ratio of the decision of the Supreme Court in Totgars
Co-operative Sale Society Ltd. (supra), and supplied emphasis where
felt necessary.

Expressing its opinion, the court stated that in case of a
society engaged in providing credit facilities to its members, income from
investments made in banks did not fall in any of the categories mentioned u/s.
80P(2)(a) of the Act; in the case of Totgars Co-operative Sale Society
(supra), the court was dealing with two kinds of activities: interest
income earned from the amount retained from the amount payable to the members
from whom produce was bought and which was invested in short-term
deposits/securities, and the interest derived from the surplus funds that the
assessee therein invested in short-term deposits with the Government
securities. The Gujarat High Court opined that the above decision was not
restricted only to the investments made out of the retained amount which was
payable to its members, but was also in respect of funds not immediately
required for business purposes. For the above reasons, the Gujarat High Court
did not agree with the view taken by the Karnataka High Court in Tumkur
Merchants Souharda Credit Cooperative Ltd. (supra) to the effect
that the decision of the Supreme Court in Totgars Co-operative Sale Society
(supra) was restricted to the sale consideration received from marketing
agricultural produce of its members, which was retained in many cases and
invested in short term deposit/security, and that the said decision was
confined to the facts of the said case and did not lay down any law.

Relying on the principles enunciated by the Supreme Court in Totgars
Co-operative Sale Society (supra), the Gujarat High court held that
in case of a society engaged in providing credit facilities to its members,
income from investments made in banks did not fall within any of the categories
mentioned in section 80P(2)(a) of the Act. In the end, the court did not find
any infirmity in the order passed by the Tribunal warranting interference, and
accordingly held that the Income Tax Appellate Tribunal was justified in
holding that interest income of Rs.16,14,579/- and Rs.32,83,410/-respectively
on deposits placed with State Bank of India was not exempt u/s. 80P(2)(a)(i) of
the Income-tax Act, 1961.

Observations

An assessee, a co-operative society engaged in providing
credit facilities to its members, is entitled to deduction for the whole of the
amount of profits and gains of business attributable to such activity. As per
section 80P(2), in the case of a co-operative society engaged in carrying on
the business of providing credit facilities to its members, what is deductible
is the whole of the amount of profits and gains of business attributable to any
one or more such activities.

A co-operative society which is carrying on the business of
providing credit facilities to its members, earns profits and gains from
business by providing such facilities to its members. The interest income so
earned from members, if not immediately required to be lent to the members,
cannot be kept idle. On deposit of such income in a bank so as to earn
interest, such interest income enhances the capital available for the credit to
its members, besides reducing the cost of interest to members. Such interest so
received from bank has the business nexus, in as much as the source thereof is
the business income, and should be treated as attributable to the profits or
gains of the business of providing credit facilities to its members only, more
so where such deposit with the bank is for short period and further so where
the bye-laws or the enactment require the society to employ funds. The income
so derived is the profits or gains of business that is attributable to the
activity of carrying on the business of providing credit facilities to its
members by a co-operative society and should be eligible for being deducted
from the gross total income u/s. 80P of the Act.

Money is stock-in-trade or circulating capital for a credit
society and its normal business is to deal in money and credit. It cannot be
said that the business of such a society consists only in receiving
contribution from its members. Depositing money with banks or such other societies,
as are mentioned in the objects, in a manner that it may be readily available
to meet the demand of its members, if and when it arises, is a legitimate mode
of carrying on of its business.

The interest received by a credit society on bank deposits,
in any case, is ancillary and incidental to carrying on the business of
providing credit facilities to its members, and as such, is deductible under
the provisions of section 80P(2)(a)(i) of the Act. The nature of credit
business, conducted out of the funds of the employees, clearly creates a
situation where surplus funds are available, which are deposited in a bank,
interest is earned thereon. The placement of such funds, being incidental and
ancillary to carrying on business of providing credit facilities to its
members, and by reason of section
80P(2)(a)(i) of the Act, the same should be eligible for deduction.

The business of a credit society essentially consists of
dealing with money and credit. Members put their money in the society at a
small rate of interest. In order to meet their demands, as and when they arise,
the society has always to keep sufficient cash or easily realisable securities.
That is a normal step in the carrying on of the business; in other words, that
is an act done in what is truly the carrying on or carrying out of a business.

It is a normal mode of carrying on credit business to invest
moneys in a manner that they are readily available and that is just as much a
part of the mode of conducting a business as receiving contributions or lending
moneys; that is how the circulating capital is employed and that is the normal
course of business of a credit society. The moneys laid out in the form of
deposits with the bank would not cease to be a part of the circulating capital
of the credit society nor would the deposits cease to form part of its
business. The returns flowing from the deposits would form part of its profits
from its business. In a commercial sense, the managers of the society owe it to
the society to make investments which earn them interest, instead of letting
moneys lie idle. It cannot be said that the funds which were not lent to
borrowers but were laid out in the form of deposits in another bank, to add to
the profit instead of lying idle, necessarily ceased to be a part of the
stock-in-trade of the society, or that the interest arising therefrom did not
form part of its business profits.

As regards the decision of the Supreme Court in the case of Totgars
Co-operative Sales Society Ltd. (supra), the court, in the facts of that
case, had observed that it was dealing with a case where the assessee –
co-operative society, apart from providing credit facilities to the members,
was also in the business of marketing of agricultural produce grown by its
members; the sale consideration received from marketing agricultural produce of
its members was retained in many cases; the said retained amount which was
payable to its members from whom produce was bought, was invested in a
short-term deposit/security; such an amount which was retained by the assessee
– society was a liability and it was shown in the Balance Sheet on the
liability side. In the above facts, the Supreme Court held that therefore, to
that extent, such interest income could not be said to be attributable either
to the activity mentioned in section 80P(2)(a)(i) of the Act or u/s.
80P(2)(a)(iii) of the Act. In the facts of the said case, the Supreme Court
held that the Assessing Officer was right in taxing the interest income u/s. 56
of the Act. The court further made it clear that it was confining the said
judgment to the facts of the said case and, therefore, was not laying down any
law.

The Supreme Court in that Totgars’ case has held that
interest on such investments, could not fall within the meaning of the expression
“profits and gains of business” and that such interest income could
not be said to be attributable to the activities of the society, namely,
carrying on the business of providing credit facilities to its members or
marketing of agricultural produce of its members. The court held that when the
assessee society provides credit facilities to its members, it earns interest
income and the interest which accrued on funds not immediately required by the
assessee for its business purposes and which had been invested in specified
securities as “investment” were ineligible for deduction u/s.
80P(2)(a)(i) of the Act.

It is true that the apex court, in the case of Totgars
Co-operative Sale Society Ltd.(supra), dealt with a case where the
assessee – co-operative society was also providing credit facilities to the
members besides marketing of agricultural produce grown by its members. On the
available facts, it appears that, in that case, the interest income from bank
was received from the sale consideration received from marketing agricultural
produce of its members, which was retained by the society in many cases before
the same was finally handed over to the members. The said retained amount which
was payable to its members from whom produce was bought, was invested in a
short-term deposit/security. Such an amount which was retained by the assessee
– society was a liability and it was shown in the balance sheet on the
liability side. Relying on such facts found by the Supreme Court, the Karnataka
High Court sought to distinguish the said decision and held that it was not
applicable to the facts of the case before it. Significantly, the Apex court
itself qualified its decision by observing that the decision was confined to
the facts of the said case . In the circumstances, it may be fair to not apply
the ratio of the said decision to the facts of any other case, unless the facts
therein are found to be identical, and are established to have been considered by the Apex court.

It is most relevant to note that the Apex court in Totgars’
case had no occasion to consider the decisions delivered by the highest
court regularly on the subject, holding that the interest income of a
co-operative bank from its investments with banks or government securities was
eligible for deduction u/s. 80P of the Act. We are of the opinion that had they
been brought to the notice of the court, the decision could have been
different. Another factor that requires that the application of the decision of
the court shall be restricted to Totgars’ case only, is that the court, at no
place, was required to consider whether the income in question could be
considered to be attributable to profits and gains of business or not. The
court was rather concerned about whether the income would be treated as
“profits and gains of business” or from other sources. Again, had the court
been persuaded to consider the language of section 80P and the meaning of the
term “attributable”, we are sure the decision could have been different.

It is also true that this culling of the fact by the
Karnataka High court, from the Supreme court’s decision in Totgar’s
case, has been later on found to be not representing the full facts by the
Gujarat high court by examining the order of the high court passed in Totgars’
case. While that may be the case, it is at the same time important to take into
consideration the fact that the Andhra Pradesh High Court, like the Karnataka
High Court, has also held that the interest income is attributable to carrying
on the main business of banking, and therefore it was eligible for deduction
u/s. 80P(1) of the Act. [Andhra Pradesh State Co-operative Bank Ltd.,200
Taxman 220]. The Andhra Pradesh High Court, while deciding the issue in
favour of the assessee society, did consider the decision of the Apex court in
Totgars’ case. In the circumstances, it may be that the Karnataka High Court
erred in deciding the issue on hand by distinguishing the facts of its case
with that of the facts in Totgar’s case. However the decision could not have
been different once it was appreciated that the income in question was
attributable to the profits and gains of business.

There appears to be merit in the conclusion of the Karnataka
and Andhra Pradesh High Courts, which have based their decisions by following
the ratio of the oft followed decision of the Apex court in Cambay’s case,
dealing with the true meaning of the word ‘attributable’ used in chapter VI-A.
The Apex Court had an occasion to consider the meaning of the word
‘attributable’ in the case of Cambay Electric Supply Industrial Co. Ltd. vs.
CIT 113 ITR 84 as under:

‘As regards the aspect
emerging from the expression “attributable to” occurring in the
phrase “profits and gains attributable to the business of the specified
industry (here generation and distribution of electricity) on which the learned
Solicitor-General relied, it will be pertinent to observe that the legislature,
has deliberately used the expression “attributable to” and not the
expression “derived from”. It cannot be disputed that the expression
“attributable to” is certainly wider in import than the expression
“derived from”. Had the expression “derived from” been
used, it could have with some force been contended that a balancing charge
arising from the sale of old machinery and buildings cannot be regarded as
profits and gains derived from the conduct of the business of generation and
distribution of electricity. In this connection, it may be pointed out that
whenever the legislature wanted to give a restricted meaning in the manner
suggested by the learned Solicitor-General, it has used the expression
”derived from”, as, for instance, in section-80J. In our view, since the
expression of wider import, namely, “attributable to”, has been used, the
legislature intended to cover receipts from sources other than the actual
conduct of the business of generation and distribution of electricity.’

The word “attributable to” is certainly wider in
import than the expression “derived from”. Whenever the legislature
wanted to give a restricted meaning, they have used the expression
“derived from”. The expression “attributable to” being of
wider import, the said expression is used by the legislature whenever they
intended to gather receipts from sources other than the actual conduct of the
business.

The Apex Court, in various decisions, has consistently held
the view that interest income on investments made by the banks was attributable
to the profits and gains of business and was eligible for deduction u/s. 80P of
the Act. [Karnataka State Co-operative Apex Bank, 252 ITR 194 (SC),
Mehsana District, Central Co-operative Bank Ltd., 251 ITR 522 (SC), Nawanshahar
Central Co-operative Bank Ltd.289 ITR 6 (SC), Bombay State Co-operative
Bank Ltd. 70 ITR 86 (SC) (para 16), Bangalore Distt. Co-op. Central Bank
Ltd. 233 ITR 282 (SC), Ponni Sugars & Chemicals Ltd. 306 ITR 392
(SC), Ramanathapuram District Co-operative Central Bank Ltd. 255 ITR 423
(SC), Nawanshahar Central Co-operative Bank Ltd.,349 ITR 689 (SC)].
These decisions are an authority for the proposition that, even though the
investment made does not form part of its main activity, stock in trade or working
capital, still the interest income therefrom would qualify for exemption u/s.
80P of the Income-tax Act.

The Apex court in Nawanshahar Central Cooperative Bank
Ltd.’s case (supra), observed as under. “this Court has consistently held
that investments made by a banking concern are part of the business of banking.
The income arising from such investments would, therefore, be attributable to
the business of bank falling under the head “Profits and gains of
business” and thus deductible under section 80-P(2)(a)( i) of the
Income-tax Act, 1961. This has been so held in Bihar State Coop. Bank Ltd. 39
ITR 114 (SC). Karnataka State Coop. Apex Bank, 259 ITR 144 and Ramanathapuram
Distt. Coop. Central Bank Ltd.255 ITR 423(SC).The principle in these cases
would also cover a situation where a cooperative bank carrying on the business
of banking is statutorily required to place a part of its funds in approved
securities.”

Attention is also invited to clause (b) of sub-section 2 of
section 80P, which clause while providing for deduction for certain primary
societies provides for a deduction in respect of “the whole of the amount of
profits and gains of such business” as against “the whole of the amount of
profits and gains of business attributable to any one or more of such
activities” covered by clause (a) of sub-section 2 of section 80P. A
bare reading of the contrasting provisions clearly shows that scope of clause
(a) is wider than clause (b), plainly on account of the insertion of the terms
‘attributable and activities’. These terms cannot be treated as redundant and
should be given the appropriate meaning.

It is well-settled that a provision for
deduction or tax relief should be interpreted liberally in favour of the
assessee. Such a provision should be construed as to fully achieve the object
of the legislature and not to defeat it. [South Arcot District Cooperative
Marketing Society Ltd.116 ITR 117 (SC), Bajaj Tempo Ltd.196 ITR 188 (SC) and
N.C. Budharaja & Co., 70 Taxman 312(SC).] Liberally interpreting sub-section
2(a)( i) of section 80P of the Act, the conclusion in favour of the assessee
appears to be a better conclusion.

shailesh.kwebmaker

Allowability of Expenditure towards Corporate Social Responsibility

Issue for Consideration

Explanation 2 to Section
37(1) declares that, for the removal of doubts, any expenditure incurred by an
assessee on the activities relating to corporate social responsibility referred
to in section 135 of the Companies Act, 2013 shall not be deemed to be an
expenditure incurred by the assessee for the purposes of business or
profession.

Companies Act, 2013 has made it mandatory for certain
companies to spend at least 2% of the average net profits towards Corporate
Social Responsibility (‘CSR’) as per the policy formulated by the CSR committee
of the company in this regard. While this is the first time a statutory
obligation has been cast upon companies to incur expenditure in the social or
charitable sphere, it is not uncommon for corporate as well as non-corporate
assessees to voluntarily incur charitable expenditure, which may or may not
have a direct nexus to their business operations.

Where such expenditure is expected to benefit the business in
some manner, either by benefitting its employees or by creating goodwill within
the community at large, it is usually claimed as business expenditure under
section 37(1). The issue has arisen on the allowability of such expenditure, on
account of conflicting decisions of the Tribunal. While the Raipur Tribunal has
upheld the claim in the specific facts of the case, the Bengaluru Tribunal has
taken a contrary view, disallowing the claim in respect of charitable expenses.

Jindal Power Limited’s case

The issue came up before
the Raipur Tribunal in the case of ACIT vs. Jindal Power Ltd. 179 TTJ 736.

In the said case, during
assessment year 2008-09, the company had claimed deduction in respect of
expenditure incurred on construction of school building, devasthan/temple,
drainage, barbed wire fencing, educational schemes and distributions of clothes
etc. voluntarily. Without much of a discussion on the factual aspects, the AO
observed that no material had been placed to substantiate the claim or in
support of existence of the facts of development activities. The AO also placed
reliance on the decision of the Patna Tribunal in the case of Central
Coalfields Ltd. for assessment years 1983-84 to 1986-87, wherein it was held
that the expenses were in the nature of charity and though laudable, they could
not be said to have been incurred for the purpose of business.

The CIT(A) made detailed observations on CSR stating that
“CSR policy functions as a built-in, self-regulating mechanism whereby a
business monitors and ensures its active compliance with the spirit of the law,
ethical standards, and international norms. The goal of CSR is to embrace
responsibility for the company’s actions and encourage a positive impact
through its activities on the environment, consumers, employees, communities,
stakeholders and all other members of the public sphere who may also be
considered as stakeholders. CSR is titled to aid an organization’s mission as
well as a guide to what the company stands for and will uphold to its
consumers.” Further, the CIT(A) noted the CSR policy of the assessee company
and that the expenses incurred on water supply for perennial availability of
portable water, roads and culverts, toilets and others, water tanks, other
community works, temple renovation, school building renovation etc. in the
villages for up-gradation as well as expenses for the welfare of the employees
were a part of implementation of CSR policies of the company. The assessee
relied upon various decisions including the decisions in the case of SECL 85
ITD 608 (Nag.) and Madras Refineries Ltd. 266 ITR 170 (Mad.).
Applying the ratio of the said decisions, the CIT(A) held that the expenditure
under the above heads incurred by the appellant company as a good corporate
citizen and as measure of gaining goodwill of the people living in and around
its industries through the aforesaid activities were admissible expenditures.
Only those expenses, which were neither substantiated with proper evidences nor
had any nexus with the CSR policies of the appellant company, were disallowed.

In the appeal before the Tribunal, the fundamental objection
of the AO was that the expenses were voluntary, not mandatory and not for
business purposes. In respect of the contention that expenses, which were
voluntary in nature and not mandatory, were not admissible as deduction, the
Tribunal referred to the judgment of House of Lords in the case of Atherton
v. British Insulated & Helsbey Cables Ltd. 10 Tax Cases 155 (HL), which
has been approved by the Supreme Court in the case of Chandulal Keshavlal &
Co. 38 ITR 601, wherein it was held that a sum of money expended not with a
necessity and with a view to direct immediate benefit to the trade, but
voluntarily and on the grounds of commercial expediency and in order to
indirectly facilitate carrying on of business, may yet be expended wholly and
exclusively for the purpose of the trade and hence be admissible. The Tribunal
also considered the decision of the Supreme Court in the case of Sassoon J
David & Co. (P) Ltd. 118 ITR 261, which laid down the principle that
the fact that somebody other than the assessee also benefited by the
expenditure should not come in the way of an expenditure being allowed by way
of deduction if it otherwise satisfied the tests laid down by law.

Further, on the contention of whether such expenses were for
the purpose of business or not, the Tribunal referred to the decision in the
case of Hindustan Petroleum Corporation Ltd 96 ITD 186 (Mum.) which held
that there could be certain amounts, though in the nature of donations, which may
be deductible under section 37(1) as well and merely because an expenditure was
in the nature of donation, or ‘promoted by altruistic motives’, it did not
cease to be an expenditure deductible under section 37(1). It also took into
consideration the decision in the case of Madras Refineries Ltd. (supra),
wherein it was observed that monies spent by the assessee as a good corporate
citizen and to earn the goodwill of the society help creating an atmosphere in
which the business can succeed in a greater measure with the help of such
goodwill, and therefore, were required to be treated as business expenditure
eligible for deduction under section 37(1) of the Act.

The Tribunal noted that Explanation 2 to Section 37(1) was
introduced with effect from 1^st April 2015 and observed that it
could not be construed to the disadvantage of the assessee in the period prior
to this amendment. It further noted that this disabling provision referred only
to such CSR expenses incurred under Section 135 of the Companies Act, 2013,
and, as such, it could not have any application for the period not covered by
this statutory provision, which itself came into existence in 2013. It also
placed reliance on the principle of lex prospicit non respicit (law looks
forward not backward) laid down in the Supreme Court’s five judge
constitutional bench’s landmark judgment, in the case of Vatika Townships
Pvt Ltd 367 ITR 466 (SC), that unless a contrary intention appeared,
legislation was presumed not to be intended to have a retrospective operation
and that law passed today could not apply to the events of the past. The
Tribunal also reiterated the well settled legal position that when a
legislation conferred a benefit on the taxpayer by relaxing the rigour of
pre-amendment law, and when such a benefit appeared to have been the objective
pursued by the legislature, it would be a purposive interpretation giving it a
retrospective effect, but when a tax legislation imposed a liability or a
burden, the effect of such a legislative provision could only be prospective.

Interestingly, the
Tribunal observed that the disallowance was restricted to the expenses incurred
by the assessee under a statutory obligation under section 135 of Companies Act
2013, and thus, there was now a line of demarcation between the expenses
incurred by the assessee on discharging CSR under such a statutory obligation
and under a voluntary assumption of responsibility. The Tribunal further held
that for the former, the disallowance under Explanation 2 to Section 37(1) came
into play, but, as for the latter, there was no such disabling provision as
long as the expenses, even in discharge of corporate social responsibility on
voluntary basis, could be said to be “wholly and exclusively for the
purposes of business”.

Thus, based on all the
aforesaid arguments, since the expenses in question were not incurred under the
statutory obligation, as also for the basic reason that Explanation 2 to
Section 37(1) came into play with effect from 1st April 2015, the Tribunal
concluded that the disabling provision of the said Explanation did not apply to
the facts of this case.

Kanhaiyalal Dudheria’s case

The issue once again came
up for consideration before the Bengaluru Tribunal in the case of Kanhaiyalal
Dudheria v. JCIT 165 ITD 14

In this case, during assessment year 2011-12, the assessee
firm claimed deduction in respect of expenditure incurred on construction of
houses under an MOU with the Government of Karnataka, that were later handed
over to the Government for helping the people affected by floods. The assessee
claimed that the said expenditure was incurred to yield benefit in the form of
goodwill and therefore, the same was allowable as business expenditure. The AO,
after referring to the MOU, came to the conclusion that the said expenditure
was not incurred wholly and exclusively for the purpose of business and
therefore held that the same was not allowable as deduction u/s 37(1) of the
Act. The CIT(A) upheld the order of the AO.

In the appeal before the Tribunal, the assessee firm relied
on the decisions in the case of Jindal Power Ltd. (supra) and Infosys
Technologies Ltd. 360 ITR 714 (Kar.) stating that on account of incurrence
of expenditure, goodwill was created in the people in the surrounding villages,
which would help in carrying out business and thus,
the expenditure should be allowed as a deduction. On behalf of the revenue, it
was argued that the said expenditure was towards charity and it was nothing but
application of income. The revenue drew support from the decision in the case
of Badrinarayan Shrinarayan Akodiya 101 ITR 817 (MP).

The Tribunal, relying on the decision in the case of Sassoon
J. David & Co. (P.) Ltd. (supra), emphasized that although for claiming
deduction u/s 37(1), it was not required to establish the necessity of
incurring of such expenditure, the onus lay on the assessee to prove that the
expenditure was incurred for the purpose of business. Since in the facts of the
case, the assessee did not establish that the expenditure was incurred for business
purpose, the Tribunal held that the expenditure amounted to application of
income voluntarily towards charity which could not be allowed as a deduction.

The Tribunal also noted that it cannot be said that the
appellant had incurred this expenditure wholly and exclusively for the purpose
of business since there was no nexus between the expenditure incurred and the
benefit derived by the business of the assessee.

Observations

Prior to insertion of
Explanation 2, section 37(1) along with Explanation 1 laid down a four-fold
test for any expenditure to be allowable in computing the income under the head
“Profits and gains of business or profession” –

– it must
not be of the nature described in sections 30 to 36;

– it must
not be capital or personal in nature;

– it must
be laid out or expended wholly and exclusively for the purposes of business or
profession; and

– it must
not be incurred for a purpose which is an offence or which is prohibited by
law.

There was no requirement,
however, to prove the necessity of incurring such expenditure. In other words,
whether the expenditure was incurred on account of a statutory obligation or
otherwise, did not have a bearing on the allowability of the expenditure.
Expenses in the nature of CSR were considered to be allowable or not allowable
as a deduction in light of the above tests.

It is common for many
taxpayers to contribute to the betterment of their employees and their
families, or the community or society, or the locality where their business
operations are based, etc. in a variety of ways. In most of the cases, there is
some perceived benefit to the business operations, either in the form of better
morale and productivity of employees or through generation of goodwill and
reputation for the business. As a result, in all such cases, the expenditure is
considered to have been spent for the purposes of the business and claimed as
deduction against the business profits. However, in cases where the spending is
not connected with the business of the assessee in any manner whatsoever, it
partakes the character of donation or charity and is not an allowable
expenditure under section 37(1).

At the same time, the mere
fact that a particular expenditure is in the form of donation, more
particularly eligible for deduction under section 80G, would not by itself
imply that it is not deductible under section 37(1). In the case of Mysore
Kirloskar Ltd. v. CIT 166 ITR 836 (Kar.), which was referred to in the case
of Infosys Technologies Ltd. (supra), it was held that if the contribution
by an assessee was in the form of donations of the category specified under
section 80G, but if it could also be termed as an expenditure of the category
falling under section 37(1), then the right of the assessee to claim the whole
of it as allowance under section 37(1) could not be denied if it was “laid
out or expended wholly and exclusively for the purpose of business”.

The debate on the
voluntary nature of the expenses and the necessity of incurring such
expenditure has been definitively settled in the case of Sassoon J. David
and Co. (P.) Ltd. (supra), where the issue arose on deductibility
under section 10(2)(xv) of the Income-tax Act, 1922 (corresponding to section
37(1) of the Income-tax Act, 1961) of expenditure on retrenchment compensation
incurred voluntarily. The Apex Court in the said case has observed as under –

“It has to be observed here that the expression “wholly and
exclusively” used in section 10(2)(xv) of the Act does not mean
“necessarily”. Ordinarily it is for the assessee to decide whether
any expenditure should be incurred in the course of his or its business. Such
expenditure may be incurred voluntarily and without any necessity and if it is
incurred for promoting the business and to earn profits, the assessee can claim
deduction under section 10(2)(xv) of the Act even though there was no
compelling necessity to incur such expenditure. It is relevant to refer at this
stage to the legislative history of section 37 of the Income-tax Act, 1961
which corresponds to section 10(2)(xv) of the Act. An attempt was made in the
Income-tax Bill of 1961 to lay down the “necessity” of the
expenditure as a condition for claiming deduction under section 37. Section
37(1) in the Bill read “any expenditure. . . . laid out or expended wholly,
necessarily and exclusively for the purposes of the business or profession
shall be allowed” The introduction of the word “necessarily” in
the above section resulted in public protest. Consequently when section 37 was
finally enacted into law, the word “necessarily” came to be dropped.
The fact that somebody other than the assessee is also benefited by the
expenditure should not come in the way of an expenditure being allowed by way
of deduction under section 10(2)(xv) of the Act if it satisfies otherwise the
tests laid down by law.”

Although the facts in the
above case were different and the issue under examination was in respect of
retrenchment compensation, the ratio laid down by the Supreme Court in respect
of allowability of voluntary expenditure under section 10(2)(xv) of the 1922
Act and section 37(1) of the 1961 Act would be applicable even in case of CSR
expenditure incurred by taxpayers without any statutory requirement or any
other compulsion.

The issue that remains
disputed then is, in which cases or under what circumstances, will the
expenditure be considered to be “wholly and exclusively for the purposes of the
business or profession”? Here again, the courts have agreed that the words
“for the purpose of business” used in section 37(1) should not be
limited to the meaning of “earning profit alone” and that business
expediency or commercial expediency may require providing facilities like
school, hospital, etc., for the employees or their families. It has also been
held that any expenditure laid out or expended for their benefit, if it
satisfied the other requirements, must be allowed as deduction under section
37(1) of the Act. However, the onus of establishing the nexus between the
expenditure incurred and the business and proving that the expenditure
“satisfies the other requirements” must be discharged by the assessee. The
Supreme Court in the case of Chandulal Keshavlal & Co. (supra) has laid
down certain tests in this regard as under –

“Another fact that
emerges from these cases is that if the expense is incurred for fostering the
business of another only or was made by way of distribution of profits or was
wholly gratuitous or for some improper or oblique purpose outside the course of
business then the expense is not deductible. In deciding whether a payment of
money is a deductible expenditure one has to take into consideration questions
of commercial expediency and the principles of ordinary commercial trading. If
the payment or expenditure is incurred for the purpose of the trade of the
assessee it does not matter that the payment may inure to the benefit of a
third party—Usher’s Wiltshire Brewery v. Bruce 6 TC 399 (HL). Another test is
whether the transaction is properly entered into as a part of the assessee’s
legitimate commercial undertaking in order to facilitate the carrying on of its
business ; and it is immaterial that a third party also benefits thereby —
[Eastern Investments Ltd. v. CIT [1951] 20 ITR 1 (SC)]. But in every case it is
a question of fact whether the expenditure was expended wholly and exclusively
for the purpose of trade or business of the assessee.”

[Emphasis supplied]

The above principle
emerges in both the cases discussed in this article. In the case of Jindal
Power Limited (supra), even though CSR expenses were allowed based on an
understanding of the need for CSR by businesses and that these expenses were a
part of the implementation of the CSR policy of the company, the Tribunal
disallowed those expenses which were not substantiated with evidence and were not
in line with the company’s CSR policy. Similarly, in the case of Kanhaiyalal
Dudheria (supra), deduction of expenses was not allowed on account of failure
on part of the assessee to establish that the expenditure was incurred for
business purpose.

The introduction of
statutory provisions for CSR in Companies Act, 2013 and a corresponding
amendment in the Income-tax Act, 1961 has added another dimension to the
existing controversy.

Section 135 of the
Companies Act, 2013 mandates that every company having –

– net
worth of Rs. 500 crores or more, or

– turnover
of Rs. 1,000 crores or more, or

– net
profit of Rs. 5 crores or more

during any financial year,
shall spend, in every financial year, at least 2% of its average net profits
towards CSR activities as per the CSR policy of the company. It further states
that the company shall give preference to the local area and areas around where
it operates for the CSR spending.

On the one hand, the above
provisions make it mandatory for certain Companies to undertake charitable
spending, while, on the other hand, Finance (No. 2) Act, 2014 introduced
Explanation 2 to section 37(1) with effect from 1st April 2015, to read as
under –

“For the removal of doubts, it is hereby declared that for the purposes
of sub-section (1), any expenditure incurred by an assessee on the activities
relating to corporate social responsibility referred to in section 135 of the
Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure
incurred by the assessee for the purposes of the business or profession.”

The above explanation
states that CSR expenditure shall not be deemed to have been incurred for the
purposes of business. Consequently, such expenditure is not allowable as a
deduction. The Explanatory Memorandum to the Finance Bill states that the
objective of CSR is to share the burden of the Government in providing social
services by companies having net worth/turnover/profit above a threshold and if
such expenses are allowed as tax deduction, this would result in subsidising of
around one-third of such expenses by the Government by way of tax expenditure.
However, it also states that the CSR expenditure which is of the nature
described in section 30 to section 36 of the Act shall be allowed as a
deduction under those sections subject to fulfillment of conditions, if any,
specified therein.

By declaring that
statutory CSR expenditure is not deemed to have been incurred for the purpose
of business, rather than clarifying that such expenditure is not an allowable
expense, Explanation 2 to section 37(1) may end up adding another angle to the
issue. It may be possible to take a view that Explanation 2 to section 37(1)
merely clarifies that the statutory CSR expenditure is not automatically deemed
to have been incurred for the purpose of business on account of the legislative
obligation (as was the presupposition in the arguments against allowability of
voluntary CSR expenses). In other words, statutory CSR expenditure would also
be considered to be incurred for the purposes of business and therefore be
deductible, so long as it satisfies the other tests and requirements discussed
earlier. The fact that the legislature intends to allow CSR expenditure of the
nature described in sections 30 to 36 would imply that the expenditure ought to
be allowed as a deduction if it is otherwise deductible.

Nevertheless, it is
pertinent to note that the explanation only makes a reference to the
expenditure incurred on CSR activities referred to in section 135 of the
Companies Act, 2013 and not to all expenditure in the nature of CSR. Further,
the explanation has been prospectively inserted with effect from 1^stApril
2015. Interestingly, the case of Jindal Power Limited (supra) pertains
to the period prior to the amendment. The Raipur Tribunal had rightly held that
since Explanation 2 was inserted prospectively and as it was a disabling
provision, it did not apply in that case to the expenditure incurred prior to
the amendment. This clearly implies that CSR expenditure, whether statutory or
voluntary, incurred prior to assessment year 2015-16 would be allowable,
provided it meets the other requirements of section 37(1). Additionally, the
Tribunal observed that there was now a clear distinction between statutory and
voluntary CSR expenditure and that the restriction placed in Explanation 2 to
section 37(1) would at best apply to the CSR expenditure incurred under the
statutory requirements. In other words, if any assessee – company or other than
company – voluntarily spends on CSR activities, whether prior to or after the
Companies Act, 2013 became applicable, the said expenditure would be allowable,
as long as it can be demonstrated to be incurred “wholly and exclusively for
the purposes of business or profession”.

Also noteworthy is the
fact that the CSR expenditure is mandated in the Companies Act, 2013 only for
companies and any expenditure of similar nature by non-corporates will always
be of a voluntary character, as in the case of Kanhaiyalal Dudheria (supra). As
the explanation makes a specific reference to section 135 of the Companies Act,
2013, the question of invoking the same for CSR expenditure incurred by
non-corporate entities does not arise. Quite aptly, therefore, Explanation 2
has not been considered in Kanhaiyalal Dudheria’s case and the allowability of
the CSR expenditure has been decided on the basis of settled principles in
respect of section 37(1) prior to the amendment.

Last but not the least, a
question may arise regarding the validity of the restriction imposed by
Explanation 2 to section 37(1). Where an expenditure is required to be
statutorily incurred and failure to comply with such statutory requirements
could attract penalties, it has a direct nexus to the business of the taxpayer.
In our view, deeming such an expenditure to not be for the purpose of business
or profession is inappropriate. In fact, if similar expenses incurred before
the imposition of the statutory obligation have been held to be deductible, the
deeming fiction was not desired in view of the existing safeguards in place in
section 37(1). Ironically, even after the amendment, the following category of
expenditures will still be allowable as a deduction –

– CSR
expenses incurred by non-corporate entities, which are demonstrated to be laid
out for the purposes of business or profession;

– CSR
expenses incurred voluntarily by companies; and

– CSR expenses incurred by companies in
discharge of the obligation under section 135 of the Companies Act, 2013, which
are covered under section 30 to 36 of the Income-Tax Act, 1961.

This disparity between the deductibility of the
CSR expenses is uncalled for. It is therefore a possibility that the
restriction of Explanation 2 to Section 37(1) may be read down by the Courts.

shailesh.kwebmaker

Payments for Use of Online Database – Whether Royalty?

Issue for
Consideration

Under the
Income-tax Act, payment of royalty is one of the items which is subjected to
deduction of tax at source u/s. 194J, if the payment is made to a resident, or
u/s. 195, if the payment is made to a non-resident. The term “royalty” has been
defined in Explanation 2 to section 9(1)(vi) of the Income-tax Act, as well as
in various double taxation avoidance agreements (DTAAs) that India has signed
with different countries.

The definition
in explanation 2 to section 9(1)(vi) defines the term “royalty” as under:

Explanation 2. —For the purposes of this
clause, “royalty” means consideration (including any lump sum
consideration but excluding any consideration which would be the income of the
recipient chargeable under the head “Capital gains”) 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 trade mark or similar property;

(ii) the imparting of any information
concerning the working of, or the use of, a patent, invention, model, design,
secret formula or process or trade mark or similar property;

(iii) the use of any patent, invention,
model, design, secret formula or process or trade mark or similar property;

(iv) the imparting of any information
concerning technical, industrial, commercial or scientific knowledge,
experience or skill;

(iva) the use or right to use any industrial,
commercial or scientific equipment but not including the amounts referred to in
section 44BB;

(v) 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

(vi) the rendering of any services in
connection with the activities referred to in sub-clauses (i) to (iv), (iva)
and(v).

Explanations 3
to 6 to section 9(1)(vi) clarify various aspects of and terms used in the
definition of royalty. Explanations 4 to 6 were inserted by the Finance Act
2012, with retrospective effect from 1.4.1976. Explanations 3 to 6 read as
under:

Explanation 3. —For the purposes of this
clause, “computer software” means any computer programme recorded on
any disc, tape, perforated media or other information storage device and
includes any such programme or any customized electronic data.

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
a licence) irrespective of the medium through which such right is transferred.

Explanation 5. —For the removal of doubts, it
is hereby clarified that the royalty includes and has always included
consideration in respect of any right, property or information, whether or not—

(a) the possession or control of such right,
property or information is with the payer;

(b) such right, property or information is
used directly by the payer;

Explanation 6. —For the removal of doubts, it
is hereby clarified that the expression “process” includes and shall
be deemed to have always included transmission by satellite (including
up-linking, amplification, conversion for down-linking of any signal), cable,
optic fibre or by any other similar technology, whether or not such process is
secret;

The issue has
arisen before the courts as to whether fees for subscription to an online
database, containing standard information available to all subscribers, amounts
to royalty or not. While the Karnataka High Court has taken the view that such
payments amount to royalty, the Authority for Advance Ruling has taken a
contrary view, holding that such payments are not royalty.

Factset Research
Systems’ case

The issue came
up before the Authority for Advance Rulings in the case of Factset Research
System Inc., in re (2009) 317 ITR 169 (AAR).

In this case,
the assessee was a US company, which maintained a database outside India
containing financial and economic information, including fundamental data of a
large number of companies worldwide. Its customers were financial
intermediaries and investment banks, which required access to such such data.
The database contained public information collated, stored and displayed in an
organised manner by the assessee, such information being available in the
public domain in a raw form. Through the database combined with the use of
software, the assessee enabled its customers to retrieve this publicly
available information within a shorter span of time and in a focused manner.
The database contained historical information, and the software to access the
database, and other related documentation were hosted on its mainframes and
data libraries maintained at the data centres in the USA.

To access and
view the database, the customers had to download a client interface software
(similar to an Internet browser). Customers could subscribe to specific
database as per their requirements, and could view the data on their computer
screens. The assessee entered into a Master Client License Agreement with its
customers, under which it granted limited, non-exclusive, non-transferable
rights to its customers to use its databases, software tools, etc. the
assessee did not carry on any business operations in India, and it had no agent
in India acting on its behalf, or having an authority to conclude contracts.
Subscription fees were received by it directly outside India from its
customers.

The assessee
sought an advance ruling on the taxability of such subscriptions received by
it, under the Income-tax Act or under the India-USA DTAA. It claimed before the
AAR that such fees received from customers in India were not taxable in India,
as they did not constitute royalty or fees for technical services either under
the Income-tax Act or under the India-USA DTAA. Further, as it did not have any
permanent establishment in India, the fees could not be taxed as business
income in view of article 7 of the India-USA DTAA.

The AAR
examined the material terms of the Master Client License Agreement. It noted
that the assessee granted the licensee limited , non-exclusive,
non-transferable rights to use the software, hardware, consulting services and
databases. The consulting services were provided through certain consultants,
who demonstrated FactSet’s products and its uses to customers. Such services
were not really required, as the assessee provided helpdesk facilitation free
of cost, though there was more such facilitation centre in India. It was further
clarified that no hardware was being provided to customers in India.

The AAR noted
that the services were provided solely and exclusively for the licensee’s own
internal use and business purposes only and that too in the licensee’s business
premises. Only the licensee’s employees, who had a password or user ID, could
access the service. The licensee could not use or permit any individual or
entity under its control to use the services and the licensed material for any
unauthorised use or purpose. All proprietary rights, including intellectual
property rights in the software, databases and all related documentation
(licensed material) remained the property of the assessee or its third-party
data/software suppliers. The licensee was permitted to use the assessee’s name
for the limited purpose of source attribution of the data obtained from the
database, in the internal business reports and other similar documents. The
licensee was solely responsible for obtaining required authorisation from the
suppliers for products received through them, and in the absence of such
authorisation, the assessee had the right to terminate the licensee’s access to
any supplier product.

The licensee
agreed not to copy, transfer, distribute, reproduce, reverse engineer, decrypt,
decompile, disassemble, create derivative works from, or make any part of the
service, including the data received from the service, available to others. The
licensee could use in substantial amounts of the Licensed Materials in the
normal conduct of its business for use in reports, memoranda and presentations
to licensee’s employees, customers, agents and consultants, but the assessee
(suppliers and their respective affiliates) reserved all ownership rights and
rights to redistribute the data and databases. Under the agreement, the
licensee acknowledged that the service and its component parts constituted
valuable intellectual property and trade secrets of the licensor and its
suppliers. The licensee agreed to cooperate with the licensor and suppliers to
protect the proprietary
rights in the software and databases during the term of the agreement.

The agreement
further provided that on termination of the agreement, the licensee would cease
to use all the licensed material, return any licensor hardware on request, and
expunge all data and software from its storage facility and destroy all
documentation, except such copies of data to the extent required by law. The
licensee could not use any part of the services to create a proprietary
financial instrument or to list on its exchange facilities.

On behalf of
the assessee, it was argued before the AAR that the assessee provided to the
subscriber, a mere right to view the information or access to the database,
while online. No transfer, including licensing of any right in respect of
copyright, was involved in this case. The right that the customer got was a
right to use copyrighted database and not copyright in the database. According
to the assessee, clause (v) of explanation 2 to section 9(1)(vi) did not encompass
the use of copyrighted material. The data was available in the public domain,
and was presented in the form of statements/charts after analysis, indexing,
description and appending notes for facilitating easy access. These value
additions were outside the public domain, and the copyright in them was not
transferred or licensed to the subscribers. The copyright which the assessee
had was similar to the head notes and indexing part of law reports. It was
submitted that none of the other clauses of explanation 2 could be invoked to
bring the subscription fee within the ambit of royalty u/s. 9(1)(vi).

So far as the
DTAA was concerned, it was argued that the fee had not been paid for the use of
or the right to use any copyright. The term “use” in the context of royalty
signified exploitation of property in the form of copyright, but not use of the
copyrighted product. The customers did not acquire any exclusive rights
enumerated in section 14(a) of the Indian Copyright Act.

On behalf of
the Department, reliance was placed on sections 14(a)(i) and (vi) of the Indian
Copyright Act for the argument that the rights specified therein were granted
to the customers, and that therefore there was a transfer of rights in respect
of the copyright. It was further argued that the data could be rearranged
according to the needs of the subscriber, and this amounted to adaptation
contemplated by sub clause (vi) of section 14(a) of the Indian Copyright Act.
Clause (iv) of explanation 2 to section 9(1)(vi) was also sought to be invoked
by the Department, by claiming that this amounted to imparting any information
concerning technical, industrial, commercial or scientific knowledge,
experience or skill.

The AAR noted
that the assessee’s database was a source of information on various commercial
and financial matters of companies and similar entities. What the assessee did
was to collect and collate the said information/data, which was available in
public domain, and put them all in one place in the proper format, so that the
customer could have easy and quick access to this publicly available
information. The assessee had to bestow its effort, experience and expertise to
present the information/data in a focused manner, so as to facilitate easy and
convenient reference to the user. For this purpose, it was called upon to do
collation, analysis, indexing and noting, wherever necessary. These value
additions were the product of the assessee’s efforts and skills, and they were
outside the public domain. In that sense, the database was the intellectual
property of the assessee, and copyright attached to it.

In answer to
the question as to whether, in making the centralised data available to the
licensee for a consideration, whether it could be said that any rights which
the applicant had as a holder of copyright in the database were being parted in
favour of the customer, the AAR’s view was in the negative. The copyright or
other proprietary rights over the literary work remained intact with the
assessee, notwithstanding the fact that the right to view and make use of the
data for internal purposes of the customer was conferred upon the customer.
Several restrictions were placed on the licensee, so as to ensure that the
licensee could not venture on a business of his own, by distributing the data
downloaded by him or providing access to others. The grant of license was only
to authorise the licensee to have access to the copyrighted database, rather
than granting any right in or over the copyright as such.

In the view of
the AAR, the consideration paid was for the facility made available to the
licensee, and the license was a non-exclusive license. An exclusive license
would have conferred on the licensee and persons authorised by him, to the
exclusion of all other persons, including the owner of the copyright, any right
comprised in the copyright in a work. According to the AAR, the expression
“granting of license” in explanation 2 to section 9(1)(vi) took its colour from
the preceding expression “transfer of all or any rights”. It was not used in
the wider sense of granting a mere permission to do a certain thing, nor did
the grant of license denude the owner of copyrights of all or any of his
rights. According to the AAR, a license granting some rights and entitlements
attached to the copyright, so as to enable the licensee to commercially exploit
the limited rights conferred on him, is what is contemplated by the expression
‘granting of license’ in clause (v) of explanation 2.

The AAR
rejected the department’s argument that there was a transfer of rights in
respect of the copyright, by noting that the applicant was not conferred with
the exclusive right to reproduce the work (including the storing of it in
electronic medium) as contemplated by sub clause (i) of section 14(a) of the
Copyright Act. The exclusive right remained with the assessee, being the owner of
the copyright. By permitting the customer to store and use the data in the
computer for its internal business purpose, nothing was done to confer the
exclusive right to the customer. Such access was provided to any person who
subscribed, subject to limitations. The copyright of the assessee had not been
assigned or otherwise transferred, so as to enable the subscriber to have
certain exclusive rights over the assessee’s works. The AAR noted that the
Supreme Court, in SBI vs. Collector of Customs 2000 (115) ELT 597, in a
case where the property in the software had remained with the supplier and
license fee was payable by SBI for use of the software in a limited way, at its
own centres for a limited period, had held that “countrywide use of the
software and reproduction of software are two different things, and license fee
for countrywide use cannot be considered as the charges for the right to
reproduce the imported goods.”

The AAR
further negated the Department’s argument that permitting the data to be rearranged
amounted to adaptation, by holding that that was not the adaptation
contemplated by sub clause (vi) of section 14(a) of the Copyright Act read with
the definition of adaptation as per section 2(a). Therefore, according to the
AAR, no right of adaptation of the work had been conferred on the subscriber,
and the subscription fees received by the assessee from the licensee (user of
the database) did not fall within the scope of clause (v) of explanation 2 to section 9(1)(vi).

Examining the
position from the perspective of the DTAA, the AAR observed that the use of or
right to use any copyright of a literary or scientific work was not involved in
the subscriber getting access to the database for his own internal purpose. It
was akin to offering of a facility for viewing and taking copies for its own
use, without conferring any other rights available to a copyright holder. The
AAR observed that the expression “use of copyright” was not used in a generic
and general sense of having access to a copyrighted work, but the emphasis was
on “the use of copyright or the right to use it”. It was only if any of the
exclusive rights which the owner of the copyright had in the database was made
over to the customer/subscriber, so that he could enjoy such right, either
permanently or for a fixed duration of time and make a business out of it,
would such arrangement fall within the ambit of the phrase ‘use or right to use
the copyright’. The AAR noted that no rights of exclusive nature attached to
the ownership of copyright had been passed on to the subscriber even partially,
the licensee was not conferred with the right of reproduction and distribution
of the reproduced works to its own clientele, nor was the subscriber given the
right to adapt or alter the work for the purposes of marketing it. Therefore,
the underlying copyright behind the database could not be said to have been
conveyed to the licensee who made use of the copyrighted product.

The AAR also
rejected the argument of the Department that there was imparting of information
concerning technical, industrial, commercial or scientific knowledge,
experience or skill. According to the AAR, the information which the licensee
got to the database did not relate to the underlying experience or skills which
contributed to the end product, and the assessee did not share its experiences,
techniques or methodology employed in evolving the database with the
subscribers, nor impart any information relating to them. The information or
data transmitted to the database was published information already available in
public domain, and not something which was exclusively available to the
assessee. It did not amount to imparting of information concerning the
assessee’s own knowledge, experience or skills in commercial and financial
matters.

As regards the
Department’s argument that such payment also included equipment royalty, i.e.
for use or right to use any industrial, commercial or scientific equipment,
since the server, which maintained the database, was used by customers as a
point of interface, the AAR was of the view that the consideration was not paid
by the licensee for the use of equipment, but was for availing of the facility
of accessing the data/information collected and collated by the assessee.

The AAR was
therefore of the view that the subscription fee was not in the nature of
royalty, either under the Income-tax Act, or under the DTAA.

Wipro’s case

The issue
again came up for consideration before the Karnataka High Court in the case of CIT
vs. Wipro Ltd 355 ITR 284.

In this case,
the assessee made certain payments to a non-resident, Gartner Group,
USA/Ireland, for obtaining access to the database maintained by the group, on
which no tax was deducted u/s. 195 of the Income-tax Act. A show cause notice
was issued under section 201 to the assessee, asking it to explain the reasons
for non-deduction of tax at source.

The assessee
responded by stating that the payment was akin to making a subscription for a
journal or magazine of a foreign publisher, and though the journal contained
information concerning commercial, industrial or technical knowledge, the payee
made no attempt to impart the same to the payer. According to it, the payment
fell outside the scope of clause (ii) of explanation 2 to section 9(1)(vi).
Further, it was claimed that the payment was not contingent on productivity,
use, or disposition of the information concerning industrial, commercial or
scientific experience in order to be construed as royalty under article 12 of
the DTAA between India and USA. Further, the assessee claimed that the payment
was for the purposes of a business carried on outside India or for the purposes
of making or earning any income from any source outside India, and therefore fell within the exception (b) to section 9(1)(vi).

The assessing
officer held that the payments amounted to royalty within the meaning of
explanation 2 to section 9(1)(vi), or alternatively amounted to fees for
technical services, both of which were liable to tax in India, both under the
Act, as well as under the DTAA. The Commissioner(Appeals) upheld the order of
the assessing officer holding that the payments amounted to royalty.

The Income Tax
Appellate Tribunal allowed the assessee’s appeals, by holding that the payments
made to Gartner Group did not constitute royalty, as the same was in the nature
of subscription made to a journal or magazine, and no part of the copyright was
transferred to the assessee, and that therefore the income was not chargeable
to tax in India.

Before the
High Court, on behalf of the revenue, it was argued that the payment made by
the assessee to Gartner Group was by way of royalty, as what was granted to the
assessee was a licence to have access to the database maintained by Gartner
Group, which was a scientific and technical service. Therefore, there was
transfer of copyright to the extent of having access to the database maintained
by Gartner Group, which access, but for the license, would have been an
infringement of copyright, the copyright continuing to be with Gartner Group.
Therefore, payments made by the assessee amounted to royalty, and could not be
considered to be akin to subscription made to a journal or magazine.

On behalf of
the assessee, it was argued that the payment made by the assessee to Gartner
Group was not by way of royalty, as no part of copyright was transferred to the
assessee for having access to the database. Further, as the right conferred
upon the assessee was only to have access to the database, it was akin to
subscription to a journal or magazine, and nothing more than that, and could
not be called as royalty.

The Karnataka
High Court, after considering the arguments observed that in identical cases,
i.e. ITA No 2988/2005 and connected cases (reported as CIT vs. Samsung
Electronics Co Ltd 345 ITR 494), after considering the contentions which
were identical to the contentions raised in these appeals, the court had held
that the payment made by the assessee to a non-resident company would amount to
royalty. According to the High Court, the fact that the issue in those cases
related to shrink-wrapped or off-the-shelf software, while that in this case
related to access to a database which was granted online, would not make any
difference to the reasoning adopted by the court to hold that such a right to
access would amount to transfer of right to use the copyright, and would amount
to royalty.

The Karnataka
High Court accordingly held that the payment for online access to the database
amounted to royalty.

Observations

To appreciate
the issue, one needs to refer to the facts and the ratio of the Karnataka High
Court decision in Samsung Electronics case (supra); the reason being
that the high court, in deciding Wipro’s case, has simply followed the decision
in Samsung Electronics case. That was a case of payment of licence fees by a
distributor of software to the overseas company and the Court held that for understanding
the meaning of ‘copyright’, one had to make a reference to the Copyright Act,
in the absence of any definition of the term under the Income-tax Act.
According to the Karnataka High Court, the right to copyright work would also
constitute exclusive right of the copyright holder, and any violation of such
right would amount to infringement u/s. 51 of the Copyright Act. According to
the court, granting of licence for taking copy of the software, and to store it
in the hard disk, and to take a backup copy and the right to make a copy
itself, was a part of copyright, since in the absence of licence, it would
constitute an infringement of copyright. Therefore, what was transferred was
the right to use the software (a right to use a copy of the software for the
internal business), an exclusive right which the owner of the copyright owned.

Therefore,
according to the Karnataka High Court, in Samsung Electronics case, the right
to make a copy of the software and use it for internal business by making a copy
of the same, and storing the same in the hard disk of the designated computer,
and taking backup copy, would itself amount to copyright work u/s. 14(1) of the
Copyright Act. Licence was granted to use the software by making copies, which
work, but for the license granted, would have constituted an infringement of
copyright. The supply of a copy of the software and the grant of the right to
copy the software was also a transfer of the copyright, since, copyright was a
negative right, in the absence of which there would be an infringement of the
copyright.

According to
the Karnataka High Court, in Samsung Electronics case, software was different
from a book or a pre-recorded music CD, as books or pre-recorded music CD could
be used once they were purchased, while in the case of software, the
acquisition of the CD by itself would not confer any right to the end-user, the
purpose of the CD being only to enable the end-user to take a copy of the
software and storage in the hard disk of the designated computer. If licence
was granted in that behalf. In the absence of licence, it would amount to
infringement of copyright.

If one
examines the logic of the Karnataka High Court’s decision, it is clear that the
case of a distributor would stand on a different footing from that of an
end-user, because a distributor would have the right to reproduce the software
for further distribution to customers, and the payment of the licence fees
would be in the ratio of the number of software licenses sold by him. In the
case of an end-user, there would be no right to reproduce for resale.

Further, the
Karnataka High Court seems to have lost sight of the fact that the payment for
the license for use of the software is made at the time of purchase of the CD
itself, and the ‘online clicking’ of the terms of the license after
installation of the software on the computer is merely a formality, and does
not involve payment of any further consideration to the owner of the copyright.
Therefore, the distinction sought to be drawn by the Karnataka High Court
between copyrighted articles such as books and music CD on the one hand, and
software on the other hand, does not seem to be valid.

Besides,
access to an online database is quite different from purchase of a
shrink-wrapped software, and an exclusive reliance on the logic of a decision
in Samsung Electronics case delivered in
the context of purchase of shrink-wrapped software to a case of subscription to
an online database in Wipro’s case does not seem to be justified.

Further, even there
various other High Courts/AAR have taken a view contrary to the view taken in Samsung
Electronics case holding that payments for purchase of shrink-wrapped
software does not amount to royalty, contrary to the view of the Karnataka High
Court. Please see DIT vs. Intrasoft Ltd 220 Taxman 273 (Del), Ericsson AB
vs. DDIT 343 ITR 470 (Del), Dassault Systems K K, in re 322 ITR 125 (AAR),
.

One can also
draw an analogy from the Supreme Court decision in the case of CIT vs. Kotak
Securities Ltd 383 ITR 1, in the context of fees for technical services,
where the Supreme Court has taken the view that provision of a standard service
does not amount to provision of technical services. The services have to be
specialized, exclusive and as per individual requirement of the user or
consumer who may approach the service provider for such assistance/service, to
constitute fees for technical services. In the case of royalty as well, the
same analogy should apply.

Internationally,
also, there is a clear distinction drawn between provision of database services
using a copyright, and transfer or use of a copyright in the OECD Commentary on
“Treaty characterization issues arising from e-Commerce” wherein ,
there is a useful discussion on this aspect under the heads ‘Data retrieval’
and ‘Delivery of exclusive or other high value data’, as under:

“Category 15: Data retrieval

Definition —The provider makes a repository
of information available for customers to search and retrieve. The principal
value to customers is the ability to search and extract a specific item of data
from amongst a vast collection of widely available data.

27. Analysis and conclusions —The payment
arising from this type of transaction would fall under Article 7. Some Member
countries reach that conclusion because, given that the principal value of such
a database would be the ability to search and extract the documents, these
countries view the contract as a contract for services. Others consider that,
in this transaction, the customer pays in order to ultimately obtain the data
that he will search for. They therefore view the transaction as being similar
to those described in category 2 and will accordingly treat the payment as
business profits.

28. Another issue is whether such payment
could be considered as a payment for services “of a technical nature”
under the alternative provisions on technical fees previously referred to.
Providing a client with the use of search and retrieval software and with
access to a database does not involve the exercise of special skill or
knowledge when the software and database is delivered to the client. The fact
that the development of the necessary software and database would itself
require substantial technical skills was found to be irrelevant as the service
provided to the client was not the development of the software and database
(which may well be done by someone other than the supplier) but rather making
the completed software and database available to that client.

Category 16: Delivery of exclusive or other high-value
data

Definition —As in the previous example, the
provider makes a repository of information available to customers. In this
case, however, the data is of greater value to the customer than the means of
finding and retrieving it. The provider adds significant value in terms of
content (e.g., by adding analysis of raw data) but the resulting product is not
prepared for a specific customer and no obligation to keep its contents
confidential is imposed on customers. Examples of such products might include
special industry or investment reports. Such reports are either sent
electronically to subscribers or are made available for purchase and download
from an online catalogue or index.

29. Analysis and conclusions —These
transactions involve the same characterization issues as those described in the
previous category. Thus, the payment arising from this type of transaction
falls under Article 7 and is not a technical fee for the same reason.”

Though the
discussion is in the context of fees for technical services, the same logic
would equally apply to royalty.

Therefore, the
better view is that of the AAR, that both under the Income-tax Act as well as
under the DTAA, subscription to an online database does not amount to royalty
or the fees for technical services and does not require deduction of tax at
source on payment, nor could it be deemed to be an income accrued in India u/s.
9(1)(vi) or (vii) or DTAA..

The decisions
discussed above (except that of Intrasoft) have been rendered in the context of
the law prevailing prior to 2012. In 2012, explanations 3 to 6 to section
9(1)(vi) were inserted with retrospective effect from 1.4.1976. We need to
perhaps examine whether the amendments affect the issue under consideration?

Explanations 3
and 4 deal with computer software. An online database is not a computer
software. The mere fact that a software may be used to access the database does
not make the payment one for use of the software. The payment remains in
substance for access of the information contained in the database. These
explanations 3 and 4 therefore do not apply to subscription to online
databases.

Explanation 6
deals with use of a process. In the case of subscription to an online database,
there is in substance no payment for use of a process. Even if the method of
‘logging in’ is regarded as a process, that is merely incidental to the access
to the database. The payment cannot be regarded as having been made for use of
a process, but for access to the information contained in the database.
Explanation 6 also therefore does not apply.

Explanation 5
deals with consideration for any right, property or information, and clarifies
that it would amount to royalty, irrespective of whether the possession or
control of such right, property or information is with the payer, whether such
right, property or information is used directly by the payer, or whether the
location of such right, property or information is in India. In case of an
online database, the consideration is surely for information, which is not
within the control of the payer. However, the imparting of information under
explanation 5 by itself cannot be read in isolation, and has to be read along
with the main definition of “royalty” in explanation 2 to section 9(1)(vi).
This is evident from the fact that if one reads explanation 5 in the absence of
explanation 2, it has no meaning at all in the context of section
9(1)(vi).

Clause (ii) of
explanation 2 refers to the imparting of any information concerning the working
of, or the use of, a patent, invention, model, design, secret formula or
process or trade mark or similar property. An online database does not provide
working of any such intellectual property, but merely provides financial or
general information in an organised manner. Clause (iv) of explanation 2 refers
to the imparting of any information concerning technical, industrial,
commercial or scientific knowledge, experience or skill. In case of an online
database, as rightly pointed out by the AAR in Factset’s case, no information
regarding knowledge, experience or skill of the database provider is provided
to the subscriber. Therefore, subscription to an online database does not fall
under either of these clauses. The insertion of explanation 5, though with
retrospective effect, therefore does not change the position in law that was
prevailing prior to the amendment, in so far as subscription to an online
database is concerned.

Even after the amendments, the law therefore seems to
be the same – subscription to an online database does not amount to royalty,
either under the Income-tax Act or under the DTAA.

shailesh.kwebmaker

RATE OF TAX APPLICABLE TO CAPITAL GAINS ON LOSS OF EXEMPTION BY A CHARITABLE OR RELIGIOUS TRUST

Issue for Consideration

A charitable or religious trust is entitled to exemption
under sections 11 and 12 of the Income-tax Act, 1961, provided that it is
registered u/s. 12AA and fulfils other requirements of sections 11 to 13. Under
sections 13(1)(c) and 13(1)(d), if a benefit is provided to a specified person
or the specified investment pattern is not adhered to, the benefit of the
exemption is lost and the income of the trust so losing the exemption is
taxable at the maximum marginal rate by virtue of the provisions of section
164(2).

Normally, for all assessees, long term capital gains is
chargeable to tax under the provisions of section 112 at the rate of 20%, while
certain types of short term capital gains arising on sale of equity shares on a
recognised stock exchange is chargeable to tax at the concessional rate of 15%
under the provisions of section 111A.

The issue has arisen before the tribunal as to what should be
the rate of taxation in respect of income in the nature of a long term capital
gains, in the case of a charitable or religious trust, losing exemption on
account of violation of section13. While the Mumbai bench of the tribunal has
taken the view that such gain is taxable at the rate of 20% u/s. 112, the
Chennai bench of the tribunal has taken a contrary view, holding that such gain
is taxable at the maximum marginal rate as per section 164(2) of the Act.

Jamsetji Tata Trust’s case

The issue first came up for consideration before the Mumbai
bench of the Tribunal in the case of Jamsetji Tata Trust vs. Jt.DIT(E), 148
ITD 388 (Mum).

In this case, the assessee trust sold certain shares of Tata
Consultancy Services Ltd, and acquired preference shares of Tata Sons Ltd. It
earned long-term capital gains on sale of the shares of TCS, which was exempt
u/s. 10(38), dividends, which were exempt u/s. 10(34), and other interest and short
term capital gains. It claimed exemption u/s. 11 in respect of the interest and
short term capital gains, besides the exemptions under sections 10(34) and
10(38) in respect of the dividends and the long term capital gains.

The assessing officer denied the benefit of the exemption
u/s. 11, by invoking the provisions of section 13(1)(d), on the ground, that by
holding equity shares of TCS and Tata Sons, the assessee had violated the
investment pattern specified in section 11(5). The assessing officer taxed the
entire income of the trust, including the dividends, the long-term capital
gains, the short term capital gains as well as the interest income at the
maximum marginal rate, by applying the provisions of section 164(2).
The Commissioner(Appeals) upheld the order of the assessing officer.

Before the Tribunal, on behalf of the assessee, it was argued
that the denial of exemption u/s. 11 was not justified, that the assessee was
entitled to the exemptions u/s. 10, and that only the income from the investments
attracting the provisions of section 13(1)(d) was taxable at the maximum
marginal rate. It was further argued that the rate of tax on the short term
capital gains arising from sale of shares should have been the rate prescribed
u/s. 111A, and not the maximum marginal rate.

On behalf of the revenue, it was argued that the denial of
exemption u/s. 11 was justified. As regards the rate of tax, it was argued that
since the provisions of section 164(2) were applicable, the maximum marginal
rate was to be applied to the entire taxable income of the assessee, and not
separate rates on income of separate nature.

The Tribunal, after considering the arguments of the assessee
and the revenue and after analysing the provisions of the Income-tax Act, held
that only the income arising from the prohibited investments was ineligible for
the benefit of the exemption u/s. 11, and attracted tax at the maximum marginal
rate, and not the entire income. The Tribunal further held that the income
which was exempt u/s. 10 (dividends and long term capital gains) could not be
brought to tax under sections 11 and 13, since those sections did not have
overriding effect over section 10. Once the conditions of section 10 were
satisfied, no other condition could be fastened for denying the claim u/s. 10.

Addressing the issue of whether the rate u/s. 111A of 15% or
the maximum marginal rate u/s. 164(2) was to be applied to the short term
capital gains, the Tribunal noted that section 164(2) did not prescribe the
rate of tax, but mandated the maximum marginal rate as prescribed under the
provisions of the Act. It observed that section 111A was a special provision
legislated for providing for rate of tax chargeable on short term capital gains
on sale of equity shares or units of an equity oriented fund, which was
subjected to securities transaction tax (STT) and as such the maximum marginal rate for income from
specified short term gains should be the rate prescribed therein.

According to the Tribunal, when the short term capital gains
arising from the sale of shares subjected to STT was chargeable to tax at 15%,
then the maximum marginal rate, referred to in section 164(2), on such income
could not exceed the maximum rate of tax provided u/s. 111A of the Act. It
accordingly held that the short term capital gains on sale of shares already
subjected to STT was chargeable to tax at the maximum marginal rate, which
could not exceed the rate provided u/s. 111A of the Income-tax Act.

India Cements Educational Society’s case

The issue again came up before the Chennai bench of the
tribunal in the case of DDIT vs. India Cements Educational Society 157 ITD
1008.

In this case, the assessee was a Society registered u/s.
12AA. It sold a plot of land and advanced the sale proceeds of the land to a
company in which the president of the Society and his wife were directors. It
claimed exemption in respect of capital gains arising on such sale on the
ground that the sale proceeds were reinvested in a specified capital asset.

The assessing officer denied exemption u/s. 11 to the Society
on the ground that the amount advanced to the company was not an approved
investment u/s. 11(5). He therefore taxed the income of the Society and the
maximum marginal rate under the provisions of section 164(2).

The Commissioner (Appeals) allowed the assessee’s appeal,
holding that the assessing officer had not proved what benefit accrued to the
specified person from the advancement of the amount to the company, and that
mere making of an advance to third parties could not be treated as utilisation
for investment in capital asset within the meaning of section 11(5). He
therefore held that while the benefit of exemption u/s. 11 was available, the
making of the advance out of the sale proceeds was not an investment in a new
capital asset. In the context of the issue under consideration, the
Commissioner(Appeals) held that the capital gains to be assessed as per section
48, was to be taxed at the rate prescribed u/s. 112 of the Act, and not at the
‘maximum marginal rate’ adopted by the assessing officer.

Before the tribunal, on behalf of the assessee, it was argued
that the entire income of the Society, other than the capital gains, continued
to be exempt u/s. 11 of the Act and that the capital gains alone was to be
taxed in terms of section 164(2) on account of the alleged violation of the
conditions of section 13 of the Act by applying the maximum marginal rate
Reliance was placed on the decision of the Bombay High Court in the case of DIT(E)
vs. Sheth Mafatlal Gagalbhai Foundation Trust 249 ITR 533, and the decision of
the Karnataka High Court in the case of CIT vs. Fr Mullers Charitable
Institutions 363 ITR 230, for the proposition that whenever there was a
violation u/s. 11(5), then only income from such investment or deposit which
was made in violation of section 11(5) was liable to be taxed, and violation
u/s. 13(1)(d) did not result in denial of exemption u/s.11 for the entire total
income of the assessee. Reliance was also placed on the CBDT circular number
387 dated 6.4.1984 152 ITR 1 (St.), where it was stated in paragraph 28.6 that
where a trust contravened the provisions of section 13(1)(c) or 13(1)(d), the
maximum marginal rate of income tax would apply only to that part of the income
which had forfeited exemption under those provisions.

In the context of the issue under consideration, It was
further argued by the assessee that, in view of the decision of the Karnataka
High Court in the case of Fr Muller’s Charitable Institutions (supra),
the rate of tax applicable for taxing the capital gains was the rate prescribed
u/s. 112. Reliance was also placed on the decision of the Mumbai bench of the
tribunal in the case of Jamsetji Tata Trust (supra), which had held, in
the case of short term capital gains on sale of shares subject to STT, that the
maximum marginal rate on capital gains could not exceed the rate provided u/s.
111A. This decision had been followed by the Mumbai bench in the case of Mahindra
and Mahindra Employees Stock Option Trust vs. DCIT 155 ITD 1046, where the
tribunal had held that capital gain was to be assessed by applying the
provisions of section 112, even if the income was assessed as per section 164.

The tribunal examined the provisions of sections 11 and 13.
It noted that in the case before it, there was a violation of section 13(1)(c),
as the Society had invested funds in a limited company, where the trustee was
the managing director and his wife was a director. Following the decision of
the Supreme Court in the case of CIT vs. Rattan Trust 227 ITR 356 and the
decision of the Madras High Court in the case of CIT vs. Nagarathu Vaisiyargal
Sangam 246 ITR 164, the tribunal held that the assessing officer was
justified in applying the provisions of section 13(1)(c), and denying exemption
u/s. 11 to the Society.

Analysing the provisions of section 164(2), the Tribunal,
observed that the income of a charitable or religious trust, which was not
exempt u/s. 11 or 12 was charged to tax as if such exempt income was the income
of an AOP. The proviso to that section provided that where the non-exempt
portion of the relevant income arose as a consequence of the contravention of
the provisions of section 13(1)(c) or (d), such income would be subjected to
tax at the maximum marginal rate.

Considering both the decisions of the Mumbai bench of the
Tribunal, cited before it, the Chennai bench of the tribunal, in the context of
the issue under consideration, found that the Mumbai bench had not considered
the meaning of the term ‘maximum marginal rate’ as defined in section 2(29C),
whereunder the term was defined to mean the rate of income tax (including
surcharge on income tax, if any) applicable in relation to the highest slab of
income in the case of an individual, association of persons or, as the case may
be, body of individuals as specified in the Finance Act of the relevant year.
The Chennai bench of the tribunal observed that on account of section 2(29C),
the two decisions of the Mumbai bench could not be said to have laid down the
correct proposition of law.

The Chennai bench of the Tribunal therefore held that the
benefit of section 112 to assess the gain from the transfer of the capital
asset could not be given to the Society, and that the long-term capital gains
was chargeable at the maximum marginal rate u/s. 164(2) r.w.s. 2(29C) of the Act.

Observations

A similar question has arisen in the case of private trusts,
where the individual share of beneficiaries is unknown, known as discretionary
trusts. Under the provisions of section 164(1), the income of such trusts is
also taxable at the maximum marginal rate. The issue has been decided by Delhi
and Gujarat High Courts, in the cases of CIT vs. SAE Head Office Monthly
Paid Employees Welfare Trust (2004) 271 ITR 159 (Del) and Niti Trust vs.
CIT (1996) 221 ITR 435 (Guj), that the long term capital gains earned by a
discretionary trust is not taxable at the maximum marginal rate u/s. 164(1),
but at the concessional rate of tax u/s. 112. These decisions have not been
considered by the Chennai bench of the Tribunal. The language of both sections
164(1) and 164(2) being similar, the ratio of these decisions would apply
squarely to section 164(2) as well.

Section 2(29C) while defining the term ‘maximum marginal
rate’ provides for adoption of the highest slab rate prescribed for an
individual, etc. This rate, in
certain cases, varies w.r.t . the nature of income and head of income and in
such cases the rate specially provided for becomes the maximum marginal rate
for taxing such income. In cases where the rate is specifically provided for in
a particular provision of the Act, it is that rate that should then be taken to
represent the maximum marginal rate. The decisions above referred to support
such a view.

Alternatively, it can be contested that both the provisions
are independent and operate accordingly. he language of neither section
111A/112 nor section 164(2) indicates that one has a specific overriding effect
over the other. None of these provisions could be said to be general. The
principle generalia specialibus non derogant providing that a specific
provision prevailing over a general provision also cannot be readily applied.
While section 111A/112 is a provision applicable to specific types of income of
all assessees, section 164(2) applies to all incomes of specific types of
assessees. In any case, if a view is to be taken then the better view is to
treat section 112 as a special provision.

It needs to be kept in mind that section 112 provides for a
rate of tax for long term capital gains, irrespective of the type of assessee
who earns the capital gains. This rate applies not only to individuals and
HUFs, but also to partnership firms, associations of persons, domestic
companies, as well as foreign companies. While an individual is liable to tax
at slab rates of tax, partnership firms and domestic companies are liable to a
flat rate of tax of 30%, and foreign companies are liable to tax at a flat rate
of 40%. Yet, for all these different types of entities liable to different
rates of tax, the rate of tax u/s. 111A or section 112 is the same, i.e. 15%
and 20% respectively. This indicates that the rate applicable to such types of
capital gains should not differ, irrespective of the rate of tax applicable to
the other income of the entity.

On the other hand, the provisions of section 164(2) are
intended to ensure that the trust losing exemption on account of the violation
of the provisions of sections 13(1)(c) or 13(1)(d) does not benefit by paying a
lower rate of tax by taxing such incomes at the maximum marginal rate. However,
till assessment year 2014-15, a trust would claim exemption under the
provisions of section 10 in respect of income such as dividends, long term
capital gains on sale of equity shares on which STT was paid, etc.,
irrespective of whether the remainder of its income was exempt u/s. 11 or not.
The question of payment of tax at the maximum marginal rate did not arise in
the case of such income which was exempt. That being the case, where certain
incomes, such as long term capital gains or short term capital gains is liable
to tax at lower rates of tax than normal income, the question of taxation at
the maximum marginal rate should equally not apply. The maximum marginal rate
should therefore apply to income which is otherwise not taxable at a
concessional rate of tax.

If one also examines the format of the income tax returns for
charitable and religious trusts in Form No 7, as well as the forms applicable
to discretionary trusts in Form No 5, there is a specific reference in schedule
SI – Income Chargeable to tax at special rates, to specific rates of 15% under
section 111A for specified types of short term capital gains and of 20% u/s.
112 for long term capital gains. This clearly indicates that such gains are not
intended to be taxed at the maximum marginal rates.

The view that is beneficial to the assessee should be adopted
in a case where two views are possible. Besides, whenever there is a difference
of opinion between two benches of the Tribunal, such a difference is required
to be referred to a Special Bench of the Tribunal for consideration. The
Chennai bench of the tribunal chose to not to follow the decisions of the Mumbai
bench of the Tribunal, though cited before it, on the ground that the Mumbai
bench had overlooked a certain provision of the Act, rather than referring the
issue to a Special Bench.

The better view therefore is that of the Mumbai
bench of the Tribunal, that even if a charitable or religious trust loses
exemption u/s. 11 by virtue of the provisions of sections 13(1)(c) or 13(1)(d),
the short term capital gains covered by section 111A or long term capital gains
covered by section 112, is chargeable to tax at the rates specified in those
sections, and not at the maximum marginal rate specified in section 164(2). _

shailesh.kwebmaker

Section 35DDA and Payments under Voluntary Retirement Scheme

ISSUE FOR CONSIDERATION

Section 35DDA provides for a deduction, of one-fifth of the amount of an expenditure, on payment of any sum to an employee, in connection with his voluntary retirement in accordance with the scheme for such retirement. The balance expenditure is allowed to be deducted, in equal instalments, for each of the four succeeding previous years. The section also contains a disabling provision, that provides that no deduction shall be allowed for an expenditure on voluntary retirement referred to in section 35DDA. It however does not prescribe any condition that requires to be incorporated in the scheme, nor does it require the scheme to be approved by any authority.

Section10(10C) confers an exemption from income tax for a receipt , in the hands of an employee, on his retirement, up to Rs. 5 lakh under a voluntary retirement scheme that is framed as per the guidelines prescribed in Rule 2BA.

An interesting issue has arisen about the application of section 35DDA to a payment of an expenditure under a scheme of voluntary retirement which is not framed as per the guidelines prescribed under Rule 2BA. In such circumstances, whether the deduction for expenditure would be restricted to one-fifth or not is an issue over which conflicting views are available. The issue that arises, in the alternative, is about the deduction in full of the amount of expenditure u/s. 37 of the Act.

While the Delhi bench of the Income tax Appellate Tribunal has held that for a valid application of section 35DDA, it was necessary that the scheme was framed as per the guidelines prescribed under Rule 2 BA, the Mumbai bench held that the provisions of section 35DDA applied once the payment was made under a scheme, even where the scheme did not meet the requirements of rule 2BA. When asked to address the issue of full deductibility, the Delhi bench held that the deduction was possible provided the expenditure was of revenue nature. The Mumbai bench however held that the expenditure was to be amortised for deduction in five equal annual instalments.

WARNER LAMBERT’S CASE
The issue arose in the case of DCIT vs. Warner Lambert (India) (P) Ltd., 33 taxmann.com 686(Mum.) for A.Y. 2003-04. The assessee company in that case was engaged, inter alia, in the business of trading, importing, marketing, manufacturing and sale of ayurvedic medicines, breath fresheners, chewing gums and drugs. It had claimed 100% deduction for payment made to an employee of an amount of Rs. 17 lakh who had opted to retire on account of restructuring of the business of the company . It explained that the said expenditure was not in accordance with the scheme of voluntary retirement to which provisions of section 35DDA applied and, accordingly, the said amount had been claimed in full. The AO observed that the said expenditure was incurred clearly under the voluntary retirement scheme and was to be allowed, as per section 35DDA, at one-fifth of the claim spread over a period of five years. The assessee pointed out that the claim was allowable u/s. 37(1) of the Act. The AO however, applied the provisions of section 35DDA by holding that the said provisions included payment of an expenditure under schemes of any nature for granting voluntary retirement to employees prior to its actual retirement date. According to the A.O, it was not material that the schem was framed under the prescribed guidelines of rule 2BA.

In appeal, the CIT(A) observed that the AO had not brought any material on record to show that the assessee had paid any compensation under the existing scheme. He further held that since the assessee had himself contended that payment was not under any scheme of voluntary retirement, the applicability of provisions u/s. 35DDA merely on presumption was not justified.

In appeal to the Tribunal by the Income tax Department, it was submitted by the Revenue that a specific bar had been imposed for not allowing deduction under any other provisions of the Act vide section 35DDA sub-section (6), for an expenditure covered by sub-section (1) of section 35DDA and as such the assessee could not have resorted to section 37(1) of the Act for claiming the deduction. It was pointed out that w.r.e.f 1st April, 2004 on substitution of the words ‘in connection with’ for ‘at the time of”, the amount that has been paid ‘in connection with’ voluntary retirement scheme was covered by the provisions of section 35DDA and only one-fifth of the amount paid could be allowed as a deduction. It was further submitted that no approval of any competent authority was required for the voluntary retirement scheme adopted by the assessee.

In reply, the assessee submitted that no formal scheme had been adopted by the company and only an option was given to those employees who were not absorbed, on reorganisation, to opt for VRS which was to be considered in the overall context. It was further explained that the scheme contemplated u/s. 35DDA was the same as in section 10(10C) and, therefore, for invoking section 35DDA, it was necessary that the scheme adopted by the company confirmed with the requirements set out in R. 2BA and as no such scheme was framed, the provisions of section 35 DDA were not applicable.

The honourable Tribunal was not inclined to accept the plea of the Income tax Department to the effect that the provisions of section 35DDA were applicable because the payment had been made in pursuance to a scheme of voluntary retirement and that it was not necessary that the said scheme should have also complied with the guidelines prescribed under Rule 2 BA r.w.s. 10 (10C) of the Act. It stated that on a bare perusal of the section, it was revealed that the provisions of the section were attracted only when the payment had been made to an employee in connection with his voluntary retirement, in accordance with any scheme of voluntary retirement. It observed that the legislature inserted the section in order to allow only one-fifth of the total expenditure since the payment reduced the burden on the assessee relatable to subsequent years.

In order to resolve the dispute, the honourable Tribunal held that the principles of harmonious construction of statute were to be applied which required that a statute be received as a whole and one provision of the Act should be in conformity of the other provisions in the same Act so as to ensure uniformity in interpretation of the whole statute. It further observed that the provisions relating to voluntary retirement scheme were contained in section 10(10C) and all the conditions laid down therein had to be fulfilled before an exemption could be availed by an employee under the said section; that the income and expenditure go together in the scheme of the Act; that it was difficult to appreciate that a claim for an expenditure could be held to be covered by section 35DDA whereas while allowing exemption of the same expenditure in the hands of the payee, only those claims were entertained which confirmed to the guidelines laid down under r. 2BA; that the language in sections 35DDA and 10(10C), clearly referred to a scheme or schemes of voluntary retirement; though it was true that section 35DDA did not specifically refer to section 10(10C) but principles of harmonious construction required that the conditions as laid down under Rule 2BA had to be met before a deduction u/s. 35DDA could be allowed.

The Tribunal noted that the scheme adopted by the assessee did not confirm to the guidelines laid down under Rule 2BA and therefore, it could not be held that the provisions of section 35DDA were applicable in the company’s case. The claim made by the company for deduction u/s. 37 was accordingly upheld by the tribunal.

SONY INDIA’S CASE
The issue arose again in the case of Sony India (P) Ltd., 21 taxmann.com 224 (Delhi) for assessment year 2005-06.

In that case the assessee company, on closure of one of its units, had floated a VRS scheme for employees of said closed unit and one-fifth of the payments made there under was claimed u/s. 35DDA. The A.O however, observed that for claiming deduction under s.35DDA provisions of rule 2BA were to be satisfied; as the assessee’s VRS scheme was not framed in accordance with Rule 2B, VRS expenditure claimed by assessee were liable to be disallowed. The assessee had claimed one-fifth of the amount of expenditure incurred on payment under the voluntary retirement scheme of the company to its employees and claimed that such an expenditure was to be allowed as per section 35DDA of the Act. The expenditure so claimed was disallowed by the A.O in assessment. Amongst the different reasons, one of the reasons of the AO, for disallowance of the claim of one-fifth of the expenditure on payments to employees under the voluntary retirement scheme, was that the scheme was not framed as per the guidelines prescribed under Rule 2BA.

The assessee, in the alternative, pleaded that the expenditure was otherwise deductible u/s. 37(1) but the A.O rejected the said plea by holding that the expenditure was incurred for achieving a benefit of enduring nature and as such it was capital in nature; the expenditure on VRS was to reduce the staff strength with a view to achieve viability and profitability of business, benefit of which was to endure over a number of years. the said expenditure could not be allowed u/s. 37(1) but was allowable only u/s. 35DDA.

On appeal by the assessee, the Commissioner (Appeals) came to the conclusion that the said expenditure was not in respect of retrenchment of employees of closed unit but the said expenditure was incurred in terms of the VRS. However, the VRS was not in accordance with rule 2BA. Therefore, the Commissioner (Appeals) held that the expenditure had been incurred to sustain the business for a longer period of time resulting in a benefit of enduring nature and thus, was capital in nature. Accordingly, the appeal of the assessee was dismissed on that ground.

On further appeal, amongst the other grounds, the assessee placed the following grounds before the Tribunal; Whether the Commissioner (Appeals) was unjustified in reading the conditions of Rule 2BA in section 35DDA? Whether VRS expenditure was otherwise allowable as deduction u/s. 37(1)?

The Tribunal noted that in the Bill, leading to enactment of section 35DDA, a provision was made regarding the application of Rule 2BA which portion was deleted when the Bill was passed and, thus, the conditionalities of the rule had not been incorporated intentionally in the section; the deletion of conditionalities originally incorporated in the Bill showed that legislative intendment was not to incorporate all the conditions of section 10(10C) in section 35DDA; the legislature left the scheme of voluntary retirement open-ended and did not place any restriction on the scheme; the plain language of the provision supported the case of the assessee; that it was not simply the case of taking guidance from a definition section but required modification of the provisions of section 35DDA by incorporating a part of section 10(10C) in it which incorporation did not find support from any rule of construction. The Tribunal held that there was no compelling reason to read section 35DDA as suggested by the revenue and therefore, the scheme of the assessee was held to be a VRS, to which the provisions of section 35DDA was applicable.

Dealing with the claim for the deduction u/s. 37(1) of the Act, the Tribunal noted the observations made by the Kerala High Court in the case of CIT vs. O E N India Ltd., 8 taxman.com 246 and in particular the following observations while allowing the deduction in full following the various court decisions. “It is mentioned that the test applied to determine whether the expenditure incurred by the assessee is revenue or capital in nature depends upon the finding as to whether the assessee has created any fixed asset or not. If an asset has been created, the expenditure will certainly be capital in nature. Where the expenditure does not lead to creation of a fixed asset, the expenditure is generally revenue in nature. However, creation of an asset is not a mandatory requirement. The expenditure incurred for achieving a benefit of enduring nature is also capital in nature. When this test is applied, it is felt that the purpose of introduction of VRS is to reduce the staff strength with a view to achieve viability and profitability of the business in general and the retrenchment will give long-term benefit to the assessee. The VRS floated with a view to encourage massive retirement is primarily to streamline the business by restructuring the work force with a view to increase profitability and to make the business viable. Therefore, the benefit will endure over a number of years to come. Accordingly, the payment under the VRS for retirement of a number of employees is nothing but a capital expenditure which could be claimed as a deduction in a phased manner over several years. It is for the assessee to provide rational basis to ascertain the number of years over which the benefit endures and accordingly write off the amount of expenditure by amortizing it over those number of years. Section 35DDA is a virtual declaration of the fact that the expenditure should not be allowed in one year and it has to be amortized over a few years. Therefore, even prior to introduction of section 35DDA, the assessee was entitled to claim deduction of expenditure in a phased manner over a number of years which have to be rationally fixed by the assessee.” The Tribunal noted that the having stated so, the court abundantly made it clear that the aforesaid had been stated only with a view to express the opinion of the court and it was not intended to disturb the settled position through various high courts’ decisions, which had not been contested before the Supreme Court. The court held that the entire amount paid under the VRS had to be held to be revenue in nature to bring in line its decision with the decisions of various high courts.

The Tribunal however held that the assessee was entitled to deduction of one-fifth of the expenditure u/s. 35DDA as claimed for the reason that it had failed to establish that the expenditure was not capital in nature. According to the Tribunal, the facts suggested that the payment was made on closure of an unit and such payment was to be held to be on capital account unless it was established by the assessee that the business of the unit closed was closely interlaced and interlinked with the business continued by the assessee.

OBSERVATIONS
Section 35DDA (1) of the Act reads as under; “Where an assessee incurs any expenditure in any previous year by way of payment of any sum to an employee at the time of( in connection with) his voluntary retirement, in accordance with any scheme or schemes of voluntary retirement, 1/5th of the amount so paid shall be deducted in computing the profits and gains of the business for that previous year, and the balance shall be deducted in equal instalments for each of the four immediately succeeding previous years.”

The relevant part of section 10(10C) reads as under :” any amount received or receivable by an employee of- (i)………. (ii) any other company; or ….. on his voluntary retirement or termination of his service, in accordance with any scheme or schemes of voluntary retirement or ……, to the extent such amount does not exceed five lakh rupees. Provided that the schemes of the said companies or ……….., governing the payment of such amount are framed in accordance with such guidelines including inter alia criteria of economic viability as may be prescribed (rule 2BA) .”

On an apparent reading of section 35DDA, what one gathers is that for a valid application of section 35DDA, the payment of expenditure to an employee should have been made in connection with his voluntary retirement under a scheme of such retirement. On fulfilment of these conditions, one-fifth of the expenditure would fall for allowance in the year of payment and the balance will be allowed in four equal annual instalments.

The section by itself does not prescribe that the scheme should have been framed as per guidelines prescribed rule 2BA. As long as the payment (not revenue in nature) is made under a scheme for voluntary retirement, the case for deduction should be governed by the provisions of section 35DDA and if so no deduction shall be allowed under any other provisions of the Income Tax Act. For the purposes of claiming an exemption u/s. 10(10C), in the hands of an employee, it is however essential that the receipt is under a scheme i.e. framed as per the guidelines prescribed under Rule 2BA.

It is the above noted distinction between the two provisions of the Act, one dealing with the payment and the other dealing with the receipt that prompted the tribunal in the Warner Lambert’s case to recommend a harmonious reading of section 35DDA & 10(10C) so as to include only such payments within the ambit of section 35DDA which are made under a scheme that meets the guidelines of Rule 2BA , and that the deduction is not to be restricted to one-fifth of the amount of expenditure but may qualify for a full deduction provided of course it is otherwise allowable. With utmost respect there is nothing in section 35DDA that stipulates reading in the manner that requires that the scheme referred to in section 35DDA should be so framed so as to meet the conditions of rule 2BA. Likewise there is nothing in section 10(10 C) that provides that the receipt by an employee should be from an employer whose case is covered by section 35 DDA . In our respectful opinion, the provision of these sections are independent of each other and operate in different fields even through both of them deal with the common subject of voluntary retirement. Accordingly the Tribunal in Sony India’s case was right in holding that scheme referred to in section 35DDA need not have been framed as per the guidelines prescribed under Rule 2BA.

The Finance Bill, leading to enactment of section 35DDA, contained a provision that required that the scheme referred to in section 35DDA is framed as per Rule 2BA however, the said requirement was omitted when the Bill was enacted and with this the condition for application of the rule was not retained intentionally in the section. The deletion of the condition originally incorporated in the Bill showed that legislative intent was not to incorporate all the conditions of section 10(10C) in section 35DDA. The legislature has consciously left the scheme of voluntary retirement, referred to in section 35DDA, open-ended and has not place any restriction on the scheme. The plain language of the provision supports the case of literal interpretation and that it is not simply the case of taking guidance from another provision of the Act for its understanding but requires a modification of the provisions of section 35DDA by incorporating a part of section 10(10C) in it which incorporation amount to doing violence to the language of section 35DDA and does not find support in any rule of construction. There is no compelling reason to read section 35DDA as being suggested by a few.

The disabling provisions of section 35DDA(6) can not help the case of mandatory application of section 35DDA in all cases of payment on voluntary retirement so as to restrict the deduction to one-fifth of the expenditure even where the expenditure is otherwise allowable in full. In our opinion, the provision of s/s. (6) has a limited application to only such cases which are otherwise covered by the provisions of s/s.(1). In other words, the expenditure of revenue nature should be deductible in full u/s. 37 of the Act and only those which do not so qualify for full deduction will be governed by section 35DDA. It is this larger issue, about the eligibility of an expenditure on payment of compensation towards voluntary retirement for deduction in full, u/s. 37, on being established that it is an expenditure wholly and exclusively incurred for the purposes of business, has remained to be directly addressed. It is possible that a payment of the nature being discussed would qualify for a full deduction once it is established to be of a revenue nature. The scope of section 35DDA should be restricted only to such expenditure that are otherwise not allowable under the provisions of section 37 of the Income-tax Act.

The test applied to determine whether the expenditure incurred by the assessee is revenue or capital in nature. Applying the test depends upon the finding as to whether the expenditure incurred has the effect of achieving a benefit of enduring nature and if yes, it is capital in nature.

When that test was applied, it was felt that the purpose of introduction of VRS was to reduce the staff strength with a view to achieve viability and profitability of the business in general and the retrenchment would give long-term benefit to the assessee. It is for the assessee to provide a rational basis to ascertain whether the benefit is of enduring nature and even if not so, it is otherwise allowable in the year in which it is incurred. Section 35DDA is not a virtual declaration of the fact that the expenditure should not be allowed in one year and it has to be amortised over a few years.

shailesh.kwebmaker

WRITE – BACK OF LOANS – SECTIONS 41 (1) & 28 (iv)

ISSUE FOR CONSIDERATION

On account of the inability to repay a borrower, may write-back a part of the
amount due or the full amount so due, in pursuance of the negotiations with the
lender or otherwise. It is usual to come across cases of write back of
liability towards repayment of loans taken by an assesssee in the course of his
business. The amount so written back is credited to the profit & loss
account of the year of write back or is credited to the reserves.

Important issues arise, under the income-tax law, concerning the treatment and
taxability of the amount written back. Will such a write back attract the
provisions of section 41 (1) of the Act and be taxed in the hands of the
assesssee in the year of write back? Alternatively, will the write back attract
the provisions of section 28 (i) or (iv) of the Act and be taxed in the hands
of the assesssee? Whether the fact that the borrowings were made for the
purposes of acquiring a capital asset, make any difference to liability for
taxation? Whether it can be said that the write back does not represent any
benefit or a perquisite for the assessment and is hence not taxable?

Conflicting decisions are rendered by the courts over a period of years
requiring us to take a fresh view of the issues on hand. Recently, the Madras
High Court has taken a view that the amount of loan written back by the
borrower is taxable in his hands in contrast to its own decision delivered a
few years ago.

Iskraemeco Regent Ltd ‘s case.

The issue arose in the case of Iskraemeco Regent Ltd. vs. CIT, 331 ITR 317
(Mad.). In that case the assessee, engaged in the business of manufacturing
energy meters, obtained a term loan from State Bank Of India for the purchase
of capital assets, both by way of import as well as in the local market. The
company also procured credit facility, through cash credit account, for import
of capital assets as well as for meeting the working capital requirements.

The assessee was declared a sick industrial company by the BIFR, which had
sanctioned a scheme for its revival, and in pursuance thereto, the State Bank
of India waived the outstanding dues of principal amount of about Rs.5 crores
and the interest outstanding for a sum of about Rs. 2 crores under the one time
settlement scheme. The assessee credited the waiver of principal amount to the
“Capital Reserve Account” in the balance sheet treating it as capital
in nature and the waiver of interest was credited to its “Profit and Loss
Account” for the financial year ending 31.03.2001 corresponding to the
assessment year 2001-02.

The assessee filed its return declaring its total income assessable at Rs.
45,160 after setting off the carried forward business losses and unabsorbed
depreciation. The AO in assessing the total income added the amounts of loan
and interest waived under the head business income by applying the provisions
of section 41(1) and section 28(iv) of the Act.

The appeals filed by the
assessee, before the Commissioner of Income Tax (Appeals) and the Tribunal,
were dismissed on the ground that the issue in appeal was no longer res integra
in as much as the same had already been concluded by the judgment in CIT vs.
T.V. Sundaram Iyengar & Sons Ltd., 222 ITR 344(SC). Aggrieved by the order
of the tribunal, the assessee preferred an appeal to the high court by raising
the following substantial questions of law;

“Whether the learned
Tribunal misdirected itself in law, and it adopted a wholly erroneous
approach, in interpreting the provisions of Section 28(iv) of the
Income-tax Act, 1961, to hold that the sum of Rs.5,07,78,410/-
representing the principal loan amount, waived by the bank under the One
Time Settlement Scheme (OTS), and credited by the appellant assessee to
its Capital Reserve Account, in its Balance Sheet drawn as at 31st March,
2001, is assessable to tax as a revenue receipt in the assessment for the
assessment year 2001-02; and whether the findings of the learned Tribunal
to this effect were wholly unreasonable, based on irrelevant
considerations, contrary to the facts and evidence on record and/or
otherwise perverse?
Whether the decision of the
Hon’ble Supreme Court in CIT vs. T.V.Sundaram Iyengar & Sons Ltd.
[1996] 222 ITR 344, applied by the learned Tribunal in passing its said
impugned order dated 26th March, 2010, has any application whatsoever, in
the facts and circumstances of the instant case, and particularly in
relation to section 28(iv) of the said Act?
Whether on a correct
interpretation of section 28(iv) of the Income Tax Act, 1961, the Tribunal
ought to have held that the principal amount of loan waived by the Bank
under the OTS, not being a trading liability and also not being a
“benefit or perquisite, whether convertible into money or not”,
the expression used in the said section, did not constitute revenue
receipt and/or business income of the appellant assessee assessable to tax
in its assessment for the assessment year 2001-02?
Whether ………….
Whether
……………..

On behalf
of the assessee it was submitted that:—

it was not in dispute that
the assessee had obtained loan from the State Bank of India for the purchase
of fixed assets, both within the country and outside the country, which
were admittedly capital assets. It was a pure loan transaction and the
same could never be termed as a trading transaction.
the loan was obtained for
the purchase of capital assets and the waiver amounted to a capital
receipt and not a revenue receipt.
it was not involved in any
business involving the transaction of money lending .
the AO had not gone behind
the loan arrangement and the loan arrangement in its entirety was not
obliterated by the waiver, considering the fact that the assessee had paid
a sum of Rs. 5 crores from the date of receipt of the loan.
a grave error was committed
in mechanically applying the judgment rendered by the apex court in T.V.
Sundaram Iyengar & Sons Ltd.’s case (supra ) without appreciating the
factual scenario that the loan had been obtained towards the purchase of
capital assets and not for a business transaction. The facts involved in
the judgment referred above disclosed that the transaction therein was a
trading transaction as against the facts involved in the assessee’s case.
reliance was placed on the
decisions in the cases of Mahindra & Mahindra Ltd. vs. CIT, 261 ITR
501(Bom.), CIT v. Alchemic (P.) Ltd., 130 ITR 168 and CIT vs. Mafatlal
Gangabhai & Co. (P.) Ltd.219 ITR 644 (SC).
relying on the decision in
the case of Solid Containers Ltd. vs. Dy. CIT, 308 ITR 417 it was
submitted that, in a case where a transaction involved a purchase related
to capital assets, a waiver made of the loan taken for the said purchase
would not constitute a business receipt.
the reasoning of the
authorities that, section 28(iv) of the Act was applicable to a money
transaction was totally misconceived and contrary to the provision itself.
Section 28(iv) provided for chargeability of profits and gains of business
or profession with relation to the value of any benefit or perquisite
arising out of business or the exercise of profession and therefore the
same would not include a money transaction. Since in the present case on
hand, the transaction involved a loan transaction, being a transaction of
money, section 28(iv) had no application.
Section 41(1) also did not
apply as it mandated that there had to be an actual allowance or deduction
made for the purpose of computing under the said section. In as much as
there was no allowance or deduction in the present case on hand, the
question of application of section 41(1) also did not arise for
consideration.
in support of the
contentions, the company placed reliance on the following judgments, CIT
vs. P. Ganesa Chettiar, 133 ITR 103 (Mad.), CIT vs. A.V.M. Ltd., 146 ITR
355 , Alchemic Pvt. Ltd.’s case (supra), Mafatlal Gangabhai & Co. (P.)
Ltd.’s case (supra ) and Dy. CIT v. Garden Silk Mills Ltd., 320 ITR 720
(Guj.) to submit that section 28(iv) had no application to a money
transaction. In so far as the scope of section 41(1) was concerned, the
judgments in Polyflex (India) (P.) Ltd. vs. CIT, 257 ITR 343 (SC) and
Tirunelveli Motor Bus Service Co. (P.) Ltd. vs. CIT, 78 ITR 55 (SC) were
relied upon by the company. the combOn behalf of the Revenue it was
submitted that:—ined reading of section 41(1) and section 28(iv) showed
that the words “whether in cash or any other manner” as found in
s. 41(1) had not been incorporated in section 28(iv) which was indicative
of the fact that section 28(iv) did not cover a cash transaction.

On behalf
of the Revenue it was submitted that:

the appellate authorities
had not rejected the company’s appeal on application of section 28(iv) but
was on application of section 28(i)of the Act and therefore, the findings
rendered by the authorities below had to be seen in the context of the
provisions contained in section 28(i) of the Act.
the ratio laid down by the
apex court in T.V. Sundaram Iyengar & Sons Ltd.’s case (supra), held
good and had been followed in CIT vs. Rajasthan Golden Transport Co. (P.)
Ltd., 249 ITR 723, CIT v. Sundaram Industries Ltd., 253 ITR 396, CIT vs.
Aries Advertising (P.) Ltd., 255 ITR 510 and the authorities below had
rightly applied the same in rejecting the case of the assessee.
it was not in dispute that
the amount had been borrowed by the assessee for the purpose of his
business and once the said amount was used for business, the question as
to whether it had been used for the purchase of capital assets or revenue
receipts was immaterial. The assessee having become richer by the
settlement, the said transaction would partake the character of the income
assessable to tax. Even assuming an amount was utilised towards the
capital assets, it would take the character of a revenue receipt,
subsequently. The borrowal and waiver were in the course of business
during carrying on of which the benefit accrued to the assessee and hence
was taxable. If the amount was received in pursuance to a business or a
contractual liability, then it was taxable as income.
relying on Jay Engg. Works
Ltd. v. CIT, 311 ITR 299 it was submitted that the facts involved in the
cases relied upon by the assessee company were different and that some of
the judgments had been rendered prior to the decision in the case of T.V.
Sundaram Iyengar & Sons Ltd.’s (supra). The Madras high court after
considering the submissions of the parties to the dispute observed and
held that;-
the assessee was not
trading in money transactions. A grant of loan by a bank could not be
termed as a trading transaction and it could not also be construed to be
in the course of business. Indisputably, the assessee obtained the loan
for the purpose of investing in its capital assets. The facts involved in
the present case were totally different than the facts involved in T.V.
Sundaram Iyengar & Sons Ltd.’s case (supra). What had been done in the
present case was a mere waiver of loan. There was no change of character
with regard to the original receipt which was capital in nature into that
of a trading transaction. There was a marked difference between a loan and
a security deposit.
every deposit of money would
not constitute a trading receipt. Even though a receipt might be in
connection with the business, it could not be said that every such receipt
was a trading receipt. Therefore, the amount referable to the loans
obtained by the assessee towards the purchase of its capital asset would
not constitute a trading receipt. The finding of the court had been
fortified by the judgment of this Court in A.V.M. Ltd.’s case (supra).
the same contention had been
raised on behalf of the revenue before the Bombay High Court in Solid
Containers Ltd.’s case (supra), by relying upon the judgment rendered in
T.V. Sundaram Iyengar & Sons Ltd.’s case (supra), however, in the said
case, a finding was given that the money was received by the assessee in
the course of carrying on his business and the agreement was completely
obliterated and the loan in its entirety was completely waived and the
loan itself was taken for a trading activity and on waiving it was
retained in business by the assessee. In the said judgment, the court had
distinguished its earlier judgment rendered in Mahindra & Mahindra
Ltd.’s case (supra) by highlighting that in the facts of the Solid
Container’s case, there was a trading transaction and the money received
was used towards a business transaction and accordingly the ratio laid
down in. T.V. Sundaram Iyengar & Sons Ltd.’s case (supra) was
applicable.
therefore, the above said
facts indicated that the ratio laid down in T.V. Sundaram Iyengar &
Sons Ltd.’s case (supra) had no application at all to the facts and
circumstances of the present case on hand. Hence, the authorities below
had wrongly applied the ratio laid down in T.V. Sundaram Iyengar &
Sons Ltd.’s case (supra) and the orders passed by them could not be
sustained. In the matter of applicability or otherwise of section 28(iv)
and 41(1), the court deemed it fit to give its views even though the
Revenue had conceded that the said provisions did not apply to the present
case. It observed that;-
Section 28(iv) of the Act
dealt with the benefit or perquisite received in kind. Such a benefit or
perquisite received in kind other than in cash would be an income as
defined u/s. 2(24) of the Act. In other words, to any transaction which
involved money, section 28(iv) had no application.
the transaction in the
present case being a loan transaction having no application with respect
to section 28(iv), the same could not be termed as an income within the
purview of section 2(24) of the said Act. In other words, in as much as
section 28(iv) was not applicable to the transactions on hand, it could
not be termed as income which could be made taxable as receipt. A receipt
which did not have any character of an income being that of a loan could
not be made eligible to tax.

Section 41(1) could apply only to
a trading liability. A loan received for the purpose of capital asset would not
constitute a trading liability.

Ramaniyam Homes P Ltd .’s case,

The issue once again arose recently before the Madras High Court, in the Tax
Case (Appeal) No.278 of 2014, in the case of CIT v. Ramaniyam Homes P Ltd., in
an appeal filed u/s 260-A of the Act. In that case, the assessee filed a return
of income for the assessment year 2006-07 admitting a total loss of
Rs.2,42,20,780. It was found by the AO that the assessee was indebted to the
Indian Bank which bank, vide a letter dated 15.2.2006, had mooted a proposal
for a one time settlement requiring the company to pay Rs.10.50 crore on or
before 30.4.2006 against which the company paid only a sum of Rs.93,89,000 by
that date.

The AO appears to have held that the One Time Settlement Scheme was accepted by
the assessee during the year and the interest waived was taxable u/s 41(1) of
the Act and the balance was taxable u/s 28(iv) of the Act. The CIT(Appeals)
held that the mere acceptance of the conditional offer of the bank under the
One Time Settlement Scheme, without complying with the substantive part of the
terms and conditions, would not give a vested right of waiver and therefore,
interest waived to the extent of Rs.1.68 Crores was not exigible to tax u/
s.41(1) and consequently, he deleted the addition of Rs.1,67,74,868. On the
issue of addition u/s 28(iv), he followed the decision in the case of Iskraemeco
Regent Limited vs. CIT, (supra) and held that Section 28(iv) had no application
to cases involving waiver of principal amounts of loans. In the appeal of the
Revenue, on the issue of the deletion of the principal portion of the term loan
waived by the bank, the Tribunal held in para 12 of its order that the term
loan had admittedly been used by the assessee for acquiring capital assets and
following the decision of the jurisdictional Madras high court in the case of
Iskraemeco Regent Limited(supra) it confirmed the order of the first appellate
authority.

In the appeal by the revenue to the high court, the following substantial
questions of law were raised therein:-

• ” Whether on the facts and in the circumstances of the case, the Income
Tax Appellate Tribunal was right in holding that the amount representing the
principal loan amount waived by the bank under the one time settlement scheme
which the assessee received during the course of its business is not exigible
to tax?
• Whether on the facts and in the circumstances of the case, the Income Tax
Appellate Tribunal ought to have seen that the waiver of principal amount would
constitute income falling under Section 28(iv) of the Income Tax Act being the
benefit arising for the business?”

The Revenue invited attention to the definition of the expressions
“income” and “total income” u/s. (24) and (45) of section 2
and the provisions of the charging section 4 as well as the relevant provisions
of sections 28(iv), 41(1) and 59. It was contended that the principal amount of
loan waived by the bank under the one time settlement was a taxable receipt
coming within the definition of the expression “income” by relying
upon the decisions in cases of CIT vs. T.V.Sundaram Iyengar & Sons Ltd. 222
ITR 344(SC), Solid Containers Ltd. vs. DCIT, 308 ITR 417 (Bom.), Logitronics P
Ltd. v. CIT,333 ITR 386 and Rollatainers Ltd. vs. CIT, 339 ITR 54.

In so far as the decision in Iskraemeco Regent Limited was concerned, it was
submitted that the Supreme Court had already granted leave to the Department
and the decision was the subject matter of Civil Appeal No.5751 of 2011, on the
file of the Supreme Court, and the Court was entitled to consider the issue
independently. At the outset, the Madras high court examined the decision in
Iskraemeco Regent Limited, since the appellate authorities had merely followed
the said decision. The court found that in the said decision it was held that a
loan transaction had no application with respect to s.28(iv) of the Act and
that the same could not be termed as an income within the purview of section
2(24).The Madras high court thereafter examined the statutory provisions and
also the decisions relied upon by the contesting parties in support of their
respective submissions. The Madras high court in particular examined the
decisions in the cases of T.V. Sundram Iyengar & Sons Ltd. (SC), Solid
Containers Ltd.(Bom), Mahindra & Mahindra (Bom.) and Logitronics P.
Ltd.(Del.) and Rollatainers Ltd. (Del).

The court noted that the law as expounded by the Delhi High Court appeared to
be that if a loan had been taken for acquiring a capital asset, waiver thereof
would not amount to any income exigible to tax and if the loan was taken for
trading purposes and was also treated as such from the beginning in the books
of account, the waiver thereof might result in the income, more so when it was
transferred to the profit and loss account. Having noted so, the court observed
that;

the Delhi High Court, both in
Logitronics as well as in Rollatainers cases, did not take note of one fallacy
in the reasoning given in paragraph 27.1 of the decision of the Madras high
court rendered in Iskraemeco Regent Limited’s case.
in paragraph 27.1 of the
decision in Iskraemeco Regent Limited’s case, it was held that s.28(iv)
spoke only about a benefit or perquisite received in kind and that
therefore, it had no application to any transaction involving money which
was actually based upon the decision of the Bombay High Court in Mahindra
& Mahindra Ltd.(supra), which, in turn, had relied upon the decision
of the Delhi High Court in the case of Ravinder Singh vs. C.I.T.205 I.T.R.
353.
with great respect, the
above reasoning did not appear to be correct in the light of the express
language of section 28(iv). What was treated as income chargeable to
income tax under the head ‘profits and gains of business or profession’
u/s 28(iv), was “the value of any benefit or perquisite, whether
convertible into money or not, arising from business or the exercise of a
profession.”
therefore, it was not the
actual receipt of money, but the receipt of a benefit or perquisite, which
had a monetary value, whether such benefit or perquisite was convertible
into money or not, which was what was covered by section 28(iv). For
instance, if a gift voucher was issued, enabling the holder of the voucher
to have a dinner in a restaurant, it was a benefit or perquisite, which
had a monetary value. If the holder of the voucher was entitled to
transfer it to someone else for a monetary consideration, it became a
perquisite, convertible in to money. Irrespective of whether it was
convertible into money or not, to attract section 28(iv) it was sufficient
that it had a monetary value.
a monetary transaction, in
the true sense of the term, can also have a value.
we do not know why it should
not happen in the case of waiver of a part of the loan. Therefore, the
finding recorded in paragraph 27.1 of the decision in Iskraemeco Regent
Limited that Section 28(iv) had no application to any transaction, which
involved money, was a sweeping statement and might not stand in the light
of the express language of section 28(iv).
in our considered view, the
waiver of a portion of the loan would certainly tantamount to the value of
a benefit. The benefit might not arise from “the business” of
the assessee. But, it certainly arose from “business”.
the absence of the prefix
“the” to the word “business” made a world of
difference. The Madras high court thereafter dealt with the issue of the
distinction, sought to be made, between the waiver of a portion of the
loan taken for the purpose of acquiring capital assets on the one hand and
the waiver of a portion of the loan taken for the purpose of trading
activities on the other hand. In the context, it held that;-
in so far as accounting
practices were concerned, no such distinction existed. Irrespective of the
purpose for which, a loan was availed by an assessee, the amount of loan
was always treated as a liability and it got reflected in the balance
sheet as such. When a repayment was made in monthly, quarterly, half
yearly or yearly installments, the payment was divided into two
components, one relating to interest and another relating to a portion of
the principal. To the extent of the principal repaid, the liability as
reflected in the balance sheet got reduced. The interest paid on the
principal amount of loan, would be allowed as deduction, in computing the
income under the head “profits and gains of business or
profession”, as per the provisions of the Act.
Section 36(1)(iii) made a
distinction where under the amount of interest paid in respect of capital
borrowed for the purpose of business or profession was allowed as
deduction, in computing the income referred to in section 28. But, the
proviso there under stated that any amount of interest paid in respect of
capital borrowed for acquisition of an asset for extension of existing
business or profession, whether capitalised in the books of account or not
for any period beginning from the date on which the capital was borrowed
for the acquisition of the asset, till the date on which such asset was
put to use, should not be allowed as deduction.
therefore, it was clear that
the moment the asset was put to use, then the interest paid in respect of
the capital borrowed for acquiring the asset, could be allowed as
deduction. When the loan amount borrowed for acquiring an asset got wiped
off by repayment, two entries were made in the books of account, one in
the profit and loss account where payments were entered and another in the
balance sheet where the amount of un repaid loan was reflected on the side
of the liability.
when a portion of the loan
was reduced, not by repayment, but by the lender writing it off (either
under a one time settlement scheme or otherwise), only one entry got into
the books, as a natural entry. A double entry system of accounting would
not permit of one entry. Therefore, when a portion of the loan was waived,
the total amount of loan shown on the liabilities side of the balance
sheet was reduced and the amount shown as capital reserves, was increased
to the extent of waiver. Alternatively, the amount representing the waived
portion of the loan was shown as a capital receipt in the profit and loss
account itself.
these aspects had not been
taken note of in Iskraemeco Regent Ltd.
In view of the above, the
Madras High court decided the issue in favour of the Revenue and the
appeal filed by the Revenue was allowed without any costs.

Observations

The issue
under consideration, of the write back of loans, has over the years turned
rotten and worse, has produced many off shoots. The sheer size of the quantum
involving this issue is another reason for addressing it at the earliest.
Settlement between the lenders and the borrowers is an everyday phenomenon and
the issues arising there from require to be handled with care importantly, due
to the fact that the borrower involved is admittedly in a precarious financial
health that can be worsened by the additional tax borrowings that may not have
been intended by the legislature.

It is time proper that a clear guideline is provided by the CBDT as regards the
Revenue’s understanding of the subject and its desired tax treatment. This
clarification is necessary in view of the fact that varied stands have been
taken by the Revenue before the courts in different cases. It is also most
desired that the apex court addresses the issue, at the earliest, in view of
the conflicting stands of the high courts, sometimes of the same high court, as
is seen by the conflicting decision of the Madras High Court and to an extent
of the Bombay High Court.

A classic case is the case of a company which has
been declared sick, under a statue, by the Board of Industrial & Financial
Reconstruction. The Board on one side mandates the lenders to compromise their
dues, in the interest of the financial health of the company, but, on the other
side, rests on the fringe when it comes to saving a sick company from
consequences of tax, directly arising out of the reliefs granted by it. We are
of the firm view that the relief from taxation should be granted in respect of
a sick company as has been done by some courts even where the CBDT has resisted
the tax relief before the BIFR.

Section 41(1) of the Act brings to tax the value of a benefit in respect of a
trading liability accruing to an assesssee by way of remission or cessation
thereof. The said section also seeks to tax the amount obtained by an
assesssee, in cash or otherwise in respect of a loss or an expenditure. In both
the cases, the charge of tax is attracted provided an allowance or deduction
has been granted to the assesssee. A charge once attracted, is placed in the
year of relief. By and large, the issues about the applicability of section
41(1) are settled. An understanding seems to have been reached that no
liability to tax arises unless an allowance or deduction has been granted to an
assesssee and subsequent thereto a relief has been obtained by him or a benefit
has accrued to him. Obviously in a case of a loan taken, the provisions of
s.41(1) should not be attracted unless the issue involves the settlement of an
interest, on the loan taken, for which a deduction was allowed.

Section 28(i) provides that the profits or gains of any business or profession
which was carried on during the year shall be chargeable to income tax under
the head “profits and gains of business or profession”. Section
28(iv) brings to tax the value of any benefit or perquisite, whether
convertible into money or not arising from business or the exercise of a
profession. The issue of taxation of a write back of a loan mainly revolves
around application of section 28. The questions that arise, in addressing the
issue are;

Whether a relief from
repayment of loan taken can be held to be profits or gains of business
carried on during the year? In other words, can a loan be said to have
been taken by the person in the ordinary course of his business where he
is not engaged in the business of granting of loans and advances? Will
such a transaction be treated as a trading transaction?
Will it make any difference
whether the loan was taken for the purpose of acquiring a capital asset or
was taken for meeting the working capital requirements of the business?
Will the relief, if any,
resulting on settlement be construed as a benefit or a perquisite arising
from the business?
Has the apex court in the
case of T.V.Sundaram Iyengar & Sons Ltd (supra) held that a write back
of loan shall be liable to be taxed as business income and that too only
where it was taken for the purposes of meeting a trading liability?

For the sake of brevity, we place our views on each of the above issues,
so identified, instead of referring and analyzing the entire case law on the
subject including the facts of the said T.V.Sundaram Iyengar & Sons Ltd
(supra)’s case . A reader however is advised to do so.

Section 28(i) brings to tax profits or gains from business carried on during
the year. Unless the profits arise from the business that was carried on during
the year, a charge under section 28(i) fails. An ordinary businessman, not
engaged in the business of money lending, etc, cannot be said to be engaged in
the business of receiving or granting loans and therefore no profits can be
said to have arisen from such a business. The Act makes a clear distinction
between an ordinary business and the business of granting any loans or advances
for the purposes of section 36(2) and section 73, for example. Accordingly, a
waiver of loan and it’s consequential write back cannot be said to be
representing any profits and gains arising from the business carried on during
the year. This finding should hold true in respect of all businessmen other
than the one engaged in the business of receiving and granting loans. The
transactions of loans are on capital account only and holding it otherwise will
lead to a situation where under a write off of an irrecoverable loan, advanced
in the past, will have to be allowed as a deduction in all cases. A loan taken
is a thing with which a person does his business; he carries on his business
with the funds borrowed. He does not deal in them; his business is that of
dealing in things other than the funds borrowed. He is a user of funds and not
a dealer of funds. He does not derive any profits from such funds nor is he
expected to derive any and rather derives profits from optimum use of such
funds in his business.

Once it is accepted that an ordinary businessman obtains a loan for the purpose
of carrying on his business, it is natural to accept that the purpose of loan
would not make any difference. Unless a loan is inextricably linked to the
regular business and its customers, it is not possible to hold that a purpose
for which a loan was taken will have any material bearing on its eventual
transaction. With great respect, we beg to differ with the view which seeks to
make a distinction, for the purposes of taxation, on the basis of the purpose
for which a loan is taken. In our opinion, the purpose for which a loan is
taken is immaterial unless the assesssee is in the business of dealing in loans
or the loan taken is inextricably linked to his business deal. The Madras high
court is spot on in the case of Ramaniyam Homes P.Ltd. (supra) when it
concludes on this aspect of the issue by holding that there is no difference
between a loan taken for the purpose of a capital asset or for meeting working
capital requirements.

Section 28(iv) reads as: “the value of any benefit or perquisite, whether
convertible into money or not, arising from business or the exercise of a
profession.” From a reading, it is noticed that a benefit or a perquisite
should arise from business and if so it would be taxable whether its value can
be converted into money or not. The twin conditions are cumulative in nature
and both of them require satisfaction before a charge of taxation is attracted.
The use of the expression “whether convertible into money or not”
clearly indicate that the benefit or perquisite is the one which is capable of
being converted into cash but is certainly not the cash itself. Had it been so
then the expression would have been “whether received in cash or in
kind”. Section 41(1) explicitly uses the expression ‘whether in cash or in
any other manner”. The intention of the legislature is adequately
communicated by the use of appropriate expression; the intention being to bring
to tax such benefit or perquisite i.e. received in kind irrespective of its
possibility to convert in money or not. Again, the use of the term ‘value’,
supports such an interpretation in as much as cash carries the same value and
therefore does not require any prefix. Even otherwise can a remission in a loan
liability ever be construed as a benefit or perquisite and be considered to
have arisen from a business are the questions that remain open for being
addressed before a charge u/s 28(iv) is completed.

An interesting aspect of section 28(iv) is brought out by the Madras High Court
in paragraph 39 of the decision in the case of Ramaniyam Homes P Ltd.’s
(supra). The Madras High Court, in the context of applicability of section
28(iv), held that a benefit might not arise from “the business” of
the assesssee but it certainly arose from “business” and the absence
of the prefix “the” to the word “business” made a world of
difference. It seems that the court would have taken a different view had the
prefix “the” before the word “business” been placed in
section 28(iv). Had that been so the court would have concluded that the waiver
of loan did not attract the provisions of section 28(iv)!! In our very
respectful opinion, the logic supplied requires a reconsideration. The court
has failed to appreciate that the benefit or perquisite, for application of
section 28(iv), has to be from a business even though not from the specific business.
In the absence of any other business, the question of attracting section 28(iv)
does not arise at all. Even otherwise the legislative intent does not seem to
support such an interpretation which is evident from a bare reading of section
28(i) and section 28(va) which has consciously used the prefix “any’
before the term expression “business” to convey the wider scope of
the provisions.

The apex court in the case of T.V.Sundaram Iyengar & Sons Ltd (supra)
has neither, explicitly nor implicitly, stated that a loan on being written
back would attain the character of income. It was a case wherein the assessee
had received deposits from it’s customers for the purposes of the trading
transactions carried on with the customers . The said deposits or a part of it
got adjusted against regular trading transactions and the excess balance
remaining with the assessee was carried in the balance sheet as the liability
to creditors. On a later day it was found that the said excess balance so
obtained from the customers was not repayable and the company wrote back the
said liability by crediting the same to the profit & loss account. It is in
such facts that the Supreme Court held that a write back of such non-repayable
deposits were to be treated as business income.

It is a settled position of law that every receipt need not be an income even
though the amount may be received as a part of the business activity of the
assesssee. It is also a settled position in law that a receipt, originally of a
capital nature, will not change its character merely by a lapse of time subject
to an exception in respect of an amount received in the course of a trading
activity, for example, advances received from a customer or a deposit received
from a contractor or a customer or a supplier or margin money received for
security of performance by the customer. An act of borrowing a loan is not a
trading transaction in that manner.

In exceptional cases a receipt originally of a capital nature would, with lapse
of time, attain the character of an income. It is this principle of law which
was propounded in the case of Jay’s- The Jewellers Ltd, 1947 (29 TC 274) (KB)
that was followed by the Supreme Court in the case of Karamchand Thapar Sons
222 ITR 112 (SC) and was reconfirmed in the case of T.V.Sundaram Iyengar &
Sons Ltd (supra). The Supreme Court in the said case of T.V.Sundaram Iyengar
& Sons Ltd (supra) had clearly restricted the application of the exception
to the case of an amount received as a part of the trading operations where a trading
liability was incurred out of an ordinary trading transaction. In our opinion,
a transaction of a loan borrowed for the purposes of funding a trading activity
can never be considered as a transaction that could be covered by the above
mentioned tests laid down by the Supreme Court. An ordinary loan, at its
inception, is of a capital character and retains its character even with the
flux of time it does not change even where it was later on waived.

Another important part of the facts in the case of T.V.Sundaram Iyengar &
Sons Ltd (supra) was that in the said case the unclaimed deposit representing
excess balance was credited to the profit & loss account of the company and
it is this fact which had influenced the Supreme Court when it observed that
“when the assessee itself had treated the money as its own money and taken
the amount to its profit & loss account then the amounts were assessable in
the hands of the assessee”. It appears that all those decisions of the
courts require a reconsideration wherein the courts relying on the ratio of the
decision in the case of T.V.Sundaram Iyengar & Sons Ltd (supra) held that a
waiver of an ordinary loan was to be treated as income. The high courts had
failed to notice that in all such cases before them the amount received did not
have any trading character which was so in the case of T.V.Sundaram Iyengar
& Sons Ltd (supra).

Attention of the reader is invited to the following pertinent
observations of the author on page 1095 of the 10th edition of Kanga &
Palkhivala’s The Law and Practice of Income Tax in the context of the ratio of
the decision in the case of T.V. Sundaram Iyengar & Sons Ltd (supra).

“The Supreme Court erroneously held that crediting deposits that had been
given by the parties to a profit and loss account after they had reminded
unclaimed for a long period of time, would definitely be trade surplus and part
of assessee’s taxable income. Surprisingly, the court did not even refer to the
statutory provisions of section 41(1). It failed to note that unless the
assesssee had claimed an allowance or deduction in respect of a loss of
expenditure or trading liability, the subsequent cessation of liability would
not attract section 41(1)”. Also see the later decision of the Supreme
Court in the case of Kesaria Tea, 254 ITR 434.

The Supreme Court in a later decision in the case of Travancore Rubber, 243 ITR
158 has reconciled the legal position and reemphasised that unless a different
quality is imprinted on the receipt by a subsequent event, a receipt which is
not in the first instance a trading receipt cannot become a trading receipt by
any subsequent process. Under the circumstances it is very respectfully
observed that the decisions delivered by different high courts simply relying
on the ratio of the decision in the case of T.V.Sundaram Iyengar & Sons Ltd
(supra) require a fresh application of mind.

shailesh.kwebmaker

Date & Cost of Acquisition of Capital Asset Converted from Stock in Trade

For the purpose of computation of capital gains under the Income-tax Act, 1961, the period of holding of a capital asset is important. The manner of computation of long term capital gains and the rate at which it is taxed differs from that of short term capital gains, and it is the period of holding of the capital assets which determines whether the capital gains is long term or short term. For determination of the period of holding, the date of acquisition of a capital asset and the date of transfer thereof are relevant.

Explanation 1 to section 2(42A), vide its various clauses, provides for inclusion and exclusion of certain period, in determining the period for which any capital asset is held, under the specified circumstances. There is however, in the Explanation 1, no specific provision to determine the period of holding of the capital asset in a case where the asset is first held as stock in trade, and is subsequently converted into a capital asset.

Similarly, qua cost of acquisition, section 55(2)(b) permits substitution of the fair market value as on 1 April 1981 for the cost of acquisition, where the capital asset became the property of the assessee before 1st April, 1981. Where an asset is held as stock in trade as on 1st April, 1981 and subsequently converted into a capital asset before its transfer, is substitution of the fair market value as on 1st April, 1981 permissible? In cases where the asset in question is acquired on or after 01.04.1981, difficulties arise for determining the cost thereof. Should it be the cost on the date of acquiring the stock or should it be the market value prevailing on the date of conversion?

There have been differing views of the tribunal on the subject. While the Calcutta, Delhi and Chennai benches of the tribunal have taken the view that only the period of holding of an asset held as a capital asset has to be considered for the purposes of determination of the period of holding and that the asset has to have been held as a capital asset as on 1st April, 1981 in order to get the benefit of substitution of fair market value as on that date, the Pune bench of the tribunal has taken the view that the period of holding commences from the date of acquisition of the asset as stock in trade, and that even if the asset is held as stock in trade as on 1st April, 1981, the benefit of substitution of fair market value as on the date is available. Yet again, the Mumbai bench has held that the adoption of the suitable cost is at the option of the assessee.

B. K. A. V. Birla’s case
The issue first came up before the Calcutta bench of the tribunal in the case of ACIT vs. B K A V Birla (1990) 35 ITD 136.

In this case, the assessee was an HUF, which acquired certain shares of a company, Zenith Steel, in 1961, and held them as investments till 1972, when the shares were converted into stock in trade. While the shares were held as stock in trade, the assessee received further bonus shares on these shares. The shares were again converted into investments on 9th September 1982, and all the shares were sold in August 1984.

The assessee claimed that the capital gains on sale of the shares was long term capital gains, and claimed deductions u/ss. 80T and 54E. The assessing officer treated the shares as short term capital assets, since they were sold within 2 years of conversion into capital assets, and therefore denied the benefit of deductions u/ss. 80T and 54E. The Commissioner (Appeals) held that since the shares were held since 1961, they were long-term capital assets.

On behalf of the revenue, it was argued that the definition of “capital asset” in section 2(14) excluded any stock in trade, held for the purposes of business or profession. It was claimed that to qualify as a long-term capital asset, the asset must be held as a capital asset for a period of more than 36 months. In calculating that period, the period during which the asset was held as stock in trade could not be considered, since the asset was not held as a capital asset during that period.

On behalf of the assessee, while it was agreed that so long as the shares were held as stock in trade, they were not capital assets, it was argued that while it was necessary as per section 2(42A) that the asset should be held as capital asset at the time of sale, it was not necessary that it should be held as a capital asset for a period exceeding 36 months to qualify as a long-term capital asset. According to the assessee, the only thing necessary was that the assessee should hold the assets for a period exceeding 36 months. Therefore, according to the assessee, the period for which the assets were held as stock in trade was also to be taken into account for determining whether the assets sold were short term or long term capital assets.

The Tribunal was of the view that the definition of the term “short term capital asset” as per section 2(42A) made it clear that it was a capital asset, which be held for a period of less than 36 months, and not any asset. The use the words “capital asset”, in the definition, and the word “capital” in it could not be ignored. According to the tribunal, the scale of time for determining the period of holding was to be applied to a capital asset, and not to an ordinary asset. The Tribunal noted that the word ”asset” was not defined, and the term “short term capital asset” was defined only for computing income relating to capital gains. Capital gains arose on transfer of a capital asset, and therefore, according to the tribunal, period during which an asset was held as a stock was not relevant for the purposes of computation of capital gains. For the Tribunal, the clear scheme of the Act required moving backward in time from the date of transfer of the “capital asset” to the date when it was first held as a capital asset, to determine whether the gain or loss arising was long term or short term.

If the capital asset was held for less than 36 months, it was short term, otherwise it was long term. The Tribunal therefore did not see any justification for including the period for which the shares were held as stock in trade for determining whether those were held as long term capital assets or not. The Tribunal therefore held that the shares had been held for a period of less than 36 months as capital assets, and were therefore short term capital assets.

Recently, the Delhi bench of the tribunal in the case of Splendour Constructions, 122 TTJ 34 held, on similar lines, that the period of holding of a capital asset, converted from stock-in-trade, should be reckoned from the date when the asset was converted into a capital asset and not from the date of acquisition of the asset. The Chennai bench of the tribunal in the case of Lohia Metals (P) Ltd., 131 TTJ 472 held on similar lines that the period of holding would be reckoned from the date of conversion of stock-in-trade into a capital asset.

Kalyani Exports & Investments (P) Ltd .’s case
The issue again came up before the Pune bench of the Tribunal in the case of Kalyani Exports & Investments (P) Ltd/Jannhavi Investments (P) Ltd/Raigad Trading (P) Ltd vs. DCIT 78 ITD 95 (Pune)(TM).

In this case, the assessee acquired certain shares of Bharat Forge Ltd. in March 1977, in respect of which it received bonus shares in June 1981 and October 1989. The shares were initially held by it as stock in trade. On 1st July 1988, the shares were converted into capital assets at the rate of Rs.17 per share, which was the original purchase price in 1977. The assessee sold the shares in the previous year relevant to assessment year 1995- 96. It showed the gains as long term capital gains, taking the fair market value of the shares as at 1st April, 1981 in substitution of the cost of acquisition u/s 55(2)(b)(i).

The assessing officer took the view that the asset should have been a capital asset within the meaning of section 2(14), both at the point of purchase and at the point of sale. Though the assessee had sold a capital asset, when it was purchased it was stock in trade, and since it was converted into a capital asset only in 1988, the assessing officer was of the view that the option of substituting the fair market value of the shares as on 1st April, 1981 was not available to the assessee. According to the assessing officer, since the shares had been converted into capital assets at the rate of Rs. 17 per share, the cost of acquisition would be Rs. 17 per share, with the date of acquisition being 1988. So far as the bonus shares were concerned, according to the assessing officer, the cost (and not the indexed cost) of the original shares was to be spread over both the original and the bonus shares. The Commissioner (Appeals) upheld the view taken by the assessing officer.

Before the tribunal, it was argued on behalf of the assessee that what was deductible from the consideration for computation of the capital gain was the cost of acquisition of the capital asset. It was submitted that an assessee could acquire an asset only once; it could not acquire an asset as a non-capital asset at one time, and later on acquire the same as a capital asset. As per section 55(2)(b), the option for adopting the fair market value as on 1st April, 1981 was available if the capital asset in question became the property of the assessee before 1st April, 1981. It was claimed that since the assessee held the shares as stock in trade before that date, they did constitute the property of the assessee before 1st April 1981.

It was pointed out that even under section 49, when the capital asset became the property of the assessee through any of the mode specified therein such as gift, will, inheritance, etc, the cost of acquisition was deemed to be the cost for which the previous owner acquired it. Even if the previous owner held it as stock in trade, it would amount to a capital asset in the case of the recipient, and the cost to the previous owner would have to be taken as the cost of acquisition. Reliance was placed on the decisions of the Gujarat High Court in the case of Ranchhodbhai Bahijibhai Patel vs. CIT 81 ITR 446 and of the Bombay High Court in the case of Keshavji Karsondas vs. CIT 207 ITR 737. It was further argued that the benefit of indexation was to account for inflation over a period of years. That being so, there was no reason as to why the assessee should be denied that benefit from 1st April, 1981, because whether he held it as stock in trade or as a capital asset, the rise in price because of inflation was the same. It was therefore argued that indexation should be allowed from 1st April, 1981 onwards and not from July 1988.

As regards the bonus shares, on behalf of the assessee, it was argued that the cost of acquisition, being the fair market value as on 1st April, 1981, did not undergo any change on account of subsequent issue of bonus shares. Therefore, the cost of acquisition could not be spread over the original and the bonus shares.

On behalf of the revenue, it was argued that the term “for the first year in which the asset was held by the assessee” found in explanation (iii) to section 48, which defined index cost of acquisition, referred to asset, which meant capital asset. It was argued that the assessee itself had taken the cost of shares at the time of conversion at Rs. 17 in its books of accounts. In fact, the market value of shares on the date of conversion was about Rs. 50 per share, and if the conversion had been at market price, the difference of Rs. 33 on account of appreciation in the value of the shares would have been taxable as business income. However, since the assessee chose to convert the stock in trade into capital asset at the price of Rs. 17, this was the cost of acquisition to the assessee.

There was a conflict of views between the Accountant Member and the Judicial Member. While the Accountant Member agreed with the view taken by the assessing officer, the Judicial Member was of the view that the decisions cited by the assessee applied to the facts of the case before the tribunal, and that the assessee was entitled to substitute the fair market value of the shares as on 1st April, 1981 for the cost of acquisition, since the shares were acquired by the assessee (though as stock in trade) prior to 1st April, 1981.

On a reference to the Third Member, the Third Member was of the view that the issue was covered by the decision of the Bombay High Court in the case of Keshavji Karsondas (supra) in which case, it was held that an asset could not be acquired first as a non-capital asset at one point of time and again as a capital asset at a different point of time. In the said case, according to the Bombay High Court, there could be only one acquisition of an asset, and that was when the assessee acquired it for the first time, irrespective of its character at that point of time and therefore, what was relevant for the purposes of capital gains was the date of acquisition and not the date on which the asset became a capital asset. The Bombay High Court in that case, had followed the decision of the Gujarat High Court in the case of Ranchhodbhai Bhaijibhai Patel (supra), where the Gujarat High Court had held that the only condition to be satisfied for attracting section 45 was that the property transferred must be a capital asset on the date of transfer, and it was not necessary that it should also have been a capital asset on the date of acquisition. According to the Bombay High Court, in the said case, the words “the capital asset” in section 48(ii) were identificatory and demonstrative of the asset, and intended only to refer to the property that was the subject of capital gains levy, and not indicative of the character of the property at the time of acquisition.

The Third Member therefore held in favour of the assessee, holding that the option of substituting the fair market value as on 1st April 1981 was available to the assessee, since the shares had been acquired in March 1977. The Third Member agreed with the Judicial Member that explanation (iii) to section 48 came into play only after the cost of acquisition has been ascertained. Once the cost of acquisition in 1977 was allowed to be substituted by the fair market value as on 1st April, 1981, it followed that the statutory cost had to be increased in the same proportion in which cost inflation index had increased up to the year in which the shares were sold.

The Third Member also agreed with the view of the Judicial Member that there was no double benefit to the assessee if it was permitted the option of adopting the fair market value of the shares as on 1st April, 1981. According to him, the difference between the market value and the conversion price could not have been brought to tax in any case, in view of the law laid down by the Supreme Court in the case of Sir Kikabhai Premchand vs. CIT 24 ITR 506, to the effect that no man could make a profit out of himself. If the assessee was not liable to be taxed in respect of such amount according to the law of the land as declared by the Supreme Court, no benefit or concession could be said to have been extended to him. If he could not have been taxed at the point of conversion, tax authorities could not claim that he got another benefit when he was given the option to substitute the market value as on 1st April, 1981, amounting to a double benefit. The right to claim the fair market value as on 1st April 1981, was a statutory right which could be exercised when the prescribed conditions were fulfilled.

The Tribunal therefore held that the shares would be regarded as having been acquired on the date when they were purchased as stock in trade, and that the assessee therefore had the right to substitute the fair market value as on 1st April, 1981 for the cost of acquisition.

A similar, though slightly different, view was taken by the Mumbai bench of the Tribunal in another case, ACIT vs. Bright Star Investment (P) Ltd 120 TTJ 498, in the context of the cost of acquisition. In that case, the assessing officer sought to bifurcate the gains into 2 parts – business income till the date of conversion of shares from stock in trade to investment, by taking the fair market value of the shares as on the date of conversion, and capital gains from the date of conversion till the date of sale. The assessee claimed the difference between the sale price of the shares and the book value of shares on the date of conversion, with indexation from the date of conversion, as capital gains. The Tribunal took the view that where 2 formulae were possible, the formula favourable to the assessee should be accepted, and accepted the assessee’s claim that the entire income was capital gains, with indexation of cost from the date of conversion.

Observations
The important parameters in computing capital gains are the cost of acquisition and the date of acquisition besides the date of transfer and the value of consideration. They together decide the nature of capital gains; long term or short term vide section 2(42A), the benefit of indexation u/s 48, the benefit of exemption u/s 10 or 54,etc. and the benefit of concessional rate of tax u/s 112,etc.

Whether a capital gains on transfer of a capital asset is a short term gain or a long term gain is determined w.r.t its period of holding. Usually, this period is identified w.r.t the actual date of acquisition of an asset and the date of its transfer. This simple calculation gets twisted in cases where the asset under transfer is acquired in lieu of or on the strength of another asset. For example, liquidation, merger, demerger, bonus, rights, etc. These situations are taken care of by fictions introduced through various clauses of Explanation 1 to section 2(42A). Similar difficulties arising in the context of cost of acquisition are taken care of either by section 49 or 55 of the Act by providing for the substitution of the cost of acquisition in such cases.

The provisions of section 2(42A) and of section 55 or 49 do not however help in directly addressing the situation that arise in computation of capital gains on transfer of a capital asset that had been originally acquired as a stockin- trade but has later been converted in to a capital asset. All the above referred issues pose serious questions, in computation of capital gains of a converted capital asset.

It is logical to concede that an asset in whatever form acquired can have only one cost of acquisition and one date of acquisition. This date and cost cannot change on account of conversion or otherwise, unless otherwise provided for in the Act. No specific provisions are found in the Act to deem it otherwise to disturb this sound logic. This simple derivation however is disturbed due to the language of section 2(42A), which had in turn helped some of the benches of tribunal to hold that the period should be reckoned from the date of conversion and not the date of acquisition.

An asset cannot be acquired at two different points of time and that too for one cost alone. A change in its character, at any point of time, thereafter cannot change its date and cost of acquisition. Again, for the purposes of computation of capital gains it is this date and cost that are relevant, not the date of conversion. For attracting the charge of capital gains tax, what is essential is that the asset under transfer should have been a capital asset on the date of transfer; that is the only condition to be satisfied for attracting section 45 and whether the property transferred had been a capital asset on the date of acquisition or not is not material at all as has been held by the Gujarat high court in Ranchhodbhai Bhaijibhai Patel (supra)’s case.

It is true that a lot of confusion could have been avoided had the legislature, in section 2(42A), used the words “ ‘short term capital asset’ means an asset held by an assessee……” instead of “ ‘short term capital asset’ means a capital asset held by an assessee……” . While it could have avoided serious differences, in our considered opinion, the only way of reconciling the difference is to read the wordings in harmony with the overall scheme of taxation of capital gains which envisages one and only one date of acquisition and one cost of acquisition. Reading it differently will not only be unjust but will give absurd results in computation of gains. Any different interpretation might lead to situations wherein a part of the gains arising on conversion of stock would go untaxed. If the idea is to tax the whole of the surplus i.e the difference between the sale consideration and the cost, the only way of reading the provisions is to read them harmoniously in a manner that a meaning which is just, is given to them.

The view taken by the Pune bench of the tribunal in Kalyani Exports case (supra) is supported by the view taken by the Gujarat and Bombay High Courts, in cases of Ranchhodbhai Bhaijibhai Patel (supra) and Keshavji Karsondas (supra) as to when a capital asset can be held to have been acquired, when it was not a capital asset at the time of acquisition. As observed by the Third Member, those decisions cannot be distinguished on the grounds that they related to agricultural land, which was not a capital asset at the time of its acquisition, but became a capital asset subsequently, on account of a statutory amendment. The ratio of the said decisions apply even to the case of conversion of stock in trade into capital asset though it is on account of an act of volition on the part of the assessee. The issue is the same, that the asset was not a capital asset on the date of acquisition, but becomes a capital asset subsequently before its transfer.

The Mumbai bench of the Tribunal in Bright Star Investments case proceeded on the fact that the assessee itself did not claim indexation from the date of acquisition of the asset as stock in trade, but claimed it only from the date of conversion into capital asset. Therefore, the issue of claiming indexation from the earlier date of acquisition as stock in trade was not really the subject matter of the dispute before the tribunal.

Section 55(2)(b), uses both the terms “capital asset” and “property”. Section 55(2)(b) does not require that the capital asset should have been held as the capital asset of the assessee as at 1st April. 1981; it simply requires that the capital asset should have become the property of the assessee prior to that date. This conscious use of different words indicates that so long as the asset was acquired before that date, the benefit of substitution of fair market value for cost is available.

The decision of the Pune bench of the Tribunal in Kalyani Exports’ case has also subsequently been approved of by the Bombay High Court, reported as CIT vs. Jannhavi Investments (P) Ltd 304 ITR 276. In that case, the Bombay High Court reaffirmed its finding in Keshavji Karsondas’ case that cost of acquisition could only be the cost on the date of the actual acquisition, and that there was no acquisition of the shares when they were converted from stock in trade to capital assets and clarified that the amendment in section 48 for introducing the benefit of indexation did not in any way nullify or dilute the ratio laid down in Keshavji Karsondas’ case.

Therefore, clearly, the view taken by the Pune and Mumbai benches of the Tribunal and approved by the Bombay high court seems to be the correct view of the matter, and the date of conversion is irrelevant for the purpose of computing the period of holding, or substitution of the fair market value as on 1st April 1981 for the cost of acquisition.

shailesh.kwebmaker

Receipt of Interest and Full Value of Consideration

Issue for consideration
In recent times, many cases have surfaced involving the receipt of interest by a shareholder for delay in making a public offer for sale. The magnitude becomes considerably higher where the transfer of shares is by a Foreign Institutional Investor. In many cases, the interest is paid under an order of the regulator or a court.

The issue under taxation that arises for consideration, in the hands of the recipient, is about the treatment of such interest, received by him for the delayed offer for sale.

Whether such a receipt would lead to increase the value of consideration and would enter into computation of the capital gains or would it be separately taxable as income from other sources. Conflicting decisions are available on the subject that requires consideration, due to sheer magnitude of the receipt.

Morgan Stanley Mauritius Co.’s case
The issue recently arose before the Mumbai bench of the Tribunal in the case of Morgan Stanley Mauritius Co. Ltd., ITA No.1625/Mum/2014 adjudicated under an order dated 29.01.2016.

The assessee company, incorporated in Mauritius, was registered with SEBI as a sub-account of Morgan Stanley and Company International Ltd. (MSCIL). It had transferred 13,79,979 shares of I-flex Solution Ltd. held by it, to Oracle Global (Mauritius) Ltd.(Oracle) under the open offer for sale made by Oracle for an agreed consideration. In addition to the said consideration, it had received an additional consideration of Rs.2.20 crore from Oracle over and above the sales consideration. The assessee had treated the said additional consideration as the part of the full value of consideration and had accordingly computed the capital gains for which it had claimed exemption from Indian taxation as per the DTAA with Mauritius. The AO held that;

the additional consideration was not linked to original consideration and hence it was to be treated and taxed separately,

the amount received by the assessee was penal in nature,

while making the payment of additional consideration the deductor i.e., Oracle had deducted TDS,

the deduction of tax proved that it was not part of sales consideration, and

the ‘penal interest’ had to be taxed @ 41.82 %.

The Commissioner (Appeals) confirmed the action of the AO.

In the appeal by the company to the Tribunal, it was contended that that the original and revised schedule to the offer proved that the additional compensation @ Rs.16 per share was paid by Oracle for a period up to January 2007 and that the compensation paid was for the delay in making the offer and not for delay in making payment and was not interest. In addition, it was contended that the additional consideration was not received in respect of any monies borrowed or debt incurred or for use of money by Oracle; that the additional consideration was also not a service fee/charge in respect of money borrowed/credit facility which was not utilised by Oracle; that the amount in question would not fall within the definition of ‘interest’ as per section 2(28A) of the Act; that for a receipt to be taxed as interest, existence of a debtor/creditor relationship was a must as per Article-11 of the DTAA ; that there was no Debtor/Creditor relationship between the assessee and Oracle; that the assessee had not made available any capital/funds to Oracle; that the money received by it constituted an integral part of the sales receipts of the shares; that the consideration and sale price arose from the same source i.e., the shares transferred to Oracle under the open offer. In the alternative, it was contended that the additional consideration could not be taxed as capital gains under Article-13 of the Treaty; that it was also not covered under any of the specific Articles of the Treaty; that it would fall under the head ‘income from other sources’ under Article-22 of the Treaty; that the assessee had no Permanent Establishment (PE) in India; that the income from other sources would not be taxable in India as per the provisions of the Act. In a further alternative, with regard to rate of tax to be levied, it was contended that AO had erred in not taxing the additional consideration in accordance with the provisions of section 115AD of the Act; that he should have applied the rate of 20.91% as against the rate of 41.82%. The assessee relied upon the order of the Tribunal dated 14.8.2013 in the case of Genesis Indian Investment Company Ltd. (ITA/2878/Mum/2006) in support of its main contention and also referred to the decisions in the cases of Sainiram Doongarmal, 42 ITR392, (SC) ; Sahani Steel Works & Press Works Ltd. 152 ITR 39(AP); K.G. Subramaniam, 195 ITR 199 (Karn.) and Hindustan Conductors P. Ltd., 240 ITR 762 (Bom).

In reply, the Department contended that the additional consideration was received for delay in making the payment of sales consideration; that it could not be taken as part of total sale value; that Oracle had deducted TDS while making payment to the assessee; that deduction of tax at source indicated that the amount was not part of sale consideration but represented the interest portion for delayed payments; that same had to be treated as income from other sources; that the letter of offer made by Oracle talked about interest payment of Rs.11.35 per share; that the assessee had accepted the open offer; that there was debtor/creditor relationship between the assessee and Oracle; that the buyer of the share should have paid the whole amount as per the scheduled dates of payments; that the nature of all consideration received by assessee was in the nature of interest; that it was governed by Article-11 of the India Mauritius DTAA ; that it could not be taxed under Article-22 of the treaty under the head “other income’; that the additional consideration was interest for late payment of the sale proceeds; that the interest income taxable in the hands of the assessee could not be treated as income from securities; and that the provisions of section 115AD were not applicable in the case under consideration.

The Tribunal found that an open offer was made by Oracle to the share holders of I-flex at the price of Rs.1,475/- per share; that the open offer indicated that additional offer of Rs.11.35 per share was to be payable to the share holders; that as per the letter of open offer the additional consideration per share was to be paid due to delay in making the open offer and in dispatching the letter of the offer based on the time line prescribed by SEBI; that later on, the consideration of open offer was revised to Rs.2,084/- per share; that the additional consideration for delay was revised to Rs.16/- per share; that the open offer letter and public announcement indicated that a revised offer of Rs.2,100/- per share (including additional consideration of Rs.16/-) was to be payable for the shares tendered by the share holders under the open offer; that in response to the open offer, the assessee tendered its holding of 13,97,879 shares of I-flex and received Rs.2,89,77,45,900/- which sum included additional consideration of Rs.2.20 crore.

The Tribunal found that the offer letter contained two schedules, original and revised, and the revised schedule contained the details of additional consideration to be paid by Oracle, which in the opinion of the Tribunal could not be treated as penal interest or interest for late payment of consideration by Oracle. It found that initially the additional consideration was fixed at Rs.11.35 per share, but, because of the delay in making the open offer and dispatching the letter of the offer, was later enhanced to Rs.16.00 per share and thus, there was increase in the offer price of the shares; it was a fact that the regulatory authority i.e. SEBI had approved the transaction; that the transaction could not be completed in due time because of certain reasons; that Oracle had revised the offer price. Considering all the factors, the Tribunal held that the additional consideration received by the assessee was part and parcel of the total consideration that could not be segregated under the heads ‘original sale consideration’ and ‘penal interest received from Oracle’. It observed that the business world was governed by its own rules and conventions and on due consideration of the time factor, if Oracle decided to increase the share price in the offer letter, it had to be taken as a part of original transaction. The Tribunal appreciated that in the original offer interest @ Rs.11.35 per share was offered by Oracle and after considering the delay in dispatch letter and other relevant factors, it decided to increase the interest @ of Rs.16 per share which was a business decision and the assessee had no control over the decision making process of Oracle. Importantly, it noted that the transaction did not have any debtor/creditor relationship between the assesse and Oracle and the sale of shares of I-flex in response to the open offer by Oracle was a pure and simple case of selling of shares; that the assessee had not entered into any negotiations with Oracle and transferred the shares as per a scheme that was approved by SEBI; that the assessee had not advanced any sum to Oracle and had not received any interest from it for delayed repayment of principal amount and in short, the additional consideration received by the assesse from Oracle was not penal interest and was part of the original consideration and was not taxable. The Tribunal noted with approval that in the decision in the case of Genesis Indian Investment Company Ltd.(ITA/2878/Mum /2006 / dated 14.08.2013) a similar issue had been decided by the Tribunal in favour of the assessee.

Dai Ichi Karkaria Ltd .’s case
The issue in the past had arisen in the case of Dai Ichi Karkaria Ltd, ITA No. 5584/Mum/2010 for A.Y. 2006- 07 decided on 28th December 2011. In that case, the assessee had raised the following issues in the appeal ;

“On the facts and in the circumstances of the case and in law, the ld CIT(A) erred in confirming the amount of Rs. 1,00,57,681/- as interest income and not allowing it as part of full value of consideration in computing long term capital gains in respect of buy back of shares and consequently erred in confirming long term capital gains at Rs.2,16,52,094/- as against Rs. 3,16,12,208 as claimed by the appellant.”

“On the facts and circumstances of the case, it is contended that the amount of interest of Rs. 1,00,57,681/- assessed by the Assessing Officer is not chargeable to tax under any provision of the I T Act.”

In that case, the assessee had computed the long term capital gains of Rs. 3,16,12,208 on transfer of shares under a scheme of buy back of shares of Colour Chem Ltd. The assessee had sold 71,233 shares @ Rs. 318 per share and had also received interest @ Rs.149.62 per share. In computing the capital gains, the assessee had added interest received as a part of sale consideration. The AO asked the assessee to explain as to why the interest of Rs. 1,06,57881, received on the investment, should not be treated as Income from other sources and taxed as such. In response, the assessee submitted that the said interest was paid by the company to eligible shareholders, including the assessee, pursuant to the order of the Supreme Court. It was explained that Colour Chem Ltd. had not deducted tax while making payment of the same, u/s. 194A of the Act, for the reason that the said payment was considered as part of sale consideration for calculating the Long Term Capital Gains.

The AO held as under: “The assessee has received interest in terms of the Supreme Court Order mentioned in the para 4.1 of the Letter of Offer to buy the shares of Colour Chem Ltd by EBITO Chemiebetelligungen AG, Claraint International Ltd and Clariant AG. The Supreme Court in its order has worked out interest at Rs. 149.62 per share. Assessee’s case falls under income by way of interest on securities which is specifically covered u/s 56(2)(id) of Income Tax Act. In fact the matter has been discussed in detail by the Hon’ble Madras High Court in the case of South India Shipping Corporation Ltd. (240 ITR 24), wherein, it has been held that the ratio of the decision of Supreme Court is applicable for existing Company also.” On appeal, the CIT(A) concurred with the view of the AO.

In an appeal to the Tribunal, it was contended by the assesseee company that the assessee had no statutory right to receive the interest or any compensation; the amount of interest received by the assessee was for the period prior to the time of the payments as well as actual transfer of the shares; the amount therefore was a part of the sale consideration and not a separate income of the assessee; there was no agreement or statutory rights to receive such interest; there was no mercantile practice to receive the interest and the amount was only compensatory in nature and could not be treated as a separate income.

It was contended that the interest paid by the acquirer of the shares was treated as the part of purchase consideration in the case of Burmah Castrol Plc., 307 ITR 324 (AAR) wherein interest paid by the acquirer was held as cost of acquisition of shares and on similar analogy, the interest received by the assessee on buyback of share, should be part of the sale consideration.

Highlighting the decision of the Supreme Court in the case of CIT vs. Ghanshyam (HUF), 315 ITR 001(SC), it was submitted that the court in that case held that the interest payable prior to the possession taken over shall be part of the compensation. Reliance was placed on the decision in the case of Manubhai Bhikhabhai vs. CIT, 205 ITR 505(Guj).

Narrating the litigation history of the case of acquiring the shares, it was explained that the purpose of the Supreme Court in awarding interest of Rs. 149.62 per share (net of dividends) was to compensate the shareholders of the target company for the loss of time or delay in making the offer and hence, such interest could under no stretch of imagination be construed to be interest income accruing in the hands of the assessee. Attention was drawn to the provisions of section 2(28A) of the Act, defining the term ‘interest’ to contend that for a receipt to be considered as interest the amount should arise from money borrowed or debt incurred and that in the given case, the assessee had invested in shares of the target company i.e. CCL and had not given any loans and that the scope of definition could not be expanded to include in itself something which by its very basic nature, did not amount to interest.

The facts of the case, it was explained, confirmed that the compensation was not on the grounds that the acquirer delayed the payment of the consideration to the shareholders but was awarded for making good the loss caused to the shareholders of CCL, due to the delay in making the offer of buy back by the acquirer.

It was pointed out that while deciding the issue of interest, the Supreme Court had clearly held that the shareholder did not have any right to get interest and the shareholders were only to be compensated for the loss of interest and nothing more ; therefore, when there was no right or any agreement to receive the interest then, the amount received by the assessee was only a part of the sale consideration.

Lastly, it was submitted that when there was no right to receive the interest and there was no source of income then, there was no provision to tax the same, as there was no source. CIT vs. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd.,179 ITR 157(P&H).

On the other hand, the Department submitted that interest was received by the assessee for delay in payment of offer price; that ‘income’ included any amount received by the assessee and would fall u/s. 56 of the I. T. Act, since the money was lying with the acquirer and the interest was a compensation for such loss; that as per the provision of section 46A, only the consideration received by the shareholder, after adjustment of the cost of the acquisition of shares was deemed as capital gains arising to such shareholder.

The Tribunal considered the rival contentions and perused the relevant material on record. It examined in detail the factual background giving rise to the dispute of interest payment and transfer of the shares under buy-back scheme. It noted that the Supreme Court while deciding the issue of rate of interest, observed that “by reason of Regulation 44, as substituted in 2002, the discretionary jurisdiction of the Board is curtailed. In terms of Regulations 1997 could award interest by way of damages but by reason of Regulation 2002, its power is limited to grant interest to compensate the shareholders for the loss suffered by them arising out of the delay in making the public offer.” The tribunal noted that it was clear from the observations of the court that interest payable as per Regulations 44 was to compensate the shareholders for loss suffered by them for delay in making the public offer and that it was not penal in nature and was not towards a statutory right or a right arising from contract but the nature of payment of interest was to compensate the loss due to the delay in the payment by the acquirer and thus, the interest was paid to compensate the shareholder who were deprived of interest payable on difference of offer price and market price.

Importantly, the tribunal extensively quoted from the decision in the case of CIT vs. Ghanshyam (HUF) (supra) wherein the court after analysing the provisions of Land Acquisition Act, 1894 had given a detailed finding on the issue of interest payable u/s. 23, 28 as well as section 34 of the Land Acquisition Act. The Supreme Court in that case had addressed the issue whether the interest paid on enhanced compensation u/s. 23,28 and section 34 would be treated as part of compensation u/s. 45(5) of the I. T. Act 1961. The Tribunal quoted the following paragraph form the said decision;

“It is to answer the above questions that we have analysed the provisions of sections 23, 23(1A), 23(2), 28 and 34 of the 1894 Act. As discussed hereinabove, section 23(1A) provides for additional amount. It takes care of increase in the value at the rate of 12 per cent. per annum. Similarly, under section 23(2) of the 1894 Act, there is a provision for solatium which also represents part of enhanced compensation. Similarly, section 28 empowers the court in its discretion to award interest on the excess amount of compensation over and above what is awarded by the Collector. It includes additional amount under section 23(1A) and solatium under section 23(2) of the said Act. Section 28 of the 1894 Act applies only in respect of the excess amount determined by the court after reference under section 18 of the 1894 Act. It depends upon the claim, unlike interest under section 34 which depends on undue delay in making the award. It is true that “interest” is not compensation. It is equally true that section 45(5) of the 1961 Act refers to compensation. But, as discussed hereinabove, we have to go by the provisions of the 1894 Act which awards ” interest” both as an accretion in the value of the lands acquired and interest for undue delay. Interest under section 28 unlike interest under section 34 is an accretion to the value, hence it is a part of enhanced compensation or consideration which is not the case with interest under section 34 of the 1894 Act. So also additional amount under section 23(1A) and solatium under section 23(2) of the 1894 Act forms part of enhanced compensation under section 45(5)(b) of the 1961 Act. ”

In the opinion of the Tribunal, there was a fine distinction between the additional amount payable u/s. 23, award of interest u/s. 28 and interest payable u/s. 34 of the Land Acquisition Act which had led the court to hold that the additional amount u/s. 23 (1A) and solatium u/s. 23(2) of Land Acquisition Act formed a part of enhanced compensation u/s. 45(5)(b) of the I. T. Act, 1961 and when the amount was paid as a compensation for enhancement in the value of the asset transferred, the same would be part of full consideration; but when the interest was paid as a compensation to loss of interest, then it could not be treated as a part of sale consideration.

The Tribunal held that the interest received by the assessee, as was held by the court, while deciding the dispute of rate of interest was only a compensation for loss of interest, which was akin to payments made due to delay in public offer and delayed payments and was not the compensation for enhancement in the value of the asset. The fact that the offer price was more than the value of the share from 24.2.1998 till 7.4.2003 weighed heavily with the Tribunal. The Tribunal accordingly held that the interest received by the assessee as per the directions of the SEBI and in pursuance of the decision of the Supreme Court could not be treated as part of sale consideration of shares and accordingly, the lower authorities had rightly treated the same as taxable under the head ‘income from other sources’.

The Tribunal noted that merely by reason that the interest paid by the acquirer would be a part of acquisition of shares would not ipso facto conclude that the said interest in the hands of the shareholder would be part of sale consideration.

Observations
The issue though moving in a narrow circle has multiple dimensions;

Does the amount go to increase the ‘full value of consideration’ for the purposes of the Income-tax Act?

Does the additional amount, received in addition to the sale consideration, represent interest or can be classified as in the nature of interest?

Can such amount be treated as ‘interest’ within the meaning of the term as defined in section 2(28A) of the Act?

Do the provisions of section 46A alter the treatment of receipt? and

Can such an amount be classified as a capital receipt not liable to tax?

The issue on hand becomes more twisted when it is examined in the context of the provisions of Double Taxation Avoidance Agreements and in particular w.r.t. certain Articles that deal with the ‘capital gains’, ‘interest’ and ‘other income’. Issue also arises as to the applicability of rate of tax and the liability to deduct tax at source under the domestic laws. But then, these are the issues that are not intended to be discussed here for the sake of focusing on the issue under debate.

There is no dispute that the amount in question in both the cases, that has been received by the shareholder, is for compensating him for the delay made by the acquirer company in making a public offer for sale. The payment is made as per the SEBI regulations to compensate the shareholder for the delay in making the offer and is calculated as per the rules of SEBI. In the matters of dispute as to the quantification and the period, the courts have the jurisdiction to intervene and provide the finality to the dispute. There is also not a dispute that the shareholders have not lent any money to the acquirer company nor is there a debtor-creditor relationship between the company and the shareholder. It is also not anyone’s case that the company had delayed the payment of the offer price or even the additional payment ordered by the SEBI.

In computing the income under the head ‘capital gains’, an assessee, to begin with, is required to reduce the cost of acquisition from the full value of consideration. The term ‘full value of consideration’ is not defined under the Income-tax Act, but is largely held to represent the sale consideration or the consideration for transfer of a capital asset. It is immaterial whether the said consideration is received in part or in full at the time of transfer, and it is also not relevant whether such consideration is received from the transferee or not.

Obviously,the compensation paid, in our respectful opinion cannot be a part of the sale consideration simply, because it is not an ‘interest’ or that it is paid for the delay in making an offer. On a first blush, the consideration moving from the company to a shareholder can be taken to be the offer price, i.e. the price at which the company has agreed to purchase or buy the shares. However, when one takes in to account the event that has preceded the actual offer, on account of which event the company has been made to offer and pay an additional amount for delaying the offer, it is appropriate to say that the shareholder in question has accepted the said offer with full knowledge of the total receipt which he is likely to receive at the time of accepting the offer and in that view of the matter, it is apt to hold that the ‘full value of consideration’ in his case represents the acceptance price, i.e the total price. It is a settled position in law that the full value of consideration referred to in section 48 does not necessarily mean the apparent consideration. It rather is the price bargained for by the parties to the transaction. ‘Full value’ is the whole price and in its whole should be capable of including the additional amount agreed to be paid before the offer is accepted.

We do not think the receipt in any manner could ever be held to be representing interest. Interest is a compensation for delay in tendering the payment of the consideration. In the case under consideration, no consideration ever became payable before the offer for sale was made and was accepted. Importantly, once it was accepted, there was no delay in the payment thereof. These aspects of the facts are even confirmed by the Tribunal in the case of Dai Ich Karkaria Ltd.(supra). It is true that the compensation for the delay is measured in terms of the period of delay and is linked to the rate of interest but the methodology adopted for quantifying the damages can not be held to change the character of the payment which remains to be compensation, and not interest.

A bare reading of section 2(28A) confirms that the receipt inn question cannot be termed as ‘interest’. Not much will turn on section2(28A) in support of the case that it represents interest. None of the parameters help the case in favour of treating the receipt as interest.

Before we deal with the last part, it is relevant to examine whether provisions of section 46A of the I. T. Act, have any implication in deciding the issue. Apparently, the scope of section 46A is restricted to the buy back of shares by the issuing company and it’s scope cannot be extended to the case of public offer by a raiding company or any person other than the issuing company. Secondly, the provision requires the difference between the cost of acquisition and the value of consideration to be taxed under the head ‘capital gains’. The ‘value of consideration’ cannot be largely different than the ‘full value of consideration’ and as such the discussion in the earlier paragraphs will largely apply to section 46A with the same force.

Lastly, whether the receipt in question could be held to be a capital receipt, not liable to taxation, is an issue that was not before the Tribunal in any of the cases, but in our opinion is a possibility worth considering, in view of the fact that the receipt is in the nature of damages and represent compensation for an injury, which can be presented to represent a capital receipt not liable to taxation.

shailesh.kwebmaker

Carry Forward of Loss and SECTION 79

Issue for Consideration
Any loss incurred in the case of a company in which the public are not substantially interested (“closely held company”), in any year prior to the previous year shall not be carried forward and set-off, if there is change in the persons beneficially holding shares of such company with 51% voting power. In other words, the persons holding such voting power as on the last day of the previous year in which such set off is claimed are the same as the persons in the year or years prior to the previous year in which the loss was incurred.

The limitation contained in section 79 is relaxed in cases of change in the voting power in the following cases – (a) death of the shareholder, (b) gift to any relative of the shareholder, or (c) amalgamation or demerger of a foreign holding company, subject to prescribed conditions.

The relevant part of section 79 reads as “Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place in a previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set-off against the income of the previous year unless- (a) on the last day of the previous year the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.”

It is common to come across cases wherein shares of a closely held company carrying 51% of voting power or more are held by another company (‘immediate holding company’), which company in turn is the subsidiary of yet another company (‘ the ultimate holding company’). An interesting controversy has recently arisen as regards application of section 79 in cases where shares with such voting power held by the immediate holding company are transferred to yet another immediate holding company of the same ultimate holding company.

Can such a change of shareholding from one subsidiary to another subsidiary company of the same holding company disentitle the closely held company from setting-off the carried forward loss, is a question that the courts have been asked to examine. While the Karnataka High Court has held that the closely held company shall be entitled to set-off the carried forward losses, the Delhi High Court has recently prohibited such set-off, ignoring its own decision in an earlier case.

AMCO Power Systems Ltd .’s case
The issue arose before the Karnataka High Court in the case of CIT vs. AMCO Power Systems Ltd. 379 ITR 375, wherein the court was asked to consider the question: “Whether the Tribunal was correct in holding that the assessee would be entitled to carry forward and setoff of business loss despite the assessee not owning 51% voting power in the company as per Section 79 of the Act by taking the beneficial share holding of M/s. Amco Properties & Investments Ltd.?”

Admittedly, up to the assessment year 2000-01, all the shares of the company Amco Power Systems Ltd. were held by AMCO Batteries Ltd.(‘ABL’). In the assessment year 2001-02, the holding of ABL was reduced to 55% and the remaining 45% shares were transferred to its subsidiary, namely AMCO Properties and Investments Limited (‘APIL’). In the assessment year 2002-03, ABL further transferred 49% of its remaining 55% shares to Tractors and Farm Equipments Limited (‘TAFE ‘) and consequently ABL retained only 6% shares, its subsidiary APIL held 45% shares and the remaining 49% shares were with TAFE . Similar shareholding continued for the assessment year 2003-04. For easy understanding, shareholdings of the company for the relevant assessment years is given in the chart below:

For the assessment year 2003-04, the company filed its return of income on 28.11.2003, wherein NIL income was shown, after setting off losses brought forward from earlier years. The return of income was processed u/s. 143(1) of the Income-tax Act, 1961, and the returned income was accepted on 6.2.2004. Subsequently, the case was taken up for scrutiny, and assessment u/s. 143(3) of the Act was completed. The income of the company for the year was determined at Rs.1,34,03,589/. The assessment order did not allow the set off of losses of the earlier years, by invoking section 79 of the Act.

Aggrieved by the order of assessment passed u/s. 143(3) of the Act, the company preferred an appeal before the Commissioner (Appeals), inter alia, for denial of set-off of brought forward business loss, on the ground that the provisions of section 79(a) of the Act were not complied with. The Commissioner (Appeals) order confirmed that the company was not found to be entitled to set-off of the brought forward losses, considering the change in beneficial holding of 51% or more, as provided u/s. 79 of the Act.

Being aggrieved by the order of the Commissioner (Appeals), the company filed an appeal before the Income Tax Appellate Tribunal, challenging the denial of the benefit of set-off of brought forward losses. The Tribunal allowed the appeal of the company, by allowing the benefit of set-off of brought forward losses. The Tribunal, in accepting the submission of the company, held that 51% of the voting power was beneficially held by ABL during the assessment years 2002-03 and 2003-04 also, and the company was thus entitled to carry forward and set-off the business losses of the previous years.

In appeal to the Karnataka High Court, the Revenue urged that, up to the assessment year 2001-02, there was no dispute that ABL continued to have 51% or more shares as its shareholding, as in that assessment year, ABL was holding 55% shares, and its subsidiary APIL was holding 45% shares. For the assessment year 2002-03, when ABL transferred 49% shares (out of its 55%) to TAFE , ABL was left with only 6% shares, meaning thereby, it was left with less than 51% shares. It was contended that, consequently, its voting power was also reduced from 55% to 6%, and the remaining 94% was divided between TAFE and APIL at 49% and 45% respectively. As a result the company was disentitled to claim carry forward and set-off of business losses in the assessment years 2002-03 and 2003-04. It was further submitted that even though APIL was a wholly owned subsidiary of ABL, both companies were separate entities, and could not be clubbed together for ascertaining the voting power. By transfer of its 49% shares to TAFE , the shareholding of ABL was reduced to 6% only. Thus, the provisions of section 79 of the Act were attracted for denial of the benefit of carry forward of losses to the company.

On behalf of the company, it was submitted that it was not the shareholding that was to be taken into consideration for application of section 79, but it was the voting power which was held by a person or persons who beneficially held shares of the company, that was material for carry forward of the losses. It was thus contended that as ABL was holding 100% shares of APIL, which was a wholly owned subsidiary of ABL, and fully controlled by ABL, even though the shareholding of ABL had been reduced to 6%, yet the voting power of ABL remained more than 51%. As such, the provisions of section 79 of the Act would not be attracted in the present case.

The Karnataka High Court noted the fact that ABL was the holding Company of APIL, which was a wholly owned subsidiary of ABL. The Board of Directors of APIL were controlled by ABL, a fact that was not disputed. The submission of the company that the shareholding pattern was distinct from voting power of a company, had force, in as much as, what was relevant for attracting section 79 was the voting power.

The High Court further noted that the purpose of section 79 of the Act was that the benefit of carry forward and setoff of business losses for previous years of a company should not be misused by any new owner, who might purchase the shares of the company, only to get the benefit of set-off of business losses of the previous years against the profits of the subsequent years after the take over. It was for such purpose, that it was provided that 51% of the voting power, which was beneficially held by a person or persons, should continue to be held for enjoyment of such benefit by the company. The court observed that though ABL might not have continued to hold 51% shares, it continued to control the voting power of APIL, and together, ABL had 51% voting power. Thereby, the control of the company remained with ABL as the change in shareholding did not result in reduction of its voting power to less than 51%. Section 79 dealt with 51% voting power, which ABL continued to have even after transfer of 49% shares to TAFE .

The Karnataka High Court noted that the Apex court, while dealing with a case u/s. 79(a) in CIT vs. Italindia Cotton Private Limited, 174 ITR 160 (SC), held that the section would be applicable only when there was a change in shareholding in the previous year, which might result in change in control of the company, and that every such change of shareholding need not fall within the prohibition against the carry forward and set-off of business losses. In the present case, the Karnataka High Court observed that though there might have been change in the shareholding in the assessment year 2002-03, yet, there was no change in control of the company, as the control remained with ABL, in view of the fact that the voting power of ABL, along with its subsidiary company APIL, remained at 51%.

The court also relied on the observation of the apex court in that case to the effect that the object of enacting section 79 appeared to be to discourage persons claiming a reduction of their tax liability on the profits earned in companies which had sustained losses in earlier years. The Karnataka High Court held that, in the case before them, the control over the company, with 51% voting power, remained with ABL. As such, the provisions of section 79 of the Act were not attracted. The court accordingly confirmed the finding of the Tribunal in this regard.

Yum Restaurants (India) Private Limited’s case
The issue came up again recently before the Delhi High Court in the case of Yum Restaurants (India) Private Limited vs. ITO in ITA No. 349 of 2015 dated 13th January, 2016 for the Assessment Year 2009-10.

The assessee, Yum Restaurants (India) Private Limited (‘Yum India’), was a part of the Yum Restaurants Group, whose 99.99% shares were held by its immediate holding company Yum Restaurants Asia Private Ltd.(‘Yum Asia’), with its ultimate holding company being Yum! Brands Inc. USA (Yum USA). 99.99% of shares of Yum India, initially held by ‘Yum Asia’, were transferred, pursuant to restructuring within the group, after 28th November 2008, to Yum Asia Franchise Pte. Ltd. Singapore (‘Yum Singapore’). The group decided to hold shares in Yum India through Yum Singapore and, therefore, the entire share holding in Yum India, was transferred from one immediate holding company, viz., Yum Asia, to another immediate holding company, Yum Singapore, although the ultimate beneficial owner of the share holding in Yum India remained the ultimate holding company viz., Yum USA.

The total income of Yum India was proposed to be assessed at Rs.40,65,40,535 in the draft order framed by the AO. In doing so, the AO, inter alia, disallowed the set off and carry forward of business losses incurred till AY 2008-09. By its order, the DRP upheld the conclusions reached by the AO and rejected Yum India’s submission as regards set off and carry forward of business losses. On the basis of the DRP’s order, the AO completed the assessment and assessed the income of Yum India.

In appeal to the ITAT , Yum India challenged the disallowance of the carry forward of business losses. By its order, the ITAT upheld the disallowances of the carry forward of business losses of earlier years. The ITAT referred to the change in immediate share holding of Yum India from Yum Asia to Yum Singapore and held that, by virtue of section 79 of the Act, since there had been a change of more than 51% of the share holding pattern of the voting powers of shares beneficially held in AY 2008- 09 of Yum India, the carry forward and set off of business losses could not be allowed.

In the appeal filed by Yum India to the Delhi High Court, the company challenged the order of the ITAT , questioning the denial of the carry forward of accumulated business losses for the past years and set off u/s. 79 of the Act.

The Delhi high court noted that the AO did not accept the contention of Yum India, that since the ultimate holding company remained Yum USA, it was the beneficial owner of the shares, notwithstanding that the shares in Yum India were held through a series of intermediary companies.; In his view, section 79 required that the shares should be beneficially held by the company carrying 51% of voting power at the close of the financial year in which the loss was suffered; the parent company of Yum India on 31st March 2008 was the equitable owner of the shares but it was not so as on 31st March 2009; accordingly, Yum India was not permitted to set off the carried forward business losses incurred till 31st March 2008.

The court also noted that, in dealing with the issue, the ITAT had in its order analysed section 79 of the Act and noted that the set off and carry forward of loss, which was otherwise available under the provisions of Chapter VI, was denied if the extent of a change in shareholding taking place in a previous year was more than 51% of the voting power of shares beneficially held on the last day of the year in which the loss was incurred. The ITAT had noted that, in the present case, there was a change of 100% of the shareholding of Yum India. Consequently, there was a change of the beneficial ownership of shares, since the predecessor company (Yum Asia) and the successor company (Yum Singapore) were distinct entities.The fact that they were subsidiaries of the ultimate holding company, Yum USA, did not mean that there was no change in the beneficial ownership. Unless the assessee was able to show that notwithstanding shares having been registered in the name of Yum Asia or Yum Singapore, the beneficial owner was Yum USA, there could not be a presumption in that behalf.

Having examined the facts as well as the concurrent orders of the AO and the ITAT , the Delhi high court found that there was indeed a change of ownership of 100% shares of Yum India from Yum Asia to Yum Singapore, both of which were distinct entities. Although they might be Associated Enterprises of Yum USA, there was nothing to show that there was any agreement or arrangement that the beneficial owner of such shares would be the holding company, Yum USA. The question of ‘piercing the veil’ at the instance of Yum India did not arise. In the circumstances, it was rightly concluded by the ITAT that in terms of section 79 of the Act, Yum India could not be permitted to set off the carried forward accumulated business losses of the earlier years.

Consequently, the Court declined to frame a question at the instance of Yum India on the issue of carry forward and set off of the business losses u/s. 79 of the Act.

Observations:
A company is required to show that there was no change in persons beneficially holding the shares with the prescribed voting power on the last day of the previous year in which the set off is desired. The key terms are; ‘beneficial holding’ and ‘ holding voting power’, none of which are defined in the Act nor in the Companies Act. The cases of fiduciary holding are the usual cases which could be safely held to be cases of beneficial holding. The scope thereof however should be extended to cases of holding through intermediaries, where the ultimate beneficiary is the final holder, who enjoys the fruits of the investment.

This principle can be applied with greater force in cases where the control and management rests with the ultimate holding company. Again ‘holding of voting power’ is a term that should permit inclusion of cases where the shares are held through intermediaries, and the final holder has the exclusive power to decide the manner of voting. If this is not holding voting power, what else could be?

Both the terms collectively indicate the significance of the control and management of the company. In a case where it is possible to establish that there has not been any change in the control and management of the company, that the control and management has remained in the same hands, the provisions of section 79 should not be applied.

The Apex court, in Italindia Cotton Private Limited’s case (supra), held that section 79 would be applicable only when there was a change in shareholding in the previous year which might result in change of control of the company, and that every change of shareholding need not fall within the prohibition against the carry forward and set-off of business losses. The findings of the Apex court have been applied favourably by the Karnataka High Court in AMCO’s case (supra) to hold that, though there might have been a change in the shareholding in the assessment year 2002-03, yet, there was no change of control of the company., The control remained with ABL in view of the fact that the voting power of ABL, along with its subsidiary company APIL, remained at 51%. It is this reasoning that was perhaps missed in the case of Yum India (supra).

In another similar case, Indrama (Investments) Pvt. Ltd., (‘IIPL’) a company held 98% of the shares of one Select Holiday Resorts Private Ltd.(‘SHRPL’) and the balance shares of SHRPL were held by four individuals, who inter alia held 100% shares of IIPL. On merger of IIPL into SHRPL, the shares held by IIPL stood cancelled and the four individuals became 100% shareholders of SHRPL. The claim of the set off of carried forward of loss of prior years by SHRPL was rejected by the AO for assessment years 2004-05 and 2005-06, by application of section 79, holding that there was a change of shareholders holding 51% voting power.

The appeal of SHRPL was allowed by the Commissioner(Appeals) and his order was upheld by the ITAT in ITA No. 1184&2460?Del./2008 dt. 23.12.2010 in the case of DCIT vs. Select Holiday Resorts Private Ltd. The appeal of the Income tax Department to the Delhi High Court was dismissed by the court, reported in 217 Taxman 110. The Special Leave Petition of the Income tax Department was rejected by the Supreme Court. The high court, in this case, equated the case of transfer of shares on a merger, with that of the transmission of shares to the legal heir on death, to hold that there was no change of voting power for attracting provisions of section 79 to enable the AO to deny the set off of the carried forward losses.

The ratio of the decision of the court in SHRPL was not brought to the attention of the ITAT as also of the high court in Yum Restaurant’s case. Also the findings of the Karnataka high court in AMCO’s case(supra) were not brought on record. We are sure that had the judicial development on the subject been brought to the attention of the Delhi High Court in the case of Yum Restaurants (supra), the outcome would have been different.

Section 79 has been amended by the Finance Act, 1988 by the insertion of the first Proviso, that excludes cases of change in shareholding consequent to death or gift. The scope of the amendment has been explained by Cir. No. 528 dated 16.12.1988 and in particular by paragraph 26.3. The CBDT clarifies that the objective behind the amendment is to save the genuine cases of change from the hardships of section 79 of the Act. Kindly see Circular No. 576 dated 31.08.1990. The section has been further amended by the Finance Act, 1999, by insertion of the second Proviso to provide for exclusion of cases involving change in shareholding of an Indian subsidiary on account of amalgamation or demerger of a foreign company – again to save genuine cases of change from hardship of section 79 of the Act.

Clause(b) of section 79(now deleted) provided for nonapplication of section 79 in cases where the change was not effected to avoid payment of taxes or for reduction of taxes. The objectives behind introduction of section 79 and the development in law thereon, as also the amendments made therein from time to time, clearly show that the right to set off of carried forward losses of prior years should not be denied in genuine cases. Kindly see CIT vs. Italindia Cotton Private Limited, 174 ITR 160 (SC), where the court observed to the effect that, the object of enacting section 79 appeared to be to discourage persons claiming a reduction of their tax liability, on the profits earned in companies after take over, which had sustained losses in earlier years.

The Delhi High Court, in Yum India’s case(supra), importantly observed that the company had failed to show that there was any agreement or arrangement that the beneficial owner of such shares would be the holding company, Yum USA. In our opinion, the situation otherwise could have been salvaged, had the company produced evidence to demonstrate that the beneficial owner of shares was Yum USA.

It may not be proper, in our considered opinion, to be swayed by the status of the subsidiaries for taxation of the dividend or other income. It would well be perfectly harmonious to hold the immediate holding company liable for taxation and, at the same time, to look through it for the purposes of section 79, right up to the ultimate holding company. Such an approach would not defeat the purposes of the Act but would serve the cause of the scheme of taxation.

shailesh.kwebmaker

Obligation of Foreign Company to File Return of Income where Income Exempt under DTAA

The obligation to file a return of income under the Income -tax Act, 1961 arises by virtue of section 139 of that Act. Section 139(1) provides that every person, being a company or a firm, or being a person other than a company or a firm, having total income exceeding the maximum amount not chargeable to income tax during the previous year, shall file a return of income in the prescribed manner. The provisos to this s/s. and s/s.s (4A) to (4F) of this section, require filing of returns of income by various entities, even where these entities’ income may not be chargeable to tax.

The 3rd proviso to section 139(1) provides that every company or firm shall furnish its return of income or loss before the due date in every previous year. The 4th proviso further requires every person, who is resident and ordinarily resident and who otherwise is not required to furnish a return of income, and who holds any foreign asset as a beneficial owner or otherwise, or who is a beneficiary of any foreign asset, to file a return of income. Sub-section (4A) applies to charitable or religious institutions claiming exemption u/s.s 11 and 12, s/s. (4B) applies to political parties, s/s. (4C) applies to research associations, news agencies, profession regulatory bodies, educational institutions, hospitals, mutual funds, securitisation trusts, venture capital funds, trade unions, infrastructure debt funds, etc., s/s. (4D) applies to research organisations, s/s. (4E) applies to real estate investment trusts and infrastructure investment trusts, while s/s. (4F) applies to alternative investment funds.

A foreign company may at times have income which is chargeable to tax in India under the provisions of the Act, but which may be exempt from tax by virtue of the provisions of a Double Taxation Avoidance Agreement (“DTAA”). The issue has arisen before the Authority for Advance Rulings (“AAR”) as to whether such a foreign company, whose entire Indian income is not taxable in India by virtue of a DTAA, is required to file its return of income in India. There have been conflicting rulings of the AAR on this issue, at times holding that there is no such obligation to file a return of income in India, while at times holding that a return of income has necessarily to be filed in India by a foreign company, irrespective of the fact that its income is not liable to tax in India.

Castleton Investment Ltd ’s case
The issue had arisen before the AAR in the case of Castleton Investment Ltd, in re, 348 ITR 537.

In this case, the assessee was a Mauritius company, part of a multinational group, which held shares of a listed company in India, amounting to 3.77% of the paid-up capital of the listed company. As a part of the reorganisation of the group structure, it proposed to transfer the shares held by it in the listed company in India to another group company based in Singapore, either through a transaction on a recognised stock exchange on which the shares were listed, or through an off market sale.

It filed an application for a ruling before the AAR, as to whether the capital gains arising from transfer of the shares of the listed company would be subjected to tax in India, or whether such capital gains would be exempt from tax by virtue of paragraph 4 of Article 13 of the India Mauritius DTAA . It also raised the question as to whether the provisions of section 115JB, relating to Minimum Alternate Tax (MAT) was applicable to it. One of the other questions raised by it in the application was that if the transfer of shares of the listed company was not taxable in India, whether it was required to file any return of income u/s. 139.

The authority held that the capital gains arising to the assessee was not chargeable to tax in India by virtue of paragraph 4 of Article 13 of the DTAA between India and Mauritius. As regards the issue of whether the assessee was under an obligation to file the return of income, it was argued on behalf of the assessee that since the income was not taxable in India under the Act read with the DTAA, there was no obligation on the assessee to file a return of income u/s. 139. On behalf of the revenue, it was argued that whatever may be the position under the DTAA , the applicant was bound to file a return of income as mandated by section 139.

The AAR, analysing the provisions of section 139, observed that every person, being a company, firm or a person other than a company or firm, had to file a return of income if its/his total income exceeded the maximum amount which was not chargeable to income tax. If an assessee had income which was chargeable under the Act, or after claiming the benefit of a DTAA, if it had chargeable income exceeding the maximum amount not chargeable to tax, it was bound to file a return as per the language of section 139.

The Authority observed that a person claiming the benefit of the DTAA could do so by invoking the provisions of section 90(2) of the Income-tax Act to claim such benefit. In other words, a person earning an income that was otherwise chargeable to tax under the Act had to make a claim by invoking section 90(2) of the Act for getting the benefit of a DTAA in order to enable him to be not liable to payment of tax in India. According to the AAR, even if a person was entitled to a relief under the DTAA , he had to seek it, and that would be during the consideration of his return of income or at best, while filing the return of income. The AAR accordingly was of the view that the obligation u/s. 139 did not simply disappear merely because a person was entitled to claim the benefit of a DTAA.

Addressing the argument that a DTAA overrides the Act, and was not the same as claiming an exemption under the Act, the AAR observed that surely, in terms of section 90(2), it had to be shown that the benefit of a DTAA was being claimed, that the claimant was eligible to make that claim, and that the DTAA was more beneficial to the claimant than the Act. According to the AAR, that had to be shown before the assessing authority, and this emphasised the need to file a return of income to claim such a relief. The AAR therefore held that the assessee had an obligation to file a return of income in terms of section 139. Incidentally, in this case, the AAR also held that the provisions of section 115JB relating to MAT on book profits, applied to the assessee.

A similar view had been taken by the AAR in the cases of VNU International BV, in re 334 ITR 56, SmithKline Beecham Port Louis Ltd., in re 348 ITR 556, ABC International Inc., in re 199 Taxman 211, and XYZ/ABC Equity Fund, in re 250 ITR 194, in all of which cases, the income was taxable in India under the Act, but exempt under the DTAA . In XYZ/ABC Equity Fund’s case, a case where business profits earned in India were held not liable under the DTAA in absence of a permanent establishment in India, a view has been taken that:

“‘Total income’ is to be computed in accordance with the provisions of the Income-tax Act. According to section 5, total income of a non-resident includes all income from whatever source derived which is received or is deemed to be received in India in a given year or accrues or arises or is deemed to accrue or arise to the non-resident in India during such year. Therefore, if the income received by or on behalf of the non-resident exceeds the maximum amount which is not chargeable to income-tax, a return of income has to be filed. It may be that in the final computation after all deductions and exemptions are allowed, it will turn out that the assessee will be not liable to pay any tax. The exemptions and deductions cannot be taken by the assessee on his own. He is obliged to file his return showing his income and claiming the deductions and exemptions. It is for the Assessing Officer to decide whether such deductions and exemptions are permissible or allowable. The assessee cannot be allowed to pre-judge the issues and decide for himself not to file the return, if he is of the view that he will not have any taxable income at all.”

Even in the case of Deere & Co, in re 337 ITR 277 (AAR), where the transaction of gift of shares to another group company was not chargeable to capital gains tax at all even under the Act, as well as under the DTAA , the AAR has taken the view that the assessee was under an obligation to file its return of income, following its earlier rulings.

FactSet Research System’s case
The issue had also come up before the AAR in the case of FactSet Research Systems Inc, in re 317 ITR 169.

In this case, the assessee was a US company, which maintained a database of financial and economic information, including fundamental data of a large number of companies worldwide, at its data centres located in the USA. The databases contained the published information collated, stored and displayed in an organised manner, which facilitated retrieval of publicly available information in a shorter span of time and in a focused manner by its customers, who were mostly financial intermediaries and investment banks. The customers paid a subscription to access the database.

Besides seeking a ruling from AAR as to whether such subscription received from customers in India would be taxable in India under the Income-tax Act or under the DTAA between India and the USA, the assessee also raised the question of whether it was absolved from filing a tax return in India under the provisions of section 139 with regard to the subscription fees, assuming that it had no other taxable income in India.

The AAR held that the payment of the subscription fees did not constitute royalty either under the Act [as it then stood before the retrospective amendment to section 9(1)(vi)] or under the India USA DTAA. While examining whether the subscription fees was taxable as business income under the DTAA , the AAR took note of the assessee’s submissions that the Mumbai office of a group subsidiary provided marketing and support services to its customers in India, but that, after initial discussions with the prospective customers, the contract was signed by the customer and by the assessee, and that the Mumbai office did not have the authority to conclude contracts with customers. The AAR accepted the assessee’s submission, but left it open to the Department to make enquiry as to the existence or otherwise of an agency PE, and as to the attribution of income to such PE.

As regards the question of obligation to file a return of income, based on its finding that there was no royalty income and on the facts stated by the assessee that there was no PE in India, the AAR held that there was no obligation on the assessee to file the return of income in India.

A similar view had been taken by the AAR in the case of Venenburg Group BV, in re (2007) 289 ITR 462, where the AAR observed that the liability to pay tax was founded upon sections 4 and 5 of the Act, which were the charging sections. Section 139 and other sections were merely machinery sections to determine the amount of tax. According to the AAR, relying on the decision in the case of Chatturam vs. CIT (1947) 15 ITR 302, there would be no occasion to call a machinery section to one’s aid, where there was no liability at all. Therefore, the assessee was not required to file any tax returns, though the capital gains from the proposed transaction would be chargeable to tax under the Act, but would be exempt under the DTAA .

Observations
Section 139(1) requires a filing of return of income by a person other than a company or a firm if income exceeds the maximum amount which is not chargeable to income tax. Clause(a) provides for filing of return of income by a company or a firm and in doing so does not expressly limit the requirement to the cases of income exceeding the maximum amount not chargeable to tax. This may be on account of the fact that a company or a firm does not have any maximum amount which is not chargeable to income tax, since it is liable to pay tax on its entire chargeable income at a flat rate of tax.

The definition of “company” u/s. 2(17) includes a body corporate incorporated by or under the laws of the country outside India and a foreign company would be subjected to the provisions of the Act provided its activities has some connection with India. Obviously, every company in the world cannot be required to file its return of income in India, if it does not have any source of income in India keeping in mind the fact that the scope of the Act as envisaged in section 1(2) is restricted to India and the intention is to charge income, which has some connection with India.

Section 5 of the Act in a way spells out the connection with India which creates a charge to tax, when read with section 4. For a non-resident, the charge to tax is of income received or deemed to be received in India, or income accruing or arising or deemed to accrue or arise in India.

Section 90(2) of the Act spells out the overriding nature of DTAA s. It provides that where a DTAA has been entered into by the Central Government with the Government of any country outside India for granting relief of tax or avoidance of double taxation, in case of an assessee to whom the DTAA applies, the provisions of the Act will apply to the extent that they are more beneficial to the assessee. Therefore, the provisions of the DTAA or the Act, whichever is more beneficial to the assessee, would apply. The DTAA would therefore override all the provisions of the Act, except chapter X-A relating to General Anti-Avoidance Rules, as provided in section 90(2A).

It must be remembered that the charge to tax u/s. 4 is on the total income, and the total income is computed under the Act, after various exemptions and deductions, including those available under the DTAA . If income of an assessee is completely exempt from tax, there is no charge to tax at all. Similarly, if the income does not accrue or arise or is not deemed to accrue or arise or is not received or deem to be received in India, it does not fall within the scope of total income, and there is no charge to tax of such income. Given the fact that there is no charge to tax, can the other machinery provisions relating to filing of return, computation of tax, etc. apply?

The AAR in Venenburg Group’s case (supra) rightly referred to the decision of in Chatturam’s case. In that case, the assessee was a resident of a partially excluded area, and received a notice to furnish his return of income. His assessment was completed, and his appeals to the tribunal were dismissed. A notification was issued after he had filed his return, but before completion of his assessment, directing that certain income tax laws would apply to that area where the assessee was a resident retrospectively. The Court, while holding that the assessments were validly made on the assessee, observed as under:

“The income-tax assessment proceedings commence with the issue of a notice. The issue or receipt of a notice is not, however, the foundation of the jurisdiction of the Income-tax Officer to make the assessment or of the liability of the assessees to pay the tax. It may be urged that the issue and service of a notice under Section 22(1) or (2) may affect the liability under the penal clauses which provide for failure to act as required by the notice. The jurisdiction to assess and the liability to pay the tax, however, are not conditional on the validity of the notice. Suppose a person, even before a notice is published in the papers under Section 22(1), or before he receives a notice under Section 22(2) of the Income-tax Act, gets a form of return from the Income-tax Office and submits his return, it will be futile to contend that the Income-tax Officer is not entitled to assess the party or that the party is not liable to pay any tax because a notice had not been issued to him The liability to pay the tax is founded on Sections 3 and 4 of the Income tax Act, which are the charging sections. Section 22 etc are the machinery sections to determine the amount of tax. Lord Dunedin in Whitney v. Commissioners of Inland Revenue [1926] AC 37; 10 Tax Cas 88 stated as follows:—”Now, there are” three stages in the imposition of a tax. There is the declaration of liability, that is the part of the statute which determines what persons in respect of what property are liable. Next, there is the assessment. Liability does not depend on assessment, that ex hypothesi has already been fixed. But assessment particularizes the exact sum which a person liable has to pay. Lastly, come the methods of recovery if the person taxed does not voluntarily pay”. In W.H. Cockerline & Co. v. Commissioners of Inland Revenue [1930] 16 Tax Cas 1, at p. 19, Lord Hanworth, M.R., after accepting the passage from Lord Dunedin’s judgment quoted above, observed as follows:—”Lord Dunedin, speaking, of course, with accuracy as to these taxes was not unmindful of the fact that it is the duty of the subject to whom a notice is given to render a return in order to enable the Crown to make an assessment upon him; but the charge is made in consequence of the Act, upon the subject; the assessment is only for the purpose of quantifying it He quoted with approval the following passage from the judgment of Sargant, L.J., in the case of Williams Not reported: —” I cannot see that the non-assessment prevents the incidence of the liability, though the amount of the deduction is not ascertained until assessment. The liability is imposed by the charging section, namely, Section 38 (of the English Act) the words of which are clear. The subsequent provisions as to assessment and so on are machinery only. They enable the liability to be quantified, and when quantified to be enforced against the subject, but the liability is definitely and finally created by the charging section and all the material for ascertaining it are available immediately”. In Attorney-General v. Aramayo and Others [1925] 9 Tax Cas 445, it was held by the whole Court that there may be a waiver as to the machinery of taxation which inures against the subject. In India these well-considered pronouncements are accepted without reservation as laying down the true principles of taxation under the Income-tax Act.”

These observations of the Court, when applied to provisions of section 139, clarifies that the machinery provisions cannot be divorced from the charging provisions.

There are various persons whose income is exempt from tax, and which were earlier not required to file a return of income u/s. 139, on account of the fact that the total income was exempt from tax. Wherever the legislature thought fit that such persons should file their returns of income, the law has been amended by insertion of various sub-sections to section 139, from time to time, being s/s.s (4A) to (4F) referred to earlier. There has been no such amendment requiring foreign companies whose total income is exempt under a DTAA to file their returns of income, in spite of the fact that the AAR has held as far back as 2007 that foreign companies need not do so.

As regards the argument that the availability of the exemption under the DTAA needs to be examined, and therefore the return of income needs to be filed, taking the argument to its logical conclusion, can one say that every agriculturist in India is required to file his return of income, even though he has only agricultural income, on account of the fact that, whether his income is agricultural or not and whether the exemption u/s. 10(1) is available or not, needs to be examined by the assessing officer?

Interestingly, this aspect of examination of the availability of exemption has also been a matter of controversy between the High Courts in the context of assessees exempt u/s. 10(22), with the Bombay High Court holding, in the case of DIT(E) vs. Malad Jain Yuvak Mandal Medical Centre (2001) 250 ITR 488, that the return of income was required to be filed for such examination of whether exemption was available, and the Delhi High Court, in the case of DIT(E) vs. All India Personality Enhancement & Cultural Centre For Scholars Aipeccs Society 379 ITR 464, holding that there was no such requirement to file return of income if the income was exempt u/s. 10(22).

A DTAA cannot be read in exclusion, but has to be read in conjunction with the Act. In particular, a DTAA does not create a charge to tax, but modifies the charge to tax created by the Act. The fact that DTAAs override the Act implies that, by virtue of the provisions of a DTAA , an income which would otherwise have been chargeable to tax under the Act, may not be chargeable to tax on account of the beneficial provisions of the DTAA. In such a case, one cannot take the view that the income is chargeable to tax in India under the Act, even though it is exempt from tax, since the DTAA takes such income outside the purview of sections 4 and 5 of the Act.

Given this background, the liability to file returns by a foreign company can perhaps be viewed by looking at the different possible situations relating to tax liability of a foreign company in India.

The first would be a situation where the income is chargeable to tax under the Act, as well as under the DTAA . In such a case, there is no doubt that the foreign company is liable to file its income tax return in India.

The second would be a situation where the income is exempt under the Act, as well as under the DTAA. In such a case, since even under the Act, there is no income chargeable to tax, the machinery section, section 139, cannot be brought into play, since it would serve no purpose. Therefore, in such a case, there would be no obligation to file the return of income in India.

The third will be the situation where the income is chargeable to tax under the provisions of the Act, but is exempt from tax by virtue of the DTAA beneficial provisions. In such a case, as discussed above, the better view would be that there is again no obligation to file the return of income in India, in the absence of a specific provision containing such requirement.

The fourth will be the situation where the foreign company has no activity in India and its income cannot be taxed in India under the Act and therefore, it is under no obligation at all to file its return of income under the Act, in India.

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