Category: Controversies

(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.”

The proviso to section 23 allows a deduction from the annual value, of the municipal taxes actually paid during the year. Two other deductions are also permitted by section 24 – standard deduction @ 30% of the annual value, and a deduction for the interest payable on borrowed capital, where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital.

In a case where a property has been let out, the actual rent receivable during the year would be the annual value of the property in accordance with section 23, which value will be further reduced by the deductions specified in section 24 of the Act. In many cases where a property is let out, a broker is appointed to identify a tenant, and brokerage is paid to the broker for finding the tenant. The question has arisen before the Tribunal as to whether such brokerage paid to a broker for letting of the property on rent is an allowable deduction from the actual rent receivable in computing the annual value of the property or not?

While a bench of the Mumbai Tribunal has taken the view that such brokerage is an allowable deduction, another bench of the Mumbai Tribunal has taken a contrary view that brokerage is not an allowable deduction in computing the income from house property .

Govind S. Singhania’s case
The issue came up before the Mumbai bench of the Tribunal in the case of Govind S. Singhania vs. ITO in ITA No. 4581/Mum/2005 dated 3 April 2008 (reported in July 2008 40-A BCA Journal 449).

In that case, relating to assessment year 2002-03, the assessee gave his office premises at Mittal Towers on lease to a company, and incurred expenses of Rs.30,000 for stamp duty and Rs.85,000 for brokerage on account of renewal of lease agreement. The assessing officer held that these expenses were not allowable in computing the income under the head Income from house property, because they did not fall within the category of allowable expenses that were specified by the legislature. The Commissioner (Appeals) confirmed the order of the assessing officer.

Before the Income Tax Appellate Tribunal, it was contended by the assessee that it could not have earned the rental income without incurring these expenses. The stamp duty had to be paid as per the provisions of the Stamp Act on the lease agreement, as a mandatory requirement and since the assessee had let out the premises to the company through a broker, the payment of brokerage was also an obligation on the part of the assessee, which he had to incurr in order to earn the rent. It was further argued that the assessee could have asked the tenant to pay the stamp duty and brokerage, and could have adjusted such expenditures by reducing the amount of rent, in which case the assessee would have got a lower rent equivalent to the net rent. Therefore, such expenses were overriding in nature in relation to the rent receivable and were claimed to be allowable in computing the annual value. It was further argued that it was not the actual gross rent, which was to be treated as annual letting value, but the rent (net of these expenses), which was to be treated as actual rent received by the assessee and as annual letting value.

Reliance was also placed on various decisions of the Mumbai bench of the Tribunal in the context of deductibility of the society maintenance and non-occupancy charges paid to the Society, where it had been held by the tribunal that it was the rent net of such charges, which was to be taken as the annual letting value.

The Tribunal observed that it was not in dispute that without incurring those expenses, the assessee would not have earned the rental income. Further, in computing the annual value u/s. 23(1)(b), rental income received or receivable by the owner had to be taken into consideration and such rent had to be taken net of the expenses on stamp duty and brokerage, and that the said expenses had to be deducted from the very beginning, since whatever came into the hands of the assessee was only the net amount.

The Tribunal also found substantial force in the argument of the assessee that had these expenses been borne by the tenant, and only the net rent paid by the tenant, then the amount of such net rent only would have been taken to be the annual letting value u/s. 23(1)(b). Accordingly, the tribunal held that the annual letting value should be taken net of stamp duty and brokerage paid by the assessee.

Radiant Premises’ case
The issue again recently came up before the Mumbai bench of the Tribunal in the case of Radiant Premises (P) Ltd. vs. ACIT 61 taxmann.com 204.

In this case, relating to the assessment year 2010-11, the assessee had earned a gross rental income of Rs. 1.29 crore in respect of its office premises. It had paid a brokerage of Rs.1.12 crore for sourcing and securing a suitable licensee for the office premises, being 2 months of the rent and 2% of the security deposit. After reducing 30% of the annual value amounting to Rs.0.05 crore, the assessee offered the net rental income of Rs.0.12 crore to tax under the head “Income from House Property”.

The assessing officer did not allow the deduction of Rs. 1.12 crore paid towards the brokerage, holding that the computation had to be done only in accordance with the provisions of section 23, and only standard reduction was allowable u/s. 24. According to the assessing officer, there was no express provision regarding allowance of any expenditure such as brokerage, commission, etc. for determination of the annual value of the property, except the taxes levied by the local authority on payment basis in respect of the property. Relying upon the decisions of the tribunal in the cases of Tube Rose Estates (P) Ltd. vs. ACT 123 ITD 498 (Del) and ACIT vs. Piccadilly Hotels (P) Ltd .97 ITD 564, the assessing officer disallowed the claim of brokerage paid by the assessee.

The Commissioner (Appeals) confirmed the disallowance of brokerage on the ground that such deduction of brokerage was nowhere specified either in section 23 or in section 24.

Before the Income Tax Appellate Tribunal, it was argued that the payment of brokerage was directly related to the earning of rental income, and had therefore to be deducted from the gross rent, since section 23(1)(b) contemplated the actual rent received/receivable. It was argued that in various decisions, the Tribunal had held that stamp duty charges on license agreement, maintenance charges paid to the Housing Society, etc. were allowable u/s. 23 itself, and on the same analogy, brokerage also had to be allowed.

On behalf of the Department, it was argued that no expenditure could be allowed other than those deductions or expenses as specified in sections 23 and 24. It was further argued that most of the decisions cited by the assessee were in respect of maintenance charges paid to the society, which stood on a different footing, because such charges were for the maintenance of the property itself so that rights in the property could be enjoyed.

The Tribunal negatived the plea of the assessee that the phrase “actual rent received or receivable” meant the rent, net of deductions, actually received in the hands of the assessee. According to the tribunal, what was contemplated u/s. 23 was that the annual value of the property, which was let out should be the amount of rent received or receivable by the owner from the tenant/licensee. The first and foremost condition was that the amount should be in the nature of rent as previously agreed upon between the 2 parties for the enjoyment of rights in the property let out against payment of rent. The deductions envisaged in sections 23 and 24 were only in respect of municipal taxes, 30% of the actual value and interest payable on capital borrowed for acquisition, construction, repair, etc.

According to the Tribunal, the word “rent” connoted a return given by the tenant or occupant of the land or structure to the owner for the possession and use thereof. The rent was a sum agreed between the tenant and the owner to be paid at fixed intervals for the usage of such property. The phrase “rent received” and “rent receivable” contemplated the amount received for the enjoyment of the property and certain rights in the property by the tenant. According to the Tribunal, if there was a charge directly related to the rental income or for the property without which the rights in the property could not be enjoyed by the tenant, then it could be construed as part and parcel of enjoyment of the property from where it was received, and then such charges could be held to be allowable from the rent received or receivable. However, in the Tribunal’s view, the brokerage paid to the third party had nothing to do with the rental income paid by the tenant to the owner for enjoying the property. It could therefore not be said to be a charge that had been created in the property for enjoying the rights, and at best, it was only an application of income received/receivable from the rent.

The Tribunal referred to the decision of the Delhi Tribunal in the case of Tube Rose Estates (supra), for the proposition that where services had been provided by a third party to whom the brokerage was payable, the value of such services was not included in the rent. In that case the Tribunal had also distinguished a situation where part of the rent might have become payable to a third party before it accrued to the assessee in terms of an overriding charge, in which case there was diversion of rent at source, and to that extent, could be claimed as deduction while computing the income from house property. In case of payment of brokerage, the Tribunal had held that there was no charge created on the property, much less an involuntary charge enforceable by law, which could be claimed as a deduction.

The Mumbai Tribunal expressed a view that if expenses such as brokerage, professional fees, etc. were held to be allowable, then numerous other expenses like salary or commission to an employee/agent who collected the rent may also be held to be allowable, which was not the mandate of the law. It noted that the decisions cited before it mainly pertained to maintenance charges paid to a society, which was held to be an allowable deduction u/s. 23 itself. It distinguished between maintenance charges and brokerage paid, on the basis that maintenance charges were paid for the very maintenance of the property so as to enjoy the property itself, whereas brokerage had nothing to do with the property or the rent, and was given to a third party, who had facilitated the agreement between the landlord and the tenant to rent the property. It also distinguished the case where stamp duty had been held to be allowable, on the ground that stamp duty was directly related and was in connection with the lease agreement for renting of the property.

The Mumbai bench of the Tribunal therefore held that payment of brokerage could not be allowed as deduction either u/s. 23 or u/s. 24, and confirmed the disallowance of the brokerage paid while computing the income from house property.

A similar view had also been taken by the Mumbai bench of the Tribunal in the case of Township Real Estate Developers (India) (P) Ltd. vs. ACIT 51 SOT 411.

Observations
The issue, as far as section 23 is concerned, revolves around the true meaning of the term ‘actual rent received or receivable’. This term is interpreted in a manner that leaves a room for deducting such expenditure from rent where the expenditure is found to be directly related or in connection with the agreement for letting or receipt of rent. This part even Mumbai Tribunal records with approval in the Radiant Premises’ case. Brokerage is an expenditure that is incurred for earning rent. It is also an expenditure connected to the agreement of lease. It is also not in dispute that a broker, on payment of the brokerage, fetches you the best possible rent. There are no two views about it. In fact, brokerage is more directly related to the earning of better rent than the stamp duty and maintenance charges.

Once it is admitted that the said term used in section 23 is capable of inclusion, it is fair to not limit its scope in an arbitrary manner by selecting a few expenditures in preference to the other few. The interpretation that encourages the deduction is preferable, more so when the facts suggest that the brokerage paid has the effect of fetching a better rent and perhaps a better lessee. If society charges are found to be diverted under an overriding title, there does not appear to be logic in leaving the brokerage behind.

In Radiant Premises’ case (supra), the Tribunal took the view that the brokerage was not a diversion of the rent by overriding title, whereas the society charges was a case of diversion of rent by overriding title. While doing so, the Tribunal failed to appreciate that the brokerage preceded the earning of the rent, and that had it not been for the payment of the brokerage, there may have been no earning of rent. Further, society charges are payable as a consequence of letting out on rent, and arise subsequent and consequent to the accrual of rent. Therefore, if society charges are a diversion of income by overriding title, brokerage is all the more so. Both are inextricably linked with the rental income, and paid to third parties, other than the landlord and the tenant.

It is improper to deny deduction of an expenditure on brokerage simply on the ground that the payment was made to a third party. Payment of stamp duty or maintenance charges are always made to the third party and not to a lessee. In any case, the lessor in rare cases makes a payment to the lessee and therefore the condition that the expenditure should qualify for deduction on the basis of the status of the payee is not tenable. In Tube Rose’s case (supra), the Tribunal held that brokerage was not deductible, as it was paid to a third party. That logic does not appear to be correct, since society charges, which are also paid to a third party, have been held to be deductible.

A separate deduction was provided for collection charges vide section 24(1)(vii), till assessment year 1992-93,. Thereafter the scope of deduction u/s. 24(1)(i) for repairs was enhanced to include collection charges, and the quantum of deduction thereunder was raised to 1/5th of the annual value. Subsequently, with effect from assessment year 2002-03, various other deductions allowable till then, u/s. 24, such as insurance premium, annual charge, land revenue tax, etc. along with the deduction for repairs and collection charges, were replaced by a standard deduction u/s. 24(1)(a) at 30% of the annual value.

It does not appear to be appropriate to hold that substitution of new section 24 for its older version eliminated any possibility altogether for claim of any deduction even u/s. 23 of the Act. One cannot conclude that the standard deduction of 30% is meant to cover even collection charges as well, as was done by the Tribunal in Township Real Estate Developers’ case.

The Tribunal, in the case of Banwari Lal Anand vs. ITO 62 ITD 301 (Del), for assessment year 1989-90, in the context of section 24, held that “any sum spent to collect rent”, referred to in section 24(1)(vii), should be interpreted to mean “any amount spent with an aim to collect rent” and in that view of the matter, brokerage was held allowable as an amount spent to collect rent, being an amount spent with an aim to collect rent. Does this mean that after the amendment, brokerage would now not be allowable?

It is true that in computing the income under each head, only such expenses are allowed that are specifically allowed under the specified chapters that deal with the respective head of income. Admitting this position does not rule out the fundamental understanding that only such an income can be subjected to tax which is the real income. Taxing the gross rent without deduction of the brokerage paid is a case of taxing an unreal income.

Lastly, the logic that, had the parties provided for lower rent, with brokerage payable by the tenant, the annual value would have been such lower rent, is an extremely compelling argument to support deduction of brokerage and the logic is approved in Govind Singhania’s case (supra). Can a mere change of form, without change in substance, change the annual value?

No doubt two views may be possible on the subject, the better view appears to be that, just as society charges and stamp duty are held to be allowable deductions in computing the annual value u/s. 23 itself, brokerage paid for obtaining a tenant too shall also be allowable as a deduction in computing the annual value u/s. 23. It is suggested that the law should be amended to put the issue beyond doubt by providing for a specific deduction, as doing so would make the taxation more realistic.

Issue
To limit concentration of Green House Gases (GHGs), in the atmosphere, for addressing the problem of global warming, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted in 1992. Subsequently, to supplement the convention, the Kyoto Protocol came into force in February 2005, which sets limits on the maximum amount of emission of GHGs by countries. The Kyoto Protocol commits certain developed countries to reduce their GHG emissions. In order to enable the developed countries to meet their emission reduction targets, the Kyoto Protocol provides three market-based mechanisms, one of which is the Clean Development Mechanism (CDM).

Under the CDM, a developed country can take up a GHG reduction project activity in a developing/least developed country where the cost of GHG reduction is usually much lower, and in consideration for undertaking the activity the developed country would be given carbon credits for meeting its emission reduction targets. Alternatively, entities in developing/least developed countries can set up a GHG reduction project, in their respective countries, get it approved by UNFCCC and earn carbon credits. Such carbon credits generated, by the entities in the developing/least developed country, can be bought, for a consideration, by the entities of the developed countries responsible for emission reduction targets. Under the CDM, carbon credits are measured in terms of Certified Emission Reduction (CER) where one CER is equal to 1 metric tonne of carbon dioxide equivalent, and for which a certificate is issued, which certificate is saleable.

The question has arisen, under the Indian tax laws, as to whether the consideration received by an entity for sale of carbon credits generated by it is of a capital nature or a revenue nature, and whether such amount is taxable or not. Incidental questions are whether such income is eligible for deduction under chapter VIA and whether it is liable for MAT. While the Hyderabad, Jaipur and the Chennai benches of the tribunal have taken the view that sale proceeds of carbon credits are not taxable, being capital receipts arising out of environmental concerns and not out of the business, the Cochin bench of the tribunal has taken the view that the sale proceeds of such carbon credits are taxable as a benefit arising out of business.

My Home Power’s case
The issue first arose for consideration before the Hyderabad bench of the tribunal in the case of My Home Power Ltd vs. Dy. CIT 21 ITR (Trib) 186.

In this case, the company was engaged in the business of power generation through biomass power generation unit. During the relevant year, it received 1,74,037 Carbon Emission Reduction Certificates (CERs) or carbon credits for the project activity of switching off fossil fuel from naphtha and diesel to biomass. It sold 1,70,556 CERs to a foreign company and received Rs. 12.87 crore. It accounted this receipt as capital in nature and did not offer it for taxation.

The assessing officer treated the sale proceeds of the CERs to be a revenue receipt, since they were a tradable commodity, and even quoted on stock exchanges. He accordingly added a net receipt of Rs. 11.75 crore to the returned income. The Commissioner(Appeals) confirmed the order of the assessing officer and further held that it was not income from business and was therefore not entitled for deduction u/s. 80-IA.

Before the Tribunal, it was argued on behalf of the assessee that the main business activity of the assessee was generation of biomass-based power. The receipt had no relationship with the process of production, nor was it connected with the sale of power or with the raw material consumed. It was also not the sale proceeds of any by-product. It was further argued that CERs were issued to every industry, which saved emission of carbon, and was not limited to power projects. Further, the certificates were issued keeping in view the production relating to periods prior to the previous year. It was claimed that the amount was not compensation for loss suffered in the process of production or for expenditure incurred in acquisition of capital assets.

It was further argued that the certificates issued by the UNFCCC under the Kyoto protocol only recognised the achievement made by the assessee in emitting lesser quantity of gases than the assigned quantity, and had no relation to either revenue or capital expenditure incurred by the assessee. The certificate itself did not have any value unless there were other industries which were in need of such certificate, and was not dependent on production. In a hypothetical situation where all the industries in the world were able to limit emissions of gases to the assigned level, it was argued that there would be no value for such certificates issued by UNFCCC.

It was claimed that the process of business commenced from purchase of raw material and ended with the sale of finished products, and that the gain was not earned in any of the in-between processes, nor did it represent receipt to compensate the loss suffered in the process. Therefore, the amount did not represent any income in the process or during the course of business. It was also claimed that the amount did not represent subsidy for establishing the industry or for purchase of raw material or a capital asset. UNFCCC did not reimburse either revenue or capital expenditure, and in fact did not provide any funds, but merely certified that the industry emitted a particular quantity of gases as against the permissible quantity. It was therefore not a subsidy granted to reimburse losses. In fact, no payment was made by UNFCCC, but only a certificate was issued without any consideration of profit or loss or the cost of acquisition of capital assets.

It was also argued that the amount could not be considered to be a perquisite, as it was not received from any person having a business connection with the company, and was not received in the process of carrying on the business. It was claimed that unless there existed a business connection, no benefit or perquisite could be derived.

It was also claimed that the amount did not fall within the definition of income u/s. 2(24). It did not represent an incentive granted in the process of business activity, as the amount was not received under any scheme framed by the government or anybody to benefit the industry or to reimburse either the cost of the raw material or the cost of capital asset. The amount was not an award for the revenue loss suffered by the company, as it was granted without relevance to the financial gains or losses. The payment was made without any relevance to the financial transactions of the assessee and there was no consideration for paying this amount. The amount was paid in the interest of the international community and not in the interest of industry as such, or in the interest of the assessee as a compensation for the loss or expenditure during the course of business, and was therefore a sort of gift given by UNFCCC for the distinction achieved by the assessee in achieving emission of lesser amount of gases than the assigned amount. It was therefore not an income within the meaning of section 2(24) or section 28.

Reliance was placed on the decision of the Supreme Court in the case of CIT vs. Sterling Foods 237 ITR 579, for the proposition that just as certificates issued by the government for export of goods which were capable of sale, was held as not arising from the industrial undertaking, but from the export promotion scheme of the government, so also such CER certificates were attributable to the climatic protection scheme of the UNFCCC, which had no relevance to the business activities of the assessee.

It was further pointed out that under the draft Direct Taxes Code (DTC), such items were regarded as income, yet no amendment had been made to the Income-tax Act to bring such items to tax as income. Therefore, the intention of Parliament was not to tax such CERs till such time as DTC came into force.

It was pointed out that in the case of subsidies, subsidies received on revenue account alone would be taxed as income, while subsidies received on capital account were not to be taxed, but would be reduced from the cost of the capital asset for the purposes of claiming depreciation. Further, subsidy received for the public good was held as not taxable. In the case of the assessee, the amount did not represent composition for loss on revenue account, nor a gain during business activities, nor a reimbursement of any capital expenditure. It was claimed that the amount received was for public good and was therefore not taxable.

Besides claiming that it was a capital receipt, it was alternatively claimed that the income was not assessable for the relevant assessment year, since it related to reduction of carbon emissions during earlier years, that the amount was eligible for deduction u/s. 80-IA since the assessing officer was of the view that it was connected to the production of power and that, if it all it was to be taxed, the expenditure relatable to earning certificates had to be arrived at by taking into consideration the assets used and the materials consumed in the earlier years and such amount had to be reduced from the gross receipts to arrive at the taxable amount.

On behalf of the revenue, it was argued that the underlying intention behind the technological implementation by a company in the developing world is not only to reduce the pollution of atmosphere, but also to earn some profit from out of excess units that can be generated by implementation of the CDM project. It was claimed that the CER credits can be considered as goods, as they had all the attributes of goods, viz. utility, capability of being bought and sold, and capability of being transmitted, transferred, delivered, stored and possessed. According to the revenue, the purchase agreement between the assessee and the foreign company indicated that the sale transaction of CERs was nothing but a transaction in goods.

It was further argued on behalf of the revenue that by implementing the CDM project, the assessee got the benefit of efficiency in respect of reduction of pollution. Had there been no other benefits attached to it, under normal circumstances, the assessee would not have bothered to obtain CERs. It was because of the expenditure incurred for implementation of the project as a pollution reduction measure that the assessee got the benefit of the certificates. The expenditure incurred was claimed in its profit and loss account. Since it was known that the UNFCCC certificates had intrinsic value and had a ready market for redemption or trading, the assessee obviously pursued obtaining of these certificates. Further, these certificates were traded and were therefore akin to shares or stocks transacted in the stock exchange, and were therefore revenue receipts rightly brought to tax by the assessing officer.

The Tribunal observed that carbon credits were in the nature of an entitlement received to improve world atmosphere and environment, reducing carbon, heat and gas emissions. According to the Tribunal, the entitlement earned for carbon credits could at best be regarded as a capital receipt and could not be taxed as a revenue receipt. It was not generated or created due to carrying on of business, but it accrued due to world concern. Its availability and assumption of the character of transferable right or entitlement was only due to the world concern.Therefore, the source of carbon credits was world concern and environment, to which the assessee got a privilege in the nature of transfer of carbon credits. Therefore, the amount received for carbon credits had no element of profit or gain and could not be subject to tax in any manner under any head of income.

According to the Tribunal, carbon credits were made available to the assessee on account of saving of energy consumption and not because of its business. Transferable carbon credits was not a result or incidence of one’s business but was a credit for reduction of emissions. In its view, carbon credits could not be considered to be a by-product. It was a credit given to the assessee under the Kyoto Protocol and because of international understanding. According to the Tribunal, the amount received was not received for producing and selling any product, by-product or of rendering any service in the course of carrying on of the business, but was an entitlement or accretion of capital, and hence income earned on sale of these credits was a capital receipt.

The Tribunal relied on the decision of the Supreme Court in the case of CIT vs. Maheshwari Devi Jute Mills Ltd. 57 ITR 36, where it was held that consideration for transfer of surplus loom hours by one mill to another mill under an agreement for control of production was a capital receipt and not an income. It was held that such sale proceeds was on account of exploitation of a capital asset, and it was a capital receipt and not an income. According to the Tribunal, the consideration received by the assessee for carbon credits was similar to the consideration received by transfer of loom hours.

Accordingly, the Tribunal held that carbon credits was not an offshoot of business, but an offshoot of environmental concerns, and that carbon credits did not increase profits in any manner and did not need any expenses. It was a nature of entitlement to reduce carbon emissions, with no cost of acquisition or cost of production to get such entitlement. Therefore, carbon credits was not in the nature of profit or in the nature of income, but a capital receipt.

The view taken by the Hyderabad bench of the Tribunal in this decision was followed by the Chennai bench of the tribunal in the cases of Ambika Cotton Mills Ltd vs. Dy CIT 27 ITR (Trib) 44 and Sri Velayudhaswamy Spinning Mills (P) Ltd vs. Dy CIT 27 ITR (Trib) 106 and recently, the Jaipur bench in the case of Shree Cements Ltd. vs. ACIT, 31 ITR(Trib) 513 has followed the decisions of the Chennai bench.

    Apollo Tyres’ case

The issue again came up before the Cochin bench of the Tribunal in the case of Apollo Tyres Ltd. vs. ACIT 149 ITD 756, 31 ITR(Trib) 477.

In this case, the assessee received Rs. 3.12 crore from sale of CERs or carbon credits generated in the gas turbine unit. The assessee claimed that the income earned on sale of carbon credits was directly and inextricably linked to generation of power and that the assessee would therefore be entitled to deduction u/s. 80-IA. However, the assessing officer and the DRP held that the income was not derived from eligible business and was therefore not eligible for deduction u/s. 80-IA.

Before the Tribunal, the assessee raised an additional ground that the income received on sale of carbon credits was in the nature of capital receipt, and therefore not liable for taxation.

On behalf of the assessee, it was argued before the tribunal that the entitlement to carbon credits arose from the undertaking of the developed countries to reduce global warming and climate change mitigation across the world. It was claimed that carbon credits was an incentive provided to a project which employed a methodology to effect demonstrable and measurable reduction of emission of carbon dioxide in the atmosphere. The mechanism provided for trading CERs provided an opportunity to the holder of such certificate to dispose of the same to an actual user to acquire such credit to be counted toward fulfilment of its committed target reduction. Therefore, the mechanism provided by the United Nations provided an incentive for employment of new technology which helped in emission reduction, and therefore contributed to the desired object to protect the world environment. The purpose of Kyoto protocol was to protect the global environment and incorporate green initiative by adopting new technologies. The underlying object of CERs by the UNFCCC was focused on climate change mitigation by reducing the harmful effect of GHG emission and not to ensure that the recipient of such CER could run his business in a more profitable or cost effective manner.

It was argued on behalf of the assessee that all capital receipts were not income, but only capital gains chargeable u/s. 45 by virtue of the specific definition contained in section 2(24) (vi). Reliance was placed on the decision of the Hyderabad bench of the Tribunal in the case of My Home Power Ltd. (supra) for the proposition that the amount received on transfer of carbon credits was a capital receipt, and therefore not liable for taxation. It was alternatively argued that in case the tribunal found that the income on sale of carbon credits was a revenue receipt, then the assessee was entitled to deduction u/s. 80-IA, because it was inextricably linked to the business of the assessee.

On behalf of the revenue, it was argued that income or amount received by termination or sterilisation of a capital asset would fall in the capital field, but if the amount was received in the course of regular business activity due to sale of a product or entitlement incentive received due to a scheme of the government or the international community, then it would fall in the revenue field. According to the revenue, in the case before the tribunal, there was no sterilisation of any capital asset. The assessee generated power by using a gas turbine. What was given to the assessee was an incentive in the course of its regular business and therefore the amount received on sale of carbon credits had to be treated as a revenue receipt.

It was further submitted that the income on sale of carbon credits was not derived from the industrial undertaking. Though there might be a nexus between the business of the assessee and the receipt of income on sale of carbon credits, the income had to be necessarily derived from the industrial undertaking. In the case before the Tribunal, the income was derived on account of the scheme of the UNFCCC and not from the industrial undertaking. It was therefore argued that the assessee was not entitled to deduction u/s. 80-IA.

The Tribunal analysed the concept of carbon credits. According to it, carbon credits was nothing but an incentive given to an industrial undertaking for reduction of the emission of GHGs, including carbon dioxide. It noted that there were several ways for reduction of emission of GHGs, such as by switching over to wind and solar energy, forest regeneration, installation of energy-efficient machinery, landfill methane capture, etc. According to the Tribunal, it was obvious that carbon credits was nothing but a measurement given to the amount of GHG emission rates in the atmosphere in the process of industrialisation, manufacturing activity, etc. Therefore, carbon credits was a privilege/entitlement given to industries for reducing the emission of GHGs in the course of their industrial activity.

While considering whether the receipt was a capital receipt or a revenue receipt, the Tribunal analysed the decision of the Hyderabad bench of the tribunal in the case of My Home Power Ltd. (supra). It noted that the Tribunal in that case had placed reliance on the judgement of the Supreme Court in Maheshwari Devi Jute Mills Ltd. (supra), and that it had held that the amount received on sale of carbon credits was on sale of entitlement conferred on the assessee by UNFCCC under Kyoto Protocol. It also noted that sale of carbon credits did not result in sterilisation of any capital asset.

Analysing the decision of the Supreme Court in the case of Maheshwari Devi Jute Mills Ltd. (supra), the Cochin bench of the Tribunal noted that in the case before the Supreme Court, it was accepted by the revenue at the lower levels that the loom hours were assets belonging to each member and that it was only at the Supreme Court level, that the revenue contended that the loom hour was a privilege, and not an asset. The Supreme Court did not consider the aspect of whether the loom hours was a capital asset, since it had been accepted to be a capital asset, right up to the proceedings before the High Court, and a change in stand was not permitted by the Supreme Court. It was based on these facts that the Supreme Court held that the receipt on sale of loom hours must be regarded as capital receipt and not as income. The Tribunal according held that the said decision did not really help the case of the assesee as it was delivered on the facts of the case and therefore found that the Hyderabad bench was unduly influenced by the said decision of the Supreme Court in concluding that the carbon credits were capital assets.

The Cochin bench of the Tribunal noted that in the case before it, right from the assessment proceedings before the assessing officer till before the Tribunal, the assessee had not made any claim that the carbon credit was a capital asset as defined in section 2(14). Further, the assessee had claimed deduction u/s. 80-IA in respect of sale of carbon credits. Therefore, the assessee had effectively conceded that carbon credits were not capital assets. According to the Tribunal, had the assessee claimed that the carbon credits were capital assets, it would not have claimed deduction u/s. 80-IA on the income derived from sale of the carbon credits. The Tribunal observed that the assessee itself treated the carbon credits as an entitlement or privilege generated in the course of business activity.

The Tribunal noted that the assessee was engaged in the business of manufacture of tyres and for the purpose of captive consumption, the assessee generated electric power by using a gas turbine. In the process of power generation, the assessee reduced emission of carbon dioxide and therefore received carbon credits. According to the Tribunal, it was obvious that carbon credits were obtained by the assessee in the course of its business activity. The Tribunal was of the view that when the carbon credits was an entitlement or privilege accruing to the assessee in the course of carrying on of manufacturing activity, it could not be said that such carbon credits was an accretion of a capital asset. It noted that carbon credits was not a fixed asset or tool of the assessee to carry on its business. According to it, the sale of carbon credits was a trading or revenue receipt.

The Tribunal also considered the aspect of whether import entitlement was at par with carbon credits. It noted that both import entitlements and carbon credits came from a scheme, one of the government and one of the UNFCCC under the Kyoto protocol. It was therefore of the view that both were on par. Following the decision of the Kerala High Court in the case of OK Industries vs. CIT 42 CTR 82, which had held that import entitlement was generated in the course of business activity and could not be treated as an asset within the meaning of section 2(14), the Tribunal held that carbon credits also could not be treated as capital assets.

The Cochin bench of the Tribunal observed that the provisions of section 28(iv) read with section 2(24)(vd), which brought to tax the value of any benefit or privilege arising from business, were not brought to the notice of the Hyderabad bench of the Tribunal in the case of My Home Power Ltd. (supra), and that therefore that decision was not applicable to the case before it.

The Tribunal therefore held that the sale of carbon credits constituted revenue receipts and profits and gains of the business u/s. 28(iv) read with section 2(24)(vd).

    Observations

Sale proceeds of carbon credits have not been specifically included in section 28, or in the definition of income u/s. 2(24). The legislature when desired, has amended the Income-tax Act to include certain specific receipts as income, even though the character of such receipts may not necessarily be in the nature of income. For instance, profits on sale of import entitlements and certain other specified receipts are specifically included as an income u/s. 28(iiia) to (iiie) read with section 2(24)(va) to (ve). Similarly, amounts received under an agreement for not carrying out any activity in relation to business is specifically taxable u/s. 28(va) read with section 2(24)(xii). The Cochin bench of the Tribunal does not seem to have considered this important fact of the omission, to expressly provide for the taxation of the carbon credits, which fact convey the intent of the legislature to not expose such receipts to taxation, which intent is further strengthened by clause(ii) to the proviso to section 28(va).

There is a specific exclusion, from taxation, under the clause(ii) to the proviso to section 28(va) for compensation received from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone Layer under the United Nations Environment Programme. Such compensation is similar in character to carbon credits, in the sense that both are received under a multilateral convention for protection of the environment for doing or not doing a particular activity, which results in environment improvement. The intention therefore appears to be not to tax such amounts, since these are rewards for benefiting the world and public in general.

The Cochin bench of the Tribunal seems to have been largely influenced by the fact that the assessee, in the initial stages before the tax authorities, had taken the stand that the amount was taxable and was relatable to its power generation business. It therefore proceeded on the footing that the assessee itself had considered the carbon credits as the receipts arising from its power generation business.

The fact that carbon credits are transferable or that they are traded on stock exchanges is irrelevant for deciding the fact as to whether they are capital receipts or revenue receipts. Similarly, it is not necessary that all benefits arising from business activity are of a revenue nature. For instance, by carrying on business, goodwill or a brand may be generated, which is of a capital nature. In fact the various receipts, now specifically made taxable under different clauses of section 28 aforesaid, are the cases of business receipts in the nature of capital, that are made taxable under specific legislation.

The real issue is whether the carbon credits, even where regarded as benefits or perquisites, arise from the business? The Hyderabad bench of the Tribunal, relied on the Supreme Court’s decision in the case of Sterling Foods (supra) to take a view that the export entitlements did not arise from the business of the industrial undertaking, but from the scheme of the Government. The view of the Cochin bench of the Tribunal, however meritorious, that the carbon credits arose on account of the manner in which the business was carried on, and was not totally divorced from the business activity, is at the most debatable. Considering the importance of the environment protection and the need to promote the measures to protect it, the Government should specifically amend the law if it believes that the carbon credits are taxable as income. In fact, the intention seems to have been to tax it once the DTC came into force, as the draft DTC had provisions for taxing such amount. If the intention is to tax it now, the Income-tax Act needs to be amended on the lines of Clauses (va) to (ve) of section 2(24) and Clauses (iiia) to (iiie) of section 28 for that purpose.

However, for the time being, the issue seems to have been concluded in favour of the assessee, by the Andhra Pradesh High Court, which approved the decision of the Hyderabad bench of the Tribunal in the case of CIT vs. My Home Power Ltd., 365 ITR 82. The Andhra Pradesh High Court agreed with the findings of the Tribunal that carbon credit is not an offshoot of business, but an offshoot of environmental concerns, and that no asset is generated in the course of business, but is generated due to environmental concerns. According to the High Court, the carbon credit was not even directly linked with power generation. The High Court held that the amount received on sale of excess carbon credits, was a capital receipt, and not a business receipt or income.

Dividend is an income under the Income-tax Act, 1961. The term ‘dividend’ is inclusively defined in section 2(22), vide five clauses, (a) to (e). These clauses primarily provide for treatment of certain distribution or payments, by the company, as dividend to the extent of the accumulated profits of the company. Clause (e) provides for payment of certain loans and advances by a company to a certain category of shareholders or for the benefit of this category of shareholders, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (popularly referred to as ‘deemed dividend’). This clause reads as under:

“(e) any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) 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 (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits;”

These loans or advances to the specified shareholders or for the benefit of such shareholders or to the concerns in which such shareholders are substantially interested, are therefore taxable as dividend. Such dividend is not subject to the dividend distribution tax u/s.115-O, and is therefore a taxable income, not exempt u/s.10(34) of the Act.

In cases of payments of loans and advances to the specified concerns, the following questions have arisen before the courts in the recent past, in interpretation of this provision, namely, (a) whether the dividend under this clause is taxable in the hands of a shareholder or in the hands of the concern receiving the loan; (b) should the person being taxed be the registered as well as the beneficial shareholder; and (c) whether in cases of the fiduciary holding, the recipient can be taxed even where he is not the registered owner of the shares by presuming the recipient concern to be the shareholder. While the Bombay High Court had approved the decision of the Special Bench of the Tribunal that the dividend be taxed in the hands of the shareholder, only and not in the hands of the concern and further that the shareholder has to be both a registered shareholder as well as the beneficial shareholder, recently the Delhi High Court in a dissenting decision has taken a different view of the matter, holding that such dividend is taxable in the hands of the concern receiving the loan or advance where the firm is a beneficial shareholder, not following its own decision in an earlier case.

Universal Medicare’s case The issue came up before the Bombay High Court in the case of CIT v. Universal Medicare Private Limited, 324 ITR 263.

In this case, an amount of Rs.32 lakhs was transferred from the bank account of one company to the bank account of the assessee-company. One of the directors held over 10% of the equity capital of the company, which transferred the funds and also held over 20% of the equity capital of the assessee-company. This transfer was part of a misappropriation by a senior employee, who had opened bank accounts and carried out certain transactions to defalcate funds.

The assessee claimed that the amount was neither an advance nor a loan to the assessee, but represented misappropriation of funds by the senior employee. Alternatively, it was forcefully contended that, even assuming that this was an amount advanced to the assessee, for the purposes of taxation, the deemed dividend would be taxable in the hands of the shareholder and not in the hands of the assessee to whom the payment was advanced. The Assessing Officer concluded that the section 2(22)(e) provided for taxation in the hands of the recipient company and that they were attracted the moment a loan or advance was made and that subsequent defalcation of funds was immaterial. Noting that all the requirements of section 2(22)(e) were fulfilled, the Assessing officer concluded that the loan was to be treated as deemed dividend in the hands of the recipient company and not in the hands of the shareholder director.

The Commissioner (Appeals) affirmed the order of the Assessing officer. The Tribunal reversed the findings of the Commissioner (Appeals) on the reasoning that the amount was taxable in the hands of the shareholder director and not in the hands of the assessee-company and also on the fact that the amount was part of a fraud committed, and that the transaction was not reflected in its books of accounts of the company.

The Bombay High Court analysed the provisions of section 2(22)(e), and observed that the clause was not artistically worded. It noted that Parliament had expanded the ambit of the expression ‘dividend’ by providing an inclusive definition. It noted that the payment by a company had to be by way of an advance or loan. On facts, it noted that the Tribunal had found that no loan or advance was granted to the assessee-company, since the amount in question had actually been defalcated and was not reflected in the books of account of the assessee-company. According to the Bombay High Court, this was a pure finding of fact which did not give rise to any substantial question of law.

The Bombay High Court, on law, concurred with the construction placed on the provisions of section 2(22)(e) by the Tribunal. It held that all payments by way of dividend had to be taxed in the hands of the recipient of the dividend, namely, the shareholder; that the effect of section 2(22) was to provide an inclusive definition of the expression ‘dividend’ and clause (e) expanded the nature of payments which could be classified as dividend; that looking at the different types of payments covered by this clause, the effect of clause (e) was to broaden the ambit of the expression ‘dividend’ by taxing the shareholder where certain payments were made by way of a loan or advance or payments on behalf of or for the individual benefit of such a shareholder and that the definition did not alter the legal position that dividend had to be taxed in the hands of the shareholder and consequently, even assuming that the payment was dividend, the payment was taxable not in the hands of the assessee-company, but in the hands of the shareholder.

National Travel Services’ case

In this case, the assessee was a partnership firm, having three partners. It had taken a loan of Rs.28.52 crore from a company, in which the assessee had invested in equity shares constituting 48.18% of the capital of the company. However, the shares were acquired in the names of two of the partners of the assessee.

Before the Delhi High Court, the assessee highlighted that the issue as to whether the person to whom the payment was made should not only be a reg-istered shareholder but a beneficial shareholder as well was concluded by the Delhi High Court in the case of CIT v. Ankitech Pvt. Ltd., (ITA No. 462 of 2009) and other cases, decided on 11th May 2011 (43-A BCAJ 327, June 2011 — full text available on www.itatonline.org), where the Court had held that the loan or advance could be taxed only in the hands of the shareholder, and not in the hands of the company receiving the loan or advance and had observed therein that the expression ‘shareholder, being a person who is the beneficial owner of shares’ referred to in section 2(22)(e) meant that the shareholder should be both a registered shareholder and a beneficial shareholder.

In addition, it was argued that for the purposes of income-tax, a partnership firm is different from its partners. A reference was made to various provisions of the Companies Act [including section 187(c) and section 153 read with section 147], and to SEBI guidelines on joint shareholding in respect of partnership firm, in support of the proposition that the partnership firm in its own right could be the shareholder as distinguished from the partners themselves. Reliance was placed by the assessee on the decision of the Allahabad High Court in the case of CIT v. Raj Kumar Singh and Co., 295 ITR 9, where the Court had held that the conditions stipulated in section 2(22)(e) were not satisfied where the assessee firm was not the shareholder of a company which gave the loan, but partners of the firm were its shareholders.

On behalf of the Department, it was argued that on first principles, under the Indian Partnership Act, a partnership firm was not a separate entity but was synonymous with the partners. It was argued that when shares were acquired by a partnership firm, for want of its own separate legal entity, the shares had to be bought in the names of partners, and in no case, shares could be held in the name of the partnership firm however, for all intended purposes, it was the partnership firm, which was the shareholder in such a case.

The Delhi High Court agreed that the person to whom the loan or advance was made should be a shareholder as well as beneficial owner and proceeded further to examine the question whether the assessee firm could be treated as a shareholder having purchased shares through its partners in the company, or whether the shareholder necessarily had to be a registered shareholder and hence the shares should have been registered in the name of the firm, itself. The Delhi High Court observed that if the assessee’s contention was accepted, a partnership firm could never come within the mischief of section 2(22)(e), because the shares would be necessarily purchased by the firm in the names of its partners since it did not have any separate entity of its own and the firm therefore could never be a registered shareholder.

According to the Delhi High Court, by requiring a firm to be a registered shareholder, the very purpose of enactment of this provision would be defeated, and this would lead to absurd results. The Delhi High Court observed that though a deeming provision had to be strictly construed, it had also to be taken to its logical conclusion by making the law workable and to meet that in case of the purchase of shares by the firm in the name of its partners, it was the firm which was to be treated as shareholder for the purposes of section 2(22)(e).

The Delhi High Court therefore concluded that a partnership firm was to be treated as the shareholder even if the shares were held in the names of its partners, and it was not necessary that the partnership firm had to be the registered shareholder. The loan received was held to be taxable as deemed dividends in the hands of the partnership firm.

Observations

The ratio of the decision in National Travel Services’ case where applied to the issues discussed here is that a person for being taxed has to be a registered and the beneficial shareholder so however in cases of the fiduciary ownership the beneficial owner can be presumed to be the registered owner even where he may not be the one. Such an assumption, found to be permissible in law by the Court, however makes no departure from the understanding held so far that the dividend under clause (e) can never be taxed in the hands of a specified concern where the concern is not holding any shares, beneficially or otherwise, in the capital of the company which makes the payment of the loan or advances. In cases where the payment is sought to be taxed on the basis of the common shareholder, the tax if any shall continue to levied in the hands of the shareholder only and not in the hands of the recipient concern. The ratio of the Court’s own decision in the case of Ankitech Pvt. Ltd. remains uncontroverted to that extent.

The Rajasthan High Court in the case of CIT v. Hotel Hilltop, 313 ITR 116 (Raj.), held that in the case of a payment of an advance by a company to a partnership firm, where a shareholder of the said company holding 10% or more of the shares of the company and who also had substantial interest in the said partnership firm, the amount of payment could not be taxed as a deemed dividend in the hands of the firm, but would be taxed in the hands of the individual, on whose behalf or for whose individual benefit, being such shareholder and partner, the amount was paid by the company to the partnership firm.

The Special Bench of the Income-tax Appellate Tribunal, in the case of ACIT v. Bhaumik Colour Pvt. Ltd., 313 ITR (AT) 146 (Mum., SB), has held that if a person is a beneficial shareholder but not a registered shareholder, or if a person is a registered shareholder but not the beneficial shareholder, then the provisions of section 2(22)(e) will not apply and in that view of the matter dividend u/s.2(22)(e) cannot be taxed in the hands of a concern where a certain shareholder is a partner with a substantial interest.

The decision of the Delhi High Court in National Travel Services’ case seems to be primarily applicable to cases of partnership firms owning shares in companies which shares are held in the names of their partners. As noted the decision does not seek to alter the understanding in respect of the loan or advances received by the firm where the firm does not hold any shares directly or indirectly through partners of the company in which case, it is only the shareholder who would be taxable i.e., a person who is the owner of the shares of the company and is also the partner of the firm and is otherwise the registered and the beneficial owner of the shares.

While the Delhi High Court has carved out an exception in the cases of partnership firms that own the shares of the company and such firms on account of the fact that partnership firms cannot hold the shares in their own names are holding the shares in the names of the partners. In doing so, the Delhi High Court has taken a view different from that of the Allahabad High Court and the Court in doing so has also not followed the ratio of the decision of the Allahabad High Court in Raj Kumar Singh and Co.’s case (supra).

The concept that the reference to the term ‘shareholder’ means registered shareholder has been laid down by the Supreme Court as far back as in the cases of CIT v. C. P. Sarathy Mudaliar, 83 ITR 170 and Rameshwarmal Sanwarmal v. CIT, 122 ITR 1, which was in the context of an HUF as the shareholder of a company. In fact, even earlier a similar view was taken by the Supreme Court in the case of Howrah Trading Co. Ltd. v. CIT, 36 ITR 215, in the context of taxation of dividends in the hands of a shareholder who had not lodged his shares for transfer, though he had acquired a beneficial interest in the shares. These decisions were rendered in the context of the law as it stood prior to the amendment by the Finance Act, 1987 made effective from 1st April 1988.

The provisions of section 2(22)(e) were amended with effect from 1st April, 1988, by the Finance Act, 1987. Prior to the amendment, only a loan or advance to a shareholder, being a person who had a substantial interest in a company, or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, was taxable as dividend. The amendment introduced the requirement of the shareholder being a beneficial owner of shares holding not less than 10% of the voting power, as well as extended the definition to concerns in which such shareholder was a member or partner, in which he has a substantial interest. This amendment also inserted the definition of ‘concern’ in explanation 3(a), to mean an HUF, or a firm, or an association of persons or a body of individuals or a company.

Does the insertion of this requirement of beneficial ownership of shares mean that the concept of registered shareholder is no longer relevant and therefore once a person is found to be a beneficial owner the dividend will be taxable in his hands, irrespective of the fact that he is not a registered shareholder? The Special Bench of the Income-tax Appellate Tribunal, in the case of ACIT v. Bhaumik Colour Pvt. Ltd., 313 ITR (AT) 146 (Mum., SB), has held that it is a principle of interpretation of statutes that once certain words in an act have received a judicial construction in one of the superior courts, and the Legislature has repeated them in a subsequent statute, the legislature must be taken to have used them according to the meaning which a Court of competent jurisdiction has given them. The Tribunal therefore held that the expression ‘being a person who is the beneficial owner of shares’ only qualifies the word ‘shareholder’ and does not in any way alter the position that the shareholder has to be a registered shareholder, nor substitute the requirement to a requirement of merely holding a beneficial interest in the shares without being a registered holder of shares. The Tribunal therefore held that if a person is a beneficial shareholder, but not a registered shareholder, or if a person is a registered shareholder, but not the beneficial shareholder, then the provisions of section 2(22)(e) will not apply.

The issue therefore is whether a partnership firm can be regarded as a shareholder in a company where the shares are held by the partners of the partnership firm for and on behalf of the firm. Similar can be the case where the shares are held by the karta of an HUF for and on behalf of the HUF and the trustee of a Trust for and on behalf of the Trust. Whether the shares are assets of the partnership firm or the individual assets of the partners would normally be determined based on how the firm and the partners have treated the assets — for instance, disclosure of the shares as assets of the partnership firm or the partners in their respective accounts, disclosure of the dividends as income of the partnership firm or the partners in their respective accounts, etc. While there may not be any dispute about the beneficial ownership of the firm over the shares, it is not possible to hold the firm as the legal owner in view of the corporate laws prohibiting the holding of shares in the names of the firm and in that view of the matter it is not possible to hold the firm as a registered shareholder and if that be so the dividend cannot be taxed in the hands of the firm and also not in the hands of the partners where the beneficial ownership is not with them.

The fact that a firm is specifically listed among the entities that are regarded as ‘concern’ indicates that the intention is also to rope in loans or advances to partnership firms, and to achieve that the payments to such concerns has to be taxed but will be taxed in the hands of such person who owns shares with certain percentage of voting rights and is also the partner holding a substantial interest in the firm. Dividend cannot be taxed in the hands of the firm in cases where the firm is not the owner of the shares as even the Delhi High Court does not suggest so. Where the firm is the owner of the shares it may not be taxable in its hands in view of the decisions referred to above. The ratio of the Delhi High Court decision therefore, if at all, applies only to a limited situation of a partnership firm, where the partnership firm treats the shares as its own assets, but the shares are held in the names of partners on behalf of the partnership firm.

Since the entire purpose is to tax dividends, and dividends can arise only to the shareholder, the better view of the matter is that it is only the shareholder who can be taxed, even if the advance is to a concern in which he is substantially interested, since the shareholder is deriving an indirect advantage or benefit through such concern.

The primary right of taxing an income of its subjects is accepted internationally to be that of a country of residence (‘Residence State’ ), irrespective of the time and place of earning an income. This rule does not preclude the country of source (‘Source State’) from taxing an income. To avoid double taxation of the same income, countries enter into agreements, to provide that only one of the two countries shall tax an income and the other shall not do so (Income Elimination or Exemption Method ‘IEM’), or to provide for credit for taxes paid ( Tax Credit Method-‘TCM’) in the country of source while taxing the same income in the country of residence. In cases of some income, for example, royalty, fees for technical services, interest, dividends etc., these agreements provide for taxing income in the country of source at a concessional rate. Income arising from an immovable property is generally taxed in the country of source. Likewise, business income is taxed in the country of source provided the businessman has a permanent establishment(‘PE’) in that country. In the same manner, income of a service provider is taxed in the country of source only, when he has a fixed base in that country or his stay in that country exceeds a certain number of days.

These above general rules of taxation or assumptions underlying international taxation, like any contract, are subject to any agreement to the contrary by the contracting countries. Countries which execute Double Taxation Avoidance Agreements (‘DTAA’) may agree to adhere to the generally accepted principles of taxation or may agree to differ from them by mutual agreements executed to the contrary.

DTAAs, to give effect to the intentions of the countries, employ different terminologies like; ‘shall be taxed’, ‘shall be taxed only’, ‘may be taxed’, ‘may also be taxed’, ‘may be taxed in’, ‘shall be taxed only in’, ‘shall only be taxable’, etc. Different treatments may be provided for different sources of income in the same DTAA by employing suitable language. It is commonly understood that an income will be taxed in one country only when the DTAA employs the terms like ‘shall be taxed’ or ‘shall be taxed only’. The income will be taxed in both the countries where a DTAA uses ‘may also be taxed’. The employment of the term ‘may be taxed’ however has posed serious issues of interpretation in the Indian context. One school of thought is of the view that use of words ‘may be taxed’ mean that the Source State has the exclusive right of taxation leading to complete exclusion of right of taxation for the Residence State . The other school is of the view that the use of the words ‘may be taxed’ preserves the right of taxation of the Residence State while conferring non-exclusive rights on the Source State. Conflicting decisions available on the subject are discussed here.

Ms. Pooja Bhatt’s case

The issue arose before the Mumbai bench of the ITAT in the case of Ms. Pooja Bhatt v. Dy.CIT, 26 SOT 574. In that case, the assessee, an Indian resident, had received income from performing stage shows in Canada on which tax was deducted in Canada. The assessee claimed that such income was not taxable in India in view of the India Canada DTAA, 229 ITR 44 (St.). The issue needed to be examined particularly under Article 18 of the said DTAA , which reads as under:

Article 18 ; Artistes and athletes

……….

Strong reliance was placed by the revenue on Article 23 “Elimination of double taxation”, to contend that the insertion of a specific provision for granting tax credit by the Residence State while taxing the income of the resident confirmed the intention to tax such income in both the states. Paragraph 1 of this Article, providing that the laws in force in either of the Contracting States will continue to govern the taxation of income in the respective Contracting States except where provisions to the contrary were made in the Agreement, was greatly relied upon. (For the sake of brevity, this article is not reproduced here.)

The assessee, a film artiste, participated in an entertainment show performed in Canada and received a sum of USD 6000. Tax was deducted at source in Canada equal to the sum of USD 900. The assessee claimed in the course of assessment proceedings that a sum of Rs. 1,86,000 (US dollars 6000) could not be taxed in India in view of Article 18 of India-Canada Treaty, which contention was rejected by the AO. The AO found that the assessee was a resident of India and consequently, it was held by him that her entire global income was taxable under the provisions of the Income-tax Act, 1961 . It was further observed by him that the assessee was entitled to relief under Article 23(3)(a) of the DTAA. On appeal, the CIT(A) confirmed the order of the AO. Aggrieved by the same, the assessee filed an appeal before the Tribunal.

On behalf of the assessee, it was contended that by virtue of Article 18 of the India-Canada Treaty, the income derived by an artiste or an athlete by performing shows/activities in Canada could not be taxed in India, since Article 18 permitted only the other contracting State, i.e., the source country to tax such income. In support of the proposition, reliance was placed on the decisions of the Hon. Supreme Court in the cases of P.V.A.L. Kulandagan Chettiar 267 ITR 654 and Turquoise Investment & Finance Ltd., 300 ITR 12, and on the decision of the Madras High Court in the case of CIT v. VR. S.R.M. Firm, 208 ITR 400 [affirmed by the Supreme Court in Kulandagan Chettiar’s case (supra)], wherein the expression “may be taxed” was interpreted to mean that the other contracting State was precluded from taxing the income.

On the other hand, the Revenue submitted that the decision of the Supreme Court in Kulandagan Chettiar’s case (supra) was on the issue of domicile, that the expression “may be taxed” was never construed by the court, that the Madras High Court decision was affirmed on different reasoning and, therefore, Supreme Court decision relied on by the assessee was distinguishable. Reliance was placed on the decision in the case of S. Mohan, In re [2007] 294 ITR 177(AAR) wherein the expression ‘may be taxed’ was construed and it was held that such words did not preclude the contracting State of residence taxing the same, if the assessee was liable to tax under the domestic law. According to this judgment, the assessee was only entitled to double taxation relief if tax had been paid in the source country. It was also submitted that the Supreme Court decision in Kulandagan Chettiar’s case (supra) was distinguished by the AAR, observing that the Supreme Court did not express any opinion regarding the scope of the expression “may be taxed”.

The Revenue further submitted that the India-Canada Treaty was similar to the OECD Model Convention and, therefore, its meaning should be understood as per the OECD Commentary. It was further submitted that there were two categories of treaties. According to one category, the relief was provided by way of exemption from tax, like in the India-Austria Treaty, and the other category was where relief was given by way of credit in respect of tax paid in other country, such as India-Canada Treaty. Therefore, the assessee was only entitled to credit for the tax paid in Canada as per the provisions of Article 23 of India-Canada Treaty. Reference was also made to page 971 of the Commentary by Klaus Vogel to contend that tax could be levied by both countries. Regarding the judgment of the Supreme Court, it was submitted that India- Malaysia Treaty considered by the Apex Court came into effect from 1-4-1973 when OECD Commentary was not in existence and, therefore, the court refused to look into the commentary. However, in the present case, the OECD Commentary was very much in existence at the time of agreement between the two countries and, therefore, the provisions of treaty should be understood as per the OECD Commentary.

The tribunal noted the undisputed facts that – (i) the assessee was a resident of India, (ii) she was an artiste who performed the entertainment show in Canada for which she was paid US Dollars 6,000 equivalent to Indian Rupees 1,86,000, (iii) tax of 900 US Dollars was deducted at source in Canada; there was also no dispute that as per the domestic law, the assessee was liable to pay tax on her entire global income. The question was whether liability to pay tax under the domestic law could be avoided in view of the provisions of Article 18 of the India-Canada Treaty.

On consideration of the rival contentions, the tribunal held that income derived by the assessee from the exercise of her activity in Canada was taxable only in the source country, i.e., Canada. On an analysis of various Articles contained in Chapter III, the tribunal found that the scheme of taxation was divided in three categories; The first category included Article 7 (Business profits without P.E. in the other State), Article 8 (Air transport), Article 9 (Shipping), Article 14 (capital gains on alienation of ships or aircrafts operated in international traffic), Article 15 (Professional services), Article 19 (Pensions) all of which provided that income shall be taxed only in the State of residence. The second category included Article 6 (Income from immovable property), Article 7 (Business profits where PE is established in other contracting State), Article 15 (Income from professional services under certain circumstances), Article 16 (Income from dependent personal services where employment is exercised in other contracting State), Article 17 (director’s fees), Article 18 (income of Artistes and Athletes), Article 20 (Govt. Service), all of which provided that such income may be taxed in the other contracting State, i.e., State of source. The third category included Article 11(Dividends), Article 12 (Interest), Article 13 (Royalty and fee for technical services), Article 14 (capital gains on other properties) and Article 22 (Other income), all of which provided that such income may be taxed in both the contracting States.

The tribunal noted that this clearly showed that the intention of parties to the DTAA was very clear. Wherever the parties intended that income was to be taxed in both the countries, they had specifically provided in clear terms and as such, it could not be said that the expression “may be taxed” used by the contracting parties gave option to the other contracting State to tax such income. Contextual meaning had to be given to such expression and if the contention of the revenue was accepted, then the specific provisions permitting both the contracting States to levy tax would become meaningless. The conjoint reading of all the provisions of Articles in Chapter III of India-Canada Treaty, led to only one conclusion that by using the expression “may be taxed in the other State”, the contracting parties permitted only the other State, i.e., State of source, to tax such income and by implication, the State of residence was precluded from taxing such income. Wherever the contracting parties intended that income may be taxed in both the countries, they had specifically so provided and the contention of the revenue that the expression “may be taxed in other State” gave the option to the other State and that the State of residence was not precluded from taxing such income, was unacceptable.

The reliance of the revenue on Article 23, the tribunal observed, was also misplaced as this provision had been made in the treaty to cover the cases falling under the third category i.e., the cases where the income might be taxed in both the countries. The cases falling under the first or second categories would be outside the scope of Article 23, since income was to be taxed only in one state.

Reliance placed by the revenue on the commentary by Klaus Vogel was found to be untenable by the tribunal, on the ground that it was now the settled legal position that commentaries could be looked into as a guiding factor only where the language of the treaty was ambiguous. In support of this view, a reference was made to the Supreme Court decision in the case of Kulandagan Chettiar (supra). In the case before them, it was found that the intention of the contracting parties was very much clear from the treaty itself. In any case, the commentaries were not binding on courts, since the same were of persuasive value or indicative of contemporaneous thinking, and the parties to the agreement were always at liberty to deviate from the same. Even assuming that the commentary supported the stand of the revenue, the same could not be accepted, since parties to the agreement had deviated from the same, clearly indicating their intention in the treaty itself.

The tribunal supported its view by referring to the Madras High Court decision in VR. S.R.M Firm (supra) where the assessee was resident of India and had earned profit on sale of immovable property in Malaysia. Article 6 of Indo-Malaysia Treaty provided that such income may be taxed in the State in which such property was situated. The assessee claimed that he was not liable to pay tax on such income in view of Article 6 of the treaty. In the above facts, the court had held that the income was taxable only in Malaysia. The tribunal observed that since the above decision had been affirmed by the Apex Court, there was no scope for taking a different view, though the Apex Court had observed that the decision of the Madras High Court was being affirmed for different reasons; the conclusion, however. remained that income could not be assessed in the State of residence, where the agreement provided that income may be taxed in the source country.

The tribunal also supported its view by referring to the decision of the Madhya Pradesh High Court in the case of Turquoise Investment & Finance Co. (supra) where the court, following the decision of the Madras High Court in the case of VR.S.R.M. Firm (supra), held that income arising on the sale of immovable property in Malaysia could not be taxed in India. It noted that the similar issue was decided in favour of the assessee by the Karnataka High Court in the case of CIT v. R.M. Muthaiah, 202 ITR 508. In that case also the assessee who was resident in India had earned income in Malaysia and claimed the same as exempt from tax in India in view of DTAA between India and Malaysia.

The AAR decision in the case of S. Mohan (supra) was found by the tribunal to be based on the interpretation of Article 16 in isolation i.e., without considering the scheme of taxation under the treaty, and the tribunal therefore did not follow the said decision.

It was held that the assessee could not be taxed in respect of the sum of Rs. 1,86,000 under the provisions of the Income-tax Act, 1961 in view of the overriding provisions of the India-Canada DTAA.

Telecommunications Consultants India Ltd.’s case

The issue recently arose in the case of Telecommunications Consultants Ltd. , 18 ITR(Trib.) 363, before the Delhi bench of the Tribunal. The assessee, a public sector undertaking owned by the Government of India under the administrative control of the Ministry of Communications, was in the business of providing full range of consultancy, design and engineering services in all fields of telecommunication in India as well as abroad. On the global front, the assessee had executed turnkey/consultancy projects in many countries in Africa and Middle East, besides South and South East Asian and CIS Countries.

The main issue involved in the appeals before the tribunal was regarding the taxability in India of income earned in a foreign country by the assessee, which was a resident of India. The relevant grounds of appeal read as under :-

“5. That on the facts and circumstances of the case and in law, the Learned CIT (Appeal) has erred in confirming the action of the Assessing Officer that the business income amounting to Rs. 10,68,26,533 attributable to the Permanent Establishment(s) of the appellate located in Oman, Mauritius, Netherlands and Tanzania, is exigible to income tax in India under the scheme of the Act.

6.    That on the facts and circumstances of the case and in law, the Learned CIT (Appeal) has erred in ignoring that the business income amounting to Rs. 10,68,26,533 is attributable to the Permanent Establishment(s) of the appellate located in Oman, Mauritius, Netherlands and Tanzania, are countries with which India has Comprehensive Agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income.”

The assessee claimed that such income was taxable only in the respective countries as per the DTAA and not taxable in India. It submitted that the income attributable to the permanent establishment in the foreign country, with whom DTAA was in existence, should not be considered for the purposes of Indian taxation . It advanced the following contentions in support of its stand;

(i)    For the purposes of interpretation of an international treaty, an important aspect that needed to be considered was that treaties were negotited and entered into at a political level and have several considerations as their basis.

(ii)    The main function of a DTAA was to provide a bargain between two treaty countries as to the division of tax revenues between them in respect of income falling to be taxed in both jurisdictions. [Azadi Bachao Andolan, 263 ITR 706 (SC)].

(iii)    Primary objective of the DTAA entered into by India was avoidance of double taxation and not relief from double taxation. [Sivagami Holdings (P.) Ltd. 20 taxmann.com 166 (Chennai) wherein the ITAT had held that the DTAA was entered into between the countries only for the limited purpose of avoiding the hardship of double taxation and if the income was not taxed in the Contracting State, holding that the same should be taxed in India was an oversimplified statement on the whole regime of DTAA].

(iv)    The prime motivating factor in developing the concept of DTAA was the genuine hardship of the international assessee that the same amount of income became the subject of taxation both in the home state and in the Contracting State. It was to alleviate this burden of double taxation that the instrument of DTAA had evolved through the process of law.

(v)    The mechanism of providing relief in the form of credit was only when, in accordance with the provisions of the DTAA, double taxation could not be avoided. Article 23 of OECD model convention would be applicable only where income may be taxed in both countries. In the instant case, since the income arising from the permanent establishment (PE) was taxable only in the country of source in accordance with Article 7 of the applicable DTAA, application of Article 23 did not arise. [Vr. S.R.M. Firm 208 ITR 400 (Mad.)].

(vi)    Article 4 of the OECD model convention defined “residence” and the determination of residency was not in question. The assessee was a tax resident of India, which was an uncontroverted fact. Therefore, any analysis or reliance on Article 4 of OECD Model Convention (Residence) in respect of residency was not proper and was misplaced.

(vii)    Article 7 of the applicable DTAA provided that the profits of an enterprise of the Contracting
State shall be taxable only in the State unless the enterprise carries on business in the other Contracting State through a PE situated therein. Therefore, once the Revenue accepted that there was a PE outside India, its profits would be taxable only in the country of source according to Article 7, and residence would not be a determinative criteria. [Lakshmi Textile Exporters Ltd. 245 ITR 521 (Mad.)].

(viii)    The classification of the Articles under the DTAA from the OECD Commentary merits consideration in view of the discussion in Ms. Pooja Bhatt, 26 SOT 574 (Mum.) which clearly stipulated that the language of Article 7 which included the phrase ‘may be taxed’ meant the Contracting States permitted only the other Contracting State i.e. State of source of income, to tax such income.

(ix)    From a perusal of the judgment of the Hon. Apex Court in Kulandagan Chettiar, [supra], it could not be inferred that the reasons given by the Special Bench of Hon. ITAT were incorrect, merely because the decision of the Hon. Tribunal was upheld by the Hon’ble Supreme Court for different reasons. [Mideast India Ltd. 28 SOT 395 (Delhi)].

(x)    The ITAT in this judgment on appreciating Article 7 of the relevant DTAA also held that the profits derived from the business carried on through a PE in a contracting State by a resident or an enterprise of the other contracting State, was liable to be taxed in the first mentioned State to the extent the same was directly or indirectly attributable to the PE and the same thus shall not be taxable in other contracting State. The profit in question was earned by the assessee in USSR through its PE in that country and since it was not the case of the revenue that the assessee company had no PE in USSR or that any portion of the profit earned by it in USSR was not attributable to that PE, it followed that the entire income earned by the assessee in USSR through its PE was chargeable to tax in that country as per Article 7(1) of the DTAA between India and USSR.

(xi)    The Bombay High Court in the case of Essar Oil , 345 ITR 443 in the context of India-Oman DTAA has observed that since the taxpayer has a PE in Oman, in view of Article 7 of the DTAA, the profits earned in Oman were rightly excluded in India.

(xii)    The case of ITO (OSD) v. Data Software Research Co. (P) Ltd., 288 ITR 289(Mad.), could be regarded as ‘per incuriam’ i.e. was rendered without having been informed about binding precedents that were directly relevant rendered in the matter of S.R.M. Firm (supra) by the jurisdictional High Court. According to the doctrine of ‘per incuriam’, any judgment which had been passed in ignorance of or without considering a statutory provision or a binding precedent was not good law and the same ought to be ignored. [Siddharam Satlingappa Mhetre v. State of Maharashtra AIR 2011 SC 312].

(xiii)    Reliance on OECD Commentary on Model Tax Convention had not been accepted by the Courts of India as having a precedent value. [ Pooja Bhatt (supra) and Kulandagan Chettiar (supra)].

(xiv)    The AAR ruling in S. Mohan, In re [2007] 294 ITR 177 as adverted during the course of the hearing did not in any way support the contention of the Department, since it had been observed in the ruling that the language of treaty provision in which the expression ‘may be taxed’ was used in Indo-Malaysia DTAA which was under consideration in Kulandagan Chettiar ( supra) was not comparable to the language employed in Article 16(1) of Indo-Norway DTAA, which was the subject matter of S. Mohan’s ruling.

(xv)  According to the provisions of Section 255, where an earlier co-ordinate bench had taken a decision, a subsequent bench could not differ from such a decision on similar set of facts. In such cases, the matter had to be referred to the President to refer the case to a larger bench. [Sayaji Iron & Engg Co.,121 Taxman 43 (Guj.)].

On behalf of the Revenue, attention of the tribu-nal was invited to some fundamental principles of international taxation, to emphasise that where a contracting state is given exclusive right to tax a particular kind of income, then relevant article of convention used the phrase ‘shall be taxable only’; that as a rule, such exclusive right was given to state of residence, though there were a few articles where exclusive right to tax was given to state of source also; that the phrase ‘shall be taxable only’ precluded other contracting state from taxing that income’ for an item of income; where attribution of right to tax was not exclusive, the convention used the phrase ‘may be taxed’; regarding ‘dividend’ and ‘interest’ income’, primary right of taxation was given to state of residence, though this was not exclusive right as paragraph 1 of relevant articles 10 and 11 of model OECD convention used the phrase “may be taxed’ and at the same time, paragraph 2 of said articles used phrase ‘may also be taxed’ and gave simultane-ous taxing rights to state of source. For these two items of income, no state was given exclusive right to tax. It was further impressed that where for an item of income the phrase ‘may be taxed’ in state of source was used and nothing was mentioned about taxing right of state of residence in convention itself, then state of residence was not precluded from taxing such income and could tax it using inherent right of state of residence to tax global income of its resident. It was only when the state of source was given exclusive right to tax an item of income by using the phrase ‘shall be taxable only’, then the state of residence was precluded from taxing it and it meant state of residence had voluntarily given up its inherent right to tax.

The Revenue highlighted that the assessee was a resident of India and thus being state of residence, India had inherent right to tax global income of as-sessee as per section 5 of IT Act, 1961; it had a PE in foreign countries with whom India had entered into DTAA and had opted for application of DTAA u/s 90(2) of IT Act; the character of income under issue was business income and therefore,Article 7 of relevant DTAAs was applicable.

The Revenue further contended that the combined reading of Article 7 meant that the state of source had non-exclusive right to tax business income attrib-utable to PE and therefore, it might tax it as per its domestic laws. However, this non-exclusive right of state of source did not extinguish the inherent right of the state of residence to tax global income of its resident. In a situation where state of residence had given up its inherent right, the second sentence of article 7 would have used the phrase ‘shall be taxable only’. Now, in all DTAAs applicable in case of the assessee, the second sentence used the phrase ‘may be taxed’. Therefore, the inherent right of India to tax global income of its resident was not lost. The contention of the assessee was fallacious in view of the discussion above. The proper course on the part of the assessee would have been to claim credit of taxes paid in foreign countries, because the relevant DTAA provided that India shall relieve double taxa-tion by giving credit of taxes paid in state of source.

For the Revenue, it was important to examine what the Supreme Court had held in Kulandagan Chet-tiar’s case (supra), as that was the source of all the decisions that followed it, to hold that income once taxed outside India was not taxable in India. It was argued that in that case, the Supreme Court had held that; interpretation of phrase ‘may be taxed’ was not required as the assessee was resident of both India and Malaysia as per their respective do-mestic tax laws and the situation of dual residence was to be reduced to situation of single residence by applying tie breaking rules contained in Article 4(2) of treaty; by applying tie breaking rules, the Supreme Court came to the conclusion that the assessee was having closer personal and economic relations with Malaysia and therefore, the assessee became resident of Malaysia; Malaysia being state of residence for the assessee, Malaysia had inherent right to tax global income of the assessee. This is how income of assessee was held not to be taxable in India which is explained by the Supreme Court at pages 671 & 672 of 267 ITR. Closer examination of this Supreme Court decision showed that it had clearly upheld the basic principle that state of residence (in that case, Malaysia) had the right to tax global income of its resident.

It was further argued that the decisions holding that income arising in state where permanent establishment was situated could be taxed in that state only and state of residence was precluded from taxing such income militated against the basics of DTAA and also were not consistent with ratio of the Supreme Court decision in Kulandagan Chettiar’s case (supra) and therefore the ratio therein was not correctly applied in those cases. In all cases relied upon by the assessee, the tax payers were resident of India and there was no situation of dual residence. India remained state of residence and therefore India had inherent right to tax global income of its residents.

Decision in the case of Data Software Research Co. (P.) Ltd. (supra ) was cited to state that the facts therein were exactly the same as were in present case. Reliance was also placed on S. Mohan’s case (supra) in which interpretation of phrase ‘may be taxed’ which was consistent with OECD Commentary had been taken. In that case, issue involved was taxability of salary income under Article 16(1) which used the phrase ‘may be taxable’ for the source state.

In a nutshell, according to the Revenue, if the assessee had paid taxes in foreign countries on income earned from PE in those countries, credit of those taxes could be claimed in India. Therefore, the crux of the controversy was whether India had given up its right to tax under Article 7 of any DTAA applicable to the assessee and if not, India shall give credit for taxes paid in country of source. To give an example, India had given up its right to tax capital gains arising in India to residents of Mauritius under Indo -Mauritius DTAA, but this was not the situation in case of DTAA applicable to present assessee. Reliance was also placed on Manpreet Singh Gambhir (supra) which had also been relied upon by the assessee. In that case, the ITAT had held that assessee was entitled to credit of taxes paid in USA on income earned in USA. Finally, it was prayed that the grounds of assessee’s be dismissed.

The tribunal on hearing the parties in detail and on perusal of the case laws relied upon, observed and held as under;

(i)    Since the assessee company was incorporated in India, the provisions of Income-tax Act, being a domestic law, were applicable to the assessee and all the incomes of the assessee, including the global income, were liable to be taxed in India.

(ii)    Section 5(1)(c) provided that the total income of any previous year of a person who was a resident, includes all income from whatever source derived which accrued or arose to him outside India during such year.

(iii)    As per the provisions of Income-tax Act, the assessee was a resident of India.

(iv)    Due to State of residency, India had inherent right to tax the global income of the assessee as per provisions of Section 5 of Income-tax Act, 1961.

(v)    The combined reading of the sentences of Article 7 of relevant DTAA meant that the state of source had non-exclusive right to tax business income attributable to permanent establishment. Such income may be taxed as per the domestic laws. The non-exclusive right of state of source did not extinguish the inherent right of state of residency to tax global income of its residents. In the circumstances, where the state of residence of the taxpayer had given up its inherent right to tax the global income, in such situation, the phrase used in Article 7 of the DTAA was “shall be taxable only”. Since all the DTAA applicable in the case of assessee the phrase used “may be taxed”, therefore, inherent right of taxation of global business income in India was not lost.

(vi)    Case laws relied upon by assessee were basically based on the decision of the Supreme Court in Kulandagan Chettiar’s case (supra) where conclusions rested on the fact that the personal and economic relations of the assessee in relation to capital asset were far closer in the State of Malaysia than in India. In view of these facts, the residency of India was held to be irrelevant and in that view of matter, issue was so decided. Assessee’s contention that its foreign income was taxable income in foreign countries and it could not be taxed in India was an untenable contention based on wrong interpretation of Article 7 of relevant DTAA.

(vii)    Only in the case of use of phrase “shall be taxed only”, the state of residence is precluded from taxing it. In such cases, where the phrase “may be taxed” was used, the state of residence had been given its inherent right to tax.

(viii)    The facts of assessee’s case were completely different from the set of facts in Kulandagan Chettiar’s case (supra). In that case, assessee sought a relief under the India-Malaysia DTAA, and the Supreme Court held that it was a case of dual residency. The Supreme Court’s conclusion rested on the fact that personal and economic relations of the assessee in relation to capital assets were far closer in Malaysia than in India and in those facts, the residence of India became irrelevant. The assessee was not having permanent establishment in India in respect of that source of income. On the aspect and scope of the expression “may be taxed”, the Supreme Court had not expressed any opinion. Thus, the facts of that case were completely at variance to the facts of assessee’s case.

(ix)    The facts of the several cases relied upon by the assessee were found to be at variance with the facts in the assessee’s case.

The tribunal therefore rejected the assessee’s appeal.

Observations
The controversy poses some very fundamental issues in taxation of an income from cross country transactions and is therefore surprising that it has been allowed to remain open for long. The issue is further fuelled by the Notification No.S.O. 2123(E) dated 28 August, 2008 wherein the Central Government, in exercise of its powers under section 90, has clarified that the term ‘ may be taxed’ used in the context of an income shall mean that such income shall be included in the total income chargeable to tax in India in accordance with the provisions of the Income tax Act, 1961, and relief shall be granted in accordance with the method for elimination or avoidance of double taxation provided in an agreement. A similar Notification bearing No.S.O. 2124(E) dated 28th August, 2008 has been issued under section 90A of the Act, the efficacy of which was tested recently by the tribunal in the case of Apollo Hospitality Pvt. Ltd.

The raging controversy requires immediate attention also for the fact that the Indian judiciary has taken a stand that is at variance with the international tax practice.

Internationally, two systems of taxation prevail for bringing to tax the profits arising on cross country transactions. One is Residence based taxation and another is Source based taxation. In the former, the Residence State has the primary right of taxation. Almost all countries follow the residence based taxation under which a country can tax its residents on their global income, wherever it is earned, while non-residents are taxed only on the income sourced inside the country. Such powers of taxation are enshrined in the domestic tax laws of a country. India largely follows the residence based taxation system, a fact that can be gathered from section 5 of the Income-tax Act, 1961.

Under a source based system, a country can tax a person, whether resident or non- resident, only on income sourced inside the country. A country following this system eliminates the need for any DTAA. It is because of the fact that the countries choose to tax a resident on his world income and the source country also needs to tax such an income, that a need arises for DTAA to eliminate double taxation of the same income.

The Model Conventions (MC), while prescribing the model agreements, rely on any of the two rules or adopt both of them to avoid double taxation. One is to allocate taxing rights between contracting states with respect to various kinds of incomes by adopting what is known as the ‘Distributive rule’ – taxing rights are distributed between contracting states. Exclusive rights to taxation in respect of certain incomes are given to one state and the other state is precluded from taxing those incomes and therefore double taxation is avoided. Generally, such exclusive rights are given to Residence State (see paragraph 19 of the OECD Commentary). The Source State is thereby prevented from taxing those items and double taxation is avoided. In the case of other items of income and capital, the right to tax is not an exclusive one. As regards two classes of income (dividends and interest), although both States are given the right to tax, the amount of tax that may be imposed in the State of source is limited.

The Second rule is to put the Residence State under an obligation to give either credit for taxes paid in the Source State or to exempt the income taxed in the Source State. These two rules have been explained in paragraph 19 of OECD commentary titled ‘Taxation of Income and Capital’. It is the stand of the Government of India that it follows credit method for relieving double taxation as a rule and departs from the said rule only under a specific writing to the contrary.

In respect of other types of income, the right to tax is not an exclusive one. The other state may also tax that income and depending upon taxing rights of Source state, incomes are classified into three categories as explained by paragraphs 20 to 23 of the OECD Commentary .

The scheme of taxation is divided in three categories; The first category includes Article 7, 8, 9 14,15, and 19, all of which provide that income shall be taxed only in the Residence State. The second category includes Article 6, 7, 15 ,16, 17, 18 and 20, all of which provides that such income may be taxed in the Source State. The third category includes Article 11, 12 ,13, 14 and 22, all of which provides that such income may be taxed in both the contracting states.

The distributive rules use the words, ‘shall be taxable only’, ‘may be taxed’ and ‘may also be taxed’. Interpretation of these phrases has been provided in paragraphs 6 and 7 of OECD Commentary. The commentary states that the use of words “shall be taxable only” in a Contracting State indicates an exclusive right to tax is given to one of the Contracting States; the words “shall be taxable only” in a contracting State preclude the other Contracting State from taxing. The State to which the exclusive right to tax is given is normally the Residence State, but in some Articles the exclusive right may be given to the Source State. For other items of income or capital, the attribution of the right to tax is not exclusive and the relevant Article then states that the income or capital in question “may be taxed”. Regarding ‘dividend’ and ‘interest’ income’, primary right of taxation is given to state of residence, though this is not exclusive right as paragraph 1 of relevant articles 10 and 11 of model OECD convention uses the phrase “may be taxed’. At the same time, paragraph 2 of said articles uses phrase ‘may also be taxed’ and gives simultaneous taxing rights to state of source. Thus, for these two items of income, no state is given exclusive right to tax.

At this place, it is to be noted that no single method or a uniform formula is adopted in drafting the tax treaties. Varied approaches are seen to be adopted to convey the mutual understandings of the countries that are party to such treaties. Even within the same treaty, different approaches are adopted for income with different characters. Even the intentions of the parties are conveyed through use of different words on different occasions. For example, paragraph 1 of Article 11 provides that dividend income may be taxed in the other contracting State, while paragraph 2 provides that dividend income may also be taxed in the State of residence. Similarly, Article 14(2) and Article 22 provide that income may be taxed in both the countries.

Article 7 of relevant MC provides that the profit of an enterprise of a contracting state shall be taxable only in that state, i.e Residence State, unless the en-terprise carried on business in other contracting state through a permanent establishment situated therein i.e., in the Source State. If the enterprise carried on business as aforesaid, the profits of the enterprises may be taxed in the other Contracting State, but only so much of them as was attributable directly or indirectly to that permanent establishment. The first part of the Article gives an exclusive right to the taxation of business income to the Residence State as the phrase used as “shall be taxable only”. The real debate is about the second part of the Article 7 where the words used are “may be taxed”. Does this part give exclusive right of taxation only to the Source State or does it give the right to the Residence State as well to tax such an income and while doing so to give credit for taxes paid in Source State? As noted, the OECD commentary as also the commentary by Klaus Vogel support the view that the Source State under Article 7 of MC has a non-exclusive right of taxation.

This position is accepted globally and countries tax the income in the hands of the resident in cases where the relevant Article uses the words ‘ may be taxed’, especially the income of the PE, though taxed in the Source State, and give credit for the taxes paid in the Source State.

It is time to take note of the developed law in India. Is the internationally accepted position ratified by the judiciary in India? The gist of the following decisions reveals the story;

(i)    The Karnataka High Court in the case of R.N. Muthaiah, 202 ITR 508 in the context of Indo-Malaysian treaty held that the Malaysian in-come was not taxable in India once it was subject to tax in Malaysia. The court observed that “When a power is specifically recognised as vesting in one, exercise of such a power by others is to be read as not available; such a recognition of power with the Malaysian Government would take away the said power from the Indian Government; the agreement thus operates as a bar on the power of the Indian Government in the instant case. This bar would operate on sections 4 and 5 of the Income-tax Act, 1961, also.”

(ii)    In the case of Vr. S.R.M. Firm, 208 ITR 400 (Mad.), the Madras High Court held that an occasion to deal with several cases involving taxation of income earned in Malaysia by Indian residents from different sources mainly capital gains, business income, dividend and interest. The relevant Articles of the said treaty dealing with income with different characteristics, all of them, provided that income may be taxed in Malaysia. In the context of the above facts, the Court held that express conferment of right to tax an income on one of the states conveyed an implied prohibition on the other state to tax the said income. The court observed that “The contention on behalf of the Revenue that wherever the enabling words such as “may be taxed” are used there is no prohibition or embargo upon the authorities exercising powers under the Act, from assessing the category or class of income concerned cannot be countenanced as of substance or merit. As rightly pointed out on behalf of the assessees, when referring to an obvious position such enabling form of language has been liberally used and the same cannot be taken advantage of by the Revenue to claim for it a right to bring to assessment the income covered by such clauses in the agreement, and the mandatory form of language has been used only where there is room or scope for doubts or more than one view possible, by identifying and fixing the position and placing it beyond doubt.” The Court accordingly held that none of the income above mentioned could be taxed in India even though the recipient of income was a resident under the Income Tax Act 1961.

(iii)    In Lakshmi Textile Exporters Ltd, 245 ITR 521 (Mad.), in the context of Article 7 of the DTAA between India and Sri Lanka, it was held that once an income of a company resident in India was liable to be taxed in Sri Lanka under the said DTAA, then such income could not have been taxed in India. Article 7 of the said DTAA provided that the profits of an enterprise shall be taxed in the contracting state of which the enterprise was resident, unless it carried on the business in the other contracting state through a PE (Permanent Establishment) situated in that state.

(iv)    The Supreme Court in the case of P.V.A.L. Kulandagan Chettiar, 267 ITR 654 was required to examine the true meaning of the words ‘may be taxed’ used in different Articles of the DTAA with Malaysia, 107 ITR 36 (ST). The said case was filed by the revenue against the decision of the Madras High Court to which a reference was made out of the decision of the Special Bench of the ITAT. The Special Bench of the ITAT and the High Court had held that income from a firm, resident of India, by way of capital gains on sale of immovable properties at Malaysia and business income from business of rubber estate in Malaysia was not taxable in India . The Madras High Court had rejected the contention of revenue in that case, to the effect that wherever the enabling words such as ‘may be taxed’ were used, there was no prohibition or embargo upon the authorities from assessing the income in India and had found such contention to be devoid of substance or merit. The Court had also found unsafe or unacceptable to apply the OECD Commentary, on MC 1977 as a guide or an aid for construction. Detailed arguments were made by the contesting parties in support of the rival contentions. The Supreme Court, for reasons different than those of the High Court, held that the income of the resident that was taxable in Malaysia was not taxable in India on the finding that the assessee firm in question was resident of Malaysia and not of India by applying the tie-breaker test contained in Article 4 of the said DTAA. The Court held that the Malaysian income was not taxable in India, unless the assessee firm had a PE in India. The Court refused to enter into an exercise in semantics as to whether the expression ‘may be’ meant allocation of power to tax or was only one of the options and it only granted the power to tax in that state and unless tax was imposed and paid, no relief could be sought. The review petition filed by the revenue against the decision was dismissed by the Supreme Court for inordinate delay and for want of any ground to entertain the petition, 300 ITR 5 (SC).

(v)    The Indore Bench of the Madhya Pradesh High Court in the case of Turquoise Investment & Finance Ltd., 299 ITR 143 (MP) held that dividend income earned by a resident of India, from a Malaysian company was not liable to tax in India. In view of this finding of the court, the other question as to whether such dividend income was taxable in India u/s. 5(i)(c) in the hands of the resident assessee, once it was taxed in Malaysia as per Article 11 of the DTAA, was considered by the Court in favor of the assessee. This decision of the MP High Court has been approved by the Supreme Court in the case reported in 300 ITR 1 (SC) by following the decision in the case of Kulandagan Chettiair(supra). The Court approved the findings of the Madras High Court in the case of Vr.S.R.M. Firm, 208 ITR 400 wherein it was held that dividend income from a Malaysian company was not taxable in India.

(vi)    The AAR in S.Mohan, In Re, 294 ITR 177 (AAR) distinguished the Supreme Court decision in Kullandagan Chettiair’s case to hold that income of an Indian resident by way of salary for services in Norway was taxable in India. It noted that the use of the words ‘may be taxed’ in Article 16 made it possible to subject to tax such remuneration derived by a resident of India. It noted that the expression ‘may be taxed’ was used in the contradistinction to the expression ‘shall be taxable’ and as such the right of taxation was available to both the contracting states for bringing to tax the employment income.

(vii)    The Bombay High Court recently in the case of Essar Oil Ltd, 345 ITR 443 (Bom.) dealt with a case of an Indian company with a PE in Oman. Interpreting Article 7 of the Indo-Oman DTAA, the court, following Kullandagan Chettiair’s decision, held that the profit earned by the company from the PE in Oman was to be excluded in computing income liable to Indian tax.

(viii)    In the case of Mideast India Ltd, 28 SOT 395 (Delhi), the assessee company, resident in India derived income from business operations in the USSR that were carried out through its PE in that country. The company had claimed that the said income was not taxable in India by virtue of Article 7(1) of the Indo-USSR treaty which provided that the profits derived through a PE by an Indian Enterprise, in the USSR may be taxed in the USSR only. The Tribunal, following the Supreme Court decision in Kullandagan Chettiar’s case held that such income was not taxable in India. It observed that “The learned DR has also contended that although the final operative decision of the Special Bench of ITAT has been upheld by the Hon’ble Supreme Court, the reasoning given by the Hon’ble Supreme Court while affirming the said decision is entirely different from the reasoning given by the Special Bench of the Tribunal. However, as rightly submitted by the learned counsel for the assessee, a perusal of the judgment of the Hon’ble Apex Court shows that there is nothing contained therein to indicate that the reasons given by the Special Bench of ITAT to come to a conclusion as it did were disapproved by the Hon’ble Supreme Court or the same were found to be inappropriate or incorrect… In our opinion, the decision of Special Bench of IT AT in the case of P.V.A.L. Kulandagan Chettiar (supra) thus still holds the field and the same being squarely on the point in issue involved in the present case and is binding on us, we respectfully follow the same and uphold the impugned order of the learned CIT(A) deleting the addition made by the Assessing Officer to the total income of the assessee on account of income earned by it in the form of profits of business earned in USSR which was entirely attributable to the permanent establishment in that country.”

(ix)    In Data Software Research Co. (P) Ltd., 288 ITR 289(Mad.), the tribunal on similar facts held that the income from PE in …………. earned by an Indian resident was taxable in India.

(x)    In Apollo Hospital Enterprises Ltd., the Chennai bench of the tribunal held that the income from capital gains from sale of shares of the Sri Lankan company by an Indian company was not taxable in India, in view of the Indian-Sri Lankan treaty which provided for taxing such an income in Sri Lanka only through the use of the words ‘may be taxed’. The tribunal rejected the contention of the revenue that the term ‘ may be taxed’ indicated the non-exclusive right of taxation of the Sri Lankan Government in view of the Notification issued in 2008 u/s 90A. It noted that section 90A had a limited application to certain jurisdictions and did not apply to nations. The revenue made a wrong reference, and should have relied on the no-tification issued u/s 90 of the Act, which was not brought to the notice of the Tribunal.

It is apparent from a reading of the above decisions that the income of a PE in the hands of a person resident in India, is taxable in the Source State only and cannot be subjected to tax in India.

There is accordingly a clear cut divide between the international tax practice and the Indian one. The case in support of the Indian understanding is unambiguous and clear, when it comes to treaties containing Articles with use of both the phrases, namely, ‘may be taxed’ and ‘may also be taxed’. This confirms that wherever the countries intended, they have provided for specific right on Residence State by inserting an additional phrase ‘may also be taxed’ to secure the right of the taxation for the Residence State. This by implication confirms that the Article using the phrase ‘may be taxed’ alone confers an exclusive right of taxation on the Source State. In such a case, the income from Source state will not be taxed in India. This is best brought out by the learned members in Ms. Pooja Bhatt’s case. The tribunal in that case has relied upon the contextual interpretation to hold that the Source State had an exclusive right of taxation. In the India Canada treaty, wherever the contracting parties intended that income may be taxed in both the countries, they have specifically so provided and this fact clearly confirms that wherever it was not so provided, there arose an exclusive right in favour of the Source State even where the phrase used is “may be taxed in other State”.

As regards the treaties where such a clear cut distinc-tion is not possible by use of the two phraseologies, one will still be supported by a good number of decisions, including that of the high courts, which have taken a view that the Source State alone has an exclusive right of taxation. Some of these decisions, mainly in Mutthaiah and Vr. S.R.M.’s cases, have been delivered independent of the Kulandagan Chettiar’s decision and have provided the sound rationale for doing so. They may also rely upon the decision of the Special Bench of the tribunal in the case of P.V.A.L. Kulandagan Chettiar , though the validity of the said decision may be debatable in view of the fact that the said decision may be treated as the one delivered on facts rendered, irrelevant by the Supreme court.

Whether the Notifications issued under section 90(3) and 90A(3) by the Government under the valid powers can be binding or not is another hurdle one will have to pass through, before heaving a sigh of relief. The Notifications, if found to be binding with retrospective effect, will take the steam out of most of the decisions. The recent insertion of explanation 3 to section 90 by the Finance Act 2012, with effect from 1st October 2009, provides that such notifications shall come into force from the date on which the DTAA was entered into. The issue is whether one country, out of two countries which have signed the DTAA, can independently assign its own meaning to the DTAA. It is felt that it may be difficult for the Government to support the validity of the concerned notification, as the same may be considered to provide a meaning that is inconsistent with the provisions of the agreement.

Sections 54, 54B,54EC, 54F, 54GA and 54GB of the Income Tax Act, 1961 provide for exemption of capital gains on an acquisition by an assessee, of a specified asset (purchase, construction, etc.) within the specified time period, subject to fulfilment of various other conditions. Section 54 exempts along term capital gains arising on transfer of a residential house and section 54F grants exemption to long term capital gains arising on transfer of any other capital asset. Section 54B provides for exemption for long term capital gains on transfer of a land used by for agricultural purposes. Similar provisions are contained in other sections for grant of exemption for capital gains on reinvestment by the assessee within the specified period, in specified assets.

All these sections require acquisition by the assessee. Section 54 reads – “the assessee has within a period of ………………purchased, or has ………..constructed a residential house”. The other sections use similar language. In view of the stipulation in the above mentioned provisions, that require the acquisition by an assessee, aquestion has arisen before the courts as to whether the acquisition (purchase, construction, etc.) by the assessee necessarily means that the new asset must be acquired in the name of the assesseeor that it would be sufficient where the funds belonging to the assessee are used for acquiring the specified asset to enable an assessee to claim the exemption from tax.

The courts do not find any difficulty in upholding the claim of the assessee for exemption in cases where the acquisition of the new asset is in the joint names of the assessee and another person, as in the courts opinion such acquisition in joint names would not hamper the claim for exemption, so long as the funds for acquisition of the new house have come from the assessee. The conflict of the judicial view however, has been in respect of acquisition of a new asset in the name of a family member, without the name of the assessee being included, though with the funds from the assessee. While the Madras, Andhra Pradesh and Delhi High Courts have taken the view that even in such a case, the assessee is entitled to the benefit of the exemption, the Punjab & Haryana, Bombay and Delhi High Courts have taken a contrary view.

Prakash’s case
The issue came up before the Nagpur bench of the Bombay High Court in the case of Prakash vs. ITO 312 ITR 40 in the context of section 54F. In that case,the assessee, an elderly person, sold certain plots of land, and acquired a plot of land in the name of his adopted son and constructed a residential building thereon by submitting plans for construction in the name of his son. He did not file his return of income voluntarily, but did so after receipt of a notice u/s. 139(2) from the Assessing Officer. The assessee besides claiming that the plots sold were agricultural land, which was not a capital asset, and that there was therefore no capital gains, also claimed an exemption u/s. 54F in respect of the purchase of a plot of land and the construction of the residential building thereon. It was claimed that the investment in the new asset was made in the son’s name, in view of the advanced age of the assessee.

The Assessing Officer rejected both the contentions of the assessee and subjected the capital gains to tax. He denied the claim for exemption on the ground that the reinvestment was in the son’s name. The Commissioner (Appeals) held that the transfer was of the agricultural land which was not a capital asset, and accordingly no taxable capital gains arose. The Tribunal held that the asset transferred was a capital asset and subject to eligibility of the assessee for an exemption u/s. 54F, a taxable capital gains arose. It however, remanded the matter back to the Commissioner (Appeals) to examine the assessee’s claim for exemption u/s. 54F.

On remand, the Commissioner (Appeals) held that section 54F contemplates only investment in a residentialproperty by the assessee; it was enough if the sale proceeds were invested in the construction of aresidential house. It was further held by the Commissioner (Appeals) that it was not necessary that the newly constructed house should be in the name of the assessee, and that an adopted son had the samerights as a natural son. The Commissioner (Appeals) allowed the appeal of the assessee granting relief u/s. 54F. The Tribunal quashed the order of the Commissioner (Appeals), denting the benefit of the exemption.

On appeal by the assessee, the Bombay High Court examined the provisions of section 54F and the definition of the term “assessee” contained in section 2(7). It noted that as per the scheme of section 54F, the assessee, who is the owner of the original asset, needs to, purchase or construct a residential house within the specified period. It noted that the concepts of “assessee”, “own”, “owner”, “ownership”, “co-owner”, “owner of house property”, and “ownership of property” contained in various sections were very much interlinked and connected for granting the benefits under the Income Tax Act. Referring to the Supreme Court decisions in the cases of Podar Cement (P) Ltd. 226 ITR 625 and Mysore Minerals Ltd 239 ITR 775, it expressed the view that an assessee must have valid title legally conveyed to him after complying with the requirements of law or should at least be entitled to receive income from the property in his own right and have control and domain over the property for legal purposes, while basically excluding a third person of any right over the said property. It was of the view that the object being to give a benefit to the assessee, it meant that the assessee must comply with the conditions strictly in all respects.

The Bombay High Court expressed the view that right from the sale of the original asset till the purchase and/ or construction of the new asset, the ownership and domain over the new asset was a must. According to the High Court, the new property must be owned by the assessee, or he should have legal title over the same. Though others might use and occupy the property along with the assessee, the ownership of the residential house should be of the assessee.

The Bombay High Court noted that by constructing the house in the name of his son, the assessee effectively transferred the new property to his son, who became the owner thereof, in spite of the prohibition on transfer of the new house for a period of 3 years from the date of transfer of the original asset. The High Court noted that the assessee had no domain and/or right on the property, which disentitled him to the claim for exemption, since there was non-compliance of the conditions as per the scheme of section 54F.

The Bombay High Court noted the decision of the Andhra Pradesh High Court cited before it in the case of Late Mir Gulam Ali Khan 228 ITR 165, where the court had taken the view that the term “assessee” must be given a wide and liberal interpretation, and that where the legal heirs had completed the purchase of the new house after the death of the assessee, the assessee was entitled to the benefit of the exemption. The Bombay High Court however expressed its disinclination to accept the liberal view given to the word “assessee” in Late Mir Gulam Ali Khan’s case, stating that the facts before it were different, since in the case before them, it was the son (who was not the assessee) who had purchased and constructed the new property. It also noted that the assessee had admitted that the son was the beneficial owner of the property.

The Bombay High Court therefore held that the as-sessee was not entitled to the benefit of exemption u/s. 54F.

A similar view has been taken in the context of sec-tion 54B by the Punjab & Haryana High Court in the case of Jai Narayan vs. ITO 306 ITR 335 , where the new land was purchased in the names of the son and the grandson of the assessee, by the Rajasthan High Court in the case of Kalya v CIT 251 CTR 174, where the new land was purchased in the names of the son and the daughter-in-law, and in the context of section 54F, by the Delhi High Court, in the case of Vipin Malik (HUF) vs. CIT 330 ITR 309, where the new house was purchased in the names of the karta and his mother.

Kamal Wahal’s case

The issue came up recently before the Delhi High Court in the case of CIT vs. Kamal Wahal 351 ITR 4.

In this case, the assessee, a retired employee, sold his share in an inherited property, and invested a part of the sale proceeds in purchase of a residential house in the name of his wife. He claimed exemption u/s. 54F for the investment in the residential house.

The assessing officer denied the benefit of the exemption, on the ground that the investment should have been made in the assessee’s name, and not in the name of his wife. The Commissioner(Appeals) allowed the assessee’s appeal, following the decisions of the Madras High Court in the case of CIT vs. V Natarajan 287 ITR 271 and of the Andhra Pradesh High Court in the case of Mir Gulam Ali Khan vs. CIT 165 ITR 228.The tribunal dismissed the appeal of the revenue, following the judgments of the Madras and Andhra Pradesh High Courts, and also of the Karnataka High Court in the case of DIT vs. Jennifer Bhide 349 ITR 80, where the property was purchased in the joint names of the assessee and her spouse. While noting the decision of the Bombay High Court in the case of Prakash(supra), the tribunal took the view that where a statutory provision was capable of more than one view, the view favouring the taxpayer should be preferred.

The Delhi High Court approved the decision of the tribunal, noting that besides the decisions referred to by the tribunal, the Delhi High Court itself in the case of CIT vs. Ravinder Kumar Arora 342 ITR 38 had also taken a similar view in the context of section 54F involving purchase of a new property in the joint names of the assessee and his spouse. The Delhi High Court also noted the decision of the Punjab and Haryana High Court in the case of CIT vs. Gurnam Singh 327 ITR 278, where a similar view had been taken in the context of section 54B involving purchase of the new land in the joint names of the assessee and his bachelor son.

According to the Delhi High Court, the predominant judicial view was that, for the purposes of section 54F, the new residential house need not be purchased by the assessee in his own name nor was it necessary that it should be purchased exclusively in his name. It noted that in the case before it, the property was not purchased in the name of a stranger, somebody unconnected with the assessee, but in the name of his wife, and that there was no dispute that the entire investment had come out of sale proceeds and that there was no contribution from the assessee’s wife.

Having regard to the rule of purposive construction and the object of section 54F, the Delhi High Court held that the assessee was entitled to the benefit of exemption u/s. 54F.

Observations

The Andhra Pradesh High Court, in Mir Gulam Ali’s case reiterated the acknowledged position in law, while deciding in favour of the assessee’s claim for exemption, that the exemption provisions should be liberally construed. None of the sections, under scanner, expressly require purchase or construction in the name of the assessee himself and a concerted effort is requfcired by the courts to read that requirement in the law so as to deny the benefit of exemption to the assessee. It is this highly debatable position, perhaps,that has led the courts to favour the assesses including the courts, which originally had taken a stand against the claim for exemption, but had later on, in other cases favoured the claim for exemption from tax. Further, the intention behind sections 54 and 54F and other provisions similarly placed is to encourage reinvestment in residential houses, which purpose is achieved by permitting reinvestment in the name of a close relative.

It is quite common to purchase properties in joint names of husband and wife, or jointly with close relatives and importantly there is no prohibition in law against it. In such an event, if the funds flow from the assessee, it is clear that the assessee cannot be denied the benefit of the exemption. Given this, should it make a difference if the assessee does not include his own name because of the circumstances of his old age or for convenience of simpler succession?

It may be noted that almost all the decisions favouring the assessee have been cases where the property has been purchased in the name of the spouse of the as-sessee and where funds have flown from the assessee. In all such cases, in any case, clubbing provisions would operate and the property would be regarded for both income tax and wealth tax purposes as the property of the assessee. The natural corollary is that the benefit of the exemption should also be given in such cases.

On the other hand, the decisions which have gone against the assessee have been cases where the prop-erty was purchased in the name of a son, daughter-in-law or grandson. In the case of a major son or grandson, clubbing provisions do not apply, and hence perhaps the adverse view was taken by the courts, though not highlighted in so many words .

The decisions involving section 54B which have gone against the assesseehave also been partly decided on account of the fact that section 54B requires use of the new land for agricultural purposes by the assessee unlike section 54F that merely requires acquisition of a residential house, and does not require the assessee to reside therein.

Mir Gulam Ali Khan’s case again was a case where the assessee initiated the process of purchase of the property, but passed away before he could complete the purchase, and the purchase was then completed by his legal heirs. Therefore, the subsequent purchase by the legal heirs was part of the same chain of events of sale of the old property and purchase of the new property initiated by the assessee himself.

Of course, one would need to take into account the provisions of the Benami Transactions (Prohibition) Act, 1988 in such a case. That Act excludes transac-tions entered into in the name of a wife or unmarried daughter. The Benami Transactions (Prohibition) Bill, 2011, seeks to exclude transactions in the name of spouse, brother or sister or any lineal ascendant or descendant. The law, therefore, seems to recognise that properties of a person can be purchased in the names of certain close relatives. Given this legal background, can the intention be to deny the benefit of an exemption, the conditions of which are otherwise fulfilled, on the mere ground that the property is pur-chased in the name of one such close relative?

In view of the fact that the issue involves interpretation of tax exemption provisions and that the said provisions do not in any case require that the investment has necessarily to be made in the name of the assessee, leading to a possibility of a debate, the better view seems to be that purchase of a property in the name of a spouse or close relative should qualify for the benefit of the exemption u/s. 54, 54B or 54F, as long as the funds belonging to the assessee are used and the assessee retains domain over the property. However, given the fact that while planning one’s affairs one should not plan in a manner so as to attract unnecessary litigation, it is advisable to purchase the property in the joint names of the assessee and such close relative, rather than in the name of the close relative alone.

    1.2 Very often substantial details are collected and inquiries are made by the AO but assessment orders are passed without reference to such details and inquiries, allowing a deduction or exemption. The factual question that arises in such cases is whether there has been an application of mind by the Assessing Officer during the assessment proceedings to the issue involved, and whether the deduction, exemption or non-taxation was after due deliberation, in which case reassessment proceedings cannot be initiated. The issue gets added dimensions where the assessee is able to show that he has filed details in response to the AO’s inquiry but the AO claims that he had not noticed the same in the myriad of details furnished with him.

    1.3 The issues that have arisen before the courts in such cases are whether, in a case where a regular order of assessment is passed u/s.143(3) without much discussion on a particular issue, there was an application of mind by the Assessing Officer; whether there was disclosure of material facts by the assessee and whether permitting reopening in such cases would amount to giving premium to an authority exercising quasi-judicial function to take benefit of its own wrong. While the full bench of the Delhi High Court has taken the view that no reassessment proceedings are permissible in such cases, the division bench of the Allahabad High Court, recently, has taken a contrary view.

2. Kelvinator’s case :

    2.1 The issue came up before the Full Bench of the Delhi High Court in the case of CIT v. Kelvinator of India Ltd., 256 ITR 1.

    2.2 In this case, the assessment of the assessee was completed u/s.143(3). Subsequently, it was noticed by the Assessing Officer that as indicated in the accounts and tax audit report, certain prior period expenditure and certain disallowable expenditure had been wrongly allowed as deductions. He therefore issued a notice for reassessment u/s.147.

    2.3 The assessee challenged the reassessment proceedings in appeal. The Commissioner (Appeals) allowed the assessee’s appeal holding that the assessee had disclosed all the facts, that no new fact or material was available with the Assessing Officer, and that it was a mere change of opinion on the part of the Assessing Officer. The Tribunal upheld the order of the Commissioner (Appeals).

    2.4 Before the Delhi High Court, on behalf of the department, it was argued that the change of opinion was relevant only for the purposes of clause (b) of S. 147, and that initiation of reassessment proceedings was permissible when it was found that the Assessing Officer had passed an order of assessment without any application of mind. According to the department, such application of mind could be found out from the order of assessment itself inasmuch as, if the order of assessment did not contain any discussion on the particular issue, the same may be held to have been rendered without any application of mind.

    2.5 On behalf of the assessee, it was argued before the Delhi High Court that the expression ‘reason to believe’ contained in S. 147 denoted that the reassessment must be based on a change of fact or subsequent information or new law. According to the assessee, income escaping assessment must be founded upon or in consequence of any information which must come into the possession of the Assessing Officer after completion of the original assessment.

    2.6 The Delhi High Court, after considering the various decisions cited before it, observed that it was not in dispute that the Assessing Officer did not have the jurisdiction to review his own order. His jurisdiction was confined only to rectification of mistakes as contained in S. 154. The power of rectification of mistakes could be exercised only when the mistake was apparent, and a mistake could not be rectified where it was a mere possible view or where the issues were debatable. Thus, where the Assessing Officer had considered the matter in detail and the view taken was a possible view, the order could not be changed by way of exercising the jurisdiction of rectification of mistake.

    2.7 The Delhi High Court further noted that it was a well settled principle of law that what could not be done directly could not be done indirectly. If the Assessing Officer did not have the power of review, he could not be permitted to achieve the object by taking recourse to initiating a proceeding of reassessment.

    2.8 According to the Delhi High Court, when a regular order of assessment is passed in terms of S. 143(3), a presumption can be raised that such an order has been passed on application of mind. In terms of S. 114(e) of the Indian Evidence Act, judicial and official acts are presumed to have been regularly performed. If it be held that an order which has been passed purportedly without application of mind would itself confer jurisdiction upon the Assessing Officer to reopen the proceeding without anything further, this would amount to giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong.

    2.9 The Delhi High Court therefore held that since the material was before the Assessing Officer at the time of assessment, the reassessment proceedings were invalid.

3. EMA India’s case :

    3.1 The issue again recently came up before the full bench of the Allahabad High Court in the case of EMA India Ltd. v. ACIT, (unreported — copy of order available on www.itatonline.org).

    3.2 In this case also, the assessment proceedings were completed u/s.143(3), and reassessment proceedings were initiated u/s.147 to disallow prior period expenditure and to tax certain interest which were disclosed in the balance sheet, profit and loss account, tax audit report, and other documents submitted before the Assessing Officer in the earlier proceedings.

3.3 The assessee challenged the reassessment proceedings in a writ petition before the High Court. Before the Allahabad High Court, it was submitted on behalf of the assessee that the initiation of proceedings and issue of notice were based on mere change of opinion and were totally without jurisdiction. It was submitted that the action of the Assessing Officer amounted to review of the earlier assessment order, and that even though the Assessing Officer had noticed such items, he did not assess these items nor add the same to the income during the assessment proceedings. Reliance was placed by the assessee on the full bench decision of the Delhi High Court in Kelvinator’s case (supra).

3.4 On behalf of the department, it was submitted that the initiation of reassessment proceedings was permissible when it was found that certain items of income, though chargeable to tax, had escaped the notice of the Assessing Officer, and no discussion of chargeability to tax of such items of income was made in the assessment order.

3.5 According to the Allahabad High Court, where the assessment order had been passed and certain items of income are not at all discussed and it escaped the notice of the assessing Officer as a result of which the reassessment proceedings were initiated in respect of those items of income, in the circumstances it could not be said that it would amount to review. Since the Assessing Officer did not form any view or any opinion with regard to the items of income which escaped its notice in the original assessment order, it would not amount to review of the order or change of opinion. According to the Allahabad High Court, there could be no change of opinion when no opinion was formed by the Assessing Officer.

3.6 The Allahabad High Court was of review that initiation of reassessment proceedings was permissible where it was found that the Assessing Officer had passed an order of assessment without any application of mind and such application of mind could be found out from the order of assessment itself, inasmuch as, in the event the order of assessment did not contain any discussion on a particular issue, the same may be held to have been rendered without any application of mind. According to the Allahabad High Court, in view of Explanation 1 to S. 147, mere production of account books or other evidence from which material evidence could, with due diligence have been discovered by the assessing authority would not necessarily amount to disclosure. This aspect, according to the Allahabad High Court, had not been considered by the Delhi High Court in Kelvinator’s case.

3.7 The Allahabad High Court therefore held that the reassessment proceedings were valid.

Observations:

4.1 Some controversies do not lead to ‘closements’ soon. The issue being discussed here is an example of one such controversy. Even the attempt in the proposed Direct Tax Code for resolving the controversy in favour of smooth reopening will surely raise new controversies. The issue is fiercely con-tested by the tax payers, in spite of amendments, as they perceive the whole exercise of reassessment as unjust weilding of power by those in the power. One finds a lot of merit in this when one notices the ease with which completed cases are sought to be reopened in large numbers.

4.2 The sting is acutely painful in cases where the reopening is made after expiry of four years, in spite of the fact that there is no failure on the part of the assessee to disclose fully and truly the material facts necessary for assessment. Even in such cases the reopening is sought to be justified on the pretext that the AO had not applied his mind to the material disclosed, though it was produced. The action is sought to be explained by resorting to Explanation 1 to S. 147 and in many cases by relying on Explanation 2 to the said section.

4.3 Fortunately for the tax payers the courts have, by and large, frustrated such attempts of the Revenue in cases where disclosure is found to be evident and also in cases where the material has been furnished in response to an inquiry by the AO. The courts have not given great credence to the Revenue’s contention, often made, that the assessment order is silent on the relevant aspect under contest. The courts have advanced the cause of the tax payers even in cases involving reopening within four years on being convinced that material facts necessary for assessment were disclosed. The courts have also taken a unanimous view that the amendments of 1989 have not materially altered the available law on the subject and that a change of opinion can not lead to a valid reopening even post 1989.

4.4 The Courts have been consistent in holding that the law does not permit a review of an order, not even in the name of reassessment. A thing which can not be done directly can certainly not be done indirectly by resorting to the provisions of re-assessment. It is this principle that has been reiterated by the Full Bench of the Delhi High Court by stating that permitting an AO to reopen a completed case in given circumstances amounted to giving a premium to an authority exercising quasi-judicial function to take benefit of its own wrong.

4.5 Whether this position stated in paragraph 4.4 has been changed by insertion of Explanation 1 and 2. The Courts do not think so. Even after the said insertion the courts are more or less consistent, in holding that a change of opinion can not lead to reopening of a completed assessment and further that in cases where the assessee has not failed in disclosing truly and fully the material facts necessary for assessment, reopening is not possible irrespective of the time of reopening.

4.6 The Punjab & Haryana High Court, in the case of Hari Iron Trading Co. v. CIT, 263 ITR 437, observed that the taxpayer had no control over the actions of an AO and that he was not in a position to direct the framing of an order in a manner that would record fully and truly all that had actually transpired during the course of assessment and in such circumstances it was appropriate to assume that the order had been passed with due diligence unless it was otherwise proved by the AO. It is normally seen that an assessment order rarely records the findings of the inquiry by AO where he is satisfied with the assessee’s explanation furnished in response to his inquiry.

4.7 The Bombay High Court, consistently follow-ing the full bench decision of the Delhi High Court, has held that once an assessment order is passed u/s.143(3) and the assessee has not been found to have failed in disclosing material facts, no reopening was sustainable. Asian Paints Ltd. v. DCIT & Ors., 308 ITR 195, Idea Cellular Ltd. v. DCIT, 301 ITR 407 and GT v. Eicher Ltd., 294 ITR 310. The same is the ratio of the decisions of several High Courts and Tribunals including the latest one by the Tribunal in the case of Vardhman Industries, ITA No. 501/ Jd/2008 dated 14-9-2009 wherein the jodhpur Bench held that even within four years it was not possible to reopen an assessment where the material facts were found to have been disclosed by the assessee. It appears that in all cases of assessments completed after scrutiny, a reopening can follow only on the basis of an information received subsequent to assessment.

4.8 Even the Allahabad High Court in the case of Foramer v. CIT & Ors., 247 ITR 436 had held that no reopening was possible on a mere change of opinion in cases where there was no failure to disclose material facts by an assessee, a decision which was later on approved by the Supreme Court. Had this decision been noted by the court in EVA’s case, the outcome could have been different. It is interesting to note that the full bench of the Delhi High Court in coming to the conclusion in assessee’s favour had concurred with the abovementioned decision of the Allahabad High Court in Foramer’s case.

4.9 The twin decisions of the Gujarat High Court in the cases of Praful Chunilal Patel, 236 ITR 732 and Garden Silk Mills, 237 ITR 668, heavily relied upon by the Allahabad High Court in EVA’s case, were not even followed by the same Gujarat high court and importantly the full bench in Kelvinator’s case had specifically dissented from these decisions of the Gujarat High Court. Like Delhi, the Bombay High Court has refused to follow the said decisions of the Gujarat High Court.

4.10 CBDT Circular No. 549 dated 31-10-1989, while explaining the implication of the scheme of reassessment, specifically clarified vide para 7.2, that the new scheme does not bring about a material change in the existing law providing that no reopening would sustain in cases of change of opinion not involving any failure on the part of the assessee to disclose material facts. It is this circular which has helped information of a definitive judicial consen-sus in the era after amendment of 1989. It is need-less to note that the circulars of the Board are binding on its officers in administering the provisions of the Income-tax Act.

4.11 S. 114 of the Indian  Evidence  Act vide clause provides that due care has been taken by a public officer in performing his duty. Therefore on completion of assessment, it can be presumed that the AO has examined the material produced before him. Frankly, Explanation 1 is an unintended but serious reflection on the state of affairs in the Revenue department, indicating that orders as a rule are passed without due diligence, unless otherwise proved.

4.12 Article 14 has been favourably relied upon by the courts to support the contention that permitting an AO to review his order results in violation of the Constitution which guarantees protection against such administrative actions of the executive.

4.13 A point which emerges from the controversy is that the issue is debatable, and the language adopted by the law is capable of two interpretations. If that is so, a view that is favourable to the assessee should be accepted.

4.14 The decision of the Supreme Court, in the case of Indian Newspaper, relied upon by the Allahabad high court in EVA’s case, clearly supported the view that the reopening of an assessment was not possible for reviewing an order.

4.15 The decision in Kelvinator’s case was delivered by the full bench of the high court. The law of precedent required that the division bench of the high court, of two judges, in EVA’s case should have followed the decision of a larger bench instead of following decisions which were specifically dissented by the full bench. The decision in the case of Shyam Bansal, 296 ITR 95 (All.), again relied upon in EVA’s case did not consider the decision of the full bench and in any case the Revenue in that case was in possession of some information obtained post assessment. The binding force of the decision of the full bench in Kelvinator’s case was specifically considered in the case of KLM Royal Dutch Airlines 292 ITR 49 (Delhi) wherein the Court, in the context of the very same issue, had considered the validity of a decision delivered by the division bench in the case of Consolidated Photo and Finvest Ltd. 281 ITR 394 (Del.) wherein the division bench had failed to follow the decision of the full bench in Kelvinator’s case. The Court in KLM Royal Dutch Airlines’ case held that the decision of the full bench in Kelvinator’s case had to be followed by the division bench of the Court. This position in law of precedent has been reiterated by the Bombay High Court in the case of Eicher Ltd., 294 ITR 310.