BCAJ | Bombay Chartered Accountant Journal

Search and seizure: Block assessment: Block period: S/s. 132A and 158B(a): Period up to which “requisition was made”: Meaning of: Date on which the authorisation u/s. 132A was issued is to be taken and not the dated of execution of the authorisation: Warrant of authorisation u/s. 132A issued on 18-09-2001: Warrant executed and books of account and other documents received on 21-03-2003: The block period will be from 01-04-1995 to 18-09-2001 and not from 01- 04-1996 to 21/03/2003 as taken by the<

Sanjay Gupta vs. CIT; 366 ITR 18 (Delhi):

The assessee derived income from purchase and sale of properties and from trading of transistor parts. He also worked as an informer for the Directorate of Revenue Intelligence. On 15-06-2001, the CBI conducted a search at the premises of the assessee and seized cash amounting to Rs. 1,12,50,000/-. The Director of Incometax (Investigation) issued a warrant of authorisation u/s. 132A of the Income-tax Act, 1961 on 18-09-2001. The Income Tax Authorities executed the warrant and received the books of account and other documents on 21-03- 2003. The Assessing Officer passed block assessment order u/s. 158BC for the block period from 01-04-1996 to 21-03-2003.

When the dispute reached the High Court in appeal the Delhi High Court held as under:

“i) “Block period” has been defined to mean the period comprising previous years relevant to the six assessment years preceeding the previous year in which search u/s. 132 of the Income-tax Act, 1961, is conducted or requisition u/s. 132A is made. It also includes the part of the previous year till the date when the search u/s. 132 is conducted or such requisition u/s. 132A is made.

ii) Making a requisition would not be the same as receiving the articles that are requisitioned. The expression “a requisition was made” cannot be equated to receiving the articles that were requisitioned. There was no reason to read the expression “requisition was made” not to mean the date on which the authorised officer made the requisition, but to mean the date when he received the records and assets pursuant thereto.

iii) The block period adopted by the Assessing Officer was not in accordance with the provisions of the Act, the assessment made by the Assessing Officer would also be required to be reviewed. Thus, the matter was remanded to the Assessing Officer to assess the income for the block period 01-04-1995 to 18-09-2001.”

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Revision: S/s. 143 and 263: A. Y. 2006-07: ITO had jurisdiction at the time issuing notice u/s. 143(2): Assessment order u/s. 143(3) passed by ITO when jurisdiction was with Dy. Commissioner/ Assistant Commissioner as per Departmental Circular: Assessment order not invalid: Commissioner does not have power to revise such order u/s. 263:

CIT vs. Kailash Chand Methi: 366 ITR 333 (Raj):

For the A. Y. 2006-07, the assessee had filed the return of income declaring income of Rs. 2,32,969/-. The ITO completed the assessment u/s. 143(3) of the Incometax Act, 1961 making an addition of Rs. 4,50,000/-. The Commissioner initiated proceedings u/s. 263 of the Act, but being satisfied with the submissions of the assessee dropped the proceedings. Subsequently, another Commissioner set aside the order of the ITO holding that the ITO had no jurisdiction to complete the assessment as the income of the subsequent A. Y. 2007-08 was over Rs. 5 lakh and the jurisdiction lay with the Dy. Commissioner/ Asst. Commissioner and not with the ITO . The Tribunal set aside the order of revision.

On appeal by the Revenue, the Rajasthan High Court upheld the decision of the Tribunal and held as under:

“i) T he Commissioner does not have unfettered or unchequered discretion to revise the order u/s. 263 of the Income-tax Act, 1961. He can do so within the bounds of the law and has to satisfy the need of fairness in action. The Commissioner cannot invoke the powers to correct each and every mistake or error committed by the Assessing Officer. Every loss to the Revenue cannot be treated as prejudicial to the interest of the Revenue.

ii) T he notice u/s. 143(2) was issued on 11-01-2007 by the ITO and at that particular time, the income for the subsequent A. Y. 2007-08 was not submitted, rather the financial year had not ended by then and the ITO assumed valid jurisdiction. The return for the A. Y. 2007-08 was submitted on 31-08-2007, and merely because the assessment order was passed after 31- 08-2007, the assessment order u/s. 143(3) passed by the ITO on 30-09-2008, could not be said to be without jurisdiction. The assessment order passed on 30-09- 2008 was within jurisdiction and validly passed.

iii) M oreover, one Commissioner had issued notice u/s. 263 for the same assessment year and he having been satisfied dropped the proceedings and it was only thereafter that another Commissioner came to the conclusion about the jurisdiction while the earlier Commissioner was also aware of this fact. The order of the Commissioner was at best a result of change of opinion and tantamount to abuse of powers granted to the Commissioner. The practice adopted by the Commissioner is de hors and it amounts to unnecessary harassment to the assessee for no fault of his. Therefore, the order of revision was not valid.

iv) We do not find any infirmity or perversity in the order of the Tribunal. The appeal, being devoid of any merits, is hereby dismissed.”

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Income: Unexplained investment: Section 69: A. Y. 2005-06: Search and seizure: Jewellery found during search: Instruction No. 1916 dated 11-05- 1994: Jewellery within prescribed limits: Addition of value of part of jewellery as undisclosed income: Not justified:

CIT vs. Satya Narayan Patni; 366 ITR 325 (Raj):

There
was a search action in the case of the Appellant on 30-06-2004,
wherein, besides other items, gold jewellery weighing 2202.464 gms,
valued at Rs. 10,53,520/- was found. Looking to the status of the
assessee and the statement given during the course of search operation
by various family members and considering the fact that there were four
married ladies in the house including the wife of the assessee, no
jewellery was seized. However, jewellery to the extent of 1600 grams,
was treated as reasonable by the Assessing Officer which had been
received by them at the time of their marriage. The balance jewellery
weighing 602.464 gms, was treated as unexplained in the absence of any
satisfactory explanation from the assessee and the value thereof of Rs.
2,88,176/- was added to the income of the assessee as unexplained
investment u/s. 69 of the Income-tax Act, 1961. The CIT(A) and the
Tribunal deleted the addition.

On appeal by the Revenue, the Rajasthan High Court upheld the decision of the Tribunal and held as under:

“i)
O n a perusal of Instruction No. 1916 dated 11/05/1994 issued by the
CBDT, it is clear that in the case of a wealth-tax assessee, whatever
gold, jewellery and ornaments have been found and declared in the
wealth-tax return, need not be seized. However, subclause (ii)
prescribes that in the case of a person not assessed to wealth-tax, gold
jewellery and ornaments to the extent of 500 gms. per married lady, 250
gms. per unmarried lady and 100 gms per male member of the family need
not be seized. Sub-clause (iii) also prescribes that the authorised
officer may, having regard to the status of the family, and the customs
and practices of the community to which the family belongs and other
circumstances of the case, decide to exclude larger quantity of
jewellery and ornaments from seizure.

ii) A dmittedly looking to
the status of the family and the jewellery found in the possession of
the four ladies, it was held to be reasonable and therefore, the
authorised officer, in the first instance, did not seize the jewellery
as being within the limit or limits prescribed by the Board and the
subsequent addition was not justifiable on the part of the Assessing
Officer and rightly deleted by both the two appellate authorities.

iii)
T he Tribunal has correctly analysed the circular of the Board and we
do not find any infirmity or perversity in the order of the Tribunal.
The appeal, being devoid of any merits, is hereby dismissed.”

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House property income: Annual letting value: Section 23(a): A. Y. 2005-06: For determining annual value of property municipal rateable value may not be binding on Assessing Officer only in cases where he is convinced that interest free security deposit and monthly compensation do not reflect prevailing rate: In such a case, Assessing Officer can himself resort to enquire about prevailing rate in locality: Where a premises is covered by Rent Control Act, Assessing Officer must undertake exercise<

CIT vs. Tip Top Typography: [2014] 48 taxmann.com 191 (Bom):

In the A. Y. 2005-06, the assessee had let out commercial premises. The assessee had received Rs. 3,60,000/- as rent and Rs. 5,25,00,000/- as interest free security deposits from the tenants. The Assessing Officer noticed that the rent received by the assessee was nominal and the circumstantial evidence indicated that the fair market value was higher. Therefore, he obtained instances of the rental amount prevailing in the market and particularly in the area and confirmed that the property was not covered by the Rent Control Act. On the basis of such comparable instance, the annual letting value u/s. 23(1)(a) was determined at Rs. 85,72,608/- as against Rs. 3,60,000/- shown by the assessee. The Tribunal remitted the matter back to the Assessing Officer and directed him to verify the rateable value fixed by the Municipal authorities and if the same is less than Rs. 3,60,000/-, then the actual rent received should be taxed. In appeal filed by the Revenue, the following questions of law were raised:

“i) Whether on the facts and circumstances of the case and in law, Tribunal was right in holding that the fair rental value specified in section 23(1)(a) is the municipal value or actual rent received whichever is higher and not the annual letting value on the basis of comparable instances as adopted by the Assessing Officer, though the property under consideration was not covered by the Rent Control Act?

ii) Whether on the facts and circumstances of the case and in law, Tribunal was right in remitting the matter back to the file of the Assessing Officer with direction to verify the rateable value fixed by the Municipal Authorities and if the same is less than the actual rent received, then the actual rent received should be taxed?”

The Bombay High Court dismissed the appeal filed by the Revenue and held as under:

“i) T he rateable value, if correctly determined, under the municipal laws can be taken as Annual Letting Value u/s. 23(1)(a) of the Act. To that extent we agree with the contention of the learned Counsel of the assessee. However, we make it clear that rateable value is not binding on the assessing officer. If the assessing officer can show that rateable value under municipal laws does not represent the correct fair rent, then he may determine the same on the basis of material/ evidence placed on record.

ii) We are of the view that where Rent Control Legislation is applicable and as is now urged the trend in the real estate market so also in the commercial field is that considering the difficulties faced in either retrieving back immovable properties in metro cities and towns, so also the time spent in litigation, it is expedient to execute a leave and license agreements. These are usually for fixed periods and renewable. In such cases as well, the conceded position is that the Annual Letting Value will have to be determined on the same basis as noted above.

iii) I n the event and as urged before us, the security deposit collected and refundable interest free and the monthly compensation shows a total mismatch or does not reflect the prevailing rate or the attempt is to deflate or inflate the rent by such methods, then, as held by the Delhi High Court, the Assessing Officer is not prevented from carrying out the necessary investigation and enquiry. He must have cogent and satisfactory material in his possession and which will indicate that the parties have concealed the real position.

iv) H owever, we emphasise that before the Assessing Officer determines the rate by the above exercise or similar permissible process he is bound to disclose the material in his possession to the parties. He must not proceed to rely upon the material in his possession and disbelieve the parties. The satisfaction of the Assessing Officer that the bargain reveals an inflated or deflated rate based on fraud, emergency, relationship and other considerations makes it unreasonable must precede the undertaking of the above exercise. After the above ascertainment is done by the Officer he must, then, comply with the principles of fairness and justice and make the disclosure to the Assessee so as to obtain his view.

v) The following conclusions are drawn:-

a) AL V would be the sum at which the property may be reasonably let out by a willing lessor to a willing lessee uninfluenced by any extraneous circumstances.

b) An inflated or deflated rent based on extraneous consideration may take it out of the bounds of reasonableness.

c) A ctual rent received, in normal circumstances, would be a reliable evidence unless the rent is inflated/ deflated by reason of extraneous consideration.

d) Such ALV, however, cannot exceed the standard rent as per the Rent Control Legislation applicable to the property.

e) If standard rent has not been fixed by the Rent Controller, then it is the duty of the assessing officer to determine the standard rent as per the provisions of rent control enactment.

f) T he standard rent is the upper limit, if the fair rent is less than the standard rent, then it is the fair rent which shall be taken as ALV and not the standard rent.

vi) We do not see as to how we can uphold the submissions of Mr. Chhotaray that the notional rent on the security deposit can be taken into account and consideration for the determination. If the transaction itself does not reflect any of the afore-stated aspects, then, merely because a security deposit which is refundable and interest free has been obtained, the Assessing Officer should not presume that this sum or the interest derived therefrom at Bank rate is the income of the assessee till the determination or conclusion of the transaction.

vii) The Assessing Officer cannot brush aside the rent control legislation, in the event, it is applicable to the premises in question. Then, the Assessing Officer has to undertake the exercise contemplated by the rent control legislation for fixation of standard rent. The attempt by the Assessing Officer to override the rent control legislation and when it balances the rights between the parties has rightly been interfered with in the given case by the Appellate authority. The Assessing Officer either must undertake the exercise to fix the standard rent himself and in terms of the Maharashtra Rent Control Act, 1999 if the same is applicable or leave the parties to have it determined by the Court or Tribunal under that Act. Until, then, he may not be justified in applying any other formula or method and determine the “fair rent” by abiding with the same. If he desires to undertake the determination himself, he will have to go by the Maharashtra Rent Control Act, 1999. Merely because the rent has not been fixed under that Act does not mean that any other determination and contrary thereto can be made by the Assessing Officer.

viii)We are of the opinion that wherever the Assessing Officer has not adhered to the above principles, and his finding and conclusion has been interfered with, by the higher Appellate Authorities, the revenue cannot bring the matter to this Court as no substantial question of law can be arising for determination and consideration of this Court. Then, the findings by the last fact finding Authority, namely the Tribunal and against the revenue shall have to be upheld as they are consistent with the facts and circumstances brought before it. If they are not vitiated by any perversity or error of law apparent on the face of the record, the appeals of the revenue cannot be entertained. They would have to be accordingly dismissed.”

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51 taxmann.com 1 (Mumbai) Johnson & Johnson Ltd. vs. Addl. CIT SA No. 288 /Mum/2014 Assessment Year: 2009-10. Date of Order: 31.10.2014

If the Tribunal has granted stay, even if there is consent of the assessee, the Officer should not collect the amount stayed.

Facts:
By
this stay application the assessee sought stay of collection of
outstanding demand of Rs. 43,24,08,871. The AO after reference to
determine transfer pricing adjustments u/s. 92C of the Act passed an
order determining the income of the assessee at Rs. 353.30 crore and
raised an additional demand of Rs. 116.27 crore. The Tribunal while
dealing with stay application dated 19.2.2014 noticed that most of the
issues stated before the Tribunal have been decided in favor of the
assessee in the orders passed by the Tribunal in assessee’s own cases
for earlier years and therefore it granted stay and directed the AO not
to make any adjustment except for the amount of Rs. 7.50 crore.

The
AO, despite the specific direction by the Bench, obtained consent
letter from the assessee and collected Rs. 16.64 crore during the
subsistence of the stay order. The amount outstanding had been reduced
to Rs. 43.24 crore.

Since the DR sought adjournment from time to time, the assessee filed a fresh stay application for extension of stay.

Held:
In
the proceedings for hearing the second stay application the Tribunal
noticed that the AO followed an innovative method of collection of taxes
despite specific directions of the Bench. The Tribunal clarified that
neither the assessee nor the Revenue has the right to flout the decision
of the Tribunal and being an officer functioning under the Government
of India it is his obligation to follow the directions of the superior
authority and even if there is consent he should not have collected the
amount.

The Tribunal having noticed that in few other cases also
similar consent letters were obtained and tax collected despite the
stay order being passed by the Tribunal, the Bench deplored this
practice and directed the Chief Commissioner of Income-tax to issue a
letter to all concerned officers not to adopt this kind of approach of
obtaining consent letters and to respect the order passed by the
Tribunal as otherwise the Tribunal would be constrained to view the
conduct of the Department adversely.

The Tribunal extended the
stay for a further period of six months and also directed the AO to
refund the amount collected, contrary to the order passed by ITAT in
S.A. No. 50/Mum/2014, along with interest within 15 days and to furnish
the proof of having refunded the amount before the Bench.

The stay application filed by the assessee was allowed.

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49 taxmann.com 578 (Cochin) Three Star Granites (P.) Ltd. vs. ACIT ITA No. 11/Cochin/2011 Assessment Years: 2007-08. Date of Order: 25.4.2014

Section 40(a)(ia) – No disallowance can be made u/s 40(a)(ia) in cases of short deduction of tax at source.

Facts :
In respect of certain payments made by the assessee to resident contractors the Tribunal vide its order dated 29th March, 2012 decided that the assessee was liable to deduct tax at source u/s. 194I and not u/s. 194C as was the contention of the assessee. Aggrieved by this order of the Tribunal, the assessee carried the matter, by way of an appeal u/s. 260A, to the High Court. The High Court vide its order dated 26th November, 2013 held that the assessee was liable to deduct tax at source u/s. 194I and not u/s. 194C. For the limited purposes of applicability of section 40(a)(ia) of the Act in respect of short deduction of tax, i.e., deduction of tax at 2.06 % instead of 10 % u/s. 194-I of the Act, the High Court restored the matter to the file of the Tribunal.

Held:
The Tribunal noted that the issue of disallowance in respect of short deduction of of tax at source has been considered by the co-ordinate Bench in the case of Apollo Tyres Ltd. vs. Dy. CIT [2013] 60 SOT 1 (Cochin). Having considered the provisions of section 40(a)(ia) and also the provisions of section 201(1A), the Tribunal held that section 40(a)(ia) does not envisage a situation where there was short deduction/lesser deduction as in case of section 201(1A) of the Act. There is an obvious omission to include short deduction/lesser deduction in section 40(a) (ia) of the Act. Therefore, the entire expenditure whose genuineness was not doubted by the Assessing Officer, cannot be disallowed. The Tribunal set aside the orders of lower authorities and deleted the entire disallowance.

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Period of Holding on Conversion of Leasehold Property into Ownership

Issue for Consideration
When an
immovable property held as a capital asset is transferred, for
computation of the capital gains, it is essential to first identify the
period of holding of the asset transferred for determining as to whether
the property was a long-term capital asset or a short term capital
asset by applying the definitions of long-term capital asset and short
term capital asset contained in sections 2(29A) and 2(42A) respectively,
of the Income-tax Act, 1961. If the immovable property was held for
more than 36 months, it is a long-term capital asset, or else it is a
short term capital asset. Such classification is important, because the
manner of computation of the gains is more beneficial in the case of
long-term capital gains. Such gains are also taxable at a lower rate,
besides qualifying for certain exemptions.

The complication
arises when the immovable property that is being transferred was to
begin with taken on lease by the assessee, and the leasehold rights
therein were thereafter converted into ownership rights within a period
of 36 months prior to the date of transfer of the immovable property,
with the combined total period of lease and ownership put together
exceeding 36 months. In such cases, the question that has arisen for
consideration is whether the property that is under transfer can be said
to have been held for more than 36 months or not, and accordingly
whether it will be regarded as a long-term capital asset or whether it
would be treated as a short term capital asset.

While the
Karnataka and the Bombay High Courts have taken the view that the gains
arising on sale of the property under such circumstances would be a
short term capital gains, the Allahabad High Court has taken a contrary
view and held that the gains would be classified as longterm capital
gains .

Dr. V. V. Mody’s case
The issue first came up before the Karnataka High Court in the case of CIT vs. Dr. V. V. Mody 218 ITR 1.

In
this case, the assessee was allotted a site by the development
authority in 1972 on lease with a stipulation that the asset in question
would be sold after a period of 10 years to the assesse. A
lease-cum-sale agreement was executed at that point of time, providing
for payment of certain amount by the assessee, and that on payment of
the entire sale consideration, conveyance was agreed to be executed in
favour of the assessee at the end of the 10th year. Subsequently, in
pursuance of the said agreement, a sale deed was executed in favour of
the assessee in March 1982, which was registered in May 1982. The
assessee sold the site in November 1982, and claimed that the capital
gains arising on sale was a long term capital gain, since he held the
site since 1972.

The assessing officer treated the gains as a
short term capital gain, holding that the assessee acquired the site
only in March 1982, when the conveyance was executed in his favour and
the asset that was transferred was a short term capital asset in the
hands of the assessee. The Commissioner(Appeals) allowed the assessee’s
appeal, agreeing with the view of the assessee that the site had been
held by him since 1972. On appeal by the revenue, the tribunal held that
the rights acquired under the lease-cum-sale agreement were also
capital assets. It held that on transfer of the site, the assessee had
in fact transferred a bundle of rights, a part of which (half) were held
as a long term capital asset. It accordingly directed that 50% of the
sale consideration should be regarded as received pertaining to the
transfer of the short term capital asset , with 50% of the consideration
being regarded as pertaining to the transfer of the long term capital
asset, with 50% of the cost of the asset being attributed to each of the
components.

Before the Karnataka High Court, on behalf of the
assessee, it was argued that the lease rights held by the assessee was a
capital asset, since the expression “property of any kind” in the
definition of capital asset in section 2(14) was wide enough to include
rights enjoyed by an assessee in respect of immovable property, even
though such rights were inferior to the rights of ownership of the
property. It was argued that transfer of such lights would legitimately
give rise to capital gains, and since these rights were held for more
than 36 months, the gains was to be treated as a long-term capital gain.

The Karnataka High Court noted that there were two questions
which arose for consideration before it – what was the capital asset
that had been transferred by the assessee giving rise to the capital
gains, and since when was that capital asset held by the assessee.
According to the High Court, the answers to these questions were
straight and simple. The asset transferred was title to the site, which
the assessee held on the basis of the conveyance in his favour since
March 1982. The gain was therefore a short term capital gain.

The
High Court noted that the approach adopted by the tribunal implied that
the transfer made by the assessee pertained to both the lease rights as
well as title to the property, which in turn meant that as on the date
of the transfer in favour of the purchaser, the assessee combined in
himself the dual capacity of being not only the owner of the property,
but also the lessee thereof. According to the High Court, this approach
was not legally sound and ignored the legal effect of the transfer of
absolute title in favour of the assessee, who was holding the site in
question till March 1982, only on the basis of the leasecum- sale
agreement.

The significance of the transfer was that it brought
about a merger of the lesser interest held by the assessee in the bigger
estate acquired by him under the sale deed in his favour. Merger
implied the vesting of lesser rights held by an individual in the larger
estate that he may acquire qua the property in question. It postulated
the extinction of the lesser estate, whenever the person holding any
such estate acquired a greater estate in respect of the same property.
In the event of the lesser and the greater estate is coinciding in the
same individual, the lesser got annihilated, ground or sunk in the
larger. The doctrine owed its origin to the English common law, but with
equity intervening, the position in England was that merger would be
deemed to take place only in case the party acquiring the larger estate
intended so. The High Court noted that this position was accepted, even
in India except to the extent that the statutory provisions like the
Transfer of Property Act, 1882 mandated otherwise. The High Court noted
the observations made by the Supreme Court in Jyotish Thakur vs.
Tarakant Jha AIR 1963 SC 605 in this regard.

The Karnataka High
Court noted that the assessee held the site in question under an
agreement of lease cum sale, and that it was not in dispute that in so
far as an agreement to sell was concerned, it did not create any right
in the property agreed to be sold. The assessee had valuable interest in
the site in his capacity as a lessee, which leasehold rights was a
capital asset. These rights, being a lesser estate in comparison to the
larger one representing the title or the property, merged with the
larger estate upon the assessee acquiring the title to the property
under the sale deed.

The Karnataka high Court noted that there were two questions which arose for consideration before it – what was the capital asset that had been transferred by the assessee giving rise to the capital gains, and since when was that capital asset held by the assessee. According to the high Court, the answers to these questions were straight and simple. The asset transferred was title to the site, which the assessee held on the basis of the conveyance in his favour since march 1982. the gain was therefore a short term capital gain.

The high Court noted that the approach adopted by the tribunal implied that the transfer made by the assessee pertained to both the lease rights as well as title to the property, which in turn meant that as on the date of the transfer in favour of the purchaser, the assessee combined in himself the dual capacity of being not only the owner of the property, but also the lessee thereof. According to the high Court, this approach was not legally sound and ignored the legal effect of the transfer of absolute title in favour of the assessee, who was holding the site in question till march 1982, only on the basis of the lease- cum-sale agreement.

The significance of the transfer was that it brought about a merger of the lesser interest held by the assessee in the bigger estate acquired by him under the sale deed in his favour. Merger implied the vesting of lesser rights held by an individual in the larger estate that he may acquire qua the property in question. It postulated the extinction of the lesser estate, whenever the person holding any such estate acquired a greater estate in respect of the same property. in the event of the lesser and the greater estate is coinciding in the same individual, the lesser got annihilated, ground or sunk in the larger. The doctrine owed its origin to the english common law, but with equity intervening, the position in england was that merger would be deemed to take place only in case the party acquiring the larger estate intended so. the high Court noted that this position was accepted, even in india except to the extent that the statutory provisions like the transfer of Property act, 1882 mandated otherwise. The high Court noted the observations made by the Supreme Court in jyotish Thakur vs. Tarakant Jha AIR 1963 SC 605 in this regard.

The Karnataka high Court noted that the assessee held the site in question under an agreement of lease cum sale, and that it was not in dispute that in so far as an agreement to sell was concerned, it did not create any right in the property agreed to be sold. The assessee had valuable interest in the site in his capacity as a lessee, which leasehold rights was a capital asset. these rights, being a lesser estate in comparison to the larger one representing the title or the property, merged with the larger estate upon the assessee acquiring the title to the property under the sale deed.

The Karnataka high Court noted the provisions of section 111(d) of the transfer of Property act, which provided that a lease of immovable property determined in case the interests of the lessee and the lessor in the whole of the property became vested at the same time in one person in the same right. According to the high Court, this provision recognised what was true even on first principles, i.e., a person cannot be a tenant and landlord qua the same property at the same time. In the opinion of the high Court, the question of the assessee intending to keep the two capacities or estates, namely one of leasehold rights and the other of ownership, separately from each other or any such separation of the interests held by him being beneficial to the assessee, did not arise. The question of intention of the assessee or his interest would arise only if the situation was not covered by the provisions of section 111 (d).

The Karnataka high Court noted that from the date of sale in favour of the assessee, the assessee had only one capacity to describe himself qua the land in question, and that was the capacity of being the absolute owner of the same. it was in that capacity alone that the assessee transferred his title over the site in favour of the purchaser. the sale did not describe the transfer made in favour of the purchaser to be one of the rights which the assessee held in respect of the site prior to the sale deed. All such rights had sunk or drowned in the larger estate and therefore stood extinguished. The legal effect of the transfer made in favour of the assessee was that he had become the absolute owner of the property and therefore all that he could convey and did actually convey to the transferee was the absolute title in the property without any reference to any inferior rights that the assessee had held prior to his becoming owner.

Viewed from that angle, according to the Karnataka high Court, it was apparent that what the assessee transferred had been held by him only from the date of the sale deed in his favour and not earlier to that. Therefore, in the view of the high Court, the question of splitting up the sale price or the cost of acquisition of the asset separately for the purposes of short-term and long-term capital gains did not arise.

The high Court rejected the argument of the assessee regarding the transfer of leasehold rights by the assessee, which were long-term capital assets. according to it, the issue was not whether such leasehold rights were a property or a capital asset, but whether any such right existed and could be transferred by the assessee after it had merged in the larger estate acquired by the assessee. This was so because what was transferred by the assessee was not the lesser interest held by him prior to becoming the absolute owner, but the total interest acquired by him in the form of absolute title to the property. Unless it was possible for the assessee to hold the two estates simultaneous and independent of each other, the transfer of the title in the property could not be deemed to be a transfer of both the larger and the lesser estates, so as to make them amenable to the process of splitting into long term and short term capital gains.

The Karnataka high Court therefore held that as from march 1982, the assessee had only one estate representing the title to the property, and the capital gain arising from the transfer of this estate gave rise to a short term gain.

A similar view was taken by the Bombay high Court in the case of CIT vs. Dr. D. A. Irani 234 ITR 850, where it dealt with a case of an assessee having tenancy right over a flat, who acquired the ownership rights to the flat and sold the flat within 5 months of acquisition. In that case as well, the Bombay high Court applied the provisions of section 111(d) of the transfer of Property act, to hold that the gain on sale of the flat was a short term capital gain.

Rama rani kalia’s case
the issue again came up recently before the allahabad high Court in the case of CIT vs. Smt. Rama Rani Kalia 358 ITR 499. in this case, the assessee acquired a property on leasehold basis in 1984. She applied for freehold rights, which were granted by the collector in march 2004. Within 3 days thereafter, the property was sold. the assessee claimed the capital gains on sale of the property to be long term capital gains.

The assessing officer took the view that since the property was sold within 3 days of conversion of the leasehold rights into freehold rights, the capital gains was a short term capital gains. The Commissioner(appeals) held that the conversion of leasehold property into freehold property was an improvement of title over the property, since the assessee was the owner of the property even prior to conversion. He therefore held that the gain was a long term capital gains. The Tribunal confirmed the order of the Commissioner(appeals).

The allahabad high Court noted that the difference between a short term capital asset and a long-term capital asset was the period for which the property had been held by the assessee, and not the nature of title or the property. according to the high Court, the lessee of the property had rights as owner of the property for all purposes, subject to covenants of the lease. The lessee may transfer the leasehold rights of the property with the consent of the lessor, subject to covenants of the lease deed. The conversion of the rights of the lessee in the property from leasehold right into freehold was only by way of improvement of rights over the property, which she enjoyed.

According to the allahabad high Court, the conversion would not have any effect on the taxability of gains from such property, which was related to the period over which the property was held. Since the property was held by the assessee as a lessee since 1984, and was transferred in march 2004, after the leasehold rights were converted into freehold rights of the same property, which was in her possession, the conversion was by way of improvement of title, which, according to the high Court, would not have any effect on the taxability of profits .

The allahabad high Court therefore held that the gains arising on sale of property was long term capital gains.

The allahabad high Court, in yet another decision, delivered in ita no. 134 of 2007 dated 22-11-2007, in the case of Dhiraj Shyamji Chauhan has confirmed that the period of holding in such cases should commence from the date of acquiring leasehold rights.

Observations
The Supreme Court, in the case of A.R. Krishnamurthy vs. CIT 176 ITR 417, held that a land is a bundle of rights. the issue is whether these rights are separable, whether they can be separately transferred, and if transferred together, whether it is possible to bifurcate the rights between those held for more than 36 months and those held for a shorter period. in the case of A R Krishnamurthy, the Supreme Court considered a situation of grant of mining rights, which was one of the bundle of rights acquired on acquisition of the land. in that case, the Supreme Court directed bifurcation of the cost of acquisition to compute the capital gains. In that case, of course, it was the assessee himself who separated the rights, and transferred one of the rights. The court found that each of the rights comprised in the bundle was capable of being separately transferred for a valuable consideration. Conversely, the different rights in an asset can be acquired at different point of time, acquisition of each of which has the effect of improving the title of the acquirer over the property. The doctrine of merger, embodied in the transfer of Property act, provides that on acquisition, by the lessee, of the freehold rights in a property, the lesser estate of the lessee i.e., his leasehold rights merge into a larger estate of the lessee i.e., his freehold rights. . .

Section 111 (d) of the transfer of Property act provides as under:

111. A lease of immovable property determines – (a)…..
(b)…..
(c) ….
(d) in case the interests of the lessee and the lessor in the whole of the property become vested at the same time in one person in the same right.

From the statutory provision, it is clear that a lease comes to an end when the same person is both the owner as well as the lessee of the property, and therefore the subject matter of transfer is the ownership rights in the property, which remain on merger, to the buyer of the property. To that extent, the views of the Karnataka high Court and the Bombay High Court at first seem to be justified when the courts dealt with the nature of rights or the title that the buyer acquired. What perhaps, was overlooked, with respect, and had remained unaddressed, was the issue whether the asset in question was held for a longer period that began with the date of acquiring the leasehold rights in the property. This issue was specifically dealt with by the allahabad high court in the later decision which after considering the ratio of the decision of the Karnataka high court chose to take a contrary view.

The issue in question, as identified by the Allahabad High Court, is about the period of holding of a capital asset which is determined with reference to the period for which an asset is ‘held by an assessee’. the property all along remained the same i.e., an immovable property. What was changed was the rights over the property – from leasehold to ownership. the assessee remained the same. Holding a property under a leasehold right as a lessee, is also a recognised mode of holding the property. It is only when the property in question is changed, that the period of holding is shortened, for e.g., warrants to shares. When the property remains the same, the change in the title to the property is not a relevant factor for the purposes of the income-tax act.

It is a settled position that lease is one of the modes of acquisition of an immovable property and that leasehold rights are a capital asset capable of being transferred. Applying the law of section 2(47) to the case of a purchase or acquisition, it is possible to hold that an asset is acquired on execution of a lease deed. It is also clear that an immovable property comprises of a bundle of rights and grant of lease is one such right.

In the case of R. K. Palshikar HUF vs. CIT 172 ITR 311, the Supreme Court held that grant of a lease of a property for 99 years amounts to transfer of the property, giving rise to capital gains. if that is the position, and under tax laws, the owner is regarded as having transferred the property, the logical consequence should be that the lessee is then regarded as the deemed owner, a position that is acknowledged by section 27 of the act. Even A.
R. Krishnamurthy’s case (supra) was a case of grant of a mining lease for 10 years, where the Supreme Court followed r. K. Palshikar huf’s decision (supra), taking a view that transfer of capital asset in section 45 includes grant of mining lease for any period.

In fact, section 27 of the income-tax act provides that a person who acquires any rights (excluding any rights by way of a lease from month to month or for a period not exceeding one year) in or with respect to any building or part thereof, by virtue of any such transaction referred to in section 269UA(F), is deemed to be the owner of that building or part thereof. Section 269UA(F), which dealt with acquisition proceedings, refers to, inter alia, a lease for a period exceeding 12 years. Therefore, for all practical purposes, the income-tax act regards the property as having been transferred to the lessee if the lease is for a period exceeding 12 years.

Under such circumstances, is it appropriate to say that the lessee was really not the owner, for the period that he was a lessee, when it comes to payment of capital gains taxes, even if he was a lessee for more than 12 years?

The cost of acquisition is a significant factor in computation of the capital gains. The cost in certain specified cases remains the historical cost, and, in those cases, the courts have taken a consistent view that the period of holding should also be so taken, by relating it back, in the interest of the harmonious construction of the provisions of the act, [h.f.Craig harvey 244 itr 578 (mad.), and manjula j. Shah, 355 itr 474(Bom)].

Alternatively, the cost would have to be taken as the market value as on the date of conversion where a view is taken that the period of holding should be determined with reference to the date of acquisition of the new asset. The law on this aspect is very clear that the cost should be the market value.

In case of an asset held under a deed of conveyance executed in pursuance of an agreement for sale, the period of holding should commence from the date of agreement and not of the deed, though on execution of the deed, the rights under the agreement are extinguished and absolute rights are acquired in the asset.

It may not be possible to separate the gains in two parts nor may it be possible to divide the consideration, but the period of holding can surely be said to have begun from the date of the lease, particularly in a case where the lessee has acquired a dominion over the property with a right to transfer the same in lieu of consideration paid by him. In fact, in dr. V. V. mody’s case, the lease was coupled with the right to acquire ownership after a period of ten years, which right itself was a capital asset. The definition of the term ‘capital asset’ u/s. 2(14) includes a ‘property of any kind’ and is wide enough to cover the case of a leasehold right. Having acquired a capital asset, it does not vanish in thin air, unless it is lawfully transferred or is improved upon.

The issue therefore is not whether there were two estates or one but is all about the period of holding of the property. It may be that the latest rights that are transferred may not be old, but the property that is transferred is certainly old. Even the pedigree of the new rights is ancestral.

Various explanations contained in ssection 2(42a) of the Act, precisely confirm the theory of harmonious construction by extending the period of holding in cases of various financial assets referred to therein. This principle also is approved by section 55 of the act. in all cases, where the historical cost is frozen in time, the period of holding of the new asset is extended to cover the period of holding of the old asset as well. this is, otherwise, also true on first principles of taxation.

One strong view is that the issue cannot be determined with reference to the provisions of section 111 of the transfer of Property act. These provisions have the limited impact of explaining the title of a person over a property. they simply explain that the inferior rights of a person are transformed into the superior rights. this does not affect the period of holding of the property at all. It only improves the legal title to the property. Tax laws clearly recognise the concept of holding of an asset other than by way of legal title – leasehold rights in a property is one such form of ownership.

In fact, the delhi high Court, in a recent decision in the case of CIT vs. Frick India Ltd. 369 ITR 328, has analysed the meaning of the term “held by the assessee” u/s. 2(42A) as under:

“We would like to elucidate and explain the expression, “held by the assessee” in some detail. General words should normally receive plain and ordinary construction but this principle is subject to the context in which the words are used as the words reflect the intention of the Legislature. The words have to be construed and interpreted to effectuate the object and purpose of the provision, when they are capable of multiple meanings or are ambiguous. Isolated reading of words can on occasions negate the very purpose. Lord Diplock had referred to the term, “business” as an ‘etymological chameleon’, which suits its meaning to the context in which it is found. The background, therefore, has to be given due regard and not to be ignored, to avoid absurdities. This principle is applicable when we interpret the word, “held” in section 2(42A) of the Act, for the said word is capable of divergent and different connotations and understanding.

The word, ‘held’ as used in section 2(42A) of the Act is with reference to a capital asset and the term, ‘capital asset’ is not confined and restricted to ownership of a property or an asset. Capital assets can consist of rights other than ownership right in an asset, like leasehold rights, allotment rights, etc. The sequitur, therefore, is that the word ‘held’ or ‘hold’ is not synonymous with right over the asset as an owner and has to be given a broader and wider meaning. In Black’s Law Dictionary, Sixth Edition, the word ‘hold’ has been given a variety of meanings under nine different headings. Four of them, i.e, 1, 4, 8 and 9 read as under:

‘1. To possess in virtue of a lawful title; as in the expression, common in grants, “to have and to hold,” or in that applied to notes, “the owner and holder.”
** ** **
4. To maintain or sustain; to be under the necessity or duty of sustaining or proving; as when it is said that a party “holds the affirmative” or negative of an issue in a cause.
** ** **
8. To possess; to occupy; to be in possession and administration of; as to hold office.

The word ‘held’ was interpreted to mean “lawfully held, to possess by legal title”. The term ‘legal title’ here not only includes ownership, but also title or right of a tenant, which will mean actual possession of the land and a right to hold the same and claim possession thereof as a tenant (we are not examining rights of a rank trespasser in the present decision and we express no opinion in that regard).”

From this, it is clear that the term “held” need not necessarily refer to only the period of holding as an owner.

Under the law contained in the income-tax act, 1961, in the context, there are only two possibilities:

a.   a transfer arises on conversion of leasehold rights into ownership rights in which case;
i.   liability to capital gains is attracted on such conversion, and
ii.   the fair market value becomes the cost of acquisition of the new asset,

9.   To keep; to retain; to maintain possession of or authority over.’

b. there is no transfer on such conversion and the period of holding is extended to include the period during which the asset was held on lease.

The latter view seems to be the more equitable view of the matter, but given the views of the Karnataka and Bombay high Courts, the debate will ultimately be settled only by a decision of the Supreme Court.

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Business expenditure: Disallowance u/s. 43B r.w.s. 2(24)(x) and 36(1)(va): A. Y. 2008-09: Employer’s and Employees’ contributions to Provident fund deposited before due date for filing return u/s. 139(1):

Amount allowable as deduction: Essae Teraoka P. Ltd. vs. CIT; 366 ITR 408 (Kar):

For the A. Y. 2008-09, the assessee company had deposited the Employer’s and Employees’ contribution to the provident fund after the due date under the Provident Fund Scheme but before the due date for filing the return of income u/s. 139(1) of the Income-tax Act, 1961. The Assessing Officer added the amounts to the income of the assessee u/s. 36(1)(va) r.w.s. 2(24)(x) of the Act and did not allow the deduction. The Tribunal upheld the disallowance.

On appeal by the Revenue, the Karnataka High Court reversed the decision of the Tribunal and held as under:

“i) F rom a bare perusal of clause (va) of section 36(1) of the Act, it is clear that if any sum received by the assessee employer from any of his employees towards the employees’ contribution to provident fund is deposited in the relevant fund within the time stipulated in the scheme then the assessee is straightway entitled to deduction as contemplated u/s. 36(1)(va) of the Act.

ii) Section 43B states that notwithstanding anything contained in any other provision of the Income-tax Act, a deduction otherwise allowable in this Act in respect of any sum payable by the assessee as an employer by way of contribution to any fund such as provident fund shall be allowed if it is paid on or before the due date as contemplated u/s. 139(1) of the Act. This provision has nothing to do with the consequences, provided for under the Employees’ Provident Funds Act for not depositing the “contribution” on or before the due date therein.

iii) T he word “contribution” used in clause (b) of section 43B of the Act means the contribution of the employer and the employee. That being so, if the contribution is deposited on or before the due date for furnishing the return of income u/s. 139(1) of the Act, the employer is entitled to deduction.

iv) I n the result, the appeal is allowed and the substantial question of law is answered in favour of the appellantassessee and against the Revenue.”

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ITAT: Duty of Tribunal to decide appeals: Section 254(1): A. Y. 1997-98 and 1998-99: Unnecessary remand by ITAT causes prejudice and amounts to a failure to exercise jurisdiction:

Coca-Cola India P. Ltd. vs. ITAT (Bom): W. P. No. 3650 of 2014 dated 14-08-2014:

For the A. Y. 1997-98 as regards the assessee’s claim for deduction of service charges the Tribunal had remanded the matter back to the Assessing Officer for fresh consideration. Allowing the writ petition filed by the assessee against the said order, the Bombay High Court (see 290 ITR 464) had held that as the CIT(A) had given specific grounds for the disallowance , the Tribunal ought to have decided the specific issues on merit and not simply remanded it. Thereafter, the Tribunal decided the issue on merits and allowed the assessee’s claim. For A. Y. 1998-99, though the CIT(A)’s order was passed on the same date as the order passed for A. Y. 1997-98 and the Tribunal was aware of the High Court order for A. Y. 1997-98, it still remanded the issue to the Assessing Officer for fresh consideration. Miscellaneous application filed by the assessee was dismissed on the ground that the remand order was a conscious “decision” and not an apparent mistake.

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

“i) T he Tribunal should not have refused to consider and decide the issue relating to service charges, more so, when an identical view taken by it earlier has not found favour of this Court. This Court repeatedly reminded the Tribunal of its duty as a last fact finding authority of dealing with all factual and legal issues. The Tribunal failed to take any note of the caution which has been administered by this Court and particularly of not remanding cases unnecessarily and without any proper direction.

ii) A blanket remand causes serious prejudice to parties. None benefits by non-adjudication or non-consideration of an issue of fact and law by an Appellate Authority and by wholesale remand of the case back to the original authority. This is a clear failure of duty which has to be preformed by the Appellate Authority in law. Once the Appellate Authority fails to perform such duty and is corrected on one occasion by this Court, and in relation to the same assessee, then, the least that was expected from the Tribunal was to follow the order and direction of this Court and abide by it even for this later assessment year.

iii) I f the same claim and which was dealt with by the Court earlier and for which the note of caution was issued, then, the Tribunal was bound in law to take due note of the same and follow the course for the later assessment years. We are of the view that the refusal of the Tribunal to follow the order of this Court and equally to correct its obvious and apparent mistake is vitiated as above. It is vitiated by a serious error of law apparent on the face of the record. The Tribunal has misdirected itself completely and in law in refusing to decide and consider the claim in relation to service charges.

iv) O rder of the Tribunal is set aside for reconsideration of the issue on service charges in accordance with law.”

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Housing projects: Deduction u/s. 80IB(10): A. Y. 2006-07: Limit on extent of commercial area of housing project inserted w.e.f. 01/04/2005 does not apply to projects approved before that date:

CIT vs. M/s. Happy Home Enterprises (Bom); ITA No. 201 of 2012 dated 19-09-2014:

The following questions were raised in this appeal by the Revenue before the Bombay High Court.

“i) Whether on the facts and in the circumstances of the case and in law the Hon’ble Tribunal was right in allowing to the assessee company a deduction u/s. 80IB(10) of the Income-tax Act, for A. Y. 2006- 07 amounting to Rs. 2,11,74,864/- wherein the commercial area built by the assessee exceeded the limit specified in clause (d) to section 80IB(10) of the I. T. Act, 1961?

ii) Whether on the facts and in the circumstances of the case and in law, the Hon’ble Tribunal was right in holding that the limits on commercial area provided in clause (d) to section 80IB(10) of the Act, would not be applicable even after 01-04-2005 as the projects were approved before that date even though no such exception is provided under the Income Tax Act?”

The High Court decided the questions in favour of the assessee and held as under:

“i) Clause (d) of section 80IB(10) is a condition that relates to and/or is linked with the approval and construction of the housing project and the Legislature did not intend to give any retrospectivity to it.

ii) A t the time when the housing project is approved by the local authority, it decides, subject to its own rules and regulations, what quantum of commercial area is to be included in the said project. It is on this basis that building plans are approved by the local authority and construction is commenced and completed. It is very difficult, if not impossible to change the building plans and/or alter construction midway, in order to comply with clause (d) of section 80IB(10).

iii) It would be highly unfair to require an assessee to comply with section 80IB(10)(d) who has got his housing project approved by the local authority, before 31-03-2005 and has either completed the same before the said date or even shortly thereafter, merely because the assessee has offered its profits to tax in A. Y. 2005-06 or thereafter.

iv) It would require the assessee to virtually do a humanly impossible task. This could never have been the intention of the Legislature and it would run counter to the very object for which these provisions were introduced, namely to tackle the shortage of housing in the country and encourage investment therein by private players.

v) I t is therefore clear that clause (d) of section 80IB(10) cannot have any application to housing projects that are approved before 31-03-2005.”

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Assessment – Best judgment assessment – Assessee not very educated person, not properly represented – Supreme Court refused to interfere with assessment but directed that no interest be recovered and no penalty proceedings be initiated.

Tripal Singh and Anr. vs. CIT & Anr. [2014] 365 ITR 511 (sc)

The dispute before the Supreme Court related to the assessment year 1998-99. The petitioner-assessee failed to appear before the assessing authority which compelled the assessing authority to complete the assessment u/s. 144 of the Income-tax Act, 1961. The said order is dated 29th December, 2005. The petitioner did not file any appeal, instead challenged the assessment order by filing a revision as provided for u/s. 264 of the Act before the Commissioner of Income-tax (Admn.), Muzaffarnagar. The memo of revision was dated 23rd May, 2006. The said revision was dismissed by the Commissioner of Income-tax on 25th March, 2008, as no one attended the office on the fixed date. Thereafter, an application to recall the said order was filed which was dated 9th June, 2008. The said application was dismissed by the order dated 26th October, 2010, on the short ground that there was no provision under the Income-tax Act for recalling the order passed u/s. 264 thereof. Feeling aggrieved, a writ petition was filed.

Before the High Court, Learned counsel for the petitioner submitted that power to pass ex-parte order included the power to recall the same notwithstanding absence of any express provision in respect thereof. He further submitted that the Commissioner of Income-tax should have decided the revision on the merits even if the petitioner could not appear on the fixed date.

The High Court held that it was not necessary to examine the proposition as to whether the Commissioner of Incometax was right in rejecting the restoration application on the ground and on the facts of the present case that he does not possess power to recall the ex-parte order. According to the High Court, even assuming that the Commissioner had power to recall the ex-parte order on the merits, it did not find that the petitioner had been able to establish sufficient cause for his non-appearance on the date fixed. The assessment order was also passed ex parte. It appeared that the petitioner was never serious to pursue his remedies under the Act and filed the revision application as a chance petition and did not prosecute it. The High Court did not find any merit in the petition.

On further appeal, the Supreme Court observed that the facts were very peculiar in this case because the appellants, who were not very educated persons, unfortunately could not be properly represented before the Assessing Officer and, therefore, the assessment was made ex-parte for the assessment year 1998-99. The Supreme Court noted that so far as the subsequent assessment years were concerned, some relief was given to the appellants-assessees by the High Court, but so far as the assessment year 1998-99 is concerned, the assessment was over and the assessment order has become final. In these circumstances, the Supreme Court was of the view that it was not proper to interfere with the assessment order. However, it directed that no penalty proceedings would be initiated and no interest would be recovered from the appellants-assessees and that the amount of tax would be paid within 60 days and if the amount was not paid within 60 days, it would be open to the authorities to charge interest on the assessed tax.

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DCIT vs. Rajeev G. Kalathil ITAT Mumbai `D’ Bench Before Rajendra (AM) and Dr. S. T. M. Pavalan (JM) ITA No. 6727/Mum/2012 A.Y.: 2009-10. Decided on: 20th August, 2014. Counsel for revenue/assessee: J. K. Garg/Devendra Jain

Section 28, 37 – Purchases cannot be disallowed, merely because the supplier is treated as a havala dealer by VAT authorities, if receipt of material is substantiated by delivery challan and other evidences and payment is by account payee cheque.

Facts:
In the course of assessment proceedings, the AO sent notices u/s. 133(6) to various parties at random. Of these, notices sent to two parties were returned unserved with the remarks not known. The AO asked the assessee to furnish correct address or explain why purchases of Rs. 13,69,417 (Rs. 5,05,259 from NBE and Rs. 8,64,158 from DKE) should not be treated as bogus purchases.

The assessee furnished its reply expressing inability to establish contact with the parties but furnished letter from its banker stating that the payment has been made to the two parties in subsequent year. Sample bills were also filed which had TIN Numbers.

The AO verified the TIN numbers from the official website and found that NBE was specifically mentioned as `Hawala Dealer’ and the search for DKE did not show any result. He, accordingly, added Rs. 13.69 lakh to total income of the assessee on account of bogus purchases.

Aggrieved, the assessee preferred an appeal to CIT(A) and contended that suppliers were registered dealers and were carrying proper VAT registration; bills were accounted and payments were made by cheque; certificate from banker giving details of payments made to said parties were furnished; copies of consignment note received from government approved transport contractor showing material was delivered at site were furnished to the AO; some of the items purchased from these parties were reflected in closing stock. The CIT(A) allowed the appeal.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The AO made addition because one of the supplier was declared a havala dealer by VAT Department. According to the Tribunal, this could be a good starting point for making further investigation and to take it to logical end. Suspicion of highest degree cannot take place of evidence. According to the Tribunal, the AO could have called for details of bank accounts of suppliers to find out whether there was any immediate cash withdrawl from their account. It observed that transportation of goods to the site is one of the deciding factors to be considered for resolving the issue. It noted the finding of fact given by CIT(A) that some of the goods received were forming part of closing stock.

The Tribunal held that the decision of the Mumbai Tribunal in the case of Western Extrusion Industries (ITA /6579/ Mum/2010 dated 13-11-2013) was distinguishable since in that case there was no evidence of movement of goods and also cash was withdrawn by the supplier immediately from the bank.

This ground of appeal filed by the revenue was dismissed.

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Raj Kumari Agarwal vs. DCIT ITAT, Agra Pramod Kumar (A.M.) and Joginder Singh (J.M.) I.T.A. No.: 176/Agra/2013 Assessment Year: 2008-09. Decided on July 18th, 2014 Counsel for Assessee/Revenue: Arvind Kumar Bansal/S D Sharma

Section 57(iii) – Interest paid on loan taken against fixed deposit is deductible against interest earned on the fixed deposit.

Facts:
During the course of the assessment proceedings, the AO noticed that the assessee had made a fixed deposit of Rs. 1 crore with abank and earned interest of Rs 11.78 lakh thereon. However, whilecomputing the income from other sources, the assessee claimed a deduction of Rs. 4.37 lakh on account of interest paid on loan of Rs 75 lakh taken on the securityof deposits. When asked to justify this deduction, the assessee submitted that she needed her funds, as she had to give money to her son and with a view toavoid premature encashment of the fixed deposits, which wouldhave resulted in net loss to her, she took a loan against fixed deposit so as to keepthe fixed deposit intact and earn the interest income thereon. It was contended thatthe interest of Rs. 4.37 lakh paid on the borrowings from the Bank against security of fixed deposit, was thus made for the purpose of earning FDR interest. The AO rejected the claim of deduction observing that interest onloan has not been laid out or expended wholly and exclusively for the purpose ofmaking or earning income from FDR. On appeal the CIT(A) upheld the order of the AO.

Before the Tribunal, the assessee also justified her claim with the working showing that she has returned higher interest income of Rs. 7.41 lakh (Rs. 11.78 lakh minus Rs. 4.37 lakh paid) while if she had encashed the FDR then the interest income from FDR would had beenat lower sum of Rs. 5.38 lakh.

Held:
According to the Tribunal, the question that needs to be adjudicated was whether interest paid can be said to have been incurred “wholly and exclusively” for the purpose of earning interest income from fixed deposits.For this purpose, it referred to a decision by the coordinate bench of its own Tribunal in the case of AjaySingh Deol vs. JCIT [(91 ITD 196). Relying thereon, it observed that even in a situation in which proximate or immediate cause of an expenditure was an event unconnected to earning of the income, in the sense that the expenditure was not triggered by the objective to earn that income, but the expenditure was, nonetheless, wholly and exclusively to earn or protect that income,it will not cease to be deductible in nature (emphasis supplied). According to it, in order to protect the interest earnings from fixed deposits and to meet her financial needs, when an assessee raises a loan against the fixed deposit, so as to keep the source of earning intact, the expenditure so incurred is wholly and exclusively to earn the fixed deposit interest income. It further observed that the assessee could have gone for premature encashment of bank deposits, and thus ended the source of income itself as well, but instead of doing so, she resorted to borrowings against the fixed deposit and thus preserved the source of earning. The expenditure so incurred, according to the tribunal was an expenditure incurred wholly and exclusively for earning from interest on fixed deposits.

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ACIT vs. Iqbal M Chagala ITAT Mumbai “I” Bench Before Vijay Pal Rao (J.M.) and Rajendra (A. M.) ITA No. 877/Mum/2013 Assessment Year 2009-10. Decided on 30/07/2014 Counsel for Revenue/Assessee: Garima Singh/P J Pardiwala

Section 14A and Rule 8D – Application of the Rule is not automatic. Disallowance cannot exceed the expenditure claimed and if no expenditure is claimed by the assessee then disallowance cannot be made

Facts:
During the assessment proceedings, the AO noted that the assessee had earned exempt income and the audit report did not show disallowance of any expenses relating to exempt income. According to the assessee, the investment transaction undertaken by him were managed by the investment advisors whose fees amounting to Rs. 5.64 lakh had been debited to the capital account of the assessee. Plus, demat expenses and security transaction tax amounting to Rs. 2.2 lakh was also debited to the capital account of the assessee. However, the AO held that looking into the fact that partof the expenses on account of salary, telephone and other administrative expenses must have been related to the activities for earning exempt income, he disallowed the sum of Rs. 16.36 lakh, being 0.5% of average investment of Rs. 32.72 crore.

On perusal of Profit and Loss Account of the assessee the CIT(A) noted that the assessee had not made any claim of expenditure incurred in relation to exempt income, therefore according to him, the provisions of section 14A (1) r.w.s.14A(2) were not attracted. Therefore, relying on the cases of Walfort Shares & Stock Brokers Pvt. Ltd.(326 ITR 1) and Godrej & Boyce Manufacturing Co. Ltd (328 ITR 81) he deleted the disallowance of Rs.16.36 lakh made by the AO.

Held:
The tribunal noted that as per the audit report filed by the assessee, expenses in respect of exempt income was Rs. Nil and the assessee had debited all expenses relating to exempt income in the capital account. The AO had merely presumed that the assessee must have incurred someexpenditure under the heads salary, telephone and other administrative charges for earning theexempt income. Further, it was noted that that the total expenditure claimed by the assessee for the year was about Rs. 13 lakh and the AO had made a disallowance of about Rs.16 lakh. According to it, the AO had just adopted the formula of estimating expenditure on the basis of investments. But, the justification for calculating the disallowance was missing. The onus was on the AO to prove that out of the expenditure incurred under various heads part related to earning of exempt income. Not only thatthe AO was required to give the basis of calculation. In any manner disallowance of Rs.16.36 lakh, as against the total expenditure of Rs.13 lakh claimed by the assessee was not justified. Provisions of Rule 8D cannot and should not be applied in a mechanical way. Facts of the case have to be analysed before invoking them. Accordingly, the appeal filed by the AO was dismissed and the order of the CIT(A) was confirmed.

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[2014] 149 ITD 363 (Agra) Rajeev Kumar Agarwal vs. Addl CIT A.Y. 2006-07 Order dated – 29th May, 2014

Section 40(a)(ia) – Second proviso to section 40(a) (ia), which states that if assessee fails to deduct tax at source while making payments but the recipient has included the income embedded in the said payments in his tax return furnished u/s. 139 and had also paid the tax due thereon on such payments, then disallowance of such payments u/s. 40(a)(ia) cannot be invoked for assessee; has retrospective effect from 01-04-2005.

Facts:
The assessee had made interest payments without discharging his tax withholding obligations u/s. 194A. Therefore, the Assessing Officer disallowed payment u/s. 40(a)(ia).

The assessee contended that, in view of the insertion of second proviso to section 40(a)(ia) by the Finance Act, 2012, and in view of the fact that the recipients of the interest had already included the income embedded in the said interest payments in their tax returns filed u/s. 139, disallowance u/s. 40(a)(ia) could not be invoked in this case.

He also contended that since the said second proviso to section 40(a)(ia) is ‘declaratory and curative in nature’, it should be given retrospective effect from 01-04-2005, being the date from which sub-clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

Held:
The scheme of section 40(a)(ia) is aimed at ensuring that an expenditure should not be allowed as deduction in the hands of an assessee in a situation in which income embedded in such expenditure has remained untaxed due to tax withholding lapses by the assessee.

Section 40(a)(ia) is not a penalty for tax withholding lapse but it is a sort of compensatory deduction restriction to compensate for the loss of revenue for an income going untaxed due to tax withholding lapse. The penalty for tax withholding lapse per se is separately provided for in section 271C, and section 40(a)(ia) does not add to the same Thus, disallowance u/s. 40(a)(ia) cannot be invoked in a case, where assessee fails to deduct tax at source but recipients have taken, in their computation of income, the income embedded in the payments made by the assessee, paid taxes due thereon and filed income tax returns in accordance with the law.

The provisions of section 40(a)(ia), as they existed prior to insertion of second proviso thereto, went much beyond the obvious intentions of the lawmakers and created undue hardships even in cases in which the assessee’s tax withholding lapses did not result in any loss to the exchequer. Now that the legislature has been compassionate enough to cure these shortcomings of provision and, thus, obviate the unintended hardships, such an amendment in law, in view of the well-settled legal position to the effect that a curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not state so specifically, the insertion of second proviso to section 40(a)(ia) must be given retrospective effect from the point of time when the related legal provision was introduced.

Accordingly, the insertion of second proviso to section 40(a)(ia) is declaratory and curative in nature and it has retrospective effect from 01-04-2005, being the date from which sub-clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

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[2014] 149 ITD 169 (Hyderabad) Binjusaria Properties (P) Ltd vs. ACIT A.Y. 2006-07 Order dated- 4th April, 2014

Section 2(47) of The Income-tax Act, 1961 Where assessee enters into a development agreement of land with a developer in terms of which developer has to develop property and deliver a part of constructed area to assessee, capital gains cannot be brought to tax in year of signing of development agreement if developer does not do anything to discharge obligations cast on it and it is only upon receipt of consideration in the form of developed area by the assessee in terms of the development agreement, the capital gains becomes assessable in the hands of the assessee.

Facts:
• The assesee gave its plot of Land for development and had received a refundable deposit in the relevant year. According to Development Agreement-cum-General Power of Attorney, the developer had to develop the property, according to the approved plan from the competent authority, and deliver to the assessee 38% of the constructed area in the residential part.

• No development activity was carried out by the developer in the year of the agreement and accordingly, assessee did not offer the sum for tax.

• The Assessing Officer was of the view that, in terms of the development agreement, the transfer has taken place during the year under appeal and the assessee was liable to pay capital gain taxes on the date of transfer.

• The CIT (A) confirmed the view of assessing officer and, therefore aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
• Tribunal observed the following:-

The assessee has executed a ‘Development Agreement- cum-General Power of Attorney’ which indicates that the assessee has given a permissive possession to developer.

The refundable deposit received by the assessee is to be refunded on the complete handing over of the area falling to the share of the assessee and in the event of the failure on the part of the assesee, the same shall be adjusted at the time of final delivery.

It is undisputed that there is no development activity carried out in the said relevant year. Even the approval of plan was not obtained and the process of construction has not been initiated.

• Considering specific clauses in the agreement, all abovementioned facts and circumstances and the reading of section 2(47)(v) of the Income-tax Act, 1961 alongwith section 53A of The Transfer of property Act, 1882, Tribunal held that the assessee had fulfilled its part of obligation under the development agreement but the developer had not done anything to discharge the obligations cast on it under the development agreement, the capital gains could not be brought to tax in the year under appeal, merely on the basis of signing of the development agreement .

It is only upon receipt of consideration in the form of developed area by the assessee in terms of the development agreement, the capital gains becomes assessable in the hands of the assessee.

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TDS: Salary: S/s. 192 and 201 of I. T. Act, 1961: A. Y. 2008-09: Consultant doctors employed by hospital: No administrative control: Doctors free to come at any time and treat patients: No provision for payment of provident fund and gratuity: No employer and employee relationship: Payment to doctors is not salary: Section 192 for TDS is not applicable:

CIT vs. Yashoda Super Speciality Hospital; 365 ITR 356 (AP):

For the A. Y. 2008-09, orders u/ss. 201 and 201(1A) were passed treating the assessee hospital as an assessee in default for non deduction of tax at source u/s. 192 of the Income-tax Act, 1961 holding that the payments made by the assessee to the consultant doctors was salary. The Tribunal held that there was no employer employee relationship between the assessee and the consultant doctors and accordingly such payments did not constitute salary paid by the assessee. The Tribunal therefore set aside the said orders.

On appeal by the Revenue, the Andhra Pradesh High Court upheld the decision of the Tribunal and held as under:

“i) O n the facts and on examining the agreement between the consultant doctors and the assessee hospital under which the services of the doctors were engaged, the appellate authorities found that there was no relationship of employer and employee between the doctors and the hospital. The doctors were not administratively controlled and managed by the assessee and they were free to come at any point of time as far as their attendance was concerned and treat the patients. There was no provision for payment of provident fund and gratuity to them.

ii) T he only clause in the agreement was that the doctors could not take up any other assignment. The existence of one prohibitory clause did not change the basic character of the relationship between the assessee and the doctors concerned. There was no employer and employee relationship. And their payments could not be treated to be salaries and, as such, deduction of tax at source did not need to be made u/s. 192.

iii) O n a careful reading of the impugned judgment and order of the Tribunal, we are of the view that the law has been correctly applied. Therefore, we do not find any question of law involved in the matter. The appeal is accordingly dismissed.”

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Industrial undertaking: Manufacture: Deduction u/s. 80-IB: A. Ys. 2004-05 to 2007-08: Assessee buying monitor, key board, mouse etc. and assembling them and selling computers so assembled: Activity is manufacturing activity: Assessee is entitled to deduction u/s. 80-IB:

CIT vs. Sai Infosystem India P. Ltd.; 365 ITR 433 (Guj):

The assessee bought basic computer items such as monitor, key board, mouse, etc., and was into the activity of assembling them. The assessee claimed deduction u/s. 80-IB of the Income-tax Act, 1961. For the A. Ys. 2004-05 to 2007-08, the Assessing Officer disallowed the claim holding that the activity of the assessee could not be said to be manufacturing activity so as to enable the assessee to claim the deduction. The Tribunal allowed the assessee’s claim.

In appeal by the Revenue, the Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) T he Tribunal had rightly deleted the disallowance of deduction u/s. 80-IB made by the Assessing Officer. There was a specific finding of the Commissioner(Appeals) that the assessee had employed at least ten persons. This was a finding of fact and it could not be said that the assessee was not entitled to deduction u/s. 80-IB of the Act.

ii) T he questions raised in the present tax appeals are held against the Revenue and in favour of the assessee. Consequently, the tax appeals are dismissed.”

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Charitable purpose: Education: Exemption u/s. 11 r/w. s. 2(15): A. Y. 2009-10: Assessee-association conducting various continuing education diploma and Certificate Programmes, Management Development Programmes, Public Talks, Seminars, Workshops and Conferences: Assessee’s activities would fall within realm of education which is ‘charitable’ as per section 2(15): Proviso is not applicable: Assessee is entitled to exemption u/s. 11:

DIT(E) vs. Ahmedabad Management Association: 366 ITR 85 (Guj): 47 taxmann.com 162 (Guj):

The assessee, a public charitable trust, was dedicated to pursue the objects of continuing education, training and research on various facets of management and related areas. It claimed exemption u/s. 11 of the Income-tax Act, 1961 on ground that it undertook multifaceted activities comprising of conducting various continuing education diploma and certificate programmes, management development programmes, public talks, seminars, workshops and conferences which falls in the realm of “education” as the charitable purpose. For the A. Y. 2009- 10, the Assessing Officer observed that considering the nature of courses, its durations and resultant surplus from each activity, the activity of the assessee is not educational in nature. The Assessing Officer held that activities of assessee fell within scope of amendment of ‘advancement of any other object of general public utility and any other activity’ of section 2(15) and, since the aggregate value of receipts were more than Rs. 10 lakh, proviso to section 2(15) was applicable and the assessee was not entitled for exemption u/s. 11. The Tribunal had held that the activities of the assessee were in the field of education and, therefore, the assessee was eligible for exemption u/s. 11.

On appeal by the Revenue, the Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) I t is required to be noted that all throughout for the previous years, right from the A. Y. 1995-96 till A. Y. 2008-09 the revenue has considered the activities of the assessee as educational activity and has granted the benefit u/s. 11.

ii) H owever, subsequently and w.e.f. A. Y. 2009-10, proviso to section 2(15) has been added and section 2(15) has been amended by the Finance Act, 2008 by adding the proviso which states that the ‘advancement of any other object of general public utility’ shall not be a charitable purpose if it involves the carrying on of (a) any activity in the nature of trade, commerce or business; or (b) any activity of rendering any service in relation to any trade, commerce or business for cess or fee or any other consideration, irrespective of the nature of use or application, or retention of the income from such activity. The revenue has denied the exemption claimed by the assessee u/s. 11 mainly relying upon the amended section 2(15) by submitting that the case of the assessee would fall under the fourth limb of the definition of ‘charitable purpose’ i.e., ‘advancement of any other object of general public utility’ and, therefore, the assessee shall not be entitled to exemption from tax u/s. 11.

iii) T he activities of the assessee such as continuing education diploma and certificate programme; management development programme; public talks and seminars and workshops and conferences etc., is educational activities and/or is in the field of education.

iv) O n fair reading of section 2(15) the newly inserted proviso to section 2(15) will not apply in respect of relief to the poor; education or medical relief. Thus, where the purpose of a trust or institution is relief of the poor; education or medical relief, it will constitute ‘charitable purpose’ even if it incidentally involves the carrying on of the commercial activities.

v) I n the present case, the activities of the assessee would fall within the definition of ‘charitable purpose’ as per section 2(15) and, therefore, would be entitled to exemption u/s. 11.”

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Capital gain: Slump sale or exchange: S/s. 2(42C) and 50B: A. Y. 2005-06: Transfer of division of undertaking in exchange for issue of preference shares and bonds: No monetary consideration: Exchange and not a sale: Not a slump sale:

CIT vs. Bharat Bijlee Ltd.; 365 ITR 258 (Bom):

In the relevant year, the asessee transferred its lift field operations undertaking to one T under the scheme of arrangement as approved by the Court in exchange for issue of preference shares and bonds. The assessee claimed that it is a case of exchange and not a case of slump sale attracting the provisions of section 50B of the Income-tax Act, 1961. The Assessing Officer rejected the claim of the assessee and held that the transaction squarely fell within the definition of “slump sale” in section 2(42C) and was taxable in terms of section 50B of the Act. The Tribunal held that a reading of the clauses in the scheme of arrangement showed that the transfer of the undertaking had taken place in exchange for issue of preference shares and bonds. The scheme did not refer to any monetary consideration for the transfer. It was a case of exchange and not a sale. Therefore, section 2(42C) was inapplicable and section 50B was also inapplicable.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) I n the given facts and circumstances and going by the clauses of the scheme of arrangement and reading them harmoniously and together, the Tribunal had held that the transfer of the lift division came within the purview of section 2(47) but could not be termed as a slump sale.

ii) This finding of fact could not be said to be perverse or based on no material. It also could not be said to be vitiated by an error of law apparent on the face of the record.

iii) We do not find any merit in the appeal. It is accordingly dismissed.”

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Business expenditure: TDS: Disallowance: S/s. 9, 40(a)(i) and 195: A. Y. 2009-10: Commission paid by the assessee to the non-resident agent for procuring orders for leather business from overseas buyers – wholesalers or retailers: Services rendered by non-resident agent can at best be called as a service for completion of export commitment: Services provided by non-resident agent are not technical services: Assessee is not liable to deduct tax at source when the nonresident agent provides servi<

CIT vs. Faizan Shoes P. Ltd.; [2014] 48 taxmann.com 48 (Mad):

The assessee is a company engaged in the business of manufacture and export of articles of leather. In the course of business, the assessee entered into an Agency Agreement with a non-resident agent to secure orders from various customers, including retailers and traders, for the export of leather shoe uppers and full shoes by the assessee. As per the terms of the Agency Agreement, the business will be transacted by opening letters of credit or by cash against document basis. The non-resident agent will be responsible for prompt payment in respect of all shipments effected on cash against document basis. The assessee undertook to pay commission of 2.5% on FOB value on all orders procured by the non-resident agent. For the A. Y. 2009-10, the Assessing Officer disallowed the claim for deduction of the said commission relying on the provisions of section 40(a)(i) of the Income-tax Act, 1961 for non-deduction of tax at source u/s. 195 of the Act. The Commissioner(Appeals) and the Tribunal allowed the assessee’s claim. The Tribunal observed that the non-resident agent was only procuring orders for the assessee and following up payments and no other services are rendered, and accordingly held that the nonresident agent was not providing any technical services to the assessee. The Tribunal also held that the commission payment made to non-resident agent does not fall under the category of royalty or fee of technical services and, therefore, the Explanation to section 9(2) of the Act has no application to the facts of the assessee’s case. The Tribunal, therefore held that the commission payments to non-resident agents are not chargeable to tax in India and, therefore, the provisions of section 195 of the Act are not applicable.

On appeal by the Revenue, Madras High Court upheld the decision of the Tribunal and held as under:

“i) T he services rendered by the non-resident agent can at best be called as a service for completion of the export commitment and would not fall within the definition of “fees for technical services”, we are of the firm view that Section 9 of the Act is not applicable to the case on hand and consequently, section 195 of the Act does not come into play.

ii) We find no infirmity in the order of the Tribunal in confirming the order of the Commissioner of Income Tax (Appeals).

iii) I n the result appeal is dismissed.”

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Business expenditure: Section 36(1)(ii): A. Y. 2006-07: Commission paid to directors for providing personal guarantee to bank as precondition for grant of credit facilities cannot be disallowed stating that otherwise it would have been payable to the directors as dividend;

Control and Switchgear Contractors Ltd. vs. Dy. CIT; 365 ITR 312 (Del):

In the A. Y. 2006-07, the assessee company had claimed deduction of Rs. 24,37,500/- being commission paid to the directors for providing personal guarantees to the bank for grant of credit facilities to the company. The Assessing Officer disallowed the claim for deduction holding that the same would have been otherwise payable to the directors as dividend. The Tribunal upheld the disallowance. Assessee’s rectification application was rejected by the Tribunal.

The Delhi High Court allowed the writ petition filed by the assessee, reversed the decision of the Tribunal and held as under:

“i) The directors having provided personal guarantees had acted beyond the call of duty as employees of the assessee. It was not within the jurisdiction of the Assessing Officer to impose his views with regard to the necessity or the quantum of the expenditure undertaken by the assessee. The Assessing Officer had only to determine whether the transactions were genuine or real.

ii) The directors would not be entitled to receive the amount paid to them as commission, as dividends because even if it was assumed that non-payment of commission would add to the kitty of distributable profits these would have to be distributed pro rata to all the shareholders and not selectively to the directors. Dividend is paid by a company as distribution of profits to its shareholders in the ratio of their shareholding in the company. The directors were not the only shareholders of the company and, therefore, in the event the commission had not been paid by the assessee it could not have been distributed to them as dividend.

iii) The writ petition is allowed. The said disallowance and the additions made on this count are set aside.”

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Agent of non-resident: Section 163: A. Y. 2003- 04: Where a person in respect of whom agent is sought to be made a representative assessee, does not attain status of non-resident during relevant accounting period, provisions of section 163 cannot be invoked in such a case:

Comverse Networks Systems India (P.) Ltd. vs. CIT; [2014] 48 taxmann.com 1 (Delhi)

One F was an employee with the petitioner. In respect of the A. Y. 2003-04, which is relevant in this case, the said F had filed the return of income and was assessed in the status of “Resident & Ordinarily Resident”. On 16/03/2010, the ACIT issued a notice u/s. 163(1)(c) of the Income-tax Act, 1961 proposing to treat the petitioner as the representative agent of F for the A. Y. 2003-04. In reply, the petitioner stated that F was not a non-resident in the A. Y. 2003-04 and accordingly that the petitioner could not be treated as a representative agent of F u/s. 163(1)(c) of the Act and, therefore, the petitioner requested the ACIT to drop the proceedings. The ACIT did not agree with the submissions of the petitioner and passed an order dated 31.01.2011 treating the petitioner as the agent of F u/s. 163 of the Act for the A. Y. 2003-04. The Commissioner rejected the revision application made by the petitioner u/s. 264 of the Act.

The Delhi High Court allowed the writ petition filed by the petitioner and held as under:

“i) S ection 160(1)(i) of the said Act makes it clear that the expression “representative assessee” has to seen “in respect of the income of a non-resident”. It is obvious that when we construe the expression “income of a non-resident” it has reference to income in a particular previous year/accounting year. The income of that year must be of a non-resident. If that be so, the agent of the non-resident or the deemed agent u/s. 163 of the said Act would be the representative assessee. The petitioner is not an agent of F.

ii) S ection 163(1)(c) talks about the person from or through whom the non-resident “is in receipt of any income, whether directly or indirectly”. The income bears reference to the accounting year for which the statutory agent is to be appointed. In the present case, the year in question is the year ended on 31-03-2003. During that year F was not a nonresident. Therefore, the petitioner cannot even be regarded as a deemed agent u/s. 163(1)(c) of the Act. Consequently, the petitioner cannot be considered to be the representative assessee of F in respect of the A. Y. 2003-04.

iii) T he writ petition is allowed and the impugned order is set aside.”

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Income: Deemed dividend: Section 2(22)(e): Advance or loan to a shareholder: Section 2(22) (e) cannot be invoked where the assessee is not a shareholder in the lending company:

CIT vs. Impact Containers Pvt. Ltd.(Bom); ITA No. 114 of 2012 dated 04/07/2014:

The Assessing Officer found that the assessee company had received loans from a company and also found that the assessee had shareholding in a company which had controlling interest in the lending company. The Assessing Officer applied the provisions of section 2(22)(e) of the Income-tax Act, 1961 and held that the loan received by the assessee is deemed dividend u/s. 2(22)(e) of the Income-tax Act, 1961 and made the addition accordingly. The Tribunal found that the assessee company was not a shareholder of the lending company and therefore, by following the decision of the Special Bench in the case of ACIT vs. Bhaumik Colour Pvt. Ltd.; 313 ITR(AT ) 146 (Mum)(SB) deleted the addition.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) T he consistent view taken is that if the words as noted by us herein-above have been inserted in the definition so as to make reference to the beneficial owner of the shares, still the definition essentially covers the payment to the shareholder and the position of the shareholder as noted in the Supreme Court’s decision, cannot undergo any change. That legal position and the status of the shareholder being same, we do not see how the view prevailing from CIT vs. C. P. Sarthy; 83 ITR 170 (SC) is in any way said to be changed. That is how all the judgments subsequent thereto have been rendered.

ii) We have noted that the Delhi High Court, even after exhaustive amendment to section 2(22)(e) held that the payment made to any concern would not come within the purview of this sub-clause so long as it contemplated shareholders. The Division Bench of Delhi High Court has made detailed reference to all the decisions in the field. It has also referred to the order passed by the Special Bench of the Tribunal in arriving at the same conclusion.

iii) In CIT vs. Ankitech Pvt. Ltd.; 340 ITR 14(Del), The Hon’ble Delhi High Court referred to both Sarathi Mudaliar and Rameshwarlal Sanwarmal, extensively. It also referred to the arguments of the Revenue which are somewhat similar to those raised before us. It is in dealing with these arguments that the Division Bench concluded that all the three limbs of the section analysed in CIT vs. Universal Medicare; 324 ITR 263 (Bom) denote the intention that closely held companies in which public are not substantially interested which are controlled by a group of members, even though having accumulated profits would not distribute such profits as dividend because if so distributed the dividend income would become taxable in the hands of the shareholders. Instead of distributing accumulated profits as dividend, companies distribute them as loan or advances to shareholders or to concerns in which such shareholders have substantial interest or make any payment on behalf of or for the individual benefit of such shareholders. In such an event, by the deeming provision, such payment by the company is treated as dividend. The purpose is to tax dividend in the hands of the shareholder.

iv) We do not see how such a view taken by the Delhi High Court and which reaffirms that of this Court in Universal Medicare can be said to be contrary to the legal fiction or the intent or purpose of the legislature in enacting it.

v) We are of the view that so long as the Tribunal holds that the assessee company is not a shareholder in any of the entities which have advanced and lent sums, then, the addition is required to be deleted.”

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Business expenditure: Disallowance of expenditure in relation to exempt income: Section 14A: A. Ys. 2001-02 to 2005-06: Where available interest free funds are more than the investment in tax free securities, disallowance of interest u/s. 14A will not be justified:

CIT vs. HDFC Bank Ltd.(Bom): ITA No. 330 of 2012 dated 23-07-2014:

In the relevant years, the assessee claimed that no disallowance of interest be made u/s. 14A of the Incometax Act, 1961 in view of the fact that the asessee had interest free funds available more than the investment in tax free securities. The Assessing Officer rejected the claim and made disallowance of interest u/s. 14A on proportionate basis. The Tribunal deleted the addition.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) We find that the facts of the present case are squarely covered by the judgment in the case of Reliance Utilities and Power Ltd.; 313 ITR 340 (Bom). The findings of fact given by the ITAT in the present case is that the assessee’s own funds and other non-interest bearing funds were more than the investment in the tax-free securities.

ii) I n the present case, undisputedly the assessee’s capital, profit reserve, surplus and current account deposits were higher than the investment in the taxfree securities. In view of this factual position, as per the judgment of this Court in the case of Reliance Utilities and Power Ltd.; 313 ITR 340 (Bom), it would have to be presumed that the investment made by the assessee would be out of the interest-free funds available with the assessee.

iii) We therefore, are unable to agree with the submission of Suresh Kumar that the Tribunal had erred in dismissing the appeal of the Revenue on this ground.

iv) We do not find that the question gives rise to any substantial question of law. Appeal is therefore rejected.

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ACIT vs. Connaught Plaza Restaurants Pvt. Ltd. ITAT Delhi `B’ Bench Before G. D. Agrawal (VP) and H. S. Sidhu (JM) ITA No. 5466/Del/2013 A.Y.: 2003-04. Decided on: 1st September, 2014. Counsel for revenue / assessee: Parwinder Kaur / Rohit Gar and Tejasvi Jain

S. 32 – Point of Sales (POS) systems qualify for depreciation @ 60% being the rate applicable to computers.

Facts:
In the course of assessment proceedings, the Assessing Officer (AO) noticed from the tax audit report that additions to Computers included a sum of Rs. 65,89,449 towards POS on which depreciation was claimed @ 60%. The AO held that POS could be regarded as computer accessories but not as computer. It is only computers and computer software which qualify for depreciation @ 60%. The rate of 60% cannot be extended to computer accessories and peripherals. He rejected the contention of the assessee that the POS systems are capable of performing the basic functions performed by a computer such as data processing, storage, etc and therefore are similar to computers. The AO allowed depreciation on POS @ 25% i.e. the rate applicable to normal plant and machinery.

Aggrieved, the assessee preferred an appeal to CIT(A) who following the decision of the Delhi High Court in the case of CIT vs. Rajdhani Powers Ltd. (ITA No. 1266/2010) decided the issue in favor of the assessee.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the CIT(A) had on perusing the technical specifications of POS from the brochure filed held that the POS terminal is akin to computer in terms of basic features and can be categorized as `Computers’. It also noted that he had followed the order of the jurisdictional High Court in the case of CIT vs. Rajdhani Powers Ltd. (supra) and therefore no interference was called for.

The appeal filed by the revenue was dismissed.

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Exemption – Educational Institute – Application for grant of certificate u/s. 10(23C)(vi) was rejected for the reason that the applicant was not using the entire income for the educational purposes – In view of the amendment to the objects, the Supreme Court set aside the orders of the High Court and authorities concerned with liberty to apply for registration afresh.

Om Prakash Shiksha Prasar Samiti & Anr. vs. CCIT & Ors. [2014] 364 ITR 329 (SC)

The appellants had applied for grant of a certificate u/s. 10(23C)(vi) of the Income-tax Act, 1961, inter alia, requesting the authorities to grant certificate to claim exemption under the provisions of the Act. The said certificate was not granted by the authorities primarily on the ground that the appellants were not using the entire income for the educational purposes for which purpose the trust was established.

Being aggrieved by the order passed by the Chief Commissioner of Income-tax, the appellants approached the High Court. The writ petitions were dismissed by the High Court.

During the course of hearing before the Supreme Court the learned counsel for the appellants stated that the appellants had amended the objects of the society, with effect from 31st March, 2008. The Supreme Court was of the view that if that was so, the appellants should make an appropriate application before the authorities for grant of certificate u/s. 10(23C)(vi) of the Act for the assessment years 2002-03 to 2007-08 along with the amended objects of the society.

In view of this subsequent development and keeping in view of the peculiar facts and circumstances of the case, the Supreme Court set aside the order passed by the High Court and the authorities concerned and permitted the appellants to file a fresh application within a month’s time from the date of the order. The Supreme Court directed that if such application is filed within the time granted the authority would consider the same in accordance with law, keeping in view the amended objects of the society, with effect from 31st March, 2008. All the contentions of both the parties were left open by the Supreme Court.

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Nitco Logistics Pvt. Ltd. vs. JCIT ITAT (Asr) Before A.D. Jain (J. M.) and B.P. Jain (A. M.) I.T.A. No. 437(Asr)/2012 Assessment Year:2009-10.Decided on 05-09-2014 Counsel for Assessee/Revenue: P.N. Arora/Saad Kidwai

Section 2(24) – Collection of Dharmarth along with the assessee company’s freight income and used for charity is not part of the income of the assessee.

Facts:
The AO made an addition of Rs. 15.99 lakh on account of Dharmarth collected by the assessee along with freight receipt which was not reflected by it in its profit and loss account. According to the AO, the receipts were directly related to the business of the assessee; that the receipts were received not by a trust created for the purposes of charity, but by a company doing business and trading and that no evidence had been filed by the assessee that the receipts had been actually spent on charity. The CIT(A) upheld the addition inter alia on the ground that the assessee was unable to establish that the object of the assessee company, as per its memorandum and articles of association, was also to carry out charity.

Held:
The Tribunal noted that the stand of the assessee was entirely in line with its stand taken earlier in A.Y. 2001-02 to A.Y. 2008-09 which was never disputed by the revenue. According to the Tribunal, once the receipts are routed as such to a charitable trust by the assessee company and the nature of that trust has not been questioned, the receipts are Dharmarth receipts and nothing else. Further, it was noted that the memorandum and articles of association of the assessee company clearly showed that one of the objectives of the assessee company is charity. Further, relying on the decision of the Supreme Court in the case of CIT vs. Bijli Cotton Mills (P.) Ltd. (1979) 116 ITR 60 the tribunal allowed the appeal of the assessee.

Facts:
The assessee being a company is an association of various industrialists formed in the year 1925 for development of trade, industries and commerce.

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Asst. CIT (TDS) vs. Oil and Natural Gas Corporation Ltd. ITAT ‘C’ Bench, Mumbai Before Sanjay Arora (AM) and Amit Shukla (JM) I.T.A. No. 5808/Mum/2012 Assessment Year: 2008-09. Decided on 03-12-2014 Counsel for Revenue/Assessee: Premanand J./ Naresh Jain & Mahesh Saboo

Section 194-I – Payments towards lease premium and additional Floor Space Index (FSI) charges not subjected to TDS.

Facts:
The issue before the Tribunal was about the exigibility to Tax Deduction at Source (TDS) u/s.194-I of the sum, described as lease premium and additional Floor Space Index (FSI) charges paid by the assessee to Mumbai Metropolitan Regional Development Authority (MMRDA) during the relevant year.

The Revenue’s case was that u/s.194-I the ‘rent’ is very comprehensively defined to include any payment made under the lease, sub-lease, tenancy or any such agreement or arrangement for use (either separately or together) of any land, building, plant, machinery, etc. By legal fiction, therefore, the scope of the term ‘rent’ stands thus extended beyond its common meaning. The same would include not only the payments on revenue account, but on capital account as well, as long as the sum paid is toward the use of any of the assets specified under the provision. For the purpose, the reliance was placed on the decisions in the case of CIT vs. Reebok India Co. [2007] 291 ITR 455 (Del); United Airlines vs. CIT [2006] 287 ITR 281 (Del); Krishna Oberoi vs. Union of India [2002] 257 ITR 105 (AP); and CIT vs. H.M.T. Ltd. [1993] 203 ITR 820 (Kar).

The CIT(A) on appeal, had held that the lease premium in the instant case was only toward acquisition of lease hold rights and additional FSI in the leased plots and thus, the payment made was not in the nature of rent hence, not covered u/s. 194(I).

Held:
The Tribunal noted that the amount charged by MMRDA as lease premium was equal to the rate prevailing as per the stamp duty ready reckoner for the acquisition of commercial premises. Further, it was also noted that there was no provision in the lease agreement for termination of the lease at the instance of the lessee and hence, for the refund of lease premium under normal circumstances. It noted that even the charges levied for additional FSI was as per the ready reckoner rate. Thus, according to the Tribunal, the whole transaction was for grant of leasehold rights or transfer of property; the lease premium paid by the assessee was the consideration for acquiring leasehold rights, which comprise a bundle of rights, including the right of possession, exploitation and its long term enjoyment. It further observed that the charges for FSI also partake the character of capital assets in the form of Transferable Development Rights (TDRs), such that the owner (of land) transfers the rights of development and exploitation of land, which rights are again capital in nature.

On the basis as discussed above and relying on the decisions in the cases of ITO vs. Naman BKC CHS Ltd. (in ITA Nos. 708 & 709/Mum/2012 dated 12-09-2013) and TRO vs. Shelton Infrastructure Pvt. Ltd. (in ITA No. 5678/ Mum/2012 dated 19-05-2014), the Tribunal upheld the decision of the CIT(A) and dismissed the appeal filed by the revenue. Referring to the decisions of the Tribunal in ITO vs. Dhirendra Ramji Vora (in ITA No.3179/Mum/2012 dated 09-04-2014) and Naman BKC CHS Ltd. (supra), it further observed that the decisions relied on by the A.O. were distinguishable and cannot be applied to the case of the assessee.

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[2014] 150 ITD 502 (Mum) Urban Infrastructure Venture Capital Ltd. vs. DCIT A.Y. 2008-09. Date of Order – 21st May, 2014.

Section 37(1) – When the assessee incurs expenditure, on the premises taken on rent by it, which does not create any new capital asset and the said expenditure merely helps the assessee for efficiently carrying on its business and the items on which expenditure so incurred cannot be reused on vacation of said premises, then such expenditure has to be treated as revenue in nature.

Explanation-1 after the fifth proviso to section 32(1)(ii) – It can be invoked only if the expenditure itself is capital in nature

FACTS
During the year under consideration, the assessee, an investment manager/advisor, had taken new premises on rent and had carried civil work, tiling work, marble work, fittings, fixtures, interior work in respect of said premises. The assessee had treated the said expenses as revenue expenditure.

However the Assessing Officer was of the opinion that these were major renovation expenses in the nature of capital and since the property was taken on lease, the assessee was entitled to depreciation only.

The Commissioner (Appeals) sustained the disallowance on the basis of Explanation (1) after the fifth proviso to section 32(1)(ii) which reads as – where the business or profession of the assessee is carried on in a building not owned by him but in respect of which the assessee holds a lease or other right of occupancy and any capital expenditure is incurred by the assessee for the purposes of the business or profession on the construction of any structure or doing of any work in or in relation to, and by way of renovation or extension of, or improvement to, the building, then, the provisions of this clause shall apply as if the said structure or work is a building owned by the assessee.

Aggrieved, the assessee preferred an appeal before the Tribunal.

HELD
The nature of business of the assessee needed a posh office as the visitors/clients were normally corporate executives and high net-worth individuals. It was submitted that during the course of its business, the assessee had to cater high-profile clients both Indian as well as foreign and hence the office premises were required to be kept to a good standard. The expenditure incurred by the assessee was in order to meet these business requirements.

The civil work, tiling work, marble work, fittings, fixtures, interior work carried out in respect of said rented premises brought changes only in the internal part of the structure. No new asset had been created and the said expenditure merely helped the assessee for efficiently carrying on its business and the items on which expenditure had been incurred could not be reused on vacation of said premises. Hence, the expenses incurred were revenue in nature.

Also the pre-condition to invoke the provision of Explanation- 1 after the fifth proviso to section 32(1)(ii) is that expenditure itself should be capital in nature. If the expenditure by its nature itself is not capital in nature and its nature is revenue then provisions of Explanation-1 after fifth proviso to section 32(1)(ii) will not be applicable at all.

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2014] 150 ITD 440 (Jd) Jeewanram Choudhary vs. CIT A.Y. 2006-07 Date of Order – 22nd February, 2013

Section 145, read with section 263 – Where Assessing Officer rejects books of account of the assessee due to its defects and applies a particular gross profit rate to derive assessee’s income, after applying his mind and after examining records and details, his order cannot be said to be erroneous or prejudicial to the interest of revenue and consequently it is not permissible for Commissioner to invoke revisionary powers to complete assessment in manner he likes by simply applying different gross profit rate.

FACTS
During the course of assessment proceedings, the Assessing Officer noted that the assessee firm had not maintained stock register and details of material consumed on a dayto- day basis. In the absence thereof, the consumption of material was not fully verifiable. Thus, on noticing various defects in the books of account of the assessee, Assessing Officer rejected the same as per section 145(3).

The Assessing Officer rather than making item-wise additions deemed it appropriate to estimate the gross profit rate considering the past history of the assessee. He accordingly worked out the addition, by applying gross profit rate of 9.5%, which was derived by comparing current year’s turnover with past year’s turnover.

Subsequently, the Commissioner pointing out defects, similar to the defects pointed out by the Assessing Officer, rejected the books of accounts of the assessee and exercising his revisionary power u/s. 263, calculated income of assessee taking gross profit rate of 10% by treating the order passed by the Assessing Officer as erroneous and prejudicial to the interest of revenue. On assessee’s appeal.

HELD
In the year under consideration, the pross profit rate declared by the assessee was 8.5% while in the preceding assessment year gross profit rate of 10% was applied by the Assessing Officer after rejecting the books of account. However, the turnover of the assessee increased in the assessment year under consideration in comparison to the immediately assessment preceding year. The Assessing Officer, therefore, keeping the past history in mind considered it fair and reasonable to apply gross profit rate of 9.5%. Therefore, it cannot be said that the Assessing Officer did not apply his mind while framing the assessment.

The Commissioner did not doubt the turnover shown by the assessee but was of the view that Assessing Officer ought to have applied gross profit rate of 10% instead of 9.5%. However the various defects in the books of account of the assessee on which jurisdiction was assumed by Commissioner u/s. 263, were already considered by the Assessing Officer while rejecting the books of account and determining the income by applying the gross profit rate.

It is well-settled that once the books of account are rejected, the only alternative to determine the income is application of net profit rate. Also, the Assessing Officer framed the assessment after examining the records and the details which were called for by him and also after applying his mind came to the conclusion of applying Gross Profit rate of 9.5%. Therefore, the assessment order passed by him cannot be said to be erroneous or prejudicial to the interest of the Revenue.

Also, when the Assessing Officer as well as Commissioner were of the same view that in the assessee’s case, gross profit rate was to be applied for determining the taxable income, it cannot be said that the order passed by the Assessing Officer by applying a particular gross profit rate, was erroneous or prejudicial to the interest of revenue. Therefore, the order passed by the Commissioner by simply applying a different gross profit is held to be not sustainable.

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Valuation of property – Reference to DVO – Section 142A – A. Y. 1991-92 – AO not rejecting books of account – Reference to DVO and addition on account of differential amount as unexplained investment is not sustainable –

CIT vs. Lakshmi Constructions; 369 ITR 271 (T&AP):

For the A. Y. 1991-92, the assessee firm had disclosed a sum of Rs. 23,75,000/- towards the cost of construction of a building. The Assessing Officer, without rejecting the assessee’s books of account, referred the matter to the DVO and as per the report of the DVO treated the difference as unexplained investment. The CIT(A) and the Tribunal deleted the addition holding that reference to the DVO could not have been made, unless the Assessing Officer rejected or doubted the veracity of the books of account of the assessee. On appeal by the Revenue, the Telangana and Andhra Pradesh High Court held as under:

“i) It is only when the Assessing Officer did not take the contents of the books of account, on their face value, that he could have resorted to an independent valuation. The Tribunal maintained the distinction and held that even before ordering the valuation of any property by independent valuer in respect of an assessee, who has maintained the books of account, the Assessing Officer must, as a first step, express his lack of confidence in the books of account. That not having been done, the very reference to the Valuation Officer could not be sustained in law.

ii) Though section 142A of the Income-tax Act, 1961 was amended in the year 2004 with retrospective effect from 1972, the exercise undertaken by the Assessing Officer could not be sustained on the touchstone of that provision.”

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TDS – Sections 194A, 201(1) and (1A) – Fixed deposit in name of Registrar General of High Court under directions of Court – S. 194A not to apply to credit by Bank in name of Registrar General – Bank has no obligation to deduct tax at source thereon-

UCO Bank vs. UOI and Dy. CIT; 369 ITR 335 (Del):

The Petitioner bank had accepted fixed deposits in the name of the Registrar General of the Delhi High Court in compliance with a direction by the Court in relation to certain proceedings before the Court. On the question of applicability of section 194A, 201(1) and (1A) of the Income-tax Act, 1961, the High Court held as under:

“i) In the absence of an assessee, the machinery of provisions for deduction of tax to his credit are ineffective. The expression “payee” u/s. 194A would mean the recipient of the income whose account is maintained by the person paying interest. The Registrar General of the Court was clearly not the recipient of the income represented by interest that accrued on the deposits made in his/her name. Therefore, the Registrar General could not be considered as a “payee” for the purposes of section 194A. The Registrar General was also not an assessee in respect of the deposits made with the bank pursuant to the orders of the Court. The credit by the bank in the name of the Registrar General would, thus, not attract the provisions of section 194A. Although section 190(1) clarifies that deduction of tax can be made prior to the assessment year of regular assessment, none the less the section would not imply that deduction of tax is mandatory even where it is known that the payee is not the assessee and there is no other assessee. The deposits kept with the bank under the orders of this Court were, essentially, funds which were in custodia legis, that is, funds in the custody of the Court. The interest on that account – although credited in the name of the Registrar General – was also part of funds under the custody of the Court. The credit of interest to such account was, thus, not a credit to an account of a person who was liable to be assessed to tax. Thus, the bank would have no obligation to deduct tax because at the time of credit there was no person assessable in respect of that income which may be represented by the interest accrued/paid in respect of the deposits. The words “credit of such income to the account of the payee” occurring in section 194A have to be ascribed a meaning in conformity with the scheme of the Act and that would necessarily imply that deduction of tax bears nexus with the income of an assessee.

ii) Circular No. 8 of 2011, dated 04-10-2011, proceeds on an assumption that the litigant depositing the money is the account holder with the bank or is the recipient of the income represented by the interest accruing thereon. This assumption is fundamentally erroneous as the litigant who is asked to deposit the money in Court ceases to have any control or proprietary right over those funds. The amount deposited vests with the Court and the depositor ceases to exercise any dominion over those funds. It is also not necessary that the litigant who deposits the money would be the ultimate recipient of the funds. The person who is ultimately granted the funds would be determined by orders that may be passed subsequently. And at that stage, undisputedly, tax would be required to be deducted at source to the credit of the recipient. However, the litigant who deposits the funds cannot be stated to be the recipient of income.

iii) Deducting tax in the name of the litigant who deposits the funds with the Court would also create another anomaly because the amount deducted would necessarily lie to his credit with the Income Tax Authorities. In other words, the tax deducted at source would reflect as a tax paid by that litigant/depositor. He, thus, would be entitled to claim the credit in his return of income. The implications of this are that whereas the Court had removed the funds from the custody of a litigant/depositor by judicial orders, a part of the accretion thereon is received by him by way of tax deducted at source. This is clearly impermissible because it would run contrary to the intent of judicial orders.

iv) Therefore, the notices issued by the Assistant Commissioner directing the bank to submit the details of deposits made with the bank by all litigants in the name of the Registrar General of the Court during the financial years 2005-06 to 2010-11, Circular No. 8 of 2011 and the order holding the bank to be an assesee in default within the meaning of section 201(1) for a sum of Rs. 7,78,34,950 determined u/s. 201(1)/201(1A) were liable to be set aside.”

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TDS: Income – Charge – Sections 4, 6 and 194A – Compensation awarded under Motor Vehicles Act is in lieu of death of a person or bodily injury suffered in a vehicular accident and it cannot be said to be taxable income; Tax is not deductible on interest on term deposits made by the Registry in terms of the orders passed by the Court in Motor Accident Claims cases – Circular No. 8/2011, dated 14-10-2011 quashed-

Court on its own motion vs. H. P. State Cooperative Bank Ltd.; [2014] 52 taxmann.com 151 (HP):

The Registrar of the Himachal Pradesh High Court had put up a note that Bank Authorities were making tax deductions on interest accrued on the term deposits, i.e., fixed deposits made by the Registry in terms of the orders passed by the Court in Motor Accident Claims cases. The matter was referred to the Finance/Purchase Committee for examination. The Committee was of the view that since the dispute involved was intricate and public interest was involved, it was recommended that the matter required consideration on judicial side. The recommendation of the Committee was treated as Public interest Litigation and suo motu proceedings were drawn. The department filed the reply and pleaded that in terms of Circular No. 8/2011, dated 14-10-2011, issued by the Income-tax authorities, income-tax was to be deducted on the interest periodically accruing on the deposits made on the court orders to protect the interest of the litigants.

The High Court Held as under:

“i) The circular, dated 14-10-2011, issued by the incometax authorities, is not in tune with the mandate of sections 2(42) and 2(31), read with section 6. The said circular also is not in accordance with the mandate of section 194A.

ii) Section 194A clearly provides that any person, not being an individual or a Hindu undivided family, responsible for paying to a “resident” any income by way of interest, other than income by way of interest on securities shall deduct income tax on such income at the time of payment thereof in cash or by issue of a cheque or by any other mode.

iii) While going through the said provisions of law, one comes to the inescapable conclusion that the mandate of the said provisions does not apply to the accident claim cases and the compensation awarded under the Motor Vehicles Act is awarded in lieu of death of a person or bodily injury suffered in a vehicular accident, which is damage and not income.

iv) Chapter X and XI of the Motor Vehicles Act, 1988 provides for grant of compensation to the victims of a vehicular accident. The Motor Vehicles Act has undergone a sea change and the purpose of granting compensation under the Motor Vehicles Act is to ameliorate the sufferings of the victims so that they may be saved from social evils and starvation, and that the victims get some sort of help as early as possible. It is just to save them from sufferings, agony and to rehabilitate them. One wonder how and under what provisions of law the income tax authorities have treated the amount awarded or interest accrued on term deposits made in Motor Accident Claims cases as income. Therefore, the said Circular is against the concept and provisions referred to hereinabove and runs contrary to the mandate of granting compensation.

v) The Apex Court has gone to the extent of saying that the Claims Tribunals, in Motor Accident Claims cases, should award compensation without succumbing to the niceties of law and procedural wrangles and tangles.

vi) The Circular dated 14-10-2011, issued by the Income- Tax Authorities, whereby deduction of income-tax has been ordered on the award amount and interest accrued on the deposits made under the orders of the Court in Motor Accident Claims cases, was quashed, and in case any such deduction has been made by department, they are directed to refund the same, with interest at the rate of 12% from the date of deduction till payment.”

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Recovery of tax – Provisional attachment – Section 281B – A. Ys. 2010-11 to 2013-14 – For valid provisional attachment notice to pay arrears is mandatory-

T. Senthil Kumar vs. CIT: 369 ITR 101 (Mad):

Allowing
the assessee’s writ petition challenging the orders of provisional
attachment u/s. 281B of the Incometax Act, 1961, the Madras High Court
held as under:

“i) A combined reading of the provisions of law
would show that even to make a provisional attachment of the property of
the assessee, there should be a notice to pay the arrears as per rule
51 of the Second Schedule, Part III of the Income-tax Act. Without any
notice to the assessee, the provisional attachment cannot be made u/s.
281B of the Act. In the instant case this court finds that without
notice of demand to pay arrears, the respondent has passed an order for
provisional attachment in arbitrary manner.

iii) This court is
of the considered view that in the absence of any notice of demand or
notice u/s. 156 of the Act, the petitioner cannot be termed as “assessee
in default” or “assessee deemed to be in default”. Similarly, in the
absence of any notice to pay the arrears of tax as per rule 51 of Second
Schedule, Part III, of the Act, there cannot be any provisional
attachment u/s. 281B of the Act. Hence the impugned orders are liable to
the quashed.”

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Penalty – Concealment of income – Section 271(1)(c) – A. Y. 1997-98 – High Court admitting quantum appeal by assessee – Debatable issue – Penalty not leviable-

CIT vs. Nayan Builders: 368 ITR 722 (Bom):

For the A. Y. 1997-98, in respect of addition made by the Assessing Officer, the High Court had admitted the appeal filed by the assessee and substantial questions of law were framed. Penalty u/s. 271(1)(c) of the Income-tax Act, 1961 imposed by the Assessing Officer was cancelled by the Tribunal on the ground that the quantum appeal has been admitted by the High Court.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) The imposition of penalty was found not to be justified and the appeal was allowed. As a proof that the penalty was debatable and arguable issue, the Tribunal referred to the order on the assessee’s appeal in quantum proceedings and the substantial questions of law which had been framed therein.

ii) Thus, there was no case made out for imposition of penalty and the penalty was rightly set aside.”

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Loss: Carry forward and set-off – Sections 80, 143(3) and 154 – A. Y. 1997-98 – Return with positive income filed in time – AO computed loss in order u/s. 143(3) – Loss can be carried forward and set off – Rectification u/s. 154 to withdraw carry forward of loss not justified-

CIT Srinivasa Builders; 369 ITR 69 (Karn):

For the A. Y. 1997-98, the assessee filed return of income on 06/01/1998 declaring income of Rs. 5,29,270/-. The Assessing Officer concluded the assessment u/s. 143(3) of the Income-tax Act, 1961 and assessed the business loss of Rs. 74,84,234/- and also allowed the same to be carried forward. Subsequently, the Assessing Officer issued notice u/s. 154, to rectify the order, withdrawing the benefit of carry forward of business loss stating that the return filed by the assessee was belated. Accordingly, he rectified the assessment order. The Tribunal set aside the order of rectification.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

“i) The assessee had not violated any of the conditions u/s. 80 of the Act. The assessee had shown positive income in the return but in the assessment, the business loss was determined by the Assessing Officer. This being the factual position the assessee was entitled to the benefit of carry forward of business loss.

ii) Whether the loss ultimately determined by the Assessing Officer was liable to be carried forward or not was a debatable issue. The order of rectification was not valid.”

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Foreign projects – Deduction u/s. 80HHB – A. Y. 1984-85 – Assessee having more than fifty construction sites in India and abroad – Assessee is entitled to deduction in respect of each project instead of netting up of profits from all overseas projects –

CIT vs. Hindustan Construction Co. Ltd.; 368 ITR 733 (Bom):

The assessee was engaged in construction activity having more than 50 construction sites in India and abroad. For the A. Y. 1984-85, the assessee computed the claim for deduction u/s. 80HHB of the Income-tax Act, 1961 in respect of each of the foreign projects. The Assessing Officer computed the deductible amount by netting off the profit from all the overseas projects. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) The Assessing Officer was not justified in computing the income from construction activities undertaken abroad and by process of clubbing or netting. The only issue before the Tribunal was whether the computation of deduction u/s. 80HHB could be made in respect of each unit and that was not prohibited by section 80HHB(1). It was only for the purpose of computation of the deduction and whether the section prohibited computation unit-wise that the Tribunal referred to the judgment of the Supreme Court. Beyond that, it had not considered any wider question or controversy.

ii) The Tribunal had decided the matter essentially in the light of the facts and material placed before it. In such circumstances and considering the provisions of section 80HHB and the order of the Tribunal, the Tribunal was not in error in holding that the assessee was entitled to the deduction u/s. 80HHB in respect of each project instead of netting up of profits from all the overseas projects.

iii) Thus, the Tribunal was in no error in directing the Assessing Officer to allow the deduction as claimed by the assessee without setting off all the losses suffered in other foreign projects.”

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Naresh T. Wadhwani vs. Dy. Commissioner of Income Tax In the Income Tax Appellate Tribunal Pune Bench “A”, Pune Before G. S. Pannu (A. M.) and R. S. Padvekar (J. M.) ITA Nos.18, 19, 20, 60 & 61/PN/2013 Assessment Years : 2007-08, 2008-09 & 2009-10. Decided on 28.10.2014 Counsel for Assessee/Revenue: V. L. Jain/M. S. Verma

Section 80 IB (10)(c) and (14)(a) – Open terrace cannot be a part of the ‘built-up area’

Facts:
The assessee’s claim for deduction u/s. 80IB(10) was rejected by the lower authorities on the ground that the condition prescribed in clause (c) of section 80IB(10) was not complied with. As per sub-Clause (c) of section 80IB(10) the residential units in the housing project cannot have built-up area of more than 1,500 sq.ft. The housing project of the assessee in Pune city was approved by the local authority on 29.07.2005. The AO applied the definition of ‘built-up area’ contained in section 80IB(14) (a). According to him, as per the said definition, the area comprising of the projected terrace was also to be considered as part of the ‘built-up area’. Based thereon the AO computed the area and found that six of the residential units of the housing project were having built-up area in excess of 1500 sq.ft. Therefore, he denied the claim of the assessee for deduction u/s. 80IB(10) of Rs.1.4 crore. On appeal the CIT(A) upheld the stand of the AO that the built-up area of the aforesaid six units was violative of the condition prescribed in Clause (c) of section 80IB(10). He, however, allowed pro-rata deduction in respect of profits from the residential units of the project which complied with the requirements of section 80IB(10)(c) of the Act. Not being satisfied with the order of the CIT(A), assessee as well as the Revenue are in appeal before the tribunal.

Before the Tribunal, the revenue submitted that open terrace was a private terrace which was available for use of the owner of the unit to the exclusion of others. It also relied on the decisions of the Hyderabad Tribunal in the case of Modi Builders & Realtors (P.) Ltd., (2011) 12 taxmann. com 129 and of the Mumbai Tribunal in the case of Siddhivinayak Homes, Mumbai vs. Department of Income Tax, vide ITA No. 8726 / Mum / 2010 order dated 26.09.2012, for the proposition that all projections and elevations at the floor level are liable to be included in the definition of ‘built-up area’ for the purposes of examining the condition prescribed in Clause (c) of section 80IB(10) of the Act. According to it, the built-up area for the purpose has to be understood in the light of what has been sold by the assessee builder to the respective customers.

Held:
Relying on the decision of the Madras High Court in the case of M/s. Ceebros Hotels Private Limited vs. DCIT (Tax Case (Appeal) No. 581 of 2008 order dated 19.10.2012) the Tribunal held that the area of open terrace cannot be a part of the ‘built-up area’ in a case where such terrace is a projection attached to the residential unit and there being no room under such terrace, even if the same is available exclusively for use of the respective unit holders. The Tribunal also observed that as per the said decision, terrace area would not form part of the built-up area even if the assessee sold it to the purchaser as a private terrace.

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Recovery of tax – Section 226(3)(vi) – Garnishee objecting to liability and payment and filing affidavit in this regard – No further proceedings for recovery can be made against garnishee – TRO cannot discover on his own that statement on oath by garnishee was false – Provision applies only to an admitted liability and not to disputed liability:

Uttar Pradesh Carbon and Chemicals Ltd. vs. TRO; 368 ITR 384 (All):

The petitioner company was engaged in the business of financial services. One assessee RCFSL, which had become defaulter of income-tax dues for Rs. 3.2 crore claimed that an amount of Rs. 1.55 crore was due to it from the petitioner. On the basis of the claim of the assessee, the TRO issued garnishee notice u/s. 226(3) of the Income-tax Act, 1961 requiring the petitioner to pay the said amount to the TRO towards the tax dues of the assessee. Since there was no response, the TRO attached 4,24,910 shares of the petitioner in Jhunjhunwala Vanaspati Ltd., and also the bank balance of Rs. 28,988.78 in ICICI bank and also got the shares and the amount transferred to the TRO. Being aware of the said action of the TRO the petitioner appeared before the TRO and raised objections and also claimed that the garnishee notice was not served on the petitioner and accordingly the garnishee proceedings are invalid. The petitioner also produced the books of account as required by the TRO and explained that there is no outstanding payable to the assessee. The petitioner also filed an affidavit denying the liability as required u/s. 226(3)(vi) of the Act. However, the TRO did not accept the petitioner’s claim.

On a writ petition challenging the garnishee action taken by the TRO, the Allahabad High Court held as under:

“i) Under Clause (vi) of section 226(3) of the Act, a limited enquiry can be conducted by the TRO to find about the genuineness of the affidavit. He is required to give notice to the person giving the affidavit that he is going to hold an enquiry for the purpose of determining whether the statement made on oath on behalf of the garnishee is correct or false. The ITO cannot discover on his own that the statement on oath made on behalf of the garnishee was false in any material particular and cannot subjectively reach a conclusion that in his opinion the affidavit filed by the garnishee was false in any material particular.

ii) Further, this provision is intended to apply only to an admitted liability where a person admits by word or by conduct that any money is due to the assessee or is held by him for or on account of assessee. The authorities under the garb of the inquiry cannot adjudicate upon a bona fide dispute between the garnishee and the assessee.

iii) Section 226(3) is not a charging section nor does it give any power to the TRO to adjudicate a dispute. Bona fide disputes, if any, between the garnishee and the assessee cannot be adjudicated by the authorities u/s. 226(3). The Legislature could not have meant to entrust the authority with the jurisdiction to decide questions relating to the quantum of such liability between the garnishee and the assessee, which matter is within the purview of the civil courts.

iv) The assessee asserted that it had advanced certain sums of money to the petitioner and, therefore, the petitioner was its debtor but the petitioner had denied this assertion. No steps had been taken by the assessee for recovery of that amount before any forum or any appropriate court of law.

vi) Pursuant to the affidavit filed by the petitioner before the TRO denying its liability to pay any amount and further denying that any sum is or was payable to the assessee, no steps had been taken by the TRO to cross check with the assessee or inquire into the genuineness of the affidavit filed by the petitioner. Since the petitioner had appeared and participated in the proceedings, the order of the TRO treating the petitioner as an assessee in default could not continue any longer.

vii) In view of the categorical denial by the petitioner to pay any amount, the attachment made by the TRO could not continue any further, especially as till date no inquiry had been made by the Revenue into the genuineness of the affidavits filed by the petitioner.

viii) Income Tax Department was restrained from alienating the shares, which were transferred to the demat account of the TRO. The order of the TRO treating the petitioner as a assessee in default could not be sustained and was quashed. Within two weeks the TRO to transfer the shares to the petitioner and also the amount of Rs. 28,988.78/- with interest”

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Business expenditure – Section 37(1) – A. Y. 2005- 06 – Payments for advertising and publicity to residents by assessee resident agent – Deduction u/s. 37(1) cannot be denied by invoking transfer pricing provisions merely because foreign principals (TV Channels) also benefit by the expenditure especially when benefit to foreign principals defy quantification – Such payments are not required to be reflected in Form No. 3CEB as these are resident to resident payments and not international

CIT vs. N. G. C. Network (India) (P) Ltd.; (2014) 50 taxmann.com 240 (Bom):

The assessee is a company incorporated in India and engaged in the business of distribution of T.V. channels popularly known as National Geographic and History Channel. The assessee also acts as airtime advertising Sales Representative for its foreign principals NGC Asia and FOX. For the A. Y. 2005-06, the assessee had claimed expenditure of Rs. 6,21,31,262/- u/s. 37(1) of the Act being the amount paid to residents for advertising and publicity. The Assessing Officer held that the benefit of the expenditure was not only to the assessee but also to the foreign principals. He found that such benefit was not disclosed in Form 3CEB. He allowed only one third of the expenditure and disallowed the balance two third. CIT(A) allowed full expenditure. He held that since expenses were made to Indian residents they were not covered in Form 3CEB as section 92 covers only international transactions. The Tribunal upheld the decision of the CIT(A). On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) The main grounds on which the revenue has questioned the order of the tribunal are (a) non-disclosure in form 3CEB of the fact that the principal is also a beneficiary of the advertising expenses; (b) that the advertising and promotional expenses are not wholly for the benefit of the assessee but it also benefited the principal who was an associated enterprise; (c) that advertising and publicity expenses were far higher than the amount of revenue earned and lastly, that although foreign principals i.e. Associated Enterprise benefited from advertising and publicity no compensation was paid by the foreign principals to the assessee to avail of such benefits.

ii) It was admitted position that the assessee is a agent of foreign principal and would naturally benefit from advertising carried on by agent in India. However, these benefits were not ascertainable. The contention of the assessee that the benefits were not ascertainable or taxable in view of extra territory appears to be correct and justified. In the instant case we find that the assessee has not suppressed any information. It has offered to tax its income from both business, namely, distribution business as well as advertisement and promotion business. In the assessment year in question, the Assessing Officer has proceeded to grant 33.33% of the total advertising expenses as allowable deduction. We do not find any justification for such restriction of the same.

iii) The contention that the expenditure should have been wholly and exclusive for the purpose of business of the assessee u/s. 37(1) read with provisions of section 40A(2) as being excessive and unreasonable does not appeal to us. There can be no doubt in the instant case, that in view of decision of the Supreme Court in Sassoon David (supra) it cannot be said that the expenditure was not wholly or exclusively for benefit of the assessee. The mere fact that foreign principals also benefited does not entail right to deny deduction u/s. 37(1). Furthermore, it is seen that all the amounts earned by the assessee were brought to tax, especially in view of the fact that the payment of expenses were made to Indian residents and there payments were not required to be included in Form 3CEB since section 92 which governs the effect of Form 3CEB covers only international transactions. Furthermore, it is seen that the respondents income from subscription fee is variable and through commission received on the advertising sales is 15% of the value of Ad-sales. The Assessing Officer’s contention that the assessee received fixed income is not justified and there is certainly, in our view, a direct nexus between the amount spent on advertising and publicity, and the appellant’s revenue

iv) Advertisers who advertise on these channels act through media houses and advertising agencies and they work to media plans designed in the manner so as to maximise value for the advertiser. They will evaluate expenditure with channel penetration in the market place inasmuch as only channels with high viewership would justify the higher advertising rates which is normally sold in seconds. Merely having high quality content will not ensure high viewership. This content has to be publicised. The great reach of the publicity, the higher chances of larger viewership. The larger the viewership, the better chances of obtaining higher advertisement revenue. The higher advertisement revenue, the higher will be commission earned by the respondent-assessee. Accordingly, we have no doubt that there is a direct nexus between advertising expenditure and revenue albeit the fact that there may be a lean period before revenue picks up notwithstanding high amount spent on such publicity. This justifies the higher expenditure vis-a-vis revenue noticed by the department.

v) It is also not necessary that the foreign enterprises must compensate the Indian agent for the benefit it receives or it may receive from the advertisement and promotion of its channels by agent in India. The agent in India earns commission from ad-sales and distribution revenue, both of which have sufficiently compensated the assessee. We would not expect the revenue to determine the sufficiency of the compensation received by the agent and as such we do not find any justification in this ground either.

vi) In the circumstances we answer questions of law in the affirmative in favour of the assessee and against the revenue. In the result the appeal is dismissed.”

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Penalty – Section 269SS and 271D – A. Y. 2007- 08 – Scope of section 269SS – Provision does not apply to liabilities recorded by book entries – Penalty not justified u/s. 271D:

CIT vs. Worldwide Township Projects Ltd.; 367 ITR 433 (Del):

In
the relevant year i.e., A. Y. 2007-08, the assessee had purchased land
worth Rs. 14.22 crore and the same was reflected in the books of
account. The purchase price was paid by one PACL to the land owners by
demand drafts on behalf of the assessee and accordingly PACL was shown
as creditor to that extent in the books of account of the assessee. The
Assessing Officer held that the assessee has taken loan from PACL in
violation of section 269SS of the Income-tax Act, 1961 and therefore
imposed penalty u/s. 271D of the Act. CIT(A) cancelled the penalty. The
Tribunal held that the order of penalty was barred by limitation.

On appeal by the Revenue, the Delhi High Court held as under:
“i)
A plain reading of section 269SS indicates that the import of the
provision is limited. It applies to a transaction where a deposit or a
loan is accepted by an assessee otherwise than by an account payee
cheque or an account payee draft. The ambit of the section is clearly
restricted to a transaction involving acceptance of money and not
intended to affect cases where a debt or a liability arises on account
of book entries. The object of the section is to prevent transactions in
currency. This is also clearly explicit from clause (iii) of the
Explanation to section 269SS of the Act which defines loan or deposit to
mean “loan or deposit of money”. The liability recorded in the books of
account by way of journal entries, i.e. crediting the account of a
party to whom moneys are payable or debiting the account of a party from
whom moneys are receivable in the books of account, is clearly outside
the ambit of the provisions section 269SS of the Act because passing
such entries does not involve acceptance of any loan or deposit of
money.

ii) No money was transacted other than through banking
channels. PACL made certain payments through banking channels to the
land owners. This payment made on behalf of the assessee was recorded by
the assessee in the books by crediting the account of PACL.

iii)
In view of this admitted position, no infringement of section 269SS of
the Act was made out. The levy of penalty was invalid.”

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Income: Accrual and time – Sections 2(24) (vd) and 28(v) – A. Y. 1995-96 – Acquisition of shares at concessional rate – Prohibition on sale of shares for lock-in period of three years – No benefit in the form of differential price accruing to assessee – No income accrues:

CIT vs. K. N. B. Investments (P) Ltd.; 367 ITR 616 (T&AP):

The assessee was allotted nine lakh shares and 8,13,900 shares in the financial year 1994-95 at a concessional rate of Rs. 90 per share. In the A. Y. 1995-96 the Assessing Officer took the view that the market value of the shares was Rs. 455 per share and that the difference of Rs. 365 was to be treated as “benefit” as defined u/s. 2(24) (vd) r.w.s. 28(iv). Accordingly, he levied tax thereon. The Tribunal held that as long as the bar to sell the shares operated, the question of any benefit in the form of differential price, accruing to the assessee did not arise. The Tribunal accordingly deleted the addition.

On appeal by the Revenue, the Telangana and Andhra Pradesh High Court upheld the decision of the Tribunal and held as under:

“i) There exists a distinction between “accrual of income”, on the one hand, and “arising of income”, on the other. While accrual is almost notional in nature, the other is factual.

ii) There was a clear bar for a period of three years prohibiting the sale of shares. The benefit can be said to have arisen to an individual, if only, any person in his place, would have got the differential price, by selling the shares. Irrespective of the willingness or otherwise of the person holding such a share, if the bar operates, it could not be said that the sale of the share would take place or that it would yield the differential price.

iii) A close scrutiny of the concept of “arising of income” discloses that, it, in fact, must flow into the assets of the assessee, during previous year, and thereby, it became taxable in the financial year.

iv) The Income-tax Officer had not demonstrated that the income in the form of “benefit” had arisen to the assessee at all. The sole basis for levying tax on the amount was on the assumption that in case the shares were sold, they would have yielded the differential price and that, in turn, could be treated as income. Even if the exercise contemplated by the Income Tax Officer was taken as permissible in law, at the most, it amounted to “accrual” and not “arising” of income.

v) The Tribunal had explained the subtle distinction between the two, in a perfect manner and arrived at the correct conclusion.”

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Export profits – Deduction u/s. 80HHC – A. Y. 2003-04 – Gain derived from change in foreign exchange rate is export profit – Gain realised in subsequent year – Entitled to deduction u/s. 80HHC:

CIT vs. Priyanka Gems: 367 ITR 575 (Guj):

The assessee was engaged in the business of export. For the A. Y. 2003-04 the assesseee received net of Rs. 71,23,361/- by way of exchange rate difference on exports made in the earlier year. The assessee claimed deduction of the said amount u/s. 80HHC of the Incometax Act, 1961. The Assessing Officer held that the sum was income from other sources and 90% thereof would be excluded for the purpose of deduction u/s. 80HHC of the Act. The CIT(A) and the Tribunal allowed the assessee’s claim for deduction of the said amount u/s. 80HHC of the Act.

On appeal by the Revenue, the Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) The source of the income of the assessee was export. On the basis of accrual, income was already reflected in the assessee’s account on the date of the export at the prevailing rate of exchange. Further, the income was earned merely on account of foreign exchange fluctuation. Such income, therefore, was directly related to the assessee’s export business and could not be said to have been removed beyond the first degree.

ii) The assessee was entitled to deduction u/s. 80HHC.”

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Depreciation – WDV – Section 43(1), (6) – A. Ys. 1976-77 to 1978-79 – Depreciation “actually allowed” – No concept of allowance on notional basis: Amalgamation – WDV of fixed assets of amalgamating company to be calculated on basis of actual cost less depreciation actually allowed to amalgamating company:

Rhone-Poulenc (India) Ltd. vs. CIT; 368 ITR 513 (Bom):

The
non-resident holding company of the assessee had an industrial
undertaking in India. Under a scheme of amalgamation, the industrial
undertaking was hived off to the assessee and the assets and liabilities
of the undertaking were taken over by the assessee. For the A. Ys.
1976-77 to 1978-79 the assessee claimed that for the purpose of granting
depreciation, the cost of the assets should be taken at the original
cost, viz., Rs. 2,54,67,325/- or alternatively at Rs. 1,72,78,297/-
being the cost, less depreciation actually allowed. The Assessing
Officer took the WDV of Rs. 93,14,942/- which was arrived at after
taking into account depreciation that would have been granted to the
parent company under the provisions of the Act.This was upheld by the
Tribunal.

On appeal by the assessee, the Bombay High Court reversed the decision of the Tribunal and held as under:

“i)
There was no concept of depreciation being allowed on a notional basis
or that depreciation can be granted implicitly as held by the Tribunal.
The depreciation has to be actually allowed as can be discerned from a
conjoint reading of the provisions in the Act. The WDV of the fixed
assets of the parent company had to be calculated on the basis of the
actual cost less depreciation “actually allowed” to the parent company.
The WDV could not have been arrived at on the basis that depreciation
had been granted on a notional basis, or implicitly as held by the
Tribunal.

ii) The scheme of amalgamation approved by the
assessee itself had valued the fixed assets at Rs. 1,72,78,297/-, which
valuation had been arrived at after taking into account depreciation.
This being the case, and the assessee having accepted the WDV of the
fixed assets at Rs. 1,72,78,297/-, it could not be heard to say that the
WDV had to be calculated by taking into account the figure of Rs.
2,54,67,325/- being the original cost of the fixed assets to the parent
company.”

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Capital gain – Short-term or long-term – Sections 2(29B), 2(42B) and 45 – A. Y. 1990-91 – In case of allotment of flat, holding period commences from the date of allotment – Allotment of flat on 7th/30th June, 1986 – Payment of first instalment on 04-07-1986 – Sale of flat on 05-07- 1989 – Gain is long term capital gain:

Mrs. Madhu Kaul vs. CIT; 271 CTR 107 (P&H):

A flat was alloted to the assessee on 07-06-1986, vide letter conveyed to the assessee on 30-06-1986. The assessee paid the first instalment on 04-07-1986. The assessee sold the flat on 05-07-1989. The assessee claimed that the capital gain is long term capital gain. The Assessing Officer rejected the claim. The Tribunal upheld the decision of the Assessing Officer:

On appeal by the assessee, the Punjab and Haryana High Court reversed the decision of the Tribunal and held as under:

“i) Admittedly, the flat was alloted to the assessee on 07- 06-1986, vide letter conveyed to the assessee on 30-06- 1986. The assessee paid the first instalment on 04-07- 1986, thereby confering a right upon the assessee to hold a flat, which was later identified and possession delivered on a later date. The mere fact that the possession was delivered later, does not detract from the fact that the allottee was conferred a right to hold property on issuance of an allotment letter. The payment of the balance instalments, identification of a particular flat and delivery of possession are consequential acts, that relate back to and arise from the rights conferred by the allotment letter.

ii) The Tribunal has erred in holding that the transaction does not envisage a long term capital gain.”

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Appellate Tribunal – Power to admit additional ground – Notice u/s. 158BD – The Tribunal cancelled the block assessment order u/s. 158BD holding that the notice u/s. 158BD was not valid – The High Court held that the notice was valid and remanded the matter back to the Tribunal for deciding on merits – The assessee raised an additional ground relying on the decision of the Supreme Court – The Tribunal was not justified in refusing to admit the additional ground:

Lekshmi Traders vs. CIT; 367 ITR 551 (Ker):

Pursuant
to the search action in the premises of one of the partners of the
assessee firm a block assessment order u/s. 158BD was passed in the case
of assessee firm. The order was cancelled by the Tribunal holding that
the notice u/s. 158BD was not valid. On appeal by the Revenue the High
Court held that the notice was valid and remanded the matter back to the
Tribunal for deciding on merits. In the remand proceedings the assessee
raised an additional ground relying upon the decision of the Supreme
Court. The Tribunal refused to admit the additional ground holding that
the powers of the Tribunal were confined to the order of the remand
passed by the Court wherein, a direction was given by the Court to
consider the appeal on merits.

The Kerala High Court allowed the appeal filed by the assessee and held as under:

“i)
The powers of the Tribunal are not curtailed by the judgment of the
Division Bench, merely because the judgment, in the operative portion “
directed the matter to be considered on the merits after hearing the
parties.”

ii) It was also not correct to say that the decision
of the Division Bench concurring the validity of the notice would
prevent the Tribunal from considering any other ground which the
assessee had raised for consideration. It could not, therefore, be said
that when the Court sent back the matter for fresh consideration, no
other points than those raised in the grounds of appeal could be
considered and no additional ground could be allowed to be raised for
consideration.

iii) Therefore, the Tribunal was to consider the additional ground raised by the assessee and take appropriate decision.”

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Appeal before CIT(A) – Power to grant stay of recovery – Section 220(6) – A. Y. 2011-12: During pendency of appeal before him the CIT(A) has inherent jurisdiction to grant stay of recovery:

Gera Realty Estates vs. CIT(A): 368 ITR 366 (Bom):

During the pendency of appeal before the CIT(A) for the A. Y. 2011-12, the assessee made application before the CIT(A) for stay of recovery proceedings against an order passed by the Assessing Officer u/s. 220(6). The CIT(A) dismissed the application holding that though he had inherent power to consider the stay application, it would not be considered for administrative reasons which according to him, madated avoidance of multiple stay application before different authorities.

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

“i) The jurisdiction of the CIT(A) to deal with applications for stay of the order in appeal before him is inherent as an appellate authority. This jurisdiction is to be exercised on examining the order in appeal. As against this, the jurisdiction with the Assessing Officer of staying the demand u/s. 220(6), and that of the Commissioner to stay the demand, are on different considerations, i.e., including other factors over and above the order.

ii) The Assessing Officer and the Commissioner do not stay the order in appeal but only stay the demand issued consequent to the order which is in appeal. This is only to ensure that the assessee is not deemed to be an assessee in default.

iii) The jurisdiction of the CIT (A) as an appellate authority ought not to be confused with that of either the Assessing Officer u/s. 220(6) of the Act or of the Commissioner in his administrative capacity.

iv) The CIT(A) was directed to dispose of the stay application as expeditiously as possible. In the mean time, the Revenue was not to adopt coercive proceedings against the assesee till the disposal of the stay application by the CIT(A).”

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Deduction u/s. 80HHA/80-IA – A. Y. 1991-92: Interest earned on fixed deposits placed out of business compulsion is “derived” from the undertaking – Interest is eligible for deduction:

Empire Pumps Pvt. Ltd. vs. ACIT (Guj); ITA No. 187 of 2003 dated 14-10-2014:

The assessee, eligible for section 80HHA/80-IA, was compelled to park a part of its funds in fixed deposits under the insistence of the financial institutions. The interest income has to be treated as business income and cannot be termed as income from other sources. Interest income is the income derived from the undertaking and is eligible for deduction u/s. 80HHA/80-IA.

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Business expenditure/loss – Sections 28 and 37(1) – Even if the business is illegal, loss which is incidental to the business has to be allowed u/s. 28 and the Explanation to section 37(1) is not relevant: Disallowance of claim for deduction of loss on account of gold seized by Custom Authorities is not justified:

Bipinchandra K. Bhatia vs. Dy. CIT (Guj): ITA No. 107 of 2004 dated 16-10-2014:

The assessee, an individual, was dealing in bullion and gold jewellery. Pursuant to search on 12-01-1999, block assessment was made u/s. 158BC. One of the additions was by way of disallowance of the claim for deduction of Rs. 40,34,898/- on account of gold seized by the Custom Authorities. The Tribunal upheld the addition relying on Explanation to section 37(1) of the Act. In the appeal to the High Court, the following question was raised:

“Whether, on the facts and in the circumstances of the case, the Tribunal has substantially erred in disregarding the fact that business is being carried on by the appellant and hence, the loss incidental to business is allowable u/s. 28 and the provision of section 37(1) of the Income-tax Act, 1961 cannot override the provisions of section 28?”

The Gujarat High Court allowed the assessee’s appeal and held as under:

“i) Learned Counsel for the appellant contended that in view of the decision of the Hon’ble Apex Court in the case of Dr. T. A. Quereshi vs. CIT; 287 ITR 547 (SC), the loss which was incurred during the course of business even if the same is illegal is required to be compensated and for the loss suffered by the appellant, the Court is required to answer this Tax Appeal in favour of the assessee.

ii) Having heard learned Advocates appearing for the parties, this Appeal is answered in favour of the assessee and against the revenue.”

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Recovery of tax – Garnishee notice – Stock exchange membership card is a privilege and not a property capable of attachment and the proceeds of the a card which has been auctioned cannot be paid over to Income-tax – Membership security which is handed over to the Exchange continues to be the assets of the members which can be liquidated on default – Stock Exchange has a lien over membership security and being a secured creditor, would have priority over Government Dues

The Stock Exchange, Bombay vs. V.S. Kandalgaonkar & Ors. (2014) 368 ITR 296 (SC)

By a notice dated 29th June 1994, the Stock Exchange, Bombay declared one Shri Suresh Damji Shah as a defaulter with immediate effect as he had failed to meet his obligations and discharge his liabilities. By a notice dated 5th October 1995 issued u/s. 226 (3) of the Incometax Act, the Income-tax Department wrote to the Stock Exchange and told them that Shri Shah’s membership card being liable to be auctioned, the amount realised at such auction should be paid towards Income-tax dues of Assessment Year 1989-90 and 1990-91 amounting to Rs.25.43 lakh. The Stock Exchange, Bombay by its letter dated 11th October, 1995 replied to the said notice and stated that under Rules 5 and 6 of the Stock Exchange the membership right is a personal privilege and is inalienable. Further, under Rule 9 on death or default of a member his right of nomination shall cease and vest in the Exchange and accordingly the membership right of Shri Shah has vested with the Exchange on his being declared a defaulter. This being the case, since the Exchange is now and has always been the owner of the membership card, no amount of tax arrears of Shri Shah are payable by it. By a prohibitory order dated 10th May, 1996, the Incometax Department prohibited and restrained the Stock Exchange from making any payment relating to Shri Shah to any person whomsoever otherwise than to the Incometax Department. The amount claimed in the prohibitory order was stated to be Rs. 37.48 lakh plus interest. On 18th July, 1996, the Solicitors of the Stock Exchange, Bombay wrote to the Income-tax Department calling upon them to withdraw the prohibitory order dated 10th May, 1996 in view of the fact that the membership right of the Exchange is a personal privilege and is inalienable. By a letter dated 27th December, 1996, the Tax Department wrote back to the Bombay Stock Exchange refusing to recall its prohibitory order. Meanwhile, Shri Shah applied to be re-admitted to the Stock Exchange which application was rejected by the Stock Exchange on 13th February, 1997.

The Stock Exchange then filed a Writ Petition being Writ Petition No. 220 of 1997 dated 24th December, 1997.

By a judgment dated 27th March 2003, most of the contentions of the Stock Exchange were rejected and the Writ Petition was dismissed.

The judgment set out two main issues which according to it arose for determination. They were:

[A] Whether, on the facts and circumstances of this case, the TRO was right in attaching the sale proceeds of the nomination rights of the Defaulter-Member. If not, whether the TRO was entitled to attach under Rule 26(1) of Schedule–II to the Income-tax Act, the Balance Surplus amount lying with BSE out of the sale proceeds of the nomination rights of the Defaulter-Member under rule 16(1)(iii) framed by BSE r/w the Resolution of the General Body of BSE dated 13-10-1999?

[B] Whether deposits made by the Defaulting Member under various Heads such as Security Deposit, Margin Money, Securities deposited by Members and Others are attachable u/s. 226(3)(i)(x) read with Rule 26(1)(a)(c) of Schedule-II to the Income-tax Act?

Issue A was answered by saying that though a defaulting member had no interest in a membership card and that the Income-tax Department was not right in attaching the sale proceeds of such card, still money which is likely to come in the hands of the garnishee, that is the Bombay Stock Exchange, for and on behalf of the assessee is attachable because the requisite condition is the subsistence of an ascertained debt in the hands of the garnishee which is due to the assessee, or the existence of a contractual relationship between the assessee and the Stock Exchange consequent upon which money is likely to come in the hands of the garnishee for and on behalf of the assessee.

Issue B was answered by saying that even on vesting of all the assets of the assessee in the defaulter’s committee, all such assets continued to belong to the assessee. Section 73(3) Civil Procedure Code mandates that Government debts have a priority and that being so they will have precedence over other dues. It was further held that the lien that the Stock Exchange may possess under Rule 43 does not make it a secured creditor so that debts due to the Income-tax Department would have precedence.

The judgment then went on to say:

“11. To sum up, we hereby declare:

(a) That, the Other Assets (as described in Issue B hereinabove) are attachable and recoverable under provisions of section 226(3)(i)(x) read with Rule 26(1) (a)(c) of Schedule-II to the Income Tax Act.

(b) That, the Government and Other Creditors such as BSE, the Clearing House and Other Creditor-Members under Rules and Bye-laws of the Stock Exchange are creditors of equal degree and u/s. 73(3), Civil Procedure Code, the Government dues shall have priority over other such creditors.

(c) That, in the matter of application of Defaulters’ Asset under bye-law 400, the Defaulters’ Committee shall give priority to the debt due to the Government and the balance, if any, shall be distributed in terms of the Bye-laws 324 alongwith Byelaw 400 of the BSE.

(d) That, a sum of Rs. 34,06,680 representing Balance Surplus lying with the Exchange out of sale proceeds of the nomination rights of the Defaulter-Member is attachable under the above provisions of the Income -tax Act read with Rule 16 of the BSE Rules and consequently, the said amount is directed to be paid over to the TRO under the impugned Prohibitory Order.

(e) We hereby direct the BSE also to hand the securities lying in Members Security Deposit Accounts to the TRO, who would be entitled to sell and appropriate the sale proceeds towards the claim of the Income-tax Department against the Defaulting Broker-Member. If the TRO so direct, those securities could also be sold by BSE and the realised value, on the date of the sale, could be handed over to the TRO. It is for the TRO to decide this point. We further direct credit balance its the Clearing House of Rs. 1,53,538/- to be paid over to the TRO and that the TRO would be entitled to appropriate the said amount towards the dues of the Department. In short, we are directing BSE to pay a sum of Rs. 35,60,218/- to the TRO and in addition thereto, the TRO would be entitled to the realised value of the Securities as on the date of sale. In this case, the Prohibitory Order is before the date of insolvency of the Broker concerned.

(f) In future, the principles laid down by this judgment should be followed by BSE and the TRO would to attach such Other Assets and appropriate the amounts towards its claim under the Income Tax Act.”

A Special Leave Petition was filed against the said judgment being SLP(Civil) No. 8245 of 2003 in which, by an order dated 7th May 2003, the operation of the judgment was not stayed to the extent that it specifically directed the petitioner to make certain payments and handover securities to the Income-tax Department. However, in so far as the judgment declared law, the operation of such declaration of law was stayed.

The Counsel appearing on behalf of the Stock Exchange made essentially three submissions:

(i) By virtue of the judgment in Stock Exchange, Ahmedabad vs. Asstt. Commisioner of Income Tax, Ahmedabad, [(2001) 248 ITR 209 (SC)], the sale proceeds of a membership card and the membership card itself being only a personal privilege granted to a member cannot be attached by the Income-tax Department at any stage. The moment a member is declared a defaulter all rights qua the membership card of the member cease and even his right of nomination vests in the Stock Exchange. The High Court was therefore not correct in saying that though a membership card is only a personal privilege and ordinarily the Income-tax Department cannot attach the sale proceeds, yet since these amounts came into the hands of the Stock Exchange for and on behalf of the assessee they were attachable.

(ii) On conjoint reading of Rule 38 and 44 it was argued that all securities in the form of shares that are given by a member shall be transferred and held either in the name of the trustees of the Stock Exchange or in the name of a Bank which is approved by the Governing Board. By operation of Rule 44, on termination of the membership of a broker, whatever remains by way of security after clearing all debts has to be “transferred” either to him or as he shall direct or in the absence of such direction to his legal representatives. The argument therefore is that what is contemplated is a transfer of these shares by virtue of which the member ceases to be owner of these shares for the period that they are “transferred” and this being so, the Income- tax Department cannot lay their hands on these shares or the sale proceeds thereof as the member ceases to have ownership rights of these shares.

(iii) It was also argued that by virtue of Rule 43, the Stock Exchange has a first and paramount lien for any sum due to it, and that this made it a secured creditor so that in any case income tax dues would not to be given preference over dues to secured creditors.

The Supreme Court dealt with each one of the contentions and held as under:

Re.: (1)
A reading of Rules 5 and 9 lead to the conclusion that a membership card is only a personal permission from the Stock Exchange to exercise the rights and privileges that may be given subject to Rules, Bye-Laws and Regulations of the Exchange. Further, the moment a member is declared a defaulter, his right of nomination shall cease and vest in the Exchange because even the personal privilege given is at that point taken away from the defaulting member.

Further, the rules and the bye-laws also make this clear. Under Rule 16(iii), whenever the Governing Board exercises the right of nomination in respect of a membership which vests in the Exchange, the ultimate surplus that may remain after the membership card is sold by the Exchange comes only to the Exchange – it does not go to the member. This is in contrast with bye-law 400 (ix) which, deals with the application of the defaulting member’s other assets and securities, and in this case ultimately the surplus is paid only to the defaulting member, making it clear that these amounts really belonged to the defaulting member.

The conclusion of the High Court that the proceeds of a card which has been auctioned can be paid over to the Income-tax Department for the dues of the member by virtue of Rule 16 (iii) is incorrect as such member at no point owns any property capable of attachment, as has been held in the Ahmedabad Stock Exchange case(supra).

Re: (2)
Rules 36 to 46 belong to a Chapter in the Rules entitled “Membership Security”. Rule 36 specifies that a new member shall on admission provide security and shall maintain such security with the Stock Exchange for a determined sum at all the times that he carries on business. Rule 37 deals with the form of such security and states that it may be in the form of a deposit of cash or deposit receipt of a Bank or in the form of security approved by the Governing Board. Rule 38 deals with how these securities are held. Rule 41 enables the member to withdraw any security provided by him if he provides another security in lieu thereof of sufficient value to the satisfaction of the Governing Board. Rule 43 states that the security provided shall be a first and paramount lien for any sum due to the Stock Exchange and Rule 44 deals with the return of such security under certain circumstances. On a conjoint reading of these Rules what emerges is as follows:

(i) The entire Chapter deals only with security to be provided by a member as the Chapter heading states;

(ii) The security to be furnished can be in various forms. What is important is that cash is in the form of a deposit and securities are also “deposited” with the Stock Exchange under Rule 37;

(iii) Rule 38 which is crucial provides how securities are to be “held” which is clear from the marginal note appended to it. What falls for construction is the expression “securities shall be transferred to and held”. Blacks Dictionary defines “transfer” as follows:

“Transfer means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor’s equity of redemption.”

It is clear therefore that the expression “transfer” can depending upon its context mean transfer of ownership or transfer of possession. It is clear that what is transferred is only possession as the member only “deposits” these securities. Further, as has been held in Vasudev Ramchandra Shelat vs. Pranlal Jayanand Thakur & Ors., 1975 (2) SCR 534 at 541, a share transfer can be accomplished by physically transferring or delivering a share certificate together with a blank transfer form signed by the transferor. The transfer of shares in favour of the Stock Exchange is only for the purposes of easy liquidity in the event of default.

(iv) The expression “transferred” must take colour from the expression “lodged” in Rule 38 when it comes to deposits of cash. Understood in this sense, transfer only means delivery for the purposes of holding such shares as securities;

(v) This is also clear from the language of Rule 38 when it says “such deposit shall be entirely at the risk of the member providing the security ………..” Obviously, first and foremost the cash lodged and the shares transferred are only deposits. Secondly, they are entirely at the risk of the member who provides the security making it clear that such member continues to be the owner of the said shares by way of security for otherwise they cannot possibly be at the member’s risk;

(vi) Under Rule 41 a member may withdraw any security provided by him if he satisfies the conditions of the Rules. This again shows that what is sought to be withdrawn is a security which the member owns;

(vii) By Rule 43 a lien on securities is provided to the Stock Exchange. Such lien is only compatible with the member being owner of the security, for otherwise no question arises of an owner (the Stock Exchange, if the Counsel is right) having a lien on its own moveable property;

(viii) Therefore, when Rule 44 speaks of repayment and transfer it has to be understood in the above sense as the security is being given back to the member under the circumstances mentioned in the Rule;

(ix) Bye-law 326 and 330 also refer to securities that are “deposited” by the defaulter and recovery of securities and “other assets” due. Obviously, therefore, securities which are handed over to the exchange continue to be assets of the member which can be liquidated on default.

(x) The Counsel’s argument would also create a dichotomy between “cash lodged” and Bank Deposit Receipts and securities “transferred.” The form a particular security takes cannot possibly lead to a conclusion that cash lodged, being only a deposit, continues to belong to the member, whereas Bank Deposit Receipts and securities, being “transferred” would belong to the Stock Exchange.

Though the judgment in Bombay Stock Exchange vs. Jaya I. Shah [(2004) 1 SCC 160] had no direct application to the facts it did held that after the assets of the defaulting member are pooled together and amounts are realized, the payments that would be made from such pool would be from the assets of the defaulting member. To that extent, therefore, the aforesaid judgment reinforces what has been stated above.

Re: (3)
The first thing to be noticed is that the Income Tax Act does not provide for any paramountcy of dues by way of income tax. This is why the Court in Dena Bank’s case [(2001) 247 ITR 165 (SC)] held that Government dues only have priority over unsecured debts and in so holding the Court referred to a judgment in Giles vs. Grover (1832)(131) English Reports 563 in which it has been held that the Crown has no precedence over a pledgee of goods.

In the present case, the common law of England qua Crown debts became applicable by virtue of Article 372 of the Constitution which states that all laws in force in the territory of India immediately before the commencement of the Constitution shall continue in force until altered or repealed by a competent legislature or other competent authority. In fact, in Collector of Aurangabad and Anr. vs. Central Bank of India and Anr. [(1968 21 STC 10 (SC)] after referring to various authorities held that the claim of the Government to priority for arrears of income tax dues stems from the English common law doctrine of priority of Crown debts and has been given judicial recognition in British India prior to 1950 and was therefore “law in force” in the territory of India before the Constitution and was continued by Article 372 of the Constitution (at page 861, 862).

In the present case, the lien possessed by the Stock Exchange makes it a secured creditor. That being the case, it is clear that whether the lien under Rule 43 is a statutory lien or is a lien arising out of agreement does not make much of a difference as the Stock Exchange, being a secured creditor, would have priority over Government dues.

The Supreme Court answered the three issues as above. The Supreme Court allowed the Stock Exchange’s appeal and the set aside the impugned judgment passed by the Division Bench of the Bombay High Court.

shailesh.kwebmaker

Taxability of a Subvention Receipt

Issue for Consideration
It is not uncommon for a company in the red to
receive financial assistance from its holding company, to enable to it
to turn the corner by recouping its losses, incurred or likely to be
incurred. In such cases, the question that arises under the Income-tax
Act, is about the nature of such receipt. The courts have been asked to
determine whether such receipts, known as subvention receipts, are
taxable or not in the hands of the subsidiary.

The Supreme court in the
case of Sahney Steel and Press Works Ltd., 228 ITR 253, laid down
extensive tests for determination of nature of income in cases wherein
an asseseee receives financial assistance under a scheme formulated by
the Government. It held that the point of time, as also its source and
the form of the assistance, are factors that are irrelevant for
determining the taxability of the receipt. The purpose for which the
payment is received is of the paramount importance for ascertaining the
taxability or otherwise of a receipt.

The issue, in the context of
assistance from the holding company, has been recently examined by the
Delhi High Court and the Karnataka High Court. While the first court
held that the receipt is of capital nature not liable to tax, the latter
held the same to be taxable.

Deutsche Post Bank Home Finance’s case

The Delhi High Court in the case of CIT vs. Deutsche Post Bank Home
Finance Ltd., 24 taxmann.com 341, was required to consider the following
question of law at the behest of the Income tax Department: “Whether
the amount of Rs. 11,22,38,874/-, infused by BHW Holding AG, Germany to
the assessee by way of subvention assistance, is taxable as a revenue
receipt and therefore falls within the definition of ‘income’ under
Section 2(24) of the Income Tax Act, 1961.”

In that case, the assessee,
an Indian company, was engaged in the activity of housing finance. It
was a 100% subsidiary of one German company BHW Holding AG. On an
evaluation by the holding company, the assessee was likely to, on
account of its business activity, incur losses by which its capital
would be substantially if not entirely eroded. By two letters dated
24-09-2004 and 04-02-2005, the holding company granted subvention
assistance to the assessee of Euro 2,000,000, equivalent to Rs.
11,22,38,874. The assessee treated the receipt to be a capital receipt,
not liable to tax.

The Assessing Officer held that the disbursement of
incentive (i.e., subvention receipt ) was by way of casual receipt in
order to assist the assessee to continue its business operation and held
the same to be taxable. On appeal to the CIT(A), the assessee’s
contention that the money received could not be taxed, was accepted by
him. The ITAT rejected the Revenue’s appeal, inter alia, holding that
the holding company had paid the money as subvention payment towards
restoration of the net worth of the company expected to be partly eroded
by the losses suffered/projected by the assessee company for the
financial year 2004-05. The certificate of inward remittance issued by
UTI Bank Ltd confirmed the said fact. This was further supported by the
copy of confirmation received through email wherein the holding company
had certified that they had not claimed the subvention payment as
expenditure in their return of income, no tax benefit had been received
by it in respect of subvention payment and it had capitalised the amount
in its books of account. The ITAT relied on the decision in the case of
CIT vs. Handicrafts & Handloom Export Corporation of India, 140 ITR
532(Delhi).

On behalf of Revenue, before the High Court, it was argued
that the ITAT fell into error in deciding that the subvention receipt
received from the Holding Company was not income, as defined in section
2(24) of the Act.

The Revenue urged that the decision in the
case of the
Handicrafts & Handloom Export Corporation of India vs. CIT, 140 ITR
532(Delhi) relied upon by the Tribunal was not applicable, since the
facts of the case were different. In that case the funds were public in
nature and the cash assistance given by the holding company to STC, was
not subjected to taxation. Reliance was placed upon the decisions in the
cases of Ratna Sugar Mills Co. Ltd. vs. CIT, 33 ITR 644 (All.) and
V.S.S.V. Meenakshi Achi vs. CIT, 50 ITR 206 (Mad.) wherein it was held
that where public funds were used as an incentive or in order to assist,
or give subsidy to recoup a unit’s losses or to provide against a
financial liability, such an assistance would not qualify as income. It
was further stressed that the true and correct test to be applied was to
be the purposive test, spelt out in the decision of CIT vs. Ponni
Sugars & Chemicals Ltd., 306 ITR 392 (SC). It was submitted that
only if the real purpose of the assistance was to protect investment or
to ensure that the liabilities adversely impacting the accounts of the
company were met, then and then only the assistance would fall outside
the ambit of taxation.

The assessee, on the other hand,
submitted that the view taken by the CIT(A) and confirmed by the ITAT
was predominantly based upon the decision in the case of the Handicrafts
& Handloom Export Corporation of India (supra) and that there was
in fact no substantial question of law which required to be answered,
since the issue had been settled by the previous decision in the case of
the Handicrafts & Handloom Export Corporation of India (supra ).

On
hearing the parties, the court narrowed the question to whether
assistance given by the assessee’s holding company was a capital receipt
or a revenue receipt in the hands of the assessee. The court examined
the Revenue’s contention that the decision in Handicrafts & Handloom
Export Corporation of India (supra) was not applicable to the case,
because the nature of funds were public in character and in that view of
the matter the appropriate criteria was the purposive test which
determined the character of funds in a given case as was done in the
case of Ponni Sugar & Chemicals Ltd. (supra) by quoting from the
said decision.

On examination, the court held that there was no
shift in the nature of the determinative test, to decide whether a
receipt was revenue or capital. It observed that no doubt there were
observations in that judgment stating that the character of public funds
was an important factor which persuaded the court to hold that such
assistance did not fall within the definition of income. However, this
did not persuade the court to take a different view in the case before
it, in as much as it was not in dispute that the assessee did incur
losses and the assistance was given at a point of time when the losses
were anticipated.

So far as the decision in Ponni Sugar & Chemicals Ltd. (supra) was concerned, the court held that “no doubt the Court clarified how a subsidy should be treated, i.e., by purposive test. The Court presciently held if the object of the subsidy scheme was to enable the assessee to run the business more profitably then the receipt is to the revenue account. On the other hand, under the subsidy scheme, if the object is to enable the assessee to set up a new unit or expand it then the receipt of the subsidy is to the capital account. Therefore, it is the assessee’s action which determines whether subsidy is to avoid losses and liabilities or boost its profits. On a proper application of the above test we see no difference between the facts of the present case and those in Handicrafts & Handloom Export Corporation of India (supra). The assessee was inevitably on the road to incurring losses; its holding company decided to intervene and render assistance. The ITAT has also recorded that, keeping aside the depreciation which the assessee would have been entitled to, actual losses amounted to Rs. 8.7 crore.”

Having regard to all the circumstances, the Delhi High Court was of the opinion that the subvention money received by the assessee company was not liable to tax.

Siemens Public communication Networks’ case
The issue again came up for consideration of the Karnataka High Court in the case of CIT vs. Siemens Public Communication Networks Ltd. 41 taxmann. com 139. The assessee, a company in this case, was incorporated under the provisions of the Companies Act, 1956 and was engaged in the business of manufacturing Digital Electronic switching systems, computer software and software services. It had filed return of income for the Assessment years 1999-2000, 2000-2001 and 2001-2002 declaring loss of substantial amounts. It had received amounts of Rs. 21,28,40,000, Rs. 1,33,45,000, and Rs. 2,95,84,556, respectively for these assessment years from Siemens AG, a German company who was its principal shareholder. The assessee explained the said sum as “subvention payment” from the principal shareholder of the assessee-company, which was paid to the assessee company for two reasons, namely, the company was a potentially sick company, and that its capacity to borrow had reduced substantially, leading to shortage of working capital.

The letter dated 24-09-1998 issued by Siemens AG, and the assessee’s letter dated 19-02-2002, explained that Siemens AG, being a parent company, had agreed to infuse further capital by reimbursing the accumulated loss. The case of the assessee was that the payment made by Siemens AG was to make good the loss incurred by it, and the receipt of the subvention monies was a capital receipt in nature, and hence, could not be treated as income or revenue receipt.

The Assessing Officer rejected the contention of the assessee. The first Appellate Authority, however, in appeal, reversed the order of the Assessing Officer treating the said monies received from Siemens AG as capital receipt. The Appellate Tribunal, in the appeal filed by the revenue, confirmed the findings recorded by the Appellate Authority in the following words; “6. The rival contentions in regard to the above have been very carefully considered. The assessee company (Siemens Public Communications)(sic) apparently paid the assessee or compensated the assessee in view of the continued losses, and this in fact was to augment the capital base and to improve the net worth which had eroded due to losses suffered by the company. With a view to compensate the erosion in the reserves in (sic) surplus, the parent company pumps into its subsidiary company, funds to stabilise its capital account. It was considering all these reasons that the Commissioner of Income Tax (A) came to the conclusion that it was on capital account. If the amount so paid by the company is treated as revenue income, it would amount to taxing the parent company itself. The other reason is that the parent company paying its subsidiary company, is within the same group and not for any purpose which is in the nature of income, so as to be treated as taxable income.”

The revenue, before the court, submitted that the monies paid by Siemens AG to the assessee were on revenue account and were paid not only to make good the loss but to make the assessee company run, which had no monies to spend over day to day expenditure to keep it running at the relevant time; that on the basis of the said monies/aid extended by Siemens AG, the assessee not only made its loss good, but started running its business in profit; that who paid the amount was absolutely an irrelevant fact and what was important was the object for which such assistance was extended; from the facts of the case, it was clear that in the first assessment year, the assessee company had suffered loss, whereas in the subsequent assessment years, it started making profit, which fact clearly showed that the amount paid by Siemens AG was used for running the business and therefore, it would fall under the category of revenue receipt and not capital receipt.

In support of the submissions, reliance was placed upon the decisions of the Supreme Court in the cases of CIT vs. Ponni Sugars & Chemicals Ltd. 306 ITR 392 and Sahney Steel & Press Works Ltd. vs. CIT 228 ITR 253 (SC).

On the other hand, the assessee submitted that the appeal deserved to be rejected outright, since no substantial question of law was involved. It was further submitted that having regard to the findings of fact recorded by the Appellate Authority and the Tribunal, the question of law as raised, did not fall for consideration as a substantial question of law and that the findings of the Tribunal even on the question of law were justified and the Tribunal had rightly treated the amount paid by Siemens AG as “Subvention payment” and had rightly treated it against the capital account. It was further submitted that the judgments relied upon on behalf of the revenue were not applicable to the facts of the present case.

The Karnataka High Court examined the facts and the law laid down by the Supreme Court in the cases relied upon by the Revenue namely, CIT vs. Ponni Sugars & Chemicals Ltd. (supra) and Sahney Steel & Press Works Ltd. vs. CIT (supra). It observed that applying the above principles to the facts of the present case, and keeping in view the objective behind the payment made by Siemens AG, the court was satisfied that it was received by the assessee on revenue account. From the facts, it was clear to the court that huge amounts were paid by Siemens AG not only to make good the loss, but also to see that the assessee would run more profitably and the payment was by way of assistance in carrying on the business. The court noted that it was not the case of the assessee that the monies paid by Siemens AG were utilised either for repayment of the loan undertaken by the assessee for setting up its unit or for expansion of existing unit/business.

The court took note of the observation of the Supreme Court to the effect that the point of time at which the subsidy was paid was not relevant and the source and the form of subsidy was immaterial. In the opinion of the High Court, the main eligibility condition for receipt was that the amount ought to have been utilised by the assessee to meet recurring expenses and/or to run its business more profitably and so also to get out of the loss that it was suffering at the relevant time. In any case, the court noted that the receipt was not for acquiring capital assets or to bring into existence any new asset. As a matter of fact, after getting the financial aid from Siemens AG, the assessee company turned its business from loss to profit, which was evident from the facts reflected in the return of income filed for all the three assessment years. In this backdrop, if the purpose test is applied, it was clear to the court that the payment was made by Siemens AG for meeting recurring expenses/working capital.

The Karnataka High Court questioned the basis of the findings of the tribunal where the tribunal had observed that Siemens AG paid the assessee or compensated the assessee in view of the continued losses, and such financial aid was extended to augment the capital base and to improve the net worth which had eroded the losses suffered by the company. According to the court, the facts on record spoke otherwise and on the other hand, supported the case of the revenue that the financial aid was extended by Siemens AG not only to make good the loss but to see that the company ran more profitably.

The court, while deciding the issue in favour of the Revenue by allowing its appeal, held as follows; “It is the object which is relevant for the financial assistance which determines the nature of such assistance. In other words, the character of the receipts in the hands of the assessee has to be determined with respect to the purpose for which payment was made. If the financial assistance is extended for repayment of the loan undertaken by the assessee for setting up new unit or for expansion of existing business then the receipt of such aid could be termed as capital in nature. On the other hand, if the financial assistance is extended to run business more profitably or to meet recurring expenses, such payment will have to be treated as revenue receipt. It is not the case of the assessee, in the present case, that the financial assistance was extended by Siemens AG either for setting up any unit or expansion of existing business or for acquiring any assets.”

Observations
A receipt of subvention money apparently is in the nature of gift and in the absence of any express provision for taxing such a receipt, the same cannot be brought to income tax. It is only when such a receipt is in the ordinary course of business and has the effect of augmenting the profits of an assessee or recouping the assessee’s revenue expenditure that a question arises for consideration whether a receipt is taxable or not. A receipt from the holding company to meet the expansion needs of the subsidiary company or for the repayment of loans are not in dispute and there appears to be kind of an unanimity that such receipts are capital in nature. Also not in dispute is the receipt to arrest the erosion of capital. It seems that even the Karnataka High Court has expressed no disagreement on this understanding of the law.

There appears to be no doubt that the purposive test is to be applied, for determination of the issue on hand, as has been laid down by the apex court in the cases of Sahney Steel and Press Works Ltd. and Ponni Sugars & Chemicals Ltd. (supra). Under the purposive test, as per the court, a receipt will not be taxable in a case where the same is received for the purpose of repayment of the liabilities or for expansion of the undertaking, including for acquisition of the assets.

As against that, a receipt will be taxable where it is for the purposes of meeting the expenditure or for increasing the profit of the business. A receipt to meet the erosion of the net worth will also be on capital account.

It is interesting to note that both the courts have relied upon the decision of the Supreme Court in the case of CIT vs. Ponni Sugars & Chemicals Ltd. (supra) to deliver contrasting decisions. This has happened mainly for the reason that the assesseee in the case before the Karnataka High Court had not been able to clearly establish to the satisfaction of the court that the receipt in question was for arresting the erosion of net worth in spite of the finding of the tribunal on this aspect. The Tribunal had given a finding of fact that the receipt was for improving the net worth of the subsidiary company but the court gave a finding to the contrary by holding that the tribunal was not right, on facts, to have given such finding.

It is also relevant that the assessee in the case before the Karnataka High Court did not cite the favourable decision in the case of Deutsche Post Bank Home Finance (supra) which was a current decision directly on the subject of the subvention receipt. It also did not cite or rely upon the decision in the case of Handicrafts & Handloom Corporation Of India (supra), a decision that was relied upon by the Delhi High Court while deciding the issue in favour of Deutsche Home Bank Finance.

In the case of Handicrafts & Handloom Corporation Of India (supra ), the assessee, a wholly subsidiary company of State Trading Corporation (STC), incurred a loss in its business of export of handloom, etc. for assessment year 1970-71. STC gave cash assistance at 6 per cent of the foreign earnings of the assessee to recoup the losses. Cash assistance of Rs. 11.70 lakh was given by STC. The question was whether such cash assistance amounted to income. The Court noticed previous rulings of the Allahabad and Madras High Court, respectively, in cases of Ratna Sugar Mills Co. Ltd. (supra) and V.S.
S.V. Meenakshi Achi (supra), the ratio of which decision was confirmed by the common judgment by the Supreme Court in the case of V. S. S. V. Meenakshi Achi (supra).

The Court held that the amounts given by the STC to the assessee, i.e., Handicrafts & Handloom Export Corporation of India in order to recoup its losses, which were incurred year after year, were akin to assistance by a father to ensure the business survival of his child. The Court held that the amount given by the father would only be in the nature of gifts/or voluntary payment and not stemming from any business consideration. The position is similar here, where the shareholder is ensuring the survival of the subsidiary.

In Lurgi India Co. Ltd. 302 ITR 67(Delhi), the assessee received a sum of Rs. 13 crore from its parent company Lurgi Company AG, which was credited to profit and loss account by way of capital grant. However, in computation of total income it was stated that the amount was received from Lurgi AG for recouping its losses. The amount so received was held to be capital grant not chargeable to tax under the Act following the ratio of the decision of the Hon’ble Delhi High Court in the case of Handicrafts & Handloom Export Corporation of India vs. CIT (supra). Kindly see the decisions of the Bombay High Court in the case of Indian Textile Engineers, 141 ITR 69 and of the Calcutta high court in the case of Stewarts & Lloyds of India Ltd. 165 ITR 416 which confirm the above treatment of receipt.

The Delhi High Court in the case of Handicrafts & Handloom Corporation Of India (supra ), held that there was a basic difference between the grants made by a Government or from public funds generally to assessee in a particular line of business or trade, with a view to help them in the trade or to supplement their general revenues or trading receipts and not ear-marked for any specific or particular purpose and a case of a private party agreeing to make good the losses incurred by an assessee on account of a mutual relationship that subsisted between them. The former were treated as a trading receipt because they reach the trader in his capacity as such, and were made in order to assist him in carrying on of the trade. The latter were in the nature of gifts or voluntary payments motivated by personal relationship and not stemming from any business considerations. The amount received from parent company was not grants received from an outsider or the Government on such general grounds. The amounts were paid by STC to the assessee in order to enable it to recoup those losses and to enable it to meet its liabilities. The amounts received by the assessee from STC could not be treated as part of the trading receipt.

It seems that subvention money received from the holding company, not as trader, but to recoup the losses likely to be suffered by the subsidiary, should be capital in nature, more so where the holding company otherwise has no trading relation with the subsidiary company. A receipt not to meet the recurring expenditure but to help in purchasing capital assets or for expansion of the business is more likely to be capital in nature. So is the case where the receipt is not for the purpose of assisting the assessee to run the business more profitably. A voluntary payment arising out of personal relationship of parent and subsidiary company, not stemming from any business considerations, is not a revenue receipt. The case is further strengthened where the holding company does not treat the payment as an expenditure. In our view, the decision of the Karnataka High Court was delivered on the basis of the facts and cannot be taken as laying down any precedent for taxing a subvention receipt in general.

shailesh.kwebmaker

Transactional Net Margin Method – Overview and Analysis

1 Background

Under transfer pricing, the transaction (controlled transaction) between the taxpayer and its associated enterprise or related party, as the case may be, has to be at Arm’s Length Price (‘ALP) i.e. the price at which the independent parties would have entered into the same or similar transaction under similar circumstances. The Chapter II of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘OECD guidelines’) prescribe the following methods in order to determine the arm’s length price of the controlled transaction:

The old OECD hierarchy of methods suggested that the CUP method was the most preferred, next came the other “traditional transactional” methods (resale price and cost plus) followed, in “exceptional” cases where the first three methods cannot reliably be applied, by the profit based methods (the transactional net margin method and profit split). Profit based methods were described as ‘methods of last resort’. This distinction is now removed. The basis for choosing one method over the others is now expressed as “finding the most appropriate method for a particular case”. Nevertheless, it is clear that some sort of comparison is required and that the basis for that comparison includes the availability and reliability of the comparable data that can be used when applying any particular method.

In line with the OECD guidelines, the Indian Transfer Pricing Regulations (‘TPR’) provides that the arm’s length price of an international transactions and specified domestic transactions is to be determined by adopting any one of the above methods, being most appropriate (i.e. the method which provides the most reliable measure of the arm’s length price considering the facts and circumstances in each case). However, in addition to above, the Central Board of Direct Taxes (‘CBDT’) under the Indian TPR has prescribed such other method which tests the arm’s length price of the controlled transaction with reference to the price which has been charged or paid for the same or similar uncontrolled transaction under similar circumstances.

2. Conceptual framework

Mechanism to apply TNMM has been mentioned Rule 10B(1)(e) of the Income Tax Rules, 1962 as under:

“(i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;

(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;

(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;

(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.”

TNMM is applied with an objective to examine the ratio of net profit in relation to an appropriate base (e.g., costs, sales, assets) that a taxpayer realises from a controlled transaction. In the event where such uncontrolled transaction of the taxpayer are not available, net profit relative to identical base realised by unrelated enterprises from comparable uncontrolled transaction is determined. The net profit of taxpayers under controlled transaction is compared either with net profit margins of taxpayer under uncontrolled transaction or with the net profit margins of unrelated enterprises from comparable uncontrolled transactions after making appropriate adjustments, if any. The net profit margin earned under uncontrolled transactions after necessary adjustments, if any is considered as arm’s length margin in respect of the international transaction or specified domestic transaction.

TNMM does not require strict product and functional comparability as is required in case of traditional methods such as CUP, RPM and CPM. The TNMM primarily focuses on comparison of net profit margin realised by the associated enterprises in their controlled transactions with that of uncontrolled transactions. Typical transactions where TNMM can be applied are provision of services, distribution of finished products where RPM cannot be applied, transfer of semi-finished goods where CPM cannot be applied, transactions involving intangibles where PSM cannot be used, etc.

TNMM is generally the preferred method amongst the taxpayers and the tax authorities. However, the manner of applying TNMM is often seen as cause of dispute in most of the practical cases. More often there exists difference of opinion between taxpayers and the revenue authorities in respect of considering the TNMM as the most appropriate method against the traditional methods. For example, practically in most of the cases of a distributor having import transactions from related parties for onward distribution in the Indian market, while the taxpayers select RPM for benchmarking such international transactions, the tax authorities select TNMM as the most appropriate method. Further, application of CUP method/CPM over TNMM or vice versa is often seen as a matter of disputes during transfer pricing audits in India.

3. Application of TNMM, pertinent issues and few judicial rulings

The steps involved in application of TNMM are as under:

Each of the above steps on application of TNMM, practical difficulties/challenges during the transfer pricing audits in India and few of the judicial rulings are briefly described as under:

Step 1: Selection of the tested party
When applying TNMM, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. As a general rule, the tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e., it will most often be the one that has the less complex functional analysis. However this has been an area of litigation during transfer pricing audits in India. The revenue authorities and the tax payers have divergent views on selection of tested party i.e., whether tested party should be Indian tax payers or foreign Associated Enterprise (AE). Selection of foreign comparables is also one of the area where litigation subsists during transfer pricing audits in India.

Judicial Rulings:

However diverse are the judicial pronouncements supporting selection of foreign AE as a tested party, including Development Consultants P. Ltd. vs. DCIT [2008] 115 TTJ 577 (Kol), Mastek Ltd. vs. ACIT [2012]
53 SOT 111 (Ahd.), AIA Engineering Ltd. vs. ACIT [2012] 50 SOT 134 (Ahd.), Global Vantedge Private Limited vs. DCIT (2010-TIOL- 24-ITAT-DEL), General Motors India P. Ltd. vs. DCIT [ITA nos. 3096/Ahd 2010 and 3308/ Ahd 2011.], the outcome of said Tribunal rulings are in accordance with the international best practices with regards to selection of tested party. It has been settled in these rulings that tested party should be the least complex entity for which reliable data in respect of itself and in respect of comparables is available. In such cases it was held that the tested party could be the local entity or a foreign AE. Such rulings gave credence to the fact that the foreign AE can also be selected as a tested party depending upon the facts and circumstances of the case.

Step 2: Selection of data for comparison
The Indian TPR requires that the arm’s length analysis be based on data for the relevant financial year only.

While applying TNMM, one of the conflicts prevails where the taxpayers are required to maintain contemporaneous documentation i.e. documentation should exist before the Form 3CEB is filed. As per the Income-tax rules, the data to be used for arm’s length analysis has to be for the relevant financial year under consideration. However, as has been experienced till date, the data for comparable companies (in case where external TNMM using search process from databases is preferred) for the arm’s length analysis in respect of the relevant financial year is generally not available before the Form 3CEB is filed due to search database limitations. This leads to need for usage of multiple year data in order to undertake arm’s length analysis. Internationally also, multiple year data analysis is considered as it takes into account relevant economic factors like business cycles etc., which may impact the determination of arm’s length price.

Judicial Rulings:
Practically it has been noticed that the India tax authorities do not consider multiple year data analysis and proceed to perform the TNMM analysis using single year data i.e. the data related to financial year under consideration. There are host of rulings against the taxpayers disregarding the usage of multiple year data including Aztec Software and Technology vs. ACIT (294 ITR 32, Bang ITAT), Symantec Software Solutions Pvt. Ltd vs. ACIT (ITAT No. 7894/ MUM/2010, etc.

However, contrary to the above rulings, the jurisdictional Bangalore Income Tax Appellate Tribunal in the case of Phillips Software Centre Private Limited (ITA No. 218/ Bang/2008) has held that the TPO cannot use data during assessment that was not available to the assessee at the time of preparation of documentation. Further, the Hon’ble Delhi Tribunal in case of Panasonic India Private Limited vs. Income Tax Officer (ITA No.1417/Del/2008) held that proviso to Rule 10B(4) would allow the taxpayer to adopt the previous two year’s average PLI along with the current year’s PLI of the tested party and on a similar footing allow the taxpayer to adopt the three year’s average PLI of comparable companies.

The above practical difficulty should be now resolved by the recent amendment in the Finance Act, 2014. It was proposed in the Budget Speech of 2014 by the Hon’ble Central Finance Minister that use of multiple year data (instead of single year data) would be allowed for comparability analysis. However, the detailed rules in this regard would be notified subsequently.

Step 3: Aggregation of transactions
While computing profits under TNMM, the international transactions in relation to a particular activity which are subject to transfer pricing are aggregated and the net profit for the activity is arrived for benchmarking with the uncontrolled transaction. While, the Indian TPR is silent on the aggregation of transactions, the principles on aggregation of transactions are contained in the OECD guidelines. For example, consider as case where there are multiple sales transaction entered by an India taxpayer, being a manufacturer to its various group companies located in different parts of the world. Due to inherent practicalities of determining net profits earned by the taxpayer in respect of each of such sales transactions, it is more often seen that all the sales transactions are ‘aggregated’ and the net profit of the taxpayer arising out of its manufacturing activities is benchmarked as a separate ‘class of transaction’.

Further, practically it is seen that while applying TNMM, all the international transactions are aggregated and entity wide net profit is determined for benchmarking purpose. For example consider a scenario where a taxpayer has entered into multiple international transactions such as sales from manufacturing activities, sales from distribution activities, payment of royalty, payment of corporate charges, interest payments, etc. It is seen that in many cases, all the transactions are aggregated and net profit of the taxpayer is determined and compared for benchmarking analysis. However, as per the various judicial pronouncements it is well settled that each and every transaction needs to be benchmarked separately taking into consideration the functions performed, assets employed and risks assumed (typically called as FAR analysis) under each of such transactions.

Aggregation and segmentation is often challenged by the income tax authorities. Appropriate level of segmentation of the taxpayer’s financial data is needed while determining the net profits of the taxpayers from controlled transaction. Therefore, it would be inappropriate to apply TNMM on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analysing the transactions between the independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination based on the FAR analysis should be excluded for the purpose of comparison.

Practically, there are numerous cases wherein while making the transfer pricing adjustments, the tax authorities have applied TNMM on overall entitywide basis instead of restricting the adjustments to international transactions only. The TNMM analysis should be restricted only to the international transaction.

Judicial Rulings:
The issue related to the principle of aggregation of transaction vis-a-vis segmentation of transactions and restriction of transfer pricing adjustment to the international transactions only is covered under various ITAT rulings such as Aztec Software and Technology vs
.ACIT, (294 ITR 32 – Bang ITAT); Ranbaxy Laboratories Ltd vs. ACIT (299 ITR 175 – Del ITAT), M/s Panasonic India Pvt Ltd vs. Income Tax Officer (2010) TII-47-ITAT- DEL-TP; UCB India Private Ltd. vs. ACIT (reference: ITA No. 428 & 429 of 2007); DCIT vs. M/s Starlite (reference: ITA No. 2279/Mum/06), Birlasoft (India) Limited vs. DCIT [TS-227-ITAT-2014(DEL)-TP]; Tecnimont ICB Pvt. Ltd. [TS-251-ITAT-2013(Mum)-TP],etc.

Application of TNMM on aggregated basis in case where unique intangibles are involved:

In certain cases, comparability analysis could be difficult where the transactions include unique intangibles. Following extracts from the OECD guidelines deals with a typical case where the transaction involves sale of branded products and difficulty that could arise in determining ALP of the transaction.

“6.25 For example, it may be the case that a branded athletic shoe transferred in a controlled transaction is comparable to an athletic shoe transferred under a different brand name in an uncontrolled transaction both in terms of the quality and specification of the shoe itself and also in terms of the consumer acceptability and other characteristics of the brand name in that market. Where such a comparison is not possible, some help also may be found, if adequate evidence is available, by comparing the volume of sales and the prices chargeable and profits realised for trademarked goods with those for similar goods that do not carry the trademark. It therefore may be possible to use sales of unbranded products as comparable transactions to sales of branded products that are otherwise comparables, but only to the extent that adjustments can be made to account for any value added by the trademark. For example, branded athletic shoe “A” may be comparable to an unbranded shoe in all respects (after adjustments) except for the brand name itself. In such a case, the premium attributable to the brand might be determined by comparing an unbranded shoe with different features, transferred in an uncontrolled transaction, to its branded equivalent, also transferred in an uncontrolled transaction. Then it may be possible to use this information as an aid in determining the price of branded shoe “A”, although adjustments may be necessary for the effect of the difference in features on the value of the brand. However, adjustments may be particularly difficult where a trademarked product has a dominant market position such that the generic product is in essence trading in a different market, particularly where sophisticated products are involved.”

Application of TNMM is such cases could be more useful as the net margins are less affected and are more tolerant to product differences and other conditions prevailing in case of controlled transactions vis-a-vis uncontrolled comparable transactions.

Further, practically let us consider an example in case of a Manufacturing concern, say A Ltd. There are sales by A Ltd. to its various group companies and also there are royalty payments to a group company towards use of brand, technical know-how, etc. The ideal approach would be to benchmark the sales transactions and royalty payment transaction separately. However, quite often due to practical difficulties related to availability of comparability of data etc., separate benchmarking of such transactions becomes difficult. To counter such scenario, TNMM is generally applied on an aggregate entitywide basis, wherein net profit from a “class of transactions” i.e. Manufacturing sales is benchmarked using comparable data either internally or using external database with appropriate adjustments, if any.

Step 4: Identification of comparables
Comparable analysis is the essence of Transfer pricing and that too while applying TNMM. Under TNMM, the comparable analysis is required at broad functional level based on the FAR analysis. For example, comparables can be chosen depending upon broad category of business i.e., trading function, manufacturing function, service function etc. The comparables (uncontrolled transaction) typically can be internal comparable or external comparables.

TNMM should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e., by reference to “internal comparables” Where the internal comparables are not available, the net margin that would have been earned in comparable transactions by an independent enterprise (“external comparables”) may serve as a guide. A functional analysis of the controlled and uncontrolled transactions is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results.

External comparables are found out using publicly available databases. Prowess (a database developed by Centre for Monitoring Indian Economy Private Limited) and CapitalinePlus (a database developed by Capital Market Publishers India Private Limited) are widely used amongst the taxpayers and transfer pricing authorities in India.

The OECD guidelines specifies the use internal TNMM over external TNMM. However, the controversy in respect of the same subsists between the taxpayer and the revenue authorities. Internal TNMM has been considered to be preferable by the Indian appellate tax authorities. While the internal TNMM is more preferred choice, it is not applied due to lack of comparable data. Further while applying external TNMM over database, there are host of differences on the manner of selection of comparable companies – commonly called as “search process”. There are continual disputes between taxpayers and tax authorities on selection of appropriate search filters. For example the prominent disagreements over quantitative filters could be application of minimum/maximum sales turnover (for example considering software giants like Infosys, Wipro etc., having huge turnover while comparing with pygmies software players), filter for service revenue over total revenue, export sales filter, employee cost to total sales filter, filter on related party transactions, etc.

Further, as we understand that in practical world no company can have its exactly comparable company with same functionalities; application of TNMM sometimes becomes a challenging task for taxpayers as well as tax authorities. Therefore qualitative analysis under TNMM more often fails to reach consensus between tax payers and tax authorities on identification of ‘ideal’ comparables.

Judicial Rulings:
The various judicial rulings placed emphasise on selection of comparable companies considering the Functions, Assets and Risk (FAR) analysis of the controlled transactions vis-a-vis uncontrolled transactions. The few important rulings include Mentor Graphics (P) Ltd. vs. DCIT (112 TTJ 408, 2007 18 SOT 76, 109 ITD 101 – Delhi
ITAT), UCB India Private Limited vs. ACIT [2009-TIOL- 184-ITAT-MUM, (2009) 30 SOT 95)], DCIT vs. Quark Systems (P) Ltd. (2010-TIOL-31-ITAT-CHDSB), etc.

Step 5: Selection of suitable PLI
The application of TNMM requires the selection of an appropriate PLI. The PLI measures the relationship between (i) profits and (ii) either costs incurred, revenues earned, or assets employed.

In applying the TNMM, an appropriate PLI needs to be selected considering a number of factors, including the nature of the activities of the tested party, the reliability of the available data with respect to the comparable companies, and the extent to which the PLI is likely to produce an appropriate measure of an arm’s length result.

A variety of PLIs can be used. TNMM aims at arriving at the arm’s length operating profit (i.e., profit before financial and non-operating expenses). The examples of PLI commonly used while applying TNMM are net operating profit/total operating cost (OP/TC), net operating profit/total sales (OP/Sales), net operating profit on total assets employed (return on assets), net operating profit on capital employed (return on capital employed), berry ratio (i.e. ratio of gross profit over operating value added expenses), etc.

Determination of the appropriate base while choosing PLI: The denominator of a PLI should be focused on the relevant indicator(s) of the value of the functions performed by the tested party in the transaction under review, taking account of its assets used and risks assumed. For instance, capital- intensive activities such as certain manufacturing activities may involve significant investment risk, even in those cases where the operational risks (such as market risks or inventory risks) might be limited. Where a transactional net margin method is applied to such cases, the investment- related risks are reflected in the net profit indicator if the latter is a return on investment (e.g. return on assets or return on capital employed).

The denominator should be reasonably independent from controlled transactions; otherwise there would be no objective starting point. For instance, when analysing a transaction consisting in the purchase of goods by a distributor from an associated enterprise for resale to independent customers, one could not weight the net profit indicator against the cost of goods sold because these costs are the controlled costs for which consistency with the arm’s length principle is being tested. Similarly, for a controlled transaction consisting in the provision of services to an associated enterprise, one could not weight the net profit indicator against the revenue from the sale of services because these are the controlled sales for which consistency with the arm’s length principle is being tested.

During the transfer pricing audits, the selection of appropriate PLI is one of the disputed issues. For example, in case where the taxpayers has imports as well as export transactions with its AEs. In such an event, selection of PLI i.e. OP/cost, OP/sales or berry ratio could be a debatable issue. The transfer pricing authorities typically do not accept usage of PLI such as return on assets or return on capital employed disregarding the functional profiles, nature of industry and other critical business or economic reasons. Usage of Berry ratio in case of typical limited risk distributors or service provider is quite often not considered appropriate by the transfer pricing authorities in India.

Judicial Rulings:
Various judicial rulings in dealt with the aspect of PLI selection, few of important ones being Schefenacker Motherson Ltd vs. DCIT [123 TTJ 509 (Del)], Kyungshin Industrial Motherson Limited vs. DCIT, New Delhi [2010-TII-61-ITAT-DEL-TP], etc.

Step 6: Economic adjustments, if any
The Indian TPR provides that the net profit margin should be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. Typical comparability adjustments while applying TNMM are working capital adjustments, market risk adjustment, capacity utilisation adjustments, etc. However, in absence of concrete guidance on manner of carrying out such adjustment workings under the Indian TPR, practically it becomes difficult for the taxpayers to convince the tax authorities on veracity of such adjustments. However, in case of working capital adjustments, guidance is more often taken from OECD guidelines on mechanisms to carry our such adjustments and this is too some extent accepted by the Transfer Pricing authorities in India.

Judicial Rulings:
There are multiple judicial rulings on economic adjustments while applying TNMM. The rulings dealt with allowance of working capital adjustments, capacity utilisation adjustments, adjustments due to accounting policies (depreciation charge), etc. The important ones being Mentor Graphics (P) Ltd. vs. DCIT [112 TTJ 408, 2007 18 SOT 76, 109 ITD 101 (Del ITAT)], E-gain
Communication (P) ltd. vs. ITO [118 TTJ 354, 23 SOT 385 (Pune ITAT)], Philips Software Centre Pvt. Ltd. vs. ACIT [2008-TIOL-471-ITAT-BANG], TO vs. CRM Services India
(P) Ltd., CRM Services India (P) Ltd. vs. ITO [ITA No. 4796(Del)/2010,ITA No. 4796(Del)/2010], etc.

Step 7: Assessment of profit for comparisons
As a matter of principle, only those items that (a) directly or indirectly relate to the controlled transaction at hand and (b) are of an operating nature are taken into account in the determination of the net profit indicator for the application of the TNMM. However, in a practical scenario, there are many controversies in the treatment of revenue items into operating or non-operating. For example, treatment of foreign exchange fluctuations, bad debts, provision for bad debt, amortisation of goodwill, etc. as operating/non-operating items. The assessment of profit depends upon appropriate selection of cost base and in absence of appropriate guidance and host of diverse judicial pronouncements, practical difficulty in applying TNMM still prevails.

Judicial Rulings:
In absence of any guidelines as to what should form part of “operating costs”/”operating revenue” while determining “operating net profit” for TNMM application is debatable under the Indian transfer pricing regime. The various judicial pronouncements in India dealt with the issue related to computation of net profits of the tested party and comparable companies in order to assess the arm’s length price. The prominent rulings being Schefenacker Motherson Ltd. vs. DCIT [123 TTJ 509 – Delhi ITAT], Chrys Capital Investment Advisors India Pvt. Ltd. [2010-TII-11-ITAT-Delhi-TP], Sap Labs India Private Limited vs. ACIT Bangalore [2010-TII-44-ITAT-BANG-TP], DHL Express India Pvt. Ltd. [TS-353-ITAT-2011(Mum)], Trilogy E business Software India Pvt. Ltd. [TS-455-ITAT- 2011(Bang)],etc.

Step 8: Determination of the arm’s length price
In order to apply the arm’s length principle, sometimes it is possible to test the same with a single uncontrolled price/ margin. However, transfer pricing is not an exact science and therefore, in most of the cases, application of the most appropriate method results in a range of prices/margin which are comparable to the controlled transaction. In such cases, as provided under the Indian TPR, the arm’s length price must be determined considering the average mean of such range of prices/margin.

The Indian TPR also provides that the average mean as mentioned above can be adjusted by +/- 1% in case of wholesale traders and 3% in case of others to fit in the arm’s length principle.

Judicial Rulings:
There are judicial rulings such as Mentor Graphics (P) Ltd. vs. DCIT [112 TTJ 408, 2007 18 SOT 76, 109 ITD 101 – Del ITAT], ACIT vs. MSS India Pvt. Ltd. [123 TTJ
657 2009-TIOL-416-ITAT-PUNE], etc. on the principles on determination of arm’s length price.

Summary of few judicial rulings on each of the above aspect related to application of TNMM is enclosed as Annexure 1.

4. advantages and limitations of applying the TNMM

5. revised chapters i-iii of the OECD guidelines

The erstwhile OECD guidelines included five comparability factors – characteristics of property or services, functional analysis, contractual terms, economic circumstances and business strategy. Under the revised OECD guidelines, while the said comparability factors are still applicable, revised Chapter III of the OECD guidelines sets out a ten-step process for performing a comparability analysis. Application of the steps is stated as being “good practice” and is not compulsory “as reliability of the outcome is more important than the process”. The ten steps, which are not necessarily sequential, are:-

?    Broad based analysis of the taxpayer’s circumstances;
?    Determination of years to be covered;
?    Functional analysis;
?    Review of existing internal comparables;
?    Determination of available sources of information on external comparables;
?    Selection of the most appropriate transfer pricing method;
?    Identification of the potential comparables;
?    Determination of and making appropriate comparability adjustments where appropriate;
?    Interpretation and use of data collected; and
?    Implementation of the support processes.

In terms of comparability adjustments, the revised OECD guidelines suggests the basis of undertaking or not undertaking adjustments to the comparables and tested party and concludes that, if possible, adjustments must be made where differences exist, which could materially affect the comparison. The revised OECD guidelines also state that where internal comparables exist, it may not be necessary to search for external comparables. However, it also recognises that internal comparables are not always necessarily a more reliable basis for evaluating arm’s length nature of transaction between taxpayer and related party.

The revised OECD guidelines reinforces that TNMM is unlikely to be reliable if both parties to a transaction contribute unique intangibles. Where TNMM is applicable, the OECD guidelines provides guidance on the comparability standard to be applied, reinforcing the importance of determining an appropriate profit level indicator as the basis of the analysis and discussing the importance of undertaking adjustments so that interest and foreign exchange income and expenses are treated in a comparable manner in the profit level indicator of both the tested party and the comparables. Annexure I to Chapter II of the revised OECD guidelines has laid down certain numerical illustrations on sensitivity of gross and net profit indicators.

Illustrations on sensitivity of gross and Net Profit Margins Due To Functional Differences

llustration 1 – Difference in functional and risk profile of distributors:

Enterprises performing different functions may have a wide range of gross profit margins while still earning broadly similar levels of net profits. For instance, TNMM would be less sensitive to differences in volume, extent and complexity of functions and operating expenses.

Let us consider an example of a distributor, say X Ltd. importing certain goods from its group companies for further distribution in India. X Ltd. performs significant marketing function and bears product obsolescence risk. Also let us assume that there is another distributor, say Y Ltd. importing similar goods from its group companies for further distribution in India. The import price for X Ltd. and Y Ltd. for the goods would be different in view of difference in the functions and risk borne by each of them. The import price in case of X Ltd. should typically be lower than that of import price in case of Y Ltd. The gross profits of X Ltd. and Y Ltd. would be influenced by such functional differences. However, TNMM is more tolerant to such functional differences. This can be explained by way of numeric illustration as under:

(*) Assume that in this case the difference of INR 100 in transaction price corresponds to the difference in the extent and complexity of the marketing function performed by the distributor and the difference in the allocation of the obsolescence risk between the manufacturer and the distributor.

From the above table, it can be observed that the risk of error at gross margin level would amount to INR 100 (10% x 1,000), while it would amount to INR 20 (2% x 1,000) if a TNMM was applied.

This illustrates the fact that, depending on the circumstances of the case and in particular of the effect of the functional differences on the cost structure and on the revenue of the “comparables”, net profit margins can be less sensitive than gross margins to differences in the extent and complexity of functions.

Illustration 2 – Effect of a difference in manufacturers’ capacity utilisation:

In certain scenario TNMM may be more sensitive than the cost plus or resale price methods to differences in capacity utilisation, because differences in the levels of absorption of indirect fixed costs (e.g. fixed manufacturing costs or fixed distribution costs) would affect the net profit but may not affect the gross margin or gross mark-up on costs if not reflected in price differences. Let us consider an example where P Ltd. a manufacturer of certain goods operates in full capacity (say 1000 units per year) vis-a- vis. Q Ltd., a manufacturer of similar goods which operates at a lesser capacity of what it could manufacture in full year (say 800 units per year in case where full capacity is 1000 units).

case and in particular on the proportion of fixed and variable costs and on whether it is the taxpayer or the “comparable” which is in an over-capacity situation.

In addition to above, the OECD guidelines have under Annexure to Chapter III has provided an example of a working capital adjustment typically undertaken while applying TNMM.

6. Conclusion

TNMM does not require stringent comparability norms (product comparability, exact functional comparability, etc.) unlike in case of other prescribed transfer pricing methods like CUP, RPM, CPM and PSM. Therefore it can be noticed that TNMM is generally the preferred method amongst the taxpayers and transfer pricing authorities in India. (*) This assumes that the arm’s length price of

However, the TNMM has its own practical difficulties and nuances explained above. As discussed, over a decade old Indian transfer pricing regime has witnessed significant number of judicial rulings relating to various aspects on application of TNMM. This include aspects such as preference of other transfer pricing methods over TNMM, selection of tested party, selection of comparable period, choosing appropriate PLIs, segmentation vs. aggregation of transactions, selection of comparable companies, application of appropriate search filters, validation of transfer pricing adjustments, determination of appropriate cost base while applying TNMM, etc. Such difference of opinion between the taxpayers and transfer pricing authorities on application of TNMM has led to disputes and controversies during transfer pricing audits in India. Reference on ten step process of comparability analysis under the revised OECD guidelines and numerical examples on sensitivity of gross and net profit indictors

The manufactured products is not affected by the manufacturer’s capacity utilisation.

From the above table it can be observed that the risk of error when applying at gross margin level could amount to 16 (2% x 800) instead of 50 (5% x 1000) if TNMM is applied.

This illustrates the fact that net profit indicators can be more sensitive than gross mark-ups or gross margins to differences in the capacity utilisation, depending on the facts and circumstances of the

Under typical circumstances could serve as guiding factor for applying TNMM under the Indian Transfer Pricing context.

Thus, in view of above, the need for hour in the Indian transfer pricing regime is to reinforce certain regulatory framework and lay out concrete guidelines on application of TNMM and mitigate the practical challenges on application of TNMM as the most appropriate method. This will certainly help in resolving perpetual uncertainty, hardship and never ending litigation for the taxpayers and transfer pricing authorities in India.

Annexure 1 – Few Judicial rulings on various aspects related To application of TNMM:
1. selection of tested party:

Judicial Ruling

Principle

Development Consultants P. Ltd. vs. DCIT [2008] 115
TTJ 577 (Kol)

Principles
laid down for selection of tested party – 1) least complex entity 2)
non-owning of valuable intangible property or unique assets

Mastek Ltd. vs. ACIT [2012] 53

SOT 111 (Ahd.)

Selected
party should be least complex and should not be unique, so that prima facie can- not be distinguished
from poten- tial uncontrolled comparables.

AIA Engineering Ltd. vs. ACIT [2012] 50 SOT 134 (Ahd.)

Upheld
selection of Foreign AE as tested party.

Ranbaxy Laboratories vs. ACIT [2008] 110 ITD 428 (Delhi)

The assessee’ s stand of consid-
ering foreign AE as tested party was rejected due to factors like geographic
locations, economic background and FAR analysis.

Global Vantedge Private Limited vs. DCIT (2010-TIOL-
24-ITAT- DEL),

Held
that least complex entity (Foreign AE in given case) re- quires fewer adjustments and thus should be accepted.

General Motors India P. Ltd., vs. DCIT [ITA nos. 3096/Ahd 2010

and 3308/Ahd 2011.

Upheld
selection of Foreign AE as tested party.

2. selection of data for comparison:

Judicial Ruling

Principle

Phillips Software Centre Private Limited (ITA No. 218/Bang/2008)

The TPO cannot use data
during assessment that was not avail- able to the assessee at the time of
preparation of documentation.

Panasonic India Private Lim- ited vs. Income Tax
Officer (ITA No.1417/Del/2008)

proviso to Rule 10B(4) would allow the
taxpayer to adopt the previous two year’s average PLI along with the current
year’s PLI of the tested party and on a

similar footing allow the taxpayer to adopt the three year’s average
PLI of comparable companies.

3. aggregation of transactions vs. segmentation:

Judicial Ruling

Principle

Aztec Software and Technology vs. ACIT,

( 294 ITR 32, Bang ITAT)

Use of
multiple year data is justified only if its influence on determination of ALP
can be demonstrated.

Chrys Capital Investment Advisors India Pvt. Ltd.
(2010-TII-11-ITAT-

Delhi-TP)

Use of multiple year data rejected

Symantec Software Solutions Pvt Ltd vs. ACIT (ITA
No.7894/ MUM/2010)

TPO is entitled to consider
the material in public domain, which was not available to the assessee at the
time of the TP study.

M/s.Smart Trust Infosolutions P. Ltd.

[ITA No. 4172/Del/2009, ITA No. 4172/Del/2009 –
TS-355-ITAT-

2013(DEL)-TP]

Multiple
year data cannot be used and only current year data is to be used.

4. Identification of comparables:

Judicial Ruling

Principle

Mentor Graphics (P) Ltd.
vs. DCIT

Selection of comparables to
be made considering the specific characteristics of the controlled
transaction (FAR) rather than a broad comparison of activities.

UCB India Private Limited vs. ACIT

[2009-TIOL-184-ITAT-MUM, (2009) 30 SOT 95)]

Emphasis
on FAR analysis while selecting comparables. internal comparables are
preferable to external comparables. This view is also supported in case of Bir- lasoft (India) Ltd. vs. DCIT [I.T.A.
No. 4776/D/2011 (Para 4).

DCIT vs. Quark Systems (P) Ltd.
(2010-TIOL-31-ITAT-CHDSB)

Proper FAR analysis
to be done while accepting the comparable company in its star-up phase.

Haworth (India) Pvt. Ltd., vs. DCIT (ITA
No.5341/Del/2010)

A company which is majorly
deal- ing in non-comparable segments cannot be accepted as function- ally
comparable.

Cummins Turbo Technologies Ltd., UK
[TS-304-ITAT-2014- (Pune)-TP]

ITAT rejected comparables with wide profit
fluctuations.

5. selection of PLI:

Judicial Ruling

Principle

Schefenacker Motherson Ltd. vs. DCIT [123 TTJ 509
(Del)]

Taxpayer can use Cash Profit/

Sales or Cost as PLI

Kyungshin Industrial Motherson Limited vs. DCIT, New
Delhi [2010-TII-61-ITAT-DEL-TP]

Operating profit to capital
employed was accepted as PLI as against operating profit to sales adopted by
CIT(A) (Case remanded).

6. economic adjustments:

Judicial Ruling

Principle

Mentor Graphics (P) Ltd. vs. DCIT [112 TTJ 408, 2007
18 SOT 76,

109 ITD 101 (Del ITAT)]

Adjustment
permitted for differ- ences in

a) working capital

b) risk and growth

c) R and D
expenses However, if differences are so

material
that adjustment cannot be made then the company should be rejected. TNMM is
more tolerant to minor functional and risk level differences. Certain
significant risks like market

risks,
contract risks, credit and collection risks, infringement of intellectual
property right etc. are material
and can lead to major difference in the value of transaction.

E-gain Communication (P) Ltd. vs. ITO

In
conformity with ‘Mentor Graphics’ Adjustment permitted for diff. in

a) working capital

b) risk and growth

c) R and D expenses

d) Accounting policies

Philips Software Centre Pvt. Ltd. vs. ACIT

[2008-TIOL-471-ITAT-BANG]

Adjustment permitted for diff. in

a) working capital;

b) risk; and

c) Accounting policies.

Skoda Auto India Pvt. Ltd. vs. ACIT

[2009-TIOL-214-ITAT-PUNE]

File remitted to TPO for consider- ing following
adjustment:

a) difference
due to higher import duty due to
higher % of import of raw materials by the tested party vis-a-vis the comparables.

b) Capacity under-utilisation
at the initial phase of operations

7. Assessment of profits for comparison:

Judicial Ruling

Principle

Schefenacker Motherson Ltd vs. DCIT

[123 TTJ 509 – Delhi ITAT]

a) There is
no standard test to compute operating margins and each item needs to be
decided on case to case basis.

b) Tax depreciation and not book depreciation should be consid-
ered for the purpose of margin calculation. However, deprecia- tion which has
varied basis and rates are not to be allowed in all

cases.

Chrys Capital Investment Advisors India Pvt. Ltd. [2010-TII-11-ITAT-

Delhi-TP]

Non-operating
expenditures – a) Interest, b) dividend, c) income from investment
operations,

d) trading
in bonds and capital market operations, etc.

Sap Labs India Private Limited vs. ACIT Bangalore
[2010-TII-44- ITAT-BANG-TP]

a) Forex
gain and b) Donation paid are operating items and

a) income
tax refunds and b) compensation payment towards termination of agreement are

non-operating
items.

Haworth (India) Pvt. Ltd., vs. DCIT [ITA
No.5341/Del/2010]

Prior period expense has to
be considered as operating if it has nexus with the revenue.

DHL Express India Pvt. Ltd. [TS-353-ITAT-2011(Mum)]

“….interest income, rent
receipts, dividend receipts, penalty collect- ed, rent deposits returned
back, foreign exchange fluctuations and profit on sale of assets do not form
part of the operational income because these items have nothing to do with
the main operations of the assessee.”

Trilogy E Business Software India Pvt. Ltd.

[TS-455-ITAT-2011(Bang)]

Held that foreign exchange
gain to be considered while computing operating profit margin.

M/s.Panasonic Sales &
Services

(I) Company Limited vs. ACIT [I.T.A. No.
1957/Mds/2012]

Outward freight on sales
and cash discount not to be reduced from sales while computing gross profit
margin under RPM.

8. Determination of arm’s length price:

Judicial Ruling

Principle

Mentor Graphics (P) Ltd. vs. DCIT [112 TTJ 408, 2007
18 SOT 76,

109 ITD 101 – Del ITAT]

ALP does not mean maximum
price or maximum profit in the range. It is not necessary for the tax payer
to satisfy all points (margins) in the range. Even if one point (margin) is
satisfied, the taxpayer can be taken to have established its case

ACIT vs. MSS India Pvt. Ltd. [ 123 TTJ 657
2009-TIOL- 416-ITAT-PUNE]

Where the arm’s length
nature of pricing arrangement has been demonstrated, the taxpayers final
profit or loss position is not relevant.

Fulford (India) Ltd. [2011 12 tax- mann.com 219 – Mumbai ITAT]

TPO should
apply his mind afresh every year and should not rely on orders of TPO for
preced- ing years while computing ALP.

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LSG Sky Chef (India) Pvt. Ltd. vs. Dy. CIT In the Income Tax Appellate Tribunal “A” Bench, Mumbai Before I. P. Bansal, (JM) and Sanjay Arora, (AM) I.T.A. No. 4828/Mum/2012 Assessment Year: 2009-10. Decided on 27-03-2014 Counsel for Assessee/Revenue: M. M. Golvala & Amey Wagle/M. L. Perumal

Section 203AA – Assessee cannot be denied credit for TDS merely because the same were not reflected in Form 26AS when TDS certificates in original were filed.

Facts:
The issue before the Tribunal was about the short credit of the tax deducted at source. In its return of income the assessee had claimed credit for TDS of Rs. 92.52 lakh. However, the AO allowed the credit of Rs. 67.99 lakh only and no credit was allowed for the balanced sum of Rs. 24.53 lakh, as the same was not reflected in Form No. 26AS despite furnishing of the TDS certificates in original by the assessee.

Held:
According to the Tribunal, the burden of proving as to why the said Form does not reflect the details of the entire tax deducted at source for and on behalf of a deductee cannot be placed on an assessee-deductee. The assessee, by furnishing the TDS certificate/s bearing the full details of the tax deducted at source, credit for which is being claimed, has discharged the primary onus on it toward claiming credit in its respect. He, accordingly, cannot be burdened any further in the matter. The Revenue is fully entitled to conduct proper verification in the matter and satisfy itself with regard to the veracity of the assessee’s claim/s, but cannot deny the assessee credit in respect of TDS without specifying any infirmity in its claim/s. Form 26AS is a statement generated at the end of the Revenue, and the assessee cannot be in any manner held responsible for any discrepancy therein or for the non-matching of TDS reflected therein with the assessee’s claim/s. The tribunal further observed that the plea that the deductor may have specified a wrong TAN, so that the TDS may stand reflected in the account of another deductee, is no reason or ground for not allowing credit for the TDS in the hands of the proper deductee. The onus for the purpose lies squarely at the door of the Revenue. Accordingly, the A.O. was directed to allow the assessee credit for the impugned shortfall.

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ACIT vs. Jayendra P. Jhaveri In the Income Tax Appellate Tribunal Mumbai Benches “J”, Mumbai Before P M Jagtap (A. M.) & Sanjay Garg(J. M.) ITA Nos.2141 to 2144 /Mum/2012 Asst.Year 2003-04. Decided on 20th February 2014 Counsel for Revenue / Assessee: S. D. Srivastava / Dharmesh Shah

Section 153A – Re-assessments made by the AO without any incriminating material found during the search action u/s. 132 not valid.

Facts:
A search and seizure operation was carried out in the case of the assessee on 14-08-2008 u/s. 132 of the Income- tax Act. Pursuant thereto, the AO issued notice u/s. 153A to the assessee to file the return of income for six years subsequent to the search. In response to the notice, the assessee filed return of income before the AO. The AO, thereafter, issued notice u/s. 143(2) and 142(1). The assessee submitted before the AO that books of account and other details were destroyed in the flood in the year 2005 and, therefore, the same could not be produced. Since the assessee failed to produce the books of accounts, the AO passed the order u/s. 144 r.w.s. 153A. On the basis of net profit ratio of certain other persons who were engaged in a similar business as that of the assessee, the AO made the additions to the total income of the assessee. The CIT(A) upheld the action of the AO. However, he directed the AO to re-compute the net profit of the assessee by adopting the net profit of 0.14%. The revenue appealed against the action of the CIT(A) in directing the AO to rework the net profit of the assessee at the lower rate of 0.14% as against the 0.99% estimated by the AO. Whereas the assessee has filed the cross objections against the action of the CIT(A) in upholding of assessment proceedings made by the AO u/s. 153A. Before the Tribunal, the assessee contended that since no incriminating material was found during the search and seizure operation, the re-assessment made by the AO u/s. 153 A was not valid. He has further submitted that since the limitation period for issuing notice u/s. 143(2) had already been expired and as such the assessments in relation to above mentioned assessment years had attained finality. The contention of the revenue was that the absence of the books of accounts, itself, was the incriminating evidence against the assessee necessitating initiation of assessment proceedings u/s. 153A.

Held:
The tribunal noted that in the present case the return was processed u/s. 143(1) and the same had attained finality due to the expiry of limitation period of 12 months from the end of the month in which the return was filed. Further, no incriminating material was found from the premises of the assessee during the search u/s. 132. In view of the same and the decisions of the Rajasthan High Court in the case of Jai Steel (India) vs. ACIT (2013) 259 CTR 281, the Andhra Pradesh High Court in the case of Gopal Lal Badruka vs. DCIT, 346 ITR 106 and of the Delhi High Court in the case of CIT vs. Chetan Dass Lachman Dass [2012] 211 Taxmann 61, the Tribunal observed that when no incriminating evidence was found during the search, it was not open to the AO to make re-assessment of concluded assessment in the garb of invoking the provisions of section 153A. According to it the contention of the revenue that since no books of account were found during the search action that itself was the incriminating material against the assessee had no force of law. Inference of concealment of income cannot be made just on mere assumptions, presumptions or suspicion. Relying on the Tribunal decision in the case of Jitendra Kumar Jain vs. DCIT (ITA Nos. 5951- 5953/M/2011 decided on 16-01-2014) it held that that such an assumption cannot be said to be having any value of evidence in eyes of law and even the assessee cannot be called to disapprove such type of assumptions and presumptions based on mere suspicions. It observed that it is not open to the revenue to rely on the weakness of the evidence produced by the assessee to make any adverse presumption or conclusion of his indulging in any illegal activity, without being there any direct or even circumstantial evidence on record against him.

In view thereof, the Tribunal held that the reassessments made by the AO u/s. 153A, without any incriminating material being found during the search action conducted u/s. 132, were not in accordance with law and the same were set aside.

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(2014) 102 DTR 151 (Mum) 3i Infotech Ltd. vs. ACIT A.Y. 2003-04 Dated : 21-08-2013

Compensation for termination of agreement for providing back office support services is regarded as capital receipt.

FACTS:
The assessee has been providing back-office services to ICICI bank in respect of retail lending business of ICICI Bank comprising of housing loans, auto loans, credit cards etc., for providing such services the assessee had put in place adequate resources in terms of office space, software, IT infrastructure, manpower sources with technical skill, managerial and other skills required to handle such activity.

With a view to exercise control over the activities and to reduce cost, the bank has decided to carry on the activities independently. On termination of the agreement, the assessee received Rs. 15 crore from the bank as compensation for loss of business/future earning/transfer of knowledge. The assesssee claimed that it has given up one source of income completely for which compensation has been received. Such compensation is towards loss of business order and towards loss of one source of income which has affected the profit-making structure of the assessee and the same is accordingly a capital receipt.

The AO did not accept such claim of the assessee and considered the said amount as revenue receipt. The main basis on which the AO has held this issue against the assessee is that there is no transfer of any asset or business expertise or IPR or such item which is normally transferred when such type of business is transferred by one entity to another. Another ground on which the AO rejected the claim of the assessee was that there is no clause in the agreement which restrain or restrict the assessee from continuing the aforementioned activities and the assessee is free to carry on such activities, if it so desired. Further, it was also contended that the abovementioned activities of the assessee were continued in respect of subsequent period also and there was no loss of business or one source of income. Thus, it was argued by the Revenue that there was no absolute erosion of such source.

HELD:
It was a case where the compensation has been received by the assessee on losing its rights to receive income in respect of services rendered by the assessee to the bank. In the facts and circumstances of the case it is a loss of source of income to the assessee and compensation has been determined on the basis of said loss. According to arguments of the learned Departmental Representative, the assessee company has not given up its entire activity of rendering back office services as the assessee has been earning income from such activity even after termination of such agreement. Therefore. it is the case of the learned Departmental Representative that the amount received by the assessee should be considered as income in the nature of revenue. However, such argument of the learned Departmental Representative does not find support from the decisions of the Hon’ble Supreme Court in the cases of Oberoi Hotel (P) Ltd. vs. CIT 236 ITR 903 (SC) and Kettlewell Bullen & Co. Ltd. vs. CIT 53 ITR 261 (SC). It has been observed that it is irrelevant that the assessee continued similar activity with the remaining agencies. So, the relevant criteria to decide such issue is that whether or not the assessee has lost one of its sources of income. In the present case, the assessee has lost its source of income with respect to its agreement entered into by it with the bank. It is also the case of the assessee that it has never rendered such services to any other person right from the inception and there is no material on record to contradict such argument of the assessee. Therefore in view of the facts it was held that the compensation received by the assessee was in the nature of capital receipt.

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2014-TIOL-270-ITAT-AHD Gujrat Carbon & Industries Ltd. vs. ACIT ITA No. 3231/Ahd/2010 Assessment Years: 2003-04. Date of Order: 13-09-2013

Section 37 – Expenditure incurred on foreign education of Mr. Goenka, the whole time director, under authority of a resolution passed pursuant to which an agreement between the assessee and Mr. Goenka, is a business expenditure which is allowable.

Facts:
The assessee had debited a sum of Rs. 33,95,589 to its P & L Account towards expenditure on foreign education of its whole-time director. In the course of assessment proceedings, in response to the show cause issued by the Assessing Officer asking the assessee to justify the allowability of this expenditure, the assessee submitted that it had sponsored MBA studies of whole-time director Sri Goenka and that expenditure was incurred to improve the management and profitability of the assessee company. The AO noted that there was no policy of company of sponsoring studies of employees. He also noted that Mr. Goenka was appointed as director on 29- 04-2002 and board resolution was passed on 24-07-2002 for his studies abroad and he resigned from the company on 18-10-2003 and was later reappointed. He noted that Sri Goenka is son of G. P. Goenka, chairman of the company. He disallowed the expenditure on the ground that it is a personal expenditure.

Aggrieved, the assessee preferred an appeal to CIT(A) who held that the assessee’s claim of improvement of business efficiency is contingent upon his completing MBA abroad and possibly meaningfully contribution to the appellant company thereafter. He held that since the business purpose is contingent, remote and in the realm of unforeseen and at least two steps away from the incurring of the expenditure, the same is not allowable.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal observed that there is no dispute that the expenditure has been incurred as per resolution passed at the meeting of the Board of Directors of the assessee and that pursuant to the resolution passed, an agreement was entered between the assessee and Sri Goenka, according to which he will work for two years after his return from USA. It also noted that this agreement was acted upon and that the facts of the case are covered by the ratio fo the decision of the Karnataka High Court in the case of Ras Information Technology Pvt. Ltd. (12 taxman 58)(Kar). It also noted that a similar view has been Ahmedabad Bench of ITAT in the case of Mazda Ltd. in ITA No. 3190/Ahd/2008. The Tribunal held that the expenses incurred by the assessee company on foreign education of whole-time director be treated as a business expenditure of the assessee and be allowed as a deduction.

The appeal filed by the assessee was allowed.

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2014-TIOL-237-ITAT-DEL Vijaya Bank vs. ITO ITA No. 2672 to 2674/Del/2013 Assessment Years: 2007-08 to 2009-10. Date of Order: 14-03-2014

S/s. 197A(1A), 201, 201(1A) – Delay in filing declarations with the jurisdictional CIT does not attract provisions of section 201 and such assessee cannot be held to be an assessee in default u/s. 201(1A).

Facts:
Survey was conducted on Gurgaon Branch of the assessee, a nationalised bank. In the course of the survey, it was found that the said branch of the assessee had short deducted tax at source in some cases and in some cases, it had not deducted tax at source. It was the case of the bank that it had obtained Form No. 15G and Form No. 15H but had not filed the same with the CIT. The Assessing Officer (AO) rejected the contentions of the assessee and determined the tax payable u/s. 201 at Rs. 3,59,950 and interest payable thereon u/s. 201(1A) at Rs. 1,61,955.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the assessee had mentioned in a letter dated 16-02-2010 filed with ITO(TDS) that it is submitting Forms 15G/15H alongwith a request to condone the delay. The Tribunal held that unless it is proved that Form No. 15G and 15H were not in fact submitted by loan creditors, the assessee cannot be blamed because at the time of paying interest to loan creditors, the assessee payer, has per force to rely upon the declarations filed by the loan creditors and the assessee was not expected to embark upon an inquiry as to whether the loan creditors really and in truth have no taxable income on which tax is payable. If such kind of duty is cash upon the assessee payer, that would be putting an impossible burden on the assessee.

The Tribunal following the decision of the Mumbai Bench in the case of Vipin P. Mehta vs. ITO (11 Taxmann.com 342)(Mum) held that if the assessee has delayed the filing of declaration with the office of the jurisdictional CIT, within the time limit specified in the Act, that is a distinct omission or default for which penalty is prescribed. Merely because there was a failure on the part of the assessee bank to submit these declarations to the jurisdictional Commissioner within time, it cannot be held that the assessee did not have declarations with him at the time when the assessee Bank paid interest to the payees.

The Tribunal allowed all the three appeals filed by the assessee.

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2014-TIOL-225-ITAT-PUNE DCIT vs. The Nashik Merchant Co-operative Bank Ltd. ITA No. 950/PN/2013 Assessment Years: 2009-10. Date of Order: 30-04-2014

S/s. 37, 43B – Premium paid in excess of the face value of investments, classified under HT M category, which has been amortised over a period till maturity is allowable as revenue expenditure since the claim is as per RBI guidelines and CBDT has also directed to allow the said premium.

Amount paid as contribution to the Education Fund of State Government, as per guidelines of Commission of Cooperative Department is allowable as deduction.

Facts I:
The assessee, a co-operative bank, had debited a sum of Rs. 3,73,600 to its Profit & Loss Account under the head Investment Premium Amortization Account. This amount represented premium on securities which were to be held to maturity (HTM). The assessee submitted that since these securities were to be HTM the premium is required to be amortised over the period remaining to maturity. The Assessing Officer (AO) rejected this contention and disallowed the sum of Rs. 3,73,600.

Aggrieved, the assessee preferred an appeal to CIT(A) who allowed the appeal.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held I:
The Tribunal noted that the Master Circular on Investment by Primary (Urban) Co-operative Banks issued by RBI required the premium to be amortised over the period remaining to maturity. It also noted that CBDT has in instruction no. 17 of 2008 dated 26-11-2008 has made a reference to the RBI guidelines and has stated that the latest guidelines of the RBI may be referred to for allowing such claims. It also noted that the Mumbai Bench has in the case of ACIT vs. Bank of Rajasthan Ltd. (2011-TIOL-35-ITAT -MUM) following the said circular of CBDT held that the premium paid in excess of face value of investments is allowable as revenue expenditure.

Following the said circular, instruction and guidelines issued by the CBDT and the RBI the Tribunal held that amortisation of premium paid on government securities is allowable expenditure.

Facts II:
The assessee had debited to its P & L Account and claimed as deduction, a sum of Rs. 10,60,882 which was paid as contribution to Education Fund. This amount represented the contribution made by assessee as a multi-state co-operative society to central government. The AO disallowed this sum of Rs. 10,60,882.

Aggrieved, the assessee preferred an appeal to CIT(A) who allowed the appeal.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held II:
The Tribunal noted that the contribution was paid by the assessee as per the guidelines of the Commission of Co-operative Department. The contribution made is mandatory on the part of every co-operative bank in the state of Maharashtra. Since the bank had to work under the control of the Commissioner of Co-operation, Maharashtra, the order issued by the Commissioner was obligatory on the bank. The Tribunal held that the CIT(A) had rightly held the contribution paid by bank to be a business expenditure wholly exclusively incurred for the purpose of business and accordingly, allowable u/s. 37(1) of the Act. This ground of appeal of the revenue was dismissed by the Tribunal.

The appeal filed by revenue was dismissed

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Recovery of tax: Attachment: Section 281: A. Y. 2005-06: Transfer of property during pendency of assessment proceedings: TRO has no power to declare sale deed void: Appropriate proceedings to be taken in civil court:

Dr. Manoj Kabra vs. ITO; 364 ITR 541 (All):

The petitioner purchased a property by means of a registered sale deed on 25-09-2007 from A when the assessment of A for the A. Y. 2005-06 was in process. The assessment resulted in certain demand. On 03-01-2008, the Assessing Officer of A issued a notice u/s. 281 of the Income-tax Act, 1961 to the petitioner to show cause why the sale deed executed by the seller in favour of the petitioner should not be treated as a void document. The petitioner’s objection was overruled by the Assessing Officer holding that there was inadequate consideration for the transfer of the property by the seller in favour of the petitioner and, therefore, the conveyance was a void document.

On a writ petition challenging the said order of the Assessing Officer, the Allahabad High Court held as under:

“i) The Legislature does not intend to confer any exclusive power or jurisdiction upon the Income-tax Authority to decide any question arising u/s. 281 of the Income-tax Act, 1961. The section does not prescribe any adjudicatory machinery for deciding any question which may arise u/s. 281 and in order to declare a transfer as fraudulent u/s. 281, an appropriate proceeding in accordance with law is required to be taken u/s. 53 of the Transfer of Property Act, 1882.

ii) The Income-tax Officer, in order to declare the transfer void u/s. 281 and being in the possession of the creditor, is required to file a suit for declaration to the effect that the transaction of transfer is void u/s. 281.

iii) The Income-tax Officer had exceeded his jurisdiction in adjudicating the matter u/s. 281. He had no jurisdiction to declare the sale deed as void. Consequently, the order cannot be sustained and was quashed.”

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Income: Capital or revenue receipt: Subsidy: A. Y. 1997-98: If the subsidy is to enable the assessee to run the business more profitably then the receipt is on revenue account: If the subsidy is to enable the assessee to set up a new unit then the receipt would be on capital account:

CIT vs. Kirloskar Oil Engines Ltd.; 364 ITR 88 (Bom):

The assessee was engaged in manufacturing of internal combustion engines of three horse power. The assessee received subsidy from the State Government of Rs. 20 lakh as incentive to set up a new unit. The assesee treated the same as capital receipt. The Assessing Officer held that it is the revenue receipt and added it to the total income. The Tribunal allowed the assessee’s appeal and deleted the addition.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) The character of a receipt in the hands of the assessee has to be determined with respect to the purpose for which the subsidy is given. The purpose test has to be applied. The point of time at which the subsidy is given is not relevant. The source is immaterial. The form of subsidy is immaterial. The main condition and with which the court should be concerned is that the incentive must be utilised by the assessee to set up a new unit or for substantial expansion of the existing unit.

ii) If the object of the subsidy scheme is to enable the assessee to run the business more profitably the receipt is on revenue account. On the other hand, if the object of the assistance under the subsidy scheme is to enable the assessee to set up a new unit, the receipt of subsidy would be on the capital account.

iii) Once the undisputed facts pointed towards the object and that being to enable the assessee to set up a new unit then the receipt was a capital receipt.”

Editor’s Note: The decision is for A.Y. 1997-98. The impact of Explanation 10 to section 43(i) inserted w.e.f. 01-04-1999 needs to be considered.

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Income: Deemed dividend: Section 2(22)(e): A. Y. 2007-08: Where assessee, a builder and managing director of a company in which he was holding 63 % shares, received a construction contract from said company, in view of fact that assessee executed said contract in normal course of his business as builder, advance received in connection with construction work could not be taxed in assessee’s hands as ‘deemed dividend’ u/s. 2(22)(e):

CIT vs. Madurai Chettiyar Karthikeyan; (2014) 45 taxmann.com 274 (Mad)

The assessee is the proprietor of Shri Vekkaliamman Builders and Promoters and he also happens to be the Managing Director of Southern Academy of Maritime Studies Private Limited, in which he holds share of 63%. For the A. Y. 2007-08, the Assessing Officer added a sum of Rs.87,57,297/- to the assessee’s income u/s. 2(22) (e) of the Income-tax Act, 1961 as deemed dividend, rejecting the assessee’s contention that the company awarded construction contract to the assessee’s proprietary concern after completing with the procedures of the Companies Act. The Assessing Officer rejected the contention of the assessee that it being a normal business transaction, the amount received as advance for the purpose of executing the construction work, it would not fall within the scope of ”loans and advances” u/s. 2(22)(e) of the Act. CIT(A) agreed with the assessee that he was rendering services to his client M/s. Southern Academy Maritime Studies P. Ltd. by constructing building; that the advance money received was towards construction of the building for the said private limited company and that the trade advance was in the nature of money given for the specific purpose of constructing the building for the private limited company and hence the payment could not be treated as deemed dividend falling within the ambit of section 2(22)(e) of the Act. Thus, the Commissioner allowed the assessee’s appeal. The Tribunal, confirmed the view of the Commissioner.

On appeal by the Revenue, the Madras High Court upheld the decision of the Tribunal and held as under:

“i) Going by the undisputed fact that the Revenue had not disputed the fact that the assessee had executed work for the company in the nature of construction of buildings and the said transaction being in the nature of a simple business transaction, we do not find any justifiable ground to bring the case of the assessee within the definition of deemed dividend u/s. 2(22) (e) of the Act. In the circumstances, we reject the Revenue’s case at the admission stage itself.

ii) In the result, the Tax Case (Appeal) is dismissed.”

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Educational institution: Exemption u/s. 10(23C) (vi): A. Y. 2008-09 onwards: Body conducting public examinations is educational institution u/s. 10(23C)(vi): Increase in the fees for generating surplus would not by itself exclude the petitioner from the ambit of section 10(23C) (vi): Generation of profit or surplus by an organisation cannot be construed to mean that the purpose of the organisation is generation of profit/surplus.

Council for the Indian School, Certificate Examinations vs. DGIT; (2014) 364 ITR 508 (Del): (2014) 45 taxmann. com 400 (Delhi): The petitioner is a body conducting public examinations under the Delhi School Education Act, 1973.

The Petitioner had applied for the approval u/s. 10(23C)(vi) of the Income-tax Act, 1961 for AY 1999-2000 to 2001-02 to CBDT. The CBDT, by order dated 31-10-2006, rejected the Petitioner’s application holding that the Petitioner was not an educational institution but was an examination body which conducts examinations for ICSC and ISC and therefore, could not be granted the exemption as an educational institution u/s. 10(23C)(vi) of the Act. The Petitioner’s applications for approval u/s. 10(23C)(vi) of the Act for A.Y. 2002-03 to 2004-05 and 2005-06 to 2007- 08 were not disposed of. The application for approval u/s. 10(23C)(vi) of the Act, for the AY 2008-09 to 2010-11, was dismissed by the DGIT on the ground that the Petitioner is not an educational institution but an examination body conducting examinations for ISCE and ISC.

The petitioner filed a writ petition being W.P.(C) No. 4716/2010 which was allowed by the Delhi High Court. The Court held that the petitioner is an educational institution as contemplated u/s. 10(23C)(vi) of the Act and the matter was remanded to the respondent to pass an order in accordance with law.

Subsequently, the DGIT passed order dated 07-06-2012, declining to grant the approval u/s. 10(23C)(vi) of the Act, inter alia, on the ground that the petitioner had failed to justify its claim that it did not exist for the purposes of profit. The respondent further held that the petitioner had conducted its affairs in a systematic manner to earn profits and the same were diverted in a clandestine manner. The Respondent further noticed that the Auditor had in its report, in respect of the Balance sheet of the petitioner relevant for the Financial Year 2008-09 (AY 2009-10), pointed out that there were lapses while awarding the contract to M/s. Ratan J. Batliboi – Architects Pvt. Ltd. (hereinafter referred to as “RJB-APL”) for installing IT enabled services and was thus unable to form an opinion on whether the accounts showed a true and fair view.

The Delhi High Court allowed the writ petition filed by the petitioner challenging the said order and held as under:

“i) The nature of the activity carried on by an entity would be the predominant factor to determine whether the purpose of the organisation is charitable.

ii) It is not necessary that a charitable activity entails giving or providing a service and receiving nothing in return. Collection of a charge for providing education would, nonetheless, be charitable provided, the funds collected are also utilised for the preservation of the charitable organisation or for furtherance of its objects.

iii) If the surpluses have been generated for the purposes of modernising the activities and building of the necessary infrastructure to serve the object of the organisation, it would be erroneous to construe that the generation of surpluses have in any manner negated or diluted the object of the organisation.

iv) In the instant case, the petitioner has been existing solely for educational purposes. Generation of profit and its distribution is not the object of the petitioner society. The fact, that surpluses have been generated in order to build the infrastructure for modernising the operation, is clearly in the nature of furthering the objects of the society rather than diluting them.

v) Generation of profit or surplus by an organisation cannot be construed to mean that the purpose of the organisation is generation of profit/surplus, as long as the surpluses generated are accumulated/utilised only for educational purposes. The same would not disable the petitioner from claiming exemption u/s. 10(23C) (vi) of the Act.

vi) Merely because the institution awarded the computerisation contract in a non-transparent manner doesn’t mean that funds have not been applied for objects of the society

vii) T he contract entered into for computerisation may not be the best decision from the standpoint of the Prescribed Authority and perhaps in the opinion of the Prescribed Authority, the petitioner society may have ended up paying more than the value of services received. But the same cannot be read to mean that the resources of the petitioner have been deployed for purposes other than for its objects.

viii) Since the assessee by its nature of activity is otherwise entitled to exemption u/s. 10(23C)(vi) of the Act, the same is liable to be granted by the respondent for future years subject to conditions as contained in the third proviso to section 10(23C) of the Act.”

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Educational institution: Exemption u/s. 10(23C) (vi): CBDT Circular No. 7 of 2010: Approval granted after 13-07-2006 shall continue till it is cancelled: Approval for period upto A. Y. 2007-08 granted on 20-12-2007 operates for subsequent years also: Application for continuation of approval and rejection of the said application has no effect in law:

The Sunbeam Academy Educational Society vs. CCIT (All); W. P. No. 1502 of 2009 dated 21/05/2014: 2014-TIOL-HC-ALL-IT:

The assessee society was running educational institutions and was granted approval for exemption u/s. 10(23C) (vi) of the Income-tax Act, 1961 for the period up to A. Y. 2007-08. The last approval for the A. Ys. 2005-06 to 2007-08 was granted by order dated 20-12-2007. On 25- 03-2008 the assessee made an application for extension of approval u/s. 10(23C)(vi) for the A. Ys. 2008-09 to 2010-2011. By his order dated 17-03-2009, the Chief Commissioner rejected the application.

Being aggrieved, the assessee filed writ petition challenging the order. The assessee brought to the notice of the High Court, CBDT Circular No. 7 of 2010 dated 27-10-2010 clarifying that the approval granted after 13-07-2006 shall continue to operate till it is withdrawn and the assessee is not required to file an application for continuation of the approval.

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

“i) The application dated 25-03-2008 filed by the petitioner for extension of the approval u/s. 10(23C) (vi) for the A. Ys. 2008-09 to 2010-11 was a redundant application. There was no requirement to apply for extension of the approval inasmuch as the approval in the case of the petitioner was granted after 01-12- 2006 on 20-12-2007. The approval so granted by the Chief Commissioner, by an order dated 20-12-2007, was a one-time affair, which was to continue till it was withdrawn under the proviso as extracted.

ii) Consequently, the impugned order dated 17-03-2009 was otiose having no effect in law. The impugned order only rejects the application for extension of the approval for the A. Ys. 2008- 09 to 2010-11. The original order of approval dated 20-12-2007 still continues to remain in force inspite of the rejection of the petitioner’s application by the impugned order dated 17-03-2009.

iii) The approval granted by the Chief Commissioner dated 20-12-2007 being a one-time affair continues to remain in force till it is withdrawn.”

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Cash credit: Charitable trust: S/s. 11 and 68: A. Y. 2001-02: Exemption u/s. 11: Donations disclosed as income: Not to be added as cash credit:

CIT vs. Uttaranchal Welfare Society; 364 ITR 398 (All):

The assessee is a charitable society eligible for exemption u/s. 11 of the Income-tax Act, 1961. For the A. Y. 2001-02, the Assessing Officer made an addition of Rs. 96,50,000/- being the donations received from different persons on the ground that the donations were not genuine. The Tribunal deleted the addition and held that section 68 is not applicable to the facts of the case and since the assessee had disclosed donations of Rs. 96,50,000/- in its income and expenditure account and all the receipts, other than corpus donations, were declared as income in the hands of the assessee, there was full disclosure of the income by the assessee.

On appeal by the Revenue, the Allahabad High Court upheld the decision of the Tribunal and held as under:

“The Tribunal was justified in treating the donations as voluntary and deleting the addition of Rs. 96,50,000/- made by the Assessing Officer u/s. 68 in allowing the exemption u/s. 11 of the Act.”

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Business expenditure: Disallowance u/s. 14A: 1961: A. Y. 2009-10: Where assessee did not earn any exempt income in the relevant year the provisions of section 14A are not applicable and disallowance u/s. 14A could not be made:

CIT vs. Cortech Energy (P) Ltd.; (2014) 45 taxmann.com 116 (Guj):

Held:
In the absence of dividend (i.e., exempt) income the provisions of section 14A of the Act is not applicable and accordingly, there can be no disallowance u/s. 14A of the Act.

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Representation regarding removal of difficulties in ITR-6 faced by Foreign Companies

19th September 2014
The Chairman,
Central Board of Direct Taxes,
North Block,
New Delhi – 110 001.

The Director General of Income Tax (Systems)
A R A Center, E-2, Ground Floor,
Jhandewalan Ext.,
New Delhi – 110 055.

The Commissioner of Income-tax (CPC)
Centralized Processing Centre,
Post bag No. 2, Electronic City Post,
Bangalore – 560 100.

Dear Sirs,

Subject: Representation regarding removal of difficulties in
ITR-6 faced by Foreign Companies

This
is in reference to Form ITR-6 applicable for Income-tax assessment year
2014-15 in case of corporate assessees notified vide Notification No.
28/2014 [F.NO.142/2/2014- TPL]/SO 1418(E), dated 30-5-2014. It has been
pointed out to us that the following difficulties are being faced by
Foreign Companies and request your urgent action to redress the same.

1. Bank Account and IFSC Code
1.1 In Form ITR-6, in Part B – TTI – Computation of Tax liability on Total Income – Refund, it is mandatory to enter Bank Account no., IFSC Code & Type of account, in all cases, without which xml file cannot be generated and the ITR-6 cannot be uploaded.

1.2
While in case of residents, one can appreciate the introduction of
mandatory requirement to give aforesaid information, in case of many
foreign companies it is creating various practical difficulties.

1.3
As you are aware that under the relevant provisions of the Foreign
Direct Investment [FDI] Scheme of Foreign Exchange Management Act, 1999
[FEMA] and relevant regulations, a non-resident is required to bring in
funds in India through normal banking channels. There is no need or
requirement of any non-resident to have a bank account in India.
Dividends and other income on the FDI investment is directly paid in
foreign exchange to their bank accounts in the home countries. Even at
the time of disposal of the investments in the Indian companies, the
sale proceeds are directly repatriable to their bank accounts aboard.

1.4
Large number of foreign companies may not have regular operations in
India. Many of them may have hardly any operations in India. Such
foreign companies will not have bank account in India as commercially
and/or legally there is no need to have bank account in India. Such
foreign companies may also be required to furnish their Return of Income
in India u/s 139 of the Income-tax Act, 1961 [the Act] and in view of
the abovementioned procedural requirement of mandatorily mentioning the
bank account no. and IFSC Code in ITR-6, they are not in a position to
fulfil their statutory obligation of furnishing Return of Income, for
want of bank account in India.

1.5 T he same issue was also
faced last year and upon representation a solution was provided whereby
the Foreign Companies who do not have a bank account in India were
permitted to put 9 times 9 in the bank account field and NNNN0NNNNNN in
the IFSC code.

1.6 In view of above, you are requested to continue to provide the same solution for AY 2014-15 and going forward as well.

2. Surcharge and education cess on income chargeable to tax at Special Rates under the DTAA

2.1
I n cases where foreign companies offer any income to tax in India at
the rates specified under the relevant Double Taxation Avoidance
Agreement [DTAA], the position is reasonably settled that the surcharge
and education cess is not applicable in such cases. In fact, many DTAAs
specifically include surcharge in Article 2, which generally deals with
Taxes Covered. For example, India’s DTAA with USA, UK, Japan and
Singapore etc.

Further, the education cess, being additional
surcharge also has the same impact. Even if by any chance, the revenue
wants to take any contrary stand in this respect, the assessee cannot be
prevented from adopting the above position.

2.2 U nfortunately,
for AY 2014-15 in the ITR-6 utility, in para 2(d) and 2(e) of Part B –
TTI relating to Tax Payable on Total Income, surcharge and education
cess is automatically calculated on such income and these fields are not
editable. This is rectly tantamount to automatic enforcement of the
view contrary to the one which the foreign company holds in these
matters. If such a procedure in ITR-6 is allowed to continue, then in
every such case, the Return of Income would show unpaid balance tax
payable to the extent of the automatic levy of the surcharge and the
education cess, which the assessee claims as not leviable.

Therefore,
this would involve unnecessary and avoidable implication of non-payment
of selfassessment tax which is factually not payable as per the claim
of the assessee. Such an incorrect position should not be created
through the above procedure of ITR-6.

2.3 In view of the above,
we request you to kindly take necessary immediate action to remedy the
situation so as to enable such foreign companies to furnish their
returns of income before the expiry of due date and to discharge their
statutory obligation.

2.4 I t is, therefore, strongly suggested
that where income is taxable under DTAA , surcharge/education cess
should not be automatically calculated in ITR 6. Alternatively, such
filed should be made editable in the ITR 6 utility.

Your early
action in redressing above difficulties shall be highly appreciated and
will immensely help the foreign companies to smoothly file their returns
in time.

Thanking you.

Bombay Chartered Accountants ‘ Society

Nitin P. Shingala                            Kishor B. Karia                                          Sanjeev Pandit
President                                       Chairman                                                   Co-Chairman
                                                     Taxation Committee

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Century Metal Recycling Pvt. Ltd. vs. DCIT ITAT Delhi `B’ Bench Before H. S. Sidhu (AM) and H. S. Sidhu (JM) ITA No. 3212/Del/2014 A.Y.: 2007-08. Decided on: 5th September, 2014. Counsel for revenue / assessee: Satpal Singh / Sanjeev Kapoor

S/s. 79, 271(1)(c) – Penalty u/s. 271(1)(c) is not leviable in a case where claim to carry forward capital loss was denied due to change in majority shareholding.

Facts:
For assessment year 2007-08 the Assessing Officer (AO) in an order passed u/s. 143(3) of the Act assessed the returned income to be the total income. However, the claim of carry forward of loss of Rs. 23,09,722 was denied on the ground that there was a change in majority shareholding of the assessee and therefore by virtue of section 79 the said loss cannot be carried forward.

Aggrieved, the assessee preferred an appeal to the CIT(A) who confirmed the action of the AO. The assessee after receiving the order of CIT(A) did not carry forward the capital loss of Rs. 23,90,722 in its return of income for AY 2012-13. The AO levied a penalty of Rs. 8,05,000 u/s. 271(1)(c) of the Act.

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

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held:
The Tribunal noted that the carry forward of long term capital loss of AY 2005-06 and 2006-07 had been duly accepted as correct as per returns filed and assessment orders passed by the AO in the relevant years. In the AY 2006-07, the AO specifically mentioned that carry forward of long term capital loss is allowed.

The Tribunal also noted that in the assessment order of AY 2007-08 there was no mention that the assessee had furnished any inaccurate particulars of income or had made any wrong claim of carry forward of long term capital loss. The disallowance of carry forward of long term capital loss was on technical ground and not on account of any concealment of any particulars of income. The Tribunal noted that section 271(1)(c) postulates imposition of penalty for furnishing of inaccurate particulars and concealment of income. It observed that the conduct of the assessee cannot be said to be contumacious so as to warrant levy of penalty. The Tribunal held that the levy of penalty was not justified. It set aside the orders of the authorities below and deleted the levy of penalty.

The appeal filed by the assessee was allowed.

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ACIT vs. The Upper India Chamber of Commerce ITAT Lucknow `B’ Bench Before Sunil Kumar Yadav (JM) and A. K. Garodia (AM) ITA No. 601 /Lkw/2011 Assessment Year: 2008-09. Decided on: 5th November, 2014. Counsel for revenue/assessee: Y. P. Srivastava/ Abhinav Mehrotra

Ss. 11, 12A, 50C – Provisions of section 50C cannot be invoked in the case of a society or a charitable trust registered u/s. 12A of the Act. In such a case income is to be computed as per section 11(1A) of the Act which is a complete code by itself.

Facts:
The assessee, a society registered u/s. 12A of the Act, transferred its capital asset whose stamp duty value was more than the consideration accruing or arising on the transfer of the asset. The net consideration arising on transfer of capital asset was invested by the assessee in other capital asset. The Assessing Officer (AO) made an addition of Rs. 43,78,588 on account of capital gain arising out of sale of property by applying the provisions of section 50C of the Act.

Aggrieved, the assessee preferred an appeal to the CIT(A) who allowed the appeal filed by the assessee.

Aggrieved, the revenue preferred an appeal to Tribunal.

Held:
The question of applicability of provisions of section 50C of the Act on transfer of capital asset in the case of a charitable society was examined by the Tribunal in the case of ACIT vs. Shri Dwarikadhish Temple Trust, Kanpur (ITA No. 256 & 257/Lkw/2011), in which the Tribunal has held that where the entire sale consideration was invested in other capital asset, provisions of section 50C of the Act should not be invoked. The Tribunal noted the following observations from the said order –

“6.1 From the order of the CIT(A),we find that the assessee is a charitable and religious trust registered u/s. 12A of the Act. It is also noted by the Assessing Officer that the assessee has sold immovable property for total sale consideration of Rs. 2.25 lakh and the entire sale consideration was invested in other capital asset i.e. fixed asset with bank. The Assessing Officer invoked the provisions of section 50C of the Act and computed the capital income at Rs. 66.38 lakh based on the value adopted by stamp duty authorities for stamp duty purposes. We find that the CIT(A) has decided this issue in favour of the assessee by following the Tribunal decision in the case of Gyanchand Batra vs. Income Tax Officer 115 DTR 45 (Jp – Trib).

6.2 We also find that it is specifically mentioned in section 50C(1) of the Act that the stamp duty value is to be considered as full value of consideration received or accruing as a result of transfer for the purpose of section 48 of the Act. It is true that the assessee is a charitable trust and the income of the assessee has to be computed u/s .11 of the Act. As per sub-section (1A) of section 11 of the Act, if the net consideration for transfer of capital asset of a charitable trust is utilised for acquiring new capital asset, then the whole of capital gain is exempt. Considering all these facts, we do not find any reason to interfere in the order of CIT(A) on this issue.

6.3 Regarding the reliance placed by the Learned D.R. of the Revenue on the judgment of the Hon’ble Kerala High Court rendered in the case of Lissie Medical Institutions vs. CIT(supra), we find that in that case, it was held by the Hon’ble Kerala High Court that claim of depreciation is not allowable on the assets which were considered as application of income at the time of acquisition of assets. In our considered opinion, this judgment is not relevant in the present case.

6.4 As per the above decision, we find that no interference is called for in the order of CIT(A).”

The Tribunal observed that the CIT(A) has adjudicated the issue based on legal provisions and various judicial pronouncements while holding that section 11(1A) of the Act which lays down a complete system of taxability of capital gains in respect of an institution approved by the CIT u/s. 12A of the Act is a complete code. The Tribunal held the order of the CIT(A) to be in accordance with law. It confirmed the order of CIT(A).

The appeal filed by revenue was dismissed.

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Company – Book Profits – Computation – Assessee is entitled to reduce from its book profits, the profit derived from captive power plants in determining tax payable for the purposes of section 115JA

CIT vs. DCM Sriram Consolidation Ltd. [2014] 368 ITR 720 (SC)

The assessee had four divisions, namely, Shriram Fertilizers and Chemicals, Shriram Cement Works, Shriram Alkalies and Chemicals and the textile division. In addition, the assessee also had four industrial undertakings which were engaged in captive power generation (hereinafter referred to as “CPP(s)”). Three out of the four CPPs were situated at Kota, which generated power equivalent 10 MW, 30 MW and 35 MW, respectively. The fourth CPP, at Bharuch, which was situated in the State of Gujarat, generated 18 MW power. For the purposes of setting up CPPs the assessee had taken requisite permission from the Rajasthan State Electricity Board (hereinafter referred as “ RSEB”), as well as the Gujarat State Electricity Board (hereinafter referred to as “GSEB”).

On 29th November, 1997, the assessee filed a return declaring a loss of Rs. 43,31,74,077. In a note attached to the return, the assessee had disclosed the profit and loss derived from each of the CPPs, and also indicated the formula adopted for computation of the profit derived from the respective CPPs. Briefly, the method for computation of profit and loss indicated in the note appended to the return was the rate per unit as charged by the respective State Electricity Board for transfer of power, reduced by 7% on account of absence of transmission and distribution losses (wheeling charges). From the figure obtained by applying the reconfigured rate per unit, deduction was made towards specific expenses, as well as common expenses attributable to each CPP so as to arrive at the figure of profit/loss of each CPP. In the note appended to the return of the assessee, the break up of total profit in the sum of Rs. 41,88,50,862 was detailed out in the following manner.

The assessee, however, for the purposes of the provisions of section 115JA of the Act based on its books of account, disclosed income of the sum of Rs.86,33,382. By an intimation dated 7th July, 1998, the Revenue processed the return filed by the assessee under the provisions of section 143(1)(a) of the Act. On 30th March, 1999, the assessee filed the revised return declaring a loss of Rs. 39,36,71,056. For the purposes of section 115JA of the Act, the assessee continued to show its income as Rs. 86,33,382. The case of the assessee was taken up by the Assessing Officer for scrutiny. A notice u/s. 143(2) of the Act was issued. During the course of scrutiny, the Assessing Officer raised a query with regard to the deduction of a sum of Rs. 41,88,50,862 from book profit by the assessee while computing tax u/s. 115JA of the Act. In response to the querry of the Assessing Officer, the assessee informed that the said amount has been reduced from the book profit as this amount was profit derived from CPPs set up by the assessee with the permission of the RSEB and the GSEB.

The Assessing Officer after a detailed discussion, vide order dated 24th March, 2000, rejected the claim of the assessee and added back the deduction claimed by the assessee from book profit, broadly on the following grounds:

(i) the memorandum and articles of association did not permit the assessee to engage in the business of generation of power;

(ii) the permission granted by the State Electricity Boards prohibited sale of energy so generated or supply of energy free of cost to others;

(iii) the sanction give by RSEB was only for setting up of turbo generator and not for parallel generation; and

(iv) the assessee was in the business of manufacturing fertiliser, for which purpose, it had received a subsidy as the urea manufactured was a controlled and consequently, a licensed item being subject to the retention price scheme of the Government of India which, mandated that since sale price and the distribution of urea was fully controlled, the manufacturer would be allowed a subsidy in a manner which permitted him to earn a return of 12 % on his net worth after taking into account the cost of raw material and capital employed, which included both the fixed and variable cost. From this, it was concluded that as the assessee had received a subsidy from the Government of India for manufacture of urea and as was apparent from the balance sheet and profit and loss account filed by the assessee, the CPPs were a part of the fertiliser, cement and caustic soda plants. The CPPs were included in the aforesaid plants and thus it could not be said that the income derived from the said plants, keeping in view the subsidy received by the assessee under the retention price scheme, was in any way, income derived from generation of power; and

(v) lastly, the assessee was not in the business of generation of power and that the assessee is not deriving any income from business of generation of power. A distinction was drawn between an industrial undertaking generating power and one which was in the business of generating power. The assessee’s case was likened to an undertaking which is generating power but is not in the business of generating power and, hence, not deriving income from generation of power.

The assessee being aggrieved, preferred an appeal to the Commissioner of Income-tax (Appeals). By an order dated 21st January, 2001, the Commissioner of Incometax (Appeals) allowed the appeal of the assessee with respect of the said issue.

Aggrieved by the order of the Commissioner of Incometax (Appeals), the Revenue preferred an appeal to the Tribunal. The Tribunal sustained the finding returned by the Commissioner of Income-tax (Appeals) in totality.

On further appeal by the Revenue, the High Court was of the view that the issue which required their determination was whether on a plain reading of the provisions of Explanation (iv) to section 115JA of the Act, the assessee would be entitled to reduce the book profits to the extent of profit derived fromits CPPs, while computing the MAT u/s. 115JA of the Act. According to the High Court, the entire objection of the Revenue to this claim on the assessee was pivoted on the submission that the assessee cannot derive profit from transfer of power from its CPPs to its other units for the following reasons:

(i) Firstly, there was no sale, inasmuch as, the transfer of power was not to a third party and consequently, no profits could have been earned by the assessee;

(ii) Secondly, in any event, the generation of power by CPPs would not constitute business within the meaning of Explanation (iv) to section 115JA of the Act as the main line of activity of the assessee was not the business of generation of power, an expression which finds mention in Explanation (iv) to section 115JA of the Act and;

(iii) Lastly, there was no mechanism for computing the sale price, and consequently, the profit which would be derived on transfer of energy from the assessee’s CPPs to its other units.

According to the High Court, the fallacy in the argument was self-evident, inasmuch as, counsel for the Revenue had proceeded on the basis that the words and expressions used in Explanation (iv) to section 115JA were to be confined to a situation which involved a commercial transaction with an outsider. According to the High Court , if the words and expression used in the said Explanation (iv) were to be given their plain meaning then the claim of the assessee had to be accepted.

The high Court thereafter went on to deal with each of the contentions of Revenue. To answer the first contention as to whether there could be sale of power and the resultant derivation of profits in a situation as the present one, the high Court held that one has to look no further than to the judgment of the Supreme Court in Tata Iron and Steel Co. Ltd. vs. State of Bihar [1963] 48 itr (SC) 123. Based on the ratio of the aforesaid Supreme Court decision, it was clear that in arriving at an amount that was to be deducted from book profits – which was really to the benefit of the assessee as it reduced the amount of tax which it was liable to pay under the provisions of section 115JA of the Act, the principle or apportionment of profits resting on disintegration of ultimate profits realised by the assessee by sale of the final product by the assessee had to be applied. In applying that principle it was not necessary to depart from the principle that no one could trade with himself.

When looked at from this angle, it was quite clear that the profit derived by the assessee on transfer of energy from its CPPs to its other units was “embedded” in the ultimate profit earned on sale of its final products. The assessee by taking resort to explanation (iv) to section 115JA had sought to apportion and, consequently, reduce that part of the profit which was derived from transfer of energy from its CPPs in arriving at book profits amenable to tax u/s. 115JA of the act.

As to the second contention as to whether the assessee was in the business of generation of power, based on the findings returned both by the Commissioner of Income- tax (appeals) as well as the tribunal, the high Court held that it could not be said that the assessee is not engaged in the business. as rightly held by the tribunal, the assessee had been authorised by the State electricity Boards to generate electricity. The generation of electricity had been undertaken by the assessee by setting up a fully independent and identifiable industrial undertaking. these undertakings had separate and independent infrastructures, which were managed independently and whose accounts were prepared and maintained separately and subjected to audit. The term “business” which prefixes generation of power in clause (iv) of the explanation to section 115JA was not limited to one which is carried on only by engaging with an outside third party. The meaning of the word “business” as defined in section 2(13) of the act includes any trade commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. The definition of “business”, which is inclusive, clearly brings within its ambit the activity undertaken by the assessee, which was, captive generation of power for its own purposes. The high Court held that the approach of the Commissioner of income-tax (appeals) and, consequently, the tribunal, both in law and on facts could not be faulted with. The High Court was of the opinion that the Assessing Officer had clearly erred in holding that, since the main business of the assessee was of manufacture and sale of urea, it could not be said to be in the business of generation of power in terms of explanation (iv) to section 115JA of the act.

In view of the discussion above, the high Court held   that the assessee was entitled to reduce from its book profits, the profits derived from its CPPs, in determining tax payable for the purposes of section 115JA of the act. It also concurred with the line of reasoning adopted both by the Commissioner of income-tax (appeals) as well as the tribunal as regards the computation of sale price and consequent profits in terms of Explanation
(iv)    of section 115JA of the act. the high Court further held that it was unfair to remand the matter for the purposes of computation of profits in terms of Explanation
(iv)    u/s. 115JA of the act since the Commissioner of income-tax (appeals) had categorically recorded the facts with regard to computation and, particularly of its judgement that despite being given an opportunity by the Commissioner of income-tax (appeals) nothing had been brought on record by the Assessing Officer, which could persuade them to disagree with the computation filed   by the assessee, which had been authenticated by the assessee’s auditors.

The Supreme Court dismissed the appeal filed by the revenue holding that the principle of law propounded in Tata Iron and Steel Co. Ltd. vs. State of Bihar (supra) had rightly been applied by the high Court in the facts and circumstances of the case.

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Appeal to the High Court – The High Court has the power to frame substantial questions of law at the time of hearing of the appeal other than the questions on which appeal had been admitted.

CIT vs. Engineers India Ltd. [2014] 364 ITR 686 (SC)

The Supreme Court noted that the appeal filed by the Revenue u/s. 260A of the Income-tax Act, 1961 had been admitted by the High Court and two substantial questions of law were framed for consideration of the appeal.

The grievance of the Revenue before the Supreme Court was that by necessary implication, the other questions raised in the memo of appeal before the High Court stood rejected.

The Supreme Court held that the Revenue was under some misconception. The proviso following the main provision of section 260A(4) of the Act states that nothing stated in s/s. (4), i.e., “The appeal shall be heard only on the question so formulated” shall be deemed to take away or abridge the power of the court to hear, for reasons to be recorded, the appeal on any other substantial question of law not formulated by it, if it is satisfied that the case involves such question.

According to Supreme Court, therefore, the High Court’s power to frame substantial questions of law at the time of hearing of the appeal other than the questions on which appeal had been admitted remains u/s. 260A(4). This power is subject, however, to two conditions, (one) the court must be satisfied that appeal involves such questions, and (two) the court has to record reasons therefore.

In view of the above legal position, the Supreme Court did not find any justifiable reason to entertain the special leave petitions. Accordingly, the special leave petitions were dismissed.

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FINANCE (NO.2) AC T – 2014 – AN ANALYSIS

1.Background

1.1 After the unique General Elections in May, 2014, the BJP led NDA Government, under the leadership of Shri Narendra Modi, presented its first Budget in the Parliament on 10th July, 2014. While presenting his first budget, the Finance Minister Shri Arun Jaitley, has stated as under in Para 2 of his Budget speech.

“The people of India have decisively voted for a change. The verdict represents the exasperation of the people with the status-quo. India unhesitatingly desires to grow. Those living below the poverty line are anxious to free themselves from the course of poverty. Those who have got an opportunity to emerge from the difficult challenges have become aspirational. They now want to be a part of the neo middle class. Their next generation has the hunger to use the opportunity that society provides for them. Slow decision making has resulted in a loss of opportunity. Two years of sub five per cent growth in the Indian economy has resulted in a challenging situation. We look forward to lower levels of inflation as compared to the days of double digit of food inflation in the last two years. The country is in no mood to suffer unemployment, inadequate basic amenities, lack of infrastructure and apathetic governance”.

1.2 T he Finance (No.2) Bill 2014 presented with the Budget, contained 71 sections dealing with amendments in the Income-tax Act and 41 sections dealing with amendments in Indirect Taxes and other matters. As is customary, the Finance Bills presented by the Governments elected in July after General Election are not referred to the standing committee on Finance and, therefore, there is no public debate on the amendments made in the Direct or Indirect Tax Laws. There was no serious debate on the amendments in the Parliament and the Bill, with minor modifications proposed by the Finance Minister in the Lok Sabha, was passed by the Lok Sabha on 25th July, 2014. This Bill was also passed by the Rajya Sabha on 30th July, 2014 and it has received the assent of the President on 6th August, 2014.

1.3 I t may be noted that in Para 4 of his Budget Speech, the Finance Minister stated his approach for economic growth as under:

“As Finance Minister I am duty bound to usher in a policy regime that will result in the desired macroeconomic outcome of higher growth, lower inflation, sustained level of external sector balance and a prudent policy stance. The Budget is the most comprehensive action plan in this regard. In the first Budget of this NDA government that I am presenting before the august House, my aim is to lay down a broad policy indicator of the direction in which we wish to take this country. The steps that I will announce in this Budget are only the beginning of a journey towards a sustained growth of 7-8 per cent or above within the next 3-4 years along with macro-economic stabilization that includes lower levels of inflation, lesser fiscal deficit and a manageable current account deficit. Therefore, it would not be wise to expect everything that can be done or must be done to be in the first Budget presented within forty five days of the formation of this Government”.

1.4 T he Finance Minister referred to the Retrospective Amendments made in the Income-tax Act in 2012 and gave the following assurance in Para 10 of his Budget speech.

“The sovereign right of the Government to undertake retrospective legislation is unquestionable. However, this power has to be exercised with extreme caution and judiciousness keeping in mind the impact of each such measure on the economy and the overall investment climate. This Government will not ordinarily bring about any change retrospectively which creates a fresh liability. Hon’ble Members are aware that consequent upon certain retrospective amendments to the Income-tax Act 1961 undertaken through the Finance Act 2012, a few cases have come up in various courts and other legal fora. These cases are at different stages of pendency and will naturally reach their logical conclusion. At this juncture I would like to convey to this August House and also the investors community at large that we are committed to provide a stable and predictable taxation regime that would be investor friendly and spur growth. Keeping this in mind, we have decided that henceforth, all fresh cases arising out of the retrospective amendments of 2012 in respect of indirect transfers and coming to the notice of the Assessing Officers will be scrutinized by a High Level Committee to be constituted by the CBDT before any action is initiated in such cases. I hope the investor community both within India and abroad would repose confidence on our stated position and participate in the Indian growth story with renewed vigour.”

1.5 While concluding his Budget Speech he stated that he had given relief to individuals, HUF etc. and also given incentives to manufacturing sector which will result in Revenue Loss of Rs. 22,200 crore in Direct Taxes. As regards Indirect Taxes, his proposals would yield additional Revenue of Rs. 7,525 crore.

1.6 I n this Article some of the important amendments made in the Income-tax Act by the Finance (No.2) Act, 2014, have been discussed. It may be noted that this year, barring one or two, almost all amendments have prospective effect.

2. Rates of taxes:

2.1 T here are no major changes in the Rates of Taxes for A.Y. 2015-16. However, certain reliefs given to Individual Tax Payers are referred to in Para 192 of Budget Speech of the Finance Minister. These are explained in brief below.

2.2 Individual, HUF, AOP etc.: The Rates of Income Tax, Surcharge and Education Cess for Individuals, HUF, AOP, BOI and Artificial Juridical Person for A.Y. 2015-16 (Accounting Year ending 31.03.2015) will be as under.

Notes:
(i) Surcharge on Super Rich: In the Budget Speech of 2013 it was announced that surcharge of 10% of the tax on persons earning total income exceeding Rs. 1 crore will be levied for A.Y. 2014-15 only. In this year’s Budget, this surcharge is continued for A.Y. 2015-16
(ii) Rebate of Tax: A Resident Individual having total income not exceeding Rs. 5 lakh, will get rebate upto Rs. 2000/- or tax payable (whichever is less) u/s. 87A.
(iii) E ducation Cess: 3% (2+1) of the tax is payable as Education Cess by all assessees.

2.3 Other Assessees: The rates of taxes (including surcharge and education cess) for A.Y. 2015-16 are the same as in A.Y. 2014-15. In the case of domestic companies the surcharge of 5% of tax, if the total income exceeds Rs. 1 crore, but does not exceed Rs.10 crore will continue to be payable in A.Y.2015-16. Further, the rate of surcharge will be 10% of tax on the entire income in the case of domestic companies if the total income exceeds Rs.10 crore.

In the case of a foreign company, there is no change in the rates of taxes. The existing rate of surcharge will be 2% of tax if the total income is between Rs.1 crore and Rs.10 crore. If the total income exceeds Rs.10 crore, the rate of surcharge will be 5% of tax on the entire income, if the total income exceeds Rs.10 crore.

2.4 Tax On Book Profits: The rates of taxes on Book Profits u/s. 115JB and 115JC will continue to be the same in A.Y.2015-16 as in A.Y.2014-15.

2.5 Dividend Distribution Tax (DDT): (i) Section 115.0 and 115-R provide for payment of additional tax by domestic companies and mutual funds on distribution of dividend or income. These two sections have been amended w.e.f. 01-10-2014. The amendment provides that the amount of dividend or income so distributed should now be grossed up and the additional tax at the rates specified in these two sections should be paid by the domestic companies or mutual funds.

ii)the logic for making this amendment is given in the explanatory memorandum to the finance Bill as under:

“prior to introduction of dividend distribution tax (ddt), the dividends were taxable in the hands of the shareholder. the gross amount of dividend representing the distributable surplus was taxable, and the tax on this amount was paid by the shareholder at the applicable rate which varied from 0 to 30%. however, after the introduction of the ddt, a lower rate of 15% is currently applicable but this rate is being applied on the amount paid as dividend after reduction of distribution tax by the company. therefore, the tax is computed with reference to the net amount. similar case is there when income is distributed by mutual funds.

Due to difference in the base of the income distributed or the dividend on which the distribution tax is calculated, the effective tax rate is lower than the rate provided in the respective sections.

In order to ensure that tax is levied on proper base, the amount of distributable income and the dividends which are actually received by the unit holder of mutual fund or shareholders of the domestic company need to be grossed up for the purpose of computing the additional tax.

Therefore, it is proposed to amend section 115-o in order to provide that for the purposes of determining the tax on distributed profits payable in accordance with the section 115-o, any amount by way of dividends referred to in sub-section (1) of the said section, as reduced by the amount referred to in sub-section (1A) (referred to as net distributed profits), shall be increased to such amount as would, after reduction of the tax on such increased amount at the rate specified in s/s. (1), be equal to the net distributed profits.

Similarly, it is proposed to amend section 115r to provide that for the purposes of determining the additional income-tax payable in accordance with sub-section (2) of the said section, the amount of distributed income shall be increased to such amount as would, after reduction of the additional income-tax on such increase amount at the rate specified in s/s. (2), be equal to be amount of income distributed by the mutual fund”.

iii) On the above basis, the ddt on grossed up dividend distributed by a domestic company on or after 01-10-2014 shall be payable at 20.03% as against 17% as at present.

iv) Similarly, the additional tax payable by the mutual funds on income distribution u/s115 r will work out as under:

v) From the logic given in the explanatory memorandum it is evident that the additional that collected u/s. 115-0 and 115-R from domestic companies and mutual funds is nothing but tax payable by the shareholder/unit holder. instead of collecting such tax from the share holder/unit holder, it is collected from the company/mutual fund. though judicial forums have taken a view that the tax paid by the Companies/ mutual funds is not tax paid by the shareholder/unit holder, the rationale set out in the memorandum may give one further opportunity to the taxpayer to urge the proposition that this income is not ‘exempt’ and section 14a ought not to apply.

2.6 Rate of tax on dividends from foreign Companies: the concessional rate of tax at 15% plus applicable surcharge and education cess which was applicable for only two years i.e., a.y. 2013-14 and
a.y. 2014-15 u/s. 115BBd has now been extended in respect of dividends received by an indian Company from a specified Foreign Company to A.Y. 2015-16 and subsequent years. For this purpose the indian Company should hold 26% or more of equity share capital in the foreign company.

3 Tax deduction at source (TDS):

the following amendments are made in some of the provisions relating to TDS w.e.f. 01-10-2014.

(i) In section 194a it is provided that tax should not be deducted at source @ 10% from interest received by a Business trust from special purpose Vehicle (i.e., the indian company in which the Business trust holds controlling interest or any specified percentage of shareholding or interest as provided in the relevant regulations).

(ii) Section 194da has been inserted w.e.f. 01-10-2014 to provide for tds @2% from the taxable amount (including Bonus) paid under a life insurance policy. in such a case, no tax will be deductible under this section from the payments which are exempt u/s. 10 (10d). it is also provided that this provision for tds will not apply where the aggregate of taxable payments is less than rs.1 lakh in any financial year.

(iii) Section 194lBa has been inserted w.e.f. 01-10-2014 to provide for tds @10% from income referred to in the new section 115ua (i.e., interest income received by Business trust from spV) distributed to a resident unit holder of Business trust.

If such income is distributed to a non-resident unit holder the rate of tds will be 5% plus applicable surcharge and education cess.

(iv) Section 194lC which provides for tds in respect of payment of interest on loans in foreign Currency by specified companies will also apply to payment made by Business trust. further, the time limit of loan agreement provided in the section from 01-07- 2012 to 01-07-2015 has now been extended up to 01-07-2017.

(v) Section 200(3) provides for filing of Statement of TDS. By amendment of this section it is now provided that the tax deductor can now file a correction statement for rectification of any mistake, or to add, delete or update information. Consequential amendment has been made in section 200A.

(vi) At present u/s. 201(3) no order treating a person as an assessee in default for failure to comply with tds provisions can be passed after the expiry of 2 years from the end of the financial year in which statement of TDS in filed and after expiry of 6 years if statement of TDS in not filed. This provision is now amended w.e.f. 01-10-2014 to provide for a common time limit of 7 years from the end of the f.y. in which payment is made or credit is given to the payee. Thus, even if TDS statement is filed, the tax deductor can be treated as assessee in default at anytime within 7 years. in other words, the existing time limit of 2 years is extended to 7 years.

(vii) Section 206aa provides for tds at higher rate where the payee does not furnish permanent account number the section is not applicable to interest on long –term infrastructure Bonds referred to in section 194 lC. it is now provided, w.e.f. 01-10-2014, that this section shall not apply to interest on long-term Bonds referred to in section 194 lC.

4. Exemptions and deductions

4.1 Section 10AA: under this section, newly established undertakings in SEZs can claim deduction in respect of profits and gains derived from export of articles or things or from providing services. Presently, deduction can be claimed even by such undertakings carrying on ‘Specified Business’ u/s. 35AD. This section is now amended w.e.f. a.y.2015-16 to provide that where deduction u/s. 10AA has been availed by any assessee in respect of the profit of the Specified Business for any assessment year, no deduction u/s. 35AD shall be allowed in relation to such Specified Business for the same or any other assessment year. Similarly, section 35 AD has, also been amended to prohibit claim of deduction u/s. 10AA in respect of Specified Business where deduction u/s. 35AD has been claimed and allowed for the same or any other assessment year. Effectively, the assessee will, therefore, have to choose between a deduction u/s. 10AA and a deduction u/s. 35AD in respect of Specified Business.

4.2 Section 24 (b): While computing income from self occupied property (sop) constructed on or after 01-04- 1999, the assessee is eligible for deduction on account of interest paid on amounts borrowed for acquisition or construction of the s.o.p provided such acquisition or construction is completed within a period of three years from the end of the financial year in which the capital is borrowed. the deduction is restricted to rs. 1.5 lakh at present. from a.y. 2015-16, this limit of deduction for such interest has now been increased to rs. 2 lakh. it may be noted that if construction of property is not completed within 3 years, deduction of interest will be of rs. 30,000/- only. if property is let out deduction of interest will be of the entire amount without any limit subject to conditions in section 24.

4.3 Section 80C: This section provides for deduction upto rs.1 lakh in respect of investment by an individual or huf in ppf, lip, elss etc. this deduction is increased from a.y.2015-16 to investment upto rs.1.5 lakh. in para 138 of the Budget speech, it is stated by the finance minister that the Limit for investment in PPF in the financial year will now be increased to rs.1 .5 lakh.

4.4 Section 80 CCD: This section provides for deduction in respect of contribution to pension scheme of Central Govt. at present non-Govt. employees employed on or after 01-01-2004 are eligible for such deduction. now, from a.y. 2015-16 even non-Govt. employees employed before 01-01-2004 will be eligible to get the benefit of this section. further, this section is amended from a.y. 2015- 16 to provide that the deduction under this section shall not exceed rs.1 lakh in any year.
4.5 Section 80 CCE: This section lays down limit for deduction u/s. 80C, 80CCC and 80CCd to rs. 1 lakh in the aggregate. this limit is now increased from a.y. 2015 to rs.1.5 lakh.

4.6 Section 80 – IA(4) (iv): At present, deduction under this section is allowed to undertakings which commence their business of Generation or Generation and distribution of power, transmission or distribution of power, complete substantial renovation or modernisation of existing transmission or distribution lines if the same is completed on or before 31-03-2014. this time limit is now extended to 31-03-2017.

4.7 New Investment Opportunities for Small Savings :
The finance minister has announced the revival of the following investment opportunities for small savings.

(i) Kissan Vikas patra : This will be reintroduced during the year.

(ii) Varishta pension Bima yojna: This scheme will be reintroduced for one year from 15-08-2014 to 14-08-2015 for benefit of senior citizens.

5 Business Trusts:

(i) This is a new concept introduced in this year’s Budget. The term “Business Trust” is defined in section 2(13a) of the income tax act from 01-10-2014 to mean “a trust registered as an “infrastructure investment trust” (invits) or a “real estate investment trust” (reit), the units of which are required to be listed on a recognized stock exchange, in accordance with the seBi regulations and notified by the Central Govt”.

(ii) In para 26 of the Budget speech, the finance minister has explained this new concept as under:

“Real Estate Investment Trusts (REITS) have been successfully used as instruments for pooling of investment in several countries. I intend to provide necessary incentives to REITs which will have pass through for purpose of the taxation. As an innovation, a modified REITs type structure for infrastructure projects is also being announced as Infrastructure Investment Trusts (invits), which would have a similar tax efficient pass through status, for PPP and other infrastructure projects. These structures would reduce the pressure on the banking system while also making available fresh equity. I am confident that these two instruments would attract long term finance from foreign and domestic sources including the NRIs.”

(iii) In order to implement the above scheme for taxation of Business trusts, its sponsors and unit holders new sections are inserted in the income-tax act and some sections are amended. these sections are 2(13A), 10(23FC), 10(23FD), 10(38), 47(xvii), 49 (2AC), 111A, 115A, 115UA, 139(4E), 194A(3) (Xi), 194LBA, 194LC, and sec. 97 and 98 of finance (no.2) act, 2004 relating to stt. these sections come into force from a.y. 2015-16 and/or 01-10-2014.

(iv) The Business trusts have the following distinctive elements:

(a) The trust would raise capital by way of issue of units ( to be listed on a recognised stock exchange) and can also raise debts directly both from resident as well as non- resident investors:

(b) The income bearing assets would be held by the trust by acquiring controlling or other specific interest in an indian company (spV) from the sponsor.

(v) The amendments are made to put in place a specific taxation regime for providing the way the income in the hands of such trusts is to be taxed and the taxability of the income distributed by such business trusts in the hands of the unit holders of such trusts. These provisions, briefly stated, are as under:

(a) The listed units of a business trust, when traded on a recognised stock exchange, will attract same levy of stt and will given the same tax benefits in respect of taxability of capital gains as equity shares of a company i.e., long term capital gains, will be exempt and short term capital gains will be taxable at the rate of 15%.

(b) In case of capital gains arising to the sponsor at the time of exchange of shares in spV with units of the business trust, the taxation of gains shall be deferred and taxed at the time of disposal of units by the sponsor. However, the preferential capital gains tax (consequential to levy of stt) available in respect of units of business trust will not be available to the sponsor in respect of these units at the time of disposal of units. further, for the purpose of computing capital gain, the cost of these units shall be considered as cost of the shares to the sponsor. The holding period of shares shall also be included in the holding period of such units. Indexation benefit in the case of long term capital gain will be available. (sections 47(xvii) and 49(2AC)).

(c) The income by way of interest received by the business trust from SPV is accorded pass through treatment i.e., there is no taxation of such interest income in the hands of the trust and no withholding tax at the level of SPV as provided in section 194a w.e.f. 01-10-2014. however, withholding tax at the rate of 5 % in case of payment of interest component of income distributed to non-resident unit holders and at the rate of 10 % in respect of payment of interest component of distributed income to a resident unit holder shall be deducted by the trust. this is provided in section 194lBa w.e.f. 01-10-2014 (sections 10 (23FC), 194A and 194LBA)).

(d) In case of external commercial borrowings by the business trust, the benefit of reduced rate of 5 % tax on interest payments to non-resident lenders shall be available on similar conditions, for such period as is provided in section 194lC of the act w.e.f. 01-10-2014.

(e) The dividend received by the trust shall be subject to dividend distribution tax at the level of SPV but will be exempt in the hands of the trust, and the dividend component of the income distributed by the trust to unit holders will also be exempt. (section 10(38)).

(f) The income by way of capital gain on disposal of assets by the trust shall be taxable in the hands of the trust at the applicable rate. however, if such capital gains are distributed, then the component of distributed income attributable to capital gains would be exempt in the hands of the unit holder. any other income of the trust shall be taxable at the maximum marginal rate.

(section 115ua and 10(23fd)). (4e).

(g) The business trust is required to furnish its return of income u/s139

(h) The necessary forms to be filed and other reporting requirements to be met by the Business trust shall be prescribed to implement the above scheme.

6 Charitable Trusts :

In this finance act, sections 10(23C), 11, and 115 BBC have been amended from a.y. 2015-16 and sections 12a and 12 aa have been amended from 01-10-2014. all these amendments relate to taxation of Charitable trusts. These amendments are briefly discussed below :
6.1 Charitable and religious trusts cannot claim exemption u/s. 10: a trust or institution which is registered or approved or notified as a charitable or religious Trust u/s. 12aa or 10(23C) (iv), (v),(vi) and (via) will not now be entitled to claim exemption under any of the general provisions of section 10. the intention is that such entities should be governed by the special provisions of sections 10(23C) 11,12 & 13, which are a code by themseves, and should not be entitled to claim exemption under other provisions of section 10. therefore, such entity will not now be able to claim that its income, like dividend income (exempt u/s. 10(34)) or income from mutual funds (exempt u/s. 10(35)), or interest on tax free bonds, is exempt u/s. 10 and hence, not liable to tax. such income continues to qualify for exemption u/s. 10(23C) or section 11, subject to the conditions contained therein.

Agricultural income of such an entity, however, will continue to enjoy exemption u/s. 10(1). Further, such an entity eligible for exemption u/s. 11 will not be barred from claiming exemption u/s. 10(23C).

6.2 Depreciation on Capital assets: (i) Hitherto, almost all courts in india while interpreting section 11 have held that income of a charitable trust u/s. 11 is to be computed on the basis of accounting method adopted by the trust following commercial principles. (CIT vs. Trustees of H.E.H. Nizam’s Supplemental Religious Endowment Trust 127 itr 378(ap), CIT vs. Estate of V.L.Ethiraj 136 itr 12 (mad) and CBdt circular no.5-p (lxx-6) dated 19-06-1968). on this basis, the courts have taken the view that depreciation on assets of the trust is to be deducted for the purpose of calculation of income of the trust in commercial sense u/s. 11 of the income-tax act. The well settled principle of law, as laid down by various courts, during the last more than 50 years is that under the scheme of section 11, there are two steps. in the first step, the income of the trust is to be “computed” on commercial principles and depreciation on capital assets is to be deducted for this purpose. In the second step, the income so computed is to be compared with “application” of this income to objects of the trust. For application of such income, Capital and revenue expenditure incurred during the year for the objects of the trust is be treated as application therefore, “depreciation” and outgoing for acquiring “Capital asset” are different and distinct claims and there is no double deduction of expenditure (refer CIT vs. Framjee Cawasjee Institute 109 Ctr 463 (Bom), CIT vs. Institute of Banking Personnnel Selection 264ITR – 110 (Bom), CIT vs. Society of Sister of St. Anne 146itr 28 (Kar), CIT vs. Seth Manilal Ramchhoddas Vishram Bhavan Trust 198 itr 598(Guj)).

(ii) By amendment of section 10(23C) and 11, from a.y. 2015-16, it is now provided that depreciation will not be allowed in computing the income of the trust or institution in respect of an asset, where cost of acquisition has already been claimed as deduction by way of application of income in the current or any earlier year. It may be noted that this amendment will overrule all the above decisions of various high Courts.

(iii) Logic for the above amendment is given in the explanatory memorandum as under:

“The existing scheme of section 11 as well as section 10(23C) provides exemption in respect of income when it is applied to acquire a capital assets. subsequently, while computing the income for purposes of these sections, notional deduction by way of depreciation etc. is claimed and such amount of notional deduction remains to be applied for charitable purpose. Therefore, double benefit is claimed by the trusts and institutions under the existing law. the provisions need to be rationalized to ensure that double benefit is not claimed and such notional amount does not get excluded from the condition of application of income for charitable purpose.”

It will be noticed that this logic is contraryto the well settled law as interpreted by various high Courts.

(iv) The effect of the above amendment will be that all the trusts/institutions which will be affected by this amendment will have to maintain separate records of Capital assets as under:

(a) WDV of Capital assets in respect of which depreciation as well as deduction by way of application of income is claimed upto a.y. 2014-15.

(b) WDV of Capital assets in respect of which deduction by way application of income has not been claimed upto A.Y. 2014-15 but only depreciation is claimed and allowed.

It may be noted that from a.y. 2015-16, depreciation will not be allowed in respect of WdV of Capital assets as stated in (a) above. as regards WdV of Capital assets as stated in (b) above, it appears that depreciation can be claimed in a.y. 2015-16 6 even after the above amendment, as the same is not retrospective

6.3 Section 10 (23C): The existing section 10(23C) (iiiab) and (iiiac) grant exemption to educational institutions, universities and hospitals that satisfy certain conditions and which are wholly or substantially financed by the Government. The term “substantially financed by the Government” is not defined and hence resulted in litigation (refer CIT vs. Indian Institute of Management 196 taxman 276 (Kar.)). It is now clarified that if the Government grant to such institutions exceeds the prescribed percentage of the total receipts, (including voluntary contributions), then it will be considered as being substantially financed by the Government.

6.4 Section 12A- Registration of trust: Section 12a has been amended w.e.f. 01-10-2014. at present a trust or an institution can claim exemption only from the year in which the application for registration u/s. 12aa has been made. as such, registration can be obtained only prospectively and this causes genuine hardship to several charitable organisations. It is now provided that the benefit of sections 11 and 12 will be available to such trusts for all pending assessments on the date of such registration, provided the objects and activities of such trusts in these earlier years are the same as those on the basis of which registration has been granted. it is also provided that no action for reopening assessment u/s. 147 shall be taken by the Assessing Officer merely on the ground of non- registration. accordingly, completed assessments in which benefit u/s. 11 has been granted, will not be adversely affected on account of non-registration. it may be noted that such benefit will not be available to trusts where the registration was earlier refused or was cancelled.

6.5 Section 12AA – Power to CIT to cancel registration: (i) the amendment made in section 12AA,
w.e.f. 01-10-2014, giving additional power to the CIT to cancel registration of a trust will create great hardships to the trusts. at present, for non-compliance with some of the requirements of section 11,12 or 13 a trust is liable to pay tax for that year. Now, the amendment in section 12aa empowering CIT to cancel registration of the trust for such non-compliance will mean that a trust which has been complying with these provisions for several years in the past and also in subsequent years will lose exemption in the year of non-compliance and also in subsequent years. this is a very harsh and uncharitable provision and will lead to unending litigation in which trustees will have to spend trust funds which they would have utilised for charitable purpose. Surprisingly, none of the public trusts or institutions have seriously opposed this amendment before it was passed in the parliament.
(ii) Briefly stated, the amendment in section 12AA is as under:

At present, registration of a trust / institution once granted, can be cancelled only under the following two circumstances:

(a) the activities of the trust are not genuine; or

(b) the activities are not being carried out in accordance with the objects of the trust.

Now, the Commissioner has also been given power to cancel registration, if it is noticed that the trust has not complied with the provisions of sections 11,12 and 13 i.e.,

(a) Income does not enure for the benefit of the public;

(b) Income is applied for the benefit of any religious community or caste (in case of a trust established on or after 01-04-1962).

(d) funds are invested in prohibited modes i.e. there is non-compliance with sections 11(5) or 13.

It is however provided that registration will not be cancelled if the trust/institution proves that there was reasonable cause for breach of any of the above conditions.

(iii) It is true that the Trustees can file an appeal against the order of Cit to itat when such registration is cancelled. But this will invite litigation in which trust money will have to be spent.

(iv) it may be noted that this additional power given to Cit raises several issues which have not been considered while making the above amendments. some of these issues are as under:

(a) Compliance with section 11,12 and 13 raise several issues of interpretation. therefore, the question will arise as to at what stage the Cit will exercise this additional power to cancel registration. in other words, whether he can cancel registration when any adverse assessment order for a particular year is passed by the a.o. or whe the entire appellate proceedings, in which the order is challenged, are completed.

(b) Whether cancellation of registration as a result of this amendment will be for the year in which there is non- compliance with sections 11, 12 or 13. if this is not the case, the trust will not be able to claim exemption u/s. 11 in subsequent years although all the conditions of sections 11 to 13 are complied with.

(c) If the registration is cancelled for non-compliance with sections 11 to 13 in one year, whether the Cit can consider granting registration in subsequent years when the trust is complying with these provisions.

(d) If registration is cancelled in the case of trust holding certificate u/s. 80 G, what will be the position of persons who have given donations and claimed deduction u/s 80G, in that year and in subsequent years. it may be noted that there is no amendment in section 80G where by CIT can cancel certificate given under the section.

(v) Considering all these issues, it appears that when the trust is required to pay tax in the year when provisions of sections 11 to 13 are not complied with, this additional power to Cit to cancel registration of the trust should not have been given. there is a grave danger of unhealthy practices being adopted by those dealing with assessments of Charitable trusts.

6.6 Section 115-BBC- anonymous donations: the existing provisions of section 115BBC provide for levy of tax at the rate of 30 % in the case of certain assessees, being university, hospital, charitable organisation, etc. on the amount of aggregate anonymous donations exceeding 5% of the total donations received by the assessee or rs. 1 lakh, whichever is higher. the section is amended from a.y. 2015-16 to provide that the income- tax payable shall be the aggregate of the amount of income-tax calculated at the rate of 30 % on aggregate of anonymous donations received in excess of 5 % of the total donations received by the assessee or rs. 1 lakh, whichever is higher, and the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by such excess. this amendment is to rationalise the provisions of the section.

7 Income from business or profession:

7.1 Investment allowance – Section 32 aC: (i) in order to encourage manufacturing companies that investsubstantial amount in acquisition and installation of new plant and machinery, finance act, 2013 inserted section 32aC (1) in the act to provide that where a company engaged in the business of manufacture of an article or thing, invests a sum of more than rs.100 crore in new assets (plant and machinery) during the period 01-04- 2013 to 31-03-2015, then the assessee shall be allowed a deduction of 15% of cost of new assets for assessment years 2014-15 and 2015-16.
(ii) as growth of the manufacturing sector is crucial for employment generation and development of an economy, this section is amended to extend the deduction available u/s. 32aC for investment made in plant and machinery up to 31-03-2017. further, in order to simplify the existing provisions of section 32aC of the act and also to make medium-size investments in plant and machinery eligible for deduction, it is now provided that the deduction u/s. 32aC (1a) shall be allowed if the company, on or after 1st april, 2014, invests more than rs. 25 crore in plant and machinery in the previous year. it is also provided that the assessee who is eligible to claim deduction under the existing combined threshold limit of rs.100 crore for investment made in previous years 2013-14 and 2014-15 shall continue to be eligible to claim deduction under the existing provisions contained in section 32aC(1) even if its investment in the year 2014-15 is below the proposed new threshold limit of investment of rs. 25 crore during the previous year.

The deduction allowable under this section from a.y. 2015- 16 after the amendment in different cases of investment is given by way of illustration in the following table:

Sl.

No.

Particulars

P.Y. 2013-14

P.Y. 2014-15

P.Y. 2015-16

P.Y. 2016-17

Section applicable

Amount of investment

–

32AC(1)

Deduction allowable

Nil

16.5

–

Amount of Investment

–

32AC(1A)

Deduction allowable

Nil

–

Amount of investment

32AC(1A)

Deduction allowable

Nil

4.5

Amount of investment

150

32AC(1) &

32AC(1A)

Deduction allowable

22.5

10.5

Nil

Specified business. Further, section 28(vii) taxes any sum received on account of demolition, destruction, discarding or transfer of such asset, the entire cost of which was allowed as a deduction u/s. 35ad.

(ii) section 35AD has been amended from a.y.2015-16 as under:

(a) The benefit of the section is extended to the following two businesses, commencing operation on or after 1st april, 2014:

(i) Laying and operating a slurry pipeline for the transportation of iron ore;

(ii) Setting up and operating a semi-conductor wafer fabrication manufacturing unit notified by the Board in accordance with the prescribed guidelines.

(b) It is now provided that any asset in respect of which deduction has been claimed and allowed under this section shall be used only for the specified business for a period of at least 8 years, beginning with the previous year in which such asset is acquired or constructed;

(c) Further, it is provided that where any asset, in respect of which a deduction is claimed and allowed under this section, is used for any other purpose during the specified period of 8 years, the total deduction so claimed and allowed in one or more previous years, as reduced by the depreciation allowable u/s. 32, (as if no deduction u/s. 35ad was allowed) shall be deemed to be the business income of the assessee of the previous year in which the asset is so used. however, this provision will not apply to a BIFR Company (sick company) during the specified period of 8

Investment Linked Deductions – Section

7.3 Corporate Social Responsibility (CSR) Expenditure Section 37: (i) it is very strange that section 37 of the act has been amended from a.y. 2015-16 to provide that expenditure incurred by a company for CSR activities as provided u/s. 135 of the Companies 35aD: (i) section 35ad provides for a deduction in respect of any capital expenditure, other than on the acquisition of any land or goodwill or financial instrument, incurred wholly and exclusively for the purposes of any act, 2013 shall not be considered as expenditure incurred for the purpose of Business or profession. this is strange because one legislation made by the parliament i.e. Companies Act, 2013, mandates certain specified companies to spend upto 2% of its average profits of last 3 years for Csr activities. elaborate list of such expenditure is given in schedule Vii of the Companies act and elaborate rules and forms are prescribed under that act. Csr expenditure is treated as part of the business expenditure of the company under the Companies act and when it comes to income-tax act it is now provided that this is not an expenditure for the business or profession of the Company. such a provision in section 37 is contrary to the provisions of section 135 of the Companies act and requires to be reconsidered. at best, the deduction u/s. 37 could have been restricted to 2% of the Gross total income under the income-tax act.

(ii) The logic for this provision in section 37 is explained in the explanatory memorandum as under:

“Under the Companies act, 2013 certain companies (which have net worth of Rs.500 crore or more, or turnover of Rs.1,000 crore or more, or a net profit of Rs.5 crore or more during any financial year) are required to spend certain percentage of their profit on activities relating to Corporate social responsibility (CSR). under the existing provisions of the act expenditure incurred wholly and exclusively for the purpose of the business is only allowed as a deduction for computing taxable business income. Csr expenditure, being an application of income, is not incurred wholly and exclusively for the purposes of carrying on business. as the application of income is not allowed as deduction for the purposes of computing taxable income of a company, amount spent on Csr cannot be allowed as deduction for computing the taxable income of the company. moreover, the objective of Csr is to share burden of the Government in providing social services by companies having net worth/ turnover/profit above a threshold. If such expenses are allowed as tax deduction, this would result in subsidizing of around one-third of such expenses by the Government by way of tax expenditure”.

From the above, it will be noticed that for tax purposes the Government has taken the view that Csr expenditure is application of income whereas under the Companies act the same Government states that it is business expenditure. if it is only application of income how there can be compulsion under the Companies act on the Directors that 2% of average profits of previous 3 years should be spent for specified activities listed in schedule Vii of the Companies act.

(iii) In the Explanatory Memorandum it is clarified that CSR expenditure which qualify for deduction u/s. 30 to 36 of the income-tax act will be allowed as deduction. if we refer to schedule Vii, most of the items of expenditure may not qualify for deduction under the above sections. in order to get deduction of the CSR expenditure most of the companies may prefer to contribute to (a) the prime minister’s national relief fund or any other fund set up by the Central Government for socio-economic development and relief and welfare of the sC, st, OBC, minorities and Women or for (b) contribution to approved rural development projects approved u/s. 35AC.

(iv) It may be noted that CSR expenditure incurred by the Company will be allowable in computing Book profits u/s. 115jB. no such disallowance is required to be made u/s. 115JB.

7.4 Disallowance for non deduction of Tax Section 40(a): (i) section40 (a) (i) is amended from a.y. 2015- 16 to provide that if tax is deducted from payment made for specified expenditure to a Non-Resident in a previous year, no disallowance for the expenditure will be made if the tds amount is deposited by the deductor with the Government before the due date for filing return of income u/s. 139(1). At present, the time limit for such deposit of tax is as prescribed in section 200(1) (refer rule 30). if the tds amount is deposited after the due date, deduction for expenditure will allowed in the year in which tds amount is deposited.

(ii) Section 40(a)(ia) provides for disallowance of payment of specified expenditure to a Resident, if tax deductible has not been deducted or deposited with the Government before the due date for filing the Return of Income. This section is amended from a.y. 2015-16 as under:

(a) At present, the section applies to payment under certain specified heads viz. interest, rent, professional fees, Brokerage, Commission etc. it is now provided, by this amendment, that the section will apply to all payments from which tax is to be deducted under Chapter XVii B. In other words, the assessee will suffer disallowance under this section if tax deductible in respect the above specified heads as well other payments viz. salaries, director’s fees, purchase of immovable property as stock-in- trade, non-compete fees etc. has not been deducted or deposited with the Govt.

(b) At present, if the tds amount is not deducted and/or deposited with the Government, 100% of the expenditure is disallowed. By this amendment, it is provided that only 30% of the expenditure will be disallowed from a.y. 2015-16.

(c) further, the amended section provides that if the amount from which tax is deductible under chapter XViiB is deducted but paid after the due date as stated above, 30% deduction will be allowed in the year in which such tds amount is deposited with the Government. it may be noted that this amendment does not take care of the following type of situations which will arise in many cases.

Illustration

•   ABC Ltd. has deducted tax of Rs. 2 lakh from payment of commission during the year ending 31-03-2013.
•   Due date for filing return for A.Y. 2013-14 is 30-09- 2013, but the company has deposited tds amount of Rs. 2 lakh in april, 2014.
•   100% of the Commission Amount will be disallowed u/s. 40(a)(ia) in a.y. 2013-14.
•   Under the amended section 40(a)(ia) since the TDS amount is deposited in april, 2014 i.e. a.y. 2015- 16, only 30% of the commission will be allowed as deduction when 100% of the commission has been disallowed in a.y.2013-14.
•   To this extent, this amendment requires reconsideration.

(d) The second proviso to section 40(a) (ia) inserted by the finance act, 2012 from a.y. 2013-14 provides that if the resident payee has paid tax on such income on the date of furnishing his return of income, no disallowance under the section will be made in the case of the payee. it may be noted that explanation below this second proviso refers to payments under specified heads viz. commission, Brokerage, professional fees, rent, royalty, technical service fees and payment to contractors. Since section 40(a) (ia) is now amended to provide for disallowance in respect of non-deduction of tds from all sections under Chapter XVii B, including salaries, directors’ fees etc.,explanation below the second proviso of this section should have been similarly amended.

7.5 Commodity Derivatives Section 43 (5): Commodity derivative transactions were excluded from the purview of speculative transactions with effect from a.y.2014-15 u/s. 43(5)(e) by the Finance Act, 2013. It is now clarified from a.y. 2014-15, that in order to be eligible for such exclusion, such transactions should be chargeable to Commodities transaction tax (Ctt).

7.6 Goods Carriages Business – Section 44 aE: section 44ae (2) is amended to provide that the presumptive amount of profits and gains for any type of goods carriage shall be Rs. 7,500 per month or part of a month for which
each such goods carriage is owned by the assessee or the amount claimed to have been actually earned by the assessee, whichever is higher. the earlier amounts were rs.5,000 for each heavy goods carriage and rs. 4,500 for each other goods carriage. the distinction between goods carriages and heavy goods carriages has been done away with from the a.y. 2015-16.

7.7 Losses in Speculation Business –Section 73:
at present, section 73 provides that if any part of the business of a specified company consists of purchase and sale of shares of other Companies, loss in such business shall be treated as speculation loss. there is one exception in the case of a company whose principal business is of banking or granting of loans and advances. this exception is now widened from a.y. 2015- 16 to provide that in the case of a company whose principal business is of trading in shares, such loss in purchase and sale of shares will not be considered as a speculation loss. this is a welcome provision for companies which are share brokers and which are mainly dealing the shares of Companies.

8 Income from other sources

(i) Sections 2(24), 51 and 56(2) have been amended from a.y. 2015-16. section 51 provides that where any capital asset was on any previous occasion the subject of negotiations for its transfer, any advance or other money received or retained by the taxpayer in respect of such negotiations shall be deducted from the cost for which the asset was acquired or the written down value or the fair market value, while computing cost of acquisition.

(ii)   It is now provided in the newly inserted section 56(2)
(ix) That the amount received as advance or otherwise   in the course of negotiations for transfer of capital asset shall be chargeable to tax under the head “income from other sources” if:
(a)   such advance money is forfeited; and

(b) the negotiations do not result in transfer of the capital asset.

(iii) Corresponding amendment is made in section 51 to provide that any such forfeited advance, taxed u/s. 56(2) (ix), Shall not be deducted from the cost or the written down value or the fair market value of capital asset while computing the cost of acquisition. Consequential amendment is also made in section 2(24)(xvii).

9 Capital gains
9.1 Definition of Capital asset: Section 2 (14): section 2(14) defining the term “Capital Asset” has been amended from a.y.2015-16. it is now provided that any security held by a foreign institutional investor (fii) which has invested in such security as per seBi regulations shall be considered as a “Capital asset”. the effect of this amendment will be that in the case of fii any gain from transfer of such investment in shares and securities as per seBi regulations will be treated as short/long term Capital Gain only. it will not be considered as Business income. it may be noted that fii is now called foreign portfolio investors (FPI) under SEBI regulations.

9.2 Short Term/Long – Term Capital asset and Tax rate-Section 2(42A) and 112:
(i) By an amendment of section 2(42a) from a.y.2015-16, the holding period for (a) unlisted shares of Companies and
(b) units of m.f. (other than units of equity – oriented funds) shall now be 36 months, instead of 12 months, as at present. accordingly, these assets will now be treated as short-term capital assets if they are held by the assessee for 36 months or less before the date of transfer, subject to applicable relaxation provided in the explanation (1) to section 2(42a).

(ii) Presently, under the proviso to section 112, an option is available to a taxpayer to pay tax at 10% on un-indexed long-term capital gains or 20% on indexed long-term capital gains on transfer of units of m.f. this option in respect of such units has now been withdrawn and the same will now be taxed at 20% after indexing the cost.

(iii) It may be noted that the finance minister has announced at the stage of passing the finance Bill that the above provision will not apply to shares of unlisted Companies or units of mf transferred during the period 01-04-2014 to 10-07-2014. The relevant sections have been amended for this purpose.

9.3 Enhanced Compensation received on Compulsory acquisition of Capital asset – Section 45(5): (i) at present, section 45(5)(b) provides that where enhanced compensation is awarded by any court, tribunal or other authority in case of compulsory acquisition of a capital asset, it shall be taxed in the year in which it is received. it is now provided that, if any amount of compensation is received in pursuance of an interim order of a court, tribunal or any other authority, it shall be taxable as capital gains in the previous year in which the final order of such court, tribunal or other authority is made. This amendment is made from a.y. 2015-16.

(ii) it may be noted that the amendment does not clarify as to how capital gain will be computed if such enhanced compensation received under an interim order of the court passed in an earlier year was taxed in that year u/s. 45(5) (b). it is presumed that only the amount receivable as per the final order, after deducting the amount taxed in the earlier years, will be taxable in the year in which the final order is passed by the court, tribunal or other authority.

9.4 Section 47:
section 47 has been amended from a.y. 2015-16 to provide that transfer of a Government security carrying a periodic payment of interest made outside india through an intermediary dealing in settlement of securities, from one non-resident to another non-resident, will not be liable to Capital Gains tax.

9.5 Cost Inflation Index – Section 48:
At present, cost inflation index for a particular financial year means such index as may be notified by the Government having regard to 75% of the average rise in Consumer price index (Cpi) for urban non-manual employees for the immediately preceding year to such financial year. since this method of Cpi has been discontinued, it is now provided that cost inflation index shall mean such index as may be notified by the Government having regard to 75% of the average rise in Consumer price index (urban) for the immediately preceding previous year to such financial year. This provision will apply from A.Y. 2016-17.

9.6 Reinvestment in residential House – Section 54 and 54F

At present section 54 dealing with long term capital gains arising on transfer of a residential house, and section 54f dealing with long –term capital gain on transfer of a capital asset other than a residential house, provide for exemption from capital gains u/s. 45, subject to specified conditions. one of the conditions is that the taxpayer, within a period of one year before or two years after the date of transfer, purchases, or within a period of three years after the date of transfer, constructs a residential house. There is a controversy as to whether the benefit of exemption is available in respect of purchase/construction of more than one residential house and whether such house has necessarily to be located in india. Both these sections are now amended from a.y. 2015 – 16 to provide that the exemption under the above section will be available only in respect of one residential house situated in India. It may be noted that if one or more adjacent flats are acquired and they satisfy the test of one residential

House as held in various tribunal and Court decisions, the tax payer may still be entitled to claim the exemption in respect of such adjacent flats

9.7 Investment of Capital gains in Specified Bonds – Section 54 EC:

(i)Section 54eC provides that where capital gain arise from the transfer of a long-term capital asset and the assessee has, within a period of six months after the date of such transfer, invested the whole or part of capital gains in the long- term (specified bonds) such capital gains shall be proportionately exempt. Such investment in specified Bonds is Limited to Rs. 50 lakh in a financial Year.

(ii) Some assesses invested rs. 50 lakh each in two successive years (while ensuring that both dates of investment fell within the specified time limit of six months) and claimed exemption of up to rs.1 crore. this interpretation was upheld in certain tribunal orders. In order to set at rest this controversy, this section is amended from a.y. 2015-16 to provide that the investment made by an assessee in the long-term specified bonds in respect of capital gains arising from transfer of one or more capital assets during the financial year shall not exceed `50 lacs whether the investment is made in that year or in the subsequent financial year.

10 Transfer pricing – sections 92b, 92c, 92cc and 271g:

10.1 Section 92B: section 92B(2) extends the scope of the definition of ‘international transaction’ by providing that a transaction entered into with an unrelated person shall be deemed to be a transaction with an associated enterprise, if there exists a prior agreement in relation to the transaction between such other person and the associated enterprise or the terms of the relevant transaction are determined in substance between the other person and the associated enterprise.

There was a doubt as to whether or not, for the transaction to be treated as an international transaction, the unrelated person should be a non-resident. By amendment of this section from a.y. 2015-16 it is now provided that such transaction shall be deemed to be an “international transaction” entered into between two associated enterprises, whether or not such other person is a resident or non-resident.

10.2 Section 92C: at present, under the transfer

Pricing (tp) regulations, where more than one price is determined by most appropriate method, the arithmetic mean of all such prices is taken for determination of arm’s length price (alp) with a tolerable range of +/-3% or +/- 1%. the application of this methodology has been one of the reasons for tp litigation. to reduce this litigation a third proviso is inserted in section 92C to provide that where more than one price is determined by the most appropriate method, the alp in relation to an international transaction or specified domestic transaction shall be computed in such manner as may be prescribed. With the introduction of the new mechanism from a.y. 2015-16 the existing methodology as stated above for determination of alp will not apply.

10.3 Section 92CC: section 92CC dealing with advance pricing agreements (apa) is amended w.e.f.10-10-2014 to provide for roll-back mechanism. accordingly, the apa may provide for determining the alp or specify the manner in which alp is to be determined in relation to an international transaction entered into, during any period not exceeding four previous years preceding the first of the previous year for which the apa applies in respect of the international transaction to be undertaken. this roll-back provision would be subject to conditions, procedure and manner to be prescribed, providing for determining the alp or for specifying the manner in which alp is to be determined.

10.4 Section 271g: penalty u/s. 271G can be levied upon any person, who has entered into an international transaction or specified domestic transaction and fails to furnish any such document or information as required by section 92d(3). such penalty can now be levied not only by the Assessing Officer or Commissioner (Appeals) but also by the Transfer Pricing Officer w.e.f. 01-10-2014.

11 Alternate minimum tax – section 115jc and 115 jee

(i) The provisions relating to alternate minimum tax (amt) contained in section 115jC to 115jf apply to non- corporate assessees claiming deduction u/s. 10 aa or chapter Vi-a. section 115jee has been amended from
a.y. 2015-16 to provide that the provisions relating to amt will apply if deduction u/s. 35ad is claimed by the assessee.
(ii) AMT is payable with respect to adjusted income. section 115JC has been amended from A.Y.2015-16 to provide that for computing the adjusted total income, the total income shall be increased by deduction claimed
u/s. 35ad as reduced by the amount of depreciation that would have been allowable as if the deduction u/s. 35ad was not allowed. this adjustment will be in addition to the adjustments already specified in the section.

(iii) section 115jee is amended from a.y.2015-16 to provide that even if provisions of the Chapter are otherwise not applicable in that year, either because non- corporate assessee’s (other than partnerships and llps) adjusted total income does not exceed rs. 20 lakh or it has not claimed deduction under Chapter Via, section 10aa or section 35ad, it will be entitled to claim credit for the amt paid in the earlier years u/s 115jd.

12   Survey – Section 133A:
(i)   At present the income-tax authorities can retain the custody of impounded books of account and documents for a period of 10 days without obtaining the approval of the Chief Commissioner or director General u/s 133a. this period is now increased to 15 days.
(ii)   further, by insertion of section 133a (2a) additional powers have been granted to the income- tax authorities to carry out survey for the purpose of verification of compliance of provisions of deduction of tax at source and collection of tax at source. in such survey, the income-tax authorities cannot impound any books of accounts or any document nor make an inventory of cash, stock or other valuable article or thing. these amendments take effect from 1st october 2014.

13 Power to call for information – New Section 133C section 133C has been inserted with effect from 1st october, 2014 to empower prescribed income-tax authorities to call for information or documents from any person for the purpose of verification of information in its possession relating to any person, which may be useful for any inquiry or proceedings.

14 Assessment and Reassement
14.1 Return of Income – Section 139: it is now made mandatory for a mutual fund referred to in section 10(23d), securitisation trust referred to in section 10(23DA) and Venture Capital Company/fund referred to section 10(23FB) to file its return of income, if its income, without considering provisions of section 10, exceeds the non-taxable limit. every Business trust is also required to file its return of income. This amendment is made from a.y. 2015-16.

14.2 Reference to Valuation Officer – Section 142a, 153 – 153B: the existing section 142a has been replaced
by new section 142a from 01-10-2014 to provide that the Assessing Officer can make a reference to the Valuation Officer to estimate the value or fair market value of any asset, property or investment, whether or not he is satisfied about the correctness or completeness of the accounts of the assessee. The Valuation Officer shall estimate the value based on the evidence gathered after giving an opportunity of being heard to the assessee. If the assessee does not co-operate, the Valuation Officer may estimate the value based on his judgment. The Valuation Officer is required to send a copy of his report to the Assessing Officer and to the assessee within a period of six months from the end of the month in which reference is made by the Assessing Officer. The Assessing Officer will then complete the assessment after taking into account such report, after giving the assessee an opportunity of being heard. the period from the date of reference to the Valuation Officer to the date of receipt of the report by the Assessing Officer shall be excluded while computing the period of limitation for the purpose of sections 153 and 153B.

14.3 Method of accounting – Section 145: section 145 is amended from a.y. 2015-16 to provide that the Central Government may notify income Computation and disclosure standards for computing income under the heads ‘Profits and gains of business of profession’ and ‘income from other sources’ . such standards are required to be regularly followed by the assessee and the income is required to be computed in accordance with such standards in order to avoid best judgment assessment u/s. 144.

14.4 Assessment in Search Cases – Section 153 C: In cases of search, if the Assessing Officer is satisfied that the assets seized or books of account or other documents requisitioned belong to another person, then he has to hand over the same to the Assessing Officer having jurisdiction over such other person. Hitherto, it was mandatory for the other Assessing Officer to assess/ reassess income of such other person in accordance with the provisions of section 153A in such cases. the section is amended from 1st october, 2014 to provide that such other Assessing Officer shall proceed against such other person to assess/reassess his income in accordance with the provisions of section 153, only if he is satisfied that the books of account or documents or assets seized have a bearing on the determination of the total income of such other person for the relevant assessment year or years. 15 Settlement Commission – Section 245a and 245C:

(i) An assessee may apply to settlement Commission for settlement of cases at any stage of the case relating to him u/s. 245C. the term ‘case’ as per section 245a (b) means any proceeding for assessment which may be pending before an Assessing Officer on the date on which application is made before settlement Commission. At present a taxpayer is not able to file an application for settlement of cases in cases where reassessment is pending before the Assessing Officer. By an amendment the proviso to section 245a which restricts the scope of the term ‘case’ has been deleted. This amendment will enable an assessee to apply to settlement commission in those cases where reassessment proceedings are pending. the changes in the provisions shall take effect from 1st october, 2014.

Similar changes have been made in Wealth-tax act as well for settlement of cases.

16 Authority for advance ruling(aar) – sections 245 n and 245-O

(i) Currently, an advance ruling can be obtained for determining the tax liability of a non-resident. this facility is not available to resident taxpayers, except public sector undertakings. section 245n(a) is amended to provided that the term ‘advance ruling’ shall mean a determination by the authority in relation to the tax liability of a resident applicant arising out of a transaction undertaken or proposed to be undertaken by him. further, the meaning of the applicant has been amended so that the Central Government may notify the class of resident persons for the purpose of obtaining the advance ruling.

(ii) Following amendments have been made in section 245-O in order to strengthen the aar.

(a) The existing provision provides that the aar will consist of three members. the amendment provides for additional appointment of Vice- Chairmen as members of aar. Further, Central Government has been empowered to appoint such number of Vice-Chairmen, revenue members and law members as it deems fit.

(b) The existing provision does not provide for constitution of benches of aar at various locations. it merely provides that office of AAR shall be located in Delhi. The amended provisions provide as under:

• The office of AAR shall be located in Delhi and its benches shall be located at such places as Central Government may specify.

• Further, benches of AAR have been given authority to exercise power and functions of aar and it has been further provided that such benches will consist of Chairman or the Vice-Chairman and one revenue member and one law member.

17 Penalties and Prosecution:

(i) section 271 FAA: this is a new section inserted from a.y.2015-16. it provides that if a person furnishes inaccurate statement of financial transactions or reportable account u/s. 285 Ba, penalty of rs. 50,000/- can be imposed by the prescribed income tax authority.

(ii) Section 271 H: at present this section does not specify the authority which can levy penalty u/s 271h for assessee’s failure to furnish or for furnishing inaccurate particulars for tds/tcs. it is now provided w.e.f. 01-10- 2014 that such penalty can be levied by the assessing officer

(iii). Section 276D: this section provides that if a person willfully fails to produce accounts and documents as required in any notice issued u/s.142(1) or willfully fails to comply with a direction issued to him u/s.142(2a), he shall be punishable with rigorous imprisonment for a term which may extend to one year or with fine equal to a sum calculated at a rate which shall not be less than Rs. 4 or more than Rs. 10 for every day during which the default continues, or with both. now in such a case, such person shall be punished with rigorous imprisonment for a term which may extend to one year and also with fine. This amendment is with effect from 01-10-2014.

18 Other Provisions

18.1 Income Tax authorities – Section 116: the following new income tax authorities are created w.e.f. 01-06-013. these are in addition to existing I.T. authorities.

(i)   principal directors General of income tax.
(ii)   principal Chief Commissioners of income-tax;
(iii)   principal directors of income-tax;
(iv)   principal Commissioners of income-tax.

18.2 Interest Payable by assessee–Section 220:
(i) s/s.(1A) Has been inserted to provide that when the notice of demand has been served upon the assessee and any appeal or other proceedings are filed or initiated in respect of the amount of such demand, then, such demand shall be valid till the disposal of the appeal by the last appellate authority or disposal of the proceedings and the same shall have effect as specified in section 3 of the taxation laws (continuation and validation of recovery proceedings) act, 1964.

(i) Section 220(2) provides for payment of interest in respect of unpaid amount of demand. such interest is payable for the period commencing from the due date of payment of demand to the date of payment. it is further provided that if as a result of any order passed subsequently u/s. 154, 250, 254 etc., the amount on which interest was payable is reduced, then the interest shall also be reduced accordingly. This section is now amended to provide that in such cases, subsequently, as a result of any order under the aforesaid sections or u/s. 263, the amount on which interest was payable is increased, then the assessee shall be liable to pay interest u/s. 220(2) for the period from the original due date of payment of demand, up to the date of payment.

The above amendments are made from 01-10-2014.

18.3 Acceptance or repayment of Loans or Deposits – section 269ss and 269t: sections 269ss & 269t prohibit every person from taking/ accepting or repaying any loan or deposit otherwise than by an account payee cheque or account payee bank draft, if the amount of loan or deposit exceeds the specified threshold. The sections now permit from a/y:2015-16 taking/accepting or repaying such loan or deposit by use of electronic clearing system through a bank account (i.e., by way of internet banking facilities or by use of payment gateways).

18.4 Period for Provisional attachment of Properties
–Section 281B: under the provisions of section 281B, the Assessing Officer may provisionally attach the properties of the assessee during the pendency of the assessment proceedings. such order of provisional attachment can remain into operation for a maximum period of six months from the date of the order. However, the Chief Commissioner, Commissioner, director General or director are given the power to extend such period up to two years. Under the amended provisions, from 01-01- 2014, the above period is extended to 2 years and six months from the date of assessment or reassessment whichever is later.

18.5 Financial Transactions or reportable account
– Section 285Ba: (i) existing section 285 Ba has been replaced by a new section 285 Ba from 01-10-2014. The new section provides for furnishing of statement of Information by a prescribed reporting financial institution along with other persons as stated in existing section 285 BA in respect of any specified financial transaction or reportable account to the income tax authority or prescribed authority or agency. The statement shall be furnished for such period, within such time, and in such form and manner as may be prescribed. The Central Government may notify the persons required to be registered with the prescribed income tax authority, the nature of information, the manner in which such information shall be maintained by the person and the due diligence to be carried out by the person for the purpose of identification of any reportable account. any person who furnishes a statement of information, or discovers any inaccuracy in the information provided in the statement, shall within a period of ten days of discovering the mistake, inform the income tax authority or any other prescribed authority of the inaccuracy and furnish the revised information. Thus, statement of financial transactions or reportable account will now replace ‘annual information return’.

(ii) In line with the amendments u/s. 285Ba as stated above, provisions of section 271fa have been suitably modified to provide for levy of penalty for failure in furnishing such new statement. Further, section 271faa has been inserted which provides for a penalty of Rs. 50,000 which can be levied by the prescribed income- tax authority on concerned reporting financial institution which provides inaccurate information in such statement.

19 To sum up:

19.1 From the above discussion, it will be noticed that the Finance Minister in his first Budget of the new Government has made an honest attempt to reduce the burden of tax on individuals, huf etc., to give incentives for increasing savings, to encourage manufacturing activities with a view to create new jobs and encourage growth of economy, to reduce tax litigation and to make the tax laws taxpayer friendly. in this context, his following observations in para 209 and 210 of the Budget speech need to be noted

“209. Income tax Department is expected to function not only as an enforcement agency but also as a facilitator. A number of Aykar Seva Kendras (ASK) have been opened in different parts of the country. I propose to extend this facility by opening 60 more such Seva Kendras during the current financial year to promote excellence in service delivery.

210. The focus of any tax administration is to broaden the tax base. Our policy thrust is to adopt non intrusive methods to achieve this objective. In this direction, I propose to make greater use of information technology techniques”.

19.2 The concept of Business trusts has been introduced for the first time with a view to encourage investment in infrastructure projects. Let us hope that this becomes popular in the years to come. similarly, the transfer pricing provisions have been simplified to reduce tax Litigation. Again, the benefit of AAR is extended to Residents. This was the demand of the business community which has been accepted after over two decades. The provisions for approaching settlement Commission have also been amended to enable assessees to approach the commission when reassessment proceedings are pending.

19.3 There are some disturbing provisions which will increase tax litigation in the coming years. One is about CSR expenditure for which specific provision is made that these expenses will be disallowed on the ground that these are not expenses incurred for business or profession. The logic for this given by the Government that this expenditure is application of income is not at all convincing when the Companies act mandates that specified companies should spend at least 2% of average profits of earlier 3 years for CSR activities. This expenditure is treated as business expenditure under schedule iii of the Companies act and considered as application of income under the income-tax act. The other disturbing provision is about the additional power given to CIT to cancel registration of a charitable trust u/s. 12AA if the trust does not comply with requirements u/s. 10(23C), 11 or 13. for non-compliance with these provisions in any year, the existing act provides for levy of tax on the trust or institution for that year. If the registration of the trust/ institution is cancelled there will be unending litigation for which expenditure will have to be incurred out of funds of the trust/institution which would otherwise have been spent for charitable purposes. There is yet another area which relates to capital gains on transfer or redemption of units of mutual fund (other than equity oriented funds). This amendment will reduce the investment in such funds and affect the mutual fund industry.

19.4 In para 208 of the Budget speech, the finance minister has discussed about the direct taxes Code (DTC) as under:

“The Direct Taxes Code Bill, 2010 has lapsed with the dissolution of the 15th Lok Sabha. Having considered the report of the Standing Committee on Finance and the views expressed by the stakeholders, my predecessor had placed a revised Code in the public domain in March, 2014. The Government shall consider the comments received from the stakeholders on the revised Code. The Government will also review the DTC in its present shape and take a view in the whole matter”.

The above observation shows that the new Government is determined to replace the existing 5 decade old income
-tax act by the DTC. We are hearing about Government intention about introducing DTC for the last about 10 years. Let us hope that this Government is able to simplify the provisions of the direct tax laws by enacting a taxpayer friendly DTC. One wonders as to why the finance minister has made so many amendments in the existing income tax act if he is keen to bring the DTC into force in the near future.

19.5 GST is another area which is under public debate for over a decade now. In pare 9 of the Budget speech the finance minister has observed as under.

“9 The debate whether to introduce a Goods and Service Tax (GST) must now come to an end. We have discussed the issue for the past many years. Some States have been apprehensive about surrendering their taxation jurisdiction; others want to be adequately compensated. I have discussed the matter with the States both individually and collectively. I do hope we are able to find a solution in the course of this year and approve the legislative scheme which enables the introduction of GST. This will streamline the tax administration, avoid harassment of the business and result in higher revenue collection both for the Centre and the States. I assure all States that government will be more than fair in dealing with them.”

Let us hope that the new Government is able to introduce GST during this year and get the necessary legislation passed. This will help all concerned and also simplify the levy of indirect taxes.

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DTAA between India and Singapore – Fees for technical services – A. Y. 2005-06 – Technical knowledge not made available with services – Amount not fees for technical services – Not taxable in India-

DIT vs. Sun Microsystems India P. Ltd.; 369 ITR 63 (Karn):

The assessee entered into an agreement for availing of logistic services of S of Singapore. Under the agreement, the services included spare management services, provision of buffer stock, defective repair services, managing local repair centres, business planning to address service levels, etc. S did not have any place of business or permanent establishment in India. The entire services were rendered by S from outside India. The Assessing Officer held that the payments made by the assessee to S were taxable in India. The Tribunal held that as S did not have any permanent establishment and had not made available the technical knowledge, experience or skill, the payments made by the assessee to S were not required to be taxed under the head “Business” and were not taxable in view of article 7 of DTAA between India and Singapore.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

“i) If along with the technical services rendered, the service provider also makes available the technology which it used in rendering the services, the case falls within the definition of “fees for technical services” as contained in DTAA . However, if technology is not made available along with technical services what rendered is only technical services and the technical knowledge is withheld, such a technical service would not fall within the definition of “technical services” in DTAA and the payment thereof is not liable to tax.

ii) From the facts of this case, it was clear that S had not made available to the assessee the technology or the technological services which was required to provide the distribution, management and logistic services. That was a finding of fact recorded by the Tribunal on appreciation of the entire material on record. The Payments made by the assessee were not liable to be taxed under the head “ fees for technical services”.”

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Capital gain: Long-term or short-term – Sections 2(42A) and 45 – Written lease for three years – Assessee continuing to pay rent and occupying premises for 10 more years – Amount received on surrender of tenancy is long-term capital gain

CIT vs. Frick India Ltd.; 369 ITR 328 (Del):

Under a written tenancy agreement for three years the assessee occupied premises on 15-03-1973. Thereafter the assessee continued to use and occupy the premises as a tenant. Rent was paid by assessee and was accepted by the landlord. On 18-02-1987 the tenancy rights were surrendered and consideration of Rs. 6.78 crore was received from a third party. The Assessing Officer held that the amount should be treated as short-term capital gains and not as long term capital gains. The logic behind the finding of the Assessing Officer was that the tenancy after the initial period of three years by way of a written instrument, was month to month. Thus the tenancy rights were extinguished on the last day of each month and a fresh or new tenancy was created. The Tribunal held that the amount was assessable as long-term capital gain.

On appeal by the Revenue the Delhi High Court upheld the decision of the Tribunal and held as under:

“The tenancy rights had been held for nearly fourteen years and consideration received on surrender had been rightly treated as long-term capital gain.”

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Capital gain or income from other sources – Sections 10(3) and 56(1) – A. Y 1992-93 – Relinquishment of sub-tenancy rights – Receipt is capital gain and not income under the head “Income from other sources”-

ACIT vs. G. C. Shah; 369 ITR 323 (Guj)

In the A. Y. 1992-93, the Assessing Officer found that the assessee had received Rs. 5 lakh as miscellaneous income from relinquishment of sub-tenancy rights of a property. He made an addition of Rs. 5 lakh as income under the head “Income from other sources”. The Tribunal held that the amount is taxable as “capital gain” and not as “income from other sources”.

On appeal by the Revenue the Gujarat High Court upheld the decision of the Tribunal and held as under:

“The Revenue could have taxed the amount of Rs. 5 lakh, which was received towards surrendering the tenancy rights from the lessor, under the head “Capital gains” and not under any other head. Therefore, the Tribunal had not committed any jurisdictional error in passing the order.”

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Capital gain vs. Business income – Sections 28 and 45 – A. Y. 2005-06 – Assessee share broker maintaining separate portfolios for investment and stock-in-trade – Profit from sale of shares of three companies held as investment – Profit assessable as short-term capital gain-

CIT vs. CNB FINWIZ Ltd.; 369 ITR 228 (Del):

The assessee was a share broker registered with the National Stock Exchange and the Bombay Stock Exchange and was engaged in the business of purchase and sale of shares. In the A. Y. 2005-06, the assessee declared short-term capital gains of Rs. 82,32,316/- from sale of shares held by it as investment. The Assessing Officer held that the profit was assessable as business income. The Tribunal accepted the assessee’s claim that it is short-term capital gain.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“i) It was clear from the finding of the Tribunal that the assessee, though a member of the Bombay Stock Exchange and National Stock Exchange, maintained two portfolios, one relating to investment and the other relating to stock-in-trade. Profits and losses from investments were shown as “capital gains” either long term or short term and profits and losses from “stock-intrade were shown as “business income”. This position was also accepted in earlier assessment years, i.e., A. Y. 2002-03 onwards.

ii) The assessee had turnover of more than Rs. 4697.23 crore, whereas investment in shares in comparison was small amount of Rs. 2.95 crore. The assessee had declared “business income” of Rs. 63.77 crore in respect of transactions as a member of the stock exchanges and as a result of carrying out trade in shares.

ii) The shares held as investment were kept in a separate portfolio. The shares related to only three companies were not treated as stock-in-trade. These shares were sold after a gap of four months or more. Hence the profits were assessable as short-term capital gains.”

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Business expenditure – Interest on borrowed capital – Section 36(1)(iii) – A. Y. 1983-84 – Assessee as guarantor repaying instalments of loans taken by its subsidiary company for its business – Interest on such payments is deductible-

J. K. Synthetics Ltd. vs. CIT; 369 ITR 310 (All):

The assessee was engaged in the manufacture and sale of synthetic yarn and cement. It had a subsidiary company. The subsidiary company incurred heavy losses and as a result, it became a defaulter in paying its debts. The assessee was also a guarantor to the loans taken by the subsidiary company for the purpose of protecting its own business interest. Since the subsidiary company could not adhere to the repayment of its liabilities, the assessee repaid instalments of the loans. It claimed deduction of the interest on the amounts advanced for such payments. The claim was rejected by the Assessing Officer and this was upheld by the Tribunal.

On appeal by the assessee, the Allahabad High Court reversed the decision of the Tribunal and held as under:

“i) Three conditions must be established by an assessee for getting the benefit u/s. 36(1)(iii) of the Income-tax Act, 1961. They are (i) interest should have been payable, (ii) there should be a borrowing, and (iii) capital must have been borrowed or taken for business purposes.

ii) In Madhav Prasad Jatia vs. CIT [1979] 118 ITR 200 (SC), the Supreme Court held that the expression “for the purpose of business” occurring u/s. 36(1)(iii) of the Act is wider in scope than the expression “for the purpose of earning income, profits or gains”. Where a holding company has a deep interest in its subsidiary company and advances money to the subsidiary company and the money is used by the subsidiary company for its business purposes, the assessee would be entitled to deduction of interest on its borrowed loans.

iii) The assessee had deep business interest in the existence of its subsidiary company and discharged its legal obligation by repaying the instalments of loan to the financial institutions. Such loans were given for the purpose of business. The assessee was entitled to deduction of interest.”

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ACIT vs. GMS Motors Pvt. Ltd. ITAT Delhi `C’ Bench Before R. S. Syal (AM) and H. S. Sidhu (JM) ITA No. 3530/Del/2012 A.Y.: 2007-08. Decided on: 6th August, 2014. Counsel for revenue / assessee: Satpal Singh / Sanjeev Kapoor

S/s. 3, 28 – In a case where premises are taken on rent, manpower was hired, registration under MVAT and CST was obtained and deposit was paid to company whose vehicles were to be sold and sales of some spare parts had been sold, it cannot be said that the business of sales-cum-service centre has not been set up merely because sale of cars has not taken place.

Facts:
The assessee was to commence a business of sale-cumservice centre. During the previous year it took the premises on rent, hired man power who were paid salaries by cheque, obtained registration required under Maharashtra VAT Act, 2002 and Central Sales Tax Act, 1956 and also deposited certain amount with Mahindra & Mahindra Ltd., whose vehicles were to be sold by the assessee. The assessee had also sold some spare parts.

The Assessing Officer (AO) disallowed expenses aggregating to Rs. 56,80,117 incurred towards financial charges and staff administrative charges on the ground that the sale of cars had not taken place during the previous year and therefore the business was not set up and hence deduction of expenses was not permissible.

Aggrieved, the assessee preferred an appeal to the CIT(A) who allowed the appeal.

Held:
The Tribunal noted that the term `previous year’ as defined in s. 3 has a relationship with setting up of the business and not with the commencement of the business. It noted that the Apex Court has in the case of CIT vs. Ramaraju Surgical Cotton Mills Ltd. (63 ITR 478)(SC) has held that the business is set up when it is ready to discharge the functions for which it is being set up and the Delhi High Court has in the case of CIT vs. Samsung India Electronics Ltd. (356 ITR 354)(Del) has held that business commences on doing first activity like purchase of raw materials, etc.

Considering the ambit of the term `setting up of the business’ in the light of the above mentioned judicial pronouncements the Tribunal held that any income arising after the date of setting up of the business is chargeable to tax and, similarly, any expenditure incurred after the setting up of the business is deductible subject to other relevant provisions. The activities carried out by the assessee, amply demonstrate that the business was set up though sale of vehicles did not take place during the year. The Tribunal noted that it was not the case of the AO that the expenses were non-genuine or capital in nature. The Tribunal upheld the order passed by CIT(A).

The appeal filed by the revenue was dismissed.

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IFB Agro Industries Ltd. vs. Joint Commissioner of Income-tax In the Income Tax Appellate Tribunal ‘B’ Bench Kolkata Before P. K. Bansal (A. M.) and George Mathan (J. M.) ITA No. 1721/Kol/2012 Assessment Year: 2009-10. Decided on 12th March, 2013 Counsel for Assessee / Revenue: S. K. Tulsiyan / Ajoy Kr. Singh

Section 2(22)(e) – Deemed dividend – Intercorporate deposit is neither loan nor advance hence not covered u/s. 2(22)(e).

Facts
The assessee had received Inter-corporate deposits of Rs. 11.20 crore. from IFB Automotive Pvt. Ltd., a company wherein the assessee held 18.82% of the shares. The said deposit was treated by the AO as a loan and invoking the provisions of section 2(22) (e), he taxed the said receipt as income of the assessee. On appeal, the CIT(A) confirmed the order of the AO.

Before the tribunal, the revenue supported the orders of the lower authorities and further relied on the decision of the Bombay High Court in the case of Star Chemicals Pvt. Ltd. reported in 203 ITR 11, wherein it has been held that a loan to a shareholder to the extent to its accumulated profits was liable to be treated as deemed dividend.

Held
The tribunal noted that the dispute primarily revolves around the issue as to whether the Inter corporate deposits received by the assessee from M/s. IFB is a ‘loan’ or ‘advance’ or is a ‘deposit’. It further noted that the provisions of section 2(22)(e) refers to only ‘loans’ and ‘advances’ it does not talk of a ‘deposit’. According to the tribunal, the fact that the term ‘deposit’ cannot mean a ‘loan’ and that the two terms ‘loan’ and the term ‘deposit’ are two different and distinct terms, is evident from the explanation to section 269T as also section 269SS of the Act where both the terms are used. Further, it was noted that the second proviso to section 269SS of the Act recognises the term ‘loan’ taken or ‘deposit’ accepted. The tribunal then observed that once it is accepted that the terms ‘loan’ and ‘deposit’ are two distinct terms which has distinct meaning then, if term ‘loan’ is used in a particular section, the deposit received by an assessee cannot be treated as a ‘loan’ for that section.

Further, on perusal of the decision of the Special Bench of the Ahmedabad bench Tribunal in the case of Gujarat Gas & Financial Services Ltd. reported in 115 ITD 218 which had taken into consideration the decision of the Special Bench of the Delhi Tribunal in the case of Housing & Urban Development Corporation Ltd. reported in 102 TTJ (SB) 936 and of the Bombay tribunal in the case of Bombay Oil Industries Ltd. reported in 28 SOT 383, the tribunal opined that the Inter corporate deposits cannot be treated as a loan falling within the purview of section 2(22)(e) of the Act. Accordingly, the addition representing inter-corporate deposits treated as loan by the AO and confirmed by the CIT(A) was deleted by the tribunal.

As regards the decisions relied on by the CIT(A) as also by his counsel before the tribunal, it observed that the same were on ‘loans’ and none of the decisions referred to by them discussed anywhere that deposits were to be treated as loans.

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Business expenditure: Revenue or capital: Section 37: Corporate club membership fees paid by the assessee is revenue expenditure: Deduction allowable as business expenditure:

CIT vs. M/s. Jindal Iron and Steel Co. Ltd. (Bom): ITA No. 1567 of 2011 dated 18-03-2014:

The Assessing Officer disallowed the club expenditure of Rs. 16,15,934/- treating the same as capital expenditure. The Tribunal allowed the claim and deleted the addition.

On appeal by the Revenue, the Bombay High Court upheld the decision of the Tribunal and held as under:

“i) T he Tribunal has held by relying on the documents and record produced by the respondent assessee that the club membership is a corporate membership. The company has obtained the membership in this case for its directors and to promote the business interests of the company and as they would get in touch and come in contact with business personalities. In such circumstances, following the order passed by this court in the case of Otis Elevator Company (India) Ltd. vs. CIT; 195 ITR 682 (Bom), the Tribunal has reversed the finding and conclusion of the Assessing Officer and the CIT(A).

ii) Such finding of fact and consistent with the material produced therefore does not merit any interference in our jurisdiction u/s. 260A of the Income-tax Act, 1961. The appeal is therefore dismissed.”

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[2013] 144 ITD 57 (Mumbai-Trib.) IGFT Ltd. vs. ITO-2(2)(1), Mumbai A.Y. 2001-02 Date of Order: 13th May 2013

Section 4 – Sum received for transfer of intangible assets on discontinuance of business resulting in loss of enduring trading assets considered as capital receipt not chargeable to tax.

Section 4 – Non-compete fees received on transfer of sole and main business for not carrying on the same for a limited period was considered as capital receipts not chargeable to tax during the A.Y. 2001-02.

Facts
Assessee-company was engaged in the business of merchant banking. It had transferred its business of merchant banking in the form of employees, customer and client relationship, a list of 10 largest clients and certain know-how for a sum of Rs. 25 lakh. Further, it also received a sum of Rs. 1 crore as non-compete fees for a consideration towards not carrying on the same business for a period of 3 years after its transfer.

Assessee claimed that a sum of Rs. 1.25 crore was capital receipts not chargeable to tax.

The Ld. CIT(A) upheld the order of the AO and taxed the receipts of Rs. 1.25 crore under the head business income due to the following reasons:

I. Business was hampered only for the period of 3 years and not forever. Amount was received as compensation during the course of business and there was no loss of capital assets or capital structure of the assessee’s business. Business has been continued as evident from the annual accounts of subsequent years.
II. Amount received Rs. 1.25 crore was negligible as compared to the earnings from the business of Rs. 7.5 crore and it defies business prudence of the assessee.
III. There was no basis for computing the amount of consideration of Rs.1.25 crore.

Held:
The Hon’ble ITAT held that impugned receipt of Rs. 25 lakh was a capital receipt due to the following reasons:

The assessee received the consideration for the transfer of its merchant banking business and the same was discontinued by it. Hence, compensation received cannot be considered as receipts during the course of business.

Also the Revenue failed to show as to how the agreement was not bona fide. It has been accepted that the agreement was with unrelated and unknown party which at relevant point of time was reputed international firm of chartered accountants. It was intended to be acted upon by both.

Further, it has been held that it is for the transferor to fix the consideration for the transfer. It is not at the instance of the revenue to raise any issue on its adequacy. After discontinuing the merchant banking business, assessee did not have any active source of income and its income consist of mainly dividend from shares and mutual funds, profit on sale of shares, interest income and nominal consultancy charges. Hence there was substantial fall in profit earning of the assessee. It has also been held that the transfer of business has resulted in loss of enduring trading.

Following the decision of the Hon’ble Supreme Court in B.C. Shrinivasa Setty 128 ITR 294, it has been held that, as said intangible assets were self generated having no cost of acquisition the sum received from transfer of the same was not liable to tax under the head capital gains also.

The Hon’ble ITAT also held that impugned receipt of Rs. 1 crore was a capital receipt due to the following reasons:
It has been held that decisions relied by Ld. CIT(A) are not applicable to the facts of this case, as in this case sole and main business had been transferred and not one of the businesses.

Secondly, agreement was made only for a period of 3 years is not relevant as generally all the noncompete agreements are limited in point of time which prescribes period of non-competition.

Thirdly, non-competition fee is taxable capital receipt and not revenue receipt by specific legislative mandate vide section 28 (va) of Income Tax Act, 1961 and that too w.e.f. 1-04-2003. Hence, it is not applicable for relevant assessment year. The Hon’ble Supreme Court has held in case of Gufic Chem (P.) Ltd. vs. CIT [2011] 332 ITR 602 fees received under non-competition agreement is capital receipt as amendment does not cover the relevant assessment year.

Editor’s Note: The decision may not apply after the insertion of Section 28 (va)with effect from A.Y.2003-04

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2013-TIOL-1038-ITAT-MUM DCIT vs. Weizmann Ltd. ITA No. 770/Mum/2011 Assessment Years: 2008-09. Date of Order: 31.10.2013

Section 32 – Dealership network is an intangible asset eligible for depreciation u/s. 32(1)(ii).

Facts
During the previous year the assessee claimed deprecation of Rs. 1,84,65,131 credit for TDS of Rs. 58,22,932

The assessee, a company which is engaged in the business of dealing in foreign exchange, filed its return of income for the year under consideration declaring total income of Rs. 9,48,61,257/-. During the course of assessment proceedings, the Assessing Officer (AO) noticed that the assessee had claimed depreciation of Rs. 1,84,65,131/- @ 25% on the dealership network purchased by it in the previous year relevant to A.Y. 2007-08 from AFL.

The assessee submitted that the AFL had vast representative/dealer network in India and the same was acquired by the assessee for expanding its base and business. It was contended that the said network was in the nature of license and franchisee and therefore was eligible for depreciation @ 25% u/s. 32(1)(ii) of the Act.

The AO was of the view that the assessee could not prove that any right of the nature as provided in section 32(1)(ii) of the Act was acquired by it and that the right or advantage so acquired was depreciable over a period of time. He, therefore, disallowed the claim of the assessee for depreciation on the dealership network.

Aggrieved, the assessee preferred an appeal to the CIT(A) who deleted the disallowance made by the A.O. by following the order of his predecessor in assessee’s own case for A.Y. 2007-08 wherein a similar claim of the assessee for depreciation @25% on dealership network was allowed by his predecessor treating the dealership network as intangible asset eligible for depreciation u/s. 32(1)(ii) of the Act.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held
It is observed that a similar issue was involved in assessee’s own case for A.Y. 2007-08 wherein the claim of the assessee for depreciation on dealership network is allowed by the Tribunal vide its order dated 30-03-2012 passed in ITA No. 3571/Mum/2011 holding that the consideration paid by the assessee to AFL was for the purpose of enhancing its network in the field of money transaction business by acquiring rights or infrastructure or other advantages attached to the marketing network and since the same was in the nature of intangible asset as contemplated u/s. 32(1)(ii) of the Act, the assessee was entitled to depreciation thereon @ 25%. The Tribunal following the decision of the co-ordinate Bench, in the assessee’s own case for A.Y. 2007- 08, upheld the order of the ld. CIT(A) allowing the claim of the assessee for depreciation on dealership network u/s. 32(1)(ii) of the Act and dismiss ground No. 1 of Revenue’s appeal.

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2013-TIOL-1045-ITAT-HYD NCC Maytas JV vs. ACIT ITA No. 812/Hyd/2013 Assessment Years: 2006-07. Date of Order: 13.09.2013

Section 199, Rule 37BA – A part of TDS cannot be denied on the ground that the corresponding turnover has not been shown in the assessment year in which credit is being claimed if income relating to such TDS has already been offered for taxation in an earlier assessment year.

Facts
During the previous year the assessee claimed credit for TDS of Rs. 58,22,932 based on the certificate filed. The certificate mentioned gross receipts of Rs. 25,23,31,091. Upon being asked to explain whether these receipts are credited to the current year’s P & L Account, the assessee submitted that Rs. 23,99,32,700 were credited to P & L Account and the balance had already been offered for taxation in the preceding assessment years. The assessee submitted that the credit of TDS was not claimed in the preceding assessment years.

The Assessing Officer held that u/s. 199 credit for TDS has to be restricted to the receipts shown by the assessee. He disallowed proportionate amount of TDS and allowed credit of only Rs. 55,36,798.

Aggrieved, the assessee preferred an appeal to CIT(A) who upheld the action of the AO by observing that Rule 37BA of Income-tax Rules, 1962 provided for such apportionment of TDS to different assessment years in which the income is assessable on proportionate basis.

Aggrieved, the assessee preferred an appeal to the Tribunal.

Held
The Tribunal observed that the revenue authorities have not disputed the claim of the assessee that the balance portion of the turnover was offered to tax in the earlier assessment year. Further, there was no material brought on record to show that the assessee had claimed corresponding TDS relating to the balance portion of the turnover in the concerned assessment years. The entire TDS relating to Rs.25,23,31,091/- was claimed for the impugned assessment year as the TDS certificate relates to the assessment year under dispute. The assessee having not claimed any portion of TDS in the preceding assessment years wherein a part of the turnover was offered to tax, the assessee’s claim of TDS in the impugned assessment year cannot be rejected on the ground that it relates to the turnover which has not been shown by the assessee for the impugned assessment year.

Income relating to such TDS having already been offered to tax in the earlier assessment years and since the assessee has not claimed corresponding TDS in those assessment years, no disallowance of the TDS claimed can be done. As regards reliance by CIT (A) rule 37BA the Tribunal observed that in the first place the said rule is not applicable to the assessment year under dispute as it has been inserted into the statute by IT (Sixth Amendment) Rules 2009 with effect from 1-4-2009. Even if we go by the aforesaid rule, the Assessing Officer was required to give credit to the TDS in the corresponding assessment years wherein the income was so offered which also would have resulted in refund to the assessee.

The Tribunal held that the assessee is entitled to claim credit for the entire TDS amount of Rs.55,22,932/- in the impugned assessment year. The appeal filed by the assessee was allowed.

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2013-TIOL-1054-ITAT-DEL DCIT vs. Usha Stud & Agricultural Farms (P) Ltd ITA No. 910 to 912/Del/2010 Assessment Years: 1998-99, 1999-2000 and 2003-04. Date of Order: 25.10.2013

S/s. 139(1), 148, 282 – Notice issued under section 148 if not served by post has to be served in a manner provided in Code of Civil Procedure, 1908 for the purposes of service of summons. Accordingly, when the copy of the notice retained by the process server did not contain the time of service nor the manner of service nor the name and address of the person identifying the service and witnessing the delivery of the notice, the same cannot be considered as a valid service of notice issued u/s. 148 though the copy retained had the signature of the receiver, date and the phone number.

Facts
For assessment year 2003-04 the Assessing Officer (AO) issued on 22-03-2005 notice u/s. 148 of the Act which according to the AO was duly served. Vide letter dated 18-10-2005 the assessee informed the AO that the said notice was not received by it and in any case the return filed u/s. 139(1) may be treated as a return in response to notice u/s. 148. Upon receiving this letter the AO wrote a letter dated 28-10-2005 informing the assessee that the notice u/s. 48 had been duly served on 24-03-2005 by the process server on the address of the company and that the same was duly acknowledged. The address where the notice was served was the declared address of the assessee company. It was only vide letter dated 13-07-2005 that the assessee had informed the AO about the change in address. A copy of the said notice was attached with the letter. The assessee filed objections in respect of reassessment proceedings u/s. 148 vide letter dated 02-12-2005, filed on 08-12-2005. The AO replied to the objections.

The assessee again contended that the notice u/s. 148 was not served and therefore the proceedings were void ab initio. The AO rejected this argument and completed the assessment.

Aggrieved the assessee preferred an appeal to CIT(A) who considering the provisions of section 282 of the Act and also the provisions of CPC held that the mandate of section 148 is that the notice should be served on the assessee. Since the notice was served through the notice server of the Department and not by post, the procedure contemplated by the CPC under Order V for service has to be followed. Having examined the procedure laid down by CPC he held that there was no material on record to even establish the person to whom notice was allegedly served was authorised to receive the notice, rather that person was not identifiable. Despite repeated requests from the assessee and even after instructions from CIT(A) the AO was not able to name the person on whom the notice was served. If notice in some way or other reached the assessee then it cannot be treated as proper service of notice since statute prescribes specific mode of service to be followed. Acquiescence does not confer jurisdiction. He held that there was no valid service of notice u/s. 148 and consequently reassessment proceedings are void ab initio. He quashed the proceedings.

Aggrieved, the revenue preferred an appeal to the Tribunal.

Held:
Service of notice is the sine qua non for a proceedings u/s. 147 of the Act to get underway. Section 148 (1) of the Act provides that the Assessing Officer shall serve a notice on the assessee, as required therein. As to the procedure for service of such notice, section 282 of the Act is the governing section and it provides that such a notice may be served either by post, or as if it was a summons issued by a court under the Code of Civil Procedure, 1908. In the present case, evidently, the service was as a summons and not by post.

Therefore, the service is governed by the relevant provisions of the CPC, i.e., Order V thereof. As per Rule 12 of Order V, CPC, service of a summons, wherever practicable, shall be made on the defendant in person, unless he has an agent empowered to accept such service. As per Rule 16, the process server shall require the signature of the person to whom the copy of the summons is delivered. According to Rule 18, the process server shall endorse or annex, on or to the original summons, a return stating the time when and the manner in which the summons was served, and the name and address of the person identifying the person served and witnessing the delivery of the summons.

The Tribunal observed that in the present case, first of all, though there is a signature on the copy of the notice retained by the process server (APB 56) and it contains a date, i.e., 24-03-2005 and a number, i.e., 26145991, neither the time of service, nor the manner of service, nor the name and address of the person identifying the service and witnessing the delivery of the notice, are present. Thus, the requirement of Order V Rule 18 of the CPC has evidently not been met with.

Thus, the servicee of the notice has nowhere been identified in spite of repeated requests made by the assessee to the Assessing Officer to do so. In fact, in para 6.7 of the impugned order, the Ld. CIT (A) has noted that even after instructions from him [the CIT (A)], the Assessing Officer was not able to name the person on whom the notice was served. In the absence of identification of the servicee, it is, obviously, well nigh impossible to contend, much less prove, that the servicee was an agent of the assessee company. And, as such, it cannot be said that the servicee had been appointed as an agent of the assessee to accept service of notices on behalf of the assessee. This, as correctly noted by the Ld. CIT (A) stands long back settled, inter alia, in the following case laws:-

i) ‘CIT vs. Baxiram Rodmall’, 2 ITR 438 (Nagpur);
ii) ‘CIT vs. Dey Brothers’, 3 ITR 213’ (Rang); and
iii) ‘C.N. Nataraj vs. Fifth ITO’, 56 ITR 250 (Mys).

The provisions of the CPC, in keeping with those of Section 282 of the IT Act, as relevant herein, are not a mere formality. Fulfillment of the requirements therein is the sine qua non for a proper and valid service of notice. Herein, not only has the alleged servicee not been identified, the person identifying such servicee has also not been even named, thereby violating the provisions of Order V, Rule 18, CPC, as has duly correctly been taken into consideration by the Ld. CIT (A).

The Tribunal upheld the action of CIT (A) in holding that the invalid service of notice u/s. 148 of the IT Act, cannot be said to be merely a procedural defect and it cannot be cured by the participation of the assessee in the re-assessment proceedings. It confirmed the order passed by CIT(A).

The appeal filed by the Revenue was dismissed.

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2013-TIOL-1063-ITAT-DEL ITO vs. Smt. Bina Gupta ITA No. 4074/Del/2012 Assessment Years: 2009-10. Date of Order: 18.10.2013

S/s. 45, 54, 54F – Deduction u/s. 54F cannot be denied in a case where the assessee has made payment and as per agreement was scheduled to receive possession of the property but did not receive possession of the property.

Facts:
During the previous year the assessee sold a residential house on 13-06-2008 and a plot of land on 10-11-2008. Both these assets were held by the assessee as long term capital assets. The long term capital gain arising on transfer of house was Rs. 31,00,369 and long term capital gain arising on transfer of plot was Rs. 19,89,914. Thus the aggregate long term capital gain was Rs. 50,90,283. The assessee claimed exemption u/ss. 54 and 54F. The assessee entered into an agreement with Golden Gate Properties Ltd. on 18-12-2008 for purchase of a house. She paid the builder Rs. 42,50,000 on different dates between 31-05-2008 to 31-12-2008 and deposited Rs. 14,50,000 in capital gain account scheme. As per agreement, the assessee was scheduled to receive possession of the house by 30- 09-2009 i.e. within the time limit mentioned in these sections for purchase of house.

Before the AO, the assessee relied upon the ratio of the decisions in the case of CIT vs. R. L. Sood (2000) 245 ITR 727 (Del); CIT vs. Sardarmal Kothari & Another 302 ITR 286; the judgment of Karnataka High Court dated 15-02-2012 in the case of CIT vs. Sri Sambandam Udaykumar in IT Appeal No. 175/2012 (2012-TIOL-217- HC-Kar-IT); Mrs. Seetha Subramanian vs. ACIT 56 TTJ 417 (Mad) and Satish Chandra Gupta vs. AO (54 ITD 508 (Del) and argued that the delay was not due to the fault of the assessee.

The AO rejected the arguments of the assessee that there was no relationship between the assessee and the builder and hence there can be no occasion to consider connivance. He also rejected the contention that the builders had since entered into a financial arrangement with M/.s J M Financial Asset Reconstruction Co. P. Ltd. who had committed funds to the builders and the builder had communicated that construction of the flat allotted was under progress and date of possession communicated by them was December 2012 and the builders had further demanded funds of Rs. 14,17,352 vide email dated 10-03-2012 and the assessee was in the process of arranging the same.

Since the assessee had not received possession of the house, the AO denied the exemption on the ground that these sections require purchase of house within a period of two years from date of transfer and even while the assessment was going on the assessee had not received possession of the house.

Aggrieved the assessee preferred an appeal to the CIT(A) who allowed the appeal.

Aggrieved the revenue preferred an appeal to the Tribunal.

Held
The Tribunal noted that the payments were made by the assessee on the specific dates pursuant to an agreement entered with the builder on 18-12-2008 i.e. within the specified time and the delivery was scheduled to take place before 30-09-2009 i.e. very much within the stipulated time and also that since there was no relationship between the assessee and the builder no connivance or collusion can be read into the agreement. Considering these facts and also the settled legal position laid down interalia by the decision of Delhi High Court in the case of CIT vs. R. L. Sood 245 ITR 727 (Del) the Tribunal confirmed the order passed by CIT(A). The appeal filed by revenue was dismissed.

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[2013] 144 ITD 668 (Delhi – Trib.) ITO vs. Indian Newspaper Society A.Y. 2007-08 & 2009-10 Date of Order – 20.06.2013

Section 194-I – Where payment of lease premium was not made on periodical basis but it was a one time payment to acquire land with right to construct a commercial complex thereon, section 194-I had no application on deposit of such lease premium.

Facts:
The assessee was a non-profit-making company. The assessee was offered certain land on lease for a period of 80 years by the Mumbai Metropolitan Regional Development Authority (MMRDA). The Assessing Officer held that the assessee was liable to deduct tax at source on lease premium u/s. 194-I and accordingly treated the assessee as assessee-indefault u/s. 201.The CIT (A) partly allowed assessee’s claim. The CIT(A) held that as the lease premium was paid once and was paid prior to date of lease agreement, such payment being in nature of capital expenditure, does not attract section 194-I.

Held:
It is well-settled that premium and rent have distinct and separate connotations in law.

The essence of premium lies in the fact that it is paid prior to the creation of the landlord and tenant relationship that is, before the commencement of the tenancy and constitutes the very superstructure of the existence of that relationship. Its another vital characteristic is that it is a one-time non-recurring payment for transferring and purchasing the right to enjoy the benefits granted by the lessor resulting in conveyance of some of the rights, title and interest in the property out of such a bundle of rights.

In the present case the payment was done before the initiation of the tenancy relationship between the appellant and the MMRDA and consequently, a cardinal ingredient of premium is satisfied.

Hence, undoubtedly premium in relation to leased land is a payment on capital account not liable to be classified as revenue outgoing.

Readers may also refer to judgement of High Court of Delhi in the case of Krishak Bharati Co-operative Ltd. vs. Dy. CIT [(2013) 350 ITR 24 / (2012) 23 taxmann. com 265]

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Settlement Commission: S/s. 245C and 245D: Where order passed by Commission u/s. 245D(2C) was not focussed on issues and contentions raised by petitioners and by revenue, same was cryptic and was set aside:

MARC Bathing Luxuries Ltd. vs. ITSC; [2013] 38 taxmann. com 308 (Delhi):

The petitioners had filed two applications u/s. 245C of the Income-tax Act, 1961 and disclosed the entire amount of unaccounted turnover which became subject-matter of orders passed by the Settlement Commission under the Excise Act. Applications were allowed to be proceeded with and a report u/s. 245D(2B) was sought from the concerned Commissioner. The Settlement Commission, however, held that applicants was indulged in suppression of income even before Commission and rejected the application filed by the petitioners. Petitioners filed writ petitions and submitted that the two petitioners were subjected to search under the Central Excise Act, 1944 and thereafter by the Income Tax Department and the Settlement Commission was swayed by factors which even the Commissioner did not consider were relevant. The Delhi High Court allowed the writ petitions and held as under:

“i) Facts and the dispute inter se parties have not been reflected upon and adverted to in the impugned order. It is recorded that the order under challenge is cryptic and is not focused on the issues and contentions, which were raised by the petitioners and by the Commissioner.

ii) The Settlement Commissioner earlier had directed and decided to proceed with the applications on 14-01-2013 in the two cases. They had set out points, which had to be adjudicated and decided. These included turnover of the two applicants for the assessment years covered, determination of the issues arising out of the stock, including valuation by the Department, allowability of excise duty for the Assessment year 2009-10 and determination of year-wise additional income. All these factors and facts have been shunned and ignored. The Settlement Commission has rejected the applications for all assessment years, without referring to facts and issues relating to each year.

iii) Once an application is filed, then the said application must be dealt with in accordance with law, i.e., refer to the contentions of the petitioners, the contention of the revenue and then an objective, considered and a reasoned decision has to be taken. This is only when the stand of the two sides are fully noticed and considered before an order u/s. 245D(2C) is passed. The impugned orders do not meet the said legal requirements.

iv) The petitioners must come clean and be honest and admit their faults and cannot but declare their true and full undisclosed income. However, their plea and explanation that their declarations are genuine and truthful, cannot be rejected without a legitimate and fair consideration. The two searches were conducted in earlier years and not in the period relevant to the assessment year 2012-13. The Settlement Commission’s order has not referred to any specific issues and documents or made references to the contentions of the Commissioner. Facts stated are incorrect or that Commissioner had not objected to the stock reduction is not adverted to. Maybe, the applications deserve dismissal for the said reasons but full factual position should be noted, before opinion is formed whether there has been full and true disclosure. There has been error and failure in the decision making process and the failure vitiates the order passed.

v) In view of the aforesaid discussion, the impugned order dated 01-03-2013 in the case of the two petitioners is set aside and pass an order of remand.”

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Reassessment: S/s. 147 and 148: A. Y. 2006-07: Additions based on reasons recorded prior to notice deleted in appeal: Reassessment on other grounds recorded after issue of notice not valid:

CIT vs. Living Media India Ltd.; 359 ITR 106 (Del):

For the A. Y. 2006-07, the assessment was completed u/s. 143(3) of the Income-tax Act, 1961. On 19-01-2010, the Assessing Officer issued notice u/s. 148 on the ground that the deduction of doubtful debts of Rs. 1,87,41,755/- was wrongly allowed and accordingly there is escapement of income from tax to that extent. Subsequently, after nine months, additional reasons as regards depreciation and section 14A disallowance were supplied by the Assessing Officer. In reassessment additions were made on all the three counts. The Commissioner (Appeals) held the notice u/s. 148 was valid. He also confirmed the addition concerning the depreciation. He deleted the additions concerning bad debts and s. 14A disallowance. Before the Tribunal, the assessee challenged the validity of notice u/s. 148 and the addition concerning depreciation. The Department preferred appeal against the deletion concerning the bad debts. The Tribunal dismissed the Department’s appeal and allowed the assesee’s appeal.

On appeal by the Revenue against the finding of the Tribunal that the proceedings u/s. 147/148 were invalid and the addition concerning depreciation, the Delhi High Court dismissed the appeal and held as under:

“i) The appeal was not concerned with the issue of bad debts and, therefore, the deletion of the addition made on account of bad debts had become final. Until and unless there was an addition on the basis of the original reasons, no other additions could be made in view of the expression “and also” used in Explanation 3 to section 147. Therefore, in the absence of any addition on the issue of bad debts no additions could have been made by the Assessing Officer.

ii) The initiation of the proceedings u/s. 147 was also bad as held by the Tribunal because of the record of the assessment completed originally nowhere showed that the assessee had claimed any deduction on account of provision for bad debt and the assessing Officer assumed jurisdiction without any material. In fact, the entire issue of the provision for bad debts was discussed by the Assessing Officer at the time of original assessment and, therefore, the Tribunal was right in holding that the attempt to reassess was based on a mere change of opinion.

iii) On the basis of the very same notice issued u/s. 148, the Assessing Officer had recorded additional reasons subsequent to the issuance of the notice and this was impermissible in law.”

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Reassessment: S/s. 147 and 148: A. Y. 2008-09: Notice u/s. 148 not to be issued on hypothesis or contingency which may emerge in future: Notice issued on alternative basis for taxing income is not valid:

DHFL Venture Capital Fund vs. ITO; 358 ITR 471 (Bom)

The assessee, a venture capital fund claimed that contributions by its investors in terms of the trust deed and contribution agreements constituted revocable transfers under the provisions of the Income-tax Act, 1961, and, hence, the income accruing to the venture capital fund was not liable to tax in the hands of the assessee but in the hands of the investors or contributors in proportion to their respective contributions. The Assessing Officer brought the income to tax on the basis that the status of the assessee was that of an association of persons. The Commissioner (Appeals) held that the income arising to the trust was taxable in the hands of the contributors and not in the hands of the assessee since there was a revocable transfer within the meaning of sections 61 to 63. The correctness of that determination was pending before the Tribunal. In the meanwhile, the Assessing Officer issued notice u/s. 148 on the ground that the income arising from the contributions made by the contributors to the venture capital fund was taxable in the hands of the body of contributors whose members being companies and individuals were an association of persons of the contributors if the provisions of sections 61 to 63 were attracted to the transactions between the contributors and the venture capital funds.

The Bombay High Court allowed the writ petition challenging the notice u/s. 148 and held as under:

“i) Recourse to section 148 cannot be founded in law on a hypothesis of what would be the position in future should an appeal before an appellate authority, being the Tribunal or the High Court, result in a particular outcome. The statute does not contemplate the reopening of the assessment u/s. 148 on such a hypothesis or a contingency which may emerge in the future.

ii) The whole basis of the reopening was the hypothesis that if the provisions of sections 61 to 63 were attracted as had been claimed by the assessee and the income of Rs. 32.83 crore which had been claimed by the assessee to be exempt was treated as exempt, in that event an alternative basis for taxing the income in the hands of the association of persons of the contributors was sought to be set up. The entire exercise was only contingent on a future event and a consequence that may enure upon the decision of the Tribunal, if the Tribunal were to hold against the Revenue.

iii) A reopening of an assessment u/s. 148 could not be justified on such a basis. “Has escaped assessment” indicates an event which has taken place. Tax legislation cannot be rewritten by the Revenue or the court by substituting the words “may escape assessment” in future.”

iv) Rule is accordingly made absolute by quashing and setting aside the notice of reopening dated 18-05-2012, issued u/s. 148 of the Act.”

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Depreciation: Section 32: A. Y. 1998-99: User of machinery: Machinery kept ready for use but not used because of extraneous reasons: Assessee entitled to depreciation:

CIT vs. Chennai Petroleum Corporation Ltd.: 358 ITR 314 (Mad):

The assessee had built the gas sweetening plant in the previous year(i.e. F. Y. 1996-97) relevant to the A. Y. 1997-98. The plant was commissioned in that year by running a test run. Considering the trial as equivalent to putting the said plant to use, depreciation was allowed by the Department in the A. Y. 1997-98. However, due to non-availability of the raw material, the plant was not run in the F. Y. 1997-98. Therefore, the Assessing Officer disallowed the claim for depreciation in the A. Y. 1998-99 on the ground that the plant was not used at any time in the relevant year. The Tribunal allowed the assessee’s claim holding that once the plant was ready for use, the assessee was entitled to depreciation.

On appeal by the Revenue, the Madras High court applied the judgment of the Bombay High Court in Whittle Anderson Ltd. vs. CIT; (1971) 79 ITR 613 (Bom), upheld the decision of the Tribunal and held as under:

“i) So long as the business is going one and the machinery is ready for use but due to certain extraneous circumstances, the machinery could not be put to use, the fact would not stand in the way of granting relief u/s. 32 of the Incometax Act, 1961.

ii) On the admitted case that the business was a going concern and the machinery could not be put to use due to raw material paucity, the machinery was entitled to depreciation.”

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Charitable purpose: Exemption u/s. 10(23C) (iv) r/w. section 2(15): Petitioner, a charitable society had acquired intellectual property rights qua bar coding system from ‘G’ and charged registration and annual fees from third parties to permit use of coding system: Charging a nominal fees from beneficiaries is not business aptitude nor profit intent: Assessee cannot be denied approval for exemption u/s. 10(23C)(iv) on ground that activity of assessee was in nature of trade, commerce or business<

GS1 India vs. DGIT(E); [2013] 38 taxmann.com 364 (Delhi):

The petitioner society was registered as a charitable society under the residuary clause of section 2(15) of the Income-tax Act, 1961. The Income-tax department had granted registration to the petitioner u/s. 12A. The petitioner has acquired intellectual property rights qua bar coding system from GSI Global Officer, Belgium and permits use of these intellectual property rights by third parties under licence agreements for initial registration fee of Rs. 20,000 and subsequent annual registration fee of Rs. 4,000. GSI, Belgium has been granted legal status of International ‘Not-for-profit’ association under the Belgium tax law and was, therefore, not liable to pay corporation tax. The petitioner claimed approval for exemption u/s. 10(23C)(iv) of the Act. However, the Director General (Exemption) denied approval on ground that no charitable activity was involved in permitting use of intellectual property right for consideration and same was in nature of trade, commerce or business and that petitioner was not maintaining separate books of account for the business/commercial activity, i.e., licencing bar coding system, and did not intend to do so in future.

The Delhi High Court allowed the writ petition filed by the assessee and held as under:

“i) Legal terms ‘trade, commerce or business’ in section 2(15), means activity undertaken with a view to make or earn profit. Profit motive is determinative and a critical factor to discern whether any activity is business, trade or commerce.

ii) Business activity has an important pervading element of self-interest, though fair dealing should and can be present, whilst charity or charitable activity is anti-thesis of activity undertaken with profit motive or activity undertaken on sound or recognised business principles. Charity is driven by altruism and desire to serve others, though element of self-preservation may be present. For charity, benevolence should be omnipresent and demonstrable but it is not equivalent to self-sacrifice and abnegation. The antiquated definition of charity, which entails giving and receiving nothing in return is outdated. A mandatory feature would be; charitable activity should be devoid of selfishness or illiberal spirit. Enrichment of oneself or selfgain should be missing and the predominant purpose of the activity should be to serve and benefit others.

iii) A small contribution by way of fee that the beneficiary pays would not convert charitable activity into business, commerce or trade in the absence of contrary evidence. Quantum of fee charged, economic status of the beneficiaries who pay, commercial value of benefits in comparison to the fee, purpose and object behind the fee etc. are several factors which will decide the seminal question, is it business?.

iv) The petitioner does not cater to the lowest or marginalised section of the society, but Government, public sector and private sector manufacturers and traders. No fee is charged from users and beneficiaries like stockist, wholesellers, government department etc. while nominal fee is only paid by the manufacturer or marketing agencies, i.e., the first person who installs the coding system which is not at all exorbitant in view of the benefit and advantage which are overwhelming. Anyone from any part of the world can access the database for identification of goods and services using global standard. The fee is fixed and not product specific or quantity related, i.e., dependent upon quantum of production. Registration and annual fee entitles the person concerned to use GSI identification on all their products. Non-levy of fee in such cases may have its own disadvantages and problems. Charging a nominal fee to use the coding system and to avail the advantages and benefits therein is neither reflective of business aptitude nor indicative of profit oriented intent.

v) Having applied the test mentioned above, including the criteria for determining whether the fee is commensurate and is being charged on commercial or business principles, the petitioner fulfils the charitable activity test. It is apparent to us that revenue has taken a contradictory stand as they have submitted and accepted that the petitioner carries on charitable activity under the residuary head ‘general public utility’ but simultaneously regards the said activity as business. Thus the contention of the revenue that the petitioner charges fee and, therefore, is carrying on business, has to be rejected. The intention behind the entire activity is philanthropic and not to recoup or reimburse in monetary terms what is given to the beneficiaries. Element of give and take is missing, but decisive element of bequeathing in present. In the absence of ‘profit motive’ and charity being the primary and sole purpose behind the activities of the petitioner is perspicuously discernible and perceptible.

vi) The statement and submission of the respondents that the petitioner was not maintaining separate books of account for commercial activity and, therefore, denied registration/notification, has to be rejected as fallacious and devoid of any merit. Similar allegation is often made in cases of charitable organisation/association without taking into account the activity undertaken by the assessee and the primary objective and purpose, i.e., the activity and charity activity are one and the same. The charitable activity undertaken and performed by the petitioner relates to promotion, dissemination of knowledge and issue of unique identification amongst third parties etc. The ‘business’ activity undertaken by the petitioner is integral to the charity/charitable activities. As noted above, the petitioner is not carrying on any independent, separate or incidental activity, which can be classified as business to feed and promote charitable activities. The act or activity of the petitioner being one, thus a single set of books of account is maintained, as what is treated and regarded by the revenue as the ‘business’ is nothing but intrinsically connected with acts for attainment of the objects and goals of the petitioner. When the petitioner is maintaining the books of account with regard to their receipts/ income as well as the expenses incurred for their entire activity then how it can be held that separate books of account have not been maintained for ‘business’ activities.

vii) The ‘business’ activities are intrinsically woven into and part of the charitable activity undertaken. The ‘business’ activity is not feeding charitable activities. In any case, when it is held that the petitioner is not carrying on any business, trade or commerce, question of requirement of separate books of account for the business, trade or commerce is redundant.

ix) On the basis of reasoning given in the impugned order, the petitioner can not be denied benefit of registration/notification u/s. 10(23C) (iv).

x) In view of the aforesaid discussion, we allow the present writ petition and issue writ of certiorari quashing the order dated 17th November, 2008 and mandamus is issued directing the respondents to grant approval u/s. 10(23C)(iv) of the Act and the same shall be issued within six weeks fr

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Capital gain: Partnership firm: Transfer: Distribution of asset on dissolution etc.: S/s. 2(47) and 45(4): Retiring partner taking only money towards value of its share: No transfer of capital asset: Section 45(4) not applicable:

CIT vs. Dynamic Enterprises; 359 ITR 83 (Karn)(FB):

The following question was referred to the Full Bench of the Karnataka High Court for consideration:

“When a retiring partner takes only the money towards the value of his share, whether the firm should be made liable to pay capital gains even when there is no distribution of capital asset/ assets among the partners u/s. 45(4) of the Income-tax Act, 1961? or Whether the retiring partner would be liable to pay for the capital gains?” The Full Bench of the High Court answered the questions as under:

“When a retiring partner takes only money towards the value of his share and when there is no distribution of capital asset/assets among the partners there is no transfer of a capital asset and consequently no profit or gain is payable u/s. 45(4) of the Income-tax Act.”

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Business expenditure: Disallowance u/s. 40A(3): A. Y. 2008-09: Cash payment exceeding prescribed limits [Payment to Government concern]: Assessee a scrap dealer, purchased scrap from Railway by making payment in cash in excess of Rs. 20,000: Since Railway is concern of Union of India, such payment in cash had to be considered as a legal tender, and, therefore, same could not be disallowed u/s. 40A(3):

CIT vs. Devendrappa M. Kalal; [2013] 39 taxmann. com 16 (Karn):

For the A Y 2008-09 the Assessing Officer disallowed certain expenditure and added Rs. 73,91,380/- on the ground that the assessee has made payment in cash in excess of Rs. 20,000/- in respect of a single transaction which is in gross violation of section 40A(3)of the Income-tax Act 1961. Before the Tribunal the assessee contended that all the payments were made by him to purchase the scrap from the Railways, which is run by the Union of India and any payment made to the Government is required to be considered as a legal tender and the question of adding the same by way of disallowance u/s. 40A(3) is not justified. The Tribunal allowed the assessee’s claim.

On appeal by the Revenue, the Karnataka High Court upheld the decision of the Tribunal and held as under:

“i) The revenue is not disputing that the assessee is a scrap dealer purchasing scrap from the Railways. Admittedly Railways is a concern of the Union of India. If any cash is paid towards purchase of the scrap the same cannot be disputed by the revenue since such payment has to be considered as a legal tender. If the revenue is of the opinion that no such payment has been made to the Railways, we could have considered their grievance.

ii) In the circumstances, the appeal is dismissed.”

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Business expenditure: TDS: Disallowance u/s. 40(a)(i) r/w. s/s. 9(1)(vii) and 195: A. Y. 2009-10: Commission or discount paid to nonresident: Circular clarifying that tax need not be deducted if non-resident did not have PE in India: Withdrawal of circular in October 2009: Not applicable to A. Y. 2009-10: Payment not to be disallowed:

CIT vs. Angelique International Ltd; 359 ITR 9(Del): 38 taxman.com 425 (Del):

The payments made by the assessee to the nonresidents by way of commission and discount were covered by the Circular Nos. 23, dated 23-07-1969; 163 dated 29-05-1975; and 786 dated 02-07-2000 wherein it was clarified that payments in the form of a commission or discount to a foreign party were not chargeable to tax in India u/s. 9(1)(vii) of the Income-tax Act, 1961 and accordingly, tax was not deductible at source. In view of these circulars the assessee had not deducted tax at source on payments aggregating to Rs. 37,87,26,158/- in the relevant year, i.e. A. Y. 2009-10. These circulars were withdrawn by circular No. 7 of 2009 dated 22- 10-2009.

In the A. Y. 2009-10, the Assessing Officer disallowed the said amount applying section 40(a) (i) of the Act and relying on the said circular No. 7 of 2009 dated 22/10/2009. The Tribunal deleted the disallowance.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under: “Circular No. 7 of 2009, cannot be classified as explaining or clarifying the earlier circulars issued in 1969 and 2000. Hence, it did not have retrospective effect. The deletion of disallowance u/s. 40(a)(i) was justified.”

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Business expenditure: Section 37: A. Y. 2004- 05: Payment to financial consultants for professional services in connection with corporate debt restructuring by negotiating with banks and financial institutions: Expenditure for purposes of business and allowable in entirety in year in which incurred: Expenditure spread over in six years by Tribunal with consent of assessee: Department not entitled to object:

CIT vs. Gujarat State Fertilisers and Chemicals Ltd.: 358 ITR 323 (Guj):

The assessee had claimed deduction of Rs. 2.57 crore being amount paid to financial consultants who provided their professional services in connection with the scheme of corporate debt restructuring by negotiating with the banks and financial institutions, which eventually helped the reduction of interest burden of the assessee.

The Assessing Officer disallowed the claim holding that the expenditure is capital in nature. The Tribunal held that the expenditure was revenue in nature and spread it over a period of six years with the consent of the assessee considering the judgment of the Supreme Court in Madras Industrial Investment Corporation Ltd. vs. CIT (1997) 225 ITR 802 (SC).

On appeal by the Revenue, the Gujarat High Court upheld the decision of the Tribunal and held as under:

“i) For the waiver of the loan, payment had been made to the financial consultants. This was for the purpose of business and was allowable u/s. 37(1). Once the expenditure was held to be revenue in nature incurred wholly and exclusively for the purpose of business, it could be allowed in its entirety in the year in which it was incurred.

ii) However, when the expenditure was spread over a period of six years and the assessee had no objection to such revenue expenditure being spread over, though it could have insisted that this amount be allowed in the year under consideration, the Department could
not challenge it as the expenditure was revenue in nature.”

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Accrual of Income – Income accrues when it becomes due but it must also be accompanied by a corresponding liability of the other party to pay to amount.

CIT vs. Excel Industries Ltd. and Ors. [2013] 358 ITR 295 (SC)

Advance Licence Benefit and Duty Entitlement Pass Book Benefit-Income does not accrue when the benefit becomes vested but accrues when imports are actually made. The assessee maintained its accounts on a mercantile basis. In its return (revised on 31st March, 2003) the assessee claimed a deduction of Rs. 12,57,525 under the head advance licence benefit receivable.

The assessee also claimed a deduction in respect of duty entitlement pass book benefit receivable amounting to Rs. 4,46,46,976/-. These benefits related to entitlement to import duty free raw material under the relevant import and export policy by way of reduction from raw material consumption.

According to the assessee, the amounts were excluded from its total income since they could not be said to have accrued until imports were made and the raw material consumed. During the assessment proceedings, the assessee relied upon a decision of the Income-tax Appellate Tribunal in Jamshri Ranjitsinghji Spinning and Weaving Mills Ltd. vs. IAC [1992] 41 ITD 142 (Mum) and also the order of the Commissioner of Income-tax (Appeals) in its own case for the assessment years 1995-96 to 1997-98.

By his order dated 24th March, 2004, the Assessing Officer did not accept the assessee’s claim on the ground that the taxability of such benefits was covered by section 28(iv) of the Income-tax Act, 1961 which provides that the value of any benefit or perquisite, whether convertible into money or not, arising from a business or a profession is income. According to the Assessing Officer, along with an obligation of export commitment, the assessee gets the benefit of importing raw material duty free. When exports are made, the obligation of the assessee is fulfilled and the right to receive the benefit becomes vested and absolute, at the end of the year.

In the year under consideration, the export obligation had been made and the accounting entries were based on such fulfillment. The Assessing Officer distinguished Jamshri on the ground that it pertained to the assessment year 1985-86 when the export promotion scheme was totally different and the taxability of such a benefit was examined only with reference to section 28(iv) of the Act but in the present case the taxability of such benefit was examined from all possible angles as it formed part of the profits and gains of business according to the ordinary principles of commercial accounting. The assessee took up the matter in appeal and by an order dated 15th September, 2008, the Commissioner of Income-tax (Appeals) referred to an earlier appellate order in the case of the assessee relevant to the assessment years 1999-2000 and 2000-01 and following the conclusion arrived at in those assessment year, the appeal was allowed and it was held that the advance licence benefit receivable amounting to Rs. 12,57,525 and duly entitlement pass book benefit of Rs. 4,46,46,976 ought not to be taxed in this year.

Reliance was also placed on the order of the Income-tax Appellate Tribunal in the assessee’s own case for the assessment year 1995-96. Feeling aggrieved, the Revenue preferred an appeal before the Income-tax Appellate Tribunal, which referred to the issues raised by the Revenue and by its order dated 29th April, 2011, dismissed the appeal upholding the view taken by the Commissioner of Income-tax (Appeals).

The Tribunal held that the issued were covered in favour of the asseessee by earlier orders of the Tribunal in the assessee’s own cases. It had been held by the Tribunal in the earlier cases that income does not accrue until the imports are made and raw materials are consumed by the assessee. As regards the accounting year under consideration, it was found that there was no dispute that it was only in subsequent year that the imports were made and the raw materials consumed by the assessee.

The Tribunal also took the note of the fact in the assessee’s own cases starting from the assessment year 1992-93 onwards these issues had been consistently decided in its favour. It was also noted that for some of the assessment years, namely, 1993-94, 1996-97 and 1997-98 appeals were filed by the Revenue in the Bombay High Court but they were not admitted. Under the circumstances, the Tribunal affirmed the decision of the Commissioner of Income-tax (Appeals) on the issues raised.

The Revenue then preferred an appeal under section 260A of the Act in respect of the following substantial question of law:

“Whether, on the facts and in the circumstances of the case and in law, the Income-tax Appellate Tribunal is justified in law in holding by following its decision in the case of Jamshri Ramjitsinghji Spinning and Weaving Mills Ltd. vs. IAC [1992] 41 ITD 142 (Mum), that advance licence benefit and the DEPB benefits are taxable in the year in which these are actually utilised by the assessee and not in the year of receipts ?” By the impugned order, the High Court declined to admit the appeal filed by the Revenue under section 260A of the Act.

On further appeal to the Supreme Court by the Revenue, the Supreme Court observed that it was well settled that Income-tax cannot be levied on hypothetical income Referring to its decision in CIT vs. Shoorji Vallabhdas and Co. (1962) 46 ITR 144 (SC) and Morvi Industries Ltd. vs. CIT (Central) (1971) 82 ITR 835 (SC) in this regards, the Supreme Court noted that it has been further held, and in its view, more importantly, that income accrues when there “arises a corresponding liability of the other party from whom the income becomes due to pay that amount”.

According to the Supreme Court therefore, income certainly accrues when it becomes due but it must also be accompanied by a corresponding liability of the other party to pay the amount. Only then can it be said that for the purposes of taxability that the income is not hypothetical and it has really accrued to the assessee. The Supreme Court held that, so far as the present case was concerned, even if it was assumed that the assessee was entitled to the benefits under the advance licence as well as under the duty entitlement pass book, there was no corresponding liability on the customs authorities to pass on the benefit of duty free imports to the assessee until the goods were actually imported and made available for clearance.

The benefits represented, at best, a hypothetical income which may or may not materialise and its money value was, therefore, not the income of the assessee. Referring to its decision of Godhra Electricity Co. Ltd. vs. CIT (1997) 225 ITR 756 (SC) and applying the three tests laid down by various decisions of the apex court, namely, whether the income accrued to the assessee is real or hypothetical ; whether there is a corresponding liability of the other party to pass on the benefits of duty free import to the assessee even without any imports having been made ; and the probability or improbability of realisation of the benefits by the assessee considered from a realistic and practical point of view (the assessee may not have made imports), the Supreme Court held that, it was quite clear that in fact no real income but only hypothetical income had accrued to the assessee and section 28(iv) of the Act would be inapplicable to the facts and circumstances of the case.

The Supreme Court further held that, as noted by the Tribunal, a consistent view had been taken in favour of the assessee on the questions raised, starting with the assessment year 1992-93, that the benefits under the advance licences or under the duty entitlement pass book do not represent the real income of the assessee, and consequently, there was no reason for if to take a different view unless there were very convincing reasons, none of which were been pointed out by the learned counsel for the Revenue.

The Supreme Court observed that, it appeared from the record that in several assessment years, the Revenue accepted the order of the Tribunal in favour of the assessee and did not pursue the matter any further but in respect of some assess- ment years the matter was taken up in appeal before the Bombay High Court but without any success. That being so, according to the Supreme Court, the Revenue could not be allowed to flip- flop on the issue and it ought let the matter rest rather than spend the taxpayers’ money in pursuing litigation for the sake of it.

Lastly, the real question was the year in which the assessee was required to pay tax. The Supreme Court noted that there was no dispute that in the subsequent accounting year, the assessee did make imports and did derive benefits under the advance licence and the duty entitlement pass book and paid tax thereon. Therefore, the Rev- enue had not been deprived of any tax. Further, since that the rate of tax remained the same in the present assessment year as well as in the subsequent assessment year, the dispute raised by the Revenue was entirely academic or at best may have a minor tax effect. According to the Supreme Court, there was, therefore, no need for the Revenue to continue with this litigation when it was quite clear that not only was it fruitless (on merits) but also that it may not have added anything much to the public coffers.

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Interest on excess refund – Section 234D is not retrospective and does not apply to assessments that are completed prior to 01-06-2003.

CIT vs. Reliance Energy Ltd. [2013] 358 ITR 371 (SC)

The Revenue filed a Special Leave Petition against the decision of the Bombay High Court dismissing the appeal of the Department following decision in DIT vs. Delta Air Lines Inc. (2013) 358 ITR 367 (Bom.) contending that the above decision had no applicability inasmuch as the question involved was in respect of retrospectivity of section 234D of the Act. Learned counsel for the assessee placed reliance on Explanation 2 inserted in section 234D of the Act by the Finance Act, 2012, with effect from 1st June, 2003. The Supreme Court noted that Explanation 2 which has been inserted in section 234D of the Act read as under:

“Explanation 2 – For the removal of doubts, it is hereby declared that the provisions of this section shall also apply to an assessment year commencing before the 1st day of June 2003, if the proceedings in respect of such assessment year is completed after the said date.”

The Supreme Court observed that the High Court was concerned with the appeal relating to the assessment year 1998-99. It was an admitted position that the assessment of that year was completed prior of 1st June, 2003.

The Supreme Court held that having regards to the legal position which had been clarified by Parliament by insertion of Explanation 2 in section 234D of the Act, in the present case, retrospectivity of section 234D did not arise. The Supreme Court dismissed the Special Leave Petition.

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TDS on Aircraft Landing & Parking Charges

Synopsis

The controversy is in regard to deductibility of tax on payments made by Airlines to Airports for use of parking and incidental. The authors analyse two deci- sions of the Delhi High court and one of the Madras High Court. The former held that the Tax should be deducted u/s. 194I considering parking and landing fees as rent. Whereas, Madras High Court held that services of landing and parking included many services in the nature of work done under the contract and covered u/s. 194C. In Authors’ view, the Madras HC decision seems to be more detailed and reasoned.

Airlines pay to airports different types of charges for use of airports and its facilities. Charges are paid for landing and take off facilities, taxiways, parking bay with necessary air traffic control, ground safety services, aeronautical communication services, navi- gation services and meteorological services besides the rent or charges for use of hangars. Landing and parking charges are paid for use of the facility of landing and parking aircrafts at airports. The land- ing charges are based on the weight of the aircraft, using the maximum permissible take-off weight of the aircraft, while parking charges are linked to the size of the aircraft and the period of parking.

Tax is deductible at source u/s. 194-C or 194-I on various types of payments made to the airport au- thorities for use of the airports or the facilities made available there at. The issue has arisen before the courts as to the categorisation of these payments for landing and parking charges for the purposes of TDS – whether it is rent falling u/s. 194-I or Pay- ments to Contractors falling u/s. 194C. Conflicting views have been taken by the Delhi and the Madras High Courts, with the Delhi High Court holding that payment of such landing and parking charges is in the nature of rent, tax being deductible u/s.194-I, and the Madras High Court holding that tax is deductible at source from such payments u/s. 194C.

United Airlines’ Case

The issue first came up before the Delhi High Court in the case of United Airlines vs. CIT 287 ITR 281.

The Delhi High Court noted that the term “rent” as defined in section 194-I read as under:

“ ‘rent’ means any payment, by whatever name called, under any lease, sub-lease, tenancy or any other agreement or arrangement for the use of any land or any building (including factory building), together with furniture, fittings and the land appurtenant thereto, whether or not such building is owned by the payee;”

According to the court, a perusal of the above provi- sion showed that the word “rent” defined therein had a wider meaning than ‘rent’ as is understood in common parlance. It included any agreement or arrangement for use of land.

The court observed that when the wheels of an aircraft touch the surface of the airfield, use of the land of the airport immediately begins. Similarly, for parking the aircraft in that airport, again, there is use of the land. Hence, the court was of the opinion that landing and parking fee was definitely ‘rent’ within the meaning of the definition in section 194-I as they were payments made for use of the land of the airport.

The Delhi High Court dismissed the arguments of the assessee based on the intention of the provision and its background, holding that considerations of equity were wholly out of place in a taxing statute, and that a strict interpretation was called for.

In the opinion of the Delhi High Court, the definition of the word “rent” in Expln. (i) of section 194-I was very clear and the plain meaning of that provision showed that even the landing of aircraft or parking aircraft amounted to user of the land of the airport.

Hence, according to the court, the landing fee and parking fee would amount to ‘rent’ within the meaning of aforesaid provision, even if it could not be assigned such a meaning in common parlance.

This decision of the Delhi High Court was followed by it in a subsequent decision in the case of CIT vs. Japan Airlines Co. Ltd. 325 ITR 298. In this case, the court also held that a letter from Airports Authority of India stating that payment of such charges at- tract TDS u/s. 194C, was not an argument available to the assessee while deciding the issue before it, though it may be relevant in proving the bona fides of the assessee in penalty proceedings.

Singapore Airlines Case

The issue again recently came up before the Madras High Court in the case of CIT vs. Singapore Airlines 358 ITR 237.

In this case, the assessee claimed that the payments made to the International Airport Authority towards landing and parking charges would not come within the definition of “rent” under the explanation to section 194-I. The assessing officer took the view that the charges paid by the assessee towards landing and parking to the International Airport Authority of India for the use of runway for landing and takeoff and also the space in the tarmac of the airport for parking of the aircraft represented rent.

The Commissioner (Appeals) upheld the order of the assessing officer. The tribunal followed the decision of the Delhi bench of the tribunal in the case of DCIT vs. Japan Airlines 92 TTJ 687, taking the view that the payment made by the airline could not be construed as payment of rent. The tribunal took the view that the provisions of section 194C would apply to such payments (while holding that the provisions of section 194J would apply to pay- ment for navigation facilities).

Before the Madras High Court, on behalf of the revenue, reliance was placed on the definition of ‘rent’ in the explanation to section 194-I and the decision of the Delhi High Court in Japan Airlines case (supra).

On behalf of the assessee, it was argued that the Delhi High Court had considered the definition of “rent” without considering the nature of services offered by the International Airports Authority of India on the landing and parking of the aircraft. It was pointed out that the definition of rent was an exhaustive definition and that considering the preceding enumeration, namely lease, sub-lease or tenancy, the term ‘any other agreement or ar- rangement’ as appearing in the definition had to be understood by applying the principle of ejusdem generis. Therefore, the said arrangement or agree- ment had to be in respect of use of any land or any building as under a tenancy or lease for the payment to qualify as rent. It was pointed out that the Delhi High Court had not taken note of the facts that there was no use of any land as in the case of tenancy or lease and that all that the airlines had paid for was only for the services rendered by the Airport Authority in providing of facilities for landing, including the navigational facility and the payment was measured with reference to various parameters, which were given by the International Airport Authority in its various circulars.

The attention of the court was drawn, in response to the question raised as to whether the various facilities offered and the charges fixed for the same on the basis of weight for the use of the facility would amount to “use of the land” and the charges would fit in within the definition of “rent”, to the Delhi tribunal’s decision in the case of Japan Air- lines, which had considered the various aspects of the services rendered to the airlines, and to the fact that the Delhi High Court in United Airlines’ case (which was followed in Japan Airlines’ case by the Delhi High Court) had not considered any of these aspects while dealing with the issue as to whether the charges would fit in within the definition of “rent”. It was claimed that the Delhi High Court had merely interpreted the provision of law to come to a conclusion that when the wheels of an aircraft coming into an airport touches the surface of the airfield, there was a use of the land immediately, so too on the parking of the aircraft in the airport there was use of the land, and hence the parking and landing fee should be treated as rent. It was argued that the issue should be decided in the light of the various facilities offered by the Airport Authority of India.

The Madras High Court observed that the definition of ‘rent’ began with the phrase “rent to mean”, which indicated an exhaustive definition. It agreed that an arrangement or agreement must necessarily be of the same nature of character of lease, sub- lease and tenancy for it to fall within the definition of rent, following the principle of ejusdem generis. The Madras High Court observed that in United Airlines case, neither the revenue nor the assessee produced any materials on the nature of services rendered. No material was produced to show the true nature of the arrangement or agreement and show whether it was in the nature of a lease or a license for the use of the land for it being char- acterised as rent.

The Madras high court observed that the Delhi tribunal’s case of Japan Airlines was the only case where the various details regarding the nature of services rendered and the payment charged as per the guidelines and principles laid down by the Council of International Civil Aviation Organisation were considered to come to the conclusion that the charges paid did not fall within the definition of ‘rent’. The court noted that the services provided as analysed by the tribunal included charges for landing and takeoff facilities, taxiways with neces- sary draining and fencing of airport, parking route, navigation and terminal navigation. These charges were based on weight formula and maximum per- missible takeoff weight and length of stay.

The Madras High Court noted that the Delhi tribunal had held that the Airports Authority of India never intended to give exclusive possession of any specific area to the airlines in relation to the landing and parking area. Since a tenancy was created only when the tenant was granted the right to enjoyment of the property by having exclusive possession, the tribunal had held that the payment could not be called a ‘rent’.

Before the High Court, various materials, such as Airport Economic Manual of ICAO and Airports Authority of India Act, 1994, were produced to demonstrate the nature of services provided by the airports. The High Court noted that the principles guiding the levy of charges for landing and take- off showed that the charges were with reference to the number of facilities provided by the airport in compliance with various international protocols and were not for any specified land usage or area allotted. The charges were governed by various considerations on offering facilities to meet the requirements of passenger safety and for safe landing and parking of the aircraft. According to the Madras High Court, the charges were of the nature of fees for services offered, rather than in the nature of rent for use of land.

The Madras High Court observed that it was no doubt true that the Delhi High Court had pointed out that an aircraft, on coming into an airport and on touching the surface of the airfield, began the use of the land, and on parking of the aircraft, used the land however, that alone could not conclude that the use of the land led to a lease or an ar- rangement in the nature of a lease. By the very nature of things, as a means of transport, an aircraft had to touch down for disembarking passengers and goods before it took off. For this facility, the airport charged a price. Given the complexity of landing and takeoff, unlike in the case of vehicles on a road, the airport had to provide navigational facilities, and the charges were calculated based on certain criteria like the weight of the aircraft which charges could not be construed as rent.

The Madras High Court also noted that the runway usage by an aircraft was no different from the us- age of a road by a vehicle or any other means of transport. Just as the use of a road could not be regarded as a use of land, the use of the tarmac could also not be regarded as the use of land. For the purpose of considering whether the payment was rent, such use would not fall within the expres- sion “use of land”.

The Madras High Court therefore expressed its in- ability to accept the view of the Delhi High Court that the use of the land on a touchdown in the airfield would amount to a use of land for the purpose of treating the charges as rent u/s. 194-I. The Madras High Court confirmed the order of the tribunal, holding that tax was not deductible at source u/s. 194-I from such payments.

Observations

When one goes through the decisions of the Delhi High Courts and that of the Madras High Court, it is evident that the decision of the Madras High Court is a more detailed and reasoned one. The Madras High Court has considered not just the law, but has applied the law to the facts of the case before it, by examining the nature of the services provided, unlike the Delhi High Court in whose decision the facts of the case in relation to services rendered, as found by the tribunal, do not seem to have been taken into account as is observed by the Madras High Court.

The definition of the term ‘rent’ contained in the Explanation 1 to section 194-I is an exhaustive definition as is clear by the use of the word ‘mean’ in contrast to ‘includes’, therein. The term “any another agreement or arrangement” should not be widely construed, but should be read by apply- ing the principle of ‘ejusdem generis’. So read , the payment for mere usage of land without any right to enjoy the land can not amount to rent for the purposes of section 194-I , more so, where the use of land is ancillary.

The services for landing and parking includes clear approach, taxiways, light, communication facilities, aerodrome control, air traffic control, meteorologi- cal information, fire and ambulance services, use of light and special radio aids for landing, etc. The landing and parking charges are based on the weight formulae and not on area of parking and hence the parking charges are for the work done under the contract and are covered by section 194C. The Airport Economic Manual lays down different criteria for rental charges for long term use of hangars, etc., where the market value of the land and buildings involved is the criteria, which is different from the criteria used for landing and parking charges. There is a clear distinction between the rent and landing and parking charges.

Looking at the substance of the transaction involving the payment of landing and parking charges, there is clearly no lease or tenancy in land is intended to be granted nor exclusive possession of land is desired to be given. Such an arrangement cannot be treated as rent.

The view taken by the Madras High Court therefore clearly seems to be the better view of the matter, that tax is not deductible u/s. 194-I from landing and parking charges paid to the authorites for use of the airports and the airports facilities of the kinds discussed here.

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Understanding provisions of Section 56(2)

Synopsis

Introduced by Finance Act, 2012 and effective from 1st April, 2013, Section 56(2)(viib) of the Income Tax Act, 1961, provides for a specific category of income that shall be chargeable to tax under the head “Income from other sources”.

The article gives an in-depth analysis of the said section and Rule 11UA that prescribes certain modes of valuation. The author suggests that a literal interpretation of the provision may result in it failing to achieve its objective. Section 56(2)(viib) { introduced by Finance Act 2012 w.e.f 01-04-2013 } r.w.s. 2(24)(xvi), of the Income tax Act (‘the Act’) provides that where a closely held company issues shares to a resident, for an amount received in excess of the fair market value of the shares, then the said excess portion will be regarded as income of the Company and charged to tax under the head ‘Income from other sources’. The said fair market value is defined as higher of the value arrived at on the basis of the method prescribed under Rule 11UA of the Income-tax Rules, 1962 (‘the Rules’) or the value as substantiated by the Company to the satisfaction of the Assessing Officer under Explanation to section 56(2)(viib). The Company can substantiate the fair market value based on the value of the tangible and intangible assets and various types of commercial rights as stated in the section. The fair market value which may be determined under Rule 11UA and the determination of date of fair market value for the purpose of valuation is discussed separately in the ensuing paragraphs below. However, this provision will not apply to amounts received by a venture capital undertaking from a venture capital fund or a venture capital company, which terms have been defined in section 10(23FB) . Further, this provision will also not apply to amount received for issue of shares from a non-resident, a foreign company or from a class of persons as may be notified by the Government.

A better understanding of the aforesaid provisions a reference should be made to the Budget Speechby the Hon’ble Finance Minister and Notes on Clauses and Memorandum Explaining the provisions. which are reproduced at Annexure 1 separately. For section 56(2)(viib) to apply, the following conditions will have to be fulfilled:

• Recipient of consideration for issue of shares should be a closely held company i.e. a company in which the public are not substantially interested, referred to u/s. 2(18) of the Act;

• Consideration received for issue of shares should be only from a person, who is resident and the consideration so received should exceed the face value of shares issued;

• Recipient must ‘receive’ income i.e. consideration in excess of fair market value for issue of shares in the previous year [i.e. relevant financial year]; and

• The share premium received (i.e. consideration received for value of shares issued which exceeds the fair market value of the shares), is charged as income and subjected to tax accordingly; Section 56(2)(viib) is one of the charging sections under the Act. The sections which provide for levy or charge should be strictly construed. The rule of construction of a charging section is that before taxing any person, it must be shown that he falls within the ambit of the charging section by clear words in the section. No one can be taxed by implication. Further, the word ‘receives’ as referred to in section 56(2)(viib) has been interpreted to mean: “The words ‘receives’ implies two persons – the person who receives and the person from whom he receives.”

However, it is equally true that mere receipt of money is not sufficient to attract tax. It is only on receipt of ‘income’ which would attract tax. Every receipt is not necessarily income. So, until the Company receives income as referred to in section 56(2) (viib) r.w.s. 2(24)(xvi), it cannot be taxed. In addition to above, it would be necessary to highlight the following exceptions and certain limitations, :

1. As regard to determination of the date as on which fair market value of the shares issued needs to be determined, the provisions of section 56(2)(viib) and Rule 11UA provide as under: Three modes of valuation are prescribed for determination of fair market value of shares for section 56(2)(viib), with each of them providing for different valuation dates i.e. the dates as on which the fair market value of the shares needs to be decided. While two modes of valuation are prescribed under Rule 11UA, one mode of valuation, which is generally subjective in nature, is prescribed under Explanation to section 56(2)(viib) of the Act: a. The subjective mode of valuation as prescribed under Explanation to section 56(2)(viib), provides for determination of fair market value of shares on the date of issue of shares. The said mode of valuation provides for applicability of any method to determine the fair market value of shares, as may be relevant, however it categorically requires satisfaction of the Assessing Officer to said determination of fair market value of shares; or b. Rule 11UA as mentioned above provides for two modes of valuation to determine fair market value of shares issued by the closely held company as on the valuation date. Recently, Rule 11UA(2) has been inserted and the term ‘valuation date’ was amended vide Notification No. 52 under Income-tax (Fifteenth Amendment) Rules, 2012 w.e.f. from 29th November 2012, which provides for the present two modes of valuation.

The term ‘valuation date’ is now defined under Rule 11U(j) as the date on which the consideration is received by the assessee for issue of shares. Rule 11UA(2) is specifically inserted to provide for determination of fair market value of shares u/s. 56(2)(viib) of the Act. Prior to the aforesaid amendment, Rule 11UA only provided for one method of valuation and the term ‘valuation date’ was also not defined to provide for cases covered u/s. 56(2) (viib). Further, Rule 11UA(2) provides for option to the Company to select for either mode of valuation as provided under Rule 11UA(2)(a) or Rule 11UA(2) (b) of the Rules. The said modes of valuation are explained in brief below and for better understanding :

(a) The said mode of valuation is generally based on the book value of the shares as on the latest audited balance sheet of the Company, subject to adjustments as provided for assets and liabilities of the Company. In other words, the fair market value (‘FMV’) of the shares of the Company are defined as under: FMV of unquoted equity shares = (Assets – Liabilities) x PV PE The term ‘assets’ and ‘liabilities’ as required to be considered with necessary adjustments are defined under the Rules, while PV stands for Paid up value of such equity shares and PE stands for total amount of paid up equity share capital of the Company as shown in the latest Audited balance sheet of the Company. So, the FMV of the shares under this method which is to be determined as on the valuation date, provides for consideration of values as on the latest Audited Balance sheet of the Company;

(b) The second mode of valuation provides for FMV of the shares to be undertaken by Merchant banker or Fellow Chartered Accountant of ICAI as per the Discounted Free Cash Flow method. The second method is silent as regard to values based on which FMV needs to be computed. However, considering FMV of the shares needs to be computed as on the valua- tion date, therefore, Discounted Free Cash Flow Method will have to be determined as on valuation date i.e. date on which consideration is received by the Company for issue of shares.

So, in the light of the above discussions, it appears that the Legislature has provided for selection of either modes of valuation under Rule 11UA and selection of the highest FMV on comparison with the mode of valuation prescribed under Explanation to section 56(2)(VIib), based on which FMV of the shares issued by the Company are to be determined. However, the modes of valuation so prescribed are subject to various limitations and subjectiveness, some of which are referred above.

2. Secondly, one finds that the taxable event of the income under discussion is based on receipt of consideration for issue of shares in the given financial year. So, it is imperative to understand the terms ‘consideration’ and ‘issue of shares’ as referred to in the section. However, the said terms are not defined under the Act.

The concept of ‘issue of shares’ could be better understood under the Indian Companies Act, 1956 (‘the 1956 Act’) with the help of the legal precedents under the 1956 Act which are referred in ensuing paragraphs who have explained the concept of ‘issue of shares’ in context of ‘allotment of shares’ as under:

“Under the Act [author’s note – i.e. Companies Act], a company having share capital is required to state in its memorandum the amount of capital and the division thereof into shares of a fixed amount. see Section 13(4). This is what is called the authorised share capital of the company. Then the Company proceeds to issue the shares depending on the condition of the market. That only means inviting applications for these shares. When the applications are received, it accepts them and this is what is generally called allotment…..

……The words ‘creation’, ‘issue’ and ‘allot- ment’ are used with the three different meanings familiar to business people as well as to lawyers. There are three steps with regard to new capital, firstly it is created, till it is created the capital does not exist. When it is created it may remain unissued for years, as indeed it was here, the market did not allow of favourable opportunity of placing it. When it is issued it may be issued on such terms as appear for moment expedient. Next comes allotment…

…Allotment means the appropriation out of the previously unappropriated capital of a company, of a certain number of shares to a person. Till such allotment, the shares do not exist as such. It is on allotment in this sense that the shares come into existence.”

The aforesaid legal proposition explaining the different stages of share capital of the Company are approved in the following legal precedents:
• Florence Land and Public Works Company (1885)
L.R. 29 Ch.D. 421;

• Mosely vs. Koffyfontain Mines Limited (1911) I.L.R. Ch. 73.84.;

• Sri Gopal Jalan and Company vs. Calcutta Stock Exchange Association Ltd. (AIR 1964 SC 250); and

• Shree Gopal Paper Mills Ltd vs. CIT (77 ITR 543) (SC);

Further, the Income tax Act, 1961 has been using the terms ‘issue of shares’ and ‘allotment of shares’ independently in different provisions at different points in time. So, the Legislature is aware of the differences between ‘issue of shares’ vis-a-vis ‘allotment of shares’ and their meanings and respective stages thereof in the share capital of the Company.

The word ‘consideration’, is defined under the Indian Contract Act, 1872 (‘the 1872 Act’) and could be considered for the purpose of understanding the meaning of the term, on account of absence of specific definition for under the Act. The word ‘consideration’ is defined u/s. 2(D) of 1872 Act as under:

“When at the desire of the promisor, the promise or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration of the promise.”

So, existence of promisor-promisee relationship is sine qua non for ‘consideration’ under the 1872 Act. In context of share transactions relating to the companies particularly on issue of shares, the determination of promisor-promisee relationship could be explained as under:

A share is a right to a specified amount of the share capital of a company with it certain rights and liabilities, while the company is a going concern and in the winding up. The promisor- promisee relationship shall not come into existence until the offer and acceptance of offer thereof in completed in a contract. So, in context of contract of shares of the Company with the proposed shareholders, the following steps take place:

• Step 1: Initially, the Company makes an invitation of offer to the public in general for subscription of shares at a given price for the share and other relevant conditions. This stage is referred to as ‘issue of shares’ under the legal precedents above;

• Step 2: Out of the said invitation of offer to public, the proposed shareholders upon having accepted the terms of conditions of issue of shares of the Company makes an offer to the Company for al- lotment of shares on payment of price referred in step 1; and

• Step 3: The Company through its Board of Directors on receipt of offer from the proposed share- holders decide in their meeting for acceptance of said offers and thereby pass resolution and undertake other compliances viz. filing of return of allotment in favour of shareholders, who are selected from the list of proposed shareholders. This stage is referred to as ‘allotment of shares’ and it is at this stage, the relationship of promisor-promisee comes into existence and simultaneously definition of ‘consideration’ under the 1872 Act is satisfied.

So, at the time of issue of shares, the receipt of money from the proposed shareholders by the Company cannot partake the nature of consid- eration, since no promisor-promisee relationship exists between the proposed shareholders and the Company. The promisor-promisee relationship comes into existence at the time of ‘allotment of shares’ by the Company; which is a stage anterior to ‘issue of shares’.

In light of above averments, it may be possible to urge that the charging provisions of section 56(2) (viib) of the Act may fail to satisfy the taxable event provided therein at the time of ‘issue of shares’, because the receipt of money at the time of ‘issue of share’ fails to satisfy the definition of ‘consideration’ under the 1872 Act. Further, the condition of ‘consideration’ is satisfied only at the time of allotment of shares because the shares also come into existence at the said stage of share capital and accordingly the incidence of share premium [which is sought to be taxed u/s. 56(2)(Viib)] is also established at that stage and not at ‘issue of shares’.

Alternatively, one may want to debate that in light of the intention of the Legislature to tax the share premium received at the time of issue of share above the fair market value, the averments as referred in above paras may require reconsideration. One may want to dispute the above understanding of the ‘issue of shares’ and distinguish it for want of relevance restricted to Companies Act, 1956 and thereby giving the term ‘issue of shares’ as a general meaning instead. In light of said understanding, one may argue that charging provisions of section 56(2)(VIIB) are satisfied and share premium shall be taxed accordingly in the hands of the Company at the time of issue of shares.

So, until the Courts of India decide upon the issue and/or clarification on the above contrary interpretation of the provision is given by the Legislature, it would be difficult to reach to any conclusions. As a way forward until any clarity is received, on a conservative basis, one may want to suggest that advance tax and/or self assessment tax, as the case may be, be paid considering the alternative interpretation as discussed later [i.e. in the immediately preceding para above] for the income under consideration be taxed u/s. 56(2)(VIIB) and at the time of filing the return of income, one may take an aggressive position of not subjecting the income under consideration to tax and a suitable note substantiating the said position be disclosed in the return of income. With this there may be limited chances of penalty and interest provisions being attracted to the transaction at the time of assessment of the company in the income-tax proceedings.

Annexure 1

Relevant extracts of Budget Speech of Finance Bill, 2012

“Para 155. I propose a series of mea- sures to deter the generation and use of unaccounted money. To this end, I propose:

(i) ……,

(ii) ……,

(iii) Increasing the onus of proof on closely held companies for funds received from sharehold- ers as well as taxing share premium in excess of fair market value.”

Relevant extracts of Budget Speech while moving in amendments to Finance Bill, 2012 “It has been proposed in the Finance Bill, 2012 that any consideration received by closely held company in excess of fair market value would be taxable. Exemption is provided to angel investors who invest in start-up company”

Memorandum explaining the provisions of Finance Bill, 2012

“Share premium in excess of the fair market value to be treated as income…….Section 56(2) provides for the specific category of incomes that shall be chargeable to income- tax under the head “Income from other sources”…. The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. This amendment will take effect from 1st April 2013 and will accordingly apply in relation to AY 2013-14 and subsequent AYs”

Supplementary Circular explaining the amendments to the provisions of Finance Bill, 2012

“Company which receives any consideration for issue of shares and the consideration for issue of such shares exceed the fair market value of the share then the aggregate consideration received for such shares as exceeds the fair market value of the share shall be chargeable to tax”

Notes on Clauses to Finance Bill, 2012 “….Company receiving the consideration for issue of shares shall be provided an opportunity to substantiate its claim regarding the fair market value of shares”.

shailesh.kwebmaker

Transfer Pricing – the concept of Bright Line Test

Synopsis

Transfer Pricing Litigation concerning Advertising marketing and sales promotion (AMP Expenses) and creation of Marketing Intangibles for the Foreign Associated Enterprise, has come to the fore in recent years. In the absence of statutory law on the subject, the law is getting developed purely through judicial pronouncements and the same is still at a very nascent stage.

The purpose of this Article is to acquaint the reader with the basic concepts, the issues involved and broad thrust of judicial pronouncements. To gain an in-depth understanding of the concepts, issues involved, rival contentions and judicial thought process, the reader would be well advised to critically study and analyse relevant judicial pronouncements. As the stakes involved are very high, the matter would be settled only at the Apex Court level.

1. Overview

In a typical MNC business model, the Indian subsidiary acts as a distributor/provider of goods/services and incurs AMP expenses for the promotion of its products or services. The Assessees have contended that the AMP expense is incurred necessarily for the purpose of selling its products/services in the Indian market. In the past, there have been instances of the Tax Department not allowing a tax deduction for such expenses on the basis that the expenses promote the brand of the foreign Associated Enterprise (‘AE’) in India and resultantly since the expenses benefit the foreign AE such expenses should not be allowed as a tax deduction in the determination of taxable income of the Indian AE. Various judicial pronouncements have held that where the expenditure has been incurred for the purposes of business of the Indian company, the payment should be allowed as a deduction. Resultantly, the issue (incurring of AMP expenses and creation of Marketing Intangibles) has now entered the realm of transfer pricing controversy. The contention of the Tax Department has been that since the Indian company incurs expenses which benefit the foreign AE, the Indian company should be reimbursed for such expenses. In fact, the proposition has been that by promoting the brand in India, the Indian subsidiary is providing a service to the foreign AE, for which it should receive due compensation (which could be the recovery of expenses incurred plus an appropriate mark-up over and above such expenses). It is contended by the Tax Department that such advertisement and brand promotion expenses resulted in creation of marketing intangibles which belong to the AE and appropriate compensation for such advertisement and brand promotion expenses was required to be made by the Foreign AE. Accordingly, the Transfer Pricing Officers (“TPOs”) in India, applying the ‘Bright Line Test’ as laid down in the decision of US Tax Court in DHL Inc.’s case, have held that the expenditure on advertisement and brand promotion expenses which exceed the average of AMP expenses incurred by the comparable companies in India, is required to be reimbursed/ compensated by the overseas associated enterprise. The principle followed by the Tax Department is that the excess AMP expenditure incurred by the Indian AE contributes towards the development and enhancement of the brand owned by the parent of the multinational group (the foreign AE). This perceived enhancement in the value of the brand is commonly referred to as ‘marketing intangibles’. The issue for consideration here is that where an Indian AE is engaged in distributing branded products of its foreign AE, and the Indian AE incurs AMP expenditure for selling the products, whether such expenses have been incurred for marketing of the product or for building the brand of the foreign AE in India. The Tax Department ought to appreciate the difference between product promotion and brand promotion. Product promotion primarily targets an increase in the demand for a particular product whereas Brand Promotion results in creation of Marketing Intangibles. There have been many decisions (mainly Tribunal Decisions) which have discussed the aspect of AMP expenditure and TP adjustments in respect thereof which lead to creation of marketing intangibles for the foreign AEs who have derived benefits. However, the Tribunals in the decisions pronounced prior to the retrospective amendments made by the Finance Act, 2012, in this regard, have held that since the specific international transactions pertaining to AMP expenses have not been referred to the TPO by the Assessing Officer (‘AO’) the assumption of the jurisdiction by the TPO in working out the ALP of the AMP transaction is not justified. Furthermore, assessees, prior to the amendments introduced by Finance Act, 2012, have contended that marketing intangibles per se were not covered under the meaning of the term “international transaction”. However, the amendments brought by Finance Act, 2012 in the Indian Transfer Pricing Regulations empower the TPO to scrutinise any international transactions which the TPO deems fit and additionally, the definition of the term international transaction has been broadened to bring within its ambit provision of services related to the development of marketing intangibles.

2 Concept of Marketing Intangibles

Intangible Property :

Para 6.2 of Chapter VI of the OECD Transfer Pricing Guidelines 2010 (‘OECD TP Guidelines’) defines the term “intangible property” as “intangible property includes rights to use industrial assets such as patents, trademarks, trade names, designs or models. It also includes literary and artistic property rights, and intellectual property such as know-how and trade secrets.

Commercial Intangibles : OECD TP Guidelines defines the term commercial intangibles as “Commercial intangibles include patents, know-how, designs, and models that are used for the production of a good or the provision of a service, as well as intangible rights that are themselves business assets transferred to customers or used in the operation of business (e.g. computer software).”

Marketing Intangibles : Marketing intangibles generally refers to the benefits like brand name, customer lists, unique symbols, logos, distribution/dealership network etc. which are not normally measured or recognised in the books of account. Marketing intangibles are created over a period of time through brand building, large-scale marketing of product, distribution network etc.

OECD TP Guidelines on Marketing Intangibles :
Para 6.3 and 6.4 of Chapter VI of the OECD TP Guidelines defines the term marketing intangibles as a special type of commercial intangibles which include trademarks and trade names that aid in the commercial exploitation of a product or service, customer lists, distribution channels, and unique names, symbols, or pictures that have an important promotional value for the product concerned. Some marketing intangibles (e.g. trademarks) may be protected by the law of the country concerned and used only with the owner’s permission for the relevant product or services. The value of marketing intangibles depends upon many factors, including the reputation and credibility of the trade name or the trademark, quality of the goods and services provided under the name or the mark in the past, the degree of quality control and ongoing R&D, distribution network and availability of the goods or services being marketed, the extent and success of the promotional expenditures incurred for familiarising potential customers with the goods or services.

3. TP Issues surrounding Marketing Intangibles/ AMP Expenses

The Transfer Pricing Issues surrounding Marketing Intangibles/AMP Expenses may be crystallized as follows:

i) Whether when the assessee has incurred AMP expenses for promotion of brand belonging to its holding company, the Tax Department can make an addition against the assessee on account of royalty or brand development fee, computed on sales turnover and on excess AMP expenditure determined on the arm’s length principle?

ii) Whether when the assessee has incurred AMP expenses for promotion of brand belonging to its holding company, the Tax Department is justified to apply the Bright Line Test for determination of Arms Length Price (ALP) of AMP?

iii) Whether the Bright Line Test applied by the Tax Department for determination of ALP of AMP fit is an appropriate method?

4. Origin of Dispute in USA – DHL Case

To understand the issue better, it would be relevant to look at the genesis of the transfer pricing con- troversy around marketing intangibles. This issue first came up for consideration in the case of DHL before the US Tax Court. This was primarily on ac- count of the 1968 US Regulations which propounded an important theory relating to ‘Developer-Assister rules’. As per the rules the developer being the person incurring the AMP spends (though not being the legal owner of the brand) was treated as an economic owner of the brand and the assister (being the legal owner of the brand), would not be required to be compensated for the use or exploitation of the brand by the developer. The rules lay down four factors to be considered:

the relative costs and risks borne by each controlled entity
the location of the development activity
the capabilities of members to conduct the activity independently
the degree of control exercised by each entity.

The principal focus of these regulations appears to be equitable ownership based on economic expenditures and risk. Legal ownership is not identified as a factor to be considered in determining which party is the developer of the intangible property, although its exclusion is not specific. However, the developer-assister rule were amended in 1994, to include, among other things, consideration of ‘legal’ ownership within its gamut, for determining the developer/owner of the intangible property, and provide that if the intangible property is not legally protected then the developer of the intangible will be considered the owner.

However, the US TPR recognise that there is a distinction between ‘routine’ and ‘non-routine’ expenditure and this difference is important to examine the controversy surrounding remuneration to be received by the domestic AE for marketing intangibles.

In the context of the above regulations, the Tax Court in the case of DHL coined the concept of a ‘Bright Line Test’ (‘BLT’) by differentiating the routine expenses and non-routine expenses. In brief, it provided that for the determination of the economic ownership of an intangible, there must be a determination of the non-routine (i.e. brand building) expenses as opposed to the routine expenses normally incurred by a distributor in promoting its product.

An important principle emanating from the DHL ruling is that the AMP expenditure should first be examined to determine routine and non-routine expenditure and accordingly, if at all, compensation may be sought possibly for the non-routine expenditure.

5. Origin of Dispute in India – Maruti Suzuki’s Case

It is pertinent to note that the Indian TPR does not specifically contain provisions for benchmarking of marketing intangibles created by incurring non-routine AMP spends. In the Indian context, the issue in respect of marketing intangibles was dealt extensively by the Delhi High Court in the case of Maruti Suzuki India Ltd vs. ACIT (2010-TII-01-HC-DEL-TP). In this case, the assessee, Maruti Suzuki India Limited (‘MSIL’), an Indian company had entered into a license agreement with Suzuki Motor Corporation (‘SMC’) for the manufacture and sale of automotive vehicles including certain new models. As per the terms of the agreement, MSIL agreed to pay a lump sum amount as well as running royalty to SMC as consideration for technical assistance and license. MSIL started using the logo of SMC on the cars and continued using the brand name ‘Maruti’ along-with the word ‘Suzuki’ on the vehicles manufactured by it. MSIL had also incurred significant AMP spends for promoting its products.

In connection with the AMP spends incurred by MSIL, the Delhi High Court laid down the following guidance:

• If the AMP spends are at a level comparable to similar third party companies, then the foreign entity i.e. SMC would not be required to compensate MSIL.

• However, if the AMP spends are significantly higher than third party companies, the use of SMC’s logo is mandatory and the benefits derived by SMC are not incidental, then SMC would be required to compensate MSIL.

However, it is important to note that the Supreme Court has directed the TPO to examine the matter in accordance with law, without being influenced by the observations or directions given by the Delhi High Court.

6. Concept of Bright Line Test

6.1) As discussed above, the US Tax Court in the case of DHL Inc., propounded the ‘Bright Line Test’ for distinguishing between the routine and non-routine expenditure incurred on advertisement and brand promotion. The US Tax Court in that case laid down that AMP expenses, to the extent incurred by uncontrolled comparable distributors is to be regarded within the ‘Bright Line limit’ of the routine expenses and AMP expenses incurred by the distributors beyond such ‘Bright Line limit’ constituted non routine expenditure, resulting in creation of economic ownership in the form of market intangibles which belong to the owner of the brand.

It may be noted that the aforesaid decision in case of DHL, sought to be relied upon by the Revenue for making adjustment on account of AMP expenses, applying Bright Line Test, was rendered in the con- text of a specific law, viz. Developer-Assister Rule, in US TPR (US Reg. 482-4). Similar provision for benchmarking of marketing intangibles allegedly created by incurring non-routine AMP expenses is not provided in the Transfer Pricing Regulations in India.

6.2 OECD’s Position:

Paragraph 6.38 of the OECD Guidelines on Transfer Pricing read as follows:

“6.38 Where the distributor actually bears the cost of its marketing activities (i.e., there is no arrangement for the owner to reimburse the expenditures), the issue is the extent to which the distributor is able to share in potential benefits from those activities. In general, the arm’s length dealings the ability of a party that is not the legal owner of a marketing intangible to obtain the future benefits of marketing activities that increase the value of that intangible will depend principally on the substance of the rights of the party. For example, a distributor may have the ability to obtain benefits from its investments in developing the value of a trademark from its turnover and market share where it has a long term contract of sole distribution rights/or the trademarked product. In such cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor in such a case might obtain an additional return from the owner of a trademark, perhaps through a decrease in the purchase price of the product or a reduction in royalty rate.”

The Transfer Pricing regulations in India being, by and large, based on OECD Transfer Pricing guidelines, the said guidelines are usually referred to in explaining and interpreting the Transfer Pricing provisions under the Income-tax Act to the extent that they are pari materia with the OECD guidelines. However, the recommendations of the OECD guidelines could not be applied in absence of a specific enabling provision or method provided under the Transfer Pricing Regulations in India to deal with such extraordinary marketing expenditure.

7. Special Bench Decision in the case of L.G. Electronics: (2013) 29 taxmann.com.300

The Special Bench of the Income Tax Appellate Tribunal, Delhi (“the Tribunal”) held by majority that the advertising, marketing and promotion (“AMP”) expenses incurred by a assessee constitute an “in- ternational transaction” and that bright line test is acceptable for determining the arm’s length price (“ALP”) of such transactions. It further held that while expenses incurred directly on promotion of sales, leads to brand building, the expenses in connection with sales are only sales specific and are not a part of AMP expenses.

Facts:
• L.G. Electronics India Private Limited (“the assessee”) is a subsidiary of L.G. Electronics Inc., Korea (“the AE”). Pursuant to Technical Assistance and Royalty agreement, the assessee obtained a right from the AE to use technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of agreed products, for which it agreed to pay royalty @ 1 per cent. The AE allowed the assessee to use its brand name and trademarks to products manufactured in India “without any restriction”.

• The Transfer Pricing Officer (“TPO”) concluded that the assessee was promoting LG brand as it had incurred expenses on AMP to the tune of 3.85% of sales vis-à-vis 1.39% incurred by a comparable. Accordingly, TPO held that the assessee should have been compensated for the difference.

• Applying the Bright Line Test, the TPO held that the expenses in excess of 1.39 % of the sales are towards brand promotion of the AE and proposed a transfer pricing adjustment.

• The Dispute Resolution Panel (“DRP”) not only confirmed the approach of the TPO, but also directed to charge a mark-up of 13 % on such AMP expenses towards opportunity cost and entrepreneurial efforts.

Issues:
• Whether transfer pricing adjustment can be made in relation to advertisement, marketing and sales promotion expenses incurred by the assessee?

• Whether the assessee ought to have been compensated by the AE in respect of such AMP expenses alleged to have been incurred for and on behalf of the AE?”

Observations & Ruling

The Tribunal has held as follows:

• Confirmed validity of jurisdiction of the TPO by observing that the assessee’s case is covered u/s. 92CA(2B) of the Income Tax Act, 1961 (‘the Act’) which deals with international transactions in respect of which the assessee has not furnished report, whether or not these are international transactions as per the assessee.

• The incurring of AMP expenses leads to promotion of LG brand in India, which is legally owned by the foreign AE and hence is a transaction. The said transaction can be characterised as an inter- national transaction within the ambit of Section 92B(1) of the Act, since (i) there is a transaction of creating and improving marketing intangibles by the assessee for and on behalf of its AE; (ii) the AE is non-resident; and (iii) such transaction is in the nature of provision of service.

• Accepted Bright Line Test to determine the cost/value of the international transaction, in view of the fact that the assessee failed to discharge the onus by not segregating the AMP expense incurred on its own behalf vis-à-vis that incurred on behalf of the AE.

• The transfer pricing provisions being special pro- visions, override the general provisions such as section 37(1) / 40A(2) of the Act.

• For determining the cost/value of international transaction, selection of domestic comparable companies not using any foreign brand was relevant in addition to other factors.

• The Supreme Court of India in Maruti Suzuki’s case examined the issue of AMP expenses where it directed the TPO for a de novo determination of ALP of the transaction. The direction by the Supreme Court recognises the fact of brand building for the foreign AE, which is an international transaction and the TPO has the jurisdiction to determine the ALP of the transaction.

• The expenses incurred “in connection with sales” are only sales specific. However, the expenses “for promotion of sales” leads to brand building of the foreign AE, for which the Indian entity needs to be compensated on an arm’s length basis by applying the Bright Line Test.

• With regard to the DRP’s approach, of applying a mark-up on cost for determining the ALP of the international transaction, on the ground that the same has sanction of law under Rule 10B(1)(c)(vi) of the Income Tax Rules, 1962 WAS accepted.

• The case was set aside and the matter was restored to the file of the TPO for selection of appropriate comparable companies, examining effect of various relevant factors laid down in the decision and for the determination of the correct mark-up.

8. Chennai ITAT decision in the case of Ford India Pvt. Ltd (2013-TII-118-ITAT-MAD-TP)

The Chennai Bench of the Tribunal, in the case of Ford India Private Limited, followed the Special Bench ruling in the case of LG Electronics India Pvt. Ltd (supra) in applying Bright-Line Test (BLT) to arrive at the adjustment towards excess AMP expenditure. Further, the Tribunal ruled that the expenditure directly in connection with sales had to be excluded in computing the AMP adjustment. The Tribunal deleted the hypothetical brand development fee adjustment computed at 1 % of sales made by the TPO, and provided relief upto 50 % with respect to adjustment made by the TPO for Product Develop- ment (PD) expenditure held as recoverable from the parent company.

Though the Tribunal has relied on the Special Bench decision in the case of LG Electronics India Pvt. Ltd on issues of principle, the distinguishing facts between the assessee and LG Electronics India Pvt. Ltd were analysed thoroughly and the Tribunal has passed a speaking order.

On selection of comparables, the Tribunal has agreed with the assessee’s contentions that the comparables selected by the TPO were not comparable to the assessee, and has stated that such comparables selected (same as in the Maruti ruling – Tata Motors, Mahindra and Hindustan Motors) were not appropriate. Interestingly, the Tribunal has further stated that even the same comparables provided in the Maruti ruling can be considered, with proper adjustments carried out on the figures for making good the deficiencies noted in such comparables.

The Tribunal has disregarded the concept of add on brand value on normal sales and add on brand value on additional sales brought by the tax department to justify two additions in relation to brand building, and deleted the brand development fees computed at 1 % of sales. However, in relation to adjustment towards product development expenditure, the Tribunal has not provided the rationale behind the 50 % adjustment in the hands of the assessee.

9. Delhi ITAT decision in the case of BMW Motors India Pvt. Ltd. (2013-TII-168-ITAT-DEL-TP)

In a recent decision in the case of BMW Motors India Pvt. Ltd., the Delhi Bench of Tribunal has distinguished the Special Bench Ruling in case of LG Electronics India Private Limited vs. ACIT (2013) 29 taxmann.com.300 (‘SB Ruling’) with regard to issue of marketing intangibles in the context of a distributor. The Tribunal adjudged that if the distributor was sufficiently compensated by the foreign principal through the pricing of products, i.e. through higher gross margins, the same would have catered to extra AMP expenses, if any, spent by the distributor as compared to the comparables. Accordingly, no separate compensation in the form of reimbursement of excess AMP expenses was required from the principal when the assessee was already earning premium profits as compared to comparables with similar intensity of functions.

The Tribunal acknowledged that in absence of a specific provision in Income – tax Act, the Tax Department could not insist that the mode of compensation for AMP expenses by foreign principal to Indian assessee (who is a distributor) necessarily be direct reimbursement and not pricing adjustment. The said remuneration for extra AMP could well be received through the pricing of imported products, namely through a commensurately higher gross margin.

After a spate of negative rulings on the issue of marketing intangibles following the SB Ruling in the case of LG Electronics (supra), this is the first favour- able ruling on marketing intangibles at the Tribunal level. In terms of key takeaways, the following points which have been acknowledged by the Tribunal in the instant ruling are worth a mention:

• In the first ruling of its kind, the Tribunal has upheld the contention that no separate compensation is needed for excessive AMP expenditure, when the distributor receives sufficient profits/ rewards as part of the pricing of goods imported from its foreign principal.

• The Tribunal has upheld the contention that a judgement or a decision considered as a binding precedent necessarily has to be read as a whole. To decide the applicability of any section, rule or principle underlying the decision or judgement which would be binding as a precedent in a case, an appraisal of the facts of the case in which the decision was rendered is necessary. The scope and authority of a precedent should not be expanded unnecessarily beyond the needs of a given situation.

• The Tribunal acknowledged that transfer pricing litigation and adjudication is a fact-intensive exercise which necessarily requires due consideration of the assessee’s business model, contractual terms entered into with the AEs and a detailed FAR analysis, so as to appropriately characterise the transactions and the business model. The Tribunal has also supported the fact that there can be no straitjacket to decide a transfer pricing matter.

• The Tribunal has dwelt on this aspect and categorically acknowledged existence of a fine line of distinction between the FAR profiles of a manufacturer vis-à-vis that of a distributor. Consequently, the remuneration model and the transfer pricing analysis for one could vary from the other.

• The Tribunal also affirmed that in the absence of suitable aids or guidelines in the Indian tax laws or jurisprudence, there is no bar/prohibition to refer to international jurisprudence/guidelines.

The Tribunal has made an important distinction on the AMP issue for a distributor from that of a licensed manufacturer. While drawing the distinction in the facts of the assessee with that of the LG India’s case, the Tribunal has provided commendable clarification on how the typical AMP issue for distributors is to be analysed.

The Tribunal’s ruling that premium profits earned by the assessee, a distributor, compensates for the excessive AMP expenditure is distinguished from the contrary findings in the case of LG India, wherein the SB held that entity level profits do not benchmark all the international transactions of LG India and that a robust profit margin at entity level would not rule out AMP expense adjustment.

The findings of the Tribunal in this case is a greater acceptance of the well accepted international practice incorporated in the OECD Transfer Pricing Guidelines, the ATO’s Guidelines (Australian Tax Office) related to Marketing Intangibles and the OECD Discussion Draft on Intangibles. Transfer pricing litigation and adjudication being fact based, necessarily requires consideration of the business model of the assessee and the contractual terms with AEs, along with a detailed FAR analysis to characterise the transactions. The Tribunal’s consideration of and reliance on the same for distinguishing this case from the LG India’s case, underscore the importance of an extensive FAR analysis, inter-alia, for the AMP issue.

The Tribunal made an important observation that the orders and judgments of co-ordinate division benches or special benches of the Tribunal, or the High Court and Supreme Court, particularly in transfer pricing adjudication cannot necessarily always be taken as a binding precedence ‘unless facts and circumstances are in pari material in a case cited before the court’.

It is worth noting that in a later decision in the case Casio India Co. Pvt. Ltd. [TS-340-ITAT-2013(DEL)-TP] a distributor of Watches and Consumer Information and other other related products of Casio Japan, in India, the Delhi Tribunal has expressly dissented from the coordinate bench’s decision in the case of BMW India Pvt. Ltd. and has followed SB decision in the case of LG Electronics. In Casio’s case, the Tribunal observed that the special bench decision in the case of L.G. Electronics is applicable with full force on all the classes of the assessees, whether they are licensed manufacturers or distributors, whether bearing full or minimal risk; that special bench order has more force and binding effect on the division bench order in BMW India’s case on the same issue.

10. Scope of/exclusions from, AMP Expenses

In Canon India vs. DCIT (2013-TII-96-ITAT-DEL-TP),
the Delhi Tribunal relying on Special Bench Ruling in case of L.G. Electronics (supra) and Chandigarh Tribunal’s Ruling in the case of Glaxo Smithkline Consumer Healthcare Ltd. [TS-72-ITAT-2013 (CHANDI)-TP/2013-TII-71-ITAT-CHD-TP] held that, while computing TP Adjustment for marketing intangibles, expenses on Commission, Cash Discount, Volume Rebate, Trade Discount etc. and AMP Subsidy received by the assessee from the Parent Company should be excluded from the total AMP Expenses. In Glaxo’s case, the Chandigarh Tribunal also held that the Con- sumer Market Research Expenses and AMP Expenses attributable to various domestic brands owned by the assessee should be excluded from the ambit of AMP Expenses and no adjustment is required to be made in respect of the same. Similarly, in Maruti Suzuki India Limited (2013-TII-163-ITAT-DEL-TP), the Delhi Tribunal held that the expenditure in connection with sales cannot be brought within the ambit of AMP Expenses.

In order to avoid unnecessary confusion and consequent litigation, the assessees should be very careful in properly accounting for various sales related expenses and adequately documenting and distinguishing the same from various AMP Expenses, which are subject matter of TP Adjustments.

11. Conclusion

One of the most challenging issues in transfer pricing is the taxation of income from intangible property. The OECD Transfer Pricing Guidelines recognise that difficult TP problems can arise when marketing activities are undertaken by enterprises that do not own the trademarks they are promoting. According to the Guidelines, the analysis requires an assessment of the obligations and rights between the parties. The United Nations Practical Manual on Transfer Pricing for Developing Countries – released in 2013 (UNTPM) also states that marketing related activities may result in the creation of marketing intangibles depending on the facts and circumstances of each case. The Chapter of the UNTPM dealing with Emerging TP Challenges in India however is more explicit when it states that an Indian AE needs to be compensated for intangibles created through excessive AMP expenses and for bearing risks and performing functions beyond what an independent distributor with similar profile would incur or perform.

While the SB ruling in case of L.G. Electronics does not seem to have specifically dealt with the issue in light of the above principles, some of the concepts articulated by the OECD Guidelines and the UNTPM may be implicit in the factors identified by the SB for undertaking a comparability analysis. These principles may also be inferred by the Delhi High Court decision in the case of Maruti Suzuki. The SB does not seem to have discussed the key issue of who benefits from the AMP spend incurred by the Assessee, even assuming it is excessive – i.e., the Assessee or the foreign AE. The SB has also not ad- dressed the issue of whether the benefit, if any, to the foreign AE may largely be incidental. However, by recognising that the Delhi High Court ruling in the case of Maruti Suzuki is still relevant, it would appear that these principles that were enunciated by the High Court would also need to be given due consideration while examining the issue.

It is important to note that the SB has also rejected a mechanical application of the bright line test by a mere comparison of the AMP to sales ratios. It may be noted that the level and nature of AMP spending can be affected by a variety of business factors, such as management policies, market share, market characteristics, and the timing of product launches.

The benefits of the AMP spend may also be realised over a period of time, even though from an account- ing perspective the amounts are expensed in the year in which they are incurred. Further, the ‘bright-line’ between routine and non-routine AMP expenses could vary for each industry and even within the same industry it could be quite company specific.

The SB’s ruling relies extensively on the facts particularly relevant to the Assessee in this case and therefore its impact on other assessees may need to be examined based on their specific facts. The applicability of a transfer pricing adjustment for AMP expenses may arise where there is influence of an AE in advertising and marketing function of the Indian affiliate. Further, the quantification of excessive AMP expenditures may also not necessarily be based on a bright line test if assessees are able to provide information related to brand promotion.

Transfer pricing aspects of marketing intangibles has been the focus of the Indian tax authority for the last few years. In light of the above, it would be useful for multinational enterprises with Indian affiliates to review their intra-group arrangements relating to sales and marketing and use of trademarks/ brand names in light of the judicial pronouncements.

In the interest of reducing avoidable, time consuming and costly litigation which benefits nobody and for providing certainty to foreign investors and encouraging inflow of much needed FDI, the Finance Ministry should issue necessary detailed fair, reasonable and equitable/balanced guidelines with suitable illustrations and examples on the lines of Australian Tax Office’s Guidelines or bring in necessary statutory amendments in Indian Transfer Pricing Regulations. The Guidelines/Statutory Amendments should be framed keeping in mind the business realities which Foreign Businessmen have to face in India; particularly the fact that, in view of accelerating changes in technology, the shelf life of a product or service is very short, such that an Electronic Product (Smart- phone, Tablet, Laptop etc.) tends to get outdated within 6-9 months of its launch. This necessitates recoupment of expenditure on product research and development by garnering significant level of market share, in a very short time by means of aggressive expenditure on advertisement, marketing and sales promotion, leaving the competition well behind.

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